Business roundtable; Role and function of profits

The following program is made possible through a grant from the nation's business. This is a business roundtable a program of current comments from leading members of America's business community. Today. Dr. Charles E. Ferguson professor of economics Graduate School of Business Administration Michigan State University and Dr. John R. Morrone also a professor of economics Graduate School of Business Administration at MSU will discuss the role and function of prophets with series host Alfred L. Seeley. Dean of the Graduate School of Business Administration at MSU. Our subject the role of profits is often overshadowed by emotional overtones. Karl Marx condemned prophets as something

evil that was obtained by exploitation of the workers. On the other hand factory owners in Great Britain shortly after the beginning of the Industrial Revolution lauded profits as that vital force that would lift many of the people out of poverty or a subsistence existence. Today we have on business roundtable two distinguished economists they will examine the rule of prophets in a modern industrial society such as the United States. They will also look into the nature of profits in a free enterprise system such as communism. Dr. Morrone what is the role of prophets in a modern highly industrialized societies such as the United States today. Well the prophets serve several roles in a free enterprise decentralized economy. Certainly one of the most important of these is that profits determine the allocation of resources among

various industries for example. Industries that have higher profit rates attract greater capital and i higher proportion of the labor force than those industries in which profit rights are lower so profit serve as a signal a signal that in a deep decentralized free enterprise economy reflects the tastes and preferences of individual consumers. So profits serve this important allocative world we would Labrie demand a minute when you say allocation to consumers just what do you mean by this. Well in a decentralized economy. Consumers have the opportunity to spend their dollars as they so desire. Dollar of gold. Well in fact a decent realized economy could be considered a system of proportional representation instead of one man one vote one dollar one vote. So of course we have an unequal distribution of dollar vote and no doctors

and women in Doctor Moroni mentions that capital tends to flow to certain industries and labor to us in terms of needs. Is this always true in our kind of society. Almost always yes indeed of course you have a government sector that does not express the direct does ours all of the consumption factor but only as they are interpreted by the government officials. And of course that is attracting greater. Perhaps greater proportion of capital than before. But generally I think if it is true we have seen good evidence of that over the pious that is whether you like them or not hula hoops get made when hoops are desired and. I think that our system has been quite responsive to the desires of consumers as time goes by.

What about tea and some other aspects of the role of profits. Well Dr. Morrone spoke to the fact that. Prophets tend to get the things made that people might think maybe even more basic than that is that the existence of profits or the prospect of making satisfactory rate of profit is responsible for getting things might begin with. That is to say it gives an incentive for people to invest their money in productive enterprise rather than in a what's a government bond. For example if the government were to limit the rate of profit lot of say the 5 percent and you have a 100 percent tax the only thing in excess of that there would be no one cent of it all to invest in a risky business where you might very well lose a considerable amount. Rather than just put money into a

known yield him out so that. We must offer the prospect of profit then excess of this buy you think minimum in order to attract anybody to invest in a Rifty risky enterprise. Now you mention the prospect of profits in other words. I've heard it said we are in a free enterprise system we have the privilege of making a profit are going broke. That's indeed true. Indeed it is. We have. Well each month between three hundred and fifty thousand business is going bankrupt in the United States month in and month out. So not everybody who invests the money makes a profit out of it. In other words and we've got some new entries I suppose coming into that into the marketplace then in terms of business is a little time. There's no question about it. For example prophets serve as a reward system or an incentive system for. Business managers who happen to make the right decision. And similarly profits

discipline those business decisions that are incorrect. I mean are you saying that the role of profits in a business penalizes bad decision precisely and it penalizes bad decisions. Very sensitively in free enterprise systems for example yet run one example that's well known was the Edsel investment. Of course it's all turned out to be an unprofitable venture and the Ford Motor Company dropped the production of but the automobile a matter of two or three years. In other words this of course is the final decision resting in the hands of the consumer. Precise as to whether they want to buy that or whether they don't. Another words this is one aspect of what you are talking about when you're talking about the allocation of resources. Yes well what other aspects are there at this subject or the role of profits in our kind of economy. Well I guess that the other principal one would be the fact that profits.

Of pork continued economic growth and. We now at least believe that continued economic growth is a necessity to prevent. An increase in the right of unemployment. At least that and maybe more. And. The existence of profits not only permits the playing of dividends to people who tend to say but it also permits corporations to retain earnings which they can directly invest to 100 percent rather than the percent that the dividend holders would. A dividend recipient would themselves invest than it is the chief source today of corporate investment is retained earnings. Now we don't want that because these are profits yes recurring profits are directly invested in it to take book pay 100 percent. That shouldn't sound too bad I mean

the. Typical shareholder is free to buy stock in any corporation he wishes and if he doesn't want to grow if he wants to buy your company he can buy your old company and he wants to buy a growth company can do that so it's not limiting Are you speaking about a group or company is there any assurance that the company's going to be a gross no no no not at all I mean this is everyone a stalwart of the declining one but I thought they were old company. But other investors have better luck and they get growth companies and if you think you can foresee the trend then consumer demand then business demand and what's even more if the government demand you can pick the growth corporation. Now we've had docked money a very high rate of growth in this country over any long period of time. We've had periods when of course it has fluctuated within some ranges but. For well fifteen hundred years we've been in a growth economy. Until today we

have one of the most well the most affluent economy in the world. There's basically as you see it the result of profits being reinvested. How did this come about. Well I think Dean Seeley that is partially the result of profits being reinvested in those areas where the rate of return is most attractive. But I think also. That profits have fulfilled. In our decentralized economy the. Very important allocative role. In other words the profit system has determined those and has determined those industries or those sectors. In which people. Wish output to be expanded. Well are people always the best judge of this. This is an interesting question. And I suppose that the. The principal indictment of a profit system by many intellectuals is that.

It tends to ensure that people get what they want rather than what someone might think they ought to want. So no one thank you for. And my answer would be unequivocal. No one other than the individual can determine better what he ought to have another way do you think if an individual wants great big fins on his automobile he ought to have great big friends on the automobile even though there is no practical utility to these. Yes indeed. And by the same token if a person doesn't want public library service I see very little reason he should have to pay for public library for them. There is no stablished in God given notion of what's good for a person and what is good for a person. So far as an economy is what that person. And I know of no other way that it can be. Assured. Take an example. If you have

a centralized system that. Dictates what is to be done. Then if you retain some kind of surplus you can achieve a much more rapid growth rate than the United States has achieved because the only thing you have to do is to direct investment toward the technologically rapidly developing sectors and we have directed investment because apparently people want them toward the service industries in which product does not increase very rapidly. So our overall growth right did not. Come up to that of. Say Soviet Russia or Yugoslavia or some of the countries where the central administration does a great deal more in directing. Does it entirely direct the investment funds and if you want to build only speak you will be old now feel happens to have a pretty high rate of product to grow. So you've got to get a high growth rate in some countries. Yeah I hear that true and if you want to invest in.

In department stores and physicians services there is just not a high rate of growth of product pity per man hour in the US and you drove right through there by a limited. Let's leave the subject of their control type economy to a little later here in our discussion turning out Doctor moaning that you think is appropriate here in terms of a highly industrialized society that depends upon the free play of the market. It's important to our discussion. Well as I said before I think that one of the central roles of a free market is to ensure that people get what they want. And. When you think this is the best mechanism for this. I think that there's no question that. A decentralized profit oriented. Economic system

promote the maximum of individual liberty. And provides most in consumer choice. Yes indeed. Absolutely. Well let's look at another aspect of this we've been talking here about profits from some of the implications of profits in a modern industrial society such as the United States Western Europe Japan. How large are these profits. What are they running. What are we talking about here. Well one of the stylized facts of American capitalism during the past hundred years has been that the share of profit in the national income has been remarkably constant. Now. It is hardly debatable that in the post-war period the share of profit that is as a fraction of total product in the economy has declined. Now the the aggregate. Amount of profit

last year I think was on the order of one hundred fifty billion dollars. Something like this. So this amounted to 25 percent roughly of the total product of the US economy that we have produced during that period. That's correct. Well what put this in a little simpler terms. What was the rate of profit in our industrial sector in terms of investment. Well the right of profit differs a great deal from industry to industry. The valuable study by George Stigler four years ago indicates that. Profits range from 4 to 5 percent as a rate of return on investment in some industries to 9 or 10 percent as a right of return on investment in some other industries. Now this means that the total profit in an industry is divided by the aggregate amount of capital in that industry would be something on the order of 45 to a maximum of nine or 10

percent. Don't force someone to so many people in the United States seem to think that profits of corporations are 25 to 50 percent. In. Fact I've seen several studies of different segments of our society where when they are asked what do you think that the profits of American industry mount to check from 25 to 50 percent profits now Doctor Moroni has just told us that last past few years profits for most of our corporations running 5 6 percent with those towards the very top of the group someplace around 8 teams. Well that's hard to explain I guess. So I really couldn't account for people who believe that if maybe they say well. I ju or have the mark up of 100 percent on a wrist watch or a diamond or whatever it might and think that well he must be earning that percent profit. But he does

incur some cost in bending that diamond our wristwatch you know that might be one particular thing. And of course you have the spectacular companies the companies that are the first in an area like computer software is now called are your tremendously spectacular growth companies that have indeed earned. There are a few that do are in that because they have assumed tremendous risk. And I'm sure there might be conceivably a company that is are in 30 percent. But for all of those there are the ones the cotton mills in Massachusetts who have earned a minus can berth it so that it tends to average out of course. We're only speaking of averages and. Average is an average of the statistic that doesn't tell you very much it cause you one thing but it doesn't tell you how to distrain am I correct

from our discussion to date that take the industries if there are some group of industries at which the profit rate is low that these are industries that generally are not expanding. Contrast it with those where the profit rate is high. But these are the expanding ones as are. Yes yes an alternative would this would be a correct assertion. And we observe that capital tends to flow out from those industries in which the profit right is low. There's an incentive for capital flow in this direction. Well Adam Smith the great economist who wrote is notable work in 1776 if I recall correctly talked about the invisible he that directed the economy to every individual seeking his own best interest in business in his own best interests was trying to make a profit. Brought

about the maximum benefit to the entire society. Now when Adam Smith wrote that it was a pretty primitive kind of industrial society the industrial revolution was just getting going in a relatively small way. Is that still true today in a highly mechanized technological industrial scientific society like we have today. Well there's room for disagreement among reasonable men's opinions. I happen to believe that it is true that the system of enlightened self-interest. That Smith expounded in his remarkable book is largely operative today although unquestionably the structure of society has changed a great deal we now have a a corporate capitalism. Some economists refer to this is a a new as opposed to the old style capitalism. Nevertheless I think that the Smiths postulant

hold very well today and I'm certain you would think that there are two dimensions there I guess. First with the development of the so-called giant corporation or as some of our colleagues call the giant corporations it is doubtless true that in the short run they have pricing power because of something like a monopoly position all right commodity in the short run they have a pricing power that perhaps enables them to charge. A considerably higher price than would be true if there were many competitors in the industry. But there is another dimension that is not considered. In Smith's day and that is technological improvement and. Well to be on it. What we have found is that. The more highly competitive. In the technical economic sense of competitive I mean the more meaning larger numbers are selling

a larger number of smaller smaller firms and the less technologically progressive they are. Tell that in a sense profits and this might be another role that we should have mentioned in another role of profits is to provide a full on for research and development. And that is the dimension of growth in it. We might should have mentioned that of the growth thing but. While a concern my in the very short period of time get a monopoly position and this very position promotes research and development which in the long run is going to redound to the benefit of consumers or industrial buyers is a case might be. So all that well the evens may have didn't think the invisible hand was perfect and as. One of my friend used to say it's like chewing gum the more you chew it the further you can stretch it but I don't think we would be stretching it very far to say that.

There is something like this operative and that in the long run if not over two months or three months or one years period of time that the. More or less free play of competition in the market and there may be very little free play and very little competition in the short run but it does plan to allocate resources better than any other volatile system. And I think Bob it was important to emphasize I don't let's turn to another kind of system we mentioned earlier that there is another type of system like the basic Soviet type system recognizing that within the soldier block there is modifications of this. Some variations from Russia to Yugoslavia to Czechoslovakia. But it basically is a different kind of an economy than we have in Western Europe or the United States. Dr. Morrone what do

how do they allocate resources and how do they provide incentives and how do they provide for growth rates if there aren't savings for the individuals to invest. Well these are three distinct although interrelated questions. Let me. Begin with the last one. Profit in a sense innovate in a loose sense in a competitive society could be regarded as a surplus over and above wages paid out to in. To workers and proprietors. Well this same type of surplus is mandatory in centralized economies as well. As us to in the form of providing growth a source of growth in the economy so the surplus in the Soviet Union for example over and above wage payment is certainly not call profit

but it is a dirty word not going to you Well yes it is. It's anathema to Marxist doctrine. And. Nevertheless this surplus has been used to finance the remarkable growth in that society now I should point out that there are costs involved in the rapid growth of the Soviet Union has achieved during the past 40 years in particular. The allocation of resources in this society has been determined primarily by a central planning bureau rather than by individual consumers. So the central planning bureau has dictated that investment occur primarily in the heavy capital intensive and capital producing goods industries rather than the consumer goods industry and our profits hasn't played the traditional role that we have talked about in the United States and as a doctor you know it. You're absolutely right thing. It is the poor to grow but not market dictated grow. But government dictated. Now we might well be

on it. There are more and more government dictated growth in this country but still nothing like it is in the Soviet Union. But. I sort of blows over materials and why a huge coal still exists and. Thought we'd industry and it is this third place that the things they are very very remarkable writer wrote when I was a remarkable writer girl has been a relatively recent phenomenon. Yeah I think you know if you start from zero you can grow very fat your percentage can increase faster that's true it can be truly dramatic. Well now this so-called surplus that you have used this term here is what we find in Russia are countries that this particular type or nature. Do understand it correctly it is essential that this. Be taken then by the government in order to sustain growth in those countries by investing it in whatever the government decides to invest to do

precisely because the capital goods in these societies. Are not owned by individuals. Rather they are own collectively so the government takes the surplus and then reinvest it so the surplus accrues instead of to individuals to the government. In these societies now I should add that this is not an entirely bad as it might sound because. A portion of these accruals come back to the individual in later years. In the form of increased out of the woods and is working something like in our society in the sense that you've got to have a surplus we call it a profit yet. And it is then utilized by the government to invest in certain things where in our country it is invested by individual consumers or corporations. Yes I like reasonably fair statement yes. Let me add one interesting point here. The. The

very rapid growth in the Soviet economy has occurred primarily at the expense of consumers and that is at the expense of yes at the expense of consumers. Most authorities for example feel that real wages of a typical Soviet worker in 1052 were actually lower than they were in one thousand twenty eight. Another interesting statistic which by itself is not particularly important but is indicative of the squeeze that has been placed on consumers in the Soviet Union. Is the per capita consumption of meat. In that country 952 is actually less than that in 1017 around the time course. High high died out the statistics myself. Though I don't know the source of all of them I think would probably be. If you take the populace as a whole and Soviet Russia Today they're much better off than they were at the time. Really I mean maybe pro-worker but they are worth all

but there are a lot more working. But whether this is true or not the matter still remains that they have expanded the state and still expand the capital good program relative to consumer goods and of course Mr. Crewe went out on that very issue and this is a government dictated decision that is not going to allow the consumers to have the kind of things they would want. Where are type this as well. At least it is in the chain. What say that they decide what the consumer wants and how much of it and they are there to fake and presume die to produce are not stored in a rupture but our time is up and Dr M Aroney We certainly thank you for a most interesting discussion in the business roundtable. Participating in today's Business Roundtable we're not there Charles E. Ferguson a professor of economics Graduate School of Business Administration Michigan State University and Dr. John R. Moroney also professor of economics in The Graduate School of Business