Recently I got into a discussion with a friend of mine about health care and how it gets paid for. We were comparing different flavors of private and public insurance and payment mechanisms. At some point during the conversation, he mentioned removing “the profit motive” as being a desirable attribute of some of the publicly paid options. It occurred to me only later that a lot of people don’t really understand what “profit” is, or what function it serves. In fact, many people have it exactly wrong!
Sometimes when I’m considering economic principals, I find it helpful to ignore money for a moment to get better clarity on what is actually happening. Let’s take a simple example of this and see if we can discover the role that profit really plays in society. Suppose that I own a furniture business and set about making a chair. I start with, say, 10 pieces of nice lumber (I don’t really know anything about furniture, so I’m making this up, obviously) and my employee spends 25 hours putting the chair together. I then give the chair to someone. Have I done something good for society? Well, let’s see: Society provided me with 10 pieces of lumber and 25 hours of labor. In return I provided society with a nice chair. Again – was this good? Hard to say, right? We’re talking about three different goods – lumber, labor and chairs – and those things don’t compare with each other very well.
In order to know whether I’ve done any good for anybody, I have to know what value society places on those three resources. What if that lumber came from the very last tree on the island? What if those hours of labor came on Christmas day? This is where money comes back into play. As the business owner, I have to pay whatever society thinks those things are worth to somebody else, before I can use them for myself. Likewise, when I give someone the chair, they have to pay me whatever society (including me) thinks that chair is worth. Now we’re getting somewhere. Let’s suppose that the lumber had a value of $50, the labor $100, and the chair $200. Now we can do a simple, straight comparison. $50(lumber)+$100(labor) = $150 of inputs from society, and the chair provided back $200 of value. So society gained $50 worth of net value from the process. Where did the value go? The value went to society in the form of a nice chair, less some wood and time. The money ended up in my pocket – profit!
Now we can see that profit is really just a measuring stick. It’s a way of keeping me informed and accountable for being productive. You can certainly imagine a scenario where all of the above takes place entirely without money. This is the dream some have of a sharing, (dare I say communist here?) structure. Everybody is working hard for the common good, and nobody needs money! I could just make that chair as before, not paying for the wood or labor, and not charging for the chair. But in that case, how would I – or anyone else – know whether it was a net positive or not? We couldn’t! Maybe it would have taken 100 hours of labor, or 1000. Who could say that it was or wasn’t worth it?
Businesses that continue to consume more from society than they contribute have shrinking bank accounts and are eventually forced out of business – as they should be. Business that consistently add value are profitable and grow and prosper, to society’s long term benefit.
Some folks still have the vague idea that profit here might be added value, but that the value goes into someone else’s bank account and is somehow “overhead” that might be reduced to our benefit. The opposite is true. Remember that money is not value. You cannot eat money. Money is how we maintain accountability. The value went to society already. You can’t put value in the bank. Society is already better off for the action (making the chair, in our example), and this would be true to the same degree, whether or not money is involved. Profit gives us a way to measure WHO created HOW MUCH value, and then gives them the ability to make additional decisions that we hope will create even more value (by buying more lumber to make more chairs).
Now you can see the potential danger in removing the profit motive: It eliminates measurement and accountability from the equation. In a program without profit, who can say if it’s doing a good job or not?! It’s impossible. In particular, with government programs, it’s usually the value of the output that goes un-measured. Costs are typically set by the market (society) and the government has to pay for them with money just like everybody else. What we can’t know is whether the outputs were really worth it, since the outputs don’t get paid for, or get paid for at non-market prices.
Say we spent 100 doctors treating 1000 patients over the course of a year, and they all ended up healthy. Was that a good thing? Who can say? Were they good doctors? Were the people sick in the first place? Could we have treated the patients with fewer doctors with the same result? Could we have instead treated 2000 other patients with those 100 doctors, to greater total benefit? How much time and effort was spent educating the doctors? Could 200 nurses have achieved the same result? Would that have been a better outcome?
“But wait!” you say “What about all the profit at companies that hurt society?!” A valid concern, especially in the way of the recent real-estate crash. Well, I won’t go to much into detail in this post as there’s a lot to say on the subject, but here’s a thought for you: Taking away profit doesn’t help that. It only hides it.
Here’s an idea for you: If you think it’s a good idea for the government to help people out, that’s great. Just don’t take away the ability to measure and hold accountable by taking away the profit. Just give cash (not a voucher – cash) to the people that you want to help. That’s really the best way to help people, but you won’t catch many people in the government going for it. They don’t want to be taken out of the loop or held accountable for success.