Heterodox Economics: The Austrian School

Authors: ARNAU REIG and EDUARD SUBIRÀ

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Abstract

This paper explores the nature of Economics, examining its core definitions and delving into its philosophical underpinnings. Unlike the natural sciences, Economics lacks a universally accepted object of study and relies on fabricated indicators like GDP and inflation. The discussion highlights the Austrian School of Economics, which, rooted in praxeology and the a priori principles of human action as articulated by Ludwig Von Mises, presents a heterodox view. This perspective challenges conventional Neoclassical and Keynesian approaches, emphasizing logical deduction over empirical methods. Additionally, the paper critiques the use of mathematics in Economics from the Austrian viewpoint, arguing that mathematical models oversimplify human behavior and fail to capture the dynamic, subjective nature of economic interactions.

1. What is economics?

All sciences are based around the object of their study: physics is the study of physical phenomena, like movement, chemistry is the study of chemical reactions, biology is the study of phenomena related to organisms, and so on. If we consider Economics as a science, we may ask then: what is the object of its study? There is no widely accepted definition. Some say Economics is the study of the wealth of nations, others say that it’s the study concerned with the production, consumption, and transfer of wealth and goods, we can also define it as the study of social behaviors related to scarcity. None of these definitions are incorrect, and all of them shed some light on what economics is and what economists do. Still, we would like to find the deeper relations of what Economics is, and what we truly mean when we talk about “the economy”. To take upon ourselves this task is to consider economics from a more philosophical perspective, we have to assume an attitude whose achievement requires no special knowledge in advance, neither scientific nor philosophical, for here only one thing is required: readiness to put the essence of Economics at risk in thinking that which grounds this essence.

First and foremost a crucial observation must be made: Economics as Macroeconomics is not a natural phenomenon. That is to say unlike in physics or chemistry, the object of our observation does not have a physical basis, it is not akin to the physical motion of a ball which can be described mathematically with Newton’s formulas, but rather a subjective selection of a set of economic indicators that we have invented to measure what we call “the economy”. In this set of indicators, we find well-known terms like “GDP”, “inflation”, “investment”, “consumption”, indicators that have a real basis, that is, they express measurements of real phenomena, that we have bundled together and used to describe whether the economy is growing or recessing. It has come to our attention that the different weights that we attribute to these economic indicators may change our perception of whether the economy is going well or not, and that this selection is rather arbitrary and subjective, not akin to an objective truth like the motion of a ball.

This observation begs the question: what is Economics? What exactly are we trying to measure? “Wealth”? “Happiness”? “Prosperity”? These are all very imprecise measurements because there are no rigorous definitions of what each of those things is.

We have now shed light on the main problem – the fact that we do not exactly know what we are trying to measure, having arrived at this impasse we must now make a decision: is Economics to be concerned with the well-being of individuals? That is, to measure economic prosperity taking into account how economic conditions affect the health, personal lives, and happiness of the individuals, or is Economics to be concerned only with material, measurable wealth? That is, to measure economic prosperity simply in terms of debt, GDP, consumption, investment, inflation, exports, imports. . .

In school and the great majority of formal education related to Economics, they mostly only teach the Neoclassical view of Economics, or what later became the Keynesian view. This view was a very important development in the 20th century, and many economists today use its principles as their main way of evaluating Economic issues. Economics students will be familiar with many of the Neoclassical concepts, such as perfect competition, general equilibrium, market failure, and an overall Econometric approach to Economics as a science, primarily based on empiricism. What we want to show in this paper is a heterodox view of Economics; the Austrian School, although having some parts in common with the Neoclassical view, is a more libertarian perspective, and it differs especially in the fundamentals, the principles of what Economics is and how to evaluate it.

2 The Austrian View

The Austrian School of Economics is a classical perspective that dates back to the 19th Century, and today is considered a heterodox view of economics. It is concerned with the principles and axioms of economics, not with dictating “Economic measures” of action, in other words, it does not try to say what economics should be doing i.e. it’s not normative, it rather tries to describe what economics is, i.e. it’s analytic. This school of thought started with the publication of Principles of Economics in 1871 by Carl Menger, but for this paper, we will mainly focus on the ideas elaborated by Ludwig Von Mises in
his book titled Human Action: A Treatise on Economics published in 1949 originally in German.

The view of Mises is that the objective of Economic Science is to systematize and make explicit what are the main principles of Economics, which according to him are the principles of human action; making Economics a branch of Praxeology (the study of human behavior). Economics must consist of a few general principles not requiring even the support of proofs and illustrations, principles grounded upon rigorous deduction of undeniable general facts1. This, according to Mises, puts Economics into the category of an a priori science, meaning that it does not need observations to prove the truth-value of
its propositions. The terminology of a priori and a posteriori knowledge is taken from the philosophy of Immanuel Kant, which we will now take a brief glimpse into to understand the Austrian School of Economics fully.

2.1 The elucidation of a priori according to Kant

Kant’s philosophical view of epistemology divides propositions into two groups: Analytic or Synthetic, and he also divides knowledge into a priori and a posteriori. Analytic propositions are those who simply analyze the concept we are talking about, without uncovering any new knowledge about it. For example, by the proposition “a tree is made of wood” I am not adding any new knowledge to my concept of “tree”, I’m simply analyzing it in further detail, but the “woodiness” of the tree was already present in my concept of tree, although in a less obvious sense. Contrarily, the proposition “wood burns at 350 °C” is a Synthetic one, meaning that the temperature at which wood burns is not given in my concept of “wood”, I had to synthesize it through experience, it’s telling me something new about wood that I did not know beforehand just by knowing what wood was.

A posteriori knowledge is all the knowledge that can be verified only through experience, for example, the fact that wood burns at 350 °C is a posteriori knowledge; its truth value cannot be determined only through the means of formal logic or pure reasoning, a posteriori knowledge is the type of knowledge that requires experimentation to verify the truth of its propositions.

A priori knowledge is a type of knowledge that derives its truth-value from pure reasoning, without the need for experimentation, meaning that the truth of its propositions is undeniable and apodeictic and that it would be impossible to reach a different conclusion from the one reached after the propositions are stated. The law of contradiction is an example of this type of knowledge: “A thing cannot at the same time be and not be of a specified kind (as a table and not a table) or in a specified manner (as red or not red)”. Any other conclusion is logically flawed, no observations are necessary to prove that this
law is true.

Kant’s major insight is that a priori synthetic knowledge is possible and that it exists, we cannot go into much detail as to how he justifies this, in short, we will say it’s a type of knowledge that does not need observations to prove its truth-value, but for which formal logic only is also not sufficient. Mathematical and Geometric knowledge are of this type, i.e. the Pythagorean theorem is true and you can know with certainty that it’s true even if you never measured the sides of a triangle with a ruler to “prove it” empirically. It’s true because trying to prove that it isn’t true is impossible, but the Pythagorean Theorem is also not given in our concept of a right triangle, it’s not obvious and therefore not Analytic but Synthetic, but it does not require any empirical observation so it’s a priori not a posteriori.

Now that we have explained Kant’s epistemology in broad terms, we can go back to understanding how the Austrian School of Economics justifies that Economics is a science that has the character of an a priori synthetic science, much like Mathematics and Geometry

2.2 Economic propositions as a priori synthetic knowledge

Let us thus turn to some of the most basic economic propositions to see the underlying nature of Economics and where the truth-value of its principles is derived from; we can begin with a proposition such as follows: “Whenever two agents A and B engage in a voluntary exchange, they must both expect a profit from it. They must have reverse preference orders for the goods and services exchanged so that A values what he receives from B more highly than what he gives him, and B must evaluate the same things the other way around2”.

Or the law of marginal utility: “Whenever the supply of a good increases by one additional unit, provided each unit is regarded as of equal serviceability by a person, the value attached to this unit must decrease. For this additional unit can only be employed as a means for the attainment of a goal that is considered less valuable than the least valued goal satisfied by a unit of such good if the supply were one unit shorter3”.

Or as a final example, a principle of unemployment: “Whenever minimum wage laws are enforced that require this minimum wages to be higher than existing market wages, involuntary unemployment will result4.

Having now considered these propositions one can start to see why Economics is regarded as an a priori science by Mises. Where is the truth value of such propositions derived from? Would one say that these are mere “Economic hypotheses” and that, for example, experiments and observations must be conducted to determine whether it’s true that two agents engaging in a voluntary exchange must both expect to profit from it? The answer given by anyone who has engaged in thinking about this propositions with
the minimum amount of reasoning would be an unambiguous No5. This uncovers the fact that these propositions are a sort of a priori knowledge, as stated before, one does not need any experiments or observations to know that they are true, it follows from pure and simple logical reasoning about the nature of what an exchange is that the agents involved in it both expect to make a profit from it.


Such propositions have the characteristic of being both a priori and synthetic, the latter is because, in the case of our first proposition, the concept of “profit” is not explicitly given in our understanding of “voluntary exchange”, but it is unconcealed after we apply some reasoning to it, given that if someone were to think that the object they are going to give is worth more than the one they are going to receive, they would simply decide not to participate in the exchange or try to bargain it to get a better deal. This also applies to the other propositions of marginal utility and unemployment, their conclusions follow logically from pure reasoning, any other conclusion would be logically flawed, one cannot deny their truth without altering some part of the proposition. Saying that one would need to make “experiments” or “observations” to prove the truth of the propositions stated would mean that one has not understood the nature of the matter, as long as a “voluntary exchange” is happening, that proposition is true, and it’s as true today as it will be in a thousand years and as it was a thousand years ago6.

2.3 Economic Reasoning and the Axiom of Action

All that we have said up to now leads us to ask ourselves: How is this possible? How can Economic propositions derive their truth value a priori? It has been made clear that this is true, but how and why this is true is an entirely different matter.
Mises in his book “Human Action: A Treatise on Economics” solves this question by observing that Economics is embedded in Praxeology, the study of human action, and that all economic statements are statements about how humans act. The human mind is one of “acting persons” for the world is conceived through acting on it. Humans are no passive observers in the world, everything we do is an action, and so in the structure of our minds the concept of “action” is undeniably embedded, it is an axiom of human
behavior, the Axiom of Action: “Humans Act7.

The principle of causality; the fact that every cause must have an effect; is itself rooted in our understanding of what acting is, for we as humans understand that with every action we pursue, we will cause an effect. Economic propositions flow directly from our reflectively gained knowledge of action, their truth value is derived from our a priori knowledge of the “the axiom of action”. “Humans Act” therefore is an undeniable synthetic a priori proposition, for the act itself of trying to refute this proposition would involve an action, thus proving the proposition “Humans Act” as being true. From this
axiom of action follow some properties of what it means “to act”:

  1. Humans Act
  2. Every action pursues a goal
  3. An action implies the employment of some scarce means
  4. Every action implies the incurrence of a cost

Thus every time we pursue an action we are choosing the precise goal that action achieves before all other possible ones, we can conclude that every action one pursues is the one he has considered as best at that exact moment, whether consciously or unconsciously. Investigation of how this mechanism of choosing actions works is precisely the task of Economics and Praxeology. The “Categories of Action” then are the means by which we evaluate said actions; those such as – value, ends, means, choice, preferences,
cost, profit, loss, as well as time and causality – they are all derived from the axiom of action. Our observational experience is constructed in these terms a priori, it is constructed by an actor, one who already knows about what “acting” involves; this is what makes “acting” an axiom in our understanding of the world.

Thus when one chooses, for example, to buy a coffee instead of making one at home, he is making that choice based on an evaluation of the costs, his coffee preferences, the time he saves, etc. Economic reasoning at its foundation is understanding of human action; Economics can be seen as applied logic derived from the action-axiom which is an a priori synthetic propositions, making all economic propositions be of that kind by proxy. Thus all economic reasoning consists of understanding the categories of action, which are embedded in our acting minds, understanding that there is a world where there are a multitude of objects to act upon and other agents that are also actors, and finally, the capability of making logical deductions from the consequences which result from the performance of certain actions by the agents in this world, how the actors interact with each other and what changes and effects they bring with their actions8.

From all this, we can demonstrate the truth of our first proposition: “Whenever two agents A and B engage in a voluntary exchange, they must both expect a profit from it. They must have reverse preference orders for the goods and services exchanged so that A values what he receives from B more highly than what he gives him, and B must evaluate the same things the other way around”. If both agents are acting in pursuit of a goal, then the only reason they would engage in an exchange is because both perceive that the object they are receiving is more valuable than the one they are giving. Such is the dispute between the Austrians and their colleagues, the latter believing that this proposition cannot be said to be “true” until we have made the much-needed observations to verify its truth as if Economics were to be treated as a Natural Science.

But it ought not to be treated as one since the propositions of Economics are derived from the undeniable axiom of action, which provided that there are no flaws in our deduction process (which is no light task), makes Economic propositions a priori and synthetic. That an object in a straight line falls at 9.8 m/s due to the force of gravity is not an obvious fact that we can derive through logic from our understanding of objects and space, it requires observations and measurements. It is obvious though that Economic propositions are not of this character and that treating them as such is a sign of utter intellectual confusion.

3 Use of mathematics in economics

Considering the entire history of economic thought, the use of mathematics in economic investigation is very recent. From the ancient Greeks to Middle Ages scholastics or the first classical economists, all of their conclusions were formulated without mathematics. The formal use of mathematics began to establish itself during the 19th century. Economists like Cournot are among the first to employ these methods in an attempt to describe a real phenomenon related to economics, specifically alluding to oligopolistic competition. In this section, several criticisms will be formulated, once again led by Austrian economists.

According to the Austrian view, there is a difference between theory and history. History would only refer to the domain of knowledge where the social scientist tries to collect and arrange data of what happened in the past, but nothing more. In order to understand what happened, a theory is needed. But as it has been justified above, in the case of Austrian economics, theory is an aprioristic science so the conclusions arrived at are through the use of reason. Unlike natural science, economics has to deal with complex phenomena and is unable to isolate all the elements observing them through controlled experimentation (Mises, 1940). The use of econometrics when it comes to predicting future values would be a tool with many limitations and could only be used to describe past phenomena. Austrian economists argue that the use of mathematics is appropriate in the domain of history but not in the domain of Economic theory. The statistical data is the result of economic and social processes but it does not provide the formal structure of those processes.

Most Economic theory developments have been presented as mathematical problems where every individual or firm solves a mathematical problem. The problem consists of which is the quantity of goods or the quantity of demand where the market would be in “equilibrium”, in a static model, where demand, quantity and quality of goods are the same during one instant. The macroeconomic field is very similar but with other variables, not taking into account the notion of continuous or dynamic, just the concept
of equality. Presenting economics as a science where the main objective is to optimize problems, creates a narrow perspective of what economics is. In fact, the formulation of the problem is rather arbitrary; it is an assumption of what the economists think the main objective of each individual, firm, or government is. Is it happiness? GDP growth? or inflation control? If economic theory consisted of solving optimization problems, it would be a branch of mathematics that takes into account time and human behavior.

Naming most of the books “Political Economy” (before Alfred Marshall contributions) clears up that economics and politics are inseparable. In contrast to Shumpeter’s thoughts, namely, that this name would only limit Economic theory to State decisions9, but politics exists among households, firms and naturally in states because when there is someone among the others that takes decisions that may affect them, we are talking about politics. The decision of which problem to optimize, which variables, parameters and function definitions (that even assume how the human behaves) used are a political
decision to face a specific problem.

Using mathematicals tools, especially functions, to describe human or institutional behavior assumes that there is an exact relationship between inputs and outputs under some specific conditions. The great issue with using economic models to predict is the fact that those models were created to understand or teach the economic mechanism; rather, it aims to use the models to apply it to reality, beyond that “laboratory of ideas”, even when it has already been acknowledged that those initial assumptions are, redundantly
speaking, theoretical assumptions only valid to those special circumstances. That means that the exact relationship between inputs and outputs in equations is false, there is no equality.

It has been argued a lot of times that mathematical language is more accurate than the formal one. Karl Menguer, a mathematician and son of the founder of the Austrian of economics, contends that formal language is in general more precise and more flexible but less accurate10. The reason relies on the fact that in order to formulate a universal concept, using a general and more abstract language may involve all the cases, creating a universal law.

The Spanish economist Jesus Huerta de Soto, considered an Austrian economist, believes that the use of mathematics unifies synchronously magnitudes that are heterogeneous from the standpoint of business rivalry, time, or subjective value11. For example, decision theory is presented as an optimization problem where utility is considered as a cardinal value, which is unrealistic; nobody assigns a value to a good in terms of X units of utility. A more accurate way of presenting the microeconomic problem of decision is considering utility as a rank, that is to say in an ordinal value. Carl Menger presented it
in that way, including in its formulation the notion of subjectivity and universality for all individuals at the same time12.

Furthermore, in mainstream economics, the notion of competition is considered as a state or an equilibrium whereas in Austrian economics it is considered as a dynamic process of rivalry between firms, a more accurate way of describing the market processes but impossible to translate in mathematical terms. Like the notion of time, mainstream economics considers economic decisions as simultaneous events where each equality is only available for one moment in its equations. Austrian economists propose time as a category of action, and not as a mere sub-index of a variable or a sequential game. Individuals take actions during time in order to increase their happiness in the future or achieve goals
in the case of organizations. This reasoning allows a more accurate way of presenting economic theory as the science of human change and relations of cause and effect.

4 Conclusions and closing remarks

We have seen in broad strokes what are the main propositions of the Austrian School of Economics and how they differ from the more established popular views, nonetheless, this paper is not meant as a definitive, self-contained, and comprehensive account of what Economics is, as it would be ridiculous to suggest that such a task can be accomplished in a mere ten pages. Rather, this paper was meant to incite its readers to go beyond the established Economic dogma and have a taste of a differing perspective, and hopefully stimulate the thoughts of other brilliant minds that may have been dormant up until now
to start thinking about these deep problems from a renewed perspective.

We must remark that The Austrian School of Economics is not flawless either; no generalistic model of how a complex phenomenon works can be flawless, and it can certainly run into epistemological or philosophical issues like the problem of consistency, but that is beyond the scope of this introductory paper. We have shown that Economics is not a Science yet set in stone and that at its core, at its most basic ground of axioms and assumptions, the choices we make can take us in completely different directions in the long run, and we must take this axioms and assumptions with the most careful consideration lest we want to end up with a theory of knowledge that is opposite and contradictory
with how reality works.

“It is, after all, not completely unheard of, after long cultivation of a science, that in considering with wonder how much progress has been made someone should finally allow the question to arise: whether and how such a science is possible at all. For human reason is so keen on building that more than once it has erected a tower, and has afterwards torn it down again in order to see how well constituted its foundation may have been. It is never too late to grow reasonable and wise; but if the insight comes late, it is always harder to bring it into play” 13 – Immanuel Kant

References

  1. Jean-Baptiste Say, Treatise on Political Economy (New York: Augustus Kelley, [1880] 1964), p. xx, xxvi. ↩︎
  2. Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995) p. 14. ↩︎
  3. Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995) p. 14. ↩︎
  4. Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995) p. 15. ↩︎
  5. For more on this consult “Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995)”. ↩︎
  6. Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995) p. 16. ↩︎
  7. Ludwig von Mises, Human Action: A Treatise on Economics (1949) Part 1 Ch. 1. ↩︎
  8. Hans-Hermann Hoppe, Economic Science and the Austrian Method (1995) p. 26. ↩︎
  9. Joseph Alois Shumpeter, Historia del análisis económico (Barcelona: Ariel, 1982) p. 58. ↩︎
  10. Karl Menguer, Marginalismo austriaco y economía matemática, published on Cuadernos Economicos de ICE, nº29, 1985. ↩︎
  11. Jesús Huerta de Soto, La escuela austríaca, mercado y creatividad empresarial (2000) p. 26-27. ↩︎
  12. Carl Menguer, Principles of political economy (1871) p 127. ↩︎
  13. Kant, I. (2001). Prolegomena to any future metaphysics (J. W. Ellington, Trans.; 2nd ed.). Hacket Publishing. ↩︎

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