Saturday, May 26, 2012

Notes on Economy — Part IV

Idea of Profit

Profit is one of the most debatable ideas in economy. People such as Karl Marx, Bernard Shaw, and Jawaharlal Nehru all opposed the concept of profit making. Prime minister Nehru is reported to have said to Tata, "Never talk to me about the word profit; it is a dirty word.". Hence, we can deduce that, profit making has different meanings in different economic models.

In a price-coordinated economic system (capitalism), profit acts as an 'incentive to creativity'. In an economic system without profit, there is no need of innovation. This means that the standard of living for any individual remains the same — perhaps, it might decrease. 

In socialism 'profit' is considered as an exploitation of the labour. A capitalist can only earn profit if he forces his labour to produce more than the intrinsic value of the product. For example, if the manufacturing cost of a product is 10 rupees, and the capitalist pays only the labour cost for producing this product. The end result would be that the capitalist won't earn any revenue. This is because, the labour value must equal the production cost in a socialist system. The capitalist can only earn a profit, if he forces his labour to produce products within the intrinsic. Hence, while he pays the labour only 8 rupees. The excess 2 rupees in called the capitalist profit or the exploitation of labour.

Nehru tried to develop Indian economy in a socialist framework. There is was profit — hence, no incentives — in such an economy. Sowell gives an apt example of an India car manufacturer 'Hindustani Motors' (HM). HM manufactured a car called 'Ambassador'. This car was a total replica of the 1954 model British car named Morris Oxford. The design remained the same for the next 25 years, with no technological innovations — as innovations don't convert into profits in a socialist economy. Therefore, the quality of Ambassador car remain the same as it was 25 years ago. Furthermore, people had to wait for months to buy a new car. The Indian government had disallowed the import of new cars from outside. As a result, many Indians couldn't own a personal car, and those who had one, the car was out-dated and less efficient. It was expensive to afford an Ambassador as there were no innovations for increasing engine efficiency and mileage per litre petrol.

In should be noted that by excluding profits, socialist economies add in systematic inefficiency. On the ither hand, capitalist economies trade off profit for removing systematic inefficiencies. At the end of the day, capitalist economies allow standard of living to increase.

It is this idea of profit which allowed Western Europe and United States to continuously increase product efficiency. Take the examples of iPhone, iPods and iPad. Apple launched two different versions of iPhone in the same year, while the new iPad 3 was launched in less than an year time. iPods have evolved from simple MP3 players into devices which are equivalent to smartphone and tablet.  All these innovations occurred in a short span of 6 years. Compare this with the development of the Ambassador Car by HM. There was no innovation for 25 years, as the manufactures found no profit in increasing efficiency. 

To conclude, profit plays an integral role in maximizing efficiency in a price-coordinated economy.

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