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Structured, rational thinking about community, cooperation, and the market
The Process Logic of Economic Reasoning

The Process Logic of Economic Reasoning

For anyone who has already acquired the skill, economic reasoning appears to be so obvious that it requires no explanation. But to anyone who has not yet learned this logic, it can appear all but intuitive – perhaps even unreasonable. The reason, I have come to understand, is the dynamic nature of any economic setting, which necessitates a process logic. While most people have no trouble with simple logic, where for example x -> y -> z and therefore x -> z, everything is typically interrelated and, to some degree or in some sense, interdependent in an economy. The market process, in other words, has no constant relations and therefore simple logic may be inapplicable. This can be easily illustrated by the core economic concept opportunity cost, which pinpoints that every choice and action in a very real sense constitutes a trade-off. Simple logic in an unconnected (or, in a sense, exogenous) world would consider choices as “either-or-not.” I either purchase an automobile or I don’t. The economy is either dependent on oil or it is not. A plant either produces plastic or it doesn’t. This type of logic is inapplicable in economic reasoning. What matters to an economist, by which I here mean anyone interested…

What It Means to ‘Maximize Profit’

What It Means to ‘Maximize Profit’

Economists are often accused by members of the general public, political pundits, and others for being overly simplistic, using outrageously foreign assumptions, and being too narrow in scope. It isn’t all about money, they (non-economists) tell us (economists). Right, it isn’t. Some of this criticism is unfortunately accurate. Looking at what goes as economics nowadays, it is hard to draw a line between economics in practice and the straw man of the discipline. In this sense, the criticism is about as accurate as economists can expect – and deserve. Yet economics is much larger than the mainstream “mathturbation” with formalized models. What is generally taught in the “principles” courses is the economic way of thinking, the economic reasoning that is the supposed origin of the streamlined models. This is at the heart of economics, and the concepts and rationales taught to freshmen and sophomores in college is in fact much more important than being able to recite Hotelling’s lemma or mathematically prove ne econometric model or the other. We cannot learn about the world from a formalized, mathematical model: a model is always of the crap in-crap out kind – it isn’t better than the reasoning and assumptions on which it is built. (This…

Understanding Resources

Understanding Resources

I have recently experienced a discussion with environmentalists, which was as frustrating as it was educational. The discussion started around the concept of economic growth, to which environmentalists are often ideologically opposed, but quickly turned into a rather cross-paradigmatic attempt at educating the other side really only talking past each other. I, as an economist, was quickly dismissed by the environmentalists for being an economist and for that reason “fundamentally naïve” and “completely in lack of knowledge” of economics. The reason? I did not realize, they claimed, the strictly physical limitations to economic reasoning. While I didn’t take their word for it, which is hard to do when being lectured in my own area of expertise, they also refused to consider what I had to say. The difference here is that both sides talked about my expertise: economics. While they were beyond reach of any theory or argument, it quickly became clear that the problem was their environmentalist understanding of what makes a resource. To them, a resource is strictly its physical composition – wrapped in economic terms. What they argue is really a fundamental contradiction that emanates from a limited understanding of something of a straw man type of economics. This…

Fractional Thinking about Banking

Fractional Thinking about Banking

In a very long article in today’s Forbes, online edition, John Tamny writes on the Closing of the Austrian School’s Economic Mind. Tamny finds the “modern evolution” of the school “disappointing” in its “more and more … statist, monetarist” appearance. He especially addresses the never-ending debate on fractional reserve banking (and manages to find a single misspelling in an article referring to “fractural” such, which he makes fun of), and the “error” of Austrians who see something wrong with it. One cannot create money, Tamny informs us, so banks don’t. I must admit that I haven’t read all of Tamny’s very long article, but that should not be considered a problem for two reasons. First, because Tamny starts out making outrageous errors due to assumptions that are so clearly in line with his critique (and so unknown to him) that they cannot be corrected further down. And second, because Tamny himself obviously haven’t read much more than a couple of phrases spewed out by a quick google search. Nevertheless, I think my addressing these assumptions made by Tamny are relevant whether or not he (which is likely) adds more “errors” of Austrians to his list. Let’s look at what Tamny says. Regarding…

What Is Economics?

What Is Economics?

A lot of people seem to believe that economics is the study of how one makes money. It is difficult to understand where this notion comes from, but since the price mechanism is prevalent and fundamental to what makes a market, perhaps the layman’s definition isn’t completely wide of the mark. However, money is neither necessary nor sufficient for the study of economics. Economics studies value, for which money may be a proxy. But a proxy is not that which it represents, just like a receipt may represent or even prove a purchase but isn’t, in itself, the purchase. Wikipedia notes JB Say’s classic definition of economics as the study of production, distribution, and consumption of wealth. Wealth denotes created and (justly) acquired value. It may be in the form of money, though money is really a means to and in fact a claim to (future) wealth through goods and services. Someone might argue that focusing on goods and services is too narrow, that there are other dimensions of wealth, and that it is too materialistic. It is true that such an interpretation is possible, but it is not accurate. Value lies not in the physical nature of “stuff,” but in our intended…

What Is Entrepreneurial Judgment?

What Is Entrepreneurial Judgment?

While Israel Kirzner asserts “alertness” as a quality among entrepreneurs that allow them to recognize (and then correct) errors through arbitrage, others (like Nicolai J. Foss and Peter G. Klein) rely on “judgment” as the distinctly entrepreneurial quality that explains success. While the latter is arguably a thicker conceptualization of what entrepreneurship entails than the former, both are supposedly derived from Ludwig von Mises’s theorizing on the entrepreneur as the “driving force” of the market – the “creator” of the market process. Kirzner’s “alert” entrepreneur has been both adopted and reinterpreted in the mainstream entrepreneurship literature (see here, ungated version here). So there is a lot of literature attempting to understand (and sometimes misunderstand) the concept, and Kirzner himself has published several books on this topic trying to clarify what he means. But what is entrepreneurial “judgment”? The original discussion on entrepreneurship as “superior” judgment can be found in Frank H. Knight’s dissertation (and book) Risk, Uncertainty, and Profit. But while the discussion is interesting, it isn’t all that helpful in terms of defining the quality. Rather, it comes across as almost a residual (though front and center) as entrepreneurship is often interpreted in Schumpeter’s Theory of Economic Development. But…

Diminishing Marginal Utility – What Does It Mean?

Diminishing Marginal Utility – What Does It Mean?

Economists talk about diminishing marginal utility, which is a generic way of saying that we value stuff less the more we already have of that particular “stuff.” In other words, if I have three eggs, a fourth egg is worth less to me that the third one (which is worth less than the second one, which is worth less than the first one). Perhaps you buy this without need for further argument, but many don’t. And the concept is actually problematic unless we already think as economists. The reason for this is that when illustrating economic problems we tend to use everyday examples that anyone understands, but the intuitive materialism of people’s thinking potentially undermines the economic case. In order to understand what diminishing marginal utility means, one cannot think solely about physical goods but about their “nature” as subjectively appreciated by a specific person. To put it differently, we are not discussing physical items but economic goods. An economic good is simply a scarce (or believed scarce) means that is usable toward an appreciated end. This is a fundamentally important point – in the example above, an economist isn’t really talking about eggs, but lets eggs illustrate a commonly traded good that…

Insurance, What It Really Means

Insurance, What It Really Means

America has become known worldwide for a high-quality failing health care system. As a foreigner moving to the United States, the enormous cost (to consumers) of health care and dental care are mind-boggling. Even with very expensive health care insurance offered through employers (and, lately, by government decree), one ends up paying quite a bit out of pocket. And pretty much all insurance policies include a maximum lifetime benefit amount as well as a cap for treatments. This raises a very interesting – but seldom raised – question: what is insurance? To make sure we are all on the same page here, let’s compare private health care insurance between two countries I have recent extensive experience living in: the United States and Sweden. In the US, my health care insurance costs some $200/month and covers, after a $20 deductible, about 80% of treatments with a lifetime benefits cap of $250,000. In Sweden, I would pay about $1,600 per year for worldwide coverage of any “reasonable” (meaning approximate market prices, that is non-usury level) expenses with no lifetime benefit cap but limited to $300,000 per treatment (only if outside of Sweden) and with a higher deductible ($90). So here we have it,…

Real Science Is with the Critics

Real Science Is with the Critics

Science is becoming ever more politicized. Or perhaps it always was, but we’re only now finding out thanks to hyper communication via the Internet. In either case, it makes it necessary for a consumer of ostensibly true (or at least fact-based) reporting to have a critical mind and be careful about the source of a claim or “fact.” Unfortunately, it is almost impossible to get a balanced view from someone else, so one must figure some kind of short hand for finding truth. This is vital when consuming debates with political implications (or even claims), and a lot of what is written nowadays is just that. I propose that one should, as a rule of thumb, listen more carefully to the critics, not the supporters. Why do I say this? Simply for this fact: the real scientific contribution is stressed by critics – it is seldom even considered by supporters. I realize this may sound unfair, but it appears to be true at a read the critics to get an idea of the claim.as worth. But do not read commentary by supporters, since they will hardly ever discuss the scientific worth of an argument, but the advantage of the politics derived from…

Austrian Economics is Not More of the Same

Austrian Economics is Not More of the Same

Whether or not it is true, as they say, that they first ignore you, then ridicule you, then attack you, and then you win, the financial crisis as well as Ron Paul’s candidacy for becoming the republican party’s presidential nominee have made Austrian economics somewhat of a household name. So it is no longer ignored, but it is certainly is both ridiculed and attacked (more of the latter more recently). So if Gandhi was right, then we’re transitioning from ridicule to attack. An example of such an attack is a (rather unbelievably ignorant and disturbingly dishonest) hit piece by Noah Smith, a professor of Stony brook university who’s dedicated to his career as an internet troll (as “Noahpinion”). I took a previous piece of his apart over at the Mises Institute blog a couple of months ago, to which he responded on Twitter as a true troll (in stark contrast to a true scholar) saying he would not even read my rebuttal because the post’s title wasn’t sufficiently original or witty. (He later deleted his tweet, but my initial and response tweets still exist…) Apparently the attention only made Smith more dedicated to trolling. His hit piece on Austrian economics as “brain worms”…

It Is Best to Ignore Economists

It Is Best to Ignore Economists

This may sound strange, coming from an economist, but it is unfortunately quite true that we would all be better off not listening to economists. What I mean by this is that economics over the past eight or so decades has been misguided and therefore blind, which means pretty much everything economists have to offer in terms of explanations, predictions, and policy recommendations are… wrong. I have already argued (for example, here and here) that the method used in economics is wrong because it is the so-called Scientific Method (better capitalized) that is a pretty good fit for the natural sciences but a disaster in the study of social phenomena. The reason for this can, though it is a gross simplification, be illustrated by the fact that the Scientific Method relies on experiments that are repeatable and rely on comparatively simple causality. You can let a stone roll down a hill and measure the gravitational pull as well as frictions and other things. You can even take the same stone from the bottom and place it at the top to do it again. If you take human beings and put them through a specific experiment they may behave in a…

The Great Problem of Planning

The Great Problem of Planning

The issue of economic planning has been a major component of Austrian theorizing since Mises’s 1920 article on the impossibility of calculating in a socialist commonwealth. But as both Mises and Hayek noted, the position is not one against planning per se but about who does the planning. Ronald Coase made a similar point, though from the very opposite perspective, saying that there is a large degree of planning even in market economies – but it is decentralized (through firms). Whatever we may think of the concept in economic or political terms, planning is a core part of human endeavor. In fact, it is the reason we are vulnerable to changes in nature and that we spend vast sums on trying to stop more or less natural processes. The reason is that we develop capital, and the capital structure (a path-dependent, cumulative development of the prerequisites for production) is productive only by being specific – and therefore lacking in flexibility. This is the reason natural changes are so very costly. Consider as an example a city harbor in the delta of a large river, which supplies a great service to people in the city as well as upstream the river and, likely,…

When the Market Suffers a Specialization Deadlock

When the Market Suffers a Specialization Deadlock

Whereas economic theory, especially the Austrian variety, discusses and ‘problematizes’ the coordination of plans, interests, and production in the market, these theories tend to emphasize generalized phenomena and, consequently, aggregates. For instance, Hayek’s interesting and highly relevant Pure Theory of Capital provides well over 400 pages discussing the intricacies of capital, production, and entrepreneurship. Yet Hayek never gets to the bottom of things. He only talks about production structures, processes, investments, and interest rates. When the interest rate (which he, in stark contrast to Moses, defines as the return on capital) changes, how does this affect the production structure? The question is important, but Hayek (as many economists, including Austrians) discusses adjustments in the market as though they are automatic – without specific or at least important problems. But this is not the same world as individual actors face. The latter never deal with aggregates, and therefore the problems that do not emerge on the aggregate level (for instance, when “adjusting a production process”) can in fact be prohibitively costly or difficult to overcome. One such potential problem is the lack of density through the division of labor, which effectively makes implementations of innovations activities that take place outside the market and…

Economists Do It With Models

Economists Do It With Models

It is funny, really, how the general perception of economists is that they are math geeks who simply draw conclusions (that is, inductively) from statistical data. Whereas there may be some truth to that, what is it in the math and stats that make economists different from other social scientists? What is it that makes such economics economics? To say that economists do it with models is not really to point to an obvious distinction from other social scientists. Anyone going through advanced studies in political science, business management or (yes, even) sociology have to take courses in advanced statistical analysis (though they’re called different things: econometrics, psychometrics, and so on). So “doing it with models” is hardly an economics deal – it is a scientistic deal, it is how “we” do research in this highly positivistic, empiristic day and age. It is distinct for economics in one way only: economics was the first of the social sciences to seriously adopt the “mathods” of the natural sciences. And, sort of consequently, economics therefore has the most developed and advanced methods – which is why for example many doctoral students in business get to (must) study econometrics. But it is really…

Theory, Exaggerated or in Moderation?

Theory, Exaggerated or in Moderation?

F. A. Hayek notes in his introduction to Mises’s autobiography Memoirs that “considering the kind of battle that he [Mises] had to lead, I also understand that he was driven to certain exaggerations, like that of the a priori character of economic theory, where I could not follow him” (p. xx). The comment refers to the many setbacks and unfortunate developments that Mises experienced during his life. But the conclusion is very interesting, and parallels with a common sentiment in present science as well as public debate: the threat of extremism or radicalism. Hayek’s statement is very interesting from a theoretical point of view, since it subjects theorizing and science to a type of Aristotelian (okay, Nicomachian) moral standard. The latter is the well known golden middle, where e.g. courage is a virtue but deviating exaggerations in both directions are vices: neither recklessness nor cowardice are virtuous. It should be noted that these “exaggerations” of both ends of a virtue create vices not because the virtue is virtuous in moderation – but because the virtue itself is moderated by the unvirtuous extremes. It is not the case that the “middle” is necessarily better, just like the middle ground “hungry” is not…

What Economists Do Isn’t Economics

What Economists Do Isn’t Economics

Jacob Viner (1892-1970) famously claimed that “economics is what economists do.” While this is a fun play on words, it really means nothing at all. And this has become even more the case over the past decades as economists have almost completely turned their backs on their discipline’s history and tradition and instead gone “all in” with advanced-seeming statistical methods and mechanist design of economic systems through oversimplified models. Considering the over-use of mathematical notation and statistical mumbo-jumbo rather than economic logic, it is safe to say that whatever economists do is not economics. Or, at least, it is nowhere close to what economics used to be and always has been. There are two parts to this statement, both of which are equally interesting on their own: (1) the lack of proper methods and (2) the refusal to consider the real market in economic research. These are fundamentally related, and I have already treated the first of these points in other posts (see e.g. The Fundamental Importance of the Trade-Off). I doubt I will have to elaborate on the second point. Whether or not these points have been made sufficiently clear, they should at least suggest that there is a…

It’s Not About the Money

It’s Not About the Money

I would probably give my left arm to once and for all rid the world of all misconceptions about economics. One such frustrating misconception is how everybody assumes that “economy” necessarily has to do with money – and only money. Perhaps this is the reason why I, as an economist, frequently get asked about investment tips, how to “beat the market” on the stock exchange, and things like that (you really don’t want my investment advice). If anything “economy” is about money, then obviously an “economy-ist” knows how to make money. In a sense I do know how to make money. I understand the Federal Reserve. Seriously, however, there is some truth to the assumption that people make regarding economics. In our advanced specialized economy money is a central and very important institution. But money is far from the only phenomenon of import, so there is much more to economic theory than dollar signs. Money, as Menger showed in his 1892 essay “Geld” (On the Origins of Money), is important because it provides a vital function to the market: it radically lowers the cost of exchanging by relieving actors in the market from the double coincidence of wants limitation of barter trade.…

Ha-Joon Chang, Yet Another Economics Skeptic

Ha-Joon Chang, Yet Another Economics Skeptic

The Huffington Post recently published an excerpt of Cambridge University economist Ha-Joon Chang’s book Economics: The User’s Guide. It has then caused a little bit of a stir, mainly through progressive followers eagerly regurgitating some of Chang’s not-so-well-founded one-liners (this article, by almost ridiculously ignorant Tyler Darden, is a good example). But these regurgitations aside, it is interesting to look at the excerpt of Chang’s book and what it tells us about Chang and his view of economics. (I will not, out of respect for Chang, assume that the excerpt was chosen because it was one of the better parts of the book, though this may be an intuitive assumption.) Chang is a development economist, which may not mean anything to those who are not well versed in economic lingo and the academic study of economics. This particular field is one of the very few where central planning is hailed as not only possible – but preferable to market. Development economists overall look at how underdeveloped or developing nations can or should bring about economic growth, but they are as much proponents of schemes to raise health, education levels, and other “welfare” measures as they are in markets and economic…

The Mysterious Endowment Effect

The Mysterious Endowment Effect

The development of modern neoclassical economics is the story of how a discipline lost its way. Before the mathematization of economics, economists tried to explain prices and macro patterns in the market place from individual human action. But modern “mathonomics” has evolved into a subfield of mathematics with no obvious ties to the real economy. Assuming “perfect” conditions and general equilibrium, the conclusions of economic analysis follow directly from the premises — as one would expect from solving mathematical equations — and are hence of little scientific interest. It follows that phenomena in the real economy that do not seem to fit the “perfect” models should be dismissed as imperfections; what remains to explain is the causes of action rather than its effect. The task of economics has therefore shifted from explaining the effect of human action to tracking the causes of it. This radical shift suggests that we already know all there is to know about markets (at least to the limited extent predicted by mathematical models), while it provides a breeding ground for analysis of behavior instead of action. In other words, in order to track the ultimate causes of our mathematically precise economic models, economists shift focus…

The Fundamental Importance of the Trade-Off

The Fundamental Importance of the Trade-Off

Whereas the natural sciences study the physical world under the fundamental assumption that it is purely subject to the law of causality and therefore strictly laws-based, the social sciences wrestle a very different problem. In the social world, as Mises reminds us, there are no constants and no constant relations. This ultimately makes the mathematical, quantitative, and statistical methods of the natural sciences inapplicable (at best). Granted, there are many who disagree with Mises’s statement and that claim that even social phenomena are subject to quantitative analysis – that idiosyncracies are balanced out if the population studied is just big enough. There is perhaps an argument for the law of large  numbers in the sense that an “average” can be identified even in some social actions. But the argument must be based on the assumption that human action is rather evenly distributed in a bell curve. Yet why should this assumption be a reasonable starting point? The fact is that it appears reasonable only if we strip the study of the social world of the typically social aspects, i.e. of will, purpose, values and valuations, and intentions. If we study only “choice” (not action) and assume all necessary information is known…