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Guest Blog: Thinking About Profit

| 15 Comments | 1 TrackBack
From one end to the other today. Randy Paul guest blogs about concentration, M. Simon guest blogs about profit. Neither talks about Hernando de Soto's work, which serves as a bridge between the two posts and issues. Profits by M. Simon bq. "Concentration of wealth is a natural result of concentration of ability, and recurs in history. The rate of concentration varies (other factors being equal) with the economic freedom permitted by morals and the law... democracy, allowing the most liberty, accelerates it. -- Will and Ariel Durant I might add that one other thing that advances wealth accumulation is rapid changes in technology. We're about to under go a very major transition in energy technology, from a fossil fuel dominated economy to a fossil fuel free one in about the next 70 years. This is bound to concentrate wealth in the hands of those who can build and finance the revolution. This new wealth will be built on that nasty five letter word - profit. What is profit? How should we think about it?
Profit is a measure of relative efficiency - in a reasonably honest market. We do want the rewards to go to those who honestly earn the greatest profit. It is the best way to increase the efficiency of the system. Getting the efficiency up is the best way to meet the needs of the poor. Which is why I left the progressive camp. I would count myself as a progressive except that every time I have scratched below the surface of a progressive I have found a socialist. Don't get me wrong, I have a lot of respect for socialist ideals. It was why I was a socialist many years ago; but they tend to think of profit as sin. I think of it as the reward for reducing waste. So we have to ask ourselves how well has profit been working? Let's look at one small measure. The median income for blacks - the lowest performing "class" in our economic system - is now $2,000 a year greater than the median income of Sweden - a socialist paradise. Did you know that Sweden is on the decline economically while America and its blacks are still advancing? In a rapidly changing economy some will do better than others. The increases in efficiency will benefit everyone, but not equally. No doubt the tide rises faster in some places than others but it has been lifting all boats. Concentrating the money where there is the most honest profit is the fastest way to increase the efficiency of the system. What about crooks who steal our money by simulating increases in efficiency while really they are just fakes and frauds? News flash - there have always been fakes and frauds. It is an inherent part of every market. The rule "buyer beware" is a very old one for a number of reasons. Very old reasons. Human nature has not changed a lot in the last 5,000 or so years. So what do we do about the frauds? Expose them from time to time, take our lumps for being gullible, learn something, and get on with our business. I think Enron is a perfect example of how a free market handles failure. The failure collapses but the real market, while wounded, heals and starts real growth again. Go to wind.enron.com - What shows up is GE Energy Corporation. What real value Enron had has been redeployed by another more honest (we hope) company. If they are not honest I predict the real resources will get redeployed again because they have real value. Real value is what every investor should be investigating, and real profits. The real problem as always is not the frauds but our own cupidity. Our system is a harsh one. The only advantage it has over any other is the results it delivers especially in two very important areas for our well being: # An continuous incentive to increase efficiency; and # Better living with continuously lower effort. I would explain why third world "sweatshops" are good for America and good for the world, but I've run out of space and time. Another time perhaps. (c) M. Simon - All rights reserved. M. L. Simon is an industrial controls designer for Space-Time Productions and a Free Market Green. Permission granted for one time use in a single periodical. Concurrent publication on the periodical's www site is also granted.

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Tracked: September 2, 2003 9:37 AM
Property from Liberty Father - Not a Grey World
Excerpt: WOC has a fine pro-DeSoto article. M. Simon had also written a fine note on profit, in July....

15 Comments

M. -

This just bears little resemblance to any reality that I know. There are a number of places where markets operate imperfectly other than via fraud; I could, for example, a) use my wealth to legislate competiiton out of the market (being done right now by the gambling-rich California Indian tribes), or b) I could use my wealth to make it impossible for a smaller competitor to stay in business (see Standard Oil). Neither of these are fraudulent, and all of them keep profit from flowing to the 'most efficient' competitor.

This isn't to suggest that we abandon government (which some libertarians suggest we do in response to a.) or control businesses by fiat (as some socialists suggest in response to b.). An economy is a complex representation of the flow of good and services through a society with a history, social patterns and standards, and laws created by politics.

Some theorists (a la Rawls and Rand...where'd you think you'd see the two of them linked!) ignore that complexity in order to create a kind of society as a gedankenexperiment (a simplified, unrealizable thought experiment). It's useful to look at their work, but dangerous to assume it is a useful representation of reality.

A.L.

just a typo alert; your link to de Soto comes as
htthttp://...
which needs to have the first three letters deleted.
(you might delete this comment after fixing it).

Tom

Joe,

I posted back in January about a study that a Princeton University Phd candidate who has done a study of land titles in Peru. Link rot has set in from my original post, but you can access her work here.

I think that de Soto is absolutely right regarding the legal and business value of land titles and much of the above paper confirms it.

I thought that "profit" was a nasty six letter word. Damn gummint must've raised taxes again.

Ok, more seriously:

"Getting the efficiency [of the market system] up is the best way to meet the needs of the poor."

I don't think the relationship between the two is nearly so obvious as to dismiss the needs of the poor (which justifiably arises as a major concern when presented with free-market idealism) as somehow automatically dealt with by an increase in profits.

"[Socialists] tend to think of profit as sin. I think of [profit] as the reward for reducing waste"

Neither statement could come remotely close to understanding the sourcees of profit in a vast, modern economy.

Regarding the section on median income, comparisons in U.S. dollars are hardly helpful as they aren't adjusted for cost of living. To address again the issue of "the best way to meet the needs of the poor", a more useful statistic might be to look at child poverty rates. The aforementioned Sweden has the lowest rate with 2.4% of children living in poverty, while the United States comes in at a staggering 20%--one out of every five children in this country (see *this press release from Syracuse University*. For what it's worth, I'm much more interested in childhood poverty and poverty rates in general than I am median income or other measures for any single ethnicity, for reasons that I hope are intuitive).

Simon then goes on to write:

"Concentrating the money where there is the most honest profit is the fastest way to increase the efficiency of the system."

Yet immediately goes on to dismiss out-of-hand his own concern for "honest profit".

"What about crooks who steal our money by simulating increases in efficiency while really they are just fakes and frauds? News flash - there have always been fakes and frauds. It is an inherent part of every market."

But how are we then to concentrate our money in centers of honest profit? The ensuing appeal to historical authority is uncompelling, not in the least because most of us (at our age) would be dead, half of our children would have died at an early age and existince was a hell of a lot more nasty, brutish and short than it is today. One can't simply appeal to history to adopt the business ethos of the neolithic in isolation.

Enron is, of course, a great example of the harm an underregulated free market can do. I encourage Simon to present his argument to the thousands who lost their life savings to those crooks, or better yet, the capitalists who lost billions due to Enron's fraud.

And I can't wait to hear how sweatshops (with forced child labor, beatings in response to unionization, etc., etc.) are good for the world.

Profit is NOT: "... a measure of relative efficiency - in a reasonably honest market."
Profit is just the owner/manager's (often unreasonable) share of the economic pie created by his company's economic activity. Of all those involved in producing a 'product' the owner/manager has the most power to manipulate the size of his share relative to the others, by law. And o/ms aren't normally shy about shortchanging the other stakeholders to the real detriment of real people.

Simon has a preference for efficiency over effectiveness that shows the extent of his delusion for another point. And lastly, the economic equation is so inadequate through its lack of comprehensiveness (there are HUGE hidden variables) that it's essentially the material man's delusion of choice.

I did not read M. Simon as putting "profit" on an alter, but rather as making the narrower point of looking at profit as a measure of relative efficiency (or productivity) and the general social advantages of incentivizing creation of efficiency (not necessarily to the exclusion of all other considerations, such as equality). The general principle holds that seeking to improve people's lives through equality and fairness without sufficient regard for profit will be counterproductive .

An example of this principle that I have seen is in structuring utility concessions: for example, distribution of water or electricity. If the operator's margin is fixed at a constant 7%, he has no incentive to increase efficiency. On the other hand, if you let him keep half of all efficiency increases, he can be incentivized to increase his profit (say by 3%) and offset prices to end users by the same amount. That sort of difference becomes even more important in a third world economy. The same effect could be achieved by bringing in a competitor (not usually feasible in natural monopolies). A telephone call from Paris to New York (a formerly monopolistic market) costs 1% of what it cost 25 years ago (in real terms). Someone had an incentive to make a profit.

On Enron, I'll pass. If any major company (GE, City Bank, Morgan Stanley) goes under tomorrow because of, say, an unexpected market or regional risk, the press will immediately find that the books are cooked and that they did a thriving business with Uday and Qusay Hussein.

I have an idea what M. Simon might tell us about sweatshops. How many families in impoverished regions of the world have the do-gooders cause to starve to death because those families no longer had the dollar a day to buy food that Nike was paying them?

I don't think anyone this side of San Francisco believes that 'profit' is evil, or, more importantly, that machine-invention is the moral equivalent of machine-stealing (see this post for an explanation). But to simply say that 'profit is the sole means by which society should be steered toward desirable ends' is as silly as my Marxist professor's comment.

We want to make sure the pie is bigger, first, and then make sure there's pie to share.

A.L.

Milton Friedman says that if the government been limited in to it's Constitutional functions (no social welfare) it would have grown at the rate of 10% a year. (faster than the rate we had in 2000 - 2001)

At that rate had we started in 1953 the economy would be over 25 times bigger than it is now. Had the poor only captured 10% of the increase they would be 2 1/2 times better off than they are today. In addition the poverty level would have been redefined to $50,000 per year vs todays $20,000 or so. Wouldn't it be nice to see poor people earning $50,000 a year?

Equality of outcome is not what real progressives want to strive for. Real progressives should be working to increase the income of the poor even if it means the rich do very much better than the poor.

Besides if you will remember 2000 - 2001 period minimum wage jobs went begging because better paying jobs were available to any one who wanted one.

I'd rather have a rich growing economy with jobs for every one rather than equality. The poor will do better.

===========================================

Using government to gain favored status in the market has a technical term. Rent seeking. The way to prevent this is to limit what government is allowed to do. The more socialist the economy in a democratic society the more rent seeking. Since a socialist system is alread in the meddling mode what is one more meddle? France is much more socialist than America. Tell me which system is more corrupt? Or take the most socialist market of all with a total government price support program of destroying as much of producers output as possible. The dope market. Is it more or less corrupt than the auto market?

In fact a study of the dope market would show more about capitalism in action than almost any other market you could think of. Government can't prevent capitalism from working. No government ever has. All government can do is affect the efficiency of capitalism. The more the government does for "equality and fairness" the less efficient the market. The greater the opportunity for "illegal" and unwarranted profits.

============================================

Most of what is called "market failure" is due to government intervention. The solution is not another layer of rules but the elimination of rules. The regulated oil market of the 70s is a perfect example. We had lots of corruption. "New oil" vs "old oil" tricks. People sending "old oil" out in tankers for a round trip that netted huge profits. Ronnie R. put an end to oil price regulation and the illegal profits and shortages disappeared. I propose doing the same every place there is a "market failure". If it worked for oil it could work for anything.

=============================================

The best and fastest way to get the pie bigger is to reduce the government drag on the economy. The best way to decide who shares the rewards of the increased pie is to give the most rewards to those who do the most to increase the pie. You really have to decide what you want - a bigger pie faster or equality of results. Every rule you make to increase the equality of results reduces the rate of pie growth. Over a working lifetime of 50 or 60 years the differentials really mount up. Working for equality of results hurts the poor more than it hurts the rich. Which is why I left the socialist camp. It is why I am a capitalist profit oriented progressive rather than a socialist equality of result oriented progressive.

=============================================

Standard oil was the result of natural market oriented forces. Markets consolidate as profit from new ideas decline. We see this today in the computer market. In 1978 there were hundreds of companies making personal computers for a somewhat limited market. Today there are only a few. In 1978 with demand growing at a rate of 5X to 10X per year any one could make a profit in the business. Today the growth rate has flattened, profits have declined, and there are only a few major companies in the market. Smaller profits means only a few very efficient companies can stay in the market. Standard oil followed the same progression in it's day. At first only a little capital and a little luck was required to strike it rich in a rapidly expanding oil market. Once the market expansion slowed only few major players could compete. Standard oil increased the efficiency of oil distribution. Had they set their profit margin too high they would have attracted competition. Had they set it too low they would have gone out of business. Of course by setting their profits lower than previously available they drove lots of small inefficient distributors out of the market. Which is exactly what you want in order to increase efficiency. Standard with its large capital profited well by lowering profits below what he independents could live with. The consumer ultimately got oil at the lowest possible price.

=========================================

In the Soviet Union every one got their fair share according to the law. The owner/managers still profited disproportionately to the workers. Was the Soviet economy as fair to the workers as the American economy? As far as any one can tell for the last 20 or 30 years of the Soviet economy the workers lot was in decline. Fairness is way over rated if you look at history.

==========================================

Let me mention that like a number of commenters I was a hard core fairness is everything socialist/communist until I was in my late 20s early 30s. I know all the arguments. I also know they are all theoretically correct but in the real world bunk. I will repeat: in capitalist America our lowest "class" is doing better than the average socialist Swede. And the gap is increasing in favor of our lowest class. The average Swede can't compete with our disadvantaged blacks. Why do you suppose that is? After all the average Swede is probably better educated than the average black. So why is s/he falling behind? Do you suppose it is as Charlie Manson has said "the system"?

============================================

Where ever you see large companies dominating a market you have a market with relatively low profits. When you have many small producers you have relatively large profits. The large producer can divide it's overhead over many more transactions than the large producer can. The large producer will be shrinking the labor force continually over time; which is exactly what you want to do when demand and profits are falling. The small producers will be adding labor; which is exactly what you want to do when demand and profits are rising.

The opening should be:

Milton Friedman says that if the government been limited in to it's Constitutional functions (no social welfare) the economy would have grown at the rate of 10% a year. (faster than the rate we had in 2000 - 2001)

Well I screwed the typing syntax and sentence structure at a number of points. Still it is clear enough so you can figure out what I meant so I'm not making any more half assed corrections.

:-)

Simon

A company makes a profit when the value of its products (as determined in the market place) exceeds the value of the resourses consumed to make the products. As Peter Drucker has stated, companies have a social responsibility to make a profit, otherwise, they are not utilizing resourses well.

Note that during times that businesses are making good profits, jobs are plentiful, people get raises, governments have sufficient revenues, and the mood of the country is generally good.

During times like now when profits are tough, none of the above is true.

Better a late comment? Real profit is also the best measure of the real increase in the size of the pie.

Monetary input costs of land/resources, labor, & capital are less than outputs of produced services.

On the other hand, gov't rules, and especially limited liability for companies, owners, and managers, allow such travesties as Enron.

The investors deserved to lose in Enron; the workers investing their retirements much less so. I'm glad it took Anderson down; but most big acc't firms are very similar (and ALL would have been happy to take over the Enron account for Anderson, and do about the same job).

Sustainability is a GREAT word -- only companies making consistent profits are sustainable. In this respect, profit is the single BEST number to measure the sustainability of a company.

And it's the job of the gov't to make rules such that there is constantly a strong incentive to be more honest. The last 20 years of corporate governance have been a disgrace towards that end.

This rambling argument makes little sense and has been done much better elsewhere.

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