Home > corruption, Keynes, New vs. Old Paradigm, The Economics Profession > Economics textbooks – how to get away with scientific fraud

Economics textbooks – how to get away with scientific fraud

from Lars Syll

fraud-kit

As is well-known, Keynes used to criticize the more traditional economics for making the fallacy of composition, which basically consists of the false belief that the whole is nothing but the sum of its parts. Keynes argued that in the society and in the economy this was not the case, and that a fortiori an adequate analysis of society and economy couldn’t proceed by just adding up the acts and decisions of individuals. The whole is more than a sum of parts. This fact shows up already when orthodox – neoclassical – economics tries to argue for the existence of The Law of Demand – when the price of a commodity falls, the demand for it will increase – on the aggregate. Although it may be said that one succeeds in establishing The Law for single individuals it soon turned out – in the Sonnenschein-Mantel-Debreu theorem firmly established already in 1976 – that it wasn’t possible to extend The Law of Demand to apply on the market level, unless one made ridiculously unrealistic assumptions such as individuals all having homothetic preferences – which actually implies that all individuals have identical preferences.

This could only be conceivable if there was in essence only one actor – the (in)famous representative actor. So, yes, it was possible to generalize The Law of Demand – as long as we assumed that on the aggregate level there was only one commodity and one actor. What generalization! Does this sound reasonable? Of course not. This is pure nonsense!

How has neoclassical economics reacted to this devastating findig? Basically by looking the other way, ignoring it and hoping that no one sees that the emperor is naked.

Having gone through a handful of the most frequently used textbooks of economics at the undergraduate level today, I can only conclude that the models that are presented in these modern neoclassical textbooks try to describe and analyze complex and heterogeneous real economies with a single rational-expectations-robot-imitation-representative-agent.

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That is, with something that has absolutely nothing to do with reality. And — worse still — something that is not even amenable to the kind of general equilibrium analysis that they are thought to give a foundation for, since Hugo Sonnenschein (1972) , Rolf Mantel (1976) and Gerard Debreu (1974) unequivocally showed that there did not exist any condition by which assumptions on individuals would guarantee neither stability nor uniqueness of the equlibrium solution.

So what modern economics textbooks present to students are really models built on the assumption that an entire economy can be modeled as a representative actor and that this is a valid procedure. But it isn’t — as the Sonnenschein-Mantel-Debreu theorem irrevocably has shown.

Of course one could say that it is too difficult on undergraduate levels to show why the procedure is right and to defer it to masters and doctoral courses. It could justifiably be reasoned that way – if what you teach your students is true, if The Law of Demand is generalizable to the market level and the representative actor is a valid modeling abstraction! But in this case it’s demonstrably known to be false, and therefore this is nothing but a case of scandalous intellectual dishonesty. It’s like telling your students that 2 + 2 = 5 and hope that they will never run into Peano’s axioms of arithmetics.

Or — just to take another example — let’s see how the important macroeconomic question of wage rigidity is treated.

Among a couple of really good intermediate – neoclassical – macroeconomics textbooks, Chad Jones textbook Macroeconomics (2nd ed, W W Norton, 2011) stands out as perhaps one of the better alternatives. Unfortunately it also contains some utter nonsense!

In chapter 7 – on “The Labor Market, Wages, and Unemployment” – Jones writes (p. 179):

The point of this experiment is to show that wage rigidities can lead to large movements in employment. Indeed, they are the reason John Maynard Keynes gave, in The General Theory of Employment, Interest, and Money (1936), for the high unemployment of the Great Depression.

But this is pure nonsense. For although Keynes in General Theory devoted substantial attention to the subject of wage rigidities, he certainly did not hold the view that wage rigidities were “the reason … for the high unemployment of the Great Depression.”

Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute “cyclical” unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.

In any specific labour market, lower wages could, of course, raise the demand for labour. But a general reduction in money wages would leave real wages more or less unchanged. The reasoning of the classical economists was, according to Keynes, a flagrant example of the “fallacy of composition.” Assuming that since unions/workers in a specific labour market could negotiate real wage reductions via lowering nominal wages, unions/workers in general could do the same, the classics confused micro with macro.

Lowering nominal wages could not – according to Keynes – clear the labour market. Lowering wages – and possibly prices – could, perhaps, lower interest rates and increase investment. But to Keynes it would be much easier to achieve that effect by increasing the money supply. In any case, wage reductions was not seen by Keynes as a general substitute for an expansionary monetary or fiscal policy.

Even if potentially positive impacts of lowering wages exist, there are also more heavily weighing negative impacts – management-union relations deteriorating, expectations of on-going lowering of wages causing delay of investments, debt deflation et cetera.

So, what Keynes actually did argue in General Theory, was that the classical proposition that lowering wages would lower unemployment and ultimately take economies out of depressions, was ill-founded and basically wrong.

Where Keynes found it unproblematic to link flexible wages and prices to involuntary unemployment, modern “Keynesian” macroeconomists has turned his theory into different kinds of fix-price models. But to Keynes, flexible wages would only make things worse by leading to erratic price-fluctuations. The basic explanation for unemployment is insufficient aggregate demand, and that is mostly determined outside the labor market.

So — for almost forty years neoclassical economics has lived with a theorem that shows the impossibility of extending the microanalysis of consumer behaviour to the macro level (unless making patently and admittedly unrealistic and absurd assumptions). Still after all these years neoclassical economists pretend in their textbooks that this theorem does not exist. Most textbooks  don’t even mention the existence of the Sonnenschein-Mantel-Debreu theorem. And when it comes to Keynes and wage rigidities, Jones’s macroeconomics textbook is not the only one containing the kind of utter nonsense we’ve mentioned.  But here the solution to the problem is more easy. Keynes books are still in print. Read them.

The real scientific challenge — that also has to be reflected in textbooks — is to accept uncertainty and still try to explain why economic transactions take place — instead of simply conjuring the problem away by assuming rational expectations, representative actors, universal market clearing  and treating uncertainty as if it was possible to reduce it to stochastic risk. That is scientific fraud. And it has been going on for too long now.

  1. BFWR
    November 29, 2013 at 9:50 pm

    What we desperately need to understand in economics is before you need to worry about whether or not your theories will lead to equilibrium…..you have to make it at least possible. The truth is something is missing in theory that does not allow equilibrium, or allow for its effective maintenance. Look at present imbalance and asymmetry of power (finance), and of the absence and/or incompleteness of a symmetrical form of consumer credit issuance (only work for pay and only loans) and you’ll be on the right trail.

  2. BFWR
    November 30, 2013 at 12:48 am

    Economists have not considered the empirical data regarding the most basic and relevant metric of a monetary economy, i.e. individual incomes and costs/prices simultaneously created in an equivalent period of time, and then thought about both the relationship between the two (the scarcity of one over the other) and the reality of the utter commercial inescapability of that state by present forms of credit issuance.

    Contemplating the sound of one hand clapping and how you deal HONESTLY with that inescapability can have the same liberating mental effect. The Zen monk now knows that mountains are still mountains and streams are still streams, it’s just that he now knows that wisely. The economist now knows the data is actually the data, and must find a NEW way to act, to craft policy WISELY.

  3. BFWR
    November 30, 2013 at 1:35 am

    It is after all, economic theory that has come into question. I’m merely suggesting we do a thoroughgoing re-analysis of all theory, and at least keep the possibility open in our minds that 1) we’ve missed an aspect of theory that needs changing and/or 2) an aspect of theory when re-examined and reformulated, utilizing ALL possible remedies, turns out to indeed be BOTH workable AND transformative of the entire body of thought.

    Sometimes the stars are aligned right, and sometimes the stars, the science, the philosophy, the data, the correct systemic policy solutions, the WHOLE nature of Man instead of just the cultural caricature of it and the condensations of Human Wisdom all line up almost like they were meant to, or just because things changed so they finally could….or maybe BOTH.

    • Bhaskara II
      December 2, 2013 at 1:44 am

      With Fred graph it might be possible to put many theories to the test (only if the data is correct {back to scientific method}). One can find the data series and apply it to the few variable economic theories. Fred graph will even do xy scatter plots or time paths. They call that option scatter in the graph option section.

      Ha. Ha! Here is the kicker. Most of their data is in time series form.* But, many economic theories assume and are formulated in equilibrium. Thus the economic variables are not functions of time as every thing is formulated with all the variables constant in time, thus they don’t have the variable, t, for time. You almost never see the variable time if formulas in a macro economics text book. The variability of the time series dispel the equilibrium myth.

      So one needs to find the time series most near to the economic theory variable. Then plot it and see how close the graphs match the theoretical formula. If there are three variables or more to plot Fred graph can export the data to be graphed in an other program such as a spread sheet or data graphing program.

      *Important point: In this case the % rate of growth (flow/stock) is stated to be in equilibrium but actually the stock level is certainly not in equilibrium at all, but, is growing exponentially! Examples are: a bank account accruing a constant rate of interest and money supply level growing at a constant percentage both equivalent to exponential growth of a money stock level.

      • BFWR
        December 3, 2013 at 8:04 am

        Bhaskara II,

        The money system, due to a flaw in the conventions of cost accounting, makes the entirety of the economic process unstable. That flaw holds in place the reality that more in prices is created and must be liquidated, that is if equilibrium is to be possible, than individual incomes are created to liquidate them with. This is the most basic “wobble” in the economy that eventually gums it up entirely. If the rules cause the problem, change the rules. That’s how James Kirk did it in fiction, and that is how we can do it for real in the temporal universe.

  4. Lyonwiss
    November 30, 2013 at 4:41 am

    Lars, Why do you regurgitate the same debate over and over, like stirring a witches’ brew? Neoclassical economics is wrong and has now been widely accepted as such. We have moved on. With assumed market failure, governments are now manipulating markets, without any sound economic basis for doing do.

    The only thing Keynes is right about is that classical economics is wrong. Keynes’ mantra that government can manage aggregate demand has been proven wrong time and time again. The simple reason is that macroeconomics is not a scientific theory which can guide government action.

    The zero interest rates and quantitative easing now are expressed US government policy to generate 2 per cent inflation and to lower US unemployment to less than 6.5 per cent. These are Keynesian actions by the US government to manage aggregate demand. The US government is also managing “failed” or “irrational” markets, by directly manipulating their prices higher to produce the wealth effect, so that individuals will consume more and increase aggregate demand.

    Keynesian economics is also scientific fraud, because of the lack of scientific evidence. We need to move on again and develop something that works which can be put in textbooks for students to learn and apply.

  5. Newtownian
    December 2, 2013 at 7:52 am

    Lars, watching the discussions/pieces in RER, especially your own, from the fringe of economics (roughly an ecological economics perspective) I keep agreeing with what you say but am still unclear as to how you are (proposing?) to move ahead – i.e. what is to be starting place equivalent of say atomic theory or wave theory? – both of which are now semi-redundant in mainstream science which you respect i.e. fantastically useful and accurate up to a point but also now revealed to be manifestations of even deeper truths/processes i.e. quantum theory.

    I just cant help but feel, judging from such things as the insular nature of economic terminology (used nightly in the media in a mantra like fashion) and very slippery concepts (e.g. money), that, as with mainstream science during the early renaissance, what draws your attention currently – the markets, interest rates, debt etc. are tertiary human constructs of some utility but overall are more a major distraction from insight. As a result they are locking most economists, even the progressives I follow here, into a straight jacket. I mean no disrespect as I’ve experienced comparable rigidity in thinking personally. Its hard to change the way you think. Further there are still some very useful concepts in conventional economics even if they arent ‘Laws’ e.g. the environmental implications of depreciation.

    Nevertheless it feels like something really akin to the above sciences is missing and until progressive economics can identify more basic underlying economic mechanisms than they seem to currently, they wont be able to replace the text books you decry.

    • BFWR
      December 2, 2013 at 8:52 am

      Wisdom, which is the integration and integrative process itself is what is required. Science is necessary, but its only half of the human mindset consisting of objective (scientific) and subjective (intuitive) experience. Wisdom encompasses, aids and combines both science and intuition.

  6. Bruce E. Woych
    January 16, 2014 at 4:26 pm

    The better part of neoclassical economics can be found here:
    http://en.wikipedia.org/wiki/List_of_fallacies

    • davetaylor1
      January 19, 2014 at 10:16 pm

      Absolutely right, Bruce, and your quote has led me on to all sorts of interesting wikipedia comment on logic, none of it even mentioning variables. In summary, we are living in a Humpty Dumpty world where we are supposed to believe words mean what liars and cheats tell us they mean when they are trying to rip us off.

      But why are we wasting out time bewailing the fact? Surely we should be making decisions about what WE intend them to mean, so we don’t argue at cross purposes and can reach agreement on what our purposes should be and how to fix the system so we are free to achieve them?

      Let’s start the ball rolling by agreeing what we are going to mean by ‘Money’. Is what it refers to defined by its function or its form?

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