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I read through this article, and the phrase "least-worst alternative" sparked a train of thought, which I would like some insights on.

To me, it seems like one of the key differences between the Austrian School and the Neoclassical School of economics is that the former has softer assumptions than the latter. Is this because the Austrian School has more of a "compare and contrast" approach than the latter? For example, a lot of insights of Hayek in his essay "The Use of Knowledge in Society" stem from the debates with socialist-leaning economists of his day, according to what I've read.

Incidentally, Adam Smith does a bit of compare and contrast himself, in The Wealth of Nations, where he implicitly compares the system of enterprise that he puts forward to alternative situations where specials interests (namely, the merchant class) would end up skewing policies in their favor.

So, my question is: Is the bolded statement above true? And if so, what are the implications for the strengths and weaknesses of each school?

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    $\begingroup$ This is an interesting question, but I suggest it would be helpful to users of the site if you could edit the title to refer explicitly to Austrian and Neoclassical economics. $\endgroup$ Jan 26, 2023 at 12:19

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Austrian School and the Neoclassical School of economics is that the former has softer assumptions than the latter. Is this because the Austrian School has more of a "compare and contrast" approach than the latter? ... Is the bolded statement above true?

The bolded statement is not true. It is actually other way around. Austrian schools makes stronger and more rigid assumptions just less rigorous. Also the article you cite is about Milton Friedman who was New Classicist and neither austrian or neoclassical economist.

First, lets have a look what are differences between the two schools of thought following Grant & Brue The History of Economic Thought 7th ed;

Neoclassical Economics:

Neoclassical economics developed out of combination of classical economics and marginalism (see Grant & Brue pp 275). In fact it can be even said Marshall or Clark who were Neoclassical economics were also marginalists (ibid). The connection is so close that marginalists such as Jevons, Megner, Von Wieser, Von Bohm-Bawerk can be considered forerunners of neoclassical school.

The neoclassical economics started in early 1850's and in changed from it is still part of today's mainstream economics. Hence it is hard to do it a justice in an SE answer as a lot has changed over that time. For example, the school did not had such heavy emphasis on mathematical modeling that came later in 1900s under influence of Walras, Von Neumann, Morgenstern, Hicks and later Samuelson. For that reason I will just focus on the methodologies of the school as it is practiced now.

Main traits are:

  1. emphasis on rigorous mathematical modeling. Economic models should have rigorous micro-foundations that start from optimizing behavior of (representative) agents.
  2. workhorse models work with rational agents and rational expectations
  3. emphasis on empirical testing of theoretical models. This was under influence of instrumentalists such as Friedman (even though Friedman himself was New Classicist or what people sometimes term 'Chicago School'.)

Austrian School of Economics:

Austrian School of Economics started as an offshoot of marginalism and neoclassicism. Menger, Von Bohm-Bawerek, von Wieser who are considered to be forerunners of the 'Austrian School of Economics' are more properly classified as marginalists or neoclassists (at least according to commonly used textbooks such as Grant & Brue The History of Economic Thought pp 211 -248).

Austrian School also evolved over time but not as much as Neoclassical School. One notable development was that modern Austrian School strongly rejects mathematical and empirical modeling, in favor of what is called praxeology, whereas Megner, Bohm-Bawerk and in fact even Hayek (1937) were not opposed to mathematical modeling as much as 'modern' Austrians. In fact the methodological approaches were quite similar originally, and that is why you see the same names popping up that were mentioned in description of Neoclassical School.

However, post 1920s-50s Austrian School of Economics went separate way. This was because of its insistence on:

  1. (radical) methodological individualism - This is an approach that argues that models should be based ground up by analyzing individual actors/actions. Now I put radical in brackets because mainstream economics also to an extent applies methodological individualism but it is not as strict about it as Austrians. For example, in mainstream economic models we typically work with representative firm, representative households etc. However, Austrians like Hayek were firmly in favor of agent-based modelling (see the Austrian economics chapter of this entry in Standford's Encyclopedia of Philosophy).

  2. Austrian School also mostly dismisses mathematical modelling and econometrics (statistics applied to economics), which over time lead Austrian School to become heterodox school (since originally it was mainstream and barely distinguishable from marginalism) - see Meijer (1995).

Comparison

As a result of the above it is actually Austrian School that ends up with more stronger assumption. In a modern austrian methodology you are supposed to start with the axioms of rationality and derive your results/conclusions from there through some logical chain that is based not on regular mathematics but on something resembling symbolic logic.

In modern neoclassical methodology you can also start from some axioms and usually you start with rational choice theory and rational expectations, but you are then supposed to empirically test predictions made by the model and test it against other model where the assumptions are relaxed. For example, modern research in microeconomic theory does often incorporate behavioral insights into what would otherwise be neoclassical model, by for example tweaking assumptions on utility function or relaxing the assumption of rational expectations by allowing for switching between rational and adaptive expectations and so on.

So although it might not be obvious as Austrian School rejects modern rigorous mathematical modelling, which gives it more softer look it actually relies on stronger assumptions and does not have much willingness to relax them based on empirical data.

what are the implications for the strengths and weaknesses of each school?

The problem is that because of its radical rejection of empirical analysis Austrian School is in a way stuck in the past. There are very few contemporary serious (i.e. having PhD from any top 500 university) economists who would say they are Austrians. The schools of thought are themselves quite obsolete (nowadays scholars borrow and mix ideas from everywhere and see what sticks when you test your theory against data), you would not probably find many people who would just state they are neoclassical economists, but you will find people who work and get published a lot with Neoclassical models whereas you would have hard time finding modern scholarship rooted in Austrian School.

Hence comparing relative strengths and weaknesses between Austrian School and Neoclassical School is like comparing strengths and weaknesses between flintlock rifles and modern semiautomatic rifles.

In 50-60's you could say that strength of Austrian economics was the fact that it discarded statistical modeling because early econometrics was plagued by terrible empirical models (ignoring issues such as unit root, reverse causality, endogeneity in general etc). In such context you can say that thinking based on some reasonable axioms will give you more insights than some spurious regression.

However, in recent decades there was a 'credibility revolution' in econometrics. This is also what Angrist, Kruger and Imbens got their 2021 Nobel Prize for (and this work was done decades earlier of course). Since late 90s (in fact you could even argue for late 80s) econometric models became much more credible, and while some terrible modelling can be still found out there, nowadays scholars ignore empirics at their own peril so nowadays shunning empirics would be weakness.

A weakness of modern neoclassical models is that since they are formal they are not easily communicable to layperson like modern physics. In addition, a risk of formal modelling is that one can always read too much into the model. An example would be reading too much into real business cycle DSGE models which were always supposed to model economy in a very long run, but in late 90s it was not uncommon to use such models to inform even economic policy in short run. This being said, Neoclassical models are in a way self correcting because of the insistence on empirics. For example, once it became clear that Neoclassical real business cycle models were not accurate people adopted insights from Keynesian economics, but built them within neoclassical framework (giving rise to neoclassical synthesis in macroeconomics).

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