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Friday, June 18, 2004

Economics and Statistics 

An interesting question in economics is the proper role of statistics.
Ludwig von Mises is my favourite economist, yet he held that statistics have
no valid role in formulating or validating economic theory. It's
interesting to explore his reasons.

First, Mises held that for economics, unlike the physical sciences, there is
no laboratory where one can perform repeated experiments while holding
various aspects constant. Each day brings a new and unrepeatable
constellation of innumerable economic causes and effects, each in varying
degree. Thus, historical statistics alone cannot give us economic
principles. In fact, it's the other way around: economic principles must be
brought to bear in order to analyze and understand economic statistics and
history.

Second, Mises argued that the economist is in the opposite position to the
physical scientist. The physical scientist observes effects, and must use
experiments and measurement to reason back to the causes that are producing
those effects. In contrast, the economist knows from the start the
fundamental causes of all economic phenomena: individuals acting to pursue
their self-interest. What's not (initially) known is how exactly these
causes interact and play out to result in various economic phenomena. This
is what the economist must reason towards.

This point leads to an important methodological principle of Austrian
economics, what they call "methodological individualism". This principle
holds that every economic concept and principle must be reducible (and
reduced) to the choices and actions of individual people. (This is in
contrast to e.g. Keynesian theories, where floating "aggregates" act upon
and "cause" one another.)

Granted, Mises' economic theories are set upon his untenable theory of
"praxeology". But I am of the firm opinion that most, if not all, of his
economics can (and should) be reset upon Objectivist foundations. For
example, the principle of "methodological individualism" is, in my view, the
correct application in economics of the Objectivist principle of
concept-reduction.

Economic theory aside, I do think statistics is enormously valuable in the
*practice* of business and the financial markets. While it's true that
humans have free will, and might choose differently even facing the same
circumstances, usually there are broad patterns of behaviour that can be
counted on to endure, within a certain degree of variation, for a certain
length of time. Statistics can help to quantify these patterns. If this
were not the case, no business could rationally plan what to produce for the
future.

As an example, while it's possible for every American to suddenly choose
never to shop at Wal-mart again, it's false to assert that Wal-mart's sales
next year could just as easily be down 95%, as up 5%.



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