Economic Myths #4 – Profits are Evil!

[First published on Free Life]

One of the elements of a capitalist system that induces purple-faced rage amongst statists and progressives is the existence of profit. This residual – the amount left over once an entity has deducted its costs from its revenue – is said to line the pockets of greedy shareholders while exploiting labourers and consumers.

First, it is important to understand what we mean and what we do not mean by “profit”. Here we will be discussing only profits that an entity may earn purely as a result of voluntary trade and free exchange; we do not mean those “accounting” profits that companies may rake in as a result of favourable state regulations, direct subsidy from the state, or any other kind of residual of a trade relationship based upon force. These profits – including bank bailouts and stimulus funding – are rightly to be condemned as unjust and immoral, sustaining the power base of the incompetent, wealthy elite at the expense of everyone else. But such a condemnation must not be allowed to throw out a very precious baby with repulsively filthy bathwater – for profit is one of the most vital elements that gives life to an economic system that relies upon the division of labour.

For the praxeologist profit is, of course, endemic in any human action and not just those based upon monetary calculation. All actions seek to produce better circumstances than those that would prevail if the action had not occurred. For instance, I “profit” from making a ham sandwich for lunch and satisfying my hunger instead of languishing with an empty stomach. All humans in everything they do seek this kind of psychic profit – making more money than before is only one possible form that profit takes, rather than its definition.

Strictly speaking, therefore, any condemnation of profit would be a performative contradiction as, in the mind of the critic, the satisfaction of disseminating a condemnation of profit would be a better circumstance than not having done so. Although such a technical, theoretical argument is unlikely to appeal to the mass of lay persons who view profits as evil and unjust, it is important to understand these roots of the concept for here we can see the importance of the profit motive – the stimulus for engaging in enterprise in the first place. Without the possibility of earning profit – i.e. a better circumstance than that which prevailed before – no entrepreneur or inventor would ever bother developing and bringing to market all of the wonderful products that make our standard of living so high.

Abandoning for a moment our commitment to wertfrei economics and embracing the belief that anything that benefits the consumer or labourer is “good” while anything that harms him is “bad”, let us examine two or three specific, recurring myths concerning the concept of profit.

First, let us deal with the allegation that businesses are “fleecing” consumers and workers by overcharging for their products and underpaying wages in order to line the pockets of the fat cats. Profits are not, in fact, achieved by “fleecing” anybody. The amount of profit is only ever determinable in retrospect after all of the consumers have purchased their wares and all of the workers have been paid their wages. At the time that the consumers bought the products and the workers negotiated their terms of employment nobody knew what the profit was going to be. Indeed, nobody knew whether there would be any profit at all and whether the business was heading for a loss. Employers do, of course, have an aim for profitability and their initial calculations may form the motivation to engage in a particular enterprise as well as determining the boundaries of their productive action. However, what they cannot do is to force the outcome to agree to their projections. Rather, they must be prepared to be the highest bidder for inputs and the lowest seller for outputs in order to ensure that they can purchase resources on the one hand and then sell the resulting products on the other. This process is fraught with uncertainty, and a certain line of production which may, hitherto, have been profitable may find itself in a sudden state of generating losses. All it may take for this to occur is a marginal increase in costs as a result of competing entrepreneurs bidding away resources to other uses, coupled with no corresponding increase in sales; or, consumer tastes may change and competing products and services become more attractive options.

Therefore, it is difficult to understand how someone feels “fleeced” at the time they purchased a product or took on a job when no one, at that time, has any idea whether the prices and wages paid were contributing to either a profit or a loss. Indeed, if a firm is cheating and stealing from consumers and workers when it ends up with a profit then isn’t it also the case that, if the firm ends up with a loss, the consumers and workers have fleeced the firm? Have they not “underpaid” for its products? Should the firm be able to go back to a customer who may have purchased an item, say, six months ago and take more from him to wipe out the deficit? And let us not forget that we aren’t just talking about big, multinational corporations – it could be the dishevelled, middle aged man struggling to make ends meet through his little corner shop. Aren’t the greedy, heartless consumers exploiting this poor fellow by demanding the lowest possible price for what they want and leaving him with nothing?

Instead of this all of this claptrap, the truth is that profits benefit the worker because they a) provide a fund that permits the worker to be paid before the product is sold so he does not have to wait for his money; and b) consequently serve to insulate him from the risk of loss as he can keep his previously paid wage regardless of the ultimate success of the firm. Profits benefit the consumer by ensuring that scarce productive resources are devoted to their most highly valued ends – industries and production lines where profits are abnormally low will have resources reduced and redirected to areas where they are abnormally high, thus decreasing supply in the former and increasing it in the latter. Ironically, the combined action of entrepreneurs has the ultimate effect of eliminating all profit by balancing resources throughout the economy. It is only because consumers’ tastes and preferences are constantly changing that profit opportunities continue to exist and the deployment of resources must be assessed repetitively and altered accordingly. Ultimately, therefore, it is the consumer who is responsible for the existence of profit, not the capitalist-entrepreneur.

Second, even if one accepts the necessity of profit for ensuring the correct deployment of resources, what of the allegation that profits are used to “extract” money from the industry to pay shareholders – money that would otherwise be invested back in the business? In other words, that profits line the pockets of the capitalists at the expense of workers and consumers.

This is, of course, complete nonsense. In the first place, profits are the source of funds that enable capitalist-entrepreneurs to invest in further capital equipment, job creation and expand the business, thus increasing supply and lowering prices. To the extent that it is worthwhile to do so then profits will be invested back into the business that generated them. If, on the other hand, a distribution is made to owners or shareholders in the form of dividends or share buybacks it is because the entity has already invested in the business to the extent that is economically viable and any further expansion would, in fact, be wasteful. While the firm may retain some additional earnings as a buffer in anticipation of a poor performing year or for some other kind of insurance, masses of retained earnings are otherwise wasted by lying around in corporate bank accounts. It is better to distribute those funds to the shareholders so that they can be reinvested in other productive enterprises that are still in need of investment. Thus the consumer is benefited by this fresh investment in other products and services that ensures that the supply of these can also be increased and their prices lowered.

This leads us onto our final myth which is that profits exist only in a capitalist system and would otherwise be wiped out if we adopted some kind of socialisation or nationalisation of industry. Profits would not, in fact, disappear in the latter types of economic management. Regardless of the specific economic system adopted, if there is to be any economic progress whatsoever then there must be a surplus of production over consumption. There has to be an excess of funds which can be invested in creating more capital goods that expand production – there is simply no other way. In a socialised economy this surplus must come either from an excess of business revenue over business costs (as in a capitalist economy) or it must come from general taxation (either directly or from borrowing/printing money). If it comes from the former then consumers would still be paying more than costs for the product and workers would still be paid less than revenue for their labour. If the surplus comes from taxation then, obviously, everyone is fleeced in order to prop up inefficient and failing industries. Moreover, as we mentioned earlier, this surplus from a prior round of production must still exist if the workers want to be paid in advance of the products produced today being sold. It is precisely because labourers desire this speedy payment and to be insulated from the risks of business failure that the wage system flourished. All in all, socialisation or any kind of other state control over industry does not eliminate profit – it simply changes the people who have it. Ironically, it is actually a capitalist system that gives ordinary workers and consumers the opportunity to partake in the profit making process by doing something as simple as depositing some money in a savings account which will earn interest by being lent out to productive enterprises. In a socialist system, however, which is devoid of capital markets and all proceeds of production are claimed by the state this opportunity would not exist.

Far from being the embodiment of all evil and exploitation, therefore, profit is, in fact, the very life blood of the economy – lifeblood that is required in any economic system if it is to invest more capital goods, create more jobs and, ultimately, more wealth that enables more products to be produced at lower and lower prices that we can all afford.