By Steve Baker MP

Steve BakerAt one hustings, I was asked for my personal opinion about climate change and anthropogenic global warming. That is, explicitly my opinion, not the Party line. And then in the comments on Paul's recent piece, The dog that didn't bark on Thursday during Energy questions, someone justified the present response to climate change by pointing to resource depletion…

Here's more or less what I said at the hustings:

  • Of course the climate is changing – it's bound to and it would be a mistake to deny it.
  • If we are driving climate change and if runaway warming is a real risk, then something had better be done about it.
  • Climate science does appear to be subject to uncertainties and climate change appears to be a problem we face in the medium to long term. But I remember the fuel protests. I lived in a remote Cotswold hamlet and I came close to running out of food as well as fuel. I remember the queues and the anxiety and how quickly the situation developed. I remember thinking that we were only ever a couple of meals from barbarism. Perhaps resource depletion is a greater threat than climate change.
  • Driving both resource depletion and CO2 emissions is population. While population growth has slowed or reversed in the wealthy world, it has not in the developing nations. As a driving factor, population growth seems to be, paradoxically, an even greater threat to humanity than either resource depletion or climate change. Moreover, the only moral way to reduce population growth appears to be to increase prosperity so that people choose to have fewer children. And that, of course, creates other demographic problems such as the "pensions time bomb".

So, the greatest problem humanity faces is how to use increasingly scarce natural resources to create greater prosperity for a growing number of people in the context of a changing environment. The study of that problem is surely economics.

And so I concluded my hustings answer by saying that bad economic science is a greater threat to civilisation than climate change, resource depletion or population growth.

Unfortunately, an economic science has grown up which claims to be a positive applied science despite the inability of its practitioners to foresee events such as a massive credit-fuelled boom which caused a bank collapse and recession. I have lost count of the number of articles in which economists have argued about whether circumstances are inflationary or deflationary. If economics were really a positive applied science, they would know and be able to prove their case conclusively. In reality, economists cannot agree whether circumstances are inflationary or deflationary because our money supply depends on bank lending and whether or not banks are lending depends upon individuals' subjective choices. The extent to which people wish to hold cash balances matters too, but that is also a subjective choice made by millions of individuals.

The result: economists could not even agree whether the general price level would rise or fall. (Although that problem seems to be resolving itself…)

Contemporary economics grew out of the scientism of the early 20th century. It simply had to be a science like physics, susceptible to the same scientific method. But that isn't true. Economics is part of the science of human action and it must take account of the fact that individuals act based on imperfect knowledge and subjective choices. Economics is not a positive applied science: to apply the methods of the natural sciences to human action is a category error.

The second major problem is that contemporary economics fails to account for people's time preferences as the origin of interest rates. The supply of loanable funds should be determined by prior production and foregone consumption: that is, saving. If the pool of loanable funds is higher, then interest rates should be lower and vice versa. Low interest rates should be an important signal that the pool of investable resources has increased, so it makes sense to invest.

This is the origin of the boom-bust cycle. If a central bank – or any other authority – wades in and artificially shifts interest rates away from those determined by the pool of loanable funds and the demand for credit, then the economy becomes dis-coordinated through time.

In practice, we have had historically low levels of saving plus historically high levels of borrowing: that was thanks to the central planning of interest rates and the banks' extension of credit in excess of real savings. The fundamental problems are central planning, legal privilege, state monopoly and the socialisation of risk.

Complementary to the problem of interest rate determination is capital theory, our third problem. We should not treat capital as homogenous with a particular money value. A good capital theory must recognise that capital goods are not interchangeable and that production takes place over time in a complex web of market exchanges. Given an indication of that capital theory, it ought to become apparent that manipulating interest rates could damage the delicate time structure of an economy…

Fourthly, it seems today that few students of economics and the social sciences are taught about the socialist calculation problem, an extension of the epistemological problem of the social sciences. It is impossible to obtain the information necessary to apply the methods of the natural sciences to human action and thereby to coordinate society by decree. That is why interest rates cannot be set appropriately by authority any more than the price of staple foods.

So, we have a contemporary economic science with four important flaws:

  • It is built on a category error: the application of the methods of the natural sciences to social science.
  • It neglects the origin of interest rates in people's time preferences.
  • It has a simplistic theory of capital goods.
  • It skates over the problem of knowledge.

I am deeply concerned about climate change and how we deal with it, about resource depletion, about population growth and about the problem of how to improve the lot of the world's desperately poor, but I am most concerned about bad economics. Bad economics drove the business cycle and delivered us into our present plight. Bad economics leads to mass malinvestment of production goods and widespread over-consumption. Bad economics discourages saving and encourages long-term dependency on a state which cannot fund the demands placed upon it. Bad economics floods the world with new money, giving it first to the wealthy, further impoverishing the poor. 

B976What we need today more than urgent action on climate change is a paradigm shift in economic thinking. The good news is that we may get one: every time I set out how the state has grown and how it has been funded by debt and debasement, every time I explain an Austrian-School interpretation of present events, I find the argument well received. My post “The Pretence of Knowledge”: how economists come to make astrologers look good is persistently popular. Traffic to The Cobden Centre grows and grows…

A primer on the economics of the Austrian School is here and you may enjoy the pocket edition of Mises' Human Action.

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