August 14, 2015

Either stupid or duplicitous

Comment on Mean Squared Errors on ‘What is it with economists and accounting identities?’


You say: “It's very strange. There seems to be something about accounting identities that causes otherwise reasonable economists — pardon my bluntness — to become either stupid or duplicitous.” (See intro)

It is not strange at all if one drops the unwarranted premise that there is, in the beginning, something like a ‘reasonable economist.’ It is as simple as that: being habitual confused confusers economists did not miss the opportunity to mess up accounting, too. This holds for balance-of-payments accounting, but in fact, goes deeper.

It started with Keynes. He gave the following elementary formal description of the economy: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

This is the most basic accounting identity and, no surprise, economists got it badly wrong — from Keynes to Hicks to Krugman to Wren-Lewis#1. Actually, the fault in Keynes's two-liner is in the premise income = value of output. This equality holds only in the limiting case of zero profit in both the consumption and investment good industry.

Profit does not appear in Keynes's elementary formalism because he never came to grips with this pivotal economic phenomenon. Neither did the Post Keynesians until this day (2011). Unaware of the underlying conceptual and logical defects, economists finally messed up National Accounting (2012).

The root cause of all accounting errors/mistakes is a complete lack of understanding of what profit is. For an economist, this is disqualifying.

To make it short here is the formally correct accounting identity for the closed economy (2014, eq. (47)). Derivation and explanation are to be found in the referenced papers.

Because the fundamental accounting identity for the closed economy has always been false, the identity for the open economy has also been false.

The problem with accounting identities has, indeed, something to do with equilibrium thinking, yet ultimately, the all-pervasive analytical blunder can be traced back to the provably false profit theory.#2

Egmont Kakarot-Handtke

Kakarot-Handtke, E. (2011). 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
Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. 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.

#1 See the 2012 MM-post Savings Equals Investment?
#2 More than two centuries of waffling in the dark