Milton Friedman On Economic Methodology

Introduction

Philosophy of economics is broadly concerned with two types of questions: questions of economic morality and questions about the methodologies employed by economists.

Questions of interest to philosophers of economics related to economic methodology include: Is economics a science? Can the study of economics be reduced to the study of physical phenomena (e.g. activities in the human brain)? Should economists adopt the research techniques and methodologies of the natural sciences, or is there something fundamentally different about the study of human behavior and institutions that precludes the use of these approaches? Should the success or failure of economics as a discipline be measured by its ability to predict (and perhaps even control) the future or are there obstacles that make that too high a bar to clear?

In a 1953 essay entitled The Methodology of Positive Economics, Milton Friedman laid out his views on some of the philosophy of economics questions related to economic methodology. 

Friedman was a University of Chicago economist most remembered for challenging Keynesianism, advancing monetarist economic thought, promoting free market economics, and having served as an economic adviser to U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher.

In particular, the 1953 essay details Friedman’s thoughts on whether economics is a science, what metrics we should use to evaluate the success or failure of an economic theory, and whether the realism of economic theories matter.  

Distinction between Positive, Normative, and the Art of Economics

Friedman begins this essay by adopting John Neville Keynes’ (1890) distinction between positive science, normative science, and art. 

In his The Scope and Method of Political Economy (1890, pg. 22), Keynes defines the three terms as follows [emphasis added]:

[A] positive science may be defined as a body of systematized knowledge concerning what is[.] …. The object of a positive science is the establishment of uniformities[.]

[A] normative science …. [may be defined as] a body of systematized knowledge discussing criteria of what ought to be, and concerned therefore with the ideal as distinguished from the actual[.] [The object of a normative science is] the determination of ideals. 

[A]n art [may be defined as] a system of rules for the attainment of a given end. [The object of an art is] the formulation of precepts. 

Friedman adopts Keynes’ nomenclature, distinguishing between positive economics, normative economics, and the art of economics. 

He offers the following definition of positive economics:

Economics as a positive science is a body of tentatively accepted generalizations about economic phenomena that can be used to predict the consequences of changes in circumstances.

He argues that positive economics should be independent of ethical considerations. 

Positive economics is in principle independent of any particular ethical position or normative judgments.

Unlike positive economics, which Friedman argues should be studied independent of ethical/normative considerations, normative economics and the art of economics can’t be independent of positive economics.

Normative economics and the art of economics, on the other hand, cannot be independent of positive economics [because] [a]ny policy conclusion necessarily rests on a prediction about the consequences of doing one thing rather than another, a prediction that must be based - implicitly or explicitly - on positive economics.

Having defined positive economics as a research agenda free from moralistic and normative considerations, Friedman proceeds to elaborate his views on how economic research should be conducted, what its aim should be, and how we should evaluate its success or failure.

Positive Economics is a Science 

Friedman argues that positive economics is a science just like the physical sciences: 

[P]ositive economics is, or can be, an “objective” science, in precisely the same sense as any of the physical sciences.

On whether there is a distinction between positive economics and the physical sciences owing to the human element of the social sciences, Friedman writes:

Of course, the fact that economics deals with the interrelations of human beings, and that the investigator is himself part of the subject matter being investigated in a more intimate sense than in the physical sciences, raises special difficulties in achieving objectivity at the same time that it provides the social scientist with a class of data not available to the physical scientist. But neither the one nor the other is, in my view, a fundamental distinction between the two groups of sciences.

As to the limitations on conducting experiments in the social sciences, and whether that makes the social sciences different from the physical sciences, Friedman argues no.

Unfortunately, we can seldom test particular predictions in the social sciences by experiments explicitly designed to eliminate what are judged to be the most important disturbing influences. Generally, we must rely on evidence cast up by the “experiments” that happen to occur. The inability to conduct so-called “controlled experiments” does not, in my view, reflect a basic difference between the social and physical sciences both because it is not peculiar to the social sciences - witness astronomy - and because the distinction between a controlled experiment and uncontrolled experience is at best one of degree. No experiment can be completely controlled, and every experience is partly controlled, in the sense that some disturbing influences are relatively constant in the course of it.

He suggests that the reliance of the social sciences on these “experiments” conjured up by the world and the limitations on controlled experiments in the social sciences does make the job of a social scientist more difficult. 

Evidence cast up by experience is abundant and frequently as conclusive as that from contrived experiments; thus the inability to conduct experiments is not a fundamental obstacle to testing hypotheses by the success of their predictions. But such evidence is far more difficult to interpret. It is frequently complex and always indirect and incomplete. Its collection is often arduous, and its interpretation generally requires subtle analysis and involved chains of reasoning, which seldom carry real conviction. The denial to economics of the dramatic and evidence of the “crucial” experiment does hinder the adequate testing of hypotheses; but this is much less significant than the difficulty it places in the way of achieving a reasonably prompt and wide consensus on the conclusions justified by the available evidence. It renders the weeding-out of unsuccessful hypotheses slow and difficult. They are seldom downed for good and are always cropping up again.

But he argues that, in some circumstances, the evidence available from experience is almost as good as running controlled experiments.

There is, of course, considerable variation in these respects. Occasionally, experience casts up evidence that is about as direct, dramatic, and convincing as any that could be provided by controlled experiments.

He suggests that experience with inflation is such a case, presenting clear evidence, Friedman argues, of a link between increases in the quantity of money and inflation.

Perhaps the most obviously important example is the evidence from inflations on the hypothesis that a substantial increase in the quantity of money within a relatively short period is accompanied by a substantial increase in prices. Here the evidence is dramatic, and the chain of reasoning required to interpret it is relatively short. Yet, despite numerous instances of substantial rises in prices, their essentially one-to-one correspondence with substantial rises in the stock of money, and the wide variation in other circumstances that might appear to be relevant, each new experience of inflation brings forth vigorous contentions, and not only by the lay public, that the rise in the stock of money is either an incidental effect of a rise in prices produced by other factors or a purely fortuitous and unnecessary concomitant of the price rise.

Differences in Economic Policy Preferences Can Largely Be Eliminated Through the Progress of Positive Economics 

Friedman argues that most of the differences on matters of economic policy among citizens of the Western world owe to differing predictions about the outcomes of economic policies, not to differing values. 

I venture the judgment, however, that currently in the Western world, and especially in the United States, differences about economic policy among disinterested citizens derive predominant from different predictions about the economic consequences of taking action - differences that in principle can be eliminated by the progress of positive economics - rather than from fundamental differences in basic values, differences about which men can ultimately only fight.

Of course, my judgment that the major differences about economic policy in the Western world are of this kind is itself a “positive” statement to be accepted or rejected on the basis of empirical evidence.

In defense of this position, he presents an example of differing policy preferences regarding the implementation of a minimum wage.

An obvious and not unimportant example is minimum-wage legislation. Underneath the welter of arguments offered for and against such legislation there is an underlying consensus on the objective of achieving a “living wage” for all, to use the ambiguous phrase so common in such discussions. The difference of opinion is largely grounded on an implicit or explicit difference in predictions about the efficacy of this particular means in furthering the agreed-on end. Proponents believe (predict) that legal minimum wages diminish poverty by raising the wages of those receiving less than the minimum wage as well as of some receiving more than the minimum wage without any counterbalancing increase in the number of people entirely unemployed or employed less advantageously than they otherwise would be. Opponents believe (predict) that legal minimum wages increase poverty by increasing the number of people who are unemployed or employed less advantageously and that this more than offsets any favorable effect on the wages of those who remain employed. Agreement about the economic consequences of the legislation might not produce complete agreement about its desirability, for differences might still remain about its political or social consequences but, given agreement on objectives, it would certainly go a long way toward producing consensus.

Predictive Accuracy is the Metric for Success

Friedman argues that the metric by which to evaluate the success or failure of positive economic ideas is their predictive capacity:

Its task is to provide a system of generalizations that can be used to make correct predictions about the consequences of any change in circumstances. Its performance is to be judged by the precision, scope, and conformity with experience of the predictions it yields.

[T]he only relevant test of the validity of a hypothesis is comparison of its predictions with experience. The hypothesis is rejected if its predictions are contradicted (“frequently” or more often than predictions from an alternative hypothesis); it is accepted if its predictions are not contradicted; great confidence is attached to it if it has survived many opportunities for contradiction. Factual evidence can never “prove” a hypothesis; it can only fail to disprove it, which is what we generally mean when we say, somewhat inexactly, that the hypothesis has been “confirmed” by experience.

[I]t should perhaps be noted explicitly that the “predictions” by which the validity of a hypothesis is tested need not be about phenomena that have not yet occurred, that is, need not be forecasts of future events; they may be about phenomena that have occurred but observations on which have not yet been made or are not known to the person making the prediction. For example, a hypothesis may imply that such and must have happened in 1906, given some other known circumstances. If a search of the records reveals that such and such did happen, the prediction is confirmed; if it reveals that such and such did not happen, the prediction is contradicted.

He argues that when there is a hypothesis that accurately makes predictions, there will always be more than one that does so, and that we should choose from amongst these various hypotheses by considering their simplicity and the precision of their predictions. 

Observed facts are necessarily finite in number; possible hypotheses, infinite. If there is one hypothesis that is consistent with available evidence, there are always an infinite number that are.

The validity of a hypothesis in this sense is not by itself a sufficient criterion for choosing among alternative hypotheses. 

The choice among alternative hypotheses equally consistent with the available evidence must to some extent be arbitrary, though there is general agreement that relevant considerations are suggested by the criteria “simplicity” and “fruitfulness,” themselves notions that defy completely objective specification. A theory is “simpler” the less the initial knowledge needed to make a prediction within a given field of phenomena; it is more “fruitful” the more precise the resulting prediction, the wider the area within which the theory yields predictions, and the more additional lines for further research it suggests.

As-If Economics

Friedman, having asserted that the test of the success or failure of an economic theory is its capacity to make predictions, suggests that the realism of theories is irrelevant. 

He asks us to consider the problem of trying to predict the shots taken by an expert billiards player. He points out that we can make accurate predictions about these shots by assuming that the player knows the complicated mathematical formulas that give the optimal directions of travel, can accurately estimate the angles describing the location of the balls merely by eyeing the table, can make lightning speed calculations using the mathematical formulas, and can make the balls travel in the direction suggested by the formulas. Of course, it is not actually possible for players to do all this. But, we can model the shots made by expert billiards players as if they can: for if their play does not correspond closely with the mathematically optimal strategy, then they cannot truly be professional billiards players.

Consider the problem of predicting the shots made by an expert billiard player. It seems not at all unreasonable that excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas that would give the optimum directions of travel, could estimate accurately by eye the angles, etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas. Our confidence in this hypothesis is not based on the belief that billiard players, even expert ones, can or do go through the process described; it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.

Friedman suggests that this as if approach is a valid one for economists to employ: why not model firms in an economy as if they are rational agents who possess perfect information and are seeking to maximize their expected returns.

It is only a short step from these examples to the economic hypothesis that under a wide range of circumstances individual firms behave as if they were seeking rationally to maximize their expected returns …. and had full knowledge of the data needed to succeed in this attempt; as if, that is, they knew the relevant cost and demand functions, calculated marginal cost and marginal revenue from all actions open to them, and pushed each line of action to the point at which the relevant marginal cost and marginal revenue were equal. Now, of course, businessmen do not actually and literally solve the system of simultaneous equations in terms of which the mathematical economist finds it convenient to express this hypothesis, any more than …. billiard players explicitly go through complicated mathematical calculations[.]  …. [U]nless the behavior of businessmen in some way or other approximated behavior consistent with the maximization of returns, it seems unlikely that they would remain in business for long.

Therefore, according to Friedman, critiques of “orthodox” economic theory as unrealistic are without merit because the true metric by which to evaluate the worth of a theory is not its realism but its predictive capacity.  

The abstract methodological issues we have been discussing have a direct bearing on the perennial criticism of “orthodox” economic theory as “unrealistic”[.] …. Economics is a “dismal” science because it assumes man to be selfish and money-grubbing …. it rests on outmoded psychology and must be reconstructed in line with each new development in psychology; …. it assumes markets to be perfect, competition to be pure, and commodities, labor, and capital to be homogeneous. As we have seen, criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or another of these respects from the theory being criticized yields better predictions for as wide a range of phenomena. Yet most such criticism is not so supplemented; it is based almost entirely on supposedly directly perceived discrepancies between the “assumptions” and the “real world.”

The Realism of A Theory’s Assumptions Is Irrelevant

For Friedman, the critique that as if theories are based on unrealistic assumptions is irrelevant.

He argues that those in favor of more realistic assumptions would need to somehow discern how realistic they should make their theory: if they attempt to make it completely realistic by consideration of every possible relevant factor, the theory would become so complex that it would be rendered useless.

Thus, Friedman argues, these critics need some way of determining how realistic they should make their assumptions. 

And the way for them to do this, according to Friedman, is to evaluate the predictive capacity of including or excluding certain factors, at which point they are accepting his view that predictive accuracy is the measure of success for economic theories. 

Friedman presents us with an example about attempting to construct a realistic theory of the behavior of businesses. He asks us to consider how we can decide that inclusion of a businessman’s eye color is irrelevant to the theory but the costs of businesses are not. He suggests that the way to do so is to see whether the inclusion of each of these factors makes the theory more predicatively accurate. And we would conclude that including the the costs of businesses increases the predictive accuracy of the theory while including the eye color of businessmen does not. 

A theory or its “assumptions” cannot possibly be thoroughly “realistic” in the immediate descriptive sense so often assigned to this term. A completely “realistic” theory of the wheat market would have to include not only the conditions directly underlying the supply and demand for wheat but also the kind of coins or credit instruments used to make exchanges; the personal characteristics of wheat-traders such as the color of each trader’s hair and eyes, his antecedents and education, the number of members of his family, their characteristics, antecedents, and education, etc.; the kind of soil on which the wheat was grown, its physical and chemical characteristics, the weather prevailing during the growing season; the personal characteristics of the farmers growing the wheat and of the consumers who will ultimately use it; and so on indefinitely. Any attempt to move very far in achieving this kind of “realism” is certain to render a theory utterly useless.

Of course, the notion of a completely realistic theory is in part a straw man. No critic of a theory would accept this logical extreme as his objective; he would say that the “assumptions” of the theory being criticized were “too” unrealistic and that his objective was a set of assumptions that were “more” realistic though still not completely and slavishly so. But so long as the test of “realism” is the directly perceived descriptive accuracy of the “assumptions” - for example, the observation that “businessmen do not appear to be either as avaricious or as dynamic or as logical as marginal theory portrays them” …. - there is no basis for making such a distinction, that is, for stopping short of the straw man depicted in the preceding paragraph. What is the criterion by which to judge whether a particular departure from realism is or is not acceptable? Why is it more “unrealistic” in analyzing business behavior to neglect the magnitude of businessmen’s costs than the color of their eyes? The obvious answer is because the first makes more difference to business behavior than the second; but there is no way of knowing that this is so simply by observing that businessmen do have costs of different magnitudes and eyes of different color. Clearly it can only be known by comparing the effect on the discrepancy between actual and predicted behavior of taking the one factor or the other into account. Even the most extreme proponents of realistic assumptions are thus necessarily driven to reject their own criterion and to accept the test by prediction when they classify alternative assumptions as more or less realistic.

Thus he concludes that as if theories: 

cannot be tested by comparing its “assumptions” directly with “reality.” Indeed, there is no meaningful way in which this can be done. Complete “realism” is clearly unattainable, and the question whether a theory is realistic “enough” can be settled only by seeing whether it yields predictions that are good enough for the purpose in hand or that are better than predictions from alternative theories.

On this view, the criticism that the assumptions made by as if economic theories are unrealistic is, for Friedman, inconsequential.

Yet the belief that a theory can be tested by the realism of its assumptions independently of the accuracy of its predictions is widespread and the source of much of the perennial criticism of economic theory as unrealistic. Such criticism is largely irrelevant, and, in consequence, most attempts to reform economic theory that it has stimulated have been unsuccessful.

Summary

Friedman’s 1953 essay entitled The Methodology of Positive Economics, lays out his views on some of the most hotly contested questions in the philosophy of economics.

On the question of whether economics is a science, Friedman argued that positive economics is indeed a science.

And he believed that most differences in economic policy preferences amongst citizens of the Western world can be eliminated through the progress of this science.

Friedman also argued that limitations on the ability to conduct controlled experiments in economics does not make the discipline fundamentally different from the physical sciences. In fact, Friedman suggests that the organic experiments conjured up by real world experience are occasionally as good as any controlled laboratory style experiment. 

Friedman further addresses the issue of economists being both observers of and participants in economic processes. Whereas in the physical sciences the natural phenomena a scientist is studying are independent of oneself, an economist both observes economic phenomena and is an actor in the economy. Friedman argues that this does not make economics fundamentally different from the physical sciences nor any less scientific. 

The Chicago economist also argues that the appropriate metric by which to evaluate the strength of an economic theory is its predictive capacity.

And he claims that the realism of the theory is irrelevant; all that matters is the ability of the theory to make predictions. Thus Friedman concludes that the criticisms of “orthodox” economics as unrealistic are unfounded. 

Critiques

Friedman’s 1953 article has become so famous that some authors have taken to referring it to by the shorthand “F53.” Mäki (2009) has called F53 “the most cited, the most influential and the most controversial piece of methodological writing in twentieth-century economics.” And articles continue to be written challenging and reinterpreting F53.  

Herbert Simon

In 1963 the American Economic Association held its 75th annual meeting. Present at this meeting were some of the day’s most influential economic thinkers, including Paul Samuelson and Herbert Simon. 

At the gathering, Herbert Simon challenged F-53, referring to its idea that accurate predications can be derived from false assumptions as Friedman’s “principle of unreality.”

His critique included two proposals. The first is to replace the assumption of classical economics that businessmen can perfectly identify the profit-maximizing course of action with a more realistic proposition. The second is a proposal to replace F-53’s “principle of unreality” with a “principle of continuity of approximation.”

Below is a summary of Simon’s brief critique of F-53. 

Proposal One

Simon introduces the three propositions which he labels X, Y, and Z. The first two deal with economic actors:

X – businessmen desire to maximize profits;

Y – businessmen can and do make the calculations that identify the profit-maximizing course of action.

The third proposition deals with theory at the level of the market. 

Z – prices and quantities are observed at those levels which maximize the profits of the firms in the market. 

He then sums up Friedman’s approach as follows.

Defending the theory consisting of X, Y, and Z, Friedman asserts that it doesn’t matter if X and Y are false, provided Z is true. 

Simon proceeded to advocate for the replacement of Y.

The logical fallacy in Friedman’s principle of unreality has exerted so much fascination – both in this session and elsewhere – that attention has been distracted from its other errors. Most critics have accepted Friedman’s assumption that proposition Z is the empirically tested one, while X and Y are not directly observable. This, of course, is nonsense. No one has observed whether the actual positions of business firms are the profit-maximizing ones; nor has anyone proposed a method of testing this proposition by direct observation. I cannot imagine what such a test would be, since the test would be as incapable as business firms are of discovering what the optimal position actually is. …. Now we do have a considerable body of evidence about X and Y, and the vast weight of evidence with respect to Y, at least, is that it is false. The expressed purpose of Friedman’s principle of unreality is to save classical theory in the face of the patent invalidity of Y. …. The remedy for the difficulty is straightforward, although it may involve more empirical work at the level of individual actors than most conventionally-trained economists find comfortable. Let us make the observations necessary to discover and test true propositions, call them X’ and Y’, to replace the false X and Y. Then let us construct a new market theory on these firmer foundations. 

Proposal Two

Simon then proposes an alternative to what he calls Friedman’s “principle of unreality” which he dubs the “principle of continuity of approximation.”

According to this principle, the closer the real world is to “ideal types” based on unrealistic assumptions – such as markets with perfect competition – the more approximately correct the conclusions reached from the use of such ideal types in theorizing will be.   

There has been much talk at this session of ideal types: perfect vacuums and perfect competition. I am not satisfied with the answers to Friedman’s argument that he has as much right as the physicists to make unreal assumptions. Was Galileo also guilty of using the invalid principle of unreality? I think not. I think he was interested in behavior in perfect vacuums not because there aren’t any in the real world, but because the real world sometimes sufficiently approximates them to make their postulation interesting. 

Let me propose a methodological principle to replace the principle of unreality. I should like to call it the “principle of continuity of approximation.” It asserts: if the conditions of the real world approximate sufficiently well the assumptions of an ideal type, the derivations from these assumptions will be approximately correct. …. Unreality of premises is not a virtue in scientific theory; it is a necessary evil – a concession to the finite computing capacity of the scientist that is made tolerable by the principle of continuity of approximation.

Sources

Milton Friedman. The Methodology of Positive Economics in Essays in Positive Economics. University of Chicago Press. 1953. pg. 3-43.

Uskali Mäki. Reading the methodological essay in twentieth-century economics: map of multiple perspectives. In U. Mäki (Editor), The Methodology of Positive Economics: Reflections on the Milton Friedman Legacy. Cambridge University Press. (2009a). pp. 47-67.

Herbert Simon. Discussion. The American Economic Review. Vol. 53, No. 2, Papers and Proceedings of the Seventy-Fifth Annual Meeting of the American Economic Association (May, 1963), pg. 229-231

Written By: Aiden Singh Published: April 21, 2020 Last Updated: August 31, 2020