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Society benefits from private enterprises, argues Ann Bernstein in an extract from her book.

UNDERLYING much of the pressure on business is a misunderstanding of what companies are there for, and how their contribution to society can best be measured. This is the notion that making profits for shareholders is immoral, or at best amoral, and that a company can only meet its social responsibilities by doing other things beyond its profit-making role. This perspective fails to appreciate the role of profits in market-based activity.

The value people place on the goods and services they obtain from various companies is demonstrated by what they are willing to pay. The costs of producing those goods and services are a measure of what society has to surrender to consume some of those products. If what people pay exceeds the cost, society has gained, and the company has made a profit.

“So profits are a guide (by no means a perfect one but a guide nonetheless) to the value that companies create for society.” (The Economist 2005). They perform a signalling function. If an enterprise does not make a profit its survival requires remedial action – change product or production process or location; pay less; or lobby for a change in laws, regulations or taxes. The permutations are endless, and keep business schools fully occupied, not to mention competing entrepreneurs. Without the profit motive the process of learning through market success or failure – one of the mainsprings of wealth and innovation – would not take place.

Many critics fail to appreciate another dimension of profit-making. They see a company’s results for one year and assume that its declared profits are paid out to shareholders or owners. They do not allow for the investments that all companies need to make – in research and development, employee training, capital equipment, restructuring – to ensure that they remain competitive.

Those who see the pursuit of profits as a symptom of greed not only fail to understand their role in the market system, but ignore the “moral benefits” of self-interested economic activity. Greed and profit are different concepts, as are greed and self-interest. The kind of self-interest that advances the public good is rational. The calculation of self-interest makes a firm or manager worry about its reputation for honesty, fair dealing, paying debts, and honouring agreements. Such companies look beyond the short term and plan ahead, sacrificing in the present for the sake of gains in the future.

These are all important individual and civic attributes. Entrepreneurs make good neighbours because they protect their assets, look after their “shop”, want a crime-free neighbourhood for themselves, their employees and customers (Sternberg 2000).

Companies are often criticised for exploiting workers, and making excessive profits. Thus, if a designer jacket sells for $190 in New York while the worker abroad who sews it gets only 60 cents an hour, this is regarded as a prime example of exploitation.

But, as Jagdish Bhagwati (2004) has pointed out, there is no necessary relationship between the price of a specific product and the wages paid by a company in order to produce it. For every jacket that sells, nine may not, so the effective price of a jacket is $19, not $190. Moreover, duties and distribution costs almost double the price of a jacket between the time it arrives in the US and finds its way to department stores.

Critics claim that multinational corporations earn huge “monopoly profits” while paying their workers minimal wages, and should share those “excess profits” with their workers. But, far from enjoying a monopoly, nearly all multinationals operate in increasingly competitive global environments.

Even though companies pursue profit, this should not be interpreted to mean that they profit at the public’s expense. The magic of competition and markets are that they enable consumers and society to benefit from the self-interested activities of private enterprises.

Consider what would happen if companies did not try to make a profit. They would soon go bankrupt, and the jobs and products they create would disappear.

The Case for Business in Developing Economies is published by Penguin Books, available at all good book stores