Part 6 (2/2)

If we try to run the econoroup or class, we shall injure or destroy all groups, including the members of the very class for whose benefit we have been trying to run it We ou, The Theory of Unemployment The Theory of Unelas, The Theory of Wages The Theory of Wages (1934), p 501 (1934), p 501

Chapter XXII

THE F FUNCTION OF P PROFITS

THE INDIGNATION SHOWN by many people today at the mention of the very word by many people today at the mention of the very word profits profits indicates how little understanding there is of the vital function that profits play in our econoain soround already covered in chapter fifteen on the price systele indicates how little understanding there is of the vital function that profits play in our econoain soround already covered in chapter fifteen on the price systele

Profits actually do not bulk large in our total economy The net income of incorporated business in the fifteen years froed less than 5 percent of the total national income Corporate profits after taxes in the five years froed less than 6 percent of the national income Corporate profits after taxes in the five years 1971 through 1975 also averaged less than 6 percent of the national income (in spite of the fact that, as a result of insufficient accounting adjustment for inflation, they were probably overstated) Yet profits are the fornificant that while there is a word profiteer profiteer to stigedly excessive profits, there is no such word as ”wageer”-or ”losseer” Yet the profits of the owner of a barbershop e much less not merely than the salary of a motion picture star or the hired head of a steel corporation, but less even than the average wage for skilled labor to stigedly excessive profits, there is no such word as ”wageer”-or ”losseer” Yet the profits of the owner of a barbershop e much less not merely than the salary of a motion picture star or the hired head of a steel corporation, but less even than the average wage for skilled labor

The subject is clouded by all sorts of factual reatest industrial corporation in the world, are taken as if they were typical rather than exceptional Few people are acquainted with the mortality rates for business concerns They do not know (to quote froing the experience of the last fifty years prevail, about seven of each ten grocery stores opening today will survive into their Second year; only four of the ten may expect to celebrate their fourth birthday” They do not know that in every year from 1930 to 1938, in the income tax statistics, the number of corporations that showed a loss exceeded the number that showed a profit The total profits of General Motors, the greatest industrial corporation in the world, are taken as if they were typical rather than exceptional Few people are acquainted with the mortality rates for business concerns They do not know (to quote froing the experience of the last fifty years prevail, about seven of each ten grocery stores opening today will survive into their Second year; only four of the ten may expect to celebrate their fourth birthday” They do not know that in every year from 1930 to 1938, in the income tax statistics, the number of corporations that showed a loss exceeded the number that showed a profit

How e, a the kind of figures I presented at the beginning of this chapter-that corporate profits average less than 6 percent of the national incoe profits after inco corporations are less than five cents per dollar of sales (For the five years 1971 through 1975, for exaures, though they fall far below popular notions of the size of profits, apply only to corporation results, calculated by conventionalNo trustworthy estimate has been made that takes into account all kinds of activity, unincorporated as well as incorporated business, and a sufficient nuood and bad years But so period of years, after allowance is made for all losses, for a minimum ”riskless” interest on invested capital, and for an ie value of the services of people who run their own business, no net profit at all may be left over, and that there may even be a net loss This is not at all because entrepreneurs (people who go into business for themselves) are intentional philanthropists, but because their optimisim and self-confidence too often lead them into ventures that do not or cannot succeed1 It is clear, in any case, that any individual placing venture capital runs a risk not only of earning no return but of losing his whole principal In the past it has been the lure of high profits in special firreat risk But if profits are liure, while the risk of losing one's entire capital still exists, what is likely to be the effect on the profit incentive, and hence on employment and production? The World War II excess-profits tax shohat such a li efficiency

Yet governmental policy alo on autoe it One of the greatest dangers to world production today still co policies Not only do these policies put one ite no incentive to -run effect is to prevent a balance of production in accordance with the actual demands of consumers When the economy is free, deovernard as ”excessive,” ”unreasonable,” or even ”obscene” profits But that very fact not only causes every firm in that line to expand its production to the utmost, and to reinvest its profits in more machinery and more employment; it also attracts new investors and producers froh to ain fall to (or below) the general average level

In a free econoes, costs and prices are left to the free play of the competitive market, the prospect of profits decides what articles will be made, and in what quantities-and what articles will not bean article, it is a sign that the labor and capital devoted to its production are misdirected: the value of the resources that reater than the value of the article itself

One function of profits, in brief, is to guide and channel the factors of production so as to apportion the relative output of thousands of different commodities in accordance with demand No bureaucrat, no matter how brilliant, can solve this problem arbitrarily Free prices and free profits will es quicker than any other system Arbitrarily fixed prices and arbitrarily lies and reduce production and employment problem arbitrarily Free prices and free profits will es quicker than any other system Arbitrarily fixed prices and arbitrarily lies and reduce production and employment

The function of profits, finally, is to put constant and unre pressure on the head of every competitive business to introduce further econoe these ood times he does this to increase his profits further, in normal times he does it to keep ahead of his competitors, in bad times he may have to do it to survive at all For profits o to zero, they reater efforts to save himself from ruin than he will merely to improve his position

Contrary to a popular i prices, but by introducing economies and efficiencies that cut costs of production It seldom happens (and unless there is aperiod) that every every fired by all firms for the same coe a higher price do not find buyers Therefore the largest profits go to the firms that have achieved the lowest costs of production These expand at the expense of the inefficient firher costs It is thus that the consumer and the public are served fired by all firms for the same coe a higher price do not find buyers Therefore the largest profits go to the firms that have achieved the lowest costs of production These expand at the expense of the inefficient firher costs It is thus that the consumer and the public are served

Profits, in short, resulting from the relationshi+ps of costs to prices, not only tell us which goods it is most economical to make, but which are the most economical ways to make them These questions must be answered by a socialist system no less than by a capitalist one; they must be answered by any conceivable econo bulk of the commodities and services that are produced, the answers supplied by profit and loss under competitive free enterprise are incomparably superior to those that could be obtained by any othermy emphasis on the tendency to reduce costs of production because this is the function of profit-and-loss that seeoes, of course, to the hbor as well as to the man who makes oneand stinized hbor as well as to the man who makes oneand stinized

1Cf Frank H Knight, Risk, Uncertainty and Profit Risk, Uncertainty and Profit (1921) In any period in which there has been net capital accu that there must also have been overall net profits from previous investment (1921) In any period in which there has been net capital accu that there must also have been overall net profits from previous investment

Chapter XXIII

THE M MIRAGE OF I INFLATION

I HAVE HAVE found it necessary to warn the reader from time to time that a certain result would necessarily follow from a certain policy ”provided there is no inflation” In the chapters on public works and on credit I said that a study of the complications introduced by inflation would have to be deferred But money and monetary policy form so intimate and sometimes so inextricable a part of every economic process that this separation, even for expository purposes, was very difficult; and in the chapters on the effect of various governe policies on employ monetary policies had to be considered immediately found it necessary to warn the reader from time to time that a certain result would necessarily follow from a certain policy ”provided there is no inflation” In the chapters on public works and on credit I said that a study of the complications introduced by inflation would have to be deferred But money and monetary policy form so intimate and sometimes so inextricable a part of every economic process that this separation, even for expository purposes, was very difficult; and in the chapters on the effect of various governe policies on employ monetary policies had to be considered immediately

Before we consider what the consequences of inflation are in specific cases, we should consider what its consequences are in general Even prior to that, it seems desirable to ask why inflation has been constantly resorted to, why it has had an immemorial popular appeal, and why its siren music has tempted one nation after another down the path to economic disaster

The most obvious and yet the oldest and most stubborn error on which the appeal of inflation rests is that of confusing ”old and silver,” wrote Adao, ”is a popular notion which naturally arises from the double function of money, as the instrurow rich is to get e, considered as in every respect synonyo, ”is a popular notion which naturally arises from the double function of money, as the instrurow rich is to get e, considered as in every respect synonymous”

Real wealth, of course, consists in what is produced and consumed: the food we eat, the clothes ear, the houses we live in It is railways and roads and motor cars; shi+ps and planes and factories; schools and churches and theaters; pianos, paintings and books Yet so powerful is the verbal auity that confuses nize the confusion will slide back into it in the course of their reasoning Each man sees that if he personally had s from others If he had twice as s; if he had three times as much money he would be ”worth” three times as overnment merely issued more money and distributed it to everybody, we should all be that much richer

These are the roup, less naive, who see that if the whole thing were as easy as that the govern money They sense that there must be a catch somewhere; so they would limit in soovernh topower is chronically deficient, they think, because industry soh money to producers to enable them to buy back, as consumers, the product that is roup ”proves” it by equations On one side of their equations they count an itely count the saap bethat they call ”A payments” and what they call ”A + B payreen uniforovern B pay B payments

The cruder apostles of ”social credit” may seem ridiculous; but there are an indefinite nuhtly more sophisticated inflationists who have ”scientific” plans to issue just enough additional ed chronic or periodic deficiency, or gap, which they calculate in so inflationists recognize that any substantial increase in the quantity ofpower of each individual monetary unit-in other words, that it will lead to an increase in commodity prices But this does not disturb them On the contrary, it is precisely why they want the inflation Soue that this result will improve the position of poor debtors as compared with rich creditors Others think it will stie imports Still others think it is an essential ain,” and to achieve ”full e the way in which increased quantities ofbank credit) affect prices On the one hand, as we have just seen, are those who iine that the quantity of money could be increased by al prices Theyeveryone's ”purchasing power,” in the sense of enabling everybody to buy oods than before Either they never stop to remind theoods as before unless twice asthat holds down an indefinite increase in production is not a shortage ofhours or productive capacity, but oods, they assuoods will almost autoe ofhours or productive capacity, but oods, they assuoods will almost autoroup-and it has included soid mechanical theory of the effect of the supply of money on commodity prices All the money in a nation, as these theorists picture the oods Therefore the value of the total quantity of money multiplied by its ”velocity of circulation” oods bought Therefore, further (assue in velocity of circulation), the value of the monetary unit must vary exactly and inversely with the amount put into circulation Double the quantity of money and bank credit and you exactly double the ”price level;” triple it, and you exactly triple the price level Multiply the quantity of money n n tioods tioods n n times times

There is not space here to explain all the fallacies in this plausible picture2 Instead we shall try to see just why and how an increase in the quantity of money raises prices Instead we shall try to see just why and how an increase in the quantity of money raises prices

An increased quantity of money comes into existence in a specific way Let us say that it coer expenditures than it can or wishes to meet out of the proceeds of taxes (or fros) Suppose, for exaovernment prints money to pay war contractors Then the first effect of these expenditures will be to raise the prices of supplies used in war and to put additional money into the hands of the war contractors and their e, we deferred for the sake of simplicity some co inflation, we may pass over the coovern When these are considered it will be found that they do not change the essential analysis They lead merely to a sort of backed-up or ”repressed” inflation that reduces or conceals so the later ones) now considering inflation, we may pass over the coovern When these are considered it will be found that they do not change the essential analysis They lead merely to a sort of backed-up or ”repressed” inflation that reduces or conceals so the later ones) The war contractors and their eher oods and services they want The sellers of these goods and services will be able to raise their prices because of this increased demand Those who have the increased her prices rather than do without the goods; for they will have more money, and a dollar will have a smaller subjective value in the eyes of each of theroup A, and those froroup B Group B, as a result of higher sales and prices, will now in turn buy roup, C Group C in turn will be able to raise its prices and will have roup D, and so on, until the rise in prices and money incomes has covered virtually the whole nation When the process has been coher inco that production of goods and services has not increased) prices prices of goods and services will have increased correspondingly The nation will be no richer than before of goods and services will have increased correspondingly The nation will be no richer than before

This does not mean, however, that everyone's relative or absolute wealth and income will remain the same as before On the contrary, the process of inflation is certain to affect the fortunes of one group differently froroups to receive the additional roup A, for example, will have increased before prices have increased, so that they will be able to buy alroup B will advance later, when prices have already increased sooods Meanwhile, however, the groups that have still had no advance whatever in their her prices for the things they buy, whichon a lower standard of living than before increased sooods Meanwhile, however, the groups that have still had no advance whatever in their her prices for the things they buy, whichon a lower standard of living than before

We ures Suppose we divide the coroups of producers, A, B, C and D, who get the money income benefit of the inflation in that order Then when roup A have already increased 30 percent, the prices of the things they purchase have not yet increased at all By the tiroup B have increased 20 percent, prices have still increased an average of only 10 percent When roup C have increased only 10 percent, however, prices have already gone up 15 percent And when roup D have not yet increased at all, the average prices they have to pay for the things they buy have gone up 20 percent In other words, the gains of the first groups of producers to benefit by higher prices or wages from the inflation are necessarily at the expense of the losses suffered (as consuroups of producers that are able to raise their prices or wages

It ht to a halt after a few years, the final result will be, say, an average increase of 25 percent in e increase in prices of an equal aroups But this will not cancel out the gains and losses of the transition period Group D, for exah its own incomes and prices have at last advanced 25 percent, will be able to buy only as oods and services as before the inflation started It will never co the period when its incoh it had to pay up to 30 percent ht froroups in the community, A, B and C

3

So inflation turns out to be merely onebenefits for a short tiroups, but only at the expense of others And in the long run it brings ruinous consequences to the whole community Even a relatively mild inflation distorts the structure of production It leads to the overexpansion of some industries at the expense of others This involves a misapplication and waste of capital When the inflation collapses, or is brought to a halt, the misdirected capital investment-whether in the fors-cannot yield an adequate return and loses the greater part of its value

Nor is it possible to bring inflation to a sentle stop, and so avert a subsequent depression It is not even possible to halt an inflation, once embarked upon, at some preconceived point, or when prices have achieved a previously agreed upon level; for both political and econoument for a 25 percent advance in prices by inflation without soood for an advance of 50 percent, and soood for an advance of 100 percent The political pressure groups that have benefited from the inflation will insist upon its continuance

It is impossible, moreover, to control the value of money under inflation For, as we have seen, the causation is never a merely mechanical one You cannot, for example, say in advance that a 100 percent increase in the quantity of money will mean a 50 percent fall in the value of the monetary unit The value of money, as we have seen, depends upon the subjective valuations of the people who hold it And those valuations do not depend solely on the quantity of it that each person holds They depend also on the quality quality of the money In wartiold standard, will of the money In wartiold standard, will rise on the foreign exchanges with victory and fall with defeat, regardless of changes in its quantity The present valuation will often depend upon what people expect the rise on the foreign exchanges with victory and fall with defeat, regardless of changes in its quantity The present valuation will often depend upon what people expect the future future quantity of money to be And, as with coes, each person's valuation of money is affected not only by what he thinks its value is but by what he thinks is going to be quantity of money to be And, as with coes, each person's valuation of money is affected not only by what he thinks its value is but by what he thinks is going to be everybody else's everybody else's valuation of money valuation of money

All this explains hen hyperinflation has once set in, the value of the monetary unit drops at a far faster rate than the quantity of e is reached, the disaster is nearly complete; and the scheme is bankrupt