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Christian Economics in One Lesson, Chapter 21

Written by Gary North on August 22, 2015

The Function of Profits

After a long time the lord of those servants cometh, and reckoneth with them. And so he that had received five talents came and brought other five talents, saying, Lord, thou deliveredst unto me five talents: behold, I have gained beside them five talents more. 21His lord said unto him, Well done, thou good and faithful servant: thou hast been faithful over a few things, I will make thee ruler over many things: enter thou into the joy of thy lord (Matthew 25:19-21).

This passage appears in the most famous passage of the New Testament that deals with the final judgment. It is a parable about an owner who entrusts coins to three servants. The servants were stewards. Then he leaves. When he returns, he demands an accounting. Two servants produced a profit. The third buried his coin. The master has no gain on his investment. The master condemns the man.

This was one of Jesus’ pocketbook parables. He knew that his listeners were interested in money. He knew they would understand the parable. The message was clear: a steward is an economic agent of the owner. The owner expects a positive rate of return on assets transferred to the steward. In short, he expects a profit on his investments. Breaking even is not good enough. It is clear how he would have regarded a loss.

The language of business is obvious. There is capital. The owner hands over these capital assets to subordinates. He diversifies his portfolio: three men, each with skills. He is future-oriented. He does not know how these stewards will perform. He has a plan: to judge their ability to perform profitably. When he returns, he demands an accounting. The two stewards who produced a profit gain a reward: additional capital. They will remain stewards of the owner. One steward failed to make a profit. He is fired — permanently.

There is no hint that profits are evil. There is more than a hint that losses are to be avoided. If breaking even gets you fired, think of what the consequences are for losses.

Why would Jesus use this as a parable of the final judgment? Because the final judgment is the archetype — the ultimate model — for all accounting. We are held responsible for our actions. We possess property, but only as stewards of God. Our ownership is a form of trusteeship.

Why would anyone imagine that profits are illegitimate? Yet millions of people do. Hazlitt dealt with this hostility in this chapter. He attributed this hostility to ignorance about the function of profits in a free society. This chapter is more explanatory than an example of a specific intervention by the state. In this sense, it is like Chapter XV: “How the Price System Works.”

1. Owners
If an individual owns a small business, he is responsible for its operations. It must produce a stream of profits if he is to remain in business. What is true of a sole proprietor is equally true of a large corporation. In this case, the owners are shareholders. They delegate to managers the responsibility of producing a profit. The managers are stewards, not owners.

Other owners are potential customers, who own money, which is the most marketable commodity.

2. Window
The window is the legal structure that identifies who is responsible to whom. The senior managers in a corporation are responsible to shareholders. They must report to shareholders. The shareholders have the legal authority to replace senior managers. If they are not sufficiently organized to do this, they may sell their shares. This will tend to lower the price of the shares. This sends a signal to other investors: the company’s management is failing to produce profits. A new owner, sometimes called a take-over specialist, can then buy shares cheaper than before. If he buys a sufficient number of shares, he can fire existing managers. He may head up a group of outside investors who buy shares. Their goal is to fire managers, re-structure the company, and make a profit. Then the price of the shares will presumably rise. They bought the shares low. They can now sell the shares high.

How do they make a profit? By selling to customers at prices that cover costs and also provide a profit. If there were no profit potential, they would not have bought the shares. If they had not bought the shares, they would not have been in a position to replace the existing managers. In that case, existing managers would have continued to make mistakes. Potential customers would not have become actual customers. Profits would have proven elusive.

In this system of ownership and disownership, the hope of profit drives managers and owners. To make profits, managers must serve customers. The customers possess money. Their decisions to buy or not to buy determine retroactively which producers were successful with their plans. What is the proof of their success? Profit. The profit system delivers planning and production into the hands of entrepreneurs, but the success of their plans depends on customers. Customers “hold the hammer.” Their retroactive control over the production process depends on the profit-and-loss accounting system.

This system is future-oriented. It is based on an inescapable fact: no one knows the future perfectly. No one knows what customers will want in the future — in what quantity, at what price, and in what location. This includes customers. Customers expect businessmen to guess what customers will want in the future, and then plan for this.

The free market’s rule is this: sellers compete against sellers; buyers compete against buyers. With respect to competition among sellers, Hazlitt wrote this:

The function of profits, finally, is to put constant and unremitting pressure on the head of every competitive business to introduce further economies and efficiencies, no matter to what stage these may already have been brought. In good 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 may not only go to zero; they may quickly turn into losses; and a
man will put forth greater efforts to save himself from ruin than he will merely to improve his position.

The stewards have four-way responsibility: upward to the owner, outward to customers, downward to any employees, and inward to themselves: their goals, dreams, and standards.

3. Stone
Hazlitt was not clear about the nature of the stone. One possibility: government price fixing.

One of the greatest dangers to production today comes from government price-fixing policies. Not only do these policies put one item after another out of production by leaving no incentive to make it, but their long-run effect is to prevent a balance of production in accordance with the actual demands of consumers.

Another possibility: a profit ceiling.

But if profits are limited to a maximum of, say, 10 percent or some similar figure, 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 wartime excess-profits tax has already shown us what such a limit can do, even for a short period, in undermining efficiency.

Could this be an excess profits tax? These were imposed in World War II.

(For the rest of my chapter, click the link.)

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