Some clear, common-sense economics on the Fed’s latest gimmick:

http://mises.org/daily/5691/The-Feds-Long-Shot

Here’s my favorite part:

So for my non-Austrian economics colleagues, I have to ask, Don’t you think the term spread on interest rates does something? In normal times, if one economy has a spread of 5 percentage points between 1-year and 30-year bonds, while another economy has a spread of 8 points, do you think that difference is meaningless?

If not, then how can you support Operation Twist? Won’t the Fed be screwing up whatever role you think the term spread serves in a market economy? For example, if you think the term spread relates to people’s “liquidity preference” and their aversion to being stuck with long-term bonds should interest rates move up, then does the Fed’s mere creation of dollars really address that underlying preference?

I recently was awarded a summer fellowship to conduct research at the Mises Institute. Here is the proposal that I submitted:

As an amateur Austrian economist, I often find it difficult to clearly and concisely explain differences in first principles to people who have been trained as mainstream economists. Austrian economics notably devotes much more time and energy to elaborating the philosophical fundamentals of economic science than mainstream and neoclassical economics does, and this may partially explain why talking about first principles with a mainstream economist often leads nowhere.

Reflecting on my own transformation from a mainstream economist to an Austrian, I think back to the first compelling arguments I heard. These arguments were not about epistemology, philosophy, or first principles but rather concerned the more apparent and outward differences between the two approaches. The supply curve doesn’t represent marginal cost of production but opportunity cost; production takes time and the various stages must be coordinated by some mechanism; the externality literature is spurious, contradictory and untenable. These arguments, which applied to conclusions rather than assumptions, are what really caught my eye and caused me to explore Austrian economics further.

I eventually realized the differences were more than just superficial. The essay “Economic Science and the Austrian Method” by Hans-Hermann Hoppe was superb in explaining how disparate Austrian and mainstream first principles really were. Once I understood the epistemological problems with positivism, I became a full-fledged Austrian. Since then, these types of difficulties have been my primary complaint with the mainstream perspective, and as such they are usually the topic of any methodological conversations I have with mainstream economists.

But they are not how I became an Austrian. The philosophical arguments against mainstream economics were not even on my radar when I first learned about Austrian economics. If I had heard the arguments, I’m not sure I would have even seriously considered them. I think this is largely because mainstream economists rarely take the time to understand the foundations to their own approach to the science. Thus, in an effort to win over mainstream economists to the Austrian method, I think Austrians should alter their approach to critiquing first the conclusions of the mainstream, rather than the assumptions.

Ever since gaining this insight about my own transformation, I have often thought it would be helpful to have an essay or short book summarizing these differences in conclusions. Inspired by Jeffrey Herbener’s lectures at Rothbard Graduate Seminar and Mises University in the summer of 2010 on this very topic, this is what I propose to the Mises Institute for my research this upcoming summer. Professor Herbener’s lectures contained many of the more compelling critiques of the mainstream approach I have heard - how a tax affects the market price of a good, how the mainstream snuck cardinal utility back into economic analysis after the Pareto era, how functional analysis is wrongfully seen as an innocuous but powerful assumption - but I have yet to find a single go-to source for all of these differences. I think a short, easy to read book, targeted towards students and professors raised in the mainstream, containing the Austrian critiques of the most ludicrous, contradictory and flimsy mainstream claims would be a very powerful tool for Austrians to have. A rough (but by no means final) outline of the book follows. It is my hope that the Mises Institute will provide me support for completion of the book next summer.

 

Part I (Approach)

1. Approach (verbal vs. mathematical logic, functional analysis, assumptions of differentiability and continuity, mutual determination vs. causal-realist…)

2. Value (valuations, subjective vs. objective, preferences, Marshallian scissors…)

3. Abstractions (unrealistic vs. anti-realistic, appropriateness…)

4. Empiricism (importance of facts to developing theory, falsifiability…)

 

Part II (Micro)

5. Individuals (existence of quantitative constants, existence of utility function, cardinal utility, indifference, optimizing, valuation of money, substitution and income effect…)

6. Prices (determination, theory…)

7. Firms (supply, input prices, cost-plus pricing, competition & entrepreneurs, perfect competition, monopoly theory…)

8. Exchanges (mutually beneficial, taxes and other interventions, effect of forced exchange on welfare, public goods and market failures…)

 

Part III (Macro)

9. Social Planner (economic calculation, production & ownership, ‘distribution’ of assets…)

10. Growth (causes, evidence, marginal propensity to consume, liquidity preference…)

11. Capital Theory (interest rate, aggregation, time structure…)

12. Monetary (inflation vs. deflation, central banks, no working theory of how macroeconomy is ‘supposed to work’, look at correlations to define cycles and assume random tech shocks, MV=PQ…)

Life enhancing. During Spring Break this week, I video chatted with my friends and family, received a personalized tour of the Museum of Natural History using the museum’s free app, and catalogued my trip to New York City with photos and videos (automatically tagged with location and people) and shared them with everyone on Dropbox - all on my iPhone. I can’t imagine how I would stay in touch with as many people I do if it weren’t for the amazingly innovate products that capitalists have developed over the past ten years.

Environmentally friendly. A physicist from my church developed a more efficient way to produce soda cans that uses 25% less aluminum - and made money for doing it!. The profit incentive is the first and best solution to the ever-present reality of resource scarcity. A rarely-mentioned fact is that the supply of nearly all natural resources today is more abundant than it was before the industrial revolution. The skeptic of my statements would do well to look at recent history, and judge for himself the plausibility of the alleged environmental disasters that we all currently face.

Innovative. The internet is increasingly making the government-enforced domain of ‘intellectual property’ irrelevant, depriving holders of copyrights and patents of their once-protected streams of monopoly income. Some producers have retaliated by seeking stronger measures to limit users’ ability to download music and movies, but Pandora.com chose to develop a completely new way to make money from music. It streams music for free to the end user, raises money from advertising, and also provides, for an annual fee, a desktop app which uses its ‘music genome’ algorithm to play custom playlists for the user. This is a great example of how capitalists are always developing cheaper and higher-quality ways to serve their customers.

All of this happens because under capitalism, complete strangers have an economic incentive to cooperate with each other, and are free to do so. It is truly amazing to reflect on the millions of exchanges that take place in our everyday lives, and that allow us to enjoy a lifestyle only dreamed of by generations past.

So here’s one to the entrepreneurs - the true public servants.

Having just finished my first semester of graduate school in economics, I find myself confirming some of my skepticisms about the the economics profession. The mainstream treatment of economics - the study of human choice - is set in the world of mathematics and statistics, mostly devoid of intuition and critical thought, and replete with models which only superficially resemble reality. All of us are aware of the order that exists in the market, the regular rotation of events that takes place on a daily basis. The spontaneity of order in our everyday lives is apparent, and yet is almost completely ignored by mainstream textbooks. We go to Starbucks and pay $1.40 for a cup of coffee, a seeming mundanity that is in reality the result of millions of individual actions, guided not by mathematical equations but purposeful human beings. Economists should be students of this phenomenon - the market - and study it, instead of trying to control and design it. Unfortunately, ranks of graduate students are being trained to see market phenomena like prices and output as simple choice variables in complex equations that only ‘professionals’ can comprehend.

This past summer I read several different perspectives on the current state of economics in academia. I was excited to learn about an unspoken debate that took place among professors, but never made it to the rows of students sitting in the principles classes. Economics is one of a small number of fields where two similarly trained professionals can disagree not only on conclusions (appropriate policy prescriptions, ultimate causal events, etc.) but also on more fundamental issues (the nature of economic statements, the proper methodology for economic “truth-seeking”, etc.). Coming across two such individuals who are diametrically opposed on almost every dimension, one would almost hesitate to call them both ‘economists’. Yet the fact remains that economists of every shape and size exist, write books, conduct research, and advise governments.

And while this is one aspect of the profession that I find particularly intriguing and intellectually stimulating, it was one that was completely absent from my first semester. I expected that my professor-in-training program would expose me to at least an overview of the ideas that professors, both past and present, agree and disagree on. It didn’t. Rather, we were thrust into a world of matrices and bordered Hessians without so much as a pause to justify why we were learning these abstract mathematical concepts in the first place. 

True, I came into the program already in disagreement with much of what I was going to learn and how it was going to be taught. But I also came in with humility, acknowledging that I was just an infant in my quest for knowledge, and that I would greatly welcome any arguments or evidence that addressed my skepticisms. Alas, instead of being engaged, these ideas have been simply swept under the carpet, ignored to the point of obscurity and heterodoxy.

I think economists could learn a lot by studying the various schools of thought; regrettably, they won’t be able to do this formally in any mainstream graduate economics program.

My latest response in an ongoing discussion about the Austrian approach to the science of economics:

The Austrian response to your letter is two-fold. First, let me distinguish apriori statements from aposteriori statements, to the best of my ability; then I will present some problems with mainstream methodology. Aposteriori statements are hypotheses for which observations are necessary (although not sufficient) to determine their validity, while all other statements are apriori. The statement “2 + 2 = 4” is thus an apriori statement, because its truth is determined solely by its logical consistency with the basic axioms of mathematics. It would be ludicrous to try to falsify the statement with empirical data or through measurement. Similarly, the Pythagorean theorem is apriori, within the framework of the mathematical axioms. Measuring the three sides of a triangle could never invalidate the theorem; it is true by logical necessity.

 

What’s important to note is that just because a statement is apriori, and requires no observations to verify, does not make the statement meaningless or trivial. With the axioms of mathematics in place, all the ingredients were present for the discovery of the conclusions and implications of the Pythagorean theorem. But Pythagoras still had to make the deductions; they didn’t just fall out of the axioms. This method of deductive rumination - apriori reasoning - produces statements which are completely true by logical necessity. These statements apply to the empirical world whenever the conditions assumed in the reasoning are present in reality.

 

The Law of Comparative Advantage is also an apriori statement. David Ricardo showed that mutually beneficial exchange can occur between two people if each specializes in the task in which his labor is relatively more productive - even if one of them is more productive in both tasks in absolute terms. No data can verify or falsify this fact, and because the law is deduced from a few undeniable axioms and deductions - the knowledge that human beings act purposefully and the law of marginal utility - any conclusion in opposition to it would violate the basic tenets of logic. (Again, this is not to say that the law is obvious or trivial. Indeed, before Ricardo’s revelation, most people merely assumed that the general scarcity of resources in the world meant that any act of production or consumption by one person was completely rival and thus harmful for potential production or consumption by another.)

 

Does the law of association apply to reality, in a world of ‘frictions’ and ‘market rigidities’ so conveniently absent from the hypothesized construct Ricardo used to formulate his deduction? Is data gathering necessary to determine the answer to this question?

 

It is true that the real world is very complex; but this fact does not change the empirical applicability of Ricardo’ law. As a simple analogy, consider the law of gravity (the law itself is aposteriori, but this is irrelevant for my purposes here; I am simply looking at how laws apply to the real, complex world). In complete isolation, we know that an object upon which gravity is the only acting force will accelerate towards the earth’s surface at 9.8 meters per second per second. In our world, gravity is never the only force acting on an object. But in the presence of wind resistance and atmospheric pressure, is it not true that the force of gravity is still acting on the object, fully and completely?

 

One accurate way to phrase how the force of gravity acts upon objects in the real, complex world is: the force of gravity will displace an object’s acceleration 9.8 meters per second per second towards the surface of the earth compared to what its acceleration would have been in the absence of gravity. If the net acceleration of an object is not 9.8 m/s/s, we know there are other forces present. But this does not nullify the complete and full effect that gravity is having upon the object. Ceteris paribus, the object is falling 9.8 m/s/s faster than it otherwise would be. The law of gravity remains true, even in the real world.

 

Similarly, Ricardo’s law remains true in the real world, and no empirical data could prove otherwise. All else equal, two individuals can benefit from exchange, even if one is absolutely more productive in all tasks. Whether or not this exchange takes place at a certain geographical location and at a certain point in time is a question of history (for which data analysis can be helpful in determining) and not of economic theory. The causal effect of differences in human beings - that beneficial trade exists - is exclusively an apriori truth.

 

Another apriori truth of economics is that an individual will allocate goods to their highest-valued uses first, and that each additional unit of a homogenous good is less valuable to the user than the unit of his existing stock that is being applied to the lowest-valued end i.e., the marginal unit. Or, whenever there is a minimum wage set by law above the market-clearing price, involuntary unemployment will be higher than it would have been in the absence of the law. If empirical analysis reveals that at some time and place unemployment decreased following an increase in the minimum wage, this does absolutely nothing to contradict the truth that minimum wage legislation fosters unemployment. It merely tells us what we already know: that historical economic data is complex, and that many forces are present in the realm of human action.

 

Apriori statements, then, are necessarily true (assuming no flaw in the logical reasoning leading to their deduction). Using mathematical modeling and statistical analysis to verify them is not only unnecessary but absurd. There is no reason to empirically test a logical certitude.

 

Positive economics is devoid of apriori statements. In fact, it forms aposteriori statements, which it then falsifies through comparisons with historical data. It is true that deductive statements formed from the standard assumptions of rationality involve the use of logic; but as logic is not sufficient for establishing these statements’ validity, any similarity between them and the deductions of mathematics, for example, is completely illusory.

 

If you buy the axioms of Austrian economics, then, apriori reasoning produces statements which are necessarily true. The method of apriori reasoning is particularly efficacious for the study of economics, as all economic data are complex and incomplete. It would be insurmountably difficult to develop an audio theory of acoustics by listening to an orchestra - but that is what economists attempt when using statistics to tease out causality from complex historical information. The logical limitations that experiments place on our understanding of causal events in the natural sciences do not apply to economics. We cannot conduct controlled experiments with purposive human actors. This is a central flaw of using observations to establish economic truth.

 

Additionally, the assumptions of consumer behavior made in the mainstream treatment - devised solely to allow for the use of functional analysis - conflict with reality. There is no reason to think that human beings’ value scales are smooth along the continuum of the real number system. In this world, humans are only given the opportunity to act upon discrete values. Far from being harmless, the assumption of continuity of preferences is both anti-realistic and unscientific. Even if we were to accept the hypothesis of continuity, though, the ever-changing subjective preferences of individuals cannot be represented by numerical functions. Functional analysis implies mutual determination, equality, and the existence of mathematical constants. In contrast, human action is a tale of cause and effect, where action always and everywhere involves the choice of one state of affairs over another, and where no quantitative constants exist.

 

Economics is the study of the universal laws of human action. History cannot prove or disprove any general statement; on the contrary, it is only through the lens of an apriori theoretical framework that historical events can be properly understood. ‘Measuring’ the elasticity of demand for labor for a definite city during a definite time period does nothing to develop universal truths about human interactions; it merely establishes a historical fact.

 

In contrast to empirical trial and error, the method of apriori reasoning is how Austrian economists develop the universal laws of economics. Austrians begin with the apriori axiom that human beings act purposefully, that is, that they employ means to achieve ends. The truth of this statement can be seen upon reflection. Any attempt to deny the statement that human beings act purposefully involves action which is directed toward the purpose of disproving the statement; that is, the denial of purposive action itself involves purposive action, so that no data or observation is required to verify the statement. Taking the statement as the main axiom of economics, we can proceed as follows: since all action is aimed toward ends, and the means (goods) employed to achieve these ends are scarce, inherent in action is the choice of one end over another. The value of the end foregone is the cost of the action taken, and every action thus involves the expectation that the psychic profit from the end pursued is greater than its cost (why else would somebody act?). Goods are valued based on the ends which they are employed to achieve, and goods of equal serviceability are applied to their highest-valued uses first. To think otherwise, that is, to think that homogenous goods are not applied to their highest-valued uses first, would contradict the very fact that human beings act purposefully. Hence, each additional unit of a homogenous good provides the user with less utility (because the end to which the new unit will be applied is necessarily less valuable than the previous marginal end), and with the introduction of exchange, we have deduced the law of demand. No measurement or data set could rebut this, because a denial of the law of demand implicitly involves a denial of the axiom that human beings employ means to achieve ends.

 

Austrians believe that historical data is useful for the study of economic history - but not for the development of economic theory. Representing the sentiments of many empiricists, Milton Friedman remarked that he is a ‘slave to the data’, and that economists should go where historical data leads them. Friedman argued that disagreements about apriori assumptions concerning human beings can never be settled, so economics should discard them completely. I have demonstrated that the action axiom is undeniable. My question is, why should economists start with one hand tied behind their backs? As scientists who study human interaction, we know something about human beings: that they behave purposefully. If there are apriori deductions which follow from this basic axiom - deductions which are true by logical necessity - why should we ignore them?

 

As a short concluding note, my knowledge of mainstream/neoclassical economics is still far from complete, and I am learning more about it every day in graduate school. It saddens me, however, that so few economists are aware of the Austrian methodology. Based on my individual research thus far, it seems to me a truly superior approach that has been unjustifiably relegated to the dustbin of economic thought.

A response I wrote to concerns about potential problems in an anarchist society:

My version of a libertarian society requires no magic genies or perfectly rational actors for the things I’m saying to apply. It is not a utopian vision of some future world, but rather a set of beliefs that results from clear and precise reflection on social interaction between imperfect human beings. I suffer no illusions about the likelihood of all of us living in a state of heavenly bliss on this planet; in fact, any system which claims to be able to achieve such an ideal is at best confused and at worst a tool for malevolence.

Because of this, the only relevant questions we should concern ourselves with are those which aim at reducing injustice, and not expunging it. By this I mean to say that there will always be murder, there will always be rape, and there will always be theft, in any large society. Thus, pointing out a hypothetical example of how someone could possibly murder someone else is not a death knell for any particular system of social arrangement, but rather an unfortunate common characteristic of the world we live in.

Along this same line of thinking, there will always be invasions of property in the area if environmental protection. You’ll notice many times throughout my post that I said it would be possible for a company to dump waste into the ocean. Of course, the important point is that this happens now. The government has an abysmal track record of protecting natural resources. The question is, why?

My argument is that the reason for our government’s constant violations of property rights in general and environmental blunders in particular is because they face no incentives to act in cooperation with the rest of humanity. Government officials get their paychecks from plundering the productive citizens of a society. The means available to them of increasing their wealth consists exclusively of better coercing their fellow citizen. Thus, allowing Walmart to dump its waste in privately owned property in exchange for political clout and campaign donations is the type of behavior we would expect to see. The politician gains, while paying absolutely no price for his flagrant violation of property. Why would he act otherwise?

Contrast this with a profit-seeking capitalist. It’s true that his goal is to maximize profits; but is this not also true for politicians? The key difference lies in how these two individuals acquire their wealth. In the market, profits come from consumers spending their own money voluntarily on the capitalist’s product in an amount greater than his costs. The important point is, of course, that his revenues are given to him voluntarily. So, the only way for him to increase his profits is to convince more people they should spend their money with him i.e. to serve his consumers better.

The point of my article was to explain that in the absence of property rights, profit-maximization will of course lead to criminal activity (some firms paying off government officials for special privileges). But this is a problem with the entity currently responsible for protecting property (the State)! It has nothing to do with capitalism and/or profits per se. In a world of securely enforced property rights - even in lakes, rivers, and the ocean - people seeking to make themselves better off (i.e. maximizing profits) are incentivized towards environmentally conscious behavior.

Would you rather someone face no cost for making a poor decision with respect to property rights in the environment, and merely cross your fingers in hope of them making a good one?

Here’s another email I wrote in response to concerns about a firm in the free market dumping waste:

There will never be utopia on this side of Eden. The question is, which system minimizes waste, damage, etc. while protecting human rights.

In a free market, plots of the ocean could be owned, just as plots of the earth’s surface are. The way somebody comes to own land is to ‘homestead’ it, by ‘mixing their labor’ with it. Since government has made this illegal with respect to certain lakes, oceans, etc. there has been little entrepreneurial creativity in this area (check out www.seasteading.org), and it is hard to know exactly how people would section off parts of the ocean they have homesteaded (buoys?). But let’s just assume they have.

Well, now that people can own parts of the ocean, they have an economic incentive to preserve it, since they can realize future gains from the resource. In econ lingo, this is called ‘maintaining the capital value’ [of the asset]. It’s the same thing with you and your house. It’s certainly possible that you could drive your car through your house, destroy the grass and trees, pour oil in the yard and litter the place with plastic, but this would have serious adverse effects on the property value. That is, you face a large opportunity cost (implicit, but nonetheless real) for environmentally destructive behavior. This is a big reason why we (largely) see people behaving in ways that preserve rather than destroy their property. We would expect them to do this; it is in their economic interest.

It is an equivalent story with respect to oceans. It is true that people or businesses could dump waste into part of the ocean, but the fact that it can now be owned means there is an opportunity cost of doing so. This opportunity cost is whatever future gains someone could realize by owning that part of the ocean (running a port, fishing, recreation, etc.). Ownership thus creates an economic incentive to behave in an environmentally friendly way. Note that other incentives people have for behaving environmentally (your love of gardening) are still wholly present in a world of private ownership.

It is interesting to point out that examples abound of governments destroying the environment. Problems of over-fishing, over-logging, and over-mining are symptoms of this exact problem we’ve been discussing. The government owns, say, a forest, and leases it out to loggers. If you are a logger, and have bought a license from the government to log for a month, what incentives do you face? You have access to the limited resource for a short period of time, and there are also other loggers who will be buying similar permits. All arrows point to logging as many trees as you can as quickly as possible.

If you owned the forest [the capital asset], however, you now care about the future. This is because you can realize future (monetary and non-monetary) gains from your asset. So, while it’s still possible that you could log all the trees as fast as you could, doing so would destroy the forest and the capital value of the forest along with it. Instead, you now face a material incentive to log at a rate which allows new trees to grow and the forest to be maintained, thereby giving you cash flows going on into the future. This is another great example of the Invisible Hand and how it promotes cooperation among all of mankind without central planning.

Contrast this with politicians who are in office for four years and have every incentive to spend as much money as possible on whatever they can! Whenever you hear people talking about businessmen being short-sighted and government having our long-term interests in mind, run for your life.

If the government actually enforced property rights in the area of environmental protection, the monetary costs of energy use would reflect the total opportunity cost of using that energy, environmental impact included. This is one of most beautiful things about market prices - they carry with them information about the entire economy.

To see how, consider going shopping at Publix for groceries. At the checkout line, you can either choose paper or plastic. When you unload your groceries at home, you throw away (or recycle) the bags. Since waste management is municipalized, you don’t pay (directly) a price for the garbage man to come pick up the trash. Throwing away a paper bag is monetarily equivalent to throwing away a plastic bag.

Yet everyone knows that plastic leaves a greater environmental footprint than paper. Another way of saying this is that the cost of disposal is higher for plastic than paper. Right now, somebody is paying those costs. But since waste management is owned by the government, those individuals who are choosing plastic rather than paper are externalizing the costs of their decision on to the rest of us.

Now compare this with the free market. If you are a business that sells waste management service, disposing plastic will cost you more than disposing paper; thus, the prices you charge for plastic disposal will be higher. Now, when people go to Publix and face a choice between paper and plastic, they are confronted with the total social costs of their decision. In this way we see that they now have an economic incentive to be ‘environmentally conscious’. This is a great example of the Invisible Hand at work.

Wouldn’t you rather people face economic consequences for being wasteful? Isn’t this better than pouring an arbitrary amount of resources into recycling centers and just hoping that people recycle?

I dissect some of the problems with empiricism in this letter to a professor:

I’ve read a bit more about the Austrian method, and have a slightly better grasp on the differences. It’s true that its claims are not falsifiable via empirical testing; but that is simply due to the nature of economic claims, none of which are quantitative. For example, the claim that human beings employ means to achieve ends (i.e. act purposefully) is not falsifiable, but it is nevertheless true. The rest of economic law is logically deduced from this main axiom of action.

The merit that I see in this method of apriorism is that it logically limits our interpretation of historical events. Empiricism’s claims, on the other hand, can never be ultimately proven or unproven, verified or rejected. And since there are no a priori statements about the nature of human action, a Keynesian can look at data from the 1930’s and say we didn’t have enough deficit spending, and that once we ran up the deficits we got out of the Depression, while a non-Keynesian can look at the exact same data and say that the Hoover deficits were the highest peacetime deficits in our country’s history, and that after the war we went from a massive deficit to a small surplus, yet growth remained strong.

It just seems to me that without a theoretical understanding of the nature of market events grounded in statements that are necessarily true, this type of back-and-forth can never be satisfactorily resolved. Even the macro professor at the UVA open house said something to the effect of, “We are re-writing our macro books and they should be ready by the time you guys start choosing field specialities.” I think statistical testing has its place, but only as a tool to gauge whether or not certain causal events transpired in the past. The effects of these events, I think, must be deduced logically from the action axiom.

If you’d like to learn more about this, I highly recommend Hans Hoppe’s Economic Science and the Austrian Method.