February 11, 2016

Have data, lack theory

Comment on David Ruccio on ‘Why is slow growth a problem?’

Blog-Reference and Blog-Reference

Everybody knows: the economy does not function as economics textbooks say. This holds — with damaging consequences — in particular for the labor market. The fatal professional incompetence consists in:
• To this day, the representative economist has not realized that the overall systemic interdependencies establish a POSITIVE feedback loop between the (aggregate) product and the (aggregate) labor market.
• To this day, the representative economist cannot tell the difference between income and profit.

In the following, a sketch of the formally and empirically correct employment and profit theory is given.

The most elementary version of the Employment Law is shown on Wikimedia AXEC62a:

 From this equation follows inter alia:
(i) An increase in the expenditure ratio ρE leads to higher employment. An expenditure ratio ρE>1 indicates credit expansion, a ratio ρE<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρF=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 (2015).
(iv) The complete and testable Employment Law is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world.

Point (i) and (ii) are familiar Keynesian stuff. Let us focus here alone on the factor cost ratio ρF 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.

In order to avoid worldwide unemployment and deflation, the average wage rate must, therefore, rise worldwide. For the relationship between real wage, productivity, profit, and real shares see (2015, Sec. 10)

The axiomatically correct Profit Law reads Qm≡Yd+I−Sm (2014, p. 8, eq. (18))#1 Legend: Qm monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditures.

The Profit Law gets a bit more complex when foreign trade and government is included. The equation says (for the world economy as a whole):
(v) Strong growth = high investment I is good for the overall monetary profit of the business sector as a whole.
(vi) Strong consumption expenditures = low saving Sm or even dissaving -Sm = growing consumer debt is good for profit.
(vii) By implication high government deficit spending = growing public debt is good for profit.
(viii) High profit distribution Yd is good for profit.

Profit and profit distribution constitute a self-reinforcing feedback loop. The same holds for profit and investment. These built-in positive feedback loops explode the notion of equilibrium: the monetary economy is NOT a self-optimizing equilibrium system.

Note, that overall profit has nothing to do with productivity or low wages. These and other factors affect only the distribution of overall profit between firms or countries. Note also, that the profit equation holds for the USA, Russia, China, the EU, and all other countries/ associations, that is, it does not matter at all whether one has a market economy or private property or free enterprise or any other of the alleged characteristics of capitalism.

David Ruccio has to do a lot of scientific homework in order to make his data speak.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

#1 See here or here or here.

REPLY to graccibros of Feb 11

From the same set of equations follow consistently the real shares (which, of course, have nothing at all to do with marginal productivity). For details see the 23 pages of the working paper The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?.

Immediately following Accounting for dummies.