December 6, 2016

Econ 101 is dead ― and now?

Comment on Noah Smith on ‘An econ theory, falsified’

Blog-Reference and Blog-Reference

Econ 101 as a whole ― not only the labor market theory ― is false. The ultimate reason is that is rests on false premises. As a result, the standard analytical tool, i.e. SS-curve―DD-curve―equilibrium, is useless because it represents a NONENTITY. So, (i) the formal representation of “the” market is false to start with, and (ii), it is, as a matter of principle, inadmissible to generalize the results of partial analysis for the economy as a whole. This is the fallacy of composition.

Walrasian, Keynesian, Marxian and Austrian economists are groping in the dark with regard to the two most important features of the market economy, that is, the profit mechanism and the price mechanism. To get out of failed economic theory requires nothing less than a full-blown paradigm shift from accustomed microfoundations to entirely new macrofoundations.

In the following a sketch of the correct macroeconomic employment theory is given.* The elementary version of the objective systemic employment equation for the investment economy (no government, no foreign trade) is shown on Wikimedia

From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment (the Greek letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.
(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 gets a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Item (i) and (ii) cover Keynes’s well-known arguments about aggregate demand. Here, though, the focus is on the factor cost ratio rhoF as defined in (iii). This variable embodies the price mechanism which, however, does not work as standard economics assumes. As a matter of fact, overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what standard economics teaches.

The systemic employment equation contains nothing but measurable variables and is therefore readily testable. As always in science, a test decides the matter.

Right policy depends on true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991)

Standard supply-demand-equilibrium economists lack the true theory. Standard labor market theory is provable false. Scientifically incompetent standard economists are responsible for unemployment, deflation, depression and stagnation.

Egmont Kakarot-Handtke

* For details see working papers
The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment
Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
The Truly General Theory of Employment: How Keynes Could Have Succeeded
Towards Full Employment Through Applied Algebra and Counter-Intuitive Behavior
Essentials of Constructive Heterodoxy: Employment
How to Get Rid of Supply-Demand-Equilibrium

Immediately following 'Methodology 101, economic filibuster, and the mother of all excuses'