What went wrong with economics?
from Lars Syll
Internal coherence is one way of adjudicating among theories, but so is correspondence to
everyday life. Too much realism may kill analysis, but too little realism is unscientific. If theoretical coherence alone were all that mattered, then the only constraint on theoretical exercises would be the human imagination. Interesting
puzzles would replace pragmatic solutions to problems encountered in the world — arguably, an accurate characterization of most contemporary economic theory. Economists must steer a course between (allegedly) pure description and the mere recording of events, on the one side, and self-indulgent mental gymnastics on the other …Parsimony won out over thoroughness … By myopically pursuing only the formal aspects of the discipline, economics was reduced to its present state, in which we continually know more and more about less and less.
Mainstream economic theory today is in the story-telling business whereby economic theorists create make-believe analogue models of the target system – usually conceived as the real economic system. This modeling activity is considered useful and essential. To understand and explain relations between different entities in the real economy the predominant strategy is to build models and make things happen in these “analogue-economy models” rather than engineering things happening in real economies.
Formalistic deductive “Glasperlenspiel” can be very impressive and seductive. But in the realm of science it ought to be considered of little or no value to simply make claims about the model and lose sight of reality. Although the deductivist mathematical modeling method makes conclusions follow with certainty from given assumptions, that should be of little interest to scientists, since what happens with certainty in a model world is no warrant for the same to hold in real world economies
Mainstream economics has since long given up on the real world and contents itself with proving things about thought up worlds. Empirical evidence only plays a minor role in economic theory, where models largely function as a substitute for empirical evidence. Hopefully humbled by the manifest failure of its theoretical pretences, the one-sided, almost religious, insistence on axiomatic-deductivist modeling as the only scientific activity worthy of pursuing in economics will give way to methodological pluralism based on ontological considerations rather than formalistic tractability.
To have valid evidence is not enough. What economics needs is sound evidence. Theories and models being “coherent” or “consistent with” data do not make the theories and models success stories.
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Real-World Economics Review Blog 
Very nice summation of all these issues , similar to my ” Real Economies and the Illusions of Abstraction” in 2010 , at http://www.ethicalmarkets.com
I’ve never been to an economics site that did NOT give off the distinct impression that economists are folks rather more interested in the means than the ends; quite contented to watch if not help the glorious goal of peace, prosperity, security and happiness for all via Fairpay Justice Equality recede into the horizon like the target of Zeno’s Arrow as they amass their personal prestige in the interests of, you know, eventually, making the world a better place.
When the time is right. Gradualism. Gently, now.
Yah right. As if justice belonged to them and they have some right to decide if and when the wealth in the world should be spread as equally as the work in the world is spread.
Sweet Christ on a cracker – what a world, what a world. Economic jargon jabberjabber, and dead babies washing up on the shore. Billions of humans working harder and harder for less and less so a few can play I’m the king of the castle. What a world. The market for good sense is all dried up. The market for visionary big-picture thinking leading to peace and happiness and justice – all dried up. The Egalitarian is seen not as the wide-eyed, pragmatic realist she is but as the dreamer. Everything is broken. Everything is rotten. Inertia over a wicked-stupid pay ratio killed the chance for humans to have a future.
“Oh, Hell. Here comes our funeral. Let us pry, for our missed understandings.”
As Hazel says, “good summation.” To add one thing, however. The models are not irrelevant to “economic reality.” The book “Do Economists Make Markets?” and other sources make the point that economics (theories, models, textbooks, advisers, etc.) is pervasively built into the modern world. The issue that needs to be tackled in relation to economies and economics is not just about “knowing” the world, accurately or not. It is also about producing it. It is not (only) about economics being “right” or “wrong,” from an “economic reality perspective, but also (and perhaps more important) about it being “able” or “unable” to transform the world. Economics has over its history swung between representation and action, between science (in one form or another) and policy, between academic inquiry and political intervention, both as a discipline and in the careers of many individual economists. That question is largely settled with economics today with representation and academic inquiry taking a back seat to direct and indirect intervention in economies. And what do economists pursue in these interventions? They seek to make “real” economies look and act more like the economies in economic models and theories. To use a term from my field, Science and Technology Studies, economics is “performative.” Economics performs, shapes and formats the economy, rather than observing how it functions. To fix this you’ll need to focus on changing economics, not just its models and theories.
Ken, that is spot on.
It’s 2015 , yet we live in the Dark Ages of economics.
It’s incredible.
Nothing wrong with economics if you study the relevant economist. Study Minsky and you will learn exactly what has happened to global economies especially after convoluted financial instruments came into use together with transaction speed via computerization. With Minsky, there is no need for all of the “assumptions” that have to be applied with neo classical models.
Yes, Minsky is great , but this makes the point. He , Keynes , and others provided much light , which has since been extinguished by the mainstream , and then they posted armed guards by the light switch.
nice simile for they are armed and dangerous
Nothing went wrong with the field of economics. It’s all in your perspective, and from ‘someone’s’ perspective, economics has all gone entirely right (no pun intended). Whose perspective might that be? Cui bono? Follow the money… you get what you pay for…The problem is with whomever is ‘buying and selling’ the ‘economics’.
The ‘problem’ is obvious to even me… and I know next to nothing about academic economics.. shouldn’t even be posting! ;)
Roger Farmer , blogging today :
“….Gather round and I will tell you a story. It is a story of how classical economists from the dark side bamboozled the Keynesian children of the light into accepting their dark version of the truth. ”
http://rogerfarmerblog.blogspot.com/2015/09/beliefs-are-fundamental-whatever-your.html
I consider Farmer a bamboozler in his own right , but he makes some good points , and it’s interesting that his post so closely follows this one on RWER.
Heterodoxy, too, is scientific junk
Comment on ‘What went wrong with economics?’
Science is defined by material and formal consistency. If a theory/model fails on one criterion it is scientifically worthless. With regard to formal consistency there is no way around “… he who contradicts himself proves nothing” (Klant, 1988, p. 113). But formal consistency alone also proves nothing.
The actual state of economics is this: Orthodoxy has failed on both counts. Therefore, all hopes rest on Heterodoxy. The crucial question is, does Heterodoxy satisfy the indispensable methodological criteria? Let us have a look at profit theory.
The profit theories of Keynes, Kalecki, Minsky, Keen are different (Marx and Mises/Hayek could be added). They cannot all be correct at the same time. As there is only one Law of the Lever, there can be only one objective Profit Law for the economy as a whole. This is not the case.
(i) Keynes: “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, pp. 12-13, 16)
(ii) “Kalecki derived this relationship in an extremely concise, elegant and intuitive way. He starts by making simplifications which he later progressively eliminates. These assumptions are:
• Divide the whole economy into two groups: workers, who earn only wages and capitalists, who earns only profits.
• Workers do not save.
• The economy is closed (there is no international trade) and there is no public sector.
With these assumptions Kalecki derives the following accounting identity:
P+W =Cw +Cp+I
where P is the volume of gross profits (profits plus depreciation), W is the volume of total wages, Cp is capitalists consumption, Cw is workers consumption and I is the gross investment that have been made in the economy. Since we have supposed workers who do not save (that is, to say in the preceding equation), we can simplify the two terms and arrive at:
P =Cp+I
This is the famous profits equation, which says that profits are equal to the sum of investment and capitalist’s consumption.” (Wiki, 2015)
(iii) Minsky: “The simple equation “profit equals investment” is the fundamental relation for a macroeconomics that aims to determine the behavior through time of a capitalist economy with a sophisticated, complex financial structure.” (Minsky, 2008, p. 161)
(iv) Keen: “Total income = Wages plus Profits” (2011, pp. 366, 146) and “… national income resolves itself into wages and profits” (2010, p. 12).
It is quite obvious that heterodox economists, like their orthodox counterparts, have no idea what profit is (2014). Hence, they fail to capture the essence of the market economy. Because of this, economists have nothing to offer in the way of a scientifically founded advice.
“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)
The true theory satisfies the criteria of material/formal consistency. All that Orthodoxy and Heterodoxy has currently to offer are contradicting opinions; neither came ever to grips with science, with profit, and with the working of the economy we happen to live in.
Egmont Kakarot-Handtke
References
Kakarot-Handtke, E. (2014). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2511741
Keen, S. (2010). Solving the Paradox of Monetary Profits. Economics E-Journal, 4(2010-31). URL http://dx.doi.org/10.5018/economics-ejournal.ja.2010-31.
Keen, S. (2011). Debunking Economics. London, New York, NY: Zed Books, rev. edition.
Klant, J. J. (1988). The Natural Order. In N. de Marchi (Ed.), The Popperian Legacy
in Economics, pages 87–117. Cambridge: Cambridge University Press.
Minsky, H. P. (2008). Stabilizing an Unstable Economy. New York, NY, Chicago, IL, San Francisco, CA: McGraw Hill, 2nd edition.
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge, MA: MIT Press.
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 http://mpra.ub.uni-muenchen.de/20557/.
Wiki (2015). Kalecki: The Profit Equation. Wikipedia. URL
https://en.wikipedia.org/wiki/Micha%C5%82_Kalecki
> “Hopefully humbled by the manifest failure of its theoretical pretences, the one-sided, almost religious, insistence on axiomatic-deductivist modeling as the only scientific activity worthy of pursuing in economics will give way to methodological pluralism based on ontological considerations rather than formalistic tractability.” [Lars]
I’m going to take exception to the use of the words ‘religion’ here and ‘church’ in the title of an adjacent book advert. Ignorant people pour scorn on what they don’t understand, and evil people get the ignorant to do their dirty work for them – not openly, but by openly twisting the intended meaning of words so that the innocent, picking up meanings by usage, think that bad is good and vice versa. (A recent British example of this even achieved legal re-interpretation of the word ‘marriage’).
The latin etymology of the Christian word ‘religion’ is to re-bind, implying having been set free, therefore grateful recommitment, this time to the one who freed them (not unlike Man Friday’s devotion to Robinson Crusoe). The word ‘church’ is a translation of the word ‘community’. One may or may not like Karl Marx’s communism, but he used the honest term ‘fetishism’. In light of the story of the Golden Calf and the current worship of money and markets made of thin air, the term ‘idolatry’ looks to be a reasonable alternative. As Marx was justifying violent revolution, the success of religion in making the unacceptable bearable makes his “the opiate of the people” a backhanded sort of complement.
> ” … methodological pluralism based on ontological considerations rather than formalistic tractability.” [Lars]
I’d started this comment with the intention of having a go at Egmont’s repeated denial of the possibility of this:-
> “THE true theory satisfies the criteria of material/formal consistency”.
But the only material in a mathematical model is the form of its symbolism, so Egmont is falling head first into Russell’s Paradox, the solution to which is dynamically typed logic.
Prices are always prices of something to someone, and whether paying the price results in a profit or a loss to someone depends on the something – whether it be good or bad – and not on its denotation in whatever unstable currency. His type of model is therefore useless: one needs something like an SSADM information systems analysis which identifies and indexes someones: who buys and sells what, when. It doesn’t attempt to add apples and bananas as chrematists posing as economists now always do. If you want to know how the economy works, you need to know how and where to look, not have someone else tell you.
Putting that in “ontological” terms, what a thing IS is what it DOES for HUMANS. So chrematism is money making, economics is human household management. What we have now is the former and not the latter. You don’t need SOUND evidence for that, Lars. As Nancy Sutton puts it humbly but much more eloquently above, you don’t need a doctorate in economics to see it. You need only open your eyes to see where money is and is not going. Let me add: “and the consequences thereof in terms of self-glorification and the ruin of households and communities”. There are different ways of managing households, whereas all the ways of making money (as against earning credit worthiness) amount to theft.
Where economics went wrong
Comment on Lars Syll on ‘Where modern economics went wrong’
Lars Syll identifies the point where he believes economics went off the rails: “The main problem with mainstream economics is its methodology. The fixation on constructing models showing the certainty of logical entailment has been detrimental to the development of a relevant and realist economics. Insisting on formalistic (mathematical) modeling forces the economist to give upon on realism and substitute axiomatics for real world relevance. The price for rigour and precision is far too high for anyone who is ultimately interested in using economics to pose and (hopefully) answer real world questions and problems.”
It is obvious, methodology is a major problem of economics. More precisely, neither orthodox nor heterodox economists apply the scientific method correctly. This started with Adam Smith and has not changed since then.
To recall, the classicals called themselves Political Economists. Therefore it is of utmost importance to distinguish between political and theoretical economics. The main differences are: (i) The goal of political economics is to successfully push an agenda, the goal of theoretical economics is to successfully explain how the actual economy works. (ii) In political economics anything goes; in theoretical economics the scientific standards of material and formal consistency are observed.
The last thing political economists do is to comply with well-defined and well-known scientific standards: “As some one has said, it would seem that even the theorems of Euclid would be challenged and doubted if they should be appealed to by one political party as against another.” (Fisher)
The quite natural outcome has been that political economics, which had dominated theoretical economics from the very beginning, has produced NOTHING of scientific value in the last 200+ years.
Let us locate exactly the point where economics went scientifically wrong. Smith’s method consisted of common sense and loose verbal reasoning: “Smith … disliked whatever went beyond plain common sense. He never moved above the heads of even the dullest readers. He led them on gently, encouraging them by trivialities and homely observations, making them feel comfortable all along.” (Schumpeter)
Smith defined total income and what we today call GDP as: “Wages, profit , and rent, are the three original sources of all revenue as well as of all exchangeable value.#1
With this seemingly commonsensical definition Smith got profit, the pivotal magnitude of economics, wrong. Needless to emphasize that neither orthodox nor heterodox economists rectified Smith’s foundational blunder until this day.
Realism, common sense, and loose verbal reasoning are always popular but do not cut much ice. Science goes beyond common sense and requires some abstraction. The functioning of the price and profit mechanism for the economy as a whole cannot be observed with naked eyes but only with the third eye of theory. So let us identify exactly where economics went wrong and fix the profit and price theory.
For the determination of monetary profit of the economy as a whole one has to start with the most elementary case of a pure consumption economy without investment, government and foreign trade.#2 In this elementary economy three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.
In case (i) the monetary saving of the household sector Sm≡Yw-C is zero and the monetary profit of the business sector Qm≡C-Yw, too, is zero.
In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.
It always holds Qm+Sm=0 or Qm=-Sm, in other words, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law.
It is important to note that (1) overall monetary profit is entirely INDEPENDENT of the average productivity of the business sector, and (2), NO share of output corresponds to monetary profit. This tells us that the familiar distribution theories are false.
When distributed profit Yd, investment I, goverment expenditures G and taxes T are added the correct profit equation reads Qm≡Yd+I-Sm+G-T.
In other words, deficit spending of the household and government sector and profit distribution of the business sector are the determinants of total monetary profit in the market economy. Total profit has NOTHING to do with marginal costs or productivity or exploitation or monopoly power or the smartness of CEOs. These factors can only influence the DISTRIBUTION of total profit BETWEEN firms.
The lethal blunder of Walrasianism, Keynesianism, Marxianism, Austrianism is that ALL four approaches lack the true profit theory. And this is the ultimate reason why economics is a failed science. The main problem of economics is the scientific incompetence of economists.
Better to get accustomed to the fact that neither orthodox nor heterodox economists can be taken seriously. NOT ONE of their economic policy proposals ever had a sound scientific foundation. It is brain-dead political blather since 1790, when Adam Smith completed the last revision of The Wealth of Nations. Economics is a fake science since then.
Egmont Kakarot-Handtke
#1 See ‘Wealth of Nations’
http://www.econlib.org/library/Smith/smWN2.html#I.6.17
#2 The macrofoundations approach starts with three systemic (= behavior-free) axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.