The Mengerian Milkstool: An Alternative History of Economic Thought

0:00There's a very interesting quotation that I came across by Eric Streisler in 1990 in a book dedicated to the legacy of Carl Menger. Intellectual history is overgrown with myth. The preconceptions of successive generations and of generations preceding our own make it difficult to uncover the truth. We tend to be wary of myths surrounding the interpretation of political or even social history. As scientists trained in objectivity, many of us are, however, naively surprised when confronted with distorted interpretations of the history of our own subject. But as intellectual history is often closely linked with political and social history, the same ideological forces which weave and shape myths here may be present there as well.

0:45And that's sort of the moral of my story, I guess, from my presentation this afternoon. So I want to start out with what my professors taught me about the history of my discipline. A miracle happened in 1871 when three men, simultaneously and independently, discovered two concepts that changed the course of economics. The two ideas were briefly marginalism, the distinction between marginal utility and total utility, and subjectivism, or the subjective theory of value. Modern economics, according to this story, is built on the foundations of this dual foundation discovered by these three people. It's called neoclassical economics because it contains something new and something old.

1:32The new are these two ideas and the old is the social coordination story of classical economics. That was what I was taught, to the extent that I was taught anything when I was a student. when I was a student. And we now know that this story is pretty much wrong. Gosen and others understood the distinction between marginal and total utility long before 1871. The Spanish scholastics, the French physiocrats, and others, maybe even the young Adam Smith, understood the subjective theory of value, again, long before 1871. And then, Jaffé, in a really insightful article in 1976, I've just pointed out that Jevons, Vollross and Menger really had quite different perspectives on the nature of economic theory or the nature of economic inquiry, even though their views are often homogenized, at least in the standard telling.

2:27And a more accurate story, I suppose, would be that most of what people understand as economics today really is Volrazian neoclassical economics as opposed to Javonsian or Mangerian. Not surprising news, I suppose, to anybody in this room. What does this matter? Well, I think it matters for two reasons. First, after 2008, it's been a hard, hard slog for economics generally. The credibility of our discipline has suffered. There have been all kinds of criticisms of neoclassical economics in the scholarly as well as in popular discussions. But this criticism doesn't differentiate among these competing alternative neoclassical traditions.

3:13The second reason that I think it matters is because of the weakened state, the disheveled state of economic methodology over the past 25 years. One of my hobbies is I study and write about and teach about economic methodology, and economists are probably more wary than ever about any sort of claims of scientific status for our discipline. So this presentation is an attempt to focus on what I think is the neglected economic methodology of Carl Menger, founder of the Austrian School. And I'll speculate a little bit at the end about how the history of economic ideas might have been different had Menger's ideas in 1883 been taken more seriously than I think they have been.

3:58Okay, Carl Menger, there he is, born in 1840, initially studied law and political science. He did all kinds of things, but the thing that I've highlighted is he was what today we might call a commodity market analyst for a while. before he turned to economics in 1867. And my understanding is that he was a bit of a problem student because he kept correcting his professors as they were explaining to him price theory of the day and his correction always seemed to be based on well, I've just studied commodity markets for a considerable part of my life and that's not the way prices actually get formed and that's not what they mean. So in four years, he went from that to producing what I think is one of the most masterful treatises in economic theory ever, in 1873, he published his investigations, which is his methodology book, and that's mostly what I'm going to be talking about in my presentation today.

4:57He was involved in this thing called the Methodon-Schreit, this dispute about methods, retired in 1902 and died in 1921, and he was an avid fisherman, so that's why I'm wearing my fish tie today. Today, I'm an avid fisherman as well, so I have this sense of kinship with Menger. Okay, Menger's methodology, by Menger's methodology, I'm not meaning his method, I'm meaning more his philosophy of science, his science theory of economics, his theory of economic knowledge generally. And the question, the point that I want to make is, well, what did economics look like, scientific economics look like according to Menger? And it turns out, much to my surprise, as I delved into his investigations, I don't think that we can call Menger an apriorist.

5:44We certainly can't call him a logical positivist, a scientific realist, an instrumentalist or a dualist. And he certainly wasn't a retortician. In other words, he differed from virtually all the main views of economic methodology that are circulating competing with one another today. And I don't think that his actual methodological views have received the attention that they Menger's theory of economic science is that progress in economic scholarship takes place as a result of the sort of rivalrous interaction among three branches, he called them orientations, and today in kind of modern language I think we might call these theoretical economics, and empirical economics and applied economics.

6:32And I call this Menger's methodological milking stool because none of the three elements trumped one another, that they were sort of complementary to one another. And this is a picture of a milking stool. My department's in an agricultural college and I find I still have to explain to even some of my students and colleagues that a milking stool is a particularly unusual piece of furniture. It has three legs. And the reason it has three legs is because a three-legged stool in general is stable on an uneven floor, like a barn. And just like a milking stool, Menger's view of economic science had these three legs. There was the theoretical leg, the empirical leg, and the applied leg. And it was the synergies and also the rivalry among those three things that made the stool, in some sense, work.

7:24Menger's theory of economic knowledge was that in each of these orientations, each of these elements, our knowledge of economic phenomena is always partial and it's always corrigible. So in some respects Menger was like a pre-postmodern when it came to his theory of economic knowledge. Other aspects of his methodology, he seems to be quite clearly in the unity of science camp. In other words, he doesn't seem to maintain that economics requires its own methodology, and his own methodology, that science has a methodology and economics fits in that. He does acknowledge that the subject matter of economics was differentiated from other branches of science, but that was true of other disciplines as well. And a very important concept in Menger's methodology and also in his knowledge theory is this concept of complexity and that various levels of complexity are present in the subject matters of scientific inquiry and that will have implications for the relative importance of these, of the three legs of the milk stool. Another view that he had on methodology was that scientific advance in general and in

8:31economics in particular is episodic. He was almost Kuhnian in that respect and that advances occur in the three constituent elements at different rates and at different times. So we might get It's stuck on one of the legs, and then a breakthrough will happen on another leg. Okay, so what he called the exact orientation of theoretical research, or what I'll call theoretical economics, he described as atomistic, abstract, essentialist, concerned with the question of, well, what is it that we're studying, and why is it the way that it is? And the goal of this orientation was to reduce complex economic phenomena to their simplest

9:41He makes this very important point that I think hasn't received as much attention as it deserves is that exact research may not be able to fully, I'm going to say, deconstruct complex economic phenomena, at least at a given point in time, and so here's where this complexity theme comes in. What he called the historical or historical empirical orientation of theoretical research, I'll call empirical economics, investigates the individual aspects of phenomenon, identifies typical empirical relationships among phenomenon and produces what he called empirical laws. These are different from exact laws, they're statistical and this may be the only option available for He acknowledged that empirical laws were unavoidably limited by the problem of induction, which he attributes to Aristotle, not Hume.

10:44He also seems to be aware of the problem of theory-laden observation, these are sort of modern philosophy of science concepts, and also of the problem of observational equivalence. And he also seems to be aware of the problem of theory-laden observation. These are sort of modern philosophy of science concepts. And also of the problem of observational equivalence. So he was certainly very cautious about the degree to which this empirical historical research could produce knowledge. But nevertheless, it was, I think, a necessary part of his science theory. Then he also talks about applied economics or policy or the theory of finance. I'll call it Practical Economics, or maybe the modern term might be Applied Economics. And this is the recognition of practical problems and experiences and efforts to address those problems often give rise to knowledge.

11:35And I think this occurred in Menger's own career when he was frustrated with the way that economists of his day, his professors, were theorizing about the origin and the nature and the formation of prices I think Menger's economics, looking back to 1871, are consistently a reflection of his methodology, his value theory, his theory of exchange, his theory of marketability, which leads him to his theory of money, are all consistent with his methodology. I'll just quickly go through this because I think this isn't news to anybody in this room.

12:17This idea that value is subjective, it exists in human minds, it does not exist in the thing. And his extension of value theory back to what he called goods of higher order, his integration of value theory back to concepts of production, his theory of exchange is based on this theory of value, which again was developed with this atomistic approach. In the process of doing a Vivelli-Siri exchange, he rehabilitates the reputation of intermediaries who appeared to not do any physical transformation to goods but nevertheless made money from doing it. His theory of the commodity based on his theory of the exchange was foundational to his theory of money and many particularly metallic money in the form of gold and silver.

13:16The one aspect of Menger's methodology book, which has attracted attention among modern Austrians and others, especially Hayek, is Menger's distinction between two types of social institutions, the intentionally designed or positive legislation institutions and what Menger called organic institutions. and his idea that the mission of social science is to try and explain the origins and the function of those organic orders. He applied his methodology to the theory of money. Money emerged before recorded history. There aren't any data. So he developed his theory of the origin of money atomically using his methodology of exact research.

14:08Alternative history, I'm kind of working on this part to kind of fill in what this would look like. Suppose we had taken Menger's methodology more seriously in the 1830s when it was produced. What would modern economics look like? And it seems to me that we would have avoided what I view as a centuries long fruitless competition between theoretical economics and empirical economics, as those two branches of our subjects struggled for supremacy. Menger's view was that neither one of them was preeminent. And that theoretical economics and empirical economics would have existed in a relationship like the relationship between theoretical and experimental physics and engineering.

14:53So that maybe instead of the Big Bang Theory being about physics and engineering it might have been about theoretical economics, applied economics and experimental or empirical economics. And then we'd all be in a sitcom rather than doing what we do. So unfortunately the milking stool that 20th century methodologists in economics ended up with is a milking stool that looks like this. One of my former graduate students read an abstract of this paper and he sent me this picture, and in a sense that's what we have. We have a one-legged, we have a series of competing one-legged milking stools. And let me just close with some examples, because I'm out of time, right? I have one minute? Okay, I think that there are examples, and some of these are kind of happy examples and some of them are not so happy, of what I'll call Mengerian trilateralism or the Mengerian three-legged milking stool.

15:50Ronald Coase, I think, is an example. Most people don't realize this, but he began his career in agricultural economics working on the hog cycle in Britain. But later on, he observed that something called transaction costs exist. Otherwise, there'd be no reason to form business firms. And then he looked at the microeconomics his professors were teaching him and said, and said there's no chapter, there's no section, there's no acknowledgement of transaction costs in microeconomics, therefore there's something wrong with microeconomic theory and that should be fixed, and as far as I understand, he maintains that position to this day. Elmer and Holbrook working, again a couple of agricultural economists who tried to estimate demand curves for agricultural commodities. They were applied economists, but basically discovered that sometimes when they ran these correlations the demand curve sloped up and sometimes they sloped down.

16:43And nobody seemed to understand how that could be the case. Well, they discovered what econometricians now call the identification problem. They weren't sort of theoretical econometricians in their own right. They were just trying to do some stuff. And then they discovered this problem, which the theoreticians then had to acknowledge. And then my final example is George Akerlof, his paper on lemons, the market for lemons was mentioned earlier, his counterpart Eric Bond is hardly ever mentioned, but Akerlof produced this theoretical paper about the market for lemons and the prediction among other things in that paper was that there would never ever be transactions in used cars anywhere in the world, which is sort of a surprising prediction, but it got him the Nobel Prize.

17:30Well, I'm going to go out and test this, because it was a theoretical paper. I'm going to go out and test it. And I'm going to test it in the market for used pickup trucks. Because if you're ever going to find a market for lemons phenomenon, that would be the market to look for it. And what Eric found is that, lo and behold, there's an extensive and well-developed market in used pickup trucks in the United States. So here's an example of where the trilateralism didn't work. Vaughn didn't get the Nobel Prize, but Akerlof did. So I think I'm out of time. So, I'll stop.