I gave a talk at Atlas Summit on ‘Economics, Evolution, and Rand’s Meta-Ethics’ and one person asked me how my ideas would alter economics. In my talks and in my book Source of Economic Growth, I suggest that economics needs to be rethought from the ground up based on my findings. Here are some of the ways economics needs to be changed in order to make it a science.
1) Fundamental Questions of Economics
No school of economics is even asking the right questions. I have written another post on point (Intellectual Capitalism: Part 1), so I will not repeat all of it here.
Every science is defined by the questions it asks. According to a sampling of websites three of the major questions economics asks are:
1) What goods will be produced?
2) How will the goods be produced?
3) For whom are the goods produced?
All of these questions are inherently collectivist and in a truly capitalist country (i.e., one that protects Natural Rights) all of these questions lead to very boring answers. In addition, none of these questions are scientific questions (Just another example of how economics is not a science).
The single most important question in economics is:
What is the source of real per capita increases in wealth?
This immediately leads to the second most important question in economics today which is: What caused the Industrial Revolution? Both of these questions have empirical and objective answers.
The answer to the first question is inventions and this leads to a number of other important questions, such as how do we measure the rate of technological change?, what things influence the rate of technological change?, why does Singapore appear to have a faster growth rate than Hong Kong despite a lower economic freedom index?, are inventions subject to diminishing returns?, etc.
2) Definition of Economics
Since economics is asking the wrong questions, the definition of economics is incorrect. Here is my suggested definition of economics vs. standard definitions. Note that I have a whole chapter on this subject in my book Source of Economic Growth.
Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.
The science that deals with the production, distribution, and consumption of goods and services, or the material welfare of humankind.
Economics is the study of how man obtains those things he needs to live.
3) Cause and Effect in Economics
Classical, Neo-Classical, and Austrian economics emphasize manufacturing and trade, while Keynesian economics emphasizes consumption as the driver of economics and all of them are wrong. The chain of cause and effect in economics is shown in the chart below.
When man applies his reason to the problems of survival he invents. Production, which is really about reproduction or replication, is not the driver in economics as the questions from mainstream economics imply. Trade is also not the driver and in fact the Manufacturing and Trade steps are not absolutely necessary. Keynesian economics focuses on consumption, so it is on the far wrong side of the cause and effect chain.
Because Classical, Neo-Classical, and Austrian economics emphasizes the effects instead of the causes in economics they waste an huge amount of time on supply and demand curves. Every supply and demand curve should come with two caveats: 1) demand does not create supply and 2) this chart assumes a technologically stagnant world. If demand could create supply then Keynesians would be right. What a supply and demand chart shows is how much people would be willing to sell of their present stock at various prices, it does not show that anyone will produce anything.
4) Economics is not a Social Science its Foundations are in Biology and Evolution
Economics is not a social science, it is a real science based on the biological facts of human existence. Specifically that humans have to obtain a certain number of calories (calories here substitute well for all our needs, including oxygen, water, etc.) per day or we die. This gives us a physical definition of profit and loss. Modern economics treats the whole subject as if it was merely a game. Venezuela, North Korea, China, and the USSR prove that it is not.
For more information see Economics, Evolution, and Rand’s Meta-Ethics (Intellectual Capitalism: Fundamentals Part 2)
The fact that profit and loss have real physical definitions means that economics is a real empirical science. Neoclassical economics pretends to be an empirical science but too often they create mathematical models in which none of the variables are measurable. That is not science.
5) Perfect Competition
Perfect competition is an inherently flawed concept that has no place in economics. All conclusions based on perfect competition are wrong, including the whole monopoly power and anti-trust analysis. Perfect competition should be laid to rest and only discussed as a historical example of how absurd economics once was. I have a large section analyzing perfect competition in my book Source of Economic Growth.
Competition is not the source of our wealth. One of the narratives of economics is that competition drives down profit margins and that is how we become wealthy. This is left over from the nonsense of perfect competition. While it is true that we do not want the government to setup rules that provide an advantage for one market participate over another and that these rules hurt the economy, it does not follow that competition creates wealth. The wealthiest countries in the world are those in which a larger percentage of people create unique products and services that have little or no direct competition. The goal is for everyone to be producing unique high value items, not 300 million or even 100 million people all producing me too products.
6) Property Rights/Ethics
There has been a movement to eliminate ethics from economics and this runs through all schools of economics. The justification for this is that science is devoid of ethical considerations. This is not true and the best example of what happens when scientists divorce themselves of ethics is Anthropomorphic Global Warming. All science has an ethics that at least includes the rules of: 1) you must report the data accurately, and 2) you must follow the data to its logical conclusions. Some sciences such as medicine have additional ethical constraints. In medicine it is not ethical for the doctor to give the patient poison or prescribe poison just to see what happens or undertake surgery just to see how the human body reacts. Similarly, economics must not prescribe economic poison. Economics is ethically constrained to policies that promote life.
This attempt by economics to divorce itself from ethics not only means that economics defaults to a utilitarian based ethics, it also means that economists have no idea what property rights are. Property rights cannot be justified on utilitarian grounds. The utilitarian benefits of ‘property rights’ are the effect not the cause. Because of this confusion economists will go around saying that taxing medallions are property rights or FCC licenses or slavery in the South. It also means that when they combine their flawed ideas on ‘property rights’ with the nonsense of perfect competition they start talking about true property rights as giving monopoly power. This leads to all sorts of nonsense including the idea that patents and copyrights are monopolies.
Property rights are based in ethics and cannot be divorced from ethics. Property rights are the recognition that someone created something of value. When economics attempts to redefine property rights, it commits both a scientific error and an ethical error. The scientific error is the result of ignoring definitions and reality. Words have meaning and when economists say property rights are any legally enforceable control over an object it is like a biologist saying a mammal is any warm blooded animal (birds are warm blooded). The definition of a mammal is based in reality and is not arbitrary and the definition of property rights are based in reality. Ignoring reality is not science.
Ethically when economists attempt to redefine property rights they are advocating fraud or theft, by advocating that a creator’s creation be taken from him and given to someone else without the creator’s consent.
It is a sad fact that most economists have no idea what property rights are, however they are in good company. Lawyers, free market advocates, and even Objectivists do not have a firm grounding in what property rights are or how they come about. Historically, the study of property rights peaked around the time of the Homestead Act of 1862 and was dead when Hoover said the airwaves belong to the public.
Adam Mossoff is one of the few academics trying to advance the theoretical foundations of property rights. Studying the nature of property rights is part of economics and is completely neglected by all modern schools of economics.
7) Regulation and Opportunity Costs (An Application)
Regulation is usually analyzed on its effectiveness and based on its opportunity costs. For instance, if we mandate that all cars have airbags, this means that the cost of all cars will increase but the cars will be safer. This means that people will put off buying newer. safer cars and when they do buy a new car they will likely be forced to buy a smaller car that is less safe.
Another example is that if we force houses to meet building codes, builders will have to spend more time complying with these rules and will not be able to make certain tradeoffs. The supposed advantage is safety, but the opportunity costs is that housing is more expensive which means consumers have to drive cars that are not as safe or eat food of lower quality or have fewer children or spend less on education.
This analysis is flawed, because the largest opportunity cost of regulation is the lost inventions. The main justification for regulations is safety. However, because regulations such building codes and the FDA lock us into a technological stagnant (or retarded) market, in the long run we are less safe and these regulated product cost more. In the case of the FDA I am sure that what minor benefits we obtain in safety are wiped out within a year or two by the lost technological advances. However there have been no empirical studies on point to my knowledge. In fact, studies looking at this issue would be excellent research project in economics.
8) Immigration (An Application)
Does immigration lower wages or not? Economists argue both side of this argument and point to differing empirical evidence to support their positions. The reason for this confusion is that economists do not understand that inventions are the source of real per capita increases in wealth. I will show how my system of economics resolves this debate and why there appears to be conflicting empirical data.
We will start with the simplest case first. If we have a country where the overwhelming majority of people are living in the Malthusian Trap (i.e., the edge of starvation, subsistence living) then if more people move into that country people’s wages will not go down, but people will starve to death. With this information let’s examine the two extreme cases: a technologically stagnant country and a technologically dynamic country. In a technologically stagnant country the total GDP is flat to declining slowly. If immigrants increase the population of this country they will not and cannot increase its GDP, so real per capita incomes will decrease and therefore wages will decline. This is similar to the country in the Malthusian Trap.
When a country is technologically dynamic then its real per capita GDP is increasing. Immigrants in this case can contribute to the country’s increasing level of technology and therefore the wealth of the country. In that case each new person that is open to using their mind is an asset and only makes the country wealthier. A pretty good measure of how technologically dynamic a country is its economic freedom index.
No countries on Earth today are fully optimized to increase their level of technology and only a few are absolutely technologically stagnant. Some of the more technologically dynamic countries
include Singapore and Honk Kong. As Peter Thiel has pointed out the rate that the U.S. creates new technologies outside the information technology area has slowed significantly. Countries that are close to being technologically stagnant include Venezuela and North Korea and many African countries
Since economists do not control for how technologically dynamic the economy (or part of the economy) was that they used in their studies of whether immigrants increase or decrease wages, it is not surprising they got differing results even if they did everything else right in their studies.
My proposed school of economics, Intellectual Capitalism, is profoundly different than Neo-Classical, Austrian, Keynesian or any other school of economics.
For more on Intellectual Capitalism see:
My Book Source of Economic Growth
 Note this assumes that this country is technologically stagnant, which is likely if most people are living in the Malthusian Trap. s
Will Thomas and I gave a talk on Austrian Economics at Atlas Summit 2016, where I pointed out that Austrian Business Cycle Theory (ABCT) does not fit the empirical facts. ABCT claims that increasing savings/capital are the cause of economic growth, which is very similar to what classical and neo-classical economics states. I pointed out that in fact it is increasing levels of technology (inventions) that are the cause of economic growth not increases in capital. One of the questioners after the talk stated that inventions (technology) are part of capital.
Many people want to conflate increasing levels of technology with capital, however they are not the same. Capital as used in economics means those durable goods used in production.
In economics, capital goods, real capital, or capital assets are already-produced durable goods or any non-financial asset that is used in production of goods or services.
Adam Smith defines capital as “That part of a man’s stock which he expects to afford him revenue”. https://en.wikipedia.org/wiki/Capital_(economics)
The article goes on to explain how to determine if something as capital.
Classical and neoclassical economics regard capital as one of the factors of production (alongside the other factors: land and labour).
This is what makes it a factor of production:
The good is not used up immediately in the process of production unlike raw materials or intermediate goods. (The significant exception to this is depreciation allowance, which like intermediate goods, is treated as a business expense.)
The good can be produced or increased (in contrast to land and non-renewable resources). https://en.wikipedia.org/wiki/Capital_(economics)
Technological change is not a good, it is the process of inventing. It is true that when these new inventions are reproduced (manufacturing) then when purchased they become capital, but that is several steps removed. If we treat technological change as just part of capital then going out and purchasing capital goods is the same thing as inventing. However, the results are not the same. Purchasing (acquiring) capital without invention results in no real per capita increases in wealth over the long run. As a simple example assume that every farmer in the U.S. has the latest most up to date tractor their land can use. Adding more tractors (capital) does not increase the output of these farms. The same is true for capital in general.
A number of economists have pointed out that increasing levels of capital are not responsible for the tremendous economic growth experienced in the West since the Industrial Revolution. Among these economists are Robert Solow, Paul Romer, and Deirdre McCloskey. They all point to increasing levels of technology as the cause for our increased wealth. Our standard of living is defined by our level of technology.
On the other hand inventing at a faster rate does produce real per capita increases in wealth. Inventions can produce returns that are staggering. For instance, Eli Whitney’s invention of the cotton gin allowed a forty times increase in the output of cotton in the U.S. in one decade.
In science it is important to isolate the factors effecting an experiment. For instance, if you conflate wind resistance and gravity then you end up with the nonsense that heavier objects fall faster than lighter objects. This means you will never be able to create a parachute or an airplane.
In economics if we conflate inventions with capital, we make the mistake that third world countries will become wealthy if we provide them capital. In fact, this is exactly what Development Economics has said for years despite overwhelming evidence to the contrary. Conflating these two concepts will cause us to ignore the role of property rights for invention as being the biggest long term driver of wealth and instead focus on capital gains taxes or increasing the savings rate or increasing comsumption.
Inventions are the cause of real per capita increases in wealth, not capital. Conflating the two is illogical and results in nonsensical economic policies.
Will Thomas and I gave a talk at Atlas Summit 2016 on Austrian Economics. The talk focused on epistemological and ethical positions of Carl Menger, Ludwig Von Mises, and F.A. Hayek. A number of people asked for the slides and related materials. Below I provide links to nine posts on blog that investigate some of the issues discussed in the talk in more detail. Below that are the slides from the talk.
Is Carl Menger a Socialist? https://hallingblog.com/2016/06/25/is-carl-menger-a-socialist/
Why Austrian Economics Subjectivity is Wrong and Condemns Economics to Being a Pseudo-Science https://hallingblog.com/2016/06/13/why-austrian-economics-subjectivity-is-wrong-and-condemns-economics-to-being-a-pseudo-science/
Can “Dignity” Explain the Industrial Revolution: A Review of Deirdre McCloskey’s Economic Ideas https://hallingblog.com/2016/05/22/can-dignity-explain-the-industrial-revolution-a-review-of-deirdre-mccloskeys-economic-ideas/
Carl Menger: Austrian Economics vs. Objectivism https://hallingblog.com/2016/03/21/carl-menger-austrian-economics-vs-objectivism/
Carl Menger: Principles of Economics https://hallingblog.com/2015/11/16/carl-menger-principles-of-economics/
Capital in Disequilibrium: The Austrians’ Answer to New Growth Theory https://hallingblog.com/2015/09/09/capital-in-disequilibrium-the-austrians-answer-to-new-growth-theory/
Praxeology: An Intellectual Train Wreck https://hallingblog.com/2015/09/08/praxeology-an-intellectual-train-wreck/
Hayek: Friend or Foe of Reason, Liberty and Capitalism? https://hallingblog.com/2015/03/04/hayek-friend-or-foe-of-reason-liberty-and-capitalism/
The Austrian Business Cycle Debunked https://hallingblog.com/2015/02/15/the-austrian-business-cycle-debunked/
The Irrational Foundations of Austrian Economics https://hallingblog.com/2015/02/12/the-irrational-foundations-of-austrian-economics/
There is a myth by the anti-patent crowd that “overly broad” patents inhibit the development of new technologies. One of the classic examples they like to cite is the Selden Patent (US Pat. No. 549,160), which supposedly inhibited the development of the automobile around the turn of the century. A new paper ‘The “Overly-broad” Selden patent, Henry Ford and Development in the Early US Automobile Industry’ By John Howells and Ron D. Katznelson, shows that in fact the automotive industry prospered and inventiveness accelerated despite the Selden patent.
According to the paper:
First, neither the ALAM-adopted restrictive licensing policy based on the Selden patent, nor the public liability threats to purchasers of unlicensed vehicles (see sections 2.2.3-2.2.4) restricted entry into the automobile industry as shown by Figure 1.
Second, measures of automobile development show it to have been most rapid during the Selden patent term; Raff and Trajtenberg’s analysis of real, quality adjusted prices for the American Automobile Industry show that the fastest rate of price decline for a given automobile quality occurred between 1906 and 1911, within the term of the Selden patent prior to its 1911 adjudication: the rate of quality improvement was greatest in the 1906 – 1911 period and more than half of the quality gain for a given price observed to have occurred by 1980, had been attained in the period 1906 – 1911 (Raff and Trajtenberg 1996, p85, 91).
Third, rather than Ford being slowed down through patent litigation with the ALAM, from the foundation of the Ford Motor Company in 1903, Ford grew sales at an exponential rate faster than that of the total industry during the period of litigation. A serial developer of five major automobile models, which gained tenfold increase in sales every four years, can hardly be considered to have been “stifled.” The Ford Motor Company became the leading manufacturer of automobiles produced in 1906, a position the company retained until 1927; see Figure 2.
The paper provides overwhelming evidence that the Selden patent did not inhibit the automotive industry or the development of new technologies in the automotive industry. This should have been apparent to anyone familiar with the history of the automotive industry. The United States led the world in developing and manufacturing automobiles at the turn of the century and beyond. Selden had a U.S. patent and it was enforced in the U.S., so the facts do not square with the anti-patent narrative.
Another interesting part of the paper is that Ford knew that they would prevail in a lawsuit over the Selden patent. This is the value of well-defined laws and courts who stick to the law.
Selden’s patent was issued by the US Patent Office in 1895 and eventually was assigned to the Association of Licensed Automobile Manufacturers (ALAM) in early 1903. The ALAM publicly asserted that the Selden patent claims should be broadly construed, meaning that the entire automobile industry was within their scope. In October 1903 suit was brought against the Ford Motor Company under the Selden patent and when finally adjudicated on appeal in 1911 the Ford Motor Company was found not to infringe because although the patent was held valid, it was construed narrowly to cover an improvement to the obsolete Brayton engine. This was the embodiment with which Selden had experimented prior to 1879, the year he applied for a patent. Columbia Motor Co. v. CA Duerr and Co. 184 F. 893, 896 (2nd Cir. 1911). The narrow Brayton-based construction saved Selden’s claims, but they were not infringed since all gasoline engines in commercial use were Otto engines by 1911, rendering the patent economically worthless
Another anti-patent lie bites the dust. When a group or a movement consistently lies and promotes lies to support their position over and over again, as the anti-patent crowd has done, they should not be taken seriously by rational people.
There is a popular myth that great ideas are a dime a dozen (see here, here, and here). I don’t know what a great idea is. Is a Dick Tracey watch or a nuclear powered rocket a great idea? No, not if you don’t know how to implement them, then it is just a fantasy and unless you have plot with it, it is not even a good fantasy story. However, I do know what a great invention is and they are not a billion dollars a dozen. A great invention takes incalculable intellectual skill, years of training, years of hard work, and significant resources.
Pendulum of Justice, the first Hank Rangar Thriller, discusses this exact point.
“Hey Mike—we’ve heard your ‘good ideas are a dime a dozen’ speech before. The electric light bulb, the cotton gin, the polio vaccine, the microcontroller, hell, the CAT scan, were all a dime a dozen”
It is my opinion that this sort of nonsense is usually spread by people in finance, who are looking to improve their negotiation position or are just too intellectually challenged to really know when an invention is great. It also inflates their self-importance.
The reality is that most people do not create much more than they consume in their lifetimes and this includes many people in finance, even if they personally get rich. It is only by raising our level of technology that we increase our per capita wealth and only inventors increase our level of technology. Great inventors create incalculable wealth and even if they become wealthy, what they receive in payment is a pittance to what they provided.
I think this nonsense of “great ideas are a dime a dozen” is a spin out from the Austrian Economist Joseph Schumpeter who made a nonsensical distinction between innovation and invention, while denigrating inventions and inventors.
According to Wikipedia:
Following Schumpeter (1934), contributors to the scholarly literature on innovation typically distinguish between invention, an idea made manifest, and innovation, ideas applied successfully in practice
There is nothing inherently wrong with the distinction above, but the way it is applied blurs together a number of different skills. Blurring skills together shows a misunderstanding of the process of innovating. Broadly speaking, innovation can be broken into two distinct sets of skills: creation and dissemination. By creation I mean creating something new, not production – creating something old.
A subset of creation is invention. An invention is a creation with an objective repeatable result. A creation that is not an invention has a subjective result, such as the effect of a painting on a viewer, or the effect of a book on a reader. Many activities combine both a subjective creation and an invention, such as architecture. However, we can separate out the invention from the other creative elements and this helps our understanding of the process.
Dissemination may include a number of processes, such as education (marketing, sales), manufacturing, finance, and management. This is not to say that marketing cannot be creative, it clearly often is very creative. However, the creative part of marketing can be separated out from the dissemination or execution part of marketing. The same is true of manufacturing, which can definitely include inventing. But an invention related to manufacturing is part of the creation step not part of the dissemination step.
Finance can also have inventions. For instance, the invention of a fractional reserve bank is clearly an invention. It has the objective result of securitizing assets and turning them into loans and currency. A fractional reserve bank will securitize land and turn it into a loan and currency. Despite this, it is important to understand that the first person to develop the fractional reserve bank is inventing and the person operating the fractional reserve bank is disseminating.
All real per capita economic progress is the result of inventing. This is not to say that it is unnecessary to disseminate inventions, but if there were no new inventions there would not be any economic progress. We would be stuck in static world once all the inventions had been completely disseminated. Of course, if we stop all dissemination activities we will quickly starve to death.
It is my opinion that business and economic professors have focused on “innovation” instead of “invention” because they have no idea how to invent or how the process of inventing works. They concentrate on what they know, i.e. business and economic practices. As a result, the focus is on dissemination, under-appreciating the importance of inventing. In addition, it results in misleading business theories, such as:
– Management teams are more important than the quality of the invention.
– Execution is everything; patents and other IP do not matter.
– Get Big Fast.
The truth-test of these theories is directly related to the strength of the patent laws at the time the company is created. When patent laws are weak, these theories are more true and when patent laws are strong, these theories are less true. Unfortunately, when patent laws are weak these theories do not overcome the disincentive to invest in risky new technologies. Management teams do not build revolutionary or disruptive technologies, they just disseminate these technologies. These sorts of teams are like large companies and generally can produce a return with less risk by NOT developing high-risk technologies. They tend to focus on incremental technologies or on stealing someone else’s technology. While this may be good business advice in a period of weak patents, it is bad for our country’s competitiveness and our standard of living.
Technological progress (i.e., inventing), in the long run, is the only competitive business advantage. The best management team in the world selling buggy whips at the turn of the century could not overcome the technological advance of the automobile and stay a buggy whip company. The best management team in the world selling vacuum tubes in the 1940s, could not overcome the advance of transistors and semiconductors and stay a vacuum tube company. This country is littered with companies that had great management teams that were overwhelmed by changes in technology. For instance, Digital Computers had a great management team, but they could not overcome the advance of the personal computer. Digital Computers, Inc. failed to invent fast enough to overcome the onslaught of small inexpensive computers. US steel was not able to overcome the onslaught of mini-mills, aluminum, and plastics. This was not because they did not have a good management team, it was because the management team under- prioritized invention and over-prioritized execution or dissemination skills. Ford & GM have not become walking zombies because they did not have strong management teams, but because they have not invented. As a result, they have antiquated production systems and weak technology in their products. 86% of the companies in the Fortune 500 in 1959 are no longer there. Some of these companies disappeared because of bad management, but most companies disappeared because they did not keep up with changing technology. In other words, they did not invent.
Inventions(i.e., advances in technology) are the ONLY WAY to increase real per capita incomes and the only long term business advantage.
Schumpeter – another Austrian School of Economics Failure.
According to this article Menger in “Carl Menger’s Lectures to Crown Prince Rudolf of Austria (trans. Monika Streissler and David F. Good; Aldershot, 1994)” argues for:
(1) public works constructed by the state such as roads, railways and canals.
(2) government established agricultural and vocational training institutions (Menger 1994: 123).
(3) government subsidies to certain sectors
(4) state intervention to stop clearing of forests on private property in the mountains of Austria when this clearing had serious and bad effects on agriculture
(5) government intervention to stop child labour (Menger 1994: 129).
Carl Menger is often touted as the savior of Austrian Economics, but assuming all the above is true he is hardly a principled capitalist. In fact he sounds like a standard conservative who is against government intrusion in the economy until he is for it.
How Strong Patents Make Wealthy Nations is an excellent paper that provides overwhelming evidence that patents create economic wealth. The paper has two excellent charts. The first chart shows the strength of a number of countries patent systems versus their wealth.
The second chart compares the per capita GDP of the U.S., Great Britain, and Brazil from 1700 until 1913. The U.S. and UK had patent systems, while Brazil did not and Brazil and the U.S. became independent about the same time. The result is that Brazil’s per capita GDP hardly changes while the U.S. and UK experience an over five-fold increase in per capita incomes from 1800 to 1913.
This paper has important implications on economists Paul Romer’s work. Paul Romer is one of the leading new growth economists and is often mentioned as likely future recipient of the Nobel Prize in economics. Romer and Robert Solow have shown that increasing levels of technology are the only way we increase real per capita wealth. Romer contends that property rights for inventions (mainly patents) are always a bad trade-off. He argues that strong patent systems encourage the creation of new technologies, but they inhibit the dissemination of new technologies. His reason for this position is based in his belief in the theory of “pure and perfect competition.” Alternatively, weak or non-existent patent systems result in good distribution of new technologies but they are poor at creating new technologies. It is clear that this paper provides significant empirical evidence that Romer’s idea that property rights are always a bad trade is incorrect.
I have one minor criticism with this paper. The authors argue that the patent system in the U.S. helped manufacturing. Manufacturing is not what causes increases in our per capita income and inventions sometimes hurt manufacturing. For instance, digital printing and the Internet have completely destroyed the manufacturing side of the publishing industry and 3D manufacturing has potential to do the same thing to manufacturing in other industries. The question is not whether patents help manufacturing, it is whether it makes us wealthier.
How Strong Patents Make Wealthy Nations by Devlin Hartline & Kevin Madigan
I was having a discussion with Objectivist colleague about the Austrian Economic idea of subjective value. In economics the subjective theory of values (STV) was developed in response to the classical economic ‘labor theory of value’. The labor theory of value states that the value of an item is equal to the sum total of the labor that went into making it. Thus the value of your computer is equal to the total amount of labor used to produce it, including all its components.
The Austrians, particularly Carl Menger, explained that this was clearly incorrect. In response he said the value of a thing is determined by each person’s own mind. Most economists today adhere to some sort of subjectivist theory of value.
Ayn Rand, in Capitalism for the Unknown Ideal, discussed the differences between intrinsic, subjective, and objective theories of value. In my opinion it was her way of making it clear that she disagreed with her friend Ludwig Von Mises.
The subjectivist theory holds that the good bears no relation to the facts of reality.
The intrinsic theory holds that the good resides in some sort of reality, independent of man’s consciousness.
The objective theory holds that the good is … an evaluation of the facts of reality … according to a rational standard of value.
(Ayn Rand Lexicon “What Is Capitalism?” Capitalism: The Unknown Ideal, 21)
The Subjective Theory of Value (STV) in economics results in economics being a subjective social ‘science’, instead of an objective, true science. It is important that we define what Austrians’ mean by the STV. They mean that people’s economic choices are not connected to reality. People have subjective values that they attempt to fulfill and we cannot say whether a person’s economic choice is correct or rational.
According to the STV we could not say that if Robinson Crusoe’s choice to trade his canteen of water for a gold doubloon to the only other survivor of a shipwreck, when there is no potable water on the island and no foreseeable chance of rescue before Crusoe dies of dehydration and no foreseeable chance of rain before Crusoe dies of dehydration, is irrational. We cannot even make this decision if we know that Crusoe’s goal is to stay alive and he has no connection to the other survivor.
If we take the STV seriously, then I can be rich if I just subjectively believe that my slum house in a decaying part of Detroit is worth $200 million. Value is all subjective, so as long as I firmly hold to this belief then I will suddenly be wealthy. Pointing out to me that the market value of my house is only $15,000 is founding your opinion “upon an arbitrary judgment of value.”
Unfortunately, the Austrian STV turns economics into a popularity game. As a result the only reason John Galt’s motor has any economic value is that other people value it. This is obvious nonsense. Galt’s motor has economic value even if no one else subjectively values it. The motor produces almost unlimited electrical power for almost zero marginal cost. Thus it has economic value to Galt, even if no one else is smart enough to see its value or take advantage of its value.
You will often hear Austrian economists describe why someone became wealthy in terms of a popularity contest. They rarely discuss the value that the wealthy person created, instead they talk about how the wealthy person made so many people happy. If wealth creation is just the result of an arbitrary popularity contest, then there is no logical reason that we should not redistribute wealth.
The macroeconomic evidence does not support the idea that people make arbitrary economic decisions. The wealthier people are the longer they live on average. If peoples’ decisions were truly subjective (disconnected from reality) then we would expect that there would be no correlation between wealth and longevity at least for those people living above the subsistence level. But in fact, there is a strong correlation. There is also a strong correlation between wealth and a number of factors related to the quality of life. This shows that people are not spending their money arbitrarily (subjective valuation), but spending it on things that enhance their longevity and their life.
Some people suggest that once people are above the subsistence level of living then economic decisions become subjective. The evidence does not support this point of view either. People who are wealthier tend to drive safer cars, have better built houses that can withstand natural disasters better, have better access to high quality health care and so on. Very few people are wealthy enough to afford the highest quality goods and services for the rest of their lives. Clearly, the wealthier people are the more they can afford to indulge some of their whimsies, however if they make enough irrational economic decisions they will not only go bankrupt, they will die – see Venezuela.
Wealthier people are also happier. There are some old studies that attempted to show that additional wealth/income above a subsistence level did not increase people’s happiness (The Easterlin Paradox). However, more recent studies have shown that increasing levels of wealth do correlate with increasing levels of happiness. The original studies were clearly biased and trying to make a political point.
Several of the ideas of Austrian economics are actually inconsistent with the STV For instance, how Austrians explain marginal utility implicitly shows that they understand peoples’ economic decisions (values) are not arbitrary. The most common way Austrians explain marginal utility is to explain that if they have one unit of water per day they will use if for drinking. If they suddenly have two units of water per day they will use the second unit for watering their garden, which they value lower than drinking. If they then find they have three units of water per day, then they will use the third unit for washing.
Why do Austrians always select drinking for water as having the highest priority? Clearly they inherently understand that people have to drink to stay alive (an objective – reality based decision) and that drinking water is more important than washing if the person wants to live.
Another example is the Austrian Business Cycle (ABCT). ABCT argues that we grow wealthier when we invest in (purchase) “higher order goods”, which is just a fancy way of saying increasing our capital. Thus they are arguing that purchasing capital goods has a higher value (economic and moral) than purchasing consumer goods. Some Austrians recognize the contradiction and try to dance around it by saying that economics can tell you what the result of certain policy actions will be, however economics cannot tell you which choice you should make. This is like a doctor telling you that a poison will kill you, but the physician cannot tell you that you should not ingest it.
Economic and moral values are not separate and cannot be isolated. Both are based on the objective nature of man. Austrians by choosing a STV for economics are logically compelled to the conclusion that ethics is subjective. The STV also condemns economics to the category of a social ‘science.’ Only by rejecting the STV and replacing it with an objective theory of value can economics be an objective science.
 If human action always aims at a purpose, which by definition it does, then human action must be rational, that is, consistent with reason or guided by one’s will and intellect. It can never be termed irrational.
In making this point, Mises in Human Action (p. 19) writes “Human action is necessarily always rational. The term ‘rational action’ is therefore pleonastic and must be rejected as such. When applied to the ultimate ends of action, the terms rational and irrational are inappropriate and meaningless. The ultimate end of action is always the satisfaction of some desires of the acting man.”
Seemingly irrational action is rational, that is, has an aim. To appraise it as irrational, the appraiser merely imposes some other external source of value. Mises writes (p. 104): “However one twists things, one will never succeed in formulating the notion of ‘irrational’ action whose ‘irrationality’ is not founded upon an arbitrary judgment of value.”
https://mises.org/library/what-do-austrians-mean-rational, What Do Austrians Mean by “Rational”?, MISES DAILY ARTICLES, Accessed 6/9/16.
 Of course it is entirely possible that Von Mises (see footnote 1) believe trying to stay alive is an arbitrary choice.
 http://www.forbes.com/sites/susanadams/2013/05/10/money-does-buy-happiness-says-new-study/#29669cf440b5 (accessed 6/10/16) and http://www.nber.org/papers/w14282.pdf?new_window=1 (Accessed 6/10/16) Betsey Stevenson Justin Wolfers, ECONOMIC GROWTH AND SUBJECTIVE WELL-BEING: REASSESSING THE EASTERLIN PARADOX, NBER WORKING PAPER SERIES.
 Austrians tend to have a very fluid definition what they mean by the STV. They shift the definition based on the discussion they are involved in and use the one they believe will make their argument most effectively.
 Murray Rothbard tried to span this contradiction. A likely result was the non-sense of anarcho-capitalism.
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