Who’s to Blame for Excessive Profits?

A recurrent theme in public discourse centers on the “excessive“ profits that some firms make. These profits are depicted as “immoral“, and people urge the government to intervene.

Profits should be distinguished from the remuneration that you receive for your labor or from interest payments on your capital. Profits, in contrast, are what entrepreneurs reap for having discovered a price discrepancy. That is, we make a profit because we correctly noted yesterday that the price for oil was too low; we bought the oil, and are today able to sell it at a higher price. This pure price difference is the profit we make.

We are able to make profits because there is radical ignorance in an uncertain world – what Frank Knight famously described in Risk, Uncertainty and Profit: as we have limited knowledge in an unexpectedly changing and thus uncertain world, we falsely estimate the prices of things. Put simply, the reason we could profit from the oil trade is that the price was too low yesterday. If the supply and demand situation of today had been correctly priced in yesterday, we could not have made aprofit.

So, what does this tell us about when the profits of some firms are very high? Apparently, some entrepreneurs had been able to estimate the ‘true’ price of the good much better than others. Only these entrepreneurs took the appropriate action and bought at prices that, as we know today, were too low the day before.

There are two reasons for their high profit. Firstly, other citizens overlooked the price discrepancies and erroneously did not invest in these areas. This is the reason why entrepreneurs could buy goods at prices too low, and it is the reason why they now, as prices have surged, make such a huge profit. So, the first culprit for high profits are we all. It was our failure to see that the prices had been flawed. If we had bought up prices so that they had reached their ‘correct’ height, no excessive profits or rather no profits at all would have emerged.

There is, however, a second culprit. And this is the government that creates barriers to entry. Doing so, the government makes it difficult for entrepreneurs to enter the market and gain profits – and thereby correct prices and, ultimately, decrease profits for the entrepreneurs overall. Imagine a young entrepreneur who yesterday had wanted to buy oil. If he had bought oil, his demand would have pushed prices higher and thus decreased today’s profits for the other entrepreneurs. However, the government had erected barriers: he first had to obtain a license to be able to buy oil. As such, it was the government that erected barriers to entry that hindered entrepreneurs from acting upon their perceived profit opportunity that, incidentally, would have decreased the profits for all while also driving prices nearer to their optimum that would have improved the situation today, as higher prices would have signaled to expand production. Today, there are manifold ways in which the government erects such barriers.

High profits, at first sight, seem reprehensible to many. These greedy capitalists making money on the backs of other people! But a closer look at the economic mechanisms behind profits reveals a more nuanced picture. Profits are what entrepreneurs reap for their adept foresight and capacity to act out on their visions of the future. With this, they do consumers a huge favor, proved by our willingness to buy their products. But they, in most cases at least, do not restrict competition. Others can freely compete with them. If the would-be rivals do not enter and those in the market make huge profits, the established entrepreneurs are doing nothing wrong. The profits they make are so huge because others were bad entrepreneurs and did not enter the market as well.

We should be thankful to those entrepreneurs who correctly anticipated and took a risk – and offered us goods that we now direly want. And we should rather look with scorn at ourselves. Why didn’t we sense the false prices and correct them earlier? That the profits for some are “excessively high“ is, in most cases at least, not their evil scheming. It is our failure to match their entrepreneurial skills. And, of course, sometimes these profits are the result of the government putting obstacles in the way of lucid entrepreneurs. It is to the government and to ourselves that we should look when we witness “excessive” profits. What we should not do is condemn those who make profits.

Max Molden is a PhD student at the University of Hamburg. He has worked with European Students for Liberty and Prometheus – Das Freiheitsinstitut. He regularly publishes at Der Freydenker.