In an interview on Austrian Economics

Let’s talk about your books. The first you’re recommending is Ludwig von Mises’s Human Action: A Treatise on Economics. This is definitely a very broad book, looking at psychology, at philosophy and so on. The title of the last chapter was my favourite: “Economics and the Essential Problems of Human Existence”.

Do you believe that Michele Bachmann reads this book at the beach?

Put it this way, in the first chapter he starts off talking about “praxeology”, which is certainly a word I had to look up. And in my edition, he uses some words which aren’t just derived from Greek, but are actually in Greek. So I’m very impressed she can read it at the beach. It’s also about 1,000 pages long. I know you love this book, but I’m not sure how many people other than Michele Bachmann are going to be able to get through it, so give us some highlights.

Mises was not just some quack, he was a serious economist. He was named a distinguished fellow of the American Economics Association in 1969, and he won the highest medal for scientific achievement in his home country of Austria. There is a great article by Paul Samuelson on who would have won the Nobel Prize in economics if it had started the same year as the other Nobel Prizes, and Mises is on his list. This book was originally published by Yale University Press, and John Kenneth Galbraith wrote a review of it in The New York Times.

Mises made at least three significant contributions to economics. The first contribution is in money and business cycle theory. What Mises tried to show is how money is central to all exchanges, because in a monetary economy, goods trade for money and money trades for goods. Goods don’t trade directly with other goods. Since money is one-half of all exchanges, if you screw around with money, you’re going to screw around with all the exchanges in the economy. He postulated that when the government distorts the monetary unit, through the manipulation of money and credit, it can generate boom-and-bust cycles. So rather than the business cycle being inherent to capitalism, it’s a consequence of distortions caused by the manipulation of money and credit.

Hasn’t what just happened with the housing boom and bust proved the Austrians right then?

There’s a Wall Street Journal profile on me, in that vein. People do argue this. This is why Paul Krugman gets so incensed. You know you’re doing something right when people get really mad. There are technical issues involved here that make this more nuanced. I have an e-book called The House that Uncle Sam Built which is a short little piece directed at the general public that tries to tell this story, how the Austrian story is consistent with what we’ve seen.

Tell me about von Mises’s next contribution.

His second contribution was on the controversy over socialism, and whether it could engage in economic calculation. To put it simply, economic calculation helps you sort out – from the array of technologically feasible projects – those which are economic and those that aren’t. For example, you don’t want to build railroad tracks out of platinum, you want to build them out of steel. Platinum might well be technologically superior – smoother, longer-lasting – but it costs too much. The idea of socialism was to completely transcend the market economy, but if I don’t have prices and I don’t have exchange ratios established on the market because I have abolished commodity production, how am I going to know that I have to use steel?

Mises came in and said: Let’s assume that ends of socialism are highly desired – I’m not going to engage in a battle over ends. What is it socialists want to achieve? A burst of productivity, leading to an overcoming of the conflict between classes. What is their means to attain that goal? Collective ownership over the means of production. Rationalisation of production for direct use and not for exchange will produce this burst of productivity that will overcome scarcity and therefore the conflict between the classes. What Mises said was: Your means are in conflict with your ends, because you can’t engage in economic calculation. You’re not going to get rationalisation of production, you’re going to have endemic waste. He was the first person to demonstrate that. As the history of the Soviet system played out, including its early history from 1917-21, it seemed to play out Mises’s argument. Socialists were always making compromises with respect to their original plan, trying to jerry-rig it, and you get on this treadmill of economic reforms that characterise the entire Soviet period. Then, eventually, it unwinds in the late 1980s, and you even have people like [left-wing economist] Robert Heilbroner admitting that Mises was right.

Which is obvious with hindsight, but is worth pointing out was not necessarily clear at the time Mises was writing. The arguments that socialism was a better way of organising the economy were very persuasive at the time.

Mises makes his argument in 1920, but the socialist calculation debate really takes place, in the English language, in the 1930s, in the middle of the Great Depression. For a lot of economists, socialism is an alternative to the capitalist order, which they see falling apart in front of them. So they’re attracted to it. Then you have the 1940s, where you’re fighting a battle against Hitler. Your ally is the Soviet Union, which has gone from a peasant economy to a military contributor – an amazing transformation of an economy – and because of that is able to help defeat Hitler. After World War II, everyone understands socialism isn’t too pretty in the Soviet Union, and Stalin is not exactly a nice guy. But if only we could have democracy with it, it would be wonderful. That’s where Hayek eventually comes in and challenges this idea as well. But at the time Mises is writing, it’s not at all clear that capitalism is superior to socialism.

You’d better get on to his third contribution.

Mises’s third contribution is an argument about methodology in the social sciences. He argues that human sciences are different from the natural sciences. His methodological argument cut against the trend of the times, which was to move towards a unity of science approach – what’s right for physics is right across the board. Mises talks about methodological dualism. To communicate this simply, he used to say: “If you throw a rock into water it sinks; if you throw a stick into water it floats; if you throw a man into water he must decide whether to sink or swim.” What does that mean then for the way we approach the social sciences? If you think about economists, in the 18th and19th centuries – John Stuart Mill, David Hume, Adam Smith – they were philosophers. The way they reasoned was like a philosopher. When you get to the mid-20th century and you look at Paul Samuelson, he’s not a philosopher any more, he’s more like an engineer. His books look like engineering or chemistry books. There was a transformation of economics – it became a tool of social control.

To the Austrians, economics is not a tool of social control, it’s a framework for helping us understand humanity, its history, and our plight in the world. Hayek had a great phrase about this. He said that the curious task of economics is “to demonstrate to men how little they really know about what they imagine they can design”. Hayek’s Nobel Prize address was called “The Pretence of Knowledge”. He was going after the idea not only of socialism, but of large-scale macro models. Because in the mid-20th century, and going up through the 1970s, the economy was envisaged like a bathtub. One spigot was monetary policy and the other was fiscal policy, and an economist’s task was to turn those spigots on to make sure the water rose to the level in the bathtub that was consistent with full employment.

Mises and Hayek stood in complete opposition to that view. Even more so than Milton Friedman, because he’s arguing over which is more effective – fiscal or the monetary policy, but he’s still telling us we’re in control of the levers. What Mises and Hayek are saying is that that whole way of thinking about the economy reflects a pretence of knowledge – that we know what the full employment output level would be, that we know exactly how much water to let in, and how much to let out – whereas in reality, if we make a mistake with any of that, the water comes gushing out all over our bathroom floor, or it drains completely out and we have nothing.

The belief that social sciences should be like social physics is built on an assumption which Mises says you can’t make. Therefore you mischaracterise what the task of economics is – you send economics in a direction which is totally different from our heritage, of what we got from David Hume, Adam Smith, Jean-Baptiste Say and John Stuart Mill, and then Carl Menger, and then Mises, Hayek, and other people in the 20th century, like Jim Buchanan.

So your view is that the profession took a wrong turn with Paul Samuelson?

That would be the argument, yes.

And do you agree with it?

Personally, yes I do. But there were a lot of things going on leading to this, one of which was that Samuelson was the brightest boy on the block, and when the brightest boy on the block goes in one direction, everyone else follows him. We’re in the midst of the Great Depression and World War II and this is a promise that we can avoid these kinds of problems. Then, the profession was really becoming professionalised, in a way that previously it wasn’t. People like John Stuart Mill were gentleman scholars. It wasn’t this whole professoriate, these departments and tenure and all those battles. Keynesian economics, post-World War II, dominated the entire profession. Everyone became a Keynesian and at the graduate, elite levels, it became a totally Samuelsonian project.

Samuelson had the intellectual entrepreneurship to write both the Principles of Economics textbook – which became the standard textbook for freshmen – and the standard graduate textbook. He dominated both ends of the economics profession. It’s a phenomenal intellectual achievement, independent of what you think about the content. I think Samuelson is worthy of intellectual attention, I just think he sent us in a wrong direction.

This idea of Hayek’s that you can’t know much – is that what leads the Austrian school towards libertarianism? And isn’t this libertarian element the reason it’s embraced by the Tea Party? Though I detect from your tone, also in your email, that you don’t particularly enjoy that connection.

What the position makes you have is not libertarianism, or anything like that, but humility. The economist is nothing more than a student of society, and any economist that tries to represent themselves as a saviour of society should be subject to ridicule. Let me read to you from Adam Smith, the section with the invisible hand explanation. He’s with Mises and Hayek on this humility point, even though the book, An Inquiry into the Nature and Causes of the Wealth of Nations, is written as advice to statesmen:

“What is the species of domestic industry which his capital can employ [ie what he should invest in], and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him. The statesman, who should attempt to direct private people in which manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.”

In The Theory of Moral Sentiments Smith calls him “the man of system” who is arrogant in his own conceit. Hayek comes back to this in an essay, “Individualism True and False”, and he tries to explain where the system goes. He writes:

“The main point about which there can be little doubt, is that Smith’s chief concern was not so much about what man can occasionally achieve when he was at his best, but that he should have as little opportunity as possible to do harm when he was at his worst. It would scarcely be too much to claim that the main merit of the individualism which he and his contemporaries advocated is that it is a system under which bad men can do least harm. It is a social system that does not depend for its functioning on our finding good men for running it, or on all men becoming better than they are now, but which makes use of men in all their given variety and complexity, sometimes good and sometimes bad, sometimes intelligent, and more often stupid. Their aim was a system under which it should be possible to grant freedom to all, instead of restricting it, as their French contemporaries wished, to ‘the good and the wise’.

“The chief concern of the great individualist writers was indeed to find a set of institutions by which man could be induced, by his own choice and from the motives which determined his ordinary conduct, to contribute as much as possible to the need of all others; and their discovery was that the system of private property did provide such inducements to a much greater extent than had yet been understood.”

That’s really the Austrian position. It doesn’t fit on a placard for a party to march with. Now we get to a situation which goes haywire for a variety of reasons. We have these big bailouts and the economy doesn’t kick back up to the extent that people thought it would, you have this big bill that’s out there in terms of the public debt. There’s an anger out there, that politics is no longer connected to the people, that it’s these special interest groups. The Tea Party aren’t just against Nancy Pelosi and Harry Reid, they’re not big fans of George W Bush, either. They want to penalise the guys on the right as well. They’re looking for people to read, and that say stuff that is somewhat similar, and they listen to Glenn Beck and they start reading Hayek. I just don’t think it’s relevant to the scholarly assessment of the ideas of Hayek to point out that Glenn Beck likes him, just like I wouldn’t look at Paul Krugman’s ideas differently because Rachel Maddow likes them.

It’s definitely the case that people have turned to Hayek and Mises as iconic figures. Mises stood against the tide of Keynesianism and animal spirits with his alternative theory about the manipulation of money and credit; he stood against the socialists. And they [the Tea Party] say, “Oh. Who was against socialism and who was against Keynesianism? Those are our theorists.” The critics of Austrian economics have used their recent popularity to try to tar and feather them. That’s why people like me get snarky in response. We shouldn’t, we should be more level-headed, and say, “OK, there’s good things about Austrian economics, there’s bad things about it, and all we’re trying to do is improve and go forward. We really just want to understand the economy.”

But to me, libertarianism is a by-product, not an assumption going in. If you look at Mises and Hayek, neither of them are natural rights thinkers. Most libertarianism – if you think about Ayn Rand or even Robert Nozick – derives from an individualist rights perspective. Mises and Hayek are all about consequentialism. If you can show them that the means of collective ownership would generate more successfully the ends of liberty, fraternity and equality, they’d say, “OK, yes, let’s have collectivism!” But because collectivist means undermine those goals, what they say is, “Maybe we ought to rethink this.”