Posted by Alex M Thomas on December 7th, 2011
Economic theory of various kinds are often employed to formulate policies in the real world. Often, certain conclusions of a particular economic theory are utilised in policy making. For instance, some of the insights/conclusions arising from mainstream economics are: fiscal deficits are inefficient and inflationary; a perfectly competitive economy is desirable because it is efficient; increase in money supply causes inflation and increase in investment (domestic and foreign) will create employment. Hence, we are regularly advised to lower fiscal deficits, encourage ‘efficiency’, etc.
Broadly, two kinds of logical fallacies are committed by economists and policy makers. Firstly, there are logical fallacies in the domain of economic theory. Secondly, a logical fallacy is committed when real-world policy decisions are derivatives of conclusions from a particular economic theory. This blog post makes use of Stephen F Barker’s book The Elements of Logic (1965) to illustrate some of the logical fallacies in economics.
According to Barker, a “fallacy is a logical mistake in reasoning.” He identifies three broad categories of logical fallacies: (1) non sequitur, (2) petition principia and (3) inconsistency. Fallacies of non sequitur (Latin: “it does not follow”) occur when there is an insufficient link between premises and conclusion. “If the premises are related to the conclusion in such an intimate way that the speaker and his hearers could not have less reason to doubt the premises than they have to doubt the conclusion, then the argument is worthless as a proof, even though the link between premises and conclusion may have the most cast-iron rigor,” logical fallacy of petition principia (Latin: “begging the question”) occurs. Lastly, fallacies of inconsistency occur “when someone reasons from a set of premises that necessarily could not all be true.”
Logical fallacies in economic theory
An economic theory like any scientific theory begins from a set of premises. These premises can be based on observation, fact, other theories, (reasonable) assumptions, etc. Obviously, these premises have to be sufficiently general for it to be a ‘theory.’ From these premises, through the process of (deductive) reasoning, we arrive at certain conclusions. Note that unrealistic assumptions do not render an economic theory fallacious. However, their utility in real-world policy making is contingent on how ‘approximate’ the assumptions are to the particular context.
Hence, given the premises, if the conclusions do not follow, the economic theory under consideration is said to be logically fallacious. This, in fact, happened to the marginalist theory of value and distribution. In the 1960s, it was demonstrated bySraffa, Garegnani and others that marginalist theory of value and distribution is logically fallacious. This was shown so clearly that defenders of the theory, notably, Paul Samuelson, admitted this defect. The main reason for this logical fallacy was/is that prices (value) and distribution are interdependent and hence are simultaneously determined. Therefore, the distribution theory in neoclassical economics (marginal productivity theory) cannot be logically prior and independent of the theory of prices (value). In other words, capital cannot be treated as a distinct factor of production, independent of prices. This is because, at an aggregate level, capital is comprehensible only as a value magnitude. Therefore, the construct of the aggregate production function breaks down and with it the whole neoclassical edifice of value and distribution crumbles. In any case, to circumvent such logical critiques, the concept of inter-temporal equilibrium was constructed. So far, it seems to have been ‘successful’ in warding off capital-theoretic critiques. But, this shift towards inter-temporal equilibrium from long period equilibrium has seriously compromised the relevance of such economic theory. For, ‘anything goes’ in temporary equilibrium. The capital theoretic fallacy is of the non sequitur type as there is an insufficient link between the premises and conclusion.
Marginalist economics studies human behaviour. It is a science of choice thanks to Lionel Robbins who presented a clear definition of neoclassical economics (which originated in the works of Jevons, Walras and Menger in 1870s). Hence, the theory assumes scarcity of both factors and commodities. The central problem in economics becomes that of – allocation. The theory starts with specifying endowments to agents and concludes that there is full employment of resources. After all, if the issue is that of allocation, there will necessarily be a full-employment of resources both before and after the process of allocation (carried out by the market forces of demand and supply). In this case, the premises and the conclusion are connected in such an intimate manner that it seems to commit the fallacy of petition principia.
Consumers maximize utility. Producers maximize profits. This gives us equilibrium. However, is there a clear line of demarcation between a producer and a consumer? What if an agent is both a consumer and a producer? In the language of set theory, what if the intersection between consumers and producers in an economy is not a null set? If so, is it logically consistent to have a strict demarcation between producers and consumers?
Logical fallacies in economic policy
Economists, policy makers and journalists argue for a particular economic policy based on certain premises. These premises are nothing but an admixture of various economic theories. Note the emphasis on ‘theories’, for there is not just one economic theory but multiple economic theories. Most of them are competing paradigms, i.e., they ask similar questions but provide dissimilar answers. Examples include Austrian economics, Marxian economics, Classical economics and Keynesian economics. The dominant paradigm, of course, is the marginalist one; variants of this include New Classical Macroeconomics, Monetarism, New Keynesian Macroeconomics, Microeconomics, etc.
The question we are interested in asking is: what is the basis on which a particular economic policy is favoured. A few examples are provided below.
Premise: Increase in money supply causes inflation.
Conclusion: Therefore, increase interest rates to reduce inflation.
Premise: Inflation is determined by inflation expectations.
Conclusion: Therefore, the Central Bank should target inflation expectations.
Premise: Given full-employment of all resources, an increase in expenditure will raise prices.
Conclusion: Fiscal deficits are inflationary. Therefore, reduce fiscal deficits.
The premise in the first example is from a Monetarist paradigm; the premise in the second one is a New Keynesian perspective and the premise in the third example is a typical neoclassical/marginalist view. Are these kinds of policy conclusions logically correct? Do the conclusions follow from the premises? Or, are we taking a leap of faith? For, the economies which the premises talk about and describe aretheoretical worlds which (hopefully) have certain characteristics of the real-world. In any case, hasty conclusions should not be made. This is especially important for policy making in an economy like India which is very distinct from the theoretical worlds mentioned above.
Yet another commonly used argument is to favour a policy based on its success in another economy. For a long time, India followed economic doctrines which were promoted in the advanced economies of the West. Today, we see a similar trend where examples and case-studies from ‘other emerging economies’ are used to argue for a particular policy recommendation in India. But, India is structurally – socially, culturally, politically and economically different from these other economies. Hence, we again take a leap of faith. I end with such a claim which was made to argue that FDI is favourable: “in Indonesia 10 years after allowing 100 per cent FDI, 90 per cent of the retail sector is controlled by the small shopkeepers.”