The Empirics of Austrian Economics

The housing boom and subsequent financial crisis, recession, and weak recovery, as well as Ron Paul’s presidential candidacy, have put the Austrian school of economics in the public spotlight, particularly among the intellectual class in the media and on the Internet. This increased attention has also meant increased criticism. One frequent charge is that Austrian economics is radically anti-empirical and cares little about putting its theories up against the reality of the world.

This criticism often focuses on Austrians’ use of “praxeology” as their term for economics. Some Austrians do indeed talk about the “a priori” nature of praxeology and how the theories it produces, such as the Austrian business cycle theory, cannot be “tested” by empirical data, which they contrast with the “apodictic certainty” of certain of their own conclusions. Such claims can be found in the work of the 20th century Austrians, such as Ludwig von Mises and, particularly, Murray Rothbard. (It is worth noting that this way of talking about Austrian theory is mostly absent in the work of F. A. Hayek.)

But it is not the case, as Josh Barro recently argued, “that Austrian economists reject empirical analysis, and instead believe that you can reach conclusions about correct economic policies from a priori principles.” To say so is to misinterpret what Mises meant by the word praxeology and therefore fail to understand what he recommended as the appropriate methods for economists. It is also to rely on interpretations of what people like Mises and Rothbard had to say, as well as the pronouncements of various advocates of Austrian economics on blogs and Internet forums, rather than engaging with the professional research being published in the peer-reviewed journals by practicing Austrians. That research offers a very different picture of the way in which Austrian economics engages the real world. Finally, as that research demonstrates, modern Austrians distinguish among “empirical evidence,” “quantitative data,” and “statistical correlation” in such a way that allows all of them, though less so the third, to play a role in their work. Rather than being anti-empirical, modern Austrian economists are trying to open up the box of what counts as “empirical evidence” to include forms normally dismissed out of hand by the rest of the profession. Arguably, then, modern Austrians might well be more empirical than other economists, at least as judged by their professional work.

Despite the impression that one might get from reading some Austrians, Mises’s term “praxeology” was not intended to be a “method” for economists. Instead, that term, which has roots in the Greek for “action,” described a field of study. That field comprised all the “sciences of human action,” or anything that dealt with humans as purposive actors rather than mere biological beings. So what today we would call economics, political science, anthropology, and sociology would all fall in this group, though human biology would not. In fact, Mises wanted to use the term “sociology” to describe these sciences of human action but thought that modern positivist sociology had corrupted the term too much for it to be valuable. Within praxeology, he argued, economics was the most well-developed branch. He used the term “catallactics” (or the “science of exchange”) to describe what we would today call economics. Catallactics was the sub-field of praxeology that studied human action involving market phenomena and monetary calculation.

Mises spends an entire chapter of Human Action on “the scope and method of catallactics.” In that chapter, he writes “the specific method of economics is the method of imaginary constructions.” This, however, was anything but fanciful; he goes on to explain how these constructions are “conceptual image[s] of a sequence of events logically evolved from the elements of action employed in its formation.”[1] One can see this in the way economists use supply and demand curves and the concept of equilibrium. These imaginary constructions are the product of logical deductions that start with the basic idea of purposive action, namely that humans seek to remove the felt uneasiness of unsatisfied ends by finding means effective for satisfying them. Mises argues that it is irrefutable that we act purposively and further argues that purposive action logically implies some important observations about human action that are just as “apodictically certain” as is the claim about action.

There is much debate among Austrians about how extensive that additional set of certain claims is. Some Austrians argue as if one can deduce all of economics in one’s armchair, but Mises was pretty clear that this core of economics was fairly limited. He points out that even the notion that labor is unpleasant is not part of that core, but rather an auxiliary assumption we make based on observation. So too is the existence of things like money. When the economist goes to analyze the world, the core toolkit that comes only from reflection on action is a rather small set of basic propositions. Most of the interesting work in economics is institutionally contingent. For example, even if we recognize the importance of being able to engage in economic calculation, our ability to do so effectively depends upon the set of institutions in the economy under analysis. Moving from what Carl Menger called “exact laws” or pure theory, to applied theory means we must include the human beliefs and social institutions of the empirical world. Going from applied theory to economic history, including contemporary analyses, we need to dig into the actual empirical record of what people did and thought, as well as the relevant economic data.

In short, Mises was making a Kantian claim about the human mind and the way in which minds are similarly structured across humans. We all have “a set of tools for grasping reality” that comes to us from our evolutionary heritage. The commonality of those tools allows us to engage in the reflection on action and the development of that core of economics as a set of necessary insights about how humans act. This core economic knowledge is not contingent but part of the very structure of human minds and is something that we can come to know.

Mises did argue that these core claims of economics (e.g., that people act purposively, that we prefer more to less and now to later, the idea of diminishing marginal utility, and perhaps the basic idea behind demand and supply curves) are not open to empirical proof because they are, or stem from, the very organizing principles of our attempts to understand the world. However, beyond that, and especially including any claims about policy, economic arguments depend upon contingent claims about human behavior and preferences, the applicability of our assumptions, and the accuracy of our chains of argument. Good economics for Austrians means sound arguments, not just valid ones. Too much of modern economics consists of valid reasoning from false premises about human action. The accuracy of those premises matter greatly for Austrians.

That is one reason why subjectivism is more important than praxeology for understanding Austrian applied research. Economics is radically subjectivist in the sense that human action depends upon the perceptions of the world held by the actor. All explanations of praxeological phenomena, i.e., any application of economics to the real world, must start with the actor and her beliefs about the world, including the limits to our knowledge and ability to optimize. As Menger wrote in the founding work of the Austrian school, “man, with his needs and his command of the means to satisfy them, is himself the point at which human economic life both begins and ends.”[2] From those beliefs, Austrians use the structure of economics to understand those choices and their consequences, especially the unintended ones.

Subjectivism also explains Austrian skepticism about statistical correlation being the privileged form of empirical evidence. It only provides correlation, and to provide causation requires a theoretical explanation. If such explanations must start with actors’ perceptions of the world, then forms of empirical evidence that capture such perceptions would be at least as useful. Austrians therefore frequently turn to primary source material and interview and survey work as well as quantitative data to tell a complete story of how a particular economic phenomenon came to be and functioned. How did actors perceive their options and constraints and what sorts of consequences emerged from their choices? That is the fundamental narrative framework for Austrian empirical work, with economic theory providing structure to the story.

Barro and other critics of Austrian economics are very quick to ignore the actual published work by modern Austrian economics that makes use of these sorts of empirical evidence. Austrian economics was part of the academic discipline of economics long before Ron Paul and the recent public attention, so if one wants to judge it, one should be looking at the work published in the professional journals and books by the dozens of Austrians teaching at universities in the United States and around the world. Most Austrian research in the last decade or two has not attempted to spin out yet more economic theory, but has used Austrian theory to offer better explanations of real-world phenomena. Although that work might be used in service of policy arguments (as is true of the work of many economists), it is usually concerned with a better understanding of some recent or past economic phenomenon.

An exhaustive list of Austrian work that attempts to confront and better explain the real world, of either the past or present, would be too long for this forum, which is part of my point. I will, however, summarize and cite a representative sample. Books by Boettke (1990) and Prychitko (1991) took detailed looks at the early years of the Soviet Union and Yugoslav self-management respectively to understand the workings of two forms of socialism. My own early research (Horwitz 1990) focused on the history of banking in the United States before the Federal Reserve, making use of primary source documents and data to explore the panics under the National Banking System.[3] Later work, such as Stringham (2003), has explored the functioning of the Amsterdam financial markets in the 17th century as a case study in the endogenous development of rules. Austrians have looked at the economies of Ireland, Somalia, and Botswana to understand economic development processes and the role played by formal and informal institutions in furthering economic growth. Coyne (2007) used core Austrian ideas to assess U.S. foreign policy and attempts at state-building in the middle east, while Leeson’s (2009) well-known work on pirates makes use of Austrian ideas to explore the way in which informal institutions arise and promote trust and social cooperation even in the hard case of criminal organizations.[4] As noted earlier, Austrians have written a large number of pieces on the Great Recession, most of which have been attempts to make sense of what happened and why by confronting Austrian business cycle theory with the historical events and data. They have often argued that while the Austrian theory is an important component of the story, the canonical version of the theory cannot explain everything.

Perhaps the most thorough and effective empirical work by Austrians in recent years is that associated with the Mercatus Center’s research project on Hurricane Katrina. Starting with a whole series of interviews conducted with Gulf residents as well as deep investigation into the events before and after the storm, Austrians produced a number of papers exploring the role of local communities and the private sector in generating recovery. Principal investigator Peter Boettke was lead author on an overview article (Boettke et. al., 2007) that appeared in the mainstream Southern Economic Journal. That piece along with the book by Emily Chamlee-Wright (2010), as well as her Rationality and Society article with Virgil Storr (Chamlee-Wright and Storr 2009), and articles by Lesson and Sobel (2007) and Horwitz (2009) exemplify this work.[5] The core insights of this work about the effectiveness of community and private recovery efforts have significantly influenced the post-Katrina narrative, arguably because they were based so thoroughly in the data generated by the interviews and the careful treatment of history.[6] They were also published in places other than explicitly Austrian journals or book series. The equally careful empirical research, both historical and contemporary, on banking by Austrian-influenced economists such as Larry White and George Selgin has moved the debate over our understanding of central banking and financial regulation. Their recent Journal of Macroeconomics paper with Lastrapes (Selgin, Lastrapes, and White 2012) on the history of the Fed is a good example, especially of how to make good use of quantitative data.[7]

All of this research is quite “falsifiable,” if by that we mean “open to revision by later researchers,” including other Austrians who come up with new or better data or better explanations for the phenomena in question. There is nothing “a priori” or “apodictically certain” about this work. Instead, Austrians are trying to open up what counts as “empirical” to a broader range of evidence than is methodologically permissible in the mainstream of economics. Austrians can make use of econometric evidence in a limited and careful way (and a few have), but they are more likely to make use of primary source historical evidence and non-econometric quantitative data to make their arguments. Mises and others rightly pointed out that statistical correlations are purely historical data, just like the qualitative data we find interviews and newspapers, and therefore should have no greater role than those other forms of data in doing historical analysis.

Despite the pretensions of many mainstream economists, their empirical studies, including newer work in experimental economics, do not have quite the same scientific power as experiments in the natural sciences do. Deirdre McCloskey’s cautions about the significance of statistical significance are to the point and often ignored by economists. As she argues, what we want is economic significance, not just statistical significance, and that is a point on which Austrians would agree. For Austrians, the goal is to provide economic analyses that use empirical evidence that is economically significant. Rendering human action intelligible means telling better stories about what happened and why. Economic theory provides the framework for organizing the plot, and the richness of the human experience, whether in the form of primary sources, interview and survey data, economic statistics, or econometric correlations, provides the particulars that make for a complete and empirically relevant story. Basing it all on realistic and empirically relevant assumptions about human knowledge and choice makes it not just valid, but sound economic reasoning.

Austrian economics is not, despite what critics argue, anti-empirical. The core of its theory emerges from what we can know empirically about human beings, both universally and in the particulars of a context of application. That theory is then used to offer a better understanding of history and contemporary events by organizing a wide range of empirical data into a coherent narrative that renders those events intelligible. We can never have the knock-down power of the scientist’s laboratory (though even there, rhetoric and storytelling matter a great deal), so the best we can do as economists is tell better-organized, more richly empirical, and more logically valid stories. If we economists limit ourselves to just econometric evidence, we are cutting ourselves off from important parts of the empirical world, and it is those who do so, and not the Austrians, who are being insufficiently empirical.

Notes

[1] Ludwig von Mises, Human Action, Chicago: Rengery, 1966, p. 236.

[2] Carl Menger, Principles of Economics, New York: NYU Press 1981 [1871], p. 108.

[3] Peter J. Boettke, The Political Economy of Soviet Socialism: The Formative Years, 1918-1928, Boston: Kluwer Academic Press, 1990; David L. Prychitko, Marxism and Workers’ Self-Management, Westport, CT: Greenwood Press, 1991; Steven Horwitz, “Competitive Currencies, Legal Restrictions and the Origins of the Fed: Some Evidence from the Panic of 1907,” Southern Economic Journal 56(4), January 1990.

[4] Edward Peter Stringham, “The Extralegal Development of Securities Trading in Seventeenth Century Amsterdam.” Quarterly Review of Economics and Finance 43(2) Summer 2003. Christopher J. Coyne, After War: The Political Economy of Exporting Democracy, Stanford: Stanford University Press, 2007; Peter Leeson, The Invisible Hook: The Hidden Economics of Pirates, Princeton: Princeton University Press, 2009.

[5] Peter J. Boettke, Emily Chamlee-Wright, Peter Gordon, Sanford Ikeda, Peter Leeson, and Russell Sobel, “The Political, Economic, and Social Aspects of Katrina,” Southern Economic Journal 74(2), 2007; Emily Chamlee-Wright The Cultural and Political Economy of Recovery: Social Learning in a Post-Disaster Environment, New York: Routledge, 2010; Emily Chamlee-Wright and Virgil Storr, “Club Goods and Post-Disaster Community Return,” Rationality and Society 21(4), 2009.

[6] Russell Sobel and Peter Leeson, “The Use of Knowledge in Natural Disaster Relief Management,” The Independent Review 7(4), Spring 2007; Steven Horwitz, “Wal-Mart to the Rescue: Private Enterprise’s Response to Hurricane Katrina,” The Independent Review 13(4), Spring 2009, pp. 511-28. Numerous examples of the Katrina research can be found in Emily Chamlee-Wright and Virgil Storr, eds., The Political Economy of Hurricane Katrina and Community Rebound, Northampton, MA: Edward Elgar, 2010.

[7] George Selgin, William Lastrapes, and Lawrence H. White, “Has the Fed Been a Failure?” Journal of Macroeconomics 34(3), September 2012.