August 22, 2017

The abject failure of orthodox and heterodox distribution theory

Comment on Lars Syll on ‘Trading in Myths’

Blog-Reference and Blog-Reference on Aug 30

For most people economics is a story about wealth and riches, the conflicts between capitalists and workers, the fraud and deception of the corrupt one-percenters and the hardships of the honest and exploited/alienated 99-percenters. This is the soap opera view of economics.

The scientific view is not focused on the human drama/farce/myth but on the functioning of the economic system as a whole. Economics leaves all questions about Human Nature/ motives/behavior/action to psychology, sociology, anthropology, history, political science, biology, etcetera.#1, #2

Because NO way leads from the explanation of Human Nature/motives/behavior/action to the explanation of how the economic system works all behavioral approaches have failed. The actual state of economics is this: Walrasianism, Keynesianism, Marxianism, Austrianism are mutually contradictory, axiomatically false, materially/formally inconsistent, and all got profit wrong. Fact is that the Walrasian approach = microfoundations and the Keynesian approach = macrofoundations have already been dead in the cradle.

Therefore, economics has to undergo a paradigm shift. Economic analysis has to be based on entirely new macrofoundations and the fundamental questions have to be put again at the top of the agenda and answered with the help of better analytical tools. The key concepts of classical economics were profit, capital, exploitation, and classes. So let us, first of all, revisit profit.

The pure production-consumption economy is defined with this set of macro 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

Under the conditions of market clearing X=O and budget balancing C=Yw in each period the price is given by P=W/R (1), i.e. the market clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. It translates into W/P=R (2), i.e. the real wage is equal to the productivity. For the graphical representation see Wikimedia.#4

Monetary profit is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm+Sm=0 or Qm=−Sm, in other words, the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law.

In the pure production-consumption economy, labor gets the whole product according to (2), and profit for the business sector as a whole is zero because of C=Yw. All changes in the system are reflected by the market clearing price. As a matter of principle, the pure production-consumption economy can go on indefinitely at any level of employment L. The living standard of the workers is defined by the productivity.

Now, the business sector is split into two identical firms and firm 1 is supposed to cut the wage rate W1 by half. From this follows that the market clearing price P declines if all other variables are unchanged. Firm 2 is affected because total income Yw falls and with it consumption expenditures C and the market clearing price P.

The reduction of the wage rate W1 increases the profit of firm 1 and produces a loss in firm 2. When we look alone at firm 1 we see what Smith, Mill, Ricardo, and Marx have seen before, to wit, wages down―profit up. This fits the time-honored stereotype of wages and profits as antagonists.

However, this situation cannot last for long if profit has been zero in the initial period. In this limiting case, firm 2 makes a loss which is exactly equal to firm 1’s profit. The arbitrary wage rate cut of firm 1 does NOT increase the profit for the business sector as a WHOLE but only REDISTRIBUTES it between the firms.

Seen from the perspective of a single firm, the antagonism of wages and profits is real. This, though, is parochial realism. The complete picture reveals that firm 1 is better off to the disadvantage of firm 2 and the workers of firm 2 are better off to the disadvantage of the workers of firm 1 because at a lower market clearing price they absorb a bigger share of output O with their unaltered income. The situation of the business sector as a WHOLE is unchanged, i.e. Qm=0, and the same is true for the household sector as a WHOLE, i.e. X=O and W/P=R. If there is exploitation it happens WITHIN the sectors. A partial wage rate change leads only to a redistribution of profits between the firms and of output between the workers.

For the economy as a whole, the classical antagonism of wages and profits is an optical illusion. This has a bearing on the POLITICAL notion of classes. There is NO distributional conflict about output between profits and wages. When classes are defined according to these economic categories the actual conflict materializes WITHIN the classes.

When, in the limiting case, there are two groups of workers and two groups of capitalists and the first group of capitalists exploits the first group of workers by slashing the wage rate, then the exploiters OBJECTIVELY act in the interest of the second group of workers whatever their own subjective motives may be. The second group of workers has no economic interest to overcome the wage discrimination of the first group, yet the second group of capitalists has indeed because its profit is indirectly affected. On a deeper level, the relation between the two groups of capitalists is antagonistic. The same holds for the two groups of workers. What looks like exploitation is, in fact, CROSSOVER EXPLOITATION WITHIN the Marxian classes. This explodes the idea of a ‘natural’ common class interest and, by consequence, of a ‘natural’ class war.

The myopic agents, workers and capitalists alike, are blind to the interdependencies of crossover exploitation and therefore prone to the Fallacy of Composition. The generalization of partial effects has the compelling logic of the profit and loss account and the irrefutable empirical evidence of firm 1 on its side. Indeed, what could be more convincing? Wages down, profits up, it works. The INVISIBLE redistribution of profit and output is anonymously effected behind the agents’ backs by the market clearing price. Neither capitalists nor workers understand how the market system works. Neither do economists since Smith, Ricardo,#5 and Marx.#3 Neither does Lars Syll.

Because the profit theory is false since Adam Smith, both orthodox and heterodox distribution theories are false until this very day. There is no such thing as good heterodox guys and bad orthodox guys or vice versa; economists ― ALL of them ― have to be expelled from the sciences.

Egmont Kakarot-Handtke
#1 Economics is NOT about Human Nature but the economic system
#2 Economics is NOT a social science
#3 For details see ‘Profit for Marxists
#4 Wikimedia, Pure production-consumption economy
#5 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism

Related 'No exploitation, no classes'

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REPLY to Yoshinori Shiozawa on Sep 6

You say: “His axiomatic system is a set of statistical concepts by which to describe what happened in the past. There is no observation or arguments on laws of economics, i.e. on how the economic system works.”

This is false. The axioms refer to one period and the periods are seamlessly interconnected.#1. The four basic laws are listed on Wikimedia.#2

You say: “His starting point in construction his economics is pure consumption economy. He is wrong to start from consumption economy because it only leads to pure exchange economy.”

This is false. What I call the pure consumption economy is the same thing which Keynes meant with “monetary theory of production”. The pure consumption economy is ANALYTICALLY PRIOR to the more complex investment economy. It should perhaps more precisely be called the pure production-consumption economy.

You say: “He is based on a wrong dichotomy of micro and macro and seeks macrofoundations. He is not aware that there are cyclic causal relations between the whole structure and processes and people’s behaviors as a result of evolution in this macro structure and processes.”

This is false. Macrofoundations are the correct axiomatic starting point.#3 Given the macro axioms, which refer explicitly to ONE giant firm, one has to proceed top-down by successive DIFFERENTIATION until one arrives at the individual agent. Differentiation is the OPPOSITE of bottom-up or aggregation. It is microfoundations and bottom-up that is the defining idiocy of Walrasianism, which literally produces the aggregation problem.

There is NO dichotomy: Walrasian microfoundations have to be FULLY replaced by the correct macrofoundations.#4


#1 The Synthesis of Economic Law, Evolution, and History
#2 Econ Starter Kit: First Economic Law, Law of Supply and Demand, Profit Law, Employment Law
#3 First Lecture in New Economic Thinking
#4 Economic methodology for the little man