March 5, 2016

Finalizing the Keynesian Revolution

Comment on Lars Syll on ‘Mainstream economics — a wildly inconsistent project’

Blog-Reference and Blog-Reference on Mar 7

Orthodoxy is a failed approach. Because every theory is defined by its foundational premises, a.k.a. axioms, there is, as a matter of principle, no need to refute every single proposition of the vast theoretical superstructure, it suffices to ‘throw over’ (Keynes) the axioms. Yet, this is not enough. The negative/destructive first step must be followed by a positive/constructive second step. As Blaug put it: “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (1998, p. 703)

First step: economics has to throw over the orthodox set of axioms which is defined by these six hard core propositions:
HC1. There exist economic agents.
HC2. Agents have preferences over outcomes.
HC3. Agents independently optimize subject to constraints.
HC4. Choices are made in interrelated markets.
HC5. Agents have full relevant knowledge.
HC6. Observable economic outcomes are coordinated, so they must be discussed with reference to equilibrium states. (Weintraub, 1985, p. 109)

Note that we follow exactly Keynes’s methodology as laid down in the General Theory: “The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight ― as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics.” (1973, p. 16)

In other words, the methodological revolution in economics consists in the switch from behavior-centered bottom-up, i.e. subjective microfoundation, to structure-centered top-down, i.e. objective macrofoundation of the world economy.

Accordingly, Keynes went on to define the new set of foundational propositions, a.k.a. axioms: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Unfortunately, at this critical juncture an error slipped in 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, p. 12)

Because of this, Keynes’s two foundational macroeconomic equations (Y=C+I, S=Y-C) have to be replaced. The most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm and is given by these three objective structural axioms:
A1. Yw=WL wage income Yw is equal to wage rate W times working hours L,
A2. O=RL output O is equal to productivity R times working hours L,
A3. C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

The investment good sector comes in at a later stage. So, what we have with A1 to A3 is the pure consumption economy as the most elementary economic configuration. These premises are certain, true, and primary, and therefore satisfy perfectly all methodological requirements. Note that unacceptable nonentities like utility, maximization, or equilibrium are absent.

Human behavior, tastes, choice, or society have no durable underlying structure, but the monetary economy has and it is given in the most elementary case by A1 to A3. Economics is not a behavioral or social science but a system science. A system can be unambiguously defined.

Keynes started the paradigm shift from micro to macro. However, he got stuck with the definition of overall macroeconomic profit. The consistent axiomatic set A1 to A3 overcomes this fatal deadlock and finalizes the Keynesian revolution (2011; 2014; 2015).

To paraphrase a summary of Blaug: ‘At long last, it can be said that the history of general theory from Walras to Arrow-Debreu and on to DSGE has been a journey down a blind alley, and it is the set A1 to A3 to have finally hammered down the nails in the coffin.’ (cf. 2001, p. 160)

Egmont Kakarot-Handtke

Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
Blaug, M. (2001). No History of Ideas, Please, We’re Economists. Journal of Economic Perspectives, 15(1): 145–164.
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
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.
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
Weintraub, E. R. (1985). General Equilibrium Analysis. Cambridge, London, New
York, NY, etc.: Cambridge University Press.