Profit is not a dirty word when it generates economic growth and raises living standards

Profit is not a dirty word when it generates economic growth and raises living standards

Profit is not a dirty word when it generates economic growth and raises living standards

By Judith Sloan

MOST of us can remember that Sky Hooks classic Ego is not a Dirty Word with its strong beat and annoying tune.

If that song were to be released in 2010, I would change just one word: profit should replace ego.

This year was the year politicians on both sides of the fence lost the plot on the policy front. And underlying this loss of direction was a failure to understand the central role of profit-making in terms of generating high rates of economic growth and raising living standards.

The low point for policy discussion came towards the end of the year when Joe Hockey developed an almost Marxist-Leninist position on the Australian banks.

There can be no other explanation for his statement: “I want a social compact between our taxpayer-guaranteed banks, their shareholders and our government and parliament. This must define the relationship and include direction on competition, expansion, expectations of credit and savings, community service obligations, risks and rates.”

My response: is he kidding? Direction on competition? Expectations of credit? Community service obligations?

But rather than shrug Hockey’s statement off as the words of an ill-informed populist, Treasurer Wayne Swan decided to cobble together a concoction of interventionist measures, which, although costly, everyone agrees will have no noticeable impact on the behaviour of the players in the financial sector.

Take the government ban on exit fees. As it turns out, this measure, which would normally be regarded as an unwarranted incursion on freedom of contract, will probably harm the small banks and non-banks and benefit the big banks. The big banks have been moving in the direction of abolishing exit fees in any case.

And then there was Swan’s suggestion that his package of measures would actually lower interest rates paid by mortgage holders. Apart from the implausibility of the argument, Glenn Stevens was quick to point out that the Reserve Bank sets interest rates. In the event of increases in the overnight cash rate not being passed on, the likely outcome would be further increases.

Even Treasury Secretary Ken Henry got in on the act, pointing out that intervention in the financial sector almost always has perverse distributional effects, whereby credit for the less well-off becomes even more rationed.

Underpinning this activist policy frenzy, and not just in relation to the financial sector, is a complete lack of understanding of the role of profits in the functioning of the economy, in terms of promoting efficient use of resources and ensuring resources are directed to their most productive ends.

Indeed, the alternative point of view seems to be that governments can decide on the social and economic outcomes they see as desirable (lower interest rates, for example), and a combination of laws, regulations and jawboning will ensure these are achieved. Needless to say, these outcomes are rarely achieved: if they are, the long-run costs may well be greater than the benefits.

Ironically, it seems to have taken a South African economist to reinforce the central role of profits in promoting economic prosperity. Ann Bernstein of the Centre for Development and Enterprise has written an important book, The Case for Business in Developing Economies, published by Penguin Books.

Her main argument is that “even though companies pursue profit, this should not be interpreted that they profit at the public’s expense. The magic of competition and markets (is) that they enable consumers and society to benefit from the self-interested activities of private enterprises”.

She is particularly critical of the concept of corporate social responsibility (a Joe Hockey favourite) as loading up companies with all sorts of burdens, which in turn dilute their focus on serving customers and making profits. Rather than improving the outcomes for South African citizens, Bernstein sees the fad as undermining the accountability of managers to their shareholders.

She points out also that many critics fail to appreciate another dimension of profit-making. “They see a company’s results for one year and assume that its declared profits are paid out to shareholders or owners. They do not allow for the investments that all companies need to make — in research and development, employee training, capital equipment, restructuring — to ensure that they remain competitive.”

It is a pity none of Australia’s business groups strongly and consistently makes the case for the central role of profit in the functioning of the economy. By contrast, these groups tend to get dragged into the detail of negotiating the least worst outcomes in terms of proposed policy measures, for objectives often not well defined or achievable.

A part of this campaign should be the central role consumers play in firms making profits. Without buyers prepared to buy in volume at appropriate prices, there can be no profits.

So while the politicians are using their summer break reading Ann Bernstein’s important book, they could also add some of the works of Ludwig von Mises, who succinctly reminds us that “the riches of the rich are not the cause of the poverty of anybody; the process that makes some people rich is, on the contrary, the corollary of the process that improves many people’s want satisfaction. The entrepreneurs, the capitalists and the technologists prosper as far as they succeed in best supplying the consumers”.

Professor Judith Sloan is an economist and company director