neoclassical economics

Economics and the Mirror of Nature

Zachary Woodman Economics, History, Law, Philosophy , , , , , , , , , , , , , , ,

Editorial Note: This is an old and longform essay I wrote on the philosophy of economics and economic methodology originally for a history of economic thought class as a sophomore undergraduate at Hillsdale College back in April of 2015. I am uploading it here mostly for posterity as a historical interest in my own intellectual development and for any curious onlookers interested in what interpretive economic social theory could look like–at least at a high, sketchy and not detailed level.

It is worth noting that there is an obvious thing I should have done differently: it really should have treated the “ecological rationality” of figures like Vernon Smith and the later FA Hayek as a fourth alternative paradigm to the sort of rationality practiced by neoclassicals, the interpretive rationality practiced by some Austrians and the Bounded Rationality practiced by behavioral economists. This ecological notion of rationality which makes room for neoclassical-style constructivist theories of rationality–so long as they are understood as maps and not the terrain–is something I am more sympathetic towards these days alongside the intepretive, hermeneutic sort of rationality argued for in this essay.

I still think it gets a lot of the genealogical and psychological diagnosis of what historically has gone wrong in economic questions about rationality as developed by neoclassical, behavioral, and Misesean Austrian economics by relying too much on an unquestioned epistemic foundationalism , but I think normative pragmatists like Robert Brandom offer us a more constructively and ecologically critical way forward than I was aware of when I penned this paper.

The essay is presented here largely as it was originally written, with only minimal editing. Its sophomoric sketchiness, grand but unrealized ambitions, and rough edges are intact.

Economics and the Mirror of Nature: Richard Rorty’s Hermeneutics as an Approach to the Historical Study of Rationality in Relation to Economic Theory and Method

The conception of man as a “rational actor” is one of the key foundations of modern economic thinking. However, what exactly economists mean by “rationality” in the technical sense has historically been a fairly sticky issue that has evolved as economic theory has evolved. In some ways, rationality is tied up with epistemological problems in economic methodology. In other ways, it has been tied to value theory, expectations theory, and a host of other issues that seem like pure theoretical theory than meta-economic questions of method. However, a historical treatment of how economists have come to understand rationality deserves sensitivity to how economists have understood internal problems to economics itself and the relationship to the nature of the economic science.

FA Hayek (1952) lays out the potential for a progressive research program in the history of thought in the social sciences in his work Counterrevolution of Science. For Hayek, “scientism,” viewing the research program of the social sciences as essentially the same as the natural sciences, is prevalent the intellectual discourse about the social sciences. Hayek objects to “the objectivism of the scientistic approach” insofar as it treats the data of the social sciences as fundamentally the same as the data of the physical sciences, objective, measurable phenomena. For Hayek, this leads to “rationalist constructivism” in approach to solving the problems of society. Examples of “rationalist constructivism” include most primarily August Comte’s approach to social engineering and sociology and socialist attempts to design economies.

In a similar vein, Richard Rorty’s Philosophy and the Mirror of Nature (1980) objects to what he calls the “Platonic Kantian” approach to philosophy. For Rorty, the “image of the mind as a great mirror, containing various representations—some accurate, some not—and being capable of being studied by pure, nonempirical methods” (12) has lead philosophy astray into a series of non-constructive topics such as philosophy of mind and philosophy of language in which philosophers tried to “ground” all of knowledge in a way that every rational being could agree.

This paper proposes that FA Hayek’s program of “rational constructivism” should be viewed as a complementary approach to Richard Rorty’s program in the history of philosophy as laid out in the Mirror of Nature. Following the tradition of Lavoie (1990), this paper argues that a hermeneutical exegesis of economics as a whole, not simply one or the other tradition, might help bring the various “schools” of economics into better dialogue with each other. The first part lays out a partial history of one subject, utility theory, in which economics has attempted to objectify itself into the realm of natural science drawing heavily off of Zouboulakis’ Varieties of Economic Rationality (2013). The second part argues that Rorty’s hermeneutical approach can explain the historical narrative in a Hayekian way. A concluding section reflects on areas needed for further research.

Part 1: Our Utilitarian Essence
One of the fundamental assumptions, especially of the English school during the marginal revolution, in the formation of the economics science as we know it today was presupposing a fairly simple psychology of utilitarianism drawing from Bentham. However, this idea of utility theory as foundational to economics was eventually replaced by Pareto’s ordinal approach to utility theory. The title of this section draws from the title of the first section of Rorty’s Mirror of NatureL “Our Glassy Essence,” which reflects on how the image of “the mind as mirror” came into existence. This section lays out how utility came to be viewed as “essential” to the meaning of economics

Rationality as Utility Maximization: Jevons and the English Marginal Revolution
When economists say “rationality,” they have always intended it as a term of art. Thus phrases such as “rational action,” “rational actor,” and “rationality” in the technical economic sense have never really meant what is thought by these phrases in the everyday sense. In the everyday sense, what is typically meant by “rational” is that one is holding a belief based on reasonable evidence. However, for early economists rationality has always been tied up with some sense of individualized self-interest.

The most primitive version of rationality as an economic term of art was found in the work of classical political economist and utilitarian philosopher Jerome Bentham. For the early nineteenth century economists, to be rational was to maximize utility in the Benthamite sense; to maximize pleasure and minimize pain in a very broad sense. Thus early economic ideas of a rationally self-interested actor were intimately related to utility. An example of this idea of rationality as pursuit of utility is the work of William Jevons. Though Jevons never used the term “rationality,” it is clear in his work that the concept today called “rationality” is very central to Jevon’s work. Jevons adopted a very strong conception of rationality in line with homo economicus.

In order to understand how Jevons conceived of economics, it is important to understand its place in his broader context of economic thought on economic method. In his Theory of Political Economy (1871/2013),Jevons claimed that “Economics, if it is to be a science at all, must be a mathematical science” (434). This is largely because Jevons had a strong commitment to making economics analogous to physics. As he wrote in the first edition of TPE (1871/2013):

The theory of economy, thus treated, presents a close analogy to the science of Statistical Mechanics, and the Laws of Exchange are found to resemble the Laws of Equilibrium of a lever as determined by the principle of virtual velocities. (cited in Zouboulakis 2013,  26).

Unlike physics, however, Jevons claimed economics was “peculiar” because “its ultimate laws are known to us first by intuition, or at any rate they are furnished to us ready made by other mental or physical sciences” (cited in  Zouboulakis 2013, 30).

As Zouboulakis (2013) notes, a very strong conception of rationality Jevons insisted upon almost axiomatically was necessary to give economics this extreme level of mathematical and scientific rigor. In order to make rationality such a strong concept, Jevons would rely upon a Benthamite utilitarian theory with a heavily scientific flavor. He argued the idea that people maximize pleasure and avoid pain is an “obvious psychological law” on which “we can proceed to reason deductively with great confidence” (cited in Zouboulakis 2013, 30-31). For Jevons (1871/2013), “pleasure and pain bare undoubtedly the ultimate objects of the Calculus of Economics” (440). Utility, therefore, is the the central object of Jevon’s economic inquiry. Jevons, quoting Bentham, defines as “that property in any object, whereby it tends to produce benefit, advantage, pleasure, good, or happiness” (1871/2013, 438). Jevons maintains a concept of “total utility” (440) that may be “estimated in magnitudes” (435). This idea of rationality is, to quote Herbert Simon (1978) “omniscient,” meaning is there is little to no concept of uncertainty, limited information, or psychological error taken into account in how people pursue rational self-interest, it is simply a law of psychology that people always seek to maximize utility, a law that is central for his understanding of economics as a science.

Jevons was not alone in his strong conception of understanding of rationality as a maximization principle. Zouboulakis (2013) argues that Cournot, Walras, and Marshall, all shared a similar conception of rationality to Jevons (35). In fact, Walras (Zouboulakis 2013) in line with Jevons adopted a strong conception of economics as another sort of mathematical physics. Edgeworth (1881/2013), though he doubted that Jevons was entirely correct on to what extent total utility was quantifiable still generally adopted the utilitarian outlook Jevons had assumed, as well as the mathematical outlook as he extensively compared it to physics (504-505).

To summarize, the concept of rationality as formulated by Jevons consists of the following four unique theoretical features:

  1. Defined as a maximization of total cardinal utility
  2. United with a psychological hypothesis
  3. Irrefutable, obviously true about human nature
  4. Assumes omniscience

It is dependent on another methodological feature: that economics is to be viewed mathematically and analogous to physics on some important level. It is important to note, however, that the early neoclassical economists were not wholly homogeneous in their outlook of economics as a science. Alfred Marshall argued that “economics cannot be compared with the exact physical sciences: for it deals with the ever changing and subtle forces of human nature” (qtd. in McKenzie 2009). Though Marshall’s conception of rationality was still largely in line with Jevons, his softer methodological positions would allow for a softening of rationality as a concept after the marginal revolution.

Rationality asInstrumentalism: Pareto’s Departure from Utility Theory
In addition to the concept of economics as a completely mathematical science, other assumptions that led to Jevon’s omniscient conception of rationality would be threatened. After the marginal revolution, primary cornerstones of how Jevons conceived of rationality, cardinal utility as a quantifiable concept, would be rejected by the economics profession. The key insight from Jevon’s subjective utility theory was his marginal analysis, his insight from the theory of exchange that consumers seek to equilibrate the ratios between the marginal utilities (what Jevons calls the “degree of utility”) of goods.

Though Jevon’s conception of total utility “constituted the metaphysical foundation of utilitarian economics, neither [its] measurement nor even their existence was central to their methods” (Read 2004). At the dawn of the twentieth century, Pareto had brought about the ordinal revolution. Any reference to “cardinal utility,” that is utility as a measurable concept, was completely removed. Instead, for Pareto, any measurable cardinal utility was replaced by ordinal utility—utility as a relative comparison of some basket of goods (cited in Read 2004).

With the change in utility followed a change, in the conception of rationality. Since one of the key theoretical implications of Jevon’s rationality thought was disproven, economists could greatly weaken what they meant by rationality. First, Pareto distanced rationality from being any sort of an axiomatic psychological claim. He did this by adopting a more positivist, experimental approach to economics, he declared “I am a believer in the efficiency of experimental methods. For me there exist no valuable demonstrations except those that are based on facts” (cited in Zouboulakis 2013, 37). However, given his rejection of cardinal utility, the hypothesis that rational actors can maximize utility becomes meaningless and untestable since it is unclear what they are maximizing (Zouboulkis 2013, 38). As Pareto said, “Let us suppose that we have a schedule of all possible choices indicating the order of preference. Once this schedule is available, homo œconimicus can leave the scene” (cited in Zouboulakis 2013, 38).

Instead, Pareto focuses only on the “facts” which he asserts are “the sales of certain goods and certain prices” (cited in Zouboulakis 2013, 38). In other words, Pareto is only concerned with the impact of rational choice theory in a market setting, not with the psychology behind those facts. For Pareto, then, “rationality is simply a choice of efficient means for serving any independently given objective,” Zouboulakis (2013) calls Pareto’s an “instrumental” conception of rationality (38).

For Pareto, contra Jevons, the extent to which rationality was wholly applicable to all of humanity was extremely limited. In his later works, he made a strong distinction between “logical” and “non-logical actions.” As Zaboulkis (2013, 39-41) puts it, logical actions are those in which the “subjective aim of the actor is reasonably connected with the action’s objective goal,” whereas everything else are things that man do not have control other such as psychological factors that an economist takes as given. This greatly limits the extent of human action that economics studies from Jevon’s attempts to universalize utilitarian psychological hypotheses.

To summarize, Pareto’s conception of rationality has the following theoretical features:

  1. Non-psychological
  2. Given within a means-ends framework (Instrumental)
  3. Non-universal, non-omniscient

Rationality as Purposeful Action: Mises’ Austrian Tautology

While Pareto had developed a fairly weak conception of rationality in contrast to Jevons, a separate tradition in the Austrian school of economists had developed a similar, though different, conception of rationality. This latter type of rationality is the conception primarily taken up by Ludwig von Mises and Carl Menger. In order to understand the Austrians, it is important to understand the historical context it was born out of in contrast to Pareto. Pareto was primarily influenced by Anglophonic and Francophonic marginalists, and had inherited from that tradition a strong conception of rationality wedded to cardinal utility that he had to soften with ordinal utility. In contrast, Mises had inherited the marginal utility theories of Menger (which included no reference to “total utility” as a cardinal concept to begin with), and had participated in the climate of the Methodenstreit which had placed heavy emphasis on theoretical methodology. Because of this, Mises’ idea of rationality bears resemblance to Pareto in important ways, however differs because of Mises’ and Pareto’s differing methods.

For Mises, to say that man is a rational actor is a tautological truth, he claims that “[h]uman action is necessarily rational” (1949/1998 18-19).[1] Though this sounds like a universalist claim found in Jevons, it is fundamentally different. For Mises to be a rational actor is not a psychological hypothesis, it simply means that man acts, or that he “the employment of means for the attainment of ends” (13). To be rational is simply to act purposefully, not to choose anything that an economist would normatively say one should chose such as maximization of cardinal utility.

It is important to note that unlike Jevons, the Austrian school adopted from the outset that rational actors are not omniscient. As Menger argued in his first statement of subjective value theory:

Even individuals whose economic activity is conducted rationally, and who therefore certainly endeavor to recognize the true importance of satisfactions in order to gain an accurate foundation for their economic activity, are subject to error. Error is inseparable from all human knowledge. (148)1

Likewise, Mises devoted a whole chapter of his magnum opus (1949/1998) to the concept of uncertainty (105-118).

It may be seen that there is a certain overlap between Mises’ idea of rationality and Pareto’s. Both have significantly weaker ideas of rationality than is implied by the utilitarians, and both distinguish economic rationality very carefully from psychology. For Mises, this means defining action as rational and defining its opposite “not irrational behavior, but a reactive response to stimuli” (1949/1998, 20). For Pareto, this means distinguishing between logical action and non-logical action and applying economic rationality only to the former.

However, there are important differences between Pareto and Mises: namely, Mises universalizes rationality as applied to all human action, Pareto does not. This is primarily due to differences in what is meant by “action,” Mises tautologically defines all action as rational, whereas Pareto simply makes action an instrument that is applied to a means-end framework. Thus, for Mises rationality defines the means-ends framework, for Pareto it is a tool that helps men pursue ends. The reason for this difference lies in their different views on economic methodology. Recall that Pareto is only concerned with facts that can be experimentally derived. However, Mises includes tautologies as an important part of his economic method which he calls “methodological a priorism” (1949/1998). Mises claims “tautologies” are helpful in providing “cognition” and “comprehension of living and changing reality” (38). Whereas Pareto would have scoffed at Mises idea of rationality as useless, for Mises it was a helpful a priori assumption for economic analysis, or in his terms “praxeological reasoning.”

To summarize, Mises’ weaker idea of rationality is marked by the following three qualities and assumes an a priorist methodological background:

  1. Rationality defines a means-end framework (is tautological)
  2. Is universal by a non-omniscient definition
  3. Non-psychological

The extent to which Mises’ idea of theory can be thought of as “foundational” to the rest of his social science is disputable. Clearly, Mises thought his theory was absolutely foundational, however that need not be the “foundation” of the rest of his economics. Zoboukalis seems to oversimplify in claiming that there’s a fundamental difference between Weber’s conception of an “ideal type” of rationality as universal and Mises’ conception of rationality as to some extent tautological. Boettke and Leeson (2006) claim that Mises rejected the analytic/synthetic distinction, thereby placing him in a more complex position than simple Kantian epistemology. However, Boettke, Lavoie, and Storr (2001) claim that Mises’ distinction between theory and history was “arbitrary” and use the philosophy of John Dewey to argue against it.

Rationality: How Lionel Robbins Misunderstood Mises, How Hayek Challenged Mises

The extent to which there is a universal “Austrian” conception of rationality is also disputable. Zaboukalis understands this in comparing the rationality of FA Hayek to Mises. Zaboukalis argues that Robbins presented Mises’ concept of rationality as “consistency” for a normative ideal in his work The Nature and Significance of Economic Science. This is supportable when Robbins (1932/2005 140) says:

There is nothing in its generalisations which necessarily implies reflective deliberation in ultimate valuation. It relies upon no assumption that individuals act rationally. But it does depend for its practical raison d’etre upon the assumption that it is desirable that they should do so. It does assume that, within the bounds of necessity, it is desirable to choose ends which can be achieved harmoniously.

Mises’ welfare economics clearly do not include all the presumptions that consistent action is “normative” that Robbins’ neoclassical misinterpretation of Mises presupposes. Mises explicitly says in Human Action that man’s preferences are situated in time and therefore are inconsistent over time. Mises places emphasis on man’s preferences as situated in time and uncertainty, Robbins makes the preferences sound as if they are independent of time and uncertainty in every sense.

Rizzo (2013) puts emphasis on how Mises postulated the meaning of economics to be primary. This passage is worth quoting at length:

First, we must distinguish between the meaning of behavior and criteria for the rationality of behavior. Abstract criteria of rationality cannot be applied without first understanding what individuals mean by what they do. Getting the meaning wrong may result in inaccurately labeling the behavior as irrational.

In Zoboukalis’ presentation, this lead Samuelson (1938) to present his revealed theory of preferences, which included the assumption of invariance, in Economica. Samuelson seems to have misunderstood Robbin’s misunderstanding of Mises on an even deeper level. In 1937 which Zoboukalis presents as “the year of uncertainty,” there were several challenges to Mises, one of which included Hayek’s challenge to Mises in Economics and Knowledge (cited in Zoboukalis, 1938). Kirzner (2001 81-89) argues that Hayek misunderstood what Mises thought about rationality. Mises did not take invariance through time to be normative, he took it to be positive at a particular instance.

Economics without Constancy in Utility: Preference Theory, Behavioral Economics as Paradigms aiming to be “Successor Subjects”

In response to the challenges to invariance raised by Hayek, Friedman and Samuelson, Zoubakalis argues, made a defense of the normative criterion of rationality, which became standard in the “neoclassical synthesis.” This was primarily the “as-if” methodology of Friedman which Austrians find so objectionable. In the research program of this paper, Lavoie’s (1980) hermeneutical way of dealing with the problem of pure methodological instrumentalism will be an issue. Lavoie argues for a way of doing economics without epistemic foundationalism, drawing directly off Rorty. The extent to which there is a balance established between what Lavoie sees as the crude epistemic foundationalism of Freidman’s positivist approach and the possibly foundationalist a priori approach of Mises will be perhaps the main focus of further research in this program. However, unlike Lavoie, the Hermeneutics will be more likely drawn directly from Rorty than Gadamer.

After Freidman, the invention of behavioral economics in Kahneman and Tverskey challenged several of the positive assumptions of neoclassical theory. Kahneman (2012) describes the Chicago school’s views on the matter in relation to the behavioral economic one as follows:

The only test of rationality is not whether a person’s beliefs and preferences are reasonable, but whether they are internally consistent. A rational person can believe in ghosts so long as all her other beliefs are consistent with the existence of ghosts. A rational person can prefer being hated or being loved, so long as his preferences are consistent. Rationality is logical coherence, reasonable or not. Econs are rational by this definition but there is overwhelming evidence that humans cannot be.

In modern neo-classical economics, which has incorporated Kahneman’s theories of loss aversion and hyperbolic discounting as mathematically as possible, this is an oversimplification. However, there is reason to believe that the rigid formalism of modern Chicago economics may or may not be consistent with the best means of developing a research program, however useful it might be in many contexts.

Recent scholarship on the relationship between behavioral economics and neoclassical theory has tried to figure out how to get past utility without invariance through time. This issue suggests there is no such thing as “true preferences” as Pareto, Samuelson, and Friedman implicitly assumed. Stigler (1977), in violation of typical Chicago school method posited a way of assuming there were “true preferences” by making appeal to the possibility that our preferences are developed into some preferences everyone could agree on in time. For example, one who tastes wine initially might not know what they are doing; however, with time, they become a wine connoisseur, and in general wine connoisseur agree on their preferences. Drawing of Stigler, Robb (2009) draws of Nietzsche’s psychology to further support Stigler’s theories. Heckman (2009), in a comment on Robb’s paper responded in typical neoclassical fashion, claiming the psychological theories of Neitzsche can be made endogenous in the neoclassical model with some mathematical tweaks. Robb made some amazingly insightful comments in response:

However, I am not prepared to take the easy way out and fully accept (R1) as Nietzschean Economics. Sticking with Occam’s razor, I would propose, as an alternative to (R1), that our engagement with time is twofold and a portion of it lies outside of pleasure maximization. While lacking the precision of fully specified models, the WTP approach gives specific predictions that are useful in practical problems in economics. Nietzsche, along with Heraclites, Kierkegaard, Hegel and Bergson, was the philosopher of becoming – whether I have expressed the point with any useful clarity at all, he should have a great deal to teach us.

I should acknowledge that Nietzschean Economics has a personal objective beyond explaining various phenomena in economic life. I wanted to arrive at a “framework for modeling intertemporal choice that is more closely aligned with our immediate experience.” A formative event for me was a yearlong spell of unemployment in 2001 after leaving a job managing the global derivatives and securities business of Japan’s largest bank. I was looking forward to inputting some ti, ei, Xi and realizing U(Z). But when my unexamined faith in U(Z) was put to the test, it did not turn out like I expected. Without obstacles to overcome, I discovered that the day is long. I got back to work. I believe my experience is not uncommon.

Rizzo (2012), meanwhile, draws on three ways Austrians in general have tried to reconcile the balance between psychology and economics. Rizzo draws off of Wittgenstein’s philosophy of language, Schutz’s phenomenological sociology, and Hayek’s gestalt psychology in The Sensory Order.

What is striking about Robb’s “Nietzschean economics” and Rizzo’s work on Austrian economics is they are two economists from two very different schools doing the same exact thing Rorty attempted to do with epistemology in the 70s. Much as there was an aversion to psychology in economics throughout the early formulations of utility theory, in philosophy there was an eversion to implementing psychology into epistemology because epistemology conceived of itself as the epistemic foundation on which all of philosophical knowledge stood. Likewise, economists have been reluctant to let any psychology into their utility theories at all. Rorty proposed a form of “behavioral epistemology” modeled after the work of William James, however Rorty proposed that “behavioral epistemology” should not be thought of as foundational to the philosophical project as a whole. “Behavioral economics” has, from a neo-pragmatist perspective, committed the sin Rorty avoided in trying to be the new foundation of preference theory and choice theory.

Just as Rorty was skeptical extensively in Philosophy and the Mirror of Nature” about “successor subjects” such as philosophy of mind and language attempting to be substitutes for Kantian epistemology as the foundation of all of philosophical, economists should be skeptical of possible “successor subjects” to Jevons-style utility theory in economics. Pareto once famously described his war against the English School as a war against “(t)hose who have a hankering for metaphysics” (McLure 199 312). Preference theory, behavioral experiments, and even Neitzschean psychology in Robb’s formulation could be viewed as merely “successor subjects” to Jevon’s ordinal utility theory. Just as Rorty claimed philosophers clung to “our glassy essence” in Kantian epistemology by postulating a whole bunch of “successor subjects” to epistemology, economists may need to be careful in clinging to “our utilitarian essence” in trying to relegate the “foundation” of the social sciences to other realms.

Part II: Utility Theory to Hermeneutics

It is striking that many of the philosophers that the economists who are trying to figure out where to go in the neoclassical and Austrian traditions are appealing to the same philosophers Rorty did. Lavoie (1990) appealed to Heiddeger and Gadamer under Rorty’s influence to rid economics of its foundationalism in the way I described. Boettke is appealing to Quine and Dewey, two pragmatists to understand Mises’ apriori assumption of rationality over human action. Rizzo is appealing to Wittgenstein, one of Rorty’s “heroes” of Philosophy and the Mirror of Nature for his philosophy of language. Robb is appealing to Neitzsche, another one of Rorty’s major influences. Rorty is in some sense what got Lavoie going in the Hermaneutic research program to begin with. Perhaps, a return more specifically to the manner in which Rorty presented hermeneutics is what is necessary for economists to approach the question of rationality at this point, this section aims to more narrowly analyze Rorty’s hermeneutics, a concluding section suggests general lessons from the history of rationality out of a Rortian Hermeneutic research program in the subject of economic rationality.

Kuhn, Rorty, and Incommensurability

In chapter seven of Philosophy and the Mirror of Nature, Rorty appeals most fully to Thomas Kuhn’s philosophy of science. Kuhn’s philosophy of science includes the idea of “paradigms” in research, that is basic fundamental assumptions that go into a scientist’s work. Khun then carefully distinguishes between “commensurable paradigms,” those fundamental assumptions that can work together, and “incommensurable paradigms,” those fundamental assumptions that cannot. If there are two incommensurable paradigms at once, there will be a “paradigm shift.” The most famous and widely cited example is the shift from Newtonian physics to Quantum Mechanics in physics.

Rorty posits the new place of philosophy should be to “edify,” to be therapeutic in some sense on the personal level of the philosopher. To some extent, that idea of an “edifying philosophy” seems to be going on in the back of Robb’s mind in his response to Heckman on Nietzsche. But not only is philosophy to edify, it is also possible to use philosophy as hermeneutics to commensurate seemingly incommensurable paradigms. It may be the case that this is the direction economics in which must go.

In Vernon Smith’s Nobel Prize lecture (2002), he laid out a way in which paradigms could be thought to relate to each other in this question of rationality in economics. Smith distinguishes between “constructivist rationality,” drawing off Hayek’s program mentioned at the outset of this paper in The Counterrevolution of Science, and “ecological rationality.” “Constructivist rationality,” to Smith, is rationality stems from Cartesian rationalism (506) and “provisionally assumes or ‘requires’ agents to possess complete payoff and other information—far more than could ever be given to one mind.” Ecological rationality, on the other hand, is rationality that is identified with Hayek and the Scottish enlightenment. It is a “concept of rational order, as an undersigned ecological system that emerges out of cultural and biological evolutionary process” (508).


Vernon Smith thought that the research paradigms between the two are somehow commensurable. Though this is likely the case, most economists researching the literature in the behavioral and neoclassical traditions seem to disagree. Most of the economists in the hermeneutic tradition researching the issue seem to have Lakatos’ philosophy of science more prominent in their minds than Kuhn’s (Cachanosky 2013). Perhaps, for the moment, economics is in a place that is closer to Kuhn’s philosophy of science than Lakatos, and we need to assume that the paradigms between “ecological rationality” and “constructivist rationality” are incommensurable in some sense, though agree with Vernon Smith that they need not be. Further research in the Rortian hermeneutic tradition may help commensurate those paradigms.

Conclusion: Open-Mindedness in Rational Economic Discourse

Often, debate over rationality gets extremely heated thanks to its connection at times to politics and the nature of capitalism. For an example, in Nudge Thaler and Sunstein primarily place blame for the financial crisis on behavioral factors (2009 255-260). New Keynsians might respond to this by yelling at the top of their lungs that they’re ignoring aggregate demand, Austrians might respond by yelling at the top of their lungs that they’re ignoring the interest rate and business cycle theory. But perhaps a combination of the three, a pluralism, is necessary for the explanation. The problem with economic debates is too often when it gets associated with the political spheres, the arguments get personally provocative and nasty. This is how incommensurable paradigms occur, and that is likely what has occurred with the debate about rationality. Thaler and Sunstein are probably oversimplifying the complex myriad of institutional factors that went into causing the recession, but yelling that your business cycle theory explains it is not the right solution.

Zouboulakis ends Verities of Economic Rationality by proclaiming “What is Rational after all?” Rorty would say something like, ‘Rationality is not a human faculty, it’s a social virtue.’ In order to maintain open-minded discussion and approach a point when there can be normal discourse in the economics profession, perhaps this is the answer that is needed. Perhaps all the actors in a market economy are the “rational” ones in Rorty’s use of the term, and economists are not.

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Lavoie, Donald. 190. “Economics and Hermeneutics.” In Economics and Hermeneutics ed. by Don Lavoie. Abidingdon, Oxfordshire: Routledge.

—. 2011. Thinking Fast and Slow. New York, NY: Farrar, Straus and Giroux.

McKenzie, Robert B. 2009. “Rationality in Economic thought: From Thomas Robert Malthus to Alfred Marshall and Philip Wicksteed.” In Predictably Rational, edited by Robert McKenzie. Berlin Heidelberg: Springer. http://link.springer.com/chapter/10.1007%2F978-3-642-01586-1_4?LI=true.

Menger, Carl. 1976. Principles of Economics. Auburn, AL: Ludwig von Mises Institute. http://mises.org/sites/default/files/Principles%20of%20Economics_5.pdf. (Originally Published in 1871.)

Mises, Ludwig. 1998. Human Action. Auburn, AL: Ludwig von Mises Institute. (Originally published in 1949).

—. 2013. Epistemological Problems in Economics. Indianapolis: Liberty Fund, Inc. http://oll.libertyfund.org/titles/2427. (Originally published in 1933).

Read, Daniel. 2004. “Utility theory from Jeremy Bentham to Daniel Kahneman.” LSE Department of Operational Research Working Paper LSEOR 04-64.

Rizzo, Mario. 2012. “The Problem of Rationality: Behavioral Economics Meets Austrian Economics.” Unpublished. http://econ.as.nyu.edu/docs/IO/28036/BEHAVIORAL_ECONOMICS.pdf.

Robb, Richard. 2009. “Nietzsche and the Economics of Becoming.” Capitalism and Society. 4(3) (January). < http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2209313>

Robbins, Lionel. An Essay on the Nature and Significance of Economic Science.

Rorty, Richard. 1979. Philosophy and the Mirror of Nature. Princeton, NJ: Princeton University Press.

Samuelson, Peter. 1938. “A Note on the Pure Theory of Consumer’s Behaviour.” Economica, New Series, 5(17) (February): 61-71.

Thaler, Richard and Cass Sunstein. 2009. Nudge. Penguin Books.

Simon, Herbert A. 1972. “Theories of Bounded Rationality.” In Decision and Organization edited by C.B. McGuire and Roy Radner. Amsterdam: North Holland Publishing. http://mx.nthu.edu.tw/~cshwang/teaching-economics/econ5005/Papers/Simon-H=Theoriesof%20Bounded%20Rationality.pdf.

—. 1978. “Rational Decision-Making in Business Organizations.” Paper Presented at Nobel Prize Memorial Lecture Pittsburg, PA.

Zouboulakis, Michel. 2013. The Varieties of Economic Rationality. New York, NY: Routledge.

[1] Though Mises’ 1949 work Human Action is cited here, it is important to note that he had laid out very similar positions much earlier (1933/2013).

Where did Homo Economicus come from?

Zachary Woodman Economics, Liberty, Philosophy , , , , , , , , , , , , , , , , , , , ,

Over on my Facebook page, I posted a short criticism of both neoclassical and behavioral economic scholarship on rational choice (drawing from a paper I’m working on exploring that topic). Stated a bit polemically,  though homo economicus has largely been dead in neoclassical theory, his spirit still haunts the work of most modern neoclassical scholars. Likewise, though behavioral economists are trying to dig the grave and put the final nails in the coffin of homo economicus, their nightmares are still plagued with the anxieties of his memory.

This led a former colleague from Hillsdale to ask me where I thought homo economicus came from historically. I wrote the following in response (lightly edited for this post):

It could be argued, in a sense, that the protestant Christian aim to complete moral purity and the Enlightenment aim to make man perfect in knowledge in morality (as embodied in Franklin’s virtue ethics) helped give rise to a culture that would be primed for such a model. Within economics, historically it comes from Bentham’s utilitarianism and Jevon’s mathematical extrapolations from Bentham’s psychology. However, I’d say this comes from a deeper “Cartesian anxiety” in Bernstein’s use of the term to make economic a big-T True, capital-C Certain, capital-S Science just like physics (which Jevon’s himself stated was an aim of his work,[1] and has preoccupied economists since the days of JS Mill). If economic science cannot be said to be completely positive and “scientific” like the natural sciences with absolutely falsifiable propositions and an algorithmic means of theory-choice, it is feared, it must be written off as a pseudo-scientific waste of time or else ideology to justify capitalism. If economics cannot make certain claims to knowledge, it must be solipsist and relativist and, again, be another form of pseudo-science or ideology. If economic models cannot reach definitive mathematical results, then they must be relativistic and a waste of time. This is just another example of the extreme Cartesian/Katian/Platonic (in Rorty’s use of the term) either/or: objectivity OR relativism, science OR nonscience, determinate mathematical solutions OR ideological emotional bickering. Homo economicus was erected as a means to be an epistemic foundation to solve all these anxieties and either/ors.

Of course, as any good Deweyan, I think all these either/ors are nonsense. Their understanding of science, as revealed through the so-called “growth of knowledge” literature in postempiricist philosophy of science (ie., the work of Thomas Kuhn, Lakotos, Karl Popper, Paul Feyerabend, Michael Polanyi, Richard Bernstein, Richard Rorty, etc.) has shown that this positivist conception of science, that is science consists of algorithmic theory choice selected based off correspondence with theory-free, brute “facts” of the “external world,” is woefully inaccurate. Dialogical Aristotelian practical reasoning in the community of scientists plays just as much of a role in formulating a scientific consensus as empirical verification. This does not undermine science’s claims to objectivity or rationality, in fact it puts such claims in more epistemically tenable terms.

Further, the desire to make the social sciences just another extension of the natural science, as Hayek shows in the Counterrevolution of Science, and as even positivists like Milton Freidman argue, is a completely misleading urge that has led to some of the worst follies in modern social theory. Obviously, I cheer the fact that “homo economicus is dead, and we have killed him,” but now that we’ve “out-rationalized the rationalizer of all rationalizers,” we must try to re-evaluate our economic theories and methods to, as Bernstein or Dewey would put it, “reconstruct” our economic science.

In short, immenatizing the eschaton in epistemology and philosophy of science created homo economicus.

For the record, you don’t have to be a radical scientific anti-realist like Feyerabend or Rorty to agree with my analysis here.[2] I myself wax more towards Quine than Rorty in scientific matters. However, the main point of philosophy of science since positivism is the exact type of foundationalist epistemology undergirding modern positivist methodology in the mainstream of the economics profession, and the concept of rationality that is used to buttress it, is a naive view of science, natural or social.

Notably, this critique is largely unrelated to much of the Austrian school. Mises’ own conception of rationality is mostly unrelated to homo economicus as he understands rationality to be purposive action, emphasizing that economists first understand the subjective meaning from the point of view of the economic actor him/herself before declaring any action “irrational.”[3] [4]

What are your thoughts on this? Are neoclassical and behavioral economics both still way too influenced by the spirit of homo economicus, or am I off the mark? Is my analysis of the historical conditions that led to the rise of homo economicus right? Please, discuss in the comments.

[1] Consider this quote from Jevon’s magnum opus Theory of Political Economy “Economics, if it is to be a science at all, must be a mathematical science.”

[2] In fact, I doubt anybody mentioned is really a scientific anti-realist, I agree with Bernstein that Feyerabend is best read as a satirist of the Cartesian anxiety and extreme either/or of relativism and objectivism in philosophy of science and think Rorty’s views are more complex than simple scientific anti-realism, but that’s an unrelated point.

[3] Of course, any critique of epistemic foundationalism would apply to Mises, especially his apriorism; after all, Mises did write a book called “Ultimate Foundations of the Social Sciences” and the Cartesian anxiety is strong with him, especially in his later works. Notably, none of this applies to most of Mises’ students, especially Schutz, Machlup, and Hayek.

[4] For a more detailed discussion of Mises and the Austrians on rationality, see my blog post here or this paper by Mario Rizzo. For a more general discussion of the insights of the type of philosophy of science I’m discussing, see Chapter 2 of Richard Bernstein’s excellent 1983 book Beyond Objectivism and Relativism: Science, Hermeneutics, and Praxis.

The 100th Anniversary of the Defeat of Economic Land

Fred Foldvary Economics, History , , , , , , , , ,

The year 2014 is the 100th anniversary of an economics article that was the final nail in the coffin of classical economics, as it marked the victory of the neoclassical economics war against land. This was a victory so great that economists today do not even realize that there had been such an academic war.

Alvin Saunders Johnson (1874-1971) was an American economist at several universities, including Columbia, the University of Chicago, and Cornell. He was a co-founder of the New School at New York City. In 1902 he wrote “Rent in Modern Economic Theory: An Essay in Distribution.” Johnson, along with other economists who were turning the classical theories of the 1800s into the neoclassical doctrines of the 1900s, generalized “rent,” from the yield of land, into any surplus above opportunity cost, i.e. above the cost needed to put a resource to its most productive use. For example, a movie star paid $1 million to act in a movie, whose next best opportunity is being a salesman earning $100,000, has an economic rent of $900,000.

In 1914, Johnson published “The Case against the Single Tax” in The Atlantic Monthly. As has been well explained by Prof. Mason Gaffney in The Corruption of Economics, Johnson played a major role in suppressing, by falsification, the land-tax ideas of Henry George. Land is now visible everywhere except in academic economics. For example, the generation of land value by public goods is not even mentioned in the general textbooks.

Johnson correctly stated that a tax on the entire rent of land would bring the purchase price down to zero, but he expressed it as: “the value kernel of landed property will have been seized by the state.” In policy analysis, we need to examine inflammatory vocabulary. The moral case for land-value taxation rests in the proposition that the benefits of nature belong to all humanity equally, that the creation of local land values by population and commerce belongs in equal shares to the members of those communities, and that the rentals generated by public works may be used to pay the providers, whether this be private-sector or government providers. None of this is confiscation or seizing by the state.

In Georgist ethics, the people own the rent, not the chiefs of state. A government may justly act as the agent of the people to protect their property, such as the atmosphere, from damage, and a government may, as the agent of the people, collect the rent to distribute it among them, or to use to pay for public goods. The premise that the rent belongs to the people implies that the rent is not being seized from the landowners as though these title holders are the morally legitimate owners, but rather that the state is facilitating the collection of the rent to the proper owners, the people. Hence the terminology used by Johnson taints his analysis and begs the question of the proper ownership of land rent.

Johnson continues his attack by calling the single tax on land value “propaganda for the universal confiscation of land.” Henry George had unfortunately stated in Progress and Poverty that “It is not necessary to confiscate land; it is only necessary to confiscate rent.” The Latin origin of “confiscate” is “confiscare,” from “fiscus” meaning the government’s treasury. Fiscal policy is about governmental revenue and spending. Thus in linguistic origin, to confiscate means simply to tax, to transfer assets to the public treasury. But in modern popular usage, to “confiscate” means to take by force, with the implication that the state is seizing property that was legitimately owned. And despite George’s statement that it is only the rent, not the land itself, that is being “confiscated,” Johnson attacks the single tax as confiscating the land.

Moreover, by dismissing the theory behind the single tax as “propaganda,” Johnson denigrated the logic and evidence for land-value taxation in an anti-scholarly manner, and thus he himself indulged in propaganda.

Johnson’s mixing up the ownership of land and of its rent is also shown by his statement that if all the value of land is taxed, the revenue would cover the costs of government, “provided, of course, that the public can manage the lands as efficiently as they are now managed by their private owners.” This despite the statement of George that “I do not propose either to purchase or to confiscate private property in land.” Land-value taxation would not disturb private titles; it would not alter private control and possession. The government would not “manage the lands.”

Johnson states that much of the financial wealth of the middle class is in land value, and that the full taxation of land value would take more value from them than they would regain in the removal of other taxes. Of course in 1914, the 16th Amendment had just been enacted in 1913, and the middle class did not yet suffer from the income tax.

Nevertheless, Johnson’s statement is illogical. Suppose the total land rent is $1 trillion, and the cost of government is half of that; then the rent does not disappear, but is distributed back to the people in cash. So the effect of land value taxation would be to equalize the ownership of the rent, and a person who owned an average amount of rent would get half back in cash, and half back, ideally, in valued public goods. If government is squandering some of the rent, then the remedy is to give it all back to the people. Then the average land owner is in a neutral position.

Johnson falsely declared that “The Single Tax is, then, essentially a device for the spoilation of the middle class.” One could justly say that Johnson’s malicious attack was a device for the spoilation of the remedy for poverty, depressions, and land conflicts. What has spoiled the middle class is high taxes on their wages and on the goods they buy. Johnson’s falsifications were the spoilation of a policy that could have promoted sustainable prosperity and prevented needless economic inequality. Johnson’s propaganda succeeded in helping squash land-value taxation, but to the ruin of economies worldwide.

With the neoclassical victory against land, most economists today suffer from cognitive dissonance. Even if economists reject an egalitarian view of natural resources, they know that the supply of land is inelastic, so public revenue from land rent avoids the excess burden that other taxes have. But they do not extend this knowledge to the rest of theory and to policy. Mason Gaffney calls this the “corruption of economics.” I call it “academic brain freeze.” At any rate, it is worth marking the 100th anniversary of Johnson’s attack.

The Canons of Economics

Fred Foldvary Economics, Liberty , , , , , , , , , , ,

by Fred E. Foldvary

A “canon” is a set of items which are regarded by the chiefs of a field to be the accepted elements of the domain. Every religion, for example, has a canon of accepted ideas and documents such as the established books of the Bible. Every scientific field has a canon of propositions and facts accepted as genuine by the experts and by those in authority such as editors of the major journals and most members of the departments of the prominent universities.

The canon of economics consists of the propositions, methods, and historical facts accepted as true and applicable by most scholarly economists. This canon appears in textbooks and in the articles of the prominent journals. The ideas and methods outside the canon are referred to as heterodox economics, in contrast to the mainstream or orthodox canon. There have been articles and organizations about the mainstream and alternative canons, but they have not laid out what the canons consist of. Here is my attempt.

The canon of orthodox neoclassical economics consists of 1) supply and demand; 2) graphical curves of equal utility, inputs, and output; 3) marginal analysis (additional amounts of utility, inputs, outputs); 4) the factors or input variables of capital goods and labor; 5) the price level; 6) equations of production and utility; 7) the government-influenced money supply and the market-based velocity of the circulation of money; 8) economic and accounting profit; 9) market failure and government corrections; 10) equilibrium; 11) maximizing and minimizing within constraints; 12) the premises of subjective values, self-interest, scarcity, unlimited desires, and the uncertainty of the future; 13) the “time preference” for present day good relative to future goods; 14) the trade-off between goods and leisure; 15) the trade-off between equity and efficiency; 16) diminishing marginal utility; 17) diminishing marginal products; 18) theory from mathematical models; 19) econometric testing of hypotheses; 20) the producer and consumer surplus.

Neoclassical economics is divided into several sub-schools for macroeconomic theory. The major schools and their canons are:
1) Keynesian or demand-side economics, with the canons of the consumption function, spending multiplier, and the determination of output from autonomous spending and the multiplier.
2) The Monetarist school, its canon being the equation of exchange: Money times velocity equals the price level times real output, hence monetary inflation generally causes price inflation.
3) The New Classical school with its canon of rational expectations, which makes inflationary policy ineffective.
4) The New Keynesian school with its canon of wages, prices, and interest rates stuck above equilibrium; it accepts New-Classical rational expectations but claims that contracts and other rigid conditions make expansionary policy effective in increasing output.

The heterodox Austrian economic school of thought accepts these elements of neoclassical economics:1, 3, 4, 7, 8, 12, 13, 14, 15, 16, 17, 20. Austrians reject the excessive emphasis on 6, 9, 10, 11, 18, 19. The canons of the Austrian school that have not been absorbed into the mainstream are: 1) the time and interest-based structure of capital goods; 2) market dynamics rather than equilibrium; 3) dispersed knowledge; 4) discrete marginal utility based on diminishing importance; 4) axiomatic-deductive theory (praxeology); 5) entrepreneurship as both discovery and creative reconstruction; 6) free-market money and banking; 7) roundabout production; 8) the market as spontaneous order; 9) the failure of government intervention; 10) the evenly rotating economy that illustrates the role of entrepreneurship in the real world of uncertainty and change.

The Marxist school canon includes 1) class struggle, 2) the labor theory of value; 3) the surplus from labor taken by the capitalists who dominate labor; 4) benefits from socializing wealth.

The Georgist or geo-classical school has these canons: 1) land and its rent as major elements of the economy; 2) the margin of production as the least productive land in use; 3) land speculation and the movement of the margin raising rent and reducing wages; 4) the creation of land rentals from public goods; 5) depressions resulting from land-value bubbles; 6) economic effects of replacing market-hampering market-hampering taxes and subsidies with land-value taxation; 7) the surplus as land rent; 8) the ethics of labor and land; 9) harmony between equity and efficiency, and 10) the social behavioral effects of economic justice.

There is also a school of thought called “public choice,” which has been accepted by neoclassical economics as well as by other schools, as a side branch. Its canon includes: 1) self-interest in politics; 2) the rational ignorance of voters; 3) transfer-seeking and getting due to concentrated interests and spread-out costs; 4) vote trading by representatives; 5) bureaucrats maximizing their power and comfort; 6) the primacy of the median voter; 7) constitutional versus operational choice; 8) clubs that provide collective goods to their members.

The classical economics canon, before it turned neoclassical, included these elements: 1) Say’s law, that production pays factors that enable effective demand; 2) the division of labor; 3) economic growth from unhampered production and free trade; 4) the margin of production as the least productive land in use; 5) population growth pushing the margin to less productive land; 6) the three factors of production as land, labor, and capital goods.

A problem in economics today is that each canon excludes the useful elements of other schools. Economics needs a universalist canon that integrates the best elements from all schools of thought. However, economists disagree on what the canon should be. In my judgment, the most glaring omission in the mainstream canon is the neglect of the Austrian-school time-structure of capital goods, its neglect of the creation of land rent by public goods, and its neglect of the benefits of a prosperity tax shift, the replacement of market-hampering taxes with market-enhancing payments of land rent and pollution charges.

Note: This article first appeared in the Progress Report.