The Night Watchman

The only authorized source of the thoughts and opinions of Per-Olof Samuelsson


Induction in Economics

A very preliminary remark

The first part of this essay is a Facebook note I wrote some months ago; the second part is added now.

Ludwig von Mises – the “dean of Austrian economics” – maintained that economics is a purely deductive (even “aprioristic”) science, and that induction has no role whatsoever to play in economics. An illustrative quote:

Reasoning is necessarily always deductive. This was implicitly admitted by all the attempts to justify ampliative induction by demonstrating or proving its logical legitimacy, i.e., by providing a deductive interpretation of induction. The plight of empiricism consists precisely in its failure to explain satisfactorily how it is possible to infer from observed facts something concerning facts yet unobserved. (Ludwig von Mises, The Ultimate Foundation of Economic Science, p. 21.)

This view obviously clashes with Objectivism. One may excuse Mises on the grounds that he had no opportunity to read David Harriman’s The Logical Leap, which explains the relationship of induction to deduction. However, Harriman’s book deals only with induction in physics and the closely related subjects of astronomy and chemistry (and in philosophy). So I will make an attempt to apply what Harriman writes to economics. It will be only an attempt.

The basis of induction is sense perception. And what is perceived by the senses are actually some simple and basic causal connections. For example, a toddler may observe that when he puts a newspaper into a fire, it will burn. (If the newspaper is damp, it will burn slower.) If he puts his hand into the fire, it will hurt. If he pours water on the fire, the fire will go out. Etc. (Anyone could find other examples.) What the toddler is actually perceiving is causal connections (“fire causes paper to burn” or “my hand to hurt”, “water causes the fire to go out”). Those generalizations are at the bottom of more advanced identifications of causal connections (such as “gravity is the cause of tides and of many other phenomena”).

Is there a similar perceptual starting point for economics? Are there causal connections in economics that a toddler could see with his own eyes? That is the question I will try to answer.

Every science must start with some basic concepts – and the process of concept formation is an inductive process, while the process of applying a concept, once it has been formed, is a deductive process:

[T]he process of forming and applying concepts contains the essential pattern of two fundamental methods of cognition: induction and deduction.

The process of observing the facts of reality and of integrating them into concepts is, in essence, a process of induction. The process of subsuming new instances under a known concept is, in essence, a process of deduction. (Ayn Rand, Introduction to Objectivist Epistemology, p. 28.)

What concepts are basic in economics? There are many, but two that I can think of off-hand are “money” and “exchange”.

A toddler can form the concept “money” by merely observing coins and/or notes. (He would have to learn from some adult that those mysterious little things are called “money”; and it is hardly immediately evident why both coins and certain pieces of paper are both subsumed under the concept “money”; but he will learn that later on.)

What about “exchange” and its relation to “money”? Well, the toddler may accompany his father (or mother or some adult) to a store and observe that his parent passes a coin or note to the store owner, and that this has the peculiar effect of making the store owner pass a bottle of milk (or whatever) to the parent. He is observing an instance of causation, just like when he observed that fire burns paper (etc). It is still mysterious to him exactly what the causal connection is (does the money cause a bottle of milk to pass over, or is it the bottle of milk that causes money to pass over? It may take the toddler some times to understand that this is a case of “reciprocal causation” – and of course that there are other underlying causes yet to be discovered.)

And I have to stress that this is a very preliminary remark. More work has to be done.

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To show that Mises took a Kantian approach, let me quote the following:

A new epistemology of rationalism aimed at the refutation of this [John Locke’s] integral empiricism. Leibniz added to the doctrine that nothing is in the intellect that had not previously been in the senses the proviso: except the intellect itself. Kant, awakened by Hume from his “dogmatic slumbers”, put the rationalistic doctrine upon a new basis. Experience, he taught, provides only the raw materials out of which the mind forms what is called knowledge. All knowledge is conditioned by the categories that precedes any data of experience both in time and in knowledge. The categories are a priori; they are the mental equipment of the individual that enables him to think and – we might add – to act. As all reasoning presupposes the a priori categories, it is vain to embark upon attempts to prove or to disprove them. (The Ultimate Foundation of Economic Science, p. 11.)

So, for Mises, economics rests upon a priori categories not derived from experience but logically and chronologically prior to experience.

Murray Rothbard is actually better (and closer to Objectivism) on this point:

Most writers on the 1929 depression make the same grave mistake that plagues economic studies in general – the use of historical statistics to “test” the validity of economic theory. We have tried to indicate that this is a radically defective methodology for economic science, and that theory can only be confirmed or refuted on prior grounds. Empirical fact enters into the theory, but only at the level of basic axioms and without relation to the common historical-statistical “facts” used by present-day economists. (America’s Great Depression, p. 81; emphasis added.)

So, in Rothbard’s view, at least the basic axioms of economics are derived from experience; which is actually an advance over Mises.

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PS. I should mention that David Harriman actually takes up the very same objection to induction that Mises writes about. Here is a short quote:

As a rule, the attempt to validate induction has taken the form of attempting to reduce induction to deduction. (The Logical Leap, p. 30.)

The Logical Leap itself is an attempt to validate induction inductively. But I won't go further into that, because you can always read the book.

Some less preliminary remarks

There is one large difference between the natural sciences (such as physics) and the humanities or social sciences (such as economics). It is not hard to grasp this difference, but it needs to be pointed out.

In the natural sciences, experimentation is crucial. The heroes of natural sciences, such as Galileo and Newton (and later, Faraday and Maxwell) performed lots of experiments. Characteristically, in experimentation, one keeps one factor constant and varies some other factor to note what difference this makes.

But in economics and the other social sciences, there is no such thing as experimentation. This, by the way, is a point that Mises stresses over and over again. But this means that the inductive method Harriman describes in The Logical Leap cannot be “translated” into the social sciences.

(Some people undoubtedly try to make experiments in the social sciences. There is much talk about the “communist” or “Soviet” experiment. But we certainly know today – and should have known from the beginning – that those experiments with human life simply end up in total disaster.)

The only kind of experiments one can do in the social sciences is “thought experiments”. Mises, for example, uses “imaginary constructions” (such as “the static state” and “the evenly rotating economy”.) Those imaginary construction have no counterpart in reality; they are merely used as aids to thought; reality can be compared to those imaginary constructions.

A similar case may be found in George Reisman’s Capitalism. He starts out with the assumption of invariable money, something that simply does not exist in reality. But having analyzed what would happen under invariable money, he then adds in what would happen under a gold standard, and then what happens under fiat money.

The way Mises and Reisman uses this deductive method is perfectly sound. But there is a grave danger with it, if one confuses those imaginary standards with reality or makes them the standard for judging reality. This is most readily seen in the idea of “pure and perfect competition”. There is no such thing in reality; but the adherents of this theory think this is how reality should be and recommend policies on this basis. The result, as I am sure you all know, is antitrust legislation. (The “pure and perfect refutation” of this theory is contained in Reisman’s essay “Platonic Competition”, included in Capitalism, p. 430ff.)

To summarize, I do not think induction plays the same crucial role in economics as it does in physics. But to say that economics is only deduction (as Mises says when he calls the subject “aprioristic”) is going too far; the simple, basic concepts used in economics have to be formed inductively (if for no other reason because concepts are never formed deductively; they can only be applied deductively).

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Now, there are a couple of schools of economics that claim to be using induction and shun the deductive approach to the subject. The best known of those schools is the “German Historical School”. This school objected to classical economics on the grounds that it was “too abstract”, that the theorems of the classical school were divorced from reality, and that the proper way of approaching the subject was meticulous historical and statistical studies. The proponents of this school are also known as the “socialists of the chair” (“Kathedersozialisten”). The errors of this school are thoroughly dealt with by Menger and Mises (the seminal work on the subject being Menger’s Investigations into the Method of the Social Sciences).

Another such school is the “English Historical School”. With this I am not familiar; but I will quote a couple of lines from Wikipedia on this school to show where it leads:

They rejected the hypothesis of "the profit maximizing individual" or the "calculus of pleasure and pain" as the only basis for economic analysis and policy. They believed that it was more reasonable to base analysis on the collective whole of altruistic individuals. (Italics mine.)

Both those schools actually reject economic science altogether. They do not attempt to ground economic theories in perceptible reality; they aim to replace economic theory with history and statistics. If this is an inductive approach, then it must be an improper form of induction.

To try to integrate economic history with economic theory would be a worthy undertaking. But it would have to consist of applying sound (Austrian or Austro-Classical) economic theory to history, not the other way ‘round.

I will give the last word to Ludwig von Mises (unfortunately, I don’t remember the source for this quote):

Facts don’t speak; they have to be spoken about by a theory.

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