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.

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

Response on Praxeology

I was just recently given this critique of praxeology, to which I wrote a response.

Here is the critique:

"Praxeology is founded on the premise that "humans act," & by "act," they exert their will with the intent to accomplish goals. Because this is taken as axiomatic - that is, because this proposition is taken as an independent, stand-alone, self-evident truth - by the Austrian school, it is argued that a whole system of thought can be derived from this axiom purely through deductive means, akin to any given branch of pure mathematics.

The problem is though, that this "axiom" is anything but self-evident. Many cognitive scientists believe that the will, intent, & goals are just illusions pre-fabricated by our brains, & indeed, Praxeology just assumes outright that we have free will. Now, whether or not those cognitive scientists are correct is beside the point - the fact that it's even *possible* that the action axiom is wrong means that if it's true, it's an *empirical* fact, not an axiomatic one. As such, Praxeological methodology is rendered invalid, & thus the study of human action, as well as of economics in general, must be conducted through largely inductive (empirical) means, like any other science.

Now, there's another angle to this, namely, Goedel's Incompleteness Theorem. The Incompleteness Theorem states that in any axiomatic system, there are always going to be true conclusions relevant to said system which can't be derived from the axiom(s). This means that Praxeology is subject to the Incompleteness Theorem. In other words, if the proposition that humans act is an axiom, then not everything which is true about human action can be derived from Praxeology; if, however, the proposition that humans act is an empirical fact, then everything which is true about human action can be inferred as an implication of said fact.

Not only does that mean that an empirical "Praxeology" would be more complete than an *a priori* one, but an *a priori* Praxeology is squarely at odds with reality, as it leads to the conclusion that not every implication of the proposition that humans act is really an implication thereof. And this isn't a flaw that can be contained to whatever conclusions that Praxeology can't reach, e

ither, for if one methodology leads to a partially accurate but false result, & another, radically different, methodology, leads to a true result, then it can be concluded that there is a rather profound flaw in the former methodology that casts a shadow on the whole enterprise.

To put it another way, conceiving of human action as axiomatic (assuming that from it you can derive all of its implications) leads to the conclusion that the action axiom cannot predict all of its own implications, & indeed, that only a radically different methodology *can,* so Praxeology is thoroughly self-refuting.

So there you go, two logical proofs that Praxeology is bunk."



Here is my response:


In response, I would first point out that in no way does praxeology assume "free will." Where our perceived goals and motivations come from is not the realm of inquiry of praxeology and is unrelated to the conclusions based on praxeologic methods. It does not matter if our will is an illusion, because praxeology studies only the results of what happens when and if people do act. The impetus to action is a different area of study. The criticism that "praxeology is actually empirically based" can apply equally to pure mathematics in this sense, because mathematics assumes such things as numbers into existence. One can argue equally well that this assumption is not "axiomatic," but that is simply pointless semantics. Wherever the idea comes from, it cannot simply be refuted in the world we live in, regardless of whether it might not be true in all conceivable universes.

Secondly, praxeology and economics by no means strictly limit themselves only to those things which can be deduced directly from the action axiom: there are many auxiliary postulates and assumptions involved. For example, we could study praxeology without the assumption that human beings value leisure time to some extent, but that would largely make such study useless. This assumption gives us all of the information we have on how labor is relevant to our economy. Goedel's Incompleteness Theorem certainly holds true: this is not in dispute, but it is irrelevant because so-called "praxeological economics" as practiced by the Austrian School is not "purely" axiomatic. It is simply based in an axiomatic framework. There is not some huge debate between defenders of "apriori praxeology" and "empirical praxeology" as holistic systems, as far as I'm aware, because no one simply defends a pure "apriori praxeology" as being the end of all praxeological study. The "empirical" assumptions give most of the breadth of praxeology qua economics, and that is recognized widely, I believe, by those calling themselves "praxeologists." The crucial point is that the auxiliary assumptions involved treated appropriately within the axiomoatic framework provided by the action axiom. Some are held loosely because they apply to our day and age and some are so universal to be considered universal truths in and of themselves, such as the proposition that human beings value leisure to some extent (which can be demonstrated through biology, for instance).

And all of this is not to say that "praxeology is bunk": all of the various implications of an axiom must be true, even if there are other things existing in our reality which are not direct implications of that particular axiom. Simply because one thing is incapable of explaining everything does not mean that the things it does explain are false. And Austrian economics does not limit itself to "pure," axiomatic praxeology. Murray Rothbard, the defender of "extreme apriorism," to use his own term, writes in a footnote of the first chapter of his Man, Economy, and State, that only the first chapter is solely derived from the implications of the action axiom: the remainder of the 1500 page book is dedicated to studying the implications of the subsidiary assumptions that give meaning to the study of economics.

The crucial point is that this is done within an axiomatic framework, and the "empirical" subsidiary assumptions work together with the action axiom instead of against it. They are not "empirical" in the loose sense of the word which is usually used (for example, Okun's "Law" is empirical in the loose sense, yet is entirely unacceptable from the praxeological methodology), and they are constructed in such a way that they apply universally. Okun's "Law" is empirically supported in a way, but it is much more unstable given changes in the day and time and lacks any real sort of "universality" unlike the proposition that people value leisure to some degree. One proposition here is fundamental (leisure) and one is not (Okun's "Law"), and seeing both as "empirical" without distinction is missing the point.

Small Business and Jobs

Whether it is tax credits to small businesses or some other kind of special privilege that is being extended to them, the focus on “small” business in many economic circles, particularly with speaking of jobs, is huge. If you were to listen to President Obama, you might get the impression that it is only the small businesses that create jobs, while big businesses simply create all of the problems. Legislation is then focused around this belief, which typically gives large benefits to small businesses, while, conversely, large businesses are burdened with heavy regulations and interventions in their operation.

What are the effects of this legislation? Well, the impact on small businesses is to give them a competitive boost and an economic advantage in the marketplace, and the impact on larger businesses is to slow them down, add costs to whatever they try to do, and often to prevent them doing something that they want to do. Both of these effects of the legislation self-fulfill its assumptions. When small businesses are given a governmental helping-hand, it makes them more likely to be hiring new workers and thus creating jobs; when big businesses are punished with heavy regulation, it makes them weaker and prevents them from wanting to take on new risks that would create jobs.

Furthermore, though the effects of this legislation do create jobs if overall they are lessening the overall burden on businesses and hiring practices, often the other burdens that the government puts on other sectors of the economy such as big business stop employment from bouncing back to where it would have been in the absence of increased regulation and intervention. The government cannot claim that it has created jobs by just pointing to the ones they think they created while ignoring the incalculable costs in terms of jobs that they may have also created in the same process.

Moreover, the focus on jobs in “small” business can also be damaging, because it is quite possible (and indeed, is usually the case) that large businesses have the funds and the projects that warrant increasing the amount of labor they use. Small businesses, particularly in turbulent times, do not have this advantage and are not ideal for hiring new workers. Furthermore, they are more likely to fail or collapse, destroying any jobs that they may have been supporting. Big businesses are in general much more stable than smaller businesses.

The most egregious claims are, however, that jobs are somehow things that are in scarce supply that have to be hacked out of existence by some organization, usually claimed by those in the government to be the government itself. This is an absurdity. A job is simply a transaction of labor; the only thing that is scarce is the labor itself. Unemployment, or a “lack of jobs” is nothing more than a distortion, manipulation, or period of transition in the fundamental economic conditions which result in people selling their labor in exchange for a wage, and concomitantly, businesses buying labor for a price. The only thing necessary is to let hiring conditions change to how they need to change and unemployment will quickly vanish, as it is beneficial to no one for there to be unemployment in the economy.

The fundamental thing that needs to change in order for there to be full employment is for the price of labor, or wages, to be as flexible as possible. This is something that most people reject, for one reason or another. Labor unions, minimum wage laws, and regulations concerning hiring and firing practices all serve to make wages and the labor market inflexible, which means that when there is a sudden economic change, unemployment or disequilibrium emerges. Allowing a free market in the labor market is the only conceivable way to ensure full employment in any realistic way. Otherwise, there is no force to equilibrate the forces of supply and demand. Having the government decide to employ everyone who doesn’t have a job does not fix the problem, but arbitrarily and decisively does the exact opposite by permanently preventing labor from going to those lines of economic production where it is most needed.

Economics in One Lesson

This short book, written by Henry Hazlitt, is one of the most concise yet easily comprehensible introduction to sound economics ever written. Hazlitt has the ability to take a commonly accepted idea and then to prompt the reader to think about that accepted idea, eventually showing that what may be commonly accepted is also thoroughly nonsensical. Though it was written in 1946, the vast majority of the fallacies which Hazlitt explodes are still commonly accepted today, and virtually everyone has something they need to learn from it.

Read it here: Economics in One Lesson.