Dr Harper is a member of the staff of the Foundation for Economic Education.
Much ado is adrift about profit sharing, or more specifically the extent to which employees should share in profits. How can a sound decision be arrived at? What is the principle involved?
The first step is to separate the matter of profit sharing from separate issues with which it is commonly confused. For instance, a business may be in trouble with employees through some fault of one or the other. A strike may be threatened or in progress. Employees’ demands are resisted by the employer until appeasement is resorted to in order to try to continue production. The employees, in fishing for favors, may include profit sharing as one form of bait, along with things like a new bowling alley, vacation trips to Florida, or what not. When this happens, profit sharing is not being judged on its own as a matter of principle, but purely as a device for appeasement — not the object of this analysis.
The claim of employees to a share in the profits may arise as a diluted form of the Marxian theory of surplus value. This theory asserts that all the product belongs to the employees who use the capital; that none of it belongs to the owner of the capital per se. One who really believes in this surplus value theory should be opposed to any profit sharing plan, because it compromises his belief that the user of the tools has a proper claim to all the profits, not just a share in them. Why should he allow the owner of the tools to have any of the profits, under this belief?
And furthermore, how can it be claimed, under the surplus value concept, that the immediate users of those particular tools should get all the profit, as against other users of other tools contributing to the task? If the theory has validity, shouldn’t the profit be shared with all the other employees elsewhere who produce goods and services purchased by this particular firm — those who made the steel it bought, those who supplied the electricity and telephones used, etc.? So even according to the surplus value theory, profit sharing in the form usually proposed has no validity.
Others who argue for profit sharing will concede that capital owners deserve some reward for their services, but they will contend that the profit should somehow be shared with the employee "partners in production." Shared how? Half and half? Or some other proportion? The only way such questions can be answered is to pin down the basis for the claim. Who has a valid claim to what — on what grounds, and how much?
Profits and Ownership
Before a thing can be shared, it is first necessary to know its precise nature and amount. What, precisely, are profits?
In business accounting, profit is the amount remaining for the owner out of his income for the period, after providing for all costs other than return for owner capital.¹
Profit sharing from the standpoint of justice, then, leads basically and at the outset to the question of ownership. This can best be seen in its essence by looking at a simple case. A helpful place to start is with a single person who, as a private owner, is producing something without the help of any employees.
Josephus Doakes, let us say, produces potatoes and sells them on the local market. His own time spent on his own land is all that is involved in their production; no employees; no other production expense. He takes a bushel of his potatoes to the local market and sells it for $2.00. Who can question the fact that since he owns both himself and the land, he thereby has an undisputed claim to the entire $2.00 derived there from? Since nothing else went into its production, nobody else has any valid claim to any of the $2.00. Each of the 200 cents is his without distinction between the first cent, the hundredth cent, or the two-hundredth cent. Valid claims cannot be made by others, to either certain cents among them or to any proportion of the whole. For to do so would violate Josephus’ rights of private property as a free man — as much, in principle, for one cent as though someone were to claim the entire $2.00.
Now let us assume that Josephus retires to the status of a landowner-manager, hiring Alonzo Brown to perform all the labor of growing and marketing the potatoes. At the outset the two men bargain for a wage. Josephus offers to pay him either on a piecework basis — so much for each bushel of potatoes he grows and markets — or on an hourly basis for the time worked. Alonzo chooses the hourly wage plan. Then they bargain for the hourly amount. Alonzo looks around at all the other jobs available and finds that the best he can do elsewhere is $1.50 an hour (a figure Josephus probably does not know, however). Josephus looks around to see what other help he can hire, and finds that it would cost him $1.90 an hour (which Alonzo probably does not know either). Let us say that when the bargaining is settled and a wage arrived at, it is $1.70 an hour. It turns out that at the end of the season Alonzo has produced and marketed an average of one bushel of potatoes per hour of work. The bushel of potatoes will still sell for $2.00 as before, since its worth to consumers is not altered by details of the production arrangement about which consumers know — and care — little or nothing.
The Owner Bears the Risk
From the standpoint of ownership, the potatoes till sold were, of course, the complete property of Josephus, just as if he had done all the work himself. Who could argue that the full $2.00 of sale proceeds does not also belong to Josephus, as before? This is clear if one realizes the nature of the agreement between the two men. Josephus agreed to pay Alonzo $1.70 for the time he worked. He did not agree to give him a proportion of either the potatoes or of the sales proceeds. The wage claim of $1.70 stands against Josephus — all his property and income alike, other things as much as the potatoes. The $1.70 is owed whether the potatoes bring $2.00 or some other price — is owed, in fact, even if the potatoes cannot be sold at all or if they were to be destroyed by a flood on the way to market.
The point is, so far as property rights are concerned, that the entire product belongs to Josephus until sold, irrespective of whether he produced it himself or hired someone to assist him in its production; that from the standpoint of property rights, ownership is entire and indivisible. Nobody working to assist in its production has any claim to it whatever, so long as the owner fulfills his contract as to the wage payment that had been previously agreed to. And if the wage has not been paid in full, the claim is against all the owner’s property equally with all other unpaid claimants such as the telephone bill, the utility bill, the family physician’s bill, or what not. There is nothing peculiar or preferential in the employee’s claim, as against any other item of expense.
The Profit Sharing Idea
We may now test the profit sharing idea against this background of the nature of profits and of ownership’s rights. Using again the instance where Josephus hired Alonzo at a wage to produce potatoes on his land, let us suppose that it is now argued that Alonzo, in justice, has a right to some share in the profits.
Since from the standpoint of ownership the so-called profits are an indistinguishable part of the entire bushel of potatoes or of the $2.00 for which they were sold, Alonzo has no valid claim to any part thereof so long as he has been paid his wage, according to the original agreement. Alonzo owns no part of them, any more than does any outside person. There is no way to arrange priorities of rights to ownership among persons, all of whom lack any such rights; and so the employee has no right to any of the profits with priority over anyone else.
And if, by some reasoning that wholly escapes my imagination, one were to argue that under private property Josephus should be forced to surrender some of the $2.00 to someone else, it would seem reasonable to argue that Alonzo should at the time of the distribution take his place in line with all other living humans. The mere fact that Alonzo happened to be closer at hand as a workman should give him no priority in rights over the telephone operator, or the engineer on the railroad, or some distant Asiatic infant.
It is therefore irrelevant to go into the complex question of how one might calculate fairly the amount of the profit that Josephus should divide with Alonzo. But let’s see what one gets into if he tries. In the instance cited, 30 cents was left over after paying Alonzo’s wage for the time he spent in producing the bushel of potatoes. Was there in this instance a profit of 30 cents? And $2.00 profit, by similar reasoning, when Josephus had done all the work? Are we then to conclude that Josephus could increase his profit by $1.70 if he did all the work himself rather than to have hired Alonzo? Or if not, what is the "profit" to be shared?
The point is that no matter how the accounting is resolved for purposes such as a corporate financial report, or income tax accounting, it does not alter the rights of ownership—Josephus owns the bushel of potatoes until it is sold, and Alonzo owns the $1.70 of agreed wage. And Josephus happened to have 30 cents left as a residual for the use of his land and for his management — call it what you will. Alonzo’s right was limited to the $1.70 wage, because he had chosen its certainty rather than the uncertainty of a residual.
Suppose there had been a loss of 10 cents instead of a profit of 30 cents; would Alonzo then claim a share in the loss? Loss sharing is the other half of profit sharing. There is as much or as little of justice and rights in one as in the other. I would say that for the situation described here neither is justice; that the wage was separately and validly agreed to as $1.70, leaving the loss as well as the profit for Josephus alone to own.
Then there is the point that Alonzo had a profit, in a sense, as part of his $1.70. The best job he could find elsewhere would have paid him only $1.50, so Josephus was paying him a benefit of 20 cents above what anyone else would offer. If the profit sharing argument were valid, should Alonzo share his 20 cents with Josephus, and Josephus share his 30 cents with Alonzo?
Whenever one departs from strict adherence to the concept of ownership in the form of personal property rights and contractual obligations, he will have constructed a seemingly unsolvable problem. The tests to be applied are those of property and of contract. However calculated, to whom does the profit belong? Is his title valid and complete? What contractual obligations were made? Have they been met in full? These are the questions to be asked. And when they have been answered, justice already will have been identified.
Profit Sharing as a Wage
So far we have been speaking of a contracted rate of pay, which is almost universal in our economy. Another approach to profit sharing is to have "profits" made a part of the wage, when arriving at a wage agreement. In other words, if we were to adapt the potato project to such an arrangement, Josephus and Alonzo would
not agree on a wage of $1.70 but would agree on some amount to be derived from the records of account after the potatoes have been sold and other costs determined — on some proportionate basis thereto. Payment by such a plan might become Alonzo’s entire reward, or it could be made a part of his wage to supplement a base pay per hour lower than $1.70.
Though such an arrangement is perfectly proper, it is erroneous to call it profit sharing. For if profits are the amount remaining to owners after payment of wages and other costs, it obviously can’t at the same time be a figure which includes some of the wage to be paid. A name — even "profit sharing"— does not change the animal. A wage is a wage, not a profit. Profits can’t include nonprofits. And profits are something over and above all wages, accruing to the owner for his ownership.
Basing a wage in part on the financial results of the over-all operation should be referred to by some name other than profit sharing. It is as correct to call it cost sharing as to call it profit sharing. Why not speak of it as merely one form of wage payment, without any fancy name? That is what it really is.
As to whether the employer and the employee want the wage determined this way or that, they will have to decide on a plan and a rate at the outset and whenever wages are reconsidered. Perhaps they will agree on an hourly wage to be paid at the end or at the beginning of each day, or weekly, or monthly; it may be on a piecework basis; it may be some proportion of the outcome of the market venture in general; it may be some combination of these, together with wages in the form of more bowling alleys and picnics for employees, or De Luxe soap in the washrooms. Whatever the design of the wage plan, it will be valid if it is proper and agreed to by both parties to the employment. But however arrived at as to form, it is still all a wage and not profits.
I do not see how any form of wage payment — including this —can be said to be wrong in principle, provided it is understood in advance by both parties and voluntarily agreed to without coercive force. That goes for what is erroneously called a "sharing in profits" by nonowning employees. One may question this or that plan on the basis of its wisdom, or its effectiveness for purposes of efficiency, but he cannot question it on the basis of rights.
True Profit Sharing
There is only one way by which an employee may share in the profits of the business where he works, and that is by becoming a part owner. To do this he must invest capital in the venture, as would any nonemployee owner, thereby becoming a sharer in any profits and losses along with the other owners. But when he does this, he becomes a dual personality economically; he profits as an owner, as well as benefiting through the wage he receives by working for his owner self. When he does this, he enjoys profit sharing as a result of his owner function, not as a result of his employee function. It is not a method for profit sharing with employees as such, but is instead merely profit sharing with some new owners who happen also to be employees.
Ownership by Employees
It is not the main purpose here to appraise the wisdom of an employee owning shares in the business in which he is employed. But in favor of his doing so might be mentioned its effect in revealing a harmony of interest that should be evident between owner and employee. This becomes more vivid to the employee if he owns a share in the business. He is then less likely to engage in the common processes of economic suicide, typical of labor unions whose activities seem to rely on maintaining a chronic state of civil war between the forces that must cooperate if they are to live economically.
A point against employee ownership in the business, on the other hand, is that when his savings are thus invested, the employee’s total risk is enhanced. For instance, if all a person’s savings are to be invested in ownership of the business where he is employed, lack of orders leading to his being laid off or losing his job will come at the same time when dividends are likely to be reduced or suspended. He would lose both ways at the same time. So instead of his savings being a backlog of income available in time of adversity, they become an even more vulnerable object of the same adversity. Perhaps he will even have to sell his shares of ownership at especially depressed, sacrificial prices in order to tide him over the adversity.
Perhaps an employee’s savings should be invested elsewhere in some form more safe and stable than his job — at least in some form not acutely vulnerable to the same adversities which affect his job. It would seem far better to place his savings where they are not so likely to suffer adversity at precisely the time when he will need reserve income. This severence of the two is hardly possible, of course, in a small self-owned, self-managed business wherein the advantages may justify the risk involved.
The more savings the employee has, of course, the more risk he can afford to take — the more safely he can put a part of his savings in the business where he works, as well as elsewhere. To the extent this can be done with safety, the more there will be true profit sharing at its best.
Profit Sharing Inherent in Capitalism
A discussion of profit sharing seems hardly complete without at least mentioning a form of employee benefit already existent throughout our entire economy to an amazing extent. It is a byproduct of the capitalist system of private ownership and free exchange. Though it is not participation in profits in the usual sense of that term, it is participation in the benefits that flow from savings and invested capital, and it goes widely to the users of the tools. It is, in other words, precisely the same sort of thing aimed at in the Marxian theory of surplus value, only it is the user primarily rather than the owner of capital who is really getting the "unearned" benefit. The idea, briefly, is as follows:
As a consequence of the savings of capital invested in the tools of production in the United States, it has been estimated that as much as a nineteenfold increase in output has resulted, in contrast to what the same person would be able to produce if he were to work equally hard or even harder without the aid of these tools.² Looked at in this light alone, it can be said that as much as 95 cents of every dollar of production in the United States now is a consequence of savings that have been invested in tools — savings and investment primarily by others than the employees hired to operate them. One might say that this amount deserves a description usually affixed to profits, in that it arises out of the production made possible by the savings and tools; that otherwise the enhanced production would not be there even if the same laborers worked equally hard without any such tools.
The other 5 cents of the average person’s income dollar, then, can in this sense be said to be a just wage for effort exerted, if we were to measure justice by what it could produce in the absence of these tools.
But when we look at the economy from the standpoint of who gets the fruits of production, we find that the owners of capital get only 15 cents instead of the 95 cents; that users of the tools get 85 cents instead of the 5 cents. Of the "profit" figure measured in this way, then, the users of the tools are already getting 80 cents out of the 95-cent amount which the tools make possible; the owners get the other 15 cents. That is a sort of profit sharing, if one wishes to think of it in the sense of a profit which tools make possible — an automatic consequence of a capitalistic, free exchange economy.
The fruits of this form of profit sharing go to the labor force of the entire nation, more or less alike and without discrimination, rather than just to the employees of a selected individual plant or business. In a degree, it goes to the labor force of the entire world, too. If we want the benefits of production to be widely dispersed, we get it under a system of private property, individual enterprise, and free exchange as a sort of automatic consequence of the free decisions of all participants. It is "profit sharing without special privilege," one might say, with opportunity for all.
Footnotes1. This differs from a concept of profits in theoretical economic analysis which uses the alternative opportunity cost for all factors of production. Whatever else may be said for it, the alternative opportunity concept is not one that a business accountant can use to measure profits as they are considered for this purpose.
2. "The Greatest Economic Charity" by F. A. Harper in On Freedom and Free Enterprise edited by Mary Sennholz. Princeton, New Jersey: D. Van Nostrand Company, Inc., 1956. pp. 94-107.
Ideas On Liberty:
The Dreaded Corporation
I do not dread these corporations as instruments of power to destroy this country, because there are a thousand agencies which can regulate, restrain and control them; but there is a corporation we may all dread. That corporation is the federal government. From the aggression of this corporation there can be no safety, if it is allowed to go beyond the bounds, the well-defined limits of its power. I dread nothing so much as the exercise of ungranted and doubtful powers by this government. It is, in my opinion, the danger of dangers to the future of this country. Let us be sure we keep it always within its limits. If this great, ambitious, ever growing corporation becomes oppressive, who shall check it? If it becomes wayward, who shall control it? If it becomes unjust, who shall trust it? As sentinels on the country’s watchtower, senators, I beseech you watch and guard with sleepless dread that corporation which can make all property and rights, all states and people, and all liberty and hope, its playthings in an hour and its victims forever.
Benjamin Harvey Hill, United States Senate, 1878