The Global Economy: Free Trade versus Managed Trade

By Richard Ebeling

Originally published on June 18, 2024 for The Future of Freedom Foundation

In 1831, Sir Henry Parnell (1776–1842), a long-time chairman of the Financial Committee of the House of Commons, published On Financial Reform, in which he made the case for freedom of trade at a time when trade protectionism was mostly the order of the day in Great Britain, especially in agriculture:

If once men were allowed to take their own way, they would very soon, to the great advantage of society, undeceive the world of the error of restricting trade, and show that the passage of merchandise from one state to another ought to be as free air and water. Every country should be as a general and common fair for the sale of goods, and the individual or nation which makes the best commodity should find the greatest advantage….

Happily, the time, if not yet arrived, is rapidly approaching, when the desire to reduce the principles of trade to a system of legislative superintendence will be placed in the rank of other gone-by illusions. The removal of obstacles is all that is required of the legislature for the success of trade. It asks nothing from Government but equal protection to all subjects, the discouragement of monopoly, and a fixed standard of money. All that is wanted is to let loose from commercial restriction, protection, and monopoly, the means the country has within itself by force of individual exertion of protecting and promoting its interests, to secure its future career in all kinds of public prosperity.

Sixteen years later, in June 1846, Parnell’s hope came to fulfillment with the unilateral abolition of the Corn Laws that had secured the British landed aristocracy a profitable protection from foreign competition in farming, especially in wheat production. The British prime minister at that time, Sir Robert Peel (1788–1850), had been placed in that office by the Tory Party to assure the continuance of agricultural protectionism against the supporters of free trade. But with the worst crop failures in living memory in 1845–1846, and with growing hardship and threatened starvation among the low-income members of British society, Peel came around to the free-trade position of Richard Cobden (1804–1865) and John Bright (1811–1889). With the support of the free-trade advocates and a sufficient number of Tory members in the House of Commons and the House of Lords, the importation of less expensive foreign wheat and other food products unilaterally became the law of the land on June 26, 1846.

Furious with Robert Peel’s defection, the Tory landowners forced his removal as prime minister. In his last speech before stepping down from his position, Peel declared:

If other countries choose to buy in the dearest market, such an option on their part constitutes no reason why we should not be permitted to buy in the cheapest. I trust the Government … will not resume the policy which they and we have felt most inconvenient, namely the haggling with foreign countries about reciprocal concessions, instead of taking the independent course we believe conducive to our own interests. Let us trust to the influence of public opinion in other countries — let us trust that our example, with the proof of practical benefit we derive from it, will at no remote period ensure the adoption of the principles on which we have acted, rather than defer indefinitely by delay equivalent concessions from other countries.

British unilateral free trade and the beginnings of globalization

Great Britain, thus, became the symbol of a policy of freedom of trade, regardless — indeed, in spite of — any restrictive and protectionist policies maintained or introduced by other countries. Of course, not every tariff was actually reduced to zero or as a modest revenue tariff. But certainly after Britain’s commercial treaty with France in 1860, for all intents and purposes Great Britain practiced what it preached. And soon, a growing number of other European countries followed the British and French examples and lowered their trade barriers.

The idea and ideal of unilateral free trade became the basis of British thinking in the face of any and all proposals for restricting imports in the name of retaliation against the protectionist policies of other countries or waiting for reciprocity before any modification on remaining duties on imported goods. Toward the end of the nineteenth century, its logic was emphasized by Henry Dunning Macleod (1821–1902) in his History of Economics (1896). Trade retaliations and reciprocations merely harmed the citizens of one’s own country far more than they imposed any supposed damage on a protectionist trading partner.

If the present hostile tariffs destroy an incalculable amount of commercial intercourse, a resort to reciprocity and retaliation would destroy it infinitely more…. If foreign nations smite us on one cheek by their hostile tariffs, if we followed the advice of the reciprocitarians, and retaliated, we should simply smite ourselves very hard on the other cheek…. The true way to fight hostile tariffs is by free imports.

As a consequence of these movements toward more universal freedom of trade, the age of globalization truly emerged and encompassed a growing part of the planet. By the end of the nineteenth century, in fact, economists could hail the amazing social, cultural, and economic integration that had occurred — and was occurring — through the internationalizing of commerce, trade, and investment. For instance, the Irish economist Charles Bastable (1855–1945) explained in The Commerce of Nations (1899):

One of the most striking features of modern times is the growth of international relations of ever-increasing complexity and influence. Facilities for communication have brought the closer and more constant intercourse between different countries of the world, leading to many unexpected results. This more intimate connection is reflected in all the different sides of social activity. International law, that two hundred years ago was almost wholly confined to the discussion of war and its effects, now contains a goodly series of chapters treating in detail of the conduct of nations during peace. It draws the bulk of materials from the large and rapidly growing body of treaties that regulate such matters, and form so many fresh links between the states that sign them. Literature, Science and Art have all been similarly affected; their followers are engaged in keenly watching the progress of their favorite pursuits in other countries and are becoming daily more and more sensitive to any new tendency or movement in the remotest nation.

But, as might be expected, it is in the sphere of material relations that the increase in international solidarity has been most decisively marked and can best be followed and appreciated. The barriers that in former ages impeded the free passage of men and of goods from country to country have been — it cannot unfortunately be said removed, but very much diminished; and more particularly during the last fifty years the extraordinary development and improvement of transport agencies both by land and sea have gone far towards obliterating the retarding effects of legislative restraints or national prejudices. So little attention is ordinarily paid to the great permanent forces that govern the changes of societies, in comparison with the interest excited by the uncertain action of minor disturbing causes, that it is eminently desirable to emphasize as strongly as possible the continuous increase of international dealings. In spite of temporary checks and drawbacks, the broad fact stands beyond dispute, that the transfer of human beings from country to country which is known as “migration,” as also similar movement of goods described as “commerce” is not merely expanding, but if periods sufficiently lengthy for fair comparison are taken, expanding at an accelerated rate.

The world was, increasingly, a single market, especially due to the global nature of the British Empire, which served as one, vast free-trade zone. All were more or less welcome to trade, invest, and reside regardless of any individual’s nationality or politics. Following the end of the Napoleonic Wars in 1815, Great Britain and many other European counties did away with the formalities of passports and visas, with the right of freedom to move an increasingly accepted principle in the middle decades of the nineteenth century. It is worth recalling that Karl Marx moved to London in 1849 and lived there for the rest of his life, without any visa requirement or residency or work permits.

The three freedoms of the nineteenth-century globalization

It is true that protectionism was making a return in the 1880s, most especially in Imperial Germany, with Bismarck’s reintroduction of an extensive political paternalism in the form of the institutions of
the modern interventionist-welfare state and tariffs meant to more
directly influence German industrial and agricultural development. Nonetheless, it is not an exaggeration to say that in comparison to the world before the nineteenth century and much that occurred in the twentieth century, the middle and late decades of the 1800s stand out as an epoch of what the German economist Gustav Stolper (1888–1947) in This Age of Fables (1942) called the era of the three freedoms: free movement of men, money, and goods:

The economic and social system of Europe was predicated on a few axiomatic principles. These principles were considered as safe and unshakeable by that age as the average American citizen even today considers his civil liberties embodied in the Bill of Rights. They were free movement for men, for goods, and for money.

Everyone could leave his country when he wanted and travel or migrate wherever he pleased without a passport. The only European country that demanded passports (not even visas!) was Russia, looked askance for her backwardness with an almost contemptuous smile. Who wanted to travel to Russia anyway? The trend of migration was westward — within Europe from the thinly populated agricultural east to the rapidly industrializing center and west, and above all from Europe to the wide-open Americas.

There were still customs barriers on the European continent, it is true. But the vast British Empire was free-trade territory open to all in free competition, and several other European countries, such as the Netherlands, Belgium, Scandinavia, came close to free trade. For a time, the Great Powers on the European continent seemed to veer in the same direction. In the sixties of the nineteenth century the conviction was general that international free trade was the future. The subsequent decades did not quite fulfill that promise. In the late seventies reactionary trends set in. But looking back at the methods and the degree of protectionism built up at that time we are seized with a nostalgic envy. Whether a bit higher or a bit lower, tariffs really never checked the free flow of goods. All they effected was some minor price changes, presumably mirroring some vested interest.

And the most natural of all this was the freedom of movement of money. Year in, year out, billions were invested by the great industrial European Powers in foreign countries, European and non-European…. These billions were regarded as safe investments with attractive yields, desirable for creditors as well as to debtors, with no doubts about the eventual return of both interest and principal. Most of the money flowed into the United States and Canada, a great deal into South America, billions into Russia, hundreds of millions into the Balkan countries, and minor amounts into India and the Far East. The interest paid on these foreign investments became an integral part of the national income of the industrial Powers, protected not only by their political and military might but —  more strongly — by the general unquestioned acceptance of the fundamental capitalist principles: sanctity of treaties, abidance by internal law, and restraint on governments from interference in business.

Globalization before 1914 versus after the world wars

This period before the First World War stands out for two reasons relating to the issue of globalization. First, it was in stark contrast to the world that followed in the 1920s and 1930s. The interwar years saw the rise of political and economic nationalism, along with the emergence of totalitarian regimes that overturned what remained of the prewar era of those three freedoms after the four years of World War I. In their place was a strongly antiglobalization movement, as many governments imposed high tariff walls as part of their systems of domestic control, command, and planning, none of which was in anyway compatible with open and free international trade.

The second reason the globalizing trends before the First World War stand out is that it differed in essential ways from the attempt to restore an international environment conducive to a return to a global economic order of human cooperation after the Second World War. The distinguishing characteristic of nineteenth-century Europe and North America and the globalization that was fostered is that, however inconsistently and imperfectly it might have been practiced, the hundred-year period between 1815 and 1914 can rightly be said to have been the product of the classical-liberal spirit.

The guiding principle that directed much of public policy in most of the countries of the “civilized world” was the depoliticizing of social life. With the triumph of free trade over mercantilism and protectionism in the early and middle decades of the nineteenth century and the elimination of many of the domestic regulations, monopoly privileges, and restraints on private enterprise, the state was dramatically removed from the affairs of everyday life. In its place arose civil society, the blossoming of the “private sector,” an extension of the network of ‘intermediary institutions” of voluntary association and market relationships. As the British classical economist Nassau Senior (1790–1865) expressed it:

The advocate of freedom dwells on the benefit of making full use of our own peculiar advantages of situation, wealth, and skill, and availing ourselves to the utmost of those possessed by our neighbors…. The principle of free trade is non-interference; it is to suffer every man to employ his industry in the manner which he thinks most advantageous, without pretense on the part of the legislature to control or direct his operation.

The liberal ideal of globalization through private enterprise

In especially the second half of the nineteenth century, governments did form international associations and reached various agreements with each other. But for the most part (and separate from various changing political and military alliances), their associations and agreements were designed to facilitate the smooth functioning of private intercourse between citizens and subjects. They included international river commissions, railway and transportation agreements, telegraph and postal unions, health rules and guidelines, procedures for uniform weights and measures, and respect for patents and copyrights. The thinking behind these arrangements was to establish general “rules of the game” to assist in the further globalization of private commercial and cultural exchange.

Within these rules of the game, individuals were to be left free and at liberty to direct their own lives and determine how best they thought the use of their own labor and private property; individuals freely and voluntarily associated and exchanged goods and services, along with investment capital and resource uses. The forms, directions, and effects of globalized trade and investment were matters of individual and private-enterprise decision-making, guided by market prices in determining the coordination of internationally connected and interdependent supplies and demands. It would be an exaggeration to say that governmental “affairs of state” never intruded itself into the private sector, but they were far more the exception than the rule. This was especially the case in Great Britain, as Herbert Feis explained in Europe, the World’s Banker, 1870–1914 (1930):

Like those who carried on industry and trade for their own profit, those who had capital to invest, and those whose business it was to deal in investments claimed the right to carry on their activities without government hinderance and control. Their affairs, they argued, were best run, judged by their own interest and national interest, without government interference. To this laissez-faire argument official opinion subscribed…. Thus, the government attempted no formal regulation of capital investment, except to prevent fraud and to prevent activities judged socially unwholesome…. Save in exceptional instances where some British interest, usually political, seemed to be threatened, there was little wish for formal official interference.

The fundamental premise was that the purpose of production was consumption, that the role of supplies was to meet and satisfy consumer demands in the least costly and most efficient ways, so as to maximize the economic well-being of as many people in society as possible. It was best to leave it to the knowledge and judgments of the individuals in the various corners of the division of labor, who would see to it that the scarce means of production were employed in such ways that a system of absolute and comparative advantage assured the most effective achievement of people’s ends through the employment of means. Not only did this not require the guiding or influencing hand of governments, but as Adam Smith also said, the assigning of any such authority to those in political power, “could be safely trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it.”

Trade liberalization through managed trade

The policies of the 1920s and 1930s had turned such arguments and reasoning on their head. The state, in both totalitarian and democratic countries, returned to the pre-free-trade notion of the mercantilists that government knew better than all the individuals about how the economic and social affairs of society should be organized and directed. The post–World War II era seemed to be a restoration of a free global international economic order only because in the context of the economic nationalism, protectionism, and autarkic policies advocated and implemented in the interwar and war years, the liberalizing tendencies introduced in the years after 1945 seemed so “liberating” in comparison.

During the Second World War, the Allied countries, led by the United States, decided that a continuation of policies of autarky and economic nationalism would be a disaster. International trade and commerce, global access to raw materials, and the opportunity for foreign investments were essential elements if a new world order was to be constructed. But the new world order that arose out of the ashes of World War II was not like the world order before 1914. Instead, the new globalization was based upon and managed in the context of a set of international governmental organizations. The new system would revolve around three intergovernmental institutions: the World Bank for long-term loans for economic reconstruction; the International Monetary Fund (IMF) for long-term monetary stability through shorter-term loans; and the General Agreement on Tariffs and Trade, out of which has grown the World Trade Organization (WTO), to coordinate trading rules and procedures among the member countries.

Why and how did this new globalization structure come into existence? While proclaiming the belief in free trade and globalized commerce, the world in the postwar period increasingly became enveloped in a spider’s web of welfare-statist programs that required governments to secure redistributive shares of income and market shares for selected and privileged sectors of their respective economies. Given the institutional responsibilities that modern governments took upon themselves in the name of the “social good,” the “national interest,” and the “general welfare,” the state’s use of domestic policy tools to serve special interests feeding at the trough of the government became inevitable.

Those institutions established after 1945 have reflected this ideological, political, and economic trend. Whether it be the IMF, or the World Bank, or the WTO, the purpose has been for governments to oversee, manage and direct the patterns of international trade and investment. The IMF and the World Bank have expanded and extended their activities to more greatly influence the distribution of loanable funds to both governments and private investors, especially in what used to be called Third World, that is, less-developed countries. They have also taken upon themselves the responsibility of tying such loans and credits to guidelines for economic policy reform in the recipient nations.

During their existence, the IMF and World Bank have followed the various interventionist and collectivist fads and fashions that have dominated public policy, whether in developed countries or in the less-developed nations: financial support for nationalized industries or government-privileged “private” enterprises; below-market interest rate loans for loss-making sectors of the economy; billion-dollar credit lines for governments in lesser developed countries; planning schemes to foster politically determined “balanced growth”; and fiscal policies pushing tax increases rather than absolute and consistent cuts in government spending and regulations.

The swings between liberal and illiberal managed trade 

As we saw, in the first several decades of international trade relations after the Second World War, global trade and commerce was noticeably liberalized, with tariff barriers and import restrictions being significantly lowered. Yet this was not the result of an ideology and policy of free trade per se but rather of the particular pattern of politically managed trade agreed upon by the international trading partners. It remained in effect only for as long as the member governments desired to regulate global markets in the direction of freer trade.

However, beginning in the 1970s and 1980s, a different set of ideas about when international trade can be considered “fair” or “just” became dominant. The central problem with an idea like “fair trade” is that it is as empty and ambiguous a term as “social justice” because it can mean almost anything that the user wishes it to. As economist Jaghish Bhagwati pointed out, “If everything becomes a question of fair trade, then ‘managed trade’ will be the outcome, with bureaucrats allocating trade according to what domestic lobbying pressures and foreign political muscle dictate.”

The 1990s saw a partial return to the idea of trade liberalization with the demise of the Soviet Union and the collapse of the socialist central-planning ideal. Socialism-in-practice had brought too much of a social and economic disaster in all the countries burdened with the Marxian ideal, so in China after the death of Chairman Mao in 1976 and then in the Eastern European nations and many of the Third World countries with the end of Soviet socialism, market-oriented institutional reforms introduced more of an economically liberal agenda around the globe.

From illiberal managed trade to a new global central planning

But with the global financial crisis of 2008–2009 and the breaks in the global supply chains due to the national lockdown during the Coronavirus crisis of 2020–2021, new calls were heard for national economic security against similar disruptions of essential resource availability and production capability. This has been exacerbated by the growing political tensions and war fears resulting from Russia’s military aggression in Ukraine and China’s drive for political, economic, and military ascendancy in East Asia and beyond.

Concerns over economic and political conflicts always serve as reasons and rationales for national or regional protectionism against imports and justifications for artificial subsidies and supports for domestic suppliers to provide import substitutions, leading to economic results that are worse than what would be the case if freedom of trade were followed by some or all nations. Humanity is less well off than it could have been.

The most recent danger to global trade and exchange is the reemergence of the central-planning mindset under the name of “stakeholder capitalism,” which is meant to fight climate change and impose a new social order of supposed equity and inclusion. A model for this has been formulated by the World Economic Forum. The intention is to impose a series of controls and commands on every corporation and business enterprise in the world, first through seemingly “voluntary” association but ultimately, as proposed, on the basis of political dictates via national and international governmental authorities. Prices, wages, work conditions, methods of production, and types of output, along with employment quota systems based on racial, ethnic, and gender group classifications and identifications would steer and direct the global economy.

Such a political-economic agenda and the governmental policies to bring it about, if sufficiently or fully pursued could result in a global central planning — regardless of any name officially given to it. It might easily be called Global Fascism — government command and control over private enterprises having little or no real autonomy over their own decision-making.

However, respective national and domestic regulatory, planning, and income-share goals necessarily come into conflict with each other in the arena of international trade, commerce, and investment. Any attempt to coordinate national politics at the international level through a global agenda such as the one proposed by the World Economic Forum would only exacerbate the conflicts due to arguments and dogmas over who gets what share based on a world-wide system of “diversity, equity and inclusion,” plus who will bear the economic costs of “saving the planet,” and by how much in terms of reduced standards of living.

Liberal globalism versus a planned world economy

This is not what was meant by a global economy in the minds of its earlier proponents in the nineteenth century. To the classical liberals of that time, a central purpose for freeing trade from the heavy hand of governments was precisely to take politics out of the marketplace, by making all such interactions private matters of peaceful mutual agreement and association; competition was not to be affairs of political power and military aggrandizement. Global competition in all its forms and facets was meant to be the means and methods for peaceful rivalries in discovering, implementing, and offering more, better, and less expensive goods and services and life opportunities to as many humans as possible. The world was to benefit from everyone’s knowledge, abilities, and talents by precisely leaving individuals at liberty to apply themselves as they thought best through the globalized division of labor and peaceful and productive human association.

These are the two opposing visions and possibilities for globalization in the remainder of the twenty-first century: free trade or managed trade. Only the classical-liberal idea and ideal of free trade is consistent with liberty, peace, and prosperity. Managed trade only offers constant conflicts as governments attempt to bend market outcomes, domestically and internationally, to satisfy power-grabbing visions of planning and regulating promoted by ideologues and special-interest groups desirous of using political power for themselves at the expense of the rest of humankind.

The Rebirth of the Austrian School and the South Royalton Conference: Marking the Fifty-Year Anniversary

By Richard Ebeling

Originally published on June 4, 2024 for the Liberty Fund Network

*The essay below is the lead essay to a longer conversation with Dr. Ebeling and other professors. Use the link above to read the full article.

It is now half a century since the first Austrian Economics conference was held during the week of June 15-22, 1974, at South Royalton, Vermont. No doubt it was a lifetime ago. But for some of us who were fortunate enough to attend the event in that small New England “rustic” hamlet, it seems like only yesterday. Sponsored by the Institute for Humane Studies, it brought together around 50 people most of whom had been identified as young economists and students interested in the ideas and legacy of the “Austrian” tradition.

During that week at South Royalton, three leading members of the, then, nearly non-existent Austrian School, Israel M. Kirzner (New York University), Ludwig M. Lachmann (University of Witwatersrand, South Africa), and Murray N. Rothbard (Polytechnic Institute of Brooklyn), delivered a series of lectures that later appeared in book form under the title, The Foundations of Modern Austrian Economics (Dolan, 1976). The presentations summarized the “Austrian” subjectivist approach to economic method, the theory of action (“praxeology”), the nature of the competitive market process and the role of the entrepreneur, the theory of capital and production, money and the monetary process, and critiques of mainstream equilibrium theory and Keynesian macroeconomics (Ebeling, 1974; Ebeling, 2019). This first Austrian conference was followed by two others, at the University of Hartford in June 1975, and then at Windsor Castle in the UK in September 1976 [Ebeling, 1975b; Blundell, 2014], with papers from the third conference published not long after [Spadaro, 1978].

Equally or, it might easily be claimed, more importantly in bringing about this revival of the Austrian School was that just four months later, Friedrich A. Hayek was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, commonly referred to as the Nobel Prize in Economics. (Ebeling, 1975). Hayek was supposed to have attended the conference and had been listed as a “distinguished guest” in the conference brochure but was unable to do so due to health problems. To the best of my recollection, no one at the South Royalton conference in June of 1974 anticipated Hayek being awarded the Nobel Prize a few months later. As a result of these two events, the South Royalton conference and Hayek’s Nobel Prize, the Austrian School was reborn.

Many of those who were among the attendees at South Royalton may have become well known in “Austrian” circles over the last half-century. But at the time, most of them were still in graduate school or even undergraduate programs with only a few already teaching and professionally writing.  Here, really, was the “remnant” of a famous economic school of thought that had been eclipsed in the post-World War II era (Ebeling, 2016, 15-23; 2023).

The Rise and the Eclipse of the Austrian School

Before the First World War, the Austrian Economists had been internationally recognized as among the pioneers of the transformative “marginalist” revolution. In the interwar period of the 1920s and 1930s, the Austrian Economists were among those at the center and even forefront of discussions surrounding money and the business cycle, the debates concerning comparative economic systems – capitalism, socialism and the interventionist state – and the nature, logic and implications of knowledge, equilibrium, market processes and the price system in economic analysis.

Hypothetically, the late 1940s should have served as the starting point for a postwar resurgence of the Austrian School. In 1948, Friedrich Hayek published Individualism and Economic Order, which brought together a series of his essays offering more than a decade of reflection and refinement of ideas relating to the nature of the social sciences, the features and functioning of a competitive market order and the price system, and the meaning of coordinative equilibrium given the inescapability of divided and dispersed knowledge in society, along with his critique of socialist central planning.

The next year, 1949, saw the publication of Ludwig von Mises’ treatise, Human Action, which integrated and synthesized four decades of his unique and original contributions in the “Austrian” tradition. This work offered a majestic vista of an alternative vision of purposeful, acting man as the methodological foundation for a dynamic market process theory that demonstrated the role of the entrepreneur as its central player. In addition, the work addressed  the essentiality of the calculative tool of the price system in an ever-changing world of uncertainty, expectations and forward-looking planning of time consuming methods of production for adaptive coordination in the complex system of associative division of labor. There were also Mises’s refined applications within his theoretical framework to the issues of the day: capitalism versus socialism versus the interventionist economy; the monetary system and the business cycle; and a multitude of other topics.

But, instead, during the three decades following the Second World War, the Austrian Economists and their ideas and approach to economic theory and policy fell by the wayside with the ascendency and near monopolistic dominance of mathematical general equilibrium theory in microeconomics and Keynesian Economics in macroeconomics. Almost the only references to the Austrian School were in history of economic thought textbooks, and in this setting, they were clearly classified as closed chapters in the earlier developments leading to economics as a positive and quantitative “science” in its modern garb.

As a personal indication of the Orwellian memory hole that Austrian Economics had fallen into, when Ludwig von Mises died in October 1973, I was an undergraduate at California State University, Sacramento. I wrote a short obituary piece about Mises for the campus student newspaper. One of my economics professors, a Veblenian Institutionalist who was also an editor of the Journal of Economic Issues, came up to me after reading it, and said, without jest, “Mises! Mises! I thought he died in the nineteenth century.”

As another instance, when Friedrich A. Hayek won the Nobel Prize in Economics in the autumn of 1974, several of my Keynesian and Marxist professors expressed their surprise and confusion. One asked what Hayek had ever contributed to economics other than his “polemical and politically extreme right-wing tract,” The Road to Serfdom.  Another asked, “Wasn’t Hayek that old business cycle theorist who assumed ‘full employment’ during the Great Depression?”

Now, I am not suggesting that such views about either Mises or Hayek reflected the knowledge, or lack thereof, of every mainstream economist in the 1970s. But I do think that my admittedly very small sample size about what was known or thought about two of the leading twentieth century members of the Austrian School was probably replicated in many departments of economics at universities around the United States and other parts of the world.

A New Generation’s Rediscovery of the Austrian School 

Hayek’s Nobel award served as a crucial catalyst for a renewed interest in his contributions and the school of thought he represented, both in scholarly and popular circles. This Hayekian revival was especially facilitated through the publication of works such as Gerald P. O’Driscoll’s Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek (1977), who had attended the South Royalton conference, and Norman P. Barry’s Hayek’s Social and Economic Philosophy (1979). By the 1980s and 1990s, there was practically a cottage industry in books and articles analyzing and interpreting Hayek’s contributions to economics and social and political philosophy. The most notable of these were John Gray’s Hayek on Liberty(1984), G. R. Steele’s The Economics of Friedrich Hayek (1993), and Bruce Caldwell’s Hayek’s Challenge (2004). Not since before the Second World War had these ideas received such attention.

There soon was an explosion of works restating and explaining the evolution and core concepts of Austrian Economics, from the popular to the scholarly (e.g., Littlechild, 1978; Taylor, 1980; Reekie, 1984; Shand, 1984, 1990; Cubeddu, 1993; Vaughn, 1994, 2021; Foss, 1994; Gloria-Palermo, 1999; de Soto, 2008; Butler, 2010; Ebeling, 2003, 2010a, 2016; Schulak & Unterköfler, 2011; Holcombe, 2014; Horwitz, 2019). Anthologies appeared bringing together earlier writings by the Austrian Economists to make them more easily accessible to a new generation of readers (Ebeling, 1990; Littlechild, 1990; Kirzner, 1994; Greaves 1996; Gloria-Palermo, 2002). There was the founding of the Review of Austrian Economics, the Quarterly Journal of Austrian Economics, and Advances in Austrian Economics. These journals were specifically devoted to “Austrian” theory, its history, and its application to contemporary economic issues. There were soon places for the study of Austrian Economics at several universities and colleges around the United States.

During the 1980s and 1990s, observers within and outside the Austrian School expressed some disappointment and frustration that many then writing in the “Austrian” tradition seemed to be “merely” repeating what the earlier “masters” had written in the late nineteenth century or the first half of the twentieth century. Austrian Economists seemed stuck in the past and simply rewriting, over and over again, the history of long gone economic ideas.

But, I would argue that this phase in the revival of the Austrian tradition was in fact necessary and essential. Except for a small circle of scholars narrowly interested in the history of economic thought, the content, character, quality and texture of economic ideas before the Second World War were hardly known or understood by the generation of economists trained in the 1950s, 1960s and 1970s. And what was known or referenced about the economists in that earlier pre-World War II period was often caricatures of them and their ideas. The Austrians theoretical contributions and policy conclusions were either ignored or widely misrepresented.

This was the intellectual climate in which the Austrian School was experiencing a revival. While I may be accused, no doubt, of “romanticizing” it, for some of us the rediscovery of the Austrian School was like the archeologists who unearth a long-forgotten civilization. They must excavate the site, explore the buildings and passageways, and carefully study the artifacts extracted from the grounds to determine what kind of civilization it was. What types of lives did those ancient people live? What was their culture, technologies, values and belief systems? Then, we compare their achievements and accomplishments with our own. Sometimes, no doubt surprisingly, “modern man” finds out that that older civilization had made discoveries and advancements in knowledge and understanding that still bewilder those in contemporary society; such was realized about the Austrians of that earlier time (Dekker, 2016).

Intellectual History as a Gateway to New Understandings and Applications

Those who were experiencing an active interest in the Austrian School after the South Royalton conference and Hayek’s awarding of the Nobel Prize literally had to go back to the foundational origins of the school starting with Carl Menger, Eugen von Böhm-Bawerk and Friedrich von Wieser. A new generation needed to explore the buildings and passageways of the theoretical construction built up by the first generation of Austrians. They discovered  different and subtly more insightful ways of thinking about the meaning of “the margin,” and an understanding of many nuances concerning the meaning of “subjective value” that broadened into a subjectivism of meaning, purpose, intention, action, uncertainty, time and causality (Ebeling, 2010b).

The static equations of Walrasian and Paretian general equilibrium were seen to be outside of time and space, to be ignoring the limits to human knowledge by assuming that everyone began with knowing everything relevant to know. This new generation of Austrian Economists, like careful and methodical historians going through “original documents,” worked their way through the controversies of the interwar period. Having all the articles and books spread before them, they retraced the steps and stages of the controversies over economic calculation and socialist central planning. Through it they came to understand how Austrians like Mises and Hayek revised, refined, and enriched their own arguments concerning property, prices, competition and entrepreneurship, as the advocates of socialism and interventionism were challenging them.

With this historical hindsight this new generation better understood why many Austrian arguments failed to persuade during the 1930s and 1940s. But through this very hindsight they could also see how Mises and Hayek, for instance, came to redefine the notion of “equilibrium,” the conception of “coordination,” and the meaning of market processes through and in time with actors inescapably acting within a division of knowledge, and its relevance for social and economic policy (Lavoie, 1985a, 1985b; O’Driscoll and Rizzo, 1985; Barry, 1988; Cordato, 1992; Thomsen, 1992; Machovec, 1995; Ikeda, 1997; Aimar, 2009; de Soto, 2009, 2010; Boettke, 2012, 2021; Mitchell & Boettke, 2017)

The same applied to the controversies surrounding money and the business cycle. The Austrians were concerned with the meaning and nature of an intertemporal equilibrium that coordinates the choices of savers and investors through a network of interest rates and stages of production by which resources are applied over time to make finished consumer goods. All market transactions occur through the medium of money. However, with the supply of money in the banking system influenced by the money-creation powers of a central bank, there is the possibility of an illusion that there is a greater plentitude of available factors of production for investment purposes than may be the case. This can result in an imbalance between investment projects undertaken relative to the actual supply of savings to sustain them over time. At the same time, however, the apparent simplicity and clarity of the Hayekian triangles to explain and illustrate this savings-investment process were seen to be more complicated and confining than they had first appeared to be in the 1930s. Thus, there was the need for a richer conceptualization of capital and its structure. (Skousen, 1990; Lewin, 1999; Garrison, 2001; Horwitz, 2016; Lewin & Cachanosky, 2019; 2021).

The advantage of the historian is that he, at least partly, knows “how things turned out,” in a way that the human actors in the stream of those earlier events did not and could not imagine, including the evolution of their own ideas and actions through the lived experiences and sequences of their own time. Through this all, the new post-South Royalton generation of Austrians came to understand the strengths and shortcomings in the ways those earlier Austrians had laid out and defended their system of ideas, and why they seemingly “lost” the debates of that interwar period. This “defeat” left the field of economics open to the “victory” of the Walrasian and Marshallian mainstream of the profession in microeconomics and to the Keynesians in the “new economics” of macroeconomic theorizing.

At the heart of many of these controversies was the realization that a good part of it centered on alternative conceptions of the philosophy and methods of the social sciences. The dichotomy between a science of the logic of the human mind and purposeful actions, along with the unintended consequences emerging from social and economic processes, versus the mainstream economics primarily focused on quantitative relationships and equilibrium states. These differences in approach became starkly clearer from the perspective of more than a hundred and fifty years after the birth of the Austrian School in 1871.

This all required a retracing of the steps and stages of the evolution of the Austrian School, with all their triumphs and tragedies in those battles of ideas. A “doctrinal” focus of attention and emphasis was almost impossible to avoid for a fuller revival of the “lost civilization” of the Austrian School of Economics. Being an historian of Austrian Economic thought was found, to a greater or lesser extent, to be part of the reconstruction and then new advancements in the Austrian tradition.

From Doctrinal Studies to New and Significant Contributions

But already in the 1980s and 1990s the focus of some of these newer Austrians began to change. Having successfully finished the process of rediscovery, the Austrian tradition was taken up and applied in new ways. Two such areas that stand out, may I suggest, were monetary and banking theory and policy, and the theory of entrepreneurship and the firm. In 1942, the German economist, Gustav Stolper, could say, “There is today only one prominent liberal theorist consistent enough to advocate free, uncontrolled competition among banks in the creation of money.” That was Ludwig von Mises (Stolper, 1942, p. 59). But following Hayek’s Denationalization of Money in 1976, an entire Austrian-inspired new theoretical field emerged developing the possibilities of private, competitive free banking in place of central banking (White, 1984, 1998; 1999; 2023; Selgin, 1988, 1996; 2017; Dowd, 1988, 1989, 1993, 2001; Horwitz, 2000, 2019; Salerno, 2010; Ebeling, 2015, pp. 104-138).

The same can be said about entrepreneurship. Kirzner’s Competition and Entrepreneurship (1973) not only was followed over the next several decades by additional works by Kirzner, himself, but fostered new contributions concerning additional sides to the entrepreneurial role besides that of coordinating arbitrageur; including the entrepreneur in relationship to the existence, nature, and workings of decision-making within the business enterprise and its organization (Harper, 1996; Sautet, 2000; Foss & Klein, 2002, 2012, 2019, 2022; Pongracic, 2009; Klein, 2010). The “Austrian” contributions to these two areas of economic study are generally recognized within the economics profession as a whole, and no longer as simply “fringe” ideas of a bygone school of thought.

In addition, during the last thirty years, several “Handbooks” (Boettke, 1994; 2010; Boettke & Coyne, 2015) and collections of essays devoted to summarizing and clarifying Austrian themes have appeared. But unlike most of the earlier anthologies that I referred to, these were not meant to merely restate the body of older Austrian conceptions and ideas on various topics. No, their purpose was to explain the relevance of the Austrian tradition to contemporary economic theory and policy, with applications and examples, and complementary connections to other schools and fields in modern-day economics. (Rizzo, 1979; Backhaus, 2005; Aligica & Boettke, 2009; Boettke, Coyne, & Storr, 2017; Coyne, Hall & Norcross, 2024).

Those who have been drawn to this revived and revitalized post-South Royalton Austrian School have also applied its analytical framework to social problems such as community disasters and “spontaneous” responses by the institutions and participants of civil society (Storr & Haeffele-Balch, 2015; 2020) and to the importance of cultural and institutional factors within the social and market processes of the open society (Storr, 2015; Gruber & Storr, 2015; Storr & John, 2020), as well as critiques of behavioral economics (Rizzo & Whitman, 2019) and the hubris of the presumed expertise possessed by social engineers (Formaini, 1990; Koppl, 2015; 2018). This has also included areas of human life as wide and diverse as a Hayekian approach to the family and marriage (Horwitz, 2015) and the economics of war and peace (Coyne. 2007; 2013; 2022).

Conclusion: The Lasting Significance of the South Royalton Conference

The first day of the South Royalton conference began with a banquet dinner. Since Ludwig von Mises had passed away less than a year earlier, in October 1973, at the age of 92, some of the attendees who had known him were asked to make a few remarks.  Free market journalist Henry Hazlitt recalled how he had first met Mises in 1940, shortly after Mises had arrived in New York City from war-torn Europe. British economist William H. Hutt talked about what he considered to be some of Mises’s most important contributions to economics. Murray Rothbard recounted some of the amusing anecdotes that Mises would tell during the graduate seminar he taught at New York University from 1946 to 1969. Milton Friedman, who had a summer home in Vermont and who was invited to the dinner, was asked to say a few words. Friedman said that, of course, Mises had made a number of notable contributions. And while he hoped that we would have an enjoyable and fruitful conference over the coming week, it was important to remember that there was no such thing as “Austrian Economics,” just “good” economics and “bad” economics.

Friedman clearly thought that many of those at the conference were on a fool’s errand in pursuing an interest in something called “Austrian Economics.” Yet, for many of those attendees, Austrian Economics was good economics, and they wanted to know more about it from the lectures that were about to be given by Israel Kirzner, Ludwig Lachmann, and Murray Rothbard over the next several days.

During a walk, one day, with Ludwig Lachmann around the South Royalton town square with its statue of a Civil War Union soldier standing on a pedestal in the middle, Lachmann said to me that he had long feared that he might very well be “the last” of the Austrian Economists.

Those lectures at the South Royalton conference half a century ago this year, have resulted in a vibrant and productive rebirth of the Austrian School of Economics. It has seen the refinement and refashioning of the original ideas for which the Austrian Economists were internationally renowned in the late nineteenth and twentieth centuries, and which have now been taken into numerous new directions of theoretical and public policy significance.

The Austrian attention to imperfect knowledge, uncertainty, and the potential for frustrated expectations, reminds us that what the future holds in store can never be fully anticipated. But the revival and growth of the Austrian School over the last fifty years has made it clear that Ludwig Lachmann had nothing to fear in thinking he might have been the last of the Austrian Economists.

Ludwig Von Mises’ Human Action After 70 Years

By Richard Ebeling

Originally published on August 1, 2019 for The Future of Freedom Foundation

September 15, 2019, marks 70 years since the appearance of Ludwig von Mises’ Human Action: A Treatise on Economics, one of the truly great “classics” of modern economics. Too often a “classic” means a famous book considered to have made important contributions to some field of study and that is reverentially referred to but is unfortunately rarely ever read any-more.

In economics, Adam Smith’s Wealth of Nations is a typical example of such a work. Every economist and a good number of people in the general public have heard of the “invisible hand” and the notion that self-interest furthers the public interest through the incentive mechanism of free-market competition; but in fact few economists nowadays have actually read more than a handful of snippets and brief passages from Smith’s profound treatise. Among the general public, the number of people who even know the snippets dwindles to almost nothing.

A still-read and still-relevant classic

However, Ludwig von Mises’ Human Action uniquely stands out as a classic in the literature of economics. Not only among “Austrian” economists but also for a growing number of other people, Mises’s brilliant treatise continues to be read and taken seriously as a cornerstone for understanding the nature of the free society and the workings of the market economy.

It has taken on even more relevance and significance in these first decades of the 21st century because of the economic crisis of 2008-2009, the full effects from which the American economy has still not fully recovered, and in the wake of a dangerous revival of a call for a “democratic socialism” that demands the implementation of various forms and degrees of government central planning. They have made the economic reasoning and public-policy analysis that runs through most of Human Action as timely today as when its first edition appeared in bookstores on September 14, 1949.

A few days after its publication, the famous free-market journalist Henry Hazlitt reviewed Human Action in his column in Newsweek magazine. He emphasized its importance by telling his readers,

[The] book is destined to become a landmark in the progress of economics.… Human Action is, in short, the most uncompromising and the most rigorously reasoned statement of the case for capitalism that has yet appeared…. It should become the leading text of everyone who believes in freedom, in individualism, and the ability of a free-market economy not only to outdistance any government-planned system in the production of goods and services for the masses, but to promote and safeguard, as no collectivist tyranny can ever do, those intellectual, cultural, and moral values upon which all civilization ultimately rests.

Keys to human progress

If the field of sociology did not have such a controversial history and so many conflicting notions about what its subject matter and approach are supposed to be about, it would not be misplaced to say that in Human Action, Mises demonstrated himself to be not only one of the greatest economists of the last century, but one of its leading sociologists as well.

In the most appropriate meaning of the term, Mises formulated a “science of society” in the tradition of Scottish philosophers such as Adam Smith. All that happens in the social world begins in the thinking and actions of individual human beings. They are the starting point for understanding society: man, as a purposefully acting being, gives assigned meanings to the world around him, selects desired ends, decides upon possibly useful means to their attainment, and undertakes courses of action through time in attempts to bring his desired plans to fruition.

Humans rose above animal existence through their developed capacity to reason, conceptualize, imagine possible futures, and conceive of ways of bringing them into reality. But on his own, man’s mental and physical powers are too limited for achieving much above bare subsistence. The profound key to the betterment of the human condition, Mises insisted, was man’s discovery of the benefits that could come from a division of labor through which men could specialize in their tasks and mutually gain through cooperative association that slowly but surely improved the standards of living, the quality of life, and the cultural elements that mark off “civilization.”

But how shall human beings collaborate — through plundering conquest or peaceful trade? It took thousands of years for people to stumble upon the superiority of market-based cooperation over politically based power and privilege. As production and trade become ever more complex owing to the extension of the system of division of labor, there had to arise a method by which the participants in the emerging relationships of supply and demand could know how and what to do.

Economic calculation

A central theme through much of the Human Action is Mises’s insistence on the essential importance of economic calculation. In the early decades of the 20th century, socialists of almost all stripes were certain that the institutions of the market economy could be done away with — either through peaceful means or violent revolution — and replaced with direct government ownership or control of the means of production with no loss in economic productivity or efficiency.

Mises’s landmark contribution 100 years ago in 1920 was to demonstrate that only with market-based prices expressed through a medium of exchange could rational decision-making be undertaken for the use and application of the myriad means of production to ensure the effective satisfaction of the multitudes of competing consumer demands in society.

“Monetary calculation is the guiding star of action under the system of division of labor,” Mises declared in Human Action. “It is the compass of the man embarking on production.” The significance of the competitive process, as Mises had expressed it in his earlier volume Liberalism (1927), is that it facilitates “the intellectual division of labor that consists in the cooperation of all entrepreneurs, landowners, and workers as producers and consumers in the formation of market prices. But without it, rationality, i.e., the possibility of economic calculation, is unthinkable.”

Such rationality in the use of means to satisfy ends is impossible in a comprehensive system of socialist central planning. How, Mises asked, will the socialist planners know the best uses for which the factors of production under their central control should be applied without such market-generated money prices? Without private ownership of the means of production, there would be nothing (legally) to buy and sell. Without the ability to buy and sell, there would be no bids and offers, and therefore no haggling over terms of trade among competing buyers and sellers. Without the haggling of market competition there would, of course, be no agreed-upon terms of exchange. Without agreed-upon terms of exchange, there are no actual market prices. And without such market prices, how will the central planners know the opportunity costs and therefore the most highly valued uses for which those resources could or should be applied to satisfy the consumer demands of “the people”?

With the abolition of private property, and therefore market exchange and prices, the central planners would lack the necessary institutional and informational tools to determine what to produce and how, in order to minimize waste and inefficiency.

Therefore, Mises declared in 1931,

From the standpoint of both politics and history, this proof [of the impossibility of socialist planning] is certainly the most important discovery by economic theory.… It alone will enable future historians to understand how it came about that the victory of the socialist movement did not lead to the creation of the socialist order of society.

Government intervention and monetary manipulation

At the same time, Mises demonstrated the inherent inconsistencies in any system of piecemeal political intervention in the market economy. Price controls and production restrictions on entrepreneurial decision-making bring about distortions and imbalances in the relationships of supply and demand, as well as constraints on the most efficient use of resources in the service of consumers. The political intervenor is left with the choice of either introducing new controls and regulations in an attempt to compensate for the distortions and imbalances the prior interventions have caused or repealing the interventionist controls and regulations already in place and allowing the market once again to be free and competitive. The path of one set of piecemeal interventions followed by another entails a logic in the growth of government that eventually results in the entire economy’s coming under state management. Hence, interventionism consistently applied could lead to socialism on an incremental basis through an unintended back door.

The most pernicious form of government intervention, in Mises’s view, was political control and manipulation of the monetary system. Contrary to both the Marxists and the Keynesians, Mises did not consider the fluctuations experienced over the business cycle to be an inherent and inescapable part of the free-market economy. Waves of inflations and depressions were the product of political intervention in money and banking. And that included the Great Depression of the 1930s, Mises argued.

Under various political and ideological pressures, governments had monopolized control over the monetary system. They used the ability to create money out of thin air through the printing press or on the ledger books of the banks to finance government deficits and to artificially lower interest rates to stimulate unsustainable investment booms. Such monetary expansions always tended to distort market prices resulting in misdirections of resources, including labor, and malinvestments of capital. The inflationary upswing that is caused by an artificial expansion of money and bank credit sets the stage for an eventual economic downturn. By distorting the rate of interest — the market price for borrowing and lending — the monetary authority throws savings and investment out of balance, with the need for an inevitable correction.

The “depression” or “recession” phase of the business cycle occurs when the monetary authority either slows downs or stops any further increases in the money supply. The imbalances and distortions become visible, with some investment projects having to be written down or written off as losses, with reallocations of labor and other resources to alternative, more profitable employments, and sometimes significant adjustments and declines in wages and prices to bring supply and demand back into proper order.

The errors of Keynesianism

The Keynesian revolution of the 1930s, which then dominated economic-policy discussions for decades following the Second World War, was based on a fundamental misconception of how the market economy worked. What Keynes called “aggregate demand failures” (to explain the reason for high and prolonged unemployment) distracted attention from the real source of less-than-full employment: the failure of producers and workers on the supply side of the market to price their products and labor services at levels that potential demanders would be willing to pay. Unemployment and idle resources were a pricing problem, not a demand-management problem. Mises considered Keynesian economics basically to be nothing more than a rationale for special-interest groups, such as trade unions, who didn’t want to adapt to the reality of supply and demand, and of what the market viewed as their real worth.

Thus Mises’s conclusion from his analysis of socialism and interventionism, including monetary manipulation, was that there is no alternative to a thoroughgoing, unhampered, free-market economy — and one that included a market-based monetary system such as the gold standard.  Both socialism and interventionism are, respectively, unworkable and unstable substitutes for open, competitive capitalism.

The classical liberal defends private property and the free-market economy, Mises insisted, precisely because it is the only system of social cooperation that provides wide latitude for freedom and personal choice to all members of society, while generating the institutional means for coordinating the actions of billions of people in the most economically rational manner.

The apparent triumph of capitalism over collectivism, following the demise of the Soviet bloc in the 1990s, has, unfortunately, turned out to be mostly an illusion. Governments in the Western world did not reduce their size or intrusiveness in the economic affairs of their citizens. The interventionist-welfare state has remained alive and well, and continued to grow along with the government debts to pay for the entire redistributive largess.

Central banking and free banking

But the heart of the interventionist system is government control of the monetary system — indeed, it has remained an untouched element of monetary central planning through the institution of central banking.

Fortunately, over the last forty years, Mises’s analysis and defense of gold-backed, private competitive banking in place of government-monopoly central banking has finally begun to win over a growing number of Austrian and other advocates. (See my ebook Monetary Central Planning and the State.)

Monetary manipulation by central banks inserts one of the most disruptive distortions into the process of economic calculation. Interest rates — which are meant to inform market participants about the availability of savings relative to the demands for investment expenditures, and which facilitate the coordination of resource use over periods of time relative to the demands of income earners for consumption in the present versus the future — send out misinformation to both producers and consumers under the pressure of monetary expansion.

The financial crisis and its interventionist aftermath

In the wake of Federal Reserve monetary mischief during the early years of the 21st century, imbalances and distortions were once again generated by monetary policies that resulted in the financial and economic crisis of 2008-2009.

There soon occurred the return of the “ghost of Keynes past.” In the face of the inescapable need for the rebalancing and re-coordination of misdirected resources and malinvested capital for a full return to normal and sustainable, market-based growth, government spending and budget deficits to “stimulate” the economy out of a recession were once again insisted upon.

The focus remained on “aggregate” output and employment, which always hides from view the underlying microeconomic relations that are at the core of the market process. How can the multitudes of market participants discern where and to what extent market errors have been made under the pressure of past monetary and interest-rate manipulations if the price system is not permitted to perform its job of telling the truth about the reality of supply and demand? That is, the degree to which resources were misallocated and wrongly priced during the preceding boom. Or the extent to which men, material, and savings-backed financial funds need to realign themselves to restore a properly understood full-employment market-driven economy.

The recovery period was drawn out for almost ten years, longer than most other periods of post-boom readjustments since the end of the Second World War. How could people know what to do and where to do it in the social system of division of labor, when the crucial tool of economic calculation was undermined by government bailouts, subsidies, price floors, capital-market interventions, and continuing monetary manipulation and near-zero interest-rate policies that threatened new misdirections of capital and labor, with the risk of another boom-bust cycle to come?

In the immediate aftermath of the 2008-2009 downturn, the argument was constantly made that many banks were too big to fail, that depositors needed to have their various bank accounts protected and guaranteed, and that the repercussions of allowing the financial markets to adjust on their own to the post-boom reality would have been too harsh. In fact, Mises had responded to such arguments in his 1928 monograph, Monetary Stabilization and Cyclical Policy, even before the Great Depression began, by warning of what today is understood as “moral hazard,” that is, the danger of reinforcing the repetition of bad decisions by the government’s bailing out mistakes made in the market:

In any event, the practice of intervening for the benefit of banks, rendered insolvent by the crisis, and of the customers of these banks, resulted in suspending the market forces that otherwise would have served to prevent a return of the expansion, in the form of a new boom, and the crisis which inevitably follows. If the banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit? If the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, then all entrepreneurs — not only banks but also other businessmen — would exhibit more caution in granting and using credit in the future. Instead, public opinion approves of giving assistance in the crisis. Then, no sooner is the worst over, than the banks are spurred on to a new expansion of circulation credit.

Mises’s warning

Just as there was a huge shift toward more and bigger government in the years leading up to the publication of Human Action, so today we are seeing an expansion of governmental presence and domination of social life, especially in health care, education, and the energy sector — as well as the financial and capital markets.

But where will all the money come from to fund this new gargantuan largess for expanded political paternalism? In the Austria of the interwar period of the 1920s and 1930s, Mises had witnessed and explained the consequences from unrestrained government spending that finally resulted in the “eating of the seed corn” — capital consumption. Mises warned of this danger, too, in the pages of Human Action, and the fact that there must be a point at which the interventionist welfare state will have exhausted “the reserve fund” of accumulated wealth, after which the consumption of capital becomes the only basis upon which to continue to feed the fiscal demands of the redistributive state. Those currently in political power in Washington seem hell-bent on bringing that about in the decades ahead.

The enduring value and importance of Human Action

A “predecessor” of Human Action had appeared in German in 1940. Shortly after it appeared, Friedrich A. Hayek reviewed it, emphasizing its astonishingly unique qualities:

There appears to be a width of view and an intellectual spaciousness about the whole book that are much more like that of an eighteenth-century philosopher than that of a modern specialist. And yet, or perhaps because of this, one feels throughout much nearer reality, and is constantly recalled from the discussion of the technicalities to the consideration of the great problems of our time…. It ranges from the most general philosophical problems raised by all scientific study of human action to the major problems of economic policy of our time…. [The] result is a really imposing unified system of a liberal social philosophy. It is here also, more than elsewhere, that the author’s astounding knowledge of history as well as of the contemporary world helps most to illustrate his argument.

The years since the original appearance of Human Action in 1949 have done nothing to diminish the validity of Hayek’s interpretation. Indeed, the social, political, and economic conditions of our world today give Ludwig von Mises’s treatise a refreshing relevance matched by few other works written over the last century.

That is what has resulted in its being read by more and more people today, rather than simply being one of those many “classics” collecting dust on a shelf. If enough people discover and rediscover the timeless truths in the pages of Human Action, the ideas of Ludwig von Mises may well assist us in stemming the growing tide toward an even larger leviathan state that dangerously looms in front of us.

Ludwig von Mises and the Austrian Theory of Money, Banking, and the Business Cycle, Part 3

By Richard Ebeling

Originally published on May 20, 2024 for The Future of Freedom Foundation

When the English-language edition of Ludwig von Mises’s The Theory of Money and Credit was published 90 years ago, in 1934, the world was in the midst of the Great Depression. The American stock market crash in October 1929 soon snowballed into a severe economic downtown in 1930 and 1931 that reached its lowest point in terms of rising unemployment and falling industrial and agricultural output in 1932 and early 1933.

In Europe, the economic conditions were no better. Great Britain and France, for instance, were experiencing the same negative effects of falling outputs and rising joblessness, though the worst of it, in terms of these two indicators of economic “bad times,” was being experienced in Germany. Intensifying the global impact of the economic downturn was a return to trade protectionism in many of the leading economies, including the United States, along with foreign exchange controls that led, not surprisingly, to a dramatic fall in international trade and investment.

Government and the Great Depression

Why was the severity and depth of this economic depression the most serious in virtually anyone’s living memory? In Mises’s view, it was due to the degree to which governments almost everywhere were introducing policies that hindered and prevented the market economy from readjusting and rebalancing following what had turned out to be the false prosperity of the 1920s. Not that all that had happened in the 1920s was unsustainable or lost. Technological innovations, cost-
efficiencies, improvements in organization and management of industry and manufacturing, had represented real improvements in the standards and qualities of life for many around the world, especially in the United States.

But overlaying these impressive improvements in production potentials had been monetary policies followed in the United States and in Europe that had brought about mismatches and imbalances between savings and investment that had set the stage for an inescapable period of correction, due to unsustainable price and wage relationships and resource and capital uses, if there was to be a return to longer term growth and stability of the market economies in these countries.

There had been economic booms and busts, inflations and depressions in the past. These earlier downturns, however, had rarely been anywhere nearly as severe and disruptive as was being experienced in the 1930s. In the past, governments, for the most part, had kept a fairly “hands off” policy approach, allowing financial and investment and consumer markets to adjust and find their new coordinating price and wage patterns and resource and capital uses across sectors of the economy to return to full employment and output potentials.

The gold standard and growing government intervention

However, in the 1930s, governments did the opposite. The British government had ended the gold standard as the basis of the country’s monetary system in September 1931. Following the inauguration of Franklin D. Roosevelt in the United States in March 1933, the United States was taken off the gold standard in June of that year with the command that Americans had to turn in their gold coins and bullion in exchange for Federal Reserve paper money under threat of arrest, confiscation, and imprisonment.

First under Republican President Herbert Hoover and then under FDR’s New Deal programs, the U.S. government ran large budget deficits, raised taxes on business, undertook sizable public works projects, and interfered with market-based adjustments of wages and prices to restore balance between supplies and demands. Indeed, with the coming of the New Deal, Roosevelt imposed a fascist-style system of economic planning over industry and agriculture that for all intents and purposes did away with the American market economy. Only a series of Supreme Court decisions in 1935 and 1936 that declared some of the major New Deal programs as unconstitutional saved America from the possibility of a permanent command economy.

In the 1920s, Germany had a weak post–World War I democratic government, known as the Weimar Republic. In 1931 and 1932, the three largest political parties represented in the German parliament were the Social Democrats, the National Socialists (Nazis), and the Communists. In January 1933, Adolf Hitler was appointed Chancellor (prime minister), and within months, the Nazis were rapidly transforming the country into a totalitarian dictatorship, with government-directed spending and investment as the keystones of the National Socialist economic program. The Nazis formally introduced four-year central planning in 1936.

In neighboring Austria, where Mises was living and working as a senior economic analyst for the Vienna Chamber of Commerce, a brief civil war broke out in February 1934 between the fascist-oriented government and the armed forces of the Social Democratic Party, which ended with the defeat of the Austrian socialists. Soon after, a new constitution was instituted that officially established an authoritarian political system and a corporativist economy. In October 1934, Mises left Austria and took up his first full-time professorship at the Graduate Institute of International Studies in Geneva, Switzerland. This enabled him to escape both from living under the fascist dictatorship in his home country and the rising tide of aggressive anti-Semitism in both Nazi Germany and in the Republic of Austria that became violent and deadly in Mises’s homeland after Hitler entered Vienna in March 1938 and Austria was annexed into the German Third Reich. (See my article “Celebrating the Arrival of Ludwig von Mises in America,” Future of Freedom, August 2020.)

Mises on the causes of the Great Depression

In February 1931, Mises delivered a lecture on “The Causes of the Economic Crisis,” which was soon afterwards published in German in an expanded version. The countries of Europe and the United States were caught in this Great Depression precisely because governments had failed to allow market-based readjustments and rebalancing to restore production and employment.

Instead, governments did their utmost to maintain prices and wages at nonmarket levels through various forms of intervention and regulation. Tariffs protected uncompetitive domestic producers from foreign rivals; trade unions were privileged with unofficial power to shut down businesses and use violence to prevent nonunion workers from filling the jobs of union workers on strike as part of the attempt to impose higher-than-market wages; unemployment insurance was used to reduce the pressure on unions from the jobless; taxes on private enterprise reduced investment and threatened the consumption of capital; and government deficit spending was used to “create” jobs bound to be found to be mostly wasteful and unnecessary. From this Mises concluded:

If everything possible is done to prevent the market from fulfilling its function of bringing supply and demand into balance, it should come as no surprise that a serious disproportionality between supply and demand persists, that commodities remain unsold, factories stand idle, many millions are unemployed, destitution and misery are growing and that finally, in the wake of all these, destructive radicalism is rampant in politics.… With the economic crisis, the breakdown of interventionist economic policy — the policy being followed today by all governments, irrespective of whether they are responsible to parliaments or ruled opening as dictatorships — becomes apparent.

The corrupting influence of the interventionist state

The corrosive effect such interventionist policies had on the functioning of the market and the perverse antisocial incentives it fostered in the private sector was explained by Mises a year later, in 1932, in an essay entitled, “The Myth of the Failure of Capitalism”:

In the interventionist state it is no longer of crucial importance for the success of an enterprise that the business should be managed in a way that it satisfies the demands of consumers in the best and least costly manner. It is far more important that one has “good relations” with the political authorities so that the interventions work to the advantage and not the disadvantage of the enterprise. A few marks more tariff protection for the products of the enterprise and a few marks less for the raw materials used in the manufacturing process can be of far more benefit to the enterprise than the greatest care in managing the business. No matter how well an enterprise may be managed, it will fail if it does not know how to protect its interests in the drawing up of the customs rates, and in the negotiations before the arbitration boards, and with cartel authorities. To have “connections” becomes more important than to produce well and cheaply.

So, the leadership positions within enterprises are no longer achieved by men who understand how to organize companies and to direct production in the way the market situation demands, but by men who are well thought of “above” and “below,” men who understand how to get along with the press and all the political parties, especially with the radicals, so that they and their company give no offense. It is that class of general directors that negotiate far more with state functionaries and party leaders than with those from whom they buy and to whom they sell.

Since it is a question of obtaining political favors for these enterprises, the directors must repay the politicians with favors. In recent years, there have been relatively few large enterprises that have not had to spend very considerable sums … [on] campaign contributions, public welfare organizations and the like…. The crisis from which the world is suffering today is the crisis of interventionism and of national and municipal socialism, in short, it is the crisis of anti-capitalist policies.

The German economic environment was one in which a symbiotic relationship closely connected those in politics and the bureaucracy with special-interest groups desiring favors and privileges at others’ expense. It is not too surprising that a year later, in 1933, the corrupt and corrupting interventionist state transitioned easily into the National Socialist command and control economy — and that in Mises’s own country of Austria, authoritarian fascism and the planned economy followed a year later in 1934.

Mises’s theory of the business cycle

However, even if a growing spiderweb of government interventionist policies explains how and why the Great Depression of the 1930s became so deep and prolonged, there still was the question of how and why the depression had occurred at all. In other words, what were the monetary and banking policies that preceded the Great Depression that made an economic downturn inevitable. Mises had first presented what later became known as the Austrian theory of the business cycle in The Theory of Money and Credit, and then in his monograph, Monetary Stabilization and Cyclical Policy (1928).

Mises’s theory of money, banking, and the business cycle was a synthesis of Carl Menger’s theory of money, Eugen von Böhm-Bawerk’s theory of capital, and Knut Wicksell’s theory of interest rates and prices. As we saw, earlier, building on Menger, Mises developed an analysis of the non-neutrality of money, that is, how changes in the money supply works its way through the market in temporal-sequential patterns that influence the structure of relative prices and wages and the allocations of resources and capital among sectors of the economy.

Mises adapted Böhm-Bawerk’s theory of a time structure of investment and production, focusing on the price-coordinating market processes by which resources and labor are combined in the required stages of production to both produce capital goods and with capital to manufacture desired finished goods wanted by consumers. Each of these of stages of production must be successfully coordinated with the others. The “length” of the respective time-structures must also be consistent with the amount of overall savings in the economy so the needed and necessary resources, labor, and capital goods may be available to complete and maintain the complex processes of production through period after period of time.

As we also saw, the market-generated rate of interest assures that investments undertaken are able to be maintained and kept within the bounds of the savings set aside by income-earners. In a world of scarcity, the uses for the resources of any society are in competition between different applications of them both in the present and between the present and time horizons of the future. More of them used in one direction means that there is less available to utilize in alternative ways.

Knut Wicksell on interest rates and the inflationary process

The Swedish economist Knut Wicksell (1851–1926) argued in Interest and Prices (1898) that if goods in the present directly traded for goods in the future, that is, as in barter transactions, the intertemporal competitively determined price between goods in the present and the future would tend to assure that investment was kept in balance with savings. The intertemporal price of present goods for future goods is the equilibrium “natural rate of interest.” However, in actual markets, all trades, including those across time, are undertaken through the medium of money. Money in the present (and the purchasing power over various goods that sum of money represents) is traded for a sum of money in the future (and the purchasing power over various goods that sum of money is expected to represent).

If the money rate of interest coincides with the hypothetical equilibrium “natural” rate of interest, then savings and investment are kept in coordinated balance even in a money-using economy. The problem, Wicksell pointed out, is that the quantity of money offered through the banking system for investment purposes may exceed the quantity of money that income-earners had originally deposited in the banking system as desired savings. Or banks could lend less in the form of money loans than had had been deposited with them as money savings. Thus, there could be either total money investments undertaken greater than money savings, or more money savings than money loans issued within the banking system. Thus, total investments greater than available savings, or total investments less than available savings.

Banks might try to extend money loans greater than deposited savings by setting the interest rate below the natural rate through the creation of bank notes or increased checking deposits for those additional borrowers to spend. But since scarcity continues to limit the real total of economic activities that can be undertaken, the increased quantity of money only ends up generating a cumulative rise in prices (price inflation) for as long as the money rate of interest is kept below the natural rate. Similarly, if the money rate of interest were to be set above the natural rate, total money loans undertaken would be less than available money savings, with part of the total quantity of money in the economy taken out of circulation, resulting in a cumulative decline in prices (price deflation) for as long as the money rate of interest was kept higher than natural rate.

Free banking and the limits on inflationary currencies

This was the backdrop to Mises’s theory of the business cycle. As he developed the theory through the 1920s and 1930s, Mises argued that if there prevailed private competitive free banking, there would be market-based checks and balances preventing such imbalances between savings and investment from occurring to any significant degree. If any one or number of banks decided to increase their respective quantity of bank notes or checking accounts by lowering the money rate of interest at which they were extending loans to potential borrowers, the sums borrowed would soon be spent by those borrowers on various goods and services they wanted to buy.

Those receiving the banknotes issued in this way by, say, the Adam Smith Bank would deposit them in their own banks, say, the Thomas Malthus Bank and the David Ricardo Bank. The Thomas Malthus and David Ricardo Banks, receiving deposits of the banknotes of Adam Smith Bank from their bank customers, would trade them in through what is called the “clearing house,” demanding the gold or silver that those banknotes represent from the bank that issued them. Banks that have overissued their banknotes relative to other banks will experience a net outflow of their gold and silver deposit reserves. If they continue their own monetary expansion in this manner, they threaten, over time, to face insolvency or even bankruptcy as the total number of banknotes claimed against them threaten a loss of all their gold and silver reserves.

At the same time, if their own depositors become concerned about the bank’s solvency, that bank would risk facing a bank run, that is, many of their depositors all demanding their gold and silver money more or less simultaneously. Thus, in their own self-interest, under the pressures of the clearing house process and maintaining the confidence of their own depositor customers, private banks, under a competitive free-banking system, would have incentives to resist excessive creation of fiduciary media (banknotes and deposits not fully covered by gold and silver reserves).

Unjustifiable creations of bank-notes and checking deposits (that is, in excess of actual gold and silver money deposited with that financial institution) would be kept in narrow bounds under private competitive banking. Looking over the market as a whole, therefore, investment would be kept within the scarcity constraints of actual savings set aside by income-earners for such purposes. As Mises explained it in Monetary Stabilization and Cyclical Policy, in a free banking environment, there might still be fiduciary media issued by banks:

However, banks would have to be especially cautious because of the sensitivity to loss of reputation of their fiduciary media, which no one would be forced to accept. In the course of time, the inhabitants of capitalistic countries would learn to differentiate between good and bad banks…. The management of solvent and highly respected banks, the only banks whose fiduciary media would enjoy the general confidence essential for money-substitute quality, would have learned from past experiences.

The cautious policy of restraint on the part of respected and well-established banks would compel the more irresponsible managers of other banks to follow suit.… For the expansion of circulation credit can never be the act of one individual bank alone, nor even a group of individual banks…. If several banks of issue, each enjoying equal rights, existed side by side, and if some of them sought to expand the volume of circulation credit while others did not alter their conduct, then at every bank clearing, demand balances would regularly appear in favor of the conservative banks. As a result of the presentation of notes for redemption and withdrawal of their cash balances, the expanding banks would very quickly be compelled once more to limit the scale of their emissions…. It may be that a final solution of the problem of [unjustifiable monetary expansion] can be arrived at only through the establishment of completely free banking.

Central banks and monetary expansion

However, this was not how the banking systems had developed in Europe or North America. It is true that in the nineteenth century, after earlier experiences with paper-money inflations caused by governments or their central banks, new rules were established under which many of the leading central banks managed their systems according to the rules of the gold standard. But these remained, nonetheless, monopoly monetary systems controlled and managed by government central banks.

Governments and their central banks would periodically oversee undue expansions of fiduciary media and the artificial lowering of money interest rates through the banking systems under their control. This would set the stage for the types of price inflationary booms and price deflationary busts that Wicksell had outlined in Interest and Prices. This was only exacerbated in the twentieth century when central banks were taken off the gold standard by their respective governments, with no longer the check and fear of losing gold reserves underlying a country’s monetary system.

The additional aspect to the Wicksellian process that Mises developed was a focus on the non-neutral manner in which monetary and credit expansions through the banking system distorted the relative price structure and the allocations and use of capital and labor across sectors of the market. Such an artificial lowering of the money rate of interest below the “natural” rate results in the newly created money and credit first passing into the hands of borrowers who utilize the new money at their disposal to undertake investment projects for which the amounts of real resources to complete and sustain them will be found to be insufficient in the longer-run.

They place orders with the suppliers of capital equipment and construction enterprises to start or expand investment projects, and they hire workers to assist in these endeavors. The resources, labor and capital for these undertakings are drawn from more immediate consumption goods production through the offering of higher prices and wages made possible by the expansion of the money and credit by which those loans have been extended to them.

If these factors of production had been redirected into the more time-consuming investment sectors due to actual increases in people’s savings preferences (and therefore an implied decrease in preferences for consumer goods), the increased demands for inputs in investment goods production would have been counter-balanced by a decrease in the demands for consumer goods production. The changes in relative prices and wages, and reallocations of inputs from some areas of the market to others, would have brought about the needed recoordinated equilibrium. In time, the greater savings and completed investment activities would bring forth the improved and increased supplies of consumer goods that would be the future “reward” for foregone consumption in the more immediate present.

Monetary expansion and misallocation of resources

But this is not the case. Instead, the central bank monetary authority increases the lending reserves of the banks (in the case of the Federal Reserve of the United States, most frequently by purchasing U.S. government securities that the federal government has issued to cover deficit spending), which expands their ability to extend additional investment loans to interested borrowers in the private sector at lower rates of interest made possible by the increase in loanable funds in the banking system.

Borrowers compete away the resources, labor, and capital to initiate their investment projects by offering higher factor prices from their current employments in the consumer-goods sectors. But there are no corresponding decreases in consumer goods prices or the factor prices in these parts of the market since there has been no decrease in consumer demands. Those drawn into the investment goods sectors may be presumed to have the same consumption-savings preferences they had before their new employments. They use their higher money incomes to demand the same proportions of consumer goods as before. Therefore, prices in the consumer goods and complementary factor markets rise, with those still employed in consumer-goods sectors experiencing also increases in their money wages and factor prices. But these higher prices and wages in the consumer goods parts of the economy act as a “pull” to attract workers and resources away from the investment goods markets and back to consumer-goods production.

If the monetary expansion, with the resulting lower rates of interest and greater investment borrowing, was a “one-off” act by the central bank, relative prices and wages and resource, labor, and capital uses would reestablish themselves after a short period of time in the pattern reflecting income earners’ underlying preferences for consumption and savings. But historically, the central-banking authorities, once they have initiated an expansionary monetary and lower interest-rate policy, continue it period after period, with new injections of lendable funds into the banking system and with interest rates pressed down below where the market would set them in a noninflationary environment.

Prices continue to rise following in the temporal sequence in which the money is introduced, spent first on investment activities, followed by rising factor incomes, and then by increased money demand for consumer and other goods and services. A tug-of-war occurs with investment goods producers and consumer goods producers competing against each other in the attempt to pull the factors of production in one direction and then another.

If the “twisted” production house of cards is to be maintained indefinitely, the central-bank authority finds it necessary to accelerate the rate of monetary expansion so in the temporal sequence of rising prices, the “injections” are great enough to keep the relative prices of production goods ahead of the relative prices of consumer goods. Otherwise, if consumer goods prices completely catch up with or start to rise at a faster rate than production good prices, the monetary-induced investment patterns will be found to be unsustainable, and the recession phase of the business cycle will set it. And, indeed, unless the monetary authority allows the inflation to get completely out of control, with a resulting hyperinflation of economic chaos, the inflation must be ended or significantly slowed down, at which point the recession can no longer be avoided.

Stabilizing the price level destabilized the market process

In the 1920s, the Federal Reserve had attempted to maintain a stabilized “price level” in an economy of growing output, productivity increases, and cost efficiencies that would have otherwise resulted in falling consumer prices to the betterment of the buying public now able to purchase more and better goods at lower prices. Instead, the Federal Reserve increased the money supply in an attempt to counteract this benign price deflation. As a result, it in fact created a hidden price inflation by keeping prices in general higher than they otherwise would have been if the money supply had not been increased.

Thus, beneath the surface of a relatively stable “price level,” central bank monetary policy had set in motion a distortion and mismatch between savings and investment that inevitably had to end in an economic downturn. But an economic downturn became the Great Depression only because government interventions of sundry sorts had prevented the market process from bringing about a healthy rebalancing of supplies and demands and prices that would have brought back full employment without the economic disaster of the 1930s.