Hume's Problem with Induction

In the following essay I will explain why Hume believes that there is no way to give a rational justification of the use of inductive reasoning to acquire knowledge. I will do so by showing that both a priori and a posteriori knowledge cannot be used to justify induction, which necessarily leads Hume to conclude that inductive reasoning cannot be justifiably used in acquiring knowledge.

In order to understand Hume’s problem with inductive reasoning, it is imperative to understand how knowledge can be gained. Knowledge can be gained in only two ways: either a priori, knowledge gained prior to experience, or a posteriori, knowledge gained after an experience. Since one is prior to experience, and one proceeding from experience, logically all knowledge must be gained in one of these two categories; there are no other alternatives to how one can gain knowledge.

A priori knowledge is usually associated with mathematics and geometry; writing after Hume, Kant mentions that a priori knowledge is analytic, meaning that it is true by virtue of meaning. For example, when one states that “a triangle has three sides,” the statement cannot be denied without a contradiction. If one understands the definition of a triangle, one must also understand that a triangle has three sides. Hume calls this knowledge that is known a priori and is analytic, “The Relations of Ideas” (Section 4). Relations of ideas, because they are a priori, cannot be justified in induction, using past experiences to predict the future, since they are necessarily prior to experience. If something is prior to experience, there is no experience therefore upon which one can use to further make inferences about the future. Therefore, Hume argues that induction cannot be justified by using a priori knowledge.

Hume then gets to the heart of his argument in which he states that cause and effect are “Matters of Fact”, knowledge acquired a posteriori and what Kant calls synthetic, meaning that they are true by how their meaning relates to the world (Section 4). Matters of fact differ from relations of ideas in that a matter of fact can be denied without contradiction, where as a relation of ideas cannot. For example, the statement “all dogs hate cats,” can be denied fairly easily and therefore without contradiction, since it is not hard for one to imagine at least one dog existing in the world who likes a cat. The statement “all dogs hate cats,” is therefore a matter of fact. However, consider the statement “a triangle has four sides.” Here the contradiction that arises is quite obvious. If one understands the definition of a triangle, one knows that a triangle has three sides, and that it is impossible for it to have four. Therefore, the statement, a triangle has four sides, is necessarily a relation of ideas since a contradiction arises.

Given that matters of fact can be denied without contradiction, we cannot deduce reason from it because there can never be a necessary connection between the cause and the effect (Section 4). Because the connection between cause and effect is not necessary, there is no reason to believe that the connection must hold in the future, and therefore knowledge which requires reasoning from a past experience [induction] cannot be rational. Hume then concludes that induction cannot be justified using a posteriori knowledge. If Hume’s argument is in fact sound, he has proven that induction cannot be a justified way of acquiring knowledge since it cannot be justified in either the a priori or a posteriori sense.

            A common objection to Hume would be, “what about the laws of physics? It is widely known that these laws were discovered a posteriori, for example, the law of gravity. Are we not absolutely sure that if tomorrow, we were to throw an object into the air, that it would eventually start to fall towards the ground at a rate of 9.8 meters per second per second?”

            Hume would state that in fact we cannot be absolutely sure that this would happen. Consider the following example of Pavlov’s dogs. Every day since the dog’s birth, the owner of the dog rings a bell before feeding it. In the beginning, the owner rings the bell, after which the dog sees the food and begins to salivate. However, as time goes on, the dog begins to realize that every day; he gets food after he hears the ringing of the bell. So eventually the dog associates the ringing of the bell with food, upon which he begins to salivate, but he does so prior to seeing the food. One can even imagine that the dog notices that he gets less food if the bell is rung really loud (since the owner is mad), than if the bell is rung quieter. Perhaps there is a genius dog who formulated a mathematical equation from this “cause and effect” relationship, in which he can calculate the amount of food he will be given based on the volume the bell is rung at. However, a day will come when the dog hears the ringing of a bell and no food will arrive, leaving the dog confused. After all he did have a mathematical equation proving the direct relationship between the ringing of the bell and the amount of food he would receive!

            Hume would argue that this argument is the same one presented by those who favor induction. Every time the bell rings for the dog, food is put in front of him; every time an object is thrown into the air, it falls back down. Both of these have been happening for the entire life of both the dog and say, Newton, when he identified gravity. The dog believes that this line of cause and effect is necessary since it has been that way his whole life, just as our laws of physics have existed for us until today. The dog, like Newton, has even formulated a mathematical equation which supports what he has experienced his entire life. However, it is quite clear that the bell is not the cause of the food appearing in front of the dog. Hume would argue that it is by this reasoning that we cannot know that an object will fall to the ground tomorrow because this is how nature could be for us. It is not impossible to imagine in the future, the laws of physics will no longer hold, just as expecting food to follow the ringing of a bell one day failed for the dog.

*References to An Enquiry Concerning Human Understanding

The Economics of Saint Thomas Aquinas

              Saint Thomas Aquinas was probably the biggest intellect of the middle ages, and developed a philosophy which combined the philosophy of Aristotle with the teachings of the Catholic Church. With this combination, a lot of what we find in Aquinas mirrors the writings of Aristotle, both the good and the bad. For example, Aquinas states in his famous Summa Theologica that the price of goods does not depend on their nature but on their usefulness to man.[i] Here Aquinas is following Aristotle in recognizing that it is consumer demand that determines the value of a good instead of the amount of labor or resources used to make a good as later scholars of political economy will suggest. Perhaps his biggest contribution to the history of economic thought, although he strays from it later in the same section, was when he states that “buying and selling seem to be established for the common advantage of both parties.”[ii] This of course is breaking away from Aristotle, at least for a sentence, and suggesting that in an exchange, there are in fact reverse inequalities of values. Immediately after he states this correct analysis however he defaults back to the position of Aristotle and claims that in order for an exchange to take place, the values of goods being exchanged must be equated. Although it is speculation, Aquinas’ brief inquiry into a mutual beneficial exchange could have led later Scholastic writers to follow this line of thought, which eventually led them to justify usury because of their understanding of time preference. If they understood that a voluntary exchange is mutually beneficial, it is not a far leap to begin searching for why individuals would participate in usury unless both parties were benefiting.

                Aquinas, unlike the later Scholastics, did not make this connection, and for that reason followed Aristotle and the teachings of the church in condemning usury, however he goes further and suggests that usury is unjust since money is in fact consumed during an exchange. He argues that money’s use is equivalent to its ownership, thus when one charges interest one is in fact double charging, which he argues is unjust. While this is a thesis he alone developed, I believe the reasoning for it came from Aristotle’s separation of primary and secondary uses. Money’s primary use is ownership, while its use for display is a secondary use. Here the primary use gets destroyed when an exchange takes place since one does not own the money afterwards and the exchange of further money results in a double charge.

                While it is quite clear today that the work of Aquinas was in no way up to par with even that of the Scholastics, he did make two major contributions to the study of economics. By sticking to the subjective theory of value as Aristotle had put forward, and by being one of the first writers to suggest that a voluntary exchange implies mutual benefits for both parties, Aquinas laid the ground work for the Scholastics to later build on.

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[i] The second section of “By sins committed in buying and selling” in the Second Part of the Second Part in Aquinas’ Summa Theologica

[ii] The first section of “By sins committed in buying and selling” in the Second Part of the Second Part in Aquinas’ Summa Theologica

The Economics of Aristotle

*Over the following weeks I'll be giving summaries and some analysis to the writings of some of the major thinkers in the history of economic thought. The authors will not precede or follow in the tradition of the Austrian school of thought (with the exception of Turgot and Cantillion), although I will analyze the pros and cons of each author from a Misesian perspective to the best of my ability. For a more in depth analysis of each of the following authors, I would recommend Murray Rothbard's two volume text on the history of economic thought.

Aristotle made some of the first contributions to the study of what is now known as economics, although some of these contributions were most definitely more advanced than others. For example, Aristotle recognized in his Politics one of the basic axioms of economics, mainly that people act in order to obtain that which they think is good.[i] These desires are represented through money, which is used by individuals who purchase what they want or need. [ii] The more money one makes, the more his services are said to be demanded by other individuals. Aristotle is touching here on subjective values, although he does not go into a deep analysis. Rothbard points out however that he does understand the Austrian insight that “if good A is more valuable than good B, the loss of good A is considered worse than the loss of good B.”[iii] Another strong point in the economics of Aristotle is that he breaks from the view of his teacher Plato, who thought that communal property would bring about peace. Aristotle counters his teacher by pointing out in a society of communal ownership, some will receive less than they feel they deserve given the amount of work they did, while some will receive more than others feel they deserve given their amount of work.[iv] While Aristotle was one of the first philosophers to touch on subjects of political economy, an area which he undoubtedly made tremendous contributions, in my opinion he did more to help lead scholars astray than to advance the study of political economy.

Perhaps the most notable and important mistake Aristotle made with regards to the study of political economy was that he believed that in order for an exchange to take place, the goods within the exchange must be equated.[v] This belief, which is incorrect due to the fact of a double inequality of values in an exchange, led later thinkers to question when a price is just, since one would infer from Aristotle’s statement that no one would take part in a transaction in which they would receive less value than they are giving away. Being unable to understand that an exchange necessarily involves a double inequality of wants led him towards dismissing usury as unjust, since the money lent would not be equated to the money paid back to the lender. It seems Aristotle did not understand how risk and time preference play a role in the decision for individuals to lend money. He further led scholars astray in a pre-Ricardian fashion by splitting the usefulness of a good into the use for exchange and that use which a good is typically used for (i.e. a shoe is used for wearing).[vi] While he did not split how value is determined as Ricardo did, he put in place the precedent for one to understand that there could be two different values for the same good. It is not a stretch from Aristotle’s writings to conclude that each use has a different value to an actor, in fact, it is essentially implicit since if one were to exchange a good instead of use the good for that which it was intended, one would be in fact placing a higher value on the good for exchange than the value of the goods intended use.

                As we see throughout the history of economic thought, it is the mistakes of Aristotle which have a bigger impact on the thinking of later scholars rather than the correct contributions he made to the study of political economy.

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[i] Book I, part I of Aristotle’s Politics

[ii] Book V, part V of Aristotle’s Nicomachean Ethics

[iii] Ch. 1, p.18 of Rothbard’s Classical Economics

[iv] Book II, part V of Aristotle’s Politics

[v] Book V, part V of Aristotle’s Nicomachean Ethics

[vi] Book 1, part IX of Aristotle’s Politics

The New Roach Motel: Quantitative Easing

https://drive.google.com/file/d/0B32uBlANVZcNY1QxdEtsMm1YcmM/view?usp=sharing

Attached is my term paper I wrote at the end of the fall semester. 

An Argument against Open Market Operations in Equity Securities

An Argument against Open Market Operations in Equity Securities

            Since 2008, many have argued that there needs to be more regulation and intervention in financial markets. After witnessing the federal government take over Fannie and Freddie as well as the insurance giant A.I.G., there has been a push to allow the Federal Reserve to also step in during times of economic panic and carry out open market operations in equity securities of private firms. While to many this may not seem like a bad idea on the surface, many problems will arise if the Fed is allowed to conduct these purchases.

            The most obvious problem that will arise is the problem of moral hazard. There is an example of this currently in the courts that is attempting to deal with what to do with the profits of Fannie and Freddie. Should they be returned to the shareholders, or continue to be paid to the government? The problem is that since the government bailed out the companies in the past, there is now an explicit backing by the government, instead of the implicit backing the companies had received prior to the financial crisis in 2008. This means that if Fannie and Freddie were to fail in the future, the government has established the precedent of bailing them out. If profits are to be returned to the shareholders of Fannie and Freddie, the government would in effect be condoning the combination private profits, paid only to the shareholders, and socialized losses, paid for by the taxpayer. The same problem would arise if, instead of the federal government, the Federal Reserve took part in the equity purchases. The only difference is that the cost of the losses would be paid for not by the taxpayer directly, but rather indirectly by anyone who held the U.S. dollar. This is simply because in order to purchase securities in the troubled firm, the Fed would need to expand its balance sheet, or in other words, more money would need to be created. The new money would expand the existing stock, therefore stealing purchasing power from the stock of money already in existence.[1] Therefore the firms would get all the benefit in times of prosperity, while in times of hardship, the losses they would incur would be shared with holders of the dollar. This strategy of privatizing profits and socializing losses is not a political strategy that would last too long in the United States, especially given the public response to the bailouts back in 2008.

            Even with the problems associated with moral hazard, the worst problem that will arise if the Fed were allowed to carry out open market operations in equity securities is one that already exists today because of the Fed; it is the problem of a misallocation of resources. When the Fed increases its balance sheet, which it would need to do in order to make open market purchases of equity securities, the interest rate is necessarily lowered below the rate that would arise on the free market, or as Knut Wicksell states, the interest rate is artificially lowered below the “natural” rate of interest.[2] Interest is, as the great economist Ludwig von Mises defines it, “the difference in the valuation of present goods and future goods; it is the discount in the valuation of future goods as against that of present goods.”[3] So why is it a problem if the interest rate is artificially lowered below the natural rate? Because the market receives mixed signals about the time preference preferred within the economy, in other words, resources are misallocated. In a genuine free market, the interest rate is raised and lowered by the amount of savings available to be lent out; the greater the amount of savings, the lower the prevailing interest rate. Therefore, when there is a large amount of savings and the interest rate is low, the market is essentially saying that consumers are presently choosing to delay consumption until a further date upon which they can consume more goods. This correlates with the production of businesses, which will now to choose to invest in capital goods due to the lower rate of interest. The increase in capital goods will bring about more goods in the future, which will satisfy the future desires of consumers who are planning to consume more in the future given their postponement of consumption today. However, when the interest rate is artificially lowered, there are mixed signals being shown in the market. It is not an increase in savings that induces the fall in the interest rate. Therefore, consumers are not choosing to postpone present consumption until the future, rather they are consuming in the present. Meanwhile, because of the lower interest rates, businesses begin investing more in capital goods, expecting that when they are producing more in the future, there will be consumers ready to buy. While it is quite clear there will be a problem in the future since there are no savings to purchase the future goods, there is also a problem in the present. More resources are trying to be used than are available in the economy since there is no increase in savings. Because of this Mises states, “Credit expansion can bring a temporary boom. But such fictitious prosperity must end in a general depression of trade.”[4]

            Given these two major problems, I do not think that the Federal Reserve should be allowed to carry out open market operations in equity securities. Following this argument to its logical conclusions, the Fed should not be able to conduct any open market purchases, since doing so is the root cause of the business cycle.[5]

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[1] See, What Has Government Done to Our Money?, by Murray N. Rothbard.

[2] See, Interest and Prices, by Knut Wicksell.

[3] Planning for Freedom, by Ludwig von Mises. pp. 187-88

[4] Planned Chaos, by Ludwig von Mises. p. 21

[5] See, Economic Depressions: Their Cause and Cure, by Murray N. Rothbard for more.