A particularly silly critique

Comment on Lars Syll on 'Piketty and the elasticity of substitution'

Blog-Reference see also later Blog-Reference

“A particularly technical and effective critique of Piketty is ... that for capital returns to be consistently higher than the overall growth of the economy – or “r > g” as framed by Piketty – ... the elasticity of substitution between capital and labor, which needs to be greater than 1 for r to be consistently higher than g.” (quote from the intro)

In order to buy this argument, one has to buy its premises and these premises are known to be false. The first rule of scientific inquiry has been aptly put by Davidson:

“..., before accepting the conclusions of any economist’s model as applicable to the real world, the careful student should always examine and be prepared to criticize the applicability of the fundamental postulates of the model; for, in the absence of any mistake in logic, the axioms of the model determine its conclusions.” (2002, p. 41), see also (Keynes, 1973, p. xxi)

The elasticity argument presupposes the existence of production function with convenient properties. There is no such thing. And any graduate student could know this.

“Orthodox economists operate with concepts like continuous substitutability in consumption and production, positively sloped industry supply curves, and well-behaved aggregate production functions, for which there is little or no empirical support, because they are wedded to a political myth of the market as a self-regulating mechanism.” (Blaug, 1984, p. 973)

Not only there is empirical support lacking, but any undergraduate student of physics also laughs out loud when confronted with an economist's production function: “The idea of a path-independent transformation of one set of physical objects into another violates so many physical laws that one can only marvel at the audacity of those who wrap themselves in the banner of physics before marching off to do battle with the opponents of production functions.” (Mirowski, 1995, p. 327)

An effective critique does not waste time with the green cheese assumptionism economists are famous for.

Suffice it to mention that capital, profit maximization, decreasing returns, equilibrium, and many other notions of marginalism are NONENTITIES.

The worst thing of all, though, is that economists are talking about distribution without knowing what profit is: “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10), for the correct approach see (2014; 2014)

The discussion about the elasticity of substitution is in no way different from the discussion about how many angels can dance on the point of a pin.

That the graduate students at MIT are not aware of this, is a small surprise. They even accept supply-demand-equilibrium as an explanation. What is a real surprise is that this shallow argumentation is taken seriously on this blog.

To be as clear as possible: Marginalism is Zombie-Economics (Quiggin, 2010).

Egmont Kakarot-Handtke


References
Blaug, M. (1984). Review: Why Economics is Not Yet a Science. Economic Journal, 94(376): 972–973. URL
Davidson, P. (2002). Financial Markets, Money and the Real World. Cheltenham, Northampton: Edward Elgar.
Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, 1–11. Palgrave Macmillan, 2nd edition. URL
Kakarot-Handtke, E. (2014a). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan. (1936).
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Quiggin, J. (2010). Zombie Economics. How Dead Ideas Still Walk Among Us. Princeton, Oxford: Princeton University Press.

The subtle distinction between storytelling and science

Comment on Simon Wren-Lewis on 'Saving Equals Investment?'

Blog-Reference

The I=S discussion is the widely visible monument of a lack of genuine scientific instinct of both orthodox and heterodox economists. In order to make this perfectly clear, it is necessary not to accept the familiar premises but to dig deeper. As Keynes already recognized: “For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (1973, p. xxi)

That an error/mistake is almost always located in the premises is well-known from methodology: “In fact, the history of every science, including that of economics, teaches us that the elementary is the hotbed of the errors that count most.” (Georgescu-Roegen, 1970, p. 9)

So, what has, first of all, to be replaced is this formal description of the economy: “In the most simple model of a closed economy without government, income (Y) = consumption (C) + saving (S), but also expenditure (Y) = consumption (C) + investment (I). So S=I by definition. But here investment includes what is called ‘stockbuilding’ or ‘inventory accumulation’, which includes goods that firms wanted to sell but could not.” (quote from intro)

Instead: The most elementary economic configuration, i.e., the production-consumption economy, is defined by (i) Yw=WL wage income Yw is equal to wage rate W times working hours L, (ii) O=RL output O is equal to productivity R times working hours L, (iii) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

This is the formal minimum, and there is no way to reduce it further. For the optical representation, see Graphic AXEC31

At any given level of employment L, the wage income that is generated in the consolidated business sector follows by multiplication with the wage rate. On the real side, the output follows by multiplication with productivity. Finally, the price follows as the dependent variable under the conditions of budget balancing, i.e., C=Yw, and market clearing, i.e., X=O. Note that the ray in the southeastern quadrant is not a linear production function; the ray tracks any underlying production function.

If the wage rate W is lowered, the market-clearing price P falls. If the number of working hours L is increased, the price remains constant, provided productivity R does not change. If productivity decreases, the price rises. In any case, labor gets the whole product, the real wage is invariably equal to productivity, and profit for the business sector as a whole is zero. All changes in the system are reflected in the market-clearing price.

In the next period, the households save. The result is shown with Graphic AXEC33.

Consumption expenditure C falls below Yw and with it the market-clearing price P. With perfect price flexibility, there are no unsold quantities and no changes in inventory. The product market is always cleared, and there is no such thing as an inventory investment. So we have household sector saving but no business sector investment, that is, saving which is given by Sm≡Yw−C is not equal to investment I=0.

Of course, we could also consider the case where the price is sticky, and part of the output O is not sold, i.e., O−X>0 (see 2014a). This, however, would not alter the crucial conclusion.

The crucial conclusion is indeed that the business sector makes a monetary loss that is exactly equal to the household sector's saving, i.e., Qm≡−Sm. Therefore, loss (and not investment) is the exact counterpart of saving; by consequence, profit is the exact counterpart of dissaving.

And this is why almost everything that conventional professors tell their students is false. Household sector saving has never been equal and will never be equal to business sector investment.

The general relationship between monetary profit, distributed profit, investment, and monetary saving is given with Graphic AXEC09

How could economists get the basics so wrong? Because they cannot tell the difference between income and profit. This is like medieval physics before the pivotal concepts of force and mass were properly defined and understood.

As a matter of fact, Keynes' conceptual problems started 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)

This kicks off the chain reaction of errors/mistakes: When profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. It is with profit that the confusion about saving “equals” investment starts. The conceptual mess has been verbally papered over with capital investment/inventory investment or ex-ante/ ex-post, and the representative economist has swallowed all this hook, line, and sinker. For the formally correct solution, see (2014b).

Because neither the Post-Neo-New Keynesians nor the Post-Neo-New Classicals have solved the profit puzzle and with it the saving-investment puzzle, they are collectively outside of science (2013).

Egmont Kakarot-Handtke


References
Georgescu-Roegen, N. (1970). The Economics of Production. American Economic Review, Papers and Proceedings, 60(2): 1–9. URL
Kakarot-Handtke, E. (2013). Why Post Keynesianism is Not Yet a Science. Economic Analysis and Policy, 43(1): 97–106. URL
Kakarot-Handtke, E. (2014a). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL
Kakarot-Handtke, E. (2014b). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. 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

Confused confusers

Comment on Admin on 'Saving=Investment fallacy'

Blog-Reference

You write: “Saving=Investment” is axiomatic in macroeconomics as it is taught in basic textbooks, found in advanced research and assumed in national statistics. Yet it is a fallacy which can be traced to Keynes (1936, p. 63), where he defined saving as “the excess of income over consumption” in a framework of equilibrium circular flow of national income.

You put your finger exactly on the critical error/mistake. To see this clearly, however, one has to take the decisive analytical step. Keynes' problem started 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, pp. 12-13, 16)

Now comes the chain reaction of errors/mistakes: When profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. It is with profit that the confusion about saving “equals” investment starts. The conceptual mess has been verbally papered over with ex-ante/ex-post (see also inventory investment), and the representative economist has swallowed all this hook, line, and sinker.

For the formally correct solution, see my recent paper (2014). It should be mentioned that there is monetary and nonmonetary profit and correspondingly monetary and nonmonetary saving. Here we deal exclusively with monetary profit and saving.

Because neither Keynes nor the Post-Neo-New Keynesians have solved the profit puzzle and with it the saving-investment puzzle, they are outside of science (2013).

The profit theory of Keynes, Kalecki, or Keen, for example, is as far away from reality as any mainstream profit theory, surely, therefore, both Heterodoxy and Orthodoxy “fail to capture the essence of a capitalist market economy.” (Obrinsky, 1981, p. 495)

Economists owe the world the true economic theory, that is, a theory that satisfies the scientific standards of material and formal consistency and that explains how the economy works.

Formal consistency requires starting with an objective set of axioms and then proceeding in the logically correct way. I=S is the widely visible monument of confused thinking and lack of genuine scientific instinct of both Orthodoxy and Heterodoxy.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2013). Why Post Keynesianism is Not Yet a Science. Economic Analysis and Policy, 43(1): 97–106. URL
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Obrinsky, M. (1981). The Profit Prophets. Journal of Post Keynesian Economics, 3(4): 491–502. URL
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


Graphic AXEC09 is the correct equation that relates profit Q, distributed profit Yd, investment expenditure I, and household sector saving S.

For equilibrium as a NONENTITY, see here.

No more critique of economics, please!

Comment on 'Saving=Investment fallacy'

Blog-Reference

In its present state, economics is unsatisfactory. Most economists can agree with this. It is not surprising then that complaining and debunking have almost become a sub-discipline of economics. Not much can be said against this, except that it is a detour.

As Schumpeter already noted: “If we feel misgivings nevertheless, all we have to do is to start appropriate research. Anything else is pure filibustering.” (1994, p. 577)

Or, Blaug, in even stronger words: “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)

The problem is that conventional economics has so many obvious defects that it is not at all clear where to start. Here, Keynes pointed the way: “For if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and of generality in the premises.” (1973, p. xxi)

And this leads back to the question that J. S. Mill posed at the very beginning of theoretical economics:
“What are the propositions which may reasonably be received without proof? That there must be some such propositions all are agreed, since there cannot be an infinite series of proof, a chain suspended from nothing. But to determine what these propositions are, is the opus magnum of the more recondite mental philosophy.” (2006, p. 746)

And this leads even further back to the beginning of science: “When the premises are certain, true, and primary, and the conclusion formally follows from them, this is demonstration, and produces scientific knowledge of a thing.” (Aristotle, Analytica)

The premises of Orthodoxy are uncertain and false and this fully explains its failure. What exactly are the premises?

“As with any Lakatosian research program, the neo-Walrasian program is characterized by its hard core, heuristics, and protective belts. Without asserting that the following characterization is definitive, I have argued that the program is organized around the following propositions: HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states. By definition, the hard-core propositions are taken to be true and irrefutable by those who adhere to the program. ‘Taken to be true’ means that the hard-core functions like axioms for a geometry, maintained for the duration of study of that geometry.” (Weintraub, 1985, p. 147)

Note well that these axioms have only been taken to be true and irrefutable by the adherents of Orthodoxy. They are by no means irrefutable for anybody else.

“If a professional group regards itself a having a message to deliver to others than its own members and makes any public claims in that respect, it thereby gives others the right to scrutinize the methods whereby that message was discovered, including the principles, or possibly prejudices, followed in choosing premises. They continue to do so. Cunningham in 1891 remarked that in the choice of premises ‘it is not always easy to tell when a professor of the dismal science is making a joke’ and I suspect that Cunningham meant that if the professor was not joking, then he was making a fool of himself.” (Viner, 1963, p. 12)

So, everyone who does not want to make a fool of himself has no choice but to come up with a new set of axioms (see 2014).

Egmont Kakarot-Handtke


References
Blaug, M. (1998). Economic Theory in Retrospect. Cambridge: Cambridge University Press, 5th edition.
Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19. URL
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.
Mill, J. S. (2006). Principles of Political Economy With Some of Their Applications to Social Philosophy, Volume 3, Books III-V of Collected Works of John Stuart Mill. Indianapolis: Liberty Fund. URL (1866).
Schumpeter, J. A. (1994). History of Economic Analysis. New York: Oxford University Press.
Viner, J. (1963). The Economist in History. American Economic Review, 53(2): 1–22. URL
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

Testing is better than critique

Comment on Admin on 'Saving=Investment fallacy'

Blog-Reference

I certainly do not want to stop you from testing existing theories. Just the contrary, I explicitly encourage testing of the structural axiom set and its logical implications in my mission statement and elsewhere in my papers.

This brings me right back to our starting point. So, let us put methodological questions for a moment aside. You said that I=S is a fallacy. I agree. Not only this, I also present the correct relation. It is in Graphic AXEC09.

This is the relation for the investment economy. It gets a bit more complex if foreign trade and government are included. But that is not the point at issue at the moment. The equation says that household sector saving and business sector investment are never equal. And this is sufficient in the first round to empirically refute the standard approach.

Now the rest is quite simple. You have the data. A cursory comparison of the data with the formula above will convince you that the formula is essentially correct. Then the crucial test has to be designed.

What will the outcome of this test be? The structural axiom set will be corroborated with a precision of two decimal places. This is how science works:

“Whether an axiom is or is not valid can be ascertained either through direct experimentation or by verification through the result of observations, or, if such a thing is impossible, the correctness of the axiom can be judged through the indirect method of verifying the laws which proceed from the axiom by observation or experimentation. (If the axiom is deemed to be incorrect, it must be modified, or instead a correct axiom must be found.)” (Morishima, 1984, p. 53)

This answers the first question of your comment: “How do you know (or prove) that your new set of axioms is better than the old set?” Then, obviously, there is no urgent need to discuss the rest.

In light of your comment, a better title of my previous contribution would have been: No more filibuster about economics, test the axioms!

Egmont Kakarot-Handtke


References
Morishima, M. (1984). The Good and Bad Use of Mathematics. In P. Wiles and G. Routh (Eds.), Economics in Disarray, 51–73. Oxford: Blackwell.

Axiomatization and testing (II)

Comment on Admin on 'Saving=Investment fallacy'

Blog-Reference

It is a matter of method, which implies testing: “Reason gives the structure to the system; the data of experience and their mutual relations are to correspond exactly to consequences in the theory. On the possibility alone of such a correspondence rests the value and the justification of the whole system, and especially of its fundamental concepts and basic laws. But for this, these latter would simply be free inventions of the human mind which admit of no a priori justification either through the nature of the human mind or in any other way at all.” (Einstein, 1934, p. 165)

Egmont Kakarot-Handtke

References
Einstein, A. (1934). On the Method of Theoretical Physics. Philosophy of Science, 1(2): 163–169. URL

All problems settled — free way ahead

Comment on asepp on 'Saving=Investment fallacy'

Blog-Reference

It is gratuitous to play ping-pong with Einstein quotes and to cook up the induction-deduction discussion once more. Schumpeter has already settled the matter.

“... there is not and cannot be any fundamental opposition between ‘theory’ and ‘fact finding,’ let alone between deduction and induction.” (1994, p. 45)

Science is about two, repeat two, consistencies: “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, 1994, p. 31)

However, as a practical matter, theory comes first: “Indeed, there is no such thing as an uninterpreted observation, an observation which is not theory-impregnated.” (Popper, 1994, p. 58)

Those common sense people who are stating the seemingly plain fact that 'the sun goes up' do simply not realize that they are stating a hypothesis.

Theory in the proper sense is a free invention, the product of pure thought, and, lo and behold, this is exactly what Einstein said (note that he never observed a relativistic effect that kicked off his thinking):

“To this I answer with complete assurance, that in my opinion there is the correct path and, moreover, that it is in our power to find it. Our experience up to date justifies us in feeling sure that in Nature is actualized the ideal of mathematical simplicity. It is my conviction that pure mathematical construction enables us to discover the concepts and the laws connecting them which give us the key to the understanding of the phenomena of Nature. Experience can of course guide us in our choice of serviceable mathematical concepts; it cannot possibly be the source from which they are derived; experience of course remains the sole criterion of the serviceability of a mathematical construction for physics, but the truly creative principle resides in mathematics. In a certain sense, therefore, I hold it to be true that pure thought is competent to comprehend the real, as the ancients dreamed.” (1934, p. 167)

The same holds, of course, in theoretical economics. Political economists, though, are too occupied with pushing their agendas. Thus, they have neither time nor brain space left over for thinking.

So there is absolutely no problem here. Take the structural axiom set or one of its logical implications and test them. Thus, you and I together are doing really good science.

To recall, those who have filibustered about induction-deduction have achieved nothing of scientific value until this sunny morning and will not in the foreseeable future.

Egmont Kakarot-Handtke


References
Einstein, A. (1934). On the Method of Theoretical Physics. Philosophy of Science, 1(2): 163–169. URL.
Klant, J. J. (1994). The Nature of Economic Thought. Aldershot, Brookfield: Edward Elgar.
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality., chapter Science: Problems, Aims, Responsibilities, 82–111.
London, New York: Routledge.
Schumpeter, J. A. (1994). History of Economic Analysis. New York: Oxford University Press.