Hayek and Praxeology

One of the most important factors that inhibited the study of praxeology for the last 60 years was Friedrich Hayek's argument that praxeology is inapplicable to the study of market phenomena. His argument against praxeology (which he called the "Pure Logic of Choice") is relatively simple. The pure logic of choice, as Hayek understood it, entails an analytical relationship between (1) the object of an actor's action, and (2) the actor's action. Here is the key passage from Hayek's essay "The Facts of the Social Sciences":

From the fact that whenever we interpret human action as in any sense purposive or meaningful, whether we do so in ordinary life or for the purposes of the social sciences, we have to define both the objects of human activity and the different kinds of actions themselves, not in physical terms but in terms of the opinions or intentions of the acting persons, there follow some very important consequences; namely, nothing less than that we can, from the concepts of the objects, analytically conclude something about what the actions will be. If we define an object in terms of a person's attitude toward it, it follows, of course, that the definition of the object implies a statement about the attitude of the person toward the thing. When we say that a person possesses food or money, or that he utters a word, we imply that he knows that the first can be eaten, that the second can be used to buy something with, and that the third can be understood — and perhaps many other things.

Hayek's conception of praxeology or the pure logic of choice is a kind of conceptual analysis. If we say the object confronting the actor is food, we can analytically conclude that the actionassociated with that object will be eating. If the object confronting the actor is money, we can analytically conclude that the action associated with that object will be buying or selling, etc. Thus, Hayek conceives an analytic or logically necessary relationship between (1) the object that we, as social scientists, assume confronts an actor, and (2) the action the actor will perform based on the assumption of the object that confronts that actor. We can see that the analytic relationship Hayek conceives is between an object appearing to an observed or studied actor, and the action that must, by conceptual analysis, "accompany" that object.

Hayek then makes the following point. The market is comprised of the interactions of a number of people. When we study the market, we study the relationship between of a number of people, notan individual actor and the relationship between his action and the object of his action.

Here are the relevant passages from Hayek's essay "Economics and Knowledge":

I have long felt that the concept of equilibrium itself and the methods which we employ in pure analysis have a clear meaning only when confined to the analysis of the action of a single person and that we are really passing into a different sphere and silently introducing a new element of altogether different character when we apply it to the explanation of the interactions of a number of different individuals.…

The sense in which we use the concept of equilibrium to describe the interdependence of the different actions of one person does not immediately admit of application to the relations between actions of different people.

To get a clear idea of Hayek's point, let us consider ourselves social scientists looking at a local marketplace from the top of a nearby building. We see many people in the marketplace interacting: buying, selling, talking, eating, etc. To each of these individual actors, the pure logic of choice, as described above, applies. If one actor has food, the action analytically associated with this is eating; if one actor has money, the action analytically associated with this is buying, etc.

But this method of analysis does not apply to the relationship between actors. If one actor has food, this doesn't say anything about the action of a second, different actor.

Thus, the pure logic of choice (praxeology) does not apply to study of the market.

This argument of Hayek's constitutes the fundamental difference between the Misesian and the Hayekian conception of economics. The fundamental proposition of Hayekian economics is that market study can only be empirical, not a priori. In other words, praxeology is inapplicable to market study:

What I see only now clearly is the problem of my relationship to Mises, which began with my 1937 article on the economics of knowledge, which was an attempt to persuade Mises himself that when he asserted that the market theory was a priori, he was wrong; that what was a priori was only the logic of individual action, but the moment that you passed from this to the interaction of many people, you entered into the empirical field. (Hayek on Hayek, p. 72)

As Hayek's argument against praxeology is relatively simple, so is it simple to see the flaw in Hayek's argument. We may ask, when a marketplace is the object of the actor's action (when the actor observes a market, or when he walks in a market, or when he buys in a market) why can't we draw an analytical conclusion from this object of the actor's action? Or, when a price is the object of the actor's action (when the actor observes a price, or asks a price, or pays a price), why can't we draw an analytical conclusion from this object of the actor's action? In short, why can't we arrive at analytical conclusions regarding any social object or social phenomenon or any market object or market phenomenon, by understanding them to be objects of an actor's action, and drawing analytical conclusions from these objects as Hayek indicates?

If we say an actor possess food, and from this we may analytically arrive at the action eating, then when the actor visits a market, why may we not analytically arrive at the action shopping? And when the actor considers a price, why may we not analytically arrive at the action purchasing?

By the terms of Hayek's own conception of praxeology it would seem this analytical method should be applicable to the objects or phenomena of the market, and this would constitute "a priori" analysis of the market.

Furthermore, this same procedure should be applicable to other social objects and social phenomena such as languages, laws, families, etc.

One other important aspect of Hayek's critique should be noted. Recall that when Hayek describes the procedure of the pure logic of choice, he does so in terms of a third-person narrative. Hayek writes,

When we say that a person possesses food or money, or that he utters a word, we imply that he knows that the first can be eaten, that the second can be used to buy something with, and that the third can be understood — and perhaps many other things. (emphasis added)

Hayek here refers to a hypothetical actor whom the scientist observes or studies. The question is, what about the case when it is the social scientist himself who interacts with the object or phenomenon in question? Let's say that the social scientist visits a farmer's market or pays a price for something in this same market, or pays interest on a loan. Because the market, the price, the loan, and the interest, appear to the scientist as objects of his own action, what prevents the scientist from drawing analytical conclusions about action from these objects that appear to him? Is there something that obligates the social scientist to study only the relationship between the objects and actions of other people? What prevents the scientist from studying the relationship between his own actions and the objects of his actions?

Thus, there are two problems with Hayek's critique of praxeology:

1. Hayek doesn't explain why the pure logic of choice can't be applied to study of the market, by considering market phenomena as objects of action (visiting a market, paying a price, etc.) and then drawing analytical conclusions from the concepts of those objects.
2. Hayek doesn't explain why the social scientist can't draw analytical conclusions about the relationship between his own actions and the objects of his actions.

As should be clear, these are problems in the application and understanding of Hayek's own conception of praxeology. Above, we assume that Hayek's conception of praxeology is valid and is the same as Mises's, and we simply ask "if praxeology applies to objects a, b, and c, why doesn't praxeology apply to objects x, y, and z?" And we ask "if praxeology applies to the objects of A's action, why doesn't praxeology apply to the objects of B's action?" Hayek agrees that it is possible to draw analytical conclusions from objects a, b, and c by considering them objects of the action of actor A. We simply ask why we can't draw analytical conclusions from objects x, y, and z by considering them objects of the action of actor B? We're asking why Hayek's principles don't apply to objects and persons besides the specific ones Hayek uses to illustrate his principles.

It should be noted though that Hayek's conception of the pure logic of choice is not identical to Mises's conception of praxeology. Hayek's pure logic of choice is a kind of conceptual analysis. Misesian praxeology is not concerned with conceptual analysis per se; it is concerned with the formal structure of action. These two things are not necessarily the same. As Mises conceives things,

Praxeology is not concerned with the changing content of acting, but with its pure form and its categorial structure. (Human Action)

Thus, as soon as we differentiate the object of action "food" from the object of action "money" (as Hayek does in the pure logic of choice), we are, according to Mises, referring to the changing content of action, and have therefore left praxeology proper.

This shows that Hayek conceives praxeology differently from Mises.

Aside from the questions about the application of Hayek's pure logic of choice, there are serious questions about the knowledge that it could possibly attain.

Recall, for example, that Hayek claims,

We can, from the concepts of the objects, analytically conclude something about what the actions will be.

Is this simple proposition necessarily true? Can we analytically conclude the action of the individual based on the concept of the object that confronts him?

If we say that an actor possesses food, does this mean that the actor will perform the action of eating? Can't an actor possess food but not eat the food? Let's say an actor possesses a ball. Must he throw the ball? If an actor possesses a ball, may we "analytically conclude something about what the actions will be"? The answer seems clearly to be no. Perhaps we can analytically conclude that if an actor possesses a ball, then he also possesses a sphere and an object having an internal volume, etc. Here we have conceptual or tautological analysis, but we have not thereby established a necessary relationship between a particular object and a particular action that an actor possessing that object must perform. The study of concepts is not necessarily identical to the study of action.

Conclusion

One of the fundamental pillars of Hayekian social thought is Hayek's contention that study of the market cannot be a priori. But Hayek seems not to have realized the implications of his own conception of the pure logic of choice. He didn't realize that the method of logical analysis he envisioned could easily be applied to the market and its various objects and phenomena (prices, interest, etc.).

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In conceiving that formal exact science is inapplicable to the study of market phenomena, Hayek's thinking diverges not only from Mises's, but from Menger's as well. Menger'sInvestigations into the Method of the Social Sciences is largely devoted to the proposition that formal exact science is valid in all realms of the world of phenomena, "economy" being but one realm of human phenomena. Thus, Mises's insight that economics is only one branch of praxeology can be traced back to Menger's vision of the "exact approach to cognition." In his Investigations, Menger provided a definition of formal exact science, a science that Mises later termed praxeology:

The aim of this orientation, which in the future we will call the exact one, an aim which research pursues in the same way in all realms of the world of phenomena, is the determination of strict laws of phenomena, of regularities in the succession of phenomena which do not present themselves to us as absolute, but which in respect to the approaches to cognition by which we attain to them simply bear within themselves the guarantee of absoluteness. It is the determination of laws of phenomena which commonly are called "laws of nature," but more correctly should be designated by the expression "exact laws."

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The Dutch West India Company

[This article is excerpted from Conceived in Liberty, volume 1, part 4, "The Rise and Fall of New Netherland." An MP3 audio file of this article, narrated by Floy Lilley, is available for download.]

The Dutch West India Company began operations in 1623, and in the same year the first party of permanent Dutch settlers landed in the New World — apart from a settlement near Cape May on the Delaware Bay in 1614. The new colonists landed in Manhattan. Others in the party settled in Fort Orange. The settlers, significantly, were a party of Walloon émigrés. Appointed governor, or director general, of New Netherland was Capt. Cornelis May. Under May's aegis the Dutch quickly began to expand over the vast virgin territory. Fort Nassau was built on the east bank of the Delaware River (now Gloucester, New Jersey, opposite Philadelphia). Another Dutch party built Fort Good Hope on the Connecticut River, and we have seen the fate meted out to it by the English "planters" of Connecticut. Still other Dutchmen settled on what is now the coast of Brooklyn and on Staten Island.

Why didn't the English, who had laid claim to the whole coast, seriously molest the Dutch settlements? For the first decade the English were busy fighting with Spain and France. After that came the troubles and distractions of the Puritan Revolution. It was only the advent of the Restoration period that enabled England to turn serious attention to exerting its power over New Netherland — as well as over Massachusetts.

In the spring of 1626 Peter Minuit took over as director general, and it was he who, in a series of fateful decisions, laid the pattern of social structure for New Netherland. In the English colonies the chartered companies and proprietors tried to gain immediate profits by inducing rapid settlement. The need for these inducements led to the inevitable dissolution of original attempts to maintain feudal land tenure, as lands were divided up and sold, and halfhearted attempts to collect feudal quitrents from the settlers were abandoned in the face of their stubborn evasion and resistance. Moreover, the need for inducing settlement also led the companies or proprietors to grant, from the beginning, substantial rights of democracy and self-government to the colonists. Happily, none of the English settlements began as royal colonies; either they were settled by individuals, for individual temporal or spiritual gain, or they were governed by profit-seeking companies or proprietors who were induced by hopes of profit to grant substantial or even controlling rights of property and self-government to the settlers. North Carolina, New Hampshire, Maine, Rhode Island, and Connecticut began as individual self-governing settlements; Virginia and Massachusetts as chartered companies; Maryland and South Carolina as proprietorships.

But the Dutch West India Company and Minuit decided quite differently. As profit seekers they first concentrated on their monopoly of the lucrative fur trade, and for this trade extensive settlements were not needed. Whether by design or not, the effect of Dutch policy was to discourage settlement greatly, and to hamper the development of the vast area over which the Dutch West India Company had been assigned its monopoly. For example, one of Minuit's first actions was to order the colonists back, to concentrate them around the fort in New Amsterdam on the tip of Manhattan, which had been purchased from the Indians. This arbitrary policy left only a few traders at Fort Orange and only one vessel on the Delaware, Fort Nassau being completely abandoned. This action stemmed from the company's high-handed decision to retain its exclusive monopoly of trade; to leave too many individuals in the interior would foster illegal, competitive trading. Second, the Dutch perpetuated a feudal type of land tenure by insisting on leasing, rather thanselling, land to the settlers. It is no wonder that with no settler permitted to own his land and thus help to dissolve feudalism and land monopoly — and with no one permitted to trade on his own account — the pace of settlement was very slow.

Furthermore, the form of government was by far the most despotic in the colonies. There was no self-government or democracy, no limitation whatever on the arbitrary rule of the company and its director general. The director, along with a Council of Five appointed by the Amsterdam Chamber, ran the entire government: its legislative, executive, and judicial functions. They were joined by two other officials appointed by the company: the schout-fiscal, who made arrests and collected revenue, and the koopman, the secretary of the colony. There were no legislatures or town meetings of any sort.

By 1629 it was evident that the colony was growing very slowly; only 300 persons, for example, lived in New Amsterdam. The company therefore decided to spur settlement, but instead of dissolving its land monopoly into a system of true private property for landed settlers, it decided to make the monopoly into a more elaborate feudal structure, sub-land monopolists placed over large particular areas in New Netherland. In the Charter of Privileges and Exemptions of 1629, the company decided to grant extensive tracts of land to any of its members who should bring over and settle 50 or more families on the tract. The tracts were required to lie along the banks of the Hudson (or other navigable rivers) and were granted in huge lots of 16 miles along one shore of the Hudson, or 8 miles on both shores. The depth on either side of the Hudson was indefinite. The grantee was termed a "patroon," or lord of the manor. In imitation of the feudal lord, the patroon was to possess civil and criminal jurisdiction over his tenants, or "peasants." The tenants had the formal right of appeal from the patroon's manorial courts to the feudal overlord — the company's government — but in practice the tenants were forced to forgo this right. The property of any tenant dying intestate reverted to the patroon, and the tenant was forced to grind his grain at his patroon's mill. The tenants were exempted from colonial taxation for ten years, but in return they were compelled to stay on the original estate for the entire period. To leave was illegal — an approximation of medieval serfdom.

Aside from being a temporary serf and having no hope of owning the land he tilled, the tenant was also prohibited from weaving any kind of woolen, linen, or cotton cloth. Even the patroons were prohibited from weaving, in order to keep the monopoly of the trade in the hands of the company government and to maintain a monopoly of the colonial market for Dutch textiles. This provision, however, was continually evaded and led to numerous conflicts. Neither tenant nor patroon could engage in the fur trade, which was still reserved to the company and its agents. Apart from these commodities, the patroons were at liberty to trade, but were required to pay a 5 percent duty to the government at New Amsterdam for exporting their goods. The use of slaves in domestic service or in tilling the soil was also sanctioned. The patroons were required, however, to purchase the granted land from the local Indians. It should be noted that Manhattan Island was exempted from the granting of patroonships: the land of that valuable island was to be reserved for the direct monopoly of the company government of the province.

While the incentive to become a tenant remained minimal, the incentive to become a patroon was now considerable. It should not be surprising that the receivers of these handsome grants of special privilege were leaders or favorites of the company itself. Thus, the first patroonship was granted by the company to two members of its own board of directors, Samuel Godyn, president of the Amsterdam Chamber of the Company, and Samuel Blommaert, who granted themselves a large chunk of what is now the state of Delaware, as well as 16 square miles on Cape May across the Delaware Bay. Godyn and Blommaert took five other company directors into partnership to expand the capital of the patroonship, and one of the partners, Capt. David De Vries, was sent with a group of settlers to found the patroonship of Swanendael (now Lewes), near Cape Henlopen in Delaware.

The Swanendael manor was settled in 1631, but the settlement soon ran into difficulties. For one thing, it was chiefly designed as a whaling station, but De Vries soon found that whales were scarce along the Delaware coast. Furthermore, the Swanendael settlers managed to provoke the Indians into attacking and massacring them. The settlers had emptied a pillow, leaving the remains as waste, which happened to contain a piece of tin embossed with the emblem of the States-General of New Netherland. An Indian chief found the abandoned tin and used it for his tobacco pipe, whereupon the settlers, in an act unexcelled for stupidity even in the sordid history of white treatment of Indians, executed the hapless chief for "treason" to the Netherlands. It is hardly puzzling that the Indians proceeded to attack and wipe out the settlement. In addition to these calamities, the patroons then quarreled and dissolved their partnership. They sold the land back to the company government in 1634 for a handsome 15,000 guilders. The first patroonship in New Netherland had proved to be a failure.

The second patroonship was also a failure. Michael Pauw, another of the grasping company directors, managed to obtain a grant for himself of the area that now includes Hoboken, Jersey City, and the whole of Staten Island. Pauw called his colony Pavonia, which he organized on the site of Jersey City for a few years. The Indians, however, proved troublesome and the patroonship was losing money, and so in 1637 Pauw sold the land back to the obliging company for 26,000 guilders (land, of course, that the company had originally granted Pauw as a gift).

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The first successful patroonship — and the only one that continued past the demise of New Netherland and through the 18th century — was the grant to yet another Amsterdam Chamber director, the wealthy jeweler Kiliaen van Rensselaer. Van Rensselaer's domain, Rensselaerswyck, prospered because of superior management and because its area was strategically located for fur trade with the Iroquois. It included virtually the entire area around Albany (now Albany and Rensselaer counties) except Fort Orange itself, which remained the property of the company government.

Immediately there began conflicts between the Hudson River patroons and the government. For the patroons began to ignore the Dutch West India company's legal monopoly of the highly lucrative fur trade, and the company began to tighten its regulations to enforce its monopoly. The patroons' illegal fur trade not only endangered the company monopoly; it also led them to concentrate on furs rather than encourage a large agricultural population, which the company government was now trying to foster. As a consequence, Peter Minuit was fired as director general by the company in 1632, on charges of being too soft on the patroons.

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Murray N. Rothbard (1926–1995) was dean of the Austrian School. He was an economist, economic historian, and libertarian political philosopher. See Murray N. Rothbard's article archives.

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Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

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A Chinese Story

[The Bastiat Collection (2011); originally from the second series of Economic Sophisms (1848)]

There is nothing that is not pretended by the writers in favor of protection to be established as an aid to the working classes — there is positively no exception, not even the custom house. You fancy, perhaps, that the custom house is merely an instrument of taxation like property taxes or the toll bar! Nothing of the kind. It is essentially an institution for promoting the march of civilization, fraternity, and equality. What would you be at? It is the fashion to introduce, or affect to introduce, sentiment and sentimentalism everywhere, even into the toll gatherer's booth.

The custom house, we must allow, has a very singular machinery for realizing philanthropical aspirations.

It includes an army of directors, subdirectors, inspectors, subinspectors, comptrollers, examiners, heads of departments, clerks, supernumeraries, aspirant supernumeraries, not to speak of the officers of the active service; and the object of all this complicated machinery is to exercise over the industry of the people a negative action, which is summed up in the word obstruct.

Observe, I do not say that the object is to tax, but to obstruct. To prevent, not acts that are repugnant to good morals or public order, but transactions that are in themselves not only harmless but fitted to maintain peace and union among nations.

And yet the human race is so flexible and elastic that it always surmounts these obstructions. And then we hear of the labor market being glutted.

If you hinder a people from obtaining its subsistence from abroad it will produce it at home. The labor is greater and more painful, but subsistence must be had. If you hinder a man from traversing the valley he must cross the hills. The road is longer and more difficult, but he must get to his journey's end.

This is lamentable, but we come now to what is ludicrous. When the law has thus created obstacles, and when in order to overcome them society has diverted a corresponding amount of labor from other employments, you are no longer permitted to demand a reform. If you point to the obstacle you are told of the amount of labor to which it has given employment. And if you rejoin that this labor is not created, but displaced, you are answered in the words of the Esprit Public, "The impoverishment alone is certain and immediate; as to our enrichment, it is more than problematical."

This reminds me of a Chinese story, which I will relate to you.

There were in China two large towns, called Tchin and Tchan. A magnificent canal united them. The emperor thought fit to order enormous blocks of stone to be thrown into it for the purpose of rendering it useless.

On seeing this, Kouang, his first mandarin, said to him, "Son of Heaven! This is a mistake."

To which the emperor replied, "Kouang, you talk nonsense."

I give you only the substance of their conversation.

At the end of three months the celestial emperor sent again for the mandarin, and said to him, "Kouang, behold!"

And Kouang opened his eyes, and looked.

And he saw at some distance from the canal a multitude of men at work. Some were excavating, others were filling up hollows, leveling and paving. And the mandarin, who was very cultivated, said to himself, They are making a highway.

When another three months had elapsed, the emperor again sent for Kouang and said to him, "Look!"

And Kouang looked.

And he saw the road completed, and from one end of it to the other he saw here and there inns for travelers erected. Crowds of pedestrians, carts, litters, came and went, and innumerable Chinese, overcome with fatigue, carried back and forth heavy burdens from Tchin to Tchan, and from Tchan to Tchin. And Kouang said to himself, It is the destruction of the canal that gives employment to these poor people. But the idea never struck him that their labor was simply diverted from other employments.

Three months more passed, and the emperor said to Kouang, "Look!"

And Kouang looked. And he saw that the hostelries were full of travelers, and that to supply their wants there were grouped around them butchers' and bakers' stalls, shops for the sale of edible bird nests. He also saw that, the artisans having need of clothing, there had settled among them tailors, shoemakers, and those who sold parasols and fans; and as they could not sleep in the open air, even in the Celestial Empire, there were also masons, carpenters, and slaters. Then there were officers of police, judges, fakirs; in a word, a town with its suburbs had risen round each hostelry.

And the emperor asked Kouang what he thought of all this.

And Kouang said that he never could have imagined that the destruction of a canal could have provided employment for so many people; for the thought never struck him that this was not employment created but labor diverted from other employments, and that men would have eaten and drunk in passing along the canal as well as in passing along the highroad.

However, to the astonishment of the Chinese, the Son of Heaven at length died and was buried.

His successor sent for Kouang, and ordered him to have the canal cleared out and restored.

And Kouang said to the new emperor, "Son of Heaven! You commit a blunder."

And the emperor replied, "Kouang, you talk nonsense."

But Kouang persisted, and said, "Sire, what is your object?"

"My object is to facilitate the transit of goods and passengers between Tchin and Tchan, to render carriage less expensive, in order that the people may have tea and clothing cheaper."

But Kouang was ready with his answer. He had received the night before several numbers of the Moniteur Industriel, a Chinese newspaper. Knowing his lesson well, he asked and obtained permission to reply, and after having prostrated himself nine times, he said, "Sire, your object is, by increased facility of transit, to reduce the price of articles of consumption, and bring them within reach of the people; and to effect that you begin by taking away from them all the employment to which the destruction of the canal had given rise. Sire, in political economy, nominal cheapness—"

The emperor: "I believe you are repeating by rote."

Kouang: "True, Sire; and it will be better to read what I have to say."

So, producing the Esprit Public, he read as follows:

In political economy, the nominal cheapness of articles of consumption is only a secondary question. The problem is to establish an equilibrium between the price of labor and that of the means of subsistence. The abundance of labor constitutes the wealth of nations; and the best economic system is that which supplies the people with the greatest amount of employment. The question is not whether it is better to pay four or eight cash for a cup of tea, or five or ten taels (Chinese money) for a shirt. These are puerilities unworthy of a thinking mind. Nobody disputes your proposition. The question is whether it is better to pay dearer for a commodity you want to buy, and have, through the abundance of employment and the higher price of labor, the means of acquiring it; or whether it is better to limit the sources of employment, and with them the mass of the national population, in order to transport, by improved means of transit, the objects of consumption, cheaper, it is true, but taking away at the same time from many of our people the means of purchasing these objects even at their reduced price.

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Seeing the emperor still unconvinced, Kouang added, "Sire, deign to give me your attention. I have still theMoniteur Industriel to bring under your notice."

But the emperor said, "I don't require your Chinese journals to enable me to find out that to create obstacles is to divert and misapply labor. But that is not my mission. Go and clear out the canal; and we shall reform the custom house afterwards."

And Kouang went away tearing his beard, and appealing to his God, "O Fo! Take pity on thy people; for we have now got an emperor of the English school, and I see clearly that in a short time we shall be in want of everything, for we shall no longer require to do anything."

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Frédéric Bastiat was the great French proto-Austrolibertarian whose polemics and analytics run circles around every statist cliché. His primary desire as a writer was to reach people in the most practical way with the message of the moral and material urgency of freedom. See Frederic Bastiat's article archives.

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The Marxian Strategy

[This article is excerpted from volume 2, chapter 12 of An Austrian Perspective on the History of Economic Thought (1995). An MP3 audio file of this chapter, narrated by Jeff Riggenbach, isavailable for download.]

Marx desperately sought a materialistic dialectic of history, a dialectic that would account for all basic historical change and would lead inevitably to communist revolution. Lacking a Boehmeian "nisus" or mystical inner drive to serve as motor of the dialectic, Marx had to fall back on class conflict embedded in historical materialism. But it was characteristic of Marx that this crucial area of the Marxian system, along with other important discussions, was presented, not systematically, but in the course of fugitive paragraphs or even passages, here and there throughout the writings of Marx and Engels. The system has to be constructed out of these widely separated passages. As a result, or perhaps from the inherently grave weakness of the argument, Marx's terminology is invariably vague and fuzzy, and his allegedly law-like linkages of the dialectic virtually nonexistent. Often they are mere unsupported assertion. As a result, the Marxian system is not only a tissue of fallacies, but of flimsy fallacies and linkages as well.

No economic or social theory is obliged to come up with correct predictions, in the sense of forecasts of the future. But the Marxian doctrine is different. Like premillennial pietists who are forever predicting an imminent Armageddon, Marx claims to come up with "laws of history" which, according to him, are "scientific" rather than mystical. Well, if he knows the laws of history, then Marx had better come up with correct predictions of such allegedly determined laws. Yet all his predictions have proved utterly wrong. At this point, Marxists invariably fall back on changing the prediction, or pointing to some offsetting factor (seen only in hindsight) that temporarily delayed the prediction from coming true. Thus, as we shall see further below, one of Marx's predictions, crucial to the inevitable workings of the road to socialism, was that the working class would suffer increasing poverty and immiseration. When the working classes, in contrast, obviously continued to gain spectacularly in living standards in the Western world, Marxian apologists fell back on the assertion that Marx meant only poverty "relative to" the capitalist class. It is doubtful, however, whether bloody revolution will be waged by a proletariat for having only one yacht while capitalists have a dozen each. "Relative" misery is a very different kettle of fish. The Marxists then came up with the view that Western workers' standards of living were rising because of a "temporary" delay brought about by Western imperialism, enabling Western workers to be "capitalists" relative to the exploited Third World. The fact that Marx and Engels were themselves in favor of Western, particularly German, imperialism, as a progressive force, is usually passed over in silence by Marxian writers.

On theoretical matters, the strategy of Marxists is similar. Increasingly, as crucial Marxian doctrines become evidently too absurd to be held seriously — e.g., technological determinism of all life, or the labor theory of value — they are abandoned by the Marxist, who then proceeds to maintain stubbornly that he is still a "Marxist," and that Marxism essentially still holds true. But this is the attitude of a mystical religious adept rather than of a scientific or even a rational thinker.

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One crucial weapon wielded often by Marxists and by Marx himself was "the dialectic." Since the dialectic allegedly means that the world and human society consist of conflicting or "contradictory" tendencies side by side or even within the same set of circumstances, any prediction can then be justified as the result of one's deep insight into whichever part of the contradictory dialectic might be prevailing at any given time.[1] In short, since either A or non-A can occur, Marxians can safely hedge their bets so that no prediction of theirs can ever be falsified. It has been said that Gerry Healy, the absolute leader of the left-wing British Trotskyite movement until scandal brought him down in recent years, was able to maintain his power by claiming the power of exclusive insight into the mysterious workings of the dialectic. And an outstanding example of hedging one's bets by Marx himself was described in a letter to Engels. Marx writes to Engels that he has just forecast something in his column for the New York Tribune. He adds cynically and revealingly: "It is possible that I may be discredited. But in that case it will still be possible to pull through with the help of a bit of dialectic. It goes without saying that I phrased my forecasts in such a way that I would prove to be right also in the opposite case."[2]

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Murray N. Rothbard (1926–1995) was dean of the Austrian School. He was an economist, economic historian, and libertarian political philosopher. See Murray N. Rothbard's article archives.

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Can Central Banks Be Tamed?

Can Central Banks Be Tamed?

Austrian economists have, since the latest boom-bust cycle and financial crisis, called for a critical reexamination of the "rationale of central banking" by emphasizing the role of central banking in generating business cycles. The argument is well summarized by Roger Garrison:

The decentralization of money, as proposed by Hayek (1976) and explored by Selgin and White (1994), has an increasing strong claim on our attention. Concerns with political feasibility should be separated from the more fundamental reconsideration of a market based money supply. In light of our continuing experience with a bubble-prone central bank, we might well anticipate that a comparative-institutions analysis would favor a market solution to our money and credit problems. At the very least, a better understanding of the workings of a decentralized monetary system would help identify the perils and pitfalls of continued centralization. ("Interest-Rate Targeting during the Great Moderation: A Reappraisal," p. 199, links added)

Thanks to Congressman Ron Paul's strong interest in a market-based money, Austrian economists have had the opportunity to argue in favor of abolishing central banks and for a decentralization or denationalization of money in testimony before Congressional committees. (For examples see Salerno, White, and Cochran here, Ebeling here, and Herbener and Klein here.)

Gerald P. O'Driscoll provides more background and raises issues and concerns in an important new working paper at The Cato Institute, "Central Banks: Abolish or Reform?" He cautions,

Plans to abolish central banks constitute an extreme reform. It is doubtful that such plans can succeed without broader institutional change, occurring either first or simultaneously. That is likely true regardless of the strength of evidence on central bank performance. (p. 2)

O'Driscoll concludes,

We have two bad systems: the fiscal and the monetary. They are intertwined now as they were in the 18th and 19th centuries. They must be reformed, or together they will destroy the economic system that sustains them. They have become parasitical. The unsettled question is whether anything less than radical reform of both will work. Can central banks be constrained to a Bagehot‐like role, or must they be abolished? Can a "bad system" be made better, or do we need wholesale replacement? That is the question that monetary economists should be discussing. (p. 30, links added).

While most Austrians favor replacing central banking with a market-based decentralized money, most mainstream economists opposed to broadly discretionary monetary policy favor rules to restrain central bankers' actions, not abolishment of central banking. As examples, John B. Taylor strongly defends rule-based reforms, while Scott Sumner and market monetarists recommend nominal GDP targeting. However, some economists are clearly beginning to recognize, as most Austrians have, that central banks are or are becoming dangerous financial central planners.

Hayek, in his writings in the 1970s, made recommendations on how central bankers could "best" function while also arguing ultimately for the elimination of central banking. He thus argued, given the widespread existence of central banks and the general acceptance of active monetary policy, which was heavily influenced by a Keynesian economic macro framework, the best policy in this environment was that "Though monetary policy must prevent wide fluctuations in the quantity of money or the volume of the income stream … the primary aim must again become stability of the value of money." To paraphrase, in normal times there is a need to, a la Friedman or Taylor, have a more or less automatic monetary framework, but if policy still generated boom-bust cycles, then to prevent "liquidity crisis or panics" there is a need "to ensure convertibility of all kinds of near-money into real money." For this, "the monetary authority must be given some discretion" (Hayek 1979, p. 18). But because he recognized the strong interconnection between monetary and fiscal policy that would threaten long-term economic stability, Hayek strongly favored a denationalization of money. As quoted in Pizano, Hayek reflected,

I do not believe that we would have major industrial fluctuations if it were not for the present banking system, which in turn depends on the government monopoly of the supply of money. I have been driven into proposing the denationalization of money. (Conversations with Great Economists, p. 10)

He continues:

Anyhow, depressions are not the result of the operation of the market. They are the result of government control, particularly in the sphere of monetary policy.

A related issue, of interest to Austrian economists, raised in debates by proponents of reform, centers on whether the Fed contributed to the recent crisis by keeping interest rates too low for too long from 2003 to 2005. Much of the discussion was triggered by John B. Taylor's March 31 "Policy Failure and the Great Recession." A review of the discussion should reinforce how important and useful Austrian insights are for properly interpreting causes of the current crisis, as argued by Garrison and Cochran, and in guiding discussions of appropriate ways to reform monetary institutions, if a goal is to make such crises less likely in the future.

Taylor used his interpretation of Robert Hetzel (The Great Recession: Market Failure or Policy Failure?) as platform to attempt to bolster his positions that (1) rules are preferred to discretion, and (2) excessive discretion allowed the monetary authorities to make two significant policy errors during the Greenspan/Bernanke watch; interest rates were too low for too long in 2003–05 leading to a boom and a necessary consequent bust and the subsequent bust was compounded and/or triggered by interest rates being too high in 2007–08. While the point that the Fed moved rates too high in 2007–08 does not appear to be controversial among economists who favor rules over abolishing a central bank, many commentators, especially supporters of nominal GNP targeting, strongly reject the rates-too-low-for-too-long argument. Defenders of the Fed policy circa 2003–05 argue, contra Austrians and Taylor, that, since Fed policy did not lead to either significant price inflation or significant increases in inflationary expectations, the policy generated no problems for the economy. For them, but often also for Taylor, major policy-induced problems for the economy are Friedman plucks, policy errors that create too much money and credit constraint, triggering a recession as the economy performs temporarily below potential.

Taylor has the key element essentially correct: rates were too low for too long. But working from a highly aggregated model, Taylor has no really adequate response to his critics. He is forced to rely on rhetoric and historical interpretation of Fed actions during the relevant period of time. Taylor relies on his reading of Hetzel, who in general defends Fed policy in 2003–05, but per Taylor, Hetzel provides evidence for the too-low-for-too-long policy error when he argues,

In 2003–2004, the Greenspan FOMC did make a decision that would later have enormous implications. At this time, The FOMC backed off its long-run objective of returning to price stability and instead adopted an ill-defined objective of positive inflation.

Thus for Taylor, as for Austrian critics of Fed policy, "there is a clear connection between the too easy period and the too tight period"; and to stress the importance of this, Taylor adds, "I have emphasized the 'too low for too long' period in my writing because of its 'enormous implications' (to use Hetzel's description) for the crisis and recession which followed."

Taylor, unlike his critics, who see the only errors by the Fed as the "Great Moderation ended as being too tight right before the bust," recognizes, as do the Austrians, that the "Fed's action in 2003–2005 should be considered as possible part of the problem." Too bad he is unfamiliar with or unwilling to use Austrian analysis to support his position relative to 2003–2005. Austrian monetary theory and business-cycle theory provide a much better understanding of why a monetary-policy-driven credit expansion, such as the 2003–04 period, fuels a boom-bust cycle in a no- or low-inflation environment and, as Ravier, in "Rethinking Capital-Based Macroeconomics" (pp. 367–371), explains in detail, even if the policy is intended to speed recovery from a recession.

Cochran ("Hayek and the 21st Century Boom-Bust and Recession-Recovery") argues the macroeconomic developments in the US economy from 1995 to present cannot be understood without a reference to a capital-structure-based macroeconomic framework. There were, in fact, back-to-back policy-driven boom-bust cycles. The first boom-bust of the period, 1995–2000, should have provided evidence that even with stable prices or low inflation, distortions in the structure of production caused by money and credit creation can create significant coordination problems in a growing economy. The monetary growth which accommodated a productivity shock generated a boom with a high-tech bubble. The resulting "bust," at least measured in terms of the cycle impact on GDP, was relatively mild. The significance of this cycle for the role of monetary policy was perhaps missed because it occurred at the end of the "Great Moderation." This period was a time of better policy — at least compared to monetary policy of the 1960s and 1970s — but, as discussed by Garrison (2009), not necessarily good policy. During this period, central banks were heavily influenced by macroeconomic events of the 1970s that seemed to discredit the neoclassical synthesis/Keynesian consensus. A vast economic literature from the consequent policy-effectiveness debate emphasized central-bank policies that — at least in the long run — aimed, much like Hayek had recommended, at price stabilization as a dominant policy goal. The Fed, while not explicitly inflation targeting, followed a policy that mimicked a Taylor-rule policy. Garrison (2009, p. 187) characterizes this as a "learning by doing policy" which, based on events post-2003, would be better classified as "so far so good" or "whistling in the dark."

The actual result of this "learning by doing policy" is described by Garrison in "Natural Rates of Interest and Sustainable Growth":

In the earlier episode, the Federal Reserve moved to counter the upward pressure of interest rates, causing actual interest rates not to deviate greatly from the historical norm. In the later episode, the Federal Reserve moved to reinforce the downward pressure on interest rates, causing the actual interest rates to be exceedingly low relative to the historical norm. Although the judgment, made retrospectively by economists of virtually all stripes, that the Fed funds target rate was "too low for too long" between mid-2003 and mid-2004, it was almost surely too low for too long relative to the natural rate in both episodes. (p. 433)

Thus the mildness of the first recession of the 21st century was followed by a relatively slow, jobless recovery. This led many economists and pundits to encourage the Fed to re-inflate — create another boom or bubble — to ignite growth and employment. Taylor is right: the Fed accommodated the requests leading to, as argued by Austrians and by Taylor in 2008, "a boom and an inevitable bust" (emphasis mine). The resulting housing-bubble-led boom-bust was a classic misdirection of production driven by monetary stimulus of an economy operating below potential. Far from being beneficial or at best benign, this attempt to use monetary policy to reduce unemployment in the short run did, as predicted by Hayek (1979, p. 11), become a cause of "more unemployment than the amount it was originally designed to prevent." From about 2005 to late 2007, the economy appeared healthy, and, at least temporarily, growth returned to its potential GDP growth path. As the end of the housing bubble clearly illustrated, and as many Austrian had predicted, the health was only apparent.

Responses to Taylor by David Glasner, Marcus Nunes at Historinhas, or Scott Sumner focus on how a central bank in a fiat-money system can do "better policy." A better understanding of the cause of crisis based on an Austrian capital-structure-based macroeconomics should shift the focus away from rules versus discretion to the more fundamental question raised most recently by O'Driscoll, echoing Hayek: are there monetary institutions that could generate consistently better economic outcomes? Research by Selgin, Lastrapes, and White strongly suggest that conclusion should be yes:

Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is … pressing today.

Central-bank response to the most recent crisis makes the discussion for abolishing the Fed even more important. The Fed has moved in the direction of greater, not lesser, central-bank involvement in the economy. John B. Taylor reported that the Federal Reserve purchased 77 percent of the net increase in the debt by the federal government in 2011. The Fed's monetary policy is now a "mondustrial policy." It is an intervention framework financed by money creation. The Fed has done extensively more in response to this crisis than Hayek's recommended prevention of a secondary deflation. It has engaged in picking winners and losers — crony capitalism at its worst. As recognized by John H. Cochrane of the University of Chicago in "The Federal Reserve: From Central Bank to Central Planner," "The Fed's 'nontraditional' actions have crossed a bright line into fiscal policy and the direct allocation of credit."

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The Great Moderation did represent a period of improved monetary policy and provides some reason for the optimism of a Taylor or Sumner that a rules-based reform might restrain a Central bank from becoming Hummel's gigantic financial central planner. However, the back-to-back boom-bust cycles that effectively ended the Great Moderation reinforce Austrian arguments that such a policy would still leave economies subject to recurring credit-creation-driven booms and the resulting recessions accompanied by financial crisis. As shown by White, "a gold standard with free banking would have restrained the boom and bust."

Thus it is even more imperative that Austrians continue to make as strong a case as possible for a return tosound money. The is why monetary freedom matters, as it is ultimately the way forward for an eventual withering away of central banks and a return to a commodity-based money; a sound market-based monetary system.

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John P. Cochran is emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He is also a senior scholar for the Mises Institute and serves on the editorial board of the Quarterly Journal of Austrian Economics. Send him mail. See John P. Cochran's article archives.

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Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

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