Blog-Reference and Blog-Reference on Jan 10, 2017, adapted to context and Blog-Reference and Blog-Reference on Jan 12 and Blog-Reference
Walrasian, Keynesian, Marxian, and Austrian economists are groping in the dark with regard to the two most important features of the market economy, that is, the profit mechanism and 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 the following, a sketch of the correct employment theory is given.#1 The most elementary version of the objective systemic Employment Law is shown on Wikimedia AXEC62:
(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 of the factor cost ratio ρF≡W/PR leads to higher employment.
The complete AND testable Employment Law gets a bit longer and contains in addition profit distribution, public deficit spending, and import/export.
Item (i) and (ii) cover Keynes’ well-known arguments about aggregate demand. Here, though, 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 standard economics assumes. 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 opposite of what standard economics teaches.
The systemic Employment Law contains nothing but measurable variables and is therefore readily testable. There is no need for further discussion. As always in science, a test decides the matter.
Right policy depends on true theory: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991)
Standard economists do not have the true theory. Standard labor market theory is provable false.
#1 See the working papers for more details.
Related 'How economists murdered the economy and got away with it' and 'Economics: the simple logic of failure' and 'From false micro to true macro: the new economic paradigm' and 'NAIRU does not exist because equilibrium does not exist'