January 3, 2016

The future of economics: why you will probably not be admitted to it, and why this is a good thing

Comment on ‘Clarence Ayres on the economic concept of capital’

Blog-Reference and Blog-Reference

“... economics is a big omnibus which contains many passengers of incommensurable interests and abilities.” (Schumpeter, 1994, p. 827)

Economics is a scientific failure. Being stranded in the middle of nowhere, evidently, no one other is responsible than the confused drivers/passengers of the big omnibus themselves. These can be roughly divided into four sects: Walrasians, Keynesians, Marxians, and Austrians. What all have in common is substandard scientific abilities. Generally speaking, the four approaches are built upon unacceptable premises and therefore violate Aristotle’s first principle of 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.” (Posterior Analytics)

What are the premises that are accepted by the majority of economists? Krugman put it thus “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point ...”. This starting point has to be abandoned because this premises are by no stretch of the imagination certain, true, and primary.

At this critical juncture, the economist has to make up his mind: either to defend the indefensible beliefs of one of the four sects or to replace the foundational assumptions and to begin in earnest with the overdue reconstruction of the whole theoretical superstructure of economics. Based on the history of economic thought it is a fair bet that the representative economist will mess up things. However, this has to be proved, so here is the challenge.

The most elementary economic configuration is the pure consumption economy which consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. This minimalist configuration is defined for one period by three equations.

(i) Yw=WL wage income Yw is equal to wage rate W times working hours L,
(ii) O=RL output O is equal to productivity R times working hours L,
(iii) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

If you cannot understand or accept these almost self-evident equations, which hold for the world economy as a whole and every closed national economy, you are out of economics. These premises are certain, true, and primary, or stated in relative terms, obviously superior to the neo-Walrasian axioms (Weintraub, 1985, p. 147) or to Keynes’s defective formal basis (1973, p. 63).

For the graphical representation of the three equations see here. At any given level of employment L, the wage income Yw that is generated in the consolidated business sector follows by multiplication with the wage rate W. On the real side, output O follows by multiplication with the productivity R. Finally, the price P follows as the dependent variable under the conditions of budget balancing, i.e. C=Yw, and market clearing, i.e. X=O. Note that the ray in the southeastern quadrant is not a linear production function; the ray tracks any underlying production function. Note also that the wage rate W is an average if the individual wage rates are different among the employees, which is the general case.

Under the conditions of market clearing and budget balancing in each period the price follows from the three equations as P=W/R (1), i.e. the market clearing price is always equal to unit wage costs. To repeat, the price is here taken as the dependent variable, of course, it can be treated as an independent variable (2015). Also to mention is that money as transaction medium is left out here for brevity; for the full picture see (2015).

The elementary consumption economy works as follows. If the wage rate W is lowered, the market clearing price P falls. If the number of working hours L is increased the price remains constant, provided productivity R does not change. If productivity decreases the price P rises. If productivity increases the price falls. In any case, labor gets the whole product, the real wage W/P is invariably equal to the productivity R according to (1), and profit for the business sector as a whole is zero. All changes in the system are fully reflected by the market clearing price P. The pure consumption economy is reproducible for an indefinite number of periods.

The changes from period to period are formally given by:
(iv) Wt=Wt-1(1+wt) The wage rate in period t — Wt — is given by the wage rate in the previous period Wt-1 and the rate of change for the current period wt.
(v) Rt=Rt-1(1+rt) Analogous for the productivity.
(vi) Lt=Lt-1(1+lt) Analogous for labor input.

The rates of change for future periods wt, rt, lt are random variables with an a priori unknown distribution function. Because of this we cannot predict the price in period t=10 but we can test it in period t=10 or any other future period. As a matter of principle, (1) is a testable proposition.

Given the enumerated premises and conditions, the market clearing price performs a random walk which is determined in turn by the random walks of wage rate and productivity. Equation (1) in combination with (iv) to (vi) replaces the ridiculous supply-demand-equilibrium model of Econ 101.

From the premises and conditions follows for a start.
— The elementary economy constitutes itself through the interaction of real and nominal variables. There is no such thing as a ‘real’ economy, in other words, all ‘real’ models are a priori false.

— There is no such thing as an equilibrium. The product market is cleared and the budget is balanced but the economy is not moved by an Invisible Hand toward some equilibrium, e.g. full employment. In other words, all equilibrium models are a priori false.

— The commonplace quantity theory does not hold. Inflation/deflation depends initially on the development of wage rate and productivity and nothing else. If the period changes of the wage rate are exactly equal to the changes of the productivity i.e. wt=rt, absolute price stability prevails over all future periods despite the random variations of productivity and employment. Hence, price stability/inflation/deflation is not a monetary phenomenon.

— The marginal principle, which ultimately derives from the unacceptable behavioral assumption of utility maximization, does not apply and plays no role at all for the price determination. All marginalist models are a priori false.

— Supply and demand functions are nonentities. Well-behaved production functions and decreasing returns do not exist. These premises are neither required nor admissible.

— Neither the income distribution nor the distribution of the real product depends on the marginal principle. All marginalist distribution models are a priori false.

In the next analytical steps the number of firms is increased, which leads to the determination of relative prices, and the conditions of market clearing and budget balancing are lifted, which gives rise to the phenomena of inventory changes, profit/loss*, and the increase/decrease of the stocks of money and debt. It is pretty obvious that all economic phenomena can successively be derived from the three premises (i) to (iii). Stock-flow consistency is guaranteed ab initio.

In order to develop the first economic theory since Adam Smith that satisfies the scientific criteria of formal and material consistency the unacceptable foundational propositions of Walrasianism, Keynesianism, Marxianism, and Austrianism have to be abandoned. Scientists would immediately perform the necessary paradigm shift but economists are no scientists. Their acceptance of the maximization-and-equilibrium world for more than 100 years is forever disqualifying. Because of this, the still confused sorta-kinda economists are kindly asked to leave the big omnibus now.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. 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.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

* See ‘Profit and the collective failure of economists

Immediately preceding post 'Economics as fool’s paradise'

***

POINTER on Economist's View

No, economists do not understand what is in their models.

***

ANSWER to Bragi on Jan 4

This is the corpus delicti from the General Theory “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

This two-liner is conceptually and logically defective because Keynes did not come to grips with profit theory.

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

Because profit is ill-defined the whole theoretical superstructure of Keynesianism is false, in particular all I=S and IS-LM models.

For the formal proof see ‘Why Post Keynesianism Is Not Yet a Science’.

Keynesians will not make it into the future of economics because of proven logical incompetence over more than 80 years.

References
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

***

REPLY Brain-dead blather, comment on anne on Jan 4

You give the good advice “Take a Krugman model, such as IS-LM and clearly explain what is not understood”.

Let me return the good advice: Read more, think more, blog less.

IS-LM is provable false since the 1930s but the representative economist has realized nothing since more than 80 years. This includes you and, of course, Paul Krugman, see ‘Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It

Here is the core of the proof.

The formal basis of the General Theory is given with: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

This two-liner is conceptually and logically defective because Keynes did not come to grips with profit.

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

Because profit is ill-defined the whole theoretical superstructure of Keynesianism is false, in particular all IS-LM models. See also ‘Why Post Keynesianism Is Not Yet a Science

Keynesians will not make it into the future of economics because of proven logical incompetence — they have no idea of what is in their models. This includes you and, of course, Paul Krugman — the proto-scientific proponent of model bricolage.

The scary fact of the matter is: economists who cannot tell the difference between profit and income [“A satisfactory theory of profits is still elusive.” Desai, 2008, p. 10] tell politicians and the central bank how to run the economy.


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
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 also 'Summary on "Musings on Whether We Consciously Know More or Less than What Is in Our Models…"’

For the new economics paradigm see cross-references.