Can Neoclassical Economics Explain the Profit Share?
Mark Thoma has an interesting post that links to other interesting posts on one aspect of the debate between the neoclassical v. heterodox economics crediting Daniel Davies for raising the question noted in my title:
The anomaly I’m talking about is that neoclassical economics, in both macro and micro forms, nearly invariably works on the basis of models in which there are no profits. Since in general, companies do earn profits, I think this is a pretty big problem. Let me add a couple of caveats. Neoclassical economics does allow for “normal profits”, meaning a sufficient surplus of income over expense to repay the cost of financial capital. But this isn’t really profit at all, and it doesn’t describe economic behaviour at all well – firms which are merely earning their cost of capital certainly don’t in general think that they’re doing as well as can be expected with no room for improvement. Neoclassical economics also allows for monopoly profits to be earned in situations in which there are legal or practical barriers to entry into industries.
Alex Tabarrok brings up the national income accounts and the capital share:
Most of gross domestic income is wages, about 56%. Proprietor’s income and corporate profits are together about 17% but most of proprietor’s income is really labor income and a good chunk of corporate profits is interest and a return to capital. In a generous accounting true profits might be 5-10% of gross domestic income – not zero but not very large either.
Alex is referring to table 1.11 of the BEA accounts. Table 1.12 is entitled National Income by Type of Income. Adding proprietors’ income to compensation of employees – these two items represent 72.3% of national income. So if Alex is right about proprietors’ income being labor income, the capital share is just over 25% of national income. How much of this could be explained by the neoclassical model depends on what the model says about the capital to output ratio and the return to capital. If we assume that the capital to output ratio is around 3 and the return to capital is around 8%, then the neoclassical model would predict a capital share of 24%. So maybe there is a little bit of an anomaly to explain, but let’s not get too carried away.