Economics and mathematical models

The mathematical methods of recent economics did not predict or prevent the current crisis. Should we look for a better way?

Mathematical modeling has revealed itself to be a vain and formalistic exercise incapable of explaining the international currency crises, stock-market and real-estate bubbles, or the global financial crises that have racked our world in the past two decades. It is increasingly evident, even to professional economists, that the tortuous positivist detour has led to an intellectual dead end. Hence, bizarre heterodox sects, such as behavioral economics, experimental economics, the “happiness” literature, neuro-economics, etc. now abound. Some market-oriented economists have even abandoned modern economic theory altogether for the less rigorous rhetoric and metaphors of Adam Smith’s “invisible hand” and Hayek’s “spontaneous order.”

The death knell is now tolling for the mathematical and positivist pretenders to the mainstream of economics.

via The Ambition of Rothbard’s Treatise – Joseph T. Salerno – Mises Institute . Note that positivism “seeks to apply the experimental methods of the natural sciences to the study of the problems of human action.” This tends to mechanize society with undesirable effects[1][2].

Finishing “Human Action, A treatise on economics”, Volume 1

It seems sometimes that there is little truly new thinking to be done, merely the attempt to catch up with previous dismissals of foolish and destructive ideas:

Of course, there will always be individuals and groups of individuals whose intellect is so narrow that they cannot grasp the benefits which social cooperation brings them. There are others whose moral strength and will power are so weak that they cannot resist the temptation to strive for an ephemeral advantage by actions detrimental to the smooth functioning of the social system. For the adjustment of the individual to the requirements of social cooperation demands sacrifices. These are, it is true, only temporary and apparent sacrifices as they are more than compensated for by the incomparably greater advantages which living within society provides.

The contractual order of society is an order of right and law. It is a government under the rule of law (Rechtsstaat) as differentiated from the welfare state (Wohlfahrtsstaat) or paternal state. Right or law is the complex of rules determining the orbit in which individuals are free to act. No such orbit is left to wards of a hegemonic society. In the hegemonic state there is neither right nor law; there are only directives and regulations which the director may change daily and apply with what discrimination he pleases and which the wards must obey. The wards have one freedom only: to obey without asking questions.

The Wall Street Journal said that Human Action “ought to be on the bookshelf of every thinking man”; I concur. It’s free online here.

They meant well

“They meant well” by D R Myddelton, published by the IEA, is a tour-de-force of government project disasters. It analyses in detail:

  • The R101 Airship
  • The groundnut scheme
  • Nuclear power
  • Concorde
  • The Channel Tunnel
  • The Millenium Dome

One would have hoped it was redundant to point out that these massive programmes needed to be managed actively, but the author finds it necessary to indicate the three essentials for managing projects in progress:

  • Regular reviews, focusing on the latest estimates of the amount and timing of future cash flows,
  • Up-to-date market research,
  • An ‘exit champion’ to argue the case for abandonment.

From the conclusion:

If everyone ‘meant well’, who was to blame: politicians, civil servants, scientists, engineers or managers? No, I think what was mainly to blame was the post-second-world-war collectivist zeitgeist — the visceral distrust of markets, partly based on ignorance, which I call ‘agoraphobia’.

… An important lesson from these projects is that governments do not understand product markets where customers are free to choose…

…My own ‘solution’ is simply: let the market work. To proceed with more large government quasi-commercial projects would be a recipe for further expensive disasters. Governments that lose thousands of millions of pounds of taxpayers’ money should not easily be excused on the grounds that ‘they meant well’. Those of us who advocate laissez-faire (which I define simply as ‘government non-interference’) mean well too.

Despite my aerospace engineer’s emotional attachment to Concorde, I thoroughly recommend the book.

The road to hell is paved with…

Good intentions, of course.

Chris Huhne proposes to introduce a bill to repeal the legislation that has stripped away our rights. So far, so good:

There has always been a problem for civil libertarians. The sacrifices of freedoms made by successive governments often seem small, particularly when they are pushed through at times of panic about terrorism. Each time, the government argues that you only need to give up a modest amount of freedom or rights to win greater security. And what could be more free than life itself? Yet the cumulative effects of this salami-slicing have now become deeply corrosive to the free spirit of a civil society. Like some sci-fi horror movie, we are slowly becoming the authoritarian threat that we are fighting.

via Chris Huhne: Our new freedom bill calls on the government to repeal the legislation that has stripped away our rights | Comment is free | guardian.co.uk

And, like all of us with good intentions, he rails against human suffering in the form of grotesque inequality:

I want the party to be true to its beliefs, as expressed in our constitution, to “balance the fundamental values of liberty, equality and community”. These three stand or fall together; inequality shackles freedom and undermines community. It was this recognition, that however much one removed political and legal constraints to freedom, the social and economic barriers of poverty, ignorance, unemployment and ill-health remained, that underpinned the new Liberalism of the early twentieth century. This was when British Liberals became a social liberal party, accepting that government intervention – in the shape of pensions, national insurance and progressive taxation, laying the foundations of the welfare state – was justified to enlarge liberty.

via Liberty, but equality too | Comment is free | guardian.co.uk
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Money, Bank Credit and Economic Cycles

Jesus Huerta De Soto’s book, “Money, Bank Credit and Economic Cycles” arrived today, all 875 pages of it. It is, apparently:

by far the most thorough treatment in print of Austrian ideas on banking and the business cycle 

It looks insightful already (from the preface to the second, 2001, edition):

While governments and central banks have reacted to the terrorist attack on New York’s World Trade Center by manipulating interest rates, reducing them to historically low levels … the massive expansion of fiduciary media injected into the system will not only prolong and hinder the necessary streamlining of the real productive structure, but may also lead to dangerous stagflation.

And so here we go. More to follow as I work towards his proposals for reform.

The New Cold War, Edward Lucas

A fascinating book by The Economist‘s Central and East European correspondent, Edward Lucas:

First a medieval fortress and then the citadel of Soviet totalitarianism, the Kremlin’s rose-red walls have rarely made lovers of liberty and justice feel at home. It is as if Britain’s government were based in the Tower of London, or France’s in the Bastille. Certainly the ideas now bubbling under its onion domes would have been all too familiar to its past occupants: put bleakly, Russia is reverting to behaviour last seen during the Soviet era.

For the justification of these remarks, see the book: it is recommended reading.

“The Plan: Twelve Months to Renew Britain”

After first reporting on the book here, I have finally returned to read it in detail; it is Cromwellian:

‘I find the country bleeding, nay, almost dying,’ Oliver Cromwell told MPs in 1644. what made him angry was not simply that people were suffering, but that Parliament was part of the problem. ‘The People are dissatisfied in every corner of the Nation,’ he raged, ‘all men laying at our doors the non-performance of these things that had been promised’.

Today, people are not so much dissatisfied as fatalistic. No one expects any party to cut taxes, make public services work for their customers, reverse the flow of illegal migration or restore Britain’s independence. Voters half sense that some politicians would like to do these things; but they know in their bones that the system is loaded against reform. ‘Nothing ever really changes,’ people protest; and, in a sense, they are right. Elected representatives have progressively ceded their powers to self-interested and inert bureaucracies – in Brussels as much as in Whitehall. With the best will in the world, there is remarkably little that politicians can change. Small wonder that fewer and fewer people vote: as matters stand, abstention is a rational decision.

Things don’t have to be this way. Other countries give meaningful power to their citizens, both as consumers of government services and as voters. In Britain, too, the rise of the quango state and the decline of Parliament are relatively recent phenomena. What’s done can be undone.

I thoroughly recommend the book. With so much incompetence to contend with, we need comprehensive and, above all, practical inspiration.

The Spell of Plato

At a friend’s request, I spoke to a sixth form class on “The Spell of Plato”, explaining how Plato’s philosophy is relevant today.

As the title suggests, I used Popper’s critique of Plato’s philosophy to explore these two propositions:

Government ought to control us to ensure social, political and economic justice.

We ought to control ourselves within the law to ensure freedom and progress.

We discovered that Plato’s Spell — his plan for building the perfect state in which every citizen is really happy — was at the root of some of the worst governments in history and we explored the echos of his philosophy in today’s political debate. We discussed Popper’s conclusion:

We must go on into the unknown, the uncertain and insecure, using what reason we may have to plan as well as we can for both security and freedom,

asking whether we should look to the state for every answer or whether we should take responsibility ourselves for making the world a better place.

It was a real pleasure to meet post-modern young people who were intelligent, thoughtful, attentive, polite and independent. They are another reason for optimism.


As an aside, I just rediscovered this in the preface to the 1950 second edition:

I see now more clearly than ever before that even our greatest troubles spring from something that is as admirable and sound as it is dangerous — from our impatience to better the lot of our fellows. For these troubles are the by-products of what is perhaps the greatest of all moral and spiritual revolutions of history, a movement which began three centuries ago. It is the longing of uncounted unknown men to free themselves and their minds from the tutelage of authority and prejudice. It is their attempt to build up an open society which rejects the absolute authority of the merely established and the merely traditional while trying to preserve, to develop, and to establish traditions, old or new, that measure up to their standards of freedom, of humaneness, and of rational criticism. It is their unwillingness to sit back and leave the entire responsibility for ruling the world to human or superhuman authority, and their readiness to share the burden of responsibility for avoidable suffering, and to work for its avoidance. This revolution has created powers of appalling destructiveness; but they may yet be conquered.

Reconciling ourselves to capitalism

Reflecting on aspects of the debate about capitalism, I picked this out of Liberalism, the Classical Tradition:

To advocate private ownership of the means of production is by no means to maintain that the capitalist social system, based on private property, is perfect. There is no such thing as earthly perfection. Even in the capitalist system something or other, many things, or even everything may not be exactly to the liking of this or that individual. But it is the only possible social system. One may undertake to modify one or another of its features as long as in doing so one does not affect the essence and foundation of the whole social order, viz., private property. But by and large we must reconcile ourselves to this system because there simply cannot be any other.

In Nature too, much may exist that we do not like. But we cannot change the essential character of natural events. If, for example, someone thinks — and there are some who have maintained as much — that the way in which man ingests his food, digests it, and incorporates it into his body is disgusting, one cannot argue the point with him. One must say to him: There is only this way or starvation. There is no third way. The same is true of property: either-or — either private ownership of the means of production, or hunger and misery for everyone.

By this point, Mises has considered — bullets my own — “five different conceivable systems of organizing the cooperation of individuals in a society based on the division of labor [sic]:

  • The system of private ownership of the means of production, which in its developed form, we call capitalism;
  • The system of private ownership of the means of production with periodic confiscation of all wealth and its subsequent redistribution;
  • The system of syndicalism;
  • The system of public ownership of the means of production, which is known as socialism or communism;
  • and, finally, the system of interventionism.”

Also, the point is explored that socialism can be brought about by retaining private ownership of property but so tightly controlling its use through rules and regulations that the fact of private ownership is of no consequence.

I won’t quote the book all day: I do recommend it.

Bureaucracy

Bureaucracy: from Stalin and Trotsky to David Cameron, we all know we loathe it. What is it?

In “Bureaucracy”, Ludwig von Mises explains:

Bureaucratic management is management bound to comply with detailed rules and regulations fixed by the authority of a superior body. The task of the bureaucrat is to perform what these rules and regulations order him to do. His discretion to act according to his own best conviction is seriously restricted by them.

“Bureaucracy” is a slim book of only 101 pages, thoroughly readable and insightful. Mises uses his understanding of economic calculation to explain succinctly the differences between bureaucratic management and profit and loss management in the free market. His argument has far reaching consequences: it demonstrates that public administration must become uneconomic and irrational.

Here’s a favourite section:

The history of Sweden can be treated with almost no reference to the history of Peru. But you cannot deal with wage rates without dealing at the same time with commodity prices, interest rates, and profits. Every change occurring in one of the economic elements affects all other elements. One will never discover what a definite policy or change brings about if one limits his investigation to a special segment of the whole system.

It is precisely this interdependence that the government does not want to see when it meddles in economic affairs. The government pretends to be endowed with the mystical power to accord favours out of an inexhaustible horn of plenty. It is both omniscient and omnipotent. It can by a magic wand create happiness and abundance.

The truth is that the government cannot give if it does not take from somebody. A subsidy is never paid by the government out of its own funds; it is at the expense of the taxpayer that the state grants subsidies. Inflation and credit expansion, the preferred methods of present-day government open handedness, do not add anything to the amount of resources available. They make some people more prosperous, but only to the extent that they make others poorer.

So we begin to see how the Austrian school of economics explains how the policies of the left create the very inequalities and injustices that they rail against: inflation hits savers and credit expansion widens inequality (the poor don’t invest with leverage). The intentions of the left are very well, but their impatience to use the power of the state to advance social, economic and political justice is a great enemy to progress in every area.

The champions of socialism call themselves progressives, but they recommend a system which is characterized by rigid observance of routine and by a resistance to every kind of improvement. They call themselves liberals, but they are intent on abolishing liberty. They call themselves democrats, but they yearn for dictatorship. They call themselves revolutionaries, but they want to make the government omnipotent. They promise the blessings of the Garden of Eden, but they plan to transform the world into a gigantic post office.[Lenin] Every man but one a subordinate clerk in a bureau, what an alluring utopia! What a noble cause to fight for!

No one likes bureaucracy. Detailed rules and regulations abolish much in life for which we strive: they destroy progress and extinguish hope. We need another way.