THE FUNCTION OF PROFITS
THE INDIGNATION SHOWN by many people today at the mention
of the very word profits indicates how little understanding
there is of the vital function that profits play in our economy.
To increase our understanding, we shall go over again some of
the ground already covered in chapter fifteen on the price
system, but we shall view the subject from a different angle.
Profits actually do not bulk large in our total economy. The
net income of incorporated business in the fifteen years from
1929 to 1943, to take some illustrative figures, averaged less
than 5 percent of the total national income. Corporate profits
after taxes in the five years from 1956 to 1960 averaged less than
6 percent of the national income. Corporate profits after taxes
in the five years 1971 through 1975 also averaged less than 6
percent of the national income (in spite of the fact that, as a
result of insufficient accounting adjustment for inflation, they
were probably overstated). Yet profits are the form of income
toward which there is most hostility. It is significant that while
there is a word profiteer to stigmatize those who make allegedly
excessive profits, there is no such word as "wageer"—or
"losseer." Yet the profits of the owner of a barbershop may
average much less not merely than the salary of a motion
picture star or the hired head of a steel corporation, but less
even than the average wage for skilled labor.
The subject is clouded by all sorts of factual misconceptions.
The total profits of General Motors, the greatest industrial
corporation in the world, are taken as if they were typical rather
than exceptional. Few people are acquainted with the mortality
rates for business concerns. They do not know (to quote from
the TNEC studies) that "should conditions of business averaging
the experience of the last fifty years prevail, about seven of
each ten grocery stores opening today will survive into their
second year; only four of the ten may expect to celebrate their
fourth birthday." They do not know that in every year from
1930 to 1938, in the income tax statistics, the number of corporations
that showed a loss exceeded the number that showed a
profit.
How much do profits, on the average, amount to?
This question is commonly answered by citing the kind of
figures 1 presented at the beginning of this chapter — that corporate
profits average less than 6 percent of the national
income -- or by pointing out that the average profits after income
taxes of all manufacturing corporations are less than five
cents per dollar of sales. (For the five years 1971 through 1975,
for example, the figure was only 4.6 cents.) But these official
figures, though they fall far below popular notions of the size of
profits, apply only to corporation results, calculated by conventional
methods of accounting. No trustworthy estimate has
been made that takes into account all kinds of activity, unincorporated
as well as incorporated business, and a sufficient
number of good and bad years. But-some eminent economists
believe that over a long period of years, after allowance is made
for all losses, for a minimum "riskless" interest on invested
capital, and for an imputed "reasonable" wage value of the
services of people who run their own business, no net profit at
all may be left over, and that there may even be a net loss. This
is not at all because entrepreneurs (people who go into business
for themselves) are intentional philanthropists, but because
their optimisim and self-confidence too often lead them into
ventures that do not or cannot succeed.'
'Cf. Frank H. Knight, Risk, Uncertainty and Profit (1921). In any period in
which there has been net capital accumulation, however, the presumption is
strong that there must also have been overall net profits from previous
investment.
It is clear, in any case, that any individual placing venture
capital runs a risk not only of earning no return but of losing his
whole principal. In the past it has been the lure of high profits in
special firms or industries that has led him to take that great
risk. But if profits are limited to a maximum of, say, 10 percent
or some similar figure, while the risk of losing one's entire
capital still exists, what is likely to be the effect on the profit
incentive, and hence on employment and production? The
World War 11 excess-profits tax showed what such a limit can
do, even for a short period, in undermining efficiency.
Yet governmental policy almost everywhere today tends to
assume that production will go on automatically, no matter
what is done to discourage it. One of the greatest dangers to
world production today still comes from government pricefixing
policies. Not only do these policies put one item after
another out of production by leaving no incentive to make it,
but their long-run effect is to prevent a balance of production in
accordance with the actual demands of consumers. When the
economy is free, demand so acts that some branches of production
make what some government officials regard as "excessive,"
"unreasonable," or even "obscene" profits. But that very
fact not only causes every firm in that line to expand its production
to the utmost, and to reinvest its profits in more machinery
and more employment; it also attracts new investors and producers
from everywhere, until production in that line is great
enough to meet demand, and the profits in it again fall to (or
below) the general average level.
In a free economy, in which wages, costs and prices are left to
the free play of the competitive market, the prospect of profits
decides what articles will be made, and in what quantities — and
what articles will not be made at all. If there is no profit in
making an article, it is a sign that the labor and capital devoted
to its production are misdirected: the value of the resources that
must be used up in making the article is greater than the value of
the article itself.
One function of profits, in brief, is to guide and channel the
factors of production so as to apportion the relative output of
thousands of different commodities in accordance with demand.
No bureaucrat, no matter how brilliant, can solve this
problem arbitrarily. Free prices and free profits will maximize
production and relieve shortages quicker than any other system.
Arbitrarily fixed prices and arbitrarily limited profits can
only prolong shortages and reduce production and employment.
The function of profits, finally, is to put constant and unremitting
pressure on the head of every competitive business to
introduce further economies and efficiencies, no matter to what
stage these may already have been brought. In good times he
does this to increase his profits further, in normal times he does
it to keep ahead of his competitors, in bad times he may have to
do it to survive at all. For profits may not only go to zero, they
may quickly turn into losses; and a man will put forth greater
efforts to save himself from ruin than he will merely to improve
his position.
Contrary to a popular impression, profits are achieved not by
raising prices, but by introducing economies and efficiencies
that cut costs of production. It seldom happens (and unless
there is a monopoly it never happens over a long period) that
every firm in an industry makes a profit. The price charged by
all firms for the same commodity or service must be the same;
those who try to charge a higher price do not find buyers.
Therefore the largest profits go to the firms that have achieved
the lowest costs of production. These expand at the expense of
the inefficient firms with higher costs. It is thus that the consumer
and the public are served.
Profits, in short, resulting from the relationships of costs to
prices, not only tell us which goods it is most economical to
make, but which are the most economical ways to make them.
These questions must be answered by a socialist system no less
than by a capitalist one; they must be answered by any conceivable
economic system; and for the overwhelming bulk of the
commodities and services that are produced, the answers supplied
by profit and loss under competitive free enterprise are
incomparably superior to those that could be obtained by any
other method.
I have been putting my emphasis on the tendency to reduce
costs of production because this is the function of profit-andloss
that seems to be least appreciated. Greater profit goes, of
course, to the man who makes a better mousetrap than his
neighbor as well as to the man who makes one more efficiently.
But the function of profit in rewarding and stimulating superior
quality and innovation has always been recognized.
THE INDIGNATION SHOWN by many people today at the mention
of the very word profits indicates how little understanding
there is of the vital function that profits play in our economy.
To increase our understanding, we shall go over again some of
the ground already covered in chapter fifteen on the price
system, but we shall view the subject from a different angle.
Profits actually do not bulk large in our total economy. The
net income of incorporated business in the fifteen years from
1929 to 1943, to take some illustrative figures, averaged less
than 5 percent of the total national income. Corporate profits
after taxes in the five years from 1956 to 1960 averaged less than
6 percent of the national income. Corporate profits after taxes
in the five years 1971 through 1975 also averaged less than 6
percent of the national income (in spite of the fact that, as a
result of insufficient accounting adjustment for inflation, they
were probably overstated). Yet profits are the form of income
toward which there is most hostility. It is significant that while
there is a word profiteer to stigmatize those who make allegedly
excessive profits, there is no such word as "wageer"—or
"losseer." Yet the profits of the owner of a barbershop may
average much less not merely than the salary of a motion
picture star or the hired head of a steel corporation, but less
even than the average wage for skilled labor.
The subject is clouded by all sorts of factual misconceptions.
The total profits of General Motors, the greatest industrial
corporation in the world, are taken as if they were typical rather
than exceptional. Few people are acquainted with the mortality
rates for business concerns. They do not know (to quote from
the TNEC studies) that "should conditions of business averaging
the experience of the last fifty years prevail, about seven of
each ten grocery stores opening today will survive into their
second year; only four of the ten may expect to celebrate their
fourth birthday." They do not know that in every year from
1930 to 1938, in the income tax statistics, the number of corporations
that showed a loss exceeded the number that showed a
profit.
How much do profits, on the average, amount to?
This question is commonly answered by citing the kind of
figures 1 presented at the beginning of this chapter — that corporate
profits average less than 6 percent of the national
income -- or by pointing out that the average profits after income
taxes of all manufacturing corporations are less than five
cents per dollar of sales. (For the five years 1971 through 1975,
for example, the figure was only 4.6 cents.) But these official
figures, though they fall far below popular notions of the size of
profits, apply only to corporation results, calculated by conventional
methods of accounting. No trustworthy estimate has
been made that takes into account all kinds of activity, unincorporated
as well as incorporated business, and a sufficient
number of good and bad years. But-some eminent economists
believe that over a long period of years, after allowance is made
for all losses, for a minimum "riskless" interest on invested
capital, and for an imputed "reasonable" wage value of the
services of people who run their own business, no net profit at
all may be left over, and that there may even be a net loss. This
is not at all because entrepreneurs (people who go into business
for themselves) are intentional philanthropists, but because
their optimisim and self-confidence too often lead them into
ventures that do not or cannot succeed.'
'Cf. Frank H. Knight, Risk, Uncertainty and Profit (1921). In any period in
which there has been net capital accumulation, however, the presumption is
strong that there must also have been overall net profits from previous
investment.
It is clear, in any case, that any individual placing venture
capital runs a risk not only of earning no return but of losing his
whole principal. In the past it has been the lure of high profits in
special firms or industries that has led him to take that great
risk. But if profits are limited to a maximum of, say, 10 percent
or some similar figure, while the risk of losing one's entire
capital still exists, what is likely to be the effect on the profit
incentive, and hence on employment and production? The
World War 11 excess-profits tax showed what such a limit can
do, even for a short period, in undermining efficiency.
Yet governmental policy almost everywhere today tends to
assume that production will go on automatically, no matter
what is done to discourage it. One of the greatest dangers to
world production today still comes from government pricefixing
policies. Not only do these policies put one item after
another out of production by leaving no incentive to make it,
but their long-run effect is to prevent a balance of production in
accordance with the actual demands of consumers. When the
economy is free, demand so acts that some branches of production
make what some government officials regard as "excessive,"
"unreasonable," or even "obscene" profits. But that very
fact not only causes every firm in that line to expand its production
to the utmost, and to reinvest its profits in more machinery
and more employment; it also attracts new investors and producers
from everywhere, until production in that line is great
enough to meet demand, and the profits in it again fall to (or
below) the general average level.
In a free economy, in which wages, costs and prices are left to
the free play of the competitive market, the prospect of profits
decides what articles will be made, and in what quantities — and
what articles will not be made at all. If there is no profit in
making an article, it is a sign that the labor and capital devoted
to its production are misdirected: the value of the resources that
must be used up in making the article is greater than the value of
the article itself.
One function of profits, in brief, is to guide and channel the
factors of production so as to apportion the relative output of
thousands of different commodities in accordance with demand.
No bureaucrat, no matter how brilliant, can solve this
problem arbitrarily. Free prices and free profits will maximize
production and relieve shortages quicker than any other system.
Arbitrarily fixed prices and arbitrarily limited profits can
only prolong shortages and reduce production and employment.
The function of profits, finally, is to put constant and unremitting
pressure on the head of every competitive business to
introduce further economies and efficiencies, no matter to what
stage these may already have been brought. In good times he
does this to increase his profits further, in normal times he does
it to keep ahead of his competitors, in bad times he may have to
do it to survive at all. For profits may not only go to zero, they
may quickly turn into losses; and a man will put forth greater
efforts to save himself from ruin than he will merely to improve
his position.
Contrary to a popular impression, profits are achieved not by
raising prices, but by introducing economies and efficiencies
that cut costs of production. It seldom happens (and unless
there is a monopoly it never happens over a long period) that
every firm in an industry makes a profit. The price charged by
all firms for the same commodity or service must be the same;
those who try to charge a higher price do not find buyers.
Therefore the largest profits go to the firms that have achieved
the lowest costs of production. These expand at the expense of
the inefficient firms with higher costs. It is thus that the consumer
and the public are served.
Profits, in short, resulting from the relationships of costs to
prices, not only tell us which goods it is most economical to
make, but which are the most economical ways to make them.
These questions must be answered by a socialist system no less
than by a capitalist one; they must be answered by any conceivable
economic system; and for the overwhelming bulk of the
commodities and services that are produced, the answers supplied
by profit and loss under competitive free enterprise are
incomparably superior to those that could be obtained by any
other method.
I have been putting my emphasis on the tendency to reduce
costs of production because this is the function of profit-andloss
that seems to be least appreciated. Greater profit goes, of
course, to the man who makes a better mousetrap than his
neighbor as well as to the man who makes one more efficiently.
But the function of profit in rewarding and stimulating superior
quality and innovation has always been recognized.
No comments:
Post a Comment