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Economics and Measurement

June 17, 2003

The quantitative treatment of economic problems must not be confused with the quantitative methods applied in dealing with the problems of the external universe of physical and chemical events. The distinctive mark of economic calculation is that it is neither based upon nor related to anything which could be characterized as measurement.

-- Ludwig von Mises, Human Action, II.3

A great revolution in the physical sciences occurred between the 15th and 18th centuries. Measurement and the subsequent establishment of quantitative formula relating various measurements gradually replaced the Aristotelian search for the proper classification of physical phenomena. As Whitehead says of Aristotelian teachings, "these doctrines said to the physicist to classify when they should have said measure" (1967, p. 45).

But, as so often happens in human affairs, a new idea produces an overreaction. The idea of measurement, so successful in the physical sciences, came to be seen as the sine qua non of all human knowledge. The notion that if something hasn't been measured, then we don't know anything about it, came to be commonplace.

Measurement in the physical sciences depends upon the postulate that certain elements in the situation being measured are constant. A meter is always a meter, whether Joe or Mary or Sam is doing the measuring. And that meter should stay constant over time. Even Einstein, in formulating his theory of relativity, which contends that measurements of length are dependent on the observer's frame of reference, still must posit some unchanging elements, such as the speed of light, in order to formulate physical laws based on that idea.

However, once we enter into the realm of human action, there are no quantitative constants. Human action springs from the meaning that humans attach to their situation. Since that is the case, as knowledge is gained, as life is lived—in short, as time passes—the meanings humans attach to the circumstances of their world will alter. Such alterations are inherently unsusceptible to quantitative measurement or prediction. We cannot measure an interpretation, nor can new human meanings be predicted in advance—otherwise, they would not be new!

Let's say we examine the copper market over a course of many years. We will find that different prices were paid and different quantities of copper were sold in each year. People's desire for copper fluctuated. The fact that from the point of view of chemistry copper remained identical during the period is irrelevant to economics. As Mises puts it:

External objects are as such only phenomena of the physical universe and the subject matter of the natural sciences. It is human meaning and action which transform them into means. Praxeology does not deal with the external world, but with man's conduct with regard to it. Praxeological reality is not the physical universe, but man's conscious reaction to the given state of this universe. Economics is not about things and tangible material objects; it is about men, their meanings and actions. Goods, commodities, and wealth and all the other notions of conduct are not elements of nature; they are elements of human meaning and conduct. He who wants to deal with them must not look at the external world; he must search for them in the meaning of acting men.

Once we realize that economics deals with human meaning and not the physical characteristics of economic goods, the futility of searching for eternal, quantitative economic laws should be clear. No one would consider measuring what "war" or "liberty" means to people. Meaning is not available for measurement, and, in any case, meanings are in continual flux. What having a horse meant to a person in 1800 is entirely different than what having one means to a person in 2003, with the availability of Internet connections, automobiles, trains, and planes.

The price of something like Priceline.com stock over the last few years illustrates the primacy of meaning in human action. What owning a share of Priceline meant to the average investor in early 2000 was phenomenal yearly increases in the stock's price and a share in the "new economy." On March 10, 2000, at the height of the dot-com bubble, a share of Priceline traded for $94.50.

A mere nine months later, Priceline had much the same web site, the same technology, and many of the same employees. Yet on December 29, 2000, a share traded for $1.31. By then, the meaning of owning Priceline for most investors was to have been a sucker, taken in by hype, holding an asset that just kept declining in value. The physical characteristics of what was owned had changed relatively little, but the meaning attached to that ownership had altered dramatically.

"But," the advocate of economic measurement may ask, "what about money?" Can't we use the "measuring rod" of money as a common unit, thereby measuring what different goods meant to people at different times?

However, money is itself an economic good, and its meaning to acting man fluctuates just like the meaning of all other such goods. Quite aside from variations in the quantity of money altering its value, the meaning of money itself will vary from person to person and for the same person across time. The acquisition of money may be a man's main pursuit in life until, one day, a religious conversion completely alters its importance for him. Even if we had an absolutely fixed quantity of an unchanging substance, such as gold, serving as money, its meaning might still vary greatly. In peaceful times with a booming economy, people might feel the need to hold very little money. But should a crisis, such as a war, suddenly arise, their desire to hold money as insurance against hard times might increase dramatically.

Nor will it help to try to adjust the value of money by some price index. Such indices try to gauge changes in the value of money by "measuring" the amount of other goods it can purchase. We can see that this procedure is viciously circular. The value to people of those other goods fluctuates as well. Initially, we were going to attempt to measure the fluctuations in the value of non-monetary goods by using money, but now we find ourselves measuring the fluctuations in the value of money by using the value of non-monetary goods! In regards to human action, there is nothing constant by which we can achieve stable measurement. If the price of oranges declines, was that because oranges are valued less, money valued more, or some combination of both factors?

The collection of national economic data and the attempt to "steer" the economy based on such numbers are plagued, among other things, by this measurement problem. We can measure the quantity of physical goods a society consumes or produces, but that tells us little about the level of satisfaction the members of that society gain from those goods. It might seem, at first glance, that we could perform capital accounting for an entire country using money prices, achieving at least the same accuracy of measurement as the businessman. But that mistakes the nature of capital accounting. As Mises says:

It is possible to determine in terms of money prices the sum of the income or the wealth of a number of people. But it is nonsensical to reckon national income or national wealth. As soon as we embark upon considerations foreign to the reasoning of a man operating within the pale of a market society, we are no longer helped by monetary calculation methods. . . . If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or to replace it against this sum. If a whole entrepreneurial unit is estimated to be $1,000,000, it means that one expects to sell it for this amount. But what is the meaning of the items in a statement of a nation's total wealth? What is the meaning of the computation's final result? What must be entered into it and what is to be left outside? Is it correct or not to enclose the "value" of the country's climate and the people's innate abilities and acquired skill? The businessman can convert his property into money, but a nation cannot.

The collection of prices and quantities contained in, for instance, GDP figures, are an arbitrary choice on the part of the government. It is arbitrary to count a dollar the government spends on some service no one may really want as "equal" to a dollar a consumer freely chooses to spend on a good she truly desires. It is arbitrary to count a dollar spent by me this year as "equal" to a dollar spent by you next year. The dollar amounts going into the GDP are adjusted yearly for inflation, but as we have seen, the measure of inflation is itself arbitrary. Nor is there any particular reason that yearly adjustments, rather than monthly or daily adjustments, should be used, other than the fact that we are accustomed to annual data. And we have no reason to believe, even if we could eliminate the above difficulties, that a dollar measure of GDP reflects anything constant about the satisfaction the citizens receive from the dollars they spend. Ultimately, GDP measures nothing more than how many dollars were spent in a nation's economy on selected goods and services.

Nevertheless, economic data and statistics are not useless. They are facts to be interpreted by economic history. If we see a steady decline in the price of raw land in some country during some period, we may draw on our understanding of other factors we know were involved and perhaps conclude that increased agricultural productivity was reducing the demand for cultivating previously raw land. But it would be a serious error to formulate a "law" stating that all declines in the price of raw land were evidence of the same process. In another country, at another time, a decline in the price of such land might be due to a general deflation, to a decline in population, or to a new source of cheap agricultural imports. Similarly, a decline in GDP figures may be rendered meaningful by being subjected to historical interpretation.

We may even find that certain quantitative patterns persist over years or even decades. That might mean that we had stumbled across an institutional or customary arrangement producing such a pattern. Political philosopher Terry Nardin has said that statistical studies in the social sciences "are not scientific generalizations about a truly time-independent class of phenomena; they are more or less well-disguised descriptions of customs specific to a particular historical situation" (2001).

A noteworthy example of this phenomenon has been pointed out by Roger Garrison. He observes that Milton Friedman's predictions on the relationship between the money supply and price inflation worked fairly well for a significant period of history. But, just as Friedman's version of monetarism was gaining acceptance with policy makers, Regulation Q, which forbade the payment of interest on checking accounts, was rescinded. The institutional framework within which Friedman's predictions had worked was altered dramatically. As a result, just as Friedman's system was being adopted, it stopped working! If Friedman had viewed his work as determining an institutionally derived regularity, rather than an economic law, he might have expected that a major institutional change would have required a revision to his system.

The collection of economic data and their subsequent econometric analysis are perfectly valid activities, if they are used judiciously. Economic data are raw material for historical interpretation, and not the launching point for a futile search for eternal, quantitative economic laws.


Gene Callahan is author of Economics for Real People. Send him MAIL, and see his Mises.org Daily Articles Archive. He delivered the Henry Hazlitt Memorial Lecture at the Austrian Scholars Conference 9, March 13, 2003. Click HERE to view the online video version of his lecture.

References

Nardin, Terry, 2001, "Oakeshott's Philosophy of the Social Sciences," Presentation to the First Annual Michael Oakeshott Association Conference, London School of Economics.

Whitehead, A.N. [1925] 1967. Science and the Modern World, New York: The Free Press.


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