This article is an excerpt from Mr. Chamberlain’s exciting analysis of The Roots of Capitalism.
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.