But alas, last weekend I couldn't resist commenting on an article in my alma maters' newspaper, the Iowa City Press Citizen, which reported that Obama would be coming to the University of Iowa to speak on the subject of the increasing burden of student loan debt. It is one of my favorite topics because it's a timely issue and a great opportunity to highlight the unintended consequences of good intentions and government subsidies.
Knowing from past experience that most people won't read a comment if it's longer than a few sentences, I tried to make it short and sweet.
Of course nothing I said was original or from my own mind. I stole the whole argument from Peter Schiff, and concluded my intellectual piracy by quoting Harry Browne.
If you haven't heard the argument that the reason college tuition is out of control is due to the unintended consequences of government guaranteed student loans, I highly recommend you listen to the below 20 minute clip from the Peter Schiff show. He interviews Kelli Space, a young woman that graduated with an astounding $200,000 in debt after graduating from Northeastern University with a degree in sociology. Rather than continue to steal his thunder, I'll leave it up to you to listen while I move on to the point of this blog.
So one of the responses my comment provoked challenged me to give evidence, calling it "those nasty little facts that get in the way". While I had no intention of reverting back to my old time-wasting habit of battling strangers on the internet, I saw that someone else accepted his challenge in my place. He proceeded to give my opponent "the facts", including quoting CPI numbers, claiming that since 1986 the overall inflation rate has been 115%, while the price of tuition has risen 498%.
This was exactly the line of argument I was trying to avoid, and for good reason. It didn't have any impact on my opponent, instead he chided my supporter for pulling biased "facts" from a Google search, and invited him to recommend similarly biased "facts" from the NRA the next time a gun control article is published.
This exchange epitomizes one of the biggest problems we have in this country. While I tried to keep my argument grounded on logic, analogy, and economic theory, he wanted hard numbers, the "facts". When my supporter gave him those "facts", he was arguing by an appeal to authority. Problem: my opponent did not respect that authority, he has his own authority with his own set of "facts". Neither my supporter nor my opponent learned anything from each other, they both walked away with the continued belief that their set of "facts" from their respective authority figures are right, and the other side has been duped by charlatans.
Like most people that identify themselves as being on the left or the right, they have mutually exclusive world views. The right has think tanks that supply them with "facts", and the left has theirs. My "facts" are your propaganda, and vise versa. Just about the only thing they have in common is they have both renounced the use of logic, particularly deductive reasoning. And that is a big problem.
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Start
with a true premise, and if you reason correctly, you will arrive at a true conclusion.
Right now humans aren't much better at this than penguins. |
Logic: the science of correct reasoning
Ludwig von Mises encouraged all of his economic students to first read a book on logic. In particular, he recommended An Introduction to Logic
by Morris R. Cohen and Ernest Nagel. This is because the Austrian school is based on a priori knowledge and deductive reasoning. A priori knowledge comes independent of experience. "All bachelors are unmarried". The truth of this statement is implied in the definition of the word bachelor. There is no experiment to be done, nothing to prove or disprove. Deductive reasoning transmits truth from premises to conclusion, such that if you start with a true premise and reason correctly, your conclusion is guaranteed to be true as well.In Human Action, Mises says,
"Aprioristic reasoning is purely conceptual and deductive. It cannot produce anything else but tautologies and analytic judgments. All its implications are logically derived from the premises and were already contained in them. Hence, according to a popular objection, it cannot add anything to our knowledge."Unfortunately, that popular objection has not lost clout. Today, if logic is taught at all, it's done with an emphasis on mathematics for computer science majors. The doctrine of Positivism took over the science of economics long ago, and it still maintains mainstream dominance. Positivism views that all authentic knowledge comes only from experience, or sensory data, and the logical, mathematical, and statistical treatment of that data.
Hence, mainstream economics is a positivist doctrine that puts the science of economics in the same category as physics or the other natural sciences. But is that where it belongs?
Ludwig von Mises believed that economics was a sub-category of praxeology, a term he coined which comes from the Greek praxis, meaning action, and logos, talk or speech. Hence, praxeology is the deductive, aprioristic study of human action based on the action-axiom. This self-proving axiom makes the radical suggestion that human beings purposefully utilize means over a period of time in order to achieve desired ends. In other words, humans engage in purposeful behavior. We are not billiard balls to be isolated in a lab and prodded with stimuli to scientifically generate a response. We have goals that we strive towards, and while humans can have a difference of opinion as to what constitute worthwhile goals, and even though we can be mistaken about where our behavior will lead us, the fact remains that we engage in voluntary and purposeful behavior.
Therefore, rather than aligning economics with physics and the natural sciences, the Austrian School views economics as a specialized category of praxeology, such that it is the study of human action under conditions of scarcity. The word economics itself implies scarcity. What does it mean to 'economize'? It means to conserve, to avoid waste, to use or manage with thrift, etc. If you can imagine a world of immortal beings that can summon goods and desires from the power of their enlightened minds, then to economize would be without meaning, as nothing, not even time, would be scarce.
Understanding that this topic can quickly get esoteric when speaking in the abstract, I'll try to elucidate the difference between the positivist and the praxeological approach to economics by analyzing a law of economics that is universally recognized among professional economists as well as laymen.
The law of supply and demand
The law of supply and demand is accepted by both the Austrian School of economics as well as the mainstream positivist economic schools of thought. This law states that if the supply of a good rises, and the demand stays the same, then other things being equal, the price will fall. It also implies that if the supply of a good falls, ceteris paribus (with other things the same), the price will rice. Conversely, if we hold the supply of a good constant, and use demand as our independent variable, then the price will rise and fall in the same direction as the demand.
The difference between the mainstream positivist approach to economics and the Austrian's aprioristic deductive method will be made clear as we see how each school discovers this law.
For the follower of the Austrian school, we start with the above mentioned action-axiom, that human beings engage in purposeful behavior. That is the only premise we need, and now we move on to our deductive reasoning.
Human beings engage in purposeful behavior, they use means to achieve ends. A mean can be a good or service, such as using the means of food to obtain the end of nourishment, or the means of a vehicle to achieve transportation to a given destination.
The first unit of a good, the means, will be used to satisfy the most urgently felt desire, the ends. This is true based on the meaning of the word "first" and "most", it is tautologically true.
It follows that the second unit of a good or service will be used to satisfy the second most urgently felt need. The third unit will be used to satisfy the third most desired need, as well as the fourth, the fifth, ad infinitum. This is true by definition. Note that these rankings are ordinal numbers, not cardinal. It makes no sense to say that you value the 10th unit of a good 10x more than the first. These rankings are the order of preference expressed through human action.
Quoting Mises' most accomplished student, Murray Rothbard:
"The important consideration is the relation between the unit to be acquired or given up and the quantity of supply (stock) already available to the actor. Thus, if no units of a good (whatever the good may be) are available, the first unit will satisfy the most urgent wants that such a good is capable of satisfying. If to this supply of one unit is added a second unit, the latter will fulfill the most urgent wants remaining, but these will be less urgent than the ones the first fulfilled. Therefore, the value of the second unit to the actor will be less than the value of the first unit. Similarly, the value of the third unit of the supply (added to a stock of two units) will be less than the value of the second unit. It may not matter to the individual which horse is chosen first and which second, or which pounds of butter he consumes, but those units which he does use first will be the ones that he values more highly. Thus, for all human actions, as the quantity of the supply (stock) of a good increases, the utility (value) of each additional unit decreases."Thus, starting with the action-axiom and following a trail of deductive reasoning, we have arrived at the law of marginal utility. Also known as the law of diminishing returns, it states that each additional unit of a good or service will be subjectively less valued than the previous. In praxeology speak, for a given individual, each additional unit of a specific good will be the means to satisfy an end of lesser and lesser importance, by definition. Just as the definition of bachelor implies the property of being unmarried, we see that the premise of purposeful human action implies this law.
To assist our understanding, we can plot the ordinal ranking of ends against an increasing quantity of a specific good (means) for a given individual. This graphic is taken from chapter 1 of Murray Rothbard's treatise Man, Economy, and State (Also available for free in pdf and epub):
By introducing the premise that there is more than one type of good that can serve as a means to accomplish the ends desired by men, we can consider how a given individual could rank two different goods that could satisfy a number of ends. Starting with another graphic from Man, Economy, and State, I've made some improvements by color-coding the data points for supply goods X and Y, and combining the two graphs to reveal the resultant value scale for an individual when only considering these two goods.
When the individual whose preferences expressed by human action are graphed above has 0 units of supply goods X or Y and is given the choice of obtaining one, and only one unit of either, he will choose one unit of supply good Y to satisfy his most urgently felt need. Given additional choices to add a unit of either good to his stock, we see the next three units of good X are subjectively valued progressively lower before our hypothetical individual comes to the point that he would rather have a second unit of good Y than a fourth unit of good X.
Another way to think about the implications of this graphic is presented in the scenario when the individual whose preferences are shown in this value scale already has 7 units each of supply goods X and Y in his stock. Faced with the choice of giving up one unit of either good, he will first choose to give up his 7th unit of good Y. His second least desired end that can be satisfied with the means of supply goods X or Y will be that satisfied by his 6th unit of supply good Y. Upon the third and fourth choice to be made, this individual will give up his 7th and 6th units of supply good X.
This example limited to only two types of supply goods is just one potential value scale for a given individual, and an infinite variety of value scales can be imagined. By adding the premise that different human beings have different value scales for the means and ends they subjectively value, we are ready to continue our chain of deductive reasoning and think of the necessary conditions for two individuals to engage in voluntary exchange.
Murray Rothbard contrasted the pre-requisites of exchange when considering single unique goods or homogenous supplies of goods in Chapter 2 of Man, Economy, and State:
"If the goods in question are unique goods with a supply of one unit, then the problem of when exchanges will or will not be made is a simple one. If A has a vase and B a typewriter, if each knows of the other's asset, and if A values the typewriter more highly, and B values the vase more highly, there will be an exchange. If, on the other hand, either A or B values whatever he has more highly than what the other has, then an exchange will not take place. Similarly, an exchange will not take place if either party has no knowledge that the other party has a vase or a typewriter.The first revelation to be noted from the necessary conditions of voluntary exchange is that both parties subjectively value what they are giving up less than what they will receive. Both Jones and Smith walk away from the transaction better off, both feel wealthier than before, both now have the means to satisfy an end that ranks higher on their value scales than the end which could have been satisfied by the means they gave up in exchange. While it would make no sense to say that both parties walked away with the "heavier good", as weight is an objective measurement, in contrast we see that in the minds of both Smith and Jones they each believe that he has gotten the better deal because of the difference in their subjective value scales. Beauty is in the mind of the beholder.
On the other hand, if the goods are available in supplies of homogeneous units, the problem becomes more complex. Here, in determining how far exchanges of the two goods will go, the law of marginal utility becomes the decisive factor. If Jones and Smith have certain quantities of units of goods X and Y in their possession, then in order for Jones to trade one unit of X for one unit of Y, the following conditions have to be met: To Jones, the marginal utility of the added unit of Y must be greater than the marginal utility of the unit of X given up; and to Smith, the marginal utility of the added unit of X must be greater than the marginal utility of the unit of Y given up."
This axiomatic truth of mutual benefits to both parties of all voluntary exchanges is of critical importance to libertarian public policy, as it would apply to everything from laws that purport to "protect the consumer" to violations of the right to contract such as a minimum wage law. Not to get distracted when we are so close to arriving at the law of supply and demand, we can now consider the second scenario described by Rothbard and consider how the value scales of Smith and Jones will determine how many exchanges they will engage in, and the implications to be considered when one of them no longer sees a benefit in exchange and they arrive at a point of equilibrium.
At T0, the time before any exchanges have been made, we have Smith possessing 5 units of Y, with his 1st, 5th, 6th, 8th and 10th most urgently felt needs being satisfied, but completely lacking in units of X that could satisfy his 2nd, 3rd, 4th, 7th, and 9th most urgently felt wants. Alternatively, Jones has 5 units of X and no Y, and a completely different value scale than Smith.
Because of their mutually unequal subjective value scales, they can both benefit by exchange, as Smith will sacrifice the means to satisfy his 10th most urgently felt need (Y5) in order to receive his first unit of X which will satisfy his 2nd most urgently felt need. Jones is just as eager to engage in trade, as he is able to get rid of his 5th unit of X, which satisfies his 10th most urgently felt need, and in exchange will receive his first unit of Y, which will satisfy his 3rd most urgently felt need.
At T1 we see how both Smith and Jones are in higher positions on for their respective value scales, both are now satisfying a need that ranks higher than they were before entering into exchange. Their value scales allow an additional trade, such that at T2 Smith now has 2 units of X and 3 units of Y, satisfying his top 3 needs, while Jones concludes with 3 units of X and 2 units of Y, with his top 5 most urgently felt needs all being satisfied.
It is at T2, after two exchanges have taken place, that another trade is no longer possible. Smith would be eager to trade his 3rd unit of Y for a third unit of X, which would move him up his value scale from satisfying his 6th to his 4th most urgently felt need. However, Jones will not make this trade, as he values his third unit of X more than a third unit of Y, and he will not sacrifice the means to satisfy his 5th most urgently felt need for the means to satisfy his 7th. Their two man, two good economy has reached a point of equilibrium.
For simplicity's sake the X price of Y and the Y price of X maintained a 1 to 1 ratio, but based on the value scales above we could have imagined other scenarios whereby Smith could have offered his 2nd, 3rd, 4th and 5th units of Y for just 1 unit of X, sacrificing the means to satisfy his 5th, 6th, 8th and 10th most urgently felt needs in order to raise his position on his value scale and satisfy his 2nd most urgently felt need. Hence, we could have had the Y price of X rise to 4, and the X price of Y fall to 1/4.
As more people enter the economy of X and Y who have an even wider variety of value scales, we will see exchanges continue to be made amongst the most eager buyers and sellers. When the market participants are aware of each other and the exchanges willing to be made, we will see one common price start to dominate the market. While a given individual may be willing to sacrifice 4 units of Y for 1 unit of X, he would much rather sacrifice just 1 unit of Y if he can find a capable seller willing to do so.
In Murray Rothbard's example, he used barrels of fish and horses as his X and Y, and ended up with the above equilibrium price, where 5 horses will each be traded for a price of 89 barrels of fish per horse. He summarized his horse-fish economy with the following,
"We began with a stock of eight horses in existence (and a certain stock of fish as well), and a situation where the relative positions of horses and fish on different people’s value scales were such as to establish conditions for the exchange of the two goods. Of the original possessors, the “most capable sellers” sold their stock of horses, while among the original non-possessors, the “most capable buyers” purchased units of the stock with their fish. The final price of their sale was the equilibrium price determined ultimately by their various value scales, which also determined the quantity of exchanges that took place at that price. The net result was a shift of the stock of each good into the hands of its most capable possessors in accordance with the relative rank of the good on their value scales. The exchanges having been completed, the relatively most capable possessors own the stock, and the market for this good has come to a close."With the market at equilibrium, only a change in the relative demand and supply schedules of the market participants can re-open the market for exchange. In that situation, or in a market that is constantly changing such that an equilibrium price is never firmly set, a change in the demand or supply schedules for a given market will result in consequences that are guaranteed to follow certain laws based on the tautological truths arrived at earlier.
For instance, if the demand schedule for a good increases, then we know that relative to the previous point of reference, the market participants subjectively value that good for the need that it will satisfy higher than before. This could come about from the previous market participants experiencing changes in their individual value scales, or from new players entering the market and displacing previous market participants with their higher demand. If we know that in addition to the demand schedule increasing, that the supply schedule has decreased or remained the same, then the equilibrium price is guaranteed to increase. If Smith's value scale has increased such that he is now willing to sacrifice his entire stock of Y in order to fulfill the need fulfilled by one unit of X, then he could pay up to 5 Y for 1 X, but Jones would certainly not accept less than the 1 Y price previously arrived at, as the seller always prefers the highest possible selling price for his good.
We can also make conclusions about the quantity of exchanges that will be made based on the supply schedule. If the supply schedule increases than either the previous market participants have become more capable or specialized in their field, or new players are entering the market and competing with the Jones' of the world in the supply of X. If the supply schedule increases while the demand schedule increases or stays the same, then we are guaranteed to have more exchanges taking place. At a price of 1 X to 1 Y each possible exchange will only occur if the ranking of the additional unit of X ranks higher than the loss of one unit of Y. If Jones or his competitor can now sell 5 X for 1 Y, then more exchanges will take place then ever before. When something is on sale you buy more of it. Think of 2 for 1 deals or the low profit high volume sales strategy.
Thus, starting with a few self-evident premises and using deductive logic to explore the implications, we have arrived at the law of marginal utility, the necessary conditions for voluntary exchange, and the necessary consequences to equilibrium price and quantity exchanged given changes in the demand schedule or supply schedule, also known as our long awaited Law of Supply and Demand. I'm stealing one last graphic from Rothbard's Man, Economy, and State to list the full matrix of possible permutations for this law.
Google, or better yet Startpage, "Law of Supply and Demand proof" and you'll find resources and papers with dozens of equations and complex formulas. While a mathematical proof may resemble the sequence of deductive logic employed here, only the Austrian school explicitly derives its conclusions from the premise of purposeful human action. The graphics used here are to assist in understanding, plotting ordinal rankings expressed in the moment of action, we do not confuse the role of the actor who chooses to buy, sell or abstain from the graph that models that behavior.
How would someone "show me the facts" that relied on positivist economics and appeals from authority? Maybe you could record the price of all exchanges of a good for a given population and time, archiving all the buyers and the sellers, examining their behavior and comparing it to a curve predicted by a mathematical equation? Of course you'd have to get visibility to buying patterns and consumer preferences, perhaps through historical surveys or consumer reports. You'd also have to factor how complementary and substitute goods could have influenced the market price and quantity sold of this specific example good.
Without a theory to guide your selection of facts, just about any hypothesis could be proposed and any theory could be arrived at. You'd be free to cherry-pick your data points and extend your imaginary line that supposedly models "perfect competition" until you are prepared to recommend the perfect rate of interest or quantity of stimulus in order to achieve a 2.1% increase in job growth. This is the height of absurdity. The pretense of knowledge knows no bounds.
Conclusion
Just for the record, I'm not afraid of math. I had to master all the techniques of vector calculus, matrix algebra, and differential equations on my path to an electrical engineering degree. While some of those techniques were hard to get my head wrapped around in the abstract, it all came together when I had to apply those lessons in my physics and electric circuits classes. It 'clicked' when I saw that these mathematical concepts truly do govern physical phenomenon in our world.
But does it make sense to apply those techniques in the sphere of human action? Is it correct to use the positivist and empirical scientific techniques one uses to discover the law of gravity or the behavior of electronic circuits to the question of how to govern and influence the behavior of free thinking human beings?
While the positivist schools of thought may claim to be more scientific and able to predict a 2.4% growth in GDP based on an $80 billion stimulus, it is the Austrian school that should get the credit in the sphere of making accurate predictions. After a few more premises and lines of deductive reasoning we could arrive at the Austrian Business Cycle Theory (ABCT), which has been used by various Austrians to predict every major boom-bust cycle from the Great Depression, the post WWII recovery, the end of the Bretton Woods system, the Japanese lost decade, the dot-com bubble, and the housing bubble.
To learn more about the Austrian School of Economics, the best books to read are the economic treatises by Mises and Rothbard, respectively, Human Action and Man, Economy and State. Gene Callahan's Economics for Real People is a good introductory book to the Austrian School. Tom Woods has also assembled an impressive collection of free books and online videos at learnaustrianeconomics.com.
