[This article is part 5 of a series of articles and a section taken out of the longer essay “Do You Even Prax, Bro?” Over the span of the following days the corresponding sections will be published until finally the essay is published in full along with the missing  and additional sections added since first publication. For previous articles on Austrian epistemology/methodology, see herehere, here, and here.]

 

Answer: Austrians don’t make quantitative predictions.  You may have heard this joke.  What is a quantitative prediction, and why don’t Austrians make them?  Let us illustrate.  A quantitative prediction would look like, “If the minimum wage is increased by 2$, unemployment will increase by n%”.  Where Austrians say, “If you increase the minimum wage, unemployment will be higher than it would otherwise have been”.  As to the why of Austrians not making them, quantitative predictions involve assumptions of mathematical constancy that are not realistic.  Not to mention the hubris of making assumptions regarding the value scales of millions of people simultaneously.  To know the quantitative outcome of some economic action is frankly nonsensical – all you can really know is the causal link that if you do A, then the result will be B.  The economy cannot be predicted quantitatively.  We can, logically, predict whether and in which direction a given event will apply pressure on a given metric, i.e., prices.  The formulas of econometricists try to predict the values of those metrics in the future, and they’re wasting their time along with our prosperity.

Regarding Austrians though, no Austrian prediction – that is, a prediction derived from the Austrian model, versus a prediction made by somebody who calls himself an Austrian – has ever been wrong.  There is no trick here, just the observation that no quantitative predictions can be made through economic analysis, because economics is a study of human action wherein there are no quantitative constants.

“Praxeological knowledge makes it possible to predict with apodictic certainty the outcome of various modes of action. But, of course, such prediction can never imply anything regarding quantitative matters. Quantitative problems are in the field of human action open [p. 118] to no other elucidation than that by understanding.

We can predict, as will be shown later, that–other things being equal–a fall in the demand for a will result in a drop in the price ofa. But we cannot predict the extent of this drop. This question can be answered only by understanding.”-Ludwig von Mises[1]

 

So, you may be asking right now: “So Austrians do make predictions then?”  Sure we do – at least qualitative ones.  It’s not exactly predicting the future, though.  It’s one thing to be able to say that with increasing minimum wage unemployment will be higher than otherwise.  It’s quite another to say that it will go up, let alone by how much.  If the minimum wage was suddenly increased to $45, saying it would go up is a pretty safe, but only because it’s pretty safe to say such a dire change would be enough to overcome other factors putting pressure in the opposite direction.  However, the ability to do that rarely comes in handy, because economic policy seldom takes big turns like that.  Qualitative predictions are useful, or being an Austrian would be silly.  Fallible but non-arbitrary quantitative predictions are possible, but economics is of no use there.  This is what speculation is for, and why speculators usually specialize in a particular market when the ability to think you know something before someone else is useful.  However, even there, quantitative predictions are nearly ultimately impossible with any real accuracy, which works because qualitative answers are all that are needed in this area.  A price will go up, or it will go down, in the face of some new development.

Now what this has to do with the joke and one reason it is funny (if you are a nerdy Austrian like me) is that to be able to answer it is not an accomplishment in economics.  In other words, Austrians could do just as well as anyone else, because Austrian theory does not apply here.  Even “how much capital does it take to start up a coffee shop?” is a question for entrepreneurs, not economists.  Even entrepreneurs don’t generally do that though.  They don’t have to.  They want to know if a price will “go up” or “go down”, not if the price would be $42.67.  You don’t need to know that commodity X will be up 4.7% next week; you only need to know that it will indeed go up.  In addition, if you could do even that consistently, you’d be a billionaire by the end of the year.  To be a successful speculator, you only need to be right more often than you’re wrong on the “up or down?” question, and when you get it wrong you still have a chance to wait and see if you become right later.

However, to be fair, one may argue that predicting human behavior is possible.  Let us assume that a coffee drinker goes to the same coffee shop, orders the same drink every day, and goes to the same place on his lunch break.  Aha!  Austrian fail!  This is where we need to distinguish between speculation and economics.  Again, this is merely speculation.

To distinguish on what speculation and entrepreneurship is, we look to Rothbard once again:

“Entrepreneurship is also the dominant characteristic of buyers and sellers who act speculatively, who specialize in anticipating higher or lower prices in the future.  Their entire action consists in attempts to anticipate future market prices, and their success depends on how accurate or erroneous their forecasts are.  Since, as was seen above, correct speculation quickens the movement toward equilibrium, and erroneous speculation tends to correct itself, the activity of these speculators tends to hasten the arrival of an equilibrium position.

 The direct users of a good must also anticipate their desires for a good when they purchase it.  At the time of purchase, their actual use of a good will be at some date in the future, even if in the very near future.  The position of the good on their value scales is an estimate of its expected future value in these periods, discounted by time preferences.  It is very possible for the buyer to make an erroneous forecast of the value of the good to him in the future, and the more durable the good, the greater the likelihood of error.  Thus, it is more likely that the buyer of a house will be in error in forecasting his own future valuation than the buyer of strawberries.  Hence, entrepreneurship is also a feature of the buyer’s activity—even in direct use.  However, in the case of specialized producers, entrepreneurship takes the form of estimating other people’s future wants, and this is obvi­ously a far more difficult and challenging task than forecasting one’s own valuations.” [2]

 

Economics is the study of human action as it relates to material scarcity.  Speculators do not contribute to economic theory, and apart from the extreme basics of the effects of supply and demand on prices, which everybody knows, they don’t use those theories either.  They think they know something everybody else doesn’t yet know about some condition that will affect supply and/or demand, and act accordingly.  With their specialized knowledge of the particular markets in which they work, speculators make money on quantitative predictions all the time.  This is not a feat of economics.  Let’s say you spot a great investment.  Congratulations, this is a feat of entrepreneurial speculation, not of economics.  Speculators or entrepreneurs are well advised to become experts in the specific market they are dealing with, to identify good opportunities for profit, be it unexploited or under-exploited.  Economists (as economists) don’t do this.  Markets in general are what economists theorize on.  Specific markets are for entrepreneurs.  However, entrepreneurship, or speculation isn’t even applied economics.  You could have vast knowledge of economics that is near useless to you as an entrepreneur.  The skills required for each task are quite separate from each other.  Speculators do analysis of a specific market, the market as a whole is done by economists.  If you have an equation you think will make you money, go right ahead.  Maybe it sometimes will.  If you think it’s “correct”, and it will always make you money, it shouldn’t take you long to become the richest man who ever lived.  However, that is a rare feat to accomplish.

The longer individuals confounds entrepreneurial speculation and economics, the more they will be confused. The significance of discussing speculation when making quantitative predictions may be arbitrary to some, but it is to illustrate that if it is indeed difficult to do in a specific market and be correct, imagine the improbability (if not impossibility) of doing it with millions of people.

Jeff Peterson II

We the Individuals

[1] Human Action, Chapter 6: Uncertainty, 7. Praxeological Prediction

[2] Man, Economy, and State with Power and Market by Murray Rothbard

 Chapter 2-Direct Exchange Pt. 7 Speculation and Supply and Demand Schedules

http://mises.org/rothbard/mes/chap2c.asp