April 25, 2011
Profits and the Profit Motive
Recently, an online commenter of this column suggested I write about profits. That was a fine suggestion, and so I shall. Most folks define profits as the money left over in a business after all the costs of producing a good or service has been paid. This is fine of course, but economists view profits as something more—they are payment to the men and women who organize and lead business. We call these people entrepreneurs. So, economists argue that some profits are the cost of doing business, for if you don’t pay someone to lead businesses and make the risky decisions, no one shall.
Profits are much maligned, and the profit motive is oft depicted as synonymous with greed. Indeed, the term “corporate profits” is reliably uttered only with sneering condescension. I hear this most often from those who, like myself, work in fields divorced from profit; government, universities, clergy, and non-profits. This is disheartening, not so much because it is simply misguided, but rather that these fields above all others demand intellectual rigor. Disdain drawn from ignorance is intellectually lazy.
Profits vary significantly across industries. Just as with wages, higher risk industries demand higher profits. Unfortunately, some profits are derived from monopoly power. Economists view this as undesirable, which is why we have anti-trust laws. Modern monopolies, which are rare, exist primarily because they can exclude competitors from a market. Government regulation, it should be noted, is the biggest enabler of monopolies.
It is often said in Op-Ed pages that corporate profits are at a record high. That is true of course, but so is the number of flush toilets worldwide. The latter data contains more useful informational content about the human condition than does the record profit claim. It is the percent of profits of total production that matters.
Since 1929, corporate profits in the U.S. have averaged 8.1 percent of gross domestic product (GDP). The low point was in 1933, when profits sank to a -0.5 percent. The profit peak was in 1942 at the beginning of the war effort, with 12.4 percent. Wages, it should be noted, are more like two thirds of GDP.
Claims of record profit rates are rubbish. In fact, corporate profits have been largely stagnant or declining over my lifetime. The last seven presidencies have had below average corporate profits. The Johnson/Kennedy, Ike and Truman periods saw the highest corporate profits, with 10.4 percent, 9.8 percent and 10.1 percent respectively. The Nixon/Ford, Carter and Reagan/Bush periods saw profits of 7.7 percent, 7.6 percent and 7.5 percent respectively. The Clinton, Bush, Obama periods have seen 8.0 percent, 7.8 percent and 7.4 percent respectively. Since modern records started in 1929, only Clinton avoided a recession, and profits during his presidency were still below the 80-year average.
Much maligned, profits and the motive for getting them are, in truth, the most critical part of an economy. The quest for profits directs society’s scarce resources towards their most productive use. Without profits and the entrepreneurs who earn them, we would all enjoy the prosperity of North Korea.
About the Author
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