I started reading Human Action which is the magnum opus of Ludwig von Mises, the great Austrian economist. I recently finished part 1 and the work is nothing short of brilliant.
Human Action is not for the faint of heart. Comprising over 900 pages, it is a very dense and methodical treatise on the nature of economic activity. In many ways, it is like reading a math paper rather than the typical economics book. This is because Mises starts with a small number of axioms and builds his entire theory of human action and markets upon them. It reminds me of studying Euclidian Geometry in 8th grade where one could prove all kinds of interesting results with just a handful of axioms about the properties of parallel lines and right angles.
Human Action is not the work I would recommend for those who want an introduction to Austrian economics. It's a real commitment and it's more interesting to tackle after becoming familiar with the principles of Austrian economics by reading more accessible works. I generally recommend Economics in One Lesson by Hazlitt and What Has Government Done to Our Money by Rothbard as good introductions.
The first 100 pages of Human Action provide the philosophical underpinnings of Austrian economics. Mises rejects positivism, i.e. the scientific approach, for understanding Economics. At first, this might sound kind of strange. Why would one reject the scientific method for trying to describe how economic activity works? As an engineer with a background in science, I was skeptical the first time I heard this -- I was trained to use science to understand and manipulate the world. As an aside, Mises' younger brother was a very prominent applied physicist.
Mises rejected the scientific method for economics not because he rejected science. Mises rejected it because the scientific method can’t help us understand economics. The scientific method works when one can run repeatable and verifiable experiments to test hypotheses. We all learned about hypotheses, theories, and experiments in grade school. The laws of physics and chemistry are constant and our theories for explaining them can be tested and falsified with experiments. This is why the scientific method works for understanding the laws of nature. The ultimate test for our scientific theories is how well they can be used to make predictions about the world.
Economics, on the other hand, involves human actors participating in the passage of time. The scientific method cannot be applied because there is no way to run repeatable experiments to test our theories. What caused the Great Depression? The scientific method can't help us with that because we can't go back to 1929 and run a repeatable experiment where we change a single variable to see if we still get a Great Depression. Without the ability to run experiments that use controls and manipulate one variable at a time, there is no way to use the scientific approach to test economic theories. Using the scientific approach just doesn’t work.
Besides the fact that there is no way to run repeatable experiments, the scientific method also does not apply because the laws of human action are not fixed like the laws of science. There are billions of humans in the world and they each act according to their own free will. There is no theory or scientific model that can model the actions of billions of humans. The Federal Reserve tries to build models for economic activity and it's no surprise they never get it right. Their models just can't account for understanding the subjective desires and actions of billions of people. And this isn’t just a matter of needing better models and computers. The model cannot work because human beings react to the model. The laws of physics do not change because we build a model for understanding force and energy, but humans do react to what the Federal Reserve does. It is impossible to model human action because humans will change their behavior based on the existence of the model. It's the ultimate uncertainty principle.
Mises explains, “We are faced with the same main differences between physics and chemistry on one hand and the sciences of human action on the other. In the realm of physical and chemical events, there exist constant relations between magnitudes, and man is capable of discovering these constants with reasonable degree of precision by means of laboratory experiments. No such constants exist in the field of human action.” He goes on, “The impracticability of the measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations…Statistical figures referring to economic events are historical data. They tell us what happened in a nonrepeatable historical case.” This reminds me of those models used by the rating agencies. They used historical housing prices to claim housing would not drop in price and to justify AAA ratings for all those CDOs.
The reason this subtle point is so important to understand is that it is the fundamental difference between mainstream economics and Austrian economics. Mainstream economists today such as Krugman and Bernanke use macroecomomic theories and build complex mathematical models using “scientific principles” to model the economy. These aren't built on axioms about the fundamenetal nature of human behavior but rather built upon historical data and events. They use the methods of science by measuring all types of indices in the economy such as unemployment and prices and then plug them into their models and formulas to decide how to intervene in the market in order to accomplish some type of policy goal. They look like they know what they are doing because they use the facade of science, but in reality, their economics is pseudo-science and their models are worthless, as we just learned again for the millionth time.
The approach Mises takes is one based on a priori axioms. He builds up the theory as a mathematician would. He defines a framework called praxelogy for understanding human action. His primary axiom is that humans are actors with logical thought and they take actions in order to decrease dissatisfaction. It's not relevant what the end goal of the individual is, just that it is based on the individual's own subjective values. Humans prioritize their dissatisfactions and take actions one a time to reduce uneasiness associated with their dissatisfactions. Mises writes, “Human life is an unceasing sequence of single actions. But the single action is by no means isolated. It is a link in a chain of actions which together form an action on a higher level aiming at a more distant end.”
Another axiom is that acting man ranks his desires on a scale of values in order to satisfy his highest priority desires over his lower priority desires. This scale of wants only exists and can be observed through a man’s actions. Mises says, “Action sorts and grades; originally it knows only ordinal numbers, not cardinal numbers.” In other words, man does not decide what the absolute values of two commodities are. He only decides between definite quantities when given a concrete choice. He writes, "Acting man is not in a position whether he must choose between all the gold and all the iron. Hs decision in choosing between 100 ounces of gold and 100 tons of iron does not depend at all on the decision he would make if he were in the highly improbable situation of choosing between all the gold and all the iron. What counts alone for his actual choice is whether under existing conditions he considers the direct or indirect satisfaction with 100 ounces of gold could give as greater or smaller than the direct or indirect satisfaction of 100 tons of iron. He does not express an academic or philosophical judgment concerning the “absolute” value of gold and iron; he does not determine whether gold or iron is more important for mankind; he does not perorate as an author of books on the philosophy of history or ethical principles. He simply chooses between two satisfactions both which he cannot have together.”
Building upon these axioms, Mises develops a theory of returns and marginal utility. In part 2, which I haven’t started yet, he addresses how human action works within the framework of society. My sense from what I've read is that I will learn how the market forms from the aggregation of each individual's ranking of scarce goods. Ths should ultimately set prices for commodities and labor. More to come as I read more.
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