June 9, 2016

Politics is national, science is not

Comment on Peter Bofinger on ‘German macroeconomics: The long shadow of Walter Eucken’

Blog-Reference

Strictly speaking there can be no German, UK, or US macroeconomics as there can be no German, UK or US physics or mathematics. Because science has no nationality there can only be true or false macroeconomics. The fact of the matter is that both Keynes and Eucken got macro wrong.

Keynes characterized the situation of theoretical economics as follows: “Though we all started out in the same direction, we soon parted company into two main groups. What made the cleavage that thus divided us?” The key question that divides economists is, in Keynes’s words: “... is the existing economic system in any significant sense self-adjusting.”

Economics has not settled the question in a scientifically acceptable way until this day. So all that we have is opinion, educated common sense, and agenda pushing in different national flavors.

The correct elementary structural employment equation (2012) 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).
(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) cover Keynes’s arguments about aggregate demand. However, the Keynesian employment equation and the multiplier are provably false. What is missing 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 and vice versa.

And here Eucken comes in. Every supply-demand-equilibrium economist fancies that the remedy for excess supply in any market is a reduction in price. From whence the claim comes that wage reductions will — in principle — restore full employment. This is the essence of the self-adjustment claim. The structural employment equation says that wage reductions INCREASE unemployment which means that the market system is — in principle — self-destabilizing. Eucken did not grasp this crucial point.

What Post Keynesians have overlooked is that there are TWO ratios in the multiplier, the expenditure ratio rhoE and the factor cost ratio rhoF. For economic policy, this means: an increase of the expenditure ratio can be counteracted at any time by a decrease of the factor cost ratio, that is, by a falling average wage rate or by a rising average price. The hitherto missing variable explains why Keynesian demand policies are sometimes effective and sometimes ineffective.

The key point is that the price mechanism does NOT stabilize the market system, neither in the short nor in the long run. This has NOTHING to do with stickiness and this systemic feature cannot be cured by Keynesian demand management. In this respect, Eucken was right. But both, Keynes and Eucken, got the price mechanism wrong (2015). Ultimately, there is not much to choose between German and Anglo macroeconomics.

Egmont Kakarot-Handtke


References
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. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL