Profits and the Future of American Society: A Book Review

One of our guest editorialists pointed out that capitalists do a lousy job of explaining the benefits of capitalism.  Many voters seem to feel that our current economic troubles spring from "greedy capitalists" who seek to maximize their profits at the expense of everyone else.  These folks believe that the way back to prosperity is for government to write more and more rules limiting profit to make sure businessmen behave properly.

The book Profits and the Future of American Society is a refreshingly-accessible explanation of how the profit-based capitalist system actually works.  The two authors are the son and grandson of Jerome Levy who achieved fame as a business forecaster.

Jerome died in 1967, but his son continued his work.  In 1980, a Barrons editorial referred to, "S Jay Levy whose track record on business ups and downs is matchless" endorsed his ability to predict the economic future.  This book claims that their forecasting ability is based on their unique understanding of profits and documents their view of the importance of profit in any economy, whether capitalist or socialistic.

Are Profits Evil?

A common theme we're hearing from the Occupy crowd is that profits are evil.  Blood-sucking capitalists force workers to accept lower wages than their work is worth, sell the products, and pocket the difference.

Anyone who buys something from a store buys it because the item is worth more to the buyer than the money required.  Is the buyer ripping off the store because the item is worth more to him than he paid?  Of course not.  What could be more democratic than letting people "vote" which product is best by spending money to buy it?

The Levys bypassed this argument and pointed out the real function of profit - it funds insurance.  In demonstrating this surprising conclusion, the Levy's start at the beginning:

The purpose of an economy is to produce consumer goods and services efficiently and and to distribute them in accordance with some principle of fairness. p 14

There have been many ways of dividing the economic output of a society ranging from slavery where owners received everything to communist or socialistic societies where the government decides who gets what.  The Levys point out that

Most Americans know that the system is supposed to reward "each according to his or her contribution to production."  The more a person's efforts increase the economic output, the larger his purchasing power should be.  To reward people on any other basis would not encourage them to be productive.  15

In the one-person economy experienced by Robinson Crusoe who was alone on an island, it's easy to discern the value of work.  When he hollowed out a log and found the resulting canoe was too heavy for him to launch, the value of all that work was precisely zero.  Determining the value of work is much more difficult in a complex, industrial economy.  How do we measure the value added by an individual worker who tightens bolts on an automobile assembly line?

This problem becomes far more difficult when we recognize that economic circumstances change so that some goods which were manufactured using a lot of labor end up not selling.  Consider the Ford Edsel which hardly sold at all, or the solar panels manufactured by Solyndra at vast taxpayer expense.

The work done by the designers, test engineers, and production engineers turned out to be worth very little, but the workers got paid anyway.  Their employer absorbed the loss, not the workers.  By paying the workers up front, the Levys observe, the employer insured the workers against the possibility that their labor would turn out to be worthless.

Based on this observation, the Levys contend, unemployment occurs when investors are unwilling to insure as much work as people would like to do.  When a willing person can't find a job, it's a sign that there are not enough profits in the economy to insure that person's work against possible future loss.  Since the "work insurance" industry can't insure enough work, people go without work.  The result is unemployment.

Capitalism and Justice

Critics of capitalism argue that it is unjust for investors to to take a large slice of the economic pie and give nothing in return.  The Levys argue:

Capitalism does have one fundamental principle of justice: the nation's income should be distributed to individuals in accordance with their contribution to production.  p 117

That principle is a major reason so many academics abhor capitalism.  They simply can't accept the notion that athletes like Michael Jordan and Tiger Woods and entertainers like Oprah and Rush Limbaugh are worth so much more to society than they are.

Consider Sam, a small businessman who suffers through booms and busts as the economy changes.  Suppose an investor sought to buy his business and pay him a salary.  The investor would keep all the profits after paying all expenses, but would bear all the losses.  The investor is assuming the economic risks that Sam has borne up until now.

Sam is trading the possibility of reduced income or income peaks over the years for security.  If Sam thinks this is a good deal, he'll sell out.  If he prefers to remain independent, he'll keep the risk and not sell out.

In a socialistic system, all economic risk is shared by the entire population.  If a ship sinks, if a factory produces unusable products, the entire society is poorer and everyone's share of the pie shrinks.  In capitalistic systems, all employees of a business suffer when it goes bankrupt, but the rest of society isn't supposed to suffer from the loss.

The Levys argue that most of our problems with unemployment are caused by lack of profit.  If profits were larger, the Levys argue, firms would hire more workers.  The skilled would be hired first, but then what?  In order to find enough workers to do all the work they would now like to insure, firms would have no choice but to train unskilled people.  Many of our education problems would be greatly reduced if the business profit picture were better.

The Levys didn't anticipate the massive uncertainty brought about by the regulatory environment created by the Obama administration.  If hiring is based on insurance as they argue, businesses must have a reasonable expectation that the risks of paying for non-sellable work are covered.  If new regulations might increase costs, prevent a factory from opening, or require that formerly legal products be destroyed as happened with children's books which had traces of lead in the ink, businesses need more profit than normal to insure the risks of hiring additional people.  The Left complains that corporate profits are now hitting record highs with little sign of additional hiring; they ignore the massively increased risks and uncertainties that Mr. Obama's policies have piled on.

Profits Drive Jobs

The bottom line is that investors need profit in order to cover the risks that the work they pay employees to do will turn out to be worthless.  The more profit a firm makes and the lower the risks in the business environment, the more workers it can cover and the more jobs it can offer.

This profit-based employment analysis and view of business as societal insurance is not at all a mainstream idea.  The Levys argue that their success in using profit information to forecast business success and failure demonstrates the fundamental soundness of their view of how profit affects businesses.  It's a book well worth reading, if for no other reason than that their perspective has worked extremely well in increasing their own personal profits; maybe it will do the same for you.