Economic Analysis and Value Judgment

Chapter 3, Section 6: Economic Analysis and Value Judgment

As is said, the criteria of competitions determine the economic operation of a society. Among all the discussions on "criteria", some belong to economic analysis, while the others are actually about subjective or ethic problems, and thus have nothing to do with objective analysis. The two must be clearly distinguished.

As we all know, under different victor criteria, the winners or losers would usually shift. Therefore, some people prefer one criterion, while some others prefer another. Such preferences fit into the scope of economics. Take examination as an example, some students prefer essay questions as they are good at argument, while some others require multiple choice questions so they have a better chance of winning. All individual choice behaviors are the objects of economic analysis.

Yet which criterion is better, or how a criterion benefits social welfare, are problems of ethics or value judgment, and irrelevant to objective analysis. For example, as I've stated, taking market price as the victor criterion doesn't waste, because that would lead to increased production, while the other criteria all have certain level of waste. However, I never say increased production is good or waste bad. What's good or bad can only be decided by personal value judgment, or only God knows. (Translator: The distinction is fairly easy: ethics or value judgment seeks a unified standard of "better", a "better" that's gonna apply to at least one more person besides oneself, while analysis of economics doesn't.)

Previously the people's communes of China led Chinese people to the edge of starvation, why was it so is a problem for economic analysis, but whether living on the edge of starvation is good or bad, is then a subjective judgment. Economics can explain human behaviors, and can inform us under which constraints people would become living on the edge of starvation, but it doesn't judge right or wrong. By "no judgment", I mean economics doesn't do that, and don't mean economists don't do that. Never forget that, economists are also human and thus have their own value judgment. If I say hunger and cold is bad, that's a subjective assertion, from the standpoint of a human, instead of objective economic analysis. I certainly have the right to make such a subjective judgment, as I have a human's rights, but this right never requires any training in economics.

I can express my value judgment, and the others can express theirs as well, but whose is better, only God knows. Expression of value judgment doesn't require any prior training of analysis. You think blue is good-looking, while I say red, then who can make a decision that satisfies both of us?  You deem government's support of education good, while I think it's bad, then we aren't gonna be able to reach any conclusion even after hundreds of years of argument. That's because the views of good or bad, love or hate, cannot be objectively agreed upon via scientific analysis.

If I say hunger and cold is not good but bad, many would agree. That's just because most (almost all) of us don't like themselves to be in hunger and cold. People agree because they have the same value judgment, instead of because there exists an objective analysis for that. Economics can explain why people would be in hunger and cold, or with the support from government what would happen to education, but it never judges good or wrong.

As is mentioned, economists are also human and thus have their value judgments. Yet, when doing analysis, they may intentionally or unintentionally bring in their value expressions about certain effect is good or bad. Objective analysis and subjective judgment can appear together. It's no big deal, although sometimes the readers or listeners may get confused. What's really important is, people dealing with economic analysis must separate subjective and objective distinctly, and never allow subjective judgment interfere with objective analysis. That's to say, if an economist twists his analysis intentionally or unintentionally because he deems government  support to education good, so that the analysis breaks away from logical norms, then that'd be an inexcusable mistake in science.

Sometimes economists may haven't say anything about good or bad, yet outsiders think they have. For instance, I've said market price can promote production, and many readers think I deem market price as a good criterion, which I have never said. The readers think I did, because themselves think production increase is good. Of course, when writing for newspapers, to avoid dullness, I sometimes make my judgments of good or bad. Nevertheless the focus of this book is objective economic explanation.

Some readers think I believe in and have special preference to market. I do trust in the capabilities of market, while I also know there are things that the market is incapable of. Yet my personal value judgment is against market, and I hate communist system as well, because I can hardly stand out under either of the two. What I really prefer, is to allocate social wealth according to study and exams, as I am really distinguished under any exam criterion. It's really sad, that nowhere of this world allocates wealth or beauties via exams. (Only God knows, the imperial examination system in old China did effect wealth allocation, but I guess I shall never have my chance to win!)

Criteria of Competitions

Chapter 3, Section 5: Criteria of Competitions

In an athletic game, it's the running speed that decides who wins. So speed is the victor criterion. But if the game has no rules to define what behaviors are prohibited, the criterion of speed would no longer function. Similarly, without game rules, the weight criterion in weightlifting wouldn't function as well. Chess games are won by intelligence; billiards are won by vision, techniques and hand control — all these criteria are guaranteed by respective game rules.

So is it for economic competitions. In a free market, the one offering the highest price wins, so price becomes the victor criterion. The game rules that give rise to this criterion are the private property rights system, which is the core of Coase and Alchian's thoughts.

For a long time, price analysis in economics had focused on how price is determined. Once the concept of price came into Alchian's hands, it gained a new life. He asserted: "what a price determines is far more important than how the price is determined!" This one sentence suffices to advance our knowledge of the world. Price is a victor criterion, while private property rights system is the set of game rules that lead to this criterion. That Coase and Alchian are honored as the founders of property rights economics, is because each has said some alike enlightening words.

Game rules and victor criteria are directly connected: the former determines the latter, and the latter determines the economic operation of a society. An interesting question is, was the birth of some game rules due to people's need of a certain criterion, or did people's need of certain game rules inevitably lead to the emergence of a victor criterion? At first sight, it's hard to tell which came earlier.

I think first came a criterion and then the game rules. Why? It's because a victor criterion settles the problem people need to solve via competition, while the game rules only assist the functioning of the criterion. Speed is the core of an athletic game, and the rules of this game only assist in judging who is really faster. School's score criterion of examinations is used to verify whether the students have put in efforts in their study, while the exam rules just fairly ensure the one with better knowledge can win. Price no only decides the victor, but also implies the one with higher productivity wins, while the private property rights system plays only an auxiliary role. You students shall be able to have a better understanding of this relationship after reading my analysis of rent dissipation in Volume 3. (Translator: It's fairly easy to understand that the price criterion came earlier. Exchange can occur without any property rights system, because on one hand both participants would benefit, and on the other hand the characteristic of information serves as a protection when there is no such from a law system. For example, you have something useful and hide it, then it's nearly impossible for the others to know you have it if you don't signal them, not to mention to know where it's hidden. With the assistance of a property rights system, exchanges just occur more frequently.)

As mentioned above, victor criteria determine the economic operation of a society. On one hand, the distribution of wealth or income of social members are decided by competition criteria. Criteria have many types, and under different criteria, the chance to win for a same person varies. For the people that are good at business running or goods production, the victor criterion of private property rights is the most helpful. For some others that have superb political tactics, non-private property system suits them the best. There are still some others that don't know how to cope with the operation of a frequent-changing market but can work honestly and industriously, then seniority would be the top criterion.

On the other hand, because victor criteria decide people's income and enjoyment, under different criteria their behaviors would change accordingly. Take price as an example. To gain profit in a market, one has to work hard, or invent new products, or formulate efficient management, or search for information that reduces cost, etc. But without the price criterion and incomes are allocated by rationing, competition participants would then choose "back-door dealings", or play political tactics, or try to become an official, etc.

Here the adage "criteria determine the operation of social economy" can be illustrated by two real cases on housing allocation in Hong Kong. As is known to all, the free market of housing properties in Hong Kong takes price as its victor criterion. Those that can and are willing to offer high enough a price or rent, can purchase or rent the housing they like for personal use. No matter how old, how beautiful, how skilled in political tactics, or how learned one is, he can't take the benefit if not paying the necessary price.

But within the University of Hong Kong (HKU), teacher housing is allocated according to points. Being a department chairman is 6 points, being married is 6 points, having one child is 6 points, having two is 12 points, one year of working is 2 points and eight years would then be 16 points. The total points is the criterion used to determine the order of housing allocation and the size allocated. It doesn't matter how learned a teacher is or what level his research has achieved. No enough points, no chance of winning an allocation.

As a matter of fact, the point criterion used for housing allocation in the University of Hong Kong is very close to that used for allocating housing to cadres at the early stage of China's reform, they are almost identical. The reason is, the constraints HKU has and China's state-owned property system share many similarities. The housing properties of HKU are not private but public, or government-owned. From the perspective of property rights, the mechanism employed by HKU actually belongs to a "shared property rights" system, in which the allocation of housing has nothing to do with market price. The difference between HKU and past mainland China is that the "shared property rights" system in HKU only works for the matters of the university, while that of past mainland China was generalized and spread to the entire nation.

From above two cases about the housing allocations in the market and HKU, we can easily see, under different victor criteria the winners are different. A man with sharp eyes in business wouldn't make any difference at HKU, while one with many children wouldn't enjoy any priority in the market. If we go deeper, we can know, under different criteria people's behaviors differ, therefore the efficiency of production would be different as well. The criterion used by HKU in housing allocation encourages more children, early marriage, and long term service to the university. The higher price criterion, instead, encourages hardworking, cost reduction, and saving, etc.

In economics the concept "waste" is not simple. Only until Volume 2 will we have a deep discussion about it. Here I only introduce the waste concept that appears in common books but is actually not quite right. Generally speaking, waste means there are other approaches, or allocations of resource usage,  that can increase the wealth or income of a society, but due to certain reasons these approaches haven't been taken.

According to the above definition, among all countless competition criteria, only one has no waste. This only one is market price. Several examples can illustrate the point. Queuing up to make purchase, which takes first-come first-served as criterion,  need pay the cost of time. As the time is used for standing and waiting instead of production, that generates no benefit for anybody, so the value of the time is wasted.

Another example, let's get back to the point criterion for HKU's housing allocation mentioned above: a teacher at HKU can get more points by giving birth to more children or teaching longer. Then at some hesitation point (so-called "marginal"), to give birth to more children or to seek an alternative employment, would be decided by the consideration of earning better housing points. If someone doesn't plan to have that many children but gives birth to them as well, that's a waste, because the housing points doesn't mean anything about product value, yet the decisions of giving birth to more children are right "coerced" by increasing his points.

Using age as a competition criterion would encourage people to misrepresent their ages, even that costs a lot of money and energy, or to idle their time away and crave for a speeded aging. In a society that strong prey on weak, force is the victor criterion and thus investments in weaponry are strongly encouraged. Many years ago, gold mines were discovered in frozen Alaska, and a game rule was set up among competitors that the one winning the speed contest to a gold mine, would be entitled the privilege to mine gold for a day at right that gold mine. Because of the rule, people poured money on their sled dogs to make them as strong as possible. All these behaviors are wasteful.

The only unwasteful criterion of competition is, market price. That higher price wins is the only criterion that makes people work harder to exchange for what they need. To work harder for money means a better chance of winning a competition, while this additional work is beneficial to the society. So market price doesn't lead to waste.

All above "waste" opinions were deemed by me since the early 70s as rent dissipations, because characteristically they are the same as the rent dissipation of fishing on high seas. In fact, when writing the Theory of Share Tenancy in 1967, I had already had a similar idea in Chapter 6, Section 4. I've spent about forty years on these complex, important, and interesting analyses, and will have them detailed in Volume 3.

Game Rules and Property Rights Systems

Chapter 3, Section 4: Game Rules and Property Rights Systems

Like any sports, the competition aroused by scarcity also has its game rules. No game rules, no way to judge who wins. No winner, then no need to compete. Athletics has rules, so does tennis. Without the rules, victory or defeat cannot be decided. Even in the competition that strong prey on weak, there is a rule that winner lives and loser dies.

From the perspective of economics, the game rules for daily man vs. man competitions are laws, disciplines, customs, and etc. Just like the ones in sports games, these rules regulate and prohibit participants' certain behaviors during competition. That's to say, in social economic competitions, laws, disciplines, or customs, whichever it is has a mandatory method to define individuals' rights. Such definitions of rights form the property rights systems. In Volume 3 I will explain that, an arrangement to constrain competition is actually a contract arrangement, which is another angle to view the property rights systems.

(Translator: The ultimate game rule for competition is always violence. Although individuals have almost the same natural capabilities, the formation of collectives, or societies, brings about every possibility. Two shall triumph one, yet three may lose to two. With the development of motion and communication technologies, the distribution of violence converges towards monopolization, where individual's violence is negligible before the monopoly, no matter it's a democratic legal system or an autocratic military government. Soft violences, like credit discrimination or cooperated isolation that appears in disciplines or customs, rely on the violence monopoly as well, for example, a bad credited person cannot revenge the people that don't trust him, as he would get punished by a legal system. Upcoming discussions are all based on a monopolized utilization of violence.)

The systems of property rights are the game rules for competition, and a type of constraints on competitive behaviors as well. If discriminated cautiously, these rules are actually quite different. Private property rights is just one of it. It's even possible to classify all the systems into several categories and systematically analyze how the variation of each category would affect human behaviors. As are the contents of institutional economics, they will be detailed in Volume 3.

The word "property" is not simple. From the perspective of economics, property is economic good with human competition, which is slightly different from its legal definition. Legally, property usually means assets (especially lands and buildings); yet in economics, other than assets, it includes consumables as well. What consumables have in common with lands and buildings, is that they both are scarce and competitive.

Alchian made it perfectly that "property", competition, and scarcity, are indeed synonymous. Readers must spend more time pondering on this "synonymy" until they fully understand in our society competition is ubiquitous. Without grasping this general concept of competition, one can never achieve anything in economics.

Essence of Competition

Chapter 3, Section 3: Essence of Competition

The desert island that Robinson once lived on is a one-man world, there competition doesn't exist. Although there'd be animals to compete with Robinson for food, there is no man vs. man competition there. In economics competition means the one between man and man — all postulates of economics are for man and most behaviors that economics explains are competition behaviors.

In Robinson's one-man world, there exist free goods, and economic goods as well. To get more of an economic good, Robinson must pay certain sacrifice. To eat one more fish, he need cut rest time; to collect more wood for fire, he need reduce apple planting; eating more wheat this year means eating less next year. In a word, on the island, Robinson faces short supply, not everything is free good and sacrifice is required, therefore like us he need choose among options. The only difference is: there is no man vs. man competition for Robinson.

In that one-man world, economics is fairly easy. We can use economics to explain Robinson's behaviors, and the whole explanation, if simplified, won't last more than two or three hours — for a thorough analysis two or three days would be surely enough. Just imagine, in Robinson's one-man world, there is no market, no price, no currency, inflation, or unemployment, and no law, police, or politics, not to mention arms, intermediary, contract or institution. Without these, economics can't be any deeper.

So the complexity and profundity of economics is all because one more man entered the one-man world. When there are two or more people in a world, they become a society — this is the clearest definition of "society". The joys of economics all stem from the existence of such "societies". We could even say: more than ninety nine percent of the complexity of economics is because we live in a world of more than one man.

Let's keep moving our reasoning on. An economic good must be better more than less. In a society, when one wants more of the good, others may want more as well. When monks are many and the gruel is meager, competition is inevitable. Competition is defined as more than one person demands an economic good. In the society we now live in, such goods are everywhere. Free goods, like fresh air, do exist, but the number is getting fewer and fewer.

In a society, economic good without competition is not easy to find. In principle, in a society an economic good doesn't have to be under competition, but examples are so few that one may need rack his brain to identify just one or two. More than sixty years ago I was attending the Wan Chai College in Hong Kong, fellow students then liked to fetch a cinema-issued brochure, called "show bridge", that briefed the story on show, when they entered a cinema. Because many students collected the brochures enthusiastically, old (out of date) "show bridges" became scarce and started to have price, some hard to get were even traded for several Hong Kong dollars. At the time several dollars meant one week's pocket money for me. Old "show bridges" became an economic good and had competition. After several years, the hobbies for collecting "show bridges" vanished, and students started to dislike and throw them away. But there was this student named Ting who loved "show bridges" so heavily that he didn't stop his collection. So for this weird student, old "show bridges" were an economic good (better more than less) but had no competition. This is one rare case that I know when an economic good has no competition. Time changes, today cinemas in Hong Kong don't issue such "show bridges" any more. I haven't met the student named Ting for fifty years, don't know how his piles of "show bridges" would eventually become.

In a society, nearly every economic good has competition. And the competition keeps going day after day. As everyone of us has been having competitions from morning to night and from young to old, we might be so accustomed that we don't even notice they are actually everywhere. The breakfast we eat is won through competition, as when one eats more someone else must eat less. In each competition someone "gains" and the other "loses" (Translator: quantitatively). Breakfast is so, lunch is, the bed for sleeping is, taking transit bus, going to school, sunbathing on the beach, watching TV at home, etc., all of them are!

So to speak, in a society we can hardly find a behavior without competition behind. "No competition", from the viewpoint of strict economics, can rarely be justified. Some unintelligible economic textbooks, when talking about monopoly and patent right, assert there'd be no competition. Yet the real fact is, monopoly and patent right only suppress one type of competition, some other type is surely enhanced at the same time, though. For example, people may strive for monopoly or patent right during competition, yet in a monopolized (or patented) market, they can still compete through similar or substitutable products for profit.

In a society without market, competitions are all around either, and they just take different forms. That strong prey on weak is competition, power struggle is, back-door dealing, seniority ranking, stratum privileges, etc., they all are forms of competition. The principle is quite clear: any time more than one person demands the same economic good, there exists competition.

What is Scarcity

Chapter 3, Section 2: What is Scarcity

"Better more than less" is how economic goods are defined, and that defines "scarcity" as well. That's saying, all economic goods are scarce and insufficient. What then does "insufficient" mean? If the breeze from a river and bright moon in mountains are, like Su Dongpo the Poet said, inexhaustible, they are sufficient (Translator: the poet lived almost 1000 years ago). In that way, they can only be free goods — although in today's real world breezes and bright moon are no longer easy to get and thus have become economic goods. Strictly speaking, "insufficiency" doesn't have to be linked with the quantity supplied. For example, there are more good eggs than bad ones, yet good ones are insufficient and bad ones are excessive. Good eggs are greatly needed and thus insufficient; bad ones are disliked by everyone, so even a few are already excessive.

If a good is not demanded, there'd be no "better some than none" for it; and if supply of the good is not insufficient, there'd be no "better more than less". So "scarcity" happens only when a good is demanded and its supply insufficient. When demand increases, more supply (still limited) remains scarce; if demand decreases, limited supply may become abundant. That's to say, scarcity is determined relative to demand.

A scarce item — an economic good — is something whose supply cannot meet people's demand. So the item is better more than less. As it's better more than less, if one wants more of it, he must pay a certain sacrifice. If nobody is willing to pay a sacrifice for more of the item, it cannot be counted better more than less, which is logically inarguable. Therefore, any item, that there is someone willing to pay a sacrifice for more of it, is scarce and insufficient, thus an economic good. On the market, the sacrifice we need pay is price. So we can conclude anything that has a price is scarce and insufficient. In some societies — like extreme communist society — there is no such a market and thus no price for a good, but sacrifice doesn't vanish. Therefore we have another assertion: an item without a price can possibly be economic good as well, and scarce of course — as is scarce (people want more), some sacrifice is inevitable.

Definition of Goods

Chapter 3: Scarcity and Competition

To explain behaviors with a theory, the theory must install constraints to those behaviors — this is a basic principle. The methods of economic explanation are the same as those of any other empirical science: on one hand, we have some general postulates, axioms or laws; on the other hand, we install test conditions or circumstances that constrain behaviors. With both of them, we can imply under certain conditions how people would behave; and when the conditions vary, the behaviors change as well. To be refutable, the implication must be definite — if not definite, how can it be "wrong" or refuted? When someone has these constraints well mastered, the applications of them would be at his will, and the implications can be stunningly accurate.

In Chapter 2 we talked about two postulates: (1) any behavior of a individual is by his choice, and the choice is predictable; (2) under constraints every individual always maximizes his self-interest. Other than these, we have some other constraining postulates and will analyze them in Chapter 4 and 5. At this point we need interrupt the topic, as scarcity and competition, two indispensable concepts in economics, require explanation first.

Chapter 3, Section 1: Definition of Goods

The word "goods" has many meanings. In addition to be interpreted as product or commodity, it can represent service, friendship, reputation, air, cleanness, serenity, lover, love, and etc as well. Everything better some than none, no matter tangible or not, is a good — "better some than none" is the economics definition of goods. From each individual's point of view, biological children, breeze from a river, or bright moon in mountains, are all "better some than none"; beautiful face, credible reputation, pleasant voice, sweet memory, ability of thinking, etc., are all goods.

Goods have two categories: one is economic goods; and the other is free

goods. In all the goods that are defined as better some than none, a major part are better more than less. "Better more than less" is how economic goods are defined. In such a definition, "better" shall be objective. Suppose we split 250 grams of gold into two shares, one 100 grams and the other 150 grams, and let people choose, if the 150 gram share is chosen, gold is then an economic good. The chosen share of a comparison always means better, and it doesn't matter whether the share is really beneficial or not. Therefore, here "better" has nothing to do with subjective or value judgment.

Better more than less are economic goods and they are countless in this world. Gold and silver, grapes and wine, abalones and shark fins, fruits and vegetables, clothings, foods, houses and cars, tours and rests, family love, etc., are all economic goods, as each meets better more than less.

Among all goods, a minor part are better some than none but not better more than less, as the supply of them exceeds demand, and any addition makes no use. Goods like this are not plenty, among them air is the most frequently cited one. In areas where air is freshing, the supply of air is unlimited, and nobody would strive for more than needed. Although air is necessary for man, it's only better some than none and not better more than less. Air is therefore a free good instead of a economic good. But when an area is crowded and the air there is stale, the need of more fresh air becomes realistic. Under this circumstance, fresh air is no longer a free good, it's now an economic good.

Conclusion on Selfishness

Chapter 2, Section 5: Conclusion on Selfishness

Although there are reasons that we shall believe selfish is human nature and unmodifiable, yet from the perspective of economic science this really doesn't matter. What's important is selfishness is treated as a postulate and we shall not argue on that starting point. Whether such a treatment is viable in explaining human behaviors, depends on whether the refutable implications derived under this constraint together with some others can pass the tests against facts. In this game of scientific dialectics, we cannot deem human selfish sometimes while not the other times, because that would mean we cannot derive any refutable implications.

Handled in this way, the postulate of selfishness does exhibit amazing explanation power. Probably in the future some genius may propose another one that replaces selfishness but functions better. As of today we haven't had such a thing, so the postulate of selfishness still has to be sticked to. This is not stubborn, it's just some rule of scientific methodology that we need follow.

If human nature is selfish (yes or no only God knows) and can't change, then should any ism be based on human selfishness can be modified, its system and policies would definitely fail. It's the experience of past China. Nowadays in this world, believers of such a selflessness become fewer and fewer, yet they still usually get exploited by some selfish guys for strengthening the latter's power and interest.

There's another important question, which is: if human's selfish nature could be modified, and the modifier omnipotent, what would he change human into? To say that nature modifiable doesn't tell us what man should be. Like a melon and cabbage? Like a computer? Or Frankenstein? I don't know what the readers would think of it. I just intuitively feel that a man as selfless as an angel would actually look more frightening than a selfish one.

In Chinese cultural tradition, the word "private" ("si" in Chinese) never means anything good: to carry something and escape privately (xie dai si tao), to give and take privately (si xiang shou shou), to seek private interest only (zi si zi li), etc., are all belittling usage of "private". After thirty years of reform and open-up, great progresses have been achieved in mainland China, yet private enterprises are intentionally called "citizen" enterprises, where the usage of "private" is avoided. How about in the western world? There "private" is respected. Why there is such a big difference between the two is elusive to me. For the translation of "private" into Chinese, by no means can I find any other except for "si". As is said, the selfishness here only means "to seek maximum private interest under certain constraints", which, as a postulate, has nothing to do with personal value at all.

Human's Selfish Nature

Chapter 2, Section 4: Human's Selfish Nature

From the perspective of history of economic thoughts, "selfishness" became a postulate only after the rise of neoclassical economics in the late nineteen century. In this newly emerged field, wide application of calculus from mathematics gave birth to marginal analysis, and made the concepts of maximization and minimization well accepted. That human act to fulfill selfish desires then became the postulate "under constraints individual maximizes self-interest" — or minimizes cost. The simple call of "selfish" is just a convenient saying.

After the rise of neoclassical economics, this branch of learning about human behaviors became scientific and professionals in the field started to view "selfishness" as an objective postulate. After that, whether human nature is really selfish or not doesn't matter any more. Of course, today many economic scholars still don't discriminate personal value and scientific dialectics very well, and confuse emotion and analysis heavily. On the other hand, connection of personal value or subjective judgment with objective analysis can sometimes perfect economics stunningly. Virtuosos of classical economics such as A. Smith, D. Ricardo and J. S. Mill had such  simple and sincere a personal value that's worth being admired and followed.

So it's correct, that the scientific postulate of "selfishness" we are using today came from the subjective judgments of past worthies. In Smith's classic Wealth of Nations published in 1776, the two paragraphs on selfish behaviors and market operation are the most popularly quoted sayings in economics. I have read them again and again, every time I ruminate I can gain new enlightenment and feel the heaviness within. He wrote: 

"Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favor, and shew them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher the brewer, or the baker that we expect our dinner, but from their regard to their own interest ...

"Every individual, therefore, endeavors as much as he can, to employ his capital in the support of self-interest maybe of the greatest value. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security and his own gain; and he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it."

After years of digestion of Wealth of Nations, I think Smith's view on "selfish" requires supplementation from two aspects. First, though Smith correctly pointed out selfish can promote effectually the public interest, he overlooked the harm that selfish can as well bring to the society. The latter plays importantly in the problems of transaction cost and property right, which have been the focus of my research. Philosophically, emphasis on the harm is the main difference between my Economic Explanations and the Wealth of Nations, so to say. However, my major conclusions, instead of discrediting Mr. Smith, have strongly reinforced him. Nevertheless, as I have a better understanding of selfishness, my explanations on behaviors shall be superior.

Second, Smith failed to indicate selfish is human nature. In his view, selfish is compelled: it's not someone desired, people just have to be selfish. This "survival of the fittest" viewpoint — many problems in Wealth of Nations were viewed in this way — subsequently influenced C. Darwin's (1809-1882) shattering work, On the Origin of Species.

My teacher Alchian published an important paper, Uncertainty, Evolution and Economic Theory, in 1950 and it ignited a massive debate on scientific methodologies that spanned for nearly two decades. The "idiots and gas stations" example I gave in Chapter 1, Section 4 was inspired by that paper.

Alchian's view shared some similarity with Smith's, but the former came much fiercer. Smith meant selfish is for survival; Alchian asserted it doesn't matter whether idiots are selfish or not, because after elimination the behaviors of left idiots inevitably accord with those when they are. (Translator: Alchian's assertion must be based on there is at least one selfish individual in the society. In fact, his result was just extrapolated from the dynamic view point of a society as an interaction system, where the selfishness of selfish people, if not all, is a sufficient driving force.)

In 1976, biologist R. Dawkins published The Sellish Gene. In that book he cited various examples and proved that selfish is innate in animals, inherited and unchangeable. The book gave rise to a new branch of learning — bioeconomics. Another teacher, J. Hirshleifer, of mine is an advocate of this new learning. More than a decade ago he wrote to me and said the learning was gonna have a bright future.

To be concluded, there are four views in "selfish". Smith thought it's compelled; Alchian always took selfish as a postulate, though, he asserted idiots would bring the same result; Dawkins took it inherited. I don't have any invention about selfishness myself, and just think a theory the simpler the better. My choice is to view selfish as a postulate of constrained maximization, a tradition from neoclassical economics. Once constraints are properly handled, explanation power won't be less.

Individual is Selfish

Chapter 2, Section 3: Individual is Selfish

That individual makes predictable choices — the first postulate of economics — is already a constraint. But it's not enough, and we need install other important ones as well. Here a second postulate is: any behavior of a individual is selfish. That's saying, under constraints, the individual acts to maximize his interest. No matter it's hard-working or rest, cheating or donation ... they are all selfish.

 As a postulate, the constraint is not arguable, and whether human nature is selfish or not is irrelevant: what's really important is not what human really are (that's a question for psychology, physiology or philosophy), but what we assume they are. Then here comes a problem, if we assert cheating, donation ... and so on are all selfish behaviors, is there anything that cannot be explained by "selfish"? The postulate comes as a constraint, but in the end it constrains nothing, how can it be justified? A good question. And the answer is: if we assert at will any behavior as selfish, like a tautology that cannot be wrong, the postulate would become empty and useless; but if we can install more constraints to indicate the circumstances under which an individual would make a selfish decision, and the variations of these constraints lead to inevitable variation of the selfish behavior, then there'd be a whole new story.

For instance, donation or help without a reason has nothing to do with selfishness. But under certain constraints, the cost of a donation is lower or its profit is higher, the actions of donation would increase. Then the postulate of selfishness comes into play. Here I can list some examples. Twenty years ago, Deng Pufang, the son of Deng Xiaoping, visited Hong Kong and raised a donation of 50 million Hong Kong dollars (he was disabled). Apparently my son doesn't have such a capability. If the donors donate just for benevolence, let's put my son's problem aside first, why did they make the donations so serious instead of mailing the checks quietly to a charity? There do be anonymous donors. But why donation would increase when there is a tax deduction for it? Where does sympathy come from? Why do people believe "good deeds will be rewarded"?

Under what constraints would people believe karmas or speak of benevolence, righteousness and virtue? Under what conditions would people have greater sympathy? And when would people be generous to ear fame? I really appreciate the generosity of Shao Yifu and alike in educations — naming a donated university building "Shao Yifu" is deserving and appropriate. To say Mr. Shao's donations were based on his own interest is not degrading him at all; if I were equally rich, I would never be that generous. If we gave up the postulate of selfishness, economics would have no other means to explain Mr. Shao's donations to universities is by choice instead of by chance. No behavior is random; donation is no exception.

And if we allow for exceptions, then any unexplainable phenomena can be attributed, and there'd be no longer irrefutable economic theories. In that way, the whole structure of economics would fail and collapse.

What's really difficult, is not whether the postulate is right or wrong, but how we explain selfishness leads to both cheating and donation under different constraints. As is said in Chapter 1, the examination and definition of constraints is the most demanding job in economics. A lot of human behaviors still have not had satisfactory explanations even today (this is why economics so interesting; a science that has answered all its questions is doomed), and that's mainly because we haven't had enough understanding of their constraints.

(Translator: Selfishness equals maximization of self-interest. In fact, since individual decides, which comes as the first postulate of economics, there can only be two options for him in any behavior: minimization, or maximization. Any other point between the two extremes cannot be deemed a decision, because it means random: given other things being equal, how can an individual acquire 6/7 of the maximum one time and 4/7 another time? Is there any reason that 6/7, if not the maximum or minimum, is superior over 4/7? Minimum, though, is too trivial to be viable, because that implies a breakdown. Therefore, that individual maximizes is actually equivalent to individual decides.)

Theory Must Install Constraints

Chapter 2, Section 2: Theory Must Install Constraints

Don't forget, a theory with explanation power must be refutable, or else it'd be of no use at all. What's equally important, to make predictions for a behavior, science must install constrains. Without constraints, the behavior can modify from time to time, like unsteady wind, and that makes no prediction wrong and the theory irrefutable.

A behavior must have constraints like under which circumstance it goes left instead of right; only in this way can the behavior be explained. Of course, when predicted to go left, the behavior may go right. So a theory that explains is possible to be refuted, but hasn't yet been. This has been explained in Chapter 1. More constraints usually means more accurate predictions, but that widens the chance a theory may get refuted as well. So science is an adventure game. The more constraints a theory has over a behavior, the better, but it shall never step into the realm of refutation. Only virtuosos of science can make assumptions boldly but weigh them cautiously, and by that way push the constraints to the safety limit that the theory won't get refuted.

Individual Makes Decisions

Chapter 2: Selfishness

Any debate must have a starting point, science is no exception. If we are still arguing the starting point, then science can do nothing. So in the development of science, everyone involved must obey a self-evident rule: once something has been specified as a postulate or axiom, people won't argue over that any longer. It's not saying all have to agree sincerely on these postulates or axioms. To agree or not to agree on them, it's not important, what's really important is to agree not to argue on the starting points. The true principle for scientific dialectic is: "Don't argue with me on the start of my theory, let me just finish my logic reasoning under the theory and derive testable or refutable implications. Only until then do you have reliable targets to object. If the implications are mercilessly refuted, I then have to consider my postulate was wrong."

Sometimes those unarguable postulates or axioms may seem groundless and very incredible. For example, an important postulate in maths says: "Given one plus one equals a number, which is called two; and given two plus one equals another number, which is called three ..." Sounds pretty silly. But without this postulate, we have no idea between one and two there can't be another number. If we argue on this foundation, then how can ever the maths theory develop?

Here is another example. In geometry, a straight line is the shortest distance between two points. Kind of hard to take, but it's far less abstract than the postulate about a point. Geometry states: "A point is unmeasurable!" Given a point is unmeasurable, how can there exist a measurable straight line?! But it just based on these specious but legitimate starting points, that geometry guided the constructions of ancient pyramids over the world (though these postulates were not clearly understood at the time), and the modern Bank of China Tower in Hong Kong. Out conclusion is: postulates that seem groundless can lead to acclaimed learnings.

Chapter 2, Section 1: Individual Makes Decisions

The first postulate in economics is: "individual" is the unit of all economic analysis. That's is saying, any group of people, organization, society or nation cannot be the starting point for analyzing economic problems. Analyses like macro economy, social welfare, or government policies all must be based on individual.

In economics there is no theory based on collective. No matter how "macro" its opinion is, or whether its starting point is mentioned or not, if not based on individual, the theory cannot be desirable. That's to say, analyzing macro economy has to be based on individual as well. Of course, there are theories that are based on collective or even the entire society, but they are detached from real foundation. Time and time agan we can hear the sayings like the macro is more important than the micro, they are just from those that don't have any economics background. The macro is summed up by individuals, therefore the difference between the macro and the micro is just size. In modern economics, some scholars classify the macro and the micro according to their emphasis of monetary, instead of the sizes.

When individual is the unit, we don't discriminate male or female, old or young, sane or insane. We don't care A is genius or B is stupid, and just treat them both individual. And "individual" itself is distinguishable to anyone capable of observation. What's equally important, the foundational postulates cannot flip-flop. The "individual" postulate is no exception. We cannot just base some problems on individual and some others on collective. Certainly, there are problems about collective instead of individual, but when dealing with them, we still need start from individual.

Why is "individual" so important? The answer is, every choice and selection is only made by individual. The choice of a collective is just a combination of the choices of its individuals. That's to say, even when someone loses his freedom under a totalitarian government, forced, it's still he that makes the choice. In other words, there is neither absolute unfreedom, nor absolute freedom; a choice must have constraints, and it's made by individual.

So economics's first postulate is that individual makes decisions and choices. In this postulate there is an unobvious philosophy. Economics explains phenomena by predicting human behaviors. We say all human actions are by decisions. Whether the decisions are wise or not, reasonable or not, is not important, what's important is that individual decides. Whether human actions are by decisions or just totally random and blind, it is not important; the important is we always follow this postulate or axiom.

That "individual makes decisions" is a convention of only economics. It seems different from those in other natural sciences. When explaining physical phenomena, physicists don't say the behavior of an object is the result of its choice. Well, in principle if physics says objects make decisions, It's actually OK, but physicists didn't do that. Every science has its starting points, and they are beyond argument. Once enough people accept the postulate "individual makes decisions", all problems of economics become problems of choices. That the most important theory for economics — price theory — is also called choice theory, it does have a reason.

To explain human behaviors with the choice theory certainly requires the behaviors are predictable. Precisely speaking, the first axiom of economics is any human behavior arises from a predictable individual choice. This is an axiom, a postulate of economics, no matter right or wrong, it's no arguable. 

(Translator: Not like in mathematics that postulates are denied by logic contradictions, i.e. based on a same postulate different paths of reasoning lead to inconsistent conclusions, postulates in empirical sciences are negated by the deviation of their implications from real world observations. Although the author says it doesn't matter whether the postulate "individual decides" is right or wrong, he fails to point out that the postulate "individual doesn't decide", which is theoretically legitimate, gets abandoned immediately.)

Methodology in Economic Science

Chapter 1, Section 8: Methodology in Economic Science

If you don't understand something in this chapter, don't take that into heart. The methodology of science involves logic and the theory of knowledge that come from philosophy. These are almost the most profound knowledge that human have ever gained throughout history. Thought I took lessons from masters, I don't think I know that much; if I use only simple terms, I am afraid the ideas may not get correctly conveyed. The methodology of science is so profound that sometimes the masters of logic may even not agree with each other; the good news is one's accomplishment in science doesn't depend much on this learning. Giants of science that don't know much about the methodology are uncountable; conversely, experts in the methodology are rarely eminent scientists. Logic usually goes to the extremes of ivory tower. Its subtleties sometimes are marveling, but to reach perfection one has to pay a very great price.

From the point of rigorous philosophical logic, what I know is only very general. I studied this knowledge fifty years ago. However, there is another angle the methodology can be viewed, the empirical methods that function in the transition between abstract theories and the real world. About this aspect I know much more. The content of this chapter combines both philosophical logic and empirical transition, so it's quite different from those in other books. Anyway, practical sciences must walk out of the ivory tower in the end.

I placed the Methodology of Science at the head of this book and used an entire chapter for it, is not because the knowledge is indispensable for this book. More important is, the Chinese cultural tradition only talks about benevolence, righteousness and virtue; it lacks any empirical character, and has a mistaken attitude towards science deep in its heart. The Three Principles of the People and Marxism, or any other isms, that have had great influence on the Chinese in the twentieth century, only add another opaque film to Chinese's understanding of science. It's been stated that this book is mainly for Chinese students. In my view, the methodology of science is more important for the Chinese than for other western nations. Yet never enter the blind alleys in methodological logic! A general idea is already sufficient.

Economic explanation is an empirical science. In essence it's the same as other natural sciences, and both use the same methodology. However, economics differs greatly from natural sciences in the characteristic of its subjects, and focal methods recruited are different as well. On the subject part, the difference is for two reasons. On one hand, not like in other sciences, the lab of economics is the real world instead of something built and operable by economists, so the difficulty in observation is exceptional. On the other hand, economics is the explanation of human behaviors, but economists are also human, so the explanation is inevitably reading themselves as well. Therefore making objective judgments in economics is usually much harder.

As for recruited methods, the emphasis in economics differs from that in natural sciences in the following aspects. First, I don't think economics should bring in that much influence by physics. As is mentioned previously, the so-called equilibrium and disequilibrium are real phenomena in physics, but in the world of economics there is no such real stuff and they are only concepts, which I have explained. Of course, there are those economists who think equilibrium and disequilibrium are observable market phenomena. That is embarrassingly big mistake. Students please pay attention, when I mention equilibrium in Economic Explanations, I mean a refutable theory is established because well enough constraints have been installed, and I'd never intend any observable steady point.

I don't think mathematics should be that heavy in economics as well, although today's journal papers in economics use more maths than in physics. Except physics, other natural sciences don't use maths that much. I don't mean maths is of no use in economics, it's just maths is never economics. Maths is an amazing language: anything obtained from formula transformation immediately follows logic. Nevertheless, the correctness in logic doesn't guarantee correctness in content. There are indeed those who are efficient at thinking with formulas, but for me it's just adding another layer of restrictions and keeps me from free thinking that I am more capable of. Without maths, my reasoning logic has never gone wrong. I suggest you students learn more maths, but when one thinks, he must take into consideration which his mind is better at, maths or direct reasoning. With enough practices, reasoning without maths can be much freer and allows for more imagination.

There is a common mistake. Lots of people think reasoning with maths or statistics formulas can be more accurate. This is not correct. Measuring is arranging numbers, while accuracy is the public recognition of this arrangement. (Translator: I don't understand either.) This should be another topic in philosophy, and I will demonstrate how to handle it when discussing transaction cost in Volume 3.

Second, I have never dealt with hypothesis test in natural sciences, yet hypothesizing and validation in economics always start from the variation of constraints, i.e. test conditions. When the happening of A implies that of B, it's actually saying the variation of A leads to the variation of B.

As is said, prediction is the same thing as explanation, it's just one is beforehand and the other afterwards. Prediction is to have the variation(s) of constraints in mind first and then infer what phenomenon is going to happen; explanation is to watch a phenomenon happen first and then go back to check what variation(s) of the constraints causes it. Same logic structure, isn't it? Yet dealing procedures of the two are different, which practice is harder is not easy to decide. Just imagine, when facing a phenomenon, to explain it, we need find the variations of constraints that cause it, but within infinite number of constraints, which one or combination shall we choose? Without doubt, backtracking the variations of constraints requires the guidance from some theory. Not easy. Then how about prediction? We may see a constraint has began to change, and then predict by theory what phenomenon is going to happen. The problem is, the variation currently revealed may not be stable and keep changing from time to time, that can easily void the previous prediction. In 1981, based on some changes of constraints I believed stable enough, I predicted that China was going to take the way of market economy. Yet it came true is all by God's blessing, as nobody guaranteed the stability of those changes would continue.

So here comes another related important topic. To make any beforehand prediction or after explanation, one has to master well enough the assisting theory and the application of concepts. However, all the books I have seen that claim to be application of economics usually just throw out a theory, grab some real world examples and then press them in. Basically this is just seeking the right, and violates the dogma of scientific validation: to strive for "wrong" but never get refuted, i.e. reputability. Being refutable and being testable is pretty much the same. As those application books have a different consideration and purpose, it's quite improbable that we can learn much from them.

The last thing I need to tell is, anything invisible is unable to test. This is philosophically very simple. Yet today's economics violates this principle frequently and that results in a catastrophic development. When asserting if A happens then B happens, we must make sure both A and B are real facts, or at least in-principle observable or touchable, or else its validation would become impossible. The starting point of a theory is usually abstract, that is to say, there exist some variables not even in-principle observable. There is one more ghost to service when one more censer is added, so we need avoid unobservable variables as much as possible. After years of exploration, there lefts only one unreal variable that I can't avoid and have to accept: quantity demanded. Only for this one had I gone over many difficulties.

In today's development of economics, there are so many unobservable variables or behaviors: game, motivation, shirking, blackmailing, threatening, concealment, laziness, opportunism, etc. I am not saying there are no such things, it's just they are not observable or measurable and thus not testable. When you can't test something due to its invisibility, you may still tell stories, and the stories can follow logic and sound trustable. Kind of like religions. A science impossible to be tested cannot explain anything. (Translator: there is a fallacy here that, the writer has confused the concepts abstracted with the variables to be tested. For example, why would we ever need to test the existence of a game? What we need to test is only the result, or the prediction, of a game. In this sense, concepts like game are pretty much the same as the "quantity demanded" that the writer has retained.)

The Realness of Theories

Chapter 1, Section 7: The Realness of Theories

Since facts cannot explain facts, theories used to explain phenomena must be abstract to some extent. Abstract concepts are not facts. This made some people feel theories were no longer hinged to reality, they were just big talks, empty and useless. Realism became a big debate. Nowadays, the dispute has calmed down, but it still requires a clarification.

Realness has many meanings, so a debate would be endless if its indication is not first defined. Abstract concepts are of course not facts, so to say a theory unreal is definitely OK. But the final motivation of any theory is to derive fact-related validations or predictions, so in this sense we could say useful theories are indeed real. As for the theories that we cannot derive any testable implications (like many ones in development economics in the 50's and 60's), they are merely games and has nothing to do with the real world.

When a theory with explanation power is said unreal, there are at least four understandings, of which three are superficial. First, a theory must have abstraction. To say it's unreal is of course correct. But concluding accordingly it explains nothing is wrong. Since facts cannot explains facts, without abstraction, nothing can ever be explained. Second, all the descriptions on facts or observations are simplified, which makes facts unreal. This is just quibbling. Let's take apple as an example. If we really need detail what an apple is,  we can't succeed even with all paper of the world used up. To fully describe the color and shape of an apple alone, not to mention its taste or vitamin, would be unattainable. By the same standard, no description in this world ever made to a phenomenon or a fact is real. Criticizing science in such a quibbling way, though plenty of people do it, is therefore unscientific.

The third understanding is about simplification as well. The world is complex; simplifying assumptions (different from those in abstraction) are necessary. Such simplifications are just for the ease of handling; omitting them doesn't change the main intention. For instance, we can ask questions like if there are two countries in this world (there are more, which makes current assumption unreal) how would it be when they trade with each other, and so on. Changing the number to three or four doesn't make any difference at all. Of course, there are occasions when changing from two to three makes great difference. When dealing with those, we can't ignore the distinction; though, other simplifications other than this one are still necessary.

The last type of unreality is not as shallow. Many people take the aforementioned test conditions as just assumptions. Of course these assumptions carries the unreality of simplifications, but not like the ones that are detached from reality in thought abstraction, they shall not be considered as castles in the air. No matter how simplified, test conditions must be traceable and not differ too much from reality. For example, when performing a chemistry experiment, we must use a clean tube (cleanness here is a test condition) instead of a soiled one, the latter of which can never be assumed clean.

In economics, test conditions are usually called constraints. No theory without a constraint exists in economics, as is the case in other fields, there must always be constraints, or else explanation power vanishes. We can assert, when there is no transaction cost (a constraint and barely an assumption), the happening of A leads to the happening of B. To test this implication, we must start when the transaction cost is really negligible. In other words, assumptions in constraints shall never be detached from the real world. That's to say, except for necessary simplification, test conditions must be real.

In conclusion, for scientific theories that originate from abstract thoughts or concepts, certain unreality is necessary, as facts cannot explain facts. "Not too detailed" and "simplification" are allowed types of unreality. But having constraints detached from the real world is a very big mistake. In economics, the research and simplification of constraints (test conditions) is the most difficult job along the economic explanation path. Worldly affairs are like chess games, every one is new, so it may take decades to get just a glimpse on certain constraints, which is normal. Time only advances one's age, so an economist of empirical researches never devotes all his heart to a problem only until the importance of it is assured.

Regarding the reality problem of theory, during the great debate of methodology in economics happened last 50's and 60's, there once was an embarrassing fallacy. That is, if we assert "A's happening leads to B's", then we have "if no B happens no A happens", and cannot have "if no A happens no B happens". The latter has been talked over previously. In that debate, many economists neglected this first lessen of logic and forgot we have no idea about B when A doesn't happen. The colleague that worked on Boston transportation companies thought the assumption A was not right and then made quite a fuss about what would B be going on. Such silly analyses never deserve a response, but sometimes the advance of science can be this baffling, that the responses of other scholars ignited that beneficial debate.

Nonfact and Non-restriction

Chapter 1, Section 6: Nonfact and Non-restriction

I expressed again and again the importance that a theory must be refutable by facts. I also pointed out tautologies, theories with ambiguity, and theories with antinomy are impossible to be refuted. There are still two other types of theories that cannot be refuted and thus have no explanation power. One is those for which phenomena used for confirmation are nonfacts, and the other is those by which phenomena predicted to happen are non-restricted.

If I say "when it rains there must be clouds in the sky", then in this statement the rain and the clouds are facts and must be observable. But if the rain or the clouds are just castles in the air, or nonfacts, then the rain-cloud theory can never be confirmed. In this example there contains a principle of empirical sciences that's not shallow. For all predictions with explanation power, their confirmations must conform to the following implication: if A happens, then B happens, of which both must be observable facts. No matter how much the cost and time might actually be spent, A and B must be at least in-principle confirmable. Both A. Einstein's relativity theory and the genetic theory in heredities had untestable implications in their early times, but afterwards, all got confirmed.

The key is, as stated before, a fact cannot explain another. The happening of A cannot explain that of B. The regularity for A and B can only be used to confirm the implications of a theory. Even if facts are so plenty that we can pick up at will, and the regularities are very obvious, they still cannot explain each other. On the contrary, theories with explanation power usually originate from abstract thoughts; at first there are just some nonfactual hypothesis, but with logic reasonings applied, they can generate testable implications. This is exactly how the rain-cloud theory comes.

Such a job is never easy, though. A testable implication must be able to be refuted; facts don't explain themselves, while abstract theory itself is not testable. So it's all in the minute transitions from abstraction to validation that how the superior and the mediocrity are divided.

Let me have an example. In economics the well-known law of demand says: when the price of a good decreases, consumers' demand for it increases. Price and its changes are observable, but demand is not. Demand stands for consumers' desire or intended need, something abstract. So the law of demand itself cannot be testified by facts. However, this law is important and indispensable for economics. The mediocre usually take the trade volume as demand. This is calling a stag horse, of course mistaken. The correct treatment is totally different. We should say: if the law of demand is correct, then by logic reasoning, under certain observable circumstance the happening of A leads to the happening of B, while both A and B are observable facts (this is how the untestable law of demand derives a testable implication). If we see an occurrence of A without B's happening, then the law of demand is flawed, we need either add other circumstance clauses to it or deem it refuted. If nonoccurence of B implies nonoccurence of A, i.e. we cannot see A happen when there is no B, then the law is not refuted and we can regard the phenomenon about A and B as explained.

You are correct, such implications and their verifications can be made very wise and crafty, which shows the beauty of science. In this book I will demonstrate tirelessly the amazing explanation power of the law of demand. What needs to be stated right here, is that aforementioned additional conditions can vary greatly in both amount and content. In terms of scientific methodologies, the additional circumstances are called test conditions, or constraints in economics. Sometimes we say if A AND B happen, or A OR B happens, it leads to the happening of C. We can also say if A happens, it leads to the happening of B AND C, or the happenings of B OR C. The variables (A, B, C, etc.) can vary in amount; either they can appear in a single observation, or part of them, maybe one, two, or three, appear in different possible observations. All of them suits the theories that have explanation power. But no matter how many phenomena get involved in a validation (i.e. implication), there must be a restriction.

If we state, the happening of A leads to B's happening, or C's, or D's, or E's... and so on, which go endless, then this implication becomes impossible to be refuted. Rigorously speaking, this is the so-called disequilibrium situation in economic theories. Conversely, when an implication becomes confirmed and refutable because there is restriction on involved phenomena, it's called equilibrium.

Above definitions on equilibrium and disequilibrium are not the same as used by traditional economists. I think they are wrong from the basis. The traditional equilibrium concept in economics was borrowed from physics. In physics equilibrium means a pendulum stays in the middle when it stops moving, or an egg reaches a fixed point after rolling for a while, or a moving object enters an orbit and becomes predictable. These equilibriums are phenomena, or observable facts.

In economics equilibrium means totally different. For example, economists take the intersection of the demand curve and the supply curve as an equilibrium. But there is no such demand curve or supply curve in real world, they are just conceptual tools made up by economists. Without economists, these tools wouldn't ever exist. In like manner, equilibrium and disequilibrium in economics are just concepts as well and don't exist in real world. Being not phenomena or facts, they can't be seen.

In the spring of 1969, Coase and I drove from Vancouver to Seattle. During the two hour trip, Coase debated with me about the equilibrium concept in economics. He thought equilibrium and disequilibrium were just castles in the air, totally waste, and thus should be removed from economics. I agreed the castles-in-the-air opinion, but since the concepts were so popular, I could save them by revisions.

I proposed to Coase that disequilibrium can be interpreted as that a theory lacks refutable implications due to non-restriction on its predicted phenomena, while equilibrium is for the case that a theory has the restriction and thus is testable. This is the difference between the aforementioned "non-restricted" and "restricted". Coase agreed at the time such an interpretation can save the useless concepts of equilibrium and equilibrium in economics. A story more than forty years ago. Today, economists that understand and agree this notion is no greater than ten.

Abstract theories themselves cannot be validated. To explain phenomena, they must have one or more refutable implications. Such implications must have the possibility to be overthrown by facts; listed constraints and predicted phenomena can be paraphrased with the certain word AND or the uncertain word OR, but they shall not be unlimited. Of course, the certain AND is superior to the uncertain OR in explanation power, and the simpler the abstract reasoning and the testable implications of a theory are, the more powerful it is. It's why scientists who reduce complex phenomena to a great extent are called genius.

Ambiguity and Antinomy

Chapter 1, Section 5: Ambiguity and Antinomy

A theory that explains phenomena must have the possibility to be refuted by facts. This is the motto for all empirical sciences. In preceding paragraphs I have repeated tirelessly that, theories like tautology that cannot be wrong have no chance to be refuted and thus cannot explain anything. In addition to tautology, there are four more occasions that make a theory impossible to  be refuted. Two of them will be discussed here, and the other two in the next section.

Firstly I will talk about something that I once amusingly called "Coase second theorem". In his startling masterpiece published in 1960 (the well-known Coase theorem comes from this paper), Coase proposed a philosophical principle that seemed commonsense but nobody had ever mentioned explicitly. After he had made every attempt to understand A. C. Pigou's economic analysis while still didn't get it, Coase wrote: "ambiguous thought can never be proved right or wrong."

Yes, ambiguous concept or analysis cannot be unambiguously wrong, so they cannot be unambiguously refuted by facts. For a theory to to be refutable, a prerequisite is : the theory must clearly show its possibility to be wrong. That "when it rains there must be clouds" is possible to be wrong (but it never is); that "in spring flowers flourish" can be wrong (it never is either). However, if we are ambiguous about what is cloud or when is spring, how can a statement be judged right or wrong?

In economics, ambiguous concepts are plenty, and theories impossible to be unambiguously refuted come and go without an end. Karl Marx's Capital can be an example. What exactly is residual value? Some scholars say it rent, some say interest, some say profit, while some others say there is no such a thing at all. Nobody can make it clear. Marx defined "residual value" as capitalists' remaining after wages are paid, but other production costs have not been deducted yet, how could the residual be deemed a gain from exploiting workers? Another concept capital in it was ambiguous as well. Only until the thirties of last century did the latter receive a clear explanation from Fisher (see Volume 2 of this book).

Nobody has ever attempted to validate Marx's theory against facts. It's not surprising at the time China didn't do that, but why didn't western scholars do that either? The answer is: an ambiguous theory is impossible to be testified. Unfortunately, alike theories that cannot be wrong tend to be taken as absolute by those blind followers.

Ambiguous concepts or theories, of course, don't come from Marx exclusively. The talent D. Ricardo, who was before Marx and had great influence on him, didn't discriminate capital and cost very well that his analysis on wage and rent is therefore very hard to understand. Another modern master F. H. Knight, of whom five students won Nobel Prize in Economics, was taken by ambiguity as well. He discriminated risk and uncertainty, between which we can find no difference at all.

Keynes' General Theory is not unambiguous as well, so for some important parts of it nobody can claim they are confirmed. The founder of the utility theory J. Bentham subjectively viewed utility as happiness, but no body knows what it exactly indicates. Afterwards, Alchian asked the question "what is utility" and soon became well-known. Bentham's utility theory was ambiguous and could not be confirmed by facts; but since Alchian there have been a lot of confirmation studies. (That as a disciple of Alchian, I don't use this concept is another story.)

Because ambiguous concepts or theories are impossible to be proven right or wrong, they don't have explanation power. Another type of theories unable to be refuted, are those meaningless. The meaninglessness here doesn't mean no content, which is for tautology; instead it's due to antinomy, the logical inconsistency in statements of a theory. When there is antinomy, people cannot understand what the statements actually conclude, therefore they can only be deemed meaningless.

Let's have some examples. If I say "there are black spots on a totally white wall", this is a sentence with content and unambiguity, but "black spots" and "totally white" are contradictory to each other and thus meaningless. If there can be black spots on a totally white wall, then logic can prove wall equals God. (The reasoning behind it is neither trivial nor economics related so omitted here.) Contradicted statements can have contents, can be unambiguous, but can't be meaningful.

In economics, antinomic theories can be found everywhere. Same as tautologies, antimonies are hard to spot. My dissertation, Theory of Share Tenancy, overthrew all predecessors' views and pinpointed their contradictions. For example, C. Issawi's theory assumed each individual fights for his own interest, but he wrote as well: "in this writing I assume inexplicitly that:  landlords don't make prompt response to economic gains and won't try to enlarge their gains by increasing their investment." If this is not contradiction, what would be? Another example, when Marshall did his analysis on tenancy, he was fully aware fix tenancy was more profitable than share tenancy, though, he didn't allow fix tenancy chosen by landlords.

Such contradicted analyses can be found in many economists' works. W. Baumol said a monopoly maximizes its sales instead of profit, but his theory didn't allow an enterprise to exchange minor sales loss for large profit gain. J. Hicks pointed out, when one's income increases, his demand for certain goods may decrease. This is correct. But when he did the analysis, it was assumed the world has only two types of goods, and in that world, the income increase will not lead to a demand decrease of any of them. Any science has the problems of antinomies; economics is no exception. Immediate contradictions are easy to spot, but indirect ones, those that have gone through one or more layers of inferences, sometimes escape masters.

The Importance of Being Refutable

Chapter 1, Section 4: The Importance of Being Refutable

If the readers ask: through out the entire framework of scientific methodologies, which point is the most important? I will answer without hesitation: conclusions of a theory must be refutable. If a theory has no chance to be refuted, it then doesn't have explanation power at all. We could say, the essence of all empirical sciences is to generate some statements or conclusions that can be refuted by facts. In other words, science is neither the search of right, nor the search of wrong; science searches for the refutable. If something is refutable but not refuted, then it's confirmed. It's been mentioned previously predicting a phenomenon's occurrence is equal to explaining it. If a prediction is refutable but not refuted, then it's confirmed by facts and we deem the phenomenon explained. Of course the same phenomenon can have different explanations. In the following I will discuss the choice problem of different theories.

What I want to stress here is: a theory impossible to get refuted has no explanation power because it doesn't allow a chance to be verified. Tautology cannot be wrong. If it cannot be wrong under any circumstance, how could it be refuted by facts? A refutable theory must be at least able to be wrong in our thinking. Tautology can't be wrong even in just our mind. Except for tautology, we have other four occasions under which a theory is impossible to be refuted and thus has no explanation power. Discussion of them will come in Section 5 and 6.

Being able to be refuted is important. If the conclusion of a theory is refuted by facts, we have two options: first, we give up the theory and look for something else; second, we add clauses to save the theory, but as mentioned before, the rescue asks for a price and it shall not be too high. A theory having not been refuted today may become refuted tomorrow, and this is exactly the way how science advances. But as long as the theory has not been refuted, we can use it today. The applicability to explain phenomena is the the most important criterion on theories. Right or wrong shall never count.

A predicting sentence or statement expresses a testable or refutable implication, which is derived from a theory. Logically, the rule for implication is very simple: if the occurrence of event A implies that of event B (A→B), then B doesn't occur implies A doesn't either (Not B→Not A). This is the most basic verification method. For example, when it rains (A), there must be clouds in the sky (B). The saying implies that if there is no cloud in the sky (Not B), there is no rain (Not A). If it rains when there is no cloud, then the theory that when it rains (A) there is cloud (B) is now refuted by facts. (Translator: the author doesn't make it clear what is an implication. That when it rains there must be cloud, is both a theory AND an implication, as the theory itself is the most trivial implication.)

To verify the implication of a theory, is to find a counterexample. This is very important. To verify the implication that when it rains there must be cloud (A→B), one needs a counterexample of the implication when there is no cloud it doesn't rain (Not B→Not A). Using the counterexample of the implication when it doesn't rain there is no cloud (Not A→Not B) instead as a verification is indeed a common mistake (In logic, the mistake is called fallacy of denying the antecedent.) When the occurrence of A implies that of B, the nonoccurence of A doesn't imply anything about B. Thus by saying nonoccurence of A implies nonoccurence of B, one is making a mistake, and scholars that fall into the trap are a lot. For example, economics assumes all individuals maximize their activity economically (A), so under certain constraints, everyone works hard (B). Some scholars think people may not maximize their activity (Not A), so under same constraints, not everyone works hard (B). This is obviously a fallacy.

In 1946, an economist named R. A. Lester published a world-famous paper. After an investigation of the policies Boston's private transportation enterprises used to hire drivers, he declared the marginal productivity theory, which is very useful in economics, be wrong (the term "marginal" will be explained later). According to economics, each private enterprise maximizes their profits, so when hiring a truck driver, the productivity contribution by the driver is equal to his wage (this is an implication of the marginal productivity theory). Lester inquired all managers of Boston's transportation companies and found they had no idea of "marginal productivity" at all, so he concluded the theory be wrong: the wages of the drivers are not equal to their marginal productivity contribution. This is another "no rain no cloud" fallacy. (Translator: the analogy is too hidden to be grasped.)

I can give another interesting (but not factual) example to illustrate the "A→B so Not A→Not B" fallacy. There are a group of people, and everyone of them is an idiot thus knows nothing. But economists assume they can maximize their activities. Since the group of people are idiots, this economic assumption is definitely wrong. The idiots think the operation of a gas station is fun, so each opens a station. Because they are idiots, some of them build their stations on high mountains, some in thick forests, and some at sea. As no car will pass by, nobody knows how the stations would survive. Luckily, some of them have their stations built beside roads. After a while, the unlucky ones are eliminated, and only those that build the stations at road sides survive. In fact, they have no idea what they did. The assumption that they know how to maximize is wrong, but survived gas stations are the exact result predicted by the same assumption. So concluding the idiots' gas stations won't be at the most profitable places because they don't know what they do, is fallacy. (Translator: the fallacy for "sane people (A) open gas stations at profitable places (B)" is "insane people (Not A) open their stations at nonprofitable places (Not B)", which has counterexamples.)

Astrology in ancient China was extraordinary and by it eclipses of the sun and the moon can be accurately predicted. I didn't investigate how they did it, but all Chinese children must have heard of the saying Tengu (the heavenly dog) eats the sun. Assuming there is the Tengu to explain the eclipses is of course nonsense, but if that generates accurate predictions, we should accept it. That we replace those ancient eclipse theories with today's, is not because today's is right and the old ones are wrong, but because today's theory has greater generality and can explain many other celestial phenomena. There might be a day today's theory is proved wrong. Tautologies are absolute, but they have no explanation power. Theories with explanation power, on the contrary, could be wrong, but that they are refutable is more important. No matter right or wrong, a theory is useful as long as it explains something. Though there is no Tengu that eats the sun, concluding it cannot be used to explain eclipses is however fallacious. We must clearly separate concepts at any time.

Special Theory and Tautology

Chapter 1, Section 3: Special Theory and Tautology

We know, the same item would weigh less on a very high mountain, and this can be explained by the theory of gravitation. But before Newton, how would people think of it? We know on a high mountain the temperature will decrease, so we say the cold temperature, due to some reason, can make an item weigh less. This is a theory, but to prove it true, we take the same item to the sea level, place it in a freezing room and then weigh it. As the weight doesn't decrease, the theory of temperature is refuted.

The following will explain, every theory that has explanation power, must be refutable but have not been refuted. The theory that explains the decreased weight by decreased temperature is refuted, though, is it wrong? This is a philosophical problem of great importance.

If we ignore other conditions and deem any refuted theory wrong, then all theories are wrong. So it won't work. Refuted theory can be rescued. Take the weight of an item on a high mountain as an example, though the temperature explanation has been refuted, we can say on top of a mountain the wind is stronger as well. So in another experiment, we store the same item in a freezing room and weigh it with a fan blowing wind. Again we won't get a decreased weight.

We proceed as the surface on a mountain is sloping. So in the freezing room with a big fan, we add a slant, weigh the item on it, and find the temperature explanation again not trustable. No surrender, we see high mountain has a increased altitude. Therefore with a big cost we build the freezing room into the sky. Finally, we reproduce the phenomenon on high mountains, with cold temperature, fan, slant and altitude, the weight does decrease, which makes the temperature explanation proved. This theory is correct, but it's only an ad hoc theory. An ad hoc theory is also a theory, but too specific that there is no general explanation power in it. In the theory there are too many clauses that it would be refuted with the slightest change.

Any scientific theory, if refuted by facts, can be rescued with additional conditions. But the rescue is not without a price and it cannot be too high. If a theory is so specific that it explains only one phenomenon and is not extensible to other ones, the price is overpaid. The measure is right the theory's general explanation power. Power can be big or small. So we should not give up a theory yet without enough explanation power, as today's not-so-general theory might be replace by another general one tomorrow, and before that happens the not-so-general one is the best we can use. (Translator: each step of generalization is a hypothesis and thus requires time to be discovered and verified.)

In this world there are truths, but the is no theory that cannot be replaced by a better one. Science advances not because the right ones replace the wrong, but because the ones of broader explanation power replace the narrower. Human thoughts can move forward, as today's best may get substituted tomorrow by a more useful one. As of today we still don't have a limit line for human imagination. After World War II science has made extraordinary progresses, this makes us believe human thinking might be limitless forever.

A special theory, if it's so specialized that it explains only one phenomenon, like the aforementioned temperature theory for weight reduction on high mountains, is at one extreme of science and cannot be generalized for other use at all. At the other extreme stand the theories that are ridiculously generalized. They cannot be wrong under any circumstance, because they don't have contents. These are the tautologies in philosophy. While a special theory has too many contents, a tautology has none. Any viable theory must sit in between of them two.

Tautologies are the statements that cannot be wrong under any circumstances. For example, I say "a four-footed animal has four legs". How could it be wrong? The second part of the sentence just repeats the first part, so we can never find a situation under which the statement could be wrong. On Earth and Mars, it can't be wrong, nor can it be at any other place of this universe. The statement has perfect generalization, but what does it exactly say? Nothing! It's absolutely right, but we can get no information from it. So the content of a tautology is void and it explains nothing. (Translator: too many "nothing" repeated here.)

However, tautology is never as simple and obvious as "a four-footed animal has four legs". Theories too generalized to be wrong sometimes even cheat college doctors. Let me give some examples.

In economics, an indispensable assumption is: all individuals maximize their economic activity. But activities like smoking or jumping off a building is harmful to oneself. If we insist these activities are maximizing, then the assumption becomes tautology, because this assumption has included all human activity and using it to explain smoking or building jumping cannot be wrong. If human activity can be vaguely and generally explained like this, there'd be no need of economics.

Another example. Once there was an economist, who wanted to figure out whether private enterprises are running at their lowest cost. According to economic definition, all private enterprises, for maximizing private profits, shall try to lower their cost as much as possible. So the investigation the scholar wanted to make is actually tautology, because the definition itself doesn't allow for the existence of a willful cost hold when it can indeed be reduced. On this job, Friedman had his remarkable comment: "A foolish question, of course deserves only a foolish answer!" What is a foolish question? The one to which you can't have a second answer or no answer is wrong.

So tautology is not always as simple and obvious, sometimes even a learned can be tricked. Forty years ago, a Harvard graduate student got his Ph. D in economics, with his thesis named best of school and a certificate honored. Afterwards, the thesis got published and widely propagated. However, Alchian's review for it was even more well-known. He just pointed out, accurately, that the whole thesis of the student was just a tautology and can never be wrong. The review made Harvard really awkward. Just think, a student's tautology even tricked the professors from Harvard's Department of Economics, how can we ever underestimate the "profoundity" of this sort of logic?

Though I say tautologies cannot be wrong and have no contents, that doesn't mean they cannot be important concepts. In fact, many important scientific theories originate from the idea or concept provided by tautology. One strength of tautology is: it's extremely generalized. If we constrain the scope of a tautology, sometimes we may get a theory of content, though quite probably wrong, and if right its explanation power could be astonishing.

We can have some cases in economics. Take the aforementioned maximization and smoking as an example, if the two are taken for granted to be of the same category, as if by definition, then it's tautology and won't give us any content; but if we add some limiting conditions (i.e. constraints), we can then decide under what circumstance one would smoke more, less, or even quit. In this way, the theory now has content and becomes verifiable.

Another more significant example that a tautology changes into a useful theory is the quantitative theory of money in monetary theory. The start point of this theory is obviously tautology: quantity of money (M) times velocity of money (V), is equal to price of goods (P) times quantity of goods (Q). The formula MV=PQ can't be wrong, as the former (MV) and the latter (PQ) are just a same quantity from different angles. Now that it can't be wrong, it becomes a definition and should be written as MV≡PQ (≡ stands for identical to). Obviously it doesn't explain anything. But because the definition offers a angle to view the world, if we constrain it with proper conditions, it becomes the important quantitative theory of money and has great explanation power. Talented Fisher and Friedman successfully pointed out under which circumstance the velocity of money (V) keeps nearly constant and thus the price of goods (P) is connected with the quantity of money (M). Such a successful theory, in the end, derives from the concept of  a tautology.

The Coase theorem that has been popular in economics for more than forty years is taken as a tautology by some people as well. I think the theorem is of great use, because when an intellectual adds constraints to it, a number of theories with explanation power can be derived. Tautology is the same tautology, but in different people's hands, the usefulness could be quite different. Those that take Coase theorem as tautology and ignore it completely, just don't understand it correctly. As for the detail of the theorem, it will not be discussed until Volume 3 of this book.

Now we can make some conclusions about the two extremes. Special theory has too many contents and only explains one thing. It doesn't have general explanation power at all. But special theory is better than no theory. R. Kessel once said: without theories at hand, you cannot win any debate. One thing is explainable is of course better than nothing explainable. However, viable scientific theories always have their generality, or else each phenomenon would require an individual theory and we can only have a mess.

Another extreme is tautology, which cannot be wrong but has no content at all. The explanation power of a tautology is even less than that a special theory. But tautology can have illuminating concepts sometimes and give us a new angle to view the world. Ignoring a tautology completely just because it's empty may make people miss the treasure. Instead, we should pick up the new angle suggested by the tautology and try to add proper constraints to make its content rich. Through this, a theory with good explanation power may arise.

Viable theories that explain a lot always stay in the between of special theory and tautology. Progresses of science usually start from one or the other extreme and then move towards the middle.