Blog-Reference and Blog-Reference on Feb 17
Ricardo asserted the seemingly obvious “There is no other way of keeping profits up, but by keeping wages down.” This assertion is pure common sense, plain and immediately convincing as “the sun goes up”. Needless to emphasize that both assertions are scientifically false.#1
By asserting an antagonism between wages and profits, Ricardo provided the economic underpinning for Marx’s sociological/political concept of class struggle or class war. In the following the proof is given that there is NO antagonism between wages and profits and that classes are an optical illusion.
The elementary production-consumption economy is defined with this set of macro 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.#2
Under the conditions of market clearing X=O and budget balancing C=Yw in each period the price is given by P=W/R (1), 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. It translates into W/P=R (2), i.e. the real wage is equal to the productivity. For the graphical representation see Wikimedia.#3
Monetary profit is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm+Sm=0 or Qm=−Sm, in other words, the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). 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 says that profit/loss has NOTHING to do with labor time, wages, productivity, greed, monopoly, power etcetera but with the change of private and public debt.
In the elementary production-consumption economy, labor gets the whole product according to (2), and profit for the business sector as a whole is zero because C=Yw. All changes in the system are reflected by the market clearing price. As a matter of principle, the elementary production-consumption economy can go on indefinitely at any level of employment L. The living standard of the workers is defined alone by the productivity.
Obviously, there is NO such thing as an antagonism of wages and profits in the elementary production-consumption economy. If the wage rate W goes up the market clearing price goes up according to (1) and the real wage remains unchanged according to (2).
This means, first of all, that Ricardo’s theory of profit and rent is proto-scientific garbage. This is fatal for Marx who built on Ricardo.
The business sector is now split into two identical firms and firm 1 is supposed to cut the wage rate W1 arbitrarily by half. From this follows that the market clearing price P declines if all other variables are unchanged. Firm 2 is affected because total income Yw falls and with it consumption expenditures C and the market clearing price P.
The reduction of the wage rate W1 increases the profit of firm 1 and produces a loss in firm 2. When we look alone at firm 1 we see what Smith, Mill, Ricardo, and Marx have seen before, to wit, wages down ― profit up. This fits the time-honored stereotype of wages and profits as antagonists.
The error/mistake/blunder of Ricardo et al. was to generalize what is true for a single firm and this is known as Fallacy of Composition.
If profit has been zero in the initial period because of budget balancing C=Yw then firm 2 makes a loss which is exactly equal to firm 1’s profit. Hence, the arbitrary wage rate cut of firm 1 does NOT increase the profit of the business sector as a whole but only REDISTRIBUTES profit/loss between the firms that constitute the business sector.
Seen from the perspective of a single firm, the antagonism of wages and profits is absolutely real. This, though, is parochial realism. The complete picture reveals that firm 1 is better off to the disadvantage of firm 2 and the workers of firm 2 are better off to the disadvantage of the workers of firm 1 because at a lower market clearing price they absorb a bigger share of output O with their unaltered income. The situation of the business sector as a whole is unchanged and the same is true for the household sector as a whole. If there is exploitation it happens within the sectors. A partial wage rate change leads only to a redistribution of profits between the firms and of output between the workers. A global wage rate change leads under the condition of budget balancing and market clearing only to a price hike.
For the economy as a whole, the Ricardian antagonism of wages and profits is an optical illusion. This has a bearing on the political notion of classes. Because Ricardo’s profit theory is false Marx’s theory of class war is false. What looks like exploitation is, in fact, cross-over exploitation WITHIN the Marxian classes.
The myopic agents, workers and capitalists alike, are blind to these interdependencies and therefore prone to the Fallacy of Composition. This is excusable. But that economists suffer from the same delusions is inexcusable.
As One of the Old School put it in 1829 “That which bears the name of Political Economy, is now taught at your University, …, as a science equally true in its principles with Geometry. If it be not a science, but a mass of fictions, you are, by teaching it, deeply disgracing your University, and destroying your own reputation as men of science.”#5
#1 Ricardo, too, got profit theory wrong. Sad!
#2 For details see ‘Proﬁt for Marxists’
#3 Wikimedia, Elementary Production-Consumption Economy
#4 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism
#5 The real problem with the economics Nobel
Related 'Profit and stupidity' and 'The abject failure of orthodox and heterodox distribution theory' and 'No exploitation, no classes' and 'Marx, the moron' and 'Your profit theory is false' and 'If we only had classes'. For details of the big picture see cross-references Profit.
You say “Well, Egmont, you forget that if the owners of capital BELIEVE that profits are a subtraction from wages (and/or vice versa) and act accordingly it becomes a self-fulfilling prophecy.”
Obviously, you have never heard of the Invisible Hand. It does not matter what people believe they are doing. They think they follow their own interest but, in fact, promote the overall optimum optimorum. Self-delusion is the whole point of the free market system and the ultimate justification since Mandeville’s Private Vices = Public Benefits. Of course, this is economic storytelling and proto-scientific garbage.
Overall net-profits do NOT come into existence because people dream or hallucinate about them but ultimately because of the increase of private/public debt. This is the Invisible Hand. If the budget is balanced C=Yw there is NO overall profit, NO matter what capitalists believe or how they act. With regard to profit, there is NO self-fulfilling prophecy only the Iron-Objective-Eternal-Testable Profit Law.
My proof shows how the Invisible Hand works. What people believe is NOT AT ALL a matter of economics but of psychology and sociology.
Take notice that economics is NOT a science of Human Nature/motives/beliefs/ expectations/behavior/action but a system science. Economics has since 200+ years been on the wrong track and has produced nothing but folk psychology and folk sociology. Economics is a failed science because economists are incompetent scientists who suffer from the social science delusion.#1
The Profit Law consists of measurable variables. It is testable and it will be corroborated without exception in all countries with a scientific infrastructure without bothering one second about people’s silly beliefs.
#1 For details of the big picture see cross-references Failed/Fake scientists
You say “The ‘invisible hand’ is a lump of labor”
Obviously, you have not realized that your lump-of-labor (EXPLETIVE DELETED) has already been refuted. See Unemployment is the outcome of political economics.
Scientific standards are well-defined: “Research is, in fact, a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant)
Because a theory must satisfy TWO criteria ― material AND formal consistency ― it is sufficient for a refutation to prove that it is EITHER materially OR formally inconsistent.
I have proven that Ricardo’s profit/distribution theory is formally inconsistent. More specifically, that Ricardo committed the Fallacy of Composition and the Humpty Dumpty Fallacy by defining total income as sum of wage income and profit.#1, #2 More specifically, the macroeconomic definition of total income as Y=W+P translates algebraically into 1=1/(1+P/W)+1/(1+W/P) and this translates verbally into Ricardo’s pivotal claim “… profits would be high or low in proportion as wages were low or high.” (Principles, p. 110) but because the premise is false Ricardo’s assertion is false.
By consequence, Ricardian economics is refuted. Now, the ball is in your field. If you do not agree with me ― and you obviously don’t ― you have to demonstrate where my logical error/mistake/blunder lies. Blah blah is NOT sufficient.
What you could alternatively do is to demonstrate that I am empirically wrong because from the axiomatically correct profit theory follows the general balances equation (I−S)+(G−T)+(X−M)−(Qm−Yd)=0 while from Ricardo’s false profit theory follows the Post Keynesian balances equation (I−S)+(G−T)+(X−M)=0.
The experimentum crucis ― which of the two equations is empirically true? ― has never been performed for the simple reason that macroeconomics runs since Keynes blindly on the false profit theory and the false Post Keynesian balances equation.#3 MMT is the Smoking Gun proof.
But again, the ball is in your field. If you know in your profound academic erudition that there is an empirical study which has corroborated the Post Keynesian balances equation or refuted my balances equation it is your scientific duty to present it in the current discussion. Again, blah blah is NOT sufficient.
As One of the Old School said in 1829: “If it [economics] be not a science, but a mass of fictions, you are, by teaching it, deeply disgracing your University, and destroying your own reputation as men of science.”
#1 Ricardo, too, got profit theory wrong. Sad!
#2 Profit, income, and the Humpty Dumpty Fallacy *
#3 How Keynes got macro wrong and Allais got it right