PHILOSOPHY OF ECONOMIC GROW & IT’S IMPLICATIONS FOR BUSINESS
Introduction: What is Economics?
Both the definition and the precise domain of economics are subjects of controversy within philosophy of economics. At first glance, the difficulties in defining economics may not appear serious. Economics is, after all, concerned with aspects of the production, exchange, distribution, and consumption of commodities. But this claim and the terms it contains are vague; and it is arguable that economics is relevant to a great deal more. It helps to approach the question, ―What is economics?‖ historically, before turning to comments on contemporary features of the discipline.
The emergence of economics and of economies
Philosophical reflection on economics is ancient, but the conception of the economy as a distinct object of study dates back only to the 18th century. Aristotle addresses some problems that most would recognize as pertaining to economics mainly as problems concerning how to manage a household. Scholastic philosophers addressed ethical questions concerning economic behavior, and they condemned usury — that is, the taking of interest on money. With the increasing importance of trade and of nation-states in the early modern period, ‗mercantilist‘ philosophers and pamphleteers were largely concerned with the balance of trade and the regulation of the currency. There was an increasing recognition of the complexities of the financial management of the state and of the possibility that the way that the state taxed and acted influenced the production of wealth.
In the Twentieth Century, economists stripped this general theory of rationality of its hedonistic clothing (Pareto 1909, Hicks and Allen 1934). Rather than supposing that all consumption choices can be ranked by how much they promote an agent's happiness, economists focused on the ranking itself. All that they suppose concerning evaluations is that agents are able consistently to rank the alternatives they face. This is equivalent to supposing first that rankings are complete — that is, for any two alternatives x and y that the agent may evaluate or choose, either the agent ranks x above y (prefers x to y), or the agent prefers y to x, or the agent is indifferent. Second, economists suppose that agent's rankings of alternatives (preferences) are transitive. To say that an agent's preferences are transitive is to claim that if the agent prefers x to y and y to z, then the agent prefers x to z, with similar claims concerning indifference and
An Essay on the Nature and Significance of Economic Science, Lionel Robbins defined economics as ―the science which studies human behavior as a relationship between ends and scarce means which have alternative uses‖ (1932, p. 15). According to Robbins, economics is not concerned with production, exchange, distribution, or consumption as such. It is instead concerned with an aspect of all human action. Although Robbins' definition helps one to understand efforts to apply economic concepts, models, and techniques to other subject matters such as the analysis of voting behavior and legislation, it seems evident that economics maintains its connection to a traditio nal domain.
Contemporary economics and its several schools
Contemporary economics is extremely diverse. There are many schools and many branches. Even so-called ―orthodox‖ or ―mainstream‖ economics has many variants. Some mainstream economics is highly theoretical, though most of it is applied and relies on only rather rudimentary theory. Both theoretical and applied work can be distinguished as microeconomics or macroeconomics. Microeconomics focuses on relations among individuals (though firms and households often count as honorary individuals and little is said about the demand of particular individuals for specific commodities as opposed to aggregate demand for those commodities). Individuals have complete and transitive preferences that govern their choices. Consumers prefer more commodities to fewer and have ―diminishing marginal rates of substitution‖ — i. e. they will pay less for units of a commodity when they already have lots of it than when they have little of it. Firms attempt to maximize profits in the face of diminishing returns: holding fixed all the inputs into production except one, output increases when there is more of the remaining input, but at a diminishing rate.
Economists idealize and suppose that in competitive markets, firms and individuals cannot influence prices, but economists are also interested in strategic interactions, in which the rational choices of separate individuals are interdependent. Game theory, which is devoted to the study of strategic interactions, is of growing importance both in theoretical and applied microeconomics. Economists model the outcome of the profit- maximizing activities of firms and the attempts of consumers to best satisfy their preferences as an equilibrium in which there is no excess demand on any market. What this means is that anyone who wants to buy anything at the going market price is able to do so. There is no excess demand, and unless a good is free, there is no excess supply.
Macroeconomics grapples with the relations among economic aggregates, such as relations between the money supply and the rate of interest or the rate of growth, focusing especially on problems concerning the business cycle and the influence of monetary and fiscal policy on economic outcomes. Many mainstream economists would like to unify macroeconomics and microeconomics, but few economists are satisfied with the attempts that have been made to do so, especially via so called ―representative agents‖ (Kirman 1992, Hoover 2001a). Econometrics is a third main branch of economics, devoted to the empirical estimation, elaboration, and to some extent testing of specific microeconomic and macroeconomic models (but see summers 1991 and Hoover 1994). Macroeconomics is immediately relevant to economic policy and hence (and unsurprisingly) subjects to much more heated (and politically- charged) controversy than microeconomics or econometrics.
Six central methodological problems
Although the different branches and schools of economics raise a wide variety of epistemological and ontological issues concerning economics, six problems have been central to methodological reflection (in this philosophical sense) concerning economics:
Positive versus normative economics
Policy makers look to economics to guide policy, and it seems inevitable that even the most esoteric issues in theoretical economics may bear on some people's material interests. The extent to which economics bears on and may be influenced by normative concerns raises methodological questions about the relationships between a positive science concerning ―facts‖ and a normative inquiry into values and what ought to be. Most economists and methodologists believe that there is a reasonably clear distinction between facts and values, between what is and what ought to be, and they believe that most of economics should be regarded as a positive science that helps policy makers choose means to accomplish their ends, though it does not bear on the choice of ends itself.
This view is questionable for several reasons (Mongin 2006, Hausman and McPherson 2006). First economists have to interpret and articulate the incomplete specifications of goals and constraints provided by policy makers (Machlup 1969b). Second, econo mic ―science‖ is a human activity, and like all human activities, it is governed by values. Those values need not be the same as the values that influence economic policy, but it is debatable whether the values that govern the activity of economists can be sharply distinguished from the values that govern policy makers. Third, much of economics is built around a normative theory of rationality. One can question whether the values implicit in such theories are sharply distinguishable from the values that govern policies. For example, it may be difficult to hold a maximizing view of individual rationality, while at the same time insisting that social policy should resist maximizing growth, wealth, or welfare in the name of freedom, rights, or equality. Fourth, people's views of what is right and wrong are, as a matter of fact, influenced by their beliefs about how people in fact behave. There is evidence that studying theory that depicts individuals as self- interested leads people to regard self- interested behavior more favorably and to become more self- interested (Marwell and Ames 1981, Frank et al. 1993).
Reasons versus causes
Orthodox theoretical microeconomics is as much a theory of rational choices as it a theory that explains and predicts economic outcomes. Since virtually all economic theories that discuss individual choices take individuals as acting for reasons, and thus in some way rational, questions about the role that views of rationality and reasons should play in economics are of general importance. Economists are typically concerned with the aggregate results of individual choices rather than with particular individuals, but their theories in fact offer both causal explanations for why individuals choose as they do and accounts of the reasons for their choices. See also the entry on Methodological Individualism.
Explanations in terms of reasons have several features that distinguish them from explanations in terms of causes. Reasons justify the actions they explain, and indeed so called
―external reasons‖ (Williams 1981) only justify action, without purporting to explain it. Reasons can be evaluated, and they are responsive to criticism. Reasons, unlike causes, must be intelligible to those for whom they are reasons.
Social scientific naturalism
Of all the social sciences, economics most closely resembles the natural sciences. Economic theories have been axiomatized, and articles and books of economics are full of theorems. Of all the social sciences, only economics boasts an ersatz Nobel Prize. Economics is thus a test case for those concerned with the extent of the similarities between the natural and social sciences. Those who have wondered whether social sciences must differ fundamentally from the natural sciences seem to have been concerned mainly with three questions:
(i) Are there fundamental differences between the structure or concepts of theories and explanations in the natural and social sciences? Some of these issues were already mentioned in the discussion above of reasons versus causes.
(ii) Are there fundamental differences in goals? Philosophers and economists have argued that in addition to or instead of the predictive and explanatory goals of the natural sciences, the social sciences should aim at providing us with understanding. Weber and others have argued that the social sciences should provide us with an understanding ―from the inside‖, that we should be able to empathize with the reactions of the agents and to find what happens ―understandable‖ (Weber 1904, Knight 1935, Machlup 1969a). This (and the closely related recognition that explanations cite reasons rather than just causes) seems to introduce an element of subjectivity into the social sciences that is not found in the natural sciences.
(iii) Owing to the importance of human choices (or perhaps free will), are social phenomena too ―irregular‖ to be captured within a framework of laws and theories? Given human free will, perhaps human behavior is intrinsically unpredictable and not subject to any laws. But there is, in fact, much regularity in human action, and given the enormous causal complexity characterizing some natural systems, the natural sciences must cope with many irregularities, too.
Abstraction, idealization, and ceteris paribus clauses in economics
Economics raises questions concerning the legitimacy of severe abstraction and idealization. For example, mainstream economic models often stipulate that everyone is perfectly rational and has perfect information or that commodities are infinitely divisible. Such claims are exaggerations, and they are clearly false. Other schools of economics may not employ idealizations that are this extreme, but there is no way to do economics if one is not willing to simplify drastically and abstract from many complications. How much simplification, idealization, abstraction or ―isolation‖ (Mäki
2006) is legitimate?
In addition, because economists attempt to study economic phenomena as constituting a separate domain, influenced only by a small number of causal factors, the claims of economics are true only ceteris paribus — that is, they are true only if there are no interferences or disturbing causes. What are ceteris paribus clauses, and when if ever are they legitimate in science? Questions concerning ceteris paribus clauses are closely related to questions concerning simplifications and idealizations, since one way to simplify is to suppose that the various disturbing causes or interferences are inactive and to explore the consequences of some small number of causal factors. These issues and the related question of how well supported economics is by the evidence has been the central questions in economic methodology. They will be discussed further below in Section 3 and elsewhere.
Causation in economics and econometrics
Many important generalizations in economics are causal claims. For example, the law of demand asserts that a price increase will (ceteris paribus) diminish the quantity demanded. (It does not merely assert an inverse relationship between price and demand. When demand increases for some other reason, such as a change in tastes, price increases.) Econometricians have also been deeply concerned with the possibilities of determining causal relations from statistical evidence and with the relevance of causal relations to the possibility of consistent estimation of parameter values. Since concerns about the consequences of alternative policies are so central to economics, causal inquiry is unavoidable.
Before the 1930s, economists were generally willing to use causal language explicitly and literally, despite some concerns that there might be a conflict between causal analysis of economic changes and ―comparative statics‖ treatments of equilibrium states. Some economists were also worried that thinking in terms of causes was not compatible with recognizing the multiplic ity and mutuality of determination in economic equilibrium. In the anti- metaphysical intellectual environment of the 1930s and 1940s (of which logical positivism was at least symptomatic), any mention of causation became highly suspicious, and economists commonly pretended to avoid causal concepts. The consequence was that they ceased to reflect carefully on the causal concepts that they continued implicitly to invoke (Hausman 1983, 1990, Helm 1984, Runde 1998). For example, rather than formulating the law of demand in terms of the causal consequences of price changes for quantity demanded, economists tried to confine themselves to discussing the mathematical function relating price and quantity demanded. There were important exceptions (Haavelmo 1944, Simon 1953, Wold 1954), and during the past generation, this state of affairs has changed dramatically.
For example, in his Causality in Macroeconomics (2001b) Kevin Hoover develops feasible methods for investigating large scale causal questions, such as whe ther changes in the money supply
(M) cause changes in the rate of inflation P or accommodate changes in P that are otherwise caused. If changes in M cause changes in P, then the conditional distribution of P on M should remain stable with exogenous changes in M, but should change with exogenous changes in P. Hoover argues that historical investigation, backed by statistical inquiry, can justify the conclusion that some particular changes in M or P have been exogenous. One can then determine the causal direction by examining the stability of the conditional distributions. Econometricians have made vital contributions to the contemporary revival of philosophical interest in the notion of causation. I n addition to Hoover's work, see for example Geweke (1982), Granger (1969, 1980), Cartwright (1989), Sims (1977), Zellner and Aigner (1988), Pearl (2000), Spirtes, Glymour and Scheines (2001).
One apparently secure way to determine causal relations is via randomized controlled experiments. If the experimenter‘s sorts subjects randomly into experimental and control groups and varies just one factor, then unless by bad luck the two groups differ in some unknown way, changes in the outcomes given the common features of the control and treatment groups should be due to the difference in the one factor. This makes randomized controlled trials very attractive, though no panacea, since the treatment and control groups may not be representative of the population in which policy- makers hope to apply the causal conclusions, and the causal consequences of the intervention might differ across different subgroups within the control and treatment groups (Worrall 2007).
Structure and strategy of economics: paradigms and research programmes
In the wake of the work of Kuhn (1970) and Lakatos (1970), philosophers are much more aware of and interested in the larger theoretical structures that unify and guide researc h within particular research traditions. Since many theoretical projects or approaches in economics are systematically unified, they pose questions about what guides research, and many economists have applied the work of Kuhn or Lakatos in the attempt to s hed light on the overall structure of economics (Baumberg 1977, Blaug 1976, de Marchi and Blaug 1991, Bronfenbrenner 1971, Coats 1969, Dillard 1978, Hands 1985b, Hausman 1992, ch. 6, Hutchison 1978, Latsis 1976, Jalladeau 1978, Kunin and Weaver 1971, Stanfield 1974, Weintraub 1985, Worland 1972). Whether these applications have been successful is controversial, but the comparison of the structure of economics to Kuhn's and Lakatos' schema has at least served to highlight distinctive features of economics. For example, asking what the ―positive heuristic‖ of mainstream economics consists in permits one to see that mainstream models typically attempt to demonstrate that an economic equilibrium will obtain, and thus that mainstream models are unified in more than just their common assumptions. Since the success of research projects in economics is controversial, understanding their global structure and strategy may clarify their drawbacks as well as their advantages.
Inexactness, ceteris paribus clauses, and “unrealistic assumptions”
As mentioned in the previous section, the most important methodological issue concerning economics involves the very considerable simplification, idealization, and abstraction that characterizes economic theory and the consequent doubts these features of economics raise concerning whether economics is well supported. Claims such as, ―Agents prefer larger commodity bundles to smaller commodity bundles,‖ raise serious questions, because if they are interpreted as universal generalizations, they are false. Can a science rest on false generalizations? If these claims are not universal generalizations, then what is their logical form? And how can claims that appear in this way to be false or approximate be tested and confirmed or disconfirmed? These problems have bedeviled economists and economic methodologists from the first methodological reflections to the present day.
Classical economics and the method a priori
The first extended reflections on economic methodology appear in the work of Nassau Senior (1836) and John Stuart Mill (1836). Their essays must be understood against the background of the economic theory of their times. Like Smith's economics (to which it owed a great deal) and modern economics, the ―classical‖ economics of the middle decades of the 19th century traced economic regularities to the choices of individuals facing social and natural constraints. But, as compared to Smith, more reliance was placed on severely simplified models.
David Ricardo's Principles of Political Economy (1817) draws a portrait in which wages above the subsistence level lead to increases in the population, which in turn require more intensive agriculture or cultivation of inferior land. The extension of cultivation leads to lo wer profits and higher rents; and the whole tale of economic development leads to a gloomy stationary state in which profits are too low to command any net investment, wages return to subsistence levels, and only the landlords are affluent.
Fortunately for the world, but unfortunately for economic theorists at the time, the data consistently contradicted the trends the theory predicted (de Marchi 1970). Yet the theory continued to hold sway for more than half a century and the consistently unfavorable data were explained away as due to various ―disturbing causes.‖ It is consequently not surprising that Senior's and Mill's accounts of the method of economics emphasize the relative autonomy of theory.