The Importance of Failed Models

Earlier, I discussed an article by Jonathan Newman discussing  what he sees as scientism, specifically:

Scientism has many forms, one of which is the use of empirical methods to do economic science, or the dismissal of claims not based on experiment results that question other claims that are based on experiment results.

I had addressed the first condition of his scientism claim in my last blog post.  Now, I’d like to address the other.

It is true that rejecting claims not based upon experiment results in favor of claims that are based on experiment results can lead to scientism.  Note I said “can lead to scientism.”  I outright reject Newman’s claim that the rejection is in and of itself scientism.  If one gets empirical results that conflict with one’s model, one should ask “why?”  Failure to ask this question is what leads to scientism, not the rejection thereof.  Furthermore, failure to ask this question can lead one to avoid important insights.

Let’s look at two major turning points in the history of economic thought: the Marginal Revolution and the development of Public Choice.

Prior to the Marginal Revolution, the idea of a Labor Theory of Value dominated the economic world.  Promoted by men like Adam Smith and David Ricardo, it was a key concept of economic theory.  However, empirical and philosophical issues were coming about calling into question the LTV.  Rather than simply dismissing these concerns as “scientism”, economists decided to look at the theory.  Carl Menger (whose writings on the matter would become the foundation of the Austrian School of thought) was one of the main questioners.  He developed the idea of diminishing marginal utility and people use rank-ordering of utility to make choices.  William Jevons and Leon Walras also made major contributions to the theory which would eventually become foundational to modern economics.*

About a century later, Gordon Tullock took up Mundell’s challenge for economists to explore why empirically there so little deadweight loss from trade compared to what theory would predict.  It’s a good thing Tullock did not simply dismiss the empirical evidence as “scientism,” but rather explored why the model was failing.  His work lead to the creation of Public Choice economics (you can read in more detail the story here).

One of my professors, Garret Jones, likes to say it is important to see how models fail, if they fail in interesting ways.  The models of the Labor Theory of Value and international trade failed in interesting ways.  One gave us a new understanding of economics (the Marginal Revolution).  They other gave us better insight in economic theory (Public Choice).  I feel confident to say that, if we had simply ignored the concerns raised by empirical results as “scientism,” then the economics profession would be worse off for it.

*I must apologize for not giving Jevons and Walras the time they deserve here for their contributions to the Marginal Revolution; space constraints force me to economize.

Know Your Limits

Former Representative Ron Paul tweeted and republished a recent article on Mises Institute  discussing “scientism” (that is, the phrase coined by FA Hayek to describe the over-reliance on the scientific method) written by Jonathan Newman.  Scientism is a problem, but Mr. Newman inaccurately describes it, and in the process, attacks science rather than scientism.

Newman’s biggest error is here (emphasis added):

Scientism is the over-reliance on or over-application of the scientific method. Scientism has many forms, one of which is the use of empirical methods to do economic science, or the dismissal of claims not based on experiment results that question other claims that are based on experiment results.

The bolded part is flat-out incorrect.  First off, if one doesn’t do empirical methods, one isn’t doing economic science.  Second, if that were true, the Mises, Hayek, Smith, Ricardo, et al are all guilty of scientism.  The empirical method requires observation, consideration, testing, etc of natural phenomena.  If we aren’t doing that, then we aren’t doing anything worth doing.  Smith’s Wealth of Nations is an empirical work.  Mises’ Human Action is empirical work.  Hayek’s Prices and Production is empirical work.

One might argue Newman is speaking more (like Hayek was) on the heavily mathematization of economics.  Ok, fine.  Newman’s criticism is still incorrect.  Mathematical and statistical models can provide us insight, so long as they are used correctly.  We must remember that the output from such models is model-dependent.  It is conditional upon certain assumptions.  This is true whether it is a highly advanced econometric model or a simple Marshallian supply and demand graph.  Knowing the limitations and applicability of models is important to getting the intuition (a great discussion of this point is made in Robert Ableson’s “Statistics as Principled Argument“).  The problem arises when we treat the results of these models as Gospel without consideration of their conditions.

Newman’s article has other issues (such as posing the hypothetical “what if the Pythagorean Theorem is wrong?”) which I will cover at a later time.

HT: Garett Jones

Update: I had incorrectly attributed the article in question to Ron Paul instead of Jonathan Newman.  My apologies.  The blog post has been updated to reflect this correction.

Transferring Wealth is Not the Same as Creating Wealth

The Commerce Department has proposed tariffs of up to 20% on Canadian sofwood lumber imports.    These tariffs are phrased by the Administration and supporters as “leveling the playing field” and wealth creating measures.  Ramiyer, commenting on this blog post by Mark Perry, has a typical protectionist scarcityist argument:

Plus [the tariff] saves thousands of jobs who can afford to purchase and go out and eat. These people are real workers. Not some people who just throw their opinions or Wall Street Looters or big cheaters as in case of some CEOs.

It is true that some jobs are ‘saved’.  But that is only half the story: many jobs are lost, too.  Tariffs do not create wealth.  They transfer it.  Tariffs transfer wealth from consumers to producers and the government (for a graphical representation, see my blog post here).  Unlike free trade, no new wealth is created (in fact, tariffs cause wealth to disappear!). The wealth is merely transferred from the consumers and their spending habits to the producers and their spending habits. Therefore, a nation cannot, though tariffs and artificial scarcity, create wealth; it cannot tax itself into prosperity.  It can merely redistribute wealth.

What’s interesting about this is, until very recently, the same people arguing for tariffs now understood this.  They decry welfare and high corporate taxes for the exact same reason I outlined above for opposing tariffs.  I find the hypocrisy nauseating.

Toward a Better World

According to the organizers of Earth Day: “Education is the key to advocacy and advocacy is the key to change.”  I agree.  Toward that end, allow me to explain why free markets, and in particular secure private property rights, help make the world a better, cleaner, and more environmentally friendly place.

Property rights are important because they encourage the owners of that property right to maximize the property’s uses.  Property rights do this by having the owners incur the costs of their property (its upkeep, its development, etc), but also confers the benefits onto its owner; in other words, the greater concentration of costs and benefits means each person’s success is dependent on his/her activities.  As such, the property owner is incentivized to minimize costs and maximize benefits over the life of the property.

While there are many kinds of property rights, the type of right matters for environmentalism.  Contrary to many popular claims, public ownership of natural resources (national parks, nature preserves, and the like) may be counter to the goals of environmentalism; in other words, state-produced environmental efforts may make the situation worse, not better!  The reason for this is the incentive may not be as strong to maximize effort on the part of the property owner.

Allow me to explain by way of paraphrasing an example Armen Alchian gives in his 1965 Il Politico article Some Economics of Property Rights:

Suppose there is a community with 100 people in it, and 10 enterprises.  Further suppose that each person, by devoting 1/10th of his time to some enterprise as an owner, he can generate a gain of $1,000 for the enterprise.  If ownership of each enterprise is divided equally among the populace (that is, all the enterprises are “publicly owned,”), then he will produce a gain of $100 for himself each day (1/100th part owner and 10 firms) and the rest of his product ($9,900) going to the other members of the community.  If the other 99 people in the community act the same way, he will get $9,900 from them, bringing his total wealth gain to $10,000.

Now suppose that each person owns 1/10th of a single enterprise.  The individual now works to produce $10,000, of which he keeps $1,000 and the other $9,000 goes to the other owners.  If the other owners do the same, all end up with $10,000.

If we go to the extreme end and each enterprise is owned by a single person, then he gets to keep all $10,000 of his own hard work.

As we can see, in each case above, the reward to the property owner depends partly on his own effort and partly on the effort of others (except the last option).  In the first of the cases, the incentive for him to maximize his efforts is minimal: no matter how hard he works, he’ll only get $100 direct benefit from it.  The other $9,900 must come from someone else who may or may not have the same work ethic as him.

So, if a person is most incentivized to act when s/he absorbs the costs and the benefits, how will that help the environment?  Well, it’ll help by incentivizing the person to keep their property in working order.  A person who owns a home will do her best to keep the house neat, to keep the fixed costs (heating, cooling, water, etc) low.  They may, if they have time and money, plant a garden or maintain a yard in order to keep the house pretty.  Larger groups with common goals could pool money to maintain a park.  Firms, seeking to minimize their costs, are constantly looking for ways to reduce waste and increase output.  Owners of farms, of mines, and the like are always looking for ways to extend the life of their sources of wealth.

In short, people will look to take care of their own little plot of the world.  Environmentalists often urge us to “think globally, act locally.”  I can’t think of anything better than property rights to accomplish this task.

There are objections some might raise to the above discussion, and those I will address in another post as this one, at nearly 700 words, is already too long.

Earth Day 2017

Today is Earth Day.  Protecting and improving the environment is a big thing for me; in fact, it is one of the many reasons I love free markets.  One of the major champions of free market environmentalism is the Property and Environment Research Center (PERC) located in Bozeman, Montana.  I highly recommend checking out their blog and publications.

In the interest of full disclosure, I have no financial ties to PERC, but there are academic ties.  One of my professors, Thomas Stratmann, is a senior fellow.

The Doctrine of Scarcity

Two brothers, Charles and Joseph, are sitting at home reading the news.  The following is a conversation between the two:

Charles: Joe, did you see the nation of Zimbabwe is facing a terrible drought?

Joseph: Are they?  What fabulous luck for them!

C: Luck?  How is this luck?

J: My dear brother, have you no capacity to reason?  The drought is a blessing for the farmers of Zimbabwe!  First, since it makes the supply of food more dear, the prices rise.  The farmers get more money!  This, they can spend on employing more workers (since the land is now less fertile) toiling all day to get the wheat out of the ground.  The demand for workers will increase their wages, making the Zimbabwean worker better off.  Surely, only good times can follow!  This is just Economics 101!

C: Perhaps, Joe, but this is only because there is less food.  Perhaps, in nominal terms, workers earn more, but they can buy less with their money.  Are they not worse off?

J: My dear brother, have you learned nothing?  Their increased pay will make them richer!  What they can’t spend on food, they’ll surely spend on other things!  That’ll further increase demand for workers, raising wages even higher!

C: But that doesn’t solve the initial problem, Joe.  There is still less food to go around.  Sure, they may have more money, but that doesn’t calm an angry belly.  Would it not be better for the rains to come and have the fields of Zimbabwe overflow with grains?

J: And have the price of food plummet?  Have the workers no longer needed (since the fields are now more productive) be unemployed?  Why, think of the chaos of having all those people unemployed!  You would undo the Zimbabwean worker with your mana from Heaven!

C: Perhaps there would initially be people who no longer need work in the fields, but they’d have more full bellies.  Since they are freed up from the labor, they could do other things (maybe make clothing?).

J: You are simply a theorist!  No, brother, it is far better for the people of Zimbabwe to have drought, to drive up prices, use more resources for less output.  Indeed, it is in scarcity, not abundance, that true wealth lies!

C: But you live with less-

J: So?  The workers have work!  That is all they need!  They have a sense of purpose, a sense of living!  What more could a person want?

C: Food, shelter, clothing, leisure…

J: Bah!  More of your theorizing!  The true strength of an economy is the number of jobs it has!

C: But what good are those jobs if you can’t buy anything?

J: Better than having lots to buy and not enough farm jobs.

C: But there are other kinds of jobs.  They can do something else.

J: “Something else!”  More theorizing!  Such an unsatisfying answer.

C: But true nonetheless.

(The conversation continued in this manner for some time).

Joe’s comments may seem weird to our ears, and yet it is the common claim of those who practice the doctrine of scarcity commonly known as “protectionism.”  Since scarcity, and not “protection” or “abundance”, is the foundation for “protectionism” I propose calling these people “scarcitists.”

The scarcitists have a weird idea that it is from scarcity that wealth arises, not abundance.   It is as if the best thing to happen to Man was to be cast from the Garden of Eden.  It is as if Hell, and not Heaven, is our goal.  Scarcisim is a strange doctrine.