November 8, 2017

The profit theory is false since Adam Smith

Comment on David Ruccio on ‘Global rentier capitalism’


David Ruccio summarizes: “Mainstream economics lies in tatters. Certainly, the crash of 2007-08 and the Second Great Depression called into question mainstream macroeconomics, which has failed to provide a convincing explanation of either the causes or consequences of the most severe crisis of capitalism since the Great Depression of the 1930s. But mainstream microeconomics, too, increasingly appears to be a fantasy…”

This is true. In fact, the situation is much worse. The major approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/formally inconsistent, and ALL got profit wrong. From the fact that Orthodoxy is false does not follow that Heterodoxy is true.

Smith treated profit as the income of the factor capital. This was the original blunder.#1 It was followed by Ricardo’s theory of rent#2, and Marx’s theory of profit#3, and Keynes’ messed-up macro.#4 As the Palgrave Dictionary summarizes: “A satisfactory theory of profits is still elusive.” (Desai, 2008)

Because economics is a failed science it has to be reconstructed from scratch. Walrasian microfoundations and Keynesian macrofoundations have to be scrapped.

As the new analytical starting point, the elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw in each period, the macroeconomic price is given by P=W/R, i.e. the market-clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Figure 1.#1

Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit (deficit = loss) equals the household sector’s deficit = dissaving (surplus = saving). This is the most elementary form of the macroeconomic Profit Law. Under the condition of budget-balancing total monetary profit is zero.

Overall profit depends alone on deficit spending, that is, on the change of private or public debt. It does NOT depend on labor time, or productivity, or monopoly power, or greedy landlords, or rent-seeking bankers. There is no such thing as normal and excessive profit.  Macroeconomic profit depends alone on objective systemic factors. More specifically:
  • The business sector’s revenues can only be greater than costs if, in the simplest of all possible cases, consumption expenditures are greater than wage income.
  • Macroeconomic profit does neither depend upon the agents’ personal qualities, motives, their ideas about what profit is, nor on profit-maximizing behavior, nor on markup-setting, nor on risk-taking.
  • In order that profit comes into existence for the first time in the elementary production-consumption economy, the household sector must run a deficit at least in one period. This presupposes the existence of a credit-creating entity.
  • Profit/loss is, in the most elementary case, determined by the increase and decrease of the household sector’s debt.
  • Monopoly power is irrelevant for macroeconomic profit and affects only the DISTRIBUTION of total profit AMONG firms.
  • There is no relation at all between profit, capital, marginal or average productivity.
  • Profit is a factor-independent residual and qualitatively different from wage income. Therefore, it is an elementary mistake to maintain that total income is the sum of wages and profits.#6
  • Innovation and efficiency are irrelevant for the profit of the business sector as a whole.
  • It is a Fallacy of Composition to trivially generalize what can be observed in an individual firm. Microfounded profit theory is one big Fallacy of Composition.#7
  • There is NO such thing as good old value-creating capitalism and bad new rentier capitalism. The macroeconomic Profit Law is the same from the beginning of time until the end.
High time that retarded orthodox and heterodox economists get their heads around the foundational fact of economics.

Egmont Kakarot-Handtke

#1 Working Paper The Profit Theory is False Since Adam Smith
#2 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism
#3 Profit for Marxists
#4 How Keynes got macro wrong and Allais got it right
#5 Wikimedia AXEC31
#6 Profit and the decline of labor’s nominal share
#7 For details of the big picture see cross-references Profit

Related 'How the intelligent non-economist can refute every economist hands down' and 'The unintended consequences of deficit spending' and 'Rethinking macro' and 'Ricardo and the invention of class war' and 'Capitalism, poverty, exploitation, and cross-over exploitation' and 'If we only had classes' and 'Profit'

Wikimedia AXEC109i