The Profit Paradox

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[For an endnote on Henry Ford’s contribution to American consumer culture, click here.]

“The unexamined life is not worth living.” — Socrates

As Calvin Coolidge once said, “The business of America is business.” Today, more than ever, business requires business corporations, fictitious “legal persons” created out of whole cloth by the law.

We have “public corporations” listed on stock exchanges. We have private corporations owned by shadowy figures, often unknown to the public. We have numerous “little” corporations, called LLCs (“limited liability companies”), which anyone can create, online, for fees as low as $150. Many restaurants and small businesses take this form. Together all these corporations share one key legal feature: limited liability. Under most circumstances, neither their owners nor their managers are personally liable for their errors and omissions, i.e., for bad things they do by mistake or stupidity.

But all corporations also share a much more important feature, which is key to understanding America and its present discontents. According to the law and to the gospel of every business school in America, the primary, if not the only, purpose of corporations is to produce profit for their owners. That is their raison d’etre.

So it’s no exaggeration to say that profit is America’s purpose. Many of us profess to believe in God, or in Jesus. But what we devote our lives to, day after day, hour after hour, in the work of our lives, is profit. We no more think about that fact than we examine the air we breathe. But it’s nonetheless true.

This fact has real consequences. This essay examines some of those consequences and explores the possibilities for organizing our lives and our society a bit differently.

The most salient and most recent consequence of our apotheosis of profit concerns the Trump corporate tax cuts of 2017.

In his signature piece of legislation (until the just-completed coronavirus bailout), Trump and Congress cut corporate tax rates from 35% to 21%. According to the Joint Committee on Taxation, the cut will save business corporations 1.35 trillion dollars over ten years. The savings were and are to be financed by government debt.

Now our corporations didn’t ask for this tax cut, and most didn’t need it. It was an unexpected windfall: a nice boost to the “bottom line” without any cost savings, increased efficiency, or indeed any effort at all, except maybe a bit of belated lobbying.

So what did most corporations do? In obedience to the dogma of profit, they passed the tax cuts on to their shareholders in the form of dividends and stock buybacks, which raise stock prices. The result was the “Trump Bump,” a nice, steady rise in stock-market prices, which the coronavirus crash just wiped out.

Who gained? Well, it’s common knowledge that only about half of Americans own stock. You don’t have to be a genius to guess which half. So the end result of the Trump corporate tax cut was to enrich (temporarily) the richest half of us, while requiring the poorest half of us, and their children and grandchildren, to help pay back the debt used to finance the cuts.

It was, in effect, a “reverse Robin Hood” event, taking from the poor and giving to the rich. And now that the coronavirus crash has wiped out some $20 trillion of stock-market “value,” the whole thing is just a bad dream, even for the rich. Sic transit gloria mundi. The transient benefit that the artificial “Trump Bump” manufactured has evaporated, except for certain members of Congress who sold their shares on inside information, while the debt that workers, their families and the rest of us must repay remains.

Yet the Trump tax cut is just the bare beginning of the fuzzy thinking and social pathology that results from our worshipping profit. There’s a corollary that’s worse, much worse.

The general formula for profit in manufacturing looks like this:

π = P - L - M - O,

Here π is the profit, P the price, L the labor cost, M the cost of materials and components, and O the “overhead” cost, including things like executive salaries, electricity, insurance, lawyers, accountants, and mortgages on premises, i.e., real-property costs. Each variable is per unit of production, i.e., car, washing machine, ventilator, etc.

The profit π is a dependent variable, while the chief independent variable is P, the item’s price. Subject only to competition—which we’ll get to in a moment—the corporation has complete discretion in setting the prices of things it produces. But for competition it therefore, in theory, has complete discretion over how much profit it makes.

The variable L, the labor cost, is where all the bodies are buried, literally. To the corporate producer, it’s just another cost. But to the workers, it’s income, livelihood and sustenance.

For big corporations—and for society as a whole—it’s something even more important. The bigger the labor “cost” L, i.e., the higher the wages to workers, the more stuff they can buy.

Henry Ford was the first to get this point. Over a decade before the Great Depression and the rise of organized labor in America, Ford more than doubled the wages of his auto workers, to the then-unheard of level of $5 per day. He did so spontaneously and unilaterally, of his own free will as company owner, in January 1914.

Inflated to 2020 prices, Ford’s $5 per day wage would be about $131. For a five-day week, fifty weeks a year (with two weeks off for vacation), that amounts to $131 x 250 = $32,750 per year, or over $16 dollars per hour. Meanwhile, we’re still trying to get most workers up to the level of $15 per hour. And bear in mind that Ford’s unprecedented wage hike came at a time when the income tax, passed to finance World War I, was only 1% on annual incomes of up to $20,000 (the equivalent to $262,000 today).

Ford’s bold move had a ripple effect. Rival industrialists grumbled, but they increased their wages to keep pace. The result was our modern consumer society with its large middle class of workers able to buy the things they made at work. At $5 a day, a worker could accumulate enough to buy a $600 brand new Ford in about four months. Of course, his family had to eat, too, but the wages were enough to cover living expenses and a new car at least every few years.

So Henry Ford helped create our modern consumer society by paying his workers enough to let them afford the cars they made. The rising tide of his more-than-doubled wages raised all boats and made us the richest and happiest society in human history.

Enter global competition. Sometime in the last two generations, globalized free trade brought a new factor into play: international competition. With that development, management attention shifted from the profit π, the dependent variable, to the price per unit P, the supposedly “independent” variable. If a corporation couldn’t compete on price, a competitor could undersell it, and it would be out of business. Its profit would go to zero.

So low prices replaced profit as the goal of business. “Win” the price game and you could dominate your industry with low prices, drive rivals out of business, and maybe (after doing so) become a monopolist and raise prices again without the inconvenience of competition. Lose the price game and you would have no business at all. The new corollary of profit above all became low prices above all.

To see how this works, just make the price P the “dependent” variable by shifting the costs to the other side of the equation, thus:

P = π + L + M + O

You can lower the profit that you and your shareholders are willing to accept, but not below zero. There are laws against selling below cost, and anyway it’s not a long-term strategy. The other costs, M and O are largely determined by forces outside your control, i.e., other corporations and powerful executives. So the only cost that you can really control is L, the labor cost.

Thus goes the terrible logic of the corollary. If you want any profit at all, you have to offer the lowest price for your goods, which means incurring the lowest cost. Since other costs are tough to control, stiffing workers is the path of least resistance. That, in a nutshell, is why our managers sold our factories and technology to China and Mexico and sold our workers down the river.

It was all a mad dash for low prices. It dried up our factories and midwest factory towns. It hollowed out our manufacturing and our ability to do something real, besides shuffle paper, spreadsheets and (badly working) Web pages. It left us with no capacity to produce ventilators, masks and other PPE in a pandemic. And of course it put Donald Trump in the White House.

What we forgot, in this mad dash for ever-lower prices, is that “labor” is not a just another dry cost factor, a mere cipher. It’s our people. Squeeze them, and keep squeezing, and eventually you’ll have a revolution.

But on the way, you’ll get exactly the opposite of the consumer society that Henry Ford fostered. You’ll get a society with cheap prices at Wal Mart and on Amazon, which the wealthy can easily afford, while what used to be the great middle class struggles to afford them because those prices don’t support a living wage for them. You’ll get a society with workers who can’t afford to sustain a robust economy because they have inadequate income or no jobs at all.

That’s precisely where we are today. For verification, just watch the must-see documentary film American Factory. It reveals workers from a closed GM plant, once earning $29-plus per hour ($58,000-plus per year), now earning $14 per hour ($28,000 per year) working in a Chinese-owned auto-glass factory.

So that’s the paradox of profit. You have to have some, or eventually you go out of business. But our national fetish for maximizing profit and absolutely minimizing costs has decimated our middle class and depleted our society of consumers who can buy things. It has therefore maimed our economy, which depends on consumer spending for 70% of economic activity.

The rich can’t support an economy all by themselves. They mostly hoard, save, and invest. They don’t spend nearly as much, as a proportion of their income or wealth, as average people.

So no corporation can succeed fabulously by building mansions, private jets, yachts, or Tesla Model S’s. The corporations that have made it big in our day, as in the past, did so by making things that the masses buy and use. When Henry Ford raised his workers’ wages, he converted the automobile from a luxury good to a mass-market product. The rest is history.

Could our dismal recent history have been different? Of course it could. It still can.

Imagine, for example, that our president actually knew something and could think and analyze problems. Suppose that, instead of imposing blunderbuss “whole-value” tariffs on products and basic commodities like steel and aluminum, he imposed rifle-shot tariffs designed to neutralize the labor-cost differences between our workers and those in nations like China and Mexico for specific products that we actually make, or that we intend to start or re-start making. Suppose he said, in effect, “you can import all of these specific products that you want freely; but you’ll have to pay a tariff equal to the labor-cost differential between your country and ours. You can pay us in tariffs, or you can pay your own workers more.”

What do you think would happen? Either our workers would have a wage cushion by virtue of the tariffs, or Chinese and Mexican workers would experience rapid wage parity, producing Henry-Ford-like consumer societies in China and Mexico. Think everybody might be better off?

But we didn’t do that and we probably won’t. Why? The best I can figure, a little knowledge is a dangerous thing. Every business-school grad knows about the basic “demand curve,” which slopes downward to the right. It says that, as prices rise, the quantity sold falls. So if prices go up, sales fall, and the economy falters. Right?

Not really. That’s only when all other things remain equal. The standard demand curve doesn’t account for increasing consumer wealth as a result of better-paid workers. It also doesn’t account for the fact that labor costs are only a fraction of the prices of most goods. So if, for example, labor accounts for 25% of the price, you can double workers’ salaries and only increase the price of what they make by one-quarter. With doubled salaries, if they catch on like Henry Ford’s, how much more can workers as consumers buy?

No, the whole focus on profit, lowest price, and the so-called “efficiency” low prices represent is a product of limited minds unable to see the big picture. It’s a result of mechanistic, crippled thinking that sees people (aka workers) as merely cogs in a big machine. It is, as Farhad Manjoo described it in explaining why the world’s richest nation doesn’t have enough tests, masks, and ventilators in the middle of a pandemic, one of our “capitalist pathologies.”

It’s not as if there were no premonitions. During the eighties, Japanese car manufacturers penetrated our consumer society by focusing on market share, not profit. Maybe they even lost some money. But beginning with the tinny Datsun, they out produced us in high-quality, fuel-efficient small cars. So today Toyota is the world’s dominant car maker.

Our own Jeff Bezos and his Amazon.com spent decades disappointing Wall Street with no or small profits as he drove relentlessly for customer satisfaction and scale of operations. Today Amazon accounts for about half of all online sales and serves as a lifeline for stay-at-home customers locked down in the pandemic. Imagine, for a moment, if Bezos bumped his corporation’s 700,000 employees from a minimum of $15 to $20 per hour. The resulting boost from $30,000 to $40,000 per year would add some $7 billion to the global economy annually, and in the hands of folk who spend almost every penny they make. Call it the “Amazon stimulus.”

And then there’s Steve Jobs and Apple, which revived from a near-death corporate experience to become, for a time, the most highly valued corporation in human history—a feat lately repeated by Amazon. Jobs’ and Apple’s secret? Ease of use, intuitive interfaces, and making complex computer technology accessible to the average American, just as Henry Ford made his cars accessible to the average auto worker.

There’s a lesson in these stories of immense corporate success. Profit is not all. Low prices are not all. Having a society in which consumers are happy and workers can afford to be consumers is the secret to success, both for individual business corporations and for our society as a whole.

Maybe the pandemic, in giving us all time to think, will let us all come to the right conclusions. Maybe the “bailouts” of ordinary people that Covid-19 forced on us will show the way. Maybe we’ll kick the spreadsheet-makers out of the temple and reconstruct a society with postwar American levels of economic equality. If we do, a vibrant economy will follow, as day the night.

Endnote: More on Henry Ford

As Henry Ford’s historic vision increasingly clashes with the cramped shorted-sightedness of modern American industrialists, a veritable cottage industry has arisen to debunk it. I refuted a lame 2012 effort by an accountant (naturally) in Forbes Magazine here. The accountant argued that Ford didn’t intend to let his workers buy his cars: he merely wanted to curtail employee turnover as workers rebelled against the tedium and monotony of assembly-line work.

There is ample history from the era, including one of the most important corporate-law cases ever, to debunk that view. But even if it were right, it wouldn’t matter. Nothing in industrial history turns on Ford’s motives. What matters is the effect of his wage hike. No one denies (or can credibly do so) that Ford’s hike spurred copycats among other industrialists, who may have wanted to retain their employees, too. That led to a general rise in manufacturing wages and our modern consumer society.

The motives of a man long dead are not the issue. What matters is the effects his causes produced. From the perspective of a century later, we can see that Ford’s act changed America by the simple expedient of letting the masses afford what they make.

From the perspective of another century of economic learning, we can understand how essential that expedient is in an economy that depends on consumer spending for 70% of economic activity. After the last century’s horrors, we can also hope that increasing social justice while insuring a robust economy might help us avoid repeating that century’s wars and cataclysms, including the Russian Revolution, while helping us fight the current pandemic.

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