The real story behind
profit
by Isaac Crawford
The concept of profit is a
nebulous and contentious one with many people. Ideas such as
"profit is exploitation" and "profit is never earned" are very
common, but they show a real ignorance of what it is and what it
accomplishes.
One reason for this is the
confusion between what accountants and economists consider profit.
Economists usually trumpet the virtues of profit, but everyone
thinks of accounting profit. What they see is how someone else
(perhaps their employer) gets a "profit" and the company got it
through their hard work! Surely this is unfair, if someone does the
work, they should get the "profit" from that effort.
To understand what economists
call "profit", let's look at why the worker continues in this
"unfair" arrangement. The worker needs money for a variety of
reasons, so work will be required (we're going to ignore government
hand outs for the time being). He looks at the available jobs,
applies for some, and some of them offer to hire him. Let's look at
some hypothetical examples of job offers:
1) The first job offers him a yearly salary of $27,000. It is a
fairly undemanding (for him) job, regular hours, no overtime, and
is close to where he lives.
2) The second job offers him a position that pays $52,000 a year.
It is a management position and there are a lot of responsibilities
and pressures. It is also requires a bit of a commute.
3) The third job pays $107,000 a year. He would be a company rep,
traveling extensively (3 1/2 weeks a month), endless meetings,
phone time, and will require 60-70 hour weeks in order to get
everything done.
4) The fourth job is a commission one. There is no guaranteed pay,
but people are earning anywhere between $40,00-$450,000 a year.
Like all commission jobs, there are long hours, and there is a lot
of effort required in order to make a living. The best performers
are putting in 60-70 hours a week and put up with endless
rejections and abuse from so-called leads.
So which job does he take?
Here's where the concept of economic profit comes into play.
Obviously, the money that each job offers is only one of the
criteria that the worker has to think about when trying to choose a
job. When you are in the accounting mindset, the only thing that
matters and is counted is the money. Everyone engages in economic
reasoning even if they don't realize it. Cost benefit analysis is
the technical jargon for what happens. The worker weighs the amount
of the benefit (in this case we're assuming that it is mostly the
salary and what it will allow him to do) vs. what it will cost him.
Economic cost (or opportunity cost) is the next best thing you give
up in order to get whatever it you want. For example, if the worker
values time with his family, he will have to weigh the "cost" of
seeing them less for more money. Obviously, there isn't a way to
quantify that exactly, but we can get a rough idea of how much he
values it by the choice he makes.
If he picks the traveling rep
job, it is obvious that he values the $107,000 more than time with
his family. On the other hand, if he picks the management job, it
becomes clear that he values the time with his family at more than
$107,000 a year. This is called revealed preference, and it is a
powerful way of seeing how people actually value things as opposed
to how they say they value them. There are endless situations and
personal reasons for picking any particular combo of costs and
benefits. Imagine if the guy hates his wife but can't divorce her,
cannot stand commuting to point of it affecting his blood pressure
and health, has a child that needs specialized (and expensive)
medical care, has a child that has very time intensive needs
(retardation, handicap, etc.), or any number of other situations
that could make him choose one job over the other. There is no way
to know what kind of decisions people face, so it is best to allow
them to make the decisions that are best for them.
So the worker makes his choice.
His economic profit consists of the benefits he receives vs. the
cost he incurs. The salary is a big part of that, but do not get
too hung up on the numbers. What is important is what he will do
with the money, not the money itself. He works in order to do these
things, not to make money. Other things that may also be a benefit
include liking the job, having a sense of accomplishment, prestige,
power, etc. The costs are spread across the time spent,
aggravation, time away from the family (although this could be a
benefit for some), stress, etc. The biggest cost is what else he
could be doing. This is what is being given up in order to work at
the job, it is the opportunity cost. As long as the worker thinks
the job is "worth it" and there is nothing better that he can do,
he will continue in the job. He feels that he is getting more than
he giving up.
This does not mean that the
worker loves, or even likes his job. It only means that he feels
that he is getting as much benefit out of a job as he thinks he can
get. Obviously, the more "profit" he gets, the more likely he is to
like his job. This can happen by lowering of the costs (less
stress, shorter hours, shorter commute, etc.), raising the benefits
(more money, more prestige, etc.) or a combination of the
two.
That is a long winded way of
saying that workers profit from having a job. The nature of this
profit can be seen by observing what the worker can do (or feels in
a positive aspect) with the job that he couldn't without it. if
there were no profits to be had, if the job cost more than what he
would get, he would stick with the "normal" unemployed condition. A
job that had no economic profit in it would make him worse off than
having no job at all.
OK, that is all well and good,
but c'mon, the company still makes money off of the worker. That
still isn't "fair." With people, profit can take all sorts of
forms, a nicer home, a new car, sending the kids through college,
not starving, etc. Companies take profit in one form only, money.
Just as the worker will not work if there is no profit for him, the
company will not employ someone if there isn't any benefit to them.
It's pretty simple, each side has to profit in order for the
transaction to take place.
The interesting thing is that
there are opposing forces at work. Each side wants as much profit
as it can get. Sometimes there is no agreement to be had. The
company cannot hire (or continue to employ) someone and achieve the
profit that they want. The employee is not willing to go as low as
the company wants. The worker can go look for another job. The
company has four options:
1) Accept lower profits.
2)"Outsource" the labor to a place that has lower labor costs. This
could mean moving the work from Dearborn to the Philippines or from
Dearborn to Tennessee.
3) Invest in machines (capital) that can do the job instead.
4) Go out of business.
Just as with workers, companies have various reasons to want/accept
certain levels of profit. Pressure from stock holders, trying to
attract investors, or just wanting a good return on the money you
are putting on the line are all common reasons for picking a profit
point. It is important to understand that option #4 is always
available, and a company would rather be "unemployed" than to
operate in a way that brings in a negative profit, or a profit that
is less than the alternative use of the money on the line
(opportunity cost again).
There are many people that
think that things are often skewed so that the company profits (in
all ways) much more than the employees. This is most noticeable in
developing countries. The thing to keep in mind is that the workers
are still enjoying a profit, if they didn't they wouldn't work
there. Along the same lines, if they thought they could do
something else with more profit in it, they would do that instead.
In short, the company is offering them their best alternative.
Remember, there has to be profit on both sides for the exchange to
happen. If a company is facing the decision of where to open a
plant, it will go with the place that, all things considered, will
maximize the profit for the company. The workers pick what will
maximize their profit and the company does the same. While some may
feel outrage that there is more profit on one side than the other,
remember that we are talking about profit. In the places where this
sort of thing happens the most, the people are happy to be able to
profit at all. Development economics is complicated (if it wasn't,
we wouldn't see so much poverty around the world), but this is the
very very short version of how things improve even when there is a
great disparity of profits at the beginning. The basic idea is that
even if the company takes all of its profits back home, the people
working have to do something with their profits. They will purchase
things, so people have to provide those things. The profits from
the first job lead to profits in another and then another... I will
devote another essay to this, but for now take my word that profit
begets more profit. It is a process that takes time. But as long as
we are talking about profits, everyone (company and workers) are
made better off.
The same concepts hold true
when the situation is reversed. When a consumer is trying to decide
whether to buy something or not, they weigh the cost and the
expected benefits. If they think the product is "worth" the price,
they will buy it. That is, if they feel that the benefit is worth
what they have to pay, they will pay the cost in order to enjoy
that profit. For those of you that are still stuck on the idea that
it is "unfair" that a company makes a profit off of the labor
supplied, let me ask you this. Is it fair that someone can pay
$800-$900 for a really nice set of pots and pans for a kitchen and
use them to run a successful restaurant? Those pots and pans may
generate $30,00-$40,000 (or more) and yet the company (and
indirectly the workers) only got $900! There are endless examples
of consumers buying a product and benefitting tremendously in the
financial sense. Cars, tools of all sorts, haircuts, clothes, they
can all lead to better financial outcomes for the consumers that
buy them, is that fair? Should we try to even everything out?
That would be a bad idea. You
see, everything that is bought or made, every job that is
performed, every service rendered, is all done for the sake of
economic profit, or at least the potential for it. If we limit or
try to lessen the amount of profit made by anyone, workers,
consumers, companies, we will have far fewer options. In addition,
all innovations and new inventions have profit as their primary
motive. With a little thought, it will be easy to see why any
sanctions to "punish" companies enjoying "excess" profits will also
punish workers and then consumers. Successful companies are the
source of employees' profits, and the products that the two of them
produce are the source of consumers' prfoits. In the big picture,
all of these categories are the same. Every company is a consumer,
every worker is a producer, and every consumer is an employer. You
cannot affect one without affecting the others. If you look at
countries that limit profit through taxation and other government
meddling, you will see far less innovation. When was the last time
you heard of anything new coming out of France?
Profit is what makes things go,
it is the reward for offering products, labor, or satisfying a
demand. Without profit, or the chance of profit, we have few
products, no jobs, and little happiness. Without the possibility of
a good profit, why would people ever risk the money they had in
order to make a new product? Why would companies try to fill the
gap when there is a want that is not being fulfilled in the market?
Why would anyone work when they could sit around the fire and enjoy
the great outdoors all year long? Economic profit is necessary,
without it, nothing happens. It is difficult to ascribe a definite
good/bad label on accounting profit, but economic profit is
unambiguously good for both the immediate beneficiaries and society
as a whole.