Debunking Economics, Part XVIII: Response to Criticisms (2/2)

This is the second part of my response to criticisms of Keen’s Debunking Economics. In my previous post* I covered some of the fundamental objections Keen had to neoclassical theory. Here, I will cover Keen’s exploration of alternatives: first, a brief note on dynamics and chaos theory; then a discussion of Keen’s own models; finally, his dismissal of the Marxist Labour Theory of Value (LTV).

Dynamics and Equilibrium

Many economists have argued that Keen’s contention that economists do not study dynamics is false. I agree. Keen does not really address the DSGE conception of equilibrium, which is highly different to the typical conception of a steady state. An equilibrium in an economic model occurs when all agents have specific preferences, endowments etc. and take the course of action which suits them best based on this. This can be subject to incomplete information, risk aversion or various other ‘frictions.’ These agents intermittently interact in market exchanges, during which all markets clear. Basically, ‘solving for equilibrium’ means you specify the actions and characteristics of economic agents, then see what happens when markets clear. It’s entirely possible that the subsequent model could exhibit chaotic behaviour.**

Now, there are obviously many problems here. The fact is that the overwhelming majority of people who learn economics will not touch this. They will instead be faced with static-style equilibrium models, which they have been told are unrealistic but ‘elucidate certain principals.’ This is nonsense – they elucidate nothing, and simply need to be thrown out. Nevertheless, many policymakers, regulators and business economists are working under this framework. Furthermore, even those economists who have gone beyond this level seem to have the concepts deeply ingrained into their minds, and regard them as useful.

However, even the more advanced ‘dynamic’ equilibrium clearly has problems. First, the presence of irreducible uncertainty – which, as far as I can see, is a concept entirely misused by economists – means that it is virtually certain not all expectations will be fulfilled, while equilibrium assumes they will be. Second, ‘fulfilled expectations’ is far stronger than economists seem to think – for example, it eliminates the possibility of default! Third, the assumption that all markets clear is obviously false, otherwise supermarkets wouldn’t throw out old food. Anyway, I digress: Keen could easily address all of these criticisms, but for some reason he doesn’t. This is indeed a shortcoming of his book.

Keen’s Models

First, a brief note on Keen’s model of firm behaviour: it seems to make the error of maximising the growth rate of profits, rather than profits themselves. I am not sure if this has been fixed. Nevertheless, I regard it as subsidiary to Keen’s main criticisms. His most important model is the Minsky Model of banking and the macroeconomy.

Keen recently had a debate over his Minsky Model with the Cambridge economist Pontus Rendahl. Andrew Lainton has a  post on this, along with a contentious discussion with Rendahl, over on his blog. In my opinion, Rendahl – though overly dismissive in tone, and not causing as many problems for Keen as he seemed to think – highlighted a number of issues with Keen’s model in its current form:

(1) Say’s Law holds. In Keen’s model, income is simply a function of the capital stock, and there is no role for demand.

(2) In what was generally a model set in continuous time, which used ODEs, there is an equation which uses discrete time intervals. Such equations cannot be solved in the same way, so Keen’s methodology is inconsistent.

(3) There is, as of yet, no role for expectations in Keen’s model.

(4) Rendahl argues that DSGE models are also Stock Flow Consistent (SFC). I think he is correct – see, for example, his own paper, which has agents accumulating stocks of money from previous periods. The major differences between SFC and DSGE appear to be: a lack of micro foundations; continuous functions; use of classes; market clearing; fulfilled expectations; and, of course, with Keen’s, the role of banks and private debt.

In terms of assumptions, I’d say Keen’s model is in the ‘heuristic’ stage – it’s not  completely right and needs development. The criticisms are essentially things that have not yet been added to the model, rather than conceptual or logical problems (save the inconsistent equation). This means they can be added as it develops. However, if the model makes good predictions, it may prove to be useful, even though that should never serve as a barrier to making it more realistic and comprehensive.

Labour Theory of Value

If neoclassical economists want a lesson in how to respond to a critique you strongly disagree with without being vitriolic and dismissive, then they need look no further than the marxist responses to Keen’s critique of the LTV. This is all the more ironic given said economist’s willingness to dismiss marxists as illogical and dogmatic.

Keen’s critique is threefold, so I will discuss it briefly, followed by the marxist responses.

The first critique  is Bose’s commodity residue. The idea is that no matter how far you go back in time, disaggregating a commodity into what was required to produce it, there will always be a commodity residue left over. Hence, no commodity can be reduced to merely labour-power. The problem here is the projection of capitalism into all of history. For Marx, a commodity only resulted from capitalist production. However, if you go back in time you will find non-capitalist production, and eventually you will be able to reduce everything into land/natural resources and labour, which Marx never defined as commodities. Having said this, one question remains: can the natural resources or land not be a source of surplus value? Could this surplus value not have been transferred into capitalist commodities?

Second is Ian Steedman’s Sraffian interpretation of Marx. Simply put, it seems Steedman had his interpretation wrong – Marx’s is not a physical, equilibrium system based on determining factor prices. This is something that actually struck me on the first read of Keen’s LTV chapter: Steedman simply converts Marx into Sraffian form without much justification. If Marx did not intend this to be the case, the criticism is defunct from the outset.Hence, it follows that Steedman’s model is simply a misinterpretation of Marx, and it is not even necessary to go into the maths. There is, of course, a possibility that this is an overly superficial interpretation and I am mistaken.

The third criticism is that Marx’s treatment of use-value and exchange-value is inconsistent: properly applied, it implies that a commodity’s use-value can exceed its exchange value, and hence be a source of surplus value. Now, I remain unsure of this area so I might be wrong in my exposition, but here is my attempt to explain the Marxist response: (warning: the following paragraph will contain a vast overuse of the word ‘value’ in what is already a necessarily convoluted explanation).

Marxists contend that Keen’s is a misinterpretation of use-value, which is simply a binary concept and not quantifiable. Something may have any number of uses which give it a use-value, which is a necessary condition for it to have an exchange-value. However, the exchange-value cannot ‘exceed’ the use-value, because the use-value cannot be measured. It is in this sense that labour is unique in Marx’s conception of capitalism: its specific use-value is the production of surplus for capitalists. It is the only ‘factor of production’ that can do this – after all, capital ultimately reduces to past labour value. If production could take place without labour, prices would fall to zero and, while Marx would be refuted, nobody would care because the problem of economic scarcity would vanish. Hence, surplus production and profits depend on labour producing more than it is rewarded.

I remain neither convinced of the LTV, nor of its critics.*** For me, most discussion of the LTV appears to rest on the LTV as a premise. The debate is split into people who accept the LTV and people who not only reject it, but see no need for it. For this reason, critics seem to misrepresent and misinterpret it continually – a common theme is to try and abstract from historical circumstance, when it’s  clear Marx emphasised that his analysis only applied under capitalism, which he saw as a particular social relation. For me, the main issue remains the same as it is for other theories: what is the falsification criteria for the LTV?

Overall, a couple of points stand out for post-Keynesians for their own theories, both of value and economic systems. The first is that DSGE models are probably not that different to some heterodox models, and identifying the actual differences is crucial to opening up a dialogue between mainstream and heterodox economists.

The second is that I would caution left-leaning economists not to be too hasty to dismiss Marxism as dogmatic (in my experience marxists are anything but), or avoid it simply out of fear of being dismissed themselves. In my opinion, the LTV – while not entirely convincing – is a cut above the neoclassical ‘utility’ conception of value, and I’d sooner be equipped with Marxist explanations of a crisis when trying to understand capitalism. This isn’t to say post-Keynesians haven’t thought about Marx; moreso that the issue is often approached with a degree of bias. At the very least, the distinction between use-value and exchange-value is something that befits post-Keynesian analysis well.

So, as far as theory goes, this is the last post on Keen’s book. I will, however, do some closing notes from a more general perspective. As I said before, if there are any other criticisms of Keen that I have not covered, feel free to discuss them in the comments.

*It is worth noting that in my previous post I was somewhat – thought not totally – off the mark with my discussion of Keen on demand curves. The Gorman conditions for the existence of a representative agent do indeed have many similarities to the SMD theorem and conceptually they are dealing with the same issue: aggregation of preferences. Nevertheless, Keen weaves between the two, when it would have been more accurate to note economists have used two (main) different methods to get around the problem, and critiqued them separately. Similarly, though Keen’s quote from MWG was incorrect, it is true that economists such as Samuelson have used the assumption of a dictator to aggregate preferences. However, the specific one Keen presented was not right.

**However, that does not make it the same as chaos theory.

***For me, claims that worker ownership of production would be desirable don’t really rest on the LTV; instead, the simple point is that workers could employ capital themselves.

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  1. #1 by Min on December 28, 2012 - 5:31 pm

    “An equilibrium in an economic model occurs when all agents have specific preferences, endowments etc. and take the course of action which suits them best based on this.”

    OK, I’ll bite. What is equal in this “equilibrium”?

    “Keen’s model of firm behaviour: it seems to make the error of maximising the growth rate of profits, rather than profits themselves. I am not sure if this has been fixed.”

    Well, from where I come from, as a game player, that seems rational, not an error. See Bernoulli and Kelly. If you aim to maximize profits themselves, you go broke. It may not be obvious, which is why you need Bernoulli and Kelly’s math, but to maximize expected growth, you have to stay solvent. Getting greedier than that is a route to the poor house. (Not that people are rational, OC, but they generally try not to go broke, and they care about return on investment.)

    • #2 by john77 on December 28, 2012 - 6:14 pm

      What a firm is *supposed* to do is to maximise the expected, discounted to the present day, value of future net cash flow from profits. Maximising profits involves double-counting those profits reinvested to generate future profits. Maximising the rate of growth in profits is (i) very sensitive to the starting point so one gets the most impressive result by reducing current year profits to one penny above breakeven (or 51 pence if accounts are rounded to the nearest £ or £501 if they are rounded to the nearest £k etc). Also maximising growth rate involves gearing up ridiculously with borrowed money past the point that one’s bank will tolerate (and many, hopefully mos,t companies have a constraint on gearing ratios in their articles of association).
      I don’t care what Kelly’s maths says, maximising profit doesn’t make you go broke *unless* you insert an additional set of constraints.

    • #3 by Unlearningecon on December 29, 2012 - 3:29 pm

      OK, I’ll bite. What is equal in this “equilibrium”?

      I guess each market is in ‘equilibrium’ in that it clears. But not really; it’s just a confusing misuse of the term

      Yeah, you don’t maximise profits – you maximise discounted profits. But it doesn’t make much sense to maximise the rate of growth of profits either, as that could similarly bankrupt you in the short term.

  2. #4 by Steve on December 28, 2012 - 7:10 pm

    If the rules of one of the most deeply embedded AND EVER PRESENT REALITIES of commerce, namely cost accounting, makes the entire economic system price inflationary and hence monetarily deflationary for individuals….then it is flawed and destabilizing of the entire system and will remain so until a policy is crafted to overcome it. Furthermore, the only way to overcome such a necessary systemic discipline as cost accounting….is to bypass the economic system altogether and distribute the monetary solution directly to individuals. And of course to keep the system stable throughout the entire process from production through to retail sale one must institute a compensated retail discount to consumers to address the inevitable cost push and demand pull inflation that is inherent in a profit making system itself.

    • #5 by john77 on December 28, 2012 - 7:35 pm

      i presume that by “cost accounting” you mean “historic cost accounting”, in which case I can point out that this system is not, per se, inflationary. For the first three hundred years of its existence, inflation was primarily a temporary effect of war or harvest failure, which was subsequently reversed during times of peace and/or plenty. Inflation has only become endemic since WWII. One of the major flaws of historic cost accounting is that it gives a heavily distorted, rose-tinted picture during periods of inflation.
      Historic cost accounting is a victim, not a cause, of inflation.

      • #6 by Steve on December 28, 2012 - 7:40 pm

        Actually I’m referring to the EFFECTS of the conventions of cost accounting. Those effects are price inflation and so monetary deflation for the individual.

      • #7 by john77 on December 28, 2012 - 8:47 pm

        No, they are not.
        As I pointed out, but you seemingly did not bother to read, there was no net inflation for over 80% of the life of historic cost accounting since the invention of double-entry book-keeping.
        You are ignoring reality.
        In an environment of pre-existing inflation, taxation on profits distorted by the use of historic cost accounting can force companies to raise prices to avoid bankruptcy but the accounting convention does not *cause* inflation and if taxation is based on *real* rather than nominal profits, it is neutral.
        Only an idiot, or Alastair Campbell, would blame the accounting system for real-world effects.

      • #8 by Unlearningecon on December 28, 2012 - 8:53 pm

        Sorry but this is an off topic conversation and considering you two are my most enthusiastic commenters, I expect it to go on for some time. Not to mention that the word ‘idiot’ has already used.

        Please wind it down or stay on topic!

      • #9 by john77 on December 28, 2012 - 10:57 pm

        Sorry: got distracted by monumental stupidity when I went onto site to comment on LTV which assumes that a stale apple on a market stall is worth more than a fresh one picked off a tree.

      • #10 by Min on December 29, 2012 - 5:44 pm

        Unfortunately I don’t have a reference, but the first hockey stick graph I ever saw, back in the ’80s, was of inflation of the British pound. The takeoff point was around 1750. Since then I have always thought that the Industrial Revolution had a lot to do with that.

      • #11 by john77 on December 29, 2012 - 7:09 pm

        My schedule of historic purchasing power is buried under a pile of papers. A quick hunt gives:
        http://www.parliament.uk/documents/commons/lib/research/rp99/rp99-020.pdf with a table starting from 1750 on page 11 and a hockey stick graph on page 2 of
        http://www.bankofengland.co.uk/publications/Documents/speeches/1999/Speech44.pdf
        The graph shows two major blips for the Napoleonic Wars and the First world War (other wars are barely visible) and a hockey stick starting nearer 1950

      • #12 by Hedlund on December 29, 2012 - 7:31 pm

        LTV which assumes that a stale apple on a market stall is worth more than a fresh one picked off a tree.

        …I don’t even know where to begin. Where in the world did you come across that notion?

      • #13 by john77 on December 29, 2012 - 9:01 pm

        I got it from LTV
        Calculate the value of the apple on the stall using LTV: it is that of the labour involved in transporting it to the stall (appropriate %ages of the lorry-driver, the picker, the sorter, the packer, and tiny fractions of those who built the lorry and extracted and processed the oil, plus a share of the stall-holder’s time *plus* the value of the apple on the tree.

      • #14 by Hedlund on December 29, 2012 - 10:19 pm

        I got it from LTV

        I’m not familiar with that source. Are you saying “I assumed this is what the LTV they’re discussing must be and then proceeded accordingly”?

        Check it: that is an extremely naive LTV you’re employing. Not only does it fail to consider determinants like demand and physical depreciation, but it’s not even using a tenable concept of labor values; distinctions like “social,” “necessary,” and “abstract” don’t even enter your picture. The version you’re using is the sort that gives rise to “mudpie”-style critiques. (“I spent as much time and money making these mudpies as you spent making those apple pies — the LTV would say they command the same price!”)

        It’s remarkable to me that people assume thinkers as well-read and thoughtful as Ricardo and Marx would have missed critiques so elementary that basically anyone could think them up after hearing an inadequate summary of the theory.

      • #15 by john77 on December 29, 2012 - 10:59 pm

        “that is an extremely naive LTV you’re employing”
        Sound of corner being knocked by goalpost!!

      • #16 by Hedlund on December 29, 2012 - 11:12 pm

        Just in case it needs to be said, I’m using a goalpost that was set literally more than a century before I was born. If your remark has any meaning at all, it’s that you’re kicking a ball even older still.

      • #17 by Unlearningecon on December 29, 2012 - 11:42 pm

        If your remark has any meaning at all, it’s that you’re kicking a ball even older still.

        To extent this already horrific metaphor even further, said ball is being kicked at a man (Marx) made of straw.

      • #18 by Min on December 30, 2012 - 3:47 am

        Thanks for the refs, John. :) Plainly I misremembered.

      • #19 by Will on December 31, 2012 - 4:12 am

        “It’s remarkable to me that people assume thinkers as well-read and thoughtful as Ricardo and Marx would have missed critiques so elementary”

        Marx was extraordinarily well read, but I think Ricardo was versed in just Adam Smith, James Mill, Malthus, Say, and his other contemporaries. Happy to be proved wrong. But what really stands out when you read Ricardo is the originality of his thought.

  3. #20 by inthesaltmine on December 28, 2012 - 9:20 pm

    When you ask “What is the falsification criteria for LTV?”, I am inclined to reply that this question is a bit misguided insofar as it misunderstands 1) the scope of the LTV and, more generally, 2) of what Marx sought to do and how he thought of his critique of political economy in relation to science where the falsification criteria is a big deal. There have been some instances where Marx’s method is referred to as an “inexact science”.

    Regardless of whether or not you agree with this, the descriptor is there to distinguish the Marxist science from the physical sciences. A similar problem is found in psychoanalysis, and for this reason you find many Althusserian schools of Freudo-Marxism. Marx, to be sure, was carrying out a particular project.

    Moving on, Marx himself defined his science as the project of uncovering that which is not evident upon direct, albeit socially mediated, observation, i.e. uncovering the true relations that compose the social and material phenomena of our world. This “revealed” object of study in Marx is class antagonism, whereas in psychoanalysis is the unconcious. In other words, Marx’s scientific methodology is a matter of dialectical materialism and historical materialism.

    ‘Real’ and ‘true’ (i.e. uncovered by the science) for him were valid categories insofar as phenomena with these attributes are socially composed (….and thus actually existing). One may contrast this with the ‘illusory’ or ‘false’ explanations of phenomena that tear them from human social-historical-geographical context and regard them as eternal, ahistorical, or otherwise essential things that compose our world while being fundamentally divorced from it.

    IHe most certainly didn’t argue for an exact equivalence between his project and the physical sciences project (hence, the term ‘inexact’), but going off of the above definitions its clear how strong connections between the two can be identified. Marx’s science is concerned with identifying social relations; the physical science with physical relations. Marx’s objects of study are only temporarily discreet and tend to come in and out of focus as one relation or another is considered; physical objects of study, following the likes of Kuhn, are temporarily discreet and changing in nature as one or another disciplinary paradigm considers them.

    The main difference, I suspect, is the role of the observer. In the Marxist project, the observer is an active element that defines and is defined by interacted objects, while in the physical project the observer plays a passive, though still ideological and framing role. Insofar as Marx’s project in general, and the LTV in particular, are of a broader scope than mere physicality, the question is perhaps ill-posed. The physical laws of nature do not have much to do with “lived-experience” or phenomenology, about phenomena such as the way we love, etc. I would imagine economics finds itself in a similar difficult position of being in-between both hard and soft science, which goes to show yet again how Marx’s science is appropriate in the context of a critique of political economy.

    I would highly recommend Althusser’s “On Marx and Freud” for a very clear analysis of Marx’s science. I would also like to invite you to read the many Marxist responses to Popper’s criticisms, as well as responses to Popper in philosophy of science: Kuhn, Lakatos, Laudan, etc. Thank you for your work.

    • #21 by Unlearningecon on December 31, 2012 - 10:35 pm

      This is a good comment if you eliminate the first paragraph. But I’m not sure how the rest of it relates to the irrelevance of falsifiability for the LTV.

      It seems to me that some Marxists, such as here, have tried to evaluate the LTV in a scientific manner. I don’t see how this is incompatible with the approach you outlined above.

  4. #22 by Steve on December 29, 2012 - 1:09 am

    My final reply on this thread unless unlearning econ. allows us more, and which I’m entitled to considering john77 has twice called me a name though unprovoked:

    You presume to know all of the statistical ins and outs as well as the history of cost accounting and its effects….and yet you’ve missed the clear and empirically undeniable effect of the cost accounting fact that labor (all wages, salaries and dividends that have or will ever be produced) is only a fraction of all costs…and yet ALL costs must go into prices. That is the definition of price inflation and its effect on the individual is monetary deflation. It is systemic and hence ever present and so a root cause of our economic and monetary problems, and finally it is a commercial REALITY, not a flimsy THEORY like Quantity or Velocity….THEORIES. Thank you for allowing me to make these FACTS clear.

  5. #23 by Hedlund on December 29, 2012 - 3:28 am

    The problem here is the projection of capitalism into all of history. For Marx, a commodity only resulted from capitalist production. However, if you go back in time you will find non-capitalist production, and eventually you will be able to reduce everything into land/natural resources and labour, which Marx never defined as commodities.

    I disagree with the bit in bold; in fact, one of the modes of production Marx contrasted with capitalist production was “simple commodity exchange” (or the “C-M-C” circuit writ large, which labor continues to use as a capitalist class emerges). It’s easy to overlook this, since a commodity is the necessary result of capitalist production. But it can also result from other productive relations, so long as the result is something is produced for the express purpose of sale on a market.

    The rest of the paragraph holds up, otherwise.

    Your stance on the LTV is not without merit; I’d actually be more concerned if you just accepted our explanations without posing questions and concerns of your own. Indeed, any and all theories should be approached with just such a skeptical eye, if science has any hope of moving more in line with Popper’s vision than Kuhn’s. If time and interest align such that you find yourself exploring Marx’s writings firsthand (especially Capital, or the much [much] shorter Value, Price and Profit, for instance), you may find his thorough treatment of the matter more satisfactory. Or, then again, you may not. But I appreciate the degree of open-mindedness you’re bringing to the inquiry, regardless.

    As much as I love debate, I don’t intend to harp endlessly on this matter — consider Churchill’s dictum about the fanatic — but I will make one more observation about why the LTV seems sensible to me: When we discuss “labor,” there tends to be a sort of connotative tendency to think of sooty men in coveralls and safety goggles, of sweat and blood and toil. In a sense, this fits, but it’s still a fairly narrow view of the matter. Labor isn’t necessarily the brute application of strength; it is also engineering, physical or mental finesse, and any other sort of activity that takes some combination of time and/or effort. And when we discuss purchasing a commodity, there is always an unspoken entrant on the market: that is, competing with all other sellers is the implicit merchant charging exactly what it would cost to just up and make the thing yourself, accepting (at least a portion of) payment in terms of time instead of money. Market exchange always is nearly always subject to this, and, interestingly, many if not all of those times that it is not — e.g., if the object for sale is something unique and not reproducible, like a centuries-old piece of artwork — are instances outside of the LTV’s particular scope.

    Thus “labor” theory of value paints a particular sort of picture, but in the broadest terms it could also be framed as a sort of “(applied) time” theory of value, or perhaps more simply a “how much trouble a thing is to get” theory of value.

    Anyhoo, thanks for the discussion so far!

    • #24 by Unlearningecon on December 30, 2012 - 5:08 pm

      I disagree with the bit in bold; in fact, one of the modes of production Marx contrasted with capitalist production was “simple commodity exchange” (or the “C-M-C” circuit writ large, which labor continues to use as a capitalist class emerges). It’s easy to overlook this, since a commodity is the necessary result of capitalist production. But it can also result from other productive relations, so long as the result is something is produced for the express purpose of sale on a market.

      Fair enough.

      I will be starting with W, P + P. It will probably be some time until I move onto capital (I expect after I’ve finished my degree) but I’ll get there eventually. I find your fourth paragraph quite convincing. That human effort is ultimately the source of value could, in many ways, be thought of as a truism: take away the commodity, and labour can produce it given enough time. Take away labour and we will remain in a stationary state.

      No doubt I will talk about this more in due time. But for now I am looking to take a break from talking about Keen’s work. Many thanks for your comments on the LTV.

  6. #25 by Steve on December 29, 2012 - 5:57 pm

    In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.[1] Blanchard (Glossary) When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money

  7. #26 by Steve on December 29, 2012 - 8:58 pm

    Your tables and statistics obscure more than they enlighten. Take away all of the central bank injections and the hockey stick would occur and be apparent immediately and repeatedly in your chart. The “necessary” build up of debt to keep the system “functioning” is the Keynesian “answer”, and the elimination of the FED is the Austrian “answer”, but neither one acknowledges the more underlying effects of cost accounting’s conventions…..which ARE real and would be obvious if again, you stopped all of the central bank injections. So its one big long term ponzi scheme dips and collapses on schedule, and that could be permanently resolved by the citizens dividend and the compensated retail discount.

    The hockey stick is actually still right there staring you in the face in your chart anyway. Your chart actually shows the acceleration of technological innovation and its capital intensive and so necessary price effects has only really started to accelerate since WW II, and is exacerbated of course by the financialization of the economy. These facts mirror the underlying problems: Cost accounting’s conventions applied to technology’s necessarily Capital intensive effects on costs in comparison to individual incomes (inflation) and both the monopoly on credit by Banks, central banks and their poodles the various governments of the world, and also the failure to evolve the the consumer financial paradigm from loan ONLY to Dividend and loan if desired and creditable.

    Replace the central bank injections with a citizen’s dividend and institute the retail discount and…..problem solved.

    UE comments: Please stay on topic. I will delete any other subsequent comments in this thread. Repeated violations will give me no choice but to ban

    • #27 by Steve on December 30, 2012 - 1:51 am

      Fine. I’ve already made my point…for anyone open enough to receive it.

      • #28 by Unlearningecon on December 31, 2012 - 10:24 pm

        No harm done Steve, it’s easy to get off topic. Just bear in mind you have done something similar on a fair few posts.

      • #29 by Steve on January 1, 2013 - 2:02 am

        Thank you unlearning. I appreciate that. If I may, however, I would like to ask a question. If a problem is systemically ever present, and if that problem is in fact a part of the “woof and warp” of the system itself in its considered normal operation…how can it not be a root cause? This is where john77 I believe mistook what I was saying. He claimed that accounting itself was not to blame. I actually agree with this. I was referring to the flawed EFFECTS of some of the rules of cost accounting, not accounting itself which of course is a necessary thing.

        To return to my question though,..If a problem/flaw that is always operational in the economy, that is commerce itself, do its EFFECTS being even more basic REALITIES than any and all economic THEORY ABOUT the economy/commerce…. not underlie any and all theory itself…and consequently never in fact be irrelevant?

  8. #30 by amarxist on December 30, 2012 - 1:06 am

    As a Marxist, I appreciate your ability to openly(yet still critically) consider concepts that you initially disagree with.

    You ask about the falsification criteria for the LTV. One might be if wealth appeared without the labor,living or dead(dead labor is capital), of a human being. This doesn’t seem to be a problem unless you believe God is aiding the production of widget or whatever. If widgets replicated themselves whenever you exchanged them then the LTV of would not hold. If some commodities are not exchangeable with other commodities then the LTV would not hold. All of these examples seem ridiculous but that speaks to how grounded the LTV is.

    I don’t know exactly what you mean by falsification criteria though. Instead of asking about the falsification criteria, instead we should ask “Is this theory logically sound? Is it internally consistent? Is its description of its subject in accordance with the reality we observe? Is it applicable universally?” I think Marxian economic theory fits all these criteria. I would abandon it, however, if capitalism displayed stable, equitable growth free of crisis. Fortunately for Marxian theory and unfortunately for humanity, this is not the case.

    • #31 by Unlearningecon on December 30, 2012 - 5:02 pm

      However, there are many other reasons capitalism could tend to crisis, all of which are logically consistent (private debt/Minsky, some variants of ABCT, Keynes, monetarism).

      I think the tendency for the rate of profit to fall is probably the most testable implication of the LTV. I am unaware of work on it: it is often referenced by critics of Marxism as self-evidently false, but I am inclined to think that is based on a straw man.

      • #32 by amarxist on December 30, 2012 - 6:00 pm

        Well I have issues will all those other theories, but that is a topic too lengthy to be discussed here. Of course, I think the validity of these theories shouldn’t depend just on how well they describe crisis, but on how well they describe capitalist society as a whole. I think Marxist theory wins on this count.

        I agree that the tendency for the rate of profit to fall is a good “test” of marxian economic theory. The Failure of Capitalist Production by Kliman tries to show this for the U.S. for our most recent recession. I’d recommend it if your interested. Sadly lack of good data prevents us from carrying out this analysis too far in the past or in certain countries.

      • #33 by Hedlund on December 30, 2012 - 8:05 pm

        Yeah, I second The Failure of Capitalist Production as a pretty important work. It can be thought of as a sort of an empirical sequel to his previous, theoretical Reclaiming Marx’s Capital. Basically the former takes the analytical apparatus expounded in the latter and applies it to the U.S. numbers from the great depression to the present.

  9. #34 by Will on December 31, 2012 - 6:07 am

    The Bose argument reminds me too much of a pro-LTV argument by Ernest Mandel (can’t find the link) that is basically its mirror image: every non-labor input you can find in a commodity, even assuming the proportion to be large, can be traced back mainly to labor inputs. The fact that these arguments are so similar tells us something.

    With regard to the falsifiability of the LTV, I’m with you. It needs to be falsifiable to be entertained. It strikes me that the approach undertaken by Anwar Shaikh — testing whether labor inputs are correlated with prices across the economy — is perhaps the best way to approach it. From this perspective, Ricardo’s blunter version of the theory actually may be more useful than Marx’s extremely nuanced and logically worked out version.

    With regard to “land” and other things like it, both Ricardo and Marx do address this at length. I have a poor history of explaining their arguments in comment sections, and so will leave it to others.

    • #35 by Unlearningecon on December 31, 2012 - 10:23 pm

      Yeah that’s far more powerful. Labour is transhistorical while capital/commodities are not, so if you are going to travel back through time disaggregating goods it clearly makes more sense to use labour as a yardstick.

  10. #36 by Steve on January 1, 2013 - 2:07 am

    Should we not have an accounting of the EFFECTS of cost accounting? And if there is a flaw in its effects, should it not be corrected?

    • #37 by Hedlund on January 1, 2013 - 7:30 am

      As long as this matter has, it seems, been reopened (with apologies to UE if I am wrong)…

      @Steve:

      I don’t think anyone objects to fixing flaws. I think the problem is that, without trying to be harsh, those trying to learn exactly what flaws the social credit types have detected in cost accounting system do not always get clear answers. I recall a month or two ago I was discussing this at length with you, and after numerous requests for examples, numerical or otherwise, none were forthcoming. It took almost a week of persistent queries to even encounter the name C.H. Douglas. So I think it would be helpful if, going forward, discussion could focus less on “how correct you are,” and more on “how you are correct.”

      Another problem is that, from my readings since then, I don’t see how Douglas or his followers have made any substantive point that has not been made better elsewhere. For instance, for all the emphasis on accounting and the role of banks, you’d get a much clearer and more comprehensive overview from a Godley-style stock-flow consistent model. Certain people (*ahem*) had observed the role of profits in crisis before Douglas was even born.

      Here’s what I suspect to be his most complete statement on the causes of underconsumption, from “The New and The Old Economics”:

      Categorically, there are at least the following five causes of a deficiency of purchasing power as compared with collective prices of goods for sale: –
      1. Money profits collected from the public (interest is profit on an intangible)
      2. Savings, i.e., mere abstentation from buying
      3. Investment of savings in new works, which create a new cost without fresh purchasing power
      4. Difference in circuit velocity between cost liquidation and price creation which results in charges being carried over into prices from a previous cost accountancy cycle. Practically all plant charges are of this nature, and all payments for material brought in from a previous wage cycle are of the same nature.
      5. Deflation, i.e. sale of securities by banks and recall of loans

      In more general terms, 1 is surplus value, 2 is hoarding, 4 is intertemporal concerns, 5 is endogenous money. I don’t think any of these are new ideas. (To his credit, he was writing about 5 at a pretty early date; still, he was by no means the founder of the feast.)

      Item #3 is odd to me; savings is already considered to be “out” of the system by dint of #2. Thus, unless we count said investment as new money in the system (and therefore new purchasing power), we’re already double-counting. Even setting that aside, the money invested is used to pay workers and buy capital, so rather than lacking purchasing power, it could be said that the purchasing power effectively precedes the prices; for instance, you can choose to think of it as an imaginary set of goods being bought in a previous turnover. If that is problematic in and of itself, then one supposes it belongs in #4. And, assuming that this is someone investing in his own business, to avoid the complication of interest, all of those prices break down to profit (or #1), labor, capital (profit, labor, et al at some other enterprise), etc., which all address themselves appropriately. So I’m not even sure 3 deserves its own entry. Can you make sense of it?

      Finally, I know you disagree with the quantity theory. I broadly agree with you. However, setting aside for a moment how the money comes to be there, it is demonstrable that more dollars chasing a fixed quantity of goods can be inflationary. If we’re viewing the social dividend as making up for the purchasing power lost from surplus, hoarding, broad money destruction through banks, etc, then consider this: Let’s say the total price (P) = A + B [as per Douglas's notation]. A becomes purchasing power (salaries, wages, etc). For now, let’s suppose that B exclusively pays off bank debts and thus is effectively destroyed. Since A < P, as I understand the argument, we'd need social dividend equal to B to bring purchasing power back into alignment with prices. But the thing is, that B still exists in a sense; that is, with its balance sheet cleared of the assets and liabilities associated with B, assuming its capital adequacy hasn't gotten any worse, the banking system is empowered to lend B again. Which means now the equation can expand to P+B = A+2B. Maybe that second B is a good thing; that could be growth in the event that there's untapped productive capacity to absorb it through expansion. However, under conditions of full factor utilization, that B will to some extent represent inflation, right? Alternately, suppose 1B is hoarded, and this exerts no pressure on prices. Good. But lest we forget, we've specified hoarding as one of the things the dividend is compensating for! Thus, the next social dividend would be 2B. What to do? Hoard it? Surely you see where this is going: the social dividend brings purchasing power in line with costs, but just below the surface exist huge hoards of cash and clean balance sheets ready to expand total purchasing power far and away beyond cost.

      I'm trying to figure out how all of this holds together, but the position just seems kind of… clumsy, at best. I am open to the possibility that my interpretation of some or all of these details is mistaken. So, if you would be so kind, could you please elucidate for me these matters raised above? Please go into as much detail as you like.

      Thanks in advance.

      • #38 by Steve on January 1, 2013 - 7:10 pm

        Thanks for the reply.

        Investment of savings in new works, which create a new cost without fresh purchasing power”

        Savings is not in the economy proper when it is savings and so is a reduction in purchasing power.. When it is re-invested it is immediately subject to the rules of cost accounting and hence a scarcity of purchasing power in relation to prices. This is a “reality” of commerce/the economy that is “always” in effect. Once you recognize the ever presentness of cost accounting’s rules and their effects (a scarcity of total individual incomes in relation to total prices) you realize that any and all scenarios of money’s re-circulation through or remaining actually in the economy in any way….are “always” subject to its effects. I’m not saying that there cannot be other problems, or other ways that inflation occurs, and hence the erosion of individual purchasing power/business profits. That’s why Douglas said “There are at least…” There are other ways. But the most underlying cause of same are the effects, the realities that the rules of cost accounting constantly enforce on every dollar actually in the economy. And the only way to undo those effects is a direct payment to individuals….because it doesn’t go into the economy/commerce “first” and hence kick in and enforce scarcity as per above. In fact if not compensated for with a direct payment to individuals the scarcity in comparison to prices increases as time goes on. It’s a basic relationship, a basic reality that is being missed and so we suffer the consequences.

      • #39 by Hedlund on January 2, 2013 - 3:34 am

        That addresses almost none of what I asked. You restated my observation about the relationship between #2 and #3, then concluded “rules of cost accounting. Therefore: Reality.” I don’t see how it follows, and your assurances that reality is your homeboy are not enlightening.

        Let’s try again. Say I start a business. I take out a loan for $50 and buy materials. I build something out of them, sell it for $150, and then repay the loan plus interest, so let’s say that’s $55. I have $95 left over. What part of what i just laid out. So in this case, A payments are 95. B payments are 55. Total price is 150. B disappears after the turnover. However, B doesn’t ALL disappear; $5 is interest. That amount represents a transfer to the bank; it’s revenue, and thus someone else’s A payment (abstracting away the capital intensity of banking for a moment). So the purchasing power that disappears is $50. But then again, that purchasing power appeared before it disappeared. And it can appear again. So, this is better explained as the vagaries of endogenous money than some flaw in “cost accounting.”

        In terms of my own income and output, net of the money created before I produced and destroyed after I sold my product, I created $100 of value, of which $95 of which went to me and $5 went to a bank as interest. If I didn’t need the loan, all of it would have gone to me. But this is better explained by surplus value extraction than cost accounting.

        In sum, I don’t see how this example either a) illustrates any magic hitch to cost accounting or b) suggests a system-wide shortage of demand in and of itself. If you disagree, my challenge to you is to explain why without using the words “reality” or “cost accounting.” Just assume I don’t even know what those phrases even mean, and proceed in the most basic, baby’s-first-bookkeeping-lesson fashion.

        Thanks in advance.

      • #40 by Jim on January 3, 2013 - 7:15 pm

        “Item #3 is odd to me; savings is already considered to be “out” of the system by dint of #2. Thus, unless we count said investment as new money in the system (and therefore new purchasing power), we’re already double-counting. Even setting that aside, the money invested is used to pay workers and buy capital, so rather than lacking purchasing power, it could be said that the purchasing power effectively precedes the prices; for instance, you can choose to think of it as an imaginary set of goods being bought in a previous turnover.” (Hedlund)

        Allow me to respond to this concern, Hedlund. Money re-invested back into capital had to have a cost attached to it when it was distributed as purchasing power (ie. the wage, salary or dividend). This cost is part of the price of a good or service sold. You are correct in asserting that if that money is invested in the construction of capital it goes towards the payment of employees which can then restore equilibrium between prices and incomes in the current accounting cycle. The problem is that the said capital’s cost is carried forward into another accounting cycle through depreciation where no additional purchasing power has been created.

        In other words, the money created two sets of costs, but money is only capable on defraying one set of costs. This is the problem that Social Crediters have with the “quantity theory of money”. The theory ignores the fact that most money is created as a debt and has a corresponding cost attached to it as it passes through the productive system. Money flows to and from the bank. It operates in an accounting cycle (or a monetary circuit in post Keynesian terminology). It does not “circulate”. $1 income is only capable of defraying $1 in cost. Money is generally issued against production and withdrawn as purchasing power as goods are purchased for consumption. It can generally only “reappear” again as purchasing power if it passes through the productive system again and then has another cost attached to it. The quantity theory of money is a myth.

        “However, setting aside for a moment how the money comes to be there, it is demonstrable that more dollars chasing a fixed quantity of goods can be inflationary.” (Hedlund)

        Your assumption is that the quantity of goods is “fixed”. I think we can both agree that the quantity of goods in existence is also a function of the quantity of money in existence? Douglas’s proposed to increase consumer’s purchasing power due to the fact that there’s a chronic shortage of purchasing power as demonstrated in his A+B theorem. Further, Douglas proposed to actually reduce prices to the consumer via a price rebate mechanism based upon his observation that the true (real) cost of production is consumption over an equivalent period of time (as opposed to the orthodox theory of “opportunity costs” being the real cost of production). So long as consumption is less than potential production over a given period of time, prices can be reduced to the consumer in the ratio of consumption/production.

        Douglas wrote in his first article, “The Delusion of Superproduction”:

        “The factory cost – not the selling price – of any article under our present industrial and financial system is made up of three main divisions-direct labor cost, material cost and overhead charges, the ratio of which varies widely, with the “modernity” of the method of production. For instance, a sculptor producing a work of art with the aid of simple tools and a block of marble has next to no overhead charges, but a very low rate of production, while a modern screw-making plant using automatic machines may have very high overhead charges and very low direct labour cost, or high rates of production. Since increased industrial output per individual depends mainly on tools and method, it may almost be stated as a law that intensified production means a progressively higher ratio of overhead charges to direct labour cost, and, apart from artificial reasons, this is simply an indication of the extent to which machinery replaces manual labour, as it should.”

        In other words, as technology replaces labour in production, B costs increase relative to A costs. If prices = A+B, and B is increasing relative to A due to technological progress, then any attempt to stabilize A (income) has to be met with rising prices – even if consumers have insufficient income to buy back all of production.

        Take care.

      • #41 by Hedlund on January 9, 2013 - 12:25 am

        Jim: Thanks for your considered reply.

        The problem is that the said capital’s cost is carried forward into another accounting cycle through depreciation where no additional purchasing power has been created.

        Sure, but doesn’t this represent what I had described as #4, a.k.a. the complications introduced by time? As such, it still wouldn’t justify the third designation, as far as I can see. It shouldn’t be a “dealbreaker” that at a given, static moment in time there may be more costs than units of PP; with endogenous money and temporal investment, it’s clear that purchasing power and total costs are constantly moving into and out of equilibrium, with now one and later the other being greater — and I would suggest that persistent and fluctuating disequilibria (including intertemporal ones) are key to the understanding of the dynamics and the dynamism of the whole system. Further, I’m not sure how depreciation fits into this explanation. Wouldn’t that represent a decline in total costs?

        In other words, the money created two sets of costs, but money is only capable on defraying one set of costs. This is the problem that Social Crediters have with the “quantity theory of money”.

        You won’t find argument from me that there are serious problems with the quantity theory. I’m still not sure I get the “two costs” explanation, though. Let me see if I’m grasping it: you’re saying that the first set of costs represents the money owed to the bank. Then, once it’s invested, that money creates another set of prices in the form of goods. Is that what you’re saying? If so, then you’re missing an element: when the bank creates the money, it also logs a debt. That’s purchasing power and cost summing — ignoring for a moment interest; I’m sure we both agree it’s problematic, but I would suggest it represents a different problem: surplus value — and then when new goods are created, you have their costs with the distributed purchasing power that went into their production again summing. So you in fact have two sets of costs, AND two means of payment. And this can be extended any number of times, in theory.

        Finally, while the quantity theory is somewhat flawed, it does still have an iota of truth to it for a few reasons. Firstly, the total money banks can create is dependent on capital adequacy, federal interest rates, operating expenses, and a few other odds and ends (credit risk, etc). With low interest rates and an expanding capital base, the amount of money banks can create expands. Over- or under-valuation of capital therefore can have effects on the total quantity of available money relative to demand for it. It’s not impossible for endogenous systems to register inflation; the gold standard was basically endogenous, and that experienced considerable inflation once sailors started hauling back huge hoards of precious metals from the new world. It’s an unusual circumstance, but for the sake of this discussion, I only need to illustrate the possibility.

        Further, though bank money is a considerable part of the whole, the presence of chartal money as free reserves in the system (called the “vertical” component of money creation by MMT folks) represents money created without a corresponding debt. Obviously, there is public debt created alongside it, but that’s not an operational necessity of the system, and said debt actually serves as an asset, anyway, which can be used as capital for further lending, anyway. Thus, there is at least some portion of the total money in the system which might be said to “circulate.” Taxation ultimately destroys this money, but the terms of a political accounting cycle are vastly different from a bank’s, and can and often do wind up with long-term deficits. Tending to those deficits is a voluntary undertaking in a sovereign system.

        Your assumption is that the quantity of goods is “fixed”. I think we can both agree that the quantity of goods in existence is also a function of the quantity of money in existence?

        Absolutely. I was just illustrating a principle, not making any claims as to its regularity or the extent to which we can move directly outward in scope from it.

        Douglas’s proposed to increase consumer’s purchasing power due to the fact that there’s a chronic shortage of purchasing power as demonstrated in his A+B theorem.

        The A+B theorem (and I’m not sure how it’s a “theorem”; from what axioms is it deduced? Can you show the derivation?) still does not appear as decisive to me as it may to you, both in its accuracy and its policy implications. To the extent that it states anything basically true, it does so in an “umbrella” fashion, describing multiple phenomena without differentiating them clearly. Meanwhile, as I said in a previous comment, those phenomena have each been addressed more thoroughly and conclusively elsewhere in the literature. The only thing that struck me as an original claim was #3, but as I keep indicating, every aspect of #3 reduces to one of the other four causes.

        In other words, as technology replaces labour in production, B costs increase relative to A costs. If prices = A+B, and B is increasing relative to A due to technological progress, then any attempt to stabilize A (income) has to be met with rising prices – even if consumers have insufficient income to buy back all of production.

        This is similar to Marx’s observations about the implications of a rising organic composition of capital (or even value composition) for the rate of profit, so my priors make me sympathetic to the perspective. And the conclusions have some compatibility, though he was speaking in different terms. However, I’m still not crazy about the A+B thing. I feel like there is a point at which B stops being sufficiently descriptive of what’s happening, because of what I previously described as its umbrella shape.

      • #42 by Jim on January 9, 2013 - 3:36 pm

        “Sure, but doesn’t this represent what I had described as #4, a.k.a. the complications introduced by time? As such, it still wouldn’t justify the third designation, as far as I can see. It shouldn’t be a “dealbreaker” that at a given, static moment in time there may be more costs than units of PP; with endogenous money and temporal investment, it’s clear that purchasing power and total costs are constantly moving into and out of equilibrium, with now one and later the other being greater — and I would suggest that persistent and fluctuating disequilibria (including intertemporal ones) are key to the understanding of the dynamics and the dynamism of the whole system. Further, I’m not sure how depreciation fits into this explanation. Wouldn’t that represent a decline in total costs?” (Hedlund)

        When you refer to #4, I assume you’re referring to: “Difference in circuit velocity between cost liquidation and price creation which results in charges being carried over into prices from a previous cost accountancy cycle. Practically all plant charges are of this nature, and all payments for material brought in from a previous wage cycle are of the same nature”?

        This is a little complicated to explain especially when people aren’t used to analyzing economics from a cost accounting perspective. What Douglas is saying is that there is a certain amount of time from the time a bank creates a loan, it passes through the productive system to the consumer, is recovered from the consumer in terms of prices or taxes, until the time that money returns to the bank to cancel the loan and the money. Let’s call this the “cyclic rate of circulation of money”. The cyclic rate of circulation of money measures the amount of time required for a loan to pass through the productive system and return to the bank. This can be calculated by determining the amount of clearings through the bank in a year divided by the average amount of deposits held at the banks (which varies very little). The result is the number of times money must turnover in order to produce these clearing house figures. In a testimony before the Alberta Agricultural Committee of the Alberta Legislature in 1934, Douglas said:

        “Now we know there are an increasing number of charges which originated from a period much anterior to three weeks, and included in those charges, as a matter of fact, are most of the charges made in, respect of purchases from one organization to another, but all such charges as capital charges (for instance, on a railway which was constructed a year, two years, three years, five or ten years ago, where charges are still extant), cannot be liquidated by a stream of purchasing power which does not increase in volume and which has a period of three weeks. The consequence is, you have a piling up of debt, you have in many cases a diminution of purchasing power being equivalent to the price of the goods for sale.[23]”

        In other words, because the vast majority of people are basically living “paycheque to paycheque”, it is impossible to liquidate all of these mounting capital costs which may be in existence for decades (through the process of depreciation).
        A more detailed description of this whole process can be found on my blog in an article I wrote entitled “Costs and Time”:

        http://social-credit.blogspot.ca/2010/08/costs-and-time.html

        “You won’t find argument from me that there are serious problems with the quantity theory. I’m still not sure I get the “two costs” explanation, though. Let me see if I’m grasping it: you’re saying that the first set of costs represents the money owed to the bank.” (Hedlund)

        I’m saying the first set of costs exists because if someone received that money as income, said income must have been costed in industry and forms the part of some cost of a good or service. In other words, if I receive the money as part of my salary, my salary forms the part of some cost of good/service I helped create. It has been costed in industry. If I take that money, and re-invest it, and this money is used to purchase some capital equipment, which is then recorded as an asset on the books of some company and depreciated over time, my salary has now created two sets of costs. The first cost it created was my salary itself which is part of the cost of some good (labour expense) I helped produce, the second cost it created was when it was re-invested back into capital via the depreciation of said capital. However, my income can only cancel one set of costs. The money I received created two sets of costs, but it was only distributed as purchasing power once (my salary). The second set of costs was created without the creation of any additional purchasing power.

        I think this is a major stumbling block for economists because they have a hard time understanding the cost accounting perspective of prices and incomes. Let me explain the process from this perspective. Assume there is only one company is in existence. Money is created as a debt, let’s say a business operating on a revolving line of credit. This money is then distributed to people in the form of wages, salaries or dividends. These wages, salaries and dividends form a part of the cost of goods sold. Industry recovers this money from the consumer in the form of prices (the government does the same in the form of taxes – and in this respect taxes and prices serve the same function.) The money then travels back to the bank, the loan is repaid, and the money is cancelled out of existence. We can add more companies to this process, but it doesn’t change the process if we add capital/raw material into the analysis (it only would complicate it at this point), but I want to ensure that you’re understanding what I’m saying at this point.

        I’m going to respond to the rest of your questions in another post because of the size of this response.

      • #43 by Jim on January 9, 2013 - 6:56 pm

        “The A+B theorem (and I’m not sure how it’s a “theorem” from what axioms is it deduced? Can you show the derivation?” (Hedlund)

        Following is the A+B theorem taken from Douglas’s book, “Credit-Power and Democracy”
        “A factory or other productive organization has, besides its economic function as a producer of goods, a financial aspect – it may be regarded on the one hand as a device for the distribution of purchasing-power to individuals through the media of wages, salaries, and dividends; and on the other hand as a manufactory of prices – financial values. From this standpoint, its payments may be divided into two groups:
        Group A: All payments made to individuals (wages, salaries, and dividends).
        Group B: All payments made to other organizations (raw materials, bank charges, and other external costs).
        Now the rate of flow of purchasing-power to individuals is represented by A, but since all payments go into prices, the rate of flow of prices cannot be less than A+B. The product of any factory may be considered as something which the public ought to be able to buy, although in many cases it is an intermediate product of no use to individuals but only to a subsequent manufacture; but since A will not purchase A+B; a proportion of the product at least equivalent to B must be distributed by a form of purchasing-power which is not comprised in the description grouped under A. It will be necessary at a later stage to show that this additional purchasing power is provided by loan credit (bank overdrafts) or export credit “.[6] C.H. Douglas “Credit-Power and Democracy”

        “ still does not appear as decisive to me as it may to you, both in its accuracy and its policy implications.” (Hedlund)
        Can you show me an organization that does not generate more costs in a given time period than it distributes to individuals in income in the same time period?
        “To the extent that it states anything basically true, it does so in an “umbrella” fashion, describing multiple phenomena without differentiating them clearly. Meanwhile, as I said in a previous comment, those phenomena have each been addressed more thoroughly and conclusively elsewhere in the literature. The only thing that struck me as an original claim was #3, but as I keep indicating, every aspect of #3 reduces to one of the other four causes.” (Hedlund)
        What Steve reproduced is some of the “financial causes” of the discrepancy between prices and incomes. At its root, the real, physical cause of the discrepancy between purchasing power and prices Douglas identified in his A+B theorem is the displacement of labour in production through increases in efficiency (technological progress). The “financial causes” of this discrepancy identified in the A+B theorem relate to #3 and #4 in the list that Steve provided. The theorem itself is based upon the observations of reality. This is another problem that I have with orthodox economics: it bases its theories on the way it thinks the world should operate, not on how the world actually operates. Douglas was an engineer. He made an observation and then tested his hypothesis on the accounts of 100 actual businesses. He found that in every case, except those businesses headed for bankruptcy, businesses always charge more in price than they distribute in income. If all companies are charging more in price than they distribute in income, how can consumers buy back all of production? The way we do it now is that we produce more and more goods and services the consumer is not expected to purchase (capital production or military production), or we ship our excess production overseas (current account surplus). By increasing capital/military production, we can use the income distributed in this process to purchase consumer goods on the market now. The problem with doing this is that the cost of this capital/military production eventually makes its way to the consumer in the cost of consumer goods or taxes respectively. Even Keynes recognized the folly of this method of obtaining equilibrium, which is fundamental to Keynesianism. Keynes wrote:
        “Thus the problem of providing that new capital-investment shall always outrun capital-disinvestment sufficiently to fill the gap between net income and consumption, presents a problem which is increasingly difficult as capital increases. New capital-investment can only take place in excess of current capital-disinvestment if future expenditure on consumption is expected to increase. Each time we secure to-day’s equilibrium by increased investment we are aggravating the difficulty of securing equilibrium to-morrow.” (J.M. Keynes , “The General Theory of Employment, Interest and Money”)
        In other words, each time we secure equilibrium between purchasing power and the price of consumer goods using this method, we make it more difficult in the future to obtain equilibrium between purchasing power and the price of consumer goods using this method. Keynesianism is unsustainable.
        The problem with dumping excess production on other countries through a “favorable balance of trade” is that this policy pursued by all countries is a technical impossibility (all countries cannot simultaneously give away more than they produce), and it eventually leads to a trade war, which could ultimately result in a real war.

      • #44 by Steve on January 10, 2013 - 1:47 pm

        Yes, the actual realities of commerce/the economy will trump theory about same. Thanks Jim.

      • #45 by Hedlund on January 10, 2013 - 3:24 pm

        A more detailed description of this whole process can be found on my blog in an article I wrote entitled “Costs and Time”:

        The discussion of how capital is “paid for twice” in here hinges on some highly specific assumptions. The idea that capital inflates consumer goods because people who made it buy consumer goods is telling: consumers are always going to buy consumer goods, because those include food, clothing, and other essentials. Plus, it’s empirically well documented that firms tend to adjust quantity rather than price. Thus, the only way incomes that come from the creation of capital could be inflationary is if we suppose that, had those workers not built the capital, they’d have made more consumer goods. If we’re at the point of asking one another for examples, as you do below, then I would love to see an example of full consumer-sector employment under capitalism (a logical impossibility). The fact is, if we are willing to allow our analysis to proceed through time, then it must be observed that capital, produced means of production, is not the conscious ends of production, but rather a means to an end. You produce capital so you can produce some other commodity more efficiently.

        So if some of the money which might have gone towards producing socks by hand instead goes towards machines to allow one laborer making socks to do the work of five, by your reckoning it would seem that the price of socks rise, since some people were making capital instead of socks. Yet you’ll find the opposite occurs, since productive capital is just the reified form of a change in productive method. Now sock production, instead of requiring ten hand-laborers, needs two hand-laborers and five machinists, freeing up some labor for other activities — including expanded sock production. If anything, this would have a downward effect on sock prices, both in terms of supply and labor-values.

        I’m saying the first set of costs exists because if someone received that money as income, said income must have been costed in industry and forms the part of some cost of a good or service. In other words, if I receive the money as part of my salary, my salary forms the part of some cost of good/service I helped create.

        Perhaps I’m just dumb, but this seems an incredibly silly way to account for costs. Why stop at two sets of costs by this reckoning? Think about it: one set of costs for the investment, one set for the costs that gave me the money to invest, one set for whatever costs prompted the money to wind up there in the first place, and so on. Before long, you’ll have hundreds, thousands, even millions of costs for every unit of purchasing power. One wonders how anyone is ever able to buy anything.

        Rather, I’d submit that the money cannot possibly create more costs than it can cover in the case of invested income. The two costs you list are your income and the amount of your investment out of income. One of those, you say, cannot be extinguished. So which is it? If we choose the former, you’d never have received income to invest in the first place; if the latter, then you’ve abstained from investing, and thus the object of the “cost” is still tapping his foot and waiting for payment, and thus can hardly be said to be a cost at all. Thus, either the money extinguishes both of the costs it “creates,” or the costs never exist in the first place; to suppose otherwise creates a contradiction!

        To my mind, saying investment creates a cost is faulty from the outset. Money doesn’t create money costs in the real sector. Costs are measured in money terms, to account for non-money objectives. If you hire a worker for $80, your having $80 to invest is not the origin on the cost; his labor is. The money just extinguishes it.

        Let me explain the process from this perspective. Assume there is only one company is in existence…

        Yes, I get all of that; in fact it’s exactly what I’m saying. Using only one company does indeed make it clearer. They don’t have external costs, since there’s no one else from whom to buy capital. If we’re treating the single company as an effective governmental entity (since what other hierarchy have we established?), then it’s not a huge leap to excise rents as a cost, since it’d be in a position of fundamental ownership over the bounty of nature. Everything is produced in-house and natural resources have no costs other than that of their extraction — that is, the only costs are labor. Assuming the interest rate on that line of credit is zero, then literally all expenses have to be income. There’s nothing else for them to be; if money moves in this example, it moves to extinguish either a cost of labor or consumption.

        There are no B payments, in this example.

        Following is the A+B theorem taken from Douglas’s book, “Credit-Power and Democracy”

        Yes, I came across that passage online already. I was just nitpicking his use of “theorem.”

        Can you show me an organization that does not generate more costs in a given time period than it distributes to individuals in income in the same time period?

        Can I personally? I don’t have access to any company’s books, so frankly I can’t make either case. Can you?

        My understanding is that in Douglas’s study of 100 companies, he found that A+B was consistently higher than A. However, based on the single-company example discussed above, it doesn’t seem unreasonable to suppose that this is a fallacy of composition; after all, once we account for the whole economy, those mysterious “external costs” cease to be such.

        At its root, the real, physical cause of the discrepancy between purchasing power and prices Douglas identified in his A+B theorem is the displacement of labour in production through increases in efficiency (technological progress).

        I have stated that I agree with this point, but also that it was far better stated by Marx. Ditto for the growing portion of “B payments” — see his critique, in Capital vol. 2, of Smith’s doctrine that all costs reduce to wages (wherein there is a growing mass of circulating capital in Department 1).

        My biggest issue with any of this, given that social creditors are almost certainly touching the same elephant, is the presentation of these matters. Trying to shoehorn everything, including real phenomena, into a financial reckoning just adds to confusion. Also, while I appreciate the level of engagement you’re bringing to this, my previous discussion partner flatly refused to explain his assertions (indeed, the part you claim “Steve reproduced” in fact came from my own efforts to dig for answers when I couldn’t get anything out of him). Plus, as indicated above, some of the reasoning strikes me as sloppy (e.g., Douglas extrapolating from 100 businesses to the nature of the entire macroeconomy taken as a closed system, among other things discussed above).

        This is another problem that I have with orthodox economics: it bases its theories on the way it thinks the world should operate, not on how the world actually operates.

        Preaching to the choir, brother.

      • #46 by BFWR on January 10, 2013 - 4:29 pm

        “Also, while I appreciate the level of engagement you’re bringing to this, my previous discussion partner flatly refused to explain his assertions (indeed, the part you claim “Steve reproduced” in fact came from my own efforts to dig for answers when I couldn’t get anything out of him).”

        My answers were statements of empirical commercial facts (the effects of the rules of cost accounting, i.e. A + B) which one will search for several life times trying to find realistic exceptions to (and fail to find such). Once it crashes home to you that these realities actually ARE realities that CANNOT be overcome by injecting money into commerce before it reaches the individual, the person without another agenda or a predilection for theory over fact, accepts that the solution indeed IS a direct distribution to the individual first.

        “Plus, as indicated above, some of the reasoning strikes me as sloppy (e.g., Douglas extrapolating from 100 businesses to the nature of the entire macroeconomy taken as a closed system, among other things discussed above).”

        If the rate of flow of TOTAL prices always exceeds the rate of flow of TOTAL incomes by cost accounting convention and this statement includes and in a technologically advanced economy obviously nominally negates the conclusions of the anecdotal examples you used….then why would one conclude that the reasoning was sloppy. Theory is fun, but reality is reality and the pragmatic person, like Douglas, is more interested in the best ethical resolution of the problem. Thus his policy prescriptions.

      • #47 by Jim on January 10, 2013 - 7:40 pm

        First of all, Hedlund, thank you for allowing me the opportunity to explain this.

        “The discussion of how capital is “paid for twice” in here hinges on some highly specific assumptions. The idea that capital inflates consumer goods because people who made it buy consumer goods is telling: consumers are always going to buy consumer goods, because those include food, clothing, and other essentials. “ (Hedlund)

        Of course, I couldn’t agree more. Consumers only buy consumer goods.

        “Plus, it’s empirically well documented that firms tend to adjust quantity rather than price. Thus, the only way incomes that come from the creation of capital could be inflationary is if we suppose that, had those workers not built the capital, they’d have made more consumer goods.” (Hedlund)

        Actually, it’s probably a little of both, but I actually agree with you here for the most part. This only goes to show that there’s a huge capacity to increase production. Instead of forcing people to engage in capital production in order to increase their incomes and thus increase production, it could as easily be done by giving them money directly.

        The point I was trying to convey is that once a consumer uses the income derived from capital production (which is costed as part of the capital itself) to purchase consumer goods, then that income is gone, and we (consumers) have “paid” for it via an increase in price of consumer goods, or the necessity to produce more consumer goods. Real costs cannot be expensed in the future. The real, physical cost of something has to be expensed now. The real cost of WWII ended when the last bullet was shot even though we’re probably still paying for it through rolled over government debt.

        “ If we’re at the point of asking one another for examples, as you do below, then I would love to see an example of full consumer-sector employment under capitalism (a logical impossibility). The fact is, if we are willing to allow our analysis to proceed through time, then it must be observed that capital, produced means of production, is not the conscious ends of production, but rather a means to an end. You produce capital so you can produce some other commodity more efficiently.” (Hedlund)

        I agree. But capital costs always make their way to consumer goods. That’s how accounting works. Only the consumer can finally liquidate costs. If we try to equate incomes with the price of consumer goods by producing more capital, this may bring about equilibrium between the two in the short term, but eventually said capital will make its way to the cost of some consumer good, which will necessitate the production of even more capital……………. This is why economic growth is imperative in the Keynesian paradigm. It’s insane in the truest sense of the word. As Douglas once said, “I do not regard it as a sane system that in order to eat a cabbage one has to produce a machine gun.”

        “Now sock production, instead of requiring ten hand-laborers, needs two hand-laborers and five machinists, freeing up some labor for other activities — including expanded sock production. If anything, this would have a downward effect on sock prices, both in terms of supply and labor-values.” (Hedlund)

        Prices SHOULD fall with the introduction of new technology, but in general they don’t (we have inflation). The inflation that I speak of in terms of wages from capital production going towards the purchase of consumer goods currently produced would be far worse if not for the negating effect on prices of technology.

        “Perhaps I’m just dumb, but this seems an incredibly silly way to account for costs. Why stop at two sets of costs by this reckoning? Think about it: one set of costs for the investment, one set for the costs that gave me the money to invest, one set for whatever costs prompted the money to wind up there in the first place, and so on. Before long, you’ll have hundreds, thousands, even millions of costs for every unit of purchasing power. One wonders how anyone is ever able to buy anything.” (Hedlund)

        You’re not “dumb”. You’re coming from an orthodox way of thinking, which I did as well. What set of costs are you referring to when you state, “whatever costs promted the money to wind up there in the first place”. If there was a cost associated with the money “winding up there in the first place”, then either that cost was distributed as purchasing power through wages, salaries or dividends, or it was not. If it was, then there is no gap between costs and purchasing power. If it wasn’t, then there is a gap. I think you’d have to give me a specific example to understand what you are referring to here.

        “To my mind, saying investment creates a cost is faulty from the outset. Money doesn’t create money costs in the real sector. Costs are measured in money terms, to account for non-money objectives. If you hire a worker for $80, your having $80 to invest is not the origin on the cost; his labor is. The money just extinguishes.” (Hedlund)

        If I hire a worker for $80, then that $80 is costed in the price of the good or service I sell as part of my labour expenses. That’s basic cost accounting. Let’s assume for simplicity that is the only cost of the product I sell, and there is no profit, so the price of the good I sell is $80, and that is the only good in existence (for simplicity). In this instance, income = $80, and price = $80 and we’re in equilibrium (price=income). Let’s say that the worker invests his money in capital for my factory, and that money goes to pay the wages of those who produce said capital, so that income again is $80 (only it’s now the capital producer’s income) and the price of the good I created is $80 – so we again have restore equilibrium (income=prices). Let’s assume I depreciate that capital over 10 periods at $8/period. In the next period I create a good using the same labour and pay $80, but now the price of my good is $88 (labour +depreciation). Now income does not equal prices by the amount of the depreciation expense. There is no $8 distributed to anyone as purchasing power. Why is there this disequilibrium? Because I used the $80 in the previous accounting cycle to produce two sets of $80 costs (the labour expense and the capital expense). The capital expense is over a period of 10 accounting cycles, but it could just as easily be one. The point is that the money distributed as purchasing power creates a set of costs as it is distributed as purchasing power, if it is re-invested, it then creates another set of costs, but no additional purchasing power was created in order to cancel that set of costs.

        “My understanding is that in Douglas’s study of 100 companies, he found that A+B was consistently higher than A. However, based on the single-company example discussed above, it doesn’t seem unreasonable to suppose that this is a fallacy of composition; after all, once we account for the whole economy, those mysterious “external costs” cease to be such.” (Hedlund)

        But ALL companies (whether they’re producing capital goods or consumer goods) have B costs. If it’s true for every company, then it’s true in totality. The point is that total incomes can never equate to total prices. There can be periods of time where total incomes are greater than, or equal to, the price of consumer goods, like during periods of heavy capital expansion, but eventually the costs of said capital makes its way to the price of some consumer good. If companies only distribute A in income, but charge A+B in prices, how can consumers buy what they just made? They can’t unless an increasing proportion of production is geared towards producing goods and services that the consumer is never intended to buy (ie. waste). Our garbage facilities are bursting at the seams because of the necessity to produce goods and services we do not really want or need in order to distribute the incomes necessary to purchase the goods and services we really do need and want. Like Douglas said, it’s not sane to suppose you need to produce a machine gun in order to eat a cabbage. What you really need to produce are cabbages, and the amount of labour necessary to produce cabbages has decreased significantly since the advent of the industrial revolution. As a result, we should have access to more leisure, but if we hold that the only way to derive income is through “work”, then the only way those displaced from producing cabbages can buy cabbages is to produce something else ……..ad infinitum. It’s insane!! The necessity for “growth” based upon a policy of full employment is insane. Economic man does satiate in terms of material needs and wants (contrary to classic economic assumptions). Man does not live by bread alone! Labour is being displaced in production which results in an accounting flaw Douglas discovered in his A+B theorem. People “pay” in real terms for capital at the time it’s built, but are forced to pay in financial terms years after it’s built. B cost really represent past consumption. That consumption was “paid for” in real terms at the time of the consumption. I can’t pay for an apple that was eaten two years ago (in real terms). I “paid for” the apple two years ago by helping to produce it. I can’t pay for it now. That “cost” in real terms is gone. But in financial terms it is probably still represented by some depreciation expense on some capital good. I know this is probably difficult to follow, because it’s not an orthodox way of looking at things, but I think if you truly follow what I’m saying, it does make sense.

      • #48 by Hedlund on January 10, 2013 - 5:59 pm

        My answers were statements of empirical commercial facts (the effects of the rules of cost accounting, i.e. A + B) which one will search for several life times trying to find realistic exceptions to (and fail to find such).

        Here we go again. That’s all very nice to say, Steve, but here’s the thing: I am a rather critical person, whose position towards things that are not self-evident (and even some things that are) tends to default to skepticism. As such, I ask for examples. In response, you make your case in what I can only describe as “proof by empirical assertion.”

        Yes, it’s a little glib. But I need you to understand how frustrating it is to have someone insist their position is empirically founded, and then never cite actual data; just some abstract form of “this is what the data would say if I had data.” I’m supposed to just loan you credence on the unbacked assurance that you’re “totes good for it, dude. Honest injun.”

        And then we get to the loop.

        Me: “How do you know?”
        You: “Because it’s reality.”
        Me: “Can you illustrate it conclusively?”
        You: “I just did.”
        Me: “What? Where?”
        You: “I’m not going over this again with you. The facts are on my side.”
        Me: “But how do you know?”

        And thus it proceeds forever.

        If the rate of flow of TOTAL prices always exceeds the rate of flow of TOTAL incomes by cost accounting convention and this statement includes and in a technologically advanced economy obviously nominally negates the conclusions of the anecdotal examples you used….then why would one conclude that the reasoning was sloppy.

        Well, for one thing, check your premises. We’ve shown ∃, but you’re treating it like ∀. And we all know that emergence should be taken seriously. So how can I rule out the differences netting to zero once you scale out to the whole economy as a closed system until someone shows me?

        You’re also saying that the example I used is too simple, which I find rather dubious. Abstraction simplifies, yes, but nevertheless there must be some degree of abstraction at which you can demonstrate your principle. If no level of abstraction is possible, and the full, messy, unknowable and thus epistemically uncertain whole of reality must somehow be fit into your head, then you can hardly determine anything. It rings of mystification, frankly.

        @Steve and Jim:

        Let me lay down some unequivocal terms of further discussion: if either of you can demonstrate what you’re describing in terms of a stock flow consistent accounting matrix, then I will consider you to have satisfied my single persistent request. I trust neither of you are strangers to double-entry bookkeeping?

      • #49 by BFWR on January 10, 2013 - 6:41 pm

        Actually I do understand, and I’m not trying or advocating for the abandonment of science/inquiry. But for economics and money systems I’ve just concluded the time is past due for action. apologize if I occasionally get somewhat contentious, its just that the stakes could be so high.

      • #50 by Hedlund on January 10, 2013 - 7:40 pm

        It’s cool. It happens, no biggie.

        I will say this, though: If you can put the social creditor case into Godley-style SFC terms, as I suggested above, you will probably win a LOT of support from the Post Keynesian crowd. So it might be a worthy undertaking.

      • #51 by Hedlund on January 10, 2013 - 7:44 pm

        Ah, crud. Jim, I didn’t see your new post until just now. Won’t really have time to digest it until I get home. I’ll definitely get back to you later; just didn’t want you to think I had ignored you.

      • #52 by Hedlund on January 13, 2013 - 9:53 am

        The point I was trying to convey is that once a consumer uses the income derived from capital production (which is costed as part of the capital itself) to purchase consumer goods, then that income is gone, and we (consumers) have “paid” for it via an increase in price of consumer goods, or the necessity to produce more consumer goods.

        This still seems odd. Why couldn’t incomes from producing capital be considered tantamount to part of the total income disbursed in the production of whatever commodities that capital was designed to make? Conceptually, that’s all it is, as I’ve stated. Revisiting my previous example, let’s add some vertical integration: now the sock company also makes its own sock-making machinery, and we’re faced with the difference between “ten knitters enter a room and a thousand socks come out” and “two knitters and five machinists enter a room and a thousand socks come out.” The idea that swapping knitters for machinists is somehow inflationary is just not clicking for me. If anything, we can make a reasonable assumption and say that the owner will only adopt technological changes that reduce costs, such that even if a machinist is paid more than a knitter, 5Ma + 2Kn will still be less than 10Kn — in other words, less total consumer income corresponds to the same real consumer good output. In the long run, this seems more likely to be deflationary. (Or is that the whole point: that in the period between the adoption of a new technology and the adjustment of price to reflect the new labor value, N goods are confronted with <N dollars? [Apropos of nothing, in Marxian terms, this is termed "super-profit," and in a competitive industry would represent an effective extraction of surplus value from competing firms.])

        I feel the need to once again clarify that I'm not disputing that "B costs" form a circulating mass of capital that never resolves into income and grows over time. I agree with the idea in principle; I'm no stranger to the concept of a rising organic composition of capital, i.e., that capital costs will rise disproportionately to labor costs over time. It's the manner in which you're illustrating it that's perplexing me.

        Real costs cannot be expensed in the future. The real, physical cost of something has to be expensed now. The real cost of WWII ended when the last bullet was shot even though we’re probably still paying for it through rolled over government debt. …

        I agree. But capital costs always make their way to consumer goods. That’s how accounting works. Only the consumer can finally liquidate costs. If we try to equate incomes with the price of consumer goods by producing more capital, this may bring about equilibrium between the two in the short term, but eventually said capital will make its way to the cost of some consumer good, which will necessitate the production of even more capital…

        Okay, with these two passages together, let me see if I get what you’re saying. This capital “making its way” to consumer goods, just to be clear, is not in the sense of “I bought steel and used it to make a tool, and thus the tool’s final price contains the cost of the steel”? Because that much doesn’t seem inflationary so much as entirely appropriate.

        Rather, what I think you’re saying is that for the time period that the capital was in production (and again here is the key duty for time, given your distinction between real/financial costs), people were receiving incomes without making consumer goods, and therefore were buying relatively more than was being made in this counterfactual state of a “pure” consumer economy. This causes other consumer good prices to rise in general. Once the capital is done and faster consumer good production can occur, this can ceteris paribus push things in the other direction, but there is a countervailing tendency: because all these prices were a bit higher, perhaps there’s more demand for capital to hasten production. So there is a sort of gradual “ratcheting” brought about by technical change, which leads to the growing B portion. Is that how you figure it?

        So the consumer discount would have to find some way to measure rising costs resulting from the production of that capital in the first place — which can be very tricky, given what I’ve noted about firms playing Cournot games before Bertrand games. If total production is below capacity, then this capital production could instead be seen as stimulative to consumer good production. Though it also makes perfect sense that the portion of society dedicated to capital production can’t grow indefinitely. At the risk of sounding like a broken record, this all reads extraordinarily like the arguments contained in the latter volumes of Das Kapital. Given the large agreement between the two ideas, I’m surprised I haven’t come across anything in the way of a marriage of perspectives. Maybe that’ll be my role, if this ever “clicks” for me.

        What set of costs are you referring to when you state, “whatever costs promted the money to wind up there in the first place”. If there was a cost associated with the money “winding up there in the first place”, then either that cost was distributed as purchasing power through wages, salaries or dividends, or it was not.

        I meant whatever costs led to a nameless, faceless employer of mine to have enough money to pay my salary in the first place, and while we’re at it I suppose we can include whatever costs prompted the salaries of whomever gave him his money, and so on. If we’re counting costs at every end, where do we stop?

        As I said: to suppose that money creates two sets of costs seems untenable. I’m gonna quote myself, because this still seems right to me: “The two costs you list are your income and the amount of your investment out of income. One of those, you say, cannot be extinguished. So which is it? If we choose the former, you’d never have received income to invest in the first place; if the latter, then you’ve abstained from investing, and thus the object of the “cost” is still tapping his foot and waiting for payment, and thus can hardly be said to be a cost at all. Thus, either the money extinguishes both of the costs it “creates,” or the costs never exist in the first place; to suppose otherwise creates a contradiction!”

        Another way of putting it: my having the money presupposes that the first cost, the one that led to me having the money, is already extinguished by the time of the accounting. Therefore, only one cost remains, and that is the one my money will extinguish.

        This seems like it severely undermines your presentation, but I have to assume you have a rebuttal. So what would you say is wrong with the above?

        Let’s assume I depreciate that capital over 10 periods at $8/period. In the next period I create a good using the same labour and pay $80, but now the price of my good is $88 (labour +depreciation). Now income does not equal prices by the amount of the depreciation expense. There is no $8 distributed to anyone as purchasing power. Why is there this disequilibrium? Because I used the $80 in the previous accounting cycle to produce two sets of $80 costs (the labour expense and the capital expense).

        I was with you up until here. That capital investment represents improved means of production. If labor is the same and MoP improves, why would you assume the same output in those ten production periods? If anything, one might assume output to be 10% higher at the least. And those $8×10 HAVE been distributed as purchasing power in this example: that was the worker who invested instead of consuming. In your example, that $80 of capital came from the worker you hired; he basically gave up some meals in order to bring his own tools into work. As far as your accounts are concerned, as the owner, that capital cost $0. So why would it even play into price? In fact, by this reckoning, it seems that any investment that comes from abstaining from consumption is a-ok. Right?

        It’s insane!! The necessity for “growth” based upon a policy of full employment is insane.

        That insanity is just a property of the capitalist system. Policies of full employment are a response to the insanity, but yes, they have the capacity to make things much worse, especially if pursued through the private sector. I’ve long been a proponent of a job and income guarantee system, though I’ve tended to emphasize the “job” part (e.g. public works jobs along the lines of the Depression-era CCC financed directly by new chartal money issuance [i.e. money created without a corresponding debt]), though this discussion is definitely reaffirming the feasibility of the “income” portion even for those who out of said jobs.

        I know this is probably difficult to follow, because it’s not an orthodox way of looking at things, but I think if you truly follow what I’m saying, it does make sense.

        Well, it’s making more sense to me than it was (mostly where I’ve finally been able to put your arguments into terms more familiar to me), but there are still a few niggling issues, as I’ve expressed above. But I do feel that I’m benefiting from this discussion, and I thank you kindly for sticking with it this far.

        As long as I’ve got your eye, could you expand a bit on the discount/dividend thing? Are these proposals mutually exclusive, whereupon either case compensates for the growing B costs?

      • #53 by Jim on January 13, 2013 - 4:27 pm

        “Rather, what I think you’re saying is that for the time period that the capital was in production (and again here is the key duty for time, given your distinction between real/financial costs), people were receiving incomes without making consumer goods, and therefore were buying relatively more than was being made in this counterfactual state of a “pure” consumer economy. This causes other consumer good prices to rise in general. Once the capital is done and faster consumer good production can occur, this can ceteris paribus push things in the other direction, but there is a countervailing tendency: because all these prices were a bit higher, perhaps there’s more demand for capital to hasten production. So there is a sort of gradual “ratcheting” brought about by technical change, which leads to the growing B portion. Is that how you figure it?” (Hedlund)

        Yes!

        “So the consumer discount would have to find some way to measure rising costs resulting from the production of that capital in the first place. (Hedlund)

        Yes! B costs represent past consumption. We have to eliminate B costs from the current accounting cycle. The way to do it, and the only way to reduce prices without totally damaging the economy is to give consumers a rebate at the point of retail based on the ratio of production to consumption. This will result in falling prices to the consumer as technology replaces labour in production, and it will bring about equilibrium between production and consumption.

        “Though it also makes perfect sense that the portion of society dedicated to capital production can’t grow indefinitely. At the risk of sounding like a broken record, this all reads extraordinarily like the arguments contained in the latter volumes of Das Kapital. Given the large agreement between the two ideas, I’m surprised I haven’t come across anything in the way of a marriage of perspectives. Maybe that’ll be my role, if this ever “clicks” for me.” (Hedlund)

        I think there may be some similarities between the two, although I suspect there are some deep philosophical differences, and Steve emphasizes the philosophical component of Social Credit. I think Marx began to recognize the problem of capital as society substitutes capital for labour in production. I think the difference lies in the fact that Marx advocated direct ownership of the capital whereas Douglas advocated beneficial ownership. Private enterprise is the most efficient method of production, and Douglas did not want to change direct ownership. He wanted to give consumers beneficial ownership by increasing their purchasing power as capital replaces labour in production. Consumers don’t need to directly own the capital so long as they have sufficient purchasing power to purchase the goods that capital produces. They can control the policy of production through exercise of their monetary vote. People who directly own capital do not really “control” it. Consumers control it. Without consumers, the capital is idle. Further, capital is not “wealth” in the truest sense of the word. Consumer goods are wealth. Capital helps create wealth, but it is not wealth in and of itself.

        I would love for you to be able to communicate this message to followers of Marx, or post-Keynesians.

        “Another way of putting it: my having the money presupposes that the first cost, the one that led to me having the money, is already extinguished by the time of the accounting. Therefore, only one cost remains, and that is the one my money will extinguish.” (Hedlund)

        But only by purchasing consumer goods can a cost be extinguished. Capital goods costs are not extinguished upon purchase; they are carried forward into future accounting cycles. In the first accounting cycle the capital workers have $80 income which can defray the $80 price I charge for my good, so there is equilibrium. But in the next accounting cycle, I pay my worker $80, but charge $88 in price, so there is disequilibrium by the amount of the capital charge carried forward.

        “And those $8×10 HAVE been distributed as purchasing power in this example: that was the worker who invested instead of consuming. In your example, that $80 of capital came from the worker you hired; he basically gave up some meals in order to bring his own tools into work. As far as your accounts are concerned, as the owner, that capital cost $0. So why would it even play into price?” (Hedlund)

        Because I have to recover the price of the capital in order to repay the worker who invested his income with me. All costs have to go into prices. The consumer pays for everything. If I can’t recover all of my costs, including my capital costs, then I go out of business.

        “Well, it’s making more sense to me than it was (mostly where I’ve finally been able to put your arguments into terms more familiar to me), but there are still a few niggling issues, as I’ve expressed above. But I do feel that I’m benefiting from this discussion, and I thank you kindly for sticking with it this far.” (Hedlund)

        Thank you for the opportunity to explain it to someone who is obviously well versed in economics. I think you can tell that I come from an orthodox economic background as well, so I have an advantage that way when discussing this subject with those who also come from this background. This does not negate anything Steve has said, I’m saying the same thing just in a different way.

        “As long as I’ve got your eye, could you expand a bit on the discount/dividend thing? Are these proposals mutually exclusive, whereupon either case compensates for the growing B costs?” (Hedlund)

        I personally believe they’re both necessary. The discount is necessary because the true cost of production is consumption, and so long as consumption is less than potential production (which it is in all industrialized societies currently), then we can increase consumption and reduce prices through this method. The dividend is necessary for philosophical reasons because it allows individuals to “contract out”. Freedom for the individual is an important aspect of Social Credit. There may have to be limitations put on people’s ability to contract out initially, as this may lead to a mass exodus from the productive system initially. In his Draft Scheme for Scotland, Douglas proposed that people could only contract out for three years initially, and if they went beyond this time frame without working, then they would lose their dividend. It is important to note that everyone would receive a dividend, and if they worked, they would receive a dividend plus a wage, so there is still incentive to work. It just means that if someone lost work, it would not be catastrophic.

      • #54 by Jim on January 13, 2013 - 3:50 pm

        “This still seems odd. Why couldn’t incomes from producing capital be considered tantamount to part of the total income disbursed in the production of whatever commodities that capital was designed to make?” (Hedlund)

        The income from the capital is tantamount to part of the total income disbursed in the production of whatever commodities that capital was designed to make. The income I disbursed to the labourer ($80) who helped produced the good my company created no longer has his income. So in that accounting cycle the labourer’s income is $0 (because he invested it, and gave it to me to then give to the labourers who create the capital), the labourers who produced the capital good have an income of $80, and the price of the good I created is $80 (there is equilibrium). In the next accounting cycle I pay my labourer $80, but charge $88 in price (there is disequilibrium).

        “Revisiting my previous example, let’s add some vertical integration: now the sock company also makes its own sock-making machinery, and we’re faced with the difference between “ten knitters enter a room and a thousand socks come out” and “two knitters and five machinists enter a room and a thousand socks come out.” (Hedlund)

        Douglas wrote, in his first article, “The Delusion of Superproduction”:

        “The factory cost – not the selling price – of any article under our present industrial and financial system is made up of three main divisions-direct labor cost, material cost and overhead charges, the ratio of which varies widely, with the “modernity” of the method of production. For instance, a sculptor producing a work of art with the aid of simple tools and a block of marble has next to no overhead charges, but a very low rate of production, while a modern screw-making plant using automatic machines may have very high overhead charges and very low direct labour cost, or high rates of production. Since increased industrial output per individual depends mainly on tools and method, it may almost be stated as a law that intensified production means a progressively higher ratio of overhead charges to direct labour cost, and, apart from artificial reasons, this is simply an indication of the extent to which machinery replaces manual labour, as it should.”

        If prices = A+B, and B is always increasing relative to A due to technological process, then any attempt to stabilize or increase A must result in rising prices (A+B). If we pursue a policy of full employment while technology is displacing labour in production, then prices will rise as a consequence. The only way to bring about falling prices, and maintain consumer’s purchasing power is to give them a source of income that has not been costed in industry, or in other words, does not comprise the sources described under A (wages, salaries and dividends).

        “I feel the need to once again clarify that I’m not disputing that “B costs” form a circulating mass of capital that never resolves into income and grows over time. I agree with the idea in principle; I’m no stranger to the concept of a rising organic composition of capital, i.e., that capital costs will rise disproportionately to labor costs over time. It’s the manner in which you’re illustrating it that’s perplexing me.” (Hedlund)

        Then we are a long ways towards agreement. Rising B costs in relation to A costs coupled with a policy of full employment is inflationary. Further, it forces society into the production of superfluous goods and service in order to distribute the necessary purchasing power for consumers to buy the goods and services they actually need. It leads to business cycles, environmental degradation through the necessity to “grow” the economy and a whole host of societal dysfunctions including exponentially increasing debt. The only way to stop this is to distribute to consumers a form of purchasing power which costed in industry, and which is created “debt free”.

        “Okay, with these two passages together, let me see if I get what you’re saying. This capital “making its way” to consumer goods, just to be clear, is not in the sense of “I bought steel and used it to make a tool, and thus the tool’s final price contains the cost of the steel”? Because that much doesn’t seem inflationary so much as entirely appropriate.” (Hedlund)

        It was inflationary at the time the steel was produced because the money distributed to the workers who extracted and created the steel was distributed to them before the tool comes into existence. They have to spend this income at the time they’re creating the steel, because they can’t wait for the tool to be created to spend their income. They spend it now, so it tends to inflate the price of current consumer goods on the market now. When the tool finally comes onto the market, the income distributed to the steel workers that helped create the steel and ultimately the tool is gone. Now you could argue it tends to increase the amount of consumer goods created as opposed to being totally inflationary, and this is partially true depending on how much unused capacity there is in the economy, but the point is that income disbursed in capital production is rarely used to defray the cost of consumer goods that said capital creates.

        Because of the size of this post, I’ll respond in another post to the rest of yours.

      • #55 by Hedlund on January 17, 2013 - 1:56 pm

        @Jim:

        Thanks for your continued correspondence, and sorry about the gap since my last response; it’s been a busy week. By this point I should note that I agree with quite a lot of what you’ve shared. Most, even. But there are a few (philosophical, prescriptive, or otherwise smallish) points that still don’t quite sit right. I’m going to carry on digesting it all, for the time being.

        Since UE closes comments on a given post after a set time, and since this was never entirely on topic in the first place, I’ll bring my thoughts to your blog once they’ve solidified a bit.

      • #56 by Jim on January 17, 2013 - 3:30 pm

        Thanks Hedlund. I look forward to the exchange.

  11. #57 by Steve on January 2, 2013 - 4:50 am

    “I don’t see how it follows, and your assurances that reality is your homeboy are not enlightening.”

    When you can give me an honest macro-economic analysis of the effects of cost accounting’s conventions that is not instead a simplistic and anecdotal micro-economic instance….is when I will back off from my claims that such effects are indeed realities.

    • #58 by Hedlund on January 2, 2013 - 6:42 am

      That’s not how it works. You’re claiming that a flaw exists. The onus is on you to show it. I’m not going to make your argument for you. The consequence of me not making your case for you is NOT that I should take your word on it.

      I’ve been making a good-faith effort to try to understand where you’re coming from, complete with what I believe are substantive queries. If you’re not willing to meet me partway, then forget I said anything, I guess.

      • #59 by Steve on January 2, 2013 - 7:44 am

        I’ve actually already given you my case with accurate descriptions of the system and its workings, and accurate observations of the general micro-economic and so macro-economic effects that the rules of cost accounting have on every dollar in the economy, i.e. scarcity of TOTAL individual incomes in comparison to TOTAL prices. There is no disputing that cost accounting itself is a deeply embedded reality of commerce. Please review it for what you have missed or left unconfronted.

      • #60 by Hedlund on January 2, 2013 - 8:38 am

        Review what exactly, Steve? That’s my point entirely! If you had any desire whatsoever to convince me of your position, you’d be tripping over yourself to provide details. Instead, it somehow falls to me to bang on your door in search of answers, while you leave up a sign reading “COST ACCOUNTING” and slip out the back. I obliged this goose chase for a bit, but now I’m fresh out of patience.

        Like I said: Forget I asked. I am no longer interested.

      • #61 by Unlearningecon on January 2, 2013 - 12:44 pm

        Stop, this is off topic and going nowhere.

    • #62 by Jim on January 3, 2013 - 7:21 pm

      Dear Dr. Keen:

      Can you show me an instance where the income distributed by any company in a given time period is greater than, or equal to, the costs associated with that production in the same time period?

      If it’s true of all companies, then it has to be true in totality (ie. the macroeconomy)

      • #63 by Unlearningecon on January 4, 2013 - 10:19 pm

        Hi, first I am not prof Keen. He has his own blog here.

        I can’t say I’m entirely sure what you mean. When you say is income ‘distributed’ greater than costs, do you mean income received?

  12. #64 by Anand on January 2, 2013 - 8:52 am

    (Sorry for this being not directly related to your post)
    I stumbled upon your blog after reading about Keen-Krugman debate. Nice series of articles on Debunking Economics.

    I am curious is you have looked at Christopher Auld’s critque of Keen’s mathematics? ( http://chrisauld.com/2012/12/06/steve-keen-still-butchering-basic-microeconomics/ )

    Without making a judgement about Keen’s larger criticisms (much of which I agree about), do you agree with the purely mathematical criticism of a very small part of Keen’s argument about marginal costs and marginal revenues?

    • #65 by Unlearningecon on January 2, 2013 - 12:34 pm

      Auld, IMO, is correct, and I didn’t agree with this until recently. The error Keen identifies is not quite correct. It is an assumption of the theory that the firm is a price taker, rather than an implication. As Auld says, Keen is right that equating MC and MR based on this will not quite maximise profits, but it’s a small point. Keen’s idea that the perfectly competitive industry as a whole will set price in the same way as a monopoly is based on the firms collusively realising this. Otherwise, the true ‘profit maximising’ firm will only set price slightly differently to how they would have before.

      Nevertheless, as far as I can see, this still means there is no supply curve. In any case the whole thing is angels on a pinhead.

      • #66 by Anand on January 2, 2013 - 2:07 pm

        Ok. I think Keen should excise his mistakes, which would make the book more persuasive. It would be a pity if his larger points are ignored because of purely mathematical errors which are not central to his arguments (perhaps?) anyway.

        I am not an economist (more a mathematician), but it seems to me the policy implications of both Keen’s and Krugman’s (in fact of “Marxists” — I don’t like that word, sounds like a cult), right now is the same — higher public spending, low interest rates etc. Keen focuses a bit more on debt and possibly debt forgiveness (which the Marxists also talk about), but it seems to me that the problem there is political, not theoretical.

        Keen has a larger point about rotten state of macro and neoclassical models, which I haven’t read enough to comment confidently about.

        As an aside, I wanted to leave a comment on your post about Friedman’s “methodology of positive economics” and assumptions etc., where I quite disagree with your points. But it seems the comments there are closed.

      • #67 by Unlearningecon on January 2, 2013 - 6:40 pm

        Yeah, comments close after 30 days, pretty much just so that I don’t spend my time trawling through comments on old posts.

        I am not an economist (more a mathematician), but it seems to me the policy implications of both Keen’s and Krugman’s (in fact of “Marxists” — I don’t like that word, sounds like a cult), right now is the same — higher public spending, low interest rates etc. Keen focuses a bit more on debt and possibly debt forgiveness (which the Marxists also talk about), but it seems to me that the problem there is political, not theoretical.

        Mostly. Keynes’ biographer Robert Skidelsky once said that ‘New Keynesians’ like Krugman choose their positions often despite their theory, whereas the ‘New Classicals’ on the right that Krugman is often arguing with prefer their theoretical positions. The fact remains that, but for a few ‘frictions,’ neoclassical economics is quite conservative and paints the economy as largely efficient and desirable from the standard of ‘consumer welfare.’

        Anyway, regardless of political positions, a rotten theory is rotten and needs to be thrown out.

        As an aside, I wanted to leave a comment on your post about Friedman’s “methodology of positive economics” and assumptions etc., where I quite disagree with your points. But it seems the comments there are closed.

        Feel free to comment here. My first post, aimed directly at Friedman, was undeveloped (though I stand by the central point that you can’t sweep everything under the rug of ‘assumption’ and say it doesn’t matter no matter the nature of said assumption). If you haven’t, first read here for a more detailed stance on assumptions.

    • #68 by Chris Auld on January 3, 2013 - 7:54 pm

      Anand, this point is not a “very small” part of Keen’s arguments, it’s the only novel argument he makes about firm behaviour, and he’s made this argument the focus of about a half-dozen academic articles. Many people over the years have demonstrated that the argument is wrong (it’s not a hard demonstration), including a paper by Paul Anglin in Physica A.

      Unlearning: you are correct that a supply curve does not exist when there a finite number of firms and firms are not price-takers. Similarly, a demand curve does not exist when there are a finite number of consumers and consumers are not price-takers. I’ll leave you to ponder the implications.

      Setting MR=MC does maximize profits, quite generally, as I point out in the blog post. I think what you mean to say is that setting P=MC does not (quite) maximize profits with large but finite n.

      Dynamic modeling in economics is hardly limited to DSGE based macroeconomics. Dynamic models are routinely used in all areas of economics, and have been for many decades.

      You get the notion of equilibrium in economics basically correct above until you say that that notion implies “all markets clear.” Killing two birds with one literature, consider the modern theory of unemployment, which is based on two-sided search. These are explicitly dynamic models in which labor markets do not clear, yet they are typically equilibrium models (see http://home.uchicago.edu/shimer/wp/search-survey.pdf).

      Incidentally, even in DSGE macro it is not true that defaults cannot occur in equilibrium (e.g., http://infoscience.epfl.ch/record/164157/files/CFP2010_02.pdf), and more generally it is routine to model default and analogous risks in dynamic, equilibrium, rational expectations frameworks. In the quote to which you refer, King is referencing certain specific macro models in which a condition is imposed that disallows people from letting their debt tend off to infinity, which should not be read as a claim that -any- model assuming rational expectations, therefore, assumes away default risk.

      • #69 by Unlearningecon on January 4, 2013 - 12:28 pm

        Yeah, Keen doesn’t talk about game theory or (really) financial models, international trade models and so forth. Of course, he can’t be expected to address everything. Personally, I would say that the following are casualties of Keen:

        – Production functions
        – Upward sloping supply curves
        – Reductionism
        – IS/LM
        – EMH
        – RET
        – Walrasian auctioneer and GE
        – Exogenous money
        – Marginalist theories of the firm in general

        I’m not convinced that an infinite number of firms cannot affect price. To me, it seems an infinite number of firms will have an infinitesimally small effect on price. If you want to assume that they don’t, or act as if they don’t, I suppose that’s tractable. But then as you note, MC=MR=P is not quite profit maximising.

        Obviously supply and demand ‘curves’ do not exist in real life. Single points exist. I am undecided as to whether I think the concept of supply-demand remains useful as a basic heuristic for undergraduates.

        Yes, you are right that labour market are often ones that do not clear. However, is it not the case that they do not clear ‘in the short run;’ that is, various ‘frictions’ get in the way? That is my impression of labour search cost models. Generally in equilibrium markets are ‘trying’ (for want of a better word) to clear.

  13. #70 by Unlearningecon on January 2, 2013 - 10:58 pm

    John, Steve: Stop. I’ve been deleting your comments and I’m asking Steve in particular to stop talking about cost accounting and other off topic subjects (this goes for other posts, too).

  14. #71 by Anand on January 3, 2013 - 3:56 am

    This is re: Friedman’s “assumptions” and “methodology of positive economics”.

    I looked at your both your posts and your exposition of Alan Musgrave’s position (I didn’t read Musgrave’s essay directly).

    Consider quantum mechanics in physics. It is neither “neglibility” nor “domain” in Musgrave’s sense. For example look at the double slit experiment with electrons. You cannot get the results by assuming “realistic” assumption and relaxing some of them. You *have* to consider the electrons as waves to get the results. And no matter how much you relax the assumptions surrounding “particles are waves”, you still cannot get a “realistic” picture of an electron going through 2 slits at the same time.

    So, quantum mechanics is a “heuristic” in Musgrave’s sense. However, it is not on the way to something in the other two categories by relaxing some assumptions, as noted above. And it is not true, clearly, in analogy with your claim about economic models that these “models are half-baked”. At this point, Musgrave’s argument seems incomplete.

    Friedman essentially says that it is sufficient to just call of the theories “heuristic” in Musgrave’s sense and it is not necessary for them to move to either of the other categories. It is sufficient for a theory to agree with empirical observations and –crucially– to make nontrivial predictions about the future — as Ptolemy’s theories could not do. The assumptions are irrelevant.

    Now, as you point out it other posts, many of Friedman’s (and neoclassical’s) theories actually do not agree with evidence. That is the way to go if you want to “debunk” the theories, rather than working through “assumptions”. Indeed, why is Steve Keen (relatively) well-known today? It is because he predicted a non-trivial event which the neoclassicals did not.

  15. #72 by Anand on January 3, 2013 - 4:37 am

    Just wanted to add a couple of clarifications.

    a) I agree that simultaneously holding Friedman’s position and a “strong” version of the Lucas critique are contradictory.

    b) Quantum Mechanics is a “domain” theory in the sense that it is only valid at small scales. However, it is not the case, as you claim in the post that: “aim of ‘domain’ assumptions is to be realistic and wide ranging”. As I noted, clearly electrons behave as particles in some cases, but to get the results in the double slit experiment, you have to assume “unrealistic” wave behaviour.

    The point in bringing up QM is that “realism” is not well defined. Our intuition can trick us on small scales (or large scales for that matter).

    • #73 by Unlearningecon on January 3, 2013 - 11:28 am

      You say QM is not a heuristic, but say some physicist discovered a way to reconcile wave-particle duality. Would physicists come out with some Friedman-esque “it is largely irrelevant what the electron actually is?” I highly doubt it.

      You are correct that, insofar as heuristic assumptions are the “best” thing available, they rely on being corroborated with the evidence. But this doesn’t mean we can have a black box that directly ignores evidence on causal mechanics – as Friedman’s essay did with the early evidence against marginalist theories of the firm. The task of science is not just to make predictions but to explain how phenomenon arise. If we have past predictions, but aren’t really sure why the model corroborates with the evidence when it’s so unlike the real world, IMO that is little better than naive conflation of correlation and causation. In fact, the example you mention is interesting because economists often defend their models by saying they ‘did a good job [predicting] in the boom.’ But it is precisely because they did not have a specific internal mechanic – private debt – correct, that they missed the impending crisis.

      • #74 by Anand on January 3, 2013 - 1:10 pm

        “The task of science is not just to make predictions but to explain how phenomenon arise.”

        But the point is that there can be many explanations (many models or many theories). Two different models can explain the same phenomenon while having totally different mechanisms.

        Let’s take an example. According to Newtonian mechanics, gravity acts on mass carrying bodies and thus the orbits of planets are elliptical.

        But general relativity says that what gravity does is to curve space-time fabric, so a straight line path in curved space-time looks like a curved orbit.

        These two mechanisms are fundamentally different, but Newtonian mechanics are very very good at predicting orbits (and many other things). But “what is gravity really” is not a useful question? Whatever conforms with experiment is a fine model to use.

        If a model does not consider banks and debt at all (what I understand of neoclassical theories), then the criticism that it does not predict huge private debt is not valid. It is not in the model at all, so it cannot predict it.

        The burden of proof is on other theories to show that a model with debt included can make better predictions (I do not know if this has been met or not). But again, the attack must go through evidence-based arguments, not assumptions.

      • #75 by Unlearningecon on January 3, 2013 - 4:46 pm

        You are right that ultimately, signs seem to point to the conclusion that none of the properties we study really ‘exist.’ However, it would be wrong to suggest that physicists do not care about this. For example, the statement:

        But “what is gravity really” is not a useful question?

        is incorrect. Scientists are worried that the properties they study don’t really exist, and invent theories to try and explain them. For example, the H-B particle was required as part of a theory that made the concept of ‘mass’ more concrete.

        In any case, I think Friedman’s methodology relies on a largely spurious distinction between ‘predictions’ and the rest of a model. A model can have multiple predictions. A model of firm behaviour, for example, predicts that firms have rising costs; it predicts that price will be set where MC=MR; it predicts that firms in large industries will take prices as a given. If the internal mechanics of the model turn out to be incorrect (which could be called a ‘prediction,’ as it relies on evidence), then the best course of action is to modify the model.

        If a model does not consider banks and debt at all (what I understand of neoclassical theories), then the criticism that it does not predict huge private debt is not valid. It is not in the model at all, so it cannot predict it.

        My criticism was not that ‘it does not predict private debt.’ It was that it does not include private debt, i.e. the causal mechanics were wrong. The New Keynesian DSGE models did OK in normal times, I suppose. But it was precisely because they were such a black box that they missed vital components of the economy.

        I don’t think Musgrave’s formulation is watertight; there is of course no real agreed upon methodology of science. But Friedman’s position is nonsensical – as I’ve said before, according to Friedman the octopus that predicted the world cup would be a great way to do science.

  16. #76 by Anand on January 3, 2013 - 5:14 pm

    Your points, in reverse order:

    a) The octopus of course was not 100% right and the sample size was very small. The samples were also not uncorrelated. If the octopus was mostly right with a very large sample size and with low correlation between samples (which is of course not possible unless we believe in magic), it would have been perfectly logical to see how the octopus worked. In particular, the null hypothesis of tossing a (perhaps biased) coin is the simplest model for the octopus, which cannot be rejected based on the data.

    b) It is perfectly possible for some property (say how the firms calculate prices) to be absent in a model and still the “larger” model being correct. Maybe individual firms price not according to MC=MR, but the interaction between the firms *produces* this outcome (I am not claiming that the output is like this in reality). If individual firms decide on prices by say asking the neighbours or bribing a politician or whatever: those features can be abstracted away by MC=MR (again, assuming that the reality is like this).

    Friedman says this explicitly: “largely neglect what seems to me clearly the main
    issue – the conformity to experience of the implications of, the
    marginal analysis…concentrate on whether businessmen…”

    c) About the Higgs Boson particle: It of course can give us an idea of “what mass really is”, but for say getting a rocket to the moon, it is sufficient to assume mass as considered by Newton. That is why I said, that it’s not really useful to ask the question “what mass or gravity really is”, — unless your profession happens to be high energy physics.

    • #77 by Unlearningecon on January 3, 2013 - 5:30 pm

      (a) The octopus was not 100% right but it was a close approximation. This is the exact defense economists use.

      If the octopus was mostly right with a very large sample size and with low correlation between samples (which is of course not possible unless we believe in magic), it would have been perfectly logical to see how the octopus worked.

      Exactly. We would investigate the internal mechanics of the prediction to clarify the precise process that was taking place to give rise to correct predictions.

      (b) Let me ask you a question. There is substantial evidence that firms use cost plus pricing. As with Friedman, do you think that this is irrelevant, and we should continue using MR=MC analysis? Or do you think it makes more sense to use C-P models?

      (c) Perhaps so for now, but any revelations in the theoretical area would eventually be filtered through to practical application.

      • #78 by john77 on January 3, 2013 - 5:53 pm

        There is also a lot of evidence that firms use “what the market will bear”. Any model that ignores this is flawed. MR=MC is a constraint, not a policy (and may be flouted when seeking to seize market share).
        There is evidence from all the anti-dumping cases ever accepted by the EU or USA or WTC that many many firms do not apply average cost plus as a pricing policy. .

      • #79 by Unlearningecon on January 3, 2013 - 6:03 pm

        There is also a lot of evidence that firms use “what the market will bear”. Any model that ignores this is flawed.

        C-P doesn’t.

        MR=MC is a constraint, not a policy (and may be flouted when seeking to seize market share).

        Not if marginal costs don’t increase.

      • #80 by john77 on January 3, 2013 - 7:26 pm

        In my version of reality greedy capitalists either have an IQ greater than their shoe size or they go out of business. So they use the cheapest (or best value for money) sources of production first. So *marginal* cost *does* increase, bulk purchasing notwithstanding, while average cost usually decreases. I have discussed pricing policy with literally hundreds, in fact a few thousand, companies over the years: the large, not quite overwhelming, majority employed market-oriented pricing; a small minority used cost-plus because it was mandated by government or a government-appointed regulator; another small minority in Eastern Europe did so because they had not yet adapted to markets after the fall of Communism; another small minority set prices to give them a pre-determined return on capital because *that* was mandated by government.
        You cannot actually apply “average-cost-plus-a-fixed-mark-up” as a pricing policy in real life because you don’t know average cost until you know how much you have sold which varies with the price and the prices set by competitors: the closest is “estimated cost” plus ….

      • #81 by Unlearningecon on January 3, 2013 - 7:33 pm

        In my version of reality greedy capitalists either have an IQ greater than their shoe size or they go out of business. So they use the cheapest (or best value for money) sources of production first. So *marginal* cost *does* increase, bulk purchasing notwithstanding, while average cost usually decreases.

        ‘Bulk purchases notwithstanding’ is assuming away an opposing argument. Anyway, this effect is not observed in reality. Firms either use vertical integration or close relationships to create stable, consistent flows of the same quality inputs. So MC is probably constant while AVC falls.

        You cannot actually apply “average-cost-plus-a-fixed-mark-up” as a pricing policy in real life because you don’t know average cost until you know how much you have sold

        No, average cost is the average cost of production. You don’t need to sell anything to know that.

        I’m sorry but release a peer reviewed study of your findings and I will pay attention to them. Otherwise they are little more than unsupported assertions.

      • #82 by john77 on January 3, 2013 - 8:15 pm

        Given infinite capital and infinite storage space, average production cost can be independent of sales: if capital and/or storage space is finite, production is not independent of sales so neither is production cost..
        At this moment all *your* assertions are unsupported by peer reviews of your writing: that does not make them worthless.
        .

      • #83 by Unlearningecon on January 4, 2013 - 12:18 pm

        We’ve done this before – I’ve linked to various studies; you’ve talked about your real world experience. One is more reliable than the other.

      • #84 by john77 on January 4, 2013 - 12:49 pm

        Yes – mine!

      • #85 by Steve on January 3, 2013 - 8:33 pm

        Indeed, that is why we need a compensated retail discount to keep the economy balanced. There are actually two inflationary flaws in the system, one (monetary scarcity in comparison to prices needed to liquidate production) that causes inflation at the inception of production and one (same problem really just that it occurs at a different point in the business cycle) that causes it throughout and at the end of that cycle at retail sale. The real problem with “free” market economic theory is that it confuses freedom with chaos. The broader and wiser perspective on it sees it as a problem to be fixed, not a canon to be ignorantly and unwisely defended.

      • #86 by Anand on January 3, 2013 - 6:26 pm

        a) We could just use the octopus as an oracle if indeed it gave results consistently. Of course using it as an oracle does not preclude trying to understand the processes involved. A “consult the octopus” is a perfectly fine model, even without understanding it, which can give useful predictions.

        b) I have no idea of the data, but it seems to me cost-plus is largely a local strategy by each firm. It is still possible for each firm to follow a cost-plus strategy and the global situation to be such that prices become such that MC=MR happens to be (approximately) true. (this is my crude understanding of equilibrium).

        c) Perhaps theory would filter to practice, but it could be the case that in fact, the theoretically “correct” model reduces to the Newtonian model on large scales and low speeds (in fact, all indications are it does – that is why experiment agrees with Newton on those scales and speeds).

      • #87 by Unlearningecon on January 3, 2013 - 6:32 pm

        Well, personally I wouldn’t want to use the octopus unless I were convinced that there were a good reason for its predictions. But I suppose that’s where we differ.

        I have no idea of the data, but it seems to me cost-plus is largely a local strategy by each firm. It is still possible for each firm to follow a cost-plus strategy and the global situation to be such that prices become such that MC=MR happens to be (approximately) true. (this is my crude understanding of equilibrium).

        This doesn’t really make sense. The reason firms do not use MC=MR is because they don’t experience increasing marginal costs. They design their production such that MC is either constant or declining and MR is always above it. Hence, if they can obtain the financing to expand, and there is demand to satisfy, they will expand. MC=MR is just irrelevant.

  17. #88 by Anand on January 3, 2013 - 7:02 pm

    a) Octopus: The reason we might not use it is just because we would need a very very high amount of evidence to believe in magic. But if we have a magic 8-ball, why not use it? (while trying to understand it). There is no rational reason for not using it.

    b) My exposition could have been confused, because I am not really very familiar with the models. What I’m trying to say is that competition could drive the average price to the point where markups become very small and thus MC=MR is the *outcome* of each firm’s local cost-plus strategy. It may not have any policy implications, as John noted.

    Again, to make an argument against MC=MR, it is not a valid argument to say that the firms bribe the government or consult a price chart or something, but look at the outcome. If a variable (like say political connections of the owner) does not add predictive power to a model — i.e. does not give different outcomes — there is no reason to include it. A model may have the mechanism all wrong (like Newton) but it can still predict the outcomes.

    All the above assumes that it *is* actually predicting the outcome.

    • #89 by Unlearningecon on January 3, 2013 - 7:48 pm

      I think there is a rational reason. If we don’t know why it is predicting the system right, and whether or not it is an accurate representation of the system, I would not deem it reliable.

      I think you have missed the point. MC will not equal MR in most industries because MC is not rising. MR is always above MC so the firm will always produce more if it is not constrained by some other factor. This is exactly the kind of mechanic that is missed completely if one adopts the approach that reality should conform to one’s model, as Friedman did.

      In fact, I don’t think MC=MR is falsifiable the way you and Friedman paint it. Al you say is ‘oh, well it doesn’t matter if xyz, all that matters is that they manage to equate MC and MR.’ You have assumed the conclusion.

      In the case of Newton, he is in fact falsifiable and furthermore physicists have been trying to figure out how to go beyond him for decades. Economists are happy with their models in a stationary state.

      • #90 by Anand on January 3, 2013 - 8:20 pm

        a) I would say that we use octopus-like oracles all the time. Take a magnet which always points to north pole. Suppose we do not have a theory of magnetism (let alone that it’s actually electromagnetism, or later quantum electrodynamics), but we still use the magnet in a compass. That does not mean we stop trying to discover the mechanism behind a magnet.

        b) About MC=MR, I (meaning the model) has not assumed the conclusion and neither it is not falsifiable.

        I have started from perfect competition or whatever the theory assumes. Then, I try to calculate the value of the maximum profit. And I discover that the profit is maximized when MR=MC. That is a prediction of the model, I did not assume it. Now — crucially — I check this non-trivial prediction against the data obtained experimentally, if MR=MC. Only then, is the model true.

        It is perfectly possible that this model has all the mechanics wrong. Perhaps, the firms are not profit maximizers. Perhaps they don’t even have global knowledge. But it is possible for the model to give accurate predictions (MR=MC) even if the mechanics are wrong.

        In some cases, you may be interested in the mechanics (for example if you are an owner or a worker). Well, then, you just use another model where it makes a difference.

      • #91 by Unlearningecon on January 4, 2013 - 12:18 pm

        But we do have a theory of magnetism, right?

        I am not aware of any evidence that does what you say it does, simply because MC and MR are so difficult – perhaps impossible – to calculate for real life firms. Let’s face it: assuming cost-plus pricing is widely used, the scientific approach is to teach it and abandon marginal analysis.

        I don’t think you are wrong that fudges can be maintained in science if empirical results are consistently good. However, bear in mind that scientists are always investigating mechanics, relaxing assumptions and generally a theory is only considered as good as its assumptions. In general, scientists recoil in horror at that way economists abuse assumptions – in many, ways, it’s simply a judgment call. I don’t think economists realise the limitations assumptions can put on a model.

  18. #92 by Anand on January 5, 2013 - 9:12 am

    Unlearning,
    About the magnet thing, I am just saying that people used it in compasses much before they had a theory or magnetism or electromagnetism. An oracle can be a useful tool (assuming it satisfies evidence).

    Thanks for the discussion. I think we have made our respective points clear to each other.

    • #93 by Unlearningecon on January 5, 2013 - 1:37 pm

      Yeah, you aren’t ‘wrong;’ I just don’t think Friedman’s approach is scientific.

      For example, evidence in the sciences is far more clear cut. I recall doing perfect gases in an engineering class I took, and the professor emphasised that the results were accurate to within 3 or 4 decimal places. No such argument is – or possibly can be – made in economics.

      Furthermore, though magnets were used, that didn’t stop scientists finding out what was going on beneath the surface. But for economists, the central problem of profit maximisation is closed. Firms must equate MC to MR. It doesn’t matter if they actually have any knowledge of marginal costs and revenues; it doesn’t matter if they don’t do it. For economists, it has become what firms should do. That just isn’t science; it’s politics.

  19. #94 by Eric L on January 6, 2013 - 6:36 am

    (3) There is, as of yet, no role for expectations in Keen’s model.

    This one will be incredibly difficult to add to the model, or any model with endogenous shocks/butterfly effects. Some relaxed version of rational expectations where actors cannot be certain about the future even though the model is deterministic will be needed.

    An easier goal is to demonstrate a model that allows you to make the following argument why you should pay attention in spite of the lack of expectations:

    1. It is trivial to create models with reasonable assumptions that create chaotic behavior.
    2. It is in fact so simple to get chaotic models that the only reason they don’t come up all the time in mainstream macro research is that researchers only want models with rational expectations in them.
    3. The problem in #2 more specifically is not that expectations prevent the chaos, but that economists have to make the models chaos-free in order to add rational expectations.
    4. The sensitivity to initial conditions varies with parameter X (let’s say the level of debt) such that instability can be arbitrarily high if X can grow high enough. Therefore, even if rational expectations would improve the stability of the economy, unless the increase of X somehow makes agents better at predicting the future, at some level of X the economy will transition from stable to unstable.

    I don’t know if Keen’s model is good enough to convincingly make all of these points, but that is the case to make.

    Alternately, another case you could make is “rational expectations is either an emergent phenomenon or it’s BS.” An approach you could take is an agent based model where agents have a variety of strategies for setting their expectations, with a certain amount of learning as well as randomness. In theory, the ones that best approximate rational behavior should see their share of the wealth grow, thus leading over time to investment being done disproportionately by relatively rational agents. And should we expect the real world to be any closer to the theoretical ideal of rational expectations than that?

    • #95 by Unlearningecon on January 7, 2013 - 12:24 pm

      Thanks for a good comment. Don’t really have much to add!

  20. #96 by Jim on January 6, 2013 - 4:03 pm

    Hi: I realized you weren’t Dr. Keen shortly after I commented, but could not delete the post once I made that realization. Sorry to be “off topic”, because I know that can sometimes be frustrating. I was mostly responding to Hedlund.

    I also do not believe that firms “maximize profits” (at least that’s not their only goal – market share would be another). And anyone who knows anything about calculus knows that the point where MR=MC may not be the point where profits are maximized – that is a local point of profit maximization, but it may not be a global point.

    As to your question in regards to my post about costs and incomes. Yes, incomes distributed by the productive system are received by consumers. Douglas’s contention is that incomes disbursed over any period of time is always less than costs generated in the same period of time.

    • #97 by Unlearningecon on January 7, 2013 - 12:14 pm

      And anyone who knows anything about calculus knows that the point where MR=MC may not be the point where profits are maximized – that is a local point of profit maximization, but it may not be a global point.

      Good point! Under economist’s assumption, the MC curve is quasiconvex and MR is either flat or decreasing, so there is only one point where they cross. however, there are good reasons to believe there would be multiple points in real life, once you relaxed some assumptions.

  21. #98 by Anonymous on January 7, 2013 - 1:41 am

    “For me, claims that worker ownership of production would be desirable don’t really rest on the LTV; instead, the simple point is that workers could employ capital themselves.”

    I for one am an “Austrian” (mostly a supporter of Lachmannian subjectivism), and i support worker ownership of the means of production on this basis. There’s nothing anti-market about worker cooperatives and mutual-banking, the economic theory of Mutualism is a clear sign that “Socialism” (in it’s original meaning) and free-markets are compatible. Bringing up Mutualism to any Austrian who brings up the economic calculation problem to debunk “Socialism” is pretty funny.

    But the thing with Marx is that his theories call for more than just “worker ownership of the means of production”, Marx sought to not only end wage-labor, but also “abstract labor” and the Law of Value completely, and he was adamant that this also required the abolition of money and the market economy. According to Marxist theory, Mutualism and other forms of worker-ownership inside a market economy would still have some of the problems Capitalism has (namely, “production for value” rather than “production for need”, a tendency for the rate of value production to fall – and hence, crisis – and an oppressive system abstract labor). This makes Marxism much more polemic, even amongst Socialists.

    • #99 by Unlearningecon on January 7, 2013 - 12:00 pm

      Ideally I’d like to see market socialism although some of Marx’s claims do ring true with me. I think the search for profit would lead to driven individuals occupying the management (I’m guessing it would be some form of representative democracy) and centralisation would occur over time as management had to implement more ‘aggressive’ strategies.

      The problem I have with Austrian advocacy of worker ownership is the general ‘in the free market, workers are free to set up their own cooperatives’ attitude (is this your belief?). I don’t think this is a sustainable idea on any large scale, partly because they would be vulnerable to aggressive strategies and buyouts from incumbents; partly because no real robust legal framework would be in place to sustain that form of organisation; partly because people are simply sued to wage labour and wouldn’t even think about an alternative. I mean, you have to ask yourself why we haven’t seen much of it under the current system.

      Btw, I’d prefer no anonymous comments – just use a consistent pseudonym. Obviously ‘anonymous’ will do for now as you are the only one.

      • #100 by Austro-Georgist Anon on January 7, 2013 - 5:26 pm

        Perhaps some firms would have hierarchical management in some areas, but i think that centralization is inefficient and unproductive and would as a general norm lose.

        My views are a bit more complex than that “standard” Austrian view that “workers can just set up shop themselves!”. I have read works by modern Mutualists like Kevin Carson and older Individualists like Benjamin Tucker, and i believe that the degree of centralization and hierarchy in the modern economy is a direct result of centuries of State intervention that protects and monopolizes the economy. All sorts of policies and laws (the patent/IP system, protectionism in general, landlordism, land speculation, the enormous aid the State gives to the big bankers via the Fed, the military-industrial complex, legal framework that benefits corporations and excludes cooperativism, transportation subsidies, regressive taxation, etc) protect the big hierarchical business from competition and subsidizes the enormous costs of maintaining them, allowing them to exist and make enormous profits despite being extremely inefficient institutions. Corporations are zombies being maintained by a large system of privatized profits and socialized losses.

        The funny thing is that the Misesian economic calculation problem and Hayek’s information problem would predict huge corporations are inefficient as hell and cooperative management would be superior, but the average Austrian never actually thinks about this. The reason why we haven’t seen much of worker co-operativism under the current system is because the State and corporations have done everything in their power to subsidize inefficient centralization and drive out small-scale production and cooperative management.

        If those monopolies were removed, huge firms would begin bearing the costs of their inefficient system and would have to severely downsize and make management more cooperative just to stay afloat, while smaller and cooperative competitors would have an economic advantage from their more efficient system and lower costs of production and would begin to grow. Eventually, co-operative labor would substitute wage-labor as the norm in the economy.

        Also, i am a huge fan of Henry George (even if i think he made many mistakes and exaggerated the effects of the Single Tax as being a panacea for social problems) and a supporter of Land Value Taxation. I believe this tax policy would also do much to decentralize the economy and weaken the power of big business and speculative capital. George himself believed that in the long term, the Single Tax would make the distinction between “worker” and “manager” dissapear.

        But i should note that i’m not against all sorts of Government intervention just because Government intervention is “always bad and anti-market” like some Rothbardians believe. Under some circumstances, certain forms of intervention help the economy (the G.I Bill for example was quite clearly a good thing). And although i think the Welfare-State should be substituted by a market system of mutual-aid societies, i think outright removing it in present economic conditions like some “Libertarians” want would cause much more harm than good in the short and medium terms.

        I’m sort of a “weird” Austrian. Lachmann, Henry George and the latter works of Hayek always made more sense than anything ever written by Rothbard to me.

        If you are interested in the ideas that free-markets would naturally lead to decentralization, Carson’s “Homebrew Industrial Revolution” and “Organization Theory: A Libertarian Perspective” are worthwhile (but radical and with some exaggerated conclusions) reads.

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