The Knowledge Problem: Foundational Economic Theory Part 2

Part 2...

Paul Krugman is the veritable face of modern scientistic, as Hayek would say, economics. His mathematical approach to economic study has drawn great praise and criticism throughout the economic community. He was the winner of the 2009 Nobel Prize in Economics for his contribution of statistical models related to New Trade Theory and New Economic Geography. Krugman and I have something in common, we both have a love for Science Fiction and our favorite book series is Foundation by Isaac Asimov.

Isaac Asimov

In the Foundation series, Asimov introduces the science of psychohistory, which is capable of predicting the actions of large aggregates of human beings long into the future. Psychohistory closely resembles the same type of thinking displayed by central economic planners around the world today and throughout modern history. Krugman had this to say about Foundation and psychohistorians when interviewed about his love for Science Fiction 

“I read Foundation, back when I was in high school, when I was a teenager, and thought about the psychohistorians, who save galactic civilization through their understanding of the laws of society, and I said ‘I want to be one of those guys.’ And economics was as close as I could get.” 

Krugman's infatuation with psychohistory reflects his economic outlook on the ability to control and predict mass action through mathematical calculation and policy implementation. The psychohistorical approach to human action holds that as populations increase the calculation and manipulation of aggregate human action becomes easier, which conflicts directly with Hayek's notion of the decentralization of knowledge.

Ben Bernanke, the Chairman of the Federal Reserve, is considered to be one of the world's top scholars on the Great Depression. As a student of monetary policy he has devoted much of his life to understanding the working of an economy and the way monetary policy influences the business cycle. As one of his generation's top students of the Great Depression few could have asked for a better man to be in charge of the United States monetary system during the recent financial crisis. But despite his lauded expertise of the Great Depression Bernanke was completely unable to anticipate, prevent, or cure the Great Recession with any effectiveness. 

What was to blame for Bernanke's failure to deal effectively with the Great Recession? He is certainly a very smart and knowledgeable person of both monetary theory and history, so that should not be blamed. It was not the facts which caused him to blunder so badly, we are all presented with the same reality, rather it was his faulty methodology and misunderstanding of the the discipline of economics which doomed him. There were those, who are not considered the foremost scholars on the Great Depression, who predicted the collapse of the housing market and resulting recession. Are these individuals smarter or more gifted than Bernanke? Did they know some secret information which Bernanke didn't? The answer to both of those questions is simply 'No', the difference is they operated from a different methodological framework. Their framework gave them the insight to understand that the impact of monetary manipulation by the Federal Reserve and economic policies by the Federal Government create artificial bubbles in the economy. Those who predicted the collapse of the housing bubble were playing the game the right way, and they properly understand the impossibility of manipulating an economy. 

Austrian Business Cycle Theory follows praxeological methods to determine that economic manipulation is unsustainable because the behavior induced by the policies is artificial. This artificial behavior cannot be sustained long term because it requires ever increasing subsidy to maintain. When the subsidy is inevitably no longer big enough to prop up the artificial boom in the economy it must correct and resume its natural form. The Austrian method does not come to this conclusion by looking at data but rather through a method of logical deduction. By following necessarily, A Priori, true steps the resulting theory must inevitably be true.

The fault within scientistic methods of economics is that neglect the humanity of the subject which they attempt to quantify. By treating human beings as nothing more than particles they ruin their entire perspective. Unlike phenomena from the physical world human beings are motivated internally. That means that each human being acts in accordance to his own set of values, and because each person is different every person acts based on different values. Adam Smith criticized the view of human beings as economic subjects in an excerpt from his book The Theory of Moral Sentiments, referred to as The Man of System. Smith contrasts and even spells out the consequence of such economic manipulation. Of the Man of System he writes:

He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.