December 6, 2016

Econ 101 is dead ― and now?

Comment on Noah Smith on ‘An econ theory, falsified’

Blog-Reference and Blog-Reference

Econ 101 as a whole ― not only the labor market theory ― is false. The ultimate reason is that it rests on false premises. As a result, the standard analytical tool, i.e. SS-curve―DD-curve―equilibrium, is useless because it represents a NONENTITY. So, (i) the formal representation of “the” market is false to start with, and (ii), it is, as a matter of principle, inadmissible to generalize the results of partial analysis for the economy as a whole. This is the Fallacy of Composition.

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. 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 macroeconomic employment theory is given.#1 The elementary version of the objective systemic Employment Law for the investment economy (no government, no foreign trade) is shown on Wikimedia AXEC62a:

From this equation follows:
(i) An increase in the expenditure ratio ρE leads to higher employment (the Greek 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 Employment Law gets a bit longer and contains in addition profit distribution, public deficit spending, and import/export.

Item (i) and (ii) cover Keynes’s 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. 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 supply-demand-equilibrium economists lack the true theory. Standard labor market theory is provably false. Scientifically incompetent standard economists are responsible for unemployment, deflation, depression, and stagnation.

Egmont Kakarot-Handtke

#1 For details see working papers
► The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment
► Keynes’ Employment Function and the Gratuitous Phillips Curve Disaster
► The Truly General Theory of Employment: How Keynes Could Have Succeeded
► Towards Full Employment Through Applied Algebra and Counter-Intuitive Behavior
► Essentials of Constructive Heterodoxy: Employment
► How to Get Rid of Supply-Demand-Equilibrium

Immediately following Methodology 101, economic filibuster, and the mother of all excuses.