Austrian Economics: An Empirical and Experimental Science

by Mario Rizzo

I have been doing research on the ideas of the first-generation Austrian economists (Menger, Wieser and Boehm-Bawerk) as they relate to contemporary developments in behavioral and experimental economics. I have come upon a number of interesting things. I expect to share some of them here as well as in a soon-forthcoming paper. Today I wish to share this quotation from Friedrich von Wieser. These sentences are the opening words of an article commissioned by the Economic Journal to explain the ideas of the Austrian school to English-speaking economists:

“The historical school of political economists in Germany, and the Austrian, or as it is frequently termed, the abstract school are more nearly related than is at first sight apparent. Both follow the spirit of the age in rejecting speculative theory and in seeking their highest laurels in the field of observation. In art, as in science, naturalism must be distinguished from truth to nature, and we Austrians, while we have certainly no wish to be disciples of naturalism, we are wholly set on being experimentalists.”

Friedrich von Wieser, “The Austrian School and the Theory of Value,” Economic Journal (March,1891).

“Rationality” isn’t always Rational

by Mario Rizzo

Over the past two years I have been reading more than I ever dreamed about rationality in economics, especially in the standard neoclassical theory of choice. I have done this because I want to get at the root of the controversies concerning whether people’s behavior is, in particular contexts, rational or not.  Claims about the rationality of individual behavior are very closely linked to important policy questions about state paternalism. The highly abstract is working its way down the line to practical policy issues.

In all of this I am well-aware of the argument that “rationality” is the result of market processes and of decisionmaking institutions. I have nothing per se against this line of reasoning. Nevertheless, I want to approach the issue on the terms espoused by many choice theorists and behavioral economists themselves. This is the idea that the axioms of rational choice have a normative importance in and of themselves. By and large, behavioral economists accept the normativity of standard rational choice even as they reject the descriptive reality of rational choice.

The funny thing about all of this is that, initially, the axioms of rational choice were supposed to shed light on how people actually made choices. Then a sleight of hand occurred. It was claimed that they shed light on how rational individuals would choose – without addressing the issue of whether people were in fact rational in the sense of the axioms. Finally, it was alleged – in the face of empirical evidence that people often did not choose rationally – that the axioms defined the norms of choice. They told us how rational individuals should choose. More than that. Since being rational is taken as “good,” they show us how people should behave – full stop.

What Is Old Can Be New

by Mario Rizzo

This is the unedited version of my letter which appears in today’s (August 9th) Wall Street Journal. The first sentence was edited out. Too bad. 

————

There is a lot of discussion of the need for “new economic thinking” these days. Henry Kaufman (“Excessive Optimism and Other Economic Biases,” August 2nd) correctly criticizes many economists for underestimating the importance of structural changes in economic behavior and overestimating the capacity of economics to forecast.  

But sometimes the “old” is really the new. Echoing an older skeptical tradition in economics, the Austrian economist Ludwig von Mises said in 1949,” The fundamental deficiency implied in every quantitative approach to economic problems consists in the neglect of the fact that there are no constant relations between what are called economic dimensions. There is neither constancy nor continuity in the valuations and in the formation of exchange ratos between various commodities. Every new datum brings about a reshuffling of the whole price structure.”  

In a sense, it was the the “new” that misled us.

Generalizations in the Social Sciences

by Gene Callahan

On his blog, Daniel Kuehn notes that “relations in economies are not stable.” In fact, we can go further:  Relations in the social sciences are not stable. As an illustration, consider Zipf’s Law as applied to city size.

In 1700, London had about 575,000 people. According to Zipf’s Law, the next-sized city should have had about 280,000 or 290,000 thousand. What was the actual size of the second largest city? As far as I can determine, it was Norwich, with a population of about 30,000. (My source for the population figures is 1688: The First Modern Revolution.) Zipf’s “Law” is off by a factor of about ten in this instance.

What I suspect is that there is some historical circumstance that leads to Zipf’s Law applying to city size in recent centuries, which was not present in 1700. As political scientist Terry Nardin put it: “Generalizations about how people usually behave are not scientific generalizations about a truly time-independent class of phenomena; they are more or less well-disguised descriptions of customs specific to a particular historical situation.”

The Genius of Weber

by Gene Callahan

This semester, I am having the pleasure of teaching Max Weber‘s The Protestant Ethic and the Spirit of Capitalism for the second time. Doing so is renewing my appreciation for one of the great works of social science.

Weber’s historical thesis is fascinating in itself, but what really makes the work is that it is a mini-study in how to historically investigate a social-science proposition, complete with asides on method were Weber explains what he is doing. He takes two situations that are in most respects the same (that of German Catholics and that of German Protestants) and notes a crucial difference (besides religion): the two populations have significantly different degrees of participation in the capitalist mode of economic organization (as of 1905).

Attributing Agency

by Gene Callahan

In C. Mantzavinos’s Philosophy of the Social Sciences there is a paper by Philip Pettit entitled “The Reality of Group Agents.” (He decides, by the way, that sometimes it makes perfect sense to attribute agency to a group, but that’s a topic for a different day.) What I wish to talk about today is the following passage, a preliminary to the issue of group agency, which discusses when it is sensible to posit agency for an individual creature such as, say, a wasp:

The Blinders of Behavioral Economics

by Mario Rizzo 

At the turn of the new-year the Financial Times published two small articles about why people often do not adhere to their new year’s resolutions. One article was by a philosopher (Julian Baggini) and the other by a psychiatrist (Antonia Macaro). Interestingly, they each seem to focus on whether people really want what they resolve to do or not do. More fundamentally, the authors say, if people understood themselves better they would know more fully what their personal goals are and not have so difficult a time achieving them.  

Predictably Rational: A Brilliant Book by Richard B. McKenzie

by Mario Rizzo 

This is the time of the year that various publications recommend Christmas books or the best books of 2010. (I have never known what a Christmas — or summer — book is. Are they supposed to be light reading? I don’t believe in reading “light.” When I am in the mood for that, I watch TV.)  In any event, I have a serious book to recommend.

Every so often a brilliant book comes out on a topic of great academic importance that is in danger of not getting the attention it deserves. I am thinking about Predictably Rational: In Search of Defenses for Rational Behavior in Economics by Richard B. McKenzie.

Further Thoughts on The Sensory Order

by Roger Koppl

Over at Austrian Addiction, Dan D’Amico responds to my recent post on The Sensory Order.  Dan wants to know “what Hayek’s theory of neuorscience is really adding here that a more basic understanding of subjective preferences does not already imply?”  Dan is not the only one with this question.  I think enthusiasts for The Sensory Order have given pretty good answers to Dan’s question, but it seems clear that we need to do a better job.

The Sensory Order

by Roger Koppl

Over at Marginal Revolution, Tyler Cowen recently said The Sensory Order is “Hayek’s most overrated book.”  In part he was complaining that “many call it his most underrated book.”  Unfortunately, he does not name names.  In any event, Tyler has other gripes including the mistaken suggestion that the science in it was not current.  As I said in a comment, “I don’t understand why TSO gets lukewarm to negative reactions from serious people who are otherwise keen on Hayek.”  The most salient example of TSO bashing may be that of Dan D’Amico and Pete Boettke, who criticize “neuro-Hayekians.” Let me go on record as an enthusiast for The Sensory Order.  The latest expression of my enthusiasm is forthcoming in JEBO.

The Method of History

by Gene Callahan

I’m currently reading Bryan Sykes excellent book, The Seven Daughters of Eve. Well, excellently written, and, I have to assume, excellent on the genetics. But there are a couple of fundamental misunderstandings of history present in the book, that I think are worth noting, because of the frequency with which people believe them.

The first such error is that Sykes keeps referring to “prehistory,” “recorded history,” “the beginnings of history,” and so forth. These phrases are symptomatic of the error, exploded decades ago by Collingwood, that there is something especially “historical” about written records, that they represent the “recording” of history by those “witnessing” it, and that, in their absence, we only have some fuzzy “prehistory” with which to deal.

Just the “Basic Facts,” Mam

by Gene Callahan

I was recently in a conversation with a very bright economist who declared “We are in agreement about the basic historical facts here; we are just interpreting them differently.”

This is a common but very damaging misunderstanding of historical knowledge: that there are a set of “basic facts” that historians are “given” to start with, and what historians then do is apply a “theory” to fit an interpretive scheme over those facts. That this view cannot be correct becomes obvious once one realizes that no such thing as the “basic facts” this views relies upon can exist in history.

The Amazing Brad DeLong

by Mario Rizzo  

I don’t know where Brad DeLong acquired his philosophy of economics. DeLong responded to an article by Jean-Claude Trichet, president of the European Central Bank, on “austerity.” The following is part of what the Financial Times edited out of the published version. DeLong posted it on his blog. He says there are two types of economists:  

“One type chooses, for non-economic and non-scientific reasons, a political stance and a political set of allies, and twiddles and tunes their assumptions until they come out with conclusions that please their allies and their stance. The other type takes the carcass of history, throws it into the pot, turns up the heat, and boils it down, hoping that the bones and the skeleton that emerge will teach lessons and suggest principles that will be useful to voters, bureaucrats, and politicians as they try to guide our civilization as it slouches toward utopia. (You will not be surprised to learn that I think that only this second kind of economist has any use at all.)”  

“In the Long Run We Are All Dead” What Does It Mean?

by Mario Rizzo 

Paul Krugman continues to invoke Keynes’s famous statement. I wish Krugman and others would give some serious thought about what it is supposed to mean and the errors it involves.   

In the first place, Keynes was complaining about the “classical” economics, that is, the ideas of the economists before him who believed that the market, if unhampered after a recession, could reduce or eliminate the unemployment associated with the business cycle.  

Of course, this puts many economists – with different ideas – in the same category and treats the issue of cyclical unemployment in a grossly simplified way. But this, in general, is how Keynes treated those who disagreed with him. Keynes, the polemicist, was without inhibition. 

Some basic methodology is in order. When economists talk about “the long run” they do not mean calendar time. Yes, that’s right.

Robert Barro and His Black Box

by Mario Rizzo

I am both intrigued and annoyed by Robert Barro’s recent opinion piece in the Wall Street Journal. He adduces empirical (econometric) evidence to support the view that the fiscal stimulus package has done very little good in the short run and will do harm in the long run. I do not want here to discuss technical data or identification problems. Instead, I want to discuss something both more elementary and more profound.

The world of econometric estimation is a world shrouded in mystery, even for some econometricians like Edward Leamer of UCLA, for example.

Growth Data Are Theoretical Constructs

by Mario Rizzo

The reader of newspapers may be confused about the newly published growth figures for the US economy. We are told that the growth rate for the fourth-quarter of 2009 was 5.7%. But when the inventory effect is taken into account it was only 2.3%. What is going on? 

How Mathematical Economists Overreach

by Mario Rizzo

In recent months there has been a discussion both in the traditional media and in the blogosphere about why orthodox macroeconomics failed to predict or explain the financial crisis and the subsequent Great Recession. Some of that discussion focused around Paul Krugman’s criticism that economics mistook  (mathematical) beauty for truth. Subsequently, there was a further discussion about the role of mathematics in economics.

Of course, this is a big topic. My task here is only to investigate, by means of a simple example, three claims made for the superiority of mathematics over ordinary (natural) language.

Why Kant Was Smarter Than Behavioral Economists

by Mario Rizzo  

Behavioral economists who like to indulge in normative pronouncements have decided that quasi-hyperbolic discounting violates rationality. In other words, suppose a person decides today that he will give up the hamburgers he loves beginning in 2010 (because of the high fat content). But then when 2010 arrives he reverses his decision and continues to eat them.  To stress the point, let’s suppose that he repeats this preference-reversal one or two more times during 2010.  

The poor fellow is, in addition to all his other troubles, violating standard economic rationality.

A Tiger Of A Mistake

by Mario Rizzo  

UCLA economist Matthew Kahn says that there is a “natural experiment” of the power of the income effect in Tiger Woods’s troubles (HT Greg Mankiw). The fall in income from endorsements should result in Tiger Woods playing more golf tournaments. The relative price (or wage) from the latter source remains unchanged while his income falls. If leisure is a normal good, then less income means less leisure and hence more tournaments. 

Possibly. But it is not a test of the labor supply theory. Why not? Economics makes predictions about markets and not individual behavior. This is a mistake often made by behavioral economists. They (and some of their neoclassical brethren) think that the individual hypothesized in the models is a “representative individual.”  

This is quite wrong. As the economist Fritz Machlup argued years ago, the individual here is an imaginary puppet whose only task is to generate predictions about market behavior. (In today’s intellectual landscape we might modify that to include predictions about aggregations of individuals in non-market contexts.)   

So whatever Tiger Woods does there has been no “natural experiment” and no test of Jacob Mincer’s labor economics. We can keep Tiger Woods out of the economics books and leave him in the gossip pages.

UPDATE: Tiger Woods says that he will reduce, not increase, his tournament participation. So I guess Jacob Mincer’s labor economics fails the natural experiment. Hmm.  Now will Professor Kahn adopt my (Machlupian) point of view?

What Is Austrian Economics?

by Mario Rizzo

Many years ago (around 1982, I think) Jerry O’Driscoll and I wrote a paper that was the basis of an American Economic Association session. The paper was called “What is Austrian Economics?” The paper gradually evolved into our book, The Economics of Time and Ignorance.

The purpose of this book was to present Austrian economics in an updated fashion. To do this we needed to do two things: (1) uncover many of the fundamental ideas implicit in the tradition but not, as of then, sufficiently elaborated or made explicit; and (2) confront Austrian ideas with recent developments in economics, both mainstream and outside of the mainstream.

We faced many initial negative criticisms of the book. I will say that I was very disappointed by some of the old-guard reaction to the book. But do not confuse “old guard” with age because some of the greatest encouragement we received was from Professor Ludwig Lachmann who well understood the necessity of going beyond what the previous generation of Austrians had bequeathed us.

Economics as a Philosophical Science

by Gene Callahan

I happened to be reading R. G. Collingwood’s famous essay (at least famous in my circles!) with the above title. While similar in some ways to Mises’s philosophical analysis of the concept of action, there are some quite significant differences present as well, and I thought that Think Markets readers might enjoy a brief discussion of one of them.

Perhaps the most notable difference between Mises and Collingwood is that the latter denies the possibility of interpersonal exchange!

What is Science?

by Jerry O’Driscoll  

Some recent controversies move me to take up the topic within the limitations of a blog post.  Many years ago (1956), Fritz Machlup ably addressed the issue in an essay titled “The Inferiority Complex of the Social Sciences.”  He rejected limiting the term science to particular subject matters or methods.  He concluded that “there is no epistemologically defensible borderline short of the widest meaning of scientific method, defined in the Encyclopedia Brittanica as ‘any mode of investigations by which impartial and systematic knowledge is acquired.’”  

I endorse Machlup’s broad definition of science as any systematic study of a subject.  As he observed in a footnote, the German Wissenschaft is more inclusive: “the historians of literature, the philologists, the philosophers, the mathematicians, the sociologists, they are all scientists (Wissenschaftler).” In French, science is knowledge and one can speak of la science infuse, intuitive knowledge. La science de l’art is simply the systematic study of art.  

Mankiw And Meltzer Are Right! More Or Less

by Mario Rizzo  

As we have been saying here, the claims that the fiscal stimulus has saved or created X number of jobs is not a simple empirical question. It must be an inference from a model that tells us what would have happened in the absence of that stimulus. Collecting reports from various firms or local governments about their job situations will not do. At best these individual reports are based on pop-theories on the part of the reporters about what would have happened.

Mises Was A Scientist

by Roger Koppl

Over at Division of Labor, Noel Campbell picks a fight with Austrian fans of Mises.  “I always conceived of Mises’ efforts as attempting to build a logically correct and (therefore) irrefutable description of human behavior. As such, I always viewed Human Action as a work of philosophy, not science.”   Noel hints that he doesn’t want to be answered with a lot of philosophy of science.  I might whine about how unfair it is to contrast Mises’ “philosophy” with “science” and then expect a response that doesn’t get into the philosophy of science.  But Noel seems to be a nice guy with a sincere question, so I’ll take a stab at it anyway.

The Great Moderation In Macroeconomics

by Mario Rizzo  

I have now read both Paul Krugman’s New York Times essay on the state of macroeconomics and John Cochrane’s reply. They are each, in very different ways, quite disappointing. The level of argument is poor, the prejudices are simplistic, and the tones are annoying.