The Rankin File

Keith Rankin is a political economist and economic historian.

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Profit has a bad name in the left­wing press. It is seen as the central capitalist vice; as a nom­de­plume for greed.

In reality, profit maximisation is no more symptomatic of moral decay than is wage maximisation, leisure maximisation, pain minimisation, crime minimisation. The central concept of economics as a discipline is that people maximise the things they like and seek to minimise what they don't like. That's a perfectly sound basis for enquiry in social science.

Two recent left­wing speakers in Auckland (Immanuel Wallerstein and Richard Douthwaite [see Immanuel Wallerstein on the Crisis of the World System and Richard Douthwaite on the Instability of the Global Marketplace ) left their audiences in no doubt that profit was a part of the problem of the capitalist world system.

Wallerstein followed the Marxian premise that capitalism is a frenetic but ultimately irrational drive to accumulate profits for their own sake. As a positive feedback process this capitalist drive may have got humankind out of the equilibrium trap that was feudalism, but its inherent contradictions are now catching up with us.

In his basic analytical model, Marx adopts the dubious sociology of David Ricardo, the founder in the 1810s of classical economic rationalism. Ricardo saw profits as the driving force of economic growth, because, he assumed, profits would be invested whereas income from other funds - such as rent and wages - would be spent on consumption. For Ricardo and Marx after him, 'profits' imply 'savings'. (The eminent 20th century economist, Paul Samuelson, while acknowledging Marx's contribution to sociology, called Marx a "minor post­Ricardian economist".)

This sociology, the ideas that profit is qualitatively different from other sources of income and that people who gain a high share of their income from profit are socially different (ie they are Scrooges), is central to Marxism, to the A+B theorem of Douglas Credit, and to the "supply­side trickle­down theory" of new classical economics. (Gerald Scully, consultant to the New Zealand Inland Revenue Department, can be called a new classical economist.) Wallerstein even invoked the A+B theorem in his Auckland lectures, without calling it by that name, when claiming that only wages feed back into the economy as consumer demand.

For Ricardo and Scully, the claim that capitalists are Scrooges serves as a reason to channel greater proportions of national income into their pockets. High profits are the key to economic growth. For Marx, Major Douglas and Wallerstein, the claim that capitalists are Scrooges is every reason to limit the flow of income to capitalists, because it is the mindless accumulation of capital that destabilises the modern word system.

This is all dogma. There is no rational reason to believe that "capitalists" have a higher propensity to save the last dollar they acquire than do wage workers, beneficiaries or governments. Redistributing income by raising capitalists' profits does not necessarily lead to a higher rate of savings. And savings are not the driving force of economic growth.

Profit is two things: it is a cost or it is a surplus. It represents the income anticipated by the shareholders, the owners. Thus, as Adam Smith emphasised over 220 years ago, demands by shareholders for high profits represent significant costs to the firm, just as demands for high wages represent costs to the firm, and high income tax rates represent high costs to the firm.

Profit, as a cost, is a market price; the price that governs the capital market. It is in fact the interest rate, in one of its guises. As interest rates on bank deposits rise, then shareholders demand a higher return from the firms they own. Otherwise they will sell some of their shares and put the money in the bank. This is the most important and least understood way in which interest rates act as a production costs. (Thus rising interest rates, hence rising profit rates, are inflationary, contrary to the assumptions that underpin the 1989 Reserve Bank Act.)

Public companies - ie companies listed on the stock exchange - that do not pay competitive dividends will see the value of their shares fall. The whole sharemarket should fall if interest rates rise and dividends across the board cannot maintain their traditional margin over fixed interest returns, but the prospect of speculative capital gains can counter this pattern. In the 1990s, unlike the 1980s, rising world share prices have generally been driven by falling interest rates.

Profits as a surplus, represent entrepreneurial income. Narrowly defined, an entrepreneur is someone self­employed or incorporated as a private company (eg a partnership). Entrepreneurs hire labour, land and capital (factor inputs), they purchase commodity inputs, and they sell goods and services as outputs. They pay wages, rents, interest, taxes. And they get to keep what's left, as a surplus, as a profit. Their profits are their personal incomes, which may be high, low or negative. Entrepreneurial surpluses should not be thought of as production costs.

In practice, 'entrepreneurial companies' are often new and undercapitalised. Under those conditions, surpluses are likely to be ploughed back into a fledgling company rather than spent on consumer goods. Entrepreneurial success takes place when the prevailing 'rate of profit' is low, whereas capitalists like the rate of interest or profit to be high. A low prevailing rate of interest means less of an entrepreneur's revenue has to be paid as interest, or as "profits" to sleeping (rentier) partners.

Some entrepreneurs make high surpluses and have low capital costs. They also pay few taxes, if they operate in the twilight zone of the informal or illegal economy. These entrepreneurs, which include drug dealers and prostitutes, are not well known as congenital Scrooges. Their profits are simply their incomes, spent in much the same ways as are other people's incomes. Wage and salary earners are just as likely to save their earnings as are profiteers.

Richard Douthwaite placed great emphasis on the potential for locally oriented non­profit enterprises. His ideas are by no means new. The Building Society and Cooperative Wholesale Society movements were built on a non­profit basis last century. The claimed virtue of this kind of collective entrepreneurship is that one layer of cost - the profit layer - is eliminated. Profits are not really eliminated; rather the profit is distributed as rebates to customers and is missing from the accounts. Ironically, by distributing profits to customers, the 'non­profit' principle rewards consumers rather than owners. Certainly the neoclassical economists of the late 19th century and the early 20th century, who placed great emphasis on "consumer sovereignty", were not opposed to such 'non­profit' enterprises.

I favour a system in which all producers are subject to what might be called "profit accounting". This might seem like a 'no­no' to the left; like requiring schools, universities and public hospitals to make a profit. I do not believe that profit accounting acts as the thin end of that wedge; profits would simply be accounting constructs and not additional costs. But profit accounting can be the thin end of another wedge. By emphasising the concept of 'ownership' and the rights of owners as owners, profit accounting can lead to new perspectives favouring owners rather than consumers.

Consumption, and not the profit motive, is the real driving force of modern capitalism. Consumer sovereignty is the main way in which profits are transferred to those who consume the most (ie the rich), and is the main reason why capitalism has a bias against leisure and non-market work as alternative forms of welfare.

How would profit accounting be applied to a publicly­owned and publicly­funded school. It would attribute a return to the owner at the prevailing normal rate of profit, say 10%. There would be no change in the amount of funds actually paid to the school. The profit would be an exercise in double­entry bookkeeping. The revenue of the school would be raised by 10%, and the payments would be raised by an equal amount. The profit would be accounted for as a part of the school's contribution to GDP (gross domestic product). The profit would be accounted for as an explicit return to the owner; to the sovereign, to the people.

(We already account for benefits in such a way. Benefits and student allowances are nominally taxable, enabling a better integration between the accounting for tax purposes of different components of persons' incomes. Benefits are always quoted net of tax. The gross payment exists for accounting purposes only.)

The correct cost of any productive facility, be it a school or a supermarket, includes a return to its owners. Thus, profit accounting is one way in which costs are internalised.

An interesting example of profit accounting is the commercialisation of public utilities. While profit accounting could have been applied to public utilities such as airports without them being commercialised, in practice it was commercialisation that forced profit accounting to be adopted. There have been problems with the commercialisation process, but not because of profit accounting. Problems occurred in the main because (i) public utilities are natural monopolies which mean that their senior employees and consultants are able to draw off their surpluses, and (ii) they are being set up so that they can be sold.

In many cases, shares in public utilities have been made transferable, creating some wonderful opportunities for capitalists. In other cases, the commercialisation process has worked very well - as for example, through the role of the Auckland Regional Services Trust (ARST) when under the management of the Alliance.

Mercury Energy - Auckland's electricity retailer - is not a part of the ARST. But it does pay explicit dividends to its owners, whereas before it paid implicit dividends to the biggest users of electricity. Electricity distribution has moved to a system of profit accounting. But it has also, through commercialisation, been able to exploit its monopoly position to extract a bigger surplus; an amount quite separate to the profit returned as a cost to its owners. That surplus has effectively become the property of the executive of Mercury Energy, and not its owners. Public utilities, as monopolies, should be regulated as well as subject to profit accounting; regulated to ensure that surpluses are eliminated, so that electricity prices represent a true reflection of the costs of electricity retailing.

The ARST, as perceived by the Alliance, is a good example of a "social profit enterprise". It is socially owned and pays social dividends; in this case to the greater Auckland community. These are universal dividends; not handouts to the deserving.

The logical extension of the idea is, of course, that social profit accounting will apply to the nation as a whole, and also to the international community of humankind. But it's an idea that can only work if profits, representing the economic rights of owners, are acknowledged. The national sovereign - a figurehead for the people - is the owner of all of the productive resources that are shared at the national level. The social profit represents the economic return to the public domain. The people are entitled to get a return on what they own, whether we are concerned with that component of profit which represents the cost of maintaining and enriching the public domain, or that component which represents an economic surplus.

In any economy, one economic class is able to gain the surplus income. It should be the public fund, and not the capital or labour funds (ref. Class: Economic, Social, Political ) that receive the economic surplus. This can only happen when the economic rights of proprietors - all proprietors - are acknowledged. Hence the need for explicit profit accounting.

There are a number of difficulties in achieving the goal set out above. One is that the term 'ownership', like profit, is cemented in our minds as a very capitalistic term, with all of the negative connotations for the left that that embodies. There is an offsetting positive, in that the language is perhaps not off­putting to those people who are not on the political left, but with whom the left must maintain a dialogue with.

The connotations surrounding the term 'ownership' are changing however. The term now refers less to private chattels over which some persons have exclusive property rights. Rather, 'taking ownership of' something is coming to mean taking responsibility for something, as in the idea that we cannot solve problems unless we 'take ownership' of them. Thus ownership becomes an obligation, and profit becomes a human right deriving from that obligation. The idea was recently expressed by George Salmond, former Director­General of Health, discussing the present predicament of New Zealand's public health system:

The driving force of capitalism is not the accumulation of profits - as savings - by capitalists. It is the acquisitive drive by consumers for indefinite increases in goods and services; a drive facilitated by our concept of consumer sovereignty. The most successful consumers are capitalists, or salaried people who politically identify with capitalism. They get to consume the social profits that they acquire on account of our failure to properly account for profit.

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