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A. The Economic Nature of Profit and Loss

7. The Computation of Profit and Loss

The originary praxeological categories of profit and loss are psychic qualities and not reducible to any interpersonal description in quantitative terms. They are intensive magnitudes. The difference between the value of the end attained and that of the means applied for its attainment is profit if it is positive and loss if it is negative.

Where there are social division of efforts and cooperation as well as private ownership of the means of production, economic calculation in terms of monetary units becomes feasible and necessary. Profit and loss are computable as social phenomena. The psychic phenomena of profit and loss, from which they are ultimately derived, remain, of course, incalculable intensive magnitudes.

The fact that in the frame of the market economy entrepreneurial profit and loss are determined by arithmetical operations has misled many people. They fail to see that essential items that enter into this calculation are estimates emanating from the entrepreneur's specific understanding of the future state of the market. They think that these computations are open to examination and verification or alteration on the part of a disinterested expert. They ignore the fact that such computations are as a rule an inherent part of the entrepreneur's speculative anticipation of uncertain future conditions.

For the task of this essay it suffices to refer to one of the problems of cost accounting. One of the items of a bill of costs is the establishment of the difference between the price paid for the acquisition of what is commonly called durable production equipment and its present value. This present value is the money equivalent of the contribution this equipment will make to future earnings. There is no certainty about the future state of the market and about the height of these earnings. They can only be determined by a speculative anticipation on the part of the entrepreneur. It is preposterous to call in an expert and to substitute his arbitrary judgment for that of the entrepreneur. The expert is objective insofar as he is not affected by an error made. But the entrepreneur exposes his own material well-being.

Of course, the law determines magnitudes which it calls profit and loss. But these magnitudes are not identical with the economic concepts of profit and loss and must not be confused with them. If a tax law calls a magnitude profit, it in effect determines the height of taxes due. It calls this magnitude profit because it wants to justify its tax policy in the eyes of the public. It would be more correct for the legislator to omit the term profit and simply to speak of the basis for the computation of the tax due.

The tendency of the tax laws is to compute what they call profit as high as possible in order to increase immediate public revenue. But there are other laws which are committed to the tendency to restrict the magnitude they call profit. The commercial codes of many nations were and are guided by the endeavor to protect the rights of creditors. They aimed at restricting what they called profit in order to prevent the entrepreneur from withdrawing to the prejudice of creditors too much from the firm or corporation for his own benefit. It was these tendencies which were operative in the evolution of the commercial usages concerning the customary height of depreciation quotas.

There is no need today to dwell upon the problem of the falsification of economic calculation under inflationary conditions. All people begin to comprehend the phenomenon of illusory profits, the offshoot of the great inflations of our age.

Failure to grasp the effects of inflation upon the customary methods of computing profits originated the modern concept of profiteering. An entrepreneur is dubbed a profiteer if his profit and loss statement, calculated in terms of a currency subject to a rapidly progressing inflation, shows profits which other people deem "excessive." It has happened very often in many countries that the profit and loss statement of such a profiteer, when calculated in terms of a noninflated or less inflated currency, showed not only no profit at all but considerable losses.

Even if we neglect for the sake of argument any reference to the phenomenon of merely inflation-induced illusory profits, it is obvious that the epithet profiteer is the expression of an arbitrary judgment of value. There is no other standard available for the distinction between profiteering and earning fair profits than that provided by the censor's personal envy and resentment.

It is strange indeed that an eminent logician, the late L. Susan Stebbing, entirely failed to perceive the issue involved. Professor Stebbing equated the concept of profiteering to concepts which refer to a clear distinction of such a nature that no sharp line can be drawn between extremes. The distinction between excess profits or profiteering, and "legitimate profits," she declared, is clear, although it is not a sharp distinction.2 Now this distinction is clear only in reference to an act of legislation that defines the term excess profits as used in its context. But this is not what Stebbing had in mind. She explicitly emphasized that such legal definitions are made "in an arbitrary manner for the practical purposes of administration." She used the term legitimate without any reference to legal statutes and their definitions. But is it permissible to employ the term legitimate without reference to any standard from the point of view of which the thing in question is to be considered as legitimate? And is there any other standard available for the distinction between profiteering and legitimate profits than one provided by personal judgments of value?

Professor Stebbing referred to the famous acervus and calvus arguments of the old logicians. Many words are vague insofar as they apply to characteristics which may be possessed in varying degrees. It is impossible to draw a sharp line between those who are bald and those who are not. It is impossible to define precisely the concept of baldness. But what Professor Stebbing failed to notice is that the characteristic according to which people distinguish between those who are bald and those who are not is open to a precise definition. It is the presence or the absence of hair on the head of a person. This is a clear and unambiguous mark of which the presence or absence is to be established by observation and to be expressed by propositions about existence. What is vague is merely the determination of the point at which non-baldness turns into baldness. People may disagree with regard to the determination of this point. But their disagreement refers to the interpretation of the convention that attaches a certain meaning to the word baldness. No judgments of value are implied. It may, of course, happen that the difference of opinion is in a concrete case caused by bias. But this is another thing.

The vagueness of words like bald is the same that is inherent in the indefinite numerals and pronouns. Language needs such terms as for many purposes of daily communication between men an exact arithmetical establishment of quantities is superfluous and too bothersome. Logicians are badly mistaken in attempting to attach to such words whose vagueness is intentional and serves definite purposes the precision of the definite numerals. For an individual who plans to visit Seattle the information that there are many hotels in this city is sufficient. A committee that plans to hold a convention in Seattle needs precise information about the number of hotel beds available.

Professor Stebbing's error consisted in the confusion of existential propositions with judgments of value. Her unfamiliarity with the problems of economics, which all her otherwise valuable writings display, led her astray. She would not have made such a blunder in a field that was better known to her. She would not have declared that there is a clear distinction between an author's "legitimate royalties" and "illegitimate royalties." She would have comprehended that the height of the royalties depends on the public's appreciation of a book and that an observer who criticizes the height of royalties merely expresses his personal judgment of value.

  • 2. Cf. L. Susan Stebbing, Thinking to Some Purpose. (Pelican Books A44), pp. 185-187.
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