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Module 11: The “Austrian” Case for the Free Market

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This module explores the contributions made to the understanding of liberty by the “Austrian” economists, mainly Ludwig von Mises (1871–1973) and F. A. Hayek (1899–1992). In the 1920s and for many years thereafter, Mises was one of a handful of scholars willing to criticize collectivism in general and socialist economic planning in particular. He was reviled and scorned for his work, but recent years have seen almost universal, albeit grudging, acknowledgement that he was right: socialism cannot solve the problem of economic calculation. As Mises noted, “Socialism is the abolition of rational economy.” A market economy based on private property is necessary to generate the prices on the basis of which resources can be allocated among competing uses. Mises’s book Socialism, published in 1922, marked a turning point in the intellectual battle against full‐​scale collectivism. As F. A. Hayek later noted, “When Socialism first appeared in 1922, its impact was profound. It gradually but fundamentally altered the outlook of many of the young idealists returning to their university studies after World War I. I know, for I was one of them. … Socialism promised to fulfill our hopes for a more rational, more just world. And then came this book. Our hopes were dashed.” The victims of socialism suffered for years before Mises’s arguments were accepted generally.

The critique of socialism launched an enormous investigation of how markets actually work. Model builders who merely included prices in their models and then assumed that prices adjust automatically overlooked the crucial problem of the decentralization of knowledge (described in Hayek’s essay “The use of Knowledge in Society,” which is included in the readings for this module) and the central role of the profit‐​seeking entrepreneur in adjusting prices. Mises and Hayek insisted that to assume away the problem of explaining how prices are adjusted was to assume away the economic problem itself. There can be no useful prices without private property, freedom of contract, and the right to the profits accruing to entrepreneurial activity. (These issues are examined by Henry Hazlitt in the excerpts from Economics in One Lesson for this module.)

Both Mises and Hayek drew on their study of economic processes to build a wider case for the liberty of the individual under limited, constitutional government. Hayek devoted great attention to understanding the proper role of law in guaranteeing rights and became convinced that law itself was a discovery process, analogous to the market process. Just as market institutions evolve, so the legal order is the result of an evolutionary process. The market is a spontaneous order that cannot be planned in advance. The institutions of the market, from legal rules to contractual forms to firms, are also the result of evolutionary processes, as the legal scholar Bruno Leoni explains in the chapters from his book Freedom and the Law. The evolution of forms of business enterprise is considered in the chapter from How the West Grew Rich, by Rosenberg and Birdzell.

Note: In the audiocassettes it is mentioned that Mises did not live to witness the growth of interest in his ideas. It should also be mentioned that he did not live to see the destruction of the Soviet Union, which also took place after these audiocassettes were recorded. (Hence the mention of Mises’s birthplace of Lemberg, “now ironically the city of Lvov in the Soviet Union.”)

Readings to Accompany The Audio

From The Libertarian Reader: Ludwig von Mises, “On Equality and Inequality” (pp. 104–07), “Socialism and Interventionism” (pp. 274–85), “Peace” (pp. 327–30); F. A. Hayek, “The Use of Knowledge in Society” (pp. 215–24), “Made Orders and Spontaneous Orders” (pp. 233–42), “The Market Order or Catallaxy” (pp. 303–11); Michael Polanyi, “Two Kinds of Order” (pp. 225–32).

From Freedom and the Law: Chapter 4, “Freedom and the Certainty of the Law” (pp. 76–94); Chapter 5, “Freedom and Legislation” (pp. 95–111); Postscript, “The Law as Individual Claim” (pp. 189–203).

From Economics in One Lesson: Chapter 15, “How the Price System Works” (pp. 87–93); Chapter 22, “The Function of Profits” (pp. 144–48).

From How the West Grew Rich: Chapter 9, “Diversity of Enterprise” (pp. 269–301).

Some Problems to Ponder & Discuss

• If markets and prices serve to coordinate the activities of the participants in a complex economy, why are there firms?

• What does it mean to say that in an advanced economy production is “roundabout”? Why are free prices and interest rates necessary to regulate a complex and roundabout system of production?

• How do prices adjust in a market economy? What role is played by the profit‐​seeking entrepreneur?

• In what ways can interventionism be self‐​defeating? How does one intervention lead to another?

• What is the difference between cost and price, and which determines which?

• What kind of knowledge do prices convey?

• If, as Hayek argues, our morals are not the product of our reason, what role can reason play in criticizing moral claims, for example, the moral claims made on behalf of socialism?

Suggested Additional Reading

Ludwig von Mises, Human Action (New Haven: Yale University Press, 1963, and later editions). This is an immensely rewarding book; it is also a rather difficult and challenging one. Rather than merely a treatise on economics, it is a general treatment of the problems of social coordination.

Murray N. Rothbard, Man, Economy, and State (Los Angeles: Nash Publishing, 1970). Like Human Action, this book is a sweeping treatise on the science of economics, but it is generally more accessible to American readers. It starts with fundamental principles, such as the principle of choice and the concept of the marginal unit of choice, and develops a coherent science of human cooperation and coordination.

F. A. Hayek, The Essential Hayek, Chiaki Nishiyama and Kurt R. Leube, eds. (Stanford: Hoover Institution Press, 1984). Hayek wrote many books and essays and numerous editions are available. This one brings together in one volume contributions to economics, the theory of knowledge, political philosophy, and intellectual history.

For Further Study

F. A. Hayek, The Fatal Conceit (Chicago: University of Chicago Press, 1988). This, Hayek’s last book, is a synthesis of his life’s work.

Ludwig von Mises, Socialism (1922; Indianapolis: Liberty Press, 1981). This is Mises’s classic critique of socialism, notable not only for his argument about the impossibility of socialist economic calculation but also for his sociological and philosophical insights into socialism.

Ludwig von Mises, Bureaucracy (1944; Irvington‐​on‐​Hudson, N.Y.: Foundation for Economic Education, 1984). As a complement to his analysis of socialism, Mises examined the differences between the organizing principles of voluntary institutions operating within the market and government bureaucracies.

Israel Kirzner, Discovery and the Capitalist Process (Chicago: University of Chicago Press, 1985). Kirzner refines the notion of entrepreneurship, explains the role of the entrepreneur as the moving force of a market economy, and applies those insights to taxation regulatory policies.

Chandran Kukathas, Hayek and Modern Liberalism (Oxford: Oxford University Press, 1989). Kukathas offers an excellent general overview of Hayek’s political philosophy.

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