Economic Schools of Thought

The Q&A session for this past week’s Economics 101 class (free online from Hillsdale College) included some definitions of three basic economic schools of thought. I refer to these fairly frequently, so I thought maybe it would be useful to have a short lesson defining them. We’ll look at these: Keynesianism, the Chicago School, and the Austrian school.

When we say “school,” we aren’t referring to a brick-and-mortar institution; we’re referring to a way of thinking. Those who agree with and follow those ideas “belong to” that school of thought. The schools aren’t necessarily mutually exclusive. Two of these three are proponents of the free market.

 

Keynesianism

John Maynard Keynes was a British economist who put forth a theory in the 1930s, purporting that government intervention could accomplish full employment and reduce the impact of business cycles.

There’s a 3-minute video intro to lecture 7 of the Hillsdale Econ 101 course, which explains the Keynesian model.

 

In the actual lecture Professor Gary Wolfram charts out the theory on a supply and demand curve. In the real world, there’s typically a gap between the number of potential employees and the number actually hired. Even in full employment, that’s around 3-4% (which was declaimed as too high all the way through the Bush administration, but has been double to triple that—or worse, depending on your measures—all the way through the Obama administration, while the same people keep claiming the economy is improving. So, one thing about statist/Keynesians is that government intervention is a good thing, to be taken on faith, regardless of measurable evidence.) Keynes’s theory is contained in his main work, The General Theory of Employment, Interest and Money, published in 1936.

Keynes's magnum opus

Keynesianism claims that government spending—any government spending—results in economic growth. (Read my Glass Breaking Fun.) That’s why you see such “growth” in Washington, DC, the past few years, while the rest of the country struggles. The DC growth is because government is literally trying to grow the economy by hiring people to do whatever (metaphorically digging holes and filling them in)—without noticing that any money for that purpose is taken from what could be spent to innovate or invest in the non-government real economy. It is Keynesianism that claims the way we got out of the Great Depression was by spending our way out because of WWII.

Keynesianism is most popular with people who want increased government power, so it’s not surprising that it was championed by such politicians over the past near century. However, as Keynesian theories have been implemented, empirical evidence of their failures has led more and more economists to leave that school of thought and take another look at the free market schools. However, Keynesianism resurged in 2007-2008, with what is now referred to as the Great Recession, which continues apace with ongoing government interference. Hmm.

One of the most prominent Keynesian economists still claiming Keynes was right is Nobel Laureate Paul Krugman, who is widely published and consistently wrong.

 

The Austrian School

Contemporary with Keynes were Ludwig von Mises and Friedrich Hayek, who are usually considered the two main Austrian economists. Ludwig von Mises, who is generally considered the original Austrian theorist, immigrated from Europe in 1940, ahead of the advance of the Nazis, landing in New York; he taught at NYU for most of the remainder of his life. He considered himself a classical liberal—that is, “liberal” in much the way our founders were; he believed in limited government and free markets among a moral people. Mises is often cited by libertarians today, although I’m not sure he completely fits in their world.


Ludwig von Mises
photo from Wikipedia

My personal view is that, on the Spherical Model, Mises is western hemisphere (most local control that can be managed for any given issue), but also northern, where laws protect people’s God-given rights to life, liberty, and property. Libertarian theory tends to encompass the entire western hemisphere, including the below-the-equator belief that government should have no role, and free market should rule, even including addictive drugs and sex trade. (See Why I’m Not Quite a Libertarian.)

Friedrich Hayek, who won the Nobel Prize in Economics in 1974, wrote The Road to Serfdom, which should be required reading for any educated individual. Hayek was a follower of Mises. While friendly with Keynes personally, Hayek disagreed with his theory. (Meanwhile, Keynes read Hayek’s book and said he agreed with it entirely.) When he left Austria, Hayek taught  in Britain for some time before ending up at the University of Chicago. Much of his work describes business cycles. Some of what he demonstrated was that government interference actually causes business cycles—both lengthening and intensifying the pain. Without the interference, the market serves to correct itself, with just minor dips and quick corrections. When there is a shortage of labor, the economy self-corrects by raising pay rates, until there is equilibrium. When there is a surplus of labor, the economy self-corrects by lowering pay rates, until there is equilibrium. He favors trust in the free market and government restraint.

Friedrich A. Hayek
photo from Wikipedia

Henry Hazlitt, another Austrian commentator, wrote a point by point rebuttal of Keynes’s The General Theory, called The Failure of the New Economics. The Austrians looked more at innovation and various movements from equilibrium, accepting that those are not necessarily negative things to be avoided.

 

The Chicago School

The Chicago school of economics usually refers to Milton Friedman, and also his wife, Rose Director Friedman. Thomas Sowell, a former Marxist who later studied in Chicago under Friedman, is probably included.

Friedman is a free-market economist. He is against government intervention. The difference between his work and the Austrians is more a matter of focus than disagreement. The Austrians look at movement from one cycle to the next. The Chicago school examines the conditions that exist at equilibrium. They look at government intervention, what it does, and why it always goes wrong: the information needed is unknowable, the timing will always be late. And government interference obscures the market signal: producers get incorrect signals about whether to produce long-term capital products or short-term consumer products—or producers fail to get a signal, because of uncertainty in the market, and therefore hold back production until there is clarity (what we’re seeing in the market now). Some of the “interference” is control of the money supply, and the Chicago school looks closely at that.

Milton Friedman
photo from Wikipedia

All of these theories deal with macroeconomics—the movement of the economy as a whole—rather than microeconomics, which is the study of why individuals make the economic decisions they do. If there is a basic macroeconomic principle for government it should be “first, do no harm.” The argument “Well, we have to do something,” is wrong; doing nothing is always an option and often the best one. Government is not responsible for the economy; government’s only economic role is preservation of rights—enforcing contracts, protecting property rights, settling disputes over property claims, and possibly standardize monetary units (although Wolfram actually discusses the suggestion of privatizing money supplies, which is an interesting idea).

Less government interference, beyond its limited role, always leads to greater prosperity. Imagine the economic prosperity we would be experiencing if government had refrained from interfering this past century.