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METHODOLOGY

In this section, we will discuss the methods of Austrian Economics, particularly those of its most modern and important representatives: Ludwig von Mises and Murray Rothbard.

Why is a method important? Because a method provides a mechanism of how things happen in economics. If you understand the mechanics, you can use logic to deduce things you did not know. If you can deduce things, then you can also test them by comparing them to reality. In this way, you can determine if your theory is correct or not.

 

Methodological Individualism

 

The Method

Austrian Economics managed to upset most of the other “mainstream” economic theories because they used what was described as Methodological Individualism. This is a bombastic title simply meaning that social processes (i.e. what people do as a group) can be understood by looking at what individual people do and why they do it. It is a common sense approach.

Economics, being a social process, can therefore be understood in terms of this method.

Think of it in these terms: a group of people does not have a mind of its own. Although it is true that sometimes groups behave differently that individuals in isolation, this is not because a group decided to do so, but because individual people within a group were influenced in so doing. Austrian Economics explains this by simply stating that different groups are composed of different people.

 

Rationality

This method assumes that people’s behavior can be explained by rational choices, but the question that remains unanswered is: what is a “rational” choice?

A rational choice is simply a decision a person made based on its own concept of what makes sense at that time. The problem is that this “common sense” is subjective. We assume that because many people think like us, therefore our point of view is “rational”. This is not the case at all. In many circumstances it may well be, but in many others it is not.

Rationality does not imply consensus. Rationality does not imply Aristotelian logic. Rationality is not mathematics.

Economists assume that most people will act rationally when making decisions about prices and incomes. A low price is better than a high price. A high income is better than a low income.

In economic terms, the idea is that a “rational” choice is the one that increases happiness or satisfaction (also called “utility” by economists). This would seem to be common sense, however, oftentimes it is not since the very concept of “utility” is subjective.  What will make you happier or more satisfied is a question that only you can answer. And because of this, your preference cannot be quantified and neither any other preference can.

Again, rationality is not mathematics.

 

Critique

One of the most important critiques that we must deal with, is the concept that some macroeconomic concepts cannot be deduced from microeconomic processes.

Let’s think this trough.

Macroeconomics is a field in economics that deals with the “big picture”. They look at the economy as a whole. They ask big questions such as “How do higher interest rate lower inflation?”  or “How is the GDP affected by unemployment?”.

Microeconomics on the other hand, is interested in supply and demand, consumers and business interaction, it is interested in the decisions people make every day, is interested in how companies behave to maximize profits and so on. It asks “small picture” questions, such as “How does a company react when  facing competition?”

The idea in general is that Microeconomics describes how people behave in an economy. Macroeconomics describes how the economy behaves as a whole. In classic economics, many Macroeconomic concepts can be explained by Microeconomic ones, but some cannot.

Since what people do individually (i.e. Methodological Individualism) sometimes cannot explain what the economy does as a whole, it stands to reason that Methodological Individualism is flawed. Or so the critique goes.

This is a classic example where economists turn and twist elements to come up with the answer they want.

Let’s reverse-engineer the premise. The concepts of Macroeconomics and Microeconomics are classic economic artificial segregations. Classic economic theories artificially separated economies in Marcro and Micro. In a real economy, such a separation does not exist.

Furthermore, Macroeconomics concerns itself to a large degree with seeking explanations to economic behaviors originating in government actions. More precisely on Central Banks actions.

We have an artificial division of the economy in two artificial terms, which sometimes do not agree with each other nor one can be deduced from the other. Furthermore, one of them attempts to explain and understand what artificial economic impositions (Central Bank decisions), based on artificial economic theories (e.g. Keynesianism) are going to have on an already artificially twisted and biased economy.

And because Methodological Individualism cannot explain this, it is dismissed.

BullShit! If the accusation is that Methodological Individualism is incapable of explaining al the moronic artificial decisions that idiotic governments make and their impacts on the economy, the answer is: Guilty As Charged!

Methodological Individualism deals with free markets, not with the infinite number of biases that artificial economic theories force on the economy. And even though it is forced to operate in less than ideal conditions, it does an excellent job in pointing out gigantic flaws in opposing economic theories.

The issue is not with Methodological Individualism, the issue is with the other economic theories that can’t even reconcile Micro with Macro outcomes!

 

Rejection of Mathematics

Methodological Individualism rejects mathematics and more importantly, statistics as a valid economic tool.

The reason is simple. Statistically speaking, it is possible to study a group to analyze its behavior. The problem is, its behavior changes all the time! It is always possible to look back and try to explain why a group did what it did, but it is not possible to extrapolate this behavior into the future and forecast what the group will do. This is so because economic behaviors are subjective and as such they change over time.

All the other classical economic theories look at statistical numbers and processes and deal with economic events as if economy were physics. They assume that people are some sort of particles with a set of properties that do not change and can be quantified statistically.

Let us ask you this: do you consider yourself to be a “particle”? Do you think that a person that has never known you can accurately forecast how you will spend your money and which economic decisions you will make? Of course not! It is ridiculous! Yet, that is exactly what classic economics assumes.

The rejection of statistics and mathematics is nothing more than an expression of facts. What Mises and Rothbard are saying is that in economics there is a large amount of information that is simply un-knowable. This is so, because it is personal and subjective.

If you think that this is unusual, you would be mistaken. In Physics there is something called the Heisenberg’s Principle of Uncertainty. It states that certain values can never be known. Now, this principle is a basic principle in nature. If nature can be so stubborn, we see no problem of having a similar Principle of Uncertainty in Economics, which is, after all, the study of subjective human behavior.

Mind you, this won’t stop economists from trying. The latest attempt is called Behavioral Economics. It attempts to create statistical models describing how people behave economically based on subjective principles. As expected, they had had some limited success (after all, they are dealing with subjective issues, which is the correct approach), but in the end, it is very likely they won’t succeed, precisely, because they are dealing with subjective issues!

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Austrian Economics In Theory - Part 3

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