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The Economic Way of Asking Questions

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It’s trite and true to observe that economics differs (or should differ) in its scientific method and in its aspirations from other sciences such as physics and chemistry.  Of all the physical, or non-social, sciences, biology is the science that is most like economics: central to both biology and to economics is the quest to understand the logic of undesigned order, and to interpret observed real-world phenomena in light of that understanding.

The fact that economics cannot make specific predictions about, say, what the price of gold will be tomorrow or whether or not this particular government program will in fact be followed in X-months time by a Y-percent increase in unemployment and a Z-percent fall in nominal GDP reflects the enormous complexity of economic phenomena rather than any weakness, faultiness, or ‘immaturity’ of economics.  As Hayek argued, the best that the best economists can do is to make plausible “pattern predictions. [2]

For me, economics is largely about sparking the right questions.  Asking the right questions, even if it is impossible to give 100% correct or very detailed answers to those questions, goes a surprisingly long way toward ensuring that thinking about the economy is sound.

For example, when a proponent of higher tariffs on steel points out correctly that such tariffs will protect jobs in the domestic steel industry, the good economists asks “And from where will the resources come that are used to pay the workers whose jobs are protected and to pay the higher dividends to owners of domestic steel-producing corporations that no longer must compete as vigorously as before?”  The question is not one that seeks an answer in terms of specific sectors (“90% of the resources will come from the domestic lumber industry and 10% will come from the domestic IT industry”).  Instead, the question is one that prompts the intelligent and honest proponent of tariffs to realize that whatever resources are directed by a tariff into the protected industry do not fall out of the sky; they must come from other sectors of the economy – which means from consumers and other industries and other workers.  Asking this question throws the spotlight on these ‘others’ even though these others are likely not individually identifiable.

Or consider this claim that was sent to me on Friday by a Cafe patron (in response to this post [3]): “You [Boudreaux] are too confident that markets are efficient and firms don’t make mistakes. How do you know that firms get it right and pay their workers enough to keep [worker] turnover at an acceptable level?”

One answer is “competition.”  As long as there are no artificial barriers to entry into the the industry, then any errors made by firms are profit opportunities for more-alert entrepreneurs or more-competent firms to exploit.  The argument is not that each private entrepreneur or business manager is a hyper-rational genius who unfailingly ‘gets it right.’  (Here is where many behavioral economists [4] err: they assume that the economists’ argument for efficient free markets requires for its validity far more narrow rationality and avoidance of individual error than this argument actually requires.)  Rather, the argument is that the combination of the profit motive, residual claimancy [5], consumer sovereignty (the freedom of consumers to spend or not to spend their money as they choose), and the competition that comes with freedom of entry, exit, and experiment incessantly works to weed out the more-wasteful and less-productive business practices in favor of less-wasteful and more-productive practices as measured ultimately by how consumers choose to spend their money.  (See, for example, Armen Alchian’s classic 1950 article [6] and Vernon Smith’s 2002 Nobel lecture [7].)

Put differently, the argument isn’t that we know for certain that all, or even most, existing business practices and contractual arrangements are ‘best.’  We don’t know any such thing because in reality such market perfection is never attained.  Rather, the argument is that we as mere observers should humbly recognize our own ignorance about market conditions and, hence, be very reluctant to assert the correctness of our own individual assessments of the alleged inefficiency of this or that market arrangement.  And in order to enforce this humility, while simultaneously recognizing that in reality room for improvement and error-correction always exists, the rules of private property demand that those who insist that they’ve spotted a correctable market error put their own resources at stake to test the correctness of their assessments.

Such putting one’s own resources at stake is what private entrepreneurs and investors do.  Many err.  And some who err even get away for a long time with their errors.  (And, likewise, some who are correct are also so unlucky as to not be rewarded for their correct assessments.)  But the requirement of putting one’s own skin in the game is a hugely important – indeed, indispensable – disciplining device that tends to weed out poor and careless assessments.  As a matter of probability, people (such as private entrepreneurs) with their own skin in the game are much more likely than are people (such as academics) with no skin in the game (1) to more accurately take account of all the relevant market information, and (2) to avoid taking market actions the success of which requires the possession of detailed information and knowledge that they are unlikely to possess.

In short, the complexity and dynamism of the world we inhabit and the costliness of information about this world mean that the best that can be said by those of us who merely theorize about it – by those of us who merely observe or describe it – by those who are empowered by legislative dictate to “regulate” it – is that any particular existing business practice, contractual arrangement, or market regularity likely fulfills the interests of all parties to those practices, arrangements, and regularities better than would any alternatives proposed by us no-skin-in-the-game observers.

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Academics are not generally celebrated for their humility.  And rightly not.  Far too many people with PhDs and JDs arrogantly fancy that their facility with words, equations, statistics, and spreadsheets certifies them as being at least as informed as, and certainly more objective and well-meaning than, are ‘mere’ profit-seeking business people and the assumed-hapless consumers and workers.  Ditto for politicians, who mistake their success at winning popularity contests (called ‘elections’) as evidence of their superior knowledge and sound judgment.  The important act of guarding private, evolved market arrangements from the officiousness of such people is one chief justification for the sound economist’s short-hand claim that competitive market arrangements are “efficient.”

The sound economist asks always: “Why should we trust you to know better than do the actual participants in the market what should be going on in the market?”  And the sound economist is one who also exercises a finely honed judgment in assessing the credibility of the answers to this question.

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To be continued in a later post.

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