October 31, 2015

Getting out of mumbonomics

Comment onLars Syll on ‘Postmodern discourse mumbo jumbo’

Blog-Reference

Above, Jan Milch quotes Chomsky with what can be taken here as definition of Postmodernism: “... a lot of it is simply illiterate, based on extraordinary misreading of texts ..., argument that is appalling in its casual lack of elementary self-criticism, lots of statements that are trivial ... or false; and a good deal of plain gibberish.”

According to this definition economists literally invented Postmodernism: “The currently prevailing pattern of economic theorizing exhibits the following three characteristics: (1) a syncopated style of argument fluctuating back and forth between literary and symbolic modes of expression, (2) naive translation, or the loose paraphrasing of formulae into sentences, and (3) loose verbal reasoning for certain aspects of theoretical argumentation where explicit symbolic formulation is lacking.” (Dennis, 1982, p. 698)

What Dennis meant with “loose verbal reasoning” is the same as Chomsky’s “plain gibberish”, and this is the realm where, as Keynes said, “nothing is clear and everything is possible” (1973, p. 292). This vast realm between true and false is traditionally occupied and vigilantly defended by the Cambridge School of Loose Verbal Reasoning: “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)

Keynes’s postmodern methodology — each reader is free to impute his meaning or to guess what Keynes/Marshall meant — became the postkeynesianic gospel: “For Keynes as for Post Keynesians the guiding motto is ‘it is better to be roughly right than precisely wrong!’” (Davidson, 1984, p. 574)

This allows us now to precisely position economics in general and Postkeynesianism in particular: “More recently, Walter Truett Anderson described postmodernism as belonging to one of four typological world views, which he identifies as either (a) Postmodern-ironist, which sees truth as socially constructed, (b) Scientific-rational, in which truth is found through methodical, disciplined inquiry, (c) Social-traditional, in which truth is found in the heritage of ... civilization, or (d) Neo-romantic, in which truth is found through attaining harmony with nature and/or spiritual exploration of the inner self.” (Wikipedia)

Postmodern economics is anything except (b), i.e., methodical, disciplined inquiry, but in fact, as Dow nicely put it ‘Babylonian incoherent babble’ (2005, p. 385).

Since Senior’s first attempt of a ‘methodical, disciplined inquiry’ economists have consistently failed to get out of mumbonomics.

“To Senior belongs the signal honor of having been the first to make the attempt to state, consciously and explicitly, the postulates that are necessary and sufficient in order to build up … that little analytic apparatus commonly known as economic theory, or to put it differently, to provide for it an axiomatic basis.” (Schumpeter, 1994, p. 575)

There is no such thing as a scientifically valid economic theory because Orthodoxy got the axiomatic foundations wrong and Heterodoxy has none at all.*

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.
Davidson, P. (1984). Reviving Keynes’s Revolution. Journal of Post Keynesian Economics, 6(4): 561–575. URL
Dennis, K. (1982). Economic Theory and the Problem of Translation (I). Journal of Economic Issues, 16(3): 691–712. URL
Dow, S. C. (2005). Axioms and Babylonian Thought: A Reply. Journal of Post Keynesian Economics, 27(3): 385–391. 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.
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

* But see for Constructive Heterodoxy

Related to 'Stop knowing nothing, start knowing something' and 'Moronomics'

October 30, 2015

The key relationship between employment and growing/shrinking debt

Comment on Steve Keen on ‘The unnatural rate of interest’

Blog-Reference

Orthodox economists know it, heterodox economists know it, and Marx, too, knew it: economics is a failed science. Economists have no idea how the monetary economy works. The ultimate reason is that the representative economist cannot tell the difference between profit and income, or as the Palgrave Dictionary summarized “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10)

In simple words: economists fail to capture the essence of the market economy.

That is particularly embarrassing in Marx’s case because profit is the core concept of the whole approach. For the overdue rectification see (2014a).

Unfortunately, Keen’s approach rests also on a false profit definition. For the overdue rectification see (2013).

Needless to emphasize that the standard approach is wanting. For the overdue rectification see (2014b).

When the profit theory is false then, by logical necessity, employment theory is affected. To cut a meticulous formal derivation 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 of private households.
(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.
(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 contains only measurable variables and is testable.

Point (i) and (ii) is well-known Keynesian stuff. What is missing in the original Keynesian employment multiplier is the factor cost ratio rhoF as defined in (iii). This variable embodies the price mechanism which, however, does not work as the representative economist hallucinates. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R. This is the key to the solution of the employment problem.

The second important property of the employment equation is that it establishes an explicit formal link between credit expansion/contraction and employment via the expenditure ratio rhoE.

Conclusion: the employment equation delivers the testable formal underpinning of the empirical correlations found by Keen. Both elements support each other nicely.

The relationship between employment and the interest rate is indirect and needs the formal inclusion of the consolidated banking sector. As a first approximation this harmonizes with Keen’s empirical findings. For the actual discussion see the thread ‘Keynes on the Theory of Interest’ on David Glasner’s blog Uneasy Money.

Standard interest theory suffers from the traditional delusion that there is a mechanism — interest rate or multiplier — that equalizes saving and investment. The provable fact of the matter is that there is no such thing as equilibrium/identity of saving and investment. What has to be realized first is that saving and investment are never equal. Because of this, traditional interest theory (including Bernanke, Krugman) is completely hanging in the air.

It is absolutely necessary to develop — as Keen attempts — a superior alternative to the defunct approaches. This requires first of all the rectification of profit theory. This is the primary task of Constructive Heterodoxy (2015). Without the correct profit theory the theory of employment and the theory of interest is a priori false.

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. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2014a). Profit for Marxists. SSRN Working Paper Series, 2414301: 1–25. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Profit. SSRN Working Paper Series, 2575110: 1–18. URL

October 29, 2015

Stop knowing nothing, start knowing something

Comment on Lars Syll on ‘Macroeconomic uncertainty’

Blog-Reference and Blog-Reference

Imagine for a moment, there is one world economy and the government consists, as Plato dreamed, of wise philosophers. There is — unfortunately, the government does not understand why — a grave problem: unemployment is rising. Understandably, this crisis shatters the faith in the economic advisers who hitherto all came from the orthodox school.

So, the Minister for Economic Affairs calls for a heterodox economist and he speaks thus: “You know, Lars, we are unhappy with our previous economic advisers and we have heard that you criticize these DSGE guys for several years now in no uncertain terms. It seems you know better. Are you prepared to help us to solve our current problem?

“Yes, of course Phil, but let me tell you something important about Heterodoxy first: we do not believe that we have access to this mythical Holy Grail, the data-generating process.”

“Hm, what does this mean?”

“It means that we simply do not know. We know this since Keynes's Treatise on Probability of 1921. We know, for example, that we cannot predict the rate of interest 20 years hence.”

“No problem, I talked the other day to this physicist Feynman and guess what he told me: The future is unpredictable. I understand quite well that only folks like soothsayers, astrologers, stock market gurus, fear mongers or prophets make predictions.”

“Yes, this is the core message of Heterodoxy: neither the economist, nor the deciding individual, can fully pre-specify how people will decide when facing uncertainties and ambiguities that are ontological facts of the way the world works.”

“I understand, it's ontological, ignoramus et ignorabimus as du Bois-Reymond always said. But this physicist could at least tell me how the Quarks and the Universe works. Seems he believed more in Hilbert, the axiomatist.”*

“Heterodoxy is different, you know, we do not lull us into the comforting thought that we know everything and that everything is measurable and we have everything under control. We just admit that we often simply do not know, and that we have to live with that uncertainty as well as it goes.”

“That is indeed quite honest. Like good old Socrates: I know that I know nothing.”

“Yes, and telling this truth is dangerous. Remember, the Athenians poisoned him.”

“Yes, afterward he became the patron saint of all know-nothings. But let us put Socrates aside, he was a gossiping sitcom sophist not a scientist.”

“He could be regarded as a forerunner of Keynesianism. After all, he was well aware that many activities, relations, processes and events are of the Keynesian uncertainty-type.”

“I think I understand uncertainty now, but is there anything heterodox economists know beyond this?”

“Yes, of course, fooling people into believing that one can cope with an unknown economic future is a sure recipe for only one thing — economic catastrophe!”

“That's indeed a bold prediction! But, frankly Lars, I expected that you could help us to prevent a catastrophe. Let me put it more precisely: we have rising unemployment and some economists say that the wage rate must be lowered others say it must be raised.** What, as a spokesperson of the heterodox school, is your take on this age-old chestnut?”

“As Keynes said: we simply do not know and it is better to be vaguely right than precisely wrong.”

“And this was already in 1921 and it is still true.”

“You got it, Phil!”

“Yes, Orthodoxy means knowing nothing and Heterodoxy means being proud of knowing nothing.”

Egmont Kakarot-Handtke

* See Wikipedia
** The average wage rate must rise, see ‘No future for the representative economist


***

ICYMI (comment on Jan Milch of Nov 4 on Nov 5)

Lars Syll’s heterodox methodology shares the common sense intuition that economics belongs to the social sciences and that human behavior is the first and foremost issue. This is a methodological cul-de-sac. In order to leave Orthodoxy alone behind the curve, Heterodoxy needs a methodologically superior approach. For details see the following posts.

The Science-of-Man fallacy
From PsySoc to SysHum
Getting out of mumbonomics
PsySoc — the scourge of economics
Redefining economics

You say “... when it comes to the Core-thinking in Economics (and other social sciences) I sadly can’t say much more, than that it’s been more of regression than progress, with few exceptions for much too long.”

Yes, and here are the reasons why
Are economists methodological retards?

October 28, 2015

Accounting basics

Comment on FedUp of Oct 24 on ‘Keynes on the Theory of Interest’

Blog-Reference

The most elementary economy is the pure consumption economy and it consists of the business and the household sector. For a start, the business sector produces and sells one consumption good.

First period: the business sector pays 100 units to the household sector and the household sector spends exactly this amount on the consumption good. There is no saving of the household sector. The business sector's profit is zero and the price of the consumption good is equal to unit wage costs.

Second period: the household sector saves 10 units (S=10) and spends 90 units. Now, the business sector makes a loss (Q=-10). The market clearing price is lower than unit wage costs.

Accounting result: saving=loss or S+Q=0. The complementary notion to saving is not investment but loss. Because of this I=S never holds. And because of this the whole discussion of whether the interest rate or the income mechanism establishes the equilibrium/equality of saving and investment is pointless. There is no such thing.

At the central bank's balance sheet we have at the end of the 2nd period 10 units of current deposits of the household sector and the equal amount of current overdrafts of the business sector. Without going further into details it should be obvious that the rate of interest on the asset side and the rate of interest on the liability side must be such that their difference covers at least the costs of the central bank under the condition of zero profit.

This is how the accounting identity and the two rates of interest are objectively connected in the most elementary case. There is no need at all of silly psycho-sociological filibuster about liquidity preference, animal spirits, or ‘comfort and confidence that individuals derive from holding money in the face of an uncertain and unknown future’. No way leads from behavioral storytelling to the understanding of how the monetary economy works. Standard economics — Keynesianism included — is in the wood and will be left behind there.

For a more detailed depiction of the accounting relationships see ‘The Profit Law’.

Egmont Kakarot-Handtke


Preceding post 'Interest and profit'.
Related to 'End of confusion' and 'I=S: Mark of the Incompetent'.


***

ICYMI (comment on Henry of Oct 28 on Oct 29)

Total wage income Yw is 100 in period 1, and consumption expenditures C are 100. Saving S=Yw-C is zero.

Total wage income Yw is 100 in period 2, and consumption expenditures C are 90. Saving S=Yw-C is 10. Profit Q=C-Yw is -10.

Accounting check: the balances of both sectors add up to zero S+Q=0.

Q.E.D

***

ICYMI (comment on djb of Oct 29)

Analysis starts with the minimum number of elementary propositions. This is known since the ancient Greeks invented science: “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.”*

When you come clear with saving, investment, and profit then the growth of real and nominal wealth emerges immediately as a result. Wealth cannot be assumed as given but must be derived from the most elementary economic configuration with zero wealth.

Keynes started from faulty premises and because of this the conclusion I=S is provable false. History from Keynes onwards, though, has shown that proper methodology is beyond the mental capacities of the representative economist. There is no hope for the present generation of economists (in particular for Henry, JKH, djb).

Nevertheless, for the consistent derivation of wealth see the working paper ‘Primary and Secondary Markets

* See Wikipedia, resume of Aristotle’s Posterior Analytics


***

ICYMI (comment on MarkanKone of Oct 28)

The introduction of distributed/retained profit and the redefinition of saving cannot rescue I=S. No semantic maneuver can. I have clarified this case in Section 17 of the working paper ‘Keynes’s Missing Axioms’.

***

ICYMI (comment on FedUp of Oct 29)

Keynesian economics is about the monetary production economy: “The entrepreneur economy was one of Keynes’ ways of showing how and why monetary and financial matters must be integrated with real factors from the start of the analysis of a monetary production economy. It is this insight that is missing from virtually all strands of modern mainstream theory.” (Harcourt, 2010, p. 49)

The most elementary monetary production economy consists of the business and the household sector. Your two person exchange example is obviously no acceptable representation of Keynes’s approach.

Here is a picture of the most elementary monetary production economy.

References
Harcourt, G. C. (2010). The Crisis in Mainstream Economics. real-world economics review, (53): 47–51. URL http://www.paecon.net/PAEReview/issue53/Harcourt53.pdf.


***

ICYMI (comment on Henry of Oct 29 2:44 pm)

Sales, as seen from the business sector, is the same thing as consumption expenditures, as seen from the household sector.

In period 2 we have: 90-100=-10 (not 0).

In the pure consumption economy, the business sector cannot recoup its wage costs if the household sector saves. This is how loss comes into the world.


***

ICYMI (comment on Henry of Oct 29 3:29 pm)

This is not a matter of definition but of hard, cold cash. The household sector spends C=90 units as consumption expenditures and the business sector receives exactly this amount but calls it sales. This in not way affects the formula for monetary profit Qm=C-Yw. Together with the formula for monetary saving Sm=Yw-C this gives Qm=-Sm (or simply Q=-S if the distinction monetary/nonmonetary is not an issue). Look at the formulas and forget the names. It is the formal proof that counts and nothing else.


***

ICYMI (comment on Henry of Oct 29 4:49 pm)

The accounting approach deals with variables that are the product of price and quantity like expenditure or income. Normally, it is not necessary to deal with each component of the product individually. Here it is indeed necessary because you fetch inventory investment out of thin air. Inventory changes occur if the quantity produced and the quantity sold are different.

So let us look closer at consumption expenditures which are given as product of price and quantity, i.e. C=PX. We start with the case of full market clearing, that is quantity produced and quantity sold are equal and do not change because labor input and productivity do not change either. That is, the real part of the pure consumption economy is frozen.

Now, if consumption expenditures C drop from 100 to 90 in period 2 and the quantity X remains constant the price P must fall in C=PX. The market clearing price in period 2 is now below the unaltered unit wage costs and this means that the zero profit of period 1 turns into a loss.

Note that the quantities produced and sold are equal in both period 1 and 2. So there is no change of inventory and therefore inventory investment does not occur. We have I=0 and S=10, so saving and investment are unequal.

Of course, the product market is normally not cleared and there are inventory changes. I have dealt with this case in full generality in ‘Primary and Secondary Markets

The inclusion of inventory changes, though, does not alter the fact that saving and investment are never equal. And for this simple reason the familiar story of the interest mechanism cannot be true.


***

ICYMI  (comment on Biagio Bossone of Oct 30)

You say: “It is not the case that Keynes didn’t have the words to speak about inequality of ex-ante and ex-post saving. Based on his income multiplier process theory, he derived aggregate saving as a pure residual variable, strictly determined by aggregate investment in a way that S = I always and invariably, both ex ante and ex post.”

It is not the case that we do not know what Keynes said, but it is the case that Keynesians have not realized since the General Theory that Keynes's formal argument is provable false (2011). This has only been papered over with the exante/expost filibuster and this Keynesian verbiage is the very proof of deeper confusion that lasts until this very day.

“Throughout the 1920s and 1930s the focus was increasingly on the role of the equality of saving and investment, but the semantic squabbles that dominated much of the debate (the distinctions between ‘ex ante,’ and ‘ex post,’ ‘planned’ and ‘realized’ saving and investment, the discussion of whether the equality of saving and investment was an identity or an equilibrium condition) reflected a deeper confusion.” (Blanchard, 2000, p. 1378)

This includes Keynes “But Keynes, too, sometimes gave the impression of not having fully grasped the logic of his own system.” (Laidler, 1999, p. 281)

Beyond Keynes’s manifest confusion, the correct relationship is ‘always and invariably’ given here.

Keynes, indeed, had the words to speak about inequality of exante/expost saving/ investment. A lack of words had never been the problem of any economist — what has always been in short supply was logic and argumentative consistency.

“The currently prevailing pattern of economic theorizing exhibits the following three characteristics: (1) a syncopated style of argument fluctuating back and forth between literary and symbolic modes of expression, (2) naive translation, or the loose paraphrasing of formulae into sentences, and (3) loose verbal reasoning for certain aspects of theoretical argumentation where explicit symbolic formulation is lacking.” (Dennis, 1982, p. 698)

The exante/expost argument squarely falls into the category of loose verbal reasoning, a.k.a. blather. And this carries over to the theory of interest.


References
Blanchard, O. (2000). What Do We Know about Macroeconomics that Fisher and Wicksell Did Not? Quarterly Journal of Economics, 115(4): 1375–1409. URL
Dennis, K. (1982). Economic Theory and the Problem of Translation (I). Journal of Economic Issues, 16(3): 691–712. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Laidler, D. (1999). Fabricating the Keynesian Revolution. Cambridge: Cambridge University Press.


***

ICYMI (comment on Henry of Oct 30 on Oct 31)

The accounting approach deals always with nominal magnitudes, which carry a monetary dimension like euro/dollar/yen, and never with real magnitudes. Hence, ‘unit’ invariably means ‘monetary unit’ in the given context. By not realizing that the I=S debate runs in nominal terms your whole argumentation has been empty from the outset. Perhaps it is some comfort that you share this sad fate with djb, FedUp and JKH.

My working paper ‘Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist’ could be of some help to deconfuse yourself.


***

ICYMI (comment on Henry of Oct 31 4:22)

Your definition of income (income = household income + enterprise income) is wrong. Total income Y is wage income Yw=WL plus distributed profit Yd=DN. Distributed profit Yd is different from profit Q.

For the complete and consistent set of foundational propositions, which includes the nominal accounting variables as subset, see this overview,

For details about the difference between profit Q and distributed profit Yd and retained profit Qre (and why Y=Yw+Q is deadly wrong) see ‘Economics for Economists

It's not so easy, indeed Keynes and many others got the distinction between profit and income wrong, and this is exactly why they all ended in the I=S cul-de-sac.* This is the correct relationship: Q=Yd+I-S. This equation tells you how the profit of the business sector as a whole is generated and how important it is that the business sector’s investment is greater than household sector’s saving, i.e. I>S. This equation tells you also how beneficial the dissaving (S with negative sign) of the American consumer (=growth of private debt) is for the world economy (until it is reversed). But this advanced topic is forever beyond the horizon of those who are stuck with I=S.

* See the post ‘I=S: Mark of the Incompetent

Followed by 'Humpty Dumpty is back again'

I=S: Mark of the Incompetent

Comment on JKH and Roger Farmer on ‘Demand Creates its Own Supply’

Blog-Reference

I=S is provable false but the representative economist never got the point. To some degree this is understandable because the deeper conceptual problem is that the representative economist does not even know what profit is because, as the Palgrave summarizes “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10)

In simple words this means that all economic models are defective — except those that come explicitly to grips with the pivotal economic concept profit. None are known from Orthodoxy and Heterodoxy. And this in turn means that all economic advice lacks a sound scientific foundation.

The I=S blunder is not a single or isolated event but a rather typical outcome of proto-scientific thinking and widespread misapprehension of scientific methodology.*

The following economists are representatives of the general intellectual malaise which manifests itself in the longstanding I=S debate. The list could be easily extended.**

— Keynes, see Keynes’s Missing Axioms, working paper
— Hicks/Krugman, see Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We       Know It, working paper
— Rowe, see IS-LM is dead and waiting to be buried, post
— Farmer, see Fundamentally flawed, post
— Syll, see Is Keynes acceptable?, post
— Glasner, see End of confusion, post, and Quod erat demonstrandum, post
— JKH, see Tricky business, post
— Radford, see No culpa, only stultitia, post
— DeLong, see Sales talk vs. Science, post
— Douglas, see Unaccountable, post
— Mitchell, see Modern moronomic theory, post
— Keen, see Mental messies and loose losers, post
— Wren-Lewis, see The subtle distinction between storytelling and science, post.

For a crash course in profit theory see The Profit Law, post.

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

* The correct relationship between monetary profit Qm, distributed profit Yd, investment expenditures I and monetary saving Sm is given here.
** For more details of the big picture see cross-references I=S

Preceding post 'Fundamentally flawed'

October 27, 2015

Fundamentally flawed

Comment on Roger Farmer on ‘Demand Creates its Own Supply’

Blog-Reference

You say “Keynesian economics begins with a basic definition.” This is true. The fact of the matter is, though, that this basic definition is provable false and, worse, that Keynesians have not got the point until this very day (2011b).

The final proof of widespread logical incapacity is that the most elementary accounting identities have been messed up. As a centerpiece of the General Theory Keynes formulated the foundational syllogism of macroeconomics. “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This elementary two-liner is conceptually and logically defective because Keynes did not come to grips with profit (Tómasson and Bezemer, 2010, pp. 12-13, 16). The fault is in the premise ‘income = value of output’. This equality holds initially only in the limiting case of zero profit in both the consumption and investment good industry. Hence, Keynes formally dealt with a zero profit economy without being aware of it (2011b). This means in concrete terms that the multiplier formula is provable false.

The first logical blunder kicked off a chain reaction of mistakes, because when profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. By consequence, all I=S models are logically defective.

The root cause of all accounting errors/mistakes is a complete lack of understanding of what profit is. The conceptual error carries over to national accounting (2012).

You conclude “Here, finally, is the answer to the exchange between Jo and Noah. It is always true, in equilibrium, that savings is equal to investment.”

Definitively not! It is always true that Qm=Yd+I-Sm, that is, monetary profit is equal to distributed profit plus investment expenditure minus household sector's monetary saving. Saving and investment is never equal. This is a testable proposition.

To repeat: all I=S models are logically defective because they fail to consistently integrate profit. A short formal proof has been given on a parallel thread.*

Not only Jo and Noah got it wrong, but Roger, too. Not to forget, of course, Keynes and Hicks and Krugman (2014) and the rest of the logically feeble profession.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011a). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL
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.
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

* See the Uneasy Money blog or the summary ‘End of confusion’ on the AXEC blog

For more details of the big picture see cross-references I=S

Moronomics

Answer to Paul Schächterle on ‘Economics, concepts, language and the progress of science’

Blog-Reference

The most curious fact about economics is that is has not taken off the ground since Adam Smith “... we know little more now about ‘how the economy works,’ or about the modus operandi of the invisible hand than we knew in 1790, after Adam Smith completed the last revision of The Wealth of Nations.” (Clower, 1999, p. 401)

Compare this to the contemporaneous evolution of physics, then economics has in fact fallen even further behind. What obscures this de facto regression is that economists have always taken in edge-of-science tools that have been developed elsewhere. Thus, over more than two centuries now, economists of all schools have been busily engaged in what genuine scientists like Feynman readily identified as cargo cult science (see Wikipedia).

Thus, economics gave the impression of scientific progress while it has not moved one millimeter above the proto-scientific level of Adam Smith. Why? It is obvious, and Merijn Knibbe’s contribution is a pertinent reminder, that economists have never managed to come clear with the fundamental concepts of their trade.

The term unemployment, however, represents only the miniscule tip of the methodological crap mountain that is advertized as queen of the social sciences. The ultimate reason for the observable self-paralysis of economics is that the representative economist cannot tell the difference between the fundamental concepts profit and income. It should be clear that without a proper understanding of the concept of profit economics is scientifically dead and what you can see still walking around is a zombie.

Among genuine scientists all this has not gone unnoticed “Time and again in the twentieth century, prominent physicists have chastised their economist colleagues in no uncertain terms ...” (Mirowski, 1995, p. 357)

It did not help much. In everyday life, how do we characterize people who are unable to apply a coherent language?

Egmont Kakarot-Handtke


References
Clower, R. W. (1999). Post-Keynes Monetary and Financial Theory. Journal of Post Keynesian Economics, 21(3): 399–414. URL
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.

Preceding post 'Incoherence as second nature'

Relates to 'End of confusion' and 'Misled by ordinary intuition and common sense' and 'The Science-of-Man fallacy.'

In this moment, Oct 27 16:20 CET, I have found out that the term Moronomics has already been invented by someone else, see the Twitter hashtag.

October 26, 2015

Is Keynes acceptable?

Comment on Lars Syll on ‘Did Keynes ‘accept’ the IS-LM model?’

Blog-Reference

You summarize “My own view is that IS-LM doesn’t adequately reflect the width and depth of Keynes’s insights on the workings of modern market economies.” (See intro)

IS-LM never has been acceptable (2014). However, it is not only unacceptable because of Hicks's numerous blunders. It is unacceptable because of Keynes’s original logical blunder which has not been rectified until this very day (2011).

As it happens, the question has been settled a few days ago on David Glasner’s blog Uneasy Money:
— For the full thread see here.
— For Keynes's logical incapacity see the post ‘Keynes and the logical brilliance of Bedlam’.
— For the rectification of Keynes’s conceptual blunder see the post ‘End of confusion’.

The ‘width and depth of Keynes’s insights’ on the workings of modern market economies should not be overrated. His recurring mantra was “we simply do not know” and this is the most appropriate summary of Keynesianism until this day.

“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)

Neither Keynesianism nor Walrasianism in all their variants delivered the true economic theory — both approaches are unacceptable.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
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
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

See also 'Interest and profit'

Incoherence as second nature

Comment on 'Economics, concepts, language and the progress of science'

Blog-Reference

In order to get out of eternal wish-wash, the progress of science requires a consistent set of concepts.

“The often heard rule that concepts are to be defined before they are used in a discussion is much too simple minded pre-Hilbertian. The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen)

The use of the word unemployment is a pertinent example of incoherent thinking and talking which is indeed second nature to the representative economist.*

Egmont Kakarot-Handtke

* For the new axiomatic approach see cross-references Curriculum

October 24, 2015

Interest and profit

Comment on ‘Keynes on the Theory of Interest’

Blog-Reference

At the immediately preceding thread ‘Keynes and Accounting Identities’ the rigorous formal proof has been given that Keynes’s elementary accounting identities are false.* From this follows first of all for economic policy that the familiar multiplier is formally defective. The correct employment multiplier is displayed here (2015a, eq. (15)).

The elementary Keynesian multiplier follows from the saving-equals-investment condition and the consumption function. Because I=S is provable false** it follows that the complementary story of the interest rate mechanism is false by logical implication. Because of this, a complete analytical reset is needed.

For good methodological reasons, one has to start — not from individual behavior but — from the institutional fact that an elementary consumption economy (no investment, no government, no foreign trade) consists of the banking sector, represented for a start by the central bank, and the production sector, represented for a start by a single firm. Now, there are two rates of interest — for overdrafts and deposits to begin with — and the difference between the two is a co-determinant of profit of the central bank, which produces, as the saying goes, money (= deposits) and credit (= overdrafts) out of nothing.

So, the interest rates on both sides of the central bank’s balance sheet and profit are closely intertwined. By consequence, if the profit theory is false the interest theory is false by logical implication. Now, in has been shown that Keynes’s profit theory is definitively false. Because of this, his theory of interest is unacceptable. An alternative is needed.

To make a long argument short: the relation of rate of interest to product price, the so-called real interest rate, has to be derived for the most elementary case from the production conditions of the sub-sectors of the elementary monetary economy (2013, eq. (28)), see also (2011, eq. (30)) and (2011) and (2015b, Sec. 7).

Roughly speaking, in the most elementary case the real rate of interest is objectively determined by the respective productivities in the consumption good sector and the banking sector. Needless to stress that things become a bit more complex as soon as different term structures on the asset and liability side and the financing of investment expenditures is taken into the picture.

As Keynes realized, there is no direct connection between saving/dissaving and “the” rate of interest. Roughly speaking, the households can accumulate their period savings on a zero interest deposit account as long as they wish, no matter what the actual rate for overdrafts/loans is. Hence the intertemporal allocation of consumption expenditures (=period saving/dissaving) is — as a matter of principle — independent from the rate of interest. Because of this, Fisher’s subjective time preference approach cannot explain anything. Therefore, Keynes was right to ignore it.

It should be noted in passing that the stock of deposits/overdrafts is, in the most elementary case, the numerical integral of period saving/dissaving of the household sector. The two interest rates refer to the respective stocks and not to period saving/dissaving. The quantity of money is endogenously determined.

Take away If profit theory is false, interest theory is false; this is the case with both Keynes’s and Fisher’s approach; I=S is always false and therefore cannot explain interest.

Egmont Kakarot-Handtke

References
Kakarot-Handtke, E. (2011a). The Emergence of Profit and Interest in the Monetary Circuit. SSRN Working Paper Series, 1973952: 1–22. URL
Kakarot-Handtke, E. (2011b). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. 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
cfm?abstract_id=2624350.

* Refers to 'End of confusion' and 'Keynes and the logical brilliance of Bedlam'
** The correct relationship is given here.

October 22, 2015

Not yet in and not yet out of the wood

Comment on Lars Syll on ‘Phelps’ smackdown on Lucas’ rational expectations’

Blog-Reference

(i) “In their mind, the scientific way is to suppose price and wage setters form their expectations with every bit as much understanding of markets as the expert economist seeking to model, or predict, their behavior.” (See intro)
(ii) Expert economists have no scientific understanding of how the market economy works.
(iii) Well-informed and rational agents do not take orthodox economics seriously. Ergo: the rational expectations approach is self-contradictory.

It is crystal clear by now that Orthodoxy badly missed ‘the scientific way’ or, as Schumpeter already realized “We are not yet out of the wood; in fact, we are not yet in it.” (1994, p. 7)

Unfortunately, Heterodoxy, too, is not out of the wood because it wastes too much time with debunking silly behavioral assumptions instead of putting economics on methodologically sound foundations and thereby leading it out of the proto-scientific wood of Lucas, Frydman, Phelps and all the quacking rest.

The scientific way has been shown by Joan Robinson: ‘Scrap the lot and start again.’*

Egmont Kakarot-Handtke


References
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

* For the new curriculum see cross-references New curriculum

End of confusion

Comment on David Glasner on ‘Keynes and Accounting Identities’

Blog-Reference

Hicks was the first to come up with a smart solution of the saving-investment conundrum: “What a tricky business this all is! In his Treatise on Money, Mr. Keynes told the world that savings and investment are only equal in conditions of equilibrium; that an excess of investment over saving means rising prices, and vice versa. In his General Theory, he told us that saving and investment are always equal, and that this is a mere identity or truism, without significance for the determination of prices. As far as I can make out, there are relevant and important senses in which all these statements are each of them right and each of them wrong.” (1939, p. 184)

Indeed, in economics anything goes and at the end of every grand debate the confusion is roughly the same as at the beginning.

“Throughout the 1920s and 1930s the focus was increasingly on the role of the equality of saving and investment, but the semantic squabbles that dominated much of the debate (the distinctions between ‘ex ante,’ and ‘ex post,’ ‘planned’ and ‘realized’ saving and investment, the discussion of whether the equality of saving and investment was an identity or an equilibrium condition) reflected a deeper confusion.” (Blanchard, 2000, p. 1378)

The saving-equals-investment debate from Adam Smith onwards is a striking example of hereditary scientific incompetence.

Lest younger economists waste another eighty+ years in deeper confusion it should be mentioned that the whole issue has been settled: “Autrement dit l’investissement n’est pas égal à l’épargne spontanée, mais à l’épargne spontanée augmenté du revenue non distribué des entreprises ....” (Allais, 1993, p. 69) Or, summed up in a crisp formula (for details see 2014; 2013).

This formally consistent accounting identity makes it clear that saving and investment never were and never will be equal and that the familiar story of the interest rate mechanism has never been more than clueless verbiage.

The formal foundations of Keynesianism are defective. For Keynesians, though, inconsistency is not a fatal flaw but the sign of an extraordinary mind: “It is well known that John Maynard was born anew every morning; for this reason, his colleagues at Bretton Woods commented that he was too intelligent to be consistent.” (Valentino, 1988, p. 239)

Any questions why Keynesians messed the whole IS thing up and, more general, why economics is a failed science?

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Blanchard, O. (2000). What Do We Know about Macroeconomics that Fisher and Wicksell Did Not? Quarterly Journal of Economics, 115(4): 1375–1409. URL
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press, 2nd edition.
Kakarot-Handtke, E. (2013). Settling the Theory of Saving. SSRN Working Paper Series, 2220651: 1–23. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Valentino, R. (1988). Discussion. In H. Hanusch (Ed.), Evolutionary Economics. Applications of Schumpeter’s Ideas, pages 238–249. Cambridge, New York, NY, etc.: Cambridge University Press.

Preceding post 'Keynes and the logical brilliance of Bedlam'

For details of the greater picture see cross-references I=S


***
ICYMI (comment on Anders of Oct 22)

The premise income=expenditure is false as I pointed out above (Oct 21) and the deeper reason is that the profit theory is false. For the rectification of Keynes's approach see the working paper ‘The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment


***
ICYMI (comment on Ramanan of Oct 22)

The mistake in your argument is that first household saving is denoted with S and then, in an additional step, the sum of household saving and “Firm's saving” is also denoted with S. With this inadmissible double notation one arrives indeed at the familiar result. I have clarified this case in Section 17 of the working paper ‘Keynes’s Missing Axioms


***
ICYMI (comment on Anders of Oct 23)

Indeed, you ask the pivotal question: “I’m still unclear how you repudiate the basic “income=expenditure” identity. Within an accounting period, if aggregate income isn’t equal to expenditure, where does the surplus (deficit) go (come from)?”

The shortest possible and graphics supported answer has been given in the 3 page working paper ‘Debunking Squared

The complete answer with the consistent inclusion of money has been derived in ‘The Emergence of Profit and Interest in the Monetary Circuit

In sum: Neither Classicals, nor Walrasians, nor Marshallians, nor Marxians, nor Keynesians, nor Institutionialists, nor Monetary Economists, nor MMTers, 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. Hence, they fail to capture the essence of the market economy.

***

ICYMI  (comment on Anders of Oct 23 on Oct 24)

The formally correct accounting relationship is given here.

Ignore for simplicity distributed/retained profit, i.e. Yd=0. Then the equation says: monetary profit Qm is equal to the difference between investment I and monetary saving Sm. All variables are measurable with a precision of two decimals and one will always find that the business sector’s investment expenditures are different from the household sector’s saving/dissaving in a period of given length and that profit/loss for the business sector as a whole is different from zero.

Again, all I=S models are false and the proof is in the national accounts, see ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach’.

Your statement ‘profit does not constitute a problem for standard economics’ is a bit strange, to say the least. The profit theory is false since Adam Smith and this disqualifies the whole of economics. The fact of the matter is that the representative economist cannot, after more than 200 years, tell the difference between profit and income. You will not find many examples in the history of science that are more embarrassing.

***

ICYMI (comment on djb of Oct 23 and Anders of Oct 23 on Oct 25)

You say: “Keynes understood profit was included in total income.”

This is true, of course, but my argument is that exactly at this point Keynes made the fatal conceptual blunder which consists in not coming to grips with the two fundamental economic concepts profit and income. To miss the crucial difference is just as unpardonable as a physicist confounding force and energy.

I perfectly agree with Anders up to this point: “Now, let’s make one business start to run a profit. This can happen from another agent running a deficit ...” This is a good example for begging the question. It is not demonstrated in detail how profit emerges from the monetary circuit but simply assumed with “let’s make one business start to run a profit ...” Note well, if one business starts to make a profit and the other makes a complementary loss, the profit of the business sector as a whole is still zero just as in the initial case. Obviously, this does not explain how the business sector has managed to make overall positive profits over several centuries.

Here is again the formally correct accounting relationship.

For simplicity, distributed profit and investment is set to zero, i.e. Yd=0 and I=0. Then the equation says for the pure consumption economy: monetary profit for the business sector as a whole Qm is equal to dissaving; and monetary loss is equal to monetary saving Sm (under the condition of product market clearing, that is, no inventory investment/disinvestment).

Profit is a phenomenon that can only emerge in a monetary economy. As a matter of principle, real models cannot explain profit.

Summary It is incorrect to say that total income is the sum of wage income and profit, but it is correct to say that total income is the sum of wage income and distributed profit. This is the all-dominant conceptual difference. Its oversight makes that economic theory from Adam Smith to Keynes and up to the present will not even make a footnote in the history of scientific thought.

***

ICYMI (comment on djb of Oct 25 on Oct 26)

Confusion is the default state of the representative economist (2013). Obviously, you cannot get out of Keynes’s accounting mess by nonstop introducing new concepts like wealth, capital, consumption function etc. The solution lies exactly in the opposite direction.

“There can be no doubt whatsoever that a problem which has not yet been solved in all its aspects under its simplest conditions will be still more difficult to tackle if other, ‘more realistic’ assumptions are being made.” (Morgenstern, 1941, p. 373)

In the most elementary case of the consumption economy the accounting identity says (i) Qm=-Sm.

After taking investment into account the accounting identity reads (ii) Qm=I-Sm (for the full investment cycle see 2011).

And so it goes consistently on to ever higher levels of complexity. Equations (i) and (ii) tell you that saving is never equal to investment. All equations are testable/refutable in principle. So there is absolutely no need for endless confused blather.


References
Kakarot-Handtke, E. (2011). Squaring the Investment Cycle. SSRN Working Paper Series, 1911796: 1–25. URL
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL

October 21, 2015

Keynes and the logical brilliance of Bedlam

Comment on David Glasner on ‘Keynes and Accounting Identities’

Blog-Reference

It is the very definition of a non-scientist to transform every objective problem into an ad-hominem story and thereby to make it definitively insoluble. This works because most people are fond of stories, which allow for good/bad moralizing or like/dislike blather, but not so much of scientifically valid theories, which allow only for clear cut true/false judgments.

Accordingly, David Glasner frames the issue of accounting identities thus: “Keynes, who besides being one of the most intelligent people of the 20th century was also so ferociously logical (and these two qualities do not necessarily overlap) that he was almost certainly incapable of making a logical mistake or of forgetting accounting identities.” (See intro)

This distraction works because now we are entangled in the question of whether Keynes or his opponent Hawtrey was more intelligent/brilliant. To be sure, the correct answer had been given long ago by Nobel laureate Allais but because it had been delivered in French it never came to the attention of the representative economist: “L’intuition de Keynes lui a fait sentir où se trouvaient les difficultés, mais son insuffisance logique ne lui a pas permis de résoudre les problèmes que son intuition lui avait fait entrevoir.” (1993, p. 70) Roughly: Keynes intuition led him to the real difficulties but his logical insufficiency prevented the solution.

This is a polite way of saying that logical consistency was not exactly one of Keynes's strong points. But, in the final analysis, this does not matter much because Keynes was first and foremost a political economists and not a scientist. In politics the effectiveness of an argument counts and, as a rule, the intended audience could not care less about logical and material consistency.

In sum, Hahn’s characterization is more to the point: “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.” (1982, pp. x-xi)

To characterize Keynes as ‘ferociously logical’ is plainly against what Keynes himself thought about the whole issue “... a remorseless logician can end up in Bedlam.” (quoted in Moggridge, 1976, p. 36)

The final proof of Keynes's logical incapacity is that he messed up the most elementary accounting identities. As a centerpiece of the General Theory he formulated the foundational syllogism of macroeconomics. “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This elementary two-liner is conceptually and logically defective because Keynes did not come to grips with profit (Tómasson and Bezemer, 2010, pp. 12-13, 16). The fault is in the premise ‘income = value of output’. This equality holds initially only in the limiting case of zero profit in both the consumption and investment good industry. Hence, Keynes formally dealt with a zero profit economy without being aware of it (2011a; 2011b). This means in concrete terms that the multiplier formula is provable false.

The first logical blunder kicked off a chain reaction of mistakes because when profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. By consequence, all I=S models are logically defective. Krugman, for one, has not got the point until this very day and underpins his economic policy advice with a recent variant of IS-LM (2014). This does not matter either, because Krugman, too, is merely a political economist and not a scientist.

The root cause of all accounting errors/mistakes is a complete lack of understanding of what profit is. The conceptual error carries over to national accounting (2012).

Walras’s original model had also been a zero profit economy. Clearly, Walrasianism and Keynesianism is squarely at odds with reality. Yet, economists are busily occupied with shoptalk about the Bedlam models of their brilliant masterminds until this very day.

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Hahn, F. H. (1982). Money and Inflation. Oxford: Blackwell.
Kakarot-Handtke, E. (2011a). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL
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.
Moggridge, D. E. (1976). Keynes. London, Basingstoke: Macmillan.
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

October 19, 2015

Misled by ordinary intuition and common sense

Comment on Edward Fullbrook on ‘The Counterintuitive Problem’

Blog-Reference

The decisive strength of Aristotle’s physics had been that it was intuitively convincing and, lo and behold, not too much has changed since the old days: “[The] stunning finding was that 87 percent of the students who had had no training in physics gave answers considered incorrect according to modern physics, but consonant with Aristotelian notions of motion and impetus. A further result, which gave even greater pause, was that 27 percent of those who had studied physics gave Aristotelian answers.” (Mirowski, 1995, p. 104)

So much for the power of intuition and common sense which have turned out in the meantime to be the most persistent impediment to scientific advancement “... that the new physics of the seventeenth century, which replaced the older concepts of motion, rest, and change, involved a radical reorientation of the view of the cosmos and the possibilities of an infinite void space, thus yielding an almost entirely new philosophy of nature and a wholly different physics that contradicted ordinary intuition and common sense.” (Cohen, 1977, p. 318-319)

In short, science begins exactly beyond ordinary intuition and common sense as already J. S. Mill told his fellow economists: “People fancied they saw the sun rise and set, the stars revolve in circles round the pole. We now know that they saw no such thing; what they really saw was a set of appearances, equally reconcileable with the theory they held and with a totally different one. It seems strange that such an instance as this, ... , should not have opened the eyes of the bigots of common sense, and inspired them with a more modest distrust of the competency of mere ignorance to judge the conclusions of cultivated thought.” (2006, p. 783)

This crucial insight was lost on the Cambridge School, first on Marshall “Economics for Marshall was the perfection of common sense.” (Hoover, 1998, p. 243), then on Keynes “L’intuition de Keynes lui a fait sentir où se trouvaient les difficultés, mais son insuffisance logique ne lui a pas permis de résoudre les problèmes que son intuition lui avait fait entrevoir.” (Allais, 1993, p. 70) [Keynes intuition led him to the real difficulties but his logical inability thwarted the solution (see also 2011)]. As Moggridge confirmed “For, if anything, Keynes was the most intuitive of men.” (1976, p. 33)

To reject Keynes’s ordinary intuition is not to reject scientific intuition “... we cannot over-emphasize the fundamental role played in this research by a special intuition, which is not the popular sense-intuition, but rather a kind of direct divination (ahead of all reasoning) ...” (Bourbaki, 2005, p. 1272)

The most misleading intuition is that economics is a science of behavior (2011). It should be clear by now that second-guessing human behavior, animal spirits or reflexive expectations cannot lead to much more than folk psychology, sociologism, storytelling or gossip.

The crucial methodological error/mistake can be traced back to Jevons: “The science of Economics, however, is in some degree peculiar, owing to the fact ... that its ultimate laws are known to us immediately by intuition, or, at any rate, they are furnished to us ready made by other mental or physical sciences.” (Jevons, 1911, p. 18)

This turned out to be the representative economist’s fatal illusion “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)

What the representative economist has not realized until this very day is that ordinary intuition and common sense are the very hallmark of proto-science. All depends on taking the decisive methodological step: “Economics inevitably goes beyond common sense and intuition.” (Dow, 2006, p. 15)

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Bourbaki, N. (2005). The Architecture of Mathematics. In W. Ewald (Ed.), From Kant to Hilbert. A Source Book in the Foundations of Mathematics, volume II, pages 1265–1276. Oxford, New York, NY: Oxford University Press.
Cohen, I. B. (1977). History and the Philosopher of Science. In F. Suppe (Ed.), The Structure of Scientific Theories, pages 308–349. Urbana, IL, Chicago, IL: University of Illinois Press.
Dow, S. C. (2006). Economic Methodology: An Inquiry. Oxford: Oxford University Press.
Hoover, K. D. (1998). Comment: Keynes, Marshall and Involuntary Unemployment. In R. E. Backhouse, D. M. Hausman, U. Mäki, and A. Salanti (Eds.), Economics and Methodology. Crossing Boundaries, pages 236–247. Houndmills, Basingstoke, London: Palgrave.
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
Jevons, W. S. (1911). The Theory of Political Economy. London, Bombay, etc.: Macmillan, 4th edition. URL http://www.econlib.org/library/YPDBooks/Jevons/jvnPE.html
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. 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.
Moggridge, D. E. (1976). Keynes. London, Basingstoke: Macmillan.

Relates to 'The Science-of-Man fallacy'.

Economics in self-paralysis

Comment on Lars Syll on ‘Representative agent models — macroeconomic foundations made of sand’

Blog-Reference and the slightly extended variant Blog-Reference

You summarize: “... Hugo Sonnenschein, Rolf Mantel and Gerard Debreu unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equilibrium solution.” (See intro)

Yes, indeed, since 1972 every smart economist can know this: General Equilibrium Theory is dead. So what? What exactly follows from this proof?

It follows nothing less than this: Orthodoxy is dead. Why? Because it has been defined thus: “It is a touchstone of accepted economics that all explanations must run in terms of the actions and reactions of individuals. Our behavior in judging economic research, in peer review of papers and research, and in promotions, includes the criterion that in principle the behavior we explain and the policies we propose are explicable in terms of individuals, not of other social categories.” (Arrow, 1994, p. 1)

There is not the slightest ambiguity, according to this self-definition of Orthodoxy the representative agent approach is a priori out, inadmissible, a self-contradiction, a methodological absurdity.

What follows from this? Because the microfoundation program is a shot in the foot it has no future. What, in turn, follows from this? “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao and Israel, 1990, p. 362)

So, what could it possibly mean? Hmmm? Which part of ‘a completely new research program’ is unclear?

It simply follows that it is a waste of time to either defend or to attack the microfoundation program because we now know for sure that it was already dead when Jevons/Walras/ Menger started it.

It is not worth the time to criticize again and again different aspects of Orthodoxy because the program is as meaty as Geo-centrism in physics. Yet, what is even worse than ‘finicky scholasticism — getting tied up in little assertions or minor criticism (Popper)’ is to resort to the conclusion that Orthodoxy is scientific junk but that it is, given the complexity/ uncertainty of the subject matter, the best that could be achieved. This, unfortunately, seems to be the resignative deadlock between Orthodoxy and traditional Heterodoxy “Yet most economists neither seek alternative theories nor believe that they can be found.” (Hausman, 1992, p. 248)

This self-paralysis explains why economics is still a proto-science. There is no way around this, after the SMD proof there remains only one worthwhile talking point and that is: what does the new economics paradigm look like?*

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.
Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the History of Science. Cambridge, MA, London: MIT Press.

* For a start see cross-references Paradigm shift

October 17, 2015

Crisis, cranks, and scientists

Comment on David Ruccio on ‘A gathering storm?’

Blog-Reference

The normal course of events is this: people look at the global/national economy or their regional/personal environment and see an acute or chronic defect (distribution of income/wealth/power/resources, unemployment, stagnation, exploitation, pollution/ depletion/extinction, asset bubbles, inflation/deflation, abuse/fraud/hype/deceit/ corruption, dysfunctional institutions, etc) and then come forward with the solution.

“A sure sign of a crisis is the prevalence of cranks. It is characteristic of a crisis in theory that cranks get a hearing from the public which orthodoxy is failing to satisfy. In the thirties we had Major Douglas, and social credit — it can all be done with a fountain pen — and Warren and Pearson who convinced President Roosevelt that raising the dollar price of gold would raise the price of everything else and bring the slump to an end. The cranks are to be preferred to the orthodox because they see that there is a problem. Nowadays we have plenty of cranks taking up the problems that the economists overlook.” (Robinson, 1972, p. 8)

This is certainly not what science is all about. Broadly speaking: economics, understood as the collective scientific knowledge of economists, can tell with a sufficiently high degree of certainty how the economy works, what the critical functions are, how institutions have to be designed to guarantee the proper functioning of subsystems and the integrated whole and thereby contribute to the prevention of major crises in the short and long run. Thus defined, there is no economics.

Crises are the high time for political economists and the normal course of events is that suggestive quick fixes are applied. A grossly simplified example is to fight unemployment with prolonged deficit spending, which leads to growing debt, which at some point calls for helicopter money, which then can ‘be done with a fountain pen’.

There is not much to say against deficit spending or helicopter money as a commonsensical quick fix in case of emergency except that it has no sound foundation in something resembling a valid economic theory. No economist is needed to figure out this kind of ‘solutions’. In many cases they are not even innovative, e.g.: “Public works to relieve the unemployed is an idea as old as the Bible; ...” (Blaug, 1998, p. 662). The same holds for debt jubilees.

When a Heterodox economist sees a meltdown coming three ideas immediately cross his mind (i) confirmation, i.e. Orthodoxy is indeed a failed approach, and (ii), regret, i.e. Heterodoxy has failed to come up in due time with the superior paradigm, and (iii), to go with panic makers and cranks is not exactly what Heterodoxy is meant to be.

The grand task of Heterodoxy was and still is to figure out what an economy looks like that is free of major crises in a way that is scientifically more convincing than general equilibrium theory.

Egmont Kakarot-Handtke


References
Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
Robinson, J. (1972). The Second Crisis of Economic Theory. American Economic Review, 62(1/2): 1–10. URL http://www.jstor.org/stable/1821517.

Preceding 'Misplaced augurs of doom'

October 16, 2015

Misplaced augurs of doom

Comment on David Ruccio on ‘A gathering storm?’

Blog-Reference

You say “Marxist and other radical economists often remind people of the inherent instability of capitalism — unlike their mainstream counterparts, who tend to focus on equilibrium and the invisible hand of free markets.” (See intro)

Not only Marxists are in the doomsday business but the gold bugs, too, and the producers of survival kits, and the Armageddon-Christians, and the fiat money abolitionists, etcetera (see zerohedge or YouTube for the daily doom menue).

Fear mongering is good business, but it is not the economist’s business. What is missing is a theoretically sound account of the famous ‘long run’. Note well that the classics and Marx based their projections on the law of the falling profit rate. This is something quite different from the current bubble/crash panic talk. Until this very day, the representative economist does not know what profit is, much less how it develops in the long run (2014; 2015). Hence, all crisis projections are not much more than journalistic extrapolations of surface phenomena.

You sum up: “That’s the gathering storm they [policymakers, central bankers] — and we — should be worried about.”

Yes, but in a quite different sense. Economic crises are, in the last instance, the result of a total lack of understanding of how the economy works, that is, of the manifest failure of economics as a science. This holds first and foremost for employment theory. It was Keynes who addressed the problem during the Great Depression but could not solve it satisfactorily, neither could the Post-Keynesians (2011), not to speak of New Keynesians and New Classics.

Amidst the theoretical mess, what economists should be worried about is that they bear the intellectual responsibility for the next occurrence of mass unemployment and the accompanying societal devastation.* Indeed, the future is bleak — for economists in particular.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). Mathematical Proof of the Breakdown of Capitalism. SSRN Working Paper Series, 2375578: 1–21. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* Unemployment is avoidable, see 'Back to science' and cross-references Employment.

October 15, 2015

The Science-of-Man fallacy

Comment on ‘Don’t throw away Angus Deaton with the bathwater of the Riksbank prize — he’s good!’

Blog-Reference and Blog-Reference

What Angus Deaton is practicing is essentially sociology. Sociology belongs to the so-called social sciences. Strictly speaking, the social sciences are what Feynman called cargo cult sciences (see Wikipedia).

The program of the social sciences has been defined by Hume: “It is evident, that all the sciences have a relation, greater or less, to human nature: and that however wide any of them may seem to run from it, they still return back by one passage or another. Even. Mathematics, Natural Philosophy, and Natural Religion, are in some measure dependent on the science of MAN; since the lie under the cognizance of men, and are judged of by their powers and faculties.” (Hume, 2012, Introduction)

Hume’s program has been explicitly taken over by Pareto: “The foundation of political economy and, in general, of every social science, is evidently psychology. A day will come when we shall be able to deduce the laws of social science from the principles of psychology ...” (Pareto, 2014, p. 20)

Pareto gives us the Science-of-Man fallacy in a nutshell. As a matter of fact, no way leads from the understanding of human behavior or the ‘principles of psychology’ to the understanding of how the actual economy works.

The crucial point is that economics deals — in the first place — not with individual human behavior or society at large (Hudík, 2011). This is the realm of psychology, sociology, anthropology, history, political science, etcetera. Insofar as economics deals with behavioral assumptions like utility maximization, greed, power grabbing, etcetera, it is a dilettantish variant of Psycho-Sociology or PsySoc.

What is the real subject matter of economics? As a first approximation, one can agree on the general characteristic that the economy is a complex system. However, with the term system one usually associates a structure with components that are non-human. In order to stress the obvious fact that humans are an essential component of the economic system the market economy should be characterized more precisely as a complex hybrid human/system entity or SysHum.

The scientific method is straightforwardly applicable to the sys-component but not to the hum-component. While it is clear that the economy always has to be treated as an indivisible whole, for good methodological reasons the analysis has to start with the objective system-component (2014).

Methodologically, the economic system is the foreground. Common sense wrongly insists that the hum-component must always be in the foreground. This is the Science-of-Man fallacy which compares to Geo-centrism. The economic system has its own logic which is different from the behavioral logic of humans. The systemic logic is what Adam Smith called the Invisible Hand.

Economic analysis has to make the Invisible Hand visible, that is, it has first of all to uncover the systemic laws of the monetary economy.

The Science-of-Man approach has abysmally failed in economics. Heterodoxy better gets out of PsySoc before the so-called social sciences — and this is overdue — are for cogent methodological reasons expelled from the sciences.

Egmont Kakarot-Handtke


References
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Hume, D. (2012). A Treatise of Human Nature. Project Gutenberg EBook. URL
Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL
Pareto, V. (2014). Manual of Policical Economy. Oxford: Oxford University Press. URL


***

ICYMI  (comment on anne of October 15, on October 16)

Cargo cult is a well defined description of the actual state of economics: “Suffice it to say that, in my opinion, what we presently possess by way of so-called pure economic theory is objectively indistinguishable from what the physicist Richard Feynman, in an unflattering sketch of nonsense ‘science,’ called ‘cargo cult science’.” (Clower, 1994, p. 809)

The precise meaning is: “So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they're missing something essential, ...”*

What is missing is an understanding of what science is all about. Feynman had this understanding, the representative economist never came even close to it, see ‘The Farce That Is Economics: Richard Feynman On The Social Sciences.’ (Tavares, 2014)

As a simple rule of thumb it holds: the student who accepts supply-demand-equilibrium as an explanation of how the market system works disqualifies himself irrevocably as scientist. The actual state of economics is that the representative economist cannot even tell the difference between profit and income (2015). Economists have no idea of the most important phenomenon of their universe and hallucinate that economics is a science.


References
Clower, R. W. (1994). Economics as an Inductive Science. Southern Economic Journal, 60(4): 805–814.
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Tavares, E. (2014). The Farce That Is Economics: Richard Feynman On The Social Sciences. Zerohedge blog post. URL

* See here

October 14, 2015

The irrelevance of economics

Comment on Lars Syll ‘On the irrelevance of formal logic in economics’

Blog-Reference and Blog-Reference

See also the almost identical post ‘Scientifically incompetent’
Comment on ‘In Search of the Science in Economics’

Blog-Reference

(i) Since the ancient Greeks it is known that science is about knowledge and that politics is about opinion/belief/second guessing/filibustering. “There are always many different opinions and conventions concerning any one problem or subject-matter .... This shows that they are not all true. For if they conflict, then at best only one of them can be true. Thus it appears that Parmenides ... was the first to distinguish clearly between truth or reality on the one hand, and convention or conventional opinion (hearsay, plausible myth) on the other ...” (Popper, 1994, pp. 39-40)
Accordingly, there is political economics and theoretical economics. The political economist cranks out opinions, the theoretical economist contributes to knowledge.

(ii) The goal of political economics is to push an agenda, the goal of theoretical economics is to explain how the actual economy works. In political economics anything goes, in theoretical economics scientific standards are observed.

(iii) Scientific standards are well-defined: “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant, 1994, p. 31)

(iv) Most economists are political economists: “However much economists may evoke their purity, they want to change the world. They want to contribute to the solution of urgent practical problems. ... Of course, they also pursue the consistency of the theories they make, for he who contradicts himself proves nothing.” (Klant, 1988, pp. 112-113)

(v) As Klant makes it clear, to be a political economist does not involve a license to suspend the rules of logic. Toulmin is utterly wrong when he speaks of the irrelevance of formal logic. He is right only insofar as formal logic is vacuous if the basic/primitive/elementary concepts have no empirical content. Formal logic is necessary, but not sufficient.

(vi) It is important to distinguish between method and actual application. Spinoza, for example, used the axiomatic-deductive method to rigorously prove the existence of God. This, obviously, is a misapplication. In general terms, the methodological blunder consists in applying formal logic to nonentities.

(vii) This is the correct understanding of the scientific method: “When we assemble the facts of a definite, more-or-less comprehensive field of knowledge, we soon notice that these facts are capable of being ordered. This ordering always comes about with the help of a certain framework of concepts .... The framework of concepts is nothing other than the theory of the field of knowledge. ... If we consider a particular theory more closely, we always see that a few distinguished propositions of the field of knowledge underlie the construction of the framework of concepts, and these propositions then suffice by themselves for the construction, in accordance with logical principles, of the entire framework. ... The procedure of the axiomatic method, as it is expressed here, amounts to a deepening of the foundations of the individual domains of knowledge — a deepening that is necessary for every edifice that one wishes to expand and to build higher while preserving its stability. (Hilbert, 2005, pp. 1107-1109)

(viii) Neither Orthodoxy nor Heterodoxy has hitherto produced an economic theory that fits Hilbert’s description. Economics is a failed science. We are left with political economics, which is scientifically worthless.

(ix) The first step of the student of economics is to realize that all theories/models are false that are built upon the following concepts: utility, expected utility, rationality/bounded rationality/animal spirits, equilibrium, constrained optimization, well-behaved production functions/fixation on decreasing returns, supply/demand functions, simultaneous adaptation, rational expectation, total income=value of output/I=S, real-number quantities/prices, and ergodicity. All these items are economic nonentities. The second step is to replace nonentities with concepts that have a counterpart in reality (2014).

(x) Economics is not even a plausible myth; the fundamental defect is that it deals with nonentities. Because of this, all formalization has hitherto been without effect. This is not the fault of formalization but of the scientific incompetence of the representative economist.

Egmont Kakarot-Handtke


References
Hilbert, D. (2005). Axiomatic Thought. In W. Ewald (Ed.), From Kant to Hilbert. A Source Book in the Foundations of Mathematics, volume II, pages 1107–1115. Oxford, New York, NY: Oxford University Press.
Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL
Klant, J. J. (1988). The Natural Order. In N. de Marchi (Ed.), The Popperian Legacy in Economics, pages 87–117. Cambridge: Cambridge University Press.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield: Edward Elgar.
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality. London, New York, NY: Routledge.

For details of the bigger picture see cross-references Incompetence


***

ICYMI (comment on Sandwichman of October 14, on October 15)

Georgescu-Roegen is one of the few economists who grasped what science is all about and he settled the ridiculous mathiness filibuster before it even occurred. “Lest this position is misinterpreted again by some casual reader, let me repeat that my point is not that arithmetization of science is undesirable. Whenever arithmetization can be worked out, its merits are above all words of praise. My point is that wholesale arithmetization is impossible, that there is valid knowledge even without arithmetization, and that mock arithmetization is dangerous if peddled as genuine.” (1971, p. 15)

Long before DSGE he arrived at the conclusion that economists are scientifically incompetent. “Knight lamented that there are many members of the economic profession who are "mathematicians first and economists afterwards." The situation since Knights time has become much worse. There are endeavors that now pass for the most desirable kind of economic contributions although they are just plain mathematical exercises, not only without any economic substance but also without mathematical value. Their authors are not something first and something else afterwards; they are neither mathematicians nor economists.” (1979, p. 317)

The same holds for Schumpeter. “At all times, including the present, in judging from the standpoint of the requirements of each period ... the performance of economic theory has been below reasonable expectation and open to valid criticism.” (Schumpeter, 1994, p. 19)

Time to make economics a science.*


References
Georgescu-Roegen, N. (1971). The Entropy Law and the Economic Process. Cambridge, MA: Cambridge University Press.
Georgescu-Roegen, N. (1979). Methods in Economic Science. Journal of Economic Issues, 13(2): 317–328. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

 *See also here.