The pivotal role of profits

By Phil Grant

Rep. Alexandria Ocasio-Cortez continuously bashes capitalism and associated profit-making as evil — sources of greed, inequality and unfairness in our socioeconomic system. Obviously she doesn’t understand profits or the very positive role they play in a dynamic, advancing increasing-standard-of-living economic community.

Socialists, in general, have never understood or appreciated how the profit motive works, or how it is good for society. They have never thought that individuals and individual businesses should make production and consumption decisions in the free marketplace, or that a nation’s resources should be allocated by consumer demand and business supply. They think government knows best and should allocate resources according to the inclinations of the power elite in government. Government should control what is produced and consumed, where, when, how much, at what quality and at what price. Government won’t waste stuff; free markets will. Government can distribute resources to assure wealth equality across a population; free markets can’t — so the socialist thinking goes.

When you challenge the socialist, pointing out that decades of experimentation with socialism around the world have not resulted in reduced waste but rather increased waste, and that under socialism wealth inequality has been increased, not decreased, they agree but counter with, “The problem is that socialist principles have just not been implemented properly.” But it is the socialist’s rejection of the critical role of profits in a socioeconomic system that is a major reason socialism doesn’t work.

The opportunity to make profit, or to increase profit, is one of the powerful features of capitalism. Profit drives so many vital economic functions. Socialism has no substitute for it.

Here are some of the reasons profit is so important: (1) Profit potential motivates business efficiency. Profit is revenue minus cost. Improved efficiency means lowering the production cost per unit — producing more with the same resources, or producing at lower expense. It raises profit, but this is good for society; it helps assure scarce resources are used in the most productive way possible.

(2) Seeking greater efficiency, or lower cost per unit, leads to lower prices per unit businesses must charge to cover their costs. In other words, the motivating potential of profits leads to lower costs for consumers. This raises the standard of living.

(3) The possibility of increased profits serves as an incentive for business to invest in innovation, in business expansion, or in improvements to operational processes. This is how we get new products, more product, higher quality product or lower product price — all good things for consumption and employment as well as for improved business profit. Profit also serves as a low-cost source of investment funds.

(4) Profit potential spurs competition. Companies that are in markets generating profit will soon be visited by other firms seeking to participate in the action. Business competition is great for society; it helps keep prices low and provide customers with higher levels of service, better products, more of them, greater accessibility and less business fraud.

(5) In a given business the desire to maximize aggregate profit provides a rational basis for distributing production effort among different products or business departments. You allocate your limited productive resources to the products or departments where the most additional profit can be earned. Since marginal profit decreases as you increase production and sale of any given product, this results in the last units of productive activity devoted to each product or department generating the same marginal profit and the most aggregate profit possible across all products or departments.

(6) From an economic perspective profit is a necessary cost of doing business. It is compensation for those willing to take risks in providing productive resources for potential gain in financial well-being.

Profit for a productive entity shows that more value is being added to society by useful products and services than is being taken away by the using up of resources. The value of that which is produced and sold exceeds the value of the resources used in the process. Businesses that can’t produce greater value than they consume can’t be sustained and eventually disappear from the marketplace. Under socialism, productive entities may be allowed to survive way beyond their useful life. In fact, under socialism, productive entities are often created in the first place to provide no net positive value to society; it depends on the choices and politics of the power elite who run government.

Profit for a business is no different than savings for an individual, or surplus funds for a nonprofit productive entity. It is the difference between the revenues, or incoming dollars, and the costs, or dollars, going out. And profits, like savings, aren’t hoarded forever; they work their way back into the system by being spent and thus becoming someone else’s income.

Often critics of profit say that profits are excessive, exorbitant or even obscene. They cite the billions that Exxon-Mobil, Amazon or Apple made in some year. But usually these billions are distributed among thousands of stockholders such that the “take” per person is not that great. Also, so-called exorbitant profits in one year, or span of time, are usually not representative of profits over time. When average profits are calculated, what seemed like exorbitance before goes away. Further, very large profits are usually not very large when compared to a firm’s total assets, or total investment, or when they are computed as a return on investment. In other words, the socialists’ argument that profits are too great is almost always blown away with further analysis.

It is government’s job in a capitalistic system to assure there is sufficient competition in an industry to deny any one business monopoly power that leads to restricted allocation of profits. Socialism reduces competition and protects bumbling, out-of-date and wasteful bureaucratic monopolies. Under capitalism there are winners and losers; losers adjust their behavior so they can improve and become more successful. Under socialism, there are no winners and losers and, therefore, little incentive to adjust and improve.

Phil Grant, Ph.D., Hon. DBA is professor emeritus at Husson University. He is a longtime management consultant/researcher and author of 13 books plus 200 professional/academic articles.

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