April 27, 2018

Neoclassical growth theory: modeling gone nuts

Comment on Lars Syll on ‘Solow’s Nobel Prize lecture’


Solow summarizes: “The end result is a construction in which the whole economy is assumed to be solving a Ramsey optimal-growth problem through time, disturbed only by stationary stochastic shocks to tastes and technology. To these, the economy adapts optimally. Inseparable from this habit of thought is the automatic presumption that observed paths are equilibrium paths. So we are asked to regard the construction I have just described as a model of the actual capitalist world.”

Standard economics is based on this verbalized set of hardcore propositions a.k.a. axioms
  • HC1 There exist economic agents.
  • HC2 Agents have preferences over outcomes.
  • HC3 Agents independently optimize subject to constraints.
  • HC4 Choices are made in interrelated markets.
  • HC5 Agents have full relevant knowledge.
  • HC6 Observable economic outcomes are coordinated, so they must be discussed with reference to equilibrium states. (Weintraub)
What has to be realized, in addition, is that these premises require a pigtail of auxiliary assumptions. So, in order to be applicable, constrained optimization HC3 requires the auxiliary assumption of a well-behaved production function.

What economists in their bottomless scientific incompetence have not realized in 140+ years is that HC3, HC5, and HC6 are plain NONENTITIES. The methodological point is this: every model that contains just one NONENTITY is a priori false. Methodologically it holds, if the set of premises is false the whole analytical superstructure is false.

Neoclassical growth theory applies a barrage of NONENTITIES. Among others:#1
  • The representative consumer is supposed to solve an infinite-time utility-maximization problem. This is a priori false because utility and HC3 are NONENTITIES.
  • Neoclassical growth models consist alone of real variables. This is false because the economy constitutes itself through the interaction of real AND nominal variables. There is no such thing as a ‘real’ economy, in other words, ALL ‘real’ models are a priori false.
  • There is no such thing as an equilibrium or disequilibrium. In other words, ALL equilibrium models are a priori false.#2
  • Profit is a nominal variable and cannot appear in a real model. The neoclassical profit theory is false.
  • Economics has to be macrofounded because no way leads from behavioral microfoundations to an understanding of how the economic system works.
“When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle, 300 BC) The neo-Walrasian axioms, aka microfoundations, are NOT “certain, true, and primary”. Because of this, neoclassical growth models are scientifically worthless.

Economics has to move from microfoundations to macrofoundations.#3

Here is the correct starter set: (A0) The objectively given and most elementary systemic configuration of the (world-) 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 behavior-free premises are certain, true, and primary, or, stated in comparative terms, superior to the neo-Walrasian microfoundations and Keynes’ defective macrofoundations.#4

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.

Monetary profit for the economy as a whole 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 surplus = profit is equal to the household sector’s deficit = dissaving. Vice versa, the business sector’s deficit = loss equals the household sector’s surplus = saving. This is the most elementary form of the macroeconomic Profit Law. Under the condition of budget balancing, total monetary profit is zero.

Under the condition of market clearing and budget balancing, the elementary economy reduces to three independent variables, i.e. W, R, L, and the price P as dependent variable. The changes from period to period are formally given by
  • Wt=Wt-1(1+wt) The wage rate in period Wt is given by the wage rate in the previous period Wt-1 and the rate of change for the current period wt.
  • Rt=Rt-1(1+rt) Analogous for the productivity.
  • Lt=Lt-1(1+lt) Analogous for labor input.
The rates of change for future periods wt, rt, lt are random variables with an a priori unknown distribution function. Given the enumerated premises and conditions, the market clearing price performs a random walk which is determined in turn by the random paths of wage rate and productivity. The general formula for the evolving elementary production-consumption economy is given on Wikimedia.#5 This path equation replaces all neoclassical growth models.

In the next step, the condition of budget balancing has to be lifted. This brings saving/dissaving and profit/loss into existence. Note that in the Wikipedia article#1 the word profit does not appear once. Alone for this reason, neoclassical growth models are NO representation of the “actual capitalist world”.#6 There is NO such thing as a capitalist world without profit/loss. Economists should know this.

To make matters short, the axiomatically correct macroeconomic Profit Law for an evolving economy is given here without further explanation. It holds, with Qm monetary profit/loss, Sm monetary saving/dissaving, I investment expenditures, G government spending, T taxes, X export, M import, Yd distributed profit
  • Qm=−Sm in the elementary production-consumption economy,
  • Qm=I−Sm in the elementary investment economy (note I is NEVER equal Sm),
  • Qm=(G−T)+(I−Sm) in the investment economy with government deficit/surplus,
  • Qm=Yd+(X−M)+(G−T)+(I−Sm) in the open economy with distributed profit.
Neoclassical growth models do not contain macroeconomic profit. They are nothing more than a bad modeling joke.#7 Economists award themselves fake Nobel Prizes for this proto-scientific junk.

Egmont Kakarot-Handtke

#1 Wikipedia, Ramsey–Cass–Koopmans model
#2 Equilirium
#3 True macrofoundations: the reset of economics
#4 How Keynes got macro wrong and Allais got it right
#5 Wikimedia, Time evolution of the elementary production-consumption economy including profit distribution
#6 Profit and the collective failure of economists
#7 Infantile model bricolage, or, How many economists can dance on a non-existing pinpoint?

Related 'Squaring the Investment Cycle'.