August 13, 2007

Essays in Positive Economics, pages 29-30

Filed under: Economics, Friedman — duncan @ 8:02 pm

Since my economic self-education is proceeding at the pace of a snail, I thought I’d return to a trusty stand-by: taking pot shots at Milton Friedman’s ‘The Methodology of Positive Economics’. Here’s the passage under review today. Friedman is, recall, arguing that there’s no problem with economists deploying wildly unrealistic assumptions, since what counts, in positive economics, is not the assumptions’ truth, but their predictive value. In today’s passage, however, he’s discussing the use of the same assumptions in different disciplines: specifically “the assumption that man seeks his own interest”. A general application of such a hypothesis “gains indirect plausibility from the success for other classes of phenomena of hypotheses that can also be said to make this assumption; at least, what is being done here is not completely unprecedented or unsuccessful in all other uses.” (p. 29)

Now listen to this:

“This kind of indirect evidence from related hypotheses explains in large measure the difference in the confidence attached to a particular hypothesis by people with different backgrounds. Consider, for example, the hypothesis that the extent of racial or religious discrimination in employment in a particular area or industry is closely related to the degree of monopoly in the industry or area in question; that, if the industry is competitive, discrimination will be significant only if the race or religion of employees affects either the willingness of other employees to work with them or the acceptability of the product to customers and will be uncorrelated with the prejudices of employers. This hypothesis is far more likely to appeal to an economist than to a sociologist. It can be said to ‘assume’ single-minded pursuit of pecuniary self-interest [notice, by the way, how Friedman has moved, in the space of a page, from self interest in general to “pecuniary self-interest”, without comment or distinction] by employers in competitive industries; and this ‘assumption’ works well in a wide variety of hypotheses in economics bearing on many of the mass phenomena with which economics deals. It is therefore likely to seem reasonable to the economist that it may work in this case as well. On the other hand, the hypotheses to which the sociologist is accustomed have a very different kind of model or ideal world, in which single-minded pursuit of pecuniary self-interest plays a much less important role. The indirect evidence available to the sociologist on this hypothesis is much less favourable to it than the indirect evidence available to the economist; he is therefore likely to view it with greater suspicion.” (p. 29-30).

The first thing to notice here is that Friedman is already framing the question he poses from an economist’s point of view. “[D]iscrimination will be significant only if the race or religion of employees affects either the willingness of other employees to work with them or the acceptability of the product to customers and will be uncorrelated with the prejudices of employers.” Of course we can distinguish individuals from their communities – and we can, if we wish, imagine the prejudices of employers as analytically dissociable from those of the broader community. But it’s surely better to begin from the idea that racial or religious intolerance is pretty much impossible to understand outside the social contexts that give rise to it. When Friedman suggests that we can, for the purposes of our economic or social analysis, neatly separate the prejudices of individual employers from the prejudices of their communities, or of the social norms by which those communities create and maintain themselves, he is already proposing a highly atomistic and individualistic vision of social life: he is already looking at things as an economist, not a sociologist.

Putting that aside, however, what’s remarkable about this passage is the way it seems to torpedo Friedman’s broader thesis. Friedman imagines the hypothesis: in a competitive industry employers’ prejudices won’t play a role in hiring decisions. And he says that an economist is more likely to find this hypothesis appealing than a sociologist.

But the hypothesis is false. Of course employer prejudice plays a role in employment decisions in competitive industries. That’s why we have legislation to outlaw it. I don’t have any empirical studies to settle the matter; if anyone’s got any data they’d like to share (especially, I guess, if it undermines my case), I’d welcome it. But surely. Employers’ prejudices can be a powerful factor in hiring decisions in competitive industries. What’s to dispute?

And now here comes the problem: assuming the hypothesis is false… and assuming economists are indeed more likely than sociologists to find it plausible… this is a perfect example of why unrealistic assumptions are dangerous in economics. Here is an assumption that (let’s grant Friedman, for the moment) works well within the limited field of strictly economic analysis. But because the (unrealistic) assumption produces useful results in that field, there is a natural and strong inclination (an inclination that Friedman apparently here endorses) to apply that assumption in other fields as well. And you know what…? It’s a bad idea.

There is no impermeable boundary between strictly economic analysis and broader political or social judgement. If, as economists, we use some ridiculous, unrealistic assumption in our discipline, that assumption will not remain within its disciplinary cage. It will escape. It will roam free. It will bite and maul. This is precisely why we ought to start with realistic assumptions: because whatever assumptions we work with will influence our general views. And when economists are asked to give political advice, we want to be pretty sure they’re not operating in the realm of economic fantasy. I’ll bet you all the money in my pockets: employer prejudice plays a role in competitive industries’ hiring decisions. If economists’ assumptions make them inclined to dispute that – so much the worse for economics.

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