June 23, 2019

The Levy/Kalecki Profit Equation is false

Comment on Alex Barrow/Macro Ops on ‘Minsky and the Levy/Kalecki Profit Equation’

Blog-Reference (Link)

Alex Barrow comes directly to the point: “Let’s kick things off with the Levy/Kalecki Profit Equation. The Profit Equation is just a macroeconomic accounting identity for how the global economy actually operates. Specifically, it answers the question as to where ‘Profits’ come from and thus, growth.”#1

And this is the answer: “The actual accounting identity looks like this: Profits before tax = + Investment – Nonbusiness saving + Dividends + Corporate profits taxes. This accounting identity, which like any identity holds true under any circumstance, is just saying that corporate profits are the direct result of net investment minus nonbusiness (Households + Government + rest of world) saving before dividends and corporate taxes are paid out.”

And this is the rationale: “Well, if you pull back and look at the global economy as a whole, it’s a closed system. It's closed in the sense that profits aren’t magically appearing from anywhere outside of the global economy. But profits obviously aren’t a zero sum game. If one company earns profits it doesn’t necessarily mean that another company somewhere has to be operating at a loss. There wouldn’t be any growth if that was the case. So, where do profits come from then?”

Yes, where? “The answer is in net investment, which is a positive sum game. If we divide the economy into our four aggregate entities (1) US Corporations (2) Households (3) All levels of US Government and (4) the Rest of the World (RoW) and look at them as a whole, there needs to be net positive investment as a whole for their to be profits. Profits are essentially the result of expanding balance sheets (increases in debt). The more balance sheets expand the lower interest rates need to drop in order to decrease debt servicing costs and keep the cost of capital down for marginally profitable firms — essentially keep the economy from going into free fall.”

Alex Barrow, respectively his source, derives the Profit Equation with the help of the identity method. More specifically:

Profits, Saving, and Investment
Aggregate profits, after corporate income taxes and dividends have been paid out, are the wealth the business sector accumulates during a period of time. Of course, businesses are not the only ones accumulating wealth ― households, government, and foreign entities also do so. The wealth the business sector accumulates is equal to the total new wealth created in the economy less that accumulated by the other sectors. In economics, the accumulation of wealth is called saving, and the creation of wealth is called investment. By common sense, the new wealth the economy accumulates equals the new wealth the economy creates; that is, saving equals investment.” and “But no matter what accounting system one uses, saving will always equal investment.”#2

This is NOT correct. On closer inspection, common sense gets the accounting identity  mathematically wrong.#3 To make matters short, here is the proof.#4, #5

The elementary production-consumption economy is defined with this set of macroeconomic axioms: (A0) 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 price as the dependent variable is given by P=W/R. The elementary production-consumption economy is shown on Wikimedia.#6

The focus is here on the nominal/monetary balances. For the time being, real balances are excluded, i.e. it holds X=O. The condition of budget balancing, i.e. C=Yw, is now skipped. The monetary saving/dissaving of the household sector is defined as S≡Yw−C. The monetary profit/loss of the business sector is defined as Q≡C−Yw. Ergo Q≡−S.

The balances add up to zero. The mirror image of household sector saving S is business sector loss −Q. The mirror image of household sector dissaving (-S) is business sector profit Q. Q≡−S is the elementary version of the macroeconomic Profit Law.

In other words, saving is NOT equal to investment (because there is NO investment in the elementary production-consumption economy) but saving is equal to loss.

So, Alex Barrow’s assertion is false: “ it [the global economy as a whole] is a closed system. Its closed in the sense that profits aren’t magically appearing from anywhere outside of the global economy. But profits obviously aren’t a zero sum game.” No, but profit/loss of the business sector and dissaving/saving of the household sector is a zero-sum game, i.e. Q+S=0.

When more sectors are added, the macroeconomic Profit Law reads with increasing complexity:
(i) Q≡−S in the elementary production-consumption economy,
(ii) Q≡I−S in the elementary investment economy,
(iii) Q≡(I−S)+(G−T)+Yd in the investment economy with government deficit/surplus (G−T), and distributed profit Yd.

The macroeconomic Profit Law fully replaces the false Profit Equations of Levy/Kalecki.#7-#12 The fact that the Profit Equation and the Profit Law look similar at the surface does not alter the fact that the Profit Equation is “educated common sense” (Stigum) and lacks proper scientific foundations.

Crucial conclusions: The monetary economy breaks down ― at the latest ― if macroeconomic profit Q turns negative. At the moment, the U.S. economy is on full life-support of the government, i.e. the government deficit (G−T) is where the greater part of profit actually comes from. It is the government that prevents “the economy from going into free fall”.

The policy of deficit-spending/money-creation clearly benefits the Oligarchy because it increases macroeconomic profit according to the Profit Law which entails Public Deficit = Private Profit. Thus the Oligarchy’s financial wealth and public debt (currently $22 trillion) grow in lockstep. The Profit Law explains the extremely skewed distribution of income and financial wealth.

Economists claim since Adam Smith that the free market economy is self-regulating and self-optimizing if left to itself. In reality, it is just the opposite: the real part of the economy is kept on life support by the State, and the monetary/financial part is kept on life support by the Central Bank.

Economics is proto-scientific garbage for 200+ years now because it does not get the foundational concept of profit right and the Levy/Kalecki Profit Equation is an integral part of the overall failure.

Egmont Kakarot-Handtke

#1 Macro Ops
#2 The Jerome Levy Forecasting Center, Where Profits Come From
#3 Wikipedia and the promotion of economists’ idiotism (II)
#4 Controlled demolition of MMT ― an exercise in elementary logic
#5 For details of the big picture see cross-references Refutation of I=S and cross-references Profit/Distribution
#6 Wikimedia AXEC31 Elementary production-consumption economy

#7 Profit: after 200+ years, economists are still in the woods
#8 Truth by definition? The Profit Theory is axiomatically false for 200+ years
#9 MMT Progressives: The knife in the back of WeThePeople
#10 MMT and grassroots movements
#11 Kalecki and Keynes: The double macroeconomic false start
#12 MMT: How mathematical incompetence helps the Kelton-Fraud

Related 'Are economics professors really that incompetent? Yes!' and 'Refuting MMT’s  Macroeconomics Textbook' and '#DrainTheScientificSwamp' and 'Macroeconomics: Drain the scientific swamp' and 'Is Nick Rowe stupid or corrupt or both?' and 'Keynes, Kalecki, MMT, and the accidental invention of the perpetual profit machine' and 'The failure of Post-Keynesianism' and 'Kalecki got it wrong, Allais got it right' and 'Rethinking deficit spending' and 'MMT Progressives: The knife in the back of WeThePeople' and 'Keynes’s Missing Axioms'.


Wikimedia AXEC143d Profit Law (with increasing complexity) and Balances Equation