Action Aversion

[As seen on LvMIC]

If I just straight out told you that there is a model within the conventional economic theory that implies most of us would prefer a world in which we would not be acting humans, you would probably tell me that I have a few screws loose. To avoid this potential label, I will develop this argument step by step. First, let us see what it means to be an acting individual.

Do we act?

Humans act. This statement is irrefutably true because the act of refutation itself implies an end – to refute the statement that humans act.[1]

But, suppose that what humans do is not action – employment of means to achieve ends. Then it must be something else. What else could it be? Even though we cannot say this with absolute certainty, we might say that non-living matter does not act.[2] Thus, we might say, if humans do not act, then they could be compared to non-living matter.

However, if we assume that humans don’t act, that simply means that humans do not make choices. They do not substitute less preferred state of nature for a more preferred one by using means available to them. In other words, they do not displace one possible future by acting to achieve another, more preferred future. In that case, humans just follow the inevitable path set out for them outside of their consciousness, just like the rocks and stones around us do (at least in our view).[3] [4]

Consequently, our attempt to refute the action axiom was not actually action – it was an illusion of action. While we can not exclude the possibility that all of us live in an illusion that we actually make choices, when we do not, we do not know whether we do in fact live in such an illusion. As Ludwig von Mises says:

We may or may not believe that the natural sciences will succeed one day in explaining the production of definite ideas, judgments of value, and actions in the same way in which they explain the production of a chemical compound as the necessary and unavoidable outcome of a certain combination of elements.[5]

Thus, it is possible that what we perceive as our choice may be just an inevitable outcome of a chemical reaction, which was in turn an inevitable outcome of some other physical process. However, accepting this as true would be pure speculation. What we do know is that our self-observation does indicate that we do indeed make choices – that we act.

The World of Action

Human action is impossible in the world of complete information. In this world everyone knows everything there is to know, including the future. Thus, one cannot act if he or she already knows his or her future. There is no space for choice in these circumstances.

It is hard to make definite statements about preferences of all human beings but we could safely state that many humans would be terrified to live in a world of complete information. In other words, many of us, if not all, would prefer a world in which we can make choices, a world in which we can use means to change our life according to our desires, a world in which we can act. Thus, it seems, at least given the general sentiment of human beings, that they prefer a world in which action is not an illusion, a world in which we are indeed different from stones that roll down a hill governed by nothing more but the law of gravity.

Now we come to an important point: If humans really prefer to be humans in the way we perceive ourselves – as acting individuals, then the probabilistic concept of risk-aversion is contrary to the nature of human preferences toward action.

The World of Probabilistic Risk-Aversion

The probabilistic concept of risk can be represented by a situation when an individual (let us call him Jim) faces different future paths that offer different payoff. It is assumed he knows the probability distributions (or probability density functions) of these future events.[6] What he does not know though is which path of all the possible paths the future would bring.

This situation is often illustrated using flip of a coin. Suppose Jim is offered a game in which a flip of a coin determines the amount of money he will receive. If the coin turns heads, Jim receives, say $100. If, however, the coin shows tails, the he receives only $50. Alternatively, he may be offered $75 dollars straight out without flipping any coins.

The next step is to qualify Jim’s risk preferences. If he chooses to flip the coin, he would be qualified as risk-loving. If, on the other hand, he chooses the certain $75 dollars, he would be qualified as risk-averse.

This risk-aversion qualification is associated with the fact that Jim refused the so-called “fair gamble” where the expected payoff of getting a $50 and a $100 with equal probabilities (1/2) is $75. In other words, the expected outcome of the gamble is $75.[7] Thus, Jim’s choice is interpreted as an aversion towards the risky nature of the gamble since that is the only difference between a certain $75 and a “risky” expected $75.

Whitin the probabilistic framework, this means that if Jim, who is risk-averse, knows the probability distribution of different future events – getting $100 and getting $50, he would prefer a world in which he would get the amount of money half way between $50 and $100 with absolute certainty. If he had an option to choose between these two worlds, he would choose the world of the-middle-of-the-road certainty instead of the world where he could possibly end up in a better situation than the-middle-of-the-road but he could also end up in a worse position. It is said that he would trade off the possibility of potential $25 gain over the average $75 for the absolute certainty of $75.

The bulk of economic literature states that most people would choose the option in which they receive $75 with absolute certainty. In other words, most people are qualified as risk-averse. This means that most people would prefer to get the expected, middle-of-the-road outcome with certainty rather than face an uncertain future where they could get much more but also much less than in the world of absolute certainty.

If we generalize further and assume that Jim knows the probability distributions (or probability density functions) of all future events in his life, using the logic of the probabilistic representation of risk, one could conclude that Jim would prefer a world in which he would live his expected, middle-of-the-road life path with absolute certainty over an uncertain world.

On the surface, this does not seem too strange. Many of us would probably like an “average” life, without too many frustrating perturbations. But, the above conclusion is not about preferences about life in an intrinsically uncertain world. It is a statement about preferences between an intrinsically uncertain world and an intrinsically certain world.

But, if one knows his or her future, where is the logical basis for purposeful human action? Is it really true that most of us would prefer not to act? I would say that this is not true. Rather, the probabilistic concept of risk-aversion does not have the robustness of a general theory. In other words, this concept seems sensible in isolated cases but when applied as a general principle, it contradicts the nature of human existence.

Averting Uncertainty through Action

On the other hand, members of what some call the Austrian school offer a more robust, qualitative[8] understanding of risk. For example, Murray Rothbard makes a clear distinction between gabling and entrepreneurial risk-taking:

Gambling on the throw of the dice and betting on horse races are examples of the deliberate creation by the bettor or gambler of new uncertainties which otherwise would not have existed. The entrepreneur, on the other hand, is not creating uncertainties for the fun of it. On the contrary, he tries to reduce them as much as possible. The uncertainties he confronts are already inherent in the market situation, indeed in the nature of human action; someone must deal with them, and he is the most skilled or willing candidate. In the same way, an operator of a gambling establishment or of a race track is not creating new risks; he is an entrepreneur trying to judge the situation on the market, and neither a gambler nor a bettor.[9]

Thus, an entrepreneur does not “consume” risk for the sake of it. He faces the unavoidable risks that are inherent to the market process in order to earn profit. All of us are, in one way or another, trying to reduce the uncertainty inherent in the world around us by using the means available to us – by acting. In this sense we are action-loving and this action-lovingness comes from our aversion to an uncertain future. We act in different ways to achieve different kinds of more certain future.

For example, this article was written for the purpose of making the future in which people understand the epistemological limitations of the probabilistic concept of risk-aversion more certain. But it would be a mistake to conclude that this means that I would prefer a world in which I would know with absolute certainty that I will write this article and the inevitable future events this would leed to. This is an error that results from extending the probabilistic concept of risk-aversion into the context of human action.

A Fundamental Economic Concept Lost in Translation

[As seen on LvMIC]

The principle of comparative advantage is one of the fundamental insights of economics. In everyday language, this principle teaches us that we can produce more goods in total if each of us specializes in the production of a product he or she is most productive in compared to other people. This productivity is expressed relative to the quantity of all those goods that each individual could have produced but are now foregone because he or she specialized only in one product. The beauty of this concept is that in our world of omnipresent interpersonal differences someone always has a comparative advantage in something. Consequently, division of labour is a natural consequence of interpersonal differences and the law of comparative advantage.

The thesis of the article is that the concept of comparative advantage has lost a fundamental aspect of its meaning in the works of economists who rely on stylized models of “aggregate” economies.  These models present the concept as a national or regional phenomenon rather than individual.

However, according to the logic of human action, only individuals can experience costs and benefits and consequently act upon those costs and benefits. All the production and consumption decisions are performed by individual human beings based on their knowledge of their own production possibilities and preferences.

As Friedrich Hayek noted, time- and place-specific knowledge owned by any individual in the society is not directly available to other human beings, including the economic analyst. Nevertheless, some of this individual knowledge is reflected in market prices through specialization and exchange. While some economists have maintained these principles attached tightly to the concept of comparative advantage, some have marginalized or even completely ignored them through the process of translation into a language that employs aggregate variables.

The individual-specific view of comparative advantage is generally accepted in the “mainstream” microeconomic literature. It is said that individuals may differ in terms of the quality of inputs they own or skills of combining those inputs into final outputs. Consequently, there is a potential for increased productivity leading to mutual benefits if some individuals specialize in some activities while others specialize in some other activities and then exchange the surplus production with each other. This is the well-known law of comparative advantage or, as Mises calls it – the law of association. This law simply states that in the world inhabited by people who differ from each other in a near-infinite number of ways, possibilities for mutual gains from association with other individuals are omnipresent.

However, the traditional macroeconomic literature is built upon the Ricardian climatic and the Heckscher-Ohlin factor-endowment aggregate models where comparative advantage is national and it is based on the difference in technologies or relative quantities of aggregate inputs between countries. For mathematical convenience, it is generally assumed that inputs are homogeneous within a country or a region and that they are assembled into outputs in an identical way throughout the entire country or region. These assumptions are seen as useful abstractions, and not as serious logical flaws.

Even when heterogeneity within an economy is introduced (at the firm level), it exists only as a special wrinkle in the generic Heckscher-Ohlin or the Ricardian model. These modifications are generally intended to explain two-way trade between countries. This is the case when the same product is both imported and exported from the same country. This situation cannot be explained using the traditional models and thus some economists called upon firm heterogeneity within countries as an explanation. However, heterogeneity within an economy is not seen here as a fundamental general requirement for the existence of a market. These models would still produce market prices within each “national” economy through its mathematical mechanics, even if heterogeneity is assumed away.

There is a logical conflict in this reasoning. Market prices are exchange ratios observed in an interpersonal exchange of goods and services. For an exchange to occur, there need to be at least two individuals in an economy. If there was only one individual in a country, he or she could not constitute a market. All the exchanges that this individual would make would be intra-personal exchanges. He might choose to devote more time to the production of clothing and thus give up some of the food he might have produced instead. However, in this situation there is no exchange ratio to be observed – there are no market prices to be compared with the market prices in some other (hypothetically isolated) country.

In the mathematical language, the intra-personal exchange ratios (i.e., the individual trade-offs when deciding between two actions) are the shadow prices or the slope of the individual Production Possibilities Frontier, not market prices. Some economists using the aggregate models of comparative advantage often ignore this important distinction between an individual and a country and treat them as equivalent economic concepts.

In order to introduce a possibility of a market, we need another individual in this country. But, if this individual was identical in all respects[1] to the already present individual, there would be no logical reason why any of them would specialize in the production of one good and exchange some of that product with the other individual. They both own equal quantities of homogeneous inputs and are equally skilful in combining these inputs into any output they may desire (and their desires are identical). In this situation there are no gains either in productivity or in the alignment of individual means and ends resulting from specialization and exchange. There is no particular reason for a market to emerge in an economy inhabited by identical clones who own identical inputs that are assembled into outputs in a precisely identical way.

Therefore, input[2] heterogeneity is not an additional wrinkle in a general market model – it is a necessary condition for the existence of any market. More precisely, input heterogeneity is an unavoidable attribute of any market. Even if all individuals were identical in all respects before specialization, if this specialization will not change them in any way and make them more productive in the selected line of production, there is no particular reason to specialize.[3] Consequently, there are no market prices to be compared between two hypothetically isolated economies.

In this case, if there were two hypothetically isolated “economies” composed of individuals identical within an economy but different across economies, the only thing we could observe is two groups of self-sufficient autistic clones. This is why individual heterogeneity is important. The same laws govern interpersonal exchange, regardless of whether the exchange occurs within a fence we call a country border or across the fence.

Conclusion

This article is a reflection on the nature of misunderstandings among economists, looking at the law of comparative advantage as an example. There are different sub-languages within economics, and the structure of the language we use can be more or less conducive to fully encompassing the meaning of the concepts we wish to explain. Sometimes, the alignment between different languages is quite thin or even nonexistent so that some messages get lost in translation. However, it is important to constantly clarify the subtle differences in the understanding of economic concepts in order to facilitate better communication, and ultimately, discover the messages that are too important to be lost.

Notes:

  1. It should be noted that, unlike Block et al. (2007) critique of Mises and Rothbard, this article looks at homogeneity in the pure mathematical sense implied by the aggregate models of “national” comparative advantage. Inputs available to any individual within a country are identical in all possible respects. Given the properties of the production function, the basic unit of inputs is infinitesimally small. It is also assumed that specialization does not affect the individual level of skill in either line of production. 
  2. Since human action ultimately enters all production processes, the actor’s physical body with all its physical and mental capabilities is an input as well. 
  3. Preference in production of one good over another as a reason for specialization is also excluded since it is assumed that all individuals have identical preferences.  The only remaining reason for specialization and exchange would be that all individuals prefer exchange for its own sake. But, this would be a trivial explanation because exchange would be its own end. 

The Price of Arrogance

The ongoing economic crisis has stirred up quite bit of debate among economists. In addition, it seems that the current students as well as the lay public show significant interest in the subject. One just needs to visit blogs of some of the well-known economists and find hundreds of comments to their posts. But, often times, these posts cross the boundaries of respectful conduct. Moreover, there is evidence that some of these economists simply erase the substantial objections to their posts while leaving the superficial ones. While this is unfortunate, it also reveals the weaknesses of some individuals and institutions and the strengths of others.

In order to illuminate the significance of this development, I will present a glimpse of the dark side of the debates among some of the “highly ranked” economists. This will show that it is no coincidence that the curious youngsters are looking for alternatives.

Battles With(out) Boundaries

Economists are often perceived as lacking tact or modesty in expressing their ideas. For example, if we look at the relative number of times the attribute arrogant was directly attached to practitioners of different professions on the World Wide Web, we can see that economists are at the top of the list. Table 1 shows one such comparison where the number of hits in Google searches for “arrogant X”, relative to the number of hits for “X”, where X denotes different professions.

Table 1. Numbers of times the attribute arrogant was attached to practitioners of different professions in Google search finds (December 12, 2010)[1]

It is interesting to note that the phrase “arrogant economist” is more frequent (both in absolute and relative terms) than the same phrase in the context of the other 9 selected professions. The difference is most striking (but not surprising) between the respective numbers for economists and labourers, where the attribute arrogant is over 800 times more likely, in relative terms (and over 2,500 times in absolute terms), to be attached to an economist than to a labourer.

Plumbers were perceived arrogant somewhat more frequently than labourers but still quite unfrequently relative to other occupations. It seems that people whose livelihood depends on solving other people’s concrete problems, where it is quite easy to recognize bad solutions, cannot afford arrogance as a business strategy. After all, it is hard to persuade anyone that you fixed his or her sink if it is still leaking or that you built them a good house if cracks open in its foundation after a month of use. Claiming that the situation would have been even worse without your service simply does not cut it. Curiously enough, many economists seem to believe in this strategy.

When it comes to other academics, sociologists and chemists are also perceived to be quite humble in comparison with economists while biologists and physicists were seen as arrogant more frequently but still about half as frequently compared to economists. Mathematicians, historians and psychologists are at the lower end of this arrogance sale but not as low as sociologists and chemists. While the explanation for these discrepancies may not be as clear-cut as in the case of labourers and plumbers, it is still apparent that the reputation of the practitioners of economics is not what one would call – enviable.

If we go further and read some actual texts, we can see that some economists, sometimes even of the “highest rank,” often try to belittle or ridicule those they don’t agree with. Just to mention a few examples, recently a well-known economist, in his blog, used a demeaning cartoonish onomatopoeia to describe the sounding of what he thought would be the response of some economists to his criticisms.

Another well-known economist characterized an article by one of his colleagues as “huffing and puffing”. Another economist, less known, but still a university professor, said that he  laughed until tears were coming out of his eyes when he read a piece of a particular economist’s writing (which was not intended to be funny). The actual names are not important here, since the purpose of these examples is to illustrate a possible tendency rather than to point a finger at specific persons.[2]

I had a first-hand taste of these exchanges of fire as well. Recently, I read a blog post of a well-known professor teaching at a prestigious U.S. university. It contained claims about what this professor thought some economists that adhere to a certain school of thought would claim about certain economic phenomena. Then he took each unreferenced statement and proclaimed it either true or false. Most of them were deemed false.

After the first wave of disappointment by the demeaning tone this professor used to address other economists, I realized that the first question I would like to ask was – where, when and by whom were these critiqued statements made. Thus, I acted accordingly and wrote a comment that pointed out that those quoted/paraphrased statements were unreferenced.

After about 15 minutes, my comment disappeared. I thought that it might have been a glitch on the website or some similar technology-related problem. Thus, I posted the same comment again. But, similar to the previous one, it was gone in about 10 minutes.

Now I started to realize that someone might be erasing these comments intentionally. I decided to check so I posted a similar comment again, with some additional explanations why I think referencing literature sources is important. This time I saved the web page in the PDF format, partly to persuade myself that I wasn’t hallucinating (and partly to be able to prove my claims if anyone decides to question them). The reader can probably guess what happened after 15 minutes – yes, the comment disappeared again.

Later, through electronic communication with some other blog participants, I found out that I wasn’t the only one experiencing these disappearances. It turned out that most of the balanced comments were erased while those filled with more emotions than reasoning were left.

In the end, I was left with a strange feeling that could be summed up in the following line of though – if this kind of conduct is nothing out of ordinary for educational institutions and individuals of this stature, what can we expect elsewhere? Or, maybe a resonating name is not all that counts; maybe it sometimes doesn’t matter at all.

One might then ask: how do we recognize the people that we value and want to learn from in this world of mixed signals? This kind of questioning is probably not alien to many current or potential future students of economics. The next section argues that that the most sensible answer to this question is – integrity.

Building Authority on Integrity

Even though some people attribute a negative meaning to the term authority in the sense that it is a threat to freedom, there is a kind of authority that is not inconsistent with personal liberty. This is the importance that most of us attribute to some people voluntarily, based on the qualities that they possess. These are the people we admire and want to learn from.

In any area of human productive activity, it is important for young people to find something to admire in their elders, may it be family, teachers, or friends.  Specifically, in the field of economics, it is important because the enthusiasm of the present and future students and practitioners depends greatly on how they view the current practitioners (i.e., professors).

It is my general impression that one of the key determinants of this view is how the current practitioners approach the situations when their authority is questioned. If they approach them with calmness, stability, honesty and modesty, students generally appreciate that and see it as a sign of personal and professional maturity and strength. This shows that the teacher respects the student’s will to learn. As Ralph Waldo Emerson nicely put it, “Men are respectable only as they respect.”[3]

Ultimately, the ideas offered by these professors will meet a fertile soil in their students. This does not, however, imply that the students will automatically accept these ideas as a dogma. Rather, it means that such ideas have a greater chance of being further analyzed, developed and scrutinized, as opposed to those that will simply be discarded or mechanically reiterated.

For example, this value attached to personal integrity is what compelled many curious students to explore the works of economists never mentioned in conventional textbooks. These works provide ideas that were never scientifically refuted but simply ignored as “unpopular”.[4]

However, if our senior colleagues approach the challenge in a way that make us wonder whether they actually know what they are doing, or if it gives us the impression that they are trying to hide something, or worse, that they are simply disregarding us as persons not worthy of an honest answer (as in my comment-disappearing experience), this will likely produce an undesirable effect – distrust. We all know that distrust is not a solid material on which to build authority.

Conclusion

The discomforting level of inappropriate discourse among some economists is unfortunate. But, this also reveals the weaknesses of some individuals and institutions and the strengths of others. One of the important strengths of a good teacher is to recognize that young people look not only for knowledge but also for figures of authority. The key step in building genuine authority based on trust is to respect the opponent, as well as giving appropriate space to those watching the “battle” of ideas.[5] The fact that people with these qualities seem to be harder to find among economists compared to other professions makes them even more valuable. Those that choose arrogance may not immediately see its price but it does exist – in the form of lost trust of their up and coming colleagues.

Notes:

  1. An identical data search technique was performed in August of this year and it produced similar results. 
  2. However, an extremely interested reader is free to contact the author to request the web links to the actual texts. 
  3. Emerson, R. W., and Cabot, J. E. 1884. Lectures and biographical sketches. Boston: Houghton, Mifflin and Co. 
  4. Buchanan, J. M. 1969. Cost and Choice: An Inquiry in Economic Theory, Vol. 6 of the Collected Works
  5. I think that F. A. Hayek provided one of the great examples of how this is is to be done.

The Pitfalls of Friedman’s Positive Economics

 

Methodology – the branch of epistemology that specifies the proper method for theory appraisal (i.e., selecting among competing theories) – is not a favorite topic for many neoclassical economists. For example, Varian says:

In my view, many methodologists have missed this essential feature of economic science. It is a mistake to compare economics to physics; a better comparison would be to engineering. Similarly, it is a mistake to compare economics to biology; a better comparison is to medicine. I think that Keynes was only half joking when he said that economists should be more like dentists. Dentists claims that they can make peoples’ lives better; so do economists. The methodological premise of dentistry and economics is similar: we value what is useful. None of the ‘‘policy subjects’’— engineering, medicine, or dentistry—is much concerned about methodology, and economists, by and large, aren’t either.[1]

But, here, we need to note that engineering, medicine and dentistry are practical applications of different sciences (physics, chemistry, biology, etc.), but they are not sciences in themselves, while economics is supposed to be a science itself. Therefore, this analogy is not appropriate if we want economics to qualify as a science, and we can see that Varian does use the term economic science.

Milton Friedman, on the other hand, was more receptive of the methodological criticisms directed at economics. He proposed to solve this problem by applying methodological monism by expanding the methodology of natural sciences like physics and chemistry to economics. This is what he calls positive economics.

Nowadays, most economists practice economics in the belief that they are following Friedman’s recipe. But, it seems that many of them are not aware of the implications of the methodology they are supposedly following. They often give policy advice based on their findings. But, applying the positivist worldview in the context of human action brings with it some fundamental implications.

This article demonstrates that if one adopts the worldview that underlies the positivist methodology, giving policy recommendation on the basis of selecting different possible future paths is self-contradictory.

There are many strands of positivism but Friedman’s name is probably most associated with positivism (or what some call instrumentalism) in economics. Thus, I will focus on his view of positivism and its implications.

The Methodology of Friedman’s Positive Economics

Friedman’s 1953 essay attempts to establish economics as a positive science on the grounds of the methodology of natural sciences, primarily classical physics. Consequently, Friedman sees the objective of economics in developing theories that can be used to predict economic phenomena. In building such a theory, an economist should employ assumptions that are sufficiently realistic but not overly detailed. This is because a theory is supposed to be a generalization of the principles underlying reality but not a description of reality.

All this seems reasonable. After all, this is the methodology of natural sciences that brought us most of the technological developments of the last 200 years.  But, this methodology has some deeper assumptions about the nature of reality under investigation that bear important implications for human action.

The basic assumption on which the positivist (or logical positivist) methodology of classical physics rests is the assumption of causality. This means that there are strict quantitative laws that relate the elements of reality over space and time in the domain of the scientist’s investigation. [2] (If we expected some laws of nature to change or appear and disappear at any instant, prediction would be pointless.)

For example, if the physicist wants to predict what would happen to an apple thrown at an angle into the air, she would need to know the relevant beginning conditions (i.e., the angle, spin, force, mass of the apple, air density, moisture, temperature, etc.)  and the laws that relate the physical matter under investigation.

Once the physicist knows this; she is able to predict the outcome of the event. If she knew all the beginning conditions and all the laws with perfect accuracy, she could predict the exact trajectory (and anything else) with perfect precision as well. However, the physicist does not know all the details precisely.

For example, she may not know how much the fact that the surface of the apple is not a sphere, as may be unrealistically [3] assumed in her theory, will affect the trajectory of the apple compared to an ideal sphere. However, if this effect is not sufficiently large, it may be ignored and the apple may be treated as a sphere. Moreover, the physicist might even decide to treat the apple as a dimensionless point in a 3-dimensional coordinate system.

It is assumed that any lack of prediction accuracy is thus due to the lack of knowledge (or intentional exclusion) of the minute details of the particular situation but not due to some uncertainty in the laws of nature. This is what Einstein meant when he said: “God does not play dice.”[4]

Friedman applies the same logic. He says that exact prediction of economic phenomena is impossible because the economist does not and cannot know all the relevant facts:

A completely “realistic” theory of the wheat market would have to include not only the conditions directly underlying the supply and demand for wheat but also the kind of coins or credit instruments used to make exchanges; the personal characteristics of wheat-traders such as the colour of each trader’s hair and eyes, his antecedents and education, the number Of members of his family, their characteristics, antecedents, and education, etc.; the kind of soil on which the wheat was grown, its physical and chemical characteristics, the weather prevailing during the growing season; the personal characteristics of the farmers growing the wheat and of the consumers who will ultimately use it; and so on indefinitely. Any attempt to move very far in achieving this kind of “realism” is certain to render a theory utterly useless.

Thus, the economist needs to make some generalizing assumptions, (i.e., like the physicist assumes apple is a sphere) select the important facts (i.e., like the physicist may choose the initial force, angle, and mass) and exclude those less important ones (i.e., like the physicist may exclude air density, moisture, temperature, etc.). Friedman then explains that the important facts are those that affect prediction accuracy the most:

Why is it more “unrealistic” in analysing business behaviour to neglect the magnitude of businessmen’s costs than the colour of their eyes? The obvious answer is because the first makes more difference to business behaviour than the second; but there is no way of knowing that this is so simply by observing that businessmen do have costs of different magnitudes and eyes of different colour. Clearly it can only be known by comparing the effect on the discrepancy between actual and predicted behaviour of taking the one factor or the other into account.

However, this still does not clearly state whether what Friedman has in mind is the same kind of positivism as the positivism of, say, classical physics. But then he clarifies that the only difference between economic prediction and prediction in a controlled experiment is not of a conceptual but of a practical nature:

The necessity of relying on uncontrolled experience rather than on controlled experiment makes it difficult to produce dramatic and clear-cut evidence to justify the acceptance of tentative hypotheses. Reliance on uncontrolled experience does not affect the fundamental methodological principle that a hypothesis can be tested only by the conformity of its implications or predictions with observable phenomena; but it does render the task of testing hypotheses more difficult and gives greater scope for confusion about the methodological principles involved.

This is crucial, for this confirms Friedman’s belief that there is no conceptual difference between prediction in a controlled experiment and prediction in (only apparently unpredictable) economic context.[5] The difference is only in the economist’s ability to perform controlled experiments in the domain of reality she is investigating, but not in the underlying guiding principles of that reality.

Thus, the economist, like a classical physicist, could (conceptually) predict with perfect accuracy if she included all the relevant facts and the laws that relate those facts. However, since she does not (and cannot) know all the facts and/or the laws, she will predict with a margin of error. As long as the error is small enough, some facts can be overlooked and some assumptions unrealistic.

This is a statement about the nature of the domain of reality under the economist’s investigation. It assumes that the path of history under the economist’s investigation is predetermined by the initial conditions and the laws that relate all the elements of reality under investigation – just like the trajectory of the physicist’s apple.

Even though this statement sounds disturbing in the context of human action, it is a possibility, which Mises recognized but concluded that:

We may or may not believe that the natural sciences will succeed one day in explaining the production of definite ideas, judgments of value, and actions in the same way in which they explain the production of a chemical compound as the necessary and unavoidable outcome of a certain combination of elements. In the meantime we are bound to acquiesce in a methodological dualism.[emphasis added][7]

The determinism implied by a possible truthfulness of this belief may have a fundamental bearing on social institutions (i.e., law) because personal responsibility loses any meaning in light of this conclusion. However, I won’t dwell on this. Instead I would like to point out the implications of the implied determinism for “policy advice” made by those adhering to what seems to be Friedman’s understanding of the positivism of classical physics (and Bohmian quantum mechanics).

First we need to note the distinction between the physicist and the economist to clarify the contextual difference between the physicist’s prediction and economist’s prediction.

The Physicist’s vs. the Positivist Economist’s Policy Advice

The physicist’s prediction is limited to the domain of the reality that she is observing (and controlling). In the above example, it was the apple and the relevant conditions surrounding it. The physicist herself is not included in the system on which this prediction methodology applies.

Thus, the statement about the deterministic nature of the physical reality, for the physicist, applies only to the part of the universe that she is examining (i.e., the apple and the relevant conditions surrounding it). Whether the deterministic philosophy that the physicist applies to her experiment applies to her as an acting being, is of no importance to her. She is not trying to predict her own action based on her brain chemistry, speed of the electromagnetic impulses in her neurons, color of eyes, hair or anything else that may be relevant. This is outside of her subject matter.

The position of the economist in relation to the statement about the nature of the subject matter that she is studying is different. The economist studies human action and its outcomes. Thus, being a human being, the economist is within her own subject matter; any statement that she makes about the nature of the elements of that subject matter must apply to her equally as to all other elements.

Thus, if an economist adopts Friedman’s positivist methodology, she is claiming that if she knew all the relevant facts and the laws relating those facts, she could make perfectly accurate predictions. But, since this is practically infeasible, she will be making some generalizing assumptions, excluding some minor facts and thus have some errors in prediction of the observed phenomena. The smaller the errors are, the better is the theory that the economist developed.

For example, in line with Friedman’s claim about knowing everyone’s eye and hair color, etc., the economist might claim that if she knew the brain chemistry of all the individuals in the society and all the other minute details of their present and past (and anything else that determines their action), she would predict the outcome of everyone’s action perfectly. Thus when the future comes, it will coincide completely with her prediction, like the actual trajectory of the apple coincides with the one predicted by the physicist who included all the details in her equations.

This again implies a statement that there is only one future. Consequently, human choice is just an illusion. For what else could it be if it is predetermined by the strict quantitative relationships of the physical reality?

What is crucial here is that many economists overlook the fact that the statement that they are making about their subject matter applies to them as well. They are humans and part of the society. Therefore, if everyone’s action could conceptually be predicted, so can theirs. If there is only one future for everyone in the economy, there is only one future for the economist as well.

Furthermore, the present was future yesterday. Therefore, those who adopt positivism and prediction as the ultimate measure of truthfulness in the context of human action must also accept that the present was already determined yesterday (or at any point in the past). Consequently, the policy recommendation that an economist is giving was already determined.

Moreover, the aim of the policy recommendation to “prevent” something or “improve” something is absurd [8]because, according to the positivist worldview, the future is already determined. The only thing we need to do is to discover the future, like the physicist discovers (with a margin of human error) what will happen in the next few seconds after throwing an apple in the air. To illustrate this let us compare a hypothetical policy advice by a physicist and an economist.

An Illustration

While the economist’s positivism implies the statement that the outcome of human action is a strict consequence of the initial conditions of the potentially observable elements of reality and the laws that relate them, the physicist’s positivism does not. The physicist can, for example say: “My findings suggest that more people will be able to cross this river next year if we build a bridge here, compared to leaving it bridgeless.”

But, the positivist economist cannot make such a statement without contradicting herself because the worldview underlying her methodology implies that the future existence or nonexistence of the bridge is already predetermined by the fact that this existence is a result of a predictable economic activity. Instead, the positivist economist could say: ”My findings suggest that there will be a bridge here next year (but, if I’m wrong, this is only due to a lack of information today and maybe a poor theory that I am using).

Her conclusion might be based on, say, a correlation of the characteristics of this area and the characteristics of all other areas a year before a bridge was built there. Her theory may be that any time a given set of initial conditions for building a bridge is met, there will be a bridge built within a year.

Thus, if the positivist worldview is correct, the economist is not giving any “policy advice.”She is merely performing her role in the inevitable historical path of the society, like each atom in the physicist’s apple is performing its role in its inevitable trajectory.

Conclusion

Applying the positivist worldview that assumes strict causality to  society implies that everything is predetermined by the initial arrangement of the elements of reality and the laws relating them. Those who accept positivism in social sciences must also accept that human choice is an illusion. Even the economist’s “decision” to develop a model that she would use to draw policy recommendations is an illusion of choice. The aim of that recommendation to change something in the society would likewise be an illusion in such a world.

If, on the other hand, positivist interventionists want to free themselves from this trap by abandoning complete determinism, the first thing that needs to be explained is how to discern whether a theory predicted poorly because it is an unsatisfactory theory or because the strict causality in the true underlying nature of the economic reality was broken down at the time and place of measurement.

Notes:

  1. Varian, R. H. 1989. What Use is Economic Theory? University of California at Berkeley, p. 2. 
  2. Note that the assumed nature of the system under examination in quantum mechanics is still open for interpretation, but there is a non-falsified theory of quantum mechanics (De Broglie–Bohm theory) consistent with the principle of causality. 
  3. A sphere is an ideal shape that exists only in the abstract, not in reality (as far as we know). 
  4. Einstein, A. 1926. Letter to Max Born (4 December); The Born-Einstein Letters (translated by Irene Born), Walker and Company, New York, 1971). 
  5. Note a striking similarity with Bohm’s (1957) interpretation of the hidden causality in the apparent uncertainty in the results of quantum mechanics experiments:

    First of all, let us recall that no matter how far one goes in the expression of the laws of nature, the results will always depend in an unavoidable way on essentially independent contingencies which exist outside the context under investigation, and which are therefore undergoing chance fluctuations relative to the motions inside the context in question. For this reason, the causal laws applying inside any specified context will evidently not be adequate for the perfect prediction even of what goes on inside this context alone.

    Bohm, D. (1957). Causality and Chance in Modern Physics. London: Routledge. 

  6. Mises, Ludwig von. 1949. Human Action, San Francisco: Fox and Wilkes (1996), p. 18. 
  7. Even though this determinism may sound strange, we cannot claim that it is impossible. As mentioned above, Mises was aware of this possibility as well as of the metaphysical and speculative nature of claiming its certainty. 
  8. Note that I am not making any claims about any actual determinism of reality but examining the mutual relationship of the positivist economist’s implied claim about the deterministic nature of the economic reality and her policy recommendation.