July 31, 2015

Yes, it's scientific junk, so leave it behind for good

Comment on ‘On the poverty of microfoundationalist fantasies’

Blog-Reference

Heterodoxy is one crucial step ahead of Orthodoxy. As a matter of fact, today it is simply no longer possible to be an orthodox economist. So far, so good, but what comes next?

“As will become evident, there is more agreement on the defects of orthodox theory than there is on what theory is to replace it: but all agreed that the point of the criticism is to clear the ground for construction.” (Nell, 1980, p. 1)

Above, Kevin Hoover summarizes: “Not only does the representative-agent model fail to provide an analysis of those interactions, but it seems likely that that they will defy an analysis that insists on starting with the individual, and it is certain that no one knows at this point how to begin to provide an empirically relevant analysis on that basis.”

Orthodoxy starts off on the wrong foot, that is, with individual behavior. From Orthodoxy's failure follows for Heterodoxy as the negative heuristic: first of all abandon nonentities like utility, equilibrium, rational expectations, and the use of functions (supply, demand, and all the rest). As the positive heuristic follows: start with the economic system as a whole and then differentiate consistently into ever smaller sub-units.

Traditional Heterodoxy has cleared the ground for construction. Now the time of Constructive Heterodoxy has come.* The citadel has been conquered and found to be empty. It can safely be left behind.

“The point ... is to suggest ... that if one maintains the fundamentally individualistic approach to constructing economic models no amount of attention to the walls will prevent the citadel from being empty. Empty in the sense that one cannot expect it to house the elements of a scientific theory, one capable of producing empirically falsifiable propositions. (Kirman, 1989, p. 126)

Egmont Kakarot-Handtke


References
Kirman, A. (1989). The Intrinsic Limits of Modern Economic Theory: The Emperor has No Clothes. Economic Journal, Conference Papers, 99(395): 126–139. URL
Nell, E. J. (1980). Growth, Profits, and Property, chapter Cracks in the Neoclassical Mirror: On the Break-Up of a Vision, pages 1–16. Cambridge, New York, NY, Melbourne: Cambridge University Press.

For the new start see the overview

July 30, 2015

How to save the economy from storytelling economists

Comment on Simon Wren-Lewis on ‘The F story about the Great Inflation’

Blog-Reference

There is political economics and theoretical economics. In political economics, it suffices to tell a good story, in theoretical economics scientific standards are observed. Because economists since Adam Smith pursued these two hares with varying intensity consistency eventually got out of sight. More precisely, economists failed to develop a theory about how the market economy works that satisfies the criteria of material and formal consistency.

The Phillips curve debate is a case in point. Originally, Phillips presented an astounding empirical relation between the rate of unemployment and the rate of change of the wage rate. After a little conceptual shell gaming, it was about unemployment and inflation. And after some additional wish-wash about expectations, the ending of the story was that there is no way to escape natural unemployment.

This conclusion lacks a sound theoretical foundation. To make a long argument short, the most elementary version of the correct employment equation is given here.

From this equation follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment. An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This explains the original Phillips curve but is contrary to conventional wisdom. It is, though, easy to prove that conventional wisdom is a mere fallacy of composition (2015).
(iv) A price increase lowers the factor cost ratio and is conducive to lower employment. This explains stagflation.
(v) The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world. All variables are measurable, the structural employment equation is testable.

Point (i) and (ii) is old Keynesian stuff. Let us focus here alone on the factor cost ratio as defined in (iii). This variable formally represents the price mechanism which, however, does not work as Orthodoxy imagines. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R. This gives one the lever to improve the employment situation all over the world and to fend off deflation without rising debt and without artificial capacity growth.

According to pre-Keynesian Orthodoxy, the price mechanism as embodied in rhoF should spontaneously establish full employment. More precisely, a falling average wage rate should restore full employment. The consistent structural employment equation says that the opposite is true.

The overlooked irony of the original Phillips curve is that it clearly shows a positive correlation between average wage rate and employment that should have cast doubt on the familiar supply-demand-equilibrium story.

The core of the employment problem is that the price mechanism does not work as orthodox economics says and this has nothing to do with wage or price stickiness but with the fact that theoretical economics never could really emancipate itself from political economics and thus arrive at a consistent theory of how the monetary economy works.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

Refers to 'The end of storytelling' and 'Storytelling and facts'

July 29, 2015

Storytelling and facts

Comment on Blissex on ‘The F story about the Great Inflation’

Blog-Reference

You write: “His [Phillips's] original graph was essentially a hunch based on a very small dataset that in some cases there is a tradeoff between labour market pressure and accelerating inflation, ...” This is inaccurate.

(i) “The original Phillips curve is about the relation of the rate of unemployment and the rate of change of the wage rate. Phillips studied more than a century's worth of data and established the stable inverse relation for the United Kingdom. Phillips's original curve was a remarkable empirical finding.” (2012, Sec. 6)
(ii) It is the bastard Phillips curve of Samuelson/Solow which initiated the ensuing discussion and it is this dilettante construction which was later found wanting.

If the Phillips curve debate proves one crucial fact beyond reasonable doubt it is that the representative economist is an utterly confused confuser. This goes down the line from Samuelson/Solow to Friedman, to Wren-Lewis and finally to Blissex.


References
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL

Refers to 'The end of storytelling'. See also 'Mental messies and loose losers'. For the detailed picture see Incompetence: cross-references

July 28, 2015

Stop guessing, start thinking

Comment on David Ruccio on ‘The guessing game’

Blog-Reference

The guessing about the effects of minimum wages makes it clear to everyone that economists lack the correct labor market theory or, even worse, the correct theory of the interaction of markets.

The acceptance of the supply-demand-equilibrium depiction by the majority of economics students can be taken as a proof that you can sell whatever green cheese assumption you may dream up to substandard thinkers.

The first task of Heterodoxy is to discard nonentities like utility or equilibrium and to fully replace the supply-demand-cross as the representation of a market (2015b).

The second task is to determine the systemic interaction between the product and the labor market and the key drivers of overall employment (2015a).

After the vertical differentiation of the product and the labor market, the next task is the horizontal differentiation of arbitrary many product and labor markets (2014).

To recall, Keynes's main issue was employment theory and he was quite clear that orthodox employment theory was defective. However, Keynes succeeded only partly, his employment theory is not general either and misses a crucial feature (2012). The most elementary version of the correct employment equation is given here.

From this follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment.
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This explains the original Phillips curve.
(iv) A price increase is conducive to lower employment. This explains stagflation.

Consisting exclusively of measurable variables, the structural employment equation can be tested. So there is no need to continue the silly guessing game as the main occupation of substandard thinkers.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2014). The Truly General Theory of Employment: How Keynes Could Have Succeeded. SSRN Working Paper Series, 2406891: 1–25. URL
Kakarot-Handtke, E. (2015a). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Kakarot-Handtke, E. (2015b). Essentials of Constructive Heterodoxy: The Market. SSRN Working Paper Series, 2547098: 1–10. URL

Oh no! How could this happen?

Comment on ‘IS-LM vs. Minsky’

Blog-Reference

“I=S is the epitome of economists’s scientific incompetence. If this were as plain as a meteorite hitting the earth the problem would have been fixed long ago; it is, though, just the contrary: subtle, unspectacular, counter-intuitive, subterranean, and rather involved.” *

Of course, IS-LM from Hicks to Krugman is unacceptable because of multiple defects (2014). Keynesians, though, have to admit that it all started with this two-liner in the General Theory: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

For the ultimate explanation of how the IS-LM embarassement could happen see the post ‘Mental messies and loose losers’ *

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. 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.

* See here or at the RWER blog

July 27, 2015

What comes after debunking?

Comment on ‘Why Real Business Cycle models can’t be taken seriously’

Blog-Reference and Blog-Reference

Orthodoxy is a failure and even laypersons understand intuitively that the behavior of the economy as a whole cannot be explained by the behavioral assumption of constrained optimization of individual agents. This has been a non-starter since Jevons-Walras-Menger and Heterodoxy has always said so. Yet, the question is not how this ‘pure nonsense’ ‘could be awarded The Sveriges Riksbank Prize in Economic Sciences’ but why traditional Heterodoxy could not produce something better than this ridiculous specimen of proto-science?

Orthodoxy is long dead but it has not been buried. Why is this scientific zombie (Quiggin, 2010) still around?

“The main reason for the considerable acceptance of the approach is that fundamental rule of scientific combat: it takes a theory to beat a theory. No amount of skepticism about the fertility of a theory can deter its use unless the skeptic can point to another route by which the scientific problem of regulation can be studied successfully.” (Stigler, 1983, p. 541)

So, this is the pork-barrel deal: Orthodoxy does not vanish because of proven scientific incompetence but only if Heterodoxy presents something better.

To do them the favor is the pleasant duty of Constructive Heterodoxy. Let us throw out the ‘real’ business cycle by advancing to the interaction of nominal and real variables which constitutes the business cycle of the economy we happen to live in (2012).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Intertwined Real and Monetary Stochastic Business Cycles. SSRN Working Paper Series, 2173528: 1–27. URL
Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, NJ, Oxford: Princeton University Press.
Stigler, G. J. (1983). Nobel Lecture: The Process and Progress of Economics. Journal of Political Economy, 91(4): 529–545. URL

July 26, 2015

The end of storytelling

Comment on Simon Wren-Lewis on ‘The F story about the Great Inflation’

Blog-Reference

“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 economists have been aware at least since the 1930s that they lack the true theory they let a change of rules happen. The true/false criterion of science vanished and had been replaced by the first rule of communication: “A good principles of economics teacher is a good storyteller.” (Colander, 1995, p. 169)

This is how economics eventually became a sitcom.

This blog makes no exception. Already the third sentence of the intro is incorrect. You write: “After Phillips discovered his curve, which relates inflation to unemployment, ...” It has to be emphasized that Phillips ‘had not made an explicit link between inflation and unemployment’ (Ormerod, 1994, p. 120).

The original curve was bastardized by Samuelson with the formula: rate of inflation = rate of wage growth minus rate of productivity growth (Samuelson and Nordhaus, 1998, p. 590). This ‘important piece of inflation arithmetic’ was fallacious but this did not prevent the acceptance of the Samuelson/Solow ‘Phillips’ curve. Phillips is said to have remarked ‘if I had known what they would do with the graph I would never have drawn it.’ (Quiggin, 2010, p. 91).

The storytelling then continued with Friedman and the vacuous filibuster about expectations and the natural rate of unemployment.

The correct Phillips curve is given here.

This testable structural curve asserts inter alia (2012, Sec. 7):
• An increase of the average wage rate leads to a lower unemployment rate. This is in accordance with the correlation of Phillips's original study, but clearly against conventional labor market wisdom (2015).
• A price increase is conducive to lower employment. This is in accordance with the stagflation of the 1970s.

The structural Phillips curve contains vastly more variables than the methodologically inferior bastard versions. All that has to be done is to stop storytelling and to check how data and formula fit together. Time to make economics a science.

Egmont Kakarot-Handtke


References
Colander, D. (1995). The Stories We Tell: A Reconstruction of AS/AD Analysis. Journal of Economic Perspectives, 9(3): 169–188. URL
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Ormerod, P. (1994). The Death of Economics. London: Faber and Faber.
Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, NJ, Oxford: Princeton University Press.
Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

July 25, 2015

Stubbornly in the wrong research program

Comment on Fredrick Welfare on ‘The Keynes-Ramsey-Savage debate on probability’

Blog-Reference

You say: “The failure to update beliefs and predictions given contradictory evidence constitutes irrationality.”

Because you do not understand the relationship between theory and evidence, you — as both orthodox and heterodox economists — do not understand what science is all about.

“I shall never be able to express strongly enough my admiration for the greatness of mind of these men who conceived this [heliocentric] hypothesis and held it to be true. In violent opposition to the evidence of their own senses and by sheer force of intellect, they preferred what reason told them to that which sense experience plainly showed them ... I repeat, there is no limit to my astonishment when I reflect how Aristarchus and Copernicus were able to let conquer sense, and in defiance of sense make reason the mistress of their belief.” (Galileo, quoted in Popper, 1994, p. 84)

The key words are ‘sheer force of intellect.’ And this gives you the explanation why economists are stuck in pointless wish-wash about utility, equilibrium, expected utility, uncertainty, and the abuse of mathematics by formalizing nonentities. There is not much difference between the Ramsey-Keynes debate and the angels-on-a-pinpoint debate of yore.

Indeed, is there any difference in pseudo-logical hypotheticalness between “angels can fly because they have wings” and “... that people had to behave in this way because if they did not, people would devise schemes that made money at their expense”? And is it not astounding that economists buy these kinds of arguments? And what does this tell you about their ‘sheer force of intellect?’

Egmont Kakarot-Handtke


References
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality., chapter Science: Problems, Aims, Responsibilities, pages 82–111. London, New York, NY: Routledge.

July 24, 2015

We simply do not know — so let us move on

Comment on Lars Syll on ‘The Keynes-Ramsey-Savage debate on probability’

Blog-Reference

Science restricts itself to things that can be known. In marked contrast, non-scientists prefer to spend their lifetime on questions that cannot be answered. Let us face the fact, it is not so much solutions that most people are really interested in, it is more the perpetual inconclusive talk about beliefs. Solutions only spoil the fun.

Economists are traditionally fond of talking about nonentities like equilibrium, utility, or rational expectations. It seems that this bad habit has a debilitating effect also on mathematicians. Our actual question is not whether statistical mechanics is good enough for physics and there is absolutely no need to discuss the finer points of quantum mechanics. Why? Because quantum mechanics and locality and all the rest is irrelevant for economics. All that is relevant about uncertainty and unpredictability is known at least since J. S. Mill and has been stated unmistakably by other well-known people.

“The phenomena with which this science [of human nature] is conversant being the thoughts, feelings, and actions of human beings, it would have attained the ideal perfection of a science if it enabled us to foretell how an individual would think, feel, or act, throughout life, with the same certainty with which astronomy enables us to predict the places and the occultations of the heavenly bodies. It needs scarcely be stated that nothing approaching to this can be done.” (Mill, 2006, p. 846)

“The future is unpredictable.” (Feynman, 1992, p. 147)

“We are very far from being able to predict, even in physics, the precise results of a concrete situation, such as a thunderstorm, or a fire.” (Popper, 1960, p. 139)

“... it has even been argued that economic explanations involving rational choice are a species of ‘folk psychology’, explaining actions in terms of beliefs and desires, variables that cannot be measured independently of the actual choices we want to predict, so that they are no genuine predictions at all.” (Blaug, 1994, p. 113)

Keynes only used more words to restate the obvious.
“The sense in which I am using the term [uncertainty] is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention … About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” (Keynes, 1937, p. 214)

It is remarkable that the representative economist simply does not accept the obvious even when politely told by one of the greatest mathematicians.

“Walras approached Poincaré for his approval. ... But Poincaré was devoutly committed to applied mathematics and did not fail to notice that utility is a nonmeasurable magnitude. ... He also wondered about the premises of Walras’s mathematics: It might be reasonable, as a first approximation, to regard men as completely self-interested, but the assumption of perfect foreknowledge ‘perhaps requires a certain reserve’.” (Porter, 1994, p. 154)

What Walras’s neoclassical heirs can either not see or not accept is that they are in the wrong research program.

“The failure to find such a law [between desire, belief and action] or any approximation to it that actually improves our ability to predict consumer behaviour any better than Adam Smith could have resulted on the one hand in a reinterpretation of the aims of economic theory away from explaining individual human action, ...” (Rosenberg, 1994, p. 224)

And this is the spoilsport. “... 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)

Because economics is definitively ‘not a science of behavior’ (Hudík, 2011), the aim of economic theory has to be changed.
  • Old definition, subjective-behavioral: “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”
  • New definition, objective-structural: “Economics is the science which studies how the monetary economy works.”
Why telling the world ad nauseam ‘We simply do not know’ when scientific knowlege about the actual monetary economy is possible?*

Egmont Kakarot-Handtke


References
Blaug, M. (1994). Why I am Not a Constructivist. Confessions of an Unrepetant Popperian. In R. E. Backhouse (Ed.), New Directions in Economic Methodology, pages 109–136. London, New York, NY: Routledge.
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Keynes, J. M. (1937). The General Theory of Employment. Quarterly Journal of Economics, 51(2): 209–223. URL
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Popper, K. R. (1960). The Poverty of Historicism. London, Henley: Routledge and Kegan Paul.
Porter, T. M. (1994). Rigor and Practicality: Rival Ideals of Quantification in Nineteenth-Century Economics. In P. Mirowski (Ed.), Natural Images in Economic Thought, pages 128–170. Cambridge: Cambridge University Press.
Rosenberg, A. (1994). What is the Cognitive Status of Economic Theory? In R. E. Backhouse (Ed.), New Directions in Economic Methodology, pages 216–235.
London, New York, NY: Routledge.

* For cross-references see here

July 23, 2015

How to consistently start off on the wrong foot

Comment on ‘The Keynes-Ramsey-Savage debate on probability’

Blog-Reference

Economists have the talent to mess up everything they touch. Curiously, everything that works fine in the real sciences does not seem to work in economics. The long standing mathiness discussion corroborates this observation. More than one physicist has wondered about the ‘unreasonable effectiveness of mathematics in the natural sciences’ (Wigner) and this led Velupillai to wonder about the ‘unreasonable ineffectiveness of mathematics in economics.’ The same holds for probability theory and empirical testing.

In a sense, economists had the bad luck that when Adam Smith started to think about the economy mathematical tools had already proven their unreasonable effectiveness. So economist could not resist to apply them as they found them. It can be said that neoclassical economics has literally been built around calculus (Mirowski, 1995). This was the first big mistake.

“The mathematical language used to formulate a theory is usually taken for granted. However, it should be recognized that most of mathematics used in physics was developed to meet the theoretical needs of physics. ... The moral is that the symbolic calculus employed by a scientific theory should be tailored to the theory, not the other way round.” (Wittgenstein, quoted in Schmiechen, 2009, p. 368)

The whole mathiness discussion is a surface phenomenon that covers the underlying incompetence of economists to create their own mathematical tools. Therefore, a precise distinction has to be made. One can agree with Keynes that constrained optimization is pointless as a formal embodiment of human behavior, but one cannot agree with him that mathematics or formalization is entirely misplaced in economics. The same holds for probability theory.

The task of Heterodoxy is therefore to quit the bad habit of taking prefabricated tools from the math department and instead to develop their own tools. As a matter of fact this has already been done. For the application of Popper's idea of propensity to behavior in the economic realm see (2015).

With regard to Keynes and methodology we should agree that his valuable contributions to economics lay elsewhere (2011).

“I consider that Keynes had no real grasp of formal economic theorizing (and also disliked it), and that he consequently left many gaping holes in his theory. I none the less hold that his insights were several orders more profound and realistic than those of his recent critics.” (Hahn, 1982, pp. x-xi)

Egmont Kakarot-Handtke


References
Hahn, F. H. (1982). Money and Inflation. Oxford: Blackwell.
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Behavior. SSRN Working Paper Series, 2600523: 1–17. URL
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited, volume 1. Norderstedt: Books on Demand, 2nd edition. URL

July 22, 2015

Make a bubble, take a free lunch, break a bank

Working paper at SSRN

Abstract  Standard economics is known to be incapable of integrating the real and the monetary sphere. The ultimate reason is that the whole theoretical edifice is built upon a set of behavioral axioms. Therefore, the formal starting point is moved to structural axioms. This makes it possible to formally track the complete process of value creation and destruction in the asset market and its consequences for the household and business sector. From the set of structural axioms emerge the well-known phenomena of a bubble from free lunches through appreciation to defaults due to a lack of potential next buyers.

Beginning, crises, and end of the money economy

Working paper at SSRN

Abstract  A crisis is but a crisis when the long run outlook is definitively positive. Then a lower turning point must exist. This implicates a vision or, in the ideal case, a formalized theory of the money economy's possible end states. This theory has to provide an endogenous explanation of end states and crises. The equilibrium approach excludes endogenous causes in principle. Thus disturbances can only be explained by exogenous random shocks. The structural axiomatic approach, that is applied in the following, consistently defines the potential systemic crisis point and the conditions of an economic happy end.

The coherency of money, profit, price, and distribution

Working paper at SSRN

Abstract  When anything goes and nothing fits together this can be euphemized as pluralism. Lacking a common point of reference, discussions between various schools of economic thought proceed in the ‘hyperspace of assumptions’ (McCloskey). The incoherency of perspectives is due to self-chosen foundational assumptions. The present paper submits three structural axioms as formal core that is neutral with regard to assumptions about behavior. The objective is to clarify the interrelation of four elementary concepts and to eliminate some logical inconsistencies. Neither neoclassicals nor Keynesians came to grips with the relation between profit and the distribution of the real product.

Unemployment out of nowhere

Working paper at SSRN

Abstract  Unemployment is usually explained with reference to the equilibrium of supply and demand in the labor market. This approach rests on specific behavioral assumptions that are formally expressed as axioms. The standard set of axioms is replaced in the present paper by a set of structural axioms. This approach yields the objective determinants of employment. They consist of effective demand, the actual outcome of price formation, structural stress as determined by the heterogeneity within the business sector and the income distribution. Sudden changes of employment are effected by latent relative switchers that are hard to spot empirically.

Exploitation and its unintended outcomes: an axiomatic view of Marx's surplus value

Working paper at SSRN

Abstract  The present paper scrutinizes the logical foundation of Marx's dialectic analysis of the evolving money economy. The frame of reference is thereby given with the set of structural axioms. It turns out, first, that the commonplace notion of exploitation has to be replaced by crossover exploitation among capitalists and workers; second, that the concept of surplus value cannot explain the existence and magnitude of overall profits; finally, that the real shares of output are determined in the spheres of income and expenditure and not, as classical, Marxian and neoclassical economists unanimously maintain, in the sphere of production.

Schumpeter and the essence of profit

Working paper at SSRN

Abstract  Schumpeter had a clear vision of the developing economy, but he did not formalize it. The quest for a germane formal basis is in the following guided by the general question: what is the minimum set of foundational propositions for a consistent reconstruction of the evolving money economy? We start with three structural axioms. The claim of generality entails that it should be possible to free Schumpeter's approach from its irksome Walrasian legacy and to give a consistent formal account of the elementary circular flow that served him as a backdrop for the analysis of the entrepreneur-driven market system.

Uniform profit ratios

Working paper at SSRN

Abstract  The equalization of profit rates as the outcome of free competition is one of the oldest tenets in theoretical economics. Being intuitively convincing its premises and implications, though, are not well defined. As Walras put it: ‘To state a theory is one thing; to prove it is another.’ First of all a consistent concept of profit is required. In the present paper the structural axiom set is taken as premise. Thereof the determinants of profit and the profit ratio follow. This makes it possible to definitively state the conditions for uniform profit ratios in a hierarchical market structure.

Geometrical exposition of structural axiomatic economics (I): fundamentals

Working paper at SSRN

Abstract  Behavioral assumptions are not solid enough to be eligible as first principles of theoretical economics. Hence all endeavors to lay the formal foundation on a new site and at a deeper level actually need no further vindication. Part (I) of the structural axiomatic analysis submits three nonbehavioral axioms as groundwork and applies them to the simplest possible case of the pure consumption economy. The geometrical analysis makes the interrelations between income, profit, employment, and money under the conditions of market clearing and budget balancing immediately evident.

Geometrical exposition of structural axiomatic economics (II): qualitative and temporal aggregation

Working paper at SSRN

Abstract  Behavioral assumptions are not solid enough to be eligible as first principles of theoretical economics. Hence all endeavors to lay the formal foundation on a new site and at a deeper level actually need no further vindication. Part (I) of the structural axiomatic analysis submits three nonbehavioral axioms as groundwork and applies them to the simplest possible case of the pure consumption economy. The geometrical analysis makes the interrelations between income, profit and employment under the conditions of market clearing and budget balancing immediately evident. Part (II) applies the differentiated axiom set to the analysis of qualitative and temporal aggregation.

What is wrong with heterodox economics? Kalecki's profit theory as an example

Working paper at SSRN

Abstract  Kalecki’s profit theory has always been popular among heterodox economist as an alternative approach to solve the paradox of monetary profits. In the present paper his formula ‘The workers spend what they get, the capitalists get what they spend’ is scrutinized for its logical and factual implications. The analysis shows that Kalecki’s alternative approach points in the right direction but unfortunately shares a crucial conceptual error with standard economics.

The wine maker's business and the logical origin of interest in the monetary economy

Working paper at SSRN

Abstract  Any serious alternative to the standard approach requires a distinct axiomatic foundation. The crucial point is not axiomatization per se but the real world content of axioms. The purpose of the present paper is to make the implications of the objective structural axiom set concerning the relation of profit, money, the nominal/real rate of interest, and the time structure of production explicit and to contrast them with the familiar conceptions.

Taxes, profits, and employment: a structural axiomatic analysis

Working paper at SSRN

Abstract  Standard economics is regarded as the theory of the market system. Profit is the pivotal phenomenon of this system. Contrary to expectations, though, profit is neither well defined not fully understood. The frailty of the theoretical core is passed on to the subfields. This paper provides a consistent definition of profit and applies it to the analysis of the effects of the government sector's budget on employment and the profitability of the business sector. Since the formal point of departure is different from the standard approach it is quite natural that we arrive at new conclusions in some fundamental issues.

The truly General Theory of Employment: how Keynes could have succeeded

Working paper at SSRN

Abstract  There is not much use to attack standard economics because deep in his heart the representative economist long knows that he is tied to a degenerating research program. The problem is, rather, that it seems to be exceedingly difficult to build up a convincing alternative. Keynes, for one, tried and was successful — albeit not fully. Unfortunately, he got some basics wrong. The conceptual consequence of the present paper is to discard the accustomed subjective-behavioral axioms and to take objective-structural axioms as the formal point of departure for the analysis of employment as the main practical issue of economics.

July 21, 2015

Cartoon science

Comment on Henry on ‘Ignoring elementary economics’

Blog-Reference

Your reference to Keynes misses the point.

(i) The neoclassical program is broadly defined by: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals.” (Arrow, 1994, p. 1) Clearly, this implies the expectation that the explanation of human behavior eventually leads to the explanation of how the actual monetary economy works. This is the funamental error.

(ii) Keynes remained within this psychological/sociological/behavioral paradigm. He only made some outright idiotic neoclassical behavioral assumptions more realistic. This is laudable but does not count as paradigm shift.* It is more like adding an epicycle to the geocentric model.

(iii) Keynes kept economics firmly in the social sciences which are in fact cargo cult sciences “... there has been no progress in developing laws of human behavior for the last twenty-five hundred years.” (Hausman, 1992, p. 320), (Rosenberg, 1980, pp. 2-3)

(iv) It should be clear by now even to economists that second-guessing other agents and gossiping about motives and conceivable actions falls into the category of entertainment/ folk psychology/politics but is as far from science as can be.

(v) Keynes's approach suffers from severe logical defects and is provable false (2011). So Keynesianism is out of science just like Neoclassics. Logical consistency is the minimum requirement and this cannot be decried as scientism.

(vi) The problem is that economists of all camps simply violate scientific standards, as Morgenstern observed long ago: “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, pp. 369-370)

(vii) Conventional economics is refuted and over the cliff just like Wile E. Coyote of the road-runner cartoon.

Heterodoxy should do better. The alternative is that it is thrown out of science just like Walrasianism and Keynesianism.

Egmont Kakarot-Handtke


References
Arrow, K. J. (1994). Methodological Individualism and Social Knowledge. American Economic Review, Papers and Proceedings, 84(2): 1–9. URL
Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL
Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.

* See ‘Mental messies and loose losers

Refers to ‘The case for pure economics

July 18, 2015

Knowledge vs. Belief

Comment on Asad Zaman on ‘The marginalisation of morality’

Blog-Reference

This blog [RWER] distinguishes itself from all the rest by its title Real-World Economics Review Blog. The key word is economics. Now, everybody understands that (i) the economy is but one aspect of the real world, and (ii), that economics is the science that tries to find out how the economy works. Hence economics is restricted with respect to its subject matter and committed to the scientific method.

Since its beginnings economics has overstepped its narrow limits. The simple reason is that authors and teachers and ideologues and politicians have consistently tried to intrumentalize economics for other purposes. This gave us political economics in the widest sense whereby the term political embraces all belief-systems including, of course, religions (Nelson, 2006).

To the extent that theoretical economics has been hijacked by political economics it has to regain its full independence. That part of economics that has been political from Smith, to Marx, to Hayek, to Keynes, and on to the actual orthodox and heterodox activists has to be clearly separated from science and eventually thrown out.

Theoretical economics is about the world economy. It is not about the Greece or European or US economy. And it is certainly not at all about the problems of the American educational system. It is the task of American citizens to organize the education of their children. And no economist has any legitimacy of telling anybody how this could or should be done.

Most belief-systems are expansionary and rely on the time-tested experience that the best way to propagate belief is to hijack the educational system, including of course, the universities.

Now, science is about knowledge and this is the exact opposite of belief. Science restricts itself to things that can be known, belief-systems second-guess about things that cannot be known. Science has its own moral standard that is not derived from any belief-system. What is most important, though, is that humanity has learned in the course of history that moral is a fundamental human trait that comes before religion or politics. Non-religious people have moral standards that are on the average higher than those of religious people who have, again on the average, unthinkingly adapted to their rather specific cultural environments.

We may agree with Assad Zaman that morality is at a low ebb in the USA and the world at large. We do certainly not agree that this is due to a lack of religious education.

As economists we have a problem that has nothing at all to do with morals and belief-systems. It is a fact that the scientific level of economics is at a low ebb in the USA and the world at large. As a result, we have no economic theory that satisfies the scientific standards of material and formal consistency. And here moral comes in again. By propagating refuted or irrefutable theories or belief-systems the representative economist violates scientific ethics.

To do some sociology about the deplorable state of American universities is not real-world economics. It is the proper task of Heterodox economics to emancipate economics from all belief-systems and to make it a real science that after 200 years of groping in the dark eventually finds out how the actual economy works.*

Egmont Kakarot-Handtke

References
Nelson, R. H. (2006). Economics as Religion: From Samuelson to Chicago and Beyond. Pennsylvania, PA: Pennsylvania State University Press.

* For a start see the new belief-free heterodox curriculum

July 15, 2015

The case for pure economics

Comment on Yanis Varoufakis on ‘On the Euro Summit’s Statement on Greece: First thoughts’

Blog-Reference see also Blog-Reference

What is the proper job of the economist qua scientist? “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (Mill, 2006, p. 950)

The economist qua scientist brings knowledge to the table, not his personal opinion. It is the legitimate political institution that determines the political ends. This is the ought-part, science is concerned exclusively with the is-part of reality. The is/ought difference is reasonably clear since Hume but has been deliberately ignored by every talented public speaker since then. However, for science this difference is fundamental.

“A genuine inquirer aims to find out the truth of some question, whatever the color of that truth. ... A pseudo-inquirer seeks to make a case for the truth of some proposition(s) determined in advance. There are two kinds of pseudo-inquirer, the sham and the fake. A sham reasoner is concerned, not to find out how things really are, but to make a case for some immovably-held preconceived conviction. A fake reasoner is concerned, not to find out how things really are, but to advance himself by making a case for some proposition to the truth-value of which he is indifferent.” (Haack, 1997, p. 1)

The economist who comments on political goals leaves the realm of science. This, of course, is no problem at all under one condition. All he has to do is to put off his scientific hat and to put on his political hat and then go the other way. This, off course, holds in normal times with legitimate political bodies in place. What has to be done if political bodies are on the way to lose their legitimacy is quite another matter.

Why has politics and science to be strictly separated? Simply because it is less probable that the scientific ethics of objectivity/impartiality/knowledge flows to politics and more probable that subjectivity/partiality/opinion flow to science. Gresham’s Law about bad money driving out good applied to sociology says: politics debases science but science does not improve politics. Therefore there is an overall net loss from close interaction. Partiality and impartiality simply cannot coexist in one and the same person.

That part of economics that has been political from Smith, to Marx, to Hayek, to Keynes, and on to the actual orthodox and heterodox activists has to be clearly separated from science and eventually thrown out. To the extent that theoretical economics has been hijacked by political economics it has to regain its full independence.

As far as politics is of importance for theoretical economics it has to be taken in from political science. Theoretical economics has to answer only one question: how does the monetary economy work? This presupposes that the economy is understood — broadly speaking — as a system with objective features. Of no primary interest is psychological or sociological second-guessing of human behavior. As far as behavioral issues are of importance for economics they have to be taken in from psychology or sociology.

It is not the task of the economist to dabble in psychology, sociology, political sciences, geopolitics, history, anthropology, law, ethics, philosophy, etcetera. Interdisciplinarity, for one, means that economics relies on the results of other sciences and in turn offers reliable knowledge about the working of the monetary economy. The same applies to all other practical cooperation.

“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)

Here is the crux. There is no such thing as a true economic theory. What economists have produced so far is not much more than educated common sense and an abundance of incoherent models that apply nonentities like equilibrium or utility or rational expectations or supply/demand functions or I=S, etcetera, etcetera. Whoever exchanges scientific ideas with an economist gets lemons.

The deep root of the failure of both Orthodoxy and traditional Heterodoxy is a complete lack of understanding of what profit is.* The profit theory is false since Adam Smith. This in turn means that economists have failed to capture the essence of the market system. Neither Marxian attack nor Liberal defense of the market economy ever had a sound theoretical foundation (2015). Economists have nothing to offer of scientific value.

In sum: the poor results of political economics are not only an embarrassment for economics but — as a severe collateral damage — have negative external effects for the true sciences. It cannot be expected from the public that it immediately recognizes the difference between cargo cult science** and the real thing. This provides an ecological niche for illusion and deceit that undermines the integrity of science.

Here is the wake-up call from a genuine scientist. “So we really ought to look into theories that don't work, and science that isn't science.” (Feynman, 1974, p. 11)

Both, Orthodoxy and traditional Heterodoxy is lost for science. Their proponents are still employable for some econ-talk and entertainment in the media. Yet, young students indeed have the choice between becoming real innovative scientists or just some redundant quacking frogs in the morass of political economics.

To recall: (i) human progress has neither been brought about by politicians nor by business men nor by economists but solely by scientists, and (ii), because of their scientific failure over the last 200 years economists have consistently stood in the way of establishing overall economic welfare.

Egmont Kakarot-Handtke


References
Feynman, R. P. (1974). Cargo Cult Science. Engineering and Science, 37(7): 10–13. URL
Haack, S. (1997). Science, Scientism, and Anti-Science in the Age of Preposterism. Skeptical Inquirer, 21(6): 1–7. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

* See the blog post ‘Mental messies and loose losers
** See Wikipedia


For more details see Labels: Science

July 14, 2015

Sexit

Comment on/Kommentar zu ‘Griechenland-Krise: Deutsche Ökonomen schlagen gegen Krugman zurück’

Blog-Reference (condensed to 1.000 characters)

Ist das Ziel eines vereinten Europa als politisches Datum vorausgesetzt, dann lautet die rein ökonomische Fragestellung: wie kann dieses Europa als Ganzes — einschließlich Griechenland — wirtschaftlich erfolgreich sein?

Die intuitive Ökonomik sagt, dass Vollbeschäftigung und Produktivität die Schlüsselvariablen sind. Wie kann das realisiert werden? Nur auf Basis einer umfassenden makroökonomischen Theorie. Und hier beginnt das Problem: Ökonomen haben diese Theorie nicht, weder Krugman noch die deutschen Ökonomen.

Weder die Walrasianische noch die Keynesianische Beschäftigungstheorie ist wissenschatlich akzeptabel.* Der Kern des Problems ist, dass der Preismechanismus nicht so funktioniert wie es die Ökonomik imaginiert, und das hat nichts mit Lohn- oder Preisstarrheit zu tun. In letzter Konsequenz leidet Griechenland und Europa insgesamt am Theorieversagen der Ökonomen.

“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)

Da sie die ‘true theory’ nach 200 Jahren immer noch nicht entwickelt haben, braucht die Welt einen Sexit (scientific exit), d.h. einen freiwilligen Exit dilettierender Ökonomen aus der Wissenschaft, die bekanntlich keine nationalen Unterschiede kennt. Was hier allein zählt ist wahr/falsch.

* Für die ausführliche Begründung siehe ‘Mental messies and loose losers

Siehe auch 'How to save Greece and Europe at the same time'

July 13, 2015

How to save Greece and Europe at the same time

Comment on ‘Employment in selected Eurozone countries. No austerity or neoliberal miracles’

Blog-Reference see also Blog-Reference

Political economics is, as most economics blogs show, just this: political gossip about what this guy said and that guy did, with all guys neatly sorted into good and bad. The well-known modus operandi of the media is personalization and horrorfication (Schauble creeps through Eurozone; Tsipras is mentally water boarded, etc). All this is Circus Maximus — senseless, yet entertaining.

Meanwhile, the solution of the economic problem got completely out of sight. What, in the broadest possible perspective, is the basic economic problem? Given the political goal of a united Europe, the economic problem is how to make it prosperous — all of it, including Greece, of course.

How can this be achieved? Common sense tells us that full employment and productivity are the key variables. The next question then is how to put this intuition into practice? This can be done only on the basis of a comprehensive macroeconomic theory. Here the problems starts, because economists have no such theory.*

To recall, Keynes's main issue was employment theory and he was quite clear that the orthodox approach was defective. However, Keynes succeeded only partly, his employment theory is not general either and misses a crucial point (2015a; 2012). The most elementary version of the correct employment equation is given here.

From this follows
(i) An increase of the expenditure ratio rhoE leads to higher employment. An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite. That's old Keynesian stuff.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This is, of course, contrary to conventional economic wisdom. It is, though, easy to prove that conventional wisdom is a mere fallacy of composition (2015b). The factor cost ratio formally represents the price mechanism.
(iv) The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world.

As a matter of principle, the structural employment equation can be tested against the graph in the intro above. Put the other way round, the equation fully explains the graph.

Let us focus here alone on the factor cost ratio rhoF as defined in (iii). This variable embodies the price mechanism which, however, does not work as Orthodoxy imagines it works. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R. This gives us the lever to improve the employment situation in all of Europe — including, of course, Greece — without ever increasing deficits.

How could it work in practice? The average wage rate increases if the wage rates in those firms that perform well increases relative to those at or below average. With a given expenditure ratio rhoE this increases overall demand and leads to a redistribution of profits among the business sector. Total profit remains unchanged, what we have is a profit ratio equalization among firms. This takes structural stress out of the economic system.

What can be done in addition is to increase profit distribution in a specific way, boost investment, and something like a Grexit writ large, that is, a depreciation of the Euro against the Dollar.

The core of the problem is that the price mechanism does not work as orthodox economics says and this has nothing to do with wage or price stickiness. Ultimately, Greece and Europe with it suffers from a scientifically unacceptable economic theory.

What the world really needs is a Sexit (scientific exit), that is, a voluntary exit of scientifically incompetent economists.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015a). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Kakarot-Handtke, E. (2015b). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* For the reason why see RWER blogpost or here

July 11, 2015

Profit theory and distribution formulas

Comment on ‘Some important limitations of income inequality data’

Blog-Reference

Blair Fix says in his post on the Capital-as-Power Blog: “For a long time now I've been bothered by the lack of a clear connection between capitalist income and inequality. ... I'm not sure why it took me so long to realize this, but last week I realized that corporate profits are not really a type of personal income.”

Exactly so. The familiar approaches are defective. In contradistinction, the superior structural-axiomatic approach starts with the equation total income is wage income plus distributed profit (2015, eq. (1)).* This gives one the theoretically well-founded distribution formulas (2015, eq. (55) ff.). For the correct profit theory see (2014).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* See Terms of use

Extremely long roots

Comment Lars Syll on ‘Schäuble goes Matrix’

Blog-Reference

You quote Mark Blyth’s article ‘A Pain in the Athens. Why Greece Isn't to Blame for the Crisis’ approvingly. Blyth explains: “The roots of the crisis lie far away from Greece; they lie in the architecture of European banking.”

This is accurate only insofar as the European banking system has adopted the negative institutional features of the US banking system.

Remember that the investment banks literally invented sub-prime lending. Not one competent mortgage banker, neither in Germany nor in France, would have taken up this type of business.* Investment banking has nothing to do with classical European banking which consists essentially of lend-and-hold, long term customer relationship, and risk-absorbing equity.

Investment banking depends basically on extreme leveraging, minimizing risk bearing equity, maximizing quarterly return on equity, shifting credit risk to non-banks via securitization, and shifting the risks from derivatives betting ultimately to the public via too-big-to fail. It is not so long ago when first Deutsche Bank and then the rest of the rather conservative German banking industry turned to investment banking.

This casino banking failed in 2008 in the US and now in Greece.

A very good advice for the Greek people would be to look at the German cooperative banking group. In effect, people can own their local bank, the lender-creditor relationship is face-to-face, risks are strictly limited, and if it actually happens that one bank fails it is bailed out by a fond, that is, by all cooperative banks together. Seen as an institution, this self-organizing group of diverse firms provides all banking/insurance services at zero risk for society at large. No tax-payer ever paid a cent for a failed cooperative bank. This is exactly the opposite of too-big-to-fail which is the de facto life insurance of the free-riding US banking system.

This system, not the German three-column institutional setup, has been exported around the world under the flag of deregulation.

In 2008 the US banking system had been rescued by the Fed. Only if the toxic assets were valued to market today one could see whether the big American banks are actually bankrupt or not. Note that the suspension of the mark-to-market accounting principle FAS157 was one of the first rescue actions in March 2009.

The Greek crisis is ultimately due to a switchover from originally safe and sound European banking institutions to US-style Ponzi-banking. The self-destructive feature of this system is extreme leveraging, as Minsky already pointed out.

It is true, indeed, that it was not alone Greece which had the whole thing messed up, but Blyth’s analysis remains on the surface. Yes, the roots of the crisis lie far away from Greece — approximately the width of the Atlantic.

Egmont Kakarot-Handtke

*See also on the RWER blog ‘It's about institution-building, stupid

July 10, 2015

Mental messies and loose losers

Comment on ‘Keenonomics, aggregate demand/change of debt, and some misleading critique’

Blog-Reference

I=S is the epitome of economists’s scientific incompetence. If this were as plain as a meteorite hitting the earth the problem would have been fixed long ago; it is, though, just the contrary: subtle, unspectacular, counter-intuitive, subterranean, and rather involved.

Already von Neumann spotted the peculiar methodological defect of economics: “I think it is the lack of quite sharply defined concepts that the main difficulty lies, and not in any intrinsic difference between the fields of economics and other sciences.” (quoted in Mirowski, 2002, p. 146 fn. 49)

This, however, has never been a point of great concern for the representative economist. In particular, for the Cambridge School of Loose Verbal Reasoning sharpness, precision, uniqueness, rigor, bivalent logic, etcetera always amounted rather to a violation of the human right to mental messiness. This stance has habitually been defended with a false but suggestive alternative.

“Marshall followed the maxim: Better to be ambigous and relevant than precise and irrelevant.” (Colander, 1995, p. 283)

Then, Keynes occupied the realm of vagueness, ambivalence, indeterminism, fogginess, wish-wash, inconclusiveness, complexity, twilight, uncertainty — the realm where nothing is clear and everything is possible — as the ecological niche of Keynesianism.

“Another danger is that you may ‘precise everything away’ and be left with only a comparative poverty of meaning. ... Such a problem was avoided, said Keynes, by Marshall who used loose definitions but allowed the reader to infer his meaning from ‘the richness of context’.” (Coates, 2007, p. 87)

This problem avoidance strategy was soon summed up in a catchy pseudo-choice: “For Keynes as for Post Keynesians the guiding motto is ‘it is better to be roughly right than precisely wrong!’" (Davidson, 1984, p. 574)

With this cavalier mentality, Keynesians, and eventually the majority of other schools, have occupied the habitat between true and false where the scientific procedure of ‘conjecture and refutation’ runs into the bottomless morass.

“Another thing I must point out is that you cannot prove a vague theory wrong.” (Feynman, 1992, p. 158)

So, economics is no longer about the true economic theory, all one has to do is to avoid a crystal-clear refutation. This can be achieved by persevering fuzzy filibustering and by maintaining that crystal-clear refutation is impossible in the first place. If, against all defensive complacency, a refutation plainly succeeds, ignorance and business-as-usual helps. This has become standard operating procedure in economics, as already Morgenstern complained.

“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.” (1941, pp. 369-370)

With these two stratagems, economists entrenched themselves in the morass of anything-goes and subsequently turned to defend their scientific no-man's land in the main with rhetorical soap-bubbles. All this is — as economists always readily admit — second-best, however, “... most economists neither seek alternative theories nor believe that they can be found.” (Hausman, 1992, p. 248)

What made this deadlock possible is a tacit quid-pro-quo agreement among different camps on the legitimacy of Humpty Dumpty methodology. "When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less." "The question is," said Alice, "whether you can make words mean so many different things." "The question is," said Humpty Dumpty, "which is to be master — that's all." (Carroll, Through the Looking-Glass)

This quasi-feudal Freedom-of-Definition privilege constitutes the different schools and has been sanctioned by the likes of Schumpeter. “For, on principle, we may call things what we please.” (1994, p. 598)

Of course, the freedom of definition is a methodological illusion. It applies only to the first definition. Subsequently, one has to make sure that every additional definition is consistent with the preceding ones. Overall consistency cannot be achieved in the economist's cavalier fashion: “The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen, 2009, p. 344)

Institutionalized economics never seriously aimed at, and therefore never arrived at, a coherent language, not to speak of an axiomatic framework of primitive concepts. Thus, debates between schools resemble nothing so much as ‘Babylonian incoherent babble’ (cf. Dow, 2005, p. 385). Without a common frame of reference perpetual cross-talk is guaranteed. Economics fits the format of a sitcom.

The lack of a minimal common ground explains the secular stagnation of economics. “We know from the history of science that entrenched classificatory schemes and misleading descriptive vocabularies have impeded scientific advance as much or more than the complexities and observational inaccessibility of the subject matter.” (Rosenberg, 1980, p. 114)

What, then, is the — minimal, objective, consistent, testable — common conceptual ground of all of economics?

Total period income in an extremely simple monetary economy with only one firm is given by the sum of wage income and distributed profit, i.e. (1) Y=Yw+Yd. Total consumption expenditures are equal to the product of price and quantity sold, i.e. (2) C=PX. That's all for a start.

Monetary profit of the business sector as a whole is then defined as difference between consumption expenditures and wage costs, i.e. Q=C-Yw. Monetary saving of the household sector is then defined as difference between total income and consumption expenditure S=Y-C. Hence, S=-Q if, for a start, Yd=0. In simple words: saving S is equal to loss -Q, or, dissaving -S is equal to profit Q. From this follows immediately that all I=S or IS-LM models from Keynes, to Hicks, to Krugman and all the busy blogging rest are false — irrevocably in all eternity.

Generally speaking, it holds for the pure consumption economy that Qre=-S, i.e. retained profit Qre is equal to dissaving -S. And for the investment economy holds Qre=I-S, i.e. retained profit is equal to the difference between investment and saving (for details see 2014). No accounting trick and no ex ante/ex post filibuster and no expected/unexpected stock changes and no equilibrium verbiage and no natural rate of interest will ever make the household sector's saving equal to the business sector's investment expenditures. Never ever! No way! No!

Saving-equals-investment is the epitome of conceptual and logical incompetence of economists of all schools. In science, there is no ecological niche between true/false and no pluralism of false theories. Humpty Dumpty’s methodological no-man’s land is an uninhabitable morass for every thinking human being.

The root cause of the IS error/mistake is a complete lack of understanding of what profit is. Total income is not the sum of wage income an profit but of wage income and distributed profit (2013). The profit theory is false since Adam Smith. This in turn means that economists have failed to capture the essence of the market system. Neither attack nor defense of the market economy ever had a sound theoretical foundation (2015). Political economics has been a complete waste of time.

Economics of the last 200 years is the most embarrassing failure in the history of modern science.

Egmont Kakarot-Handtke


References
Coates, J. (2007). The Claims of Common Sense. Moore, Wittgenstein, Keynes and the Social Sciences. Cambridge, New York, NY, etc.: Cambridge University Press.
Colander, D. (1995). Marshallian General Equilibrium Analysis. Eastern Economic Journal, 21(3): 281–293. URL
Davidson, P. (1984). Reviving Keynes’s Revolution. Journal of Post Keynesian Economics, 6(4): 561–575. URL
Dow, S. C. (2005). Axioms and Babylonian Thought: A Reply. Journal of Post Keynesian Economics, 27(3): 385–391. URL
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Mirowski, P. (2002). Machine Dreams. Cambridge: Cambridge University Press.
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL
Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.
Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited, volume 1. Norderstedt: Books on Demand, 2nd edition. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

July 9, 2015

The economics of here and now

Comment on ‘An inconvenient historical truth’

Blog-Reference

I agree, graccibros, let us return to the economics of here and now. With regard to the correct macroeconomic formula that describes the actual Greek situation, see my post: Poisoned, hanged, and shot. Comment on ‘Austerity policies — prescribing rat poison for ailing economies.’*

The Greek situation, however, is only exemplary for a really profound question, that is, the relationship between growth of debt, profit, and employment. Put simply: can the market system (global, not Greece, not Germany, not US, not China, etc) survive without steadily growing public/private debt?

The answer is that a local debt reduction leads to local recession (2013), this is the case of Greece, and a global debt repayment brings the whole system down (2014).

This is, with regard to the future, the really inconvenient historical truth.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2013). Redemption and Depression. SSRN Working Paper Series, 2343561: 1–28. URL
Kakarot-Handtke, E. (2014). Mathematical Proof of the Breakdown of Capitalism.SSRN Working Paper Series, 2375578: 1–21. URL

*See on the RWER blog or here

July 8, 2015

Separation of politics and economics

Comment on Blissex on ‘Euro — the antithesis of democracy’

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“To be sure, economics may perform a valuable social role without adding any significant understanding to knowledge of the economy — a “good myth,” economically speaking, can work not only in primitive tribal cultures but also in modern societies. ... Indeed, ... the religious function may have been the most important role throughout the history of modern economics since the Enlightenment.” (Nelson, 2006, pp. 300-301)

We had the separation of church and state, what is needed next is the separation of politics and economics.

The task of the economist is to figure out how the actual economy works, just like the physicist figures out how Nature works. What the economist has first of all to do is to take an objective observer standpoint — as far as possible. This is not compatible with taking a political side.

I am, of course, not against taking a political side. What I emphasize is that it is humanly impossible to do politics and science simultaneously. Because of this, an institutional separation is necessary.

I have no trouble to acknowledge that, for example, Hayek has the right to write political pamphlets, to defend capitalism, to support Thatcher, and to found a political club like Mont Pelerin. What I say is, the moment he or any other economist starts with politics, the same moment he leaves economics understood as a science for good. It is the mixture that is toxic. Independently of this, Hayek is simply unacceptable as economist. His economics is scientifically substandard.

You cite many cases of economists involved simultaneously in academe/business/politics that simply are not compatible with scientific ethics. Now, I cannot check them and, most importantly, I do not want to occupy myself with corrupt people in science, politics, business, and elsewhere. Something went wrong with these institutions, that much is clear at the moment. A lot of corruption fighters are needed, that much is also clear. Finally, a lot of institution-builders are needed, obviously. But the rest is hanging in the air at the moment.

This is why I urge heterodox economists not to become redundant quacking frogs in the morass of political economics but instead to focus on economics as science. To refute political economists according to well-defined scientific rules is the first step. As Feynman, a genuine scientist, put it: "So we really ought to look into theories that don't work, and science that isn't science." (1974, p. 11)*

Orthodoxy is scientifically substandard: there is much opportunity to develop something better.

Egmont Kakarot-Handtke


References
Feynman, R. P. (1974). Cargo Cult Science. Engineering and Science, 37(7): 10–13. URL
Nelson, R. H. (2006). Economics as Religion: From Samuelson to Chicago and Beyond. Pennsylvania, PA: Pennsylvania State University Press.

* See also: The Farce That Is Economics: Richard Feynman On The Social Sciences

July 7, 2015

How to get out of psychology/sociology/wish-wash

Comment on ‘Economic Value is NOT Price’

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At the end of the day value theory has to explain the exchange value expressed as the price relation P1/P2, P1/P3, and so on. This is what can be observed and measured with the accuracy of two decimal places.

Somehow, the agent must translate preferences, utility, expectations, targets, physical needs, budget restrictions, cultural norms, and what not into a subjective valuation price which is comparable with the market price and this helps him to decide whether to buy/sell or not. This process of translation is opaque. We can only speculate about it or turn to introspection. All this psychologism is a waste of time for the economist. Nothing useful follows from this exercise.

Prices and exchange relations are an objective result of all interactions of the whole economy including production.

The first important distinction for value theory is between primary and secondary markets (2011a). Already at this juncture neoclassical theory and all subjective value theories run into the wrong direction.

For the most elementary economic configuration exchange value is given by P1/P2=R2/R1, that is, the price relation is the inverse of the productivity relation. This is an objective and testable proposition. It can be generalized to: the price structure, i.e. relative prices, are determined by the productivity structure. To recall, this holds for the most elementary economic configuration (2014; 2011b).

The beauty of this solution is that there is absolutely no need to speculate further about what goes on in the agents's brains. It has long been known that this leads to nowhere.

“It is possibly very encouraging for the economist to hear that compared with the natural scientist the psychological method saves him “ages of laborious research” but it is curious and a pity that this huge start has not enabled him to formulate any considerable body of reliable prognoses such as the natural sciences have managed to achieve.” (Hutchison, 1960, p. 132)

The structural-axiomatic approach yields a testable proposition. So, let us get out of wish-wash and proceed to testing.

Egmont Kakarot-Handtke


References
Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
Kakarot-Handtke, E. (2011a). Primary and Secondary Markets. SSRN Working Paper Series, 1917012: 1–26. URL
Kakarot-Handtke, E. (2011b). The Pure Logic of Value, Profit, Interest. SSRN Working Paper Series, 1838203: 1–27. URL
Kakarot-Handtke, E. (2014). The Logic of Value and the Value of Logic. SSRN Working Paper Series, 2399550: 1–20. URL

In science, NO is the answer

Comment on Paul Schächterle on ‘In Greece, NO is the answer’

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OK then, here is my final comment.

You say: “The collection of knowledge about particular facts *is* part of science. On what basis could you otherwise come up with theory?”

Yes, this is an essential part of science and I never characterized science as fact free arm chair phantasy. I agree with you that utility theory is a fact free arm chair phantasy, and general equilibrium theory too, and DSGE, and so on. That is why Orthodoxy is not a science.

But a scientific fact is not what you get by simply looking out of the window or into the newspaper. The physicists never saw a quant but arrived at this ultimate reality by a long, long chain of theoretical reasoning. So you need a theory to get hold of reality. You cannot ‘see’ the economy without a theory.

This is what J. S. Mill told economists. “Since, therefore, it is vain to hope that truth can be arrived at, either in Political Economy or in any other department of the social science, while we look at the facts in the concrete, clothed in all the complexity with which nature has surrounded them, and endeavour to elicit a general law by a process of induction from a comparison of details; there remains no other method than the à priori one, or that of ‘abstract speculation’.” (Mill, 1874, V.55)

And this is what Popper said. “Indeed, there is no such thing as an uninterpreted observation, an observation which is not theory-impregnated.” (Popper, 1994, p. 58)

And this is what Marx already knew. "That in their appearance things often represent themselves in inverted form is pretty well known in every science except political economy.” (Marx, 1906, VI.XIX.7)

So, what we can agree upon about Orthodoxy and Heterodoxy and political economics is this: “If one takes seriously what Popper says about falsifiability and the critical attitude, then the methodological practice of economics is not only mistaken, it is stupid and intellectually reprehensible.” (Hausman, 1992, p. 275)

Is this acceptable to an economist with a scientific conscience? NO is the answer!

Egmont Kakarot-Handtke

References
Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
Marx, K. (1906). Capital: A Critique of Political Economy, Vol. I. The Process of Capitalist Production. Library of Economics and Liberty. URL
Mill, J. S. (1874). Essays on Some Unsettled Questions of Political Economy. On the Definition of Political Economy; and on the Method of Investigation Proper To It. Library of Economics and Liberty. URL
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality., chapter Science: Problems, Aims, Responsibilities, pages 82–111. London, New York, NY: Routledge.

Regarding politics see also here and here

Heterodoxy's big fat Greek error

Comment on Paul Schächterle on ‘In Greece, NO is the answer’

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You say: “I am by no means against theorising as a part of an economic science.”

Theorizing is not a nice add-on, it is the very task of science. What we expect from physics is the correct theory of how Nature works, from the universe down to the smallest particle. Along the same line, we expect from economics the correct theory of how the economy works. Theory is not some exotic and inconsequential speculation, it is the incorporation of knowledge — the best thing we can achieve as humans.

The situation in economics is this: what has been produced in the last 200 years has objectively not much scientific value. Take Newton and Smith as the base line, then physics has arrived in the meantime at quantum theory while economics has not even produced something like the law of the lever.

Could it be that economists have been too much occupied with playing political games and writing pamphlets instead of doing serious scientific work?

The crucial point is this:
“Whatever knowledge we possess is either knowledge of particular facts or scientific knowledge.” (Russel, 1961, p. 620)

What you can learn in business schools and most universities is knowledge of particular facts, eg. how the Federal Reserve System or the gold standard works. This is all good and fine and useful but it is not science.

Heterodoxy criticizes Orthodoxy, and rightfully so. But here care has to be taken. Is it on political grounds or on scientific grounds?

My point is this: both Orthodoxy and Heterodoxy is mired in political economics. What they have both produced so far is good practical political ammunition but scientific crap.

In my view, Heterodoxy is not another political movement, nor a charity for the Greeks that suffer much from financial deficits but most from deficits in institution-building which cannot be repaired by throwing money at it. In my view, Heterodoxy's task is to get economics out of the political swamp and to make it a science.

You say “I mean, we should try, but we should not see it as an easy task.”

No it's not easy — to become another quacking frog in the swamp is much easier.

Egmont Kakarot-Handtke

References
Russel, B. (1961). The Basic Writings of Betrand Russel, chapter Limitations of Scientific Method, pages 620–627. London: Routledge.

July 6, 2015

Beware of the 9th circle

Comment on Paul Schächterle on ‘In Greece, NO is the answer’

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(i) I agree about the “unfortunate way that neoclassical economists actually do make politics by giving advice towards a very specific and highly disputed set of policies, but hide their political attitudes and beliefs behind a veil of pseudo-science.”

If there is a scientific analogon to Dante's Inferno all political economists will eventually meet again in the 9th circle.

(ii) The Greek referendum was a political manifestation and has to be accepted as such. It compares directly to political manifestations of the other European democracies which are uncomprehending.

(iii) When I speak of economic laws I clearly do not mean man-made laws but objective and testable structural laws. I agree, of course, that in economics any silly behavioral assertion is illegitimately advertized as a law.

(iv) You say “those well-defined scientific criteria *is* a somewhat political question.” That criteria are to some extent negotiable is in fact the representative economist's greatest self-delusion. The scientific criteria are material and logical consistency. And there is absolutely no way around this. There is true/false and nothing in-between. Economists know that neither Walrasianism nor Keynesianism nor the rest satisfies these criteria.

“... suppose they [the economists] did reject all theories that were empirically falsified ... Nothing would be left standing; there would be no economics.” (Hands, 2001, p. 404)

Because of this, economists have moved from science's true/false to Hollywood's good guy/bad guy. Actually, that's more fun for all.

(v) The task of Heterodoxy is to refute Orthodoxy according to well-defined scientific rules and not to complain about political bias. It is too easy to return this compliment and thus all ends with the pluralism of false theories and the uneasy coexistence of confused confusers.

Economics has to get out of politics before it drowns with it in idiocy. Better one iota of knowledge than a heap of opinion.

Egmont Kakarot-Handtke


References
Hands, D.W. (2001). Reflection without Rules. Economic Methodology and Contemporary
Science Theory. Cambridge, New York, NY, etc: Cambridge University Press.

True/false is different from good/bad

Comment on ‘In Greece, NO is the answer’

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Yes, the Classics called themselves political economists. But at the same time they claimed to do science, even Marx, who arguably was the most political of all political economists. This is where the schizophrenia started. However, as the quote from J. S. Mill shows, it was quite clear from the very beginning what it meant to be an economist who is committed to science.

Economics has been, but is not longer, about the economy of the polis. Nowadays it is about the world economy. Because of this, there is no such thing as an American, European, or Greek economics as there is no American, European, or Greek physics or mathematics. Economic laws apply everywhere.

Of course, economics is intertwined with politics. As a matter of fact, political economics has hijacked theoretical economics. The conclusion from this is that economics has to emancipate itself from politics.

The only relevant criterion for economics as a science is true/false and not whether it serves any political party, or social group, or nation.

To instrumentalize economics for any power struggle whatever is the original intellectual corruption in economics and incompatible with the ethics of science. The fact of the matter is that it is simply beyond human capacities to be a politician and a scientist at the same time. All this is long known.

“But if a man occupies himself with investigating the truth of some question for some ulterior purpose, such as to make money, or to amend his life, or to benefit his fellows, he may be ever so much better than a scientific man, if you will — to discuss that would be aside from the question — but he is not a scientific man.” (Peirce)

So, eventually a decision has to be made. To be more precise, (i) you can look at the actual economic conditions in a country like the US or Greece and come to the conclusion that they are unacceptable for a number of good reasons and therefore have to be changed; this is a political decision, or (ii), you can look at economics and come to the conclusion that it is unacceptable according to well-defined scientific criteria and therefore has to be changed; this is a scientific decision.

What I say is that to flip-flop between the two spheres has not yielded results for over two hundred years. The proof is in the dismal state of economics as a science and of too many economies as the inevitable practical result. False theory makes bad policy. As economists our task is to fix the former.

Egmont Kakarot-Handtke