False Concepts in Economics
There are a lot of interesting concepts in modern mainstream economics. Both economists and laymen use them every day. And everything is all right, except one thing: a great number of these concepts (and the most central) are either completely unrealistic or wrong from a scientific point of view. It seems impossible to build a correct system of knowledge which is based on false assumptions. So let's examine the most misleading ideas of neoclassical and Keynesian economists.
1. Economic experiment.
Some people that are aware of the success in natural sciences try to use their methods in economics. However to make a correct experiment means to fix all the variables except one and then analyze the result. Is it possible to do so in social sciences? Of course, not. The only way of obtaining knowledge about human action is deduction. Starting from the universal fact that every individual acts, i.e. uses means to attain chosen ends, we can step by step receive necessarily true conclusions with the help of logic.
2. Economic model.
As Murray Rothbard pointed out:
People do not construct theories any more; they "build" models of the society or economy. Yet no one seems to notice the peculiar inaptness of the concept. An engineering model is an exact replica, in miniature, that is, in exact quantitative proportion, of the relationships existing in the given structure in the real world; but the "models" of economic and political theory are simply a few equations and concepts which, at the very best, could only approximate a few of the numerous relations in the economy or society.[i]
Moreover, there is no such thing as "exact quantitative proportion" in economic science. Economics always establishes only qualitative, not quantitative laws. And these laws are a priori true, and there is no need (and no possibility!) to test them empirically. It is a correct science that can help us to interpret historical events.
3. Measurement of utility.
Nowadays everyone tries to measure all sorts of things. Econometricians tell us: "Science is measurement", but what science, I'd like to ask. Utility can be described only in ordinal, not cardinal numbers. For example, my preferences can be as follows:
1) To read Mises's "Human Action"
2) To watch a popular TV-show
3) To play football with my friends
But it's nonsense to describe my utility in the following way:
To read Mises's "Human Action" - 15 utils
To watch a popular TV-show - 10 utils
To play football with my friends - 8 utils
In economics we deal with a real man, not a homo oeconomicus or something like that. As Mises has brilliantly shown in his magnum opus:
Economics deals with the real actions of real men. Its [laws] 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. . . . Man with all his weaknesses and limitations, every man as he lives and acts, is the subject matter of [economics].[ii]
4. Product life cycle.
This is a wide-spread fallacy of almost all modern textbooks on marketing. The authors of these textbooks claim that like human beings, products also have a life-cycle. Human beings pass through various stages of their life: birth, growth, maturity, decline and death. In mainstream theory it's the same for a product. However this analogy is absolutely not applicable here. First of all, human life-cycle is determined by biological laws, and relations between the buyer and the seller (and the success of this or that product) are determined by praxeological laws. The sequence of stages in biological life-cycle is strictly determined and inevitable: it's impossible, for instance, first to be old, then young, and then die. The situation is the opposite in marketing. The sales of the product may decline, but then after the right decisions of entrepreneurs they may go up. The product has no will, it is not alive. The sales of a product are a reflection of how successfully the entrepreneurs satisfy the needs of the consumers.
5. Economic growth.
It is curious enough that the central concept (and the final goal) of mainstream economists has no meaningful sense whatsoever. "Growth" is a biological term, absolutely inapplicable to economics. Only individuals think and act, and only they themselves can make a conclusion whether they are better off or not. If I prefer an additional hour of leisure for a $20 work and my friend prefers a $20 work for an additional hour of leisure, what does it mean? Maybe I don't help our economy to "grow" as my friend does? Mainstream economists may argue that they are able to take into consideration my additional leisure by using different indexes, for instance. But this kind of thinking misses the point. The answer is that both my friend and I are better off if we voluntarily have made our choice. We cannot measure how much we are better off but we know that our situation has improved (at least ex ante). And the worst method of determining the size of economic growth is to use different aggregates.
6. GDP and other aggregates.
GDP, as we know, measures only final sales, but a lot of sales are intermediary. Certainly it will be incorrect from mathematical point of view to measure all sales, for we will have the situation of double-counting. But to abstract from them will be incorrect from praxeological point of view, where we deal with the real life and the real people (of course, to analyze market transactions from Austrian perspective is not the same thing as to add or multiply aggregates as other economists do). Moreover if people changed their time preferences and they now prefer to save more and to consume less, then GDP will fall (ceteris paribus). So the mainstream economists may conclude that something bad has happened, the economy is in recession, and so on. Or another case: during artificial boom GDP (both nominal and real) will rise, and these economists will not see any premises for the end of euphoria and for the beginning of depression which is already inevitable. That's why GDP and other aggregates are absolutely inapplicable in economics; they ignore the essence of human action, i.e. the purposeful behavior of individuals.
7. Government investments.
When a businessman or a private company make an investment, they try to allocate the resources in such a way that to satisfy the most urgent needs of the consumers in the best possible way (not because they are so kind, but simply because it is the only way to earn profits in a free-market economy). But when government tries "to invest" some problems arise:
1) The part of the resources are withdrawn from productive use by taxation;
2) The market rate of interest is distorted by government intervention;
3) And the main factor: when the entrepreneurs invest their funds, they satisfy the needs of other people, and when government bureaucrats "invest" they satisfy only their own needs.
All this means that it is impossible to play in entrepreneurship. There is no such thing as "government investments", all government expenditures are the consumer expenditures (and the consumer in this case is government itself).
8. Price level.
The importance of free-market prices is almost impossible to overestimate. They show entrepreneurs where they can earn the highest profits, and in this way satisfy the most urgent needs of the consumers. They show buyers what is happening at this or that branch of the economy. The consumers of coffee, for example, may not be experts in climate changes, but if due to this factor the supply of coffee has declined, and consequently prices go up, they will act taking this into consideration: some people will be eager to pay higher prices; others will purchase the substitutes of this good (for instance, tea). Society as a whole would economize relatively more scarce coffee. But all this has nothing to do with allegedly scientific concept of price level. Consider we have the following information: the price of the book in Year 1 is $20 and in Year 2 is $ 25; the price of the sandwich in Year 1 is $3 and in Year 2 is $6. What can we say about the prices of both the book and the sandwich? Frankly speaking, not very much. In Year 1 the book costs $20 and the sandwich - $3, and together they cost $23. In Year 2 accordingly they cost together $31 ($25+$6). The price of the book has increased by 25 % ($5/$20*100%) and the price of the sandwich has increased by 100 % ($3/$3*100%). That's all we know. We cannot calculate any "price level" simply because the book and the sandwich are two different goods and they cannot be added to one another.
9. Velocity of circulation.
Now it's not difficult to understand why velocity of circulation is a false concept. According to Fisher's equation: M*V=P*Q, then V=(P*Q)/M. But if P (price level) is meaningless, then V (velocity of circulation) is meaningless too (by definition).
10. Neutral tax.
In spite of numerous attempts of government, the public refuses to accept taxation as something good. That's why mainstream economists try to find or to invent a neutral tax. But all their searches for it are vain. It is true that regressive taxation is closer to free-market prices than progressive, for example. But all the systems of taxation are necessarily compulsive and all market transactions are necessarily voluntary. So even on this ground we see that no tax can be neutral to economy.
11. Public goods.
Mainstream economists claim that some goods are nonrival and non-excludable, so they can be effectively supplied only by government. And this, of course, is not true. Take defense as an example. National defense is not homogeneous; there are different units of this good that can be supplied by the market as any other good. It's a great mistake to believe in such a myth as "public goods". All economic resources are scarce, and the best way to use them in the most effective way is a free-market economy.
12. Market failure.
Market failure is a concept within mainstream economic theory wherein the allocation of goods and services by a free market is not efficient. However we should remember that only individual himself can decide what is desirable for him, and only through the system of market competition and entrepreneurship the resources can be allocated in the most efficient way from the point of view of the consumers, and according to time preferences in the society. There is no such thing as "market failure"; there is no place for government in the economy.
[i] Murray N. Rothbard, Economic Controversies (Auburn, Ala.: Ludwig von Mises Institute, 2011), pp. 11-12.
[ii] Ludwig von Mises, Human Action (Auburn, Ala.: Ludwig von Mises Institute, 1998), pp. 646-47.