July 13, 2015

How to save Greece and Europe at the same time

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

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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 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 on Wikimedia AXEC62:
From this follows:
(i) An increase in the expenditure ratio ρE leads to higher employment. An expenditure ratio ρE>1 indicates credit expansion, a ratio ρE<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 ρF≡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 ρF as defined in (iii). This variable embodies the price mechanism which, however, does not work as Orthodoxy imagines it works. 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 increases relative to those at or below average. With a given expenditure ratio ρE 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

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