only groping in the dark.
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for the internal workings of a factory. Von Mises considered alternatives to money, such as Marx’s idea of valuing products by the number of hours of labor that have gone into making them. But such a measure ignores the relative scarcity of different materials, the different qualities of the labor, or the actual (as opposed to labor) time that the production process takes. Only market prices take all these factors into account.
Changing prices
Von Mises, and his followers in the Austrian School of economists, did not believe that societies reach equilibrium, where they “naturally” hover around a certain level, or state of balance. He argued that economies are in constant disequilibrium; they are always changing, and participants are surrounded by uncertainty. Furthermore, a central planner cannot simply adopt the prices that previously prevailed under a market system. If central planning relies on prices from a different system, how could socialism possibly supersede the market economy?
Von Mises’s challenge sparked several responses. Some economists claimed that a central planner could equate supply and demand through trial and error, similar to the process that Léon Walras (p.120) had suggested for establishing equilibrium in a market economy. However, this mathematical approach was really no different from the arguments of Barone, and any discussion of mathematical equilibrium was considered unrealistic by the Austrian School.
Von Mises’s supporters, Lionel Robbins and Friedrich Hayek (p.177), added that such computation was not practical. Moreover, the socialist system could not replicate the risk taking in the face of uncertainty undertaken by entrepreneurs in the market system. In 1936, economists Oskar Lange and Abba Lerner proposed a system of “market socialism” whereby many separate firms are owned by the state and seek to maximize profits, given prices set by the state. Hayek, the Austrian School’s new champion, led the response to market socialism (pp.172–77), arguing that only the free market could provide the necessary incentives and information.
Socialism in action
For some of its life the Soviet Union operated a form of market socialism. At first it appeared to do well, but the economic system suffered from persistent problems. There were periodic attempts at reform, shifting targets from output to sales, and trying to give more discretion to state firms. But state firms often hid resources from central planners, met targets through shortcuts that did not meet customer needs, and neglected tasks outside their plans. There was considerable waste, and output fell well short of targets. When the system collapsed, the Austrian School’s concerns about incentives and information seemed to have been justified by events.
Von Mises was equally critical of any form of government intervention in the market economy. He claimed that intervention produces adverse side effects that lead to further intervention until, step-by-step, society is led into full-blooded socialism. In the market economy firms make profits by serving consumers, and in his opinion— and that of the Austrian School— there should be no restrictions
CENTRAL PLANNING
Planned economies lack basic market information about
demand, so a central planning committee has to guess the type and level of demand for any item. Their ideas about what people want or need are unlikely to be accurate.
Demand Central planning Production Supply
The central planning committee sees only a demand for footwear— not for types of footwear.
Everyone ends up with boots, even if some people wanted sneakers.
The committee tells the factories to produce sensible, long-lasting footwear—boots. There is demand
for different types of footwear in the economy —for example, some people want sneakers.
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Socialist economies saw
themselves as vast production lines, assembling everything the economy needed. During World War II this command style of production line worked relatively efficiently.
on such a worthwhile activity. The Austrian School does not accept the concept of market failure, or at least sees it as trumped by government failure. It believes monopoly is caused by governments rather than by private enterprise. Externalities (outcomes that are not reflected in market prices) such as pollution are taken into consideration by consumers or solved by voluntary associations or the responses of people whose property rights are affected by the externality.
For the Austrian School one of the worst forms of government intervention is interference in the money supply. They claim that when governments inflate the supply of money (by printing more money, for example) it leads to interest rates that are too low, which in turn result in bad investments. The only thing to do when a bubble bursts is to accept the commercial failures and ensuing depression. They recommend abolishing central banks and basing money on a real commodity
standard, such as gold. The
Austrian School are firm believers in laissez-faire (hands-off) government.
In 1900, there were five leading schools of economics. Marxism, the German Historical School (which was also critical of the market system), and three versions of the mainstream free market approach: the British School (led by Alfred Marshall), the Lausanne School (centered on general equilibrium through mathematical equations), and the Austrian School, led by Carl Menger (p.335). The British and Lausanne schools became mainstream economics, but the Austrian School trod an
uncompromising path. Only recently, following the 2008 financial crisis and the retreat of socialism, has it begun to grow in popularity. ■
Ludwig von Mises
The leader of the Austrian School, Ludwig von Mises was the son of a railway engineer. He was born in Lemberg, Austria–Hungary, in 1881 and studied at the University of Vienna, where he regularly attended the seminars of the economist Eugen von Böhm- Bawerk. From 1909–34, von Mises worked at the Vienna Chamber of Commerce, serving as principal economic adviser to the Austrian government. At the same time he also taught economic theory at the university, where he attracted a dedicated following but never became professor. In 1934, concerned by Nazi influence in Austria, he took a professorship at the University of Geneva. In August, 1940, shortly after the German invasion of France, he emigrated to New York and taught economic theory at New York University from 1948–67. He died in 1973.
Key works
1912 The Theory of Money
and Credit
1922 Socialism: An Economic
and Sociological Analysis
1949 Human Action: A
Treatise on Economics
INDUSTRIAL AND ECONOMIC REVOLUTIONS
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W
hen a recession bites and companies and jobs start to disappear, there is often a demand for government intervention to counteract these effects. The Austrian economist Joseph Schumpeter, writing in the depths of the Great Depression in the 1930s, disagreed. He insisted that recessions are how capitalism moves forward, weeding out the inefficient and making way for newgrowth in a process originally described by Karl Marx (p.105) as “creative destruction.”
Schumpeter believed that entrepreneurs are at the heart of capitalist progress. Where Adam Smith (p.61) saw profit arising from the earnings of capital, and Marx from the exploitation of labor, Schumpeter said that profit comes from innovation—which does not derive from capital or labor. He saw
IN CONTEXT
FOCUS Economic systems KEY THINKER Joseph Schumpeter (1883–1950) BEFORE1867 Karl Marx states that capitalism moves forward by crisis, repeatedly destroying a whole range of productive forces. 1913 German economist Werner Sombart argues that destruction opens the way for creation, just as a shortage of wood led to the use of coal. AFTER
1995 US economist Clayton M. Christensen distinguishes between disruptive and sustaining innovation. 2001 US economists Richard Foster and Sarah Kaplan argue that even the most exceptional corporations cannot beat the capital markets indefinitely.