Jewish World Review Dec. 23, 2003 / 28 Kislev, 5764

Thomas Sowell

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Consumer Reports

Profits without honor

http://www.NewsAndOpinion.com | Profits are certainly without honor among the intelligentsia. The very word produces negative reactions, even from people who cannot give you a single reason why money carrying that label is worse than money called by other names.

Many professional athletes and entertainers earn salaries higher than what the vast majority of business owners earn as profits, yet there is no moral indignation from those who are in the business of moral indignation.

Some claim not to be against profits, as such, but against "obscene profits." Yet they offer no clue as to how we are to tell obscene profits from R-rated profits or PG-13 profits.

One of the supposedly damning charges against pharmaceutical companies is that they earn those famous obscene profits. The figure of 18 percent is thrown around and may even be accurate, for all I know. But it doesn't make enough difference to bother checking it out.

The unspoken assumption — and fallacy — is that high profits mean high prices. But, back in the heyday of the A & P grocery chain, its profit rate never fell below 20 percent for a whole decade — and it was at that time the pre-eminent grocery chain in the country precisely because of its low prices and high quality.

Then, as conditions changed, other grocery chains found ways to operate at lower costs, enabling them to charge even lower prices than A & P, taking away its customers.

It has been estimated that a supermarket makes a clear profit of about a penny on a dollar of sales. If that sounds pretty skimpy, remember that it is collecting that penny on every dollar at several cash registers simultaneously and, in many cases, around the clock.

When a supermarket sells out its entire contents in about two weeks, that means that the dollar on which it made a penny of profit in the first half of January comes back for them to make another penny in the second half of January. By the end of the year, that dollar has come back 26 times and made 26 cents.

Does that mean that the supermarket is making a 26 percent rate of profit? Not at all. The rate of profit on sales differs from the rate of profit on investment, which is what really counts. The point here is that the relationship between prices and the rate of return on investment can be very tenuous.

Why have both local and national governments in recent years begun having many of their traditional functions, from garbage collection to running prisons, done by private companies? Because these private, profit-making companies can usually get the job done cheaper and better.

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If profits were just extra costs arbitrarily added on to the costs of production, then non-profit institutions or whole countries that operated without profit, such as the Soviet Union, would have had lower costs. Almost invariably, however, enterprises that operate without the incentive of profit have had higher costs, not lower costs.

It was not a free-market think tank, but Soviet economists, who pointed out that Soviet industry used far more inputs to produce a given output than did market economies like Germany, Japan or the United States. Economically illiterate people — which, unfortunately includes much of the intelligentsia — have never understood the role of profit as an incentive to keep costs down.

To the economically illiterate, if some company makes a million dollars in profit, this means that their products cost a million dollars more than they would have cost without profits. It never occurs to such people that these products might cost several million dollars more to produce than if they were produced by enterprises operating without the incentives to be efficient created by the prospect of profits.

If "obscene profits" are what cause pharmaceutical drugs to cost so much, why haven't socialist countries set up their own government-owned pharmaceutical enterprises to produce drugs more cheaply? Why don't non-profit organizations here do that?

It is because rhetoric is cheap but creating drugs is not. Recent estimates are that it costs $800 million per new drug. That is why drug prices are so high. But needless suffering and premature deaths are even higher costs.

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JWR contributor Thomas Sowell, a fellow at the Hoover Institution, is author of several books, including his latest, "Applied Economics: Thinking Beyond Stage One." (Click HERE to purchase. Sales help fund JWR.)

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