Saturday, March 30, 2013

Profit and Loss, Private Property, and the Achievements of Capitalism

IN DEALING WITH ALL MATTERS CONCERNING CAPITALISM, it is fundamental never to forget the difference between “capital goods” and “capital.” “Capital goods” are physical things. The concept of “capital” is purely a theoretical concept within the framework of a definite method of calculation and computation. The evolution of this concept of capital finally resulted in including in the accountant’s concept of capital, the auditor’s concept, and also those things that are not capital goods.
The system of accountancy started, of course, with businessmen. Anxious to know what the results of their transactions were they developed this method of accounting—double-entry bookkeeping and so on. The concept of capital that they applied referred to, and included, only those funds that they had diverted to the development of business. It did not include real estate or the private property of the head of the enterprise, of his family, and so on. You can still read in legal treatises and papers essays debating whether or not the private capital of the owner should be included in the balance sheet of a firm. According to the methods in practice in accountancy, the concept of capital as used today includes the real estate and all rights owned by the enterprise.
Agriculturists also began to pay attention to these problems, but only much later. In the beginning they developed methods of accounting which were limited to the operation of the farm only, without including the whole property of the owner. I mention these facts because if you look into the balance sheet of an enterprise there is room for the building, the real estate, owned by the enterprise. The concept of capital as used today includes more than capital goods; it includes all the things owned by the enterprise.
From this point of view we must raise the question also of whether or not there are other distinctions which may have greater importance for the practical problems of capital. If we speak of capital we discover that we have in mind all the total material factors of production as far as they may be used for production purposes.
If we talk about the decisions to be made concerning the employment of capital, we must take into account the fact that the greater part of the capital available is embodied in nonconvertible or not perfectly convertible goods. Capital goods are intermediary factors between the natural goods and the final consumer’s goods. In a changing world, in which the productive processes and other things are constantly changing, the question is whether we can use these intermediary products, which were originally designed for a specific end use, for any other end. Is it possible, even after a change in plans and intentions, to use for other purposes capital accumulated or produced in the past with different plans and different intentions in mind? This is the problem of the convertibility of capital goods.
For more than one hundred years, a movement popular in the whole world, today especially in California, is represented by a group of reformers who call themselves “technocrats.” Technocrats criticize the fact that we have still going on side by side with the most modern methods of production, processes of production of an outdated character. And they are not the only ones to criticize this fact. They point out how wonderful it would be if all that they call “economic backwardness” were eliminated, if we had all the factories located in the best places, and if all the factories were equipped with the most modern equipment. Then there wouldn’t be any backwardness, nor any machines and methods of production being used which are no longer up to date. There was a German, or a Russian—I had better say a Baltic—socialist who pointed out, for instance, how backward German agriculture was. He would abandon or diminish all existing farms and machines, substitute the most modern achievements of agriculture, and then it would be possible to produce everything cheaper.
The weak point of these plans is that the capital accumulated in the past was in the form of capital goods that represented the technical wisdom of the ages in which it was accumulated. Although the factories are out of date it does not necessarily mean that the old machines have to be sold as scrap iron and new machines substituted. It depends upon the superiority of the new machines. Unless it is impossible for the old factory to make any surplus over current expenses, it would be a waste, not only both from the point of view of the individual factory owner but also from the point of view of a socialistic system that had to deal with the same thing. The problem is similar to that of a man who must choose between buying a new typewriter or a new television set because better ones have now been invented, or buying something else that he doesn’t have at all. Just as not everybody will throw away his old typewriter or his car when a new model appears, so will a businessman have to make similar decisions in business. While in the household precise calculations are not needed, in business these decisions are made on the basis of more careful calculations.
The capital equipment that makes up the wealth of our age and that also makes one country richer as against poorer countries is embodied in capital goods created in the past by our ancestors, or created by ourselves under different technical conditions and for different purposes. If we want to use this old capital equipment in the future, too, in spite of the fact that it does not render as much service as new equipment, we do so because we consider the service it renders worth more than what we can gain by throwing away the old machines and replacing them with new machines.
The settlement of the world was done in other ages under other assumptions and other conditions with other technical knowledge. If we were to come to earth from another planet with perfect knowledge of today’s geographical conditions, we would settle the world with the use of that other knowledge, knowledge very different from that which was responsible for our present capital equipment. In the past our wealth consisted to a great extent of capital goods adjusted to conditions which are different from our conditions. Decisions of the past were based on conditions at that time. The fact that our ancestors made the decisions they did helps to influence us to keep things as they are; it wouldn’t be worthwhile to abandon the investments of the past. In every individual case we have to make a decision between continuing in the old ways, in spite of the fact that we now know better, or renouncing the old ways for some other employment of additional capital goods which we now consider more important.
In answer to the technocrats, we say we are not rich enough to scrap everything that was built in the past. Perhaps it would be better to have the industrial centers somewhere else than where they were built in the past. But this transfer, this shifting, is a very slow process. It depends on the superiority of the new sites. This is a refutation of the famous infant-industry argument, which says that the new industries must be protected against the old industries. In this case too—in the case of shifting industries from physically less favorable to more favorable sites—the decision must depend on the degree of superiority of the new sites. If the superiority of the new sites is sufficient the industries will move without any outside assistance at all. If it is not sufficient, it is a waste to assist industries to make such a move. (For instance, the textile industries developed in New England even though the cotton was grown in the south. More lately the textile mills have been shifting to the south, again without any outside assistance.) If the advantage to be derived from the abandonment of capital goods is great enough, the change will be made.
Technical backwardness is not the same as economic backwardness. If capital needed for eliminating this technical backwardness, from our point of view or from the point of view of the buying public, has a more urgent employment somewhere else, then it would be economically a very serious mistake to employ it in making changes to new equipment simply because there are already better machines.
Capital goods are scarce. The economic problem consists precisely in the fact that consumers seek to employ them for the satisfaction of their most urgent not-yet-satisfied demands. The economic problem is not to employ capital goods for producing something which is less important than another product, which cannot be started precisely on account of the fact that these capital goods are being employed in the production of the less important product. This is what unprofitability means. A businessman says, “This is unprofitable. The project could be undertaken but it would be unprofitable. Therefore, we do not want to start it.” What the socialists say is, “But businessmen are greedy; they want to produce only those things which are profitable, not those which are unprofitable.” However, what makes an enterprise unprofitable is that, given the prices of the factors of production and the rate of interest, the anticipated proceeds would lag behind the expenditures.
What does it mean if the price of copper is higher than it used to be? It means that consumers are ready to pay a higher price for the copper that goes into the making of other products; they are not ready to pay the higher price for copper in its present uses. They make some prices high enough to make the production of other products profitable. On the other hand, if there is an increase in the supply of copper, or if some branches of business which used to employ copper until now use something else instead of copper in production, then copper becomes more readily available, the price of copper drops, and it now becomes profitable to use copper to produce some things that yesterday were unprofitable. Ultimately it is the consumers, in their buying, who determine what should be produced and what should not be produced.
When aluminum was first introduced, many things could not be produced from aluminum because its price was very high. Napoleon III [1808–1873] immediately had the idea to give to his cavalry armor of aluminum, but it was so expensive then that it would have been cheaper to give them armor made of silver. When I was a child, aluminum was used for children’s toys, but the really serious industrial use of aluminum was then more or less out of the question. Slowly the production of aluminum improved and the use of aluminum for many articles became possible. Years ago, it was as unprofitable to use aluminum as it is today to use some high-grade metals for certain commercial purposes.
The slogan “Production for use and not for profit” is meaningless. A businessman produces for profit. But he can make profits only because consumers want to use the things he produces, because they want to use them more urgently than other things.
In the absence of profits and losses there wouldn’t be any guides for production. It is profits or losses that show the businessmen what the consumers are asking for most urgently, in what qualities and in what quantities. In a system in which there were no profits or losses, the businessman would not know what the wishes of the consumers were, and he wouldn’t be able to arrange his production processes according to the wishes of the consumers.
Besides this function of profit or loss there is the role they play in shifting ownership of the means of production into the hands of those who knew—in the past, of course, i.e., until yesterday—how best to employ them for the needs of the consumers. This is no guarantee that the means of production will be used in the best way tomorrow. But if they aren’t, the owners will suffer losses. And if they do not change their methods of production, they will lose their property and will be thrown out of their eminent position as the owners of factors of production. But this is something given, and it cannot be changed. Every judgment about people refers to the past. A candidate in an election can only be judged by what he has done in the past. The same applies also to the choice of a doctor, a shop, and so on, and also to producers. It is always good will referring to the past.
Past profits shift the ownership of the means of production from the hands of those who were less efficient in using them in the eyes of the public into the hands of those who are expected to be more efficient. Therefore, the meaning of ownership of the means of production is very different in a system based on the division of labor from its meaning in a feudal system. In a feudal system, private ownership was acquired by conquest or by the arbitrary appropriation of pieces of land. The proprietor was the conqueror; the supreme conqueror was the head of the army, the king, the “Führer.” Other people acquired private property as gifts from the supreme lord. There was a whole hierarchy—kings, dukes, knights, and so on, and at the bottom were the people with no property. The dukes and knights could lose their property by being deprived of their “gift” by the higher authority—the king—revoking his gift; or they might be defeated by a successful conqueror. This system prevailed until capitalism replaced it to varying degrees in many countries.
If you study the history of private ownership in land you can, of course, go back either to conquest or to appropriation of ownerless property by somebody. From this point of view, the older critics of private ownership said property does not have a legal origin; it was acquired by might, by conquest, without any legal basis. Hence, they say they want to take it away from the current private owners and give it to everybody. Whether the origin described here is right or wrong is one question. Another question is what to do now that property is privately owned.

The socialists took over this critique of the origin of property without realizing the enormous difference that existed between then and now. If you say that in the old days the owners of land did not depend on the market, that is true; there was no market; there was only an insignificant amount of trade. The feudal lord had only one real way to spend his great income in the products of the earth—to retain a great retinue of armed men in order to fight his battles. The court of a feudal lord consisted of an enormous household in which many people lived (boarders I would say), supported by the great estate. In Brandenburg in Berlin, for instance, there was one case of a councilor in the sixteenth century who was living in the king’s household. This is very different from the conditions in the market economy.
In the market economy, private ownership is, as it were, a social function because it can be retained and enlarged only by serving customers in the cheapest and best possible way. Those who do not know how to serve consumers in the cheapest and best possible way suffer losses. If they do not change their methods of production in time they are thrown out of their positions as owners, entrepreneurs, capitalists, and shifted to positions in which they no longer have entrepreneurial and capitalistic functions. Therefore, the meaning of private ownership in the capitalistic system is entirely different from the meaning of private ownership in the feudal system.
Critics of private ownership are still living mentally in the Middle Ages (like critics of interest and creditors). They don’t realize that the market determines every day who should own what and how much he should own. The market gives ownership to those people who are best fitted to use the means of production for the best possible satisfaction of the needs of the consumers. Therefore it is not correct to criticize the institutions of private property by citing conditions as they existed in the early days under feudal conditions, under absolute kings.
As President Franklin Roosevelt [1882–1945] said, capitalism has never been really tried.1 There always remains something from the old days. But it is absolutely useless to tell us today, “Look how the wealth of many aristocratic families originated in the seventeenth century.” Some modern wealthy people may be descendants of wealthy aristocratic families, but what has that to do with the situation today? The Prussian Junkers were still privileged in the nineteenth century and early twentieth century; they could retain their property only because the whole apparatus of the imperial government was glad to preserve them, to protect them, and to prevent consumers from putting persons in their places who were better equipped to serve consumers.
We must realize that every governmental measure that lowers the amount of profit successful enterprises can make or which taxes away their profits is a measure that weakens the influence of the consumers over producers. For example, the great industrial fortunes of the nineteenth century were acquired by successful innovators in their business. Henry Ford [1863–1947] started with almost nothing; he made enormous profits which were plowed back in his enterprise; in this way over a comparatively short time he developed one of the biggest fortunes of the United States. The result was that something quite new happened, mass production of automobiles for the masses. At the beginning of the twentieth century there were some successful motor cars. The French Renault cost about $10,000 in gold; it was a luxury car for a few very rich men. The activities of Ford and of some other people made the motor car something for everybody. In this way great fortunes were developed. The great department stores and the great factories developed in this way. But now this cannot happen. If a man starts a small enterprise and makes huge profits, the greater part of this profit is absorbed by taxes. However, there are still some loopholes. If you have a good accountant you may avoid being expropriated 90 percent and may be expropriated only 70 percent. But the greater part of the profits which would have been reinvested are taken by the government and spent for current expenses.
In the case of department stores, formerly an old store had to compete for potential new consumers with new competitors. Today this is no longer the case. The small man will never develop into a big store because his profits are taken away by the government. It is true that the old and new stores operate under the same laws; the large old store also has to pay high income taxes. But the old store has already accumulated the capital needed for a big business, while the new man is prevented from accumulating the capital needed to expand into a big-scale enterprise. The consequence, therefore, is that the competitive spirit could easily disappear from the management of the big store. Without any danger to the old store in the conduct of its affairs, the old store may sometimes become “lazy.”
There are people who say capitalism is dying because the spirit of competition no longer exists as it used to and because great enterprises become bureaucratic. But capitalism is not dying; people are murdering it. There is a difference between dying by a disease that finally results in death and dying as a result of assault and assassination. It is fantastic to use as an argument against capitalism the fact that the competitive spirit in business is weakening and that businesses sometimes become bureaucratic. This is precisely due to the fact that people are fighting against the capitalistic system and don’t want to tolerate the institutions that are essential for its existence. Therefore, I must say something about the difference between profit and loss under business management on the one hand, and bureaucratic management on the other hand.
Profit-and-loss management is the sign of an enterprise, of an outfit, that is subject to the supremacy of the market, i.e., the supremacy of consumers. In such an outfit the determining factor is “Is it profitable or not?” This yardstick is applied not only to the whole enterprise but to every portion of the enterprise. This is the method of double-entry accounting which Goethe characterized in such a wonderful way by saying that it makes it possible for the man at the head of an organization to control every aspect of a business without becoming enmeshed in too much detail work.
Under such an accounting system you can establish whether or not any special department or branch pays. For instance, an enterprise in New York has a branch store in San Francisco. There is only one standard the head of the company in New York need apply: is it profitable? He has a special balance sheet for the store in San Francisco. He assigns to this branch on his books the necessary capital, compares the costs and the prices of this branch, and on this basis judges whether or not it is useful, whether or not it is profitable, for the total enterprise to continue this branch office in San Francisco. He can leave all the details to the head of the branch office in San Francisco because this man always knows that he is responsible. It is not necessary that the branch manager get a share of the profits. He knows very well that if the branch does not pay it will be discontinued and he will lose his job; his future depends on this branch. Therefore, the man in New York does not have to say to this branch manager in San Francisco anything more than, “Make profits!” The head in New York doesn’t interfere because if he does and the branch office has losses, the branch manager will be able to say it was because “You ordered me to do so and so.”
The consumers are supreme. The consumers are not always intelligent—not at all—but the consumers are sovereign. They can be stupid and they may change their minds, but we must accept the fact that they are sovereign. Businessmen are subject to the supremacy of the consumers. The same is, of course, true for the whole business establishment; the decisive voice is the voice of the consumers. It is not the problem of the producers or manufacturers to criticize consumers, to say, “These people have bad tastes—I recommend they buy something else.” This is the task of philosophers and artists. A great painter, a great leader, a man who wants to play a role in history must not yield to the bad taste of consumers. However, businessmen are subject to profit-and-loss management and are directed in every detail by the wishes of the consumers. The consumers are supreme; they are buying the product and this is justification for the producer. If it is not weakened by government interference, this is profit-and-loss management, production for consumers.
Now what is bureaucratic management? People often confuse bigness with bureaucracy. Even such an eminent man as Max Weber [1864–1920] thought that the essential factor of a bureaucracy was that people sat at desks and had a lot of paperwork to do. But this is not the essential feature of a bureaucracy. The characteristic of a bureaucracy is that it deals with things which are necessary but which cannot be sold and that do not have a price on the market. Such a thing, for instance, is the protection of individuals against gangsters and other criminals. This is the job of the police department. It is very important, indispensable. But the services of the police department cannot be sold on the market. Therefore, you cannot judge the results of these police operations in the same way as you can judge the operations of a shoe factory. The shoe factory can say, “The public approves of our operations because we make profits.” The police department can only say the public approves through the actions of its town council, congress, parliament, and so on. Therefore, the system of management which must be used for a police system is the bureaucratic system.
The nation, or the citizenry, elects parliamentary bodies and these parliamentary bodies determine how much should be spent for the various functions of the government, including the police department. You cannot evaluate in dollars and pennies the results of a police department. And, therefore, you cannot have bookkeeping and auditing of a police department in the same way you do in private businesses. In private businesses, the expenses are measured in terms of dollars against the proceeds. In the police department you cannot measure the expenses against the proceeds. The police department has only expenses. The “proceeds” of a police department are, for instance, the fact that you can walk safely through the town, even after midnight. Such proceeds cannot be evaluated in terms of money.
The parliaments set the budget for the police department; they determine the amount of money to be spent. They must also tell the police department what services they should perform. The FBI could no doubt be improved by increasing its appropriations, but it is the will of the people that it not go any further; the head of the Department of Justice tells the FBI what to do and what not to do; the Department of Justice head cannot leave these decisions to the “branch managers.” Therefore, the manager of a bureaucratic operation issues instructions on many things which appear unnecessary to the businessman—how often to clean the offices, how many telephones to have, how many men to watch a certain building, and so forth. These detailed instructions are necessary because in a bureaucracy what has to be done and what has not to be done must be determined by such rules. Otherwise the man on the spot would spend money without giving heed to the total budget. If there is a limited budget you must tell the employees what they can and what they cannot do. This refers to all branches of government administration.
This is bureaucracy, and in these areas it is indispensable. You cannot leave it to the individual employee; you cannot tell a man, “Here is a big hospital. Do what you want with it.” A limit is drawn by the parliament, the state, or the union and, therefore, it is necessary to limit the money spent in each department. This bureaucratic method of management does not apply under profit management. But, of course, if you weaken the profit motive of private businesses, bureaucratic ideas and bureaucratic management creeps in.
Given the present-day excess-profits tax, corporation taxes, and individual taxes on corporation shareholders, many enterprises say when calculating a new expenditure, “It means an expenditure of $100 more, of course. But considering the 82 percent tax I must pay on the firm’s earnings, it will cost much less. If I don’t spend this $100 on business, I will still have to pay a tax of $82. Therefore, spending this $100 will cost the firm only $18.” People calculating this way no longer compare the total expenditure with the advantages to be derived from it on the market; they compare only that part of the expenditures which affects their own income. In other words, in spending $100 on its business, the company could afford to be lavish, wasteful, or extravagant; it would no longer consider consumer wishes primarily.
If this tax system is continued, it could lead finally to complete government control. For instance, if government takes 100 percent of a company’s income, its business expenses would all be deductible and chargeable to the government. The company wouldn’t need to worry then about consumer sovereignty, about whether consumers would be willing to pay enough for their product to cover costs; it wouldn’t need to worry about keeping expenses down. But then the government couldn’t allow the business to do as it wished; the government would have to control all aspects of the business’s operations. Therefore, if you hear that business is becoming bureaucratic and wasteful, it is not the consequence of big business, of capitalism, of an unhampered market system; it is the consequence of government taxation and government interference with these things.

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