August 21, 2016

Failed institutions

Comment on jlegge and Robert Locke on ‘Trade, Truth and Trump’


The monetary order and banking are institutions that evolved historically. Like in biological evolution the outcome of this messy process is often sub-optimal. Institutions can and must be carefully designed and constructed. The U.S. is particularly bad at institution building.

Mortgage financing, for example, is a very old and rather simple business. In Germany, it was institutionalized in 1900 with the Mortgage Banking Act. This law was so well-crafted that it worked with minor modifications until 2005 when deregulation became the hype of the day.

The core of the risk-minimizing regulation had been that a mortgage bank can finance at most 60 percent of the carefully assessed long-term value of a house (without imputed speculative gains). As a result, there has never been a real estate boom-bust cycle in Germany since 1900. That is quite remarkable when one considers that Japan, the U.S., UK, Spain, and many other economies have been badly devastated by real estate busts.

Interim results: (i) financial crises are the result of bad institutional design, (ii) the U.S. is particularly untalented at institution building, (iii) in the international arena, according to a variant of Gresham’s Law, bad institutions crowd good institutions out. This is the most detrimental side-effect of globalization.

What holds for banking holds for other institutions. First and foremost for the relations between business and labor. The legal status of unions has always been precarious in the U.S.

With regard to trade, one has to keep in mind that the beneficial effects have been theoretically derived since Ricardo under the condition of equilibrium. So, the often lamented negative effects for the American workforce do not necessarily come from trade per se but from the balance of trade DEFICITS of the U.S.

Dean Baker concludes: “Donald Trump is a hateful bigot, but that doesn’t mean that everything he says is wrong. It would be a huge step forward if his critics could acknowledge that the recent pattern of trade has been harmful to large segments of the population.”

On closer examination, the harm to the U.S. population stems ultimately from the rather shaky micro and macro institutional setup. This, though, is alone the POLITICAL business of the American people and their future president. Politics, in turn, is NOT the proper business of economics understood as a science.

What Mr. Trump says about trade or any other economic issue is neither true nor false but simply irrelevant because we can be sure that he does not understand how the economy works. This sad fate he shares with orthodox and heterodox economists.

Egmont Kakarot-Handtke


COMMENT on Ken Zimmerman, William Neil, Robert Locke on Aug 22

There is politics and there is economics. If the American people elect a president who is committed to Neoliberalism then this is their internal affair.

Economics is a science that tries to find out how the market economy works. At present economics is a failed science. As far as Neoliberalism is based on economic theory it has NO sound scientific foundation. This holds across the board for Walrasianism, Keynesianism, Marxianism, and Austrianism which are all PROVABLY inconsistent.

So the whole discussion about economic policy hangs squarely in midair. Economists simply do not know how the market economy works.#1

The failure of traditional Heterodoxy consists of never rising above the level of baseless and pointless politicizing. The proper task of Heterodoxy is to replace Orthodoxy and to make economics a science. It is NOT the task of Heterodoxy to comment on Mr. Trump’s or Mrs. Clinton’s utterances about the economy. This has been done much better by comedians.

#1 For details see here and here.

REPLY to Robert Locke on Aug 23

There is politics and there is economics. If the American people elect a president who is committed to Neoliberalism then this is their internal affair. If the German people elect politicians who implement co-determination then this is their internal affair. If the UK people votes for Brexit then this is their internal affair. NO economist has to comment on this. In the political sphere, the economist can participate just like every other citizen but NOT as an economist. Comment on Mr. Trump’s or Mrs. Clinton's policy is a political statement but not economics.

An economist is committed to scientific standards alone and his subject matter is the economy and nothing else. From history, we know that science and politics do NOT mix. Science has never bettered politics but politics has always corrupted science. So both spheres have to be kept strictly apart.

All this is clear since J. S. Mill: “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.”

Political economics has not produced anything of scientific value in the last 200 years. Science has nothing to do with opinion but solely with knowledge. Scientific knowledge takes the form of a consistent theory. At the moment neither Orthodoxy nor Heterodoxy has to offer anything in the way of a consistent theory ― only storytelling and agenda-pushing.

REPLY to William Neil on Aug 23

You ask: “Are you familiar with L. Randall Wray’s book, ‘Modern Monetary Theory,’ which is, in my view, an attempt to do what you say has not been done: advance a heterodox theory, internally consistent.”

Yes. I commented on Wray’s approach on several occasions.#1

You say: “... if Neoliberalism is right, then both Great Britain, at the end of the Napoleonic wars in 1815-1830, and the U.S. at the end of WWII should have been in deep economic trouble based on the size of their national debts in relation to GDP.”

These concerns are as old as economics: “Adam Smith, when he wrote his Wealth of Nations, and Burke, when he produced his famous speech on economic reform, understood by ‘political economy’ a ‘branch of the science of the statesman or legislator’, a theory of practice, the science of the prudent management of the public finances. The growth of the huge debts which weighed on the great military nations would end in proving their ruin. This was especially true of England, which had become immensely in debt through the conquest of her colonial Empire.” (Halévy, 1960, pp. 104-105)

What is not well understood since Adam Smith is the relationship between growing private/public debt and monetary profit for the economy as a whole (2014). The axiomatically correct Profit Law reads Qm≡Yd+I−Sm. Legend: Qm monetary profit, Yd distributed profit, Sm monetary saving, I investment expenditure. The profit equation gets a bit more complex when foreign trade and government are included.

Roughly speaking, what happens in the monetary economy is this: the profit of the business sector as a WHOLE does NOT depend on productivity or low wages or the greed of capitalists or the smartness of managers or the degree of monopoly but on the growth of the household sector’s (public sector’s) debt. Therefore, as long as this private (public) debt grows employment and profit are fine. Needless to add that this implies the existence of a banking sector with the capacity of credit/money creation. Things become worrisome, though, as soon as the credit expansion stops and nasty as soon as the household sector (public sector) as a whole pays the debt back. In this case, profit turns into loss and the business sector breaks down (2014). Note well, this happens without any debt crisis or market failure, or wrongdoing of the banking sector. It SUFFICES that the private (public) households eventually pay back their debt as they are supposed to do. This is because a growing/shrinking household sector (public sector) debt immediately translates into profit/loss of the business sector. Economists cannot see this because the standard price- and profit theory is false since Adam Smith.

The size of the debt is of secondary importance. Of primary importance is whether (the sum of private and public sector) debt grows or shrinks ― the first derivative of debt, so to speak. The debt/GDP ratio is a misleading indicator.

Halévy, E. (1960). The Growth of Philosophic Radicalism. Boston: Beacon Press.
Kakarot-Handtke, E. (2014a). Mathematical Proof of the Breakdown of Capitalism. SSRN Working Paper Series, 2375578: 1–21. URL
Kakarot-Handtke, E. (2014b). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL

#1 Please go to the AXEC blogspot and enter Wray in the search field. See also the references to working papers

REPLY to William Neil

You say: “It was pre-credit card, although there was a growing segment of long-time purchases of consumer capital goods…but I never see that debt cited as a major contributing factor…more the speculative frenzy on stocks as the chief form of ‘indebtedness’, ...”

The outer form of debt is secondary. If the household sector as a WHOLE gets 100 monetary units per period as wage income and spends 110 units this is dissaving -S and increases the household sector’s debt. This involves creating money out of nothing. However, whether the increase of debt takes the form of overdrafts or credit card debt, or whatever concrete historical form is secondary. It is -S where the positive effect on employment comes from.

When speculators buy stocks on credit this is an entirely DIFFERENT matter which has NO immediate effect on employment (2011).

In very rough terms the Great Depression had three interlocking and self-reinforcing causes: (0) Trigger: stock market crash, which weakened the banking sector, (i) debt deflation as described by Koo (2016d; 2016c), (ii) shortfall of aggregate demand as described by Keynes, (iii) falling profits, FALLING wages (2016b).

The Great Depression is the empirical proof that the market economy is NOT self-adjusting (2016a). In other words, it is a REFUTATION of equilibrium theory or Orthodoxy as a WHOLE.

In a nutshell, this is what formally/materially consistent economics (= theoretical economics = science) tells you. Political economics in the incarnation of Friedman tells you that it was all the fault of the FED and Bernanke gladly repeats it (2000).

As for every economist your first decision is to do (a) theoretical economics (= science), or (b), political economics (= agenda-pushing). In case (b) you will forever burn in scientific hell. It is as simple as that.

Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, NJ: Princeton University Press.
E.K-H (2016a). Could we, please, all focus on the key question of economics? Blog post. URL
E.K-H (2016b). Demystifying employment theory and policy. Blog post. URL
E.K-H (2016c). The other half plus the hitherto missing true foundations of macroeconomics. Blog post. URL
E.K-H (2016d). There is no thrift paradox, or, How economists fell over their own feet. Blog post. URL
Kakarot-Handtke, E. (2011). Primary and Secondary Markets. SSRN Working Paper Series, 1917012: 1–26. URL

REPLY to Robert Locke on Aug 25

You say: “Keynes gave ONE explanation for it; others long before him gave explanations. Marx. for example, List, for another, Hobson, Lenin for two more, etc.”

In economics, almost everything and the exact opposite has already been said sometime, somewhere, by somebody.

The problem is more than 2700 years old and Parmenides solved it: “There are always many different opinions and conventions concerning any one problem or subject-matter (such as the gods). This shows that they are not all true. For if they conflict, then at best only one of them can be true. Thus it appears that Parmenides ... was the first to distinguish clearly between truth or reality on the one hand, and convention or conventional opinion (hearsay, plausible myth) on the other ... “ (Popper, 1994)

Science is the way to figure out what is mere opinion = doxa and what is genuine knowledge = episteme. Knowledge is what is materially/formally consistent and this has to be established by PROOF. Blah-blah and opinion count for nothing.

Keynes understood this. In the 1934 BBC radio address, he tried to answer the central question of economics: “Is the Economic System Self-Adjusting?” Obviously, this is the fundamental question for economic policy because it defines the roles of business/state.

Now, this is the situation. General equilibrium theory delivered the formal proof that an equilibrium exists. This proof is for several reasons not acceptable as we know by now.

What is still lacking since Keynes is the PROOF that the monetary economy is NOT self-adjusting.#1 All else is opinion, and of opinion, we have more than enough.

Heterodoxy has to become serious and move from political economics (= blah-blah, plausible myth, agenda-pushing) to theoretical economics (= science).

#1 What Keynes really meant but could not really prove


REPLY to Robert Locke, Ken Zimmerman, Dave Taylor, etcetera on Aug 26

Cheap talk is the core problem of economics since Adam Smith: “But he had no such ambitions; in fact, he disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter, 1994)

This is how economics became the honeypot for morons, populists, incompetent scientists, and agenda pushers. In principle, there is nothing wrong with this, of course ― these folks, too, need a forum for the exchange of their ideas and an opportunity to politicize and to gossip and to hype their friends and mob their foes.

The problem arises with the claim that economics is a science that is as old as Adam Smith/Karl Marx. Because Walrasianism, Keynesianism, Marxianism, and Austrianism are PROVABLY false this claim is either self-delusion or fraud.

For every intelligent person, it is crystal clear that economics is a failed science. The two main tasks at this critical juncture are (i) positive, i.e. to promote the necessary paradigm shift, and (ii) negative, i.e. to get rid of the proto-scientific dung of the past 200 years. The latter task compares to the Fifth Labor of Heracles and is therefore called Project Augean Stable: “[Augeas] is best known for his stables, which housed the single greatest number of cattle in the country and had never been cleaned, until the time of the great hero Heracles.”#1 This is a fitting metaphor for current economics.

Project Augean Stable starts with a clear separation of political economics (= storytelling, agenda-pushing) and theoretical economics (= science). The mission of Heterodoxy is to flush the heap of proto-scientific dung out and to make economics a science. Clearly, this cannot be done by gossiping about Mr. Trump or any other freak phenomenon of Circus Maximus.

Politics is currently trumped to absolute zero. Economics is a trumped science since Adam Smith. Heterodoxy is here to change the latter but not to cheap talk about the former.

The current situation of economics is summarized in this exhibit.

The key point is that there are political economics and theoretical economics and ALL political economics is proto-scientific dung. The distinction Orthodoxy/Heterodoxy does NOT stand for right-wing/left-wing but for cargo-cult/science. This translates into the Augean Project: to flush the cheap talkers of ALL colors/schools.#2

#1 Wikipedia
#2 Nothing to choose between Orthodoxy and traditional Heterodoxy and Enough! Economists, retire now!


REPLY to Robert Locke, Ken Zimmerman, Dave Taylor, gracchibros et al. on Aug 27

Trumpism has become a widespread nuisance. It consists of nonsense maximization = sense minimization under the constraint of 140 characters. Economists are traditionally good at this discipline and they hold the record with zero sense for a standard peer-reviewed DSGE/I=S/IS-LM paper but they regularly need more than 140 characters for the demonstration.

Economists in general and heterodox economists, in particular, dabble in:
― economic history (William Neil et al.)
― history of scientific thought (Asad Zaman et al.)
― psychology (Ken Zimmerman et al.)
― sociology/Frankfurt School (graccibros et al.)
― philosophy/religion/literature (Dave Taylor et al.)
― political science (gracchibros et al.)
― ethics (mariaalejandramadi et al.).

All this is very, very interesting but OUT of economics. Isn’t it time for the Jacks-of-all-Trades to do a little economics? Theory of employment? Theory of profit? What about a consistent and comprehensive explanation of how the economic system works which beats general equilibrium theory hands down?

Please notice: Heterodoxy and Trumpism do not mix. Never ever. Who cannot answer the question about the difference between income and profit is out of economics. Recall, that you are not admitted to physics if you cannot tell the difference between potential and kinetic energy. Science is hard, and this holds also for economics. But in politics, they are happy about every Trumpy. Think about it.

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