The lack of realism in mainstream economics shocked physicists in 1987 and led to the creation of a new branch of the mainstream labeled “complexity economics.” That year, the economist Kenneth Arrow invited a group of top physicists and economists to gather at the Santa Fe Institute in New Mexico to talk about their fields for ten days. The economists’ obsession with equilibrium disturbed the physicists. Brian Arthur wrote in the preface to his book Complexity and the Economy that,
I’d summed up my earlier understanding in a 1999 article in Science, and the editor insisted I give this different approach a name. I called it “complexity economics.” Looking back now, the features of complexity economics are clear. The economy is not necessarily in equilibrium; in fact it is usually in nonequilibrium. Agents are not all knowing and perfectly rational; they must make sense of the situations they are in and explore strategies as they do this.
Arthur seemed to be unaware that Mises wrote in Human Action, “The experience with which the sciences of human action have to deal is always an experience of complex phenomena” in 1949. And Hayek had written about the economy as a complex system twenty years before Arthur in 1967 in his paper “The Theory of Complex Phenomena.” Unfortunately, Arthur and his colleagues in complexity economics attempted to re-invent the wheel instead of building on the outstanding accomplishments of Austrian economists and as a result have produced meager results. For example, the researchers created an artificial stock market in which agents randomly generate and test methods for forecasting the stock market. Those that worked were retained and failures discarded. Prices formed from the bids and offers of the computer agents. The results, published in “Complexity Economics: A Different Framework for Economic Thought,” showed episodes of bubbles and crashes as well as clusters of high and low volatility. Arthur seems unaware that in the Austrian business-cycle theory savings act as a brake on new investment that would dampen if not eliminate booms and busts if allowed to work by the government. Also, other economists have shown that similar patterns appear in a randomly generated time series. In essence, Arthur has merely fallen victim to the mainstream financial myth that the stock market is nothing but a collection of random events.
So why would intelligent people, as Ph.D. economists are, cling to a method has failed so spectacularly in foreseeing the 2008 “Great Recession” and has such unrealistic foundations? Part of the answer is that because economics is a relatively new field, economists have always suffered from physics envy. But the error persists because most mainstream economics are closet socialists. Socialists need to murder the entrepreneur in order for the state to have credibility in planning and directing the economy. Again, in Human Action Mises wrote,
He no longer deals with human action but with a soulless mechanism mysteriously actuated by forces not open to further analysis. In the imaginary construction of the evenly rotating economy [equilibrium] there is, of course, no room for the entrepreneurial function. Thus the mathematical economist eliminates the entrepreneur from his thought. He has no need for this mover and shaker whose never ceasing intervention prevents the imaginary system from reaching the state of perfect equilibrium and static conditions. He hates the entrepreneur as a disturbing element. The prices of the factors of production, as the mathematical economist sees it, are determined by the intersection of two curves, not by human action...
The result is that from the writings of the mathematical economists the imaginary construction of a socialist commonwealth emerges as a realizable system of cooperation under the division of labor, as a full-fledged alternative to the economic system based on private control of the means of production. The director of the socialist community will be in a position to allocate the various factors of production in a rational way, i.e., on the ground of calculation. Men can have both socialist cooperation under the division of labor and rational employment of the factors of production. They are free to adopt socialism without abandoning economy in the choice of means.
As a result, many mainstream economists who championed free markets opened the back gate for socialism through their obsession with equilibrium. Milton Friedman was one. Socialists could hear his plea for less state intervention in the economy, but his equilibrium economics shouted louder.
Economics was born with a Biblical view of human nature, but as socialists, mathematicians, atheists and deists began to dominate the field, economics embraced a non-Christian human nature with disastrous results. Nazi Germany had the goal of creating the super race through socialism. The old Soviet Union and China under Mao were primarily experiments in shaping human nature and returning mankind to its original innocence. The Nazis caused the deaths of tens of millions in World War II while Stalin and Mao murdered over thirty million each of their own citizens trying to perfect them.
The mainstream economics view of humans as automatons is strikingly similar to Marx’s concept of ideology. Marx taught that except for socialists all people are the slaves of their social and economic conditions and their ideas on any subject merely defended the existing power structure. In other words, only socialists can actually think; others can only respond to the prevailing structure of production and economic conditions, just as mainstream economics casts humans in equilibrium analysis.
Only one school of economics treats humans as they really are, rational but with warts and ignorance, and that is the Austrian school of economics. The differences among the mainstream schools are minor compared to the vast disagreements with the Austrian school. Founded by Karl Menger, one of the three who discovered the marginal theory of value, in nineteenth century Vienna, it was championed by Mises and Hayek in the twentieth. Some recent Austrians have made a close connection between the school from Vienna and the school of Salamanca, Spain, in the sixteenth century, as Jesus Huerta de Soto wrote in “New Light on the Prehistory of the Theory of Banking and the School of Salamanca.”
Hayek, Mises and other Austrian economists insisted that the methods of physics cannot be used to study economics because the subjects of study are vastly different: economics studies humans; physics studies matter. For example, electrons do not choose whether they have a negative charge or how they orbit a nucleus. Apples do not debate whether or not to obey gravity. But human beings decide, learn from mistakes and have the gifts of reason and limited foresight. Controlled experiments in physics are easy to set up but extremely difficult in economics. Because of these major differences in the subjects under investigation, Austrian economists insisted that economists must use different tools for analysis.
Instead of a mechanical man responding to stimuli and lacking free will, or an animal that obeys only instincts, the human in Austrian economics is a real human being that can reason, learn and choose. He possesses a free will. Mainstream economics assumes rational agents, but the rationality in Austrian economics bears no resemblance to it. In mainstream, rationality means that every person has the omniscience of a Ph.D. economist. Austrians mean by rationality and reason that entrepreneurs adopt goals and choose the best means to achieve them, although within the range of their limited knowledge.
A student of Mises, Israel Kirzner, devoted much of his career to analyzing the contributions of the entrepreneur to the functioning of an economy because mainstream economics had dismissed the entrepreneur with its assumption of equilibrium. He provided an apt analogy to describe the differences between mainstream and Austrian economics in The Economic Point of View:
The Purposefulness of human action – a category to which nothing in physical science corresponds – is the unique element that invests economic science with its individuality. The propositions of economics relate to the effective execution of the purpose willed by the actor.
Stones dislodged from a hillside by the elements and hurtling down on the unsuspecting traveler in the valley are part of a different “event” than stones hurled with intent by men waiting in ambush. The latter are hurled with purpose; they are – in this case literally – aimed by human bei
ngs.
Christian economics should deal with real human nature, as Mises wrote in Human Action concerning Austrian economics: “Economics deals with the real actions of real men. Its theorems refer neither to ideal nor to perfect men, neither to the phantom of a fabulous economic man (homo oeconomicus) nor to the statistical notion of an average man (homme moyen). Man with all his weaknesses and limitations, every man as he lives and acts, is the subject matter of catallactics. Every human action is a theme of praxeology.”
Poverty
The issue of poverty is so laced with myths that it would be impossible to write enough books to untangle the truth from all of them. But one myth tends to be the dragon’s head for many others, so if we can kill it then many others will die. The arch myth is that one man cannot grow wealthier except at the expense of others. However, that is a difficult myth to kill because for most of human history it has been true. It has only been a myth for the past three centuries since the advent of capitalism.
As detailed in chapter 4, through most of history people held commerce in contempt. The “honorable” ways to gain wealth, if someone did not inherit it, were through looting in war, kidnapping for ransom, bribing state bureaucrats or accepting bribes as a bureaucrat. In other words, most people who accumulated wealth did so by making someone else poorer. With the birth of capitalism in the sixteenth century, that changed. Only criminals and politicians in the West have accumulated their wealth in the old manner since then. However, some of those methods are still common in other regions of the world. For the most part, the West did not take its vast wealth from others; business people manufactured it by creating new products or services that people wanted to buy or through making popular products cheaper. And they created new wealth by taking unused resources, such as coal and oil, and turning them into something useful.
Poverty was not the original state of mankind. In the Biblical account, Adam and Eve lived in a garden that produced extraordinary abundance. Of course, they were naked and probably did not require housing. God expelled them from the garden after their rebellion and cursed the earth so that humans faced a scarcity of food, clothing and shelter. God blueprinted prosperity in his design of a government for Israel in the Torah, but even the Hebrews refused to follow it after a while. As a result, poverty dominated and standards of living for every human that followed remained static at near-starvation levels for millennia, except for the nobility. No one considered progress possible; everyone saw life as revolving in endless cycles. Empires rose and stole the wealth of others then declined when upstart empires stole their wealth.
Even though a Torah-style government would have increased the prosperity of the Hebrews dramatically, God understood that they would not follow his plan and poverty would continue to exist. So God promoted charity as a means to alleviate poverty in Israel. When confronted with the problem of poverty, Christians understood only one solution: give to the poor.
Then the most important event in economic history happened, the sudden explosive growth in standards of living in the West beginning with the Dutch Republic in the sixteenth century. For the first time in history the middle class made up the majority of the population. Even those considered poor by the relative standards of the middle class enjoyed greater wealth than their poor ancestors. It took a few centuries for economists to catch on, but a new solution to poverty had appeared – economic growth through capitalism.
Charity helps, a little
Still, most Christians continue to cling to the idea of charity as the cure for poverty. There are two problems with that approach. First, it is not too difficult to calculate the total wealth of the world and divide it by the total number of people to come up with an amount of wealth that each person would have. The West has created enough wealth to improve the standards of living of the rest of the world, but not to eliminate poverty. Second, most of the wealth of the West is tied up in businesses. But the left assumes that the wealth of the rich today is like that of the rich in the Middle Ages that consisted of land and stacks of gold coins gathering dust in a warehouse. Centuries ago it would have been trivial to divide up the gold and land among the world’s poor. Today it would be almost impossible.
Many Christians live in a world that is more fantasy than even that of mainstream economics. They assume that people in the West are rich because they have stolen the wealth of poor nations and a simple redistribution of wealth would solve all poverty problems. Some, such as Jim Wallis, have called for a rejection of the “gospel of scarcity,” by which they mean the science of economics, and an embracing of the “gospel of abundance,” by which they mean socialism. But God calls Christians to live in the real world of scarcity and not a fantasy world, and to do that we have to analyze real world data using sound economics. Also, socialists do their best to keep the discussion focused on the short run effects of redistribution while the good economists want to analyze the long term as well.
In 2014, the bank Credit Suisse Research Institute issued its Global Wealth Report 2014, one of the most comprehensive compilations of world wealth. It reported that total world wealth added up to $263 trillion, or $56,000 per person in the world. That figure assumes a planet population of 4.7 billion, when in fact it is closer to 7 billion, which would reduce the per capita wealth to about $38,000, but let us stick with the report’s figures. Clearly, if wealth was perfectly distributed, the majority of people in the world who have no wealth would be much better off. A family of four would own assets worth $224,000. If we stop our analysis at that point, we can fantasize about a world without poverty and everyone doing well and that is what socialists want us to do. But we must push the analysis into the real world.
The report states that most of the wealth consists of real estate and financial assets such as stocks and bonds. That wealth changes a lot over the course of business cycles. The year 2014 was close to the peak of the latest cycle when asset prices are highest. In fact, the report mentions that high asset valuations usually indicate the beginning of the next recession when asset prices collapse. So asset prices are unusually high at this point in the business cycle, but let us retain them for analysis.
Regarding real estate, the rich in the West do not necessarily own more land per person than people in other countries; real estate merely costs more in the West so the owners are wealthier only on paper. For example, someone in Ghana may own five acres valued at $500 while in the United States five similar acres might sell for $5 million. Since we cannot physically redistribute land, we would have to give ownership of much of the land in the West to people in poor countries who might collect a rent from it. Shares of stock and bonds could be physically transferred and redistributed.
Suppose we could redistribute the wealth of the world as described. What would happen next? A reasonable income to expect from those assets would be a yield of 5 percent, or $11,200 per year for a family of four. If nothing changed, that would be a great improvement in income for the world’s poor, but nothing remains the same. One change causes another. In the case of the poor countries, citizens will have much larger incomes but will not have increased production so more money will chase a fixed amount of output and land. That means prices will soar like rockets in poor countries and eat away at the purchasing power of the new income. If incomes rise by a factor of ten, prices will rise close to that amount and real living standards will have improved little. At the same time, incomes in the West will have fallen and that will lead to less spending and investment so that the assets located in the West, but owned by people in poor countries, will fall in value as well. In turn, that will reduce the annual income for poor people who depended on the yields from those assets.
In other words, nothing much will have changed in the long run except that the West will be much poorer while the poor in the rest of the world will be in the same situation as before. That highlights an important economic principle: wealth issues from production, not charity.
Other socialists fixate on redistribu
ting incomes rather than wealth. Some have estimated that if all income was distributed perfectly then the average person would get about $8,000 per year or $32,000 for a family of four. Initially, that looks a lot better than trying to redistribute wealth. But keep in mind that, according to good economic principles, income is a factor of labor productivity. Workers in poor countries earn low wages because their productivity is low. Productivity is a factor of culture, training, intelligence and having the right equipment to work with. Redistributing income will not magically make workers in poor countries more productive.
Meanwhile, will the high income workers in the West continue to be as productive as they have been without the incentives to do so? The experiences of the old Soviet Union and China under Mao prove that they will not. Russians used to quip that the state pretends to pay them and they pretend to work. The whole point of the Soviet Union and Communist China was to change human nature and create people who would work for the common good, who needed no personal incentives. Both failed miserably. They could not change human nature. Therefore, when the productivity of high paid Western workers collapses, there will be no more income to redistribute to the poor. Again, nothing would change for the poor, but the West would join them in their poverty.
God is a Capitalist Page 41