Principles of Economic Analysis

["Gunnar Tomasson" <tomasson@xxxxxxxx>]

For the background information of PKT subscribers, I am forwarding my brief
note of October 1, 1999 on 'Principles of Economic Analysis', on which Paul
Davidson commented on February 20, 2000 (see below).

Gunnar Tomasson

> >Regarding your 1999 paper, you are correct in arguing  that Paul
Samuelson
> >'s FOUNDATION OF ECONOMIC ANALYSIS is responsible for the terrible mess
of
> >economics.  But it was not because Samuelson used Walras's general
> >equilibrium [GE] methodology per se rather than Keynes's
> >Marshall  equilibrium analysis.  The reason that Samuelson went so wrong
> >(and in so doing won the first Nobel Prize --setting a precedent for
> >wrong-headed economists to receive this award) is that he adopted the
> >classical axioms of neutral money, gross substitution, and ergodicity in
> >his FOUNDATIONS as Samuelson tried to mimic the physicists that
surrounded
> >him at MIT (which was mainly a technological school in the 1930s when
> >Samuelson joined the faculty).  One should read the interview of Lorie
> >Tarshis in Colander and Holdreth's book THE COMING OF KEYNESIANISM TO
> >AMERICA to see why Samuelson did not have the slightest clue as to what
> >Keynes's GT was all about.
> >
> >Paul
>
> Paul Davidson
> Holly Chair of Excellence in Political Economy
> Editor, JOURNAL OF POST KEYNESIAN ECONOMICS [JPKE]
> Economics Department -- 523 SMC
> University of Tennessee
> Knoxville, Tennessee 37996-0550
> email: Pdavidson@xxxxxxx;   phone: (865)974-4221;    fax: (865) 974-4601
> http://econ.bus.utk.edu/Davidson.html
>
>
©Gunnar Tomasson
October 1, 1999
Principles of Economic Analysis
(Summary - Revision)

Samuelson's Foundations

 In The Economists (1976), New York Times economics correspondent Leonard
Silk reviewed the careers of several leading U.S. economists, including Paul
Anthony Samuelson.  Of this erstwhile enfant terrible of mainstream
economics, Silk wrote that his ideas must be the starting point for any
attack on or defence of modern economics.

 This refers to Samuelson's Ph. D. thesis written at Harvard around 1940 on
the methodological aspects of neo-classical mainstream economics and
published in 1947 as Foundations of Economic Analysis.  In it, Samuelson
noted, inter alia, the "unmistakable signs of decadence which were clearly
present in economic thought prior to 1930." (p. 4)

 After a brief interlude from the publication of Keynes' General Theory in
1936 to his death in 1946, the decadence in question was refurbished in
"keynesian" garb and given a new lease on life by American "keynesians".
The essence thereof, in Hayek's apt phrase, was elevation of "the more naïve
inflationist fallacies" of old to the status of new science.

 In his memorial article on Keynes (Econometrica, July 1946), Samuelson bid
good riddance to the newly departed on assorted grounds, including charges
(a) that he had not understood his own theory, (b) that, in any case, he had
not had any interest in theory, (c) that he had criticized econometrics
without knowing what he was talking about etc., etc.

 Soon thereafter, the unspoken point of Samuelson's intellectual vitriol was
spelled out by Lawrence Klein, whose Ph. D. thesis on The Keynesian
Revolution written in the early 1940s at MIT, attacked Keynes for deriding
Soviet economics as "religion" when, in fact, the Soviet system embodied the
virtues of a full-employment Keynesian model.

 Keynes' analytical approach to monetary theory was both a key target and an
early casualty of the Cambridge, Mass. missionary work towards the back-door
socialization of the U.S. economy through deficit-driven monetary inflation
become part of the "science" of "aggregate demand management" predicated on
the idea that "Money Does Not Matter".

 Shortly before his death, Hayek asked Keynes whether he was concerned about
the uses to which the ideas of the General Theory were being put by some of
his most "orthodox" followers.  Keynes replied that these ideas had been
important in the 1930s and that he would act promptly to stem any abuse
thereof in the period ahead.

 In his Preface to the General Theory, Keynes explicitly noted that his
presentation therein was such that most "technical monetary detail" was left
in the "background". However, his The Economic Consequences of Mr Churchill
(1927) and Treatise on Money (1930) make it abundantly clear that he
understood that Money Does Matter very much.

Mainstream Methodology

 In 1937, Keynes dismissed the general equilibrium method as "a little
better than nonsense". In his Foundations, Samuelson misconstrued the method
itself while claiming that "any sector of economic theory which cannot be
cast into the mold of such a [general equilibrium] system must be regarded
with suspicion as suffering from haziness." (p. 9)


As detailed further below, the misconstruction concerns Samuelson's
make-belief that "a [general equilibrium] system may be as broad or as
narrow as we please depending upon the purpose at hand; and the data of one
system may be the variables of a wider system depending upon expediency."
(p. 9)

 Again, Samuelson's subterfuge serves an unspoken agenda, namely, to bestow
the glitter of methodological propriety to the modus operandi of all
econometric theorists.  Unlike Keynes, whom he charged with lack of
"technical expertise" with respect thereto, it stretches credulity to
imagine that Samuelson did not - and does not now - know better.

 At the time, Samuelson sought to rationalize his make-belief on the grounds
that "a good deal of theoretical physics consists of the assumption of
second order differential equations sufficient in number to determine the
evolution through time of all variables subject to given initial conditions
of position and velocity." (p. 8)

 In theoretical physics, of course, this modus operandi is sanctioned by
 predictive success whereas predictive failure is the econometric norm.

 Moreover, theoretical physicists, who are literate in the epistemological
aspects of modern science, recognize that predictive success of partial
models of physical reality is immaterial insofar as the admissibility in
principle of such abstraction from a more general model is concerned.  The
point has been underscored by Stephen W. Hawking as follows:

 "It turns out to be very difficult to devise a theory to describe the
universe all
 in one go.  Instead, we break the problem up into bits and invent a number
of
 partial theories.  Each of these partial theories describes and predicts a
 certain limited class of observations, neglecting the effects of other
quantities,
 or representing them by simple sets of numbers.  It may be that this
approach
 is completely wrong.  If everything in the universe depends on everything
else
 in a fundamental way, it might be impossible to get close to a full
solution by
 investigating parts of the problem in isolation." (A Brief History of Time,
p. 11)

 Of course, in the Walrasian economic universe become Samuelson's
hypothetical "[market] system in 'stable' equilibrium or motion"
(Foundations, p. 5), "everything depends on everything else in a fundamental
way" such that all simultaneous exchange transactions are judged to be
interrelated through an economic calculus.

 As in Newton's model, where the positions and paths of all moving particles
in the universe are interrelated, so Walras reasoned that the precise
"configuration" of observed exchange transactions reflected underlying
maximizing-minimizing behavior by economic agents, whose motivation served
his model as the force of gravity did that of Newton.

 In the Newtonian case, it is readily apparent that any given particle's
position and path at any point in time is uniquely determined by the
totality of forces exerted on it by all other particles.  By the same token,
Walras recognized that real-world market economies must be held to satisfy
the formal conditions of general equilibrium at all instants in time.

 This attribute of Walrasian systems exposes as quixotic the task which
Samuelson attempted in Foundations of Economic Analysis, namely, "to show
that there do exist meaningful theorems in diverse fields of economic
affairs" (p. 5) concerning the system's response to any displacement of
general equilibrium which, by definition, can never occur.

  As he would later do with respect to Keynes, Samuelson resorted to
shameless bluster and obfuscation to fudge the logical point at issue,
charging that "The majority [of his predecessors] would have been glad to
enunciate meaningful theorems if any had occurred to them." (p. 4)   By
1971, Samuelson had blustered his way to a Nobel Prize.

Monetarist Methodology

 In the 1960s, monetarist methodology, as outlined by Milton Friedman in an
essay (ca. 1950) entitled 'The Methodology of Positive Economics', was
routinely derided by his mainstream rivals who, correctly, held it to
comprise a "black-box" approach to empirical analysis and, incorrectly,
judged it to compare unfavorably with the mainstream approach.

 In physics, the primacy of the "black-box" approach was underscored by
Newton, who cautioned in Principia that "the reader is not to imagine that
by [.] words [such as "attraction", "impulse," or "propensity [.] towards a
centre"] I anywhere take upon me to define the kind, or the manner of any
action, the causes or the physical reason thereof."

 Later, David Hume detailed the epistemological grounds of Newton's position
and, more recently, Stephen W. Hawking gave back-handed endorsement thereof
as follows:

 "In order to talk about the nature of the universe and to discuss questions
 such as whether it has a beginning or an end, you have to be clear about
 what a scientific theory is.  I shall take the simple-minded view that a
theory
 is just a model of the universe, or a restricted part of it, and a set of
rules
 that relate quantities in the model to observations that we make.  It
exists
 only in our minds and does not have any other reality (whatever that might
 mean).  A theory is a good theory if it satisfies two requirements:  It
must
 accurately describe a large class of observations on the basis of a model
 that contains only a few arbitrary elements, and it must make definite
 predictions about the results of future observations." (Op. cit., p. 9)

 Friedman's essay was "concerned primarily with certain methodological
problems that arise in constructing [Positive Economics] - in particular,
the problem how to decide whether a suggested hypothesis or theory should be
tentatively accepted as part of the "body of systematized knowledge
concerning what is" [as distinct from what should be]."

 "Its performance," Friedman wrote, "is to be judged by the precision,
scope,
 and conformity with experience of the predictions it yields.  In short,
positive
 economics is, or can be, an "objective" science, in precisely the same
sense
 as any of the physical sciences." (Essays in Positive Economics, p. 4)

 If the latter claim is discounted as academic hyperbole aimed at his
mainstream rivals, then the methodological foundations of Friedman's case
for 'Positive Economics' and associated monetarist doctrine are
non-existent.  Nor has it been notably advanced by "the precision, scope,
and conformity with experience of [monetarist] predictions."

 During the past quarter century, the track record of mainstream and
monetarist economic models alike has ranged from poor to abysmal, as
evidenced by successive "surprises" involving (a) Third World Debt, (b) U.S.
Savings & Loans, (c) commercial bank loan meltdowns in Japan, and (d)
financial and economic catastrophes in Asia and Russia.

 In an essay on methodological issues in economics, John Stuart Mill
suggested that an empiricist approach to economic analysis exemplified a
"low estate" of human intelligence, and advised that those who are caught by
"surprise" by developments such as the above should construe it as clear
evidence of defects in their theoretical mind-sets.

 There is nothing on record to suggest that senior officials of the U.S.
Treasury, the Federal Reserve, the IMF, and the World Bank and leading
mainstream and monetarist scholars are so construing their collective
"surprise" of recent years.  If Economic Science is not beyond repair, the
intellectual leadership for its renewal must come from elsewhere.
 What Is Economics?

 For mainstream and monetarist scholars alike, the answer to the question
"What is economics?" reduces to their job description.  Thus, Samuelson's
definition of economics requires the application of high-school algebra and
calculus, while that of Friedman places a premium on data-mining skills
whereby economic variables may be correlated over time.

 At first glance, this would seem to place economics on par with physics
insofar as dependence on the application of mathematical skills to empirical
data is concerned, albeit at a much lower level of technical difficulty and
conceptual precision.  Yet, writing in 1964, Samuelson conceded that the
economics-physics analogy is more apparent than real.

 ".economics is by its nature," he wrote, "a softer and less exact science
 than, say, conventional physics.  Now in a hard, exact science a
practitioner
 does not really have to know much about methodology.  Indeed, even if he is
 definitely a misguided methodologist, the subject itself has a
self-cleansing
 property which renders harmless his aberrations.  By contrast, a scholar in
 economics who is fundamentally confused concerning [methodology] may
 spend a lifetime shadow-boxing with reality.  In a sense, therefore, in
order
 to earn his daily bread as a fruitful contributor to knowledge, the
practitioner
 of an intermediately hard science like economics must come to terms with
 methodological problems.  I stress the importance of intermediate
hardness,"
 Samuelson added, "because when one descends lower still, say to certain
 areas of sociology that are almost completely without substantive content,
 it may not matter much one way or the other what truths or errors about
 scientific method are involved - for the reason that nothing matters."
 (Foundations of Economic Analysis, Atheneum, 1979, Foreword, p. ix)

 And why might "economics" be " a softer and less exact science than
physics"?

 Since there is nothing "soft" about high-school algebra and calculus, the
obvious answer is that mainstream economics is "soft" because of the
imprecision of the concepts to which such mathematics is applied.  In other
words, in Whitehead's cutting phrase, the "softness" of mainstream economics
exemplifies "the fallacy of misplaced concreteness".

 Samuelson did not respond to the present writer's suggestion in the late
1970s that mainstream economics is "soft" in its methodology and "hard" in
conclusions arrived at by means thereof. As for Friedman, he dismissed as
"egregious nonsense" a piece of classical monetary analysis which the writer
forwarded to him around the same time.

This accorded with Friedman's view that "Logical completeness and
consistency are relevant but play a subsidiary role" in all "theory", as he
put it in 'The Methodology of Positive Economics' (p. 10).  In other words,
whatever Friedman may mean by "theory", it cannot have anything to do with
the classical concept of 'The Theory of Economics'.

 For, as Keynes summarized it in 1922, "The Theory of Economics does not
furnish a body of settled conclusions immediately applicable to a policy.
It
is a method rather than a doctrine, an apparatus of the mind, a technique of
thinking, which helps its possessor to draw correct conclusions."

 Thus, if "theory" is to serve economists as "an apparatus of the mind, a
technique of thinking," then "logical completeness and consistency" is an
essential attribute thereof.  In this respect, the "Theory of Economics" is
on par with algebra and analytic geometry in its use of axiomatic premises
and deductive conclusions that "exist only in our minds."


'Science' and 'Art'

 Keynes' qualifying remark that "theory" so defined must "help its possessor
to draw correct conclusions" mirrors John Stuart Mill's comments to the
effect that only some of all the conceivable sets of axiomatic premises,
which might satisfy the formal requirements of "theory", would also aid
economists in addressing real-world issues.

 Earlier, the like view was reflected in Adam Smith's comments in Book IV of
Wealth of Nations on the abstract physiocratic "commercial system", which he
commended for further study by readers interested in the "principles" of the
"very important" science of Political Economy, while noting that no such
system had ever existed in the real world.

In its final form, the set of "logically complete and consistent" axiomatic
premises that comprised the "commercial system" was named Say's Law after
one of Adam Smith's foremost disciples, Jean Baptiste Say.  Later, Keynes'
incongruous attack on Say's Law as counter-factual would plant the seed of
mindless modern mainstream macroeconomics.

However, the classical thrust of his 1922 definition of the "Theory of
Economics" and his blunt characterization in a 1937 letter to Hicks of the
General Theory's conceptual framework as "inconsistent hotch-potch" from the
"classical" viewpoint both suggest that Keynes regarded his 1936 attack on
Say's Law as transparent academic gamesmanship.

 Indeed, Keynes advised Hicks that "the inconsistency creeps in [.] as soon
as it comes to be generally agreed that" the correlation between an increase
in money and employment is akin to that shown in the Hicksian IS-LM model.

 By "generally agreed", Keynes would seem to have been alluding to the need
to distinguish between the static (Quantity Theory) and dynamic
('Keynesian') aspects of classical monetary analysis, as reflected in the
writings of James Mill and David Ricardo, on the one hand, and Jeremy
Bentham and John Stuart Mill, on the other hand.

 As stated by Bentham, these twin aspects of classical monetary analysis
reduce to the proposition that, when there are unemployed resources, the
FIRST USE of new money determines whether its impact is to increase factor
employment or inflate prices.  In 1810, Ricardo commended this innovative
thrust of Bentham's monetary analysis to James Mill.

 In the context of the classical "Theory of Economics", both aspects of
Bentham's monetary analysis were later subsumed by John Stuart Mill's dictum
in Principles (1848) that DEMAND FOR COMMODITIES IS NOT DEMAND FOR LABOUR.
Failure to understand this, Mill wrote, was an unerring indicator of
illiteracy in the field of theoretical economics.

 Mill's dictum is rooted in the logical attributes of monetized
entrepreneurial market economies and, as such, is immune to challenge on
empirical grounds akin to those which have made "the more naïve inflationist
fallacies" of past economics illiterates attractive to their modern kin in
academe, the U.S. Treasury, Federal Reserve, IMF, and World Bank.

 As indicated by the earlier review of the methodological aspects of
mainstream and monetarist orthodoxy, the point at issue with respect to
Economic Science is that of which Einstein wrote late in life with respect
to science in general as follows: "Science without epistemology is, insofar
as it is thinkable at all, primitive and muddled."

 In the case of economics, the current disastrous state of affairs traces
back to the displacement after mid-19th century of logically sound Value
Theory by mathematical Price Theory which, divorced from coherent Monetary
Theory, has left the practitioners of what Bentham termed the 'Art of
Economics' without any footing in the 'Science' thereof.