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Mind the Theory

Economics / Economic Theory Aug 15, 2012 - 12:29 PM GMT

By: Thorsten_Polleit

Economics

Best Financial Markets Analysis ArticleThe saying that things may work nicely in theory, but do not necessarily work in practice is well known.[1] It is typically meant to disparage the importance of theory, suggesting it would be too far removed from practical matters to help in solving the issue at hand.

The Prussian philosopher Immanuel Kant (1724–1804), in his 1793 essay "On the Popular Judgment: 'This May Be True in Theory, But It Does Not Apply in Practice,'" responded to such criticism; in fact, he responded with his essay to criticism leveled against his ethical theory by the philosopher Christian Garve (1742–1798).


Therein, Kant made the point that theory provides "principles of a fairly general nature," or general rules. However, theory does not tell man how to apply it, says Kant. For this, the act of judgment is required:

For a concept of the understanding, which contains the general rule, must be supplemented by an act of judgment whereby the practitioner distinguishes instances where the rule applies from those where it does not.[2]

The Prussian philosopher effectively called for respecting the role theory has for acting man:

No one can pretend to be practically versed in a branch of knowledge and yet treat theory with scorn, without exposing the fact that he is an ignoramus in his subject.[3]

In this methodological work Ludwig von Mises (1881–1973) emphasized the importance of theory for acting man at the most fundamental level, noting that theory and human action are in fact inseparable. Mises writes,

Action is preceded by thinking. Thinking is to deliberate beforehand over future action and to reflect afterwards upon past action. Thinking and acting are inseparable. Every action is always based on a definite idea about causal relations. He who thinks a causal relation thinks a theorem. Action without thinking, practice without theory are unimaginable. The reasoning may be faulty and the theory incorrect; but thinking and theorizing are not lacking in any action. On the other hand thinking is always thinking of a potential action. Even he who thinks of a pure theory assumes that the theory is correct, i.e., that action complying with its content would result in an effect to be expected from its teachings. It is of no relevance for logic whether such action is feasible or not.

With theory being inseparable from human action, the crucial question is this: What is the correct theory? For obvious reason, acting man will be interested in correct theory: "No matter how one looks at it, there is no way in which a false theory can serve a man or a class or the whole of mankind better than a correct theory."[4]

II.

In today's mainstream economics the truth value of a theory is typically tested along the lines of an "if-then hypothesis." For instance, economists test whether a rise in the money supply leads to higher prices, or whether a rise in the money supply causes rising prices — or whether the reverse holds true.

Such a procedure is typical of positivism-empiricism-falsificationism — a methodological approach in economics that must not only be rejected as intellectual confusion;[5] it can also be criticized as being prone to demagogic abuse.

For if one holds the view that nothing can be known (for sure) without testing it (which, by the way, is a contradiction in itself, but this finding shall not be of no further concern here), one must try it to find out.

Once a theory sounds good, or benevolent, enough — such as the theory that a rise in the money supply brings prosperity for all, or the theory that government deficit spending creates new jobs — people will love to see it put into practice.

What is more, under the reign of positivism-empiricism-falsification there is even an economic incentive for spreading theories just for the sake of their political efficacy — even if these theories are false: those who provide credible scientific legitimization to actions pursued by government can typically expect high rewards.

To provide a metaphorical illustration, to make robbery socially accepted, the robber will be willing to share some of his loot with those helping to make his crime acceptable from the viewpoint of his victims.

When it comes to benevolent-sounding economic theories, consider the following examples:

  • The state is indispensable for peace and prosperity; without the state, social chaos, relentless aggression, and misery would result.[6]

  • Money production must be monopolized by the state, for there is no other way to obtain reliable money.

  • Commodity money (gold and silver) is better replaced by fiat money, as only fiat money allows for an adequate increase in the money supply — which, in turn, is necessary for output and employment growth.

  • Capitalism exploits the working class and leads to widespread poverty, war, and imperialism; socialism will maintain peace and raise the standards of living for all.

  • Democracy (majority voting) is the form of political organization respecting individual freedom and property rights, necessary for peaceful cooperation and prosperity.

These examples may suffice to make the point: once theories are considered to be benevolent theories, they can be expected to be put into action; the more benevolent the theory is, the more likely social experimentation gets under way.

However, engaging in social experimentation for alleged truth-finding purposes comes at a high price — at times at a prohibitively high price, as the experimentation with socialism in many countries has made all too clear.

III.

In the field of economics, however, it is possible to decide whether or not theories are correct without having to take recourse to experimenting and testing.

Mises reconstructed the science of economics as the logic of human action, which he termed praxeology. As a priori theory, praxeology allows deducing irrefutable — or apodictic — truths from the irrefutably true axiom of human action.

In Mises's words,

Praxeology is a theoretical and systematic, not a historical, science. Its scope is human action as such, irrespective of all environmental, accidental, and individual circumstances of the concrete acts. Its cognition is purely formal and general without reference to the material content and the particular features of the actual case. It aims at knowledge valid for all instances in which the conditions exactly correspond to those implied in its assumptions and inferences. Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification or falsification on the ground of experience and facts.

Praxeology provides a methodology that allows separating correct economic theories from false economic theories on a priori grounds — that is, without having to engage in social experimentation.

In view of the illustrations given above (without developing the argument at length), we know for sure that the state is not the solution but the root cause of the most severe social conflicts.

From praxeology we also know with certainty that money is a free-market phenomenon; that commodity money, the logical choice of free market action, is sound money; and that the state monopolization of money production brings unsound money.

We also know for sure that an increase in the money supply doesn't make an economy richer; it merely benefits the early receivers of the new money (who are those issuing it) at the expense of those receiving the new money late or not at all.

It can also be deduced from praxeology that socialism leads to great misery, as it is a form of social organization that cannot work; it is bound to fail, and capitalism is the only economically viable form of societal organization.

Finally, it can be shown on the basis of praxeology that democracy is actually — and this may be surprising to the many — incompatible with preserving individual freedom and property rights and thus peaceful cooperation and prosperity.

The power of unmasking and demystifying false economic theories on a priori grounds, that is without having to engage in social experimentation, is certainly one of the most fascinating aspects of the Misesian-oriented Austrian School of economics.

In his introduction to Critique of Pure Reason (1787), Kant title chapter 3, "Philosophy stands in need of a Science which shall Determine the Possibility, Principles, and Extent of Human Knowledge 'a priori.'" For the science of economics, Mises has done just that.

Notes
[1] "The term theory is ordinarily understood to signify that the suggested explanation is held to have been satisfactorily proved, and to be no longer open to questions." Joyce, G. H. (1908), Principles of Logic, Longmans, Green & Co, London et al., p. 362.

[2] Kant, I. (1992 ), Über den Gemeinspruch: Das mag in der Theorie richtig sein, taugt aber nicht für die Praxis, Zum ewigen Frieden, H. F. Klemme, ed., Felix Meiner Verlag Hamburg, p. 3 [A 202], my translation.

[3] Ibid, p. 4 [276], own translation.

[4] Mises, L. v. (1957), Theory & History, p. 124.

[5] See in this context Hoppe, H. H. (2006), Austrian Rationalism in the Age of the Decline of Positivism, in: The Economics and Ethics of Private Property, Studies in Political Economy and Philosophy, 2nd ed., Ludwig von Mises Institute, Auburn, US Alabama, pp. 347–379.

[6] Murray Rothbard defines the state is defined as

that institution which possesses one or both (almost always both) of the following properties: (1) it acquires its income by the physical coercion known as "taxation"; and (2) it asserts and usually obtains a coerced monopoly of the provision of defense service (police and courts) over a given territorial area.

Rothbard gives a positive definition of the state: Iit says what the state really is, not what it ought to be (normative definition).

Thorsten Polleit is Honorary Professor at the Frankfurt School of Finance & Management. Send him mail. See Thorsten Polleit's article archives. Comment on the blog.

© 2012 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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