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Profits
Profits Tony Aspromourgos, School of Economics, The University of Sydney, Sydney, NSW, Australia Ó 2015 Elsevier Ltd. All rights reserved.
Abstract This article outlines the main currents in the economic theory of profits from the eighteenth to the twentieth century – with particular reference to classical economics, marginalist or ‘neoclassical’ economics, the significance of profits for entrepreneurship, and Keynesian economics. It also examines how theories have connected the determination of rates of profit on capital, shares of profits in revenue, and absolute levels of profits.
Introduction From the standpoint of the history of economic theory, the development of attempts at systematic explanation of the determination of profits has its beginnings in the mideighteenth century, most notably, with Richard Cantillon (1680?–1734) and François Quesnay (1694–1774) – the latter, the key figure of the French Physiocratic school. The object of their analyses is a more or less decentralized market economy, but not yet a social economy that could be regarded as genuinely capitalist. These are early contributors to what later comes to be called ‘classical economics,’ from William Petty (1623–87) to Karl Marx (1818–83), discussed in the next section. From the late-nineteenth century, there is the rise of the ‘marginalist’ school, commonly called neoclassical economics, which becomes dominant in academic economics after World War II, discussed in the following section. The significance of profits for theories of entrepreneurship is then examined. The penultimate section considers how theories have connected the determination of rates of profit on capital, shares of profits in gross revenue or value added, and absolute levels of profits. But what of earlier Western thought? Is there anything that could be called ‘theory’ of profits to be found there? The systems of premodern Western thought concerning society, polity, and economy are first and foremost normative systems rather than descriptive systems. The most salient of these is medieval Catholic Scholasticism, a synthesis of the JudeoChristian religious tradition and the ancient Greek philosophical tradition (as well as Roman law), most famously personified in the thought of Thomas Aquinas (c.1225–74). Perhaps the most striking theme of Scholastic thought that contingently touches upon profits is its strictures against money-lending for a return in the form of interest payments (‘usury’). But there is no essential connection between these doctrines about interest and the subject of profits, since the former could apply to a world of only consumption loans (as distinct from loans for business purposes). In any case, our purpose here is to elucidate descriptive doctrines; explanations of the existence of the phenomenon of profits, rather than ethical doctrines concerning the moral legitimacy or otherwise of profits. Nevertheless, in the course of the development of primarily ethical doctrines, elements of what may reasonably be called descriptive economic theory do arise in premodern thought. For example, Scholastic concepts of ‘the just price’ of a commodity gave rise to explanations of
International Encyclopedia of the Social & Behavioral Sciences, 2nd edition, Volume 19
actual market prices, albeit crude; but little about the determination of profits that might be associated with those market prices. The concept of profits that arises in the eighteenth century belongs to a world of capitalism in which the systematic protection of individuals’ property rights and enforcement of private contracts, together with free competition (in particular, the free mobility of capital and labor between different economic activities), establishes profits as a systematic phenomenon with structure and a certain logic, within a form of generalized liberal market economy. These institutions and forms of market organization only exist in fragmentary form in premodern times.
Classical Economics The theorizing of profits in classical economics is focused upon rates of profits on capital ‘advanced’ or invested in production; that is to say, the ratio between the absolute level of profits and the value of capital invested, per time period. From the standpoint of profit maximization, this ratio is the magnitude that the owners or investors of capital are ultimately interested in: the proportion between their investment and their return. Anne Robert Jacques Turgot (1727–81) and Adam Smith (1723–90) are the earliest writers to clearly conceptualize profit rates so understood; but we concentrate on Smith, David Ricardo (1772–1823), and Marx in this section. The previous writers mentioned above, Cantillon and Quesnay, gave profits a systematic role in their economic theories, but not conceptualized in terms of the ratio of profits to capital invested. In Cantillon, profits appear as primarily a return for risk-bearing by ‘entrepreneurs.’ In Quesnay, they are the source from which capital accumulation by entrepreneurial farmers is financed, driving economic growth; but their persistence over time is difficult to rationalize in his theoretical framework. Turgot and Smith, as well as the subsequent contributors to the classical tradition, decompose profit rates into risk premia that differ across different capital investments and a kind of ‘pure’ rate of return on capital investment as such (our term). See, for example, Smith (1976[1776]): book I, chapter 10. Hence, on the presumption of risk averse behavior by capital owners or capitalists (at least on average), there will be a kind of equilibrium structure of profit rates, even under competitive conditions, reflecting higher returns for riskier investments, although Smith has some doubts as to the predominance of
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risk averse behavior. (Restrictions on competition – notably, restrictions on the free mobility of capital between different activities – will also cause profit rate differentials, with higher than competitive profit rates earned in activities less exposed to competition.) Smith is also careful to establish that, conceptually, remunerations for the functions of supervision and management of production, even if commonly referred to as profits, are, in functional terms, really a species of wages (Smith, 1976[1776]: pp. 128–130). This can be obscured when one and the same person is both the provider of capital to an enterprise and the manager of the enterprise. Smith and Turgot are also clear that if an enterprise employs borrowed funds to finance capital expenditures, some proportion of the profits will be distributed to the lenders as interest payments (e.g., Smith, 1976[1776]: pp. 112–113; Turgot, 1977[1769–70]: pp. 76–77, 85–88). At the most abstract level of theorizing, it is common for the classical economists, as well as later economic theory, to focus upon a uniform or ‘general’ rate of profit in the economy, thereby leaving aside (to be treated separately) differential risk and the associated profit rate differentials under competitive conditions. As to what determines this underlying, uniform or general rate of profit on capital as such, Smith treats profits as an element of the realization, at the level of revenues or incomes, of the economy-wide production of a social surplus. This classical concept of surplus refers to that part of the gross product of the economic system which is available for free disposal, after replacement of the necessary inputs used up in the production of that gross output, including among those inputs the customary subsistence consumption of the labor employed. The question then is how the surplus is distributed or realized in the form of incomes. For Smith, the surplus is realized in the income forms of land rents, pure profits, and a part of wages, depending on the balance of bargaining power around the labor contract. But his theory of the actual magnitude of the general rate of profit rests on a highly unsatisfactory notion of ‘competition of capitals.’ Smith supposes that the greater the extent of capital accumulation, the greater the degree of competition between enterprises, and hence downward pressure on the general rate of profit (Smith, 1976[1776]: book I, chapter 9). This does not amount to a convincing, determinate theory of the profit rate; and indeed, a generation or so after Smith, Ricardo demonstrates – albeit under rather restrictive conditions – that given the production methods in use in an economy, the general rate of profit is determined by, and inversely related to, the level of real wages (Ricardo, 1951 [1821]: chapter 6). The restrictive conditions Ricardo utilizes to arrive at this fundamental result involve, in particular, a labor theory of exchange value: It is supposed that the relative prices of commodities are explained by the quantities of labor time directly and indirectly required in the production of those commodities. Subsequently, it has been rigorously demonstrated that the inverse relationship holds under quite general conditions (e.g., Kurz and Salvadori, 1995). From the analytical point of departure of this inverse relationship, Ricardo’s focus is the course of the profit rate over time, resulting from change in production methods over time. On the one hand, declining output from capital investment on poorer quality land as population expands will place downward pressure on the profit
rate, given the real wages of labor. On the other hand, technical innovation associated with human invention can enable a rising profit rate, given the level of real wages. If the former factor dominates the latter, the general rate can fall to such a low level as to extinguish the motive to capital accumulation, bringing about a stationary state (zero economic growth; Ricardo, 1951[1821]: chapter 21). In Marx’s economics, considerably derivative from Ricardo’s, profits are explained by ‘exploitation’ of labor, in the descriptive sense that profits are attributed to labor time worked by the average worker being greater than the labor time directly and indirectly required for the production of the worker’s own consumption. The level of the rate of profit is then determined by reference to the proportion between the surplus labor time worked by the workforce (over and above the labor time required to produce its own consumption) and the labor time embodied in the capital invested in production (Marx, 1967: vol. 1 (1867)). (Thus expressing the profit rate, in terms of surplus labor time, does not seem to add any insight additional to the simple observation that in a capitalist economy the workers as a whole, as workers, do not receive the entire net product of the economy.) In the so-called ‘transformation problem,’ Marx seeks to translate economic variables (such as the profit rate), which he first expresses in terms of labor time, into the monetary values associated with competitive prices (‘prices of production’). Marx also famously supposed a tendency for the general rate of profit to decline in the course of capitalist economic development, connected with the likelihood of crises under capitalism. But even within Marx’s own theoretical framework, this is a contingent result. To translate it into more familiar modern language, in effect, Marx is expressing the general rate of profit as a ratio between profits per employed worker and capital per employed worker. The basis for a tendency toward a declining rate of profit is then the supposition of a rising capital-to-labor ratio, relative to any rising profits per worker. The possibility that any such trend toward a rising capital-labor ratio could be offset, or more than offset, by rising profits per worker is evident (Marx, 1967: vol. 1 (1867): pp. 304–305. vol. 3 (1894): pp. 232–240, 250–259).
Marginalist Economics The key founding figures of this new approach to economic theory are William Stanley Jevons (1835–82), Alfred Marshall (1842–1924), Carl Menger (1840–1921), and Léon Walras (1834–1910). Rather than attempting to outline the particulars of the various efforts toward a theory of profits in these writers, and in those who followed their lead in subsequent decades of the twentieth century, we here seek to distil the essence of the theory of profits that arises out of this framework. The fundamental point of departure is a conception of human psychology in terms of behavior governed by a pleasure/pain calculus. From this vantage point, economic behavior is explained in terms of the individual’s maximizing net benefit (‘utility’ net of ‘disutility’). Hence, for example, the desire to work and consume can be theorized along these lines. Suppose a person whose only marketable resource is his labor and who wishes to consume. He can supply labor, with a view to acquiring revenue, in order to enable consumption. On the
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supposition that work generates disutility and consumption generates utility, the individual will have a desired labor supply and associated desired consumption demand that maximizes net utility – at least on the further supposition that there is increasing ‘marginal disutility’ from work and decreasing ‘marginal utility’ from consumption. Assuming there is sufficient labor demand and sufficient supply of consumption goods to satisfy the individual’s desired labor supply and consumption demand, more time worked increases income, enabling higher utility from consumption; but notionally, as time worked and consumption increase, the increment of ‘pain’ from additional labor is rising and the increment of ‘pleasure’ from additional consumption is falling, so that at some point there is an ‘optimal’ combination of labor supply and consumption demand for the individual, where the rising marginal disutility from labor is just offset by the diminishing marginal utility from the consumption enabled by labor income. The underlying characterization of human psychology here is certainly open to question (although ‘utility’ need not be supposed as cardinally measurable, but rather, merely as ‘ordinal,’ expressing individuals’ preference rankings). But even if, for the sake of argument, one accepts the validity of that psychology, how can it apply to explaining profits from capital investment? With respect to capital, what possible analogue could there be to the supposed disutility of labor? Capital goods are produced means of further production; they are reducible to the labor, natural resources, and capital goods used to produce them; and those latter capital goods are in turn reducible to labor, natural resources, and yet other capital goods; and so on. So that, in the limit, capital is reducible to a ‘dated’ series of labor and natural resource inputs. What then is the painful contribution to production for which capital provision must be compensated by way of profits? The fundamental marginalist answer is the pain of waiting. The provision of capital is understood to result from saving: abstinence from current consumption, or deferral of consumption into the future. It is the disutility of not consuming, or of saving, which must be balanced against the utility of future consumption resulting from current capital investment. Greater saving enables more capital investment and hence, higher consumption goods output in the future; but notionally, as saving and investment increase the increment of disutility from additional saving is rising and the increment of utility from additional capital (the ‘marginal product’ of capital) is falling. That is to say, supposedly analogous to the rising marginal disutility of labor and diminishing marginal utility of consumption (discussed above), there is rising marginal disutility of saving and diminishing marginal productivity of capital as the capital intensity (or ‘roundaboutness’) of production increases. At the level of the social economy as a whole, the general rate of profit (renamed ‘the rate of interest’ in the marginalist framework) is supposed to be determined so as to balance or equilibrate the aggregate supply of capital (saving) and the aggregate demand for capital (or investment, in flow terms). The equilibrium rate of interest induces the required saving. In this marginalist theoretical framework, there is no classical surplus – in the sense of a net product available for free disposal – to be found. Under competitive conditions, all remunerations to all ‘factors of
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production’ (notably, labor and capital) are ‘necessary,’ at least at the margin, in the sense that they are functional to ensuring the equilibration of the system. This theory of the general rate of interest (profit) is embedded in the marginalist framework within a larger system of simultaneous determination of commodity prices, distributive variables (prices of factors of production), and economic activity levels. The economics of Knut Wicksell (1851–1926), who adopts the ‘Austrian’ approach to capital theory of Eugen von Böhm-Bawerk (1851–1914), provides the best illustration of the logic of profits within this larger theoretical system, from among what may be called the second generation of marginalist economists (e.g., Wicksell, 1934[1901], 1935[1906]). It is one thing to propose a kind of ‘parable’ in which an individual balances the disutility of work against the utility of consumption, or the disutility of saving (of abstinence from current consumption) against the utility of future consumption. It is another to demonstrate that this vision can be applied to explain outcomes in a mass social economy in which the plans of a myriad of maximizing individuals have to be coordinated so that the aggregated planned demands and supplies for each and every commodity and factor of production (notably, labor and capital) are brought into balance (a ‘general equilibrium’). In particular, with regard to our focus here, this requires demonstrating how the rate of interest (along with all the other interacting variables of the complete theory) can coordinate the planned saving and planned demand for capital (or planned investment, in flow terms) of a myriad of individuals, with the saving and investment in general undertaken by different people. The plausibility of this notion of the rate of interest (profit) as determined by the balancing or equilibration of the supply of and demand for capital (or of planned saving and investment) crucially rests upon the idea of demand functions for factors of production (in particular, capital), in which demand is a negative function of the relative factor price (for capital, the rate of interest relative to other factor prices). This construct has been subject to a decisive critique since the 1950s, although with alarmingly little impact on marginalist orthodoxy (Garegnani, 1990; Kurz and Salvadori, 1995: pp. 427–467). That critique turns upon a certain circularity of reasoning resulting from the heterogeneity of capital goods, which entails that the rate of interest (profit) is already presupposed in the prices of the capital goods that make up any measure of the quantity of aggregate capital demanded. It is to be noticed also that the hoped for marginalist ‘general equilibrium’ under competitive conditions entails full employment of the factors of production (a balance of demand and supply for factors of production as well as commodities). John Maynard Keynes (1883–1946) attacked this aspect of the marginalist theory in particular. In Keynes’s (1936) alternative theory of aggregate economic activity levels in a capitalist economy, based upon his principle of effective demand, rather than the aggregate activity levels and the demand for factors of production adapting to the supply of factors of production (the potential productive capacity of the economy), activity levels and aggregate labor employment are regulated by aggregate effective demand for commodities, with persistent labor unemployment possible if not likely. It follows also from this that, vis-à-vis marginalism,
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the equilibration of planned saving and investment is turned on its head, so to speak: rather than saving being the prerequisite for investment, investment determines saving via a ‘multiplier’ mechanism (Garegnani, 1978–79).
Entrepreneurship In both the classical and marginalist traditions of economic theory, the fundamental object of analysis with respect to profits is the rate of return for the provision of capital in production, as such, notwithstanding very different theories of the profit (interest) rate in these two frameworks. What about the figure of the ‘entrepreneur’ in capitalism, and her remuneration? There is a loose sense of the term, commonly employed, in which the entrepreneur is merely the primary decision-maker in the firm or economic enterprise: the agent who organizes production and sale and so on. There is also the aspect of risk-bearing in production and sale. In the classical tradition, these two sorts of economic phenomena can be reduced to a species of labor and of capital provision respectively: managerial and organizational functions can be conceived of as a particular kind of labor earning wages, and the theory of profit rates on capital can conceptualize profits as proportional to both the quantity of capital invested and the degree of exposure to risk – risk of business failure or default in particular. (There is also a differential illiquidity aspect to different forms of capital, also generating profit rate differentials under competitive conditions.) The same kind of reduction can be accommodated within the marginalist framework. But it is evident that in both the classical and marginalist traditions, a positive rate of profit (interest) is not primarily attributed to ‘risk,’ although risk and differential risk can be incorporated as additional factors in gross rates of return on capital in both approaches. In the former, net profits are fundamentally a realization of part of the distribution of the social surplus, depending in particular upon the forces regulating real wages; in the latter, net profits are a remuneration for ‘waiting’ – for abstention from consumption (saving). From the standpoint of both theories, an economy subject to complete certainty with respect to economic outcomes – e.g., a steady-state growing economy or a stationary economy, with all the economic agents’ expectations of the future completely fulfilled – in general will exhibit a positive, equilibrium general rate of profit (interest). But there is a stronger sense of entrepreneurship – which is not reducible to some combination of managerial labor and risk exposure – conceptualized in somewhat different ways in seminal contributions by Joseph Schumpeter (1883–1950; 1934[1911]) and Frank Knight (1885–1962; 1933[1921]). In the former, the focus is upon the entrepreneur as the economic agent driving innovation (e.g., technical progress); in the latter, it is exposure to ‘uncertainty’ of pecuniary outcome in unprecedented economic situations – conditions of uncertainty (rather than mere risk) in the radical sense that no well-defined probability distribution over all possible outcomes of the enterprise exists. This uncertainty cannot be reduced to calculable risk for which an ex ante required remuneration could be specified. It is economic action or
decision-making in these kinds of conditions or situations, which constitutes the substantial sense of entrepreneurship. What the contributions of Schumpeter and Knight point to is that the notion of a normal or equilibrium rate of remuneration for entrepreneurship, in that substantial sense of the term – remuneration that would be akin to normal or equilibrium rates of remuneration for labor or capital (under competitive conditions) – does not really make sense. Rather, the entrepreneur, properly understood in this substantial sense, is the ‘residual claimant’ to the net revenues of an innovative or unprecedented enterprise – the gross revenues net of the remuneration of all other contributors to the enterprise. And more often than not, the residual will be nonpositive; that is to say, the majority of ‘entrepreneurs’ (properly understood) actually fail. ‘Profit,’ in some indeterminate sense as to magnitude, might be a motivation (or even the sole motivation) to entrepreneurial activity; but there can be no definite rate of return to entrepreneurship, which can be conceived of as bringing forth an equilibrium supply of entrepreneurship. Entrepreneurship in this strong sense might better be thought of as akin to a scarce natural (human) resource, which may earn a kind of scarcity rent, even if such remuneration is commonly called profits.
Rates, Shares, and Levels In the discussion of classical and marginalist economics above the focus was upon rates of profit (interest) on capital. What about the share of profits in revenue and the absolute level of profits – whether at the firm, industry, or economy-wide level? If we suppose we have a sound or plausible theory of the general rate of profit (interest) – whether the classical surplus approach, the marginalist approach, or some other – and of equilibrium profit rate differentials, are there equilibrium profit shares and equilibrium absolute levels of profits, associated with the equilibrium profit rates? Conceptually at least, it is straightforward to derive shares and levels from rates. The share of profits in the gross or net revenue of a firm, an industry, or an economy will be equal to the relevant profit rate times the capital-output ratio of the firm, industry, or economy. (For the share in gross revenue, the ‘output’ measure will be gross revenue from sales; for the share in net revenue, the output measure will be value added.) Then one can arrive at the absolute level of profits as the relevant profit share times the level of output of the firm, industry, or economy. But are there equilibrium capitaloutput ratios and equilibrium output levels, analogous to equilibrium profit rates? The answers are more clear-cut for the marginalist approach. The general equilibrium character of the theory, with all variables simultaneously determined, means that capitaloutput ratios are simultaneously determined with profit rates, as a consequence of the supposed existence of demand functions for capital, in which capital-output ratios are a negative function of the general rate of interest (profit). In the modern reconstruction of the classical approach, arising out of the seminal work of Piero Sraffa (1898–1983; 1960), it can also be shown that – given the level of real wages or the general rate of profit – the profit-maximizing
Profits capital-output ratios are determinate (whether or not firms and industries have a spectrum of alternative production methods available to them). But there are no demand functions for factors of production, as in the marginalist framework, entailed by, or required for, those results in the modernized classical framework. Furthermore, it is not necessary that every firm or enterprise in an industry should exhibit the profitmaximizing capital-output ratio: only the ‘dominant’ production method employed in an industry will be associated with that capital-output ratio; and firms employing that dominant production method will only exhibit that equilibrium capital-output ratio, and associated equilibrium profit share, when the level of output produced enables ‘normal’ or desired rates of utilization of the firms’ capital stocks. With regard to absolute levels of profits, also in the marginalist framework economic activity levels are simultaneously determined with profit rates and capital-output ratios. Hence, absolute levels of profits are fully determined in the general equilibrium. These equilibrium activity levels are associated with full employment of factors of production due to the ‘supply-side’ determination of activity levels in that approach. In classical economics, the issue of absolute levels is more complicated since there is not really a theory of aggregate activity levels to be found there (although Marx has interesting insights on the subject). However, a Keynesian demand-side determination of activity levels and aggregate outputs can be synthesized with the classical approach to income distribution and prices (Garegnani, 1983). A classical-Keynesian synthesis along these lines enables a determination of equilibrium outputs and profits, radically different from the marginalist approach. But this proposition is subject to a caveat, derivative from the qualification above concerning dominant production methods: a demand-side, Keynesian determination of activity levels does not necessarily entail that all firms in the industries making up the economy exhibit equilibrium capital-output ratios, nor that firms are operating at normal or desired rates of utilization of capital. Independently of Keynes, and at about the same time, Michal Kalecki (1899–1970) also formulated a demand-side approach to explaining economic activity levels – the principle of effective demand – along essentially the same lines as Keynes. From the point of view of the theory of profits, what is of particular interest about Kalecki’s formulation of the theory is that the multiplier mechanism, whereby planned investment spending determines planned saving, is shown to be also a principle for determining the absolute level of aggregate profits in the economy as a whole (e.g., Kalecki, 1937). To see this logic, suppose a simple case in which the aggregate income of the economy is divided between wages and profits; ‘households’ earn the wages and spend them entirely on consumption; and ‘firms’ earn the profits and engage in spending on investment, the latter spending being determined independently of the level of profits. Aggregate revenue to the firms will be governed by the sum of consumption and investment spending; and their aggregate profits will be that spending net of aggregate wages paid. Hence, since aggregate wages equal consumption spending, aggregate
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profits are determined by the level of investment spending. The same essential logic continues to apply under more general assumptions (notably, saving by wage earners, consumption by profit recipients, the existence of a public sector, and foreign trade and financial flows).
Conclusion In the view of the present writer, the modern reconstruction of the classical approach, combined with Keynes’s approach to economic activity levels, provides a more robust and plausible framework for the theory of profits than the marginalist approach. As a matter of fact, subsequent to the faltering of the marginalist general equilibrium research program of the immediate decades after World War II, in marginalist economics there is not much interest any more in addressing the ‘big question’ of the determination of the general rate of return on capital as such (although the notion is more or less entailed, or at least implied, by conventional macroeconomic models). In mature liberal capitalism, with sophisticated financial systems (in particular, largely autonomous credit creation by banks), it is possible for theory in a classicalKeynesian framework to affirm that profit rates on capital in production and interest rates on financial instruments are brought into alignment by competition (not necessarily strict equality), but to turn the traditional causation (from profit rates to interest rates) on its head, so to speak. Instead of the general rate of profit being the independent variable determining the general level of interest rates, the latter – independently determined by monetary policy interacting with financial markets – regulates profit rates. Both Keynes (1936: pp. 202–204) and Sraffa (1960: p. 33), from rather different perspectives, pursued this fruitful idea. A confirmation of the validity of that conception of the determination of the profitability of capital would give transparency to the ultimately arbitrary or conventional character of the magnitude of pure profits (rates, shares, and absolute levels) – profits as the appropriation of a part of the social surplus, rather than a necessary supply price of capital in the manner of marginalism.
See also: Capital: History of the Concept; Capitalism: The History of the Concept; Labor, Division of; Value: History of the Concept.
Bibliography Garegnani, P., 1978–79. Notes on consumption, investment and effective demand. Cambridge Journal of Economics 2, 335–353, 3, 63–82. Garegnani, P., 1983. Two routes to effective demand. In: Kregel, J. (Ed.), Distribution, Effective Demand and International Economic Relations. Macmillan, London, pp. 69–80. Garegnani, P., 1990. Quantity of capital. In: Eatwell, J., Milgate, M., Newman, P. (Eds.), The New Palgrave: Capital Theory. Macmillan, London, pp. 1–78. Kalecki, M., 1937. A theory of the business cycle. Review of Economic Studies 4, 77–97. Keynes, J.M., 1936. The General Theory of Employment, Interest and Money. Macmillan, London. Knight, F.H., 1933. Risk, Uncertainty and Profit. London School of Economics and Political Science, London (first ed. 1921).
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Kurz, H.D., Salvadori, N., 1995. Theory of Production: A Long-Period Analysis. Cambridge University Press, Cambridge. Marx, K., 1967. Capital: A Critique of Political Economy, 3 vols. International Publishers, New York (first German edns 1867, 1885, 1894). Ricardo, D., 1951[1821]. On the Principles of Political Economy and Taxation, third ed. In: Sraffa, P. (Ed.), The Works and Correspondence of David Ricardo, vol. 1. Cambridge University Press, Cambridge (first ed. 1817). Schumpeter, J.A., 1934. The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. Harvard University Press, Cambridge, MA (R. Opie, Trans., from the second German ed. 1926; first German ed. 1911). Smith, A., 1976[1776]. An Inquiry into the Nature and Causes of the Wealth of Nations. In: Campbell, R.H., Skinner, A.S., Todd, W.B. (Eds.), The Glasgow Edition of the Works and Correspondence of Adam Smith, vol. 2. Clarendon, Oxford.
Sraffa, P., 1960. Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory. Cambridge University Press, Cambridge. Turgot, A.R.J., 1977[1769–70]. Reflections on the formation and distribution of wealth. In: Groenewegen, P.D. (Ed.), The Economics of A.R.J. Turgot. Martinus Nijhoff, The Hague, pp. 43–95 (Trans. of Réflexions sur la Formation et la Distribution des Richesses, in Éphémérides du Citoyen, Paris, November 1769, December 1769, January 1770 (three instalments), from the 1788 ed.). Wicksell, K., 1934. Lectures on Political Economy, vol. 1 (General Theory). George Routledge & Sons, London (E. Classen, Trans., first Swedish ed. 1901). Wicksell, K., 1935. Lectures on Political Economy, vol. 2 (Money). George Routledge & Sons, London (E. Classen, Trans., first Swedish ed. 1906).
Abstract This article outlines the main currents in the economic theory of profits from the eighteenth to the twentieth century – with particular reference to classical economics, marginalist or ‘neoclassical’ economics, the significance of profits for entrepreneurship, and Keynesian economics. It also examines how theories have connected the determination of rates of profit on capital, shares of profits in revenue, and absolute levels of profits.
Introduction From the standpoint of the history of economic theory, the development of attempts at systematic explanation of the determination of profits has its beginnings in the mideighteenth century, most notably, with Richard Cantillon (1680?–1734) and François Quesnay (1694–1774) – the latter, the key figure of the French Physiocratic school. The object of their analyses is a more or less decentralized market economy, but not yet a social economy that could be regarded as genuinely capitalist. These are early contributors to what later comes to be called ‘classical economics,’ from William Petty (1623–87) to Karl Marx (1818–83), discussed in the next section. From the late-nineteenth century, there is the rise of the ‘marginalist’ school, commonly called neoclassical economics, which becomes dominant in academic economics after World War II, discussed in the following section. The significance of profits for theories of entrepreneurship is then examined. The penultimate section considers how theories have connected the determination of rates of profit on capital, shares of profits in gross revenue or value added, and absolute levels of profits. But what of earlier Western thought? Is there anything that could be called ‘theory’ of profits to be found there? The systems of premodern Western thought concerning society, polity, and economy are first and foremost normative systems rather than descriptive systems. The most salient of these is medieval Catholic Scholasticism, a synthesis of the JudeoChristian religious tradition and the ancient Greek philosophical tradition (as well as Roman law), most famously personified in the thought of Thomas Aquinas (c.1225–74). Perhaps the most striking theme of Scholastic thought that contingently touches upon profits is its strictures against money-lending for a return in the form of interest payments (‘usury’). But there is no essential connection between these doctrines about interest and the subject of profits, since the former could apply to a world of only consumption loans (as distinct from loans for business purposes). In any case, our purpose here is to elucidate descriptive doctrines; explanations of the existence of the phenomenon of profits, rather than ethical doctrines concerning the moral legitimacy or otherwise of profits. Nevertheless, in the course of the development of primarily ethical doctrines, elements of what may reasonably be called descriptive economic theory do arise in premodern thought. For example, Scholastic concepts of ‘the just price’ of a commodity gave rise to explanations of
International Encyclopedia of the Social & Behavioral Sciences, 2nd edition, Volume 19
actual market prices, albeit crude; but little about the determination of profits that might be associated with those market prices. The concept of profits that arises in the eighteenth century belongs to a world of capitalism in which the systematic protection of individuals’ property rights and enforcement of private contracts, together with free competition (in particular, the free mobility of capital and labor between different economic activities), establishes profits as a systematic phenomenon with structure and a certain logic, within a form of generalized liberal market economy. These institutions and forms of market organization only exist in fragmentary form in premodern times.
Classical Economics The theorizing of profits in classical economics is focused upon rates of profits on capital ‘advanced’ or invested in production; that is to say, the ratio between the absolute level of profits and the value of capital invested, per time period. From the standpoint of profit maximization, this ratio is the magnitude that the owners or investors of capital are ultimately interested in: the proportion between their investment and their return. Anne Robert Jacques Turgot (1727–81) and Adam Smith (1723–90) are the earliest writers to clearly conceptualize profit rates so understood; but we concentrate on Smith, David Ricardo (1772–1823), and Marx in this section. The previous writers mentioned above, Cantillon and Quesnay, gave profits a systematic role in their economic theories, but not conceptualized in terms of the ratio of profits to capital invested. In Cantillon, profits appear as primarily a return for risk-bearing by ‘entrepreneurs.’ In Quesnay, they are the source from which capital accumulation by entrepreneurial farmers is financed, driving economic growth; but their persistence over time is difficult to rationalize in his theoretical framework. Turgot and Smith, as well as the subsequent contributors to the classical tradition, decompose profit rates into risk premia that differ across different capital investments and a kind of ‘pure’ rate of return on capital investment as such (our term). See, for example, Smith (1976[1776]): book I, chapter 10. Hence, on the presumption of risk averse behavior by capital owners or capitalists (at least on average), there will be a kind of equilibrium structure of profit rates, even under competitive conditions, reflecting higher returns for riskier investments, although Smith has some doubts as to the predominance of
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risk averse behavior. (Restrictions on competition – notably, restrictions on the free mobility of capital between different activities – will also cause profit rate differentials, with higher than competitive profit rates earned in activities less exposed to competition.) Smith is also careful to establish that, conceptually, remunerations for the functions of supervision and management of production, even if commonly referred to as profits, are, in functional terms, really a species of wages (Smith, 1976[1776]: pp. 128–130). This can be obscured when one and the same person is both the provider of capital to an enterprise and the manager of the enterprise. Smith and Turgot are also clear that if an enterprise employs borrowed funds to finance capital expenditures, some proportion of the profits will be distributed to the lenders as interest payments (e.g., Smith, 1976[1776]: pp. 112–113; Turgot, 1977[1769–70]: pp. 76–77, 85–88). At the most abstract level of theorizing, it is common for the classical economists, as well as later economic theory, to focus upon a uniform or ‘general’ rate of profit in the economy, thereby leaving aside (to be treated separately) differential risk and the associated profit rate differentials under competitive conditions. As to what determines this underlying, uniform or general rate of profit on capital as such, Smith treats profits as an element of the realization, at the level of revenues or incomes, of the economy-wide production of a social surplus. This classical concept of surplus refers to that part of the gross product of the economic system which is available for free disposal, after replacement of the necessary inputs used up in the production of that gross output, including among those inputs the customary subsistence consumption of the labor employed. The question then is how the surplus is distributed or realized in the form of incomes. For Smith, the surplus is realized in the income forms of land rents, pure profits, and a part of wages, depending on the balance of bargaining power around the labor contract. But his theory of the actual magnitude of the general rate of profit rests on a highly unsatisfactory notion of ‘competition of capitals.’ Smith supposes that the greater the extent of capital accumulation, the greater the degree of competition between enterprises, and hence downward pressure on the general rate of profit (Smith, 1976[1776]: book I, chapter 9). This does not amount to a convincing, determinate theory of the profit rate; and indeed, a generation or so after Smith, Ricardo demonstrates – albeit under rather restrictive conditions – that given the production methods in use in an economy, the general rate of profit is determined by, and inversely related to, the level of real wages (Ricardo, 1951 [1821]: chapter 6). The restrictive conditions Ricardo utilizes to arrive at this fundamental result involve, in particular, a labor theory of exchange value: It is supposed that the relative prices of commodities are explained by the quantities of labor time directly and indirectly required in the production of those commodities. Subsequently, it has been rigorously demonstrated that the inverse relationship holds under quite general conditions (e.g., Kurz and Salvadori, 1995). From the analytical point of departure of this inverse relationship, Ricardo’s focus is the course of the profit rate over time, resulting from change in production methods over time. On the one hand, declining output from capital investment on poorer quality land as population expands will place downward pressure on the profit
rate, given the real wages of labor. On the other hand, technical innovation associated with human invention can enable a rising profit rate, given the level of real wages. If the former factor dominates the latter, the general rate can fall to such a low level as to extinguish the motive to capital accumulation, bringing about a stationary state (zero economic growth; Ricardo, 1951[1821]: chapter 21). In Marx’s economics, considerably derivative from Ricardo’s, profits are explained by ‘exploitation’ of labor, in the descriptive sense that profits are attributed to labor time worked by the average worker being greater than the labor time directly and indirectly required for the production of the worker’s own consumption. The level of the rate of profit is then determined by reference to the proportion between the surplus labor time worked by the workforce (over and above the labor time required to produce its own consumption) and the labor time embodied in the capital invested in production (Marx, 1967: vol. 1 (1867)). (Thus expressing the profit rate, in terms of surplus labor time, does not seem to add any insight additional to the simple observation that in a capitalist economy the workers as a whole, as workers, do not receive the entire net product of the economy.) In the so-called ‘transformation problem,’ Marx seeks to translate economic variables (such as the profit rate), which he first expresses in terms of labor time, into the monetary values associated with competitive prices (‘prices of production’). Marx also famously supposed a tendency for the general rate of profit to decline in the course of capitalist economic development, connected with the likelihood of crises under capitalism. But even within Marx’s own theoretical framework, this is a contingent result. To translate it into more familiar modern language, in effect, Marx is expressing the general rate of profit as a ratio between profits per employed worker and capital per employed worker. The basis for a tendency toward a declining rate of profit is then the supposition of a rising capital-to-labor ratio, relative to any rising profits per worker. The possibility that any such trend toward a rising capital-labor ratio could be offset, or more than offset, by rising profits per worker is evident (Marx, 1967: vol. 1 (1867): pp. 304–305. vol. 3 (1894): pp. 232–240, 250–259).
Marginalist Economics The key founding figures of this new approach to economic theory are William Stanley Jevons (1835–82), Alfred Marshall (1842–1924), Carl Menger (1840–1921), and Léon Walras (1834–1910). Rather than attempting to outline the particulars of the various efforts toward a theory of profits in these writers, and in those who followed their lead in subsequent decades of the twentieth century, we here seek to distil the essence of the theory of profits that arises out of this framework. The fundamental point of departure is a conception of human psychology in terms of behavior governed by a pleasure/pain calculus. From this vantage point, economic behavior is explained in terms of the individual’s maximizing net benefit (‘utility’ net of ‘disutility’). Hence, for example, the desire to work and consume can be theorized along these lines. Suppose a person whose only marketable resource is his labor and who wishes to consume. He can supply labor, with a view to acquiring revenue, in order to enable consumption. On the
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supposition that work generates disutility and consumption generates utility, the individual will have a desired labor supply and associated desired consumption demand that maximizes net utility – at least on the further supposition that there is increasing ‘marginal disutility’ from work and decreasing ‘marginal utility’ from consumption. Assuming there is sufficient labor demand and sufficient supply of consumption goods to satisfy the individual’s desired labor supply and consumption demand, more time worked increases income, enabling higher utility from consumption; but notionally, as time worked and consumption increase, the increment of ‘pain’ from additional labor is rising and the increment of ‘pleasure’ from additional consumption is falling, so that at some point there is an ‘optimal’ combination of labor supply and consumption demand for the individual, where the rising marginal disutility from labor is just offset by the diminishing marginal utility from the consumption enabled by labor income. The underlying characterization of human psychology here is certainly open to question (although ‘utility’ need not be supposed as cardinally measurable, but rather, merely as ‘ordinal,’ expressing individuals’ preference rankings). But even if, for the sake of argument, one accepts the validity of that psychology, how can it apply to explaining profits from capital investment? With respect to capital, what possible analogue could there be to the supposed disutility of labor? Capital goods are produced means of further production; they are reducible to the labor, natural resources, and capital goods used to produce them; and those latter capital goods are in turn reducible to labor, natural resources, and yet other capital goods; and so on. So that, in the limit, capital is reducible to a ‘dated’ series of labor and natural resource inputs. What then is the painful contribution to production for which capital provision must be compensated by way of profits? The fundamental marginalist answer is the pain of waiting. The provision of capital is understood to result from saving: abstinence from current consumption, or deferral of consumption into the future. It is the disutility of not consuming, or of saving, which must be balanced against the utility of future consumption resulting from current capital investment. Greater saving enables more capital investment and hence, higher consumption goods output in the future; but notionally, as saving and investment increase the increment of disutility from additional saving is rising and the increment of utility from additional capital (the ‘marginal product’ of capital) is falling. That is to say, supposedly analogous to the rising marginal disutility of labor and diminishing marginal utility of consumption (discussed above), there is rising marginal disutility of saving and diminishing marginal productivity of capital as the capital intensity (or ‘roundaboutness’) of production increases. At the level of the social economy as a whole, the general rate of profit (renamed ‘the rate of interest’ in the marginalist framework) is supposed to be determined so as to balance or equilibrate the aggregate supply of capital (saving) and the aggregate demand for capital (or investment, in flow terms). The equilibrium rate of interest induces the required saving. In this marginalist theoretical framework, there is no classical surplus – in the sense of a net product available for free disposal – to be found. Under competitive conditions, all remunerations to all ‘factors of
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production’ (notably, labor and capital) are ‘necessary,’ at least at the margin, in the sense that they are functional to ensuring the equilibration of the system. This theory of the general rate of interest (profit) is embedded in the marginalist framework within a larger system of simultaneous determination of commodity prices, distributive variables (prices of factors of production), and economic activity levels. The economics of Knut Wicksell (1851–1926), who adopts the ‘Austrian’ approach to capital theory of Eugen von Böhm-Bawerk (1851–1914), provides the best illustration of the logic of profits within this larger theoretical system, from among what may be called the second generation of marginalist economists (e.g., Wicksell, 1934[1901], 1935[1906]). It is one thing to propose a kind of ‘parable’ in which an individual balances the disutility of work against the utility of consumption, or the disutility of saving (of abstinence from current consumption) against the utility of future consumption. It is another to demonstrate that this vision can be applied to explain outcomes in a mass social economy in which the plans of a myriad of maximizing individuals have to be coordinated so that the aggregated planned demands and supplies for each and every commodity and factor of production (notably, labor and capital) are brought into balance (a ‘general equilibrium’). In particular, with regard to our focus here, this requires demonstrating how the rate of interest (along with all the other interacting variables of the complete theory) can coordinate the planned saving and planned demand for capital (or planned investment, in flow terms) of a myriad of individuals, with the saving and investment in general undertaken by different people. The plausibility of this notion of the rate of interest (profit) as determined by the balancing or equilibration of the supply of and demand for capital (or of planned saving and investment) crucially rests upon the idea of demand functions for factors of production (in particular, capital), in which demand is a negative function of the relative factor price (for capital, the rate of interest relative to other factor prices). This construct has been subject to a decisive critique since the 1950s, although with alarmingly little impact on marginalist orthodoxy (Garegnani, 1990; Kurz and Salvadori, 1995: pp. 427–467). That critique turns upon a certain circularity of reasoning resulting from the heterogeneity of capital goods, which entails that the rate of interest (profit) is already presupposed in the prices of the capital goods that make up any measure of the quantity of aggregate capital demanded. It is to be noticed also that the hoped for marginalist ‘general equilibrium’ under competitive conditions entails full employment of the factors of production (a balance of demand and supply for factors of production as well as commodities). John Maynard Keynes (1883–1946) attacked this aspect of the marginalist theory in particular. In Keynes’s (1936) alternative theory of aggregate economic activity levels in a capitalist economy, based upon his principle of effective demand, rather than the aggregate activity levels and the demand for factors of production adapting to the supply of factors of production (the potential productive capacity of the economy), activity levels and aggregate labor employment are regulated by aggregate effective demand for commodities, with persistent labor unemployment possible if not likely. It follows also from this that, vis-à-vis marginalism,
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the equilibration of planned saving and investment is turned on its head, so to speak: rather than saving being the prerequisite for investment, investment determines saving via a ‘multiplier’ mechanism (Garegnani, 1978–79).
Entrepreneurship In both the classical and marginalist traditions of economic theory, the fundamental object of analysis with respect to profits is the rate of return for the provision of capital in production, as such, notwithstanding very different theories of the profit (interest) rate in these two frameworks. What about the figure of the ‘entrepreneur’ in capitalism, and her remuneration? There is a loose sense of the term, commonly employed, in which the entrepreneur is merely the primary decision-maker in the firm or economic enterprise: the agent who organizes production and sale and so on. There is also the aspect of risk-bearing in production and sale. In the classical tradition, these two sorts of economic phenomena can be reduced to a species of labor and of capital provision respectively: managerial and organizational functions can be conceived of as a particular kind of labor earning wages, and the theory of profit rates on capital can conceptualize profits as proportional to both the quantity of capital invested and the degree of exposure to risk – risk of business failure or default in particular. (There is also a differential illiquidity aspect to different forms of capital, also generating profit rate differentials under competitive conditions.) The same kind of reduction can be accommodated within the marginalist framework. But it is evident that in both the classical and marginalist traditions, a positive rate of profit (interest) is not primarily attributed to ‘risk,’ although risk and differential risk can be incorporated as additional factors in gross rates of return on capital in both approaches. In the former, net profits are fundamentally a realization of part of the distribution of the social surplus, depending in particular upon the forces regulating real wages; in the latter, net profits are a remuneration for ‘waiting’ – for abstention from consumption (saving). From the standpoint of both theories, an economy subject to complete certainty with respect to economic outcomes – e.g., a steady-state growing economy or a stationary economy, with all the economic agents’ expectations of the future completely fulfilled – in general will exhibit a positive, equilibrium general rate of profit (interest). But there is a stronger sense of entrepreneurship – which is not reducible to some combination of managerial labor and risk exposure – conceptualized in somewhat different ways in seminal contributions by Joseph Schumpeter (1883–1950; 1934[1911]) and Frank Knight (1885–1962; 1933[1921]). In the former, the focus is upon the entrepreneur as the economic agent driving innovation (e.g., technical progress); in the latter, it is exposure to ‘uncertainty’ of pecuniary outcome in unprecedented economic situations – conditions of uncertainty (rather than mere risk) in the radical sense that no well-defined probability distribution over all possible outcomes of the enterprise exists. This uncertainty cannot be reduced to calculable risk for which an ex ante required remuneration could be specified. It is economic action or
decision-making in these kinds of conditions or situations, which constitutes the substantial sense of entrepreneurship. What the contributions of Schumpeter and Knight point to is that the notion of a normal or equilibrium rate of remuneration for entrepreneurship, in that substantial sense of the term – remuneration that would be akin to normal or equilibrium rates of remuneration for labor or capital (under competitive conditions) – does not really make sense. Rather, the entrepreneur, properly understood in this substantial sense, is the ‘residual claimant’ to the net revenues of an innovative or unprecedented enterprise – the gross revenues net of the remuneration of all other contributors to the enterprise. And more often than not, the residual will be nonpositive; that is to say, the majority of ‘entrepreneurs’ (properly understood) actually fail. ‘Profit,’ in some indeterminate sense as to magnitude, might be a motivation (or even the sole motivation) to entrepreneurial activity; but there can be no definite rate of return to entrepreneurship, which can be conceived of as bringing forth an equilibrium supply of entrepreneurship. Entrepreneurship in this strong sense might better be thought of as akin to a scarce natural (human) resource, which may earn a kind of scarcity rent, even if such remuneration is commonly called profits.
Rates, Shares, and Levels In the discussion of classical and marginalist economics above the focus was upon rates of profit (interest) on capital. What about the share of profits in revenue and the absolute level of profits – whether at the firm, industry, or economy-wide level? If we suppose we have a sound or plausible theory of the general rate of profit (interest) – whether the classical surplus approach, the marginalist approach, or some other – and of equilibrium profit rate differentials, are there equilibrium profit shares and equilibrium absolute levels of profits, associated with the equilibrium profit rates? Conceptually at least, it is straightforward to derive shares and levels from rates. The share of profits in the gross or net revenue of a firm, an industry, or an economy will be equal to the relevant profit rate times the capital-output ratio of the firm, industry, or economy. (For the share in gross revenue, the ‘output’ measure will be gross revenue from sales; for the share in net revenue, the output measure will be value added.) Then one can arrive at the absolute level of profits as the relevant profit share times the level of output of the firm, industry, or economy. But are there equilibrium capitaloutput ratios and equilibrium output levels, analogous to equilibrium profit rates? The answers are more clear-cut for the marginalist approach. The general equilibrium character of the theory, with all variables simultaneously determined, means that capitaloutput ratios are simultaneously determined with profit rates, as a consequence of the supposed existence of demand functions for capital, in which capital-output ratios are a negative function of the general rate of interest (profit). In the modern reconstruction of the classical approach, arising out of the seminal work of Piero Sraffa (1898–1983; 1960), it can also be shown that – given the level of real wages or the general rate of profit – the profit-maximizing
Profits capital-output ratios are determinate (whether or not firms and industries have a spectrum of alternative production methods available to them). But there are no demand functions for factors of production, as in the marginalist framework, entailed by, or required for, those results in the modernized classical framework. Furthermore, it is not necessary that every firm or enterprise in an industry should exhibit the profitmaximizing capital-output ratio: only the ‘dominant’ production method employed in an industry will be associated with that capital-output ratio; and firms employing that dominant production method will only exhibit that equilibrium capital-output ratio, and associated equilibrium profit share, when the level of output produced enables ‘normal’ or desired rates of utilization of the firms’ capital stocks. With regard to absolute levels of profits, also in the marginalist framework economic activity levels are simultaneously determined with profit rates and capital-output ratios. Hence, absolute levels of profits are fully determined in the general equilibrium. These equilibrium activity levels are associated with full employment of factors of production due to the ‘supply-side’ determination of activity levels in that approach. In classical economics, the issue of absolute levels is more complicated since there is not really a theory of aggregate activity levels to be found there (although Marx has interesting insights on the subject). However, a Keynesian demand-side determination of activity levels and aggregate outputs can be synthesized with the classical approach to income distribution and prices (Garegnani, 1983). A classical-Keynesian synthesis along these lines enables a determination of equilibrium outputs and profits, radically different from the marginalist approach. But this proposition is subject to a caveat, derivative from the qualification above concerning dominant production methods: a demand-side, Keynesian determination of activity levels does not necessarily entail that all firms in the industries making up the economy exhibit equilibrium capital-output ratios, nor that firms are operating at normal or desired rates of utilization of capital. Independently of Keynes, and at about the same time, Michal Kalecki (1899–1970) also formulated a demand-side approach to explaining economic activity levels – the principle of effective demand – along essentially the same lines as Keynes. From the point of view of the theory of profits, what is of particular interest about Kalecki’s formulation of the theory is that the multiplier mechanism, whereby planned investment spending determines planned saving, is shown to be also a principle for determining the absolute level of aggregate profits in the economy as a whole (e.g., Kalecki, 1937). To see this logic, suppose a simple case in which the aggregate income of the economy is divided between wages and profits; ‘households’ earn the wages and spend them entirely on consumption; and ‘firms’ earn the profits and engage in spending on investment, the latter spending being determined independently of the level of profits. Aggregate revenue to the firms will be governed by the sum of consumption and investment spending; and their aggregate profits will be that spending net of aggregate wages paid. Hence, since aggregate wages equal consumption spending, aggregate
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profits are determined by the level of investment spending. The same essential logic continues to apply under more general assumptions (notably, saving by wage earners, consumption by profit recipients, the existence of a public sector, and foreign trade and financial flows).
Conclusion In the view of the present writer, the modern reconstruction of the classical approach, combined with Keynes’s approach to economic activity levels, provides a more robust and plausible framework for the theory of profits than the marginalist approach. As a matter of fact, subsequent to the faltering of the marginalist general equilibrium research program of the immediate decades after World War II, in marginalist economics there is not much interest any more in addressing the ‘big question’ of the determination of the general rate of return on capital as such (although the notion is more or less entailed, or at least implied, by conventional macroeconomic models). In mature liberal capitalism, with sophisticated financial systems (in particular, largely autonomous credit creation by banks), it is possible for theory in a classicalKeynesian framework to affirm that profit rates on capital in production and interest rates on financial instruments are brought into alignment by competition (not necessarily strict equality), but to turn the traditional causation (from profit rates to interest rates) on its head, so to speak. Instead of the general rate of profit being the independent variable determining the general level of interest rates, the latter – independently determined by monetary policy interacting with financial markets – regulates profit rates. Both Keynes (1936: pp. 202–204) and Sraffa (1960: p. 33), from rather different perspectives, pursued this fruitful idea. A confirmation of the validity of that conception of the determination of the profitability of capital would give transparency to the ultimately arbitrary or conventional character of the magnitude of pure profits (rates, shares, and absolute levels) – profits as the appropriation of a part of the social surplus, rather than a necessary supply price of capital in the manner of marginalism.
See also: Capital: History of the Concept; Capitalism: The History of the Concept; Labor, Division of; Value: History of the Concept.
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