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This post isn’t about making great hires, having a badass product or service, or making smart cost-control purchases.

This is a look at business profits at the economy wide (or macro) level. It is inspired (damn near copied!) from this post by Bill Mitchell. I’m sure it sounds dreadful, but stick with me through the equation and hopefully it will be rewarding.

The profit equation was developed by economist Michal Kalecki using a simplified accounting model, and then expanded to include additional elements. Let’s jump straight to the expanded conclusion. The equation is: Pn = I + (G – T) + NX + Cp – Sw.

What this says is that Gross Profits after tax (Pn) equals Gross Investment (I) plus Government deficits (g-t), plus the export surplus (Nx) plus Capitalist consumption (Cp) minus household savings (Sw).

Gross Investment (I) is business investment plus household investment, which is mostly new residential real estate.

Investment (I) can generally be thought of as any new bank lending for the given period.

Government deficits are the amount the Government spends over the amount it taxes. So we can see that, contrary to conventional wisdom, deficits add directly to private profits and will allow for increased “capital formation” (code for investment), which is an addition to the real assets in the economy.

An export surplus is the opposite of a trade deficit. It will add foreign currency to the domestic sector as the sale of goods and services abroad outstrip the amount of dollars sent abroad through imports. If there is a trade deficit which sends dollars abroad then that deficit, if it becomes chronic, can create a domestic demand problem as those dollars are not able to be recycled domestically. This is the situation we are currently in in the US and requires one of the other elements (New investment, Government deficits, decreased household savings) to pick up the slack in demand.

Household savings, likewise, act as a drain on demand, and will require additional investment in the next period to maintain business revenues and profits.

Finally, as Bill says in the post linked to above: “when the government runs a surplus it reduces profits via its squeeze on aggregate income. That is why all the business sector should be screaming at the fiscal austerity plans that are rampant at present.”

So now we can see that the two primary drivers of the economy (as well as business profits) are new private investment and government deficits, with the trade surplus being a lesser element. We can also get why we hear such a clamor in the news media for a more export driven policy, so as to maintain the ideological bias against deficits as a critical component of economic health.

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