Windfall Profits; R. Anderson

This massive assault on profit making reflects a belief that prof its are something extra, the elimi nation of which would result in a general improvement in human welfare, that profits are gained at the expense of others- "unearned" and "unjust." This anti-profit mentality stems from a failure to ·understand the true nature and source of profits, the integral relationship existing 1974 WINDFAI,L PROFITS 287 between profits and losses, and their basic importance to the func tioning of the market system. It is a failure to understand that an attack upon profits, even excess or windfall profits, is an attack upon the market system itself. Within the framework of a free market price system, profits show which producers have best satis fied the wants of consumers. Prof its appear as the result of actions taken earlier by those producers most successful in anticipating and serving the demands of the consumer. Profits demonstrate how well a producer has employed scarce resources in the past to ward the satisfaction of consumer wants. Profits are a record of ex perience, a reward for satisfac tory service rendered.

The process of profit-making, however, is not the same thing as the amount of profits recorded. Profits earned in the past serve as no specific guide for future pro-· ductive activity, though the fact that they were earned may offer hope of future profits. Past profit-· able activity in a given form of production assures nothing about the future. Attempts to imitate activities that have been profit-· able have resulted in many busi-· ness failures. The opportunity for profit-mak·· ing stems from the changing val·· ues of consumers over time, and the reflection of these changing values on prices. The individual who foresees correctly these de veloping changes in market prices, and acts upon his foresight, will be the profit-maker. Adjusting to Change If man were omniscient, or if his values were to remain static, the concept of profit and loss would not exist. But fallibility and change are part of the human con dition and necessarily affect man's economic behavior.

Today's market prices are reflec tions of values previously held by consumers and of the production those values generated. The prices so established will be either too high or too low with respect to the market conditions of tomorrow, conditions which could only be known by knowing the future, which is impossible. The profit-maker, however, must attempt the impossible. The un certainty of the future overrides all human action. The fact that fu ture prices are uncertain does not dissuade the potential profit maker from acting. It is this potential of profit making that provides the entre preneur's motivation and incentive for production. The entrepreneur identifies resources in today's mar ket that he believes will possess a higher market value tomorrow. If 288 THE FREEMAN May his foresight about the future values of the consumers is correct, a profit can be realized. The mag nitude of the profit will depend upon the degree of change in fu ture market prices and the entre preneurial decision to act on his foresight.

When the rise in prices is large, the entrepreneur holding the re sources so affected will experience large profits. The identification of this development as excess or windfall profits has been grossly misleading. The fact that he did not anticipate the precise degree of change in prices is no basis for denying the owner of the resourc es his right to the gain. The concept of windfall profit merely observes that large gains can be realized from drastic changes in consumer evaluations and their resultant impact on mar ket prices. The owner of the af fected resources experiences a dramatic and sudden increase in the value of his property. But, if consumer evaluations change in the other direction, market prices can just as suddenly and drama tically fall, causing windfall loss es to the owners of resources so affected. Windfall profits or losses simply emphasize the risk of productive activity resulting from the chang ing values of consumers. While the entrepreneur attempts to calculate future market conditions, he is not omniscient. An under estimate of future prices may yield him a higher profit than he had an ticipated when he took productive action, but that same higher profit becomes the magnet for an influx of new competitive activity.

A Reliable Guide With the profit and loss system as their guide, competing entre preneurs decide how resources shall be directed for future con sumption. Anticipated profitability attracts the productive capital of the entrepreneurs, but the ultimate prof).t is determined by the actions of the consumers. The entrepre neur's astuteness in judging the consumer's demands will decide whether profits or losses are to be realized by him in the future. A significant contributor to a smoothly functioning market is the much maligned speculator. As an entrepreneur, the speculator acts in anticipation of the changing val ues of consumers. His buying and selling of resources creates a more orderly market, reducing erratic fluctuations in prices, and thus holds down the magnitude and se verity of gains and losses. Accurate foresight by the speculator miti gates the errors of resource pricing and the consequent large profits or losses brought on by changing consumer tastes.

1974 WINDFAIIL PROFITS 289 Once profits are understood to evolve from the actions of the con sumers, it becomes pointless to speak of profits as being "fair," "normal," "excess," or whatever. The decision on how to allocate existing resources into future use is made by entrepreneurs on the basis of their interpretation of the consumer's actions in the market place of the future. Through a sub sequent return of profits and losses to the entrepreneur, the consumer is constantly signaling entrepre neurs, as to how to direct scarce re sources toward best satisfying con sumer wants. This relationship between the entrepreneur and the consumer is much like that of a revocable trust. The trustee-entrepreneur allocates resources for the benefit of the trustor-consumer, a relationship perpetuated by profits and revoked by losses. Through the signal of these profits and losses the con sumer steers the producer.

The allure of profit-making is the catalyst for productive activ ity. Sparked by an entrepreneurial decision on the future state of the market, resources are continually being directed into hopefully pro ductive use. The soundness of the original decision is reflected by profits or losses generated by the venture. Without some prospect that profits will substantiate the original decision, no productive activity would be undertaken. The problem of determining how re sources should be allocated could not be resolved. There would be no response to the will of the consumer in the market. The market would be in a state of chaos. The Fundamental Issue Concerns Property Rights The real controversy over the concept of excess or windfall pro fits evolves over who should be the beneficiary of these subsequent unanticipated changes in market prices. The fundamental issue in this controversy is one of property rights. In a free market system the entrepreneur subjects his property to risk in a prod ucti ve acti vity in the hope of generating a profit. If his judgment of the future demand of the consumers proves correct, his property increases in value, and he profits. The extent of his gain is thus determined by the con sumer. In a market system of pri vate ownership the gains would therefore accrue to the owner of the property.

Similarly, the burden of wind fall losses is borne by the entre preneur. If he directs his property into productive activities later re jected by the consumer's changing values, he is responsible for his erroneous decision. The sudden ab stention from buying on the part of the consumers causes a fall in 290 THE FREEMAN May the value of his property and a loss to the entrepreneur. Within such a market system, the entrepreneur subjects his property to risk-to the gain or loss that accrues from the changing tastes of the con sumer. The notion that windfall profits accrue at another's expense or loss is patently false. They result from the same forces that bring wind fall losses: changes in the values of consumers. Such windfalls re sult from future uncertainty, and should accrue to the owners who expose their property to the risks of production. Profits or Losses Stem from Changing Values of Consumers Once it is understood that pro ,fits and losses evolve from the changing values of consumers, it becomes obvious that abolishing windfall profits or windfall losses is impossible. Fallibility and change are a part of our nature, and both large errors and great changes are inevitable. To deny to the entrepreneur the gains or losses resulting from such error or change does not eliminate gains or losses; it eliminates entrepre neurs, disrupts the market, and ultimately leaves everyone under the dead hand of government con trol.

As long as consumers continue to express their changing values in the market place, profits, antic ipated or not, will continue to materialize. The only question is whether the gain in the value of the entrepreneur's property should accrue to the owner or to some one else. When the government attempts to make itself the beneficiary of windfall profits, it can only disrupt the productive processes of the market. The natural adjustments in supply and dem.and that occur in the free market are hampered, and further disequilibrium develops. The consumer's urgent signal for increased production, which is the essence of windfall profits, cannot be heard or acted upon by pro ducers to whom the market is closed. The ultimate consequence must inevitably be even higher prices for the resources involved. Thus, the expropriation of wind fall profits is not only counterpro ductive, but also denies the sov ereignty of the consumer in the structuring of society.

If the individual as consumer is to retain his personal liberty, if he is to remain the sovereign force in the structuring of society, he must be free to reflect fully his chang ing values in the market place. This requires that the profit and loss signal must remain unham pered. For that is the only signal to which entrepreneurs can reason ably respond. ~ BRIAN SUMMERS TheRole of Savings ONE of the least appreciated as pects of the private enterprise sys tem is the role of savings in in creasing the wealth of all the peo ple. That the savings of some can increase the wealth of all may seem, at first glance, paradoxical, so let us consider for a moment just what happens when an individual - call him Joe - forgoes a little spending to put a sum in the bank. Some people say: "The money that Joe has saved is money that won't be spent. The decrease in Joe's consumption can only mean a commensurate decrease in produc tion and a resulting rise in unem ployment. Saving should really be discouraged."