 the history and importance of the Austrian theory of the market process. That is the assigned title of my talk this evening. And I believe that this is an appropriate topic as an introduction to a seminar on advanced Austrian economics. The Austrian school is usually dated as beginning in 1871. That's 145 years ago. And the midpoint of that would be in the mid 1940s. And it is somewhat embarrassing for me to recognize that almost all of those last half years was while I was part of the Austrian program, the Austrian economics venture. What I would like to point out this evening is that the history and importance of the Austrian theory of the market process boils down to the history of the second half of the history of the Austrian school. That's what it boils down to. And there is a certain drama in the description of this history because at the beginning of that period, in other words, by the middle of the 1940s, it had generally been understood that Austrian economics was dead, that the Austrian economics school was a closed chapter in the history of economic thought. That picture began to develop during the latter 30s. And by the time I began my studies in 1952 or 1954, the Austrian school was pronounced as dead. You had a chapter on them in the history of economic thought, and that was it. Some were willing to give it a decent burial, and some were not even willing to do that. It was simply dead. Now, the Austrian school is usually, and quite correctly, identified with subjectivism. Subjectivism in economics means that when we are convinced, Austrian economists are convinced that the regularities in economic life, and we do see regularities, these regularities can be understood only by focusing analytical attention on individual actions with full attention to what people have perceived in undertaking those actions. This contrasts with the earlier, the classical view, that saw the root of explanation for economic phenomena, for change of economic causation, as arising from physical constants, from the rate of population growth, from the fertility of ground, from the Lord diminishing returns in physical terms. This is how the classical economists saw, they were powerful thinkers, and they were masterful thinkers, and they saw a great deal. But they failed to recognize that the human decision is that which plays the crucial role in determining economic outcomes. It was the Austrian school before some of the other neoclassical schools that focused attention on the human decision, on the individual decision. It was the individual decision, and the individual decision has to be understood in terms of what the individual sees, what he expects, and so on. It's in terms of these decisions that we have to look for the explanation for economic phenomena. And I will be attempting this evening to develop a link between the Austrian theory of the market process and this notion of subjectivism, as being the central idea in Austrian economics. Let me focus on the decade from around 1937 to around 1948. It's my position, I've developed this many times, that they're developed during that decade as sophisticated Austrian understanding of the market process, which had not been present in the Austrian literature until that time. It had not been present in any economic literature at that time. The key figures in that development were Ludwig von Mises and Friedrich Hayek. These were responsible for this new understanding. It wasn't a joint effort. The Missessian development of ideas were separate, distinct from the Hayekian. But they together, they constituted a radical novelty in subjectivism and a radical novelty in explaining market processes. It's strange, in a way, that neither Hayek nor Mises quite recognized the novelty of what they were doing and certainly not the drama of what they were engaged in. They thought that they were merely stating carefully what everybody understood till now. And this requires some explanation. Why did they not see what they were innovating? Why did they not see the almost revolutionary character of the explanations that they were giving? Let me start with an oft-quoted statement that Mises published in 1933. 1933, he published it in German. It was translated into English in 1960. But the paragraph that he wrote in 1933 was as follows. Within moderns, he was quoting Oscar Morgenstern in the following terms. Within modern subjectivist economics, notice what he means by there. Modern subjectivist economics will soon see what he means. It has become customary to distinguish several schools. We usually speak of the Austrian, the Anglo-American schools, and the school of Lausanne. Now notice that he's calling all of these the subjectivist economics. He's calling all of these schools the schools of modern subjectivist economics. And within modern subjectivist economics, he was pointing out, there were several schools. People usually talk about several schools. But Morgenstern wrote, Well, what Mises wrote is, Morgenstern's work has said almost all that is necessary about the fact that these three schools of thought differ only in their mode of expressing the same fundamental idea. Mises was then saying in 1933 that the Anglo-American school, the Austrian school, and the school of Lausanne, that's while raising economics, they are all saying the same idea. And that they are divided more by their terminology and by peculiarities of presentation than by the substance of their teachings. I find this a remarkable statement. This was in 1933. 20 years later, I can assure you, 20 years later, 20 years disappears in a flash. 20 years later, when I began studying under Mises, Mises would never have made that statement. He would never have said that his ideas of the Austrian school are basically the same as the Anglo-American school as the school of Lausanne. He would never have said that. In fact, what was projected at that time in Mises' lectures and in his writings and his courses and his seminars, what was projected was the sharp contrast between these newfangled schools that teach wrong things and the truth, the Austrian economics. The Mises in 1933 missed what was going on. He hadn't realized that by 1933, there was no longer a common understanding of a dynamic market process. What Morgenstern and Mises both meant in 1933 was that in the post-1870 development of economics, that was the development of subjectivist economics. There was the Austrian development, there was Walras and there was Jebens in England, okay? So there was all these, were all subjectivist branches of economics, the subjectivist versions of economics. They were all focusing on marginal utility. They were all explaining price in terms of diminishing marginal utility, that's subjectivism. So of course, these subjectivisms, all these different schools of subjectivist thought were basically saying the same thing. They were all explaining market developments as being the consistent consequences and outcomes of decisions based on these subjectivist perceptions of utility, diminishing marginal utility and so on. And yet, as I say, by 1933, this was no longer the case. Mises hadn't seen it. I mean, Mises didn't know what hit him. By the end of the 30s, Mises hadn't realized what had hit him. By 1954, when I came into Mises' seminar, he had realized it. He was reeling at that time by being hit over the head, but he hadn't realized what hit him. By 1933, he hadn't realized that. What had happened was that as a result of, perhaps three developments, doctrinal developments, the gradual acceptance of the Walrasian perspective, general equilibrium, the introduction by Frank Knight of his sophisticated concept of perfect competition, which hadn't existed before. Frank Knight developed that. It was developed in his 1921 risk uncertainty and profit. It became articulated in his subsequent writings. Later on, it entered the textbooks. But until then, it was never in the textbooks. Textbooks talk about competition, not about perfect competition. Perfect competition was introduced as an analytical concept, as a little tool by Frank Knight. And the Marshalian supply-demand diagrammatics tended to focus attention on the intersection point of those two lines, the supply and demand economics. Now, I yield to no one in my recognition of the value of simple supply and demand diagrams. If I had to teach simple economics in one lecture, the supply and demand diagram would be the center of attention. But it nonetheless remains true that as a result of that emphasis on supply-demand intersections, especially on the intersection point, economists gradually came to perceive economics as being the subject that has to determine the intersection point, that economics has to explain the intersection point. Perfect competition exists at the intersection point. While Rayesian general equilibrium occurs when that intersection point is fulfilled in every single market simultaneously. In 1933, Mises haven't realized that. When I came in 1954, he was teaching me, he was teaching the exact opposite. He was teaching that one has to stay away from those heretical approaches. What was it that finally taught Mises and Hayek that the old orthodoxy had crumbled? I would suggest that it was the socialist calculation debate of the mid 1930s. I see many of you have the late professor Don LaVoy's brilliant book, Rivalry and Central Planning. I think if you read that book, you will understand what I'm trying to say here. That it was the socialist calculation debate that finally taught Mises and Hayek what had happened to mainstream economics. They hadn't realized it until then. They had pointed out, this was a brilliant innovation by Mises, that socialist economic planning, central economic planning is impossible. Is impossible. Central economic planning is impossible. Now that was a revolutionary idea. It was an idea which captured professional attention. It triggered a tremendous series of attempts by socialist economists to find a flaw in the Misesian argument. And that resulted in a vigorous debate. And it was that debate, it seems to me, which the mainstream literature considered to have resulted in an outstanding victory for the socialist concept? It was that debate that taught Mises and Hayek that they had to go back to the drawing board and restate the central orthodoxy which had suddenly disappeared from the mainstream. It's a great interest that from the end of World War II, until the 1970s, all the textbooks dealing with comparative economic systems all taught that Mises and Hayek had been decisively refuted during the socialist calculation debate. It was during the 70s, to a large extent, as a result of Professor Lavoie's brilliant work, that the general professional view began to waver. It began to become less solid. And gradually it came to be recognized that the refutations in 1936 by the various socialist writers, Oskar Lange, Abba P. Lerner, were really faulty, were not as solid as had been understood earlier. What was it that had earlier been the common position shared by all the neoclassical schools? What did Morgenstern and Mises mean when they say all the neoclassical subjective schools were saying the same thing? Well, I believe that all these schools had a healthily vague, sometimes vagueness is healthy. They had a healthily vague understanding that the dynamic competition which is always at work in free markets continually inspires market movements, movements in prices and methods of production and in the arrays of products being produced. It continually inspires these movements to tend to identify and to correct wasteful or inefficient uses of resources. If resources were being used in non-optable methods of production, this would generate patterns of costs and prices which would invite entrepreneurs, inviting quotes. Invite entrepreneurs through opportunities for pure profit. It would invite them to bid away resources from less socially valued uses towards more valuable uses. I'm putting it very crudely. There are a lot of sophistication that would have to be added to make this absolutely analytically airtight, but that's basically the healthily vague insight that all the schools shared. The market is a market of dynamic competition, not the perfectly competitive model. It's a process, a competitive process, a dynamic competitive process. The process consisting somebody realizes that you can make money by buying resources cheap and selling output more expensively. What that does is to pull away resources from where they're being used at a low-value use and to transfer them to a higher-valued use. And it's the continual shurning of entrepreneurial discoveries and entrepreneurial profit-making changes that pull and push the market away from wastefulness, away from inefficiency towards, if you will, towards a more efficiently allocated system. It was a vague understanding. There was not too much effort to precisely identify the entrepreneurial role, to identify the role of entrepreneurial competition. But in the general, it was understood. That, unfortunately, by 1933, despite the fact that Mises hadn't recognized it, by 1933, that general vague understanding had gradually come to be quote unquote refined and restated in equilibrium terms. The tools of Marshallian geometry, while raising in general equilibrium and knight's articulation of the conditions for perfect competition, gradually focused economists' attention on the state of affairs in which inefficiencies have somehow been eliminated by being rendered impossible, unthinkable. By the end, by the mid 1940s, it was generally understood that any position outside equilibrium was, in a way, impossible, impossible. If you remember the simple supply-demand analysis, you've got a supply curve, you've got a demand curve, and where's the market price? Well, obviously, at the intersection. That's it. That's it. If sometimes the professor in economics 101 would say supposing the price was above equilibrium, well, there would be an oversupply. Obviously, if there's an oversupply, the price is gonna sink until it reaches the equilibrium. It has to be that way, automatic, spontaneous, immediate. There was no attempt to understand the process by which prices would be forced down. It was simply taken for granted. The price is gonna drop. If there's an oversupply, the price drops. If there's a shortage, the price hikes. Why? How? The truth is that the price dropped in the price hikes as a result of entrepreneurial competition. That was, as I say, in the earlier versions, it was understood in a vague way. Without getting too precise about it, it was generally understood. But in a vague way, by the time of the mid-30s and the early 40s, the profession had become mathematically sophisticated. And the answer to an economic question was seen to consist strictly and solely in the equilibrium conditions relevant to that market. Gradually, as this was happening in the pure analytics, something parallel was happening in so-called welfare economics. It was about this time that welfare economics was developing, and what it was teaching was that in order for an economy to be pronounced to be efficient, it was necessary for the system to be in equilibrium. So that economic optimality was identified with equilibrium. And it was this equilibrium understanding, both of the positive analytics of the market and also of the normative aspects of welfare economics. It was this. It was this that inspired the various refutations of the Mises Hayek demonstration of the impossibility of economic calculation under socialism. That demonstration, what Mises and Hayek showed was that without market prices for resources, there would be no way of estimating the relative importance of resources in different uses. In order to know that the resources being used less optimally in this industry, and it could be used more optimally in that industry, you have to know something about prices. Without market prices, and by definition in the socialist economy, resources have no market prices. They can have all kinds of quote unquote prices, but they're not market prices. Without market prices, the central planners would have no way of understanding the possible misallocations. They would have no way of understanding how allocation could be improved. But if you start out with a mindset of instantaneous equilibration, that markets equilibrate instantaneously, then it doesn't seem strange to postulate that central planners could emulate that instantaneous corrections, those instantaneous corrections. And there were all kinds of demonstrations, how the managers of socialist enterprises would realize that at the current prices there's an oversupply or an excess demand, and they will immediately wire the central authorities to adjust prices, and immediately everything would be okay. It was the uncritical confidence in rapid market corrections that made it possible to imagine that socialist managers would be able to rapidly signal to central planners when prices were too high or too low. My contention is that it is exposure to these kinds of arguments that gradually enabled Mises and Hayek to grasp how differently these critics understood the workings of markets, how differently they understood it from the way in which the earlier commonly shared near classical understandings of the markets operated. And this led them to restate more carefully, more precisely, more articulately what really happens in markets, what really happens under competitive conditions. And it was that that constituted, in my reading of the history, it constituted a dramatic deepening of the subjectivism of the Austrian school and a dramatic series of advances in the substance of Austrian economic theory. Hayek wrote a remarkable series of papers between 1937 and 1945. He wrote a remarkable series of papers. These have been reprinted in his Individualism and Economic Order. And in these papers, he pointed out the role of knowledge and the discovery of knowledge in competitive markets. He was able to point out that equilibrium is the state of perfect knowledge. So that what mainstream economists were saying, were working with, was a world of perfect knowledge. I don't know what world you grew up in. I grew up in a world without perfect knowledge. And to explain markets as expressing perfect knowledge leaves a lot to be desired. Hayek was able to show how, unlike in the textbook models of perfect competition, genuine dynamic competition is the manner in which market knowledge is arrived at and is disseminated. It is not the state of initial perfect knowledge, which what perfect competition is, one of the conditions of perfect competition is complete knowledge about everybody, what everybody else is doing. Dynamic competition, as Hayek pointed out, represents the discovery of knowledge that had hitherto not been recognized. Where the equilibrium model simply assumed perfect knowledge, in when you draw some Marshalian supply and demand curve, you say it's opposing the prices above equilibrium. What are you saying? Everybody knows that that's the price. Everybody knows the price. You start out by saying everybody knows the price. You have to recognize that in markets, people very often do not know what the price is. In fact, there is no such thing as the price. There are prices, and these prices may be all over them all over the lot. There is a process of reaching a single price, which may of course be above equilibrium, may be above the intersection point. But Hayek pointed out that it is during the equilibrating movements of the market under dynamic competition that the mistakes that were being made, those mistakes generate a learning process which teaches market participants where the mistakes had been made and inspires them to correct them. So Hayek focused on knowledge. Mises did not focus on knowledge. He's not explicitly not directly. He focused on entrepreneurship, on human action. He replaced rabbincy and economizing. You see, Robbins, Lionel Robbins, great British economist, wrote a book in 1932, The Nature's Significance of Economic Science. Economics, economic science, in which he developed the idea that economics deals with the implications of the circumstance that individuals economize. That is, that they allocate resources, scarce resources, among competing multiple ends. Robbins wrote that book under Austrian influence. But he articulated that Austrian influence in a manner which served the equilibrium theories of the mainstream economists of the 1930s. The mainstream textbooks traced back directly to Robbins of 1932. Mises chose, and he was explicit on this, to replace the emphasis on economizing, on efficient allocation, on constrained maximization, to replace that concept by the broader, more profound concept of human action. He even shows that as the title of his book. Each market participant is seen as an entrepreneur, meaning an individual who is alert to opportunities that are around the corner. They are being offered in the market around the corner. Why did, why are these opportunities being offered? Well, they're being offered because people made mistakes. People have made mistakes because knowledge is imperfect. It's the discovery of these mistakes that constitutes the entrepreneurial process. The process of dynamic competition then consists of the entrepreneurial steps taken by competing entrants into the market. I myself have argued that every such entrepreneurial step must be seen as competitive. Every competitive step must be seen as entrepreneurial. So Mises and Hayek enriched the account of the steps taken during the market process. I don't believe they saw themselves as innovating. I believe they merely thought they were elaborating on an earlier, widely accepted neoclassical understanding of markets. But I have maintained that what they were doing in these years, Hayek in his series of papers between 1937 and 1945, Mises in his national economy of 1940, which developed into the human action of 1948. In the same decade, they were both articulating the same insistence that the market is an entrepreneurial process, a process of dynamic competition. I don't believe they quite realized that in presenting all this, they were in fact deepening and extending the scope of Austrian economics. To illustrate what I mean by attributing to Mises the entrepreneurial theory of human action. What does the decision mean? Standard economics based on decision, microeconomics, Rebenzian economics, based on the decision. That's subjectivist, right? Subjectivist, decisions, that's subjectivist. But for a Rebenzian, for a Walrasian, for a mainstream neoclassicist in its 20th century meaning of the term, to decide is to compute the solution to a mathematical problem. I often put it this way. Supposing there's a room with a sign outside, decision making room. You want to make a decision? Knock on the door, open the window. What would you like to do? I'd like to make a decision. You know what you do, you don't have to bother to come in. Just present us with your objective function. Objective presents us with your list of resources. We'll do the calculation. You can have a cup of coffee and we'll tell you what you decided. That's the decision making room. Because that's all that's what it is. It's a calculation based on decisions. Now, I don't know how many of you have made a decision whether or not to get married, but that's not the way you make a decision. That's not the way you make a decision. That's not the way you make a decision whether or not to get married. That's not the way you make a decision whether or not to go to law school. It's not the way you make a decision when you decide whether or not to buy a dining room set. Well, whatever decision you're making is not made on the basis of a mathematical calculation. It's made primarily on your estimation of what's going to be in the future, what you will need, what she will look like in 10 years' time. What the dining room set will look like in 10 years' time? That's how you make a decision. That's not a mathematical calculation. They can't help you in that room. They can have super-duper computers. They can calculate solve equations one, two, three. But your decision consists in identifying the parameters of the equation that need to be solved. That's the Missessian recognition of what decision-making means. Decision-making is subjectivist, not merely in the sense that you are making the calculation. It's subjectivist that you are determining what the parameters are of that which has to be calculated. You have to make decisions as to what the future is going to be. If you decide whether or not to go to medical school to become a heart specialist, you've got to make an assessment of the future trends of smoking. You've got to make an assessment of the future role of medications having to do with heart surgery. For mainstream economics, the market outcome consists of a pattern of interlocking, economizing decisions, each correctly aware of the other relevant decisions. In other words, you've got a whole series of these decision-making rooms. And somehow or other, they're all in touch with each other. And the market somehow arranges that all of these decisions should fit. So if you want to become a heart specialist, there's a medical school that's willing to take you. And so on. Whereas the truth is that decisions are made in ways which do not fully take into account the decisions that are simultaneously been made by others. And that's exactly what you discover in the real world. You discover that you decided to buy a dining room set and it's too expensive for you. That's what happens in markets. You discover that people are making decisions which don't fit the decisions that other people are making. You learn. You discover that some people have been over-optimistic. Some people have been insufficiently optimistic. For Mises and Hayek, a market outcome is the set of open-ended entrepreneurial decisions, each taking advantage of the opportunities believed to have been discovered in these decisions. For mainstream economics, the market functions as a computer, determining the solution to the set of simultaneous Waldrazian equations. That's how they perceive the market. For Mises and Hayek, the market functions as a discovery procedure. That phrase is a phrase of a paper by Hayek. Discovery procedure. The market functions as a discovery procedure. It discovers the parameters of the relevant equations. Notice that when we talk about discovery in Austrian economics, we are not talking about the economics of search, which in mainstream economics has become a fairly prominent branch of analysis. In the economics of search, it is recognized, and we're happy to see that it has been recognized, that knowledge is imperfect. OK, if knowledge is imperfect, what do you do? You buy some knowledge. You go out and buy knowledge. How much knowledge do you buy? Well, as much knowledge as it's worth buying. You know in advance how much knowledge is worth buying. And you know in advance what it costs to get the knowledge, what the knowledge will enable you to achieve, and you make a decision as to how much knowledge to produce, how much knowledge to buy, and so on. In other words, you know what it is you don't know. Not that you know the information, but you know the value of the information. You know how to get the information. That's economics of search, which is a very, very valuable piece of analysis. But it has nothing to do with discovery. Discovery refers to discovering something that you didn't know you didn't know, which is the world in which we live. We live in the world in which we are continually encountering discoveries. Gee, I never knew this. I never even knew that I didn't know it. Now you know. That's the discovery. And the market is a discovery procedure. Nothing to do with economics of search. I repeat, I'm not denigrating economics of search. But economics of search is like the economics of production. You can have the economics of production as if you know exactly what needs to be produced. You know exactly what the inputs are. You know exactly how much they cost. You know exactly how much the output is worth. And you can make a maximizing decision based on that. In the case of search, you can decide optimally how much to search. But that's not the same thing as discovery. The market process is the discovery procedure. It is a procedure by which people are continually made aware of that which they didn't know. They didn't know, they didn't know it. That's what discovery is about. Hayek wrote this paper called the meaning of competition. He wrote that paper in the early 40s, mid 40s I guess. And when I began studying under Mises, he sent me to read that paper. I'm emphasizing that he sent me to read it to emphasize that people very often exaggerate the differences between Mises and Hayek. Mises thoroughly appreciated the emphasis of Hayek on knowledge. He thoroughly appreciated that. That was not his own emphasis. But he appreciated Hayek's emphasis on knowledge. He sent me to read the meaning of competition. When competition is understood in this dynamic sense, then one's attitude to public policy measures aimed at promoting and enhancing the advantages of competition change dramatically. For the competitive process, it's not important how many competitors there are in a market. The, for decades, public policy regarding competition has involved counting the number of competitors. That's not important. The number of competitors is not important. The competitive process depends on one condition only, freedom of entry. If people are free to enter, they are invited in to enter if they discover profit opportunities, which means they are discovering errors on the part of other market participants. When you discover error, you enter, and that's competition. The potential for pure profit opportunity to be noticed and acted upon, that's the important element in the dynamic competition upon which the market depends. The secret of the Mises Hayek understanding of the market process, I think, can be best set forth by juxtaposing two statements. A statement which I remember hearing from Hayek in the early 60s, and a statement that's printed, was published by Mises a few years before that. Hayek referred to what he called the fundamental law enunciated by economic theory, the law of the single price. But when he said, when he enunciated that law, he right away added, of course, there's only a tendency towards a single price. There is no guarantee of a single price ever. But there was always a tendency towards a single price. What is that tendency? What is responsible for that tendency? Competition. If there is more than one price for a single item, there is profit to be made by buying where the price is low and selling where the price is high. That invites discovery. That's the competitive process leading towards a single price. There is a competitive process that is leading towards a single price. Will the single price ever be really achieved? Of course not. Because long before that price is achieved, parameters will have changed, and there will be a whole new set of competitive steps to be taken. That is the first statement, that the fundamental law of economics is the law of the single price. Now let me juxtapose that with a statement by Mises. I remember when I first saw that this statement, it opened my eyes. He made this following statement. He's giving us a theory of pure profit. Pure profit. Pure entrepreneurial profit. What does that mean? What causes pure entrepreneurial profit? What is it? Mises wrote as follows, what makes profit emerge is the fact that the entrepreneur who judges the future prices of the products more correctly than other people do buys some or all of the factors of production at prices which, seen from the point of view of the future state of the market, are too low. This difference is entrepreneurial profit. In other words, what drives entrepreneurial profit is the absence of a single price. So that Mises was saying, what drives the market is what Hayek was pointing to. There is a tendency for a uniform price to emerge. There is a tendency for zero profit to emerge. How does zero profit emerge by the fact that profit opportunities attract attention? That is the secret of the market. And that is the shared secret of Mises and Hayek. It's a focus on the market process. It's a process of entrepreneurial discovery. It turns out then that the entrepreneurial drive for pure profit, which drives the most complicated and complex market systems, is the very tendency responsible for the simplest, most fundamental law of economics, as Hayek defined it, the tendency towards a single price. This is a remarkable insight when you put together the statement that I heard from Hayek and the statement that's published by Mises, you begin to understand the market process. During the resurgence of interest in the Austrian school, which has occurred over the past few decades, I believe that the insights of Mises and Hayek that we've been describing here this evening, insights into the economics of the market process under open-ended free entry competition, I believe that these insights have played a central role in the development of Austrian economics over the past 40 years or so. So that when we come to return to the title of this talk, the history and importance of the Austrian theory of the market process, I believe that we can see that the importance of this Austrian theory consists not only in the illumination it provides, for example, for competition policy, for the critique of socialist planning, for the critique of interventionist economic policy, not only for all that, but also in the role that this theory has played in generating the fascinating intellectual development in contemporary economic thought. That is the resurgence of Austrian economics, which is you. Thank you very much.