The Philosophy of Economics An Anthology Third Edition Edited by DANIEL M. HAUSMAN University of Wisconsin–Madison CAMBRIDGE UNIVERSITY PRESS Contents Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521883504 © Cambridge University Press 1984, 1994, 2008 Introduction page 1 PART ONE. CLASSIC DISCUSSIONS 39 This publication is in copyright. Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place 1. On the Definition and Method of Political Economy 41 without the written permission of Cambridge University Press. John Stuart Mill First published in print format 2007 2. Objectivity and Understanding in Economics 59 Max Weber ISBN-13 978-0-511-37141-7 eBook (NetLibrary) 3. The Nature and Significance of Economic Science 73 ISBN-10 0-511-37141-1 eBook (NetLibrary) Lionel Robbins ISBN-13 978-0-521-88350-4 hardback 4. Economics and Human Action 100 ISBN-10 0-521-88350-4 hardback Frank Knight 5. Selected Texts on Economics, History, and Social Science 108 Karl Marx 6. The Limitations of Marginal Utility 129 Cambridge University Press has no responsibility for the persistence or accuracy of urls Thorstein Veblen for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. PART TWO. POSITIVIST AND POPPERIAN VIEWS 143 7. The Methodology of Positive Economics 145 Milton Friedman 8. Testability and Approximation 179 Herbert Simon 9. Why Look Under the Hood? 183 Daniel M. Hausman 10. Popper and Lakatos in Economic Methodology 188 D. Wade Hands v vi Contents Contents vii PART THREE. IDEOLOGY AND NORMATIVE ECONOMICS 205 24. What Has Realism Got to Do with It? 439 11. Science and Ideology 207 Tony Lawson Joseph Schumpeter 25. Feminism and Economics 454 12. Welfare Propositions of Economics and Interpersonal Julie A. Nelson Comparisons of Utility 222 26. Credible Worlds: The Status of Theoretical Models in Economics 476 Nicholas Kaldor Robert Sugden 13. The Philosophical Foundations of Mainstream Selected Bibliography of Books on Economic Methodology 511 Normative Economics 226 Daniel M. Hausman and Michael S. McPherson Index 521 14. Why Is Cost-Benefit Analysis So Controversial? 251 Robert H. Frank 15. Capability and Well-Being 270 Amartya Sen PART FOUR. BRANCHES AND SCHOOLS OF ECONOMICS AND THEIR METHODOLOGICAL PROBLEMS 295 16. Econometrics as Observation: The Lucas Critique and the Nature of Econometric Inference 297 KevinD.Hoover 17. Does Macroeconomics Need Microfoundations? 315 KevinD.Hoover 18. Economics in the Laboratory 334 Vernon Smith 19. Neuroeconomics: Using Neuroscience to Make Economic Predictions 356 Colin F. Camerer 20. The Market as a Creative Process 378 James M. Buchanan and Viktor J. Vanberg 21. What Is the Essence of Institutional Economics? 399 Geoffrey M. Hodgson PART FIVE. NEW DIRECTIONS IN ECONOMIC METHODOLOGY 413 22. The Rhetoric of This Economics 415 Deirdre N. McCloskey 23. Realism 431 Uskali M¨aki 2 Introduction was working on the first edition of this anthology, this interest was already growing, with philosophers, economists, other social scientists, and ordi- nary citizens all showing more curiosity about what sort of an intellectual discipline economics is and what sort of credence its claims merit. At the Introduction time, many turned to the literature on methodology because of doubts about the value of economics. After the economic successes of the generation fol- lowing World War II, economic growth stalled in the 1970s, and many came to doubt that anybody knew how to restore prosperity without rekindling inflation. A decade later, at the time of the second edition, things looked brighter for economics, although there were still doubts about how to restore prosperity without aggravating budget deficits, how to reinstitute markets in state- Premises assumed without evidence, or in spite of it; and conclusions drawn from controlled economies without precipitating economic collapse, and how to them so logically, that they must necessarily be erroneous. alleviate widespread misery in the so-called developing countries. In that – Thomas Love Peacock, Crochet Castle atmosphere, it is not surprising that economists turned to methodological reflection in the hope of finding some flaw in previous economic study or, Ever since its eighteenth-century inception, the science of economics has more positively, some new methodological directive to improve their work. been methodologically controversial. Even during the first half of the nine- Nor is it surprising that ordinary citizens, whose opinions of economists are teenth century, when economics enjoyed great prestige, there were skeptics more influenced by the state of the economy than by systematic evaluation like Peacock. For economics is a peculiar science. Many of its premises of economic theories, should wonder whether there might be something are platitudes such as “Individuals can rank alternatives” or “Individuals awry with the discipline. choose what they most prefer.” Other premises are simplifications such as Today, in 2007, in contrast, economists are riding high. Although there “Commodities are infinitely divisible,” or “Individuals have perfect infor- have been serious economic problems during past fifteen years, such as mation.” On such platitudes and simplifications, such “premises assumed the international financial crisis in 1997, continued high unemployment in without evidence, or in spite of it,” economists have erected a mathemat- Europe, and a prolonged and severe recession in Japan, nevertheless, there ically sophistical theoretical edifice, whose conclusions, although certainly has been significant economic growth in developed economies, which have not “necessarily erroneous,” are nevertheless often off the mark. Yet busi- generally prospered. Serious problems remain in the formerly socialist coun- nesses, unions, and governments employ thousands of economists and rely tries, but conditions have stabilized and for the most part improved. And on them to estimate the consequences of policies. Is economics a science or rapid economic growth in the two most populous countries on earth, India isn’t it? and especially China, has transformed the economic landscape. Although it This is a complicated question. What does it mean to assert or deny is overly optimistic to claim that the central economic problems have been that economics is a science? To be called a science is, no doubt, an honor. solved (especially in the light of the disastrous performance of the economies As the scientific credentials of economists rise, so do consulting fees. But of many of the poorest countries in the world), such a claim today, unlike a what question is one posing when one asks, “Is economics a science?” Is one generation ago, would not strike most people as absurd. inquiring about the goals of economics, about the methods it employs, about While the doubts about the value of economics that helped fuel the inter- the conceptual structure of economic theory, or about whether economics est in economic methodology that began in the 1970s have receded, the can be reduced to physics? If economics is a science, is it the same kind of theoretical reasons to be interested in economic methodology have only science as are the natural sciences? grown stronger. In previous editions, I identified three theoretical reasons. During the last generation, interest in philosophical questions concern- First, not only economists but also anthropologists, political scientists, social ing economics has increased enormously. Twenty-five years ago, when I psychologists, and sociologists influenced by economists have argued that 1 Introduction 3 4 Introduction the “economic approach” is the only sensible theoretical approach to the This volume aims to assist those interested in the methodology of eco- study of human behavior. This provocative claim – that economics is the nomics by providing a comprehensive and up-to-date introduction to the model that all social sciences must follow – obviously makes method- subject. My hope is that this book will be useful both as a research resource ological questions concerning economics more important to other social and as a teaching tool. It provides an introduction to a wide range of method- scientists. ological issues and and to a wide range of positions which have been taken In the 1970s and 1980s, it was ironic that some economists were mak- with respect to these issues. ing grandiose claims for the universal validity of the economic approach to Unlike a textbook, this anthology also provides some historical perspec- human behavior at the same time that others had serious qualms about their tive. Methodological questions concerning economics – questions about own discipline. As those qualms have faded, so has this irony. There is, how- the goals of economics, the ways in which economic claims are established, ever, a second ironical twist, which constitutes the second theoretical reason the concepts of economics and their relation to concepts in the natural sci- why interest in the methodology of economics has increased. During the ences and so forth – are all philosophical questions, and in philosophy it same period that