PROFITS & CAPITALIST PRODUCTIVITY:

A BARGAIN AT TWICE THE PRICE

FUTURECASTS online magazine
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Vol. 3, No. 8, 8/1/01.

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 The benefits conferred by current and prospective profits:
  The benefits conferred upon us by profits are beyond calculation. Nevertheless, it remains fashionable in certain influential academic and intellectual circles to disparage the profit motive and the capitalist commercial activity that it drives. Yet, profit driven, market directed capitalism is the goose that lays the golden eggs that makes possible all our lives, and all of our freedoms and liberties - including those of its critics.
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  Current and prospective profits:

  • induce the production of goods and services;
  • inspire the assumption of risks;
  • cause the elimination of inefficient and outmoded facilities and enterprises;
  • aid in the essential task of allocating scarce resources;
  • induce and determine the growth, maintenance, and destruction of productive capital;
  • dictate a high degree of ethical conduct whenever repeat business is important - which comprises the vast majority of commercial transactions; and,
  • provide essential mechanisms for the efficient management of complex economic entities.

Wages, salaries, and fringe benefits are the profits of human capital:
  As "wages," "salaries," and "fringe benefits," profits induce productive labor and efforts to develop human capital. Human capital undoubtedly constitutes the largest percentage - and most stable segment - of the capital structure of a modern capitalist economy.
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 Interest is the "time-cost" of money:
  As "interest," profits provide and maintain debt capital. Interest provides an essential guide to the time-cost of money, without which it is impossible to calculate whether a given project is worthwhile - and whether, if worthwhile, it is being pursued rapidly enough or too rapidly.
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 Rent is the costs and profits of capital invested in and around land:

 

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  As "rent" - which is actually almost entirely comprised of the costs and profits of capital invested in or around land - profits assign priorities to the use of land, and provide guides as to the amount of capital that should be invested in and on land, and on the nature of the capital assets placed upon the land.
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  While the amount of land is limited, there is no limit to the amount of capital that can be invested in and around land. The Malthusian stupidity crashes on these rocks.
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 Profits are a cost of doing business:
  Profits -just like interest and rent, are an ordinary and necessary cost of doing business - and should be treated as such under the tax laws. Unfortunately, they are not - resulting in profoundly noxious economic and financial distortions.
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 Profit centers and sales charts are indispensable tools of management:
  As an accounting convention, profits are the primary feature in the mechanism by which complex economic organizations and relationships can be managed without the imposition of the labyrinthine bureaucratic controls inherent in the administration of complex government and nonprofit organizations. By establishing separate semi-autonomous "profit centers," a complex economic entity can provide middle management the discretion needed for efficient operation while efficiently assuring competent performance.
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 Capitalism is far from being a perfect - but is by far the best - economic system:

 

Capitalism is the only system capable of raising large numbers of people out of poverty.

  Capitalism is not an utopian concept. It is true, of course, that profit driven, market directed private enterprise capitalism cannot provide everything that society needs. It is true that it does not provide a magic wand. Economic development and rising living standards take much time and effort.
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  From the beginning, in Adam Smith's "The Wealth of Nations," capitalism was presented as an inherently imperfect system in an inherently imperfect world. It is merely, by far, the most effective system available for allocating scarce resources and producing goods and services for general public consumption. It is the only system capable of raising large numbers of people out of poverty.
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  To criticize capitalism for not meeting all of society's many needs is like criticizing a fine hammer for failing to cut down a tree.
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 The Marxist propaganda myth:
  Marxists and other leftist ideologues try to present all profits, interest, and rent as unnecessary to the production of goods and services. Only labor and management are viewed as necessary. Profits, interest, and rent, therefore, are viewed as available - under some future utopian nonprofit economic system - for use to achieve the betterment of mankind.
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All profits are theft:

 

 

 

 If you destroy profits, you destroy the capitalist economy.

  

The acceptance of Marx as a serious economist is one of the most irrational episodes of intellectual history.

 

 

Without the reward of profits, economic development comes to a halt or drags at a snails pace as men shy away from assuming the ordeal and risks of enterprise. Without the risk of personal loss, the "moral hazard" problem causes destructive recklessness.

  

That the vast majority of commercial transactions take place in an atmosphere of trust is a characteristic unique to competitive, private enterprise capitalism.

 

The right to fail is as important as the right to succeed.

  

Without profits, there is no solution to "The Middle Management Dilemma."

 

Rational economic planning is impossible without knowledge of the time cost of money, rent, and personal compensation rates.

 

 

 

 

 

 

  Marx attacked profits ("All profits are theft!") precisely because he knew that a capitalist economy must collapse if profits are destroyed. He constructed his ridiculous propaganda myth to convince people that profits - an absolutely essential factor in capitalist productivity - are unneeded and can be dispensed with.
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  This ridiculous view has been given serious consideration in the academic and intellectual community to an extent that is one of the most troublesome aspects of 20th century intellectual history. Respected authorities, like Profs. John Kenneth Galbraith and Lester C. Thurow, have made a career of disparaging the capitalist system. They have routinely advocated policies and offered advice that has been the exact opposite of what was needed to maintain healthy growth.
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  Even today, there are those who disparage capitalism - believe it to be unstable - resent its great and growing success - and ardently await its collapse. It is inevitable that this intellectual trend will continue well into the 21st century.
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  The capitalist "risk-reward" ratio is the only mechanism evolved by man that promotes economic activity that is both energetic and prudent. Without the reward of profits, economic development comes to a halt or drags at a snails pace as men shy away from assuming the ordeals and risks of enterprise. Without the risk of personal loss, the "moral hazard" problem causes destructive recklessness.
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  Yes, "greed is good."
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  But "fear" is necessary, too.
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  Stated in terms that are not pejorative - both the right to succeed and the right to fail are equally as important. Protectionist efforts to guarantee success are just as destructive as Marxist efforts to destroy profits. There must be no "Freedom from Fear" for economic managers.
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  Private enterprise capitalism is the most ethical economic system devised by man. Every day, tens of billions of dollars in commercial transactions take place on  the basis of nothing more than a phone call and established relationships. Even if competition is far from perfect, as long as it is robust, profitability requires a reputation for ethical conduct. This is because profitability almost always depends on repeat and referral business. Personal reputation and brand name reputation remain among the most valued of assets.
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  Scandalous conduct does work in commercial transactions - primarily because it is sufficiently rare that it almost always catches people by surprise. Yet, ethics is not a "normal" human trait. Tendencies towards unethical conduct become apparent in transactions where it is difficult to judge quality or where repeat business is not a factor. Auto repairs and "alternative health care" treatments for chronic ailments are notorious for the difficulty customers experience in judging reliability. The "fly-by-night" contractor is a well known cliché.
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  That the vast majority of commercial transactions take place in an atmosphere of trust is a characteristic unique to competitive, private enterprise, profit driven, market directed, capitalism.
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  No economic management decision-making process can succeed without the use of profits. For example, in the early 1970s, a Congressional Procurement Commission, after two years of concentrated analytical effort, utilizing the services of hundreds of experts, failed to come anywhere near a solution for government's "Middle Management Dilemma." Lacking profit and loss statements and meaningful sales charts for profitable goods and services, there is still no way for complex, nonprofit economic organizations to give middle management the discretion needed for efficient operation while maintaining control adequate to prevent abuses of discretion  and to assure competent performance.
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  Without profits, there can be no "profit centers" with which to efficiently organize complex economic entities.
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  Without the time-cost of money, rational economic planning is impossible. For years, one of the notorious weaknesses of Soviet economic planning was the tendency to devote resources to starting many new projects at the expense of existing projects.
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  Without the aid of interest costs to reveal the time-cost of money, there was no way to judge the rationality of proposed projects, or whether the start of a new project should be delayed so that resources could be concentrated on completing existing projects. In the Soviet Union, huge cranes and other expensive equipment stood idle for months besides slowly progressing construction projects. Maintenance of most existing facilities and equipment was deferred with devastating consequences.
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  Similarly, rents provide essential guidance for the efficient use of real assets, and personal merit compensation provides essential guidance for the efficient use of labor and management skills.
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 Controls that restrain returns on capital adversely distort economic and commercial flows:

Price and rent controls result in flights of capital, abandoned and deteriorating buildings, and gross reductions in the production of many lines of goods and services.

 

  Price, wage, and rent controls that restrain returns on capital and labor have similar consequences. Rent controls routinely result in the destruction of housing stock. Wage controls inevitably break down over time as workers withhold labor and otherwise refuse to be constrained. Price controls grossly distort production.
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  Typically, price controls cause production to shift away from the lower cost, lower profit versions of the variety of products and services that most people use. Instead, producers expand production of higher grade, higher cost and thus higher profit items. During our disastrous experiments with price controls during the 1970s, for example, manufacturers shifted to higher grade paper for gift wrapping, and hardwood for shipping pallets. Regulated industries - like the airlines and stock brokers before deregulation - routinely "gold plated" their services with added features that most customers would willingly do without to keep costs down.
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  Price and rent controls result in flights of capital, abandoned and deteriorating buildings, and gross reductions in the production of many lines of goods and services.
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 Business taxes are just taxes on consumers and workers:
  Business taxes - including taxes on profits - reduce capital. Taxes on dividends have destroyed huge amounts of equity capital, much of which has been replaced by debt capital - which is a far more unstable form of capital. Inevitably, the absolute reduction of capital is enough to limit production to levels where almost all the burden of the taxes can be passed on to customers as higher prices, and/or to employees as lower wages and salaries.
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  When businesses can no longer pass these costs on to their customers, they either decline or are eliminated, leaving surviving producers with competition that is sufficiently diminished to enable them to raise prices and/or lower wages and salaries sufficiently to pass all their net costs - including taxes and profits - on to their customers and workers.

  Businesses pay almost no taxes! Businesses exist for the sole purpose of passing on all their costs to their customers. These costs include taxes. Taxes cannot permanently reduce profits below levels at least adequate enough to justify the raising and maintenance of capital. The real purpose of business taxes is thus to turn businesses into tax collectors to squeeze additional tax revenues from business customers - the general public.

 Imperfect competition means higher costs, but still confers massive benefits:

 

 

 

Antitrust law enforcement is the best way to limit excessive profits.
  Like any other costs, profits can be excessive. This can occur in the absence of price competition. Adam Smith recognized that the monopolistic tendencies of business, labor, and government were a primary threat to the effectiveness of a private enterprise, capitalist economy.
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  Even when competition is limited, profits provide essential management tools unavailable to the management of nonprofit organizations. Also, especially when accompanied by the threat of antitrust action - or the threat of entry of new competitors - even imperfect competition generally bestows substantial benefits upon the consuming public.
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  Despite very limited and imperfect competition, the deregulation of such industries as the airlines and telecommunications have bestowed vast benefits on the consuming public. The facilitation of competitive markets and vigorous enforcement of the antitrust laws and are the best government policies for protecting the consumer against excessive profits.
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 Even "excess profits" confer many benefits:

 

 

 

By 2003, if not sooner, there will be a glut of electric energy supplies and the nation will enjoy very low electric rates -- except in California.

 

 

 

California will have to force its citizens to buy its overpriced electricity, or it will be stuck with massive amounts of high priced power that nobody wants.

 

 

 

From 2003 onwards for the rest of the decade, there should be ample supplies of energy to fuel world economic growth.

  However, "excess profits" - realized when some unexpected economic, military or natural disturbance suddenly restricts supplies, play a positive role in the economic adjustment process. Price controls and excess profits taxes can grossly extend the time and expense of the disturbance.
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  This is what happened during the phony "energy shortage" of the 1970s. Even just the threat of excess profits taxes and price controls can destroy all incentive for farsighted businessmen to take the risks of investing in or even maintaining excess capacity for use in the event of future supply shortages.
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  The "obscene profits" earned this year by electric energy suppliers in the California market have been doing their job. New generation capacity is being brought on line throughout the west at a rapid rate. By 2003, if not sooner, there will be a glut of electric energy supplies and the nation will enjoy very low electric rates -- except in California.
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  With exquisite stupidity and bad timing, Gov. Davis has committed his state to 20 year long term contracts at ridiculously high rates. Instead of entering into long term contracts at the beginning of the crisis - for the 3 to 5 years needed for the market to respond - he delayed until the worst phase of the crisis - then panicked.
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  California is now burdened with the highest prices for much of its electric energy for the next 20 years. The state government will have to force its citizens to buy this overpriced electricity, or it will be stuck with massive amounts of high priced power that nobody wants.
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  Of course, if there were antitrust violations, the perpetrators should be suitably punished. But it was colossally stupid to believe that the markets would not work to increase supplies enough to bring prices back down to normal levels within the time it takes to build new power plants.
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  In the oil market - another market that has long lead times on its supply side - we see new energy supplies streaming on line in response to oil prices of about $25 per barrel. Although we might still run into energy shortages if economic recovery is vigorous, there should be plenty of energy for the world's needs during the last years of the decade. The more successful OPEC is at maintaining the current price levels, the more ample energy supplies will be.
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  The markets work -- a hell of a lot better than politicians or regulators -- even where competition is imperfect and there are long lead times on the supply side.

  Profits are as legitimate and necessary an economic cost as the cost of labor and raw materials. Only the automatic disciplines and controls of the profit and loss statement - and the sales charts for profitable goods and services - enable free men to conduct their economic lives free, to a large extent, from the smothering controls of bureaucracy and the destructive whims of politics.
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  We owe a great deal to the profit system, and must protect it against the misguided policies of government and the stupidity of leftist ideologues.

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Copyright © 2001 Dan Blatt