Freeman

ARTICLE

The Invisible Hand, 1980

MARCH 01, 1980 by WILLIAM H. PETERSON

Dr. Peterson is the Scott L. Probasco, Jr., Professor of Free Enterprise and director of the Center for Economic Education at the University of Tennessee at Chattanooga.

Pitiful helpless giant.

Is that what America is becoming, wracked by inflation, energy constrictions and an unfolding recession? If so, it’s all, I submit, for want of understanding the ramifications of one little word: profits.

The immediate problem may have started last March when a 26 per cent advance in fourth-quarter 1978 corporate profits (over fourth-quarter 1977 profits) was greeted by Administration spokesmen as a “catastrophe,” as putting “business on trial,” as “unnecessarily high.”

Then, later in the year, the assault turned on “already enormous” oil profits. In a television address to the American people, President Carter demanded a “windfall profits tax” to curb those who would “cheat the public and . . . damage the nation” via “unearned billions of dollars.”

Catastrophe? Unearned? Cheat? Damage? What goes on here?

This is not the place to engage in extensive statistical rebuttal. Enough to say that inflation causes plant and equipment to be under-depreciated and inventories under valued, due to IRS rules and regulations. Profits become overstated, exaggerated. Remove the resulting phantom profits, and corporate profits are indeed what they have been for a long time, a “catastrophe”—a catastrophic low: for example, a 5.5 per cent return on assets in 1978 against 7.6 per cent 10 years prior. So talk nowadays of “record profits” is really an inflationary mirage, a national delusion.

One result of this prolonged profit famine has been a drop of the current Dow Jones Industrial Average by more than half in real terms since hitting 1,000 in February 1966. Another result has been prolonged weakening in the rates of personal saving, business investment and productivity growth—rates now about the lowest in the Western industrial world, even though they represent pathways to job creation and rising living standards, and offsets to inflationary pressures.

Enough to say, too, that oil profits, when measured as a return on sales or equity, were less than industrial profits as a whole in 1978, that, as President Carter himself concedes, oil price controls—read oil profit controls—have failed, that they have caused domestic oil production to lag almost every year since they were first imposed in 1971.

Profit Controls

Why, then, the masochism in denying ourselves desperately-needed domestic oil supplies via a tax on “windfall profits”? After all, it is profits, or rather, the lure of profits that induces production, not prices. The bigger the lure, as a rather strict rule, the greater the production. This logic is now officially recognized for heavy oil—why not for all oil?

And in view of the overall anti”big profits” campaign (super-market operators and meatpackers have also been singled out), with its veiled implication that perhaps profit itself is somehow unethical, the larger question is: Just what is profit and how, if at all, is it earned?

Critics from antiquity on have equated profit with greed and selfishness. In a typical vein, Cicero wrote in his De Officiis: “Those who buy to sell again as soon as they can are to be accounted as vulgar; for they can make no profit except by a certain amount of falsehood, and nothing is meaner than falsehood.” In 1704 Bernard de Mandeville saw profit as vile in origin but positive in effect in his Fable of the Bees: Private Vices, Public Benefits. Mandeville’s idea was that not only wealth but also the arts and sciences—indeed all civilization—is the result of not the nobility of man but rather his baser nature. In other words, Mandeville labeled as vices normal longings for the good things of life—luxury, comfort, well-being and all the other pleasures stemming from man’s natural wants. And more recently, to cite another example, in the introduction to the Modern Library 1937 edition of Adam Smith’s classic Wealth of Nations (1776), Max Lerner called Smith “an unconscious mercenary in the service of the rising capitalist class,” and held that he gave “a new dignity to greed and a new sanctification to the predatory impulses.”

In truth, profit does extend beyond business and finance. It is, frankly, gain, advantage, self-interest; and it applies to every man, woman and child—even to the altruist, who seeks to profit others. It can parade under other colors—wages, salaries, fees, interest, tuition, rent and so on. It can be seen in the winning of nonfinancial re-wards—say, the captaincy of a football team, a prize in a bridge tournament, a jury’s verdict of “not guilty.” (Conversely, not winning these things involves losses in one degree or another.)

A Natural Motive

The profit-and-loss idea can be readily inferred from the writings of philosophers from Aristotle to Santayana, of psychologists from Freud to Skinner. It can be seen in all human motivation, in every human action, said Austrian economist Ludwig von Mises, holding that profit and loss are ultimately psychic phenomena.

Broadly speaking, I think that what every individual really wants is, in the word of early 20th century labor leader Samuel Gompers, “more”—more as the individual sees it. More happiness as a rule. And more is but another name for profit. Again, I think that given the primordial economic law of scarcity, of the universal urgency to allocate limited resources, including time, man must seek the most for the least, to maximize gain, to minimize loss. Profit-seeking is part of human nature. Nobody is exempt.

Adam Smith saw the immensity and pervasiveness of human incentive, of self-interest, of the profit motive in human affairs when he wrote in The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

This is not to glorify profit. Like sex, the profit drive is subject to abuse. When profit overrides individual rights as in fraud or force, obviously the social fabric is torn. The mugger in Central Park, for example, is obeying his self-interest but to the detriment of his fellow man.

But in any free exchange both parties profit or expect to profit, else the exchange would not take place. Advantage is two-way. Gain is mutual. Moreover, it invariably in volves service to the other or others, and it is immediately reciprocated. It is, in this sense, the Golden Rule in action. The exchangers—buyers and sellers—are saying to each other, in the words of Adam Smith: “Give me that which I want, and you shall have this which you want.”

The profit motive is also a great civilizer. It promotes not only civility and individual responsibility but division of labor and specialization, social cooperation and still more exchanges. Hence productivity improvement emerges as does in time an economic surplus beyond mere provisioning of necessities. Hence the surplus permits the flowering of charity, religion, music, painting, literature, education, science. Hence—if I may accelerate the thought—Western Civilization.

So Montaigne and Marx had it all wrong when they argued one man’s profit involves another man’s loss, that production for profit is at variance with production for use.

The Market at Work

The fact is that the prospect of profit—along with its magnitude—motivates and activates producers, steering production into those uses most demanded by consumers, i.e., into products broadly considered to be the most useful. This is supply and demand in action, the market place at work. As University of Chicago economist Yale Brozen and others have noted, production for profit is production for use.

Indeed, the genius of the free enterprise system is that it can take the profit motive—this innate, inescapable and potentially destructive human trait of self-interest—and peacefully, harmoniously and, above all, voluntarily convert it into constructive channels of human effort, cooperation, service and advancement. Are profits, then, earned? Most assuredly, yes.

In this light the concept of a “windfall” profits tax on oil becomes, however inadvertently, a great deception—a tax ultimately borne not by the companies but by the American consumer, a tax that will hamper the discovery and development of new domestic oil supplies. Windfall? Again, it is the U.S. Government itself that has repressed oil prices, beginning in 1971.

To be sure, repressing and decontrolling prices and then taxing “windfall” gains are done under the name of the public interest. But self-interest in a market system usually advances the public interest more than those who profess to serve the public interest (apart from their own inevitable personal interest). As Adam Smith observed, the indi vidual “neither intends to promote the public interest nor knows how much he is promoting it . . . . By . . . directing (his) industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

Energy availability. Inflation alleviation. Economic growth. Profit motive. All are of one piece.

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March 1980

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