April 29, 2016

The unintended consequences of deficit spending

Comment on David Andolfatto on ‘On the want of U.S. government debt’


You conclude: “There seems to be a strong presumption among people (Americans in particular) that the government should run its finances in the manner of a household. Economic theory is quite clear that this sentiment, however noble, is just plain wrong.”

What is curious about the deficit discussion since Keynes is that profit is entirely left out of the picture. The ultimate reason is that Keynes got profit theory wrong and After-Keynesians simply parroted Keynes’s blunder. As a result, conventional profit theories are provable false until this day. As the Palgrave Dictionary summarizes: “A satisfactory theory of profits is still elusive.” (Desai). This is not exactly a great scientific achievement.*

The correct profit equation in the most elementary case of the pure consumption economy is given by Qm=C-Yw. Legend Qm: monetary profit, C: consumption expenditures, Yw: wage income. Monetary profit of the business sector is equal to the deficit spending of the household sector.

The profit equation for the investment economy reads: Qm = Yd+I-Sm.** Legend Qm: monetary profit, Yd: distributed profit, Sm: monetary saving, I: investment expenditure.

When we leave this part unaltered for the moment and add the government sector then we have: the increase of overall monetary profit of the business sector is equal to the deficit of the government sector.

And here we arrive at the irony/absurdity of the balanced budget discussion. Normally, the friends-of-the-workers argue in favor of public deficit spending in order to push employment. This has the unintended consequence that overall profits increase one-to-one with the growth of public debt. On the other hand, the friends-of-the-capitalists argue in favor of deficit reduction in order to balance the government’s budget. This has the unintended consequence that overall profits decrease. In full ignorance of the profit effect on the distribution of income and wealth BOTH sides argue ultimately AGAINST their own interest. Obviously, this constitutes the worst violation of the foundational principles of economics, i.e. of self-interest and utility maximization.

Egmont Kakarot-Handtke

* See ‘The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?
** See ‘The Three Fatal Mistakes of Yesterday Economics: Profit, I=S, Employment’ eq. (18)