The Inadequacies of Modern Economic Theories

The Inadequacies of Modern Economic Theories


1. In respect to the above I put forward my analyses of “classical & modern economic theories” as I have found most of them are grossly ineffective to deal with modern economic situation of the world.
It must be said modern economic theories are inadequate to explain present economic environment which some classical ones do somewhat successfully.

I will deal with both modern & classical theories in short.

I begin with the famed quote of Daniel Fusefeld : “A prosperous economy requires levels of spending high enough to employ the work force fully”.

Most economists from time of Adam Smith believed that capitalistic & market oriented economies can provide full employment.

The lower the wages the more workers will be employed.

If wages are flexible a competitive economy will maintain maximum employment.


Now coming to J.B. Say’s law : “Production of goods creates its own demand; it generates an income that is equal to the goods produced, so production process will automatically provide people with buying capacity”.

Are above theories & laws equally applicable in modern economy? Or some new concept is required to explain it?
As per Say’s law intt rate depends on demand of capital & supply of it. In a bad economy (in an economic down turn) as there is job loss & savings dwindle so intt rate will tend to go higher, but as loan offtake is lesser so intt will tend to go down. And in a growing economy as demand is more & more so there will be more & more investment for production so there will be more job creation, hence more savings will take place therefore intt rate will stabilize to a normalcy.

But in a super charged (heated) economy saving will vanish as people will go for more consumptions as now in China & a bit like in India which are charged due to huge money pumping.

So a normal economy is a 4 to 5% growth rate & a 3 to 4% inflation rate. It is the exact balance.






2. Keynes contradicted classical theories mainly on following points:-

He said savings depend on “national income” (NI), so to increase NI, infuse money in the system, when economy in depressive/shrinking mode. It is only partially true as he did not envisage paradox of modern economy. He missed on some major counts, infusion of money will increase consumptions in all sectors he assumed, from gadgets to foods to clothing to housing to education, but my point is if one sector takes away the most?

He called for pumping money when there is a depression, he talked of domestic production & domestic demand but he had no clue if depression was caused by free trade, inflicted by other economies.

He advocated for an artificial increase of national income which would create demand & people would get back the employment, but in the present modern economic scenario would it happen? The capital infusion will go in vain.
Theory of Insulation answers this dilemma.

Keynes although criticized wartime infusion of capital, but the truth is US mostly benefited from 2nd world war & that advantage ran up to 1980.

He misconceptuatized trade unions & modern labour market as trade unions can’t now prevent job loss & control wage market.
Modern trade unions are not at all Keynesian models.

The most influential of his theories is “money supply” & creation of “aggregate demand” & thereby enhance employment; here he collided with classical economists head on. But his money pumping theory is totally clueless in today’s economy.

Actually problem is that, not much economic theories have evolved in economics as in physics or other sciences, so economists are bound by so called modern economics theories of 1930s to 1950s, many of them may have bagged Nobel prizes it may sound harsh, but is true.
Yes, some great modern times’ economists (if they are also taken as economists) like Nash & Borlaug are mathematician & agronomist, I am sorry to point out.

3. Milton Friedman’s Hypothesis: This is very interesting in respect of cost of education, as he assumed “transitory consumption components” are unrelated to “permanent consumption components”.
This is absolutely unfit in modern financial system; please refer to “Financial system & Cost of education”.

4. R. G. Lipsey’s “theory of equilibrium of income” is not a sufficient tool to solve paradox of modern economy, also Keynes’s “consumption function & investment function” the most powerful components as per him fail miserably to explain world economic scenario of today.

Liquidity Trap: When there is an excess liquidity in the system & as there few are takers of funds as demand (that is because of lesser spending by people) is down as in a jobless economy, govt spending has no effect to revamp the market.
This creates the “crowding effect”, govt borrowings may raise intt rate but as the govt spends the borrowed money it crowds out public spending.
This happens when public is jobless, but a large liquidity in the market due to govt spending, money goes to a few people & they make huge money.
But Keynes & his followers attach main importance to “fiscal policy” & put it superior to “monetary policy” to the point “where money does not matter”, the Keynesian model of employment is to raise output (production) by using fiscal policy, which is according to his theory; it is possible to eliminate deflation & achieve employment by infusing money.

This is no more a viable option in modern economic system unless there is a “market of demand” already existing & that is exploited, be that within or out of national boundary. For example, as China is doing today.
To quote P.H.Thurow “The final function of money is its purchasing power & money tends to live a life of its own, which is difficult to control. These cause a disturbing fluctuations in value, which can at one hand stimulate activity & on the other can disrupt activity & seriously damage achievement of economic objectives. Is this not happening today?

As per Keynes money supply by govt in a depression economy can expand output & employment, but P.A.Samuelson & Milton Friedman differed from this Keynesian view, as in a situation they called “stagflation” both stagnation & inflation can occur at the same time, i.e. unemployment & inflation can coexist.

5. Modern economists theorized increase in price level, due to inflation results in more profit & more production, so more employment, so inflation eventually becomes productive not counterproductive.
Yes, production & employment increase due to money supply, causative inflation & price rise, but money goes to only to a handful of people, 90% people lose “income”, mind it I am saying “income” not employment, as rise in price is fall of value of money, so the income of the mass does not rise, rather decreases as wages fall, that is per capita wage due to initial job losses caused by depression & wage cuts in a depression economy with inflationary force caused by excessive govt money supply, so the mass become actually poorer, even though they may have got some employment.

This was completely overlooked by Keynes & modern economists did not come out with suitable theories to explain modern economy, unlike in other sciences, where daily new grounds are broken.


Keynes has gone on records, strongly advocating that only way to fight depression is deficit financing; only way to raise “aggregate effective demand’ is to incur deficit & cover the deficit by printing “paper money”.
How wrong! If not wrong how inadequate this is in modern economy if we look at the world scenario.
If we use “cobweb syndrome”, that is fluctuations of prices & quantities overtime as generally seen in agriculture produces cyclically, to factory products, a depression economy becomes very interesting, that is if demand & price of factory products are low in previous year, then production will be less in the current year, so in the depression, the domestic production will fall in a cobweb & be caught in a bind in today’s economy.

Even to solve the basic dilemma of oligopoly “the game theory” of John Nash had to be employed & today’s modern world economy is developing a highly oligopolistic trend, a kind not seen before & China is creating this oligopoly as a leader.

Advancing Euler’s theorem, Samuelson synthesized “In the long run cost of inputs & outputs will settle towards a level, no surplus or profit will be there for the entrepreneur excepting his own wages for his labour & intt on his capital invested, so profit will be there only if there is a monopoly”.
But this is absolutely wrong theoretically, may be true hypothetically in an imaginary, perfectly built-up model.
There can be no absolute monopoly i.e. only one is producing a particular product & everyone is buying from him, in that situation production will be equal to the demand or less than the demand i.e. supply will always be lesser than the demand to sellout the whole production, to avoid stagnation of goods produced & to maximize profit.
So Samuelson is wrong as talks of a hypothetical situation. See:-

Suppose if China only is making cheapest items & others are out as China is selling at the cheapest rates, so it will have a monopoly & really it is setting a kind of monopolistic trend, in trade of many goods, but this monopoly cant give right to China to raise prices, as although others are seemingly out, but will bounce back at the slightest opportunity & at that time China will be in great trouble to lower prices as input costs including the labour cost have gone up meanwhile with rise of product prices, so China will be immediately out of business.

6. Heckscher-Ohlin Theory: Recardian theory predicts except for transport cost free trade would lead to equalization of commodity prices, later Heckscher & Ohlin added to it “endowment factor to international trade”, as per them international trade takes place due to differences in factor endowment (resource bases such as raw material, labour, capital, government policies etc). They argued a labour abundant country would always export labour intensive goods, similarly a capital abundant country would export capital intensive goods, so logically every country would import commodities which are produced with scarce factors. From this theory Paul Samuelson & K. Lancaster developed “the factor price equalization theory”. The theory states that “free trade of goods & services” across national borders would not only equalize commodity prices, but factor prices as well, although inputs are not traded, as the trade in commodities actually is trade of factors.
Here they have again gone wrong, not only wrong, but could not see through the haze they themselves created, as actually a created product when reaches its destinations (station to station) is not the factors themselves, but it is entirely something else, it may have been produced out of factors be that labour, materials, processes, packaging, transportations, like everything is made of electrons, protons & neutrons (except normal hydrogen i.e. made of only electron & proton) but final things become very different from one another, like evolution of living beings as they become very different species over time in different environs.
Take a simple example, if one only transports an object in space (by a rocket on charges) the object in space is no more a combination of original object, its parts & transportation to space, but entirely a different thing. So Samuelson & Lancaster’s theorizing that free trade will lead to factor price equalization is very misleading, neither it has happened ever, nor it seems to happen any day, yes in an imaginary situation it is possible.

Now coming to The Stolper-Samuelson theory formulated on the basis Heckscher-Ohlin theory, it made a case to tax scarce factors, as imports happen in scarce factors, so impose high tax & due to this taxation domestic produces will get higher prices, as imports will be costlier, so more domestic production will take place, as it will be lucrative to produce due to price rise & this will engage more employees.

Here they have gone very shortsighted & much narrowed, as they have harped on old protectionism method, totally failed to deliver a new concept, not to talk of a theory.
Then what is the difference between the protectionists & them?

“Theory of Insulation” does not talk of protectionism; it puts every economic activity in a new perspective, in a new dimension, a pure theory, perfect, derived from nature & totally practicable & it has to be practiced some day, as no other way out.
It covers whole activities, whole life related activities & beyond.

7. Economics of Protection
--------------------------------.
R.G.Lipsey: As some trade is better than no trade, so a normal proposition is “a bit more trade is better than the current trade”.
How wrong he is, actually misleading, as his postulation ends up to “absolute free trade” with absolutely no restrictions, but as per theory of insulation this is against nature, so will cause devastation.

The Case for Free Trade: As advocated by modern economists “specialization & free trade lead to an efficient allocation of world’s resources, they enable all nations to have more of all the goods than in absence of free trade”. It is based on Recardian principle of “comparative advantage”. Opposite of free trade has been termed as protectionism, as in Stolper- Samuelson theory, taxing the scarce factors (i.e. tax imports of scarce factors) is the only theoretical solution of the crisis, how ludicrous, at one hand modern economists talk of free trade, at other talk of restrictions, actually they could not grasp the matter.

Here we can see a very funny thing, Norman.E. Borlaug who halted India’s grueling famines by bringing in green revolution in India, by increase of food production manifolds by introducing high yielding hybrid dwarf varieties & by extensive farm mechanization (Borlaug is revered highly in India), but Mr. Amartya Sen theorized that those famines were artificial, caused due to hoardings of food grains, not due to low productions & he got Nobel for this research.

Modern economists always freely deride Abraham Lincoln’s famed quote “I do not know much about the trade, but I know this much: when we buy manufactured goods abroad, we get the goods & the foreigners get the money. When we buy manufactured goods at home, we get both the goods & the money”. Economists say “only first eight words of Lincoln are correct, i.e. I do not know---”.
But modern economists are now in a situation to be derided, by the present economic crisis, as they have gone belly up with limitations of their theories.
Most of the modern economists are data crunchers & data interpreters & can’t think beyond protectionism & free trade.

Referring to the analysis of economist D. Fusefeld, it clearly expresses the inability of modern economic theories to explain modern economic situation.
The view of great American economist Henry Clay is interesting in this regard; it comes very near to finding the law i.e. “the theory of insulation”, but gets entangled in protectionism veil & falls short.

Almost all economists have advocated free trade & explained protectionism as only political, but theory of insulation does not talk of protectionism, it has nothing to do with protectionism, it gives an economical, theoretical, scientific & social explanation for viability of survival, trade with social context.


Subhro Das
Araria, India
Conceptualized: 2002 to 2006
Written: 15/09/2010