The Chicago School of Economics

The Chicago School of Economics emerged prominently in the 1940s, chiefly founded under Frank Knight at the University of Chicago. Unlike The Austrian School of Economics which begins with the study of purposeful human action, the Chicago School focuses its economic inquiry on the allocation of scarce resources that have alternative uses. This focus on resources, rather than solely on people, has significant consequences for their approach.

A major consequence of this focus is that the Chicago School views economics as being closer to a hard science, akin to physics. Since resources can be recorded as data, and hard data can be analysed as empirical evidence, Chicago economists believe they can study the economic effects of various policies almost like scientists conducting experiments in a laboratory. As a result, the school develops an almost entirely data-driven view of the world and of economics. Whereas Austrian economists tend to advance their arguments a priori using reason from first principles, Chicago school economists are more likely to demand empirical evidence. This heavy reliance on data means the Chicago School has no objections to utilising mathematical models. The efficacy of any model is determined by its ability to predict real-world outcomes; if a model is incorrect, it should be refined and revised until it aligns with predictions.

Key figures associated with the Chicago School, alongside Knight, include three of his students: James M. Buchanan, George Stigler, and Milton Friedman. Buchanan went on to establish the sub-branch of political economy known as Public Choice. Stigler authored a seminal work on price theory and developed the economic theory of regulation, including the insight known as regulatory capture, which posits that regulatory bodies, once established, have incentives to expand far beyond their initial purpose. Thomas Sowell, a doctoral student of Stigler, notably combined Stigler's insights on regulation with F.A. Hayek's knowledge problem in his book Knowledge and Decisions. Milton Friedman became the driving force behind monetarism in the late 20th century and is perhaps one of the most famous economists associated with the school.

The Chicago School has made several significant contributions to economic theory:

• Quantity Theory of Money: Milton Friedman advanced the theory that the total amount of the money supply dictates real-world prices. Friedman contended that central banks worsened the Great Depression in the 1930s by restricting the money supply, suggesting they should have printed more.
• Rational Expectations: When building their models, Chicago economists typically assume that economic agents within these models are rational agents. However, these models have faced criticism because real-world people are not always rational. Gary Becker's Rotten Kid Theorem is an example often used to illustrate how incentivising rational behaviour may not always produce the desired outcome in practice.
• Analysis of Regulation and Government: George Stigler's work on regulation and James M. Buchanan's Virginia School of Public Choice, which grew out of the Chicago School, developed robust ways of analysing government functions. This work serves as a pushback against Keynesian claims of market failure by highlighting numerous examples of government failure.
• Application of Economics to Non-Traditional Topics: One of the most enduring contributions of the Chicago School is its successful application of economic tools to analyse topics beyond traditional trade or money. Examples include works like David Friedman's Hidden Order or Steven Levitt and Stephen Dubner's Freakonomics.

In terms of macroeconomic theory, the Chicago School considers the economy as a whole, often using aggregate statistics, aligning somewhat with John Maynard Keynes in this regard. However, they differ from Keynes in their emphasis on controlling the money supply as the primary area for government intervention, rather than focusing on aggregate demand for goods. Friedman's monetarism explicitly argued against the Keynesian focus on aggregate demand. They adopt the neoclassical view that sees production costs as a factor in determining prices, contrasting with the Austrian school's strictly subjective approach.

Generally, the Chicago School advocates for minimal intervention in the market and limited government. Opinions on the precise size of the state within the school range from minarchists and contractionists who favour a limited government or "night-watchman state" to full anarcho-capitalists who believe all functions would be better handled by private enterprise.

Despite differences, the Chicago School shares notable similarities with The Austrian School of Economics. Both schools strongly support the free market and are generally opposed to government interventions and regulations. They are utterly opposed to Socialism. Both broadly accept Hayek's insights about the knowledge problem, which has enabled them to broaden their analysis to aspects of everyday life as well as traditional economic topics like trade or money.

The Chicago School has strongholds not only at the University of Chicago but also at influential think tanks such as the Hoover Institution in Stanford. While the Austrian view may be more consistently and rigorously argued in substantive areas like monetary policy or pricing, the Chicago School has won many more debates in the real world because it relies on data and statistics to support its arguments. There is considerable persuasive power in being backed by statistics.