A relatively new area of study in economics, behavioral economics, has started to gain popularity. The behavioral economics framework emerged because of dissatisfaction with the neoclassical theory regarding consumer choice. A major problem with the neoclassical theory is that human beings are presented as if hardwired with a scale of preferences. Regardless of circumstances, this scale is considered to remain the same at all times.

Mainstream economics argues that, if preferences are constant, it is possible to compress preferences into a mathematical formulation called a utility function. Similarly, the assumption of constancy is considered an important characteristic of rationality.

According to behavioral economics, however, human beings are not considered rational actors. behavioral economists consider emotions to be the key drivers of consumer choices. Furthermore, whether or not consumers are patient determines whether they are inclined to spend or save money on a given day. If they patient and save more money, entrepreneurs can generate funds for new investment projects.

Also, behavioral economists emphasize the importance of personality. Emphatic people are more likely to make altruistic choices. Impulsive people are more likely to be impatient and less likely to save money for retirement. Venturesome people are more likely to take risks and gamble. Behavioral economics reduces people to emotional archetypes and assumes they act in accordance with their emotional type in a consistent manor.

Obviously, once reason is dismissed, humans can be treated like objects. Human action is driven by external factors. By means of a given stimulus, one can observe various human responses and draw all sorts of conclusions regarding the world of economics. According to Ludwig von Mises, “it is impossible to describe any human action if one does not refer to the meaning the actor sees in the stimulus as well as in the end his response is aiming at.”

Introducing Psychology in Economics Will Not Make Economics More Realistic

Psychology plays an important role in behavioral economics; however, there is a distinct difference between these two. Psychology deals with the content of ends and values. Economics starts with the premise that people pursue purposeful action. It does not deal with the particular content of various ends. According to Murray Rothbard,

A man’s ends may be “egoistic” or “altruistic,” “refined” or “vulgar.” They may emphasize the enjoyment of “material goods” and comforts, or they may stress the ascetic life. Economics is not concerned with their content, and its laws apply regardless of the nature of these ends.

Whereas, Rothbard continues, “psychology and ethics deal with the content of human ends; they ask, why does the man choose such and such ends, or what ends should men value?” Economics deals with the formal implications of the fact that human beings have ends and utilize means to attain these ends. Consequently, economics is a separate discipline from psychology.

Contrary to popular economics, Rothbard held that valuations do not exist by themselves (regardless of the things to be valued). On this, he suggested, “there can be no valuation without things to be valued.” According to this thinking, valuation is the outcome of the mind valuing things; it is a relation between the mind and things.

It follows that an individual’s scale of preferences, supposedly hardwired, is a fiction. Whenever an individual is confronted with a thing, he assesses it according to how it might benefit his life or well-being. Benefits are likely to vary with changes in the individual’s circumstances. What was acceptable to the individual yesterday may not be acceptable today.

Obviously, humans do change their minds. It is not surprising that human behavior deviates from the machine model of behavior depicted by mainstream economics. Rather than dismissing the assumption of constant preferences, behavioral economists have retained the assumption and instead modified the utility function in order to bring supposedly more realism to the mainstream model. This means that the erroneous foundation of mainstream economics is left unchanged.

Furthermore, since in behavioral economics reason is not the key driver of individuals’ choices, evaluations of goods are not connected to reality. The reason why someone chooses a particular good over another is not much different that the preference scale advocated by popular economics. Does it make sense to discuss the goods individuals choose without also discussing the purpose those goods are meant to serve?

The Misesian Framework of Consumer Choices

According to Mises, the fact that individuals have a certain knowledge about themselves can assist in ascertaining a logically driven choice theory. For instance, one can observe that people engage in a variety of activities. They may perform manual work, drive cars, walk on the street, or eat in restaurants. All activities are conscious and purposeful.

Using that knowledge, we can establish the meaning of individual conduct. Thus, manual work may be a means to earn money which can then be used to achieve various goals like buying food or clothing. Dining in a restaurant can be a means for establishing business relationships. Driving a car may be a means for reaching a particular destination. People operate within a framework of means and ends; they use various means to secure ends.

The assertion that individuals pursue purposeful action implies that causes in economic analysis emanate from human beings and not from outside factors. The knowledge that human action is conscious and purposeful is certain not tentative. Anyone who objects to this contradicts himself, for he is engaging in a purposeful and conscious action to argue that human actions are not conscious and purposeful.

Conclusions derived from this knowledge are valid, and there is no need to subject them to laboratory tests as is done in experimental economics. Something that is certain does not require empirical verification.

Purposeful action implies that individuals assess or evaluate means against their ends. Individuals’ ends set the standard for human valuations and choices. By choosing a particular end, someone also sets a standard of evaluating various means.

For example, If John intends to buy a car, and cars are available on the market, John will specify the specific ends that the car will help him to achieve. For example, John may consider whether he plans to drive long distances or short distances. John’s ends will dictate how he will evaluate various cars. Perhaps, John will conclude that, for short distances, a secondhand car will do the trick. Since an individual’s ends determine the evaluation of means and, thus, his choices, the same good will be valued differently by different individuals.

At any point in time, individuals have numerous ends they wish to achieve. What limits the attainment of various ends is the scarcity of means. Hence, once more means become available, a greater number of ends can be accommodated.

If a preference scale is not hardwired in the human mind, it is futile to conduct experiments to extract this nonexistent scale. Therefore, results obtained from laboratory tests or from questionnaires do not advance our understanding of human action as far as economics is concerned. On the contrary, this kind of thinking prevents the acquisition meaningful knowledge.

Conclusion

By casting doubt on human reason, behavioral economics emphasizes the importance of emotion as the fundamental factor determining human actions. Using psychological analysis, behavioral economists have supposedly demonstrated that individual economic conduct is irrational. Consequently, behavioral economists may have unintentionally laid the foundation for the introduction of government controls that strip citizens of their rights and freedoms to protect them from their own irrational behavior.

Dear Friend,

In the midst of this busy Christmas season, I want to make sure you received our year-end letter from Lew Rockwell.

If you already responded, thank you! But if not, will you take a minute today to make your most generous contribution and support the Mises Institute?

We are all thankful to have the political season of 2022 over, but now the 2024 presidential election looms like a bad moon. The midterms solved nothing and brought no relief to a divided and angry America.

But as a supporter of the Mises Institute, you know a better world is possible.

Democrats are insane and full of hate, doubling down on their every failed idea. Conservatives, for their part, are clueless about money, markets, property, and the crucial need for peace. Democracy itself is a huge failure, despite all the nonsense about our sacred political system.

In the midst of it all, the Mises Institute stands as a beacon of sanity in a politicized world. Please take a moment today to support us.

There is trouble around the globe. But there is tremendous cause for optimism. The Great Pushback (challenging progressivism) and the Great Relocation (voting with your feet) show no signs of slowing. Americans now question control by DC and central banks like never before. The covid and Ukraine narratives are collapsing. A handful of governors are asserting state sovereignty. Businesses and capital exit the crazy states. Momentum for our view grows!

History shows how things can change very quickly. But we need spirited Americans like you to help the Mises Institute reach more people than ever in the New Year.

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Industrial policy is earnestly touted by democrats and conservatives as a tool to rejuvenate the US economy. Some argue that innovation will flounder unless the US applies industrial policy to major sectors. The success of East Asian countries is often cited to bolster the case for industrial policy, however, advocates have been selling a simplistic story.

While it is sometimes noted that there is a correlation between high growth rates and industrial policy investment, this is not the case. During the 1980s, Japan was the poster child for industrial policy, and many feared that failing to embrace industrial policy would relegate the US to second-class status. But these doomsday predictions proved themselves wrong. Instead of eclipsing America, Japan entered a long economic slump.

Rather than propelling economic growth in East Asia, industrial policy was costly and resulted in several failures. In Japan, for example, industries that were abetted by industrial policy failed to become globally competitive. Coal mining received tremendous support from the 1950s to the 1960s, yet it declined from the 1950s to the 1970s. Output fell from fifty-four million metric tons in 1954 to nineteen million metric tons in 1978.

Landmark studies of industrial policy in Japan show that distributing resources was largely a political activity that benefited connected firms and fostered an atmosphere of corruption. Moreover, new research continues to cast doubt on the efficacy of industrial policy in Japan. According to a study by the National Foundation for American Policy, industrial policies had no effect on the productivity of Japan’s most dynamic industries between 1955 and 1990.

The findings reveal that a disproportionate amount of government efforts went to slow-growth and declining industries. Richard Beason, in his review, exposes the defects of industrial policy by pointing out the success of industries that received limited support:

The industries that we associate with Japan during the high growth period, electrical machinery (most of the “tech” sector), general machinery (most capital goods industries) and the transportation equipment sector (which includes autos) were generally toward the bottom in terms of government support between 1955 and 1990. . . . government policy acted as an impediment to the more rapidly growing sectors because such sectors had higher rates of effective taxation than slow growers.

Furthermore, other research on the topic has shown that industrial policy did not alter the sectoral structure of industry or rates of productivity change in East Asian countries. Even without industrial policies, East Asian countries would still experience growth. Like Japan, South Korea is championed as a successful product of industrial policy, but growth rates indicate that the latter experienced more success in decades when government policies were sector neutral.

Arvind Panagariya, in an economic development bulletin, posits that the downsides of industrial policy are usually ignored by proponents:

When critics claim success for industrial targeting, they entirely eschew the discussion of the crucial decade of 1963–1973. Instead, they focus on the following decade, in which Korea did engage in a heavy and chemical industry (HCI) drive. But the growth rate during 1974–1982 actually fell to 6.9 percent. Moreover, toward the end of this period, the economy faced serious macroeconomic instability, culminating in the abandonment of the HCI drive and the restoration of a neutral policy regime. That in turn returned the country to 8.7 percent during 1983–1995.

Although a 2021 paper argues that the labor productivity of targeted industries and regions increased faster than nontargeted ones, over time these gains eroded due to a misallocation of resources. Without an industrial policy, the productivity of targeted industries would have been forty percent higher in 1980. It turns out that creating a favorable business environment is the best industrial policy. If the South Korean government was unsuccessful in removing barriers to exports, South Korea would not have established a thriving beauty industry.

For Taiwan, observers note that in the absence of private capital, public funding initiated commerce. By the 1980s, however, it became evident to policy makers that the benefits of industrial policies came at a considerable cost to the economy. Reviews of industrial policies in Taiwan have shown that they led to the emergence of politically connected interest groups that often resisted innovation and new management techniques.

Yet, despite the data on the deficiencies of industrial policy, many lobby for intervention. In fact, scholars attribute the East Asian miracle to high levels of human capital and market reforms. Industrial policies obviously coincided with the success of East Asian countries, but they were never the cause of prosperity.

Forty years ago, I was worried. I had had the honor of working with Ludwig von Mises. But, not long after his death, the greatest economist and defender of freedom in the twentieth century was being ignored.

Some years before, I had worked for the great Neil McCaffrey at his Arlington House Publishers. One day, I was called into his office and asked, “How’d you like to be Ludwig von Mises’s editor?”

I was to correct and bring back into print three of the great man’s books—Bureaucracy, Theory and History, and Omnipotent Government—and publish his new monograph on the history of the Austrian School.

When the books were published, Leonard Read held a celebratory reception, and I had a private dinner with Ludwig and Margit von Mises. They represented an old and better world.

I was just twenty-four, but I realized what an immense opportunity Neil was giving me. I thanked my boss and told him I was thrilled.

I was working, years later, for a “think tank” in Atlanta. Mises was mentioned occasionally, but there were far too many neoclassicals for me, though I was the number two person. Each day I had to drive past the CDC to get to work! My dad, a surgeon, despised the bureaucrats.

Finally, one day, I looked around and said to myself, “I can do this!”

So, I got to work on the future Mises Institute on weekends and evenings. First, I incorporated the Institute in Washington, DC, a great place, believe it or not, for such things. Then, I applied for 501(c)(3) tax-exempt status. When I got that, I gave my notice to the think tank.

Next, I wrote Mrs. Mises in New York City and asked her to lunch at her favorite restaurant, the Russian Tea Room. There, I told her of my plans and asked her to serve as our chairman. She agreed, but said, “I know you only want my name.”

“No,” I said. “I also want your guidance.” This great lady provided that for almost ten years.

Next, I asked the great Murray Rothbard—the greatest living Austrian economist—to be our academic vice president. We were walking in New York City to meet Neil and Joan McCaffrey at a jazz performance. Murray was so excited by my news that he clapped his hands and jumped in the air.

Another person essential to our success was Burton S. Blumert. He was a famed libertarian coin dealer in California and a man of such intelligence and integrity that people approached him to settle their disputes, and always accepted his advice. On Mrs. Mises’s passing, he became our second chairman. He and Murray also had the greatest senses of humor I have ever encountered.

I wrote everyone on my Rolodex, with good results. Many people loved and admired Mises, and wanted to see his name and ideas carried on into the future.

There was only one sour note. It involved a friend who was executive director of a multibillion-dollar libertarian charity.

When he got my fundraising letter, he phoned and said, “Do you realize how much money we’ve spent to make Hayek the main figure in Austrian economics, and not Mises? Nobody liked Mises,” he said.

“That’s baloney,” I responded, “as even my initial fundraising results show.”

“We’ll oppose everything you do,” he said, and hung up the phone. Some people are scared by such an attack. It only made me work harder.

Of course, Hayek became a member of our board. I didn’t give my friend our greatest news. Dr. Ron Paul, whom I had had the honor of serving as chief of staff for, did something unheard of in fundraising: he signed a letter to his own list, with the money going to the Mises Institute. No question about it. Dr. Paul’s endorsement was essential to our success. He serves on our board today.

As I look back over the past forty years, I have to thank our great donors. Without them, we wouldn’t exist, let alone be an independent organization of worldwide significance.

We would not have been able to do so many things that would make Mises and Rothbard proud, most recently our master’s in Austrian economics. Thanks to our donors, it’s far less expensive than the typical MA.

The Mises Institute is expanding and flourishing as never before. Its scholarly journals, high-level publications in the theory and applications of Austrian economics, serve to expand and develop the truths of Austrian economics. But it also nurtures and encourages new, young Austrians to read and to write for the journal, and finds mature Austrians heretofore isolated and scattered in often lonely academic outposts, stimulating them to write and submit articles. These men and women now know that they are not isolated, that they are part of a large and growing nationwide and even international movement.

In these days of communism on campuses, not all smart students want to go to college, and their parents and grandparents agree. For these students, we’re offering a six-month paid Mises Apprenticeship. We’ll teach these students how to write better, how to start a business, how to give a speech, and other valuable skills.

The Institute’s comprehensive program in Austrian education also includes publishing and distributing books, working papers, and monographs; holding conferences on a variety of important economic topics; and later publishing the conference papers in book form.

Last, but emphatically not least, the Institute sponsors a phenomenally successful weeklong summer conference in the Austrian School, Mises University. This program, which features a remarkable faculty, has attracted the best young minds from the world over.

Since 1995, our robust website has reached students, professors, and businesspeople across the world, through thousands of archived talks and interviews, livestreamed events, weekly podcasts, daily articles, homeschool resources, and free publications for download. Forbes magazine reported that the Mises Institute provides more “presence per dollar” around the world than any other free-market nonprofit organization.

Of course, our faculty and staff are also essential. Thanks to them, we’ve been able to educate thousands and thousands of students, enable others to finish their PhDs, build one of the greatest libraries of its kind, and do much more of lasting significance. We also publish important new books and our magazine, The Austrian. In addition, we hold an annual research conference for professors and advanced students.

We want to keep going. In these leftist and even commie days, our ideas need even more support. Please help.

With your generous tax-deductible donation, you can help build the foundations of liberty for the future. You can help us make sure that we reach all the good students and young professors who are dedicating their lives to freedom, private property, and free markets.

With your help, we are determined to fight and win the intellectual battle. Government cannot defeat ideas, and our ideas are both right and necessary.

Warmest regards,

Llewellyn H. Rockwell, Jr.

Chairman and Founder

PS: We can’t do anything without you. Please contribute as much as you can. The Marxists are on the march, and we must stop them. We have the ideas, but we need to put them into practice. Now more than ever.

[Originally published in the Housing Finance International Journal.]

The 21st century, only 23 years old, has already had two giant, international housing bubbles. It makes one doubt that we are getting any smarter with experience.

Among the countries involved in the second bubble, both the U.S. and Canada fully participated in the newest rampant inflation of house prices. Prices this time reached levels far above those of the last boom peak. In the U.S., the S&P/Case-Shiller National House Price Index by mid-2022 had risen to 67% over its 2006 bubble peak (130% over its 2012 trough). In Canada, the Teranet-National Bank House Price Index had soared to 143% over its 2008 peak (168% over its 2009 trough). What the Federal Reserve and the Bank of Canada both wrought with their hyper-low interest rate policies, were house prices which would be unaffordable as soon as mortgage interest rates returned to more normal levels. For a number of years, one could ask: When would that ever happen? Now we know: in 2022.

Now, in late 2022, with mortgage interest rates higher, housing bubbles are deflating, and house prices are dropping on a nationwide basis in both the U.S. and Canada. Here we go again into another house price fizzle following another house price boom.

How is it that we could find ourselves caught up in the problems of another housing bubble so soon? It is only ten years since 2012, the year house prices stopped falling in the U.S., and formed the trough of the painful bust which had followed the preceding bubble of 1999- 2006. Up to the point when house prices started falling across the U.S. last time, expert voices pronounced that U.S. house prices could fall on a regional basis, as they had numerous times, but that it was not possible for house prices to fall on a national basis in an economy so large and diversified. That theory could not have been more mistaken, and national average house prices fell 27%. In 2022, the theory is again being shown to be wrong, but how big the fall will be this time is not known or knowable.

We can take as a key ironic lesson that when large numbers of people believe house prices cannot fall, especially when they are emboldened by central bank behavior, it makes it more probable, and finally makes it certain, that the prices will ultimately fall. When they do, what had been built into everybody’s financial models as “HPA,” or “House Price Appreciation,” becomes instead “HPD”— “House Price Depreciation.” It would be better all along to refer to it as “HPC,” or “House Price Change,” thus reminding ourselves that prices of any asset can go both up and down, perhaps by a lot.

Ten years, it seems, is long enough to dim the memories that prices can move dramatically in both directions, even on a nationwide basis. A bubble market when extended for years makes a great many people happy, since they are making money and seem to be growing richer, and the higher their leverage, the faster they seem to be growing richer. As the great financial observer Walter Bagehot wrote 150 years ago, “the times of too high price” mean “almost everything will be believed for a little while.”

Then the reversal comes and different beliefs come to prevail. In just four months, from June to October 2022, U.S. median house prices dropped a remarkable 8.4%, with prices declining from their peak in all 60 of the largest metropolitan areas in the country. In October, sales of existing houses declined for the ninth month in a row, and were down 28% from a year earlier. Applications for a mortgage to buy a house were down 42% from the year before. Mortgage banks reported they were on average losing money on mortgage originations and many were laying off staff. The share price of 2021’s largest mortgage bank, Rocket Companies, was down 70% from its 2021 high. The CEO of the National Association of Home Builders stated, “We’re heading into a housing recession.”

In Canada, average house prices fell 7.7% from May to October, the largest five-month drop in the history of the Teranet index, which goes back to 1997. In Toronto, the country’s financial capital and a former star of rapid house price inflation, the May to October house price drop was a vertiginous 11.9%. Successive headlines in monthly Teranet-National Bank House Price Index announcements read: “Record price drop in August”; “Another record monthly decline in September”; “Another monthly decline in October.”

In spite of these rapid percentage rates of decline, house prices in both countries are still at very high levels. How much further can they fall from here? For the U.S., the Federal Reserve carefully stated in its latest Financial Stability Report, “With valuations at high levels, house prices could be particularly sensitive to shocks.” Coming to specifics, the AEI Housing Center predicts a 10%-15% nationalaverage fall in house prices during 2023. That would wipe out a lot of housing wealth that the bubble made people think they had, a reduction of perhaps $4 or $5 trillion of perceived wealth on top of the $3 trillion lost so far this year. It would put many houses bought near the top of the market, especially under government low- down payment programs, into no or negative owner’s equity.

For Canada, the Wall Street Journal suggested that its housing market is “particularly sensitive to monetary tightening,” and reported that Oxford Analytics “estimates that home prices in Canada could fall 30%.”

Recall that a price has no substantive reality: it is an intersection of human expectations, actions, hopes and fears. I like to ask audiences, “How much can the price of an asset change?” My proposed answer: “More than you think.”

Of course, nobody, including the Federal Reserve and the Bank of Canada, knows just where house prices will go, but we can all guess. Noted economist Gary Shilling wrote in November, “Price declines are just starting,” and “recent weakness probably has far to go.” This seems to me likely.

In any case, the second great housing bubble of this still young century is over and a new phase has begun.