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The State of the Global Markets 2015

A Message for Armchair Economists

Economics / Economic Theory Jul 03, 2009 - 10:10 AM GMT

By: LewRockwell


Best Financial Markets Analysis ArticleBetsy Hansen writes: At some point in our intellectual development, we libertarians are naturally drawn to study economics. I think this stems from the fact that we love to explore the forces which drive our world. Economics is, in a broad sense, the study of human cooperation. A solid understanding of economics enables us to see how and why our world looks and behaves as it does.

You might have started studying economics on your own, and are now thinking that it would be great to pursue further study in this field at a university. Not so fast.

When you study economics at a university, especially at the graduate level, you are dealing with a completely different animal. Economics has been technically supercharged. A math-mania has replaced the economic logic we know and love.

How do I know this?

I started studying economics in high school, loved it, majored in economics along with finance at the University of Denver, and now I am on the market for a graduate program in economics. I hope to be one of those "good" economists, seriously in the minority these days, who study the way economies actually operate and are not just apologists for government policies.

I have been looking for the right graduate program for a few years now. I have interviewed professors at a number of departments and the most important message they have shared with me has been that the current focus of economic education at the graduate level is almost solely math based. Given my previous work at the undergraduate level, I somewhat expected this, but the degree to which programs were focused on math surprised me. When do students learn about advanced business cycle theories, money and banking, and the ideological and political influences on economic activity? When do students engage in critical reasoning about previous works that have passed as truth in the economics discipline if they are spending most of their time working math problems?

It is very unfortunate that economists spend so much time applying mathematics to economics because it severely limits the amount of time students spend learning about how the real economy functions. Economic activity is complex and unpredictable, but amidst this seemingly chaotic scenario, there is a beautiful capacity for order and organization. Economics at its best studies how this works by looking at what motivates individuals and how they seek to achieve their desired ends.

Mathematics is not an appropriate means of explaining human action for a number of reasons. A wealth of literature on this subject exists, so I recommend further reading on this topic, but to give you a general idea of what I am talking about, here is a summary of the argument against using math as a means of describing and predicting human action. The following sections come from a brilliant article by Bruno Leoni and Eugenio Frola, published in 1977 in the Journal of Libertarian Studies, Vol. 1, No. 2 pp.101–109.

"The application of mathematics to the human sciences, and particularly to economics, rests on the implicit assumption that mathematics is an appropriate tool for all the sciences. The widespread adoption of this assumption stemmed from the brilliant success achieved by the use of mathematics in physics, consisting mainly of accurate predictions of events taking place under controlled conditions. It is often overlooked, however (particularly by non-physicists), that these successes scarcely imply that every type of prediction of events can be attained by mathematics. In fact, events can only be predicted when the physicist can reduce and simplify them so as to correspond with a mathematical formula, capable of a calculable numerical solution."

Here is a specific explanation of this problem. Referring to indifference curves and utility analysis, two common concepts in economics where math is used as an illustrative and predictive tool, Bruno Leoni and Eugenio Frola write,

"Both the theories of indifference classes and of numerical utility rest on mathematical concepts that are essentially different from any validly empirical view of utility. The adherents of the mathematical theory of utility have not justified their substitution of a mathematical construct for the processes occurring in the real world. The utility which we have called "empirical" is that which governs the actual behavior of human operators, with perhaps the undoubtedly rare exception of those who purposely commit themselves to following postulates of the mathematical theory. At best, mathematical utility theory will only permit us to predict the behavior of these peculiar operators."

Murray Rothbard offers further explanation of the inappropriate use of mathematics in praxeology, the study of human action, in an article entitled, "Praxeology: The Methodology of Austrian Economics." Here he provides the following description of praxeology:

"Praxeology rests on the fundamental axiom that individual human beings act, that is, on the primordial fact that individuals engage in conscious actions toward chosen goals"…"The praxeological method spins out by verbal deduction the logical implications of that primordial fact. In short, praxeological economics is the structure of logical implications of the fact that individuals act." (p.58)

He adds that mathematics cannot be used to describe human activity without seriously oversimplifying the reality of how human beings actually act. Bolstering his argument, Murray goes on to say, "as political scientist Bruno Leoni and mathematician Eugenio Frola pointed out,

It is often claimed that translation of such a concept as the maximum from ordinary into mathematical language, involves an improvement in the logical accuracy of the concept, as well as wider opportunities for its use. But the lack of mathematical precision in ordinary language reflects precisely the behavior of individual human beings in the real world…. We might suspect that translation into mathematical language by itself implies a suggested transformation of human economic operators into virtual robots. (p.62)

Rothbard continues, "Similarly, one of the first methodologists in economics, Jean-Baptiste Say, charged that the mathematical economists

have not been able to enunciate these questions into analytical language, without divesting them of their natural complication, by means of simplifications, and arbitrary suppressions, of which the consequences, not properly estimated, always essentially change the condition of the problem, and pervert all its results. (p.62)

I could give many more explanations of why mathematics is not appropriate for the analysis of human action, but I think you get my point.

Math is used to such an extent because economists are required to understand and create mathematical models which are used to make forecasts, calculate variances, correlations and much, much more. I don’t want to sound too critical here because mathematical models can be effective if the assumptions they are based on are reasonable, but in many economic models assumptions are clearly false. For example, most models used for forecasting purposes need to measure risk in some way. They factor in various market risks and asset-specific risks. At first glance, this seems reasonable, but how do you define risk? Risk is very subjective, just as value is subjective. So it should be obvious that a model would not forecast future prices or growth rates if the assumptions about relevant risks are completely wrong. Unfortunately, false assumptions are accepted because they make it easier to build and manipulate mathematical models.

The way I see it, economists have become glorified mathematicians. Of course, statistics and modeling can be very useful, but they are not a means to solving every economic problem. Unfortunately, the economics profession has been hijacked by those who think that economists are most useful when they are trained to run models, versus discussing and developing economic theory and history. This has led to the regrettable demise of history of economic thought courses in graduate programs. There just isn’t enough time, most teachers say, to teach all the necessary math and modeling techniques students are expected to know, as well as cover the history of economic thought.

I spoke with an admissions officer who told me that the math content of their economics programs was so difficult that even math majors had a hard time. And even according to lenient admissions standards, you have no place in graduate economics programs unless you have taken 2 years of calculus, 1 year of statistics, linear and matrix algebra. This is ridiculous! When the use of mathematics gets this complex, how in the world do students have the time to deal with the study of human action, uncertainty and change? The answer is that they don’t.

What is the problem with academia that they do not have the backbone to stand up to whoever is calling the shots about the graduate economics curriculum? Is this all due to an intentional "scientific" push from economists seeking academic respect from the scientific community? If it is, don’t they realize that they have taken the quantitative focus too far?

When will academics revolt against this obsession with quantitative analysis that runs rampant throughout graduate economics programs today?

Hasn’t the current crisis proven that economists and their models have failed miserably? If anything good comes of this economic downturn, one would think that a thorough reexamination of existing economics programs was in order.

I am not the only one complaining about this problem. I have not met a single professor who is happy about the current state of economics. Many lament the fact that economics has become more or less a math program rather than a study of human actions and economic logic. A huge number of financial and economic commentators are making the same point as well. Here's an excerpt from a speech given by former Fed Chairman, Paul Volcker:

"There was so much opaqueness, so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events only happen once every hundred years. But we have "once every hundred years" events happening every year or two, which tells me something is the matter with the analysis."

So there you have it – even Paul Volcker sees that the mathematically driven economic and financial analysis is unsound. Yet, if professors and many in the financial community are so unhappy with the analytical techniques which are taught in economics programs today, why have we not seen much change? I presume that economics departments could adapt if they wanted to, right? Who is influencing the discipline so much, to the point where no one likes it, but they go along with what looks and feels like torture to everyone but math nerds? Is it the government? Our bureaucracy needs lots of bean counters to manage their affairs. I don’t really know. The whole discipline seems like it’s lost its mind.

Thankfully we have the wonderful exception of a few Austrian programs, with the Ludwig von Mises Institute leading the way. Until we see a Mises University that can train and certify economists, I think economics students are forced to make the best of things as they are. Unfortunately, the unseen cost of our poor state of economic education is enormous. Because economics programs are so mathematically focused, many brilliant minds are deciding not to go into that field of study. The opportunity costs our society faces by having mathematicians run economics programs are huge. Society will be worse off because of it.

July 3, 2009

Betsy Hansen [send her mail] is a summer fellow at the Mises Institute. See her site.

    © 2009 Copyright - 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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