September 22, 2015

Profits, Entrepreneurs, and the Social Welfare: Action and Profit

By In Blogs, Brian Jacobson

This is the first post in a series on: Profits, Entrepreneurs, and the Social Welfare. This is first post is on the praxeological foundation of entrepreneurship and profit and why it leads to social welfare. The next couple post will focus on the economics (or catalytics) of entrepreneurial activity and what exactly is profits, what do they really mean or say, and are profits a good thing. I was prompted to write this because it seems many have a poor view of profits as either bad and something to be ashamed of or that they can be defended only by Randian (Ayn not Paul) glorifications of selfishness. Also I think it is imperative and encouraging for people who do regular secular work that valuable production of goods and services is true service to others.

To even talk about profits and entrepreneurs, or the social utility (value) or the function that they play in society, we must have a basic overview of capitalism. Even just to verbally explain the “free economic system constitutes a great architectural edifice,”[1] Rothbard said. Ludwig von Mises emphasized the market economy as method for social cooperation. “Capitalism or market economy is that system of social cooperation and division of labor that is based on private ownership of the means of production. The material factors of production are owned by individual citizens, the capitalists, and the landowners. The plants and the farms are operated by the entrepreneurs and the farmers, that is, by individuals or associations of individuals who either themselves own the capital and the soil or have borrowed or rented them from the owners.”[2] Of course the idea of profit to some degree assumes ownership. To act in your physical person, in the most basic praxeological sense, assumes ownership or control of your own body in order to benefit (or profit) from your action, or else why act? It is really only through ownership that we can profit and have the ability to make decisions about the use of our labor or property in order to profit. “The objective of every enterprise-whether businessman or farmer-is to make profit.”[3] This is of course is objectively true and irrefutable not just of the entrepriser but of every human being and every human action.

Entrepreneurship is virtually nonexistent in mainstream economic textbooks and neoclassical models. One may not even find the word in the glossary of a macro or microeconomics textbooks. Instead entrepreneurship often is treated as a sort of special phenomenon in its own rite. In both cases it is considered only of those unique individuals and circumstances of the self-employed, start-ups, small business management, or new product innovation.  On the contrary the concept of the entrepreneur plays a fundamental role in Austrian economic literature and its conception of the firm and the structure of production and fundamentally underlies all economic action. Mises said in fact that it was impossible “to eliminate the entrepreneur from the picture of a market economy. The various complementary factors of production cannot come together spontaneously. They need to be combined by the purposive efforts of men aiming at certain ends and motivated by the urge to improve their state of satisfaction. In eliminating the entrepreneur one eliminates the driving force of the whole market system.”

Human Action and Entrepreneurship

Action, in the sense that Mises spoke about, is itself an entrepreneurial concept, or that is to say entrepreneurship and profit (or loss) are at the heart of human action. There is a broader and a narrower sense the entrepreneur. In the broadest sense entrepreneurship encompasses all action. It can be defined as actors using scarce resources under uncertainty to achieve ends. This of course means that entrepreneurship is really an inherent concept in human action. “All actions aim at rendering conditions at some time in the future more satisfactory for the actor than they would have been without the intervention of the action.”[4] Which is to say, all action is an exchange. The actor exchanges present conditions and means for what he believes to be a more satisfactory condition in the future. As Mises explain in any action “that which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called the cost…the difference between the value of the price paid (the cost incurred) and that of the goal attained is called gain or profit or net yield.”[5] Every action towards any end at the very least takes time and energy and can be judged on whether the end was attained or if the end was worth the means it took to achieve.

Notice Mises did not say that the objective of every individual is to make money but to make profit. “The originary praxeological categories of profit and loss are psychic qualities [that is, they are in the mind of the actor] and not reducible to any interpersonal description in quantitative terms. They are intensive magnitudes. The difference between the value of the end attained and that of the means applied for its attainment is profit if it is positive and loss if it is negative.”[6] One person uses certain means to maximize their leisure time and to enjoy the outdoors or family, while another more greatly focuses on monetary revenue and a material lifestyle. Both are motivated by the chance to profit; to reach their ends based the subjective value each of them place on these two different ends.

This reveals the absurdity of any universal dictum against profits. “The businessmen are blamed because the only thing they have in mind is to succeed. Yet everybody—without any exception—in acting aims at the attainment of a definite end. The only alternative to success is failure.[7] Hence it is rather silly to say, without qualifying, “that people should not try to profit off each other.” It may be well meant but this would be akin to saying that people should not try to be successful in their actions in achieving their ends. Part and parcel of entrepreneurship, and indeed of human action itself, is the profit motive–to gain more than you lost.

There is of course of a more narrow use of the term entrepreneur which von Mises and Rothbard use beyond their introductory works on human action. Any economic actor who employs scarce means in anticipation of uncertain rewards may rightly be considered and thought of as entrepreneurial. Yet Rothbard referred to the capitalist-entrepreneur specifying it to one who buys factors or factor services in the present while his product is sold in the future.[8] As has been noted fundamentally connected to this then is the reality of uncertainty and risk. While there is an element of uncertainty and risk in all action the entrepreneur takes this to a new level. As Rothbard notes “none of these future values or events is known; all must be estimated, guessed at, by the capitalists. They must advance present money in a speculation upon the unknown future in the expectation that the future product will be sold at a remunerative price.”[9] The wage earner faces little uncertainty and is paid at the end of the week or month. His wage is not put on hold until the finished product is sold and bears no relation to the success of the product. Entrepreneurial profit and loss is only possible because there is uncertainty about the future. “If all people were to anticipate correctly the future state of the market, the entrepreneurs would neither earn any profits nor suffer any losses.”[10] The knowledge of the future would already be incorporated into the price now.

In the narrow sense of analyzing entrepreneurs and their economic function (or catalytics) we can distinguish: laborers, landowners, capitalists, and entrepreneurs. All groups in the broad sense of purposeful human action profit, but not in quite the fashion that entrepreneurs do. Laborers earn a wage which is relatively risk free and timewise comes long before the profits of a venture of realized. Landowners (land is a very broad concept in economics) earn steady and stable rents on land, storefronts, building, and plants more akin to an interest rate. Capitalists earn interests and dividends by making their savings available to others to use in the present. The entrepreneur however earns profit or loss in its own category from these other economic functions.

Thus Mises definition of market entrepreneurs was those who stand to suffer/gain capital losses and profits from adjustments, or as Rothbard labeled them capitalist-entrepreneurs. “There is a simple rule of thumb to tell entrepreneurs from non-entrepreneurs. The entrepreneurs are those on whom the incidence of losses on the capital employed falls. Amateur-economists may confuse profits with other kinds of intakes. But it is impossible to fail to recognize losses on the capital employed.”[11] Losses are what uniquely set entrepreneurs apart. This is why risk and uncertainty are fundamental to the Austrian conception of the entrepreneur. No other actor in the economy faces them quite like the entrepreneur.

Marxists claim profit is the exploitative extraction of the surplus value of labor. Entrepreneurial profit to them is simply underpaying wage earners and cutting them off from the fruits of their labor (“alienating them”).  While the Marxists claim wage labor and profit is simply exploitation of the worker few are demanding that wage earners also share in an enterprise’s losses in addition to its profits. When it comes to the great risk and uncertainty of a vast structure of production that will only pay off later volunteers to share in losses as well as the profits is suddenly lacking. The wage earner does not see the great service the entrepreneur does for him. The wage earner comes to work and labors diligently with the full assurance that he will be paid at the end of the week regardless of the fact that the products he himself worked on that day may not be in store shelves for months, or worse yet, may not sell at the price or quantity level expected. The capitalist-entrepreneur removes the burden of risk and waiting for income from the worker. There are vast swaths of production processes that would be untenable because the wage earner could never last that long without an income. The capitalist-entrepreneur provides a sort of division of labor to risk and savings–having not previously consumed all his income he invests, pays the worker in advance (regardless of success), and takes upon himself the risk of losses. (Next posts will be What is a Profit?)

“All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent, the more they are subconsciously aware of this fact. There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill-got.” – Ludwig von Mises (Profit and Loss, 22)

[1] Murray Rothbard, Man Economy & State with Power and Market, 624.

[2] Ludwig von Mises, Bureaucracy, 20.

[3] Ibid.

[4] Murray Rothbard, Man Economy & State with Power and Market, 4.

[5] Ludwig von Mises, Human Action, 97.

[6] Ludwig von Mises, Profit and Loss, 26.

[7] Ibid, 47.

[8] Murray Rothbard, Man, Economy, & State, with Power and Market¸510.

[9] Ibid.

[10] Ludwig von Mises, Profit and Loss, 7.

[11] Ludwig von Mises, Profit and Loss, 12.

Written by Brian Jacobson

Brian Jacobson works as a quality technician for a manufacturing company in St. Louis, Mo where he lives with his new bride. He studied biblical and theological studies at Reformation Bible College under R.C. Sproul in Orlando, FL. He’s an Old-School Presbyterian who enjoys the simple means of grace, Machen, and living the high life on a budget. Follow him @briankjacobson on Twitter.