The Austrian School (also known as the Vienna School or the Psychological School) is a non-mainstream school of economic thought that emphasizes the spontaneous organizing power of the price mechanism or price system. Austrians hold that the complexity of human behavior makes mathematical modeling of the evolving market extremely difficult (or undecidable) and advocate a laissez faire approach to the economy. Austrian School economists advocate the strict enforcement of voluntary contractual agreements between economic agents, and hold that commercial transactions should be subject to the smallest possible imposition of forces they consider to be coercive (in particular the smallest possible amount of government intervention).
The Austrian School derives its name from its predominantly Austrian founders and early supporters, including Carl Menger, Eugen von Böhm-Bawerk and Ludwig von Mises. Other prominent Austrian School economists of the 20th century include Henry Hazlitt, Murray Rothbard, and Nobel Laureate Friedrich Hayek.[1] Though called 'Austrian' today, supporters or proponents of the Austrian School can come from any part of the world. The Austrian School was influential in the early 20th century and was for a time considered by many to be part of mainstream economics. Austrian contributions to mainstream economic thought include involvement in the development of the neoclassical theory of value, including the subjective theory of value on which it is based, as well as contributions to the "economic calculation debate" which concerns the allocative properties of a centrally planned economy versus a decentralized free market economy.[2] From the middle of the 20th century onwards, it has been considered a heterodox school[3][4] and arguably contributes relatively little to mainstream economic thought.[5][6]
Austrian School economists advocate strict adherence to methodological individualism, which they describe as analyzing human action from the perspective of individual agents.[7] Austrian School economists argue that the only means of arriving at a valid economic theory is to derive it logically from basic principles of human action, a method called praxeology. Additionally, whereas natural experiments are often utilized within mainstream economics, Austrian economists contend that testability in economics is virtually impossible since it relies on human actors who cannot be placed in a lab setting without altering their would-be actions. Mainstream economists are generally critical of methodologies used by modern Austrian economics.[5]
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Classical economics focused on the labour theory of value, which holds that the value of a commodity is equal to the amount of labour required to produce it. In the late 19th century, however, attention was focused on the concepts of “marginal” cost and value. The Austrian School was one of three founding currents of the marginalist revolution of the 1870s, with its major contribution being the introduction of the subjectivist approach in economics.[8] Carl Menger's 1871 book, Principles of Economics was the catalyst for this development; while marginalism was generally influential, there was also a more specific school that grew up around Menger, which came to be known as the “Psychological School,” “Vienna School,” or “Austrian School.”[9] Thorstein Veblen introduced the term neoclassical economics in his Preconceptions of Economic Science (1900) to distinguish marginalists in the objective cost tradition of Alfred Marshall from those in the subjective valuation tradition of the Austrian School.[10][11]
Austrian economics is closely associated with the advocacy of laissez-faire views. The Austrian School, especially through the works of Friedrich Hayek, was influential in the revival of laissez-faire thought in the 20th century.[12]
The school originated in Vienna, in the Austrian Empire. However, later adherents of the school such as Murray Rothbard have derived the roots of the thought of the Austrian School from the Spanish Scholastics teaching at the University of Salamanca of the 15th century and the French Physiocrats of the 18th century.[13] The School owes its name to members of the German Historical School of economics, who argued against the Austrians during the Methodenstreit ("methodology struggle"), in which the Austrians defended the reliance that classical economists placed upon deductive logic. Their Prussian opponents derisively named them the "Austrian School" to emphasize a departure from mainstream German thought and to suggest a provincial, Aristotelian approach.
Specifically, in 1883 Menger published Investigations into the Method of the Social Sciences with Special Reference to Economics (Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere), which attacked the methods of the Historical school. Gustav von Schmoller, a leader of the Historical school, responded with an unfavorable review, coining the term "Austrian school".
The name "Psychological School" derived from the effort to found marginalism upon prior considerations, largely psychological – compare behavioral economics. The school was no longer centered in Austria after Hitler came to power, and is now based almost entirely in the United States.
Carl Menger was closely followed by Eugen von Böhm-Bawerk and Friedrich von Wieser, in what is known as the "first wave" of the School. Austrian economists developed a sense of themselves as a school distinct from neoclassical economics during the economic calculation debate with socialist economists. Ludwig von Mises and his student Friedrich A. Hayek represented the Austrian position in contending that without monetary prices and private property, meaningful economic calculation is impossible.[14]
The Austrian economist Böhm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, as was part of the Austrian economists' participation in the late 19th Century Methodenstreit, during which they attacked the Hegelian doctrines of the Historical School.
Austrian economics after 1920 can be broken into two general trends. One, exemplified by Friedrich A. Hayek, while distrusting many neoclassical concepts (like most of the corpus of Keynesian macroeconomics), generally accepts a large part of the neoclassical methodology; the other, exemplified by Ludwig von Mises, seeks a different formalism for economics. The main area of contention between the mainstream and the Austrian school is on their view of the market system as a process, not only to be studied using equilibrium models, but to be viewed as an incessant process that only tends toward a constantly changing equilibrium. This difference is the root of the Austrian business cycle theory, the economic calculation debate, and their different views of monopoly and competition. The second primary area of contention between neoclassical theory and the Austrian school is over the possibility of consumer indifference – neoclassical theory says it is possible, whereas Mises rejected it as being “impossible to observe in practice.” Of observation, Caplan uses an example of clothing choice to explain that, "One can only observe that I choose a green sweater, but this does not rule out the possibility that I was actually indifferent between the green sweater and the blue sweater."[5][15] This is a more philosophical problem, than one directly relevant to the understanding of the operation of the market. The third major dispute arose when Mises and his students argued, building on Czech economist Franz Cuhel,[16] that utility functions are ordinal, and not cardinal; that is, the Austrians contend that one can only rank preferences and cannot measure their intensity. Though Austrians describe this work as being in direct opposition to the neoclassical view at the time,[citation needed] Luce and Raiffa and later, Bryan Caplan, wrote that mainstream theorists have shown that their results hold for all monotonic transformations of utility, and so also hold for ordinal preferences.[17][15][5]
Finally there are a host of questions about uncertainty and the utility of "conventional" financial models raised by Mises and other Austrians, who argue for a fundamentally different means of risk assessment in economics compared to that used by the mainstream. Mises and others argued that numerically accurate "probabilities" could never be assigned to "singular" cases. The utility and accuracy of financial modelling is an on-going source of debate, even within the Austrian School.[18] These questions are directly linked to the dynamic market process approach to economic theory, where it is argued by Mises and others that the unique confluence of events in each moment of time in real markets makes the assignment of "objective" probabilities unrealistic, as these events are intrinsically unique and not capable of numerical probabilistic modelling. Mises and others argued that the application of probabilistic uncertainty would require the ability to exactly replicate objectively similar events to obtain an accurate understanding of the range of probabilistic outcomes of any event, and this is not possible in real markets, where past market events intimately affect the present and the future.
Austrian economics was ill-thought of by most economists after World War II because it rejected mathematical and statistical methods.[19] Its reputation rose somewhat in the late 20th century with the work of Israel Kirzner and Ludwig Lachmann, as well as a renewed interest in Hayek after he won the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel (a.k.a. the Nobel Prize in Economics).[20] Following Hayek, one of Ludwig von Mises's students, Murray Rothbard, became prominent in both Austrian applied theory and Libertarian philosophical thought.[21] However, it remains a distinctly minority position, even in such areas as capital value. Currently, universities with a significant Austrian presence are Loyola University New Orleans and Auburn University in the United States and Universidad Francisco Marroquín in Guatemala. The library of Universidad Francisco Marroquín is named after Ludwig von Mises, and the university also provides seminars and lectures through a program named for Austrian School proponent Henry Hazlitt. Austrian economic ideas are also promoted heavily by bodies such as the Mises Institute and the Foundation for Economic Education.
According to economist Peter J. Boettke, during its history the position of the Austrian School within economics profession has changed several times from the center to the fringe of the mainstream, and currently its position lies between mainstream and heterodox economics.[3]
The former U.S. Federal Reserve Chairman, Alan Greenspan, speaking of the originators of the School, said in 2000, "the Austrian school have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country."[22]
Nobel Laureate James M. Buchanan is sometimes considered to be a member of the Austrian School[23][24] and he stated that, "I certainly have a great deal of affinity with Austrian economics and I have no objections to being called an Austrian. Hayek and Mises might consider me an Austrian but, surely some of the others would not."[25] Republican U.S. congressman Ron Paul is a firm believer in Austrian school economics and has authored six books on the subject.[26][27] Paul's former economic adviser, Peter Schiff,[28] is an adherent of the Austrian school.[29] Jim Rogers, investor and financial commentator, also considers himself of the Austrian School of economics,[30] as does political columnist Vox Day.
Austrian economists reject empirical, statistical methods and artificially constructed experiments as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of human beings are too complex for this treatment. Instead one should isolate the logical processes of human action. Von Mises called this discipline "praxeology" – a term he adapted from Alfred Espinas (but which had been in use by others).[31]
The Austrian praxeological method is based on the heavy use of logical deduction from what they assert to be self-evident axioms or undeniable facts about human existence. The primary axiom from which Austrian economists deduce further certain conclusions is the action axiom which holds that humans take conscious action toward chosen goals.[32] Austrian economists focus on action and say that it is undeniable because in order to deny action, one would have to employ action in the act of denial.
Methodology is the one area where Austrian economists differ most significantly from other schools of economic thought. Mainstream schools such as the neoclassical economists, the Chicago school of economics, the Keynesians and New Keynesians, adopt mathematical and statistical methods, and focus on induction to construct and test theories; while Austrian economists reject this approach in favor of deduction and logically deduced inferences. Austrian economists stress deduction because deduction, if performed correctly, leads to certain conclusions and inferences that must be true where the underlying assumptions are accurate. Austrian economist, Robert Murphy, says that those using Austrian theories can still err in their interpretations of history, even if based on a theory formulated by deduction[33]; Caplan makes a similar point about quantitative significance, explaining that a theory, such as one which logically relates minimum wage and unemployment, tells nothing of the approximate quantity of change in unemployment one can expect upon minimum wage increases.
Austrian economists do not discount induction, but they hold that it does not assure certainty like deduction. Mainstream economists hold that conclusions that can be reached by pure logical deduction are limited and weak.[34]
Critics of the Austrian school contend that by rejecting mathematics and econometrics, it has failed to contribute significantly to modern economics. Additionally, they contend that its methods currently consist of post-hoc analysis and do not generate testable implications; therefore, they fail the test of falsifiability.[5] Austrian economists contend that testability in economics is virtually impossible since it relies on human actors who cannot be placed in a lab setting without altering their would-be actions.
Austrian school theorists, like Ludwig von Mises, insist that praxeology must be value-free—that the method does not answer the question "should this policy be implemented?", but rather "if this policy is implemented, will it have the effects you intend"? However, Austrian economists often make policy recommendations that call for the elimination of government regulations and their policy prescriptions often overlap with libertarian or anarcho-capitalist solutions. These recommendations are similar to, but further reaching than the minarchist ideas of Chicago School economists, and frequently address issues that other schools ignore, such as monetary reform.[35] Both schools advocate strict protection of private property, and support for individualism in general,[36] and are often cited by libertarian, classical or laissez-faire liberal, fiscal conservative, and Objectivist groups for support.
Austrian economists view entrepreneurship as the driving force in economic development, see private property as essential to the efficient use of resources, and usually (if not always) see government interference in market processes as counterproductive. In this, their views do not differ far from those of the Chicago school.
As with neoclassical economists, Austrian economists reject classical cost of production theories, most famously the labor theory of value. Instead they explain value by reference to the subjective preferences of individuals. This psychological aspect to Menger's economics has been attributed to the school's birth in turn of the century Vienna. Supply and demand are explained by aggregating over the decisions of individuals, following the precepts of methodological individualism, which asserts that only individuals and not collectives make decisions, and marginalist arguments, which compare the costs and benefits for incremental changes.
Contemporary neo-Austrian economists claim to adopt economic subjectivism more consistently than any other school of economics and reject many neoclassical formalisms. For example, while neoclassical economics formalizes the economy as an equilibrium system with supply and demand in balance, Austrian economists emphasize its dynamic, perpetually dis-equilibrated nature.
The opportunity cost doctrine was first explicitly formulated by the Austrian economist Friedrich von Wieser in the late 19th century.[37] In its original and purist sense, opportunity cost doctrine argues that the only cost relevant to the price of a product is the cost involved in choosing it over other competing, and mutually exclusive, options, and its technical coefficients of production. In the 1930s Gottfried Haberler applied the doctrine to the problems of foreign trade, confident that much of the work done in classical economics to incorporate the much broader array of costs in price analysis could be abandoned.[38]
This focus on opportunity cost alone means that their interpretation of the time value of a good has a strict relationship: since goods will be as restricted by scarcity at a later point in time as they are now, the strict relationship between investment and time must also hold. A factory making goods next year is worth much less than the goods it is making next year are worth. This means that the business cycle is driven by mis-coordination between sectors of the same economy, caused by money not carrying incentive information correct about present choices, rather than within a single economy where money causes people to make bad decisions about how to spend their time.
Some general contributions of Austrian economists:
The Austrian School has consistently argued that a "traditionalist" approach to inflation yields the most accurate understanding of the causes (and the cure) for inflation. Austrian economists maintain that inflation is by definition always and everywhere simply an increase in the money supply (i.e. units of currency or means of exchange), which in turn leads to a higher nominal price level for assets (such as housing) and other goods and services in demand, as the real value of each monetary unit is eroded, loses purchasing power and thus buys fewer goods and services.
Given that all major economies currently have a central bank supporting the private banking system, almost all new money is supplied into the economy by way of bank-created credit (or debt). Austrian economists believe that this bank-created credit growth (which forms the bulk of the money supply) sets off and creates volatile business cycles (see Austrian Business Cycle Theory) and maintain that this "wave-like" or "boomerang" effect on economic activity is one of the most damaging effects of monetary inflation.
According to the Austrian Business Cycle Theory, it is the central bank's policy of ineffectually attempting to control the complex multi-faceted ever-evolving market economy that creates volatile credit cycles or business cycles, and, as a necessary by-product, inflation (especially in asset markets). By the central bank artificially "stimulating" the economy with artificially low interest rates (thereby permitting excessive increases in the money supply), the government-sponsored central bank itself allows debasement of the means of exchange (inflation), often focused in asset or capital markets, resulting in "false signals" going out to the market place, in turn resulting in clusters of malinvestments, and the artificial lowering of the returns on savings, which eventually causes the malinvestments to be liquidated as they inevitably show their underlying unprofitability and unsustainability.[43]
Austrian School economists therefore regard the state-sponsored central bank as the main cause of inflation, because it is the institution charged with the creation of new currency units, referred to as bank credit. When newly created bank credit is injected into the fractional-reserve banking system, the credit expands, thus enhancing the inflationary effect.[44]
The Austrian School also views the "contemporary" definition of inflation as inherently misleading in that it draws attention only to the effect of inflation (rising prices) and does not address the "true" phenomenon of inflation which they believe is the debasement of the means of exchange. They argue that this semantic difference is important in defining inflation and finding a cure for inflation. Austrian School economists maintain the most effective cure is the strict maintenance of a stable money supply.[45] Ludwig von Mises, the seminal scholar of the Austrian School, asserts that:
Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.[46]
Following their definition, Austrian economists measure the inflation by calculating the growth of what they call 'the true money supply', i.e. how many new units of money that are available for immediate use in exchange, that have been created over time.[47][48][49]
This interpretation of inflation implies that inflation is always a distinct action taken by the central government or its central bank, which permits or allows an increase in the money supply.[50] In addition to state-induced monetary expansion, the Austrian School also maintains that the effects of increasing the money supply are magnified by credit expansion, as a result of the fractional-reserve banking system employed in most economic and financial systems in the world.[51]
Austrian School economists claim that the state uses inflation as one of the three means by which it can fund its activities, the other two being taxing and borrowing.[52] Therefore, they often seek to identify the reasons for why the state needs to create new money and what the new money is used for. Various forms of military spending are often cited as reasons for resorting to inflation and borrowing, as this can be a short term way of acquiring marketable resources and is often favored by desperate, indebted governments.[53] In other cases, the central bank may try avoid or defer the widespread bankruptcies and insolvencies which cause economic recessions or depressions by artificially trying to "stimulate" the economy through "encouraging" money supply growth and further borrowing via artificially low interest rates.[54]
Accordingly, many Austrian School economists support the abolition of the central banks and the fractional-reserve banking system, and advocate instead a return to money based on the gold standard, or less frequently, free banking.[55][56] Money could only be created by finding and putting into circulation more gold under a gold standard.
At the beginning of his career Alan Greenspan, former chairman of the Federal Reserve, was also a strong advocate of the Gold Standard as a protector of economic liberty:
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard. [57]
Advocates argued that the Gold Standard would constrain unsustainable and volatile fractional-reserve banking practices, ensuring that money supply growth ("inflation") would never spiral out of control.[58][59] Ludwig von Mises asserted that civil liberties would be better protected:
It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings.[60]
According to Austrian School economist Joseph Salerno, what most distinctly sets the Austrian school apart from neoclassical economics is the Austrian Business Cycle Theory: [1]
The Austrian theory embodies all the distinctive Austrian traits: the theory of heterogeneous capital, the structure of production, the passage of time, sequential analysis of monetary interventionism, the market origins and function of the interest rate, and more. And it tells a compelling story about an area of history neoclassicals think of as their turf. The model of applying this theory remains Rothbard's America's Great Depression.
Austrian School economists focus on the amplifying, "wave-like" effects of the credit cycle as the primary cause of most business cycles. Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set "artificial" interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles" and "artificially" low savings.[61]
According to the Austrian School business cycle theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable "monetary boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas which would not attract investment if the money supply remained stable. Economist Steve H. Hanke identifies the financial crisis of 2007–2010 as the direct outcome of the Federal Reserve Bank's interest rate policies as is predicted by Austrian school economic theory.[62]
Austrian School economists argue that a correction or "credit crunch" – commonly called a "recession" or "bust" – occurs when credit creation cannot be sustained. They claim that the money supply suddenly and sharply contracts when markets finally "clear", causing resources to be reallocated back toward more efficient uses.
The economic calculation problem is a criticism of socialist economics. It was first proposed by Ludwig von Mises in 1920 and later expounded by Friedrich Hayek.[7][63] The problem referred to is that of how to distribute resources rationally in an economy. The capitalist solution is the price mechanism; Mises and Hayek argued that this is the only viable solution, as the price mechanism co-ordinates supply and investment decisions most efficiently (provided there are no relevant government policies or banks operating fractional reserve banking). Without the information efficiently and effectively provided by market prices, socialism lacks a method to efficiently allocate resources over an extended period of time in any market where the price mechanism is effective (an example where the price mechanism may not work is in the relatively confined area of public and common goods). Those who agree with this criticism argue it is a refutation of socialism and that it shows that a socialist planned economy could never work in the long term for the vast bulk of the economy and has very limited potential application. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by economic historians as the The Socialist Calculation Debate.[64] Ludwig von Mises argued in a famous 1920 article "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if government owned the means of production, then no prices could be obtained for capital goods as they were merely internal transfers of goods in a socialist system and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily inefficient since the central planners would not know how to allocate the available resources efficiently.[64] This led him to declare "…that rational economic activity is impossible in a socialist commonwealth."[7]
Critics have concluded that modern Austrian economics generally lacks scientific rigor,[5][65] which forms the basis of the most prominent criticism of the school. Austrian theories are not formulated in formal mathematical form,[66] but by using mainly verbal logic and what proponents claim are self-evident axioms. Mainstream economists believe that this makes Austrian theories too imprecisely defined to be clearly used to explain or predict real world events. Economist Bryan Caplan noted that, "what prevents Austrian economists from getting more publications in mainstream journals is that their papers rarely use mathematics or econometrics."
A related criticism[67][68] is applied to Austrian School leaders; these leaders have advocated a rejection of methods which involve directly using empirical data in the development of (falsifiable) theories; application of empirical data is fundamental to the scientific method.[69] In particular, Austrian School leader, Ludwig von Mises, has been described as the mid-20th century's "archetypal 'unscientific' economist."[70] Mises wrote of his economic methodology that "its statements and propositions are not derived from experience... They are not subject to verification or falsification on the ground of experience and facts."[71] Also, Murray Rothbard was an adherent of Mises's methodology (and though Rothbard assigned a sort of empirical description to it, he comments that "it should be obvious that this type of 'empiricism' is so out of step with modern empiricism that I may just as well continue to call it a priori for present purposes"[72]). Additionally, the prominent Austrian, F. A. Hayek, stated his belief that social science theories can "never be verified or falsified by reference to facts."[73] Such rejections of empirical evidence in economics by Austrian School leaders have led to the school being dismissed within the mainstream.[67]
Another general criticism of the School is that although it claims to highlight shortcomings in traditional methodology, it fails to provide viable alternatives for making positive contributions to economic theory.[74] In his critique of Austrian economics, Caplan stated that Austrian economists have often misunderstood modern economics, causing them to overstate their differences with it. He argued that several of the most important Austrian claims are false or overstated. For example, Austrian economists object to the use of cardinal utility in microeconomic theory; however, microeconomic theorists go to great pains to show that their results hold for all monotonic transformations of utility, and so are true for purely ordinal preferences.[5][15] Caplan has also criticized the school for rejecting on principle the use of mathematics or econometrics. In response, Austrians argue that neoclassical economists fail to recognize hidden (and not necessarily true) assumptions they make to arrive to tractable mathematical models.[75] Austrians also claim that econometrics is fundamentally based on mathematically and logically invalid summation and averaging of demonstrably non-additive personal utility functions, and therefore is subjective.[76]
There are also criticisms of specific Austrian theories. For example, Nobel laureate and neo-Keynesian economist Paul Krugman argued that Austrian business cycle theory implies that consumption would increase during downturns, and cannot explain the empirical observation that spending in all sectors of the economy fall during a recession.[77] Austrian theorists argue a recession can result from a monetary contraction or a "credit crunch" that causes the investment boom not to shift but simply to disappear.[78] Nobel laureate Milton Friedman, after examining the history of business cycles in the US, concluded that "The Hayek-Mises explanation of the business cycle is contradicted by the evidence. It is, I believe, false."[79][80]
Economist Jeffrey Sachs states that when comparing developed free-market economies, those that have high rates of taxation and high social welfare spending perform better on most measures of economic performance compared to countries with low rates of taxation and low social outlays. He asserts that poverty rates are lower, median income is higher, the budget has larger surpluses, and the trade balance is stronger (although unemployment tends to be higher). He concludes that Friedrich Hayek was wrong when he said that high taxation would be a threat to freedom; but rather, a generous social-welfare state leads to fairness, economic equality, international competitiveness, and strong vibrant democracies.[81] In response to Sachs' article, William Easterly states that Hayek, writing in 1944, correctly recognized the dangers of large-scale state economic planning. He also questions the validity of comparing poverty levels in the Nordic countries and the United States, when the former have been moving away from social planning toward a more market-based economy, and the latter has historically taken in impoverished immigrants. Easterly also argues that laissez-faire countries were the leaders of "the ongoing global industrial revolution" which is responsible for abolishing much of the world's poverty.[82]
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