August 22, 2016

Demystifying employment theory and policy

Comment on Adair Turner on ‘Demystifying Monetary Finance’

Blog-Reference

Walrasian, Keynesian, Marxian, and Austrian economists are groping in the dark with regard to the two most important features of the market economy: the price mechanism and the profit mechanism. The fault lies in the fact that economists argue from false premises, that is, Walrasianism in all shapes and forms (DSGE, RBC, AD/AS etc.) argues from unacceptable microfoundations, and Keynesianism in all shapes and forms argues from false macrofoundations (2011). To get out of failed economics requires nothing less than a paradigm shift.

In the following a sketch of the formally and empirically correct employment theory is given. A rather elementary version of the objective structural employment equation (2012) is shown on Wikimedia.

From this equation follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment (the letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.
(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.

The complete AND testable employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Items (i) and (ii) cover Keynes’s arguments about aggregate demand, which have been commonsensically right but formally defective. More precisely, Keynes’s multiplier is provable false (see 2012). The factor cost ratio rhoF as defined in (iii) embodies the price mechanism which works very different from what the representative economist falsely assumes. As a matter of fact, overall employment (in the world economy or a closed national economy) INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

For the relationship between real wage, productivity, profit and real shares see (2015, Sec. 10).

So, in simple terms, full employment (in any definition) can be achieved by increasing overall demand (expenditure ratio, investment expenditures etc.) or by INCREASING the average wage rate or by a combination of the two.

The Keynesian approach is macrofounded but incomplete because Keynes had no deeper understanding of the price and profit mechanism. Both, the Walrasian and Keynesian approaches have produced counterproductive policy advice. Unemployment is ultimately the result of theory failure.

The arguments for helicopter money are covered with items (i) and (ii). What has been overlooked so far is that deficit spending (with or without helicopter money) has massive distributional effects. Roughly speaking, the household sector’s and public sector’s deficits reappear one-to-one as monetary profit of the business sector (2015). Ultimately, helicopter money is a free lunch for the business sector.

The employment equation suggests a better way to full employment. The factor cost ratio rhoF translates roughly into the policy recipe (for a closed national economy): if the central bank wants an average inflation rate of, say, 2 percent and the average productivity growth is, say, 1.5 percent then the average wage rate must rise with 3.5 percent until full employment is established. The crucial point is that by using the price mechanism the known drawbacks of deficit spending/helicopter money are greatly reduced.

Egmont Kakarot-Handtke


References
E.K-H (2015). Keynesianism as ultimate profit machine. Blog post. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL