Economics, Citizenship and Freedom

We intentionally skip sections 4 and 5 dealing with Economics and Universities and Economics and General Education. We now conclude with sections 6 and 7 discussing about Economics and Citizenship, and Economics and Freedom.

Economics and Citizenship

Citizens cannot withdraw from the study of economics without serious negative consequences. We cannot trust the interventionists to teach us economics. It is the solemn duty of each citizen to learn this science of human action.

It is high time that the study of economics must go beyond the confines of the academe and control of the specialists. The burning issues of today both political and social are all economic issues. No wonder, philosophers and theologians are now leaving the old problems dealt by earlier generation and are becoming more interested to participate in economic issues. Even the common man, whether he is conscious or not, is actually involved in economic affairs in his day to day activities. Civic activities like taking side to a specific political party and casting a ballot are inescapably economic realities. The relevance of economics for today is captured by Mises in summarizing the concerns of the last five centuries:

“In the sixteenth and seventeenth centuries religion was the main issue in European political controversies. In the eighteenth and nineteenth centuries in Europe as well as in America the paramount question was representative government versus royal absolutism. Today it is the market economy versus socialism” (p. 878).

With the challenges we are facing today, the study of economics is the primary civic duty of a responsible citizen. By fulfilling this duty, you demonstrate that you care not only about your future but the future of your children as well.

Economics and Freedom

Interventionists know that the study of economics could enlighten the citizens to their civic responsibilities. This will frustrate the expansion of the interventionists’ dream and that is why all attempts are made to restrict the freedom of economic thought.

“Subversive” ideas are suppressed and only interventionists “truth” is allowed to reach public consciousness. In order to have a secure position for this truth, coercion is a necessary tool at the disposal of those who control the centers of power. Even religion is used to justify the promotion of interventionists’ agenda resulting to the gradual loss of human freedom.

Interventionists’ policy is most evident in restraining the activity of the free market. Economic issues like cutting down profits, lowering prices, lowering interest rates, and raising salary rates appear commendable in the eyes of the uninformed public. Only few are able to penetrate behind the appearances of things and fewer still are able to connect the economic disaster brought about by the widespread influence of those interventionists’ doctrines. Continued search for truth is the only weapon freedom lovers have in their arsenal to reverse the trend and provide the intellectual climate for the growth of market economy.

Economics and Forecasting as Professions

We now proceed to Sections 2 and 3 in our study of The Place of Economics in Learning. These two sections talk about Economics as a Profession andForecasting as a Profession.

Economics as a Profession

Early economists shared the product of their intellectual labor to influence public opinion in the formation of sound policies to govern civic affairs. In doing this task, they did not see themselves as professional economists. The emergence of professional economists is a direct outcome of interventionists’ policy. They now utilize popular libertarian rhetoric in convincing the public while in reality they only advocate their interventionists’ concerns.

The service of early economists aiming for public good is now deceptively changed with the emergence of professional economists. A special breed of men has risen as specialists and has been serving in various capacities as experts and advisers. They can be found in all power centers and their influence is widespread. You can find them in government bureaus, economic legislation, political affairs, diverse political parties, editorial newspapers and periodicals, pressure groups, business advisers, big banks, and even as cabinet members. They provide the necessary measures to suppress the free operation of the market economy.

As a result of the dominance of professional economists, creative statesmanship is now largely missing. It is because interventionists’ control does not provide the necessary intellectual and social climate conducive to the development of qualities of creative statesmanship.

Forecasting as a Profession

In the face of the reality of business cycle, another type of skill or “profession” is expected from economists. This is related to business forecasting.

Businessmen want to know in advance the end of business boom so they can adjust and avoid losses. Some are looking for specific formula to guide them in their decisions. However, such formula does not exist due to the unpredictability of the future. There is no possibility that economists could know in advance the precise date where “good business” would end.

Such forecasting skill is the task of an entrepreneur. Depending on the accuracy of the forecast, an entrepreneur is taking financial risk.  Mises describes this entrepreneurial advantage as follows:

“The entrepreneurial idea that carries on and brings profit is precisely that idea which did not occur to the majority. It is not correct foresight as such that yields profits, but foresight better than that of the rest. The prize goes only to the dissenters, who do not let themselves be misled by the errors accepted by the multitude” (p. 871).

The Study of Economics

In this article, we will begin our study of Chapter 38 of Human Action. The chapter is about The Place of Economics in Learning. And we will start with Section 1, The Study of Economics.

According to Mises, the study of economics is a very important duty for every citizen. However, studying it is not easy due to several obstacles. Among them, the primary obstacle is the antagonism coming from the socialists and interventionists’ camps. This antagonism is a result of the economists’ unanswerable objections against the teachings of both the socialists and the interventionists.

Intellectually, the antagonism is done by sowing confusion into the minds of the people as to the real nature of economics. This is accomplished particularly through the academic attempt to remove the distinction between natural sciences and the science of human action.  The introduction of economic history is the concrete demonstration of an attempt to destroy the academic prestige of economics in order to advance the socialist and interventionists’ propaganda.

In section 1, we find three dominant themes. These are the inappropriateness of empirical approach in economics, the proper place of economic history, and the nature of economics.

Ludwig von Mises is popularly known as the Austrian economist who refused to categorize economics under empirical and scientific investigations. To him, empirical studies are only appropriate for natural sciences and not for the study of the science of human action. Since economics is under the science of human action, the methodology appropriate for natural sciences is not suitable to it. It is therefore erroneous to believe that the progress in economics could only be achieved once it is subjected under experimental studies.

Since the socialists and interventionists were determined to sow confusion, two distinctions are necessary to avoid unnatural interference in the study of economics. As already mentioned, these are the attempts to make economics part of natural sciences and the removal of distinction between economics and economic history.

The study of economic history has its proper place provided that it will not be used as a substitute to the study of economics itself. It must be clarified in the first place that the value of economic history could neither be found in providing facts that could be tested in laboratories nor in supplying data to formulate a posteriori theorems. The appropriate place of economic history is inseparable from the specific theory that develops it in the first place. As such, economic history simply provides an interpretation to economic phenomenon.

The reason why economics could not be subjected to experimentation applicable to natural sciences is due to its unique quality that can only be appreciated through abstract reasoning. What is necessary in the study of economics is not an expensive laboratory for its research but the ability to reason and to distinguish the essential from the incidental in the jungle of economic activities.

Respecting the boundary between economics and economic history, one can therefore find no conflict between these two branches of knowledge. Any conflict between these two academic disciplines emerged not from the scope of study, but from the intention of both the socialists and the interventionists to use the latter to displace the former.

Disproportionality Doctrines as Explanations of Business Cycle

This is the last article in our study of Chapter 20, Section 9 of Human Action. We end here our discussion about the impact of business cycle on the market. And we will focus our attention on the charges against free market advanced by nonmonetary theorists of business cycle known as “disproportionality doctrines.”

In the previous article, we mentioned that nonmonetary theorists of the business cycle explain an inherent contradiction within the free market as the real cause of business boom and bust. They identified it as the “disproportionality in the size of investments made in various branches of industry” (p. 582). And the two most popular disproportionality doctrines are “durable goods doctrine” and “acceleration principle.” Let us give a brief definition of each of them.

Durable goods doctrine is an economic belief that:

“…goods retain their serviceableness for some time. As long as their life period lasts, the buyer who has acquired a piece abstains from replacing it by the purchase of a new one. Thus, once all people have made their purchases, the demand for new products dwindles. Business becomes bad. A revival is possible only when, after the lapse of some time, the old houses, cars, refrigerators, and the like are worn out, and their owners must buy new ones” (p. 583).

Acceleration principle on the other hand is:

“A temporary rise in the demand for a certain commodity results in increased production of the commodity concerned. If demand later drops again, the investments made for this expansion of production appear as mal investments. This becomes especially pernicious in the field of durable producers’ goods” (p. 584).

Responding to the first accusation against free market, Mises argued:

“There are, to be sure, always promoters who in a mood of deceptive optimism are prone to over expand their enterprises. In the pursuit of such projects they snatch away factors of production from other plants of the same industry and from other branches of industry. Thus their overexpansion results in a relative restriction of output in other fields. One branch goes on expanding while others shrink until the unprofitability of the former and the profitability of the latter rearranges conditions. Both the preceding boom and the following slump concern only a part of business” (p. 584).

Mises’ response shows that the accusation is unsound for in the trade cycle, not only part of a business is affected. In fact, almost all entrepreneurs suffer financial lost. Durable goods doctrine cannot provide a reasonable explanation for this economic phenomenon.

Responding to acceleration principle, Mises explains that:

“The fundamental error of this doctrine is that it considers entrepreneurial activities as a blindly automatic response to the momentary state of demand. Whenever demand increases and renders a branch of business more profitable, production facilities are supposed instantly to expand in proportion. This view is untenable. Entrepreneurs often err. They pay heavily for their errors. But whoever acted in the way the acceleration principle describes would not be an entrepreneur, but a soulless automaton” (p. 584).

Mises then goes on to describe the character of a real entrepreneur as speculator. By this, he meant the quality of an entrepreneur to have an “anticipative understanding.” This quality is basically instinctive and cannot be learned in school. No existing rules could assess the presence of this entrepreneurial quality. An entrepreneur according to Mises is not guided by what was and is, but by how he sees the future.

Concluding his refutation of disproportionality doctrines, Mises claims that even if the arguments of nonmonetary theorists are accepted as valid, still they could not sufficiently explain how businessmen could proceed in expanding their business apart from credit expansion caused by increase in money supply. Only monetary credit theory of business cycle could provide reasonable explanation for business expansion caused by credit expansion.

Impact of Business Cycle

Let us now proceed to Chapter 20, Section 9 of Human Action. The central idea discussed under this section is about the impact of business cycle on the market.

Reading the previous post should make it clear by now that increase in money supply promoting credit expansion is the real cause for business fluctuations. These fluctuations are popularly known as “boom” and “bust” of business.

Mises appropriately describes the “boom” aspect of business cycle as “delusive prosperity.” It is an economic illusion not based on real data. It is an artificial wealth. No corresponding increase in production is taking place with the increase in money supply. This increase in money supply also called as inflation is mistakenly identified with economic progress. Such an artificial boom therefore is already doomed from its very source. It is the real culprit. It is the disease caused both by inflation and credit expansion.

The “bust” side of business is dreaded by politicians, bankers, economists, and the public. But in reality, economic depression is the way of the free market to restore health back into the economy. It is an act of economic recovery. Mises states: “we must call the boom retrogression and the depression progress” (p. 575).

The business cycle has several serious impacts on the market. In reality, business boom is a waste of economic resources through bad investments and decreases the quantity of goods through overconsumption. Its inescapable outcome is impoverishment.

The material impoverishment that follows after economic prosperity is a little consequence in comparison to the mental and psychological damages resulting from economic depression. People would turn despondent, dispirited, and frustrated. People would lose their “self-confidence and the spirit of enterprise to such an extent that they even fail to take advantage of good opportunities” (p. 578).  “The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration” (p. 576).

The unthinkable part among the impact of business cycle in the market is the public longing for more inflation and credit expansion. For Mises, this proves the incorrigibility of the people. For the public, “more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about” (pp. 576-577).

A popular argument in favor of more credit expansion upholds that more credit would enable the entrepreneurs to expand production, the unemployed to find jobs, and consumers to purchase products. It is argued that refraining from more credit would sink the economy into a prolonged depression. It is an erroneous analysis. In fact, this longing for more credit expansion only interrupts and prolongs the curative process resulting from depression. It could create a new boom resulting to deeper economic depression. This failure to learn the lesson from depression would keep the old story of boom and bust in repeating itself.

The prevailing erroneous opinion and response to economic depression is a result of the influence of the nonmonetary explanations of the trade cycle and the advocates of inflation and credit expansion. Only the monetary credit theory has clarified the notion about the neutrality of money and has provided also reasonable explanation about the cause of business cycle.

However, those motivated by political bias would certainly persist in nonmonetary explanation of the cyclical trade fluctuations despite of evidence. Mises identified them as the Marxians, non-Marxian socialists, and the interventionists.

The Marxians uphold that business boom and bust are inherent flaws in capitalism. The primary concern of non-Marxian socialists and interventionists is to exploit the alleged weakness of free market in order to destroy it and establish statist omnipotence. As a whole, the nonmonetary theorists of the business cycle receive inspiration from the Marxian and explain the trade cyclical fluctuations in terms of “disproportionality in the size of investments made in various branches of industry” (p. 582). They see it as inherent contradiction within the free market economy.

To explain these disproportionality doctrines in detail is the subject of the next post.

The Monetary Credit Theory of Business Cycle

The knowledge of Austrian economic way of thinking is a basic requirement in the education of an informed entrepreneur. Financial education and personal development are insufficient. They failed to supply the necessary knowledge to understand inescapable realities that all entrepreneurs face. Understanding of the increase in money supply, credit expansion, and business cycle are relevant economic realities that a responsible entrepreneur cannot afford to ignore without serious negative financial consequences.

Our goal in this article is to share our personal understanding on the writings of Ludwig von Mises about business cycle. And we will start with Chapter 20, Section 8 of Human Action where Mises discussed about the monetary credit theory of business cycle.

This business cycle is popularly known as business “boom” and “bust.” Understanding the cause of this cycle serves as necessary information for those who made the decision to enter into the world of entrepreneurs.

Chapter 20, Section 8 of the book provides two major explanations of business cycle: direct exchange theory and monetary credit theory. The first explanation is the dominant one and the second is coming from the Austrian school.

In the study of modern capitalism, it is popularly accepted that progress and depression characterized its history. Investigating this economic phenomenon, one can discern a general connection among the increase in the amount of capital, visible prosperity, and economic decline. The efforts of statistician to go beyond the general connection into details of business fluctuations with statistical methods are useless and futile due to the misdirection caused by mainstream interpretation.

It is evident that the Austrian school does not have the monopoly in explaining business fluctuations. Other schools of thought have their own version of business “boom” and “bust.” An example of this is the British Currency School.

The explanation of the British Currency School about business cycle is unsatisfactory in two ways: it failed to see the role of bank deposits in credit expansion and it limited its explanation of economic crisis to external source. As such, it failed to analyze the connection between money supply, lower interest rate, and credit expansion and their relationship to economic boom and bust.

Interest rates are anathema in the eyes of the public. It is considered a great barrier to production. For critics of free market, high interest is perceived as a tool for economic exploiters. Such mindset is a favorite dominant social theme for the interventionists. The state is seen as the savior from economic woes through either lowering or totally abolishing interest rates. Mainstream publication praise constant credit expansion as necessary to economic prosperity and advocate lower interest rates. Money’s neutrality is accepted as given assumption.

The above trend results into misleading analysis of economic crisis and business cycle using the theory of direct exchange. The monetary credit theory has therefore faced two primary obstacles: erroneous economic theory providing alternative and misleading explanation of economic crisis and business fluctuation and political bias.

The monetary credit theory therefore provides an explanation how the increase in money supply, lower interest rates, and credit expansion affect the trade cycle. Business fluctuation is the unavoidable consequence of credit expansion resulting from the increase in money supply and lower interest rates. The boom created by credit expansion would naturally result into bust, and nothing can be done to avoid such a collapse. The only alternative is either to accept the crisis sooner by abandoning further credit expansion or by delaying the crisis through continued credit expansion that would ultimately result into the collapse of monetary system.