July 15, 2018

Wikipedia and the promotion of economists’ idiotism (II)

Comment on Wikipedia’s ‘Accounting identity’#1

Own post, no external Blog-Reference

“In accounting, finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition (or construction) must be true.” and “The term accounting identity may be used to distinguish between propositions that are theories (which may or may not be true, or relationships that may or may not always hold) and statements that are by definition true.”

The first point to notice is that there is NO such thing as “true by definition”.#2 Truth has to be established by proof. Scientific truth is well-defined by material and formal consistency: “Research is, in fact, a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant)

The second point is that the term “accounting identity” shows that economists do not understand the elementary mathematics that underlies accounting.

The third point is that identities that are incompatible are declared “true by definition”. Simple logic tells everyone that wildly different accounting identities cannot all be “true by definition”.

Economists have obviously a serious problem with methodology. More specifically, they suffer badly from the Humpty Dumpty Fallacy which is expressed in these familiar slogans:

• “You can define anything you want but as a sage once said ‘A rose by any other name will smell as sweet!’” (Davidson)
• “For, on principle, we may call things what we please.” (Schumpeter)
• “This is a tough question to adjudicate on scientific grounds since the issue is largely definitional and, as Lewis Carroll pointed out, everyone is entitled to his own definitions. (Blinder)
• “‘When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’ ‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all’.”

The point is that a single definition is indeed arbitrary but one NEVER has only one definition. So, one has to make sure that the set of definitions that refer to one subject matter is internally consistent.

From methodology, it is known that “The often heard rule that concepts are to be defined before they are used in a discussion is much too simple-minded pre-Hilbertian. The only way to arrive at coherent languages is to set up axiomatic systems implicitly defining the basic concepts.” (Schmiechen) The fact of the matter is that the foundational concepts of economic are ill-defined. And this is why economics never rose above the proto-scientific level.

For compelling methodological reasons, economics has to be built upon objective-systemic macrofoundations.#3, #4, #5

(A0) The objectively given and most elementary systemic configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. For a start, the elementary production-consumption economy is given with three macroeconomic 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.

From the macroeconomic axioms follow models by specification. The Ur-Model is given by two conditions (X=O, C=Yw) and two definitions (monetary profit/loss Qm≡C−Yw, monetary saving/dissaving Sm≡Yw−C).

It always holds Qm+Sm=0 or Qm=−Sm, in other words, at the heart of the monetary economy is an identity: the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law.

The point to notice is that a definition is a one-way relation. The new term “monetary profit Qm” (= definiendum) is derived from the terms already given by the axioms, i.e. C and Yw (= definiens).

From the definition (≡) of the balance of the business sector Qm≡C−Yw follows that to write down the identity Qm+Yw=C is INADMISSIBLE. So, one is NOT permitted to say that “total income” is the “sum of profits and wages” and that “total income” is equal to household sector spending C or that Income = Value of Output (Keynes). Economists, though, do not get it to this day.#6, #7

What should be quite clear is that profit Qm is a balance, i.e. a difference of flows, and wage income is a flow from the business to the household sector. So profit is NOT a sub-category of total income but a balance. A balance can either be positive or negative while a flow like wage income is always greater than zero.

So, Qm+Yw=C is NOT a balance identity that is “true by definition” but plain methodological garbage. From Qm=−Sm, in turn, follows immediately that the Keynesian accounting identity I=S and the MMT balances equation (I−S)+(G−T)+(X−M)=0 are methodological garbage by logical implication.

What holds for the flows of the Profit-and-Loss-Account holds also for Wikipedia’s “most basic identity in accounting”, that is, Assets=Liabilities+Equity. The correct definition for the Asset-and-Liability-Account of the business sector is the one-way relation Equity≡Assets−Liabilities.

The economic Ur-Model above tells us two important things: (i) under the condition of market-clearing X=O and budget-balancing C=Yw, macroeconomic profit is zero and independent of employment, productivity, wage rate, etcetera, and (ii), because of Qm=−Sm macroeconomic profit comes in the most elementary case from dissaving, i.e. the growth of household sector debt.#8

From the fact that the foundational concepts of economics ― profit and income ― are ill-defined follows (i) that the Wikipedia entry “Accounting identity” is proto-scientific garbage, and (ii), that all Wikipedia entries which directly or indirectly depend on the definition of profit/income are proto-scientific garbage by logical implication.#9, #10

Egmont Kakarot-Handtke

#1 Wikipedia Accounting identity
#2 Truth by definition? The Profit Theory is axiomatically false for 200+ years
#3 For details of the big picture see cross-references Axiomatization
#4 The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
#5 Wikimedia AXEC137 Macrofoundations
#6 How the Intelligent Non-Economist Can Refute Every Economist Hands Down
#7 For details of the big picture see cross-references Profit
#8 The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?
#9 Wikipedia and the promotion of economists’ idiotism (I)
#10 Hooray! The formalization issue is finally settled

Related 'Humpty Dumpty is back again' and 'The Humpty Dumpty methodology' and 'Economics: 200+ years of scientific incompetence and fraud' and 'Economists: just too stupid for counting' and 'Keynes and the logical brilliance of Bedlam' and 'Yes, economists are really that stupid' and 'Keynes ― the poster boy for the weakness of the economist’s mind' and 'MMT and the canonical macroeconomic model'.

Wikimedia AXEC143