July 19, 2017

New Economic Thinking: the 10 crucial points

Comment on Bradford DeLong on ‘How to Think Like an Economist’

Blog-Reference and Blog-Reference and Blog-Reference on Jul 19 and Blog-Reference and Blog-Reference and Blog-Reference on Jul 20 adapted to context

Bradford DeLong gives a comprehensive overview of what he and the representative economist understands under economic thinking.#1 His post can be taken as an inventory of all that is wrong with economics. This, in turn, delivers the red thread for the systematic enumeration of necessary changes.

(i) The State of Economics

The four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/formally inconsistent and all got the pivotal economic concept profit wrong.

Provable false:
• profit theory, since 200+ years,
• Walrasian microfoundations (including equilibrium), since 140+ years,
• Keynesian macrofoundations (including I=S, IS-LM), since 80+ years.#2

This means that the popular textbooks from Samuelson (1947) to Mankiw and Rodrik are scientifically worthless.#3

(ii) Paradigm shift

Economics is a failed science. The four main approaches are indefensible. The arguments of the representative economist about specific difficulties of his subject matter have to be taken for what they are: as excuses, more precisely as thoroughly refuted excuses.#4

The fact that an approach is axiomatically false means that it cannot be improved but must be fully replaced.

(iii) System science

Bradford DeLong argues: “While economics is not a natural science, it is a science — a social science.” This is a popular misunderstanding. Economics is a system science. Economics is about how the economy works and NOT about Human Nature/motives/ behavior/action.#5 These issues are left to psychology, sociology, anthropology, history, political science, social philosophy, biology/Darwinism/evolution theory etcetera.

(iv) Separation of Politics and Science

The question about the good society is a political question that has to be answered in the political realm and NOT in the scientific realm. Already John Stuart Mill was quite explicit about the separation of politics and science.#6

(v) True macrofoundations

Fact is that the subject matter of economics is ill-defined or, in methodological terms, that economics is axiomatically false.

A paradigm shift means in practical term that economics has to move from false Walrasian microfoundations and false Keynesian macrofoundations to true macrofoundations because if it isn’t macro-axiomatized, it isn’t economics.#7

(vi) Methodology

The failure of economics is mainly due to the Fallacy of Insufficient Abstraction. In other words, economists cannot rise above the level of storytelling. One story line is that of supply-demand-equilibrium and the wonderful feats of the Invisible Hand, the other story line is that of the struggle between the good guys=workers and the bad guys=capitalists. Storytelling is scientific rubbish but people like it.

The economy is an abstraction. The correct abstraction to start with is what Keynes called the ‘monetary theory of production’. Scientific theories are defined by material/formal consistency.

The analysis proceeds top down, that is it starts with macrofoundations which are step by step differentiated, in other words, the analysis advances from the elementary to the complex.

There is no vague blather, no rhetoric, no metaphors, no psychologism, no sociologism, no second-guessing of human motives or expectations, no gossip, no sitcom talk and no storytelling. There is nothing but measurable variables, equations, and graphs. Because all variables are measurable all conclusions are testable.

(vii) The pure consumption economy

The objectively given and most elementary configuration of the (world-) economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm.#8 The pure consumption economy is formally given by:

• Three 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.

• Two initial conditions: market clearing, i.e. X=O, and budget balancing, i.e. C=Yw.

• Two definitions: monetary saving of the household sector Sm≡Yw-C and monetary profit of the business sector Qm≡C-Yw. It always holds Qm+Sm=0 or Qm=-Sm.

(viii) The evolving economy

The axioms A1 to A3 refer to a period of predetermined length. The variables for one period and the next period are connected by rates of change (deterministic or random). The proper formal representation is not a system of equations but a simulation. The open ended simulation is given with the Economics God Equation.#9

(ix) The market

It is a must to forget a whole bunch of NONENTITIES: utility, production function, supply function = SS-curve, demand function = DD curve, equilibrium/disequilibrium. Supply-demand-equilibrium, the totem of micro/macro, is dead. Functions are fictions and therefore reduced to period elasticities.

The macroeconomic market is formally defined with the Law of Supply and Demand.#10

(x) Employment and real growth/decline

The pure consumption economy has, of course, to be expanded to the investment economy. This yields the employment equation.#11This equation shows how employment/ unemployment depends on aggregate demand and the price- and profit mechanism, i.e. on the relative changes of wage rate, price, and productivity. The growth/decline of output and changes of the income distribution can be derived from the employment equation. The stocks of inventory, money, and capital are consistently derived from the period flows as numerical integrals.

The employment equation proves that the market economy is inherently unstable and shows the possible entry points for effective policy measures.

Egmont Kakarot-Handtke

#1 How to think like an economist (if, that is, you wish to …)
#2 Economics: 200+ years of scientific incompetence and fraud
#3 The father of modern economics and his imbecile kids
#4 Failed economics: The losers’ long list of lame excuses
#5 Economics is NOT about Human Nature but the economic system
#6 The end of political economics
#7 First Lecture in New Economic Thinking
#8 For the verbal description see ‘How the intelligent non-economist can refute every economist hands down
#9 Wikimedia Economics God Equation

#10 Wikimedia Law of Supply and Demand
#11 Wikimedia Employment equation/structural Phillips curve

Immediately preceding 'How economists habitually mess it up'. For details of the big picture see cross-references Paradigm shift.