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Economic Method

Mises Daily: Saturday, January 23, 1999 by

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What follows is a rare example of a piece of journalism that deals directly with the topic of economic method, a subject that has been central to the development of Austrian theory from Carl Menger's time until our own. As informative as this piece is, it also illustrates the confusions that have long animated the debate.

Mises contended that economics is a deductive science of human action-- not a speculative moral theory, not a branch of mere history or engineering, and not a different application of the methods of the natural sciences. And yet the debates on method have tended to continually shift from one exaggerated emphasis to another.

January 23, 1999, Saturday
New York Times
Arts and Ideas

A Challenge to Scientific Economics
By LOUIS UCHITELLE

Ask economists in the baby boom generation why they became economists, and any number will give some credit to Robert L. Heilbroner. His 1953 book, ''The Worldly Philosophers,'' which has sold nearly four million copies, is a ''Profiles in Courage'' of the great thinkers who shaped modern economics. So it is somewhat surprising to find Mr. Heilbroner increasingly critical of the economists he helped inspire. They have missed the point, he says.

Mr. Heilbroner, 79, is at one end of a growing debate over whether economics, as practiced today, is effective. Sure, economists do a lot of good research, Mr. Heilbroner acknowledges. Some of it yields important insights. But their models are too simplistic. They overlook factors that shape the economic and social system and in doing so forfeit the deep understanding achieved by an Adam Smith or a John Maynard Keynes, two of his worldly philosophers.

''The worldly philosophers thought their task was to model all the complexities of an economic system -- the political, the sociological, the psychological, the moral, the historical,'' Mr. Heilbroner said. ''And modern economists, au contraire, do not want so complex a vision. They favor two-dimensional models that in trying to be scientific leave out too much and leave modern economists without a true understanding of how the system works.''

The worldly philosophers would have agreed.

''Noneconomic motives are an essential element of economic theory,'' Joseph A. Schumpeter wrote in 1942, two years after Mr. Heilbroner graduated from Harvard, where he had heard Schumpeter lecture. A few years earlier, Keynes had said that ''no part of man's nature or his institutions must lie entirely outside an economist's regard.'' And Alfred Marshall, the 19th-century British economist, warned that ''economics cannot be compared with the exact physical sciences, for it deals with the ever changing and subtle forces of human nature.''

The shift from this way of thinking came after World War II, when economics gradually ceased to be a social science and took on the techniques of a natural science. Mathematics became the language of economics, and computer models of the economy became the chief research tool. These models require assumptions about the way markets and people behave, assumptions that are often unrealistic, although in recent years economists have fed more and more actual data into their equations in an attempt to approximate the real world.

''If math is correctly used, then it can incorporate all kinds of things that really make the analysis very much broader,'' said George Akerlof, an economist at the University of California at Berkeley. ''The best of this new work pays attention to psychology and sociology.''20

That still falls short of what Mr. Heilbroner has in mind. The modern economists separated out the subjective, often intuitive judgments that earlier economists had considered so important. These were considered not susceptible to scientific inquiry, not measurable.

In the process, economists also squeezed out the word capitalism, the once traditional name for the market system, with its subjective connotation of class struggle between owners or managers and workers and with its suggestion of the privileges that go with various levels of wealth. The word capitalism rarely appears in popular textbooks for Economics 101.

Explaining why, N. Gregory Mankiw, 40, a Harvard economist and author of a popular new textbook, ''Principles of Economics,'' said: ''We make a distinction now between positive or descriptive statements that are scientifically verifiable and normative statements that reflect values and judgments. The question is, can you do positive economics without normative economics. I think so.''

The science of economics, for example, has found that the causes of extreme income inequality, a relatively new phenomenon, can be objectively measured.

Those who are well educated are well paid in the American high-tech service economy, and those who have not gone beyond high school are not well paid. For Mr. Mankiw, that is a ''positive'' statement in that it is verifiable.

But left out of this finding are factors like job insecurity, which tends to make wages more unequal -- whatever the education level -- and labor union bargaining power, which helped to equalize wages until union power declined. These are subjective observations that Mr. Mankiw or Paul Romer, a 43-year-old Stanford University economist, would classify as political or public policy issues but not part of a scientific explanation of the workings of the economic system.

''There was a kind of a hubris among earlier generations of economists who thought they themselves could make the scientific statements and then the value judgments,'' Mr. Romer said.

He likens an economist's role to that of a doctor who explains what will happen if a cancer patient is taken off an aggressive program of chemotherapy and radiation. ''You can let the pastor, the legislator, the family and the philosopher struggle with the moral question of whether to actually stop the treatment,'' Mr. Romer said, ''but what you want from a doctor is correct scientific statements about what will happen if.''

Keynes made no such distinctions. Drawing on intuition, observation and his own broad experience, he concluded that the United States and other nations found themselves stuck in the 1930's Depression in large part because business refused to invest, although the nation offered plenty of savings to finance investment. Keynes's sweeping insight forever changed the way economists think about the way a capitalist system functions. And Keynes, having found the problem, saw no reason to be shy about solutions, calling for enormous Government spending to offset the decline in business investment.

''Keynes certainly had a view of what was a good society,'' said Robert M. Solow, a Nobel laureate in economics at the Massachusetts Institute of Technology. ''And he tried to save society from itself.''

Leaving Politics To the Politicians

Modern economists reject such a role. Mr. Romer's father, Roy Romer, the former Governor of Colorado, had to decide while in office whether to cut taxes or spend more on education, a value judgment properly left to politicians, in the son's view. ''I saw my father as someone very skilled at what he does,'' the son said. ''I have sought to be as skilled on the scientific side.''

The father chose more education, partly on the advice of his son, who told him of the scientific finding of economists that income inequality is a result of unequal education.

But in this sort of a case, science does not take you far enough, says Mr. Heilbroner, an economics historian at the New School for Social Research. ''You have to ask, what is the correlation between high levels of education and high levels of wealth,'' he said. ''Is education in our system a privilege of wealth and a function of the class structure?''

These are questions that science cannot address but economics must, says Mark Blaug, an economics historian. Otherwise, the findings are skewed. ''There are so many things going on in the economics world at the same time,'' he said. ''Not just standard economic forces, but all the other elements that shape an economy -- politics, morals, psychology, sociology -- and therefore economics will always be vague and imprecise, more like history than math.''

Going beyond science sits easier with older economists like Mr. Heilbroner or Mr. Blaug, who is 71, or Mr. Solow, who is 74 and, like Mr. Heilbroner and Mr. Blaug, came of age as an economist in the 1950's, while Keynesianism was still in its heyday and the cold war had not yet helped squeeze value judgments out of economics.

Mr. Solow, however, is a pillar of mainstream economics. His economic growth theory, in which he explained the interactions of capital, labor and technology in generating economic expansion, is a model of economics practiced as a science. He would never, he said, ''advise a student to go to work on the nature of the class structure.''

''You are condemning him to failure,'' he continued. ''We do not know if there are applicable rules.''

And yet in an autobiographical sketch, he argued against thinking of economics as science with a capital S. ''That is perfectly consistent,'' he wrote, ''with a strong belief that economics should try very hard to be scientific with a small s. By that I mean only that we should think logically and respect fact.'' Fact, he said, should be enlarged ''to include, say, the opinions and casual generalizations of experts and market participants, attitudinal surveys, institutional regularities, even our judgments of plausibility. My preferred image is the vacuum cleaner, not the microscope.''

And gradually economics is moving this way. The younger generation, while holding tight to its scientific approach, is nevertheless opening up its equations, feeding into them all sorts of new data from other disciplines, then trying, more than in the past, to make the hypotheses fit the data. Surveys are increasingly being used, and old assumptions -- that supply and demand, for example, balance at a healthy level -- are being amended or put aside.

The new approach was on display at the recent annual meeting of the American Economics Association, where economists at one session reviewed their research into today's unusual spectacle of an unemployment rate and an inflation rate falling together instead of moving in opposite directions, as economic theory dictates and as they once did. Drawing on psychology, the researchers have even tried to quantify how people actually behave or feel about work. ''Our modeling now is much more flexible,'' said Lawrence Katz, a Harvard labor economist. ''I really think we are seeing a blossoming of a broader social science field, where the core research techniques are maintained but are supplemented with findings from other fields that were once quite separate.''

Judging Numbers, Not Just Calculating

And Mr. Heilbroner applauds. But it is not, in his view, enough. The questions that absorb the younger economists are too narrow, he says. From Adam Smith's day, economics has always been an inquiry into the nature of capitalism in its various forms, an inquiry that requires as much history, sociology and ethics as it does science, Mr. Heilbroner says.

Economists, for example, cannot just chronicle the rise of output as an economy grows. There must also be a judgment about the quality of that output: Does it show up as more school construction or warmer clothing in winter or as more channels of bad television programs and higher pay for chief executives. That is how the worldly philosophers would have thought, Mr. Heilbroner suggests in a new chapter added to the seventh edition of ''The Worldly Philosophers,'' to be published in the spring by Simon & Schuster.

''Economics will not, and should not, become a political torch that lights our way into the future,'' he writes, ''but it can and should become the source of an awareness of ways by which a capitalist structure can broaden its motivations, increase its flexibility and develop its social morale.''

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For more information on economic method, see the Austrian Study Guide

For an excellent summary of the Austrian position, see Michael Prowse on methodology.