Home > Uncategorized > Making firm governance part of the economists’ dialogue

Making firm governance part of the economists’ dialogue

from Robert Locke

In a recent article,”The Milton Friedman Doctrine is Wrong.  Here’s How to Rethink the Corporation,” Susan Holmberg and Mark Schmitt intoned: “We won’t fix the problem until we address the nature of the corporation.” at http://economics.com/milton-friedman-doctrine-wrong-heres-rethink-corporation/. Egmont Kakarot-Handtke asserts that sciences of society make no contribution to economics because they are scientifically invalid — to which I replied that his assertion is not true because the neoclassical economists who took over economics in the 20th century excluded history and social studies from the discipline’s purview. History and social studies could make no contribution since they have been ignored. The neoclassical economists’ failure to incorporate firm governance into the economists’ dialogue is a prime example of what I mean.   

“The Milton Friedman Doctrine”, H and S explain, is based on “’agency theory’ or ‘shareholder primacy.’ The intellectual godfather of shareholder primacy is Milton Friedman, who wrote in 1970 that ‘a corporate executive is an employee of the owners of the business [i.e., the shareholders]. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible, without breaking the law or cheating people.’ … Michael C. Jensen and William H. Meckling codified Friedman’s argument with their seminal 1976 article, ‘Theory of the Firm.’ The purpose of corporate governance, they argued, is about finding ways to align the incentives of shareholders (whom they referred to as ‘principals’) and executives (‘agents’ of the shareholder-owners). This theory has enraptured economics departments and business and law schools for decades and profoundly shaped how corporate officers, shareholders, taxpayers, policy-makers, and even most Americans think about the roles and responsibilities of corporations.”

[A] bit of heresy did happen at the 2013 annual meeting of the Allied Social Science Associations.  … That year, a French financial economist named Jean-Charles Rochet gave the keynote address, in which he skewered the very foundation of pay for performance. Cornell Law School professor Lynn Stout calls it the “shareholder value myth”—the idea that corporations exist for shareholders and no one else. Rochet told the conference: “Everyone knows that corporations are not just cash machines for their shareholders, but that they also provide goods and services for their consumers, as well as jobs and incomes for their employees. Everyone, that is, except most economists, [for whom] shareholder primacy has never been challenged in a serious way.”

H and S argue that the prevalent economic theory prevents economists  from “fixing” the problem,” of the growing gap between the incomes of the top 1% and the bottom 99% of Americans, because the doctrine of shareholder value when combined  with “the economic theory of marginal productivity— justifies the gap, i.e., the theory holds that ‘any worker is paid based on what he or she adds to the firm’s income’— and inasmuch as executives work for the shareholders —  the explanation for the extraordinarily high pay for those at the top has to be performance . As Harvard economist N. Gregory Mankiw phrased it, the value of a good CEO is extraordinarily high ”because of what she/he add to the firm’s income.”

“But,” they continue, “this is the most tautological of economic ideas. The theory requires very strict assumptions that are found nowhere in the real world, and it cannot be put to the test, because it is impossible to measure the performance of a CEO in terms of his or her marginal contribution to a firm, particularly when success is the function of an entire team. And when ‘pay for performance’ is based on the company’s stock price, it is really ‘pay for luck,’ because more of the share price performance that CEOs are paid for is driven by broader macroeconomic factors, particularly economic upswings, than anything the executives did.”

In any event H and S, with reference to the argument of Lucian Bebchuk and Jesse Fried, in their 2004 book Pay Without Performance, went on to observe that executive pay cannot even be said to be based on a subjective appreciation by stockholder-owners of executive performance.  They (Bebchuk and Fried) “wrote that skyrocketing executive pay is the blatant result of CEOs’ power over decisions within U.S. firms, including compensation.  (Also see, S Bainbridge’s 2006 article. “Director Primacy and Shareholder Disempowerment,” Harvard Law Review, Vol. 119 and UCLA School of Law – Research Paper No. 05-25.)  Salaries at the top rose rapidly under director primacy governance, because those at the top had the power to rig the system to their advantage.

Stakeholder primacy as an alternative form of firm governance.

“Simply put,” H and S point out, “a stakeholder is any group or individual who can affect, or is affected by, the achievement of a corporation’s purpose. Stakeholders include employees, customers, suppliers, stockholders, banks, environmentalists, government, and other groups who can help or hurt the corporation. The stakeholder concept provides a new way of thinking about strategic management—that is, how a corporation can and should set and implement direction. By paying attention to strategic management, executives can begin to put their corporations back on the road to success.”

They further specify:  “the term stakeholder has been in circulation since the 1960s to characterize the key groups of people that support an organization. R. Edward Freeman brought it into the management world in 1984, when he published Strategic Management. The book proposed that effective management consists of balancing the interests of all the corporation’s stakeholders, including employees, customers, and communities.”

If the words stakeholder primacy became common phraseology then, the concept and practice has been around much longer, especially if frames of reference are extended outside America.  In Germany the Law for the Protection of Labor granted the workers joint consultation right on social matters in firm governance during the Second Empire (1871-1918); members of the Constituent Assembly wrote co-determination into the Weimar Constitution (Article 165) in 1919;  Hitler, who personified the Führerprinzip, countermanded worker participation in firm governance during the 12 years of the 3rd Reich, but, on the founding of the Federal Republic of Germany(1949), the Bundestag passed with a vengeance a Co-Determination Law for the Iron and Steel Industry (1951) and then in 1952 a Works Constitution Act.

It is important to stress the historical origins of the stakeholder concept of the corporation for two reasons.  First the development of a participatory form of firm governance takes time.  The Germans have worked on integrating the various components of their system for over sixty years (see “The Emergence of the German Management Alternative,” pp. 80-103, in The Collapse of the American Mystique).  Second, American Management’s preoccupation with stakeholder forms of corporate governance began much earlier than the publication of Freeman’s book on Strategic Management in 1984.

In fact, the American preoccupation with employee participatory management began in Germany immediately after the war. General Lucius Clay, who headed the US Zone of occupation, stymied German efforts to introduce co-determination modes of management in German firms when Germans assumed increasing control over their civil government in the late 1940s.  American private business openly opposed the German legislation, i.e., the National Association of Manufacturers sending a delegation to Europe to speak against it, a representative of NAM writing an open letter to the German Council in New York, published in the New York Times, which warned  that Americans would not invest in German industry if the co-determination bill passed. (Locke, 1996, 64-67). When the Social Democrats-Liberal coalition legislation in the mid-1970s strengthened employee participation in firm governance, Henry Ford III, visiting his company’s factories in Cologne at the time of the debate, deplored the new legislation’s infringement on the prerogatives of management. (Reported in New York Times, 17 Oct. 1975). The Americans warned the Germans that workers participation in firm governance would result in bad management.

As long as American and Germans firms thrived the issue was muted, but around 1980 the rise of a revitalized Japanese industrial-managerial challenge to industries in both countries squarely posed the question: to what extent did forms of firm government shape the response in each country  to the Japanese challenge to their industries?   The answer: director primacy-stockholder-value forms of governance hampered American firms as they adapted to the Japanese management challenge and German co-determination governance did not .

On the contrary, one manager at Opel (Rüsselsheim) observed that because of the institutions of co-determination, Opel plants could implement shop floor reforms better than GM plants in the US. [W. Streeck (1984). Industrial Relations in West Germany: A Case Study of the Car Industry. p. 84.)] Another, Professor Horst Wildemann, a leading figures involved in the transformation of German firms along Japanese lines, reported after four years of reform at Volkswagen that the contributions of works councilors and shop stewards to change are uniformly positive; indeed, employee representatives often led rather than followed management. (Locke Interview, 19 July 1994).

For Germany if a sustainability yardstick is used to evaluate corporations, their performance is remarkable. Among the Fortune magazine global 500 corporations in 2007 (23 July issue), 37 German firms are listed; among them 30 trace their origins to the German postwar recovery and among the 30 at least 13 had been successful firms in the 19th century. In the 20 top German corporations listed by revenues in 2013, ten were manufacturing firms, half of which were German automobile companies, with Mercedes and Volkswagen (rated number one on the list of 20) included.

Evidence about the fate of established US firms, caught in the manufacturing crisis supports an opposite conclusion.  In the tire industry, United States Rubber and Royal went under and rising Japanese Bridgestone bought declining Firestone; in the steel industry once mighty US Steel fell to 479th on the 2007 Fortune Global 500 list; previously renowned US manufacturers of machine tools (for example, Burgmaster), and manufacturers of electronic products (Philco, Zenith, RCA, and others) were replaced by Sony, Matsushita, Sanyo, and others, and Japanese automobile manufacturers crowded out or replaced American firms at the top of the 500. Once mighty General Motors and Chrysler declined into receivership.

Comparisons of the manufacturing sectors in both countries during the crisis period (1980-2000) show that the German stakeholder firms outperform the Americans. In all advanced economies in the West, the manufacturing sector shrank between 1990 and 2012, but the numbers employed in manufacturing in Germany declined the least (ten percent) compared to America’s 28 percent (in the UK it was over 50 percent). (Bureau of Labor Statistics, 2013, Table 2-4). Between 2002 and 2012, the employment in manufacturing increased in both countries, but the percentage of the increase was higher in Germany (20 percent) compared to 12 percent in America.  Inasmuch as the manufacturing employment numbers included people working in the new information technology firms, in which the US was the acknowledged leader, the percentage of Germans working in the older manufacturing firms, where work process reform had been concentrated, was even more weighted in their favor.

Under the regime of director primacy, US management let employees of the struggling firms shoulder, compared to stockholders, a disproportionate burden, primarily if not exclusively, through the elimination of so-called legacy costs after 1980.  There had been 112,000 defined-benefit private pension plans in them in 1983, each guaranteeing fixed levels of income to a company’s retirees. Jack Rasmus, reported in 2004 that “From the passage of the Employee Retirement Income Security Act (ERISA) in 1974 until 2003, more than 160,000 Defined Benefit plans have gone under in the US.”  [J. Rasmus (2004) Pension Plans in the Corporate Cross-Hairs. Kyklos Productions.  p. 3)] During the same time the number of personal retirement accounts mushroomed. Very few households had such accounts in 1982; by 1995 23 percent of households had a 401K or an equivalent individual retirement account.

Most Americans, except for those located in rust belt manufacturing cities, ignored the comparative American failure. And for good reason, because while staple US industries declined and their workers suffered, a Pentagon induced revolution in information technology transformed the American economy and through it the world economy.  Because of this Americans praised their management capabilities as second to none, and they made the very disappearance of the old firms a virtue. R. N. Foster and S. Kaplan 2001 book portrayed the era of industrial decline positively as one of ‘Discontinuity.’ They observed that when Forbes’ list of the 100 largest US corporations in 1987 is compared to Forbes’ first list in 1917, only 18 of the original 100 firms appear among the 100 sixty years later; 61 percent of the firms were gone. Scanning the S&P 500 over the period 1957-1998, they estimated that the pace of turnover at the top was accelerating so rapidly that by 2010 the average life-span of an S&P listed firm would be ten years. By 2020 at that turnover rate, ‘no more than one third of today’s major corporations’ on the S&P list ‘will have survived in an economically important way.’ (Foster and Kaplan, Creative Destruction:  Why Companies that are Built to Last Underperform in the Market. chap 1)

It was convenient to praise this discontinuity as an economic positive and to fault continuity in Germany as stagnation, but the high tech start-ups in “Phenomenal Silicon Valley” (see, R Locke & K Schöne, The Entrepreneurial Shift, CUP, 2004, chap. 1) had nothing much to do with management systems in firms, and everything to do with networking in high tech regional clusters.  Most discussion of this phenomenon trace its origins to the Triple Helix, the symbiosis among government sponsored scientific research in private and public universities, promoters of private firm start ups, and developing circles of angel and venture capitalism outside traditional financial institutions, the best example of which existed in Silicon Valley networks.

Tradition forms of American firm management did enter the picture when successful IT start-ups went public. The management systems that took over the new high tech public firms mirrored the stockholder primacy-director-controlled model, typical of US corporations.  Their management policies as the firms grew followed the model:  big emoluments for those at the top, a strategy of low cost, often off shore located production facilities, where workers are treated not as stakeholders in the firm but as a variable cost to be minimized.

The recent transformation of the US economy from managerial to finance capitalism has accelerated the gap between high and low incomes that director primacy governance in public corporations fostered.  Managerial capitalists believed that returns on investment are based on the value created by productive enterprise; finance capitalists, whose ideas and actions have superseded theirs, treat “companies … as assets to be bought and sold for maximizing profits through financial strategies.”  [R. Ball and E. Appelbaum (2013).  “The Impact of Financialization on Management and Employment Outcomes.” Upjohn Institute for Employment Research, Working Paper, pp.  13-19)]  Financialization brought new financial institutions (investment banks, hedge funds, private equity firms, etc) and instruments (i.e., derivatives and stock options) concocted and used by Wall Street analysts, finance economists, and managers of public pensions adept at increasing the income of people at the top through financial strategies. Petra Dünhaupt claims that just one financialization instrument, the introduction of stock options into pay packages, is responsible for increasing the share of total incomes of the top 1% from two percent in 2000 to eight percent in 2007 [(P. Dünhaupt (2011). The Impact of Financialization on Income Distribution in the USA and Germany. p. 19)]

H and S believe, as German economists anticipated in the 19th century Verein für Sozialpolitik and German business economists thoroughly discussed in their professional publications in the 1920s that the Milton Friedman’s agency theory and stockholder primacy theory of firm governance promote not just the mal-distribution of incomes but the lack of firm sustainability. [(See, R. Locke (1984, 2006). The End of the Practical Man, pp. 155-62)]  They also affirm that in rethinking the corporation the adoption of the German stakeholder form of corporate government is a viable alternative that has proven itself in Rhineland capitalism.  In their words:

“Yes, we need to reform corporate boards, but let’s do it by following the successful German model and creating a place for workers at the board table. Employee board-level representation is a core part of Germany’s corporate “dual structure”: a management board for day-to-day functions and a supervisory board for more high-level decisions. …

The stakeholder corporation is not only a brilliant model, as the German economic success, especially in manufacturing, shows—it is also the key to the unresolved problem of CEO pay.”

  1. jlegge
    July 20, 2016 at 3:47 am

    Smith (Book V, Chapter 1, Part 3) explained that shareholders are not owners, unlike partners in an unincorporated enterprise. Shareholders do not make operating decisions for a company and they are not responsible for its debts or crimes. Friedman chose to ignore this, as do those who apply principal-agent theory to CEO remuneration.

    “Companies are formed by entrepreneurs who raise cash for expansion by selling shares in the prospective profits to investors. The company, as an incorporated person, is not really owned by anybody; but it is called into existence to further the entrepreneur’s ambitions, not those of the shareholders.” (Legge, Economics versus Reality p. 267)

    Entrepreneurs seek profitable growth because they need profits to fund further growth. Few active entrepreneurs choose to live in hovels and eat gruel; but if there is a choice between investing in the business and buying another bucket of caviar the business wins. I met one globally successful Australian entrepreneur wearing a cheap suit (his only one), not because he couldn’t afford better but because he didn’t want to take time off building his business to visit a tailor. Some Silicon Valley entrepreneurs have become famous, or infamous, for getting their PAs to hire dining and bedroom companions for them because they can’t spare the time from the business for ordinary courtship.

    To such entrepreneurs the stakeholder model is a “no-brainer”. They need their workers to be as enthusiastic about their business’s aims and the=y and their workers are obsessively focussed on their customers’ needs and wants. Shareholders ae an irritant that must be soothed with stock price appreciation and where the tax system favours it, growing dividends.

    Before the Friedman doctrine took hold the CEOs of great American corporations saw themselves as entrepreneurs, motivated by growth opportunities. Friedman’s acolytes successfully denigrated this by claiming that men like E C Wilson of GM or Don Frey of Bell & Howell sought growth because larger companies paid higher CEO salaries. It’s bitterly ironic that men like Wilson and Frey worked for salaries that today’s shareholder focused CEOs would consider pocket change. The attempt to cure a non-problem created a raging disease.

  2. charlie
    July 20, 2016 at 4:13 am

    ideology trumps all … oops

  3. charlie
    July 20, 2016 at 4:18 am

    btw the economics link to H&S is broken/notavailable/ any way to look at the article

  4. July 20, 2016 at 5:49 am

    I’ve never been an academic. My jobs have been in areas where stakeholders are everything. They’re all in the events together. In clinical psychology treating a patient without also considering the others things and people involved in that patient’s life is not only impossible but leads to poor treatment results. And these other are not just subordinates of the patient. They are of equal relevance and importance with the patient. In electrical engineering all the parts of an electric energy provider are interrelated and necessary for the delivery of energy. None can be considered primary while others are secondary. In economic regulation of public utilities the obligations of these utilities are broad and interrelate. The utilities have obligations to customers (reasonable rates and reliable service), to employees (good pay, retirement, and safe working conditions), to the banks (repay loans), to the community (safe services that support community goals), and to stockholders (reasonable dividends). But the shareholder value myth has penetrated utility boards and CEOs, creating especially vexing situations for regulators overseeing and expecting utilities to meet all their obligations. And the recent stampede to customer choice and market-based rates for utilities has damn near destroyed the US utility systems. In the history of bad ideas subordination of all to shareholder value is near the top of the list.

  5. robert locke
  6. July 20, 2016 at 10:25 pm

    Making the economy the focus of the economists’ dialogue
    Comment on Robert Locke on ‘Making firm governance part of the economists’ dialogue’

    One way to explain the actual state of the world is the historico-genetic (K. Mannheim) approach. And this is how Robert Locke explains the differences between firm governance in different countries (US, Germany, Japan). I have no problem with this account except that it is not economics.

    Let us make a thought experiment and imagine we have a country with direct democracy. So, the question who rules is already solved. Now comes the very practical question of how to organize the economy. Clearly, it is in the POLITICAL sphere where this question has to be addressed and decided. In the given framework of direct democracy one can expect that the majority decides that the firms should organize themselves. So, the dominant legal form of the firm would probably be something like a cooperative.

    The crucial point is that the question who rules the firm is ultimately a political question and not an economic question. The two spheres should be strictly kept apart. Of course, everybody knows that in real life they are intimately entangled. Real life is muddle and confusion and compromise. The history of economic thought shows that economists have never properly separated the political and the economic sphere, neither in theory nor in practice.

    Economics started as Political Economy. Political Economy is agenda pushing and economists from Smith, Ricardo, Marx, Keynes, Hayek, Friedman to the present were agenda pushers first and scientists second. As a matter of fact, they were lousy scientists because they never figured out how the actual monetary economy works. How do we know this? We know this for sure because the profit theory is provably false and without the correct profit theory the economist cannot rise above the level of proto-scientific storytelling.

    Their scientific incompetence, though, could not stop economists from giving economic policy advice and telling people how to organize the economy and how to organize firms. The history of who pushed which agenda with what arguments is nicely summarized in Robert Locke’s intro.

    As a matter of principle, though, political questions have to be answered in the political sphere and are the subject matter of political science and sociology. The economist has a voice in the political sphere like every other voter. But he is not allowed to bring his political preferences into economics and to make it the guiding principle of his scientific work. Science neither serves the one-percenters nor the ninety-nine-percenters. Science is strictly committed to true/false and NOTHING else. The primary task of the economist as scientist is to figure out how the monetary economy works. It is not his task to dabble in politics. J. S. Mill was very clear about this.

    “A scientific observer or reasoner, merely as such, is not an adviser for practice. His part is only to show that certain consequences follow from certain causes, and that to obtain certain ends, certain means are the most effectual. Whether the ends themselves are such as ought to be pursued, and if so, in what cases and to how great a length, it is no part of his business as a cultivator of science to decide, and science alone will never qualify him for the decision.” (2006, p. 950)

    It is the mixture of politics and science that is the root cause of the manifest scientific failure of economics. Political economics has not produced much, if anything, of scientific value in more than 200 years. What is first of all needed is a strict separation of politics and science. This means that economists have to leave all question about who rules whom to political science/sociology for analysis and to the legitimate sovereign for decision.

    Heterodoxy has criticized Friedman that his theory of the firm is politically biased. Asad Zaman would call it a 1%er economic theory. Now, to put a 99%er theory of the firm against Friedman is a natural reaction but to correct one political bias with the opposite political bias is still politics. It is definitively not science. Science asks: is the mental construct called economic theory true or false, and NOT does it fit the agenda of the one-percenters or the ninety-nine-percenters.

    Science tells us that the conflicting theories of the firm are based on a false premise. Since Ricardo and Marx, both orthodox and heterodox economist believe that there is a fundamental antagonism between the firm’s owners (= capitalists) and the employees/workers. Accordingly, firms should be regarded as battlefields of class war.

    The idea that an antagonism between classes is built into the economic system, though, rests on an optical illusion. And this optical illusion ultimately derives from the theory of the firm. It is obviously true that an individual firm can increase profit by lowering the wage rate. But this is NOT true for the (world-) economy as a whole. To generalize what is true for an isolated part of a system is known as fallacy of composition.

    In the most elementary case, the interdependencies of the economic system have the unintended effect that if firm A makes a profit by lowering the wage rate, firm B (= the rest of the economy) makes a loss under the initial macroeconomic condition that total consumption expenditure is equal to total wage income (2014; 2015). And, by the same token, the real wage of the workers of firm A decreases and that of the workers of firm B increases. So, what happens is that a redistribution of profit between firms and a redistribution of output between households takes place. In political terms this means that there are no classes with a common interest. Put differently, what appears as exploitation of the workers of firm A is only part of the complete picture of a REDISTRIBUTION of profits WITHIN the business sector and a REDISTRIBUTION of output WITHIN the household sector. In political terms: the exploitation of workers in firm A benefits the workers in firm B. And the profit increase of firm A’s capitalists comes from firm B’s capitalists. Taken all capitalists together their profit does not change. Taken all workers together their real share of output does not change.

    Economists are supposed to be experts on the economy. So it is quite natural to think that they know how the profit mechanism works; after all, this is the pivotal phenomenon of their subject matter. Yet, this is definitely not the case. So economists have nothing to contribute to the discussion about how the economy or about how firms should be organized. This holds for Walrasians, Keynesians, Marxians, and Austrians.

    The theory of the firm presupposes the correct macroeconomic theory. Heterodox economists are supposed to develop this objectively true theory and to replace false and scientifically worthless orthodox economics by true heterodox economics. This is a scientific task and has nothing in common with incompetent political agenda pushing.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2014). Profit for Marxists. SSRN Working Paper Series, 2414301: 1–25. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2414301
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Profit. SSRN Working Paper Series, 2575110: 1–18. URL
    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.

    • robert locke
      July 21, 2016 at 10:09 am

      Whoever said economics is a science? From the historical evidence it is an unwarranted assumption. Just wishing it were won’t make it come true.

      • July 21, 2016 at 1:00 pm

        robert locke

        You ask: “Whoever said economics is a science?”

        Economics is even multiple sciences and it is in the news every year: “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”.

        Egmont Kakarot-Handtke

      • robert locke
        July 21, 2016 at 5:15 pm

        Egmont, please, everybody knows that this prize is not a Nobel Prize. It was thought up in 1969 by neoclassical economists.

      • July 21, 2016 at 7:43 pm

        robert locke

        You say: “… everybody knows that this prize is not a Nobel Prize.” That is not the point. The key word is NOT Nobel but science(s). And this claim has ALWAYS been a constitutive element of the definition of economics.

        “The science which traces the laws of such of the phenomena of society as arise from the combined operations of mankind for the production of wealth, in so far as those phenomena are not modified by the pursuit of any other object.” (Mill, 1874, V.39)

        “That Political Economy is a science which teaches, or professes to teach, in what manner a nation may be made rich. This notion of what constitutes the science, is in some degree countenanced by the title and arrangement which Adam Smith gave to his invaluable work. A systematic treatise on Political Economy, he chose to call an Inquiry into the Nature and Causes of the Wealth of Nations; and the topics are introduced in an order suitable to that view of the purpose of his book.” (Mill, 1874, V.7)

        “Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” (Robbins, 1935, p. 16)

        Needless to add that the psycho-social-behavioral definition of economics has been false from the very beginning because economics is a SYSTEM science.

        Like all so-called social scientists you are far, far behind the curve.

        Egmont Kakarot-Handtke

        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 http://www.econlib.org/library/
        Robbins, L. (1935). An Essay on the Nature and Significance of Economic Science. London, Bombay, etc.: Macmillan, 2nd edition.

      • July 22, 2016 at 4:05 am

        You say “…economics is a SYSTEM science.” If so what is a system, how does it work, how do we know it when we see or experience it? If we assume, as I do that what we call the world is created. That we begin with a flat universe, with no differences in size, shape, energy etc. The differences are made. This includes what you and we call systems. Systems can be used to explain certain actions and actors. But more important we need to examine how not just a system but all systems are built up. That this is difficult to grasp – difficult to get past the world we live in everyday – does not make it any less the case and important.

      • robert locke
        July 21, 2016 at 10:34 pm

        I could cite many critics of economics that say it is not a science, and have in my books. But you won’t be convinced. Here is one. Neumann and Morgenstern, “The concepts of economics are fuzzy but even in those parts where the descriptive problem has been handled more satisfacitorily, mathematical tools have seldom been used appropriately Mathematical economics has not achieved very much.” Game Theory, 1944, 70 years after Walras proclaimed that economics was a science. And similar quotes continue up to the present. Can you see why historians might be skeptical about the scientific claims. When I talk to applied scientists about the science of economics, they usually just laugh.

      • July 22, 2016 at 1:38 pm

        robert locke

        You say: “I could cite many critics of economics that say it is not a science, …” and then you quote von Neumann.

        I agree with the quote, but not with your conclusion. Note what conclusion von Neumann drew from his diagnosis: “… von Neumann developed the conviction over time that economics stood badly in need of revision and reconceptualisation; what changed over the course of his writings was the intended shape and contours of this revision.” (Mirowski, 2002, p. 97)

        von Neumann urged what is called a paradigm shift. He saw clearly that the fundamental concepts of economics were hopelessly muddled and inadequate: “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.” (quoted in Mirowski, 2002, p. 146 fn. 49)

        But note also that von Neumann accepted the claim that economics is a science. What he diagnosed was that economics was still at the proto-scientific level: “Economics is simply still a million miles away from the state in which an advanced science is, such as physics.” (quoted in Ingrao et al. 1990, p. 197)

        So, von Neumann and I are on the same page: (i) economics is incoherent gibberish because its fundamental concepts (= axiomatic foundations) are defective (2013), (ii) economics does not live up to its claim to be a science (2011), (iii) economics is in need of a paradigm shift (2014).

        From this follows, firstly, that the word ‘sciences’ has to be eliminated from the “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”. The general public has to be informed that the 200 year old claim and the actual state of economics still do not match. It follows, secondly, that incompetent scientists have to be thrown out of economics regardless of their affiliation to either Walrasianism, Keynesianism, Marxianism, Austrianism or any other failed approach. It follows, thirdly, that it is the very task of Heterodoxy to carry out the paradigm shift and to make economics a science.

        What economics needs least is the skepticism of historians, the realism of engineers, the toolism of physicists, the Verstehen of psychologists, the anything-goes of methodologists, the nothing-goes of intellectual sclerotics, the machinations of agenda pushers, and the quick-and-dirty fixes of commonsensers and practical men. From all this economics had more than enough in the last 200 years.

        Egmont Kakarot-Handtke

        Ingrao, B., and Israel, G. (1990). The Invisible Hand. Economic Equilibrium in the History of Science. Cambridge, MA, London: MIT Press.
        Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL http://ssrn.com/abstract=1966438.
        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 http://ssrn.com/abstract=2207598.
        Kakarot-Handtke, E. (2014). Objective Principles of Economics. SSRN Working Paper Series, 2418851: 1–19.
        Mirowski, P. (2002). Machine Dreams. Cambridge: Cambridge University Press.

      • July 23, 2016 at 4:55 am

        If the main problem with economics and what stops it from being scientific is “the lack of quite sharply defined concepts,” two questions. First, where and how do we get these concepts? Second, are these concepts related to what the banker, the retail store owner, the McDonald’s clerk, the international trade negotiator, and many other non-economists call economics and how are they related?

      • robert locke
        July 22, 2016 at 6:54 pm

        Egmont, Neumann and Morgenstern wrote the book on Game Theory to eliminate the mathematical shortcomings of neoclassical economics. What has happened to their work? Did it clarify the shortcomings of Walras’ mathematical economics and turn it into a prescriptive science, or are we with Game theory in the same scientific cul de sac. That is what I read repeatedly on this blog.

      • July 23, 2016 at 11:56 am

        robert locke

        With regard to von Neumann there are two things to be kept apart: diagnosis and therapy. His diagnosis was correct. The project of the proper formalization of economics, though, had one fatal drawback: von Neumann left the underlying theory untouched: “But this [establishing the analytic mother-structure] required one very crucial maneuver that was nowhere stated explicitly: namely, that the model of Walrasian general equilibrium was the root structure from which all further work in economics would eventuate.” (Weintraub, 2002)

        This is the REAL mathiness problem. Formalization does not help if the conceptual root structure, a.k.a. axioms, is defective.

        Egmont Kakarot-Handtke

      • robert locke
        July 25, 2016 at 10:45 am

        Egmont, how can you have a systems science that leave morality out of the system? But economics, in the name of science, does. Any economic system that thrives must be rooted in some moral order. Conservative thinkers, great religious teachers, and philosophic thinkers recognize this when they talk about sustaining economic communities. The systems disconnect with any moral compass, that your science implies, is not only a recipe for disaster but in our specific time and place its cause. The error is theoretical not therapeutical.

      • July 26, 2016 at 12:13 pm

        robert locke

        You ask me: “… how can you have a systems science that leaves morality out of the system?”

        The Is/Ought difference is reasonably clear since Hume but, beginning with Adam Smith, it has been mostly ignored by economists. It is important to realize that Smith wrote The Theory of Moral Sentiments before The Wealth of Nations.

        Science voluntarily restricts itself to the Is and leaves the Ought to philosophers/priests/mythologists/politicians/storytellers. Why? Because Is-questions have a general objective answer (= true/false) while Ought-questions are in the last instance arbitrarily/politically/historically decided within a space/time restricted society. Good/bad were very different things in Athens and Sparta.

        The voluntary self-restriction of science is not something to be criticized as deficiency and juxtaposed against the richness of philosophical/mythical/religious/historical storytelling. The tight focusing on questions that have an answer which satisfies the conditions of formal/material consistency is the very prerequisite of the growth of knowledge.

        You say: “Any economic system that thrives must be rooted in some moral order. Conservative thinkers, great religious teachers, and philosophic thinkers recognize this when they talk about sustaining economic communities.” Yes, the great teachers have taught awesome things to their stupid pupils. On closer inspection, the greatness of the teachings consists of enormously inflated social trivialities (do not kill, steal, lie), vacuous talk about an almost infinite multitude of nonentities (= Pantheon), emotionally charged and neuroticizing dietary/behavioral rules, ridiculous claims of a truth monopoly, threat in the form of prophecy, and of the explanation of the principle of positive/negative feedback, that is, of self-caused reward/punishment in this and the other world.

        Yes, indeed, every society has a moral order. This order, though, is NOT the subject matter of economics. The moral order is the subject matter of sociology and other so-called social sciences.

        The trouble with the founding fathers is that they started off at the wrong foot. The subject matter of Political Economy has been society and not the economy. As enlightened moralist, Adam Smith began to replace the religion-based regulation of society by the principle of enlightened self-interest (which is NOT the same thing as greed and egoism) and mutually beneficial exchange. With Smith, the moral carrot/stick morphed into profit/loss.

        The drawback of Smith’s approach is obvious by hindsight: he was so occupied with moral sentiment that he never figured out how the economy works. And neither did his successors until this day. Economics is a failed science, but NOT because it has nothing to say about the moral social order, just the contrary, economists messed up economics BECAUSE OF permanent pointless waffling about good/bad human nature/behavior/action.

        Science keeps out of the Ought-issues and focuses on the Is-issues. Its very strength lies in focusing on tiny and seemingly insignificant segments of reality (lever, pendulum, falling apples, etcetera) and in leaving the infinite x-dimensional whole to the thinkers/storytellers/agenda pushers of philosophy/religion/politics. What these folks have produced so far is provably wrong. Science does not explain everything, but non-science explains nothing.

        Economics has to explain how the monetary economy works. The economist as scientist has NOTHING to say/blog about the moral order of society. This holds for Orthodoxy AND Heterodoxy. Economists have to fix economics. It is deeply immoral to maintain, defend, and disseminate theories that are known to be false (2014; 2011).

        Egmont Kakarot-Handtke

        Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–20. URL http://ssrn.com/abstract=1966438.
        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

      • July 27, 2016 at 3:13 am

        This is one of the more ridiculous sets of statements I’ve ever read. First, science is not, cannot be a simple look-see the facts, write them down, and then reveal them to the world. Many, many choices are involved in doing science. Where to look what to look at, how to look at whatever is chosen, how to compare those looks with others from other sources, how to share what you think you’ve found, which other research to use for comparison, etc. etc. Since morality is fundamentally about right/wrong scientists are always asking themselves what’s the right, the correct path to find the facts. And then there are the facts. How does a scientists determine s/he’s found a fact? By comparing it to empirical observations, say the textbooks. But which observations, from where, gathered how, through what process, and for what purposes? Just looking at a square meter of earth an observer can identify all sorts of “empirical” results. The issues are which ones to choose for which purposes and how to figure out what each possible combination of data is, if anything. Again a process of choices. Finally, there is the ultimate moral question that each scientist must deal with. What is science, why is it a pursuit worthy of my time and effort, who benefits from science, what moral code should govern scientists? Science is filled with moral choices because humans are moral creatures. They come to believe certain things (like finding the facts) are right, which others (like distorting or covering up the facts) are morally wrong. You claim that science deals with what is, not what ought to be. But the very notion of having a science or being a scientist is all about what ought to be. Science ought to be because it is good; science is worthwhile and valuable, science reveals knowledge. So if science is all about “ought to bes” then how can the results of the work of scientists not also be tied up with “ought to bes?” Including the work and results of “economic scientists.” I agree with you that many economists and most economic theory is not scientific. But clearly not for the reasons you cite. Economics is not scientific because most economists skip over, fail to consider all the questions listed above. They want quick answers, and answers that fit their pre-formed theories without any chance of contradiction. This is not science. This is purely and simply ideology. Ideologues believe their own particular ideology can’t possibly be mistaken and is thus unchallengeable. Science is about constant and unending challenging. In my book this view of science is interesting and worthy of consideration. The sterile view you present is neither interesting nor worthy of consideration.

    • July 22, 2016 at 4:12 pm


      you say: “The idea that an antagonism between classes is built into the economic system, though, rests on an optical illusion.” and I have seen the mathematical derivation of this statement in your papers.

      However, this derivation is under the assumption of zero distributed profits (Y_D=0 and rho_D=0 in your notation).

      I wonder if “class struggle” is exactly about that, ie, the struggle by workers and capitalists to set the value of Y_D vs Y_W ie the rho_D variable.

      I would love to hear your comment on this.


  7. robert locke
    July 26, 2016 at 6:01 pm

    “You say: “Any economic system that thrives must be rooted in some moral order. Conservative thinkers, great religious teachers, and philosophic thinkers recognize this when they talk about sustaining economic communities.” Yes, the great teachers have taught awesome things to their stupid pupils”

    Do you teach your children or students that moral order is not necessary in economics system? If so you are urgently in need of education. Read Huston Smith, The Religions of Man, especially the chapter on Confucius and become enlightened. What you write is tripe.

    • David Chester
      July 27, 2016 at 6:35 am

      Have you ever thought that the most suitable system for a government to run its country, can also be the most ethical one? To my way of thinking these different ideals correspond, so ethics is part of the same problem, and not another one.

      • robert locke
        July 27, 2016 at 5:15 pm

        Make a distinction between government run and the organization of civil society and I would agree with you. I don’t like governments to “run” things, other than to help provide the ethical foundations of a harmonious civil society.

  8. July 27, 2016 at 6:53 pm

    I view economics as a science akin to field biology and theoretical biology up to about 1945. some might say quantum physics is a science—-when shrodinger was assigned the task of deriving the schrodinger euqation using eikonal physics ofr his PhD, he did it, and then said he didnt think it made any sense—just a math excercize. others disagreed, and that equation is still used tho most formalisms now use feynman/dirac/heisenberg approaches (which are basically equivalent. schrodinger equaiton seems more prevalent in either intorudctory courses, or else often highly speculative ‘high theory’ much of which tends to be ignored ior is avoided in ‘polite company’ the way kids wont in general hear about the facts of life in sunday school, this is a ‘moral choice’. people have decided that its immoral to discuss possibly inconvenient truths in public since people need to learn survival skills appro[priate for this world—eg ‘my country right or wrong’ ).

    my view is if one looks at old fisher-wright genetics, old physics, walras, Leontief, Tinbergen, and many others they are no more wrong and non-scientific than Newtonian mechanics , just outdated and only applicable to many fewer phenomena than occurs nowadays. no one even knew what DNA really was until Watson and crick, Delbruck, pauling, and schrodinger. . and most of those people came from physics.

    I think the term ‘natural philosophy’ is better than science because it doesn’t make an. artificial boundary between the objective and subjective. (I think from the tiny bit of Aristotle or plato I read—I don’t read dialgues nor learn much from video lectures or mooc type courses—they pointed this out long ago, as did the Hindus iin the vedas.

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