In Aggregate Economic Accounting Most Spending Is Not Consumption but Is Concealed under Net Investment

Attention: all economics students. Perhaps the most prominent equation in macroeconomics is that national income (essentially the sum of profits and wages) equals net national product, which is the sum of consumption plus net investment.

Because consumption is much larger that net investment, it is almost universally assumed that it pays the bulk of national income. However, most spending in the economic system is actually not consumption. RATHER, IT IS CONCEALED UNDER NET INVESTMENT.

Net investment is the difference between two enormous sums: a minuend consisting of the total of business spending for capital goods and labor, and a subtrahend consisting of the costs that are deducted from sales revenues in calculating profits.

The minuend contains additions to asset accounts (plant and equipment and inventory and work in progress) while the subtrahend contains subtractions from asset accounts, notably depreciation and cost of goods sold. Selling, general, and administrative expenses appear equally in both the minuend and the subtrahend.

The difference between additions to and subtractions from asset accounts is the net change in those accounts, i.e., net investment.

The minuend in calculating net investment is where the bulk of spending in the economic system lies. I call this spending “productive expenditure.”

The concept of productive expenditure is not recognized in contemporary economics. It is believed that it is somehow included in consumption expenditure and that to recognize it separately would constitute the error of “double counting.”

For further elaboration and proof, including a thorough discussion of the issue of “double counting,” see Chapter 15 of my Capitalism: A Treatise on Economics. It’s available at https://amzn.to/2PM19ut

Read this chapter, tell your economics professors about it, and ask them to show you what’s wrong with my claim that most spending takes place under the head of net investment.

WHERE PROFIT COMES FROM

Labor unions like to argue that the payment of higher wages is to the self-interest of employers because the wage earners will use their higher wages to make additional purchases from business firms, thereby increasing the sales revenues and profits of business firms. However, wrong and foolish it may be, this is an argument worth analyzing in some detail, because it can provide a gateway to a discussion of the actual sources of profit in the economic system.

The union argument, of course, ignores the fact that the business firms paying the higher wages and those earning the additional sales revenues and profits that are alleged to result are likely to be different firms. Indeed, insofar as any one, individual firm is considered, this will certainly be the case, if for no other reason than that very little, if any, of the additional wages paid by that one firm are likely to be expended by its employees in purchasing goods specifically from it. Whatever kind of firm it may be, it specializes in just one or, at most, a very few kinds of business. Yet its employees will almost certainly expend their higher wages in buying a wide variety of products, from a wide variety of firms.

The only way that an individual firm might expect to gain comparable additional sales revenues following its payment of additional wages is if the payment of additional wages takes place on the part of very many firms, throughout the economic system. In that case, while its employees spend most or all of their additional wages in buying from other firms, the employees of other firms may very possibly spend enough of their additional wages in buying from it, to provide it with additional sales revenues sufficient to match its additional payment of wages.

But even in this case, firms producing capital goods will not have additional sales revenues. This is because, in the nature of the case, all of the additional sales revenues accrue to the sellers of consumers’ goods. For it is consumers’ goods on which the additional wages are expended, not capital goods. All that the sellers of capital goods will have is additional costs of production, corresponding to their payment of additional wages.

Indeed, in any circumstances, even in the highly unrealistic case in which all firms sold nothing but consumers’ goods, there would be additional costs of production equal to the additional wages paid. The additional wages sooner or later always show up as equivalent additional costs of production. The consequence of additional costs of production equal to the payment of additional wages offsets the existence of additional sales revenues equal to the payment of additional wages.

Insofar as the effect of the payment of additional wages is the combination of additional sales revenues and additional costs of production, there can be no increase in profits in the economic system. In both being equal to the same thing—viz., the additional wages paid—the additional sales revenues and the additional costs are equal to each other. In the face of equal additions to sales revenues and costs, profits, the difference between sales revenues and costs, remain unchanged in the economic system in terms of their dollar amount. Equals added to unequals not only do not affect the amount of the inequality, but serve to reduce the percentage that the unchanged amount of profit constitutes of the now larger sales revenues and costs. Profit as a percentage of sales revenues and cost necessarily declines.

Furthermore, while it is not unreasonable to assume that the payment of additional wages results in equivalent additional expenditure by the wage earners and thus in equivalent additional sales revenues for sellers of consumers’ goods, it is by no means the case that it must result in an equivalent additional expenditure and sales revenues in the aggregate, i.e., for consumers’ goods and capital goods taken together. It might well be the case that the additional payment of wages comes at the expense of purchases of capital goods, notably the materials and machinery business firms buy. In that case, aggregate sales revenues in the economic system will be unchanged.

And if this is the case, then it is almost certain that business profits in the aggregate will substantially decline in amount as the result of an increase in wage payments. This is because expenditures for capital goods, especially machinery and buildings, show up as costs of production in business income statements much more slowly than do wage payments of equivalent amount. For example, an additional $1 billion of expenditure on wage payments is likely to show up as costs of production within a matter of weeks or months. However, that same $1 billion expended on machinery or buildings will show up as equivalent costs of production only over a period of years or even decades, as the machinery or buildings undergo depreciation.

Consequently, a shift in expenditure from machinery and buildings to wage payments would result in an increase in aggregate costs of production in the economic system in the current year, and many years thereafter, of the far greater part of the $1 billion. Profits in the economic system would equivalently fall because, in the conditions of the case, the increase in aggregate costs would occur in the face of aggregate sales revenues that were unchanged.

It should be realized here that by the same token, a decline in wage payments that made possible an equivalent rise in the expenditure for machinery or buildings would result in a substantial increase in profits in the economic system. This is because, in this case, aggregate costs of production in the economic system would fall as depreciation cost, representing a relatively modest fraction of the additional $1 billion that was now spent on machinery or buildings, replaced what would have been current operating costs representing the far greater part or all of the $1 billion otherwise spent in paying wages.

This conclusion, of course, flies in the face of the views of the labor unions and the Keynesians, who believe that reductions in wage rates reduce business profits insofar as they result in a reduction in total wage payments and consequently consumer spending. The truth, as I have just shown, is the exact opposite insofar as the reduction in wage payments serves to increase expenditure for durable capital goods.

Profits and the Average Period of Production

There is an abstract principle that is present in these examples, one that relates to the “Austrian” concept of the average period of production and the closely related Ricardian concept of the necessary lapse of time that takes place between expenditures for means of production and the receipt of proceeds from the sale of the ultimate consumers’ goods that result. The principle is that, other things being equal, a lengthening of the average-period-of-production/necessary-lapse-of-time brings about a transitory decrease in aggregate costs of production in the economic system and increase in profits in the economic system. By the same token, other things being equal, a shortening of the average-period-of-production/necessary-lapse-of-time brings about an increase in aggregate costs of production in the economic systems and decrease in profits in the economic system.

I describe the change in aggregate costs of production as “transitory” because ultimately, if the amount of spending for means of production, i.e., labor and capital goods, remains the same in the economic system year after year, costs of production will equal that amount of spending, irrespective of the length of the average-period-of-production/necessary-lapse-of-time. For example, on the scale of an individual company, $1 billion per year expended on labor and materials will probably result in $1 billion of annual costs of production for that company within little more than a year. That same $1 billion expended year after year in purchasing machinery with a depreciable life of 10 years, will result in annual depreciation costs of $1 billion after 10 years. At that point, 10 years’ of machinery purchases will be in place, with the purchases of each year resulting in $100 million of annual depreciation cost, or $1 billion in all. Similarly, the expenditure of $1 billion year after year for buildings with a 40-year depreciable life must result in $1 billion of annual depreciation cost once 40 years have passed. At that point, there will have been 40 years of building purchases. With each of those 40 years’ purchases resulting in an annual depreciation cost of one-fortieth of $1 billion, the total annual depreciation cost from than point on will be $1 billion.

So long as further lengthening of the average-period-of-production/necessary-lapse-of-time occurs, the process makes a further contribution to aggregate profitability. But once further lengthening ceases, the contribution to aggregate profitability comes to an end. (Mises implicitly recognizes the contribution to aggregate profit made by a lengthening of the period of production. See Human Action, 3d ed. rev. [Chicago: Henry Regnery Co., 1966], pp. 294-97.)

Profits and the Increase in the Quantity of Money/Volume of Spending

Nevertheless, there is a second factor connected with the passage of time in the productive process that can be gleaned from our discussion of the union argument concerning wage payments, and whose contribution to aggregate profitability is capable of being permanent. This factor is the increase in the quantity of money/volume of spending in the economic system.

The increase in wage payments so much desired by the unions could make a contribution to aggregate profits in the economic system insofar as it was financed by an increase in the quantity of money. (A decrease in the demand for money for cash holding would also have this effect. However, inasmuch as decreases in the demand for money for cash holding cannot go on indefinitely and, indeed, ultimately depend on increases in the quantity of money, they require no further separate discussion.)

Moreover, what serves to contribute to profits in the economic system here is in no way peculiar to higher wage payments. It is present equally in greater expenditures for materials and supplies and machinery and buildings, i.e., in greater expenditures for means of production as such.

The contribution to profits in the economic system derives from the fact that additional expenditures for means of production resulting from the increase in the quantity of money serve to raise sales revenues in the economic system immediately or almost immediately while they serve to increase the costs of production deducted from sales revenues only with a more or less considerable time lag. Thus, what business firms spend in buying capital goods is simultaneously sales revenues to the sellers of the capital goods. What they spend in paying wages shows up very quickly as additional sales revenues for sellers of consumers’ goods.

Consistent with the principles of business accounting, in the case of all goods sold out of inventory, additional costs of production appear in business income statements only as and when the goods produced from the means of production purchased for larger sums of money are sold. That often entails a lapse of time of several months, and, sometimes, several years. For example, the additional expenditures made by an automobile company for labor and materials will not show up as costs of production until the automobiles produced in the process are actually sold, at which time cost of goods sold is incurred. Such outlays made in November or December of a calendar year will not show up in the auto firms’ current-year income statements ending on December 31, but only in the income statements of the following year.

In the case of a distillery, producing aged whiskey, such time interval may be 8, 12, or 20 years, or even more. Of course, in the case of the machinery and buildings purchased by business firms, major time intervals are present everywhere before additional depreciation cost comes to equal the additional outlays.

In these intervals, sales revenues are increased without costs being increased, or increased equivalently, and thus profit emerges. And then, if the increase in the quantity of money and volume of spending is continuous, by the time costs do rise to reflect the higher level of expenditures made in purchasing the means of production, there are further increases in the expenditures for the means of production and thus in sales revenues. In other words, there is a continuing contribution to aggregate profit.

It follows from this discussion that a continuing given percentage increase in the quantity of money/volume of spending in the economic system tends to add an approximately equivalent percentage increase to the economy-wide average rate of profit/interest. For example, a continuing 2 percent annual increase tends to add approximately 2 percentage points to the rate of profit/interest on top of what it would otherwise have been. This conclusion follows by conceiving of outlays for means of production in any given year as being paired with receipts from the sale of consumers’ goods in definite future years. If the volume of spending and thus of sales revenues in the economic system were growing at some definite compound annual rate, an equivalent additional rate of return on those outlays would be implied.

For example, if with no increase in the quantity of money/volume of spending, an outlay for means of production of 10 would grow to sales revenues of 11 in a year, but now a 2 percent increase in money and spending makes it grow to 11.22, the rate of return on the outlay of 10 is increased from 10 percent to 12.2 percent, an increase of approximately 2 percentage points. In the same, way an outlay of 10 that would otherwise grow to (11/10) x (11/10) in 2 years, will now, with a compound annual increase of 2 percent in money and spending, grow to (11/10) x (11/10) x 1.02 x 1.02. Again, on an annualized basis, there will be an addition of approximately 2 percentage points to the rate of return. Since every dollar of sales revenues in the economic system can conceptually be paired with outlays for means of production made at one specific time or another in the past, a uniform compound annual increase in money and spending covering the entire time interval must have this effect everywhere.

The increase in the rate of return resulting from the increase in the quantity of money/volume of spending should not be dismissed as inflation. In a free market, under a gold standard, the quantity of money would increase and that increase, as Rothbard has convincingly shown, would not be inflation. Inflation, Rothbard showed, applies only to increases in the quantity of money more rapid than increases in the supply of gold. The modest increase in the quantity of money in a free economy and its gold standard would almost certainly be accompanied by increases in the production and supply of commodities in general that were at least as great and, most probably, significantly greater. The result would be falling prices. However, and this is a very significant finding, these falling prices would not at all be deflationary, because, as I have just shown, they would be accompanied by an increase in the average rate of return on capital rather than a decrease, which last is a leading symptom of any actual deflation.

In a free market and its gold standard, a reasonable scenario would be a 2 percent annual increase in the quantity of gold and spending in terms of gold, accompanied by a 3 or 4 percent annual increase in production and supply in general. The effect would be prices falling at an annual rate of 1 or 2 percent along with an approximate 2 percent addition to the average rate of return. The real rate of return, of course, would be elevated further, to the extent that prices fell.

There is a further very important conclusion to be drawn here, concerning the actual significance of the rate of return, the rate of profit/interest. And that is that to a very significant extent, the nominal rate of return is the reflection of nothing more than the increase in the quantity of money and volume of spending, while the real rate of return is the reflection of nothing more than the rate of increase in production and supply. In other words, at least to this extent, the rate of return cannot possibly be at anyone’s expense. It is the accompaniment and marker of more gold and of more goods in general, i.e., of economic progress and general improvement.

It must be pointed out that profits derived from lengthenings of the average period of production are also ultimately at no one's expense. To the contrary, in adding to the total of the capital employed in the economic system, they serve to increase the quantity and quality of the products produced. To the extent that these products are consumers' goods, the effect is a rise in real wages inasmuch as they are purchased overwhelmingly by wage earners. To the extent that the larger supply of products produced is capital goods, it serves to bring about a further increase in the supply of consumers' goods, and thus in real wages, and yet a further increase in the supply of capital goods, which in turn will have the same result. Continuing increases in the supply both of consumers' goods and capital goods, and thus continuing increases in real wages can occur.

The Rate of Return Under a Fixed Quantity of Money/Volume of Spending

In addition to increases in the quantity of money/volume of spending and lengthenings of the average period of production, there is a third source of profit in the economic system. This is the consumption expenditure of businessmen/capitalists, i.e., the expenditure of businessmen/capitalists that is not for business purposes, not for the purpose of making subsequent sales.

Like the consumption expenditure of wage earners, this expenditure is a source of business sales revenues in the economic system. But, unlike the consumption expenditure of wage earners, it has no counterpart in expenditures that generate costs of production. Its sources are primarily dividends paid by corporations and the draw of funds from partnerships and sole proprietorships. These payments do not show up as costs of production on the part of the firms that pay them. They are simply a transfer of funds from the firms to their owner(s).

Their existence enables business sales revenues in the economic system to exceed the expenditures by business firms for means of production and thus also to exceed the equivalent costs of production generated by those expenditures. In this way, they are a source of profit in the economic system.

Interest payments by business firms are also a source of funds making possible consumption expenditure by businessmen/capitalists. Interest payments, of course, do show up equivalently in costs of production. Nevertheless, their existence helps to explain the existence of business profits pre-deduction of interest. And thus they help to explain the general rate of return on capital, which is calculated gross of interest. This rate of return—the rate of profit pre-deduction of interest—of course, is what determines the rate of interest. (In the terminology of Mises and most other economists of the “Austrian School,” these profits are called “originary interest.” Taken relative to capital invested, they constitute the rate of originary interest.)

Profits resulting from the consumption expenditure of businessmen/capitalists would exist in the absence of further increases in the quantity of money/volume of spending. Their existence, moreover, acts to put an end to any indefinite prolongation of the average period of production. This is because, to be worthwhile, a lengthening of the average period of production requires that businessmen find that the investment of additional capital results in cost savings or revenue increases at the level of the individual firm sufficient to yield something more than the prevailing rate of return on capital. Thus, the higher is the prevailing rate of return, the greater is the obstacle in the way of additional investment being worthwhile. At the same time, the greater is the volume of capital that has already been accumulated in the economic system relative to sales revenues, the smaller is the contribution to costs savings or revenue increases that is likely to be made by the investment of still more capital and a further rise in the ratio of accumulated capital to sales revenues.

The implication of this discussion is that ultimately the rate of return in the economic system is determined by the combination of the rate of increase in the quantity of money/volume of spending and the ratio of the consumption expenditure of businessmen/capitalists to their accumulated capitals.

The second factor is clearly the more fundamental and should be understood as a reflection of time preference. In conditions in which the annual consumption expenditure of businessmen/capitalists is on the order of 5 percent of their accumulated capitals, time preference is lower than in conditions in which it is on the order of 10 percent of their accumulated capitals. It is lower still in conditions in which it is on the order of 2 percent. In the first case, their capitals are sufficient to provide for the consumption of 20 years; in the second, for only 10 years; in the third, for 50 years. A lower time preference is required to make greater relative provision for the future.

Establishing the relationship between time preference and the consumption expenditure of businessmen/capitalists relative to their capitals and, on that basis, to the rate of return on capital, serves to integrate time preference and its determination of the rate of return into “macroeconomics.”

Avoiding Confusions

It’s necessary to anticipate two possible confusions that may arise. One is the conviction that the claim that the consumption of businessmen/capitalists is a determinant of the rate of return on capital implies that to increase its rate of return, a company should increase its dividends and simply be sure that its stockholders consume the proceeds.

If enacted such a policy would, to some very modest extent, serve to increase the economy-wide average rate of return on capital. But the profits earned by the firm in question would be decimated. The extra profits would go to others, not to it. This is because such behavior would reduce its capital, which is an essential means of its competing for profits, by far more than it increased the economy-wide amount of profit.

For example, a huge firm, with a capital of $100 billion might increase its dividend by $10 billion and add $10 billion to the excess of sales revenues over expenditure for means of production in the economic system, and over costs equal to the now reduced expenditure for means of production. This would increase economy-wide profits from, say, $1 trillion to $1.01 trillion, a 1 percent increase. But at the same time, it would reduce the capital of this firm by 10 percent. Thus, the firm would be in a position to compete for its share of a 1 percent increase in profits in the economic system on the foundation of a capital that had been reduced by 10 percent. The profit it earned would thus certainly be much lower than it was before.

The second confusion that may arise is to ignore the fact that the discussion of profit in this article has been almost entirely at the level of the economic system as a whole, not at the level of the individual firm. As indicated in the last paragraph, competition exists at the level of the individual firm and plays a decisive role in determining its profits. Such factors as its relative efficiency and the relative quality of its products are vital for the profitability of the individual firm, but play little or no role in determining profits at the level of the economic system as a whole. This is because there competitive factors cancel out.

Summary

The central question that this article has been concerned with is what permits an excess of sales revenues over costs of production in the economic system as a whole. Here, as we have just seen, such things as producing a larger quantity of products more efficiently, or producing better products that can command premium prices, simply do not provide an explanation. This is because at the level of the economic system as a whole, they cancel out, with the profits of the more efficient, higher quality firms matched by the losses of the less efficient, lower quality firms.

The explanation of profit/interest in the economic system as a whole is provided by:

1) A shifting of expenditures for means of production from products and processes in which they show up more quickly as costs of production to be deducted from sales revenues, to products and processes in which they show up more slowly as costs of production to be deducted from sales revenues. In both cases, the same expenditure for means of production generates the same volume of sales revenues in the economic system, but in the second case costs are lower for a more or less considerable period of time, and thus profits are higher for that period of time. This, of course, represents a lengthening of the average period of production.

2) The increase in the quantity of money/volume of spending. This increase serves to increase sales revenues immediately or almost immediately while increasing the costs deducted from the sales revenues only with more or less substantial time lags. In the interval, profits are generated. The process is perpetuated by continuing increases in the quantity of money/volume of spending. At the same time that more money and spending add to profits and the rate of profit in terms of money, increases in the production and supply of ordinary goods can serve to prevent price increases or even result in price decreases, with the result that the nominal profits generated are accompanied by equivalent or greater real profits. This would be the situation in a free market and the gold standard.

3) The consumption expenditure of businessmen/capitalists. This is the source of sales revenues in excess of expenditure for means of production and of costs of production equal to those expenditures. It is the most fundamental source of profit in the economic system and ultimately rests on time preference.

Further Development of the Theory of Profit/Interest

I discuss all aspects of the present article at greater length, along with a host of other, related matters as well, in my book Capitalism: A Treatise on Economics. It will be helpful to provide a short bridge from this article to that book, in the form of the introduction of some new terminology.

In Capitalism, I refer to expenditure for means of production by business firms as productive expenditure, which is expenditure for the purpose of making subsequent sales. Productive expenditure is in sharpest contrast to consumption expenditure, which is expenditure not for the purpose of making subsequent sales, but for any other purpose.

Productive expenditure, of course, has two components: expenditure for capital goods and expenditure for labor—i.e., wage payments. Productive expenditure plays a twofold role in the generation of aggregate business profits: it is the source both of most of business sales revenues and of the costs business firms deduct from their sales revenues.

Productive expenditure can exceed costs deducted from sales revenues insofar as the costs it generates follow it with time lags. To the extent it does exceed costs, the sales revenues it generates also exceed those costs. There is profit.

Any excess of productive expenditure over costs is net investment. This is because, in accordance with the principles of business accounting, productive expenditure to a substantial extent constitutes additions to business asset accounts, notably, the gross plant and equipment and inventory/work in progress accounts. Expenditures on account of machinery or buildings add to the former; expenditures for materials add to the latter. Expenditures even for labor often represent additions to these accounts—for example the wages paid to workers constructing plant or to workers employed in the production of inventories.

Costs of production, on the other hand, largely represent subtractions from these accounts. Depreciation cost is a subtraction from gross plant and equipment. Cost of goods sold is a subtraction from inventory/work in progress. Thus, while productive expenditure adds to the asset accounts of business, cost of production subtracts from them. The difference between the sum of the additions and the sum of the subtractions is the net change, i.e., net investment.

Net investment reflects the effect both of changes in the length of the average period of production and changes in the quantity of money/volume of spending. The ratio of net investment in the economic system to accumulated capital in the economic system is the measure of the rate of profit/interest insofar as it is the result of these factors. In Capitalism, I call this ratio the “net investment rate.”

The rate of profit/interest in the economic system is explained by the combined operation of the net investment rate and one other rate, which I call the “net consumption rate.” Net consumption is the excess of spending for consumers’ goods over the wages paid by business firms. As explained, its primary source is the consumption expenditure of businessmen/capitalists. Net consumption is also equal to the excess of business sales revenues in the economic system over productive expenditure. Inasmuch as the expenditure to buy capital goods is present equally both in business sales revenues and in productive expenditure, the difference between sales revenues and productive expenditure reduces to the difference between the part of sales revenues constituted by consumption expenditure and the part of productive expenditure constituted by wage payments, i.e., net consumption.

Perhaps the simplest way to conceive matters is by starting with the fact that profit is the difference between sales revenues and costs. Sales revenues minus costs equals sales revenues minus productive expenditure plus productive expenditure minus costs. The first part of the result is net consumption; the second part is net investment. Thus, profit equals the sum of net consumption plus net investment. The further result is that the rate of profit, i.e., the ratio of profit to accumulated capital, equals the sum of the rate of net consumption plus the rate of net investment, with each of these rates being understood as the result of respectively dividing net consumption and net investment by the amount of accumulated capital in the economic system.

This theory of profit/interest has major implications for the understanding of capital accumulation, the determination of real wages and the general standard of living, taxation, inflation/deflation, and the business cycle. It also provides the basis for the overthrow of virtually all aspects of Keynesianism and its system of national income accounting, along with an equally fundamental and thorough refutation of Marxism and the exploitation theory.

Copyright © 2011 by George Reisman. George Reisman, Ph.D., is Pepperdine University Professor Emeritus of Economics, Senior Fellow at the Goldwater Institute, and the author of Capitalism: A Treatise on Economics. His website is http://www.capitalism.net/.

Standing Keynesian GDP on Its Head: Saving Not Consumption as the Main Source of Spending

[This article is based on a portion of Chapter 15 of the author's Capitalism: A Treatise on Economics.]

According to the prevailing Keynesian dogma, consumption is the main form of spending in the economic system, while saving is mere non-spending and thus a “leakage” from the spending stream. This dogma underlies much of government economic policy in the United States, including the so-called economic stimulus package that has just been enacted. In this article, I prove, to the contrary, that consumption is not the main form of spending in the economic system and that the source of most spending is, in fact, saving. I prove my claims by starting with the very formulations of the expenditure aggregates presented by the Keynesian doctrine itself.

Thus, the simplest, core accounting relationship of Keynesian economics is that national income, which is essentially the sum of profits plus wages, is equal to the sum of consumption expenditure plus net investment.

It is only a small step from national income to gross domestic product (GDP). Essentially all one does is add business depreciation allowances to profits on the left-hand side of the equation and to net investment on the right-hand side. This last raises net investment to what contemporary economics calls gross investment. The sum of consumption plus gross investment is held to equal GDP.

In a slightly more complex formulation, government expenditure is stated as a third component of expenditure, alongside of consumption and investment. In yet a still more complex formulation, net exports are also included. These expenditure items, whether two, three, or four, are understood as paying the national income or GDP.

For the sake of simplicity, I’ll ignore net exports, which, rounded off at minus $1 trillion, represents the smallest of the four items. By far the largest single item of expenditure reported is personal consumption expenditure, which is currently running at an annual rate of about $10 trillion. The next largest item is government expenditure, currently running at roughly $3 trillion. Gross private domestic investment is reported as slightly more than $2 trillion.

These numbers add up to approximately $15 trillion, which is a rough approximation of today’s annual rate of GDP. Business depreciation allowances of roughly $1 trillion, imply net investment in the amount of approximately $1 trillion and a national income on the order of $14 trillion.

Now government expenditure is itself a species of consumption expenditure. But with or without the inclusion of government expenditure, consumption spending appears as the overwhelming source of GDP and national income: $10 trillion out of $15 trillion and $10 trillion out of $14 trillion respectively. Count government spending in with private consumption, and the figures rise to $13 trillion out of $15 trillion and $13 trillion out of $14 trillion.

It is data such as these that lead commentators routinely to make such statements as “consumption accounts for two-thirds of GDP.” The clear implication of such statements is that consumption expenditure, private or private plus government, is what constitutes the overwhelming bulk of spending in the economic system and pays the overwhelming bulk of the incomes of the economic system.

Nevertheless, this proposition is not in fact supported by the various formulas used in aggregate economic accounting. The formulas are all mathematically correct. For example, national income does in fact equal consumption plus net investment. And it is true that consumption spending almost always dwarfs net investment. Indeed, on occasion, net investment might even be zero or, still more extreme, a negative number. Yet in no case is it true in a modern economic system that consumption is the main form of spending and pays most of the incomes. The belief that it does rests on a radically incomplete, highly superficial understanding of the formulas.

Most Spending in the Economic System Is Concealed Under Net Investment

The truth is that the great bulk of spending and income payments in the economic system is concealed under net investment! Net investment is analogous to an iceberg, nine-tenths of whose volume is concealed beneath the surface. Only in the case of net investment, what is concealed can easily be much more than nine-tenths.

Net investment is the difference between two enormous monetary magnitudes, which are never radically different from one another in size and sometimes may even be approximately equal. Indeed, occasionally the one that is subtracted may even be larger than the magnitude it is subtracted from, which gives rise to negative net investment.

The monetary magnitude that is subtracted in the determination of net investment is the aggregate of all of the costs that business firms report in their income statements as subtractions from their sales revenues in calculating their profits, namely, depreciation cost, cost of goods sold, and selling, general, and administrative expenses. The monetary magnitude from which the costs are subtracted has no name in contemporary economics. I call it productive expenditure.

Productive expenditure is expenditure for the purpose of making subsequent sales. It is the expenditures made by business firms in buying capital goods of all descriptions and in paying wages. Capital goods include machinery, materials, components, supplies, lighting, heating, and advertising. In contrast to productive expenditure, consumption expenditure is expenditure not for the purpose of making subsequent sales, but for any other purpose. In the terminology of contemporary economics, consumption expenditure is described as final expenditure. Productive expenditure could be termed intermediate expenditure. Implicitly or explicitly, productive expenditure is always made for the purpose of earning sales revenues greater than itself, i.e., is made for the purpose of earning a profit.

I now must demonstrate just why net investment is in fact the difference between productive expenditure and business costs. My demonstration consists of two parts. First, a demonstration that the definition of national income as the sum of profits plus wages implies that national income also equals the sum of consumption and productive expenditures minus business costs. Second, a demonstration that the difference between productive expenditure and business costs is in fact net investment.

Let me begin with the proposition that national income equals the sum of profits plus wages. This proposition can be taken as true simply as a matter of definition. There are profits, there are wages, and the sum of the respective aggregates of each across the entire country is what we call national income.

Restatement of National Income as Sales Minus Costs Plus Wages

Now a simple but critical step is to recognize that profits are the difference between the sales revenues and the costs of business firms. The aggregate profit earned in an entire country in a year is equal to the sum of the sales revenues of all the business firms of the country for the year minus the sum of all of the costs that those business firms subtract from their respective sales revenues in calculating their respective profits.

Stating profits as sales revenues minus costs allows us to reformulate national income as the sum of sales revenues minus costs plus wages.

The next step in my demonstration is based on the realization that every dollar of business sales revenues and every dollar of wages received represents an identical dollar of expenditure by those who pay the sales revenues or wages. Thus the sales revenues of a steel company, say, represent expenditures on the part of such buyers as automobile companies. Wages received are wages paid by employers of one description or other.

From this point forward, we must look at sales revenues and wage incomes from the perspective of the buyers who pay them. In paying sales revenues or wages, the buyers can have only one or the other of two basic purposes in mind. They can be paying the sales revenues or wages for the purpose of themselves making subsequent sales. Or they can be paying the sales revenues or wages not for the purpose of themselves making subsequent sales.

Sales revenues and wages paid for the purpose of the buyer himself making subsequent sales constitute productive expenditure. Sales revenues and wages paid not for the purpose of the buyer himself making subsequent sales constitute consumption expenditure.

Examples of sales revenues constituted by productive expenditure are all the sales revenues paid by one business firm to another. It is the receipts from the sale of steel to automobile companies and of iron ore to steel companies, receipts from the sale of flour to baking companies and of wheat to flour millers. It is receipts from the sale of all goods purchased by retailers at wholesale, And, of course, it is receipts from the sale of all newly produced machines and equipment purchased by one business from another.

Examples of sales revenues constituted by consumption expenditure are the sales revenues of grocery stores, clothing stores, movie theaters, restaurants, and the like. However, even here, some portion of the sales revenues may be productive expenditures, as when a restaurant buys supplies in a supermarket or a business buys work clothes for its employees.

Examples of wage payments that are productive expenditures are all of the wages paid to the employees of business firms, from the wages of field hands, miners, and factory workers, to the wages of office secretaries, advertising executives, bank tellers, and sales clerks—the wages of all workers paid for the purpose of the employer making subsequent sales. (All wage payments and purchases of goods that are necessary to the existence or functioning of a business enterprise are to be conceived of as made for the purpose of making subsequent sales, for that is the purpose of the business enterprise itself.)

Examples of wage payments that are consumption expenditures are the wages paid to maids and baby sitters by housewives, and, among the very rich, the wages paid to butlers, personal cooks, and chauffeurs. These wages, of course, are obviously trivial in comparison with the wages paid by productive expenditure. The one substantial example of wage payments constituted by consumption expenditure are the wages of government employees. Those wages are not paid for the purpose of the government making subsequent sales.

Revenue/Expenditure Subcomponents

What we’ve done at this point is conceptualize national income in terms of its revenue/expenditure subcomponents. We’ve seen that profits plus wages equals not only sales revenues minus costs plus wages, but also, and more precisely, that it equals the sum of that part of sales revenues that is constituted by productive expenditure plus that part of sales revenues that is constituted by consumption expenditure, minus costs, plus that part of wages that is constituted by productive expenditure plus that part of wages that is constituted by consumption expenditure. The revenue/expenditure subcomponents are, of course, the two constituent parts both of sales revenues and of wages from the perspective of their respective types of expenditure, i.e., productive expenditure or consumption expenditure.

At this point, the revenue/expenditure subcomponents are grouped according to the type of revenue they represent, i.e., sales revenue or wages. National income is conceived as representing the addition of all four revenue expenditure/subcomponents, with costs subtracted from the two that are grouped together as business sales revenues.

What we need to do now is simply regroup the revenue expenditure subcomponents according to expenditure type rather than revenue type. Thus we will add that part of business sales revenues constituted by consumption expenditure to that part of wages paid by consumption expenditure. When we do this, we obtain total consumption expenditure, i.e., the “C” in the equation “National Income Equals C + I.”

We must also regroup that part of business sales revenues constituted by productive expenditure with that part of wage payments constituted by productive expenditure. When we do this, we obtain total productive expenditure, which, as I’ve said, has no designation in contemporary economics.

If we now subtract from productive expenditure the same costs that up to now we’ve subtracted from business sales revenues, the result will be net investment, the “I” in the equation “National Income Equals C + I.”

Why Net Investment Equals Productive Expenditure Minus Costs

All that remains to be shown is why productive expenditure minus costs does in fact equal net investment. At a superficial level we already know that it must if we’ve accepted the proposition that national income equals consumption plus net investment in the first place. This is because we began with what was unquestionably national income (the sum of profits plus wages) and have shown that that sum can logically be reformulated exactly as we’ve reformulated it. Thus if it’s true that national income equals consumption plus net investment and also true that it equals consumption plus productive expenditure minus costs, it follows inescapably that productive expenditure minus costs equals net investment.

However, we can do much better than this and show that the very nature of net investment implies that it equals productive expenditure minus costs. All we need do is break down productive expenditure and costs into three exhaustive subcategories respectively. Thus, we will have that part of productive expenditure which is capitalized into plant and equipment accounts, that part of productive expenditure which is capitalized into inventory/work in progress accounts, and finally that part of productive expenditure which is not capitalized but deducted as a cost from sales revenues immediately.

With respect to costs, we will have that part of costs which is depreciation cost, that part of cost, which is cost of goods sold, and that part of costs which represents productive expenditure that is deducted as a cost from sales revenues immediately. Obviously the difference between this third component of cost and the third component of productive expenditure must always be zero, since they are necessarily identical.

At least for some readers, a few words are necessary about the meaning of capitalizing productive expenditures and the relationship of such capitalized expenditures to costs. When productive expenditures are made for plant and equipment, they do not immediately appear as a cost deducted from sales revenue. Instead, they are added into a balance sheet account usually described as “gross plant and equipment,” or something very similar. A $1 million expenditure for new computers, say, is treated as a $1 million addition to this account. The computers may be depreciated over a three year period. In this case, one-third of a million dollars will appear as depreciation cost in the firm’s income statement for each of three years.

As depreciation cost is incurred in the firm’s income statement, the same amount of depreciation is added into another balance sheet account, known as “accumulated depreciation reserve,” or something very similar. Yet a third balance sheet account appears as the result of the subtraction of accumulated depreciation from gross plant. This account is the “net plant and equipment” account.

At the beginning of the first year of the computers’ depreciable life, the value of the net plant account, as far as these computers are concerned, is $1 million, representing $1 million of gross plant minus zero of accumulated depreciation. At the end of the first full year of the computers’ depreciable life, however, the net plant account will be down to $666,6667, owing to the subtraction of $333,333 of accumulated depreciation from the $1 million of gross plant. At the end of the second year, the net plant account will be down to $333,333, owing to the subtraction of twice as much accumulated depreciation from the gross plant account. At the end of the third year of the computers’ depreciable life, the value of the net plant account, as far as these computers are concerned, will be zero, because the accumulated depreciation reserve will then equal the part of the gross plant account that represents the purchase price of the computers.

The essential point here is to recognize that, other things being equal, productive expenditure for plant and equipment represents additions to the net plant accounts of business, while depreciation cost represents subtractions from the net plant accounts of business. To the extent that in the economic system as a whole the totality of such additions exceeds the totality of such subtractions, there is an increase in the aggregate value of net plant and equipment accounts. This increase is net investment in plant and equipment.

Of course, it is possible that in a given year, productive expenditure for plant and equipment might be less than the depreciation cost incurred in that year. In that case, net investment in plant and equipment would be a negative number, just as it is a negative number in the second and third years of our example concerning the purchase of computers.

The case of inventory/work in progress is similar. When expenditures are made on account of inventory, the sums in question are added into yet another balance sheet account, known as “inventory/work in progress” or something similar. Thus, for example, when a furniture retailer purchases furniture from a furniture manufacturer and brings that furniture into his warehouses or showrooms, the purchase price of that furniture is added into the retailer’s inventory account. Only as and when the furniture is sold and leaves the premises of the retailer, does a cost item appear in the retailer’s income statement. It appears as “cost of goods sold,” which is an excellent, literal description of it.

Just as purchases on account of inventory add to the inventory account, so cost of goods sold represents subtractions from the inventory account. A furniture retailer who has purchased, say, 100 sofas at a price $1,000 per sofa adds $100,000 to his inventory account. Each time he sells a sofa, he subtracts $1,000 from his inventory account and deducts that $1,000 as a cost of goods sold in his income statement. (The same principle applies to more complex cases, such as General Motors’ purchases of steel sheet. The purchase price of the steel sheet is added to GM’s inventory/work in progress account and only as the automobiles into which that steel sheet enters are sold, does GM incur cost of goods sold and make an equivalent deduction from its income statement.)

Here the essential point is to recognize that, other things being equal, productive expenditure on account of inventory/work in progress constitutes an addition to the balance sheet account “inventory/work in progress,” while cost of goods sold constitutes a subtraction from that account. To the extent that productive expenditure on account of inventory et al. exceeds cost of goods sold, the value of the inventory account is correspondingly increased and there is thus net investment in inventory (or inventory/work in progress). To the extent that productive expenditure on account of inventory et al. falls short of cost of goods sold, the value of the inventory account is correspondingly reduced and there is thus negative net investment in inventory (or inventory/work in progress).

So, hopefully, it is now clear to every reader why productive expenditure minus costs does in fact equal net investment: net investment in plant and equipment plus net investment in inventory.

Productive Expenditure Exceeds Consumption Expenditure

Productive expenditure, the sum of the expenditures for capital goods and labor by business firms, almost certainly not only exceeds consumption expenditure but does so by a wide margin. The truth of this proposition can be inferred from common knowledge about the size of business profit margins. A profit margin, of course, is the ratio of profit to sales revenues.

In the case of supermarkets, profit margins are often as low as just 2 percent. In instances of highly capital intensive investments, such as electric utilities, they may be as high as 20 percent. We will not go far wrong if we assume that on the average profit margins are 10 percent.

If profit margins are 10 percent of sales, it follows that costs are 90 percent of sales and thus that the productive expenditures that gave rise to these costs are also 90 percent of the sales. If we assume that those productive expenditures on average were divided between capital goods and labor in the ratio of 5 to 4, then for every $1 spent in buying a consumers’ good, there were 50¢ expended in buying the capital goods needed to produce it, and 40¢ expended in paying the wages of the workers needed to produce it.

However, the same story is repeated in the production of the capital goods that sold for 50¢ of productive expenditure. They will have a cost of production of 45¢, broken down into 25¢ of productive expenditure for earlier capital goods and 20¢ of productive expenditure for earlier labor. As we trace the process further and further, we reach a point at which the cumulative expenditure for capital goods itself approaches $1 and the cumulative expenditure for labor approaches 80¢ (i.e., 50¢ + 25¢ + 12.5¢ … = $1, and 40¢ + 20¢ + 10¢ … = 80¢).

These expenditures can be taken as representing not only the productive expenditures of earlier years but also as indicating the productive expenditures of the present year. Some part of today’s productive expenditures is devoted to producing consumers’ goods. Another part is devoted to the production of the capital goods that will produce consumers’ goods at a later date. A third part of today’s productive expenditure is devoted to producing the capital goods that will serve in the production of the capital goods that will serve in the production of consumers’ goods, and so on.

In any event, what we have in the present case is $1.80 of productive expenditure for every $1 of demand for consumers’ goods. And, for the reasons explained, such a relationship must be considered as typifying the economic system in any given year.

Keynesian Macroeconomics Plays with Half a Deck: Inadequacy of GDP

What all of the preceding discussion implies is that Keynesian macroeconomics is literally playing with half a deck. It purports to be a study of the economic system as a whole, yet in ignoring productive expenditure it totally ignores most of the actual spending that takes place in the production of goods and services. It is an economics almost exclusively of consumer spending, not an economics of total spending in the production of goods and services.

An accounting aggregate that would be far more appropriate to a genuine macroeconomics is what I have called gross national revenue (GNR). This is the sum of all business sales revenues plus wage payments. It also equals the sum of the consumption and productive expenditures that actually pay it.

Imagine an equation in which the sales revenues and wage incomes that constitute GNR appear on the left-hand side, while the consumption and productive expenditures that actually pay those sales revenues and wages appear on the right-hand side. If one then subtracts the aggregate of the costs that appear in business income statements from the left-hand side of the equation, sales revenues reduce to profits, and GNR thus reduces to national income. If one subtracts these costs from the right-hand side, productive expenditure reduces to net investment, and consumption expenditure plus productive expenditure reduce to consumption plus net investment.

Now if, instead of subtracting all costs on both sides, one subtracts all costs with the exception of depreciation, GNR reduces to GDP. That is, on the right-hand side, it will reduce to consumption expenditure plus what contemporary economics terms gross investment (a “gross” investment, incidentally, one of whose components is explicitly described as the net change—the net investment—in inventories).

Thus, it turns out that GDP falls far short of a measure of the aggregate expenditure for goods and services. If falls short by an amount equal to the sum of all costs of goods sold in the economic system plus all of the expensed productive expenditures in the economic system. It is these costs which must be added to GDP to bring it up to a measure of the actual aggregate amount of spending for goods and services in the economic system.

Adding cost of goods sold to contemporary economics’ “gross investment” would bring it up to true gross investment: that is, not only gross investment in plant and equipment but also gross investment in inventory as well. Adding expensed productive expenditures to this true gross investment would raise the latter up to productive expenditure.

Saving as the Source of Most Spending

My substitution of a radically new approach to aggregate economic accounting for that of the Keynesian approach, has numerous major implications. One of them pertains to the role of saving in the economic system. In Keynesian economics, saving appears as mere non-spending. This is because essentially the only spending that Keynesian economics recognizes is consumer spending. Thus, if funds are earned and are saved rather than consumed, it appears to Keynesians that they are simply not spent, i.e., are hoarded. It is on this basis that Keynesian economics describes saving as a “leakage.”

Yet the truth is that the only way that funds expended in the purchase of consumers’ goods can ever subsequently show up as productive spending for capital goods and labor is if and to the extent that the business recipients of those funds do not consume them. Only by saving the funds in question can they have them available to make productive expenditures of any kind. Productive expenditure depends on saving.

And because productive expenditure is the main form of spending, most spending in the economic system depends on saving. Even consumption expenditure depends on saving, inasmuch as saving is the basis of the payment of the wages out of which most consumption takes place.

The purchase of expensive consumers’ goods, such as homes, automobiles, major appliances, vacations, indeed, anything whose price exceeds more than a significant fraction of the income earned in one pay period, can be purchased only on a foundation of saving. Virtually no one buys a home out of current income, not even the income of an entire year. Likewise, very few people can buy a new automobile out of a year’s income, let alone out of the proceeds of just one pay check. And the same is true of many other goods. Saving is essential to the purchase of all such goods—if not the saving of the purchaser himself, then the saving of those from whom the purchaser borrows.

Implications for the “Economic Stimulus Package”

The dependence of productive expenditure on saving in turn has major implications for the so-called economic-stimulus package that has just been enacted. So too does the understanding we have developed of net investment and the role of cost of goods sold in connection both with net investment and with profits.

The supporters of the stimulus package assume that all that is necessary to increase the demand for goods and services all up and down the line, that is, at all stages of production from retailing to wholesaling, through manufacturing, to mining and agriculture, is to increase the demand for consumers’ goods—essentially by printing money and giving it to various consumers to spend. Yet if all that happened were that people spent the new and additional money in purchasing consumers’ goods, there would not be any additional demand for capital goods and labor whatever based on that new and additional money.

To demonstrate this, imagine that, precisely in accordance with the wishes of the supporters of the stimulus package, some consumer somewhere receives a thousand-dollar tax refund that is financed by the government’s creation of new and additional money. He cashes his refund check and proceeds to a nearby large shopping mall, where he buys $1,000 worth of furniture, say.

The owner of the furniture store happens to be on the premises, and, like a model Keynesian consumer, with a “marginal propensity to consume of 2/3,” he proceeds to withdraw $666.67 from his till and walks down the hall to a nearby men’s clothing store, where he spends that amount for new clothes.

The owner of the clothing store also happens to be on the premises, and he too, like another perfect Keynesian consumer with a marginal propensity to consume of 2/3, takes $444.44 out of his till and walks to a third store in the mall, where he spends that sum in buying a new television set. The owner of this store, in turn, removes two-thirds of his additional receipts and telephones his wife and in-laws to come and have dinner at a restaurant in the mall.

If this process kept on going, over and over again, there would ultimately be $3,000 of additional consumer spending. The Keynesians believe that this $3,000 would constitute new and additional net income and would increase the demand for labor and employment to that extent back through all of the stages of production leading up to the presence of consumers goods on the shelves of retailers

The spending multiplier and the alleged benefits to the demand for labor and thus employment would be even greater, according to the Keynesians, if the marginal propensity to consume were three-fourths instead of two-thirds, and greater still if it were nine-tenths instead of three-fourths. The multiplier and its benefits are allegedly restrained only by the disappearance of funds into the “leakage” constituted by saving.

Now the truth is that in order for additional consumer spending to constitute equivalent additional income, as the Keynesians believe, the only type of additional income that it could possibly constitute would be business profits, specifically the profits of the sellers of the various consumers’ goods. It would not constitute any additional wage income or the employment of any additional workers. This is because all that is present is additional business sales revenues. The income earned on sales revenues is profit, and if the additional income is to equal the additional sales revenues, it means that there will be additional profits equal to the additional sales revenues.

A further implication is that the prices of the consumers’ goods must rise, thereby depriving other buyers of consumers’ goods of the ability to buy them. This follows from the fact of more money being spent to buy the same quantity of goods.

Of course, the Keynesians will be quick to object that more goods will be sold, not the same quantity. Sellers will reduce their inventories to meet the additional demand. To the extent that this happens, prices need not immediately rise. But the reduction in inventories implies an increase in cost of goods sold and thus profit income rising at each point of additional consumer spending by equivalently less than the increase in such spending.

Thus, for example, if the seller of the furniture incurs $500 of additional cost of goods sold when a purchaser spends $1,000 in his store, his additional profit income will be only $500, not $1,000. His consumption, as a model Keynesian consumer, will therefore be only two-thirds of that amount. And similarly for all other sellers in the chain of spending and respending. The alleged “stimulus” will be radically less than the Keynesians expect and desire, e.g., not only $333.33 instead of $666.67 but also $111.11 instead of $444.44, and so on, with each subsequent round of spending reflecting not only the alleged “leakage’ of funds into saving but the effects on profit income of having to subtract cost of goods sold.

If the sellers practiced Keynesianism to the hilt, they would ignore the little matter of additional cost of goods sold and accompanying inventory depletion and simply consume in proportion to their additional sales proceeds, as though it were additional income, as Keynesianism assumes and teaches. In that case there would be $3,000 of consumption, and $1,500 of inventory decumulation.

Such behavior would set the stage not only for there being no additional demand for capital goods and labor but for there being less such demand than there was before, with the result of an actual increase in unemployment.

This is because if at some point the sellers, wanted to replace the goods they had sold, they would find that their ability to do so would be diminished, because they had consumed part of their capital. To replace that capital they would need either to raise additional capital from outside or to withdraw capital that they themselves had been advancing to others. Either way less capital would be available somewhere in the economic system and where less capital is available, business activity must shrink. The consequence is more unemployment not less.

In order for the new and additional money injected into the economic system through additional consumption expenditure to find its way back to earlier stages of production, the sellers must not consume their additional sales proceeds to any great extent. To the contrary, they need to save them to the greatest extent possible. If the furniture store owner saves and productively spends his $1,000 of additional sales revenues, he will be able give some “stimulus” to his suppliers. If they in turn save and productively expend the great bulk of their additional sales revenues, they will be able to give some stimulus to their suppliers, and so on back. Along the way, the demand for labor and employment may increase. But any such result will depend on additional saving and productive expenditure, not consumption expenditure.

The fact that if accompanied at all stages of production by heavy saving out of sales revenues, an increase in consumer spending financed by inflation can serve to increase the demand for capital goods and labor at all the stages is not a sufficient basis for recommending such a policy. In fact, what it represents is an effort to reestablish the same kind of misdirected, wasteful production that leads to a recession or depression in the first place and which then creates the appearance of a need for stimulus.

It should never be forgotten that our present problems originated in an arrangement whereby a very large amount of production, i.e., the construction of hundreds of thousands of new houses, was taking place for the benefit of people whose own production was grossly insufficient ever to allow them to pay for those houses. It is a positive good thing that that wasteful, inherently loss-making production has now ceased.

The solution is not to now attempt to create another such loss-making arrangement to take its place. Another arrangement under which producers will produce goods for the benefit of people whose own production is insufficient to enable them to afford the goods in question—people who will buy the producers’ output only with “refunds” of taxes they never even paid. The problems created by building houses for “sub-prime” borrowers cannot be corrected by now producing goods of all descriptions for “sub-prime” consumers in general.

A real solution requires making it possible for production to be directed to the needs and wants of those whose own production is sufficient to enable them to pay for the production of others.

Summary and Conclusions

I’ve shown that contrary to superficial appearance, in the most literal sense of the word “superficial,” consumption expenditure is not the main form of spending in the economic system and does not pay the national income or gross domestic product. I’ve shown that most spending in the economic system is in fact concealed under the head of net investment. However modest in size, including possibly being actually negative, net investment represents the true source of most revenue and income. That source is productive expenditure, which, I showed, is expenditure for the purpose of making subsequent sales and is represented by the spending of business firms for capital goods of all descriptions and for labor. (Consumption expenditure, in contrast, I showed is expenditure not for the purpose of making subsequent sales.)

The role of productive expenditure is concealed because net investment is the difference between it and business costs, the same costs that appear in business income statements in calculating business profits, and which do not differ very greatly from productive expenditure in size. Thus only a very small portion of the actual magnitude and importance of productive expenditure is ever revealed in conventional, Keynesian national income accounting.

I demonstrated the presence of productive expenditure behind net investment by means of a step-by-step logical demonstration of the equality between profits plus wages on the one side, and consumption plus net investment on the other. The crux of the demonstration was the restatement of profits as sales revenue minus costs, and then the breakdown both of sales revenues and wage incomes into productive expenditure and consumption expenditure. I called the resultants of the breakdown “revenue/expenditure subcomponents” and showed how the equality of profits plus wages and consumption plus net investment resulted simply from changing the order of addition of those subcomponents, from one based on revenue and income type to one based on expenditure type.

I showed on the basis of elementary business accounting principles why productive expenditure minus costs is the sum of net investment in plant and equipment and net investment in inventory. I then demonstrated why and how productive expenditure exceeds consumption expenditure and does so by a wide margin.

I presented gross national revenue (GNR) as the appropriate measure of total spending that constitutes revenue or income payments in the economic system. I showed GNR as equal to sales revenues plus wages on the left and consumption expenditure plus productive expenditure on the right. I showed how by means of the subtraction of business costs from sales revenues on the left and productive expenditure on the right, GNR reduces to national income on the left and consumption plus net investment on right. I showed the deficiencies of GDP as a measure of total spending in comparison to GNR.

And finally, I’ve shown the radical difference between my analysis and the conventional, Keynesian analysis for understanding the role of saving as a source of spending in the economic system, and have shown its relevance to the so-called economic stimulus package that has just been enacted.

Copyright © 2008, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is www.capitalism.net.