Property, Profit, and Labor
We turn now to an examination of the important concepts in economics as well as business ethics. The importance of profit and labor to business should be obvious but perhaps not the importance of property or its connection to the other two. As Richard Pipes points out in his book Property and Freedom, there is an important connection between property and our fundamental rights and liberties. In an economic sense, these would include the ability to work and earn the fruits of one’s labor. But, while these are important subjects, they have often been misunderstood. We’ll begin with the standard philosophical justification for private property by John Locke. Then we’ll examine the argument for profit and its origins in labor put forward by the classical economist Adam Smith. Finally, we’ll examine Karl Marx’s critique of the capitalist foundations of these institutions. We have a lot of issues to cover so let’s get to it.
You might be wondering why we need to bother philosophically justifying private property in the first place. Isn’t it obvious that we all have a right to own things and dispose of them as we see fit? For us now this may be obvious but it wasn’t always so. Additionally, if our rights are intrinsically connected to the institution of private property we would do well to understand the justification for the institution to better defend it if (or when) it comes under assault.
Locke’s argument for the private property begins with a problem. The world is given to us in common which means that at some point in the beginning no one owned anything. But, to use anything one has to take possession of it; i.e. own it. So, how do we go from a state of non-ownership to ownership? This question is answered by the justification of private property.
Locke begins with what he regards as a self-evident proposition: I own my own body. This is self-evident since if I don’t own my body who does? If anyone else does then I’m a slave. Since I’m not a slave, it follows that I must own my own body. From this, it is easy to deduce that I own the labor my body performs. Since this is true it follows that anything I mix my labor with becomes my private property. That’s essentially it! Labor confers ownership.
There are other considerations though that we must address. Locke recognizes that there is a potential problem here because I could mix my labor with many things and it would seem that I would then own them. This raises two problems. First, can I own things I cannot use? Secondly, what about cases where there is prior ownership?
Locke is careful to point out that there are limits to how much one can acquire. Suppose there is an apple tree somewhere that no one owns. I come along and mix my labor with some of the apples which make them mine. As Locke points out the apples become mine at that point. After all, if mixing labor did not make them mine no subsequent act (such as eating them) could. But, it doesn’t follow that I can mix my labor with all the apples on the tree to make them mine. Doing so would constitute a waste of resources. So, the limit is connected to how much I can use. If, on the other hand, I collect all the apples and then sell them or barter them, they have not been wasted. Locke also points out that this doesn’t necessarily apply to all things equally. “Again, if he would give his nuts for a piece of metal, pleased with its color; or exchange his sheep for shells, or wool for a sparkling pebble or a diamond, and keep those by him all his life he invaded not the right of others, he might heap up as much of these durable things as he pleased.” Collecting these things would not detract from anyone or be a waste since I am not depriving anyone of collecting other “pieces of metal.” This passage could be interpreted in many ways one of which would be that there is no rational justification for limiting one’s income since one person’s income is not depriving anyone of their income.
The second character in our property and profit story is the classical economist Adam Smith who is responsible for at least one of two important historical events in 1776. I’ll give you a hint, it wasn’t the American revolution or Declaration of Independence! No, Smith’s contribution to the history of that year was the publication of The Wealth of Nations. You may be tempted to think that this event was insignificant in comparison to the other but don’t be so quick. Smith revolutionized economics and, in essence, wrote the first “how to become rich” book. In a sense, America is founded as much on Smith’s economics as on Jefferson’s Declaration.
The historical context of Smith’s work was a world where mercantilism was the norm. This was the view that nations became wealthy by amassing gold and taxing imports (thus limiting free trade). Smith stands against these ideas by advocating free trade and the value of the division of labor as a means of increasing not only national wealth but also individual wealth. Indeed, the opening sentence of the book alludes to the importance of labor: “THE greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labor.”
What’s so great about the division of labor? Well, first it allows for greater productivity. If you take a task (like making pins which is the example Smith uses) and divide it into many little tasks each given to one person the amount of pins you can make in a day is greatly multiplied. We can see this daily in an automobile factory. Think about how many cars you could make in a day if you had to do everything yourself. Perhaps not even one. But how many cars get produced each day by just one car plant. Hundreds? Thousands? Certainly, whatever the number is, it is more than you could make on your own.
Now, who does this increased productivity benefit? Your first answer might be the owner of the factory (this will be Marx’s answer) but Smith points out that this productivity also benefits the worker. The more productive a worker is, the more he can earn. Additionally, the more a worker can specialize the more that worker can improve his skill (thus increasing his productivity and marketability). Finally, Smith points out that the more a worker can specialize, the more incentive they will have to improve their methods of production and make them more efficient by introducing labor-saving devices. So, contrary to what we might think about how automation puts workers out of business and that this is bad for them, Smith points out that it is the workers themselves who are the innovators of such devices!
The subject of free trade was a contentious one in Smith’s day and to some extent still is today with the worries over outsourcing. It was Smith who pointed out that free trade (like division of labor) is not only a benefit to the owners (and consumers by the way; we shouldn’t forget about them) but also to the workers. Today the benefits of free trade are best explained by the theory of comparative advantage. Those who have taken economics are probably already familiar with this concept. But for Smith, the whole idea of free trade and its benefits can be seen as a direct outgrowth of the division of labor.
Given that I need certain basics to survive (food, clothing, shelter) I have to find the most efficient way of procuring these things. One option is to do everything myself. But, this would lead to gross inefficiency and perhaps poor quality products. I might be a good cook but a poor builder. So, the result would be good food but not so good accommodations. The alternative is to let someone take care of my housing. But, what incentive do they have to do this? In the most famous passage in Wealth of Nations, Smith addresses this:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their interest. We address ourselves, not to their humanity but their self-love, and never talk to them of our necessities but their advantages.
That is, it is in the builder’s best interest to supply me with good housing as this will be rewarded by the food I provide him. So, we each benefit more by cooperating than by working alone. But, the incentive we have for cooperating is not necessarily to benefit our fellow citizens, but ourselves. This finally leads to the insight that Smith is most famous for: by pursuing our interest we can benefit society more so than if we directly attempt to benefit society. Here’s how he puts it:
Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his advantage, indeed, and not that of the society, which he has in view. But the study of his advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.
And we are, says Smith, led by an “invisible hand” to benefit society even as we intend to benefit ourselves. Smith goes so far as to say that attempting to directly benefit society often has negative consequences. As he puts it, “I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”
But, no good theory is without critics and for our story, the main critic is Karl Marx. Part of Marx’s criticism is based on the fact that it seems that everything Smith is saying is counterintuitive. Don’t we need people to work for the benefit of society? If we only pursue profit won’t the only people benefit from the owners? What incentive do they have to pay anything more than subsistence wages to their workers?
Marx has had a profound influence on society, if not economics, even though he is notoriously difficult to read and understand. If you have read the text you have already noticed this! Let me attempt to clarify Marx's criticism. He begins "from a contemporary economic fact. The worker becomes poorer the more wealth he produces." From this, he derives the concept of alienated labor. The basis of the Marxist criticism is that workers are exploited and deprived of the profit they create. It is a stirring criticism and insofar as Marx is speaking to his contemporaries it is valid in part because of the unspeakable conditions workers endured in the first years after the industrial revolution. Unfortunately, the criticism is based on an invalid idea. This is not entirely Marx's fault since the idea (the labor theory of value) was borrowed from Adam Smith!
From Marx's perspective what seems to be occurring in the free market is that the capitalists (the owners of the means of production) are paying their workers a subsistence wage and reaping all the profits. This is what he means by saying that the worker becomes poorer the more wealth he produces. But, when examined in real economic terms this "fact" seems false. The worker's wages increase as his productivity increases. Yes, perhaps the owner's profit increases faster (see the chart on the PowerPoint) but in absolute terms, the worker also benefits. But, let's look at the labor theory of value and how it leads to alienated labor.
The labor theory of value was a staple of classical economics (though it did turn out to be wrong). The basic idea is simple. The value of any product comes from the price of the raw materials plus the price of the labor used to produce it: raw material + wages for labor = final price. The problem is that this didn't add up. The final price was always higher than the cost of materials and labor. What accounted for the "surplus value?' This was profit. In Marx's view, the ultimate source of this profit was labor, but they did not receive this profit. That is, they were separated from it (alienated). So, while the labor was responsible for the profit (and so rightfully entitled to it) the capitalists reaped the profit and this was the problem.
But, as I've mentioned, the criticism is based on a faulty theory of value. This was shown to be faulty by the Austrian economists in the 19th century. The final price of any product is not determined solely by the cost of materials and labor. There is also a subjective element involved. For example, suppose I manufacture a product; a book for example. I write the book and send it to the printer for publication. Suppose it costs me $5.00 per book for printing. Suppose my labor as the author is $5.00. So, I should sell the book for $10.00. But wait! When you go to the bookstore to purchase it you pay $25.00. What's going on here? Well, there are several factors involved. First, if I were to sell the book myself I might charge $10.00 to cover my costs but it is unlikely that I will sell many books. I don't have the means to generate publicity or widely distribute the book. Were I to hire someone to do this I would have to pay them. This is in essence what authors do when they make their books available through bookstores. But the bookstore is taking a risk by offering a book because they can't be sure it will sell but they still have to carry the costs for making it available. Now, suppose the book just sits on the shelf and no one purchases it. Then, it will be relegated to the clearance table where you will be able to purchase it for $5.00. Now, what's the real value of the book? The answer (and this is where the subjective element of value comes into the story) is partially given by what a buyer is willing to pay. The cost of a product is then never the sole source of its value. The source of value has much to do with how much demand there is for the product. This may seem like an obvious insight to you but at the time this was revolutionary in economics.
There are several factors here that explain the problem with Marx's criticism. The most important is the explanation for why the worker receives less in wages than the owner receives in profit. The simplest way to understand this is to put yourself in the position of joining my company. I offer you the following deal to join my new company. You have your choice. I will pay you $35,000 a year as a worker or I will pay you 50% of the profits we make. Which would you choose? Many would choose the security of the wage over the potential for profits. Why? Well, since my company is new there are NO profits at this point so your income would be 50% of Zero. Sure, eventually there may be huge profits but these are not assured. In economic terms, workers are paid a discounted rate because they are not carrying any of the risks. The more risk you are willing to carry the more you can make (or lose).
So, what happens to the wealth? What should happen to the wealth? What about the huge disparity that is created in a free market economy? To answer these questions we'll next examine the writing of one of the wealthiest Americans of the 19th century: Andrew Carnegie.
You might be wondering why we need to bother philosophically justifying private property in the first place. Isn’t it obvious that we all have a right to own things and dispose of them as we see fit? For us now this may be obvious but it wasn’t always so. Additionally, if our rights are intrinsically connected to the institution of private property we would do well to understand the justification for the institution to better defend it if (or when) it comes under assault.
Locke’s argument for the private property begins with a problem. The world is given to us in common which means that at some point in the beginning no one owned anything. But, to use anything one has to take possession of it; i.e. own it. So, how do we go from a state of non-ownership to ownership? This question is answered by the justification of private property.
Locke begins with what he regards as a self-evident proposition: I own my own body. This is self-evident since if I don’t own my body who does? If anyone else does then I’m a slave. Since I’m not a slave, it follows that I must own my own body. From this, it is easy to deduce that I own the labor my body performs. Since this is true it follows that anything I mix my labor with becomes my private property. That’s essentially it! Labor confers ownership.
There are other considerations though that we must address. Locke recognizes that there is a potential problem here because I could mix my labor with many things and it would seem that I would then own them. This raises two problems. First, can I own things I cannot use? Secondly, what about cases where there is prior ownership?
Locke is careful to point out that there are limits to how much one can acquire. Suppose there is an apple tree somewhere that no one owns. I come along and mix my labor with some of the apples which make them mine. As Locke points out the apples become mine at that point. After all, if mixing labor did not make them mine no subsequent act (such as eating them) could. But, it doesn’t follow that I can mix my labor with all the apples on the tree to make them mine. Doing so would constitute a waste of resources. So, the limit is connected to how much I can use. If, on the other hand, I collect all the apples and then sell them or barter them, they have not been wasted. Locke also points out that this doesn’t necessarily apply to all things equally. “Again, if he would give his nuts for a piece of metal, pleased with its color; or exchange his sheep for shells, or wool for a sparkling pebble or a diamond, and keep those by him all his life he invaded not the right of others, he might heap up as much of these durable things as he pleased.” Collecting these things would not detract from anyone or be a waste since I am not depriving anyone of collecting other “pieces of metal.” This passage could be interpreted in many ways one of which would be that there is no rational justification for limiting one’s income since one person’s income is not depriving anyone of their income.
The second character in our property and profit story is the classical economist Adam Smith who is responsible for at least one of two important historical events in 1776. I’ll give you a hint, it wasn’t the American revolution or Declaration of Independence! No, Smith’s contribution to the history of that year was the publication of The Wealth of Nations. You may be tempted to think that this event was insignificant in comparison to the other but don’t be so quick. Smith revolutionized economics and, in essence, wrote the first “how to become rich” book. In a sense, America is founded as much on Smith’s economics as on Jefferson’s Declaration.
The historical context of Smith’s work was a world where mercantilism was the norm. This was the view that nations became wealthy by amassing gold and taxing imports (thus limiting free trade). Smith stands against these ideas by advocating free trade and the value of the division of labor as a means of increasing not only national wealth but also individual wealth. Indeed, the opening sentence of the book alludes to the importance of labor: “THE greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labor.”
What’s so great about the division of labor? Well, first it allows for greater productivity. If you take a task (like making pins which is the example Smith uses) and divide it into many little tasks each given to one person the amount of pins you can make in a day is greatly multiplied. We can see this daily in an automobile factory. Think about how many cars you could make in a day if you had to do everything yourself. Perhaps not even one. But how many cars get produced each day by just one car plant. Hundreds? Thousands? Certainly, whatever the number is, it is more than you could make on your own.
Now, who does this increased productivity benefit? Your first answer might be the owner of the factory (this will be Marx’s answer) but Smith points out that this productivity also benefits the worker. The more productive a worker is, the more he can earn. Additionally, the more a worker can specialize the more that worker can improve his skill (thus increasing his productivity and marketability). Finally, Smith points out that the more a worker can specialize, the more incentive they will have to improve their methods of production and make them more efficient by introducing labor-saving devices. So, contrary to what we might think about how automation puts workers out of business and that this is bad for them, Smith points out that it is the workers themselves who are the innovators of such devices!
The subject of free trade was a contentious one in Smith’s day and to some extent still is today with the worries over outsourcing. It was Smith who pointed out that free trade (like division of labor) is not only a benefit to the owners (and consumers by the way; we shouldn’t forget about them) but also to the workers. Today the benefits of free trade are best explained by the theory of comparative advantage. Those who have taken economics are probably already familiar with this concept. But for Smith, the whole idea of free trade and its benefits can be seen as a direct outgrowth of the division of labor.
Given that I need certain basics to survive (food, clothing, shelter) I have to find the most efficient way of procuring these things. One option is to do everything myself. But, this would lead to gross inefficiency and perhaps poor quality products. I might be a good cook but a poor builder. So, the result would be good food but not so good accommodations. The alternative is to let someone take care of my housing. But, what incentive do they have to do this? In the most famous passage in Wealth of Nations, Smith addresses this:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their interest. We address ourselves, not to their humanity but their self-love, and never talk to them of our necessities but their advantages.
That is, it is in the builder’s best interest to supply me with good housing as this will be rewarded by the food I provide him. So, we each benefit more by cooperating than by working alone. But, the incentive we have for cooperating is not necessarily to benefit our fellow citizens, but ourselves. This finally leads to the insight that Smith is most famous for: by pursuing our interest we can benefit society more so than if we directly attempt to benefit society. Here’s how he puts it:
Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his advantage, indeed, and not that of the society, which he has in view. But the study of his advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to the society.
And we are, says Smith, led by an “invisible hand” to benefit society even as we intend to benefit ourselves. Smith goes so far as to say that attempting to directly benefit society often has negative consequences. As he puts it, “I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”
But, no good theory is without critics and for our story, the main critic is Karl Marx. Part of Marx’s criticism is based on the fact that it seems that everything Smith is saying is counterintuitive. Don’t we need people to work for the benefit of society? If we only pursue profit won’t the only people benefit from the owners? What incentive do they have to pay anything more than subsistence wages to their workers?
Marx has had a profound influence on society, if not economics, even though he is notoriously difficult to read and understand. If you have read the text you have already noticed this! Let me attempt to clarify Marx's criticism. He begins "from a contemporary economic fact. The worker becomes poorer the more wealth he produces." From this, he derives the concept of alienated labor. The basis of the Marxist criticism is that workers are exploited and deprived of the profit they create. It is a stirring criticism and insofar as Marx is speaking to his contemporaries it is valid in part because of the unspeakable conditions workers endured in the first years after the industrial revolution. Unfortunately, the criticism is based on an invalid idea. This is not entirely Marx's fault since the idea (the labor theory of value) was borrowed from Adam Smith!
From Marx's perspective what seems to be occurring in the free market is that the capitalists (the owners of the means of production) are paying their workers a subsistence wage and reaping all the profits. This is what he means by saying that the worker becomes poorer the more wealth he produces. But, when examined in real economic terms this "fact" seems false. The worker's wages increase as his productivity increases. Yes, perhaps the owner's profit increases faster (see the chart on the PowerPoint) but in absolute terms, the worker also benefits. But, let's look at the labor theory of value and how it leads to alienated labor.
The labor theory of value was a staple of classical economics (though it did turn out to be wrong). The basic idea is simple. The value of any product comes from the price of the raw materials plus the price of the labor used to produce it: raw material + wages for labor = final price. The problem is that this didn't add up. The final price was always higher than the cost of materials and labor. What accounted for the "surplus value?' This was profit. In Marx's view, the ultimate source of this profit was labor, but they did not receive this profit. That is, they were separated from it (alienated). So, while the labor was responsible for the profit (and so rightfully entitled to it) the capitalists reaped the profit and this was the problem.
But, as I've mentioned, the criticism is based on a faulty theory of value. This was shown to be faulty by the Austrian economists in the 19th century. The final price of any product is not determined solely by the cost of materials and labor. There is also a subjective element involved. For example, suppose I manufacture a product; a book for example. I write the book and send it to the printer for publication. Suppose it costs me $5.00 per book for printing. Suppose my labor as the author is $5.00. So, I should sell the book for $10.00. But wait! When you go to the bookstore to purchase it you pay $25.00. What's going on here? Well, there are several factors involved. First, if I were to sell the book myself I might charge $10.00 to cover my costs but it is unlikely that I will sell many books. I don't have the means to generate publicity or widely distribute the book. Were I to hire someone to do this I would have to pay them. This is in essence what authors do when they make their books available through bookstores. But the bookstore is taking a risk by offering a book because they can't be sure it will sell but they still have to carry the costs for making it available. Now, suppose the book just sits on the shelf and no one purchases it. Then, it will be relegated to the clearance table where you will be able to purchase it for $5.00. Now, what's the real value of the book? The answer (and this is where the subjective element of value comes into the story) is partially given by what a buyer is willing to pay. The cost of a product is then never the sole source of its value. The source of value has much to do with how much demand there is for the product. This may seem like an obvious insight to you but at the time this was revolutionary in economics.
There are several factors here that explain the problem with Marx's criticism. The most important is the explanation for why the worker receives less in wages than the owner receives in profit. The simplest way to understand this is to put yourself in the position of joining my company. I offer you the following deal to join my new company. You have your choice. I will pay you $35,000 a year as a worker or I will pay you 50% of the profits we make. Which would you choose? Many would choose the security of the wage over the potential for profits. Why? Well, since my company is new there are NO profits at this point so your income would be 50% of Zero. Sure, eventually there may be huge profits but these are not assured. In economic terms, workers are paid a discounted rate because they are not carrying any of the risks. The more risk you are willing to carry the more you can make (or lose).
So, what happens to the wealth? What should happen to the wealth? What about the huge disparity that is created in a free market economy? To answer these questions we'll next examine the writing of one of the wealthiest Americans of the 19th century: Andrew Carnegie.