By Dean Peng
I am an Austrian school economist. The reason is purely logical: Austrian economics is the only logically consistent economics.
However, I will not continue contrasting Austrian economics with other “schools” and argue why Austrian is correct others are wrong. This has been done already, probably too much.
First thing first, I want to argue that the term “school” is misused.
There are schools in science and mathematics. Each school is good at some subjects. Warsaw school, headed by Alfred Tarski, was the best in mathematical logic. There was a Chinese school of mathematics, which was leading the studies of value distribution. Obviously, “school” is misuesed in economics. There are no schools but only doctrines. Different schools should learn from each other, while different doctrines only fight each other. The doctrine proposed by John M. Keynes is called Keynesianism, which has been falsified. Karl Marx proposed a theory of economics, which is a part of Marxism. Marx himself was aware that it was wrong. He couldn’t finish his Das Kapital. However, some people continue claiming that it is the ultimate truth, immune from criticism. Austrian economics was founded by Carl Menger and was developed by others. It is the only economic theory that is self-consistent. I am going to outline this theory, while leaving the origination and development of other doctrines to the subject of the history of economics. Strange enough and sad enough, students of other disciplines spend little time studying the history of their science (students of physics study theories of physics instead of history of physics), while students of economics are dumped in various different doctrines.
Now, I will briefly outline this valid theory of economics (so-called Austrian school).
1. The object that economics studies is not natural phenomena. By studying the unintended yet necessary consequences of human action, it discovers the laws of human action. Economics in the narrow sense studies human action in regard of wealth creation and distribution. Economics in the broad sense studies human action in general. Ludwig von Mises invented the term praxeology for this broad-sense economics. I will limit myself in the narrow sense of economics.
2. Some material things and services (we call them goods) meet human demands. Air, water, food, clothes, traffic, even sex service. However, not everything of use is of value. Air, for example, is of vital use. But in most circumstances it is of no value. People get it for free, because it is abundant. Only those scarce goods of use are of value. They are wealth. People chase wealth and exchange wealth for other wealth. People can chase wealth by stealing, robbery, burglary or even by pure luck (find a diamond on the ground). Here we only study economic actions of chasing wealth, i.e., to produce and to exchange. We start with production. People transform sth of no value (sand) to sth of value (semiconductor) or increase the value of sth (cooking, oil refining) via labor. However, not all labor creates value. Labor creates value only when it creates sth that is needed. It happens from time to time that farmers planted too many bananas or potatoes, far more than what is needed. In this case, bananas or potatoes are dumped and labor is wasted. Net loss. So we see there is no necessary connection between labor and value. Marxist theory of value determined by labor collapsed. As I said, pure luck (no labor) can bring value. A beautiful face or charming legs of a celebrity, where there is no labor involved, can be very valuable. I may go fishing for vain, hard labor evaporates. I may plant scallions year after year, and pay same amount of labor. But a natural disaster suffered by other scallion plantations will increase the value of my harvest. So we come to 2 conclusions: Value precedes labor. Value is determined by need. Labor is value-oriented. Now, if value is not an intrinsic character of goods, it may vary from place to place and from time to time. Same goods may be of different values at different geographical or time spots. This explains why commerce or speculation creates value.
3. A further comment on value. Is value subjective? Yes, it is, but with restraints. Scallions are of value because some people enjoy it. For those who don’t like it, it is of no value, in the subjective sense. However, under the restraints of market, scallions acquire an objective value determined by demand and supply. I like scallions and I am willing to pay a high price for them in poor harvest years. However, in good harvest years, I don’t have to pay that price. I need only to pay the objective market price. So we see that subjective evaluation of any individual is invalid in a big enough market. Market prices are determined by collective evaluation of buyers and sellers. Subjective individual evaluations turn out objective prices via market. BTW, even individual evaluation is not completely subjective. Some people like sweet food but hate chilli. I am addicted to chilli while unable to tolerate anything sweet. This is fine. But if someone likes dust, that is a disease. If someone likes shit…Although I don’t know anyone of the kind, I do know people who claim their firm belief in ridiculous Marxism.
4. Now we come to exchange. Exchange is one of the basic key concepts in economics. Animals in the Nature have no conception of ownership. There is only consumption no ownership in the jungle world. A leopard captures an antelope. It can eat it but cannot occupy it. If a lion passes by, the prey goes to the lion. The residuals cannot be sold but only dumped and goes to hyenas and bald eagles. However, human beings understand that they possess sth. This conception implies exchange. In the very primitive stage, I am willing to exchange 3 pound of grain for a chicken, because a chicken is of higher subjective value for me and the subjective evaluation of the chicken owner is the opposite. This exchange soon resulted in marketplace, where exchange is gauged by objective prices. Unavoidbly, there comes the need for a general medium of exchange. Currency comes into being. A very important note here. Currency does not only facilitate exchange, it is also a general measure of value. We will come back to this point later. It is obvious that those goods which are relatively stable in amount and easy to keep serve as currencies. Shells, millet (in revolution years in China), Camel cigarettes and silk stockings in post war Germany served as currencies. Well, naturally, inert precious metals, gold and silver in particular, became the main types of currency before legal tender.
5. Currency measures value. It is too important a tool in economic life. Economic calculation becomes possible because of it. With currency, people will know that a pound of beef can exchange for 6 pound eggs. Beef and eggs are of different individual subjective values, but they are equal in objective price. Exchange is equal in this sense. Only with currency can people evaluate values of goods of totally different nature. More than this. A general measure of values makes long-term economic projects possible. This brings the basic drive of economic development—investment. People will be able to calculate how much money they should invest in making facilities, and how much rewards they can expect. People can choose from different options to invest on the most rewarding, in other words, most wealth-creating project. Of course the currency has to be sound. I will come to this later. Currency deflects wealth of different nature into mathematical figures and therefore make them comparable. If I want to build a bridge, I have options of a wood one or a steel one. Each project involves thousands of thousands of specific elements. With currency, I need only to know how much each option costs, how long each life-span is, how much rewards each will bring to me. I can make a reasonable decision with this calculation. Currency is considered source of all evils by some extremists. But the reality is, only Khmer Rouge abolished currency. This most evil regime in human history quickly went back to primitive communism. It had no commodities, no marriage, no families, but only Anka and its slaves. It survived 4 years before being overthrown by Vietnamese because China supplied it everything it needed, of course for free because it had no money. Even overall socialist planning in Soviet Union before 1991, in China before 1978, and in PD(Democratic!)R Korea required currency to make plans.
6. Gold and silver were main currencies. And there were standards, gold standard and silver standard. Later there came banks, and paper credit came into being. Soon enough, the state took over currency issuance. With the invention of paper and printing, legal tender, which is pure credit, came into being. Almost all state tend to issue more currency than it should. They debase metal money or print more paper money than it should. Therefore inflation has been seen all along human history all over the world. Some dynasties failed on it. Venezuela, Zimbabwe are the latest examples. Other than that, the discovery od silver mines in Mexico contributed a lot in the destruction of China’s silver standard. Now comes our question. What is the criteria of a “sound” currency? Currency, as the measure of value, has to be stable, both in material and in value. It has to be in correspondence with actual wealth in a highly stable manner. Therefore, it is easily seen that not everything of a value can be used as currency. Lobsters are of high value, and they cannot become currency. Glasswares are of value, but if we use them as currency, the value will soon devaluate because they will be produced as much as possible. Electronic products are of value, but their values are in no way stable. Gold was the only standard that could have been valid. However, the amount of gold does not meet the need of modern world. The collapse of Breton Woods System (35USD = 1 ounce of gold, not only in value but in material) is of no surprise. Today people have to deal with paper money, or legal tender, which is credit in essence. We see how much USD or GBP or RMB devaluated. Yet on the other hand, so much wealth has been created, which makes inflation tolerable. Today people have no other option other than legal tender, with the hope that it will not inflate in a Venezuelan manner. So the reality is, there is no standard of money issuance! Can we invent one? Yes. Let’s look it this way. We can practise a standard not grounded on gold but anchored by gold. That is, the authorities monitor the price of gold in the free market, and guarantee that price to be stable. In this way, paper money acquires a credit, in the sense that 35USD can buy what an ounce of gold can buy. When gold price goes up, the central bank shrinks the circulation, and vice versa. A comment on Bitcoins. They are of value, and they are limited in amount as gold is. They may be collectibles, but cannot serve as currency.
7. Now we come to credit, which is the derivative of currency. Financial institutions may creat credit in the market. In essence, credit is IOU to the society. Commercial credit undergoes a creation-annihilation cycle. In normal circumstances, credit will gain, wealth increases. Credit can even be used in short-term investment. Credit expansion is allowed to the extent that the society has that amount of surplus wealth to lend out. Credit expansion must not exceed that limit, otherwise inflation will happen, and the whole currency system becomes unstable, and economic calculations will be twisted, even becomes impossible. How to control credit expansion within this limit? Don’t forget we have an anchor of gold price.
8. Now we come to the field of economic policy. Let’s start with growth. Growth is a deep-rooted misconception in economics. Economic progress cannot be measured by growth rate. Progress changes the structure of economy rather than increases the amount. A 100% growth rate compared to 20 years ago does not imply that we had 2 pieces of bread for breakfast and now we have 4. Economic progress implies that we have brand new goods that we never had before. In addition, technical innovations may reduce GDP. I had to make a long distance call or send a letter to send a message from China to US before, and that contributed to GDP. Today, I send messages instantaneously to anywhere in the world, excluding PDRK, for free. WE see how prices of electronic products dive everyday. So economic progress may reduce GDP. Any economic policy aiming at certain growth rate is mistaken. Let me show you how absurd economic policies a state can make. China used to practice an official state policy of “expanding domestic demands”. The state encourages people to eat more drink more consume more instead of producing more. Why? Because that will increase growth rate.
9. Some philosophical remarks. Complexities and extended order. Why planned economies always fail while free markets prosper? This is a philosophical issue. Let me start with physics. Physical phenomena are the SIMPLEST phenomenon. Great genius, Issac Newton, Albert Einstein and thousands of others, have been capable of promoting significantly our understanding of those phenomena. Yet we still understand only a small part of them. About chemistry, people understand much less. Even less with large molecules. Scientists have to rely largely upon empirical methods, i.e. they know how but don’t know why. In other words, people understand chemistry to a less degree. Yet by understanding how, scientists and engineers are able to produce quite some chemical products. When it comes to life phenomena, people understand very little. So far scientists cannot make the simplest cell, placate. They make something of bioactivity like insulin at best. And it is the general consensus of the scientific world that people will never create a life in a lab. For there is a limit of human intelligence– people will never be able to overcome the intrinsic complexities involved. Life can grow but cannot be made. Until as late as the 18th century, people considered human action to be controllable. With big municipalities came into being, people realize that human action has its own laws and goes beyond the control of power. It is social scientists who first recognized there is sth called spontaneous order, and it is this conception that inspired the great idea of biological evolution. This is, to my knowledge, the only example that a conception in social science inspired an idea in natural science. Later, natural science did inspire some ideas in social science, but largely in a negative way. If physics cannot be properly applied to biology, how can it be applied to human action where each individual has its free will? Behaviorism is the typical example how social science does damage. This is not the fault of natural scientists. The reason is psychologists and social scientists understand no philosophy. Extended order can be observed in any rural market, where prices, labor division and mass production appear spontaneously. So we see , government cannot plan economy properly because it cannot overcome the complexities involved. There is yet another reason. No plan can contain innovations. Notice, any state plan is an overall long term plan, like 5-year plans in Soviet Union and China. This type of plan is different from plans of individual enterprises. The state plan allows very little, if any, modification, while individual plans respond to new situations reflected by prices promptly. No individual or government can plan net society of today. Even agriculture plantation cannot be properly planned, because no government can predict new species or natural disasters or a good climate which result in big harvest. No government can properly plan for restaurants even, because it cannot predict the trend of taste of customers. The state can plan and carry it out by force, but that is necessarily a bad plan. A state plan is prohibitive in nature, while market accomodates innovations smoothly. A state plan decrees what everyone should produce and should consume, while in market economy, businessman “foster a market” for new products.
10. Some miscellaneous notes. Marginal cost and mass production. Marginal cost is the cost of manufacturing N+1st piece after manufacturing N pieces. This conception is the key contribution of Austrian doctrine. Profit is the sales income minus cost. This is applicable to the overall sales, but does not apply to individual product. When people ask about the real cost of certain product, I have no answer. A wrongly posed question has no answer. A product from mass production has no real cost. If you ask me the cost of my mobile phone, the best I can say is that its marginal cost is very close to 0. In a mass production, the producer pays a fixed cost—facilities, power, human resources, rent of house, management etc. Then it will forecast the market and decide a price for its product. In regard to individual product, producer makes a good profit. However, the final outcome is decided by whether his overall sales surpasses his overall cost—fixed cost plus sales cost like advertising. If he gains, he was told by market that he did a right decision, and vice versa. The basic model of modern industry is mass production for the mass. I am willing to pay 1 USD for a beer with the knowledge that the marginal cost of a beer is close to zero because I would have spent hundreds of dollars to produce one for my own, if I can manage. When the brewer meets the demand of many enough clients like me, he gains. He is happy, I am happy, other beers drinkers are happy. Cheers!
11. Competition and monopoly. Competition is a natural phenomena. A beer brewer makes good money, others will follow his example and produce beer. They will compete each other not only on price, quality but also on taste. We will have more and more kinds of beer. So the market will develop more and more niches! Consumers have more choices. But if one of the brewers is extremely outstanding and advantageous in market share, that is fine. As far as there is no barrier to the admission into the market, there is no monopoly. The state has no right to decree its partition. Monopoly comes from the state. Chinese government prohibities free admission into industries like post, telecom, petroleum and power. Monopoly is created by power, not competitive advantage.
12. My last note is on investment. Mass production requires facilities, which is tools in the broad sense. They are not consumer goods, but capital goods aiming at producing more consumer goods in better and better manners. More than this. Capital goods make possible what was impossible. Only with tower cranes can we build skyscrapers. It is due to investment that we have production lines, containers, modern harbors, high-speed railways etc. A proper economic policy should encourage investment not consumption.
That is the whole economics. Economics is neither science nor mathematics. It is a doctrine based on a set of axioms of human action without frontier problems. I believe I have outlined the whole doctrine, although extremely briefly. According to this doctrine, governments should not intervene into economic activities, but should maintain a free space for intended order to grow. Governments should have no economic targets. Economy has its own rules, not predicted by anyone, not to be promoted by any policy. Intervention only do harm. Privatization (clear-cut ownership) and indepent and just judiciary system are the two pillars of economy. Sadly enough, they are still missing in many places.
Dean Peng studied philosophy and economics independently. He never read a textbook, only the primary source classics. These are the condensed insights from 30 years of study, averaging 5 years for each page. He is open to comments, particularly critical comments. Feel free to write to him at: [email protected]