"The Phillips Curve model is wrong because Keynesians get causality reversed."

"In fact, the Keynesian Phillips curve model is simply wrong. It’s not wrong because there is no relationship between inflation and unemployment. A sharp fall in both wage and price inflation tends to be associated with a temporary rise in unemployment. Rather the Phillips Curve model is wrong because Keynesians get causality reversed. They assume that causation goes from economic overheating to wage and price inflation, whereas the opposite is more nearly true. To be precise, it is unexpected increases in nominal growth in spending that cause both rising inflation and falling unemployment."

~ Scott Sumner, from his post 'Fortunately, this isn't the Volcker disinflation'

The Trojan Horse of a Wellbeing Budget

The Government's Budget delivered tomorrow will, unusually, purport to measure not just the usual gobs of government spending but the anticipated effect of all those ill-gotten gobs on the "wellbeing" of all New Zealanders. But on what  are such heady anticipations based? As our guest poster Thomas Di Lorenzo points out, research rooted in several dubious assumptions and directed down an unsurprising path: that poverty and servitude to the state are superior to prosperity and freedom.

A very large literature has built up over the past several decades in the area of so-called "happiness research." Such research is based on several very dubious assumptions: namely, that people's utility is cardinal and measurable after all; that interpersonal utility comparisons can therefore be made; and that the great unicorn of economic theory — the "social welfare function" — has finally been spotted. Armed with these assertions, socialists around the world believe they have finally discovered their holy grail.

Now that governments supposedly know with "scientific certainty" what constitutes "happiness," there can be no argument (or so they think) against virtually unlimited government intervention in the name of creating happiness.

Affluence, i.e., general prosperity, is actually a disease that generates massive unhappiness, claims the Australian author of a popular book in this field, entitled Affluenza. The government of Brazil is in the process of enshrining this notion into its constitution, and similar movements exist in Great Britain and other countries.

These assumptions rest on the proclamation that public-opinion surveys are sufficient measures of cardinal utility.

The economists who make such assumptions studiously ignore all of the reasons why economists have disavowed such practices — especially the notion of demonstrated preference — for generations. As Murray Rothbard explained in his essay, "Toward a Reconstruction of Utility and Welfare Economics,"

The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man's preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. … This concept of preference, rooted in real choices, forms the keystone of the logical structure of economic analysis, and particularly of utility and welfare analysis.

Rothbard continued to explain the folly of relying on public opinion surveys, as opposed to the actual demonstrated preferences of economic decision makers:

One of the most absurd procedures based on a constancy assumption [i.e., the false assumption that people never alter their preferences] has been the attempt to arrive at a consumer's preference scale not through observed real action, but through quizzing him by questionnaires. In vacuo, a few consumers are questioned at length on which abstract bundle of commodities they would prefer to another abstract bundle, and so on. Not only does this suffer from the constancy error, no assurance can be attached to the mere questioning of people when they are not confronted with the choices in actual practice. Not only will a person's valuation differ when talking about them from when he is actually choosing, but there is also no guarantee that he is telling the truth.

The one economist who is arguably the leader in the field of "happiness research" (at least among economists) is Bruno Frey of the University of Zurich. When I asked him at a conference in Prague several years ago about the age-old criticisms of replacing actual demonstrated preferences with questionnaires, his response was that his "data" were no worse than GDP data. As bad and as unreliable as GDP data are, "happiness research" questionnaire data are at least no worse, he said.

But in fact, much of the happiness-research data are much, much worse.

European socialists in fields outside of economics have gone even further with their research of "happiness." A bestseller in Europe is The Spirit Level: Why Equality is Better for Everyone, by Richard Wilkinson and Kate Pickett. The book is an excellent example of the misuse and abuse of statistics by these two British epidemiologists. It is an abuse of statistics because the entire book is a fishing expedition for simple correlations between the degree of material "inequality" in a country and myriad other variables. Wilkinson and Pickett don't even attempt the use of multiple-regression analysis, as is typical in their own field, in economics, and elsewhere. Consequently, they arrive at contrived statistical conclusions that greater material equality in a country supposedly leads to improvements in community life, mental health, drug use, physical health, obesity rates, intelligence, teenage births, recycling, violence, imprisonment, social mobility, dysfunctionality, anxiety, and self esteem.

(One critic of this research mocked its abuse of statistical methods by presenting a scatter diagram that purportedly showed a positive correlation between recycling and suicide, suggesting that the more one recycles, the more likely that one will commit suicide!)

According to these scientific-sounding conclusions (which have been lavishly praised by politicians, of course), the people of the former Soviet Union must have been the happiest people on earth, since the pursuit of equality was always the pronounced objective of socialism. As F.A. Hayek wrote in the 1976 edition of The Road to Serfdom, socialism was originally defined as government ownership of the means of production, and then changed to mean the redistribution of income and wealth through the auspices of the welfare state and progressive income taxation. In each case, "equality" was the ultimate end; only the means changed over time.

"Happiness researchers" make no mention at all of the long-recognised deleterious effects of welfare statism, including destruction of the work ethic, family breakup, the growth of dysfunctional citizens who are paid by the state to remove themselves from the work force, etc. [And nor will the NZ Treasury's researchers take account of the effect on involuntary taxpayers of their own pockets being fleeced to make other folk happy - Ed..]

Bruno Frey is no socialist, but the area of research that he champions is nonetheless being very enthusiastically embraced by a grab-bag of interventionists, socialists, and would-be central planners. Frey himself explained this in his June 2002 survey article in the Journal of Economic Literature entitled "What Can Economists Learn from Happiness Research?" (with Alois Stutzer). Among the many things economists can "learn" from this strange branch of psychology, Frey and Stutzer approvingly report, are the following:

• "Happiness functions have sometimes been looked at as the best existing approximation to a social-welfare function. It seems that, at long last, the so far empirically empty social welfare maximisation … is given a new lease on life."
• Income has increased dramatically since World War II, but "happiness" supposedly has not. The counterintuitive implication is that work, investment, and entrepreneurship — the ingredients of economic success — do not produce happiness, but human beings nevertheless keep doing more and more of it year in and year out.
• Interpersonal utility comparisons have also been resurrected, supposedly proving that "social happiness" can be created by the state's theft of one person's income and the redistribution of it to another (while keeping a tidy sum for "administrative expenses").
• "Wealthier people impose a negative external effect on poorer people but not vice versa." The supposed negative external effect is the envy of "poorer" people. Welfare parasites are assumed to impose no negative effects by being given the income of their hardworking, taxpaying hosts.
• "If unemployment rises by 5 percentage points the inflation rate must decrease by 8.5 percentage points to keep the population equally satisfied," write Frey and Stutzer. Thus, the rotted corpse of the Phillips curve — and of Keynesianism — is given new life by happiness research.
• Welfare payments should be increased "to compensate for a larger family," write Frey and Stutzer, so as "to maintain the subjective well-being of the family." Again, there is no mention of the harsh negative effects of welfare statism, or of the negative effects of massive tax increases on economic growth rates. (Affluence is a disease, remember.)
• "The fight for relative positions is socially wasteful, and … the high-income recipients, as winners of these races, should be more heavily taxed," happiness research informs us. Thus, Frey and Stutzer define hard work, saving, production, and entrepreneurship as merely "the fight for relative positions" in society, and a rather trivial "race" rather than a job-creating engine of prosperity.
• Not surprisingly, Frey and Stutzer point out that the socialist John Kenneth Galbraith is widely regarded as the "father" of "happiness research" because of his numerous anticapitalist, pro-socialist books such as The Affluent Society.
• "Raising everybody's income does not increase everybody's happiness," but improving one's income "in comparison to others does." These, like other claims mentioned here, come from the two British socialist epidemiologists mentioned above.

If one were to go to a university library and survey some of the top economics journals, it would be easy to find dozens of articles that seem to employ a blur of mathematics in page after page, followed by mind-numbing econometric pyrotechnics that prove water runs down hill. (For example, I can recall reviewing a book on innovation for the Southern Economic Journal that required 66 equations to arrive at the conclusion that businesses are likely to invest more money on innovations that promise a higher rate of return on their investment.) Much of happiness research that is conducted by economists is exactly like this, very often stating conclusions that are extraordinarily simplistic and downright comical. The following are a few examples from the Frey/Stutzer article in the Journal of Economic Literature. Every one of them could be appropriately concluded with the expression, "Duh."

• "Persons with higher income have more opportunities to achieve what they desire."
• "British lottery winners … reported higher mental wellbeing the following year."
• "There is more to subjective wellbeing than just income level."
• "On average, persons living in rich countries are happier than those living in poor countries."
• "Happiness of unemployed persons is much lower than that of employed persons."
• "Experiencing unemployment makes people very unhappy."
• "Freedom and happiness are positively related."
• "Happy people smile more during social interactions."
• "People receiving an inheritance reported a higher mental wellbeing in the following year."
• "Persons with higher incomes … can buy more material goods and services" and can therefore "achieve what they desire." This contradicts the other statements about how increased income supposedly does not increase happiness.

[It is on the basis of banalities such as these combined with the paeans to poverty and servitude that Grant Robertson will be "revolutionising" budget delivery on Thursday - Ed.]

One thing these mundane, pedestrian statements do demonstrate however is that "happiness research" has indeed been a gold mine for résumé-building academic economists whose econometric game playing is no longer limited by the requirement of digging up actual economic data. Instead, they can make up all of their own data by simply mailing (or emailing) out questionnaires.

Bruno Frey himself has published dozens of articles and several books of this sort, and may well win the Nobel Prize in Economics for them. That would be an enormous boon to all the socialists of the world, who have never let economic reality or economic logic stand in their way. As explained in an excellent critique of happiness research in the form of a book entitled The Spirit Level Delusion: Fact-Checking the Left's New Theory of Everything, by Christopher Snowdon (p. 147),

Apologists for Marxism have made myriad excuses for their ideology's failure to provide the same standard of living and liberty as was enjoyed in capitalist nations. Until recently, few have been so brazen as to claim that lowering living standards and curtailing freedom were the intended consequences, let alone that people would be happier with less of either. In that sense, books like 'The Spirit Level' represent a departure for the left. Limiting choice, reducing wealth and lowering aspirations are now openly advocated as desirable ends in themselves.

Thus, "happiness research" is really a crusade to persuade the public that poverty and servitude to the state are superior to prosperity and freedom. It is what 20th-century communists referred to during the last days of Soviet and European communism as "socialism with a smiling face."

Welcome it aboard, New Zealand.

* * * * * 

Thomas DiLorenzo is professor of economics at Loyola University Maryland and a member of the senior faculty of the Mises Institute. His post previously appeared at The Mises Wire.

Shock news: Humans don't act as economists say they should! (update 2)

Austrian economists have known for a long time that people don't act the way mainstream economists say they do.  But mainstream economists and the New York Times are only just finding it out themselves [hat tip Brain Stab]. 

"Anomalies" is what one Nobel prize winner called behavioural departures from the rationalistic idea that people act as mainstream economists say they should, ie., with both 'perfect' knowledge and 'perfect' self-interest.  This wouldn't be important to the rest of us, except that when these 'anomalies' occur in ways that attract the attention of the business pages the more state-worshipping economists start to yell about "market failure" -- whining in other other words that people don't fit their "models," and calling for government agency to make them fit, ie., to"fix" a problem that doesn't actually exist.

But the way people behave is only anomalous to people who think other people should behave the way their equations say they should.  The fact is that economics is not a science of human choice, as mainstream economists insist it is; it is instead a science that studies the result of human action, however mistaken the graduates of business schools might think those actions to be.

Rather than devising and formulating abstract, arbitrary models predicting the choices people make, and then throwing up the hands in horror when people over-eat, over-spend and generally act in ways other than those predicted, Austrian economists base their system of thought on one very simple principle: Man acts.  Specifically, he acts in ways he think will move him from a less satisfactory to a more satisfactory state of affairs, whatever the hell that might actually be. He might be wrong in the way he acts to achieve his goals, and he might even be mistaken in the goals or choices themselves (and people might even act in ways they explicitly disown) but they act nonetheless, say Austrians, and in their actions they seek to further their own ends (whatever these might be) -- it is with this 'action axiom,' says economist Ludwig von Mises, that the science of economics begins.

A shame that mainstream economists and the New York Times's writers haven't read more Mises or observed more human activity before they burst into print calling what we do every day "anomalous."

UPDATE 1:  New Zealand's funniest bloke, John Clarke, has the testimony of an unusually truthful  "economics expert" appearing before a Royal Commission on What the Hell's Happening to the Australian Economy. The relevance to this post can be seen almost from the first exchange.  Here's a small sample:

BARRISTER: Mr Trouser, you've told us over a 3 month period you collect information and analyse it for trends...  So what's going to happen Mr Trouser? In the next few months?  What's a likely next development in the economy.
TROUSER: I've no idea.  I don't have the current information.
BARRISTER: I thought this [holds up telephone book sized sheaf] was the current information.
TROUSER: They are the current figures, but they're not based on the current information.
BARRISTER: The current figures are not based on current information?
TROUSER: No. The current information is coming in now.
BARRISTER: So what are the current figures based on?
TROUSER: They're based on the information available at the time the current figures were being prepared.
BARRISTER: Which was when?
TROUSER: 3 months ago.  The figures take 3 months to assemble.
BARRISTER: Is it possible for you to tell what's happening now?
TROUSER: Yes, of course it is.
BARRISTER: When could you do that?
TROUSER: In 3 months.

Read it all.  It's hilarious.  And then send the link to your nearest economist.

UPDATE 2: Clifford Thies draws parallels between the predictions of mathematical economics, and the equations and prediction of pro-warmist super computers.

The emerging discipline of climatology is an interesting one. It has no laboratory. Instead, various measurements are put into computer models to see the extent to which they are consistent with the hypothesis that human activity has contributed to the trend of global warming. Unable to conduct experiments, all climatologists can do is examine statistical correlations.

In my field of economics, we have generally dismissed inferences based on mere correlations. Such things as interest rates, inflation, the unemployment rate, and real GDP growth are highly trended. Almost necessarily, they are highly correlated over discrete periods of time. This correlation doesn't prove anything regarding cause and effect, and the still short history of econometrics is littered with theories such as the Phillips Curve that once enjoyed a consensus among economists, that are now understood to be little more than statistical illusions.

Today, the econometric standard for testing theories involves determining if changes in one variable tend to be followed by changes in another variable. Thus, the sequence of fluctuations in variables is seen as a key to discerning cause and effect. This new standard has been humbling in revealing just how complex are macroeconomic phenomena.

Commenters on this thread are recommended to read and digest.