July 5, 2017

Macrofounded labor market theory

Comment on Bill Mitchell on ‘The rise of the “private government”’

Blog-Reference and Blog-Reference

Economics suffers from the fact that the subject matter is ill-defined. Economists think that they are doing economics while they bungle amateurishly in sociology and psychology, that is, in some conveniently stripped down version of these disciplines. What economists overlook is that their subject matter is the structure and behavior of the economic system and that all questions about Human Nature/motives/behavior/action are NOT their business.

Bill Mitchell’s post about the relationship between employees and the firm’s government is pure sociology and firmly rooted in a tradition that goes back to the founding fathers. John Stuart Mill, to recall, had been engaged in a pen-friendship with Auguste Comte, the founder of sociology.#1

The subject matter of standard economics is defined by the Walrasian axiom set which is ultimately based on methodological individualism. Microfoundations ― with constrained optimization and equilibrium as pivotal axioms ― is the wrong approach. This explains why economics is a failed science. Economics is a system science, NOT a social science. Accordingly, the correct approach is macrofoundations.

The elementary version of the correct (objective, systemic, behavior-free, macrofounded) employment equation is shown on Wikimedia.#2

From this equation follows:
(i) An increase of the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase of the factor cost ratio ρF=W/PR leads to higher employment.

The complete employment equation contains in addition profit distribution, the public sector, and foreign trade.

Item (i) and (ii) cover Keynes’ familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what microfounded 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)

“If the price of bananas is kept too high in relation to the price required to balance supply and demand there will be a surplus of bananas. If the price of bananas is below the market clearing price there will be a shortage. The same applies to labour. If the price ― i.e. the wage ― is too high there will be a surplus of workers, i.e. unemployment. If it is kept too low there will be a shortage of workers … Workers do sell their services just as banana producers sell their bananas.” (Brittain)

The banana theory of the labor market is just that: bananas. The lethal methodological blunder of microfounded employment theory consists in the Fallacy of Composition, i.e. the illegitimate transfer of truths that hold for one firm/market onto the economy as a whole. NO way leads from the explanation of Human Nature/motives/behavior/action to the explanation of how the economic system works.#3

False theory leads to false policy guidance. Scientifically incompetent economists bear the intellectual responsibility for the social devastation of mass unemployment.#4

Egmont Kakarot-Handtke

#1 See also ‘John Stuart Mill as a social science founder
#2 The macrofoundations approach starts with three systemic (= behavior-free) axioms: (A0) The objectively given and 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. (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.
#3 See also ‘The happy end of the social science delusion
#4 For more details see cross-references Employment

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REPLY Steve D on Jul 7

Your good advice to take the “relentless ranting over to Billy blog” is not as novel as you might think. These comments have already been posted on Billy blog:

Macrofounded labor market theory
Economics is NOT about Human Nature but the economic system
Where MMT got macro wrong
Rectification and generalization of MMT
Economics as poultry entrails reading
Rethinking MMT
Hobson got full employment policy almost right
How to start off on the right foot
Australian upside-down economics
Modern moronomic theory