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Economics in One Lesson
conditions of business averaging the experience of the last fifty years
prevail, about seven of each ten grocery stores opening today will sur-
vive into their second year; only four of the ten may expect to celebrate
their fourth birthday.” They do not know that in every year from 1930
to 1938, in the income tax statistics, the number of corporations that
showed a loss exceeded the number that showed a profit.
How much do profits, on the average, amount to?
No trustworthy
estimate has been made that takes into account all kinds of activity,
unincorporated as well as incorporated business, and a sufficient num-
ber of good and bad years. But some eminent economists believe that
over a long period of years, after allowance is made for all losses, for
a minimum “riskless” interest on invested capital, and for an imputed
“reasonable” wage value of the services of people who run their own
business, no net
profit at all may be left over, and that there may even
be a net loss. This is not at all because entrepreneurs (people who go
into business for themselves) are intentional philanthropists, but
because their optimism and self-confidence too often lead them into
ventures that do not or cannot succeed.
1
It is clear, in any case, that any individual placing venture capital
runs a risk not only of earning no return but of losing his whole prin-
cipal. In the past it has been the lure of high profits in special firms
or industries that has led him to take that great risk. But
if profits are
limited to a maximum of, say, 10 percent or some similar figure, while
the risk of losing one’s entire capital still exists, what is likely to be the
effect on the profit incentive, and hence on employment and produc-
tion? The wartime excess-profits tax has already shown us what such
a limit can do, even for a short period, in undermining efficiency.
Yet governmental policy almost everywhere
today tends to assume
that production will go on automatically, no matter what is done to
discourage it. One of the greatest dangers to production today comes
from government price-fixing policies. Not only do these policies put
one item after another out of production by leaving no incentive to
1
Cf. Frank H. Knight,
Risk, Uncertainty and Profit
(Boston: Riverside Press, 1921).
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The Function of Profits
143
make it, but their long-run effect is to prevent a balance of produc-
tion in accordance with the actual demands of consumers. If the
economy were free, demand would act so
that some branches of pro-
duction would make what government officials would undoubtedly
regard as “excessive” or “unreasonable” profits. But that very fact
would not only cause every firm in that line to expand its production
to the utmost, and to reinvest its profits in more machinery and more
employment; it would also attract new investors and producers from
everywhere, until production in that line was great enough to meet
demand, and the profits in it again fell to the general average level.
In a free economy, in which wages, costs, and
prices are left to the
free play of the competitive market, the prospect of profits decides
what articles will be made, and in what quantities—and what articles
will not be made at all. If there is no profit in making an article, it is
a sign that the labor and capital devoted to its production are misdi-
rected: the value of the resources that must be used up in making the
article is greater than the value of the article itself.
One function of profits, in brief, is to guide and channel the fac-
tors of production so as to apportion the
relative output of thousands
of different commodities in accordance with demand. No bureaucrat,
no matter how brilliant, can solve this problem arbitrarily. Free prices
and free profits will maximize production and relieve shortages
quicker than any other system. Arbitrarily-fixed prices and arbitrarily-
limited profits can only prolong shortages and reduce production and
employment.
The function of profits, finally, is to put constant and unremitting
pressure on the head of every competitive business to introduce fur-
ther
economies and efficiencies, no matter to what stage these may
already have been brought. In good times he does this to increase his
profits further; in normal times he does it to keep ahead of his com-
petitors; in bad times he may have to do it to survive at all. For prof-
its may not only go to zero; they may quickly turn into losses; and a
man will put forth greater efforts to save himself from ruin than he
will merely to improve his position.
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Economics in One Lesson
Profits, in short, resulting from the relationships of costs to prices,
not only tell us which goods it is most economical to make, but which
are the most economical ways to make them. These
questions must be
answered by a socialist system no less than by a capitalist one; they
must be answered by any conceivable economic system; and for the
overwhelming bulk of the commodities and services that are pro-
duced, the answers supplied by profit and loss under competitive free
enterprise are incomparably superior to those that could be obtained
by any other method.
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