June 6, 2015

Tricky business

Comment on David Glasner on ‘JKH on the Keynesian Cross and Accounting Identities’


“What a tricky business this all is! In his Treatise on Money, Mr. Keynes told the world that savings and investment are only equal in conditions of equilibrium; that an excess of investment over saving means rising prices, and vice versa. In his General Theory, he told us that saving and investment are always equal, and that this is a mere identity or truism, without significance for the determination of prices. As far as I can make out, there are relevant and important senses in which all these statements are each of them right and each of them wrong.” (Hicks, 1939, p. 184)

Many senses make no sense at all, but inconclusiveness is the inevitable outcome of every economic discussion. This is no coincidence. Economists do not solve problems, they are the problem. Inconclusiveness and vagueness is the survival strategy of the scientifically incompetent.

“Another thing I must point out is that you cannot prove a vague theory wrong.” (Feynman, 1992, p. 158)

This conveniently prolongs the shelf-life of crappy theories. The I=S debate is a case in point.

Keynes messed up the basics of macro with this faulty syllogism: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

Since theories have an architectonic structure it is clear that if there is a fault in the formal foundations the whole superstructure is faulty. Actually, the defect in Keynes' syllogism is in the premise income = value of output. This equality holds — see the formal proof in (2011) — only in the case of zero profit in both the consumption and investment good industry. Is it necessary to add that zero profit models never had and never will have a counterpart in the real world?

Keynes' conceptual problems started with profit: “His Collected Writings show that he wrestled to solve the Profit Puzzle up till the semi-final versions of his GT but in the end he gave up and discarded the draft chapter dealing with it.” (Tómasson and Bezemer, 2010, p. 12)

This failure kicked off the chain reaction of errors/mistakes because when profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. By consequence, all I=S models, including IS-LM, are methodologically defective. The mistake has also been carried over to accounting (2012). Since the days when Keynes wrote down his faulty syllogism, the representative economist did not realize the elementary logical blunder.

“In fact, the history of every science, including that of economics, teaches us that the elementary is the hotbed of the errors that count most.” (Georgescu-Roegen, 1970, p. 9)

To sum up: All I=S models are false and absolutely unacceptable. This is not a matter of taste or choice or wish-washy but of conceptual logic. The correct relationship reads Qre≡I−S, that is, the business sector's investment expenditures are never equal to the household sector's saving and their difference is always equal to the business sector's retained profit. This has already been figured out by a very smart Frenchman, Nobel Laureate Maurice Allais: “Autrement dit l’investissement n’est pas égal à l’épargne spontanée, mais à l’épargne spontanée augmenté du revenue non distribué des entreprises ....” (Allais, 1993, p. 69), see also (2011, fn. 4)

Let there be no inconclusiveness and vagueness: the somewhat moronic I=S debate ended in 1993 at the latest. More than 75 years after the General Theory it is high time for a general intellectual upswing. After endless drivel perhaps JKH could give an example.

Egmont Kakarot-Handtke

Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Georgescu-Roegen, N. (1970). The Economics of Production. American Economic Review, Papers and Proceedings, 60(2): 1–9. URL
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press, 2nd edition.
Kakarot-Handtke, E. (2011a). Keynes’ Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
Tómasson, G., and Bezemer, D. J. (2010). What is the Source of Profit and Interest? A Classical Conundrum Reconsidered. MPRA Paper, 20557: 1–34. URL