I have sworn upon the altar of God eternal hostility against every form of tyranny over the mind of man. -- Thomas Jefferson

Thursday, April 22, 2010

Homeschooling Economics:
Economics as the Key to a Civilized Society

Economics is the study of how human beings satisfy their needs and desires by mutually beneficial exchanges and interactions and thereby create a prosperous and civilized society.

The ignorance or rejection of the principles of economics leads to the boom-and-bust cycle, ongoing inflation, and, at the most extreme, the Soviet Gulag, the mass murders of the Maoist “Cultural Revolution,” and the “killing fields” in Cambodia under the Khmer Rouge.

Studying economics may, peripherally, help one pursue a career in business or manage one’s own finances. But the primary reason for studying economics is to understand how to create and maintain a free, civilized, and affluent society.

The study of economics is therefore a crucial part of a classical, humane education.

Following is a discussion of what I consider the twelve over-arching, core principles of economics, followed by a detailed discussion of how to integrate the principles of economics into one's education. These core economic principles emphasize not the technical details of supply-and-demand or the operation of the money supply but rather the broader concepts that make sense of all those finer details. Those finer details cannot be ignored, but they only make sense within this broader context.

(I came close to switching to economics after completing my Ph.D. in physics: I actually had an offer to do a post-doctoral fellowship in economics. My interest in economics goes back nearly as long as my interest in physics.)

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The Twelve Core Principles of Economics

The economy is individual people working together to solve human problems

Crack open an economics textbook or listen to the news and you will get the idea that economics is about abstract concepts such as consumer demand, the business climate, the unemployment rate, etc. It is all too easy to get caught up in such abstractions and forget that economics is about nothing more than individual human beings working together with each other to solve human needs and wants.

Used properly, the graphs in an economics text (e.g., supply-and-demand graphs) can help explain the interactions of all the individuals that make up an economy. But, if those graphs and abstractions hide the reality of individual people solving problems, working out how to get a job done, figuring out where to get the tools or supplies that they need, etc., then the analyses supplied by the textbooks are simply obfuscating the true reality of economic behavior.

Anyone who has worked for any length of time in a successful private business and who has paid attention to the overall operation knows that real economic life involves juggling schedules, figuring out what customers want and what suppliers can deliver, working out new procedures to carry out tasks more efficiently, looking for improved tools to get the job done better, faster, or cheaper, etc.

That is economics.

Any approach to economics that tries to make the student forget all this is an attempt to obscure reality.

The result can be catastrophic.

A concrete example is the recent attempts to end the current “Great Recession” by injecting money into the economy, by bailing out unsuccessful businesses, by increasing consumer demand, or by making it easier for businesses to borrow money.

The recession began because workers and businesses were engaged in unproductive activities, notably in the area of real estate. The federal government, via the Federal Reserve System, Freddie Mac, Ginnie Mae, etc. encouraged and subsidized an unsustainable bubble in the real-estate field.

Reality popped that bubble.

The only road to a sustainable recovery involves individual workers, investors, and businesses working out for themselves all the messy details of how to move away from unproductive activities and into more productive lines of activity.

There is no short-cut here: stimulating demand, encouraging investment, etc. cannot solve the problem. There are millions of separate detailed problems that have to be solved, a separate problem for each individual worker, for each failing business, etc. No central authority can do this. No one else can vicariously solve your detailed personal problems, just as no one else can lose weight for you or get into good physical condition on your behalf.

You have to do it yourself.

When we understand that the economy consists of many millions of people working out complicated, detailed problems, and that interfering with their doing so only worsens the economic situation, we understand the key reality of economics.

Economics is about millions of human beings applying their own intelligence and problem-solving ability to solve human problems and satisfy human wants. Impede their ability to do so and you wreck the economy.


Private property = accountability

There is an old saying that we do not own our possessions but that our possessions own us.

That, in a sense, is the point of private property: people can be expected to take full responsibility for their decisions only when they themselves bear the consequences of those decisions. When you own something, you take care of it because it is yours, because you yourself will have to deal with your failure to be responsible.

People protect, defend, maintain, and care for their own property.

That which is “owned” by everyone is in fact owned by no one.

This leads to the “tragedy of the commons”: we have, for example, a problem with air pollution because no one owns the air. Add a bit of pollution to the air and you do not feel that you have diminished the economic value of something that belongs to you.

Indeed, “Coase’s theorem,” the result which won Ronald Coase the 1974 Nobel Prize in economics, maintains that all economic “externalities” are due to improperly defined or inadequately enforced property rights.

The connection between having personal authority over one’s personal property and taking responsibility for that property is, at a simple level, obvious to almost everyone. But many people have trouble seeing that the same point applies at a larger level. The reason that Walmart is much better managed than the Post Office or the Department of Motor Vehicles is that there are people who own Walmart and who will suffer economic losses if Walmart is run badly. Unfortunately, we all supposedly “own” the Post Office and the DMV, so no one really owns them: no one feels that he must see that the Post Office or DMV runs well in order to protect his own personal property.


Prices as signals

If private property makes accountability possible, it is the price system of a market economy that sends the signals and provides the information that makes it possible to carry out that accountability wisely.

If a worker can make twice as much money being a carpenter as he can being a plumber, that difference in wage rates sends him the message that the economy currently needs carpenters more than it needs plumbers. If a manufacturer could make twice the profit selling electric cars as he could selling internal-combustion cars, then the price system would be sending him the message that consumers prefer electric cars over conventional cars (his profit of course depends on the price he can sell the cars for versus the price he must pay for labor and for raw materials – prices are the key to making estimates of profitability).

If you prevent prices from moving freely by setting price controls, minimum or maximum wage rates, etc. then you destroy the communication system of the economy: you are, metaphorically speaking, cutting the phone wires, shutting down the network, that transmits the information that allows the economy to operate.


Capitalists keep workers from starving

The stereotype of the greedy capitalist goes back centuries. Yet, in a free market, workers are perfectly free to build the factory, create the tools, gather the raw materials for themselves, without any capitalists, and thereby avoid “exploitation” by “greedy” capitalists.

So, why don’t they?

Because it takes time, often many years, between the beginning of a project and the final point where one can sell the products resulting from that project. It takes a long time to erect factories, to design and build machines, to extract and transport raw materials.

And, in the interim, the workers need to eat.

The capitalist buys time for the workers. He enables them to do productive work in the present, work that will not pay off for quite a while, and yet, thanks to the capitalist, the workers can be paid now instead of waiting until the factory finally starts selling products.

If the workers think that this is unfair, they can always go it alone, and somehow figure out how to eat until the factory is finally in operation. Or, they can stay in other activities where there is no significant delay in time between the initial work and the final sale.

Most workers prefer the income security and the higher wages made possible by the capitalist.

Capitalists allow workers to reap the fruits of more productive, long-term methods of production while still enjoying an income before their labor yields its final results.

As a result, workers under modern capitalism enjoy a standard of living exceeding that of kings and emperors in millennia long past.


The interest rate is the price of time

It is often worth a great deal to have money now instead of having money later. Sometimes, one needs money immediately for a personal emergency; sometimes one can reasonably expect to have more money in the future, and it is useful to borrow money today and pay it off in the future (e.g., when buying a house).

Most importantly, in an industrial economy, the building of factories, machines, etc. takes a good deal of time, but that investment in time can ultimately pay off handsomely in increased productivity.

The interest rate is the price of time: it sends messages throughout the economy of the availability and cost of doing something now versus later.

If the government or the central monetary authority attempts to interfere with interest rates, it is distorting one of the most crucial forms of communication in the economy.

Trying to set interest rates is a form of price control, and it distorts and damages the economy as any price controls do. But, in an industrial economy, where production processes throughout the economy are based on lengthy, time-consuming projects, distorting interest rates is especially destructive.

In an industrial economy, “bubbles” are typically due to the monetary authority attempting to set interest rates. Attempts to control interest rates ends in depressions when those bubbles inevitably pop.

Government control over the monetary and financial system, largely via “central banking” (the “Federal Reserve System” in the United States), induces bubbles and the resulting depressions by interfering with the natural rate of interest.


Economic advance comes not from labor but from those who make labor more efficient and productive

The “labor theory of value” maintained that the economic value of a good or service is measured by the labor that went into producing that good or service.

If that were true, economic progress would be impossible.

Long ago, Benjamin Franklin pointed out a simple point of economic arithmetic. Suppose that everyone in an economy labors for forty hours a week. Then, on average, each person can enjoy the fruits of forty hours of human labor, no more.

A few wealthy people may employ a retinue of servants and assistants. But, it is mathematically impossible, for simple arithmetic reasons, for everyone to employ a full-time butler, a full-time cook, etc. The numbers cannot add up (i.e., there would have to be more butlers and cooks than there are people!).

The only way to improve the living standards of the average human being is for everyone to work much harder for much longer hours (which is hardly an obvious improvement in human welfare!) or to figure out how to make each hour of human labor more productive.

We know only three ways to do this: give workers more and better tools (machines, trucks, computers, etc.), have workers employ newer and better technology, organize workers in a manner so that their efforts and activities are better coordinated to produce more productive results.

In practice, all three of these approaches generally involve pursuing more long-term, more roundabout processes of production: i.e., they require more capital.

That is why “capitalism” is indeed an appropriate designation for a modern industrial economy that brings affluence to the mass of the people: only capitalism can physically alleviate widespread human suffering and poverty.


Optimal methods of economic organization are worked out by the market

It is easy enough to see that the wonders of personal computers, cell phones, etc. are the product of the innovative capabilities of a free-market economy – i.e., of millions of human beings freely trying out new ideas, freely deciding what jobs to offer to prospective employees, freely deciding what products to buy, etc.

But it seems harder for many people to understand that the same applies to modes of economic organization. Shouldn’t we “protect” the corner variety store from Walmart or the corner burger stand from McDonald’s?

It was not that long ago when many people wanted to protect tiny, antiquated steel mills from technologically modern, large-scale mills, or tiny inefficient oil refineries from modern efficient refineries.

The huge increase in worker productivity since the Industrial Revolution may well owe more to changes in business organization – everything from marketing and finance to the actual physical operation of factories – than to improvements in technology.

The key point to understand is that there is no surefire analytical method for predicting what new organizational methods will end up working. How many people realized that eBay or amazon.com were the wave of the future? And how many people gambled and lost on “dot coms” that sounded promising but failed?

There is sometimes talk about “running government like a business.” The problem is that there is not a single, distinct way in which to “run a business.” A free economy consists of thousands or millions of people trying out a plethora of different ways to run a business and finding out what works.

And, it therefore may turn out that a college dropout comes up with a better way of running a business than was ever envisioned by hordes of MBAs.


The “Red Queen Principle”: the market erases “sure thing” opportunities

In Lewis Carroll’s Alice's Adventures Through the Looking Glass, the Red Queen declared, “It takes all the running you can do, to keep in the same place.”

Everyone would like to believe that he has stumbled upon a “sure thing,” a gravy train guaranteed to keep money rolling in forever, without requiring ongoing effort and innovation.

There can be no such “sure thing” in a free-market economy.

“Just invest in blue chips.” If that really is an ideal investing strategy, sooner or later other investors will pick up on it. They will bid the price of blue chips up to a point where they are so pricey that they are no longer great investments.

“Real estate can only go up.” It is perhaps mean-spirited to bring up that particular fallacy after the recent bubble has popped. But, wait a few years, and we will hear it again. The fallacy of course is that if real estate really is a great investment, the price of real estate will be bid up to the point where it no longer is a great investment, maybe to the point where it has become a disastrous investment.

This principle goes beyond avoiding investment bubbles.

Whenever you think you see some area of the economy where the market seems to be operating inefficiently, ask yourself why someone has not moved in to make some profit off of that inefficiency. If you are right, someone either has moved in, or soon will be moving in, to offer goods or services to eliminate the inefficiency: if you are sure of the inefficiency, and in a position to take a risk, move into the area yourself.

You think some industry or profession is making “exorbitant” profits? Move into that industry or profession, or watch others move in, and see the increased competition eat away those exorbitant profits.

It is “exorbitant” profits and unrealized opportunities that drive a market economy: they drive people to take advantage of those profits and opportunities in a way that creates new businesses, new jobs, and new products. In very short order, the “exorbitant” profits and unrealized opportunities have vanished, to be replaced by a higher standard of living for everyone.

There is one exception: if the government can restrain or prohibit new entrants into an industry or profession, exorbitant, truly exploitative incomes and profits can indeed be sustained indefinitely at the cost of consumers. This need not consist simply of laws prohibiting competition; it can also consist of onerous governmental regulations that can be more easily monitored and complied with by large existing firms than by new, small start-ups.

Whether intentionally or not, government regulations tend to favor large, established, bureaucratic corporations over small, innovative start-ups: the large corporations can hire lobbyists to protect their interests and gain special privileges; they can afford large legal departments; they can absorb the costs of complying with regulations. A start-up company cannot.

Indeed, economists have recognized for decades that regulatory agencies created to restrain business tend to get “captured” by the established firms in the industry they are supposed to regulate (see, e.g., the 1970 classic The Crisis of the Regulatory Commissions edited by MIT economist Paul MacAvoy): the Carter Administration abolished the Civil Aeronautics Board for precisely this reason.

The need to run rapidly in order to stay in the same place can be unappealing to the incompetent, the lazy, and those who are already affluent and powerful. They may therefore appeal to the government to try to preserve the status quo.

The result is the stifling of economic growth. The “Red Queen Principle” is the engine of economic progress and the only means to better the material condition of humankind.


“Market failure” = utopian speculation or government intervention

Economic textbooks, media pundits, and politicians go on at great length about areas in which the market has “failed.”

Keeping in mind that the economy is nothing but individual human beings, a “failure” of the market in fact means a failure of human beings to work together to solve their problems.

What could cause such a failure?

Well… the market has indeed “failed” to create an elixir of immortality or turn base metals into gold or invent a means to travel faster than light or…

But, all of those “failures” are simply due to the fact that humans do not know (yet) how to do those things.

More commonly, market “failure” means simply that someone wants other people to pay for his own desires or pet projects and they choose not to do so.

The market has “failed” to provide for everyone free childcare, or free health care, or free sirloin steaks or…

Yes, the free market allows people to decide for themselves what charities to contribute to, and most people are reluctant to contribute to charities to provide free childcare, health care, and sirloin steaks to others who are unwilling to provide those things for themselves.

Aren’t there cases where people really could provide, and want to provide, some good or service, but for some reason cannot do so through the market?

Yes, when government regulation makes that impossible. Someone, for example, wants to do yard work for you at a mutually agreeable wage, but for you to pay him that wage would violate minimum-wage laws, ignore regulations requiring you to pay half of his Social Security payments, etc. Government regulations prevent a mutually beneficial exchange from occurring.

“Market failures” are due either to inadequately defined and enforced property rights (vide “Coase’s theorem”) or to government intervention in the economy.

I know of no exceptions.


If you think you are wiser than the market, prove it

Again and again, we hear that the market has its place, but that it needs to be properly guided, controlled, or restrained by some wiser, over-riding authority.

For example, we were told for many years that the market was failing to offer enough loans to low-income, minority borrowers. Government regulators pressured lenders to relax their standards for such borrowers. Many of those borrowers, of course, ended up defaulting when the real-estate bubble popped: it turned out that the market’s standards had been wiser than the well-intentioned regulators’ judgment.

If minority borrowers had really been under-served, there would have been a wonderful profit opportunity here: the regulators who truly believed this could have quit their government jobs, opened new lending institutions focused solely on worthy minorities, and made a bundle financially while also serving the cause of social justice.

You believe women or minorities are underpaid in the workplace? Start a business that only hires women and minorities and outshine your competitors by getting good workers cheap.

This is not hypothetical: Malcolm Forbes, Sr. claimed to do just that by hiring largely female employees, whom he thought were undervalued in the market.

It apparently worked.

But it will not work forever – as the “Red Queen principle” reminds us, others will soon notice your success, and everyone will soon be following the wiser and more profitable (and socially more just) approach to business.

You’re wiser than the market? The market is just other people – maybe you are smarter than they are. Put your money, time, and energy where your mouth is and prove it. If you’re right, you will make a bundle, and everyone will end up better off.

If you are not willing to do that, well… talk is cheap. An economy progresses on action, not talk.


“Economic harm” = fraud, theft, or just whining

We often hear that foreign competition “harms” American workers, that Walmart “harms” smaller, older retailers, etc.

What such “harm” usually means is that the group being “harmed” had a good thing going by overcharging consumers and wanted to preserve their exploitative position: they wanted to be granted immunity from the “Red Queen principle.”

The freedom offered by a free market is the freedom to buy or sell what you want to whomever you want, to employ whomever you wish, to work for whomever you wish, provided that the person on the other end of the deal finds that the deal works for him.

If you want to hire a worker at a lower wage than he can get elsewhere, if you want an employer to pay you more than he can pay for other workers, if you want consumers to shop at your store when another store offers lower prices or more variety, none of that is guaranteed to you by a free market.

A market economy is millions of human beings figuring out the best way they can solve their own and other people’s problems. If you think they are “harming” you by passing you by, because someone else makes them a better offer, you had best understand how the “Red Queen principle” works in a market economy.

The free market advances human well-being and eliminates human suffering by allowing people to constantly invent new and better ways of solving each other’s problems and meeting each other’s needs. If you refuse to participate in that constant round of change and innovation, you will not participate fully in the benefits.

Yes, in that sense, you will be “harmed”: you will not reap the benefits of a process in which you yourself decline to participate.

Of course, in any human society, there can be real physical, not merely metaphorical, harm: theft, fraud, murder, rape, etc. That is the province of the criminal law, not the economy in general. Arguably, the primary source of theft and fraud in most contemporary human societies is the government itself: the monetary cost of ordinary crime is trivial in comparison to the cost of taxes, and the fraudulent promises of government certainly exceed the fraud most of us encounter in our everyday economic lives.


A free-market economy economizes on love

Lewis Carroll wrote:
“’Tis love, ’tis love,” said the Duchess, “that makes the world go round.” “Somebody said,” whispered Alice, “that it's done by everybody minding their own business.” “Ah well,” replied the Duchess, “it means much the same thing.”
Several decades ago, the British economist D. H. Robertson published a brilliant paper that opened with this quote; his essay was entitled “What Does the Economist Economize?”

Robertson concluded that the ultimate resource that is economized in a free-market economy is “love.”

That may sound paradoxical in light of the widespread belief that the market not only allows but demands untrammeled greed.

However, as I have tried to emphasize, “the market” is nothing but millions of people trying to solve each other’s problems and satisfy each other’s needs in a mutually beneficial fashion.

The genius of the market is that both sides expect to benefit in a market exchange: we receive benefits from our fellow participants in the market even if they have no love for us personally but are merely pursuing their own self-interest, “minding their own business,” in Alice’s words..

This does not in any manner preclude participants in a market economy from acting out of altruistic motives. Indeed, I myself have again and again engaged in economic transactions where the other person seemed genuinely proud and pleased to be of help – everything from the craftsman who built our fireplace mantle to friends who run a local Greek restaurant. Conversely, I can only recall one occasion where a government employee, a civil “servant,” truly went out of his way to be helpful beyond what his job required (strangely enough, he was a supervisor at the Department of Motor Vehicles).

The difference is that a government employee who provides service beyond what is required is not serving his economic interest, but someone who does so in the market economy helps himself by helping others (I recommend the Greek restaurant to friends).

While a market economy does not require altruistic behavior, it does cause people to serve the interests of others simply by pursuing their own self-interest.

A market economy thereby allows people to focus their limited altruistic impulses on efforts that are not adequately served by the larger, money-based economy: charitable and cultural activities, physical and moral defense of the society at large and of civilized values, and, above all else, their own friends, family, and children.

The human capacity for altruism is not unlimited. We cannot spend every breathing, waking minute thinking about how to save the world. A free market allows us to tend to our own needs by also serving others, and, in our time away from the job, we can exercise our purely altruistic impulses as we judge best.

Socialism works in exactly the opposite way: citizens of a socialist society are exhorted to constantly put the needs of the larger society above their own needs in all of their everyday activities.

The effort is morally exhausting: socialism means life as an ongoing emergency, a constant need to sacrifice oneself, just to create a viable society.

Human beings cannot do this: the demands on human altruism made by socialism exceed the supply of altruistic impulses that are available to us as human beings.

The result is bizarre monstrosities such as the Maoist “Cultural Revolution,” Stalinist “Stakhanovism,” or the “killing fields” under the Khmer Rouge, which physically consumed human lives.

A market economy is millions of human beings working to solve each other’s problems. It works so brilliantly because, as I have emphasized above, the free market decentralizes accountability via the institution of private property, disseminates information via the price system, and encourages innovation and the alleviation of human suffering via the “Red Queen principle.”

But above all else, a free economy allows a flourishing of human altruism by allowing altruism to be used where it is truly needed and allowing more mundane, “selfish” motives to operate when they are sufficient.

It is still fashionable to ridicule “Victorian values.” But those “bourgeois” values, the values of laissez-faire capitalism, saw an outpouring of charity (vide Andrew Carnegie, and many others), a diminution in poverty, and the well-known emphasis on family life, all hitherto unparalleled in human history.

“Bourgeois” capitalist values make a peaceful, civilized, humane, affluent society possible.

The twentieth century consisted largely of a rejection of those values – the Gulag, the Holocaust, the Cambodian “killing fields” were all quite insane from the perspective of bourgeois capitalism and were all motivated by an intense rejection of bourgeois values.

Economics is the study of how a market economy is possible, how and why it works, and why the alternatives to a market economy produce human suffering, poverty, incivility, and death.

In short, economics is about how human beings can acquire their daily bread and still live in a civilized society. And that is why the study of economics is necessary to a liberal and humane education: we need to understand that the ultimate object of economics is, as Robertson wrote, “to economize on love” so that we may live good and fulfilling lives as human beings in a humane society.

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These twelve principles are, of course, by no means the entirety of the discipline of economics. There are other basic principles – the “sunk-cost” fallacy, the importance of “thinking at the margin,” the law of comparative advantage, basic supply-and-demand analysis, cost as being foregone alternative opportunities, the effects of varying incentive structures, etc.

And, there is the application of all of this to specific areas and problems:
  • applying supply-and-demand theory to money to see how inflation of the money supply causes prices to rise

  • showing why international trade helps consumers and why protectionism reduces economic welfare

  • explaining how consumer demand directs resources to different uses and creates the overall structure of the economy

  • discussing how the banking system functions (and malfunctions)

  • demonstrating how capital markets allocate resources across different firms and industries in the economy

  • understanding why socialism always fails

  • exploring how government causes recessions and depressions

  • discovering the different forms of contractual and institutional relationships that people have created for different economic settings

  • exhibiting how governmental controls, regulations, and interventions impede the operation of the economy and distribute special privileges to the members of the government and their supporters
and much more.

One of the features of the discipline of economics that is strange to those of us trained in the natural science is the division of economics into a number of competing “schools”: Keynesians, Chicagoites, Marxists, neo-Ricardians, Austrians, etc.

Nonetheless, this is the reality in economics. Several of these “schools” have as their primary purpose justifying the predatory role of the state and obfuscating the damage that an interventionist government inflicts on the economy.

Several of these “schools” also have a somewhat strange fixation on a rather bizarre use of mathematics: my own mentor in physics, Richard Feynman, labeled this “cargo-cult science.” On certain Pacific islands after the Second World War, “cargo cults” arose in which the natives would construct imitation airfields hoping that these would magically bring back the American airplanes and all the goodies the Americans had brought with them.

In the same way, Feynman argued, some people in the “social sciences” imitated the mathematical form of physics, although there was no real substance behind this form. I was told by one of Feynman’s colleagues in the economics department that Feynman was particularly disdainful of Paul Samuelson’s famous Foundations of Economic Analysis, often considered the seminal book in this move to mathematize economics.

Much of this mathematization of economics is simply navel-gazing, but some is positively harmful. For example, one can find in many economics texts quite rigorous mathematical proofs that if we possessed God-like knowledge of the economy then we could arrange it in a better way than the market. That is of course quite true – if we possessed God-like powers, we could do many things better than mere human beings can do.

(Essentially, these mathematical proofs assume knowledge of certain complicated mathematical functions, often represented in the textbooks by graphs of supply curves, demand curves, production-possibility curves, etc. The problem is that these functions are not actually known to any human being: indeed, economic activity can be thought of as people’s inventing or discovering the small portions of those curves that are relevant to their own economic activities. To assume that these curves are known and can be used in formal mathematical calculations is therefore like assuming that dinner is ready when one has not yet done any cooking. The curves assumed by the textbook are not inputs to economic analysis; rather, those curves (or portions of them) are the output of economic activity in the market – i.e., the result of the very difficult and complicated problem-solving activities and decisions of millions of hard-working people. To take those curves, or the mathematical functions they represent, as “given” is to make, as the philosophers say, a “category error.”)

Alas, we lack the God-like powers required to grasp all the information needed to replicate the results of a market economy. The whole point of a market economy is that the market allows real human beings, lacking God-like powers, to use their own knowledge and intelligence to solve a myriad of difficult, concrete problems in a decentralized yet cooperative manner. To assume that we have God-like knowledge of the economy is to basically assume away the economy itself.

Unfortunately, these rigorous but irrelevant mathematical proofs are commonly used to justify governmental controls over the economy, ignoring the fact that the government is made up of people notably lacking in God-like knowledge or wisdom!

Of course, the proponents of mathematizing economics could prove us critics wrong quite simply: they could make verifiable, testable predictions of future developments in the economy.

They have tried. Repeatedly. And failed. Spectacularly.

There have been numerous attempts to escape this cul de sac in mathematical economics for more than half a century: input-output analysis, game theory, rational-expectations theory, behavioral economics, Arrow-Debreu theory, evolutionary economics, etc.

I will not try to deny that there has been and continues to be some interesting work in some of these areas. But none of it has lived up to the standards of natural science and none of it, I think, has significantly invalidated the basic principles of economics I outlined above.

Furthermore, even some brilliant economists, notably Milton Friedman, have argued that economics can and should take a “positivist” approach, similar to that taken by the natural sciences, in which one forms broad theories, deduces hypotheses from those theories, and then tests the theories by rigorously testing the deduced hypotheses against actual empirical data.

An interesting idea – except anyone familiar with economics knows that almost none of the major economic theories and principles have actually been developed and tested in that way.

There are several reasons why this sort of “scientific” approach to economics has in fact proved to be a will o’ the wisp.

I have already alluded to one of these reasons – physics and astronomy have relied on detailed and successful mathematical models. Such empirically-successful mathematical models just do not exist in economics. The subject matter of economics is human desires, human innovation, human problem-solving, etc.: it is doubtful that such matters can ever be quantified and subjected to empirically-meaningful mathematical analysis in the manner in which we can measure and analyze mass, forces, etc. in physics.

At any rate, attempts to do so have simply not resulted in broad mathematical models that make detailed empirical predictions that have been rigorously tested by observation and proven to be correct.

Furthermore, as the sociologist Randall Collins pointed out in his 2005 paper, “Why the Social Sciences Won't Become High-Consensus, Rapid-Discovery Science,” one key to the rapid progress of the natural sciences has been constant innovations in research equipment used for observations and measurements, resulting in the accumulation of new sorts of observational data and the discovery of hitherto unsuspected natural phenomena.

Astronomers build increasingly powerful telescopes, physicists create higher energy accelerators to make new subatomic particles, biologists supplement light microscopes with electron microscopes – all of this means that natural scientists are constantly able to uncover new clues revealing the secrets of nature.

It is hard to see how anything like this can ever occur in economics or the other social sciences: we already have far more data about human beings than we have about subatomic particles, for we ourselves have an “inside view” of human beings.

And, indeed, in the last half century, there have been monumental advances in the natural sciences – the discovery of quarks in physics, the recognition of plate tectonics in geology, the cracking of the genetic code in biology, the discovery of quasars, pulsars, etc. in astronomy – that have revolutionized the natural sciences and that will remain important parts of those sciences as long as they exist.

I doubt that anyone can point to similar “discoveries” in economics (or the other social sciences) in the last half century – i.e., discoveries that have revolutionized our understanding of social reality, that are universally accepted within the discipline, and that are certain to remain central to the discipline throughout its future history.

There has been a huge amount of “research” published in the social sciences in the last half century, but it is hard to claim that any of that research truly, radically, and permanently changed our understanding of reality in the way that new discoveries in the natural sciences have done.

“Research” in the social sciences tends not to be cumulative: to put it bluntly, it tends to consist of academic fads, in fashion for a decade or two, and then largely forgotten and ignored as new fads become fashionable.

In all of these respects, I think that the present-day school of economics that best preserves the fundamental insights of economics, without succumbing to the ever-changing fads of the moment, is the so-called “Austrian school,” which began in Austria in the nineteenth century but which now exists largely in the United States. Among the most prominent figures in the Austrian school have been Ludwig von Mises, Murray Rothbard, and the Nobel laureate F. A. Hayek.

The Austrians have been particularly strong in exploring how the economy uses the problem-solving abilities of millions of human beings to bring about economic progress, explaining how government policies can wreck that progress (e.g., by producing the “boom-bust” cycle by interfering with the monetary and financial system), and showing why socialism does not work because it cannot utilize the human capacity to solve problems, coordinate actions, and create new ideas.

Much of what I have presented here I myself learned from reading the Austrian economists; some of this I learned from my own experiences in industry and from talking with my father about his experiences in manufacturing (thanks, Dad).

However, there are certainly other schools of economics that have also shed important light on economic reality – e.g., the “public-choice” school, notably Gordon Tullock. And, the concepts of “information costs,” “transaction costs,” and “bounded rationality” associated with economists such as the Nobelists Oliver Williamson, Ronald Coase, and Herbert Simon, are also, I think, crucial to understanding economic reality.

On the other hand, some “schools” of economics have been wholly negative in their impact: I do not know of any positive result from the revered J. M. Keynes (and, yes, I have read and studied carefully, in its entirety, The General Theory of Employment, Interest, and Money). The same can be said of Karl Marx.

How, then, does this connect to homeschooling?

Some of the basic principles of economics that I have outlined above can be and must be integrated into history and social studies very early in grade school. As soon as a child is old enough to understand that construction workers build buildings, he can understand that someone has to pay them so that they can eat while they are building a factory, before the factory is completed and ready to churn out clothes, toys, etc.: that is the essence of the idea of “capital” and “capitalism.”

The idea that ownership equals responsibility is also a concept that can be and should be taught in early grade school: even young kids understand that it is our job to mow our own grass, gas up our own cars, etc., but that we have no reason to mow other people’s grass, gas up their cars, etc. A yard that is owned by no one is likely to go ummown. This is why private property is necessary.

Even kids early in grade-school can understand that some countries once tried to run things so that “everyone” – i.e., no one – owned all the stores, farms, factories, etc. in the country, and that this worked horribly, just as a yard owned by no one is likely to be horribly overgrown with grass.

The failure of socialism, and the tens of millions who died in the name of making socialism work, is the central historical fact of the twentieth century. Any attempt to discuss twentieth-century history that ignores this fact and fails to explain the economic principles that the socialists themselves insisted on ignoring, is almost criminally negligent.

But, of course, it is not enough simply to integrate economics into discussions of history, politics, etc. Students also need to explicitly and seriously study economics as early as feasible.

The only books that I know that seriously try to do this at a grade-school level are Richard J. Maybury’s “Uncle Eric” books – e.g., Whatever Happened to Penny Candy. I happened to be going through that book with my grade-school kids when the financial collapse occurred in late 2008: it was very illuminating to watch the nightly news and then read a section in the book with the children that presented the economic principles that explained what we had just seen on the news.

Maybury’s perspective is similar to mine: i.e., he sees economics as an intellectual tool that enables one to understand what makes a humane and decent civilization possible.

Let me emphasize that one can find books that talk about some basic concepts of economics without engaging the broader perspective I am discussing. Such books are counter-productive, indeed inimical, to acquiring a broad education: this is true not only of many economics textbooks at the high-school and college level but also of many of the “gee whiz” pop economics books published in recent years. (Some of those pop-economics books try to apply economics, in very dicey ways, to issues of love, sex, etc. That no doubt helps to sell the books, but it is missing the central point: economics is about the large-scale structure of cooperation that makes an affluent, civilized, and humane society possible via the free market, not about topics better suited to Oprah.)

David Gordon’s An Introduction to Economic Reasoning introduces much of the basic apparatus of economics (e.g., supply and demand curves, the idea of marginal utility) in a brief, readable format (upper-grade school to middle-school reading level) that also stresses the broader framework of economics.

Henry Hazlitt’s classic Economics in One Lesson is at a somewhat higher reading level but avoids any technical apparatus to focus on the central point of thinking about the actual actions of participants in the economy in a number of detailed, illustrative discussions.

Murray Rothbard’s The Mystery of Banking and What Has Government Done to Our Money present the basic theory of money and banking in a readable form that emphasizes the broader context: the deleterious effects of government intervention in the monetary and financial system.

At a middle-school / early-high-school level, I like Alchian and Allen’s Exchange and Production and University Economics, both out-of-print but available at any decent university library.

The basic goal of a high-school economics course should be to read and understand Rothbard’s Man, Economy, and State, which unifies economic and political analysis in a careful, detailed, readable text (make sure to get the recent edition that includes “Power and Market” – the original, abbreviated edition is inadequate).

For seventy years, the reigning conventional wisdom in economics has been the Keynesian synthesis. Keynes was simply wrong: he did not understand the fact (known as the “real-balance effect” or “Pigou effect”) that a declining price level increases the effective quantity of money (since the same money goes further at lower prices) and that an increased demand for money can therefore be satisfied by a decline in the price level. Failing to grasp this, Keynes convinced himself that an increased demand for money would result in people “hoarding” money and shutting down the economic system: he did not see that an increased demand for money would simply result in lower prices (i.e., cheaper goods). Focused on a mistaken explanation, Keynes failed to understand that depressions are created by government meddling in the monetary and financial systems leading to “bubbles,” and that the recovery process is impeded by governments' trying to prop up failed businesses and dying sectors of the economy.

While Keynes’ errors were simple, the massive treatise in which he presented these errors, The General Theory of Employment, Interest, and Money, comes close to being unreadable.

However, I myself, as a high-school student, did manage to make it through the entire book with the help of Hazlitt’s The Failure of the New Economics and the collection of essays Hazlitt edited, Critics of Keynesian Economics.

To really understand modern economics, this truly is necessary. Although Keynes was obviously, embarrassingly, wrong, Keynesian views are so embedded in the news media and in introductory university texts, that anyone who does not carefully work through the Keynesian morass cannot see how radically misguided modern economic policy really is.

If a student masters all of this, where then should she turn, later in high school and as she moves on into college?

Most of us are interested in economics largely because of its intersection with politics. None of the books I have mentioned above ignore that connection (how could they?). But there are books that focus on this connection, more from the political side, by Gordon Tullock, Rothbard, H.-H. Hoppe, and others that are well worth reading. I’ll go into some of those in another post that focuses on political science.

The history of economic thought is also important in understanding economics, partly because economic fallacies never seem to die but merely metamorphose into new forms: an interesting discussion of the history of economics is Rothbard’s two-volume An Austrian Perspective on the History of Economic Thought. Economic history is interconnected with the history of economic thought, because what people believe about economics helps determine the economic policies they actually pursue: Rothbard’s America’s Great Depression and The Panic of 1819 illustrate that interconnection.

It is important to understand that a lot of popular economic history is written by authors who lack an adequate understanding of economics themselves, who do not grasp the core principles of economics I have laid out above, and who therefore reduce economic history to a soap-operaish tale of good-guy governments or labor unions versus evil, “greedy” capitalists. Rothbard does not deny that there are indeed “bad guys” in economic history – government officials who pursued policies based on misguided or malevolent economic theories, businessmen who used their connections in government to line their own pockets and wipe out competitors, thereby exploiting consumers, economists who obtained cushy positions for themselves by providing justification for predatory governmental actions, etc. But he does insist that these judgments must be based on sound economic understanding, not on uninformed emotional musings.

Finally, isn’t all this just too much, way, way too much?

Well… I started studying economics as a sophomore in a traditional high school, and I did work through most of the above in high school, while I was also teaching myself a good deal of advanced physics and math.

What I have outlined here is really doable: as I said above, I myself made it through Keynes and the Hazlitt books (as well as Mises’ massive Human Action) as a high-school student in a traditional school: I had less freedom, and less time to spend on serious study, than homeschoolers do.

But, the main point is that homeschoolers do not need to start that late. Start with Maybury in fourth or fifth grade, then move on to Gordon’s introductory text and Rothbard’s books on money and banking.

Tackle Alchian and Allen in middle school, and, yes, by high school it should be feasible to at least handle Man, Economy, and State, Keynes, and the two books by Hazlitt that are critical of Keynesian theory.

Yes, this is a serious course of study, but economics is about serious things – inflation, depression, unemployment, and, ultimately, war and peace, freedom and slavery, and life and death.

How can human beings, through mutually beneficial interactions, create a free, prosperous, and humane society? That is what economics is about.

It is a subject worth mastering.

__________

Most of the books I have mentioned are available through the Mises Institute, the premiere site for economics on the Web. Alchian and Allen’s books and, of course, Keynes' can be found in any decent university library. Thanks to my kids for helping to proof-read this essay, to several friends and relatives for countless discussions on these subjects, and to Ludwig von Mises, Murray Rothbard, and all those others who helped me understand the critical importance of economic knowledge to sustaining a prosperous, humane, and free society.

35 comments:

  1. 成功是一把梯子,雙手插在口袋裡是爬不上去的。........................................

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  2. 能猜得出女人真實年齡的男人也許耳聰目明,但肯定毫無大腦。哈哈!..................................................................

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  3. Dave,

    Which introductory texts on economics would you recommend for an adult with no previous background in the field?

    Best,
    Sean Casey

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  4. 生存乃是不斷地在內心與靈魂交戰;寫作是坐著審判自己。......................................................................

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  5. 在莫非定律中有項笨蛋定律:「一個組織中的笨蛋,恆大於等於三分之二。」....................................................................

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  6. 人生的「三部曲」應該是無愧的昨天,充實的今天,與充滿希望的明天。..................................................

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  7. 人自幼就應該通過完美的教育,去建立一種好的習慣。......................................................

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  8. 堅持是為著某種目的或目標,而持續不斷朝向既定方向努力的一種意念。..................................................

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  9. 與朋友在一起,分擔的痛苦是減半的痛苦,分享的快樂是加倍的快樂。......................................................................

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  10. 我愛那些使自己的德行成為自己的目標或命定的人................................................

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  11. 不會從失敗中找尋教訓的人,成功之路是遙遠的。.................................................

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  12. I strongly agree with all the previous commenters, especially 于庭吳

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