[OPE-L:4131] Re: New Quiz and New New Quiz!

andrew klima (Andrew_Kliman@msn.com)
Mon, 3 Feb 1997 11:31:40 -0800 (PST)

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I was hoping that Allin and/or Bruce and/or Chai-on and/or Paul C. would enter
into this discussion, but since they haven't, I think the time for me to reply
is now.

I of course agree with Rieu (ope-l 4097) that the example I presented is too
simple to constitute a complete format for discussing the equalization of
profit rates. But I think this very simple example does show something very
important. It is something that contradicts what a lot of simultaneists have
been claiming for a long time and that a highly respected simultaneist (not a
listmember of ope-l) has recently claimed in correspondence with me. Let me
start from the beginning.

Back in 1986, Ted and I produced an example of Marx's Vol. III, Ch. 9,
transformation according to the conception now known as TSS. Input and output
prices were not necessarily equal, but the profit rate on the capital actually
*advanced* was equalized across branches (not because we believe this to be
true, but because prices of production are those prices that correspond to
uniform profitability, and the Ch. 9 transformation concerns prices of
production). Total price and profit always equaled total value and
surplus-value, respectively, and the general profit rate was always the same
computed with prices and with values, s/(c+v). We said this refuted charges
of internal inconsistency in Marx's own transformation.

We showed this to people. One of the main objections we heard, an objection
that people referred to in order to deny that we had refuted the charge of
internal inconsistency, is that the "real" profit rate in our example isn't
equalized, or that the profit rate "really" isn't equalized. They claimed
that the "real" profit rate is not computed on capital actually advanced, but
on the "replacement costs" of its physical components. Another version of the
same claim is that "real" profit is not price minus costs actually incurred,
but price minus what the costs would have been were they incurred when the
output was produced (or sold), i.e., the "replacement costs."

In the succeeding 11 years, various arguments have been made to support these
claims. One of the main ones, which we have heard from the very beginning,
that we heard last year on ope-l, and that my correspondent has put forth once
again, is that "real" profit and the "real" profit rate are based on
"replacement costs" because the "replacement cost" rate of profit is what
guides investment decisions. Firms seek the highest "replacement cost" rate
of profit and shift their capital into lines of business that yield the
highest "replacement cost" profit rate. The tendency to equalize the profit
rate is thus the tendency to equalize the "replacement cost" profit rate.
Hence, the equalization of the profit rate refers to the equalization of the
"replacement cost" profit rate, and, since we did not show *this* profit rate
can be equalized on the basis of Marx's conception as we interpret it, we have
not refuted the charges of internal inconsistency in his account of the
transformation. (An alternative, single-system but simultaneous view puts the
compliant this way: we do not have "real" prices of production unless the
"replacement cost" profit rates are equalized, and that is true only if input
and output prices are equal. So we are only correct in the special case in
which our results conform to those of the simultaneous single-system

On logical grounds, this line of reasoning does not deserve to be taken
seriously. Marx does not say the "replacement cost" profit rate tends to
equality; he says the profit rate on capital *advanced* (what people now call
the "historical cost" rate of profit) tends to equality. And if there's any
doubt about this, the fact remains that the two-system interpretation fails to
replicate Marx's transformation results, whereas ours does replicate them.
Hence, ours is a superior interpretation of Marx's account. The simultaneous
single-system interpretation also replicates Marx's results in this case, so
we're even on this basis, taken alone, but we replicate other important
results that the SSS interpretation cannot, and the reverse isn't true, so we
have a superior interpretation. Since the "historical cost" interpetation of
profit and the rate of profit is thus what makes sense of Marx, while the
"replacement cost" interpretation fails to do so, it makes no sense to say
that we've failed to refute charges of internal inconsistency. Even if the
above objection were completely true concerning how capitalists behave, their
goals, and what tends to equality, the fact remains that our interpretation of
Marx indicates that he held the opposite view and our interpretation is the
one that makes sense of what he said. Therefore he held the opposite view.
If the above objection is true, then Marx was wrong, but we have still have a
superior INTERPRETATION of his theory, and we have refuted charges of INTERNAL
INCONSISTENCY. Someone can be internally consistent and completely wrong.
Therefore we have refuted the charges of internal inconsistency and that
should be acknowledged clearly and openly, without equivocation.

There are ONLY 2 things that can challenge our interpretation. ONE: another
interpretation that makes better sense of what Marx wrote, as a whole,
including by being better able to replicate his actual theoretical results.
TWO: a demonstration that does not rely on a debatable *interpretation* of
what Marx wrote, but that relies only on what he *actually* wrote, and that
shows him to be internally inconsistent. No appeal to economic facts can do
anything to challenge our interpretation.

Unfortunately, we are debating from a position of (material, not
interpretative or theoretical) weakness, and we thus rarely succeed in
dismissing illogical objections. Nor do we succeed in getting people to stick
to the actual issues, (in this case, Marx's own transformation, not what is a
correct economic theory of capitalist behavior and the outcomes it leads to).
We unfortunately have had and continue to have to try to persuade people away
from their positions simply in order to get them to focus on the actual
issues. And so, for instance, I have had to deal with the irrelevant issue of
whether capitalists seek to maximize the "replacement cost" profit rate.

Now, my example, though insufficient to discuss *everything* concerning the
equalization of profit rates, demonstrates clearly that there is a huge
difference between maximizing the expected rate of return and maximizing the
"replacement cost" rate of profit. In my example, the "replacement cost" rate
was higher in one industry but the expected rate of return was lower. Hence,
my example showed clearly that any capitalist interested in maximizing his/her
expected rate of return will not invest his/her capital in that line of
business that has the highest "replacement cost" profit rate if it is not
expected to yield the highest ACTUAL rate of return. Indeed, the
"replacement cost" rate will be not be used to make decisions. Only the
expected actual rate of return will matter. And if the movement of capital
from one line to another results in the *tendency* to equalize that which the
capitalists seek to maximize, then it will tend to equalize the expected
actual rate of return if that is indeed their objective, NOT the "replacement
cost" rate.

But what is this "expected actual rate of return"? It is an HISTORICAL COST
rate of profit. That does not mean it refers back to the past. This is a
major fallacy of simultaneist thinking. An historical cost rate may link the
present (today's revenues) to the past (actual past costs incurred). That is
appropriate for assessing what the actual rate of return has BEEN, from some
past time to the present. But another rate of return that is EQUALLY an
historical cost rate links the FUTURE (expected future revenues) to the
PRESENT (actual present costs incurred). That is exactly what the internal
rate of return does, it is exactly what present discounted value computations
do. They are historical cost measures of profitability. What makes something
an historical cost measure is thus that it considers an *expanse* of time, not
a *moment* in time. It has nothing to do with whether it is "forward-looking"
or "backward-looking." The "replacement cost" profit rate is NOT
forward-looking. It is mired in the present moment alone. It measures
revenues today aganist costs today. It abolishes not only past history but
future history. The ONLY case in which the "replacement cost" rate is
forward-looking is if the investor expects the prices that determine revenues
to remain stationary throughout the whole lifetime of the investment.
Otherwise, if firms seek to maximize their actual profitability, it is no
guide to their behavior. But even in the case in which they expect stationary
prices, the "replacement cost" rate equals the expected actual - "historical
cost" - rate, so it is *always* the "historical cost" rate that matters. The
"replacement cost" rate is at best redundant and almost always the wrong

In fact, it is not really even a profit rate. The concepts of capital
advanced and of investment, and therefore the concepts of profit relative to
capital advanced and rate of return on investment, are rooted in TIME. They
consider an *expanse* of time. They link past to present, and present to
future. The "replacement cost" rate violates the very nature of the capital
advances, of investment, when it freezes time. It has no existence in
reality, it has no existence in capitalists' decisionmaking or behavior.
There is only one kind of profit rate in reality: "historical cost" profit
rates. Hence, if the profit rate tends to equality, it is an "historical
cost" rate that tends to equality. This does not mean that firms invest on
the basis of the past profit rates. They invest on the basis of future
expected profit rates. Nonetheless, if we say that the profit rate is (is
not) actually equal today, we are saying that profits received *today*
relative to costs incurred in the *past* are (are not) equal. There is no
contradiction here. Firms seek to maximize the ex ante "historical cost"
profit rate and this may (or may not) lead to an equalization of the ex post
"historical cost" profit rate. So when Kliman and McGlone (1988) or Maldonado
Filho (1995) or McGlone and Kliman (1996) show an equalized rate of return on
capital actually advanced, they are showing the equalization of the only kind
of profit rate that has any significance for capital.

If all this is obvious to you, Rieu, I apologize. It has not been obvious to
the simultaneists who say capitalists seek to maximize the "replacement cost"
profit rate.

I think it may be obvious to Rieu because he gives two examples in which
simultaneist investors evidently do not seek to maximize the "replacement
cost" rate, at least not as our other critics have meant it. That is, they do
not invest today on the basis of *today's* revenues and *today's* costs.
Rather, in his circulating capital example in which production take 1 year,
they evidently invest on the basis of revenues *expected to be received in
one year* and what the things they purchased *today* are *expected to cost in
one year*. This is a novel claim. At least I have never heard it before. It
is not even what Rieu seems to have thought when he got the right answer to my
example. To get the right answer to my example, you must hold that the
investor invests on the basis of revenues *expected to be received in one
year* and what the things they purchased today *actually cost today*.
Therefore, although I realize Rieu didn't copy off of Alejandro Ramos and I
was ready also to award Rieu first prize, a "TSS: It's About Time" button,
I'm sorry to say that he has since disqualified himself. I base my decision,
not on his actual "historical" answer, but on what he would have answered had
he given his "replacement" answer when in fact he gave his actual answer.

The only other thing I can say about the replacement answer is that I think it
is totally wrong. Imagine a firm that invests in a machine that lasts one
year and that at the end of the year produces 2 machines of the same type.
Imagine that there are no other costs. Imagine that the firm pays $1000 for
the machine it purchases and receives $200 for each of the machines it
produces. Is its rate of return 100%? Internal rate of return calculations
will tell us it is -60%. Would you invest in this machine, Rieu, or instead
buy a one-year bond paying 10 0nterest?

Thinking about borrowing doesn't change the situation but only makes it more
clear. The firm borrows the $1000 and pays it back ... with WHAT? Machines?
"Well, you lent us $1000 and we bought a machine. Here's a new machine of the
same type. Nice doing business with you." Or maybe the settlement goes as
follows, with the benefit of some simultaneist economic theory: "Well, you
lent us $1000 and we bought a machine. A machine is worth $200, and the
interest rate was 7%, so here's your $214. The principal isn't the amount
that you actually lent us, that's the historical principal. The real
principal is the replacement principal, the amount that we would have asked
you to lend us had the machine we purchased a year ago cost then what it costs
now. The interest rate isn't a percentage of what we actually borrowed,
that's the historical interest rate. The real interest rate is the
replacement interest rate, a percentage of what we would have borrowed had the
machine we purchased a year ago cost then what it costs now. Nice doing
business with you."

Andrew Kliman