5. Profit and productivity

It is necessary to distinguish profit and economic growth. As our models are saying that without additional resources it is not possible to achieve profits long term, it does not apply to economic growth. Economic growth is possible to achieve even without making the profits. The growth in productivity enables increases in real life living standards, but must be fully passed towards buying power of people.

The relationship between profit and productivity documents the following scheme:

Let´s imagine a cooperative, where 10 people are baking breads. Their monthly production is 10 pieces and to ensure justice in distribution of duties and rewards they all agreed, that wage will be 1$ for each and price of finished product 1$ as well. So everybody who works his part will get salary which will enable him to buy exactly one bread and cooperative will achieve full sales. Sales are equal to costs, there is no profit planned.

This is an example where there is full realization of production, all that was produced will be sold. There are no losses from overproduction but no profit either. As redistributed buying power is of the same volume as planned sales, no additional resources are needed to achieve these sales.

Now let´s add category of profit.

There comes this smart guy with entrepreneurial skills and he says to our bakers: you have it very nice here, but you are working rather inefficiently. Sell this cooperative to me, I will introduce capitalism here which will be making profits and together we shall be working more efficiently. We shall be producing twice as many breads and you will be getting the same wage as today, that is 1$.

Sounds like a good proposition, does it not? Productivity will rise twofold, wages will stay the same so there should be mutual satisfaction and bakers should be better off. And so they agree and introduce capitalism. But capitalism asks for some profits, does it not?

Let´s say that by changing the character of economic system our businessman really manages to achieve better productivity, brings new technologies, improves organisation of work and production really increases twofold as he promised.

But how can be in this improved way of doing business achieved profit, how big it is going to be?
This depends from setting the unit selling price. The entrepreneur has four generic choices to make:

A)    The price will stay the same, that is 1$ per bread. In this case bakers will gain the same as before introduction of profits, they will be able to buy the same amount for their salaries, their buying powere will be not diminished and as set selling price per unit remains the same their needs will be satisfied at the same level.

The problem is what to do with the remaining 10 unsold breads. As our market represents  10$ (total buying power), there will be no more sales as there are no more buyers, that would be possessing additional buying power. 10 additionally produced breads will rot as there is nobody needing them. This represents problem of capitalism that is known as overproduction. We can see it every day. Hypermarkets are dumping tons of food every day because there is nobody to buy it, while there are countries where people are dying from hunger.

Such business result would please no businessman. If he were to achieve growth in productivity and managed to produce twice as many and achieved no profit he would be really unhappy. The additional production of 10 breads representing hypothetical profit of 10$ would never be realized, as there would be no additional buying power to make it so. The result of business in this case would be zero and consequently there would be pointless wasting of natural resources as to produce twice as many breads he would have to use twice as much ingredients.

Another subvariant ( in case of durable goods) is that this unsold production will remain in the warehouse.  Here comes the increase of balance sheet and anticipation of future sales in next period. However, as there is no more buyers in our little simulated economy, respectively all employess already spent all their wages we cannot expect from them any further sales in the next period. Their buying power will be restored only with next wages which anticipates also next round of production which is not going to happen. The already produced goods are still at the warehouse, there are no buyers and so instead of further production and wages what follows are layoffs. Production for warehouse is not a solution of this price variant.

The only salvation for businessman who sets price at his employees buying power level is to sell his overproduction in another economy, where there is additional buying power. This leads to expansion, globalization and colonial practises. The efforts to gain new markets is another of build in genes of capitalism, desperately trying to achieve profits. But this effort is at the global level not sustainable longterm. What is trying to achieve businessman in country X, is identical to businessmann in country Y. I shell describe this situation further in the chapter of international trade.

If there is no external economy where this overproduction could be realized, there must come to play the phenomenon of additional resources as transfers and loans. That way the buying power of citizens gets a boost temporarily but it is really only temporary fix which does not enable long term profit creation. Option, where missing buying power is replaced by loans looks like this:

In the first step the consumers will borrow 10$ and so will manage to make planned sales  20$.

In the second step the company will again produce 20 breads but buying power is no longer supplemented by loan. Indeed, it is the contrary. After its repayment at the amount of 10$ + interest (say 10% = 1$) the buying power will decrease to negative numbers. Employees are not only unable to buy any product ( all their wages are used to repay the loans) but they are at the minus caused by their inability to repay interest. Payed salaries, which are at full used to repay the loans represent a net loss for the enterpreneur, which he is at this stage not aware of. His planned sales will not be realized at all. Sales from previous year financed through loan will come back as boomerang in the form of totally decimated buying power.

Therefore the final bilance looks like this:

In total the enterpreneur gained nothing as with this strategy the profit achieved in the first year is fully offset with the loss, coming from paid wages in second year which are not transformed to buying power as these are in full used to repay the loans. As paid wages were at the level of 10$, the interest will not be repaid at all, there are no financial resources in the system for that. Bank will suffer a loss, which will manifest itself as write off of profits deposited by enterpreneur in the previous year. 

This model is showing that to achieve profit by financing consumption through loans is not possible, it is allowing only for cyclical boost in buying power which is subsequently followed by its decline and this decline is greater by amount allocated to interest.

B)    At price between 0,5$-1$ we are speaking about partial passing of productivity gains to employees. The result would be similar to 1$ in the fact that actually making profit without loan is not possible, only employees would benefit a little more. With price 0.7$ they are able to buy some 14.3 breads but 4$ in additional resources is still missing.

C)    If the enterpreneur would set the price at 0,5$ per unit of production, the planned sales would be at the level of available buying power but he would not achieve any profit.

This option is in full benefiting employees (full passing of productivity gains towards employees) but with zero profit for enterpreneur.

D)    By setting price below production costs, say 0,4$ it is obvious that the result would be a loss and the employees would have theoretically saved  2$ from their available buying power but the saving would remain really only theoretical as their wages would not be paid at full. The business with sales of 8$ would not be in the position to pay wages of 10$.
As options C and D bring no profit to enterpreneurs, they will not be used.