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The Role of Profits

Profits are central to capitalism, and I am often asked whether profit making is evidence of greed. Not in itself. The fact that a business is profitable tells us little that is morally relevant. Profit, after all, is simply the name that accounting attaches to the condition of income outpacing costs. In other words, a company that earns a profit brings in more money than it expends for all of its costs, including materials, real estate, labor, and taxes. The opposite of profits is financial loss. A firm that is losing rather than making money cannot long survive. So, under ordinary circumstances, profits are a necessary condition for the success and continuation of a business.

Of course, the government can bail out unprofitable businesses at taxpayers' expense. But that only shifts the need for profits to the other— profitable—enterprises that pay the taxes. Bail out enough unprofitable people and companies, and the profitable ones start wondering why they are working so hard. When a company is not profitable, it is a sign that something is wrong with the firm: maybe its manufacturing methods are inefficient, its overhead is excessive, its products are in need of revamping, or any number of other possible weaknesses. Government support simply suppresses the incentive to improve, delaying reforms that are necessary to bring the company back to economic health. History is littered with examples of dysfunctional companies bailed out by government: a double blow to the consuming public, which is deprived of both the benefits that an improved company would bring to the market as well as a large amount of its tax money spent to shore up the dysfunctional company's finances.

Profitable companies are the ones that find a way to create and deliver products and services at prices high enough to cover their costs, but low enough that customers find them attractive. The profitable company, in other words, is one that flourishes by creating and delivering value.

This positive dimension of business is often obscured by the common stereotype of the greedy capitalist—a stereotype epitomized in the images on the Chance and Community Chest cards in the board game Monopoly: a well-fed businessman in a top hat smoking a cigar. He simultaneously represents big business and the successful Monopoly player, who is growing rich through luck and cutthroat competition. Victory in Monopoly comes not when a player gets rich by creating new value in a business enterprise but instead when a player has successfully taken everyone else's money and driven them all into bankruptcy. Monopoly, then, is literally a zero-sum game. But it seems that some people confuse the real world with a game of Monopoly—and fall into the fallacy of thinking that people can gain in a marketplace only if others lose. For instance, if poor people exist, clearly it must be because the rich have taken such a massive piece of some pre-existing pie that hardly any was left over for the poor folks. If that's the case, the obvious solution is to forcibly divide up the pie in a more equitable way.

But perhaps the pie wasn't always just sitting there, the exact same size for all eternity. Maybe many of the rich didn't take more than their fair share; maybe they made more than their fair share. The zero-sum assumption prevents people from ever asking whether the solution to poverty might be to grow the pie even more.

This zero-sum mentality is particularly prevalent among clergy, who often view profits with disdain. In conversations with fellow clergy who take this view, I often ask, if profits are morally dubious, are losses more ethical? The point is to shed light on the nature of profit and loss. Both are tools for understanding a company's health. Profits indicate that resources are being used wisely by a business; losses suggest that they are not. Although profits and losses are not the be-all and end-all of a company, they are crucial first-level indicators of how effectively they are serving the wants or needs of customers.

Because human wants always outpace scarce resources, every society must have some guide for allocating those resources. Something or someone must decide whether water will be used for drinking, bathing, or irrigation, and whether iron ore will be used for making cars or manufacturing tractors. The same is true for all social resources. Even the resource of time, which is also scarce, requires some tool for sensible allocation.

One solution to the problem of allocating scarce resources is to control marketplace decisions and resources from some central point. To varying degrees, this is the strategy advocated by socialism in its different forms. As we have learned from bitter experience, the problem with this strategy for allocating resources is that it concentrates enormous power in a few hands. Excessive power tends to do nasty things to human nature. But there's also a second problem—the knowledge problem. Even if the political elite controlling the economy were morally perfect, they still wouldn't have enough information to effectively allocate all of the human and material resources effectively. These twin problems have hampered or undone every centrally planned economy in history.

Fortunately, there is an alternative strategy for allocating scarce resources: the network of prices that arises naturally from voluntary exchanges among buyers and sellers in a marketplace. Here the laws of economics come into play. A lower price for any particular good signals relative abundance; people can buy more of that good. A higher price signals relative scarcity, forcing people to economize their use of the good. Through this system, where the prices of goods and services are constantly in flux, consumers can balance their needs against the availability of various goods and know at any moment how much of each they should purchase and use, and producers can know how much of a good they should produce and sell. Prices help us determine whether a good or service is being wasted and therefore should not be in production, or if it is highly desired and therefore more of it should be produced. For instance, when entrepreneurs discovered how to pump, store, refine, and use petroleum oil, its price dropped well below that of whale oil. Whale oil was priced out of the market, and there was less pressure to kill whales for their fat.

Profit can also be understood as a kind of price signal. Making a profit indicates to a company that it is performing its tasks in a way that a segment of the public approves—not just notionally, in opinions they might give a pollster, but with their hardearned cash. Losses inform the managers and owners that they need to make adjustments or turn to other pursuits so that social resources are not wasted. Thus the signaling device of profit and loss serves an irreplaceable economic function. Profitability serves as a motivating force, but also—and more importantly— they signify a job well done.

An important caveat: the social obligations of the business do not stop with profitably delivering goods and services. Business must deal honestly, keep their contracts, serve the community in the broadest sense, and be attentive to the moral dimensions of the investment process. The price system does not magically guarantee moral behavior. To give a painful but all too realistic example, the price system in a depraved society may signal that the most valued use of young women from poor families is for them to become prostitutes. Confusion arises when people see such evils and mistakenly assume that getting rid of the free market will somehow magically solve the problem. Only a little reflection should reveal the error. Moving to a command-andcontrol economy doesn't remove lust and selfishness from the human heart. Those vices go right on thriving. Only now they are fed and cared for by some arm of the state—with the added problem that poor families have even fewer alternative economic options because the command-and-control economy has placed a host of morally preferable enterprises beyond their reach. While the price system in a free economy does not provide a moral foundation for a society, and while it doesn't remove opportunities for ill-gotten gain, it handily beats every form of socialism at providing moral and socially beneficent options for escaping poverty.

This article is drawn from Rev. Robert A. Sirico's new book, Defending the Free Market: The Moral Case for a Free Economy. (Regnery, May 2012).