Monday, May 21, 2007

The Morality of Profit

In most societies today, making profits are accepted as moral, if not especially praiseworthy. This was not as obvious as it appears today – people used to be embarrassed about making a profit not so long ago.

Crazy as it seems today, it is worth thinking why it was so.

Profits, as economists will put it, is the reward for risk-taking, for putting a business enterprise together in the pursuit of an objective. In this definition, remember, profits are not what it is commonly understood to be – the gross middle-line towards the bottom – but a figure net of entrepreneur’s earning [wages for his labour], dividends and interests on borrowed capital, and provisions for building and other physical assets [a sort of rent, offsetting what these assets could have earned if leased out]. This pure profit – surplus – accrues to a business as a reward to its organisation, for the act of entrepreneurship itself.

Economists were divided on how this surplus comes about. The conventional wisdom was, as I mentioned, that this is a reward for risks taken. However, there were others, most notably Marx, who saw profits as a fruit of exploitation of labourers by industrialists. In Marx’s view, human beings create value by adding labour to raw material available naturally, and hence labour was the only source of all human value-creation. However, capitalists, to use Marx’s language, pay labourers less than fair share of the value they created, and pocket the rest – surplus value – as profits. In Marx’s world, the poor entrepreneur would have been entitled to a salary commensurate with the hours he would put in, and may be an interest if he has put in any money, and possibly a rent if he used his own house – but not much else.

Marx’s view was highly influential, as we all know. However, this was, if I may say, a straightjacket befitting the pen of a brilliant journalist, as Marx indeed was. He lived in Industrial Revolution England and observed labourers toiling in sub-human condition to earn their masters an idle life of luxury. Marx’s was a moral outrage, but like an excitable journalist, he equated his momentary observations with the vision of a universal truth, and stigmatised profits.

However, if Marx lived today, he would have known he missed two significant points. First, in the post-industrial era, it is evident that profits don’t solely come from the amount of labour put in. And, second, in the era of organised labour and talent shortage [in complete reverse of Marx’s days when labourers were unorganised, unskilled, and without any option but to work for a subsistence wage], the bargaining power of workers are significant. Despite this, however, the profit margins are growing, and not shrinking, as it should have been following Marx’s model.

Marx’s views proved to be enduring. It is not just the socialists thought of profit as unjust, everyone on the other side of the profit divide have been suspicious of its nature. This is because there is an inherent moral question to be asked about profits, and the industrial era exploitation may have changed form, but still persists and often rear its head.

Today’s profits can be seen as

Total Profits = Rewards for Value Creation + Value Grab

To explain, a business creates value in many ways, starting with by simply being there, making available goods and services in a beneficial way to customers who wish to pay for it. Businesses also create value through other methods, most notably through innovation [by creating new product or service possibilities, by meeting a market need], information [by creating demand, educating customers about solutions to their problems or desires] and enabling [by allowing able employees, suppliers and associates to use their infrastructure to solve problems]. Profits, justifiably, reward these value creating activities.

But, this is only part of the overall profits businesses earn. The other portion is the profit arising from value grab, through usurpation of what’s not morally owned, such as the extra fruits of worker’s labour, natural resources, subsidies funded by public money, and income generated by bullying the customers without alternative. Modern businesses are replete with examples of value-grab, and all businesses earn an element of profits through value-grab.

Now, understandably, there is a thin line between value creation and value grab, similar to the one between being an opportunist and being an entrepreneur. However, it is not impossible to identify, or even measure profits arising out of value grab. This is essentially because while value creation is a win/win process, value grabbing is a zero sum game, and someone must earn less of a profit or be worse off for a business to earn its value-grab extra.

If it’s zero-sum, is it such a bad thing for businesses to earn profits through value-grab? After all, this sounds like businesses earning profits at the expense of a competitor, though agreeably earning profits by compromising environment and bullying customers will indeed be a bad thing.

The simple answer to that question is that since it is zero-sum, businesses grabbling value don’t contribute in the society. For a society, total incremental benefit of the business is

Social contribution of business = (total profits – value grab) – social costs

Besides, businesses earn as often at the expense of the community, the environment and its employees, as its competitors. And, often unravelling competition affects communities and ways of life, thereby increasing social costs in its turn. Therefore, it may be said that the value-grab activities erode value that the businesses create for society, and goes against the moral justification of profit-making.

So, what ensures the morality of profit-making? The salary-taking entrepreneur model has proved to be a failure – precisely because such a model discounts all value creation possibilities and contributes nothing to the society in turn.

The capitalist checks-and-balances theory always put emphasis on Competition. The theory goes that the competition in the product market ensures that value creation is the only method of creating surpluses, by limiting, and eventually eliminating, all possibilities of value-grab. The new ‘love your profits’ morality makes an implicit assumption of existence of perfect competition in the market, and views all profits as purified by the trial of fire by Competitive Markets.

However, this is journalism posing as universal truth, yet again. Competition exists, in certain market sector, in certain countries. However, to eliminate value grabbing possibilities, competition must exist on all markets, such as capital markets [so that everyone has access to capital on fair terms], labour markets [labour should be free to move for highest reward], global markets [there should no tariff barriers, or at least a fair system], none of which exist in reality. Besides, the biggest profits are being made in some industries which have been kept non-competitive by design, or on the back of monopolistic former public utilities.

And, this presents us with the biggest problem of profits by value-grab. While apparently zero-sum, these tendencies do actually destroy value, by discouraging value creating entrepreneurialism, and indeed, by creating barriers against it. As we move towards a society of scarcity, our highest priority should be encouraging those entrepreneurs who set out to create value – and deliver something out of nothing – and in this context, pampering the deal-making types will become inconvenient, immoral and ultimately counter-productive.

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