February 14, 2018

Ricardo, too, got profit theory wrong. Sad!

Comment on Sandwichman on ‘No Other Way of Keeping Profits Up’

Blog-Reference and Blog-Reference

In his letter of 1829 To the Heads of the University of Oxford, One of the Old School asked: “ARE THE PRINCIPLES OF POLITICAL ECONOMY WHICH GOVERNMENT IS ACTING ON TRUE OR FALSE?”#1

He got the following answer in the Westminster Review.#2

“The first of the principles which ‘the old school’ think so erroneous, is the well-known doctrine of Mr. Ricardo, that, putting rent out of the question, the price of every commodity consists wholly of wages and profits.”

Ricardo is known for having asserted: “… profits would be high or low in proportion as wages were low or high.” (1981, p. 110) However, things are not as straightforward as they seem.

The WR now goes on to filibuster: “In this nomenclature low and high have no reference to amount; they indicate only proportion. If a commodity should at one time sell for ten shillings, of which the labourer received nine, and should afterwards sell for twenty, of which the labourer received fifteen, this, according to Mr. Ricardo’s nomenclature, would be a fall of the labourer’s wages. Though he would receive a larger amount, he would have a smaller proportion. And proportion is all that Mr. Ricardo considers.”

“This strange use of words, like every other deviation from ordinary language, has produced much obscurity. It has some times led even such men as Mr. Ricardo and Mr. M'Culloch into inconsistency. Our readers may imagine how it has confused Mr. Blackwood’s correspondent. He has not the least glimmering of the meaning of the writers whom he attacks, but goes on heaping abuse on economists for propositions in which they understand by the word low wages a low proportion, while he supposes them to mean a small amount.”

“But he [Ricardo] is not consistent. When he says, that ‘whatever raises the Wages of labour, lowers the Profits of stock,’ he considers Wages as a proportion. When he says that ‘high Wages encourage population,’ he considers wages as an amount. Even Mr. M'Culloch, who has clearly explained the ambiguity, has not escaped it. He has even suffered it to affect his reasonings. In his valuable essay ‘On the rate of wages,’ he admits that ‘when Wages are high the Capitalist has to pay a larger share of the produce of industry to his labourers,’ An admission utterly inconsistent with his general use of the word, as expressing the amount of what the labourer receives, which, as he has himself observed, may increase while his proportion diminishes.”

The profit theory has not improved since 1829. As Mirowski put it “... one of the most convoluted and muddled areas in economic theory: the theory of profit.”

The error/mistake/blunder of Ricardo’s profit theory is that it is a generalization of what can be observed at the microeconomic level, that is, it is a Fallacy of Composition. The profit for the economy as a whole has to be derived from macroeconomic axioms.#3

Monetary profit for the economy as a whole is defined as Qm≡C−Yw (C consumption expenditures, Yw wage income) and monetary saving as Sm≡Yw−C. It always holds Qm+Sm=0, or 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 C=Yw total monetary profit is zero.

Macroeconomic profit depends in the most elementary case alone on deficit spending, that is, on the change of private or public debt. It does NOT depend on labor time, or wages, or productivity, or monopoly power, or greedy managers. 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 pure 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/rent-seeking is irrelevant for macroeconomic profit and affects only the DISTRIBUTION of total profit BETWEEN firms.
  • There is no relation at all between profit, capital, marginal or average productivity.
  • Innovation and efficiency are irrelevant for the profit of the business sector as a whole.
  • Profit is a factor-independent residual and qualitatively different from wage income (difference of flows vs flow). Therefore, it is an elementary mistake to maintain that total income is the sum of wages and profits.#4

Microfounded profit theory suffers from three methodological blunders: the Fallacy of Insufficient Abstraction, the Fallacy of Composition, and the Humpty Dumpty Fallacy. The Principles of Political Economy were false in 1829 and are false to this very day.

Egmont Kakarot-Handtke


#1 Blackwood’s Magazine (courtesy EconoSpeak)

#2 Westminster Review
#3 The profit theory is false since Adam Smith
#4 Profit, income, and the Humpty Dumpty Fallacy

Related 'When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism' and 'Profit for Marxists' and 'The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?'

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REPLY to Barkley Rosser on Feb 14

Like Ricardo, I consider the most elementary case, i.e. wage income and profit. The axiomatically correct macroeconomic Profit Law says for the general case Qm=Yd+(I−Sm)+(G−T)+(X−M). Legend: Qm monetary profit, Yd distributed profit, I investment expenditures, Sm monetary saving, G government expenditures, T taxes, X exports, M imports.

All variables are measurable with the accuracy of two decimal places. Therefore, the Profit Law can be tested, in principle, for every country around the globe. There can be no doubt that it will be confirmed without exception.

to Sandwichman

The link #2 to the article in the Westminster Review works probably better from my blog.

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REPLY to Barkley Rosser on Feb 15

You say “But while you have been asked to do so many times, you have never offered a shred of evidence to support this claim that data will support your crank theory. And evidence does not support it.”

Instead of gossiping about the sex life of the House of Saud you should have done some methodological homework, You may have stumbled across Popper’s meme of conjectures and refutation. And you may have realized that there is theoretical physics which provides the conjectures and experimental physics which does the testing. Both tasks require different talents/tools and are normally performed by different people.

Your scientific education apparently ended with the story of Galileo throwing cannon balls from the Leaning Tower of Pisa in order to prove his Law of Falling Bodies. In modern science, the division of labor is firmly institutionalized.

The first calculation of the deflection of light by mass was published by Johann Georg von Soldner in 1801. Einstein calculated the relativistic deviation of light two times. Ironically, he got it wrong the first time in 1908 without realizing it until 1915. Luckily for him, the First World War prevented testing. It was Eddington (and two other expeditions to Brazil and Russia) who tried in 1919 to actually test = measure the deviation during a solar eclipse. Einstein did NOT test relativity himself. The same goes for Higgs and the testing at CERN. Note that the folks at CERN had to build first the biggest and most expensive machine in human history. Something that was obviously beyond the means of the theoretical physicist Higgs.

No scientist ever came up with the idea that von Soldner, Einstein, or Higgs should have tested their theories themselves or with the brain-dead critique that they have “never sullied their hands” with actual empirical data.

So, theoretical physics provides the testable formula and experimental physics does the testing. Likewise, theoretical economics provides the formula, and the econometricians do the testing.

Here is my challenge: MMT asserts in the Keynesian tradition that the macroeconomic balances equation reads (I−S)+(G−T)+(X−M)=0 while I claim that the axiomatically correct balances equation reads (I−S)+(G−T)+(X−M)−(Qm−Yd)=0.

I wonder how long it takes to test such a clear-cut alternative and why neither Post Keynesians, Anti-Keynesians, MMTers nor you can get their asses up and “sully their hands” and settle this fundamental economic question once and for all. Wouldn’t it be a field day for you to PROVE me wrong?

I understand, as an economist, you are busy 24/7 with the WaPo gang, the CIA/SVR meeting, and the sex life of the House of Saud.

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REPLY to Sandwichman on Feb 15

Note that One of the Old School challenged the scientific status of economics: “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.”

Note also that economics is still “a mass of fictions”. And the reason why economics is a failed/fake science is that economists can to this day not tell what profit and income is.

Note also that the ‘refutation’of One of the Old School is a semantic shell game that messes up simple algebra.

“In this nomenclature low and high have no reference to amount; they indicate only proportion. If a commodity should at one time sell for ten shillings, of which the labourer received nine, and should afterwards sell for twenty, of which the labourer received fifteen, this, according to Mr. Ricardo’s nomenclature, would be a fall of the labourer’s wages. Though he would receive a larger amount, he would have a smaller proportion. And proportion is all that Mr. Ricardo considers.”

Ricardo defined total income Y as sum of wages W and profits P, i.e. Y=W+P. This gives after transformation 1=1/(1+P/W)+1/(1+W/P) with 1/(1+P/W) = share of wages and 1/(1+W/P) = share of profits. And yes, One of the Old School is right, if wages rise the share of wages increases and the share of profits decreases. The absolute amount and the share move in the SAME direction. However, the critics of One of the Old School confused themselves by simultaneously increasing wages and profits but in different proportion, i.e. wages from 9 to 15 and profit from 1 to 5. Wages seem to rise but actually fall IN RELATION to profit and this is why the share of wages falls. No ambiguity here, no paradox, all plain and simple algebra.

The one thing that the alleged refutation of One of the Old School proves is the utter scientific incompetence of economists. Ricardo got profit theory wrong and neither Walrasianism, Keynesianism, Marxianism, Austrianism, nor Barkley Rosser has realized it to this day. Not to speak of rectification.

As One of the Old School clearly saw in 1829, these folks are disgracing their universities. High time to throw them out.

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REPLY to Barkley Rosser on Feb 16

Your restless attempt to mess up any issue is not even comical. You simply cannot resist the temptation to parade your absolutely irrelevant knowledge of biographical and historical detail. As always, you are missing the essential point.

The essential point is the alleged antagonism between wages and profits which provided the economic argument for Marx’s sociological/political concept of class struggle.

Sandwichman’s introductory quote “There is no other way of keeping profits up, but by keeping wages down.” (David Ricardo) clearly defines the point at issue.

The Westminster reply starts “The first of the principles which ‘the old school’ think so erroneous, is the well-known doctrine of Mr. Ricardo, that, putting rent out of the question, the price of every commodity consists wholly of wages and profits.”

“… putting rent out of the question” means focusing on the relationship between wages and profits and putting rent aside for the moment.

This, of course, is unacceptable for the confused confuser Barkley Rosser because he has a lot to parade about rent and Malthus and Oxford and Cambridge and who was alive and who was dead.

This drivel is, as always, pure disinformation.

The point at issue is that Ricardo’s theory of profit and rent is provably false.#1

This, in turn, means that Political Economy has no scientific merits, a fact that One of the Old School did not fail to mention “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.”

This is as true today as it was in 1829 because profit theory is still false, or as the Palgrave Dictionary puts it “A satisfactory theory of profits is still elusive.” (Desai, 2008)


#1 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism

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REPLY to Sandwichman on Feb 16

The issue of substance theories has been dealt with exhaustively by Mirowski in More Heat Than Light.

So we know definitively that both the Labour Theory of Value and the Utility Theory of Value are dead and buried just like the Flat Earth Theory.

The only interesting question is now where the exit of the scientific graveyard is. Or, as Feynman put it “The problem is not just to say that something might be wrong, but to replace it by something — and that is not so easy.”

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NOTE on Sandwichman’s ‘Rumble on Wall St. ― No Other Way of Keeping Profits Up!’ on Feb 16

You say “And this is also why I think it would be impossible to empirically confirm Egmont Kakarot-Handtke’s ‘law’ of profit. There is no ‘real’ yardstick with which to measure aggregate profit. If Egmont is right that ‘[m]acroeconomic profit depends in the most elementary case alone on deficit spending, that is, on the change of private or public debt,’ then he is wrong that his profit ‘law’ can be tested empirically and ‘will be confirmed without exception’.”

You are wrong, of course. What you overlook is that there are TWO kinds of profit: monetary profit Qm and nonmonetary profit Qn. Monetary profit emerges in the production-consumption economy and can be measured with the accuracy of two decimal places in all countries with a proper system of National Accounting and at least one intelligent economist. Countries that do not satisfy these conditions may be called scientific shitholes.

Therefore, the structural/systemic/behavior-free/objective/macroeconomic Profit Law#1 will be confirmed without exception in all (non-shithole) countries around the globe.

The market economy, though, consists of TWO entirely different types of markets: the primary markets of the production-consumption economy and the secondary markets of all kinds of real and financial assets.#2 In these markets, non-monetary profits/losses Qn emerge through the re-evaluation of assets. These re-evaluations are highly subjective and can, at the moment at least, be entirely fictitious/fraudulent.

So, there are TWO theories of value and there are TWO entirely different kinds of profits, i.e. objective/measurable monetary profit Qm and subjective and currently not reliably measured non-monetary profit Qn.

As you can see from the correct axiomatic foundations,#3 total profit is given with the 4th axiom as Q=Qm+Qn. The macroeconomic Profit Law relates to Qm and is provably true.#4


#1 First Fundamental Law vs. Fundamental theorem of income distribution
#2 Primary and Secondary Markets
#3 Wikimedia


#4 For details of the big picture see cross-references Profit

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REPLY to Barkley Rosser, Sandwichman on Feb 18 and Blog-Reference MNE

Barkley Rosser says: “So, to get back to the main issue, where both S-man and the execrable Egmont decided that they were in it together being really serious, neither of them has even recognized the point I made from Ricardo that rent is the third category of income, “

False. I gave you the reference to my paper about rent. Here, once more.#1 The whole point of this thread is to clarify first the relation between wages and profits which is the pivot of all of economics. Your repeated attempts to draw attention away from the point at issue is ridiculous. Your assertion “neither of them has even recognized the point I made from Ricardo that rent is the third category of income” is provably false.” Anybody can check it anytime by browsing the posts above.

Sandwichman says: “The ‘lump of labor’ is FUNDAMENTAL to ‘economic thinking’ and the way that economists disavow the foundation of their very own fetish is to project it on to others.”

False. First of all, there is NO such thing as economic thinking. There is merely the blathering of confused confusers.#2 And you and Barkley Rosser are here and now providing the Smoking Gun proof.

Second, NOT the lump-of-labor is fundamental to economic thinking but profit. Who does not understand what profit is does not understand how the economy works. This applies to all economists between Ricardo and Barkley Rosser/Sandwichman.

You muddleheads do not even understand the existential problem of economics. Marx did: “How can they continually draw 600 p. st. out of circulation, when they continually throw only 500 p. st. into it? From nothing comes nothing. The capitalist class as a whole cannot draw out of circulation what was not previously in it.”

Marx saw the problem but he could not solve it. He drowned in the semantics of the Labour Theory of Value just as the Neoclassicals later on drowned in the verbiage of the Utility Theory of Value.

Just like Ricardo, Marx got the profit theory wrong.#3 The correct answer to the existential problem of economics is that the “capitalist class as a whole” can only “draw out of circulation what was not previously in it” if either the household sector or the government sector throws more into the circulation than they take out, that is, if they run a deficit, that is, if they increase their debt. And this is something that can be observed and measured with the accuracy of two decimal places. The axiomatically correct profit theory is given with this general balances equation (I−S)+(G−T)+(X−M)−(Qm−Yd)=0 which fully replaces the false After-Keynesian balances equation (I−S)+(G−T)+(X−M)=0.

Sandwichman says: “Poor, dumb Kaka-root thinks he can overturn ‘unscientific’ economics with ‘scientific’ economics.”

Economics is, according to its self-definition for 200+ years, a science. And everybody who doubts it is reminded each year in no uncertain terms with the “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel”. This Prize, of course, is a fraud because economics is a proto-science or what Feynman called a cargo cult science that has not even managed to get its foundational concepts consistently together. The dire consequences were pointed out by One of the Old School back 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.”

The muddleheads of economics sit squarely in the swamp where “nothing is clear and everything is possible”. (Keynes) And when they are told that their inconclusive blather is cargo cult science they pull the ejection seat and claim that there is no scientific truth because of ontological uncertainty and because of Heisenberg and Gödel.#4

It is absurd in the extreme when scientific morons who have not gotten the foundational concepts of their own discipline right and fail at the elementary mathematics of accounting waffle about advanced physics and mathematics. On this score, Barkley Rosser and Sandwichman never disappoint the audience: “Well, S-man, … I have a paper coming out in the Journal of Evolutionary Economics with Simone Landini and Mauro Gallegati on the implications of that theorem for economics, which is a deep jump into such matters.”

We are all looking forward to Barkley Rosser’s jump from the 10m springboard into the empty swimming pool.#5, #6


#1 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism
#2 Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist
#3 Karl Marx, fake scientist
#4 Failed economics: The losers’ long list of lame excuses
#5 How economists shoot themselves non-stop in the methodological foot
#6 The insignificance of Gödel’s theorem for economics

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REPLY to Sandwichman on Feb 19

Rent is profit as it appears in the agricultural industry. Economically, a farm is not different from a firm. Ricardo did not understand what profit is and things have not improved in the meantime. The foundational concepts of economics are ill-defined since 200+ years. Well done, soapbox economists!


#1 When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism

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REPLY to Sandwichman on Feb 20

“That in their appearances things are often presented in an inverted way is something fairly familiar in every science, apart from political economy. (Marx)

“But all science would be superfluous, if the appearance, the form, and the nature of things were wholly identical.” (Marx)

“People fancied they saw the sun rise and set, the stars revolve in circles round the pole. We now know that they saw no such thing; what they really saw was a set of appearances, equally reconcileable with the theory they held and with a totally different one. It seems strange that such an instance as this, . . . , should not have opened the eyes of the bigots of common sense, and inspired them with a more modest distrust of the competency of mere ignorance to judge the conclusions of cultivated thought.” (Mill)

Rent is profit as it appears in the agricultural industry. The bigots of common sense don’t get it since Ricardo. The blather of the bigots of common sense is to this day called economics.

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REPLY to Sandwichman on Feb 20

You still have not answered the foundational question of economics: What is macroeconomic profit and how is it related to wages?

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QUESTIONNAIRE back to Sandwichman on Feb 21

no
n/a
n/a
look it up in my working papers on SSRN
no
n/a

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JFTR on Feb 22

“To determine the laws which regulate this distribution, is the principal problem in Political Economy .” (Ricardo, Principles, 1821, Works, I, p. 5)

The Law of Distribution for the production-consumption economy is shown on Wikimedia


The Law presupposes the axiomatically correct definition of monetary profit Qm and total nominal income Y.