Throwing Down the Gauntlet

Nicholas Taleb is making waves again – and in a good way, as we will explain below. It began with an altercation between him and a few mainstream economists on Twitter (what is apparently called a 'Twitter brawl'). Here is an post from Taleb's Facebook page that he put up in the wake of said brawl – Taleb announced that he will go with a fine comb through the papers of one Karl Whelan, one of the countless 'monetary economists' who are writing papers for the Fed and are thereby providing justifications for its meddling with the markets. Here is his post:

 

“We Can Start Exposing Economists:

I just finished a very rough draft of *Fat Tails & (Anti)Fragility* (~100 pages).

PART I provides a mathematical toolkit to detect anything that is bullshit in economic modeling (particularly macroeconomics), figure out which papers are flawed from a scientific standpoint, etc. When I mean flawed, it is on the basis that the math used impresses nonmathematicians but does not support the stated policy conclusions.
So I start by putting one Karl Whelan "scientific" work under severe mathematical scrutiny. I select him to start as he worked with central banks, the perfect profile of

the person supported by the taxpayer against the taxpayer's own interests. I also had a disgraceful encounter with him and his macro peers on twitter. Mr Whelan's papers can be found here: http://ideas.repec.org/e/pwh23.html We can progressively expose mathematized social science that way, as I am refining the text, adding words and examples.”

 

(emphasis added)

Then Taleb followed that up with a tweet that makes abundantly clear what he sees as his mission:

 

 

Mr. Taleb of course needs to continually market himself, since he is a book author and economic and financial pundit on television and various financial media. Courting controversy is a good way of staying in the limelight. In this case though, we think he has picked an excellent fight. We will explain below why that is so and why we wish him success.

 


 

Taleb
Maverick economist Nicholas Taleb – challenging the establishment

(Photo via Bloomberg)

 


 

Modern-Day Macro-Economists – Who Needs Them?

We are certainly not against people trying to advance economic science. We are also vehemently disagreeing with those who assert that 'there are no economic laws' or that economics is somehow not a science. What these people fail to grasp is that economics – a branch of the larger science of praxeology (the science of human action) – is a social science, not a natural science. It therefore requires a methodological approach that is different from that employed in the natural sciences. It therefore is also different in terms of what we can and what we cannot know. We will return to this point further below. 

What once used to be a field in which men of towering intellect tried to establish, discuss and lay down the tenets of what was widely considered an entirely new science as recently as the late 19th century, has become a field in which a great many rather mediocre intellectuals are mainly serving the interests of the State. The classical economists such as Ricardo, for all their flaws, did humanity an invaluable service by showing that there are in fact economic laws and that a ruler cannot suspend them, just as he cannot suspend gravity. The era during which the classical economists dominated the new science was one that saw the implementation of a fairly enlightened economic policy – as close to 'laissez faire' as we ever got – which led to an  enormous spurt in the growth of real wealth and prosperity between the late 19th and early 20th century. We owe a huge debt to this era of capital accumulation and the men who made it possible – without it, the world may be a lot poorer than it actually is.

Economic science advanced in great strides with the independent discovery of the principle of marginal utility by Carl Menger, William Stanley Jevons and Leon Walras in the 1870s. The Austrian subjectivist school which Carl Menger founded, advanced value theory, price theory, capital theory and monetary theory enormously. However, as many of the most important works were originally published in German language and not translated into English in a timely fashion, it never gained the influence in the English-speaking world it would actually have deserved (ironically, today the Austrian School enjoys far greater support and popularity in the US than in the German-speaking world).

One 'problem' is of course that the Austrians advocate the adoption of an unhampered free market economy. This is not based on 'right wing ideology',   but on a value-free assessment of economic laws. It is a 'problem' only because there would be fairly little, if anything, to do for macro-economists in a truly free market economy. Only exceptional men of great intellect could hope to get enough support to be able to pursue their scientific interest in economics as their main job. In today's era of unbridled statism, a great mass of people are by contrast employed by the State in one form or another, and their output is therefore, as Hans-Hermann Hoppe points out, as a rule both mediocre and “viciously statist”. To quote him more fully:

 

“Intellectuals are now typically public employees, even if they work for nominally private institutions or foundations. Almost completely protected from the vagaries of consumer demand ("tenured"), their number has dramatically increased and their compensation is on average far above their genuine market value. At the same time the quality of their intellectual output has constantly fallen.

What you will discover is mostly irrelevance and incomprehensibility. Worse, insofar as today's intellectual output is at all relevant and comprehensible, it is viciously statist. There are exceptions, but if practically all intellectuals are employed in the multiple branches of the state, then it should hardly come as a surprise that most of their ever-more voluminous output will, either by commission or omission, be statist propaganda.”

 

To put some numbers on this by way of an example: The Fed's board of governors in Washington employed a staff of 220 economists and the 12 regional banks employed another 171 as of 2004 (the most recent number that could be ascertained). The Fed doles out several hundred million dollars every year in research grants and for statistics gathering, so that at any given time, an estimated 500 economists are working on the Fed's behalf in addition to its staff. Some 1,600 economists across the US had listed "domestic monetary and financial theory and institutions" as either their primary (968) or secondary field (717) of study as of 1992. The most influential editors of prominent academic journals are as a rule on the Fed's payroll and provide a 'gate-keeper' function as to what does and what doesn't get published. An article that describes in detail how the economics profession was 'bought by the Fed' can be found here.

This is why most economists, who otherwise largely agree that monopolies and price controls are a bad thing, somehow all seem to support the idea that an exception to this rule should be made in the case of money. They simply won't bite the hand that feeds them so generously.

Of course, if an economist rejects interventionism and supports the establishment of an unhampered free market, then there is obviously no role for him as an 'economic planner' and 'adviser to policymakers' (except for advising them to stay the hell out of the economy and stop meddling with it). 

 

Economics and Mathematics

As Ludwig von Mises pointed out, there is no statement in economic science that can be made only by mathematical means and cannot be stated quite clearly in verbal form as well. In his early years, Mises' criticism of mathematical economists was still confined to such fairly innocuous and polite statements. His position on the topic hardened later, and  he eventually called the use of mathematics in economic science utterly 'barren' and a 'vicious method'. We have often pointed out that the econometric approach of gathering statistics, torturing them with mathematical formulas and then deriving hypotheses from them that form the basis for 'economic predictions' and 'policy advice' is as erroneous as it is dangerous (these predictions have a record of constant abysmal failure, and in light of the economic and market upheaval of recent years it should be obvious to all that the same holds for the policy advice given to the 'planners').

For one thing, as Oskar Morgenstern and many others have pointed out, the measurement of the data themselves is fraught with insuperable difficulties. In fact, in most cases there is actually nothing to 'measure', at least not anything that it would be sensible to measure. Economics is not physics, even though modern-day economists are beset by 'physics envy' and are trying to make it more akin to physics by couching their theories in mathematical gobbledegook. That may make many otherwise quite nonsensical papers appropriately incomprehensible to the layman, something that is probably held to imbue them with the necessary 'scientific gloss', but it represents mainly a case of 'garbage in, garbage out'.

Economics deals with purposeful, goal-oriented human action – with human beings who possess volition. It analyzes the means to achieve these goals. It is not a science studying inanimate objects. One would think that it should therefore be rather obvious that there must be a clearly delimited methodological difference between economic theory and the natural sciences. As Murray Rothbard writes on this in the foreword to Ludwig von Mises' work 'Theory and History':

 

“At the heart of Mises and praxeology is the concept with which he appropriately begins Theory and History, methodological dualism, the crucial insight that human beings must be considered and analyzed in a way and with a methodology that differs

radically from the analysis of stones, planets, atoms, or molecules.

Why? Because, quite simply, it is the essence of human beings that they act, that they

have goals and purposes, and that they try to achieve those goals. Stones, atoms, planets, have no goals or preferences; hence, they do not choose among alternative courses of action. Atoms and planets move, or are moved; they cannot choose, select paths of action, or change their minds. Men and women can and do.

Therefore, atoms and stones can be investigated, their courses charted, and their paths plotted and predicted, at least in principle, to the minutest quantitative detail. People cannot; every day, people learn, adopt new values and goals, and change their

minds; people cannot be slotted and predicted as can objects without minds or without the capacity to learn and choose.”

 

As Rothbard explains further:

 

“Mises saw that students of human action are at once in better and in worse, and certainly in different, shape from students of natural science. The physical scientist looks at homogenous bits of events, and gropes his way toward finding and testing explanatory or causal theories for those empirical events. But in human history, we, as human beings ourselves, are in a position to know the cause of events already; namely, the primordial fact that human beings have goals and purposes and act to attain them. And this fact is known not tentatively and hesitantly, but absolutely and apodictically.”

[…]

“Is the fact of human purposive action "verifiable"? Is it "empirical"? Yes, but certainly not in the precise, or quantitative way that the imitators of physics are used to. The empiricism is broad and qualitative, stemming from the essence of human experience; it has nothing to do with statistics or historical events.

Furthermore, it is dependent on the fact that we are all human beings and can therefore use this knowledge to apply it to others of the same species. Still less is the axiom of purposive action "falsifiable." It is so evident, once mentioned and considered, that it clearly forms  the very marrow of our experience in the world.”

 

This is in a nutshell why economic statistics and mathematics should have no place in economic science. It is of course different in the field of business economics and entrepreneurial activity, where economic calculation, even though it lacks precision, is an indispensable tool.

 


 

ludwig_von_mises

Ludwig von Mises, the father of 'praxeology'; his thoughts on the methodological and epistemological problems of economics remain a bone of contention – however, he was and remains right.

(Photo via Wikimedia Commons)

 


 

Nicholas Taleb is himself a trained mathematician and statistician, so he may well tackle the papers he intends to critically examine by employing his knowledge in these fields (at least that is what it sounds like in his Facebook announcement). That is certainly a legitimate approach, on account of the above mentioned 'garbage in, garbage out' phenomenon. Most of the models used to support specific policy conclusions are constructed in a manner that ensures that they will spit out the desired results. They simply employ certain assumptions as 'given' and beyond debate, when those assumptions can by no means be considered indisputable facts (as a good example for this  'GIGO' phenomenon, consider this critique of the infamous Blinder-Zandi 'stimulus study').

Presumably it is this aspect that Taleb will focus his critique on. However, it should be noted that in spite of his employment of 'mathematical tool kits', Taleb is mainly known for his 'black swan' theory, which states that in financial markets, events that are considered extremely rare from a purely statistical standpoint (so called 'fat tails'), are in fact anything but rare.

In our opinion this is so because in the course of boom-bust cycles there is always a threshold, a 'tipping point' if you will, where the boom turns into bust.  It is the point at which a critical mass of investors realizes that the boom is no longer sustainable. By acting in concert on this recognition, they tend to produce rather outsized market moves, such as for instance the stock market crash of 1929.

Anyway, even if Taleb is not an 'Austrian' – at least he has to our knowledge never declared himself to be one – his assessment and analysis of the flaws of modern policy-making and central economic planning as well as the fractionally reserved banking system is quite often spot on. We therefore wish him success in tackling the handmaidens of statism and their pseudo-scientific output. Anyone criticizing the producers of fig leaves for interventionism deserves our support.

 


 

 

 

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6 Responses to “Nicholas Taleb Against Establishment Economists”

  • mc:

    “This is in a nutshell why economic statistics and mathematics should have no place in economic science.”

    I have to strongly disagree with this statement. I have read Taleb’s paper, and he definitively makes the point that it is not the application of mathematics to economics that is the issue, but the incorrect usage of the fundamental methods of statistics. It is not the quantity of math in the economics profession, but what exists lacks the mathematical rigor we would expect from anything calling itself a science. Just as Mises thought that concepts of economics expressed in math could be expressed in logical statements, we should expect the reverse to be true if we are correctly applying the logical framework first.
    Taleb’s mathematical framework expresses in equations what could be explained in text. Exactly what is the mathematical error that is made by an assumption, for example, assuming that a deviation is normally distributed? The problem is easily solvable if it is normal, but could be of unbounded difficulty if the deviations are not normal. Do econ papers do this? Yes. Does the data support this? Not at all. He tests all sorts of conditions and markets, and that is not true. Yet, the econ world will blithely pretend it is true because it allows use of the powerful statistical toolkit developed for normal variables. The econ world will draw conclusions and feel confident the math is correct, while ignoring that it is completely misused from the start.
    The conclusions of Mises are not invalid – we must start from the barest set of assumptions and reason logically to build a framework for interpreting economic events. We cannot collect data first and then infer what the underlying processes are from the data alone. Not all economic math must be the narrow minded empiricism or overly simple Gaussian models.
    The mistake that the econ profession makes is to think that the correlation of two variables has a meaningful causal relationship. First we have to determine what is the relationship between them logically, and then try to understand if the data supports that conclusion. Too often is the correlation that is first reported (increasing inflation lowers unemployment – the Phillips Curve), when in fact the logical outcome we would expect is the underlying cause (high unemployment causes low wage growth).

  • Mr. Tenebrarum,

    I agree with you that economics is a science but not for the basis that you do. I think the definition you choose of economics as a branch of praxeology is too narrow. In the past few years I came to understand science as the study of reproducible events. In this study, mathematics, elementary counting is a fundamental aspect. Your disdain of mathematics in the study of economics comes from, I think, your narrow definition and is denying you of some very powerful tools of logic. Mises had the same bias.

    The wonderful thing about logic is that it describes whether in sentence structure or mathematics the same set of principles. It is for this reason that logic when properly formed has mathematical and spoken language analogues, technically they are an equivalent mapping from one space to another.

    I was able to show that by adopting Morgenstern’s axioms of Game Theory, defining individuals preference, that it is indeed possible to aggregate individual action. As a consequence of this aggregation are economic laws, and some physical ones too. Also by aggregating in this manner I showed how conventional macro economic theory ignores individual action. I did this by using the same mathematical framework (Hamiltonian mechanics) that modern Keynesians used. I just didn’t ignore the sum of individuals’ contributions. A society does not prescribe law to individuals, it is the action of individuals that provide the law to society. The laws of economics as Hayek properly identified in Law Legislation and Liberty are an organic construction and a consequence of individuals and are influenced, but not determined by outside constraints. He separated the law from legislation.

    You might have complaints with a Hamiltonian mechanics as being physics. And you are correct it is physics, but on the mathematical level the Hamiltonian is a system that describes the time evolution of a Markov process, a reformulation of the Lagrangian of a state space representation of dynamical individual action. (Note Hamilton’s equations are readily derived from Lagrangian mechanics used to describe Markov processes.) The real difficulty is coming up with the functional relationships within the economy. One has to identify from heuristics and observation the appropriate intensive (endogenous) state space representations. Saying that such relationships exist in theory and that their complete definition is actually knowable are two very different things. In fact, it is impossible to know the entire set of functional relationships between the individuals within a society, and that to obtain such knowledge would affect the system. This is more of a restatement of Heisenberg’s Uncertainty Principle. Hayek talked about this very point in The use of Knowledge in Society.

    Now some of the more common relationships are knowable, we all know them as societal norms or customs. Some also include such abstractions as property rights and the rule of law (I am not talking legislation). Being able to turn this knowledge into some mathematical formulation is another issue all together. It is very difficult, but not impossible. As more detailed knowledge of the system evolves, the more complex the relationships become and more and more degrees of freedom for each individual come into being. I started simply and looked at the laws of motion, as describing the first set of constraints on an individual. We can’t avoid them, even though sometimes we try awfully hard. As we learn more later we can increase the model complexity. That is the study of true social science, not the pseudo science that pervades the modern education experience and that presumes to subvert the natural laws of human existence.

    In my blog, I lay out the initial framework of turning praxeology into something more mathematically formal. I had to use praxeology in my derivation in order to restrict what it was that was admissible into the overall concept of science. Action requires that something be observable. We have to be aware of it to observe its impact, if we have this awareness we can begin to study it by counting it. This gets rid of whole sets of silliness like intrinsic value and social values as being distinct form the individuals of a society. Praxeology mixed in with a little Pragmatism serves as the overall foundation of my work. Like Mises, I have a tremendous respect for the spiritual work of authors like William James and the demand that for something to be real it has to be observable, just that our understanding is incomplete. This is not to say that we know everything. We do not, but that as our knowledge increases what we are able to observe increases and so does our fundamental understanding of the world around us.

    Here is the link to where I do the bulk of the work in defining the theory, it is in a pre-alpha stage, it works, but has a lot of bugs and hangs up in some areas, but is an overall functioning structure. http://statisticaleconomics.org/testing-and-development/pre_alpha/elementary-principles-in-statistical-economics/

    Cal Abel

  • Hi RI,

    Many thanks, this is very interesting. I knew of Spitznagel (due to a very sharp analysis he wrote about the true causes of the growing wealth disparity in the US), but I wasn’t aware that he used to work with Taleb. And I totally agree, knowledge of Austrian economics provides one with a considerable advantage in investing. I also agree that most swans are therefore ‘gray’, not black, and that they only appear black to the great mass of investors.

  • Rothbardian Investor:

    Dear Pater,

    You may be interested in the works of Mark Spitznagel (a former business partner of Taleb and sort of an Austrian quant and outspoken Ron Paul’s supporter,most definitely a fascinating character).
    You may like this paper in particular:

    http://www.universa.net/UniversaSpitznagel_research_201205.pdf

    In it he seems to re-elaborate Taleb’s theory that black swans are more frequent than anticipated and that as such the opportunity lies in buying mispriced options all the time until something happens: he argues that the colour of the swan depends on the observer and that the real advantage lies in using the Austrian approach to identify specific white(or at least grey)swans that are perceived to be black by the vast majority of market participants, to their ignorance of Austrian economics(these are just my observations and my own takeaways).
    By the way, this happens to mirror my own approach to investing: I see knowledge of Austrian economics as a great strategic/positional advantage(as shi, to again talk in Spitnagel-ese: http://www.forbes.com/sites/realspin/2012/07/29/the-grand-shi-strategy-of-ron-paul/ ).

  • anto:

    Pater,

    I thought you might be interested in this:

    http://www.huffingtonpost.com/2013/05/01/gop-census-bill_n_3188043.html

    “GOP Census Bill Would Eliminate America’s Economic Indicators”

    “The bill, introduced last week by Rep. Jeff Duncan (R-S.C.), would bar the U.S. Census Bureau from conducting nearly all surveys except for a decennial population count. Such a step that would end the government’s ability to provide reliable estimates of the employment rate. Indeed, the government would not be able to produce any of the major economic indices that move markets every month, said multiple statistics experts, who were aghast at the proposal.

    “They simply wouldn’t exist. We won’t have an unemployment rate,” said Ken Prewitt, the former director of the U.S. Census who is now a professor of public affairs at Columbia University.

    “I don’t know how the market reacts if there is suddenly no unemployment rate at the start of the month,” Prewitt said. “How does the market react if we don’t have a GDP [gross domestic product]?”

    • Hi Anto,

      Thanks, I have heard about this – it would actually be quite a good idea, as without macro-economic statistics, the main basis for interventionism would cease to exist. In fact, former Hong Kong governor Cowperthwaite refused to collect economic statistics like unemployment data for this very reason (leaving a number of British delegations that came to visit Hong Kong dumbfounded). Incidentally it didn’t take very long for Hong Kong to be transformed from one of the poorest places on earth into one of the richest. :)

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