Profits are misunderstood, seen as unearned and sometimes
condemned as evil. Maybe that's why people often reverently pronounce, with
an air of moral superiority, "We're a nonprofit organization."
Before people mount their moral high horse, they should remember
that nonprofit organizations have caused some of the world's greatest evil,
heartache and dissatisfaction. After all, among nonprofit organizations are:
oppressive governments, postal services and public education.
Profits are not a large item in national income accounts. In
1999, after-tax profits accounted for about 6 percent of gross domestic
product (GDP) compared to wages, which accounted for over 60 percent.
Profits -- like wages, interest and rent -- are a vital component of a
smoothly operating economy.
So what are profits? Put simply, profits are a price, just as
wages, rents and interest are prices. Profits are the prices paid as
residual claims to entrepreneurs in their role as risk-takers, innovators
and decision-makers. Just as workers will not provide their services without
wages, entrepreneurs will not provide theirs without profits. Profits, like
other prices, steer resources from low-valued uses to higher-valued uses.
A successful businessman must take in enough revenue not only to
cover wages, rents and interest, but profits as well. In order to accomplish
that feat, he must not only please customers but he must do it in a manner
that efficiently utilizes all of his resources. If he fails to cover all of
his costs, it means that he's not using his resources efficiently and-or
consumers don't value his output relative to some other alternative.
When a firm cannot turn a profit, it goes out of business. That
means its resources, workers, building and capital become available to
someone else who might put them to a better use. Of course, government can
thwart this process with subsidies that enable entrepreneurs to continue to
You say, "OK, Williams, I'm with you on normal profits, but what
about windfall profits -- what some people call obscene profits?" Windfall
profits are indeed profits far beyond what's necessary for an entrepreneur
to stay in business, but windfall profits also play a vital role. Windfall
profits signal that a human want is not being met. Resources emerge to meet
that want. For example, when Hurricane Andrew devastated parts of South
Florida, plywood prices skyrocketed. Florida's attorney general threatened
actions against companies for price-gouging.
Those windfall profits conveyed messages to the rest of the
economy. Let's say that pre-hurricane plywood prices were $10 a sheet and
afterward they were $20. That profit potential created a powerful signal.
Instead of plywood manufacturers selling their plywood inventory to, say,
Pennsylvania wholesalers for $8 a sheet, they were more than happy to ship
them to Floridian wholesalers for higher prices. Wholesalers in other states
were happy to sell their plywood to Floridians for higher prices. Since
plywood supplies were moving to Florida, plywood prices elsewhere rose.
From a social point of view, this is wonderful. Say I planned to
spend a Saturday afternoon building a house for my dog. I go to my
neighborhood lumberyard in Pennsylvania expecting to pay $10 for a plywood
sheet, and get there and find out it's $18. I say, "The heck with the dog;
let him sleep in the rain!" I have voluntarily made a plywood sheet
available for a more valuable use -- rebuilding the house of a human.
None of these and other voluntary actions making plywood
available to Floridians would happen if price controls were slapped on
plywood making the pre- and post-hurricane prices the same. Freely
fluctuating prices, including the potential for windfall profits, encourage
people to do voluntarily what's in the social interest.
In free and open markets, profits are to be praised -- not
scorned, as economic and political charlatans would have us do.