Mathematical Economics vs. “Literary” Economics?

Originally posted on July 28, 2014

Famed Chicago economist John Cochrane gives a report from a recent meeting at the National Bureau of Economic Research (NBER, the US government institution which is tasked with determining whether or not the economy is in a recession, and where Ludwig von Mises was first employed upon moving to the United States). He reports that a recurring theme throughout the discussions was about “just how we do economics”. Certainly a topical conversation. Unfortunately, just how Professor Cochrane frames the discussion proves that gross methodological misunderstandings are still pervasive in the profession.

Firstly, Cochrane frames the methodological debate as “math vs. literature”. While the current orthodoxy in economics is to have quantifiable theories that can be “proved” or falsified by empirical evidence, and though there may be some who hold that the proper way to ascertain economic truths is through “imaginative and creative writing, especially recognized artistic value”, this dichotomy is not comprehensive of the Austrian view.

The Austrian methodological position is that economics should proceed logically from realistic foundations.

Economics proceeds logically (meaning that uses valid reasoning) because that is how the human mind perceives the world. Logic helps us to differentiate between cause and effect.If event X occurs, then event Y will happen. Event X occurred, therefore event Y will happen. If I throw a rock at a beehive, then I will swarmed by angry bees. I am not being swarmed by bees, therefore I did not throw a rock at a beehive. Logic helps us understand the world, learn new information about the world, and survive. Logic is an indispensable tool of inquiry.

Realistic foundations begin with the recognition that human beings act, meaning that they consciously use means to achieve ends. This self-evident truth is called the “action axiom”. Contrary to what many critics of the Austrian school believe, this is in fact the only axiom in economic theory. In fact, it is through the lens of this axiom that we can even interpret economic reality, to what is actually going on around us. Without this lens, this interpretive feature of human thought, the world would seem like a totally random and chaotic place, beyond human comprehension.

Some elementary logical implications of the action axiom that only require acknowledging the fact that human act include: action implies choice, choice implies scarcity, therefore means are always scarce; action implies valuing, valuing implies preferring one specific thing to another specific thing, therefore values are ordinal (they order things first-best, second-best, etc.) as opposed to cardinal (saying how many of something there is); values are personal, and values are cardinal, therefore no interpersonal value comparisons can be made; action implies voluntary exchange, voluntary exchange implies something of lower value is given up for something of higher value, therefore all voluntary exchanges (initially) make both parties better off. There are many more direct implications we can learn about the human condition, simply by understanding what it means to act, that is consciously make a decision.

Some elementary empirical observations we can make after acknowledging the a priori action axiom include: there is scarcity in the world, there is a division of labour, people’s values tend to change over time, money exists, and people generally prefer leisure over work. These are very, very broad observations. They help guide us in what we choose to study, and serve as an anchor so we know when we are moving too far from reality.

By merely incorporating the elementary empirical observations of the world and the elementary logical implications of action, we can get comprehensive theories of barter, prices, money, production and economic growth, and banking. With a few more very basic observations and theoretical tools, we can have theories of government, business cycles, entrepreneurship, socialism and capitalism.

(Important caveat: just because the observations and logical tools start out “elementary” and “basic” does not mean that their application is easy. Layering several observations on top of each other makes identifying causal chains rather difficult.)

Finally, Austrians use verbal logic (as opposed to mathematical logic) for one simple fact: there are no constants in human action. Math necessary requires constant relations between variables. With natural language, we can describe complicated, nuanced events using strict and rigorous definitions, all the while making clear exactly what are the discrete steps in the economic action. In principle, we can accurately describe economic reality using verbal language. “People use means to attain ends.” The mathematical approach, on the other hand, is doomed to unreality, as there are no constants in human action–and thus at most mathematics serves as a mere metaphor.

Professor Cochrane mentions a seminar participant claiming that math “forces logic to be out in the open.” While clear logic is an admirable goal, what is important also is that our logic is sound. If I were to assert X > Y, Y > Z, therefore X > Z, that is clear logic. But if X is the value that John places on apples, and Y is the value that Steve places on cats, and Z is the value that Amanda places books, then we know (because our economic principles taught that interpersonal value comparisons are impossible) that this logic is not based in reality, even though it may be valid. Mathematics may “force logic to be out in the open”, but because it cannot make deductions based in reality, it is an unsatisfactory method of inquiry.

These are fundamental building blocks of Austrian economics. Austrians focus on causality by using logic and realism by starting with very general observations about the actual world. Hence, this method is known as the causal-realist approach to economics.

This approach contrasts with the mainstream mathematical approach, that models “representative agents” that have “rational expectations” about the future, have “perfect information”, are from “infinitesimal and infinitely-lived households”. The mainstream claims these assumptions are made for simplicity. Austrians argue that these assumptions obfuscate the real economic issues, making the theories unrealistic and thus poor tools for understanding reality.

The mainstream claims that mathematics helps clarify thought. But when it comes to understanding the real problems affecting real people, what good is having a clear thought of imaginary problems faced by people who never could possibly exist?