<h2>CHAPTER 31</h2>
<h3>THE LAW OF PROFITS</h3>
<h4>§ I. MEANING OF TERMS</h4>
<div class="sidenote">Broadest use of the term profit</div>
<p>1. <i>The term profit is popularly used as any gain or advantage secured
by any means in business.</i> The terms used in economics, being taken from
popular language, vary in meaning according to the context. It is
necessary to clear thinking to reject some words entirely and when using
others to define them more strictly. The broad usage of the term profits
just noted includes every kind of return to industry: such as interest
on capital, and wages or services of the man owning the industry.
Precise thinking requires its use in a much narrower sense.</p>
<div class="sidenote">Used of gross gains on sales</div>
<p>2. <i>A common meaning of profits in retail business is the gross gain on
a given sale.</i> Buying an article for one dollar and selling it for two
dollars, is said by the merchant to be selling at one hundred per cent.
profit, jocularly called, "The Dutchman's one per cent." The cost price
is considered to be that paid to the manufacturer or wholesaler. In
different lines of goods there is added regularly to this cost twenty,
thirty, or fifty per cent., as the case may be, as the merchant's profit
on the sale. This is of course a gross profit, and not net, or true
profit. It leaves out of account rent, interest on capital, clerk hire,
freight, and many other minor items that enter into the cost of running
a store. It often happens that the Dutchman's way of reckoning is nearer
the truth, and that the gross profit of one hundred per cent. proves at
the end of the year to be only a net<span class="pagenum"><SPAN name="Page_283" id="Page_283">[Pg 283]</SPAN></span> profit of one per cent. This
evidently is a loose meaning, impossible in the discussion of
theoretical questions. This meaning is sometimes developed, making
profits the sum of all the gross profits on separate sales within a
year, or the difference between the wholesale and retail prices of goods
sold within the year.</p>
<p>Another meaning given to the term is gross profit (as above) compared
with the capital invested. The "profit" in this case varies partly with
the rate of the turnover. To illustrate: if the amount invested in a
printing-office is $100,000, and the annual business done is $300,000,
the capital is said to be turned over three times; if the gross profits
on sales averaged twenty per cent., they would be sixty per cent. on the
investment; but, if the capital had been turned over four times, the
gross profit would have been eighty per cent. on the investment.</p>
<div class="sidenote">Of net gains as a percentage of invested capital</div>
<p>3. <i>Another meaning of profits is the annual net gain of the business,
as compared with the average investment of capital.</i> This is a long step
toward greater definiteness. If at the end of a year it were found that
after paying all outside expenses there were $10,000 to set aside, this
would be accounted a profit of ten per cent. on $100,000 invested. But
confusion still reigns because of wide variation in the methods of
estimating costs before fixing net profits. In one case the enterpriser
rents lands and buildings, in another he owns them; in one case he has
borrowed money and counts interest as a cost, in another he is free from
debt; in one case he counts as a part of cost an estimated fair salary
for himself and his partners, in another (usually in a small business)
no such allowance is made Such a variation in business usage is most
perplexing. In all these cases one must have the exact conditions in
mind before it is possible to make any comparisons and draw any
conclusions as to the relative profits of different industries.</p>
<div class="sidenote">Profits in economic theory</div>
<p>4. <i>In the narrower and exacter sense profits are the net gain of the
enterpriser after counting the rent of material agents and contract
wages of employees at the prevailing rates.</i> <span class="pagenum"><SPAN name="Page_284" id="Page_284">[Pg 284]</SPAN></span>Into the practical problem
of cost and profit many factors enter, and the theoretical problem is to
determine just how much ought to be attributed to each. In a large
business usually the practical bookkeeping problem is not unlike that of
economic analysis. A stock company counts as cost, as a part of fixed
charges, interest on capital borrowed either from banks or bondholders.
Its managers are paid salaries, counted as a part of cost. The net
balance, after deducting these and all other expenses, is counted
profits and paid in dividends to stockholders. The economic student is
not attempting to get a theory of profits that is in contrast with
practice. Rather, he is trying to analyze profits generally, just as
they are analyzed in the few cases where the books are properly kept. In
economic theory, therefore, profits are the part of the gain of any
business that is logically attributable to fortunate investment and good
management; profits are the income attributable to the enterpriser's
services.</p>
<div class="sidenote">Profits a species of wages</div>
<p>5. <i>Typical economic profits are thus a species of wages but are marked
by peculiar features.</i> In some of the older treatises on political
economy, profits are treated merely as a combination of "wages of
management," and of interest on capital invested. A man hired at a fixed
sum to manage a business is receiving simply contract wages. Economic
profits are not <i>contract</i> wages, not being paid by agreement, but being
yielded impersonally by the industry. Profits are, however, <i>economic</i>
wages or the earnings of services. As business has developed, it has
been seen that the enterpriser's work has its peculiar character and
deserves special attention. The old English word "enterpriser," used of
the "adventurer" who embarked in foreign trade, may fittingly apply to
the organizer and director of business to-day. Foreign trade then, more
often than now, was most uncertain, and there were many chances that the
ship would be lost, or the venture prove a losing one. In the simplest<span class="pagenum"><SPAN name="Page_285" id="Page_285">[Pg 285]</SPAN></span>
business to-day there is this element of enterprise, or undertaking,
combined with ordinary capital and labor. As industry develops, this
special service stands out more clearly. In the corner-grocer and in the
manager of the little news-stand, the elements of enterprise and labor
are not apart. In the large wholesale house, the enterpriser is seen to
be not merely an abstractly thinkable function, but a separate and
concrete person. The typical enterpriser is the man who gives his time
and energies to the launching and guiding of business.</p>
<h4>§ II. THE TYPICAL ENTERPRISER'S SERVICES REVIEWED</h4>
<div class="sidenote">The enterpriser's skilful use of capital</div>
<p>1. <i>The enterpriser guarantees to the capitalist-lender a fixed return.</i>
Agents will yield the highest economic rent of which they are capable
only in the hands of those who can use them with exceptional skill.
Owners of capital who for any reason, such as youth, inexperience, ill
health, incapacity, or conflicting duties, are not able to make agents
yield the average rent, seek out, or are sought out by, those who in
general can make the agents yield more than the average. The interest
contract between them is one of mutual advantage, in that the
enterpriser pays a definite sum to the investor unable himself to apply
his productive agents. Immense sums of capital are now put into the
hands of small enterprisers, such as Western farmers improving their
lands, builders of city homes and business blocks, and small
manufacturers. But stocks and bonds of corporations give a wide variety
of investments which shade off from the safer or capitalistic type, to
the more uncertain, or enterpriser's type. First-mortgage bonds, being a
first claim on the income and property, have the highest security and
yield generally the lowest interest. Even national bonds are not
absolutely safe, and for that reason as well as because of their
fluctuation in price, even their purchase has something of the nature of
an enterprise. Stocks are the enterpriser's type of investment,<span class="pagenum"><SPAN name="Page_286" id="Page_286">[Pg 286]</SPAN></span> the
dividends being more uncertain, but giving the chance of a higher return
than the average. It is because some stand ready to assume the risk of
making goods yield average returns or more, that others can sit and
enjoy a fixed income with little effort and in comparative security.</p>
<div class="sidenote">The enterpriser's insurance of the lender's capital</div>
<p>2. <i>The enterpriser gives up the certain income to be got by lending his
own capital, and, becoming a borrower, offers his capital as insurance
to the lender.</i> Every business has an element of uncertainty in it, and
some one must meet the risk. A man with marked ability as an organizer
of industry is rarely found long without capital of his own. But even a
penniless man who can gain the confidence of investors is able to get
backing and to secure the necessary funds to engage in business. The
lenders in such a case, however, run a greater risk than when the
enterpriser is a man of some means, and they therefore ask a higher rate
of interest than if they were loaning to a wealthy man or to a wealthy
company. They are in part the enterprisers. When, as usually, the
enterpriser invests some of his own capital, it is a guarantee of his
good faith, a sort of insurance reserve to protect the lender from loss.
The first loss falls on the enterpriser, and the chance of loss to the
lender is in large part, though not entirely, eliminated. It is
characteristic of modern loans that the borrower may be rich, not
poor,—often richer than the lender. The mortgage on real estate and the
creditor's claim on a merchant's property usually give security of far
greater value than the loan.</p>
<div class="sidenote">The enterpriser's insurance of the laborer's production</div>
<p>3. <i>The enterpriser gives to other workers a definite amount for
services applied to distant ends.</i> In discussing the wage system it was
pointed out that most labor at the present time is put upon future
goods. It is not known what they will be worth a month or a year later
when they mature as consumption goods; their present worth can merely be
estimated. If they prove to be worth little, the profits may be nothing
or less than nothing. The enterpriser, however, buys the services for
ready money, embodies<span class="pagenum"><SPAN name="Page_287" id="Page_287">[Pg 287]</SPAN></span> them in goods, and assumes the risk; the goods
may sell for more or less than the wages. It is sometimes said with a
certain irony that if the enterpriser assumes the risk he is very
careful to pay so little for labor that he does not lose. In this naive
view the enterpriser is so independent of the market that he can pay
much or little as he pleases. In fact in many cases he gains little, and
in many he loses and loses largely.</p>
<div class="sidenote">The risk of the enterpriser's services</div>
<p>4. <i>The enterpriser risks his own services and accepts an indefinite
chance instead of a definite amount for them.</i> Assuming the risk for the
right conduct of industry, he backs himself, expresses his faith in
himself as a manager who can make labor earn more than the prevailing
wages and make capital yield more than the prevailing rate of interest.
If it were otherwise, he would loan what capital he has instead of
borrowing more; instead of employing others, he would himself seek
employment in some other industry. Men are constantly shifting from the
class of hired workers to that of enterprisers. It is a rude and often
tragic process of adjustment and selection that enables men having
ability as enterprisers to continue in that work, and forces others into
the class of employees.</p>
<div class="sidenote">The enterpriser the intermediary in industry</div>
<p>5. <i>The enterpriser is the economic buffer; economic forces are
transmitted through him.</i> In a more primitive industry each man is
wage-earner, capitalist, and enterpriser combined in one. As industry
develops, some of the factors of cost become distinguishable, and
relatively stable and calculable. A low rate of interest, ranging from
three to four per cent., can be secured with practical certainty by
putting one's money into good corporation securities, into the
savings-bank, or into national bonds. Contract wages in each class of
labor also are fixed by competition at a point where they are a medium
or average of gains and losses. The enterpriser is the most movable
element. As the specialized risk-taker, he is the spring or buffer,
which takes up and distributes the strain of industry. He feels<span class="pagenum"><SPAN name="Page_288" id="Page_288">[Pg 288]</SPAN></span> first
the influence of changing conditions. If the prices of his products
fall, the first loss comes upon him, and he avoids further loss as best
he can by paying less for materials and labor. At such times the
wage-earners look upon him as their evil genius, and usually blame him
for lowering their wages, not the public for refusing to buy the product
at the former high prices. Again, if prices rise, he gains from the
increased value of the stock in his hand that has been produced at low
cost. If the employer often appears to be a hard man, his disposition is
the result of "natural selection." He is placed between the powerful,
selfish forces of competition, and his economic survival is conditioned
on vigilance, strength, and self-assertion. Weak generosity cannot
endure.</p>
<div class="sidenote">Fluctuation of profits</div>
<p>6. <i>Profits therefore fluctuate more from industry to industry and from
man to man than do other incomes.</i> As a somewhat exceptional case, small
employers in industries such as baking and tailoring, may for long
periods get less for their work than their employees get in wages. The
pride in being an employer and occasional chances of greater gains
perhaps explain the fact. The fluctuations of the market may sweep away
from the enterpriser not only all his "profits," but all his accumulated
wealth. As a consequence, profits may be at other times very high, for
men will not take the risk of great losses unless there is a chance of
large gains. While the income of the salaried man is occasionally
advanced, and then for long periods remains unchanged, the profits of
enterprise come in waves. In seasons of prosperity the income of the
employer swells with a dramatic swiftness while rents and wages move
tardily upward. But for years again the employer earns a return hardly
exceeding a low interest on the capital invested in the enterprise, or
runs the business for a time at a loss. Profits of this kind should not
be spoken of as a percentage. Greater or less, they are the net result
attributable to the enterpriser's skill, and bear no fixed or calculable
relation to any capital investment.</p>
<p><span class="pagenum"><SPAN name="Page_289" id="Page_289">[Pg 289]</SPAN></span></p>
<h4>§ III. STATEMENT OF THE LAW OF PROFITS</h4>
<div class="sidenote">Antisocial or pseudo-profits</div>
<p>1. <i>Some apparent profits are due to antisocial or criminal acts.</i>
Cheating, lying, breaking of contracts, bribery of public officials, and
many similar acts may greatly increase individual incomes. These are not
profits, as the term is here understood, but they are hard to
distinguish from profits in practical life. One man gains a temporary
success by acts that are later punished as crimes; another, guilty of
like deeds, escapes conviction for lack of evidence or on
technicalities, and enjoys ill-gotten wealth. More fortunes, however,
are due to actions on the border-line of ethics, which society is not
yet honest enough to condemn or wise enough to prevent. No code of laws
can be framed that will make possible the punishment of all antisocial
acts. Any law that would catch all the guilty would injure many of the
innocent. Economic analysis may exclude from the concept of profits the
gains made by such means, but only omniscience could distinguish them in
every actual case from "swag and boodle."</p>
<div class="sidenote">Chance profits</div>
<p>2. <i>Some profits are the result of pure chance or luck.</i> What is luck? A
result that is not calculable, coming to pass in conditions where a
rational choice is not possible, is called luck, for lack of another
name. Now pure luck often brings temporary profit to the individual, but
chance does not in the least account for the average and abiding
profits. There is bad luck as well as good luck. According to the law of
chance, in the tossing of a coin for "heads and tails," one side is as
likely to come up as the other, and in the long run the number of heads
and tails will be equal. Where cases are numerous, losses and gains
distribute themselves about a general average, and may be eliminated by
insurance, as that against fire, flood, lightning, against sickness of
the employer, which would cripple the business, or against his death,
which would check it. But many factors evade all<span class="pagenum"><SPAN name="Page_290" id="Page_290">[Pg 290]</SPAN></span> attempts to reduce
them to rule, and chance remains a considerable factor in the success of
many individuals. It still sometimes appears better to be born lucky
than rich.</p>
<div class="sidenote">Profits due to a union of chance and choice</div>
<p>3. <i>Some profits are temporary gains from happy but not entirely
accidental choice of the best course.</i> Many cases of profit said to be
due to chance are found on closer knowledge to be due to superior
judgment. A slight advantage in choice will give now and then apparently
chance gains. The adventurer who, on the discovery of gold, goes at once
to California or to Alaska, may stumble upon a gold-mine. It is luck;
but if he stays at home it is more likely, according to the theory of
chances, that he will stumble over an ash-heap. In places where
gold-mines are comparatively plentiful, one takes chances between a load
of lead and a bag of money. Throughout life there is constant
opportunity, but it must be sought. One who has the good judgment to be
ever at the right time at the place where he has the best chance of
stumbling upon a good thing, usually gets the advantage, and men call it
luck. The more the causes of success in general are studied, the larger
is found the element of choice, the smaller that of luck. Some writers
make these temporary gains the essence of profits. Considering that
profits are always due to the introduction of new and better methods,
and not to the continued use of better ones, they argue that as the
knowledge of these becomes common property profits will disappear. But
this in our view is a partial truth.</p>
<div class="sidenote">Skill the essential condition of continuing profits</div>
<p>4. <i>Continuing profits arise from the continued exercise of superior
judgment.</i> After all the chance elements are taken into account, there
remain differences in the abilities of men, and a continued and
ever-renewed need of organizing power. Profits, being recognized as due
to these differences in the abilities just as rent is due to differences
in the fertility and efficiency of goods, have therefore been called
differential gains. There would be no objection to the term were it not
intended to emphasize a supposed difference between<span class="pagenum"><SPAN name="Page_291" id="Page_291">[Pg 291]</SPAN></span> profits and rents
on the one hand and interest wages on the other.</p>
<div class="sidenote">Risk of loss reduced by skill</div>
<p>Some writers have so magnified the thought that the enterpriser's
function is to assume risk, as to make it a denial of the view that
profits are the earnings of ability. The risks of business are not those
of the throwing of dice in which (if it is fair) skill plays no part,
and gains in the long run offset losses. Business risks are rather those
of the rope-walker in crossing Niagara; the task is easily undertaken by
the skilful Blondin, it is fatally dangerous to the man of unsteady
nerve and limb. Profits are due not to risks, but to superior skill in
taking risks. They are not subtracted from the gains of labor but are
earned, in the same sense in which the wages of skilled labor are
earned. So long as some men have better organizing ability than others,
have better judgment, are better able to take the risks, there is reason
to believe that profits will continue.</p>
<p>Profits are the share, or income, of the enterpriser for his skill in
directing industry and in assuming the risks. Despite the complex
influences, they are determined by his contribution to industry
essentially as is the value of any skilled service.</p>
<hr class="chap" />
<p><span class="pagenum"><SPAN name="Page_292" id="Page_292">[Pg 292]</SPAN></span></p>
<div style="break-after:column;"></div><br />
1 of 2
2 of 2
Previous
Next
Update Required
To play the media you will need to either update your browser to a recent version or update your Flash plugin.