IN PRAISE OF PROFITS! Introduction

This is the Introduction to In Praise of Profits!, which is the sixth in our series of Predicting the Markets studies. It is now available on Amazon along with the other studies. See the Table of Contents. You can find the book's footnotes and charts here.

Time to Clear Up the Confusion

There has been much confusion about corporate profits. That’s because there are several measures of profits and very little understanding of, or even interest in, how they differ. As a result, there has been lots of sloppy analysis and misinformed discussion of such important issues as the central role of profits in economic growth, the trend of profits, the corporate tax rate, the profit margin, profits’ share of national income, and corporate share buybacks.

The confusion has played into the hands of progressives. They claim that free-market capitalism, driven by the profit motive, causes wage stagnation and results in both income and wealth inequality. They want the government to redistribute income and wealth by increasing taxes on the rich and on corporations. They refuse to acknowledge that profit-driven capitalism is the source of our nation’s widespread prosperity. They say that the relevant data support their claims; that’s not so, as I demonstrate in this book. I conclude that the entrepreneurial variety of capitalism should be allowed to flourish. If it does so, so will we all.

More recently, some of these progressive critics have suggested ways to save capitalism from itself by forcing company managements to stop focusing on maximizing profits for the benefit of their shareholders. Instead, the would-be saviors of capitalism promote the idea that companies should focus on satisfying the diverse needs of their “stakeholders.” This broad group includes customers, employees, vendors, communities, minorities, environmentalists, the press, and the public at large.

Progressive politicians and their economic advisers often claim that the data show that profits have gained share of national income at the expense of workers, thus causing income stagnation and exacerbating income and wealth inequality. Furthermore, they claim that corporate share buybacks represent an egregious misallocation of capital by greedy corporate executives aiming to boost their companies’ earnings per share and share prices for the benefit of shareholders and to enrich themselves by driving up the value of their stock grants and options. The money would be better spent paying workers more and investing more in their companies for the benefit of their diverse stakeholders, say the progressive politicians. Yet, though they hold strong opinions on how companies ought to be managed and regulated, most have never actually run a business.

As I will show in this study, the progressives’ narrative about the relationship between profits and prosperity is wrong and misleadingly pessimistic. In short, it’s backward: Market-driven profit is the source of prosperity, not its nemesis. Ironically, profit is what drives the progress in standards of living that progressives, with their policy approaches, claim to champion. But progressives seem blind to the progress that has been achieved and perpetually want to do more. In my opinion, progress has been made despite their persistent policy interventions thanks to the power of the profit motive to deliver profits and widespread prosperity in a free-market economic system.

Meanwhile, on Wall Street prior to the pandemic, there was a different sort of misinformed view of profits: The stock market’s perma-bears growled that corporate profits had been flat since 2012 and that profit margins had been trending down since then. They claimed that the bull market was a bubble inflated by the ultra-easy monetary policies of the Federal Reserve. After the shock of the pandemic’s onset, once the bull market resumed rising to record highs, they remained convinced that it was a bubble that will eventually burst. They may very well be right, eventually, but they’ve been wrong so far, partly because they’ve misinterpreted the profits data that they have been using to make their case.

The goal of this study is to add significant clarity to the discussion of all these controversial issues by enabling more precise understanding of the crucial role that profits play in our economy. The analysis will be supported by a careful review of the underlying profits data that all too often are used misleadingly, both unintentionally and intentionally, by capitalism’s critics.

Golden Goose

To be fair and balanced, I acknowledge from the get-go that income inequality is an inherent consequence of capitalism. Perversely, capitalism causes the most income inequality during periods of prosperity. The rich do get richer, but almost everyone’s standard of living improves during good times. However, the wealthy get richer faster than everyone else. Entrepreneurs get richer during periods of prosperity by improving the standard of living of their customers. They do so by improving the quality, and lowering the prices, of the goods and services they offer and by creating new and better products and services. The more customers they attract, the more prosperous they become while simultaneously enriching the lives of their customers.

Here is a short list of some of the major contributions to the prosperity of Americans made by some of the most successful American entrepreneurs: railroads (Cornelius Vanderbilt), electricity (J.P. Morgan and George Westinghouse), steel (Andrew Carnegie and J.P. Morgan), kerosene and gasoline (John D. Rockefeller), automobiles (Walter Chrysler, Pierre Du Pont, Henry Ford, and J.P. Morgan Jr.), consumer credit (J.P. Morgan Jr. and Alfred Sloan), investment banking (Marcus Goldman and Samuel Sachs), commercial aviation (William Boeing and Edsel Ford), packaged foods (C.F. Birdseye II, H.J. Heinz, Milton Hershey, W.K. Kellogg, and James Kraft), fast foods (Ray Kroc and Colonel Harland Sanders), media and entertainment (William Randolph Hearst, Walt Disney, and Ted Turner), lodging (Howard Johnson and John Marriott), semiconductors (Andrew Grove), computers (Thomas Watson, Steve Jobs, and Michael Dell), software (Bill Gates), Internet search and maps (Larry Page and Sergey Brin), mutual funds (Edward C. Johnson and John C. Bogle), shipping and logistics (Fred Smith and Jeff Bezos), retailing (Richard Warren Sears, Sam Walton, and Jeff Bezos), and cloud computing (Jeff Bezos). They all got very rich by selling lots of products and services that improved their customers’ lives. Most of these capitalists have set up large charitable trusts that continue to benefit lots of people in the United States and around the world.

These titans of business faced fierce competition from contemporaneous entrepreneurs. Competition forced them all to improve the quality of their offerings even as they lowered their prices. That could be done only by innovating in ways that boosted productivity. The titans were the winners of the ongoing competitive races they were in, and so were all their customers. The losers whose business gambles failed rarely get mentioned in the history books.

Keep in mind that most entrepreneurs who succeeded and became rich started out either poor or certainly much less well-off. They struck it rich by offering consumers goods and services that improved their collective well-being, often spotting consumer needs that no one else saw. So the notion that the rich and the poor constitute two distinct classes is false in a competitive, entrepreneurial capitalist economy. Enterprising individuals can become very rich indeed, but only by improving the lives of their customers. They can also fail to do so or fail once they have done so.

Capitalism is an inherently dynamic economic system. While it will always be associated with some degree of income inequality at any point in time, it also provides lots of mostly upward income mobility with plenty of opportunities both to succeed and to fail over time and to do so more than once. Persistent entrepreneurs who learn from their mistakes and failures often eventually succeed. Today’s wannabe business titans can achieve their dreams. They might very well do so by coming up with a new mousetrap that puts entrenched tycoons—who got rich selling the old mousetrap—out of business.

But the reality is that most people are inclined to be workers, not entrepreneurs. Some workers can and do get poorer in competitive economies. Some lose their jobs because their companies are put out of business by competitors or unforeseen and unfortunate setbacks (such as the pandemic). Some employers are forced to move production overseas to remain in business by tapping into cheaper labor abroad. New products offered by upstarts can make older products obsolete and wipe out entire industries. In a competitive economy, workers who lose jobs can usually find opportunities for gainful employment elsewhere in the economy, especially in the industries that are flourishing. However, that might be challenging if they’ve been replaced with cheaper foreign labor or by automation. Their skills may no longer be in demand, forcing them to take jobs that pay less than they were making.

Over the years, progressives have made a great deal of progress in expanding the social safety net provided by the government to help people in need. Among their major achievements are Social Security, Medicare, Medicaid, Unemployment Insurance, and the Supplemental Nutrition Assistance Program. The marginal tax rates on individual incomes have been very progressive for a very long time. The tax code also includes the Earned Income Tax Credit and the Child Tax Credit. Yet ironically, progressives regularly trot out data that exaggerate both income and wealth inequality by excluding some of these programs— programs that mark their success in addressing this very issue.

Most disturbing is that progressives don’t seem to understand that economic growth fueled by profits is much more effective in the endeavor to improve standards of living than redistributing income. The profit motive drives entrepreneurs to risk their time and money to boost productivity and to innovate, with the goal of attracting as many consumers as possible with better and newer products at affordable prices. Without that motive, economic growth, and progress at improving living standards, would grind to a halt. Accordingly, weakening that motive via policies that excessively redistribute income jeopardizes such progress.

Progressives seem to have a cognitive bias that blinds them to this risk. In their push for ever more income redistribution, higher taxes, and more regulation on businesses, they jeopardize the profit motive of entrepreneurs. Progressives often vilify entrepreneurs as “robber barons.” In fact, the entrepreneur is the golden goose that lays the golden eggs. Collectively, entrepreneurs, driven by the profit motive, are the ultimate source of prosperity that benefits everyone. Kill their profit motive, their entrepreneurial spirit, and their work ethic, and you’ll kill the golden goose.

In Praise of Progressives

This book is dedicated to progressives. I couldn’t have written it without them. I hope they will read it. Any explicit or implicit criticism is offered in the spirit of helping progressives reach a more balanced view of the problems they bring to light and the cures they champion.

In 1509, Desiderius Erasmus of Rotterdam wrote his famous essay titled In Praise of Folly. It is a satirical attack on superstitions. Folly is often based on fallacious beliefs. In this essay, I will show that many of the progressives’ beliefs and their policy proposals are based on faulty assumptions that are simply not supported by lots of easily available data.

Progressives no doubt mean well. They are always finding income and wealth inequality and recommending policies to fix these problems. In many ways, they succeeded with their New Deal, Great Society, and Obamacare. However, “mission accomplished” is not part of their lexicon.

Progressives are big supporters of big government. Few of them are big fans of capitalism and free markets. But they all believe that government intervention is often necessary to, in essence, “save capitalism” when free markets fail to fairly distribute income and wealth. Government regulation is also required to protect workers and consumers from the excesses of laissez faire capitalism, they say.

Some progressives are outright opponents of capitalism. The moderates among them tend to be socialists. They favor heavy government regulation and supervision of private enterprises and high taxes on the wealthy. The extremists are communists, who oppose private property and champion the nationalization of businesses, especially big ones. This book isn’t written for the extremists. It is written for progressives who advocate more government intervention. My goal is to explain what I see as the errors of their ways and the unintended consequences of their policies.

I hope to convince progressives that they must be mindful of the profit motive as a key driver of productivity and prosperity. They can redistribute income with their progressive policies, but aggregate income won’t grow if they place too many hurdles in the way of profits.

For those of you who don’t need to be convinced about the importance of profits in stimulating productivity and prosperity, I hope that the following analysis will provide you with a better analytical understanding of why our perspective makes the most sense.

Finally, to bridge the gap between “us” and “them,” I will acknowledge that progressives have some legitimate current concerns that should be addressed. In particular, shareholder capitalism needs to be reformed so that corporate governance isn’t corrupted by crony capitalists, as most clearly evidenced by the excessive pay packages received by some CEOs.

Furthermore, our country clearly faces a child- and eldercare crisis. Many families with one parent working and the other staying home to attend to the needs of family members can barely make ends meet. Many families with two income earners aren’t making enough to cover the costs of such care without remaining impoverished. Progressives have been pushing for solutions to both problems. I agree with them on the need to address both issues.

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The above is the Introduction to In Praise of Profits!, which is the sixth in our series of Predicting the Markets studies. It is now available on Amazon along with the other studies. See the Table of Contents. You can find the book's footnotes and charts here.

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