March 9, 2017

A vacuous analysis of profits and productivity

Comment on Dietrich Vollrath on ‘Profits and Productivity’

Blog-Reference and Blog-Reference

Dietrich Vollrath starts with a couple of macroeconomic phenomena, i.e. productivity slowdown, falling labor share of output, an uptick of the profit share, rise in corporate saving and tries to establish a relationship between overall profit and overall productivity.

The explanation of macroeconomic profit starts with the explanation of microeconomic profit: “Firms generate profits by marking up prices over marginal costs. So if profits are higher, it implies that the markup has increased. To say something about the effect that higher markups could be having on productivity, we need some conception of why firms are able to charge a markup over marginal cost, and also some conception of what drives those markups.” (See intro)

This explanation is methodologically false because, as a matter of principle, NO way leads from the explanation of the micro-behavior of individuals/firms to the macro-behavior of the economy.

For the determination of the monetary profit of the economy as a whole one has to start with the most elementary case of a pure consumption economy without investment, government, and foreign trade. In this elementary economy three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.

In case (i) the monetary saving of the household sector Sm≡Yw−C is zero and the monetary profit of the business sector Qm≡C−Yw, too, is zero.
In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

It always holds Qm≡−Sm, in other words, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law.

It is important to note that (1) overall monetary profit is entirely INDEPENDENT of the average productivity of the business sector, and (2), NO share of output corresponds to monetary profit. This tells us that the whole of distribution theory is false.#1

When profit distribution Yd, investment I, government expenditures G, and taxes T are added the correct profit equation reads Qm≡Yd+I−Sm+G−T.

In other words, deficit-spending of the household and government sector and profit distribution of the business sector are the determinants of total monetary profit in the market economy. Total profit has NOTHING to do with marginal costs or productivity or exploitation or monopoly or the smartness of CEOs. These factors only influence the DISTRIBUTION of total profit BETWEEN firms.

The crucial blunder of Dietrich Vollrath’s analysis is that he lacks the true profit theory. The true profit theory tells us that there is NO relationship between overall profit and productivity. Because of this, Dietrich Vollrath’s analysis is methodologically on the same level as the scholarly discourse of medieval theologians about how many angels can dance on a pinpoint.

Egmont Kakarot-Handtke

#1 The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?