August 17, 2016

How to get rid of an obsolete theory

Comment on Raphaële Chappe on ‘General Equilibrium Theory: Sound and Fury, Signifying Nothing?’


Orthodoxy has failed on all counts and has no future. This is the point of departure of all new economic thinking. The ultimate reason for failure is the proven scientific incompetence of economists since Adam Smith.

The rules of conduct of the scientific community demand that the actual state of economics is at all times unambiguously communicated to the general public. This implies, as the VERY FIRST step, that the word sciences is deleted from the “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”.

Because every theory is defined by its foundational premises, a.k.a. axioms, there is, as a matter of principle, no need to refute every single proposition of the elaborated theoretical superstructure, it suffices to ‘throw over’ (Keynes) the axioms. Yet, this is not enough. The negative/destructive first step must be followed by a positive/constructive second step. As Blaug put it: “The moral of the story is simply this: it takes a new theory, and not just the destructive exposure of assumptions or the collection of new facts, to beat an old theory.” (1998, p. 703)

First step: economists have to throw over the orthodox set of axioms which is defined by these six hard core propositions:

HC1 There exist economic agents.
HC2 Agents have preferences over outcomes.
HC3 Agents independently optimize subject to constraints.
HC4 Choices are made in interrelated markets.
HC5 Agents have full relevant knowledge.
HC6 Observable economic outcomes are coordinated, so they must be discussed with reference to equilibrium states. (Weintraub, 1985, p. 109)

The methodological blunder that suffices to make this axiom set unacceptable is that HC3 and HC5 introduce nonentities and that HC6 is a petitio principii.

Note that we follow here Keynes’s methodological insight as laid down in the General Theory: “The classical theorists resemble Euclidean geometers in a non-Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight ― as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics.” (1973, p. 16)

In other words, the methodological revolution in economics consists in the switch from behavior-centered bottom-up, i.e. subjective microfoundations, to structure-centered top-down, i.e. objective macrofoundations.

Accordingly, Keynes went on to define the new set of foundational propositions: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Unfortunately, at this critical juncture, an error slipped in because Keynes did not come 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)

Because of this, Keynes’s two foundational macroeconomic equations (Y=C+I, S=Y-C) have to be replaced. The most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm and is given by these three objective structural axioms:

(A1) Yw=WL wage income Yw is equal to wage rate W times working hours L,
(A2) O=RL output O is equal to productivity R times working hours L,
(A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

The investment good sector comes in at a later stage. So, what we have with (A1) to (A3) is the pure consumption economy as the most elementary economic structure. This structure is the core of what Keynes called the monetary theory of production and it fully replaces the silly real exchange models.

After-Keynesians either got stuck at I=S/IS-LM-models which are provably false (2011) or fell back to maximization-and-equilibrium, i.e. HC1 to HC6, or both as in the case of the maximal confused Krugman (2014).

Human behavior, tastes, choice, or society have no durable underlying structure but the monetary economy has and this systemic structure is given in the most elementary case by (A1) to (A3). Economics is NOT a behavioral or social science but a systems science. A system can be unambiguously defined. This is the indispensable condition to do science. The alternative to science is storytelling. This is what Walrasians, Keynesians, Marxians, and Austrians are actually doing.

Keynes started the paradigm shift from micro to macro. However, he got stuck with the definition of overall profit. Not to know what profit is, turns out to be fatal for every economist and every approach. This methodological deadlock is overcome with the consistent axiomatic set (A1) to (A3) which provides the formally and materially consistent economic theory.#1 Thus Sysdoxy replaces both Orthodoxy and Heterodoxy.

Raphaële Chappe concludes: “When a way of thinking limits our thinking then it’s time, with due appreciation for those who built it, to ‘throw away the ladder’.” This, though, misses the crucial point: “There is no evidence to suggest that economists abandon degenerating programs in the absence of a progressive alternative.” (Weintraub, 1985, p. 148)

The real task, then, is to define the foundations of a materially and formally consistent economic paradigm. This is beyond the means of the adherents of both Orthodoxy and traditional Heterodoxy.

Egmont Kakarot-Handtke

Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
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
Weintraub, E. R. (1985a). General Equilibrium Analysis. Cambridge, London, New York, NY, etc.: Cambridge University Press.
Weintraub, E. R. (1985b). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

#1 For details of the big picture see cross references Paradigm Shift