Overthrowing Smith & Marx: Profits, Not Wages, as the Original and Primary Form of Labor Income

karl_marx-adam_smith 1Remarks at the Conferral of Honorary Doctorate from Universidad Francisco Marroquin, July 9, 2013

A video of the degree ceremony appears at http://newmedia.ufm.edu/reismandoctoraldegree

The author wishes to note that a full and comprehensive development of the foundations of this article and its harmonization with the body of Austrian economics is to be found in Chapters 11 and 14-17 of his book Capitalism: A Treatise on Economics.

Vice President Calzada (President Calzada as of next month), Provost Castillo, Treasurer Parellada, and friends.

I want to thank Universidad Francisco Marroquin, in the persons of these three of its highest officials, for the great honor just conferred on me, of an honorary doctorate in social sciences.

Universidad Francisco Marroquin is a rare beacon of light in a world growing intellectually dark. It is a relatively new light, founded in 1971 by the late Manuel Ayau, the leading advocate of liberty in Latin America and UFM’s first President. (I’m glad to say that in 1987, my wife and I met President Ayau in San Diego, when he was a guest lecturer at the summer conference of our organization The Jefferson School of Philosophy, Economics, and Psychology.) Hopefully Universidad Francisco Marroquin’s example will inspire the establishment of other universities throughout the world that are dedicated to upholding the value of individual freedom and capitalism.

I know that the award just bestowed on me is all the more valuable for having previously been bestowed on men of such caliber as Henry Hazlitt, F.A. Hayek, Leonard Read, and William H. Hutt. All of these men, through their writings, were my teachers, most especially Henry Hazlitt.

Now I would like to accept this honor not just on behalf of myself but also on behalf of the two most outstanding teachers in my life: Ludwig von Mises and Ayn Rand. Mises was the source or inspiration for most of what I know and consider important in the fields of economics and social philosophy. His overall, outstanding accomplishment was to present a comprehensive, in-depth, intellectually powerful, and uncompromising case for laissez-faire capitalism. This was something that no one else had ever done before and which urgently needed doing—more than anything else in the world if individual rights and the founding principles of the United States were to be upheld. Ayn Rand greatly supplemented that knowledge, above all by explaining, the precise nature of individual rights. I also acquired a great deal of other knowledge from her as well, which I’ve described in my book Capitalism.

***

The first thing I want to accomplish in the time available for me to speak, is to explain what I consider to be one of the most important of my own original contributions to economics, namely, my demonstration that profits are not a deduction from wages.

The belief that profits are a deduction from wages goes back to Adam Smith, who is believed by many to be the leading advocate of capitalism. In The Wealth of Nations, Smith claims that wages are the original and primary form of income and that profits are taken from what naturally and rightfully belongs to wage earners.

He postulates a state of affairs that he refers to sometimes as “the early and rude state of society” and sometimes as “the original state of things.”

In this state of affairs he imagines that workers are producing and selling products and that the income they receive from the sale of their products is wages. He imagines that as yet there are no businessmen or capitalists present. Just manual workers. He assumes that because the workers are performing labor, the income they receive must necessarily be wages. Labor and wages in his mind are inseparable concepts. Where labor is performed, its income must be wages, he believes.

The conditions present in his alleged “original state of things” stand in his mind as a kind of economic Garden of Eden insofar as he believes that the situation represents one of economic justice. It is just, he believes, because the workers who produce the products, get to keep the full value of the products they produce. Their wages are allegedly 100 percent of the value of the products they produce.

But then comes the economic version of the Fall from the Garden of Eden. Businessmen and capitalists appear on the scene. And because they provide capital and must be remunerated for doing so, in the form of earning profits on their capital, the workers are no longer able to keep the full value of the products they produce. The capitalists’ profits are deducted from what originally went completely to the workers as wages.

The Wealth of Nations was published in 1776. Ninety one years later, in 1867, Karl Marx’s Das Kapital was published.

Marx took over these ideas of Smith and carried them further. He too argued that profits, along with all other income that was not wages, constituted a deduction from wages, and that this deduction started with the coming into being of capitalists and their capital.

Where Marx differs from Smith is that he goes further and develops “the exploitation theory.” Smith provided merely the framework of the exploitation theory. Within that framework, Marx propounded an elaborate analysis that attempted to show that the nature and extent of the alleged deduction of profits from wages was comparable to the process by which a slave owner gained from owning a slave and that the wage earners of capitalism were in fact virtual slaves. (This is the source of the expressions “wage slave” and “wage slavery.”)

What made the workers of capitalism slaves, according to Marx, was the fact that, like slaves, all of their product in excess of the portion required to keep them alive was taken by the capitalists. Indeed, the capitalists, according to Marx, were not only willing and able to extort profits to the extent of driving wages to the level of bare minimum subsistence but were also motivated by the quest for profit to extend the hours of work to the maximum humanly endurable while making working conditions brutal and driving small children into the mines.

To this day, this is the popular assessment of the effects of the profit motive if it is not restrained by such things as labor unions, minimum wage and maximum hours’ laws, and child labor laws. I believe that practically all the members of the Democratic Party and perhaps half or more of the members of the Republican Party believe that these are the conditions that would result in the absence of labor unions and these laws. When it comes to an understanding of the operations of laissez-faire capitalism, that is, capitalism free of such government interference, the great majority of people today are Marxists, and have been since the late 19th Century.

Now it’s impossible for me to fully answer all of these beliefs in the course of a talk as brief as this one. But I assure you that I do fully answer them in my book Capitalism.

I will start by demolishing the framework of the exploitation theory—the notion that originally all income is wages and that the emergence of capitalists serves to bring into existence the phenomenon of profit and its deduction from what allegedly was originally all wages.

All we need do to accomplish this demolition is to realize that when a worker sells a product, such as a loaf of bread, or a pair of shoes, he is not being paid wages. There simply are no wages present. A wage is money paid in exchange for the performance of labor, not for the products of labor. Again, a wage is money paid in exchange for the performance of labor, not for the products of labor. In contrast, the money paid in exchange for the products of labor is a sales revenue. The workers producing products that they sell do not earn wages. They earn sales revenues.

Thus what the workers in Smith’s original state of things and Marx’s equivalent, which he called “simple circulation”—what these workers receive are not wages but sales revenues.

And because there are no capitalists and thus no spending to buy anything that would serve in the production of the goods the workers are selling, there are no money costs to deduct from the sales revenues these workers earn.

Let me pause here. Costs of production are always the reflection of expenditures of money made for the purpose of bringing in sales revenues. These expenditures are made by capitalists. In fact, Marx and Smith agree that the essential feature of capitalistic activity is buying for the sake of selling at a profit. Where there are no capitalists, there is no such buying. But if there is no such buying, there can be no money costs. At the same time, for the same reason, there are no wages paid in production. Wages are the money that capitalists pay to workers to produce the products that the capitalists plan to sell.

The inescapable implication of this is that in the starting point that Smith and Marx have chosen, namely, workers producing and selling products in the absence of capitalists, the income of these workers is profit, not wages. These workers have sales revenues but they have no money costs of production to deduct from their sales revenues, because no one has acted capitalistically and spent any money to bring in those sales revenues. It follows that 100 percent of these workers’ sales revenues is profit.

It follows further that so far from being responsible for the creation of profit and its deduction from wages, what the capitalists are actually responsible for is the creation of wages and costs of production, including costs of production on account of spending for capital goods such as materials and tools, and thus for the reduction in the proportion of sales revenue that is profit. A true statement, in direct opposition to Smith and Marx, is that capitalists create wages and reduce the proportion of income in the economic system that is profit.

***

I’ve established so far that profits are an income attributable to the performance of labor in the conditions postulated by Smith and Marx as their starting point, indeed, the only such income in those conditions, since there are no wages paid in production without the existence of capitalists.

Now are profits earned by capitalists, rather than the manual workers of Smith’s “original state of things,” are these profits also an income attributable to the performance of labor—namely, to the labor of the capitalists, the people who earn them in the conditions that follow “the original state of things”?

Can the profits of business Titans, ranging from John D. Rockefeller and Henry Ford to Steve Jobs and Bill Gates be understood as being earned on a foundation of their labor? For their manual labor may go no further than jotting down thoughts, dictating memos to subordinates, and reading reports.

Remarkably, a major clue to the answer is provided by none other than Adam Smith, about 200 pages after he presented the views I’ve criticized. Here he points out that what drives the economic system and determines how the great bulk of its labor is used, is the various plans and projects of the capitalists, who use their capital for the purpose of earning profit.

I believe that all by itself this qualifies capitalists as workers and producers. It captures the essential element of being a producer, namely, providing guiding and directing intelligence to the means required to achieve the goal of producing a product.

A manual worker uses his arms to produce his product. What makes him a producer is not the fact that he uses his arms, but that his mind directs the use of his arms to achieve the goal of producing the product. His mind provides guiding and directing intelligence to his arms and to whatever tools, implements, or machines he may use in the production of his product.

Now a capitalist supplies goals and provides guiding and directing intelligence not merely to his own arms and whatever tools or implements he may personally use, but to an organization of men, whose material means of production he has provided. A capitalist is a producer by means of the organization he controls and directs. What is produced by means of it, is his product.

Of course, he does not produce his product alone. His plans and projects may require the labor of hundreds, thousands, even tens of thousands of other workers in order to be accomplished. Those workers are appropriately called “the help”—in producing his products. Thus, the product of Standard Oil is primarily the product of Rockefeller, not of the oil field and refinery workers, who are his helpers. It is Rockefeller who assembles these workers and provides their equipment and in determining what kind of equipment, tells them what to produce and by what means to produce it.

I hasten to point out that the standard of attribution I have just used, is the standard usually employed, at least in fields outside of economic activity. Thus history books tell us that Columbus discovered America and that Napoleon won the battle of Austerlitz. What is the standard by which such outcomes are attributed to just one man? It is by the standard of that one man being the party supplying the goal and the guiding and directing intelligence at the highest level in the achievement of that goal.

Now I also want to point out that everything I have said is perfectly consistent with the well-known fact that in business the amount of profit a firm earns tends to vary with the size of its capital. Of course it does. A businessman who owns one store or one factory will earn a certain amount of profit. If he owns ten such stores or factories, it should not be surprising that he earns ten times the profit. His labor is of an intellectual nature and thus can be applied the more extensively the larger is the capital he owns. In ignorance of this fact, Adam Smith assumed that in order for profits to be attributable to the labor of a capitalist, they would have to be proportional to his labor, and since they were more likely to be proportional to his capital, this precluded their being attributable to his labor.

***

Now I think I have succeeded up to this point both in demolishing the framework of the exploitation theory and in demonstrating the fact that the profits of capitalists are a fully earned income, attributable to their labor by virtue of their providing the goals of their firms and the highest level of guiding and directing intelligence required to achieve those goals.

I now want to demonstrate in briefest essence how capitalism operates in diametric opposition to the claims of the exploitation theory about wages, hours, and working conditions.

Here’s how it does so. Namely, based on the combination of saving and investment, mainly by capitalists, and the profit motive and competition that drives the capitalists, the output of goods per worker under capitalism tends continually to increase.

This is the source of progressively rising real wages. Accordingly, the average wage earner can afford to buy more and more as time goes on.

A major advantage of being able to buy more is being in a position in which one can afford to earn less. In the early years of the Industrial Revolution it was necessary for many people to work 80 hours a week to earn enough to be able to live. (Before that, many such people didn’t live. They died of malnutrition and accompanying disease.) A generation or two later, after the output per worker had doubled or tripled, thanks to the capitalists, the average worker came to be in a position in which he could afford to accept the lower earnings of a shorter work week. In fact, he could afford to accept wages lower in greater proportion than his hours were reduced. This made it actually profitable for employers to shorten the work week, with or without any laws or regulations requiring it.

On the same foundation, people could afford to keep their children at home longer. This was because the earnings of children were less and less required for families to survive. In this way, with or without legislation, child labor progressively disappeared.

And again, on the same foundation, workers came to be able more and more to afford to bear the cost of improvements in working conditions of a kind that benefitted them but did not pay for themselves through improved efficiency. They could afford to accept lesser earnings accompanying more desirable jobs.

***

My overall conclusion is very simple. It is that contrary to Smith, Marx, and the prevailing state of public opinion, a profound harmony of interests exists between wage earners and capitalists. Capitalists not only earn their incomes, but in the process benefit everyone else. They pay wages and use their wealth in the production of ever more and better products that the wage earners can afford to buy. The more and bigger the capitalists, the greater is the demand for labor and the larger the supply of products. Everyone’s actual self-interest lies with the capitalists being free to earn the profits they richly deserve and use them to accumulate as much wealth as possible, for that wealth serves everyone who sells his labor and buys products.

The case for capitalism is virtually unknown, however. And when it is presented, it is viewed with great suspicion, because the influence of Marxism is so ingrained that it is widely taken for granted that capitalism can serve the interests of no one but a handful of capitalists, who are allegedly the exploiters of the great mass of mankind.

Nothing will change until capitalists themselves learn to value their achievements and recognize the actual good they accomplish for everyone. And neither that nor anything else that is necessary will occur until universities begin to teach the value of capitalism.

Universidad Francisco Marroquin is in the forefront of the enormous and vital intellectual change that is needed. I’m proud to have been recognized by it for my contributions to this cause.

Thank you.

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11 Responses to “Overthrowing Smith & Marx: Profits, Not Wages, as the Original and Primary Form of Labor Income”

  1. David says:

    This guy is not really answering Reisman. A mere imaginative projection of a value that one might have gained by taking a different course of action is not a value that one did gain and must then pay to acquire some economic good.

  2. Alex says:

    I omitted the words "opportunity cost" in my second to last line right after the bracketed phrase (…..acknowledged exists). Sorry

  3. Per-Olof Samuelsson says:

    This speech will also be available in a Swedish translation in the not too distant future.

  4. Alex says:

    Just to emphasize the important error of Reisman, the two main notions of profits are "accounting profit" and "economic profit." What Reisman has effectively done is confuse these two notions. In fact, he argues that economic profit is the same thing as accounting profit, which it certainly is not. Consider the following two simple examples.

    A person, working 8 hours for himself produces something that sells for $100. Reisman would say that his "profit" is $100. An accountant would say, yes, the accounting profit is $100-$0=$100, but an economist would ask what the 8 hours used to produce this product is worth in other uses. Perhaps the person could have produced something else worth $125, in which case his economic profit in producing something worth $100 is minus $25. Or, he may have no other production possibilities but his leisure may be worth $60 to him. In this case his economic profit is $100-$60=$40.

  5. Frank Zeleniuk says:

    "Nothing will change until capitalists themselves learn to value their achievements and recognize the actual good they accomplish for everyone. And neither that nor anything else that is necessary will occur until universities begin to teach the value of capitalism."

    …and nothing sticks in my craw like platitudinous calls for "capitalists" to give back to the community. Whoever makes these claims has obviously no understanding of what a community is. How many times has a community died because its prime employer closed its doors? It needn't "give back" to the community in such case, it was plainly the greatest contributor to the community as are the vast majority of capitalist endeavors.

  6. 1st Family Virginia says:

    It is no wonder that you were so honored by this institution. That was the best brief explanation of the theory of capitalism that I have ever read. Thank you.

  7. If what one wants to say is that an individual can be better off financially by making a combined $60,000 wage and interest income rather than a $50,000 profit income, it is sufficient just to say that. It is totally unnecessary and the source of major confusions and contradictions to claim that the $50,000 profit thereby becomes a $10,000 loss. There is no loss.
    Our individual with the $50,000 accounting profit has gone through the year consuming $40,000 and adding $10,000 to his net worth. If he in fact had had a $10,000 loss while consuming $40,000, his net worth would have fallen by $50,000.
    This is the first contradiction: the opportunity cost doctrine's implication of a $50,000 decline in net worth In contradiction of the fact of a $10,000 increase in net worth.
    A further contradiction arises if one tries to reconcile the implication with the fact. What is required to do this is to claim that this individual not only has a $10,000 loss he never incurred but alongside the loss earns the very $60,000 in interest and wage income that he does not earn and his failure of which to earn created the supposed problem in the first place.
    An analogy to this would be an individual gains 10 pounds but might have gained 20 pounds. This is taken to mean that he has lost 10 pounds. When his alleged weight loss cannot be reconciled with the fact he is now 10 pounds too large for his clothes, it is claimed that his clothes have shrunk the equivalent of 20 pounds.
    Or: a man marries a pretty woman. But he might have married a very beautiful woman. If the difference is great enough, the subtraction of great beauty from merely pretty implies "ugly." When the woman's alleged ugliness cannot be reconciled with the fact that she is pretty, it is alleged that she has had plastic surgery.
    For elaboration and further contradictions, please see again pp. 459-462 of my book Capitalism.
    The opportunity cost doctrine represents a vast pile of intellectual clutter standing in the way of recognizing not only the significance of the propositions I have demonstrated in my article, namely, the primacy of profit doctrine and its implication of the existence of a harmony of interests between wage earners and capitalists, but also further progress in practically every aspect of the theory of profit/interest and its implications.
    Abandoning the opportunity cost doctrine does not at all imply abandoning recognition of the fact that prices of factors of production are formed on the basis competition for them emanating from all the various alternative uses of those factors of production. All that is required is keeping in mind that the prices of the factors emerge as the result of the bidding of different SUMS OF MONEY by the various users and potential users of the factors.This process does not at all represent the concoction of any kind of make-believe costs. The costs are actual, in the full business and accounting sense.

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