SimpleDon
Veteran Member
I thought that we had put this question to bed a long time ago in the 28 year graduate student debunks Piketty thread.
The author of this study unfortunately goes to MIT where the economics department apparently doesn't teach even their graduate students about the Cambridge Capital Controversy, the CCC. This is somewhat understandable, the Cambridge that finally conceded the points was MIT's Solow and Samuelson to Sraffa and Robinson of Cambridge University in England.
The conversity hinges around the question of, what is capital? The neoclassical theory of capital and profit is that profits are the rewards for capital like wages are the rewards for labor. The neoclassical production function, the calculation of the production costs due to the capital investment, in a word the profits, is based on the marginal productivity of the capital. The part of the capital that is needed to produce the last item produced. It is obvious that the neoclassicalists are talking about physical capital, for example, the machinery that produces product, the trucks that transport it.
But this presents the first of many problems. Because the physical capital both appreciates and, at the same time, it also depreciates, its value, especially for the stockholders, is not defined by the initial investment required to buy and install the machinery, but by the profits that the machinery generates.
In other words you have circular relationship. The production function for profits from capital depends on the marginal productivity of the physical capital but the valuation of the physical capital depends in part on the value of the profits.
And, while it may not be obvious in this short discussion, it turns out that any attempt to define and to add together capital to find aggregate capital across the whole economy, for the capital share, or in this age of microfoundations, disaggregating capital to an individual, is not possible without an accepted value of the interest rate involved, which because it has to be a prior value, it has to be a financial factor not related to the physical capital at all.
If the actual interest rate is a financial variable, that is, it changes for financial reasons, the physical interpretation of a dollar-valued capital stock is close to meaningless.
What this means among many other things is that the richer countries didn't get that way because they employed more capital. That richer countries often use less capital and have more services and more labor in their export products than poorer countries, reference the “Leontief paradox.” Rather than through capital investment these countries became rich by learning, by improving technique, by installing infrastructure, through education, and by implementing thorough regulations, a competent IP system and social insurance. None of this has any necessary relation to the production function or to the physical concept of capital, and little to a measure of the financialization of wealth in stock markets.
What this means is that defining ”capital" is a term of art, not of science. Going back to your exhibit, the graduate student who is unaware of the CCC and its implications for his theory, the question has to be asked not only which capital, that is, book value, replacement value or market value, is he talking about that has to be depreciated to correct the income from profits, but which form of depreciation is to be applied? There are as many models of depreciation as there are of capital. There is straightline, mark to market, accelerated for tax purposes, and all favors of graduated ones beyond straightline. So the question is multiplied, it is which "capital" is considered and which depreciation is applied?
And if you apply this standard you have to go back to 1980 and apply the same reduction of profits to that year.
And not to mention that there are a lot of plants still running, producing product and profits, even though their entire physical plant has been depreciated to zero value. But obviously the plant is not worthless, and it may even be worth more than it cost originally.
And his conclusion raises questions beyond these. It is based on the statement that it is valid "only if we count housing" in the nation's capital counted as profit and loss. Housing certainly counts as wealth, but it is questionable if it should be counted as capital because it doesn't contribute to producing products, the real profit and the real purpose of the economy.
Housing is just one of the ways available for storing the money earned from corporate profits. When you suppress wages you discourage investment in businesses because you have reduced demand along with the wages. The money has to go somewhere, part of it certainly finds its way into expensive homes.
A thought experiment. We could all agree that our homes were worth $100,000 more than the current Zillow estimated value. What would be the impact on the economy? Would it be positive or negative? We can agree that wealth would increase for everyone who owns a home. But to cash in they have to sell their house and not buy another. Every house's price has also been inflated by $100,000. A house isn't an investment because you always need a place to live.
What we will have done is to increase the cost of housing for everyone, property taxes would increase, rents would have to go up, it would be harder for the young starting out to buy their first home, fewer homes would be built and the pressure on wages to increase to cover the increase in the cost of housing would be huge. Once again, a macroeconomic paradox, what is good for the individual is bad for the whole economy. In other words the increase in the costs of housing is a negative to the economy.
The important point isn't that there aren't any employees of increased housing valuation, but that increased valuation of housing doesn't produce anything and for the most part hurts the economy.
If there is capital gain taken from the sale of a house it's counted is the individual's capital gain, his income. This paper lumps it together with corporate capital and profits. We could just as easily define it as part of the labor share, resulting in an entirely different conclusion.
This is why most non-neoclassical economists concentrate on the flows of money in the economy and don't worry about accumulations. They look at profits as a flow and don't look at capital gains until they are realized, the house or plant is sold and we have the capital value defined, the selling price, money changes hands, the money flows.
Or when money is created, a loan, or taken out of storage in the bank or T-Bills and invested in a business. Once again, when the money changes hands, when it flows through the economy.
Money that is not moving through the economy is not money in any economic sense. When it is parked in a bank it's not money impacting the economy unless it's loaned out. Unrealized capital gains or losses aren't money either.
The entire reason behind the tortured idea of a regular production function is to prove that capital earns the profits as a legitimate cost of production and not just the surplus left over after accounting for all of the costs of production. There is no reason to have to prove this other than to inflate the importance of investment. To give it an exaggerated role in the economy. To turn the clock back to when capital was limited, when it was land suitable for agriculture, and the capital holders, the landowners, played an important role in the economy. Unfortunately for the wealthy who control financial capital today, capital is just money and the economy doesn't need the money that the wealthy hold because the modern economy can generate any amount of money that it needs.
The question of the OP is should we be increasing wages by decreasing profits, not capital. Wages and profits are flows. If wages go up, profits go down. If wages go down, profits go down. If wages go up and profits go down, the demand in the economy goes up. Reverse them and demand goes down and the available financial capital goes up. But investment in the productive economy goes down because of the diminished demand.
The answer to the question is an unqualified "yes." A reduced labor share limits effective demand. Without added demand there is no reason to invest. The economy is now demand lead. It is not limited by insufficient supply, investment. Supply doesn't create its own demand, not that it ever did. Demand creates supply, that is investment and investment creates savings, not the other way.
We have had record profits in the last eight years. But wages have been going down, deflating, while what little inflation that we have had was due to the increased profits, not to increased wages. Profits are currently dropping because we have hit the effective demand limit. Consumers are spending as much as they and their banks are willing to spend. Unemployment has stabilized but it is because the labor participation rate is historically low.
