All Commentary
Monday, December 1, 1980

Winners and Losers

Mr. Nelms is a professional librarian in Virginia.

Critics of the free market are hard to please. While they may applaud the opportunities offered and praise entrepreneurial effort, they frown upon the person who gains success. Charges of monopoly, price gouging, and selfishness are leveled. Envy of the competitor who succeeds in the market leads to calls for higher taxation and confiscation of profits. Many critics assume that the successful businessman must have cheated in order to gain his reward.

Conversely, we find persons equally critical of the leveling force of the market which drives out of business those who cannot compete. This may have been the experience of the critics themselves, or they know friends who have failed in business. And such a somber lesson always raises cries about the cruelty of capitalism and calls for government subsidies for failing ventures.

In the final analysis, market critics are satisfied with neither the opportunities for success nor the possibilities for failure. Instead, some type of equilibrium is sought, where all will be secure, where none can fail. They ask, “Why must some profit and others fail?” They call for a system where opportunities for great wealth may no longer exist, but at least the possibilities for failure will be eliminated.

It would be nice to live in a world where no one fails. But a close analysis reveals what a dull and impossible situation this alternative offers. If the chances for success and failure are destroyed, the end of progress and prosperity is inevitable. An examination of the market process reveals the necessity for profit and loss in a healthy society.

The incentive for profit and opportunities for success encourage improvements in life. This chance at wealth is a strong attraction which carries with it the possibility of loss. One is not available without the other. In order to allow the maximum degree of consumer satisfaction and productivity, people must be free to succeed or fail. Protecting us from ourselves will only inhibit the satisfaction of all concerned.

Let’s look at the profit incentive for a moment. The prospect for wealth encourages new people to enter the market with new products and new ideas. These entrepreneurs consider the risks, often using all their savings, and borrowed capital as well, to begin an enterprise of their own. Yet, they are willing to take these chances for the opportunity of bettering themselves.

Even though the vast majority of new ventures fail, the incentive for profit still causes an increasing number of people to compete in the market. These businessmen offer new products, new services, new competition for the consumer’s patronage. The only way they can succeed is by offering the consumer a product for which he will willingly trade other valuable resources.

The possibility for profit is the reason that people like Henry Ford, Cyrus McCormick, and Chester Carlson risked their own capital to test new ideas in the market. Without the profit motive, the world might not have known the automobile, the grain reaper, or the inexpensive photocopier. Taking away the prospect for profit may soothe someone’s sense of envy, but it retards the development of new products and diminishes consumer satisfaction.

Another key feature of the profit system is that it keeps producers on their toes. Entrepreneurs are constantly seeking new fields in which they can maximize their profits. If they see a line of business where profits are high, this is a key for them to enter with a competing product. In this manner, the market encourages new competitors, which tends to lower prices and to discourage monopolies.

Our market critics often grant that a “reasonable” profit is all right, but that “excessive” earnings should be taxed away and used to help the less fortunate. In this argument, they fail to see the real purpose of profits. If a producer knows that his earnings will be taxed away when they exceed a certain level, he will not strive to be more productive.

It should be clear that the profit system is of benefit to everyone. Producers are given the chance to realize earnings, new goods are developed, new jobs are created, and the consumer gains a product suited to his needs. Without this incentive, why should anyone wish to risk his time, labor and talent to enter business?

But what about the other side of the coin? Surely, something should be done to prevent the thousands of business failures each year. Think of the poor man who fails and is obliged to sell out to a more successful competitor.

It is important to realize that the market economy must be a profit and loss system in order to function effectively. The market insures that those who meet the consumers’ needs will succeed. Competitors who do not meet these needs will not be able to continue in business very long. This prospect of failure is a stern reminder that efficiency and productivity are required. If failure is not allowed, businessmen can become lackadaisical with the knowledge that they will not have to face the consequences of their unproductivity.

The fact is that businesses fail for many reasons—undercapitalization, poor management, inadequate planning, just to name a few. The market allows a means for the unsuccessful competitor to liquidate his business and to cut his losses. History records many stories about people who failed in one area but were able to realize success in other fields. The market afforded these individuals a means of selling their stock and moving on to try their hand at more productive ventures.

But why should someone benefit at the cost of the poor businessman who must sell out? In a market economy, a person will trade only if he believes it is in his best interest. Thus, the man who goes out of business has the choice of continuing his present line or selling his assets. If he chooses the latter, it is because he deems it to be in his best interest. The buyer of his property is the one person offering him the most attractive deal.

The market provides signals for a person to know when to expand or to contract or to go into another field. If a business is consistently losing money, this is a sign either to re vamp the organization or to sell the business. A person who ignores these signals does so at his own risk; the person who buys such a business when it is offered for sale is actually helping the loser cut his losses in retiring from this segment of the market.

The alternative to allowing business failure in the market is subsidy. We are all familiar with such subsidies that have become a part of the American scene over the years. They require that people who are productive and have met customers’ needs—plus consumers themselves—must give part of what they have earned to support the less productive businessman. In this way, the inevitable collapse of the subsidized business is delayed, and the market process is circumvented. Ultimately, everyone pays for this inefficiency with higher prices and a distortion of the signals that the market issues.

Whenever government steps in to protect individuals from failure, it hampers the working of the market process. Instead of allowing the entrepreneur to see that he must change his practices to meet consumer needs, subsidies allow him to dwell in a dream world, where failure never comes.

In essence, what happens when government enters the market is a distortion of reality and the creation of a vicious cycle. To insure that no one fails, others must be ordered to sacrifice the fruits of their labor. To keep the productive from earning their rewards, the incentive to create and develop new products—with new jobs—is removed.

If our critics are concerned about the plight of the small businessman, they can best help by removing government regulations which place an oppressive burden on any small entrepreneur. A variety of laws, from building codes to zoning regulations, retard the ability of businessmen to face the requirements of the market.

The producer who risks his capital and goes out to borrow from others to realize the goal of owning his own business deserves better than the present state of affairs. He gen erates a product, for which people are voluntarily willing to exchange their own goods; he offers this at a competitive price; he employs workers at a wage for which they are willing to trade their labor; and he adds to the overall wealth of his community. In exchange, he is forced to collect sales taxes, keep various records for the government, observe licensing requirements, and pay taxes of differing degrees on his earnings.

The profits earned are the seeds from which progress grows. Profits encourage efficiency of production and the expansion of industry. Consumer needs are met as buyers are allowed to purchase the goods they wish in free exchange. Jobs are created, which help to meet the needs of workers. All of this is possible only through the workings of the free market. Winston Churchill once observed, “Private industry runs at a profit and uses the profits to expand producing capacity. Government industry runs at a loss, and taxes the substance of the people to pay for its inefficiency.”

In reality, our critics who seek equilibrium must understand that such a state of affairs is both impossible and undesirable. Human nature dictates that we constantly strive. The chance for profit must be available as an incentive for men to reach higher. Likewise, the market records a loss for lack of productivity and it affords the least painful way for people to move from one business to another. If profits are not possible, we all lose; if failure is not allowed, none of us can win.