The Con in Economics
“In so far as a theory can be said to have assumptions at all, in so far as their realism can be judged independently of the validity of predictions, the relation between the significance of a theory and the realism of its assumptions is almost the opposite of that suggested by the view under criticism. Truly important and significant hypotheses will be found to have assumptions that are wildly inaccurate descriptive representations of reality and, in general, the more significant the theory, the more unrealistic the assumptions.” Milton Friedman .
I first read this remarkable passage by Milton Friedman a few years ago in Steve Keen’s book Debunking Economics . Keen is one of only twelve economists to have predicted the recent great recession  so he is entirely credible. Still I’m a skeptical person and with due respect to Friedman I had to read the original paper. Even assuming Keen’s quote is accurate and it is; it may have been taken out of context, and it is not. I found Friedman’s remark so outrageous that I had to comment on it, and apparently so did a whole lot of other people. I came across the original paper along with several critiques by other economists, including Paul Samuelson, and philosophers, including Ernest Nagel, in Bruce Caldwell’s book Appraisal and Criticism in Economics, A book of Readings . Economic methodology is an esoteric subject even for economists but the selections in the book are interesting and expose us to yet another example of how not to think.
Unfortunately, the book contains no critiques of Friedman’s paper by scientists who seem to have ignored him. Scientists at the time were perhaps paying more attention to debunking that other but far less dangerous pseudo scientist Immanuel Velikovsky . While Velikovsky garnered a small following of ordinary people then; he is now largely forgotten. Friedman, on the other hand, had outsized influence with many powerful political leaders including the Iron Lady, the Great Communicator and Pinocchio (for those of you much younger than me: Maggie Thatcher, Ronald Reagan and the ruthless dictator Augusto Pinochet). And though he died in 2006, his ideology still dominates American conservative economics.
While Friedman doesn’t use the term, the methodology he describes in his 1953 paper is called instrumentalism. The economist Lawrence Boland confirmed, from private communications with Freidman that it was still his methodology of choice in 1980  at the height of his influence. To understand what instrumentalism is, it is useful to contrast it with science or the scientific method, which instrumentalism is not.
Science is the collection of data by very careful observation such as the position of the planets and other heavenly bodies and by experiments such as rolling balls down incline planes and carefully recording velocity and acceleration. These are the activities which Johannes Kepler, Nicolaus Copernicus, Galileo Galilei and other scientists exhaustively performed. Scientists then propose hypotheses which explain the collected data. These hypotheses are used to analyze the data and make testable predictions. In the scientific realm hypotheses include their assumptions. This process is a loop where each experiment or observation or calculation produces a better hypothesis or redefines more realistic assumptions over which it applies.
Newton’s law of gravity, which Friedman calls the “law of falling”, predicts the acceleration and velocity of a mass being acted on by a gravitational field in a vacuum. It turns out to accurately explain the orbit of the moon, which is moving in a vacuum, and also quite accurately explain what happens to a hammer if we drop it off a roof which isn’t moving in a vacuum but close enough. And it also explains, despite Friedman’s protestations, the movement of a feather dropped off the same roof and why it will eventually hit the ground even in a gale force wind. It will not achieve escape velocity. Newtonian mechanics explains the motion of a feather provided we include all the forces acting on it as it falls. And as the astronomer David Scott, on Apollo 15, demonstrated, on the moon, in a vacuum, a hammer and a feather do fall at exactly the same rate and hit the moon’s surface at exactly the same time . The point is one cannot separate the theory of gravity from its assumptions. The assumptions are part of the theory and inform us when the theory applies directly and when we must consider other forces or better theories.
Using the “law of falling” to show that unrealistic assumptions, a vacuum, lead to significant theories was an unfortunate choice for Friedman since a vacuum is hardly an unrealistic assumption. In reality the density of atoms in the universe is on the order of a single hydrogen atom for every four cubic meters of volume  and thus the assumption of a vacuum holds nearly everywhere in our universe and it is rather parochial to assume that everything takes place in the very thin veneer of the Earth’s atmosphere.
There are other assumptions of Newtonian mechanics which are more limiting such as an absolute space-time reference and that the objects of interest must be traveling much slower than the speed of light. Friedman might have made hay with those but again the reality of the assumptions are part of the theory and the assumptions of Newtonian Mechanics are good enough approximations to reality to put a man on the moon not because Newton’s assumptions are unrealistic but because they are.
Instrumentalism is an entirely different matter. While the goal of science is to understand the natural world; the goal if instrumentalism is to make predictions. According to Friedman, assumptions need not be realistic at all in order to derive a theory, the more unrealistic the better. And the theory can only be judged on the accuracy of its predictions and not the reality of the assumptions. Samuelson points out  that Friedman’s use of “unrealistic” is a euphemism for “empirically dead wrong.” Friedman’s argument, which goes on for forty pages, turns out, at least according to Samuelson, to be a rather elaborate justification for the perfectly competitive laissez faire model of the economy and the maximization of profit hypothesis . Keen discusses  in great detail why the assumptions leading to Freidman’s economic model and hypothesis really are unrealistic and why exactly that undermines them. Defending rubbish rather than admitting one might be wrong is what Samuelson dubs the Freidman Twist. Paul Samuelson wrote : “The whole force of my attack on the F-twist is that the doughnut of empirical correctness in a theory constitutes its worth, while its hole of untruth constitutes its weakness. I regard it as a monstrous perversion of science to claim that a theory is all the better for its shortcomings; and I notice that in the luckier exact sciences, no one dreams of making such a claim.”
In review, Friedman began with “assumptions that are wildly inaccurate descriptive representations of reality” and when caught instead of the expected mea culpa, he dug a deeper hole defending an untenable position with a weirder hypothesis. Why would such a smart person do this? In The Believing Brain , the psychologist Michael Shermer writes “smart people believe weird things because they are skilled at defending beliefs they arrived at for non-smart reasons.” This is the Friedman Twist.
In my last article I stated that falsifying the assumptions does not disprove any resultant conclusion or theory but after reading the variety of opinion in Caldwell’s book, I’ve changed my mind. If the assumptions are shown to be false or unrealistic or if the logic is unsound then the resultant theory is not likely correct and even if it was shown to be capable of making a prediction which turned out to be true, one cannot possibly know whether or not this was by pure chance, or what limitations might or might not apply if the assumptions were unrealistic. If the assumptions are unrealistic, one has no understanding. A theory derived from “assumptions that are wildly inaccurate descriptive representations of reality” gives no insight into the underlying physics. In other words, one knows nothing about such a theory and it is impossible to test. Ernest Nagel, in a half-hearted attempt to defend Friedman , writes: “Sound conclusions are sometimes supported by erroneous arguments, and the error is compounded when a sound conclusion is declared to be mistaken on the ground that the argument for it is mistaken.” I submit that we can reformulate this statement more accurately: “Conclusions supported by erroneous arguments are not sound and cannot be confirmed based on a few presumably successful predictions. The error is compounded if one assumes the predicted outcome was a confirming outcome rather than having happened by chance.”
Friedman’s Wikipedia page  says this about his paper. “Friedman’s essay “The Methodology of Positive Economics” (1953) provided the epistemological pattern for his own subsequent research and to a degree that of the Chicago School.” His paper wasn’t just a one off bit of obfuscating nonsense but describes the core methodology of the American conservative movement.
The page continues, “[A] useful economic theory should be judged not by its descriptive realism but by its simplicity and fruitfulness as an engine of prediction. That is, students should measure the accuracy of its predictions, rather than the ‘soundness of its assumptions.”
In his paper, Friedman writes that such theories “can be used to predict the consequences of changes in circumstances.” Let’s assume for the sake of the discussion that Friedman is indeed correct that theories based on unrealistic or erroneous assumptions can be true and that this can be proved if they make accurate predictions. Let’s indiscriminately put all of neo-classical economic theory to Friedman’s test. How many neo-classical economists and their theories predicted the 2006 housing bubble bursting, 2007 start of the great recession, and 2008 bank failures and credit crises. Indeed, the economist Dirk Bezemer of Groningen University argues : “The credit crisis and ensuing recession may be viewed as a ‘natural experiment’ in the validity of economic models.” By this simple experiment, we prove that the entire body of neo-classical theory failed utterly . During the ensuing bloodbath, economists assured us that “nobody” could have seen it coming, where “nobody” in this case is a euphemism for “no neo-classical economist”. Although much shorter than forty pages, that line is a classic Friedman Twist. Rather than admitting the obvious truth: “we were wrong and therefore something is seriously wrong with our theories and our assumptions about how the economy actually works and our strange methodology,” economists tried to tell us the events were impossible to predict. On December 9, 2008, Glenn Stevens, Governor of the Reserve Bank of Australia asserted: “I do not know anyone who predicted this course of events. This should give us cause to reflect on how hard a job it is to make genuinely useful forecasts;”  not more “accurately” how hard a job it is to derive useful theories from assumptions that are wildly inaccurate descriptive representations of reality.
That these events were predictable and predicted I know with certainty since even I predicted them, despite having never taken an economics course in my life. I didn’t do this in a vacuum, of course. Twelve economists did make quite accurate predictions  and I was lucky enough to have discovered six of them quite early on: Dean Baker, Stephen Keen, Kurt Richebächer, Nouriel Roubini, Peter Schiff, and Robert Shiller. I’m only taking credit for having reasonably good judgment as to which experts to heed; I’m not claiming to be an expert on the economy. I’m not even taking credit for being a “nobody”.
Why is neo-classical economics then such a failure? This is precisely because, believe it or not, their assumptions are wildly inaccurate descriptive representations of reality. Keen documents an abundance of false assumptions on the part of neo-classical economists using economic theory itself. In Frustration, he concludes that his own discipline is not a science at all and needs rescue from real scientists. One gets the impression that Samuelson’s attack on Friedman was motivated by a desire to defend the discipline. Luckier exact sciences don’t have such knuckleheads. Economics is full of them. Personally, I feel bad for those economists like Samuelson who tried to represent the field with scientific dignity and honesty. The kicker is that even the credible Keen though misses several of the most egregious false assumptions in all neo-classical economic models: one, the assumption that infinite exponential economic growth is possible, two, the assumption that there are no limits to low entropy resources, three, the assumption that high entropy wastes can be ignored, and four, the assumption that greed is good and that unregulated perfectly competitive laissez faire economies can exist or if they did that this would actually be good for us.
The first three wildly inaccurate assumptions are related to the economic community’s denial of the second law of thermodynamics. This is unequivocally fatal as pointed out by the physicist Arthur Eddington :
“The law that entropy always increases-the second law of thermodynamics-holds, I think, the supreme position among the laws of Nature. If someone points out to you that your pet theory of the universe is in disagreement with Maxwell’s equations-then so much the worse for Maxwell’s equations. If it is found to be contradicted by observation-well, these experimentalists do bungle things sometimes. But if your theory is found to be against the second law of thermodynamics I can give you no hope; there is nothing for it but to collapse in deepest humiliation.”
There are two schools of economics which do recognize the entropy law and these are ecological economics, founded by the economist Herman Daly , and the biophysical school of economics founded by the ecologist, Charles Hall . In his book Debunking Economics, Steve Keen lists a few economic schools he suggests might be able to reform economics. He does not list ecological or biophysical economics. I asked him why and he replied that they were too small to show up on his radar.
The economy is an irreversible process and therefore subject to the second law of thermodynamics, the entropy law. One cannot unscramble an egg, reconstruct it and shove it back into the chicken and redistribute all the money that changed hands along the way from the consumer, to the grocer, to the distributor, to the farmer and so on. The economic process is not reversible. We can increase the level of difficulty by trying to reconstruct the scrambled egg after we’ve eaten and digested it. Though the odds of this happening are much less than once in the entire existence of our universe, having managed that, it would be interesting to see if any grocer would take it back, knowing what the egg had been through. There is no hope for neo-classical economics.
The fourth false assumption economists make, that is perhaps more relevant to the events that began in 2006, is that consumers and producers are rational. In fact, Kevin Phillips’ law  holds that “Bad capitalism drives out good capitalism.” We all know this. In fact in Sunday’s Washington Post there is a wonderful three page story about a local professional cyclist, Joe Dombrowski. Dombrowski says “No matter what it is, whether it’s sports, business, whatever, people are always going to cheat.” And when regulation is slack or non-existent and one bank inevitably cheats then the rest have to cheat to compete. This is one reason Friedman’s perfectly competitive laissez faire model of the economy is unrealistic. Economists assume greed is good and consumers and producers are rational and that may be the most irrational, unrealistic assumption in Friedman’s quiver.
What does the failure of neo-classical economics and in particular Friedman’s conservative economic ideology mean for us? How can we apply this knowledge? The National Association of Manufacturers represents a self-contradiction in Friedman’s belief system. Friedman opposed organized labor because it disrupted the efficient operation of the free market but a natural outcome of his ideology is the organization of capital which because of the concentrated wealth and power has a far more disruptive influence on the market. The National Association of Manufacturers  released an economic study recently which predicts that a carbon tax will cripple the economy. The underlying assumption of this report, that we can ignore the Entropy Law, is “empirically dead wrong” and we can advisedly reject the findings out of hand. What we do know from this physical law is that if we do not introduce a rather large carbon tax and very soon, there will be no economy. As energy economist Vaclav Smil  laments: “Everything has to get worse. We are behaving so badly.” We are behaving like Friedman.
For an excellent description of Friedman’s ideology in action, please read Naomi Klein’s well researched book, The Shock Doctrine, The Rise of Disaster Economics .
Human-Caused Global Warming update: Australia has just experienced their hottest summer ever. See Figure 1 below. Perhaps another disaster for the Friedmanites to take advantage of.
Figure 1. Devastating wildfires swept through many areas of Australia during January 2013, the nation’s hottest month on record. In this photo provided by the New South Wales Rural Fire Service, a wildfire near Deans Gap, Australia, crosses the Princes Highway Tuesday, Jan. 8, 2013. (AP Photo/NSW Rural Fire Service, James Morris http://www.wunderground.com/blog/JeffMasters/comment.html?entrynum=2359 )
 Milton Friedman, The Methodology of Positive Economics, in Essays in Positive Economics, Chicago: University of Chicago Press, 1953, pp. 3-43.
 Steve Keen, Debunking Economics,
 Bezemer, Dirk J, “No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models, Groningen University, 16. June 2009, Online at http://mpra.ub.uni-muenchen.de/15892/
 Bruce Caldwell, ed., Appraisal and Criticism in Economics, A Book Of Readings, Allen and Unwin, 1984. Friedman’s, Samuelson’s, Boland’s and Caldwell’s essays can all be found in this book and much more.
 Michael Gordin, The Pseudo-Science Wars, Immanuel Velikovsky and the Birth of the Modern Fringe, University of Chicago Press, 2012,
 Lawrence Boland, A Critique of Friedman’s Critics, Journal of Economic Literature, vol. 17, June 1979, pp. 503-522.
 A link to the video of David Scott on Apollo 15. : http://www.youtube.com/watch?v=4mTsrRZEMwA
 Paul Samuelson, Theory and Realism: A Reply, American Economic Review, vol. 54, September 1964, pp736-9.
 Paul Samuelson, Problems of Methodology – Discussion, American Economic Review, vol. 53, May 1963, pp. 231-6.
 Michael Shermer, The Believing Brain, 2011
 Ernest Nagel, Assumptions in Economic Theory, American Economic Review Papers and Proceedings, vol. 53, May 1963, pp. 211-219.
 http://brleader.com/?p=2025Eddington, A.S., “The Nature of the Physical World,” , The Gifford Lectures 1927, Cambridge University Press: Cambridge UK, 1933, reprint, pp.74-75.
 Herman Daly and Joshua Farley, Ecological Economics, Principles and Applications, Island Press, 2004.
 Charles Hall and Kent Kitgaarrd, Energy and the Wealth of Nations, Understanding the Biophysical Economy, Springer, 2012.
 Kevin Phillips, Bad Money, Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism, Viking, 2008.
 Naomi Klein, The Shock doctrine, The Rise of Disaster Capitalism, Metropolitan Books, 2007.
What do you think? Leave a comment below.
Sign up for regular Resilience bulletins direct to your email.