Profit: beyond the carrot-and-stick

When Raphie called in to Freedomain Radio to argue for an end to the market economy, he didn’t do so as a sociology student whose only exposure to economics came from a required reading by Marx.
Instead, at the time he called, Raphie had been a Canadian businessman with 21 years of experience running his Montreal-based shoe repair service. He charged money prices, pursued profit, charged interest, and paid hourly wages, just as his competitors did, without a second thought, before one day in his mind “it just clicked.” Raphie found himself looking in the mirror, questioning what worth to society these activities had:

“What bothered me most in this traditional way of doing business was the lack of connection I had with the customers. Then I went deeper into the philosophy of my way of thinking and asked ‘why don’t I charge…my daughter to fix her boots? Why is it free for her? Why is it free for friends, family, loved ones? Why do I charge to strangers, to customers?”

Raphie arrived at the answer which seems intuitive to the contemplative layman: man is a selfish creature, who does not make great sacrifices for others unless he stands something to gain. Profit exists solely as a motivator for some to do good for others. But man willingly makes sacrifices for loved ones out of compassion.

Why then is it not possible to regard everyone on Earth as your “loved one,” and make sacrifices for the neediest among them, without expecting anything in return? Without a meaningful answer, Raphie concluded that money, interest, wages, private ownership, and profit could be done away with, without a tear shed, if only we humans weren’t so greedy.

To see why the invisible hand wags its finger at Raphie’s conclusion, let us first consider one model that economist Ludwig von Mises uses in Human Action, called the “Evenly Rotating Economy” model. In this purely hypothetical construction of the economy, all needs are continually being satisfied, and these needs do not change from one “rotation” to the next. Thus, there is perfect certainty about which goods need to be produced, in what quantities, and which people will consume them.

Let us contrast this with a real economy. We live in a world of unlimited desires but limited resources. There is no formal distinction between “want” and “need,” and everyone prefers more goods to fewer. To produce goods, we need to expend time and energy—time and energy that could be spent doing other things.

Given all these facts of reality, we need some convenient way both to discover and to communicate among our seven billion brethren whose desires are most worthwhile trying to satisfy. Without this information, worldwide cooperation is impractical to impossible.

This is the role of the price system. It allows us to communicate in standardized terms (money) which desires are most urgent to satisfy. Because we live in a world of uncertainty where desires change based on circumstance, we need to make educated guesses about what to produce. The entrepreneur assumes this task.

If an entrepreneur’s predictions about what, how much, and for whom to produce are correct, that information is recorded in terms of profit. If his predictions are incorrect, the corresponding loss is noted. Financial markets exist to make this information known quickly, for all to see, so its participants can direct money resources into the lines of production that are most profitable (satisfy the most desires).

In the linked video, Stefan Molyneux makes this point, albeit vaguely, with the example of a banana producer. His point is that no matter how altruistic the banana producer may be, no matter how motivated by compassion he is to produce, he cannot serve his fellow man effectively without the sort of information that the price system provides.

Today, Raphie does not charge a standard price to his customers. For a year, he has allowed his patrons to offer whatever price they can afford. He has not given up money for barter however, and he still buys from his suppliers at prices determined by supply and demand. Like a good father should, he continues to fix his daughter’s shoes for free. He is able to provide for her because of the prosperity he inherited from a system where worldwide cooperation becomes ever more possible—the system we call capitalism.

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