That's What I Thought...
columnist: Gene DeNardo

Topic: Economics
Profit, Where Art Thou?

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We hear about Profits or lack of them all the time, where exactly do they originate from?

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by Gene DeNardo
(libertarian)
Saturday, April 25, 2009

"Profit, like sausages.....are esteemed most by those who know least about what goes into them."           Alvin Toffler

Profit is one of those many economic terms that have been shrouded in mystery. As much effort is devoted to concealing it at tax time as is invested in bolstering it in bold type in shareholder's reports. Again, as with money itself, how can one thing exist in our world as two or more things at the same time? If there is a benefit, and the benefit is to those who are powerful enough, it seems the entirely unnatural is common occurrence.

Profit, though it is often also defined economically, is an accounting term. It is the difference in total cost between that which is produced or bought and its selling price. Simply the difference between what the seller paid when he bought or produced a good and what the buyer paid to the seller for the same.

But, where does profit originate from? If we can determine this, we will certainly have a better understanding of how our economy works and maybe how it really should work. We can only "profit" from this knowledge!

We could argue endlessly whether one could profit from barter, so let's skip it entirely. It is an important argument and fundamental but also all consuming.

Let's propose that early Merchant Man procured a limb from the forest and carved it into a walking stick. He has gathered the wood at no cost and carved it with his own labor, using a sharp stone he also found. He sells it to a local walker for a small amount. Has he profited?

In this transaction, the only "cost" is the woodworker's labor. All materials and tools were "free", so it is his labor that has a cost, and he has been compensated for it. If there is profit, he must be able to "profit" on his own labor. If we still believe profit is the difference between the "cost" of what is produced and what is sold, this is impossible. Can the worker's own labor cost less than the worker paid himself for it?

If in time he must "pay" for his wood, then the material or resource now has a "cost". Is it possible for the woodworker to profit by "marking up" the cost of the stick or resource?

Not for long! As long as there is equal access to the purchase of the resource, wouldn't free competition in a pure market allow another carver to "mark up" the resource a bit less, therefore underselling the original worker? Other than the effort to purchase the stick and transport it to his workplace, what other compensation would carvers as a whole demand to be included in the final cost? Competition must be eliminated for "mark up" to sustain, a monopoly or cartel must be in place.

Tools and implements fill a vital role in our economy. Can the carver pass on a greater amount than the cost of his tools? The same above principles apply; free competition will force down the "mark up" of tool costs to the minimum that is necessary to maintain production, in fact the "means of production". This does not mean that one can't be employed and be compensated in the production of tools or machines, simply that the producer of our walking stick sees no sustained profit in his enterprise from procuring the tools and machines necessary to provide his product.

At some point, the land upon which the carver works has become "scarce". This leads us to the concept of "rent". No longer free, the woodworker producer must now "pay" to occupy his workspace. What determines the "cost" of this rent and where does it come from?

In a free economy, the amount of rent charged is simply the result of the "supply and demand" of landowners and tenants. At one end of the spectrum we have one landlord, such as a King might be, and many tenants. The King may extract any amount from the carver's compensation above the amount of his subsistence. If he has unlimited tenants and a heart of stone, he can even extract more and let a few die off, keeping the excess rent.

Once there are more landlords, the amount extracted from the tenant is open to negotiation. Supply and demand will determine what portion of the tenant's wage goes to "rent" and what remains as compensation for work.

The producer can raise the cost of his product to compensate for this rent, only if the consumer is willing and able to pay the increased cost. The consumer also has costs and also receives compensation and also pays "rent". Although he may "value" the product at a point higher than its cost, economics will determine if the cost is justified for each individual consumer.

Rent is confusing in that it can be profit [a greater amount received than cost] and a cost at the same time. If we assume free land as the base condition, the difference between what the homesteader pays [free] and what he eventually receives as rent as scarcity occurs, would be profit. At the time of the land transaction, this profit becomes a "cost" to the party that purchases the land from the homesteader. The "rent" is capitalized into the "price" of the land because of its newfound scarcity and the fact that unlike a produced good, it is limited in supply. It is a natural monopoly. While the reason for purchase may remain utility, the bonus for selling becomes profit.

Even though the homesteader "profits", he has played a very small role in this appreciation. The added value comes from what all others have done around him, including the basic action of homesteading. This "value" created by the actions of the whole economy is "capitalized" into the land rents and values. It is in this way that each succeeding owner "profits" as long as the economy continues to prosper and "grow". The capitalization of this value into the limited supply of land continues and each successive owner experiences a "profit" on the original rent and land value. If for any reason this process accelerates, the reason for land purchase no longer becomes utility but the opposite, speculation and non-utility. We have a "bubble".

Though this phenomenon is technically a "profit", it is provided at a cost to the whole of the economy. The increased rents and land values diminish the "return" to the producers and put upward price pressures on consumers. A percentage of the "output" of the whole economy is diverted away from the actual production process into maintaining the "conditions" of the process.

When our original producer, the woodworker, has sold a number of his walking sticks, he may have accumulated a surplus or what we call "capital". He might use this to "hire" a worker or two to do the actual production work while he carries on the "business" and organization of his enterprise. Is it possible, as Marx noted, for him to "profit" in this manner on the labor of his employees?

Again, not in a pure free market! If all avenues of the economy are free and open, this "profit" on labor would be demanded by other entrepreneurs and soon the "profit" would be driven down to the "wage". Our woodworker executive could certainly draw a wage, which would also be dictated by supply and demand and the amount of work that he took to task. Adam Smith recognized and described this organizational function in "The Wealth of Nations".

But since our woodworker has control of his capital, which is his basis for funding his future operations, is it possible for him to draw "interest" on this capital? Does it have value to others and if it does, is its value over time greater than its "principle", providing a "return"?

It certainly would have a value to those who lack their own capital and wish to perform a similar economic function. Our woodworker capitalist could certainly charge, depending on supply and demand of the capital itself, more than the capital cost him but his "interest" must come from the economic activity the capital is applied to. The "rate of interest" is somewhat limited as any "borrower" of capital must also compete with those who are "self-capitalized". Obviously, one need not charge oneself interest for using one's own capital, so these fortunate self-sufficient producers have a greater control and flexibility with overall product cost, which is in direct competition with a borrower of capital.

Much has been made of the great "expansionary" power of Capital, but if we hold these above examples of a pure free market as being accurate, then no correspondingly great expansion of profit methods is possible. All aspects may grow and multiply but the basic actions would remain similar. The suggested immeasureable powers of Capital are instead the result of a monopolized and controlled market that benefits the elite rather than an expression of a truly free market.

Our simple examples have brought out a few points: profit in a pure free market seems to exist solely in the areas of land rent and Capital. The profit from land rent and land value is due not to the parcel itself but to its location within a growing and prospering economy. The profit from Capital is due to its ability to enable production that might not be possible with its absence and the "interest" is dependent on the success of this increased production.

In our examples, unlike real world situations, access to Capital and its resulting opportunities appear virtually unlimited. This is due to the open and free access of the producer and worker to the results and value of their product. Due to free competition, other values are not extracted under the pretense of profit but allowed to flow naturally throughout the economy. Capital is not some special dividend paid to selected members of some exclusive club, but the common reward for labor and enterprise. In a better world, it originates and is processed by those who are responsible for its production and it goes where it is most needed, unimpeded by forced direction.

True to its Latin root, the verb "proficere", profit allows one the "make progress". In a free market, individuals have the choice to pay for this utility, whether through the use of land or the practicality of Capital. This is in stark contrast to a present day system that often "extracts" profits. Subtracting from the whole seldom aids progress.

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©2009 Gene DeNardo, all rights reserved. You must have written permission from the author in order to republish this work.
Published: Saturday, April 25, 2009
Last modified: Saturday, April 25, 2009

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