September 2, 2016

Economists and the economy ― a nonstarter since 200 years

Comment on Peter Radford on ‘Basics’


Economics is a failed science. Neither orthodox economists nor their heterodox critics understand how the economy works. One tends to think that heterodox economists are smarter because they regularly debunk Orthodoxy but the fact of the matter is that both factions are caught in the deep woods ― without any clue of how to get out.

This, for example, is Peter Radford’s idea of what the economy is: “Economies are people doing stuff: stuff we all do. They are not time-series, accounting conventions, lines on charts, or equations in models. They are people going about ordinary life. How that activity then gets expressed — some of it — in the collective we call a market is something to talk about. Why is some activity in that collective and not in another collective such as a family? And so on.” (See intro)

This description (which dovetails with Marshall’s “... economics is a study of mankind in the ordinary business of life”) certainly appeals to ordinary people, the commonsensers, and the often cited little man. This populism, clearly, is a bit silly.

Let us face the facts, what we call ‘the economy’ is an abstract mental construct. Nobody can see or touch or experience ‘the economy’. From the history of science, though, it is known that abstraction/idealization can go badly wrong. This happened in economics as almost everybody has realized by now. But this does not mean that the populist’s approach is better or preferable.

Peter Radford realizes that economics has a starting problem: “... economics, when it is taught, ought to begin with a discussion of what an economy is.” Orthodox economists have done this, of course. As Krugman put it “most of what I and many others do is sorta-kinda neoclassical because it takes the maximization-and-equilibrium world as a starting point.” In more detail, the orthodox starting point is defined by these hard core propositions, a.k.a. axioms, a.k.a. basics:
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)

Orthodoxy, it has to be admitted, has clearly stated “what an economy is.” However, the methodological blunder that suffices to make this axiom set forever unacceptable is that HC3 and HC5 introduce nonentities and that HC6 is a petitio principii.

So, the microfoundations approach as defined by the basics HC1/HC6 is dead.

Keynes made an attempt to switch from microfoundations to macrofoundations but he, too, failed methodologically (2011).

So Walrasianism and Keynesianism have provided a clear definition of their subject matter. Traditional Heterodoxy, on the other hand, never went above criticism and has never delivered a consistent definition of “what the economy is.” Everybody is here entitled to apply their own definition and this is why Heterodoxy is an anything-goes heap of rubbish.

Needless to say that Heterodoxy is not in the position to replace Orthodoxy despite the fact that even orthodox economists admit the obvious, i.e. that the microfoundations approach has failed.

What is required, therefore, is a paradigm shift and this in turn requires the switch from behavior-centered bottom-up, i.e. subjective microfoundations, to structure-centered top-down, i.e. objective macrofoundations.

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 the minimalist set A1 to A3 is the pure consumption economy as the most elementary economic structure. This structure is the core of what Keynes called the monetary theory of production and it fully replaces silly real exchange models, silly Walrasian equilibrium models, silly Post Keynesian models, and silly heterodox populism.

The ordinary business of life is the subject matter of psychology, sociology, and Hollywood soaps. Economics is the science which studies how the monetary economy works. The ultimate economic basics are given with the set A1 to A3 which replaces Orthodoxy and traditional Heterodoxy.*

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Weintraub, E. R. (1985). General Equilibrium Analysis. Cambridge, London, New
York, NY, etc.: Cambridge University Press.

*See cross-references Paradigm shift