The Science of Demand (5) - Unofficial Translation of Steven Cheung's 经济解释 - 科学说需求

Section 5.  Ambiguity and Contradictory

For a theory to be capable of explaining phenomenon, it must be refutable by phenomena (facts). This is a maxim in empirical science. I have elaborated earlier that a “theory”, like tautology, that cannot be falsified has no explanatory power since it is not potentially refutable by facts. However, other than tautology, four situations could render a theory not refutable by facts. We’ll explore the first two here; in the next section we’ll discuss the remaining two.

The first one is what I teasingly term “the second Coase theorem”. In his 1960 seminal article (from which the “Coase theorem” was originated), Coase advocated a familiar yet had never before been distinctly proposed philosophy. After exhausting all possible means to comprehend Arthur Cecil Pigou’s economic analysis, but still unable to figure out what it referred to, Coase wrote: “An idea not clearly stated can never be proved clearly wrong.”

Indeed – ambiguous concept or analysis, being not clearly wrong, is impossible to be clearly refuted by facts. To be refutable by facts, a precondition is: the theory itself has to clearly indicate a possibility of being falsifiable. “If it rains, then there are clouds” can be falsified (but has never been falsified); “if it is spring, then a bud blossoms” can be falsified (but has never been falsified, either). Yet if we are uncertain what clouds are or what spring is, how can we determine right from wrong?

There are lots of ambiguous concepts in economics. Theories not susceptible to refutation by facts – impossible to be clearly refuted by facts – emerge one after another. Karl Marx’s “Capital” is an example. What exactly is residual value? Some scholars say it is rent, some say interest, some say profit, while some say there is nothing like that at all. Despite all the rhetoric, it is still ambiguous. According to Marx, “residual value” was the residual after capitalists had paid wages. However, other production costs had not been completely deducted, how could that be said to be residuals after exploiting workers? The “capital” concept in the “Capital” was also ambiguous. It was only until 1930s that such concept was clearly explained by Irving Fisher (see Volume II of this book).

No one has ever tried to empirically test Marx’s theory. It is not surprising that there was no verification in China then, but why didn’t Western scholars put Marx’s theory to the test? The answer is: ambiguous theory cannot be empirically tested. Very unfortunately, a non-falsifiable theory is often believed by some blind adherents as “not falsified means absolutely right”.

Ambiguous concepts or theories are of course not unique to Marx. David Ricardo, an earlier genius who had an enormous influence on Marx, was confused about the concepts of “capital” and “cost”, resulting in his analysis on wages and rent not understood by later generations. Modern gurus like Frank Knight – with five of his students winning Nobel Prizes in Economic Sciences – also fell into the trap of ambiguity. Knight split risk and uncertainty into two, yet after much deliberation we still cannot tell the difference.

John Maynard Keynes’ “The General Theory of Employment, Interest and Money” was ambiguous, too. Consequently, for certain important areas of that theory, no one could boast about having done any verification. The originator of the utility theory, Jeremy Bentham, subjectively using utility as a proxy for happiness, baffled later generations. Therefore Alchian became famous by asking the question “what is utility?”. Bentham’s utility theory, being ambiguous, is not refutable by facts. However, after Alchian, studies on testing of the utility theory started cropping up here and there. (Being Alchian’s student inside the chambers, I refrain from applying this utility concept for explanation. This will be elaborated later.)

Since ambiguous concepts or analyses cannot be proved clearly wrong, they possess no explanatory power. Another type of theory that is not refutable is the meaningless type. Meaningless refers to neither devoid of content (unlike tautology) nor ambiguous, but statements of this type are contradictory and logically inconsistent, puzzling people as to their meaning, hence they become meaningless.

Let’s cite a few examples. If I say: “There are black dots on an all-white wall.” This sentence is not devoid of content. In fact it is extremely clear, though “black dots” and “all-white” are contradictory and cannot co-exist. This sentence is therefore meaningless. Logic can certify that an all-white wall that has black dots could lead people identifying a deer as a horse, or a wall as God! (This is no trivial logical reasoning, but since it is outside the scope of economics, we will not elaborate here.) Contradictory statement can have content, can be crystal-clear, yet cannot have meaning.

There are plenty of contradictory theories in economics. Like tautologies, contradictions may not necessarily be readily detected. My thesis, “The Theory of Share Tenancy”, overthrew the previous view by pointing out its contradiction. For instance, the theory of Charles Issawi was based on every individual maximizing his self-interest, yet he wrote: “In this paper I implicitly assume that the landlords will not respond speedily to economic gains, nor attempt to increase investment in order to increase their income.” What is it if not contradiction? And in a separate case, in guru Marshall’s analysis of share tenancy, he did not allow the landlords to choose the system of fixed rent, even though he knew well the income of fixed rent was higher than that of share tenancy, and the two systems could co-exist.

Similar contradictory analyses are often found in the publications of economic masters. William Baumol said that a monopolized enterprise did not seek the highest profit but the highest sales, yet his theory did not allow the enterprise to give up a little sales for a much bigger profit. John Hicks pointed out that when a person’s income increased, his demand for certain goods would decrease. This is not incorrect, but in his analysis, the model that he used was a world with only two kinds of goods, and in that particular world, any increase in income would not cause the quantity demanded of one of the two goods to decrease. Contradictory problems are commonly seen in any science, and economics is no exception. Direct contradictions are not difficult to identify, yet indirect ones – those after one or multiple inferences – often cannot be avoided even by masters.