[2. STATISTICS] It stands to reason that for economics, statistics, that is, the statistical figure or series of figures must be of vital importance. In practice this has been recognized at least since the sixteenth and seventeenth centuries when a large part of the work of the Spanish políticos, for example, consisted in the collection and interpretation of statistical figures—not to mention the English econometricians, who were called political arithmeticians, and their fellow workers in France, Germany, and Italy. 1 We need statistics not only for explaining things but also in order to know precisely what there is to explain. But a comment has to be added that is analogous to the comment made in the preceding paragraph on the subject of history. It is impossible to understand statistical figures without understanding how they have been compiled. It is equally impossible to extract information from them or to understand the information that specialists extract for the rest of us without understanding the methods by which this is done—and the epistemological backgrounds of these methods. Thus, an adequate command of modern statistical methods is a necessary (but not a sufficient) condition for preventing the modern economist from producing nonsense, though very much more so in some fields than in others: our stake in these methods is too great for us to leave judgment on the virtues or shortcomings, say, of the variate-difference method to specialists, even if they were unanimous about it. Again, we shall not be able to live up to the program that follows from this. But again, we shall recognize, in principle at least: statistical methods are part of the tools of economic analysis even when not specially devised to meet its particular needs; and Jacques Bernoulli’s Ars conjectandi or Laplace’s Théorie analytique stand in the history of many sciences but they have their places also in the history of our own. 2 [3. ‘THEORY’] The third fundamental field is ‘theory.’ This term carries many meanings but only two of them are relevant so far as our own usage in this book is concerned. The first and less important one makes theories synonymous with Explanatory Hypotheses. Such hypotheses are of course essential ingredients of historiography and statistics also. For 1 It is therefore only as a curiosum that we notice the fact that the simple and apparently unchallengeable statement in the first sentence of the paragraph above has been staunchly denied by some economists to this day. 2 Lest the reader should throw up his hands in despair at the range of competence which the historical and statistical requirements seem to indicate, let me point out that these requirements can be easily fulfilled by every graduate student who has had a tolerably good undergraduate training in history or mathematics. Only the student without any training in either will have to realize that, as an all-round economist, he is suffering from a handicap and that he can move with assurance only within narrow portions of the science unless he is prepared to make up for his deficiencies by a heroic effort for which one or two years of graduate study are altogether inadequate. But it also takes more than that to become a scientifically competent lawyer or engineer or doctor. History of economic analysis 12 instance, even the most fiercely factual historian, economic or other, can hardly avoid forming an explanatory hypothesis or theory, or several explanatory hypotheses or theories, on the origins of towns. The statistician must form a hypothesis or theory, say, on the joint distribution of the stochastic variables that enter into his problem. All that needs to be said about this is that it is an error—though a widespread one—to believe that the sole or main business of the economic theorist consists in formulating such hypotheses (some may wish to add: out of the blue sky). Economic theory does something entirely different. It cannot indeed, any more than can theoretical physics, do without simplifying schemata or models that are intended to portray certain aspects of reality and take some things for granted in order to establish others according to certain rules of procedure. So far as our present argument is concerned, the things (propositions) that we take for granted may be called indiscriminately either hypotheses or axioms or postulates or assumptions or even principles, 1 and the things (propositions) that we think we have established by admissible procedure are called theorems. Of course a proposition may figure in one argument as a postulate and in another as a theorem. Now, hypotheses of this kind are also suggested by facts—they are framed with an eye to observations made—but in strict logic they are arbitrary creations of the analyst. 2 They differ from the hypotheses of the first kind in that they do not embody final results of research that are supposed to be interesting for their own sake, but are mere instruments or tools framed for the purpose of establishing interesting results. Moreover, framing them is no more all the economic theorist does than framing statistical hypotheses is all that the statistical theorist or in fact any theorist does. Just as important is the devising of the other gadgets by which results may be extracted from the hypotheses—all the concepts (such as ‘marginal rate of substitution,’ ‘marginal productivity,’ ‘multiplier,’ ‘accelerator’), relations between concepts, and methods of handling these relations, all of which have nothing hypothetical about them. 3 And it is the sum total of such gadgets—inclusive of strategically useful assumptions— which constitutes economic theory. In Mrs. Robinson’s unsurpassably felicitous phrase, economic theory is a box of tools. The rationale of this conception of economic theory is very simple and the same as in all other departments of science. Experience teaches us that the phenomena of a given class—economic, biological, mechanical, electrical, and what not—are indeed individual occurrences each of which, as it occurs, re- 1 By ‘principle’ we shall mean in this book any statement that we (or the authors under discussion) do not propose to challenge. But it may be a proposition that we (they) have established as well as a proposition that we (they) have postulated or assumed. The same holds for the objectionable term ‘law,’ the emergence and use or misuse of which will have to be carefully considered: we speak of the ‘law’ of decreasing returns or of Keynes’s ‘law’ of the propensity to consume, which are assumptions, but also of the Marxist ‘law’ of the falling rate of profit, which is a proposition that Marx thought he had established. 2 To use J.H.Poincaré’s simile: tailors can cut suits as they please; but of course they try to cut them to fit their customers. 3 Example: theoretical mechanics proceeds upon a number of assumptions (or hypotheses in this sense); but evidently the list of these assumptions is not the whole of theoretical mechanics but only constitutes, where explicitly assembled, its first chapter. Interlude I 13 veals peculiarities of its own. But experience also teaches us that these individual occurrences have certain properties or aspects in common and that a tremendous economy of mental effort may be realized if we deal with these properties or aspects, and with the problems they raise, once and for all. For some purposes it is indeed necessary to analyze every individual case of pricing in an individual market, every case of income formation, every individual business cycle, every international transaction, and so on. But even where this is necessary we discover that we are using, in each case, concepts that occur in the analysis of all. Next we discover that all cases, or at least large sets of individual cases, display similar features which, and the implications of which, may be treated for all of them together by means of general schemata of pricing, income formation, cycles, international transactions, and so on. And finally we discover that these schemata are not independent of one another but related, so that there is advantage in ascending to a still higher level of ‘generalizing abstraction’ on which we construct a composite instrument or engine or organon of economic analysis—though not the only one, as we have seen—which functions formally in the same way, whatever the economic problem to which we may turn 4 it. Richard Cantillon’s 5 work is the first in which awareness of this last truth is clearly discernible, though economists took over a century to realize all its possibilities—Léon Walras was in fact the first to do so (see below Part IV, ch. 6, sec. 5b). Although it is neither possible nor desirable for us to embark upon an epistemology of economics and although some of the topics pertaining to that field will receive attention both in the subsequent chapters of this Part and in all the subsequent Parts, it will be helpful to insert here a few additional remarks in the hope that they will do something to scale down possible barriers between myself and my readers. First, then, a qualification should be added to the preceding argument about the nature and functions of economic theory. This argument ran in terms which are applicable, substantially at least, to all sciences that have any all-purpose apparatus of analysis. But there are limits to this parallelism and the most important of them are represented by the two following facts. Economics lacks the benefits that physics derives from laboratory experiments—when economists talk about experimenting they mean something quite different from experimenting under laboratory conditions—but enjoys instead a source of information that is denied to physics, namely, man’s extensive knowledge of the meanings of economic actions. This source of information is also a source of controversies that will bother us repeatedly on our journey. But its existence can hardly be denied. Now, when we speak, for example, of motives that are supposed to actuate individuals or groups, our source of information may be roughly identified with knowledge of psychic processes, conscious or 4 The statement above is a brief rendering of E.Mach’s doctrine that every (theoretical) science is a device for effecting economy of effort (Denkökonomie). 5 See below Part II, ch. 4, sec. 2. History of economic analysis 14 subconscious, which it would be absurd not to use, although, as I shall never cease to emphasize, this is not the same thing as trespassing upon the field of professional psychology—any more than stating the ‘law’ of decreasing returns from land implies trespassing upon the realm of physics. There is, however, also another way of interpreting our knowledge of meanings which is more akin to logic. If I state, for example, that—under a number of conditions—instantaneous gains of a firm will be maximized at the output at which marginal cost equals marginal revenue (the latter equaling price in the case of pure competition), I may be said to be formulating the logic of the situation and a result that is true, just as is a rule of general logic, independently of whether or not anyone ever acts in conformity to it. This means that there is a class of economic theorems that are logical (not, of course, ethical or political) ideals or norms. And they evidently differ from another class of economic theorems that are directly based upon observations, for example, on observations as to how far expectations of employment opportunity affect workmen’s expenditure on consumers’ goods or how variations in wages affect the marriage rate. It would no doubt be possible to assimilate both types of theory by interpreting the logical norms also as ‘purifying’ generalizations from observational data, if need be, from observations that are subconsciously stored up by common experience. On the whole, however, it seems better not to do so but to recognize frankly that we have, or think we have, the ability to understand meanings and to represent the implications of these meanings by appropriately constructed schemata. Second, the foregoing explanation may have done something toward exonerating me from the suspicion that I am tainted with Scientism. This term has been introduced by Professor von Hayek 6 to denote the uncritical copying of the methods of mathematical physics in the equally uncritical belief that these methods are of universal application and the peerless example for all scientific activity to follow. This history as a whole will answer the question whether there actually has been such uncritical copying of methods that have meaning only within the particular patterns of the sciences that developed them—apart of course from programmatic utterances that have been numerous enough ever since the awe-inspiring successes of the physical sciences in the seventeenth century but mean next to nothing. As regards the question of principle, there cannot be the slightest doubt that Hayek is right—and so were all who in the nineteenth century preceded him in uttering protests similar to his—in holding that the borrowing by economists of any method on the sole ground that it has been successful somewhere else is inadmissible, 6 F.A.von Hayek, ‘Scientism and the Study of Society,’ Economica, August 1942, February 1943, and February 1944. This treatise—these articles are nothing less than a treatise—is strongly recommended both because of the profound scholarship of which it is the product and because it presents an excellent example of how near to each other, in discussion of this kind, dwell truth and error. Interlude I 15 and that the rare and unimportant cases in which this has actually been done deserve what they get at his hands. Unfortunately this is not the real question. We have to ask what constitutes ‘borrowing’ before we can proceed to ask what constitutes illegitimate borrowing. And here we must beware of an optical illusion similar to the one that makes Marxists so reluctant to use such terms as price or cost or money or value of the services of land or even interest when speaking of a future socialist order: these terms denote concepts of general economic logic and seem to Marxists to be tainted with a capitalist meaning only because they are used also in capitalist society. Similarly, the concepts and procedures of ‘higher’ mathematics have indeed been first developed in connection with the physicist’s problems, but this does not mean that there is anything specifically ‘physicalist’ about this particular kind of language. 7 But this also holds for some ‘of the general concepts of physics, such as equilibrium potential or oscillator, or statics and dynamics, which turn up of themselves in economic analysis just as do systems of equations: what we borrow when we use, for example, the concept of an ‘oscillator’ is a word and nothing else. Two circumstances combine, however, to reinforce that optical illusion. On the one hand, physicists and mathematicians, when they hit upon those general concepts that occurred to us only later, not only baptized them but also worked out their logic. So long as this logic does not introduce anything ‘physicalist’ it would be waste of effort not to make use of it. On the other hand, students sometimes understand a physical analogy more readily than they do the economics of the case to be presented. Hence such analogies are often used in teaching. It therefore seems as though the things we are accused of borrowing are merely the reflexes of the fact that all of us, physicists or economists, have only one type of brain to work with and that this brain acts in ways that are to some extent similar whatever the task it tackles—the fact to which the Unity-of- Science movement owes its existence. This does not involve any mechanistic, deterministic or other ‘-istic’ errors, or any neglect of the truth that ‘to explain’ means something different in the natural and in the social sciences, or finally any denial of the implications of the historical character of our subject matter. Third, if economic theory is such a simple and harmless sort of thing as I have represented it to be, the reader might wonder where the hostility comes from that has followed it ever since it attracted any attention at all (which was roughly since the time of the physiocrats) to this day. I shall simply list the main headings for an answer which our story will amply verify: (1) At all times, including the present, in judging from the standpoint of the requirements of each period (not judging the state of the theory 7 Hayek’s teachers, the Austrian utility theorists, by operating the concept of marginal utility, actually discovered the calculus. It cannot be a crime to formulate their reasoning correctly. History of economic analysis 16 as it was at any time by standards of a later time) the performance of economic theory has been below reasonable expectation and open to valid criticism. (2) Unsatisfactory performance has always been and still is accompanied by unjustified claims, and especially by irresponsible applications to practical problems that were and are beyond the powers of the contemporaneous analytic apparatus. (3) But while the performance of economic theory was never up to the mark, that is, never what it might have been, it was at the same time beyond the grasp of the majority of interested people who failed to understand it and resented any attempt at analytic refinement. Let us distinguish carefully the two different elements that enter into this resentment. On the one hand, there were always many economists who deplored the loss of all those masses of facts that actually are lost in any process that involves abstraction. So far as application is concerned, resentment of this type is very frequently quite justified. On the other hand, however, there are untheoretical minds who are unable to see any use in anything that does not directly bear upon practical problems. Or, to put it less inoffensively, who lack the scientific culture which is required in order to appreciate analytic refinement. It is very important for the reader to bear in mind this curious combination of justified and unjustified criticism of economic theory, which will be emphasized all along in this book. It accounts for the fact that criticism of economic theory practically always proceeded from both people who were above and people who were below the level of the economic theory of their time. (4) The hostility that proceeded from these sources was frequently strengthened by the hostility to the political alliances which the majority of theorists persisted in forming. The classical example for this is the alliance of economic theory with the political liberalism of the nineteenth century. As we shall see, this alliance had the effect of turning for a time the defeat of political liberalism into a defeat of economic theory. And at that time many people positively hated economic theory because they thought it was just a device for bolstering up a political program of which they disapproved. This view came all the easier to them because economic theorists themselves shared their error and did all they could to harness their analytic apparatus into the service of their liberal political creed. In this and many analogous cases, of which modern economic theory is another deplorable example, economists indulged their strong propensity to dabble in politics, to peddle political recipes, to offer themselves as philosophers of economic life, and in doing so neglected the duty of stating explicitly the value judgments that they introduced into their reasoning. (5) Although really implied under one or more of the preceding headings, we may just as well list as a separate one the view that economic theory consists in framing unfounded, speculative hypotheses in the first of the two meanings that were distinguished above. Hence, the Interlude I 17 tendency quite frequent among economists or other social scientists to rule out economic theory from the realm of serious science. It is interesting to note that a propensity 8 of this kind is by no means confined to our field. Isaac Newton was a theorist if he was anything. Nevertheless, he displayed a marked hostility toward theory and especially toward framing of causal hypotheses. What he really meant was not theory or hypothesis of our second kind but just inadequately substantiated speculation. Perhaps there was also something else in this hostility, namely the aversion of the truly scientific mind to the use of the word ‘cause’ that carries a metaphysical flavor. Newton’s example may also be appealed to in order to illustrate the truth that dislike of the use of metaphysical concepts in the realm of empirical science does not at all imply any dislike of metaphysics itself. [J.A.S. intended to have these nine paragraphs of indented material set in small type so that it would be easy for the average reader to skip them.] [4. ECONOMIC SOCIOLOGY] The reader will have observed that our three fundamental fields, economic history, statistics and statistical method, and economic theory, while essentially complementing each other, do not do so perfectly. In writing economic history, there are indeed statements that should not be added at all unless properly substantiated by pieces of reasoning that belong to economic theory: such a statement is, for instance, the one that links England’s great economic development from the 1840’s to the end of the nineteenth century to the repeal of the Corn Laws and of practically every other kind of protection. The schemata of economic theory derive the institutional frameworks within which they are supposed to function from economic history, which alone can tell us what sort of society it was, or is, to which the theoretical schemata are to apply. Yet, it is not only economic history that renders this service to economic theory. It is easy to see that when we introduce the institution of private property or of free contracting or else a greater or smaller amount of government regulation, we are introducing social facts that are not simply economic history but are a sort of generalized or typified or stylized economic history. And this applies still more to the general forms of human behavior which we assume either in general or for certain social situations but not for others. Every economics textbook that does not confine itself to teaching technique in the most restricted sense of the word has such an in- 8 There is nothing to wonder at in the fact that on this ground alone the word economic theory, as used by some fellow economists, in itself implies derogation. To some extent, however, this attitude is simply a consequence of the fact that our intellectual tastes and aptitudes differ and that we naturally practice in our research according to our preferences. It is merely human nature that we overrate the importance of our own types of research and underrate the importance of the types that appeal to others. Perhaps it is not too much to say that we should never do what we are doing, both in science and in other pursuits of life, if we did not do this. History of economic analysis 18 stitutional introduction that belongs to sociology rather than to economic history as such. Borrowing from German practice, we shall find it useful, therefore, to introduce a fourth fundamental field to complement the three others, although positive work in this field also leads us beyond mere economic analysis: the field that we shall call Economic Sociology (Wirtschaftssoziologie). To use a felicitous phrase: economic analysis deals with the questions how people behave at any time and what the economic effects are they produce by so behaving; economic sociology deals with the question how they came to behave as they do. 1 If we define human behavior widely enough so that it includes not only actions and motives and propensities but also the social institutions that are relevant to economic behavior such as government, property inheritance, contract, and so on, that phrase really tells us all we need. Of course, it should be observed that this distinction is one we make for our own purposes. It is not implied that this distinction has been made by the authors themselves whom we are going to encounter. The proof of any pudding is in the eating and hence I refrain from saying anything in its defense just now. [5. POLITICAL ECONOMY] The sum total of the historical, statistical, and theoretical techniques that have been characterized above, together with the results they help to produce, we call (scientific) economics. This term is of relatively recent growth. A. Marshall’s great treatise was the first to establish its use, from 1890 on, at least in England and the United States. 1 In the nineteenth century, the term commonly in use was Political Economy, though in some countries other terms competed with it in the first decades of that century. This unimportant matter will be attended to, as we go along, in the subsequent Parts. But it is just as well to note two points at once. First, political economy meant different things to different writers, and in some cases it meant what is now known as economic theory or ‘pure’ economics. A warning must therefore be issued right now that in order to interpret correctly what any given writer said about the scope and method of political economy, we must always make sure of the meaning he attached to this term—some propositions about those subjects that have outraged critics become perfectly harmless if this rule be borne in mind. Second, ever since our science or agglomeration of sciences was baptized political economy by a not very significant writer of the seventeenth century whose work owes an undeserved immortality to this fact, there has been the implicit or explicit suggestion that the exclusive concern of our science was with the economy of the state— though of course not only of the polis, the city-state of Greece—or, what is almost the same thing, with public policies of an economic nature. This suggestion, which was still more emphasized by the German term frequently used as a synonym of political economy, Staats- wissenschaft, implied of course an altogether too narrow conception of the scope of economics. Incidentally, it over-emphasized the largely meaningless distinction between 1 I believe that this phrase is due to Mr. Gerhard Colm. 1 Later on, a parallel usage was introduced, though less firmly established, in Germany. The word was Social Economics, Sozialökonomie, and the man who did more than any other to assure some currency to it was Max Weber. Interlude I 19 economics and what is now called business economics. Let us therefore have it understood that we ourselves do not divorce the two and that all the facts and tools relevant to the analysis of the behavior of individual firms, past or present, come within our meaning of economics just as much as do the facts and tools relevant to the analysis of the behavior of governments, and therefore will have to be added to the contents of any narrower political economies of the past. We have, however, to notice a novel meaning of the term political economy that has asserted itself of late. Some contemporaneous economists are of the opinion that modern economic theory (in our sense) hangs too much in the air and does not take sufficient account of the fact that no sensible application to practical questions or even to the analysis of given situations of an economy can be made of its results without reference to the historico- political framework within which they are to hold. This opinion is sometimes extended so as to imply criticism of any work that concentrates on the improvement of theoretical or statistical tools of analysis, and then it seems to me to mean nothing except a failure to realize the inexorable necessity of specialized work. But all the more justified is this opinion if it be formulated as it has been in the first sentence of this paragraph. In particular, an economics that includes an adequate analysis of government action and of the mechanisms and prevailing philosophies of political life is likely to be much more satisfactory to the beginner than an array of different sciences which he does not know how to co-ordinate—whereas, to his delight, he finds precisely what he seeks ready-made in Karl Marx. An economics of this type is sometimes presented under the title Political Economy. In partial recognition of the truth that seems to be contained in this program, we have set up our ‘fourth fundamental field,’ Economic Sociology. Political Economy in the sense discussed in the preceding paragraph calls up still another meaning of the term, the one that occurs in a discussion of Systems of Political Economy. And this meaning in turn evokes, by association, the term Economic Thought. But it will be convenient to deal with these two concepts in Chapter 4. There we shall also try to clarify the relation of this History of Economic Analysis to any history of the systems of political economy and to any history of the thoughts on economic subjects that float in the public mind. [6. APPLIED FIELDS] Division of labor, in research as well as in teaching, has produced, in economics as elsewhere, an indefinite number of specialties that are usually described as ‘applied fields.’ In order to obtain a list of them (which does not claim to be complete) let us draw inspiration from the courses offered by the larger institutions of higher learning in the United States that teach economics. In addition to general survey courses and courses in economic history, statistics, economic theory, and economic sociology, 1 we find, first, offerings in a group of fields 1 Owing to the discredit that, for good reasons and bad, attaches to the word ‘theory’ in many minds, this word is occasionally replaced by the word ‘analysis’ which then carries a meaning that is more restricted than the one attached to it in this book. The field of economic sociology does not, so far as I am aware, appear under this title or separately, but topics belonging in it are treated in History of economic analysis 20 courses on history, theory, ‘comparative economic systems,’ the more institutionally oriented courses on labor, and in a number of others. which everyone considers part and parcel of ‘general economics’ and which receive separate treatment only in order to facilitate more intensive treatment of their subjects. Such are money and banking, business fluctuations (or cycles), foreign trade (international economic relations), and, occasionally, location. Second, we find a group of fields, such as accounting, actuarial science, and insurance, that, historically, have preserved altogether too much independence from general economics (which is slowly being surrendered in the case of accounting) but are useful or even indispensable for all or some economists, because they offer both instruments of economic analysis or opportunities for applying it—witness, for example, the subject of depreciation. Third, we find a group of standard fields that pivot on the old-established departments of public economic policy especially: agriculture, 2 labor, transportation and ‘utilities,’ the problems of manufacturing industry (and of its public control)—for which there is no generally accepted English name—and public finance (‘fiscal policy’), to which most people will add (for the present) a number of other fields such as marketing (‘commodity distribution’) and social security (so far as not covered by insurance). Socialism and ‘comparative economic systems’ or again ‘population’ may stand for a fourth group, and the ‘area studies’ that have become so popular of late for a fifth. Inclusion of other fields or the subdivision of some of those that have been mentioned could swell impressively the number of passengers in what we have described as a big bus. But our list as it stands and the reader’s general knowledge suffice to verify the three statements which it is relevant to our task to make. First, there is evidently no permanence or logical order to this jumble of applied fields. Nor are there definite frontier lines to any of them. They appear or vanish, they increase or decrease in relative importance, and they overlap with one another as changing interests and methods dictate. And, as has been indicated already, this is as it should be. To undertake or to refrain from undertaking any interesting task out of respect for frontiers or tectonics would be the height of absurdity. Second, all those special or applied fields, and not only the three that have been mentioned as constituents of our first group, are mixtures of facts and techniques that form what we have described as the four fundamental divisions of economic analysis in our sense. The mixtures differ greatly from one another because there are wide stretches of ground on which there is much less need or opportunity for elaborate statistical or theoretical tools than there is in others or even none at all, though the historical element can hardly ever be entirely neglected with impunity. In addition, the mixtures also differ for another reason: the specialist workers in the various fields are, individually and groupwise, very differently grounded in the fundamental fields, and so 2 The field of agriculture offers an interesting example of a department of economics that it is hardly possible to treat without a considerable command of agricultural technology. In principle, though mostly to a lesser extent, this is true also in other departments and, so far as this is so, there is no point in drawing any sharp line between, say, the economics of banking, marketing, or manufacturing industry and the corresponding ‘technologies.’ Interlude I 21 . crime to formulate their reasoning correctly. History of economic analysis 16 as it was at any time by standards of a later time) the performance of economic theory has been below reasonable expectation. the analysis of the behavior of individual firms, past or present, come within our meaning of economics just as much as do the facts and tools relevant to the analysis of the behavior of governments,. rendering of E.Mach’s doctrine that every (theoretical) science is a device for effecting economy of effort (Denkökonomie). 5 See below Part II, ch. 4, sec. 2. History of economic analysis