As Ludwig von Mises taught way back in 1949, economics is, above all, the study of human action. The two main assumptions of economics back this up: 1) economic actors are rational (that is, with the knowledge they possess, they are working toward some goal), and 2) economic actors seek to improve their conditions (that is, their goal is improvement of wealth, utility, happiness, etc rather than the reduction of such). Essentially, these assumptions boil down to: people, generally speaking, know what they’re doing (as the incomparable Walter Williams likes to say: “never assume someone is stupid until they prove themselves otherwise”). One should deeply consider these two assumptions as what follows is derived from them.
The study of human action in the present can provide us with important insights. In this author’s opinion, I fear this study of present conditions is not done enough by economists. Many economists focus too much on the future (what will the effect of this policy be, etc) rather than an analysis of the current situation. Current-situation analysis can provide us insights into the future, too. For example, an oft-heard defense of minimum wage is the “efficiency-wage theory,” that is, employers, when faced with a mandatory higher wage, will increase the productivity of their workers through training or other programs in order to meet the new wage. Any lost profits from the higher wages would be offset by the higher profits from the increased productivity. However, given the two assumptions mentioned in the first paragraph, we can look at the current situation and question the validity of the prediction: if employers could already increase productivity (and thus their profits) of workers, why aren’t they already doing it? From this point, this current-situation analysis, should the conversation begin, rather than the future-situation analysis of a post-minimum wage world. We should be further skeptical of any answer to the current situation question that involves tossing away one or both of the two main assumptions discussed in the first paragraph.
The current-situation analysis is also helpful in understanding why institutions and law pop up where they do. Why was a private-property rights regime adopted in one area but not in another? Why do people in New England act a certain way compared to people in North Carolina? And so on.
The current-situation analysis prevents us from falling into the pretense of knowledge problem. For future-situation analysis, there can always be models or logical steps that can come to all sorts of conclusions (eg, the efficiency-wage theory and minimum wage example earlier). Current-situation analysis helps us avoid this mistake.
An Important Caveat
The above discussion holds most true when the acting parties feel the majority of costs of their actions. In situations where this is not true, where the costs of an individual’s actions are diffused over a large group that may not even involve the actor himself, it becomes harder to derive a clear picture from his current-situation actions. For example, voting. With voting, and politics in general, the cost of the action (or, more importantly, being wrong) is diffused among a large group of people that may not include the actor himself. For example, if a voter votes to increase minimum wage, he is not paying the cost for such an action. Rather, he is (potentially) compelling others to do his preferred action with no or minimal cost to himself. His action is consistent with our two assumptions, but it is not a clear picture of what his preferred action is. In other words, we cannot draw a conclusion from his action here as we could with the businessman in the above example. For this reason, we should be careful drawing conclusions from political actions. Rather, his actions where he bares the brunt of the costs gives us more information.