All Commentary
Sunday, September 1, 1985

The Limitations of Profit-Sharing

Henry Hazlitt has had a long and distinguished career as economist, journalist, author, editor, and literary critic.

A funny thing happened on March 28 of this year. The New York Times ran as its leading editorial a piece entitled “Best Idea Since Keynes.” This must have puzzled many readers. The main idea of Maynard Keynes was that the sovereign remedy for almost any economic depres sion was more credit creation, i.e., inflation. Bitter experience has already taught an increasing number of economists that this is the most dangerous “remedy” of all.

Passing over this difficulty, what is this “best idea since Keynes”? According to the Times editorial writer—profit-sharing!

He treats this as if it were a brand-new idea, and gives all the credit for it to “Martin Weitzman, an M.I.T. economist . . . . in a readable little book, called The Share Economy which was published last October . . . . The core of his idea is something like profit-sharing; to change our system of fixed-rates to one in which workers’ incomes are determined by company performance.”

The Times thought so much of this that it ran another article on the same subject about a month later, on April 25.

The first thing that needs to be pointed out to the Times is that profit-sharing, as an applied idea in individual firms, is at least nearly two centuries old. It has usually taken the form of a supplementary payment to fixed wages. The first venture of any size seems to have been that of the French National Fire Insurance in 1820. During the nineteenth century it got a further extensive trial in Britain, Germany, Holland, Italy and Switzerland. There were a number of such schemes in the U.S. between 1910 and 1930, but most of them were abandoned in the depression of the 1930s.

Why weren’t there more? Why are profit-sharing arrangements for workers still so rare?

Market Determined Salaries

Let us begin with the reasons from the standpoint of the employer. If he hopes to attract competent workers, he will know that he must offer (even apart from union demands) at least the going market rate of wages or salaries. If he offers his workers a profit-sharing plan, it must be in addition to this basic market-rate.

Employees for the most part feel that they cannot afford to gamble—that they cannot be left in doubt regarding their future income, unless it is almost certain to be larger than the going market rate of wages or salaries. Workers would feel that under straight profit-sharing their future would be much more dependent on the decisions of management than on their own individual performance. And as we shall shortly see, they would be right.

Moreover, the employer in a prosperous firm, instead of offering a profit-sharing plan, has another choice. He can simply offer a specially competent worker a higher salary than the average for that type of work. Most good workers would probably prefer that to a profit-sharing gamble. The employer, in turn, would be free to adjust his payment to each particular case.

Now let us look at profit-sharing further from the standpoint of the employee. The advocates of profit-sharing contend that it is or would be a great stimulus to increase the workers’ output and effort. This is very doubtful.

Let us consider a firm with 100 workers. An individual worker, even if he doubles his effort or output, would stand to increase his individual share of profits by only I per cent or less. If he worked for a firm with 10,000 employees or more, his increased share of profits would be in finitesimal. Of course, if all the workers increased their effort and output they would stand to achieve a more substantial share of profits; but it would be very hard to get them to think collectively, or for each to trust all the others.

The Times editorial, perhaps taking its cue from the Weitzman book, offers a hypothetical example of how profit-sharing might work in practice: “Imagine that General Motors . . . had agreed in such negotiations to pay its workers 70 per cent of revenues. Since it would keep 30 per cent, G.M. would want to keep hiring as long as the additional workers made any contribution to revenues.”

This example reveals that the Times writer did not know what the average division of corporation earnings has actually been under the present wage system. Over a long period of years, as shown by figures compiled annually by the Department of Commerce, non-financial corporations have paid about 90 per cent of their total net earnings to their employees and retained an average of only about 10 per cent in profits. This division, of course, has not reflected any intention on the part of the corporation stockholders. It has merely been what has happened in fact.

The Times writer believes that the introduction of profit-sharing would reduce our recent persistent American unemployment rate of about 7 per cent. It is doubtful that it would have any effect at all in this direction. Our unemployment rate has been mainly brought about by two governmental policies. One of these is our legal minimum wage. This has decreed in effect that if a man cannot be employed at a certain minimum legal rate per hour he must not be employed at all. The result was dramatically shown when the minimum wage was first enacted, and threw thousands of teenagers, and particularly black teenagers, out of jobs. The other government policy that assures continued joblessness is high and prolonged unemployment insurance or relief. The Times news columns frequently refer to jobless men and women who have become “too discouraged to look for work.” As long as they have an assured income whether they work or not, their “encouragement” to look for work will remain low.

One final thought. I am assuming that neither Mr. Weitzman nor the Times is proposing to introduce profit-sharing by force. This would be an appalling proposal. But if coercion is not used, all employers are still free, as they have always been, to offer workers profit-sharing plans instead of straight wages, and unions or individual workers are free to express their preference for them.

I suspect that risk-taking will continue to be left to the entrepreneurs, where it belongs, and that employees will continue to prefer the relative assurance of a fixed and more dependable income.

  • Henry Hazlitt (1894-1993) was the great economic journalist of the 20th century. He is the author of Economics in One Lesson among 20 other books. See his complete bibliography. He was chief editorial writer for the New York Times, and wrote weekly for Newsweek. He served in an editorial capacity at The Freeman and was a board member of the Foundation for Economic Education.