Saturday, November 21, 2015

The Paradoxical Kalecki (part i)

(Motivated by a side discussion at Peter Cooper's)

Following Keynes and the paradox of thrift he popularised, Keynesian economists have developed a taste for paradoxes. In most cases I'm sure there is something to those paradoxes; in a few cases, they may be meaningless, but otherwise harmless.

In one case, however, this reliance on paradoxes seems detrimental. Paradoxically it involves misinterpreting Polish economist MichaƂ Kalecki's price equation:

(1)          P = Cp + I.

In that very simple equation (the version above is the simplest one), P is gross operative profits, Cp is capitalists' consumption, and I is private gross investment (all in AUD, as measured locally by the ABS). In this series of three posts I'll argue that equation (1) -- together with the Keynesian fondness for paradoxes -- can lead to theoretical paradoxes.

The derivation of (1) is trivial (see Kalecki's Wikipedia entry) and I don't dispute it.

Things start getting tricky when one tries to interpret that accounting identity. Perhaps the most natural interpretation, given the meaning of the variables, is that gross operative profits fund capitalist's consumption and investment. In other words: P logically precedes and constrains Cp and I.

Kalecki, however, rejects that interpretation. Capitalists -- he argues -- control their own spending decisions (Cp, I), but not their earning outcomes (P): their spending decisions determine their profits. Kalecki famously put it thus: "capitalists get what they spend". For him, Cp and I logically precede and enable P. A fundamental corollary would be: workers' demand is utterly irrelevant to capitalists' profits (keep this in mind along this series).

More subtly: an accounting identity becomes a function P = P(Cp, I) and there is now a causality, where there was none before.

Frankly, I find Kalecki's justification -- at least as stated here -- less than persuasive, with a chicken/egg quality to it. Too much concluded on too little ground.

But I will no dispute it, either: others -- much more qualified than me -- seem to accept it without reservations. Besides, I suspect a different argument could do a much better job.

My beef with that interpretation -- as proposed -- is that it gives rise to comments like the one below. And, in this case, it's a lot easier to find specific -- and in my opinion fatal -- errors:
"Answering the question 'Where do profits come from?' requires a macroeconomic perspective. Profits are produced by specific macroeconomic flows of funds. Unfortunately, the macro perspective necessary to investigate these flows can be elusive because of a logical trap: the tendency to assume wrongly that circumstances that apply to the familiar case of the single firm also apply to the entire business sector.
"To illustrate the problem of applying a microeconomic perspective to a macro situation, consider the following. As every entrepreneur knows, employee costs are a major influence on a firm's profits. Cutting payroll expenses means a more robust bottom line. Accordingly, it is commonly believed that when firms throughout the economy hold down wages, they improve aggregate profits. However, for the whole business sector, cutting employee compensation reduces revenue as well as expenses. Less worker pay means less personal income and, therefore, less personal spending on the goods and services sold by businesses. Therefore, cutting payrolls will not directly increase corporate profits".
That quote comes from "Where Profits Come From?", published in 2008 by the Jerome Levy Forecasting Center. Although the word itself does not appear in that quote, it uses a typical Keynesian paradox device. (Incidentally, this is not the only instance of similar arguments, although it is probably the best argued and most attractively presented I've seen. I suspect it is, too, a rather influential one, apparently being quoted by many without attribution.)

In the second post in this series I'll go through this argument in detail to test its logical consistency.

(To be continued)


  1. Thanks, Larry.

    Hopefully, I won't disappoint. :-)

    More social democracy proponents.