The Problem with Economics

Courtesy of Sandeep Jaitly @ Fekete Research:

“Thank goodness my task is to teach economics to a bunch of physicists and engineers. The other way around would take an infinite amount of time,” was the comment made by my economics lecturer on a supplemental course to my maths degree at Imperial College.

Economics is an often maligned subject, especially to the scientifically inclined. To the physicist, mechanical engineer or chemist, economics is a mystery. They cannot see why graduates in the subject could be honoured with a bachelor of science. Is this disdain justified? With the current state of classical economics, it most certainly is. Scientific enterprise has achieved many things that have improved the living standard of humanity, for example: the pyramidal teabag; the jet-propelled aircraft and the suspension bridge. Classical economics has no such claim.

The sciences are based on ‘axiomatic systems.’ An axiom is a proposition that cannot directly be proved but is rather self-evident. For example, in Euclid’s geometry one axiom is ‘all right angles are equal to one another.’ From a system of axioms, a science such as planar geometry can be described. Axioms might seem too obvious to individually contemplate – but are the sine qua non of all scientific endeavour. But what is the axiom or set of axioms that defines the subject of economics? Is it even possible to have a set of axioms that defines the essential character of economics? The German word for economics ‘volkswirtschaft’ is a better starting point for this question than the word ‘economics’ itself. The former describing activity with relationship to people and the latter implying a set of ethereal household rules that don’t really exist (‘economics’ is derived from the Greek work όικος and υομος meaning ‘house’ and ‘law’ respectively.)

There have been many attempts to define the characteristic principles of economics in a similar vein to Euclidean geometry and all were utterly lacking until the mid 19th century. For it was then that the father of what was to become the ‘Austrian’ school, Carl Menger, espoused the true and simple nature of economics with just one axiom…

Value does not exist outside of the consciousness of mankind.

This might not seem like a statement worth considering more than once, but its simplicity conceals the fundamental truth not only of economics, but of the nature of existence (however that is another story.) This axiom is a necessary and sufficient building block for the whole of economics. All economic traditions bar the ‘Austrian’ do not adhere to this statement whether blatantly or more hidden. ‘Classical’ economics always ties value down to something else other than the human being: land; labour and cost of production to name but a few. Karl Marx assumed labour determines value. Marx was wrong with tragic consequences.

Economics begins and ends with the human being. Menger’s axiom (as it shall now be known), certainly not scientific, mathematical or mechanical in character, has the ability to turn economics from a fuzzy and error fraught subject into an ideology on par with quantum physics in terms of rigour. A philosophical, poetic and non-scientific axiom has the ability to turn a non-science, indeed a nonsense, into a science as much as it can. How is this done?

Menger’s axiom gives rise to marginal utility. Marginal utility is the only correct expression of economics. It is the ‘boundary use’ that determines value to the human being. Each substance that satisfies a particular need can be graded with regards to satisfying various human needs. For example, water is undoubtedly of great use to the human being. Humanity cannot exist without water. Any particular individual might have the following ordinal uses for water, assuming they don’t have access to it currently: relief of own thirst; relief of pet’s thirst; watering flowers and cleaning windows. As each use to the individual is satisfied, the next use is considered all the way to cleaning windows – which is the marginal use in this case – that determines its ‘value’ to the human being.

The mechanical process above is an application and constant reapplication of Menger’s axiom. It is an ‘iterative’ or ‘self-similar’ procedure. The mechanism by which the value of a substance is achieved is similar in nature to the mechanisms that achieve fractal boundaries. The elaboration of this is well beyond this short missive. Professor Mandelbrot has shown that price point evolution (i.e. price charts) tends to exhibit fractal characteristics. A reflection on the application and reapplication of Menger’s axiom shows that the observations as well as the mechanisms are fractal in nature. There is no reason to assume that both the mechanism and observation would be similar in nature. Curiously they are…

The discovery of marginal analysis shattered the prevailing disciplines in economics at the time, but the reluctance to apply it in totality to all aspects of economic action survived. Cost of production, or ideas in a similar mould, would always be used to halt ideas progressed in the marginal style completely erroneously. Whenever this was done it was always against the grain of Menger’s axiom whether explicitly or not. The truth of the matter is that land and labour do feature in all economic activity to be sure, but their value is determined in so far as they satisfy a human need – they are an expense of economic endeavour, not the cause. The price of copper is not guaranteed to rise because of an exponentially rising cost base of production, as commentators frequently frame an argument for ever rising commodity prices. Rather the cost base of copper production is bid higher as a result of people desiring more copper. Should that desire go away, no matter how high the cost base of production, the price of copper will fall.

Menger’s axiom is the gateway to understanding the true nature of economics. Reflecting on it from time to time is a must. Let it be the mantra of the ‘Austrian’ school. Menger did not have the time to complete the finer details of marginal analysis. That is up to his intellectual descendants – whom you should count yourselves amongst. It is up to us to ensure that the ignorance of classical economics is destroyed and that the truth of the Austrian school rises in its place.

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