Economics as Science: The episode debates whether economics qualifies as a real science, contrasting empirical prediction in physics with economic reasoning and market complexity.
Efficient Markets Hypothesis: Discussion of EMH’s logic that known crashes get “pulled forward,” and why this defense can be overextended when used to dismiss critiques or warnings.
2008 Crisis Case Study: Extended analysis of the housing bubble, Lehman’s failure, and debates between Chicago-school economists and critics like Paul Krugman and Peter Schiff.
Model Limitations: Critique of Fed and quant models, including flawed assumptions about real estate market independence and rare-event probabilities in mortgage-backed securities.
Austrian Perspective: Argument that credit expansion and artificially low rates helped fuel the bubble, with policy factors like Fannie and Freddie channeling liquidity into housing.
Predictability vs. Prevention: Analogies to plane crashes and earthquakes illustrate why inability to perfectly predict timing doesn’t absolve failure to recognize and mitigate systemic risks.
Methodology: Emphasis on praxeology and a priori reasoning (like geometry) for economic laws such as incentives and opportunity cost, rather than purely empirical falsification.
Investment Implications: No specific tickers or sectors were pitched; the focus was on understanding model risk, incentive responses, and systemic correlation risks.
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Hey everybody, welcome back to the human action podcast. Today I am going to discuss the forever interesting [music] topic of whether economics is a real science. So, the motivation for this, just let me give you the background in terms of what pushed me over the edge to talk about this and some of the particulars I'm going to get into in this episode, was a Twitter battle, as often happens, which guides my day and my thoughts. So, here we'll flash it up. So the backdrop here, I only grabbed a particular nested version or subset of what was going on here, but this guy Join Hog, sorry if I'm butchering your name, sir. Um, he had come out swinging, you don't see it here in the screenshot, saying that, uh, you know, economics by its very nature is very political and ideological and it's not scientific um, the way other disciplines are. And then he listed a bunch of reasons that he thought it was necessarily ideological. Okay. And then this guy Matt Darling chimed in who uh goes out of his way to to defend orthodox economics. Like one of his favorite things is to go around and just anytime someone cites some stat about the median household income, Matt Darling will come along and correct the person. You know, just nope, nope, nothing to see here. everything's fine. Um, you know, no rock in the boat. There's a reason things are the way they are and suck it up, sir. So, that's kind of his role in these things. And so, he was chiming in to this joust guy saying like, "Oh, yeah, all these reasons you're listing as to why economics is ideological and political and blah blah blah." And he said, "Just like biology, chemistry, and physics." That was Matt Darling's. So now this guy responding to Matt Darling says these hard sciences have much more robust laws than economics. For example, no law of economics can be as easily tested and empirically debunked slashverified as the law of gravity. Yet many economists claim that their field is a real science. It's not. All right. So you see what he's getting at there. And let me just go ahead and while I have this screenshot up, I'll explain the rest of the jocular banter. So then Alex Tabarok, economist, uh, the GMU chimes in and says, "Explain this physicists showing a picture." I'm I'm narring this folks because some people are just listening to the audio. Showing a picture of a plane either taking off or landing. And then Alex has in parenthesis, "Economists get challenged with equivalent questions every day. Okay, so presumably, you know, what Alex has in mind, in other words, is to say, "Oh, wait a minute. If there's a law of gravity, then how come planes can go up in the air? I thought, shouldn't they fall towards the Earth?" And so, obviously, he's saying other things counteract that. And then presumably what Alex has in mind is that if somebody's I don't know the specifics of what he means, but I guess somebody could say something like, "Well, geez, you economist said that uh tariffs would cause consumer prices to go up, but look at actually consumer prices haven't gone up that much this year, and so you guys are wrong." Or you economists said raising the minimum wage would lead to large unemployment among unskilled workers. But no, this state raised their minimum wage and actually uh the fast food restaurants hired more kids the next summer. So what about that? Right? So Alex's point is in economics, we can talk about particular causal forces, but there's so many things going on in an actual historical episode that sometimes the thing you're focusing on gets swamped by other factors. All right? or geez you economists think everybody is greedy but actually you know some rich guy wrote a check and funded some local softball team so I guess uh that goes out the window your models with your egoistic rationalistic behavior right be another example okay so now to explain my zinger so then I came in in responding to Alex and said if engineers knew why planes crashed there wouldn't be any plane crashes okay so by By the end of this episode, you will fully understand the majesty in wit packed into my little zinger there. So, what I was actually doing there was making fun of economists. A lot of people, as so often happens on Twitter, thought I was making fun of engineers, and they were coming up and telling me, "No, no, no, dude." Because I can see you're an economist, so you must be tribal, and you must be defending your guys. No, engineers actually can do, and that's why we're so much better than you, idiot economist. Again, I was making fun of economist there, right? So what Alex was trying to do in this exchange was to chime in and say, you know, oh, it's funny that you're sitting there trying to say how physics is so much better than economics and more scientific, but a lot of the challenges that we get as economists for people outsiders trying to blow up our discipline and say how stupid we are and how we can't look out the window and see reality compared to our, you know, uh, false assumptions or unrealistic assumptions that actually people are just misunderstanding how economics works and he said it would be analogous to someone looking at a plane taking off and saying oh gez I thought you physicist said there was a law of gravity right so Alex is clearly circling the wagons and defending economics is a science and so then because I had recently interviewed somebody on this very topic on a different show about you know the use of mathematics and economics and so on and then I brought up this issue of a lot of People say economics is overrated and you economists at MIT and Harvard and whatever walking around thinking you're geniuses and that you've got your sophisticated mathematical models and so forth, but uh you guys didn't know the 2008 crisis was coming, right? You could, you know, what good are you if you can't even warn us about an impending global financial crisis? And the response to that or one response to that kind of an objection is to say, "Oh, no, no. By its very nature, stock market crashes can't be predicted because like you know, if if six months ahead of time, all the smart people knew that the stock market was going to crash in the fall of 2008, well then what would they have done? They would have gotten out of the stock market to try to get out before the crash happened. But that just means the crash would have occurred in the spring of 2008, right? And so it's that so that's so the idea is that's why you can't predict a stock market crash. And so you can't wag your finger at the economist for not predicting the financial crisis because you know that's misunderstanding how economics works. It just show if you think that it just shows you don't understand economics. Pal, why don't you go take a class in Chicago price theory? Duh. Okay, so where am I going with this? I'm what I'm trying to show here in my little Twitter trolling comment is to say that typical defense of the legitimacy of economics and how economists often defend themselves when outsiders say, "You guys are a bunch of clowns." I'm saying imagine if somebody else tried to use that defense in some other discipline. How goofy that would sound, right? So imagine a plane crashes and people get mad at the, you know, the various safety, you know, inspectors and the people who built the plane or what, you know, the the whole infrastructure. People were questioning saying all you people whose job it is to run the airline industry and to build planes and whatever and regulate airspace. This is a problem. Why did that plane crash? And then imagine if somebody said in response to that, well, let's think about this. Suppose all the smart people knew like the pilots and everybody and the people, you know, running the airline companies and things like that. Suppose they all knew a week ahead of time that there was going to be a jumbo jet crash that was going to kill 200 people next week. Well, they wouldn't have run that flight and the people wouldn't have gotten on it and they wouldn't have the pilots certainly wouldn't have taken off and so the crash wouldn't have happened. So, you can see it's kind of silly to say how come you guys didn't predict the plane crash because if we could have done that then the plane wouldn't have crashed the way it did, right? So, do you see why that defense it's it's actually not wrong? Right? What I just said is actually correct. If people could accurately predict a plane crash and know that, oh yeah, the way things are going a week from now that 747 is going to crash and kill 200 people. And so if if a bunch of insiders, you know, smart people knew that was going to happen, then they would change their behavior such that that would no longer happen. like the timeline wouldn't go down that path anymore. You would So that's true, but the conclusion is not therefore. So anytime there's a bad plane crash, it exonerates everybody involved that you couldn't have expected them to see that coming, right? And so likewise uh yes given that there was a global financial crisis in the fall of 2008. If we just stipulate that that happened and then you say could it have been you know predicted by all the smart people and could all the economists at MIT and Harvard have known that was coming right they they couldn't have given that it was going to occur. But still, you're allowed to ask after the fact, how come you guys didn't see this coming and avert it, right? That's kind of the issue, right? So, it's not so like sometimes people try to make analogies with earthquakes and say seismology is a real scientific discipline. It's an empirical science and um the fact that you know if a major earthquake hits and the seismologist didn't give a warning one week out that doesn't prove that the science like you know that it's just alchemy or something right okay I mean you you would want them to get good at predicting it but right the mere fact that sometimes a quake happens they don't that doesn't disprove it but with there. Part of the issue is at least with our current level of technology, we think we can't stop the earthquake from happening, right? It's not that we built the earth's crust and the reason earthquakes happen is because of what we're doing. I mean, people talk about fracking and stuff and you can get into that, but you get what I'm saying in terms of major earthquakes, especially looking backward in time. It's not that those happen because of human activities. Okay? Whereas a financial crash, part of the reason the critics are saying or or packed into it, how come you didn't see this coming? Is they mean because if you had, we could have done things to avert that. It's not just saying, yes, we know that every once in a while there's going to be a global financial panic and we just want some more of a heads up next time. That's really not what they mean. Okay. So, let me now that I've walked through that and sort of given you the the motivation I had for this topic, let me circle back to an earlier mises.org.org article that I did because I want to give you folks some more meat here. in case you think I'm attacking a straw man or I'm just like going after people on Twitter or something. So, back in November of 2009, I wrote an article, we'll link to it, of course, in the show notes page here called Economists Can Be Hilarious. This was a Amis's Daily. And ironically, what kicked this off was that Paul Krugman was criticizing orthodox economists for not um for relying too heavily on what's called the efficient markets hypothesis or the EMH. And so partly what's going on here is Krugman was able to do that because the EMH is associated with the Chicago school. So a bunch of people that Krugman doesn't get along with, you know, because he's an MIT guy. Um, and so like the Chicago guys and the people associated with the efficient markets hypothesis, they came in and you know in the 60s and the 70s kind of blew up the prestige of the Keynesians, you know, warning about stagflation, coming up with critiques like of of the nature of the this crude Keynesian models and then this like Robert Lucas in particular, you know, comes up with you know uh saying the model the agents of the model should have rational expectations things like that. Okay. And so out of that Chicago school tradition comes the efficient markets hypothesis. You can see people advancing it with various degrees of um purity let's say or or claims that they're making on its behalf. But that is what it is. And so Krugman wrote a piece, you know, this is a year after the financial crisis, criticizing his Chicago school rivals and saying that yeah, they gave this false sense of assurance and so on. And actually these old school Keynesian models are much more useful in a financial crisis that you can't these Chicago guys are insane. A lot of them don't even think a bubble is possible. Okay? And that that's not a straw man that Eugene FMA for example was interviewed after the crash and they were asking him about the stock the housing bubble and he said something like you know I don't even know that that term has any operational meaning like uh if everybody knows housing's overpriced then they would just sell. So like no that doesn't yeah after the fact you know prices go up and prices go down and if they go way up and then come down fast afterwards we can say that was a bubble but what does that even mean? Okay. So that's how uh methodologically committed he was to the efficient markets hypothesis that he was saying even after what happened in you know 2003 through 2007 he was saying no what do you mean there wasn't a housing bubble was again he literally saying what do you mean by that like just what I I don't even get what you're talking about. Okay so Krugman actually is not attacking a straw man here. So what I did in this article is I went through so in the wake of Krugman's attack and then other people too were saying like what the heck is going on here? How come you know the economists didn't see this coming the orthodox defenders of the EMH circled the wagons and so in this article I had some excerpts of people commenting on this stuff. So let me just read you some quotations and then I'll give some uh responses myself to what they said. So, Robert Lucas again who's one of the biggest guns in this field, you know, Nobel Prize winner and so forth, he says, uh, one of the things he wrote is one thing we're not going to have now or ever is a set of models that forecast sudden falls in the value of financial assets like the declines that followed the failure of Layman Brothers in September. This is nothing new. It has now been more known for more than 40 years and is one of the main implications of Eugene FMA's efficient markets hypothesis which states that the price of a financial asset reflects all relevant generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier. All right, so let me just pause and react to that for a bit. because that's a central argument in all this stuff. I would encourage listeners if you if you've never heard that kind of an argument before, don't just dismiss it is sofism and just say, "Oh, come on. That's just you're arguing in a circle. That's just gobbledygook. Get out of here." Right? even though you know I may have led you to want to conclude that based on um you know my earlier analogies with the plane crashes and such. Okay, but there is a certain profoundity to that perspective that in some settings I think is quite useful. So, for example, you know, if somebody's got some newsletter for their, you know, their subscribers that tells them, here's how to beat the market and, oh, you do this foolproof thing. And we, you know, we've gone back and we've analyzed this past data and see like every Tuesday, you know, the first full Tuesday in a new month, um, or the first Tuesday, you know, every every month, uh, we we found this pattern that these particular stocks always go this way. And so we've been we've back tested this pattern and if you had followed this strategy starting in 1960, you'd right now be up blah blah blah percent. Okay? And so what's interesting about something like that is there's lots of things that could go wrong with that. You know, maybe they're not taking into account volatility or something like that. Maybe it's a very risky strategy. But beyond all that, the the point of the efficient markets hypothesis is if you then started trading on that, like let's say it really was a some pattern that was in the data that was real like for whatever reason that yeah, there was this arbitrage opportunity that nobody had noticed up till then. But what's interesting is once people started trading on that and profiting, it would quickly get uh you know competed away. So that pattern would disappear and there's there's examples of this actually happening in in the real world where you know various people watching the stock market found some patterns that were in the historical data. In other words, that people had not made money off of, but they just noticed these patterns and go, "Oh, and then" and so they would construct like a hypothetical trader who if he had been following this strategy starting 10 years ago at this point would be up, you know, so much relative to the to the market index. And so now we're going to go do that and be that guy. But it and it just doesn't work out the way it should have. And it's like all of a sudden that pattern just disappears. And so when you understand the logic of you know FMA's framework it makes sense like why that why that pattern you know why why you would see that okay and you know intuitively the idea is that if you see this opportunity well when you're buying you're pushing up the price and if you're selling something you're pushing down the price. So the very act of you getting in and trying to profit from this arbitrage opportunity, you kind of whittle it away and that especially if the secret gets out and more and more people learn about it such that it eventually becomes quote common knowledge. Well then clearly there can't be this arbitrage opportunity that everybody knows about, right? Like to pick something goofy. Somebody says, "Oh, you know what? Every July 4th people blow up a lot of fireworks. So what I'm going to do is I'm going to in mid July invest heavily in the stock of companies that make fireworks and I'm going to make a killing. And obviously the market already knows that, right? That's already priced in. Okay. So that's that's the idea that in order for you to profit on something, you have to have access to inside information and that you know what's the best gauge of the public sentiment about something? it's the existing market prices. Okay. And then related to that, yes, it is a narrow, you know, it is a true statement in so far as it goes is to say if most of the informed people on Wall Street or, you know, people trading financial assets were pretty sure there was going to be a big crash next month, then that wouldn't happen because that would just pull forward and the crash would happen this month. because people would try to get out early and then in the act of doing that they would crash the market now, right? So that's all true. However, um I think that that that proves way too much. All right. So, let me just here quickly um give some of the push back to that. Again, very typical defense of orthodox economics is um for one thing people analyzing the market have different theories and another element too is sometimes their quote predictions are more open-ended. So, for example, if you read Mark Thornton or if you watch Peter Schiff when he was making the rounds on like CNBC and stuff like that in 2005, 2006, you know, Thornton very preiently wrote out things and it's it's eerie how um accurately he predicted the contours of what was coming. And Peter Schiff again nailing it in terms of saying this is, you know, this is the situation we face. housing's overpriced, this is going to happen, da d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d and people were laughing in his face. Okay, so when you say like so if somebody is arguing and saying based on my understanding of how the economy works and how the world works in financial markets and blah blah blah, I think we are in sto there's a giant bubble right now that's going to pop. It doesn't work to say, "Well, no, because if everybody knew that, then the bubble would pop right now." Is because that's the whole point. This person is one voice, you know, he's he's bearish and there's a bunch of bulls and they're vying for the public's attention and they each all have their newsletters or whatever, their platforms that they're telling people, "This is what I think's happening." Okay, so that's one element. So, it it doesn't really pro prove that somebody was wrong. Right? In other words, Mark Thornton could have been perfectly correct in what he was saying and the fact that other people ignored him and kept pushing up housing prices, that doesn't mean he was wrong, right? So, so there's that element. Um and then more generally you could be um giving warnings, qualitative warnings and saying hey this is a very risky system we're fostering here and this will make it much more likely that a crash will happen. I can't predict exactly when to give you an analogy like before the Hindenburg you know somebody could say hey uh having balloons filled with hydrogen seems like a bad idea and maybe we should switch to a different gas and you know it you could be correct in saying that and if somebody says oh well then predict and tell me exactly which you know when is something bad going to happen and you say well I can't tell you which particular flight I don't know I'm just saying you're asking for trouble doing this and we should do something else and that will make it much less likely that a major explosion is going to happen right so in a situation like that can you see why it would be goofy just to say well I mean that's impossible nobody could know something like that I mean if everybody knew that Hindenburg was going to blow up then nobody would get on it so how could anybody have known that ahead of time right you see how goofy that would be in that context and I'm saying that's that's just an analogy to show theoretically In principle, maybe the economists who warned about a crash have a point. I think they did have a point in reality, right? that we Austrians think that partly what happened in terms of the 2008 crisis was earlier that the Fed and the commercial banks in the system that you know the authorities have set up were allowed to pump in a bunch of artificial credit you know not backed up by genuine saving pushing interest rates down to artificially low levels that fueled the the housing bubble and there were other you know government policies Fanny and Freddy and all that stuff that kind of steered that excess liquidity into housing. And you know, I I'll link to some if you've never seen actually my book um understanding money mechanics from the institute. Uh I have a chapter on applying standard Austrian business cycle theory to the housing bubble and empirically and just showing how the Austrian story fits the facts nicely in case you haven't seen that ever done. Okay. So I'm not just merely armchair theorizing and saying, "Oh, the economy is bad. The government must have done it." Like I can show how the Austrian story fits the facts. Okay. So if that's what we're saying, then there's that's not at all it's not at all a response to that to just say, "Geez, if everybody knew housing was going to collapse, then it, you know, it would have happened earlier." Like, right? And Okay. Yeah. And yeah, if more people had listened to Mark Thornton early on, the bubble wouldn't have gotten as big as it did. But they didn't listen to him. So that doesn't prove, you know, just like the Hindenburg blows up. That that vindicates the critics. It doesn't show that the critics didn't understand uh chemistry or something like that. It's just it's a goofy way of proceeding. Okay, let me just read some more here. Um this is I just have to read because it's so funny. Lucas wrote this really long article on this stuff. [snorts] Um, and he says the economist, like here he's referring to the the magazine, The Economist. The Economist briefing also cited as an example of macroeconomic failure the quote reassuring simulations that Frederick Michigan, then a governor of the Federal Reserve, presented in the summer of 2007. Okay. So, Frederick Michigan, who was a governor at the Fed in the summer of 2007, had all of these computer simulations showing that, you know, the economy was fine because at this point, you know, people were worried about the subprime mortgage market and the housing prices in general, wondering if things were problematic. And so, you know, Fish Michigan has these models showing that no, no, this situation looks all right. The charge is that the Fed's um forecasting model failed to predict the events of September 2008. Here's the money line. Yet, the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring. Until the layman failure, the recession was pretty typical of the modest downturns of the post-war period. There was a recession underway led by the decline in housing construction. Mr. for Michigan's forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. All right. So [laughter] I there's not I don't think I need to do much more except just make sure you realize the move he just made there that again everything thing blows up in this fall of 2008 after the fact people are trying to figure out what the heck happened. And how come we didn't have early warning of this? They're looking at this Frederick Michigan guy who in the summer of 2007 in his capacity as governor at the Fed and he's author of like money and banking textbooks and stuff too. This is a big gun in the field. he had produced some computer simulations of the economy just saying like no it's you know things look all right like yeah there's there's a fall-off in construction and that's going to have reverberations in demand and this is going to happen and okay and so we're going to see some rise in unemployment in these sectors and blah blah but nothing you know to write home about and then the world blows up a year later and so people are saying hey he kind of missed the boat right giving the economy a clean bill of 14 months before the world blows up. And the way Lucas is defending that is to say, "No, no, his model just says so long as there's not, you know, a financial crisis, things will play out smoothly." Like [laughter] I mean again you could have somebody sign off on the Hindenburg taken off and say yeah so long as uh there's no uh combustion going on that we're not uh taken into account everything should be fine. Okay. Um and then here's another goofy one that I'll read for you folks. It's this guy David Lavine. And so he had this open letter to Paul Krugman responding to Krugman's scurless attacks. And he says the predictive failure is not a problem of the field. It's a problem for those who are under the impression that we should be able to predict crisis. Do you number yourself in this bunch? Do physicists get it wrong because their theory says that they cannot predict where a photon shot through a sufficiently narrow slit will land? Economic models are like models of photons going through slits. Just as those models predict only the statistical distribution of photons, so our models only predict the likelihood of downturns. They do not predict when any particular downturn will occur. Saying quote most economists failed to predict the downturn, which Krumman had said is exactly like saying most physicists failed to predict the impact of the 12th photon passing through the slit. Okay, so that's just ludicrous. Um, if if you're not familiar with physics and what he's talking about, there's a famous uh genre of experiments called the double slit experiment. You should go look watch a YouTube video on it or something if you if you don't know what I'm talking about because it's really fascinating and it underlies like quantum physics and why it's counterintuitive and stuff like that. Okay. But the idea is that oh, particles sometimes behave as if they're waves. And when you, you know, if you have a a piece of paper with two slits in it and you shine a light on it and each individual photon going up, you don't know ahead of time, like you can't predict which slit it's going to go through. And all you can do is on the back end, you know, of the of like the paper on the other side where the light collects and you can kind of look at the patterns that, you know, that's what you can see. But all it is is a statistical thing, right? Because they're saying like there is no fact of the matter of where the photon actually is. Okay? It's only afterward when you observe that you know what path it took. Okay? That's kind of what he's getting at. Now, quantum mechanics is uh experimentally verified to an unbelievable precision. Okay? So, the idea that he would say, "Oh, yeah, we're basically as good as the people in quantum physics, that's I it's hard for me to convey to you how ludicrous of a statement that is." Okay? And no, it's not that uh Michigan said that, oh yes, here's the probabilities of recession and that there's any sense in which like oh yeah, he didn't literally know that the 2008 crisis was coming, but he gave us a good sense of the of the probability like no. And another thing too is with some of these models in terms of the ones that like were giving AAA to some of these mortgage back securities and things, it was like the type of event that happened in these models was like, you know, should have happened one every 10,000 years or something and yet it happened. So yeah, you can say, well, the model said it could have happened. And I guess it's just as a you know a one in 10,000 year event where it's like sure but on the other hand what would have to happen for us just to say those probabilities are wrong. Okay. And specifically what was going on there is um some of these models that like the quant guys at the you know hedge funds and stuff were using to eval or at the credit rating bureaus to evaluate the mortgage back securities. They knew that real estate could go down, but they thought that each market was independent, right? So, they thought, "Oh, yeah, there's a decent chance home prices in Miami go down 40%." And there's a chance that home prices in Phoenix go down 40%. Or in St. Louis or whatever, but they thought those were independent statistical events. And so, they looked backwards in time and they built in, you know, safety, margins for error, and stuff like that. They weren't being stupid and they didn't think they were being reckless, but they just thought real estate's local. And so they thought, oh yeah, if there's a, you know, a one in 10 chance that real estate prices are going to fall that much in Miami and there's a one in 10 chance that they're going to fall that much in Las Vegas, they thought the chance of them both falling that much simultaneously is only one in a 100 because it's a onetenth chance times a one10enth chance, right? And so then when you have a mortgage back security which has got little bits of mortgages spread out all over the country they thought they were being very well diversified and that's why for some of these things with the tranches that were you know like the first to get paid they were getting AAA ratings because they were like the only way these things would fail is like if the you know real estate market across the whole country went down all at the same time. What are the chances of that? That would happen every 10,000 years. All right. So that was the intellectual mistake behind this stuff besides all the other stuff going on. Okay. Um so that's kind of my response to you know the efficient markets hypothesis and the way that that's been used in these debates about is economics a science. Let me now just pivot and talk a bit about you know the broader question is economics a science and how do I feel about that? And here I'm just saying what I think is pretty standard in the uh you know Mises Rothbard tradition of the Austrian school. Um so Mises did think economics was a science in the sense that it studied you know regularities and and uh social phenomena and that there were patterns in the marketplace that were definitely objective and that like the political authorities had to take this knowledge into account when they were setting policies and that if their subjects were behaving in a certain way that it wasn't just a failure of sufficient penalties to get them to do what the authorities wanted. That no, there seemed to be they were like, "No, if if you think prices are too high and you just make it illegal for merchants to charge above a certain price, that doesn't just keep everything affordable. That just means the goods disappear from the shelves, right?" Like stuff like that. or geez if they debase the coinage and then they pass a law saying merchants have to accept the debaseed coins as if they hadn't been debased all that does is mean people hoard the the good money and they they transact with the bad money stuff like that and Misa said and they you know realize that this this new accumulating knowledge of the you know people writing down and noting these regularities in the marketplace in response to you know government edict that he said that it wasn't history and it wasn't math and it you know it wasn't chemistry what was it it wasn't law and he said eventually you know that's now what we called economics okay but Mises placed economics as a the most developed element of a broader area of human inquiry which he called praxiology the logic of action All right. And so economics were what he could call catalactics was like the theorems you could deduce in the broader praxiology category. If you also added in the institutional setting that there was private property and people were using money. If you know if you had those because that in general just because people act they use means to achieve ends that doesn't necessarily mean that there's private property and the use of money right so the stuff you could say with the approach of praxiology if you made those additional assumptions is what Mises said that yeah that's what we kind of mean by economics proper all right so how does that proceed what's the method of praxiology is mises thought it was opriori It was just logical deductive reasoning. You start out with certain axioms and then you end up with conclusions deductively. So you don't go test them. So that is radically different from the empirical natural sciences. All right? And so the problem is nowadays, and you saw that in those screenshot I showed at the beginning, when people want to argue, oh, is economics a science or not? And people are comparing it to physics or chemistry, the people who think economics isn't a science, and they hold up physics and chemistry as like the quintessential examples of genuine science. They mean because, oh, look at look at how rigorous this stuff is. We have quantitative laws that make very specific predictions and those things have been you know borne out many times in the laboratory and out in the real world. And so that's that's why we believe in physics and chem and they also would say and that's why it works. That's why we can put a satellite up in orbit. That's why we can make an atomic bomb and so on. Whereas you economists are just bumbling around. You don't even see a financial crisis coming. What the heck? What are you good for? Right? But a messian would object to that and say you're wrong for therefore concluding that economics isn't a science because you all you're really showing is not a science in the way that physics and chemistry are sciences. But economics is quite rigorous but by its very nature it proceeds in a different fashion according to a different method. And so a better analogy for economics as opposed to physics or chemistry is geometry. And so nobody denies that geometry is very rigorous and that is a useful field of human inquiry. And yet like the something like the Pythagorean theorem, how do you prove that? You don't just go around and measure a bunch of right triangles and see, you know, do the results approximate at least to the third decimal place, you know, what um Pythagoras said that, you know, a square plus b²= c^² if a and b are the short legs of a right triangle and c is the long leg, right? So, how do you do it? Well, you make some axioms and you go through and then you just literally prove if you give me these assumptions that we're dealing with a right triangle and you have to define your terms and stuff and then we agree on very reasonable sort of undeniable moves that I can make in geometry like you know if I have this well then I can do this right and like yeah of course can if you grant that kind of stuff well then boom I can show you a square plus b square necessarily equals c² for any right triangle, right? And then once you have that and you understood the proof, it's yours forever. You don't need to go test it, that would be superfluous. You can test it if you want, but if you get the wrong if it looks like it doesn't work, it's because you either did the math wrong or because it's not really a right triangle. Okay? So now and having gone through that it would be also silly once you understand how geometry works to say oh well we're not really learning anything new about the world that's just we're kind of building in the result at the front end I mean so there's a sense in which yeah all the results of a theorem are contained in the premises that's true in a sense but it still makes sense for people who want to go build bridges to first study uklidian geometry and understand all that stuff. You need to know more than that, but it it makes sense to go do that. It's not just like, oh yeah, you already knew that from the moment you were born or something that that knowledge was already was always inside of you and so what's the point, right? Um there's more to like the Pythagorean theorem than someone just saying a bachelor is an unmarried male, right? Like that's a tautology. That's a priori. You don't have to go test various bachelors and see are you an unmarried male? Are you an unmarried male? Yep. Yep. 100% of the time the survey I conducted the bachelors were you see what it's like. No, that's just the definition. That's just what we mean by that term. So yeah, there's a sense in which oh all we mean or what we mean by right triangle implies a square + b square= c^2. But you see how it seems like you learned more about the world by thinking through that rather than just someone telling you the definition, right? And so um the best exposition I've seen is by Hans Hapa and his book uh economic science and the Austrian method. So we'll link to that too. There's free PDF available at the institute's website on that where he just explains it. Let me just give you a brief snippet something. So the idea is by starting with primitive um axioms or assumptions, you can then deduce things logically step by step. You're not going out and testing it empirically, but what you end up with is is more useful to you. like you feel like you understand that subject matter better than you did at the start of your deductive introspection or if somebody else teaches it to you and like guides you down this chain of reasoning that you might never have stumbled ac upon yourself then once you have that chain of reasoning under your belt you're like a yes and you're walking around and you can just see the world with this new framework that's necessarily correct okay and so for example a statement like um every action or every choice necessarily incurs an opportunity cost. Okay, that's a statement that if we had time and I do it in my lessons for the young economist, by the way, that book I try to unpack some of this stuff more step by step. I'll put a link to that, too. You know, first I would have to define the terms, make you understand what I'm even talking about. But eventually we would get to a point where I would say if someone makes a choice or if an actor makes a choice, he or she necessarily incurs an opportunity cost. And that statement is not testable. It's not like I would go out and say, "Okay, let me go sample a thousand people who make choices and then I want to see in how many of those cases did they incur an opportunity cost because they made that choice." like that you're you're missing the point that no given that we're going to evaluate a particular thing that we're observing an event that we're seeing and saying the way I'm interpreting that is there is a a conscious being that's making a choice that's acting then necessarily there was an opportunity cost involved in that choice. Okay. So just to be clear here, it's because I may have triggered some people when I said it's necessarily correct framework. I forget the exact word I use. If I take a rock and I throw it and it, you know, kind of goes up in the air first and then comes down in a, you know, parabolic fashion, you wouldn't say or I wouldn't say, oh yeah, the the rock chose originally to go up a bit and then it decided it it preferred to be lower and so it chose to come down and there must have been an opportunity cost involved with its choice to come down. I guess it was the value the rock placed on staying at that higher altitude would be the opportunity cost of its choice to I wouldn't talk like that. Okay. But the reason is because I'm saying I don't interpret the sensory data coming into my eyes and stuff from what just happened is that the rock chose anything. All right? So it's not that the rock did choose something and ah my theory was wrong and therefore opportunity cost wasn't involved in that particular episode. It's that no I'm not I wouldn't even describe that as a rock choosing anything. Okay. Okay. And so that's where like praxiology and to discover is this relevant or applicable here. That's where it would come in is you have to decide for some particular phenomenon that you're evaluating. Am I going to interpret this as conscious willful action versus mindless behavior? Okay. And um so you know so again starting from the premise like the humans act then you can make deductions but that doesn't tell you where do you apply that to like for a particular example is that person acting or not right if somebody's sleeping and then there's an earthquake and he falls out of bed on the floor you wouldn't necessarily have to say oh he chose to go on the floor because on his value scale being on the floor. I was high. No, I mean, you just say he just fell out. That's just gravity operating on his body. That wasn't a conscious choice on his part. Or, you know, the doctor hits your knee with the hammer and your leg goes up. That's an unconscious reflex. It's not that you prefer to raise your leg than to keep it down. Okay? Now, if you see the doctor coming with the hammer, you could say you preferred to allow him to hit your leg than to stop him because that was a choice on your part, right? So you see how this stuff you know gets tricky to and how to apply it. But the point is once you decide to deploy praxiology to a situation and you think that the assumptions are uh satisfied well then the results the conclusions pop out necessarily unless you made you know a mistake in your deductive reasoning. All right. And so again, there's a lot of stuff you can deduce about economics. And I don't even mean stuff like what causes the business cycle, which is really complicated. I'm saying more simpler things like um like if you open up a micro textbook, especially like an undergrad one, they might have an early section about like how to think like an economist or something like that, and they'll list a bunch of bullet points and it'll be things like people respond to incentives. And I'm saying a statement like that that's not falsifiable. That's not like saying nothing can go faster than light, right? That in principle you could observe something going faster than light and the physicist would have to say, "Oh, I guess Einstein was wrong." Huh, that's surprising. But economists aren't going to look at ever look at something and say, "Oh, people didn't respond to incentives there." Right? that if you go up to somebody and say, "Hey, I'll pay you $10 if you chop your left hand off and they say no." The conclusion isn't, "Oh, I guess people don't respond to incentives." You would just say that's not enough of an incentive. Or you could, you know, really get abstract about it and say he responded to the incentive of not wanting to bleed out. Okay, but you get what I'm saying? But but also too, you might say, "Oh, so it's vacuous." No, it's not. A lot of social scientists unfamiliar with economics go around and say all kinds of goofy stuff and they look at something especially like you know some new program that the government introduces and they think X Y and Z are going to happen and it blows up in their face and why is because they did not adequately account for the fact that people respond to incentives. So it's not vacuous. Economists are good for stressing that and that's what we're known for and that's kind of what we do in a situation like to give you an example um you know people afterward like Daniel Moyahan of talking about the so-called war on poverty and saying huh the government started paying single mothers you know more if they had kids and you know they would get a bigger check if they weren't married because you know there's not like a male bread winner and then we wonder you know geez how come the rate of unwed motherhood went up over time and maybe the fact that the government's paying for an outcome subsidizes it and makes it happen more often than otherwise would have right and so I'm saying to a lot of people they would say that that can't no it's not like some girl who's 17 decides oh because the government's going to pay me this check I'm therefore going to get pregnant from my boyfriend and then you know drop out of school and not marry him because he's a jerk and blah blah blah in right it's not that in any given case but economists think you know what empirically in general you'd be surprised at how much you add an incentive to something and then that changes the aggregate outcome okay so there is a mix of the empirical to decide is this relevant is this important but the insight that people respond to incentives that's kind of just a decision at the front end like this is how we're going to analyze the situation you could never falsify that like the statement per se. Okay, so that's kind of just my thoughts on this general topic of is economics a science or not. I will put links as I say to various things in the show notes page if you want to do more reading on this. Thanks for tuning everybody. See you next time. [music] Check back next week for a new episode of the human action podcast. In the meantime, you can find more content [music] like this on mises.org. board. [music] >> [music]
What Makes Economics Scientific?
Summary
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Hey everybody, welcome back to the human action podcast. Today I am going to discuss the forever interesting [music] topic of whether economics is a real science. So, the motivation for this, just let me give you the background in terms of what pushed me over the edge to talk about this and some of the particulars I'm going to get into in this episode, was a Twitter battle, as often happens, which guides my day and my thoughts. So, here we'll flash it up. So the backdrop here, I only grabbed a particular nested version or subset of what was going on here, but this guy Join Hog, sorry if I'm butchering your name, sir. Um, he had come out swinging, you don't see it here in the screenshot, saying that, uh, you know, economics by its very nature is very political and ideological and it's not scientific um, the way other disciplines are. And then he listed a bunch of reasons that he thought it was necessarily ideological. Okay. And then this guy Matt Darling chimed in who uh goes out of his way to to defend orthodox economics. Like one of his favorite things is to go around and just anytime someone cites some stat about the median household income, Matt Darling will come along and correct the person. You know, just nope, nope, nothing to see here. everything's fine. Um, you know, no rock in the boat. There's a reason things are the way they are and suck it up, sir. So, that's kind of his role in these things. And so, he was chiming in to this joust guy saying like, "Oh, yeah, all these reasons you're listing as to why economics is ideological and political and blah blah blah." And he said, "Just like biology, chemistry, and physics." That was Matt Darling's. So now this guy responding to Matt Darling says these hard sciences have much more robust laws than economics. For example, no law of economics can be as easily tested and empirically debunked slashverified as the law of gravity. Yet many economists claim that their field is a real science. It's not. All right. So you see what he's getting at there. And let me just go ahead and while I have this screenshot up, I'll explain the rest of the jocular banter. So then Alex Tabarok, economist, uh, the GMU chimes in and says, "Explain this physicists showing a picture." I'm I'm narring this folks because some people are just listening to the audio. Showing a picture of a plane either taking off or landing. And then Alex has in parenthesis, "Economists get challenged with equivalent questions every day. Okay, so presumably, you know, what Alex has in mind, in other words, is to say, "Oh, wait a minute. If there's a law of gravity, then how come planes can go up in the air? I thought, shouldn't they fall towards the Earth?" And so, obviously, he's saying other things counteract that. And then presumably what Alex has in mind is that if somebody's I don't know the specifics of what he means, but I guess somebody could say something like, "Well, geez, you economist said that uh tariffs would cause consumer prices to go up, but look at actually consumer prices haven't gone up that much this year, and so you guys are wrong." Or you economists said raising the minimum wage would lead to large unemployment among unskilled workers. But no, this state raised their minimum wage and actually uh the fast food restaurants hired more kids the next summer. So what about that? Right? So Alex's point is in economics, we can talk about particular causal forces, but there's so many things going on in an actual historical episode that sometimes the thing you're focusing on gets swamped by other factors. All right? or geez you economists think everybody is greedy but actually you know some rich guy wrote a check and funded some local softball team so I guess uh that goes out the window your models with your egoistic rationalistic behavior right be another example okay so now to explain my zinger so then I came in in responding to Alex and said if engineers knew why planes crashed there wouldn't be any plane crashes okay so by By the end of this episode, you will fully understand the majesty in wit packed into my little zinger there. So, what I was actually doing there was making fun of economists. A lot of people, as so often happens on Twitter, thought I was making fun of engineers, and they were coming up and telling me, "No, no, no, dude." Because I can see you're an economist, so you must be tribal, and you must be defending your guys. No, engineers actually can do, and that's why we're so much better than you, idiot economist. Again, I was making fun of economist there, right? So what Alex was trying to do in this exchange was to chime in and say, you know, oh, it's funny that you're sitting there trying to say how physics is so much better than economics and more scientific, but a lot of the challenges that we get as economists for people outsiders trying to blow up our discipline and say how stupid we are and how we can't look out the window and see reality compared to our, you know, uh, false assumptions or unrealistic assumptions that actually people are just misunderstanding how economics works and he said it would be analogous to someone looking at a plane taking off and saying oh gez I thought you physicist said there was a law of gravity right so Alex is clearly circling the wagons and defending economics is a science and so then because I had recently interviewed somebody on this very topic on a different show about you know the use of mathematics and economics and so on and then I brought up this issue of a lot of People say economics is overrated and you economists at MIT and Harvard and whatever walking around thinking you're geniuses and that you've got your sophisticated mathematical models and so forth, but uh you guys didn't know the 2008 crisis was coming, right? You could, you know, what good are you if you can't even warn us about an impending global financial crisis? And the response to that or one response to that kind of an objection is to say, "Oh, no, no. By its very nature, stock market crashes can't be predicted because like you know, if if six months ahead of time, all the smart people knew that the stock market was going to crash in the fall of 2008, well then what would they have done? They would have gotten out of the stock market to try to get out before the crash happened. But that just means the crash would have occurred in the spring of 2008, right? And so it's that so that's so the idea is that's why you can't predict a stock market crash. And so you can't wag your finger at the economist for not predicting the financial crisis because you know that's misunderstanding how economics works. It just show if you think that it just shows you don't understand economics. Pal, why don't you go take a class in Chicago price theory? Duh. Okay, so where am I going with this? I'm what I'm trying to show here in my little Twitter trolling comment is to say that typical defense of the legitimacy of economics and how economists often defend themselves when outsiders say, "You guys are a bunch of clowns." I'm saying imagine if somebody else tried to use that defense in some other discipline. How goofy that would sound, right? So imagine a plane crashes and people get mad at the, you know, the various safety, you know, inspectors and the people who built the plane or what, you know, the the whole infrastructure. People were questioning saying all you people whose job it is to run the airline industry and to build planes and whatever and regulate airspace. This is a problem. Why did that plane crash? And then imagine if somebody said in response to that, well, let's think about this. Suppose all the smart people knew like the pilots and everybody and the people, you know, running the airline companies and things like that. Suppose they all knew a week ahead of time that there was going to be a jumbo jet crash that was going to kill 200 people next week. Well, they wouldn't have run that flight and the people wouldn't have gotten on it and they wouldn't have the pilots certainly wouldn't have taken off and so the crash wouldn't have happened. So, you can see it's kind of silly to say how come you guys didn't predict the plane crash because if we could have done that then the plane wouldn't have crashed the way it did, right? So, do you see why that defense it's it's actually not wrong? Right? What I just said is actually correct. If people could accurately predict a plane crash and know that, oh yeah, the way things are going a week from now that 747 is going to crash and kill 200 people. And so if if a bunch of insiders, you know, smart people knew that was going to happen, then they would change their behavior such that that would no longer happen. like the timeline wouldn't go down that path anymore. You would So that's true, but the conclusion is not therefore. So anytime there's a bad plane crash, it exonerates everybody involved that you couldn't have expected them to see that coming, right? And so likewise uh yes given that there was a global financial crisis in the fall of 2008. If we just stipulate that that happened and then you say could it have been you know predicted by all the smart people and could all the economists at MIT and Harvard have known that was coming right they they couldn't have given that it was going to occur. But still, you're allowed to ask after the fact, how come you guys didn't see this coming and avert it, right? That's kind of the issue, right? So, it's not so like sometimes people try to make analogies with earthquakes and say seismology is a real scientific discipline. It's an empirical science and um the fact that you know if a major earthquake hits and the seismologist didn't give a warning one week out that doesn't prove that the science like you know that it's just alchemy or something right okay I mean you you would want them to get good at predicting it but right the mere fact that sometimes a quake happens they don't that doesn't disprove it but with there. Part of the issue is at least with our current level of technology, we think we can't stop the earthquake from happening, right? It's not that we built the earth's crust and the reason earthquakes happen is because of what we're doing. I mean, people talk about fracking and stuff and you can get into that, but you get what I'm saying in terms of major earthquakes, especially looking backward in time. It's not that those happen because of human activities. Okay? Whereas a financial crash, part of the reason the critics are saying or or packed into it, how come you didn't see this coming? Is they mean because if you had, we could have done things to avert that. It's not just saying, yes, we know that every once in a while there's going to be a global financial panic and we just want some more of a heads up next time. That's really not what they mean. Okay. So, let me now that I've walked through that and sort of given you the the motivation I had for this topic, let me circle back to an earlier mises.org.org article that I did because I want to give you folks some more meat here. in case you think I'm attacking a straw man or I'm just like going after people on Twitter or something. So, back in November of 2009, I wrote an article, we'll link to it, of course, in the show notes page here called Economists Can Be Hilarious. This was a Amis's Daily. And ironically, what kicked this off was that Paul Krugman was criticizing orthodox economists for not um for relying too heavily on what's called the efficient markets hypothesis or the EMH. And so partly what's going on here is Krugman was able to do that because the EMH is associated with the Chicago school. So a bunch of people that Krugman doesn't get along with, you know, because he's an MIT guy. Um, and so like the Chicago guys and the people associated with the efficient markets hypothesis, they came in and you know in the 60s and the 70s kind of blew up the prestige of the Keynesians, you know, warning about stagflation, coming up with critiques like of of the nature of the this crude Keynesian models and then this like Robert Lucas in particular, you know, comes up with you know uh saying the model the agents of the model should have rational expectations things like that. Okay. And so out of that Chicago school tradition comes the efficient markets hypothesis. You can see people advancing it with various degrees of um purity let's say or or claims that they're making on its behalf. But that is what it is. And so Krugman wrote a piece, you know, this is a year after the financial crisis, criticizing his Chicago school rivals and saying that yeah, they gave this false sense of assurance and so on. And actually these old school Keynesian models are much more useful in a financial crisis that you can't these Chicago guys are insane. A lot of them don't even think a bubble is possible. Okay? And that that's not a straw man that Eugene FMA for example was interviewed after the crash and they were asking him about the stock the housing bubble and he said something like you know I don't even know that that term has any operational meaning like uh if everybody knows housing's overpriced then they would just sell. So like no that doesn't yeah after the fact you know prices go up and prices go down and if they go way up and then come down fast afterwards we can say that was a bubble but what does that even mean? Okay. So that's how uh methodologically committed he was to the efficient markets hypothesis that he was saying even after what happened in you know 2003 through 2007 he was saying no what do you mean there wasn't a housing bubble was again he literally saying what do you mean by that like just what I I don't even get what you're talking about. Okay so Krugman actually is not attacking a straw man here. So what I did in this article is I went through so in the wake of Krugman's attack and then other people too were saying like what the heck is going on here? How come you know the economists didn't see this coming the orthodox defenders of the EMH circled the wagons and so in this article I had some excerpts of people commenting on this stuff. So let me just read you some quotations and then I'll give some uh responses myself to what they said. So, Robert Lucas again who's one of the biggest guns in this field, you know, Nobel Prize winner and so forth, he says, uh, one of the things he wrote is one thing we're not going to have now or ever is a set of models that forecast sudden falls in the value of financial assets like the declines that followed the failure of Layman Brothers in September. This is nothing new. It has now been more known for more than 40 years and is one of the main implications of Eugene FMA's efficient markets hypothesis which states that the price of a financial asset reflects all relevant generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier. All right, so let me just pause and react to that for a bit. because that's a central argument in all this stuff. I would encourage listeners if you if you've never heard that kind of an argument before, don't just dismiss it is sofism and just say, "Oh, come on. That's just you're arguing in a circle. That's just gobbledygook. Get out of here." Right? even though you know I may have led you to want to conclude that based on um you know my earlier analogies with the plane crashes and such. Okay, but there is a certain profoundity to that perspective that in some settings I think is quite useful. So, for example, you know, if somebody's got some newsletter for their, you know, their subscribers that tells them, here's how to beat the market and, oh, you do this foolproof thing. And we, you know, we've gone back and we've analyzed this past data and see like every Tuesday, you know, the first full Tuesday in a new month, um, or the first Tuesday, you know, every every month, uh, we we found this pattern that these particular stocks always go this way. And so we've been we've back tested this pattern and if you had followed this strategy starting in 1960, you'd right now be up blah blah blah percent. Okay? And so what's interesting about something like that is there's lots of things that could go wrong with that. You know, maybe they're not taking into account volatility or something like that. Maybe it's a very risky strategy. But beyond all that, the the point of the efficient markets hypothesis is if you then started trading on that, like let's say it really was a some pattern that was in the data that was real like for whatever reason that yeah, there was this arbitrage opportunity that nobody had noticed up till then. But what's interesting is once people started trading on that and profiting, it would quickly get uh you know competed away. So that pattern would disappear and there's there's examples of this actually happening in in the real world where you know various people watching the stock market found some patterns that were in the historical data. In other words, that people had not made money off of, but they just noticed these patterns and go, "Oh, and then" and so they would construct like a hypothetical trader who if he had been following this strategy starting 10 years ago at this point would be up, you know, so much relative to the to the market index. And so now we're going to go do that and be that guy. But it and it just doesn't work out the way it should have. And it's like all of a sudden that pattern just disappears. And so when you understand the logic of you know FMA's framework it makes sense like why that why that pattern you know why why you would see that okay and you know intuitively the idea is that if you see this opportunity well when you're buying you're pushing up the price and if you're selling something you're pushing down the price. So the very act of you getting in and trying to profit from this arbitrage opportunity, you kind of whittle it away and that especially if the secret gets out and more and more people learn about it such that it eventually becomes quote common knowledge. Well then clearly there can't be this arbitrage opportunity that everybody knows about, right? Like to pick something goofy. Somebody says, "Oh, you know what? Every July 4th people blow up a lot of fireworks. So what I'm going to do is I'm going to in mid July invest heavily in the stock of companies that make fireworks and I'm going to make a killing. And obviously the market already knows that, right? That's already priced in. Okay. So that's that's the idea that in order for you to profit on something, you have to have access to inside information and that you know what's the best gauge of the public sentiment about something? it's the existing market prices. Okay. And then related to that, yes, it is a narrow, you know, it is a true statement in so far as it goes is to say if most of the informed people on Wall Street or, you know, people trading financial assets were pretty sure there was going to be a big crash next month, then that wouldn't happen because that would just pull forward and the crash would happen this month. because people would try to get out early and then in the act of doing that they would crash the market now, right? So that's all true. However, um I think that that that proves way too much. All right. So, let me just here quickly um give some of the push back to that. Again, very typical defense of orthodox economics is um for one thing people analyzing the market have different theories and another element too is sometimes their quote predictions are more open-ended. So, for example, if you read Mark Thornton or if you watch Peter Schiff when he was making the rounds on like CNBC and stuff like that in 2005, 2006, you know, Thornton very preiently wrote out things and it's it's eerie how um accurately he predicted the contours of what was coming. And Peter Schiff again nailing it in terms of saying this is, you know, this is the situation we face. housing's overpriced, this is going to happen, da d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d d and people were laughing in his face. Okay, so when you say like so if somebody is arguing and saying based on my understanding of how the economy works and how the world works in financial markets and blah blah blah, I think we are in sto there's a giant bubble right now that's going to pop. It doesn't work to say, "Well, no, because if everybody knew that, then the bubble would pop right now." Is because that's the whole point. This person is one voice, you know, he's he's bearish and there's a bunch of bulls and they're vying for the public's attention and they each all have their newsletters or whatever, their platforms that they're telling people, "This is what I think's happening." Okay, so that's one element. So, it it doesn't really pro prove that somebody was wrong. Right? In other words, Mark Thornton could have been perfectly correct in what he was saying and the fact that other people ignored him and kept pushing up housing prices, that doesn't mean he was wrong, right? So, so there's that element. Um and then more generally you could be um giving warnings, qualitative warnings and saying hey this is a very risky system we're fostering here and this will make it much more likely that a crash will happen. I can't predict exactly when to give you an analogy like before the Hindenburg you know somebody could say hey uh having balloons filled with hydrogen seems like a bad idea and maybe we should switch to a different gas and you know it you could be correct in saying that and if somebody says oh well then predict and tell me exactly which you know when is something bad going to happen and you say well I can't tell you which particular flight I don't know I'm just saying you're asking for trouble doing this and we should do something else and that will make it much less likely that a major explosion is going to happen right so in a situation like that can you see why it would be goofy just to say well I mean that's impossible nobody could know something like that I mean if everybody knew that Hindenburg was going to blow up then nobody would get on it so how could anybody have known that ahead of time right you see how goofy that would be in that context and I'm saying that's that's just an analogy to show theoretically In principle, maybe the economists who warned about a crash have a point. I think they did have a point in reality, right? that we Austrians think that partly what happened in terms of the 2008 crisis was earlier that the Fed and the commercial banks in the system that you know the authorities have set up were allowed to pump in a bunch of artificial credit you know not backed up by genuine saving pushing interest rates down to artificially low levels that fueled the the housing bubble and there were other you know government policies Fanny and Freddy and all that stuff that kind of steered that excess liquidity into housing. And you know, I I'll link to some if you've never seen actually my book um understanding money mechanics from the institute. Uh I have a chapter on applying standard Austrian business cycle theory to the housing bubble and empirically and just showing how the Austrian story fits the facts nicely in case you haven't seen that ever done. Okay. So I'm not just merely armchair theorizing and saying, "Oh, the economy is bad. The government must have done it." Like I can show how the Austrian story fits the facts. Okay. So if that's what we're saying, then there's that's not at all it's not at all a response to that to just say, "Geez, if everybody knew housing was going to collapse, then it, you know, it would have happened earlier." Like, right? And Okay. Yeah. And yeah, if more people had listened to Mark Thornton early on, the bubble wouldn't have gotten as big as it did. But they didn't listen to him. So that doesn't prove, you know, just like the Hindenburg blows up. That that vindicates the critics. It doesn't show that the critics didn't understand uh chemistry or something like that. It's just it's a goofy way of proceeding. Okay, let me just read some more here. Um this is I just have to read because it's so funny. Lucas wrote this really long article on this stuff. [snorts] Um, and he says the economist, like here he's referring to the the magazine, The Economist. The Economist briefing also cited as an example of macroeconomic failure the quote reassuring simulations that Frederick Michigan, then a governor of the Federal Reserve, presented in the summer of 2007. Okay. So, Frederick Michigan, who was a governor at the Fed in the summer of 2007, had all of these computer simulations showing that, you know, the economy was fine because at this point, you know, people were worried about the subprime mortgage market and the housing prices in general, wondering if things were problematic. And so, you know, Fish Michigan has these models showing that no, no, this situation looks all right. The charge is that the Fed's um forecasting model failed to predict the events of September 2008. Here's the money line. Yet, the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring. Until the layman failure, the recession was pretty typical of the modest downturns of the post-war period. There was a recession underway led by the decline in housing construction. Mr. for Michigan's forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. All right. So [laughter] I there's not I don't think I need to do much more except just make sure you realize the move he just made there that again everything thing blows up in this fall of 2008 after the fact people are trying to figure out what the heck happened. And how come we didn't have early warning of this? They're looking at this Frederick Michigan guy who in the summer of 2007 in his capacity as governor at the Fed and he's author of like money and banking textbooks and stuff too. This is a big gun in the field. he had produced some computer simulations of the economy just saying like no it's you know things look all right like yeah there's there's a fall-off in construction and that's going to have reverberations in demand and this is going to happen and okay and so we're going to see some rise in unemployment in these sectors and blah blah but nothing you know to write home about and then the world blows up a year later and so people are saying hey he kind of missed the boat right giving the economy a clean bill of 14 months before the world blows up. And the way Lucas is defending that is to say, "No, no, his model just says so long as there's not, you know, a financial crisis, things will play out smoothly." Like [laughter] I mean again you could have somebody sign off on the Hindenburg taken off and say yeah so long as uh there's no uh combustion going on that we're not uh taken into account everything should be fine. Okay. Um and then here's another goofy one that I'll read for you folks. It's this guy David Lavine. And so he had this open letter to Paul Krugman responding to Krugman's scurless attacks. And he says the predictive failure is not a problem of the field. It's a problem for those who are under the impression that we should be able to predict crisis. Do you number yourself in this bunch? Do physicists get it wrong because their theory says that they cannot predict where a photon shot through a sufficiently narrow slit will land? Economic models are like models of photons going through slits. Just as those models predict only the statistical distribution of photons, so our models only predict the likelihood of downturns. They do not predict when any particular downturn will occur. Saying quote most economists failed to predict the downturn, which Krumman had said is exactly like saying most physicists failed to predict the impact of the 12th photon passing through the slit. Okay, so that's just ludicrous. Um, if if you're not familiar with physics and what he's talking about, there's a famous uh genre of experiments called the double slit experiment. You should go look watch a YouTube video on it or something if you if you don't know what I'm talking about because it's really fascinating and it underlies like quantum physics and why it's counterintuitive and stuff like that. Okay. But the idea is that oh, particles sometimes behave as if they're waves. And when you, you know, if you have a a piece of paper with two slits in it and you shine a light on it and each individual photon going up, you don't know ahead of time, like you can't predict which slit it's going to go through. And all you can do is on the back end, you know, of the of like the paper on the other side where the light collects and you can kind of look at the patterns that, you know, that's what you can see. But all it is is a statistical thing, right? Because they're saying like there is no fact of the matter of where the photon actually is. Okay? It's only afterward when you observe that you know what path it took. Okay? That's kind of what he's getting at. Now, quantum mechanics is uh experimentally verified to an unbelievable precision. Okay? So, the idea that he would say, "Oh, yeah, we're basically as good as the people in quantum physics, that's I it's hard for me to convey to you how ludicrous of a statement that is." Okay? And no, it's not that uh Michigan said that, oh yes, here's the probabilities of recession and that there's any sense in which like oh yeah, he didn't literally know that the 2008 crisis was coming, but he gave us a good sense of the of the probability like no. And another thing too is with some of these models in terms of the ones that like were giving AAA to some of these mortgage back securities and things, it was like the type of event that happened in these models was like, you know, should have happened one every 10,000 years or something and yet it happened. So yeah, you can say, well, the model said it could have happened. And I guess it's just as a you know a one in 10,000 year event where it's like sure but on the other hand what would have to happen for us just to say those probabilities are wrong. Okay. And specifically what was going on there is um some of these models that like the quant guys at the you know hedge funds and stuff were using to eval or at the credit rating bureaus to evaluate the mortgage back securities. They knew that real estate could go down, but they thought that each market was independent, right? So, they thought, "Oh, yeah, there's a decent chance home prices in Miami go down 40%." And there's a chance that home prices in Phoenix go down 40%. Or in St. Louis or whatever, but they thought those were independent statistical events. And so, they looked backwards in time and they built in, you know, safety, margins for error, and stuff like that. They weren't being stupid and they didn't think they were being reckless, but they just thought real estate's local. And so they thought, oh yeah, if there's a, you know, a one in 10 chance that real estate prices are going to fall that much in Miami and there's a one in 10 chance that they're going to fall that much in Las Vegas, they thought the chance of them both falling that much simultaneously is only one in a 100 because it's a onetenth chance times a one10enth chance, right? And so then when you have a mortgage back security which has got little bits of mortgages spread out all over the country they thought they were being very well diversified and that's why for some of these things with the tranches that were you know like the first to get paid they were getting AAA ratings because they were like the only way these things would fail is like if the you know real estate market across the whole country went down all at the same time. What are the chances of that? That would happen every 10,000 years. All right. So that was the intellectual mistake behind this stuff besides all the other stuff going on. Okay. Um so that's kind of my response to you know the efficient markets hypothesis and the way that that's been used in these debates about is economics a science. Let me now just pivot and talk a bit about you know the broader question is economics a science and how do I feel about that? And here I'm just saying what I think is pretty standard in the uh you know Mises Rothbard tradition of the Austrian school. Um so Mises did think economics was a science in the sense that it studied you know regularities and and uh social phenomena and that there were patterns in the marketplace that were definitely objective and that like the political authorities had to take this knowledge into account when they were setting policies and that if their subjects were behaving in a certain way that it wasn't just a failure of sufficient penalties to get them to do what the authorities wanted. That no, there seemed to be they were like, "No, if if you think prices are too high and you just make it illegal for merchants to charge above a certain price, that doesn't just keep everything affordable. That just means the goods disappear from the shelves, right?" Like stuff like that. or geez if they debase the coinage and then they pass a law saying merchants have to accept the debaseed coins as if they hadn't been debased all that does is mean people hoard the the good money and they they transact with the bad money stuff like that and Misa said and they you know realize that this this new accumulating knowledge of the you know people writing down and noting these regularities in the marketplace in response to you know government edict that he said that it wasn't history and it wasn't math and it you know it wasn't chemistry what was it it wasn't law and he said eventually you know that's now what we called economics okay but Mises placed economics as a the most developed element of a broader area of human inquiry which he called praxiology the logic of action All right. And so economics were what he could call catalactics was like the theorems you could deduce in the broader praxiology category. If you also added in the institutional setting that there was private property and people were using money. If you know if you had those because that in general just because people act they use means to achieve ends that doesn't necessarily mean that there's private property and the use of money right so the stuff you could say with the approach of praxiology if you made those additional assumptions is what Mises said that yeah that's what we kind of mean by economics proper all right so how does that proceed what's the method of praxiology is mises thought it was opriori It was just logical deductive reasoning. You start out with certain axioms and then you end up with conclusions deductively. So you don't go test them. So that is radically different from the empirical natural sciences. All right? And so the problem is nowadays, and you saw that in those screenshot I showed at the beginning, when people want to argue, oh, is economics a science or not? And people are comparing it to physics or chemistry, the people who think economics isn't a science, and they hold up physics and chemistry as like the quintessential examples of genuine science. They mean because, oh, look at look at how rigorous this stuff is. We have quantitative laws that make very specific predictions and those things have been you know borne out many times in the laboratory and out in the real world. And so that's that's why we believe in physics and chem and they also would say and that's why it works. That's why we can put a satellite up in orbit. That's why we can make an atomic bomb and so on. Whereas you economists are just bumbling around. You don't even see a financial crisis coming. What the heck? What are you good for? Right? But a messian would object to that and say you're wrong for therefore concluding that economics isn't a science because you all you're really showing is not a science in the way that physics and chemistry are sciences. But economics is quite rigorous but by its very nature it proceeds in a different fashion according to a different method. And so a better analogy for economics as opposed to physics or chemistry is geometry. And so nobody denies that geometry is very rigorous and that is a useful field of human inquiry. And yet like the something like the Pythagorean theorem, how do you prove that? You don't just go around and measure a bunch of right triangles and see, you know, do the results approximate at least to the third decimal place, you know, what um Pythagoras said that, you know, a square plus b²= c^² if a and b are the short legs of a right triangle and c is the long leg, right? So, how do you do it? Well, you make some axioms and you go through and then you just literally prove if you give me these assumptions that we're dealing with a right triangle and you have to define your terms and stuff and then we agree on very reasonable sort of undeniable moves that I can make in geometry like you know if I have this well then I can do this right and like yeah of course can if you grant that kind of stuff well then boom I can show you a square plus b square necessarily equals c² for any right triangle, right? And then once you have that and you understood the proof, it's yours forever. You don't need to go test it, that would be superfluous. You can test it if you want, but if you get the wrong if it looks like it doesn't work, it's because you either did the math wrong or because it's not really a right triangle. Okay? So now and having gone through that it would be also silly once you understand how geometry works to say oh well we're not really learning anything new about the world that's just we're kind of building in the result at the front end I mean so there's a sense in which yeah all the results of a theorem are contained in the premises that's true in a sense but it still makes sense for people who want to go build bridges to first study uklidian geometry and understand all that stuff. You need to know more than that, but it it makes sense to go do that. It's not just like, oh yeah, you already knew that from the moment you were born or something that that knowledge was already was always inside of you and so what's the point, right? Um there's more to like the Pythagorean theorem than someone just saying a bachelor is an unmarried male, right? Like that's a tautology. That's a priori. You don't have to go test various bachelors and see are you an unmarried male? Are you an unmarried male? Yep. Yep. 100% of the time the survey I conducted the bachelors were you see what it's like. No, that's just the definition. That's just what we mean by that term. So yeah, there's a sense in which oh all we mean or what we mean by right triangle implies a square + b square= c^2. But you see how it seems like you learned more about the world by thinking through that rather than just someone telling you the definition, right? And so um the best exposition I've seen is by Hans Hapa and his book uh economic science and the Austrian method. So we'll link to that too. There's free PDF available at the institute's website on that where he just explains it. Let me just give you a brief snippet something. So the idea is by starting with primitive um axioms or assumptions, you can then deduce things logically step by step. You're not going out and testing it empirically, but what you end up with is is more useful to you. like you feel like you understand that subject matter better than you did at the start of your deductive introspection or if somebody else teaches it to you and like guides you down this chain of reasoning that you might never have stumbled ac upon yourself then once you have that chain of reasoning under your belt you're like a yes and you're walking around and you can just see the world with this new framework that's necessarily correct okay and so for example a statement like um every action or every choice necessarily incurs an opportunity cost. Okay, that's a statement that if we had time and I do it in my lessons for the young economist, by the way, that book I try to unpack some of this stuff more step by step. I'll put a link to that, too. You know, first I would have to define the terms, make you understand what I'm even talking about. But eventually we would get to a point where I would say if someone makes a choice or if an actor makes a choice, he or she necessarily incurs an opportunity cost. And that statement is not testable. It's not like I would go out and say, "Okay, let me go sample a thousand people who make choices and then I want to see in how many of those cases did they incur an opportunity cost because they made that choice." like that you're you're missing the point that no given that we're going to evaluate a particular thing that we're observing an event that we're seeing and saying the way I'm interpreting that is there is a a conscious being that's making a choice that's acting then necessarily there was an opportunity cost involved in that choice. Okay. So just to be clear here, it's because I may have triggered some people when I said it's necessarily correct framework. I forget the exact word I use. If I take a rock and I throw it and it, you know, kind of goes up in the air first and then comes down in a, you know, parabolic fashion, you wouldn't say or I wouldn't say, oh yeah, the the rock chose originally to go up a bit and then it decided it it preferred to be lower and so it chose to come down and there must have been an opportunity cost involved with its choice to come down. I guess it was the value the rock placed on staying at that higher altitude would be the opportunity cost of its choice to I wouldn't talk like that. Okay. But the reason is because I'm saying I don't interpret the sensory data coming into my eyes and stuff from what just happened is that the rock chose anything. All right? So it's not that the rock did choose something and ah my theory was wrong and therefore opportunity cost wasn't involved in that particular episode. It's that no I'm not I wouldn't even describe that as a rock choosing anything. Okay. Okay. And so that's where like praxiology and to discover is this relevant or applicable here. That's where it would come in is you have to decide for some particular phenomenon that you're evaluating. Am I going to interpret this as conscious willful action versus mindless behavior? Okay. And um so you know so again starting from the premise like the humans act then you can make deductions but that doesn't tell you where do you apply that to like for a particular example is that person acting or not right if somebody's sleeping and then there's an earthquake and he falls out of bed on the floor you wouldn't necessarily have to say oh he chose to go on the floor because on his value scale being on the floor. I was high. No, I mean, you just say he just fell out. That's just gravity operating on his body. That wasn't a conscious choice on his part. Or, you know, the doctor hits your knee with the hammer and your leg goes up. That's an unconscious reflex. It's not that you prefer to raise your leg than to keep it down. Okay? Now, if you see the doctor coming with the hammer, you could say you preferred to allow him to hit your leg than to stop him because that was a choice on your part, right? So you see how this stuff you know gets tricky to and how to apply it. But the point is once you decide to deploy praxiology to a situation and you think that the assumptions are uh satisfied well then the results the conclusions pop out necessarily unless you made you know a mistake in your deductive reasoning. All right. And so again, there's a lot of stuff you can deduce about economics. And I don't even mean stuff like what causes the business cycle, which is really complicated. I'm saying more simpler things like um like if you open up a micro textbook, especially like an undergrad one, they might have an early section about like how to think like an economist or something like that, and they'll list a bunch of bullet points and it'll be things like people respond to incentives. And I'm saying a statement like that that's not falsifiable. That's not like saying nothing can go faster than light, right? That in principle you could observe something going faster than light and the physicist would have to say, "Oh, I guess Einstein was wrong." Huh, that's surprising. But economists aren't going to look at ever look at something and say, "Oh, people didn't respond to incentives there." Right? that if you go up to somebody and say, "Hey, I'll pay you $10 if you chop your left hand off and they say no." The conclusion isn't, "Oh, I guess people don't respond to incentives." You would just say that's not enough of an incentive. Or you could, you know, really get abstract about it and say he responded to the incentive of not wanting to bleed out. Okay, but you get what I'm saying? But but also too, you might say, "Oh, so it's vacuous." No, it's not. A lot of social scientists unfamiliar with economics go around and say all kinds of goofy stuff and they look at something especially like you know some new program that the government introduces and they think X Y and Z are going to happen and it blows up in their face and why is because they did not adequately account for the fact that people respond to incentives. So it's not vacuous. Economists are good for stressing that and that's what we're known for and that's kind of what we do in a situation like to give you an example um you know people afterward like Daniel Moyahan of talking about the so-called war on poverty and saying huh the government started paying single mothers you know more if they had kids and you know they would get a bigger check if they weren't married because you know there's not like a male bread winner and then we wonder you know geez how come the rate of unwed motherhood went up over time and maybe the fact that the government's paying for an outcome subsidizes it and makes it happen more often than otherwise would have right and so I'm saying to a lot of people they would say that that can't no it's not like some girl who's 17 decides oh because the government's going to pay me this check I'm therefore going to get pregnant from my boyfriend and then you know drop out of school and not marry him because he's a jerk and blah blah blah in right it's not that in any given case but economists think you know what empirically in general you'd be surprised at how much you add an incentive to something and then that changes the aggregate outcome okay so there is a mix of the empirical to decide is this relevant is this important but the insight that people respond to incentives that's kind of just a decision at the front end like this is how we're going to analyze the situation you could never falsify that like the statement per se. Okay, so that's kind of just my thoughts on this general topic of is economics a science or not. I will put links as I say to various things in the show notes page if you want to do more reading on this. Thanks for tuning everybody. See you next time. [music] Check back next week for a new episode of the human action podcast. In the meantime, you can find more content [music] like this on mises.org. board. [music] >> [music]