23Sep
EconomicsNewsOpinionWorld

In Defence of Profits, Part I

 

One of the most infuriating bumper stickers has to be the one that reads “People Before Profits”. This insufferable slogan bespeaks an endemic and illiterate assumption in anti-market thought: the notion that profits are counter to the interests of people; that they are, by definition, exploitative. After all- a worker produces a product, but keeps less than the full proceeds of that products sale. The heartless capitalist keeps the rest, skimming off the ‘surplus value’ of the worker’s labour. How could this not be unjust?

Very easily. Why?

To explain, we must ask a third question of the ‘profits-as-exploitation’ camp. Would you loan someone $1 million for the promise of repaying you exactly $1 million ten years from now, even assuming you could guarantee that the person would repay you and that inflation would be 0%? Unless you wanted to be charitable, the answer is no. Because you would forfeit the benefit of that money for ten years, to obtain no reward. You cannot be sure that in that intervening ten years, you will not find the best opportunity to spend that money, or another investment opportunity that does yield some return. You cannot even be sure that you will still be around in ten years to spend it. For these reasons, present dollars are worth more than future dollars, so for people to defer consumption, and thus allow others to bring consumption forward, they must be paid a premium.

Suppose a builder wants to earn a living by building a house and selling it. It takes him five years to build a house that will certainly sell for $1 million meaning his average productivity is $200,000 per year. However, this income will only be realised when he sells the house, meaning that he will certainly starve in the intervening five years. He either has to go through the agonising process of accumulating five years of consumer goods to tide him over, or he can take out a bank loan. However, he will only have $1 million to repay the loan plus interest, thus limiting him to borrowing, say, $800,000 to support him over five years, at an average income of $160,000.

Or, he can work for a capitalist, who will promise to pay him every week for five years until the house is sold, in return for keeping the entire proceeds of the sale- $1 million. However, the capitalist will obviously not pay him $1 million in wages over five years, only to obtain $1 million dollars at the end of it. After all, he could simply put that money in the bank and earn interest. But unlike the bank, he does not have to advance five years’ wages to the builder all at once, but progressively, rendering his opportunity cost lower. Therefore, he may be willing to pay the builder $175,000 per year, which the builder will willingly accept, as it saves him the arduous process of accumulating enough capital to last five years.

The same phenomenon holds for all products, even if they do not take as long to produce as a house. Producing one’s own bread requires not just flour and yeast, but an industrial oven, an array of utensils, and most expensively, a premises to store and sell the bread. And aspiring baker can spend years accumulating this capital for himself, or implicitly rent the capital of a bakery owner and work for a wage less than the marginal revenue he brings to the bakery.

So to summarise, wages are essentially an implicit loan, and profits are therefore just an implicit form of interest. More specifically, profits are the premium a capitalist receives for forwarding workers the proceeds from the end product of the workers’ labour, and in doing so, deferring his own consumption, in order that they may bypass the lengthy and life-threatening process of accumulating the necessary capital and producing the product itself, such that workers will be willing to work for less than their marginal revenue product at a rate discounted by the real interest rate, given the market’s preference for present consumption over future consumption.

What part of that don’t socialists understand?

 

Read Part II and Part III here.

John Hajek

John Hajek is the IPA Campus Coordinator at the University of Melbourne.

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