Pragmatism and Economics

[So I'm digging through my email archives (yay gmail search!) looking for my resume, and I come across an old term paper I wrote for a philosophy course on pragmatism. I've probably posted this before, but it's one of my favorite essays, so here it is again.]

 


At first glance, it appears as though the field of economics and the philosophy of pragmatism[1] are fundamentally at odds with each other. Economics operates from the perspective of methodological individualism, focused primarily on the viewpoint of individual decision makers. Pragmatism, on the other hand, rejects an individualistic, atomic conception of man and takes a communitarian approach instead. Furthermore, economics has borrowed heavily from logical positivism, and logical positivism in turn has been historically opposed to pragmatism.

Despite these apparent differences, economics and pragmatism have much in common with each other. Indeed, on closer examination, many of the conflicts between the two disappear entirely. The cause of this misunderstanding is a lack of dialogue: economists have much to learn from pragmatists and so too the reverse. Specifically, economists practice a methodology of pragmatism (even though they mistakenly speak a language of logical positivism), economists share a pragmatist conception of value, and most importantly, economists and pragmatists use similar tools to explain how knowledge is acquired, modified, and disseminated.

It is somewhat ironic that during the same year when logical positivism was effectively destroyed as a sufficient explanation for scientific methodology among philosophers, it was just coming into fruition as a philosophy of science among economists. In 1953, the year that Willard van Orman Quine published his “Two Dogmas of Empiricism,”[2] Milton Friedman published “The Methodology of Positive Economics.”[3] The importance of Friedman’s paper to how economists understand (or misunderstand) the methodology of their own field cannot be overstated.[4] Friedman begins by distinguishing between positive and normative economics along classic Humean lines. Although such a sharp distinction between fact and value is rejected by some pragmatists, it can be saved on validation/vindication grounds: economists are more likely to reach agreement with their colleagues and the general public if they avoid making policy recommendations based upon highly controversial values. This is not to say that positive, “factual” claims are immune to controversy, but less so than normative, value-laden ones. Similar to Quine’s soft-demarcation between more germane and less germane beliefs, positive and normative claims can be described as different in degree, not different in kind. All beliefs ultimately rest on some kind of value judgments, but the less a claim relies on controversial values, the less likely one needs to resort to vindication to resolve a dispute, if such a resolution is even possible at all. Conversely, claims based upon widely-shared values are more likely to be accepted through validation.

Later in his paper, Friedman defends economic methodology on instrumentalist as opposed to realist grounds. Friedman concedes that the basic assumptions of economics—people have rational preferences among outcomes; individuals maximize utility and firms maximize profits—are certainly not true in any universal sense and may not lead to reliable predictions insofar as the phenomena under examination are the assumptions themselves. However, Friedman argues that we can use these same assumptions legitimately if they are successful in predicting other phenomena of interest.

Friedman provides two examples. First, suppose a physicist wants to predict the shots made by an expert billiard player. The physicist can reasonably assume that the expert billiard player will make his shots “as if he knew the complicated mathematical formulas that would give the optimum directions of travel, could estimate accurately by eye the angles, etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas.”[5] Of course, even the most expert billiard players do not actually go through this impossibly complex process. Rather, our assumption that expert billiard players will act as if they do go through this process is justified based on the argument that “unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.”[6] The phenomenon of interest is not the rationality or mathematical ability of the billiard player, but the results of his shots as if he acted upon perfect rationality or mathematical ability.

Friedman’s second example is similar to an evolutionary argument. Suppose a biologist wants to predict the density of leaves around a tree. The biologist can reasonably assume “that the leaves are positioned as if each leaf deliberately sought to maximize the amount of sunlight it receives, given the positions of its neighbors, as if it knew the physical laws determining the amount of sunlight that would be received in various positions and could move rapidly or instantaneously from any one position to any other desired and unoccupied position.”[7] Of course, leaves do not act this way; indeed leaves do not “act” at all in the sense that action requires conscious choice. Rather, those areas of the tree which receive more sunlight will be more conducive to leaf growth, and thus denser than areas which receive little or no sunlight. The phenomenon of interest is not the consciousness of the leaves, but the results of leaf density in relation to sunlight as if leaves were capable of conscious action.

However, there is a weakness in Friedman’s argument. As-if assumptions may be useful and reliable insofar as they are applied to the specific phenomenon for which they have been tested. But this presents a difficulty if economists ever wish to apply these assumptions to new applications, with no assurance that the same approximations will hold true. The as-if assumptions will need to be empirically tested for each new application; they cannot be relied upon as general principles because the assumptions themselves have not been tested as the phenomena of interest. Still, Friedman’s instrumentalism seems closer to pragmatism than to logical positivism.

Although Friedman tried to sidestep the issue by distinguishing between positive and normative economics, even positive economics must answer the question: What determines the value of a commodity? Economists from Adam Smith to David Ricardo to Karl Marx all shared a common belief that commodities have an objective value, independent of the subjective preferences people place on them. Smith came to this conclusion as a result of reasoning through the diamond/water paradox. Smith distinguished between value in use and value in exchange: Why is it that diamonds have such a high exchange value compared to water yet water is so much more useful than diamonds? Water is necessary for human existence and diamonds are not. Smith concluded that exchange value must be determined by a factor other than usefulness. The determinant of exchange value, Smith reasoned, is the labor cost of producing a commodity.

Smith’s reasoning, however, was flawed. He failed to distinguish between "total" utility and "marginal" utility. It is true that the total utility or satisfaction of water exceeds that of diamonds; if given a choice, people would prefer a life without diamonds than a life without water - which is, of course, no life at all. Yet most people would prefer to win a prize of a single diamond instead of an additional bucket of water. To make this last choice, people do not ask themselves whether diamonds or water give more satisfaction in total, but whether more of one gives greater additional satisfaction than more of the other. For this marginal utility question, the answer will depend on how much of each commodity the consumer already has. Though the first units of water consumed every month are of enormous value, the last units are not. The utility of additional (or marginal) units continues to decrease as a person consumes more and more.

Smith’s failure to distinguish between total utility and marginal utility does not necessarily demonstrate that the labor theory of value is wrong, but it does remove his impetus for rejecting usefulness—or preference—as a standard of value. There are numerous other economic arguments against the labor theory of value, the strongest of which—the transformation problem—was discovered by Marx himself. But these arguments are beyond the scope of this essay. More important for the present discussion is the modern understanding of what determines value.

The labor theory is an objective explanation of value in the sense that value is determined by material conditions, and not by the preferences of those living in a specific society. In contrast, the current paradigm in mainstream economics is based on economic subjectivism: the theory that value is a feature of the appraiser and not of the thing being appraised. According to economic subjectivism, commodities do not have inherent value, but have value only insofar as people desire them.

This notion of subjective economic value is nearly identical to the way pragmatism approaches concepts like moral values and legal or ethical rights. Values, whether economic or moral, cannot be derived from outside society – from outside the value makers. People cannot remove themselves from their social context in order to gaze at the objective principles “out there,” because there is no “out there” at which to gaze. Instead, since value does not exist outside of the social paradigm, it must come from within that community. The propensity of consumers to consume, the propensity of producers to produce, the relative scarcity of a good, the available substitutes, current technology – all of these factors—and others—interact with each other through a system of price signals to indicate to consumers and producers the values other people place on certain commodities and the opportunity costs one must give up in order to acquire a certain commodity or pursue a certain production strategy.

This system of prices for the economist is akin to a linguistic system for the pragmatist. No human knowledge can exist outside the linguistic system, and no economic knowledge (or economic values) can exist outside a pricing system. This idea was made clear in F.A. Hayek’s well-known essay, “The Use of Knowledge in Society.”[8] Hayek focuses on what initially may seem at odds with pragmatism: information available only to individuals through their particular circumstances of time and place and their subjective desires. Hayek, like other economists, ultimately operates from a standpoint of methodological individualism; the focus, as always is on how human action originating from the individual can lead to a social structure more than the sum of its parts.

However, this is not contrary to the pragmatist conception of human knowledge as a fundamentally communal process. Even though it originates from individuals, the kind of tacit, unarticulated, habitual, inchoate, personal knowledge Hayek describes can only be harnessed through a social process, precisely because it is dispersed across the very individuals who posses it. As Hayek puts it, “the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.”[9] Hayek claims that

The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.[10]

If this kind of tacit knowledge is dispersed across everyone in society, and cannot be concentrated or integrated into one single mind or entity, how can it be utilized? Hayek offers a two part solution. First, “the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them.”[11] It would be impractical if not impossible to communicate all of this tacit decentralized knowledge held by millions of individuals to one central authority and expect this authority to integrate and act upon this knowledge in time for it to still be relevant. Instead, there must be some method by which people can communicate their decentralized, tacit knowledge to each other. This method, Hayek argues, is a system of price signals.

Prices serve two basic functions in economics. In the short term, prices serve a rationing function by directing goods to their highest valued uses. In the long term, prices serve a resource allocation function by communicating to producers that consumers want more of good X and less of good Y. Through these two functions, prices communicate information to both consumers and producers and at the same time give them incentives to change their behavior.

The system itself is ingeniously simple. No one needs to expend much thought inquiring into the nature and causes of price fluctuations. The only thing consumers and producers need to do is react to the price signals as they receive them. Hayek recognized this beautiful simplicity when he wrote,

The problem which we meet here is by no means peculiar to economics but arises in connection with nearly all truly social phenomena, with language and with most of our cultural inheritance, and constitutes really the central theoretical problem of all social science. As Alfred Whitehead has said in another connection, "It is a profoundly erroneous truism, repeated by all copy-books and by eminent people when they are making speeches, that we should cultivate the habit of thinking what we are doing. The precise opposite is the case. Civilization advances by extending the number of important operations which we can perform without thinking about them." This is of profound significance in the social field. We make constant use of formulas, symbols, and rules whose meaning we do not understand and through the use of which we avail ourselves of the assistance of knowledge which individually we do not possess. We have developed these practices and institutions by building upon habits and institutions which have proved successful in their own sphere and which have in turn become the foundation of the civilization we have built up.[12]

This is nothing more than pragmatism. Hayek rejects abstract theorizing as essentially a waste of time and a distraction from real kinds of knowledge – knowledge which can influence our actions. His criterion for judging habits and institutions is Darwinian – that which succeeds over time survives and that which does not is discarded.

Most economists are already pragmatists; they just don’t know it yet. They have adopted the language of logical positivism to describe their methodology, yet they do not practice it. They have rejected realism as untenable for the study of complex human interactions, while at the same time, pragmatists have rejected realism insofar as they object to any claims of a reality or “Truth” external to the human language and human social experience necessary to understand it. Instead, both groups—economists and pragmatists—have adopted instrumentalism on grounds of practical results. Both economists and pragmatists reject any notion of objective value outside of human value-creators. And most importantly, economists like Hayek have come to recognize that the market itself is a social institution, and prices, like language, are a form of communicating knowledge for social progress.


[1] If not the philosophy of pragmatism, then the pragmatic way of thinking: “[William] James presented pragmatism…not as a philosophy but as a way of doing philosophy, and Peirce…described it as a method for making ideas clear and not as a place to look for ideas themselves.” Menand, L. 1997. Pragmatism: A Reader, pp. xxv-xxvi. New York: Vintage Books.
[2] Quine, W. 1953. Two Dogmas of Empiricism. In From a Logical Point of View, pp. 20-46. Cambridge, Mass.: Harvard University Press.
[3] Friedman, M. 1953. The Methodology of Positive Economics. In Essays in Positive Economics, pp. 3-43. University of Chicago Press.
[4] “Indeed, Friedman’s essay is by far the most influential methodological statement of this century. It is the only essay on methodology that a large number, perhaps a majority, of economists have ever read.” Daniel Hausman, D. 1988. Economic Methodology and Philosophy of Science. In Winston, G. and Teichgraeber, R. The Boundaries of Economics, p. 96. Cambridge University Press.
[5] Friedman, M. p. 21.
[6] Ibid.
[7] Ibid. 19.
[8] Hayek, F.A. 1945 “The Use of Knowledge in Society.” American Economic Review, XXXV, No. 4; September, pp. 519-30.
[9] Ibid.
[10] Ibid.
[11] Ibid.
[12] Ibid. Share this

Much as a I dislike

Much as I dislike pragmatism, this remains a great essay.

Thanks, Scott. I had a

Thanks, Scott. I had a strong aversion to pragmatism at the beginning of the course, and still have major issues with Oliver Wendell Holmes and Dewey, but Charles Sanders Peirce is the shit, and pragmatism does kinda grow on you over time. It's a nice contrast for a recovering Randian.

Peirce

Peirce is the only pragmatist I have read (aside from snippets here and there) and "pragmatism" for me pretty much just means "the philosophy of Peirce". So when someone says, "I hate pragmatism" or variants thereof, I interpret that to mean, "I hate Peirce's philosophy." I'm not just being self-centered - Peirce isn't merely the one I've read, he's the creator, the definer. It derives from his philosophy.

You are correct; Peirce

You are correct; Peirce is pretty much pragmatism incarnate. William James was basically just his press agent; everyone else associated with the pragmatist movement was even further removed from the originator. And despite whatever faults I may find in the rest of the pragmatist movement, it's difficult for me to find anything significant or substantial that Peirce ever wrote that is disagreeable to me.

I had a fantastic comment

I had a fantastic comment written. It had two insights, three learned allusions, plus a pun. I'm not patient enough to recreate it exactly. Never read Pierce. Read Dewey--Dewey influenced legal thought, that's where I was introduced. Russell criticized pragmatists--I've never found such a criticism I disagree with. The basic tenet of truth as what is useful may be a caricature, but I don't know the more subtler form of that pragmatist tenet. The caricature, at least, is stupid. Not knowing the philosophy in greater depth, I can't say more, intelligently.

I hate when that happens;

I hate when that happens; some of my best comments ever disappeared down the memory hole.

I haven't read it yet, but the always useful Stanford Encyclopedia of Philosophy has a webbed entry on Peirce. I'm adding it to my reading que, as should you.