There was a time when free market economists were some of the most highly praised intellectuals in the modern world. In the early twentieth century, Austrian economics was understood for what it truly is: a social science based on praxeology and human action. But from the mid-1900s through the 2000s, society replaced their appreciation for the Viennese method with a false claim that Austrian economics was an ideological, archaic pseudoscience used to justify libertarian and conservative ideas. And although the mainstream throws Chicagoan and even Austrian economists a bone from time to time, most academics have drifted toward the modern monetary theory (MMT) or some form of Keynesianism. But in order to understand why the mainstream is the way it is, we must first understand how the economic consensus came to be.
Origins of the Economic “Consensus”
The London School of Economics (LSE) played a crucial role in the shaping of modern academia. A little-known fact about the LSE is that the institution was largely built and supported by the Fabian Society, a socialist institute founded in 1884. In fact, Beatrice and Sidney Webb, two of the founders of the Fabian Society, were also the founders of the LSE.
In the Fabian Society’s infancy, it often constituted a small, tight-knit group of intellectuals who met to discuss Marxist ideas. But as the Fabian Society expanded to include the London School of Economics and the New Statesman magazine, its influence on economics underwent a sort of metamorphosis. The LSE’s reputation began to grow and few ever questioned its stances. To this day, the rapid spread of Keynesianism is largely a product of the London School of Economics and its ideologically similar neighbor, the University of Cambridge. John Maynard Keynes, after all, was an alumni of Cambridge and made notable contributions to institutions near and far, such as the LSE and the International Monetary Fund (IMF) Bretton Woods system. The circulation of socialist and Keynesian philosophies between neighboring British institutions created a pseudo-intellectual echo chamber, in which the same ideas were debated over and over again among the same academics.
However, there was a major problem with Keynesianism. Many believed that the theories of demand-side economics sounded just and noble, but they were rarely backed by empirical evidence. Therefore, most schools of economics decided to abandon Keynes’s specific prescription of demand-side economics for a broader form of policy interventionism.
Paving the Way for Modern Macroeconomics
Thus, we turn from John Maynard Keynes and the Fabian Society to other significant influencers who paved the way for modern macroeconomics. The American Economic Association (AEA), one of the leading publishers of economic literature, was founded by politically progressive intellectuals such as Richard T. Ely, an activist and professor who advocated for greater government oversight and the implementation of desirable social policies. Based on his work, Ely’s views can best be summarized as moderately redistributive and highly interventionist. One of his books contains a chapter entitled “Taxation of Incomes,” in which he states the following:
It has already been stated…that all men of means should contribute to the support of government in proportion to their ability….It is universally, or almost universally, admitted that no [other] tax [than the income tax] is so just….[T]he income tax, unlike license charges, does not make it more difficult for a poor man to begin business or to continue business. Its social effects, on the contrary, are beneficial, because it places a heavy load only on strong shoulders.
Richard T. Ely was not the only interventionist who helped establish the AEA. Katharine Coman, a progressive activist who was highly critical of capitalism, also played a major role in forming the organization. Additionally, in appointing Alvin Hanson, one of the most influential Keynesians, to its presidency in 1922, the AEA is partly responsible for the rise of Keynesianism in America. To the American Economic Association’s credit, they have given similar positions to free market economists such as Herbert Joseph Davenport and Frank Fetter. But the bigger picture here is the AEA’s clear intent to draw an equivalency between Austrian intellectuals and progressive ideologues—as if the two were morally and intellectually comparable.
In later years, the American Economic Association would attempt to distance itself from the Austrian school altogether. The last time an Austrian economist was elected president was in 1966, with the appointment of Fritz Machlup. To put this into perspective, Jacob Marschak, an economist who worked with the Menshevist International Caucus, was scheduled to be appointed to the presidency in 1978. In other words, the American Economic Association would sooner elect a Soviet sympathizer president than an Austrian economist.
All in all, the impact of the anti-Austrian and, to some extent, the anti-Chicagoan biases of mainstream academia can be traced back to various instances of famous institutions either backing progressive thought leaders or dismissing certain kinds of economic methodology that fail to fit the interventionist narrative.
The Flaws of Mainstream Economics
Much of our understanding of mainstream economics is derived from econometrics—the use of mathematical modeling to predict economic outcomes. It is arguably true that econometrics is the reason why economics as a field is suffering from an identity crisis. On the one hand, economics deals with human behavior and is therefore a social science. On the other, econometrics and similar methods of study result in a field that resembles mathematics and cold calculation rather than behavioral science or the study of human action.
It should be no surprise that econometrics has become quite popular in the mainstream. After all, the aforementioned Jacob Marschak was one of the fathers of econometrics and made an undeniable impact on universities such as Yale and UCLA before catching the attention of the American Economic Association. Since its inception, econometrics has become a sort of “industry standard” for mainstream academics. However, the fatal flaw of econometrics lies in its failure to understand praxeology. In the words of Frank Shostak in his 2002 article entitled “What is Wrong with Econometrics?”:
There are no constant standards for measuring the minds, the values, and the ideas of men. Valuation is the means by which a conscious purposeful individual assesses the given facts of reality.
As for the Keynesian and post-Keynesian schools, far too much can be said about their flaws. Little empirical evidence exists that stimulus packages are particularly effective, and the idea that Say’s law ought to be completely discarded for a demand-driven approach to the economy is nonsensical. Henry Hazlitt’s The Failure of the “New Economics” provides a full perspective on the shortcomings of Keynesianism.
The Mises Institute exists to promote teaching and research in the Austrian school of economics, and individual freedom, honest history, and international peace, in the tradition of Ludwig von Mises and Murray N. Rothbard. These great thinkers developed praxeology, a deductive science of human action based on premises known with certainty to be true, and this is what we teach and advocate. Our scholarly work is founded in Misesian praxeology, and in self-conscious opposition to the mathematical modeling and hypothesis-testing that has created so much confusion in neoclassical economics. Visit https://mises.org