The Market Isn’t a Schoolmarm: The Austrian School versus Chicago

There are profound methodological differences between the Austrian and Chicago schools that lead to very different characterizations of the nature and function of the market economy. I was recently reminded of this by an article entitled “The Racist Premium Is Just One Way the Market Punishes Racism” by Andrew Moran. The point that Moran makes is basically correct. In certain circumstances taking race into account in market transactions does involve a cost to the one inclined to do so.

What I take issue with is the Chicago-school approach that the author implicitly adopts and the resulting rhetoric that he invokes, namely, that the market metes out punishment to “irrational” preferences that tends to inhibit their expression. This approach is based on the fallacious Chicago view pioneered by Nobel laureates George Stigler and Gary Becker in their famous article asserting that tastes and preferences for “fundamental” consumption commodities are both uniform among individuals and stable over time. In other words, all human beings whenever they have existed or will exist are viewed as possessing essentially the same underlying tastes — or in economic jargon, the same “stable, well-behaved preference functions” — for health, nutrition, “euphoria” (derived from alcohol or drugs), safety, social prestige, and so on. With subjective and unobservable tastes banished from economic analysis, the fact that different agents at the same time or the same agents at different times may consume goods in wildly different proportions is then wholly attributable to differences in objective and observable factors, namely, the prices they confront or the real income they earn.

The Chicago school depicts the market economy in most cases as perfectly competitive, which implies that all households and firms have perfect knowledge of all prices and therefore all buyers pay the same price for the same commodity. However, according to Stigler and Becker, even though everyone pays the same price for “derivative” market commodities, the costs households incur for the “fundamental” consumption commodities vary widely because different households have different productivities in producing the same commodities. Without going into detail, the reason is that fundamental consumption commodities are produced using a combination of derivative commodities purchased on the market, householders’ (unequally valued) time, and their varying levels of “consumption capital.” The prices of fundamental consumption goods are determined by these household costs and do not have precise monetary expression. They are imputed or “shadow” prices. If a Chicago economist observes an alcoholic or heroin addict, he would pray: “There but for the higher price of euphoria go I.”

Chicago school economists thus explain all intertemporal and interpersonal differences in human behavior as attributable to external forces, that is, to prices and incomes formed on the market. The market thus confronts the individual as an impersonal and unalterable system of incentives and penalties that governs his selection—I hesitate to use the word “choice” — of consumption commodities. In the Chicagoan view, then, the market economy is a mechanism that exists apart from the individual and shapes his behavior, penalizing or even stamping out aberrant preferences that do not accord with narrowly monetary considerations that maximize the acquisition of broad classes of fundamental consumption commodities.

In sharp contrast, Austrians take the view the market and its price structure is created and recreated at every moment by the interaction of continually changing individual human values and actions against a passive background of naturally limited resources. The market does not mechanistically rule human behavior; rather, market prices are the objective outcome and expression of what Mises described as “the conflict which the inexorable scarcity of the factors of production brings about in the soul of each individual.”1 With roots deep in the human soul, it is absurd and vain to attempt to analyze the operation of the market without reference to the vagaries of individual tastes and preferences. On this basis, Mises demolished the entire Chicago view of the market and prices in a few trenchant sentences:

It is customary to speak metaphorically of the automatic and anonymous forces actuating the “mechanism” of the market. In employing such metaphors people are ready to disregard the fact that the only factors directing the market and the determination of prices are purposive acts of men. There is no automatism; there are only men consciously and deliberately aiming at ends chosen. There are no mysterious mechanical forces; there is only the human will to remove uneasiness. There is no anonymity; there is I and you and Bill and Joe and all the rest. … A market price is a real historical phenomenon, the quantitative ratio at which at a definite place and at a definite date two individuals exchanged definite quantities of two definite goods. It refers to the special conditions of the concrete act of exchange. It is ultimately determined by the value judgments of the individuals involved.2 (Emphasis added.)

For Austrians, multifarious, concrete goods — and not abstract homogeneous classes of consumption commodities — are the object of human action. Even when purchasing physically identical products, consumers differentiate among them by location, brand name, personal attributes of the producer and his employees, promotional campaigns, packaging, and so forth. There is no demand for nourishment, but a demand to eat at a specific restaurant at a specific location with a specific menu, wait staff, interior décor, and seating arrangement. The market does not “punish” those who would rather consume steak in a cozy restaurant with an attractive and polished wait staff by charging them a higher price than the price charged for the same quantity of equal grade beef at a curbside food truck. In fact what economists call “the market” is nothing but a network of voluntary exchanges of definite items of property in which both parties always expect to benefit.

This brings us to the case of discrimination by someone who takes account of the race or other personal attributes of his potential exchange partners. Is it not the case that the market levies a “racist premium,” in the form of lower selling prices or higher buying prices, on any seller or buyer who discriminates in selling or buying on the basis of any other criterion then the money price? Now this racist premium appears to exist if one views the market à la Stigler and Becker as a censorious schoolmarm whose function it is to punish preferences that depart from the basic, uniform set of tastes that every human being is or should be endowed with. From the Austrian perspective no such premium is imposed, because voluntary exchange confers mutual benefits on all buyers and sellers. These include buyers who voluntarily and knowingly pay relatively higher prices and sellers who voluntarily accept lower prices for indulging their subjective preferences to avoid transactions with individuals with particular attributes or beliefs they object to, whether it be race, religion, ideology or hair color.

This is not to deny that sellers and buyers who choose among potential exchange partners on the basis of nonpecuniary considerations do in many cases incur higher monetary costs. But costs are not punishments imposed by an external mechanism. In an un-coerced exchange, a cost is a concrete opportunity for satisfaction that is voluntarily surrendered in exchange for a benefit of greater value to the individual. The man who pays a higher price to sip wine in in an elegant and comfortable wine bar in midtown Manhattan rather than imbibing in a local haunt in Staten Island is not being punished for his uneconomical behavior by an impersonal market. Indeed it is precisely this choice and those of many others like him that constitute the market and determines prices.

The same analysis applies to preferences to purchase or abstain from purchasing goods from certain groups. One who hires a member of her family or church to provide landscaping services while foregoing the cheaper services of other reputable landscapers is not punished with a “nepotist premium” or “sectarian premium” by the market. She willingly incurs an additional monetary cost for the greater benefit she derives from “discrimination” against nonmembers of the group she prefers to exchange with. However, if one views the market through the lens of the perfectly competitive model, as Chicago economists do, this behavior appears to be irrational and uneconomical and deserving of punishment. For as Frank Knight, a founder of the Chicago school, pointed out, under perfect competition buyers and sellers treat one another as anonymous and featureless “vending machines” or “slot machines.”3 In contrast, Mises recognized that choices which take into account the nonpecuniary aspects of potential exchange opportunities are an unremarkable exercise of consumer sovereignty, despite the fact that they may involve higher monetary prices or lower quality products:

In an unhampered market society there is no legal discrimination [that is, enforced by law] against anybody. Everyone has the right to obtain the place within the social system in which he can successfully work and make a living. The consumer is free to discriminate, provided that he is ready to pay the cost. A Czech or a Pole may prefer to buy at higher cost in a shop owned by a Slav instead of buying cheaper and better in a shop owned by a German. An anti-Semite may forego being cured of an ugly disease by the employment of the “Jewish” drug Salvarsan and have recourse to a less efficacious remedy. In this arbitrary power consists what economists call consumer’s sovereignty.4 (Emphasis added.)

In the course of criticizing the fallacy that there are differences in “the cost of living” between different regions or countries, Mises generalized the point made in the passage above. He argued that every good has a spatial component and if consumers are not indifferent to the different locations and therefore the different cultural and linguistic milieus in which physically identical goods are available for consumption, then they are different goods. Thus the choice to live in the country of one’s birth may involve the sacrifice of an opportunity to satisfy one’s supposed “fundamental” wants more cheaply abroad. But for Mises, although such cultural “discrimination” involves higher monetary costs, it is fully consistent with the highest valued uses of one’s scarce resources:

The differences in prices in the two areas [Germany and Austria] do not refer to commodities of the same nature; what are supposed to be identical commodities really differ in an essential point; they are available for consumption in different places. Physical causes on the one hand, social causes on the other, give to this distinction a decisive importance in the determination of prices. He who values the opportunity of working in Austria as an Austrian among Austrians … must not forget that part of every price he pays is for the privilege of being able to satisfy his wants in Austria.5

Mises also understood that most people do not have the opportunity to earn a living abroad because of language difficulties, immigration barriers and so on, but for those who do and choose to remain in their country of birth, “cultural” or “national” discrimination is an economically rational alternative:

An independent rentier [living on an income from investments] with a free choice of domicile is in a position to decide whether or not he prefers a life of apparently limited satisfactions in his native country among his own kindred to one of apparently more abundant satisfaction among strangers in a foreign land.6

It should be noted that if one accepts the concept of a racist premium, then he is bound to also accept that the market levies what has been called a “tax on blackness” or a “segregation tax.” These terms refer to the notion that the market punishes minority groups which many nonmembers prefer not to engage with in exchange relations. For example, substantial anecdotal evidence and numerous empirical studies indicate that black home sellers in the U.S. receive reduced prices for their houses compared to prices received by white sellers for physically similar houses even in neighborhoods with similar amenities. A 2001 Brookings Institution study of the nation’s 100 largest metropolitan areas, home to 63 percent of all blacks and 58 percent of all whites in the country, found that black-owned homes were valued at 18 percent less compared to white-owned homes when controlling for the incomes of the homeowners. Other research shows that homes appreciate more rapidly in overwhelmingly white neighborhoods then in mixed neighborhoods. This “appreciation gap” begins when black households in a neighborhood exceed 10 percent and rises with the proportion of black households. An article on Prince Georges county in Maryland , the highest income majority-black county in the U.S., reported that the level and cyclical stability of housing wealth of white home-owners in neighboring suburbs exceeded that of black home-owners because whites generally choose to live in largely white neighborhoods which attract buyers of all races. In contrast blacks tend to choose homes in communities where minorities are the majority and which “attract a narrower group of mainly black buyers, dampening demand and prices.” A 2014 Harvard study of Chicago neighborhoods found that neighborhoods displaying early signs of gentrification in the mid-1990s “continued the process only if they were at least 35 percent white. In neighborhoods that were 40 percent or more black, the process slowed or stopped altogether.” Overall a large body of research concludes , “The higher the percentage of blacks in the neighborhood, the less the home is worth, even when researchers control for age, social class, household structure, and geography.”

Let me be crystal clear. The market neither punishes nor rewards, neither censures nor condones, racism. The market determines prices that coordinate the actions of diverse human beings thereby permitting individuals with disparate and fluctuating values to peacefully coexist. Both the “racist premium” and the “tax on blackness” are misleading metaphors, the result of economic reasoning that profoundly misconceives the nature of the market economy. The market is nothing but a short-hand expression for the network of mutually beneficial voluntary exchanges undertaken daily by people each intent on improving his or her own welfare by serving the wants and needs of others. Unlike a moralistic schoolmarm, or a government, it does not punish or tax anyone. Higher prices paid by racists and lower prices received by those who choose to live in diverse or minority-majority neighborhoods reflect the values and choices of consumers no less than the prices of all other goods and services.

This discussion illustrates the fundamental difference between Austrian economics and Chicago economics. Austrian economics adopts a causal-realist approach. It seeks to conceive and explain the reality of differentiated and changeable individual value scales that underlie human exchange relations and give rise to actual prices and quantities exchanged from moment to moment in dynamic markets. In sharp contrast, the Chicago school, invoking the fictional assumptions of the static model of perfect competition, portrays the market as a mechanism that generates a supra-human system of price incentives and punishments that tames — or can be used by policymakers to tame — unruly or irrational individual economic behavior.7

  • 1. Ludwig von Mises, Human Action: A Treatise on Economics, Scholar’s Edition, Mises Institute, Auburn AL, 1998, p. 372.
  • 2. Ibid., pp. 311-12, 390.
  • 3. Ross B. Emmett, Frank Knight and the Chicago School in American Economics, Routledge, New York, 2009, p. 91.
  • 4. Ludwig von Mises, Omnipotent Government: The Rise of the Total State and Total War , Libertarian Press, Inc., Grove City PA, 1985, p. 182.
  • 5. Ludwig von Mises, The Theory of Money and Credit, trans. H. E. Batson, 2nd ed., Yale University Press, New Haven, 1953, pp. 177-78.
  • 6. Ibid., p. 178.
  • 7. I am indebted to a comment by Mark Thornton for the content of this paragraph, although he bears no responsibility for its imperfect expression.

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