The 5 Basic Principles of Austrian Economics

What is the Austrian School of economics?  If you’re even slightly familiar with this school, you’ve probably heard of economists such as Hayek and Mises.  If you’ve done more than cursory research, you’ve also probably come across some thoughts by Murray Rothbard, Israel Kirzner, and Carl Menger.  You might be aware of some interesting insights into the Austrian theory of the business cycle, the study of human action, the concept of “deciding at the margin,” Austrian theories of banking, or the socialist calculation debate.

These names and ideas are great starting places for those who are interested in Austrian economics.  However, it’s always important to take a step back from the conglomeration of names and theories in order to better understand the comprehensive whole. 

Whether you are in the middle of attempting to dissect Mises’ most famous treatise on economics, Human Action, or you have a copy of Economics in One Lesson by Hazlitt sitting on your bookshelf, it is always important to go back and remind ourselves to ask: what is the Austrian School of economics?

Defining the Austrian School of economics

The term “Austrian School” is a label that we use to categorize a certain type of economic methodology.  Now, I understand that labels are often criticized for oversimplifying issues and lumping complex beliefs into broad categorizations.  Leaving aside the fact that this accusation refutes itself (since it labels all labels as being overly broad), this contention also overlooks the reason that we make labels.  We make labels because it helps us to distinguish between different viewpoints, methods, and presuppositional biases.  This clarification is significant because it helps us look for the most compelling reasons to separate various schools of thought from each other.

In the case of the Austrian school, what are the unique distinctions that separate it from other economic schools?  Without getting too technical, let’s look at five of the most basic fundamentals of Austrian economic methodology:

1. Austrian economics is deductive

2. Austrian economics presupposes the axiom that humans act

3. Austrian economics derives methodological individualism from human action

4. Austrian economics rejects empiricism as the standard for proof

5. Austrians economics does not endorse a political ideology

Without further ado, let’s briefly unpack the theory behind each of these principles in order to develop a comprehensive understanding of what Austrian economics is.

1. Austrian economics is deductive

The Austrian School’s economic methodology is an exercise in deductive reasoning.  The big, fancy way to describe Austrian economics is to call it axiomatic deductivism. This means that Austrian economists study human decision-making by starting with a set of fundamental axioms and then reasoning from those axioms to truths about economic principles.  Now, remember, an axiom is a presupposition that cannot be deductively proven, but is nevertheless self-evident and irrefutable.

In this sense, Walter Block says that Austrian economics takes a geometric approach to scientific inquiry.  Much like Euclid’s system of geometry, which builds itself upon fundamental axioms and necessary postulates using abstract theory, Austrian economics systematizes its understanding of human action before diving into the specific circumstances.  Why does this matter?  Because Austrian economics is a thoroughly systematic approach that provides us with a rigorous and robust framework for understanding economic issues.

This does not mean that Austrian economists agree on everything!

Just like there were many debates among Greece’s students of geometry, there are disagreements between Austrian economists over certain issues, including some aspects of methodology.  However, the point is not that Austrians always agree, rather, the point is that they attempt to construct their economic system based upon a generally shared and accepted deductive methodology.  This brings us to the question: what is the starting point for the Austrian methodology?  The answer is found in the second principle of Austria economics:

2. Austrian economics presupposes the axiom that humans act

The fundamental axiom for the Austrian is that humans act.  This is irrefutable because if anyone tries to disprove it, they have to in some way think, read, write, and speak in order to make their argument.  In other words, they have to act in order to prove that humans do not act.

A necessary assumption that is derived from this outcome is that humans act purposefully, given their limited knowledge and means in any given circumstance.  This does not mean that Austrians argue that humans necessarily behave rationally or that they always have good reasons for acting.  It also does not mean that the result of the outcome will align with the individual’s perception of desired results.  It simply means that humans do things because they perceive either a non-negative outcome or a benefit as a result of the action, given the constraints placed upon them.

Murray Rothbard clarified that the Austrian concept of human action, “contrasts to purely reflexive, or knee-jerk, behavior, which is not directed toward goals.”  Austrian economics is not meant to provide us with the tools of studying purposeless and random behavior.  That is left to the domain of other fields of study.

However, the irrefutable fact that humans generally act toward perceived goals remains–and it’s quite evident in the world around us.  People act purposefully and rationally to improve their conditions around them given the state of affairs they find themselves in and the incentives they perceive.  If this wasn’t true, then we wouldn’t have all of the advances of modern civilization.

Therefore, properly speaking, Austrian economics goes beyond the study of exchanges involving money, goods, and services.  Instead, as Mises said, it is a subset of the study of all human decision-making that is purposefully conducted.  The fancy word for this study is praxeology.

3. Austrian economics derives methodological individualism from human action

After having proven human action as a reliable postulate, Austrians move on to the notion of methodological individualism, arguing that individual human actors are the most important factors in understanding  observable causation in this world.  The ultimate question of methodological individualism is: who acts?

Think about it this way: ideas are not people, thus, they cannot act.  Moreover, since a group of people can only exist because multiple individuals are acting within the group, then the notion of a group of people is a helpful description of the concept of multiple people acting—i.e. a group of people is just a descriptive idea.  Therefore, since a group of people is nothing more than an idea, then a group of people cannot act since ideas cannot act.

Thus, businesses, governments, society, neighborhoods, etc. do not act.  Individuals forming associations in such environments are the stimulants of all action that occur within such group frameworks.  This is why Mises argued in Human Action that, “a social collective has no existence and reality outside of the individual members’ actions.”

Again, a clarification point is needed: the concept of methodological individualism as a method of analysis does not carry with it the value implications of a moral or philosophical advocacy of individualism.  By saying that individuals, not groups, act, Austrians are not necessarily saying that the individual is the source of reality or that the individual is the highest form of a moral being.  Regardless of what they personally believe about theology, ethics, and metaphysics, Austrian economists do not claim to answer these questions within their economic methodology, arguing that these issues lie outside of the scope of economic inquiry.

Instead, Austrians are simply saying that if we are to understand purposeful human behavior, we must seek to understand it at its most basic level: the individual human actor.  From this, we can extrapolate to different levels of social cooperation and community behavior, but the Austrian never forgets that the individual is the reason for and the source of action in society.

4. Austrian economics rejects empiricism as the standard for proof

The deductive approach of Austrian methodological individualism starkly contrasts with the empirical and mathematical approaches of much of the rest of economics.  Although Austrians do not contest the notion that economics is a science, they recognize that it is not a quantifiable science in the way that chemistry is a quantifiable science.  Thus, they do not believe that the primary means of understanding economics should come through models, graphs, formulas, and equations.

Because of the plethora of variables involved with each individual action, it is mathematically impossible to understand each variable behind each human action on an aggregate level.  There are literally hundreds of variables acting upon one individual as he faces the decision to make one action.  Multiply this by millions of individuals facing hundreds of their own specialized variables, and you can see why developing mathematical formula to rule and predict human behavior is ultimately futile.  This is why Mises said, “All authors eager to construct an epistemological system of the sciences of human action according to the pattern of the natural sciences err lamentably.”

A few important clarifications are necessary at this point: although Austrians will not deny that there is a place for econometrics and mathematical modeling, the difference between Austrians and most other economists is one of emphasis.  Most mainstream economists place their emphasis on understanding human decision-making with statistics, graphs, GDP, indexes, etc.  Austrians believe that this is a hopeless endeavor and thus emphasize the discovery of economic principles through a deductive approach that incorporates the math, graphs, and statistics when it properly aligns with those economic principles that are established by logic.

The Austrian is not opposed to trying to measure and model economic phenomena; however, he does not believe we can learn the fundamental truths about economics through such empirical analysis.  While isolating variables in biology, physics, and chemistry can indeed tell us more about scientific truths, the inability to isolate variables in economics can potentially lead us to false knowledge if we continue to assume that we can hold “everything else equal.”  If policy and business decisions are enacted based on these false understandings, then there will likely be disruptions, inefficiencies, fraud, and cheating in the market system.

5. Austrians Economics does not endorse a political ideology

Ultimately, the goal of Austrian economics is to tell us both why and how humans act, make decisions, and conduct economic exchanges.  In other words, it’s a “nuts and bolts” explanation for economic transactions and human choice.

It is absolutely not meant to be a moral prescription for government policy.

Although the principles of Austrian economics help us to better understand the economic phenomena associated with modern circumstances and political realities, it cannot be emphasized enough that Austrian economists view their study as a science of inquiry, not necessarily a prescription for policy.

This distinguishes Austrian economics, which is an economic school of thought that attempts to describe the way things happen, from libertarianism, which is a political philosophy that tries to tell us what government and society should look like.  Now, often the two do seem to go together since most Austrian economists nowadays are libertarians.  Furthermore, most of the influential Austrian economists, such as Hayek, Mises, and Rothbard all held to varying degrees of libertarian political philosophy.  Much of the findings of Austrian economics, such as Hayek’s business cycle theory, do seem to mold very well with the ethical and policy prescriptions of libertarians.  Ultimately, however, applying Austrian economic methodology does not require an individual to be a libertarian and vice versa.

That said, many defenders of liberty have found the methodological analysis of Austrian economics to be an important tool in refuting advocates of big brother government.  Austrian economics helps bring the arguments back to reality, pointing statists to the facts that deficit spending creates inflation, that inflation creates unsustainable booms, that government stimulus programs cannot create employment, etc.  Yet, Austrian economic methodology never actually makes any statements about reality outside of what it deduces and observes in human behavior.  Prescriptions about what to do in light of the findings of Austrians are left to the area of political philosophy.

Lesson 1: Conclusion

There is a very deep and rich history behind Austrian economics, going all the way back to Carl Menger who pioneered the Austrian school with his elaboration of the principle of subjective value theory.  Although Austrian economics has unfortunately never been a mainstream viewpoint, its consistency and accuracy in helping us to understand the world around us is forcing scholars of the modern era to check their Keynesian premises and seriously consider the Austrian school.  It is these real-world considerations that will be considered in my next article in this guide to Austrian economics.

Additional Resources

Human Action by Ludwig von Mises (Online version accessible at: http://mises.org/resources.aspx?Id=3250&html=1)

“Praxeology: The Method of Austrian Economics,” by Murray Rothbard (PDF file accessible at: http://mises.org/rothbard/praxeology.pdf)

“Austrian Economics and Libertarianism” by Walter Block (Youtube video of lecture accessible at: http://www.youtube.com/watch?v=Xn6TXqgyj_M)

Economics for Real People (2nd ed.) by Gene Callahan (PDF file accessible at: http://mises.org/books/econforrealpeople.pdf)

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