What If The Austrian School of Economics Became Dominant?

The Actual History

The Austrian School of Economics emerged in the late 19th century with the publication of Carl Menger's "Principles of Economics" in 1871. This approach to economic thought, developed primarily by scholars from Austria-Hungary, emphasized methodological individualism, subjective theory of value, and the role of time and uncertainty in economic processes. Key figures in its development included Eugen von Böhm-Bawerk, Ludwig von Mises, and Friedrich Hayek.

The school's influence reached a critical juncture during the interwar period (1918-1939) when its proponents offered explanations for business cycles that differed markedly from mainstream views. Ludwig von Mises developed the Austrian business cycle theory, which blamed economic downturns on central bank manipulation of interest rates and artificial credit expansion. Friedrich Hayek further refined these ideas, particularly in his work "Prices and Production" (1931).

However, the Austrian School's moment of potential mainstream breakthrough coincided with the Great Depression, which began in 1929. This economic catastrophe created an intellectual battleground where competing economic theories vied for dominance in explaining and solving the crisis. While Austrian economists advocated for allowing market corrections to run their course with minimal government intervention, John Maynard Keynes presented a dramatically different approach.

Keynes's 1936 publication of "The General Theory of Employment, Interest and Money" offered a theoretical framework that justified active government intervention to boost aggregate demand during economic downturns. His ideas gained rapid acceptance among policymakers, particularly as they aligned with the political momentum for government action during the crisis. The Keynesian approach became the dominant economic paradigm, informing the New Deal in the United States and similar policies elsewhere.

Following World War II, Keynesian economics became firmly entrenched in academia, government, and international institutions like the newly formed International Monetary Fund and World Bank. The Bretton Woods system, established in 1944, created a global monetary order that rejected many Austrian principles, particularly by moving away from the gold standard toward a managed international monetary system.

The Austrian School experienced a partial revival in the 1970s when stagflation—the combination of high inflation and economic stagnation—challenged Keynesian orthodoxy. Friedrich Hayek received the Nobel Prize in Economics in 1974, bringing renewed attention to Austrian ideas. Milton Friedman and the Chicago School, while not strictly Austrian, incorporated some similar elements in their critique of Keynesian policies.

Despite this revival, the Austrian School remained largely outside the economic mainstream. By the 1990s and 2000s, the dominant paradigm had evolved into a "neoclassical synthesis" that incorporated elements of Keynesian intervention alongside more market-oriented approaches, but still fundamentally differed from Austrian principles on methodological and policy grounds.

The 2008 financial crisis briefly revived interest in Austrian explanations of boom-bust cycles, but the policy response globally remained largely influenced by Keynesian and neo-Keynesian frameworks, including massive government stimulus programs and unprecedented central bank interventions. Through organizations like the Mises Institute (founded 1982) and figures like Ron Paul, Austrian economics maintained a devoted following, particularly among libertarian political movements, but never achieved the academic dominance or policy influence of competing economic paradigms.

Today, Austrian economics continues to influence debates on monetary policy, business cycles, and the role of government in the economy, but remains a heterodox approach outside the mainstream of academic economics and policy-making circles.

The Point of Divergence

What if the Austrian School of Economics had become the dominant economic paradigm instead of Keynesian economics? In this alternate timeline, we explore a scenario where a series of different outcomes in the 1930s and 1940s led to Austrian economic theories supplanting their Keynesian counterparts as the foundation for economic policy and academic thought throughout the 20th century and beyond.

The point of divergence centers on the intellectual and policy responses to the Great Depression, particularly in the United States and United Kingdom between 1930 and 1936. Several plausible alternative events could have shifted the trajectory of economic thought:

First, Friedrich Hayek's debates with John Maynard Keynes in the early 1930s might have unfolded differently. In our timeline, these debates, particularly those in the pages of academic journals, generally saw Keynes's views gain more traction. But what if Hayek had more effectively communicated his theories of business cycles and capital? Perhaps Hayek could have presented a more accessible version of Austrian theory that resonated more broadly with both policymakers and the public.

Alternatively, the implementation of New Deal policies in the United States could have produced more visibly negative consequences or failed to generate the political appeal they achieved under President Franklin Roosevelt. If the interventionist policies of the 1930s had been more obviously counterproductive in the short term, Austrian explanations of how government intervention prolongs economic adjustments might have seemed more prescient.

A third possibility involves the political ascendance of Austrian-sympathetic figures. If someone like Republican Senator Robert Taft, who was skeptical of extensive government intervention, had won the presidency instead of Roosevelt, American economic policy might have moved in a direction more aligned with Austrian principles of limited government involvement and sound money.

The most consequential divergence point could have been the 1944 Bretton Woods Conference. In our timeline, this conference established a post-war international monetary system heavily influenced by Keynesian thinking, with the dollar linked to gold but most other currencies pegged to the dollar. If representatives more sympathetic to Austrian views on sound money had held greater influence, perhaps a different international monetary framework—one with stronger ties to gold or greater restraints on central banking—might have emerged.

Any of these divergences, or a combination of them, could have altered the perception of Austrian economics from a minority position to a mainstream approach, creating a fundamentally different trajectory for economic thought and policy throughout the 20th century.

Immediate Aftermath

Academic Transformation (1936-1945)

The immediate consequences of Austrian economic thought gaining predominance would have first manifested in academic and intellectual circles. With Hayek's perspectives winning the crucial debates against Keynes, prestigious economics departments, particularly at the London School of Economics, the University of Chicago, and later Harvard and Princeton, would have oriented their curricula and research programs around Austrian methodologies.

Graduate students in economics would have focused on subjective value theory, methodological individualism, and capital structure analysis rather than macroeconomic aggregates and mathematical modeling of economies as unified systems. The profession would have remained more closely tied to its classical liberal roots, with greater emphasis on verbal logical analysis over mathematical abstraction.

Key academic journals that in our timeline became strongholds of Keynesian thought—like the American Economic Review and the Quarterly Journal of Economics—would instead have published primarily Austrian-influenced work. This shift would have created a very different foundation for economic education, with generations of economists trained in Austrian approaches to understanding market processes.

Policy Responses to the Depression (1936-1941)

With Austrian economics ascendant, governmental responses to the lingering Great Depression would have differed markedly from our timeline's New Deal expansion:

Monetary Policy: Rather than pursuing expansionary monetary policy, the Federal Reserve would likely have focused on preventing artificial credit expansion while allowing interest rates to find their natural level. The monetary contraction that occurred in the early Depression years would have been addressed not through inflation but through allowing prices and wages to adjust downward more rapidly.
Fiscal Approach: Government spending would have been curtailed rather than expanded. Programs like the Works Progress Administration would have been scaled back or never implemented. Instead, policy would have focused on balancing budgets and reducing tax and regulatory burdens on businesses to encourage private investment.
Market Adjustment: Austrian policymakers would have emphasized allowing malinvestments from the 1920s boom to be liquidated, arguing that although painful in the short term, this would create a more solid foundation for sustainable growth.
Banking Reform: Rather than establishing more governmental oversight of banking through expanded Federal Deposit Insurance Corporation and Securities and Exchange Commission powers, reforms might have pushed toward free banking approaches with greater emphasis on bank responsibility and transparency.

International Relations and Trade (1936-1945)

The Austrian emphasis on free trade and international division of labor would have influenced international economic relations:

Trade Policy: The Smoot-Hawley Tariff of 1930 would have been more quickly reversed, with a stronger push toward free trade rather than the managed trade that characterized much of the post-Depression era.
Monetary Coordination: International monetary coordination would have placed greater emphasis on stable exchange rates backed by gold or similar commodity standards, rather than the discretionary management approach that prevailed in our timeline.

As World War II approached, Austrian-influenced economies would still have mobilized for war production, but with greater reliance on private industry coordination and less direct government management of resources. The financing of war efforts would have relied more heavily on direct bond sales to citizens rather than monetary expansion.

Public Perception and Political Realignment (1936-1945)

The public understanding of economics would have been shaped by different narratives about the causes of prosperity and depression:

Media Coverage: Economic journalism would have emphasized individual responsibility, entrepreneurship, and the dangers of government overreach rather than the need for collective action and government safeguards against market failures.
Political Discourse: Politicians advocating limited government would have gained intellectual credibility, changing the dynamic of political campaigns. Roosevelt might have either not won re-election or been forced to significantly moderate his interventionist agenda.
Business Leadership: Business leaders would have more effectively positioned themselves as creators of prosperity rather than targets of regulatory control, potentially leading to different relationships between the private sector and government.

By 1945, as the war ended, the intellectual groundwork would have been laid for a very different post-war economic order—one built on Austrian principles rather than the Keynesian framework that dominated our timeline. This would set the stage for dramatic divergences in economic structure, policy approaches, and international institutions in the decades to follow.

Long-term Impact

The Post-War Economic Order (1945-1960)

An Alternative Bretton Woods

In July 1945, with Austrian economics now the dominant framework, the Bretton Woods Conference established a fundamentally different international monetary system:

Gold Standard Reinstatement: Rather than creating a dollar-based system with limited gold convertibility only for governments, the conference established a more comprehensive return to the gold standard, with currencies directly convertible to gold at fixed rates for both governments and private citizens.
International Monetary Fund: The IMF's mandate differed dramatically, focusing primarily on facilitating international clearing of payments rather than providing loans to manage balance of payments problems. Its role became maintaining the integrity of the gold standard rather than managing adjustable pegs.
World Bank: The International Bank for Reconstruction and Development (World Bank) focused much more narrowly on post-war reconstruction loans with strict market-rate terms, avoiding the development-oriented mission it later adopted in our timeline.
Trade Liberalization: The General Agreement on Tariffs and Trade adopted more aggressive schedules for tariff reduction, prioritizing free trade principles over exceptions for developing economies or strategic industries.

Domestic Economic Policies

Within major economies, particularly the United States and United Kingdom, economic policy followed Austrian prescriptions:

Monetary Policy: Central banks operated under much stricter rules, with their primary mandate being currency stability rather than full employment. The Federal Reserve acted primarily as a clearinghouse and lender of last resort for solvent banks, not as an active manager of economic conditions.
Fiscal Approach: Government budgets remained significantly smaller, with balanced budgets becoming not just a goal but a constitutional requirement in many countries. The U.S. never developed the extensive welfare state of our timeline, with Social Security remaining a much more limited program and Medicare/Medicaid never being established in their familiar forms.
Regulation: Business regulation focused narrowly on preventing fraud and enforcing contracts rather than managing economic outcomes or protecting specific industries. The administrative state remained much smaller and less pervasive.

The Global Economy in Transition (1960-1980)

Economic Development Patterns

The Austrian-dominated approach to economic development created different trajectories for emerging economies:

Development Strategy: Rather than import substitution industrialization and centralized planning that characterized development economics in our timeline, countries were encouraged to pursue their comparative advantages within a global trading system. Development aid was minimal, replaced by an emphasis on property rights, rule of law, and open markets to attract private investment.
Asian Tigers: Countries like South Korea, Taiwan, Hong Kong, and Singapore still emerged as economic powerhouses, but their development followed even more market-oriented paths without the industrial policy elements that characterized their growth in our timeline.
Latin America: Without the influence of dependency theory and structuralist economics, Latin American countries pursued more consistent free-market policies, avoiding the debt crises and hyperinflation of the 1980s that occurred in our timeline.

The Oil Shocks and Inflation

The oil price shocks of the 1970s played out very differently:

Monetary Response: With central banks constrained by gold standard discipline, the inflationary response to oil shocks seen in our timeline never materialized. Price adjustments were more rapid but less persistent.
Economic Adjustment: The Austrian emphasis on allowing markets to adjust led to faster but more severe adjustments to the new energy reality, with greater short-term unemployment but less prolonged stagflation.
Energy Policy: Government responses focused on removing barriers to energy production and allowing prices to signal scarcity, rather than imposing price controls and rationing that characterized the 1970s in our timeline.

The Modern Economy (1980-2025)

Financial System Evolution

The global financial system developed along very different lines:

Banking Structure: Without deposit insurance and extensive central bank backstops, banking remained more conservative but also more diverse, with smaller average institution size and greater emphasis on relationship banking over transactional approaches.
Capital Markets: Stock and bond markets still developed sophisticated instruments, but with greater transparency requirements and without the implicit government guarantees that encouraged excessive risk-taking in our timeline.
Financial Crises: The savings and loan crisis of the 1980s, the Asian financial crisis of the late 1990s, and especially the 2008 global financial crisis either did not occur or manifested in substantially different ways, with faster but potentially more painful market corrections and less government intervention.

Technological Development and Innovation

The technological revolution still occurred but with different emphases:

Entrepreneurship: With lower taxes and regulatory burdens, entrepreneurial activity played an even larger role in economic development, though with less government-funded research supporting basic science.
Internet and Digital Economy: The internet still emerged (though perhaps without the DARPA funding that initially created it in our timeline), developing with less regulation and greater emphasis on private solutions to concerns about privacy, security, and content.
Pharmaceutical and Biotechnology: Medical innovation followed a different model, with less government-funded basic research but potentially more rapid translation of discoveries into marketable products due to lighter regulatory approval processes.

Global Economic Governance in 2025

By 2025 in this alternate timeline, global economic institutions reflect Austrian principles:

International Monetary System: The international monetary system maintains its gold-backed discipline, with digital currencies emerging as privately-issued competitors rather than central bank initiatives.
Trade Governance: The World Trade Organization (or its equivalent) focuses narrowly on preventing tariffs and trade barriers rather than managing trade disputes and harmonizing regulations.
Economic Inequality: Economic inequality likely remains significant or even greater than in our timeline, but with potentially greater absolute prosperity at all levels and more economic mobility. The political response to inequality emphasizes opportunity creation rather than redistributive policies.
Environmental Challenges: Climate change and environmental concerns are addressed primarily through property rights approaches and market mechanisms rather than regulatory mandates and international agreements.

This Austrian-dominated world of 2025 would be instantly recognizable to us in its technological capabilities and global interconnectedness, but profoundly different in its economic organization, with a much smaller public sector, more volatile but potentially more dynamic markets, and a different set of winning and losing nations and industries than in our own timeline.

Expert Opinions

Dr. Jonathan Haslam, Professor of Economic History at Princeton University, offers this perspective: "Had Austrian economics triumphed over Keynesianism in the 1930s and 40s, we would likely have seen a much more volatile economic history throughout the 20th century. The post-war boom might have been less pronounced without deficit-financed demand management, but the stagflation crisis of the 1970s would likely have been avoided entirely. The most profound difference would be in our institutions—central banks would be either nonexistent or constrained to narrower functions, while international organizations would emphasize facilitating free exchange rather than coordinating intervention. Whether this alternate path would have produced greater or lesser prosperity in aggregate remains one of the great counterfactual questions in economic history, though I suspect the distribution of gains would have been markedly different, with savers and creditors faring much better relative to debtors."

Dr. Maria Vasquez, Chair of Monetary Economics at the University of Chicago, presents a contrasting view: "An Austrian-dominated economic paradigm would have fundamentally altered how we experience economic cycles. Without counter-cyclical fiscal and monetary policy, recessions would likely have been more frequent but shorter and sharper—economic forest fires that clear underbrush regularly rather than allowing fuel to accumulate for devastating conflagrations. The 2008 financial crisis might never have occurred, as the housing and credit bubbles would have faced correction much earlier. The most interesting aspect would be the impact on innovation and long-term growth—without extensive government funding for research and development, would technological progress have slowed? Or would private capital, deployed more efficiently without monetary distortion, have found even more productive investments? History suggests the latter possibility deserves more credit than many contemporary economists give it."

Professor William Chen, Senior Fellow at the Institute for Economic Analysis, observes: "The triumph of Austrian economics would have created dramatically different political dynamics worldwide. The welfare state would be significantly smaller, with greater emphasis on private charity and mutual aid societies. This would have profound implications for social stability—either creating more precarious conditions for vulnerable populations as Austrians' critics suggest, or fostering greater community responsibility and voluntary cooperation as their proponents argue. What's certain is that public debt levels would be a fraction of current amounts, and taxation would be correspondingly lower. The political divide might not center on questions of redistribution and regulation as much as on other aspects of governance. One intriguing possibility is that without the ability to use monetary policy for economic management, greater pressure might have developed for political reform of other institutions to address economic concerns, potentially producing more responsive political systems in other dimensions."