ECONOMIC THEORY FOR PEOPLE WHO VALUE THE TRUTH

Economics is deliberately confusing, but after fifteen years of study, I have cut through the jargon and math and can now explain economics in just one sentence: Economics is an expression of political agendas that are hidden within known-false assumptions. If one accepts those false assumptions, then one also accepts those hidden agendas. This brilliant method for subliminal programming has been very effective in instilling libertarian ideals into university students for half a century.

Common known-false economic assumptions (click to open)
#1. People are Bayesian equation solvers (the entire argument for market outcomes rests upon this known-false assumption). Here is a partial list of exceptions to the Bayesian model: List of cognitive biases
#2. Money is just a medium of exchange (money is inherently political because it can buy others, thus, the political power money of money is intentionally-hidden by economists).
#3. Energy is just a commodity (the production function only assumes capital and labor, thus, hiding a limit to growth).
#4. Debt is neutral to an economy (another hidden limit to growth).
#5. The environment is part of the economy instead of the other way around (yet another hidden limit to growth).
#6. Wants are identical to needs (deliberate deception).
economics

Those who believe society can best be understood as a series of markets begin by positing a rational, calculating individual whose goal is to 'maximize utility.' This premise says everything and nothing, since it is true by definition in all cases. But it is a key aspect of the market model, since it is the behavioral part of the logical argument that whatever the market decides must be optimal.
Robert Kuttner, EVERYTHING FOR SALE

If 'maximize utility' is true in all cases, then it is equivalent to: 'do whatever.' Therefore, we may say:

Those who believe society can best be understood as a series of markets begin by positing a rational, calculating individual whose goal is to 'do whatever.' This premise says everything and nothing, since it is true by definition in all cases. But it is a key aspect of the market model, since it is the behavioral part of the logical argument that whatever the market decides must be optimal.
—Robert Kuttner, EVERYTHING FOR SALE


PARETO: THE KEYSTONE

The belief that “Pareto optimality” occurs in the real world is the linchpin of the contemporary economic political agenda. If one accepts that “Pareto optimality” actually occurs, then market exchanges are beneficial by definition. Conversely, if exchanges weren't beneficial, the entire argument for market solutions would disappear:

“The neoclassical school is the dominant (and probably the numerically largest) school in contemporary economics. For neoclassical economists, microeconomic theory (i.e., welfare economics) underlies every theoretical subfield of specialization and every theoretical, practical, and policy-oriented conclusion at which they arrive. All of their cost-benefit analyses, their demonstrations of the universal gains from foreign trade, their notions of market efficiency that are encountered in every branch of applied economics, as well as their notion of rational prices, have absolutely no meaning whatsoever other than that manifested in their faith that a free-enterprise, competitive market system will tend toward a Pareto optimal situation. Without a Pareto optimal situation in effect, these phrases and notions cannot be defended. In fact, in the absence of an optimal situation, these phrases have no meaning whatsoever. They are given meaning only when the neoclassical economists first posit the existence of a Pareto optimum; then, by definition, all exchangers are said to gain, resources are said to be ‘efficiently allocated,’ prices are said to be ‘rational’ and therefore conducive to making accurate assessments—on utilitarian grounds—of the social costs and social benefits of various government projects. Utilitarian neoclassical welfare economics pervades and dominates nearly all neoclassical analyses on all theoretical and practical matters.” (Emphasis in original)—HISTORY OF ECONOMIC THOUGHT: A CRITICAL PERSPECTIVE, Third Edition, E. K. Hunt & Mark Lautzenheiser, 2011

“Pareto optimality” is not scientific because it is not defined in a way that can be falsified. “Pareto optimality” is a belief in the same sense as “Christ died for our sins” is a belief—neither can be falsified. Economists proselytize for their doctrinal beliefs like Christian missionaries proselytize for theirs. For “Pareto optimality” to be true, people are required to be “mathematicall rational.”

THE BIG LIE: MATHEMATICALLY RATIONAL

In 1948, economist Milton Friedman and psychologist Leonard Savage proposed the application of mathematical rationality to all economic choice situations that involve uncertainty. In Friedman’s proposed mathematical model, consumers decide by instantly solving probability equations without even knowing it!

In 1952, Maurice Allais tested the Friedman/Savage mathematical model and found that it did not correctly predict consumer choices. Allais made Savage fill out a list of questions with which he could show that Savage violated his own theory. The history of Allais’ paradox (as it became known) is in itself intriguing. It seems that several other researchers, amongst whom Friedman, when presented with the same questions some months later passed the test.

“Furthermore, the Allais paradox remained practically unknown until some twenty years later. But what was decisive for subsequent developments in economics and psychology, was that Savage took the critique of Allais seriously whereas Friedman, as far as I can tell, put the whole subject aside. Friedman left EUT as a basis for decision and game theory without further comments as a positive (as-if) theory; Savage retreated into a normative account of the theory.”—Floris Heukelom, Kahneman and Tversky and the Origin of Behavioral Economics, 2007

Indeed, modern biologists have found that consumers are not like the mathematical model, instead of mathematical, they are logical—they respond logically to environmental cues:

“People surely do use some sort of logic. All languages have logical terms like not, and, same, equivalent, and opposite. Children use and, not, or, and if appropriately before they turn three, not only in English but in half a dozen other languages that have been studied. Logical inferences are ubiquitous in human thought, particularly when we understand language. … Logic is indispensable in inferring true things about the world from piecemeal facts acquired from other people via language or from one’s own generalizations.”—Steven Pinker, HOW THE MIND WORKS, 1997

Even after he knew his model failed, Friedman continued to deceive his students by claiming that it hadn’t failed, and then used his failed model—the assumption of mathematical rationality—to further his libertarian agenda:

“Adam Smith’s key insight was that both parties to an exchange can benefit and that, so long as cooperation is strictly voluntary, no exchange will take place unless both parties do benefit.”—Milton & Rose Friedman, 1980

Friedman’s claim could only be true if consumers could make mathematically-rational decisions in the marketplace—they can’t. When Friedman’s students challenged his unbelievable model, he tried to explain it away with more deceptions:

“To be important, therefore, a hypothesis must be descriptively false in its assumptions…”—Milton Friedman, 1953

“[ In 1955,] Friedman provided a defense of RCT (his mathematical model) that, in one way or another, still commands the respect of many of its practitioners… Friedman argued that in accepting or dismissing a theory, we should only look at its fit with the data, not at the realism (or lack thereof) of its assumptions. Bluntly speaking, he urged us to apply to theories the principle we often apply to sausages: as far as the final product is good, better not to ask about the ingredients. This is the famous ‘as if’ defense of RCT: however implausible an assumption may seem, it is acceptable as long as humans behave ‘as if’ it were true.”—Louis Fernando Molina, 2004

Nevertheless, humans do not behave “as if” Friedman’s model were true! Friedman’s model failed when it was tested in 1952! Moreover, his model fails consistently in repeatable experiments. This is well documented in the work of Daniel Kahneman, who won the 2002 Nobel in economics:

“Kahneman and Tversky proved in numerous experiments that the day-to-day reality of decision makers varies from the assumptions held by economists.”—Goldberg and von Nitzsch, 2001

For over 50 years, mainstream economics has been based on the known-false assumption of mathematical rationality!

WELL, IS FRIEDMAN TELLING THE TRUTH? MUST ASSUMPTIONS BE FALSE? DO ASSSUMPTIONS MATTER? (click to open)

In REFLECTION WITHOUT RULES, D. Wade Hands explains why assumptions do matter. What follows here is all a direct quote:

Hausman begins by summarizing Friedman’s “assumptions do not matter” argument in the following way:

1. A good hypothesis provides valid and meaningful predictions concerning the class of phenomena it is intended to explain (premise).
2. The only test of whether an hypothesis is a good hypothesis is whether it provides valid and meaningful predictions concerning the class of phenomena it is intended to explain (invalidly from 1).
3. Any other facts about an hypothesis, including whether its assumptions are realistic, are irrelevant to its scientific assessment (trivially from 2). (Hausman 1992, p. 166)

The main problem with the argument is that is it not a valid “argument” at all: Statement 2 is not true and it does not follow from statement 1. Hausman uses the following analogous argument to make his point:

1’ A good used car drives reliably (over-simplified premise).
2’ The only test of whether a used car is a good used car is whether it drives reliably (invalidly from 1’).
3’ Anything one discovers by opening the hood and checking the separate components of a used car is irrelevant to its assessment (trivially from 2’). (Hausman 1992, p. 166)

The problem is of course that with a used car or an economic model the relevant issue is how well it will perform in the future and in other circumstances. Theory should be a guide—even if we focus on empirical prediction—to new circumstances and new situations, and for those forward-looking applications examining the parts (the assumptions) matter. In fact, though Hausman does not make this point, Friedman’s emphasis on novel facts gives away his commitment to successful future performance, but Friedman never closes the circle. Friedman seems to be making the implicit assumption that success in one novel situation improves the probability of success in additional and/or future novel situations that we might have an interest in, but there is no obvious reason for this to be the case. Such issues actually carry the discussion beyond Friedman’s essay and into debates about “realism” and “instrumentalism” in the philosophy of science: a discussion that must wait until the next chapter. At this point I just want to note that Hausman’s criticism of Friedman seems to be correct—even if one is only interested in prediction, the assumptions still matter.

Friedman’s deceptions were published as “The Methodology of Positive Economics” (1953) which is clearly the best-known work in twentieth-century economic methodology. It was “a marketing masterpiece” (Caldwell 1982, p. 173) that is cited in nearly every economics textbook, and it remains, almost a half-century after its publication, “the only essay on methodology that a large number, perhaps majority, of economists have ever read” (Hausman 1992, p. 162). D. Wade Hands, 2001

Friedman’s disproved mathematical model ultimately became the so-called “Standard Social Science Model” (SSSM) that has dominated the social sciences, colored popular thought, and, by its pervasiveness, directly and indirectly influenced public policy for over 50 years!

Economics is the intellectual “Trojan Horse” of our time with political propaganda hidden by known-false assumptions. The conclusions follow logically from the deception, so if you accept the known-false assumptions, then you accept the deception:

“Economists enamored of pure markets begin with the theory, and hang models on assumptions that cannot themselves be challenged. The characteristic grammatical usage is an unusual subjunctive—the verb form ‘must be.’ For example, if wages for manual workers are declining, it must be that their economic value is declining. If a corporate raider walks away from a deal with half a billion dollars, it must be that he added that much value to the economy. If Japan can produce better autos than Detroit, there must be some inherent locational logic, else the market would not dictate that result. If commercial advertising leads consumers to buy shoddy or harmful products, they must be ‘maximizing their utility’—because we know by assumption that consumers always maximize their utility. How do we know that? Because to do anything else would be irrational. And how do we know that individuals always behave rationally? Because that is the premise from which we begin. The truly interesting institutional questions—the disjunctures between what free-market assumptions would predict and the actual outcomes—are dismissed by the tautological and deductive form of reasoning. The fact that the real world is already far from a perfect market is ignored for the sake of theoretic convenience. The dissenter cannot challenge the theory; he can only describe the real world.”—Robert Kuttner, EVERYTHING FOR SALE

SEVEN UNSCIENTIFIC ASPECTS OF ECONOMICS

POLITICS:
n 1: social relations involving authority or power

Adam Smith provided English merchants with a rationalization of what they had always wanted to do: treat their fellow human beings as beasts of burden. Economists continue to perform the same function. John Kozy


Unscientific Aspect #1: Economists assume that the world economy is powered by money rather than by energy (click to open)

Unscientific Aspect #1: Economists assume that the world economy is powered by money rather than by energy:

“Minerals are inexhaustible and will never be depleted. A stream of investment creates additions to proved reserves, a very large in-ground inventory, constantly renewed as it is extracted… How much was in the ground at the start and how much will be left at the end are unknown and irrelevant… There are plenty of fossil fuels and no limit to potential electrical capacity. It is all a matter of money.”
M. A. Adelman, 1993

Even Nobel-prize winning economists believe that money creates resources:

“…the world can, in effect, get along without natural resources… at some finite cost, production can be freed of dependence on exhaustible resources altogether.”
Nobel winner Robert Solow, 1974

But physical scientists know that all resources are natural and that economists have lost touch with reality:

“One must have a very erroneous view of the economic process as a whole not to see that there are no material factors other than natural resources. To maintain further that ‘the world can, in effect, get along without natural resources’ is to ignore the difference between the actual world and the Garden of Eden.”
Georgescu-Roegen, 1975

Neoclassical economists hoped they could gain social status by mimicking old-fashioned physics:

“[ With the development of modern physics ] it became possible to see orthodox economic theory for what it really was: a bowdlerized imitation of nineteenth-century physics [ with money replacing energy ].”
Philip Mirowski, 1988

Almost 150 years ago, physical scientists attempted to convince economists that the economy was powered by energy instead of money:

“It is, in fact, the fate of all kinds of energy of position to be ultimately converted into energy of motion. The former may be compared to money in a bank, or capital, the latter to money which we are in the act of spending … If we pursue the analogy a step further, we shall see that the great capitalist is respected because he has the disposal of a great quantity of energy; and that whether he be nobleman or sovereign, or a general in command, he is powerful only from having something which enables him to make use of the services of others. When a man of wealth pays a labouring man to work for him, he is in truth converting so much of his energy of position into actual energy… The world of mechanism is not a manufactory, in which energy is created, but rather a mart, into which we may bring energy of one kind and change or barter it for an equivalent of another kind, that suits us better—but if we come with nothing in hand, with nothing we will most assuredly return.”
—Balfour Stewart, 1883

Unscientific Aspect #2: Economists select known-to-be-false-hypothetical assumptions (click to open)

Unscientific Aspect #2: Economists select known-to-be-false-hypothetical assumptions so they can mislead the public into supporting their political agendas (e.g., market efficiency, Homo economicus, advertising, money):

“Neoclassical economics is based on the premise that models that characterize rational, optimizing behavior also characterize actual human behavior.”—R. Thaler, 1987

The “rational, optimizing behavior” model at the center of modern economics fails consistently in repeatable experiments. This is well documented in the work of Daniel Kahneman who won the 2002 Nobel in economics:

“Kahneman and Tversky proved in numerous experiments that the day-to-day reality of decision makers varies from the assumptions held by economists.”—Goldberg and von Nitzsch, 2001

Here is a partial list of exceptions to “rational, optimizing behavior”: List of cognitive biases

Economists prefer lies to truth and don’t care if their theories are known-to-be-wrong:

“Contrary behavioral evidence has had little impact on economics because having a theory of how the world ‘ought’ to act, economists can reject all manner of evidence showing that individuals are not rational utility maximizers.”—Lester Thurow, 1983

You may call it what you wish. I call it “lying”—so does Herman Daly:

“We must stop crying to the growing economy, ‘Deliver me, for thou are my god!’ Instead, we must have the courage to ask with Isaiah, ‘Is there not a lie in my right hand?’”—Herman Daly

Unscientific Aspect #3: Economists assume that “money” is only a “medium of exchange” (click to open)

Unscientific Aspect #3: Economists assume that “money” is only a “medium of exchange”:

MONEY: Anything which is widely acceptable in exchange for goods, or in settling debts, not for itself but because it can be similarly passed on, has the character of money since it serves the primary function of money, i.e. a means of payment. As a means of payment money is an entity which is transferred when a payment is made; as such it acts as a medium of exchange, a function essential to any economy other than the most primitive.” [p. 285, THE MIT DICTIONARY OF ECONOMICS]

But even the casual observer can see that money is social power because it “empowers” people to buy and do the things they want—including buying and doing other people: politics.

If employers have the freedom to pay workers less “political power,” then they will retain more political power for themselves. Money is, in a word, “political,” and “economic efficiency” is correctly seen as a political concept designed to conserve political power for those who have it—to make the politically powerful, even more powerful, and the politically weak, even weaker.

Our national currency provided the means for moneyed interests to capture our formal political system.

Unscientific Aspect #4: The economic unit of measure is a “transitory effect”—not a “cause.” (click to open)

Unscientific Aspect #4: The economic unit of measure is “price”—which is a “transitory effect”—not a “cause.” For example, a dollar’s worth of oil today will not be a dollar’s worth of oil tomorrow. Thus, today’s economic assumptions used to create a Nobel-Prize-winning economic model—which is a correlation of transitory effects—may be worthless tomorrow:

The Nobel-Prize-winning Black-Scholes-Merton model failed spectacularly in 1998 after losing $4.6 billion in less than four months. To save the U.S. banking system, then-Federal Reserve Chairman Alan Greenspan personally convinced 14 banks to remain invested in Long Term Capital Management, thereby averting disaster.—Wikipedia

Unscientific Aspect #5: The economic method is “correlation”of transitory effects (click to open)

Unscientific Aspect #5: The economic method is “correlation” (this happened before that happened, and thus assume, that it must have caused it) of transitory effects. Correlation is also called “magical thinking” for the obvious reasons:

“Note as well that the isoquant hits the vertical axis at point A, indicating that we can produce future output level Q* with no oil and gas. How is this possible?”
Paul Samuelson and William Nordhaus

Economists can make any lie seem like the truth by carefully selecting assumptions and cherry-picking the data:

“There are three kinds of lies: lies, damned lies, and statistics.”
Mark Twain

Unscientific Aspect #6: The “ceteris paribus” assumption (click to open)

Unscientific Aspect #6: The “ceteris paribus” assumption further reinforces the unrealistic—and unscientific—nature of economic correlation:

“We show there the amounts of the two kinds of capital that would be required to attain a certain level of output in the future (Q*), holding other inputs constant.
Paul Samuelson and William Nordhaus

Real scientists do not hold “other inputs constant”:

“The unscientific nature of ordinal utility theory was further shown to be reinforced by the insulating role played by the ceteris paribus proviso.”
L.D. Keita

Unscientific Aspect #7: Economics is always “political” (click to open)

Unscientific Aspect #7: Economics is always “political” (it always implies how we should behave). Every economic theory assumes to know what is best for us. Economists always publish to support specific political agendas:

“Should we be taking steps to limit the use of these most precious stocks of society’s capital so that they will still be available for our grandchildren? … in the long run, oil and gas are not essential.”—Paul Samuelson and William Nordhaus

Real science is not inherently normative:

“It is impossible to define ‘good,’ ‘service,’ or even ‘utility’ without making ethical judgments. Every object has mass, but not every object has utility.”—George Brockway, 1995

“No discipline [ except economics ] attempts to make the world act as it thinks the world should act.”—Lester Thurow, 1983

What did we learn? If the so-called “scientific” aspects of economics are nonsense what are we left with? Politics! Thus, we can cut through the jargon, math, and explain the discipline of economics in just one sentence: “economics” is an expression of political agendas within hidden known-false assumptions; the economics department teaches political ideals in disguise:

“The vocabulary of physics is amoral—not antimoral, but amoral. Mass, force, and velocity have no moral implications because the laws describing them have no alternatives. The vocabulary of economics, in contrast, abounds in ethical terms. It is impossible to define ‘good,’ ‘service,’ or even ‘utility’ without making ethical judgments. Every object has mass, but not every object has utility. Moreover, some people may consider a certain object a good while others do not, but there can be no disagreement about the equivalence and direction of action and reaction. There is no other or better way for a body to fall in a vacuum than v(t)=-gt+vo y(t)=-1/2gt^2+vot+yo; this is not because physicists don’t happen to be interested in making this a better world. There is no unchanging price for a bushel of wheat; and this is not because economists don’t happen to be interested in a stable universe. The price of wheat depends upon what people do, but bodies fall as they do regardless of what people do or think... Economics is not value free, and no amount of abstraction can make it value free. The econometricians’ search for equations that will explain the economy is forever doomed to frustration. It is often said that their models don’t work, because, on the one hand, the variables are too many and, on the other, the statistical data are too sparse. But the physical universe is as various as the economic universe (they are, to repeat, both infinite), and Newton had fewer data and less powerful means of calculation than are at the disposal of Jan Tinbergen and his econometrician followers. The difference is fundamental, and the failure to understand it reduces much of modern economics to a game that unfortunately has serious consequences.”
—George Brockway, 1995

“The problem is, of course, that not only is economics bankrupt but it has always been nothing more than politics in disguise … economics is a form of brain damage.”
—Hazel Henderson

More on the Unscientific Aspects of Economics including “Game Theory” (click to open)


Besides being the centerpiece of modern economics, Friedman’s known-false assumption of mathematical rationality is also used in “Game Theory!” The following BBC 17 minute video will explain the history and known-failure of Game Theory

The following study by Paul Glimcher illustrates the deliberate mis-characterization of facts by economists. D. G. C. Harper (the biologist who actually did the experiment) claimed that the ducks decided where to swim by responding to “environmental cues.” Glimcher is claiming that ducks decide where to swim by mathematically solving probability equations:


“Harper’s experiment was critical because it tested the idea that the ducks could reach this kind of stable Nash equilibrium.”—Paul W. Glimcher, 2002


“Nash Equilibrium” is a Game Theory model that is based on the known-false assumption of mathematical rationality. Biologists tell us that mathematical rationality could not have evolved. No animal decides what to do by dynamically solving math problems subconsciously:

“…neither human engineers nor evolution can build a computational device that exhibits these forms of unbounded rationality, because such architectures are impossible, even in principle.”—John Toby and Leda Cosmides


What about “Bounded” versus “Unbounded” Rationality?

“Another school of thought, whose theory of rationality is called optimization under constraints, has offered a possible escape from these interminable calculations. They recognize that computational resources are limited and that stopping rules are needed to determine when enough possible outcomes have been evaluated. To accomplish this, they suggest that we should evaluate whether considering each successive outcome justifies the additional computational costs of doing so. Now, this is not a solution! It compounds the problem by adding an additional layer of computation: Not only do the outcomes have to be evaluated, but also the benefits of performing each evaluation have to be weighed. Optimization tinder constraints requires even more cognitive resources than the approach it claims to simplify, and thus it represents just another version of unbounded rationality.

Gigerenzer and Todd’s alternative to these computational nightmares is what they call bounded rationality. It explicitly recognizes that computational resources are limited and that speed is often critical in real-world decision situations. Thus evolution should build what Gigerenzer calls fast and frugal heuristics that solve real-world problems quickly with a minimum of information. A heuristic could be a simple rule of thumb (for example, if it’s bigger than a bluejay, it’s probably a hawk), or it may involve a few more steps. But the computationally bulky approaches of unbounded rationality and optimization under constraints are far too complex to qualify as heuristics.”—EVOLUTIONARY PSYCHOLOGY


Maurice Allais falsified in Game Theory in 1952! In fact, people consistently fail to act according to Game Theory models in repeated experiments (e.g. the Ultimatum Game). However, that fact that the model fails consistently, has not changed the assumption of mainstream economists:

“In a classic experiment, Harper (1982) tested the ability of a flock of ducks to achieve a stable Nash equilibrium when fed balls of bread.”—J. M. Gowdy, 2007    ( Nash was insane.    Game theory is propaganda at its finest! )

Mathematical rationality and Game Theory were falsified in 1952! Yet eight game theorists have won Nobel prizes in economics. John Maynard Smith was awarded the Crafoord Prize for his application of game theory to biology. Yet, Game Theory does not describe how any animal makes decisions:

“A test of the theory’s validity was presented to Savage by Maurice Allais over lunch, during a conference in Paris in 1952. Allais made Savage fill out a list of questions with which he could show that Savage violated his own theory. The history of Allais’ paradox (as it became known) is in itself intriguing. It seems that several other researchers, amongst whom Friedman, when presented with the same questions some months later passed the test.

“Furthermore, the Allais paradox remained practically unknown until some twenty years later. But what was decisive for subsequent developments in economics and psychology, was that Savage took the critique of Allais seriously whereas Friedman, as far as I can tell, put the whole subject aside. Friedman left EUT as a basis for decision and game theory without further comments as a positive (as-if) theory; Savage retreated into a normative account of the theory.”

Download the entire paper at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=956887

More on Friedman’s world-destroying lie, which ultimately became know as the “F Twist,” can be found here: http://www.debunkingeconomics.com/Sample/method.htm#F-twist

Humans cannot maximize. Therefore, the market is not efficient. Therefore, the world does not need economists!


Everything you ever wanted to know about economics can be found at:
http://www.debunkingeconomics.com/lectures/
http://www.jayhanson.org/_Economics/TheDeathOfEconomics.pdf
http://www.jayhanson.org/_Economics/Nitzan and Bichler - Capital As Power.pdf


AGAINST MECHANISM: Protecting Economics From Science, Philip Mirowski, 1988;

[p. 6 ] “Chapters 2 and 3 demonstrate that is was not so much the methods of science that were appropriated by the early neoclassicals as it was the appearances of science, for the early neoclassicals possessed a singularity inept understanding of the physics that they so admired. Chapters 1 and 2 also introduce the crucial concept of economic conservation principles, perhaps the most neglected and yet most significant clue to the scientific pretensions of neoclassical economic theory.

“Another antidote to the widespread ailment of scientism in economics is an examination of the various philosophical preconceptions that are freighted in as part of an unthinking acquiescence to ‘mathematical rigor.’ In Part 2 the relationship of the first institutionalist program in economics to mathematical models is examined from various angles and aspects. First, the assertion that there is a ‘New Institutional Economics’ of an orthodox cast is evaluated in Chapters 4 and 5. Basically, the argument there is that neoclassical economists have tried to preempt the questions of the institutionalist school by attempting to reduce all social institutions such as money, property rights, and the market itself to epiphenomena of individual constrained optimization calculations. All these attempts have failed, despite their supposed dependence upon mathematical rigor, because they always inadvertently assume what they aim to deduce.”

[pp. 45-48]

JEVONS’ SUNSPOTS

Macroeconomic Instability and the ‘Natural’ Process in Early Neoclassical Economics

“It may seem odd to disinter an economic theory—in this instance, William Stanley Jevons’s claim that sunspots caused macroeconomic fluctuations—which no one now believes or much cares about. In fact, my purpose is not to scoff at a dead theory, but to use it as a pretext to discuss the following issues: economic historians often have suggested a dichotomy between a premodern and industrial macroeconomy, with the premodern economy largely at the mercy of weather and other natural phenomena; this dichotomy is rooted in early neoclassical economic theory (here restricting ourselves to Jevons); there is little historical evidence that premodern macro fluctuations were caused by natural disturbances, such as the weather (here restricting ourselves to the case of England); and the above three theses have some interesting implications for the way economic policy is conceived, both then and now.

“William Stanley Jevons, in his 1870 Presidential Address before the British Association for the Advancement of Science, Section F, lamented that, ‘There is no one who occupies a less enviable position than the political economist. Cultivating the frontier regions between certain knowledge and conjecture, his efforts and advice are scorned and rejected on all hands.’ Although this may prompt nods of assent in the 1980s, it is important to understand the historical context of such complaints. As he said later in the same address, ‘The growth of the arts and manufactures and the establishment of free trade have opened the widest means of employment and brought an accession of wealth previously unknown… Nevertheless within the past few years we have seen pauperism almost as prevalent as ever, and the slightest relapse of trade throws whole towns and classes of people into a state of destitution little short of famine.’

“The problem of English political economy in the 1870s was its firm association with the doctrine of free trade, which in turn was a direct corollary of the fundamental theoretical principle that unfettered market structures were a superior means of organizing production and distribution. In periods of buoyancy such a stance was easy to defend; but by the 1870s doubts became more insistent in England: doubts about the stability of market organization, which resulted in sharp aggregate fluctuations, and doubts about the long-term efficacy of free trade due to the successes of Britain’s foreign economic rivals. Jevons personally had felt these chill winds when his father’s iron firm was bankrupted in 1848, and his family bore the stigma of being the ‘poor relations.’ This experience did not sour Jevons on free trade and the efficacy of market organization, however, because he felt that by hard work from an early age he had managed, in the face of adversity, to improve his station in life, and further that such an avenue was open to all who would but avail themselves of it. In practice, the early Jevons responded to the mistrust of political economy by blaming the victims. But, as he soon came to understand, that was not a winning strategy.

“All of Jevons’s innovations in economics—his pioneering efforts in marginalist price theory, his work on the Coal Question, and his sunspot theory—may be understood as a unified rational response to the increasing skepticism about political economy in Britain. Economists in the late twentieth century tend to view the innovations in price theory as Jevons’s crowning achievement and the sunspot theory as some unfortunate lapse, or even an embarrassment. Indeed, for some the sunspot theory has attained the status of joke, whereas for others it is a cautionary parable concerning the pitfalls of inductive argument. All of these interpretations are much too facile, because they ignore the unified thrust of Jevons’s theoretical project. In short, his project was to portray the market as a ‘natural’ process, so that doubts about its efficacy would be assuaged, or at the very least, countered by scientific discourse. The ultimate object was to reconstruct the foundations of the case for free trade.

“In the case of neoclassical price theory the evidence for this thesis is extensive, but would be superfluous in the present context; in any event it is summarized above. Briefly, Jevons’s price theory laid claim to scientific status because it was identical in mathematical form and analytical content to the physics of the mid-nineteenth century, which is sometimes referred to as ‘energetics’ by historians of science. For our present purposes, it is only necessary to survey the broadest implications of this stratagem. First, it drew a direct analogy between economic transactions and transfers of energy, which subtly endowed the transactions with the ‘natural’ ontological status of the transfers. Second, it encouraged specialization within economics and the cultivation of an internal language (mathematics), which served to buffer the discipline from the intrusions of lay critics. Third, it demonstrated that market processes maximized utility in a regime of free competition, thus implying that no improvement was possible through conscious intervention in production and exchange. These were a much more formidable set of defenses of the doctrine of free trade than those provided by the demoralized and disheveled remnants of classical political economy.

“However, effective these new foundations, they did not address the most significant objection to British political economy: If free trade was such an able method of economic coordination, why did it result in such devastating contractions punctuating economic expansion? In this respect, Jevons’s sunspot theory was the necessary adjunct to his newly formulated price theory. If the market always functioned in an effective manner tended toward a configuration insuring maximum happiness, then there was only one obvious way to explain the incongruity of the misery and suffering of depressions. The natural operation of the market could only be deflected or stymied (although never fully neutralized) by another opposing ‘natural’ force—here Jevons proposed that macroeconomic fluctuations and credit crises were caused by meteorological disturbances, ultimately caused in turn by variations in sunspot activity. The advantage of this sort of explanation was that no one was to blame, or as Jevons put it, ‘We must not lay to the charge of trades-unions, or free trade, or any other pretext, a fluctuation of commerce which affects countries alike which have trades-unions and no trades-unions, free trade and protection; as to intemperance and various other moral causes, no doubt they may have powerful influence on our prosperity but they afford no special explanation of a temporary wave of calamity.’ The issue of macroeconomic instability, then, could not be used as an argument for protection, for instance, since the cause fell on all countries indifferently as a natural state of affairs. To my knowledge, no one has adequately explored the hypothesis that the English retained their allegiance to free trade long after the Continent did because they, unlike the French or Germans, persisted in seeing economic relations grounded in a physical (and not physiological) analogy.

“Throughout his life, Jevons subscribed to the principle that macroeconomic fluctuations were of natural origins, but he encountered great difficulty in fleshing out the theory. His first article on the subject in 1875 tried to establish that English grain prices from 1254 to 1400 cycled with a period of 11 years. Because astronomers at that time believed that sunspot activity also rose and fell in cycles of 11.1 years, he asserted that the coincidence of periodicities implied that observed price fluctuations were caused by exogenous shocks. Of course, this was a very flimsy argument, as Jevons was well aware: he could not cite sunspot data contemporaneous with his fourteenth-century price data. Objections that would daunt the less resolute were not sufficient to restrain him: ‘I am aware that speculations of this kind may seem somewhat far-fetched and finely wrought; but financial collapses have occurred with such approach to regularity in the last fifty years, that either this or some other explanation is needed.’

“What was needed was some connection between the existing sunspot data-the Wolf Zurich relative sunspot numbers, beginning in 1749—and some contemporaneous indicator of economic activity. Jevons openly admitted that he had attempted to find a regular periodicity in the prices of European grains in the eighteenth and nineteenth centuries, but the search had failed. His next tactic was to assert the existence of a very stable 11-year period between English credit crises, and to suggest that the equality of periodicity with that of the sunspots was sufficient evidence to infer causality. This argument hinged crucially upon the claim that there was a clockwork regularity in the appearance of crises in England; and it was to this thesis that Jevons committed much intellectual effort. He produced one list of the dates of credit crises in 1877-1878, but then received the unpleasant surprise that astronomers had repudiated their earlier estimate of the periodicity of the sunspot cycle, revising the estimate to read 10.45 years. Again Jevons was not to be frustrated in his quest. He simply redefined a few of the dates of his ‘crises’ so that the average interval became equal to 10.5 years. His final list of crisis dates (with those Jevons indicated as doubtful in italics) were: 1701, 1711, 1731-1732, 1742, 1752, 1763, 1772-1773, 1783, 1793, 1804-1805, 1815, 1825, 1836-1839, 1847, 1857, 1866, and 1878.

“At this point, Jevons became the butt of some ridicule: one example was a satirical statistical study showing that the periodicity of winning Oxbridge teams in collegiate boat races was the same as that of sunspots. Other more serious challengers pointed out that Jevons’s conception of crises, as revealed in his choice of dates, was so vague as to admit of any and all interpretations. He responded by maintaining that he was simply proposing the following working hypothesis: ‘A wave of increased solar radiations favorably affects the meteorology of the tropical regions, so as to produce a succession of good crops in India, China, and other tropical and semi-tropical countries. After several years of prosperity the 6 or 800 millions of inhabitants buy our manufactures in unusual quantities; good trade in Lancashire and Yorkshire leads the manufacturers to push their existing means of production to the utmost and then to begin building new mills and factories. While a mania of active industry is thus set going in Western Europe, the solar radiation is slowly waning, so that just about the time when our manufacturers are prepared to turn out a greatly increased supply of goods, famines in India and China suddenly cut off the demand.’

“In his published work, Jevons also stressed that it was the long credits given in the Eastern trade that provided a transmission mechanism for the financial credit crises. The explanation was actually much more popular than we today might think, because it resonated with an ethos of the "white man’s burden" prevalent in the popular English culture of the 1880s and 1890s. Jevons capped this narrative in 1879 by publishing a series of wheat prices from Delhi, 1763-1834, which he claimed displayed the sought-after periodicity and corresponded to his chronology of crisis dates. From 1879 to his death in 1882 he published nothing further on the subject, but his correspondence reveals that he persisted in his defense and employment of his sunspot theory in discussions of macroeconomic fluctuations.”


[ pp. 150-151, SCIENCE, RATIONALITY, AND NEOCLASSICAL ECONOMICS, L.D. Keita; Delaware, 1992.]

“The bulk of this text was taken up with examining the claims of neoclassical economic theory to scientific status. Given contemporary views on the nature of scientific theory, I examined neoclassical economic theory in terms of both its historical and contemporary phases. I demonstrated that the cardinal theory of utility that formed the foundation for early neoclassical theory foundered on account of its inability to measure utility in any acceptable scientific way. Its substitute, the ordinal theory of utility, was shown to be equally unacceptable. The scientific pretensions of ordinal utility theory and its correlate, revealed preference theory, were shown compromised by the normative structure of the foundational postulate of rationality. The unscientific nature of ordinal utility theory was further shown to be reinforced by the insulating role played by the ceteris paribus proviso.

“This general critique was extended not only to the neoclassical theory of individual agent choice but also to general equilibrium theory and positive neoclassical welfare economic theory. Given the general dissatisfaction with neoclassical theory, a number of alternative theories have been proposed, but the problem with the latter is that, with few exceptions, they are founded on the premise that an objective science of economics is still possible despite its present failings. I pointed out the shortcomings of those theories and argued that on account of the nature of human decision making, no analysis of it could be scientific in the way in which the natural sciences are scientific. Mental states that must be invoked to explain behavior are just not subject to empirical analysis. The attempts by theorists to establish explanatory theories by appeal to heuristic concepts such as rationality were shown to be unsuccessful. The point is that ‘rationality’ plays a normative role similar to that of ‘goodness’ in ethical theory.

“The sociologist can indeed record the behavior of individuals in terms of cultural norms of ‘goodness,’ ‘badness,’ ‘deviancy,’ and so on, but he or she must recognize that theories of behavior founded on such concepts are necessarily normative. Similarly, the neoclassical theorist who embraces a particular notion of rationality and grounds his or her theories on such a notion is certainly formulating a normative theory. My analysis showed that the neoclassical theorist of economic behavior is confronted with the dilemma of restricting his or her analysis to a case-by-case taxonomy of individual agent choice, given the inaccessibility to mental states, or grounding his or her explanatory theories on the normative heuristic of rational choice. Neither alternative yields scientific results.”


Here Nobel Prize-winning economist Milton Friedman demonstrates his duplicity in an interview:

Ravaioli: But there are many other environmental problems…

Nobel Laureate Friedman: Of course. Take oil, for example. Everyone says it’s a limited resource: physically it may be, but economically we don’t know. Economically there is more oil today than there was a hundred years ago. When it was still under the ground and no one knew it was there, it wasn’t economically available. When resources are really limited prices go up, but the price of oil has gone down and down. Suppose oil became scarce: the price would go up, and people would start using other energy sources. In a proper price system the market can take care of the problem.

Ravaioli: But we know that it takes millions of years to create an oil well, and we can’t reproduce it. Relying on oil means living on our capital and not on the interest, which would be the sensible course. Don’t you agree?

Nobel Laureate Friedman: If we were living on the capital, the market price would go up. The price of truly limited resources will rise over time. The price of oil has not been rising, so we’re not living on the capital. When that is no longer true, the price system will give a signal and the price of oil will go up. As always happens with a truly limited resource.

Ravaioli: Of course the discovery of new oil wells has given the illusion of unlimited oil …

Nobel Laureate Friedman: Why an illusion?

Ravaioli: Because we know it’s a limited resource.

Nobel Laureate Friedman: Excuse me, it’s not limited from an economic point of view. You have to separate the economic from the physical point of view. Many of the mistakes people make come from this. Like the stupid projections of the Club of Rome: they used a purely physical approach, without taking prices into account. There are many different sources of energy, some of which are too expensive to be exploited now. But if oil becomes scarce they will be exploited. But the market, which is fortunately capable of registering and using widely scattered knowledge and information from people all over the world, will take account of those changes. [ p. 33, ECONOMISTS AND THE ENVIRONMENT, Carla Ravaioli; Zed, 1995]

(In fact, none of the Club of Rome’s predictions has failed. Economists like Friedman routinely lie to further their global political agenda.)

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