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Jeff Deist has excellent advice for us: listen to dead economists. He explains how economics has lost its way by trying to emulate the physical sciences and their empirical method. He cites Menger, Mises, Hayek, and Rothbard as primary resources for those interested in understanding economics as a “theoretical science.” According to Austrian economists, economic theory is constructed through deduction and not experimentation or mathematical modeling.
It is unfortunate that this position elicits more backlash than almost any other claim made by Austrian economists, because this one is so fundamental. If there cannot be agreement about how to do economics, then how fruitful can a discussion about policy be?
Much of the criticism I see is based on a misunderstanding and caricaturization of what Mises called “praxeology.” The same critics would not say the same things about logic, but praxeology is logic, just applied to human choice, or action. This is why I often avoid the term “praxeology” in mainstream company, and just use “the logic of action.”
Criticism #1: “‘Logic of action’? But some people are irrational!”
One initial misconception that usually arises is that this method must assume everybody is “logical” or “rational” in the colloquial senses of those terms. Relatedly, some take this terminology to mean that Austrian economists believe that all human behavior is deliberate. None of this is the case. The logic of action pertains to the primitive man choosing to do a rain dance to bring about rain as much as the climate scientist choosing what sort of thermometers to employ in his next experiment.
Also, taking conscious, purposeful choices as a subject matter does not mean that the existence of unconscious, reflexive behavior must be denied. Climate scientists take the climate as their subject matter, but they do not deny the existence of everything that isn’t the climate. There is no “economics of sneezing” for the same reason there is no “climatology of the stomach.”
Criticism #2: “But what can it do?”
Another common criticism is that such a method would get you nowhere. The critic asks, “How much can really be logically deduced from ‘Human action is purposeful behavior.’?” I would point this critic to some of the larger tomes in Austrian literature, like Human Action and Man, Economy, and State. Mises and Rothbard began with the same starting point — human action — and filled hundreds of pages with valuable economic theory and policy analysis.
For those who are still doubtful about the practicality of such a method, but don’t want to read so many pages, I can briefly show how to get to diminishing marginal utility. All economic theory hinges on being able to reach this conclusion.
When individuals act, they necessarily employ some means toward the satisfaction of a preferred end. A limited supply of means can only satisfy a limited number of ends. A homogeneous stock of means may be dedicated to a variety of ends. As such, an individual will use this stock of means to satisfy the most important or most desired ends, and leave the less important ends unsatisfied. Therefore, additional units of this homogeneous stock of means would be employed by the individual to satisfy lower-ranked ends, because the most highly preferred ends that could be satisfied by the means would be attained first.
This line of reasoning gives us a powerful claim: diminishing marginal utility. It is a rock-solid explanation of the way we value the things around us. It tells us a lot about the world and the way we deal with scarcity. It is universal and incontrovertible because of the way it was derived, and it is impossible to act in violation of this law.
It is useless to try to come up with some experiment to disprove it. It literally cannot be disproven in the same way that 1+1=2 cannot be disproven. You may wonder, “who in the world is out there trying to disprove diminishing marginal utility?” I would point you to the mainstream fascination with Giffen goods, which are goods that supposedly violate the law of demand, a close corollary to the law of diminishing marginal utility.1
Criticism #3: “Why do you hate data so much?”
This is the basis for a third frequent criticism of Austrian economists. Detractors say that Austrians are afraid of data and stubbornly plug their ears and sing “lalala” whenever they are confronted with supposedly inconvenient facts about the real world. But we’ve seen that there is no aversion to data, math, or statistics. These are just properly used in economic history or psychology and not in the testing of economic theory. The most that observation can do for theory is to guide the theoretician to construct relevant theory and perhaps to encourage the theoretician to take another look at a theory when all of the data “goes against it”, so to speak. Importantly, observations cannot falsify logically derived economic theory, but they can point an accusatory finger at a flawed step in the logic sometimes.
Thus you see how differences in method quickly lead to differences of theoretical conclusions. Differences in theoretical conclusions inevitably lead to debate over policy prescriptions. Even though normative claims like “There ought not to be a minimum wage” are technically outside the realm of positive economics, there is not a big jump from “Binding minimum wage laws cause unemployment” to “We shouldn’t enact minimum wage laws.” This is why there is such a large overlap of Austrian economists and libertarians.
The consequences of starting on different methodological grounds
The Giffen good concept obviously is not the extent of the differences between the mainstream and Austrians. The two schools start on different epistemological and methodological grounds and construct two different edifices of economic theory. The differences become especially polarizing in macro-level theory, even though there are some similar-looking façades on the micro-level.
Mainstream macroeconomics is so deeply flawed even mainstream macroeconomists are starting to admit it. It is marked by ridiculous levels of aggregation, outlandish policy proposals, and high-powered mathematical modeling that doesn’t seem to have anything to do with the way real human beings live and act. Though their science is founded on prediction, the 2007–08 financial crisis seemed to catch them all by surprise.
Austrian economists had been warning of a housing bubble for years, and it’s because they are equipped with a method of doing economics that is firmly grounded in the logical implications of real choices made by real humans.
- 1Giffen goods are theoretically possible in neoclassical microeconomics when the income effect outweighs the substitution effect for an inferior good. They are theoretically impossible in Austrian microeconomics because the two bundles of goods that are bought when the price of one of the items in that bundle changes are not viewed by the individual as homogeneous. For example, two pounds of potatoes and 16 ounces of meat consumed at the lower price for potatoes versus five pounds of potatoes and 10 ounces of meat consumed at the higher price for potatoes. Diminishing marginal utility only applies to an individual’s valuation of a homogeneous stock of a good, and bundles of items satisfy a different end for the individual than what the items would satisfy for the individual separately. You can see Peter Klein’s full explanation here.
