Economics Is, Indeed, A Real Thing

Scott Adams asks if economics is a real thing.  My answer is that yes, it is, but that many people don’t really understand what it actually is.  Economics is not predicting what markets will do; economics, properly defined, is the study of human action, of catallactics.  Adams talks about a “newly expanded” definition of economics which “involves studying human behavior as opposed to business and money,” but I would counter by arguing that this is not a new definition at all.  Good economists were studying human behavior for centuries.  I’m not talking about Ludwig von Mises and FA Hayek; I’m talking about Nassau Senior and Richard Cantillon.  To be honest, I think that a study simply of “business and money” is not only a naive interpretation of economics, but economists are not investment advisors.  Actually, every good economist I’ve ever met has said the same thing:  they bet on the market, not on individual participants.  This is because they understand, first of all, that markets are reasonably efficient (even if we don’t all completely buy into Gene Fama’s arguments), and second of all, that economics has never truly been about individual stocks or even prediction; it’s about understanding and analyzing human behavior.

It’s Like Planned Economies Don’t Work Or Something…

(Via Mike Munger)

When the government starts mandating that organizations use things which don’t exist, you have problems.  This kind of idiocy—and then following through on fines because organizations didn’t buy something which didn’t exist!—is a natural outcome of government control.  The major difference between the US and USSR in this case is that at least the government officials in charge of the businesses knew the game well enough to lie through their teeth…

Free Currency Competition

Larry White has a great write-up of the Free Competition in Currency Act of 2011.  It’s important that he notes that it would not eliminate the USD, or even the Federal Reserve’s role in currency markets.  Rather, it would re-create the open competition which existed for over a century in the United States.  The best part about this act is that it does not mandate anything either way.  If people decide that they want to use only Federal Reserve USD, they are free to.  But if there are better alternatives, people are free to switch.

One problem that I could see is that the elimination of the USD as applicable to “all debts” is that there could be higher transaction costs in negotiating currencies.  This would also require that the Supreme Court not try to re-establish Juilliard v. Greenman.

In The Papers: Those Dishonest Economists

I have a lot of respect for George Selgin’s academic research, and his paper entitled Those Dishonest Goldsmiths is a good reason why.

Abstract:

Modern accounts of the origins of fractional-reserve banking, in economics textbooks and elsewhere, often assert that London goldsmiths came up with the idea around the middle of the 17th century, and first implemented it by clandestinely lending coin that they were supposed to keep locked away in their vaults. I assess the veracity of this claim by examining contemporary, circumstantial evidence bearing upon it, and also by considering the circumstances under which, according to English legal doctrines at the time in question, goldsmiths were entitled to lend coin that had been surrendered to them. I conclude that the goldsmiths were almost certainly innocent of the crime for which they are so frequently accused, and that the accusation may well have taken shape through later writers’ confusion of (1) crimes other than embezzlement of whichgoldsmiths were accused by their contemporaries and (2) documented embezzlement of stored coin, not by goldsmiths but either by the British crown or by merchants’ servants.

Goldsmiths are believed to have pioneered fractional reserve banking in the 17th century (1).  This is a myth, but is very popular (2-4), including for many Austrians (4-5).  The basic idea is that jewelers and goldsmiths would hold gold (in coin and non-coin forms) in safes.  They realized that the gold is just sitting there, waiting to be collected.  So what’s the harm in lending out this gold in the meantime, earning a bit of interest back at low risk? (2)  People who tell this story talk of “warehouses” and goldsmiths who charged “storage fees,” implying that the smiths were embezzling or at least performing shady activities.

In reality, that entire story is almost entirely backwards.  Fractional reserve banking dates back at least to medieval northern Italy, and possibly even to ancient Rome or Greece (6).  Furthermore, there are no facts supporting the embezzlement claim (6).  There are, however, facts which go against the claim.  For example, instead of charging “storage fees,” goldsmiths paid out interest, or at least did not charge fees to holders.  This implies that people believed that the goldsmiths were getting something out of the arrangement.  Furthermore, there is no court testimony on the books for claims of embezzlement (6-7).  Considering that most goldsmiths at that time were Jewish, and considering that Screw the Jew was a European pastime, it would seem that if this line of legal argument held any validity, somebody certainly would have used it.  But as far as we know, nobody did.

In fact, in Samuel Pepys’s diary, he described interest payments and was shocked that the Amsterdam markets didn’t pay out interest (8).  So why would people like Pepys give their gold to smiths?  Because consumers prefer the convenience of bank deposit notes over carrying relatively heavy specie (8).  Also, government coins during the 1600s were awful—it was hard to find a coin which was not clipped, shaven, or otherwise degraded.  Bank notes did not have those problems (10).  And bearer notes, written by goldsmiths, were “intended to pass anonymously from hand to hand” (11).  This belies the idea that what you put in the vault was supposed to remain yours in perpetuity without claim to ownership shifting.

Selgin also discusses bailment laws which were in place in England during the 1500s and possibly even earlier.  These laws are based on Talmudic principles (no great surprise).  In the Talmud, if specie is tied in a package, it is meant to be stored for safekeeping; on the other hand, if the coins are “loose,” they may be lent out (14).  In English law, there was no resource to demand specific coins back unless they were presented to the holder in a sealed bag (15-16).

So where do these charges come from?  Selgin argues that the charges gained traction due to actual misconduct charges and actual embezzlement against smiths (18).  Goldsmiths were charged with clipping and melting down coins for sale as bullion, as well as usury (20).

In The Papers: Human Action

Gene Callahan has a relatively old paper that I just recently found, entitled Oakeshott and Mises on Understanding Human Action.

Abstract:

Although Michael Oakeshott and Ludwig von Mises were arguably two of the more 
profound theorists of human activity in the twentieth century, there has been remarkably 
little comparative study of their ideas. That is especially surprising when one considers 
how compatible those ideas were in a number of areas, such as the a priori nature of the 
postulates of human action, the nature of historical thought, the  fundamental dichotomy 
between explaining not- intelligent goings-on and intelligent activity, the ambiguous 
character of the statistical social sciences, and the importance of meaning in theorizing 
human conduct. Comparing their formulations of common concepts permits new, 
illuminating perspectives into each thinker's work.
Despite such compatibility, their ideas also contain interesting and important differences: 
on the modality or lack thereof in human thought, the nature of rationality and its 
relationship to tradition, and the character of economics as a science. This paper will 
explore both the similarities and differences between the ideas of Mises and Oakeshott. 
Because a full consideration of all of the areas mentioned above would likely result in a 
book rather than a paper, I will restrict myself here to examining their views on the 
general principles of human action and how those principles relate to the character of the 
social sciences

Callahan starts by elaborating upon Ludwig von Mises’s idea of praxeology:  from the fact that humans engage in purposeful activity, we may derive a number of things (1).  Mises spent much of his career diving deep into the science of human action—science in the old European sense of an “organized body of knowledge” rather than the modern notion of a quantitative natural science.  Although Oakeshott never directly engaged with Mises’s ideas, Callahan argues that the two share a number of similarities.  For example, both find vital the notion that actors understand their own circumstances and assign their own meaning to these circumstances.  A person acts because something “as he understands it, must appear to be unsatisfactory to him.”  In addition, there is an expectation for both that this action will improve the individual’s circumstances (2).

For both philosophers, values are not “given” and certainly neither believed that human action was nothing more than maximization subject to constraints (3).  Beyond that, though, there are certain strands which are compatible even though the two were not in contact.  Callahan argues that Mises understands what praxeology implies, whereas Oakeshott “puts them on the broader philosophical basis” (4).  Neither had a required ontology regarding how postulates come to be—they could come from G-d, biological evolution, or even random guesses (4).  What is important simply is that they exist, not necessarily how we get there.

What’s interesting is that Callahan argues that Mises was a methodological dualist:  Mises subscribed to the idea that intelligent action needs completely different theories compared to “non-intelligent goings-on” and that these are “fundamentally different activities” (5).  Oakeshott seems a little fuzzier, but you could make an argument that his thoughts are compatible with that notion as well.  Both believed, as Nardin wrote on Oakeshott, that “the social sciences, like the natural sciences, are explanatory, not prescriptive” (7).  In other words, we may use the social sciences to explain how people behave, not necessarily how people should behave.  This is where normative individualism comes into play.  Both also reject the notion of social holism, placing them squarely in the methodological individualist tradition (7-8).

I’ll end this with a quotation from Mises which I like a lot and wish would get broadcast in every econometrics course:

If a statistician determines that a rise of 10 per cent in the supply of potatoes in Atlantis at a definite time was followed by a fall of 8 per cent in the price, he does not establish anything about what happened or may happen with a change in the supply of potatoes in another country or at another time. He has not “measured” the “elasticity of demand” of potatoes. He has established a unique and individual historical fact. No intelligent man can doubt that the behavior of men with regard to potatoes, and every other commodity is variable. Different individuals value the same things in a different way, and valuations change with the same individuals with changing conditions. (11)

Leijonhufvud’s Hayek Interview

Not too long ago, I watched an interview of FA Hayek by Axel Leijonhufvud.  The interview was mostly historical and biographical, focusing on Hayek’s growing up in Vienna and the circles in which he traveled there.  Near the end, though, I heard Leijonhufvud try to steal a point intellectually.  This is in the third to final topic, “Interfering in spontaneous changes.”  The interviewer asks,

The process whereby the Western countries gave up first the gold standard, and then what you call a discipline–and I agree there is a discipline–of fixed exchange rates: Is that not an evolutionary process, and are you not, with these proposals, in effect rationally trying to reconstruct, rationally trying to controvert, as it were, a process of evolution?

Hayek’s response was sharp and correct:  it is not a rationalist intervention to reverse rationalist intervention.  Governments forcing us down one path does not make it “evolutionary,” even democratically elected governments.  Those are still politicians and planners trying to push their agendas and not the spontaneous interactions of free individuals pursuing their own ends.  Opposing interventions made in the past does not mean that you are imposing your own plan, but can also be removing the plans of others and letting everybody create their own plans for their own spheres, instead of one plan from up high, regardless of how the planners were brought into the fold.

In The Papers: Hayekian Anarchism

Ed Stringham and Todd Zywicki argue, in their paper entitled Hayekian Anarchism, that a Hayekian should be in favor of anarchy.

Abstract:

Should law be provided centrally by the state or by some other means? Even relatively staunch advocates of competition such as Friedrich Hayek believe that the state must provide law centrally. This article asks whether Hayek’s theories about competition and the use of knowledge in society should lead one to support centrally provided law enforcement or competition in law. In writing about economics, Hayek famously described the competitive process of the market as a “discovery process.” In writing about law, Hayek coincidentally referred to the role of the judge under the common law as “discovering” the law in the expectations and conventions of people in a given society. We argue that this consistent usage was more than a mere semantic coincidence — that the two concepts of discovery are remarkably similar in Hayek’s thought and that his idea of economic discovery influenced his later ideas about legal discovery. Moreover, once this conceptual similarity is recognized, certain conclusions logically follow: namely, that just as economic discovery requires the competitive process of the market to provide information and feedback to correct errors, competition in the provision of legal services is essential to the judicial discovery in law. In fact, the English common law, from which Hayek drew his model of legal discovery, was itself a model of polycentric and competing sources of law throughout much of its history. We conclude that for the same reasons that made Hayek a champion of market competition over central planning of the economy, he should have also supported competition in legal services over monopolistic provision by the state — in short, Hayek should have been an anarchist.

The authors point out that Hayek’s idea of spontaneous order comes from his experience in noting that institutions such as money can emerge endogeneously (3).  When it comes to serving consumers, “we often don’t know what should be produced until a market test occurs” (6), meaning that not only would a central planner have trouble determining the best way to produce things, a central planner would be lost as to where even to begin the process.

Stringham and Zywicki then point out that there were two Hayeks when it comes to the notion of law:  the first Hayek was in favor of the Rechtsstaat (civil law), whereas the second Hayek was decidedly in favor of common law (8).  This accounts for the difference you can see in reading Hayek’s Constitution of Liberty versus his later Law, Legislation, and Liberty series.  In the former, he dedicates much more discussion to legislative processes, and in the latter, more to judicial processes for evolving a common law.  This bottom-up common law approach is “more conducive to liberty, coordination of individual expectations, and efficient use of disbursed knowledge” (8).  Also, the authors point out that the common law approach is based on the notion that there are pre-societal rules, and the object of judges is to apply the law based on these rules, “discovering” how past precedent and notions of order would lead to judgment in wholly new cases  (9).  The thing is that a verbal articulation of understood rules is not “the law”; rather, the rules, principles, and expectations themselves make up the law (13).

So why was Hayek not an anarchist?  Because, as the authors note, he argued that we need to expect that others will follow the same law as us, and so there needs to be a single legal authority with jurisdiction, able to forge common expectations of behavior (13).  The authors posit a rejoinder, noting that we don’t expect the same thing with currencies:  we don’t need common currencies in order to make an exchange.  I am not totally satisfied with this argument, however, as there is a mechanism for harmonizing different currencies:  exchange rates.  I don’t see a similar legal mechanism in the event that “you have your law and I have mine.”

At any rate, the authors go on to note that there are institutional problems in limiting judges simply to following and applying precedent (17), which is a strong criticism and justly applied.  A weaker criticism is their note that “a view of law wedded to precedent must start with the assumption that all previous precedents are correct” (19).  I don’t buy this, as any follower of common law would tend to believe in the notion of the “crooked timber of humanity.”  Humans make mistakes, are imperfect, and have flaws; this applies to jurists as well.  As a result, the common law system has a number of checks:  appeals courts, en banc hearings (which can act as an appeal within a court), and even going against one precedent when there exists a stronger argument for a better one.  This last point does raise some level of uncertainty in the common law system, but I think it is more flexible than the authors allow.

Finally, the authors point out that international and interstate laws differ, meaning that interpersonal laws may differ without negative consequence (23).  As an Ohioan, I make dealings with Indianians without a great level of difficulty, even though Ohio law differs in some respects from Indiana law.  Thus, it would be entirely possible to see individuals adhere to different, privately provided, legal codes in harmony.

I see two problems with this.  The first one is, to whom do these organizations turn when there is a problem?  In our current world, if Alice hires Legal Firm A and Bob hires Legal Firm B, these two legal firms may sometimes argue over jurisdiction, but generally that is clear-cut, and there is always an arbiter to whom they may turn.  However, suppose that in the world of private provision of law, Alice joins the Court Association A and Bob joins Court Association B.  If Alice and Bob have a legal scuffle, and if the rules of A and B do not jibe, where does it go?  To some higher-up arbiter?  A random choice between A and B?  Whichever court association has the more guns?

The second problem is that we have a system of law denoted by territory.  Going back to the above example, if I make a deal with a resident of Indiana (or India, for that matter) in the state of Ohio, Ohio laws will apply.  With the private provision of law, there is more uncertainty as to which law will apply.  Some of this could be mitigated by defining this before-hand, but that raises the cost of compliance.

All in all, I’m not ready to buy the idea of becoming an anarchist; I think there are still too many unanswered questions for my taste.

In The Papers: Re-Scoring Hayek vs. Lange

I am a big fan of the Socialist Calculation Debate.  I think it was the Austrian school’s finest hour, and although they ultimately lost in the eyes of most economists, I believe that history has vindicated the arguments that Mises and Hayek brought forth against socialists of all stripes.  Jan Hanousek and Randall K. Filer found an interesting case study for trying to turn the Socialist Calculation Debate into an empirical matter, in a paper they entitled Lange and Hayek Revisited:  Lessons from Czech Voucher Privatization.

Abstract:

A fundamental question in economics since the 1930s has been whether an administrative price system could simulate the results of perfect competition even without a true market for the means of production. The theoretical possibility of such a system has been known since the introduction of market socialism by Oskar Lange. We have used the artificial bidding market involved in the Czech voucher privatization process to test whether a sequential process of trial-and-error can set administrative prices close to equilibrium. It would appear from this natural experiment that Robbins and Hayek were correct in doubting the real-world feasibility of market socialism.

The basic idea is that the Czech government, after the collapse of the Union of Soviet Socialist Republics (as the joke went, the Russians went 0-for-4 in naming that day), introduced an artificial form of money which could be used to purchase shares of privatized companies at an auction (2).   The government used administrative price committees to set the share prices (2).

The government’s goal, ironically enough given what they were just exiting from, was to create a socialist market economy:  a set of government allocations which would mimic the end results of the market process, skipping the whole competition part and leaving out the messy bits.  Unlike a full-scale socialist experiment, this would be pretty constrained, as the endowments (amount of artificial money per person and numbers of shares of government enterprises) were fixed and a small number of stages of bidding set.

The question the authors ask is, was the administrative authority able to establish equilibrium prices?  In other words, could they clear the market without excess supply or demand? (3)  In the case of this auction, the voucher mechanism provided for bidding across several rounds, and the government set up two distinct auction periods (4-5).

To kill the suspense, the pricing authorities were not able to find an equilibrium price vector—they always had excess demand (7-8).  In the early rounds, 50-67% of the demand was unsatisfied, and even by the final rounds, that amount was still 12-17%.  This governmental authority could not, even in a simple example with fixed endowments and resources, come up with a set of share prices which would satisfy consumer demand.  This should make it even more obvious why a socialist market economy as Lange envisioned could never exist:  no small group of actors has enough information to satisfy the needs and desires of an entire population.  In this case, they couldn’t even do it in a constrained scenario for a short period of time.