Okay, so welcome to our second lecture. We'll deal now with the Austrian School and let's say with the state of affairs and economic science more generally.
Around 1900, that's the period that we usually call the fin de siècle, the end of the century, and culturally, intellectually, psychologically,
The end of the century lasts until World War I, so about 1914.
Now, the chapter is one of the longest chapters of the book, possibly the longest chapter.
I deal with the Austrian School, the beginnings of the Austrian School, the main thinkers,
and also the differences between the Austrian School and other approaches in economic analysis of the time.
The Austrian School was represented in particular by Carl Menger, who is the founder of the Austrian School.
It is, by the way, the first Austrian School at all that existed, as Mises later pointed out in a short manuscript that he published many years later in the 1960s,
and the historical setting of the Austrian School is the title of this manuscript.
He said that in those days, again, everything that was German was synonymous with progress, liberal and good, beautiful, everything positive.
And Austrian was backward, reactionary, ugly, bad smelling, whatever. You add the adjectives.
And it was inconceivable even for the Austrians themselves that anything good could come out of Austria.
So if the quality of the research and teaching in the university had to be improved, well it was only by importing foreign scholars, in particular Germans.
And if there was ever something like an Austrian school, well this smelled like Metternich.
Metternich was the great politician who led Austrian reaction in the first four decades of the 19th century
after the restoration of the Napoleonic wars. Metternich led the restoration and suppressed freedom of thought
and various other ugly and evil things. So when you said Austrian School, well it sounded something like the Bavarian School
Menger was the first one who dared to set up something that he himself called the Austrian School of Economics.
He was the first and others were to follow. In fact, cultural and intellectual life in Austria in those decades experienced an enormous and we might today say unprecedented and unparalleled flowering.
flowering. So we not only had an Austrian School of Economics, we also had an Austrian School in Psychological Analysis and in particular Psychoanalysis.
We had an Austrian School in Philosophy, which developed a realist philosophy of mental phenomena.
We had Austrian schools in architecture and painting and various other things.
But the economists were first, so the one who dared to confront this destiny was this man, Carl Menger, born 1840 in Western Galicia, so another Galician.
The town where he was born is today in Poland. It's called in German Neusandetz. I don't know how the Poles would pronounce this.
Whereas Mises was from Eastern Galicia, which has a stronger Jewish population, Lemberg.
and so Menger was born into, well it was not a Jewish family, it was a family of civil servants and merchants on the mother side,
it was a noble family also, it was von Menger, but he never used the title of nobility,
because he was certainly inspired by the liberalism that we find in the poetry and in the writings of Frederic von Schiller,
There was also von Schiller, but he never used this Frederic Schiller, where we have the idea of a natural aristocracy,
which encompasses social classes, whether of traditional pedigree or not.
And so he wanted to excel not by his name, but by his achievements.
And later on then, when he had the opportunity to join the really high ranks of nobility,
when he could aspire to knighthood, he renounced to this too.
He rejected this, wanted to remain a bourgeois. So it was this man, well he looks very earnest and profound and calm and everything,
who was the great pioneer of the Austrian School, of a new approach, of a new way of doing economic analysis.
And Menger very early on emphasized that what made his approach particular was methodology or we might also say his epistemological conception
because what he was, what he aspired to was the development of what we might call an empirical theory, empirical theory
That is a theory that is itself descriptive of certain layers of reality.
Now, to some of you, maybe most of you, this might sound like an oxymoron.
It's like a square circle or something, empirical theory.
In any case, what strikes us here as paradoxical in this formula is precisely the basic hypothesis
The hypothesis under which we operate today in most sciences, namely the hypothesis that there is a dichotomy between theory on the one hand and empirical reality on the other hand.
We implicitly suppose that theory cannot be descriptive. The theory is always a set of hypotheses, of assumptions and that therefore need to be tested,
brought into conformity with reality by various intermediate steps.
Now Menger rejected this hypothesis, which by the way is fairly old. It goes back to René Descartes,
so a 17th century French philosopher, and it was developed in the 18th century by luminous personalities,
among them Kondiak, whom we will talk later on because he was also a great economist.
But in any case, so Menger rejected this. He sided with Aristotle and with the scholastics of the Middle Ages,
although he didn't say so, in his epistemological realism, that is he thought that the theory itself, even economic theory,
or fairly abstract, could be realistic, that is empirical, it was descriptive of reality.
The way Menger approached this was to go back in his explanation of fairly elementary phenomena.
What is the most elementary phenomenon that we have in economic analysis?
Most people would say prices. So if this is the most elementary phenomenon, the most simple thing that we can perceive,
When we perceive, then we would say, okay, prices are our starting point, and then going from prices, we use prices as a factor that explains other things.
Behavior, for example. Okay, so that's a matter of logic. You cannot avoid this connection. You always have in a scientific, in any explanation, not only in scientific, in any explanation.
You have one thing that explains the other thing, the thing that explains is called the explanandum, that's the Latin word, sorry, that explains the explanandum and the thing that is to be explained is the explanandum.
There's one thing to be explained and the other thing that explains.
And then of course you can go back beyond the thing that explains and try to explain it itself and it becomes the thing to be explained and you go there, find other factors.
Factors. But then these factors, again, are your last step. They are not yet explained. Only in the second step can you try to explain them.
That's a matter of logic. You cannot avoid these relationships. Now what Menger did was to push the economic explanation beyond prices.
So for him, the price was no longer a micro phenomenon, the smallest accessible phenomenon, but it was already a micro phenomenon.
It was already something that resulted from even more elementary factors, but that we could still describe realistically.
What were these even more elementary factors, what we call the elements of the human economy?
We have here human needs, and Menger emphasized in particular that we should not fall into the trap of reasoning about classes of human needs.
I have a need of drink. So Menger says, well, it's not right to reason about drink as if it was a homogeneous block and then any need of drink that I could ever have to be described by this word, but there are discrete units of needs of such drink.
And in order to understand economic phenomena like value and prices, we need to place special emphasis on these individual units, on these partial units of this larger class.
That is of course the essence of the marginal approach and therefore also because we consider marginal units, that is partial units and not total units.
In order to understand the prices for water as compared to diamonds, we should not consider the class of all diamonds as a whole as compared to the class of all units of water as a whole.
We will never be able to understand why water commands a lower price on the market than diamonds, because you cannot drink diamonds.
So, because it's very important to drink, at least from time to time, it would follow that water in general is more important than diamonds.
This is what is called the classical paradox of value.
When the classical economists tried to explain value, they realized that, of course, value somehow depends on needs,
There is something that relates to individuals, but they could not square this with prices.
They say, look, we have water, water is more important than diamonds because you cannot live without water,
but still water commands a much lower price.
So how is this possible?
Clearly, human needs cannot be the key to explain market prices.
And the solution to this riddle, to this paradox is to abandon the analysis of total classes of goods and to turn one's attention to individual units or partial units of goods, the marginal units.
And Menger teaches us that we need to start looking at partial needs first and then from there we move to the partial quantities or marginal quantities that can be used to satisfy these discrete needs.
And from there on then we come to understand marginal value, the value of discrete units, not the value of all classes of things.
What are the other elements of the human economy? Well, it's most importantly time and the passage of time.
The passage of time implies uncertainty. Menger doesn't use this word, uncertainty.
But he was very well aware and he emphasized that because we are living now and we are providing for a future that we do not know now,
we might be wrong about things. So there is another element here, namely the element of error, very important.
I believe in Menger's principle there is this one section that says time-error. Time is linked up with error.
If all things were immediately accessible to us now, if we could have direct knowledge of things that would happen only in a year from now and a hundred years and so on, there could be no error.
I would always be perfectly informed.
But so there is passage of time, therefore we can earn, therefore there is uncertainty.
Then there is human knowledge, also linked up with this. In order to understand the economic importance of marginal units, we need to have certain knowledge or at least certain beliefs about causes and consequences.
And then we also need another element of the human economy, we need to have control.
That is we need to have property, some construct thereof. So control two is an element that is even more fundamental than the price that we observe on the market.
So that's the particularity of the Mengerian approach and Menger develops this approach only up to a certain level because he starts at the fundamental ground, lays the ground,
and then works up his way through value theory, value theory occupies about one-fourth of his book
and then finally gets to speak about prices, you talk about prices only after speaking about value
and then you talk about commerce and then about money, so you have a certain order in the book
that follows the dependence relationships that exist between these different elements of the fundamental elements first.
As a result of the interplay of these elements, you get something like this called human value, economic value.
Once you can understand value, you can move on to explain prices.
Once you have understood prices, you can talk about trade.
Once you understand trade, you can talk about money, because money is only the most liquid of all traded goods, the most marketable good.
So Menger lays the foundation, there are various problems that he did not deal with in detail.
For example, the pricing of factors of production was one of the areas in which Boehm-Bawerk worked after him.
And also the theory of money, the field where Mises then made his contribution.
So you have one thinker who starts first and then he lays the groundwork.
And then others build on this groundwork but also correct the groundwork, correct the errors that he has been laying in his groundwork.
And that's how science proceeds. It's a natural way. But Menger was first.
Now, Menger's approach differed from the prevailing approach, which was at the time the approach of the classical economists.
Menger mainly dealt with the foundations, with value theory, advising and so on.
And there the dominating approach was the one of the classical economists, in which the explaining factor were costs of production and in particular labor.
So Menger deviated from them and his approach was convincing to many of his contemporaries because, well, the approach of the classical economist had, well, apart from its contradictions and the difficulty of reconciling it with observed reality, it had in its conceptual foundations various fictions.
For example, the concept of labor value. How can we observe this, as nobody has ever observed a labor value?
Even in the form given by Karl Marx, it's an absolutely mystical concept.
Marx stipulates this as something like a labor substance, a value substance in human labor.
I mean, even if this is true, how can we know about this? There's no empirical foundation, whatever.
It's a postulate or hypothesis or however you might call it, but it's not more.
So Menger radically breaks with this and he proposes an analysis entirely based on elements that are immediately accessible to human knowledge.
Menger, in his approach, could rely on certain elements that already existed in the German literature of his time.
and I should like to mention in particular two elements namely the idea
that value was subjective and the idea that there is a principle of marginal
value both of these ideas did not originate in the German literature with
Menger but were developed before him by other writers in the first case so the
The idea that value is subjective, which has again several connotations, but it means in any case that value is something that is dependent on individuals.
It is not something that is exclusively inherent in things itself. It is also or maybe also exclusively dependent on the individuals for whom an economic good is valuable.
Now this notion goes back to the late scholastics, that is a group of Jesuit and Dominican monks who wrote essentially in Spain, the city of Salamanca in the 16th and 17th century, also therefore called the School of Salamanca.
And these Spanish late scholastics develop the notion of subjective value.
They perceive that the value of things is dependent on the individuals, dependent on individual choices and on circumstances that relate to individuals' needs, for example.
Now this idea never was lost in continental Europe. In Britain, it got a little bit lost under the impact of the writings of Adam Smith and of David Ricardo.
But on the continent, it always remained in the common trunk of the traditional, of the mainstream approach.
French economists writing in the 18th century, Italian economists writing in the 17th and in the 18th century,
German economists writing in the 18th and in the 19th century all upheld this notion that value is subjective.
So here Menger did not have to break with tradition, he could build on a tradition.
It's very important. It greatly facilitated the acceptance of his work within Germany.
Whereas other economists who came up with the marginal value approach at about the same time as Menger in other countries
had much greater obstacles to overcome because in their countries the theory of subjective value had been forgotten.
The second element is the idea of marginal value. There's two we find in several writers.
before Carl Menger, writers as from the 1840s, 1850s like Hildebrand, Peter Mischler who actually taught also at the University of Vienna
and he was one of Menger's teachers but we do not know whether Mischler had any direct impact on Menger, in any case Menger didn't quote him on this issue.
But again for us what is important too is that so Menger could build on the existing literature here too.
What Menger did in fact was to radicalize these elements, whereas in the German literature before him, the standard textbooks of his time,
The standard textbook writers were a man called Karl Heinrich Rao, R-A-U, Rao, and the other who came a little bit later was Wilhelm Rocha, R-O-S-C-H-E-R.
And both of them combined in their presentation of price theory both elements. They had, if you wish, a juxtaposition of the classical cost of production theory of prices
and a Marginal Value Theory of Prices next to one another.
Now, what Menger showed was that you could do completely without the Cost of Production Theory.
He didn't need it. You could construct a coherent theory and a systematic theory exclusively on the second element.
The principle of marginal value was the key to a systematic and unified theory of value.
So he radicalized the works of his predecessors.
And one implication of his contribution was then that since all value is derived from consumer evaluation,
that's ultimately from needs because consumers evaluate goods and services according to their needs,
that therefore all values in the economy, therefore all prices in the economy, therefore the whole arrangement, the whole setup of economic institutions is geared towards the satisfaction of consumer needs.
That's the logical implication.
The market economy is no longer a gothic interaction of greedy entrepreneurs who just want to make a buck.
It is a rational economic order that one of the working capacities of which is that it satisfies consumer needs with the least effort.
That's one of the implications.
Now Menger in this respect furnishes then a complement to a thesis that had been developed in the 18th century by a French philosopher Etienne de Condillac.
So we have here various portraits. We have David Ricardo, Adam Smith, so Adam Smith publishing his Wealth of Nations in 1776.
Ricardo publishing his Principles of Economics in 1817, successive editions.
Down here we have the French connection with Jean-Baptiste Say, born in 1767 and published the first edition of his Principles of Economics in 1802, intermediate between Smith and Ricardo and a contemporary of Ricardo to some extent.
And now we come to our man, Etienne de Condillac, so you see he's dressed in religious garment, born in 1714.
And he writes essentially on problems of philosophy, epistemology, rhetorics, education, several volume history of France.
His main activity throughout his life was to be the educator of the Prince of Parma in Italy.
So he spent many years of his life, about 20 years he spent in Parma and educated the prince.
And many of his books were an outgrow of this teaching experience,
and this resumed his way of teaching, for example, the art of writing and so on.
and so on, of course the history of France also comes out of this.
Now what is important for us that Kondiak publishes only one economic book, one book dealing with economics, commerce and government.
Published in 1776, the same year in which Adam Smith's Wealth of Nations has been published, 1776.
But Kondyak's book has been completely neglected in the history of thought.
In fact, it has been translated only a few years ago.
The first English edition has appeared 10 years ago, 1997.
So almost, well, not almost, more than 200 years after its first publication in French.
Whereas most of the writings of his contemporary French economists were immediately translated into English.
Why is this?
According to the introduction of this English edition written by two British historians of thought,
Condiac was out of the professional network as we might say today in France.
In France, economic science was organized by the disciples of François Quenet, or Quesnet, as we might say in English.
And they adhered more or less slavishly to the doctrine of their guru, about as much as several Keynesian economists adhere to the words of the master, and you cannot deviate from this.
So, Kondya comes up with a very different approach and what he does in many respects resembles what Menger did almost 100 years later.
Namely, he develops a systematic political economy based on the notion of subjective value.
He explains how a market economy works and confronts or compares to this operation the interventions of government.
and he shows case by case that government intervention just doesn't work, doesn't bring about the foods that are hoped to be derived from this.
The one element that Kondiak did not have at his disposal was the idea of marginal utility.
But apart from this, Menger pretty much completes and perfects an approach that had been first proposed by Kondiak.
And Menger therefore delivers a compliment to a general thesis that Kondiak had developed in his other works.
Kondiak in these other works had presented human needs as the great regulator of all institutions.
For example, most importantly this holds true for epistemology.
That is, we come to learn things dependent on the needs we feel to know certain things.
He has a famous thought experiment in which he considers that there is a marble statue that somehow suddenly comes to life.
and this marble statue therefore explores its environment dependent on the need that it feels to stay alive and so on.
So perception, action and so on is always geared toward the satisfaction of needs and Menger completes this project by his principles of economics.
And he quotes, in fact, Kondiak more than any other author, more than any other foreign author apart from Adam Smith.
So Adam Smith, I believe, has nine quotes and Kondiak has six quotes.
The quotes to Kondiak are always positive, always endorsing Kondiak's position.
The quotes to Adam Smith are mostly critical.
Of course he quotes most people who are not foreign but German predecessors because after all he wants to make a career in Germany or in the Germanys.
So he quotes especially Russia and Rao and Hildebrandt and so on, but again not as unanimously positively as he quotes Kondiak.
So Menger's project must be seen as a continuity of Kondiak's book and Kondiak himself relies on this older tradition of subjective value that emerges with the late Scolestes.
Now, about the time, as Menger writes, we have two other approaches that were competing for the attention of the younger economists,
and the attention of those economists that were already in place for the attention of the public at large,
competing approaches that are therefore important to understand Menger's contribution
but also the subsequent development of economic science.
Now these two approaches were on the one hand the historical school as developed in Germany
in Germany and on the other hand the mathematical neoclassical approach to value and price theory as developed in France and in England or more precisely in Switzerland and in England by Leon Varas, a Frenchman expatriate teaching in Lausanne in Switzerland and by William Stanley Jevons, an Englishman teaching in England.
Now we'll first talk about the historical school and then compare the Austrian school to this other mathematical school.
We have here a couple of portraits of the main protagonists. We have here William Stanley Jevons, Leon Varin and we have here Gustav Schmoller.
Gustav Schmoller, the head of the historical school, or more precisely of the younger historical school, because we need to distinguish two historical schools.
One is called the older historical school. Here we have people like Rao and Rocha, whom I mentioned before, and Hildebrand and others, who were skeptical of economic theory of the Anglo-Saxon type because the letter was built on fictions to a large extent.
And there was somewhat weary about fictions, especially in Germany, because Germany was invaded after all by the Napoleonic armies under the banners of abstract human rights.
Once you are invaded and hit on your head for a couple of times, all this in the name of liberty, you tend to get a little bit skeptical about things.
are not sufficiently rooted in immediate experience and verifiable or falsifiable evidence.
Now therefore German scholars tended to be sceptical of Adam Smith and of David Ricardo
and as a consequence they tended to be more interventionist also in economic policy, social policy,
than their peers in England and in France.
But this healthy skepticism made way to sort of new extremism in the form of the Younger Historical School,
spearheaded by Gustav Schmoller.
Gustav Schmoller was a professor in Halle, which is today in Eastern Germany, near Magdeburg, it's not far away from Berlin, small town, small university, but Schmoller was a very active and dynamic young professor,
and he created a movement of people opposed to laissez-faire politics,
particularly in economic policy but also social policy at large.
So he convened a first congress of all such economists in 1872 in the city of Eisenach,
what is also today East Germany.
Eisenach was a symbolic town because it was the town that just a few months before had hosted the foundational meeting of the first socialist party ever, namely the Socialistic Party of Germany, the SPD, which was founded in 1872 in Eisenach.
And so when Schmoller a few months later convened this meeting of scholars with an interest in what he called social policy and he expressly gave the hint,
well I invited all those who do not believe that laissez-faire is the answer to all our problems.
and we want to get therefore a stronger role for government in shaping economic policies.
So it was a faith community meeting, if you wish.
So it was absolutely symbolic that he organized this in this town of Eisenach.
The meeting was a great success and the Congress established there the Verein für Sozialpolitik, the Association for Social Policy.
And again, I said this this morning, social policy in those days was synonymous, was a shorthand for things the government should do to improve the lot of the working classes.
This group is organized within the Verein Führer Sozialpolitik, was quickly called the Socialists of the Chair.
The Socialists of the Chair, well they were Socialists and of the Chair refers to the teaching puppet.
So people who held university employment as professors and so on and in fact who were socialists.
The movement was a great success especially because it coincided with the establishment of a new German Reich.
of the Reich. Germany had been politically, always never very strongly organized,
centrally organized. The medieval Reich that had existed until 1806 was loosely
confederated around the emperor. The emperor had virtually no power, whatever.
He spent most of his time making battles against recalcitrant other princes and so on.
He didn't want to obey his orders and his laws and so on, so he never had much time to invade foreign countries.
He was occupied most of the time to make himself be respected within Germany, so there was not much power for him.
And then we had about 60 years without any central organization, whatever, until Bismarck popped on the scene
and through a series of successful wars rallied a coalition of princes behind the project of establishing a new central government only this time without the Habsburgs.
The Habsburgs, the rulers of Austria-Hungary, had been for centuries the rulers of the medieval German Reich.
With the dissolution of the Reich, they lost this position, but it was always clear they were the preeminent political house within the Germanys,
and the Prussian kings envied this position when they aspired themselves to be the emperors.
And so Bismarck gave them the tools into their hands, they led a series of successful wars,
and finally the endorsement of the other princes for this new project.
So it was a new Reich being created, a new Emperor called, which was William I, King of Prussia, became first German Emperor.
and now if you think a little bit what this implies, you have a new central
government, you have lots of new administrative positions, lots of new
jobs, lots of new agendas, because you need to justify the new government,
needs to have tasks, of course needs to defend the country, yeah, must be more
and more than this, there's also social justice and various other things.
So you see with the new government, the new funds that were suddenly available for people dynamic enough to grasp them,
there was just an agenda to be created very freely in order to capture these possibilities and that's what they did.
So many universities created, especially in the newly annexed territories, southwestern Germany, then Alsace and Lorraine, fell back to the Germanys again, they had been annexed by the French king in the 17th century, so now came back.
And so then new German institutions were established, crowding out the previous French institutions, so new jobs for German professors and so on.
And then of course the most radicals got these new jobs.
Schmoller himself moved from Halle to Strasbourg, capital of Alsace and was their professor for many years.
Before he finally got one of the chairs of economic science in Berlin, even closer to his employer.
Now Schmoller did not hesitate to very quickly seize the opportunities that were now available
and he profited also from another factor that was very important.
He had very good personal relations with the chief civil servant that was responsible for hiring processes of full professors within the Reich
which meant that in the decades that would follow it was virtually impossible to get a job at one of the German universities in economics or Staatswissenschaften, government science
if you did not more or less fully share the vision that was expressed in the writings of Gustav Schmoller and his associates in the Fein für Sozialpolitik.
So Menger, Carl Menger saw this and for the reasons that we discussed before, well he had a difficult standing in Austria anyway, he had some influence and we'll talk about this later, but there was this challenge then, the new radicals under Schmoller, they threw out the fictional economics baby with the theoretical bath water,
They got rid of theory, wanted to get rid of theory altogether. They contested the necessity of economic theory at all.
They contested that it was a science at all. So according to them, to put it nastily, we might say they had a kind of fact-finding approach to economics.
and economics, you create lots of statistics, you go to count things and measure things and so on
and then based on all the data that you have so gathered, you come up with some proposal for economic policy or social policy
but which, as Mises has pointed out, does not necessarily follow from all these facts.
One critic of the Younger Historical School put the approach this way, he said,
well, they go into worker flats, they measure how many square feet they have and so on,
they say, well, they're too small.
Okay, you see, you already see what is wrong with it, right? It's not by, you find, okay, they have a certain size and so on.
Now, it simply doesn't follow that you say they are too small, because we have the problem of scarcity, right?
Of course, it would be great to have, wonderful to have greater, bigger apartments, but because things are scarce,
Building bigger apartment would imply that more resources are dedicated to the construction job and would therefore not be available elsewhere, that is food would be more expensive, clothing would be more expensive and so on.
Who is to tell whether it's more important to have bigger apartments rather than cheaper milk or whatever, cheaper steaks or whatever.
Okay, who is to say this? So it's not as easy as this. You go there and say, well, it's a certain size that's too small, or they do not drink enough beer, or they do not smoke enough tobacco.
The economic problem is to find the right proportion between the different economic goods, and this problem was never raised in the writings of the historical school.
School. But that's precisely what they did. So Menger saw this but he was not concerned about these, well he did not directly attack these practical issues.
He was more concerned about the fundamental epistemological claim of the historical school because the younger historical school claimed that there was no such thing as a scientific economic theory.
did not exist. The only science that we had in this field was history, the fact finding or the number counting approach.
You go there, measure things, count things and so on, ask people, lead interviews and that's it. There's nothing else, there's no such thing as economic law.
Law. And here Menger said, wait a minute, I didn't put it quite this way, but that's what he did. And he started writing a second treatise that dealt with these methodological questions.
The title of the book was Investigations into the Methods of the Social Sciences and of Political Economy in Particular. It was published in German in 1883.
There was this reaction to the claims of Schmoller and his friends and it was in fact an all-round indictment of their claims.
And as a consequence of this publication followed what is today known as the Methodenstreit.
That is the debate about methods used in economic science.
Are the methods used in history, are they the only methods that can be used in economic science, the only scientific methods,
Is there any scientific methods or is there also something else? Is there also economic theory that can be studied in the way Menger proposes? That was the big question.
So it came to an exchange of opinions. The first reaction to Menger's book was a review by Schmoller himself, published I believe in either the same year or the year after,
in which she vigorously rejected Menger's claims, but also went beyond this in associating the type of economics that Menger proposed with a particular political opinion, namely with the Manchester School of Economics,
in Manchester School, economics, laissez-faire economics, which was justified to some extent, but of course, which brought into the debate, which could have been a purely scientific debate centered on epistemological questions, a political edge.
And so things started getting nasty and so they would remain for about the next 15 years, constant exchanges, Menger weighed against him and Schmoller himself and disciples of Menger, disciples of Schmoller and so on, taking part of this debate, which was led often on a very emotional level.
and for this reason probably was doomed to not be decisively fruitful but at least it created an interest for this kind of questions.
Now one negative consequences of this debate was that since the question was so generally asked,
I have been asked, is there something like economic theory, as opposed to the methods employed by the historical school?
Since all the attention was centered on this fairly general question, the differences that existed between the various theoreticians vanished into the background, got completely eradicated away.
This is very important to understand the history of the Austrian School.
It is important to understand because it explains why later economists working under the banner of the Austrian School are taken as authorities.
The most important cases are Friedrich von Mises and Josef Schumpeter, whereas in their work they markedly deviated from the type of theory that Menger had proposed.
And as I've presented it before, the decisive characteristic of Menger's approach is empirical theory.
It's a realistic theory that sticks to the facts as they can be ascertained by human reason and human observation.
Whereas these other theoreticians often worked on the basis of more or less heroic fictions or assumptions.
One such approach, well I mentioned already the name of Visa, but before we can talk about Visa, we need to briefly talk about the differences between Menger's approach and the approaches of these other two gentlemen, Stanley Javins and Leon Walrass.
In standard accounts of the history of thought, Menger is typically presented as a co-founder of the Marginalist Revolution along with these two other men.
Okay, something like this. Okay, so we have a marginalist evolution, revolution,
three thinkers in three different countries coming up at approximately the
same time with approximately the same idea. Menger in Austria 1871, William
Stanley Jevons in England the same year 1871 in England and Leon Varas three
years later in Switzerland and in fact there are seemingly only superficial
differences. Menger talked about value, there were Vara and Jevons talked about
utility, otherwise was pretty much seemed to be the same thing because there were
These are very strong analogies. In the approaches of all three of them, they try to go beyond prices as the smallest element of economic theory,
and explain them in terms of more fundamental factors. In the case of Menger, we've already talked.
In the case of Jevons and Baras, this more fundamental element was utility.
So from the point of view of Menger, economic value was the explaining element of prices, which were the phenomenon to be explained.
In the approaches of Jevons and Baras, we had utility, which were the explaining elements of prices, the elements to be explained.
But the common point already stopped there, so we had this rather general analogy as a general analogy of procedure, but then the differences come into play and I will mention only one element that is important here, namely the element of human psychology.
In particular for Germans, utility was conceived to be an expression of one satisfaction for an individual.
And as a consequence, therefore, you had a bilateral two-party relationship between psychological one satisfaction on the one hand and prices on the other hand.
Okay, and this was very elegant from various points of view, in particular because it facilitated the introduction of mathematical methods,
as I will explain to you in a minute, but of course it has its greatest disadvantages.
Well, first of all, it seems to be a patent fact that we do not make all our decisions in terms of the psychological pleasure that we derive from them, right?
I might very well drink the 13th and 14th beer in the evening and it might still give me pleasure and so on, but still I do not make this decision because I need to give a lecture on the next morning, right?
and even if there is no psychological pleasure that is tickling me with the thought of giving this lecture,
so there are things like sense of duty and honoring one's promises and all these things
and this seems to be difficult to square with the theory developed by Jevons.
In Varaz we have the same element, he didn't place as much emphasis as Jevons on the psychological side, one satisfaction, but we have the same fundamental relationship also in Varaz, we have utility on the one hand, which is a function of one satisfaction, as in any case one element, and prices on the other hand, so we have a bilateral two element relationship.
Now, in the case of Menger, things were very different because, according to his theory of value, the value of one thing obviously had to do with the individual under consideration.
It had depended on the individual, therefore also maybe on the psychological state.
But the value could be defined only in relationship to other economic values, that is, the economic values of other goods and services that were also subject to choice.
to Choice. That is, from the outset, the explaining factor in Menger's theory was a much more complicated, complex element than in the theory of Jevons and of Varaz.
And one consequence, one implication was that it lend itself less or maybe not at all to mathematical theorizing, at least in the way it has been done in those days.
The way it has been done by Jevons and Varas was through the construction of functions. Prices were explained as functions of utility.
And here we have definitely, we come to the advantage of this approach because we have utility on the one end and prices on the other end.
Utility, well, can lend itself then obviously to the mathematical operations of different utilities, you can add utilities, you can subtract them from one another,
you could conceivably at least also add and subtract utilities of different individuals, it's a one-dimensional thing, so you have no problems here.
Whereas if Menger is right and the value is something more complex that can only be defined in a relationship to various elements and these elements change from one point of time to another because the context constantly changes and therefore the alternatives that are open for choice change too.
You don't have a one dimensional function or the elements in your function don't remain stable.
Then you are screwed up.
Well, maybe not indefinitely, there will be a genius mathematician who comes up with a solution to this riddle,
but at least it cannot be done as smoothly and as easily as the other two theoreticians have proposed.
Now, this raises an interesting question on which I will talk very briefly. Why did they do it? Why did they come up with this theory?
And here, I mean, one cannot quite get around the fact that all these people were passionate mathematicians before they turned to economics.
That is, they were first and foremost, they had an interest in using a certain tool which they liked for aesthetic reasons or some other psychological things
because sometimes you say, well, if you have a hammer in the hand, every problem looks like a nail.
So if you are good mathematicians, try to formalize all problems that present themselves in a way that they can be treated mathematically.
So this concerns not only Jevons and Varas, but many others as well. Let me just read a section from the footnote that I have in the biography.
I think I rely here on Mark Bloch, a British historian of thought. He points out that Jevons first studied chemistry and biology and then turned his attention to economics.
His inspiration was Jeremy Bentham's philosophic calculus of pleasure and pain, supplemented by the works of Dionysius Lardner and so on, two British engineer economists of the 1860s.
Varas pursued formal studies in letter science and engineering from his father, the economist August Varas.
He adopted the conviction that some concept of utility maximization is the fundamental element of economic science.
As a go-on son and find the solution, Varas' great follower, Wilfredo Barreto, an Italian, was an engineer and turned to economics only at the age of 42.
Similarly, Knut Wichsel and Irving Fischer's first university degrees were in mathematics.
Gustav Kassel, who had written the most widely read textbook of the interwar period, was a PhD in mathematics,
then became a schoolmaster and then turned to economics,
becoming the greatest popularizer of general equilibrium theory a la Varas.
In contrast, the predominant formative influence on Austrian economists did not come in the form of mathematical training,
but through legal studies. Until the interwar period all Austrian economists
had to obtain a first degree in law before they could turn their research to
economic problems. As a consequence the Vienna economists distinguished
themselves by a great capacity to think conceptually and most importantly by
their eagerness to relate all of their concepts to the observed real world.
Their training in law effectively counterbalanced the inclination some of them felt for the natural sciences.
For example, Boehm-Bawerk, who was first interested in physics but never went on to study physics.
Okay, so here we have these differences.
Now we need to talk briefly about the breakthrough of the Austrian School, how the Austrian School triumphed in the early days.
And then the further development where these differences that we talked about waved in more and more.
The breakthrough came when Carl Menger was appointed tutor of the Austrian dolphin, the crown prince Rudolf.
The crown prince.
Here we have him, His Majesty Rudolf, became famous or infamous later on because he killed himself in 1889 in the presence of his mistress whom he killed first.
Menger was appointed Rudolf's tutor in economics, all of government science, in 1875 and starting in 1876 he traveled with Rudolf throughout Europe.
different places, talk to other economists, other famous scholars in France, Britain, Belgium, Germany and so on.
And of course, as a consequence of these ties, Menger henceforth enjoyed the protection of the royal house, the imperial house.
So his standing within the economics department was dramatically increased and he obtained a chair shortly thereafter
and was also appointed to various learned societies abroad,
Royal Academy of Moral Sciences in France and corresponding academies in Britain, Italy and so on.
People whom he had learned on his trip with Rudolf.
But he also now had great influence on the appointment of new full professors throughout Austria.
And there were at the time, I believe around nine universities where economics was taught.
So as I said before, at each economics department there were two full professors, two chairs.
So nine times two, that makes 18.
And Menger came to have so much influence that he was involved in appointing more or less all of them in the next two decades or so.
The only chair that he could not fill, according to his liking, was the rival one at the University of Vienna, where he wanted to put Boehm-Bawerk, which was prevented by the Ministry of Education.
Let me just give you a few names of people who got their training under Menger and later obtained chairs in Austria-Hungary, chairs of economics in Austria-Hungary.
So there was Boehm-Bawerk and Wieser, Boehm-Bawerk chair in Innsbruck, Wieser a chair at the University of Prague, the German University of Prague, there was also the Charles University,
Then we have Emil Sachs, Johann von Komorchinsky, Robert Meyer, Gustav Gross, Eugen von Filippowitsch, Victor Mataja, Robert Zuckerkandl, Hermann von Schullern-Schrattenhofen,
that's a very Austrian name, Richard Reich, who was later on also the president of the Central Bank, of the Austrian Central Bank, Mises worked very closely with him in the 1920s,
and Richard Schiller. Richard Schiller was the last student who got his
habillitation degree under Menger in 1895 and he almost outlived Mises and was
certainly the oldest Austrian economist still around, so he died I
believe in 1971, he was more than a hundred years old. A very influential
Not all of these were, of course, libertarians.
In fact, Menger could not have.
But he turned them away from the historical school and inspired them with the conviction
that economic theory could be developed scientifically along the lines that he had proposed.
And this was the influence that we had.
Speaking about libertarianism, this teaching job that he had with the Crown Prince, many years later revealed to us Menger's political opinions
because a biographer of Crown Prince Rudolf, Brigitte Hamann in Austria, has discovered the notebooks of the Crown Prince.
Conference. And so, in the notebooks, the conference would write down the summaries of the lessons he had received from Menger.
And according to these lessons, Menger had an economic policy agenda that was even more minimal than that of Adam Smith.
In Adam Smith we have three elements, suppression of domestic criminals, defense against foreign enemies, and public goods.
I didn't say public goods but that's what he meant, things that could not be in the interest of any individual or private association to produce.
But in Menger's teaching apparently there was no such thing as public goods.
Okay, so here is how one historian of thought who has also looked at these notebooks summarized it.
It's a quote from Erich Streisler, a great historian of economic thought of the Austrian School in particular.
Menger's Rudolf lectures are in fact probably one of the most extreme statements of the principles of laissez-faire ever put to paper in the academic literature of economics.
There is just cause for economic action only in abnormal circumstances, only when disaster is impending, only when government support becomes indispensable, should the state step in.
Otherwise, government interference is, again I quote, always harmful.
Okay, so that's what emerged through these notebooks. It was not something that you could have guessed from Menger's writings because in his scholarly work he never expressed himself on any economic problems,
was not a political economist like Kondyak a century before him and as Mises and Boehm-Bawerk would become after him. Menger was more of a pure scholar and in the few journal articles that he contributed on economic problems
You could even have thought that we felt great sympathies for the agenda of the fine for social politics.
OK, so what this leaves us with is that the Austrian School relatively quickly had a position of very strong influence, at least within Austria-Hungary, which was an important country within Europe.
It started from a position of force and a decline over many decades in the years after Menger for reasons that we will talk about in what follows.
Whereas the other schools started on a weak institutional basis, well of course the historical school also started off strong,
started off strong, but Jevons and Varas did not start off strong, they were finally supported by a more general epistemological movement that we call positivism,
a conviction that in economics you should apply the methods that are being employed in the natural sciences, and so even without any strong institutional support geared toward them individually,
The doctrines of Jevons and Baras finally had their day.
So what about the further development of the Austrian School?
Here we should first of all point out a few crucial facts that have to do with biography.
Menger leaves the university in 1902.
This was at a relatively early age, he was just 62 years old,
and was due to a scandal he had caused through a love affair with his housemaid.
They had a son, and Menger acknowledged the legitimacy of the son, which was caused, the scandal.
It was okay to have a child, but not to acknowledge them.
It was okay to have a bastard, but it was not okay to acknowledge them as your son.
Menger later on, he also said, well, one of the things that caused him to have health problems in later years, when he was probably 70 or 80, was that he spent too many hours in bars or in coffee shops, had bad food in some periods of his adolescence and too many love affairs.
So this must have been one of them.
So for us what is important is Menger, as from 1902, is no longer at the university.
Now, okay, I always say individuals are less important than doctrines and so on, and in a way it's true, but individuals are not unimportant either.
It's important to have them there and to defend the ideas that they stand for.
Menger stood for realistic empirical theory. With Menger being gone, the field was open for others.
So who was there in place? Menger's successor at the University was Friedrich von Mises.
Mises was not a realist, so we'll talk about this in a minute.
And the other one was Boehm-Bawerk, someone not particularly interested in epistemological questions,
and certainly a great economist, a great inspiration for Mises, as a political economist in particular.
But Boehm-Bawerk dies in 1914, just at the outbreak of the war.
dies in the first few days of August 1940.
So after Boehm-Bawerk, therefore there's only Filipowicz and there's Wieser and then after the war they hire people who are not Austrian economists at all.
So there's no more voice among the chairs of economics, of economic realism.
There is in particular only Wieser, and Wieser is now, after the death of Boehm-Bawerk, the uncontested authority in the field of Austrian economics.
His word is the standard, that's the main authority, Wieser.
And the other main authority is not Mises in the 1920s, it is Joseph Schumpeter.
Both of them were not pure Mengerians on epistemological grounds.
Wieser thought to create a synthesis between the works of Menger on the one hand and William Stanley Jevons on the other hand.
And on epistemological grounds he was a strong adherent of Jevons approach.
Schumpeter created a synthesis between Wieser and Varas.
So he brought the connection to the mathematical general equilibrium theory.
Both of them were the main figures of the Austrian School after Boehm-Bawerk's death and Mises only came thereafter.
Mises was number three. So we need to take a closer look at Wieser and Schumpeter and that's what I do in the book
and now I will only go through a few main facts because we are running out of time.
So, Wieser was especially imposing as a personality.
He was a beautiful man, very tall, nice voice, cultivated, educated, accomplished piano player,
a man who knew lots of artists and had a good sense of the German language and so on.
But for us, all these things are secondary and there are more things to be said about him as a scholar, which you can read in the book.
What for us here is only important that Wieser cherished the use of fictions in his conceptual work.
I'll just give a few examples. So he wrote in the early 1900s, he wrote an entry on marginal utility for the standard German language economic dictionary of the time.
Here he purported to develop the rules according to which one scales and computes economic utility.
So it's a computation of economic utility, something you do not find in, you can calculate in terms of economic utility.
Wanted to develop the economic calculation of utility, it's a direct quote, develop the economic calculation of utility.
In Visa's view, value was a cardinal measure of utility. If an economic good, X, is not reproducible, then the value of X measures the marginal utility of X itself.
If it is a reproducible good, then the value of X measures the fog on utility of another good, Y, that cannot be enjoyed if the factors of production are used to make X rather than Y.
In any case, the value of a reproducible good is a measure of the opportunity cost of producing it.
And you can calculate with it, you can compute in terms of it.
Now, that's clearly a fiction because no such unit is known.
I mean, after more than a century or 140 years, we're still not there that we could say what is this unit, this util,
in terms of which we could calculate, nobody's ever observed it or touched it or shaken hands with it and so on.
It's a fiction that greatly facilitates the use of mathematical tools, but has no empirical basis, whatever.
These fictions about value and the speculations that he based on them in his first book,
the book for which he got his chair in economics, gained Wieser a reputation as a pure theorist
This is in precisely the sense that German mainstream economists of the historical school disdained, namely someone who constructs theories without foundation in human experience.
The historicist Hopsperse must have loved Wieser, for he was living proof that they were not guilty of battling straw men.
It had been very difficult to make a case against Menger, a rigorously tied theory to experience, but there could be no doubt that the work of this disciple lacked empirical foundation and thus scientific integrity.
Young Werner Sombart, famous left-wing social scientist in Germany, a disciple of Schmoller,
to whom Schmoller had entrusted the job of reviewing Wieser's second book, concluded that this work was,
quote, entirely unsound, end of quote. Ironically, therefore, the heated atmosphere of the Methodenstreit
considerably enhanced the significance of Wieser's work. His elegant prose and his
highly developed sense for coining catchphrases like marginal utility and
imputation gained him a widespread reputation as one of the leading
representatives of the Austrian School, which meant in the mind of contemporary
German mainstream economists an advocate of theoretical studies dissociated from
and Historical Research. Because of this publicity, Wieser was largely successful in promoting among German economists the notion that the New Economic Theory,
advocated by Menger and his disciples, was a form of applied psychology. And the same thing can be said about another central notion of Wieser's theoretical edifice,
Let me explain to you the notion of natural value. That's the title of the second book, Natural Value, The Theory of Natural Value.
According to this doctrine of natural value, there can be situations in which entrepreneurs produce certain goods in unnecessary quantities merely because they command the highest market prices.
In these cases, when market prices do not indicate the rationally established or natural value, there is a conflict between objective exchange value or market price and social utility.
The question then is, of course, how social utility is to be understood.
Understood, here Wieser refers to the concept of natural value.
He asserts that the natural value of economic goods is the value that these goods have only in light of their available quantities and their utility.
Natural value is the value that results if only these two factors come into play, the available quantities and their utility,
are utility dissociated from individual concrete context. As soon as any other factors come into play, market prices can deviate from their natural values.
Thus, the conflict between market prices and social utility can be made intelligible by comparing the real world to a fictional state of affairs of ownerless quantities
and of homogeneous psychological utilities, dissociated from the specific biological and economic characteristics of concrete human beings.
According to Wieser, this fictional state of affairs obtained, for example, in a communist state, which he understood to be a totally unified and utterly rational commonwealth.
So we have common ownership, so individual property and so on plays no role.
It follows that real world market prices give only an imperfect representation of natural value.
Not only are they subject to the impact of abusers, namely individual egotism, error and other frictions,
but they are also subject to the distribution of resources.
Thus, only in a pure Viserian communist state does the actual value of goods coincide with their natural value.
Now, Wieser offered no proof for these assertions, just said. That's how I define natural value.
Apparently, he took their plausibility for granted. Neither did he encounter any objections on these grounds.
It hardly needs to be stressed that his views were quite removed from Menger's views both on the conception of value and prices and on the nature of economic science.
Menger believed that the task of economic theory was to describe certain exact laws of the human economy.
It did not deal with all aspects of human action but it did treat the economy as it actually exists and is therefore subject to empirical analysis.
From VISA's point of view, economic science addressed only the laws of natural value, which cannot possibly exist in the real world.
Now again, these were the views that were authoritative after 1914.
In 1914, VISA published a big book on social economics, a few years later translated into English,
and this was the main reference book in Theoretical Economics for the next 20 years or so in the Germanys.
And here he reproduced exactly those ideas. So biography does count, physical presence of individuals does count,
with Menger exited from the university and Boehm-Bawerk died in 1914.
These views formed the common ground of the emerging generation of the so-called fourth generation, Hayek, Machlub, Haberler, Morgenstern and various others.
It's very important to keep this in mind. They did not receive their training as hardcore Mankerians or Misesians.
Mises might have been one of the teachers that took maybe part in one of his seminars at the university and then especially in his private research seminar
but their formative influence came through Wieser and also through reading Schumpeter.
Now we don't have much time for Schumpeter but it's important, Wieser is more important.
I propose that we'll use the last four minutes for questions that you might have.
The question is what was Mises opinion of Schumpeter, did they have any contact or conflict in the early period?
Well, Mises did not have a very high opinion of Schumpeter. He liked certain aspects of his works.
For example, Schumpeter took a very strong stance against
a psychologist in economic analysis. Schumpeter was not necessary at all, and here Mises fully agreed.
Mises also liked Schumpeter's stress on entrepreneurs as the driver, individual, creative entrepreneurs as the driving forces of the market economy.
But again, he was maybe not fully admirative, maybe only of the presentation because he liked it because of its unequalitarian implications.
But this came from Wieser also. Schumpeter only fleshed it out.
Mises often made, well, apparently in private conversations, disparaging remarks about him.
So they laughed a little bit about Schumpeter because he never really got things thoroughly done.
It was also the reproach that he received from his main teachers, Boehm-Bawerk and Wieser at the University of Vienna.
They all admired his prowess and oral expression and written expression.
They say, well, he didn't think through the things. So it's a rather unfinished job.
And this was Schumpeter's destiny throughout the rest of his career.
The guy who is brilliant, he's one of the great writers. It's a pleasure reading Schumpeter.
But it's never fully thought out, that's the problem. But there was never any written debate or something, never really debate at any point.
What does that mean?
About Visa? Well, there's a passage in his autobiographical notes and recollections where he says, well, all in all, Visa did more harm than good.
Good and he never really understood the principle of subjective value, yeah,
that's why and which is clear right from this formulation if you have natural
value depends only on available quantities and utility, how can you speak
of utility if it has something to do with subjective value without reference to
individuals and how can you aggregate this?
Well, yeah, that's a good question. In any case, he derived more inspiration from William Stanley Jevons.
In the first book that he publishes, he acknowledges two sources of inspiration, Menger on the one hand and then Stanley Jevons on the other hand.
And as far as, let's say, foundational concepts or categories are concerned, he waved with Jevons rather than with Menger.
The reasons, he never explained why this is. Obviously, he believed this to be either the truth or most useful. He didn't really explain why, didn't explain his choice.
But that's the fact.
Was John Stuart Mill at all that time?
Well, I think so. Yeah, of course, John Stuart Mill was a reference that was unavoidable in economic science in those days, so they certainly read him.
But it's true, Mises never quoted him, but in any case, the principles, he later criticized John Stuart Mill in his book Socialism and then liberalism.
Socialism is making too many concessions to the socialists, unnecessary concessions.
It's not justified by the facts. And liberalism is the one thinker who has turned liberalism on the wrong path.
On the path that we call liberalism in current English language today.
Yeah, but there are no positive references to John Stuart Mill, and he didn't comment much on him.
______________
Well, Wieser was very conscious of this fact.
In fact, he wrote only one book review, namely of Schumpeter's book,
book, Theory of Economic Development, in which he deals with these epistemological
questions, it's the only place that we have, and here he criticizes, as I've
said, Schumpeter for having not thought out these things, and here
Wieser makes the distinction between two types of hypothesis, hypothesis that can
be readily verified by the facts and not disconnected and idealizing
They're using assumptions. Okay, so he was very conscious of the fact that certain assumptions that we make are not grounded, in fact.
And he says they are useful anyway.
They're useful because of our freedom to make decisions.
No, I mean, no prediction did not play a big role because they...
So why are they useful? Why are they useful?
Well, yeah, well, he did not go into much length explaining this. So, I mean, that's only, but the fact is he recognized that certain assumptions were non-fictional.
The other question is, even those assumptions that he thought were realistic, were they really realistic or were they only somewhat closer to reality?
For example, his notion of utility. Is this actually a fiction? I think he didn't think it was a fiction.
I think he thought it was a fairly faithful description of reality.
Well, we're already three minutes over time. Thank you very much for your attention. We'll meet together tomorrow morning.