Tuesday, September 27, 2011

The Paradox of Profit-Pt. 1

From time to time I take up my old vice of economics (U.M. '04) and dork out on it for awhile.  Here's the first installment of what's been going through my head recently is this regards.  

 We start off broadly, by asking what exactly we mean when we use the word “economy?” We might define an economy as a system of producing and distributing goods and services within and between groups of people. There are, of course, many ways in which such a system might be designed, as we can see from studies of history and anthropology. From an ethical, normative standpoint, we might distinguish between just and unjust economic systems. We could define a just economic system as one in which there is a high positive correlation between effort expended in the production process and the ability to consume the fruits of that process. An unjust system, then, would be one in which there is no correlation, or a negative correlation, between effort expended and the consumption potential realized by any given individual.

To demonstrate this we can consider the economic system of slavery as practiced in the United States prior to 1865. Using our simple guidelines above, we conclude that the slavery system is unjust, since those expending the greatest amount of effort in the productive process (the slaves) receive the least amount of remuneration and vice versa; those whose exertions in the productive process are minimal (the plantation owners) receive the greatest reward from the process. There is an obvious negative correlation between effort and gain within the system and we are therefore justified in criticizing such a system as economically unjust1.

In discussing contemporary “capitalist” economics, the standard explanation breaks down the production process into three major areas of input along with the individuals who provide each of the inputs. These inputs are typically listed as land, labor, and capital; owned, respectively, by the landlord, the worker, and the capitalist. For allowing his/her land to be used in production the landlord receives rent, for contributing his/her labor the worker receives a wage, and for supplying the necessary real and financial capital (i.e. tools, factories, money) the capitalist receives profit. Thus each contributor to the process of production receives their repayment. Without considering any deeper than this we might conclude that the modern capitalist economy is, in fact, a just one.

That would, however, be a premature conclusion, for in examining this system we see that there is something different, something special and unique about the capitalist's profits. This unique aspect of capitalist profit-making, different from either the rent of the landlord or the wages of the worker, is that in exchange for a temporally-limited contribution to production the capitalist is able to realize temporally unlimited returns. Whereas for the landlord and the laborer their incomes cease the moment they remove their factors of production from the economic process, the capitalist is able to make a one-time contribution to the process in exchange for a (conceivably) never-ending income.

To clarify this point, we can consider a simplified case involving only labor and capital. Let us suppose we have a capitalist who puts up the money to build a factory and purchase initial inputs and pay wages during the first production-cycle. The revenue realized from sale of the product must, necessarily, be enough to cover the cost of the material and labor inputs (variable costs) as well as some amount to off-set the capitalist's initial investment in the factory (fixed costs). As the production-cycle continues the revenue generated by the factory must continue to cover the variable costs of production as well as pay down the capitalist's fixed cost in the factory2. After some period of time the capitalist will have been fully repaid for his/her initial financial investment in the productive enterprise, i.e. all fixed costs will have been fully covered by returns to the enterprise. From this point on any gains realized by the capitalist are what we can consider actual profits.

Since the revenues created by the factory must continue to cover all variable costs, and since the fixed costs have been fully repaid, the returns to the capitalist from this point on represent not remuneration for contributing to the process of production, but rather returns to the legally-defined right of ownership. While the laborers must continue to supply their labor-power to the production process in order to continue receiving their returns in the form of wages, the capitalist need now contribute nothing further to the production process to continue receiving his/her returns in the form of profits. While it is true that without some actual profit, above and beyond simple repayment of the initial financial outlays, the capitalist could not be convinced to contribute his/her resources to the production process, it should be apparent that the potential gains to ownership of a productive enterprise far outstrip the minimum return on investment that would be sufficient incentive for the capitalist to engage their resources.

Given our above minimal definition of just and unjust economic systems, we now see that capitalism must be placed, at least on the prima facie evidence, into the latter category. For the workers3 in the system, a fixed amount of time and effort engaged in production yields a fixed amount of return, i.e. consumption potential. Whereas, for the capitalist, a fixed amount invested in production can yield, at least theoretically, unlimited returns. For certain actors in the economic process a one-time effort leads to a one-time reward, while for other actors a one-time effort can lead to endless rewards; thus effort expended does not positively correlate with consumption potential realized; thus the system is open to criticism on grounds of basic injustice.

1Besides considerations of simple “fairness,” unjust economic systems, as we have defined them here, also create divergent and conflicting incentives between different actors in the production process which lead inevitably to decreased efficiency in production. This aspect will be discussed in greater detail later.

2In this simplified treatment I am not taking additional costs of production (namely capital depreciation) into account, however the analysis can be easily expanded to cover these, as it is apparent that any firm whose revenue does not cover all costs, from whatever source, can not long remain a going concern.

3For simplicity we will continue with a basic labor/capital dichotomy. How the question of land ownership fits in will be examined later.

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