The case for pure economics

Comment on Yanis Varoufakis on ‘On the Euro Summit’s Statement on Greece: First thoughts’

Blog-Reference see also Blog-Reference

What is the proper job of the economist qua scientist? “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (J. S. Mill, 2006, p. 950)

The economist qua scientist brings knowledge to the table, not his personal opinion. It is the legitimate political institution that determines the political ends. This is the OUGHT-part, science is concerned exclusively with the IS-part of reality. The is/ought difference is reasonably clear since Hume, but has been deliberately ignored by every talented public speaker since then. However, for science, this difference is fundamental.

“A genuine inquirer aims to find out the truth of some question, whatever the color of that truth. ... A pseudo-inquirer seeks to make a case for the truth of some proposition(s) determined in advance. There are two kinds of pseudo-inquirer, the sham and the fake. A sham reasoner is concerned, not to find out how things really are, but to make a case for some immovably-held preconceived conviction. A fake reasoner is concerned, not to find out how things really are, but to advance himself by making a case for some proposition to the truth-value of which he is indifferent.” (Haack, 1997, p. 1)

The economist who comments on political goals leaves the realm of science. This, of course, is no problem at all under one condition. All he has to do is put off his scientific hat and put on his political hat, and then go the other way. This, of course, holds in normal times with legitimate political bodies in place. What has to be done if political bodies are on the way to losing their legitimacy is quite another matter.

Why must politics and science be strictly separated? Simply because it is less probable that the scientific ethics of objectivity/impartiality/knowledge flow to politics and more probable that subjectivity/partiality/opinion flow to science. Gresham’s Law about bad money driving out good applied to sociology says: politics debase science but science does not improve politics. Therefore, there is an overall net loss from close interaction. Partiality and impartiality simply cannot coexist in one and the same person.

That part of economics that has been political from Smith, to Marx, to Hayek, to Keynes, and on to the actual orthodox and heterodox activists has to be clearly separated from science and eventually thrown out. To the extent that theoretical economics has been hijacked by political economics, it has to regain its full independence.

As far as politics is of importance for theoretical economics, it has to be taken from political science. Theoretical economics has to answer only one question: how does the monetary economy work? This presupposes that the economy is understood — broadly speaking — as a system with objective features. Of no primary interest is psychological or sociological second-guessing of human behavior. As far as behavioral issues are of importance for economics, they have to be taken from psychology or sociology.

It is not the task of the economist to dabble in psychology, sociology, political science, geopolitics, history, anthropology, law, ethics, philosophy, etcetera. Interdisciplinarity, for one, means that economics relies on the results of other sciences and, in turn, offers reliable knowledge about the workings of the monetary economy. The same applies to all other practical cooperation.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

Here is the crux. At the moment, there is no such thing as a true economic theory. What economists have produced so far is not much more than educated common sense and an abundance of incoherent models that apply NONENTITIES like equilibrium or utility or rational expectations or supply/demand functions or I=S, etcetera, etcetera. Whoever exchanges scientific ideas with an economist gets lemons.

The deep root of the failure of both Orthodoxy and traditional Heterodoxy is a complete lack of understanding of what profit is. #1 The profit theory is false since Adam Smith. This, in turn, means that economists have failed to capture the essence of the market system. Neither the Marxian attack nor the Liberal defense of the market economy ever had valid theoretical foundations (2015). Economists have nothing to offer of scientific value.

In sum: the poor results of political economics are not only an embarrassment for economics but — as severe collateral damage — have negative external effects on the true sciences. It cannot be expected of the public to immediately recognize the difference between cargo cult science #2 and the real thing. This provides an ecological niche for illusion and deceit that undermines the integrity of science.

Here is the wake-up call from a genuine scientist. “So we really ought to look into theories that don't work, and science that isn't science.” (Feynman, 1974, p. 11)

Both Orthodoxy and traditional Heterodoxy are lost for science. Their proponents are still employable for some econ-talk and entertainment in the media. Yet, young students indeed have the choice between becoming real innovative scientists or just some redundant quacking frogs in the swamp of political economics.

To recall: (i) human progress has neither been brought about by politicians nor by businessmen nor by economists but solely by scientists, and (ii), because of their scientific failure over the last 200+ years, economists have consistently stood in the way of establishing overall economic welfare.

Egmont Kakarot-Handtke


References
Feynman, R. P. (1974). Cargo Cult Science. Engineering and Science, 37(7): 10–13. URL
Haack, S. (1997). Science, Scientism, and Anti-Science in the Age of Preposterism. Skeptical Inquirer, 21(6): 1–7. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, Vol. 8 of Collected Works of John Stuart Mill. Indianapolis: Liberty Fund.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.

#1 Mental messies and loose losers
#2 Wikipedia Cargo cult science

Related 'The end of political economics' For details of the big picture, see the blog label Science and cross-references Political Economics/Stupidity/Corruption.

Sexit

Comment on/Kommentar zu ‘Griechenland-Krise: Deutsche Ökonomen schlagen gegen Krugman zurück’

Blog-Reference (condensed to 1.000 characters)

Ist das Ziel eines vereinten Europa als politisches Datum vorausgesetzt, dann lautet die rein ökonomische Fragestellung: wie kann dieses Europa als Ganzes — einschließlich Griechenland — wirtschaftlich erfolgreich sein?

Die intuitive Ökonomik sagt, dass Vollbeschäftigung und Produktivität die Schlüsselvariablen sind. Wie kann das realisiert werden? Nur auf Basis einer umfassenden makroökonomischen Theorie. Und hier beginnt das Problem: Ökonomen haben diese Theorie nicht, weder Krugman noch die deutschen Ökonomen.

Weder die Walrasianische noch die Keynesianische Beschäftigungstheorie ist wissenschatlich akzeptabel.#1 Der Kern des Problems ist, dass der Preismechanismus nicht so funktioniert wie es die Ökonomik imaginiert, und das hat nichts mit Lohn- oder Preisstarrheit zu tun. In letzter Konsequenz leidet Griechenland und Europa insgesamt am Theorieversagen der Ökonomen.

“In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum)

Da sie die ‘true theory’ nach 200+ Jahren immer noch nicht entwickelt haben, braucht die Welt einen Sexit (scientific exit), d.h. einen freiwilligen Exit dilettierender Ökonomen aus der Wissenschaft, die bekanntlich keine nationalen Unterschiede kennt. Was hier allein zählt ist wahr/falsch.

#1 Für die ausführliche Begründung siehe Mental messies and loose losers.

Siehe auch How to save Greece and Europe at the same time.

How to save Greece and Europe at the same time

Comment on ‘Employment in selected Eurozone countries. No austerity or neoliberal miracles’

Blog-Reference see also Blog-Reference

Political economics is, as most economics blogs show, just this: political gossip about what this guy said and that guy did, with all guys neatly sorted into good and bad. The well-known modus operandi of the media is personalization and horrification (Schauble creeps through the Eurozone; Tsipras is mentally waterboarded, etc). All this is Circus Maximus — senseless, yet entertaining.

Meanwhile, the solution to the economic problem got completely out of sight. What, in the broadest possible perspective, is the basic economic problem? Given the political goal of a united Europe, the economic problem is how to make it prosperous — all of it, including Greece, of course.

How can this be achieved? Common sense tells us that full employment and productivity are the key variables. The next question, then, is how to put this intuition into practice? This can be done only on the basis of a comprehensive macroeconomic theory. Here, the problems start because economists have no such theory.*

To recall, Keynes's main issue was employment theory, and he was quite clear that the orthodox approach was defective. However, Keynes succeeded only partly; his employment theory is not general either and misses a crucial point (2015a; 2012). The most elementary version of the correct Employment Law is given with Graphic AXEC62

From this follows:
(i) An increase in the expenditure ratio ρ_E leads to higher employment. An expenditure ratio ρ_E>1 indicates credit expansion, a ratio ρ_E<1 indicates credit contraction/debt repayment.
(ii) Increasing investment expenditures I exert a positive influence on employment; a slowdown of growth does the opposite. That's old Keynesian stuff.
(iii) An increase in the factor cost ratio ρ_F≡W/PR leads to higher employment. This implies that a higher average wage rate W leads to higher employment. This is, of course, contrary to conventional economic wisdom. It is, though, easy to prove that conventional wisdom is a mere Fallacy of Composition (2015b). The factor cost ratio formally represents the price mechanism.
(iv) The complete Employment Law is a bit longer and contains, in addition, profit distribution, public deficit spending, and the trade balance with the rest of the world.

As a matter of principle, the structural Employment Law can be tested against the graph in the intro above. Put the other way round, the equation fully explains the graph.

Let us focus here alone on the factor cost ratio ρ_F as defined in (iii). This variable embodies the price mechanism, which, however, does not work as Orthodoxy imagines it does. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R. This gives us the lever to improve the employment situation in all of Europe — including, of course, Greece — without ever-increasing deficits.

How could it work in practice? The average wage rate increases if the wage rates in those firms that perform well increase relative to those at or below average. With a given expenditure ratio ρ_E this increases overall demand and leads to a redistribution of profits among the business sector. Total profit remains unchanged; what we have is a profit ratio equalization among firms. This takes structural stress out of the economic system.

What can be done in addition is to increase profit distribution in a specific way, boost investment, and something like a Grexit writ large, that is, a depreciation of the Euro against the Dollar.

The core of the problem is that the price mechanism does not work as orthodox economics says, and this has nothing to do with wage or price stickiness. Ultimately, Greece and Europe with it suffer from a scientifically unacceptable economic theory.

What the world really needs is a Sexit (scientific exit), that is, a voluntary exit of scientifically incompetent economists.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Disaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015a). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Kakarot-Handtke, E. (2015b). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* For the reason why, see RWER Blog or here

Profit theory and distribution formulas

Comment on Jonathan Nitzan on ‘Some important limitations of income inequality data’

Blog-Reference

Blair Fix says in his post on the Capital-as-Power Blog: “For a long time now I've been bothered by the lack of a clear connection between capitalist income and inequality. ... I'm not sure why it took me so long to realize this, but last week I realized that corporate profits are not really a type of personal income.”

Exactly so. The familiar approaches are defective. In contradistinction, the superior structural-axiomatic approach starts with the equation total income is wage income plus distributed profit (2015, eq. (1)).* This gives one the theoretically well-founded distribution formulas (2015, eq. (55) ff.). For the correct Profit Theory see (2014).

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

* See Terms of use

Extremely long roots

Comment Lars Syll on ‘Schäuble goes Matrix’

Blog-Reference

You quote Mark Blyth’s article ‘A Pain in the Athens. Why Greece Isn't to Blame for the Crisis’ approvingly. Blyth explains: “The roots of the crisis lie far away from Greece; they lie in the architecture of European banking.”

This is accurate only insofar as the European banking system has adopted the negative institutional features of the US banking system.

Remember that the investment banks literally invented sub-prime lending. Not one competent mortgage banker, neither in Germany nor in France, would have taken up this type of business.#1 Investment banking has nothing to do with classical European banking which consists essentially of lend-and-hold, long-term customer relationship, and risk-absorbing equity.

Investment banking depends basically on extreme leveraging, minimizing risk-bearing equity, maximizing quarterly return on equity, shifting credit risk to non-banks via securitization, and shifting the risks from derivatives betting ultimately to the public via too-big-to-fail. It was not so long ago when first Deutsche Bank and then the rest of the rather conservative German banking industry turned to investment banking.

This casino banking failed in 2008 in the US and now in Greece.

A very good piece of advice for the Greek people would be to look at the German cooperative banking group. In effect, people can own their local bank, the lender-creditor relationship is face-to-face, risks are strictly limited, and if it actually happens that one bank fails it is bailed out by a fund, that is, by all cooperative banks together. Seen as an institution, this self-organizing group of diverse firms provides all banking/insurance services at zero risks for society at large. No taxpayer ever paid a cent for a failed cooperative bank. This is exactly the opposite of too-big-to-fail which is the de facto life insurance of the free-riding US banking system.

This system, not the German three-column institutional setup, has been exported around the world under the flag of deregulation.

In 2008 the US banking system had been rescued by the Fed. Only if the toxic assets were valued to market today, one could see whether the big American banks are actually bankrupt or not. Note that the suspension of the mark-to-market accounting principle FAS157 was one of the first rescue actions in March 2009.

The Greek crisis is ultimately due to a switchover from originally safe and sound European banking institutions to US-style Ponzi banking. The self-destructive feature of this system is extreme leveraging, as Minsky already pointed out.

It is true, indeed, that it was not alone Greece which had the whole thing messed up, but Blyth’s analysis remains on the surface. Yes, the roots of the crisis lie far away from Greece — approximately the width of the Atlantic.

Egmont Kakarot-Handtke


#1 See also on the RWER blog It's about institution-building, stupid.

Mental messies and loose losers

Reply to comments on E.K-H's ‘Keenonomics, aggregate demand/change of debt, and some misleading critique’

Blog-Reference

I=S is the epitome of economists' scientific incompetence. If this were as plain as a meteorite hitting the earth the problem would have been fixed long ago; it is, though, just the contrary: subtle, unspectacular, counter-intuitive, subterranean, and rather involved.

Already von Neumann spotted the peculiar methodological defect of economics: “I think it is the lack of quite sharply defined concepts that the main difficulty lies, and not in any intrinsic difference between the fields of economics and other sciences.” (quoted in Mirowski, 2002, p. 146 fn. 49)

This, however, has never been a point of great concern for the representative economist. In particular, for the Cambridge School of Loose Verbal Reasoning sharpness, precision, uniqueness, rigor, bivalent logic, etcetera always amounted rather to a violation of the human right to mental messiness. This stance has habitually been defended with a false but suggestive alternative: “Marshall followed the maxim: Better to be ambiguous and relevant than precise and irrelevant.” (Colander, 1995, p. 283)

Then, Keynes occupied the realm of vagueness, ambivalence, indeterminism, fogginess, wish-wash, casual conversation, inconclusiveness, complexity, twilight, uncertainty — the realm where nothing is clear and everything is possible — as the ecological niche of Keynesianism: “Another danger is that you may ‘precise everything away’ and be left with only a comparative poverty of meaning. ... Such a problem was avoided, said Keynes, by Marshall who used loose definitions but allowed the reader to infer his meaning from ‘the richness of context’.” (Coates, 2007, p. 87)

This problem avoidance strategy was soon summed up in a catchy pseudo-choice: “For Keynes, as for Post Keynesians the guiding motto is ‘it is better to be roughly right than precisely wrong!’" (Davidson, 1984, p. 574)

With this cavalier mentality, Keynesians, and eventually the majority of other schools, have occupied the habitat between true and false where the scientific procedure of ‘conjecture and refutation’ runs into the bottomless swamp: “Another thing I must point out is that you cannot prove a vague theory wrong.” (Feynman, 1992, p. 158)

So, economics is no longer about the true economic theory; all one has to do is avoid a crystal-clear refutation. This can be achieved by persevering in fuzzy filibustering and by maintaining that a crystal-clear refutation is impossible in the first place. If, against all defensive complacency, a refutation plainly succeeds, ignorance and business-as-usual help. This has become standard operating procedure in economics, as already Morgenstern complained: “In economics we should strive to proceed, wherever we can, exactly according to the standards of the other, more advanced, sciences, where it is not possible, once an issue has been decided, to continue to write about it as if nothing had happened.” (1941, pp. 369-370)

With these two stratagems, economists entrenched themselves in the swamp of anything-goes and subsequently turned to defend their scientific no-man's-land in the main with rhetorical soap bubbles. All this is — as economists always readily admit — second-best; however, “... most economists neither seek alternative theories nor believe that they can be found.” (Hausman, 1992, p. 248)

What made this deadlock possible is a tacit quid-pro-quo agreement among different camps on the legitimacy of Humpty Dumpty methodology: "When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less." "The question is," said Alice, "whether you can make words mean so many different things." "The question is," said Humpty Dumpty, "which is to be master — that's all." (Carroll, Through the Looking-Glass)

This quasi-feudal Freedom-of-Definition Privilege constitutes the different schools and has been sanctioned by the likes of Schumpeter. “For, on principle, we may call things what we please.” (1994, p. 598)

Of course, freedom of definition is a methodological illusion. It applies only to the FIRST definition. Subsequently, one has to make sure that every additional definition is consistent with the preceding ones. Overall consistency cannot be achieved in the economist's cavalier fashion: “The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen, 2009, p. 344)

Institutionalized economics never seriously aimed at, and therefore never arrived at, a coherent language, not to speak of an axiomatic framework of foundational concepts. Thus, debates/conversations between schools resemble nothing so much as ‘Babylonian incoherent babble’ (cf. Dow, 2005, p. 385). Without a common frame of reference, perpetual cross-talk is guaranteed. Economics fits the format of a sitcom.

The lack of a minimal common ground explains the secular stagnation of economics: “We know from the history of science that entrenched classificatory schemes and misleading descriptive vocabularies have impeded scientific advance as much or more than the complexities and observational inaccessibility of the subject matter.” (Rosenberg, 1980, p. 114)

What, then, is the — minimal, objective, consistent, testable — common conceptual ground of all of the economics?

Total period income in an elementary production-consumption economy with only one giant firm is given by the sum of wage income and distributed profit, i.e., (1) Y=Y_w+Y_d. Total consumption expenditures are equal to the product of price and quantity sold, i.e., (2) C=PX. That's all for a start.

The monetary profit of the business sector as a whole is then defined as the difference between consumption expenditures and wage costs, i.e., Q_m≡C−Y_w. Monetary saving of the household sector is then defined as the difference between total income and consumption expenditure S_m≡Y−C. Hence, S_m≡−Q_m if, for a start, Y_d=0. In simple words: saving S_m is equal to loss −Q_m, or, dissaving −S_m is equal to profit Q_m. From this follows immediately that all I=S or IS-LM models from Keynes, to Hicks, to Krugman, and all the busy blogging rest are false — irrevocably in all eternity.

Generally speaking, it holds for the production-consumption economy that Q_re≡−S_m, i.e., retained profit Q_re is equal to dissaving −S. And for the investment economy holds Q_re≡I−S_m, i.e., retained profit is equal to the difference between investment and saving (for details see 2014). No accounting trick, no ex-ante/ ex-post filibuster, and no expected/unexpected stock changes, no equilibrium verbiage, and no natural rate of interest will ever make the household sector's saving equal to the business sector's investment expenditures. Never ever! No way! Forget it!

Saving-equals-investment is the epitome of conceptual and logical incompetence of economists of all schools. In science, there is no ecological niche between true/false and no pluralism of false theories. Humpty Dumpty’s methodological no-man’s-land is an uninhabitable swamp for every thinking human being.

The root cause of the IS error/mistake is a complete lack of understanding of what profit is. Total income is not the sum of wage income and profit but of wage income and distributed profit (2013). The profit theory is false since Adam Smith. This, in turn, means that economists have failed to capture the essence of the market system. Neither attack nor defense of the market economy ever had a sound theoretical foundation (2015). Political economics has been a complete waste of time.

The economics of the last 200 years is the most embarrassing failure in the history of modern science.

Egmont Kakarot-Handtke


References
Coates, J. (2007). The Claims of Common Sense. Moore, Wittgenstein, Keynes and the Social Sciences. Cambridge, New York, etc.: Cambridge University Press.
Colander, D. (1995). Marshallian General Equilibrium Analysis. Eastern Economic Journal, 21(3): 281–293. URL
Davidson, P. (1984). Reviving Keynes’s Revolution. Journal of Post Keynesian Economics, 6(4): 561–575. URL
Dow, S. C. (2005). Axioms and Babylonian Thought: A Reply. Journal of Post Keynesian Economics, 27(3): 385–391. URL
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
Mirowski, P. (2002). Machine Dreams. Cambridge: Cambridge University Press.
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL
Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.
Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited, Vol. 1. Norderstedt: Books on Demand BoD, 2nd edition. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York: Oxford University Press.

Related 'Economists: Jacks of all trades ― except economics' and 'Economics ― a doctor worse than the disease' and 'Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist' and 'Knowledge is attainable ― even in economics'. For details of the big picture see cross-references Failed/Fake Scientists and cross-references Not a Science of Behavior and cross-references Profit (i.e., the foundational concept of economics).

For more about the Humpty Dumpty Fallacy, see AXECquery.

For more about inconclusiveness, see AXECquery.

***

Graphic AXEC172

The economics of here and now

Comment on ‘An inconvenient historical truth’

Blog-Reference

I agree, graccibros, let us return to the economics of here and now. With regard to the correct macroeconomic formula that describes the actual Greek situation, see my post: Poisoned, hanged, and shot. Comment on ‘Austerity policies — prescribing rat poison for ailing economies.’*

The Greek situation, however, is only exemplary for a really profound question, that is, the relationship between growth of debt, profit, and employment. Put simply: can the market system (global, not Greece, not Germany, not US, not China, etc) survive without steadily growing public/private debt?

The answer is that a local debt reduction leads to local recession (2013), this is the case of Greece, and a global debt repayment brings the whole system down (2014).

This is, with regard to the future, the really inconvenient historical truth.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2013). Redemption and Depression. SSRN Working Paper Series, 2343561: 1–28. URL
Kakarot-Handtke, E. (2014). Mathematical Proof of the Breakdown of Capitalism.SSRN Working Paper Series, 2375578: 1–21. URL

*See on the RWER blog or here