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 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. In other words, the faulty axiomatic foundations of standard economics have to be replaced and Keynes’ ill-defined employment function has to be rectified (2012).
In the following, a sketch of the formally and empirically correct price, employment, and profit theory is given.#1 The most elementary version of the objective structural Employment Law is shown on Wikimedia AXEC62:
(i) An increase in the expenditure ratio ρE leads to higher employment (the letter rho ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, a ratio ρE less than 1 indicates credit contraction.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.
The complete and testable Employment Law is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.
Item (i) and (ii) cover Keynes’ arguments about aggregate demand. Here, the focus is on 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.
For the relationship between real wage, productivity, profit, and real shares see (2015, Sec. 10)
The 2-sector Profit Law reads Qm≡Yd+I−Sm (2014, p. 8, eq. (18)).#2 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 on 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. Note also that Keynes, Marx, Kalecki, Keen, Minsky, and other heterodox economists got profit provably wrong. There is nothing to choose between Orthodoxy and Heterodoxy.
Keynes’ approach is macrofounded but incomplete because he had no deeper understanding of the profit and price mechanism. Therefore, both the Walrasian and Keynesian approaches produce misleading policy guidance.
The structural Employment Law contains nothing but measurable variables and is therefore readily testable. So, there is no need for prolonged waffling. As always in science, a test decides the matter.
The ultimate cause of unemployment is the proven scientific incompetence of orthodox and heterodox economists for more than 200 years.
Kakarot-Handtke, E. (2012). Keynes’ 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 for more details.
#2 See Wikimedia AXEC09 or Wikimedia AXEC08 or Wikimedia AXEC42.