The Market Is the Lab of Economics and Entrepreneurs Are the Experimenters

The market is a vast and on-going laboratory of experiments

I love this e-mail that I received last evening from Cafe Hayek patron Corey Henderson, a physicist; I paste it in full below with his kind permission (original emphasis):

I wanted to comment on some of your recent posts where you ask economists to “put their money where their mouths are” and actually start businesses that back up their claims. I don’t use Facebook, however, so I am e-mailing you directly. It’s been a great series of posts and I’ve enjoyed them.
Consider this, though: I am a physicist and we tend to bifurcate into theoreticians and experimentalists. One cannot really exist without the other, and there has long been a tension between the two groups. No one, however, can doubt that both groups are scientists. The scientific enterprise, of course, must contain both exercises. A theoretical physicist who does not include a pathway to experimentation in his work is not a scientist, and the best ones are enthusiastic whenever an experimental group is pursuing evidence for (or against) their claims. They collaborate extensively. THIS is science.
The TV show Mythbusters is credited by many scientists (including myself) for being the BEST childhood introduction to science possible today. Why? Because the show is about taking a proposition, usually “common knowledge”, and gradually working up more and more rigorous tests to prove or disprove it. It’s hands-on, messy, disastrous experimentation writ large and hugely entertaining.
If economists claim they are scientists, it’s incumbent on us to ask “who are your experimentalists then?”
The answer, obviously, is “entrepreneurs”. Just like Mythbusters, they’re doing the experiments, millions of them every day, and no fancy degrees or advanced math required (usually).

Exactly so. The market itself is a vast and on-going laboratory of experiments — experiments that are relevant, real, and revealing.

These experiments are valuable not least because they are made under real-world circumstances and by people with strong personal incentives to discover and comprehend the “truth” better than their rival experimenters. (This is a point the general thrust of which I associate with Michael Polanyi.)

When entry into, and exit out of, markets aren’t restricted by government, and when people are free to contract, or not, with their own money (and only with their own money), on terms to which each voluntarily agrees in a regime of secure private property rights, the market discovers which goods and services, production and distribution and financing processes, and trading arrangements work best compared to realistically available alternatives.

While I sincerely believe that much useful information can be gathered by academics doing empirical studies (both quantitative and non-quantitative), it is an unwarranted conceit of academics to suppose themselves and their empirical studies to be the only, or even the chief, source of empirical knowledge of social reality.

For example, against some academic economists’ empirical findings that employers of low-skilled workers in America today enjoy monopsony power we must place the findings of those experienced and skilled real-world experimenters: entrepreneurs.

If the laboratory conditions (the market settings) are such that experimenters (entrepreneurs) are free to experiment — that is, if neither entry into nor exit out of the laboratory (the market) is artificially blocked by government, and if government hasn’t otherwise restricted the experimenters’ ability to peacefully use the available lab equipment — then these experimenters are far more likely to discover the “truth” about the current state of the market than are outside observers (such as academics) who seldom, if ever, actually do relevant work in the laboratory itself, and who also are necessarily restricted to using only limited sources of information for the kinds of quantitative analyses that they typically perform.

If the entrepreneurs-experimenters believe that they’ve found that some workers are underpaid, these entrepreneurs-experimenters test their hypothesis by actually trying to employ these underpaid workers differently and at slightly higher wages.

If the entrepreneurs-experimenters profit, the hypothesis is confirmed. If instead the entrepreneurs-experimenters suffer losses, the hypothesis is rejected. Either way, the knowledge revealed by such entrepreneurs-experimenters ought to be considered and used far more frequently by academic economists.

UPDATE: Prompted by a commenter on this post, I just remembered this relevant post from this past April.

This piece first appeared at Cafe Hayek.

{{article.Topic.Topic}} {{article.Topic.Topic}}

{{article.Title}}

{{article.BodyText}}