THE first three chapters laid the foundation upon which rests all that is to follow. As a first fruit we arrive at an explanation of entrepreneurial profit, and indeed so easily and naturally that in order to keep this chapter short and simple I prefer to put some more difficult discussions, which really belong here, in the next chapter, where all the knotty problems may be dealt with as a whole.
Entrepreneurial profit is a surplus over costs. From the standpoint of the entrepreneur, it is the difference between receipts and outlay in a business, as we have already been told by a long line of economists. Superficial as this definition is, it is sufficient as a starting point. By “outlay” we understand all the disbursements which the entrepreneur must make directly or indirectly in production. To this must be added an appropriate wage for labor performed by the entrepreneur, an appropriate rent for any land which may chance to belong to him, and finally a premium for risk. On the other hand I do not insist here that interest on capital should be excluded from these costs. In practice it is included in them, either visibly or, if the capital belongs to the entrepreneur himself, by the same accounting method as wages for his personal work or rent for his own land. This may suffice for the moment, all the more so since many theorists put interest on capital in the same category with wages and rent. I now leave it to the reader's discretion in this chapter either to neglect the existence of interest on capital, in the sense of our interpretation, or to recognise it, in the sense of any theory of interest whatsoever, as a third “static” branch of income and to include it in business costs. Its nature and its origin do not concern us here in any case.
Upon this definition of outlays it may appear doubtful whether there is any surplus at all as against costs. To prove that there is a surplus is therefore our first task. Our solution may be expressed briefly: in the circular flow the total receipts of a business — abstracting from monopoly — are just big enough to cover outlays. In it there are only producers who neither make profits nor suffer losses and whose income is sufficiently characterised by the phrase “wages of management.” And since the new combinations which are carried out if there is “development” are necessarily more advantageous than the old, total receipts must in this case be greater than total costs.
In honor of Lauderdale,2 who was the first to deal with our problem, I shall begin with the improvement of the productive process and indeed with the time-honored example of the power-loom, which is also commended by the fact that it has been subjected to a searching analysis by Böhm-Bawerk.3 Very many if not most of the achievements of the leaders of modern economic life are of this kind; in particular the new era of the eighteenth and nineteenth centuries exhibits efforts in this direction. It is true that in this period we find the several functions which are to be distinguished in the process of introducing improvements in production even less separated than to-day. Men of the Arkwright type invented and at the same time put their inventions into practice. They had not our modern credit system at their disposal. However, I hope I have taken the reader so far that I may make use of our analytic tools in their purest form without further explanations and repetitions.
The matter then appears as follows. If anyone in an economic system in which the textile industry produces only with hand labor sees the possibility of founding a business which uses power-looms, feels equal to the task of overcoming all the innumerable difficulties, and has made the final decision, then he, first of all, needs purchasing power. He borrows it from a bank and creates his business. It is absolutely immaterial whether he constructs the power-looms himself or has them constructed by another firm according to his directions in order to confine himself to employing them. If a worker with such a loom is now in a position to produce six times as much as a hand-worker in a day, it is obvious that given three conditions the business must yield a surplus over costs, a difference between receipts and outlay. First, the price of the product must not fall when the new supply4 appears, or else not fall to such an extent that the greater product per worker brings no greater receipts now than the smaller product obtainable by hand labor did before. Secondly, the costs of the powerloom per day must either remain below the daily wages of the five workers dispensed with or else below the sum which remains after allowing for the possible fall in the price of the product and deducting the wage of the one worker required. The third condition supplements the other two. These two cover wages of the workers who attend to the looms, and wages and rent which go in payment for the looms. So far I have taken the case in which these wages and rents are simply those which ruled before the entrepreneur hit upon his plan. If his demand is relatively small we can rest content with this.5 If not, however, then the prices of the services of labor and land rise because of the new demand. For the other textile businesses at first continue working and the necessary means of production need not be withdrawn directly from them, but from industry in general. This happens by means of an advance in prices. And therefore the businessman, who must anticipate and estimate the rise in prices in the market for production goods which follows his appearance, may not simply include the former wages and rents in his calculation, but must add an appropriate amount, so that yet a third item must be deducted. Only if the receipts exceed outlays after allowing for all three sets of changes is there a surplus over costs.
These three conditions have been fulfilled innumerable times in practice. This proves the possibility of a surplus over costs.6 However, they are obviously not always fulfilled, and when they are not, and the fact is foreseen, the new business is not organised; if this fact is not foreseen no surplus results but rather a loss. If the conditions are fulfilled, however, the surplus realised is ipso facto a net profit. For the looms produce a greater physical product than the services of labor and land contained in them could produce by the previous method, although in the case of constant prices of production goods and products this latter method would also enable production to be carried on without loss. Furthermore, the looms are obviously available at cost to our entrepreneur — we neglect the possibility of patenting as being intelligible without further consideration. Hence there arises a difference between receipts, which are determined according to the prices which were equilibrium, that is cost, prices when hand labor alone was being used, and outlays, which are now essentially smaller per unit of product than for other businesses. And this difference need not be annihilated by the price changes brought about by the appearance of the individual in question on the demand and the supply side. This is so clear that we may forego a more rigorous formulation at this point.
But now comes the second act of the drama. The spell is broken and new businesses are continually arising under the impulse of the alluring profit. A complete reorganisation of the industry occurs, with its increases in production, its competitive struggle, its supersession of obsolete businesses, its possible dismissal of workers, and so forth. We shall consider this process more closely later. Only one thing interests us here: the final result must be a new equilibrium position, in which, with new data, the law of cost again rules, so that now the prices of the products are again equal to the wages and rents of the services of labor and land which are embodied in the looms plus the wages and rents of the services of labor and land which must still cooperate with the looms in order that the product may come into existence. The incentive to produce more and more products will not cease before this condition is arrived at, nor before price falls as a result of the growing supply.
Consequently, the surplus of the entrepreneur in question and of his immediate followers disappears.7 Not at once, it is true, but as a rule only after a longer or shorter period of progressive diminution.8 Nevertheless, the surplus is realised, it constitutes under given conditions a definite amount of net returns even though only temporary. Now to whom does it fall? Obviously to the individuals who introduced the looms into the circular flow, not to the mere inventors, but also not to the mere producers or users of them. Those who produce them to order will only receive their cost price, those who employ them according to instructions will buy them so dearly at first that they will hardly receive any profit. The profit will fall to those individuals whose achievement it is to introduce the looms, whether they produce and use them, or whether they only produce or only use them. In our example the chief importance attaches to employment, but that is not essential. The introduction is achieved by founding new businesses, whether for production or for employment or for both. What have the individuals under consideration contributed to this? Only the will and the action: not concrete goods, for they bought these — either from others or from themselves; not the purchasing power with which they bought, for they borrowed this — from others or, if we also take account of acquisition in earlier periods, from themselves. And what have they done? They have not accumulated any kind of goods, they have created no original means of production, but have employed existing means of production differently, more appropriately, more advantageously. They have “carried out new combinations.” They are entrepreneurs. And their profit, the surplus, to which no liability corresponds, is an entrepreneurial profit.
Just as the introduction of looms is a special case of the introduction of machinery in general, so the introduction of machinery is a special case of all changes in the productive process in the widest sense, the aim of which is to produce a unit of product with less expense and thus to create a discrepancy between their existing price and their new costs. Many innovations in business organisation and all innovations in commercial combinations are included in this. For all such cases, what has been said may be repeated word for word. Representative of the first group is the introduction of large-scale manufacturing businesses into an economic system in which they were previously unknown. In a large-scale business a more suitable arrangement and better utilisation of the factors of production are possible than in smaller businesses; and furthermore the choice of a more favorable location is possible. But the introduction of large-scale businesses is difficult. Under our assumptions all the necessary conditions are wanting — workers, trained personnel, the necessary market conditions. Innumerable resistances of a social and political character work against it. And the organisation itself, still unknown, requires special aptitude to set it up. However, if anyone has in him all that pertains to success under these circumstances, and if he can obtain the necessary credit, then he can put a unit of product on the market more cheaply, and, if our three conditions are realised, make a profit which remains in his pocket. But he has also triumphed for others, blazed the trail and created a model for them which they can copy. They can and will follow him, first individuals and then whole crowds. Again that process of reorganisation occurs which must result in the annihilation of the surplus over costs, when the new business form has become part of the circular flow. But previously profits were made. To repeat: these individuals have done nothing but employ existing goods to greater effect, they have carried out new combinations and are entrepreneurs in our sense. Their gain is an entrepreneurial profit.
As an example of the cases of commercial combinations, the choice of a new and cheaper source of supply for a means of production, perhaps a raw material may be cited. This source of supply did not exist previously for the economic system. No direct and regular connection existed with its country of origin — if overseas, for example, neither a steamship line nor foreign correspondents. The innovation is hazardous, impossible for most producers. But if someone establishes a business having regard to this source of supply, and everything goes well, then he can produce a unit of product more cheaply, while at first the existing prices substantially continue to exist. He then makes a profit. Again he has contributed nothing but will and action, has done nothing but recombine existing factors. Again he is an entrepreneur, his profit entrepreneurial profit. And again the latter, and also the entrepreneurial function as such, perish in the vortex of the competition which streams after them. The case of the choice of new trade routes belongs here.
Analogous to the cases of simply improving the process of production is the case of replacing one production or consumption good by another, which serves the same or approximately the same purpose, but is cheaper. Concrete examples are offered by the partial replacement of wool by cotton in the last quarter of the eighteenth century, and by all production of substitutes. These cases are to be treated exactly as those just mentioned. The difference, that the new products here will certainly not bring the same price as those previously produced in the industry under consideration, is only one of degree, as may easily be seen. For the rest, exactly the same holds good. Again it is immaterial whether the individuals concerned produce the new production or consumption good themselves or only employ or dispose of it as the case may be, and draw it for this purpose from its possible existing uses. Here also these individuals contribute neither goods nor purchasing power. Here also they nevertheless make a profit which is connected with the carrying out of new combinations. We recognise them accordingly as entrepreneurs. Here too the profit will not last long.
The creation of a new good which more adequately satisfies existing and previously satisfied needs is a somewhat different case. The production of improved musical instruments is an example. In this case the possibility of profit rests upon the fact that the higher price received for the better commodity surpasses its costs, which are likewise higher in most cases. One can easily convince oneself of its existence. Furthermore, the adaptation of our three conditions to this case presents no difficulties and may be left to the reader. If a surplus exists and if, therefore, the introduction of better instruments occurs, then here also a tendency to reorganisation in the industry will set in, which will finally restore the rule of the law of cost. Hence, here also there is clearly a new combination of existing factors, an entrepreneurial act and an entrepreneurial profit, even though it is not permanent. A combination of the case of the better satisfaction of a need with the case of lower cost of the unit of product following the appearance of a very great increase in demand is presented by the example of railway and canal construction.
The search for new markets in which an article has not yet been made familiar and in which it is not produced is an extraordinarily rich, and in former times was a very lasting, source of entrepreneurial profit. Primitive trading profits belong here, and the sale of glass beads to a negro tribe may serve as an example. The principle of the matter is that a new commodity is valued by purchasers much as gifts of nature or pictures by old masters, that is its price is determined without regard to cost of production. Hence the possibility that it may sell above costs, including all the expenditure connected with overcoming the innumerable difficulties of the venture. At first only a few see the new enterprise and are able to carry it out. This also is an entrepreneurial act, the carrying out of a new combination; and it yields a profit, which remains in the entrepreneur's pocket. It is true, the source dries up sooner or later. To-day an appropriate organisation would soon come into existence and the trade in glass beads would very soon no longer yield a profit.
At the same time the above covers the case of the production of a completely new good. Such a good must first of all be forced on consumers, perhaps even given away gratis. A host of obstacles arise. But when these are overcome and the consumers take to the commodity, there follows a period of price determination solely on the basis of direct valuation and without much regard to costs, which here also consist fundamentally of the hitherto prevailing prices of the necessary services of labor and land. Hence a surplus can exist which remains in the hands of the successful producers. These again are entrepreneurs who have only contributed will and action and have only carried out the new combination of existing productive factors. Again there is an entrepreneurial profit. And this disappears again when the new commodity becomes part of the circular flow and its price is put in the normal relation to costs.
These examples show us the nature of profit as the result of carrying out new combinations. They show too how the process must be thought of — essentially as the new employment of existing production goods. The entrepreneur does not save in order to obtain the means which he needs, nor does he accumulate any goods before beginning to produce. Furthermore, when a business is not established all at once in its definitive form but slowly develops, the matter is not as different as one would believe. If the entrepreneur's strength is not exhausted on one project and yet he continues to carry on the same business, then he proceeds to new changes which are always new enterprises according to our terminology, often with means which he draws from his past profits. The process then appears to be different, but its nature is the same.
The same is true if a new enterprise is started by a producer in the same industry and is connected with his previous production. This is by no means the rule; new enterprises are mostly founded by new men and the old businesses sink into insignificance. But even if an individual who previously carried on his business by annually repeating his part in the circular flow becomes an entrepreneur, no change takes place in the nature of the proceeding. The fact that in this case the entrepreneur himself already has the necessary means of production, wholly or in part, or, as the case may be, can pay for them out of existing resources of his business, does not change his function as an entrepreneur. It is true our conception does not then fit the facts in every detail. The new enterprise still coexists with the other businesses, which at first continue to operate in the customary manner, but it does not increase the demand for means of production nor does it necessarily supply new products. Yet we only so arranged our picture because the practically more important case demands it and because it shows us the principle of the matter and especially the fact that the new business need not spring directly from the old. Appropriately interpreted, it also fits this case in essentials. Here also it is only a matter of carrying out new combinations and nothing else.
The entrepreneur is never the risk bearer.9 In our example this is quite clear. The one who gives credit comes to grief if the undertaking fails. For although any property possessed by the entrepreneur may be liable, yet such possession of wealth is not essential, even though advantageous. But even if the entrepreneur finances himself out of former profits, or if he contributes the means of production belonging to his “static” business, the risk falls on him as capitalist or as possessor of goods, not as entrepreneur. Risk-taking is in no case an element of the entrepreneurial function. Even though he may risk his reputation, the direct economic responsibility of failure never falls on him.
It may now be briefly observed that profit as here conceived is the main element of the phenomenon which is described as promoter's profit. Whatever promoter's profit may be in addition, its basis is the temporary surplus of receipts over cost of production in a new enterprise. The promoter may indeed be, as we saw, the purest type of the entrepreneur genus. He is then the entrepreneur who confines himself most strictly to the characteristic entrepreneurial function, the carrying out of new combinations. If, during the founding of a business, everything were to proceed correctly and with ideal perfection and foresight on all sides, the profit would be what remained in the founder's hands. Of course, in practice it is quite different. But this still gives the principle of the matter. It is true, this applies only to the real promoter and not to the agent who sometimes performs the technical work of forming a company and frequently also goes by this name. The latter only receives a remuneration which is of the character of wages. Finally, everything new that is created in a company is not in most cases perfected with the promotion of it. On the contrary, its leading men often continually embark upon new enterprises, whereby they then continue the rôle of the original promoter and are entrepreneurs, whatever their official position in the company may be. If we assume, however, that the company, once founded, is simply carried on, then the promoter is the only one who exercises entrepreneurial activity in relation to this business. Let us assume that the prices of the means of production 10 are represented by bonds, that the capitalised higher return of the lasting sources of gain associated with the enterprise are represented by shares, and that there are also promoter's shares which were transferred to the promoter gratuitously. Then these promoter's shares will not yield a lasting income, but will only bring to the promoter that temporary surplus which exists before the enterprise is embodied in the economic system, and then they become worthless. In such a case profit would appear in its purest form.
This picture of profit must now be worked out. And this is done by our asking ourselves the question of what corresponds to this phenomenon in other than the capitalist form of society. The simple exchange economy, that is the kind of economic system in which there is exchange of products but in which the “capitalistic method” is unknown, gives us no new problem to solve. In the units of such a society there must be a different kind of power of disposal over means of production, in which respect the exchange economy can be dealt with as in the case which we are about to take up. For the rest, however, the same will hold true as for the capitalistic system. Therefore in order to avoid repetitions I shall turn to the simple non-exchange economy.
Here two types of organisation come into consideration. The first is that of an isolated manorial estate in which most means of production belong to the lord and all people are subject to him. The second is that of an isolated communist society in which a central organ disposes of all material goods and services of labor, and expresses all value judgments. At first both forms may be treated in common. In both some individuals have absolute control over the means of production. They expect neither cooperation in production nor the offer of possibilities of profit-making from other economic units. The world of prices does not exist and only that of values remains. Thus, when we pass from the consideration of our examples to the treatment of the non-exchange economy we begin the investigation of value phenomena which are at the bottom of profit.
We know that here too there is a circular flow, in which the law of cost strictly rules, in the sense of equality between value of products and value of means of production, and that here too economic development in our sense is only accomplished in the form of carrying out new combinations of existing goods. One might think that the accumulation of stocks of goods would here be necessary and would form a special function. The first is in part correct; not always, it is true, but frequently the accumulation of stocks is a step towards the end of carrying out new combinations. But it never constitutes a special function to which special value phenomena may be attached. A different employment of goods is simply prescribed by the leader or leading organ of the system. Whether the desired result is reached directly or only indirectly through a preparatory stage of collecting stocks is completely immaterial. Whether all the participators individually agree with the new aims and are willing to undertake the collection of stocks is likewise immaterial. The leaders make no sacrifice and take no notice of a possible temporary sacrifice of those led — if and so long as the reins rest firmly in their hands. If the execution of far-reaching plans diminishes the present consumption of the people led—which is not necessary, but possible — the latter will oppose them, if they can.11 Their opposition may make these plans impossible. But neglecting this, they have no direct and economic influence on what shall happen; in particular a shrinkage of consumption and accumulation of stocks is not their voluntary service. Therefore this also involves no special function which should be inserted in our picture of the process of development. If the leader promises the people a premium it amounts to nothing more than when a general promises his soldiers some special remuneration; it is a gift intended to make the people more docile, but it is not part of the essence of the matter and forms no special, purely economic category. Hence the difference between the “lord” and the leader of a communist economy is only one of degree. The fact that according to the idea of a communist society the advantages accruing are to go to the whole community while the lord possibly has only his own interest in view, constitutes no fundamental difference.
From this it follows also that the element of time can have no independent influence here. It is true, leaders must compare the result of the contemplated combination not merely with the result that the same productive factors could produce in the same time in their previous method of employment, but also with the results of other new combinations which could alternatively be carried out with the same means. And if these latter require less time, the results of as many other combinations as could be carried out in the time saved must be allowed for in estimating the relative importance of the competing methods of employment. Therefore the time element will certainly appear in a non-exchange economy, while in the capitalist system its influence is expressed by the interest item, as we shall see later. This, however, is self-evident. Even here time plays no other rôle; none, for example, that would make the necessity of waiting or the smaller desire for future enjoyments special factors. One only waits unwillingly because, and as long as, one can do something else in the meantime. Future enjoyments only appear smaller because the further in the future their realisation lies, the greater become the deductions on account of “enjoyments realisable elsewhere.”
Thus the leader of such a community, whatever his position may be, withdraws a certain quantity of means of production from their previous uses and with them carries out a new combination, for example the production of a new good or the production of a good already known by a better method. In the latter case it is quite immaterial whether he withdraws the necessary means of production from the branch of industry which hitherto manufactured the same commodity, or whether he allows existing firms to continue working in the habitual manner and begins to produce alongside of them with the new method and withdraws the necessary means of production from quite different branches of industry. The new products will be ex hypothesi of higher value than those produced previously by the same quantities of means of production — however valuations in such a society may be formed. How does the process of imputation proceed with respect to the new products? At the moment when the combination is completed and the products come into existence their value is determined. How will the values of the factors which have participated be formed? It is still better to choose the moment when the decision is made to carry out the new combination and to assume that everything happens exactly according to the decision. First of all a valuation must be made by the producers: the value of the new products must be compared with the value of those products which the same means of production have been producing so far in the normal circular flow. Clearly this valuation is necessary in order to make any estimate of the advantage of the new combination, and without it no action would be possible. The central question for our problem is now, which of the two alternative values that may be produced by the means of production will be imputed to the latter. So much is clear: before the decision about carrying out the new combination is made, only that value which corresponds to the old employment. For there would be no sense in imputing beforehand the surplus value of the new combination to the means of production, since the carrying out of it would then no longer appear as an advantage and the basis for the necessary comparison of the values in the two uses would be lost. But how does the matter stand once the decision is made? Must not the whole gain in satisfaction be imputed in the Mengerian sense12 to the means of production, just as in the circular flow, since they now realise the higher value; so that if everything functions with ideal perfection the whole value of the new products will be reflected in the means of production used?
I answer no; and assert that even here the services of labor and land are to be estimated at their old values; and in fact for the following two reasons. First, the old values are customary values. Long experience has determined them, and they are established in the consciousness of individuals. They are only altered in the course of time and under the pressure of further long experience. Their values are stable to a high degree, all the more so since the services of labor and land themselves have not changed. The values of the new products on the contrary stand just as much outside the existing value system as the prices of new products in the capitalist system. They are not joined in continuity with the old values, but are separated discretely. Hence the justification of the method of interpretation 13 according to which any productive good is only assigned the value which it would realise in other than its actual employment. For only this value, that is in our case its hitherto prevailing value, is dependent upon the concrete means of production. If they ceased to exist they would be replaced by other units from these other employments. No unit of a commodity can be valued higher than another identical unit, if they exist simultaneously. Now the services of labor and land employed in the new combination are homogeneous with those simultaneously employed — if they were not there would indeed be a difference in value, but one easily explicable without affecting the principle — and therefore cannot have a different value from the latter. Even in the extreme case, if all productive powers in the economic system were put at the service of the new combination they would have to be invested at this stage with the values hitherto prevailing, which in case of failure they could realise again and upon which the magnitude of the losses would be based if they were completely annihilated. Therefore the successful carrying out of new combinations also results in a value surplus in the non-exchange economy, not only in the capitalistic; and in fact a value surplus in the sense of a quantity of value to which there is no corresponding claim of imputation by means of production, not merely a surplus of satisfaction as against the earlier position. As we may also put it, surplus value14 in development is not only a private but also a social phenomenon, and so far is in every respect the same thing as the capitalistic entrepreneurial profit which we met before.
Secondly, the same result may be reached by another approach. The entrepreneurial activity of the leader, which is indeed a necessary condition of the realisation of the combination, may be conceived as a means of production. I do not so conceive it ordinarily, because more interest attaches to the contrast between entrepreneur and means of production. But here this method of consideration does good service. For the time being, therefore, let us constitute the leadership function a third original productive factor. Then it is clear that some part of the value of the new products must be imputed to it. But how much? Leader and means of production are equally necessary, and the whole surplus value of the new products depends upon the cooperation of both of them. This requires no further comment and does not contradict what was said in the preceding paragraph. The appropriate magnitudes of all value categories are only determined by the force of competition, whether of goods or of individuals. Since this second kind of competition does not exist in the non-exchange economy, and since in it the difference between what is and is not profit is also of much less significance than in an exchange economy (as we shall see immediately), its value would not always appear with the clearness that it does where this difference is very essential. But we can nevertheless specify for most cases how much is to be imputed to the entrepreneur's function. In most cases, as we have said, the means of production are replaceable, but not the leader.15 Hence the former will have imputed to them that value which will be lost in the event of replacement being necessary, and the leadership function will be assigned the remainder. To the leadership function is imputed the value of the new products minus the value which could be realised without it. Hence, the surplus here corresponds to a special claim to imputation, and can therefore in no case swell the claim which originates in the means of production.
In this it must not be forgotten, however, that it would not be quite right if we were always to speak of the imputation of the hitherto prevailing value to the means of production. The marginal value in the previous uses indeed rises in consequence of the withdrawal of means of production from them. We observed the same phenomenon in the capitalistic system. The rise of prices of means of production in consequence of new demand by entrepreneurs in the capitalistic system corresponds exactly to this valuation process. Our method of expression must be corrected accordingly. However, nothing is changed in fundamentals. This rise in value must not be confused, of course, with the imputation of the value due to development to the means of production.
No one can assert that the valuation process described above is not real and that profit as a special value magnitude has no meaning in a non-exchange economy. Even a non-exchange economy must know clearly what it is doing, what advantage its new combinations yield and also to what this advantage is to be attributed. One might assert, however, that profit has no significance as a distributive category in a non-exchange economy. In a certain sense this is true. In the feudal type of non-exchange economy the lord can indeed dispose freely of the quantity of product corresponding to his “ service,” but in it the lord can dispose freely of all returns — he can give the workers more but also less than corresponds to their marginal productivity. In the communist type the profit falls entirely to the people as a whole — at least in theory. This in itself does not concern us. But can one not infer from it, especially for the communist type, that profit is absorbed in wages, that reality pushes the theory of value aside and that wages embrace the whole product? No, one must distinguish the economic nature of a return from what happens to it. The economic nature of a return rests upon a productive service. In this sense we call wages that return which is to be imputed to a labor service. Under free competition in an exchange economy this return goes to the worker, but only because the principle of free competition is remuneration according to marginal significance. It is necessary only in the sense that in the capitalistic system precisely this wage calls forth the effort. If the effort were assured by another method — by the feeling of social duty or perhaps by compulsion — the worker might receive less; but his wages would nevertheless be determined by the marginal productivity of labor, and the amount by which his remuneration fell short of this should be classified as a deduction from his economic wage. This deduction would also be wages, quite on the same plane with the wage paid to the worker. In a communist society the leader would certainly not receive profit. And most decidedly it cannot be asserted that this would make development impossible. On the contrary, it is possible that the people in such an organisation would in time think so differently that they would no more lay claim to profit than a statesman or a general would wish to keep the spoils of victory wholly or partly for himself. But the profit would remain profit. That it will not do to characterise it as the wages of labor may be seen by adapting the argument which Böhm-Bawerk formulated classically with respect to interest.16 It also applies to rent of land, in which likewise the nature and value of the productive contribution of land are to be distinguished from the revenue received by particular individuals.17
As the wage of which workers would the profit be designated? Two answers to this question are conceivable. In the first place it may be said: as part of the wage of the workers who worked on the new product. Now this cannot be. For then these workers would ex hypothesi get higher wages than their fellows. The latter, however, perform no less work of no inferior quality, so that if we accept this possibility we come into conflict with a fundamental economic principle, that excludes different values for different parts of homogeneous goods. Quite apart from the injustice that would lie in such a measure, privileged workers would plainly be created by it. The arrangement is possible, but the surplus received by these workers would not be wages.
The other conceivable answer is: the values which we call profit and the amounts of product corresponding to them simply constitute a part of the national dividend and are to be allotted equally to all labor services contributed in the relevant economic period — assuming homogeneity of the services or, as the case may be, taking account of disparities in any recognised way. In this case the laborers who have not worked on the new products get more than the product of their labor. Never yet has an economic meaning been associated with a wage that is higher than the total value product. Therefore it will easily be conceded that in this case the workers get their share not wholly as an economic wage but partially under a non-economic title. To be sure, this arrangement is also possible, and many others equally so. The community must indeed dispose somehow of its “profit” as of all other returns. It must dispose of it in favor of the workers since there are no others entitled to shares. In this it can proceed according to the most varied principles; it can for example distribute according to intensity of need or promote general ends without distributing it. But this alters nothing in the economic categories. In the normal circular flow it is not possible for the workers, any more than land, to receive directly or indirectly more than their economic product, for more does not exist. If this is possible in our case it is solely because some other agent does not receive its product. If we so define the ambiguous expression “exploitation” that exploitation occurs when a necessary agent of production, or the possessor of it as the case may be, receives less than its product in the economic sense, then we can say that this extra payment to the workers is only possible by exploiting the leaders. If we confine the expression to the case in which some personal service is deprived of its product — in order to exclude the concept of exploitation from being applied to land, where, considering the non-existence of landlords in the communist society, it would be out of place — then we can still say that exploitation of the leaders occurs, to be sure, without wishing to pass any moral judgment.
Therefore profit does not become wages in the economic sense even if it goes wholly to the workers. It is practically important for a communist system to recognise this clearly and always to separate profit from wages. For the general understanding of its life as well as decisions about concrete questions manifestly depend upon such recognition. This whole consideration teaches us the independence of the phenomenon from the concrete form of economic organisation. And then there is the general truth: profit as a special and independent value phenomenon is fundamentally connected with the rôle of leadership in the economic system. If development required no direction and no force then profit would indeed exist; it would be a part of wages and rents, but it would not be a phenomenon sui generis. As long as this is not the case, that is as long as the bulk of the people have the slightest resemblance to the masses of all nations of whom we have any knowledge, so long the whole return cannot be imputed to the services of labor and land, even in the ideally perfect case of frictionless and timeless economic process.18
But also in the non-exchange economy profit does not live eternally. Here too, necessary changes appear which put an end to it. The new combination is carried out; its results are at hand, all doubts are silenced; the advantages, and at the same time the manner of obtaining them, are henceforth evident. There is further need, at the most, of a manager or foreman, but not of the creative power of a leader. It is only necessary to repeat what has been done before to acquire the equivalent advantages. And that can and will be done without a leader. Even if resistances from friction must still be overcome, the matter has become essentially different, and easier. The advantages have become realities to all members of the community, and the new products, uniformly distributed in time, are continually before their eyes; they free them, in the sense of what we said on this point in the first chapter, from every sacrifice or necessity of waiting for the completion of further products. The economic system is no longer expected to advance, but only to assure the continuity of the existing stream of goods. We can expect that of it.
Thus the new process of production will be repeated.19 And for this entrepreneurial activity is no longer necessary. If we conceive it again as a third productive factor, then we can say that in the mere repetition of the familiarised new combinations one of the factors of production, which were necessary to carrying them out initially, disappears. At the same time the claim to imputation associated with it is abolished and the values of the others, that is of the services of labor and land, will be increased until they exhaust the value product. Only these are necessary now, they alone create the product. Imputation is to them alone; in the first place to the services of labor and land which are actually used in the given production, but subsequently, in accordance with well known principles, equally to all. The values of the former services of labor and land will first increase and then will diffuse themselves over all others.
Hence, the values of all services of labor and land will rise correspondingly. This rise, however, must be distinguished from that which appeared with the carrying out of the new combination, not only in degree but also in kind. It signifies no rise in their scale of values but only in their marginal utility in consequence of the fact that, because of the withdrawal of means of production from the hitherto prevailing uses, production cannot be carried as far as before, hence only needs of higher intensity than before can be satisfied. In the other case something quite different occurs, namely the entry of the value of the new products into the scale of values of means of production. This may also raise the marginal utility of the latter; but it raises their total value too, a difference which is of practical importance where the disposal of larger quantities of factors is concerned. Hence the values of the means of production now express the fact that the new increase in satisfaction depends upon them and them alone, that the product of labor and land has become greater. They will now no longer be assigned the values which they had in the former circular flow, but those which they realise in the new circular flow. At the time of the transformation there was no sense in imputing to them a value higher than their replacement value then. Now their replacement value already includes the value of the new employment. The rise in the value of the social product draws the values of the means of production after it and the new state of affairs will soon replace the old accustomed value by a new one, which will finally become the customary one, based upon the new marginal productivity. Thus the contact between value of product and value of means of production would be reestablished. There will be no more discrepancy between the two value categories in the new system than there was in the earlier. And if everything functions with ideal perfection then the communist society is now quite right if it considers all the resulting product as a permanent return to its labor and land and distributes it amongst its members for consumption.20 The facts would not disavow it.
So far the elimination of profit in the non-exchange economy proceeds in a manner quite analogous to its elimination in the capitalistic system. But the other part of this process in the capitalist system, namely the forcing down of the price of the new product in consequence of the appearance of competing firms, must be absent in the non-exchange economy. It is true that here too the new products have to be incorporated in the circular flow, that here too their values must be brought into relation with the values of all other products. Theoretically we can still distinguish the carrying out of the innovation and the process of its embodiment in the circular flow as two different things. But it is easily seen that it makes a considerable difference practically whether both actually take place uno actu or not. In a non-exchange economy the demonstration of a surplus attributable to entrepreneurial activity is quite enough to solve our problem. In a capitalist system these surpluses can only find their way to the entrepreneur with the help of the mechanism of the market and can be wrested from him again only by means of this mechanism. Thus there is besides the simple value problem the further one of how it happens that the profit actually accrues to the entrepreneur. And this mechanism creates many phenomena which must be absent in a non-exchange economy.
In spite of this, not only is the innermost economic nature of profit the same in all forms of organisation, but so is the innermost nature of the process that eliminates it. In all cases the matter turns upon the elimination of the obstructions which prevent the whole value product from being imputed to the services of labor and land, or, as the case may be, their prices from being put on a level with the price of the product. The ruling principles are always that the economic process, if unobstructed, first does not tolerate value surpluses in the case of individual products, and secondly always forces the values of the means of production up to those of the products. These principles are valid immediately in a non-exchange economy, and they are realised through free competition in a capitalist system. In the latter the prices of the means of production must under free competition be such that they exhaust the price of the product. In so far as this is not possible the price of the product must correspondingly fall. If under these circumstances profit exists at all, it is only because the transition from one position in which there are no surpluses to another new position in which there are again none cannot happen without the help of the entrepreneur, and unless the further condition necessary in a capitalist system is also fulfilled, namely that the profit cannot be immediately wrested from him by competition.
Profit clings to the means of production in no other sense than does the effort of a poet to his partly finished manuscript. No part of the profit is imputed to them, nor is the possession and the furnishing of them the content of the entrepreneurial function. And above all, as we saw, profit is not to be sought in the permanent increase in value which the original means of production experience in consequence of the new employment. Let us consider the case of a slave economy in which land and workers belong to the entrepreneur who has bought them for the purpose of carrying out new combinations. One could say in this case, if anywhere, that a price will be paid for land and workers corresponding to their hitherto prevailing employments, and that profit is the amount by which land and workers now permanently produce more. But this would be wrong for two reasons. First, the receipts for the new products will reach a height from which competition must pull them down again, so that this conception would not allow for an element of profit. Secondly, the lasting surplus amount — in so far as it is not quasi-rent — is economically simply an increase of the wages of labor, which, it is true, accrues to the “owner of labor” here, not to the worker, and of rent of land. Slaves and land certainly have a higher value now for their proprietor, but he has become permanently richer as their proprietor and not as an entrepreneur, if one neglects occasional or temporary profit. Even if a natural agent of production first comes into existence in the new combination, for example a brook as water-power, the matter is in no way different. It is not the water-power that yields the profit. What it permanently yields is rent in our sense.
Hence a part of what is in the first instance profit changes into rent. Thereby the economic nature of the quantity in question is changed. Let us assume that a planter who has previously cultivated sugar cane changes over to cotton-growing, which until recently was more lucrative than it is now.21 This is a new combination; the man thereby becomes an entrepreneur and makes a profit. For the time being rent of land appears in the list of costs only at the amount appropriate to sugar cane cultivation. As has actually happened, we shall assume that competition sooner or later forces down the receipts. If a surplus still remains, however, how is that to be explained and what is it economically? Neglecting friction, it can only result because the land either is differentially suited to cotton-growing or the rent of land has risen in general as a result of the new employments — in principle it is always a consequence of both elements. This at once characterises that part of the increase in total return which is permanent as rent of land. The entrepreneurial function of this man disappears if he continues to grow cotton, and the whole return is henceforth imputed to the original factors of production.
A word about the relation of profit to monopoly revenue. Since the entrepreneur has no competitors when the new products first appear, the determination of their price proceeds wholly, or within certain limits, according to the principles of monopoly price. Thus there is a monopoly element in profit in a capitalist economy. Let us now assume that the new combination consists in establishing a permanent monopoly, perhaps in forming a trust which need fear absolutely no competing outsiders. Then profit is obviously to be considered simply as permanent monopoly revenue and monopoly revenue simply as profit. And yet two quite different economic phenomena exist. The carrying out of the monopolistic organisation is an entrepreneurial act and its “product” is expressed in profit. Once it is running smoothly the concern in this case goes on earning a surplus, which henceforth, however, must be imputed to those natural or social forces upon which the monopoly position rests — it has become a monopoly revenue. Profit from founding a business and permanent return are distinguished in practice; the former is the value of the monopoly, the latter is just the return from the monopoly condition.
These discussions cannot be continued further within the scope of this work. Perhaps they are too long already. But if I must reproach myself with having wearied the reader too much with these things, I still cannot spare myself the reproach that not all points are exhaustively explained and not all possible misunderstandings excluded. The fundamental aspects of the matter ought to be elucidated. A few more observations before we leave the subject.
Entrepreneurial profit is not a rent like the return to differential advantages in the permanent elements of a business; nor is it a return to capital, however one may define capital. So that there is no reason for speaking about a tendency towards equalisation of profits which does not exist at all in reality: for only the jumbling together of interest and profit explains why many authors contend for such a tendency,22 although we can observe such extraordinarily different profits in one and the same place, at the same time and in the same industry. We want finally to emphasise that profit is also not wages, although the analogy is tempting. It is certainly not a simple residuum; it is the expression of the value of what the entrepreneur contributes to production in exactly the same sense that wages are the value expression of what the worker “produces.” It is not a profit of exploitation any more than are wages. However, while wages are determined according to the marginal productivity of labor, profit is a striking exception to this law: the problem of profit lies precisely in the fact that the laws of cost and of marginal productivity seem to exclude it. And what the “marginal entrepreneur” receives is wholly a matter of indifference for the success of the others. Every rise in wages is diffused over all wages; one who has success as an entrepreneur has it alone at first. Wages are an element in price, profit is not in the same sense. The payment of wages is one of the brakes to production, profit is not. One might say of the latter, but with more right, what the classical economists asserted of rent of land, namely that it does not enter into the price of the products. Wages are a permanent branch of income, profit is no branch of income at all if one counts the regular recurrence of a return as one of the characteristic features of income. It slips from the entrepreneur's grasp as soon as the entrepreneurial function is performed. It attaches to the creation of new things, to the realisation of the future value system. It is at the same time the child and the victim of development.23
Without development there is no profit, without profit no development. For the capitalist system it must be added further that without profit there would be no accumulation of wealth. At least there would not be the great social phenomenon which we have in view — this is certainly a consequence of development and indeed of profit. If we neglect the capitalisation of rents and saving in the narrow sense of the word — to which we ascribe no very big rôle — and finally the gifts which development in its repercussions and chance throw in the lap of many individuals, which it is true are in themselves temporary but which may lead to the accumulation of wealth if they are not consumed, then by far the most important source of the accumulation of wealth still remains, from which most fortunes spring. The non-consumption of profit is not saving in the proper sense, for it is not an encroachment upon the customary standard of life. And so we may say that it is the entrepreneur's action that creates most fortunes. It seems to me that reality convincingly substantiates this derivation of the accumulation of wealth from profit.
Although I left the reader free in this chapter to put interest on capital beside wages and rent as a productive outlay, I have yet conducted the investigation as if the whole surplus over wages and rent passed to the entrepreneur. Actually he must still pay interest on capital. That I may not be reproached with designating a sum first as profit and then as interest, let it be expressly remarked that this point will be fully elucidated later.
The size of profit is not as definitely determined as the magnitude of incomes in the circular flow. In particular it cannot be said of it, as of the elements of cost in the latter, that it just suffices to call forth precisely the “quantity of entrepreneurial services required.” Such a quantity, theoretically determinable, does not exist. And the total amount of profit actually obtained in a given time, as well as the profit realised by an individual entrepreneur, may be much greater than that necessary to call forth the entrepreneurial services which were actually operative. It is true that this total amount is frequently overestimated.24 It is true that it must be borne in mind that even obviously disproportionate individual success has its function, because the possibility of attaining it works as a stronger incentive than is rationally justified by its magnitude multiplied by the coefficient of probability. Such prospects also belong, as it were, to the “remuneration” of those entrepreneurs for whom they are not realised. Nevertheless it is quite clear that in very many cases smaller amounts and especially smaller total amounts would have the same result, as it is also clear that the connection between quality of service and private success is here much weaker than for example in the market for professional labor. This is not only important for the theory of taxation — even though the importance of this element in practice is limited by the need of taking account of “ capital accumulation” in the sense of increasing the supply of produced means of production — but it also explains why the entrepreneur can be relatively so easily deprived of his profit and why the “salaried” entrepreneur, for example the industrial manager who frequently plays the entrepreneurial rôle, can generally be adequately remunerated with much less than the full amount of the profit. The more life becomes rationalised, levelled, democratised, and the more transient become the relations of the individual to concrete people (especially in the family circle) and to concrete things (to a concrete factory or to an ancestral home), the more many of the motives enumerated in the second chapter lose their importance and the more the entrepreneur's grip on profit loses its power.25 To this process the progressive “automatisation” of development runs parallel, and it also tends to weaken the significance of the entrepreneurial function.
To-day, as well as in the epoch in which the beginnings of this social process were not yet known, the entrepreneurial function is not only the vehicle of continual reorganisation of the economic system but also the vehicle of continual changes in the elements which comprise the upper strata of society. The successful entrepreneur rises socially, and with him his family, who acquire from the fruits of his success a position not immediately dependent upon personal conduct. This represents the most important factor of rise in the social scale in the capitalist world. Because it proceeds by competitively destroying old businesses and hence the existences dependent upon them, there always corresponds to it a process of decline, of loss of caste, of elimination. This fate also threatens the entrepreneur whose powers are declining, or his heirs who have inherited his wealth without his ability. This is not only because all individual profits dry up, the competitive mechanism tolerating no permanent surplus values, but rather annihilating them by means of just this stimulus of the striving for profit which is the mechanism's driving force; but also because in the normal case things so happen that entrepreneurial success embodies itself in the ownership of a business; and this business is usually carried on further by the heirs on what soon become traditional lines until new entrepreneurs supplant it. An American adage expresses it: three generations from overalls to overalls. And so it may be.26 Exceptions are rare, and are more than compensated for by cases in which the descent is still faster. Because there are always entrepreneurs and relatives and heirs of entrepreneurs, public opinion and also the phraseology of the social struggle readily overlook these facts. They constitute “the rich” a class of inheritors who are removed from life's battle. In fact, the upper strata of society are like hotels which are indeed always full of people, but people who are forever changing. They consist of persons who are recruited from below to a much greater extent than many of us are willing to admit. Whereupon a further host of problems is opened up, the solution of which alone will show us the true nature of the capitalist competitive system and of the structure of its society.
1 The most important theories of profits may be characterised by the following terms: friction theory, wages theory, risk theory, differential rent theory. I refer to the discussion of them in Wesen, bk. III, and shall not here enter into a critique of them. For history of the doctrine see Pierstorff and Mataja. At the same time J. B. Clark, whose theory is nearest to mine, may be cited here; cf. his Essentials of Economic Theory.
2 Inquiry into the Nature and Origin of Public Wealth. It is true that he had an altogether different object in view, viz. the explanation of interest.
3 In his Capital and Interest, VII, 3.
4 Here we depart from Lauderdale's example in order to remain true to our whole conception of the process and at the same time to reality.
5 This would be the case of completely free competition, to the concept of which it is necessary that no firm be strong enough perceptibly to influence prices by its own action on supply and demand.
6 It should be noticed that in this statement there is not an appeal to the reality of a phenomenon yet to be explained, of the kind found respecting the fact of interest in many representatives of the productivity theory. For the rest, further substantiation comes later.
7 Cf. Böhm-Bawerk, loc. cit., p. 174.
8 However, for the sake of simplicity of exposition we confine the process in general to one economic period.
9 Cf. Chapter II, p. 74 ff.
10 That is, strictly speaking, those prices of the means of production constituting the material investment, which correspond to their values in their hitherto prevailing employments without regard to the contemplated new one, even though in practice more would have to be paid in most cases.
11 For they will have in view only the immediate loss, while the future gain may possibly have just as little reality as if it would never exist. This applies to all stages of civilisation of which we have any knowledge; throughout history the element of force has never been absent when it has been a question of development which presupposes the cooperation of great masses. In many cases, it is true, no sacrifice at all was exacted from the people.
12 Cf. Wieser, Natürlicher Wert, p. 70 f.
13 With which I do not agree in every respect; cf. Wesen, bk. II, and “Bemerkungen über das Zurechnungsproblem,” Zeitschrift für Volksw., Sozialp. und Verw. (1909).
14 Only this surplus, which appears from the private economic standpoint as profit and interest on capital, can be described as surplus value in the Marxian sense. No other surplus exists.
15 Even if the activity of the leader competes with an irreplaceable means of production, a value surplus remains over in favor of the former. For, at the time of the introduction of the innovation, the latter is only to be assigned its hitherto prevailing value.
16 Positive Theorie, final chapter.
17 Cf. Wesen, bk. III.
18 A word about the argument which is so often heard to-day: that the entrepreneur produces nothing, organisation everything; that no one's product is his own, but the product of the social whole. At the bottom of this is the truth that everyone is the product of his inherited and personal milieu and that no one can produce anything for which the conditions do not exist. But we can do nothing with this in the realm of theory, which is not concerned with the moulding of men but with men already formed. To the question whether individual initiative has a function, even the representatives of this interpretation would eagerly reply affirmatively. Further, it is precise and correct with respect to the secondary phenomena of development. For the rest, it is merely based upon the popular preconception that only physical work is really productive and upon the impression that all elements of development work harmoniously together and every phase of development is based upon preceding ones. This, however, is the result of development already set in motion and explains nothing. The principle of its mechanism is the main question.
19 One might object that if the innovation is too far removed from the accustomed methods compulsion will still be necessary. We must differentiate as follows. First, in such a case it is not yet understood and has not become familiar. Then, the new combination is simply not yet carried out. We assume that this has happened, and it may last an indefinitely long time. After that, compulsion of the kind incident to organisation, especially in the ranking of workers in higher and lower classes, is certainly always necessary. But this is something different from the compulsion to carry out new things. Finally, in the feudal organisation a direct injury to the masses may be connected with the innovation. Compulsion is then also necessary if it is to be carried out. But this is again a different thing. In maintaining something already in existence our leader type is not necessary, but only a ruler.
20 As the capitalist system does too after its own fashion.
21 Written in 1911.
22 Others, as Lexis for example, dispute also the uniformity of the rate of interest. The problem, which made so many difficulties for Marx, disappears if our conclusion is accepted.
23 How very closely this corresponds to reality and how clearly it represents an unprejudiced view is seen in Adam Smith's observation — which any practical man might have made and actually does make in ordinary life — that new branches of production are more profitable than old.
24 Cf. on this Stamp, Wealth and Taxable Capacity, p. 103 f.
25 Cf. on this my article, “Sozialistische Möglichkeiten von heute “ in the Archiv für Sozialwissenschaft (1921).
26 We have only a few investigations into this fundamental phenomenon. Cf., however, for example, Chapman and Marquis: “The Recruiting of the Employing Classes from the Ranks of the Wage Earners,” Journal of the Royal Statistical Society (1912).