The Road to Fallibilism (Part III)
The Methodological Missteps of Friedrich von Hayek, and the Popperian Cure
by John Saudino
27 October 2019
This is the final article in a three-part series. See Part I here and Part II here.
4 Conclusion
4.1 Introduction
Although the methodological part of this series of articles has required me to devote the lion’s share of my writing to these issues, I feel I must at least summarily sketch what I see as the consequences of Hayek’s epistemological missteps in the real world. I reserve the right to be speculative here in part because of the fact that the scope of this article will not allow me to get into the kind of systematic detail. As I am describing the effect of economic philosophy, more specifically, philosophical error, it follows quite logically that the ramifications, that is to say the translation of economic theory into real life economic policy, have been negative. If the ramifications were not negative, it would not make sense for me to speak of error in this context. If I am to talk of the negative effects of economic policy that result from faulty economic theory, I am naturally going to speculate as to both the cognitive and epistemological error that gives rise to it but also about certain other relevant biases that are evident in Hayek’s own more explicitly political writings. I am not here ridiculing or bashing Hayek, whom I believe to be a very important philosopher, and I do not intend to prove any necessary connection between these biases and Hayek’s epistemology per se. However, as I pointed out above in reference to conservative vs. progressive philosophers, there are some striking correlations.
4.2 General Ramifications of the Pitfalls in Hayek’s Epistemological Approach
The impression of Hayek here should be clear. He was a great thinker and a great liberal defender of individualism and freedom. There are, however, more than a few indications that he One: had some ingrained methodological pitfalls as I have, hopefully, demonstrated and Two: that an argument can be easily made that these may be related to a desire to protect his theory from criticism because of his own ideological convictions.
I will first review the pitfalls. The first pitfall is the mistaken doctrine that there is an inherent and unbridgeable chasm between the natural and the social sciences. Popper shows that such errors have to do with misconceptions about what the natural sciences actually are. I have shown above that this misconception is based, as are some of his further epistemological errors, on the residual inductivist bias Hayek had, which I have shown to be a symptom of the earlier errors made in solving Hume’s induction problem. This bias led Hayek to adopt the false doctrine that what is important in science is how theories are formed and that this requires a systematic inductive process. Popper by contrast shows that it is the testing, not the forming of theories, which is largely intuitive by nature, that is important. Popper also explains how the complexity argument is also a fallacy. The dichotomy Hayek tries to make between the natural and the social sciences is also a fallacy, as Popper points out, because both sciences are based on models in essentially the same way.
I have shown how Hayek’s errors are related to a faulty attempt to solve the problem of induction stemming from German idealism. Kant’s supposed synthesis of empiricism and rationalism turned out to be a petrification of the dichotomy between the two such that philosophers either engaged in fruitless inductivist probability calculi, like John Stuart Mill, or retreated from empirical science into apriorism, like the Austrian Economists. The error here was the conflation of truth with certainty, whose results in Hayek are quite conspicuous in his misplaced emphasis on “theory for its own sake”, caused by the false distinction he makes between necessary and contingent truths.
Popper points out that, in order to grow, genuine science requires a very different relationship between T1 and T2 that involves critical testing or falsification. By sacrificing certainty and embracing truth, Popper shows that science progresses towards verisimilitude by retaining its critical and empirical nature. Hayek and the other Austrian Economists on the other hand insist on constructing axiomatic systems in which, instead of having T2 falsifying T1, T2 is compelled like a catechistic building block of rarified doctrine into maintaining the “logical foundations” of its predecessors.
The net result of all this in the Austrian Economists, including Hayek, is what I have described as a radical rejection of empiricism and a prevalent conceptual rigidity, if not dogmatism. The combination of the lack of falsification and testing on the one hand, and the dogmatic, obscurantist and unfounded banning of “scientism” from the social sciences on the other, serve to insulate their astrology-like theories from all critical evaluation. These theories become ideological constructs designed to project, by invoking the “universally valid science of human action”, a particular set of priorities onto “the social realm”, claiming that for policy makers “there is something operative which power and force are unable to alter and to which they must adjust themselves if they hope to achieve success, in precisely the same way as they must take into account the laws of nature.”[1] The “laws of nature” here invoked are of course to be discovered by the empirical sciences, precisely the kind of science that is banned from partaking in Hayek’s thus immunized doctrine.
In spite of the fact that this rather uncharitable characterization is what should naturally follow from the detailed analysis above, I will nonetheless back up these claims by discussing two concrete examples of where truly false economic doctrine on Hayek’s part has come to play. One of these examples involves the endogenous nature of the trade cycle and the other involves the quantity theory of money.
4.3 The Assumed Endogenous Nature of Trade Cycles and the Case of 1970’s Stagflation
As I mentioned briefly above, it seems to me that one can point to at least one instance of genuine rigidity and dogmatism with regard to Hayek’s insistence on the endogenous nature of the trade cycle. Though it is, of course, from the point of view of method or “theory for its own sake” quite preferable to seek explanations that are endogenous because those that are exogenous will only give you one instance to explain the causes of the trade cycle whereas an endogenous one will give you a theory that will explain the business cycle independently of this. Hayek makes much of this in his Monetary Theory and The Trade Cycle.
Basing his argument in part on the “real capital market” theory of Knut Wicksell (1851-1926) Hayek argues that there is a delayed effect of adjustments in interest rates by banks, which come about because of how they function in an aggregate rather than individually. Individually banks cannot know which credit in the economy is “additional credit” and which creditis a genuine component of the “real interest rate”, that is to say, what money is being offered as credit on the basis of the real savings rate and what is being offered “artificially” because of an expansive monetary policy. The lack of this knowledge, plus the competition between banks, leads them to exacerbate the expansion of credit in that they maintain a lower “nominal interest rate” below the “real interest rate” which should be based on real private savings. His argument is that the boom created must necessarily lead to a bust because of imbalances in relative prices between the capital goods sector and the consumer goods sector that will leave companies that are overinvesting in the capital sector high and dry as soon as they realize, for too late, that the boom was a fake boom and their ambitious investment plans will either not find any market for their output or their projects will have to be abandoned before completion.
It is because of this mechanism in the banking system itself that Hayek insists that this process “must always recur under the existing credit organization, and that it thus represents a tendency inherent in the economic system, and is in the fullest sense of the word an endogenous theory”.[2]
What Hayek has to say here about the expansion of credit inherent in the system becomes all the more critical when it comes to criticizing what he viewed as the inflationary policies on the part of Keynesian economists. I cannot now provide a critical analysis of Keynesian aggregate demand based trade cycle theory vs. Hayekian over-investment trade cycle theory here. I will however refer to one aspect of the divide and how it became a curious point of contention in the 1970’s.
My point has to do with the so-called Phillips Curve. This is a feature of Keynesian economics that sees unemployment and inflation as tradeoffs. That is to say, under normal conditions a rise above “full employment”, that is to say, a drop of unemployment below 4% will lead to inflation and a rise in unemployment will cause inflation to drop. This is because there will be either too much or too little consumer demand, causing either inflation to rise or to fall. The inflation that occurs in the case of a rise in employment or consumer demand here is called “cost pull inflation” because it is the overheated demand that is pulling the prices up. But what would happen if it is not the demand curve that shifts to the right but the supply curve that shifts to the left? The result of this in the 1970’s was stagflation: a simultaneous increase in inflation and unemployment.
The cause of this shift in the supply curve in the 1970’s was the sudden exogenous shock to the economy caused by the Arab Oil Embargo of 1973, an act carried out as a way of punishing western economies, especially the United States but also Europe and Japan, for their support of the State of Israel in the Yom Kippur war. By the end of 1974 the price of oil had risen by 400%, this at a time when the average fuel efficiency of an American car was only 13.5 miles per gallon or around 18 liters for 100 Km, about half the efficiency of today’s cars.
The sudden cost push inflation naturally increased the price and lowered the supply of nearly every commodity resulting in a higher equilibrium unemployment rate.
In spite of this quite transparent cause and effect mechanism to explain the stagflation, Hayek, in the same way as Milton Friedman, chose in his Nobel Memorial Lecture of December 1974 to discount the 400% increase in oil prices as the cause of the crisis and blame the supposedly inflationary policies of his Keynesian/aggregate demand based rivals instead.
…the economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue.[3]
After opening his Nobel Memorial Lecture with this air of seeming omniscience, Hayek goes on to repeat his old claim, since refuted by Popper in my view, that there is a necessary demarcation to be made between the natural sciences and the social sciences. He mentions his charges against the “scientistic” approach that he had described 30 years prior in The Counter Revolution of Science. He then aims his attack, without naming him, on William Phillips (1914-1975), the father of the Phillips Curve, who based his theory on the one thing that Hayek seems to reject rather categorically, the empirical and statistical studies that led Phillips to formulate his theory in the first place:
I want today to begin by explaining how some the gravest errors of recent economic policy are a direct consequence of this scientistic error. The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for the extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced.[4]
“Quantitative evidence”, which would for the natural sciences represent a virtue, represents a vice for Hayek in the field of economics because it is based on the assumptions of the natural sciences which are incapable of penetrating the voodoo of his axiomatic system that must, according to Hayek, remain free of such “scientistic” errors.
By attacking the concept of a demand based understanding of the trade cycle he is, of course, also attacking John Maynard Keynes. It is difficult to say precisely why Hayek and Friedman swoop down so gratuitously on this crisis of the 1970’s and, with the hellfire of the inflationary spiral to back them up, try to prove that the economic theories of their rivals are to blame for the inflation rather than what was clearly the primary cause, namely the 400% increase in the price of oil. Do they really think that they have disproven the theories based on aggregate demand here or are they fully aware of the cost push inflation and choose to ignore it for the sake of their pet theories?
In Hayek’s case I would say his misinterpretation of the situation is caused in good measure by the conceptual rigidities and other epistemological errors that I detailed in the beginning of the article. His stubborn insistence to maintain these errors, on the other hand, could very well be linked to ideological biases.
4.4 Hayek and the Gold Standard: a case of methodological essentialism
In his philosophy of science Popper goes to great lengths to denounce the practice of methodological essentialism. For him it was related to the Aristotelian tendency to see science as the creation of a catalogue of true definitions i.e. Aristotelian essentialism: “Every discipline which still uses the Aristotelian method of definition has remained arrested in a state of empty verbiage and barren scholasticism”.[5]
Methodological essentialism in the social sciences refers to the analysis of institutions. Institutions change over time and it is quite easy for the essentialist to insist so doggedly on the original essence of what the institution really is that the changes in it are ignored. An approach that is advocated by Popper as more scientific is that of methodological nominalism, where nominalism refers to the use of words and concepts more as a short hand to fix a reference and not as the direct connector to a metaphysical essence within the thing itself.
I would argue that because of the rigidities inherent in Hayek’s approach that I described above and his insistence on maintaining the “logical foundations” of earlier theories in the new ones that he tends to apply a kind of methodological essentialism to many issues.
The most striking of these is his attitude towards the institution of money. One of the theories that the monetarists and Hayek seem to hold fast to is what I have argued to be a totally outdated concept of money called the quantity theory of money.[6]
In spite of the fact that money has so fundamentally changed over the years, Hayek and others like him still call for the return to the gold standard or to some other kind of fundamental backing of currency with some commodity of real physical value. Money started out as gold and silver coins, became paper money backed by gold and silver coins, and since the end of the Bretton Woods agreement in 1971 it has become simply numbers created by central banks in the form of credit money and bills.
An overly essentialist approach to the institution of money, as evinced by both Austrian economists and monetarists, unnecessarily ties the hands of policy makers, because it does not allow them to employ the multiplier effects that Keynes demonstrated as an effective policy to stimulate the economy.
A much more appropriate theory with regard to money that takes into account its changing nature is a theory that has gained significant currency recently called “New Monetary Theory” NMT.
4.5 Closing Remarks and Unanswered questions on Hayek’s Ideological Predilections
His suspicion regarding progressive social schemes is well documented in The Road to Serfdom and in The Counter Revolution of Science. There is another very political work of his called The Constitution of Liberty that enjoys a bit of dubious distinction, namely that during her rise to power Margaret Thatcher reportedly once banged the book on her lectern in parliament and cried out “This is what we believe!”
The pages of that book reveal quite a bit of what I can only term a kind of class bias on the part of Hayek. His demonstrative hostility towards unions, his almost celebration of natural inequality and the futility of ameliorating it, his desire to restrict university education to those who, because of their connections one must conclude, would not form the ranks of an educated and disgruntled radical clique, his rejection of meritocracy, his wholesale rejection of fiscal policy to ameliorate unemployment, etc.
This class bias can be seen, I would argue, also in his purely economic works like Monetary Theory and the Trade Cycle. When he insists that any actions to curb the trade cycle would do more damage because they would stultify the technological advance that comes about in the boom phase, he conveniently forgets that it is the working class that will have to bear the crushing blow of the economic depression to which he urges us to acquiesce. Similarly when he and other economists of a monetarist or classical variety insist on blaming unions for the failure of the economy to readjust toward equilibrium, he takes it for granted that the working population will simply have to bear the resulting austerity until their poverty, i.e. falling demand, adjusts the relative prices to what they should be. Both the inflationary spiral and the deflationary depression are to be adjusted by the austerity of the general population; the unemployment reduces the prices during inflation and the deflation of wages adjusts for the unemployment during a depression.
Admittedly these biases do not necessarily make his theories false; they do however explain a bit of what may very well be motivating him to remain quite adamant about rejecting offhand the “scientistic” approach, so commonly advocated by those of a decidedly more Social Democratic tendency, of applying scientific methods to the social sciences in an effort to improve society and to promote greater equality.
A
more explicit explication of these biases and a more stringent connection of
them to Hayek’s methodology and its consequences will have to be taken up in a
later article, which will also take a closer look at competing trade cycle
theories and evaluate them in the context of specific crises.
[1] Epistemological Problems of Economics, by Ludwig von Mises, D. Van Nostrand Company inc., Princeton, NJ, 1960 (first published in German in 1933) p. 12
[2] Hayek, Monetary Theory and the Trade Cycle, pp. 146-147
[3] Hayek, „The Pretense of Knowledge“, 1974
[4] Ibid
[5] The Open Society and its Enemies Vol. II, Karl Popper, 1945, p. 8
[6] Saudino, “The Quantity Theory of Money and Classical Economics”, April, 2019
