Friday, May 25, 2012

Profit maximization 101.

From yesterday's WSJ op-ed by Professor Paul Rubin: "In justifying his attacks on Bain Capital, President Obama argues that 'profit maximization' might be an appropriate goal for a private-equity firm, but not for more general public policy. This argument ignores one of the most basic premises of economics."

Don't you have to know any basic economics to become a lawyer, never mind teach constitutional law at the University of Chicago?! I mean everyone should know basically how markets work in order to give us what we want. Shouldn't they?

As Adam Smith put it, we don't get the meat from the butcher because of his benevolence; but rather because he is intent on "maximizing" his profits, or, in other words, he does the best he knows how, to make his profits as big a possible within the constraints that he faces - including legal and moral constraints. It is not that he is greedy or uncaring. He may be, but he may be a wonderfully compassionate and generous individual. But deviating from his endeavor to maximize his profits may put him at a disadvantage to his competitors and leave us with less meat, from him. So while not intending our benefit, and intending only his own, he is led, by the invisible hand of the market, to provide us with what we want. Why? Because the market process works by making his interest coincide with ours. It is the only social mechanism that can do this, however imperfectly. It works by providing the butcher with incentives to be efficient in the provision of what we want when we want it, to use his special and particular knowledge and abilities in doing so, and to be alert to new opportunities to do so better, opportunities that he is in a special position to recognize and exploit. To repeat, by being successful he benefits not only himself but also all those whom he serves. His “greed” is kept in check by the completion or potential competition of those who would like to fill his place by promising to serve us better.

How else could his “greed” be kept in check? By regulation? On what basis? Who would decide how much profit is sufficient, reasonable? How do the regulators get this privileged knowledge? Why should we trust them? What incentive do they have to get it right? What good does it do to try and “shame” profit-earners into adopting some other goal? None, it will either be completely ineffective or produce more harm than good.

To require 
that businessmen should not strive to maximize profits, as President Obama seems to want to do,  betrays either a woeful ignorance of how things work, or a crass hypocrisy. Either way its not good and it tends to perpetuate the kind of economic illiteracy that has gotten us into so much trouble.

1 comment:

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