THE

QUARTERLY JOURNAL

OF

ECONOMICS

OCTOBER, 1887

THE THEORY OF BUSINESS PROFITS.

PRESIDENT WALKER invites criticism of his theory of business profits,* and, presumably, of the theory of wages it is designed to supplement. Responding to the invitation, I wish to present some reasons why, in my opinion, both theories must be rejected as untenable. As Professor Alfred Marshall has expressed a general agreement with Mr. Walker, I shall take the liberty of examining, in conjunction with Mr. Walker's views, several passages of Economics of Industry bearing on these subjects.

The mode by which Mr. Walker seeks to maintain his theory of the manager's earnings is certainly marked by great ingenuity. Much that he says is undoubtedly sound and just. In large part, it is a contention that high business capacity is a rare gift, and that the possessors of this gift, being able to perform highly useful service in production, are able also to obtain large rewards for their labor. This would be to apply to busi

* See Quarterly Journal of Economics, April, 1887, p. 288.

ness management the familiar law of monopoly wages, coupled with the principle that the highest success in every calling is due to something in the nature of a personal monopoly, as against the general body of competitors in the same business. If this had been all, the adherents of the old views would find little ground for criticism. Here, if anywhere, they might be expected to agree with Mr. Walker; for here certainly is a case of wages depending on production and a case of labor rewarded out of product rather than out of previous savings. But the agreement, I am sorry to say, must be a qualified one, extending not much beyond the fact that the employer's personal wages are, by as much as they exceed ordinary wages, the result of monopoly. As to the elements that constitute the monopoly, Mr Walker's theory will hardly win general acceptance. His view is that the dearth of natural ability is everything, or so nearly everything that the other elements may safely be neglected. He argues as if the born manager, on coming of age, had only to whistle the proper note, in order to have all the requisites of production laid at his feet. On this point, I can but think that the general verdict will be more nearly in agreement with Professor Marshall, in holding that the necessity of having capital and training is a much more influential element in constituting the monopoly than the lack of men with the requisite talent.* For myself, I think the "captain of industry," now that he has found recognition, is in some danger of getting overdone. I cannot forget that, for all but the highly gregarious industries, which, after all, do but a small part of the world's production,- this splendid captain is and must remain a rather mythical personage. I rejoice to think that, for the most part, the business of production, even in some gregarious industries, can be very well man

*

*Journal of Economics, July, 1887. I understand thus Mr. Marshall's remark that, at a rough guess, he should attribute a tenth part of the extra gains of the successful business man to rent of special ability.

aged by men who have average ability, plenty of common sense, the requisite training, and sufficient energy to devote themselves unflaggingly to the work. Not at all because I wish to disparage the great captain, but because I think the service he does for society consists mainly in the example he sets of improved organization of labor. The world needs inventors there as in other things. When the best mode of conducting the business is demonstrated, a lower grade of talent may well enough suffice for safe and successful management.

It is probable that there are thousands of men born with all the natural gifts required for successful management, who nevertheless fail to get control of business enterprises, solely for lack of the necessary training and capital. Both of these are extremely hard to get. There is no training school for business men but actual business. A man who has no capital cannot even try the experiment of business in a small way, in order to prove his ability. He cannot ask men of capital to put him in charge of their business until he has had training and has proved his capacity and, I will add, his honesty. He cannot borrow, because he has no security to offer for the repayment of the loan. The only course open to him in most cases is to work hard and save hard until he can command capital of his own. This is an ordeal that natural ability for management on the large scale does not help men to face successfully. It demands rather plodding patience and severe self-denial. Even with these, the chances are heavily against great success. Partly by sustained exertions, partly by good luck, the man who begins life without means or backing does sometimes climb to the control of large enterprises; but this, I fear, is the happy event that comes only to few. We hear much of these few, but the history of those who fall by the way is not written. This is my opinion-I admit it is only an opinion as to the character of the business man's monopoly.

As to the mode by which this monopoly brings its special gains to those who hold it, there will be, I think, a very decided rejection of nearly all the reasoning that Mr. Walker urges in behalf of his theory of business earnings. Let us, in the first place, consider the proposition that the "no-profits" employer regulates the price of each commodity, on the same principle as that on which no-rent lands regulate the price of wheat. One naturally asks why the no-profits employer should have this function, seeing that there are always in every business, as Mr. Walker himself tells us, some employers who are not only making no profits, but are making losses. The products of these losing employers are continually in the market. Why should they not regulate the price, rather than the products of employers who are doing indefinitely better? In the case of land, we take the poorest in steady use as the regulator of price. If we are to have the same rule as regards employers also, let us have it, and take the least efficient employers as the regulators of prices. Mr. Walker seems to me to shrink from applying the principle he announces. What should we think of Ricardo, if, in developing his theory of rent, he had "thrown out of account" several of the poorest grades of land in constant use, in order to find the basis for prices and rent?

But, even if the lowest in the scale be taken, we come upon great difficulties in the application of the principle. How is it to apply in the case of the extractive industries, such as farming and mining? We should have, according to this new doctrine, two descending scales of productiveness, one due to differences in the natural agents, the other due to the varying capacity of employers. Both of these (the foot of the scale in each case) are supposed to be operative in determining the price. The cost of production of that part of the supply which is produced at the greatest disadvantage settles the price of the whole. But what part, on this theory, is produced at the greatest

disadvantage? Unless, by happy chance, the lower end of the one scale coincides with the lower end of the other, unless the least efficient employers have the least productive lands, we lose our regulator of price and our base for reckoning rent. If the least efficient employers should happen to have farms and mines somewhat above the poorest, the consequences would be extremely awkward. The poverty of the poorest lands might be counterbalanced, to an indefinite extent, by the superior business capacity of those tilling them; and the inferior business capacity of the least capable farmers would be offset by the natural advantages of their land. If each of these is to operate in fixing the price, how are they to combine their effects? The produce that comes under the influence of the one escapes the effects of the other. Where shall we look, on this theory, for "that portion of the supply which is produced under the greatest disadvantage"? Also, in this case, how shall the law of rent be stated? How is the "rent of ability" to be distinguished from the rent of the land? On these questions, Mr. Walker gives us no clear information. In discussing the law of rent in his general treatise, he dwells only on differences of soil and situation, as causing one farmer to have larger returns than another. Incidentally, indeed, in connection with another subject, he makes a remark, which, if taken literally, can only mean that, in his theory, all farmers are to be regarded as of the same grade of ability, and all of the "no-profits" class! Comparing the special gains of the successful business man with the rent of land, he says, "just as the cultivator of soils of the better class has a surplus left in his hands after paying wages for labor and interest for capital employed, which surplus, called rent, goes to the owner of the soil."* If it is assumed that the whole surplus above wages paid for labor and interest for capital goes to the landlord, of course that would obviate the difficulties I have mentioned: all farmers are then of the "no-profits"

* Walker, Political Economy, § 284.