[First published on Free Life]

The myth that capitalism is exploitative – or rather, that capitalists and entrepreneurs are responsible for the exploitation of both workers and consumers – is almost as old as the history of this political-economic system itself, having been a primary driving force behind the growth of the state and, indeed, of outright socialist and communist revolution. Although much watered down from those early days, the idea that there is some kind of antagonism between the capitalist “class” and the rest of us seems to persist.

As “Austrian” economists we know, of course, that it is absolutely and undeniably true that any free and voluntary exchange, upon which capitalism and private property must rely, only takes place because each party expects to benefit from the transaction. This alone is sufficient scientific proof to dismiss any idea that capitalism exploits one party for the benefit of another. Nevertheless we should, of course, tackle directly the specific incarnations of this myth as they appear today.

The myth has its roots in the Marxian confusion of political castes with economic classes – the idea that the relationship between capitalists and workers, which is free and voluntary, was akin to that of king and subject, or lord and serf, relationships that were involuntary and subjected the masses to servitude. Caste systems were static and designed to keep people in their place; under conditions of free exchange, however, economic classes have a continually changing membership based upon one’s ability to serve consumers.

This ability varies from person to person, of course, but the critical point is that nobody is legally prevented from becoming an entrepreneur and nobody, once they are a successful entrepreneur, has either their wealth or status legally protected. A wealthy capitalist might find his fortune decimated when he loses this crucial ability to serve consumers as the latter turn to other suppliers for their wares; he may have to re-join the ranks of salaried employees if he is to make ends meet. On the other hand, an ordinary worker may see a gap in the market that has been unnoticed by the current entrepreneurs of the day and he may set up a successful business accordingly.

This does not mean say, of course, that political castes do not exist today. We can see quite clearly from bank bailouts and the like that there is a distinct upper caste that is protected from its mistakes and is able to retain its wealth and status at the expense of the rest of us. Indeed all the similar injustices that did occur during the early history of capitalism were not owing to the capitalists’ reliance upon genuine private property and free exchange – rather, they used the power of the state to enforce their illegitimate property interests. The mercantilist Corn Laws, for instance, which artificially propped up the price of corn for the benefit of domestic cereal producers are a good example from the early nineteenth century. Capitalism itself, however, does not produce these injustices.

Moving on to some more contemporary arguments, do businesses exploit the “needs” of consumers for whatever it is that the latter want? Do they withhold “vital” and “necessary” wares releasing them only at extortionate prices thinking only of their selfish greed for profits?

This argument is ridiculous because all trade and exchange relies upon the desires of the trading parties – whether it is for food, housing, cars, computers, or trips to the cinema. The entrepreneurs in business exist to fulfil and satisfy, not exploit these needs. If they are able to charge high prices it is only because the supply, relative to demand, is low and has to be rationed to those who value the goods the most.

This argument regarding exploitation usually surfaces today in one of two situations. The first is during sudden supply shocks or demand spikes that send prices soaring and allows suppliers to book large profits as they obviously paid for the inputs at earlier wholesale prices which were much lower. As these usually occur during times of emergency or crisis, aren’t the businesses exploiting the dire need of the consumers for such staples as water, canned food and fuel?

Such an argument ignores the fact that it is not the businesses driving the demand – it is other people who are willing to pay more to get their hands on the suddenly scarce items. The only options are to a) allow other entrants to be attracted into the marketplace by the higher prices, bringing with them more resources into the production of the scarce goods and thus lower their prices with an increased supply (thus solving the problem); or, b), to fix the prices of the wares below their market clearing level which would lead to guaranteed shortages as the existing supply is simply exhausted. Needless to say, government always opts for the latter.

The second situation that attracts criticism is when the entrepreneur is in the business of providing something “essential” such as energy or healthcare. Yet these businesses are almost always so cripplingly regulated and interfered with by the state that it is impossible to define them as anything approaching free markets.

Britain’s energy market is a case in point. Apart from the vast state bureaucracy that oversees the industry, idiosyncratic interferences such as threats by the government to either freeze or cap energy prices also take their toll upon consumers. One of the criticisms advanced is that firms fail to “pass on” any reduction of wholesale energy prices to consumers in the form of lower retail prices. But apart from the fact that the wholesale cost is not the only factor that suppliers have to consider when setting prices for their consumers, what are the chances of them offering lower retail prices now if they fear that the government will one day lock them into furnishing energy at these low tariffs in a future period when wholesale prices might be rising?

In contrast if you look to any industry that the state tends to leave alone you do not find the same vitriol hurled at the dominant suppliers. Up until now we have seen that supermarkets, although subjected to food standards regulations that no doubt have served to raise prices, have benefited from relatively less state interference. Apart from a few murmurings from food purists and activists promoting local supply and produce, inexpensive food has ensured that they have never been a serious political issue. However, should food prices ever begin to rise, could we expect the state to start poking its nose increasingly into the food industry and blaming the resulting shortages and disarray on “exploitation” by the big supermarkets?

Furthermore, if we follow the logic of the “exploitation” argument, we could also say that, given that trade is always a two-way process, the consumers “exploit” the need of businesses for money. These entities have suppliers and employees to pay and they are often desperate to get their hands on your cash. If some other business offers a lower price they could be left high and dry by your decision to shop elsewhere, threatening the employment and livelihoods of all of those people that work in the business you shun simply because you have the guile to find what you want for less! It is partly for this reason that the supply curve for consumer goods, once they are in stock, is generally vertical, with merchants willing to sell them for any price they can get simply to shift them and bring in at least some cash to meet their future outgoings.

In a genuine free market businesses can never exploit anyone or hold anyone to ransom. A consumer would have the power to take his custom elsewhere if the business failed to meet his needs at an agreeable price. Although businesses as a whole set prices for consumer products and wages, no individual business can do so and each one must be prepared to sell goods for, at most, as much as the next business, and to pay wages at least as high. These boundaries can be crippling if the selling prices are lower or insubstantially higher than the costs that the business must bear. Businesses, unprotected by government privilege, therefore have to be on their toes constantly in case someone comes along with a better offer. The beneficiary of this process is the consumer-employee, who always knows he is paying the lowest price for what he buys and receives the highest wage for his work that can ever be paid.

[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.