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a fundamental problem

by DeAnander Tue Jul 19th, 2005 at 09:49:57 PM EST

On the bus on my way to work at the U I overhear many undergraduate conversations.  Most are bloody depressing, as I have noted in previous comments on literacy, the US educational system, etc.  However last week I was treated to an interesting exposition by an undergrad who had been taking some economics classes.  Here is his version of a fundamental paradox of capitalism which I had not, myself, really grasped before.  And yet it seems so obvious.

In the market of theory (the Platonic Market):

  1. the market is supplied with goods and services by commercial enterprises.

  2. every commercial enterprise must make a profit in order to survive as a business.

  3. therefore every enterprise must offer for sale goods whose selling price is higher than the total expenses of producing them including salaries.

  4. therefore the total salaries paid to all workers contributing to the production of goods and services must axiomatically be less than the total value of the g & s produced.

  5. therefore the salaried consumers in the marketplace cannot possibly consume all the goods and services that they provide, since the total value of their salaries is always less than the total value of the g & s produced.  a great deal of the production must go unsold and constitute a loss.

So how can the businesses run at a profit?  the higher they jack up the selling price, the fewer consumers can afford the goods.

The answer historically appears to be playing one market against another with strict compartmentalisation -- that plus hyperconsumption by an elite class whose wealth does not derive from their labour but from rents or inherited capital -- consumers who are not workers.  Goods produced by underpaid wage-slave labour in China can be sold in the temporarily more affluent US.  The Indian textile industry can be wrecked -- and a million disemployed people starved to death iirc -- in order to boost production and consumption back home in Blighty.    Multimillionaires can furnish 10,000 sq ft homes and consume as much as 100 ordinary workers.

But what happens when the market is global?

The sense I get is that industrial capitalism "kites" production and consumption in the way that real estate speculators kite mortgages, borrowing against one to capitalise another.  It seems the only solution to the fundamental paradox of goods, services and salaries is to keep the capital and production in constant mutual flight, running on poverty at the production end and temporary wealth at the consumption end...  not to mention the liquidation of "free" physical resources.

Maybe those with deeper economic literacy can comment on the problem.

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a fundamental problem | 24 comments (24 topical, 0 editorial, 0 hidden)
Re: a fundamental problem (none / 0)
Three notes.

First, I think this picture ignores money not earned, i.e. stock prices and land and interests and such, which can grow. But some professional economist would surely put it much better.

Second, while the original socialist ideal would be to pay all income to workers, I think R&D and upgrading of the means of production is a rather good reason to run companies on some profit at least.

Third, for the above reason, I think the cut-throat capitalism libertarians and neoliberals dream of is also cutting away at its own feet: relentless price wars eliminate the companies' capability to invest into the future (or eliminate just those companies from the competition that do invest into the future). Ironically, it is the monopolistic tendencies of corporations that until now haven't allowed this devastation to play out in its full extent.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Wed Jul 20th, 2005 at 04:38:09 AM EST
Re: a fundamental problem (none / 0)
every commercial enterprise must make a profit in order to survive as a business.

Why is this true? Every business needs to cover all of it's expenses, including R & D and other future oriented activities. I would even include a modest return on investment as an expense.

But the "profit" here is the money that allows some people to live in "starter castles" and consume way beyond their "work." When profit becomes the overriding end of a business, and maximizing that profit is the logical conclusion of that mindset, then greed takes over and the human oriented social nature of corporations becomes antithetical to society and humanity at large.

Shorter US Blues: Greed Kills.

by US Blues on Wed Jul 20th, 2005 at 11:01:02 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
The theoretical economy produces wages for workers, but also interest that goes to capital owners, rent that goes to land owners, and profits that go to entrepreneurs.

Consumption from workers is not the only source of demand, as you indicate; land and capital owners and entrepreneurs consume too. There is also investment demand from business. If we have an open economy, there is also export demand from foreigners, and if we have a government sector we also have demand from there.

Also, strictly speaking in a theoretical competitive economy all firms get zero profit.  

by TGeraghty on Wed Jul 20th, 2005 at 04:45:16 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
TGeraghty, can you please expound on that fascinating remark?  in a theoretical competitive economy all firms get zero profit?

is this because in a theoretical competitive economy all prices fall to exactly the cost of production, because a competitor with equal intelligence and resources can produce Widget A cheaper than you can, and buyers will always prefer the cheaper widget (all other things being equal) until the profit margin is zero?  so profit margins always approach zero?

this kind of "rule" is why I tend to think theoretical economists should be confined gently in small rooms with soft, friendly walls :-)  obviously the theoretical competitive economy bears absolutely no relation to what happens in the real world :-)

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Thu Jul 21st, 2005 at 07:42:26 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
The comment was actually supposed to be tongue-in-cheek.

In the abstract "perfect competition" model that ecoonmists teach, all firms do end up with zero profit when the system reaches equilibrium, because if there are any firms with positive profits, other firms will enter that sector to get a piece of those profits, which inturn will reduce said profits toward zero.

Sure, the real world doesn't work exactly like that model, any more than a model airplane works exactly like a real one, but it's far too extreme to say it "bears absolutely no relation to what happens in the real world."

But then again your little thought experiment was only a model too, wasn't it? So now you are moving the goal posts by bringing the "real world" into it.

by TGeraghty on Thu Jul 21st, 2005 at 09:07:13 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
Well, my "no relation" comment was mostly triggered by the notion of equilibrium since, in historical memory, no "market" system has ever reached equilibrium... instead they seem to spin out of control -- in a boom/bust cycle, in bubbles, in what Mr G calls "irrational exuberance," and other manifestations of the irrationality of mass human behaviour.  One can tolerate divergences of scale between a model and the real world it claims to signify -- a model plane has different physics from a real plane.  But if the model plane (or,  in this case, the real plane based on the model) consistently flies upside down or crashes at high speed into the ground immediately after launch, I start to wonder who designed the model and why the fit seems so loose.

The difference between theory and practise in practise ...
by DeAnander (de_at_daclarke_dot_org) on Thu Jul 21st, 2005 at 09:37:41 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
Some model planes just sit on your desk and can't fly at all.

Seriously, though, you obviously raise important points. Models have to be tested against the real world, certainly.

And of course no economic system ever reaches any kind of equilibrium. But, equilibrium models are still useful for identifying tendencies or directions of change when economic systems (or parts of them) are perturbed in some way.

All I am saying is don't throw the baby out with the bathwater. Sure, economics needs to be criticized, just like any other discipline, and many economists claim far more for their models than the evidence can bear. But that doesn't mean that economics doesn't have important things to say about how the world works.

by TGeraghty on Thu Jul 21st, 2005 at 11:23:02 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
You've left out consideration of the profit, which also goes into somebody's pocket.
by asdf on Wed Jul 20th, 2005 at 10:41:51 AM EST
Re: a fundamental problem (none / 0)
But that's the nub:  to make a profit, the company must sell stuff at a price higher than it cost to make it.  That profit doesn't go into those pockets until it is made.  So ummm... if the base of consumers cannot possibly buy all the stuff that is consumed, where does the profit come from?  I think the answer really must lie in the rentier and financier class who are not workers, do not produce, yet consume at least some of the overproduction.

Greider, as I recall, said that overproduction was the primary problem of late capitalism:  the system so efficiently reduces raw materials into briefly valuable but ultimately worthless junk, that it produces more Stuff than can be sold -- yet it must be sold, and within a short time frame.  Hence the obsession with "opening new markets" to find someone who will buy, or can be made to buy, the excess production.  India's native textile industry had to be destroyed so that Indian consumers could be forced to buy the excess production of English cotton mills which in turn were usurping the raw materials flow (cotton in bales) from other continents...

A lot of the history of industrial capitalism seems bassackwards in this way.  I'll try to find the reference, but iirc the use of corn syrup in US food processing was instigated because there was a glut of corn and some bright soul thought of a way to market it;  and one reason for the kickstart of the auto industry was that there was a glut of cheap oil and someone wanted to stimulate a market for it.  The doctrine is that demand creates production, but often times it appears that production needs to create artificial demand in order to absorb excess (while still maintaining a profit instead of letting glut crash prices as it would in an unmanipulated market).  "Gee, I've got a lot of smooth river pebbles here and the landscaping business is a bit slow, I think I need a way to sell these rocks... how about... hey, Pet Rocks, that's a crazy idea, but it might just work!"

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Wed Jul 20th, 2005 at 02:50:33 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
Suppose you have a really simple one-company economy, and the company has an income from sales of $2, a cost of salaries of $1, and a profit of $1. Your question is, if the salaries are only $1, who provides the other $1 of sales? The answer: The guy who makes the profit.
by asdf on Wed Jul 20th, 2005 at 03:02:54 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
But then how is economic growth possible?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Jul 20th, 2005 at 03:05:46 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
If workers save some of their $1, that plus the profit is available for investment, which does not go to current consumption today but goes to purchasing things that result in higher output and consumption tomorrow.

That's one way growth can happen.

by TGeraghty on Wed Jul 20th, 2005 at 04:38:53 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
Hm, I don't get it.

Let's say the "company owner" has a wealth of $1, "workers" another $1. Now in one year, the "company" sells products for $2 - to "company owner" and "workers", using up their savings. $0.50 goes into the pocket of "company owner", $0.50 goes into investment, $0.80 goes into the "workers"' pockets, $0.20 goes into the bank accounts of "workers" as savings. Now investment is also purchase, from the "company" - so $0.25 again goes into "company owner"'s pocket, $0.20 into the "workers" pocket, $0.05 into their bank accounts. Leaves $1.75 spent on products in the second year and $0.25 spendable in later years...

No, I think we need some input of money into the system.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Thu Jul 21st, 2005 at 06:27:42 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
No, because the concept of "in your pocket" doesn't exist. Well, it exists in terms of pennies, but not in big amounts. The capitalist puts his money into an investment of some sort, a bank or some company shares. Thus that money is actually in use in some other part of the system.

If you want to make the model more complicated, then you have to account for all of the various flows. It gets complicated pretty fast.

by asdf on Thu Jul 21st, 2005 at 11:57:27 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
But the money that is "in pocket" or invested elsewhere is not buying goods.  So what happens to the goods that don't get bought because the workers can't afford them and the financiers' capital is tied up elsewhere?

The difference between theory and practise in practise ...
by DeAnander (de_at_daclarke_dot_org) on Thu Jul 21st, 2005 at 01:27:12 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
The capital is spent as well. The bank lends it out. Actually, the bank lends it out a couple of times. So, if I put €1 on deposit, the bank can safely lend €9 against it. If I invest in a building, then that money goes to the builder, who spends or invests it.
by Colman (colman at eurotrib.com) on Thu Jul 21st, 2005 at 01:35:36 PM EST
[ Parent ]
Re: a fundamental problem (none / 0)
I think this is where we should be looking deeper.

Basically, money lent out by banks will be used for investment (i.e. spending) by companies, but then they have to re-pay it with a profit, which in turn means a larger sum of money spent by others than the bank has.

But, banks not just deal in hard cash, they also deal in value. Value of stocks, value of estates, value of gold. Without banks and not necessarily with the same objects of value, this existed in earlier times too. This is a possibility for input into the economy.

Tough, the normal mode of economic growth is what DeAnander writes, getting it somehow from others (by colonisation as the British, by export as post-WWII Germany and Japan, by exploiting natural reserves like Saudi Arabia).

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Fri Jul 22nd, 2005 at 06:23:08 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
...or eating up the rest of the world's profits - mostly in the form of securities (stocks, bonds, treasuries) sold to foreigners that are recycled as credit for consumers - like the USA today.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jul 22nd, 2005 at 06:27:12 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
DeAnander, I think you are misled by the simplicity of asdf's one-company model. For investment means purchase of goods, too: just not those for personal consumption, but those that serve as means for research or production. Thus in the super-simplified one-company model, "investment" also stands for purchase of "goods", in this instance by the "company" from itself.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jul 22nd, 2005 at 06:08:44 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
If you re-read what I wrote, you'll note that "in the pocket" stands for money to be spent on consumption, so I wasn"'t speaking about money taken out of the system.

Anyway, taking money out of the system and spending it later (TGerarthy's suggestion) won't result in economic growth. Our model still doesn't conform to reality.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Fri Jul 22nd, 2005 at 06:06:06 AM EST
[ Parent ]
Re: a fundamental problem (none / 0)
Well, there are a lot of simplifications in this simple model, aren't there. It doesn't account for the impact of technology, for example, or risk-taking, or current value versus future value. Economics is quite complicated.
by asdf on Fri Jul 22nd, 2005 at 04:05:52 PM EST
[ Parent ]
No deeper economic literacy here (none / 0)
 but we are 50-75 years from the flashpoint yet.

 Before this flashpoint can be reached, labor must organize and become an accepted part of the capital structure of all countries, since economic history shows us that is the quickest and most productive way for workers to obtain fair wages and conditions. Business will move production to more disadvantaged areas until they run out of them.

 Only then will you start to see a contraction of the maximization of profit meme. Unrestrained capitalism is feudalism with suits. Restrained capitalism is....no one knows, it hasn't happened yet in human history.

....because I would rather see us reduce the consumption of imported oil than have to send American boys to fight in the Persian Gulf. - John B. Anderson

by Anderson Republican on Wed Jul 20th, 2005 at 05:58:00 PM EST
Re: No deeper economic literacy here (none / 0)
Feudalism with suits, that's rather good.

But can we be running in circles?  sometimes I think that's what I see coming... take the IMF strategy of deliberately crashing economies that get "too prosperous" or "too socialised".  Each of those crashes (Argentina et al) creates a new immiserated labour pool, a new low-cost captive work force, forcibly looting public resources and handing them over at pennies on the dollar into private hands.  Back to suited feudalism, gotta start all over again and it takes decades (if ever) for the working class to climb back out of the Dickensian pit.  

It's like a "Game Over, Reset" for an economy that has finally succeeded in creating a strong middle class, a public sector, universal education and the other stuff that capitalism promises (prosperity and public order).  All of that is destroyed overnight, unions demolished, poverty and insecurity re-established, and now that country can serve as a low-cost labour and raw materials source for prosperity elsewhere (comparative "advantage" is restored).

When "elsewhere" gets "too prosperous" then it too can be crashed and looted -- as the ruling class are now doing in America and seem to be thinking hard about in the EU and Oz.  When finance capital is infinitely mobile but workers and resources are not, it seems that this shell game can be played over and over, with a different set of countries assigned to the cheap labour pool each couple of decades. Smart money will sell out just before the "reforms," then come back to buy up the wreckage at fire sale prices.

Can the smart money keep doing this and thus avoid the nightmare of all financiers and rentiers -- a unified global working class, global unions, global laws governing pay and working conditions, global OSHA, etc?

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Wed Jul 20th, 2005 at 08:37:40 PM EST
[ Parent ]
Re: No deeper economic literacy here (none / 0)
It occurs to me that the IMF "structural adjustments" (this euphemism imho should make us shudder or gag just as we do at "Sonderbehandlung") are the exact opposite of the Jubilee Year...  a different kind of "game over, reset" designed to the opposite end:  to prevent the accretion of all wealth into fewer and fewer hands and the permanent immiseration of the majority.

The difference between theory and practise in practise ...
by DeAnander (de_at_daclarke_dot_org) on Wed Jul 20th, 2005 at 08:40:11 PM EST
[ Parent ]
a fundamental problem | 24 comments (24 topical, 0 editorial, 0 hidden)


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