Freeman

ARTICLE

From Where Comes Profits?

OCTOBER 01, 1959 by JOHN CHAMBERLAIN

This article is an excerpt from Mr. Chamber­lain’s exciting analysis of The Roots of Capi­talism. Princeton: D. Van Nostrand, 1959.

The theory that an enterpriser with the ability to promote a real "union of forces" does proportion­ately more for society—and the worker—than he does for himself was not fully and comprehensively stated for the American factory age until a Civil War veteran, Gen­eral Francis Amasa Walker, who taught at the Yale Sheffield Scien­tific School from 1871 to 1880 be­fore becoming president of the Massachusetts Institute of Tech­nology, applied his fertile mind to the subject of economics. It was Walker who definitely killed what the late Garet Garrett has called the "disastrous foreign theories" by a show of logic that was as beautiful as it was imperious.

What Walker did was to set forth a body of theory in Ameri­can terms that was eventually to make it impossible for a respect­able intellectual opposition to the Ford idea to form. There was, as we shall see, much grumbling in Detroit when Henry Ford decided to share his mounting income with his workers and so help to get in­creased marginal efficiency out of them; and there were some pre­dictions, naturally, that ruin would shortly encompass both the auto­mobile industry and the American economic system as a whole. But the predictions lacked fire and co­gency—and nobody emerged with the power of persuasion to head Ford off.

Exploding Economic Myths

With great force, precision, and originality Walker exploded one by one the "laws" laid down by England’s gloomy men when the science of political economy was largely a series of deductions from premises that had not been suffi­ciently tested by observation of facts. After Walker had written his articles and books there was no longer any warrant for believ­ing that wages are paid out of a circumscribed wage fund, or that profits are wrung out of the hide of the worker by keeping him close to subsistence levels, or that the entrepreneur "steals" his profits by seizing the laborer’s "surplus value," or that every increase in production must eventually go in­to the pockets of the landlord in the shape of the "unearned incre­ment" of skyrocketing rents or mounting charges for raw ma­terials.

In his writings on wages and rents Walker appeared in the guise of the Great Unstiffener. He car­ried on his role in his considera­tion of profits.

It is a commonplace that one can find forty different definitions of profit in as many books on econ­omics. To the businessman, a profit is what is left when he has paid his costs; it is the difference be­tween red ink and black. To the economist who believes that an economic system strains toward equilibrium, profit is a temporary thing which is destined to disap­pear whenever competition in a given field of endeavor has reached the point of saturation. To a Marx­ist, profit is wrung from the poor by taking from the worker the "surplus value" he creates over and above the cost of his subsistence. And to believers in an illusory "perfect competition," profit is a monopolistic charge which the pro­prietor of a patent or the possessor of some temporary secret piles on top of the "natural" price which is compounded of costs plus the "wage" of management and the in­terest paid out for the loan of capi­tal.

To Walker, most of these defini­tions seemed sterile; they tended to miss the point of motivation, and they ignored the social func­tion of profit, which is to guide production and provide the where­withal for new investment. They also missed the point that some men have special aptitudes, a spe­cial faculty for seeing where labor can be most creatively employed.

To state the matter in the more rounded terms of John Bates Clark, the man of entrepreneurial skill will know what to risk in pay­ment for the relative productivity of "last units" of land, labor, and capital, and will make a profit if his calculations are correct.

But it was Walker who first ac­cented the "where" as well as the "how." In order to clarify his theory, Walker considered profit as something more than the remuner­ation for the use of capital, some­thing more than a "reward for ab­stinence," or for taking the risk of loss. Such remunerations, such re­wards, were covered adequately by the term "interest." Beyond the concept of interest there was an­other thing—the entrepreneur’s share of the product of industry, which could be great or small, de­pending on the ability of a special breed of man.

By limiting his idea of profit to the share which is due the man who exercises the "entrepreneurial function," Walker directed the at­tention of economists to a fourth species of reward in the distribu­tion cycle. Schumpeter and others have tended to accept this idea of a "fourth" reward in addition to wages, rent, and interest—but they have tried to circumscribe it by de­fining it as a "payment for inno­vation," as something which one willingly gives to an inventor for enlarging the productive horizons of man. To Walker, innovation was indeed a part of the entrepreneur­ial function. But there was con­siderably more to it than that.

The Entrepreneurial Contribution

During Walker’s lifetime, the consumer cooperative movement in England had had considerable suc­cess. But nearly all the attempts of labor to form producer coopera­tives had come to grief. Surveying the wreckage of these attempts, Walker concluded that the entre­preneur, far from being an ex­crescence on production, was really the heart of it. An imaginative en­trepreneur, with a good grasp of market possibilities and internal shop economies, was worth more to the working classes than fine gold. It was the entrepreneur who brought jobs into being in the first place, and who enabled the worker to use his talents in the most mar­ketably worthwhile manner in the second.

Concentrating upon the entre­preneur’s special talents, Walker concluded that profits bore more than a superficial resemblance to rent. For, just as there were no-rent lands which produced for the market at the bottom margin of cultivation, so there were no-profit industries which somehow stag­gered along, consuming savings or proceeding from bankruptcy to bankruptcy. The capitalist received his interest from no-profit indus­tries willy nilly; either that, or he took over as receiver. In the no-profit company, the entrepreneur could gain no recompense beyond a salary for putting in his time and efforts; he was like a landlord who had to be satisfied with barely enough income from property to pay the taxes. But as a company "measured up" from the no-profit margin, there was more and more to spare for the enterpriser who could devise the ways of improv­ing unit productivity, or of in­creasing the sales.

Walker observed that profits, like rent, do not figure in selling price under properly competitive conditions. For, just as the price of wheat is set at the margin by the wheat grown on no-rent lands, so is the price of an industrial prod­uct set at the margin by the out­put of the no-profit company. Profits, then, are the special crea­tion of the ability, the know-how, the inventiveness, the foresight, the imagination, of the superior executive. They are, in effect, not added into price but taken out of the cost.

Walker doubted that the entre­preneur could take all of the in­creased wealth he brought into be­ing by cutting costs and enlarging the market. For every time an en­trepreneur improved a given company’s position, he made it harder for incompetent companies at the no-profit margin. Some of these companies would be forced out of business by the successful entre­preneur’s action. By "leveling up," then, the competent employers who were both willing and able to pay more in order to raise the stand­ards of efficiency would be left to dominate a given field. Society would be better off all around, for the efficient company, in addition to paying more in wages as an ef­ficiency-lure, is obviously in a bet­ter position to charge less for its product and to plow more funds back into research.

Profit: The Driving Force

By keeping his eye on the spe­cific contribution of the entrepre­neur, Walker isolated profit as the driving force of industrial prog­ress. Theoretically, an equilibristic economic system might outgrow the need for the enterpriser’s spe­cial abilities. But Walker, with his eye on what was happening around him in America, knew that the good enterpriser is always able to turn equilibrium (another word for stagnation) into dynamic change. He doubted that the world would ever reach a stage in which all secrets have been discovered, all potential wants plumbed, and all opportunities exploited to the uttermost limits of human ingenuity and human energy. Such a stage might be imaginable, but only at the close of the evolution­ary cycle. Obviously, the human race had not reached that point in Walker’s lifetime. Indeed, the possibilities of American techno­logical ingenuity, spurred onward by the entrepreneur with the vision to see its market applications, had just begun to unfold in the days when Walker was establishing a specifically American economics to explain the du Ponts, the Sears Roebucks, the Fords, and the Beth­lehem Steels which would emerge in the post-Walker generation.

Walker, of course, lived before the dynamics of mass production had become the distinguishing fea­ture of the American economic landscape. When he was writing, people still believed in Adam Smith’s more or less static "natu­ral price." Smith had defined the natural price as the sum of the cost of production (labor, etc.) which had gone into the article, plus the going rate of profit on capital in the neighborhood. But this simple definition did not reck­on with the dynamic effect of the good entrepreneur on cost of pro­duction and profit.

By separating the two concepts of interest and profit, and by show­ing that profit was something saved on cost, Walker had de­stroyed the possibility of consider­ing "natural" price as a simple sum. The natural price was what­ever the enterpriser could make it: if he could perform the seeming miracle of expanding production and sales by rearranging his tools and simultaneously raising the wage and lowering the price, the "natural" basis for price could be changed overnight. This is essen­tially what Henry Ford did, and it has been done over and over again since his day.

The Ford system of pushing the use of labor-saving machinery way past the "break even point" of clearing expenses on the tooling was still in the womb of time when Walker lived. But by removing the blocks which had prevented econo­mists from seeing that wages and profits—and the price—were de­pendent on the entrepreneur’s im­agination in a dynamically interre­lated way, Walker cleared the theo­retical ground for Henry Ford in particular and for the American system in general. In our national emphasis on doing, on action, on the method of cut-and-try, Walker has been overlooked in the history of our thought. But generations at the Yale Sheffield Scientific School and the Massachusetts Institute of Technology listened to him—and the seed must have sprouted in in­dustry in a myriad uncelebrated ways.

ASSOCIATED ISSUE

October 1959

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Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.
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