The Austrian school of economics dates back to early in the 19th century, when Carl Menger and Eugen Bohm-Bawerk laid foundations for modern theories of demand. Austrians rejected earlier emphasis on "objective" costs (e.g., labor theories of value accepted by Smith and Ricardo) as underpinning market dynamics. Prices, they said, were ultimately subjective: Things are worth what people think they are worth. The foremost disciples of this approach in the 20th century were Ludwig von Mises (1881-1973) and Friedrich Hayek (1899-1992), who stressed how our perceptions broadly shape the entire spectrum of economic activities.
Born in Austria, Von Mises taught at the University of Vienna before fleeing to America to escape Hitler's invasion. As a youth he was fond of tennis, but when someone noted that he was not very good at it, he replied: "The fate of the ball does not interest me very much." Human creativity and its consequences were his passions. Von Mises chose not to be limited to a narrowly-defined economics. He attempted, instead, to survey the full range of human action, focusing on the supremacy of the individual as a purposeful decision maker who constantly adjusts prices, production, and consumption in order to live better and to enjoy maximum freedom. In a free marketplace, economic calculation provides prices and profits as signals that motivate firms to mesh production with consumers' demands. But in a government-directed economy, agencies have no measure comparable to profits by which to evaluate their operations.
Von Mises also rejected the Keynesian notion that business cycles can be cured by countercyclical policy. Such an idea ignores the fact that politicians have a strong propensity to spend in good times as well as bad. Von Mises viewed government managers as always fumbling in the dark because they cannot possibly know all the data needed to make "correct" macroeconomic adjustments. He concluded that budget management is likely to set off a chain reaction of, first, inflation, then price controls and, ultimately, economic stagnation.
Friedrich Hayek, another giant of Austrianeconomics, became a Nobel Laureate in 1974. While Keynes advocated a very active role for government in controlling the economy, Hayek argued that government control is the enemy of freedom. He denounced extension of the role of government as The Road to Serfdom (the title of his best-selling book).
Hayek decried constructivism above all else, calling it "the pretense of knowledge" and "the illusion of human omnipotence." Constructivism is the idea that enlightened leaders can steer a society in desirable directions. Theocratic theories and the concept of a revolutionary elite (developed by V. I. Lenin, an early leader of the Soviet Communist Party), epitomize the constructivist vision. Hayek, however, believed that culture and civilization are not consequences of deliberate human design but are instead the products of the survival of society's successful groups. Hence, civilization depends on rules of behavior, not on goals.
Some examples of constructivism in action: In the 1980s and 1990s Iraq's dictator, Sadaam Hussein, wanted to unify Arabs to zealously follow the precepts of Islam as he interpreted them. His regime killed tens of thousands of Iranians, Kurds---and Iraqis---in attempts to reconstruct society to his design. Hitler, too, was a constructivist, as were the Soviet Union's Joseph Stalin, and China's Mao Zedong.
Hayek viewed Keynesianism as a less virulent strain of the constructivism disease. Keynes's message is seductive: Government can manipulate total spending to control the twin problems of unemployment and unstable prices. Keynes's comforting message has not been lost on many politicians, who no longer consider themselves to be helpless before the convulsions of a business cycle or limited in what they can deliver voters. Keynesian analysis looks like an instruction manual for running the economy as a well-oiled machine.
The trouble, said Hayek, is that societies are more like organisms than machines. Our interactions are so complex that they cannot be manipulated as many Keynesians suppose. In vain attempts to maintain very low unemployment, government may feel compelled to spend faster and faster, so that prices rise faster and faster as well. This kind of artificial stimulant, said Hayek, distorts the price signals that indicate individuals' desires and genuine scarcities.