August 10, 2017

Sending Solow’s growth model to the dump of proto-scientific history

Comment on Luis C. Corchón on ‘A Malthus-Swan Model of Economic Growth’

Blog-Reference

Economics fits Feynman’s definition of a cargo cult science: “They’re doing everything right. The form is perfect. ... But it doesn’t work. ... So I call these things cargo cult science because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential.”

Orthodox economics messed up the theory of production. Georgescu-Roegen was quite clear about “… the completely faulty form by which standard economics represents a production process”. As a consequence, all growth models of the Solow-type since the QJE paper of 1956 are worthless. But the problem goes deeper. All microfounded models are worthless.

The whole theoretical superstructure of Orthodoxy is based upon this set of hard core propositions a.k.a. axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

In order to be applicable HC2, which translates formally into calculus, requires a lot of auxiliary assumptions, most prominently a well-behaved production function. The compelling reason for the introduction of out-of-thin-air auxiliary assumptions is that without these specifications the axiom HC2 does NOT work and the whole of Marginalism, which hinges on HC2, falls apart.

It should be pretty obvious that the axiomatic core of Orthodoxy contains THREE NONENTITIES: (i) constrained optimization (HC2), (ii) rational expectations (HC4), (iii) equilibrium (HC5). Every theory/model that contains a nonentity is A PRIORI false. This includes all Solow-type models.

Economics has to start — NOT with behavioral assumptions — but with the ‘monetary theory of production’ (Keynes). The pure production-consumption economy is defined with 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.

These premises are certain, true, and primary, and therefore satisfy all methodological requirements. The set of premises is minimal, that is, it cannot be reduced further, only expanded. The set contains no nonentities like maximization or equilibrium and no normative assertions. Note that all variables are measurable.

For a start, it holds: market clearing X=O and budget balancing C=Yw.

Monetary profit is defined as Qm≡C-Yw and monetary saving is defined as Sm≡Yw-C. It always holds Qm+Sm=0 or Qm=-Sm, which is the most elementary form of the Profit Law.

Under the conditions of market clearing and budget balancing in each period the price follows as P=W/R, i.e. the market clearing price is always equal to unit wage costs. This is the most elementary form of the Law of Supply and Demand. It translates into W/P=R, i.e. the real wage is always equal to the productivity.

The changes of the wage rate from period to period are formally given by Wt=Wt-1(1+wt). Analogous for all other independent variables. The rates of change for future periods are, for a start, taken to be random variables.

With this, the formal framework of the elementary growth model for the pure production-consumption economy is defined. The systemic formal framework#2, which combines the nominal and real key variables, fully replaces all Solow-type real models.

It does not matter how employment develops, that is, whether the labor force grows or shrinks over time. If the productivity remains constant with growing (shrinking) employment the real wage does not change. If the productivity increases so does the real wage. Labor gets always their full product. Monetary profit is zero. If the productivity declines the real wage heads towards the subsistence level. This, though, has nothing to do with exploitation. Needless to say that at the subsistence level all further expansion comes to a halt. This is the Malthusian outcome. The ultimate driver of real affluence is increasing returns.

This was the first step. In the second step investment and capital have to be added.#3

Egmont Kakarot-Handtke

#1 The future of economics: why you will probably not be admitted to it, and why this is a good thing
#2 The Economics God Equation (including distribution) is shown on Wikimedia
#3 Squaring the Investment Cycle