June 30, 2015

Economics, Gödel, and a would-be field day for math-Luddites

Comment on ‘It’s all over — Gödel’s incompleteness theorems’

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“But lots of people have misused Gödel's theory.” (Tony Mann, Gödel's incompleteness theorem, youtube, 5:01)

There have always been lots of people who had considerable trouble with the clear-cut truth claim of mathematics. For one reason or another they prefer the realm of vagueness, ambivalence, indeterminism, fogginess, wish-wash, inconclusiveness, twilight, uncertainty, where “... nothing is clear and everything is possible.” (Keynes, 1973, p. 292)

For these people, who are at least mildly anti-scientific, science itself offered two god-sents: Heisenberg's uncertainty principle and Gödel's incompleteness theorem. These masterpieces of pure logic seemed to establish an ecological niche where true and false overlap, where contradictions can peacefully coexist, and where opinion and knowledge are equal. Tortured souls hailed von Neumann's “It's all over” as the end of their nightmare and the licence for anything-goes.

What von Neumann, who was for a time member of the most ambitious program in mathematics, meant was that Hilbert's goal of a complete proof of all mathematical truths was unattainable. What Gödel had shown was that there are true propositions that cannot be proved within a given consistent formal system. This was by no stretch of imagination the end of mathematics because there are many, many proposition that can be proved. And this invalidated none of the propositions that had already been proved since the days of Euclid. So Pythagoras's theorem and 2+2=4 still stand after Gödel.

Gödel had used Hilbert's axiomatic-deductive method to demonstrate that the axiomatic-deductive method has limits. To conclude from this demonstration that the method is inapplicable in economics is a gross logical blunder of the math-Luddites.

To tell the logically handicapped majority of economists of the limits of logic and mathematics is to warn a snail that it will encounter an absolute limit when it approaches the speed of light.

“In hindsight, the basic idea at the heart of the incompleteness theorem is rather simple. Gödel essentially constructed a formula that claims that it is unprovable in a given formal system. ... Thus there will always be at least one true but unprovable statement.” (Wikipedia)

The problem of economics is not that there is one true but unprovable statement. To the contrary, the problem is that there is not one true and provable statement.

The curious thing is that there are so many economists who are quite content with this deplorable state of affairs.*

Egmont Kakarot-Handtke


References
Keynes, J. M. (1973). The General Theory of Employment Interest and Money. The Collected Writings of John Maynard Keynes Vol. VII. London, Basingstoke: Macmillan.

*For details see also here and here

The double crisis and the real question

Comment on ‘As it happened – Yanis Varoufakis’ intervention during the 27th June 2015 Eurogroup Meeting’

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Economics has invariably two aspects: political and scientific. With regard to the breakdown of negotiations an outside observer cannot say who has failed or who was successful because one does not really know the true motives of the two sides. As always in politics, this is open to anybody’s guess/paranoia.

The underlying problem is that what is essentially an economic issue has with some inner necessity shifted into a different frame of reference, that of Hollywood, drama, tragedy, entertainment, soap opera, Circus Maximus. The economic issue has been reformulated in terms of good guys vs. bad guys. Thereby it has become insoluble.

The format-shift characteristically results in descriptions of the situation like this: “So the stakes are high, the conditions brutal. The Old Man and the Sea, the great fish has been caught, is being towed, and the sharks are closing in. Human endurance in the face of the horrific, the face of European neoliberalism.” (see graccibros above; I am still waiting for the more appropriate crash scene of Alexis Sorbas)

With this, of course, we are entirely out of economics — at least as far as it claims to be a science — and in the communicative kindergarten. The laws of showbiz rule.

The political issue is this: if you want your money back it is, first of all, not such a good idea to economically cripple the debtor.

The economic issue is this: The Greek crisis can be seen as the inevitable result of false economic theory.

Orthodoxy says the price mechanism sees to it that the economy tends always to efficiency and full employment. Keynesianism says the price mechanism obviously does not work as promised and because of this deficit spending is needed in case of emergency. However, when deficit spending has run up the hill of debt for some time the advice becomes less and less convincing. It seems that all that Keynesianism can achieve is a postponement of the breakdown of an economic system that has a fundamental defect.

The real question then is: can the market system work without a steadily growing debt? And it is only secondary whether private or public households are the deficit spenders.

If the answer is No then it is only a question of time that a debt crisis must occur and Greece had the misfortune to be the weakest part of the global debt engine. Under this broader perspective we have no Greek crisis but a systemic crisis (2015).

Therefore, the crucial question is: can the world economy as a whole work without ever growing debt? Both, Walrasian and Keynesian economics cannot answer this question.

Because of this, the Greek crisis is not only a political crisis of the EU but the indisputable proof of the failure of economics as a science. To solve this crisis economics has to get out of showbiz first. It is high time for both orthodox and heterodox economists to figure out how the monetary economy works.

Egmont Kakarot-Handtke

References
Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL

June 29, 2015

Major defects of the market economy

Working paper at SSRN

Abstract  When we characterize an argument that has no sound theoretical foundation as political, then what has been produced by economists so far is political economics. However, since the Classics and Marx all major economic schools have defended the claim that they were doing science. This claim has been convincingly rebutted. So, the task is still before us. The way forward is to move from behavioral to structural economics. In what we should be mostly interested are not so much the behavioral defects of economic agents but the structural defects of the market system and how to repair them.

June 27, 2015

The trouble with counting to 3

Comment on Blissex on ‘Keenonomics, aggregate demand/change of debt, and some misleading critique’

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You comment my verbatim quote from the General Theory as: “That’s a ridiculous misquote.” Obviously you had not the time to check it. For your convenience, here is a direct link to Google-books.

Ok, we agree, my quote is correct and your assertion is incorrect, or, don't let us mince words, utterly ridiculous.

And so it goes on. You refer to the ex ante/ex post storytelling. Nice try. Here is the fact of the matter.
“Throughout the 1920s and 1930s the focus was increasingly on the role of the equality of saving and investment, but the semantic squabbles that dominated much of the debate (the distinctions between "ex ante," and "ex post," "planned" and "realized" saving and investment, the discussion of whether the equality of saving and investment was an identity or an equilibrium condition) reflected a deeper confusion.” (Blanchard, 2000, p. 1378)

This confusion has not been resolved in a formally satisfactory way until today and your reiteration is a telling example that 'deeper confusion' is still with us.

The almost tragic thing is that accounting is elementary mathematics and that economists botch it up even at the beginner's level. An accountant who writes down every single real-world transaction during a period and then comes up at period end with I=S instead of Qre=I-S gets fired because of incompetence or cooking up the books. And telling the ex ante/ex post story cannot prevent this (2012).* Bookeeping provides the most precise and reliable empirical test in economics. Is anyone surprised that economists cannot handle it properly?

Egmont Kakarot-Handtke


References
Blanchard, O. (2000). What Do We Know about Macroeconomics that Fisher and Wicksell Did Not? Quarterly Journal of Economics, 115(4): 1375–1409. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL

* See the I-unequal-S cross-references for blog posts and the formal proof

June 26, 2015

Value — the Bermuda triangle for economic theories

Comment on ‘Economic Value is not Price’

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“Repeated reflection and inquiry have led me to the somewhat novel opinion, that value depends entirely on utility.” (Jevons, 1911, p. 1)

Since Jevons and the other Neoclassicals utility and equilibrium have been seen as the two pillars that support the whole theoretical superstructure of standard economics. It is common knowledge that standard economics is a failure. And it is pretty clear why. Utility and equilibrium are nonentities, green-cheese assumptions, much too swampy and muddy to build anything more upon than a shaky proto-scientific construct.

Because of this, the new heterodox curriculum will certainly not mention these concepts except as an example for orthodox incompetence, or worse. By the way, that utility is not such a good starting point for a serious theory of value is known since Cournot.

“The abstract idea of wealth or value in exchange ... must be carefully distinguished from accessory ideas of utility, scarcity and suitability to the needs and enjoyment of mankind .... These ideas are variable, and by nature indeterminate and consequently ill suited for the foundation of a scientific theory ....” (Cournot 1897, quoted in Mirowski, 1995, p. 208)

What is more, as already Ricardo saw clearly, the theory of value cannot be based on exchange alone but must include production.

“In speaking the of commodities, of their exchangeable value, and of the laws which regulate their relative prices, we mean always such commodities only as can be increased in quantity by the exertion of human industry, and on the production of which competition operates without restraint.” (Ricardo, 1981, p. 12)

Marx developed this idea further in his analysis of surplus value. This goes in the right direction because the ultimate goal of value theory is the explanation of profit.

“But in the act of exchange viewed as a whole, equals are in general always exchanged for equals, individual variations being canceled out. How then, are profits made, for, obviously, they are made?” (Kirkenfeld, 1948, p. 35)

As real-world economists, the Classicals and Marx had an objective value theory in mind while Jevons ended in subjective wish-wash. In a nutshell, this is his value theory.
“The truth is that pearls are valuable because there are so many ladies who have not got pearl necklaces, and who would like to have them.” (Jevons, see Google-Books)

This slipslop counts as explanation among orthodox economists. Or take Samuelson's entirely tautological solution of the so-called water-diamond paradox.
“In other words, how is it that water, which is essential to life, has little value, while diamonds, which are generally used for conspicuous consumption, command an exalted price? Although it troubled Adam Smith 200 years ago, we can resolve this paradox as follows: ‘The supply and demand curves for water intersect at a very low price, while supply and demand for diamonds are such that their equilibrium price is very high’.” (Samuelson and Nordhaus, 1998, p. 90), see also (2011b)

Note well that supply and demand curves, too, are nonentities because they are ultimately based on utility. So, on closer inspection, economics has no acceptable value theory.

I think that there can be no doubt that a lot of New Economic Thinking is required for Heterodoxy to develop a superior value theory — without ever mentioning utility again (for a start see 2011a).

Egmont Kakarot-Handtke


References
Jevons, W. S. (1911). The Theory of Political Economy. London, Bombay, etc.: Macmillan, 4th edition. URL
Kakarot-Handtke, E. (2011a). The Pure Logic of Value, Profit, Interest. SSRN Working Paper Series, 1838203: 1–27. URL
Kakarot-Handtke, E. (2011b). The Value of Water and Diamonds: Back to Square One. SSRN Working Paper Series, 1954047: 1–19. URL
Kirkenfeld, T. (1948). The Paradox of Profit. Science & Society, 12(1): 33–41. URL
Mirowski, P. (1995). More Heat than Light. Cambridge: Cambridge University Press.
Ricardo, D. (1981). On the Principles of Political Economy and Taxation. The Works and Correspondence of David Ricardo. Cambridge, New York, NY, etc.: Cambridge University Press. URL
Samuelson, P. A., and Nordhaus, W. D. (1998). Economics. Boston, MA, Burr Ridge, IL, etc.: Irwin, McGraw-Hill, 16th edition.

June 22, 2015

When numbers don't add up

Comment on Merijn Knibbe on ‘Keenonomics, aggregate demand/change of debt, and some misleading critique’

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Thank you for the link to ‘Why Steve Keen is even more right than he thinks.’ In this 2011 thread you have already pointed out that Keen's argument leads directly to accounting. Basically, this dovetails with Stützel's balance mechanics approach. So we have an analytical square consisting of Keen-Reissl-Stützel-Knibbe which encloses the general issue of accounting.

With regard to the whole formalization and mathiness debate it is worth remembering that accounting is the natural formal tool of the economist and the indispensable integrating hub of all empirical work.

“Somewhere between the Political Arithmetician, alias the National Income Accountant, and the Financial Analyst, alias the Accountant, lies the task of the quantitative economist’s analytical role, and none of the theoretical or applied tasks of these two pragmatic and paradigmatic figures requires anything more than arithmetic, statistics and the rules of compound interest.” (Velupillai, 2005, pp. 866-867)

The trouble is, as you point out, that the representative economist cannot handle this tool properly and this applies first and foremost to Orthodoxy.

I have addressed the inconsistency between theory and accounting/balance mechanics in (2012). As you say, this inconsistency has to be eliminated first from the current discussion.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. URL
Velupillai, K. (2005). The Unreasonable Ineffectiveness of Mathematics in Economics. Cambridge Journal of Economics, 29: 849–872

Relates to Keenonomics, aggregate demand/change of debt, and some misleading critique
and  More than two centuries of waffling in the dark

June 21, 2015

More than two centuries of waffling in the dark

Comment on Nick Edmonds on ‘Keenonomics, aggregate demand/change of debt, and some misleading critique’

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Nick Edmonds quotes me correctly: “…the business sector’s investment expenditures are never equal to the household sector’s saving..” and then asks: “Does anyone say they are generally equal?”

Yes, and this is well known among economists.

“As is well known, and taking over that argument from Smith, both Ricardo and Malthus in England and Say and Sismondi on the Continent always identified decisions to save with decisions to invest. Since they all considered as a fact that ‘what is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too’ (Smith, 1776, vol. I, pp. 337–8), the question of a possible divergence between saving and investment was never asked.” (Bridel, 1987, p. 1)

Nick Edmonds is ignorant of the history of economic thought. Worse, he does not understand the significance of the question at issue. The I-equals-S assertion is not only more than 200 years old but there has always been an uneasy feeling that there must be something deeply wrong with the whole idea.

“For the best part of the last two centuries, this equality (and the ways by which it comes to be established) has been at the heart of long and protracted debates. Indeed, two of the most fruitful periods in the history of economic thought were entirely devoted to this riddle which, still today, is far from being satisfactorily solved. For all the participants in the ‘general glut controversy’ as well as for Keynes and all the leading economists of the interwar period, the saving–investment problem was the key to macroeconomic stability.” (Bridel, 1987, p. 1)

Some observes correctly noted that nothing had been solved and that the participants could not even rise above the level of senseless filibustering.

“Throughout the 1920s and 1930s the focus was increasingly on the role of the equality of saving and investment, but the semantic squabbles that dominated much of the debate (the distinctions between "ex ante," and "ex post," "planned" and "realized" saving and investment, the discussion of whether the equality of saving and investment was an identity or an equilibrium condition) reflected a deeper confusion. It was just not clear how shifts in saving and investment affected output.” (Blanchard, 2000, p. 1378)

Ok, this was in the old days. We have made tremendous progress recently. Nobody talks any more about the equality of saving and investment — except perhaps Paul Krugman.

“An excess of desired investment over desired savings can lead to economic expansion, which drives up income. And since some of the rise in income will be saved – and assuming that investment demand doesn’t rise by as much – a sufficiently large rise in GDP can restore equality between desired savings and desired investment at the new interest rate.” (Krugman, 2011)

This is what Adam Smith told us already. The answer to the self-debunking question “Does anyone say they are generally equal?” should be pretty obvious by now.

What I have clearly stated is that all variants of IS stories are provable false and this includes Krugman's IS-LM versions and Wren-Lewis's inventory story and Edmonds definitorial shell game (2014), (Wren-Lewis, 2012), (E.K-H, 2014).*

The irrevocable conclusion is that I-equals-S has always been and still is the epitome of utter confusion and scientific incompetence. And here we can agree: this is all pretty standard stuff in economics.

Which brings us to the crucial question.

“In economics we should strive to proceed, wherever we can, exactly according to the standards of the other, more advanced, sciences, where it is not possible, once an issue has been decided, to continue to write about it as if nothing had happened.” (Morgenstern, 1941, pp. 369-370)

With Qre=I-S the issue has been decided. How could Paul Krugman, Simon Wren-Lewis, Nick Edmonds, and not to forget Severin Reissl, be prompted to adhere to the standards of the more advanced sciences?

Egmont Kakarot-Handtke


References
Blanchard, O. (2000). What Do We Know about Macroeconomics that Fisher and Wicksell Did Not? Quarterly Journal of Economics, 115(4): 1375–1409. URL
Bridel, P. (1987). Saving equals Investment. In J. Eatwell, M. Milgate, and P. Newman (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–5. Palgrave Macmillan, 1st edition. URL
E.K-H (2014). The subtle distinction between storytelling and science. Blogpost. URL
Kakarot-Handtke, E. (2014). Mr. Keynes, Prof. Krugman, IS-LM, and the End of Economics as We Know It. SSRN Working Paper Series, 2392856: 1–19. URL
Krugman, P. (2011). IS-LMentary. New York Times, The Opinion Pages, Online, October 9. URL
Morgenstern, O. (1941). Professor Hicks on Value and Capital. Journal of Political Economy, 49(3): 361–393. URL
Wren-Lewis, S. (2012). Savings Equals Investment? Blog post. URL

* See the I=S cross-references for blog posts and the formal proof

June 20, 2015

Information and ignorance

Comment on ‘Information Matters?’

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Information is a good thing because if people have the right information they make the right decisions. This is the idea of the market system as gigantic information processor that helps to achieve the overall best outcome.

Interestingly, Adam Smith said exactly the opposite, i.e., that it is self-deception that keeps the system running.

“Smith turns from these self-deceptions to the role that the striving in pursuit of such mirages means for society. For society’s sake, he assures us, it is well that these ‘deceptions’ are widespread because ‘this deception rouses and keeps in continual motion the industry of mankind’: ...” (Kennedy, 2009, p. 247)

In any case this easily explains how bubbles are kept in motion. Note well that Smith solves also a moral dilemma because the self-deception of the myopic egoistic individuals assures that they unintentionally work for the best of all. Ignorance is exactly what puts the Invisible Hand to work.

“... the social sciences are largely concerned with the unintended consequences, or repercussions, of human actions. And ‘unintended’ in this context does not perhaps mean ‘not consciously intended’; rather it characterizes repercussions which may violate all interests of the social agent.” (Popper, 1960, p. 158)

The real problem, however, is this. Information is not enough. In order to arrive at the right decision the agents need the correct model of the market system. Now, we know for sure that neither the Walrasian nor the Keynesian theory is correct and this makes the whole concept of rational expectation/decision self-contradictory.

It far surpasses the economist's capabilities to realize that economic theory cannot be built upon behavioral assumptions and that economics is quite different from psychology, sociology, moral philosophy, anthropology, information theory, etcetera. Economists show up in every domain — except economics.

When it is the Invisible Hand that actually runs the show then it is consequential to change the very definition of the subject matter to: economics studies how the economic system works.

Egmont Kakarot-Handtke

References
Kennedy, G. (2009). Adam Smith and the Invisible Hand: From Metaphor to Myth. Econ Journal Watch, 6(2): 239–263. URL
Popper, K. R. (1960). The Poverty of Historicism. London, Henley: Routledge and Kegan Paul.

June 19, 2015

Flight of ideas and the dead end of all econtalk

Comment on ‘Anti-Keynesianism — in most cases a sign of ignorance’

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The two-hats Keynes
There are two public Keynes'es: the practical politician and the theoretical economist. The first trouble is that the two are constantly confused. Wren-Lewis's post is a case in point.* The theoretical question whether Keynes's employment theory is right/wrong is immediately confuted with the question of whether state intervention is good/bad. This guarantees that the discussion ends up in some parallel universe.

Second things first
To put political questions first is the bane of economics. It is pretty clear that, when the employment theory is false (Classicals) or incomplete (Keynes) then the whole discussion of how to fix unemployment is vacuous.

What action?
Keynes, the theoretical economist, clearly said what the appropriate action was: “Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry. Something similar is required to-day in economics. We need to throw over the second postulate of the classical doctrine and to work out the behaviour of a system in which involuntary unemployment in the strict sense is possible.” (See intro)

No pre-emptive labeling
Keynes started to “work out the behaviour of a system in which involuntary unemployment in the strict sense is possible” but it is fair to say that the General Theory is not in all respects satisfactory. To criticize it is, first of all, neither a sign of Anti-Keynesianism nor of ignorance (2015).

Scientific correctness
“Accordingly, scientists, in their critical discussions, do not attack the arguments which might be used to establish, or even to support, the theory under examination. They attack the theory itself, qua solution of the problem it tries to solve.” (Popper, 1994, p. 159)

Flight of ideas
Due to the complete lack of scientific focus the discussion about employment drowned in word play about voluntary/involuntary unemployment and unemployment equilibrium.

Post Keynesianism
The main task of Post Keynesianism is not to defend Keynes against critique or to get mired in Keynes-exegesis but to develop a theory of employment that shows clear signs of material and formal consistency.

The dead end of all econtalk
“I’m an anti-Keynesian because I want smaller government. Both of us can find evidence for our worldviews. Whose evidence is better? I’m not sure it’s a meaningful question. My empirical points about Keynesianism won’t convince Krugman. His point don’t convince me. I am not saying that we will never get any kind of decisive evidence on the question. I’m saying it sure isn’t here now.” (Roberts, 2011)

As they always say in Cafe Hayek: It's much too complex and nobody can do anything.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality., chapter Models, Instruments, and Truth, pages 154–184. London, New York, NY: Routledge.
Roberts, R. (2011). The evidence for Keynesian economics. Blog-post. URL

* See my comment on the discussion or here

June 18, 2015

From true/false to garbage-wrestling and back

Comment on ‘Speak for yourself, or why anti-Keynesian views survive’

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Science is about true/false and this is why most people do not like it. They point out that the world we live in is not black and white. So we have a zone of indeterminism (Schrödinger's cat!) where true and false coexist.

This idea reappears in economics as a positive methodological principle: “For Keynes as for Post Keynesians the guiding motto is ‘it is better to be roughly right than precisely wrong!’” (Davidson, 1984, p. 574)*

The logical snag of this popular slogan is that roughly right is equivalent to roughly wrong. Indeterminacy works both ways, but consistency has never been the strongest point of Keynesianism.

Keynes enthusiastically took indeterminacy on board and became the prophet of vagueness and uncertainty. Thus he occupied the ground between true and false where “nothing is clear and everything is possible.” (Keynes, 1973, p. 292)

The problem with indeterminism is that it degenerates to anything-goes and wish-wash faster than an egg boils. The remarkable thing is that two of the most advanced scientific propositions, Heisenberg's uncertainty principle and Gödel's incompleteness theorem, are routinely cited by people who have not realized that supply-demand-equilibrium is scientifically barely on a par with the Law of the lever.

What economics urgently needs is a return to the Principle of bi-valence, i.e. true/false, in order to minimize the zone of indeterminism. For scientists the guiding motto is “It is better to be precisely right than roughly wrong!”

When we focus on the formalized part of Keynes's theory there is no way around the fact that it is precisely wrong. Keynes stated in the General Theory: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

This elementary syllogism contains a fundamental conceptual error/mistake (2011) that invalidates all I=S-models without exception. The fundamental flaw of the General Theory is that Keynes got the pivotal distinction between income and profit wrong. Now, because I=S is wrong, the multiplier is wrong, and this affects the whole employment theory. The only question that remains is whether Keynes's common sense arguments apply independently from the defective formal foundations.

Now we can advance from the intense yet pointless pro/anti-Keynesianism wrestling of Cafe Hayek, viz. “The evidence for the Keynesian worldview is very mixed”, to the straightforward Principle of bi-valence, which states unambiguously and definitively that Paul Krugman, Russ Roberts and Simon Wren-Lewis are out of science because they refer to models that are built upon the logically defective and empirically refutable I=S-proposition.**

Pro/anti-Keynesianism survives because ‘nothing is clear and everything is possible’ is the perfect motto for a sitcom of indeterminate duration.

Egmont Kakarot-Handtke


References
Davidson, P. (1984). Reviving Keynes’s Revolution. Journal of Post Keynesian Economics, 6(4): 561–575. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. 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.

* See also Lars Syll on the RWER blog
** See Krugman  Roberts  Wren-Lewis

June 17, 2015

Keenonomics, aggregate demand/change of debt, and some misleading critique

Blog-Reference

In a recent critique of Steve Keen's approach Severin Reissl announces: “It is also shown that many weaknesses in Keen's argument stem from a lack of terminological clarity which originates in his interpretation of the works of Hyman Minsky.” (Reissl, 2015, Abstract)

This is true as I have shown with regard to Keen's definition of profit (2013) but Reissl argues from an unacceptable reference point, that is, from Stützel's version of balance mechanics. It has to be emphasized that balance mechanics is an indispensable tool of economic analysis; the crucial point is that Stützel got it not exactly right. For a start, a succinct summary of the different strands that treat the interconnection between the circular flow, the creation of credit/money, and balance mechanics is to be found in (Schmitt and Greppi, 1996).

Reissl summarizes Stützel's key methodological insight as follows.
“Partial statements are valid for groups, while global statements are valid for the aggregate economy. The application of a partial statement to the aggregate economy is very often only possible through the addition of highly restrictive assumptions; otherwise it is an outright fallacy of composition.” (2015, p. 7)

In fact, the crippling methodological defect of the microeconomic approach is that partial truths are habitually but illegitimately generalized. Most conclusions of standard supply-demand-equilibrium analysis are false when generalized. Stützel was correct and far ahead of his time on this score.

The socially most deleterious fallacy of composition is what has become known as Ricardo's principle. “... profits would be high or low in proportion as wages were low or high.” (Ricardo, 1981, p. 110) This is true for a single firm but not for the economy as a whole. Hence it is not a great exaggeration to define the microfoundation Orthodoxy as the proto-science that confuses logic and fallacy of composition.

Reissl first correctly points out that it is important to distinguish between flows like consumption expenditures and income which affect net worth, on the one hand, and receipts and payments which affect the household/business sector's stocks of money, on the other hand.

But then, directly after eq. (6), the fatal blunder occurs: “Saving here denotes the difference between all additions and all reductions in net worth during a period. Investment (that is, by definition, a change in the quantity of tangible assets) is hence only a subcategory of saving for any subset of economic actors.”

This misleads Reissl in the course of the argument finally to: “These relations imply that, in a macroeconomic sense, investment is saving, but also that saving is investment.” (2015, p. 17)

And this, of course, is analytical rubbish but one that Reissl shares with the majority of economists. Keynes stated in his General Theory: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Just like Reissl's balance mechanics, this elementary syllogism contains a fundamental conceptual error/mistake (2011) that invalidates all I=S-models without exception (see also the post E.K-H, 2015).

Where is the flaw in Reissl's critique of Keen? Reissl — just like Keen, Minsky, Keynes, Krugman, Wren-Lewis, Glasner, and the rest — got the pivotal distinction between income and profit wrong. So, welcome to the party: “... one of the most convoluted and muddled areas in economic theory: the theory of profit.” (Mirowski, 1986, p. 234)

The correct relationship between the key variables is given by Qre=I-S (2015, eq. (49)), that is, the business sector's investment expenditures are never equal to the household sector's saving and their difference is always equal to the business sector's retained profit. Balance mechanics cannot possibly yield a different result.

While Keen's approach is formally deficient, his assertion that there is a straightforward connection between aggregate demand and the change of the household sector's debt is absolutely correct for the pure consumption economy. For every economist, including Reissl, this is the firm ground in the conceptual morass. The First Law of balance mechanics says: saving:=loss and not saving:=investment.

Not to have realized this in more than 200 years is the scientific opprobrium of economics.

Egmont Kakarot-Handtke


References
E.K-H (2015). Tricky business. Blog post. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Financial Markets. SSRN Working Paper Series, 2607032: 1–33. 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.
Mirowski, P. (1986). Mathematical Formalism and Economic Explanation. In P. Mirowski (Ed.), The Reconstruction of Economic Theory, pages 179–240. Boston, MA, Dordrecht, Lancaster: Kluwer-Nijhoff.
Reissl, S. (2015). The Return of Black Box Economics - a Critique of Keen on Effective Demand and Changes in Debt. IMK Working Paper, (149): 1–24. URL
Ricardo, D. (1981). On the Principles of Political Economy and Taxation. The Works and Correspondence of David Ricardo. Cambridge, New York, NY, etc.: Cambridge University Press. URL
Schmitt, B., and Greppi, S. (1996). The National Economy Studied as a Whole: Aspects of Circular Flow Analysis in the German Language. In G. Deleplace, and E. J. Nell (Eds.), Money in Motion, pages 341–364. Houndmills, Basingstoke, London: Macmillan.

For more on I≠S see cross-references

June 16, 2015

Lost between pure fiction and parochial realism

Comment on ‘Why economic models constantly crash’

Blog-Reference

Think for a second of an apple tree. Each falling apple is a unique historical event. There are arbitrary many causes for an apple to fall: a hailstorm, playing children, an exploding meteorite, material fatigue, an earthquake, and so on. In almost all cases the singular event is uncertain and unpredictable. That is so obvious that no physicist ever lost much thought about the historicity and uncertainty of falling apples.

What scientists figured out instead was the Law of gravity. This Law does not predict when a concrete apple falls but is rather abstract and predicts the exact position and velocity of any mass m at some time t and applies also admirably to apples.

It is obvious that the scientist and the layperson have different modes of looking at reality. The layperson never gets above parochial realism, historicity, uncertainty, and storytelling about this or that apple.

Economists are different from both the scientist and the layperson. They ask the wrong questions, formulate the wrong hypotheses, and build the wrong models.

Orthodox economists simply hypothesize uncertainty away.
“The hypothesis that all markets for all future times exist today is, of course, unrealistic, but is equivalent to the assumption that all individuals correctly anticipate all future prices, the so-called rational-expectation hypothesis.” (Arrow, 1988, p. 276)

Heterodox economists are glued to the historical surface and endlessly reiterate the obvious.
“The sense in which I am using the term [uncertainty] is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention … About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” (Keynes, 1937, p. 214)

It was J. S. Mill who draw the right methodological conclusion.
“Since, therefore, it is vain to hope that truth can be arrived at, either in Political Economy or in any other department of the social science, while we look at the facts in the concrete, clothed in all the complexity with which nature has surrounded them, and endeavour to elicit a general law by a process of induction from a comparison of details; there remains no other method than the à priori one, or that of ‘abstract speculation’.” (Mill, 1874, V.55)

Curiously, it were physicists and not economists who successfully applied Mill's methodology.

There is uncertainty, but there are also economic laws. Economic laws relate to the economic system and they have the same methodological status as physical laws (see for example the Profit Law: 2015, eq. (29)). Because of the reasons given by Mill they are not immediately recognizable. Traditionally, economists have not looked for them because both orthodox and heterodox economists have a distorted view of reality. This is the ultimate reason why their models crash.

Egmont Kakarot-Handtke


References
Arrow, K. J. (1988). Workshop on the Economy as an Evolving Complex System: Summary. In P. W. Anderson, K. J. Arrow, and D. Pines (Eds.), The Economy as an Evolving Complex System, pages 275–281. Redwood City, CA, Menlo Park, CA, etc.: Addison-Wesley.
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Profit. SSRN Working Paper Series, 2575110: 1–18. URL
Keynes, J. M. (1937). The General Theory of Employment. Quarterly Journal of Economics, 51(2): 209–223. URL
Mill, J. S. (1874). Essays on Some Unsettled Questions of Political Economy. On the Definition of Political Economy; and on the Method of Investigation Proper To It. Library of Economics and Liberty. URL

Heterodoxy at the crossroads

Comment on Rhonda Kovac on ‘The Context-Dependency of Human (Economic) Behaviour’

Blog-Reference

Science can be seen as either a means to an end or an end in itself. It is pretty obvious that the Classics had a political agenda and used economic theory for pushing it. Marx's main theme was the power struggle in all its historical forms and theoretical economics was only insofar of importance as it gave scientific support to what in the strict sense has been sociology/political science/history.

What the Classics and Marx had in common was the claim that they were doing science. This claim has been rebutted with rather convincing arguments. The same holds true for Walrasian and Keynesian economics.

So it is a bit misleading to speak of economics without qualification. There is political economics and theoretical economics. Political economics pushes an agenda, theoretical economics figures out how the actual economy works. Theoretical economics is judged according to the well-defined scientific code true/false and nothing else.

In the history of economic thought political economics has been dominant and more or less successful in hijacking theoretical economics. As a result we have a lot of small-scale practical know-how and many dubious generalizations but no scientific knowledge about how the actual economic system works. It is plain to economists and non-economists alike that General Equilibrium Theory does not explain the real-world economy in the sense that physics explains the universe. The same holds for Marx's surplus/profit theory and other approaches. True knowledge is lacking in economics. By consequence, expert advice of economists has no scientific foundation.

You say — let's call it the Kovac Doctrine — “... the purpose of economics is human well-being, which is psychological in nature.” I think there is no doubt that you treat economics as a means to an end. So you are a political economist in the tradition of Smith or Marx.

I have no qualms with this. My point is: political and theoretical economics are similar on the surface but ultimately incompatible pursuits. Both are legitimate but they follow different procedures and goals. It is important, therefore, to keep them properly apart.

At the moment Heterodoxy is in a mixed state: Orthodoxy is attacked for methodological or political reasons or both. This confusion cannot last. There must be a clear decision between political or theoretical economics.

If Heterodoxy decides for theoretical economics it commits itself to the standards of material and formal consistency and to the goal of a paradigm shift. Theoretical economics does not commit itself to any political goal.

Since science is essentially a journey into the unknown it is unknown at the outset whether a paradigm shift promotes human well-being. It is also entirely unknown at the outset how new scientific knowledge is put into practice. For this reason theoretical economics refrains from any better-world or save-humanity promises.

In sum I think that the Kovac Doctrine and all its implications is acceptable for Heterodoxy as a political movement but not for Heterodoxy as a scientific endeavor.

Egmont Kakarot-Handtke

June 15, 2015

McCloskey and the lizard's tail

Comment on ‘Silly economics’

Blog-Reference

Deirdre McCloskey is critical of the profession “... economics and its imitators in other social sciences exhibits a good deal of foolishness, strutting about claiming dignity ...” (See intro)

In earnest, that is the world's problem with economics? False dignity of economists? Oh, that's easy. Let's poke fun at them.

The audience likes this ‘human, all too human’ critique and, after all, every spin doctor will tell you that you must always show a small weakness in order to distract from the real issue. What is the real issue? Re-read the first part of the sentence (see intro). McCloskey praises economics “For all its sober achievements ...” A fine piece of rhetoric, indeed, when the indisputable fact is taken into account that, on closer inspection, there are no sober achievements.

The problem of economics is not that it is silly but that it is downright unacceptable as science. To belittle General Equilibrium or DSGE or the New Classicals or the New Keynesians as silly is beside the point. In these cases, absurdity has only grown out of proportion so that every idiot can see it.

The point where economics becomes an intelligence test is not rational expectation but much, much earlier. The student who accepts supply-demand-equilibrium is already lost for science.

“At every stage in the development of an economist, beginning with the first introductory course, the neoclassical theory serves as a screening device to filter out the disbelieving. Usually just an exposure to the subject is sufficient to divert into other fields those hoping to understand economic and other social processes. The unrealistic nature of the assumptions, proudly proclaimed, are a clear warning that those seeking knowledge should steer clear of the field.” (Eichner, 1983, p. 518), see also (2011)

What the intelligent student realizes in Econ 101 is that supply function, demand function, equilibrium and the underlying utility maximization are all nonentities. The average student swallows the lesson and flunks out of science already at this early stage.

McCloskey has never realized that silliness in economics starts with supply-demand-equilibrium but has herself produced 'A Study Guide for the Applied Theory of Price.' What do you see on the book's cover? Yes, the economist's most sober achievement thus far, the disqualifying, scientifically forever unacceptable epitome of silliness, the supply-demand-equilibrium cross.

McCloskey's rhetorical swap of a little dignity for the entire loss of scientific credibility is for all intents and purposes a good deal.

Egmont Kakarot-Handtke


References
Eichner, A. S. (1983). Why Economics Is Not Yet a Science. Journal of Economic Issues, 17(2): 507–520. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL

Warning: Einstein can be hazardous to heterodox methodology

Comment on Lars Syll on ‘Econometrics — rhetorics and reality’

Blog-Reference

In order to rehabilitate ‘conventionally verbal based economic discourses as the principal medium of rhetoric’ Duo Qin refers to a well-known Einstein quote which reads in full length:
“In my opinion the answer to this question is, briefly, this: As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.” (Einstein, 1921)

From the quote's final part Qin concludes that the laws of mathematics are ‘certain’ when ‘they do not refer to reality.’ Reality, everybody knows, is uncertain, hence mathematics, as a matter of principle, misses reality. And therefore formalization is not only useless in economics but definitively misleading.

Thus, it seems to be just the other way round: because reality is uncertain it is vagueness that captures reality. This has been the methodological gospel of the Cambridge School of Loose Verbal Reasoning since Marshall.

“From his discussions with Wittgenstein, Keynes was well aware of the significance of vague concepts and the possible trade-off between precision and accuracy: This led him to conclude that formalization runs the risk of leaving behind the subject matter we are interested in.” (Coates, 2007, p. 256)

Keynes dismissed formal precision and became the prophet of vagueness.
“Theories constructed with vague concepts paradoxically can maximize precision and economy.” (Coates, 2007, p. 8)

It seems that Einstein supports what became Post-Keynesian and heterodox methodology. But let us read the full quote again. What exactly was the question Einstein was answering?

“At this point an enigma presents itself which in all ages has agitated inquiring minds. How can it be that mathematics, being after all a product of human thought which is independent of experience, is so admirably appropriate to the objects of reality?” (Einstein, 1921), see also (Wigner, 1979), (Velupillai, 2005)

That is a bit surprising, now mathematics captures reality admirably. Einstein does not support Qin's interpretation? Not at all. Here, Einstein clarifies the puzzling relationship between the axiomatic-deductive method and reality:
“It is clear that the system of concepts of axiomatic geometry alone cannot make any assertions as to the relations of real objects of this kind, which we will call practically-rigid bodies. To be able to make such assertions, geometry must be stripped of its merely logical-formal character by the co-ordination of real objects of experience with the empty conceptual frame-work of axiomatic geometry. To accomplish this, we need only add the proposition:—Solid bodies are related, with respect to their possible dispositions, as are bodies in Euclidean geometry of three dimensions. Then the propositions of Euclid contain affirmations as to the relations of practically-rigid bodies.” (Einstein, 1921)

In other words:
“Formal axiomatic systems must be interpreted in some domain ... to become an empirical science.” (Boylan and O'Gorman, 1995, p. 198)

What is the domain of economics? The accustomed definition is:
“Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” (Robbins, 1935, p. 16)

The key words are human behavior. But wait, the study of human behavior is the domain of psychology/sociology/anthropology etcetera. The domain of economics is fundamentally different from the so-called social sciences. Therefore Robbins's definition must change to: Economics is the science which studies how the actual economic system works.

The economic system is something objective that follows its own structural laws. In the system's behavior there is no vagueness and uncertainty. It is humans that are the randomizers (2015).

The inexcusable methodological dilettantism of Orthodoxy does not consist in the application of the axiomatic-deductive method but in the application of behavioral axioms. Who, except generations of economists, would ever accept utility maximization as an axiom? To paraphrase Einstein: An enigma presents itself which in all ages has agitated inquiring minds.

Egmont Kakarot-Handtke


References
Boylan, T. A., and O’Gorman, P. F. (1995). Beyond Rhetoric and Realism in Economics. Towards a Reformulation of Economic Methodology. London: Routledge.
Coates, J. (2007). The Claims of Common Sense. Moore, Wittgenstein, Keynes and the Social Sciences. Cambridge, New York, NY, etc.: Cambridge University Press.
Einstein, A. (1921). Geometry and Experience. Website. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Behavior. SSRN Working Paper Series, 2600523: 1–17. URL
Robbins, L. (1935). An Essay on the Nature and Significance of Economic Science. London, Bombay, etc.: Macmillan, 2nd edition.
Velupillai, K. (2005). The Unreasonable Ineffectiveness of Mathematics in Economics. Cambridge Journal of Economics, 29: 849–872.
Wigner, E. P. (1979). Symmetries and Reflections, chapter The Unreasonable Effectiveness of Mathematics in the Natural Sciences, pages 222–237. Woodbridge, CT: Ox Bow Press.

Cross-references: Axiomatization and Mathiness and Burn the mathematic and Don't blame the method

June 14, 2015

The art of start

Comment on Bruce Edmonds on ‘The Context-Dependency of Human (Economic) Behaviour’

Blog-Reference

“I think it is the lack of quite sharply defined concepts that the main difficulty lies, and not in any intrinsic difference between the fields of economics and other sciences.” (von Neumann, quoted in Mirowski, 2002, p. 146 fn. 49), see also (2013)

Therefore, it is of utmost importance to consequently stick to sharp definitions and to stay clear of ambiguity and vagueness.

ad (i) First you quote me correctly asserting ‘the task of theoretical economics is to explain how the monetary economy works’ and then you ask ‘does this exclude barter systems.’ The answer is evidently yes. Then you go on asking ‘does it exclude the sharing of value within families and communities?' Again, the answer is evidently yes. The focus is on the economy we happen to live in and not on issues that belong to the domains of psychology and sociology. Apart from this, to exclude some real-world phenomena at the start means only that they are to be included at a later stage. So nothing of importance is lost.

The economist's task is to incorporate valid results of PsySoc into his models but not to make ‘a fool of himself’ (Viner, 1963, p. 12) with utility maximization, rationality, bounded rationality, rational expectations, situational analysis and all the rest. Economists have no correct theory of human behavior, neither do they have a correct theory of how the monetary economy works, and it is for the latter defect that economics is a failed science. As long as Heterodoxy is preoccupied with PsySoc it will share the cheerless fate of Orthodoxy.

ad (ii) You say: “There is a way from the the understanding of individual human behavior to the understanding of the behavior of the economic system – it is called agent-based simulation.”

Generally speaking, a simulation is the proper tool of economic analysis and this has already been said in my paper on behavior (2015). However, a simulation presupposes the definition of the structural properties of the monetary economy. Hence, not any simulation will do. Here is the correct version.*

“A simulation as defined by the four structural axioms and the probability distributions is a well-defined mathematical object just like a system of equations. While they are formally on the same footing, both mathematical objects yield different kinds of outputs: the system of equations yields a solution vector, a simulation yields a bundle of paths. This bundle has a counterpart in reality.” (2015, p. 5).

In sum: every economic analysis must start with the definition of the objective structure of the monetary economy because it is this structure, a.k.a. reality, that determines the outcome of individual and collective human action. The monetary economy is the meta-context of every partial analysis. To start with a specific behavioral assumption means to get off at the wrong foot and to end up eventually in the scientific wood. Orthodox economics is a cautionary tale. Heterodoxy is expected to do much better.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Behavior. SSRN Working Paper Series, 2600523: 1–17. URL
Mirowski, P. (2002). Machine Dreams. Cambridge: Cambridge University Press.
Viner, J. (1963). The Economist in History. American Economic Review, 53(2): pp. 1–22. URL

* For the full picture see also the cross-references

June 13, 2015

A farewell to PsySoc economics

Comment on Rhonda Kovac on ‘The Context-Dependency of Human (Economic) Behaviour’

Blog-Reference

You say: “The claim that psychology/sociology/etc. is irrelevant in economics is an assertion that economic processes are basically self-contained, the internal variable set sufficient to account for the behavior of any of the variables within it.”

This conclusion has obviously not much to do with the argument of my post. Alone from the fact that my proposal for a new heterodox curriculum* includes a paper with the title ‘Essentials of Constructive Heterodoxy: Behavior’ (2015) you can safely conclude that my argument does not amount to the claim that psychology/sociology/etc. is irrelevant. So let us first put aside this windmill.

My core assertions are (i) the task of theoretical economics is to explain how the monetary economy works, and (ii), no way leads from the understanding of individual human behavior to the understanding of the behavior of the economic system.

From this follows that Orthodoxy is a failed approach because it has been built upon a set of behavioral premises. It follows in addition that Heterodoxy is bound to fail if it merely replaces constrained optimization, rational expectations and other green-cheese premises with some behavioral assumptions that are more realistic. With this one remains trapped within the confines of psycho-sociology. What is needed is a radical methodological turnaround.

First of all, it is advisable that economics gets as far away as possible from the so-called social sciences which Feynman has debunked as cargo-cult sciences (see Wikipedia). Their track record has been abysmal and will remain so.
“... there has been no progress in developing laws of human behavior for the last twenty-five hundred years.” (Hausman, 1992, p. 320), (Rosenberg, 1980, p. 2)
The social sciences cannot, as a matter of principle, rise above the level of storytelling.

From all this follows: As a first approximation, one can agree on the general characteristic that the monetary economy is a complex system. However, with the term system one usually associates a structure with components that are non-human. In order to stress the obvious fact that humans are an essential component of the economic system the market economy should be characterized more precisely as a complex hybrid system/human entity or sys-hum.

While it is clear that the economy always has to be treated as an indivisible whole, for compelling methodological reasons the analysis has to start with the objective system-component.

Common sense wrongly insists that the hum-component must always be in the foreground. This fallacy compares to Geo-centrism. The economic system has its own logic which is different from the behavioral logic of humans. The systemic logic is what Adam Smith has called the Invisible Hand.

What the agents subjectively think or expect about the relationship of economic variables is immaterial for the understanding of the whole. The agents are caught in parochial realism and have no idea about how the whole fits together. What really counts are the objective structural properties of the economic system. When human behavior and system behavior are not aligned crises result.

Because of this, it is of utmost importance to know how the monetary economy works. Let us face the facts: neither Orthodoxy nor Heterodoxy has a clue. This is the result of more than two hundred years of PsySoc.

Nothing short of a paradigm shift will bring economics out of the dead end. To debunk Orthodoxy is one thing, to successfully replace it with the correct economic theory is quite another thing.

Egmont Kakarot-Handtke


References
Hausman, D. M. (1992). The Inexact and Separate Science of Economics. Cambridge: Cambridge University Press.
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Behavior. SSRN Working Paper Series, 2600523: 1–17. URL
Rosenberg, A. (1980). Sociobiology and the Preemption of Social Science. Oxford: Blackwell.

* See cross-references New curriculum

June 12, 2015

Wake up: economics is not a science of behavior

Comment on Bruce Edmonds on ‘The Context-Dependency of Human (Economic) Behaviour’

Blog-Reference

You say: “Let me start this post by making clear what everybody knows: people behave differently in different kinds of situation, but we can effectively recognise these kinds of situation and use them to understand, and even predict, how to behave and what people will do in these situations.” (See intro)

Yes, everybody knows this already from Popper.

“Thus the situational analysis will comprise some physical things and some of their properties and states, some social institutions and some of their properties, some aims, and some elements of knowledge.” (Popper, 1994, p. 168)

Because you invented a new name for an old chestnut you erroneously think that context-dependency has been overlooked thus far. Just the contrary is true.

“... it is the central point of situational analysis that we need, in order to ‘animate’ it, no more than the assumption that the various persons or agents involved act adequately, or appropriately -- that is to say, in accordance with the situation. ... Thus there is only one animating law involved ... It is known in the literature under the name of ‘rationality principle’, ... ” (Popper, 1994, p. 169)

From your examples it is clear that you have not yet realized that economics is not a science of behavior (Hudík, 2011). What you are talking about belongs entirely to the realm of sociology, psychology, anthropology, history, etcetera. Hence, what you and most economists are practicing is a dilettantish variant of Psycho-Sociology.

In marked contrast, theoretical economics deals exclusively with the systemic behavior of the actual monetary economy. Theoretical economics is objective. There are systemic laws but no behavioral laws. Systemic laws, for instance the Profit Law (2015)*, have the same methodological status as physical laws. The Profit Law holds always and everywhere. The economist's task is to find these systemic laws and this implies to leave all speculations about human behavior to the yellow press.

Does the world expect from economists to find out how people behave? No, this is the proper job of psychology, sociology, anthropology etcetera. Does the world expect from economists to figure out what profit is? Yes, of course, no philosopher, physicist, biologist, or sociologist will ever try to figure this out.

Have economists done their proper job? No. Do you know what profit is? No. Does context-dependency help to find out what profit is? No.

Let me sum up this post by making clear what everybody knows: Is someone who does not understand what profit is a good economist?

Egmont Kakarot-Handtke


References
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Profit. SSRN Working Paper Series, 2575110: 1–18. URL
Popper, K. R. (1994). The Myth of the Framework. In Defence of Science and Rationality., chapter Models, Instruments, and Truth, pages 154–184. London, New York, NY: Routledge.

* See here

June 11, 2015

Sloppiness as economic methodology

Comment on ‘Ditch ‘ceteris paribus’!’

Blog-Reference

Bruce Edmonds asserts “Natural language accounts get around this [drawback of formal models] by utilizing the shared knowledge of the appropriate context ....”

This brings us almost verbatim back to Keynes who was a tireless proponent of the Cambridge School of Loose Verbal Reasoning.
“Another danger is that you may ‘precise everything away’ and be left with only a comparative poverty of meaning. ... Such a problem was avoided, said Keynes, by Marshall who used loose definitions but allowed the reader to infer his meaning from ‘the richness of context’.” (Coates, 2007, p. 87)

In other words, the reader is encouraged to substitute almost any meaning he likes. The result is well-known. Keynes loose verbal reasoning triggered an enthusiastic exegesis movement that circled for some decennia around the question ‘What Keynes really meant?’ Predictably, the question has never been answered. Richness of meaning only generated a wealth of blah.

But Keynes made also one very precise statement in his General Theory, viz.
“Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (Keynes, 1973, p. 63)

Unfortunately, this simple syllogism contains a fundamental conceptual error (2011) which makes nonsense of all I=S-models beginning with Hicks's IS-LM and straightforwardly continuing to Krugman's and Wren-Lewis's confused blogs. After more than 75 years Keynes's definitional sloppiness is still with us.

Since Adam Smith, economics has never been in any danger to ‘precise everything away.’ To the contrary, sloppiness enabled a senseless productivity. Neither Walrasian pseudo-rigor nor Keynesian looseness has produced anything that satisfies the scientific standards of material and formal consistency.

The call for more natural-language economics can only prolong the agony.

Egmont Kakarot-Handtke


References
Coates, J. (2007). The Claims of Common Sense. Moore, Wittgenstein, Keynes and the Social Sciences. Cambridge, New York, NY, etc.: Cambridge University Press.
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. 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.

June 10, 2015

Around the world: storytelling vs. science

Comment on ‘What is it about German economics?’

Blog-Reference

It is important to distinguish first between political and theoretical economics. The goal of political economics is to push an agenda, the goal of theoretical economics is to explain how the monetary economy works. Theoretical economics has to be judged according to the scientific criteria true/false and nothing else.

When economics is understood as a science there is, first of all, no such thing as a German or UK economics. When economics is understood as a sub-discipline of politics then of course there are at least as many “economics'es” as there are nation states.

The scientific value of this political variants is zero. As a matter of principle, there is no such thing as a national mathematics or physics or, for that matter, economics. True scientists transcend the trivial fact that they are born into some specific regional entity.

Political economics consists mainly in the reshuffling of psycho-sociological stereotypes. The standard explanation of folk psychology is the childhood trauma, in the collective variant it then reappears as depression- or inflation- or debt-trauma. All this is ridiculous as an economic explanation, but most people are happy with it.

Yet, even if political economics aims at a scientific explanation it could at best explain the functioning of society but not the working of the economic system. In the strict sense, therefore, political economics has not much to do with economics proper.

Broadly speaking: whether German economists are more Keynesian or more Walrasian, or whether ordo-liberalism is for all practical purposes better than neo-liberalism, or whether they are for or against a minimum wage is a matter of indifference because they, too, do not realize that they have no proper scientific understanding of how the monetary economy works. German economists are in the political storytelling business like their colleagues elsewhere.

Egmont Kakarot-Handtke

June 9, 2015

Ditch it all

Comment on ‘Ditch ‘ceteris paribus’!’

Blog-Reference

Environmental pollution is, no doubt, one of our most serious problems. Second, perhaps, only to intellectual pollution. It can be said without much exaggeration that the collective human brain is a voluminous stockpile of slogans, memes, beliefs, legends, barren paradigms, and defunct theories. Orthodox economics has contributed much to this pile. Think of general equilibrium, constrained optimization, rational expectation, supply-demand-equilibrium.

It has to be admitted, though, that Heterodoxy too has contributed a fair amount of confused stuff. Dave Taylor's monetary communication PIDs are a case in point (see his previous posts on this blog).

This big heap of analytical rubble has to be shoved aside. What is most urgently needed is a new beginning on cleared ground. This reset requires a small number of absolutely transparent foundational propositions that are entirely free from hidden assumptions and, above all, from psychologism/sociologism. From historical experience we have learned that this dabbling in PsySoc is the bane of economics.

All this applies also to the theory of money. There is a subjective and an objective theory of money. The former is not much different from gossip, only the latter is of real interest. The fault of traditional Heterodoxy is that it could not get out of the PsySoc impasse. In marked contrast, Constructive Heterodoxy gives an objective and consistent account of how money and the diversity of financial markets emerge from the elementary monetary circuit (2015).

Orthodoxy and traditional Heterodoxy have been ditched. Constructive Heterodoxy is the only game in town.

Egmont Kakarot-Handtke

References
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Financial Markets. SSRN Working Paper Series, 2607032: 1–33. URL

Cross-references here and here

June 7, 2015

The guessing game

Comment on ‘Repeat after Me: Inflation’s the Cure not the Disease’

Blog-Reference

Always when economists have been reminded that the actual economy does not work as economic theory says the Pavlovian answer since the classics has been: yes, it perhaps looks like a clear-cut refutation, but, just wait, in the long run we will be vindicated. It is important to note that this is, to begin with, not a testable proposition because the long run is never properly specified.

This old short-run-long-run shell game has shifted entirely to the thin-air-discussion of the interdependency of expectations between agents and the central bank. What is the outcome of the guessing game? Remember the Morgenstern-Paradox and the train chase between Victoria Station and Dover where Holmes and Moriarty try to outguess each other?

What always makes a good story makes bad science.

“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, p. 30)

Economists have no true theory, in other words, they are clueless about how the actual economic system works (2014). It is therefore quite natural that they resort to a discussion about what could possibly happen in the never-ever-nowhere-land of the long run.

It should be common knowledge by now that all variants of Keynes-Wicksell-Hicks-Krugman models which underlay the discussion are methodologically defective.*

Which brings us to the point at issue: could inflation be the cure against economic stagnation?

To make the argument short, the true employment theory (2015), which is absolutely free of behavioral guesses, is summarized in this simplified formula.

The formula contains Keynes's employment theory as special case, that is, if investment expenditures (I) or the expenditure ratio (rhoE) increases employment (L) increases. The generalization vis-à-vis Keynes consists in the factor cost ratio (rhoF). This configuration of wage rate, price, and productivity encapsulates the working of the price mechanism.

The implicit promise of conventional economics is that the price mechanism works smoothly such that the configuration of wage rate/price/productivity ultimately produces full employment — in the long run. This is wishful thinking.

The correct employment formula says:
• An increase of the wage rate W taken in isolation, i.e. rhoF up, leads to higher employment. This is contrary to received economic wisdom (which rests on the fallacy of composition).
• A price increase taken in isolation, i.e. rhoF down, is conductive to lower employment.

Price inflation and wage inflation have opposite effects on employment. The net effect depends on the relative rates of change in the simple formula. The absolute rates are of no consequence if they are equal (with productivity constant, of course). Hyperinflation at full employment is therefore possible as a limiting case.

The formula is perfectly compatible with the observation of rising prices and increasing employment.

In sum: The net employment effect of inflation is positive if the rate of change of the wage rate W exceeds that of the price P; in the opposite case one gets stagnation, rising unemployment, or stagflation. Note that the simple employment formula is testable in principle.

What the agents subjectively think or expect about the relationship of quantity of money, inflation, and employment is immaterial. The simple employment formula represents the objective structural properties of the economic system. When subjectivity and objectivity are at odds it is always subjectivity that has to give way.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment. SSRN Working Paper Series, 2489792: 1–13. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.

* See also on this blog

June 6, 2015

Tricky business

Comment on David Glasner on ‘JKH on the Keynesian Cross and Accounting Identities’

Blog-Reference

“What a tricky business this all is! In his Treatise on Money, Mr. Keynes told the world that savings and investment are only equal in conditions of equilibrium; that an excess of investment over saving means rising prices, and vice versa. In his General Theory, he told us that saving and investment are always equal, and that this is a mere identity or truism, without significance for the determination of prices. As far as I can make out, there are relevant and important senses in which all these statements are each of them right and each of them wrong.” (Hicks, 1939, p. 184)

Many senses make no sense at all, but inconclusiveness is the inevitable outcome of every economic discussion. This is no coincidence. Economists do not solve problems, they are the problem. Inconclusiveness and vagueness is the survival strategy of the scientifically incompetent.

“Another thing I must point out is that you cannot prove a vague theory wrong.” (Feynman, 1992, p. 158)

This conveniently prolongs the shelf-life of crappy theories. The I=S debate is a case in point.

Keynes messed up the basics of macro with this faulty syllogism: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

Since theories have an architectonic structure it is clear that if there is a fault in the formal foundations the whole superstructure is faulty. Actually, the defect in Keynes's two-liner is in the premise income = value of output. This equality holds — see the formal proof in (2011) — only in the case of zero profit in both the consumption and investment good industry. Is it necessary to add that zero profit models never had and never will have a counterpart in the real world?

Keynes's 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 and Bezemer, 2010, p. 12)

This failure kicked off the chain reaction of errors/mistakes because when profit is not correctly defined, income is not correctly defined, and then saving is not correctly defined. By consequence, all I=S models, including IS-LM, are methodologically defective. The mistake has also been carried over to accounting (2012). Since the days when Keynes wrote down his faulty syllogism the representative economist did not realize the elementary logical blunder.

“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)

To sum up: All I=S models are false and absolutely unacceptable. This is not a matter of taste or choice or wish-wash but of conceptual logic. The correct relationship reads Qre=I-S, that is, the business sector's investment expenditures are never equal to the household sector's saving and their difference is always equal to the business sector's retained profit. This has already been figured out by a very smart Frenchman, Nobel Laureate Maurice Allais.

“Autrement dit l’investissement n’est pas égal à l’épargne spontanée, mais à l’épargne spontanée augmenté du revenue non distribué des entreprises ....” (Allais, 1993, p. 69), see also (2011, fn. 4)

Let there be no inconclusiveness and vagueness: the somewhat moronic I=S debate ended in 1993 at the latest. More than 75 years after the General Theory it is high time for a general intellectual upswing. After endless drivel perhaps JKH could give an example.

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Georgescu-Roegen, N. (1970). The Economics of Production. American Economic Review, Papers and Proceedings, 60(2): 1–9. URL
Hicks, J. R. (1939). Value and Capital. Oxford: Clarendon Press, 2nd edition.
Kakarot-Handtke, E. (2011a). Keynes’s Missing Axioms. SSRN Working Paper Series, 1841408: 1–33. URL
Kakarot-Handtke, E. (2011b). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL
Kakarot-Handtke, E. (2012). The Common Error of Common Sense: An Essential Rectification of the Accounting Approach. SSRN Working Paper Series, 2124415: 1–23. 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

Poisoned, hanged, and shot

Comment on ‘Austerity policies — prescribing rat poison for ailing economies’

Blog-Reference  see also Blog-Reference

Amartya Sen asks: “How was it possible, it has to be asked, for the basic Keynesian insights and analyses to be so badly lost in the making of European economic policies that imposed austerity?” (See intro)

The basic Keynesian insight is, of course, for all immediate practical purposes correct. Nevertheless, Keynes's employment theory is indeed not general and misses a crucial point (2015; 2012).

The most elementary version of the correct employment equation reads: here

From this follows:
• An increase of the expenditure ratio rhoE leads to higher employment. An expenditure ratio rhoE>1 indicates credit expansion, a ratio rhoE<1 indicates credit contraction or debt repayment.
• Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.
• An increase of the factor cost ratio rhoF leads to higher employment. This implies that a higher wage rate W leads to higher employment. This is, of course, contrary to conventional economic wisdom.

Conventional economic wisdom is, we know this from Keynes, wrong. Here is not the place for a formal proof but the actual graphics from Nick Bunker's post ‘Waiting for healthy U.S. wage growth’ gives intuitive empirical support: here

The correct employment theory tells us that Greece has not only been poisoned, but in addition hanged and shot.

In the old days economics has been called the dismal sience. It has now become the lethal science.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2012). Keynes’s Employment Function and the Gratuitous Phillips Curve Desaster. SSRN Working Paper Series, 2130421: 1–19. URL
Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Employment. SSRN Working Paper Series, 2576867: 1–11. URL

The answer is: No

Comment on ‘Ditch ‘ceteris paribus’!’

Blog-Reference

You say: “Rigorous deductions from precise axioms is mathematics, not economics, not science.”

“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.” (Einstein, 1934, p. 167)

It is pretty obvious that you do not understand the relationship between science and mathematics and in particular of economics, science, and mathematics.*

The answer to your question ‘Do we have to keep saying it over and over?’ is therefore No.

Egmont Kakarot-Handtke


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

* The study of the new heterodox curriculum is strongly recommended

June 5, 2015

Methiness

Comment on ‘Ditch ‘ceteris paribus’!’

Blog-Reference

Lars Syll writes: “When applying deductivist thinking to economics, neoclassical economists usually set up “as if” models based on a set of tight axiomatic assumptions from which consistent and precise inferences are made. The beauty of this procedure is of course that if the axiomatic premises are true, the conclusions necessarily follow.” (See intro)

Exactly so.  Now, it is not breaking news that the neoclassical premises are green-cheese assumptions. The neo-Walrasian approach takes, among other nonentities, constrained optimization and equilibrium into the premises (Weintraub, 1985, p. 147). Only for the representative economist it comes as a surprise that the logical conclusions from these premises have never found a correspondence in reality. Yet, as we all know since J. S. Mill, this, and nothing else, is the point of the whole exercise.

“The ground of confidence in any concrete deductive science is not the à priori reasoning itself, but the accordance between its results and those of observation à posteriori.” (Mill, 2006, p. 896)

Reality is the final arbiter of the deductive method. Absolutely nothing has changed between the classical economist Mill and the modern physicist Feynman.

“It does not matter that moos and goos cannot appear in the guess. You can have as much junk in the guess as you like, provided that the consequences can be compared with experiment.” (Feynman, 1992, p. 164)

What the representative economist never understood is that his green-cheese assumptions have no testable consequences and therefore are inadmissible in the first place.

Alternatively, if it turns out that there is no accordance between ‘results and observation’ modus tollens applies, that is, one can be sure that at least one of the premises is false. This is the built-in error-correction mechanism that guarantees progress. The wrong premise has to be found and eliminated.

Having dealt long enough with the neoclassical approach it is obvious that all premises are false. Therefore, there remains but one consequence: all neoclassical premises have to be replaced. Debunking Orthodoxy is the easy part, to spell out the heterodox axiom set is the real task.

Let us face the facts: since Veblen's fundamental critique of Orthodoxy Heterodoxy has failed at this task. What is worse, many heterodox economists simply have no clue how to use the axiomatic-deductive method to their advantage.*

The methiness of economics consists of two interlocked mistakes: (i) to spoil the deductive method with green-cheese assumptionism (=Orthodoxy) and (ii), not to apply it at all (=Heterodoxy).

Egmont Kakarot-Handtke


References
Feynman, R. P. (1992). The Character of Physical Law. London: Penguin.
Mill, J. S. (2006). A System of Logic Ratiocinative and Inductive. Being a Connected View of the Principles of Evidence and the Methods of Scientific Investigation, volume 8 of Collected Works of John Stuart Mill. Indianapolis, IN: Liberty Fund.
Weintraub, E. R. (1985). Joan Robinson’s Critique of Equilibrium: An Appraisal. American Economic Review, Papers and Proceedings, 75(2): 146–149. URL

* See the references to the discussions on this blog

June 4, 2015

Objective Principles

Comment on ‘Modelling consistency and real world non-coherence in mainstream economics’

Blog-Reference

You write: “This conclusion is based on two common erroneous statements. First, Walras’s general equilibrium theory is identified with Pareto’s general equilibrium theory; ...”

Pareto has not been mentioned at all in this thread until your recent post. Hence no conclusion has been based on Pareto.

Anyway. Let us take the opportunity and do away with Pareto. He obviously was a Subjectivist.
“The foundation of political economy and, in general, of every social science, is evidently psychology. A day will come when we shall be able to deduce the laws of social science from the principles of psychology ...” (Pareto, 2014, p. 20)

Subjectivists cling to the naive idea that the understanding of human behavior somehow leads to the understanding of how the economic system works. Since Pareto, Walras, Jevons, Marshall, Menger et al. we have sufficient experience with this approach. And it is pretty obvious that it has failed completely.

Psychologism/sociologism inverts the Midas touch of science — to turn whatever it might touch into knowledge — into a curse: it turns everything it touches into balderdash.

So let us paraphrase Pareto.
“The foundation of theoretical economics is evidently different from every social science. A day will come when we shall be able to deduce the laws of economics from the Principles of Objectivity, that is, from a handful of elementary structural axioms.”*

Egmont Kakarot-Handtke

References
Pareto, V. (2014). Manual of Policical Economy. Oxford: Oxford University Press. URL

* For a start see the new heterodox curriculum