What I Love about Economics

I’m not an expert in economics, but the subject comes up here at the Spherical Model pretty regularly, since the Economic Sphere is one of the three overlaying spheres. I did take basic econ in college, and I read a fair amount. That seems to have done me more good that Alexandria Ocasio-Cortez’s degree in the field. One thing I know is that economics is inextricably connected to politics and culture.

As economist Ludwig von Mises said,

One of the indispensable prerequisites of a master of economics is a perfect knowledge of history, the history of ideas and of civilization, and of social, economic, and political history. To know one field well, one must also know other fields.—Ludwig von Mises, in Shawn Ritenour, ed. The Mises Reader, p. 22 , quoted from John Chamberlain, “My Years with Ludwig von Mises,” The Freeman 27, no. 2 (February 1977): 126–27.

Looks like we even agree on the three spheres: political, economic, and social.

I’ve been a follower of Mises economics, usually called Austrian economics, for a while. [Mises.org is a good source.] I’m also a follower of the Chicago school, of Milton Friedman—and eventually bringing around Thomas Sowell. To an expert there’s probably a lot of difference, but to me they’re both about free-market economic principles. I think Mises is possibly more theoretical—the philosophy behind the policy—while Friedman is more about implementation: based on these free-market principles, what policy will work best in this situation?

The Mises Reader cover

Anyway, I’ve just started reading The Mises Reader, a collection of Mises’s shorter and more accessible works, as well as excerpts from his major works, edited by Shawn Ritenour. Even the introduction has been rich with quotes. I thought I’d share a few, to offer a taste of how Mises thought—making us wish there were more thinkers like him today. The first several are quotes about him, by Ritenour. Then there are some of Mises’s own words.

This may not seem like much of a Valentine’s Day post, but, being who I am, a truth seeker, I love words like these. Enjoy.

The work of Ludwig von Mises is an important guide for thoughtful citizens because he strongly, yet matter-of-factly sets forth economics as the pursuit of truth. Not the truth of the passing fancy, nor the so-called “small t-truth” that is always in danger of being refuted by the latest bit of empirical data; but economic truth that will stand for all ages.—Shawn Ritenour, ed., The Mises Reader, Introduction, p. 15.

This is what happens when intellectuals, teachers, and college professors see themselves as destroyers instead of cultivators. If we want to preserve our noble cultural inheritance, we cannot think that it will happen automatically. It is always easier to destroy than to maintain and build up. If civilization is not to descend into barbarism, we must teach each generation the importance of truth, liberty, and private property. It is not called culture for nothing. We must cultivate civilization.—Shawn Ritenour, ed. The Mises Reader,  p. 12-13, Introduction

Today people are increasingly urged to support this or that political program advertised as solving a vexing social problem with no understanding of economics and hence no frame of reference from which to evaluate different policies. All that is mustered in justification for interventionism are feelings that make people want to “do something.” The economics of Mises is the crucial antidote for the current interventionist ideology supporting the progressive march to economic fascism. Citizens acquainted with Mises quickly understand that any sort of middle-of-the-road economic policy does indeed lead to socialism.—Shawn Ritenour, ed., The Mises Reader, Introduction, p. 21.

An economy that has taken advantage of an extensive division of labor is very complex and yet, decentralized. Such an economy features a multitude of different markets in which the participants must coordinate their activities if we want to avoid recessions and depressions. The biggest problem for this decentralized economy to work is that all of the various producers have to know what to produce, how much to produce, and how to produce it. This can only be done if some method of calculation exists. No other economist of his day stressed this point more than Mises. Indeed in the 1920s Mises demonstrated that the lack of economic calculation is the Achilles heel of socialism.—Shawn Ritenour, ed., The Mises Reader, p. 18.

Mises recognizes that what makes such comparisons even harder is that we all value goods subjectively, according to our personal preferences. We cannot, therefore, measure value because there are no objective units of value measurement. Again it was Mises who demonstrated that voluntary exchange in a monetary economy opens the door to a solution. In a monetary economy, every good is exchanged against money, so every price is expressed in terms of the monetary unit—in our case dollars and cents. Even though value is subjective, in a free market, people manifest their values by voluntarily deciding what they will pay for particular products and services. These objective prices, therefore, are reflections of subjective values. Entrepreneurs are able to use these objective prices to calculate expected profit and loss and act accordingly. In a free market, Mises shows, entrepreneurs are able to plan for the future and consumers will receive what they most want.

Socialism, on the other hand, is doomed because there is no way for the central planner to efficiently allocate factors of production because there is no way to calculate profit and loss. In a completely socialistic economy all of the means of production are owned by the state. There is, therefore, no actual exchange of goods, and hence no actual prices that reflect the actual subjective values of human beings. Producers, then, have no way to calculate whether their actions are productive or wasteful from the point of view of society. What is called a planned economy is, instead, as Mises so eloquently put it, “groping about in the dark.”—Shawn Ritenour, ed., The Mises Reader, pp. 18-19.

 

Ludwig von Mises
image from Wikipedia

A man who chooses between drinking a glass of milk and a glass of a solution of potassium cyanide does not choose between two beverages; he chooses between life and death. A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings. To stress this point is the task of economics as it is the task of biology and chemistry to teach that potassium cyanide is not a nutriment but a deadly poison.—Ludwig von Mises, in Shawn Ritenour, ed., The Mises Reader, p. 20, quoted from Mises, Human Action, p. 676.

One may try to justify [social security] by declaring that the wage earners lack the insight and the moral strength to provide spontaneously for their own future. But then it is not easy to silence the voices of those who ask whether it is not paradoxical to entrust the nation’s welfare to the decisions of voters whom the law itself considers incapable of managing their own affairs.—Ludwig von Mises, in Shawn Ritenour, ed., The Mises Reader, p. 21, quoted from Mises, Human Action, p. 613.

I was sometimes accused of representing my viewpoint in a manner too abrupt and intransigent. It was also claimed that I could have accomplished more had I displayed a greater willingness to compromise.... When I look back at my work… my only regret is my willingness to compromise, and not my intransigence.—Ludwig von Mises, in Shawn Ritenour, ed., The Mises Reader, pp. 22-23, quoted from Mises, Memoirs, p. 60.

Economics Schools of Thought

We had family filling the house for Thanksgiving, and that meant time for some conversation about economics with son Economic Sphere. I was wondering about the economics degree of the new, apparently clueless, socialist congresswoman from New York, Alexandria Ocasio-Cortez. Her degree is in economics, and it was my understanding that most notable economics departments had changed in the past few of decades toward free market, and away from Keynesianism. But she seems economically unaware (if I am being kind).

I got this explanation—not recorded, so any errors are mine and not my son’s. Anyway, Economic Sphere said that there are two types of economics programs: those focused on macroeconomics, and those focused on microeconomics. The macroeconomics ones use Keynesian models—despite their being wrong nigh unto 100% of the time. If the model says there will be a particular outcome, they act as though that is the outcome, even after it isn’t, even though sensible people can show why it would never be the outcome.

The ones focused on microeconomics go with free market economic principles. For some reason, they’re more aligned with what actually happens. They’re less willing to interfere, to try to wield power over the economy to get a particular outcome, such as by enforcing pricing, but will instead let the market set prices.

I asked another question, about the difference between the Chicago school (way of thinking) and the Austrian school, since both are free market.

What I got was some basic review. So I thought it might be useful to define a few terms today, and the reasons we prefer what we do--i.e., freedom instead of government interference. While Economic Sphere tends to be a walking encyclopedia, and his answers filter through my explanations below, I've also turned to Wikipedia fairly liberally.

Keynesian Economics

Keynesians, according to my old Webster, “hold that full employment and a stable economy depend on the continued governmental stimulation of spending and investment through adjustment of interest rates and tax rates, deficit financing, etc.” In other words, a healthy economy requires government intervention.

According to Wikipedia,

Keynesian economists generally argue that, as aggregate demand is volatile and unstable, a market economy will often experience inefficient macroeconomic outcomes in the form of economic recessions (when demand is low) and inflation (when demand is high). These can be mitigated by economic policy responses, in particular, monetary policy actions by the central bank and fiscal policy actions by the government, which can help stabilize output over the business cycle. Keynesian economists generally advocate a managed market economy – predominantly private sector, but with an active role for government intervention during recessions and depressions.

One of the first lesson I was taught in a basic econ class, by a free-market economist, was that intervention lags. Legislators—or other officials—look at the current situation, decide it isn’t what they’d like it to be, so they set in motion a policy to change it, that takes about six months, by which time the original situation has changed, and most likely the intervention causes new problems.

Supposedly, the Federal Reserve is there to mitigate and smooth out the damage of cyclical market recessions. What we had before that was occasional volatility. What we’ve had since is occasional volatility plus more regular cyclical recessions. Are the problems all caused by the interventions? We don’t know. And you can’t prove a negative; we don’t have a parallel universe to compare to. But we do know it didn’t do what it set out to do.

Macroeconomics

Macroeconomics is described here by Wikipedia:

Macroeconomics (from the Greek prefix makro- meaning "large" + economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.

Macroeconomists study aggregated indicators such as GDP, unemployment rates, national income, price indices, and the interrelations among the different sectors of the economy to better understand how the whole economy functions. They also develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade, and international finance.

While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income).

So, macroeconomic models—such as those developed by Keynes—are used by governments to develop policies. But, like I said, interference doesn’t work the way their models say they will. Our Spherical Model saying fits here again: 

Whenever government attempts something beyond the proper role of government (protection of life, liberty, and property), it causes unintended consequences—usually exactly opposite to the stated goals of the interference.

Microeconomics

By comparison, here’s the smaller story of microeconomics, also according to Wikipedia:

Microeconomics (from Greek prefix mikro- meaning "small" + economics) is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms.

One goal of microeconomics is to analyze the market mechanisms that establish relative prices among goods and services and allocate limited resources among alternative uses. Microeconomics shows conditions under which free markets lead to desirable allocations. It also analyzes market failure, where markets fail to produce efficient results.

Microeconomics stands in contrast to macroeconomics, which involves "the sum total of economic activity, dealing with the issues of growth, inflation, and unemployment and with national policies relating to these issues". Microeconomics also deals with the effects of economic policies (such as changing taxation levels) on the aforementioned aspects of the economy.

In short, microeconomics is what a business would do to figure out how to price a product, and whether to produce the product, based on the price. How well businesses do in predicting price, and allocating limited resources, determines the health of the overall economy. Government interference makes that decision-making process more challenging, adding in tax burdens and other punishments or incentives that distort the actual value of a product.

Free-Market Economics

I looked up both free enterprise and free market in the dictionary.

Free enterprise is “the economic doctrine or practice of permitting private industry to operate under freely competitive conditions with a minimum of governmental control.”

Free market is “any market where buying and selling can be carried on without restrictions as to price, etc.”

So these terms relate mainly to microeconomics. But they are affected by macroeconomic policies, which alter money supply, pricing, taxes, and allocation of resources, distorting information that normally leads to sound pricing and/or production decisions.

I also asked Economic Sphere what is the difference between the Chicago school of economics (i.e., a school of thought, or a set of ideas adhered to by various people—not a physical school) and Austrian, or Mises economics, because they’re both free market. Economic Sphere said the Austrian school of economics is theoretical. It’s about principles and ideas related to the free market. The Chicago school of economics is about policy: how to implement policies as close to the free market as we can get in an imperfect political world.

So, the Austrians tend to be libertarians? I guessed. And he said that was right. Here’s a bit more on those terms.

Austrian School of Economics

I usually hear about the Austrians through the Ludwig von Mises Institute. The originals showed up in Vienna in the late 1800s to early 1900s, although they are all over the world today.

According to Wikipedia,

Among the theoretical contributions of the early years of the Austrian School are the subjective theory of value, marginalism in price theory and the formulation of the economic calculation problem, each of which has become an accepted part of mainstream economics.

Since the mid-20th century, mainstream economists have been critical of the modern day Austrian School and consider its rejection of mathematical modelling, econometrics and macroeconomic analysis to be outside mainstream economics, or "heterodox." Although the Austrian School has been considered heterodox since the late 1930s, it attracted renewed interest in the 1970s after Friedrich Hayek shared the 1974 Nobel Memorial Prize in Economic Sciences and following the 2008 global financial crisis.

I’m assuming that “mainstream economists” from mid-century on refers to Keynesians in this context. Interference was all the rage from about 1910 onward. Keynes and Friedrich Hayek were contemporaries, and Hayek does a good job of refuting the pro-controlled economists with real life. The controllers love their models, and they can’t be bothered with things like real-life evidence and facts.

If Hayek hasn’t been on your reading list, his Road to Serfdom is a must read. Hayek qualifies as an Austrian, but he is also of the Chicago school, because of his influence there. Here’s how Wikipedia describes his contribution:

Friedrich Hayek
image from Wikipedia

Friedrich Hayek (1899–1992) Hayek made contact with many at the University of Chicago in the 1940s, with Hayek's The Road to Serfdom playing a seminal role in transforming how Milton Friedman and others understood how society works. Hayek conducted a number of influential faculty seminars while at the U. of Chicago, and a number of academics worked on research projects sympathetic to some of Hayek's own, such as Aaron Director, who was active in the Chicago School in helping to fund and establish what became the "Law and Society" program in the University of Chicago Law School. Hayek, Frank Knight, Friedman and George Stigler worked together in forming the Mont Pèlerin Society, an international forum for libertarian economists. Hayek and Friedman cooperated in support of the Intercollegiate Society of Individualists, later renamed the Intercollegiate Studies Institute, an American student organisation devoted to libertarian ideas.

Chicago School of Economics

This school of thought got its name because of the work of a number of neoclassical economists on the faculty at the University of Chicago, producing twelve Nobel laureates in economics.

They rejected Keynesianism, and looked at a variety of other ideas for macroeconomics—that is, policy ideas. They’re a little harder to pin down, but in general are trying to apply free market principles to national policy. Bruce Kaufman, in The Elgar Companion to the Chicago School of Economics (2010) says they are characterized by:

A deep commitment to rigorous scholarship and open academic debate, an uncompromising belief in the usefulness and insight of neoclassical price theory, and a normative position that favors and promotes economic liberalism and free markets (p. 133).

The great economist Thomas Sowell studied at the University of Chicago for his PhD—and remained a Marxist throughout. It was later, when real life woke him, that he transformed into a free-market economist.

Milton Friedman
image from Wikipedia

The Chicago name I know best is Milton Friedman, who was at the University of Chicago for some thirty years. According to Wikipedia, again:

Milton Friedman (1912–2006) stands as one of the most influential economists of the late twentieth century. A student of Frank Knight, he was awarded the Nobel Prize in Economics in 1976 for, among other things, A Monetary History of the United States (1963). Friedman argued that the Great Depression had been caused by the Federal Reserve's policies through the 1920s, and worsened in the 1930s. Friedman argued that laissez-faire government policy is more desirable than government intervention in the economy.

One of the critics of the Chicago school, economist and three-term Democrat senator Paul Douglas, complained that, “The opinions of my colleagues would have confined government to the eighteenth-century functions of justice, police, and arms.”

That doesn’t seem like a valid criticism to me; it seems like something to appreciate—limiting government to its proper role. What a concept!

We could summarize today’s economics lesson with this Friedman quote:

One of the great mistakes is to judge policies and programs by their intentions rather than their results.— Milton Friedman Interview with Richard Heffner on The Open Mind (7 December 1975)

Economic Schools of Thought

The Q&A session for this past week’s Economics 101 class (free online from Hillsdale College) included some definitions of three basic economic schools of thought. I refer to these fairly frequently, so I thought maybe it would be useful to have a short lesson defining them. We’ll look at these: Keynesianism, the Chicago School, and the Austrian school.

When we say “school,” we aren’t referring to a brick-and-mortar institution; we’re referring to a way of thinking. Those who agree with and follow those ideas “belong to” that school of thought. The schools aren’t necessarily mutually exclusive. Two of these three are proponents of the free market.

 

Keynesianism

John Maynard Keynes was a British economist who put forth a theory in the 1930s, purporting that government intervention could accomplish full employment and reduce the impact of business cycles.

There’s a 3-minute video intro to lecture 7 of the Hillsdale Econ 101 course, which explains the Keynesian model.

 

In the actual lecture Professor Gary Wolfram charts out the theory on a supply and demand curve. In the real world, there’s typically a gap between the number of potential employees and the number actually hired. Even in full employment, that’s around 3-4% (which was declaimed as too high all the way through the Bush administration, but has been double to triple that—or worse, depending on your measures—all the way through the Obama administration, while the same people keep claiming the economy is improving. So, one thing about statist/Keynesians is that government intervention is a good thing, to be taken on faith, regardless of measurable evidence.) Keynes’s theory is contained in his main work, The General Theory of Employment, Interest and Money, published in 1936.

Keynes's magnum opus

Keynesianism claims that government spending—any government spending—results in economic growth. (Read my Glass Breaking Fun.) That’s why you see such “growth” in Washington, DC, the past few years, while the rest of the country struggles. The DC growth is because government is literally trying to grow the economy by hiring people to do whatever (metaphorically digging holes and filling them in)—without noticing that any money for that purpose is taken from what could be spent to innovate or invest in the non-government real economy. It is Keynesianism that claims the way we got out of the Great Depression was by spending our way out because of WWII.

Keynesianism is most popular with people who want increased government power, so it’s not surprising that it was championed by such politicians over the past near century. However, as Keynesian theories have been implemented, empirical evidence of their failures has led more and more economists to leave that school of thought and take another look at the free market schools. However, Keynesianism resurged in 2007-2008, with what is now referred to as the Great Recession, which continues apace with ongoing government interference. Hmm.

One of the most prominent Keynesian economists still claiming Keynes was right is Nobel Laureate Paul Krugman, who is widely published and consistently wrong.

 

The Austrian School

Contemporary with Keynes were Ludwig von Mises and Friedrich Hayek, who are usually considered the two main Austrian economists. Ludwig von Mises, who is generally considered the original Austrian theorist, immigrated from Europe in 1940, ahead of the advance of the Nazis, landing in New York; he taught at NYU for most of the remainder of his life. He considered himself a classical liberal—that is, “liberal” in much the way our founders were; he believed in limited government and free markets among a moral people. Mises is often cited by libertarians today, although I’m not sure he completely fits in their world.


Ludwig von Mises
photo from Wikipedia

My personal view is that, on the Spherical Model, Mises is western hemisphere (most local control that can be managed for any given issue), but also northern, where laws protect people’s God-given rights to life, liberty, and property. Libertarian theory tends to encompass the entire western hemisphere, including the below-the-equator belief that government should have no role, and free market should rule, even including addictive drugs and sex trade. (See Why I’m Not Quite a Libertarian.)

Friedrich Hayek, who won the Nobel Prize in Economics in 1974, wrote The Road to Serfdom, which should be required reading for any educated individual. Hayek was a follower of Mises. While friendly with Keynes personally, Hayek disagreed with his theory. (Meanwhile, Keynes read Hayek’s book and said he agreed with it entirely.) When he left Austria, Hayek taught  in Britain for some time before ending up at the University of Chicago. Much of his work describes business cycles. Some of what he demonstrated was that government interference actually causes business cycles—both lengthening and intensifying the pain. Without the interference, the market serves to correct itself, with just minor dips and quick corrections. When there is a shortage of labor, the economy self-corrects by raising pay rates, until there is equilibrium. When there is a surplus of labor, the economy self-corrects by lowering pay rates, until there is equilibrium. He favors trust in the free market and government restraint.

Friedrich A. Hayek
photo from Wikipedia

Henry Hazlitt, another Austrian commentator, wrote a point by point rebuttal of Keynes’s The General Theory, called The Failure of the New Economics. The Austrians looked more at innovation and various movements from equilibrium, accepting that those are not necessarily negative things to be avoided.

 

The Chicago School

The Chicago school of economics usually refers to Milton Friedman, and also his wife, Rose Director Friedman. Thomas Sowell, a former Marxist who later studied in Chicago under Friedman, is probably included.

Friedman is a free-market economist. He is against government intervention. The difference between his work and the Austrians is more a matter of focus than disagreement. The Austrians look at movement from one cycle to the next. The Chicago school examines the conditions that exist at equilibrium. They look at government intervention, what it does, and why it always goes wrong: the information needed is unknowable, the timing will always be late. And government interference obscures the market signal: producers get incorrect signals about whether to produce long-term capital products or short-term consumer products—or producers fail to get a signal, because of uncertainty in the market, and therefore hold back production until there is clarity (what we’re seeing in the market now). Some of the “interference” is control of the money supply, and the Chicago school looks closely at that.

Milton Friedman
photo from Wikipedia

All of these theories deal with macroeconomics—the movement of the economy as a whole—rather than microeconomics, which is the study of why individuals make the economic decisions they do. If there is a basic macroeconomic principle for government it should be “first, do no harm.” The argument “Well, we have to do something,” is wrong; doing nothing is always an option and often the best one. Government is not responsible for the economy; government’s only economic role is preservation of rights—enforcing contracts, protecting property rights, settling disputes over property claims, and possibly standardize monetary units (although Wolfram actually discusses the suggestion of privatizing money supplies, which is an interesting idea).

Less government interference, beyond its limited role, always leads to greater prosperity. Imagine the economic prosperity we would be experiencing if government had refrained from interfering this past century.