People often ask me, "How are the Austrians
different from the Chicago School economists? Aren't you all free-market guys
who oppose big-government Keynesians?"
In the present article I'll outline some of the main
differences. Although it's true that Austrians agree with Chicago economists on
many policy issues, nevertheless their approach
to economic science can be quite different. It's
important to occasionally explain these differences, if only to rebut the
common complaint that Austrian economics is simply a religion serving to
justify libertarian policy conclusions.
Before jumping in, let me give a few obvious disclaimers: I do not speak for all Austrian economists, and in this article I will be discussing modern Austrian followers in the tradition of Ludwig von Mises and Murray Rothbard. (On methodology in particular, the Austrians in the Rothbardian camp differ somewhat from those who look more to Friedrich Hayek and Israel Kirzner for inspiration.) It's also important to note that not every Chicago School economist thinks alike. Even so, I hope the following generalizations are representative.
Methodology
The Austrians are oddballs among professional
economists for their focus on methodological issues in the first place. Indeed,
Mises's magnum opus, Human Action, devotes the entire second chapter (41 pages) to "The Epistemological
Problems of the Sciences of Human Action." There was no such treatment in
the last Freakonomics book.
Although most economists in the 20th century and our
time would disagree strongly, Mises insisted that economic theory itself was an
a priori discipline. What he meant is that economists shouldn't ape the methods
of physicists by coming up with hypotheses and subjecting them to empirical
tests. On the contrary, Mises thought that the core body of economic theory
could be logically deduced from the axiom of "human action," i.e., the insight or viewpoint that there are other conscious beings
using their reason to achieve subjective goals. (For more on Mises's
methodological views, see this and this.)
In contrast, the seminal Chicago School article on
methodology is Milton Friedman's 1953
"The Methodology of Positive Economics." Far from deriving
economic principles or laws that are necessarily true (as Mises suggests),
Friedman instead advocates the development of models with false assumptions.
These false premises are no strike against a good theory, however:The relevant question to ask about the "assumptions" of a theory is not whether they are descriptively "realistic," for they never are, but whether they are sufficiently good approximations for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.
Although Friedman's analysis sounds perfectly
reasonable, and the epitome of "scientific," Mises thought it was a
seductive trap for economists. For a quick illustration of the difference in
perspectives, let me relay an example from my teaching experience.
It was a principles of microeconomics class, and we
were using the (excellent) textbook by
Gwartney, Stroup, et al. In the first chapter they have a list of several
guideposts or principles of the economic way of thinking. As I recall, these
are items such as, "People respond to incentives," and "There
are always tradeoffs." These were noncontroversial things that every
economist would agree were important for getting undergrads to "think like
an economist."
However, the one guidepost that stuck out like a sore
thumb announced, "To be scientific, an economic theory must make testable
predictions." I explained to the class that even though this was a popular
view among professional economists, it was not one that I shared. I explained
that everything we would learn the entire semester from the Gwartney et al.
textbook would not yield testable
predictions. On the contrary, I would simply teach them a framework with which they could interpret the world. The students would have to decide
whether the framework was useful, but ultimately their decision wouldn't boil
down to, "Did these tools of supply and demand make good predictions?"
After I went through my spiel, one of the students
made the excellent observation that not a single one of the other guideposts
was a testable prediction. He was right! For example, how could someone test
the claim that, "People respond to incentives"? I could say to a
person, "I'll give you $20 if you cut off your big toe." Regardless
of what happens, my claim is safe and secure. If the person doesn't cut off his
big toe, it just shows that I didn't offer him a big enough incentive.
This is not mere philosophical grandstanding. Mises
stressed that the important heritage of sound economic thought is not a collection of empirically tested claims
about the behavior of economic variables. Rather, economic theory is an
internally coherent framework for interpreting "the data" in the
first place.
It's true that certain applications of
economics involve historical evidence — such as investigating whether the Federal Reserve played an important role in the housing bubble — but this is a far cry
from the typical mainstream economist's justification for mathematical model
building.
Booms and Busts
Another major divergence between the Austrian and
Chicago Schools is their explanation for booms and their policy prescriptions
for busts. The readers of this article are likely familiar with the Austrian view, so I will omit another discussion.
Chicago School economists obviously have nuanced
views, but generally speaking they subscribe to the "efficient markets
hypothesis." In its strongest form, the EMH denies that there could even be such a thing as the housing bubble (see here and here). Given their
assumptions of rational actors and markets that quickly clear, and given that they lack a sophisticated theory of the capital structure of the economy, the Chicago School economists
are forced to explain recessions as an "equilibrium" outcome due to
sudden "shocks."
Historically they didn't consider the distortions
caused by below-market interest rates (which of course are the key ingredient
in the Austrian theory of the business cycle). However, recently more and
more Chicago School critics of the Fed have been pointing out the dangers of Ben Bernanke's
zero-interest rate policy.
Ironically, the policy area where the Austrians and
the Chicago School differ most is in regards to money, the issue in which Milton Friedman specialized. Friedman (and
coauthor Anna Schwartz) famously faulted
the Federal Reserve for not printing enough new money in the early 1930s to
offset the decline fueled by bank runs. In our time, some Chicago-trained economists — who justifiably point to Milton Friedman himself for vindication —
blame the crisis in the fall of 2008 on Bernanke's "tight-money"
policies. Naturally, these views are anathema to modern Austrians in the
tradition of Murray Rothbard, who think the central bank should be abolished.
Law and Economics
Finally, most modern members of the Austrian and
Chicago Schools have vastly different ideas when it comes to the field known as
"Law and Economics." Whether based in natural law or the traditional
inheritance from the common law, Austrians tend to think that people
objectively have property rights, full stop, and once we specify these rights
the economic analysis can begin. In contrast, some of the more extreme
applications of what could be called "the Chicago approach" would say
that the assignment of property rights themselves should be determined on the
grounds of economic efficiency. (In Walter Block's reductio ad absurdum, a judge decides if a man has
stolen a woman's purse by asking how much each party would be willing to pay
for it.)
This is a particularly subtle area that I cannot
adequately summarize in this article. Suffice it to say, Austrians and Chicago
School economists alike can appreciate the amazing insights — and challenge to
the standard Pigovian critique of the
market — contained inRonald Coase's famous article. However, the Chicago School tradition has taken
Coase's work to conclusions that many (perhaps most) modern Austrians find
repellant.
Conclusion
On typical issues such as the minimum wage, tariffs,
or government stimulus spending, Austrian and Chicago School economists can
safely be lumped together as "free market." However, on many other
areas — particularly issues of pure economic theory — the two schools are
entirely different. As a self-described Austrian economist, I would encourage
free-market fans who only know Friedman to add Ludwig von Mises and Murray
Rothbard to their reading lists.
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