June 22, 2016

Iatrogenic economics

Comment on Jared Bernstein on ‘Do economists understand economies?’


You summarize “... something seems quite wrong with contemporary economics.” That is not quite accurate because economics is wrong since Adam Smith (2014).

Walrasian, Keynesian, Marxian, and Austrian economists are groping in the dark with regard to the two most important features of the market economy: (1) the profit mechanism, and (2), the price mechanism. The fatal fault lies in the fact that economists argue from the micro-level upwards to the economy as a whole. And here the Fallacy of Composition regularly slips in. To get out of failed economic theory requires nothing less than a full-blown Paradigm Shift from accustomed microfoundations to entirely new macrofoundations.#1

In the following, a sketch of the formally and empirically correct price, employment, and profit theory is given. The most elementary version of the objective-structural Employment Law is shown on Wikimedia AXEC62:
From this equation follows:
(i) An increase in the expenditure ratio ρE leads to higher employment (the letter ρ stands for the ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, and a ratio ρE less than 1 indicates credit contraction.
(ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

The complete AND testable Employment Law ― which is systemic and entirely free of green cheese behavioral assumptions like constrained optimization or rational expectations ― is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Items (i) and (ii) cover Keynes’ arguments about the relationship between aggregate demand and employment. Not much new here, so let us turn to the factor cost ratio ρF as defined in (iii). This variable embodies the price mechanism which, however, does NOT work as the representative economist hallucinates. As a matter of fact, overall employment INCREASES if the average wage rate W INCREASES relative to average price P and productivity R.

This is the exact opposite of what standard economics says about the functioning of the price mechanism. Indeed, economists do not understand how the actual economy works and this explains why their standard policy advice regularly WORSENS the situation. In healthcare, this is called iatrogenesis (Wikipedia).

For the relationship between real wage, productivity, profit, and real shares see (2015, Sec. 10)

The axiomatically correct Profit Law reads Qm≡Yd+I−Sm (2014, p. 8, eq. (18)). Legend: Qm monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditure. The Profit Law gets a bit longer when import/export and government are included.

Note that OVERALL profit and by consequence the income distribution has NOTHING to do with productivity or low wages or market power. These and other factors affect only the DISTRIBUTION of overall profit BETWEEN firms. What holds at the firms’ level does NOT hold for the economy as a WHOLE. Not to realize this is the fatal insufficiency of economists’ feeble-minded ruminations about the relationship between (average) wage rate, price, productivity, and employment. In sum, economists got the Phillips curve and the concept of the ‘natural rate of unemployment’ provably false (2012). So, they bear the intellectual responsibility for the social devastation that has been caused by mass unemployment.

The ultimate cause of secular economic stagnation is the secular intellectual stagnation of 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. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

#1 Students are referred to the working papers on SSRN for the analytical details

Related 'As Napoleon said: don’t listen to economists' and 'Macrofounded labor market theory'. For details of the big picture see cross-references Employment.

For more about iatrogenic economics see AXECquery.

REPLY to Smith on Jun 24

The question of this thread is ‘Do economists understand economies?’ and the answer is NO. Neither Walrasianism, Keynesianism, Marxianism nor Austrianism satisfies the criteria of material and formal consistency. Economics is a failed science.

Because of utter scientific incompetence economists have never risen above the level of storytelling. This applies also to your post which explains the economy as a machination of rich people. You simply do not grasp the difference between a scientific and a yellow-press explanation.

Imagine for a moment an aircraft flying from, say, New York to Paris. Now we can ask why? One way to answer the question is to speculate about the motives and reasons of the passengers, the pilot, the crew, the flight controllers, and the managers and stockholders of the airline. The other way to look at flight is to think about the laws of aerodynamics, thermodynamics, and so forth.

It is pretty obvious that an aircraft does NOT fly because people have the motive to fly. This is animistic thinking. This thinking yields the same trivial psychological crap over and over again. Notice: whatever the subjective motives/actions of passengers/crew are, they do — as a matter of principle — NOT explain the phenomenon of flight in the abstract.

Just as the phenomenon of flight has to be understood in objective physical terms the functioning of the monetary economy has to be understood in objective systemic terms. What is needed, to begin with, are the objective laws of economics, for example, the Profit Law.

You, too, have NO idea of what profit is and how markets interact.#1 Instead, you tell the bad guy/good guy story. People like this sitcom stuff but it is NOT science.

To recall: since Smith and Marx, economics claims to be a science but the feeble thinkers and strong blatherers that call themselves economists have to this day not figured out how the monetary economy works and how the product and the labor market interact and whether the system is self-adjusting or not.#2

Either economists stop storytelling and start to do their scientific homework or they will be thrown out of science and sued for damages.

#1 How the Intelligent Non-Economist Can Refute Every Economist Hands Down
#2 Could we, please, all focus on the key question of economics?

REPLY to Smith on Jun 25

You say: “Economists I admire, mostly dead, Keynes and John Kenneth Galbraith, I think they had a pretty good understanding.”

You obviously overlook this point: the decisive criterion in science is true/false and NOT like/dislike.

You overlook, secondly, that Keynes was not such a profound thinker. He defined the formal core of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income − consumption. Therefore saving = investment.” (1973, p. 63)

This two-liner is conceptually and logically defective because Keynes never came to grips 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 et al., 2010, p. 12)

Let this sink in, Keynes had NO idea of the fundamental concepts of economics, viz. profit, and income. Now it is pretty obvious because profit is ill-defined the whole theoretical superstructure of Keynesianism is false, in particular, all I=S/IS-LM models.

But things get from bad to worse. Neither Post-Keynesians nor New Keynesians nor Anti-Keynesians have realized Keynes’ logical blunder to this day (2011). And ― ridiculous to the extreme ― Paul Krugman bases his economic analysis and policy advice still on IS-LM (2014).

The question of this thread is ‘Do economists understand economies?’ and the unequivocal answer is NO. From the history of economic “thought”, it is known that economists swallow every brain-dead garbage from utility maximization to supply-demand-equilibrium to I=S without turning a hair. From all scientific write-offs, economists are the worst and this certainly includes you.

Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. 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