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Lost and found: Recovering missing links

The subtle distinction between storytelling and science

This post is for economics professors (and the occasional blogger) who appear confused.

Abbridged version submitted 30 November, 2014, MM-Blog  (abbridged because of space restriction to 4.096 characters)

 

The I=S discussion is the widely visible monument of a lack of genuine scientific instinct of both orthodox and heterodox economists. In order to make this perfectly clear it is necessary not to accept the familiar premises but to dig deeper. As Keynes already recognized:

“For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (1973, p. xxi)

 

That an error/mistake is almost always located in the premises is well-known from methodology:

“In fact, the history of every science, including that of economics, teaches us that the elementary is the hotbed of the errors that count most.” (Georgescu-Roegen, 1970, p. 9)

 

So, what has first of all to be replaced is this formal description of the economy:

“In the most simple model of a closed economy without government, income (Y)=consumption (C) + saving (S), but also expenditure (Y)=consumption (C) + investment (I). So S=I by definition. But here investment includes what is called ‘stockbuilding’ or ‘inventory accumulation’, which includes goods that firms wanted to sell but could not.” (quote from above)

 

Instead:

The most elementary economic configuration, i.e. the pure consumption economy, is defined by (i) Yw=WL wage income Yw is equal to wage rate W times working hours L, (ii) O=RL output O is equal to productivity R times working hours L, (iii) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

 

This is the formal minimum. For the graphical representation see here.

 

At any given level of employment L, the wage income that is generated in the consolidated business sector follows by multiplication with the  wage rate. On the real side output follows by multiplication with the productivity. Finally, the price follows as the dependent variable under the conditions of budget balancing, i.e. C=Yw and market clearing, i.e. x=O. Note that the ray in the southeastern quadrant is not a linear production function; the ray tracks ANY underlying production function.

 

If the wage rate W is lowered, the market clearing price P falls. If the number of working hours L is increased the price remains constant, provided productivity R does not change. If productivity decreases the price rises. In any case, labor gets the whole product, the real wage is invariably equal to the productivity, and profit for the business sector as a whole is zero. All changes in the system are reflected in the market clearing price.

 

In the next period, the households save. The result is shown here.

 

Consumption expenditure C falls below Yw and with it the market clearing price P. With perfect price flexibility there are NO unsold quantities and NO change of inventory. The product market is always cleared and there is no such thing as an inventory investment. So we have household sector saving but no business sector investment, that is, saving which is given by S=Yw-C>0 is NOT equal to investment I=0.

 

Of course, we could also consider the case where the price is sticky, and part of the output O is not sold, i.e. O-X>0 (see 2014a). This, however, would not alter the crucial conclusion.

 

The crucial conclusion is indeed that the business sector makes a loss which is exactly equal to the household sector's saving, i.e. S=-Qm. Therefore, loss (and NOT investment) is the exact counterpart of saving; by consequence, profit is the exact counterpart of dissaving. 

 

And this is why almost everything that conventional professors tell their students is false. Household sector saving has never been equal and will never be equal to business sector investment.

 

The general relationship between monetary profit, distributed profit, investment and saving is given by URL.

 

How could economists get the basics so wrong? Because they cannot tell the difference between income and profit. This is like medieval physics before the pivotal concepts of force and mass were properly defined and understood.

 

As a matter of fact, Keynes's conceptual problems started with profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson and Bezemer, 2010, p. 12)

 

This kicks off the chain reaction of errors/mistakes: When profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. It is with profit where the confusion about saving “equals” investment starts. The conceptual mess has been verbally papered over with capital investment/inventory investment or ex ante/ex post and the representative economist has swallowed all this hook, line and sinker. For the formally correct solution see (2014b).

 

Because neither the Post-Neo-New Keynesians nor the Post-Neo-New Classicals have solved the profit puzzle and with it the saving-investment puzzle, they are collectively out of science (2013).

 

Egmont Kakarot-Handtke

 

References

Georgescu-Roegen, N. (1970). The Economics of Production. American Economic Review, Papers and Proceedings, 60(2): 1–9. URL

Kakarot-Handtke, E. (2013). Why Post Keynesianism is Not Yet a Science. Economic Analysis and Policy, 43(1): 97–106. URL

Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL

Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke:

Macmillan. (1936).

Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL

 

 

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It's all in the structural employment equation — end of discussion

Comment on 'The low wages fallacy'

Submitted November 15, 2014, LPS-Blog

 

When one switches from the obsolete subjective-behavioral approach to the correct objective-structural paradigm then one gets this employment equation for the business sector as a whole under the condition of product market clearing: URL

 

The equation says that employment L increases with

  • investment expenditures I,

  • an increasing expenditure ratio rhoE  (i.e., average propensity to consume),

  • an increasing wage rate W,

 

if price P and productivity R in the consumption and investment industry as well as distributed profit remain unaltered in the period under consideration. A falling wage rate for the business sector as a whole increases unemployment.

 

The testable structural employment equation (2014, eq. (22)) is general; it includes the working of the wage-price mechanism and contains Keynes's argument as a special case. And it holds under inflationary and deflationary conditions.

 

Egmont Kakarot-Handtke

 

References

Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

 

 

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From anything goes to nothing goes right

Comment on 'Mainstream macroeconomics distorts our understanding of economic reality'

Submitted 12 November, 2014, LPS-Blog

 

Economists owe the world the true economic theory, that is, a theory that satisfies the scientific standards of material and formal consistency and that explains how the economy works.

 

Economists have not delivered. But they have delivered a lot of reasons why they have not delivered. Complexity is number one. Hypotheses-testing-is-not-possible is number two. Duhem-Quine comes next. Very popular is also the solidarity of ignorance: “There is no objective truth in economics,” “Nobody understands the whole picture. Everybody gets a piece of it.” (Roosevelt URL)

 

Here is the mother of all excuses:

“Economics is a strange sort of discipline. The booby traps I mentioned often make it sound as it is all just a matter of opinion. That is not so. Economics is not a Science with a capital S. It lacks the experimental method as a way of testing hypotheses. . . . There are always differences of opinion at the cutting edge of a science, . . . . But they last longer in economics . . . and there are reasons for that. As already mentioned, rival theories cannot be put to an experimental test. All there is to observe is history, and history does not conduct experiments: too many things are always happening at once. The inferences that can be made from history are always uncertain, always disputable, . . . You can’t even count on a long and undisturbed run of history, because the “laws” of behavior change and evolve. Excuses, excuses. But the point is not to provide excuses.” (Solow, 1998, pp. x-xi)

 

Indeed.

 

When we turn to Heterodoxy things seem to get better at first, but then they become abysmal.

 

Tony Lawson has properly identified the methodological blunder of green cheese assumptionism. In short, it is inadmissible to put assumptions like optimization, equilibrium, decreasing returns, perfect competition etcetera into the premises. This mistake is known as petitio principii and J. S. Mill, the founder of economic methodology, dealt with it at length in his System of Logic (see also 2014b).

 

The crucial point is: standard economics is based on behavioral axioms (McKenzie, 2008) and this is not a solid enough foundation.

 

“. . . if we wish to place economic science upon a solid basis, we must make it completely independent of psychological assumptions and philosophical hypotheses.” (Slutzky, quoted in Mirowski, 1995, p. 362)

 

Axel Leijonhufvud sees this quite clearly: “Our axioms are, after all, a good deal shakier than Euclid’s.” Indeed, but then comes the Great Heterodox Methodological Horror.

 

Instead of replacing the shaky behavioral axioms with something objective and solid, Heterodoxy rejects the axiomatic-deductive method (2012). Does it really come as a surprise that since Lawson has written about open systems Heterodoxy has not produced much of scientific value? Instead it has become the most outspoken proponent of the pluralism of wish-wash.

 

Note that the profit theory of Keynes, Kalecki, or Keen, for example, is as far away from reality as any mainstream profit theory, “... surely, therefore, they fail to capture the essence of a capitalist market economy.” (Obrinsky, 1981, p. 495)

 

Each paradigm stands or falls with its premises. For the scientific beginners among economists it is all in Wikipedia:

 

“When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle, Analytica, URL)

 

For the correct axiomatic foundations of the open market system see (2014a). Seventeen years of methodological distortion are over for Lars Syll  — thank Heaven and Euclid.

 

Egmont Kakarot-Handtke

 

References

Kakarot-Handtke, E. (2012). Crisis and Methodology: Some Heterodox Misunderstandings. SSRN Working Paper Series, 2083519: 1–22. URL

Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL

Kakarot-Handtke, E. (2014b). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL

McKenzie, L. W. (2008). General Equilibrium. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–18. Palgrave Macmillan, 2nd edition. URL

Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.

Obrinsky, M. (1981). The Profit Prophets. Journal of Post Keynesian Economics, 3(4): 491–502. URL

Solow, R. M. (1998). Foreword, volume William Breit and Roger L. Ranson: The Academic Scribblers. Princeton, NJ: Princeton University Press, 3rd edition.

 

 

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From opinion recycling to real scientific progress

A general comment on the blog's content

Submitted November 7, 2014, TSW-Blog

 

 

It is widely known that the representative economist does not understand how the economy works. Many explanations have been advanced. Putting aside all individual specifics and exceptions for the moment, the main reason is this:

 

Neither Classicals, nor Walrasians, nor Marshallians, nor Marxians, nor Keynesians, nor Institutionialists, nor Monetary Economists, nor Austrians, nor Sraffaians, nor Evolutionists, nor Game theorists, nor Econophysicists, nor RBCers, nor New Keynesians, nor New Classicals ever came to grips with profit (cf. Desai, 2008). Hence, 'they fail to capture the essence of a capitalist market economy' (Obrinsky, 1981, p. 495).

 

Neither orthodox nor heterodox economists understand the two most important phenomena in the economic universe: profit and income (2014b; 2014a). Because of this economists have nothing to offer in the way of a scientifically founded advice.

 

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

 

It is important to distinguish between political and theoretical economics. In political economics 'anything goes'; in theoretical economics scientific standards are observed. The fundamental rule that guarantees the self-government of the scientific community demands to accept refutation. Refutation refers to material and formal consistency.

 

“In economics we should strive to proceed, wherever we can, exactly according to the standards of the other, more advanced, sciences, where it is not possible, once an issue has been decided, to continue to write about it as if nothing had happened.” (Morgenstern, 1941, p. 369)

 

Political economics is ignorant of this rule and preoccupied with recycling 'dead ideas' (Quiggin, 2010). This explains the secular stagnation of economics.

 

Because they lack the correct profit theory the contributions to this blog cannot claim to offer more than personal opinion. Of opinions, though, economics always had plenty. What is needed is knowledge — scientific knowledge, that is.

 

Egmont Kakarot-Handtke

 

References

Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave

Macmillan, 2nd edition. URL

Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL

Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL

Obrinsky, M. (1981). The Profit Prophets. Journal of Post Keynesian Economics, 3(4): 491–502. URL

Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, NJ, Oxford: Princeton University Press.

Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

 

 

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Economic theory — as false as ever

Comment on Peter Temin and David Vines's 'Keynes — more important than ever'

Submitted November 4, 2014, LPS-Blog

 

 

You write: “We show how hard it was for Keynes to break away from previous theories that work well for individual people and companies — and even for the economy as a whole in the long run — to define the short run in which we all live.”

 

You thereby acknowledge that pre-Keynesian economics, i.e. “previous theories”, are valid except in the short run. That is to say, the Keynesian Revolution claims only the short run as its ecological niche and leaves the rest to what Keynes called the 'classicals'.

 

This is not only false modesty but downright nonsense. Why? Because 'classical' economics always has been invalid and it is still invalid in its recent reincarnations. Why?

 

Let us take the widest possible perspective. The fact of the matter is that neither Classicals, nor Walrasians, nor Marshallians, nor Marxians, nor Keynesians, nor Institutionialists, nor Monetary Economists, nor Austrians, nor Sraffaians, nor Evolutionists, nor Game theorists, nor Econophysicists, nor New Keynesians, nor New Classicals ever came to grips with profit (cf. Desai, 2008, p. 10). Hence, 'they fail to capture the essence of a capitalist market economy' (Obrinsky, 1981, p. 495).

 

Keynes, to his greatest honor, realized that there was something wrong with previous profit theories: 

“His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson and Bezemer, 2010, pp. 12-13, 16)

 

Neither orthodox nor heterodox economists understand the two most important phenomena in the economic universe: profit and income (2014b; 2014a). This is like pre-Newtonian physics before the elementary concepts force and mass were clearly defined.

 

There seems to be complete ignorance among both orthodox and heterodox economists that they have nothing to offer in the way of a scientifically founded advice:

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

 

Because they lack a correct profit theory neither the proponents of the 'classical' nor of the Keynesian approach have a true theory that could help to fix a crisis or to make the world a better place.

 

Egmont Kakarot-Handtke

 

References

Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave

Macmillan, 2nd edition. URL

Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2511741: 1–29. URL

Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL

Obrinsky, M. (1981). The Profit Prophets. Journal of Post Keynesian Economics, 3(4): 491–502. URL

Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL

 

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