The waxing and waning schools of economics

by Fred E. Foldvary

Mark Skousen, economist and financial analyst, has written a very good book on Vienna and Chicago: Friends or Foes; A Tale of Two Schools of Free-Market Economics. The comparison and contrast of the Vienna and Chicago schools was also a theme of the summer economics courses taught at ESPI, the Economic and Social Policy Institute at Belgrade, Serbia.

Vienna refers to the Austrian school of economic thought, which began in Vienna, capital of the Austrian-Hungarian empire, in 1871 with the publication of Principles of Economics by Carl Menger, founder of that school of thought. Chicago refers to the school of economic thought that originated in the University of Chicago during the 1930s with economists such as Frank Knight and Henry Simmons, and which later flourished with the influential economists Milton Friedman, George Stigler, Gary Becker, and others.

The Austrian and Chicago schools have both held the viewpoint that markets work well, in contrast to the socialist Marxist school that believes that the free market inevitably fails, and the Keynesian interventionist school that believes that markets are subject to failures that have to be corrected by government policy.

But there is another free-market school that also believes that markets, when properly structured, work well: the San Francisco school of economic thought, founded by Henry George with his book Progress and Poverty, published in 1879. In this and other works, George analyzed the cause of poverty in land tenure and taxation, the remedy being a free-market with public revenue from land rent replacing taxes on wages, business profits, goods, and value added.

The major economists of the Austrian School were Ludwig von Mises, Friedrich Hayek, Joseph Schumpeter, and Murray Rothbard. They argued against both socialist central planning and Keynesian-influenced government interventions. Austrian-school economists point out that even today we have central planning in money, with central banks controlling the creation of money. Their proposed remedy is the return to gold as money and free-market banking, where the interest rate and money supply are set by markets rather than a governmental monetary authority.

The Austrian school has a theory of the business cycle based on money and capital goods. An expansion of money and credit by the monetary authority artificially lowers the interest rate and induces unsustainable investments in long-lasting capital goods, which later results in a recession.

The Chicago school economists used historical and statistical studies to debunk interventionist dogmas such as that the free market failed to prevent the Great Depression. The Great Depression was instead an example of government failure, as the Federal Reserve allowed a huge monetary contraction and deflation, along with other failed policies such as high tariffs. Friedman’s monetarist theory showed that in the long run, government cannot use inflation to reduce unemployment, and that government cannot magically multiply its spending into greater GDP. Unlike the Austrians, Friedman thought the government could best handle money by increasing the money supply by a fixed percentage each year.

The followers of Henry George have been called Georgists, but with George having written the founding work in San Francisco, where he lived, it could well be called the San Francisco school, just as the city of Vienna has been applied to the Austrian school. The Vienna school emphasizes the dynamics of the economy, while the Chicago method is to apply self-interest and economizing in an equilibrium analysis. The San Francisco school uses both equilibrium and dynamics. The dynamic approach of change over time is used to show the advance of rent and lowering of wages as the margin of production moves to less productive land and as land speculation moves the margin out even further. Equilibrium shows that since market rent is based on the fixed supply of land and the demand to rent space, the tax on land not affecting the rent.

The San Francisco school agrees with the Vienna school that the spontaneous order of the free market best allocates goods to human desires. But the San Francisco school points out that if the ground rent is not tapped for public revenue, when taxes on other things finance civic works, then there is in effect a subsidy to land owners, which distorts the market.

The San Francisco school has a theory of the business cycle based on land values, which rise during a boom, when speculation carries land prices so high that investment gets choked off, resulting in a recession. But San Francisco has lacked a consensus on the role of central banking and money.

It seems to me that each of these free-market schools of thought offer ideas that complement the others, and so a synthesis of all three would create a powerful theory of the free market that is consistent with the historical evidence. Join together the Vienna and San Francisco theories of the business cycle to get a more complete picture. Meld the Vienna and Chicago free-market ideas with the San Francisco concept of using geo-rent (the potential ground rent of land put to its best use) for civic revenues, an idea which Milton Friedman agreed with.

If the Vienna school’s money-based cycle theory is to be synthesized with the San Francisco school’s land-based theory, then logically San Francisco schoolers should also adopt the Vienna critique of central banking and fiat money. Free banking plus land-value tapping would eliminate the real estate and business cycles.

The Vienna and Chicago schools should recognized that there is a third free-market school, while the San Francisco school should seek solidarity with Vienna and Chicago rather than fight them. Vienna, Chicago, and San Francisco should be friends, as together they can create a VieChiSan joint school that would triumphantly conquer the field of economics and bring peace, prosperity, and freedom to the world.

This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.