The Supreme Court’s answer to the presidential reference contains the following observation: “When such a policy decision is not backed by a social or welfare purpose, and precious and scarce natural resources are alienated for commercial pursuits of profit-maximizing private entrepreneurs, adoption of means other than those that are competitive and maximize revenue may be arbitrary and face the wrath of Article 14 (right to equality) of the Constitution.” That could upset a lot of folks.
The court seems to have made a distinction between “a social and welfare purpose” and “the commercial pursuits of profit-maximizing entrepreneurs”. For the man in the street, this is no surprise. Profit-maximization and greed are often seen as synonymous.
Not so, however, by economists, who may get their knickers in a twist over the court’s observation. There are good reasons for their angst. Perhaps, the most famous quotation in economics is the one about the “Invisible Hand” from Adam Smith’s Wealth of Nations: “As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.”
Simply put, the father of modern economics is saying here there’s no distinction between profit-maximization and social welfare. It is precisely through maximizing profits, or “pursuing his own interest”, that a person does the most for society.
The argument is simple. It is only the business that maximizes its profits that is using scarce resources the most efficiently and is, therefore, the most productive. The surplus that an efficient business produces can be used for growth which churns out more goods and services, increases consumer satisfaction, fosters technical innovation and creates more jobs. Does all this not promote social welfare? And if businesses do not grow and prosper, where will the money come from for the government’s social welfare measures?
Profits are what drive growth in a capitalist economy. That is why tax concessions to companies are invariably called incentives, while lower prices to consumers are called subsidies. The Union budget documents show that net revenue foregone in direct taxes for corporate taxpayers in 2011-12 was Rs.51,292 crore and for excise duties it was Rs.212,167 crore. Nobody raises a stink about it, except the Communists, although the budget document explicitly says the revenue foregone “may be viewed as subsidy payments to preferred taxpayers”. Most people swallow the line that these sops are needed to help businessmen create more goods and services and more jobs.
The Adam Smith quote also says that by trying to maximize his own gain, “every individual necessarily labours to render the annual revenue of the society as great as he can”. Is this not the revenue maximization the court is talking about?
Of course, nobody would argue that the government should gift away natural resources, which can then be used to make windfall profits by its cronies. Instead, economists would probably claim that the best way to sell natural resources is by some form of competitive tendering, allowing the price to be set by the market. If the government feels it needs to subsidize telecom or power or whatever, the way to do that is through the budget. That way, you don’t interfere with the price signals. But who will decide whether the purpose is social welfare or maximizing profits? That could leave the door open for plenty of litigation.
Why is popular perception about profit maximization so different from that taught by economists? Simply put, reality is very different from Economics 101. There may be collusion between producers to keep prices high, about which Adam Smith has also warned; there may be monopolies; wants and needs are often the creation of advertisers; and consumers may be far from rational. The real economy is very different from the textbook version. In fact, reactions to free market economics varies widely according to ideological predilections, with some like Austrian economist Friedrich Hayek singing hosannas to free markets while radicals such as Mikhail Bakunin believed that property is a god and has its metaphysics, economics being that metaphysics.
What is interesting is that the judges of the Supreme Court do not seem to share the views of economists about there being no distinction between maximizing profits and social welfare. But that may astonish only economists. Indeed, in light of recent events, it would be quite a stretch to argue that the behaviour of profit-maximizing banks in the West has been perfectly aligned with the welfare of their people and their economies.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at email@example.com.