The following is a guest post by my friend Michael Stahlman.
Profit (and loss) is an amoral market signal that guide economic transactions. It works automatically within the price system to direct goods and services to the persons most willing to pay for them, and this usually reflects society’s collective demand for scarce goods and services. When demand increases, price increases, which increase profits in the short run to encourage more production of the good or service. Likewise, when supply increases, prices fall which reduce profits in the short run and production is reduced. In fact, in any voluntary exchange, both parties profit by necessity; an exchange will not occur unless both the seller and the buyer benefit by it.
Profit also provides the incentive for businesses to be increasingly efficient with resources. Consider the efficiency in home heating and cooling. In Germany, the standard house used 30 liters of oil per square meter per year for heating and cooling in 1982. Twenty years later, that number dropped to 1.5 liters (McDonough & Braungart, 2002). Without loss, there wouldn’t be an incentive for many homeowners to invest in more efficient windows and insulation. The link between profit and efficiency can be seen more clearly in regimes that attempt to ban profit. Although it is theoretically possible to be efficient without markets, profits, and prices, the high informational and computational costs make efficiency unlikely (Prato, 1998). This is because the coercion that is necessary in a system without profit stifles innovation. In the Soviet Union, a premier noted that managers avoided innovation like the devil avoids incense (Sowell, 2004). This is not surprising, considering that in Stalin’s Russia failure was treated like sabotage. In socialist India, the most popular car was the Ambassador which remained relatively unchanged from the original, which was a copy of the 1954 Morris Oxford (Sowell, 2004). As Thomas Sowell says, “Profit is a price paid for efficiency” (2004, p. 81). Without profit, there is little incentive for entrepreneurs or anyone else to take the risks that are necessary to improve efficiency and drive economic development.
Profits tell us nothing about the morality of the market, only the incentive to produce the good. By looking solely at profit, it is impossible to tell if a company uses slave labor or high wage workers, if the demanded good was drugs or baby formula, nor does it inform us if the transaction was voluntary or under duress. But we do know that if a market is subject to competition, then the morality of society can be expressed through markets. For example, even without government regulation, the greediest businesses won’t remain solvent for long if they sell shoddy goods or have prices too high. In the 1990s, Nike changed its child labor practices due to market pressures. “The Nike product has become synonymous with slave wages, forced overtime and arbitrary abuse. I truly believe that the American consumer does not want to buy products made in abusive conditions” (Cushman, 1998). Although profit is seen as a motive for people to act immorally, this example show that it can also force companies to act morally. In short, profit is not something that can behave or misbehave; it merely reflects and reacts to real conditions.
Deriding profits as immoral may just be an easy scapegoat for bad policy. A state representative once told me that the “Law of Unintended Consequences” was the greatest law in the land. This was because he learned over the years how policy and laws with good intentions can incentivize immoral conduct. In New York City, the only way for some landlords to avoid massive losses due to the rent control laws was to save money by neglecting services, accepting bribes, or committing arson and selling the land to industrial or commercial uses (Sowell, 2004). Furthermore, when the laws were changed to compensate tenants who lost their apartments from arson, tenants began to commit arson (Sowell, 2004). Similarly, the Aid to Families with Dependent Children act in the United States became infamous for its significant immoral consequences prior to 1996; it made fathers uneconomical in the low income levels of society while encouraging single mothers to have more children in order to receive more money from the government program (Codevilla, 2009). Were the benefits they earned immoral? No, the profits were an incentive to commit an immoral action; it reflected real conditions as set by law.
Profit is a function of the irreparable laws of supply and demand. These basic market forces are present in any regime and work to transmit information about how society collectively desires to distribute scarce resources. In this sense, markets are purely amoral; they provide information about interactions in the economy but are incapable of declaring the morality of the interactions.
Codevilla, A. M. (2009). The Character of Nations: How Politics Makes and Breaks Prosperity, Family, and Civility. Basic Books. New York.
Cushman, J. H. Jr. (1998). “Nike Pledges to End Child Labor and Apply U.S. Rules Abroad.” The New York Times, International Business. http://www.nytimes.com/1998/05/13/business/international-business-nike-pledges-to-end-child-labor-and-apply-us-rules-abroad.html?pagewanted=all (28JAN10).
McDonough, W., Braungart, M. (2002). Cradle to Cradle. North Point Press. New York.
Prato, T. (1998). Natural Resource and Environmental Economics. Iowa State University Press. Ames, IA.
Sowell, T. (2004). Basic Economics: A Citizen’s Guide to the Economy. Basic Books. New York.