The profit motive: everyone knows that the free market economic system operates in terms of the profit motive. The trouble is, hardly anyone understands where profits come from. This includes the businessmen who make them. This failure to understand the source of profits has given a real advantage to the critics of the market. When the supposed defenders of the free market argue that the hope for gaining a profit is the motivating force of capitalism, yet they cannot state clearly where profits come from, they have left themselves intellectually defenseless.
First, the critics of capitalism identify the profit motive with greed. Since a profit is identified economically as an above-average rate of return on an investment, it can easily be equated with greed. Greed sounds bad. Since there is no way ‘scientifically to define greed, this is a difficult argument to refute. Already, profits sound immoral.
Second, the critics claim that profits come from the ability of the stronger, richer, and more ruthless members of a society to exploit their weaker neighbors. The word “exploitation” has been a favorite one in socialist circles. Karl Marx made the word a weapon against capitalism. The workers are exploited by the capitalists, Marv said, because the capitalists can extract surplus value from laborers. The laborer has to work, say, five hours in order to have enough money to buy minimum food and shelter, but the capitalist keeps him on the job many hours longer. Thus, the capitalist “exploits” extra money from his workers: surplus value. He expropriates this surplus. It really belongs to the worker. It is his labor. What was a technical explanation of the origin of profit — incorrect but initially plausible — became a moral critique because of the choice of a pejorative word: exploitation.
Marx’s exploitation theory was theoretically wrong, and it was demolished by the Austrian economist, Eugen von Bohm-Bawerk, before Marx died. There is no way that the capitalist could retain such a surplus in the face of competition from other capitalists. They will bid against each other in a quest to appropriate any surplus for themselves. They will keep doing this until the wage paid to the worker is equal to the value of his output.
Workers in a free market economy are paid the value of their output, or very close to it. When they are not paid according to the value of their output, other profit-seeking employers start offering them more, since they want the “surplus value” for themselves. The market price of the formerly “exploited” labor services then climbs, since no capitalist wants to allow his competitors the advantage of hiring underpriced labor services. Capitalists may well be greedy; this is the best assurance for workers that they are being paid what they are worth. It is the “greed” — profit-seeking — of the employers that leads them to seek out productive factors of production that are underpriced, including workers, and pay more for them in order to put them to work.
If Marx’s theory were true, the greatest profits on earth would be made in places such as China and India, where wages are the lowest on earth and the available supply of workers to “exploit” is enormous. Yet the fact is that capital flows into high-wage nations, not the low-wage nations. Capital seeks productive workers, not cheap workers. This means workers with good educations and far more opportunities to work somewhere else. Capitalists must compete against each other to gain the services of such high-value workers. This competition raises wage rates. In capitalism, high profits are associated with high wages and low-priced goods. When Henry Ford raised the wages of his workers in 1913 and kept lowering the price of the Model T, he became a billionaire. Why did this work? Because it drastically reduced labor turnover and absenteeism, and it increased the volume of car sales, thereby making profitable even more cost savings.
Why are there underpriced resources available in the market? Because of ignorance. If every participant knew exactly what the factors of production are worth, there would be no profits or losses. But no one knows for sure what anything is worth, that is, what the rational, market-clearing price of anything ought to be. It is the continual quest for better information about the proper pricing of factors of production that is the driving force of the capitalist system. It is not just goods and services that are for sale in the free market; it is also accurate information about prices. We pay dearly for accurate information. Sometimes we pay dearly for inaccurate information. (If we had better information to begin with, we wouldn’t.)
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