New directions in the theory of profit

Having ascertained that wages accrue to households broadly speaking, in this chapter we shall investigate how profits accrue to companies and the linkage between profits and investment. At least at the outset, we shall assume the existence, in the economy, of a single company and of a single financial institution, a commercial bank. We shall assume that the commercial bank acts as pure intermediary between households and the company. The analysis, rather than on social classes, shall be based on income typologies: wages, profit, dividends, taxes, and interests. Wages shall be supposed to be spent in the purchase of a single stock of goods and services. Exogenous money shall not be included as a source of profit. Therefore, we shall not allow for the existence of the foreign sector. Also, collecting taxes on wages and on profit, the public sector shall play a mere distributive role. Further, it shall be assumed that companies have no access to bank lending so as to finance investment, which shall uniquely be financed by profits. The chapter shall also investigate the relation between profit and interest, as well as the growth of bank deposits in the long-term.

Wages and profit allocation

We shall resume the example proposed in Chapter 1 so as to introduce profit into the analysis. Suppose that households’ accounts at Nantucket Bank are credited with $100 for producing ten tons of chowder at Seafarer Co. The value of chowder is thus $100. Wages constitute households’ credit and the debit of Seafarer Co. toward Nantucket Bank, which pays wages whenever asked for by the company. The bank acts as an intermediary between Seafarer Co. and households: on the one hand, being the company registered on the asset side of the bank’s balance sheet, the product is financially deposited within the bank; on the other hand, the bank liability represents a credit in favor of households whose object is the product. Supposing chowder is sold at its production cost (i.e. if nominal wages are $100, the price of one ton is $10), when households spend wages to buy seafood chowder, the credit-debit relationship no longer exists. In fact, households get the product

(chowder) at the very instant they spend wages; at the same time, the company pays back its debit toward Nantucket Bank. No profit has been made. However, things do change as soon as we relax the hypothesis of a selling price equal to the cost of production.

We shall consider here the case in which chowder (ten tons) is sold at a price higher than its production cost. Suppose, for instance, that nominal wages are $100 and that each ton is sold at $12.50, meaning that the selling price of total output is $125. The company will never get $125, since total income amounts to just $100. By spending their entire salary of $100, households cannot purchase the entire tonnage of chowder, but just a share of it.

Given wages, Wp and the selling price, p, it follows that: the rate of sold output, a= W_t/p, is 0.8; the value of sold output, tzW_p amounts to $80; the rate of profit, rt = 1-ct, is 0.2; and profit, P, = n W„ amounts to $20.

Table 4.1 may help clarify. Households are paid $100 (entry 1). Subsequently (entry 2), households spend $100 to purchase eight tons, valued at $80; the remaining part, two tons, valued at $20, is still stocked within Seafarer Co. The company sells a share of output and stocks the remaining part. A real income or profit accrues to the company. Further, $100 is credited on Seafarer Co.’s deposit: $80 covers the cost of production of eight tons of chowder; the remaining $20 constitutes the company’s monetary profit.

Macroeconomic profit is not given by the numerical excess of the overall price level over total costs of production, as mainly thought since classical times. The previous reasoning shows, for instance, that profit amounts to $20, not to $25, as one would think at first sight.

Having covered production costs amounting to $80, the company’s debt toward the bank shall be extinguished to the same extent. At this point, $eafarer Co. faces some alternatives.

(1) The stock of goods stored at $eafarer Co. (valued at $20) may turn out to be unsalable. Output may be unfit for sale, for instance, because of manufacturing defects. Output could also be deteriorated by flood, fire, earthquake, etc. In such a scenario, Seafarer Co. pays the $20 back

Table 4.1 Wages and profit

Source: author’s elaboration from Cencini and Rossi (2015).

to the bank, and in this way it extinguishes the debt toward the bank. Production costs have been fully covered, and the stock is thus finally purchased by the company. This case is shown in Table 4.2. Entry 1 refers to the payment of wages. Entry 2 regards households’ expenditure (bank’s assets), which leads to the expenditure of $80 income and the transfer of $20 to the company as profit (banks’ liabilities). The company buys the stock of goods which is still warehoused by paying back its debt toward the bank, as results from entry 3.

(2) The company distributes profit back to households. This may happen for several reasons. For instance, shareholders may get dividends; Seafarer Co. may also join charity campaigns and donate its gain; profit may also be taxed by the fiscal authority and be distributed to the population. An example may be of help. Suppose Seafarer Co. distributes $5 of its profit to shareholders. Once profit has been distributed (for example, to shareholders, or in charity, or through the intervention of the fiscal authority), the bank accounts of the various beneficiaries are credited. Meanwhile, the company’s bank account decreases to the same extent. The picture switches from the one represented in entry 1 (Table 4.3) to the one pictured in entry 2. Households (shareholders) are the ultimate beneficiaries of profit distribution. Following the distribution of profit, no

Table 4.2 Profit and unsalable output

Source: author’s elaboration from Cencini and Rossi (2015).

Table 4.3 Dividends, taxes, and interests

Source: author’s elaboration from Cencini and Rossi (2015).

alteration occurs in deposit levels. At this point, as described in entry 3, households purchase a $5 stock of goods from Seafarer Co. (for the sake of simplicity, suppose at a price equal to the production cost, $5). The final situation is shown in the last row of Table 4.3 (entry 4): the company’s debt toward the bank is equal to $15 (entered as a bank asset); the monetary profit of Seafarer Co. amounts to $15 (entered as a bank liability). A stock of goods valued at $15 is still to be sold by Seafarer Co.

(3) Seafarer Co. has made a monetary profit of $20 and expects to cover the costs of production of the goods still warehoused by selling them to households. In this case, as represented in Table 4.4, monetary profit is recorded on the bank account of Seafarer Co. (the liabilities in entry 3). Once both production and exchange are studied as part of a single, coherent framework, profit can be said to be both physical and monetary. Profit, at the macroeconomic level, turns out to be positive. In particular, it is a substitution income that forms thanks to the transfer of a fraction of wages to the hands of companies.

At this time, households’ income is zero, though. Therefore, how are production costs covered by the company? As it shall be observed, the answer to this question is strictly connected to the investment of profit in the production of fixed capital.

Macroeconomic foundations of macroeconomics

Before studying investment, a few remarks are worth making. So far, we have studied the existence of profit over a short time period and by considering a single company. However, the analysis is not limited to such a case and may be applied to all real-world examples in which several companies interact among themselves. Rather than attempting to describe all of them -an impossible task - some examples might serve to comprehend the matter. Despite the simplicity of the following examples, infinite, more complex

Table 4.4 A way to investment

Source: author’s elaboration from Cencini and Rossi (2015).

examples could be studied as desired. Nevertheless, the reasoning remains the same in all scenarios. Its lesson is therefore universal. This highlights the fact that the analysis in question, valid in the case of a single company, also holds true for a multi-company scenario, and, above all, it includes the entire set of companies existing in the same monetary system: in this context, therefore, the object of inquiry for the political economist is the economic system taken as a whole.

Let us suppose an economy where a number of companies do exist, each company specializing in a specific productive activity. Companies specialize in food (Wal-Mart Stores Inc.), clothing (American Eagle Outfitters Inc.), real estate (Trulia), automobiles (Ford Motor Company), services (Citibank), and other sectors (see Table 4.5).

Supposing that, for instance, Wal-Mart Stores Inc. sets a selling price of $100 million, if households spend all their income in the purchase of food, Wal-Mart makes a profit of $20 million. In fact, the food company’s earnings amount to $100 million, while its wage-costs total $80 million. All other companies, instead, have faced overall costs for $20 million, but have made no gain. Still, an observation shall be made. As soon as Wal-Mart’s profit is distributed to shareholders, for instance, it can be spent in purchasing the goods produced by the other companies. If clothes, houses, cars, and services are sold at their production cost, shareholders will purchase the whole produced stock. Thus, all companies will entirely cover their production costs.

From a macroeconomic viewpoint, total wages amount to $100 million, which is the production cost of all companies, taken as a whole. Namely, if we were to consider all companies as individual branches of a unique representative firm, that firm would sustain productive costs of $100 million. The profit made by the food company is also arrived at by setting a selling price of $125 million over production costs of $100 million. A proportion may help to understand the previous example, where a company (Wal-Mart

Table 4.5 Wages in a multi-company economy (in millions of dollars)

Stores Inc.) makes a profit and all the others cover their production costs without making any gain:

Productive costs of the firm making a profit: Selling price set by the firm making a profit = Productive costs of the representative firm: Selling price set by the representative firm

In the case under study,

$80 Mio.: $100 Mio. = $100 Mio.: $xMio.

Hence, the selling price set by the representative firm would be $125 million.

Another example might help make things clearer. Suppose that households spend the totality of their wages. Suppose also that companies sell a percentage of output and stock the remaining part, meaning that all companies make profits. Further, the rates of profit differ the one from the others. This case is summed up in Table 4.6. By using the data in the first two columns, total profit can be calculated as the sum of each company’s profits. When needed, numbers are rounded down.

Given global wages and companies’ incomes, the profit rate of the economy, n, approximately amounts to 0.19 (more precisely, to 0.193). If we were to conceive companies altogether (Wal-Mart Stores Inc., American Eagle Outfitters Inc., Trulia, Ford Motor Company, Citibank, and the others) as belonging to one single group or as a single firm, the macroeconomic or selling price of the whole product would amount to $123,915,737.30,

SW

as given bv the following formula: p =----. Caeteris paribus, the higher

1 — 7T

Table 4.6 Wages, prices, and profit in a multi-company economy (in millions of dollars)

the price of the domestic product with regard to its cost of production, the higher the profit, both in real and in monetary terms.

The examples proposed so far show that, whenever profit arises in the economy, a stock of goods is in the hands of one or more companies. The existence of monetary profit always indicates that the costs of production incurred by one or more companies have not yet been covered entirely.

To sum up,

macroeconomic magnitudes [.. .] are not obtained by aggregation; they are sets in the mathematical sense. Each product, however ‘small’, is a set; the product of every individual is macroeconomic, the sum of products gives a macroeconomic result quite simply because each product is already a macroeconomic magnitude. This means that the product is the result of a net creation [...]. Each product thus increases the wealth of society as a whole, even if it appears in the possession of a single individual.

(Schmitt 1986: 129)

Each product, taken alone, constitutes the macroeconomic foundations of macroeconomics (see Cencini 2005). All products, taken together, constitute the aggregation of macroeconomic magnitudes. One then realizes that the payment of wages allows for the creation of a real and monetary income that is a mathematical set: however small or big, this set is macroeconomic in nature, for it is a net product that modifies the overall income level in a given national economy. The macroeconomic nature of all sets is given not by their aggregation, but by the fact that each of them is a macroeconomic entity.