April 24, 2016

Why do workers not tar and feather economists?

Comment on ‘Why not full employment?’

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Economists nowadays wonder “... unemployment not only has an economic cost in terms of lost output, but a massive psychological cost because the unemployed are significantly unhappier than those in work.” Does anybody remember that economics always claimed that the market system produces full employment?

“From the time of Say and Ricardo the classical economists have taught that supply creates its own demand; — meaning by this in some significant, but not clearly defined, sense that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product. .... Evidently, this amounts to the same thing as full employment.“ (Keynes, quoted in Baumol, 1999, p. 200)

It seems that employment theory urgently needs rectification. To cut the meticulous formal derivation short (2015; 2014; 2012), the most elementary version of the CORRECT employment equation for the economy as a whole is given here.

From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the letter rho stands for ratio). An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction of the household sector.
(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.

The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Item (i) and (ii) is familiar since Keynes. What is missing in the Keynesian employment multiplier, though, is the ratio rhoF as defined in (iii). This variable embodies the price mechanism. It works such that overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

This is the very OPPOSITE of what standard economics teaches. “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)

The explanation of unemployment is given by the fact that the price mechanism does NOT work as the representative economist hallucinates. Ultimately, unemployment is caused by the scientific incompetence of economists, therefore the economic and psychological costs of unemployment can be directly attributed to them.

Egmont Kakarot-Handtke

Baumol, W. J. (1999). Retrospectives: Say’s Law. Journal of Economic Perspectives, 13(1): 195–204. URL
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
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
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.

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