September 28, 2015

Profits, Entrepreneurs, and the Social Welfare: What is Profit II

By In Blogs, Brian Jacobson

(This is the third post in a series see part 1, and part 2)

What is Profit?
In the last piece I described the economic function of entrepreneurial actions and profits as recognition and action against maladjustment. They correct economic mistakes regarding the use and distribution of factors and scarce resources across an economy. But what are profits in relation to consumers, value, and general social utility? Can profits be excessive? Should there be a certain rate of profit? Does chasing profit necessarily mean that one is greedy? Many in their defenses of profit and capitalism suppose that we must simply embrace greed and extol self-interest while demeaning anything less as altruistic fancy. This is not the case nor is it necessary for the Reformed Libertarian to embrace in order to defend profits as a good (morally and socially). Instead we argue the conclusion that the process of the free market (of which the profit motive is key) always leads to a gain in social utility and the most efficient distribution and use of scarce resources across a society.

As argued in the beginning of this series all action is exchange, even in the case of a solo actor. All action seeks to profit. To cease attempts profit altogether would be a stagnant and motionless world. An individual acts because he supposes that by performing that action circumstances will be better for him than they otherwise would have been had he not acted; else he would not have done it. He exchanges the present situation and circumstances for what he hopes is a more satisfactory situation. That is, he trades what he desires less for what he desires more.

This is still the case if we introduce a second person into the situation. If these two (voluntarily) exchange we must conclude that both exchange because they expect (ex ante) that it will benefit them; otherwise they would not have agreed to the exchange. It is not simply that as they barter they reach an “equality of value” between the two items proposed for the exchange, but each individual necessarily values more highly the good he receives than the good he gives up. Not only is there not an equality of value (as Aristotle supposed) but a double inequality of value in that each individual values what the other has more than what he has.

“Thus, suppose A and B are the two exchangers, and A gives B good X in exchange for good Y. In order for this exchange to take place, the following must have been their value scales before making the exchange:

A                                              B
1—(Good Y)                            1—(Good X)
2—Good X                               2—Good Y

A possesses good X, and B possesses good Y, and each evaluates the good of the other more highly than his own. After the exchange is made, both A and B have shifted to a higher position on their respective value scales. Thus, the conditions for an exchange to take place are that the goods are valued in reverse order by the two parties.”[1] The above account is purely devoid of monetary units. All actions (and by definition exchanges) have costs and can succeed (profit) or fail (loss) in attaining their end. As Mises explains “That which is abandoned [good X for A, and good Y for B in the above] 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.”[2] The cost “is equal to the next best use that he could have made of the resources that he has used.”[3]

But what if we introduce money into the equation? Does this change the nature of exchange? No, people are still trading what they value less for what they value more in comparison to each other. Money however becomes a measurement of value. It is a universal medium of exchange by which most goods and services can be bought and sold. It is a common denominator of value. Just as common denominators in fractions allow us to more easily compute fractions so money prices allow us to see and compare the value of goods and services that are not alike. It makes calculable the incalculable psychic phenomena of profit and loss from which goods derive their value. Money isn’t a good which we value for its own sake, since we do not consume it, but for its value as a commonly accepted medium of exchange. If one exchanges a certain amount of money for a good he is still exchanging the next best use of that money he could have had for the item he purchases. There still must be a reverse and double inequality of valuing between the buyer and the seller of the value of the good in their in mind and the value of the money (or what it might purchase); they both shift to a higher position on their value scales. As Frank Chodorov stated “it is as pertinent for the buyer to say ‘thank you’ as for the seller.”[4]  We can then conclude with Rothbard that “the free market benefits all its participants,” since “every exchange demonstrates a unanimity of benefit for both parties concerned.”[5]

Again, profits are not a normal or automatic phenomenon that anyone with capital receives at a certain rate simply by going through some set of motions. While it is true that the seller (in our case entrepreneur) always prefer the highest possible selling price for his good the converse is also true that buyers will always prefer to purchase his good at the lowest possible price. Thus for an entrepreneur to profit it must be the case that a sufficient amount of consumers valued his product more than the next best thing their money could buy and have moved up their value scale. They are better off than they were if they had not purchased it (according to their own value scales). If this brings in more revenue than the entrepreneur spent on the inputs of his product he has made a profit. As consumers spend and refrain from spending they reveal their demonstrated preference of what they genuinely value and in what proportion to other goods they could have bought with that money.  Consumers by their buying and abstaining determine market prices of goods, which in turn set factor prices, and therefore consumers decide which entrepreneurs succeed or fail.

Entrepreneurs who misjudge consumer’s value scales and devote resources to an unprofitable product have used factors that were more urgently demanded by consumers elsewhere evidenced by their lack of willingness to purchase the failed entrepreneurs good. Thus those who profit are those who best judged consumer value scales, that is they have best served the consumers and their desired ends. This inevitably leads to the conclusion that if money is a common denominator of value, then profits are the measurable successes of entrepreneurs in serving consumers in the most efficient manner. The larger the profits the more he has served consumers! And the greater his efficient use of scarce resources and therefore more resources are available elsewhere and for other products to serve consumer ends. As Murphy says “if an individual’s flow of income in a market is a reflection of the flow of services he provides to the consumers, then the individual’s stock is a reflection of the consumers’ evaluation of his stewardship of a collection of resources.”[6] Material resources can be used in innumerable ways either for different commodities or to make the same commodity in a different way. The higher the profit the better those materials have been arranged. Profit is service performed and value created measured by a common means of exchange.

This is why I say that it is unnecessary and unhelpful for Reformed Libertarians to embrace a kind of Randian libertarianism (Ayn not Paul) which glorifies greed and selfishness. Profit and loss are key components of reaching optimal social welfare across the board. It is the profit motive itself which pushes entrepreneurs into service of consumer’s most urgent desires. For the entrepreneur to be constantly searching for profits simply means for the entrepreneur to be ever looking to adjust production for the greater satisfaction of his neighbor and greater social utility as a whole. Entrepreneurs attack high prices and ill-used resources. If nature abhors a vacuum the free-market abhors inefficiency and large profit margins. Through efficiency entrepreneurs preserve and steward value and through innovation they create value. This is why profiting is not a zero sum game. One man profiting does not mean that another man’s lost. He may very well have created something that previously had no value! To profit in this sense is to add wealth to society not simply transfer it within.

Now we can observe absurdity of the non-problem of excessive profits. One may be in agreement with all of the above yet still say we must be against “excessive” profits, through taxation after a certain percentage of profit. What exactly would this mean? For instance suppose a plant producing widgets uses C amount of capital to make X amount of widgets with L labor which sell at S price and render a profit P.
C+L=X                                    S – (C+L) = P
However firm B produces the same widgets using 2% more capital and 3% more labor to produce the same amount of widgets. Their profits look like this:
⇑2%C+⇑3%L=X                     S – (⇑2%C+⇑3%L) = ⇓5%P
The State regulator looking from above only at the net gain decides that firm B’s profit level is more “fair” and through taxation equalizes the profit margins between the companies. What does it mean that firm B has been more socially responsible and reduced their profits to a fair level? It means “the entrepreneur was less efficient and because his lack of efficiency deprived his fellow men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.”[7] Taxing profit beyond an arbitrary level only promotes socially irresponsible use of scarce resources and hurts consumers. “Taxing profits is tantamount to taxing success in best serving the public…it is waste, praised as virtue.”[8]

Another common myth about how profit is made is the artificial restriction of production in order to increase price. The truth most likely is “that the production of a commodity p is not larger than it really is, is due to the fact that the complementary factors of production required for an expansion were employed for the production of other commodities. To speak of an insufficiency of the supply of p is empty rhetoric if it does not indicate the various products m which were produced in too large quantities with the effect that their production appears now, i.e., after the event, as a waste of scarce factors of production.”[9] It is silly to blame entrepreneurs in a given field for supposed shortage of commodity A since they are those who have taken it upon themselves to make more. “Certainly those engaged in the production of steel are not responsible for the fact that other people did not likewise enter this field of production.”[10] This would be like blaming your local orchestra for a lack of good live classical music in the area. Or blaming of the lack of enlistees in an army on those who have already joined. Entrepreneurs in any area are those who have already joined the fight against scarcity. So long as entrance into a field is not prohibited or limited by the interference of state agencies any artificial restriction in production will simply yield a profit opportunity for other entrepreneurs and capitalists.

But in truth, people’s problem with profits is not and never has been because they view it as bad for the economy or social utility, but simply envy. It is the simple case of the speck in the entrepreneur’s eye missed for the plank in the sluggards. Mises says as much when he notes our profit hypocrisy, “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.”[11] If others earn a profit it is because they are crafty and devious. If we earn a profit it is because we worked hard and slaved, envy is a weakness indeed.

(see part 1 and part 2 of the series)

[1] Murray Rothbard, Man, Economy, and State with Power and Market, 85.

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

[3] Murray Rothbard, Man, Economy, and State with Power and Market, 104.

[4] Frank Chodorov, The Rise and Fall of Society.

[5] Rothbard, Toward a Reconstruction of Utility and Welfare Economics, https://mises.org/library/toward-reconstruction-utility-and-welfare-economics-0#4a.

[6] Robert Murphy, Choice: Cooperation, enterprise, and Human Action, 140.

[7] Ludwig von Mises, Profit and Loss, 21.

[8] Ibid.

[9] Ibid, 15.

[10] Ibid.

[11] Ibid, 22.

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.