Hayek's Challenge: An Intellectual Biography of F.A. Hayek 9780226091921

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Hayek’s

Challenge

Hayek’s Challenge An Intellectual Biography of F. A. Hayek

Bruce Caldwell The University of Chicago Press Chicago & London

The University of Chicago Press, Chicago 60637 The University of Chicago Press, Ltd., London © 2004 by The University of Chicago

All rights reserved. Published 2004 Paperback edition 2005 Printed in the United States of America 12 11 10 09 08

5

ISBN: 0-226-09191-0 ISBN: 0-226-09193-7

(cloth)

(paperback)

Library of Congress Cataloging-in-Publication Data Caldwell, Bruce J. Hayek's challenge: an intellectual biography of F. A. Hayek I Bruce Caldwell.

p.

cm.

Includes bibliographical references and index. ISBN 0-226-09191-0 1.

(cloth: alk. paper)

Hayek, Friedrich A. von (Friedrich August), 1899-

Austria-Biography.

3. Economics.

2.

Economists-

1. Title.

HBI0l.H39 C39 2004 330' .092 -dc21 2003006768

§ The paper used in this publication meets the minimum requirements of the

American National Standard for Information Sciences-Permanence of Paper for Printed Library Materials,

AN SI Z39.48-1992.

For Leslie, Claire, and Sam

CONTENTS

Acknowledgments ix Introduction 1 I. THE AUSTRIAN SCHOOL AND ITS OPPONENTS— HISTORICISTS, SOCIALISTS, AND POSITIVISTS

1. Menger’s Principles of Economics 17 2. The German Historical School 39 3. The Methodenstreit 64 4. Max Weber and the Decline of the Historical School 83 5. Positivism and Socialism 100 II. HAYEK’S JOURNEY

6. Hayek in Vienna 133 7. Monetary Theory and Methodology 150 8. Hayek at the London School of Economics 165 9. Some Methodological Debates of the 1930s 182 10. “Economics and Knowledge” and Hayek’s Transformation 205 11. The Abuse of Reason Project 232 12. Individualism and the Sensory Order 261 13. Rules, Orders, and Evolution 288 III. HAYEK’S CHALLENGE

14. Journey’s End—Hayek’s Multiple Legacies 323 15. Epilogue: A Meditation on Twentieth-Century Economics 370 Appendixes 407 Bibliography 439 Index 473

ACKNOWLEDGMENTS

I think that it is fair to say that Hayek had many debts to other writers and that he did not always acknowledge them. Like Hayek, I have many debts, and, like Hayek, I will not acknowledge them all. I want to, but I am not able to. I apologize in advance for this. My excuse—if it can be considered to be one—is that I have been working on this project for well over ten years and I cannot remember all who have helped. Hayek wrote professionally for nearly seventy years, which is excuse enough. I thank first the many who have offered me comments on my work, among them Roger Backhouse, Bill Bartley, Brad Bateman, Peter Bearse, Jack Birner, Mark Blaug, Stephan Boehm, Peter Boettke, Larry Boland, Ted Burczak, Bill Butos, Nancy Cartwright, Will Christie, Bob Coats, Avi Cohen, Annie Cot, Helena Cronin, John Davis, Neil De Marchi, Giles Dostaler, Richard Ebeling, Ross Emmett, Philippe Fontaine, Roger Garrison, Craufurd Goodwin, Malachi Hacohen, Dan Hammond, Wade Hands, Dan Hausman, Abe Hirsch, Geoff Hodgson, Kevin Hoover, Steve Horwitz, Eric Howard, Terence Hutchison, Ian Jarvie, Albert Jolink, Israel Kirzner, Arjo Klamer, Peter Klein, Roger Koppl, Stephen Kresge, Ludwig Lachmann, Maurice Lagueux, Don Lavoie, Mike Lawlor, Tony Lawson, Axel Leijonhufvud, Robert Leonard, Alain Leroux, Harro Maas, Uskali Mäki, Alain Marciano, Deirdre McCloskey, Steve Medema, Phil Mirowski, Don Moggridge, Mary Morgan, Larry Moss, Robert Nadeau, Doug North, Jerry O’Driscoll, Greg Ransom, Mario Rizzo, Dave Rose, Dan Rosenbaum, Jochen Runde, Malcolm Rutherford, Andrea Salanti, Warren Samuels, Jason Schenker, Karl Schleunes, George Selgin, Esther-Mirjam Sent, Jeremy Shearmur, Vernon Smith, Brian Snowdon, Gerry Steele, Vincent Tarascio, Karen Vaughn, Nick Vriend, Jack Vromen, and Roy Weintraub. Next, I thank the hosts and participants at workshops and department seminars at the University of Cambridge, the University College Cork, Duke University, the Erasmus University of Rotterdam, George Mason University, the University of Georgia, the University of Graz, the London School of Economics, the University of Provence–Aix Marseille, the University of Puget Sound, the University of Québec at Montréal, New York University, [ ix ]

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Northumbria University, the University of Paris–Sorbonne, and the University of Toronto. I also gratefully acknowledge the comments of those who attended sessions at meetings of the American Economic Association, the History of Economics Society, the International Network for Economic Method, and the Southern Economic Association where I delivered papers. I thank my brother, Tom Caldwell, for translating Gustav Schmoller’s review of Menger’s Principles and Stephan Boehm for checking over the translation and making suggestions for stylistic changes. I thank Stephen Kresge for giving me the opportunity to edit volumes of The Collected Works of F. A. Hayek and for his sound advice and insight over the years in our many discussions and correspondence about matters Hayekian. I also thank him for inviting me to succeed him as general editor of the Collected Works, a dream assignment for a historian of economic thought. I thank the participants in the Research Methods in Philosophy seminar at the London School of Economics, Lent term 2001, especially Peter Dietsch, Till Gruene, John Latsis, Mary Morgan, Robert Northcott, Julian Reiss, Christoph Schmidt-Petri, Arhat Verdi, and Sang Wook Yi. I also thank Sir Samuel Brittan for taking time to attend two of the sessions and for his contributions. The seminar participants forced me to clarify my arguments as I was writing the last two sections of the book. I owe another huge debt to Karen Vaughn for organizing a Liberty Fund Colloquium on my manuscript on 16 –19 May 2002 in Alexandria, Virginia; and I thank the participants—Larry Arnhart, Stephan Boehm, Will Christie, Hans Eicholz, Steven Gerencser, Steve Horwitz, Ejan Mackaay, Chris Mantzavinos, Kevin McCabe, Dave Prychitko, Mario Rizzo, Viktor Vanberg, Karen Vaughn, and Juliet Williams—for their many insightful suggestions for improvement. I add another note of thanks to Stephan Boehm, who sent me detailed notes on the manuscript after the colloquium. I will finally thank Mary Morgan of the London School of Economics (LSE) for two enormous acts of kindness. Mary was the person who first told me about the existence of the Lachmann Fellowship at the LSE; I completed most of the manuscript during the 2000 –2001 academic year, which I spent there. At the end of my stay, Mary read through what I had finished and offered me detailed editorial comments. Popper once said that Hayek saved his life twice; I feel the same sort of gratitude toward Mary. I gratefully acknowledge the financial support that I have received over the years from the University of North Carolina at Greensboro, which has included three research assignments, a research grant from the Joseph M.

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Bryan School of Business and Economics, and travel grants from the Bryan School and from the Office of International Programs. I also thank for their support the Charlottenburg Trust, which funds the Ludwig M. Lachmann Research Fellowship, the Liberty Fund, the National Science Foundation, and the John W. Pope Foundation. I thank Geoffrey Huck of the University of Chicago Press for encouraging me to do the book, his successor John Tryneski for helping me to get it into final form, Joe Brown for his virtuosity as a copyeditor, and two anonymous reviewers for their helpful comments on the penultimate draft. I dedicated this book to my family, Leslie, Claire, and Sam. My children grew up with this book. (Sam was born two days after Hayek himself died.) It is hard to write a book and also be a good husband and father. During the 1990s, when I thought that I would never get the book written, there were dark days when I toyed with the idea of a dedication that read: “For Leslie, Claire, and Sam: without you life would be incomplete (the book, on the other hand, would have been, earlier).” I am finally now realizing just how much of a team effort the whole venture has been. I could not have done any of this without their support and their willingness to follow me abroad (twice) and to help me enjoy the many adventures that we were having. They were coauthors without knowing it. As the last chapter of the book makes clear, the history of economic thought is not doing very well in the profession. The generation of historians of which I am a member, those who were trained as economists, may well be among the last, if not the last. I will therefore close by recognizing four individuals with whom I “grew up” professionally and who have become my close friends: Wade, Uskali, Phil, and Tony. My beleaguered band of brothers, I salute you.

INTRODUCTION

Hayek is a puzzle. Certainly he started out as one for me, now some twentyodd years ago. It was the spring of 1982, and I was finishing up a postdoctoral year at New York University (NYU). An assistant professor, I had received my doctorate in economics a few years earlier with a specialization in the history of economic thought. My thesis had carried the earnest and pedantic title “The Methodology of Economics from a Philosophy of Science Perspective,” and part of the reason I was at NYU was to try to transform it into a book that people might actually want to read.1 But I was also there to study Austrian economics or, more precisely, to learn more about the distinctive methodological views of the Austrians. These differed radically from, and, indeed, directly criticized, the positivistic pronouncements of mainstream economists. In particular, I wanted to know more about the rather strange-sounding apriorist methodology that had been advocated by Ludwig von Mises. I knew next to nothing about Hayek. NYU was very much the place to go if you wanted to learn about the Austrian movement. There was (and still is) a formal program dedicated to the study of Austrian economics there, with courses, a weekly seminar, and funding for faculty positions, postdocs, and graduate students. The faculty members present that year included Israel Kirzner, Mario Rizzo, Jerry O’Driscoll, and (in the spring) Ludwig Lachmann. Larry White was a visiting professor, Richard Langlois held another postdoc, and among the dozen or so students were Don Boudreaux, Mark Brady, Sandy Ikeda, Roger Koppl, Kurt Schuler, and George Selgin. It was a great gathering of minds and personalities and, for me, a very rich experience.2 1. The book that resulted was Beyond Positivism: Economic Methodology in the Twentieth Century (Caldwell [1982] 1994a), and chapter 5 of the book most directly reveals the influence of my year at NYU. 2. One of the highlights for me was a weekly meeting with Ludwig Lachmann during the spring semester. I report on this in my obituary memorial for Lachmann (see Caldwell 1991b). [ 1 ]

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That spring, Jerry O’Driscoll handed me a book by Terence Hutchison and said, “So what do you think of his argument about Hayek’s U-turn?” Hutchison had claimed that Hayek underwent a “methodological U-turn” in the mid-1930s. More precisely, he had argued that the publication in 1937 of an article by Hayek titled “Economics and Knowledge” marked Hayek’s turning away from Mises’s apriorist approach and toward the falsificationist methodology propounded by the philosopher Karl Popper (Hutchison 1981, chap. 7; see also Hayek [1937] 1948a). The claim certainly seemed strange to me. I had studied Popper’s thought carefully for my dissertation and now knew more about Mises’s ideas, and, frankly, it is hard to conceive of two viewpoints more at odds with one another. How could anyone change so much as to switch from one to the other? Yet it was also evident that Hayek was close friends with both men. Hutchison was a leading historian of thought who had lived through the period in question, and he provided detailed textual evidence to support his argument. So Hutchison’s interpretation presented a puzzle, and it was in trying to solve that puzzle that I began to do research specifically on Hayek. I have been at it ever since, even though people who care about me have warned me against putting so many of my eggs in one basket. I hope that, in this introduction, I am able to convey some of the reasons why I ended up doing so. For the first eight or nine years of his academic life, the economist F. A. Hayek wrote in German. Afterward, he wrote principally in English, at least until he moved to Germany in 1962. Perhaps because of the novelty and challenge of trying to communicate ideas in a new language, he chose his titles with considerable care. Sometimes he made allusions to other works. Thus “The Trend of Economic Thinking,” his 1933 inaugural lecture at the London School of Economics, alluded to The Trend of Economics, a volume edited by Rexford Tugwell that had appeared in America a decade before (see Hayek [1933] 1991c; Tugwell [1924] 1930). He got the idea for the title of his most famous book, The Road to Serfdom ([1944] 1976b), from a phrase used by Alexis de Tocqueville, “the road to servitude” (see Hayek 1983b, 76). And I offer as a conjecture that the title of his Finlay lecture, “Individualism: True and False” ([1946] 1948c), was a reference to passages about individualism in Oscar Wilde’s “The Soul of Man under Socialism.” 3 3. Wilde’s essay contains the following line: “Private property has crushed true Individualism, and set up an Individualism that is false.” A page later we find: “With the abo-

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On other occasions, titles had multiple meanings. The paper that gave rise to Hutchison’s claim about Hayek’s “methodological U-turn,” “Economics and Knowledge,” was one of these. Its subject was the assumptions that are made in economic theories about agents’ knowledge, but it was also about what economists themselves could know. It would seem that Hayek’s Nobel address, “The Pretence of Knowledge” ([1975] 1978e), can be similarly interpreted. My own title, Hayek’s Challenge, follows Hayek’s lead; it refers to the multiple challenges that surround his work. Hayek himself, of course, faced challenges. Economists are used to the pose of being bearers of bad news. (I say pose because demand for our services, like that for those of undertakers and therapists, is highest when times are bad.) For Hayek, however, it was less of a pose than for most. It is not enough to say that some of his views were unpopular. For most of his life his economic and political positions were completely out of sync with those of the rest of the intelligentsia. He attacked socialism when it was considered “the middle way,” when seemingly all people of good conscience had socialist sympathies. He disavowed the Keynesian revolution— even before it had properly taken place. In the latter half of the twentieth century, when some form of welfare state existed within virtually all the Western democracies, he criticized the concept of social justice that provided its philosophical foundations. Although a small group of libertarians and conservatives always read him with enthusiasm, for much of the century Hayek was a subject of ridicule, contempt, or, even worse for a man of ideas, indifference.4 Because of his political views, Hayek faced many challenges in trying to find an audience for his ideas among the thinkers of his day.5 lition of private property, then, we shall have true, beautiful, healthy Individualism” (Wilde [1891] 1931, 12, 13). Hayek’s lecture was delivered 17 December 1945 at University College, Dublin. At least some in Hayek’s audience could have been expected to understand the allusion to the writings of their countryman—if there was, in fact, an allusion. 4. Note, e.g., the opinion of Rudolf Carnap, a leading positivist philosopher, who, writing to Karl Popper, asked about Popper’s acknowledgment of Hayek in a book: “I was somewhat surprised to see your acknowledgment of von Hayek. I have not read his book [The Road to Serfdom] myself; it is much read and discussed in this country, but praised mostly by the protagonists of free enterprise and unrestricted capitalism, while all leftists regard him as a reactionary” (Rudolf Carnap to Karl Popper, 9 February 1946, quoted in Notturno 1999, 41). 5. He did find a more popular following, as the April 1945 condensation of his Road to Serfdom in the Reader’s Digest attests. This is somewhat paradoxical as Hayek had not long

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Hayek also presents challenges to those who try to interpret his thought. (Since I am one of these, I may as well share the secret title of my book: Caldwell’s Challenge.) There are multiple problems here. First, there is the simple fact that Hayek’s writings lie within the Austrian tradition. Now, to be sure, in the 1930s that tradition was part of the thendeveloping mainstream in economics. In the postwar era, however, economics changed. One way to characterize the changes is to say that the discipline moved from interwar pluralism to postwar neoclassicism (Morgan and Rutherford 1998). Another is to point out that the mainstream experienced a number of “revolutions”: the Keynesian revolution, the econometrics revolution, the general equilibrium or formalistic revolution, and so on. However one might choose to characterize the changes, it is clear that the Austrians did not participate in them. More strongly, people like Hayek and Mises actively opposed them. It may, therefore, be difficult for modern-day economists (who I hope make up at least a portion of my audience) to make much sense of the Austrians. Part of my task is to provide the necessary background to make the Austrians’ viewpoint comprehensible to those unfamiliar with their tradition. The volume of Hayek’s work provides another daunting challenge for interpreters. Hayek lived from 1899 to 1992, and his writings span seven decades. Worse, he was incredibly prolific. Even worse, he did not restrict himself to economics, making contributions in fields as diverse as psychology, political philosophy, the history of ideas, and social-science methodology. I joke, of course, when I use the word worse, for part of Hayek’s fascination is that he contributed, at times significantly, to so many fields. Studying Hayek forces you to read outside your field, and that can be a liberating experience. But, in this age of specialist training, it is also difficult not to feel inadequate when reading him, and his sheer reach makes any attempt at assessment of his ideas dicey, to say the least. An even more serious challenge for those who would interpret him arises from the fact that Hayek seems to have changed his mind about certain things over the years or, put in another light, that his work appears to contain conbefore warned of the dangers of “praise and public recognition” for economists (Hayek [1944] 1991b, 35 –36). His at times bitter attack on “professional secondhand dealers in ideas” a few years later indicates that he was aware of the low esteem in which the pundits and (in his view) false intellectuals of his day held his ideas (Hayek [1949] 1997b, 221).

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tradictions. We will see, for example, that, in the course of one decade, Hayek seems simultaneously to have held the views that what he called equilibrium theory is necessary if one is to do economic science at all and that it is also a highly misleading model for understanding the workings of a market system. Within the covers of the same book he will both argue that policies that aim at income redistribution violate the rule of law and endorse the provision of a “safety net” that is itself an instrument of redistribution. He will trumpet both methodological individualism and group selection, positions often viewed as mutually exclusive. Now, if one disagrees with Hayek on ideological or other grounds, these apparent contradictions are not, of course, a problem. They are a solution, for they provide grounds for dismissing him. But, for someone who wants, as I do, to make sense of Hayek, to provide a plausible reading of the development of his ideas, they pose real difficulties. There is a huge secondary literature on Hayek, and it produces challenges as well. Part of the problem derives from the fact that Hayek was, and is, a controversial figure. Many who write about him have strong opinions about whether he was right or wrong, and this affects their readings. Furthermore, the enormous scope of his corpus makes for multiple interpretations, as writers draw on different parts of his work. Finally, some people use Hayek’s writings as input into their own substantive theories, and, in such cases, the temptation is great to interpret Hayek himself as participating in the same project. As a result, very different interpretations of what Hayek was up to exist—probably more so than for most writers. As I said, I hope to provide a plausible reading of the development of Hayek’s thought. But part of my job will also be to confront my own readings with others that exist in the secondary literature.6 Another set of challenges has to do with what Hayek has said about himself. Hayek occasionally introduced autobiographical elements into talks and papers, and he even gave a few interviews, but the degree of autobiographical revelation changed dramatically when he was awarded the Nobel Prize in economics in 1974. A few years later, under the auspices of an Oral History 6. You, the reader, may well come to this book with your own preconceptions about what Hayek said and thought. I challenge you to sublimate, or at least to bracket, them. This procedure will, at a minimum, make for a less frustrating reading experience, but it may also help you see at least a portion of the world anew, which is not in itself a bad experience.

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Project at the University of California, Los Angeles, Hayek agreed to sit for an extensive set of interviews. The sessions stretched over a number of weeks in late 1978, with nine different people asking him questions.7 The topics covered ranged far and wide, and there appears to have been little attempt to coordinate what was asked, so sometimes he repeated himself. Hayek discussed his personal life, his academic history, his ideas, his times, his interactions with and impressions of the many great and near-great figures whose paths he crossed. The resulting 493-page transcript (Hayek 1983b) is a wonderful source of information on all aspects of his life and work.8 So why is this a problem? As Malachi Hacohen has amply demonstrated in his superb new biography of Karl Popper (see Hacohen 2000), sometimes autobiographical accounts are inaccurate. Popper wrote an autobiographical sketch for the volume on his work in the Library of Living Philosophers series, a slightly revised version of which later appeared in book form as Unended Quest (1976). Popper spent a long time working on the manuscript, producing a number of drafts before he was finally done. Despite this, Hacohen discovered factual errors in Popper’s careful reconstruction, some of them serious. Although he was at first inclined to think that Popper had intentionally fudged the record, he later came to the conclusion that the mistakes were not intentional. Popper just remembered things wrong. In this, Hacohen concluded, he was doubtless anything but abnormal: “Autobiographical anachronism is common, and Popper’s memory failure may not even be as surprising as I still occasionally find it” (Hacohen 2000, 14). Hayek had prepared for the oral-history interviews, of course. Still, he was over seventy years old when he gave them, and he was responding extemporaneously about events some of which had taken place forty or more years earlier. It also appears that Hayek had answers for certain questions almost programmed, using exactly the same wording again and again.9 This is not to suggest that he made things up. But, after a while, what a person recalls may be the story that he told last time, rather than what actually happened.10 The 7. The interviewers were Armen Alchian, Robert Bork, James Buchanan, Robert Chitester, Earlene Craver, Thomas Hazlett, Jack High, Axel Leijonhufvud, and Leo Rosten. 8. Some of the oral-history interviews are collected in Hayek (1994), and they provide, to varying extents, the basis for the two existing biographical treatments of Hayek in English, Raybould (1999) and Ebenstein (2001). 9. I explore a particularly glaring example of this in Caldwell (1998b). 10. As it turns out, Hayek’s own psychological work on memory leads us to expect this kind of problem.

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interviews provide many insights, but they must be handled with care. This is particularly true when the subject matter is sensitive or controversial and when independent verification of his claims is absent. The final challenge for the Hayek interpreter is the question, Why? Hayek’s research path was anything but straightforward. This was a man who, after all, started out as an economist but whose most famous (or, for some, notorious) book, The Road to Serfdom, was in part a political tract. Furthermore, right after he published The Road to Serfdom, he started work on a book on theoretical psychology. He would later say that the resulting volume, The Sensory Order ([1952] 1967h), was extremely important for understanding his later work. But he never said how or why, and, for that matter, subsequent references to The Sensory Order were not particularly prominent. Later in his career, he would turn to political theory, and, ultimately, he would offer an evolutionary theory of the development of human social norms. These sorts of violent twists and turns in research interest cry out for explanation. Is it possible to make sense of Hayek’s journey? That is certainly one of the biggest challenges that we face. The challenges, I can say, have been well worth it. (I speak for myself; I am writing this introduction after having finished writing the book.) Even after all these years, I have at times felt exhausted from, but have never grown tired of, wrestling with Hayek. His mind, of course, fascinates. Anyone with his breadth of interests, with his ability to write on so many different subjects, cannot fail to attract an intellectual historian. Since I was a boy, I have always loved puzzles, so I have enjoyed the puzzling parts, too, the work of trying to piece together, to make sense of, his odyssey. I may as well admit that the controversial nature of his writings also appeals to my contrarian instincts; I have come to enjoy the challenge of presenting his ideas to audiences in which I know there are people who are prepared to dismiss them. In trying to be a good historian, I have been forced in explicating Hayek to confront my own commitments and biases, simply because I have been challenged so often to defend my readings. You can judge for yourself the extent of my self-delusion on this score. Finally, Hayek’s story is, well, just a plain good story. The people he knew and those he corresponded with, worked alongside of, and argued against include many of the most influential economists of the twentieth century. His is, in many ways, the story of the development of modern economics. But, because Hayek so frequently disagreed with those around him, his was a contrapuntal variation, parallel but contrasting, and the more intriguing for

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it. It is a great tale, one that I will relish recounting, and I suspect that my enthusiasm will shine through my analysis.

The plan of the book is straightforward. Part 1 is intended to provide background on the Austrian school. Given that the Austrian approach often differs from that of the mainstream within economics, few are likely to question the need for some sort of background. It may be appropriate, however, for me to offer some justification for the length of this part, for long it is. Here we will meet Carl Menger, whose 1871 Principles of Economics became a founding document of the school (see Menger [1950] 1976). Because the book is a foundational document, we will explore in detail a variety of its themes. But, to understand the Austrian approach, it is not enough simply to review its proponents’ ideas. One must also recognize the fundamental fact that the Austrian school was a movement formed in opposition; indeed, its very name was given to it by its detractors and intended as a slur of sorts. We will, therefore, need to spend some time on the Austrians’ first rival, the German historical school, and on the battles, methodological, political, and academic, that ensued as the two schools vied with one another for power, prestige, and, not least of all, academic positions. The Germans quickly subdued their Austrian competitors, although, in a way, the Austrian movement became more united for it: as the Viking motto goes, things that do not kill you outright tend to make you stronger. The rivalry between the two schools of thought, known as the Methodenstreit, or “battle over methods,” was a defining element in the first twenty years or so of the Austrian school’s existence. But it also obscured the many similarities between the two schools, similarities that are the more striking if one compares either school to what passes today for the mainstream of economics. Unraveling all of this is one of the chief goals of the first part of the book. The battle over methods is, however, only part of the story. If the Methodenstreit provided the initial impetus for the growth and development of Austrian thought, new conflicts were to sustain it. The twin forces of socialism and positivism increasingly became, for the economists of Vienna in the first two decades of the twentieth century, the new opposition. Incredibly, all the forces and personalities came together in a seminar presided over by Eugen von Böhm-Bawerk at the University of Vienna in the years just before the war. Little did the Austrian economists realize the strength of their new antagonists or that the arguments that they were formulating were but a dress

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rehearsal for disputes that would echo through the coming century. Every one of the arrayed forces, from the positivists to the historicists, from the subjective value theorists to the socialists, would claim for his ideas the mantle of science. Hayek fought in the First World War, then went to university during the cold, hungry, and at times violent days that followed. He would encounter each of the contending sets of ideas during his student days, and the ghosts of Menger and Gustav Schmoller, as well as the larger-thanlife influence of seminar participants like Ludwig von Mises and Otto Neurath, would leave their marks. But it would take nearly a lifetime of scholarly work before his particular vision of what it meant to do scientific economics would finally emerge. In part 2 of the book I tell Hayek’s story. If Hayek is sometimes a puzzle for later interpreters, he was also himself a puzzler. Schooled in a university tradition that permitted bright students to explore areas on their own, he was confident enough to plunge into new fields of study when he thought that they might help him discover solutions to his problems. The first puzzle that Hayek encountered had to do with the role of money in an economy. The existence of money obviously conferred substantial benefits—at the most basic level, it facilitates trade, thereby encouraging specialization and growth. Money is a puzzle because its manifold benefits come at a cost: money itself can destabilize an economy, as the hyperinflation that wracked the alreadydecimated economies of Germany and Austria following World War I amply demonstrated. Hayek’s first puzzle was to provide a theory of how a monetary economy works, one that would also explain why at times it fails to work. By the 1930s, Hayek was working on a second, related puzzle: a theoretical description of how a capital-using monetary economy, one with freely adjusting prices, might operate through time. Hayek was not, of course, the only one to tackle this question, and the answer offered by one of his rivals, a British economist named John Maynard Keynes, would be taken by many economists as definitive during the middle decades of the twentieth century.11 Keynes was not only a theorist, he was also a man of affairs, and he saw himself as saving capitalism. Others of his rivals among the economists, market socialists like Oskar Lange, thought the rescue mission chimerical and recommended more drastic remedies. Whatever the many differences that separated Keynes from Lange might 11. I should add that Keynes’s model was not dynamic and that his solution to the problem of capital was, from an Austrian perspective, to drop it as a problem.

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be, both of them saw a machine that had broken down when they looked at the economy. This provided another puzzle for Hayek, for, when he looked at the economy, he saw an organism that sometimes failed to work, to be sure, but at other times was able to coordinate the activities of millions of independent human beings. Why did almost everyone else of his day see the world so differently? Hayek began to wonder whether the theoretical tools that economists employed were to blame. He came to the conclusion that even the most advanced theories of the time failed to capture the central features of a market economy, in particular the way it was able to coordinate dispersed knowledge and allow that knowledge to be used by others. Hayek eventually came up with an alternative description that highlighted that fact. It convinced no one, or virtually no one, at least not at first. And Hayek recognized immediately that changes in economic reasoning alone were not enough. If he was to convince his opponents, he would need to develop a more complete theory of society, to show how a host of social institutions might work together to allow free individuals to put their knowledge to use. This recognition led Hayek into all sorts of new areas of study and to new puzzles. Why did some institutions work better than others? Where did they come from? Could they be altered? At what cost? Every step along the way, then, Hayek encountered puzzles and opponents who offered alternative solutions to them. But there was one constant: every one of his opponents claimed to be doing “real” science. This provided a final puzzle, one with which Hayek would deal all his life. What was science, after all? What distinguished it from pseudoscience? (This question also engaged one of Hayek’s closest friends, the philosopher Karl Popper.) It was clear enough that, for much of the twentieth century, science was regnant. But Hayek felt that many of his opponents, all claiming the mantle of science, were but pretenders to the throne. He constantly encountered people who thought of themselves as objective scientists, people who held ideological views different from his and who immediately felt comfortable attributing their differences to the fact that, whereas they were scientists, he was an ideologue. Hayek developed criticisms of what he called scientism and also tried to explain how his opponents had come to hold their erroneous beliefs. In the process, like Carl Menger before him, he turned to the study of methodology to make his case. And, just as, earlier, he had found that the tools of equilibrium theory did not illuminate the workings of a market economy, he found that the methods of study endorsed by his scientistic antagonists ob-

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scured the workings of the complex, spontaneously ordered phenomena that social scientists seek to explain. He therefore proposed alternative methods. In my intellectual biography of Hayek, then, I trace the development of Hayek’s ideas, focusing on the development of his ideas regarding methodology as a unifying theme. Although certain methodological pronouncements were present in Hayek’s early work, like most economists (this was also true of Menger) his first love was not methodology. Therefore, when, in his early work, Hayek wrote about methodology, he simply echoed some standard Austrian doctrines, doing so principally to make a case to a German audience for an Austrian approach to business cycle theory. It was only later, as he engaged in numerous debates over how well his and alternative theories captured what he saw as essential features of a market economy, that Hayek began to explore methodological issues more thoroughly. The end result was a distinctive vision of what was possible in the social sciences and of how social phenomena might best be studied. Hayek’s methodological views are of interest in their own right, but they also increasingly came to inform much of his substantive work. Accounts that leave out this part of his thought miss much of the rationale for why he took the specific positions he did. In tracing out the evolution of his ideas, I will try to show the relations between his methodological writings and his contributions to such areas as economics, political philosophy, and psychology. I will not try to provide a systematic and detailed exposition of all his theories. There already exist a number of excellent generalist accounts that provide overviews as well as others that deal with specific aspects of his thought.12 On the other hand, my book does not presuppose a knowledge of Hayek’s work; indeed, it is intended to be accessible to readers who are neither economists nor historians. I also hope that those who wish to undertake a more systematic study of Hayek’s thought will, after reading my book, both understand his broader vision and know where in his massive oeuvre to look for specific ideas. 12. Vaughn (1994) provides an accessible history of the Austrian movement and of the Austrian revival in America. Two surveys of Hayek’s multifarious contributions are Barry (1979) and Gray (1998). O’Driscoll (1977) focuses on his monetary theory, Steele (1993) emphasizes his economics more broadly, and Kukathas (1989) and Shearmur (1996) explicate and assess his political theory. Ebenstein (2001, 327– 46) provides a guide to the secondary literature on Hayek.

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I call the middle part of the book “Hayek’s Journey.” The title is meant not so much to draw attention to the physical journeys that he took, from Vienna to London to Chicago and beyond—although they too are part of the tale to come—as to emphasize Hayek’s intellectual voyage. Where Hayek began was with the Austrian presuppositions, but, after decades of study, where he ended up was in a place that was unique. I hope to offer a plausible account of the many twists and turns that the road to that unique place took. There are, of course, different stories that could be told. More to the point, different stories have been told, and, although some of them complement my account, others clearly compete with it. I will address some of these alternative interpretations, but, to keep to the main thread, I will do so in appendixes to the volume.13 History is always like this, of course. It is always a negotiation between the present and our reconstructions of the past, between the evidence and our interpretations of the evidence, a struggle between contending plausible stories offered by different narrators whose own histories, perspectives, and agendas color their accounts. I have puzzled over Hayek’s journey for a long time, and I believe the story that I am about to tell you, but I also know that the strength of my convictions matters very little. What perhaps matters most is that, in putting forward my account, I provide a clear target for those who will carry the interpretive task further. That is something that I have tried to do. I should perhaps say a few words about where my book fits into the now enormous secondary literature on Hayek and on the Austrian school. When I started work on this project over ten years ago, not much had been written on the early history of the Austrian school. This has now been to a considerable extent remedied. Caldwell (1990) contains conference papers on Menger, English translations of some early work are provided in Kirzner (1994a), and Endres (1997) offers a book-length explication of some of the theoretical contributions of Menger, Böhm-Bawerk, and Wieser. The methodological positions of the founding fathers are analyzed in Cubeddu (1993) and Oakley (1997). There has also been a revival of interest in the thought of the German historical school, as documented in Peukert (2001). Even in the light of the recent additions to the literature, I still feel that, in part 1, I am able to add considerably to our understanding of Hayek’s prede13. There are four appendixes. The first contains a translation of Gustav Schmoller’s review of Carl Menger’s Principles of Economics (Menger [1950] 1976). The other three deal with interpretive debates.

introduction

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cessors and their effects on his thought. In particular, I have tried to emphasize the complex interplay of theory and methodology and to highlight the contending ideological, political, and academic rivalries that existed between the Austrians and their historicist, and, later, their positivist and socialist, opponents. This background would help shape Hayek’s perceptions of, and responses to, his own opponents, from the American institutionalists to the assorted groups and personalities that he would encounter in England and beyond. An understanding of it will allow us to make better sense, I think, of the unique blending of perspectives and viewpoints that would emerge in his own thought, a blending that resulted in a thoroughly modernist critique of the scientistic pretensions of his age and yet simultaneously pointed toward some surprising (some might even label them postmodern) new directions. Part 3 of my book contains two chapters. In the first, I review Hayek’s journey, in the process trying my hand at assessing his legacy. Although I feel confident about the story I tell about Hayek’s journey, I must confess that I feel less certain about my attempt at assessment. Writing that assessment was, for me, the scariest part of the book, for it required me to enter into regions well outside my own areas of expertise. (Indeed, part of the assessment involves pointing the reader toward newly developing literatures in diverse fields that may be read as part of Hayek’s continuing legacy.) I have given dozens of talks about Hayek over the years. During the discussion periods that followed the talks, I discovered that people take very different things away from their readings of Hayek. Hayek wrote so much and in so many different areas that that is, perhaps, inevitable. I therefore recognize that my own assessment will equally inevitably be idiosyncratic, reflecting my own readings and interests. Still, I feel that this is something that I owe to the reader. In the second chapter, one styled as an epilogue, I examine a final challenge that Hayek’s work provides, a challenge to the discipline of economics. Hayek had a particular vision of the subject matter studied by economists and was critical of the methods that economists employed in their investigations. If Hayek was right, then some of the directions taken by the discipline in the twentieth century have been wrong. In this final chapter, I try to take those criticisms seriously and use them to reflect, as a historian of economic thought, on the development of economics in the century that has just passed.

I The Austrian School and Its Opponents— Historicists, Socialists, and Positivists

CHAPTER 1

Menger’s Principles of Economics

Prelude — Carl Menger Gets a Chair Because every story must begin somewhere, I start my account of the origins of the Austrian school at a particular time and place. The time and place— Vienna, 1871—will not surprise those who know something about the Austrian school, but perhaps the choice of protagonist will . . . In the spring of 1871, Albert Shäffle surrendered his professorship at the University of Vienna to become the Austrian minister of trade in the cabinet of Count Hohenwart. This was not to be the most propitious of career decisions. Before the year was out, the count’s government had collapsed, and Schäffle was out of a job. Schäffle did not return to the university and, indeed, was never again to hold a position in either academe or the government, although his few months of service to the state did gain him a lifetime pension. History has not treated Schäffle particularly well. He is virtually unknown among economists today, and, when he is mentioned, he usually is dismissed. The conclusion of the brief entry in the New Palgrave is both typical and unequivocal: “Schäffle’s influence as theorist and teacher of economics was in his own day rather limited. It seems to be of little importance for our time” (Recktenwald 1987, 256).1 We are interested in the now obscure Herr Doktor Schäffle, not for his ideas, but for his decision to accept a government position, a decision that had a direct effect on the fortunes of the founder of the Austrian school, Carl 1. Schäffle was not treated so abruptly by everyone. The American sociologist Albion Small thought him sufficiently important to include a “slightly abbreviated” (it still ran to nine pages) translation of the table of contents of Schäffle’s sociological treatise in his own General Sociology (see Small 1905, 158 – 66). For more on Schäffle’s contributions, see Hutchison (1953, 296), Streissler (1990b, 155), and Hennings (1997, 31, 37, 46 – 47, 54 –55).

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Menger. It was Menger who, after a somewhat difficult Habilitation process, was appointed to Schäffle’s chair at the university. Menger had studied law, receiving his degree in 1867. Over the next four years, he worked briefly as a journalist for the leading Viennese newspaper, the Wiener Zeitung, then entered the press section of the prime minister’s office, where he was responsible for reporting on economic news.2 Over the same period, he wrote the Principles of Economics (Grundsätze der Volkswirthschaftslehre) and submitted it as his Habilitation paper. In German-speaking countries at the time, the attainment of an advanced degree was only one step along a long road leading to a university appointment. Next one was required to find a sponsor (Habilitationsvater) among the professors. Then one could apply for one’s Habilitation by submitting an original piece of research, usually a book, for assessment by faculty at the university where one wished to teach. The Habilitation defense followed, a formal oral presentation before the professors during which one’s arguments were cross-examined. (Cross-examined is an appropriate term because what we now call economics was, in the Austro-Hungarian Empire at that time, taught within the faculty of law.) If one’s research was deemed acceptable, then by faculty decree one was recommended to the minister of education, who was empowered to grant the Venia legendi, or “right to lecture.” Right to lecture is a precise description, for, if no university position was available, the best one could do was to become a Privatdozent. A Privatdozent could collect fees for lectures to students, but the position was not a formal university appointment and carried no salary. One received a salary only if one was able to fill a vacant position and obtain the title of Dozent or ausserordentlicher Professor (literally “extraordinary professor,” which sounds impressive but is roughly equivalent to the rank of associate professor).3 Menger’s Principles was published in 1871 (see Menger [1950] 1976), he passed his Habilitation in 1872, and in 1873 he was appointed to Schäffle’s chair as a Dozent. It was quite a coup to be appointed at age thirty-three to a professorship in the university of the Austrian imperial city, and, after this serendipitous 2. As Hayek (1992b, 68 – 69) reports, Menger once commented to Friedrich von Wieser that keeping track of market conditions for the newspaper led him to recognize the role of demand in price formation. 3. For more on the intricacies of the German system of higher education, see Ringer (1969, 33 –38).

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start, things only got better. In 1876, the emperor chose Menger to be the eighteen-year-old crown prince’s private tutor. For the next two years, he accompanied Rudolf on a number of European tours. Not surprisingly, by decade’s end Menger had risen to the rank of full professor at the University of Vienna. As the professor of the chair of political economy, Menger had considerable power. He made recommendations to the faculty for the unsalaried Privatdozent positions and similarly advised the emperor about whom to appoint to the salaried chairs. He was left as the senior academic in the field when the venerable Lorenz von Stein, who occupied the other chair in economics, departed in 1885. And he also more or less controlled who could earn an advanced degree in economics. The public libraries in Vienna were, to put it gently, less than complete, and to use them one had to adhere to a host of aggravating and time-consuming regulations (Seager 1893, 261). To avoid having to deal with the bibliobureaucracy, favored students were permitted to work in the private libraries of their professors. Menger’s personal collection of books on political economy was the most complete in Austria. If a young man wanted to pursue an academic career in economics, an invitation to use Menger’s library was very nearly a necessary first step (Streissler 1988, 197). Within the economics field of the law faculties of the Austro-Hungarian Empire, Carl Menger was, without question, the big enchilada (to use a phrase made famous during the Watergate hearings). Let us now turn to the book that earned him that status. Menger’s Principles of Economics is the founding document of the Austrian school of economics, yet, as its name implies, it is basically a textbook. It may seem strange today that a textbook could serve to found a school of thought, but, in contrast with current scholarly practice, professors in the Austro-Hungarian and German Empires typically wrote textbooks rather than articles or monographs. The motivation was economic: professors’ incomes largely depended on their success as lecturers, so the incentive to develop a textbook to accompany one’s lectures was strong. Monographs were sometimes written by young men applying for their Habilitation but otherwise were produced only by those outside the academy, as was the case with the famous outsiders H. H. Gossen and J. H. von Thünen (Streissler 1990a, 62 – 64). Before we undertake a more thorough exploration of themes in the Principles, it may help to provide a brief outline of its contents. The book has a preface and eight chapters. In chapter 1, four conditions that must be present

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for a thing to be considered a good are listed. In chapter 2, Menger notes that, when human requirements for a good exceed the available quantity, the good becomes subject to economizing activity; it becomes an economic good. Value theory is taken up in chapter 3: the value of any unit of an economic good is equal to the value of the marginal unit to the economizing agent. In chapter 4, Menger explains that exchange arises when individuals place different valuations on the marginal unit. Chapter 5 concerns price formation. In it, Menger contrasts the ranges of prices that emerge under bilateral monopoly, straight monopoly, and competition and offers a welfare comparison between the last two. In chapter 6, he discusses the venerable distinction between use and exchange value and describes when each will dominate in determining the value of a good. Chapter 7 contains Menger’s theory of the commodity: commodities are goods intended for sale, and marketability is their most essential aspect. Menger uses the notion of the marketability of a commodity in chapter 8 on the theory of money, where he argues that the most marketable commodity gradually becomes accepted as a general medium of exchange, or money. These are the major threads of Menger’s argument. In the next section, some important themes of the book are highlighted.

Themes in the Principles of Economics The Compositive Method in Menger’s Principles In the second paragraph of his preface, Menger states: “Never was the need of a scientific foundation for economic affairs felt more generally or more acutely” ([1950] 1976, 45). His intent is clear: the Principles is a textbook that will provide a scientific and theoretical foundation for economics. And, even though his book is bereft of the mathematical formalisms that economists of the twentieth century usually associate with the word theory, it does possess certain other attributes of a scientific treatise. One is struck first off by how systematic the author is—indeed, almost painfully so. Hayek once remarked on the book’s “persistent slow approach to its main object” (1992b, 100). Elsewhere, in a less charitable mood, he said: “Menger’s exposition is generally characterized more by painstaking detail and relentless pursuit of the important points than by elegance or the use of graphic terms to express his conclusions. Though always clear, it is labored” (1992a, 46).

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Menger uses his systematic reasoning “to contest the opinion of those who question the existence of laws of economic behavior” (Menger [1950] 1976, 48). His primary goal is to discover the invariant principles or laws governing economic phenomena. And, time and again, he feels that he has been successful—which we see in the fact that his chapter sections carry such headings as “The Laws Governing Goods-Character,” “The Laws Governing the Value of Goods of a Higher Order,” and “The Principles of Monopoly Trading.” (The first section discusses how things become goods when they are capable of satisfying human needs, the second how the value of inputs, what Menger calls “goods of a higher order,” depends on their ability to produce “lower-order” consumer goods, and the third how a monopolist can set either price or quantity but not both and will choose to set it at a level that will allow him to reap the best return.) How does Menger establish his “principles”? Many of them, after all, may seem like simple common sense to a modern reader—hardly the stuff of real science. It is here that it becomes evident why Menger believed that he was making a scientific contribution: every one of his “laws” is built up (step by painful step) from an analysis that begins with the relation between a person’s needs and those goods that are capable of satisfying them. When the quantity of such goods is less than a person requires, economizing activity begins. Or, in the jargon of modern economists, in attempting to maximize utility humans encounter scarcity, and scarcity requires that choices be made.4 All the other laws governing such things as the valuation of goods and their prices under various market structures, as well as the emergence of such institutions as trade and money, follow from the logic of economizing activity. Labeling Menger’s particular approach has posed problems for later writers. In his preface, Menger uses the term empirical to describe his methodology. But, because this term might better be applied to the methods that were 4. Although the word scarce appears in the English translation of the Principles (see Menger [1950] 1976, 111), scarcity (Knappheit) is not to be found in either the English or the German versions (Hayek 1992b, 71). The term Grenznutzen, or “marginal utility,” is also absent. Alfred Marshall ([1920] 1990, 79) tells us that “Grenz-nutz” was first used by Wieser in 1884; it was his translation of the English economist William Stanley Jevons’s terminal utility or final degree of utility. Marginal utility finally appeared in English in 1888 in Philip Wicksteed’s The Alphabet of Economic Science, but Wicksteed may simply have translated Wieser’s term (Howey 1960, 134, 145 – 46). Streissler (1986, 97) notes that Wieser also appears to have been the first Austrian to use the term Knappheit, this in the 1889 German edition of Natural Value (see Wieser 1893).

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to be advocated by his rivals in the German historical school, it is confusing to modern sensibilities. Another candidate is causal. There is some support for this in the literature. In 1932, the Viennese economist Hans Mayer used the term causalgenetic to describe the Austrian approach to price formation, which he contrasted with the functionalist theories of Walras, Pareto, and others (Mayer [1932] 1994). Mayer’s definition gets at an important distinction. Austrians have always been more interested in the (causal) processes by which prices actually get formed than with enumerating conditions for equilibrium. The phrase causal-genetic could, thus, accurately be used in reference to Menger’s method. There are dangers here too, however. The Principles begins with the sentence “All things are subject to the law of cause and effect,” and Menger quickly follows this with the assertion that goods arise when “useful things” are brought into a causal relation with a person’s needs (see Menger [1950] 1976, 50 –52). This use of the term causal is quite different from Mayer’s. As Frank Knight noted in his introduction to the first edition of the English translation of the Principles, the relation between goods and the satisfaction of needs is not best viewed as a causal one (Knight 1950, 22). Knight was surely right; it is better to conceive of the relation that Menger described as one between means and ends than as a cause-and-effect sequence. Indeed, we will see that the same objection was raised by one of the earliest reviewers of Menger’s book and that Menger basically accepted it.5 It is possible that the only reason that Menger originally couched his theory in terms of cause and effect was to challenge the views of certain other writers (e.g., Karl Knies) who denied that causal concepts could be applied to the historical and social sciences. Standing alone, then, the term causal is decidedly not a good adjective for describing Menger’s approach. In keeping with the usage that is now standard in the secondary literature, when the term causal is used here to describe Menger’s methodology, it will be paired with the term genetic. Most of the time, however, I will use the term compositive to describe Menger’s methodological approach. This is all the more attractive since the 5. Knight’s conclusion that Menger’s analysis is a naive and “mechanical” causal version of economic action cannot be sustained, given all that Menger says about error and information in the Principles. Knight’s introduction is often idiosyncratic and at times borders on the cranky, which is only to say that it is a standard Knightian exposition. Betz (1988, 419 –20) notes Karl Knies’s opposition to the use of causal concepts outside the natural sciences, and Silverman (1990, 70ff.) analyzes Menger’s causal-genetic approach.

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word was also used by Hayek, who reported that he “borrowed the term compositive from a manuscript note of Carl Menger, who, in his personal annotated copy of Schmoller’s review of his Methoden der Sozialwissenschaften . . . , wrote it above the word deductive used by Schmoller” (Hayek [1942 – 44] 1979e, 67 n. 4). Compositive emphasizes that social phenomena like exchange or market valuation are built up or composed from the economizing actions of individual agents and, thus, nicely captures the method that Menger employs. Institutions as Unintended Consequences of Individual Action A second theme of the Principles is that the economizing activity of individuals produces effects that go far beyond the intentions of the agents themselves. Economizing human action has unintended consequences, especially in terms of the emergence of social institutions. To illuminate this central theme, three of Menger’s examples will be briefly recounted. Trade: Two neighboring farmers, one with a surfeit of cows, the other a surplus of horses, chew the fat during their midday break. They soon discover that the first would like to have more cows and the second more horses. Put another way, they recognize that each evaluates the last unit of each of the two goods differently. This leads them to begin exchanging horses for cows, an act that makes each farmer better off. If we know the valuation that they put on each unit, we can tell when trade will stop: when the gain from the last unit added no longer exceeds the loss of the last unit given up. This is the “marginalist” aspect of the tale. The “unintended consequences” part of the story concerns the origins of trade. Menger explicitly rejects Adam Smith’s conjecture that trade emerged as a result of a peculiarly human “propensity to truck, barter, and exchange one thing for another” (Smith [1776] 1976, 17). After all, if such a propensity existed, the two farmers would simply trade back and forth the same two horses and cows, each exchange producing a new rush of excitement (Menger [1950] 1976, 175 –76). Trade finds its origins in a human propensity, but it is not a fondness for exchange. It is the desire to satisfy one’s needs to the greatest extent possible, given the quantity of goods available. That desire naturally leads to trade when two humans have different valuations of the marginal unit. Money: So economizing man engages in trade. But what if there is no mutual coincidence of wants? What if you have the scotch that I desperately desire but I don’t have the running shoes that you want in exchange? Menger notes: “This difficulty would have been insurmountable, and would have

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seriously impeded progress in the division of labor, and above all in the production of goods for future sale, if there had not been, in the very nature of things, a way out. But there were elements in their situation that everywhere led men inevitably, without the need for a special agreement or even government compulsion, to a state of affairs in which this difficulty was completely overcome” (Menger [1950] 1976, 258 –59). The solution is simplicity itself. As a producer of ceramic plates, I will whenever possible trade them directly for goods that I desire. But, when this is not possible, my activity will not stop, for I wish to satisfy as many of my needs as possible. I will, therefore, trade my surplus plates for other commodities that are more marketable: yards of cotton cloth, for example. I will then trade the new good for other goods that I wish to consume. As time goes on, certain goods, like yards of cloth, become demanded, not only for their immediate use, but also because they are marketable, that is, they are widely accepted by others in trade. If one follows this reasoning to its logical conclusion, what eventually emerges is a single commodity that is accepted by everyone in trade. This most marketable of commodities is money. Its form will differ depending on the nature of society (e.g., because they are self-transporting, cattle might emerge as money in a nomadic society, whereas easily stored metals might better suit a more urban society), but it emerges everywhere as a result of the economizing activities of trading humans. Monopoly and competition: When a manufacturer introduces a new good, his innovation is welcomed by members of his community. But soon an allocation problem emerges: too many people want the good relative to its supply. Who should get the existing units? The monopolist, who is concerned about making the best return that he can, does not take long to find a solution: he raises his price, with the goal of finding the maximum price that will just exhaust his (say, weekly) flow of output. This solution is not stable in the long run, however. The high price attracts new producers, eager to make their best return. Meanwhile, consumers who have become unhappy with the activities of the monopolist begin to search the market for a lower price. This becomes feasible because, as more and more producers enter the market, the quantity of the good available grows and its market price drops. Indeed, as time passes, the once exclusive good becomes affordable to even “the lowest social classes” (Menger [1950] 1976, 225). Competition, then, is the natural successor of monopoly, and it brings with it an expansion of production and a lowering of price. All this occurs naturally, unless, of course,

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the monopolist is successful in appealing to the government for protection of his market.6 What links these apparently disparate scenarios is that all three exemplify what Ullmann-Margalit (1978) has dubbed “invisible-hand explanations.” In such explanations, individual economizing activity brings unintended and beneficial results if left unimpeded. Some of the benefits are directly linked to the production of goods: because of economizing action, new goods are brought to market, the quality of all goods improves, and greater quantities of goods are produced. Benefits also include better information about human needs, both present and future, and about the means of satisfying them. These benefits ultimately extend to all segments of society. Perhaps most important, the expansion of goods has positive implications for “the progress of civilization” (one of Menger’s favorite phrases). This concern with the evolution of society had many affinities with traditional German historical scholarship and especially with the approach of the historical school of law. As Hayek was later to discover, it also had antecedents in a wholly different tradition, the Scottish Enlightenment. Menger’s Subjectivist Theory of Value Menger claimed to have identified certain scientific laws the use of which allowed him to explain the origins of various social and economic institutions. In examining the laws from which Menger begins, we encounter his subjectivism. The term subjectivism has many meanings (Boehm 1982). In the present context, it means that the subjective valuations placed by individuals on things that they believe will satisfy their needs are the origin of all economic activity. Menger’s commitment to subjectivism is clear from the opening chapter of the book, where he offers his definition of a good. Useful things are those things that are capable of being brought into a relation with those human needs that they can serve to satisfy. For a useful thing to become a good, the individual must know the relation and, further, must be able to act on it. Thus, goods are not goods without people to use them, people who both have beliefs about their qualities and are able to use them to satisfy their needs. Without people who (subjectively) evaluate the ability of goods to satisfy their own (subjectively) perceived needs, there literally would be no goods. 6. To reach his results, Menger clearly assumed both free entry and the absence of conditions that might lead to natural monopoly.

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The best way to bring out the full force of Menger’s theory is to contrast it with the cost of production theories of value endorsed by British classical economists like Adam Smith and David Ricardo. In the standard account, the classicals did not believe that demand-side variables (i.e., consumer valuations and income) played any role in determining the exchange value of goods, except in those rare instances when the supply of a good was fixed.7 Value in exchange, or a good’s price, was determined by its long-run, or normal, cost of production. Sometimes this valuation was reached simply by adding up that portion of rents, wages, and profits attributable to the production of one unit of a good. In Ricardo’s labor theory of value (given certain assumptions concerning the distribution and durability of capital), relative prices reflect the amount of labor “embodied” in the two goods. The classicals’ neglect of consumer valuation was justified by using examples like the diamond-water paradox (Smith [1776] 1976, 33). Diamonds are valued highly in the marketplace, and water is often a free good. Yet, in terms of human needs, water is necessary for life, while diamonds are a luxury. Thus, human valuations concerning the usefulness of objects apparently play no role in determining their observed market prices, or value in exchange. For the classicals, use value is subjective, but exchange value depends on how much it cost to produce a good. In this sense, the value of a good is inherent in the good: its value is determined by its history of production. If Menger had a target in his book, it was the classical theory of value. Reliance on the classical theory left economics in “need of a scientific foundation” (Menger [1950] 1976, 45). Again and again Menger repeats that such things as “goods-character” (56 –58), whether a good is economic or noneconomic (101), and an economic good’s value (115 –16, 226 –28) are not inherent in a good but are due to its being brought into a particular relation with some human need. The classical view that the value of a consumption good (a good of the first order) depends on the value of the inputs (goods of a higher order) used to produce it is “a complete reversal of the true relationship” (108). Instead, goods of a higher order owe their value to their ability to be combined to produce goods of the first order that are used by humans to satisfy needs. 7. I use the term standard account to mean one that, despite being widely held, is typically at least a caricature and may even be largely false. Suffice it to say that the theory of value was only a part (and by no means the central part) of classical analysis, that the classicals differed among themselves in their analyses of value, and that alternative value traditions existed in a number of countries.

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Menger’s subjectivist theory permits a resolution of the diamond-water paradox. An economizing individual compares the number of units of a good that are available to him with his “requirements” or needs. Using Menger’s own example (Menger [1950] 1976, 133 –36), let us say that one hundred units of water would fully meet the requirements of a stranded Robinson Crusoe. The first unit provides drinking water. The next nineteen are used for cattle and watering the food garden. The next forty are used to maintain good health, for example, for washing. The last forty are for things like a flower garden and nourishing pets. The valuation of any given unit depends on how many units are available to Crusoe. Specifically, the value of any unit of a good is equal to the use from which it would be withdrawn, that is, the least important use. The least important use has considerable value (life itself!) if there is only one unit of water but very little if Crusoe has close to one hundred units. If more than one hundred units are available, the last unit would have no economic value. Generalizing to a social setting, the reason that water has little or no exchange value is because it is so abundant: the value of the marginal, or last, unit is close to or at zero. Of course, in situations where water is not abundant (think of a desert or the situation depicted in the film Ice Pirates), its exchange value is much higher. Similarly, the relative rareness of diamonds causes their exchange value to be high. Menger’s theory of subjective value had a further advantage over its costof-production predecessors. The argument that a good’s value depends on its production costs simply pushes the value determination question back a step: What determines production costs? Some classicals, like Smith, never came up with a complete answer. Others came up with a plethora of answers, a different one for each of the factors of production. Thus, in the Ricardian story, rents are a differential surplus on intramarginal land, wages are set according to the long-run subsistence requirements of labor, and profits are a residual. The advantage of his own formulation (and of marginalism in general) is recognized by Menger in his preface: it is that it places “all price phenomena (including interest, wages, ground rent, etc.) together under one unified point of view” ([1950] 1976, 49).

Menger’s Followers Menger was a gifted lecturer and taught every winter and summer semester beginning in 1875 until his retirement in 1903 (Hayek 1992b, 93 –95; Yagi and

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Ikeda 1988, 211). More important, however, was his influence on two young men who never had a class with him, Eugen von Böhm-Bawerk and Friedrich von Wieser, the “second generation” of Austrian economists. Until Böhm-Bawerk and Wieser were in their late twenties, their lives followed nearly identical paths. Born in the same year (1851), the two were high school classmates at the prestigious Schottengymnasium. They attended the University of Vienna together, and both entered the civil service after graduation. Menger began teaching in 1872, the year Böhm and Wieser graduated. Both read his book that year, and, apparently, its message stuck. After three years of government work, they received travel grants (scholarships) to study at the German universities of Heidelberg, Jena, and Leipzig. In papers that they presented at Karl Knies’s seminar in Heidelberg in 1876, Menger’s influence was evident. The seminar papers also foreshadowed their later contributions, Wieser’s on the relation between utility and cost, Böhm-Bawerk’s on capital theory.8 The two decided to pursue university careers, and both were successful. In 1881, Böhm-Bawerk was appointed ausserordentlicher Professor at Innsbruck, having passed his Habilitation in 1880, the same year he married Wieser’s sister. In his Habilitation paper, he examined the utility aspects of goods, arguing that credit, patents, and goodwill are not “economic goods.” Although Böhm-Bawerk employed Mengerian concepts, he did not have any treatment of marginal utility. Wieser’s Habilitation paper, Über den Ursprung und die Hauptgesetze des wirthschaftlichen Werthes (On the origin and principal laws of the economic value of goods), led him to a professorship at Prague. The standard account credits Wieser with developing the notion of opportunity cost and applying it to production.9 8. Hennings (1997) provides a biography of Böhm-Bawerk. The seminar papers were submitted to Menger when Böhm-Bawerk and Wieser applied for a renewal of their scholarships in 1876, and, even though the scholarships were renewed, Menger did not show much interest in Wieser’s contribution (Hayek 1992e, 113 –14). Wieser’s paper was not published until 1929, three years after his death; for a recent translation, see Wieser (1994). Böhm-Bawerk’s paper was never published, but Yagi (1983) provides a transcript as well as copies of Menger and Böhm-Bawerk’s 1884 – 85 correspondence relating to the latter’s capital theory. 9. See, e.g., Hayek’s (1992e) obituary notice or his remark in his discussion of Menger’s Principles that “it was left to Wieser to develop what later became known as the principle of opportunity cost or ‘Wieser’s Law,’ i.e. the principle that the other uses competing for the factors will limit the quantity available for any one line of production in such a way

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The Austrians (with the curious exception, it turns out, of Menger) soon rallied around marginal utility as their unifying concept. In 1886, BöhmBawerk published a two-part article on marginal utility in Conrads Jahrbücher. This was the first presentation of the idea in a German academic journal and marked Böhm-Bawerk as a member of the Austrian school. It also brought fame to its author, for it quickly became known as the standard German-language exposition of marginal utility theory.10 In 1889, the German editions of Böhm-Bawerk’s Positive Theory of Capital (see Böhm-Bawerk 1959, vol. 1) and of Wieser’s Natural Value (see Wieser 1893)—for which Wieser was awarded a full professorship and which Hayek (1992e, 115) described, a bit overgenerously, as “among the most brilliantly written and organized books on economic theory”—and four other works by members of the Austrian School were published. Indeed, by the decade’s end, there were eight other economists in Austria who, when added to Menger, Böhm-Bawerk, and Wieser, could be considered part of a school of thought (see Hayek 1992e, 77). The Austrians began to attract attention around the world: Panteleoni expounded their doctrines in Italy in 1889, and Gide did so later in France. Their ideas found a particularly warm reception in Holland and the United States—that in the United States was due to the presentations of Simon Patten and Richard T. Ely. In 1890, the first edition of Alfred Marshall’s Principles of Economics appeared; it showed more of Menger’s influence than did later editions (see, e.g., Marshall [1920] 1990). And, as we will see later, Menger’s dispute with the German Gustav Schmoller over methodology that the value of the product will not fall below the sum of the value which all the factors used in its production obtain in these competing uses” (Hayek 1992b, 73). Streissler (1986, 1988) offers an interpretation that is revisionist in two respects. On the one hand, he argues that the notion of opportunity cost is already discernable in Menger’s Principles, so that Wieser’s originality here is greatly exaggerated. Wieser had the bad habit of not citing sources so that his debt to Menger, whose work was out of print when Wieser was at his prime, was easily missed. On the other hand, Streissler claims that two of Wieser’s legitimate contributions are often overlooked. The first is the notion that economies develop through a process of innovation and imitation, an idea taken up by Schumpeter. The second is that Wieser’s repeated emphasis on “management and value” anticipates the notion that prices provide information about relative scarcities and thereby permit rational calculation about factor use, a central theme in Mises’s attack on socialism and in Hayek’s vision of the workings of the market process. 10. The article, slightly altered, can be found in Böhm-Bawerk (1959, 2:121–204).

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further contributed to the establishment of a distinctly Austrian school of economics.

Some Interpretive Issues Two interpretive issues in the secondary literature are taken up next. These concern the extent to which Menger may be properly said to have been a marginalist and the extent to which he may be properly said to have been a subjectivist. Menger’s Marginalism The standard account holds that Menger, together with William Stanley Jevons in England and Léon Walras in Lausanne, Switzerland, are the founders of the marginal revolution. The three codiscoverers of the marginal principle applied it to utility theory in the early 1870s. Later theorists saw that the marginal principle could be applied to virtually any choice problem. Summarizing its widespread applicability, the historian T. W. Hutchison wonderfully quipped: “What was important in marginal utility was the adjective rather than the noun” (1953, 16). Modern microeconomic theory thus traces its origins to the marginal revolution. The standard account is not without truth, but it must be immediately added that Menger was the least marginalist of the triumvirate. As Erich Streissler aptly countered, for the Austrians “marginalism was not the essence of their endeavor; it remained—pace Hutchison—an adjective, not the noun” (1972, 426). Marginal concepts first appear in the Principles about halfway through the book. There we find the famous table in which ten goods are listed across the top, with rows representing the cardinal rankings of satisfaction that the consumer receives from additional units of each good. To be sure, the table shows diminishing satisfaction of needs or diminishing marginal utility. But, because he uses discrete units of each good, Menger does not get to the standard marginalist result that consumer equilibrium implies equal marginal utility–price ratios for all goods. Instead, he simply shows the order in which successive units of the various goods would be chosen. And, when he discusses price determination two chapters later, his use of discrete units forces him to talk of a range of prices within which the actual price will fall, rather

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than arriving at the more widely accepted marginalist result, the “law of one price,” with the price equal to the marginal consumer’s valuation of the good. One reason, then, that Menger failed to get to what are now viewed as the standard results of marginal analysis was his wariness of mathematics and consequent reluctance to use smooth functions. This distrust of mathematics as a tool for understanding the social was to become a hallmark of much of the Austrian tradition. It would also lead some economists in the next century to dismiss the Austrians as mathematical (and, hence, theoretical) illiterates. Some have argued that Menger simply did not have adequate mathematical training to handle marginalism properly, but this line of criticism ignores the fact that Menger’s verbal approach had its advantages.11 Menger was not interested in getting mathematically precise results; he was interested in explaining the essential causes of social phenomena. In the real world, production takes time, and the future is uncertain. Agents make plans on the basis of their beliefs about what the future may hold, and those beliefs may be in error. Transactions costs typically exist. When goods are brought to market, they are sold in discrete units. Terms of trade are often determined through a process of bargaining: Menger’s term is Preiskampf, or “price conflict.” None of these propositions about real-world economic phenomena are easily incorporated into mathematical models. As Erich Streissler remarks: “Menger had incorporated into his founding volume practically all the ideas which make the application of the marginal calculus difficult and hazy.” This formed the basis for Streissler’s ultimate assessment that “Menger is uniquely great because he surpassed marginalism at the same time he created it” (1972, 438, 430). In the end, Menger holds this distinctive position because of the doubleedged nature of the subjectivist sword. A subjective value theory that depends on the idea of diminishing marginal utility points directly toward marginalism and away from the classical theories of value; this much Menger had in common with other marginalists. But, if taken seriously, subjectivism also 11. For contending views on Menger’s lack of mathematical skills, see K. Menger (1973, 44) and Reiss (2000, 481– 82). Kauder (1965, 97) notes that both Jevons and Walras believed that, in Jevons’ words, “economic writers must be mathematical so far as they are scientific at all” but that Menger consistently held to the view that mathematics failed to get at the essence of economic phenomena.

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points toward the importance of knowledge, time, human perception, and the possibility of error in individualistic decisionmaking, and all these create problems for the clean application of the marginalist calculus. Menger’s deviation from the other marginalists was not just a matter of his failure to utilize mathematics. There is also evidence that he himself came to see marginalism as among his less important contributions. There is little evidence in Menger’s work after the Principles of any attachment to marginalism. Indeed, as Kauder (1965, 76) notes, Menger crossed out the marginal utility table in his “author’s copy” of the book. He barely mentioned marginalism when he gave his lectures on economics to the crown prince later in the 1870s (Streissler and Streissler 1994, 19 –22). And things did not change in the 1880s. Despite the fact that, by this time, the Austrian school was increasingly identified as the marginal utility school—thanks to the efforts of Böhm-Bawerk and Wieser—in his reviews of the economic contributions of fellow Austrians for the Wiener Zeitung Menger repeatedly failed to emphasize the importance of marginal utility. Indeed, he seldom identified himself as part of the tradition (see Howey 1960, 142). Menger’s reticence concerning subsequent printings of the Principles must also be mentioned. The book had gone out of print quickly. By the 1880s copies were scarce, yet Menger insisted that no reprint or translation be undertaken. Apparently, he was working on a revision that he hoped would resolve certain problems contained in the original. He even got so far as completing a preface for the second edition in 1889, but no new edition appeared in his lifetime (Alter 1990, 98). Had Menger thought of the marginal principle as his fundamental contribution and of himself as a founder of a marginal utility school, none of his behavior would make sense. It was, instead, Wieser, Böhm-Bawerk, and a host of other Austrians who, in succeeding decades, turned the Austrian tradition into a solidly marginalist one. As Streissler has put it: “The further his pupils escaped him, the more marginalist they became” (Streissler 1972, 429). Menger’s Deviations from Subjectivism It is also evident that, although it was clearly a dominant theme, Menger’s subjectivism was not thoroughgoing. And, indeed, his occasional lapses from a pure subjectivist framework were to cause consternation among later generations of Austrians. The tension in his work first appears in chapter 1 of the Principles, where the possibility of “imaginary goods” is introduced.

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As the author of a theoretical text, Menger wanted his categorization of goods to be complete. As such, his scheme actually should have begun with what might be called nonuseful things, things that are incapable of satisfying human needs. Useful things (the term he did start with) refers to things that are capable of satisfying needs. For a useful thing to become a good, what Menger called the causal relation (i.e., the capability of the good to satisfy a need) must be known by someone, and further, the person must be physically able to obtain the good. The introduction of knowledge about the relation is crucial, for the possibility of error is introduced along with that knowledge. At least two sorts of errors can be made. People can be mistaken about what their needs actually are, as when they believe that they are suffering from diseases that they do not actually have. Or they can erroneously believe that a nonuseful thing (say, snake oil) is a good. Menger used the term imaginary goods when discussing either of these sorts of mistakes, one concerning the content of needs, the other concerning the character of goods. The distinction is a key one, for it implies that “goods-character” depends on a thing’s actual ability to satisfy a real need. The need is not just a subjective perception; it exists objectively in a person. A thing is a good, not simply because someone thinks it useful, but because the causal relation between the thing and a need truly exists. It is also significant that Menger believed that, with “the progress of civilization” (something that occurs “as men penetrate more deeply into the true constitution of things and of their own nature”), the number of imaginary goods becomes smaller (Menger [1950] 1976, 53). As society advances, progress occurs on many fronts. More and more people of every social class are introduced to an ever wider variety of goods. Individuals come to understand better what their own needs actually are, and the true nature of all goods also becomes better and more widely understood. Indeed, this even extends to future assessments of needs and of goods, as people gradually learn how better to plan for future consumption. As Menger put it: The quantities of consumption goods at human disposal are limited only by the extent of human knowledge of the causal connections between things, and by the extent of human control over these things. Increasing understanding of the causal connections between things and human welfare, and increasing control of the less proximate conditions responsible for human welfare, have led mankind, therefore, from a state of barbarism and the deepest misery to its present stage of civilization and well-being,

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and have changed vast regions inhabited by a few miserable, excessively poor, men into densely populated civilized countries. Nothing is more certain than that the degree of economic progress of mankind will still, in future epochs, be commensurate with the degree of progress of human knowledge. (74) Menger’s occasional “lapses” from pure subjectivism might be of only passing interest were it not for their implications for questions of government policy. Menger argued that “the progress of civilization” was linked to improvements in objective human knowledge concerning the real needs of people and the true characteristics of goods. If objective knowledge about such things is available, then government might help society advance by providing information about goods or, perhaps less benignly, by “educating” people about what their “true” needs are. Objective knowledge about needs would also be useful if a redistributive government wanted to ensure that the basic and fundamental needs of all individuals in a society were met. Such issues did not trouble Menger, who sidestepped them by invoking an invisible-hand theorem. For Menger, the economizing actions of individual agents lead naturally to the development of beneficial social institutions that themselves promote the progress of civilization. Since such progress occurs naturally, no intervention by the government is necessary. Such arguments might convince those whose faith in the beneficence of voluntary and free exchange was already strong. But, if one did not share Menger’s confidence in invisible-hand theorems, if one suspected that the progress of civilization was not inextricably linked to the natural emergence of competition, one might easily conclude that government intervention was warranted. The argument for intervention becomes even stronger if one believes that a system of free and voluntary exchange has pernicious effects, as later critics of capitalism maintained. Later generations of Austrians soon recognized the implications of Menger’s deviations, and responded by enunciating a more thoroughgoing subjectivist viewpoint. As a result, the central role of subjectivism has become part and parcel of the modern Austrian credo. Indeed, Hayek’s statement that “it is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism” is one of the most quoted of Austrian aphorisms (Hayek [1942 – 44] 1979e, 52). From a modern Austrian perspective, Menger’s dalliance with objectivism must appear as a regrettable mistake.

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But such a conclusion must not be reached too quickly. The decision to include imaginary goods was anything but arbitrary. All things fall into two categories, the useful and the nonuseful. For Menger, a subset of all useful things qualifies as goods, once people correctly recognize the causal relations and are able to obtain the goods. Next, any goods for which requirements exceed quantities are subject to economizing action. This last move establishes the basis of all economic activity, and the rest of the Principles is devoted to tracing out the implications of individual economizing action. Menger’s system is brilliantly executed and logically complete. The fly in the ointment is the requirement that people correctly recognize the causal relations. How should one deal with the possibility of error? Standard neoclassical analysis defines it out of existence by assuming fully informed agents, thus eliminating by assumption the possibility of error. Pure subjectivists handle it by saying that good status depends, not on actual characteristics or needs, but on subjectively perceived ones, thereby eliminating the very possibility of imaginary goods. This is justified by saying that subjective perceptions are sufficient to explain the emergence of a price for a good, which is what economists are supposed to explain (Mises [1960] 1981a, chap. 5). Menger takes a third path: he admits the existence of imaginary goods but holds out the hope that “the progress of civilization” will gradually reduce their number. One might question his optimism about the progress of civilization, but only someone committed to the purest form of subjectivism could conclude that the presence of imaginary goods reveals an inconsistency in his system. Reception of the Principles I conclude with a review of reviews of the Principles. Of the three that appeared in German-language economics journals, two were anonymous. The first (Anon. 1871), in a journal sympathetic to free trade, was generally favorable, but the reviewer worried about whether Menger’s distinctions among goods of different orders might lead to protectionist policies à la Friedrich List. The reviewer looked forward to the volumes to come. (Menger had intended the Principles to be the first of four volumes and indicated on his title page that more was to follow. This plan was never carried out.) The other anonymous review (Anon. 1872) appeared in the prestigious Jahrbücher für Nationalökonomie und Statistik. Although the reviewer had some words of

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praise (e.g., calling the Principles an “able start” that he read “with pleasure”), he was also critical of young men with pretensions to write textbooks in economics, a task that he thought better suited to older, more established scholars. The final review, by Friedrich Hack (1872), appeared in the Zeitschrift für die gesamte Staatswissenschaft. Although the review was generally favorable, Hack raised some methodological questions. He wondered whether the “socalled causal connection between needs and things” was better thought of as a teleological one between ends and means rather than as a causal one. He also questioned how the existence of free will could be squared with the notion that there are economic laws.12 Of the criticisms raised by the three reviewers, Menger apparently took those of Hack most to heart when planning his revisions of the book. In the mid-1870s, he ordered some special author’s copies of the Principles to aid him in the revision process. These copies intersperse blank pages with the original so that the author can make notations where he wants to make changes in the text. One of these copies is preserved at Hitotsubashi University. Menger’s notes therein indicate a change in the title of the second section of the first chapter from “The Causal Connection between Goods” to “The Teleological Connection between Goods.” He also added the following sentences: “A [causal] connection can be a double one. A mechanical one and a teleological one. The former must be the foundation for the latter.” 13 One is hard-pressed to make any sense of this change. (Perhaps he meant something like ontological when he wrote mechanical?) But it does indicate that he took Hack’s comments seriously. In addition to the journal reviews, Menger’s book received mention in Roscher’s 1874 treatise on the history of German economic thought, Geschichte der National-Oekonomik in Deutschland (History of economics in Germany). Roscher placed Menger’s work within the subjectivist tradition of Hermann and praised him as follows: “[I will mention] finally the Austrian C. Menger with his very abstract, always original and frequently quite fruitful conceptual analysis which is usually founded on a thorough knowledge of the his12. The discussion in the text draws on Howey (1960, 139 – 40) and Streissler (1990a, 38 – 39). Information about and quotations from the three reviews are taken from Yagi (1989, 29). Yagi also notes that a fourth review appeared in the literary journal Literarisches Centralblatt für Deutschland (see Sch. 1873). We will return to it soon. 13. Yagi (1989, 6) provides the text: “Ein Zusammenhang kann ein doppelter sein. Ein mechanischer und ein teleologischer. Ersterer muss letzerem zu Grunde liegen.”

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tory of thought. For instance, he examines price formation first for the case of isolated exchange, then for monopoly trading and only finally under the influence of competition on both sides” (Roscher, translated in Streissler 1990a, 38). There was a fourth review of the Principles—this last one in a literary rather than an economics journal and taking up only about one column. Although polite, the reviewer thought that Menger’s treatment of his subject was flawed. He noted that the Austrian had borrowed the English fiction of egoistic economic man and had posited it as representing a universal human character trait. He would also have none of Menger’s claiming the mantle of scientific respectability for his approach. The authorship of the review is unclear: it is signed simply “G. Sch.” Given the nature of the complaints, however, and the fact that he had written other reviews for the journal, it is a safe bet that “G. Sch.” was none other than Gustav Schmoller.14 (A translation of the review may be found in appendix A.) While Hack’s criticisms might be dealt with by making some terminological modifications in the text, Schmoller’s were more far-reaching. Recall that Menger was trying to do nothing less than resuscitate a theoretical approach to economics in a land where theory was associated with the twin evils of the labor theory of value and Manchesterism.15 Schmoller’s review was an explicit repudiation of his efforts. To respond adequately, Menger would first have to show that the historical-statistical approach advocated by his rival was not the sole legitimate way to study economic phenomena, that a theoretical science of the discipline was both possible and fruitful. Next, he would have to overcome Schmoller’s objections to his specific approach and defend the use of the abstract fiction of an egoistic, economizing automaton. In short, Schmoller’s attack demanded a methodological defense. Menger’s response 14. Schmoller had earlier reviewed Lujo Brentano’s history of guilds in the Literarisches Centralblatt (see Sheehan 1966, 52). Yagi (1989) summarizes the reviews of both Hack and Schmoller, then analyzes the evolution of Menger’s thought, an analysis based on a comparison of the content of the Hitotsubashi author’s copy with the posthumous 1923 second edition of the Principles. 15. Manchesterismus is a German term for the doctrine of free trade. It refers to the selfinterested enthusiasm for free trade exhibited by the manufacturing class of Manchester and other industrial cities: free trade in grain meant lower grain prices, which permitted lower nominal wage payments to workers. The term implied that, rather than the universal principle portrayed in classical British political economy, free trade was a doctrine that served specific class interests.

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appeared in his 1883 Investigations into the Method of the Social Sciences with Special Reference to Economics ([1963] 1985). The book launched the Methodenstreit, a subject to which we soon will turn. But first we must find out a little more about Menger’s rivals, Gustav Schmoller and the German historical school(s) of economics.

CHAPTER 2

The German Historical School Interest in the German historical school has picked up in the past two decades among historians of thought in Germany and beyond. In 1988, two separate symposia were held to commemorate the 150th anniversary of Gustav Schmoller’s birth. Papers from the symposia were published in books and in issues of academic journals, and there have subsequently appeared more books, articles, and edited collections.1 One reason for the recent flurry of activity is that the school had, for a variety of reasons, been neglected for decades.2 Just as nature abhors a vacuum, historians of thought view such a lacuna as a golden opportunity. But professional opportunism in response to relative past neglect is not the only explanation; some of the ideas expressed by the German historical school economists clearly resonate with some individuals, especially those who may be dissatisfied with the current direction of mainstream economics.3 1. Some of the papers from the symposium held in Heilbronn in 1988 appear in a double issue of the journal History of Economic Ideas (vol. 1, no. 3/vol. 2, no. 1). In a paper on “the Schmoller renaissance,” Peukert (2001) reviews recent additions to the literature. The historian Heath Pearson (1999) argues that the German historical school is itself an artificial and unhelpful abstraction since its membership was not exclusively German, its methods not particularly historical, and its legacy not that of an identifiable school. This reading is challenged by Caldwell (2001d); Pearson (2001) is the reply. 2. Senn (1993 –94, 267–70) lists five reasons for the neglect: the German language poses a barrier to treatments in English; the detailed and lengthy historical analyses that were the hallmark of the school strike many as uninteresting; some of the methodological pronouncements of the school were viewed as extreme; the fact that members of the school supported the political agenda of the house of Hohenzollern undermined their credibility; and antagonisms left over from the First World War reduced interest in the school’s contributions. Senn questions the validity of some of these objections. 3. As the editor of one recent collection put it: “A new perspective for economics will be suggested through an interpretation of the German Historical School that provides an alternative to present-day mainstream economics with regard to scope and method” (Shionoya 2001, 1). [ 39 ]

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For example, some have found appealing these economists’ insistence that questions of ethics should play a more fundamental role in economics. Rejecting the “isolating abstraction” of rational economic man as one-sided, the German historical school economists insisted that ethical beliefs are an important determinant of behavior. They also believed that a society’s ethics help determine its cultural and social mores, norms, and institutions and that an understanding of ethics is, therefore, key for comprehending the differences that may exist among cultures (Meyer 1988, 571–76; Backhaus 1993 –94, 13 –14). Also attractive is these economists’ preoccupation with the evolution of social institutions and with the variety of forms that such institutions exhibit in different cultures. The dual emphasis on institutions and evolution strikes a chord among various (often quite different) groups, from those who still adhere to the “old institutionalism” to more recent advocates of a “new institutionalist economics,” the latter associated with such organizations as the European Association for Evolutionary Political Economy and the International Society for New Institutional Economics.4 Finally, these economists’ endorsement of reformist social policy appeals to those who feel that the swing toward more market-oriented policy approaches in recent decades has been either mistaken or overdone. Their blaming of liberal “laissez-faire” doctrines for creating the social problems of their own day appeals to those who are concerned about the spread of the market or widening inequality in the distribution of income. Similarly, their tendency toward protectionism, one that they justified as necessary for the survival of latecomers to the game of global trade (and, not incidentally, for the preservation of the national, or imperial, interest), makes sense to those who may fear the effects of globalization and of foreign competition on their domestic economies and ways of life. As such, a number of recent authors consider Schmoller to be the father of the modern welfare state, a designation that, without apparent irony, they typically take to be one of approbation (e.g., Balabkins 1993 –94, 32; Schmölders 1993 –94, 95).5 Schmoller’s effective4. These groups seem to differ chiefly over how far to incorporate the property rights and transactions costs approaches into their analyses. Pearson (1997) claims that, with its heavy emphasis on legal institutions, the German historical tradition was the precursor, not only of the new institutionalist economics, but also of the law and economics movement and of constitutional economics. 5. At the session “The German Social Market Economy: A Critical Reappraisal” of the 2002 meeting in New Orleans of the Southern Economic Association, Jürgen Backhaus ar-

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ness at using the state bureaucracy for reformist purposes has led some to view his accomplishments with a certain air of wistfulness, seeing him as having lived in a kind of golden age for the economist– cum–policy adviser, one that regretfully can never be repeated.6 Given the past neglect of the German historical school, the new wave of scholarship is surely welcome. And, perhaps inevitably, given the nature of the revival of interest, those writing about the school have tended to emphasize the benefits and insights to be derived from its closer study. This should not, however, allow us to omit or sugarcoat the darker side of its history. As we will see, it is this side that would crucially affect the formation of the Austrian school of economics as well as influence Hayek’s perception of the statecentered reformist movements of his own day. This chapter begins with a review of the antecedents to the German historical school, the cameralist and Nationalökonomie traditions. Next I document the effects of the Enlightenment, the French Revolution, and the Napoleonic conquests on German thought. That intellectual movement and those political events fostered a new nationalism among many Germans and, ultimately, produced among its scholars a rejection of cosmopolitanism and an insistence on the importance of a people’s own, unique history. Such

gued that Schmoller, together with Adolf Wagner, might more appropriately be viewed as an advocate of a social market economy. 6. This seems to be the view of Jürgen Backhaus, who has probably been the single most influential force behind the German historical school revival. Backhaus describes Schmoller’s accomplishments as follows: “He presided over an unprecedented increase in economics students, both national and international; an unprecedented extension of economics programs in his country and in line with his approach (this he did with the support of his friend Friedrich Althoff, the far-sighted builder of educational institutions). Moreover, Schmoller won an unprecedented influence on economic and social policy making through a system of professional and advisory organizations he helped establish and steer through the most disruptive conflicts of interest. Economists have never regained such a measure of influence on such a broad scale of policy issues” (1993 –94, 16 – 17). Backhaus later comments: “One of the fascinating features of Schmoller’s personality consists in the fact that Schmoller, perhaps sub-consciously, knew about the institutional requirements for launching his program and went about meeting them through skillful political and scholarly activity.” The three necessary steps were “the formation of a state executive power willing to launch policies of social reform” (the new German Empire fit the bill), “reform of the universities” (it was here that his friend Friedrich Althoff would be a key player), and “the foundation of the Verein für Socialpolitik” (19).

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general sentiments found particular expression in the early decades of the nineteenth century in the German historical schools of law and, later, of economics. There was a brief moment when it seemed that the German cameralist heritage might be eclipsed by liberalism, as it was for a while in other European countries in the middle of the last century. But, in Germany, liberalism died in its cradle, replaced by the new and much more powerful cameralist successor that was Bismarck’s German Empire. The two traditions, one intellectual, the other political, became mutually reinforcing as the century waned. And it is not too forced a metaphor to say that they ultimately converged to a single point in the person of Gustav Schmoller, the leader of the younger German historical school, an economist of (and academic apologist for the policies of ) imperial Germany, and Menger’s methodological opponent.

Background to the Emergence of the German Historical School Two traditions preceded the rise of historical economics in Germany, cameralism and the study of Nationalökonomie. Cameralism dominated German economic discourse prior to the nineteenth century. A form of administrative economics, it was meant to assist the ruler of a state and the associated civil bureaucracy to govern wisely. Maintaining external and internal security; making sure that a steady revenue flow reached the state coffers; encouraging appropriate amounts and forms of trade and manufacture; seeing to the happiness and economic well-being of the populace: these were but a few of the provinces of cameralist instruction. In the early eighteenth century, the doctrine was taught at only a few of the northern Prussian universities. A more standardized textbook literature on “the science of governing” began to emerge by the middle of the century, however, and this allowed a fairly rapid expansion of cameralist teaching (Tribe 1988, chaps. 3, 5). The end of the eighteenth century brought the French Revolution and the Napoleonic Wars—but also a change in the language of economics being taught in the German universities. Keith Tribe describes the change as follows: “At the very point at which the Cameralistic sciences were at last gaining acceptance as a university discipline, they were displaced by a new form of economic reasoning. Economic teaching in universities was henceforth

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the province of a new Nationalökonomie which emphasized the economic activity and needs of the individual as the founding moment of the economic order, and not the activity of government over the populations of territorial states” (1988, 92). Nationalökonomie posited human needs and their satisfaction as the starting point of economic analysis. The forces that fostered the adoption of the new discourse were manifold and their interrelations complex; they included the growing influence of foreign ideas on German economic discourse, a more widespread knowledge and understanding of Adam Smith’s work (which was initially ignored in Germany, the few who noticed it thinking of him as a Scottish Physiocrat), and the emergence of Kant’s critical philosophy. The adoption of the language of Nationalökonomie masked the fact that cameralism had never really been replaced. Tribe’s exhaustive examination of the textbook literature shows that cameralist principles and the individualistic discourse of Nationalökonomie came to exist side by side in many texts. The joining of the two traditions received perhaps its best statement in H. K. Rau’s famous three-volume textbook Lehrbuch der politischen Oekonomie (1st ed., 1826 –37), which served as a model for other texts. Both Adolf Wagner and Wilhelm Roscher attended Rau’s lectures at Heidelberg, and Menger studied his text before writing the Principles of Economics (Tribe 1988, 183). Both the German historical school economists and Menger were able to draw on the German economic tradition and to see themselves as the heirs of the earlier writers. The German historical school of economics was also heavily influenced by the German approach to history in general. This approach was formed in reaction to the Enlightenment and natural law, to the revolutionary Terror and the conquests of Napoléon, and created for the founders of German history a set of common assumptions. These beliefs provided an essential precondition for the emergence of historicism. Central among the beliefs was a rejection of natural law doctrines (Iggers 1983, 30, 39 – 43). The French philosophes believed that natural law was discoverable by reason and, once revealed, was applicable to all human societies. Echoing Hegel and Herder, the German historians demurred. For them, each society was unique, each had its own complex developmental history, and each had its own Geist, or “nature,” which depended on the specific characteristics of its people. This challenge of natural law doctrines would have profound consequences, for, eventually, it would widen into a more general argument con-

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cerning appropriate methods for the natural and the social sciences. Because they deal with universal and generalizable phenomena, the natural sciences might profitably employ theory. But theory has much less value for the study of social phenomena in all their rich and varied uniqueness. At best, such purportedly universal doctrines could accurately reflect only a given experience eines Volkes. It is simply hubris to think that such generalizations apply to all other cultures. Accordingly, the urge to generalize must be suppressed when it comes to the study of society. Does this mean that a science of the social is impossible? Not at all. Historical investigation was viewed as fully scientific and, indeed, the only legitimate way to study the evolution of society.7 If the modern methods of scholarship recently introduced by German historians were used, history could be as objective and value free a means for studying society as theory was for the study of natural phenomena. The historians also rejected the notion that one can simply impose “rationally constructed institutions” onto societies. The famous German jurist Friedrich Karl von Savigny emphasized that social institutions grow organically and reflect the particular idiosyncrasies of a people’s history. They cannot be changed at will, even within a given society, unless one has intimate knowledge of the role that they played in the development of the society. It is, therefore, unlikely that the institutions that emerge in one country can be successfully transplanted to another. A specific instance of this idea was the widespread distrust among German-speaking people of democratic institutions. The French experience made it clear that mass democratic movements could rend the fabric of society. Even liberals in Germany (the group most likely to look favorably on natural law doctrines) came to believe that a strong state was the best guarantor of individual liberties. The state was viewed as an ethical institution. Should the study of history reveal that certain social changes are both possible and desirable, they should be undertaken by the state, for only a strong central power can adjudicate fairly among the self-interested claims of the various segments of society. A final element of our brief history is the German reaction in the 1840s to the British classical tradition in economics. The attack on the “cosmopolitan 7. As McCloskey ([1994] 2000) emphasizes, the German word for science, Wissenschaft, has a different connotation in German than in English. In German and many other languages, science simply means “systematic inquiry.”

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doctrine” of Adam Smith was launched by Friedrich List, who developed his position while observing the tariff debates in America in the 1820s. List felt that the classical position in favor of free trade wrongly generalized to the rest of the world what was true only for Britain. In particular, he felt that arguments for free trade held true only in a world of equal trading partners. In order for latecomers, or economically less advanced countries, to gain equal footing, a period of protection was necessary. Although he was often viewed as more of a journalist and propagandist than an analyst by later academic writers, List’s policy analysis received a sympathetic reception from the members of what has been called the older German historical school. The leading lights of this group were Wilhelm Roscher, Bruno Hildebrand, and Karl Knies. Our focus here will be on Roscher.8 In 1843, Wilhelm Roscher published a pamphlet of 150 pages entitled Grundriss zu Vorlesungen über die Staatswirthschaft nach geschichtlicher Methode (Outline of lectures on political economy following the historical method). Designed to assist students with their note taking, the pamphlet was also a programmatic statement of a new way of doing political economy and, hence, a founding document of the historical school. For Roscher, the proper aims of political economy went beyond the classical desire to reveal the causes of the wealth of nations. The enterprise should be a larger one: to show what people have felt, thought, written about, and attempted to accomplish in the field of political economy. To address these broader issues, one must take into account the political, legal, social, and cultural contexts in which economic institutions operate. Furthermore, one must concentrate, not only on present institutions, but also on the evolution of those institutions through time. If this were not enough, one must also compare the evolution of institutions in different nations through time. Roscher linked his project to that undertaken by the German historical tradition in law: “One sees that this method aims to accomplish for public economy what the Savigny-Eichorn method did for jurisprudence. It is far from the school of Ricardo, although it does not oppose that school directly, and even thankfully appropriates its results” (Roscher translated in Small 1924, 155). Roscher proposed a biologically based stage theory of development. Every nation goes through the same evolutionary pattern—youth, adulthood, and 8. Tribe (1995b) places the work of Friedrich List within the German context. For more on Hildebrand, Knies, and other German historical school economists, see Betz (1988), Hodgson (2001, chap. 4), Kobayashi (2001), and Streissler and Milford (1993 –94).

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decline—although specific nations reach different stages at different points. The three most important determinants of a country’s prospects are its own developmental position, the corresponding positions of neighboring states, and its national character. Roscher wanted political economy to follow the method of comparative cultural history. Only through a close study of the developmental history of a nation within the wider context of the development of its neighbors could one reach a proper understanding of its cultural and institutional identity. An important implication is that nations in different stages of development require different state policies. What is appropriate for one nation at one period is not necessarily appropriate for another or for the same nation at another time. Roscher’s position thus provides a general framework for making sense of List’s specific claims (Small 1924, 154 – 66; Betz 1988, 415 –16). Roscher opposed certain of the doctrines of the British classicals. T. W. Hutchison (1953, 15) notes that he “complained that when one read some of the followers of Adam Smith one got the impression that goods were not produced for man, but man was there for the sake of the goods.” But, as his reference to Ricardo makes plain, Roscher was not completely hostile to the classical school. He accepted, for example, the assumption that self-interest is a basic human instinct, although he insisted that other motives also play a role in human decisionmaking. And, although he spoke of a new method in his 1843 outline, he did not follow that method in his most famous work, a textbook on political economy first published in 1854 (see Roscher [1878] 1972). His strategy, rather, was to supplement classical analysis with a myriad of historical examples. A later pundit remarked that Roscher’s contribution was little more than “historical sauce over a classical dish” (Betz 1988, 415).

Carl Menger dedicated the Principles to Roscher, writing in the preface that his book built “upon a foundation laid by previous work that was produced almost entirely by the industry of German scholars,” and asking that his work “be regarded, therefore, as a friendly greeting from a collaborator in Austria” (Menger [1950] 1976, 49). Menger also cited other German authors repeatedly. He clearly thought of himself, initially at least, as working fully within the German tradition. Our review of the development of German economics should help us realize why. Menger’s ideas had much in common with the German economics that preceded him. With Roscher and the other German historical economists he

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shared the conviction that the labor theory of value was simply a British mistake. And, as Erich Streissler’s (1990a) research on the “proto-neoclassical” tradition demonstrates, the German textbook literature itself contained a number of subjectivist ideas.9 Furthermore, the means-ends framework already existed within German and Austrian cameralist thought, although it was typically applied to state policy rather than to the economizing activity of an individual (Silverman 1990). Going beyond Germany, the notion of economizing individuals was not without precedent; something like it existed in both Enlightment and Puritan thought (Streissler 1988, 191). Nor was Menger’s the first theoretical work, for a theoretical structure clearly existed in the writings of the later British classicals. This is not to say that Menger’s economics was wholly derivative. Both his attempt to treat the interaction of a number of markets simultaneously and his formulation of a vertical order of goods in which the valuation of all goods (including factors of production) depends on the valuation of first-order goods were new. So too were certain ideas that were to become fundamental Austrian tenets: the connection between time and error; the causal-genetic or compositive methodological approach; and the notion of unintended consequences (Streissler 1990a, 58 – 61). But what was most striking in Menger was how he put things together, how he gave a new and thoroughly systematic structure to various previously expressed notions concerning the effects of human action. That structure differed from those of his predecessors at crucial junctures. Whereas the classicals dealt with the growth of output and its distribution among broad social classes, Menger concentrated on the economizing action of individuals, action that was based on their knowledge and subjective perceptions. The subjectivist emphasis in Menger was consistent with the already existing proto-neoclassical tradition in German social thought. But, within the German-language traditions, his individualist starting point was more in keeping with the Nationalökonomie linguistic turn than with the older state policy orientation of cameralism. Finally, his efforts to provide a universal 9. Streissler’s list includes the following: that production costs are demand dependent; that value is subjective in nature and dependent on human needs; that exchange takes place when two agents value units of a good differently; that utility diminishes as the quantity of a good increases; that a consumer does his best when the equimarginal principle is satisfied; and that, in any adequate theory of value, all prices should be treated within the same supply-and-demand framework (Streissler 1990a, 41– 48).

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theoretical foundation for social science distinguished his approach from that of historians who thought that such an approach revealed cosmopolitan pretensions. Because Schmoller was a fellow critic of the British classical school, his review of the Principles must have come as a shock to Menger. How could Schmoller possibly accuse him of being a follower of Ricardo? Both Schmoller and Menger felt that the classical theory was fundamentally flawed. For Menger, the solution was to invent a new theory. For Schmoller, the error was the premature use of theorizing in the social sciences.

Schmoller and the Younger German Historical School It was on the foundation of German philology and German historical science that there developed the truly scientific and scholarly movement which again, and for good, filled the veins of the consumptive body of economics with blood and life. — Gustav Schmoller

Gustav Schmoller was born in 1838 and grew up in the southern Catholic state of Württemberg. His father was an administrator of the royal estates and intended that his son enter the local bureaucracy. Young Gustav accordingly studied Kameralwissenschaft at Tübingen, taking a degree in 1861. His chances for a post were dashed the following year. Prussia had negotiated a trade treaty with France that was not favored by the rulers of Württemberg, who in such matters were usually allied with Austria. Schmoller wrote a pamphlet defending the Prussian viewpoint. It was published anonymously, but he failed to keep his identity secret. Once his name got out, all hope for a position in Württemberg disappeared. Schmoller spent the next few years studying philosophy before finally obtaining a position in 1864 at the University of Halle in eastern Germany (Balabkins 1988, chap. 1). In Halle, Schmoller became fascinated with the career of Frederick William I of Prussia, the father of Frederick the Great. He examined in painstaking detail the king’s administrative practices, financial policies, and legislative initiatives. He drew some important lessons from his research. As one scholar put it: “These studies convinced him that because Frederick, aided by a dedicated and incorruptible civil service, had taken the initiative in reviving the economic and cultural life of a number of stagnant cities, in introducing legislation helpful to agriculture, in imbuing the population with a sense of jus-

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tice, honor and duty and in organizing an efficient army and bureaucracy, it had been possible for Prussia to develop into the ‘most modern and healthiest European state’” (Ascher 1963, 289). Accounting for Prussia’s meteoric rise to power soon became for Schmoller “an intellectual obsession” (Balabkins 1988, 18). In 1870, he published his first book, a monograph of over seven hundred pages on the evolution of small crafts in Germany. He documented how the Prussian monarchs encouraged the immigration of skilled craftsmen into Germany in the dismal period following the Thirty Years’ War. Their far-sighted policies were carried on by certain of their successors, garnering considerable success. For example, in 1784, Prussia had 1 master carpenter per 417 population. Only sixtythree years later, the ratio was 1 to 185. For Schmoller, the lesson was clear: “If you believe that Prussian crafts could have developed more rapidly under laissez-faire conditions, then you have no thorough knowledge either of history or of political economy and you have no solid ground to stand on” (Schmoller translated in Balabkins 1988, 19 –20). In the early 1870s, Schmoller helped organize the Verein für Socialpolitik (the Association of Social Economics), more of which anon. In 1872, he was called to the newly named Kaiser Wilhelm University (formerly Strassburg University) in the recently annexed territory of Alsace-Lorraine. There he developed his famous seminar, continued working with the Verein, and reviewed a book by an unknown Austrian named Carl Menger. His prominence in the Verein helped lead to his appointment to a chair in Berlin in 1882. He was appointed to the Prussian State Council in 1884 and to the Prussian Upper House in 1899. Through his editorship of one of the leading economic journals and his influence over faculty appointments, for thirty years Schmoller had substantial control over the direction of economic study within the German Empire. Knighted in 1908, he finally stepped down from teaching in 1912. He died 27 June 1917 at the age of seventy-nine. Schmoller is usually known as the leader of the younger German historical school, the initial adjective suggesting both continuity and differences with his intellectual forebears. How is Schmoller to be distinguished from predecessors like Roscher? We are lucky because he spoke to the issue himself, if indirectly, in 1888. The date marked the fiftieth anniversary of Roscher having received his doctorate. In commemoration of the occasion, Schmoller published a book on the history of the literature of the political and social sciences that he dedicated to the elder statesman of the historical school. The book contained a collection of literary portraits of political economists that

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Schmoller had written over the preceding twenty-five years. The central essay was on Roscher.10 As one might expect, Schmoller begins the essay on Roscher with some history. In a few deft lines on the intellectual development of political economy, he positions Roscher in time. First came the mercantilists and cameralists: “The method characteristic of the economic literature of the seventeenth and eighteenth centuries, which preceded that of the Physiocrats, was predominantly empirical. Those purely theoretical statements which can be found in that literature were hasty generalizations, based on crudely conceived empirical facts. Its practical doctrines, however, often had a truth content much more substantial than that of its rationalist successors because they were rooted in real experience and because there was still a direct link between life and doctrine” (Schmoller 1952, 364). Although they had occasional insights into real economic phenomena, the mercantilists failed to develop any theoretical structure for their observations. Their rationalistic successors, writing under the influence of natural law doctrines, reacted against this. The reaction was fruitful at first but gradually led the discipline farther and farther away from reality. Since this constituted in his opinion a fundamental error, it is worthwhile to quote Schmoller at length on the mistake: Smith was a brilliant observer of the life of the human soul and of the simple economic processes of his period. Being attached to the views of his time concerning natural science and natural law, he drew simple conclusions from the general and uniform nature of man which the eighteenth century believed to have established. . . . While he still combined empiricism and rationalism in a superior manner, the empirical element evaporated more and more in Ricardo’s work. Among the later economists the rationalistic element is greatly exaggerated. The increase in acumen and in wealth of speculative thought could not protect the late-comers from losing more and more the ground of reality under their feet. More and more did they turn into completely drab, abstract arm-chair scholars, interested in divisions and definitions; into socialist visionaries; into calculating mathematicians; into doctrinaire, all embracing theorists of natural law and of Robinson-Crusoe stories. In this manner, intellectual rot was the outcome of a rationalism entirely divorced from experience. (365) 10. Schmoller (1952) is Henry Spiegel’s slightly abridged translation of Schmoller’s 1888 essay on Roscher. Böhm-Bawerk (1890) is a critical review of the book and constitutes the Austrian response.

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Schmoller next seeks a remedy for the “rationalistic anemia” that began afflicting economics during the late classical period. The cure, “a strong dose of empirical-historical knowledge,” was provided by German philology and historical science; their beneficial effects on “the consumptive body of economics” are described in the epigraph to this section. Although others are listed as having contributed to the rescue of economics from the rationalists, Schmoller credits Roscher as being “the true founder of the historical school of German economics” (1952, 366). Having placed Roscher in the stream of history, Schmoller turns to an assessment of his contributions.11 Although not stingy with praise, Schmoller also peppers his narrative with comments about Roscher’s shortcomings. If one catalogs these, it is quickly evident that Roscher was a step (an important one, to be sure, but still only a step) along the way to the present, where the real work of historical economics had finally begun. Thus, we find that Roscher and other philologists “succeeded in producing a basic foundation for cultural and economic history rather than a scientific integration” (Schmoller 1952, 367). To Roscher’s goal of uncovering “laws of general historical development,” Schmoller responds with the gentle admonition: “Perhaps this is an aim too high for the present generation” (368). In a passage at the end of his portrait, Schmoller presents his predecessor with the ultimate backhanded compliment: Roscher had the good sense, after all, not to take his own stage theory too seriously! Clearly, not all problems are tractable with the help of Roscher’s method; clearly, in the initial stages comparisons of the type made by him are liable to be based on relatively inadequate material; admittedly, the first attempt often will yield no more than a scheme, a series of stages, without 11. In his review of Roscher’s contributions to the history of thought, Schmoller commends Roscher for discontinuing the practice— one begun by Smith and continued by his French and English devotees— of heaping scorn on the ideas of the mercantilists. Schmoller expresses incredulity that, as late as 1840, J. B. Say could get away with the following condescending remark (one that, alas, may sound surprisingly familiar to modern ears): “What can we gain by collecting the absurd opinions and rejected theories which deserve oblivion? It would be useless as well as boring to disinter them. Errors must be forgotten, not studied. The history of economic doctrine serves only idle curiosity” (Say quoted in Schmoller 1952, 372). Ironically, and doubtless doubly dismaying to the spiritual remains of Say, in the 1930s his name was revived by Keynes, but (as Say had done with the mercantilists) with the express purpose of castigating him as the author of an erroneous doctrine.

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complete explanation of the causal development; the notions of youth, flowering, and decay, the analogy with individual human life, slip in. But Roscher is well aware of these imperfections. He emphasizes that every analogy of this type is only a means to an end—to a many-sided and more profound explanation. (377) In the end, Schmoller is forced to conclude that Roscher “holds the middle ground between two scientific epochs, winding up the older period and ushering in the new one” (1952, 377). Writing six years later (in 1894, the year that Roscher died), Schmoller displays an eagerness to move on: The earlier so-called historical school has often attempted to use the results of general history too quickly for theoretical purposes; today we realize that laborious monographs in economic history constitute only the foundation upon which it becomes possible to comprehend history from the point of view of political economy and social policy and to put economic theory upon an adequate empirical basis. It is precisely for this reason that it was not the general efforts of Roscher and Hildebrand in the direction of a historical treatment of economic problems, but the historical monographs of a later period which opened a new epoch in the evolution of economic science. (Schmoller 1946, 523) Schmoller’s view of the distinctions between the older and the younger historical schools is, then, quite clear. To their credit, the founders of the older school recognized the premature theoretical generalizations of the classical economists as errors. The rationalistic, abstract, bloodless models of the English and French were founded on the mistaken Enlightenment doctrines of natural law. The doctrines were not universally applicable; if they had any application at all, it was only to a passing phase of human development within particular societies. But the German predecessors of Schmoller’s school had fallen into mistakes of their own. They failed to observe the truth contained in one of Schmoller’s favorite phrases: “But gentlemen, it is all so infinitely complicated” (“Aber, meine Herren, es ist alles so unendlich compliziert”) (Gay [1941] 1953, 411). The lingering temptation of theory had led them to their own brand of premature generalization. The unfortunate result was their own inadequate stage theories of development. The older school erred, too, in trying to study the social “organism” as a whole. Although also ambitious, Schmoller’s goals were comparatively more

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modest: to examine specific social institutions, in all their infinite variety; to observe, describe, and classify them; to identify their evolution through time; and to lay bare their complex interrelations. This careful descriptive work was preparatory for the ultimate task: understanding social phenomena in all their grand complexity. But the completion of that mammoth task lay quite some distance in the future. In the meantime, a mountain of work, requiring many hands, needed the attention of historians. Fortunately for science, Schmoller found himself in a position to see that it was attended to. Some things for Schmoller were not, in the end, so very complicated. Clearly, the younger German historical school stood as a prophylactic against premature theoretical generalization. Admittedly, it was also the next step in the gradual and orderly evolution of the historical approach to economics. But it was also more than these. For the younger German historical school was also to be a bulwark against all manner of mistaken political preferences and the erroneous social policies associated with them. As we will see, the political platforms that Schmoller opposed covered the spectrum from conservatism to liberalism to (and especially to) socialism. In Schmoller’s mind, mistakes in theory had a direct bearing on errors in policy. Writing in 1921, Joseph Schumpeter offered the following apt description of the views of the younger school: “It looked as if theory had been no more than an interlude in the history of ideas, an attempted foundation for the economic policies of a particular fleeting period” (Schumpeter 1965, 82). To the political and policy dimensions of the school’s thought we now turn.

The Verein für Socialpolitik The state is the centre and the heart in which all institutions empty and unite. . . . Above all it exercises as legislator and administrator the greatest indirect influence on law and custom, on all social institutions; and this is the decisive point. The right man in the right place, the great statesman and reformer, the far-seeing party chief and legislator can here accomplish extraordinary things, not directly, not immediately, but through a wise and just transformation of the economic institutions. . . . [A]dverse opinions forget that the state is and must be the leading intelligence, the responsible centre of public sentiment, the acme of existing moral and intellectual powers, and therefore can attain great results in this direction. — Gustav Schmoller

54 ] the austrian school and its opponents I have never lived on principles. When I have had to act, I never asked myself on what principles I was going to act, but I went at it and did what I thought fit. I have often reproached myself for my want of principles. — Otto von Bismarck

On 18 January 1871, King William I of Prussia was crowned German emperor in the Hall of Mirrors at Versailles.12 The German Reich was finally reborn. Ten months later, Adolf Wagner, who had been appointed professor of political economy at the University of Berlin the previous year, gave a speech before the assembly of the Evangelical Church of Prussia. Wagner was a gifted orator; a later observer compared him to “a cataract, whose words came fast and impassioned, carrying his audience along by their vigor” (Epstein 1917a, 437). Wagner’s message startled many in the audience. Writing in 1924, the sociologist Albion Small likened the event to the head of the Economics Department of Princeton telling the Presbyterian General Assembly that the Bolsheviks had a number of good ideas about social reform and that the gathered WASPs had better try to do something to improve social conditions before it was too late (Small 1924, 236).13 The cause for alarm was clear enough. By the last third of the nineteenth century, population pressures of earlier times were exacerbated by two more wrenching transformations among the countries of Western Europe, urbanization and industrialization. A new impoverished class, the urban industrial proletariat, had been created. Like their destitute peasant forebears a half century earlier, the German workers had not yet found a political voice. But at least one group, the socialists, wanted to speak for them, and their message was a revolutionary one. Dangerous times lay ahead. For the governing elite of Germany and other countries, it was, in Yogi Berra’s memorable phrase, “déjà vu all over again.” Significantly, Wagner’s focus was not solely on the social problem, as unrest among the working classes came to be called. He also spoke about the current status of political economy and about the role of the state in economic affairs. 12. The crowning took place at Versailles because the German siege of Paris was under way at the time. 13. The account of Wagner’s speech and subsequent details about the founding of the Verein are taken from Small’s (1924) masterful history, which includes translations of many key documents. Small was an important figure in his own day. His advocacy of an ethical (as opposed to a positivist) sociology and his contributions to the founding of the Chicago school of American sociology are discussed in Ross (1991).

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Wagner began with the claim that classical political economy was a discipline in crisis. The root of the problem was one that earlier German historical economists had identified, the reliance on the postulate that all human behavior is based on narrowly conceived self-interest. By taking this unidimensional view, the classicals had ignored the many other factors motivating human behavior, in particular the ethical dimension. Wagner’s next step, the insistence that the classicals’ neglect of ethics had important consequences for social policy, was crucial. By ignoring ethics and focusing only on self-interest, classical economists were incapable of even perceiving the horrors that currently afflicted the working class, horrors that had made socialism appear to be a viable alternative. Wagner concluded that classical political economy must be abandoned and that ethical principles must again come into play in social relationships, especially those between employer and worker and between rich and poor. The speech ends with these words: “Always, poverty and misery, harm and suffering, welfare and riches, will exist side by side in this world. There will always be differences in property which cannot be traced back to actual merit or personal fault. It is our business, however, so far as possible, to diminish the evils that grow out of this fact and to keep the existing inequalities from increasing. We have the means of doing this in progressive measure. If we use these means, we have then performed our duties, and this may be demanded of us; not more, but also not less” (Wagner translated in Small 1924, 237). Wagner’s speech encapsulates the position that the younger German historical school would take toward the economic program of classical liberalism. The causal chain was clear. Laissez-faire led directly to class inequalities, and class inequalities led the workers to consider the false remedy of socialism. As Schmoller would put it in 1875, social democracy was “a product of superficial culture as well as of half-understood and half-realized aims of the modern liberal state, and for a large part also a product of the sins of liberalism” (Schmoller translated in Ascher 1963, 288). Fortunately, as noted by Wagner in his last two sentences, a new “means” had appeared for carrying out the reforms necessary to avoid the peril of social democracy. The new means was the imperial bureaucracy. Of course, given Germany’s cameralist tradition, reliance on a bureaucratic solution was not really new— only the recourse to an imperial bureaucracy was. Wagner’s speech did not occur in a vacuum. Many at the time shared the sentiments that the crown prince had expressed in his diary in February 1871: “The task when peace is concluded will be the solution of social questions”

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(quoted in Sheehan 1966, 48). Indeed, the year before his address to the Evangelicals, Wagner and a number of other academics had corresponded about the need for joint action to promote social reform. Liberals, of course, disagreed with the nature of the proposed reforms. In December 1871, one of the most famous journalists of the day, a caustic liberal named Heinrich Oppenheim, attacked the new generation of reformist professors, labeling them Kathedersozialisten (socialists of the chair). The label stuck and provided further stimulus for group action. The next July, Wagner and a group of academics held an organizational meeting in the home of Gustav Schmoller in the university town of Halle. Bruno Hildebrand, then aged sixty, was elected chair, and Schmoller led the discussions. It was decided that a conference would be held to promote a program of social reform. The event took place in Eisenach in October 1872. The conference focused on three social issues: factory legislation; layoffs; and the housing problem. Schmoller delivered the opening address. Among those invited were over a dozen members of the press. At the conclusion of the conference, it was decided that a regular series of meetings would be instituted. The next step was taken on 31 May 1873, when a call was issued for the formation of a new body, the Verein für Socialpolitik. A guiding principle of the organization was that a strong central government acting in the interests of the whole community was necessary if the public good was to be promoted. Lest anyone miss the point, in their call the founders emphasized that their mission was a noble one: “We do not regard this civic guardianship as a desperate expedient, as a necessary evil, but rather as the fulfilling of one of the highest tasks of our time and of our nation. In the serious discharge of this task, the egoism of the individual and the immediate interests of the classes will fall into proper subordination to the permanent and higher destiny of the whole” (translated in Small 1924, 245). This was a standard Schmollerian theme; Schmoller was constantly “hammering into the minds of his contemporaries the overriding purpose of state authority to shape a civilized society” (Schmölders 1993 –94, 95). Perhaps not incidently, it was only three months earlier that his review of Menger’s Principles had appeared. The Verein would last for sixty years, until 1932. Each year, meetings were held and papers presented on the pressing social issues of the day. Not everyone, of course, looked favorably on the Verein’s activities. We have already seen that it initially gained some impetus from the attack of a liberal newspaperman. On the other end of the political spectrum, Karl Kautsky labeled the welfare legislation endorsed by the Verein as “a transparent attempt to buy off

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the labor unions” (Balabkins 1988, 40). Rosa Luxemburg described the organization as caught between the anvil of the Prussian state and the hammer of the revolutionary movement, hence doomed to failure (Spiegel 1991, 426). As noteworthy as the liberal and socialist responses was the reaction of other conservatives. In 1874, Schmoller gave a speech in Berlin attended by the kaiser in which he defended the principles of the Verein (Balabkins 1988, 38). This speech was later published as an article in the journal Preussische Jahrbücher, edited by the conservative historian and passionate nationalist Heinrich von Treitschke. Treitschke had earned his credentials in the FrancoPrussian conflict with the argument that the residents of Alsace-Lorraine needed to be saved from the contamination of French culture, even if the rescue mission went against their expressed will (Clough et al. 1969, 1047). The next year Treitschke attacked Schmoller, equating his reformist impulses with socialism. This was two low blows at once. A socialist revolution from below was, of course, one of the very things that the conservatives of the Verein were trying to prevent. To add to the insult, Treitschke was accusing his adversary of copying from the French: ever since the publication of Lorenz von Stein’s 1842Der Sozialismus und Kommunismus des heutigen Frankreich (Socialism and communism in today’s France), socialism was associated by Germans with their perennial enemy to the west. The broadside led to a bitter exchange between Schmoller and Treitschke that brilliantly illustrates the differences between nationalists of the reformist and conservative varieties (Small 1924, 247–94). The battle lines were drawn. In one camp were Gustav Schmoller and a small band of academics. Contending against them were liberals, socialists, and conservatives. Who would win the struggle for power? As it turns out, the fight was a terribly one-sided affair. To understand why, a brief digression into the history of imperial Germany is necessary.

Sozialpolitik in Imperial Germany Although William I was the new German emperor, the real power lay with his chancellor, Otto von Bismarck. A decade earlier, Bismarck had been appointed the Prussian chancellor with the charge of resolving a conflict between King William and the liberal-dominated Parliament. The Parliament had refused to appropriate funds to support a reorganization meant to strengthen the Prussian military. Bismarck’s solution was to appropriate and

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collect the necessary funds without parliamentary approval. The ensuing constitutional crisis lasted four years before the liberals finally capitulated. Prussian military victory over Austria in 1866 virtually eliminated any remaining liberal opposition to the regime. By the late 1860s, realpolitik, a term first coined in 1853, had become the dominant liberal strategy (Iggers 1983, 120 –22). For a while it seemed that compromise was a wise course. By 1871, Bismarck had formed a coalition with the liberals. Having finally committed himself to unification, he wanted to make sure that the plan succeeded. His method was to try to rouse the newly formed empire against a common enemy, and he found one in the Catholic Church. His attack on church power, dubbed the Kulturkampf, was a typically Bismarckian affair, an improbable blend of reform and repression. Although the secularization of social institutions was welcomed by many, not the least the liberals, the repressive measures undertaken by the Iron Chancellor were not popular. In any event, by the late 1870s, unification appeared secure, and Bismarck’s persecution of the Catholics all but ceased. The advent of universal manhood suffrage in 1871 and the formation of the Social Democratic Party in 1875 meant that the time had arrived to deal with a new foe, the socialists. By then, Bismarck also wanted to sever ties with the liberals. The problem was not that their coalition had deteriorated. Quite the opposite, Bismarck felt that it had become too powerful. He feared that the liberal push for constitutional reform would, if successful, strengthen the power of the elected Reichstag at the expense of both the conservatives and, more important, the chancellor’s office. The timing seemed right to abandon the liberals, too. An economic downturn that began in 1873 caused many to lose faith in liberal principles, a faith that Bismarck had in any case never shared. Indeed, his own views were similar to those of the conservative professors. As early as 1871 he had written: “The action of the state is the only means of arresting the Socialist movement. We must carry out what seems justified in the socialist program and can be realized within the present framework of state and society” (Bismarck translated in Taylor [1955] 1967, 162). In 1875, Bismarck tried without luck to get the Reichstag to pass “exceptional laws” that would break up various socialist organizations and news organs. Liberals opposed this infringement on the rights of expression. A new opportunity came in 1878, when two different attempts on the emperor’s life allowed Bismarck to claim that the socialists were fulminating revolution.

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That he saw this as an opportunity to kill two birds with a single stone is evident in his reported response to the news of the second assassination attempt: “Now I’ve got the scoundrels!” “Your Highness means the Social Democrats?” “No! The National Liberals!” (Taylor [1955] 1967, 173) Bismarck dissolved the Reichstag and called for elections. The two themes of the election, both designed to dispose of the liberals once and for all, were the necessity of instituting tariff protection and the necessity of halting the perilous spread of social democracy. The conservatives gained strength and the liberals considerably weakened by the results of the July election. In the autumn, Bismarck had his antisocialist laws in place, and, by the summer of 1879, his attacks against free trade broke up the coalition and thereby reduced the political power of the liberal reformers (Taylor [1955] 1967, 175 – 84). By the beginning of the 1880s, then, the stage had been set for the ascendancy of a strong but benevolent central government in Germany. Liberalism, never really a force in Germany anyway, was dead. Socialist agitation was met (as one might expect given Bismarck’s past performance) with a program that combined repression and reform. With one hand the leaders of the Social Democrats were harassed and imprisoned; with the other social security, health and accident insurance, and other reforms designed both to ameliorate the social problem and to solidify worker support for the regime were instituted. Trade legislation designed to protect conservative agricultural and manufacturing interests from foreign competition brought these groups into line. The power of the the empire to act in what it determined were the best interests of all its (right-thinking) subjects was complete. It was now time to consider external threats. The end of the century was known, of course, as the age of imperialism. The belief was commonplace among the industrial powers that both population pressures at home and the needs of large-scale manufacturing to have stable supplies of natural resources demanded the acquisition of new territories. The very ubiquity of the idea meant that the German Empire was already in competition with the other powers for colonial outposts. In such a race, it was clear that the day would belong to the strongest state. The social reform movement endorsed by the Verein and carried out by the imperial bureaucracy may well have initially been inspired by a desire for social justice, one made all the more urgent by the potentially destabilizing

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agitation of the socialists.14 But, as the century ended, another set of imperatives emerged: reforms were meant to reduce domestic turmoil to a minimum so that the empire could concentrate on building an invincible military machine, one that could compete effectively with the other economic powers. This view soon permeated the thinking of the policymakers and their professorial supporters. One commentator described the behavior of Wagner in the purest of realpolitik terms: “Wagner rarely expressed moral scruples or remorse about the foreign policy he advocated. His proposals for social reform were motivated only slightly by humanitarian considerations; he espoused them mainly because he considered them essential for the establishment of a strong national community. . . . [E]very aspect of Wagner’s domestic program was geared to serve the strengthening of Germany” (Ascher 1963, 299). Of Schmoller, another has said: “He used his authority as an economic historian to present English neo-mercantilism as an immediate threat to Germany. He persisted in this prediction even after the Liberal victory in the British election of 1906. He was thus partly responsible for the dangerous stridency of the German Navy League” (Wright 1993 –94, 102). A similar story played out elsewhere, of course. In the end, the shooting at Sarajevo most resembled the killing of Mercutio. The Capulets and Montagues of Europe already had a good feud going; all that was lacking was a little spilled blood. A final point: My snapshot of the rise of the German Empire emphasizes the role played by Bismarck, and, indeed, he was a unique, compelling, and intriguing historical figure whose influence on German history is difficult to overestimate.15 It must not be imagined, however, that Bismarck led the Germans in directions that were wholly inconsistent with their past history. The area making up the new German Empire had only recently been agglomerated out of a collection of hundreds of semi-independent states, each of 14. Did Schmoller and his allies use Bismarck to accomplish their goals of social reform, or did Bismarck use the professors to justify policies that he needed to accomplish his own aims? The question of who was using whom is probably moot. As Senn (1993 –94, 291–92) notes: “Bismarck, it is well substantiated, paid close attention to the views of the Verein.” But Senn’s earlier quotation of George Stigler’s dictum about the ability of economists to shape policy (“our influence appears to be powerful only when we support policies ripe for adoption” [274]) seems equally apposite. 15. Writing at war’s end, Hayek ([1945] 1992g, 228 –30) claimed that Bismarck’s lack of scruples had affected German morals, paving the way for the rise of the Nazis. His hypothesis is fully within the German historical school tradition of linking a society’s ethical code to the characteristic behavior of its population.

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which had lived in perpetual fear of being overrun by its neighbors, either singly or in coalition. Albion Small aptly characterized the earlier situation: “The problem of bare existence loomed up before each of them. . . . No prince could foresee how long it would be before his present allies would be his enemies. Under these circumstances, the life-and-death question of every state was, How may a government be strong enough to resist other states, and to preserve order among its own people? This question produced the body of social theory known as cameralism. It contained germs of all subsequent social science and governmental practice in Germany” (1924, 111). The central location of the German states on the European continent compounded the problem. With the Bourbons (or, worse, Bonaparte) to the west, the Habsburgs to the south, and the Romanovs to the east, for nearly two centuries German lands became the ground on which the armies of Europe tested their mettle. That the Germans would come to view a strong central state as a necessary condition for survival is not curious. It is difficult to imagine that they would draw any other conclusion. Collectivist impulses were, then, nothing new for the Germans. What had been new was the attempt between 1820 and 1870 to combine German notions of the supremacy of the interests of the state over those of the individual with the individualistic liberalism of the French philosophes and the British classical economists. This attempt “to make the water of Adam Smith’s individualism mix with the oil of German collectivism” (Small 1924, 132) never succeeded. Wagner’s speech before the Evangelicals was more than a plea for social reform. It was also a call to return to the earlier German tradition of strong state control. In a like manner, Bismarck’s change of course away from liberalism in the late 1870s was a return to the cameralist heritage. Bismarck’s social reforms broke new ground, but they were also conservative in at least two senses. They were designed to preserve order in the face of threats from within and without. And they were a return to a past conception of the proper role of the state, one with which both the elites and the masses of Germany were most comfortable.

Gustav Schmoller, Professor Maker of Imperial Germany Whatever the motivation that lay behind them, the new imperial policies would necessitate a strong government presence in the economy. They

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required as well a well-educated bureaucracy, one whose commitment to the empire was unquestioned. Its members would have to understand the necessity of the welfare reforms for ensuring the continued survival of the state. Who could handle this powerful educational responsibility? Remember that, in 1874, just as Bismarck was formulating a plan for dealing with the socialists, Schmoller began his battle with the conservative historian Treitschke. In one of his papers, Schmoller laid out his interpretation of the history of the German people. He finished with a vision of the role of the state within the new German Empire, one that was bound to receive a sympathetic hearing in the chancellor’s office.16 Schmoller’s reconstruction was brilliant. All the necessary components were there: the wise policies of the Prussian kings that allowed revolution to be averted; unchecked economic liberalism as the primary cause of the social problems of the day; the bankruptcy of the response of the propertied classes to the social question; the moral imperative for the joint forces of the monarchy and the state bureaucracy to act.17 All that was missing was any mention of the pragmatic advantages of such policies in making the empire stronger. Perhaps the good professor felt that Bismarck did not, after all, require such instruction. It was reasonable, then, that Gustav Schmoller, keynote speaker of the Eisenach conference, founding member of the Verein, and brilliant reformminded opponent of Treitschke, should eventually be tapped to play an integral role in the imperial educational apparatus. In 1882, Schmoller was offered a chair in political economy at the University of Berlin, a post that he would hold until 1913. Adolf Wagner was already a professor there, and, in the same year, Schmoller’s friend Friedrich Althoff (they had known each other in Strassburg) was chosen to serve in the section of the Prussian Ministry of Education responsible for recommending university appointments. Soon to be known as “the secret minister of education” or “the Bismarck of German universities,” Althoff was often quite willing to follow Schmoller’s advice on choosing candidates for posts in political economy (Balabkins 1988, 48 – 49; Mises 1969, 26 –27). Schmoller himself soon gained the unofficial title “professormaker” (Epstein 1917a, 437). The “Althoff system” was born. Schmoller’s friendship with Althoff enabled him to influence appoint16. Although perhaps not in the office of the Prussian Ministry of Education: Schmoller was twice turned down for a professorship in Berlin in the 1870s, apparently because of his outspoken support for social policy (Backhaus 1993 –94, 8). 17. Small (1924, 249 –52) translates key elements of Schmoller’s paper.

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ments in political economy throughout the empire. It also ensured that the many hands that were necessary to do the essential (but admittedly tedious) historical work that lay ahead would be provided. In this way were the fates of the German historical school and the German Empire joined together in the person of Gustav Schmoller. By the early 1880s, the world (or at least the from his point of view not inconsequential corner of the world that was the German academic economics community) was very much his oyster. But, at the very moment of Schmoller’s ascension, a new foe was hard at work in Vienna, putting the finishing touches on a book that would embroil Schmoller in yet another controversy, perhaps his greatest. So we move to the eventful year of 1883. It was a year for entries and exits in economics. Karl Marx died, and Joseph Schumpeter and John Maynard Keynes were born. Ludwig von Mises was two years old. And Carl Menger published his less than gracefully titled Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere (Investigations into the method of the social sciences with special reference to economics) (see Menger [1963] 1985). The book would be condescendingly reviewed (together with another by Dilthey) by Schmoller in his house journal.18 The Methodenstreit was about to begin. Hayek, whose earthly existence would not start for another sixteen years, would have to deal with the ideas of all of them. 18. For a discussion of the episode, see Hayek (1992b, 80 – 81).

CHAPTER 3

The Methodenstreit I am far from overrating the significance of methodology for research in general and in particular for research in the field of political economy. The most important scientific results have come from men who were far removed from methodological investigations, while the greatest methodologists have not infrequently proved to be extremely barren scholars in the field of those sciences whose methods they could expound with imposing clarity. . . . Only in one case, to be sure, do methodological investigations appear to be the most important, the most immediate and the most urgent thing that can be done for the development of a science. It may happen in a field of knowledge, for some reason or other, that accurate feeling for the goals of research coming from the nature of the subject matter has been lost. It may happen that an exaggerated or even decisive significance is attributed to secondary problems of the science. Erroneous methodological principles supported by powerful schools prevail completely and one-sidedness judges all efforts in a field of knowledge. In a word, the progress of a science is blocked because erroneous methodological principles prevail. In this case, to be sure, clarification of methodological problems is the condition of any further progress. — Carl Menger

We come at last to the Methodenstreit, the battle over methods between Carl Menger and Gustav Schmoller. I begin with an examination of the book that began the conflict, Menger’s Investigations into the Method of the Social Sciences. Menger’s major goal was to show that, despite Schmoller’s assertions to the contrary, a theoretical approach to the investigation of social phenomena is, indeed, possible. We will see that, although certain aspects of his defense of theory involved principles that are widely accepted today, other parts raised questions that would occupy many subsequent generations of students of methodology. Looking further into the book, I will identify issues that reemerge in the debates that Hayek would have with opponents a half century later. [ 64 ]

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Once the investigation of the Investigations is complete, I will describe and reflect on the polemical battle that followed. Although Joseph Schumpeter’s (1954b, 814) assessment that the conflict was a “history of wasted energies” has much truth to it, the struggle had important consequences for the development of both the German historical and the Austrian schools, at the time as well as in subsequent decades.

The Investigations The English translation of Carl Menger’s Investigations into the Method of the Social Sciences contains a preface, four parts (or books), and nine appendixes. Book 1 defends a theoretical approach within economics against its historicist detractors. Book 2 deals with historical studies of economic phenomena. Book 3 looks at the uses and limitations of the “organic” approach. Finally, book 4 is Menger’s statement of the origins and development of the ideas of the older German historical school, one that contrasts markedly with the one provided by Schmoller. Even for someone with a background in methodology, reading Menger’s Investigations is a bit like learning to play golf: one must keep at it. Menger’s intent—to provide a spirited defense of a theoretical approach to the social sciences as well as an attack on a variety of alternative approaches—is clear enough. Unfortunately, when he criticizes particular views, it is seldom clear exactly whose ideas he has in mind. In addition, at least some of the approaches under discussion (organicism chief among them) fell out of favor after he wrote, and, even among those that have survived, few bear much resemblance to the methods employed by twentieth-century economists. What follows is the main outline of his argument as well as selected themes whose importance will become evident later. The Nature and Defense of the “Exact Theoretical Orientation” Menger begins by delineating three spheres of investigation within economics. The first category is the study of concrete, individual economic phenomena; it can be further subdivided into statistical and historical studies. The second is theoretical economics, which examines general aspects of economic phenomena. The third is the study of the technologies of economics (like economic policy or public finance), which shows us what conditions must hold if certain policy aims are to be achieved.

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Menger wants to justify the legitimacy of the second area, theoretical economics. First, he provides some examples of what the term means: We work at the development of theoretical economics by seeking to determine the empirical forms recurring in the alternation of economic phenomena, for example, the general nature of exchange, of price, of ground rent, of supply, of demand, and the typical relations between these phenomena, e.g., the effect on prices of the increasing or decreasing of supply and demand, the effect of population increase on ground rent, etc. The historical sciences of economy, on the contrary, teach us the nature and development of . . . the economy of a definite nation or of a definite group of nations, the state or development of a definite economic institution, the development of prices, of ground rent in a definite economic district, etc. (Menger [1963] 1985, 42) Menger distinguishes between two “orientations” within the theoretical approach, the “realistic-empirical orientation” and the “exact.” The first employs real types that are identifiable in the real world as well as empirical laws, which are regularities that admit exceptions. The second employs exact types and exact laws of nature, the latter holding with causal necessity. Many people think that exact laws and types are to be found only among natural phenomena and that, therefore, only the realistic orientation is applicable to social phenomena. Menger will show that this is an error (see Menger [1963] 1985, 56 –59). The question arises: What exactly are exact types and laws? According to Menger, theories that utilize exact types seek to “ascertain the simplest elements of everything real, elements which must be thought of as strictly typical just because they are the simplest” (Menger [1963] 1985, 60). These elements of necessity must abstract from full empirical reality, for they reveal only “a special side of the phenomena of human activity” (62). In like manner, exact theories also utilize exact laws, laws that always hold within “an analytically or abstractly conceived economic world” (73). As a consequence, it is misguided to attempt to test exact theories against phenomenal reality: “To want to test the pure theory of economy by experience in its full reality is a process analogous to that of the mathematician who wants to correct the principles of geometry by measuring real objects, without reflecting that the latter are indeed not identical with the magnitudes which pure geometry presumes. . . . Realism in theoretical research is not something higher than exact orientation, but something different” (70).

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Menger provides an example from economics to clarify his argument. The law of demand is an exact law. In order for it to hold exactly in the “real world,” the following “presuppositions” must be met: “(1) that all the economic subjects considered here strive to protect their economic interest fully; (2) that in the price struggle they are not in error about the economic goal to be pursued nor about the pertinent measures for reaching it; (3) that the economic situation, as far as it is of influence on price formation, is not unknown to them; (4) that no external force impairing their economic freedom (the pursuit of their economic interests) is exerted on them.” He follows immediately with the comment: “There is scarcely need to remark that the above presuppositions in real economy all hold only in rare cases and that therefore as a rule real prices deviate more or less from economic ones” (Menger [1963] 1985, 71). In his discussion of “exact laws,” Menger cites his own Principles of Economics (Menger [1950] 1976) in a note (see Menger [1963] 1985, 71 n. 23). As Kirzner (1978, 35 – 40) shows, not only is the citation appropriate, but it also helps clarify what Menger was doing in his earlier book. The distinction between real (Kirzner calls them uneconomic) and economic prices explains why, in the fifth chapter of the Principles, Menger assumed away the problems of error and ignorance that were so ubiquitous in the rest of the volume: it was his treatment of exact laws.1 The “Fundamental Error” of the Historical School Having described in some detail the “exact” theoretical orientation, Menger was now in a position to respond to the claims of his historical school critics. He was nothing if not blunt: “There is scarcely any need to remark that the 1. Menger’s description of the exact theoretical approach gave rise to various interpretive controversies among historians of economic ideas and economic methodologists. On the basis of Menger’s cultural heritage and assumptions about his educational background, Kauder (1957, 1965) initially argued that Menger’s exact types and exact laws are best interpreted as Aristotelian essences, a view that became widely accepted. Silverman (1990) demurred, suggesting that the origins of Menger’s categories owed less to Aristotle than to the Austrian cameralist tradition. B. Smith (1986, 1990a), however, marshals more evidence in favor of an Aristotelian interpretation of Menger, which now seems the dominant reading. Both Cubeddu (1993) and Oakley (1997) provide full accounts of the discussion. The links to Aristotelian realism help explain the interest that contemporary realists like Lawson (1999), Mäki (1990), and Oakley (1997) have shown in the Mengerian tradition.

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nature and significance of the exact orientation of research is completely misunderstood in the modern literature on national economy. In German economics, at least in the historical school, the art of abstract thinking, no matter how greatly distinguished by depth and originality and no matter how broadly supported empirically—in brief, everything that in other theoretical sciences establishes the greatest fame of scholars is still considered, along with the products of compilatory diligence, as something secondary, almost as a stigma” (Menger [1963] 1985, 65). The historical economists’ principal objection to the theoretical orientation is (quite accurately) summarized by Menger as follows: People in their actions are guided, to judge by experience, neither in general nor even in particular in their economic actions exclusively by a definite motive. For along with self-interest, which at most can be recognized as the mainspring of human economy, also public spirit, love of one’s fellow men, custom, feeling for justice, and other similar factors determine man’s economic actions. And the presupposition with which the (nonhistorical) economists of the Smith school start is accordingly false. But with the above presupposition there also collapses the basis for strict laws of economy independent of temporal and spatial conditions, and with that the basis of a science thereof, that is, a theoretical economics. (83 – 84) In his response, Menger points out how limited his opponents’ focus on “the dogma of self-interest” is. After all, even if humans were entirely motivated by self-interest, they still could fall into error, or be coerced, and thereby fail to reach their goals. Menger snidely notes that the dogmas of “infallibility” and “omniscience,” not to mention “the dogma of complete freedom from external compulsion, among others,” would have to be added to the list of dogmas the holding of which advocates of theory are accused (Menger [1963] 1985, 84 – 85). Menger is unimpressed by any such argument for the simple reason that all theoretical sciences of necessity abstract in this way. All theories focus on specific sides of the phenomena under study. This is, indeed, precisely the way in which a theoretical treatment of a subject differs from a historical one. The historical economists have mistaken history for theory and, in doing so, overlook “that history, to be sure, has the task of making us understand all sides of certain phenomena, but that exact theories have the task of making us understand only certain sides of all phenomena in their way. A science can

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never be called one-sided if it completely fulfills its task” (Menger [1963] 1985, 79). Menger argues further that historical economists who think that the realistic theoretical orientation avoids abstraction and, thereby, allows them to capture the totality of the historical situation also err. Even the realist approach must employ some level of abstraction. Thus, the prohibition against abstractions is contradicted by the practices of the historical economists themselves (79 – 81). Menger is clearly right to argue that all theoretical sciences employ abstractions. The $64,000 question is whether the right things are abstracted and whether the process of abstraction ends up illuminating or obfuscating the phenomena under study. Menger answers this with the assertion: “Among human efforts those which are aimed at the anticipation and provision of material (economic) needs are by far the most common and important. In the same way, among human impulses that which impels each individual to strive for his well being is by far the most common and most powerful.” He continues with the claim that the special side of life that theoretical economics isolates is “one of the most important sides of human life,” an assessment that is upgraded to “the most important” only ten lines later (Menger [1963] 1985, 87). His repeated assertion that self-interest is a sufficiently dominant motivator of human action to warrant the construction of an exact theory constitutes the heart of Menger’s response to the criticisms of “G. Sch.” (see chapter 1). His argument contains a slide, however, that raises many crucial questions. Menger begins from the reasonable position that all theories employ abstractions. He then moves to the position that the specific abstraction of assuming economic motivation and self-interested behavior on the part of agents is legitimate, for it captures one of the most important sides, if not the most important side, of human life. How can one justify such a claim? What would count as evidence for or against it? Would the seeking of such evidence blur the supposed distinction between exact and real types? What exactly is the content of the assumption of self-interest? Is self-interest defined narrowly to mean economic self-interest or broadly to mean whatever is of interest to the specific agent in question? Is the assumption based on psychology, or is it a category common to all situations involving choice? Menger’s all-too-brief discussion of the issues raises far more questions than it answers. Students of methodology would struggle with them well into the twentieth century.

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Atomism and Organicism Along with the doctrine of self-interest, Menger also defends what he called atomism, the premise that the appropriate starting point of exact theoretical economics is the individual person or “agent.” This doctrine would later be dubbed methodological individualism. According to Menger, theoretical economics begins from “the most original, the most elementary factors of human economy” and from there builds up to “the laws by which more complicated forms of the phenomena of human economy develop from those simplest elements” ([1963] 1985, 63). Menger initially defends the atomistic method in the social sciences by noting that other (natural) sciences employ it. He then cites his own Principles as an example, which is entirely appropriate: the method used there (the compositive method) is, in fact, identical to the one that he calls the atomistic method. Does this mean that Menger’s methodological pronouncements are nothing more than a self-justifying description of his own preferred methods? This is, indeed, a perennial problem for methodological arguments. In this particular case, however, it looks like Menger is on solid ground. His goal, remember, is to show that, despite what his detractors might think, a theoretical approach is possible in economics. The Principles is, in fact, the best evidence available that he is right. (I would argue further that the Principles is sufficiently impressive to justify the claim that the atomistic method can also be fruitful for economics.) What has not been established, however, is that atomism is the only theoretical approach or that a theoretical approach is the best for solving all the problems that a social science might face. The extent to which Hayek was a proponent of methodological individualism, and, if so, of which variant, will be a matter of central concern later in this study. Menger contrasts atomism with organicism, a doctrine that was not a part of the historical school doctrine and that has few advocates today. Organicists were impressed by the many analogies between natural organisms and various social structures. For example, although bodily organs and social institutions both serve purposes, neither are the result of intentions aimed at achieving such purposes. Since the “anatomical-physiological orientation” is used to investigate organisms, the inference was drawn that there should also be “an anatomy and physiology of ‘social organisms’ of state, society, economy, etc.” (Menger [1963] 1985, 131). Menger notes that advocates of these approaches typically stipulate that the entire social organism be studied and, therefore, prefer a “collectivist” to an atomistic approach. They justify their

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preference by claiming that the collectivist approach mimics those taken in the natural sciences. Hayek would later echo some of Menger’s arguments against collectivism, but the context would be very different.2 Undesigned Social Institutions Menger concedes to the organicists that a special class of social structures is analogous to a body’s organs, namely, those that are not consciously designed but, instead, emerge spontaneously. On the other hand, social structures that are intentionally created (by, e.g., the “common will”) are analogous to mechanisms rather than to organisms and are best studied using a “pragmatic” approach. Therefore, to the extent that the organic approach is useful, it should be applied only to some, not all, social structures. It is not a universal method. Menger goes on to say that, even in those areas where an organic approach might be considered useful, it does not answer all the questions that one might ask about such spontaneously generated social structures. In particular, the organic approach tells us little about “the laws of the coexistence and succession of social phenomena” that he feels constitute the domain of theoretical social science (Menger [1963] 1985, 135). In contrast, the atomistic approach to economics is particularly well suited to addressing this “most noteworthy” of questions, namely, “How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed towards establishing them?” (146). Menger again provides examples: “Law, language, the state, money, markets, all these social structures in their various empirical forms and in their constant change are to no small extent the unintended result of social development. The prices of goods, interest rates, ground rents, wages and a thousand other phenomena of social life in general and of economy in particular exhibit exactly the same peculiarity. Also, understanding of them cannot be ‘pragmatic’ in the cases considered here. It must be analogous to the understanding of unintentionally created social institutions” (147). Menger concludes by offering examples of how the self-interested actions of individual economic agents are 2. Interestingly, one of the organicists whom Menger criticizes is Schäffle, his predecessor at Vienna (Menger [1963] 1985, 136 n. 48). About Schäffle’s “sociological” writings, even the usually sympathetic Albion Small stated: “His name is now seldom omitted from references to the recent literature, but there are only rare indications that those who name him have read him. In general, he is cited chiefly as an awful example of the vices of the biological method of interpretation” (1905, 157). For a more sympathetic view of the promise of organicist approaches, see Hutter (1994).

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capable of generating such unintended but benign social institutions (151ff.). Once again, some of the examples (e.g., that of the origin of money) first appeared in the Principles. This final argument of Menger’s against his organicist rivals is really quite brilliant. First, he undermines the claim that theirs was the only way to investigate social structures (since their “orientation” properly applies only to structures that are undesigned). He then shows that, even for the class of undesigned structures, the theoretical approach (one that he propounded a decade before in the Principles) is able to answer the “most noteworthy” question that one might ask about such structures. That is to say, not only is a theoretical explanation of undesigned social institutions possible; it is also better than the organicist approach for dealing with (what Menger claimed were) the most important questions that one might ask about them. Menger’s Alternative History Menger was not finished; there were further points to be scored against the German historical school. He argued, for example, that the historical school economists could not rightly consider themselves the heirs of Savigny that they claimed to be because that early jurist was reacting against the pragmatic rationalism of Smith. That is, Savigny was concerned, not with constructing or designing institutions, as Menger assumed the classicals were, but with tracing out the “unintended result of a higher wisdom” (Menger [1963] 1985, 175). Instead, the historical school economists were the heirs of a group of historians teaching politics and history at Göttingen and Tübingen (178). In case anyone misses the point, it would appear from this that Menger himself is the true heir of Savigny, whereas the historical school economists, with their penchant for remodeling society along rationalistic lines, are closer to the classicals, the group whose work they had denounced for decades.3 Menger’s reconstruction is not without flaws: in particular, it is not clear how he could have gotten Adam Smith so wrong. Smith had, after all, made famous the notion of an “invisible hand” that would cause the self-interested behavior of the butcher and the baker to bring about socially beneficial results. One scholar suggests that Menger simply borrowed parts of Adam Müller’s earlier interpretation of Smith as a proponent of abstract and rationalistic individualism (Sheehan 1966, 50). Or perhaps he just lumped together the 3. Yagi (2001, 88) points out that, in later years, Schmoller distanced himself from Savigny, which suggests that he may have accepted Menger’s argument.

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“individualism false” of Bentham and his followers with the “individualism true” of the Scots, to employ terminology that Hayek ([1946] 1948c) was to use. In any case, Menger’s intent is clear: he, the theorist, was challenging the veracity of the historical school’s interpretation of its own history. In addition, he was claiming that he, not the historical school, was the true heir of Savigny’s historical school of jurisprudence. Napoléon may have said, “L’audace, l’audace, toujours l’audace,” but few of his campaigns exceeded Menger’s for sheer cheek. Menger showed that one’s interpretation of history could be an effective weapon against one’s opponents. The lesson would not be lost on subsequent generations of Austrians or their opponents: in his inaugural lecture at the London School of Economics, Hayek would provide his own alternative history, a reading that was decidedly at odds with the one that he had heard from the mouth of Wesley Clair Mitchell in New York.

This completes my examination of theInvestigations, and what shines through in the reconstruction is the subtle interpenetration of Menger’s views. He first had to show, contra Schmoller, that a nonsterile theoretical approach was possible in economics. He then had to establish, this time contra both Schmoller and the organicists, that an atomistic (methodologically individualist) approach was a viable way to do theoretical economics. I have suggested that the Principles provides the best evidence for both claims. In that book, Menger provided a theoretical explanation of the same sorts of economic phenomena (most notably, the workings of the price mechanism) that had been treated by the classicals. He could plausibly argue that his approach there was better than those of the classicals (no small feat) since its value-theoretic foundations were more unified and secure. He could also argue that his approach provided a theoretical explanation for how undesigned social institutions come into being. This last was surely the coup de grâce. The evolution of social institutions was a topic that he felt (wrongly, as it turns out) the classicals had not broached and that had previously been thought of as the special domain of historians and organicists, not theorists. Yet it was the area where his real contribution was most evident. This account also helps us understand why Menger stopped focusing on the idea of diminishing marginal utility in his later years. The marginal concept was only a small part of a much larger contribution, namely, a theoretical demonstration that individuals, acting in their own self-interest, give rise

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to social institutions that have effects that no one intended and that are in many cases benign. It also explains why, having realized the importance of his discovery, Menger felt it necessary to write a methodological tract. It was on methodological grounds that the German historians’ distaste for classical economics and laissez-faire in policy was expressed. From Menger’s perspective, their hatred of the theory of the classicals had wrongly led them to disparage theory in general; their disdain for the classicals’ use of the assumption of self-interested agents blinded them to its legitimate use in Menger’s system. As a result, they could not see that Menger’s creation was as much a refutation of classicism as their historical approach was purported to be. It is evident, finally, why Menger wrote in the preface to the Investigations about “the greatest methodologists” often being “barren scholars” and about the unimportance of methodological work except in those instances where “the progress of a science is blocked” by “erroneous methodological principles” (Menger [1963] 1985, 26 –27). Carl Menger was no champion of “methodology for methodology’s sake.” He turned to the field only in an attempt to ensure that the marvelous discoveries that he felt he had made in the Principles were not overlooked by those who had used methodological arguments to justify the abolition (at least for the foreseeable future) of a theoretical orientation in the social sciences.

The Methodenstreit Menger’s efforts were an utter failure. It was not simply that many of the discoveries that he considered to be his most important were gradually forgotten by two generations of Austrians. Worse, the methodological debate, always secondary in Menger’s mind, ended up taking center stage. When it had finally died down, the Austrians were known as the subjective utility marginalists rather than as theorists who aimed to explain the origins of social institutions. One wonders whether this may have affected Menger’s decision to retire prematurely in 1903 and to spend the rest of his life pursuing interests in ethnology and psychology.4 One must put at least some of the blame for these outcomes on Menger’s 4. Another explanation for the early retirement was that he wanted to avoid the public scandal surrounding his fathering of an illegitimate child.

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own shoulders. There are passages in the Investigations, especially in the preface, that are absolutely scathing. As T. W. Hutchison (1953, 145) rather gently put it: “The contrast between the prefaces to Menger’s two books could not be greater.” Although Menger’s arguments were formidable, he made the classical rhetorical error of leaving his opponents no graceful way out. One might wish that he had had a bit more of the Marshallian mediator about him.5 Schmoller’s review of the Principles was not enthusiastic, but it was also, perhaps, not as bad as it could have been. He stuck to his standard line, that extensive “preparatory labors” had to be accomplished before theorizing could bear fruit: “The way to make progress consists first and foremost in adding to the number, precision and thoroughness of observations, so that with the assistance of more comprehensive and more perfect descriptive material of every sort gathered from experience, the classification of phenomena, the elaboration of categories may be improved, finally the typical phenomenal series and their interconnections, the causes in their entire scope may be more clearly recognized” (Schmoller translated in Small 1924, 220). Later in the review Schmoller repeated his earlier claim that Menger was simply continuing the mistakes of his classical predecessors, a statement that was bound to rankle someone who viewed himself as correcting the classicals: “In the future there will come a new epoch for national economy. It will come, however, only through giving full value to the whole body of historicodescriptive and statistical material that is now being assembled, not through further distillation of the already hundred times distilled abstract theories of the old dogmatism” (221). Apparently, there was little of Marshall in Schmoller, either. Even so, nothing more might have come of this had Menger simply let things be. The two camps could simply have ignored each other, each practicing its own preferred approach, perhaps occasionally mouthing the bland truism that both history and theory can contribute to our understanding of economic phenomena so as not to appear extreme. But this was not to be. Menger shot back an answer the next year, bring5. But perhaps not. A less complimentary assessment of Marshall’s character is offered by Jacob Viner, who in his Ely lecture wrote: “[Marshall] shrank from participation in open controversy, was so irenic as upon occasion to praise to the skies an economist, notably Schmoller, with whom he had nothing in common, strove constantly to blur rather than to sharpen the differences between contending schools and doctrines, and by persistent practice became the great virtuoso in economics of the art of comfortably maintaining a sitting posture between two stools without visible recourse to any substitute means of support” (Viner [1963] 1991, 231).

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ing out a brochure (in the form of a series of letters) entitled Die Irrthümer des Historismus in der deutschen Nationalökonomie (The errors of the German historical school).6 In it, he attacked, not just Schmoller’s position, but Schmoller himself. The German’s response was classic: he stated in his journal that the pamphlet was not worth a review and that it had been returned to Menger. He did see fit subsequently to print the insulting letter that accompanied the returned book, however. His letter read in part: It was brought to my attention some time ago, from various sides, that this would, in essence, be an attack on me, and an initial glance at the first page confirms as much to me. . . . I throw all such personal attacks unread into the furnace or the waste basket, especially when I expect from the author no further benefit for myself. So I never enter into any attempt to bore the public by continuing literary feuds in the polemical manner of many German professors. I do not, however, wish to be so rude to you as to destroy a little book that is so nicely fitted out. Hence I am returning it to you herewith. (Schmoller translated in Hayek 1992b, 80 – 81 n. 53) From here, of course, there was no turning back. Writing a methodological defense of either deduction or induction or an attack on either “abstract theorizing” or “the useless piling up of observations” became a virtual oath of fealty for many of the great antagonists’ followers.7 The trading of methodological position papers continued for more than a decade. A particularly unfortunate aspect of the debate is that, typically, neither side’s position was accurately portrayed. Schmoller did not reject theory tout court; rather, he thought that current theories applied only to a limited domain and that extensive additional data collection was necessary before more universal generalizations could be made. For his part, Menger did not reject empiricism. In6. Menger’s pamphlet was never translated. Its arguments are paraphrased in Small (1924, 221–32). Two translations of articles that provide a good sense of the arguments on either side are Böhm-Bawerk (1890) and Schmoller (1946). 7. As always, there were exceptions. For example, Adolf Wagner, Schmoller’s colleague at Berlin, sided with Menger on the necessity of theory. This led him to be viewed in the United States as taking a reasonable intermediate position. See, e.g., Laughlin (1892, 10) (Laughlin’s was the lead article of the first issue of the Journal of Political Economy); the translator’s remarks in Wagner (1886) and those of a reviewer of one of his books (“Adolph Wagner’s New Treatise” 1892); and the remarks on Wagner’s teaching style compared to Schmoller’s in Seager (1893, 241–52).

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deed, he felt strongly that his own theoretical work identified essential elements of empirical reality.8 This is not to say that there were no differences between them and that a debate on the actual disparities would not have been worthwhile. In this regard, Schumpeter’s observation about wasted energies was right on target. But not just energy was wasted; there were other costs as well. Certainly, one of the most important of these was the obscuration of the fact that the Austrians and the German historical school economists actually shared many views. For example, both groups employed a variant of “acting man” as their representative agent, a tradition that was passed on to the American institutionalists.9 To be sure, the Austrians retained the device of a self-interested agent, but, as time went on, their agent diverged significantly both from the classical homo economicus and from the utility-maximizing agent (later dubbed “the Robbinsian economizer” by Israel Kirzner) that would emerge in mainstream economics. As such, the Austrian “acting man” could be viewed as a compromise between the complexly motivated agent of the Germans (and of diverse later groups critical of neoclassicism) and the passive automaton of standard neoclassical analysis. (Because the latter’s choices are fully determined by preferences, prices, technology, and endowments, a standard Austrian barb is that neoclassical choice theory is one in which all true choice has been eliminated.) Both groups officially abhorred positivism, which they viewed as the worst kind of scientism, although others would later accuse certain members of both groups of (perhaps unconsciously) harboring positivist sympathies. Both also opposed Marxism. Indeed, as Hutchison (1953, 293 –98) has shown, certain historical school economists anticipated parts of the later Austrian critique of socialism in their writings. 8. In time, both leaders publicly acknowledged this. In 1894, Menger wrote: “The true contrast between these schools is not even remotely characterized as that between an empirical and a rationalist approach or an inductive and deductive one. Both recognize that the necessary basis for the study of real phenomena and their laws is that of experience” (Menger translated in Hutchison 1973, 35). In 1897, Schmoller wrote: “Induction and deduction are both necessary for the science, just as the right and the left foot are necessary for walking” (Schmoller translated in Senn 1993 –94, 278). 9. For further thoughts on similarities and differences, see the papers in Samuels (1989) on the Austrian and institutionalist movements.

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Both saw the origins of social institutions as a principal question for economics, a position that distinguished them from later marginalists, who would take the static allocation of resources as the key problem for investigation. Where the Austrians differed from the Germans was in a preference for investigating the topic theoretically rather than historically. Futhermore, both took inspiration from Savigny’s rejection of the notion that one can impose “rationally constructed institutions” designed for one society onto another. And both felt that institutions grow organically and reflect the characteristics of either a specific nation or people (for the Germans) or a specific set of cultural or social norms and values (for the Austrians). The Germans used this doctrine to support their rejection of Manchesterism. The Austrians would use the observation in arguing against planners who hoped to transform overnight existing social institutions. Finally, in their early days, neither group looked kindly on democracy. The experience of the French Revolution taught the Germans that mass movements endanger the fabric of society, and their cameralist heritage led them to view the state as an ethical institution capable of providing the lead in promoting positive social change. Even liberals in Germany thought that a strong state was the best guarantor of individual liberties. As for the Austrians, the Austro-Hungarian Empire was being torn apart by ethnic rivalries, and it was obvious that an extension of the franchise would tend to exacerbate rather than ameliorate the situation. It was only in the twentieth century, after the empire was gone and the dangers of Communist and fascist totalitarianism became evident, that Austrians like Hayek placed democracy on the list of desirable social institutions. Even then, democratic institutions were viewed as good, not in themselves, but instrumentally: they are the best way to ensure that the actions of bad leaders are limited and that such leaders can be replaced peacefully.

The Immediate Aftermath The Methodenstreit had further consequences. On one level, the dispute can be viewed simply as a battle over academic turf, a fight for influence over university appointments (Streissler 1990b, 158 – 63). We saw earlier that Menger was in a position of considerable power as the occupant of the chair of political economy at the University of Vienna. He had influence over faculty appointments and, via his library, over any student who aspired to an academic

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career. In addition, the law schools were the recruiting ground for the administrative section of the civil service. Students paid a per lecture fee to the professor, who also made a salary. Owing to the captive demand, teaching in the law faculties was very remunerative. Menger’s power was accompanied by wealth. It initially appeared that Menger had ascended at just the right moment. For the previous twenty-five years or so, many chairs in Austrian universities had been given to Germans and Swiss in order to generate new ideas. The Austrian Ministry of Education had just decided that new and newly vacated chairs should again be filled by Austrians. Menger assumed that it was only just that he should be able to send his students to Germany since Austria had been accepting Germans in earlier years. His plan, of course, directly conflicted with the vision of Schmoller, who saw his own role as ensuring that future members of the German imperial bureaucracy would be properly trained and that the few who went on to academic careers would be committed to carrying out the huge task of data collection confronting the younger historical school. Schmoller won the power struggle outright. With no little bitterness, Ludwig von Mises later explained why: From 1882 to 1907 Friedrich Althoff was in the Prussian ministry of instruction in charge of university affairs. He ruled the Prussian universities as a dictator. As Prussia had the greatest number of lucrative professorships, and therefore offered the most favorable field for ambitious scholars, the professors in other German states, nay, even those of Austria and Switzerland, aspired to secure positions in Prussia. Thus Althoff could as a rule make them, too, virtually accept his principles and opinions. In all matters pertaining to the social sciences and the historical disciplines, Althoff entirely relied upon the advice of his friend Gustav von Schmoller. Schmoller had an unerring flair for separating the sheep from the goats. (Mises 1969, 26 –27; cf. Kurz 1995, 9) 10 10. An alternative view is to be found in the papers in Backhaus (1993a), a number of which offer laudatory views of Althoff ’s admittedly numerous accomplishments. Backhaus (1993b, 16), e.g., justifies Althoff ’s assistance in appointing economists sympathetic to the German historical school approach by invoking the nature and requirements of a successful historical research program: “In economics, the historical school under Gustav Schmoller proposed large empirical research projects which required the cooperation of many people working on essentially the same research programme. The productivity of

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The dominance of the Althoff system had unintended consequences as well. Even before the battle over methods erupted, Menger had developed a following, men who would have made their own contribution to the spread of economic (and especially marginalist) thought anyway. What the Methodenstreit did was to create a separate Austrian school of economics. Simply put, Schmoller’s ostracism promoted unity among the Austrians. Indeed, Menger’s detractors’s characterization of Menger’s followers as the Austrian school was intended initially as a gesture of contempt. Ludwig von Mises recalls how an educated German speaker of the day would react to the notion of an Austrian school of thought: “Even if no political or nationalistic prepossessions had disturbed their judgment, they could not help becoming somewhat suspicious of a line of thought which the professors of the German Reich dubbed specifically Austrian. Never before had any new mode of thinking originated in Austria. The Austrian universities had been sterile until— after the revolution of 1848 —they had been reorganized according to the model of the German universities. For people who were not familiar with economics, the predicate ‘Austrian’ as applied to a doctrine carried strong overtones of the dark days of the Counter-Reformation and Metternich” (Mises 1969, 14). As was mentioned earlier, it was Böhm-Bawerk and Wieser, and not Menger, who were most responsible for spreading the fame of the Austrian school worldwide, especially in the English-speaking world. The first two volumes of Böhm-Bawerk’s Capital and Interest were translated into English and published in 1890 –91 (see Böhm-Bawerk 1959), and the translation of Wieser’s Natural Value followed shortly thereafter (see Wieser 1893). By way of contrast, Menger’s Principles of Economics, which went out of print quickly, was not reissued in his lifetime and was not translated into English until 1950 (see Menger [1950] 1976). It was Wieser’s “The Austrian School and the Theory of Value” that appeared in the first volume of the Economic Journal (see Wieser 1891). It was Böhm-Bawerk’s description of the Austrian position in theMethoone researcher clearly depended on the work of the other. It took many similarly conducted case studies in order to arrive at the kind of economic theory Schmoller had proposed. . . . The historical research programme, if it was to satisfy the conditions laid out by Schmoller, could only be carried out as a common venture.” As one might imagine, this sort of justification was viewed as less than compelling by the excluded economists of Austria.

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denstreit that graced the first volume of the Annals of the American Academy of Political and Social Science (see Böhm-Bawerk 1890). According to Paul Sweezy, by the end of the century, Böhm-Bawerk was second only to Alfred Marshall in worldwide fame (Sweezy [1949] 1975, viii). The only work of Menger’s that was translated into English in his lifetime was a seventeen-page article entitled “On the Origin of Money” (see Menger 1892).11 Böhm-Bawerk and Wieser also bear responsibility for helping transform Menger’s wide-ranging analysis into a more narrowly marginalist one. Recall that, although by the late 1880s Menger had begun to talk of a school, he never mentioned any role for marginal utility as a unifying concept, even though by then the term had been used by Wieser. His article on money contained no reference to marginal utility. The contrast with Böhm-Bawerk is evident in the latter’s “The Austrian Economists,” published in 1891 and intended to introduce Austrian ideas to the American audience. After a brief allusion to the Methodenstreit, Böhm-Bawerk asserts that the “cornerstone” of the Austrian movement is “the well-known theory of final utility” (1891, 363). The rest of the article is a demonstration of a claim made two pages later: “The idea of final utility is to the expert the open sesame, as it were, by which he unlocks the most complicated phenomena of economic life.” The assumption of self-interest is briefly defended at the end of the article (379), but there is no reference to unintended consequences or to the evolution of institutions. Of course, by the 1890s, marginalism was beginning a worldwide ascendance, and a desire to identify with the larger marginalist movement may, therefore, also have motivated the change in emphasis. Evidence for this includes Wieser’s (retrospectively presumptuous, but in any event unsuccessful) attempt to appropriate the name marginal utility school for the Austrians. Besides the emphasis on marginal utility, the Austrians also became known for Böhm-Bawerk’s capital theory and for critiques of the labor theory of value that had been taken on board by a number of socialist writers, among them Karl Marx. As a result, the Austrians were among the first to criticize Marxist ideas. The first volume of Böhm-Bawerk’s Capital and Interest contained one of the earliest criticisms of the Marxian theory of surplus value. Wieser added his two cents in Natural Value (although Proudhon, rather than Marx, appears to have been his major target). And, as we will see, 11. Menger’s much longer “Money,” an encyclopedia article, was only recently translated (see Menger 2002).

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Böhm-Bawerk’s devastating review in 1896 of the third volume of Marx’s Capital was soon to draw a response from Austro-Marxists (see Böhm-Bawerk [1898] 1975). The battle over methods thus helped form an identifiably Austrian school of economics, but the subjects for which the school became known—marginal utility theory, capital theory, and an aversion to Marxism—were quite different from the ones that had preoccupied its founder. In conclusion, if one focuses narrowly on the two parties to the Methodenstreit —the economists of the German and the Austro-Hungarian Empires—the German historical school economists were the clear winners. Schmoller won the battle over academic turf outright and, with the help of Althoff, set the direction of academic research in German-speaking universities for the next thirty years. Schmoller’s victory helped create a distinct Austrian school, but Menger’s successors sought to emphasize aspects of the Austrian message that were more in line with marginalist thinking elsewhere. For a new generation of Austrians, as for their counterparts in England and Lausanne, marginalism became the “open sesame” to economics. It was not until subsequent generations rediscovered them that Menger’s writings on the evolution of social institutions were recognized as a valuable contribution to social theory.

CHAPTER 4

Max Weber and the Decline of the Historical School Although Schmoller’s camp had won the initial battle, it would lose the larger campaign. By the first decade of the twentieth century, the historical school faced challenges from within Germany and without. By the end of the First World War, it had lost almost all its influence. In this chapter, I trace the reasons behind the decline of the historical school. As it turns out, one of the most famous social scientists of the twentieth century, Max Weber, played an important role in the story. Weber is known today principally as a sociologist. For most of his career, however, he identified himself, not only as an economist, but specifically as a member of the historical school of economics. His dissension from historicist doctrine would provide the foundation for many later Austrian arguments on methodology.

The Value-Freedom Issue A signal characteristic of the German historical school was the willingness, even eagerness, of its members to hold forth on policy matters. Schumpeter’s vivid description of German historical school economists’ classroom demeanor is worth repeating: “Lujo Brentano addressed his classes as he would political meetings, and they responded with cheers and countercheers. Adolf Wagner shouted and stamped and shook his fists at imaginary opponents, at least before the lethargy of old age quieted him down. Others were less spirited and effective but not less hortatory in intent” (Schumpeter 1954b, 802). There is nothing wrong with enthusiasm, of course, nor anything unusual about economists making policy pronouncements. Still, many people thought that such performances directly contradicted the often-repeated methodological edicts of the historical school. In his favorite phrase, Schmoller emphasized how complicated social phenomena were. They were so complicated, [ 83 ]

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indeed, that it would be many generations before the patient collection and sifting of facts could yield anything like a theory of society. This was Schmoller’s central argument against the “premature generalizations” of his more theoretical opponents. It was the grounds for his criticisms of Manchesterism and of laissez-faire. But, if what Schmoller said about social phenomena were true, how could he justify drawing policy conclusions of his own? Were he consistent, he would have to say that the world is too complicated, and our knowledge of it at present too limited, for us to be able to infer anything about policy. To say anything else smacked of the very error of premature generalization of which he accused the Manchester liberals. One could be a historical school economist, or one could be a social reformer, but one could not be both (Hennis 1991, 32 –33; Mises 1981a, xiii).1 Some of the specific conclusions reached also seemed difficult to defend. Schmoller took strong positions against both liberalism and socialism. Now it might be possible for a German academic at the turn of the century to claim that “history had demonstrated” the weaknesses of liberalism since support for liberal institutions had all but collapsed in his country. But what about socialism? What inexorable lessons had history taught about it? A consistent follower of the historical method who was fully cognizant of the complexity of social reality would surely want to take a wait-and-see attitude toward such contemporary movements. As time went on, it became increasingly evident that there was an identifiable regularity in the judgments rendered by many historical school economists: namely, that the existing and proposed policies of the German Empire were appropriate ones. It is, therefore, not surprising that the German economists were often criticized abroad for their steadfast imperial allegiance, a response that only strengthened as the international situation deteriorated before the beginning of the First World War (Wright 1993 –94, 103 – 4; Senn 1993 –94, 285). Thorstein Veblen’s remarks in his review of the first volume of Schmoller’s 1. Senn (1993 –94, 299) reports that Martin Bronfenbrenner (who equates historicism with “stage theorizing”) puts the problem this way: “Now I wonder how many of these gentlemen were stage theorists on Monday, Wednesday and Friday and social reformers Tuesday and Thursday. Is there a problem here requiring further explanation, or am I just plain wrong?”

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Grundriss (see Schmoller [1900 –1904] 1978) are representative.2 Veblen commends Schmoller for his “comprehensive general survey” of the factors governing the growth of various cultural institutions and for his “shrewdly chosen” examples but finds his praise of contemporary German institutions completely out of place in a scientific tract: Students whose interest centers in the science rather than in the ways and means of maintaining the received cultural forms of German society have long fancied that they had ground to hope for something more to the purpose when Professor Schmoller came to put forth his great systematic work. Brilliant and no doubt valuable in its way and for its end, this digression into homiletics and reformatory advice means that the argument is running into the sands just at the stage where the science can least afford it. . . . [I]t is precisely at this point that a genetic theory of economic life most needs the guidance of the firm, trained, dispassionate hand of the master. And at this point his guidance all but fails us. (Veblen [1901] 1919, 269 –70) 3 The reaction against the German professoriate’s injection of values into scientific discourse was not limited to those outside Germany. There was an indigenous reaction as well, and this has come to be associated with the name of Max Weber. Weber is famous for, among other things, his contributions to the methodology of the social sciences. But, significantly, the context for 2. Balabkins (1987) offers a summary of the first volume of the Grundriss. 3. Given Veblen’s comments, it is interesting to note Wesley Clair Mitchell’s comparison of the contributions and styles of Veblen and Schmoller: “I should say there are very important differences between Schmoller and Veblen. Veblen is very much more of a theorist in the ordinarily accepted sense than Schmoller, and he has a much greater philosophic grasp. On the other hand, he is much less of an historian. Veblen is inclined to treat his facts in a rather masterful fashion. He has his own mental patterns, and he takes the materials more or less in the order which those patterns suggest. Schmoller’s approach is rather more empirical; he is a man who is enormously industrious in collecting materials; he throws them together without really cementing them together. That is the greatest weakness of his book, I think. . . . The sections, for instance, on the history, the statistics, the theory, and public policy relating to a given topic are likely to follow each other without really being fused together in any genuine sense. On the other hand, in reading one of Veblen’s books one finds that fusing is complete. In fact, it is so complete that anything that is not fused readily into the whole is likely to be omitted from the presentation” (Mitchell 1949, 2:193).

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many of his methodological contributions was a critique of the German system of higher education. As Wilhelm Hennis put it: “[Weber’s] postulate of value freedom goes far beyond ‘logical’ problems—at stake is the moral and institutional integrity of science and the university in modern Society” (1991, 41). Weber’s problems with the system started early. After completing his graduate studies, he was offered a position as a professor of commercial and German law in Berlin in 1893. Apparently because he disliked the Byzantine academic politics of the (Berlin-based) Althoff system, he accepted instead the offer of a chair in economics at Freiburg. Althoff himself then intervened, apparently telling his ministerial counterpart in Baden that Weber’s ultimate intention was to become a lawyer and that he was simply using the economics position in Freiburg as a jumping-off post. (Recall that those who wished to study economics in German universities at this time did so in the law faculty and that Weber could, therefore, as easily have chosen to practice law as pursue an academic career.) Althoff ’s intervention initially soured the deal, but another round of negotiations ensued that ultimately resulted in Weber’s being hired at Freiburg the next year (Tribe 1995a, 81– 82; Oakes 1975, 5 – 6). By the end of the next decade, Weber had established a reputation as a critic of German higher education. Between 1908 and 1911, he penned about two dozen journalistic articles on the academy and academic politics. In one of them, published just before a meeting of the Congress of University Teachers in Jena in 1908, he ridiculed the German interpretation of the notion “freedom to teach.” He pointed out that, in order to get a position in a German university, one had to kowtow to the proper authorities and to pass litmus tests on one’s ecclesiastic and political background. Once in a teaching position, however, one could say whatever one wanted. Weber insisted that, as a professional duty, teachers take on the exercise of self-restraint in the classroom. Discussion of Weber’s article, not the previously announced topic, dominated the Jena conference (Hennis 1991, 39 – 45; cf. Ringer 1969, 143). This was not all; at a later meeting, “in a manner violating all dictates of tact,” he “initiated a diatribe on the Althoff system, proceeded to make digs at Schmoller, and then finally attacked in the coarsest terms the business colleges that were just then beginning to flourish” (Hennis 1991, 46).4 4. The relationship between Schmoller and Weber was complex. Weber joined the Verein early in his career (in 1888), viewed himself as a member of the historical school, and was acknowledged and perhaps even liked by the elder statesman, but he was also of-

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I have described the local context at length, not only to shed some light on Weber’s motivation, but also to show how fervent was his belief that the German system of higher education, once regarded as the world’s finest, had, in terms of instruction in the social sciences, deteriorated drastically. The cloud had a silver lining, however, for, in his very local fight against the Althoff system, Weber came up with a set of methodological recommendations that were to have long-lasting and wide-reaching effects. The occasion for his contribution came in 1904, when Weber, together with Werner Sombart and Edgar Jaffé, took over the editorship of the journal Archiv für Sozialwissenschaften und Sozialpolitik. The new editors published a position piece, written by Weber, that directly tackled the valuefreedom problem: How can a journal be scientific and still express judgments on important matters of social policy? The classic essay, “ ‘Objectivity’ in Social Science and Social Policy” (see Weber 1949a), provides their response. Weber begins by stating that “meaningful human conduct” is best understood by relating means to ends. The culture that we inhabit provides us with the ethical values that influence which ends we as a society wish to pursue. It is not the role of science, however, to judge or defend certain ends as ethically desirable: “Whatever the interpretation of the basis and the nature of the validity of the ethical imperatives, it is certain that from them, as from the norms for the concretely conditioned conduct of the individual, cultural values cannot be unambiguously derived as being normatively desirable; it can do so the less, the more inclusive are the values concerned. Only positive religions— or more precisely expressed: dogmatically bound sects —are able to confer on the content of cultural values the status of unconditionally valid ethical imperatives” (Weber 1949a, 57). Although such a statement may not seem controversial today, at the time it contradicted the practice of the historical school, whose members typically justified their policy pronouncements with the claim that they were based on prevailing German ethical presuppositions. Weber continues that science can be helpful in answering other sorts of questions having to do with the means-ends relation: Given that society has already decided to pursue a certain end, is that end in fact attainable? What ten severely critical of the positions taken by the older members of the historical school. In addition to differences over methodology, there were political, pedagogical, and even generational dimensions to the disagreements between Schmoller and Weber, as recent scholarship demonstrates (e.g., Krüger 1987; Schön 1987; Hennis 1991, 32 –34).

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costs are associated with attaining a particular end? Are two or more given ends pursued by a society mutually consistent? Are the means chosen the best for attaining a given end? The role of science in judging social policy is, then, to clarify the means-ends relation, not to judge the specific ends chosen. Weber’s pronouncements on the value-freedom question laid the foundation for what is now the standard line on value judgments in economics.5 Although the clean line between positive and normative statements was to be questioned by certain economists and philosophers of science later in the century, Weber’s contribution is probably the most widely accepted methodological precept among practitioners of economics. Significantly, two later groups who would differ on almost everything, the positivists and the Austrian economists, both accepted Weber’s dictum that facts and values must be kept separate in scientific discourse.6

The Impossibility of “Presuppositionless” Science When Max Weber objected to the injection of values into scientific discourse, he was criticizing the actual practice of the German historical school economists. But what about their proposed practices? What if, for example, Schmoller had resisted the urge to be a good member of the German state bureaucracy and declined to mix together his data collection and historical reconstruction with a celebration of the empire? Surely, the methodological approach proposed by the historical school economists— one that includes a study of values but refrains from the imposition of one’s own values—is separable from the procedures that they actually followed. 5. Weber was not the only one to make the distinction, of course. As Hands (2001, 29 – 34) notes, the “is-ought” division dates back to Hume, and others who were contemporaries of Weber, perhaps most notably J. N. Keynes, had made similar pronouncements. Weber’s critique no doubt directly influenced the Austrians, however, and, ironically, probably gained more widespread adherence once the positivists came to embrace it. 6. Some may think it strange that the Austrians, universally known for their criticisms of socialism and their advocacy of the market, should also be adherents of wertfreiheit. If one reads carefully, however, one usually finds that the arguments of men like Mises and Hayek fit the pattern advocated by Weber. Thus, Austrian objections to socialism typically take the form of the assertion that a specific socialist program fails to accomplish the goals that it sets for itself. The traditional Austrian position on the value-freedom question is defended in Kirzner (1994b) and further explored in Boettke (1995).

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There is no denying that, at first blush anyway, Schmoller’s methodological position has considerable appeal. He began from the evident (and, for the social analyst, sobering) premise that social reality is enormously complex. He then drew what would seem to be the obvious conclusion: that any hope for creating a deductive theoretical structure capable of capturing that reality must lie far off in the future. For today, the more urgent task was the careful amassing and grouping of facts. Schmoller’s proposal was nothing if not modest. Who could object to such humility? Once again, Max Weber offers an alternative perspective. In his “Objectivity” essay, Weber agrees with Schmoller that the reality that we confront “presents an infinite multiplicity of successively and coexistently emerging and disappearing events” (Weber 1949a, 72). But the conclusion that he draws is radically different. Confronted with an infinitely complex reality, we should not simply collect facts. Rather, we must choose the portions of reality that are of interest to us: “Only a small portion of existing concrete reality is colored by our value-conditioned interest and it alone is important to us. . . . Only because and to the extent that this is the case is it worthwhile for us to know it in its individual features. We cannot discover, however, what is meaningful to us by means of a ‘presuppositionless’ investigation of empirical data. Rather perception of its meaningfulness to us is the presupposition of its becoming an object of investigation” (76). Weber’s objection is not a denial of the efficacy of the historical school’s methodology. Rather, Weber’s claim is that Schmoller’s approach is wrong in principle; our observations are of necessity colored by our interests and by our theoretical framework. Even “pure observation” is always observation from a point of view; there is no such thing as “facts in themselves.” In modern terminology, what we take to be the facts are themselves “theory laden” in that they reflect our own prior interests. By missing this point, the historical economists were likely to be unaware of the frameworks that they were themselves employing, to be unaware of their own assumptions. Weber makes the point explicitly: “If the notion that those standpoints can be derived from the ‘facts themselves’ continually recurs, it is due to the naive self-deception of the specialist who is unaware that it is due to the evaluative ideas with which he unconsciously approaches his subject matter, that he has selected from an absolute infinity a tiny portion with the study of which he concerns himself ” (1949a, 82). A contemporary American student who, having sat in on lectures in both Vienna and Berlin, thought that Schmoller’s failure to avail himself of theory led him into sloppy

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thinking echoes Weber’s complaints: “In his treatment of value and price he showed his acquaintance with the work of the Austrians by freely borrowing their results, not, however, as consequences of a long and difficult chain of deductive reasoning, but simply as the obvious inferences from his own description of market phenomena. In this part of his lectures the student meets only confusion, loose definitions, description instead of careful analysis, and conclusions arrived at, no one knows how. His elucidation of the action of demand and supply in fixing price seemed to me especially unhappy” (Seager 1893, 250). Recall that, in describing the differences between “exact types” and “real types,” Carl Menger had made a similar claim: that both orientations in fact involve the use of prior theoretical abstractions (Menger [1963] 1985, 79 – 81). So Weber and Menger were on the same side when it came to recognizing that all conceptualization necessarily involves the use of theoretical abstraction. Weber, however, was writing more than a generation later and had been influenced by the Baden neo-Kantian movement and particularly the writings of Heinrich Rickert regarding the nature of concept formation in science (Oakes 1988). Weber proposed that what Menger had called an exact type was better described by another construct, the one that would soon be universally associated with his name: the ideal type. The ideal type selects out from an infinite reality the characteristic features that are of interest to the investigator. An ideal type is not a description of objective facts but, rather, what Weber calls “a utopia” or “a purely ideal limiting concept with which the real situation or action is compared” (1949a, 92, 93). In his opinion, “abstract economic theory” provides a fitting example: “It offers us an ideal picture of events on the commodity-market under conditions of a society organized on the principles of an exchange economy, free competition and rigorously rational behavior” (90 –91). Because reality is infinitely complex and interests in it differ both among investigators and across time, a given phenomenon can give rise to multiple ideal-typical constructs. The question arises: How do we judge among the constructs? Weber’s response is that the ideal type is never an end in itself; rather, it is a means for understanding. It must be judged, therefore, by how well it helps us understand the phenomena of interest to us: “Whether we are dealing simply with a conceptual game or with a scientifically fruitful method of conceptualization and theory-construction can never be decided a priori. Here, too, there is only one criterion, namely, that of success in revealing concrete cultural phenomena in their interdependence, their causal conditions

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and their significance. The construction of abstract ideal-types recommends itself not as an end but as a means” (Weber 1949a, 92). The ideal type represents Max Weber’s attempt to clarify certain of the ambiguities that accompanied Menger’s concept of exact types. Menger had said that theory always looks at one side of a particular phenomenon and that exact theory examines its most typical, or generic, aspects. Using Rickert’s notions of concept formation in the face of an infinite and irrational reality, Weber went beyond Menger to claim that all description is theory laden. He also replaced Menger’s exact type with the ideal type, which, rather than emphasizing those aspects of the phenomenon that are generic, picks out those features that are of most interest to the investigator. Weber further clarified the relation between his own views and those of Menger in a famous article on marginal utility theory (see Weber 1975b). Weber insists there that developments in psychology have nothing to do with economics. Psychology deals with relations between external stimuli and sensations. The value theory of economics has a different basis; it is derived by tracing out the consequences of rational choice in the face of scarcity. Economics concerns the relation between ends and means, between an experience in the mind (a want) and an action designed to satisfy it. The usefulness of this particular ideal type depends on the nature of society. Weber further asserts that recent changes in society have made the economic way of viewing things more and more useful: “Under today’s conditions of existence the approximation of reality to the theoretical propositions of economics has been a constantly increasing one” (Weber 1975b, 33). According to Weber, then, changes in society have rendered Menger’s specific ideal type more and more applicable. By replacing Menger’s exact type with his own ideal type and asserting that it helps us understand current society, Weber both modified Menger’s position and provided a rationale for it. Recall that Menger’s justification for his own specific theoretical approach included the claim that it helps us understand the past formation of certain social institutions. Weber provides a present-centered rationale to supplement Menger’s original justification. Weber’s insistence that economics studies the relation between means and ends and, thus, does not depend on any particular theory in psychology would eventually become a standard Austrian tenet. Equally important was his claim that all observation presupposes prior theorizing. The “theoryladenness” assumption would, with the Kuhnian revolution, become a commonplace among philosophers of science in the second half of the twentieth

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century. Even before Thomas Kuhn, however, the idea would be found in the writings of the Austrian philosopher Karl Popper, who famously would ask his students to “observe” the classroom and write down what they saw (Popper [1957] 1965a, 46). (Without further instruction, each would, of course, write down something different.) Max Weber’s work would be much discussed by Viennese economists in the 1920s, so much so that the dependence of observation on theory doubtless became a standard assumption among them. This helps explain why the extreme empiricism of the logical positivists of the Vienna Circle would immediately strike the Austrian economists as so perverse.7

The Practical Failures of the German Historical School Weber’s critique of the doctrines of the historical school was based on the claim that there is no such thing as presuppositionless observation and fact collection. If one accepts Weber’s claim, the conclusion is clear: the historical school had based its methodological approach on a flawed premise. But what is the practical import of such a critique? Most historical economists in fact acknowledged that theory played some role in their choice and treatment of subjects. If their supposedly flawed methodology actually yielded fruit, would such a logical objection be viewed as important? After all, in the twentieth century, economists justified all manner of unrealistic theorizing by repeating Milton Friedman’s dictum that the realism of assumptions does not matter if a theory predicts well. Could not a similar sort of pragmatic defense be used to justify the methods of the German historical school? But it was precisely in the practical application of its methodology that the historical school most evidently came up short. This is not to say, of course, that there were no positive contributions, for there were many. Massive amounts of data were collected, archival sources mined, careful and detailed historical accounts of the development of crafts, industries, and trades in various regions produced, nuanced integrative studies of the development of social institutions created. How can one even begin to judge the value of such a mammoth effort? We are fortunate in that a master of the history of eco7. The term circle (Kreis) refers to a discussion group that meets on a regular basis. There might be a common reading or a paper presentation by a member or an invited guest. A number of such groups were formed in Vienna in the interwar period.

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nomic thought, Joseph Schumpeter, did just that, and his assessment of the value of the 188 “volumes” (he used the scare quotes because many of the volumes themselves were multivolume works) published by the Verein is worth recounting: Many of the volumes presented work of a high grade that was not only exemplary in its minute attention to detail but also analytically significant and inspired by considerations of scientific as well as practical urgency. The Verein’s comprehensive price studies (begun in 1910) may serve as an example. Most of them, however, were no better and no worse than such investigations were and are at all times and in all countries. . . . [T]he economists responsible for the reports that fill those volumes of the Schriften cared little for analytic refinement. They took no end of trouble with their facts, but most of them went straight from their impressions of the factual pattern to recommendations, just as would have any nonprofessional worker. They neither used nor contributed to theoretical or statistical technique, in spite of their obvious opportunities for doing so. And the analytic apparatus of economics did not improve but rather deteriorated in their hands. (Schumpeter 1954b, 804; cf. Schefold 1987, 257) Very little of this work has been translated, but we can perhaps get a taste of what some of it contained by looking at an article by Schmoller himself. Titled “The Idea of Justice in Political Economy” and first published in German in 1881, it appeared in translation as the lead article in the March 1894 Annals of the American Academy of Political and Social Science. As the title suggests, the article treats of a serious subject, and, for Schmoller at least, the paper constitutes a succinct discussion of it. The forty-one pages of text reveal that his famous admonition that “everything is so infinitely complicated” was no pose. Schmoller rambles far and wide, examining the psychological origins of our varying concepts of justice, how the meanings of such terms are socially determined, and their effect on all manner of class and political struggles. A discussion of the concepts of community, benevolence, liberty, and custom follows. As he nears the end of the piece, we start to get to the real meat, as evinced by his assertion that the concept of justice has something to do with “equality measured in some way” (Schmoller 1894, 34). The crowning paragraph is perhaps the following one: We demand to-day above all, besides a just system of barter, just economic institutions, i.e., we demand that the complexes of rules of morals and

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right which govern groups of men who live and work together should harmonize in their results with those ideal conceptions of justice which on the basis of our moral and religious conceptions are prevalent to-day, or which are gaining recognition. We do not acknowledge any one of these institutions to be above history, as having always existed or as necessarily everlasting. We test the result of every one of them, and ask of each: How did it originate, what conceptions of justice have generated it, what necessity exists for it to-day? (35) Schmoller concludes that, for any given group, the concept of justice will depend on that group’s ideals, on its moral and religious heritage, on its currently existing as well as emerging mores: in short, the concept of justice means something different to everyone. Filled with initial promise, Schmoller’s article ends up being about as stark a demonstration as one can imagine of the limitations of a purely descriptive approach to social phenomena. In his attempt to canvass everything, all focus is quickly lost. This, perhaps, is the practical upshot of Weber’s logical argument: if one tries to observe from no point of view, one ends up with . . . just that. Defenders of Schmoller insist, of course, that he did have a theory. Thus, Prisching (1993 –94) offers a summary of Schmoller’s theory of society, one in which human history reveals a gradual process of moral improvement. Biological, sociological, and demographic elements are among those that determine the direction of the process. Progress often has costs, however. The division of labor, which occurs in all manner of social settings, brings both material benefits and social and class conflicts. Another sign of progress is that violence and war have gradually been replaced by market competition. This has brought more rapid economic growth—but with it further social inequities. Social reform directed by the state in the interests of all will help guarantee the moral advance of humankind by ameliorating the social costs associated with progress. This, according to Prisching, is the broad outline of Schmoller’s theory. Even if one accepts the idea that this historical account constitutes a theory, the question remains: What specific policy advice does the theory yield? How does one determine the actual content of the social reforms that, according to the theory, the state must initiate and oversee? 8 8. Backhaus (1993 –94, 6) offers the following answer to the question of how the Schmollerian policy analyst decides on which policy to recommend: “He arrives at policy

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The point was driven home once World War I had begun. It rapidly became apparent that “the world is complex” was not an adequate answer to questions about how to mobilize for the war effort. Instead of consulting its economists, Germany turned instead to men of industry to put the economy on a war footing. Walther Rathenau, head of the electricity cartel, not Gustav Schmoller, became the man of the hour. It was not long before sentiment turned against the professors. The episode was summarized in an article published a year before the armistice: The moment seems opportune, therefore, for reviewing economic teaching at the German universities, especially as one of the effects of the war has been to bring that teaching under searching criticism. The economic reconstruction of the national life on the war basis was the work, not of the professors, but of the “practical” men. The provision of the supply of raw materials for the German army, for instance, with its embargo and price regulation, is associated with the name of Walter Rathenau, the chairman of the Allgemeine Elektricitäts Gesellschaft. The professors are associated with the slaughter of pigs, which has brought them into bad odour. Public opinion in Germany seems hardening in favour of making the study of economics more practical. The historical school is said to have had its day. (Epstein 1917b, 432) If their impotence during the war effort spotlighted the weakness of their position, the final nail in the historical school economists’ coffin was their failure to oppose the policies that led to the German hyperinflation. Some later writers even held Schmoller accountable for the disaster, noting that the word inflation did not appear in the index of his two-volume Grundriss and that the economists in positions of power in the early 1920s, who presided over the debacle, were all products of the historical school’s teachings (Balabkins 1988, 77; cf. Barkai 1991, 38 –39). Such charges evidently overstate the case, given that Schmoller died before the hyperinflation occurred. In addition, even the presence of good theoretical work is seldom any guarantee that bad policy will be avoided; if it were, classes in economics would have very prescriptions by enriching the analysis with enough historical, institutional, political, fiscal and cultural data to impose constraints on the set of available solutions.” Backhaus also asserts that such an analysis is value free because it is just such an institutionally rich analysis that narrows down policy options, not the analyst’s values. This, of course, begs the question of how the policy analyst decides which institutionally rich data to include.

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few case studies to present. The events of the early 1920s were, nonetheless, widely viewed as a further indication of the bankruptcy of the historical school’s approach. Intriguingly, the war had a similar effect on the economics profession in America. If the “theories” of the German historical school economists failed to provide any help during their own country’s mobilization, the same could be said, and was said, about the “standard theory” of the day in America. This is how Wesley Clair Mitchell put it in the early 1920s: One of the outstanding lessons of the war to all economists who had a share in planning was the indispensable necessity of carrying their analyses beyond the stage represented in orthodox treatises. It seldom sufficed to say that a given action would have consequences of a certain kind, that would have been easy—and trifling. The important thing was to find out at least in what order of magnitude these consequences should be reckoned. Continually grave decisions turned on the questions: How many? How much? How soon? . . . Such questions came up—literally by the thousands—and they had to be answered in figures, figures drawn from official records if there were such, figures carefully estimated if there were no records, figures intelligently guessed at if there was no real basis for an estimate. . . . The theorist discoursing at large may content himself with pointing out the kinds of causes and consequences to be considered; the practitioner dealing with specific cases must calculate the magnitudes involved. In proportion as economists face real problems they will strive to cast even their general theory into the quantitative mold. (Mitchell [1924] 1930, 27–28) Mitchell concluded that what is needed, in peacetime no less than in times of war, are hard facts, data, and trained experts who are capable of interpreting them. That is, numbers—and numbers in the hands of scientifically trained policy advisers, not historians—were what was called for by the group that would become known as the American institutionalists. Members of the new movement would share the reforming zeal of their German historical school counterparts—but with none of the imperial ardor. Facts would be used to reshape society along more rational lines. They would be used for prediction and control, not for understanding a nation’s history. The age of the true social scientist was dawning. Given later developments, it is interesting that both Carl Menger and Ludwig von Mises criticized the historical school approach for its inability to

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produce predictions. Their point is one familiar to most economists: once the tools are in place, virtually any news story with economic content can be analyzed, and often plausible qualitative predictions (suitably hedged with a ceteris paribus clause) can be made about the ultimate results of changes in underlying demand and supply conditions. Economists in the positivist era would hold out the hope that much more precise prediction and control were possible. Rejecting this more extreme view, the Austrians would come to be associated—wrongly—with the view that prediction is impossible in the social sciences. Concluding Remarks In this chapter, I traced the ultimate decline of the German historical school. We saw that, even though Max Weber identified himself as a member of the school, he formulated many of the arguments that were to prove decisive in the struggle. Beyond that, Weber’s proposals regarding the value-freedom question, his vision of the independence of economics from psychology, and his claim that all observation is theory laden were to become central tenets of Austrian (and other) thought. This list does not exhaust his contributions,9 but, certainly, it suffices to justify the attention paid him. 9. Other contributions include Weber’s criticisms of the concept of laws in science; his critique of socialism (contemporaneous with but independent of Mises’s work); and his discussion of the role of “understanding” (Verstehen) in social science (see Weber 1975a; Weber 1975c; Weber 1947, 194, 202 –18; Weber 1949a, 68 – 69; cf. Tribe 1995a, 92). If one takes into account Alfred Schütz’s phenomenological reinterpretation of certain of Weber’s sociological categories, one prompted by Felix Kaufmann’s urgings that Schütz study Edmund Husserl’s writings, the web expands still further (for more on Schütz and Kaufmann, see chapter 6). Ludwig Lachmann would in the 1970s claim that Schütz was Weber’s best interpreter, and this helped fuel a revival of interest among Austrians in Schütz’s work, one that continues today. See, e.g., Lachmann (1970), Koppl (1994), Augier (1999), and Boettke and Koppl (2001). As interesting as they are for the production of new syntheses in Austrian thought, an exploration of these disparate connections is beyond the scope of the present work. I offer as justification Hayek’s own words on his experiences with Schütz in the 1920s: “Through Schütz we all became familiar with Max Weber and Husserl’s phenomenology (which, however, I never understood, though Kaufmann’s unique expository talents assisted Schütz in this)” (Hayek 1992c, 32). It was not Kaufmann’s phenomenology but his critique of mixing together analytic with synthetic statements that may have had an influence on Hayek. But we get ahead of ourselves.

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I end with a concluding ironic point about the Methodenstreit. Although at first the Germans were successful and then later (for a time) the Austrians appeared vindicated, in the still longer term it might be said that neither group won.10 One focused on national destinies might be tempted to say that the French won. Both schools would, after all, end up losing out to the followers of Léon Walras (who mathematized marginalism) and of Auguste Comte (the father of positivism). Ah, the French. But such a story, so appealing in its simplicity, does not really work. Positivism would enter economics, not through the French, but, at least in part, through the influence of Austrian scientists and philosophers of science, first Ernst Mach, then the Vienna Circle. The further development and refinement of the doctrines would take place principally in the English-speaking world, giving rise to the Anglo-Austrian alliance of which Ernest Gellner (1985, 4) has spoken. The French would end up joining with their old rivals the Germans to develop the hermeneuticist, structuralist, and postmodernist approaches to social-science phenomena, doctrines that until recently have had little effect on economics. And, although the mathematization of economic theory was inspired by the work of the Lausanne school and carried on in part by French economists, it soon became an international phenomenon, with English, American, Italian, Scandinavian, and Japanese economists all contributing. As for socialism, the reform impulse that spawned it was not restricted by national boundaries, and it was an equally important determinant of the direction of economics in the twentieth century. The quest for a true science of the social (the ascendance of positivist methodological rhetoric and of apparently rigorous mathematical theories supported the view that such a lofty goal was in fact being achieved) went hand in hand with the hope that the methods could be used to reform, and sometimes radically reform, society. Not everyone shared the reformist impulse, of course, and a backlash against it would develop later in the twentieth century. Faith in the possibilities for a science of the social remained intact for a much longer time. Although he too was heavily influenced by the scientistic worldview, Hayek was also one of the few who rebelled against it. 10. Curiously, certain participants in the literature associated with the Schmoller renaissance have written that the standard view is that Schmoller lost the battle to Menger (e.g., Häuser 1988, 539; Shionoya 2001, 11). This makes sense only if one equates Menger’s approach with mainstream neoclassical marginalism, and, even then, one must take a very long-run view of history.

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In the next chapter, we will see how socialism and positivism grew up together in Vienna in the first two decades of the twentieth century. Although there is no necessary connection between the two doctrines, a connection was always to be there in the minds of Austrian economists like Ludwig von Mises and F. A. Hayek. Given the political prominence in Vienna of the Austro-Marxists and the philosophical claims that were being made by the likes of Otto Neurath, it could not be otherwise.

CHAPTER 5

Positivism and Socialism

The Changing of the Guard In 1903, Carl Menger stepped down from his chair at the University of Vienna, succeeded by Friedrich von Wieser. The next year, Eugen BöhmBawerk concluded his third stint as minister of finance, a post that he had held with some distinction, and retired to a supernumerary position at the university. Although his new post required no teaching, he would run a seminar on economics for the next decade that would gain considerable prominence. The second generation of Austrian economists had taken command, beginning what Hayek would later describe as “the period of the school’s greatest fame” (Hayek 1992a, 51). Let us take Wieser first. The new appointment clearly energized his research activity. In his inaugural address, he applied the principle of subjective value to the problem of the valuation of money, an approach that would be expanded and systematized by Ludwig von Mises in the 1912 The Theory of Money and Credit (see Mises [1934] 1981c). His new interest in monetary questions led Wieser significantly to develop his whole system over the next decade. Ultimately, he began taking up questions of a sociological nature. This attracted the attention of Max Weber, who invited him to contribute what was to be the first, introductory theoretical volume of the Grundriss der Sozialökonomik series that Weber was editing. Wieser’s contribution, Theorie der gesellschaftlichen Wirtschaft (translated as Social Economics), was published in 1914, a few weeks before the outbreak of the war (see Wieser 1927). In his 1926 obituary notice for Wieser, Hayek wrote that Social Economics “offers not only the sole consistent treatment of economic theory produced by the modern subjectivist school, but it also constitutes, above all, what may well be the greatest synthesis achieved by economic theory in our time” (Hayek 1992e, 119). During the last two years of the war, Wieser served as minister of commerce. He returned to his university chair in 1919 and taught [ 100 ]

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until his retirement in 1922. It was during this final period that Hayek became one of his students. Although Wieser had the more prestigious position, it was his brotherin-law, Böhm-Bawerk, whose seminar became the focus of attention in the decade before the war. A chief reason was that it brought two apparently irreconcilable forces, the marginalists and the Marxists, together for debate. A brief examination of the development of Marxism may help set the stage.

Marxism versus Marginalism Karl Marx published the first volume of Capital in 1867.1 The second, edited by Friedrich Engels, appeared in 1885, two years after Marx’s death. Marxism was in the 1870s and 1880s just one of many socialist doctrines competing for the allegiance of the workers. In central Europe, the competition generally took place in an environment of harassment and repression. We have noted how Bismarck succeeded in having antisocialist laws passed in Germany in the 1870s, and similar constraints were imposed in Austria in the 1880s at the instigation of Count Taaffe. Trade unions and other worker organizations were outlawed, presses destroyed, leaders tried and imprisoned, and meetings and demonstrations broken up, often violently. As far as party politics went, in the closing decades of the nineteenth century Continental Marxism was most closely allied with the German Social Democratic Party. Its statement of principles was the Gotha Program of 1875, which combined various Marxian doctrines with the more moderate ideas of one of Marx’s chief rivals, Ferdinand Lassalle—much to the consternation of Marx. Antisocialist laws were finally abandoned in Germany in 1890, and the next year the Erfurt Program, with Karl Kautsky the principal architect, superceded the Gotha Program. This marked a return to a more revolutionary, and, hence, more purely Marxian, vision among socialists in Germany. Things developed more slowly in Austria-Hungary. There, the Marxists had to contend, not only with the usual anarchist and Lassallean rivals, but also with trade union radicalism and Czech nationalism. It was not until December 1888 that Viktor Adler, with the help of Kautsky, was able to bring the disparate parties together at Hainfeld to form an Austrian Social Democratic Party (Rabinbach 1983, 7–11). 1. Parts of this and the next several sections draw on Caldwell (1997b).

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This was, of course, at precisely the same time that the new Austrian school of economics was beginning to take shape. The Methodenstreit had begun only a few years earlier, and the publication in 1886 – 87 in a German academic journal of Böhm-Bawerk’s detailed exposition of Austrian marginalism (see n. 10, chap. 1) marked the emergence of the school. In describing the implications of marginalist theory, men like Böhm-Bawerk and Wieser almost of necessity had to criticize the labor theory of value that Marx and other socialist writers had taken over from the classical economists. As Wieser (1891, 112) concisely put it in his article introducing the Austrian school approach to English readers: “The most momentous consequence of the theory of imputation is, I take it, that it is false, with the socialists, to impute to labor alone the entire productive return.” While marginalism had to contend with historicism in Germany, the going was easier in England, where inroads had even been made among the socialists, chiefly the Fabians. Living in England, Engels was clearly horrified by this development, remarking bitterly on it in correspondence with compatriots in Germany in the late 1880s. For at least some Marxists living in Germanspeaking lands, then, marginalism (or, as it was often called, the psychological tendency in economics) as endorsed in such places as Austria and England was yet another rival to be dispatched (Kurz 1995, 15 –24). The stakes went up in the 1890s. In 1892, Conrad Schmidt published a critique of Austrian marginalism in the German Social Democratic outlet Die Neue Zeit, an article that drew an appreciative letter of support from Engels (see Kurz 1995, 24). In 1894, Engels finally brought out the third and final volume of Marx’s Capital. The book was long awaited by Marxists, for Marx had promised that, in it, he would resolve a key problem for the labor theory of value, the transformation of values into prices. The so-called transformation problem had been dealt with in the earlier volumes by making the unrealistic assumption that capital-labor ratios were identical across all industries. The third volume would drop the assumption and show how the transformation could take place. Having finally completed the last act of their long collaboration, Engels followed Marx to the grave the next year. A response from the Austrians followed immediately. In 1896, BöhmBawerk offered a comprehensive assessment of Marx’s system (see BöhmBawerk [1898] 1975), one that concentrated on the foundation of its theoretical structure, the Marxian theory of value. Böhm-Bawerk essentially denied that Marx had successfully solved the transformation problem. His argument

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combined analytic precision with rhetorical flourish. The title of the English translation, Karl Marx and the Close of His System, arguably carried a double meaning. The essay was obviously meant as a response to Marx’s now finally completed trilogy. But Böhm-Bawerk’s closing sentence, in which Marx is compared to Hegel, made evident his intent also to bring on the collapse of the Marxian edifice: “The specific theoretical work of each [i.e., Marx and Hegel] was a most ingeniously conceived structure, built up by a fabulous power of combination, of innumerable storeys of thought, held together by a marvelous mental grasp, but—a house of cards” (Böhm-Bawerk [1898] 1975, 118). Many (even including some on the Left) were swayed by Böhm-Bawerk’s critique, and defections from the traditional Marxian dogma soon began to occur. Writing in 1897, Conrad Schmidt declared: “The insight that Marx’s value theory by no means provides the proof on which socialism is founded, has gradually made its way in the widest circles” (Schmidt quoted in Kurz 1995, 27). Even more significant internationally was the publication in 1899 of Eduard Bernstein’s Evolutionary Socialism (see Bernstein [1909] 1961). Bernstein lived in London from 1888 through 1901 and, while there, had been heavily influenced by the Fabians. In his openly revisionist tract, Bernstein opposed the labor theory of value, questioned a number of Marx’s predictions, and touted an evolutionary rather than a revolutionary path to a democratic socialist future. Bernstein was excoriated by Kautsky and by Rosa Luxemburg, defenders of the Marxian orthodoxy in Germany. The first revisionist controversy had begun. Meanwhile, in Austria, a young student named Rudolf Hilferding, writing in 1904 in the first issue of a new Viennese Marxist outlet, Marx Studien, of which he served as coeditor, offered another response to Böhm-Bawerk’s article. Besides defending Marx’s solution to the transformation problem, Hilferding claimed that the subjectivist and individualist approach that underlay Böhm-Bawerk’s own theory made it impossible for him to interpret Marx correctly.2 Hilferding’s critique appeared, then, just as Böhm-Bawerk was returning to the university. Böhm-Bawerk took up the challenge: the topic of his first year’s seminar was the theory of value. This set the stage for an ongoing meeting that must be counted as one of the most noteworthy intellectual events in 2. Hilferding (1975) is a translation of Hilferding’s critique of Böhm-Bawerk, and Kurz (1995, 32 – 43) contains an analysis of the exchange.

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the history of economics. If the greatness of the minds that sat together at Böhm-Bawerk’s seminars could have been overshadowed, it would have been only by the force of their personalities. There was Hilferding, who would gain even more fame with the publication in 1910 of Das Finanzkapital (Finance capital) (see Hilferding 1981), perhaps the most important work in Marxian economic theory in the twentieth century.3 There was Otto Bauer, a friend of Hilferding’s who helped him organize the first student socialist society at the university. Bauer would become a leading political theorist of the AustroMarxists and, at the conclusion of the First World War, the party leader of the Austrian Social Democrats. There was the sociologist Emil Lederer, who would go on to become the first dean of the Faculty of Political and Social Sciences at the New School for Social Research. There was the precocious Joseph Schumpeter, who in the course of the decade would write three books that anticipated many of his later contributions to economics. There was the sociologist Otto Neurath, who would become one of the leading members of the Vienna Circle of logical positivists in the 1920s. And there was Ludwig von Mises, who, although trained in the style of the historical school economists, would embrace the doctrines of his teacher and, in 1912, publish a classic Austrian contribution to monetary theory, The Theory of Money and Credit (see Mises [1934] 1981c). In his memoirs, Mises recalled the first semester’s meetings of BöhmBawerk’s seminar, his respect for the other members of the seminar, even those with whom he sharply disagreed, evident: “As the subject matter of the first seminar, Böhm-Bawerk chose the fundamentals of the theory of value. From his Marxian position, Otto Bauer sought to dissect the subjectivism of the Austrian value theory. With the other members of the seminar in the background, the discussion between Bauer and Böhm-Bawerk filled the whole winter semester. Bauer’s brilliant intellect was very impressive; he was a worthy opponent of the great master whose critique had mortally wounded Marxian economics” (Mises 1978, 39 – 40). Erich Streissler (1988, 196) reports that, despite their disagreements over value theory, both Böhm-Bawerk and Hilferding shared a “basically negative attitude towards economic policy, Böhm-Bawerk thinking state intervention bad because it only throws a spanner into the smoothly working machine of private enterprise, while Hilfer3. Howard and King (1989, 100) judge Finance Capital “the most influential text in the entire history of Marxian political economy, only excepting Capital itself.”

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ding thought it useless in a system which could only be changed to the better by complete revolution.” Streissler (1988, 201) further suggests that the seminar interaction may have had a moderating effect on the policies that would be undertaken by the Austrian Social Democrats when they achieved political power in the “Red Vienna” of the 1920s.4 This may help explain the strange fact that, although in terms of their rhetoric they were among the most doctrinaire of Marxists, in terms of their actual policy the AustroMarxists under Bauer seemed intent on preventing the more radical workers from engaging in outright revolution. Bauer never thought the conditions right for revolution in Austria. The ultimate violent rout of the Viennese socialists in the 1930s led many later socialists to censure Bauer. There is a final element of Austro-Marxist thought to consider. Marx and Engels had dubbed their own brand of socialism “scientific,” in contrast with the “utopian” schemes of earlier socialists like Saint-Simon, Fourier, and Owen. Engels considered the dialectical method of Marxism, one taken over from Hegel (although radically transformed from an idealist to a materialist doctrine), superior to the “metaphysical” approach employed successfully in certain natural sciences but much less fruitfully in the study of society (Engels [1892] 1978, 688 –98). The founding fathers of Marxism, then, were eager to claim the mantle of science for their theories. The Austro-Marxists also believed that theirs was a scientific approach to socialism. Their own variant would remain very close to Marx’s economic writings, but it would also incorporate positivist ideas borrowed from Ernst Mach, the famed Austrian physicist, psychologist, and philosopher. Not everyone outside the Ringstrasse looked favorably on the innovative Austrian integration of Marxism and positivism. Lenin, for one, viewed it as tantamount to heresy. In 1909, he published Materialism and Empirio-Criticism: Critical Comments on a Reactionary Philosophy (Lenin 1988), a defense of dialectical materialism and critique of the ideas of Mach, Richard Avenarius, and Russian Machists like A. Bogdanov. Lenin denied the basic Machian 4. Although it took part in two coalition governments directly after the war ended, the Austrian Social Democratic Party fell from power nationally in June 1920. After that, its stronghold was in large urban centers, and Vienna became the centerpiece for various socialist experiments, hence the epithet. Somewhat characteristically, in his memoirs Ludwig von Mises (1978, 16 –19) took credit for having convinced Bauer to resist supporting a Bolshevist revolutionary takeover in Vienna in the dangerous period immediately following the armistice.

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thesis that sensations are all that exist. For Lenin, there was something out there that produces sensations; when we experience a sensation, there is a thing-in-itself independent of us that is its cause. Lenin’s work would prompt a reply from Friedrich Adler, the son of the Austrian Social Democrat leader Viktor Adler. (This was written while he was in prison for the 1916 assassination of Count Karl von Stürgkh, the imperial prime minister.) Mach’s influence was also evident in the work of other prominent Austro-Marxists, among them Bauer and the philosopher Max Adler (Bottomore and Goode 1978, 15 –16, 45, 210). This was one of the ways in which positivism gradually became associated in the minds of many Austrians, on both the Left and the Right, with a scientific approach to socialism. Other participants in BöhmBawerk’s seminar helped reinforce still other associations.

The Multiple Apostasies of Joseph Schumpeter The most flamboyant and intriguing member of the seminar was undoubtedly Joseph A. Schumpeter, a man destined to become, not only one of the greatest, but also one of the most storied economists of the twentieth century. He was, according to one biographer, characterized by “pretentious arrogance, a sense of self-importance and superiority, elaborate manners, omniscient attitude, . . . conspicuity, ambition,” and as sporting “spats, an unusual vest or cravat, a bracelet, colored or two-toned shoes, a silver-headed cane.” He was an “elitist, a snob’s snob,” with “flamboyant but impeccable manners” (Robert Loring Allen quoted in Shionoya 1995, 314). Schumpeter’s life was an ongoing series of personal and professional setbacks and triumphs, productive of a legacy yet filled with contradictions. His overbearing selfconfidence and “elaborate manners,” for example, are often attributed to a deep sense of personal insecurity. Schumpeter was born into a middle-class merchant family, and it was only when his widowed mother remarried into a wealthy and aristocratic Viennese family (some suggest with the aim of providing opportunities for her son) that he was able to mix with the highest society. Personal tragedies haunted Schumpeter all his life. He was only four when his father died. His first marriage in 1907 to an older English woman went sour almost immediately, ultimately ending in divorce. He remarried in 1925, this time to a woman almost half his age. It was a good match for him, and

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for the first time he seemed to have achieved a measure of personal happiness. It would not last. A year later his mother, to whom he was devoted, died. The next month his new wife died in childbirth, and after a few hours his infant son also succumbed. In the space of a month, his entire family was gone. Soon thereafter Schumpeter began a morbid and bizarre practice that would continue for the rest of his life. He began keeping a diary in which he would recopy entries from his dead wife’s old diary, writing in shorthand on the top of each page: “O Mother and Mistress—please protect me!” He would then add prayers for success in his work. His dead wife and mother had become his guardian angels (Shionoya 1995, 20). In 1932, Schumpeter took a position at Harvard, where he would remain until his death in 1950. Although in America he kept up the public persona of the urbane, meticulously dressed Continental intellectual, it is clear from correspondence with the woman who would become his third wife, Elizabeth Boody Firuski, that, during much of this period, he was deeply, if not chronically, depressed (Swedberg 1991, 25 –26). There were professional mishaps as well. Although Schumpeter had university appointments in Czernowitz and Graz and, before the war, spent a year as a visiting professor at Columbia University, he longed to be a man of affairs. He got his chance in 1918, when two other seminar participants, Rudolf Hilferding and Emil Lederer, asked him to serve on the German Socialization Commission in Berlin. The commission studied the feasibility of socializing the German economy, and, although he was no socialist, Schumpeter signed a majority report that argued that socialization was necessary to increase economic efficiency. Doubtless, his work with the commission played a role in his being invited in the spring of 1919 (at the behest of Hilferding and Otto Bauer) to become finance minister for the new Austrian coalition government. Schumpeter held the post for only eight months, but, while in office, he managed through his policies and intrigues to infuriate virtually all his constituencies, becoming one of the most reviled men in Austria (Swedberg 1991, 16 –18).5 After his stint as finance minister, he became the 5. As Stolper (1994, 224 –27) demonstrates, at least one story from this period is false. Schumpeter never said, “A krone is a krone,” a phrase that, when spoken by a former finance minister about a period of hyperinflation, easily betters Marie Antoinette’s, “Let them eat cake.” The phrase actually came from a newspaper editorial reporting on a court decision in 1924 upholding an order that had been issued by Schumpeter when he was finance minister. The decision meant that no revaluation of the then-worthless currency

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president of the Biedermann Bank in Vienna. This also turned out badly: the bank became insolvent, and Schumpeter was forced to resign in 1924. These very public failures all took place in the years immediately preceding the deaths of his mother, wife, and son. Schumpeter finally returned to academic life, where he would remain for good. Although he was regarded from the start as a first-rate economist, in his own mind there were failures even in this domain. Schumpeter managed to be upstaged by John Maynard Keynes, not once, but twice. In the late 1920s, he worked feverishly on a major book on monetary theory, but, before he could finish it, Keynes’s A Treatise on Money appeared (see Keynes [1930] 1971b). Some say Schumpeter tore up his own manuscript on reading Keynes’s book; in any case, no part of his work in this area would be published while Schumpeter was living. His 1939 book on business cycles was similarly preempted by Keynes’s publication in 1936 of The General Theory (see Schumpeter 1939; Keynes [1936] 1973b). Even the decision to go to Harvard was not untarnished: Schumpeter accepted the offer only after having been passed over for the post he really wanted, a professorship at Berlin that went instead to Lederer (Swedberg 1991, 21–27). As in his life, there were (at least apparent) contradictions in his work. He considered Léon Walras, the father of static general equilibrium theory, to be “the greatest of all economists” (Schumpeter 1954b, 827), but his own theories of the workings of the economy were thoroughly dynamic, about as distant from Walras’s as is possible. He championed the use of mathematics in economics, but his own work tended toward the historical and sociological. He was a conservative who disliked socialism and detested Roosevelt and the New Deal but who sided with the Marxists on the Socialization Commission and with the market socialists in the English-language socialist calculation debate. It is hard to make Schumpeter out, which adds to the fascination. In the decade before the First World War, however, he was known, quite simply, as one of the most brilliant young economists of his generation. This reputation was based on his publication between 1908 and 1914 of no less than three major books. The second of these, The Theory of Economic Development (Schumpeter [1934] 1961), is probably his most renowned work, for it contains his description of the “process of creative destruction” by which a capfor purposes of debt repayment was to be allowed. Many who experienced financial ruin in the hyperinflation blamed Schumpeter for their misery, hence his widespread notoriety.

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italist economy develops. The third, Economic Doctrine and Method: An Historical Sketch (Schumpeter 1954a), was prepared for Max Weber’s Grundriss der Sozialökonomik series and foreshadowed Schumpeter’s lifelong interest in the history of ideas. It is, however, his first book, Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie, that established Schumpeter’s reputation in the Austrian camp as the enfant terrible of the prewar circle.6 Schumpeter announced two goals for the Wesen. The first was to clarify the foundations of economics theory, by which he meant static equilibrium theory, and, thereby, to resolve various methodological disputes that had plagued the discipline. The second was to make his German-language readers more familiar with recent developments in pure theory and, in particular, with the general equilibrium approach of Walras and his followers in Lausanne. Schumpeter begins the book with a vision of science, one drawing on a variety of epistemological claims developed by philosophers (especially Ernst Mach and Henri Poincaré) who had studied the natural sciences. From Mach Schumpeter takes the idea that science seeks not to explain the ultimate causes of phenomena but rather simply to describe the functional relations that exist among elements, elements that are accessible to our senses. From Mach he also took the idea—shared by Poincaré—that theories are not true or false statements about the world but rather conventions or instruments, useful fictions that help us organize data and express the relations that exist among them. The value of a theory depends on how well it accomplishes these tasks (Shionoya 1995, 93 –95, 99 –104). Having set out his account of the status and role of theories in science, Schumpeter then drops (what for his Austrian readers was) his bombshell: that the Walrasian general equilibrium approach, one in which the economy is represented by a system of equations, is, within economics, the theoretical framework that currently best exemplifies a truly scientific approach. This is so because the Walrasian system allows one to express functional relations 6. Das Wesen und der Hauptinhalt der theoretischen Nationalökonomie, written in 1907 while Schumpeter was in Cairo and published in 1908, is over six hundred pages long, which is probably why it has never been translated. Shionoya (1995, chap. 5), however, provides a detailed exposition and interpretation of the book’s arguments, on which the discussion in the text is based. Shionoya renders the title The Nature and Substance of Theoretical Economics, rather than the more literal The Essence and Chief Contents of Theoretical Economics, because the term essence carries metaphysical connotations and Schumpeter opposed metaphysics in his book.

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that exist among objective entities like prices and quantities. A system-ofequations approach is a perfect vehicle for representing the interdependence and mutual interaction of objective economic phenomena. Schumpeter, then, used Mach’s theory of science to clarify and defend the Walrasian approach within economics. Schumpeter next endeavors to show how his framework could be used to resolve some of the methodological disputes of his day. If, for example, his instrumentalist interpretation of the status of theories is accepted, it follows that many of the German historical school objections to theorizing were simply misplaced. Theories of necessity abstract from reality. But, because they are nothing more than useful fictions, tools to be used to organize data, their lack of realism should not be a matter of concern. Theories are to be judged solely for their usefulness in organizing objective phenomena. On the other hand, the historical study of a given social phenomenon is quite clearly a distinct exercise from a theoretical treatment of it. Theory and history thus occupy separate domains, and there is, therefore, no conflict between them. On this reading, the Methodenstreit truly was a waste of energy (which was Schumpeter’s mature judgment) because it was based on a misunderstanding of what a theoretical approach was supposed to do (Shionoya 1995, 110 –13). The debates that enthralled the participants of the Böhm-Bawerk seminar— debates between Marxists who embraced the labor theory of value and subjective value theorists— could likewise be clarified using Schumpeter’s new scientific program. The debate between the two camps was usually framed as: Which one is true, the labor theory or the subjective theory of value? But this was a false issue. Neither theory is true since theories are not true or false. The relevant question is: Which theory is more useful? The answer depends on one’s purposes. Schumpeter argues that, in most cases, the subjective value theory as expressed in the Walrasian equations is preferable on the grounds that it is simpler, it is more general, and it can be applied to a wider range of phenomena (Shionoya 1995, 113 –15). The third methodological dispute was one that was internal to marginalism, that between the Austrians and more mathematically inclined economists like Walras and Jevons. The debate had some history behind it. Although they had made their discoveries independently, Léon Walras and Carl Menger were by the early 1880s well aware of each other’s contribution. A correspondence began in 1883. In his initial letter, Menger acknowledged that the mathematical method was useful for expositing or demonstrating certain results of economics but denied that it was helpful for conducting research.

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As might be expected, in his reply, Walras disagreed. After one more letter from Menger, their correspondence ceased for three years, after which there was another brief exchange. In his letters, Menger rejected a mathematical approach because he felt that it failed to illuminate the essences of economic phenomena. Only his own “exact” method, the one described in his Investigations into the Methods of the Social Sciences (see Menger [1963] 1985), was capable of doing so.7 By the end of the century, Menger’s recourse to Aristotelian essentialism in defense of the Austrian approach seemed dated, so alternative arguments began to appear. Wieser in particular started using the term psychological method when referring to the Austrian variant of subjective value theory (Wieser 1927, 3). As he would later admit, Wieser’s initial terminological choice turns out to have been unfortunate. In contrast, Walras’s successor at Lausanne, Vilfredo Pareto, had already begun to embrace a positivist defense of his own mathematical approach to marginalism. He recommended, for example, that the older term utility be replaced by ophelimity and promoted the use of the indifference curve approach, which allows one to avoid metaphysics by eliminating all reference to unobservable states. Schumpeter felt that his own proposed approach allowed the resolution of this apparent dispute within the marginalist camp. If theories are only instruments, the whole question of whether they refer to anything, from “essences” to psychological states, is moot. As Shionoya (1995, 117) summarizes: “[Schumpeter] first contrasted Austrian essentialism and Lausanne phenomenalism and then resorted to instrumentalism in order to provide a kind of compromise between them. If the instrumentality of theories and hypotheses is accepted, then a disagreement over the ontological nature of theoretical entities can be replaced by a rivalry over the practical success of theories.” For Schumpeter, the economic facts are what drive economic theorists to make assumptions about psychology, not vice versa. The assumptions are unimportant; what matters is how well the theory works. Although Schumpeter portrayed himself as resolving a methodological debate, it was clear to the Austrians that he was endorsing the Walrasian approach—and doing so because he considered it the more scientific. As for his positivism, he went beyond even Pareto in insisting that economics should concern itself only with measurable quantities. All these new ideas coming 7. Antonelli (1953) reproduces the letters, and Kauder (1957) offers a discussion.

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from the pen of a former member of Böhm-Bawerk’s seminar took the Austrians very much by surprise, but, as Ludwig Lachmann (1982, 34) later lamented, “They seemed strangely helpless against them.” There was no response until 1911, when a review of Schumpeter’s book, written by Wieser, finally appeared (see Wieser 1994). In his review, Wieser again defended the “psychological method” in economics. By this point, Max Weber had published his argument that marginal utility theory does not depend on any particular psychological foundation. Wieser agreed with both Weber and Schumpeter that the two must be kept separate: “The psychological school of thought of economics must distinguish its territory very clearly from that of scientific psychology. Its tasks are not our tasks.” He regretted the ambiguity of his earlier use of the term psychological and even apologized, albeit indirectly, for not formulating things more carefully “in the stormy days of my scientific beginnings” (Wieser 1994, 289). If the psychological method à la Wieser wasn’t psychology, what exactly was it? Wieser addresses the issue with these words: “Our subject-matter is simply the consciousness of a person engaging in economic activity with his treasure-house of universal experience, that is, the experience possessed by every practitioner and which every theoretician finds ready in him as a practitioner without his first needing to gather it by means of special scientific methods” (Wieser 1994, 289). Wieser’s new description is itself not exactly unambiguous, but it looks like he might be talking about the sort of experience that one might encounter through a process of introspection.8 A later passage seems to reinforce this interpretation: “The opposing positions can be put in a nutshell. Schumpeter wants to observe economic facts from the outside alone, just as natural scientists do with phenomena, whereas the psychological method observes them above all from inside one’s consciousness. It does so because from there it can observe incomparably more and in more depth from the outside. We can only observe nature from the outside, but we can observe ourselves from the inside as well, and why should we forego this opportunity when we can do it?” (290 –91). 8. Kauder (1957, 416) remarks: “The label ‘psychological’ is somewhat inexact; what Wieser really meant, is introspection in the sense of Dilthey and Simmel.” Since Wieser refers to universal human experience, another reading might be that his psychological method is a precursor to Mises’s praxeology, but without the neo-Kantian foundations and without any mention of apriorism. This might account for Hutchison’s (1981, 208) linking of Wieser and Mises with regard to method.

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Wieser briefly repeats his defense of the psychological method in the introduction to Social Economics, which was published a few years later (see Wieser 1927). He reiterates there that “everyday economic experiences” are those “which every scientist shares with the layman” (3, 4). The method is described as empirical but also as employing methods of isolation and idealization, a combination of characteristics not usually thought of as fitting easily together (3 – 6). I think that it is fair to say that Wieser’s description of the psychological method does little to clarify matters. Indeed, Wieser’s position even became the butt of jokes among some of the Austrian circle-goers.9 Given the popularity of Mach among groups as diverse as the Marxists and the followers of Walras and Wieser’s anemic response to Schumpeter’s challenge, it is no wonder that Schumpeter’s Wesen attracted a considerable following. In his obituary for Schumpeter, Oskar Morgenstern wrote about the book’s impact as follows: “The work was read avidly in Vienna even long after the First World War, and its youthful freshness and vigor appealed to the young students. I myself remember what sort of revelation it was to me when I first laid hands on it and, like many others of my generation, I resolved to read everything that Schumpeter had written and would ever write” (Morgenstern quoted in Shionoya 1995, 92). It was clear that a more refined response to the various inroads that had been made by the positivists was necessary. In the 1920s, Ludwig von Mises would develop one. But another duty beckoned first. Those who favored the Walrasian approach to marginalism were not the only ones rushing to embrace positivism. Socialists were, too, and among them was another member of Böhm-Bawerk’s seminar, Otto Neurath.

Otto Neurath: From War Economy to Economy in Kind While Ludwig von Mises was willing to praise Böhm-Bawerk and most of his rivals in the seminar, one member of the group he detested: “Böhm-Bawerk was a brilliant seminar leader. He did not think of himself as a teacher, but as 9. Kauder (1965, 122) states: “Even the members of the Austrian school found that Wieser had gone too far. In a song written for the Mises ‘kreis’ the young philosopher Felix Kaufmann held Wieser’s dogma up to ridicule: ‘so handle ich und das ist jedermann.’ (So I act and that means everybody.)” Kaufmann would also later criticize Mises’s formulation.

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a chairman who occasionally also participated in the discussion. Unfortunately, the extraordinary freedom to speak which he granted to every member was occasionally abused by thoughtless talkers. Especially disturbing was the nonsense which Otto Neurath presented with fanatical fervor” (Mises 1978, 40). Who was Otto Neurath, and what sort of nonsense was he spouting with such fervor? Neurath was born in Vienna in 1882. In 1902, he graduated from secondary school and began his studies at the university there, but he soon left Vienna for Berlin to study under Eduard Meyer and Gustav Schmoller. Finishing his doctorate in 1906, he returned to Vienna and an academic post at a business school. His wife of five years died in 1911 after giving birth to a son. The next year Neurath married Olga Hahn, the blind sister of Hans Hahn, later one of the founders of the Vienna Circle. A few years prior to the First World War, Neurath began investigating what he called war economy, that is, how to run an economy under conditions of modern warfare. He argued that the continued use of a peacetime market economy would hinder the pursuit of military objectives and that only with centralized control could a successful effort be mounted. Neurath was drafted when war was imminent but by 1916 had been made the head of the General War and Economics Section of the Scientific Committee for War Economics in the War Ministry. He also directed a Museum of War Ministry in Leipzig, which was intended to be a “centrepoint for the dissemination of knowledge and research in war economy” (Cartwright et al. 1996, 20). Neurath’s efforts continued after the armistice. By then, his theses were, first, that the wartime experience had demonstrated that the efficient central planning of a complex economy was feasible and, second, that a concern for justice dictated that such planning should be continued now that the fighting had stopped. Neurath advocated the full socialization of the economy. A “central office for measurement in kind” would run the economy as if it were one giant enterprise. Planning and administration authorities would make extensive use of statistics to guide them in their decisionmaking. Neurath, then, was one of the first to articulate the view that a war economy provided a transitional state toward more extensive central planning. Perhaps most controversially, Neurath also believed that money would be unnecessary in the new planned order. Calculation regarding the appropriate inputs and outputs of goods would be handled in physical terms. For the determination of societal needs, various statistics measuring demographic

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and social variables would be employed. In Neurath’s opinion, the real needs of society could not be measured in money terms. The monetary system was uncontrolled and disorderly. Any attempt to employ monetary calculations within a planned society would render impossible scientific economic management, which had to be conducted in terms of “real” physical quantities.10 Neurath’s life after the war is worth a brief mention. In 1919, he served as the president of the Central Planning Office of the short-lived Bavarian Soviet Republic. Returning to Austria, in 1924 he became the director of the Social and Economic Museum, one of the showplaces of 1920s “Red Vienna.” Visitors to the museum encountered Neurath’s ISOTYPE system (the International System of Typographical Picture Education), images meant to represent economic and social conditions. He also participated in the Vienna Circle, advocating physicalism, the doctrine that all scientific theories make reference to phenomena that are observable and, when feasible, quantifiable. Neurath fled Vienna in 1934, ultimately settling in Oxford, where he died in December 1945. In the months just before his death, he invited Hayek to debate economics (Cartwright et al. 1996, pt. 1). Throughout his life Neurath, worked on many apparently disparate projects, but connections among them existed.11 His insistence that nonmonetary statistics be used to manage a planned economy led naturally to the development of ISOTYPE. The ISOTYPE system, in which signs represent social reality, was itself a practical analogue to the logical positivist claim that scientific theories are nothing more than formal systems of signs, rules for their manipulation, and “correspondence rules” that link the signs to elements of phenomenal reality. Neurath’s physicalism was wholly compatible with the view that statistical information on the physical quantities of goods and on “life dispositions” is all that is needed to manage a complex economy scientifically. It was also a good antidote to the “metaphysical” view that a monetary order expresses through prices such subjective entities as utility and value. 10. Neurath (1973) contains translations of the table of contents and certain articles from Neurath’s 1919 Durch die Kriegswirtschaft zur Naturalwirtschaft. The title of this book is translated there as “Through War Economy to Economy in Kind.” Naturalwirtschaft can also be translated as “barter economy” or “natural economy,” terms that are also sometimes used in reference to Neurath’s ideas. 11. Leonard (1999) examines the interpenetration of the social sciences and the arts in Neurath’s work.

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Ludwig von Mises and the German-Language Socialist Calculation Debate According to Hayek (1992f, 139), it was Neurath’s 1919 Durch die Kriegswirtschaft zur Naturalwirtschaft (Through war economy to economy in kind) that “provoked” Ludwig von Mises to initiate the socialist calculation debate. Mises first wrote about socialism in a book also published in 1919 (see Mises 1983), and, although Neurath was not mentioned by name in it, there is no mistaking his ideas or Mises’s reaction to them: “Right at the beginning of the war a catchword turned up whose unfortunate consequences cannot be completely overlooked even today: the verbal fetish ‘war economy’” (Mises 1983, 140). Mises argued that “war socialism,” widely credited for helping the war effort, in fact hindered it, that, while “statism sought to avoid the inevitable collapse, it only hastened it” (147). Mises’s main contribution to the calculation debate came in a journal article published the next year (see Mises [1935] 1975). He took as a starting premise the fact that, under socialism, all “production-goods” (factors of production) are owned by the state and that there is, therefore, no market for them. This premise has substantial consequences: “Because no productiongood will ever become the object of exchange, it will be impossible to determine its monetary value. Money could never fill in a socialist state the role it fills in a competitive society in determining the value of production-goods. Calculation in terms of money will here be impossible” (Mises [1935] 1975, 92). Mises’s reasoning was straightforward. In a market economy, entrepreneurs choose from among innumerable possible combinations of factors of production in an attempt to find the combination that minimizes their expected costs. This self-interested search for the best input combination helps guide resources to their most highly valued uses, an outcome beneficial to the society as a whole. Because of the multiplicity of “production-goods” and the fact that production takes place over time (during which all manner of changes on both the demand and the supply sides of the market might occur), the task is not an easy one. Entrepreneurs are aided in their deliberations by money prices attached to the factors of production, prices that reflect their relative scarcity. Socialist managers would not have recourse to price signals to tell them which factors are relatively scarce and which relatively plentiful; they would be left “groping in the dark.” The results would be plain

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to see: “Where there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation” (11). The contrast between two views could hardly be greater. Neurath argued that the use of money undermined the rational management of a planned economy. Mises, the monetary theorist, argued that, in the absence of marketgenerated money prices to direct the allocation of resources, the rational planning of production (by which he meant, planning that attempts to avoid wasting resources) in a complex economy is impossible. Mises also made clear that the two apparently unrelated subjects under discussion (monetary theory and socialism) are, in fact, intimately linked. Mises recognized the limitations of money as a tool for measuring value, noting that many aspects of life are not subject to monetary calculation, and he also recognized that money’s value could change. Only when the value of money is reasonably stable will prices accurately reflect relative scarcities and, thereby, help guide production. For Mises, sound money and freely adjusting market prices work together to make a private enterprise system work. Neurath wanted to do away with all of it and justified his views by invoking principles of scientific management. It is not surprising that, in the debate with Neurath, Mises very quickly won the day; indeed, as Chaloupek (1990, 662 –70) documents, many socialists of the time agreed with Mises that Neurath’s scheme of a moneyless planned economy was fundamentally flawed. This was, doubtless, due in part to the clear and horrifying evidence provided by Soviet policies during the period of “war communism” from May 1918 through the end of 1920.12 When Mises wrote in 1920 (see Mises [1935] 1975) about the importance of money prices for rational calculation, then, his initial target was Otto Neurath. But Neurath was not the only person calling for planning based on the wartime model; had that been the case, Mises would not have felt it necessary to write a whole book devoted to the refutation of socialism (see Mises [1936] 1981b). Socialization schemes were being proposed everywhere. One of the most widely respected voices was that of the German industri12. Policies enacted during the period of “state capitalism” (which directly preceded the war communism episode) were explicitly drawn from German “war economy” models. Boettke (1990b, 106) notes: “[For Lenin] the Soviet dictatorship of the proletariat provides the political basis for social transformation, while the German war-planning machine provides the economic basis.” Under war communism, the first steps toward the abolition of money were instituted. For more on this period, see Zaleski (1971, 13 –24).

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alist Walther Rathenau. Rathenau was a leading official within the AEG (Allgemeine Elektrizitäts Gesellschaft), the electrical cartel, one of Germany’s largest cartels. At the start of the war, German materials supplies were dangerously low. Rathenau and Wichard von Moellendorff, another AEG official, managed to convince government officials that, if the war effort were to succeed, the procurement and disbursement of raw materials would need to be centralized. In August 1914, a new section at the Ministry of War, designated the KRA (Kriegsrohstoffabteilung, or “Raw Materials Section”), was established, with Rathenau at its head. Although he served in the position for only eight months, he put raw materials procurement on a solid footing for much of the duration of the war. The KRA became for many Social Democrats the model of what could be accomplished through efficient central planning. Rathenau was the sort of businessman that made the German historical school professors look so ineffectual during the war. A successful industrialist and a man of action, Rathenau was also an urbane intellect. He wrote an influential pamphlet published in 1918 entitled The New Economy in which the variety of goods available under capitalism was portrayed as indicative of the system’s great wastefulness. He argued that far greater amounts of standardized goods could be produced (thereby ensuring plenty for all) if the centrally controlled mass-production techniques developed during the war were utilized. Given his role in the war, Walther Rathenau was a hero to the German-speaking people in a period when precious few heroes were to be found.13 This progressive Jewish internationalist was assassinated by right-wing thugs soon after becoming foreign minister. Instead of playing a leading role in the Weimar Republic, he ended up a harbinger of the world that was to come. There were many other contributors to the socialization debate. Indeed, socialists argued as much among themselves as they did with the likes of Mises. In general terms, Austrian socialists were theoretical purists who saw a fully centrally controlled economy as their ultimate goal. At the same time, the party leadership under Bauer adopted a gradualist approach to policy. In Germany, non-Marxist socialists like Eduard Heimann and Carl Landauer favored variants of market socialism, a mixed system in which market prices 13. Hayek (1994, 47) mentions the pamphlets of Rathenau and of Karl Renner as providing his first exposure to economic and social analysis. Shearmur (1996, 26 –28) places Rathenau’s writings in the context of his times.

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play some role in the allocation of resources.14 The Austrian Karl Polanyi was an exception to these general national trends, proposing a guild socialist system that he had adapted from the writings of the English academic G. D. H. Cole. Throughout the 1920s, a variety of socialization schemes were, thus, introduced in the German-language literature. When the Great Depression began, the discussion was further broadened to include policies that socialist regimes might use to combat high unemployment. In the 1930s, the debate would spread to England, where Hayek would emerge as one of the main protagonists. Ludwig von Mises on the Reconstruction of Social Science Mises’s critique of socialism left untouched the philosophical arguments of Neurath and other positivists concerning the metaphysical (hence suspect, if one were a positivist) nature of economic reasoning. Mises decided that subjective value theory needed a firmer foundation than had been provided by earlier Austrians like Menger or Wieser. The positivists were not his only opponents, however. Although, with the benefit of hindsight, we today know that the German historical school was on its last legs in the 1920s, it was perhaps not so evident at the time. Furthermore, in America, the institutionalists were gaining ground, and the similarities of their arguments to those of the historical school economists were evident. Like Menger before him, Mises had multiple opponents when he decided to turn to epistemological studies. Mises was looking for new sources of inspiration, and he found one when Max Weber spent a semester at the end of the war teaching in Vienna, during which time he and Mises “became good friends” (Mises 1978, 69 –70). Weber had, of course, gained no little fame as a critic of both historicism (or at least certain variants of it) and positivism. Mises ultimately would place the Austrian theory of value within a neo-Kantian philosophical framework 14. Carl Landauer’s Planwirtschaft und Verkehrswirtschaft (Planned economy and market economy) was reviewed by Hayek in 1933, and a translation of the review, one of Hayek’s first contributions to the socialist calculation debate, appears as an appendix to Hayek ([1935] 1997c). Chaloupek (1990) provides further discussion of the German-language socialization debate.

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that owed much to the work of Weber and his predecessors in the southwest German (Baden) school but that also differed in significant ways from what had gone before. The end result—what Mises would later call praxeology, or the science of human action—is one of the most original and controversial contributions of the Austrians to the study of economics. Mises developed his ideas in meetings of his own Privatseminar, the Miseskreis, which met every two weeks in term. The circle met in the office at the Chamber of Commerce where he worked. After the formal meeting concluded, some of the group would adjourn to the Ancora Verde restaurant for dinner, and, after that, the hardy might go on to the Künstler-Café for further discussion. The seminar themes varied, although those who attended reported that social-science methodology (including assessments of Weber’s verstehende sociology, the relation of history to economics, and the ideas of the phenomenologist Edmund Husserl and of the positivists) was a favorite topic. The circle met from 1920 through 1934. After 1924, and until he left for England in 1931, Friedrich Hayek was a regular participant.15 Mises began publishing papers on the philosophical foundations of economics in 1928, and a collection of them appeared in his 1933 Epistemological Problems of Economics (see Mises [1960] 1981a). In his preface, Mises praises Weber, Wilhelm Windelband, and Heinrich Rickert for clarifying the methods of the historical sciences. Such writers understood that all actual historical events are complex phenomena, phenomena that always involve the interaction of many differing variables; that social reality consists of an “infinite multiplicity” of events. Because of this, no amount of data collection could ever hope to yield inductively a set of historical laws. Schmoller’s promise that, someday (once enough data were collected), the laws of society would emerge and that it would then, in Mises’s words, be “possible to derive ‘theoretical’ knowledge from historical experience” was one that could never be kept (Mises [1960] 1981a, x, xiv). Mises also praises Weber for his critique of the historicist idea that observation could be “presuppositionless.” Mises repeatedly insists that, “at every step of the way,” history makes use of theory, that “each and every proposition of history implicitly contains theorems of sociology” (Mises [1960] 1981a, 122, 101; cf. xiv). The only question was whether history would be based 15. The Mises seminar is described in Hayek (1983b, 38 – 45); Mises (1978, 97–100), which includes a list of participants; M. Mises (1984, app. 1); and Boehm (1984).

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on the “universally valid propositions of sociology” or a “naive theory of prescientific thought” (101). Mises differed from Weber, however, in how he characterized the social sciences. For Weber, both history and economics employ the same methods. Both fields utilize ideal types that pick out or intensify certain aspects of reality. The specific ideal type used defines the subject matter and determines the focus of the investigation. A historical investigation of towns might utilize the ideal type of the town in general, just as an economics investigation might utilize the ideal type of a perfectly competitive economy with fully rational agents. It is because history employs ideal types that the notion of a presuppositionless history is an illusion: the specific ideal types used determine what parts of the infinitely complex reality are selected for examination. Mises agreed with Weber that the use of an ideal type was appropriate for a certain type of history, what he called universal history (Mises [1960] 1981a, 106). But he disagreed that economics employed ideal types. Unlike Weber, Mises felt that a nomethetic social science, one based on universal laws, was possible. As such, Mises proposed a different division of the social sciences. For Mises, human action could be investigated both historically and theoretically. Theoretical investigation does not use an ideal type; that is, it does not pick out certain aspects of action. Rather, it is based on the comprehension of elements that are always present in all human actions. The most basic common element is the concept of action: “All action is economizing with the means available for the realization of attainable ends” (Mises [1960] 1981a, 80). As humans we all act because we all exist in a world of scarcity, or “privation”: “Only in a Cockaigne populated by men who were immortal and indifferent to the passage of time, in which every man is always and everywhere perfectly satisfied and fully sated, or in a world in which an improvement in satisfaction and further satiation cannot be attained, would the state of affairs . . . [called] ‘privation’ not exist” (79). Mises argues that all human action is purposeful, in the sense of aiming at goals. This is necessary because we live in a world of scarcity: ends compete; our means to satisfy them are limited; even the wealthy face time constraints; and, in the end, we all die. We act in order to improve our affairs or to remove, as he would later put it, “felt uneasiness” (Mises 1966, 14). The action concept, or action axiom, is the starting point for praxeology, Mises’s new term for the science of human action (although, in Epistemological Problems of Economics, he still called it sociology). From the action axiom, much follows: “As think-

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ing and acting men, we grasp the concept of action. In grasping this concept we simultaneously grasp the closely correlated concepts of value, wealth, exchange, price and cost. They are all necessarily implied in the concept of action, and together with them the concepts of valuing, scale of value and importance, scarcity and abundance, advantage and disadvantage, success, profit, and loss. The logical unfolding of all these concepts and categories in systematic derivation from the fundamental category of action and the demonstration of the necessary relations among them constitutes the first task of our science” (Mises [1960] 1981a, 24). Weber’s failure to realize that a generalizing or nomethetic science of human action was possible led him into some errors. For example, Weber posited four different types of human action—rational, valuational, emotional, and traditional. For Mises, there was just one type of human action because all action, no matter what motivates it, aims at ends. The opposite of purposeful action is not an act of passion, or habit, or charity, or despair, for all these reflect intentional action. The opposite of purposeful action is some sort of unintentional action, a reflex, say, as in the case of blinking when an object approaches the eyes. All that Weber had done with his categorization scheme was to point out that different sorts of ends exist.16 Mises’s insistence that all human action is intentional, or purposeful, and that that forms the starting point for much that counts as economic analysis seems incontestable. Economics, after all, traces choices (actions) back to human desires (or tastes and preferences) and human beliefs (or knowledge), all in a world of scarcity (we optimize subject to constraints). The framework goes beyond economics, however. It is very similar to what Karl Popper termed situational analysis and is, therefore, a form of reasoning that one can find in a variety of fields, from history to psychology to the folk-psychological explanations that we use to understand everyday human action.17 Unfortunately, Mises often chose to get his point across by saying, “All hu16. Mises ([1960] 1981a, 81–91) also pointed out that Weber’s distinction of four different types of human action led him into some inconsistencies. Weber had, after all, been a prominent spokesperson for value-free social science. But, by distinguishing certain types of human action as rational, he was implicitly making a value judgment about types of action. For Mises, all human action is rational, so no value judgments are made. 17. Caldwell (1991a) describes Popper’s situational analysis, compares it with various types of microeconomic theorizing, and examines varying interpretations of the rationality principle, which has analogues with Mises’s action axiom.

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man action is rational.” One can see why he did this: he was arguing contra Weber that, not just one form of action, but all action was rational—if, by rational, one means “intentional” or “aiming at goals.” Still, Mises must have known that his formulation was opaque. Had he simply said, “All human action is purposeful,” the chances of his being misunderstood (which he was) would have been much reduced.18 If one accepts the idea that we explain human action by tracing it back to the intentions or goals and knowledge of the actors, then one can see how this formulation is incompatible with positivist or behaviorist approaches. These empiricist doctrines insist that science studies relations among observables. Desires are not observable, and neither is knowledge. If one believes that one must make reference to motives to understand human action, the more stringent empiricist philosophies set up methodological prescriptions that make it impossible to do so. Mises, then, borrowed from Weber, whose critique of the German historical school position became part and parcel of the Austrian catechism. But he also went beyond Weber, arguing that economics is a nomothetic science. Mises ([1960] 1981a, 21–22) acknowledged that his own approach also shared certain similarities with those of Wieser, Menger, and the British classical economists Nassau Senior and John Cairnes. All viewed introspection as a valuable source of knowledge and emphasized the universality of the experience on which their schema drew. In Mises’s opinion, however, his predecessors had been contaminated by John Stuart Mill’s claim that all sciences that follow the a priori method (this would include economics as well as logic and mathematics) are still empirical sciences, for even axioms are based on inductions from experience (17–19).19 This brings us to another aspect of Mises’s contribution, one that would be far more controversial than his wordplay about rational action. For Mises, 18. Such potential for misunderstanding does not occur only in Epistemological Problems. Contrast the opening sentence of the first section of Human Action (Mises 1966, 11), “Human action is purposeful behavior,” with the opening sentence of the fourth section, “Human action is necessarily always rational” (19). Although Mises was always careful to explain in detail what he meant, his idiosyncratic use of terms made it much easier for him to be misread, especially by those who disagreed with him or who sought to discredit his ideas. 19. Hands (2001, chap. 2) traces the “Millian tradition” in economic methodology from Mill through Senior and Cairnes to J. N. Keynes and Lionel Robbins.

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the action axiom was known to be true a priori, and (contra Mill) this meant that it was not empirical. He states this repeatedly in the opening essay of Epistemological Problems: The science of human action that strives for universally valid knowledge is the theoretical system whose hitherto best elaborated branch is economics. In all of its branches this science is a priori, not empirical. Like logic and mathematics, it is not derived from experience; it is prior to experience. ([1960] 1981a, 12 –13) In the last analysis, logic and the universally valid science of human action are one and the same. . . . Its goal [i.e., that of the science of human action] is the comprehension of the universal, and its procedure is formal and axiomatic. . . . [W]hat we know about our action is derived not from experience, but from reason. (13) We conceive all this from within, just as we conceive logical and mathematical truths, a priori, without reference to any experience. (13 –14) As an a priori category the principle of action is on a par with the principle of causality. (14) The theorems of economics are derived not from the observation of facts, but through deduction from the fundamental category of action, which has been expressed sometimes as the economic principle (i.e., the necessity to economize), sometimes as the value principle or as the cost principle. They are of aprioristic derivation and therefore lay claim to the apodictic certainty that belongs to basic principles so derived. (17) Mises would go on to develop and defend his apriorist approach to praxeology in part 1 of Human Action: A Treatise on Economics (see Mises 1966). There is no space here for further articulation of the subtleties and complexities of this doctrine, or for a review of the many debates over its meaning, or for any attempt at assessment.20 All we need do here is note that, as Mises 20. As Oakley (1997, 176) puts it in his superb chapter surveying the literature and assessing Mises’s position: “A study of the secondary literature that deals with these facets of [Mises’s] work reveals a bewildering array of suggestions relating to his philosophical alignment.” Oakley argues that both Aristotelian (or “reflectionist” or realist) and neoKantian (or “impositionist”) elements are present in Mises’s writings and that, ultimately, such elements cannot coherently coexist in a single position. In later work, Oakley’s solu-

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himself doubtless well knew, his formulation was a direct challenge to the theory of meaning then being developed within the Vienna Circle. Within logical positivist philosophy of science, all scientific propositions are either analytic or synthetic. The latter are contingent, their truth or falsity dependent upon facts, and they therefore constitute the empirical statements of science. The former include statements that are either true (i.e., tautologies) or false (i.e., contradictions) by virtue of how terms are defined, independent of the facts of the world. Analytic statements are useful in science (all sciences employ definitions), but they tell us nothing about the world; they are empirically empty. Furthermore, statements that are neither analytic nor synthetic cannot be considered part of science; they are (to use the ultimate positivist put-down) mere metaphysics. There was no room in the positivist demarcation of science from metaphysics for an action axiom that was both analytic and capable of yielding, through deduction using a “verbal chain of logic,” true synthetic statements about the world.21 Mises formulated his system in a time before positivist rhetoric had swept into the social sciences like a California brushfire. He might even have imagined that his views would serve as a prophylactic against them. But to say that they were ineffectual would be the grossest of understatements. Mises’s attempt to provide praxeology with foundations that are known a priori to be true made him a figure of ridicule in the new positivist age and beyond. He became the archetypal “unscientific” economist, and, given that his political

tion to Mises’s “chronic ambivalence” is to “give priority to Mises’ realist inclinations” (Oakley 1999, 57), which makes sense given that Oakley’s own program is to provide a realist reconstruction of a subjectivist approach to economics. Barry Smith has also tried to reconstruct an apriorist approach along Aristotelian or reflectionist lines (see B. Smith 1986, 1990a, 1990b, 1992). He claims that his reconstruction is fully compatible with fallibilism (see Smith 1992, 267– 69), which, if true, would remove one of the principal objections that many (including myself ) have harbored against past formulations of apriorist doctrines. 21. Mises would have known of developments in the logical positivist theory of meaning because, beginning around 1928, Felix Kaufmann attended both the Miseskreis and the Vienna Circle (Prendergast 1986, 6). Mises had this to say in his memoirs, written in 1940, about the publication of his Epistemological Problems: “I was fully aware that at first my theory would meet with rejection. I knew the Positivist bias of my contemporaries rather well” (Mises 1978, 123). If Mises was attempting directly to counter the positivists’ analyticsynthetic distinction, this might explain why, as noted by Oakley (1999, 45), he tended to conflate a priori with analytic in his writings.

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views were, in the Age of Keynes, even more unpopular, the adjective reactionary was also often appended. Here is how one prominent mainstream economist put it in 1964, perhaps the high-water mark for positivist dominance: “In connection with slavery, Thomas Jefferson has said that, when he considered that there is a just God in heaven, he trembled for his country. Well, in connection with the exaggerated claims that used to be made in economics for the power of deduction and a priori reasoning—by classical writers, by the 1932 Lionel Robbins . . . , by disciples of Frank Knight, by Ludwig von Mises—I tremble for the reputation of my subject. Fortunately, we have left that behind us” (Paul Samuelson quoted in Blaug [1980] 1992, 81– 82). When offering us this quotation, a decade and a half after the original statement was made, in his famous survey of methodological thought, Mark Blaug could not resist adding: “Yes, I do believe that we have.” The positivist age of science took few prisoners.

The Austrian School of Economics This concludes my historical account of the development of the Austrian school of economics. We see it now as a school formed in opposition, but it originally began, not as a school at all, but as the effort of a single man, a scholar in Vienna who wanted to write a book on the theoretical foundations of economics. This book would oppose the cost-of-production theories of value that had been the mainstay of British classical economics and build on the “proto-neoclassical” tradition that existed among German-speaking economists. Given such goals, one can only imagine the disappointment that accompanied Carl Menger’s reading of one of the reviews of his Principles of Economics, the one that was signed simply “G. Sch.” (see chapter 1). Rather than lauding his new book as a signal theoretical contribution, the reviewer found Menger guilty of “reviving the old, slanted English fiction,” of harboring a view “reminiscent of Ricardo rather than the tendencies reigning today in German scientific circles” (see app. A below). This was just the opposite, of course, of what Menger saw himself as doing. Schmoller was certainly right, however: Menger’s theoretical approach did not fit well with the reigning tendencies in German scientific circles. But, come to think of it, a lot of things Austrian did not fit well in Germany at the time. The empires shared a common language, but they had different positions on the geopolitical map of Europe, with correspondingly different histories;

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they had different philosophical traditions, different educational systems, and, most basically, different stories that they told about themselves and each other. When in the 1880s the economists among them confronted these differences, when, more precisely, Menger sought to establish with his Investigations into the Methods of the Social Sciences that a theoretical approach to the social sciences was possible, the stronger empire again, as in 1866, prevailed. The ensuing episode, known ever after as the Methodenstreit, generated some benefits—but mostly costs. The major benefit was the formation of an identifiable school of economics, the Austrian school, in central Europe. But one wonders whether even this would have been possible had there not been nascent marginalist movements also springing up in England and Lausanne (which soon spread to other European nations and to America) whose presence gave the Austrians succor. In any event, as at the turn of the century the Austrian school under Böhm-Bawerk and Wieser became conscious of itself as a school, it also came to look more and more like the other marginalist schools that were forming. Gone was Menger’s insight about how individual human action can lead to the formation of social institutions, about how intentional actions can have unintended social consequences. This fundamental insight would have to be rediscovered by later generations of Austrians. The Methodenstreit also obscured the many similarities in outlook shared by the Austrians and their historical school opponents. These areas of congruence are perhaps more evident today as virtually all heterodox groups (as the heirs to both traditions are now considered) define themselves by way of contrast with the dominant, neoclassical tradition in economics. As such, it is not really surprising that economists now working within the new institutionalist economics movement might identify writers from both these traditions as precursors. For the variety of reasons documented in chapter 4, the German historical school ultimately faded into history, losing out, not so much to the Austrians, as to marginalism in general and, later, to the specific form of marginalism known as neoclassical economics. As the century turned, and even as Schmoller and the Althoff system were coming under fire from without and within, the Austrian economists were confronting new opponents. What had euphemistically come to be called the social problem, the manifold miseries that ultimately resulted in the rise of a politically powerful laboring class, had itself generated alternative theories of how the economy worked (or failed to work). Again, there were many contenders, but one of them, Marxism, would slowly emerge as a dominant force, not least because of the role of certain

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prominent Marxists in writing the party platforms for working-class political movements in the German-speaking countries. Because Marx drew on the British classical tradition in formulating his economics (the ever-denounced Ricardo being the dominant influence on his theory of value), he was a perfect target for Austrian marginalists. The ensuing debates across and within schools would lead to schisms among socialists in different nations, resulting in such variant doctrines as Fabianism in England, market socialism in Germany, and Marxist-Leninism in Russia. Within Austria, yet another variant emerged. Austro-Marxists followed Marx closely, but they added a heavy dose of positivist philosophy. For the believers, positivism and Marxism supplied the twin pillars of a truly scientific study of society. Writing in 1931, Otto Neurath captured the mood perfectly in his (itself aptly titled) “Empirical Sociology: The Scientific Content of History and Political Economy”: “Of all the attempts at creating a strictly scientific unmetaphysical physicalist sociology, Marxism is the most complete” (Neurath 1973, 349). For those seeking scientific sociology, “The living contemporary form of such sociology is Marxism” (363). Austria—and, indeed, Vienna itself—would in the 1920s and 1930s become the birthplace of logical positivism, refined in the writings of members of the Vienna Circle, with Neurath as their social-science expert. The age of positivist social science had arrived, and, for many, Marxism was its face. Subjective value theory was no longer considered simply vulgar capitalist apologetics. It was also, to reverse Neurath’s phrasing, “unscientific metaphysical subjectivist” sociology. It is hard to tell which among the adjectives was viewed as the worst pejorative. It was against this backdrop of competing ideologies, of occasionally internecine cross-group conflicts, of political and imperial and academic rivalries, that various methodological propositions that would become fundamental for the Austrian economists slowly took form. First among them, perhaps, was the primacy of theory. The Austrians insisted that a theoretical approach to social science was possible, even fruitful, for it could be used to explain the development of the very social institutions that the historical school economists themselves sought to explain. This led the Austrians to assert that all historical narrative, that the collection and interpretation of statistical data, that, indeed, observation itself, is always and must be from a point of view, that a theory underlies each of these activities. These ideas would live on in the twentieth century in Karl Popper’s and Thomas Kuhn’s claims (for them, against the prevailing logical empiricist philosophy of science) that all obser-

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vation is theory laden. Albeit in a different context, the Austrians had embraced such antipositivist ideas long before. If the Austrians were convinced that theory underlies observation, it was a bit harder to identify just which theory underlay the observations of social scientists or, once that theory was identified, to determine how best to describe its epistemological and ontological status. Menger took a first stab when he claimed, in good Aristotelian fashion, that the “exact types” and “exact laws” used by economists capture the essences of social elements and their relations. His realist approach would not survive the dual assault of postKantian philosophy and positivism, although it would make him attractive again to certain late-twentieth-century philosophers of social science. Max Weber came up with a formulation more in keeping with his own times. The theoretical construct rational economic man was, for Weber, an ideal type, a fiction that picked out a certain aspect of reality that was of interest to the investigator. The fiction could be judged only by how well it allowed the investigator to understand some aspect of the infinitely complex reality that he confronted. Weber asserted that changes in society made the ideal type of rational economic man increasingly relevant and further hoped that his new construct would resolve some of the methodological debates that had raged in German-speaking lands over most of his academic life. The ideal type lived on, but only in the new field of sociology, not in economics, as he had wished. Ludwig von Mises borrowed from Weber, but he had no use for the ideal type. For Mises, economics was a nomethetic, or generalizing, science. The starting point for Mises’s praxeological science of human action was the action axiom, the idea that scarcity forces all humans to act, purposefully, to improve their affairs, to remove felt uneasiness. Like Wieser, Mises thought that introspection provided all humans with access to this basic insight. He thought further that all descriptions of human action, including historical narratives, made use of the basic category of action. Mises went on to assert that the logical status of the axiom was that of an a priori true statement. This bold assertion carried with it the implication that the axiom is apodictically certain and that its certainty is transmitted to any theorems correctly derived from it. Mises’s commitment to apriorism would cause many in the positivist age to reject his position completely. Finally, there was the iconoclastic (at least for an Austrian) intervention of Joseph Schumpeter. Schumpeter, too, wanted to resolve the debates of the

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Methodenstreit. His proposal was simplicity itself: Stop worrying so much about the foundations of economics; what matters, after all, is whether our theories are useful. Weber, too, had talked about the usefulness of a theory to the practitioner, so there is at least some similarity between their positions. But, unlike Weber, Schumpeter also took on board the positivism of his day. Economics was about measurable physical quantities. Psychologism and subjectivism were metaphysical remnants of a less scientific age, unnecessary baggage that could easily be jettisoned. Schumpeter’s doctrines shocked the Austrians when they first heard them, not the least because Schumpeter also had the audacity to associate science in economics with the school of Lausanne. As it turns out, in both his enthusiasms—for the formalism of Walras and for the doctrines of the positivists—Schumpeter the enfant terrible ended up being the most prescient of his contemporaries. This formed what would become Friedrich von Hayek’s milieu, the backdrop against which he would act, the pool into which he would plunge, the diverse serving plates at the banquet table from which he would compose his meal. Now, at long last, we are ready to hear his story.

III Hayek’s Challenge

CHAPTER 14

Journey’s End—Hayek’s Multiple Legacies In part 2, I offered an interpretation of Hayek’s intellectual odyssey. In telling the story, I seldom paused to assess his substantive claims. Rather, I focused on making sense of the journey, on telling a plausible tale, and on comparing my own interpretation to others that exist in the secondary literature. But, now that the details of the story have been laid out, it is time to settle accounts. In this chapter, I offer a chronological summary and assessment of Hayek’s methodological legacy. In some instances, this involves my commenting, even if indirectly, on his contributions to such fields as economics, psychology, and political philosophy. In others, I note how various authors have tried to extend or build on Hayek’s work. I undertake this exercise with considerable trepidation. I am a historian of economic thought, and my own self-image is that I am a careful one. One need not be a genius to recognize that writing outside one’s field is not a good way to be careful. But, if this study of Hayek is to have any value beyond the titillation of antiquarian sensibilities, it must go beyond an examination of the development of his ideas and inquire into their value, past, present, and future. As promised in the introduction, my assessments will inevitably be idiosyncratic, reflecting both my own limited reading and understanding of the various literatures to which Hayek contributed and of the massive secondary literature that has arisen in response and my own perspectives on where his contributions fit. My only solace is that whoever ventures into these waters faces the same dangers. I began this book with the comment that Hayek was both a puzzle (at least for me) and a puzzler, someone who kept running into obstacles as he tried to understand how the complex “organism” of society worked and how best to study it. In this chapter, I will recount how, not all at once, but slowly, gradually, and by a circuitous route, Hayek found solutions to his puzzles.

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Monetary Theory and the Trade Cycle Hayek’s first systematic statement of methodological views occured in the opening chapter of Monetary Theory and the Trade Cycle ([1933] 1966), where he discussed the role of theory and empirical work in explanations of the trade cycle. I reconstructed Hayek’s methodological position as consisting of the following four theses: 1. To offer a scientific explanation of the trade cycle, one must employ a theory. 2. The theory must be consistent with the existing theoretical foundation of economics, or “equilibrium theory.” 3. Equilibrium theory carries the implication that all markets clear. A trade cycle is a situation in which some markets do not clear, so an additional factor must be introduced that would cause this to happen. Money qualifies as such a factor since it is demanded, not for its own sake, but to satisfy other demands. This implies that the theory of the cycle must be a monetary theory. 4. Much existing monetary theory draws on the quantity theory of money. But the quantity theory only relates changes in the money supply to changes in the aggregate price level, and is, therefore, incapable of explaining the changes in the structure of production that constitute the cycle. Changes in the structure of production are caused by changes in relative prices. As such, a monetary trade cycle theory must be capable of showing the origins and effects of cycleproducing relative price changes. As it turns out, the Austrian theory of the cycle meets all four conditions. What can be said about Hayek’s argument? How might an audience today respond to his claims? The first thing that a modern reader would notice, I think, is that Hayek does not attempt to justify, or argue for, his claims. He just states them. Why did Hayek think it unnecessary to justify his arguments? I think that the only way to make sense of his claims is to recognize who his presumed audience was. In chapter 7, we saw that Hayek was writing for German cycle theorists and, in particular, the Kiel school, led by Adolf Löwe. In contrast with their historical school predecessors, members of this tradition insisted on taking a theoretical approach. In claiming that a theory was necessary to do science,

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Hayek was invoking the standard claims made by the protheory side in the Methodenstreit: there is no presuppositionless observation; all empirical work is theory laden; one cannot build a theory from the inductive collection of data. By invoking Löwe’s writings on these matters, Hayek was identifying himself as a fellow theorist. He was, in effect, saying: I am one of you. Hayek saw no reason to justify his first two arguments because he knew that his intended readers already accepted them. Löwe had argued that one’s cycle theory needed to be consistent with the prevailing static equilibrium theory. When he found that none of the existing theories could be built up from static theory foundations, he concluded that a dynamic, rather than a static, starting point was necessary. Hayek’s innovation was to argue that an appropriate theoretical description of the cycle had to be a monetary one because money was the only thing capable of doing away with, in his words, “the rigid interdependence and self-sufficiency of the ‘closed’ system of equilibrium” (Hayek [1933] 1966, 44). He thus took Löwe’s criticism and turned it in his favor. This was, in my estimation, a brilliant move. Contra Löwe’s assertion that a theory of the trade cycle consistent with static theory was impossible, Hayek argued that such a theory could be made to cohere with the accepted micro foundations of “static equilibrium theory.” But it required the introduction of money. With one stroke, Hayek was able to rescue both static equilibrium theory and a monetary approach to the explanation of the cycle. Furthermore, by showing the similarities between the views of the German and those of the Austrian economists regarding theory, he was also able to make common cause against the American institutionalists. How successful as a persuasive device was this, Hayek’s initial foray into methodology? The answer here is clear: not very. As Gehrke (1997, 236 –37) reports, in his contribution to the 1928 meetings of the Verein für Socialpolitik, Löwe remained unconvinced, arguing that “monetary factors are neither necessary nor sufficient in the explanation of business cycles.” And, indeed, there were many different responses to Löwe’s impossibility claims among German-language theorists, Hayek’s being just one (Gehrke 1997, 238 – 42). As for his (and Löwe’s) methodological strictures concerning the limitations of empirical work, many of these would soon be forgotten once the econometrics revolution swept the discipline in the postwar period. Finally, in my opinion, the specific cycle theory developed by Hayek must now be viewed as chiefly of antiquarian interest. Not all modern Austrians would agree with that last assessment. I think,

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however, that Hayek probably would. If one takes seriously his later work on the theory of complex phenomena, then one cannot make precise predictions about the path that a cycle must take, which is what his original cycle theory purported to do. In my opinion, Hayek began to recognize the difficulties with his approach as he responded to critics while laboring over The Pure Theory of Capital (1941b). As noted earlier, he gave hints about those limitations in his 1978 oral-history reminiscences (Hayek 1983b, 185 –91) and again (and more provocatively) a few years later in his fiftieth-anniversary address (Hayek 1981a) at the London School of Economics (LSE). His ultimate position seems to have been very close to that of T. W. Hutchison (1981, chap. 8), who expressed doubts about whether a general theory of the cycle was possible at all. This is not to say that there is no Austrian legacy in macroeconomics. On the contrary, the long-standing Austrian tradition in monetary economics has, of late, shown signs of considerable vigor. Steve Horwitz’s recent book on Austrian macroeconomics (Horwitz 2000) is a case in point. In a review of the book, Leland Yeager concisely summarized some of the most important Austrian themes: Explaining the widespread discoordinations that beset advanced monetary economies from time to time requires bringing Austrian themes into the story—the incompleteness and dispersion of knowledge; the price system as an information-mobilizing, -transmitting, and -economizing device; competition as a process rather than as an ideal state of affairs; the reality of disequilibrium; the scope for and nature of entrepreneurship; the significance of time; the great role of money in facilitating the division of labor, capital formation, and economic calculation; and the consequent great scope for damage from money’s malfunctioning. All this contrasts with neoclassical conceptions of pure and perfect competition (against which benchmark the real world stands condemned as “imperfect”), general equilibrium, the associated notion of Pareto optimality, and economic analysis as exercises in maximization subject to constraints. (Yeager, on [email protected], 23 January 2001) 1 1. Horwitz (2000, xi) states that it is his “personal mission” to show Yeager that “Austrian macroeconomics is more than its business cycle theory.” An implicit theme of Horwitz’s book is that Mises’s and Hayek’s focus on the trade cycle as the most prominent macro phenomenon obscured other important Austrian insights into the workings of a

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In his comments, Yeager goes on to say that much mainstream theorizing about business cycles is useful and complements the Austrian insights. In his reconstruction of the Austrian theory of the macroeconomy, Roger Garrison (2001) uses a common set of diagrams to reveal those places where the Austrian view differs from mainstream approaches. The explorations of White (1984), Selgin (1988, 1996), and Selgin and White (1994) into the history and theory of free banking and the papers collected in Latzer and Schmitz (2002) on electronic money and the evolution of payment systems must also be mentioned as innovative extensions of the Austrian tradition. As regards methodology, of Hayek’s four claims, only one has become relatively widely accepted among modern-day macro theorists—this is the notion that macroeconomic theory should have the appropriate “micro foundations” in general equilibrium theory. Those who emphasize micro foundations accordingly sometimes mention Hayek as a predecessor. But, as noted earlier, such accolades are unintentionally ironic: Hayek would revise his views about static equilibrium theory in subsequent years.

Robbins and Hayek The next step in Hayek’s journey was his move to the LSE. Much has been written about his engagement with John Maynard Keynes over their respective attempts to develop monetary models of the economy. My focus instead was on another aspect of the story, Hayek’s relationship with Lionel Robbins. I portrayed Hayek’s inaugural lecture ([1933] 1991c) and Robbins’s (1932) book on methodology as providing a one-two punch in defense of the economic theory of the day. Robbins outlined the methods of economic theory, responded to its critics, and offered his own set of criticisms of alternative approaches. Hayek had presumably heard Mitchell’s version of the history of the discipline in New York, one summarized in his contribution to the Tugwell volume (see Mitchell [1924] 1930). In a lecture whose title alluded to the Tugwell collection, Hayek offered an alternative historical account, one that explained why the “common man” was often so suspicious of the theories of economists. monetary economy, a view with which, as by now is probably evident, I wholeheartedly concur.

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Hayek argued that the economic system is an “organism” of considerable complexity and that it was, therefore, only gradually that the classical economists came to understand how it functioned. Their theories contained some errors, and members of the German historical school drew the conclusion that a theoretical approach to the understanding of social phenomena was fruitless. In the depressed economy of the early 1930s, the desire to improve economic conditions was strong, and this made the arguments of the historical school economists attractive to new groups whose own policies flew in the face of prevailing theory. A more thorough understanding of the historical record would, however, reveal that the apparently avant-garde pronouncements of people like the institutionalists came to little more than the rehashing of the ill-advised arguments of a now-discredited school of German economists. In retrospect, Hayek’s recourse to history must appear a little disingenuous: in an environment in which measured unemployment is 25 percent, public suspicions about the theories of economists would be rife even had the German historical school never existed. But Hayek hit on an important, and persistent, question. What is it about economics that so provokes the distrust of so many noneconomists, that leads otherwise intelligent people sometimes to think that economics is little more than ideology (or worse, astrology) dressed up in scientific garb? It is this kind of perception, after all, that gives rise to the many economist jokes that others crack about economists and that we have taken to telling on ourselves. Hayek’s answer is worth considering. It was in this lecture that he first hinted at the idea of society as a complex organism, and one of the conclusions that he drew is that, when we deal with a complex order, our ability to control it or to predict its movements is limited. This message was not a popular one in 1933, and it would be even less popular in the age of positivism that was about to begin. But failure to understand the limits of economics, by the public and perhaps even by economists themselves, may help explain why suspicions about the prognostications of economists do not appear to have subsided in the time since Hayek gave his lecture. We also examined Robbins’s debt to Ludwig von Mises and asked whether there was evidence of a lessened Misesian influence in the second edition of Robbins’s Essay on the Nature and Significance of Economic Science. I argued that Robbins accepted Mises’s “acting man” construct as the starting point for economic reasoning but not the apriorist foundations that accompanied

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it. The many debates over the logical status of the postulates of economics led Robbins to a studied agnosticism on the issue. I suspect that Hayek shared this agnosticism, but, as usual, compelling evidence is hard to find. Terence Hutchison’s 1938 The Significance and Basic Postulates of Economic Theory ([1938] 1965) may be viewed as a direct challenge to Robbins’s methodological treatise. Both had borrowed from earlier traditions. Robbins drew on Mises, Weber, Knight, and the first chapter of Hayek’s Monetary Theory and the Trade Cycle, and Hutchison’s arguments echoed those of the German historical school economists and the institutionalists. What is most striking in Hutchison’s book is that he supported his arguments by citing Continental philosophers writing about the nature and methods of science. Hutchison did so in part to break the monopoly that Hayek and Robbins had enjoyed as the interpreters of Continental ideas to their ever-insular British academic audience. In retrospect, however, Hutchison was the herald of a new age. For the next half century, whenever most economists wrote about the methodology of their discipline, they would invoke the writings of (mostly positivist) philosophers of (natural) science. The chief exception was Milton Friedman, who cited no philosophers.2 The title of his essay “The Methodology of Positive Economics” (1953) shows, however, that his differences in citation practice were not mirrored by a difference in general worldview. Hutchison’s book nicely anticipated the postwar growth in the influence of positivist (or, perhaps better, logical empiricist) rhetoric on the methodological writings of economists. It would go hand in hand with—in fact, it would undergird— the vision of economics as a hard, rigorous discipline, the physics of the social sciences. Another key area of contention concerned Robbins’s claim that homo economicus was only an analytic construct. Hutchison demurred, arguing that homo economicus was a fundamental assumption of economic theory and that, since it was false, economic theory needed to be reconstructed on firmer empirical foundations. So: Is the rationality assumption fundamental, as Hutchison claimed, or only an expository device, as Robbins averred? 2. This is not to say that his position was sui generis: Friedman’s debt to the American pragmatist and other traditions is detailed in Hirsch and De Marchi (1990).

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Homo Economicus: Fundamental Assumption or Universal Bogey? Robbins’s precise claim was that assumptions like maximizing behavior and perfect foresight are expository devices whose role is to make tractable the “analytic constructions” or formal models of economists. They are different from the basic postulates that underlie (what I labeled) basic economic reasoning. In the first edition of his book, these postulates referred to supplyand-demand analysis. In the second, they were such “facts of everyday experience” as the notions that the existence of scarcity requires us to choose and that choosing agents can order their preferences and choose purposefully.3 These postulates imply that agents generally respond to perceived changes in prices and incomes (or to perceived changes in constraints) by substituting “in the right direction,” that is, away from more costly resources or goods. Like Robbins, I will not deal here with the thorny philosophical question of the status of the basic postulates. I simply note that, if Robbins’s argument is accepted, it is a vitally important one, for it vitiates the claims of critics who argue that assumptions like those of rationality and perfect foresight drive all the results of economics. If the results of economics do not depend on these unrealistic assumptions, then any confidence that we might have in the results of basic economic reasoning has a much stronger justification. On the other hand, if one focuses, not on basic economic reasoning, but 3. In some ways, supply-and-demand analysis was the better candidate, for, as a simplifying device for capturing the effects of market-level interactions and relations, it is hard to improve on. Although Robbins’s 1935 modification (see Robbins [1935] 1984) was more in line with Mises’s methodological individualism, it also drew criticisms from the Austrian camp. Israel Kirzner (Kirzner [1960] 1976, 108 –37, 159 – 63; Kirzner 1973, 32 –35) interpreted Robbins’s Essay as a defense of what Kirzner called the Robbinsian economizer. Kirzner contrasted this agent with a Misesian acting man, whom Mises used as the starting point for developing a theory of entrepreneurship. Austrians, then, have long been suspicious of the constructs used in analytic decision theory. I share their skepticism but find Robbins less culpable for the profession’s missteps. My interpretation is to develop more fully a distinction that is only implicit in Robbins, that between basic economic reasoning and formal modeling, only the latter of which employs “the Robbinsian economizer.” If that distinction is accepted, Robbins can be read not as endorsing “rational economic man” so much as explaining the necessity of using him in the formal models of the day.

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on the “analytic constructions” of economics, on formal economic theory, it is equally clear that the “unrealistic” assumptions have had a much more crucial role to play. And, contrary to Robbins’s claim, these “first approximations” decidedly did not disappear once the arguments of economic theory were “in their full development.” For many years after Robbins wrote his Essay, the dominant approach to choice theory (or, more broadly, decision theory) sometimes modified but rarely abandoned the twin notions of consistency in choice and optimizing behavior. Indeed, since rationality itself was typically defined as consistency in choice over a well-defined preference ordering, even Robbins’s “fact of everyday experience” that people are generally able to order their preferences was integrated into the formal apparatus of economics. There were modifications in assumptions about information and expectations, but even these nods toward reality usually made strong assumptions about what decisionmakers could know.4 Robbins made his argument when formal modeling in economics was in its infancy. In the intervening years, modeling became the (often sole) accepted means of discourse among economists. At the same time, positivist rhetoric (i.e., an emphasis on testing and prediction) hit its high-water mark within the discipline. This required that protagonists on each side of the homo economicus debate change their arguments. Defenders of the use of unrealistic assumptions typically took on board the arguments provided by Milton Friedman in “The Methodology of Positive Economics” (Friedman 1953). Friedman argued that the realism of a theory’s assumptions did not matter; all that mattered was how well a theory predicted. Prediction in this case meant “market-level predictions.” In a sense, 4. Mirowski (2002, chaps. 4 –5) traces the emergence of decision theory and other characteristic aspects of neoclassical analysis to a shift occurring at the Cowles Commission under Tjalling Koopmans in the 1950s, although he also notes that “neoclassical analysis” itself comprises a number of different approaches. Mirowski’s history of developments within mainstream economics, together with Weintraub’s (2002) description of how economics became a “mathematical science,” nicely complements my own discussion of a movement peripheral to that mainstream. In his final chapter, Mirowski claims that all the variant neoclassical approaches are now moribund and offers economists a menu of alternative analyses from which to choose. While not denying that a number of new approaches are now on offer in economics, it seems to me that the standard paradigm is still sufficiently well entrenched in textbooks and in the curricula to which students (especially undergraduates) are subjected to justify my attention to it in the text.

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what Friedman was saying was: Economic theory works at the market level; let’s not worry about why. Critics of homo economicus also called for testing and prediction, but their focus was on the prediction of individual choice behavior. As such, although Mitchell’s dream that behaviorism would provide a new foundation for economics was never realized, Hutchison’s dream of more empirical studies of choice behavior was, at least belatedly. Scores of psychological studies of choice behavior were eventually undertaken. It was found that, in experimental settings, people were generally able to order preferences but were not always transitive in their orderings. Households exhibited varying amounts of consistency in choice over time. Experimental subjects might tend toward rationality, but none was perfectly rational.5 In short, these studies established that real, choosing people are not always perfectly consistent in arranging their preferences and, more strongly, that, under certain conditions (especially in situations involving decisions under risk), real, choosing people repeatedly make similar types of mistakes. The psychological literature on choice behavior—from critical studies of preference reversal to more positive contributions like prospect theory and the theory of regret—has established robust results, not only about when systematic and persistent errors in decisionmaking might occur, but also about how they might be explained. Initially, mainstream economists disputed, discounted, or even simply ignored these results. But, in the 1990s, a change occurred, as “behavioral economics” slowly became more and more respectable. At least part of the reason for the change was that the new behavioral approach employs formal models and that these allow economists to overcome certain persistent problems and paradoxes encountered in other models in game theory and rational expectations theory (Sent 2002).6 In any event, by the turn of the millennium, the behavioral economics revolution had gained professional recognition and apparent sanction. The prestigious John Bates Clark medal 5. Some of the earlier studies are reviewed in Caldwell ([1982] 1994a, chap. 7). 6. I offer as an unargued conjecture that at least some of the paradoxes that game theorists and rational expectations theorists have encountered share structural similarities with the logical conundrums identified by Morgenstern, Hayek, and others when contemplating the static equilibrium models of their day, models that were populated by identical “omniscient” agents. It is also interesting that recourse to psychology is as prominent a response to such anomalies today as it was then. Hayek’s ultimate response, of course, was different.

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(given by the American Economics Association biannually to an economist under the age of forty) was awarded twice in a row to recent prominent contributors to the behavioral economics literature (Andrei Shleifer in 1999 and Matthew Rabin in 2001), and, in 2002, Daniel Kahneman received a Nobel Prize for his pioneering early work in behavioral economics.7 While, in some ways, the potted history that I just delivered might be taken by some as a paradigmatic example of theory change or even of progress, it must also produce a certain amount of ambivalence among those sympathetic to the Austrian viewpoint. Remember, Austrians assume only that acting man is purposeful and, thus (like the behavioral critics of the mainstream), have long been critical of the “Robbinsian economizer.” That the artificial models of individual choice so long used by the mainstream have finally been successfully challenged is, therefore, certainly a welcome development. On the other hand, current developments continue to focus on the psychology of the individual choosing agent, a research path that, in “Economics and Knowledge” ([1937] 1948a), Hayek thought would not be particularly fruitful for economics. His (eventual) preferred approach was to examine the sorts of institutional arrangements that, in a world of dispersed knowledge, might best allow individuals to coordinate their actions and achieve their goals, whatever those goals might be. Austrians, then, take a position that may be viewed as a third way. While they do not follow the mainstream in its enthusiasm for highly formal economic theory, they do believe that the simple (although unrealistic) models used for basic economic reasoning allow economists to do pretty well at making market-level predictions. On the other hand, they agree with critics like the behavioral economists that real people often make errors in decisionmaking. They do not think, however, that this fact alters their conclusion about the validity of basic economic reasoning. Are the Austrians right? Or do the results of basic economic reasoning in fact depend on the “unrealistic assumptions” that economists have long made in their models? As it turns out, there are both theoretical arguments and empirical studies (some of them undertaken quite some time ago) that suggest that many of 7. Surveys of developments in the literatures of psychology and economics and behavioral economics, and of alternative decision theory models that have resulted, include Schoemaker (1982), Rabin (1998), and Starmer (2000). Sent (2002) traces the origins of the behavioral economics revolution and offers some reasons why it took place when it did.

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the results of basic economic reasoning in fact do not depend on the standard assumptions that agents have full information and always choose consistently. Thus, Gary Becker (1962) demonstrated that even habitual or random behavior on the part of individual agents will yield reductions in expenditure at the market level in response to an increase in the price of a good. This result is due to the fact that a rise in price causes a restriction in the size of the opportunity set available to all the agents in the market. Werner Hildenbrand (1994) showed that the law of demand depends more on the heterogeneity of households that are aggregated in a market than on the rationality of the decisionmakers. Using evolutionary arguments, Armen Alchian ([1950] 1977) showed that all sorts of firm behaviors are consistent with the usual predictions about aggregate market outcomes. One way to explain some of these findings is to invoke Richard Langlois’s distinction between situational constraints and system constraints. Situational constraints dictate that certain actions are “reasonable.” (The rationality assumption is, therefore, a paradigmatic situational constraint.) But, in addition to situational constraints, there may exist in a given choice problem system constraints, which add another layer of constraints to the setting. When such system constraints are operative (something that occurs, e.g., in competitive market situations), they, rather than any assumptions about the reasonableness of the agent, carry most of the explanatory weight (Langlois 1986b; Langlois and Csontos 1993). Langlois’s distinction has much in common with Satz and Ferejohn’s (1994) discussion of “highly scaffolded” choice situations, those in which the structure of the environment favors actions that are the predictions of neoclassical theory.8 These theoretical results also find empirical support in the field of experimental economics. Some of the most dramatic evidence showed that all sorts of experimental subjects, from rats to female psychotics, often responded in the “right” direction to changes in prices and incomes. Experimental economists like Vernon Smith, the other Nobel Prize winner in 2002, who focus on market experiments rather than on individual choice, have reached equally startling results: “In many experimental markets, poorly informed, errorprone, and uncomprehending human agents interact through the trading rules to produce social algorithms which demonstrably approximate the 8. For a report on this work, as well as on experimental studies in which humans were able to do only 1 percent better than “zero-intelligence” traders in a bidding game, see Clark (1997, 181– 83).

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wealth maximizing outcomes traditionally thought to require complete information and cognitively rational actors” (Smith 1994, 118). When taken together, these diverse arguments seem to me to lend support to Robbins’s contention that economic reasoning does not depend on real agents having perfect foresight or being able to exhibit perfect rationality. They support his idea that these assumptions are expository devices used in simple models, not fundamental assumptions. Their usage allows the models to capture the results of certain constraints that operate in a world of scarcity and that allow (typically market-level) predictions to be made.9 If one accepts this idea, then, although much of the later research on psychology and economics is of independent interest, it does not serve to challenge the rough and ready sort of simple models that one encounters, say, in first-year undergraduate economics courses in the United States. Why, then, is it sometimes interpreted as directly challenging economics? The answer, I think, is that, as economics developed in the twentieth century, the distinction between economic reasoning and economic modeling was lost. Typically, economic modeling is taken to be the only way to do economics; economic modeling is economic reasoning. If one’s models include a very thin (but mathematically tractable) model of an omniscient and rational agent, one opens the profession to charges of using “unrealistic” theories. And, indeed, such charges have frequently been made against the formal mathematical models of economists, as they had been in earlier years, when models were not mathematized. Economists usually responded to the charge that the assumptions of their models were unrealistic with the line that all models are unrealistic or with the quip that “it takes a model to beat a model” and the implied invitation to come up with a substitute for the rationality assumption. At least until the behavioral economics revolution occurred, the last statement became the ultimate conversation stopper. Although the conversation stopped, it was not because critics were satisfied. If one’s position is that real people do not examine all their margins, that the choices made by real people are not always consistent, and that models that postulate otherwise are, therefore, unrealistic, then the conversation stoppers could not be viewed as persuasive. I suspect that this is a major reason why the debate over the “realism” of the rationality assumption has been 9. I will argue later that these are the sorts of predictions that Hayek had in mind when he talked about “pattern predictions.”

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such a perennial one.10 This appears to be a clear case of a situation in which the use of more formal methods has not, as is so often claimed, clarified a murky verbal argument. Indeed, the situation is quite the reverse. The hegemony of economic modeling has often forced mainstream economists into making all sorts of clever but specious arguments in favor of homo economicus, thereby undermining their (our) credibility in the eyes of noneconomists. But, far worse, it has led some economists to undervalue, and in some instances not even to recognize, the existence of basic economic reasoning, what Robbins referred to as a “body of generalizations” that developed over many years and that provides considerable insight into the workings of a complex market order. Basic economic reasoning is what is fundamental in economics, not its ever more sophisticated models of individual choice. I have argued that basic economic reasoning seems to work reasonably well and that it does not depend on the unrealistic assumptions that, for many decades, economists made in their formal models. I offered reasons why it might work and cited studies in support of that view. Of course, at the time Hayek and Robbins were writing, most people were convinced that markets did not work and that theories that purported to show how markets worked, theories populated by virtually omniscient agents, were just ideologically motivated nonsense. When Hayek looked at the world, he saw more coordination than his opponents did, but he had to agree that the then-current theory shed little light on the matter. How is it that, in a world of many interacting human beings, each of us possessing only limited knowledge, we are generally able to obtain outcomes that, in our models, require agents with full knowledge and perfect rationality? This would become one of Hayek’s central questions, one that he first wrestled with in the mid-1930s. It would lead him down paths quite different from those taken by other economists because it was the sort of question that neither the positivist defenders of formal models with unrealistic assumptions nor their equally positivist behavioral critics could think to ask. 10. The methodological issues have been considerably clarified by Mäki’s (1989) careful differentiation between the “realism” and the “realisticness” of assumptions. But this has had little effect on heterodox criticisms of and resistance to the “unrealistic” theories of the “neoclassical mainstream.”

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“Economics and Knowledge” Let us move, then, to “Economics and Knowledge” ([1937] 1948a), an article that Hayek identified in later years as a key document, one that marked a change in the direction of his thinking. I argued that the change was not, as alleged by Terence Hutchison, a methodological shift away from Mises’s apriorism and toward Popper’s falsificationist philosophy. My own story was that, for diverse reasons, from problems with his own research program to his participation in the socialist calculation debate, Hayek came to have doubts about the ability of static equilibrium theory to capture certain essential features of a free market economy. In particular, by assuming that all agents have the same, objectively correct knowledge, the theory ignores two central facts of human existence: the subjectivity of our beliefs and the dispersion of our knowledge. In Hayek’s world of fallible agents, each of whom has access to different bits of knowledge, the real question becomes: How is the coordination of human action ever possible? Static equilibrium theory answers the question by assuming away the very conditions that cause the question to arise. Hayek does not spell out his answer until later, in articles like “The Use of Knowledge in Society” ([1945] 1948g), “The Meaning of Competition” ([1946] 1948f ), and “Competition as a Discovery Procedure” ([1968] 1978b). He would ultimately stress the importance of freely adjusting market prices, prices that are produced by actions that reflect the beliefs, plans, and intentions of millions of market participants. Such prices are both behavior induced and behavior inducing; they reflect past decisions, and they provide signposts for prospective decisions in a complex market economy. The actions that agents take reflect the local knowledge—in Hayek’s phrase, “knowledge of circumstances of time and place”—that millions of individuals possess. Some of that knowledge may be tacit, and the dispersion of such knowledge is a permanent condition of life. Market prices permit this local, sometimes tacit, and always dispersed knowledge to be used by others, thereby assisting in the mutual coordination of plans. In addition to its role as a transmitter of information, the process of market competition provides incentives for the discovery of new information, products, and processes. The price system alone is not enough to explain the coordination that we observe; it is only one of a number of social institutions that help coordinate the actions of market participants. Hayek’s later work in political philosophy

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was, in part, designed to identify the fuller set of institutions whose presence would create an environment that would least hinder the coordination of knowledge. The phrasing least hinder is intentional—there was nothing Panglossian in Hayek’s vision. This is why he so often invited us to view the manifest social coordination that we do experience as a marvel. In any event, the world portrayed by general equilibrium theory views such coordination as inevitable rather than as marvelous. Hayek’s varied insights into the “knowledge problem” probably constitute his most enduring legacy in economics. (Peter Boettke [1998] has identified the critique of socialism as the central Austrian contribution to economics, and I am inclined to agree with him.) They played a key role in his critique of central planning and of various other proposals for constructing socialist economies. For many years, however, Hayek’s and Mises’s arguments went largely unrecognized or unappreciated among economists. For most of the economics profession, the socialist calculation debate was judged to have resulted in a draw. In the middle decades of the last century, when Hayek was remembered at all, it was almost always as the author of The Road to Serfdom ([1944] 1976b), hardly ever as the economist who identified the role of the price system in the discovery, transmission, preservation, and use of knowledge. Only the theoretical economists who developed the economics of information have recognized the relevance of Hayek’s seminal contributions for their field, and he is frequently cited in this literature as a forebear. As a number of authors have recently argued, however, economists working in information theory have not always adequately understood the nature of the Austrian contribution.11 One common source of misunderstanding is the assumption that knowledge is the same thing as information. Indeed, the Austrian description of market participants as purposeful but fallible agents whose decisions reflect their subjective beliefs concerning market conditions, beliefs that are based on local and often tacitly held knowledge, has little in common with the agents hypothesized in standard economic models. The Austrian description of rivalrous market competition can be taken as a critique of models of perfect competition. Austrians tend to distrust static allocative efficiency as a criterion of economic welfare. They tend to see rationality as a function of a particular set of institutional arrangements rather than as a starting assumption about agent capabilities. Because they view 11. Among those who have pointed out the tension are Boehm ([1989] 1999), Thomsen (1992), Caldwell (1997a), Kirzner (1997), and Runde (2002).

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market participants as embedded in a structure of social institutions, they are more likely to insist on the importance of having detailed information about political and other social institutions in assessing the functioning of markets. The frequent refrain in Hayek’s writing that knowing economics is not enough to be a good economist expressly reverses the trend toward disciplinary specialization that was a defining characteristic, not just of the development of economics, but of virtually all the academic social sciences in the twentieth century. Whether these characteristics of the Austrian position are best viewed as challenging or complementing mainstream economic analysis is a question to which observers give different answers.12 But the differences and tensions are there and should be recognized for what they are. A final point: Because he developed his insights about the knowledge problem while engaged in debates about the viability of socialism, Hayek was often accused as being an ideologue. His vision of the way the world worked and his criticisms of certain results of standard theory were, accordingly, viewed as suspect, as ideologically founded rather than as true contributions to social science. From the perspective of the early twenty-first century, it seems more accurate to say that, although all the participants in these debates had ideological preferences, Hayek’s vision of how a market economy worked to produce, preserve, and coordinate knowledge was the more perceptive. The “scientists” who accused Hayek of being blinded by ideology wore blinders of their own.13

The “Scientism” Essay as a Transition Piece In the late 1930s, Hayek began his Abuse of Reason project. The abusers ran the gamut from William Beveridge to Karl Mannheim, from socialist planners to behaviorists, from “men of science” like Lancelot Hogben and Joseph Needham to positivist philosophers of science like Otto Neurath. Hayek’s opponents all hoped to use the power of science to reconstruct society along 12. For an ambitious attempt to model some of the Austrian insights theoretically and to compare and contrast the Austrian view with that of mainstream economics, see Makowski and Ostroy (2001). 13. Mirowski (2002, chap. 5) traces the (albeit often indirect) impact of political preferences on the development of mainstream economic analysis among economists at Cowles and RAND in the 1950s.

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lines at once more rational and more just. Some would abolish markets, or even money, altogether, while others called for less drastic institutional change. But all believed that, once freed from the constraints imposed by unfettered market capitalism, science would provide the means for societal reconstruction. Hayek embarked on a work of grand scale, one in which he would first trace the historical origins of a host of erroneous beliefs that he saw as underpinning his opponents’ plans, then provide a battery of methodological arguments against them. Although he never completed the larger project, Hayek laid out in the “Scientism” essay ([1942 – 44] 1979e) diverse criticisms of what he dubbed the collectivism, the historicism, and the objectivism of the scientistic approach. There was a blunderbuss quality to Hayek’s attack. He endorsed the “compositive method” (or methodological individualism) of Carl Menger, the father of the Austrian movement. He borrowed arguments that had been offered up by the likes of Mises, Weber, and Knight. Finally, he referred to research findings in psychology that he had discovered and reported on in an essay written in his student days. The sheer variety of his arguments has led to multiple plausible interpretations of the essay in the secondary literature. Now that we are at the end of Hayek’s journey, it is, perhaps, more evident why I consider the “Scientism” essay to be a transition piece. Of all the arguments that Hayek came up with in his essay, one stands out as truly essential. This was his insight that, for many social phenomena, the market mechanism among them, the best that we will ever be able to do is to explain the principles by which they work. For such phenomena, precise predictions will be forever out of our reach; only pattern predictions will be possible. The claim did double duty in Hayek’s system. It served first to buttress the standard Austrian complaint about the limitations of empirical work in economics. But it did this in the new age of positivism and planning, and it could, therefore, also be used to highlight the limited ability of planners to apply their engineering principles to social phenomena and, in particular, to replace markets with artificially constructed allocation mechanisms. Hayek’s methodological views about the limits of the scientistic approach thereby complemented his earlier claims about the ability of markets to discover, transmit, and preserve knowledge and about the unintended negative consequences that interference with markets could have. In retrospect, the evident failures of central planning in the Soviet bloc and elsewhere have certainly lent support to Hayek’s claims. Once controversial, they are in the new

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millennium closer to the stuff of common wisdom. Whether that consensus will last in an age that knows no history is another question. From the period of the “Scientism” essay on, Hayek would maintain his belief that, when working with certain phenomena, only explanations of the principle are possible. But, in that essay, he had not yet hit on the reasons why this was so or even on how to make the distinction between phenomena that could and could not be so characterized. He may for a while have thought that this characteristic was a difference separating the social from the natural sciences, and he certainly concluded that the application of certain (purported) natural-scientific methods to the study of social phenomena was mistaken. It may be, too, that he thought that methodological individualism might provide a firmer footing for making the distinction. Ultimately, however, grounds for the distinction would clearly emerge only as he studied in more depth another spontaneously arising order, the human mind. The “Scientism” essay was a transition piece, but the transition took a while, and, initially, it involved two different, but later gradually intertwining, programs. One of these led to The Sensory Order ([1952] 1967h), the other to The Constitution of Liberty (1960a).

The Sensory and Other Orders Hayek undertook the research that would lead to The Sensory Order in a state of heightened excitement, but he probably did not realize at the time just how important the work would be in terms of its influence on his thought. His initial goal was, I suspect, to see whether the subsequent development of the psychological theories that he had explored in his youth held any promise as an antidote to the then-dominant behaviorist movement. As we saw, the theory of mind that he developed was a powerful weapon against behaviorism, but it also made some independent, and, in some cases, paradoxical, contributions of its own. So how has Hayek’s psychological theory, and the theory of the mind that underlies it, fared since he propounded his ideas now a half century ago? By their very nature, some of Hayek’s claims could never be directly tested. Of those that could, subsequent research suggests that he got certain details wrong. For example, Hayek was agnostic about whether certain neuronal pathways or linkages were hardwired in the brain prior to the onset of those formed by the first synaptic firings. In The Sensory Order, he made the

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simplifying assumption that no such linkages existed. Recent tests by cognitive neuropsychologists and linguists suggest, however, that certain classificatory abilities, such as phonetic categorization, do, in fact, appear to be genetically hardwired.14 On other matters, Hayek seems to have gotten things right, and, intriguingly, as the psychologist Joaquim Fuster (1995, 89) notes, his theory appears to have anticipated current advances in neuropsychology: “It is truly amazing that with much less neuroscientific knowledge available, Hayek’s model comes closer, in some respects, to being neurophysiologically verifiable than models developed fifty to sixty years after his. It is no less amazing that virtually none of the developers ever cites him.” Among the contributions that Fuster identifies are Hayek’s claims about the relational character of sensory perception, its categorical and hierarchical character, and his emphasis on the dynamic interaction between perception and memory (87). Fuster’s own work is in the neurobiology of memory, and Hayek’s contributions here include the idea that memory is not “stored” in any one place in the brain but rather resides in the system of connections as well as the notion that a sort of “memory” precedes sensory experience, as initial neuronal connections are formed prior to perception. In a post to an on-line discussion group, Fuster compares Hayek’s theory to recent research: Hayek’s connectionism is a most reasonable construct for understanding the neural organization of perception and memory. There is still much indeed that we do not know about the brain’s cognitive functions, but empirical neuroscience is moving every day closer to theoretical positions similar to his. The connective (and classificatory) apparatus that Hayek postulates appears to develop largely in the neocortex, on a base of inborn modules of primary sensory and motor cortex that contain what I call 14. Although challenging Hayek’s simplifying assumption, this finding probably supports another of Hayek’s conjectures, namely, that such similarities in the structure of our minds account for the apparent similarity of our experiences of the phenomenal world. I owe my limited knowledge of these literatures to Will Christie, who, in an independent study undertaken at the University of North Carolina at Greensboro in the fall of 1999, compared some of Hayek’s theses in The Sensory Order with recent research in neuroscience. I have also been much helped by various contributors to the Hayek list-serv; archives of past discussions may be found at http://www.hayekcenter.org/friedrichhayek / hayek.html.

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“phyletic memory,” or memory of the species. This form of ancestral memory has been acquired in the course of evolution, “in the night of times.” It constitutes the foundation of individual memory, at the lowest levels of its hierarchical organization. Those modules of phyletic memory in primary cortices, still somewhat plastic at birth but largely pre-wired, would provide the building blocks, the sensory and motor primitives on which, and with which, the perceptual and motor memory of the individual would grow into cortex of association. Here the genius of Hayek is to have intuited the cortical connectionism of perception and memory, across modules and across areas, much before the rich connectivity of the primate cortex became known. It is increasingly apparent that the neural code in perception and memory is a relational code a la Hayek, not a frequency or an interval code—though both frequency and interval of cell potentials play a critical role in decoding. The variability and idiosyncrasy of individual perceptions and memories most likely derive simply from the practically infinite combinatorial power of some 10 billion neurons in the cortex. (Fuster, 8 November 1997, [email protected]) Gerald Edelman, a Nobel laureate in biology (for his work in immunology) and the father of “neural Darwinism,” has both criticism and praise for Hayek’s work. His criticism concerns Hayek’s focus on the individual synapse (Edelman prefers “population thinking,” where bundles of neuronal connections are adaptively selected) and his description of the synapse mechanism (Edelman 1987, 179). His praise is summarized in his endorsement of The Sensory Order: “I recommend this book to your attention, as an exercise in profound thinking by a man who simply considers knowledge for its own sake. What impressed me most is his understanding that the key to the problem of perception is to comprehend the nature of classification” (Edelman 1982, 24 –25). Certain recent developments within the philosophy of mind are also congruent with some of Hayek’s themes. As Barry Smith (1997) and Jack Birner (n.d.) demonstrate, Hayek’s emphasis on networks of neuronal connections has many affinities with recent connectionist, or neural network, theories of mind. Edward Feser claims that Hayek’s analysis of the sensory order suggests a possible solution to the so-called hard problem of consciousness, the problem of qualia (Feser 1999). And both Runde (2001) and Boettke and Subrick

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(2002) have identified similarities between Hayek’s work and that of John Searle, a prominent philosopher of mind.15 Hayek never tried to apply his psychological theories directly to economics. Others, however, have begun to explore the connections. In an ambitious and promising first book, Rizzello (1999) attempts to synthesize the insights of Hayek on knowledge and Herbert Simon on procedural rationality, using Hayek’s cognitive theory as a link. Chaumont-Chancelier (1999) shows the complex interplay in Hayek’s work of what he calls internal rules (those governing the formation of mind) and external rules (those governing institutional dynamics). And Kevin McCabe, a professor of economics and law at George Mason University and member of the Interdisciplinary Center for Economic Science, has recently begun pioneering work in the field of neuroeconomics, in which brain-imaging research is used to see how the brain works in various two-person strategic decision settings.16 In sum, Hayek’s research program in psychology anticipated and sometimes stimulated a not inconsiderable amount of additional work—and this in a variety of directions. One of the more important philosophical consequences of Hayek’s psychological studies is the claim that it is impossible for the mind to explain itself. Hayek’s argument hinged on the twin ideas that explanation is itself a sort of classification and that the explanation of a given classification system requires a classification system of greater complexity than the one being explained. If these premises are accepted, his argument follows. But, clearly, not everyone would accept Hayek’s definition of explanation. Hayek never backed away from his “impossibility” claim, although he did acknowledge later that “to prove it strictly is probably of a degree of difficulty comparable to that of the famous Goedel theorem in mathematics” (Hayek 15. The latter similarities, however, have less to do with The Sensory Order than with Hayek’s writings on the tacit dimensions of knowledge. Thus, Boettke and Subrick (2002) claim that Hayek’s arguments complement Searle’s “Chinese box” critique (which draws on the difference between semantics and syntax) of the artificial intelligence research program. 16. McCabe attended the Liberty Fund conference at which a manuscript version of the present volume was discussed. While Hayek’s theories were not an original stimulus for McCabe’s work, he told me that he subsequently found much of value in them as he grappled with how the brain worked. Smith’s (n.d.-a) description of neuroeconomics links the discipline explicitly to Hayek’s work on the brain.

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1982b, 292). I do not think that Hayek proved his claim, but, that said, despite numerous advances, there has been little evidence provided in neuropsychological research to refute it. In fact, the evidence so far supports his conjecture. Gerald Edelman eloquently identifies at least one of the reasons that this is so: “Ironically, the self is the last thing to be understood by its possessor, even after the possession of a theory of consciousness. . . . [T]hat should be no surprise, except to each of us as a possessor. Embodiment imposes ineluctable limits. The wish to go beyond these limits creates contradiction, fantasy, and a mystique that makes the study of the mind especially challenging, for after a certain point, in its individual creations at least, the mind lies beyond scientific reach” (Edelman 1992, 136). There is a final hypothesis in The Sensory Order that I have personally found fascinating, the idea that metaphoric thinking may have a neurophysiological basis. Hayek’s conjecture that, because of the way in which the mind forms, much of our sensing is relational and that this is why humans tend to apply various relational notions across diverse phenomena is breathtaking in its range of applications. It allows us an entrée into understanding why humans can recognize faces (and why we see them even where there are none, as when we look at the moon) and why poetry is a cross-cultural phenomenon. It helps us see why metaphors are as essential in science as they are common in literature, why such disparate words as dry, biting, black, cutting, and wicked might be used to describe a sense of humor (although only some of them apply to a wind), or why a statement like “Noël Coward’s play SemiMonde is darkly witty light entertainment” can actually be informative rather than contradictory.17 17. In their original (in both senses of the word) book Metaphors We Live By (1980), George Lakoff and Mark Johnson argued that many metaphors arise from domains of human experience, including our experiences with our own bodies and our interactions with the environment and with other people. Hence, arguments might be conceived of as battles (I attacked his position; your criticisms are on target), as journeys (I will set out to prove my point; I arrived at a conclusion), as containers (yours is an empty argument; it is full of holes and will not hold water), or as buildings (I have structured my argument as follows; I buttress my case with the following supporting evidence). Lakoff and Johnson did not, however, include the insight that the structure of the mind may itself be responsible for the ubiquity of metaphors. This has to a considerable extent been remedied in their more recent work (e.g., Lakoff and Johnson 1999), although Hayek is not mentioned in their references.

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In earlier chapters, I emphasized the importance of The Sensory Order in the development of Hayek’s thought. The mind was, for Hayek, another example of a spontaneously organizing complex structure, and writing the book caused him to think more deeply about how such orders come to be formed and how they could be studied. In it, he drew the conclusion that, with the mind, as with certain social phenomena, only an explanation of the principle is possible. By the mid-1950s, he had hit on what would be his final argument about “pattern predictions” and “explanations of the principle.” He would, thenceforth, distinguish phenomena, not by using the natural science–social science split that he had used in the “Scientism” essay, but by using the simple phenomena– complex phenomena dichotomy. This was, I argued, viewed by Hayek as a more scientific way to make the distinction, one that would fit in better with the prevailing view in the philosophy of science regarding the unity of scientific method. It would bring him closer to Popper but distance him from the hermeneutical critique of naturalism. His psychological theory challenged the dominant empiricist prejudices of his day and provided him with the means to launch a scientific critique of modernist scientism. His framework ultimately led to tensions with (certain interpretations of ) Popper’s work because it implied strict limits on the falsifiability of social and other theories that deal with complex phenomena. As Hayek developed his ideas in the 1950s, he added new elements. I identified a variety of possible influences on his thought during these years. Up until the mid-1950s, Hayek kept his emerging studies on spontaneous complex orders separate from his political theory, but the two would begin to come together in The Constitution of Liberty. That would also be the book where he would unveil “the evolutionary conception” as it applies to the development of human institutions. The “twin ideas of evolution and spontaneous order” would evermore be joined in his work.

Hayek’s Political Theory I dealt with Hayek’s political ideas only peripherally earlier. How have they fared? There is a huge secondary literature on this, most of it critical. Critics argue that Hayek mixed a number of ethical and political philosophies in constructing his system, positions that do not necessarily cohere one

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with another and all of which have been independently criticized (Diamond 1980). Kukathas (1989) notes that, in particular, it is difficult to square his Kantian ethical ideas about universalizability with his Humean epistemological pessimism. Hamowy ([1971] 1999) shows that the characteristics that Hayek required laws to possess (e.g., they should be abstract, universal, prospective, and equally enforced) are, because they focus on the form rather than substance of restrictions, not sufficient to guarantee that personal liberty is preserved. Some question the consistency of the more rationalistic approach taken in The Constitution of Liberty with his later, more evolutionary (and, for some, agnostic) work (e.g., Gray [1981] 1989; Vanberg [1994] 1999). There are evident tensions as well between his earlier advocacy of planning a framework of law and his later enthusiasm for the gradual evolution of judgemade common law. Finally, Hayek’s opinion that judges operating under the common law tradition are bound to draw “conclusions that follow from the existing body of rules and the particular facts of the case” (Hayek 1960a, 153) has struck more than one observer as naive.18 If one is judging his work against the standard of whether he provided a finished political philosophy, Hayek clearly did not succeed. This is not to say, however, that all have found it wanting. Shearmur (1996) contains a diagnosis of what might need to be done to build a coherent liberal political philosophy starting from Hayek’s foundations as well as an (admittedly preliminary) attempt to begin the enterprise. And Gissurarson (1987, 164) argues that, despite its flaws, Hayek’s political philosophpy— one based on “his recognition of our inevitable individual ignorance and his acceptance of, indeed commitment to, a concrete social and historical reality, the liberal civilization of the west, which has enabled us to achieve so much despite our ignorance” —is coherent “in a practical sense.” 19 18. See, e.g., the comments by Judge Bork in Hayek (1983b, 311–13). Mario Rizzo raised similar objections at the Liberty Fund conference on my manuscript. 19. Hannes Gissurarson studied under John Gray and was one of a remarkable group of people who in the 1980s were members of the Hayek Society at Oxford— others included Chandran Kukathas, Stephen Macedo, Andrew Melnyk, and Emilio Pacheco—all of whom have contributed in various ways to our understanding of Austrian thought. Although John Gray has long been regarded as an eminent Hayek scholar, in recent years much of what he has written about Hayek (especially in his more popular writings, e.g., Gray [2001], where Hayek is described as “a conservative ideologue” and “one of the gurus of the intellectual right” who “believed that we must submit to the unfathomable

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While the reaction of political theorists has been principally critical, I think that economists may find Hayek’s political writings useful in a number of ways. First, he provided the general insight that, if a market system is to work, it must be embedded in a set of other social institutions. Among the specific institutions that he identified are a democratic polity subject to the rule of law, strong constitutional protections for a private sphere of individual activity, enforced and exchangeable property rights, and a stable currency. Hayek might be faulted for not providing more flesh for these bones. Furthermore, his are not new insights; most of the general ideas were familiar to the Scottish philosophers whom Hayek praised so often. But, such caveats aside, these ideas certainly were not the common currency of economists in the middle of the twentieth century. If one considers the discussions of economic development, growth, and planning that took place during this period, the formulaic approaches to “economic takeoff ” that so often dominated mainstream economic analyses, or the alternative but equally simplistic Marxist models of capitalist exploitation by the West of the developing nations, his approach is both subtler and more convincing. These issues have come to the fore once again with the collapse of the Soviet bloc. Although Hayek was still alive when the Berlin Wall fell, he never contributed to the literature on the transition. A number of economists who have written about it, however, might be viewed as working within a (broadly defined) Hayekian tradition. For example, both Boettke (1994) and Murrell (1995) make the Hayekian argument that those who hope to redesign institutions are often overly optimistic about the amount of knowledge that is available to them. Their warnings should give pause to market reformers who hope overnight to install new institutions in countries formerly under Communist rule. If such reforms are to have any hope of working, sensitivity to the previously existing institutional framework is essential. The new emphasis in recent decades on the importance of institutions in economics goes hand in hand with a fascinating replay of some of the old arguments between the Austrians and the institutionalists (Plus ça change . . . ). One wing of the new institutionalist economics (a good example is Hodgson [1988]) seeks principally to rehabilitate the insights of the old institutionalists and to join them with more recent heterodox theories of economic processes. workings of the market”) has been rife with caricatures and even misrepresentations. For a devastating critique of Gray’s arguments as well as of his style of argumentation, see Klein (1999).

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Another branch, perhaps best represented by some of the work done under the umbrella organization ISNIE (the International Society for New Institutionalist Economics), tries to blend Hayekian themes with those found in the more mainstream fields of transactions costs and property rights economics. One of the leaders of the latter movement, Douglass North, has commented on how Hayek’s insights might help provide part of the research agenda for ISNIE. Although, as an economist, I do not feel competent to judge the critical literature in political philosophy, at least some of Hayek’s critics employ a strategy that is both familiar (because others have used it in criticizing his economic writings) and suspect. In economics, the strategy begins by assuming that Hayek was trying to prove that markets always work efficiently or that they always produce optimal outcomes. The critic then provides examples of cases in which markets fail to function properly. Hayek is, thus, supposedly refuted (and, in the process, revealed as an ideologue).20 This line of attack fails, however, because the initial premise is demonstrably false: Hayek never claimed optimality for markets. This is why I characterized him earlier as seeking that set of institutions that least hinder coordination. In like manner, if Hayek is read as trying to prove, for example, that government by the rule of law always minimizes coercion, then it is easy to find examples that refute him. But there are other ways to read him. Hayek’s insights are more evident when one reads him as investigating alternative institutions rather than as constructing proofs of optimality. What are the alternative institutional forms that might be used in structuring society? How do they come into widespread use, and what are their effects? What possibilities are there for institutional change, and how has it occurred in the past? To what extent can social institutions be consciously changed? These are the sorts of questions that Hayek asked, and he provided his own set of 20. A particularly glaring example in economics is provided by John Eatwell and Murray Milgate, who argue that Hayek’s economics contains a “contradiction.” Hayek was critical of perfect competition, but, these authors assert, “he claims virtues for the price system that can only be proved by assuming perfect competition” (Eatwell and Milgate 1994, 83). Eatwell and Milgate base their charge that Hayek believed that market competition leads to a maximum or optimum level of efficiency on a single quotation. They conveniently ignore his many statements that suggest that the case for markets is best made, not by invoking notions of optimality, but by comparing market results with those of other forms of economic organization. Indeed, Hayek makes this very point on the page from which the passage they quote is taken (Hayek [1968] 1978b, 185).

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answers to them, usually at a very high level of generality.21 It is in dealing with these questions, no matter what answers we may come up with, that we engage his legacy in political philosophy. And it is then that we realize his true contribution, its ambition, its magnitude, and, perhaps, its durability. I will note, finally, that there is a good deal of common sense in Hayek’s specific policy recommendations. Take, for example, his view that, although a safety net should be provided, social policy should not have a specific income redistribution as its goal. This pragmatic recommendation has drawn fire from all manner of critics. Libertarians think that the provision of a safety net is inconsistent with the “equal treatment” requirement of the rule of law, while social democrats think that the denial of income redistribution as a legitimate goal of policy is draconian. Yet a similar pragmatic approach is widely accepted in other venues. For example, an analogous policy is followed in college classrooms everywhere, as a little thought experiment demonstrates. Assume that the students in a classroom constitute the “society.” They do homework assignments, they write papers and take tests, and they earn grades for the class. There is a distribution of final grades, with so many As, so many Bs, and so on. The final grade distribution is, then, analogous to the “income distribution,” reflecting as it does the “work” that the students have done. What determines the grade that a particular student receives, that is, where she ends up in the final distribution? Many factors come into play. There are things like effort—how many hours she studied, how many draft revisions of the term paper she did, and so on. There is her natural intelligence and aptitude for the material studied. There are the multifarious factors, some with effects that accumulate over a lifetime, that affect how prepared she is to do the work in the class: Was she firstborn (firstborn children perform on average better at school than do subsequent siblings)? Did her parents read to her as a child? Were they rich enough to send her to private school? Did she have peers who valued education? Did she attend a challenging high school? Did 21. As Vanberg (2001a, 6485) puts it: “More than any of his contemporaries in the social sciences Hayek has made an effort in his own work to address the fundamental issue of an ‘appropriate social order’ from a general social theoretical perspective that cuts across traditional disciplinary boundaries. With his ideas on the two kinds of social order, on the function of rules and institutions, and on cultural evolution he has made important steps towards a theoretically integrated social science.”

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a particular teacher inspire her when she was young? Is she a freshman or a senior? All these factors will affect the grade that she receives. There are other factors too. Maybe the teacher is prejudiced against certain types of students—those with their hair dyed purple, or sorority sisters, or those with pierced navels, or athletes. In such cases, discrimination may play a role. And, finally, there is luck—sometimes students just happen to study the “right” things before an exam, and sometimes they don’t. In every class, certain students have an advantage over their peers. Those who are smarter or more experienced, those who had better preparation or more time to study, will typically do better. Most people would agree that differences in the final grade distribution that are attributable to differences in effort or natural ability are acceptable. What seems unfair is when people are judged for something other than their classroom performance (as occurs when teachers act on their prejudices) or when people with genuinely unequal starting points are competing against each other. So what would a Hayekian teacher do? First of all, classroom policies would have to be clearly stated, prospective, applicable to all, and equally enforced. Most professors accomplish this by going over their syllabus on the first day, explaining the rules and requirements of the class. That policies are equally applied is probably the best available (although not a failsafe) method for ensuring that discrimination against any particular group of students is minimized. What about unequal starting points? One hopes that admissions policies are designed to admit students with roughly comparable backgrounds.22 To the extent that that is not true, professors typically offer things like review sessions or office hours to help out students who are having trouble. Hayek would not prohibit such remedial activities, although he would doubtless insist that activities that are designed to help equalize starting points be offered to anyone who wanted to take advantage of them—no fair excluding those who got good grades from review sessions or office visits. Hayek’s final and most important rule in this regard would be: No matter which set of remedial activities is offered, it is illegitimate to correct for unequal starting points by adjusting the grade distribution. What about the safety net? I think that the analogue here is the adjustments that professors make when a student (again, any student) faces some 22. Policies that focus on factors other than academic preparedness in making admissions decisions tend to undermine this goal.

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sort of unforeseen emergency—the death of a family member or a severe illness. Of course, safety nets can be abused—the student who loses a grandmother every semester throughout her college career is the apocryphal and long-cherished example. Some may wish to question the details of the analogy. The general point should, however, hold up. In their classrooms, most professors think that it is right to follow policies that are clearly stated from the outset, equally applicable and enforced. They believe in a safety net—they think that it is permissible to make adjustments for students who face unforeseen emergencies. They believe that it is wrong to discriminate against individuals or groups. And they think that it is wrong to compensate for inequities that clearly always exist in either the education system or the background of their students by adjusting the overall grade distribution. Most professors, then, are Hayekians in the classroom. Yet many of them would reject Hayek’s political philosophy as grossly unjust. And it is Hayek who is accused of being inconsistent!

Cultural Evolution and Group Selection I documented in earlier chapters Hayek’s incorporation of evolutionary themes in The Constitution of Liberty and described numerous influences on his work in the 1950s that may have led him in that direction. By the middle of the following decade, the “twin ideas of evolution and spontaneous order” became prominent in his work, especially in his discussions of cultural evolution. Hayek’s work on cultural evolution has struck a chord with researchers in experimental economics and the new institutional economics. Researchers interested in the relation between ethics and market behavior, those who undertake comparative studies of norms, practices, and institutional structures, those who inquire about their origins, and those who study how specific institutional arrangements can affect behaviors all draw on Hayekian themes in their explorations.23 Hayek never developed the distinction between orders 23. At a 1999 Liberty Fund conference in Bleibach, Germany, and in conversations with me, Douglass North noted that Hayek laid out many of the problems that are currently on the agenda of the new institutionalist economics. For an early exploration of the links between Austrian economics and the new institutional economics, see the articles in Langlois

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and organizations so central to his theses in Law, Legislation, and Liberty (Hayek 1973, 1976a, 1979d), but others working in the Austrian tradition have used it both in general and in specific applications of his ideas.24 In describing the process of cultural evolution, Hayek repeatedly and approvingly made reference to the notion of group selection. Some of Hayek’s writings about cultural evolution, and, in particular, his endorsement of group selection, have generated a large critical literature.25 I will briefly examine and comment on five areas of concern. First, some oppose Hayek’s use of group selection because of the problems that it encountered within the discipline in which it was first developed, biology. Group selection was typically used there to explain the puzzle of “altruistic” behavior by animals: for example, birds that warn the group of the presence of a predator, thereby putting themselves at risk. It was argued that such behaviors persist because the groups that contain altruistic members do better than those composed only of “selfish” (in this instance, non-warninggiving) members. But group selection runs into problems of its own. There is not just competition between groups; there is also competition within groups. Groups with altruistic members also usually contain nonaltruistic members, members that do not give warnings. How is it that individually altruistic but group beneficial behavior like warning giving can persist in the face of “free riding” by nonaltruistic members of a group? After all, it is the nonaltruistic free riders who are more likely to survive and, thus, more likely to pass on their nonaltruistic genes to their offspring. In a phrase, groups containing altruistic members are vulnerable to “subversion from within.” Critics concluded that

(1986a). Robson (2001) explores the biological bases of economic behavior. Finally, two survey articles by Vernon Smith (n.d.-a, n.d.-b) emphasize the connection between experimental economics and Hayek’s contributions. 24. Vanberg (2001b, 9222) argues that the distinction is key for understanding the determination of “a political community’s legal-institutional framework.” For a generalization of Hayek’s distinctions, see Langlois (1992). For a novel treatment of the function of families in the larger Hayekian social order, see Horwitz (2002). Horwitz notes that nonmarket institutions like the family are indispensable within the larger order of society. One function of the family is to help people bridge the gaps between the “micro” and “macro” orders, to assist people in learning and internalizing the rules appropriate to each. 25. Some of this literature is cited in Caldwell (2002a), from which parts of this section are drawn.

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alternative explanations for such behaviors that did not rely on group selection were preferable. Other plausible alternatives were offered by evolutionary biologists, most of them (e.g., the kin selection or inclusive fitness arguments) denying that the (apparently) altruistic behavior was really altruistic. Thus, some warninggiving birds may die, but, if enough of the birds in the group share similar genes, the kin of the warning-giving bird are more likely to survive and will, therefore, pass on the genes. Alternatively, maybe the warning giver is simply advertising how fit it is, so fit that it can escape even a predator that has seen it give a warning. The advertisement may allow such a bird to mate more frequently than others; hence, its warning-giving genes get passed on. It is, of course, often difficult to conduct experiments that would allow one to choose among such competing hypotheses. In any event, in the decades in which Hayek was writing, the simple existence of plausible alternative explanations seemed sufficient to discredit group-selection arguments in biology. Hayek knew of the arguments against group selection in biology. He doubted, however, that they applied to cultural evolution, principally because cultural evolution evidently differs in certain key respects from Darwinian evolution. Among the differences are the facts that cultural traits are passed down by many others, not just one’s parents; that imitation and learning allow the process of cultural evolution to take place much faster than Darwinian evolution; and that, because acquired characteristics are what is passed on to others, “cultural evolution simulates Lamarckism” (Hayek 1988, 25). Furthermore, arguments against group selection in economics have more force if one assumes, as some economists do, that agents always act to promote their own narrowly defined self-interest. Because Hayek’s conception of the individual allowed for considerably more complex human responses, his framework is less susceptible to this objection. Others agree with Hayek that the criticisms of group selection in biology may not apply to cultural evolution. The biologist Ernst Mayr (1988, chap. 5), who generally opposes group selection, argues that, although recourse to “inclusive fitness” arguments may allow us to explain the earliest origins of human ethical behavior, what he calls genuine ethics was based on conscious decisionmaking and, therefore, developed only later. Mayr ultimately concludes that instances of cultural evolution supply “the only well-established cases of group selection” (Mayr 1988, 122). Note, finally, that group selection has experienced a bit of a comeback even within biology in recent years

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(Sterelny and Griffiths 1999, chap. 8). To the extent that cultural evolution differs from biotic evolution, of course, this turn of events is of less direct relevance for Hayek’s arguments. A second objection is not that Hayek used group selection but how well he used it. The criticism is just. One of the group selectionists whom Hayek cited most often, V. C. Wynne-Edwards, was the very person whose proposed examples of group-selectionist behavior (animals “voluntarily” limiting their procreation) prompted sociobiologists to attack the doctrine.26 More seriously, Hayek never systematically developed a theory of cultural evolution (Witt 1994, 184 – 86). His formulations were so varied and vague that, after reproducing a number of passages from Hayek’s work, Robert Sugden (1993, 399) was forced dryly to observe: “In the quotations which I have given, we can see hints of several quite different models of group selection, none of which has been developed.” Putting the best face on it, we might conclude that, although Hayek’s reconstruction of the process of cultural evolution was richly suggestive, it was also incomplete. As with so many things, he left much for future generations of scholars to do. Witt (2001) represents one attempt, using a game-theoretic framework, to take Hayek’s ideas on social learning and group selection a further step forward. Our next concern has been so frequently raised that ChaumontChancelier (1999) has dubbed it Das Friedrich Hayek Problem, namely, the 26. This is perhaps the appropriate place to note Erik Angner’s (2001) thesis that A. M. Carr-Saunders “was among the most important influences on Hayek’s evolutionary thought,” this despite Hayek never having said so, which leads Angner to the conjecture that Hayek sought to distance himself from Carr-Saunders to avoid association with the eugenics movement. I do not think that Carr-Saunders influenced Hayek. Hayek started citing CarrSaunders when he introduced the notion of group selection in the late 1960s. Angner lists five places in which the citations of Carr-Saunders occur. Three of the five, however, involve Hayek quoting the same passage from The Population Problem! Having found a good quote, he kept reusing it. Angner does not point out that Hayek referenced a whole host of other people along with Carr-Saunders in the same places. Among these were Alexander Alland, Peter Farb, W. K. Clifford, G. G. Simpson, Karl Popper, William Durham, Julian Huxley, V. C. Wynne-Edwards, W. H. Thorpe, C. H. Waddington, Donald T. Campbell, and Theodosius Dobzhansky. Hayek knew that group selection was being criticized in biology. He thought that it was applicable to cultural evolution. Hayek was looking for people who defended it, and Carr-Saunders provided a good quote, so he cited him. CarrSaunders was not the long-hidden major influence that Angner claims.

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question of whether Hayek’s advocacy of group selection is inconsistent with his methodological individualism.27 Those who have made it this far in the book will anticipate that I do not feel that this is a real problem. Hayek was never a doctrinaire methodological individualist. He was willing to seek explanations on many different levels, depending on the question at hand. If my characterization is accurate, there is no inconsistency. A fourth area of controversy concerns whether Hayek committed “the naturalist fallacy” in his writings about evolution. The naturalist fallacy would, in this context, be the assertion that whatever social practices emerge from the evolutionary process do so because they are in some way optimal, efficient, “the best,” and so forth. Because Hayek is seen as favoring markets, and because he describes the emergence of markets in works like Law, Legislation, and Liberty and The Fatal Conceit (1988), it is natural to conclude that his descriptions of their emergence are accompanied by normative claims. As Whitman (1998) has carefully documented, however, in The Constitution of Liberty, in Law, Legislation, and Liberty, and in The Fatal Conceit, Hayek took pains explicitly to deny the naturalist fallacy (e.g., Hayek 1960a, 67; Hayek 1973, 24, 88; Hayek 1988, 20, 27), and, as we have seen, he often criticized historicist attempts to predict the outcome of history.28 His evolution27. Chaumont-Chancelier’s allusion is to “Das Adam Smith Problem,” the inconsistency that German historical school economists attributed to Adam Smith for his reliance on “sympathy” in The Theory of Moral Sentiments, which they felt conflicted with his reliance on “self-interest” in The Wealth of Nations. Overton Taylor (1930, 233) offers the following brief but effective refutation of the charge that Smith was inconsistent: “In one work we have a theory of the way in which ‘sympathetic transfers of feeling’ set limits to the assertion of individual interests and promote social harmony: partly by creating moral sentiments in the minds of individuals which directly modify their conduct, and partly by causing society to evolve a legal system which expresses the moral sentiments common to the mass of mankind, and imposes restraints which not every individual would always impose on himself. In the other work we have a theory of the way in which individual interests, thus limited, themselves promote economic adjustment and harmony. The two treatises therefore give us complimentary halves of Smith’s social philosophy.” 28. As was previously noted (see chap. 11, n. 4, above), Hayek encountered the same sort of criticism nearly fifty years earlier when, despite numerous statements aimed at squelching such an interpretation, The Road to Serfdom was read, not as a warning of the possible dire consequences of socialism, but as a historicist-type prediction about the future of Europe. Given that some have also claimed that he “predicted” the fall of the Soviet bloc, Hayek has the rare honor of being known as someone who supposedly predicted both the inevitable success and the inevitable failure of communism!

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ary thought had no teleology attached to it. It is, therefore, remarkable that people would choose simply to ignore his repeated denials that the evolutionary process that he had described would necessarily lead to a particular “approved” outcome. Why is he so often misread? For a possible explanation, let us examine a passage taken from one of Hayek’s papers in which he uses the normative words beneficial and harmful: “The evolutionary selection of different rules of individual conduct operates through the viability of the order it will produce, and any given rules of individual conduct may prove beneficial as part of one set of rules, or in one set of external circumstances, and harmful as part of another set of rules or in another set of external circumstances” (Hayek [1967] 1967d, 68). The quotation comes from “Notes on the Evolution of Systems of Rules of Conduct,” which contains a general discussion of spontaneous orders. Hayek uses “normative” language, but, clearly, when he states that a rule or practice is beneficial or advantageous, he simply means by this that it allows an order to persist. And, indeed, it is very difficult not to use terms like beneficial or advantageous when speaking about rules or practices that provide an advantage in a selection process. But such words do not convey notions of either optimality—after all, what is advantageous today or in one environment need not be so tomorrow or in a different (changed) environment, as the quotation underlines— or the author’s normative approval. Another example of an evolutionary explanation, taken from Colin Tudge’s wonderfully titled Neanderthals, Bandits, and Farmers: How Agriculture Really Began (1998), may shed some light on what I think Hayek was trying to say. In his description of the development of agriculture, Tudge argues that early man did not particularly like farming because hunting-gathering (where it was possible) offered a much less arduous way of life. In regions where farming happened to develop, either because of the fertility of the soil or because of the larger number of indigenous plants that could be domesticated or the paucity of animals to be hunted, its emergence allowed the population in that area to grow. Once that had happened, farming became necessary for continued survival. Because it provided alternative food sources to fall back on, farming also permitted hunters to overhunt their areas. This resulted in what has been called the Pleistocene overkill period, during which the food sources for hunter-gatherer groups like the Neanderthals were decimated, which led in turn to their gradual extinction. In summary: “Farming eventually succeeded, ecologically speaking, not because it is pleasant but because it works: it coaxes more food from the environment than otherwise

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would be the case. Because of this, it enables human populations to arise” (Tudge 1998, 49). I think that Tudge’s description of the emergence of farming has much in common with Hayek’s description of the emergence of markets. Farming arose where it did as a result of unique circumstances of time and place. But, once in place, it became necessary, unless one was prepared to accept huge decreases in population via starvation. Many of the practices, rules, norms, and institutions that Hayek described emerged in the same way. As he frequently pointed out, these were not practices that people particularly liked, and we often do not understand exactly how they came to be adopted. And eliminating at least some of these practices once they are in place would result in a society that would not be able to support the large population that now exists. That, it seems to me, is Hayek’s central message. One might contest Hayek’s claim that eliminating certain practices would result in largescale starvation. But it is a positive claim, not a normative one. A final criticism asks whether the epistemological pessimism that is evident in Hayek’s more evolutionary writings implies that all attempts to alter institutions are fruitless. This criticism has been most pointedly raised by advocates of constitutional political economy (CPE), who wish to design optimal constitutions and who, from the perspective of some interpretations of Hayek, might be seen as having a bit too much of the “constructivist rationalist” in them. Over the years, Hayek was at least ambivalent about the sorts of issues that are dear to the hearts of proponents of CPE. On the one hand, in Freedom and the Economic System, he talked about planning the “system of rules” under which individuals act (Hayek [1939] 1997a, 194). He restated the case for the rule of law in The Constitution of Liberty and offered his own “model constitution” in the final volume of Law, Legislation, and Liberty (1979d, chap. 17). And, in The Fatal Conceit (1988, 36), he praised the work of property rights theorists, noting that it “opened new possibilities for future improvements in the legal framework of the market order.” All this is consistent with CPE. On the other hand, throughout his life, Hayek railed against the view that we have both the ability and the obligation to reconstruct our institutions along more rational lines. His labels changed through time: the enemy was first the “planning mentality” of the “men of science,” then “individualism false,” and, finally, “rationalist constructivism.” If anything, it seems that, as time passed, Hayek’s epistemological pessimism deepened. In the end, he seemed to conclude that we simply can never know enough to try to reshape

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our social institutions. Reason properly used seeks to understand its own limitations; to think otherwise is to fall victim to the sin of hubris (Hayek 1960a, 69 –70). When one couples this with his evolutionary turn, it seems at times that Hayek had concluded that the best that we can do is simply trust to evolution. Which is the real Hayek? Is Hayek the epistemological pessimist being inconsistent when he proposes a model constitution? How do we resolve this tension in his thought? One way to resolve the dilemma is to take Hayek’s remarks as occupying different levels of generality, one being about rule proposal or design, the other about rule selection.29 Rule selection takes place through an evolutionary process: new rules and practices are tried out, and they succeed or fail. This is different from rule design or rule proposal. Anyone, including Hayek himself, is free to propose new designs for rules. Hayek’s own proposed rules were informed by what he thought succeeded in the past and might work in the future. But Hayek the epistemological pessimist realized that what he proposed need not be selected in new situations. Another solution is to see Hayek as accepting what might be considered “piecemeal” or marginal changes to existing institutions (Hayek [1979d, 204 n. 50] might be cited in support of this reading). His warnings about rationalist constructivism would then be seen as applicable only to the wholesale reconstruction of institutions. Either of these solutions might allow Hayek to be interpreted as supporting CPE, even as he voiced pessimism about rationalist constructivism. Neither solution, however, sheds any light on how Hayek reached his conclusions about which institutions should be tinkered with and which left alone. This is especially relevant given that his proposals (e.g., his model constitution) sometimes go far beyond tinkering and that, as Shearmur (1996, 83 – 87) observes, at various points in his writings certain institutions (e.g., religion) are both praised and criticized. It may well be that, at the end of the day, Hayek was simply less optimistic 29. Karen Vaughn made this point in a discussion at a Liberty Fund conference “Spontaneous Orders, Complexity, and Liberty” held in Charleston, S.C., in March 1998. A closely related issue regards one’s interpretation of Hayek’s position(s) on ethics. The equivalent position there might be that, from his writings, we can deduce that Hayek was basically a utilitarian but that, in his evolutionary writings on ethics, his goal was different: it was to offer a positive account of the origins, persistence, and functions of a system of ethics and of certain specific ethical norms.

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than those who endorse CPE about the viability of constructing institutions. Hayek’s foundational belief was that the institutional framework of any society consists of a complex and intertwined set of practices, norms, and structures and that these cannot simply be imposed on a new society. The argument is obviously at too high a level of generality to be of much use empirically. The transitions now taking place in the former Soviet bloc countries and in Western Europe are the sorts of natural experiments that may, ultimately, yield the evidence as to whether CPE or Hayek had the more plausible view. I might finally point out that, fascinating though they may be, these issues do not really answer the question that Hayek was trying to address when he wrote about group selection and cultural evolution. One can use the gametheoretic framework of the prisoner’s dilemma to show that, in certain circumstances, rational choice leads to suboptimal social outcomes unless additional constitutional constraints are added (e.g., Vanberg 1994, chaps. 4, 5). In his writings on cultural evolution, what intrigued Hayek were precisely those institutions and practices that were not evidently in the narrow selfinterest of the parties engaging in them but that nonetheless came into existence, the moral code being the principal case in point. CPE addresses the question: How can we make the environment in which rules are followed better? Hayek was interested in explaining how institutions whose development did not make sense given the prisoner’s dilemma nevertheless came into being. Hayek’s turn toward group selection in order to answer the question may have been a mistake. But his question is an important one—indeed, the problem that he poses is, in my opinion, far more interesting than the solution that he proposed for it. Others who have grappled with it include Jon Elster (1989, 115), who sought the origins of norms that do not arise from the actions of self-interested agents, and Douglass North (1981, chap. 5), who inquired about the origins of “ideology,” or self-sacrificial behavior, given the freerider problem. In recent years, some progress has been made. Viktor Vanberg (2002) argues that the rational choice model should be replaced by one that is more firmly grounded in evolutionary theory (the traditional sort as well as evolutionary psychology and evolutionary epistemology) with an emphasis on how rule-following agents adapt their behavior to their environments.30 Ac30. This development might be viewed as the social-science analogue to the recent move by economic theorists in the direction of behavioral economics.

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cording to Vanberg: “The concept of program-based behavior deserves particular interest because it provides a unifying paradigmatic framework, at the same level of generality as rational choice theory, within which such other approaches can be readily integrated and be related to each other in a coherent manner. . . . It can provide economics and other social sciences with a behavioral foundation that is embedded in the ongoing discourse of modern behavioral research, by contrast to the isolationist existence to which the ‘economic model of man’ has been largely confined” (2002, 9). When linked with the suggestive work of experimental economists on the evolution of reciprocity norms or work in other fields on the evolutionary origins of morality, this framework might well contain the seeds of a solution to some of the problems that drove Hayek to group selection.31 At the Liberty Fund conference on my manuscript, Viktor Vanberg argued with vigor and persistence that, had Hayek known of attempts to explain such phenomena as the emergence of the moral code without recourse to group selection, he would have embraced them. In any event, one can certainly view these efforts as part of Hayek’s continuing legacy. Finally, Chaumont-Chancelier (1999) argues, and I think correctly, that Hayek’s move to evolutionary themes assisted him in filling out his theory of complex phenomena. In a sense, Hayek’s interest in issues of complexity helps us make sense of his movement to evolution. So let us now turn to the second of his “twin ideas of evolution and spontaneous order.”

The Theory of Complex Spontaneous Orders Hayek’s writings about spontaneous orders share certain similarities with recent work in complexity theory, the study of self-organizing complex adaptive systems. Hayek had written about the market order in terminology suggestive of the language of “spontaneous orders” as early as 1933 (see Hayek [1933] 1991c). I argued, however, that it was with the publication of The Sensory Order that his interest in the ubiquity of such phenomena became apparent. He linked the notion of a spontaneous order that forms when agents follow (often simple) rules with the idea of complex systems in the 1950s. This 31. The experimental work is reported on in Smith (1998). The evolutionary origins of morality was the topic of the papers in the Journal of Consciousness Studies, vol. 7, nos. 1– 2 (January–February 2000).

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was a critical breakthrough, for it allowed him to drop the old natural science–social science dichotomy that he had endorsed in the “Scientism” essay, a distinction that could have led to a hermeneutical or interpretive turn, and place economics squarely among those sciences that studied complex adaptive orders. He had a new platform for organizing arguments that he had been developing over his lifetime about the appropriate methods for studying social phenomena. It was during this period that Hayek began citing work in fields like cybernetics and systems theory, which themselves investigated similarities among systems studied by a variety of disciplines. He was, perhaps, closest to the systems theorist Ludwig von Bertalanffy, who had provided comments on the The Sensory Order when it was in draft form. He also cited Warren Weaver on organized complexity, John von Neumann on the logic of automata, and Norbert Weiner on cybernetics. Later, Hayek came to know others working in the field of complex systems. Milan Zeleny of Columbia invited him to a symposium on autopoiesis, dissipative structures, and spontaneous social orders held in Houston in January 1979, but Hayek was unable to attend.32 In September 1985, he was invited to attend a conference on complex systems sponsored by the International Cultural Foundation, but, by then, his health was deteriorating, and nothing came of it.33 In a survey of the development of complexity theory, Rosser (1999, 185) notes that Hayek “had significant communication with both Ilya Prigogine and Hermann Haken, respectively the founders of the Brussels and Stuttgart schools.” Hayek, then, knew at least some of the work that would later be viewed as foundational for the science of complexity, and at least some of the central figures knew about and appreciated his contributions to the study of complex self-organizing systems.34 32. Correspondence between Hayek and Zeleny concerning the conference can be found in Hoover Institution, Hayek Archives, box 60, folder 30. 33. The proposal for the conference, with no reply from Hayek, can be found in Hoover Institution, Hayek Archives, box 66, folder 27. 34. The development of complexity theory is often linked to the Santa Fe Institute’s concern with emergent phenomena. At least in the early days, most of those associated with the institute did not know much about the work of the Austrians. Vaughn (1999b, 241) reports on an interview with Brian Arthur, who said: “Right after we published our first findings, we started getting letters from all over the country saying, ‘You know, all you guys have done is rediscover Austrian economics.’ . . . I admit I wasn’t familiar with Hayek and

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The title of his most famous paper in this area notwithstanding, I do not think that Hayek ever developed a full-fledged “theory of complex phenomena.” His contributions were to document the existence of a wide assortment of fields that studied self-organizing complex orders, to articulate some of the general characteristics of such phenomena, and to speculate on how certain specific orders came to be formed. Vaughn (1999b, 249) suggests that Hayek’s vision may have been limited by his focus on the number of variables in a system as the key to its complexity and also by his preoccupation with static general equilibrium theory, which, as Weimer (1987, 271) notes, is incapable of capturing the essential characteristics of spontaneous orders. That said, the richness of what Hayek did accomplish is remarkable. Anyone who has read him will be startled on encountering recent work in agentbased computational economics or “artificial society modeling,” for it all seems so familiar, as two examples from the literature illustrate. Epstein and Axtell (1996) report on their experiments with an artificial society model that they dub Sugarscape. The model consists of agents, an environment, and rules that define and govern agent-agent, agent-environment, and environment-environment interactions. Agents have internal states and follow behavioral rules. Agent states can be fixed (e.g., sex, metabolic rate, vision) or variable (e.g., health, wealth, preferences). The environment is separate from the agents, something on which they operate and with which they interact. In the Sugarscape model, the environment consists of a lattice of resource-creating and -bearing (sugar) sites. Rules of behavior and interaction vary in complexity. A simple movement rule for an agent might be: Look around as far as you can see (agents vary in “vision” capabilities), find the empty site that is richest in sugar (sites vary in sugar produced), then go there and eat it. Movement and consumption requires the metabolism of an agent’s store of sugar. If an agent needs to use more sugar than it possesses to move, it dies. Sites vary in terms of how much sugar is produced. Epstein and

von Mises at the time. But now that I’ve read them, I can see that this is essentially true.” Parallels are documented in Miller (1996), Vaughn (1999b), and Rosser (1999, 185 – 86). I organized a session on the Austrians and complexity for the Allied Social Science Association meetings in New York in January 1999, one that I understand was quite fruitful. Unfortunately, a snowstorm kept me from attending. (To invoke the related field of chaos theory: the storm was itself doubtless brought about by the flapping of butterfly wings in Taiwan.)

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Axtell describe how their model can be used to study the formation of larger orders: “Typically, we release an initial population of agent-objects into the simulated environment (a lattice of site-objects) and watch for organization into recognizable macroscopic social patterns. The formation of tribes or the emergence of certain stable wealth distributions would be examples. Indeed, the defining characteristic of an artificial society model is precisely that fundamental social structures and group behaviors emerge from the interaction of individual agents operating on artificial environments under the rules that place only bounded demands on each agent’s informational and computational capacity. The shorthand for this is that we ‘grow’ the collective structures ‘from the bottom up’” (Epstein and Axtell 1996, 6). By altering the specifications of agents, environment, and rules, the Sugarscape model can be used to produce patterns indicative of migration, reproduction, birth- and deathrates, the transmission of cultural attributes, the spread of disease, the emergence of trade or war, and myriad other social phenomena. Epstein and Axtell report the results of numerous specifications of the relevant variables. Although Epstein and Axtell nowhere mention Hayek or the Austrians, their book contains numerous familiar themes. The analysis begins with individual agents. Agents are heterogeneous; they differ from one another in terms of their attributes. In most cases, agents are limited to local interactions, and their knowledge is similarly limited—it is “knowledge of circumstances of time and place.” Agents have goals, they are “purposeful,” but they typically follow simple rules of thumb in trying to obtain them. In short, the agents in Sugarscape are just like those described by Austrians in their writings—and quite different from homo economicus. Epstein and Axtell begin with individual agents, but they are chiefly concerned with “what macroscopic structures emerge” when they “spin the system forward in time” (1996, 16). Because they begin with individual agents, they view themselves as “methodological individualists,” but they also recognize that their concern with institutions, and with the fact that the collective structures that emerge “can have feedback effects in the agent population,” means that theirs is a special sort of methodological individualism (16 –17). Indeed, their variant shares much in common with the “institutional individualism” that I attributed to Hayek. Certain aspects of the model resonate with Hayek’s writings about cultural evolution. Agents have “genetically and culturally transmitted traits” that

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adapt according to interaction with other agents or the environment (Epstein and Axtell 1996, 15). The authors envision other models in which societies “learn” as the distribution of rules evolves (18), a notion similar to Hayek’s idea that cultural traditions contain “knowledge.” Epstein and Axtell recognize that, like Hayek’s, their approach differs from what Hayek would have called static equilibrium theory, and their comparisons contain contrasts that he could have penned: Price formation takes place by a process of completely decentralized bilateral trade between neighbors. Under some conditions prices converge to a statistical equilibrium. This artificial economy stands in stark contrast to the neoclassical general equilibrium formalism, which relies on aggregate excess demand functions— or some other form of global information— for the existence of and convergence to equilibrium. (Epstein and Axtell 1996, 15 –17) A social system’s rest points, its equilibria, may be the most analytically tractable configurations, but it is by no means clear that they are either the most important or the most interesting configurations. Indeed, in much of what follows it will be the dynamic properties of the model, rather than the static equilibria, that are of most interest. (17) A general equilibrium price, when obtained in our model, is an example of an emergent entity. In the usual general equilibrium story it is assumed that every agent “takes” a price issued from the top down, by the so-called Walrasian auctioneer. By contrast we “grow” an equilibrium price from the bottom up through local interactions alone, dispensing with the artifice of the auctioneer and the entire aggregate excess demand apparatus. (17) Some of the results of the Sugarscape model also square with what an Austrian economist might expect. Trade tends to increase both the “carrying capacity” of the environment and “income inequality” (see Epstein and Axtell 1996, 10 –11). The authors even report on one simulation in which two societies are compared, one in which interagent trade occurs, one in which it does not. The result: “The nontraders ended up extinct, while the traders are progenitors of a prosperous civilization” (10 –11). In their conclusion, Epstein and Axtell deliberate over whether their research might imply that there are “theoretical limits to what is knowable in

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such computational systems as artificial societies” (1996, 178). The formal study of complex adaptive systems seems, then, to be leading at least some researchers to articulate the same sorts of “impossibility theorem” conjectures that Hayek hit on when he considered the nature of spontaneous orders. While Epstein and Axtell make no reference to the work of Hayek and the Austrians, Vriend (2002) sets out explicitly to answer the question, “Was Hayek an ACE?” (i.e., an agent-based computational economist). Vriend examines the characteristics of an ACE model of information contagion, then compares his findings against certain of Hayek’s writings. The model employs individual agents (one hundred of them) who face a choice between two items. Each item has an expected value associated with it, although the actual value of any given choice is governed by a distribution of values. The only information that agents have about the expected values of the two items is the choices made and the outcomes achieved by six of the one hundred agents. Vriend assumes that agents make their decisions according to one of a number of possible rules of thumb and that the “propensity to use any of these rules may change over time as a result of the agent’s experience in the use of these rules” (Vriend 2002, 817). Rules are of the if-then variety, and the set of all rules constitutes a classifier system. Vriend examines ten runs of the model, each with one hundred agents for twenty-five thousand periods. He describes the questions that he hopes to answer as follows: “From an objective point of view, in almost every period one of the two items is superior, but knowledge is very much divided in my model. Each individual agent has a sample of six observations, and such a sample may overlap with the samples of some other agent. Hence, some more specific questions to answer are the following. Do the agents through their interaction learn to use rules of thumb that solve the division of knowledge problem? What do the market outcomes look like? Do I get path-dependence and lock-in effects?” (2002, 820). Vriend finds that his “ACE model of information-contagion is related to various important Hayekian themes” (2002, 833). The model utilizes individual agents acting according to simple rules of thumb on the basis of limited and divided (dispersed) information. Agents are adaptive, reacting to the success or failure of the chosen rules. Rules are typically of the if-then variety. And practices that are deemed successful are “selected for” as the model is iterated over time (833 –35). He could also have mentioned that, as his own summary reveals, his description of a “classifier system” reads very much like Hayek’s own of the human mind as a classification system:

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Although each rule itself in a classifier system is a simple rule, it is the set of rules that forms the link between actions and previous actions and outcomes, and it is not the individual rules that matter. As is well-known, this type of representation of knowledge is not restrictive in any sense, and any program that can be written in a standard programming language can be implemented as a classifier system. . . . Hence, a classifier system may be thought to model the most complex and sophisticated human decision procedures, as well as the most simple. In other words, any decision can be modeled “as if ” made by a classifier system. (819) Both the Epstein and Axtell volume and the Vriend paper identify areas where modeling might go in different directions than those anticipated by Hayek. For example, although they are keen to stress the differences between their approach and “neoclassical general equilibrium theory,” Epstein and Axtell do not seem to question the neoclassical welfare criterion of static allocative efficiency. For his part, Vriend observes that, in his runs, “the system continually moves back and forth between order and disorder. . . . [T]he selforganization is a continuing, on-going story, in which the emerging order unravels time and again” (2002, 28). He also points out that, although, on average, performance improves over time, from time to time information contagion creates “disasters.” 35 These and other new lines of research might someday shed light on the sorts of questions that Hayek’s own program generated. For example, in The Fatal Conceit, Hayek claimed that the imposition of egalitarian income distributions could greatly reduce the number of agents that a system could support. Does this ever happen in models when a distribution is imposed? Is there a way to use the models to make more explicit the Austrian notion of 35. Summarizing his own contributions to the session mentioned in n. 34 above, Robert Axtell concluded with the idea that Hayek might not have liked certain applications of his and Epstein’s approach: “Hayek himself might have anti-CAS [complex adaptive systems] feelings. In the same way that Saint-Simon, Fourier, Proudhon and the other 19th century socialists all thought they had the solution to social problems, so might naïve bureaucrats (and others!) use (empirically unverified) artificial society models to dictate social policy; each model providing the answer. So he might have significant trepidations, at least if I read his ‘Scientism’ volume [i.e., Hayek (1942 – 44) 1979e] correctly. Such models are in development in various quarters. Viewed as one more decision aid for busy policy makers it is innocuous, I think. But if the models are taken to be reality then there is trouble ahead” (e-mail to the author, 23 March 1999).

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adaptiveness, or speed of adjustment to changed circumstances, as an alternative welfare criterion? Have there been any efforts to model the evolution of norms of behavior? Could generative social science be used to test the notion that, as societies become more complex, only a few ways of setting them up may emerge as viable? Perhaps the most heartening aspect of these new developments is that others in the scientific community are now coming to recognize, as Hayek did, that the nature of the phenomena that economists and other social scientists study may require approaches quite different from those utilized during earlier eras. Economists in the middle of the century may have been able to conceptualize the economy as a giant machine, one that occasionally broke down, but one that could be made to run properly once we gathered together enough knowledge in one place about how all its parts fit together. Others sought to model the choice behavior of an individual along lines of a machine. Such conceptualizations fit both the positivist image of the power of objective and disembodied science and the progressive notion that science could be used to reengineer society along more rational lines. Such optimistic visions are certainly not dead, but the record of the past century makes the images a bit harder to hold on to today.36 I close with the conjecture that the growth of the Internet will serve only to bolster further this recognition. The Web is about as dramatic an example as can be imagined of a constantly growing and changing complex order, one whose path follows certain principles but whose specific future course is unpredictable. It is a phenomenon with which all of us will be forced to come to grips, and any attempt to understand it must, I think, make use of categories and ideas that Hayek helped identify. It is, therefore, no surprise that a number of recent contributors to the literature on the Web have begun referring to the ideas of Hayek and the Austrians.37 36. A metaphor that economists often used in the mid-1960s, at least in reference to policy aimed at countering the business cycle, was that of fine-tuning. The metaphor did double duty. It conjured up both a finely tuned machine and the tuning of FM stations on the radio. At least in the United States, FM was at that time associated with classical music and, hence, with high culture. Economists were at once sophisticated intellectuals and scientific mechanics. 37. A conference entitled “Austrian Perspectives on the New Economy,” held in Pisa in May 2001, addressed many such issues. I might also mention Virginia Postrel’s (1999) intriguing argument that the old Left-Right ideological division is being replaced by one that stresses one’s comfortableness with conditions of dynamism versus stasis. Given that he

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One of my recurring themes has been that Hayek’s views have consequences for the way one thinks about the economy and about the study of economics. He was often critical of the latter. So we come at last to some final questions: What challenges did Hayek’s thought pose for the economics profession? Are there really limits to what we can know? How might this affect how we study economic phenomena and what we teach? By studying Hayek’s journey, might economists learn a bit more about themselves? To Hayek’s final challenge, the one that his work poses for economists, we are now ready to turn. was so often engaged in ideological battle, it would be intriguing indeed if one of Hayek’s legacies turned out to be an evolutionary cultural change that destroys the old ideological boundaries and terms of debate.

CHAPTER 15

Epilogue: A Meditation on Twentieth-Century Economics I begin my epilogue with two quotations from Hayek, quotations whose relevance will soon become apparent: But if it is true that in subjects of great complexity we must rely to a large extent on such mere explanations of the principle, we must not overlook some disadvantages connected with this technique. Because such theories are difficult to disprove, the elimination of inferior rival theories will be a slow affair, bound up closely with the argumentative skill and persuasiveness of those who employ them. There can be no crucial experiments which decide between them. There will be opportunities for grave abuses: possibilities for pretentious, over-elaborate theories which no simple test but only the good sense of those equally competent in the field can refute. There will be no safeguards even against sheer quackery. Constant awareness of these dangers is probably the only effective precaution. But it does not help to hold up against this the example of other sciences where the situation is different. It is not because of a failure to follow better counsel, but because of the refractory nature of certain subjects that these difficulties arise. There is no basis for the contention that they are due to the immaturity of the sciences concerned. It would be a complete misunderstanding of the argument of this essay to think that it deals with a provisional and transitory state of the progress of those sciences which they are bound to overcome sooner or later. (Hayek [1955] 1967a, 19) All these things I’ve stressed—the complexity of the phenomena in general, the unknown character of the data, and so on—really much more point out limits to our possible knowledge than are contributions that make specific predictions possible. This is, incidentally, another reason why my views have become unpopular: A conception of scientific method became prevalent during this period which valued all scientific fields on the basis of the specific predic[ 370 ]

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tions to which they would lead. . . . The aim of science, in that view, was specific prediction, preferably mathematically testable, and somebody pointed out that when you applied this principle to complex phenomena, you couldn’t achieve this. This seemed to people almost to deny that science was possible. Of course, my real aim was that the possible aims of science must be much more limited once we’ve passed from the science of simple phenomena to the science of complex phenomena. (Hayek 1983b, 191–92) I choose to call my closing chapter an epilogue to signal to the reader that it will be more personal than what has come before. As I noted in the introduction, I am an economist whose area of specialization is the history of economic thought. Before I began my research on Hayek, I studied the methodology of economics. In both instances, I hoped that my studies would lead me to a better understanding of why economics developed in the way that it did in the twentieth century.1 I believe that one of the most important contributions that the study of methodology and doctrinal history can make is to enhance disciplinary self-understanding. The less time devoted to the study of these subjects, the less that economists know about themselves and their work, its potential usefulness and its limitations. I think that the present study has implications for the way in which we view the discipline of economics. In what follows, I use what we have learned about Hayek, about the puzzles he wrestled with and offered solutions to, about the ideas he developed and those he opposed, to argue for a number of theses. First, Hayek’s major message was one of the limits that we face as analysts of social phenomena. His view of the world contrasted starkly with that proposed by his antagonists, what one might label a positivist or scientistic view. One can best see the contrast between the two worldviews by seeing what kinds of progress each leads us to expect to occur in a science like economics. Second, although there has been much progress of a variety of sorts, I argue that the history of economics in the twentieth century lends support to 1. Many others have tried to answer this question, and their explanations range from the ideological to the economic, from the sociological to the pedagogical (e.g., Colander 1992; Brenner 1992; Klamer 1992; Mayer 1993; Mäki 1999; Mirowski 1989, 2002; Weintraub 2002). I think that each of these explanations contains part of the truth, so the further words that I offer should be viewed as supplementing what others have said.

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Hayek’s views about the empirical limits of the discipline. The positivist hope for continuous progress has not been achieved. Third, things are more complicated when it comes to developments in theory. I argue, first, that, when dealing with complex phenomena, the sorts of pattern predictions that basic economic reasoning permits are often very useful. Next, I claim that much of what has been taken to be progress in various branches of microeconomic theory has, in fact, been simply the endless reconfiguration of what Hayek’s friend Popper called situational analysis. Although this reconfiguration has yielded some benefits, we have probably reached the point of diminishing returns for its ability to shed light on complex social phenomena. Finally, I suggest that alternative approaches may well be useful for shedding light on the sorts of questions that Hayek raised and note that a number of recent research programs are more consistent with the way in which Hayek thought the study of complex adaptive systems might best be pursued. Fourth, a dominant subtext of this concluding chapter is that the effects of positivist or scientistic thought on the profession have been nearly entirely negative. One of the worst effects is to mislead economists about the nature of their own discipline, its prospects, and (perhaps especially) its limitations. A tragic related effect is to cause economists to think that the study of fields like the history of ideas and methodology is unnecessary for the training of economists. The apparently imminent extinction of these fields is a legacy of the scientistic worldview, evidence of its malignant persistence in the way in which economists understand themselves and their discipline. Hayek and His Opponents on the Prospects for Economics Hayek’s theory of complex phenomena ultimately served as the foundation for many of his methodological conclusions. Among the conclusions that he reached, those of interest to economists might include the following: Many of the phenomena that economists study are, in fact, examples of complex phenomena. When we deal with complex phenomena, precise predictions will be impossible. When we theorize about complex phenomena, usually the best that we are able to do is offer explanations of the principle by which the

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phenomena occur. Although this may enable us to predict broad patterns of behavior and, thereby, rule out certain outcomes, our ability to falsify theories is diminished. As Hayek put it: “The advance of science will thus have to proceed in two different directions: while it is certainly desirable to make our theories as falsifiable as possible, we must also push forward into fields where, as we advance, the degree of falsifiability necessarily decreases. This is the price we have to pay for an advance into the field of complex phenomena” (Hayek [1964] 1967j, 29). Because we study complex phenomena, the possibility of final “crucial experiments” is more or less ruled out. As such, the elimination of contending rival theories “will be a slow affair” (Hayek [1955] 1967a, 19). Finally, “what we can know in the field of economics is so much less than people aspire to” (Hayek 1983b, 258). The last point sums up Hayek’s ultimate conclusion about economics. How might one go about assessing these assertions? It should be immediately apparent that, given Hayek’s emphasis on limits, there is no way to establish his claims. That would involve proving a negative: the limits that economists encounter today may, after all, be gone tomorrow. But one can contrast them with the vision offered by Hayek’s opponents and then ask whose vision better describes the subsequent history of the discipline. Had the positivists been right, here is what we might expect: Over the course of the twentieth century, there will be steady, even cumulative, progress as economic laws and law-like relations are discovered and multiplied. Improvements in empirical methods will allow ever more precise predictions to be made. Theory change will involve the steady accumulation of a wellcorroborated theory base. Errant theories will be gradually but steadily falsified and eliminated. As the findings of economic science become more widely accepted, methodological debate across competing paradigms will wither away, as will, indeed, the competing paradigms themselves. Which vision is more descriptive of economics in the twentieth century? It turns out that this is, in principle, an extremely difficult question to address, not the least because there is neither an agreed-on set of criteria by

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which to measure scientific progress nor an agreed-on history of economics in the twentieth century against which to test our claims. Historians of thought have long recognized how difficult it is to characterize a particular period in the past, for assessments of what took place are always contestable. Was the Keynesian revolution a progressive problem shift, as Mark Blaug ([1987] 1990b) once averred, or simply an erroneous generalization based on local problems afflicting Britain in the interwar period? 2 Was the marginal revolution an essential transformation leading to the development of modern microeconomics, or was Philip Mirowski (1989) correct to characterize it as a mimetic mistake brought on by economists’ “physics envy”? More generally, and as every reader of this book should by now understand, there are no brute historical facts against which to test our historical constructions. History, like any other empirical basis, is theory impregnated; what we include in it depends on our prior theories about what is deserving of attention. These problems vex, not just economists, but anyone trying to construct the history of a science or to assess its theories (Losee 1987). In the current context, we can add another layer of problems in that, to answer the question before us, I must try to characterize what might be called the very recent history of economics. Given the huge number of changes that have taken place in economics in the past few decades, this is an undertaking more suited to an encyclopedia than to the final chapter of a book. What follows, then, is necessarily suggestive and, I hope, provocative: the latter in the sense that perhaps my speculations will provoke others to look into these matters more carefully and in more depth. With these important caveats in mind, let us now turn to the recent past and compare it against the visions of Hayek and his opponents.

Empirical Work in Economics Even if we acknowledge the difficulty of defining scientific progress, it should still be clear that, by almost any definition, there has been an immense amount of progress in the area of empirical work. The profession has at hand better statistical techniques, better data, and ever more powerful computers. Huge data sets are now available, panels of data tracking all sorts of variables 2. For views that contrast with Blaug’s characterization of the Keynesian revolution, see Hands (1985b) and Caldwell (1991c).

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across households and through time, and the techniques to squeeze information from them seem to multiply no less promiscuously. I work in a largely empirical department of economics, and the econometric techniques that people of my generation learned as Ph.D. students are easily eclipsed by what we teach our master’s students today. And, of course, modern computers are ever smaller, ever more powerful, faster, and cheaper: as far as computing goes, there have been improvements along virtually every dimension that counts. Perhaps even more impressive than the speed at which such improvements have taken place is the pace at which they are anticipated to occur in the future. It may be, in fact, that we are only just at the beginning of a new era. Even so, had Hayek’s opponents been right, one would think that, by now, we would have at least started seeing some results in economics: more precise predictions, the discovery and establishment of empirical laws, and, perhaps, even a policy payoff in terms of a better ability to fine-tune or to command and control our national economies. I do not think that I am being overly provocative if I assert that that has not been what has happened so far. There has not been, in the first instance, a steady accumulation of well-established empirical laws. Terence Hutchison, who has, as we have seen long been an advocate of more empirical work in economics (and especially of the testing of our theories), sought in 1977 to specify more exactly what we mean when we say that we are making a scientific prediction. Drawing on the philosopher Karl Popper’s idea that “an explanation or prediction should be accepted as ‘scientific’ if, and only if, it is deduced from a universal law that has been well tested and corroborated, and from specific initial conditions which have been independently checked,” Hutchison fairly quickly concluded: “Unfortunately this pronouncement seems to rule out ‘scientific predictions’ in economics. In fact economists have constantly used, and are constantly using, trends, tendencies, patterns or temporary constancies, as the basis for predictions, because, in fact, they have not available any genuine, relevant, non-trivial laws” (Hutchison 1977, 15, 21). More recently, Tony Lawson echoed Hutchison’s assessment of the results of the profession’s long quest for well-established empirical relations: “Fifty years ago Haavelmo justified his efforts in developing the ‘probability approach in econometrics’ with the observation that ‘economics, so far, has not led to very accurate or universal laws like those obtaining in the natural sciences’ (Haavelmo 1944, 15). With the passage of time this situation does not seem to have changed significantly. Econometricians continually puzzle over

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why it is that ‘estimated relationships’ repeatedly ‘break down,’ usually as soon as new observations become available” (Lawson 1997, 70).3 In his book Truth and Progress in Economic Knowledge, Roger Backhouse concluded his own lengthy and careful examination of the nature of empirical progress in economics with these words: “Despite the immense effort, undreamed-of increases in computing power, and the development of vastly more sophisticated statistical techniques, econometrics has failed to produce the quantitative laws that many economists, at one time, believed it would” (Backhouse 1997, 136). Those who are familiar with the literature on the methodology of economics know that Terence Hutchison, Tony Lawson, and Roger Backhouse seldom agree on anything. Yet their assessments of the results of the search for law-like relations in economics are for all purposes identical. Robert Goldfarb provides additional evidence in support of these claims. He documents twenty-one cases of empirical literatures in economics in which an “emerging recalcitrant result” (ERR) pattern exists: “A number of empirical literatures in economics display the following pattern of results. First, some evidence accumulates that suggests and seems to support an empirical result. As time passes, however, contrary results emerge that challenge or even seem to overturn that initial result” (Goldfarb 1997, 221).4 Of course, it could be that such a pattern simply demonstrates the steady advance of empirical science. That inference would require that the later results typically be viewed as more reliable than the earlier ones. Unfortunately, this is sometimes, but by no means always, the case. Goldfarb notes the implications of his finding for the use of empirical work to support policy: 3. Lawson (1997) notes that “the Lucas critique” helps explain why the relations break down but that the responses to the critique do not address the fundamental problem, the fact that the social system is an open system for which the usual tools are inappropriate. 4. To give the reader a flavor for the sorts of ERRs that Goldfarb (1997, 222 –24) identifies, they include the following: a higher minimum wage lowers employment; public infrastructure investment has a high return in promoting growth; savings are quite responsive to the interest rate; cutting capital gains tax rates raises revenues; plausible estimates of nonobservable contingent values can be obtained using contingent valuation techniques; economists are less cooperative than everyone else; unemployment patterns are dominated by spells of short duration; income and substitution effects in labor are quite large; business taxes have no effect on industry location; and social security has a very large effect in depressing personal savings.

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These emerging contrary results or “potential reversals” present a dilemma for the conscientious economist who is part of an empirical literature’s audience. How is he or she to make believable inferences from such a literature, when results may have already been, or in the future be, challenged and even conceivably overturned? Part of the answer would seem to depend on whether the “later” results are very likely to be more reliable than “earlier” results. More generally, an intellectually adequate answer depends on having a good understanding of what might be causing these ERRs. As this paper will show, some ERR mechanisms imply that “later” results are more dependable, while others suggest the opposite or are ambiguous. (222) The econometrician Edward Leamer has, in such wonderfully titled articles as “Let’s Take the Con Out of Econometrics” (Leamer 1983), been in the forefront in pointing out the “fragility” of many econometric results. In a symposium, he offered an assessment that both supports and may help explain some of Goldfarb’s findings: I have a sense that most economists feel that conclusions from data sets are fragile. Somebody will add another variable, or they will control for some aspect of the time series phenomena in some other way, which will yield a substantially different conclusion. One of the reasons that we don’t treat empirical work seriously is that there have been so many cases of fragile conclusions. Somebody claims to have found something, and then six months later a new equation is estimated, and the same finding seems to be reversed. It creates the feeling among economists that conclusions from data are very fragile. (Leamer quoted in Lawson 1997, 301) What about forecasting, that is, predicting the future values of certain variables of economic interest? It has long been recognized that economic models that try to provide elaborate specifications of the relations that hold among various sectors of the economy are often inferior to less complicated “moving-average” models that simply forecast future values on the basis of past trends (Nelson 1972). As might be expected, while this has caused some econometricians to call for greater efforts to improve the links between econometric models and economic theory, it has caused others to insist that one should allow the data themselves (rather than one’s theoretical “priors”) to play more of a role in determining the forecast.

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The latter approach has actually generated substantial progress. The use of statistical model selection criteria and of cross-validation techniques has greatly improved our ability to distinguish systematic variation from “noise” within any set of data. Given virtually any array of past values for a set of variables, it is now possible to produce a mathematical function that could generate them. Unfortunately, it is also often the case that the systematic component in many variables of interest to economists is small relative to the noise. As for forecasting “turning points” (e.g., the trough of the business cycle or the point at which a decline in interest rates reverses itself ), my own departmental econometrician (Peter Bearse) put it succinctly as: “On average, we’re wrong.” A recent commentary on the dismal performance of a group of thirty-four forecasters in the United Kingdom, reported on by Tony Lawson, adds credence to Bearse’s judgment: “Economic forecasters do not speak with discordant voices; [keeping an eye on each other] they all say more or less the same thing at the same time. And what they say is almost always wrong. The differences between forecasts are trivial relative to the differences between all the forecasts and what happens” (J. Kay quoted in Lawson 1997, 301). Econometrics itself has undergone substantial changes in the past twenty years or so. There are now a number of competing econometric methodologies from which to choose when undertaking an empirical study. In a fascinating recent experiment (Magnus and Morgan 1999), eight teams of researchers were asked to apply differing econometric techniques to a set of problems laid out by the experimenters. Among the tasks that the teams were asked to perform were the following: estimating the income elasticity of food demand in the United States using data that had originally been used in a similar study by James Tobin in the late 1940s; repeating the procedure with a full set of U.S. data; undertaking similar exercises when additional information of various forms from other data sets is available; and forecasting future food demand for the next twelve years. (The teams were also asked to perform a hypothetical policy analysis, but none completed this part of the experiment, which itself may suggest the difficulty of moving from an empirical study to the realm of policy.) A panel of “expert” outside assessors then evaluated the exercise and the econometric methodologies employed. As might be expected, almost all the groups came up with results very similar to Tobin’s when using the original data. After that, the results diverged: “In nearly all the other tasks, we observe a considerable lack of consensus from those same methodologies that gave us consensus in the estimate of

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the 1941 income elasticities” (Magnus and Morgan 1999, 304). One of the assessors (Anton Barton) commented on the results of his groups’ findings as follows: The cross-section part of Tobin’s original contribution appears to be robust against recent developments of a methodological nature. That is a comforting thought. If our empirical results are very sensitive to the way the data are handled one would feel suspicious about the outcomes in general. Another feature is the failure of the forecasting part of the experiment. The results show the impact of the within model lack of precision. To this, one should add the uncertainly about the conditioning variables. Is it, in general, true that our knowledge of the future is so inadequate? It is commendable of Magnus and Morgan to have formulated the prediction question, because its answer has revealed a weak spot in our empirical research. (270) It is difficult to draw any generalizations from the Magnus and Morgan study: it was the first of its kind, and, as its authors freely note, the design of the experiment had (as might be expected in a first-time study) some flaws. The fact that it was the first study of its kind must, however, give pause. Empirical work is ubiquitous in economics. How is it possible that economists have been so uninterested in systematically comparing the results that one might obtain from different approaches? Is it because the fact that the results are different comes as no surprise? There are many rationales for undertaking empirical investigations in economics, but, surely, one of the most compelling is the hope that empirical studies can provide an impartial means for arbitrating disputes over policy questions. People often hold strong views on questions of public policy. Empirical work can help resolve such differences of opinion—to the extent that they are the result of disagreements over the predicted effects of alternative policies. At least such was the hope fifty years ago, when this position found a persuasive spokesman in the person of Milton Friedman, whose 1953 essay “The Methodology of Positive Economics” was, in many ways, the perfect expression of the optimism concerning the prospects for empirical work that reigned during the positivist era. Noting that “laymen and experts alike are inevitably tempted to shape positive conclusions to fit strongly held normative preconceptions,” Friedman explained that positive economic science

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could help adjudicate such disagreements, especially to the extent that the differences of opinion actually lay in the positive rather than the normative realm, which he thought was often the case: I venture the judgment, however, that currently in the Western world, and especially in the United States, differences about economic policy among disinterested citizens derive predominantly from different predictions about the economic consequences of taking action— differences that in principle can be eliminated by the progress of positive economics—rather than from fundamental differences in basic values, differences about which men can only fight. . . . Agreement about the economic consequences of the legislation might not produce complete agreement about its desirability, for differences might still remain about its political or social consequences; but, given agreement on objectives, it would certainly go a long way toward producing consensus. (1953, 4, 5 – 6) In their recently published memoirs, Milton and Rose Friedman note that they have long differed in their explanations of why economists sometimes disagree with one another. Milton held out the hope that the differences were over the positive matters, or the predictions that one made concerning the effects of alternative policies. Rose took a different view: “On this issue, my husband and I have always differed though I am inclined to believe that he is moving in my direction. I have always been impressed by the ability to predict an economist’s positive views from my knowledge of his political orientation, and I have never been able to persuade myself that the political orientation was the consequence of the positive views” (Friedman and Friedman 1998, 217). Milton in fact confirms that he has been moving in Rose’s direction: “As Rose said, by 1976 . . . I was already moving in her direction. I must confess that I have continued to move in that direction and that I am much less confident now that I am right and she wrong than I was four decades ago when I wrote the methodology article” (219). The conclusion that Milton drew from his lifetime of experience is that economists seem to be driven more by values than by the scientific findings of their discipline. But he does not reflect on why this is so. He does not appear to consider the possibility that empirical studies taken alone are seldom decisive in determining “the facts of the matter,” which means that any study is always a potential candidate for an ERR (to use Goldfarb’s language) or that the elimination of contending rival theories “will be a slow affair” (to use Hayek’s).

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I have compiled here a host of observations concerning empirical work in economics, so perhaps it is time to pause to assess what is being said and, as important, what is not being said. It should be clear that I am affirming the existence of various types of empirical progress in economics—as mentioned, we have better and more varied statistical methods, more powerful computers, and more detailed data. Certainly, we can describe various aspects of the economy far better than we could two generations ago. We have developed the ability to take better snapshots, so to speak, of what the economy looks like. And we have made much progress in distinguishing the signal from the noise in complex sets of data. But, because the systematic component is typically dominated by the noise in most data of interest to economists, we have been less successful in achieving the long-hoped-for goals of steadily improved forecasts and the discovery of law-like relations. This should disappoint anyone who clings to the positivist vision of science. On the other hand, it is just what we should anticipate in the empirical realm if we accept Hayek’s contention that economics is a field that studies complex phenomena. As for the role of empirical work in helping us adjudicate among competing theories: perhaps surprisingly, given what has been said so far, it appears to be the case that, as Milton Friedman states in his memoirs, disagreement among economists over positive matters is not as great as many people believe (Friedman and Friedman 1998, 216).5 Where I differ from Friedman is that I doubt that whatever consensus may actually exist is due solely, or even mainly, to the results of empirical work narrowly defined. It is due, rather, to the training that one receives in becoming an economist and to observing through the eyes of an economist the way the world works.6 I once told a colleague that a pretty good definition of an economist is someone who knows that demand curves slope downward. We know this, not 5. At least this seems to be true with respect to microeconomics. Kearl et al. (1979) provide evidence of consensus among economists on economic issues. Their finding that there tends to be more consensus on microeconomic than on macroeconomic issues, and on positive than on normative issues, was confirmed in Alston, Kearl, and Vaughn (1992). 6. Interestingly, surveys have revealed less consensus among European than among American economists on positive issues. Given that Europeans appear to be more comfortable with state intervention in the economy than are Americans, this again suggests that Rose rather than Milton Friedman may have the better argument on what drives people’s reading of evidence. Both groups tend to respond to the empirical evidence in ways that allow them to preserve their normative priors.

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because empirical work has proved it, but because, if one is going to reason like an economist about any social phenomenon, one must begin from this and similar ideas, ideas that were earlier identified by the likes of Lionel Robbins. Deirdre McCloskey (1985, 57– 62) makes the point persuasively when she notes that, were we to rely on empirical studies for evidence of the relation, we would be hard-pressed to have any confidence in the finding since empirical studies do not always give the “right” results. Luckily (luckily, that is, if one is an economist), there are many other reasons to believe that demand curves slope downward (McCloskey lists eight, ranging from introspection and thought experiments to analogies and recent economic history); economists therefore need not worry too much about not having proved the fact empirically. One may wonder why I am being so sanguine about this apparently embarrassing state of affairs. There are two reasons. First, the belief that demand curves slope downward is one of the beliefs that informs what I have called basic economic reasoning, and it is the power and usefulness of such reasoning that constitutes the best defense of the belief, more of which anon.7 Second, it strikes me that taking a sanguine attitude about this matter is the first step in throwing off the shackles of the positivist vision of science that has so dominated economics in the past century.

Basic Economic Reasoning, Pattern Prediction, and Explanations of the Principle Let us turn next to theoretical work in economics, for which, according to Hayek, “explanations of the principle” and “pattern predictions” are the best 7. The attentive reader will notice the similarities between my statement here and my previous argument that it was the ability of Menger’s Principles to provide causal-genetic explanations for many social institutions that provided the best argument for his methodological defense of a theoretical approach to the social sciences in the Investigations. In a phrase: Results matter. Of course, not everyone does believe in the results of basic economic reasoning. This has been true throughout the history of the discipline. And the inability of empirical work to establish the arguments of one side or the other should guarantee that this situation is a perennial one. Each generation has to hash it out anew with the best tools at its disposal because the tools will never definitively establish one or the other side as having won.

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that we can expect. When Hayek was writing about pattern predictions and explanations of the principle back in the 1950s, most of his examples were drawn from fields outside the social sciences, like biology. Indeed, his whole point in many of these writings was to show his readers that other sciences, in fact, study complex phenomena so that they would accept it as a legitimate model for economics. What is the relation between the terms pattern prediction and explanations of the principle? Hayek’s usage is pretty clear. When one studies complex phenomena, often the best that one can do is explain the principle by which the phenomenon of interest operates. For Hayek, this implied that only pattern prediction (rather than precise numerical prediction) is possible. Although Hayek’s meaning is clear enough, it seems to me that, in the light of how economics has come to focus much more on economic modeling since Hayek’s day, there may be a more effective way to conceptualize the relation between the two terms. When I use explanation of the principle, I will be emphasizing an explanation of the principle by which something works, an explanation that says how or why something works the way it does. I will use pattern prediction, on the other hand, merely to indicate that we are able to make only a qualitative (rather than a quantitative or precise numerical) conditional prediction about some phenomenon of interest. If we use these rough-and-ready definitions and consider the microeconomic theory of Hayek’s day, which in its partial equilibrium instantiation is the stuff of our own present-day undergraduate microeconomics textbooks, it appears that the notion of pattern prediction describes what microeconomic theory is able to accomplish pretty well.8 (I will hold off on an explication of the role of “explanations of the principle” until a little later.) So, for example, when I tell my students that price controls lead to a 8. In what follows, I restrict myself to a discussion of microeconomics. I do so for three reasons: there is (as noted in n. 5 above) more consensus among economists about the validity of microeconomic than macroeconomic results and reasoning; macroeconomics has changed much more dramatically than has microeconomics in the last thirty years, so much so that it is difficult to know how to characterize the field as a whole; and, finally, restricting the discussion to microeconomics allows the delimitation of the subject (to a certain extent). Blaug ([1980] 1992, chap. 12) argues that macroeconomics is the area in economics that comes closest to an empirically driven discipline, so it may also be that the conclusions drawn in the text about microeconomics are less applicable to macroeconomics.

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misallocation of resources, that, ceteris paribus, price supports cause gluts, or that price ceilings result in the creation of excess demand, of black markets, of deterioration in the quality of the products on offer, and of nonprice rationing, I am making pattern predictions. When I tell them that, ceteris paribus, the incidence of taxation depends on the elasticities of demand and supply that a good faces, I am explaining why a tax increase on cigarettes (the demand for which is inelastic) tends to be passed on to consumers while a tax increase on luxury goods (the demand for which is elastic) tends to be borne by the producers of such goods. When I enumerate the conditions under which one might expect third-degree price discrimination to emerge (sellers must be able to segment a market and prevent resale for it to be possible, and the different segments of the market must have different elasticities of demand for price discrimination to be profitable), it helps them understand why price discrimination is more likely to be observed in some markets (e.g., markets for airline or movie tickets) than in others (markets for food or apparel). When I point out that three conditions must be met for a cartel to be successful through time (the cartel must produce a large share of total output, the good must have few close substitutes, and cartel members must be able to catch and sanction cheaters on the agreement), it makes it easier to explain why some cartels (e.g., the diamond cartel) are more successful in keeping prices high than are others (e.g., OPEC). In all these standard classroom examples, economists provide arguments about when to expect certain patterns of market behavior, rather than others, to come about. In such exercises, we identify the sorts of variables that are important in explaining the phenomenon in question. The ceteris paribus clause is crucial, for it is there to remind us how hard it is to pass from such qualitative and conditional theoretical deductions to precise numerical predictions about such phenomena as they exist in the real world. But our models do allow us to provide plausible explanations of, and even sometimes to predict, certain ubiquitous patterns of behavior that recur in the social world. All this is simply to say that Hayek’s idea of pattern prediction might be viewed as fitting certain aspects of standard undergraduate microeconomic theory pretty well. It fits the sorts of positive microeconomic questions that, when surveyed, economists tend to express agreement on. Alternatively, if we use the language that I used in discussing Lionel Robbins’s contribution to methodology, we make pattern predictions when we utilize basic economic reasoning. Robbins’s defense of basic economic reasoning, the sort of reasoning that economists utilize all the time in the classroom, thus fits hand in

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glove with Hayek’s notion that, when dealing with complex phenomena, pattern predictions are often all that is possible.9 Milton Friedman was mentioned a bit earlier, and I will provocatively suggest here that Hayek’s “pattern prediction” was also the same sort of “prediction” that Milton Friedman had in mind when he wrote his famous methodology article (Friedman 1953). The very first example that he used in that article was that of predicting the effects of a price control in a labor market: the minimum wage law. I think that, not just Hayek, Robbins, and Friedman, but a majority of at least American economists would agree about the expected effects of increases in the minimum wage— despite the recent work of David Card and Alan Krueger. To digress a little: The economists David Card and Alan Krueger undertook empirical work (see Card and Krueger 1995) that showed that a moderate rise in the minimum wage in the 1990s had no disemployment effects, a finding that directly conflicts with the pattern predictions of basic economic reasoning. As Thomas Leonard, a historian who reviewed the debate, notes, although critics have since argued that the Card-Krueger study was flawed, only one study (Neumark and Wascher 1996) attempted to reply to Card and Krueger’s own devastating claim that earlier econometric studies that established the disemployment effects were themselves flawed. (“The silence is fairly deafening” [Leonard 2000, 139].) Leonard showed that, relative to debates that took place earlier in the century regarding the minimum wage, today all economists agree that such issues should be tested empirically. But it would seem that, when empirical results are ambiguous, as they so often turn out to be when dealing with complex phenomena, economists rely on a host of other reasons in assessing the adequacy of a theory. There are good reasons to anticipate that the empirical evidence regarding disemployment effects of a rise in the minimum wage should be ambiguous. Such effects need not show up in the data even when they exist in the world. Firms could decide to reduce the number of jobs that they would have offered rather than those already existing. Potential employees who would have looked for work might not seek employment and, thus, would not show 9. One can find further examples of what I have been calling basic economic reasoning in many introductory-level economics textbooks, but perhaps the best exemplar is Heyne’s classic The Economic Way of Thinking (see Heyne 2000). Heyne died in 2000, but a new edition of his text was recently issued (Heyne, Boettke, and Prychitko 2003). Appropriately, the two new coauthors have made numerous contributions within the modern Austrian tradition.

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up in either the employment or the unemployment statistics. And, given that agents in markets are forward looking, both sorts of changes could occur before a scheduled rise in the minimum wage even went into effect (i.e., in anticipation of the rise), further dampening the effect on collected data. In these cases, disemployment effects exist but simply do not show up. Of course, there are other instances—for example, in markets where the new minimum wage still lies below the prevailing wage—in which one would expect that a change in the minimum wage would have no effect. However, even with all this ambiguity, there is still a core belief among most economists that a large increase (say, a doubling) in the minimum wage would have disemployment effects and would, therefore, not be an effective weapon in the fight against poverty. It is basic economic reasoning that leads to that conclusion, and it is what perhaps most clearly separates economists from other social analysts, advocates of “living wages” and the like. Where Friedman went wrong in his methodology article was in his overemphasis on the role of predictive adequacy as a criterion of theory appraisal and in his insistence that empirical work alone should be enough to decide positive issues. The practice of science is much more complex than the positivist vision of it allowed. I say in his methodology article because, in his actual scientific work, Friedman fully understood the complexities, and, accordingly, he typically incorporated all manner of empirical, theoretical, and institutional insights into his arguments.10 In any event, the term pattern prediction seems to be a pretty good description of what basic economic reasoning is able to accomplish. Let us turn 10. Robert Clower begins his review of Friedman and Schwartz’s 1963 A Monetary History of the United States, 1867–1960, with these words: “If successful prediction were the sole criterion of the merit of a science, economics should long since have ceased to exist as a serious intellectual pursuit” (1964, 364). Clower then describes Friedman and Schwartz’s contribution as follows: “They blend analysis so effectively with narrative that one can hardly tell which of their historical judgments rest on fact and which on theoretical fancy” (367). Later he states: “Their historical judgments about this history are based on painstaking examination of a fantastically large body of evidence and on thorough, honest and closely reasoned analysis of its implications” (379). In his actual work, then, Friedman often did not follow the methodological dictums that he had laid out in his methodology article. By combining empirical data, theoretical insights, and extensive institutional knowledge, he and Schwartz produced an intricate historical narrative that had little to do (Friedman’s own rhetoric aside) with the sort of “positive economics” that he had touted in the methodology article. One is tempted to add: And a good thing, too!

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now, briefly, to Hayek’s other phrase,explanations of the principle. Some might think that the assumptions of economic theory provide the starting point for constructing such explanations. That might be true for some of the assumptions utilized by Hayek in his descriptions of the market process, but it is not true for the economic theory of today. It is here that the distinction between basic economic reasoning and the analytic models of economics, first drawn in chapter 9, comes into its own. Robbins had argued that the foundations of economics were based on certain facts of reality: that scarcity forces people to choose and that people try to do so purposefully. These are different from the “unrealistic” assumptions that economists use in their analytic models, assumptions like perfect rationality and full information that Robbins’s critic, Terence Hutchison, claimed were the fundamental ones. In my discussion of basic economic reasoning in the previous chapter, I argued that simple models that used such unrealistic assumptions nonetheless seemed able to capture certain essential aspects of phenomenal reality, thereby enabling economists to make pattern predictions. That leaves us with the recognition that simple, unrealistic models seem to allow us to make passably workable pattern predictions about a complex world. That also leaves us with the question: Why does this happen? What is it about the world that allows people who are purposeful (but not perfectly rational) and who have limited information (not perfect knowledge) to coordinate their economic activity fairly well, indeed, well enough that models that make unrealistic assumptions about their rationality and knowledge can still do a pretty serviceable job of predicting the outcomes of their actions? Hayek’s investigations of the evolution of social institutions that had come into being as the result of human action, but not of human design, and that allowed the discovery, preservation, and coordination of dispersed knowledge all seem to me to be aimed at understanding the principles that underlie the social coordination that we observe in the world and in certain experimental situations. Hayek certainly did not finish the task, but he pointed us in the right direction. A fuller “explanation of the principles” underlying the social phenomena in question might help us understand why the simple analytic models of economists often work (and also alert us to when to expect that they would not work). The variety of sorts of explanations in this domain may be very large indeed. It seems to me, then, that, in addition to pointing out the limits that we

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face, another important (and more positive) aspect of Hayek’s program is to direct us to seek out explanations of the principles that underlie social phenomena. I will take up this issue again later in the chapter.

Situational Analyses in Economics In this section, I will argue that a dominant research strategy in economics over the course of the twentieth century has been to provide models at varying levels of formality of what Karl Popper called situational analyses. To show this, I first describe three apparently quite different theoretical developments in economics and then show how Popper’s model unifies them. One of the developments, the economics of information, gained the 2001 Nobel Prize for three economists who contributed to its growth— George Akerlof, Michael Spence, and Joseph Stiglitz. The economics of information allows economists to analyze situations of asymmetrical information in which one party to a transaction or contract has more or better information than the other. If one assumes that the better-informed party tries to take advantage of its superior information, certain well-defined problems arise. Precontractual opportunism, for example, leads to situations of adverse selection. Thus, higher-risk patients (e.g., those who know their own health conditions when insurers do not) are more likely to seek insurance than are healthy ones, or sellers of services or products (e.g., one’s own services in a labor market or goods in a product market) are in a position to deceive buyers about the quality of their services or product, again because they have more information than the buyers do. In like manner, postcontractual opportunism leads to problems of moral hazard. The standard case is when the existence of a contract leads to altered postcontractual behavior (e.g., less careful driving by those with insurance or shirking by employees) and, owing to imperfect information, monitoring or enforcement of sanctions against the behavior is difficult. It is theoretically possible for such informational asymmetries to eliminate a market completely (e.g., only the sickest people seek insurance; as a result, insurance premiums rise precipitously; this drives the healthiest of the sick out of the market, causing a further rise in premiums, and so on, until the market collapses), but much more interesting is the light that the economics of information sheds on a wide assortment of market institutions that have arisen precisely to overcome the problems that arise owing to informational

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asymmetries. Thus, insurance companies try to overcome the problem of adverse selection by pooling risks through group coverage arrangements. Sellers of services can signal their quality by offering warranties or by showing that they have obtained a qualifying degree or certificate. Buyers can likewise protect themselves by employing various screening devices. Deductibles on insurance contracts and various pay-for-performance incentive schemes can be used to overcome problems associated with moral hazard. Another area that has grown rapidly in recent decades is transactions costs economics. Although parts of transactions costs analysis cover areas similar to those covered by the economics of information, there are distinct differences too. Whereas the economics of information is a straightforward extension of mainstream neoclassical theory, transactions costs analysis traces it roots to a diverse set of writers, some of whose work dates as far back as the 1930s, in the fields of organizational behavior, law, and institutional economics. Transactions costs analysis generally assumes that agents are opportunistic but, drawing on Herbert Simon’s work, only boundedly rational (i.e., agents’ actions are intended to be rational, but agents possess only limited cognitive ability). Less formally mathematical than the economics of information, transactions costs economics instead emphasizes the comparative study of organizational forms, governance structures, and the like. The common bond linking these social institutions is that all can be interpreted as economizing on transactions costs. As one of its chief interpreters characterized the approach: “The organizational imperative that emerges in such circumstances is this: organize transactions so as to economize on bounded rationality while simultaneously safeguarding them against the hazards of opportunism” (Williamson 1985, 32). A third area within economics that has seen rapid growth in recent years is game theory. A body of techniques for investigating situations of strategic interdependence rather than an economic theory proper, game theory has virtually taken over certain fields within economics (e.g., industrial organization) and is extensively used in many others. Game theory was not always so well received. In its early years, and right up until the 1970s, it was mostly used to model situations of oligopoly or bilateral monopoly. One reason for its recent popularity is that it allows one to model explicitly the informational regime that agents confront. Thus, its range of applications increased naturally and dramatically as the economics of information grew. In the last decade or so, game theorists have been increasingly interested in formally modeling choice situations in which agents are only boundedly rational or, in its

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evolutionary variants, in which questions of agent rationality are sidestepped altogether.11 All these moves have helped extend professional interest in game theory. As different as these three programs might at first appear, all of them can be described using Karl Popper’s model of situational analysis. This may not be so surprising if one knows that Popper claimed that all explanations in the social sciences (not just economics, but all the social sciences) typically take the form of situational analyses. While Popper himself was not always crystal clear about what he meant by the term situational analysis, his student Noretta Koertge provided a more systematic restatement, a short version of which reads: Description of the Situation: Agent A was in a situation of type C. Analysis of the Situation: In a situation of type C, the appropriate thing to do is action X. Rationality Principle: Agents always act appropriately to their situations. Explanandum: (Therefore) A did X. A more extensive version reads: Description of the Problem-Situation: Agent A thought he was in problem-situation of type C. Dispositional Law: For all such problem-situations A would use appraisal-rule R. Analysis of the Situation: The result of appraising C using R is action X. Description of the Agent’s Competence: A did not make a mistake in applying R to C. Rationality Appraisal Principle: All agents appraise their situations in a rational manner. Explanandum-1: (Therefore) A concluded that X was the rational thing to do. Rationality Principle: Agents always act on the outcome of their rational appraisals. Explanandum-2: (Therefore) A did X. (Koertge 1975, 440 – 45) 11. I should add that the recent evolutionary developments are less consistent with situational analysis than are the standard approaches in game theory that utilize rational agents who try to maximize their payoffs.

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It should be evident that many standard textbook microeconomic theoretical arguments take the form of situational analyses. Wade Hands (1992, 28) shows us why: Economists specify the situation of the agent (individual or firm) usually in terms of the preferences and/or technology and the relevant constraints (prices, income, factor constraints, etc.). Included in the description of the situation is some “motivating” consideration (maximizing utility, maximizing profit, etc.). The second step is to deduce the appropriate behavior of the agent given the situation (buy more, buy less, increase production, decrease production, etc.). This second step is what constitutes most of economic theory, the formal deduction (usually mathematical) of the “appropriate” behavior in a given “situation.” Finally, if the economist’s task is to explain an observed action, the rationality principle is activated to connect the analysis of the situation with the action to be explained.12 Hands focuses on standard microeconomic theory, but it is also evident that many theoretical innovations in microeconomics, including the three mentioned above, may be viewed as reconfigurations of certain of the initial conditions of a situational analysis and the elucidation of their effects. In the simplest formulations of microeconomic theory, one might assume that agents have perfect information, that transactions are costless, that agents have unlimited computational ability, and so on. By altering each of these assumptions, one obtains any of a number of extensions of or alternatives to the standard account: decisionmaking under risk; exchange under conditions of positive transactions costs; the satisficing and bounded rationality models; analyses of problems arising from informational asymmetries; and so on. The general framework of situational analysis can be used to describe the mathematically formal models of the economics of information and less formal models like those dealing with transactions costs analysis. It can also be used to describe the simpler models used by those engaging in basic economic reasoning. 12. It should, however, be noted that, in another paper, Hands (1991, 117–18) questions whether situational analysis can explain either aggregated market behavior or the unintended consequences of intentional human action. This is one of the reasons why situational analyses are not enough if one is concerned with the sorts of questions that Hayek raised.

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Situational analysis is very adaptable. Simply by altering their descriptions of the problem situation, economists have been able to generate large numbers of modifications and variations on their basic models. This doubtless helps explain the popularity and longevity of the approach. It has also been the source of progress in our theoretical understanding of economic phenomena. Again, think of the three areas mentioned above. The economics of information offers a means for understanding many organizational practices and market institutions whose very existence would be unnecessary in a world of perfect information. It directs us to look at the sorts of incentive structures that might arise under different informational regimes and helps us understand the form that labor, insurance, and other contracts might be expected to take. Like basic economic reasoning (of which certain parts of the economics of information are now becoming considered), it may also help us avoid policies that are likely to lead to adverse outcomes. The partial deregulation of the savings-and-loan industry in the United States, which encouraged managers to seek out risky but high-return investments with depositors’ money, a strategy that resulted ultimately in hundreds of billions of dollars in losses, has now become a standard textbook illustration of moral hazard.13 Like the economics of information, transactions costs analysis allows economists to make sense of a number of market institutions whose existence might otherwise be puzzling. At its most basic level, transactions costs economics explains why markets are used for certain transactions while hierarchies (the firm itself being the paradigmatic case) are used for others. Transactions costs analysis also helps explain why certain forms of nonstandard contracting (e.g., tie-in arrangements, block booking, territorial and customer restrictions on franchisees) might be used to safeguard against opportunism in certain industries. Various alternative institutional forms for organizing the work and corporate governance relations have also been analyzed using the approach. Finally, game theory provides economists with a language and a set of techniques for analyzing situations of dynamic strategic interdependence. 13. Until the example became too dated, I would tell students in my introductory economics course about John Kareken’s 1983 “Deposit Insurance Reform; or, Deregulation Is the Cart, Not the Horse,” which warned about the dire consequences of deregulating banks while leaving deposit insurance intact. Kareken could not say exactly when or how large the savings-and-loan debacle was going to be, but his pattern prediction that one was coming held up. It represents basic economic reasoning at its best.

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The extent of its spread has been phenomenal: terms like zero-sum game and prisoner’s dilemma have become part of public discourse. Although game theory can be used to model situations of intricate complexity, it is simple enough to be fruitfully employed at the introductory level, at least in its “normal form.” These modifications provide useful tools that help us explain the world better. But, intriguingly, none of them would be considered progressive under the positivist criteria, which require that theoretical advances be ever more testable (or falsifiable) and, hence, able to support more precise predictions. Although at times the evidence is mixed, I think that, in general, the three theoretical approaches just described typically involve theories whose explanatory strength is bought at the cost of less predictive power. Consider game theory first. To be falsifiable, a theory must predict certain specific outcomes and prohibit others. I remember studying game theory in graduate school in the 1970s, mostly in applications involving oligopoly, and I can distinctly remember my professor, Bill Pfouts, complaining about how the theory does not allow us to make firm predictions about market outcomes, like the theories of perfect competition and monopoly did. (Oligopolists can end up acting like joint-profit-maximizing monopolists, or like competitors when they engage in price wars, or somewhere in between. Worse, from a predictive point of view, the outcomes are rarely stable.) That was the positivist era, and predictive impotence was viewed as a severe limitation. Such positivist prejudices help explain why, in its early formulations, game theory was not widely viewed as being a particularly helpful body of techniques. True enough, it helped explain why oligopoly might yield a number of different outcomes, which some might see as an advance. But, by widening the field of possible outcomes, it necessarily forbid less and, thus, was less falsifiable, which any good positivist would have to view as a liability. In more recent years, noncooperative game theory has been praised for sharpening our predictions in situations involving asymmetrical information, particularly in applications utilizing the theory of competitive auctions. This has potential policy payoffs since it suggests ways to organize auctions so as to increase expected revenues (Kreps 1990, 82 – 87; Sutton 2000, 47–57; cf. McAfee and McMillan 1987, 733 –34). In this area, it would seem that advances consistent with the positivist vision have, in fact, been made.14 14. Sutton (2000, chap. 2) discusses two recent success stories: the theory of auctions and the Black-Scholes option-pricing model. In his closing words, however, he cautions

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Other developments, however, seem to confirm Hayek’s thesis. In his Game Theory and Economic Modelling (1990), David Kreps spends much of a chapter titled “The Successes of Game Theory” reviewing a part of the literature in industrial organization in which ever more detailed models of entry deterrence are developed. As details are added to existing models, previous predictions are sometimes overturned. The end result is a multiplicity of very specific models, some predicting one outcome, others another. Whatever its other merits, this procedure reduces the falsifiability of the set of models. If a one-to-one correspondence existed between a model and reality, one might get a firm prediction. But reality is always more complex than the model, so, when a prediction does not hold, there are always a number of alternative specifications that can be tried in its place until the one that fits is found. As Kreps (1990, 104) himself concludes, “Game theorists are very clever individuals, and given almost any form of behavior, they can build models that ‘explain’ the behavior as the result of an equilibrium in a sufficiently complex elaboration of the game originally written down.” In the chapter “The Problems of Game Theory,” Kreps notes that, for certain types of games, there is a proliferation of solution concepts, or, as he puts it, “too many equilibria and no way to choose” (1990, 95). A theory that allows multiple solution concepts is one that prohibits fewer outcomes. In these cases, although the game-theoretic models are better able to capture the complexity of social phenomena, they are again less falisifiable in that they allow us to make less precise predictions. In a review of the impact of game theory on industrial economics, Franklin Fisher commented on this problem as follows: “A great many outcomes are known to be possible. The context in which the theory is set is important, with outcomes depending on what variables the oligopolists use and how they form conjectures about each other. A leading class of cases concerns the joint-maximization solution and when it

about the generality of the results obtained in studies of the former: “A comprehensive analytical survey by Laffont (1997) discusses the extent to which testable predictions can be developed, which depend on directly observable outcomes; this review serves inter alia to underline the fact that the example we looked at in the preceding section [i.e., the theory of auctions] is rather special. Over the general run of situations we encounter in practice, such straightforward predictions are not possible” (57). One wonders, too, whether the fate of Long-Term Capital Management may have taken some of the luster off the second example.

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will or will not be achieved. The answer to the latter question is known to be very dependent on the context and experience of the oligopolists” (Fisher quoted in Backhouse 1997, 20). As Roger Backhouse notes: “The very same words, Fisher points out, could have been used to summarize the state of industrial economics in the early 1950’s, long before the advent of game theory” (Backhouse 1997, 20). Such results doubtless produce deep depression among those who adhere to a positivist vision of science, but they are what Hayek anticipated would occur when we study complex phenomena, and, surely, the dynamic competitive interaction of oligopolists is a topic that meets any criterion of complexity that one might want to propose. Indeed, the tendency for game theorists to produce such “exemplifying” (as opposed to “generalizing”) theory supports the general notion of the limits of our knowledge when dealing with complex phenomena. I will not here discuss more recent developments in game theory and, in particular, the move toward evolutionary game theory, with its promise to expunge the necessity of the “common knowledge” and “rationality” assumptions, except to point out Robert Sugden’s (2001) argument that this apparently fundamental change in the foundations of economics may actually represent a tautological response to analytic problems in the previous program. Sugden’s conclusion—“a genuinely evolutionary approach to economic explanation has an enormous amount to offer; biology really is a much better role model for economics than is physics” (2001, 128)—is one wholly consistent with the arguments advanced in this chapter. What about the economics of information and transactions costs analysis? Both help us understand why certain institutions and organizational forms emerge within certain market settings. Certain aspects of the world that would not make sense under the older theories are suddenly explained. But, again, the not inconsiderable explanatory virtues of these theories are also part of what makes them less falsifiable. And the reason is that, as I just showed, both very explicitly follow the method of situational analysis. What does that have to do with falsifiability? In describing how the method of situational analysis works, Popper insisted that, whenever a theory employing the rationality principle is falsified, the appropriate thing to do is rethink one’s model of the situation. Crucially, one should never reject the rationality principle. By following this methodological principle, one gets “far more interesting and informative” models (Popper 1985, 362). But it also means that, as a matter of methodological principle, the falsification of theories based on the

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method of situational analysis is never taken as grounds for rejecting the theory. Instead, any falsification immediately leads to an ad hoc theory adjustment, a redescription of the problem situation, thereby immunizing the theory from falsification. That Popper’s description of how explanation takes place in the social sciences appears to be inconsistent with his prescriptions about the importance of falsifiability and the avoidance of immunizing stratagems has often been remarked on by methodologists (e.g., Hands 1985a; Caldwell 1991a). Again, I should say what all this means and what not. I think that there has been theoretical progress in economics. We know more now about the problems that arise from informational asymmetries, and the importance of incentives, and how certain institutions have arisen to deal with such problems, and some of that has filtered into our everyday thinking about how the world works. Economists see the world differently from the way we did a half century ago, and that change on net represents progress. That some of this has also spilled over into what I have been calling basic economic reasoning, the undergraduate-level sort of analysis that allows us to make pattern predictions, is also very important. In my opinion, for all the esteem that our profession bestows on mathematical virtuosity when dealing with analytic models, it is progress in basic economic reasoning that really counts when one thinks about what progress can mean in a field that studies complex phenomena. On the other hand, few of the changes that have occurred in microeconomics in the past century confirm the image of our discipline held by economists in the positivist era, for our explanatory progress has come at a cost: either the models that we develop are less directly falsifiable, or (at least when we deal with models that employ situational analyses) it is now a matter of methodological principle not to take falsifications seriously. This is an inevitable result when trying to model complex phenomena. Economists have often not recognized the disjuncture between their rhetoric and reality, perhaps because the ever-increasing mathematical sophistication of our models obscured it, or perhaps because the sheer variety of ways of reinterpreting economic problems as situational analyses has led us to feel that the discipline was progressing. There has been progress. But the progress has been different from that envisioned in the positivist era. Economists have employed positivist rhetoric for decades, but their practice has contradicted it.

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Some Alternative Paths for the Twenty-First Century The endless reconfiguring of initial conditions of economic situational analyses has yielded some theoretical progress. (In my opinion, the most significant theoretical developments have been those that have added to the storehouse of basic economic reasoning.) One wonders, however, whether there might be other ways to study complex social phenomena, other directions in which economics as a discipline might go? It seems to me that there are a number of ongoing areas of research that are consistent with Hayek’s vision, some of which were mentioned in the previous chapter, and any number of which might bear some real fruit in the future. But it also seems to me to be foolish to go into too much detail, for trying to prophesy the future course of knowledge is, as Hayek’s friend Popper famously pointed out, about as fundamental an example of the foibles of historicism as one can imagine. Among current programs with a distinctly Hayekian tenor, the most obvious candidates are interdisciplinary efforts at the interstices of cognitive science and complexity theory, or fields that examine the role of rule-following behavior in the creation of social institutions, or those that undertake historical or experimental or multidisciplinary comparative investigations of the evolution of alternative institutional or organizational forms. As a result, within economics, parts of both the new institutional economics and transactions costs economics have distinctly Hayekian elements, as does certain work in experimental economics, as does work in the biological bases of economic behavior, as do areas like artificial society modeling, even if the proponents of such approaches do not always reckon Hayek as a precursor. Of course, one must also include here the research of those who first and foremost consider themselves as participants in the modern Austrian tradition. The field expands even more dramatically when one considers the need to provide “explanations of the principles” underlying various social phenomena. I claimed that this was something that Hayek began but that much remains to be done. For example, we clearly need a much more carefully and fully articulated theory of complex phenomena. That theory was supposed to have provided the underpinning for Hayek’s methodological claims, but it was one that (it must be admitted) he never really fully developed. As work at the Santa Fe Institute demonstrates, not just economists but also scientists,

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mathematicians, computer specialists, and philosophers from a variety of backgrounds might contribute to such a project. One wonders, too, whether such work might someday be able to identify, in either a general systems framework or within particular fields, the validity of Hayek’s conjecture that there are, in principle, limits to what we can know. Another area that is ripe for study, and one that historians of thought can participate in very directly, is the testing of the theses offered here by examining the historical record to see exactly what sorts of progress actually have occurred in economics and other social sciences. A hopeful sign here is that the fourth annual conference of the European Society for the History of Economic Thought held in Graz, Austria, in 2000 took as its theme the question, “Is There Progress in Economics?” (see Boehm et al. 2002). We also need a better understanding of the nature of the models used in economics and of their relation to the social phenomena that we study. The Research Group in History and Methodology of Economics at the University of Amsterdam has already done a considerable amount of initial work in this latter area. Finally, we would benefit from seeing exactly how the practice of economics compares with that of other disciplines, the natural sciences and the social, those that study complex and those that study simple phenomena. Wade Hands (2001) reports on some of the prospects for this sort of activity in his Reflection without Rules: Economic Methodology and Contemporary Science Theory (2001). A final challenge is to explore the social ontology that informs Hayek’s and other descriptions of social reality. Such investigations would, one hopes, help us understand why certain very simple economic models nonetheless seem able to capture essential features of social reality. We need a better understanding of what lies behind the successes of basic economic reasoning, and one could imagine such an understanding coming from studies from a number of different perspectives. We also need to understand better the relation between human agency and the social institutions that condition human action. Tony Lawson’s fairly well developed critical realist program seems to me to provide an excellent starting point for investigations into such questions of social ontology.15 15. Although he may disagree, Lawson’s “demi-reg” concept (Lawson 1997, chap. 15) seems quite consistent with Hayek’s notion of pattern predictions. Paul Lewis (2002) explores the relation between social structure and agency.

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Getting beyond Positivism I have argued that Hayek’s vision of the subject matter of economics and of the methods appropriate to its study allows us to make better sense of the development of economics in the twentieth century than does that proposed by his positivist antagonists. Another way of testing Hayek’s claims is to note that, if he were right, others certainly would have noticed some of the same things that he did. It turns out that some economists, especially those interested in methodology or the history of thought, have long been making observations that are roughly similar to Hayek’s. For example, the indictments made by Terence Hutchison (1988) and Mark Blaug ([1980] 1992, 111) that most economists fail to engage in anything much better than “innocuous falsificationism” are obviously consistent with the idea that much of economic theory follows the method of situational analysis. The philosopher Daniel Hausman’s (1992, 253 –54) argument that the data that economists have been using offer little hope for crucial tests of their theories is fully consistent with Hayek’s claims about the empirical limitations of economics. Where these analysts differ from Hayek is in their response to what they see happening in economics. Whereas Hayek might take such observations as being the natural and expected outcome when we study complex phenomena, these other observers urge economists to try harder: try harder to falsify, try harder to get better data. Now, as noted above, Hayek may be interpreted as urging us to try harder too, but his principal emphasis was on getting us to recognize, not just the ubiquity, but, even more important, the permanence of these sorts of problems when we study complex phenomena. One does not find that emphasis in the analyses of these other writers. Other writers have drawn still other conclusions from their observations of the practice of economists. Although the philosopher Alexander Rosenberg’s (1992) observation that there has been virtually no improvement in the predictive powers of economic theories mimics Hayek’s views, he concludes that economics is, therefore, not a science. Contra Rosenberg, the outcome is, for Hayek, just what one expects from sciences that study complex phenomena. It also seems to me that Deirdre McCloskey’s (1985) claim that the argumentation of economists is principally rhetoric is also wholly consistent with the views expressed here. We do not establish our theories on the basis of their having survived severe empirical tests. Our belief in them is based,

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rather, on a wide variety of evidence. I doubt that such a claim would ever have been made had economics shown the sort of progress that positivists confidently envisaged half a century ago. Both the birth of the rhetoric movement and the revival of professional interest in methodology are, in many ways, the direct result of the failure of economics to deliver on the promises of positivism. I have been using the weasel word positivism to stand in for that array of empiricist doctrines that dominated the philosophy of science in the first half of the twentieth century and that filtered into the social sciences through a variety of channels. However one might wish to define these doctrines, their impact in economics has been largely malefic. Positivism in its various guises fostered false hopes and permitted self-delusion. It misled economists into thinking that we can, and, indeed, that to be scientific we must, always improve the predictive adequacy of our theories. When this did not occur, more and more resources were devoted to the quest, all in the name of science. Built into all this is a basic failure to recognize that, if economics is a science that studies complex phenomena, by its very nature its prospects for such progress are limited. Such self-understanding is liberatory and counts as knowledge of a sort. It is a hard lesson to learn—but an important one. Our failure to recognize the limitations of economics has cast a long shadow over the discipline. Not only does it affect how some mainstream economists regard their work. But it is also to be found in the writings of people like Mark Blaug, Terence Hutchison, and Daniel Hausman—all of whom hold out the hope that, if we just try harder, “real” empirical progress will be possible—and in Alexander Rosenberg’s charge that reliance on folk psychology prevents economics from becoming a “real” science. If we believe Hayek, economics is a science, but it is a science that studies complex phenomena. For such sciences, a philosophy of science that makes steady improvement in predictive adequacy and the discovery of law-like empirical relations the principal criteria of scientific status or scientific progress is inappropriate. It has now been almost fifty years since Milton Friedman, writing in the heyday of positivism, enshrined prediction as the goal of positive economic science. His goal was clear and noble: to use empirical methods to decide on positive issues and, thereby, to reduce disagreement. We knew a lot less then than we do now about the prospects for such a program’s success. One can always hold out some hope for such an outcome, but to fail to acknowledge the problems with the positivist worldview at this late date is nothing short of a scandal.

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It should, perhaps, come as no surprise that Hayek took a very different view from Friedman on the prospects for empirical work in economics. Indeed, in an interview in the last decade of his life, Hayek put it this way: “You know, one of the things I have often publicly said is that one of the things I most regret is not having returned to a criticism of Keynes’s treatise, but it is as much true of not having criticized Milton’s [Essays in] Positive Economics, which in a way is quite as dangerous a book” (Hayek 1994, 145). It would represent great progress indeed if some leading members of the profession would emphasize the limitations of economic science in their statements to the public and, perhaps more important, in their recommendations concerning pedagogy.16 Unfortunately, as we will see in the next section, there is little evidence to suggest that most of the economics profession has either the ability or the desire to heal itself.

A Final Casualty: The End of History and Methodology? It is as a historian of economic thought that I must speak in conclusion and in a very personal way to a final legacy of positivism in economics. If the positivists had been right, there would have been cumulative progress in the science of economics. Had that been the case, one would have much less use for intellectual history, which apparently deals with the superseded theories of the past. If the positivists had been right, all the relevant true results would, after all, be there to be found in the latest working papers. Paul Samuelson gave a speech to the History of Economic Society in the 1980s in which he stated that the reading lists of certain graduate economics courses at leading universities consisted almost wholly of working papers. One suspects that this is even truer today. It would, thus, appear that many 16. A shining example is the lecture “Identification Problems in the Social Sciences and Everyday Life” given by the econometrician Charles Manski at the November 2002 meeting of the Southern Economic Association. Manski noted that one can usually get a point identification of a variable by making very strong assumptions, whereas one can get “partial” or range identification of the same variable with much weaker assumptions. He argued that the quest for precision often drives economists to ignore the important information that one can get from employing partial identification procedures. Manski’s conslusion was very Hayekian: to understand the limits of what can be known itself constitutes an advance in knowledge.

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economists have accepted the positivist assumptions. The history of one’s discipline has, on this view, little relevance for the scientist. One can study it for fun on one’s own, but it has no importance for the training of scientists. Similar things have been said, of course, about the study of economic methodology. From a positivist’s point of view, there is only one “methodology of economics”—it is what students learn when they train to become economists. We do not need a separate field devoted to the study of methodology. If this portrait of the dominance of the positivist view regarding the status of history and methodology sounds like a caricature, do not be fooled. If anything, it is an understatement. Economic methodology was never a formal field for graduate training, and it is taught today at only a handful of institutions, most of them in Europe. The history of economic thought was formerly considered a legitimate area, but it has since been eliminated as a field of study from nearly every leading graduate institution in the United States.17 As historians of economic thought retire, they are not replaced. The short-term consequences of such disciplinary fratricide are as disquieting as they are evident. Unless they had an undergraduate course in the history of economic thought or enough of an interest in the subject to pursue their studies independently, newly minted Ph.D.’s in economics today increasingly have no knowledge of the history of their discipline. They know the major names—Smith and Marx and Keynes—but their knowledge of these figures’ ideas does not go much beyond the sound bite. Their exposure to less prominent figures, like Ricardo, is far more restricted (“Did he invent the Ricardian equivalency theorem?”). They certainly do not recognize names like Menger or Wieser, or Lerner or Lange, and have, of course, read none of them, not even the most famous. The only history that they know might be dubbed theorist’s history, in which the great name is invoked to set up a problem (“Hayek was concerned about information . . .”), the rest of the time being spent building a model that examines the problem.18 The longer-term consequences of this downward spiral are equally daunt17. There is, perhaps, a sign of hope. In France, a backlash against standard economics education has developed among the students, in the form of the post-autistic economics (PAE) movement. For more on the PAE movement, visit its website at www.paecon.net. 18. A classic example of theorist’s history is Joseph Stiglitz’s (1994) treatment of market socialism. In Caldwell (1997a, 1875 – 86), I argue that, among other costs, such approaches inevitably tend to misunderstand alternative paradigms, such as the Austrian position.

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ing. Economists with no knowledge or appreciation of history are making decisions about its importance in the curriculum. If current trends continue, there will be no more history of thought taught by economists trained in the field, not even at the undergraduate level. (If none are trained in graduate school, there will eventually be no one to teach it at any level.) We will gradually but inevitably lose our touch with history. A science ignorant of its history is a science more likely to be arrogant as well as ignorant—ignorant of both its arrogance and its ignorance. It is also a science more likely to be led astray, more prone to divigations that a knowledge of history might have prevented. It is a sad fate. The argument one hears in defense of this shortsighted practice is always the same. “If we hire a historian of thought, we will not be able to hire an econometrician, or a labor specialist, or a theorist who will be able to work with others in the department and allow us to advance our science.” It is an opportunity cost argument, one that presumes that the contribution made by a historian of thought must, at the margin, always be less than that provided by another sort of economist, indeed, any sort of economist. The argument might make some sense if the positivist vision of science on which it is premised were right. I have argued and provided evidence that the positivist vision is a false one. And it was for the most part those who studied the history and methodology of economics who recognized the nature of the problems that this approach engendered. Most of the observations that I have made in this final chapter are not unique; they have been echoed, as noted above, by many historians of thought and specialists in economic methodology. I do not think that it is an accident that people in such fields, even those who begin from very different starting points, should come to similar conclusions, conclusions that are often quite different from those reached by practitioners of economics about the nature of their work. In their efforts at understanding, historians and methodologists make it a practice to step back from a field, to try to see it in a different light. If the observations that have been advanced here are right, this is an extremely valuable exercise. It implies that many economists have not understood the nature of their own area of study and that, because of the unspoken dominance of positivist ideas, they have been misled about what their discipline can and cannot do. And this has misled them in what they allow to be taught. I doubt that the current direction of economics, the dismissal of history

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and of alternative approaches, would be possible without the positivist hope that the steady agglomeration of new techniques would one day solve the riddles of empirical and theoretical adequacy that have for so long eluded economists. Like the program of the German historical school economists, the positivist vision requires the efforts of many people, all working toward a common goal. One can only hope that this narrow-minded approach will suffer the same fate as the German historical school. But this does not look likely, at least for now. So I end this meditation on a sad note. This has been a history of ideas that began with an account of the origins of the Austrian school of economics. This was a school whose tenets were forged in battle. The first war waged, that between Austrian theorists and German historians who thought that history was theory, was in many ways truly a wasted effort, for it obscured the legitimate roles of both history and theory in understanding social phenomena. The next war was against socialists of many stripes, but particularly those Viennese Marxists who combined a particular socialist vision with positivist doctrines of the proper way to do science. Although his awareness of the German historical school’s errors colored Hayek’s earliest work, for most of his life it was against the combined forces of socialism and positivism that he fought. It was a lonely struggle. But, at least by the end of his life, he could claim that considerable progress had been made against the socialists. The same could not be said about positivism, later variants of which eventually shaped the way in which social scientists, economists prominently among them, came to understand (or, better, misunderstand) themselves. Given his background, Hayek felt from the start that a radically empiricist approach to the subject matter of economics could not succeed, and he came to believe that the theory of his day left out important aspects of social reality, that, indeed, to be a social scientist, one had to understand economics, but that that was not enough. Whatever else one may think about his views, there is certainly evidence that supports his claims about the limitations of economics. And, if his claims are right, they suggest that there may be alternative ways to do economics. That is Hayek’s legacy and his final challenge. This book presents an alternative perspective on my profession’s history. And—I will come clean here about something that is probably already obvious—having taken my cues from Mitchell and Hayek, it is my hope that the story that I have told may help in some small measure to alter my profession’s practice. If the current trend continues, there will be, literally, no historians

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of economics who have been trained as economists to provide future analyses of the discipline. That would be the final casualty of the pernicious doctrines against which Hayek fought for so long. I close with the plea that the trend be reversed, that the history of economic thought be restored to the graduate curriculum. We owe it to our students—and to ourselves.

APPENDIX A

A Translation of Schmoller’s Review of Menger’s Principles It is somewhat awkward to pass judgment on a book that has appeared so far only as a part of a whole. The present first part of Principles of Economics includes theories of: the good, the economy, value, exchange, price, use value and exchange value, the commodity, and money, thus being mainly concerned with elementary concepts and manifestations of economic life. However, a critique of such a part, even if it has been published separately, must try to be fair. In order to form an impartial opinion, we must first try to characterize the author’s orientation. Our author, as a fellow researcher from Austria, extends his greetings to German economics; he is also totally familiar with it, but his point of view is thoroughly independent. His strength lies in abstract, detailed pondering of simple processes; he loves mathematical forms and formulas; the basic idea that dominates him is to ascribe, with consistent urgency, the elementary manifestations of economic life to the simple economic motivation of mankind, the inclination toward the improvement of one’s own economic condition. Thus, we come to a way of viewing things reminiscent of Ricardo rather than the tendencies reigning today in German scientific circles. Lucidity in abstract theory is his objective; very detailed, indeed, tiresomely extensive, discussion of examples, which is much more tied to Robinsonades than to contemporary economic conditions, is the way in which he proceeds. The results are the indubitable products of a not ordinary acumen; but they amount to no more than new formulations of abstract conventional topics rather than actual solutions to real problems. The author presents his point of view in the introduction; he wants to proceed in a way similar to that in which the natural sciences have proceeded; he wants to reduce economic life to its simplest observable elements and acknowledges herewith the following proposition: whether and under what conditions a thing is useful to me, whether and under what conditions it is an This review of Carl Menger’s Principles of Economics (see Menger [1950] 1976) appeared in the 1 February 1873 issue of the Literarisches Centralblatt für Deutschland and was signed “G. Sch.” It has been translated by Thomas Caldwell. The translation incorporates stylistic changes suggested by Stephan Boehm. [ 407 ]

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economic good, whether it has value for me, and whether and under what conditions an economic exchange takes place (from which price will ensue) —all this is independent of my will, just as the laws of chemistry are independent of the will of the practicing chemist. Is this, however, in fact so? Is not the psychological basis of economic life ever changing, according to people and era? Is the author not herewith reviving the old, slanted English fiction, namely, that economic life could be properly derived from the constant basic driving force of the abstract average man? Are not herewith all economic problems becoming for him merely and purely private considerations? The natural sciences have done their precise research with scales and microscopes; the approaches that correspond to them in economics are the historical, statistical, etc.; if the natural sciences wanted to proceed, as Dr. Menger does in economics, they would have to abstractly explore the concept of the cell, the chemical element, and the like and derive their arguments therefrom. This too has its worth and its justification, but it is not so much exact method as speculation about concepts. Herewith is our judgment pronounced on Menger’s book as a whole; it consists of ingenious analyses of some of the basic concepts of economics. For a textbook that would claim to be current, the entire direction of the study is already too one-sided. And perhaps the author would have done better not to have presented the results of his studies to the public in textbook form. It has by now become proverbial that each newcomer to economics begins with a textbook, instead of first proving his legitimacy with research on specific topics.

APPENDIX B

Continuity versus Change in Hayek’s Economics in the 1930s At the end of chapter 8, I noted some changes that began to take place in the direction of Hayek’s research in the 1930s. This raises an issue of historical interpretation. How fundamental were the changes that took place? Did they constitute a break? More generally, should a historian emphasize elements of continuity or elements of change in reconstructing the development of a person’s thought? In Hayek’s case, it is evident that both elements of change and elements of continuity were present, and the issue is, therefore, a live one in the secondary literature. The suggestion of a discontinuity was first raised by T. W. Hutchison, who argued that Hayek underwent a “methodological U-turn” in the 1930s, switching from being an advocate of Misesian apriorism to being a follower of Popper’s doctrines of falsifiability (Hutchison 1981, chap. 7). Other scholars have come down on the side of continuity. For example, O’Driscoll (1977) argued that all Hayek’s work may be read as dealing, in one way or another, with questions of coordination. Jack Birner provides one of the most sustained arguments for continuity in the secondary literature in a series of papers (Birner 1994a, 1994b, 1999b, 1999c), the most fully developed of which is Birner (1999c). I will discuss Birner’s thesis at length because his argument nicely demonstrates both the strengths and the weaknesses of a full-fledged “continuity” approach. It also highlights some of the terminological and other difficulties that typically plague any attempt to categorize Hayek’s thought. Birner’s principal claim is that we are justified in viewing Hayek’s work as a unified “research programme,” that is, as involving the systematic investigation of a number of related problems from the perspective of a predetermined set of methodological principles: A striking feature of Hayek’s economics (and indeed all of his work) is its systematic character. He starts out by stating the problem he wants to solve, and the methodological constraints that a successful solution has to satisfy. Then he gives a historical survey of the solutions that have been

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attempted, which he then analyzes in light of his own problem statement and methodological principles. On the basis of this analytical, historical and philosophical analysis, Hayek gives an outline of his own future research. Subsequently, he starts to fill in the outline. This systematic approach justifies discussing Hayek’s work as a research programme. (Birner 1999c, 53) In explicating Hayek’s program, Birner utilizes Karl Popper’s scheme for the development of theories. A theorist starts with a problem situation, then proposes a theory as a solution to the problem. A theory that is successful (i.e., one that does not get eliminated for containing errors) then gives rise to new problem situations, and so on. According to Birner, Hayek’s original problem situation was to construct an equilibrium model capable of explaining the existence of business cycles. Because business cycles are dynamic disequilibria phenomena, this left him with two distinct problems to solve: how to introduce time into what had been up until then a static model and how to generate cyclical disequilibrium. As we have already seen, Hayek introduced time through his intertemporal equilibrium construct and viewed money as the factor that permitted disequilibria to be generated. These two elements were then incorporated into a theory of the cycle in which changes in the structure of production were taken as constituting the cycle. That theory, however, utilized the simplifying notion of an “average period of production” that was inadequate for dealing with the problems of explaining changes in the overall structure of production. According to Birner, Hayek’s response was to begin reconstructing capital theory along more individualistic lines. The final result was The Pure Theory of Capital (Hayek 1941b), which Birner considers “capital theory in accordance with individualism” (1999c, 58). Because of Hayek’s emphasis on individualism, Birner dubs this line of research Hayek’s individualist subprogram (59). Birner claims that a second subprogram, one that deals with the problem of the mutual coordination of agents’ plans, also emerged during this time period and, ultimately, led Hayek to his theory of markets and competition. He calls this Hayek’s subjectivist subprogram because it has to do with how individuals perceive their environment (1999c, 59). Birner summarizes his thesis with a one-page diagram that shows how each in a sequence of Hayek’s theories was designed to solve a certain problem, with each giving rise to a new problem in its turn (58).

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Birner’s schematic representation allows the reader to see how certain of Hayek’s theories were the natural outgrowth of earlier work, which, in my mind, is its greatest strength. But his thesis also includes a stronger claim— namely, that four methodological principles “guide the development of Hayek’s research programme in economics” (1999c, 56). The four principles, which Birner appears to claim were present in Hayek’s mind right from the outset, are theoretical unification, the method of decreasing abstraction, methodological individualism, and subjectivism. Let us analyze the four principles in turn. If one recalls what was said in chapter 7 about Hayek’s early methodological writings in Monetary Theory and the Trade Cycle ([1933] 1966), it is evident that the first of the principles that Birner identifies is one that we have seen before. Theoretical unification refers to Hayek’s goal of making his cycle theory consistent with existing economic theory. This position, originally articulated by Adolf Löwe, was certainly one that Hayek accepted in his early work. The second principle, the method of decreasing abstraction, should also be familiar. This was the procedure advocated by Wieser, one that was praised by Hayek in his obituary notice (see Hayek 1992e), and (as Birner himself notes) one that was used by Hayek in only one publication, The Pure Theory of Capital. Given his scant use of it, one might question why Birner considers this to be a fundamental methodological commitment of Hayek’s, but Birner’s acknowledgment that Hayek uses it sparingly makes that objection more of a quibble. The last two are in any event the more important of Hayek’s commitments since, in Birner’s view, they give rise to two of Hayek’s subprograms, the individualist and the subjectivist subprograms. Because of their importance to his argument, we should spell out exactly what Birner means here. The commitment to methodological individualism consists of “the demand that all explanations of the business cycle have to be reduced to the theory of rational individual choice, i.e., marginal value theory (Hayek speaks of the pure logic of choice).” The commitment to subjectivism means “that all explanations should involve individual perceptions” (Birner 1999c, 57). Although Birner’s summary of the development of Hayek’s research program has much to recommend it, I disagree with his claim that the four methodological principles that he identifies guided that development from the outset. In particular, I dispute Birner’s characterization that either methodological individualism or subjectivism played any significant role in Hayek’s work on the trade cycle or in his attempt to construct a dynamic model

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of a capital-using monetary economy. I offered my own reconstruction of the criteria that Hayek employed in Monetary Theory and the Trade Cycle in chapter 7, and that interpretation followed very closely what Hayek actually said in his text. Birner’s reconstruction does not, it seems to me, fit the facts. The first problem is perhaps the most obvious one: in his writings on the theory of the cycle in the 1920s and 1930s, Hayek himself seldom ever used the terminology that Birner employs in describing his program. As far as I know, Hayek did not use the term methodological individualism before the 1940s, and subjectivism and its cognates did not start appearing in any meaningful way in his published work until “Economics and Knowledge” appeared in 1937 (see Hayek [1937] 1948a).1 I think that subjectivism did obviously play an increasingly important role in Hayek’s work in that piece and in his subsequent writings on the knowledge problem. But Birner claims that it also informed his theories of the cycle and of a monetary economy. The absence of these terms in those writings certainly raises doubts that he systematically followed these principles in constructing his research program. It may be, however, that Birner is trying to reconstruct Hayek’s implicit program; that is, he may simply be showing us a fruitful way of thinking about what Hayek was doing, even if Hayek himself never thought of it this way. To test this hypothesis, we must examine Hayek’s practice, to see whether the theories he developed from the mid-1920s through The Pure Theory of Capital adhered to the tenets of methodological individualism and subjectivism. Let us take up the question of Hayek’s methodological individualism first. Here, we immediately run into the problem of what the term “methodological individualism” means. Birner’s own definitions are a bit vague in that they include “the theory of rational individual choice,” “marginal value theory,” and “the pure logic of choice.” Hayek surely agreed with the proposition that individual action underlies marginal analysis and that that provides the foundation for the rest of microeconomics. Thus, if all that Birner means is that Hayek accepted the results of microeconomic theory, then little separates us, 1. In both editions of Prices and Production (see Hayek [1935] 1967e, 4), Hayek talks of the “individualistic” method used in “non-monetary economic theory” and contrasts modern “subjective” theory with classical theory. Although he uses the terms, he is talking about what we would today call microeconomic theory, and he is contrasting the subjectivism of the marginalist approach with the (objective) labor theory of value of the classicals. This is quite different from claiming that either methodological individualism or subjectivism provides a starting point for his own monetary theory.

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and our differences may boil down to the question of the extent to which an analysis that presupposes individuals but does not start from them is properly called methodologically individualist. Usually, however, when one says that a person is committed to methodological individualism, it means something more. Because I do not want to quibble about terms, I will begin by offering my own definition. For me, a theory exemplifies methodological individualism if the starting point of its analysis is a description of the choice behavior of an individual agent. There are many ways in which this general commitment might be filled out. Three different possible instantiations of methodological individualism are provided by Carl Menger in his Principles ([1950] 1976), by Ludwig von Mises in Human Action (1966), and by the standard approach taken in undergraduate microeconomic theory textbooks of today. As was shown earlier, Menger began the Principles with the idea that, when human requirements for a good exceed the available quantity of that good, it becomes a candidate for economizing activity. For that to occur, an individual must rank order the satisfactions that he would obtain from various units of the good. From there, Menger shows how the exchange value of a good is established, then how such institutions as trade, markets, and money all come into being as the result of purposeful individual action. Mises takes a somewhat different approach, but, nonetheless, the starting point of the science of human action, or praxeology, is the individual human being, what Mises (1966, chap. 1) called acting man. Finally, standard undergraduate microeconomic theory starts, on the demand side, from an individual consumer’s indifference maps and budget constraints and, on the supply side, from an individual firm’s production function, moving later to firm cost and revenue functions. In each of these cases, even though aggregation to the market level later occurs, the starting point of the analysis is the individual agent. Interestingly, many Austrians would challenge the notion that the mainstream approach constitutes methodological individualism. Stephan Boehm puts the objection nicely: Let’s take perfect competition as the paradigm case. . . . What you have here is pure atomism (there is no need for agents to take others’ moves into account) made possible by the centralizing assumption of price-taking (which, of course, is possible only in equilibrium). Far from being a result of decentralized exchange activities, equilibrium prices in this model are

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just there, inexplicably, from the outset; or else they are imposed on agents by some centralizing agent such as the auctioneer (or, euphemistically, “the secretary of the market”). The model works the better the more negligible the individual agent is. No wonder Austrians of all persuasions are so scathing about this model. No wonder the market socialists were so fond of this model. (e-mail to author, 26 June 2002) In any event, it seems clear that, in neither Monetary Theory and the Trade Cycle nor Prices and Production, Hayek uses neither the Austrian nor the more mainstream definition of methodological individualism. There is no tracing out of what individual agents might do; the whole analysis in both books is carried on in terms of sectors of an economy. Now again, Hayek’s model may presuppose that, absent monetary disturbances, the forces of supply and demand operate as usual. But this is different from providing the actual micro foundations in the model. This Hayek does not do. The evidence that Birner provides for his own interpretation does not seem to me to be compelling. Thus, he states that, in papers published in 1927 and 1928, Hayek employs the “notion of the planning individual” (1999c, 57). The 1928 paper is Hayek’s paper on intertemporal equilibrium (see Hayek 1999b), and, as noted in chapter 7, I think that it is, indeed, a shining example of a methodologically individualist approach. The problem is that it is the only one! I do not see the same sort of method being followed in the other paper that Birner cites, the 1927 paper titled “On the Problem of the Theory of Interest” (see Hayek 1984b). Hayek’s work during this period at best occasionally reflected a methodologically individualist approach; it was not, however, fully committed to it. Birner also notes that Hayek used the phrase the pure logic of choice in “Economics and Knowledge” ([1937] 1948a) and some of his later writings. While this is certainly true, I will show later that what Hayek had to say about the pure logic of choice is nearly the opposite of what Birner’s portrayal implies! Hayek was eager to show that the pure logic of choice applies only to the case of an isolated individual and that, in Hayek’s words, “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” (Hayek [1937] 1948a, 35). This would suggest a very limited role for the pure logic of choice in explaining social phenomena. Birner’s view is quite different: “The reduction of the

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description of all economic behavior, and particularly investment, to the pure logic of choice is the theme of the first branch of Hayek’s research programme” (Birner 1999c, 60). This leads us to Birner’s claim that Hayek’s work on capital theory was also individualist in nature. Thus, Birner asserts that work on an “individualist sub-programme . . . kept Hayek busy for most of the 1930’s”: “It involved finding solutions to mainly technical problems in capital theory, and the introduction of idealizations. One of these is the description of the production processes in terms of single investment processes of which production is supposed to be composed” (1999c, 59). Does Hayek’s approach to the theory of investment reflect methodological individualism? Yes and no. Clearly, one of Hayek’s goals in the years leading up to The Pure Theory of Capital was to replace Böhm-Bawerk’s “average period of production” with a new capitaltheoretic foundation. Because Hayek eliminates reference to averages, one might want to characterize the result as more individualistic. On the other hand, the second part of the book, titled “Investment in a Simple Economy” and containing 150 pages, is carried on in terms of “the economy of an isolated individual, or with that of a communist society where all economic activity is directed by a dictator” (Hayek 1941b, 99). Might not the methodological fiction of a society where all choices are carried out by a Communist dictator be taken as evidence that Hayek did not have a commitment to methodological individualism? 2 Is this not closer to the “representative agent” construct that, according to many Austrians, might look like individualism but really is not? Birner’s final piece of evidence is that Hayek’s objection to the use of aggregates in economics was based on his commitments to methodological individualism and subjectivism. That a social theory whose basic elements are aggregates is inconsistent with methodological individualism is evident: aggregates are not individual human agents. Birner also claims that such theories are inconsistent with Hayek’s subjectivism: “For Hayek’s theory, the perceptions that individuals have of their economic environment (and hence the medium through which individuals perceive their environment) is of crucial 2. As should be evident, the approach taken by Hayek in this section of The Pure Theory of Capital is the same as that used by Wieser in Social Economics (1927). This is why Birner had to include a commitment to “the method of decreasing abstraction” in his list of Hayek’s “four principles.”

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importance. He states this very explicitly from his very earliest writings in economics. Hayek is opposed to the use of aggregates in economic theory because they are not the sort of things which individuals perceive” (Birner 1999c, 60). As was shown in chapter 7, Hayek did, indeed, object to the use of aggregates in Monetary Theory and the Trade Cycle and again in the opening pages of Prices and Production (see Hayek [1935] 1967e). Had he in fact been a devotee of the sort of methodological individualism that insists that one must start one’s analysis from a description of the choice behavior of an individual agent, this surely would have provided him a golden opportunity to advocate the doctrine. He could have said: “The use of aggregates obscures the fact that individual agents are the ones who are making decisions in an economy.” And, were he someone whose theory of the cycle was informed by a commitment to subjectivism, he would have argued that aggregates are not things that people can perceive. But, as was shown, this was not how Hayek argued. Hayek’s chief objection to the use of aggregates was that, to understand how a cycle got started, one had to understand the effects of changing relative prices on various sectors of the economy. He did not put this objection in terms of individuals and their subjective perceptions. Rather, his claim was that theories that focused on aggregates like the price level misunderstood how the economy worked and were liable to lead policymakers to draw wrong conclusions. (For example, those who promoted a policy of stabilizing the price level might believe that an unchanging price level was associated with neutral money, which Hayek denied.) As far as I can see, such a claim has little to do with either methodological individualism or subjectivism. The methodological principles that guided Hayek’s cycle theory work were identified in chapter 7. To be scientific, an explanation must employ a theory. An adequate theory of the cycle must be consistent with equilibrium theory, but it must also show why that theory breaks down when cycles are to be explained. Money is the factor that allows “rigid interdependence” of the closed system of equilibrium to be broken, so an adequate theory of the cycle must be a monetary one. Finally, the theory that results must be able to show the effects of monetary disturbances on relative prices. Each of these methodological precepts played a specific role in Hayek’s system. Jack Birner is to be commended for concisely summarizing Hayek’s long and ultimately unsuccessful struggle to construct an intertemporal equilibrium model of a capital-using monetary economy. His summary is, in my opinion, wholly

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accurate. But his alternative account of Hayek’s methodological commitments, and especially his addition of methodological individualism and subjectivism as driving the development of Hayek’s monetary theory of the cycle, cannot be sustained, not at least without further clarification of what one means by methodological individualism. What is the importance of all this? What implications may we draw from this first look at the continuity-discontinuity debate? I think that there are three. First, I believe that one danger of a reconstruction that stresses continuity is the notion that all Hayek’s ideas were already laid out in the 1920s and that his subsequent work was simply the fleshing out of these ideas. This is obviously not to deny the presence of certain continuities. For example, it is clearly true that Hayek was fascinated throughout his life with the problems arising from a money-using economy and that, from the 1930s onward, he was a critic of socialism. So certain problems remained on his agenda all his life. But, as time went on, Hayek also learned; he changed his arguments and added new ones. That is why I refer to his research path as a journey. To impose a framework is not faithful to the texts, but, perhaps more important, it does less than justice to the man and to his journey of discovery. Another problem with a continuity approach is that it misses the richness of what is, at times, a very rich story indeed. Take, for example, Hayek’s views on methodological individualism. In the theoretical models that he constructed, Hayek rarely started at the level of the individual, yet his early models can also be taken as presupposing that the system adjusts to full equilibrium. In this respect, in his early writings, he probably came closest to accepting the presuppositions that underlie the mainstream approach to economics. As I demonstrate in chapter 12, in his later methodological writings, Hayek indeed explicitly comes out in favor of a variant of methodological individualism. But, by this time, his preferred variant had little in common with that endorsed by mainstream neoclassical economists and can, indeed, be viewed as a criticism of it, especially of the construct known as rational economic man. In its broad outlines, his variant shares certain similarities with Ludwig von Mises’s praxeological “science of human action,” yet his first explicit discussion of it may be read as a criticism of the apriorist elements in Mises’s formulation. The blanket statement that Hayek was a methodological individualist misses all this. Indeed, perhaps a more reasonable conclusion to be drawn from these considerations is that the term methodological individualism has been used in so many different ways that, without qualification, it

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is no longer helpful and should be banished from the vocabulary, at least of those who would describe Hayek’s ideas.3 Finally, getting the interpretation wrong here sets one up for all sorts of misinterpretations later. For example, one commonly hears the bland and seemingly uncontroversial assertion: “The Austrians are methodological individualists.” Not only does this miss the differences that exist in the Austrian camp, but it can lead the incautious to believe that the Austrians endorse the same variant of methodological individualism as mainstream economists do when they should instead recognize the them as critics of it. This has led to people as diverse as Robert Lucas, who thinks of Hayek as a precursor, and Geoffrey Hodgson, who has written that Hayek endorsed the neoclassical version of methodological individualism, into errors of interpretation. Furthermore, if one believes that Hayek was a committed methodological individualist of a certain type, then his decision to endorse group selection for the explanation of certain social phenomena must appear like a dramatic mistake. But, once one recognizes that Hayek’s own substantive work in economics may have presupposed but rarely started from an analysis of the individual decisionmaker, then the fact that he thought that still other approaches might be fruitful for the analysis of certain other social questions becomes much less of a problem. 3. This seems to be the position of Greg Ransom, who, in a post to the list-serv [email protected] dated 29 November 1995, notes five different definitions of methodological individualism, all of which exclude or falsify in one way or another (his reading of ) Hayek’s approach. Ransom concludes his post with the query: “Why retain this misleading term ‘methodological individualism?’ I don’t see how this term helps communication at all.”

APPENDIX C

Hayek’s Transformation Redux I titled my article discussing Hayek in the 1930s “Hayek’s Transformation” (Caldwell 1988). T. W. Hutchison subsequently challenged my characterization, so this is a good place to revisit our differing interpretations. It was appropriate for Hutchison to challenge my reading, for “Hayek’s Transformation” began as a critique of a chapter of his 1981 The Politics and Philosophy of Economics, on the Mises-Hayek-Popper relationship. This is the same Terence Hutchison, by the way, who criticized Robbins on methodology in the 1930s. There is some further background to our debate that may be of interest. I first encountered Hutchison’s views when writing my dissertation, which served as the basis for my book on methodology, Beyond Positivism (Caldwell [1982] 1994a). In that study of the development of methodological thought in economics in the twentieth century, Hutchison played a prominent role, for, as we saw in chapter 9, he was the person who introduced a philosophically justified version of positivism into the literature on economic methodology. I tended to be critical of Hutchison’s position; my book’s theme was, after all, that we should move beyond positivism. My book also included a section on the methodological views of one of Hutchison’s chief nemeses, Ludwig von Mises. In the heyday of positivism, Mises’s apriorism could be (and had been—recall Paul Samuelson’s assessment, reported on in chapter 5) dismissed out of hand. It seemed to me that, if we were, indeed, in a postpositivist age, then Mises’s position needed to be reexamined. In my book and a subsequent paper (Caldwell 1984), I attempted to do so. Using the Austrian position as a case study of how criticism takes place in economics, I argued that the old positivist arguments no longer worked very effectively, then went on to offer some alternative arguments against Mises’s position. Apparently, I was unclear, for Hutchison and others (e.g., Rotwein 1986; Hirsch 1986) got the impression that my main goal in criticizing positivism was to rehabilitate Mises’s apriorism (for my reply, see Caldwell [1986]). In case anyone has any doubts, let me state for the record that, as I think was also true of Hayek, I do not now and never have in the past accepted Ludwig von Mises’s apriorism. Indeed, I spent a considerable amount of time during my post-doc year studying Austrian economics at [ 419 ]

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NYU trying to convince a number of Austrians to abandon their commitment to apriorism.1 Be that as it may, in The Politics and Philosophy of Economics, Hutchison distinguished between a Hayek I and a Hayek II. Although the argument is subtle and nuanced, Hutchison’s basic claim was that “Economics and Knowledge” ([1937] 1948a) marked Hayek’s turning away from Misesian apriorism and toward the falsificationist methodology of Karl Popper. In my investigations, I came to the conclusion that Hayek did not undergo such a methodological U-turn in the 1930s. Both Hutchison and I agreed that “Economics and Knowledge” contains a criticism by Hayek of Mises’s position. But I claimed that Hayek had never been a follower of Mises’s apriorist approach. I argued further that Popper’s influence on Hayek was not evident in the 1930s, that it did not come until much later, and that, when it did come, the relation between their ideas was more complex than Hutchison’s story implied. I put my arguments against Hutchison’s position in what may seem an unnecessarily provocative way in my “Hayek the Falsificationist? A Refutation” (Caldwell 1992a), and that led to an undeniably bombastic further exchange with Hutchison (see Hutchison 1992; and Caldwell 1992b). One reason I was so tenacious in my argument was that I had by that time gotten a letter from Hayek responding to some of my queries on this specific issue. Hayek’s letter did not mention anything about apriorism, but he did suggest that I was right about his relationship with Popper. About the latter, he also included a line that said “(not for quotation!),” so I could not cite his letter in print in my defense. I will now simply quote from another letter that I subsequently discovered in the Hayek Archives. The letter is to Terence Hutchison and is dated 26 November 1981 (i.e., about a decade before our own exchange). Hayek begins with praise for Hutchison’s The Politics and Philosophy of Economics, then goes on to say: The main intention of my 1936 lecture was to explain gently to Mises why I could not accept his a priorism. Curiously enough, Mises, who did not readily accept criticism from his juniors, accepted my argument but insisted that it was not incompatible with his view which, by implication, he 1. I have only recently looked more carefully at Barry Smith’s attempt to rehabilitate an alternative apriorist approach (see chap. 5, n. 20). I have yet to reach any conclusions about Smith’s proposals, although, as I mentioned earlier, his intriguing claim that his approach is compatible with fallibilism would, if true, remove one of my chief objections to apriorism.

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restricted to what I called the Logic of Choice or the Economic Calculus. I left it at that, but I did want to say that I was never an a priorist, though I would still insist that part of the essential knowledge of the economist or the social theorist generally is derived from his given familiarity with the processes of human thinking. (Hayek 1981c) In his comment on my paper, Hutchison referred to “recent statements in letters from Hayek” and how they make matters of interpretation difficult (Hutchison 1992, 19). He probably, therefore, put more emphasis on the second clause of Hayek’s last sentence above, whereas I put emphasis on the first. I would note, however, that, even if Hutchison read Hayek’s letter in this way, “familiarity with the processes of human thinking” seems to me to be something quite different from Mises’s version of apriorism. But, from this further evidence, one can see once again how hard it can be to pin Hayek down on the matter of his adherence or opposition to apriorism. In any event, if I was right that the change was not principally a methodological one, a question still remained: What was the change that Hayek referred to in his reminiscences, a change that he explicitly and repeatedly linked to the publication of “Economics and Knowledge”? The goal of my 1988 “Hayek’s Transformation” was to develop an alternative account of what was happening to Hayek in the 1930s. In the paper, I traced Hayek’s gradual movement over the period 1928 – 41 away from equilibrium theory and into all sorts of new areas of investigation; that is, I told pretty much the same story that I told here in the text, and it is to that story that I wish to stick. I say pretty much because, in “Hayek’s Transformation,” I left out “the Swedish connection,” that is, the fact that two of the ideas contained in “Economics and Knowledge” (that equilibrium for an individual is different from equilibrium for a society and that “foresight that is in a certain sense correct” is central to the idea of equilibrium) can be found in Hayek’s Copenhagen lecture (Hayek [1939] 1999d), a fact pointed out by Foss (1995).2 The Copenhagen lecture also prompted Morgenstern’s criticism of Hayek, which caused 2. Foss’s addition is a welcome one, but I disagree with another claim that he makes, namely, that Hayek’s earlier work also contained the other two insights that I identified as major themes of “Economics and Knowledge.” Foss’ own words are these: “As Hayek suggests in 1933, dispersed and subjectively held knowledge was integral to his early business cycle theorizing” (Foss 1995, 347). Contra Foss, I do not think that either subjectivism or dispersed knowledge was present in, and certainly was not integral to, Hayek’s work before 1937.

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him to alter his views somewhat in “Economics and Knowledge” from those taken in his earlier lecture. So those two parts of the story are additions to my previous account. My initial failure to cite Hayek’s Copenhagen lecture was, by the way, due to a unique circumstance of time and place: the University of North Carolina at Greensboro library did not have a copy of the book in which the lecture is found!

APPENDIX D

The “Scientism” Essay as Rorschach Test One reason that I am particularly sensitive to matters of interpretation when it comes to the “Scientism” essay (Hayek [1942 – 44] 1979e) is that I have studied it on at least three separate occasions, each time seeing things that I had not noticed before. I first came to the paper in the context of my debate with T. W. Hutchison (see appendix C). Recall that Hutchison had argued that Hayek underwent a methodological U-turn in the 1930s, moving away from the apriorism of Mises and toward the falsificationist philosophy of Karl Popper. Given that “Scientism and the Study of Society” was published in the early 1940s, I felt that, if what Hutchison said was true, it was reasonable to expect that one might discern some evidence of Popper’s influence in it. My goal, then, was to find that evidence—if it existed. It turned out that it did not. The narrowness of my focus, however, led me to an equally narrow reading of the essay. Not only did I miss much that was there, but I was also led to at least one conclusion that I now think is just plain wrong. I said: “The ‘Scientism’ essay is Hayek’s most important methodological work. . . . [V]irtually all of Hayek’s later writings on methodology simply extend themes found in this essay; little of importance was added in the intervening years” (Caldwell [1988] 1989, 79).1 I still think that the “Scientism” essay is an important methodological piece and that Hayek would retain in later work many of the conclusions reached in it, in particular those having to do with limits on our ability to predict. But, in later work, those limitations would apply when one was dealing with complex phenomena. The distinction between natural and social phenomena that played a central role in the “Scientism” essay was dropped. I think that that is a significant enough emendation of his ideas to warrant a retraction of my statement that “little of importance was added in the intervening years.” The next time I worked with the “Scientism” essay was when I was preparing an essay on Hayek for The Handbook of Economic Methodology (Caldwell 1998a). There, I tended to emphasize the significance of Hayek’s method1. The quotation comes from the original English version of an article published in French, to which the citation refers. [ 423 ]

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ological individualism, which (again) I still think is an important part of the essay. However, my views about how best to read Hayek’s position on methodological individualism have since undergone modification. I returned to the “Scientism” essay for a third time on a family trip to Disney World, but, perhaps more important, I had readThe Sensory Order (Hayek [1952] 1967h) not long before. That time, it seemed that the essay was just filled with ideas that would later be spelled out in more detail. That experience influenced how I wrote the first draft of chapter 11. The chapter was discussed in a seminar at the London School of Economics by a group of people who had just read the “Scientism” essay but who had not yet read The Sensory Order, and they found my reading, shall we say, idiosyncratic in its emphases, something that they were quick to point out to me. So, when I say that the “Scientism” essay would serve well as a Rorschach test, I know of what I speak. With that as background, I will review a few other interpretations.

The “Scientism” Essay as Conspiracy Theory Thomas Uebel (2000) examines the “Scientism” essay together with Karl Popper’s The Poverty of Historicism (see Popper [1944 – 45] 1960). Noting that arguments against scientism like those offered by Hayek and Popper typically carry “a moral-political sub-text,” Uebel adds that sometimes “such arguments carry an additional sub-text of another type” (Uebel 2000, 151). His goal is to help the modern reader uncover the various subtexts, then to assess the adequacy of the arguments against their “‘hidden’ opposition” (151). Uebel makes three key points. His first is that Hayek and Popper had ulterior motives in attacking historicism and scientism. Although their essays appear to be about methodology, they are really about politics. Thus, in Hayek’s case: “Though Hayek did not name it so, his enemy was scientific socialism —the view that a scientifically guided socialist transformation of capitalist economies and class-structured societies is possible. . . . Here emerges the deep agenda of Hayek’s polemic. His concern lay with the normative political debate about the principles along which society should be organized. Hayek sought to show that his political opponents are operating with a deeply flawed conception of scientific knowledge: the topic of social science methodology was but means, not end” (Uebel 2000, 154). The chief evidence of Popper’s collusion in this dark plot against socialism is that, although he criticized Hayek’s natural science–social science split using the same sorts of

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arguments as would be employed by the logical empiricist philosopher Ernest Nagel, Popper’s criticisms were muted. In seeking to explain Popper’s gentleness (Popper the critical rationalist was not, after all, known for holding back when it came to criticism), Uebel speculates: “One wonders whether Popper muted his criticism at least in part because he shared Hayek’s latent agenda” (154). Next, because “the positions correctly attacked by Hayek and Popper are so extreme as to count as virtual straw-men for all but the crudest of anticommunist crusades” (Uebel 2000, 159), Uebel hypothesizes that they must have had another, “real” target. Of all the contemporaries mentioned by Hayek in the “Scientism” essay, only Otto Neurath and Bertrand Russell favored full-scale central economic planning. After pointing out Neurath’s previous connections with the Austrian school economists, Uebel draws the obvious conclusion: “We do well to remember here what Hayek does not note explicitly, that Neurath was the central villain of Hayek’s in his introduction to his edition of essays Collectivist [Economic] Planning [(1935) 1975] and even still before that of von Mises in his original paper on the calculation problem of 1920 [Mises (1935) 1975] and his book-length refutation of socialism [Mises (1936) 1981b] built thereon. . . . Neurath apparently is the one twentieth-century theorist upon whom Hayek can with at least prima facie plausibility pin the joint sins of scientism and comprehensive planning theory” (Uebel 2000, 160 – 61). Adding that Neurath’s adherence to a “conventionalist-pragmatist conception of the empirical basis of science” made him “a central figure of opposition” for Popper in the 1930s, Uebel then allows that the attack was not so much directed against Neurath personally as it was directed against his ideas: “It is the philosophy of social science propounded by logical empiricism that was placed in the dock” (161). Uebel’s final claim is that Hayek’s argument against Neurath does not work, or, more positively, that “politicized logical empiricist philosophy of social science does not fall foul of reasonable strictures on objective social science” (Uebel 2000, 165). A related claim here is that Hayek and Popper misconstrued the content of Neurath’s physicalism, that, in particular, “Neurath’s naturalist methodology did not preclude reference to intentional phenomena” (166). This reading is supported by a quotation in which Neurath acknowledged that it was possible “while avoiding metaphysical trappings” to obtain predictions of human action based on what people plan and intend, although Neurath added that behaviorism allows one to reach far better predictions (see Uebel 2000, 166).

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Thomas Uebel is a leading authority on Neurath and has played no small role in both the “dehomogenization” of the Vienna Circle and the rehabilitation of Neurath among philosophers. He knows the historical context intimately. So I must admit that parts of his article mystify me. I am baffled first of all by all the talk of dark conspiracy, which permeates the article: of Neurath as the “‘hidden’ opposition,” of the “deep agenda of Hayek’s polemic,” of his “latent” versus “manifest” agendas, of Neurath as “the true whipping-boy of two of the most distinguished polemics,” of their “clearly political animadversion,” of how their “rhetoric of disembodiment and decontextualization worked its ruse brilliantly” (Uebel 2000, 151, 154, 158, 162, 163). What is strange in the first instance is Uebel’s pose that he is shocked that there might be “political” elements in all this. Of course there were political elements! The whole point of Hayek’s Abuse of Reason project was to show how, when transferred into the social realm, certain ideas about science and its possibilities lead to disastrous consequences. In particular, Hayek believed that the scientistic worldview made it seem possible, maybe even easy, rationally to reconstruct social institutions as socialists of all stripes wanted to do. He lays this all out in the final three sections of the essay; in contrast to Uebel’s claim, he manifestly did “name it so.” It might be added that this was not at all a paranoid delusion of Hayek’s, nor was he guilty of attacking straw men. The views that he was criticizing palpably existed, as the first section of chapter 11 above amply demonstrates, and, indeed, they retained their popularity long after Hayek and Popper wrote their essays.2 2. Let me provide but one example. In the last chapter of his widely read and influential Rede Lecture, The Two Cultures (1965), C. P. Snow wrote about the growing gap between the industrialized countries (among which he included the Soviet Union) and the nonindustrialized. Snow felt that the gap could and must be closed, possibly by the coordinated efforts of the United States and the Soviet Union. His remarks about the process are a study in the scientistic worldview, the engineering mentality writ large, all of it ironic enough given his putative mission of bridging “the two cultures.” Snow begins with the assertion that there are no real technical obstacles to closing the gap: “It is simply that the technology is rather easy.” He continues: “For the task of totally industrializing a major country, as in China today, it only takes will to train enough scientists and engineers and technicians. Will, and quite a small number of years.” If either the United States or the Soviet Union tried to do it alone, it would be a task comparable to war mobilization, but, if both worked together, “it wouldn’t mean that order of sacrifice— though in my view it’s optimistic to think, as some wise men do, that it would mean no sacrifice at all.” It requires “trained scientists and engineers adaptable enough to devote themselves to a foreign country’s industrialization for at least ten years out of their lives”:

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For his part, Neurath was actually far more politically involved than Hayek ever was, as Uebel well knows. As is fully documented in a book that Uebel coauthored, Neurath was tried for high treason for his participation— as the head of the Central Economic Administration—in the short-lived first and second Bavarian Soviet Republics, which formed in April 1919. He was convicted of assisting high treason and sentenced to a year and a half in prison, although he ended up serving less time (Cartwright et al. 1996, 49 – 56). Neurath was also someone who was quite willing to accuse those whose views differed from his of being politically motivated.3 But the point is: Why does the fact that all the principals had strong political views during this trying time count as evidence of some sort of dark, hidden agenda? 4 “Here . . . the Russians have a clear edge. This is where their educational policy has already paid big dividends. They have such men to spare” (Snow 1965, 44 – 47). Revisiting the lecture four years later, Snow offered the following emendation: “I made judgments which were totally unlike those of my critics. Some of mine were wrong: in the Rede Lecture, I much overestimated the speed of Chinese industrialization. But the more significant ones, now that time has passed and we can check some of our guesses, I see no reason to change” (1965, 98). Snow of course was not the only one in the West to misjudge the Soviet Union or China during this period; indeed, such errors were common. (One wonders, however, who the “wise men” were who thought that it would involve “no sacrifice at all” to industrialize China totally in ten years.) His faith that technology alone (and the will to use it) is all that is necessary to end world poverty, with no discussion of the myriad social and economic institutions that must also be in place for development and reform to be successful, is the part of his message that best represents the scientistic worldview. 3. Neurath (1973, 356) contrasted the motivations of those who did and those who did not attach themselves to the scientific worldview as follows: “On the whole the representatives of metaphysically directed sociology are at the same time representatives of the ruling order. Most governments and other centres of power favor metaphysically inclined scholars, even theologising ones, whereas they are mostly suspicious of anti-metaphysically inclined scholars. . . . Conversely, the revolutionary masses of workers and the groups attached to them become more vigorous through anti-metaphysical physicalist sociology, and above all the fight against metaphysics and theology means the destruction of bourgeois ideology.” 4. In Cartwright et al. (1996, 49 –56), Neurath is portrayed (and, indeed, this was a key to his trial defense) as “not political” (in the sense that he had no interest in securing a position of political power within any particular party structure), as simply a forceful bureaucrat whose only motivation was to get his socialization scheme put into place. Within the context of the Hayek-Neurath discussion, however, his commitment to full socialization would still allow us to describe him as harboring “political” convictions.

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Perhaps Uebel takes this approach because it makes it easier to support his second thesis, that Otto Neurath was the real target of Hayek’s and Popper’s essays. I cannot speak for Popper.5 But, in Hayek’s case, it seems evident that Uebel misunderstands the purpose of Hayek’s larger Abuse of Reason project. To be sure, Neurath was one of Hayek’s opponents. In the “Scientism” essay, Hayek was fighting in part against behaviorism. And Neurath’s eliminative physicalism, a doctrine that called for the elimination from science of all claims that make reference to unobservable states, provided a philosophical justification for the behaviorist insistence that any reference to intentional states was just “metaphysics.” So it was certainly one of Hayek’s goals to offer arguments against physicalism. But, as was argued in the text, this was only one part of a much larger project, one that surveyed a wide array of arguments as they developed through time. Hayek really was trying to argue against supporters of scientism both past and present. His extended treatment of people whom Uebel considers to be “straw men” was not just some ruse to camouflage his criticism of Neurath. Uebel’s passing comment that Neurath was the “chief villain” of Hayek’s Collectivist Economic Planning (see Hayek [1935] 1975) is also strange. It just was not so. Neurath was mentioned in the book, of course, because, as was noted earlier, it was his proposal concerning in natura calculation that “provoked” Mises to write his 1920 essay on socialist calculation, and that essay is translated in the collection (see Mises [1935] 1975). Recall that Mises found Neurath’s proposals incredible, as did, it turns out, nearly everyone else, in5. Hacohen (2000) does not address the question directly, and his text offers evidence that could be used to support either reading. On the one hand, Hacohen notes: “Historicism’s identity and the political concerns that gave rise to [The Poverty of Historicism] have remained obscure” (358). On the other, Neurath’s “arguments on sociological prediction and historical laws were precisely those Popper later labeled historicist” (361), and “no view of science aroused Popper’s indignation as much as Neurath’s” (362). Hacohen’s final statement on the Popper-Neurath relationship is worth extended citation: “Neurath embodied the politico-methodological syndrome of historicism. He was the single thinker who combined the naturalist and antinaturalist doctrines of historicism, synthesizing positivism, Marxism, and Historismus. Still, Neurath was not the issue; the syndrome was. Popper underestimated him, as the circle members did. He thought of him as a politician, not a thinker. His name did not come up in discussions of [The Poverty of Historicism] with Simkin. He was part of the background, but Popper would not waste his time arguing against him when he could argue against Marx and Mill” (373).

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cluding many prominent Marxists (Chaloupek 1990, 662 –70). When Mises went on to write his book against socialism (see Mises [1936] 1981b), he (like the later Hayek) had many opponents in mind and many arguments to offer, as even a quick perusal of the book’s table of contents demonstrates. Neurath was an impetus, but, once he had been criticized, Mises moved on to more serious opponents. Neurath was still propounding his ideas about in natura calculation, first developed prior to the First World War, in the 1940s. That would be sufficient reason to mention this aspect of his thought in passing in the “Scientism” essay. But, as was the case with Mises, it is hard to imagine that Hayek took this part of Neurath’s program very seriously; people like Mannheim or various market socialists were much more formidable opponents.6 So it is hard to credit Uebel’s charge that Neurath was really Hayek’s hidden political opponent. To the extent that Neurath was a target, it was due to his perceived support of physicalism and, more broadly, of positivism, the latter a doctrine that generations of Austrian school economists had opposed. Uebel’s final claim—that Hayek and Popper misread Neurath’s philosophical position—is to me the most intriguing portion of his paper. Hayek clearly believed Neurath to be an advocate of physicalism. His belief was based on the following sorts of statements, taken from Neurath’s “Empirical Sociology,” where Neurath spells out the doctrine in some detail: Physicalism encompasses psychology as much as history and economics; for it there are only gestures, words, behavior, but no “motives,” no “ego,” no “personality” beyond what can be formulated spatio-temporally. (Neurath 1973, 325) To one who holds the scientific attitude, statements are only means to predictions; all statements lie in one single plane and they can be combined, like all parts from a workshop that supplies machine parts. Physicalism knows no “depth,” everything is on the “surface.” (326) The problem of “matter” or “mind” is solved by the disappearance of the theory of the “mind”, leaving nothing but the theory of “matter”: only physics remains. All genuine science can only be physics. (360) 6. I suspect that Hayek shared Popper’s opinion of Neurath, as summarized in Hacohen’s lengthy description (see n. 5 above). Neurath’s continued enthusiasm for in natura calculation would have provided Hayek with ample reason to dismiss him.

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Sociology on a materialist basis deals therefore only with relations of men with men or with their environment. It knows only of such behavior of men that one can observe and “photograph” scientifically. . . . [S]ociology treats men in the same way as other empirical sciences treat animals, plants and stones. It is a doctrine of “behavior” in the widest sense; it is “social behaviorism.” . . . Sociology on a materialist foundation knows no effective structures which are not spatial and not temporal. (361) Uebel is the expert on the thought of Neurath. If he thinks that these sort of statements do not accurately represent Neurath’s true beliefs or can be made to cohere with his own portrayal of Neurath’s views, then more from Uebel on the matter would be welcome.7 The “Scientism” Essay as Hermeneutics: Foundationalist, Realist, Postmodernist, or Austrian? A more prominent reading of the “Scientism” essay is that it represents an “interpretive turn,” or a turn toward hermeneutics, for Hayek. An influential early proponent of this view was G. B. Madison, who claimed that “Hayek’s critique of scientism in the human sciences is a call to his readers to make the interpretive turn” that “is evidenced by his maintaining that human affairs can properly be understood only in light of the category of meaning, a category which is, quite understandably, absent from the physical sciences” (Madison 1989, 172). Madison reproduces a variety of statements—for example, “the human sciences deal with the interactions between humans and things or between humans and humans”; “[the human sciences] must start from what men think and mean to do”; “so far as human actions are concerned the things are what the acting people think they are” (Hayek [1942 – 44] 1979e, 41, 57, 44)—statements that he weaves together to support his contention. A number of other scholars also accept the presence of hermeneutical elements in the “Scientism” essay, among them Burczak (1994), Fleetwood (1995), Lawson (1997), Oakley (1999), and Runde (2001). Their readings, however, differ considerably. Tony Lawson is an advocate of critical realism, of 7. Hacohen (2000, 261–75) expresses skepticism about the historical veracity of some of the recent scholarship that aims at rehabilitating the Vienna Circle, referring to the reinterpretations as “ingenious but strained” (262). Agassi (1998) is even less impressed with recent work, especially the effort to portray the circle critic Karl Popper as a foundationalist.

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bringing social ontology into economics as a remedy for what he sees as the defects of generations of “positivist” influence there.8 Although praising Hayek for his early foray against positivism, Lawson claims that Hayek ended up defending what is, from his own critical realist perspective, a “suspect and cumbersome hermeneuticism” (Lawson 1997, 145). Thus, Hayek’s claim that the data of the social sciences are the opinions, beliefs, and attitudes of individual agents is viewed as too restrictive. For Lawson, it is evidence that Hayek’s theory lacks an adequate social ontology, which requires recognition that intransitive and layered social structures condition human behavior: “Hayek’s social scientific ontology is not restricted to phenomena given in direct experience, but also includes the opinions, beliefs and attitudes of others. However, it does not extend to structures at once both social yet irreducible to individual conceptions” (140). Indeed, such statements by Hayek that “things are what people think they are” provide further evidence that individual conceptions are about all there are for Hayek. That Hayek insists that the opinions of individual agents must not be further analyzed is taken by Lawson to show that his “position is indeed a foundationalism of an atomistic, individualist, sort” (148). And that Hayek describes agents’ opinions as “facts” is taken as further evidence that the Austrian had not fully escaped the positivist worldview that he criticized, with its emphasis on objective facts. Fleetwood (1995) provides a similar reading, like Lawson from the perspective of how well Hayek’s ideas might be fitted into a critical realist framework. Other scholars, however, even some who broadly support the critical realist program, challenge Lawson’s interpretation. Jochen Runde (2001, 5) argues, “contrary to Lawson’s reading, that Hayek’s social structures (1) do have an existence over and above the conceptions of the individual actor and (2) serve as a precondition for human action on the lines proposed by critical realism.” Runde defends his first thesis by showing that Hayek indeed refers to the existence of such social structures in his essay and that Hayek’s 8. I put scare quotes around the word positivist to indicate that Lawson and I differ in our use of the term positivism. In Beyond Positivism ([1982] 1994a, chaps. 2 –3), I identified various forms of positivist thought, among them logical positivism, operationalism, and logical empiricism. I also argued that, although the rhetoric of positivism suffused the methodological writings of economists, few practiced it because it could not be put into practice. For Lawson, mainstream economic practice exemplifies positivism. His definition includes a Humean concern with a search for strict empirical regularities and the use of deductive methods.

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discussions of the similarity of agents’ classifications and of the possibility of intersubjective communication both point toward his acceptance of an intransitive social reality. He defends his second thesis by demonstrating that, in Hayek’s discussions of “persistent structures and relationships” and “social wholes,” such entities “serve as an (often unacknowledged) precondition for action and the further development of society” (14). While Runde focuses explicitly on the narrow question of the veracity of Lawson’s interpretation of the “Scientism” essay, Allen Oakley (1997, 1999) pursues the broader project of using parts of the Austrian tradition to reconstruct a more fully subjectivist economics. Oakley thinks that Lawson’s critical realism “is the most fundamental starting point for subjectivists in search of a methodology,” but he criticizes Lawson’s suspicion that, when hermeneutics is combined with subjectivism, all reference to a structured social reality existing beyond the conceptions of agents is surrendered: “My alternative is to envisage critical realism and hermeneutics as consistent, compatible and complementary methodological strategies required to maintain a subjectivist ontology. Hermeneutics is to be envisaged as the means of inquiry that will enable economics to achieve the ‘deep’ analytical insights that are the hallmark of critical realism” (Oakley 1999, 16). Oakley challenges Lawson’s reading of the “Scientism” essay, arguing: Very early in his researches Hayek had formed a vision of agents contending with an existentially independent and intransitive world of reality. . . . For Hayek, agents must be depicted as necessarily having a conceptdependent vision of their external world. In forming this vision, they may well fail to represent the given reality completely or correctly because they rely on the mediation of an ultimately subjectivist mind. The result is that agents potentially exhibit a contingent remainder in their individual conduct that cannot be reliably or fully tied back to their situational conditions. This is not because they have a purely relativist vision, but because their interpretations and reasoning are fallible. (142 n. 1) Oakley offers his own interpretation of key passages in the “Scientism” essay and argues that in contemporaneous work—for example, “The Facts of the Social Sciences” ([1943] 1948b)—Hayek made statements indicating that he adhered to a “realist vision of the existential independence of the world confronted by acting agents” (Oakley 1999, 133). Oakley further demonstrates that, when more fully developed in Hayek’s The Sensory Order ([1952] 1967h),

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the ideas regarding social phenomena found in the “Scientism” essay support a realist reading.9 Other treatments of Hayek’s work also stress the hermeneutical elements to be found there. One of the more provocative is Ted Burczak’s claim that Hayek’s “discussion of subjectivism and the constituents of perception combined with his emphasis that people are rule-following as well as purposeful creatures produces a theory of human agency which, I believe, is aptly characterized as nonessentialist, or postmodernist” (Burczak 1994, 46 – 47). That such a reading is at odds with Lawson’s claim that Hayek was unable to eradicate the positivism from his hermeneutical framework and with Oakley’s claim that Hayek’s work on perception is wholly consistent with a realist reconstruction of subjectivist economics is likely evident. It should perhaps be mentioned that some within the Austrian camp have also stressed the general compatibility of the Austrian approach with a hermeneutical one. One of the most vocal of these was Ludwig Lachmann; I know because he tried to recruit me. I quote here from his letter to me of 11 March 1987: To take your main point first: Why am I anxious that we establish our eligibility for membership of the Hermeneutics Club? What matters to me is our access to a broad reservoir of ideas that, at this moment, look interesting; our ability to meet in the club lounge (and not by appointment), informally, a number of interesting people and exchange thoughts with them. What use we are going to make of our club membership, how often we visit it, are quite different matters. I am anxious that we establish our eligibility. Perhaps the cuisine is not to our liking or more likely, has its ups and downs. Perhaps they serve at the bar a vodka that is bad for our health. If so we shall have to take obvious precautions. What matters is our ability to participate in the commerce of ideas. 9. It seems to me that Runde and Oakley have established that a realist reading of the early Hayek is both possible and plausible. In further support of their reading, let me point out that the problematics explored by Hayek in both “Economics and Knowledge” ([1937] 1948a) and “The Use of Knowledge in Society” ([1945] 1948g) presuppose the notion of an independently existing reality, one that is constituted in part by the beliefs and intentions of other agents but includes other social and natural phenomena, from prices to production processes.

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Let me briefly give you three examples of harm we have suffered in the past when we had no such broad reservoir to fall back on. The 1930’s were a decade of calamity anyway. When in 1938 Hutchison hit out at Austrian methodology, Robbins gave in. He had no reservoir of general ideas to fall back on. Knight, by contrast, had one, but its texts were mostly in German and thus, in 1940, not much good in the Anglo-Saxon world. Thus in his 1940 paper he had to improvise, to write as Max Weber would have written had he confronted Hutchison. Finally, who could doubt that Shackle would have had much less difficulty establishing himself as an authoritative thinker on human action if he had been able to draw on a broad body of thought, of general ideas. (As a matter of fact he did not even draw on Bergson!) As you say, there are of course “dangers of association.” There is the possibility that the more radical deconstructionists take over the Hermeneutic movement. Seems to me that our chance to stave off such an event will be greater to the extent to which we have established an accredited place within the Club. (Caldwell 1991b, 143) Lachmann chastised Hayek for his failure to explore hermeneutics and teasingly referred to him as a “positivist” (Caldwell 1994c, 310).10 Returning to Hayek: We have seen that the claim that Hayek embraced a hermeneutical approach in the “Scientism” essay seems to be both ubiquitous and uncontroversial. But it also creates some interpretive problems of its own, for there is much less evidence of a commitment to hermeneutics in Hayek’s later work. A fundamental claim of the hermeneutics approach is that interpretation is unavoidable in the human sciences, specifically because 10. Lachmann had followers of his own, as the volumes edited by Kirzner (1986), Lavoie (1990b), and Koppl and Mongiovi (1998) attest. In addition to his formidable mind, Lachmann’s kindly manner and his possession, like Keynes, of a bewitching voice made him especially popular among some of the younger Austrians. Lachmann’s major economic contributions were in the theories of capital and expectations. His praise of G. L. S. Shackle for extending subjectivism to an analysis of expectations (the Lachmann problem, as Koppl [1998b] calls it) made his work a bridge between certain Austrians and post-Keynesians. For others, however, it was evidence of his “radical subjectivism.” Lachmann also emphasized the market as a process and argued for replacing Max Weber’s notion of an ideal type with the praxeological notion of “the plan.” Some representative citations are Lachmann (1956, 1970, 1976). For some Austrian hermeneuticist writings, see Ebeling (1986, 1990) and Lachmann (1990).

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their subject matter differs from that of the natural sciences. Whereas the natural sciences study inanimate objects, both the “objects of study” in the human sciences and the researchers who study them are interpretive beings. When in subsequent work Hayek proclaimed that the natural science–social science split is less important than that between simple and complex phenomena, he was downplaying, perhaps even dismissing, the hermeneutical insistence that different methods of study are necessary in the social sciences. Those who read the “Scientism” essay as providing evidence of Hayek’s interpretive turn must deal with this fact. For people like Tony Lawson and Steve Fleetwood, of course, it’s all’s well that ends well. They take the later writings about rule-following behavior and spontaneous orders as showing that Hayek moved beyond his early (and, in their opinion, unfortunate) flirtation with hermeneutics to a view that appreciates that the actions of human agents are conditioned by their encounters with a structured reality.11 For someone like Oakley, for whom hermeneutical elements are an essential aspect of an envisioned new realist theory, it is little short of a disaster. Here is Oakley’s response to Hayek’s change in methodological focus: “Hayek began his critique and research in these directions with much promise, focusing on the problem as one of human ontological veracity as the crucial precondition for methodological design. . . . [F]or reasons that remain less than fully clear, he was induced to retreat from a position of defending a subjectivist ontology as the irreducible conditioning factor in economic theory construction. The emergent and inherently confusing alternative was one of compromise that made the object distinction in economics merely a matter of greater complexity. . . . That Hayek reached a point where he seemed unaware of this is mystifying” (Oakley 1999, 127–28). Madison, too, is saddened by Hayek’s “retreat,” which he blames in part on the nefarious influence of Karl Popper. That some of Hayek’s later writings indicate that he did not wholly accept Popper’s views is taken as a faint ray of hope. 11. Lawson (1997, 200) acknowledges that the “hermeneutic moment is fundamental for any social science.” His doubts about the hermeneutical approach seem most evident when hermeneutics is linked with individualism. Antagonism toward individualism is evident in the work of some other critical realists, as well: note Lawson’s (1999, 56) blunt statement that “the conception of a structured ontology sits uneasily with any form of individualist position.” Neither Runde nor Oakley appears to share this antipathy toward individualism, however.

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If one focuses on the hermeneutical elements in the “Scientism” essay, a number of questions naturally arise. What was going on in Hayek’s head when he wrote the essay? Was he self-consciously propounding a hermeneutical approach? Did he actually take, or at least start to take, an “interpretive turn”? If so, why did he seem to back away from it in his later writings? And, if not, why did he sound so much like an advocate of hermeneutics in the essay? These are extremely hard issues to decide, not the least because the evidence points in so many different directions. My own reading is that Hayek never really took the interpretive turn. He did, however, supply scientific grounds to support the methodological dictum that reference to intentional states will always be necessary in explaining and interpreting human behavior. So, although he was not a hermeneuticist, his scientific research supported the idea of the practical necessity of a “verstehende” psychology. Hayek sounded like a hermeneuticist in the “Scientism” essay when he insisted that “opinions” (or beliefs, desires, and intentions) are the fundamental data of the social sciences and that one can understand human actions only by interpreting them as being based on the opinions of the acting agents. His criticisms of various scientistic doctrines would also appeal to hermeneuticists. He shared their disdain for behavioral psychology, an objectivist program that denied the legitimacy of explaining behavior by reference to intentions. He attacked collectivists for failing to realize that acting human agents, not putative social aggregates like society or the state, are the appropriate focus of attention in the social sciences. And he scolded historicists for their emphasis on supposed laws of history, laws that ignored human agency. In all these arguments, Hayek sounded like a hermeneuticist. On the other hand, in making his arguments, Hayek never invoked the key idea that explanation in the social sciences is different from explanation in the physical sciences precisely because both researcher and subject are interpreting agents. For Hayek, the necessity of interpretation was not limited to the social sciences. He included examples drawn from the social sciences, of course—the recognition of a “friendly face” or a “threatening gesture” come to mind. But these were side by side with examples from the physical sciences (the levers and pendulums example) as well as everyday life (the hammer example). For Hayek, perception itself was an act of interpretation. That we classify some of our stimuli as friendly faces and others as hammers did not for him signal a significant difference in kind; both were interpretations. Hayek made this point explicitly in his subsequent work in psychology. But he also

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insisted that, as a practical matter, we will always have to refer to beliefs, desires, and intentions (what he calls mental terms) when we interpret human actions: “In some ultimate sense mental phenomena are ‘nothing but’ physical processes; this, however, does not alter the fact that in discussing mental processes we will never be able to dispense with the use of mental terms, and that we shall have permanently to be content with a practical dualism, a dualism based not on any assertion of an objective difference between the two classes of events, but on the demonstrable limitations of the powers of our own mind fully to comprehend the unitary order to which they belong” (Hayek [1952] 1967h, 191). I believe that Hayek’s hesitancy to take the “interpretive turn” was based on his commitment to a scientific worldview. His opponents were people who thought of themselves as true scientists but whom Hayek considered to be pretenders to the mantle of science. His was to be a scientific rebuttal of scientism. Hermeneutics, with its origins in the exegesis of sacred texts, was too literary in orientation, too extrascientific, to serve his purposes. His opponents were the same as those of the hermeneuticists, but his tactics were very different. Or, at least, that is the interpretation that I favor. Further support for this reading is offered in chapter 12. I will close with a final comment on the various interpretive projects mentioned above. Some of them appear to share my goal of explicating what Hayek was up to when he wrote the “Scientism” essay. This is certainly the case for Uebel, and it seems to be the case for Madison, who says that the “Scientism” essay is Hayek’s “call to his readers to make the interpretive turn” (1989, 172). In such cases, my alternative reading competes with theirs. Some of the other projects are quite different, however. Oakley (1997, 1999) clearly wants to use relevant bits and pieces of Hayek’s work in constructing a new approach to the methodology of the social sciences. His frustration with Hayek’s apparent “reversal” is real, not surprising given his desire to incorporate hermeneutics into a realist framework. For his part, Tony Lawson already has a fairly well developed realist framework on offer. When he reads earlier writers like Hayek, his goal seems to be to see how much of Hayek’s work coheres with his own preferred position. These projects are similar to those within the Austrian tradition that attempt a synthesis of the work of Mises, Hayek, and others in constructing a modern Austrian economics. While I certainly have no objection to this sort of project, two things should be made clear. First, they are not trying to explicate what Hayek himself was up to when he wrote what he wrote, so their

438 ] appendix d

accounts do not directly compete with mine or with those of any historian (like Uebel) who tells a different story from mine. Second, when they assess the value or the consistency of Hayek’s contribution, they do so from within the framework of their own larger story. This should not count as criticism of Hayek’s position. Thus, for example, if Hayek himself was not trying to develop a realist ontology, it is hardly fair to criticize him for falling short of providing one. In such cases, his only sin, if sin it be, was a failure to anticipate the preferred frameworks of later writers.

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INDEX abstraction, theoretical, 69, 75, 90 Abuse of Reason project, 181, 231, 232, 240, 241n, 253 – 60, 280, 284 – 85, 305, 319, 339, 426, 428 action. See human action Althoff, Friedrich, 41n, 62, 79, 79n, 86 Althoff system, 62, 80, 86 – 87 analytic-synthetic distinction, 125, 195 –96 Anschluss, 138, 139n. 6 anticipations. See expectations apriorism: and analyticity, 125n. 20, 222 – 23; Hayek’s multiple uses of the term, 222 –23; and Kant, 274n. 10; in Mises, 1–2, 112n, 124 –26, 125n. 21, 129, 149, 190, 192 –96, 200n, 220 –23, 328 –29, 409, 417, 419 –21, 423; and Robbins, 191–96, 330 –31, 382 assumptions: realism of, does not matter, 331; realisticness of, 336n; unrealistic, 333 –36, 336n, 387 assumptions, fundamental. See postulates of economics atomism, 70 –71, 73 Austrian academic system. See higher education, Austrian Austrian economics: and the German historical school, 46 – 48, 77–78, 127; history of, 4, 8, 17, 28 –32, 80 – 81, 100 – 106, 126 –30; and institutionalism, 77, 77n. 9, 348; literature on, 12; at New York University, 1; and other marginalist approaches, 31–32; recent contributions to, 228 –29, 326 –27, 326n Austro-Marxism, 99, 104 –7, 113, 128 automata: logic of, 278n. 15, 299, 362; theory of, 303

behaviorism, 123, 143, 282n. 18, 436; criticized by Knight, 184n, 248; criticized by Robbins, 189; criticized in the “Scientism” essay, 247–50, 259, 284; criticized in The Sensory Order, 270 –73, 272n, 273n. 9, 341; endorsed by Mitchell, 153, 154n. 3, 184 – 86, 202, 270, 332; and physicalism, 270 –73, 272n, 273n. 9, 425, 428, 430; and positivism, 273n. 9, 336 Benham, Frederic, 210, 210n, 212 Berlin, 49, 54, 76n. 7, 86, 89, 107, 108, 114 Bernal, J. D., 235, 238n. 2 Bertalanffy, Ludwig von, 278n. 14; and general systems theory, 303 – 4, 307, 362 Beveridge, Sir William, 173, 199, 236; on capitalism and fascism, 233, 238, 239, 339; and Keynes, 174 –75, 174n. 8; and the LSE, 168 – 69, 168n. 3, 170n. 4 biology, 299; and economics, 353, 397; group selection in, 302n. 19, 309, 315, 353 –54 Birner, Jack, 143, 277, 300 –301; and Hayek’s “methodological research programme,” 409 –18 Bismarck, Otto von, 42, 54, 57– 62, 101; Hayek on, 60n. 15 Blaug, Mark, 126, 312, 374, 399, 400 Boehm, Stephan, 140n. 9, 142n, 143n, 147n. 17, 212 –13, 407, 413 –14 Böhm-Bawerk, Eugen, 134, 138, 177, 179; critique of the Marxist theory of value, 102 –5; early years of, 28 –30; later contributions of, 80 – 81; and the promotion of marginalism, 32, 80 – 82, 127; seminar of, 8, 100 –101, 103 – 6, 110, 113 – 14

Bartley, W. W., III, 254n, 316 –18, 317n. 33 Bauer, Otto, 104 –7, 105n

calculation debate, socialist: Englishlanguage, 108, 199, 214n. 6; German-

[ 473 ]

474 ] index calculation debate (continued) language, 116 –19, 119n, 215; Hayek’s contributions to, 119n, 199, 215 –20; influence of, on Hayek’s thought, 209 – 10, 215 –20, 224; Mises and, 144, 116 –19, 210, 215, 425, 428 –29; Schumpeter on, 225n Cambridge: Circus, 176; and the LSE, 167–71; University of, 148n cameralism, 41– 43, 47, 50, 55, 61, 67n, 78 Cannan, Edwin, 167, 169, 171 capital theory, 9, 28, 176, 177n, 226 –27, 227n. 14, 228, 297n. 10, 410 –12, 415, 434n Carnap, Rudolf, 3n. 4, 272n Carr-Saunders, A. M., 355n Catchings, Waddill, 171–72 central planning, 118, 216 –20, 225; comprehensive, theory, 425; and democracy, 234, 239 – 40; in interwar England, 232 – 41; and Lange, 215 –20; under liberalism, 238, 238 –39n. 3, 358; mentality, 358; and Neurath, 114 –17; and positivism, 340; scientific, 117, 234 –38; and socialism, 198 –99, 215 –20, 232 – 41, 251–53 Chicago, 304, 306, 312; University of, 233, 297, 297– 8nn. 10, 11, 312 choice, pure logic of, 207, 221–22, 411, 414 –15, 421 Christie, Will, 309n. 27, 342n circle (Kreis), defined, 92n. See also Geistkreis; Miseskreis; Vienna Circle classical economics, 328; German reaction toward, 44 – 48, 50, 55, 61, 75, 198; and the market mechanism, 197; Menger on, 26 –27, 72 –74, 126; Mitchell on, 184 classification: as act of interpretation, 271–72, 436; and agent-based computational models, 366 – 68; as discussed in the “Scientism” essay, 242 – 44, 248 –50,

259; explanation as an act of, 276, 344 – 45; impossibility of explaining a more complex, system, 249; the mind as a, system, 259, 264 – 67, 293, 342; in the natural sciences, 242 – 43, 262 – 63, 275; observation as, 243, 248 – 49, 271, 307, 343, 436; as rule-following behavior, 307, 314, 366 – 67; system of the natural sciences, 275, 275n; systems, 366 – 67 coercion, 280, 289, 291 Collectivist Economic Planning (Hayek), 199, 209, 214 –17, 428 Committee on Social Thought, 297, 298n competition: as a discovery procedure, 219 –20; market, 216 –20, 225, 337–38, 410; in Menger, 24 –25, 37; perfect, 338, 349n, 393, 413; rivalrous market, 219, 338 complex adaptive systems, 361– 68, 367n complex phenomena, 11, 177n, 228, 230, 250, 278 –79, 326, 328, 361– 68, 370 –73, 375, 394 – 400, 423; simple phenomena vs., 255, 284, 301– 6, 310 –12, 346, 371, 398, 435 compositive method, 285; in Menger’s Principles of Economics, 20 –23, 47; in the “Scientism” essay, 245, 256, 279, 315 Comte, Auguste, 98, 247, 250, 253, 254, 298 constitutional political economy, 238n. 3, 358 – 61 Constitution of Liberty, The (Hayek), 256, 261, 280, 305 – 6, 341, 346 – 47, 358; rules, orders and evolution in, 292 –96, 352; summary of, 288 –92 constraints: situational vs. system, 334 constructivism: rationalist, 358 –59; social, 238n. 3 coordination of knowledge. See knowledge, coordination of Cowles Commission, 297n. 10, 331n, 339n. 13

index critical rationalism, 312n Crowther, J. G., 235, 236, 238n. 2 crucial experiments/tests, 370, 373, 399 Crusoe, Robinson, 27, 50, 187 cybernetics, 303 – 4, 309, 362 cycle, business, 151–54, 156 – 64, 368n. 36 Darwin, Charles, 295, 295 –96n. 7, 303 data, 370, 399, 436; constancy of, 209; fragility of empirical results from, 377– 78; given, 210, 210n, 212, 214; objective, 207– 8, 212 –13, 225; subjective, 207– 8, 212 –13, 220 democracy: German view of, 44, 78; liberal, 237; and planning, 234, 239 – 40 Descartes, René, 279 diamond-water paradox, 26 –27 Dickinson, H. D., 215 –16, 218, 235, 288 – 89; and the mathematical solution, 216 Dobb, Maurice, 215 dynamic equilibrium theory. See equilibrium theory, dynamic econometrics, 378 –79, 401n economic models. See models, economic economic policy, 230n, 376, 379 – 80, 416 economic reasoning, 382, 382n, 391–92, 397–98; ceteris paribus clause and, 384; examples of, 383 – 86, 385n, 392n; formal economic modeling vs., 330n, 330 –31, 333, 335 –36, 387; and Friedman, 385 – 86; not dependent on unrealistic assumptions, 333 –36; and pattern prediction, 335n, 372, 392n, 396; in Robbins, 191, 330 –31, 382, 384 economics: agent-based computational, 366 – 68; behavioral, 332 –33, 360n; experimental, 334 –35, 352, 353n. 23, 361, 361n, 387, 397; of information, 338 –39, 388 – 89, 391, 392, 395, 396; limitations of (see progress, absence of, in economics); mainstream, 331n, 332, 336,

[ 475

400; neoclassical, 331n, 77, 127, 334, 365, 367, 417, 418; transactions costs, 389, 391, 392, 395, 397; of the transition from old to new, 348, 360 “Economics and Knowledge” (Hayek), 2 –3, 421–22, 421n, 433n; Hayek’s legacy in, 337–39; origins of key ideas in, 209 – 14, 220; role in the development of Hayek’s thought, 205 – 6, 220 –30; and the socialist calculation debate, 214 – 20; summary of, 206 –9 economizing activity: in Menger, 20 –21, 23 –25, 34 –35, 47; in Mises, 121 Eisenach conference, 56 emergent phenomena, 309, 309n. 27 emerging recalcitrant results (ERRs), 376 –77, 376n. 4, 380 empirical studies, 157–58, 174, 297n. 10; Hutchison on, 201–2, 209, 230, 332; and institutionalism, 161, 185 – 86, 202, 209; Robbins on, 189 –90, 189n; in twentieth-century economics, 373 – 82 Engels, Friedrich, 101–2, 105 engineering mentality, 252 Enlightenment: French, 281, 295; German reaction to, 41, 43, 52; Scottish, 25, 279, 281, 284, 294n, 295 –96, 295 –96n. 7, 306, 316 entrepreneur, 216 –19 entrepreneurship, 330n Epistemological Problems of Economics (Mises), 120 –21, 123n. 18, 125n. 21, 192, 221 epistemology, evolutionary, 317 equality, before the law vs. material, 291 equilibrium: construct, 155 –56, 224 –30; as defined by the compatibility of plans, 208, 211–13, 224, 226; of the individual, 196, 207– 8, 210, 221–22; intertemporal, 155 –56, 155n. 5, 172, 410, 414; order vs., 306n; societal, 207–13, 221–22; stationary, 217–19; stream

476 ] index equilibrium (continued) metaphor as a replacement for, 226 – 27, 227n. 14, 318; tendency toward, 208 equilibrium theory: dynamic, 160, 163 – 64, 179 – 80, 188; general, 4, 108 –11, 143n, 163, 177, 327, 363, 365, 367; Hayek on, 143n, 155 –56, 159 – 60, 202, 207–13, 221–22, 224 –30, 301– 6, 324 –25, 421; in Schumpeter and Walras, 108 –11, 143n; static, 5, 10, 154n. 4, 155 –56, 159 – 60, 217–19, 224 –30, 324 –25, 363, 365; weakness of, for describing the market process, 224 –30 error: in Hutchison, 201; in Menger, 33, 47, 67 Essay on the Nature and Significance of Economic Science, An (Robbins), 182, 200, 328; and the basic postulates of economics, 187– 88; and empirical studies, 189 –90, 189n; and psychology, 188 – 89; and the rationality assumption, 189 –96, 330 –32; and the scope of economics, 186 – 87; second edition of, 191–96; and value-freedom, 187 eugenics, 355n evolution: and complex phenomena, 301– 6; cultural, 295, 314 –16, 352 –55, 360 – 61, 364 – 65; and rules, 298, 309 – 10, 313 –16, 357, 359; in The Sensory Order, 277–79; social, 295; and spontaneous orders, 262, 278, 294 –96, 309 –10, 313, 316, 346, 352, 357–58, 361 exact theoretical orientation: Menger’s defense of, 67–72, 111; Menger’s description of, 65 – 67, 129; Weber on, 90 –91 expectation, perfect. See perfect expectation expectations: in Hayek, 180, 202, 209 –14, 224; in Lachmann, 434n explanation, covering law model of, 311 “explanation of the principle,” 247, 259,

275 –77, 310, 340 – 41, 370, 372, 382 – 83, 387– 88, 397; definition of, 383; and evolutionary theory, 302, 302n. 20, 304; and other fields, 303 –5, 383 fallibilism, 125n. 20, 420 falsifiability, 304 –5, 310 –12, 312n, 346, 399; of recent theoretical advances in economics, 393 –96 falsification, 2, 194n fascism, 233 –35, 239 Fatal Conceit, The (Hayek), 227n. 15, 314 – 19, 356, 358, 367 Ferguson, Adam, 279, 280 Finer, Herman, 148n, 257–58 fine-tuning, 368n. 36 First World War, 9, 39n. 2, 83, 84, 95, 108, 113, 114, 118, 168, 182, 215, 429 forecasting, economic, 151n, 158, 230n, 377–78, 381 foresight, perfect. See perfect expectation Foster, William Trufant, 171–72 free trade, 37, 40, 45, 59; origins of, 23, 315 Freiburg, 86, 297 French Revolution, 41– 43, 78 Friedman, Milton, 92, 145n, 233, 297– 98n. 11, 385; on methodology, 164, 203, 329, 329n. 2, 331–32, 379 – 80, 386, 386n, 400 – 401; and positivism, 379 – 80, 400 – 401; and Rose Friedman on positive vs. normative issues, 379 – 81, 381n. 6 game theory, 211n, 332n. 6, 355, 360, 389 – 90; evolutionary, 390n, 395; and falsifiability, 393 –95; and situational analysis, 392 –93 Geistkreis, 140 – 41, 140n. 9, 145n, 151, 195 general equilibrium theory. See equilibrium theory, general General Theory, The (Keynes), 108, 174, 176, 179, 179n

index German historical school, 254, 328, 356n. 27, 404; background on, 42 – 48; decline of, 83 –99, 119; and ethics, 40, 44, 55, 86 – 87; and institutionalism, 154, 154n. 4, 162, 198 –99, 198n; introductory remarks on, 39 – 41; of law, 25; and new institutional economics, 40; older, 45 – 46; revival of interest in, 12, 39 – 41; as a rival of Austrians, 8, 13, 78 – 82; Robbins on, 188; Schmoller’s place in, 49 –53, 250; similarities and differences with Austrian thought, 46 – 48, 77–78, 127; and social institutions, 40; and socialism, 54, 198 –99; and social reform, 40 – 41, 54 –57, 59 – 61, 84 – 85, 94, 197– 99; younger, 48 –53, 250 –51 grade distribution analogy, 350 –52 Great Depression, 119, 151n, 175, 233 group selection, 283, 286, 299, 352 – 61; in biology, 302n. 19, 309, 315, 353 –54; and cultural evolution, 314 –16, 352 –55, 360 – 61; and methodological individualism, 356; and the naturalist fallacy, 356 –57; and the origins of moral codes, 354; and sociobiology, 355 Haberler, Gottfried, 140, 147n. 18, 200n, 221, 301n. 17 Habilitation, 18, 28; Hayek’s, 151 Hacohen, Malachi, 6, 134, 134n, 196n. 8, 203n. 12, 428n, 429n, 430n Haldane, J. B. S., 235, 238 Hands, Wade, 391, 391n, 398 Hayek, F. A.: assessing the contribution of, 13, 324 –25, 328, 337–39, 339 – 60, 362; in Cambridge, 148n; challenge to economics, 13, 370 – 405; in Chicago, 297–99, 304, 306, 312; and the Chicago seminar, 298 –99, 299n. 14, 304; early life of, 133 –35; family and personal life of, 133 –35, 133n, 150 –51, 297, 297n. 9; introductory remarks on, 2 –7, 9 –13; in

[ 477

London, 73, 148n, 172 –75, 206, 232, 306, 327; multiple legacies of, 323, 326 –27, 337–39, 341– 45, 355, 360 – 69; in New York, 73, 144n, 150, 196 –97, 327; and The Road to Serfdom trip, 258n; in Vienna, 133 – 46, 150 –51, 171 Hayek, F. A., and (person): BöhmBawerk, 134, 138; Clark, J. B., 150; Dickinson, 215 –16, 218, 288 – 89; Finer, 148n; Foster and Catchings, 171–72; Friedman, 145n, 164, 297–98nn. 10, 11, 401; Haberler, 200n; Hutchison, 230, 230n, 409, 419 –21; Kaufmann, 97n, 140 – 41, 195 –96, 195nn. 6, 7, 200n; Keynes, 177–79, 179n, 214n, 289, 401; Knight, 209, 297n. 10; Lachmann, 145n, 434; Lange, 217–20, 218n; Löwe, 157– 63, 324 –25; Mach, 136 –37, 137n, 250, 273, 273n; Machlup, 140, 145n, 147; Mannheim, 234, 239 – 40, 252, 253, 339, 429; Menger, 20, 23, 139, 139n. 8, 212 – 13, 213n, 254, 254n, 284; Mises, 120, 141, 143 – 49, 145n, 213, 220 –23, 254, 409, 419 –21, 423; Mitchell, 150 –54, 154nn. 3, 4, 174, 196 –97, 327; Monakow, 136; Morgenstern, 140, 158, 211–12, 211–12n, 214, 299; Myrdal, 179 – 80, 211; Neumann, 212n, 278n. 15, 299 –300, 300n, 303, 362; Neurath, 253, 257, 257n, 424 – 30, 429n; Polanyi, 145n, 238, 238n. 2, 294, 294n, 307n, 308n. 26; Popper, 144, 145n, 203, 254n, 255, 258 –59, 300 –301, 304 –5, 307, 308, 308n. 26, 310 –12, 317– 18, 346, 359n, 397, 419 –20, 424 –26, 428, 428n, 429, 429n, 435; Rathenau, 118n; Robbins, 133n, 172 –74, 187, 189, 195 – 96, 199, 218n, 236 –38, 238 –39n. 3, 254, 327–28; Schumpeter, 143n, 147– 48, 148n, 150, 225; Schütz, 97n, 140 – 41; Spann, 136 – 40; Weber, 141, 151, 173, 254; Wieser, 28 –29nn. 8, 9, 141– 43, 143n, 164, 223n. 11, 411, 415, 415n

478 ] index Hayek, F. A., and (subject): the Abuse of Reason project, 181, 231, 232, 240, 241n, 253 – 60, 280, 284 – 85, 305, 319, 339, 426, 428; aggregates, 152 –53, 161– 62, 305, 415 –16; anti-Semitism, 145 – 46n; apriorism, 149, 196, 220 –23; behaviorism, 143, 154n. 3, 247–50, 270 –73, 272n, 273n. 9, 284; capital theory, 176, 177n, 180 – 81, 180n, 226 –27, 227n. 14, 297n. 10, 410 –12, 415; capital-using monetary economy, theory of, 176, 177n, 180 – 81, 411–12, 416 –17; complex phenomena, 177n, 228, 230, 278 –79, 284, 301– 6, 310, 361– 68; denationalization of money, 206, 288n. 1; empirical studies, 157–58, 174, 209; equilibrium theory, general or static, 143n, 155 –56, 159 – 60, 202, 207– 13, 221–22, 224 –30, 301– 6, 324 –25, 421; evolution or evolutionary theory, 262, 277–79, 298, 301– 6, 309 –10, 313 –16, 352 – 61, 364 – 65; expectations, 180, 202, 209 –14, 421; “explanation of the principle,” 247, 259, 275 –77, 302 –5, 302n. 20, 310, 340 – 41; group selection, 286, 302n. 19, 314 –16, 352 – 61; historicism or the German historical school, 198 –99, 250 –51, 254, 328, 356, 356n. 27; institutionalism, 151–54, 198 –99, 209, 328; knowledge, 206 –9, 211, 213 –14, 224 – 26, 228 –29, 244, 277, 281, 337–39, 412, 421n; Marxism, 141; methodological individualism, 156, 162, 223n. 11, 256, 261n. 1, 279, 281– 87, 286n, 287n, 411–18, 412n, 418n, 423 –24; monetary theory, 155 –57, 160 – 64, 288n. 1, 298n. 11, 324 – 27, 410, 412, 412n, 414, 416 –17; pattern prediction, 247, 304 –5, 310; political theory, 292 –96, 346 –51; psychology, 136 –39, 262 –79, 282, 285 – 86, 306, 341– 46, 356, 436; rules and orders, 292 –96, 298, 306 –10, 313 –16, 352, 357–59, 361– 68; scientific methods, unity of, 299,

311; scientism, 241– 60, 280, 339 – 41; socialism, 119n, 181, 199, 209 –10, 215 – 20, 224, 280, 338 –39; spontaneous orders, 135n. 3, 177n, 228, 230, 279 – 80, 294, 294n, 298, 306 –10, 313, 316, 352, 357–58, 361– 68; stabilization of the price level, 152 –53, 155, 155n. 6, 161– 62, 416; statistical approaches, 152 –53, 157–58; subjectivism, 210, 212 –13, 223n. 9, 410 –12, 412n, 415 –16; trade cycle theory, 151– 64, 172 –74, 209, 228 –29, 324 –27, 410 –12, 414, 416 –17. See also The Constitution of Liberty; “Economics and Knowledge”; “Individualism: True and False”; Monetary Theory and the Trade Cycle; “Scientism and the Study of Society”; The Sensory Order Hayek, John Maynard von, 175n. 8 hermeneutics, 98, 253, 277, 346, 362, 430 – 37, 435n Hicks, John, 176, 179 higher education, Austrian, 18 –19, 80; and rivalries with German higher education, 8, 13, 78 – 82, 127 higher education, German, 41n. 6, 42 – 43; Böhm-Bawerk and Wieser’s experience with, 28; and rivalries with Austrian higher education, 8, 13, 78 – 82, 127; Schmoller’s influence on, 61– 63, 79 – 80; Weber’s reaction to, 85 – 87 Hilferding, Rudolf, 103 – 4, 107 historicism. See German historical school; “Scientism and the Study of Society” history of economic thought, 371, 374, 399; and disciplinary self-understanding, 371; effects of positivist thought on, 401–5; and the German historical school, 39 – 40; Hayek’s reading of, 196 –99, 327–28; Menger’s reading of, 72 –73; Mitchell’s reading of, 184 – 85,

index 196 –97, 327; Schmoller’s reading of, 50 –52 history of ideas, 12 –13, 372, 374 Hodgson, Geoffrey, 287n, 296n. 9, 348 Hogben, Lancelot, 234, 236, 238, 238n. 2, 253, 339 homo economicus. See rationality assumption Horwitz, Steven, 326n, 353n. 24 Howson, Susan, 173n, 179n human action, 243 – 44; as intentional or purposive behavior, 122 –23, 190 –91, 193 –94, 248 –50, 254, 260, 269 –70, 413, 433; Mises on the science of, 120 –26, 129, 413, 417; Mises’s claim that all is rational, 122 –23, 123n. 18, 190; necessity of interpretation for understanding, 248 –50, 277; necessity of using intentional language in describing, 254, 260, 276 –77, 285 – 86, 437; rationality assumption vs., 77; status of the axioms of, 124 –26, 129, 192 –96; unintended consequences of, 246, 250, 391n Human Action (Mises), 123n. 18 Hume, David, 88n. 5, 229, 279, 293, 347 Hutchinson, H. H., 165 – 66 Hutchison, Terence W., 199n, 200n, 204, 312, 326, 434; on the German historical school, 46, 77; on Hayek’s U-turn, 2 –3, 203, 230n, 337, 409, 419 –21, 423; and the introduction of positivism in economics, 202 – 4, 329, 419; on the marginal revolution, 30; on methodology, 199 –204, 230, 329, 332, 399, 400; on perfect expectation, 201–2, 207; on the rationality assumption, 191, 194 –95, 201–2, 329, 332 hyperinflation, 95, 108n ideal type, 90 –91, 121, 129, 434n ideologue, Hayek criticized for being an, 5, 339, 347n. 19

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income, redistribution of, 5, 289 –91, 291n. 3, 313, 350, 367 individualism, 435n; atomistic, 431; false, 280, 306, 358; holistic, 286; institutional, 286, 364; true, 279 – 80, 296, 306. See also methodological individualism “Individualism: True and False” (Hayek), 2, 256, 261n. 1, 262, 295; Hayek’s variant of methodological individualism revealed in, 281– 87; summary of, 279 – 80 institutional economics. See new institutional economics institutionalism, 13, 119, 161n, 182n, 209, 328; emergence of, 182 – 83; and the German historical school, 154, 154nn. 3, 4, 162, 198 –99, 198n; and German trade cycle theorists, 157–58, 158n; Mitchell and, 150 –51, 154, 154nn. 3, 4, 164, 172, 183 – 86; similarities and differences with Austrians, 77, 77n. 9, 348; and transactions costs economics, 389 institutions. See social institutions instrumentalism, 183; in Schumpeter, 109 –11, 129 –30 intellectuals and the intelligentsia, 3, 4n, 233 –34, 253, 257 interest rates, natural and market, 177–78 interpretive issues: regarding the German historical school, 39 – 41; regarding Hayek, 2 –7, 12, 133n, 139, 142 – 43, 143n, 148 – 49, 164, 195n. 6, 196n. 9, 209 –14, 211n, 213n, 214n. 5, 223, 223n. 10, 253 – 60, 284 – 87, 316 –19, 409 –38; regarding Menger, 26n, 30 –35, 67n; regarding Mises, 124n, 145 – 49; regarding Wieser, 29n. 9, 141– 43, 164 interpretive turn, 253, 305, 362, 430, 436, 437 interviews, 5 – 6, 133n, 140n. 10, 148 – 49, 195n. 6, 205 – 6, 221, 227n. 14, 228, 257, 258 introspection, 112, 129, 193, 247

480 ] index intuitive universalism, 137–38 Investigations into the Method of the Social Sciences (Menger), 63; atomism vs. organicism in, 70 –73; “exact” vs. “realistic-empirical” orientations in, 65 – 67; history in, 72 –74; Menger’s defense of exact theory in, 66 – 62, 111; reasons Menger wrote, 73 –74, 127; Schmoller’s review of, 23, 63, 75, 245n. 6; summary of, 65 –74; undesigned social institutions in, 71–72. See also Menger, Carl; Principles of Economics invisible hand explanations, 25, 34 Jevons, William Stanley, 30, 31n, 179, 184 justice. See social justice Kaldor, N., 175n. 9, 224 Kant, Immanuel, 43, 347 Kaufmann, Felix, 97n, 113n, 125n. 21, 140 – 41, 157, 194 –96, 195nn. 6, 7, 196n. 9, 200n Keynes, John Maynard, 9, 126, 163, 177– 79, 179n, 183, 214n, 229, 232, 237, 327, 401, 402, 434n; and Cambridge, 167n; and The Road to Serfdom, 289; and Robbins, 170 –74, 170n. 5, 173n, 174n. 7; and Schumpeter, 108 Keynesian Revolution, 3, 4, 176, 176n, 374, 374n Kiel school, 157, 157n Kirzner, Israel: on Menger, 67; at New York University, 1; on the Robbinsian economizer, 330n; on the socialist calculation debate, 217 Knies, Karl, 22, 28, 45 Knight, Frank, 22, 22n, 126, 169, 179, 209, 254, 297n. 10, 327, 340, 434; on behaviorism, 184n, 248 knowledge, 3, 217, 340, 412; acquisition, 209; coordination of, 213 –14, 224 –26, 228 –29, 339; as different from infor-

mation, 338 –39; dispersion of, 206, 208, 211, 213 –14, 244, 277, 281, 366, 421n; local, 214, 337–38, 364; in Menger, 33; objective, 207– 8, 212 –13, 225; subjectively held, claims, 207– 8, 212 –13, 220, 244, 277, 281, 337, 421n; tacit, 337– 38 Koppl, Roger, 274n. 10, 275n, 434n Kresge, Stephen, 154, 318, 319n Kuhn, Thomas, 91–92, 128 Lachmann, Ludwig, 1, 1n. 2, 97n, 112, 145n, 163; contributions of, 434n; on hermeneutics, 433 –34 laissez-faire, 290; German attitudes toward, 40, 49, 74, 84 Lange, Oskar, 9, 217–20, 218n, 402 law: equality before the, 291; general principles of, 290 Law, Legislation, and Liberty (Hayek), 205, 256, 312 –17, 317n. 34, 353, 356, 358 laws, economic, 373; failure to discover empirical, in the twentieth century, 375 –76, 381; Hutchison on, 202, 230n, 375 –76; in Menger, 21; Robbins on, 188; Schmoller on, 51–52, 198 laws, historical, 241n, 251, 428n, 436 Lawson, Tony, 253, 375 –76, 376n. 3, 378, 398, 398n, 430 –33, 431n, 435, 435n, 437 Lenin, Vladimir, 105 – 6 liberalism, classical, 289; in Germany, 42, 44, 55, 58 –59, 61, 78, 84; and Hayek, 205, 238, 313, 347– 48; and Mises, 143 – 44, 146, 202 liberty, 284, 289 –92, 347; attributes of the laws of, 289; institutions of, 290 –92, 306, 348 List, Friedrich, 35, 45, 46 logical empiricism, 203, 425, 431n London School of Economics (LSE), 2, 73, 148, 234, 236, 306, 326, 327, 424; and Cambridge, 167–71; founding and early

index years of, 165 –71; and Robbins, 166, 168 –75, 195 Löwe, Adolf, 157– 63, 324 –25 LSE. See London School of Economics Lucas, Robert, 229, 418 Mach, Ernst, 98, 105, 109 –10, 113, 136 –37, 250, 273, 273n. 10, 298 Machlup, Fritz, 140, 145n, 147, 221 Manchesterism, 37, 37n. 15, 78, 84 Mannheim, Karl, 234, 239 – 40, 252, 253, 339, 429 Manski, Charles, 401n marginalism: Böhm-Bawerk and Wieser’s promotion of, 32, 80 – 82, 127; and Marxism, 101– 6, 110, 128; in Menger, 30 –32, 73 –74, 81 marginal revolution, 30 market process, 22, 29n. 9; inadequacy of general equilibrium theory to capture, 10, 216 –20, 224 –30, 413 –14; as a procedure for coordinating, transmitting, or preserving knowledge, 219 –20, 224 – 26, 228; as a procedure for discovering knowledge, 217, 219 –20 market system, 216 –20, 224 –26, 239 – 40, 290, 358 Marshall, Alfred, 29, 75, 75n, 81, 161n, 167– 69, 167n Marx, Karl, 81, 82, 101–3, 105, 128, 165n, 251, 253, 258, 402, 428n Marxism, 77, 81, 82, 141, 258, 428n; debates among Marxists over, 103; and marginalism, 101– 6, 110, 128; and positivism, 105 – 6, 128 –29; reception in England, 165 – 66, 165n mathematics: Menger’s distrust of, 31–32, 110 –11; Pareto, Schumpeter or Walras on, 108 –11, 130 Mayer, Hans, 22, 139, 139n. 6, 143n, 146 means and ends framework, 22, 47, 87– 88, 91, 121; in Robbins, 189, 191

[ 481

memory, 6n. 10, 268, 342 – 43 Menger, Carl, 139, 139n. 8, 184, 213n, 254, 254n, 284, 340, 382n, 402; and Aristotle, 67n, 111, 315; introductory comments on, 8 –12; and marginalism, 30 –32, 73 – 74; and the Methodenstreit, 74 – 82; on the nature of goods, 21, 32 –33, 36, 413; problematic methodology of, 21–22; on the “progress of civilization,” 25, 33 –35; and Roscher, 46; similarities and differences with German historical school, 46 – 48; subjectivism of, 32 –35, 212 –13; themes in his Investigations, 65 –74; themes in his Principles of Economics, 20 –27; at the University of Vienna, 17–19, 27. See also Investigations into the Method of the Social Sciences; Principles of Economics mercantilism, 50 –51, 51n metaphor, 368; neurophysiological basis of, 345, 345n; stream, 226 –27, 227n. 14, 318 metaphysics: logical positivist view of, 115, 125 –26, 137, 427n. 3, 428; as a term of derision, 105, 128, 137n, 186, 272n, 427n. 3 Methodenstreit, 8, 63, 64, 65, 74 – 82, 98, 102, 110, 127, 130, 158, 162, 166, 325 methodological individualism, 5, 364; and Hayek, 156, 162, 223 –24n. 11, 256, 261n. 1, 279, 281– 87, 286n, 287n, 341, 356, 411–18, 412n, 418n, 423 –24; Menger’s defense of, 70 –71; in Robbins, 192, 330n. See also “Individualism: True and False” methodology, economic, 1–3, 10 –12, 371, 372, 399 – 403, 431n; causal-genetic approach in, 22, 47, 139n, 382n; functionalist approach in, 22, 139n. 6. See also individual writers methods. See scientific methods Mill, John Stuart, 297n. 9, 428n

482 ] index mind: as a classification system, 259, 264 – 67, 293, 342; as a complex order, 266 – 67, 276, 296; connectionist approaches to, 300n, 342 – 43; “explanation of the principle” and the, 275 –77; as a network of connections, 264 – 69; philosophy of, 300n, 343 – 44 Mirowski, Philip, 331n, 339n. 13, 374 Mises, Ludwig von, 1–2, 4, 9, 99, 100, 141, 143 – 49, 213, 237, 248, 254, 340; and anti-Semitism, 145 – 46, 145n; and apriorism, 1–2, 112n, 124 –26, 125n. 21, 149, 190, 192 –96, 200n, 220 –23, 328 –29, 409, 417, 419 –21; on Bauer, 105n; and Böhm-Bawerk’s seminar, 104, 113 –14; and the classicals, 123; critique of socialism, 116 –19, 144, 210, 215, 425, 428 – 29; on the German historical school, 79 – 80, 120; and liberalism, 143 – 44, 146, 202; and Machlup, 147, 147n. 18; as a monetary theorist, 100, 117, 144; and Neurath, 113 –14, 116 –18; and positivism, 123, 125 –26, 129; and praxeology, 112n, 120 –26, 129, 413, 417; realist or Aristotelian influences in the work of, 120n; and Robbins, 145, 192 –96, 328 –29, 330n; on Spann, 139n. 7; and Weber, 119 –23, 129; and Wieser, 29n. 9, 123, 129, 142 Miseskreis, 113n, 120, 120n, 125n. 21, 151, 195, 195n. 6, 251n Mitchell, Wesley Clair, 96, 158n, 174; and behaviorism, 153, 154n. 3, 184 – 86, 202, 270, 332; on the history of economics, 73, 184 – 85, 196 –97, 327, 404; and institutionalism, 150 –51, 154, 154n. 4, 164, 172, 183 – 86; on Schmoller and Veblen, 85n. 3 models: artificial society, 363 – 66, 397; economic, 388 –96, 398, 402 modernism, Hayek’s commitment to, 260, 277, 346

Monetary Theory and the Trade Cycle (Hayek), 151, 163 – 64, 174, 224, 411–12, 414, 416; assessment of, 324 –25; summary of, 156 – 62 money, 155 –57, 160 – 64; denationalization of, 206, 288n. 1; Mises on, 100, 117, 144; origins of, in Menger, 23 –24; role of, in the economy, 9, 228 monopoly, 389, 393; in Menger, 24 –25, 37 Mont Pèlerin Society, 147n. 18, 238 moral codes, 280; origins of, 313 –14, 316, 354, 359n, 360 – 61 morals, as not rationally justifiable, 317–18 Morgan, Mary, 214n. 5 Morgenstern, Oskar, 113, 140, 158, 211–12, 211n, 214, 299, 332n. 6 Myrdal, Gunnar, 179 – 80, 211 Napoleonic Wars, 41– 43 Nationalökonomie, 41– 43, 47 National Socialism, 60n. 14, 233 –34 naturalist fallacy, 356 –57 natural law doctrines, German rejection of, 43, 50, 52 natural sciences, 259 – 60; classification as a goal of, 242 – 43, 262 – 63, 275; differences between, and social sciences, 242 – 43, 255, 284; methods of, 44, 71, 242 – 43, 255 Needham, Joseph, 234, 238, 252, 253 Nef, John, 259n, 297, 297n. 10 neo-Kantian movement, 90, 112n, 119 –20, 124n Neumann, John von, 212n, 278n. 15, 299 – 300, 300n, 303, 362 Neurath, Otto, 9, 99, 104, 182, 183, 339; economic views of, 113 –17, 141n. 11, 252, 428 –29, 429n; and in natura calculation, 428 –29, 429n; life of, 114 –15; and physicalism, 115, 247, 257, 257n, 270 –71; and Popper, 424 –26, 428 –29, 428n, 429n, 430n; and positivism, 128, 272n;

index “Scientism” essay as an attack on, 253, 424 –30; and war economy, 113 –17 neuroeconomics, 344, 344n. 16 neuropsychology, 342 – 45 new institutional economics, 40, 349, 352, 352n, 397 New York, 73, 196, 327; Hayek in, 73, 144n, 150, 196 –97, 327; Mises in, 145 – 47; University, 1; World’s Fair, 237 Nobel Prize, 5 North, Douglass, 349, 352n, 360 Oakley, Allen, 432 –33, 433n, 435, 437 ontology: social, 398, 431; subjectivist, 435 order: classical liberal, 261; and equilibrium, 227n. 14, 306n; Hayek’s definition of, 309, 309n. 28; the mind as a complex, 266 – 67, 276, 296, 346; phenomenal, 262 –79; physical, 262 – 63, 271–72, 275; polycentric, 294. See also rules, and orders; spontaneous orders organicism, 70 –73 Pareto, Vilfredo, 22, 111, 154 perfect expectation: in Hayek, 211–14, 224, 421; in Hutchison, 201, 207– 8 physicalism, 115, 247, 257, 257n, 298, 427n. 3, 429; and behaviorism, 270 –73, 272n, 273n. 9, 425, 428, 430 piecemeal engineering, 311 Pigou, A. C., 167n, 168 –70, 179n planning. See central planning Polanyi, Michael, 145n, 294, 294n, 307n, 308n. 26 Popper, Karl, 2, 3n. 4, 6, 10, 134n, 144, 145n, 194n, 196n. 8, 203, 203n. 12, 254n, 255, 258 –59, 307, 308, 308n. 26, 317–18, 359n, 375, 397, 419 –20, 423, 435; and Hayek on falsifiability, 304 –5, 310 –12, 312n, 346; and Neurath, 424 –26, 428 – 29, 428n, 429n, 430n; on presuppositionless observation, 92, 128; and The

[ 483

Sensory Order, 300 –301, 304; and situational analysis, 122, 122n. 17, 312n, 372, 388, 390, 395 –96 positivism, 8 –9, 77, 88, 123, 159, 429, 431; and behaviorism, 273n. 9, 336; deleterious effects of, 372, 400 – 405; and economics, 199, 202 – 4, 328 –29, 336, 371– 74, 379, 381, 393, 395 –96, 399 – 405, 419, 431n; and falsifiability, 373, 393 –96; and the history of economic thought, 401– 5; logical, 92, 104, 115, 125 –26, 128, 136 – 37, 203, 272n, 298, 431n; and philosophy of science, 201– 4, 400; and planning, 340; and progress in economics, 371– 74, 379, 381, 393, 395 –96, 399 – 401; rhetoric of, 98, 203 – 4, 331, 329, 396, 400, 431n; and science, 126, 128 –30, 203 – 4, 273n. 9, 368, 403; and socialism, 99, 105 – 6, 113, 119, 128 –29, 404 positivist, Hayek as, 434 postmodernism, 98, 274n. 11, 433 postulates of economics: in Hutchison, 201–2, 329, 387; in Robbins, 187– 88, 192 –96, 329 –31, 387 praxeology, 112n, 120 –26, 129, 413, 434n prediction: and control in social science, 96, 328; and game theory, 393 –95; as a goal of social science, 230n, 331, 371, 373, 399 – 401; of individual choice behavior, 332 –36; market-level, 331–35; Menger and Mises on, 96 –97; pattern, 247, 304 –5, 310, 335n, 340, 346, 372 –73, 382 – 87, 392n, 396; qualitative, 97; in study of complex phenomena, 228, 305, 310 –12, 326, 328, 370 –73, 375 presuppositionless observation, 88 –92, 120, 128, 158, 248, 325 prices: coordinative role of, 228; freely adjusting market, 9, 117, 337; markets and, 219 –20, 337, 340; relative, importance for Hayek, 153, 161– 62, 164, 225 – 26, 252

484 ] index Prices and Production (Hayek), 162, 173, 178 –79, 412n, 414, 416 Principles of Economics (Menger), 8, 212, 382n; compositive method in, 20 –23; criticism of classical theory in, 26 –27; introductory comments on, 17–20; marginalism in, 30 –32; reception of, 35 –38; Schmoller’s review of, 37, 49, 126, 407– 8; subjectivism in, 25 –27, 32 –35; summary of, 19 –20; unintended consequences of human action in, 23 –25. See also Investigations into the Method of the Social Sciences; Menger, Carl progress: absence of, in economics, 398, 404; difficulties in measuring, 374; empirical, 370 – 82, 400 – 401; positivist view of, 371, 373 –74, 379, 381, 393, 395 – 96, 400 – 401; theoretical, 372 –73, 392 – 93, 395 –96 Prussia, 48, 49, 54, 57–58, 62, 79 psychology, 136 –39, 230, 282, 285 – 86, 306, 436; and economics, 332 –33, 335 – 36; evolutionary, 283; gestalt, 262 – 63, 262n; Menger’s incomplete subjectivism and, 32 –35; and Mitchell, 153, 154nn. 3, 4, 184 – 86; Robbins on, 188 – 89; theoretical, in The Sensory Order, 263; “verstehende,” 436; Weber on, 91, 97, 112; and Wieser, 111–13. See also The Sensory Order Pure Theory of Capital, The (Hayek), 143, 176, 179n, 180, 180n, 223n. 11, 224, 326, 410 –12, 415, 415n purposive behavior. See human action quantitative studies. See empirical studies Ransom, Greg, 139n. 8, 418n Rathenau, Walther, 95, 118, 118n, 182, 183 rational economic man. See rationality assumption

rationalism, critical, 425 rationality assumption, 209, 390n; “acting man” and, 77; criticized by German historical school, 40, 55, 190; criticized by Hutchison, 191, 194 –95, 201–2, 329, 332; as an ideal type in Weber, 90 –91, 129; in mainstream economics, 77, 281– 82, 286 – 87, 332 –36, 395; in Robbins, 189 – 86, 330 –32; rule-following behavior vs., 360 – 61, 360n. See also Menger, Carl; self-interest rationality principle, 390 –91, 395 –96 Rau, H. K., 43 Reader’s Digest, 3n. 5, 258, 258n realism, critical, 398, 430 – 43, 433n; indirect, in The Sensory Order, 274 –75; in Mises, 124n Red Vienna, 105, 105n, 115 rhetoric: of economics, 399 – 400; of positivism, 98, 203 – 4, 331, 329, 396, 400, 431n Ricardo, David, 402; German criticism of, 45 – 46, 48, 50, 126; Mitchell’s criticism of, 185; theory of value in the work of, 26 – 67 Rickert, Heinrich, 90 –91, 120, 251n Road to Serfdom, The (Hayek), 2, 3nn. 4, 5, 7, 148, 240 – 41, 256, 257, 258, 289, 319, 338; and the inevitability thesis, 241n, 356n. 28 Robbins, Lionel, 123n. 19, 126, 133n, 178, 218n, 223, 236 –38, 238 –39n. 3, 248, 254, 327–31, 335 –36, 419, 434; and apriorism, 192 –96, 191, 330 –31, 382; and basic economic reasoning, 191, 330 –31, 382, 384; and defense of economic theory, 186 –91; and institutionalism, 182, 186, 188 – 89, 199 –200; and Keynes, 170 –74, 170n. 5, 173n, 174n. 7; and the LSE, 166, 168 –75, 195; and Mises, 145, 192 –96, 328 –29, 330n; and the postulates of economic theory, 187– 88, 192 –96,

index 328 –31, 387; and the second edition of Nature and Significance, 191–96. See also An Essay on the Nature and Significance of Economic Science Robbinsian economizer. See rationality assumption Robinson, Joan, 175n. 9, 190, 192, 199, 199n Roscher, Wilhelm: economic views of, 45 – 46; on Menger’s Principles of Economics, 36; and older German historical school, 43, 45; and Schmoller, 49 – 53 Rudolf, Crown Prince, 19 rule of law, 5, 205, 289 –92, 358 rules: abstract, 205, 280, 293, 313; in artificial society models, 363 – 64, 366 – 67; of conduct, 284, 314 –16; design of, 359; as different from commands, 293; emergence of, 292 –93, 313 –16; ethical / moral, 295, 316; and evolution, 298, 309 –10, 313 –16, 357, 359; general, 280, 293; as habits/norms, 292, 314 –16; Hayek’s use of the term, 296n. 8; institutions as providing a system of, 238, 238 –39n. 3, 358; and orders, 292 –96, 298, 306 –10, 313, 316; selection of, 359 Runde, Jochen, 312n, 431–32, 433n Samuelson, Paul, 126, 203, 401 Santa Fe Institute, 362n. 34, 397 Savigny, F. K. von, 44 – 45, 72 –73, 72n, 78 Say, J. B., 51n scarcity, 21, 21n, 121–22, 187, 188, 193, 335 Schäffle, Albert, 17, 17n, 71n Schmoller, Gustav, 9; and Althoff, 41n. 5, 62 – 63, 86; and the German Empire, 42, 60 – 63, 84 – 85; and German higher education, 61– 63, 79 – 80, 86; on justice, 93 –94; life of, 48 – 49; and the Methodenstreit, 74 – 82; methodological views of, 52 –53, 75, 77–78, 83 – 85, 88 –

[ 485

90, 92 –94, 202, 250; and Neurath, 114; renaissance of interest in, 39 – 41, 98n; review of Menger’s Investigations, 23, 63, 75, 245n. 6; review of Menger’s Principles of Economics, 37, 49, 126, 407– 8; on Roscher, 49 –53; and the Verein für Socialpolitik, 56 –57, 62 Schottengymnasium, 28 Schumpeter, Joseph, 104, 150, 225; on the calculation debate, 225n; on the German historical school, 53, 83, 93; on Hayek, 147– 48, 148n; and instrumentalism, 109 –11, 129 –30; life and work of, 106 –13; on the Methodenstreit, 65, 77, 110; and Das Wesen, 109 –13, 143n; and Wieser, 29n. 9, 143n Schütz, Alfred, 97n, 140 – 41, 157 science, 10; cognitive, 397; German views of, 44; invoked by behaviorists, 271; invoked by Hayek, 271; invoked by Marx and Engels, 105; invoked by Menger in Principles of Economics, 20 –21, 26; invoked by Mitchell, 96, 184 – 86; invoked by Schmoller, 51–53; men of, 234 –37, 358; philosophy of, 273n. 9, 304, 329, 400; and positivism, 126, 128 –30, 203 – 4, 273n. 9, 368, 403; and prediction, 399; and socialism, 98, 117–19, 128 –29, 280; and social reform, 184 – 86, 234 – 38, 368; social relations of, movement, 234 –37 sciences. See natural sciences; social sciences scientific methods, unity of, 299, 311 scientism, 10, 77, 196, 241, 254 –55, 258, 280, 346, 371–72, 424, 426, 426n, 437; defined, 242 “Scientism and the Study of Society” (Hayek), 222, 223n. 9, 294n, 298, 301– 4, 302n. 18, 315; alternative interpretations of, 253, 256 – 60, 423 –38; assessment of, 339 – 41; character and methods of the

486 ] index “Scientism and the Study of Society” (Hayek) (continued) social sciences in, 243 – 47, 250, 255 –56; and classification, 242 – 44, 248 –50, 259; constitutive and speculative opinions in, 244 – 45, 245n. 5, 255; critique of collectivism in, 250, 255; critique of historicism in, 250 –51, 424; critique of objectivism in, 247–50, 255, 259; critique of planning in, 251–52, 253 –54, 304 –5; “explanation of the principle” in, 247, 259; the natural science/social science distinction in, 242 – 43, 284, 301, 311, 341, 346, 362, 423 –24, 435; as part of the Abuse of Reason project, 256 – 60, 428 –29; pattern prediction in, 247; and The Sensory Order, 259n, 275; summary of, 241–53; as a transition piece, 339 – 41 secondary literature. See interpretive issues Second World War, 146n, 204 self-interest: and the development of a moral code, 360; German reaction to, 46, 356n. 27; in “Individualism: True and False,” 282; Menger on, 68 – 69, 73 –74, 77, 81; in Smith, 72, 356n. 27 Sensory Order, The (Hayek), 7, 222, 223n. 9, 250, 256, 257n, 284, 293, 296, 298, 307, 314, 361, 362, 424, 432; and behaviorism, 270 –73, 272n, 273n. 9, 341; classification as an act of interpretation in, 271–72; and evolution, 277–79; “explanation of the principle” in, 275 –77; Hayek’s legacy in, 341– 45; and Hayek’s student paper, 137, 268; and Kantian categories of the mind, 273, 274n. 10; maps and models in, 268 – 69, 274n. 10; the mind as a classification system in, 264 – 67; the mind as a network of connections in, 264 – 69; and physicalism, 270 –73, 272n, 273n. 9; and the physical order, 262 – 63, 271–72, 275; Popper’s reaction

to, 300 –301, 304; and purposive behavior, 269 –70; and relational thinking, 262, 265; role of memory in, 268; and the “Scientism” essay, 259n, 275; and the sensory or phenomenal order, 262 –79; task of theoretical psychology in, 263; and the “Within Systems and about Systems” paper, 299 –301, 301n. 17 situational analysis, 122, 122n. 17, 312n, 372; alternative versions of, 390; in economics, 388 –97, 390n, 391n; and falsifiability, 395 –96, 399 Small, Albion, 17n, 54, 54n. 13, 61, 71n Smith, Adam, 313, 402; Cannan on, 167; Menger on, 68, 72 –73; reception in Germany of, 43, 45 – 46, 50, 61, 356n. 27; theory of value of, 26 –27; on trade, 23; and true individualism, 279; unintended consequences in the work of, 197 Social Democratic Party: in Austria, 101, 104 – 6, 105n, 118, 141; in Germany, 58 – 59, 101 Social Economics (Wieser), 100, 113, 142 – 43, 154, 415n social institutions, 10, 339, 397; as economizing on transactions costs, 389; evolution of, 45, 73, 81, 142, 397; as examples of complex spontaneous orders, 279 – 80; as a framework in which individual action takes place, 238, 281; and liberty, 229, 238, 290 –92, 306, 348; origin of, 23 –25, 71–72; 74, 78, 285, 357–58; rationally constructed, 251, 279 – 80, 426, 426n; role of, in the discovery and coordination of knowledge, 220, 290, 306, 338 –39, 349, 387; and Savigny, 44, 78; Schmoller on the proper way to study, 52 –53; as unintended consequences of human action, 23 –25, 71–72, 306

index socialism, 3, 8, 29n. 9, 181, 224, 338 –39; Austrian reaction to, 77, 81– 82, 88n; in England, 119n, 215 –16, 216n, 232 – 41; Fabian, 102, 128, 141, 143, 165 – 66, 215; German reaction to, 55, 57– 60, 77, 84; and income redistribution, 291; and marginalism, 101– 6; market, 118 –19, 128, 215 –20, 402n. 18, 414; Mises’s critique of, 116 –19, 144, 210, 215; and planning, 198 –99, 215 –20, 232 – 41, 251–53; and positivism, 99, 105 – 6, 113, 119, 128 – 29, 404; and science, 98, 117–19, 128 – 29, 280; scientific, 424 Socialism (Mises), 144, 149 socialists of the chair (Kathedersozialisten), 56 social justice, 3, 239, 291, 297n. 9, 313; in Schmoller, 93 –94 social reality, complexity of: in Schmoller, 52, 83 – 84, 89; in Weber, 89 –90 social reform, 127; and the German historical school, 40 – 41, 43 – 44, 54 –57, 59 – 61, 84 – 85, 94, 197–99; and positivism, 98, 368; scientific, 98, 234 –38, 368; and socialism, 184 – 86, 234 –38, 368 social sciences, 11; the character of, 243 – 45; German view of, 43 – 44; methods of, 44, 243, 245 – 47, 250, 255 –56, 424; and natural sciences, 242 – 43, 255, 284; nomothetic, 121, 129; philosophy of, 425; a theoretically integrated approach to, 350n sociobiology, 283, 355 Sozialpolitik in the German Empire, 57– 61 Spann, Othmar, 136 – 40, 139n. 7 spontaneous orders, 11, 135n. 3, 228, 230, 261, 298, 313, 316, 361– 68, 435; arising from the interaction of individual elements, 261n. 1, 284 – 85; and evolution, 262, 278, 294 –96, 309 –10, 313, 316, 346,

[ 487

352, 357–58, 361; first appearance of the term in Hayek’s work, 294, 294n; as kosmos, 313; in Menger, 23 –25, 71–72; modeling of, 363 – 68; organizations vs., 313, 353, 353n. 24; social institutions as complex, 279 – 80, 293 –94, 306, 328, 361– 68 Sraffa, Piero, 177n, 179 stage theories of development, 45 – 46, 51–52, 84n state, the, 436; as an ethical institution, 44; Schmoller on, 53, 56, 94; role of, in a liberal society, 280; and social justice, 239 static equilibrium theory. See equilibrium theory, static Stein, Lorenz von, 19, 57 Streissler, Erich: on Böhm-Bawerk and Hilferding, 104; on the marginal revolution, 30 –32; on Mises, 146 – 47; on the “proto-neoclassical” tradition, 47, 47n; on Wieser, 29n. 9 subjectivism, 177n, 210, 212 –13, 223n. 9, 260, 410 –12, 412n, 415 –16, 432 –33; in Menger’s Principles of Economics, 25 – 27, 31–35, 47; scientific, 260 Sugarscape model, 363 – 66 theories: the elimination of, in economics, 370, 373; as hypothetico-deductive structures, 201 theory: ad hoc, adjustment, 396; choice, 331–33, 336, 368; complexity, 361– 62, 362 – 63n. 34, 397; decision, 330n, 331, 331n, 333n; game (see game theory); general systems, 303, 307, 362, 398; German attitude toward, 44, 52 –53, 199; German trade cycle, 156 – 64, 324 –25; in Menger, 20, 65 –73; necessity of, in Monetary Theory and the Trade Cycle, 157–59; quantity, of money, 156 –57, 161– 62, 164, 324

488 ] index theory-laden observation, 89, 91–92, 97, 158 –59, 254, 277, 325 Theory of Money and Credit, The (Mises), 100 Tocqueville, Alexis de, 2 trade. See free trade Treatise on Money, A (Keynes), 108, 170, 177–79 Trend of Economics (Tugwell), 2, 184, 197 “Trend of Economic Thinking, The” (Hayek), 2, 197–99, 214 trial and error method: in Dickinson, 216, 218; in Lange, 217–18 Tübingen, 48, 72 Tugwell, Rexford, 2, 184, 186, 197 Uebel, Thomas: on Hayek, Popper and Neurath, 253, 424 –30, 437–38 unintended consequences of human action: in Menger, 23 –25, 47, 71–72, 81; in the “Scientism” essay, 246, 250, 256; in Smith, 23, 197 value, theory of: Böhm-Bawerk’s critique of the Marxist, 102 –5; classical, 26 –27; Menger’s subjectivist, 25 –27; as a speculative belief, 245 value-freedom: and Austrian thought, 88n. 6; and Robbins, 187; and Weber, 87– 88, 97, 122n. 16 values, sources of, 283, 313 –14, 316, 354, 359n, 360 – 61 Vanberg, Viktor, 353n. 24, 360 – 61 Vaughn, Karen, 224n. 12, 359n, 362n. 34 Veblen, Thorstein, 84 – 85, 85n. 3, 154n. 4, 183 verbal chain of logic, 125, 222 Verein für Socialpolitik, 41n. 6, 49, 53, 93, 325; and Bismarck, 59 – 63; founding of, 56 –57; Karl Kautsky on, 56 –57; Rosa Luxemburg on, 57; Schumpeter on, 93; Heinrich von Treitschke on, 57

Verstehen (understanding), 97n, 120 Vienna, 8, 17, 89, 92, 92n, 99, 113 –15, 126, 128, 133 –38, 139n. 6, 143 – 46, 145n, 150, 171; Hayek in, 133 – 46, 150 –51, 171 Vienna, University of, 8, 9, 17–19, 28, 78, 100, 135, 145; Hayek at, 135 – 46 Vienna Circle, 92, 104, 114 –15, 125, 125n. 21, 128, 136 –37, 141, 141n. 11, 195, 195n. 6, 203, 203n. 12, 270, 272n, 426, 430n Wagner, Adolf: 1872 speech, 54 –56, 61; and the German Empire, 60, 62; and Roscher, 43; and Schmoller, 41n. 5, 76n. 7; as a teacher, 83 Walras, Léon, 184; functionalist theories of, 22, 139n. 6; and general equilibrium theory, 108 –11, 154, 215, 225n, 305; and mathematical formalism, 98, 130; Menger and, 30, 31n war economy, 114 –17, 117n Weaver, Warren, 301–2, 301n. 18; and “organized complexity,” 302, 305, 362 Webb, Beatrice and/or Sidney, 165 – 68, 174 –75n. 8, 215, 234, 236 –37 Weber, Max, 83, 100, 141, 151, 173, 251n, 434; and the ideal type, 90 –91, 434n; on means-ends framework, 91; and Mises, 119 –23, 129; other contributions of, 97n; and presuppositionless observation, 88 –92, 120, 248, 254; on psychology, 91, 97, 112; and Schmoller, 86 – 87, 86n; and value-freedom, 87– 88, 97, 122n. 16 Weiner, Norbert, and cybernetics, 303, 362 Wells, H. G., 236 –37 Wesen, Das (Schumpeter), 109 –13, 109n, 143n Wicksell, Knut, 177–79 Wiener Zeitung, 18, 32 Wieser, Friedrich von, 12, 28n. 8, 139, 146, 154, 402; early years of, 28 –30, 29n. 9;

index and general equilibrium theory, 143n; influence on Hayek, 29n, 141– 43, 143n, 164, 411, 415, 415n; later work of, 80 – 81, 100 –101; and the method of decreasing abstraction, 411, 415, 415n; and Mises, 29n, 123, 129, 142; and promotion of marginalism, 32, 80 – 82, 127; and the “psychological method,” 111–13; and The Pure Theory of Capital, 113, 143,

[ 489

223 –24n. 11; and Schumpeter, 29n. 9, 143n; on socialism, 29n. 9, 102 Wilde, Oscar, 2 Wootton, Barbara, 175n. 9, 215, 257 world wars. See First World War; Second World War Wright, Sewell, 299, 314 Young, Allyn, 169, 172