by Barry A. Liebling
In the Fall of 2005 when major oil companies reported record high quarterly profits a swarm of anti-free-market zealots – including leftists, populists, and conservatives – expressed their outrage and demanded that the oil companies be punished. Proposals for how to penalize the firms that made “excessive, unconscionable, exorbitant” profits are varied. A popular cable talk show host proposed that they “voluntarily give back 25% of their profits.” Several United States senators have called for a windfall profits tax where the proceeds would be used to finance welfare programs, including energy subsidies for low income consumers.
The significance of the attacks is not fundamentally about petroleum but about the right of the individual to seek and keep a profit. The primary reason to get into any business is profit. You take a course of action because you anticipate the benefits will exceed the costs. If you act ethically, you deserve all the profit you make and owe nobody an apology. If you engage in business and do not make a profit you have not succeeded. If you consistently fail to profit you are wasting your time and should switch to another business.
These points are often lost on those who attempt to champion free markets and oil companies. Instead, when the “confiscate exorbitant profits” mob attacks, the defenders typically employ two arguments that are seriously flawed.
The first defective approach is to deny the oil companies’ success. The defender asserts that the critics are mistaken – oil companies do not really make high profits. Attackers are using the wrong statistics when they accuse the industry of enormous earnings. Typically, the foes of oil companies point to the absolute profit – more than $10 billion – and say that no enterprise should be allowed to make so much. The defender counters by asserting that $10 billion is not the relevant number. You have to consider profitability – how many dollars were made compared to how many dollars were invested. By that measure other industries – perhaps entertainment, pharmaceuticals, software – performed better than the petroleum industry. And there are alternative indices of profitability. Some defenders point to profit as a percentage of total sales and maintain that several industries are more profitable than oil.
The mistake in arguing that oil company profits are not particularly high is that it caves in to the anti-free market view that profits can be too high. The defender concedes that profits might be exorbitant, but is hoping to show they are not. What if the statistics were different? Suppose the petroleum sector turned out to be more profitable than other industries. The defender has painted himself into a corner. He would have to say, “you caught me, oil companies are very profitable, and that is troublesome.”
The second defective approach is the argument that oil companies should keep their profits because profits are incentives. The “defender of free markets” points out that profits motivate petroleum companies to produce more oil. If these incentives were reduced – profits curtailed – less oil would be available at even higher prices. The economic analysis of incentives is correct. More potential profit in oil will attract more people to the business, will encourage higher levels of investment, and will result in more plentiful oil at lower prices.
The flaw in the incentives argument is that it misses the ethical point – that when you do business properly you deserve any profit you make – or any loss you incur. In a free society profits and losses are a natural consequence of individual choices and voluntary trade. It should not be the role of the government to decide – or to tamper with – the profits in any particular business.
The argument that profits are justified because they incentivize production can be used for mischief. At some future date when the price of petroleum products is lower, a meddler could contend that it is no longer necessary to incentivize the petroleum industry so generously. He might propose lowering incentives and taxing “surplus profits” to fund “socially responsible” programs.
Defenders of the free market should stick to basic principles in debates. Oil companies – like all businesses – are entitled to all of their profits providing their business practices are ethical – they are acting honestly and dealing by mutual consent. Of course, in any industry scoundrels can emerge – behaving mendaciously and using coercive force. But even in this case confiscating a portion of the profits is not the right course. A villain does not deserve any profit.
*** See other entries at AlertMindPublishing.com in “Monthly Columns.” ***