Blog-Reference and Blog-Reference on Sep 22 adapted to context
There is political economics and theoretical economics. The founding fathers were straightforward people and called themselves political economists, that is, they left no doubt that their main business was agenda pushing. Economists never got out of political economics. In other words, theoretical economics (= science) ultimately could not emancipate itself from political economics (= agenda pushing). This is how economics became one of the most embarrassing failures in the history of scientific thought.
Standard economics is built upon this hard core set of foundational propositions/axioms: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub, 1985)
Methodologically, this axiom set is forever unacceptable but economists swallowed it hook, line and sinker from Jevons/Walras/Menger onward to DSGE. The failure of methodological individualism is indisputable. The ultimate reason can be stated as an impossibility theorem: NO way leads from the explanation of individual behavior to the explanation of how the economic system works. In other words, the microfoundations approach has already been dead in the cradle.
Keynes started the macrofoundations research program in the General Theory formally as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (p. 63)
These formal foundations are conceptually and logically defective because Keynes never came to grips with profit and therefore “discarded the draft chapter dealing with it.” (Tómasson et al., 2010)
Keynes’s original blunder kicked off a chain reaction of errors/mistakes. As a result, all I=S/IS-LM models are worthless. Most importantly, Keynes’s profit conundrum remained unsolved. Until this day neither Walrasians, nor Keynesians, nor Marxians, nor Austrians got profit right. As the Palgrave puts it: “A satisfactory theory of profits is still elusive” (Desai). Because economist have NO IDEA of the pivotal concept of their subject matter they cannot explain how the actual economy works which means that their policy guidance has NO sound scientific foundation.
This is the current state of economics: Walrasian microfoundations are false since 140 years and the Keynesian macrofoundations are false since 80 years. As a consequence, all models that contain maximization-and-equilibrium or I=S/IS-LM are a priori false and together this is roughly 90 percent of the content of peer-reviewed economic quality journals and 100 percent of textbooks. Robert Lucas has been a major participant in this scientific disaster. To expect good advice for the future of macro from an economist who has proven his scientific incompetence over the last three decades is beyond ridiculous.
To get out of failed economics requires a paradigm shift from Walrasian microfoundations and Keynes’s flawed macrofoundations to entirely new macrofoundations. In methodological terms: to build a better macroeconomics requires the replacement of the false axioms of Lucas et al. by true axioms and the dishonorable discharge of the DSGE crowd from science.
You say: “I understand the potential importance of profit as a driver of investment (i.e. it is important from the point of view of motivation and micro-foundations), but I don’t see the relevance to macro flow analysis.”
This is because you are way behind the curve and still cling to the fundamental error that economics is a behavioral science (Hudík, 2011).* Profit, though, does not appear because agents need an incentive. Profit for the economy as a whole appears, or fails to appear, independently of what the agents subjectively wish or think or imagine or expect or need because of the objective, systemic, macroeconomic Profit Law (2014).
Systemic laws have the same methodological status as physical laws.
In the Middle Ages, physicists did not understand the pivotal phenomenon of their subject matter, viz. energy, and could not tell the difference between potential and kinetic energy.
At present, the representative economist is still at the proto-scientific level, that is, he does not understand the pivotal phenomenon of his subject matter and cannot tell what the difference between profit and income is.
You say “Profit is just another part of income” and this proves your utter scientific incompetence.
Hudík, M. (2011). Why Economics is Not a Science of Behaviour. Journal of Economic Methodology, 18(2): 147–162.
Kakarot-Handtke, E. (2014). The Profit Theory is False Since Adam Smith. What About the True Distribution Theory? SSRN Working Paper Series, 2511741: 1–23. URL
* See also ‘Economics is NOT a social science’