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Friday, October 10, 2008

Theory and Crisis

What might be even more distressing than the current buildup of the corporate state in response to the supposed economic crisis is the way some self-styled advocates of the free market are willing to cast aside the economic theory they claimed to embrace.

(Aside: I say supposed crisis because the credit freeze that was said to require such massive government intervention seems to be a Big Lie. All indicators, from Federal Reserve statistics to anecdotal evidence based on my phone calls to local bankers and auto dealers, confirm that ample money is available to people with good credit and/or collateral. I still see Ditech TV commercials and get credit-card come-ons in the mail nearly every day. See Robert Higgs's The Data Don't Justify the Financial-Market Panic.)

Back to theory. If you are a glutton for cable news-talk shows, you know it's been little more than a parade of experts declaring the absolute imperative of government bailouts. Many of these experts preface their remarks by saying how much they hate the idea of government intervention to save business from its mistakes. I'm a free-market, small-government advocate, but…. Jack Welch, formerly head of government-contractor GE, and columnist Lawrence Kudlow are among many who have said things like that. Since they spoke on television programs, I can't quote them verbatim, but the tenor of their remarks is that the free market is great when things are going well, but this is an emergency and we don't have the luxury of theory. Statements like this were most common during the frantic week between the House's rejection of and reversal on the Troubled Asset Relief Program, or TARP.

Where to begin? Right off the bat we can see a problem. Any bailout plan that is believed to be potentially effective must be based on a theory. Otherwise it would merely be a shot in the dark. If you asked a TARP advocate why the intervention is necessary, he presumably would explain the problem and how the bailout would remedy it. For example, he might say that when the government borrows $700 billion in order to buy banks' bad mortgage-backed securities, it will inject liquidity into the credit markets and improve the economy. But that is a theory. (It's a bad theory, but it is a theory.) So the apparently bold thrusting aside of all theory in the name of pragmatic action is a mere pose. The move is as theory-bound as free-market opposition to the bailout is.


Contest of Theories

The debate, then, is a contest of theories. Free-market theory can explain the cause of the crisis — government intervention in the mortgage market through promotion of easy home-buying and implicit guarantees to lenders and underwriters, including its privileged creatures, Fannie Mae and Freddie Mac. Given that genesis of the problems and the general theory of markets, the solution is for government to back off — way off — and to let the economy adjust to real conditions and recover without subsidy, guarantee, or regulation. What is the alternative theory used by those who have jettisoned free-market theory in this time of crisis? Why should we believe that things will be fine only if the government has the discretionary power to transfer resources from those who haven't screwed up to those who have?

There's a unattractive anti-intellectualism in the scoffing at theory. The fact is, we can't live without it. As I've noted before, William Graham Sumner long ago dismissed the claim that something can be true in theory but not in practice:

That a thing can be true in theory and false in practice is the most utter absurdity that human language can express. For, if a thing is true in practice (protectionism, for instance) the theory of its truth can be found, and that theory will be true. But it was admitted that free trade is true in theory. Hence two things which are contradictory would both be true at the same time about the same thing. [Protectionism: The -Ism which Teaches that Waste Makes Wealth (1885), chapter 4, section m.]


Mises and Theory

Ludwig von Mises had a thing or two to say about theory. For Mises the theories of economics (more broadly, human action) are derived by spinning out the logical corollaries of the inescapable concept action, of which we have apodictic a priori knowledge. (These corollaries include among others: purpose, means and ends, value and preference, cost, time preference, and profit and loss.) We do not acquire economic theories through observation. Indeed, as Roderick Long suggests, we can't imagine observing human behavior outside a means-end framework: [O]ur conceptual understanding plays a constitutive role in our perceptual experience. This is the a priori nature of Mises's praxeology, or logic of action. As he wrote in Social Science and Natural Science:

Economics therefore is not based on or derived (abstracted) from experience. It is a deductive system, starting from the insight into the principles of human reason and conduct. As a matter of fact all our experience in the field of human action is based on and conditioned by the circumstance that we have this insight in our mind. Without this a priori knowledge and the theorems derived from it we could not at all realize what is going on in human activity. Our experience of human action and social life is predicated on praxeological and economic theory.

Or as he wrote in Human Action: History speaks only to those people who know how to interpret it on the ground of correct theories.

If our premises are true and our reasoning is logically sound, our conclusions are true. This doesn't mean that economics is done without reference to the world. It means only that we look at the economic world, as it were, with praxeological lenses — and are powerless to do otherwise. To be sure, we must first confirm that we are observing human action in an economic context (and not, say, a game, ritual, or reflexive motion), but once we do that, our a priori understanding of economics applies.

There is never a good time to throw aside theory and just act, for such a thing is impossible. The only question is whether our theory is good or bad.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.