On “empirical” methods in economics

Robert Murphy wrote a very good post showcasing the extremely poor record of the so-called empirical methods in macroeconomics. I commented there as follows:

The problem is that the statistical methods economists use (Daniel is right that it weren’t physicists who invented them) aren’t very scientific. First of all, statistical inference is in general, strictly speaking, not scientific. No one knows what probability is at the bottom level and it is not an intrinsic, fundamental thing like energy (except, perhaps, for the collapse of the quantum wave function).

At the practical level, probability is now defined as a share of a certain outcome of the experiment in all the observed multiple outcomes of such experiment. Even if we ignore the previous point and treat this approach as scientific there is a big problem for applying the method to economic phenomena. The problem is that choices aren’t repeated, separate experiments, they are unique events.

I know that statisticians have found a way to go around this problem by showing that certain metrics of distributions of non-experimental data-generating processes are very similar to those of the distributions of outcomes of what they believe are repeated random experiments (like throwing dice). But this go-around is a non-sequitur. It requires a question begging assumption that probability is applicable where certain metrics of the distribution are similar to those of the distributions that are believed to be random.

On the other hand, I disagree with Bob to the extent that he maintains that praxeology isn’t empirical. It isn’t empirical in the narrow, positivist sense of the word. But it is empirical in the Aristotelian realist sense of the word. All our knowledge is ultimately based on experience, including the knowledge of what action, means, money, etc. are.

Economics and Math

Daniel Kuehn asked Austrian economists here why he can’t use calculus in economic analysis implying that there is no irreconcilable difference between the Austrian and mainstream approaches to marginal utility:

I might say that although people don’t actually do calculus when making decisions, we can probably agree they’re trying to figure out the best option for them, and they are probably saying something in their head like “I’m going to keep doing this until the cost to me of doing it again is higher than the benefit of doing it again”. That’s not a very big assumption on my part, after all. And that’s a pretty fair account of all that I’m importing into the model by using calculus.

In fact, it’s not very difficult to give a response from the praxeological standpoint and show that an irreconcilable difference actually exists.

First, one needs to note that Daniel is talking here not about one choice but about several iterative choices of one more unit of certain course of action. Second, the cornerstone of praxeology is the idea that costs only exist as an integral part of a particular choice.

It follows from this that the utility and cost of one unit in the first choice may not be meaningfully compared to the utility and cost of one unit in nth choice. However, it is of course possible ex post to fit the choices into a graph with a marginal benefit and a marginal cost curve. The problem is that from the praxeological standpoint these curves are meaningless. As a corollary utility maximization (cost minimization) is an artifact of this curve-fitting.

The upshot of this discussion is that the mainstream rational choice model and the praxeological reasoning are two fundamentally different things. The latter takes the fact of choice and its logical structure as given and proceeds from it while the former is just one possible psychological model trying to make a mapping from hypothetical preexisting preferences to actual choices. This is incidentally why the mainstream rational choice model is so vulnerable to criticism from other branches of psychology like behavioral psychology, while praxeology has nothing to fear from it.