#44 – “Profit Is Evidence of Suspicious Behavior”

 

The Foundation for Economic Education (FEE) is proud to partner with Young America’s Foundation (YAF) to produce “Clichés of Progressivism,” a series of insightful commentaries covering topics of free enterprise, income inequality, and limited government. See the index of the published chapters here.

#44 – “Profit Is Evidence of Suspicious Behavior”

(Editor’s Note: The author is president of the Foundation for Economic Education and the editor of the “Clichés” series.)

A great truth is encapsulated in this comment widely attributed to Samuel Gompers: “The worst crime against working people is a company which fails to operate at a profit.”

Gompers was the founder of the American Federation of Labor. He appreciated something back then that many of today’s progressives don’t: An economy without profit is an economy in deep, deep depression.

Perhaps no progressive ever actually put it in the same terms as the title of this essay, but it’s a fact that progressives routinely frown at the very mention of profit. To them, it’s a dirty word (mainly if other people earn one, but not when they do).

Here’s another related comment:

“The economic situation of enterprises will have to depend directly on profit, and profit cannot fulfill its function until prices are liberated from subsidies. Over the centuries, humankind has found no more effective measure of work than profit. Only profit can measure the quantity and quality of economic activity and permit us to relate production costs to results effectively and unambiguously . . . .  Our suspicious attitude toward profit is a historical misunderstanding, the result of the economic illiteracy of people . . .”

Those words were written by economist Nikolaay Shmelyov in the June 1987 issue of Novy Mir, the leading political and literary journal of the then-Soviet Union, no less. The Soviets, after years of anti-profit propaganda and policies that produced a world-class basket case economy, were showing signs of shedding some of that economic illiteracy by the late 1980s.

The settlers at the Plymouth colony whose legendary feast led to the Thanksgiving holiday tradition nearly wiped themselves out when they set up a communal, socialistic economy. Each person was producing for everybody else and received an equal share of the total production. In the absence of a strong profit motive, the settlers starved until Gov. Bradford altered the arrangement. Thereafter, men and women produced for profit and the result was bountiful harvests with full Thanksgiving tables.

The people who don’t like profit prefer to extol the virtue of selflessness, the charitable motive. A loving, caring concern for others can be a beautiful thing, especially when it’s genuinely from the heart. Of their own free will, Americans have always been the most charitable, giving people on the planet. But the fact remains that profit is responsible for more good things—by a long shot—than all the charity in the world.

As you read this, gaze around the room in which you’re seated. Notice the furniture, the building itself, your computer and smart phone, the clothing you’re wearing. How much of what you see came into being because someone wanted to break even or lose money just to make you comfortable?

Consider this the next time you feast at the Thanksgiving table. The people who raised the turkey didn’t do so because they wanted to help you out. The others who grew the cranberries and the yams didn’t go to the trouble and expense out of some sacrificial or even charitable impulse. If you think those folks and the others who made almost everything else you own performed their tasks as sacrificial rituals, then you probably believed the old McDonald’s line when they said in their commercials a while back, “We do it all for you.”

Here’s a simple, layman’s way of viewing profit: Imagine you have a hundred dollars’ worth of raw material. You shake it up, add your ingenuity and labor, and end up with a final product that people in the marketplace will pay $150 for. You’ve added value to society and earned a profit because of it. Now imagine that you take that same hundred dollars’ worth of stuff, shake it up, and produce a final product worth only $50. You’ve certainly made no profit, and have actually subtracted from total value in society. How can that possibly be virtuous? And furthermore, which do you think is easier to accomplish year-after-year—a profit or a loss? I assure you that it takes no special skill or talent to consistently generate a loss. It’s often tough just to break even.

Economists see profit in an even more insightful way. To them, profit is not some amorphous lump of what’s left over after costs are paid. It’s actually composed of several important components. In a typical small business in which the owner is also the manager, what he pays himself out of profit is “managerial remuneration.” It may be small or nonexistent in the early, formative stages of the business but in most cases, it must ultimately be substantial enough to keep him from giving up and finding employment elsewhere. A second component of profit is interest on capital invested. Over the long run, any business must earn enough to pay a competitive return to its investors or they will take their capital some place else.

If a business generates profit above and beyond what it takes to pay its owners, managers and investors a competitive return, then it has earned a third component that economists call “entrepreneurial profit” (sometimes called “economic profit”). When a particular business comes to market with a new or greatly improved product before anyone else thinks of it, meeting genuine needs and desires in ways that attract eager customers, the resulting “entrepreneurial profits” may at first be sizable. But the bigger they are, the more they attract additional supply (from the original provider as well as from competitors), and those high profits soon evaporate. In hindsight, it’s apparent that the high profits acted as a signal to producers that declared, “Hey, look over here! People really want this thing, and more of it!”

Sometimes, people turn up their noses at a big firm that earns a bottom-line profit that sounds like a big number. “Walmart made an astonishing $16 billion in profit in 2014! Such greed! That’s way too much!” These are the rants of the prejudiced and uninformed. Yes, Walmart profits in 2014 were about $16 billion. But they were earned on sales of $476 billion, resulting in profits as a percentage of sales of a mere 3.4 percent. The company paid far more in taxes and in wages than it earned in profits. Likewise, energy companies pay many times more in direct and hidden taxes on every gallon of gasoline, yet they are vilified for it while government, which took none of the risk and produced none of the product, rakes in its taxes and earns the praise of progressives for having done so.

In Marxist North Korea, there’s a regime that works night and day to see that nobody makes a profit. There won’t be anything like Thanksgiving dinner in North Korea this year, and that’s no coincidence.

The hostility toward profit, whether motivated by envy or ignorance or demagoguery, is undeserved with this exception: when it’s generated because of a firm’s use of political connections to rig the market or attain subsides and special favors from politicians at the expense of others. Otherwise, in free markets, it’s more than just healthy—it’s indispensable to the process of enhancing life and progress. It’s what all of us seek when we try to improve our well-being by improving that of others through peaceful commerce.

Profit is not evidence of suspicious behavior, but raising fears and unfounded accusations against it certainly is.

Summary

  • Profit earned in free and competitive markets is the target of the misinformed and the uninformed; it’s evidence of value added, not value subtracted.
  • Profit is a great motivator and incentivizer.
  • As most economists see it, profit is composed of managerial remunerations, interest on capital invested and “entrepreneurial” or “economic” profits.
  • By itself, the sheer dollar amount of a firm’s profits tells you nothing about profit as a portion of sales or as a return on capital invested.
  • For further information, see:

“Profit” – short videos and articles by various authors in The Freemanhttp://tinyurl.com/lua3zb9

“The Ethics of Profit Making” by Brian Summers: http://tinyurl.com/l7xhe56

“The Pursuit of Profit is Pro-Social” by Matthew McCaffrey: http://tinyurl.com/lvc8cqo

“Fire-Fighting for Profit” by Nancy W. Poole: http://tinyurl.com/oyxwfyt

If you wish to republish this article, please write [email protected].

More by Lawrence W. Reed

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