(III) The Theory Part in Modern Economics
For economics, basic theory is an unavoidable fundamental issue, while people who make profound contributions to basic theory are mainly some great economists, below, we want to briefly introduce some views, research methods and research styles of several economists.
1 Alfred Marshall. As one of the founders of modern economics, in the book Principles of Economics (1890), Marshall establishes the complete system of modern economics, and in it, he firstly systematically studies many problems, like necessity, income, capital, desire, consumer demand, production factors, land, population, industrial organization, increasing return, supply and demand, marginal cost, monopoly, distribution of national income, land tenancy, etc, and in them, the equilibrium theory of supply and demand forms the central part of his theory.
To better understand Marshall’s research methods and thinking features, here, it is appropriate to quote one passage from Principles of Economics, in this book, he writes: “Excessive applications of any means to the attainment of any end are indeed sure to yield diminishing returns in every branch of business; and, one may say, in all the affairs of life. We may take some additional examples of a principle that has already been illustrated. In the manufacture of sewing machines some parts may well be made of cast iron; for others a common kind of steel will suffice; there are yet others for which a specially expensive steel-compound is needed; and all parts should be finished off more or less smoothly, so that the machine may work easily. Now if any one devoted a disproportionate care and expense to the selection of materials for the less important uses, it might be truly said that that expenditure was yielding a rapidly diminishing return; and that he would have done better to give some of it to making his machines work smoothly, or even to producing more machines: and the case might be even worse if he devoted an excessive expenditure to merely brilliancy of finish, and put low grade metal to work for which a higher grade was needed.”[8] Through these delicate and endowed with life experience analysis about diminishing returns in this passage, we can realize that, Marshall’s major purpose is to build a systematic and organized theoretical system, for this, on one hand, he creatively introduces many basic concepts of modern economics and is also good at using these economic concepts to analyze many problems, on the other hand, he is also familiar with much life experience and likes to use some vivid examples in real life to explain some abstract economical principles (like this example of sewing machine here), and meanwhile, in other parts of this book, Marshall is also good at using quantitative expositions to analyze many economic facts; to sum up, these three aspects are all important characteristics of Marshall’s works.
2 Knight. As is widely known, Knight is an active advocate of free economy, and he discusses many central economical issues throughout his life, like profit, uncertainty, capital goods, manufacturer and etc, broadly speaking, his main ideas are that due to there exist many kinds of uncertainty in the market and economic development process, thus, free market is more efficient than market regulation. Knight is a prolific scholar, and also has extensive and far-reaching impacts.
In the representative classic Risk, Uncertainty and Profit (1921), Knight discusses about many complex and interrelated issues, and in it, about the generation and nature of profit, he writes: “Of course the money is a mere medium of exchange. It represents to the saver the ownership of a certain amount of the wealth of the society, which can be ‘drawn’ or ‘cashed’ in any form he pleases at existing prices. If the saving is ‘invested’, used for capital creation, this wealth is transferred to those engaged in these operations and ‘cashed’ by them in the form of the things they want, mainly consumption goods. The title to these things is what the saving is and what is transferred. The transferred goods maintain or support the producers of capital goods, including laborers, landowners, and owners of capital goods who would otherwise be engaged in making consumption goods for themselves or for exchange. Interest arises when saved wealth is not invested by the saver, but transferred by loan to another person, either direct from saver to investor or mediated by a bank or financial institution as middleman.”[9] “The crux of current confusion in interest theory lies in the failure to see the significance of the fact that we live in a progressive society, that new net surplus production is constantly flowing through the loan market into the investment field and being converted into material equipment. That is, it is surplus production on the part of the individuals and classes who save it; from the standpoint of society as a whole there is no surplus production of consumption goods, the surplus appears in the form of additions to capital equipment. In an unprogressive society where new saving was not being used to create new resources, there could not be interest in the sense in which the term has significance to economic theorists, -i.e., as a distributive share,-though interest could be paid for consumption loans.”[10] Here, Knight’s analysis is complicated, but the essence is clear, namely, the nature of money is representative of surplus production, while in a progressive society, new net surplus production enters investment field through the loan market in the form of money, and is transferred into material equipment, while in this process, interest arises.
Through reading Knight’s wide-ranging writings, we can see that, on one side, their ideas are all abstract and deep, on the other side, they also have somewhat strong connections with the industry, and these two facts are important features of Knight’s books, for example, he has one paragraph to discuss about one of the central issues he cares about-uncertainty: “He (entrepreneur) bears the technological uncertainty as to the amount of physical product he will secure, but the probable error in calculations of this sort is generally not large; the gamble is in the price factor in relation to the product. But changes in the prices of producers’ goods affect him indirectly, because they are likely to be connected with changes in product prices; they form one of the factors to be taken into account in forecasting the sales market. This is probably a secondary consideration, however, except in so far as capital values are involved, a fundamental exception, to be sure, which will have to be discussed at length presently. The main immediate sources of uncertainty are the amount of supply to be excepted from other producers and the consumers’ wants and purchasing power.”[11] This paragraph evidently embodies the overall style of Knight’s books, namely, what they discuss are all some abstract issues, but the words in them, like “amount of physical product”, “prices of goods”, “forecasting the sales market”, “the amount of supply from producers”, “consumers’ wants and purchasing power”, also have practical features, and these words are different from the theoretical terms in macroeconomics and microeconomics, to sum up, Knight’s thinking style has certain similarities with the practical business education in business school.
3 Hayek. As is known to all, Hayek insists on the overall views of classical liberalism in all his life, however, he is not merely a pure economist, and his research extends to many other areas, like politics, jurisprudence and intellectual history. Hayek’s original contributions in the area of economics are mainly in his early academic works, like Monetary Theory and Business Cycle (1929), Price and Production (1931),etc, and in these works, he makes a sophisticated and deep analysis about many basic issues, including price, business cycle, money, demand, subjective value and etc.
To better understand Hayek’s academic style, we can refer to one of his late works, and in this book, he writes the following statement: “why men should ever have adopted any particular new custom or innovation is of secondary importance. What is more important is that in order for a custom or innovation to be preserved, there were two distinct prerequisites. Firstly, there must have existed some conditions that made possible the preservation through generations of certain practices whose benefits were not necessarily understood or appreciated. Secondly, there must have been the acquisition of distinct advantages by those groups that kept to such customs, thereby enabling them to expand more rapidly than others and ultimately to supersede (or absorb) those not possessing similar customs.” [12] From it, we can see that the economical attribute of academic terms Hayek uses is not very professional, but incorporating some terms in politics, philosophy and sociology (of course, Hayek is naturally not unable to use many economical terms, and his works also have many economical words, thus, is still quite different from works by some scholars like political scientists), and this phenomenon is naturally hugely related with his knowledge structure, namely, what he represents is an overall research method to integrate economics with politics, intellectual history, etc, in other words, a type of broad sense of economical research.
4 Schumpeter. If we observe the overall style of another economical master, Schumpeter, we will find out that he has quite a difference with the above several economists. For instance, if compared with Hayek, what Hayek cares about is mainly political philosophy, while in Capitalism, Socialism and Democracy, what Schumpeter cares is political science; in the economical field, Schumpeter is more familiar with economical journals and books than Hayek, and he is more professional in economics than Hayek; Hayek also cares about jurisprudence, psychology and other fields, while Schumpeter mainly focuses on economics with some political components, and due to the above many reasons, resulting that Hayek’s research style is somewhat philosophical, while Schumpeter’s thinking is more concrete, and not so abstract. To sum up, the knowledge structure of Hayek and Schumpeter has a large difference, which leads to a big difference of the problems they concern and their research styles.
Below, we want to expound one specific issue which Schumpeter analyzes, namely, the economic cycle phenomenon and its cause, about it, he writes: “The so-called cycle perhaps has two meanings. Firstly, it means the fact that every prosperity follows the last depression, and every depression follows the last prosperity. But about this point there is no theory which can explain in quantity, because it obviously relies on the specific data of individual situations. However, my theory can still give a kind of general answer: after a period of time, before the new companies’ products can appear on the market, the prosperity ends, and the depression starts. When the absorbing process of innovation finishes, new prosperity starts, and depression is over.” [13] About the cause of economic cycle, he further analyzes :“Adverse motions not only hamper development, and they also make development to end. A number of values are eliminated, and the fundamental condition and premise of leaders’ plans in the economic system are changed. This economic system, before it moves forward again, needs to regain its strength, and the value system also needs to reorganize. And the restarted development is a new process, and not simply the continuation of the old process.” “The new development process arises from different situations, and partly arises from different people’s actions; many old values and expectations are forever buried, and completely new things emerge.” [14] From this passage, we can see that Schumpeter is using his own “innovation theory” to explain the cause of economic cycle, and he thinks that economic development relies on whole new technologies and products, and is not a simple process of gradual change. Today, when people talk about Schumpeter, we often mention “innovation” and “entrepreneurial spirit” these two things, but if we carefully read Schumpeter’s original work, we can discover that Schumpeter’s relevant exposition is much more complex, deep and rich, in fact, he uses “innovation” to systematically explain many basic phenomena in economics, including profit, capital, credit, interest, economic cycle and etc (as the subtitle of The Theory of Economic Development shows).
If we holistically examine the above several important economists, we can easily see, they actually are all concerned about issues like profit, capital, interest, economic cycle, demand and price, but for these things, their analytical perspectives are quite different : Marshall represents the orthodox economical tradition developed by Smith, Ricardo, Mill and etc, and his analysis is somewhat normalized and academic, Knight’s analysis uses uncertainty and risk as supporting points, and expounds the cause and nature of the above facts, while Hayek uses the subjective value of Austrian School of Economics as the starting point to investigate these basic issues, and Schumpeter uses entrepreneurial spirit and innovation as the basis to systematically analyze and discuss about the cause, nature, basic intension and internal relations of the above things. In other words, these economists actually all care about some fundamental and major economical concepts and things, but their analytical perspectives and thought systems are quite different, resulting that their understandings about these basic things also have a large difference, which is naturally an interesting and important basic fact.
5 North. As another important economist, the major research area of North is economic history, as is well-known, he uses many theories in modern economics as integrated tools to study American economy and modern economy, and gets rich achievements, and North’s overall view is that good institutions are the premise of economic development, and in these institutions, the most important is property rights system, and due to that the definite property rights are effective incentive mechanism, and thus, it can stimulate people’s hard working and creativity, and further promote the overall social progress by people’s work and innovations.
Here, we can select one passage from his Structure and Change in Economic History: “In western Europe, the population grows but the total revenue drops already arises in the 12th century. Then relevant factor scarcity also changes: the value of labor drops, while the value of land rises. The rise of land value causes that people strive for getting exclusive ownership and transferable rights. If every resident has the equal rights to use the public land in the manor, then the public land inside the manor will be overly farmed. Reactions to this kind of farming embodies in the customary rule of manor, and manor customs restrict the use of public land. Regulative negotiations to restrict the number of livestock one family can graze in the public land becomes conventions. In the thirteenth-century England, the wide development of land law, the beginning of enclosure movement, finally leads to the possibility of land transfer. In Burgundy, Champagne and France, there are also similar developments. The rise of land value further stimulates people to change property rights and makes the increasingly scarce resources can be effectively used.”[15] In this paragraph, North expounds the process of how land property rights appear in western Europe, and his exposition integrates both specific historical facts and theoretical analysis, with rigor logic and wide vision, and has great enlightenment; from it, we can see that North is very familiar with manor economy, British agrarian movement in the thirteenth century and Dutch and French economy, etc, namely, his research is based on rich and concrete historical facts, not just several hollow and abstract general theory, and meanwhile, we can also see, the research tools North uses are many classical theories in macroeconomics and microeconomics (from the academic terms he uses here, like ‘factor scarcity’, ‘public land’, ‘land transfer’, ‘land value’, ‘change of property rights’, etc, we can partially feel this point), namely, his knowledge structure is mainly the broad and delicate theories in modern economics and many concrete and delicate systematic facts in economic history. The masterpiece The Rise of the Western World (1973) he co-authors with Thomas is also somewhat similar, namely, though the mainline is very clear, to strengthen the argument, North and Thomas incorporate a large number of empirical details; broadly speaking, this book is also an organic combination of plentiful and diverse economic theories and rich economic historical facts.
6 Summary. About the above several important economists, we want to do some general conclusions. Firstly, if we take a macroscopic perspective, we can get some meaningful conclusions: in these thinkers, what Knight, Hayek and North hold are all liberal economy ideas, however, Knight and North are somewhat pure economists, and thus the terms they use mainly belong to the economical area, but Knight’s style is more inclined to practical business, while North’s style belongs to the mainstream economical study, and Hayek is a scholar who study many subjects simultaneously, including economics, politics and jurisprudence,etc, thus, many research terms, categories and concepts he uses are beyond the economical scope, while his utilisation of economical terms are not professional and rich enough. Secondly, if we examine one particular basic issue, namely, the government regulation issue, Friedman, Hayek and Arrow these three masters all object to too much government regulation, but their ways of argument have a quite difference, and in them, Hayek’s argument is : the market is coordinated by the price system, and through the gradual coordination of the price, the whole market system can well function, while the government regulation will distort the coordination mechanism of price, thus, destroy the market’s auto-adjustment, while Friedman’s two major arguments are: firstly, people will have a long process to accept and digest the government’s many policies, namely, there will be a lagging in time, thus, government’s regulation will not achieve its goal, secondly, due to the existence of “natural-rate hypothesis”, though government’s policies can reduce the unemployment rate by printing money and increasing inflation in the short run, in the long run, unemployment rate and inflation do not have necessary connections, and due to the permanent existence of natural-rate unemployment, which cannot be eliminated, thus, government’s policies will have no effect in the long run, while Arrow’s argument is mathematical, which is based on general equilibrium model, and as we know, he thinks that due to the existence of general equilibrium, the market is an effective means to regulate resources allocation, thus, government regulation is harmful for the economy’s healthy function. In brief, Hayek’s argument is based on price mechanism, which is relatively abstract and principle, while Friedman’s argument focuses on the lagging effect of policy and unemployment issue, which is more professional from the disciplinary perspective of economics, and meanwhile, Arrow’s argument is based on mathematical models, and the mathematical flavor is strong. In conclusion, these great economists have many basic differences in both the macro overall views and certain concrete issues, in other words, the economical theoretical research does not just have one pattern, but have many different kinds of research method, which is naturally a meaningful basic fact. (of course, these specific research methods need to lead to important original results, otherwise, is of little meaning)
In the above, we mainly discuss about several great economists’ certain views and research styles, and meanwhile, we need to to be clear that, the wide reputation of these great economists naturally does not stem from several isolated ideas, but from their important books, like Marshall’s Principles of Economics, Knight’s Risk, Uncertainty and Profit, Hayek’s The Constitution of Liberty (1960), Schumpeter’s Business Cycles (1939) and North’s Institution, Institutional Change and Economic Performance (1990), which are all groundbreaking classics. If we deeply analyze the broad and novel contents of these books, we can find out that these books all have the following basic features: 1 they all have rigid and magnificent structure, namely, on one side, they are all precise and coherent systems, on the other side, these systems’ contents are also very extensive; 2 most importantly, though they are overall structures, each book of them has a lot of original ideas (not merely few new ideas); 3 meanwhile, the quality of these new ideas is high, and has big importance, not just some minor new ideas, and more broadly, apart from many important new ideas, these books’ many other aspects, including views, intellectual framework, argument, empirical materials and writings,etc, are also somewhat important; 4 aside from many original brand-new notions, these books all have rich intensions and contain broad, complex and deep experience, not just few and conventional common facts, and thus, these books all contain many nutrients. To sum up, these books all at least have the above four basic features, and thus, they have stood the test of a long time, and also have an enduring multi-faceted impact in academia.
(IV) Review on Some New Theories in Economics
A somewhat obvious fact is, some frontier theories in economics are numerous, for instance, some theories emerge since the 1980s and 1990s include: behavioral economics (in the 90s, Rabin [16] and some others contribute to it, Thaler[17] and others study the influence of individuals’ limited rational behaviour to financial market), transition economics, corporate finance (Jensen and Meckling’s paper published in 1976[18] -form the incentive problem of company managers to study the allocation issue of corporate equity and company credit, is the pioneering work in this field), information economics (Akerlof’s paper on “lemon market”[19] makes groundbreaking contribution, Spence [20] and others also have contribution), etc, and these theories naturally attract great attention of the economical world[21] . However, I think these theories all have two major problems: firstly, these theories (partly are mathematical, partly are economic theoretical, and some others are combinations of mathematics and economic theory) all donot have profound intensions, and compared with the above masters’ books, these theories all do not have broad originalities, and they are mostly some local new ideas, namely, these theories all donot have a profound foundation; secondly, I don’t think that these theories can stand the test of a long time, with the passage of time (30 years or 50 years), these theories will be gradually forgotten by people (as some theories which are popular in the first half of the 20th century also have been forgotten by people), and even if they are not forgotten, they perhaps will just become tributaries of economics, and what can remain are only some masters’ works and theories, including Marshall, Keynes, Samuelson, Schumpeter, Knight, North, Hayek, Friedman, Arrow, Fisher and etc, while these masters’ works will still be read by people after 200 years, and I think this is a somewhat obvious fact. In brief, in humanities and social sciences, like economics, politics, history and philosophy, whether one book can still be read by people after 200 years or not is a good criterion to test its academic value. (we can say that, this type of works is actually quite a few, on the other hand, as pointed out in section (I), economical empirical research is also valuable, and thus, whether one academic work can be handed down or not is only one of the important criteria to measure its value, but not the only standard.) On the other hand, we need to explain that, these frontier theories also have certain originality and also have a somewhat big academic value, and they also extend the overall connotation of economics, generally speaking, after a period of time, these economical frontier theories will be gradually integrated into the overall system of economics and become its tributaries.
(V) Comparisons between Economics and Mathematics, Politics
As is generally known, modern economics has the closest relationship with mathematics and politics these two subjects, and thus, systematically discussing the differences and similarities between modern economics and mathematics, politics will help us to deepen the understanding of modern economics’s overall feature.
In part (II), we discuss about the extensive uses of modern mathematics in economics, but after all, there exist many basic differences in the research method of economics and mathematics, and broadly speaking, these differences at least have the following 6 points: 1 For the basic courses of mathematics (and physics), like linear algebra and functional analysis, since these courses have been thoroughly studied, thus, no mathematical researchers will think that they can make original contributions in these highly mature fields; but the situation in economics is very different, and in the undergraduate economical courses, like macroeconomics and microeconomics, people can continue to innovate in these broad subjects, which is naturally an important feature of economic research. 2 For the specific problems, what the mathematical (and physical) world studies are naturally many frontier and unresolved questions, while many questions which the economical world studies are difficult to be said as unresolved concrete questions, and as we know, almost all the economists will study issues like employment rate, inflation, economic cycle, currency, interest, capital goods, labor force, production, etc, and these questions are hard to be said as unresolved specific questions, while the questions mathematicians study are naturally all frontier, unresolved definite problems, like Hodge conjecture, NP complete problem and Riemann Hypothesis, etc, namely, the basic features of many problems the economists and mathematicians study are quite different. This phenomenon also results in another important fact, namely, all the good mathematical papers are based on deep and complicated frontier mathematical theories, and are all complex and abstract, because some mature basic theories like real analysis and complex variable function have been thoroughly studied, thus, in them, there cannot be significant unknown problems, but some good economical papers of mathematical properties are developed by simple mathematical deductions, which is naturally directly related with economics’s discipline features. 3 Though modern economics uses much mathematics, the mathematics it uses after all is somewhat limited, and some mathematical branches born in the second half of the 20th century, like function theory of several complex variables, homological algebra, algebraic geometry, dynamic system, differential topology, and nonlinear differential equation, are not widely used in the economical world, as we know, the mathematical tools used by most economists are mainly calculus and linear algebra, and only a small number of people will use some profound tools like real analysis and functional analysis, but even these subjects are also somewhat shallow compared with frontier branches of mathematics; in summary, the mathematics used by economics has two basic features: firstly, the tools used by most scholars are mainly calculus and linear algebra; secondly, broadly speaking, the mathematics used by the economical world is somewhat shallow; and considering these two facts, we can say that the mathematics used by economics cannot be compared with mathematics used by the mathematical world, and broadly speaking, the mathematics used in economics is probably just 1/5 of the mathematical world. 4 The basic study objects of mathematics and economics have fundamental differences, because the study objects of mathematics (and physics) are mostly natural phenomena, while the economical study merely aims at social phenomena, thus, the conclusions of mathematics (and physics) can deepen our understanding of natural phenomena, while economical study can deepen our understanding of social phenomena, which is naturally also a significant difference of these two subjects. 5 For modern mathematical (and physical) research, the major research method is naturally symbolic deductions, and none of the good mathematical papers do not have plentiful, systematic and delicate notations, while many important economical papers are literary, which is also a basic difference of these two subjects. (the reason of this phenomenon naturally stems from the significant difference of study objects as we say in point 4) 6 For research levels and contents, the research level of modern mathematics (and physics) just have one kind, namely, theoretical research, and different directions, including algebraic geometry, dynamical system, nonlinear differential equation and functional analysis, etc, all belong to the theoretical research category, but the economical research contains three levels and parts, namely, experience, mathematics and theory, which naturally leads to a certain degree of disturbance of economical research.
Due to the extensive use of mathematics in modern economics and the breadth and abstraction of economic knowledge, it leads to a common phenomenon that many students and scholars do not thoroughly grasp much knowledge in some courses, like macroeconomics, microeconomics and econometrics, for instance, in macroeconomics, the teachers will teach monetary phenomenon, which contains many mathematical and graphic deductions and economic thoughts, but even some teachers who teach this part of knowledge do not well grasp them, and there are probably two reasons: firstly, though the mathematical deductions in them are relatively simple, they also involve some courses like calculus, thus, to thoroughly understand these many mathematical deductions and graphic analysis actually needs somewhat solid mathematical foundation (at least needs to grasp calculus to a certain degree); secondly, besides mathematics, the economic ideas in these courses are also relatively abstract, and these economic ideas are also very many, thus, not easy to grasp, and meanwhile, in these courses, only one knowledge point often involves many relevant economic thoughts, like money, income, capital, output, inflation and etc, and due to these knowledge’s complexity, abstraction and breadth, also leads to that these teachers’ understanding is not systematic, clear and thorough enough, and in many cases, they just understand partial fragmented information in them. To sum up, mathematics has a complex influence to economic research, but conversely, economics hardly has any impact to mathematics.
After discussing the relationship between economics and mathematics, we want to explore the basic similarities and differences between economics and politics. As we have pointed out, economical research can roughly be divided into three different levels, namely, economics, mathematics and theory, while the study of politics can be divided into two basic levels-experience and theory. In them, the theoretical research of politics has two different directions: political science and political philosophy; for the former one, some famous political scientists, including Sartori, Linz, Almond, Dahl, Barrington Moore, etc, belong to the research method of political science, for the latter one, some important scholars, including Rawls, Nozick, Charles Taylor, Dworkin, Sidgwick, belong to the research method of political philosophy (of course, the division of these two directions is not absolute, and there also exist active intellectual exchanges between them); broadly speaking, these two directions of political theoretical research are both thrivingly developing. Meanwhile, the empirical research of politics involves many different areas, like American politics research and European politics research, and their research scope is also very extensive, involving many issues like community-level democracy, regional politics and diplomatic relations.
As is generally known, the research topics of politics are different from economics, and research topics of economics include inflation, unemployment rate, business cycle, international trade, manufacturer, consumer, market mechanism, development theory, contract, taxation and etc, while the research topics of politics include democracy, liberty, justice, rule of law, government policy, political culture, community and etc, obviously, the research topics of them have quite a difference. Of course, their research fields also have overlapping places, for instance, some topics like social equity, economic freedom and government regulation have attracted attention of both the economical and political world, and as is well known, politics and economics have certain internal connections.
Broadly speaking, the differences between politics and economics can be distinguished into the following two aspects: 1 Because there is not much mathematics used in politics, thus, political research is not so intricate and contour blurring as economics, and its discipline structure is more clear and orderly, while due to the convolution of the three parts, mathematics, experience and theory, in modern economics (for instance, experience can lead to new mathematical models, and theory can also lead to new mathematical models), results in a certain degree of complexity of economical disciplinary system. 2 Due to the issues which economics studies belong to the business and economic affairs category, thus, people often have a certain utilitarian expectation for economics, namely, in a certain degree, people think that economics can boost economic development and promote social progress, while people will not have similar psychological expectations for politics.
Through this part’s exposition, we can know the connections and differences between economics and mathematics, politics in many ways, and since economical research will be constantly influenced by these two subjects, and moreover, people’s opinions on the interrelations between economics and these two subjects are still varied, thus, we think that the systematic analysis in this part has certain intrinsic value.
(VI) The Development of Economics and Cross Interactions between Experience, Mathematics and Theory
In the first three parts, we separately examine the basic intensions of experience, mathematics and theory these three major parts of economics, now, we want to analyze the combined effect when these three broad parts intersect in the practical economical research. Below, we want to use some prominent economists’ research features as the entry point to begin our relevant analysis.
Firstly, for experience, the great economist Friedman naturally knows much experience, and as stated above, his great work A Monetary History of the United States contains a very large number of economic facts, while though Hayek is a scholar with an empiricism view, through reading his books, we can roughly realize that he does not know too much real experience, and what he is really familiar with are some theoretical books, and he once expresses the view that it is corruptive for scholars to enter politics which will let them deprave, which evidently shows that he does not have too much interest for the practical economic operations, while for Samuelson, what he knows best is mathematics, and thus, his understanding of the practical economic experience is also inadequate.
Secondly, for mathematics, Samuelson’s mathematical foundation and mathematical creativity are naturally the best in modern economists, and in his fruitful academic career, he builds many important mathematical models; Marshall’s mathematical foundation is also good, because he first systematically introduces calculus into economics, and thus, starts the mathematization process of economics, and in undergraduate, he makes effort in mathematics and receives systematic training, in the appendix and annotation part of Principles of Economics, it contains many mathematical deductions and complex graphs; Friedman also has a certain mathematical foundation, but cannot be called good, in his undergraduate at Rutgers University, he is firstly enrolled at mathematics department, but due to mediocre grades, he transfers to other department, and his bachelor degree is in literature, in A Theory of the Consumption Function (1957), he builds some mathematical models, but :1 not many, 2 not very complex, of course, in his long professional career, he also builds some important mathematical models, thus, he has a certain mathematical foundation (Friedman also has a high attainment in statistics and can develop some statistical methods to deal with complex data, of course, as we know, the really profound statistical research needs to be based on real analysis and probability); while Hayek is very distrustful about mathematics, and he once wrote a book called The Counter-Revolution of Science, in it, he very objects to the use of scientific method and mathematical models in economics, and for the mathematical foundation, he probably does not well grasp calculus, thus, he naturally cannot understand general equilibrium model or Samuelson’s many economic models; North’s mathematical foundation is probably also limited, for instance, in Structure and Change in Economic History, though he uses some statistical analysis, these analysis are somewhat simple, not very complex, at most are the simple parts in calculus, and I think what North really knows are many theories and much knowledge in economic history; finally, Knight’s and Schumpeter’s mathematics are probably also not good. To sum up, among economists, there are probably quite a large proportion of scholars whose mathematical foundation is not good, and the reason for this phenomenon is that modern mathematics actually has quite a high threshold, and it is a relatively difficult thing to even grasp calculus and linear algebra these two basic courses.[22] Of course, the fact that there are certain defects in some scholars’ mathematical foundation will not prevent them from doing the first-class brilliant research, and the reasons probably have two points: firstly, the theory and experience in economics are both very broad, thus, there are enough good problems to study; secondly, using some simple mathematical models to analyze experience and theory actually can also get many important conclusions.
Finally, for theory, Samuelson naturally can not write great theoretical works like Schumpeter’s History of Economic Analysis (1954), because his knowledge structure mainly concentrates in mathematics, and as analyzed in part (III), though Knight, North, Hayek and Schumpeter are all economists who have theoretical depth, their research styles still have quite differences. And meanwhile, different from scholars who focus on deep theories, the theoretical researches Friedman does contain many practical experience, and his research is probably between theory and experience (and mixed with some mathematics), thus, his theoretical depth is slightly lower than scholars like Knight, because he is not a purely theoretical economist.
After some analysis of several well-known economists’ relevant attainments in experience, mathematics and theory these three aspects, now we want to wholly explore the deep research trends of the economical world, while if we examine the overall development in the twentieth-century economics, we will find out that there at least exist three different research directions: firstly, some developments are mathematical, like the rational anticipated school developed by Hurwicz, Sargent and etc, and the economic growth model pioneered by Solow and Lucas, in them, the mathematical developments can further be divided into two aspects: the first type is conclusions obtained by using shallow mathematics, like the IS-LM model in macroeconomics; the second type is conclusions obtained by using profound mathematics, like the rational expectation school developed by Hurwicz and etc; secondly, some are theoretical innovations, like North’s new economic history, Coase’s theory of transaction cost, Friedman’s monetarism school, etc; finally, there also exist some comprehensive research progress, for instance, Keynes’s money and demand theory is roughly between theory and mathematics, and the social choice theory developed by Arrow, Amartya Sen and etc is also between theory and mathematics, while Friedman’s monetarism school is between experience and theory; to sum up, in the broad development of twentieth-century mathematics, some are mathematical developments, some are theoretical developments, and some others are cross-cutting developments of mathematics and theory, or cross-cutting developments of experience and theory, or cross-cutting developments of mathematics and experience. In general, though the developments of economics in the 20th century are flourishing and abundant, we can still roughly observe some major basic trends.
(VII) Some Prominent Economists’ Thoughts and the Acceptance and Perception Degree of Relevant Thoughts
As stated above, the development of economics is mainly driven by important economists, because these important economists all put forward far-reaching academic theories, like Coase’s theory of transaction cost, Hayek’s “spontaneous order” theory, Arrow’s general equilibrium theory and impossibility theorem, Schumpeter’s “creative destruction” theory, Friedman’s monetarism or North’s new economic history, etc, and obviously, these theories are widely known in the economical world; while the major reason why these theories have extensive impact is naturally the importance of these theories, because they all describe some significant features of the world we live in, and thus, have strong explanatory power, to sum up, these theories all have solid foundation.
But, I think it is also not inappropriate to exaggerate the impact of these theories, for instance, Coase’s theory of transaction cost is certainly important, but if we think it can explain all the economic phenomena and social phenomena, then that is also improper, because what it elaborates is naturally just part of the facts in economic area, here, we want to give some similar examples in the mathematical world, for instance, the geometry theory and complex function theory pioneered by Riemann are certainly highly important, but these theories are also just a small part of the whole mathematical field, and it naturally cannot solve all the mathematical problems. Therefore, the theories of these important economists all have two basic features: firstly, they are very important and have wide-ranging and deep explanatory power; secondly, since economic phenomena are all-embracing and extremely complex, and thus, any important theory also has its limitation and can just explain part of the economic and social facts, namely, if we overemphasize and excessively explain some theories, and unilaterally exaggerate their explanatory power, then it is also not wise and prudent enough. I think only by understanding both these two basic features can we have reasonable views to many economic theories, and moreover, if we use some important theories as synthesis tools, and using many important theories together to analyze complex economic facts, then we probably can get many more mature and wise understandings.
Meanwhile, the ideas raised by important economists is one aspect, while academia’s overall understanding and acceptance degree about their thoughts is another equally important issue. We think, due to the combined impacts of many factors, in many cases, people’s understandings of some great economists’ theories have two universal basic defects: piecemeal, unilateral and shallow.
Firstly, take the brilliant economist Coase as an example, and his best-known contribution is naturally the original theory of transaction cost, thereby, he becomes one of the founders of neo-institutional economics, but we think many scholars’ understanding towards him is often somewhat shallow; since part of his academic essence embodies in his most important two papers, namely, the Nature of the Firm published in 1937 and The Problem of Social Cost published in 1960, thus, we want to make some analysis about Coase’s ideas and academia’s overall acceptance and understanding based on the essay the Nature of the Firm. As is widely known, in this paper, Coase’s central problem is : why does a company arise? Many people think that Coase’s problem consciousness is : since the price mechanism can already coordinate the market function, then every individual becomes a single producer, for him, isn’t this enough? Perhaps many people think in this way, but actually, Coase also considers another basic issue, namely, entrepreneur’s organization issue; some previous economists, from Adam Smith, Marshall, Knight, Robertson to Robbins all value entrepreneur’s organizational, coordinate and pioneering functions, and think their organizational function also makes great contribution to social development, namely, the economical world then already recognized two important facts: “Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-coordinator, who directs production.” But these two basic conclusions have internal conflicts, namely: since the price mechanism is already complete enough, and can already guarantee the effective utilisation of resources and operation of production, why do we still need another factor, the organizational and coordinate functions of the entrepreneur? This issue exactly makes up one of Coase’s overall thinking premises, and about it, he gives a definite summation: “The purpose of this paper is to bridge what appears to be a gap in economic theory between the assumption (made for some purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur-coordinator.”[23] The answer provided by Coase now is widely known, namely, the existence of company can eliminate transaction cost, while the overall intension of the concept “transaction cost” is :“ The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of ‘organising’ production through the price mechanism is that of discovering what the relevant prices are. This cost may be reduced but it will not be eliminated by the emergence of specialists who will sell this information. The cost of negotiating and concluding a separate contract for each exchange transaction which takes place on a market must also be taken into account. Again, in certain markets, e.g., produce exchanges, a technique is devised for minimising these contract costs; but they are not eliminated.”[24] Namely, transaction cost includes searching cost, negotiating cost and implementing cost these three major parts, and in the following parts of this paper, Coase uses the concept transaction cost to analyze the inherent cause why organizations expand or decline. From this classical essay, we can probably feel the following three points: firstly, Coase’s thoughts are very rich and profound, and from the complicated literature citations of this paper (these citations naturally need to mark the pages, editions and etc), we can realize that the range of Coase’s reading and thinking is indeed broad, which is also the bedrock of his academic originality; secondly, if Coase just discovers “transaction cost” this general concept, but not clarifying three major transaction costs, then his paper will also not have a big influence (after it, North and others creatively apply the transaction cost into economic history field, and endow this abstract concept with substantive intensions, and with the effort of some other scholars, which further widens the influence of transaction cost theory), namely, for academic essays, only some thin original ideas are not enough, and it must have deep intension; thirdly, the property of this paper is original and basic, which is a sharp contrast with some of our scholars’ research, on one side, some of our scholars’ papers just present some common facts which most of us know, on the other side, even though the contents of some scholars’ essays have certain originality, due to that they are not principle enough, thus, they just have temporary meaning, which are also naturally unlikely to have a big academic importance. To sum up, many of our economists’ understandings of the problem consciousness and theoretical intension of Coase’s these papers are not deep enough, and their understandings contain much parrot-learned component.
As another example, when people talk about Friedman, many people probably can just think about his monetarism view, namely, the government needs to control money quantity, which can control inflation, but they probably do not well understand the theoretical basis of Friedman’s this view: this view of Friedman comes from Fisher’s exchange equation: MV=PT, here, M represents the average amount of currency in circulation during a certain period, V represents the average turnover times of unit currency in a certain period, namely, the currency circulation velocity, P represents the weighted mean of product and labor price, T represents business and labor’s weighted quantity, because V is determined by factors like social system and habit, thus, it is stable in the long run and can be seen as constant, and in the full employment condition, compared with output level, T keeps a fixed proportion, which is roughly stable, and can also be seen as constant, thus, exchange equation changes into the money quantity theory, namely, the price level P only depends on the change of money quantity M, when M changes, P changes with the same proportion, obviously, these analyses directly lead to Friedman’s monetarism view, and meanwhile, about Friedman’s monetarism view, many people are probably also not familiar with his money demand function: Md/P=f(Y,w,Rm,Rb,Re,gP,u)[25] . In the meantime, Friedman also at least makes another two important contributions: the first one is consumption function theory, namely, Friedman refutes Keynes’s diminishing marginal propensity to consume law, and he thinks that individual demand and consumption will not decrease along with the increase of income, and since individual’s consumption desire is infinite, thus, the increase of income will not reduce people’s consumption demand; the second one is natural-rate hypothesis (raised in 1968, with Phelps at the same time), namely, Friedman thinks that even in the full economic development and adequate employment positions situation, there also exists certain unemployment rate and this unemployment rate is caused by many reasons, including too low salary of recruitment positions, voluntary unemployment, and quitting the previous job to find a new job, etc, namely, even in the full employment condition, the unemployment rate will also not be 0, there also exists natural unemployment rate. In conclusion, many people’s understandings of Friedman’s economic thoughts are also not comprehensive and clear enough.
Thirdly, take another economist Hayek as an example, many people’s understanding towards him often stays at the point that he insists on free market and opposes planned economy, but Hayek’s overall thought system is naturally much more complex and deep than this simplified understanding; for instance, Hayek’s emphasis on dispersed knowledge is widely known and generally accepted, but his view is actually based on the unpredictability of individual action, the unpredictability of the birth of new ideas and the broad originality in social spontaneous progress process these three aspects, while many people’s understanding of this is somewhat shallow, and thus, many scholars’ understandings of Hayek are often not deep and systematic enough, as historian Lin Yusheng says: “Whenever Hayek publishes one book, many newspaper and journals will express different praises and criticism. But, in fact, many book reviews’ authors do not thoroughly understand his arguments. For example, several years ago, I read the book review about The Counter-Revolution of Science by Harvard University’s political professor Carl Friedrich in Political Review, and felt that he says a lot, but in the end he actually does not really understand Hayek’s main message in this book. Friedrich is a distinguished scholar, and he is also like so, for other people, we donot need to say more. Take Hayek’s great work The Constitution of Liberty as another example, after being published, many British scholars co-wrote a book report……a few of them is wonderful, but some essays do not have a deep understanding about Hayek’s main arguments.”[26] Obviously, Mr. Lin’s description appears in some scholars’ overall understanding towards Hayek, and also appears in some scholars’ holistic understanding towards other important economists.
Fourthly, economists’ understanding degree to the important economist Arrow shows some other features,since Arrow’s mathematical ability is very good, thus, his papers and books use a lot of mathematics, which naturally results that people are somewhat difficult to deeply understand him. When people talk about Arrow, they will naturally think about his general equilibrium theory and impossibility theorem, but these models are all very complex: firstly, their premises are somewhat complex, involving many economical hypotheses; secondly, their deduction processes are also tortuous and complex, involving many other relevant theorems, thus, these theorems actually all have rich contents, and meanwhile, behind them, there are also broader overall theories (like social choice theory), and are parts of these theories, thus, many economic scholars’ understandings of Arrow’s general equilibrium theory and impossibility theorem are also often somewhat piecemeal, shallow and ambiguous.
To sum up, through the analyses of Coase, Friedman, Hayek and Arrow these four important economists, we can realize that, in fact, the economical world’s understandings towards them are often somewhat piecemeal and vague, on one hand, nearly all the economists are very familiar with these brilliant scholars, and they also often talk about these economists’ theories, but on the other hand, their understandings of these economists are actually somewhat ambiguous, not orderly and deep enough. It is easy to understand that many scholars’ understandings of economists like North and Schumpeter perhaps also have this basic issue, in brief, brilliant economists indeed put forward important views and write important works, but people’s understandings towards these views and books are often not deep enough, and this point is perhaps a meaningful reminder for us.
(VIII) The Basic Value of Economics
After we make a somewhat systematic discussion about the methodology of economics and etc in the above, in the final part of this paper, it is valuable to make some analyses about the internal value, meaning and etc, of economics. As is well known, humanities and social sciences theoretical researches have three major values : explaining facts, predicting facts and changing (directing) facts, then, does economics have these three values?
Firstly, among the various values of theories, explaining facts is naturally the most basic, and economists also often aim at explaining facts, for instance, the Cambridge school led by Marshall exactly uses explaining life affairs as the guiding principle. I think many scholars perhaps also think that the basic mission of politics, economics and etc is to explain the complex real life: since the real life is chaotic and broad, thus, it needs the intelligentsia to comb and analyze it, and arrange them into ordered understandings, and analyze their deeper causes; this kind of academic work will benefit people’s daily life in various social fields, and also will benefit the real work of practitioners in political and economical fields. However, since the actual world we live in is all-inclusive and extremely complicated, thus, to comprehensively and reasonably explain it is naturally not easy; because various factors in the actual reality often interrelate, while economists’ considerations sometimes will overlook other important factors, resulting that when economists use their own theories to explain the facts will often be unilateral. Below are several appropriate examples.
The myth of free market is a good case to examine the explanatory power of economics, as is well known, Hayek, Friedman and others are all believers of free market, and they also put forward many proofs to argue for the validity of free market, on one hand, these proofs are naturally all well founded, and their logic of arguments is also rigorous and orderly, but on the other hand, I think their overall views also have unilateral places. We can give two examples: the first example is Germany in 1870-1914, namely, Germany before the first World War, the institution Germany applied then was naturally not market economy, and it also did not carry out mature democracy, but the German economy then was very good, and Germany at that time was also the center of science, technology, thought and culture in the world, how will Hayek and Friedman explain this? The second example is many countries’ developing experience in contemporary world, as we know, today what most countries apply is market economy system, but, why is only some developed countries’ economy prosperous, like America, France, Great Britain, Sweden and Japan, and other countries’ economy is not so wealthy? Can we explain this basic phenomenon by using free market theory? From the above two examples we can probably feel that, the differences between free market and government regulation may have some impacts on economic development, but in some occasions it is actually not the major influence factor. In summary, I think Hayek’s, Friedman’s and others’ free market theory has certain rationality, but obviously also has its limit.
We can take North’s new economic history as another example, as stated above, North and others think that the key to economic development is to clearly define the property right, because private property rights can stimulate individual’s creativity and work enthusiasm; in several wide-ranging books, North uses the property right to explain the economic history process of America, European countries, etc; but, a central problem is: can only with definite property right really promote social progress? In it, the most important point is: if without the development of science and technology, can a society keep progressing? About this point, North and Thomas once wrote: “In the 13th and 14th century, there also existed a series of important technological changes in military warfare, and in them, the most important are longbow, spear and gunpowder (as a result, artillery and musket emerge). What remains unclear is whether the development of exchange economy became the full condition to enlarge the optimal war scale or the institutional innovations mentioned above expanded the war.” [27] Here, North uses institutional factors to explain the causes of some significant innovations in technical field, but I think this is relatively unconvincing; on one hand, we need to admit that the exchange economy which North talks about probably has a certain stimulus and promotion for these technical innovations, but on the other hand, these technical innovations are actually created by scientific workers, and they do not have a main connection with the transaction institution; and meanwhile, we also do not believe that Galileo’s physical experiment, Newton’s mechanics, Descartes’s analytic geometry or Harvey’s blood circulation theory are mainly stimulated by institutional innovations, instead, they should mainly be incubated within the scientific community, and the decisive factors to stimulate their birth are probably curiosity, thirst for knowledge, exploring spirit, philosophical idea and scientific thought. In a word, I think using North’s theory to explain the economic reality is also unilateral. (Interestingly enough, Hayek uses his “spontaneous order” theory to explain the cause of Industrial Revolution, which I think is also unilateral, because if Watt and others do not have a solid knowledge foundation and technical ideas, then I think they could not invent many machines like steam engine; “spontaneous order” can probably explain part of social phenomena, but if it is used to explain many significant technical innovations then it is also far-fetched and not strong enough)
After analyzing two classical economic theories’ explanatory power, now we want to analyze one well-known economic model’s explanatory power, namely, Cobb-Douglas production function. Firstly, its basic form is:
Y=A(t)L^α K^βμ
In it, Y is the gross industrial output, A(t) is the comprehensive technological level, L is the input labor force, K is the input capital, α is the elasticity coefficient of labor output, β is the elasticity coefficient of capital output, μ is the impact of random disturbance, μ≤1. From this model, we can see, the major factors which determine the development level of industrial system are the input labor force, fixed assets and comprehensive technical level.
Based on the combination situation of α and β, it has the following three types:
(1) α+β>1, which is called increasing return type, and shows that according to the current technology, to expand the scale of production to increase output is profitable.
(2)α+β<1, which is called decreasing return type, and shows that according to the current technology, to expand the scale of production is bad.
(3)α+β=1，which is called unchanged return type, and shows that the production efficiency will not improve with the expansion of scale of production, and only by improving the technical level can increase the economic benefit.
Broadly speaking, Cobb-Douglas production function is consistent with many economic data in agriculture and industry, etc, thus, has certain value; but because it is a highly simplified model, thus, it has a big error with many other empirical data, and therefore, there is much criticism about it, in them, there are two major queries: firstly, the elasticity coefficient of labor output α and the elasticity coefficient of capital output β are assumed as constant in this model, but, in real life, elasticity coefficient of labor output and elasticity coefficient of capital output these two parameters are obviously constantly changing; secondly, this model only considers the relationship between industrial production and labor with capital, and overlooks important levels like technology and administration, which is naturally also inappropriate, because the impact of technology and administration on production is also very huge. [28]
When facing mathematical model type theories like Cobb-Douglas production function, we cannot help asking: how much practical explanatory power does it have? On one hand, Cobb-Douglas technology is roughly consistent with many economic data, and meanwhile, it also has certain guiding value for practical economic activities, and thus, naturally has certain validity; but, on the other hand, it is so simplified, while in reality, the factors and variables which affect industrial output are highly complex, thus, using such a model to analyze many issues is also inappropriate. In summary, most economic models all have certain explanatory power, but meanwhile, we also cannot falsely amplify their application range, or overly trust some conclusions obtained by them; only by combining these two basic facts together can our understanding of many economic models’ values be somewhat reasonable and mature.
To sum up, combining facts in many aspects and the above several classical examples, we can feel that economical theories have certain explanatory ability, but at some times are also unilateral, and these two aspects are both significant features of economical theory.
Secondly, after examining the explanatory function of economics, we naturally need to examine the predicting function of economics, and about economics’s ability to predict facts, some economists think that they can predict the precise tendency of future economy, I think this is not rational enough. Firstly, about the predicting of company’s future situation, we can refer to one passage of Buffett, he says: “Charlie and I think it is both deceptive and dangerous for CEOs to predict growth rates for their companies. They are, of course, frequently egged on to do so by both analysts and their own investor relations departments. They should resist, however, because too often these predictions lead to trouble.”[29] In other words, even for people like Buffett who has extremely rich business experience, he also thinks that predicting the future development of one company is very difficult, thus, we can probably understand that, precisely predicting the future trend of one company is a hard thing, because there are too many influencing factors: macroeconomical trends, social psychology, technical change, personal transfer in company and monetary policy, etc, and the change of every important factor will more or less affect the future trend of one company. Of course, we need to point out that, predictions restricted in a certain degree are partially reasonable, as Buffett says : “It’s fine for a CEO to have his own internal goals and, in our view, it’s even appropriate for the CEO to publicly express some hopes about the future, if these expectations are accompanied by sensible caveats.” [30] Namely, for the prediction of one company, we can give some rough estimates, after all, the major aspect of one company’s operation also have stability; but, scholars and relevant people should not and also are unlikely to give some precise predictions. Broadly speaking, predicting the future trend of one company is a somewhat complex thing.
Meanwhile, about predicting the overall economic condition of one country or one industry, obviously, is also a hard thing; generally speaking, if we know extensive experience and much information, then we can probably estimate the rough direction in a certain degree, while these overall predictions are naturally closely related with certain scholars’ knowledge structure, experience range and thinking ability, namely, the accuracy of predictions for macro-economy is directly related with relevant scholars’ overall accumulation of knowledge, experience, ideas and comprehensive ability.
Thirdly, we also need to examine the guiding (changing) facts function of economics. In general, the ability of economists to guide (change) facts at least exists two obstacles: firstly, about many economic issues, different economists’ views are often different, and a common statement is that if we raise the same question to 100 economists, they will give 101 different answers; though this sentence is just a joke, it also explains part of the facts, namely, economists’ judgements about many issues are different; for instance, about whether the Chinese central bank should increase the interest rate or decrease the interest rate, scholars’ opinions will be widely divided, while the disagreements in opinions will certainly undermine the opinion strength of economists. Secondly, the economic knowledge which the economists master is not necessarily more than ordinary people, because many economists are addicted to theoretical investigation, thus, the real economic information they know is perhaps less than ordinary people, for instance, some economists are not familiar with some common facts, like the prices of many daily food, e.g. cabbage, tofu, tomato, lettuce, carrot and etc, which is naturally also a big issue.
Of course, economics still has certain basic function of guiding (changing) facts, and this conclusion can be divided into two points: firstly, for practical and empirical economical research, the business school in university trains many brilliant CEOs, and what these talented and business-minded CEOs receive is certainly the systematic training in business school, which illustrates that the training in business school has practical value. (however, there are also many brilliant CEOs who are not trained by the business school) Secondly, as stated above, besides concrete actual economic issues, economists will also explore many theoretical issues, and some significant theories in them can provide useful guidance for social development in the macroscopic level, for instance, Schumpeter’s “creative destruction” theory can provide far-reaching and effective enlightenment for the overall social development; at the same time, these theoretical works also contain many deep ideas and nutrients, thus, will have a positive and profound impact on various classes of society, for it, at the ending of The General Theory of Employment, Interest, and Money, Keynes once wrote a well-known statement: “But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Mad men in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”[31] Obviously, this passage has certain rationality, and it needs to be noted that, the major purpose of these profound academic inquiries is to explain the reality (like the research of Knight, North and Coase, etc), but in this process, many deep and novel ideas will emerge, and these notions involve various aspects, like life experience, thinking in social level, business idea and cultural cultivation, while after these wise and mature ideas are born, they will also have the function to guide (change) the reality, namely, the explanatory ability and guiding ability of theory are often interwoven.
Here, we need to point out that, economical theories’ function of changing the reality mainly embodies in providing rich and wise thought nutrition, and not the direct change in material level, because we cannot directly produce material products like fridge, car, air-conditioner, washing machine by using economics, and what it can provide is just enlightenment in thought and institution. To sum up, economics’s function of guiding (changing) the facts roughly embodies in empirical research and theoretical research these two levels.
[8]SeePrinciples of Economics, book V, Chapter VIII, section 4, p.236, London : Macmillan and Co. 8th ed. 1920
[9] SeeRisk, Uncertainty and Profit, chapter XI, p.147,148, Boston: Houghton Mifflin Company, The Riverside Press, Cambridge, 1921
[10] See the above book, p.150
[11] See the above book, p.145
[12] The Fatal Conceit, Chapter III, section “The Density of Occupation of the World Made Possible by Trade”, p.43, T.J. Press Ltd. Padstow, Cornwall, 1988
[13] SeeThe Theory of Economic Development, Chapter VI, pp.237,238, Commercial Press, 1991
[14]See the above book, chapter 6, section 1, pp.241, 242
[15] SeeStructure and Change in Economic History, Chapter X, “The Rise and Fall of Feudalism”, section 3, p.151, Sanlian Press, 1994
[16] Rabin,Matthew.”Psychology and Economics.”Journal of Economics Literature. 36(1), pp.11-46, March 1998
[17]Thaler,Richard. The Winner’s Curse: Paradoxes and Anomalies of Economic Life. Princeton: Princeton University Press, 1994
[18]Jensen, Michael and William H.Meckling. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.”Journal of Financial Economics, 3(4), pp.305-360, October 1976.
[19]Akerlof, George. “The Market for Lemons: Quality Uncertainty and the Market Mechanism.”Quarterly Journal of Economics. 84(3),pp.488-500, August 1970.
[20]Spence, Michael. “Job Market Signaling.”Quarterly Journal of Economics.87(3), pp.355-374, August 1973
[21]The exposition of this passage is strongly enlightened by Qian Yingyi’s article Understand Modern Economics, I want to thank him here, and some analysis about these new economical areas can refer to the somewhat detailed elaboration in this paper.
[22]The complex analysis can refer to my paper "On Undergraduate Science and Engineering Education"
[23]The Nature of the Firm, Section 1,Economica, (Nov., 1937), pp.387-389
[24] See the above paper, Section 2, pp.390-391
[25]In it, Md represents nominal money demand, P represents price level, Y represents nominal permanent income, W represents the proportion of non-human wealth in total wealth, Rm represents the currency’s expected nominal profitability, Rb represents the bond’s expected nominal profitability, gP represents the expected rate of change of price level, namely, the expected profitability of physical assets, u represents the relevant factors which affect money demand, and the relationship between w,u,Md is uncertain. Friedman thinks that this money demand function is stable, because the factors which affect money demand and money income are independent, and some variables in them also have relative stability.
[26] See the paper Professor Hayek inThe Creative Transformation of Chinese Tradition,p.332, Joint Publishing, 1994
[27]SeeThe Rise of the Western World,Chapter VIII, Section III
[28]Considering that Cobb-Douglas technology is an oversimplified model, and thus, there are many of its generalizations, in them, one generalization is the CES (constant elasticity of substitution) production function firstly introduced by Solow: Y=A〖(αK^γ+(1-α) L^γ)〗^(1/γ)
As we know, elasticity of substitution is a somewhat complex concept, and it measures the change of proportion of factor rate divides the change of proportion of technology substitution rate; the elasticity of substitution of Cobb-Douglas technology is 1, while CES technology’s elasticity of substitution is unchanged, but not must be 1, is 1/(1-γ) , thus,CES production function is a generalization of Cobb-Douglas technology. This production function has constant factor substitution rate, which means, in an unchanged condition of technology level and input price, due to the relative change of marginal technology substitution rate, the proportion of input capital and labor in productivity will correspondingly change with constant. With simple calculations, the limit of this technical form at γ=0 corresponds to Cobb-Douglas technology.
To do this, we take the log form of CES production function, and get:
ln(Y)=ln(A)+1/γ ln(αK^γ+(1-α)L^γ)
Using LHospital’s rule, we get
lim┬(γ→0)〖ln(Y)=ln(A)+αln(K)+(1-α)ln(L)〗
Thus, we have Y=AK^α L^(1-α)
[29] To the Shareholders of Berkshire Hathaway Inc., 2000, Section “Full and Fair Reporting”
[30]See the above letter, the same section
[31]SeeThe General Theory of Employment, Interest, and Money, Chapter XXIV, Section V, p.317, Shaanxi People’s Publishing House, 2005