Profits have a bad name these days. The resurgent far left has historically had an inherent and profound distrust of the profit motive, owing back to Marx’s concept of surplus value – the yield on capital investment in excess of labour cost. But doubts about the incentives created by the pursuit of profits extends beyond the far left into mainstream politics. The profit motive has long been demonized within certain industries like health care or utilities, which are seen by a majority as services to be provided by the state and as incompatible with private enterprise and the pursuit of profits. Indignant howls of ‘profiteering’ is regularly heard, and any talk of privatizations in the NHS is unfailingly met with the claim that private profits is money that could have been reinvested into the cash-strapped health service.
What counts as profits constitute a very small part of total economic output, but play a pivotal role in allocating resources and motivating risk taking. In a capitalist economy, it is the entrepreneur who must anticipate the future state of markets in order to organize production to satisfy consumer demand at an economic price. The role of profits is to reward risk taking and to signal that the cost of supplying a service or product is lower than the value put on the output by the consumer; that is, secure that through the entrepreneurial process value is being added. Should another entrepreneur compete for the same production inputs to produce another product, he will, if he can add more value, generate larger profits and be able to outbid his competition for input such as labour or land. Such competition for inputs encourages business to continuously strive for improvements in production methods, leading to falling prices and rising living standards. This is how, through increased productivity, real remuneration of land and labour (wages) rise. Should the entrepreneur incur a loss, the market signals for him to stop production as resources are being wasted; the value of labour and capital required to produce the product is higher than the value of the product itself. As such, the mechanism of profit and loss, in interplay with consumer demand, secures the most efficient allocation of resources possible, determines what products will be produced in what quantities and drives productivity increases and real wage growth.
The emotional public debate ignores the economic function of profit and often completely disregards the risk of loss. Regularly, profit is nonsensically debated in absolute terms, not in relation to capital investment (return on equity). But most frustrating is the indignation reserved for private provisions within the NHS. Under the banner of ‘patients before profit’, a popular movement routinely protests at any attempt to outsource even the most basic services within the health service. The notion is that all services should always be provided in-house, to avoid leaving money on the table that is skimmed by private companies in the form of profits. By the same logic, no private company should ever outsource for example cleaning, catering or logistics, as any profit earned by 3rd party providers would come directly out of the pocket of shareholders. This is clearly non-sensical.
The distrust of profits takes many forms. This year, reports of price gouging in areas affected by the US hurricane season were met with outrage. What an indignant public failed to appreciate is the role prices play in a free market. By hiking prices, vendors of scare products like water, hotel rooms and gasoline rationed use – for example, a family of four might choose to huddle together in one expensive hotel room, freeing up a room for others in need – and encouraged additional supply – seeing the high price of bottled water might encourage vendors from out of state to load up a truck and set up shop in affected areas. Showing no appreciation for such economic realities, all the public saw was profiteering.
The question of how to allocate resources in the most efficient way does not disappear because public provision of goods and services removes the price mechanism. It only becomes impossible to answer. The state can only substitute the price mechanism with a system of political bargaining, patronage and lobbyism. Profits are not a tax on the consumer, it is a reward for delivering value and a signal that resources are being used in a way that creates, not destroys, wealth. Profit drives risk taking, productivity increases and innovation and is in many ways the basis for civilized society. Social systems that have tried to abolish private profits have always failed, succumbing to misallocation of resources, wastefulness and corruption.