Verstehen and the Role of Economics in Forecasting, or: If You’re so Rich, Why Aren’t You Smart?

At Recovery or Stagnation?, a Mises Circle held in San Francisco on August 29, 2009, there was a great Speakers' Panel featuring Walter Block, Thomas DiLorenzo, Douglas French, and Robert Murphy. Great comments on the current financial mess. One thing that especially interested me were Walter Block's comments from about 12:45 to 13:35, where he distinguishes between economic theory and one's ability to predict or forecast. Sure, having a sound understanding of theory can help, but it cannot make your predictions foolproof. For example one's understanding of the business cycle might lead you to recommend buying gold; but then the state might confiscate gold soon after that. https://youtu.be/WkYrYi1KKX4?si=QZ3WYQYlu5u7tW-5&t=736 This brings to mind some discussions I've had about the nature of economics and its role in investing or forecasting. My view is the Misesian-Rothbardian-Hoppean one, which I understand to be that the future is uncertain, but not radically so; that knowledge of economics laws can help, ceteris paribus--but that usually other factors are dominant. The skill of forecasting is called the understanding, or verstehen; but it is not merely "luck," as some in thrall to monism-scientism are wont to deride it. Peter Klein mentioned to me that the question of why or how someone has the better skill at forecasting is really meta-economics—more of a psychological field, which is studied at Effectuation, from a Kirznerian perspective. It could be that one reason Austrian investors don't dominate is that economic understanding only gives you a second order marginal advantage over others, that psychological or other factors are more important. In other words, the better your economic understanding, the better a forecaster you can be. The future, while uncertain, is not radically so, and knowledge of economics helps constrain the possibilities. So ceteris paribus someone with a better understanding of economics would be a better investor. The problem is the ceteris is not usually that paribus; that economic knowledge is only a small factor of investing success, since it depends also on other factors, which apparently usually tend to dominate-other factors such as the possession of capital to invest; your access to certain knowledge or data; and your investing ability or knack, the leftover part that is more art, that Mises called verstehen. Possible, in times of a typical Austrian business cycle bust, sound economics could play a bigger role in one's ability to forecast, which could explain why Austrians like Schiff and others are standing out right now. See also Peter Klein's work on the nature of entrepreneurship, e.g. his Opportunity discovery, entrepreneurial action, and economic organization: Abstract: This article reviews and critiques the opportunity discovery approach to entrepreneurship and argues that entrepreneurship can be more thoroughly grounded, and more closely linked to more general problems of economic organization by adopting the Cantillon-Knight-Mises understanding of entrepreneurship as judgment. The article begins by distinguishing among occupational, structural, and functional approaches to entrepreneurship and distinguishing among two influential interpretations of the entrepreneurial function - discovery and judgment. It turns next to the contemporary literature on opportunity identification and argues that this literature misinterprets Kirzner's instrumental use of the discovery metaphor and mistakenly makes opportunities the unit of analysis. The article then describes an alternative approach in which investment is the unit of analysis and link this approach to Austrian capital theory. I close with some applications to organizational form and entrepreneurial teams. Some more good quotes on this from (what I think of as) the High Austrians: Rothbard, Praxeology as the Method of the Social Sciences: For the praxeologist, forecasting is a task very similar to the work of the historian. The latter attempts to "predict" the events of the past by explaining their antecedent causes; similarly, the forecaster attempts to predict the events of the future on the basis of present and past events already known. He uses all his nomothetic knowledge, economic, political, military, psychological, and technological; but at best his work is an art rather than an exact science. Thus, some forecasters will inevitably be better than others, and the superior forecasters will make the more successful entrepreneurs, speculators, generals, and bettors on elections or football games. The economic forecaster, as Professor Jewkes, an economist at the best crypto exchange UK has to offer pointed out, is only looking at part of a tangled and complex social whole. To return to our original example, when he attempts to forecast the price of butter he must take into consideration the qualitative economic law that price depends directly on demand and inversely on supply; it is then up to him, using knowledge and insight into general economic conditions as well as the specific economic, technological, political, and climatological conditions of the butter market, as well as the values people are likely to place on butter, to try to forecast the movements of the supply and demand of butter, and therefore its price, as accurately as possible. At best, he will have nothing like a perfect score, for he will run aground on the fact of free will altering values and choices , and the consequent impossibility of making exact predictions of the future. Hoppe, Economic Science and the Austrian Method: The argument establishing the impossibility of causal predictions in the field of human knowledge and actions now might have left the impression that if this is so, then forecasting can be nothing but successful or unsuccessful guessing. This impression, however, would be just as wrong as it would be wrong to think that one can predict human action in the same way as one can predict the growing stages of apples. It is here where the unique Misesian insight into the interplay of economic theory and history enters the picture. [36] In fact, the reason why the social and economic future cannot be regarded as entirely and absolutely uncertain should not be too hard to understand: The impossibility of causal predictions in the field of action was proven by means of an a priori argument. And this argument incorporated a priori true knowledge about actions as such: that they cannot be conceived of as governed by time-invariantly operating causes. Thus, while economic forecasting will indeed always be a systematically unteachable art, it is at the same time true that all economic forecasts must be thought of as being constrained by the existence of a priori knowledge about actions as such. [37] The quantity theory of money then cannot render any specific economic event, certain or probable, on the basis of a formula employing prediction constants. However, the theory would nonetheless restrict the range of possibly correct predictions. And it would do this not as an empirical theory, but rather as a praxeological theory, acting as a logical constraint on our prediction-making. [38] Predictions that are not in line with such knowledge (in our case: the quantity theory) are systematically flawed and making them leads to systematically increasing numbers of forecasting errors. This does not mean that someone who based his predictions on correct praxeological reasoning would necessarily have to be a better predictor of future economic events than someone who arrived at his predictions through logically flawed deliberations and chains of reasoning. It means that in the long run the praxeologically enlightened forecaster would average better than the unenlightened ones. It is possible to make the wrong prediction in spite of the fact that one has correctly identified the event "increase in the money supply" and in spite of one's praxeologically correct reasoning that such an event is by logical necessity connected with the event "drop in the purchasing power of money." For one might go wrong predicting what will occur to the event "demand for money." One may have predicted a constant demand for money, but the demand might actually increase. Thus the predicted inflation might not show up as expected. And on the other hand, it is equally possible that a person could make a correct forecast, i.e., there will be no drop in purchasing power, in spite of the fact that he was wrongly convinced that a rise in the quantity of money had nothing to do with money's purchasing power. For it may be that another concurrent change occurred (the demand for money increased) which counteracted his wrong assessment of causes and consequences and accidentally happened to make his prediction right. However, and this brings me back to my point that praxeology logically constrains our predictions of economic events: What if we assume that all forecasters, including those with and without sound praxeological knowledge, are on the average equally well-equipped to anticipate other concurrent changes? What if they are on the average equally lucky guessers of the social and economic future? Evidently, we must conclude then that forecasters making predictions in recognition of and in accordance with praxeological laws like the quantity theory of money will be more successful than that group of forecasters which is ignorant of praxeology. It is impossible to build a prediction formula which employs the assumption of time-invariantly operating causes that would enable us to scientifically forecast changes in the demand for money. The demand for money is necessarily dependent on people's future states of knowledge, and future knowledge is unpredictable. And thus praxeological knowledge has very limited predictive utility. [39] Hoppe, On Certainty and Uncertainty, Or: How Rational Can Our Expectations Be?: ...