The thinking of Frederick Hayek and his fellow economists in the Austrian school is sometimes seen as an antidote for misdirected government intervention. Whether you but into it or not, executives would do well to learn more about such thinking, if only for its ability to bring overly optimistic CEOs down to earth.
I have never met an executive that did not have a keen interest in the future course of the economy. Where the likes of growth, inflation, employment, interest rates and exchange rates will go profoundly affects the profitability, competitiveness and even survival of an enterprise. The state of economy is at the heart of decisions on everything from acquisition, disposition and capital investment to product pricing, staffing and compensation.
The economy in particular is a front-burner issue for executives these days. Financial crisis always focuses executives minds on the economy and the just-passed financial crisis was a whopper, the worst since the 1930s. Those astonishing events of September 2008, including especially the Lehman Brothers failure and the U.S. financial institution bailouts, are still being played out in the economy.
Forming a sensible view on where the economy is headed is no small trick. There are often serious accuracy and timing problems with the needed input data. Opinions on the economy abound and it can be difficult separating those with something wise to say from those who are just making a lot of noise. Economic conditions can be highly volatile to the point where one month’s sensible view can be next month’s rubbish. The behaviour of economic agents like consumers, savers, investors, governments and businesses enormously affects the course of the economy, but the trouble is that such behaviour can range from the random to the rational and is always subject to abrupt change. Finally, if you want to know where the economy is going you have to make assumptions about how the economy works in the first place. You have to make an act of faith in what is called a school of economic thought. The obscure Austrian School, which is enjoying a bit of a resurgence, is the subject of this article.
The Austrian School doesn’t get much coverage in college courses or business periodicals but it is worth a look from executives as they contemplate the sustainability of robust, low inflation economic recovery in the aftermath of financial crisis and as monetary and fiscal stimulus is removed.
The more familiar Keynesian and Monetarist schools offer some optimism on the economy; the Austrian School not so much. That the Keynesian and Monetarist schools offer optimism should not surprise in that policymaking since the financial crisis has largely been driven by a combination of Keynesian and Monetarist thinking. Noting concerns that stimulus may be removed too soon and abort recovery, and that excessive monetary ease will stoke inflation, my view own leans towards the optimistic side of things. But that said, the Austrian School has a take that warrants a seat at the executive table.
The Austrian School originates with a number of Hapsburg Empire Austrian economists who were writing towards the end of the 1800s. Perhaps the best known Austrian School economists are Carl Menger, Eugen von Bohm-Bawerk, Ludwig von Mises and his student, Friedrich August Hayek. Hayek is the most honoured Austrian School economist. He shared the 1974 Nobel Prize in Economics and received the U.S. Presidential Medal of Freedom in 1991. Two of his best known books challenge socialism and central planning, The Road to Serfdom (1944) and The Fatal Conceit: The Errors of Socialism (1988).
Reading the Austrian School gives executives a number of reasons to be cautious about the economy going forward. First, the Austrian School puts great emphasis on individual choices and the crucial role that prices, acting as signals, have in those choices. The more prices depart from what they would be in a free market, the more concerned Austrian School economists become about economic performance. Things like free health care and subsidized daycare give the Austrian School great pause in that they do not remotely reflect market prices.
The Austrian School would be particularly concerned about the effects of developed-country central banks running monetary regimes that have artificially put nominal policy interest rates (the price of money) indefinitely at just about zero. Specific concerns about such artificially low interest rates include serious economic instability, financial market bubbles, housing and other hard asset bubbles, excessive borrowing, inadequate savings, banking system troubles, excessive investment, and the difficulties of an orderly exit strategy for a return to normal interest rates. The Austrian School does not believe that policymakers can be so smart as to indefinitely pick the right interest rates for something as complex as a modern economy, which explains its preference for relying heavily on free-market prices.
The Austrian School has the same view of managed exchange rates. For example, no one is smart enough to pick a Canadian dollar priced in U.S. dollars that would make our economy work best. Since central banks are the principle manipulators of interest rates and exchange rates, it is not surprising that extreme Austrian School economists would get to the view that central banks should be abolished and replaced with a return to the gold standard. A bit much! But the Austrian School’s preoccupation with stable money and more market-based interest rates and exchange rates is not without merit.
Second, the Austrian School believes in an absolute minimal role for government in economic affairs. In the jargon of the Economics 101, the Austrian School is laissez faire – leave it alone, with the “it” being the economy.
Government ownership, regulation, rules, taxes, subsidies and other interventions are viewed as costly in their administrative excesses and their impact on economic performance, their ability to distort resource allocation and richly fertile ground for the law of unintended negative consequences. Extreme Austrian School economists would not see much of a role for government beyond security, some international arrangements, enforcing the rule of law and the contracting process, and the provision of certain public needs such as roads, sewers and bridges, which cannot be realistically provided and maintained by individuals.
A number of recent moves by governments, especially the U.S. government, give the Austrian School concern for economic performance going forward. The financial institution and industrial bailouts of 2008 and 2009 may or may not have been necessary but they certainly ratcheted up government involvement in traditionally exclusive corporate domains such as CEO appointment, executive compensation and financial policy. As did government involvement in the Enron and related company failures and the BP oil spill. Add to that pressures to raise taxes and trade barriers in many countries to counter government spending deficits and current account deficits and it certainly looks like there will be more, not less, government in a lot of places going forward. Financial crisis, deep recession and unsteady recovery have a long history of provoking more government and that is the developed world in spades right now. All in all, not a cocktail to inspire Austrian School economists.
Third, modern economic policymaking and forecasting is heavily dependent on mathematical modeling. Using historical data and elaborate statistical methods, economists build models of the economy that they then use to test and evaluate policy options under different scenarios. What the models say surely does affect choices by policymakers, but this is not to say that subjective judgement does not play an important role as well.
The Austrian School has little confidence that any model can capture the complexities of a modern economy, given the myriad economic decisions that every agent in the economy makes every day. They have even less confidence that models can adequately accommodate risk and uncertainty. Austrian School scepticism about economic models translates into scepticism about the effectiveness of policies and forecasts that come out of the models.
Fourth, the Austrian School believes big government can only become big by borrowing and then using easy monetary policy to inflate the currency, so they can pay their debts back in cheaper money. The Austrian School does not have much confidence that governments will indefinitely pay for their programs with taxes or hard currency debt.
Today’s extraordinary monetary stimulus leads the Austrian School to the view that a big jump in the inflation rate is likely to occur somewhere down the road. To the Austrian School, inflating their way out of trouble is always an attractive policy option for governments.
Finally, the Austrian School is very respectful of the importance of credit to a properly functioning economy. They connect a breakdown in credit at least in part to wrong monetary policy. What distinguishes this downturn from other downturns since the 1930s is that this one had a major credit component. The Austrian School believes that the road back from credit trouble is usually long and bumpy; it would caution against getting too optimistic too quickly.
You would not want – even if you were capable of doing so – to run a modern economy based strictly on Austrian School precepts. But the Austrian School does offer insights into how things work and may play out. For executives, it might be worthwhile to once in a while pose the question “What would Austrian School economists think?” If you are prone to denial and like rose-coloured glasses, thinking about the Austrian School might from time to time serve as a needed dose of cold water.