Austrian Economics Explained
The Austrian School of economic thought is often misunderstood.
April 12, 2015
Fred Foldvary, Ph.D.

The Austrian school of economic theory began in the Austrian-Hungarian empire in 1871 with the publication of Principles of Economics by Carl Menger. Two of the best-known Austrian economists were Friedrich Hayek and Ludwig von Mises, both of whom moved from Austria to the USA, as the Austrian school became global. Austrian economic theory is a combination of several elements of method and theory:

1) Axiomatic-deductive reasoning establishes a pure universal economic theory. Economic theory is deduced from premises and elements of human action, such as scarcity, unlimited human desires, economizing behavior, a mental ranking of ends as more or less important, a “time preference” tendency to want things sooner rather than later, and the proposition that much of the future and the beliefs about the current economy are uncertain, not available as organized knowledge, and not knowable in advance.

2) Marginal analysis: Menger along with other economists of the latter 1800s developed a theory of marginal utility, the importance of extra units of goods that help determine market prices.

3) Methodological individualism: economic analysis is ultimately based on the purposeful action of individual persons, in contrast to “holism” which treats an economy as a whole entity that is distinct from its parts.

4) A theory of capital goods based on their particular qualities rather than treating them only as homogenous goods, especially regarding the time duration of investments, and the role of capital goods relative to their final consumption and provision to households.

5) Interpretive understanding: an understanding of human action depends on the interpretations by the observer of human intentions, and therefore the methodology of social science cannot merely copy that of physical science.

6) Subjective values: all values are subjective, based on individual beliefs, interests, and preferences.

The main topics of Austrian theory and historical studies include a) entrepreneurship; b) money and banking; c) the time structure of capital goods; d) the business cycle; e) the dynamics of markets and spontaneous orders; f) critiques of governmental intervention and planning; g) knowledge as decentralized and unknowable to central planners.

Austrian economists have critically analyzed Marxism, Keynesianism, and the excessive neoclassical emphasis on mathematical modeling. With their critique of state socialism and governmental interventions into markets, Austrian economists tend to believe that markets work well. Austrian theory concludes that interventions as taxes, subsidies, mandates, and prohibitions, which interfere with peaceful and honest human action, reduce the productivity of economies and human well-being.

Therefore Austrian economics is identified as a free-market school, although Austrian economics as such has no ideological bias. One could be an Austrian-school interventionist if one believes that governmental intervention has subjective benefits that are greater than the costs.

Austrian economics recognizes land as a factor distinct from labor and capital goods, as land is a non-produced factor of infinite duration. Austrian analyses of land have been collected in the book, The Spatial Market Process, volume 16 (2012) in the book series, Advances in Austrian Economics. My chapter, “An Austrian Theory of Spatial Land,” analyzes the role of land in the Austrian theory of the business cycle. Just as an artificial reduction in interest rates by governmental intervention generates unsustainable investments in buildings, which Austrians call “malinvestments,” cheap credit also induces “malspeculation” in land value. Economic growth gets choked by both interest rates that have risen back up and by unsustainable high prices for land. The Georgist theory of the business cycle, which emphasizes land, and the Austrian theory that emphasizes money, interest, and capital goods, are complimentary, and their integration provides a more complete Austrian theory of economic cycles.

Other chapters in this book analyze real estate market dynamics, the use of knowledge, governmental land-use planning, urban agglomoration (the growth of cities), and spontaneous cities (private alternatives to zoning and master plans).

Austrian economists have been the leading theorists of “free banking,” the replacement of central-banking controls with a free-market setting of interest rates and the money supply, an application of the Austrian critique of central planning.

The Austrian critique of governmental intervention includes the proposition that taxes on wages, investment returns, entrepreneurial profits, and produced goods, all distort market prices and profits as signals for efficient investment, production, and consumption. The policy consequence is that public goods are better provided by markets, such as with voluntary private communities, or from non-distorting sources of public revenue, namely pollution levies and land rent.

The complementarity of Austrian and Georgist thought has been recognized by some Austrian economists such as Leland Yeager, and by some Georgist economists such as Mason Gaffney, but some Austrian economists have let their anarchist ideology dominate their economic thinking, and so they mistakenly reject the public collection of land rent as statist intervention. In evaluating Austrian theory, as with any theory, we need to separate the pure economic logic of the school of thought from the individual doctrines of some individuals who identify with a school of thought.

Find Out More.
Inside information on economics, society, nature, and technology.
Fred Foldvary, Ph.D.

FRED E. FOLDVARY, Ph.D., (May 11, 1946 — June 5, 2021) was an economist who wrote weekly editorials for since 1997. Foldvary’s commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and San Jose State University.

Foldvary is the author of The Soul of LibertyPublic Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary’s areas of research included public finance, governance, ethical philosophy, and land economics.

Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.