How Obscene Are Profits?
OCTOBER 01, 1983 by HENRY HAZLITT
Henry Hazlitt, a frequent contributor to The Freeman, has a long and distinguished career as an economist, journalist, editor, and literary critic. Best known of his numerous books is Economics in One Lesson, originally published in 1946 and since translated into ten languages with sales of more than 700,000 copies. The recently revised edition is once more available in inexpensive paperback.
A few months ago in these pages, I hinted that in this allegedly “capitalistic” country, the dominant ideology, as revealed daily by the majority of politicians, TV programs, and the press, was anticapitalistic. This is shown by the endless number of faults daily alleged against capitalism. I dealt specifically with ten of these charges, as presented in a letter from a troubled young college graduate, in an effort to reassure him that the alleged faults, if they were serious, were in any case not inherent in the capitalistic system as such.
But one criticism that was surprisingly not in his list of ten is probably the most frequent of all. It is made every day by at least some politician, or some TV program, or some newspaper, charging that as a result of “unrestrained” capitalism this or that person or firm has just been caught making “obscene” profits. Or it is charged that under capitalism profits are in general inexcusably high and wages shamefully low.
One reply to the first of these charges is that it is very fortunate in the long run that profits are sometimes extravagantly high, because this incites more people to become entrepreneurs, stimulates increased production in the line in which the high profits exist, and eventually brings down the relative price that consumers have to pay for that product.
As for the general charge about the relation between wages and profits, it is easily shown that the truth is the exact opposite. In 1982, according to the calculations of the U. S. Department of Commerce, the U. S. national income amounted to $2,436.6 billion, the wages and salaries of workers to $1,856.5 billion, and corporate profits before taxes to $174.9 billion. In other words, wages were more than ten times as great as corporate profits.
The comparison is much the same if we consult Table B-12 in the latest Economic Report of the President (February, 1983). This table presents the “gross domestic product of nonfinancial corporate business” for 46 years, including 1929, 1933, and every year from 1939 on. If we take 1981, the last year for which final figures were available, we find that these corporations paid in that year $1,150.1 billion as compensation to their employees, had ]eft profits before tax of $186.6 billion, and paid their stockholders $52.9 billion in dividends. In other words, the wages paid by these corporations were six times as great as their profits, and twenty-one times as great as the amount paid out to their stockholders.
I find I was also calling attention to this typical distribution in an article in The Freeman in August 1979, in which I presented tables of both the dollar and percentage distribution of corporate earnings for the years from 1949 through 1978 inclusive. (In the last ten years of this comparison, employees got an average of 90.2 per cent of the combined total available for division between the two groups, and stockholders an average of only 9.8 per cent—a 9 to I split.) But in view of the persistence of the Marxian myth that the workers are mere “slaves” of the bourgeois class, are systematically “oppressed,” and are subjected to “naked, shameless, direct, brutal, exploitation” (in the words of The Communist Manifesto), the real distribution cannot be presented too often.
Concerning the Accuracy of the Statistics
Before I go further, I should say a word about the official figures I have just been citing. Are they accurate? My reply is that I believe them to be careful and conscientious. Especially when we consider that all values are ultimately subjective (as the “Austrian” economists have reminded us) there are basic questions to be raised about the validity and meaning of estimates of such things as total national income.
Questions about legitimacy are much less serious when we are dealing with such smaller and more explicit figures as the total of money-wages and corporate profits and dividends. But even such estimates have to be extrapolated from smaller samples. For example, the Department of Commerce estimates of the total net profits of some 2.7 million corporations are based on the total net profits reported to the Internal Revenue Service by only 85,000 of the largest corporations (including all with assets of more than $25 million). But I have neither the detailed knowledge nor the statistical skills to second-guess the Department’s official figures, so I am assuming them—with one reservation—to be good enough for our present purposes.
That reservation concerns not the government compilation, but the accounts of the individual corporations. In an inflationary period such as we have been having, net profits are likely to be systematically overestimated, because costs, for example, are likely to be systematically underestimated. Depreciation is apt to be written off against acquisition cost, rather than against present or future replacement cost.
There remain further questions to ask about profits. What per cent are they of the total national income? What is the net burden that they impose upon the consumer?
Let us take these questions in order. First, let us look again at the official estimates of profits. The national income for 1982 is estimated at $2,436.6 billion and corporate profits before taxes at $174.9 billion. But we must also add to this second figure the profits of small unincorporated business—the farmers, grocers, butchers, drug stores, independent gas stations, and so on. We find these estimated under “proprietors’ income”—for farms $19 billion, for nonfarms $101.3 billion. From this we get a total of $295.2 billion. This would come to about 12 per cent of the national income.
This figure may seem modest enough, compared with most popular assumptions, but now we have to ask a further question. Is the estimate too high?
The answer turns partly on what we decide to call a “profit.” Economists—including those in the Department of Commerce—now conventionally divide the sources of personal income into wages, rent, interest, capital consumption, and profit.
Profits Tend Toward Zero
With the exception of a few socialistic writers, economists have seldom deplored profits. Adam Smith, the father of classical economics, viewing the problem historically, looked forward to a time when profits would tend to diminish. John Stuart Mill, in his Principles of Political Economy (1848), wrote a special chapter on “The Tendency of Profits to a Minimum”—though his conception of “profits” included what economists are now careful to separate as “interest.” Since a little after the appearance of Alfred Marshall’s Principles of Economics in 1890, an increasing number of economists have even agreed that under conditions of perfect competition pure profits tend to fall to zero.
This conclusion will amaze most laymen, but there are economists who go even further. Frank H. Knight, in his book Risk, Uncertainty, and Profit, which appeared in 1921, concluded that “pure” profit is probably a negative sum: “The writer is strongly of the opinion that business as a whole suffers a loss” (p. 365); and “It seems probable that with society and human nature as they are, the individual not only charges nothing for this [risk-taking] service, but pays something for the privilege of rendering it—on the average” (p. 368). The entrepreneur did this, Knight believed, not because he was an altruist, but because he was an optimist. The typical entrepreneur not only believes that the business on which he has embarked will enjoy higher than average profits, but he tends to be overconfident about his own abilities.
Can we reconcile such a conclusion—or even the conclusion that profits tend to be non- existent on the average—with the Department of Commerce profit figures that we have just been citing?
Let me remind the reader that what we are now discussing is not the total amount that the typical entrepreneur receives, but what he receives in the form of “pure” profit. Part of his income in any one year may consist of what he receives for his managerial labor (or would receive as salary if he worked for somebody else); part of it may represent the equivalent of interest on his investment; part of it what he might otherwise have received in rent on his buildings; and part of it capital consumption, represented either by insufficient write-offs for depreciation or withdrawal of previous savings.
So there is no irreconcilable contradiction between the positive figures of corporate and individual “profits” that the government compiles and the conclusion that on the average “pure” profits may be zero or even a negative sum. We need merely recognize that corporations tend to earn, for the most part, little more than the equivalent of interest on their investment (even though it is called “earnings” or “dividends”) and that entrepreneurs, on the average, tend to work for less than they might otherwise have received from others in salary.
So, finally, what should be the buying public’s political attitude toward the profit-seeker, the entrepreneur? Broadly speaking, it should be just the opposite of what it actually is.
All entrepreneurs are trying to meet better than others the needs or wants of the consumers. If, under competitive conditions, one company is making greater profits than others—even “inordinate” profits—it means that it is serving the wants of consumers better. Either it is supplying them, in their own judgment, a product superior to that of its competitors, or it is supplying them with it at a lower price. (It could not be selling it to them at an obviously higher price, for they would not buy it.) It is selling the product at a lower price, or making a greater margin of profit at the same price, because it has learned how to cut costs below its competitors. So profits, under free competition, cost the consumer nothing—or less than nothing.
If the consumer ought to get mad at somebody, it ought rationally to be at the unsuccessful competitor, the company that is losing money. Forsuch a company is wasting resources. The value of the resources it is pouring into manufacturing and selling a product is greater than the value for which that product can be sold. True, the losses fall in the first instance on the unsuccessful company itself, but in the long run its failure tends to impoverish the rest of us, because it has wasted capital that could have been employed in supplying something at a lower cost that was more needed.
It is not rationality that leads politicians to denounce what they call “obscene” profits, but an appeal to envy. Their denunciations lead to the conclusion that profits deserve to be punished by heavy taxation. But as Ludwig von Mises once put it: “Taxing profits is tantamount to taxing success in best serving the public.”