December 29, 2015

Austerity and the utter scientific ignorance of economists

Comment on Simon Wren-Lewis on ‘Exploring one set of reasons why austerity happened’

Blog-Reference and Blog-Reference The secular stagnation of labor market theory on Jan 11

“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)

Economists lack the true theory and because of this they have nothing to offer but some political opinion. The market economy does not work as standard economics says. This holds — with damaging consequences — in particular for the labor market.

The core of labor market theory goes as follows “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed. Applied to economy-wide unemployment, this doctrine places the blame on trade unions and governments, not on any failure of competitive markets.” (Tobin, 1997, p. 11)

Until this day, the representative economist has not realized that the overall systemic interdependence establishes a positive feedback loop between ‘the’ product and ‘the’ labor market, that is, wage rate down - employment down - wage rate down - and so on. Vice versa with an increasing average wage rate. The market system is not an equilibrium system. All equilibrium models are a priori false.

The most elementary version of the correct employment equation is given here. From this structural equation follows inter alia:
(i) An increase of the expenditure ratio rhoE leads to higher employment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This is, of course, contrary to conventional economic wisdom. It is, though, easy to prove that conventional wisdom is a mere fallacy of composition (2015).

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.

(i) and (ii) translate into Keynesian anti-austerity policy, which has its own drawbacks*. Let us focus here alone on the factor cost ratio rhoF as defined in (iii). This variable embodies the price mechanism which, however, does not work as 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.

The correct employment theory states that the average wage rate must rise on a global scale in order to prevent unemployment and deflation. For the relationship between real wage, productivity, profit and real shares see (2015, Sec. 10)

With the provable false standard employment theory economists bear the intellectual responsibility for the social devastation of unemployment. The political discussion about austerity is somewhat beside the point. It is the market mechanism which is defective at the core and economists have not realized this in more than 200 years.

The only remaining talking point between politicians and economists is to bring an action for damages.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.
Tobin, J. (1997). An Overview of the General Theory. In G. C. Harcourt, and P. A. Riach (Eds.), The ’Second Edition’ of The General Theory, volume 2, pages 3–27. Oxon: Routledge.

* See 'Deficit spending, helicopter money, and profit' and 'Keynesianism as ultimate profit machine'

Related  'Methodological retards' and 'How the intelligent non-economist can refute every economist hands down' and 'One entirely sufficient reason for the shutdown of economics' and 'The future of economics: why you will probably not be admitted to it, and why this is a good thing' and 'Austerity and the total disconnect between economic policy and science' and 'Austerity and the idiocy of political economists' and 'Economics as poultry entrails reading'