In the wake of the Great Recession, “excessive profits” have come under repeated attack by politicians and frustrated Americans.
These frustrations are driven by a perceived unfairness of the privileged position of businesses allowing them to take advantage of consumers.
The most recent example is a bill, H.R. 3784, introduced in Congress in January and titled the “Gas Price Spike Act.” It would create a Reasonable Profits Board with the purpose of taxing profits of oil and natural gas companies that are deemed “excessive.”
This bill — and the broader aggravation with businesses in general — provides an excellent opportunity to step back and reconsider the important role profits play in our society.
There are essentially two ways to gain wealth in the world. One option is to produce things that people want, then make a profit through voluntary exchange.
Voluntary trade generates a benefit to both parties involved: An individual trades a good he has for a good he more greatly desires; the same occurs on the other side of the transaction.
Both leave the exchange better off than they were previously. Under this scenario, the only way to earn large profits is to satisfy your fellow citizens’ desires.
But there is a second way to earning wealth, which is by taking it from others. This may occur through violent theft, but more often in the United States, it comes about through lobbying politicians to redistribute wealth to a particular group at the expense of others.
In contrast to voluntary exchange, which is mutually beneficial, this method of accumulating wealth is one-sided. Instead of pleasing society to increase wealth, individuals utilize the political system. The individual is made better off, but society loses.
If we care about improving general well-being, we want to encourage the first type of wealth-creation, which entails production and exchange of things that make others better off.
Conversely, we want to discourage the taking of profits through theft or through the political system. This might seem like common sense, but it has important implications.
Our concern should not be with “excessive profits,” but rather with how profits are earned. Profits earned through voluntary exchange indicate that the producer has done a superior job in satisfying his fellow citizens.
Higher profits indicate better service of others. In contrast, profits earned through the political system indicate that producers are able to effectively lobby politicians.
Voluntary exchange and the resulting profits drive innovation and wealth creation. This benefits not just people in the U.S., but around the world. It is a mistake to view profits generated through productive activities to be harmful or excessive.
Instead, what should concern us are profits (regardless of the business or industry) that are earned through political relations.
Oil companies, like any other business, can earn profits in the two ways described above. If they are earning profits through voluntary exchange, their earnings represent a reward for effectively satisfying the wants of consumers.
If they are earning profits through political favoritism, then the solution is not more political regulation, but rather the removal of politics from the process.
When thinking about profits, it is useful to remember the wise words of Henry Ford: “A business absolutely devoted to service will have only one worry about profits. They will be embarrassingly large.”
What we need is not less profits, but less cronyism between business and politicians.
Christopher J. Coyne is the F.A. Harper Professor of Economics at George Mason University. Abigail R. Hall is a Mercatus Graduate Fellow in the Department of Economics at George Mason University.
