March 17, 2016

“As goes GM, so goes America” — A rather ordinary fallacy of composition

Comment on David Ruccio on ‘"For years I thought what was good for our country was good for General Motors, and vice versa"’

Blog-Reference

Let us call it the Marshallian Vice. The vice consists in taking a firm or a sub-sector of the economy, to analyze the basic relationships under the condition of ceteris paribus, and then to generalize the result for the economy as a whole. As a rule, the generalization is false, despite the fact that the conclusions of partial analysis are for all practical purposes correct. Because of this, Walrasian total analysis is — in principle — the methodologically correct way. Marshallian partial analysis is — in principle — misleading and scientifically worthless.

To see this let us make a simple example. Imagine two firms, GM and the rest of America. In the initial period the respective prices are equal to unit wage costs, i.e. GM Pg=Wg/Rg and rest of America Pr=Wr/Rr. Therefore, the profit in both firms is initially zero. The household sector spends total wage income on the two products, so there is neither saving nor dissaving (for details see 2014).

Now GM slashes the wage rate from Wg to W'g. Total employment is kept constant. Thus, total wage income falls. Because total consumption expenditures are equal to total wage income, nominal demand for both firms falls. Because total employment remains unchanged, the output of both firm remains unchanged. Under the condition of market clearing the respective prices adapt accordingly — both fall.

GM now makes a profit because the difference between the new price P'g and the lower unit wage costs W'g/Rg is now positive: “And thus we arrive at Mr. Ricardo’s principle, that profits depend upon wages; rising as wages fall, and falling as wages rise.” (Mill, 1874, IV.12)

GM provides the clear-cut empirical proof that the profit theory of all economic half-wits from Ricardo via Marx to Marshall and beyond is true — except for the conclusion ‘As goes GM, so goes America’.

The second firm (= the rest of America) now makes a loss because the new price P'r is lower than the unchanged unit wage costs Wr/Rr. The loss of the second firm is exactly equal to the profit of GM. Overall profit of the American economy is exactly zero, just as it was in the initial period. Because of this redistribution of profit the generalization ‘As goes GM, so goes America’ is patently false. The nuisance with economic half-wits is not that they are downright false but that they are at best half true. This is the fatal methodological flaw of all partial analysis. The proper subject matter of economics is the world economy as a whole and NOT the profit maximizing firm or the utility maximizing agent.

In the value-laden language of political economics the complete picture is as follows. With the wage cut W'g < Wg GM increases its profit and exploits the rest of the American business sector which now makes a loss of equal magnitude. Because output remains unchanged the real situation of the household sector as a whole remains unchanged in real terms. However, the employees of the second firm absorb now a greater part of the total output because of lower prices and an unchanged wage rate. They exploit the employees of GM which can buy less now because of their lower wage rate. So, what we have as a result is a cross-over exploitation WITHIN the business and the household sector. The big picture is entirely different from what simpleminded partial analysis suggests.

What the big picture shows is that the fundamental concepts of profit, exploitation, and class — which are common to Ricardo, Marx, the president of GM, the union leaders, the Econ 101 students, and all the other half-wits of political economics — are simply false.

When the profit theory is false, then the rest of economic theory is false, including the theory of international trade. And when economic theory is false, then economic policy is wrong-headed, and then the economy eventually goes down the drain.

Egmont Kakarot-Handtke


References
Kakarot-Handtke, E. (2014). Profit for Marxists. SSRN Working Paper Series, 2414301: 1–25. URL
Mill, J. S. (1874). Essays on Some Unsettled Questions of Political Economy. On Profits, and Interest. Library of Economics and Liberty. URL

For details of the big picture see cross-references Profit.