October 16, 2017

Proof of the inherent instability of the market economy

Comment on Simon Wren-Lewis on ‘How Neoliberals weaponise the concept of an ideal market’

Blog-Reference and Blog-Reference and Blog-Reference on Oct 17

The foundational tenet of economics is that the interaction of free markets tends, in principle, to produce an inherently stable optimal outcome with all factors fully employed or, with regard to labor, at worst ‘naturally’ unemployed.

This tenet has NEVER been proven. General Equilibrium Theory is known to be a methodological disaster and economics is known to be in need of a Paradigm Shift: “There is another alternative: to formulate a completely new research program and conceptual approach. As we have seen, this is often spoken of, but there is still no indication of what it might mean.” (Ingrao et al.)

As a result, economic policy guidance in ALL variants between the outer right wing and outer left wing has had no sound scientific foundations for 200+ years. It can be proved that the market economy is inherently unstable.

Economics is a systems science. Accordingly, the correct approach is not microfoundations but macrofoundations.#1 The elementary version of the objective, systemic, behavior-free, macrofounded Employment Law is shown on Wikimedia AXEC62

From this equation follows
(i) An increase in the expenditure ratio ρE leads to higher employment L (the Greek letter ρ stands for the ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase in the factor cost ratio ρF≡W/PR leads to higher employment.

Items (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio ρF as defined in (iii) embodies the macroeconomic price mechanism. The fact is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R and vice versa. This is the OPPOSITE of what microfounded economics teaches: “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed.” (Tobin)*

This is false: a reduction of the average wage rate W in the situation of unemployment INCREASES unemployment. In general terms: at the heart of the market economy is a positive feedback loop, i.e. the very OPPOSITE of what is required for a self-adjusting system.

The lethal methodological blunder of the microfounded market theory consists of the Fallacy of Composition, i.e. the illegitimate generalization of truths that hold for one firm/market for the economy as a whole.

The free market system is neither efficient, self-adjusting, nor stable. Neoliberalism has no sound scientific foundations.

Egmont Kakarot-Handtke

#1 New Economic Thinking: the 10 crucial points

Related 'How to overcome the manifest silliness of Econ 101 and save the economy'

For more about self-adjusting see AXECquery.


* Lars P. Syll blog, James Buchanan, Wall Street Journal