April 19, 2016

Where advanced Heterodoxy — represented by Steve Keen — took the wrong turn

Comment on Lars Syll on ‘Physics and economics’

Blog-Reference and Blog-Reference

“... economics is a big omnibus which contains many passengers of incommensurable interests and abilities.” (Schumpeter, 1994, p. 827)

Roughly speaking, the economic omnibus contains four sects: (i) Walrasians, (ii) Keynesians, (iii) Marxians, and (iv) Austrians/Others. Because they contradict each other, as a matter of logic, only one can be true yet all can be false.

Heterodoxy comes in different flavors, but normally it means approaches (ii) to (iv) in opposition to Orthodoxy (i). Constructive Heterodoxy goes one step further and proves that all four approaches are false, that is, traditional Heterodoxy (ii) to (iv) also. In other words, after more than 200 years there is NO scientifically valid economic theory. Economics is a failed science. Economic policy guidance is worthless or even counter-productive.

A false theory is never obviously false but contains propositions that are partially true, commonsensical, descriptively correct, realistic, or plausible. Moreover, a false theory is corroborated by selected evidence/examples and is rhetorically fortified with widely accepted platitudes or tautologies. False theories contain many elements that are convincing at first sight. This is the main reason why they can survive for a long time: “The truth is, most persons, not excepting professional economists, are satisfied with very hazy notions.” (Fisher, quoted in Mirowski, 1995, p. 86). This is why social reality consists of 99% storytelling and 1 % scientific knowledge.

The common denominator of Heterodoxy is that Orthodoxy is unacceptable. Starting with this broad consensus, there are different ways to proceed. Here we follow the path of Steve Keen. His approach is one of the most advanced in the heterodox camp. He has gone through extensive debunking of Orthodoxy and he has correctly identified the methodological root cause of obvious failure.

Orthodoxy is committed to methodological individualism. This is the foundational error/mistake. After more than 140 years since Jevons/Walras/Menger the representative economist still has not gotten the point that the formal foundations of Orthodoxy are defective. The microfoundation approach is defined by six axioms (Weintraub, 1985, p. 109), which have been loosely summarized by Krugman as “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point”.

This must be taken as the confession of a confused mind (2013) because the starting point is provable false and this requires a paradigm shift from microfoundations to macrofoundations (see link #1).

Each theory/model is built upon a set of foundational propositions a.k.a. axioms. Steve Keen follows the example of Goodwin and chooses ‘a logically incontestable starting point’ which consists of three elementary definitions. Then he goes on to build a complex simulation upon these foundations by adding variables and functions.

Keen’s approach is methodologically correct, except for the fact that his definitions are still not elementary enough. Because of this, they have to be replaced by deeper macrofoundations as follows.
(A0) The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.
(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.

These premises are certain, true, and primary, and therefore satisfy ALL methodological requirements. The new axiom set contains NO NONENTITIES like utility, maximization, or equilibrium. For the graphical representation of the absolute formal minimum set see #3.

At any given level of employment L, the wage income Yw that is generated in the consolidated business sector follows by multiplication with the wage rate W. On the real side, output O follows by multiplication with the productivity R. Finally, the price P follows as the dependent variable under the conditions of budget balancing, i.e. C=Yw and market clearing, i.e. X=O. Note that the ray in the southeastern quadrant is NOT a linear production function; the ray tracks ANY underlying production function. Note also that the wage rate W is an AVERAGE if the individual wage rates are different among the employees, which is normally the case. These details are not needed at the beginning.

Under the conditions of (i) market clearing and (ii) budget balancing in each period the price is derived as P=W/R (1), i.e. the market clearing price is in the most elementary case equal to unit wage costs. This is the elementary form of the Law of Supply and Demand which, in a second step, has to be generalized for an arbitrary number of markets.

If the wage rate W is lowered, the market clearing price P falls. If the number of working hours L is increased the price remains constant, provided productivity R does not change. If productivity decreases the price P rises. If productivity increases the price falls. In any case, labor gets the whole product, the real wage W/P is invariably equal to the productivity R according to (1), and profit for the business sector as a whole is invariably zero. So, the next question is where does profit come from?

All changes in the system are reflected by the market clearing price. The most elementary economy is REPRODUCIBLE for an indefinite number of periods under the interim condition of no external limitations.

The time evolution of any variable is formally given by the 4th axiom (see link #4), which is nothing other than the familiar mathematical growth formula (the three dots indicate a DISCRETE rate of change, e.g. 3,7 %, in contradistinction to the first derivative which is usually symbolized with one dot).

With the final step we again depart from Keen as we do NOT introduce deterministic functions (like the Phillips curve) because at this early stage of the analysis we do not posses such functions. What has to be strictly avoided is the usual assumptionism.

At this stage there is only one legitimate assumption about the rates of change of the independent variables: “The simplest hypothesis is that variation is random until the contrary is shown, the onus of the proof resting on the advocate of the more complicated hypothesis (...).” (Kreuzenkamp et al., 1995, p. 12)

Now, the minimal set of premises is complete. The four axioms and the random rates of change constitute the simulation of the elementary consumption economy (see link #5) which is the formally correct starting point of ALL economic analysis. The exemplary outcome of a simulation is shown in #6.

Note, that NONE of the ridiculous behavioral assumptions (utility, maximization, bounded rationality, rational expectation, equilibrium, etc.) is applied. For a start, the simulation yields a drifting consumption economy that neither collapses nor explodes nor approaches an equilibrium. The elementary consumption economy simply evolves stochastically with a balanced budget and a cleared product market. Note in passing that the dynamic properties of Keen’s simulation of the capitalist economy are ultimately determined by his assumptions of deterministic functional relationships. These assumptions are methodologically inadmissible.

For more details about the axiomatically correct and stock-flow consistent price, profit, money and market theory see (2015).

Conclusion: Orthodoxy is a failed approach. Constructive Heterodoxy goes beyond debunking and dead-horse beating. The paradigm shift consists in the move from microfoundations to macrofoundations. The correct macrofoundations are given with the structural axioms A1 to A3. Strictly speaking, current economics consists of Constructive Heterodoxy (#7). Orthodoxy and traditional Heterodoxy is manifest scientific garbage.

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Kreuzenkamp, H. A., and McAleer, M. (1995). Simplicity, Scientific Inference and Econometric Modeling. Economic Journal, 105: 1–21. URL
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.
Weintraub, E. R. (1985). General Equilibrium Analysis. Cambridge, London, New York, NY, etc.: Cambridge University Press.

#1 ‘From microfoundations to macrofoundations
#2 YouTube, Steve Keen, ‘Transcending the Lucas Critique with Minsky
#3 Wikimedia, The pure consumption economy with market clearing and budget balancing
#4 Wikimedia, Discrete time evolution
#5 Simulation, Download of the Excel spreadsheet from Dropbox
#6 Wikimedia, Exemplary depiction of the drifting consumption economy
#7 See New Curriculum

REPLY to Ken Zimmerman on Apr 20

(i) The core of your methodological blather is the Baconian research program: “Bacon, the philosopher of science, was, quite consistently, an enemy of the Copernican hypothesis. Don’t theorize, he said, but open your eyes and observe without prejudice, and you cannot doubt that the Sun moves and that the Earth is at rest.” (Popper)

Note that observationism was dead in the cradle back in 1600.

(ii) The proof of a method is in the application. Apply your own advice and show results that fit the scientific criteria of material and formal consistency.

(iii) Economics is neither physics nor psychology/sociology/history but a system science. Because of this, Steve Keen’s approach is way ahead of Ken Zimmerman’s observationism of 1600.