THE VALUE OF PURE THEORY
Investment decisions, like all choices which depend upon a prediction of the future, in some degree, require the investor to develop a theory about events. Even the fool who "invests" at the gaming table or in the horses has a theory, although this theory might be inchoate and mystical (e.g., Lady Luck). One's success in life, not just the value of one's portfolio, depends critically upon the validity of one's own personal theorizing. A bad investment is nothing more than an investment which looked good from the perspective of a bad theory of events.
The primary strength of the capitalist system is that it is more sensitive to events than the various government-enforced systems. If an entrepreneur launches a project with expectations of consumer demand, and errs, the project is quickly terminated. If the businessman himself doesn't go broke, at least he can see that such a fate lies in his future if he continues. On the other hand, if a government launches a project which falls short of its promised benefits, the shortage is made up by taxation or government borrowing (i.e., future taxation).
Pro-capitalists are rare in the world today, perhaps because it has become so easy for businessmen to mix government with business and reduce their risks of loss. The theory which underlies such a perspective is the belief in a "free lunch," or at least the cynical belief that if and when civilization grinds to a halt, they will be on top in the new feudal system. There are some pro-capitalists still active, however, as readers of this publication know.
Two major schools of economics can be considered pro-capitalist: the Austrian school and the Chicago school. The latter, in the words of one of its most famous masters, George J. Stigler, denies that it is a "school" at all. Stigler argues that the professors at the University of Chicago just teach "scientific" economics. In the words of another of the Chicago masters, Milton Friedman, there are not any legitimate differences among schools of economics—there is just good economics and bad economics, and the difference between good and bad can be found in the ability of an economic theory to predict the future. The Chicago approach is sweeping the economics profession today, although it may be 50 years before the last traces of Keynesian theory have died out. Meanwhile, of course, the Democratic majority in Congress proposes to shove "stimulation" and "controls" down everybody's throat in spite of massive evidence that such policies yield perverse results (viz. Britain).
THE AUSTRIAN ECONOMIC CONFERENCES
The Austrian school has been largely ignored by the economics profession for a number of years, although it was the Austrian theory of subjective value which revolutionized the science of economics 100 years ago. The classical economists tended to objectify the concept of "cost" and to look at the economic system in terms of static models in equilibrium. The Austrian theorist, Carl Menger, observed that cost is not just what you pay for something, but more importantly it is the full set of opportunities which you give up when you choose a certain course of action. If you buy a new car, the cost of the car is the full set of everything else you can no longer afford because you bought the car instead—perhaps a boat, a vacation, a new wardrobe, or merely a larger savings account. The important thing to note is that "cost" involves predicting the future: you have to make a subjective, personal judgment about the lost value to you of that new boat or vacation which you will never see. This was one of the major points presented by Prof. Gerald O'Driscoll of Iowa State University at a recent Austrian Economics Conference in Milwaukee. Previous conferences have been held in Virginia, New Jersey, Connecticut, and Vermont. The Koch Foundation of Wichita, KS, is the invisible hand behind the conferences, although the sponsorship is usually arranged through a local college or university. Joey Rothbard observed humorously that the conference might be called "the Austrian road show," since the speakers and program had been similar each time.
The next Austrian Economics Conference will be held at Windsor Castle, in Britain, late in August. That conference will not be open to the public, but the papers will be published next autumn. Mario Rizzo, who will receive his PhD in economics from the University of Chicago this spring, presented a paper in Milwaukee which he has prepared for the conference at Windsor. The paper is a carefully reasoned critique of Milton Friedman's concept of "positive economics," which is the epistemological cornerstone of the Chicago school. Rizzo points out that the ability to predict the future is not the essence of "science," and that the narrow methodological concentration of the Chicago school on statistical evidence causes them to throw out much valid scientific knowledge which we do possess.
Other participants at the Milwaukee conference included Profs. Murray Rothbard, Israel Kirzner, and Ludwig Lachmann, of New York University. Prof. Lachmann spoke on two occasions, observing two important corollaries of the theory of subjective value. First, that the Austrian analysis of time in the economic system is different from the concept of time in the physical sciences, or in "scientific" economics. The Austrians break time into two continua, the past which is knowable and the future which is imaginable, but in principle unknowable. Imagination is a strictly individual human process, not a social or collective phenomenon. Second, with the subjective concept of cost, the famous macro-aggregates such as Capital, Labor, GNP, National Income, Interest Rate, etc. take on only the most limited and even misleading meanings. Prof. Rothbard further developed the argument of subjective cost to call into question the entire field of welfare economics and the concept of cost-benefit analysis in the macro-framework. Prof. John Egger and Walter Grinder presented an Austrian theory of money and the business cycle.
Prof. Kirzner's talk focused attention on the central role of the entrepreneur in Austrian theory as opposed to his absence in the comparative statics, or simultaneous solution, models. It is not the price level, but the relative prices, which are important, he said; it is the entrepreneur who acts upon price differences and alternative scenarios of the future which is central to Austrian economics. He pointed out a number of problems which conventional theory worries about, but which cease to be problems altogether when one views the economic system as a process for the discovery of economic information by entrepreneurs. Kirzner's book, Competition and Entrepreneurship (University of Chicago Press, 1973) is one of the most important recent contributions to economic theory from the Austrian perspective.
COMBATING ECONOMIC ILLITERACY
The banquet speaker at the Milwaukee conference was Prof. James Buchanan, whose book, Cost and Choice (Rand Corp., 1969), received very favorable comment throughout the program. Buchanan observed that the teaching of economic theory itself has virtually disappeared. What undergraduates and graduate students are taught today is a mass of ad hoc truisms and statistical techniques. He related a story about a conversation he had recently with a prolific author of textbooks in economics, a person who received his PhD from the University of Chicago in 1968 and presently holds an important position—and who vigorously supports laissez-faire policies. Buchanan happened to mention to the young professor the concept of economic harmony, the general process which Adam Smith called "the invisible hand" and which Austrian economists grasp intuitively as the working of the market system. This young professor was amazed, and exclaimed that this was a beautiful idea! He would forthwith incorporate it into the next edition of his most popular textbook. Buchanan was dumbstruck that this fundamental concept of economics should be so completely unknown to such a well-educated young professor.
Buchanan told the conference that the idea of economic harmony is a quasi-religious concept. In his own experience, it had come upon him like a revelation—and he said that it seemed to be most successfully communicated in that manner. He related a number of instances in which he had effectively communicated the concept in this quasi-religious manner.
Mario Rizzo stimulated some of the most interesting arguments of the evening by disputing Buchanan's proposition. He argued instead that it was extremely important for Austrian economists to steer clear of any quasi-religious or normative claims, even though these might be quite effective with some people. As a scientific paradigm, Rizzo asserted, the epistemology of Austrian economics is just as valid—if not more valid—than the paradigm of the Chicago school, or "positive economics." It would be harmful in both the long and short run if economic "scientists" were able to use Buchanan's argument against him, to dismiss Austrian theory as mere economic "religion."
Mises would have been proud.
This article originally appeared in print under the headline "Frontlines".