Disastrous Economic Fallacies --Terror as Stimulus?
This is a link to a very short video (courtesy of the Atlas Institute) that illustrates a point that shouldn't take very long to explain in the first place, and yet one that even Nobel Prize-winning economists like Paul Krugman cannot understand: namely, why the broken window fallacy is in fact a fallacy, or in other words, why destruction is not good for the economy (yes, this point is disputed by some, watch the video).
Wednesday, March 31, 2010
Saturday, March 27, 2010
A Letter I Wrote to David Brooks
David Brooks recently wrote an op-ed in the New York Times entitled "The Return of Histroy," in which he argues that economics is, today, fundamentally flawed in its scientistic methodology (that of constructing abstract models that heavily rely on mathematics and believe themselves to be based on empirical evidence). However, his prediction for the future of economics is that economics will hopelessly fail as a science at all, and will become an "art." So I decided to write him this letter, explaining why both the method of "scientism" and simply dropping all scientific technique are both flawed. Here's that letter:
Dear Sir,
In reading your article "The Return of History," I have reason to believe that you are currently unaware of a glaring answer to your question about the future of economics. This answer I refer to is not a victim to the pitfalls of scientism that you mention in economics, namely the fallacy of analyzing "economic man," or the perfectly rational, calculating, utility-maximizing individual. There is an entire economic school of thought that not only recognized all of these errors, but also corrected the foundations of economics, proposing a sound basis for economics: that of the concept of human action. This school of thought also has predicted the Great Depression, the stagflation of the 70's, and other economic crises including the current one. This school of economic thought is the Austrian School.
In the analysis of the Austrian school, economics consists of the study of the fact that human beings have to make choices between various ends. In doing this, it is free from the failure of many economists to recognize that things like love, friendship, and having children are not "uneconomic," but simply choices that people make. People, when making decisions, compare all possible ends that they may desire on one scale of valuations. Choosing to have a child given the cost is not "irrational" to the person making the decision, and it is an error to say that the actor in this case is behaving irrationally, because the purpose of economic analysis is to analyze how people act, not how the economist thinks people should act. In other words, value is subjective.
Because Austrian economics starts with an objective analysis of human action, it does not fall into the hole of thinking that econometric and empirical studies of past data from the marketplace can either prove or disprove an economic theory, on the grounds that the data of the marketplace is a result of specific value judgments held by market participants at a previous point in time. Economics as a science has to look for universally valid laws and, fundamentally, causal relations between variables, and correlation (think: econometrics) does not imply causation. Using reason and the the principle of human action, real economic claims can be derived, not mere models that describe past market performance perfectly, but which fail when it comes to predicting what will come to pass.
Furthermore, psychology and economics are two entirely separate things: economics in the Austrian view studying the results of human action given their individual valuations and preferences, while psychology studies where those individual valuations come from, and currently psychology cannot make definite, universally valid statements about how a specific circumstance can cause all people, at all times, anywhere to make the same choice given their surroundings. Thus, a methodological dualism exists between these two fields, and psychology is not an aid to economics.
It might also be tempting to dismiss the idea of the ability to deduce universally valid laws about human action that would be applicable in any way to the real world. However, the proof that this is indeed possible is present in the results of Austrian economics, whose theories properly explain everything from the basic functioning of markets to the business cycle. Ludwig von Mises' book Human Action is the deduction of all of economics not from empirical studies, but from axioms and basic, realistic assumptions that hold in our economies (such as the valuation placed on leisure time, or the use of money).
With a proper methodology in place, Austrian economics is neither scientism nor an art: universal laws and principles can exist but not be quantifiable and testable. The future of economics relies, one could only hope, on the adoption of the proper, logical basis for the field of study. It would not be the end of the "development" of economics if all attempts at objective laws and causal relations were dropped in favor of an "art of economic." You mentioned F.A. Hayek in your article, and Russ Roberts, but please look more into Austrian economics, not merely for your sake but for the sake of your readers and the future of economics. And besides Human Action, which I recommend everyone to read, you would find another of his works, Epistemological Problems of Economics, interesting in that he defends the basis of Austrian economics in contrast to the competing schools.
Hoping that you have given this some thought,
Eric Perkerson
Dear Sir,
In reading your article "The Return of History," I have reason to believe that you are currently unaware of a glaring answer to your question about the future of economics. This answer I refer to is not a victim to the pitfalls of scientism that you mention in economics, namely the fallacy of analyzing "economic man," or the perfectly rational, calculating, utility-maximizing individual. There is an entire economic school of thought that not only recognized all of these errors, but also corrected the foundations of economics, proposing a sound basis for economics: that of the concept of human action. This school of thought also has predicted the Great Depression, the stagflation of the 70's, and other economic crises including the current one. This school of economic thought is the Austrian School.
In the analysis of the Austrian school, economics consists of the study of the fact that human beings have to make choices between various ends. In doing this, it is free from the failure of many economists to recognize that things like love, friendship, and having children are not "uneconomic," but simply choices that people make. People, when making decisions, compare all possible ends that they may desire on one scale of valuations. Choosing to have a child given the cost is not "irrational" to the person making the decision, and it is an error to say that the actor in this case is behaving irrationally, because the purpose of economic analysis is to analyze how people act, not how the economist thinks people should act. In other words, value is subjective.
Because Austrian economics starts with an objective analysis of human action, it does not fall into the hole of thinking that econometric and empirical studies of past data from the marketplace can either prove or disprove an economic theory, on the grounds that the data of the marketplace is a result of specific value judgments held by market participants at a previous point in time. Economics as a science has to look for universally valid laws and, fundamentally, causal relations between variables, and correlation (think: econometrics) does not imply causation. Using reason and the the principle of human action, real economic claims can be derived, not mere models that describe past market performance perfectly, but which fail when it comes to predicting what will come to pass.
Furthermore, psychology and economics are two entirely separate things: economics in the Austrian view studying the results of human action given their individual valuations and preferences, while psychology studies where those individual valuations come from, and currently psychology cannot make definite, universally valid statements about how a specific circumstance can cause all people, at all times, anywhere to make the same choice given their surroundings. Thus, a methodological dualism exists between these two fields, and psychology is not an aid to economics.
It might also be tempting to dismiss the idea of the ability to deduce universally valid laws about human action that would be applicable in any way to the real world. However, the proof that this is indeed possible is present in the results of Austrian economics, whose theories properly explain everything from the basic functioning of markets to the business cycle. Ludwig von Mises' book Human Action is the deduction of all of economics not from empirical studies, but from axioms and basic, realistic assumptions that hold in our economies (such as the valuation placed on leisure time, or the use of money).
With a proper methodology in place, Austrian economics is neither scientism nor an art: universal laws and principles can exist but not be quantifiable and testable. The future of economics relies, one could only hope, on the adoption of the proper, logical basis for the field of study. It would not be the end of the "development" of economics if all attempts at objective laws and causal relations were dropped in favor of an "art of economic." You mentioned F.A. Hayek in your article, and Russ Roberts, but please look more into Austrian economics, not merely for your sake but for the sake of your readers and the future of economics. And besides Human Action, which I recommend everyone to read, you would find another of his works, Epistemological Problems of Economics, interesting in that he defends the basis of Austrian economics in contrast to the competing schools.
Hoping that you have given this some thought,
Eric Perkerson
Thursday, March 18, 2010
Theory and Empiricism
It is all too common a trait to attempt to dismiss an economic claim on the grounds that the economic claim in question applies “only in theory,” and not in the real world. It is argued that economics makes an array of assumptions which are fantastically impossible, and therefore, in spite of what may be sound reasoning from those premises, has no relation to the events of the real world. And to be fair, this is true of some schools of economics, such as the neoclassical school, with models assuming perfect competition, perfect information, and whatnot.
However, Austrian economics makes no such otherworldly assumptions: economics is treated as a subset of praxeology in the Austrian school, and is therefore based on the action axiom, or the simple fact that people act with certain goals in mind. That is a statement that cannot simply be dismissed as not applying to the real world. There are a few auxiliary postulates, but these merely guide the progression of economics; and are likewise real features of the world, such as the fact that leisure is one of the things that people value. The otherworldly assumptions of the neoclassical school have no equivalent in Austrian economic theory, which indeed focuses on the aspects of the real world such as a lack of perfect information that the neoclassicals assume away.
The crucial point here is that, if the reasoning from these premises is sound, then if what they assume is true, then so is the theory. To quote Ludwig von Mises, “All the propositions established by the universal theory hold to the extent that the conditions that they presuppose and precisely delimit are given. Where these conditions are present, the propositions hold without exception.” This is unquestionable: to question it would be to question reasoning itself, an endeavor for which there can be no recourse. A sound theory of money, for example, is descriptive of the real world if the real world economy being analyzed uses something seen as money according to the theory.
What is often proposed as being an alternative to theory is empiricism, where one attempts to “test” economic theories in the “real world” to either falsify or verify them, with no recourse to the theories themselves. It is posited that if a theory cannot be falsified, it cannot be considered true, or descriptive of reality, and that theories can be demonstrated to be false using empirical evidence. This is the most brought up criticism of Austrian economics by both academic economists and by the public in general, if they are aware of Austrian economics at all, that is.
However, this criticism is entirely based upon long-standing myths in economic thinking. In reality, it is impossible to verify or refute an economic theory on the basis of empirical evidence. An economic theory describes how an economy works, and the process by which anything functions does so because there are certain causal relations that exist. However, by looking at empirical data, there is no way to determine causation in a complex system such as society. This leads us to the first reason why it is impossible to test theories in economics: there is no way to conduct a controlled experiment in a complex system where no variables can be controlled. A change in one variable can never be shown empirically to result in a change in another variable.
The second reason why it is impossible to test economic theories is because the fundamental data at the base of the economic system have no basic constant relations between one another. For example, no one would ever propose that a rise in the price of potatoes of 50% will always and everywhere result in a decrease in the quantity demanded of potatoes by 50%. In physics and chemistry, such constant relations do exist and experimentation is the method by which they are determined. In economics, the personal values of individual people determine such things as the demand for potatoes, and these personal values are arbitrary, subjective, and changing. No one would ever stop and think that a certain condition will cause for all people and at all times the exact same response in everyone. People react different to the same conditions.
Knowledge of these important facts about the foundation of economic science, the Austrian school of economics does not attempt to make quantitative predictions about economic variables, but instead tries to describe how the economy works in general, i.e. at all times and for all places and people. A remarkable body of thought has then been developed from simple, axiomatic propositions, and the best evidence for this is in the great economic treatise by Ludwig von Mises Human Action. It should now be evident that the most fundamental assumption of most people on economics, that economic ideas and theories need to be proven with empirical evidence, has no basis and is impossible to comply with. Instead, a logical, or apriori, method is the only method suitable.
However, Austrian economics makes no such otherworldly assumptions: economics is treated as a subset of praxeology in the Austrian school, and is therefore based on the action axiom, or the simple fact that people act with certain goals in mind. That is a statement that cannot simply be dismissed as not applying to the real world. There are a few auxiliary postulates, but these merely guide the progression of economics; and are likewise real features of the world, such as the fact that leisure is one of the things that people value. The otherworldly assumptions of the neoclassical school have no equivalent in Austrian economic theory, which indeed focuses on the aspects of the real world such as a lack of perfect information that the neoclassicals assume away.
The crucial point here is that, if the reasoning from these premises is sound, then if what they assume is true, then so is the theory. To quote Ludwig von Mises, “All the propositions established by the universal theory hold to the extent that the conditions that they presuppose and precisely delimit are given. Where these conditions are present, the propositions hold without exception.” This is unquestionable: to question it would be to question reasoning itself, an endeavor for which there can be no recourse. A sound theory of money, for example, is descriptive of the real world if the real world economy being analyzed uses something seen as money according to the theory.
What is often proposed as being an alternative to theory is empiricism, where one attempts to “test” economic theories in the “real world” to either falsify or verify them, with no recourse to the theories themselves. It is posited that if a theory cannot be falsified, it cannot be considered true, or descriptive of reality, and that theories can be demonstrated to be false using empirical evidence. This is the most brought up criticism of Austrian economics by both academic economists and by the public in general, if they are aware of Austrian economics at all, that is.
However, this criticism is entirely based upon long-standing myths in economic thinking. In reality, it is impossible to verify or refute an economic theory on the basis of empirical evidence. An economic theory describes how an economy works, and the process by which anything functions does so because there are certain causal relations that exist. However, by looking at empirical data, there is no way to determine causation in a complex system such as society. This leads us to the first reason why it is impossible to test theories in economics: there is no way to conduct a controlled experiment in a complex system where no variables can be controlled. A change in one variable can never be shown empirically to result in a change in another variable.
The second reason why it is impossible to test economic theories is because the fundamental data at the base of the economic system have no basic constant relations between one another. For example, no one would ever propose that a rise in the price of potatoes of 50% will always and everywhere result in a decrease in the quantity demanded of potatoes by 50%. In physics and chemistry, such constant relations do exist and experimentation is the method by which they are determined. In economics, the personal values of individual people determine such things as the demand for potatoes, and these personal values are arbitrary, subjective, and changing. No one would ever stop and think that a certain condition will cause for all people and at all times the exact same response in everyone. People react different to the same conditions.
Knowledge of these important facts about the foundation of economic science, the Austrian school of economics does not attempt to make quantitative predictions about economic variables, but instead tries to describe how the economy works in general, i.e. at all times and for all places and people. A remarkable body of thought has then been developed from simple, axiomatic propositions, and the best evidence for this is in the great economic treatise by Ludwig von Mises Human Action. It should now be evident that the most fundamental assumption of most people on economics, that economic ideas and theories need to be proven with empirical evidence, has no basis and is impossible to comply with. Instead, a logical, or apriori, method is the only method suitable.
Monday, March 8, 2010
An Open Letter to President Obama
Don Boudreaux, posting on the blog CafeHayek, wrote this earlier today:
An Open Letter to President Obama
by Don Boudreaux on March 8, 2010
in Health, Prices, Reality Is Not Optional, Seen and Unseen
8 March 2010
Mr. Barack Obama
President, Executive Branch
United States Government
1600 Pennsylvania Ave., NW
Washington, DC 20500
Dear Mr. Obama:
CBS radio news this morning ran a clip of one of your recent speeches. In it, you criticize insurance companies because they “ration coverage … according to who can pay and who can’t.”
My first thought was “not exactly; coverage is rationed according to who pays and who doesn’t.” Ability to pay isn’t the same thing as actually paying, and what insurers care about is the latter. Many folks – especially young adults – have the ability to pay but choose not to do so. They get no coverage.
But further pondering of your point leads me to look beyond such nit-picking to see fascinating possibilities. Not only insurers, but all producers who greedily refuse to supply persons who don’t pay should be set aright. Now I’m sure that you don’t ration the supply of the books you write according to any criteria as sordid as requiring people actually to pay for them. But our society is full of people less enlightened than you.
For example, the typical worker rations his labor services according to who pays and who doesn’t. That must stop. Oh, and supermarkets! Every single one rations groceries according to who pays. Likewise with restaurants, clothing stores, home-builders, furniture makers, even lawyers! You name it, rationing is done according to who pays. Indeed, my own county government has been corrupted by this greedy attitude: if I don’t pay my taxes, the sheriff takes my house – effectively booting me out of the county merely because I didn’t pay for its services.
Preposterous!
I look forward to your changing this selfish and unfair system of rationing that for too long now has kept Americans impoverished.
Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030
An Open Letter to President Obama
by Don Boudreaux on March 8, 2010
in Health, Prices, Reality Is Not Optional, Seen and Unseen
8 March 2010
Mr. Barack Obama
President, Executive Branch
United States Government
1600 Pennsylvania Ave., NW
Washington, DC 20500
Dear Mr. Obama:
CBS radio news this morning ran a clip of one of your recent speeches. In it, you criticize insurance companies because they “ration coverage … according to who can pay and who can’t.”
My first thought was “not exactly; coverage is rationed according to who pays and who doesn’t.” Ability to pay isn’t the same thing as actually paying, and what insurers care about is the latter. Many folks – especially young adults – have the ability to pay but choose not to do so. They get no coverage.
But further pondering of your point leads me to look beyond such nit-picking to see fascinating possibilities. Not only insurers, but all producers who greedily refuse to supply persons who don’t pay should be set aright. Now I’m sure that you don’t ration the supply of the books you write according to any criteria as sordid as requiring people actually to pay for them. But our society is full of people less enlightened than you.
For example, the typical worker rations his labor services according to who pays and who doesn’t. That must stop. Oh, and supermarkets! Every single one rations groceries according to who pays. Likewise with restaurants, clothing stores, home-builders, furniture makers, even lawyers! You name it, rationing is done according to who pays. Indeed, my own county government has been corrupted by this greedy attitude: if I don’t pay my taxes, the sheriff takes my house – effectively booting me out of the county merely because I didn’t pay for its services.
Preposterous!
I look forward to your changing this selfish and unfair system of rationing that for too long now has kept Americans impoverished.
Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030
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