Yeah, I know, Marx wrote three volumes on this, and in 2014 Piketty published in English a more than 700 page book on it that ended up on the bestseller list, although neither of these resolved the long-running debates about the nature of profit or of capital, which continue to swirl. We have seen recently someone claiming that distinguishing between retained and distributed earnings is the key to understanding profit, and failing to do so means all of economics as we know it is wrong. But then there have been many other views that this view does not remotely address. Regarding capital itself, which profit is usually thought of as being one of the sources of income related to, let me quote the following that notes a range of views out there.
“What really is capital and what does it mean for value, growth, and distribution? Is it a pile of produced means of production? Is it dated labor? Is it waiting? Is it roundaboutness? Is it an accumulated pile of finance? Is it a social relation? Is it an independent source of value? The answers to these questions are probably matters of belief.” From Catastrophe to Chaos: A General Theory of Economic Discontinuities, Kluwer, 1991, p. 125.
I leave it the imagination (or googling) of the reader as to who the author of that book is, although I note that the quotation appeared in the second edition of the book that came out in 2000.
So there are surface issues regarding the nature of profit and capital, and there are deeper issues. This quotation lists some of the deeper arguments that have been made by different schools of economics. The “pile of produced means of production” is basically a Principles textbook orthodox position, which rules out financial definitions, with many “people in the street ” thinking it is an “accumulated pile of finance,” a later answer in the list. People teaching intro econ courses like to pound on wrongness of this popular view, ultimately falling back on the argument that capital is a “factor of production,” which means that whatever it is one must be able to use it in actual production processes.” Machinery and buildings and other such “produced means of production” do that, so they count, and the building of them is what “real investment” is, not just somebody using some money to buy some financial assets, which is what the person in the street usually means by “investing my capital.” We spend lots of time disabusing them of their delusions, we who know that “money is an illusion,” and that while finance is very important in the functioning of modern economies, piles of money or financial assets do not in and of themselves actually produce something. Rather they are indicators and means for determining who gets to own those actually productive forms of “real capital,” oh to throw out another term.
So some of the later definitions seek to get at the foundations of where this producing of these productive means of production come from, all that “real capital investment.” So, if we are inclined to a Ricardo or Marx labor theory of value view, then all we see about is either produced by current or past labor. That truck over there was put together by workers with machines in a factory, with those machines made by worker and some other machines, which in turn were made further in the past by yet other workers and other machines, and so on and on until we can reduce all of those produced means of production to being really a bunch of current labor plus a whole string of past labor going way back into the depths of time from many many now-dead workers.
Curiously, although the Austrians abjure the labor theory of value, the theory of “roundaboutness” is theirs, notably Bohm-Bawerk anyway, and he derived it precisely from looking at this sort of Ricardo-Marx argument that I laid out. So past time gets dragged in, with the longer that stream of past labor goes into the past, well, the more roundaboutness, and this is what he said was capital, and to get at another question raised, how it came to be an “independent source of value,” from just current labor time.
But dragging in time gets us to”waiting,” which also drags in finance, given that we are talking about saving, which is usually done by piling up financial assets of one sort or another, some of which may pay yet another source of capital income, namely interest. Proto-neoclassical, Nassau Senior, got on this one, although this is deeply part of the official neoclassical canon, which in the formulation of Irving Fisher had the real rate of interest being that which established the intertemporal equilibrium between the willingness to wait by not consuming today, and effectively the marginal product of infestment, or capital is you prefer, coming from the production side, those produced means of production, with an implicit assumption that what does not get consumed and so saved, ends up being invested to create that “real capital,” waiting being crucial to all this.
Of course the “social relation” answer is the deeper Marxist view, the part that distinguishes Marx from Ricardo.
Quite aside from this there is the surface aspect of profit and capital, which turns out to be quite complicated, even the trivial surface matter of accounting to measure it. I said in an earlier post that it is at one level simple, for a firm at least, profit is revenues minus costs. But agreeing on the proper accounting measure of that gets messy, even for the simplest of firms. One has to pick a time unit, although a year is pretty conventional for tax reasons, if nothing else. But what gets counted as revenues? Sales? How about money gained from lawsuits? How about money from illegal bribes that is unreported?
But it is on the cost side where things get really hairy, and some of those disputes end up with the schools of economics also. So, we know that since Marchall standard economists have counted the “opportunity cost of capital” and indeed of other factors in principle, as costs, with accountants most definitely not counting those. Accountants like things to be easily measured and straightforward, whereas deciding what is the “niormal rate of return” throws one into much messier territory without a definite answer. But even avoiding that sort of thing, there are competing schools of accounting. So does one look af FIFO or LIFO? In looking at the costs of a machine, is it the original amount paid for it or the cost of replacing it, and so on? In short, even the surface matters of accounting are a huge mess once one looks beneath the surface at all,
And none of this, not the deeper issues, nor even the surface accounting issues, are remotely resolved by declaring that one must focus on the division between retained and distributed earnings. Heck, that does not even fully explain firm investments, as only about half of the funding for investments comes from retained earnings, at least in the US economy. But, maybe this does not matter if one is trying to build a general theory of all economics on such a shallow and empty accounting identity.
Addendum: There is far far far more I could talk about here, but let me add just a few remarks on one issue that has had a lot of attention recently, the rising share of capital income at the aggregate level, which, whle not the whole explanation of it, has correlated with the rising income inequality going on in most nations of the world during the last several decades. Of course this was the main theme of Piketty’s book. He had the data, but his theoretical explanations drew lots of criticism, including from me. He fell back on his r> g argument, which was good for marketing the book, but was easily shown not to do the trick to explain the rising capital income share even on a garden variety aggregate neoclassical production function analysis. Of course, Cobb-Douglas such functions are useless in this matter as they generate constant factor shares. And then there is the whole Cambridge capital theory critique of aggregate capital and aggregate production functions, ironically a critique at least partly shared by more sophisticated Austrian economists as well. Many dumped on him for throwing in land with the capital stock and returns to land as capital income, which some have argued carries a lot of the weight on the empirical findings. In the end when pushed, he has tended to fall back on waving his hands about politics and the collapse of unions and social-political power trends for at least part of his explanation, which looks to me to be playing a big part of it. Needless to say, focusing on the division between retained versus distributed profits does not remotely address the question of how much of national income is going to capital forms of income.