THE STOCK MARKET tumbles of recent months are a reminder that when it comes to economic phenomena, subjectivism reigns. One of the pillars of the Austrian school of economics is the principle that in explaining economic events, objective entities and quantities in themselves dont count. What counts is what human beings make of them.
As F.A. Hayek wrote, It is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism. Up to the time of Carl Menger, founder of the Austrian school in the late 19th century, much of classical economics was preoccupied with what was regarded as objective, wealth for example, which purportedly existed apart from human plans and purposes. Menger put acting, valuing man at the center of economic study. For Menger, understanding economic phenomena meant seeing them through the eyes of the relevant actors.
Subjectivism in economics should not be confused with subjectivism in philosophy. Philosophy attempts to discover ultimate truths about reality and the means by which we learn them. Economics studies the unintended consequences arising from exchange. Subjectivism in philosophy holds that truth in metaphysics and the good in ethics are determined by individuals or groups, making these ultimately arbitrary. Subjectivism in economics means that human choice is what drives the economy. This should be uncontroversial, but it has been a source of confusion, even among some libertarians.
The major Austrian theorists have distinguished the hard sciences from the social sciences; they kept subjectivism in its proper place. Hayek noted:
Not all the disciplines of knowledge which are concerned with the life of men in groups, however, raise problems which differ in any important respect from those of the natural sciences. The spread of contagious diseases is evidently a problem closely connected with the life of man in society and yet its study has none of the special characteristics of the social sciences in the narrower sense of the term.
Likewise, Hayek wrote, the disciplines that focus on heredity, nutrition, demography, and parts of anthropology also qualify as natural sciences.
The social sciences in the narrower sense, that is, those which used to be d escribed as the moral sciences, are concerned with mans conscious or reflected action, actions where a person can be said to choose between various courses open to him, and here the situation is essentially different.
What makes the social sciences different from other disciplines is that we know the entities from the inside. When we study acting beings, we do so as acting beings. When we study subatomic particles, atoms, molecules, microbes, nonhuman animals, planets, and galaxies, we stand apart from the objects of our study. We may observe, form hypotheses, gather data, conduct tests, and draw conclusions. But when we study the consequences of human choice, we can do more. As acting beings we are equipped with a good deal of knowledge, thanks to introspection.
For Ludwig von Mises, a Kantian in epistemology, this made the study of human action (praxeology) synthetic a priori. Murray Rothbard, reformulating Misess method through an Aristotelian prism, called the certainties of human action broadly empirical on the grounds that introspection qualifies as experience. In either case, we can possess certain undeniable, self-evident truths about human action precisely because we are acting beings.
A human being acts to bring about a state of affairs that he believes he will prefer to the one that would obtain if he did something else or nothing at all. This uncontroversial statement contains a wealth of implications.
First, a persons preference for that state of affairs and the intensity of that preference are personal matters, stemming from his particular rich context. What one person abandons is often picked up by another, Menger wrote.
Second, embarking on an action entails the comparison of unexperienced future states of satisfaction; the cost of any action is the top-ranked alternative left unchosen. This opportunity cost is obviously subjective and not observable by anyone. The actor himself does not know precisely what he gives up in quest of his chosen objective, since he makes his decision on the basis of anticipated future states of satisfaction. Considering the uncertainty of the future, his projections might be mistaken. No one knows for sure what was down the road not taken.
Third, all action reaches into the future. Strictly speaking, the consequences of no action are instantaneous. The delay between action and consequences may be brief, but it exists nonetheless.
Fourth, the future is uncertain. The time between act and expected consequences holds the possibility of the unexpected, which can change the consequences or nullify them entirely. In Human Action Mises quotes the adage, Theres many a slip twixt cup and lip. At any moment, a persons knowledge is incomplete, and the gaps leave his plans open to being thwarted. With different or fuller knowledge, he might have chosen differently.
All of this has clear application to the stock market. Fallible people buy stock in a company in anticipation of future gains superior to what they might obtain in other ways. They do so on the basis of expectations about the company, what they guess other peoples expectations are, and other considerations, for example, interest rates and government policy.
A change in any of the elements can change an investors outlook on the future and prompt him to adjust his course. Thus if the release of a rising consumer price index summons fears of a Federal Reserve hike in an interest rate, the investor may revise his plans and sell his shares in a particular company.
Or if a high-tech company is threatened with dismemberment by a judge after an antitrust conviction, the investor, fearing the consequences for the high-tech sector and perhaps more antitrust action, may dump his high-tech stocks and turn to more traditional companies.
Many investors may read these events in essentially the same way, creating a bear market. The beginning of a downturn can stimulate others to sell also.
On the other hand, investors with optimistic expectations may mitigate or offset the effects created by pessimists.
The upshot is that the stock market and what is said about it are not a science in the hard sense of the word. The market depends on the necessarily imperfect judgment of human beings. When cable TV commentators scoff that a company is worth only what people think its worth, they are right, of course; but they mistakenly imply that there is a better way to make such determinations. There is no better way. Any other method would turn the market process from the course it naturally follows: serving consumers.
In a market economy consumers endow objects with value, then, following Mengers key principle, value flows from those objects back to the factors of their production. A factor has value only insofar as it contributes to the production of things that consumers value.
This is true no matter how remote from the final product a factor may be. There is no other source from which a factor can derive value. The value of a corporations shares depends on that corporations ability to produce goods or services that satisfy consumers. If anything, internal or external, prompts investors to doubt that ability, the stock price will soon reflect that doubt.
When it comes to causes of distress, people always want to know, What can the government do? Heres what it can do: it can stop creating uncertainty. The world is uncertain enough. The last thing we need is fiscal, monetary, and regulatory authorities with fluid policies. One of the virtues of a regime of property rights is that it eliminates most, if not all, policy fluidity and discretion at the macroeconomic level. This is yet another reason for abolition of the income tax, full deregulation, and the privatization of money.