Principles of Economics

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All rights reserved.

Principles of Economics

ISBN     979-8-9879755-1-0  Hardcover

              979-8-9879755-4-1  Paperback

              979-8-9879755-7-2  Ebook

              979-8-9879755-0-3  Audiobook

To my father, who taught me the most important lesson of this book before I could read, and to my son, so he too may learn it.

Table of Contents

About the Author

Introduction

PART I. FUNDAMENTALS

Chapter 1     Human Action

Action, Purpose, and Reason

Economic Analysis

Quantitative Analysis

A Contrast of Approaches

Chapter 2     Value

Utility and Value

Valuation: Ordinal and Cardinal

Value and Price

Free Exchange

Determinants of Value

Marginalism

Marginal Utility

Law of Diminishing Marginal Utility

Valuation by the Least Valuable Use

Water-Diamond Paradox

Chapter 3     Time

The Ultimate Resource

Opportunity Cost

Material Abundance

Simon’s Bet

Time Preference

Economizing Time

Economizing Action

PART II. ECONOMY

Chapter 4     Labor

Labor and Leisure

Production

Productivity of Labor

Unemployment

Will Work Ever End?

Is Labor Exploitation?

Chapter 5     Property

Scarcity and Property

Types of Property

Self-Ownership

Importance of Property Rights

Chapter 6     Capital

Lengthening Structure of Production

Saving

Higher Productivity

The High Cost of Capital

Capital and Time Preference

Saving Fallacies

Limits to Capital

Chapter 7     Technology

Technology and Labor

Technology and Productivity

Technological Innovation and Entrepreneurship

Software

Property in Ideas

Chapter 8     Energy and Power

Energy in Human History

Energy Abundance

Power Scarcity

Power of Hydrocarbon Alternatives

Energy and Freedom

PART III. THE MARKET ORDER

Chapter 9     Trade

Subjective Valuation

Absolute Advantage

Comparative Advantage

Specialization and the Division of Labor

Extent of the Market

Chapter 10   Money

The Problem Money Solves

Salability

Salability across Time

Why One Money?

Money and the State

Value of Money

Money’s Uniqueness

How Much Money Should There Be?

Chapter 11   Markets

Consumer Good Markets

Equilibrium

Producer Good Markets

Economizing in the Market Order

Consumer Sovereignty

A Contrast of Approaches

Chapter 12   Capitalism

Capital Markets

Capitalism Is Entrepreneurial, Not Managerial

Profit and Loss

The Economic Calculation Problem

Modern Economics and Calculation

The Effects of Entrepreneurial Investment

PART IV. MONETARY ECONOMICS

Chapter 13   Time Preference

Time Preference and Money

Time Preference and Saving

Time Preference and Civilization

Time Preference and Bitcoin

Chapter 14   Credit and Banking

Banking

Credit

Commodity Credit

Interest Rates

Can Interest Be Eliminated?

Chapter 15   Monetary Expansion

Circulation Credit

Mises’ Typology of Money

Business Cycles

The Business Cycle Graphically

Capital Market Central Planning

PART V. CIVILIZATION

Chapter 16   Violence

Non-Aggression Principle

Government Coercion

Rationales for Government Violence

Rationality in Economics

Chapter 17   Defense

The Market for Defense

The Market for Law and Order

State Monopoly of Defense and Law

State Monopoly Failure Modes

A Free Market in Defense

Chapter 18   Civilization

The Cost of Civilization

The Case for Civilization

The Fiat Slavery Alternative to Civilization

The Triumph of Reason

Appendix 1

Bibliography

About the Author

Saifedean Ammous is an internationally best-selling economist and author. In 2018, Ammous authored The Bitcoin Standard: The Decentralized Alternative to Central Banking, the best-selling book on bitcoin, published in 36 languages. In 2021, he published The Fiat Standard: The Debt Slavery Alternative to Human Civilization, available in 12 languages. Saifedean teaches courses on the economics of bitcoin, and economics in the Austrian school tradition, on his online learning platform Saifedean.com, and also hosts The Bitcoin Standard Podcast.

Saifedean was a professor of Economics at the Lebanese American University from 2009 to 2019. He holds a PhD in Sustainable Development from Columbia University, a Masters in Development Management from the London School of Economics, and a Bachelor in Mechanical Engineering from the American University of Beirut.

Introduction

The vast majority of textbooks taught in universities today are in the mainstream Keynesian-Samuelsonian economic tradition, which confuses students more than it informs them. I have taught these university textbooks for years and witnessed droves of intelligent students leave class with more questions than they entered it with, struggling to understand the significance of the obscure equations they studied, or to see any convincing reason to believe their outputs. Over the years, I have spoken to dozens of highly intelligent students and graduates who report a similar experience: They did what they had to do to get the grade they wanted, but none of the material made sense to them. They incredulously try to convince themselves to undertake the astounding leaps of logic necessary to make sense out of the irrelevant equations in order to pass exams, never to consider the ideas of the course again. If students learn from the mainstream textbook, they learn to understand theoretical models with only a tenuous link to reality. Success in the courses consists of understanding the models, not reality.

While teaching economics, I would include insights from the Austrian school of economics. Students invariably found these to be the most practically and intellectually interesting parts of the course, and the one that provided them lasting value beyond securing a degree. Austrian ideas are almost entirely ignored in most of today’s universities. Modern textbooks rarely ever mention the Austrian school, let alone elaborate their ideas. I had to constantly resort to a variety of readings on various topics. The most prominent Austrian textbooks and treatises, such as Mises’ Human Action and Rothbard’s Man, Economy, and State, are difficult for most modern readers to digest, and, sadly, they spend far too much time attempting to argue with mainstream thinking, which after a point impedes clarifying the Austrian perspective.

I always wanted a clear, concise, and readable treatment of the main economic ideas in the Austrian tradition, culminating in an understanding of the civilizational importance of the extended monetary market order. I began developing the outlines of such a textbook for graduate and senior courses I taught at the Lebanese American University. After publishing The Bitcoin Standard and finding a receptive readership that appreciated my writing on economics, I decided to turn my attention extensively to writing the textbook that I had always wanted to teach. In 2019, I decided to leave my university job and start teaching and publishing independently, on my website saifedean.com. In 2019 and 2020, I developed two Principles of Economics courses, ECO11 and ECO12, which further developed the ideas that would grow into this book.

Teaching and interacting with hundreds of students from around the world, and being liberated from the academic publication mill’s increasingly arcane and esoteric journals and publishers, I could now focus on writing for the reader, not committees of academics. After two decades of studying and learning economics at university level, this book represents the knowledge of economics I would like to have had when I was 17. It is what I hope my children will read when they become curious about economics.

This book forms an introduction to the principles of economics, and the economic way of thinking—a powerful tool of mental planning useful for everyone to understand. In a university, I would teach this book over two semesters, to introduce students to a broad view of the topic of economics and the economic way of thinking. More than just a university textbook, this is a book written for a general audience of anyone interested in economic ideas. Even if you are not studying economics at a university, you are making economic decisions every day of your life. For this reader, I hope this book offers a concise and actionable summary of the most useful insights of the economic way of thinking, which would be helpful in personal and business decision-making.

This book is unapologetically Austrian in its approach. It uses the plain written word to explain what many economists throughout history have found to be the most powerful methods of understanding economic phenomena. It applies the human action approach to explaining the most important concepts and topics in economics, building on the work of the economists of the Austrian school. It tackles major economic concepts and topics independently, but in a logical sequence aimed at delivering the reader an understanding of economics at an individual and societal level, and the widespread implications of economics as a topic. The first part of the book introduces the foundational concepts in economics and the Austrian method of this book. The second part of the book, Economy, introduces the actions that individual humans perform to economize. Part III, The Market Order, examines economizing in the social context, why the capitalist economy develops, and the role of money. Part IV, Monetary Economics, examines time, interest, and monetary and financial economics. Part V, Civilization, examines the economics of violence and security, and what they imply for the possibility of advancing human civilization.

Each chapter of this book discusses an important economic concept, and can be read as a standalone essay on the topic. But the book is also structured as a monograph narrative, laying out these concepts in a logical sequence. The first chapter introduces the Austrian methodological approach to economics, and provides an example, as well as a comparison with the methodological approach of the natural sciences. Chapter 2 introduces the foundational concept of value, and explains its subjective nature, as well as the concepts of utility and marginal analysis, based on the work of Carl Menger, father of the Austrian school. Chapter 3 introduces the importance of time in economics, the unique nature of economizing time, and how all economizing acts can be understood as attempts to increase the quantity and subjective value of our time on earth. This chapter also introduces the pivotal concepts of opportunity cost and time preference.

The second section of the book introduces the main actions humans carry out to economize individually. In each of the chapters of this section, a key concept is introduced and analyzed in terms of the reasons humans engage in it, the problem it solves, and how it helps them economize on time. The first and most basic concept is labor, the topic of Chapter 4. Chapter 5 explains the economics of property, why it emerges and the problem it solves, and the concept of self-ownership. Chapter 6 introduces a particular type of property, capital, which consists of goods used for the production of other goods, and discusses the cost of capital, its productivity, and its connection to time preference.

Chapter 7 discusses technology as an economic concept, why it increases labor productivity, and its unique status as a non-material economic good that is non-scarce. The chapter concludes with a discussion of the concept of intellectual property, and how the non-scarce nature of information makes it differ from other productive goods.

Energy, the topic of Chapter 8, is not a conventional topic in most economic textbooks. However, I believe that understanding the economics of energy is essential to understanding economics, particularly as the modern capital-intensive and technologically advanced market economy would not be possible without substantial increases in modern humans’ power—the ability to wield large amounts of energy in short periods of time. Moreover, approaching economics through the Austrian method, through marginal analysis, is essential to understanding the realities of energy production in the world today.

Whereas the second section of the book examines individual economizing acts, the third part of the book looks at economizing in a social context, introducing other people into the analysis and exploring the implications. As soon as another person is present, trade becomes possible, and both parties have an incentive to engage in it, as it benefits them both. Chapter 9 explains the rationale of trade, its benefits, and the implications of the growth of the market in which the division of labor takes place.

Chapter 10 introduces the concept of money, explaining the problems it solves, how these problems shape the characteristics that are desirable in money, and how money helps humans economize and increase the value and productivity of their time. The chapter explains how money is a product of the market, and not the state, as is commonly but erroneously taught in economic textbooks. While this chapter introduces money, the broader discussion of monetary economics will be left to Part IV, so it can follow the discussion of capital markets, an essential topic in monetary economics.

The social order in which individuals peacefully engage in all the aforementioned economizing acts is called a market order. Chapter 11 examines how individual preferences and economizing acts result in the formation of prices, whose essential significance to the market process is explained. Chapter 12 explains the term capitalism in the Misesean tradition, and how it is an entrepreneurial system inseparable from private property and economic calculation. We examine Mises’ litmus test for determining whether a society has a market economy, and how it can help us understand economic history.

Part IV, Monetary Economics, approaches the topic of money from an Austrian perspective, and so Chapter 13 begins with time preference, and its relationship with saving, money, and capital accumulation, which is what makes credit and banking possible, the topics of Chapter 14, which also explains interest rates and whether they can be eliminated. Chapter 15 examines the Austrian understanding of the business cycle by examining its underlying cause, monetary expansion via circulation credit issuance.

As the earlier parts illustrate the function and form of a capitalist market economy, and how it can only work in a system of respect for private property, the fifth and final part of the book, Civilization, examines the viability of capitalist civilization against the threat of violent aggression. Chapter 16 examines the economics of violence, in both its private and governmental forms, while Chapter 17 examines the economics of defense, and shows how this is just another market good, which today is predominantly provided on the market.

The book’s final chapter discusses the concept of civilization from an economic perspective. Civilization is viewed as an order that emerges when a society can remain peaceful, productive, low time preference, cooperative, and innovative enough to sustain intergenerational improvements in living standards. The costs of this monumental enterprise are discussed, as well as the chances for the continuation of capitalist civilization in the face of the formidable threats it faces.

This book is supplemented by its webpage, saifedean.com/poe, where you can find a full bibliography with live links to the readings listed in this book. Since the internet has become so pervasive, I decided it would make sense to optimize the paper copy of this book for the reader experience by eliminating urls from references, and keeping a live full bibliography on saifedean.com/poe. After concluding this book, I will be offering another online course on saifedean.com to study this material in more depth.

This book benefitted and improved immensely as a result of the feedback of Ross Stevens, Jeff Deist, Per Bylund, Conza, Allen Farrington, Jonathan Newman, Peter Young, and Thomas Semaan. The last two also provided extremely valuable research assistance throughout the writing of this book. I also profusely thank the excellent editors whose thorough and meticulous editing improved this manuscript immensely: Alex McShane, Steve Robinson, Chay Allen, Renata Sielecki, Magda Wojcik, Evan Manning, and Elizabeth Newton. I also thank Tamara Mikler for producing the graphics, and Max DeMarco for editing the audiobook. I am also very grateful for the saifedean.com team of Pavao Pahljina, Marko Pahljina, Dorian Antešić, Flora Fontes, and Valentino Cnappi for all the effort they put into running the website and arranging the publication.

This book would not have been possible without the support, encouragement, and feedback of members of my online learning platform saifedean.com. I am most grateful to them for allowing me to work productively on finalizing my work. In particular my sincere gratitude goes to my readers who supported the publication of this book by buying the pre-ordering signed copies. Thank you A Patel, Aaron Macy, Abdulla Al Abbas, Abdullah Almoaiqel, Adam Higgs, Ágúst ragnar Pétursson, Aidan Campbell, Aleksi Meldo, AJ Garnerin, Alex, Alex Bowe, Alex Vanya, Alex Voss, Alistair Milne, Amit Barkan, Anderson Thees, Andrea Bortolameazzi, Andrew Brasuell, Andrew Rosener, Andrew Stanger, Anthony Clavero, Antonio Caccese, Arnaud Cart, Ashok Atluri, Avery, Ben Johnson, Bertrand Marlier, BitcoinTina, Björn Tisjö, BK, Blake Canfield, BowserKingKoopa, Brian Daucher, Brian Kim, Brian Lockhart, Bronson Moyen, Browning Hi-Power 9mm, Bryan Matthieu, Bryan Renero, Bryan Wilson, Burcu Kocak, Carlo Barbara, Carlos Chida, Caspar Veltheim, Cedric Youngelman, Charles Smith, Chase Oleson, Chen YH, Chris Cowlbeck, Christian Amadasun, Christof Mathys, Christopher Lamia, Christopher P Valle, Christopher Pogorzelski, Christopher To, Cletus Reynolds, Dale Williams, Dan Skeen, Dane Bunch, Daniel Ostermayer, Daniel Schneider, Dave Hudson, David Heller, David Lawant, Dirk Seeber, Domingo Ochotorena, Donald Johnson, Dylan Parker, Ed Becker, Eduardo Lima, Edward Cosgrove, Elio Fattorini, Ernest Huttel, Fabian von Schilcher, Federico Quintela, Francisco Reyes, Frank Acklin, Gary Lau, Gary Speed, Gen Shin, Glenn Thomas, Greg Doyle, Götz Rößner, Haris M, Harlan Robinson, Hayden Houser, Hugh Starr, Hunter Hastings, Jaap Willems, Jackson Forelli, Jaeger Hamilton, James Seibel, James Weaver, Jason DiLuzio, Jawad Barlas, Jeffery Lee Degner, Jerrold Randall, Jesse Powell, Jim Patterson, Joachim Boudet, John A. Krpan, John Brier, John Dixon, Jon E, Jonas Karlberg, Jonas Konstandin, Jonathan Camphin, Jonathas Carrijo, Jordan Wilby, Jose Areitio Arberas, José Niño, Jules, Julio Neira, Justin Schwartz, Keith G, Kelly Lannan, Kenneth Gestal, Kevin Coffin, Kim Butler, Lachie McWilliam, Larry Salibra, Luis Alonso, Luke and Henley, Maksymilian Korzuchowski, Manuel Tomasi, Marco Daescher, Marco Mouta, Marcus Dent, Marius Kjærstad, Marius Reeder, Martin Brochhaus, Matija Grlj, Matt, Matt Unks, Matthew Robin, Matthew Sellitto, Max Cash, Maximiliano Guimarães, Michael Atwood, Michael Culhane, Michael Felch, Mike Clear, Mitch Soboleski, Mitchell Vanya, Nate Kershner, Nathan Smith, Neal Nagely, Nelson Minier, Nicholas Sheahan, Nick Giambruno, Nicolás Ahumada, Niko Laamanen, Nikolai Maevskii, Noah Amadasun, Noded, Odi Kosmatos, Oleg Mikhalsky, Paola Frapolli, Paweł Sławniak, Per-Olof Vallin, Petar Sutalo, Petr Zalud, Philip Karageorgevitch, Pierre Porthaux, Rasmus Berg, Raycheslav Karagyozov, Rene Bos, Richard Duke, Robert Koonce, Robin Dea, Ron M Dewberry, Ronald Zandstra, Rosie Featherby, Ross Stevens, Rowais Hanna, Ryan Nadeau, Ryan Sandford, Saagar Singh Sachdev, Sam Dib, Sam Shams, Samuel Douglass, Scott Manhart, Scott Schneider, Scott Shell, Seb Walker, Shakti Chauhan, Shaun McFarlane, Simonna Pencev, Stefano D'Amiano, Stephen Labb, Subhan Tariq, Tami Uitto, Tanner Dowdy, Théo Mogenet, Thierry Thierry, Thomas Jenichen, Timo Oinonen, Tom Karadza, Tomas Hrncir, Travis Tripodi, Trevor Smith, Vik, Viktor Geller, Wendy Hiam, William Azzoli, Wilfred Tannr Allard, Will Phillips, William Green, William Johnston, Winfred Nadeau, Wityanant Thongsawai, Yani Eberding, Yoism, Yorick de Mombynes, Zachary Hollinshead, Zarak Ortega, Zsuzsanna Glasz

PART I

Fundamentals

Chapter 1

Human Action

Economics is not about things and tangible material objects; it is about men, their meanings, and actions. Goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.¹

—Ludwig von Mises

Ludwig von Mises’ magnum opus, Human Action , offered an explicit redefinition of the field of economics as the study of human action and choice under scarcity. Mises believed proper economic reasoning and analysis of economic phenomena must be based on analyzing human action, rather than analyzing material objects and their properties, or analyzing aggregate and abstract units. While Mises’ perspective might initially seem pedantic and unproductive, this chapter will explain how it is a very powerful tool for understanding economic reality.

Mises argues that philosophers had long attempted to analyze humanity’s evolution and destiny based on an understanding of what history, God, or nature had intended for humans. Such analyses dealt with humanity as a whole or analyzed collectivist concepts like nation, race, or church, and sought to find laws to explain the behavior of such entities and their consequences, as if history had ironclad laws to be discovered, akin to the natural sciences.

In writing Principles of Economics in 1871, Carl Menger pioneered marginal analysis of economic questions. This marginal revolution provided a starkly different alternative to the previous methods of analyzing humans. Rather than analyzing history based on the will of God, nature, or through nation, race, or church, marginal analysis showed that human society is better understood by analyzing its prime driving forces: individual human choice and action. The Austrian school of economics emerged around Menger in Vienna. A few years after him, Léon Walras would develop his own conception of marginalism couched in a concept of general equilibrium. The Walrasian general equilibrium would become the dominant tradition in modern economics, relying on mathematization and relationships between aggregates.

Action, Purpose, and Reason

Mises defines human action as purposeful behavior,² so as to distinguish it from instinctive, impulsive, or emotional acts. Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life.

Mises’ student, Murray Rothbard, defines human action as purposeful behavior toward the attainment of ends in some future period which will involve the fulfillment of wants otherwise remaining unsatisfied.³ Mises posits that for action to take place, it requires a human to have a current state, to imagine a more satisfactory state, and the expectation that purposeful behavior can alleviate uneasiness.⁴

Rational action is a quintessentially human quality that distinguishes humans from other animals. Humans act purposefully because we are endowed with reason and are able to direct it to the meeting of our ends. Humans are capable of recognizing causal relations in the world around us, and acting upon this understanding to bring about a more favorable state of affairs. We are also able to understand that others have reason and are able to act to their end. As Mises puts it:

Man is not a being who cannot help yielding to the impulse that most urgently asks for satisfaction. Man is a being capable of subduing his instincts, emotions, and impulses; he can rationalize his behavior. He renounces the satisfaction of a burning impulse in order to satisfy other desires. He is not a puppet of his appetites. A man does not ravish every female that stirs his senses; he does not devour every piece of food that entices him; he does not knock down every fellow he would like to kill. He arranges his wishes and desires into a scale, he chooses; in short, he acts. What distinguishes man from beasts is precisely that he adjusts his behavior deliberatively. Man is the being that has inhibitions, that can master his impulses and desires, that has the power to suppress instinctive desires and impulses.⁵

A useful mental image to explain the primacy of human action is to think of the physical world around us as inert playdough we can mold with our hands into different shapes and objects based on our reasoning and imagination. Inanimate objects are dead matter, and it is human reason shaping human actions that rearranges this matter and gives it value, meaning, and purpose. One understands the material world far better if one studies it as the product of human reason and action. Attempts to explain social phenomena through reference to physical objects, abstract nouns, or collectivist entities are ultimately futile and decidedly inferior to thinking in terms of human choice and action. It is not the stars, nor abstract nouns and entities that act, but individuals. If you want to understand the conditions of the material world, it is most useful to study the actions of the humans who mold it.

In the Misesean and Austrian tradition, human action is understood and defined as being rational. The word rational in this context does not refer to the correctness of the action according to some objective criteria, nor does it refer to the suitability of the action in achieving the ends of the acting man, nor does it pass other moral judgments on the action. Rather, rational here is defined as the product of deliberative reason. Whenever man reasons and acts, he acts rationally. Whether such an action is conducive to achieving his goal or not, and whether such an action meets the approval of another party assessing it are irrelevant to rationality as understood and defined by Mises. A person may regret an action and realize it was counterproductive to achieving his ends, but that does not change the rationality of the act, in the sense that it was the product of deliberative reason, correct or faulty. Other individuals may pass judgment on this individual’s actions. No matter how wrong they find it, that would also not detract from the rational nature of the act. The Austrian conception of rationality becomes clearer with Mises’ explanation that the opposite of action is not irrational behavior, but a reactive response to stimuli on the part of the bodily organs and instincts which cannot be controlled by the volition of the person concerned. Further, An action unsuited to the end sought falls short of expectation. It is contrary to purpose, but it is rational, i.e., the outcome of a reasonable—although faulty—deliberation and an attempt—although an ineffectual attempt—to attain a definite goal.⁶

Economic Analysis

Thinking of economics as the study of human action under scarcity allows us to define the most important terms in economics based on their relation to human needs, how human reason treats them, and how humans shape them. When explained, defined, and understood through the lens of human action, economic terminology becomes clearer and economic analysis more fruitful.

Hans-Hermann Hoppe explains:

All true economic theorems consist of (a) an understanding of the meaning of action, (b) a situation or situational change—assumed to be given or identified as being given—and described in terms of action-categories, and (c) a logical deduction of the consequences—again in terms of such categories—which are to result for an actor from this situation or situational change.⁷

At the heart of the Austrian approach to economics is the goal of understanding the causal processes of economic activity and their consequences. Logical deduction, thought experiments, and common sense familiarity with reality are employed to understand the implications of economic processes. Initially, this approach might appear banal and fruitless compared to the dominant approaches of mainstream economics today, which rely on mathematical analysis. But a closer look shows us why quantitative analysis is unsuited for building an economic theoretical framework. It will also show us why quantitative analysis is meaningless and mute without logical deduction and conclusions to motivate it and understand its results. In keeping with the Austrian critique of quantitative approaches to economic analysis, this book will present and analyze economic acts in plain language, not with mathematical equations. Human action will be understood through logical deduction and thought experiments, not equations and quantitative analysis.

Quantitative Analysis

The Austrian critique of quantitative analysis is summed up in Mises’ critique of the application of quantitative methods to economics in Human Action:

The fundamental deficiency implied in every quantitative approach to economic problems consists in the neglect of the fact that there are no constant relations between what are called economic dimensions. There is neither constancy nor continuity in the valuations and in the formation of exchange ratios between various commodities. Every new datum brings about a reshuffling of the whole price structure. Understanding, by trying to grasp what is going on in the minds of the men concerned, can approach the problem of forecasting future conditions. We may call its methods unsatisfactory and the positivists may arrogantly scorn it. But such arbitrary judgments must not and cannot obscure the fact that understanding is the only appropriate method of dealing with the uncertainty of future conditions.⁸

This is a profound criticism of the methods of modern economics. As discussed in detail in Appendix 1, there is no standard unit with which economic measurements of value can be made and compared. As discussed in Chapter 2, value is subjective. The utility that individuals get from goods is also subjective and constantly changing based on the individual, the time at which they are making their valuation, and the relative abundance of the good. There is no possibility for aggregated interpersonal utility comparison, and therefore the mathematization of utility will always be hypothetical and theoretical and never precise and replicable.

Without a common unit with which to measure and compare utility, it is impossible to formulate a quantitative law around, for example, changes in demand and supply based on changes in price, such as a law positing that a 1% increase in price corresponds to a certain percentage decrease in quantity demanded. The impact of a specific change in price on an individual’s demand for a good happens through the causal mechanism of changes in individually assessed utility. That factor is not measurable or quantifiable.

Replicable experimentation on economic questions is also impossible. The objects of study of the natural sciences are the structure and behavior of the physical world. It is assumed at the outset that these are regular, that their properties can be isolated and observed by repeatable experimentation, and that they can be appropriately and fully modeled with mathematics. It is fundamental to the intellectual enterprise that the sole and entire purpose of this methodology is to rigorously pin down causation. In the physical world, what causes what else? Why do things happen exactly and only the way they do? But the objects of study of the social sciences are the ideas and actions of humans, which are immeasurable and non-quantifiable. Experimentation with ill-­defined units of irregular phenomena cannot yield comparable and reproducible results, and so experimentation will fail to produce quantitative laws because there are no units in which these laws can be expressed. Without measurement and repeatable experimentation, it is not possible to find regularities, derive constants, and formulate mathematical relationships and scientific laws. Accurate experiments in economics are also not possible because the subject of economics is the action of humans in the real world, and conditions in testing laboratories cannot replicate the real-world consequences of economic decisions. The real world is the only laboratory that can approximate the real conditions shaping economic decision-making, but it is impossible to experiment on the real world using scientific methods such as those employed in the natural sciences.

Beyond the issues of measurement and experimentation, a deeper logical problem with quantitative approaches to economics is that they conflate the factors we can measure with the causative factors that shape the world around us. The quantitative methods which establish relationships between aggregate measures place the aggregates as the driving causal forces for no reason more well founded or coherent than the fact that they can be measured. Whereas in the natural sciences, regularities and constants are discovered through repeated open experimentation, empirical economists simply make the assumption that their data is regular and deduce laws based on it. In the natural sciences, the complexity of the atoms that make up a gas, for example, can be reduced to basic aggregate measures of pressure, temperature, and volume without any loss in analytical accuracy. The atoms have no will of their own, they have no mind, they cannot reason, and they cannot act in response to surrounding conditions, like human beings can. Because they lack reason, the behavior of physical objects can be studied and accurately predicted.

When examining economic questions, however, we are confronted with the reality that human beings and their actions are the causative factors shaping economic reality, motivated by their subjective considerations and personal preferences. Far from being inanimate objects reacting in mathematically predictable ways, humans react in irreducibly complex ways. Attempting to paper over the complexity of the actions of millions of humans by examining only superficial aggregate measures of some economic phenomenon is the core mistake of failed modern pseudosciences like macroeconomics and epidemiology. These fields ignore the actual causative factors of the phenomena they study and instead attempt to hypothesize based on whatever aggregates can be measured. As Hayek explains:

Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones. While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.⁹

Just because we are able to construct measures of unemployment, gross domestic production, consumption, investment, and other economic quantities does not mean that these factors are causally related to one another in scientifically preordained relationships based on quantifiable and testable magnitudes. In fact, since the actual drivers of these measures are the actions of individuals, there is no reason to suppose that they are any more than superficial epiphenomena unrelated to the causal mechanisms driving the relationships examined.

Attempting to formulate meaning from the relationships between these aggregates is akin to scientists studying gases and attempting to formulate laws based on the color of different containers, the number of containers used, the brand of the manufacturer, the first letter in the name of the experimenter, and various epiphenomena with no causative effect on the experiment. A scientist can indeed formulate relationships between these (irrelevant) parameters, but it will be impossible for any such relationship to hold after repeated testing by independent parties because they have no connection to the causal process being studied. Repeating the same experiment with an experimenter with a different name or a container of a different color will still yield the same results, making the original experimenter’s theorizing pointless. It is the inanimate gas particles whose temperature, pressure, and volume are the control knobs for the system being studied; the container’s color and experimenter’s name are irrelevant. Similarly, it is the action of humans that shapes economic outcomes, not the aggregate measures constructed in government statistics offices.

This is not to say that all statistical measures are worthless noise, as one can find subjective value when examining these aggregates as close approximations of economic phenomena. The Austrian objection is not to economic statistics per se, but to attempting to build scientific-seeming theories out of statistical aggregates. The most egregious and harmful attempts to ape the methodology of the natural sciences in economics happen in macroeconomics. The physics envy of macroeconomists has, for a century, fueled the search for a system of equations that can explain the dynamics of an economy in the same way equations can explain and predict the movement of objects. Friedrich von Hayek calls this scientism: the slavish imitation of the method and language of science where it is inapplicable.¹⁰ The hope is that, with an accurate scientific system of equations for understanding the working process of an economy, it would become possible to manage economic activity to achieve desirable goals. In the same way that chemists’ equations have helped engineers perfect and optimize the working of engines and pumps, scientism searches for economic equations that can help economists improve the state of an economy.

In macroeconomics, aggregates are constructed from national accounts, and mathematical relationships are sought between them. Such relationships are established theoretically, based on some economist’s authority to declare how the causal mechanisms function, not on experimentation. English economist John Maynard Keynes’ macroeconomic system is the most prominent example. For decades, economists have formulated equations based on Keynes’ theoretical hypothesizing. The state of the economy is primarily a reflection of the amount of spending. If spending is too high compared to output, then inflation and growth are the outcome, but if spending is too low compared to the output, then unemployment and recession are the outcome. Should unemployment be too high, modern macroeconomic equations suggest this can be fixed by increasing aggregate spending through increased government spending or expansionary credit policies. High inflation, on the other hand, can be fixed by reducing aggregate spending through increased taxes or contractionary credit policies.

But accounting identities do not denote real-world causality. There are no mechanisms in macroeconomics to experimentally establish causality as is possible in the natural sciences. Keynes’ equations attempting to predict the impact of one aggregate metric on another bear no relation to real-world cause and effect, because there is no way of measuring, testing, and verifying any of it.

No studies can test Keynes’ hypothesis, because one cannot experiment on entire economies comprising millions of people who have individual life plans. Nor can one run a suitable control on those same people under different circumstances. But even by observing government statistics collected by adherents of the theory, real-world experience has contradicted the theory for decades. The Keynesian system necessarily implies a trade-off between the unemployment rate and the inflation rate, a relationship termed the Phillips curve, which is supposed to be a downward-sloping curve to illustrate the trade-off. But real-world experience does not show this, as Figure 1, with data from sixty years of U.S. government statistics, shows no such trade-off.

Figure 1. Unemployment and inflation¹¹

However, this theory persists to this day, in spite of decades of accumulated evidence that it is not an accurate explanation of how the world works. In the 1970s, as inflation and unemployment both increased at the same time worldwide, the Keynesian trade-off was comprehensively refuted beyond a shadow of a doubt. But the advantage of economics having no systematic and replicable method of experimentation and testing is that theories can always be adjusted after their failure in a way that can justify non-compliant real-world observations. That is the essence of pseudoscience.

Hilariously, Keynesians simply revised their theory to include a new term, supply shock. Supply shock is an incoherent term, made as an after-the-fact justification to explain how increases in unemployment and inflation can happen simultaneously. Since then, the world’s economies have witnessed every imaginable combination of inflation and unemployment rates, and the Keynesians have successfully maintained the delusion that such a trade-off between unemployment and inflation exists. Any diversion away from this relationship can be explained by invoking a supply shock or various other thought substitutes,