Blog-Reference and Blog-Reference
Since Adam Smith/Karl Marx, economists have not figured out how the price- and profit-mechanism works. Because economists do not know what profit is, distribution theory is a mess. Ruccio/Morgan maintain that this is no accident: “Mainstream economics in general tends to deflect attention from the existence of inequality (e.g., by focusing on growth, output, and the price level versus distribution) and from the economic and social problems created by inequality ….”
Fact is, though, that not only orthodox economists but also heterodox economists like Ruccio/Morgan themselves get profit and distribution theory utterly wrong. The bad news for the general public is that economics is a failed science and economists are fake scientists. For lack of valid scientific knowledge in the past 200+ years, economists have never been helpful in bringing about the Good Society.
The root defect of distribution theory is that economists do not know until this day what profit is. What has to be done is a Paradigm Shift, that is, the four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― have to be buried in the darkest corner of the Flat-Earth-Cemetery.
The new paradigm starts with three macroeconomic axioms that consistently define the elementary production-consumption economy: (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.#1, #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 productivity.
Monetary profit/loss of the business sector is defined as Qm≡C−Yw and monetary saving/dissaving of the household sector is defined as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit equals the household sector’s deficit = dissaving. Vice versa, the business sector’s deficit = loss equals the household sector’s 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.
In the elementary production-consumption economy, workers get the whole product and profit is zero at any level of employment. The wage rate W can be doubled or halved, this does not matter, the real wage is always equal to the productivity. So, where does profit come from?
Macroeconomic profit depends, in the most elementary case, alone on deficit spending, that is, on the increase of the household sector’s debt. It does NOT depend on labor time, or wages, or productivity, or risk-taking, or monopoly power, or exploitation, or on psychological factors like greed or utility maximization.#3
In the elementary production-consumption economy, the wage rate for all employees (employees = labor = working-class = blue-collar workers + white-collar workers + management + executives) is equal, labor gets the whole product according to (2), and profit for the business sector as a whole is zero because of C=Yw. This is as equal as one can get for a start.
Obviously, there is NO such thing as 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).
Now, the employees are arbitrarily split into two groups of equal size. The wage rate of group 1 is then increased by a factor of 1.5 and the wage rate of group 2 is halved thus that the total wage income Yw=WL=W1L1+W2L2 remains unchanged. All other things, i.e. output O, consumption expenditures C, and the market-clearing price P remain unchanged.
Accordingly, the real wage of group 1, i.e. W1/P, increases 1.5 fold, and the real wage of group 2 halves. The macroeconomic profit is still zero because of C=Yw. The unchanged real product O is redistributed among the employees, that is, group 1 is better off at the expense of group 2.
The profit of the business sector is zero before and after wage discrimination. So, it is NOT the case that the capitalists, defined as owners of the firm, are better off through wage discrimination. The redistribution of output O happens WITHIN the working class. There is NO exploitation of workers by capitalists.
Now, the business sector is 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 wage 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. Exactly at this point, the idea of class war strikes the naive observer with the force of a revelation.#4, #5
The error/mistake/blunder of economists since the Classicals has been 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 now 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 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.
For the economy as a whole, the antagonism of wages and profits is an optical illusion. The concept of exploitation of the working class by the capitalist class has to be replaced by the concept of cross-over exploitation WITHIN the classes.
When Capitalism is roughly defined as ownership of the firms that make up the business sector by profit-seeking capitalists then the capitalists taken as a whole cannot increase overall profit by lowering wages. Only the individual capitalist can do this at the expense of the other capitalists. On closer inspection, it turns out that there is NO capitalist class with a common class interest.
The understanding of the phenomenon of cross-over exploitation quite naturally leads to the conclusion that it would be institutionally advantageous to have classes. Imagine, there is an institutionalized capitalist class that represents the interests of the business sector as a whole. From the class standpoint, it makes NO sense at all that one firm increases its profit by slashing wages and at the same time reduces the profits of the rest of the business sector. This is a silly zero-sum game. The fundamental construction defect of historically evolved capitalism is that it does NOT function according to class interest but according to the myopic interest of individual capitalists. This does NOT lead to an optimal outcome for the economy as a whole.
It would be much better to have a capitalist class that embodies the interests of the business sector as a whole and a working class that embodies the interests of the employees as a whole and to let them negotiate all economic issues and solve all economic problems. The socially most destructive effect of the current institutional order is the phantasmagoric class war that is produced by the Fallacy of Composition.
Economists have always been the sand sacks on the way to the Good Society because in their bottomless scientific incompetence they never understood the concepts of profit, classes, and cross-over exploitation.
Retarded folks like Ruccio/Morgan are still trapped in the Fallacy of Composition: “And it is important to remember that the growth of corporate profits is both a condition and consequence of the stagnation of workers’ wages.” False! Instead, it is important to remember that the growth of corporate profit is the mirror image of the growth of government sector and household sector debt. There has NEVER been an antagonism between overall wage income and macroeconomic profit.#6
Profit- and distribution theory are false since Adam Smith. Economists ― both orthodox AND heterodox ― have a 200+ years track record of incompetence/stupidity/corruption and are the main obstacle on the way to the Good Society.
* Real-World Economics Review
#1 Capitalism, poverty, exploitation, and cross-over exploitation
#2 Wikimedia, Elementary Production-Consumption Economy
#3 For details of the big picture see cross-references Profit
#4 Ricardo and the invention of class war
#5 Proﬁt for Marxists
#6 There is NO such thing as a “labor share of income”
Related 'The Profit Theory is False Since Adam Smith. What About the True Distribution Theory?' and 'Major Defects of the Market Economy' and 'Income Distribution, Profit, and Real Shares' and 'The Coherency of Money, Profit, Price, and Distribution' What is Wrong with Heterodox Economics? Kalecki’s Profit Theory as an Example' and 'Debunking Squared' and 'When Ricardo Saw Profit, He Called It Rent: On the Vice of Parochial Realism' and 'The Emergence of Profit and Interest in the Monetary Circuit' and 'How the Intelligent Non-Economist Can Refute Every Economist Hands Down' and 'Truth by definition? The Profit Theory is axiomatically false for 200+ years'.