The Role of Profits in Free-Market Capitalism, and Why High Profits are Good for a Company’s Workers

Underpants Gnomes Meme - Phase 1: Physical Labor Phase 2: ? Phase 3: ProfitWhether people like it or not, it is a fact that the production of valuable things requires more than physical labor. (I’m looking at you, Karl Marx, with your Labor Theory of Value and “profit as exploitation.”) This is especially true when it comes to industrial-scale mass production. To successfully deliver products at a reasonable price and quality, a company must be organized in certain ways that are effective; there must be communication and coordination between the various departments; there must be management to make sure things keep running smoothly together and that timetables are kept; there must be wealth invested for buildings, machinery and raw materials in the right amounts; any machinery and facilities must be continually maintained; there must be management of sales and distribution of the product; etc.

A collection of factory workers without power tools, without specific roles and without management direction will produce very little and very inefficiently. In any line of business, there is a tremendous amount of strategy, business planning, technical planning, management, and industry knowledge that goes into making a company productive and successful.

As I discussed in my essay, “How Business Executives and Investors Create Wealth and Earn Large Incomes,” a company’s chief executive officer (CEO) carries tremendous responsibility: he is crucial in making large-scale decisions for the company, implementing and coordinating major changes, planning long-term for the future market and technology the company will face, formulating and holding onto a large-scale vision of where the company should go, etc.

If the CEO is the company’s sole proprietor, (owner of the whole company) then any profits go to him as a reward for doing well at his job and making a positive contribution to the company’s production of value. A profit is the difference between the company’s total revenue and total expenditures, when the revenue is greater. (When the expenditures are greater, the same difference is called a loss.) So, in a free market, a profit means that the owner created net value–beyond any salary he received–according to the judgments of the relevant people–those who voluntarily do business with the owner through the company, including customers, employees and suppliers. A loss, correspondingly, would mean that the company’s owner destroyed and/or consumed net value according to the same judgments. (1)

If the company is a corporation, and ownership is distributed among shareholders, then there is a separation between the day-to-day management of the company by the CEO and those who receive the company’s profits (shareholders.) But it is still the case that the company’s owners (shareholders) bear ultimate responsibility for the overall constitution and direction of the company, each according to the extent of his individual ownership. This is because the shareholders typically elect the board of governors, who in turn appoint the CEO. (indeed, typically, the board members are also shareholders. Here I recommend Yaron Brook’s excellent audio course, “The Corporation.”)

Even when a shareholder does not directly manage a company, he bears some responsibility for his judgment in shareholder voting and for his judgment in how to use the money he’s earned: whether to invest the money, and if so, in what companies. Many companies are not profitable, and many companies fail, so there is an achievement in investing in a company that can reliably turn profits.

This judgment on the part of potential shareholders is part of what makes modern, large-scale, productive businesses possible. It is an essential part of the modern productive process, just as much as having workers on a factory floor: The workers in a modern business are only able to produce what they do, because of the conditions set up for them by the owners and managers of the company. (Capital investment, organization, coordination, machines, training, raw materials, etc.)

So profits are a reward to a company’s owners for playing their role in the productive process well: exercising good judgment in their investments and whatever management they participate in. Losses, on the other hand, serve as a punishment for poor choices in these areas. But beyond this function, profits also serve as an encouragement for more people to invest in a productive, efficient company and increase the pool of capital available to it. (2)

Profits can be used to hire more employees, or be invested in capital assets to grow the company, or saved in an account for future needs. The first option can make the company more productive and/or efficient. The second option–and even more so, the third–make the company more robust. The company can rely on the money in an account, or the value in its assets, to weather times of difficulty that might otherwise cause it to go bankrupt. Having more money in its accounts also allows a business to more easily undertake long-term plans that require long periods of expensive development before they start to pay off.

How High Profits are Good for Workers

If a business is making high profits in a free market, then that means the owners are adding a lot of value to what the business produces over and above what it consumes. This is good for anyone who uses or consumes the company’s product or products that the company’s activities make possible. So, in many cases, the value that owners add to products benefit employees in their capacities as consumers.

Beyond this, high profits make a company robust. They enable discretionary spending that doesn’t threaten the solvency of the business. So some of the profits can be–and sometimes are–put into bonuses for employees as incentives and rewards. Many companies also have stock option plans, enabling employees to benefit directly from profits.

High profits attract more investment in a company, enabling it to grow and become productive on a larger scale. This often results in the hiring of more employees who can reap the benefits of working for a profitable company. Expansion often results in greater division of labor within a company, which means more types of jobs available and greater potential for advancement among employees.

So, far from being exploitative or detrimental to a company’s workers, high profits actually benefit them in a variety of ways.

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(1) Those who are concerned that negative externalities are not taken into account in this process should see my post: Laissez-Faire Capitalism Solves “The Tragedy of the Commons” and Deals With Negative Externalities: A Dialogue

(2) It should be noted that there is no country in the world that is a fully free market. The government regulation of economies that prevents countries from being free markets also leads to exceptions to profits being rewards for actual productivity on the part of business owners (coercively unjust profits.) The solution to these exceptions is to eliminate such government regulation and establish a free market in which the government only protects individual rights to life, liberty and property.

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Related Posts:

Socialism and Welfare vs. Justice: Why Inalienable Private Property Rights are Required for Justice

On Fairness and Justice: Their Meanings, Scopes, and How They Are Not the Same

Wealth is Created by Action Based on Rational Thought

19th-Century Capitalism Didn’t Create Poverty, But Reduced It

How Business Executives and Investors Create Wealth and Earn Large Incomes

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