Profit, Profits, and Profit Motive
F. Neil Brady
In popular usage, profit is loosely associated with a ‘‘markup’’ of merchandise or a rate of return on capital. The average person typically thinks of profit as what is left over from revenues after all the bills have been paid. A normal profit is often defined as the implicit cost of the resources contributed by the owners. A more technical definition of profit becomes quite elusive, and probably no concept in economics is used with such a wide range of meanings.
Profit in Economic Theory
The history of economic thought regarding the word ‘‘profit’’ is important to the field of business ethics. What generally makes the issue of profit an ethical issue are distributional questions such as ‘‘Who gets to profit?’’ and ‘‘How much do they deserve?’’ Answers to these questions depend on being able to determine the source of profits. Many factors enter into the profitable business venture: available capital, competent management, entrepreneurial ideas, skilled labor, market advantage, and sheer luck. Ethically speaking, profit should be distributed to the most deserving source, and economists have argued for 200 years over the nature of profit.
Adam Smith was one of the first to articulate a theory of profit. He argued that social classes were partly defined by their source of income: landlords collected rent, laborers received wages, and businessmen earned profits. Smith was one of the first to see that profit was a major motivating force in economies. Indeed, he saw that it was often potential for profit that attracted resources into those activities that produced goods and services most desired by buyers. But why should profit exist at all? Why would anyone want to pay more for a product than what it cost to produce it? There are several answers. Smith mentions two. One is that profit represents the surplus value created by labor returning to the capitalist as profit after wages are deducted. Both Ricardo and Marx articulated this view more fully, referring to profit as a form of exploitation of one social class over another. The other view mentioned by Smith is the idea that profits are related directly to the cost of production and are, therefore, a fixed component of price.
There are more factors in profitable business activity than either labor or the costs of production. Alfred Marshall lists money capital, physical capital, management, land, and labor as the productive factors in economies. His view of the factor most deserving of profit was management: management provides business ability, energy, and organization; and management takes the risks associated with business ventures. There fore, since management takes the risks, it should earn the profit (and take the losses).
Of course, any risk that can be estimated or measured can also be insured. Therefore, if profit arises from risk bearing, profit should dis appear as the cost of insurance against loss. Frank Knight pointed out, however, that there is a difference between risk and uncertainty. Risk is insurable; uncertainty is unmeasurable and is, therefore, uninsurable. Therefore, according to Knight, profit arises from the bearing of uncertainty, not just risk. He was less clear about who, exactly, bears uncertainty. To say that entrepreneurs, creditors, or managers bear uncertainty is to view the matter too narrowly. Indeed, entrepreneurship and innovation are diffused throughout organizations, as all levels of personnel assume uncertainty in various forms. For example, good ideas often are generated by labor, yet they may be least likely to realize a profit from their contribution. Also bearing the burden of innovation are the suppliers of previously needed inputs to production who have lost their market, and the suppliers of new equipment who need to redesign. Paradoxically, those most likely to profit from innovation are often those with the weakest claim to such an improvement – shareholders and management.
So profit can be attributed to a variety of sources, and deciding the equitable distribution of profits has been one major theme in business ethics. Various profit sharing programs are popular among organizations that assume employees contribute strongly to profit.
Social theory has also contributed to this discussion. Foremost among the contributors in recent decades are Robert Nozick and John Rawls. In his A Theory of Justice Rawls argues that eco nomic and social inequalities are justified only when they ultimately result in benefits to those most in need. Because markets frequently fail to accomplish this, government functions to pro vide for the redistribution of profits. Like health and education, wealth is the product of a social context, without which it could not occur, and upon which all citizens begin with an equal claim. But society can do better for all its citizens by encouraging the use of skills and talents on behalf of society. Thus, corporations are chartered, managers are given executive compensation, and entrepreneurs are made wealthy so long as those least advantaged in society are made better off in the process. Thus, for Rawls, profit (or wealth accumulation) is directly linked to the production of social good at all social levels.
Robert Nozick countered with a more individualistic view of profit making. His ‘‘Wilt Chamberlain example’’ (1974: 161–4) is famous for attempting to demonstrate that great wealth is just, so long as it derives from a history of just transactions. His view is that the moral status of wealth accumulation should be judged, not by some ideal distributive pattern of social justice, but at the micro level by the moral status of the individual economic transactions that gave rise to the wealth. His Anarchy, State, and Utopia (1974) has come to be regarded as a major modern statement of libertarian philosophy.
Not only might profit making be socially allowed, but to some it is also the prime moral imperative for business activity. Milton Fried man has argued that the sole social responsibility of business is to increase its profits without deception or fraud, implying that other ‘‘socially conscious’’ motives are improper for business. Such ‘‘extra profit’’ motivations might include responding to the interests of people who are affected by corporate activity but who are not actual shareholders, such as employees, consumers, and the local community on which the firm depends for good will and cooperation. Like Friedman, some would see the firm as simply an economic entity legally bound to pursue exclusively the will of the shareholders who, it is assumed, are motivated simply by return on investment. This ‘‘libertarian’’ outlook under lies the popular creed ‘‘Greed is Good,’’ since the pursuit of self interest is thought to contribute to efficient markets and the general health of an economy.
In contrast, others see businesses as embedded in a social context which encourages interests beyond those of sheer profitability, to include the pursuit of a variety of goods that businesses, because of their economic and political power, are often in a unique position to bring about. Hence, successful businesses commonly contribute to worthy societal causes. Of course, it is possible that such seeming social conscious ness may ultimately be motivated by the utilitarian realization that the success of a corporation relies partly on its public perception as a ‘‘good citizen’’ rather than as a ‘‘Mr. Scrooge.’’ So, regardless of theory, the nature of actual business motivations remains elusive from case to case. Additionally, estimates of the importance of the profit motive must be tempered by the realization that the chief motivating factor for some business persons is the pride they take in providing a product or service of superior quality or that directly contributes to the well being of society. In their minds, profitability might be a secondary motivating factor. So the pursuit of profit may or may not be the prime motivating factor in business activity, but it is likely not the only one.
Bibliography
Arnold, N. S. (1987). Why profits are deserved. Ethics, 97, 387 402.
Friedman, M. (1970). The social responsibility of business is to increase its profits. New York Times Maga zine, September 13, 32 3, 122 6.
Knight, F. (1971). Risk, Uncertainty, and Profit. Chicago: University of Chicago Press.
Marshall, A. (1948). Principles of Economics. New York: Macmillan.
Nell, E. (1987). On deserving profits. Ethics, 97, 403 10.
Nozick, R. (1974). Anarchy, State, and Utopia. New York: Basic Books.
Obrinsky, M. (1983). Profit Theory and Capitalism. Philadelphia: University of Pennsylvania Press.
Rawls, J. (1971). A Theory of Justice. Cambridge, MA: Harvard University Press.