Pure Surplus Income’s Norms in the Pure Cycle; Aberrations Called Booms and Slumps

In particular, we are concerned with the correlation between variations in surplus income and variations in the basic price spread.  As we hope to show, a surplus expansion gives rise to an increasing basic price spread, while a surplus contraction leads to a contracting basic price spread. The former encourages tendencies towards a boom; the latter involves a recession that can turn into a depression. [CWL 15, 72]

In a “proportionate phase”, a “surplus phase”, and in most of the “basic phase” of the long-term expansion of the economy, pure surplus income is a significant explanatory functional quantity. It is an element in the immanent intelligibility of the creative destructive process. Its existence is identifiable, systematically normal, and morally proper.

Assuming stable pricing in a closed economy without a government surplus or deficit, since pure surplus income is the monetary correlate of expansionary investment, its curve would bear similarity to the curve of the expansion of the stock of capital. It would accelerate, decelerate, and tail off.

Lonergan has constructed an ideal model based on the dynamic structure and the inner logic of production and payments in the dynamic macroeconomic process. He has posited a theoretical pure cycle – or a pure theory of successional phases in which investment in the accumulation of capital follows closely, though not perfectly, a logistic growth pattern or “S-curve.”[1] A logistic growth equation is a first-order differential equation with a growth component and a braking component, with the latter representing phenomena such as mounting internal competition or maximum sustainability, or the demand of mounting maintenance and repair requirements.

In Burley, the limiting factor is a maximum determined by full employment and the technical coefficients of productivity. Lonergan expresses this as a limiting of marginal efficiency by a combination of exhaustion of opportunities for expansion and internal competition from the demands for repair and maintenance funds.

Lonergan posits an initial exponential, concave-upward, new-capital curve, followed by an algebraic upward trendline, and a final abrupt leveling off as saturation is reached. The basic fundamental principle is that, to depart from a fully-realized static phase into a new long-term cycle, the surplus sector must first increase itself so that it can subsequently use its own increased capital to produce more capital for the basic sector; then the increase in expansionary capital gets limited by the mounting requirement for repair and maintenance and by the optimal combination of available point-to-point and point-to-series factors, given their technical coefficients.

Note in the next excerpt that Lonergan calls his theoretical pure cycle a framework. It is a pure or ideal theoretical form against which we may compare an actual cycle. This actual cycle possesses indeterminacy; ceteris paribus is not always the case, plus human agents may misunderstand or violate the norms of adaptation such that the process can deviate from the normative ideal. By its distinctions and correlations this pure cycle articulates both the formal norms of orderly expansion as well as the causes of disorders such as excessive booms and subsequent, systematically necessary, corrective slumps.

The ideal pure cycle stands to everyday sentient and perspectival experience of good times and bad times as the ideal d2x/dt2 stands to the sentient and perspectival experience of going faster. The pure cycle’s differential equations of product flow and money flow constitute the governing general forms of velocity, acceleration, and accumulations of the economy. The pure cycle’s mathematical forms possess the scientific significance of explanation whereas the mere experience – without understanding – of good times and bad times are in and of themselves of zero explanatory or scientific significance. Thus the pure cycle is an analytical framework, not like a blueprint for a steel arch bridge, but rather as a general pattern universally applicable to and explanatory of particular velocities and accelerations in a system of dynamic interdependencies.

A systematic explanation, then, requires a normative theoretical framework. The basic terms and relations of such a framework would specify the distinctions and correlations that articulate the causes, which are not necessarily visible, of events that are apparent to all. The framework would thus stand to the ordinary apprehension of the booms and slumps of the trade cycle in much the same way that the explanatory grasp of acceleration as the second derivative of a continuous function of distance and time stands to the ordinary, commonsense grasp of what it is to be going faster. [CWL 15, Editors’ Introduction, lv]

This pure cycle stands to our ordinary apprehension of economic booms and slumps as the explanatory conception of acceleration stands to our ordinary apprehension of going faster and slower. It sheds the ‘new light on equilibrium’ that Schumpeter was seeking. [CWL 15, Editors’ Introduction, lxiii ]

Recall the subtitle of CWL 15, An Essay in Circulation Analysis. Among other purposes, Lonergan is attempting to demonstrate how money should circulate, i.e. how it should be transferred within and between the basic and surplus circuits for dynamic equilibrium and for the realization of the full potential of the creative-destructive, threefold economic process.

In the systematics of the pure cycle, expansionary investment initially grows geometrically, then algebraically, then it levels off.[2] The associated pure surplus income accelerates, reaches a peak, decelerates, and eventually reverts to zero as the new economy has realized its full potential and all surplus activity is devoted to the repair and maintenance of existing capital.[3] In this last phase there is ordinary surplus income for repair and maintenance of the accumulated installations but zero pure surplus income associated with capital expansion. There is no longer innovation or expansion and the economy is merely reproducing itself. It is replacing its wear and tear through maintenance and repair of existing capital, but it is not installing more new capital.

It is regrettable, sometimes disastrous, that economists, financial analysts, corporate CEO and CFOs, and politicians do not understand the logistic rhythmicality of the requirement for savings for investment.

The contrast regarding expectations between Lonergan’s expectations and the present tradition is neatly brought out by a comment )by Lonergan) on Robert Gordon’s text on Macroeconomics: “I now know how my analysis differs from Gordon’s and presumably others. He gives as the empirically determined propensity to consume 75% and to save as 25%. For me these are variables with saving increasing in the surplus expansion and consumption increasing in the basic.” [CWL 21, xxvi, footnote 14, Letter of Lonergan to Philip McShane, 10 January 1979 …]

The example of the long pure cycle specifies phases based on comparison of dQ”/Q” vs. dQ’/Q’[4]: the long pure cycle emerges from a static phase (dQ”/Q” = dQ’/Q’ = 0) and then proceeds through a proportionate-expansion phase(dQ”/Q” = dQ’/Q’ > 0), a surplus-expansion phase(dQ”/Q” > dQ’/Q’), a basic-expansion phase(dQ”/Q” < dQ’/Q’), and settles back into a higher static phase(dQ”/Q” = dQ’/Q’ = 0).

dQ”, dQ’
       I. Unspecified Surplus Advantage Proportionate Phase Basic Advantage
II. Neither negative Surplus Expansion Proportionate Expansion Basic Expansion
III. Neither positive Surplus Contraction Proportionate Contraction Basic Contraction
       IV. Both zero Mixed Phase
       V. One positive,

one negative

Mixed Phase Mixed Phase

In both the basic expansionary phase and the static phase, efforts to satisfy the conventional wisdom’s performance criterion of an ever increasing accounting profit (which covers interest, rents, royalties, and feeds the increasing dividends and retained earnings for further investment) inspires counterproductive activities. The normative, systematic requirements for a.) declining pure surplus income for owners, alongside b.) increasing incomes to employees to purchase the fruits of the capital expansion militate against the conventional wisdom’s criterion of ever-increasing accounting profit. This increase of accounting profit – which increase would be underpinned by subsurface increasing pure surplus income – is simply not being produced by the system. It is not there! Layoffs and wage freezes designed to squeeze out more accounting profit and assist the survival of the firm serve only to reduce demand for the fruits of the expansion and to cause much usable capital in the system to sit idle and useless.

The criticality of an understanding of the natural path of pure surplus income and the acceptance of pure surplus income’s inevitable decline are critical to managing a unit of enterprise or an economy. Recall McShane’s insistence on functional analysis, especially in the light of so many politicians claiming to be Keynesians, yet having no idea of what Keynes said or meant, much less of where his thinking went wrong.

The flow of income in a functional analysis requires somewhat more attention: it is the corner of the analysis which holds the key to the sublation both of Keynes’ problems of consumption, savings and investments, and of Kalecki’s dictum that the workers spend what they get and the capitalists get what they spend. [McShane 1980, 120]

Pure surplus income, whether so called or called by any of its equivalent designations, is not understood. It is not grasped within the systematics of the objective economic process. In the semantics and babel of everyday discussion, pure surplus income is not even mentioned.

Recall the following sentences in the path to grasping the concept of pure surplus income:

“The flow of income in a functional analysis requires somewhat more attention: it is the corner of the analysis which “holds the key to the sublation … of Keynes’ problems of consumption, savings and investments.” [McShane 1980, 120-121]

“The concomitance of outlay and expenditure follows from the interaction of supply and demand. The concomitance of income with outlay and expenditure is identical with the adjustment of the rate of saving to the requirements of the productive process.” [CWL 15, 144]

‘A condition of circuit acceleration was seen … to include the keeping in step of basic outlay, basic income, and basic expenditure, and on the other hand, the keeping in step of surplus outlay, surplus income, and surplus expenditure. It follows that one may legitimately project a division of expenditure into the division of income, and it is in this manner that we arrive at the concept of pure surplus income.’ [CWL 15 144]

Now it is true that our culture cannot be accused of mistaken ideas on pure surplus income as it has been defined in this essay; for on that precise topic it has no ideas whatever. [CWL 15:153]

Pure surplus income is at the nerve center of free economies. CWL 15:147

Proper management of the economy is conditioned by proper understanding of how the system of interrelated and interdependent, productive and monetary functionings actually works, and among other particulars, by proper understanding of the natural genesis and career of pure surplus income. But such understanding does not exist. Misinterpretation of increasing accounting profits coincident with increasing pure surplus income a.) by entrepreneurs as a signal to expand beyond bounds or b.) by unions and fee-collecting individuals as a signal to demand higher wages is the root cause of booms and slumps.

At the root of the depression[5] lies a misinterpretation of the significance of pure surplus income. In fact it is the monetary equivalent of the new fixed investment of an expansion…..our culture can not be accused of mistaken ideas on pure surplus income as it has been defined…; for on that precise topic it has no ideas whatever………However the phenomena referred to by …”pure surplus income” are well known. Entrepreneurs are quite aware that there are times of prosperity in which even a fool can make a profit and other mysterious times in which the brilliant and the prudent may be driven to the wall……….Thus pure surplus income may be identified best by calling it net aggregate savings and viewing them as functionally related to the rate of new fixed investment [CWL 15, 152-53]

The (basic) price spread is the excess of basic receipts over basic costs. In microeconomics it is interpreted as profit, and so trade-union leaders argue that commercial and industrial profits justify a rise in wages. But in macroeconomics, which is aware of the need of a crossover balance for equilibrium, the basic price spread is to a greater or less extent a part of the social dividend (rate of saving) in an expanding economy. It is only in the static economy that it justifies a rise in wages. [CWL 15, 145]

Cooperation by enlightened free people does not occur.

Now the general theorem of continuity is that this (organic whole) has a nature that must be respected. … to violate this organic interconnection is simply to smash the organism, to create the paradoxical situation of starvation in the midst of plenty, of workers eager for work and capable of finding none, of investors looking for opportunities to invest and being given no outlet, and of everyone’s inability to do what he wishes to do being the cause of everyone’s inability to remedy the situation. Such is disorganization. Continuity, on the other hand, is the maintenance of organization, the stability of the sets and patterns of dynamic relationships that constitute economic well-being in a society. [CWL 21, 74]

Investment of pure surplus income confers ownership and control upon the organizers, doers, risk-takers, creative personalities, and visionaries who are so vital to a creative-destructive economy. The valuation of entrepreneurs’ holdings in and of itself does not constitute a single dollar of income;[6] however, as owners of bonds and stocks they can vote to themselves interest and dividends, which are income. In addition, owner-visionaries decide how much money to set aside for retained earnings and appropriate investments. Many entrepreneurs know their business well from having worked in the trenches rather than in a remote, central bureaucracy where ignorance and incompetence are directly proportional to the distance from the trenches, and where the bureaucrat’s vague but nagging sense of his ignorance and incompetence leads to defensiveness and resentment and to adversarial rather than cooperative behavior.

The flowing of pure surplus income to enlightened and savvy investors in the form of interest and dividends, or under any other rubric, for another round of responsible investment is a natural and good occurrence. Better that it be reinvested in fruitful capital by entrepreneurs than confiscated and wasted by bureaucrats.

However, despite their operational expertise, entrepreneurs themselves are not as yet enlightened regarding the systematically cyclical nature of pure surplus income and the nonincome nature of static wealth; nor are their employees; nor are unions. The failure to understand pure surplus income’s “lawful” cycle of ascent and descent can be disastrous; four bad things may happen:[7]

  1. The increasing pure surplus income of the surplus expansion magnifies GAAP “profit” making shareholders giddy and investors more sanguine than they should be. They imagine a permanently ascending trendline rather than an S-curve approaching its maximum. They invest to excess. (Go back to source and add to the following excerpt.)

Now in any expansion it is inevitable that quantities under production run ahead of quantities sold. Current production is with reference to future sales, and if there is an expansion, then future sales are going to be greater than current sales. But in the free economies the acceleration factors are not held down to the minimum that results from this consideration. During the surplus expansion the basic price-spread ratio J will increase from an increase of R, of a”, and also of a’. The advance of the price-spread ratio will work out through a rise of the basic price level, and selling prices generally will mount. Now, when prices are rising and due to rise further, the thing to be done is to buy now when prices are low and sell later when they are high. There results a large amount of liquid investment. Each producer orders more materials, more semifinished goods, more finished goods, tan he would otherwise. Moreover, he makes this speculative addition to a future demand estimated upon current orders received, so that the further back in the production series any producer is, the greater [will be] the speculative element contained in the objective evidence of current orders received, the more rosy the estimate of future demand, and the greater the speculative element he adds to this estimate when he places orders with a producer still further back in the series. Thus an initial rise in prices sets going a speculative expansion that makes the acceleration factors quite notable, expands the price spread still more, and stimulates a pace of further acceleration that it will be quite impossible to maintain. Etc. [CWL 15, 160]

  1. Increasing GAAP profits and higher prices of the surplus expansion (dQ”/Q”>dQ’/Q’) incite wage-earners to demand a greater share of the so-called “profits,” which further inflates the prices of basic goods to initiate an inflationary spiral.

Something like the same mistaken reasoning based on profit as a criterion and not only a motive underpins the reaction of labor unions to the tremendous increases in profits and income in the earlier phases of the surplus expansion (MD:ECA 138) [CWL15, Editors’Introduction, lxvi]

Insofar as their demands for higher wages are out of season, they represent one group’s misguided attempt to claim for itself what is actually the social dividend of a society-wide aggregate. This would be another way of misreading the demands of the pure cycle (CWL 15, 128-129) [CWL15, Editors’Introduction, lxvi]

  1. Pure surplus income may be channeled out of the real economy of production and exchange and into the casinolike trading of second-hand assets, such as previously-issued stocks and bonds, older works of art and ingenuity, and existing real estate, thus draining the real economy of circulating money while inflating the secondary market of products of past production. Pricing in the circuits and pricing in the secondary markets are bifurcated

Thus pure surplus income may be identified best of all by calling it net aggregate savings and viewing them as functionally related to the rate of new fixed investment’ (CWL 15, 153)

(Pure Surplus Income) is money to be invested either directly or, through the redistributional area, indirectly. For it is the equivalent of the money that, if not invested, contracts surplus production, [and] that, if invested, keeps surplus production at its attained volume; [moreover,] if a further appropriate sum is added interval by interval, surplus production will not merely level off but keep accelerating (CWL 15, 81-82)

  1. In the later phases of the long cycle, decreasing pure surplus income is misinterpreted by entrepreneurs: the instinct for self-preservation takes over and leads to panic and macroeconomically counterproductive measures. Entrepreneurs drain the basic circuit by layoffs which only reduces demand and makes things worse.

when profit shifts from being a motive to being a criterion, however, then the inevitable and reasonable tapering off to zero of profits as pure surplus income goes against mistaken expectations. This may induce measures akin to panic on the part of capitalists, who drain the basic circuit in order to keep surplus profits and incomes accelerating – which is one of the ways the pure cycle is transformed into the booms and slumps that economies usually experience. [CWL 15, 128-29]

We repeat what we said early in this section: To understand a.) the correspondence of pure surplus productive activities to basic productive activities, b.) pure surplus income’s correlation with pure surplus productive activities, c.) pure surplus income’s relations to the flows of ordinary surplus income and pure basic income, and d.) pure surplus income’s genesis and normative career within a long cycle from zero to a maximum and back to zero, is to understand how the economy works. It is to see all the interrelated workings of the current dynamic process in a single view, or to understand all macroeconomic dynamics in a single comprehensive act of understanding. On the other hand, to fail to understand the genesis and career of pure surplus income implies and involves ignorance of how the key interdependent functionings of the economic process actually mesh and to be at sea in attempting to run a business or manage the economy, and to be incented to make counterproductive adjustments.

 

 

 

[1] the 3 forms of logistic growth

[2] See CWL 15, 148-152

[3] See Chapter x of CWL 15, titled The Cycle of Pure Surplus Income.

[4] CWL 15, 114 See the table exploring the possibility of different types of phases.

[5] Lonergan is not referring specifically to The Great Depression of the 1930’s but rather to the phenomenon of depression in general as a systematically necessary correction to previous excesses.

[6] unless he exchanges cash for title in the secondary market, in which case the net aggregate affect on aggregate incomes is zero, because plant and machinery are in fact only “static wealth,”

[7] See the sections: Misadventures, The Cycle of the Productive Process, The Cycle of Pure Surplus Income, and the Cycle of Aggregate Price Spread.