Mises Wire

Economics Needs a New Methodenstreit Based on Austrian Methodology

Per Bylund has called for a new Methodenstreit in economics. He’s referring to the late-nineteenth-century debate between Carl Menger, representing the newly dubbed “Austrian School,” and Gustav Schmoller, representing the German Historical School. The Historicists derided Menger’s causal realism, in which the laws of economics are derived from the fundamental character of human choice. They favored an atheoretical approach based on case studies that always seemed to support government intervention in line with their ideological biases. According to Ludwig von Mises, “The Historical School emphatically denied that there are economic theorems of such a universal validity. But this did not prevent them from recommending or rejecting—in the name of science—various opinions or measures necessarily designed to affect future conditions.”

Mises suggested that “Methodenstreit” is a misnomer because the debate was not truly over methodology but over the existence of economics as a science. Historicism and positivism preclude any universal, time-invariant claims about human action. It only produces tentative hypotheses based on data that is collected under specific circumstances—circumstances that include innumerable and unmeasurable factors that confound the collected data, especially when humans and their choices are the subject matter being observed.

The legacy of the Methodenstreit is mixed. Menger founded a fruitful and long-lasting school of economics that expanded out of Austria and multiplied through the work of Eugen von Böhm-Bawerk, Frank Fetter, Ludwig von Mises, Friedrich von Hayek, Murray Rothbard, and modern Austrian economists around the world. In contrast, no economist calls himself a member of the German Historical School today, but their failed ideas persist. The movement died (nominally) in the 1930s as “the adepts of the Historical School and Sozialpolitik transferred their loyalty to various splinter-groups, out of which the German Nationalist-Socialist Workers’ Party, the Nazis, eventually emerged.” Werner Sombart, who was “by far the most gifted of Schmoller’s students,” carried the torch for the German Historical School after World War I. Mises recounts his legacy:

Sombart tried to revive the Methodenstreit by a volume full of invectives against economists whose thought he was unable to understand. Then, when the Nazis seized power, he crowned a literary career of forty-five years by a book on German Socialism. The guiding idea of this work was that the Führer gets his orders from God, the supreme Führer of the universe, and that Führertum is a permanent revelation.

The moral bankruptcy, political ruin, epistemological mess, and academic failure of the German Historical School should have resulted in a total death of their ideas, but the history of economic thought since World War II reveals their methodological views marching on like an undead zombie.

In 1969, Mises saw the ghost of historicism haunting the economics profession:

Today, all over the world, but first of all in the United States, hosts of statisticians are busy in institutes devoted to what people believe is “economic research.” They collect figures provided by governments and various business units, rearrange, readjust, and reprint them, compute averages and draw charts. They surmise that they are thereby “measuring” mankind’s “behavior” and that there is no difference worth mentioning between their methods of investigation and those applied in the laboratories of physical, chemical, and biological research. They look with pity and contempt upon those economists who, as they say, like the botanists of “antiquity,” rely upon “much speculative thinking” instead of upon “experiments.” And they are fully convinced that out of their restless exertion there will one day emerge final and complete knowledge that will enable the planning authority of the future to make all people perfectly happy.

Even a cursory look at what passes for economic scholarship in mainstream journals today shows that the methodological errors that were exploded by Menger and Mises persist. We also see that the empirical findings tend to justify the state. Here is a sampling of the methods and conclusions in the most recent issue of the American Economic Review, which is widely regarded as the top journal in economics.

  1. Atal, Juan Pablo, José Ignacio Cuesta, Felipe González, and Cristóbal Otero. 2024. “The Economics of the Public Option: Evidence from Local Pharmaceutical Markets.” American Economic Review 114, no. 3 (March): 615–44.

Method: uses data from Chile to analyze the impact of public pharmacies on drug markets.

Conclusion: “Overall consumer savings outweighed the costs of public pharmacies.”

  1. Coibion, Olivier, Dimitris Georgarakos, Yuriy Gorodnichenko, Geoff Kenny, and Michael Weber. 2024. “The Effect of Macroeconomic Uncertainty on Household Spending.” American Economic Review 114, no. 3 (March): 645–77.

Method: “Randomized treatments that provide different types of information about the first and/or second moments of future economic growth to generate exogenous changes in the perceived macroeconomic uncertainty of treated households.”

Conclusion: “Recessions are characterized by increased uncertainty, and so an economic recovery may require management of expectations and assurances by policymakers (e.g., as was done by President Franklin D. Roosevelt; see Pedemonte 2020). In addition, policies that provide a stronger safety net for the more vulnerable groups (e.g., in affected sectors) will support aggregate demand.”

  1. Bollerslev, Tim, Jia Li, and Yuexuan Ren. 2024. “Optimal Inference for Spot Regressions.” American Economic Review 114, no. 3 (March): 678–708.

Abstract: “Betas from return regressions are commonly used to measure systematic financial market risks. ‘Good’ beta measurements are essential for a range of empirical inquiries in finance and macroeconomics. We introduce a novel econometric framework for the nonparametric estimation of time-varying betas with high-frequency data. The ‘local Gaussian’ property of the generic continuous-time benchmark model enables optimal ‘finite-sample’ inference in a well-defined sense. It also affords more reliable inference in empirically realistic settings compared to conventional large-sample approaches. Two applications pertaining to the tracking performance of leveraged ETFs and an intraday event study illustrate the practical usefulness of the new procedures.”

  1. Anderson, Axel, and Lones Smith. 2024. “The Comparative Statics of Sorting.” American Economic Review 114, no. 3 (March): 709–51.

I’ll just show you a screenshot:

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  1. Esponda, Ignacio, Emanuel Vespa, and Sevgi Yuksel. 2024. “Mental Models and Learning: The Case of Base-Rate Neglect.” American Economic Review 114, no. 3 (March): 752–82.

Method: “We experimentally document persistence of suboptimal behavior despite ample opportunities to learn from feedback in a canonical updating problem where people suffer from base-rate neglect” (abstract).

Conclusion: Economic agents make “suboptimal decisions.”

  1. Clark, Robert, Ig Horstmann, and Jean-François Houde. 2024. “Hub-and-Spoke Cartels: Theory and Evidence from the Grocery Industry.” American Economic Review 114, no. 3 (March): 783–814.

Method: Empirical analysis of collusion between bread suppliers and grocery stores in Canada.

Conclusion: Lawyers and policymakers should use these results to help identify cartels. “It is necessary for authorities to establish underlying motivations and intentions if they hope to prove that the law was violated. To this end, our empirical results confirm that hub-and-spoke can have a significant effect on prices, providing a profit motive for this sort of arrangement.”

  1. Buntaine, Mark T., Michael Greenstone, Guojun He, Mengdi Liu, Shaoda Wang, and Bing Zhang. 2024. “Does the Squeaky Wheel Get More Grease? The Direct and Indirect Effects of Citizen Participation on Environmental Governance in China.” American Economic Review 114, no. 3 (March): 815–50.

Abstract: “We conducted a nationwide field experiment in China to evaluate the direct and indirect impacts of assigning firms to public or private citizen appeals when they violate pollution standards. There are three main findings. First, public appeals to the regulator through social media substantially reduce violations and pollution emissions, while private appeals cause more modest environmental improvements. Second, public appeals appear to tilt regulators’ focus away from facilitating economic growth and toward avoiding pollution-induced public unrest. Third, pollution reductions by treated firms are not offset by control firms, based on randomly varying the proportion of treated firms at the prefecture level.”

  1. Exley, Christine L., and Kirby Nielsen. 2024. “The Gender Gap in Confidence: Expected but Not Accounted For.” American Economic Review 114, no. 3 (March): 851–85.

Method: Experiment in which participants, designated as “workers,” are given a test and then they self-evaluate their test performance. Other participants, designated as “evaluators,” evaluate the workers’ self-evaluations, with questions about over—and underconfidence. The goal was to detect evaluators’ bias against females.

Conclusion: “The confidence gap—conveyed via workers’ self-evaluations about their performance on a math and science test—results in overly pessimistic beliefs about women relative to men.” The authors are skeptical of the idea of removing gender information from applications and evaluations because it would make it difficult for evaluators to evaluate men and women differently: “The removal of gender information likely decreases the chance that employers can accurately account for gender differences in confidence.”

As you can see, scientism, empiricism, and historicism abound, despite the crushing defeat of the German Historical School. Not only do modern economists employ their methods, but the conclusions tend to justify government intervention and disparage free markets, just like the work of Schmoller and his disciples.

Per Bylund is absolutely right. We need another Methodenstreit.

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