August 22, 2016

Demystifying employment theory and policy

Comment on Adair Turner on ‘Demystifying Monetary Finance’


Walrasian, Keynesian, Marxian, and Austrian economists are groping in the dark with regard to the two most important features of the market economy: the price mechanism and the profit mechanism. The fault lies in the fact that economists argue from false premises, that is, Walrasianism in all shapes and forms (DSGE, RBC, AD/AS, etc.) argues from unacceptable microfoundations, and Keynesianism in all shapes and forms argues from false macrofoundations (2011). To get out of failed economics requires nothing less than a paradigm shift.

In the following, a sketch of the formally and empirically correct employment theory is given. A rather elementary version of the objective structural Employment Law (2012) is shown on Wikimedia AXEC62:

From this equation follows inter alia:
(i) An increase in the expenditure ratio ρE leads to higher employment (the letter ρ stands for ratio). An expenditure ratio ρE greater than 1 indicates credit expansion, 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 is a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Items (i) and (ii) cover Keynes’ arguments about aggregate demand, which have been commonsensically right but formally defective. More precisely, Keynes’s multiplier is provably false (see 2012). The factor cost ratio ρF as defined in (iii) embodies the price mechanism which works very differently from what the representative economist falsely assumes. As a matter of fact, overall employment (in the world economy or a closed national economy) 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).

So, in simple terms, full employment (in any definition) can be achieved by increasing overall demand (expenditure ratio, investment expenditures, etc.) or by INCREASING the average wage rate or by a combination of the two.

The Keynesian approach is macrofounded but incomplete because Keynes had no deeper understanding of the price and profit mechanism. Both, the Walrasian and Keynesian approaches have produced counterproductive policy advice. Unemployment is ultimately the result of theory failure.

The arguments for helicopter money are covered with items (i) and (ii). What has been overlooked so far is that deficit spending (with or without helicopter money) has massive distributional effects. Roughly speaking, the household sector’s and public sector’s deficits reappear one-to-one as monetary profit of the business sector (2015). Ultimately, helicopter money is a free lunch for the business sector.

The Employment Law suggests a better way to full employment. The factor cost ratio ρF translates roughly into the policy recipe (for a closed national economy): if the central bank wants an average inflation rate of, say, 2 percent and the average productivity growth is, say, 1.5 percent then the average wage rate must rise with 3.5 percent until full employment is established. The crucial point is that by using the price mechanism the known drawbacks of deficit spending/helicopter money are greatly reduced.

Egmont Kakarot-Handtke

E.K-H (2015). Keynesianism as ultimate profit machine. Blog post. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
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. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL