October 30, 2015

The key relationship between employment and growing/shrinking debt

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


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

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