The Laws of Economics Do Not Stop at Borders and Do Not Face an Expiration Date

|Peter Boettke|

In the age of scientism, the language of the inexorable laws of economics gave way to the language of falsificationism.  The modern scientific mind did not sit well with claims about foundations and universality.  But as Kirzner pointed out in his introduction to Mises's The Ultimate Foundations of Economics Science "Mises saw the denial of economics as an alarming threat to a free society and to Western civilization." (1978, vii)  It is economics, after all, that can demonstrate through its tools of critical evaluation the impossibility of rational economic calculation under socialism, the unstable dynamics of interventionism, and the great benefits of social cooperation under the division of labor that the unhampered market economy can deliver for all of mankind.

The laws of economics have no geographic border and no expiration on time.   The laws of economics hold across time and place.  Demand curves sloped downward for our ancestors and they will slope downward for the future human inhabitants of this world.  Time and place matter in questions of the manifestation of the laws of economics, and the magnitude of the effect.  But the pure logic of human action is neither time specific nor country specific.

Why start this discussion today?

Well because we are seeing the vindication of Mises (and other good economists) main points about economic policy all around the world today, but not everyone "gets it."  What happened in Greece, what happened in Ireland, what is happening in Portugal, and will happen in Spain, is not limited to those countries or to problems in 2010.  The western democratic states have attempted to live in the denial of economic laws for decades.  Governments where aided in this denial by growing legions of "economists" and economic policy "experts".  This has produced a world which attempted to "paper over" (literally with currency manipulation) the fault lines in economies that have resulted from bad economic policies.  But what is wrong with Portugal is also what is wrong with California, let alone the other "PIGS" countries.

Markets are amazingly resilient forces as individuals even in the worst of circumstances will attempt to realize the gains from trade and the gains from innovation.  We are constantly confronted in economic life with the counter-factual --- what would economic growth look like if the parasitic and predatory state simply wasn't in place to thwart economic progress.  If even relatively free market economies produce such amazing growth through the gains from trade and the gains from innovation, then imagine what might result under a truly free market system.  And also realize how much stupidity the gains from trade and the gains from innovation can off-set.  Adam Smith recognized the stupidity, as did Ludwig von Mises -- we have experienced tremendous progress since Adam Smith and also since Ludwig von Mises wrote, but not as much as would have been experienced had we really learned from them rather than just pay lip-service to the teachings of economics in the realm of public policy.  And the denial of the teachings of economics by politicians and policy experts has brought the economies of the western democracies to their knees in a public debt crisis.  Next up, unless we watch and heed Adam Smith's warnings, will be a monetary system crisis.  The "juggling tricks" of deficits, debt and debasement can only conceal the deleterious effects of bad policy for so long.

In the concluding paragraph of Human Action, Mises provides us with as clear a message as any ever written by an economist: "The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built.  It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused.  But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race." (1966, 885).

As you watch the events unfold in Europe and also right here in the US recognize that the policies that have resulted in the situation are a consequence of men (whether they "economists" or not is besides the point) denying the laws of economics.  It is high time that the teachings of mainline economics (and not the fashionable scientistic or statist trend of thought at the moment that reflects 'mainstream' economics) be taught consistently and persistently in our schools, be voiced clearly and loudly in public talks and policy discussions, and be expressed in written word with force and clarity in newspapers, magazines, scientific journals, and books (both popular and specialized monographs).  Economics proper must be wrestled from the grip of the pretend "economists" and policy "experts".  Not every true economist must fight on each of these margins, the law of comparative advantage holds for economists as well as everyone else!  But what is true, is that we have to once again understand and appreciate the status of economic laws --- they know no geographic boundary, and possess no historical expiration date.  The laws of economics hold over time and across people.  Denial of the laws by popular vote or strike or clever thought experiments does not deny the laws of economics themselves.  It just produces things like the Great Depression, or the Collapse of Communism, the Failure of Development Planning, and the fiscal crises that is plaguing the PIGS at the moment.

 

Comments

[Roger McKinney]

Nice! Thanks! I was wondering the other day why economics isn't a required subject in high school. We require specific hours of education in English, art, history, science and PE, but not economics. Yet 90% of politics is about economics, and most of our daily lives involve economic issues. Yet we teach things that have no bearing on the most important issues in our lives.

[Jerry O'Driscoll]

Bravo!

As Pete indicates, the problem of public debt and the linkage to monetary mischief was known to Adam Smith and elaborated on by the classical political economists. Their hostility to public debt was animated by familiarity with historical experience.

Now we face excess private debt fueled by public-sector guarantees. In a banking crisis, bank debt becomes public debt: in Greece, Ireland and the US. The mortgage debt created in excess of housing values now is a burden on taxpayers as a whole. Those who pay their mortgages are now doubly burdened: they must pay their own debt plus that of deadbeat borrowers and insolvent banks.

[Pietro M.]

I'm quite happy that Ireland stole the 'I' in PIGS to Italy. :-)

[jiam]

Don't forget about Giffen goods!

[Peter Boettke]

Jiam,

No such thing, the empirical phenomena can be explained using a shift of the curve not a movement along the curve.

Pete

[Rafael Guthmann]

I would say that we can understand the possibility existence of Giffen goods, even if it may be purely theoretical possibility. They don't violate the laws of economics.

[Current]

> I'm quite happy that Ireland stole the 'I' in PIGS to Italy. :-)

In Ireland we use the term "PIIGS"

I've written about this too...
http://www.cobdencentre.org/2010/11/learning-the-wrong-lessons-from-ireland/

[Jerry O'Driscoll]

Ireland's problem was letting its economy become dominated by finance, insurance and real estate. It's an unstable brew that few countries can pull off. It doesn't happen w/o government connivance.

Euro skeptics predicted that the project would end badly. No single interest rate could possibly be correct for all the members.

It's a Hayek story for today.

Happy Thanksgiving to all.

[pc kurse]

waht is PIIGS? i dont know it

[Current]

> waht is PIIGS? i dont know it

The Eurozone countries that are in trouble:

Portugal Ireland Italy Greece Spain

[Current]

Jerry,

I'm sure that your view on this is quite sophisticated. The problem though with criticizing economies "dominated by finance, insurance and real estate", is that when the message gets put out for public consumption it gets mangled into something about greedy bankers and regulating them.

As I said in my article I still don't like the idea of "correct" interest rates.

[Mathieu Bédard]

What's scary is that no deep change, no self-questioning, no debate is born from this crisis. I used to believe it was pessimistic to think European governments wouldn't steer their public finance before they hit the wall, but now I see that even after they've hit it not only they won't steer back to sanity, but they still honk trying to make the wall go away.

[Current]

> Ireland's problem was letting its economy become dominated by
> finance, insurance and real estate. It's an unstable brew that few
> countries can pull off. It doesn't happen w/o government connivance.

Ask yourself this: what should the government have done? Enacted laws to suppress "speculation" or subsidised the "real economy"?

The fact is that the reason these countries locate in Ireland is because of how they are treated elsewhere. The corporation tax rate is very low here. That means that companies with proven business models gain a lot by locating here. That's important for technology companies too, such as Dell and Analog Devices where I've worked.

Finance companies also benefit from English style laws that make drawing up contracts easier. Did you know that the Greek bailout agreement which was between the Eurozone countries and Greece was made under English law?

Much the same is true for real estate. Ireland has reasonable planning laws (unlike Britain where it takes years to get permission for anything). And Ireland needs a lot of new buildings, the preceding 70 years of economic stagnation haven't produced a stock of good existing buildings as in other European countries.

So, it's natural that finance businesses thrive and that construction is important. The government did encourage that with construction projects and it's true they didn't need to do that. And of course there are the corrupt relations with Irish banks. But, the boom would have happened anyway.

> Euro skeptics predicted that the project would end badly. No single
> interest rate could possibly be correct for all the members.

I agree that the Irish banking industry dealt badly with the great rise in funds available to them as a result of the euro.

But, I don't think that availability of more savings can ever be a bad thing by itself. There are perhaps a few circumstances where it could be. Hayek believed that a short term rise in savings followed by a fall could provoke this. Perhaps it can, through account falsification have a similar effect to central bank money creation. Also, banks may fail to deal with maturity transformation well.

But, I don't think that this necessarily means that common currencies are a bad idea. Rejecting them in this case means making funds for investment more expensive, because of concerns about the cycle. Remember that if a gold standard were implemented then there would not have one interest rate per country there would be a "gold zone" interest rate.

I agree that we should criticise the political aims of the Eurozone and it's prevention of currency competition. But, I don't agree with the idea that there is one correct interest rate per country. The interest rate is a market price. Like any other market prices there are regional variations. But, if the market eliminates those regional variations it's hard to claim that this is detrimental.

In the long run I think each countries economy and banking system must become accustomed to being part of the global credit market. That doesn't mean that every economy must become used to the behaviour of central banks, but it does mean that they must become used to the natural ebb and flow of savings. We can't let a situation come about where governments deny their countries the benefit of capital flows because they don't think those countries can deal with them.

Austrians often talk about the "hangover" from the "binge" of the boom. By analogy central bank induced low interest rates are like alcohol or drugs. Certainly we should avoid those. But international capital flows are really not the same, they're more like someone offering you a curry after you've lived all your life eating potatoes. Yes, you may not be able to stomach the curry the first time around, but it's probably best that you try it and become accustomed to what the rest of the world has to offer.

[Bill Stepp]

How about PIGIS, as in "these little PIGIS went to market"?
The Buttonwood column in The Economist this week (Nov. 20th) is about the Austrian explanation for the crisis, "Taking von Mises to Pieces."
He mentions the misallocation of capital in housing and real estate, but neglects its occurence in other markets as well. He mentions Lawrence White's promotion of the Austrian theory.

[Jerry O'Driscoll]

Bill,

I'm sure there are country-specific stories with respect to housing bubbles. (I know some.) As John Taylor has argued, however, other countries follow Fed policy with a lag. Taylor is no Austrian.

Ireland was a high-growth economy and the equilibrirum ("natural") interest rate for it would have been higher than for the EU core. In other words, the EU was not a common currency area. So Ireland (and Spain and others) boomed while others struggled with the same ECB monetary policy.

Housing is a pre-eminent interest-sesnitive asset. Modern mortgage finance has arguably made it more so. And modern restrictions on supply have made its supply less price elastic.

[Pietro M.]

Has anyone argued that the fact that 10 years of euro haven't put Spain and Germany in intertemporal equilibrium speaks volumes against general equilibrium theorizing? I don't know how stationary analyses (99% of GE models in macroeconomics) can be trusted when it is so evident that the hypothesis is absurd. If countries take more than ten years to get used to a common money, then neutrality is not a property of real-world money.

[Jerry O'Driscoll]

Good point, Pietro.

[Current]

Pietro & Jerry,

I think that Spain and Germany have both adjusted to the Euro. But, they're domestic policies are different, just as Ireland's are quite different from mainland Europe.

Adjustments of wages can't occur in the same way across the Eurozone because of different domestic policies. The same is true of many other prices too. Banking regulation is very different. (We had a thread on that a while ago where I gave how Irish and British mortgages work and French and German commentators explained how there's are different).

> Ireland was a high-growth economy and the
> equilibrirum ("natural") interest rate for it would
> have been higher than for the EU core. In other words,
> the EU was not a common currency area. So Ireland (and
> Spain and others) boomed while others struggled with
> the same ECB monetary policy.

When I lived in Cambridge in England that was a high-growth economy. When I lived in Sheffield in England that wasn't. Does that mean that they weren't part of a common currency area?

Don't get me wrong, I hate the EU. But, I'm really not sure about this whole idea of optimum currency areas.