Profits and Losses

Daniel Davies thinks that it’s a point in favor of heterodox economics that neoclassical economics assumes profits are zero ("normal") while profits in the real world are not zero.  Tyler says the explanation is market power.  I think both are mostly wrong.

Take a look at the national income accounts.  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.  Indeed, 5-10% is an amazingly low figure when one recognizes that the entire capitalist economy depends on the existence of profits. 

Is the explanation for profits monopoly power?  Not really.  Or rather, the better way of phrasing it is that most profits are a return to innovation and entrepreneurship.  Innovation and entrepreneurship typically bring some market power but disequilibrium monopoly has very different implications for policy than equilibrium monopoly. 

Here’s some intuition.  Textbook neoclassical economics says profits and losses are zero. The standard monopoly story can explain profits but not losses.  The return to entrepreneurship/dynamic economy/creative destruction story that I am telling can explain both profits and losses. 

Thus Davies is correct, profits do suggest a role for heterodox economics but it’s not the paleo-Keynesian/Marxist heterodoxy that gets the boost but the Austrian heterodoxy of Mises, Hayek and Schumpeter.