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 in understanding the economy, is not the simple either-or-not- but the either-or-what: if not, then what? It is simply not the case that our choices and actions are binary with only two outcomes: nothing or something. The outcomes are always something’s, simply because we don’t have unlimited resources and therefore, should we choose not to pursue one end, we revert to the second most highly desired end – individually, cooperatively, or collectively.
In other words, if I don’t use a certain resource in one way, I or someone else will use it in some other way. I either purchase an automobile or do something else with those funds. What I do instead also affects the economy: if I save the money in a bank savings account, I earn interest, the bank lends the money to someone else (at a profit), and that someone else invests those funds in something (perhaps an automobile, but perhaps not). It is simply not the case that the outcome of my decision makes an automobile magically appear as part of my property – or not. I give up something to purchase the automobile (a trade-off), and my choice to or not to affects the market through changing supply and demand and, consequently, prices.
This is what is meant by the endogeneity of any economic system: its structure and changes depend on factors that already exist within it. Due to this, the simple logic doesn’t apply: it is not either-or-not but either-or-what. This dynamic of the market place can be difficult to understand if one has not already made explicit and realistic assumptions about what people do and why they do it. The power of economics is the realization that society is endogenous and that people act in their self-interest. While the latter is often criticized or even scorned, though almost always on false assumptions, the former (and especially its implications) is practically unknown.
That people are motivated by their self-interest must be understood endogenously, which is how economics properly uses the concept. It follows directly and logically from the easily established fact that people act and make choices – and that they can never choose everything they fancy, so there is a trade-off and ranking of values. Since we choose, we obviously must value the anticipated outcomes of those choices – and we value them differently. Self-interest really only means that you make those choices for a reason, and since you have a reason for the choice (it is not unconscious and random) it is in your interest. What you consider to be your interest, and whether you’re right (however this is determined), is of no relevance for economics: we study the outcome of these choices on the overall allocation of productive resources in society.
To use an illustrative example of faulty economic logic, consider the discussion on our “dependence” on oil (or, more generally, fossil fuels). Environmentalists argue that “we’re running out” of the resources and therefore that economic growth is fundamentally unsustainable. This claim is based on very simple logic of the type noted above, which is inapplicable for economic analyses. The reason for this is that the very concept “resource” suggests a value in use; it also suggests a trade-off and a cost (primarily opportunity cost). It’s an economic concept and therefore subject to economic reasoning. It is valued and valuable because it serves as a means toward some end; should our preferred ends change, the availability of oil – or its substitutes in production – change, it may no longer be valued. Just like a horse and carriage was highly valued for transportation before the automobile, and just like gasoline-thirsty automobiles are valued until they’re not (whether there’s a suitable alternative, which is likely to emerge, or our preferences for transportation simply just change).
Peak oil, the theory that says that at some point the rate of oil extraction will fall and eventually reach zero as we consume the non-renewable fuels is a great example of completely failing to understand economic reasoning. It is based on the assumption that the need and use for oil is a constant and that we therefore will “run out.” But that is true only if there are no trade-offs and no choices, which clearly is not the case. When one technique of extraction can no longer satisfy demand, prices go up. But this causes, at the same time, consumers to limit their consumption and capitalists to increase their investments in finding and developing alternatives (both alternative sources of energy, and new oil extraction methods). There is therefore no problem of “running out” of oil, which the environmental movement tends to assume. We are also not dependent on oil just because we use it heavily today.
The real problem here is when the dynamic change process is hindered: when, for example, the extraction of oil is subsidized or alternatives directly or indirectly made more costly or even prohibited altogether. Such measures, always taken by government (since they’re the only institution able to enforce such measures), manipulate the working of the economy so that consumers’ demand becomes disconnected from investments in supply. In other words, our choices become much more limited and therefore we cannot act toward the most highly desired ends (if we can even identify which are more valuable). This state of affairs is a fundamental case of waste: we use resources in suboptimal ways, get stuck with old and comparatively inefficient production techniques, and get much less prosperity than would otherwise be the case.
These truths are easy to see, and following the logic is not difficult, but requires that we have already understood that an economy is endogenous and therefore requires a process logic rather than the static and simple either-or-not logic. Maintaining that self-interest is an objective rather than subjective concept, that choices are technology- rather than value-based, that there is no opportunity cost, are all quite severe misconceptions that are inapplicable in economics.
To properly deal with the issues identified by environmentalists, socialists, conservatives and others, we need to first realize that the economic system is endogenous and that, therefore, we cannot use the simple either-or-not logic. Understanding of the dynamic market process necessitates an either-or-what logic, a process view.
Structured, rational thinking about community, cooperation, and the market