January 1, 2015

Kalecki got it wrong, Allais got it right

Comment on Lars Syll on 'Kalecki and the loanable funds doctrine'

Blog-Reference

It is not exactly a great performance. After more than two hundred years economists still have no clear idea of the fundamental concepts income and profit. As Schumpeter already observed: “At all times, including the present, in judging from the standpoint of the requirements of each period ... the performance of economic theory has been below reasonable expectation and open to valid criticism.” (1994, p. 19)

The point to start with is the official acknowledgment of the New Palgrave Dictionary: “A satisfactory theory of profits is still elusive.” (Desai, 2008, p. 10)

Because the profit theory is false, the income theory is false, by consequence the saving theory is false, and this results in a defective loanable funds theory. With regard to the relationship of saving and investment Kalecki dug at the right site but not deep enough.

The correct relationship is given by:
Qre =I-S (2011, p. 8, eq. (13)) and (Allais, 1993, p. 69)
Legend: Qre: retained profit, S: saving, I investment expenditure.

If it happens that household sector saving S is zero then, as a corollary, retained profit Qre is equal to investment I and the business sector as a whole is in the position to finance investment entirely 'out of its own pocket'. However, the firms with retained profits may prefer to keep their money in the bank.

If it happens that household saving is equal to investment expenditure then, as a corollary, retained profit is zero and the household sector as a whole is in the position to fully finance the investment of the business sector. However, the households with new period savings may prefer to keep their money in the bank (instead of buying bonds from the business sector, for example).

Since household sector saving is never equal to business sector investment reality will be found between these two limiting cases.

The situation becomes a bit more complex when the fact is taken into account that the household sector may consist of savers and dissavers (2014).

The build-up of financing relationships (credits, bonds, stocks, etc) within and between the sectors is in an intricate way related to the flow magnitudes saving and investment. However, what Kalecki got wrong in the first place was the relationship between profit, distributed profit, and retained profit.

It will be interesting to observe how long it takes economists to realize that the theoretical superstructure of Kalecki, Keynes, Walras, and their post-, new-, and neo-derivatives rests on a logically untenable conception of income and profit. No doubt, methodologists and the scholars of the history of economic thought will sooner than later have the unique chance to see a paradigm shift in real time. Two hundred years without a correct understanding of income and profit should be enough, even for economists.

Egmont Kakarot-Handtke


References
Allais, M. (1993). Les Fondements Comptable de la Macro-Économie. Paris: Presses Universitaires de France, 2nd edition.
Desai, M. (2008). Profit and Profit Theory. In S. N. Durlauf, and L. E. Blume (Eds.), The New Palgrave Dictionary of Economics Online, pages 1–11. Palgrave Macmillan, 2nd edition. URL
Kakarot-Handtke, E. (2011). Why Post Keynesianism is Not Yet a Science. SSRN Working Paper Series, 1966438: 1–15. URL
Kakarot-Handtke, E. (2014). Loanable Funds vs. Endogenous Money: Krugman is Wrong, Keen is Right. SSRN Working Paper Series, 2389341: 1–17. URL
Schumpeter, J. A. (1994). History of Economic Analysis. New York, NY: Oxford University Press.

For Kalecki and wage-led growth see on this blog.

For the correct formal foundations of theoretical economics see here.