Reliance on historical data as a foundation for understanding economics is problematic. Data cannot explain the facts of reality without a theory that both “stands on its own feet” and is not derived from the data itself.
Most mainstream economists believe the application of quantitative methods on historical data can explain the state of the economy. Others such as Ludwig von Mises held that the data utilized by economists is a historical display, which by itself cannot provide the facts of economics. Ludwig von Mises wrote, “Experience of economic history is always the experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment.”
To make sense of historical data, economists must have a theory that stands on its own and does not originate from the data itself. Even economists who call themselves “practical” must employ a theory to make sense of historical data. Even seeking correlations between the various pieces of historical data is using a theory that says correlations help explain reality. There cannot be historical data analysis without a theory to direct it.
A theory resting upon the view that human beings act consciously and purposefully fulfills this requirement. That human beings act consciously and purposefully cannot be refuted, for anyone who tries to do so does it consciously and purposefully, thus contradicting himself. Murray N. Rothbard wrote, “But while most things have no consciousness and therefore pursue no goals, it is an essential attribute of man’s nature that he has consciousness, and therefore that his actions are self-determined by the choices his mind makes.”
That human action is conscious and purposeful allows one to make sense of historical data. Contrary to various theories that rely on correlations, which merely describe the data, the theory that human actions are conscious and purposeful explains it.
Why Methods of Natural Sciences Are Not Applicable in Economics
Most economists believe that the methods of natural sciences such as laboratory experiments can lead to a major breakthrough in our understanding of economics. According to Rothbard,
This methodology, briefly, is to look at facts, then frame ever more general hypotheses to account for the facts, and then to test these hypotheses by experimentally verifying other deductions made from them. But this method is appropriate only in the physical sciences, where we begin by knowing external sense data and then proceed to our task of trying to find, as closely as we can, the causal laws of behavior of the entities we perceive. We have no way of knowing these laws directly; but fortunately, we may verify them by performing controlled laboratory experiments to test propositions deduced from them. In these experiments we can vary one factor, while keeping all other relevant factors constant. Yet the process of accumulating knowledge in physics is always rather tenuous; and, as has happened, as we become more and more abstract, there is greater possibility that some other explanation will be devised which fits more of the observed facts and which may then replace the older theory.
In contrast,
while laboratory experiments are valid in the natural sciences, it is not so in economics. In the study of human action, on the other hand, the proper procedure is the reverse. Here we begin with the primary axioms; we know that men are the causal agents, that the ideas they adopt by free will govern their actions. We therefore begin by fully knowing the abstract axioms, and we may then build upon them by logical deduction, introducing a few subsidiary axioms to limit the range of the study to the concrete applications we care about. Furthermore, in human affairs, the existence of free will prevents us from conducting any controlled experiments; for people’s ideas and valuations are continually subject to change, and therefore nothing can be held constant. The proper theoretical methodology in human affairs, then, is the axiomatic-deductive method. The laws deduced by this method are more, not less, firmly grounded than the laws of physics; for since the ultimate causes are known directly as true, their consequents are also true.
While scientists can isolate various particles, they do not know the laws that govern these particles. All that they can do is hypothesize regarding the “true law” that governs the behavior of the identified particles and can never be certain what that law might be.
According to Mises,
The physicist does not know what electricity “is.” He knows only phenomena attributed to something called electricity. But the economist knows what actuates the market process. It is only thanks to this knowledge that he is in a position to distinguish market phenomena from other phenomena and to describe the market process.
Mainstream economists employ various quantitative methods. Rothbard and others, however, have had serious misgivings on the use of quantitative methods in economics. On this Rothbard wrote,
Not only measurement but the use of mathematics in general in the social sciences and philosophy today, is an illegitimate transfer from physics. In the first place, a mathematical equation implies the existence of quantities that can be equated, which in turn implies a unit of measurement for these quantities. Second, mathematical relations are functional; that is, variables are interdependent, and identifying the causal variable depends on which is held as given and which is changed. This methodology is appropriate in physics, where entities do not themselves provide the causes for their actions, but instead are determined by discoverable quantitative laws of their nature and the nature of the interacting entities. But in human action, the free-will choice of the human consciousness is the cause, and this cause generates certain effects. The mathematical concept of an interdetermining “function” is therefore inappropriate. Indeed, the very concept of “variable” used so frequently in econometrics is illegitimate, for physics is able to arrive at laws only by discovering constants. The concept of “variable” only makes sense if there are some things that are not variable, but constant. Yet in human action, free will precludes any quantitative constants (including constant units of measurement). All attempts to discover such constants (such as the strict quantity theory of money or the Keynesian “consumption function”) were inherently doomed to failure.
Again, contrary to the natural sciences, the factors pertaining to human action cannot be isolated and broken into their simple elements. However, in economics we know that human beings act consciously and purposefully. This knowledge, in turn, better helps us to understand economics.
Consider a situation in which the central bank announces that raising the money supply growth rate while price inflation is low could lift real economic growth. Being the medium of exchange, however, money can only facilitate existing wealth. It cannot generate more wealth on its own. Money is not a physical factor of production, nor can it be consumed. Thus, we can conclude that printing money cannot expand economic growth. On the contrary, increasing the money supply growth rate will lead to economic impoverishment. Hence, we can conclude that money supply is not a suitable mean to raise real economic growth.
The fact that individuals pursue purposeful actions implies that causes in economics emanate from human beings, not outside factors. This means that quantitative methods will not be helpful in explaining economics. All that quantitative methods can do is describe movements of historical data; it cannot identify the driving forces of economic activity.
Conclusion
Reliance on historical data as a foundation for understanding economics is problematic. Data cannot explain the facts of reality without a theory that both “stands on its own feet” and is not derived from the data itself.
