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People generally believe that economics is of interest
only to businessmen, bankers, and the like and that there is a separate
economics for every group, segment of society, or country. As economics is the
latest science to have been developed, it is no wonder that there are many
erroneous ideas about the meaning and content of this branch of knowledge. It
would take hours to point out how common misunderstandings developed, which
writers were responsible, and how political conditions contributed. it is more
important to enumerate the misunderstandings and discuss the consequences of
their acceptance by the public.
This first misunderstanding is the belief that economics does not deal with the
way men really live and act, but with a specter created by economics, a phantom
that has no counterpart in real life. The criticism is made that real man is
different from the specter of the “economic man.” once this first
misunderstanding is removed, a second misunderstanding arises—the belief
that economics supposes that people are driven by one ambition and intention
only—to improve their material conditions and their own well-being.
Critics of this belief say that not all men are egoistic.
A third misunderstanding is that economics assumes all men to be reasonable,
rational, and guided by reason only, while in fact, the critics maintain,
people may be guided by “irrational” forces. These three
misunderstandings are based on entirely false assumptions. Economics does not
suppose that economic man is different from what man is in everyday life. The
only supposition of economics is that there are conditions in the world with
regard to which man is not neutral, and that he wants to change the situation
by purposeful action. So far as man is neutral, indifferent, content, he takes
no action, he does not act. But when a man distinguishes between states of
various affairs and sees an opportunity to improve conditions from his point of
view, he acts.
Action is the search for improvement of conditions from the point of view of
the personal value judgments of the individual concerned.
(DR. McCloskey terms this 'betterment')
This does not mean improvement from a metaphysical view, nor from God’s
point of view. Man’s aim is to substitute what he considers a better state
of affairs for a less satisfactory one. He strives for the substitution of a
more satisfactory state of affairs in place of a less satisfactory state of
affairs. And in the satisfaction of this desire, he becomes happier than he was
before. This implies nothing with reference to the content of the action, nor
whether he acts for egoistic or altruistic reasons. To eliminate the
misunderstanding that arises when a distinction is attempted between
“rationalism” and “irrationalism,” it must be realized that
what man does consciously is done under the influence of some force or power
which we call reason. Any action aimed at a definite goal is in this sense
“rational.” The popular distinction between “rational” and
“irrational” is entirely without meaning. Examples of
“irrationalism” cited are patriotism or the purchase of a new coat or
a symphony ticket when something else might have appeared a more sensible
action. The theoretical science of human action presupposes only one
thing—that there is action, i.e., the conscious striving of individuals to
remove uneasiness and to substitute a more satisfactory state of affairs for
one that is less satisfactory. No judgment of value is made as to the reason or
content of the action. Economics is neutral. Economics deals with the results
of value judgments, but economics itself is neutral.
Nor is there any sense in trying to distinguish between “economic”
and “non-economic” actions. Some actions deal with the preservation
of man’s own vital senses and necessities—food, shelter, and so on.
Others are considered to be driven by “higher” motivations. But the
value placed on these various goals vary from man to man, and differ for the
same man from time to time. Economics deals merely with the action; it is the
task of history to describe the differences in goals. Our knowledge of economic
laws is derived from reason and cannot be learned from historical experience
because historical experience is always complex and cannot be studied as in a
laboratory experiment. The source of economic facts is man’s own reason,
i.e., which we call in epistemology a priori knowledge, what one knows already;
a priori knowledge is distinguished from a posteriori knowledge, knowledge
which is derived from experience. Regarding a priori knowledge, the English
philosopher John Locke [1632–1704] developed the theory that the human
mind is born a blank slate on which experience writes. He said there was no
such thing as inherent knowledge. Gottfried Wilhelm von Leibniz
[1646–1716], a German philosopher and mathematician, made an exception in
the case of the intellect itself. According to Leibniz, experience does not
write on empty white pages in the human mind; there is a mental apparatus
present in the human mind, a mental apparatus that does not exist in the minds
of animals, which makes it possible for men to convert experience into human
knowledge.
I am not going to enter into the argument between “rationalism” and
“empiricism,” the distinction between experience and knowledge, which
the British philosopher and economist John Stuart Mill [1806–1873] called
a prioristic knowledge. However, even Mill and the American pragmatists
believed that a prioristic knowledge comes in some way from experience. The way
in which economic knowledge, economic theory, and so on relate to economic
history and everyday life is the same as the relation of logic and mathematics
to our grasp of the natural sciences. Therefore, we can eliminate this
anti-egoism and accept the fact that the teachings of economic theory are
derived from reason. Logic and mathematics are derived in a similar way from
reason; there is no such thing as experiment and laboratory research in the
field of mathematics. According to one mathematician, the only equipment a
mathematician needs is a pencil, a piece of paper, and a wastebasket—his
tools are mental. But, we may ask, how is it possible for mathematics, which is
something developed purely from the human mind without reference to the
external world and reality, to be used for a grasp of the physical universe
that exists and operates outside of our mind? Answers to this question have
been offered by the French mathematician Henri Poincaré [1854–1912]
and physicist Albert Einstein [1879–1955]. Economists can ask the same
question about economics. How is it possible that something developed
exclusively from our own reason, from our own mind, while sitting in an
armchair, can be used for a grasp of what is taking place on the market and in
the world?
The activities of every individual—all actions—stem from reason, the
same source from which come our theories. Man’s actions on the market, in
the government, at work, at leisure, in buying and selling, are all guided by
reason, guided by choice between what a person prefers as against what he does
not prefer. Reason is the method by which a solution (whether good or bad) is
reached. Every action can be called an exchange insofar as it means
substituting one state of affairs for another. Hopefully the actor is
substituting a situation he prefers for one which he likes less. The starting
points for the natural sciences are the various facts established by
experiment. From these facts, theories are built to more and more abstractions,
to more and more generalities. Final theories are so abstract that they are
practically inaccessible to the general multitude. That doesn’t make them
less valuable; it is enough that they are accessible to the few scientists. In
an a prioristic science, we start with a general supposition—action is
taken to substitute one state of affairs for another. This
theory—meaningless to many—leads to other ideas that become more and
more understandable and less abstract.
Natural sciences progress from the less general to the more general; economics
proceeds in the opposite direction. Natural sciences are in a position to
establish constant relations of magnitude. In the field of human action, no
such constant relations prevail, so there is no opportunity for measurement.
The value judgments which spur men to act, which lead to prices and market
activity, do not measure; they establish distinctions of degree; they grade.
They do not say “A” is equal to, or is more or less than
“B.” They say, “I prefer A to B.” They don’t establish
judgments. This has been misunderstood for 2000 years. Even today there are
many persons, even eminent philosophers, who misunderstand this completely. It
is from the system of values and preferences that the price system of the
market arises. Aristotle wrote, among other things, about the various
attributes of men and women. He was often mistaken. Had he asked Mrs. Aristotle
about women, he would have found he was mistaken in some respects; he would
have learned differently. He was also mistaken in stating that if two things
were to be exchanged on the market, they must have something in common, that
they were being exchanged because they were equal. Now if they were equal, why
was it necessary to exchange them? If you have a dime and I have a dime, we
don’t exchange them because they are the same. It follows, therefore, that
if there is an exchange, there must be some inequality in the items being
traded, not equality.
Karl Marx [1818–1883] based his theory of value on this fallacy. In
Capital and Interest, by Eugen von Böhm-Bawerk [1851–1914], see
Chapter XII dealing with Marx (“The Exploitation Theory” in Volume
I, History and Critique of Interest Theories). Long after Marx, Henri
Bergson, in a much-admired book about the two sources of morals in religion,
accepted the same fallacy—if two things are exchanged on the market they
must be equal in some way. But things that are “equal” are not
exchanged; exchanges take place only because things are unequal. You take the
trouble of going to the market because you value the loaf of bread more highly
than the money you give for it. People exchange things because at that time
they prefer other things to money. An exchange never occurs with the intention
of a loss. The acting man is never pessimistic because his action is inspired
by the idea that conditions can be improved. The aim of action is to substitute
a state of affairs better suiting the men taking the action than the previous
situation. The value of any change in their situation is called a
“gain” if it is positive, a “loss” if it is negative. This
value is purely psychic, it cannot be measured. You can say only that it is
greater or less. It becomes measurable only insofar as things are exchanged on
the market against money. As far as the action itself is concerned, it has no
mathematical value.
But, you say, this contradicts our daily experience. Yes, because our social
environment makes calculations possible insofar as things are exchanged for a
common medium of exchange, money. When things are exchanged against money, it
is possible to use monetary terms for economic calculations, but only when
three conditions are filled:
1. There must be private ownership, not only of the products, but also of the
means of production;
2. There must be division of labor and, therefore, production for the needs of
others;
3. There must be indirect exchange in the terms of a common denominator.
By and large, given these three conditions some mathematical values may be
established, although not precisely. These measurements are not exact because
they deal with what took place yesterday, historically. Business financial
statements may look precise, but even the money value of an inventory entered
at “so many dollars” is a speculative value of future anticipations;
the value credited to equipment and other assets also is speculative. The real
problem of inflation is that it falsifies these calculations and brings about
tragic problems. Monetary calculations do not necessarily exist in all kinds of
organizations or societies. They did not exist when economics began. The
earliest humans acted; humans have always acted; but it was thousands of years
before the evolution of the division of labor and of a financial apparatus made
monetary calculations possible. Monetary calculations developed step by step
during the Middle Ages. In their early development they lacked many features we
think of today as necessary. (In a socialist system, these conditions would
again disappear and make such calculations and measurements impossible.)
The quantitative nature of the natural sciences enables mechanics to make plans
and build bridges. If you know what must be built, technology based on the
knowledge of the natural sciences is sufficient. The questions are, however:
What should be constructed? What should be done? Technologists cannot answer
these questions. In life the materials of production are scarce. No matter what
we do there will always be other projects for which the necessary factors of
production cannot be spared. There will always be other urgent demands. This is
the factor that businessmen take into account in calculating loss and success.
When a businessman decides against a certain project because the cost is too
high, it means the public is not prepared to pay the price to use raw materials
in that manner. Use is made of the available factors of production for the
realization of the greatest number of those projects that satisfy the most
urgent needs without wasting factors of production by withdrawing them from
more urgent to less urgent employment. To establish this it is necessary to be
in a position to compare the outlays of various factors of production. For
example, let it be assumed that it is necessary to build a railroad between two
towns—A and B. Let us assume that there is a mountain between A and B.
There are three possibilities—to go over, through, or around the mountain.
A common denominator is necessary to calculate the comparative value. But this
can give only a picture of the monetary situation; it is not a measurement. It
is an evaluation in the light of present-day needs and situations. Tomorrow
conditions will be different. The success or failure of every business project
depends upon its success in anticipating future possibilities.
The problem with trying to develop a quantitative science of economics is that
many persons imagine that theoretical economics must follow the evolution of
other branches of science. The natural sciences developed from being
qualitative to being quantitative in nature and many people are inclined to
believe that the same trend must take place in economics also. However, there
are no constant relationships in economics, so no measurement is possible. And
without measurement, the quantitative development of economics cannot take
place. Quantitative facts in economics belong to economic history—not to
economic theory. A book titled Measurement of the Elasticity of Demand
was reviewed recently by a man now in the U.S. Senate, Paul Douglas
[1892–1976], who may even be hoping for higher political office sometime.
Douglas said economics should become an exact science with fixed values like
atomic weights in chemistry. But this book itself does not refer to fixed
values; it refers to the economic history of one definite period of time in one
particular country, the United States. The results would have been different if
another period of time or if another country had been considered. Within the
framework of the universe in which we operate, atomic weights do not change
from one period of time or from one country to another. On the other hand,
economic values and economic quantities do change from time to time and from
place to place.
Economics is the theory of human action. It is a historical fact of great
importance, for example, that the usefulness of the potato was discovered by
the natives of Mexico, brought to Europe by a British gentleman, and that its
use spread all over the world. This historical fact has had important effects
on Ireland, for instance, but from the point of view of economic theory it was
just an accident. When you introduce figures into economics you are no longer
in the field of economic theory, but in the field of economic history. Economic
history is also, of course, a very important field. Statistics in the field of
human action is a method of historical study. Statistics give a description of
a fact, but they cannot prove any more than that fact. (It is true that some
statisticians are “swindlers” and, as a matter of fact, some
statisticians in the government were probably appointed merely for that
purpose.)
Some people may misinterpret these statements and conclude that the purpose of
economics, being a purely a prioristic science, is to develop a program for a
future science, and that economics is a theory practiced only by “armchair
gentlemen.” Both these statements are wrong. Economics is not a program
for a science that doesn’t yet exist. And it is not a science merely for
purists. Therefore, we must reject the ideas of some people that one must learn
history to study human action. History is important. But you cannot deal with
present-day conditions by studying the past. Conditions change. As an example
of what I mean. The National Bureau of Economic Research published a report on
the subject of installment selling which appeared on the eve of World War II,
on the eve of inflation, and on the eve of government credit restrictions. At
the moment when the study was made, it was already “dead”; it dealt
with matters that were already past. I don’t mean to say that it was
useless. With good brains one can learn a lot from it. But don’t forget it
is not economics—it is economic history. What they were really studying
was the economic history of the most recent past. Darwin realized this too. He
saw that in studying animals, the animal was killed at the moment when it was
dissected for study, so that one could never actually study the animal—one
can never study life itself. The same is true of economics. One cannot describe
the present economic system—one can only describe the past. One cannot
predict about the future as a result of studying the past. Very often economic
historians teach history under the label of “economics.” Even though
you know everything about the past, you know nothing about the future.
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