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Some Logical Fallacies in Economics

Posted by Alex M Thomas on 7th December 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 bySraffaGaregnani 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.

I

Premise: Increase in money supply causes inflation.

Conclusion: Therefore, increase interest rates to reduce inflation.

II

Premise: Inflation is determined by inflation expectations.

Conclusion: Therefore, the Central Bank should target inflation expectations.

III

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.”

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Posted in Capital Theory, Classical Economics, Economic Philosophy, Economic Thought, Economics, India, Inflation, Neoclassical Economics, Paul Samuelson, Philosophy and Economics, Pierangelo Garegnani, Piero Sraffa | 2 Comments »

On Causality in Economics

Posted by Alex M Thomas on 9th December 2009

This post tries to unsettle some of the methods used in economics today – Regression analysis and Granger causality. Apart from this objective, the post also tries to understand the meaning (rather, meanings) of causality. Do we economists mistake correlation for causality? Can we have a single method for capturing causality?

Causation is defined in the following ways:

-the action of causing or producing.

-the relation of cause to effect; causality

-anything that produces an effect; cause [Dictionary.com]

And the definition of Correlation is:

-mutual relation of two or more things, parts, etc. [Dictionary.com]

I once asked a professor who had offered to give a lecture for our Advanced Economic Theory class this: “Sir, is it possible to establish causation conclusively?” He replied “That is simple. There are these tests- Granger test, Sims test, Sargent test, McClave-Hsiao test, Haugh-Pierce test, etc.” And he wrote the names of these so-called ‘scientific’ tests on our black board.

What we often forget is that, there is no single and simple understanding of causation. There are various kinds of causality like epistemic, conceptual, factual, counterfactual etc. Causality in economics also are of different natures- poverty is causing unemployment, increased demand for oil has resulted in oil price rise, supply constraints are hiking up the price, etc. For instance, conceptually we know that poverty causes unemployment (vicious cycle of poverty) and that increased demand causes a concomitant price rise. In economics, it is important to have an account of both conceptual as well as factual causality.

For causality to be present between two variables A and B, it is necessary for them to be related in some way. This relationship among them can be of a linear nature or a non-linear one. If it is linear in nature, then it is called correlation. [Note that regression analysis (OLS) is based on correlation and is linear in nature.] But, correlation alone does not imply causation. Hence, all those who think that causation and correlation are the same make an inductive leap – from correlation to that of causation.

As R G D Allen writes in his Statistics for Economics: “This statistical concept of correlation is quite neutral as regards causation. One of the variables may be ’caused’ by the other, but this can only be known from other than statistical considerations.” Usually, causal hypotheses are derived from economic theory, because ‘data does not speak on its own’. We need to pass data through theory in order to make sense of it.

However, economic theory (like any other theory) contains a lot of assumptions, mostly unrealistic. What happens to causality then? Causality, then is dependent on these assumptions. Hence, drawing inferences from such theoretical models for practical purposes should be undertaken with caution.

It is this caution that seems to be missing amongst econometricians. This will be evident after looking into the workings of Granger causality. Granger causality analyses probabilistic causality. However, this per se is not a limitation of the test. For, in social sciences, it is exceedingly difficult to talk about deterministic causes in real-world scenario- especially, in a macroeconomic environment.

Granger causality
If X and Y are probabilistically dependent and X precedes Y, then X causes Y.

And, in actual testing, Y is regressed on X (t) and also on X (t-1). If the latter regression is found to be more significant, then X is said to Granger-cause Y. In actual practice, there are economists who forget the prefix. That is, again, some sort of correlation analysis is carried out between Y and X (t-1). In any case, the concept of causation is a problem-ridden one. And as economists who contribute to policy-making, one ought to be on their toes all the time.

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Posted in Economic Philosophy, Economics, Economics Education/Teaching, Inflation, Philosophy and Economics | 7 Comments »