A new piece in The Economist’s series on the shortcomings of the economics profession tackles the tricky question of the boundaries of economic science. It points out two flaws in the modern study of prices and exchange: first, the idea that “prices are all we need to know” about the economy and economic well-being. Second, the issue that “economists today still treat things which cannot easily be measured as if they matter less.”
As usual, it is not what The Economist says about these issues, but why they say it that matters.
In a sense, prices are all we need to know about the economy. As Joseph Salerno (1990, 52-3) explains, through market exchange and competition among entrepreneurs
…comes into being the market’s monetary price structure, a genuinely social phenomenon in which every unit of exchangeable goods and services is assigned a socially significant cardinal number and which has its roots in the minds of every single member of society yet must forever transcend the contribution of the individual human mind.
The price system and the market division of labor are two sides of the same coin, the economic sphere of human society.
As economists, our task is to explain the economic laws which lead to the realized prices in the market. As such, there is no reason to be dissatisfied with the prices we observe. Economists cannot and should not theorize, within economic science, links between income and happiness, nor use these shaky foundations as excuses for government policies and intervention in prices. For example, a statement like “as inequality rises, the price mechanism may do a worse job of allocating resources” implies an unachievable knowledge of a ‘better’ allocation of resources than the one resulting from voluntary market exchange. This highlights the conceit of economics practitioners, who see the world as needlessly flawed and wish to shape it according to their own subjective values. Instead, economists as such should be content with explaining it.
But mainstream economists are also guilty of disregarding essential aspects of human action in the quest for mathematical perfection in their models. As they use these models to predict and re-shape the economy, they cannot deal with "unpredictable" things. They do treat unmeasurable variables—like time, moral values, and non-monetary incentives — as if they matter less, in fact, as if they are non-existent, eliminating them completely from their idealized models.
This does not mean, however, that the solution is to introduce psychology, for example, into economics. Simply explaining the world around us in terms of human action and causal relations, as Mises taught, is sufficiently enlightening in itself, and quantitative predictions are not necessary for the science of economics.
More importantly, people’s subjective valuations, which coalesce into their economic choices, and thus into prices, are shaped by both monetary and non-monetary considerations. As Mises explained,
Honor, virtue, glory, and likewise vigor, health, and life itself play a role in action both as means and as ends, but they do not enter into economic calculation. […] The values that are not reflected in any monetary exchange ratio are, on the contrary, by this very fact lifted into a particular position which makes the decision rather easier.
No complaint is less justified than the lamentation that the computation methods of the market do not comprehend things not vendible. Moral and aesthetic values do not suffer any damage on account of this fact.
The purpose of economic science is not to resolve all social problems, nor does it have appropriate tools for this. What economics can do is to explain how entrepreneurs and consumers, through their interaction in the market, resolve some of these issues themselves.