What Are Profits?
Harry Gunnison Brown
[Reprinted from the American Journal of Economics
Vol. 4, No. 3 (April, 1945), pp. 333-342]
FOR GENERATIONS -- certainly for well over a hundred and sixty years
-- economists have distinguished three types of income from the
productive process. These are income from labor, income from the
ownership of capital and income from the ownership of land. Income
from labor -- at any rate when the labor is hired by an employer --
has been called "wages." To the income from capital some
writers, e.g., Henry George, have applied the term "interest."
And the income received by way of the ownership of land has commonly
been called "rent" or, sometimes, "land rent" or "economic
It cannot be said that there has been any one generally followed and
unquestioned terminology. Economists -- and there are some-who use
both the term "rent"' and also the term "interest"
to refer alike to income from capital and income from land, may
strenuously deny that the usage referred to above is the prevailing
one. But something like this use of terms has been general enough so
that we may perhaps refer to it as more widely accepted than any
However this may be as regards "interest" and "rent,"
there is wide variation in the use of the term "profits."
And it may be worth while to inquire (1) whether any of the meanings
most frequently given to the term makes it helpful in economic
analysis; and (2) whether there is an advantage in having any such
term in addition to the terms "wages," "interest"
JOHN STUART MRLL defined "profits" as including interest on
capital, wages of management and compensation for risk. The same usage
was followed by Alfred Marshall.
As against this concept of "profits" the question at once
arises why we want to include wages of management along with interest
on capital in a single term. Wages of management, as such, are
received for work done. True, the particular kind of work is not of
the manual variety, but neither is the work of the accountant or the
clerk or of those junior executives whom the top executive hires.
Indeed, the top executive himself is pretty likely to be, in these
days of wide use of the corporate form of organization, an employee of
a corporation. To class together the returns on capital, received by
stockholders of (investors in) the corporation, and the wages (salary)
of a hired president or manager, under the heading "profits,"
would certainly be incongruous. Why should not the wages of the hired
manager be classed rather with the wages of junior executives,
accountants, clerks, artisans and other employees, since all of these
incomes are received for working?
Probably the economists who have defined "profits" so as to
include wages of management, especially the earlier writers, were
thinking of individually owned businesses rather than of corporations.
But, even if so, it still seems that the incomes received by business
managers by virtue of their managerial activities, should be classed
with other incomes that are received by virtue of work done rather
than with incomes received by virtue of ownership of capital (or of
If we should follow in the inclusion of some wages and some interest
in the term "profits" such writers as those referred to
above, why should we not include some land rent in that term, also? If
the return on his capital received by a man who is managing his own
business is thought of as "profits," along with that part of
his return which comes from his management (and which, presumably, he
would not receive if he hired a manager to do the work), why should we
not include also, as part of his "profits," the part of his
income that he receives by virtue of his ownership of land?
The tradition among economists is not to include this last in "profits."
But the individual business man managing his own little business
generally does so. Whatever he gains from his business over outlays
for his goods, wages for his employees and payments made for the use
of land and capital belonging to others, he is likely to refer to as "profits."
He will not usually make any separation of his own gains into income
from his labor, income from his capital and income from his land.
Actually, a part of his income is due to his work, managerial or
otherwise, for, if he did not work, his income would, in general, be
considerably less. Another part is due to his ownership of land. This
part he could enjoy even though he did no work, for potential tenants
would be found ready to compete with each other in offering him rent
for the use of his land. Still another part is derived from his
capital and this part, too, since others are ready to pay him for the
use of his capital, he could enjoy regardless of whether or not he
works. But instead of saying that he receives these three kinds of
income-which are conveniently referred to as wages for work, rent of
land and interest on capital-he is likely to call the total his "profits."
The individual who owns and operates a business is likely to think
chiefly of the net income from his business and to be interested
relatively little in tracing this total income to its various sources.
The term "profits" may involve as much analysis as he cares
to be bothered with!
But what if (say) his land and capital together could be leased to
another business man who would pay for their use $10,000 a year net
(in excess of depreciation), whereas he is himself able to make only
$10,050 a year from running his own business. That would indicate that
his managerial labor for an entire year adds only $ 50 to the income
he could enjoy if he did no work at all. It would presumably indicate
that he was wasting his time in work for which he was not fitted and
that he should either change to other work or, perhaps, devote his
time to other things than earning (or trying to earn) a living. Thus,
even to the individual proprietor who may imagine that he is not
interested in dividing "profits" into its economically
significant components, such division may be important as a guide to
BUT IF THE INDIVIDUAL business man, often, is not interested in an
inquiry regarding the different factors from which his income is drawn
and how much of his income is attributable or "imputable" to
each, the student of economics ought nevertheless to be greatly
interested. For such analysis is essential to an understanding of our
economic order and, especially, to an appraisal of its fairness.
Surely there is reason for distinguishing between an income which an
individual receives from work that adds to the total output of
enjoyable goods and, on the other hand, income which he receives by
virtue of holding title to a part of the earth. The latter kind of
income he could receive without work, merely by charging a tenant for
permission to use that part of the earth.
To inquire here on a specific question of public policy, may it not
be economically desirable to tax more heavily an income which owners
of land can thus enjoy merely for permitting others to work on or live
on the earth, than an income earned by productive labor?
There is a difference, too, between an income derived from permitting
men to work on the earth and to enjoy community-produced location
advantages and, on the other hand, an income from capital brought into
existence by means of one's own saving. As for the practical
application of this distinction, it should be noted that a high tax on
capital or the income from it may possibly discourage the saving
necessary to produce it or may cause the capital to be invested in
some other state or country where such a tax is not levied. But a
land-value tax will not decrease the total amount of land or cause
land to be transferred from one state or country to another!
Surely the student of economics interested in public policy cannot
afford to rest satisfied with the lumping together of wages and
interest and rent in a single term "profits." Rather will
such a student insist -- at any rate he ought to insist-on putting
into one class all incomes from land, whether derived from an
individual landowner's private business or paid to him by a tenant or
tenants or received in the form of dividends on the stock of a
corporation owning and using land. Such a student will -- at any rate
he should -- insist on putting into one class all incomes from capital
and distinguishing such incomes from land rent, even though the
particular owner makes no distinction and calls them both "profits."
And the student of economics will wish to class together also, for a
large part of his analysis, all incomes from labor, whether the labor
be managerial, "junior" managerial, clerical, statistical,
professional or manual.
But how about the view that "profits" include a "compensation
for risk"? Or the view that "profits" are nothing but
the excess gains from fortunate enterprises or in fortunate years
which compensate, more or less, for the losses from unlucky ventures
or in unlucky years?
If we are consistent in this use of the term, must we not say that "profits"
are so offset by "losses" that in the long run and on the
average there are really no -- or almost no -- net "profits"?
In other words, may it not be that, on the average, the returns from a
business will just about equal the ordinary or normal rate of pay for
the capital, land and labor devoted to it?
If we are to make a special point of income received as compensation
for risk" in the case of a corporation or other business concern,
should we not do likewise in the case of the salesman who works on a
commission basis? For he, too, is "compensated" for his "risk"
of having inadequate income at certain times, by his chance of having
appreciably larger income at other times. The fluctuations of his
income, in other words, are not entirely or, perhaps, at all, the
result of fluctuations in his effort, concentration and skill. Shall
we then call the excess income of his lucky weeks or months his "profits"?
Indeed, even the employee who is paid by the day, week or month, may
be said to assume some risk, for example, the risk of periodical
unemployment, the risk that failure of the employing concern will
leave him minus some of his accrued wages, or the risk that his
employer or some hired executive will abscond with the payroll,
leaving the company without means to meet its wage obligations. Shall
we then say that a small part of every worker's wages ought to be
regarded as "compensation" for the "risk" that he
will not continuously receive his full regular wage, and that this
part should be separated in thought from the rest and be considered
not as wages at all but as "profits"?
And how about the income received by the owner of a bond? May we not
regard a certain part of this income as "compensation" for
the "risk" that the full return promised, or possibly, even
any return at all will not be realized? If so, just how much of the
income received shall be thus reckoned separately from the rest and be
classed with "profits"?
The truth is that there is risk in all the relations of life,
including all the relations of business. Every type of income is
subject to some possibility of fluctuation or irregularity, whether it
be income from labor or from capital or from land. But to pick out a
part of the income from each such source and put all these selected
parts together under the heading "profits," tends to divert
attention from the problem of the source or sources of the income. It
tends to confusion in any attempt to attribute incomes to their
respective sources, whether in productive contribution or in
The choice of terms and of the meanings to be attached to them should
be made in the light of the problem or problems we are seeking to
solve. We should select and define our words with a view to
emphasizing-not to blurring-the distinctions which need to be clear to
us if we are to discover the cause and effect relations we seek and
thereby further the adoption of wise and just policy.
IF WE CONSIDER "profits" as excess gains the possibility of
which compensates for the risk of suffering losses, then we are
directing our attention primarily to the fluctuations in incomes. If,
indeed, it is the up and down fluctuations and, in general, the
variations from the norm or average, rather than the average and
normally-to-be-expected income in each industry and from each source,
in which we are interested, this use of the term ""profits"
is relevant. But it is hardly relevant to an inquiry which would trace
incomes to their sources in the so-called "'factors of
production," viz., labor, land and capital.
Suppose we wish to examine critically the socialistic view that all
incomes from property are unearned. We shall get no help in this
venture from a demonstration that, in pro- portion as demand for a
particular commodity is inconstant or unpredictable, the income from
the capital used in its production is likely also to be inconstant or
unpredictable, with the chance for gains above the average per cent
off- setting the chances of lower than average gains and of positive
Or suppose we are interested in a study of the rent of land. Suppose
we are considering the fact that land rent is received from
geologically-produced and community-produced advantages for which some
men are allowed to charge other men. Suppose we are inquiring, then,
whether land rent thus going to particular individuals is not really
unearned. Suppose the question is raised whether the rent of land
differs from both interest on capital and wages of labor, because it
is not paid for any equivalent service rendered. Suppose, in short,
that we are seeking to test incomes received by their relation to
functions performed. Surely, in that case, we shall get no light from
the fact that what a tenant agrees to pay for the use of a piece of
land is sometimes a fixed amount and sometimes a proportion of the
output. In the latter case, a few writers might regard the
above-average income of the landowner from his land, which he receives
in good years, as "profits." But both the above-average
income of good years and the below-average income of poor years he
receives by virtue of his ownership of land and not by virtue of his
doing productive work or of his owning capital brought into existence
by work and saving.
In the voluntary agreements of business, it is customary for some
persons to assume the major fluctuations in income and thereby
guarantee, to some extent, more constant income to others. Thus, if
the owner of land and capital hires a manager to operate the business
in which they are used, he will probably agree to pay this manager a
definite or constant wage ("salary") during some agreed
period. He then accepts for himself a somewhat fluctuating and
unpredictable rent from his land and interest from his capital. But
if, on the other hand, the manager hires from the owner the land and
capital to be used in the business, the conditions are reversed. The
rent paid to the owner for his land and the interest on his capital
are agreed upon in advance. They are constant or definite (barring
business failure by the manager, or some kind of fraud) while the
wages (though he may call them "profits") of the manager
take the unpredictable fluctuations resulting from the changing
circumstances of demand, "cost," etc.[ 3]
Or, again, the owner of a piece of land may be promised a definite or
constant rent by a person (or a corporation) undertaking to construct
buildings and other improvements to be used with the land in some kind
of production. The owner of the improvements may hire workers for
definite or constant wages. His own income-interest on his capital --
is then subject to fluctuation and may be more than the usual per cent
return on capital, or less, or he may lose some of his original
investment. And if, instead of hiring a manager to operate the
business to which his capital is thus devoted, he manages the business
himself, then he receives unpredictable or fluctuating wages as well
as unpredictable or fluctuating interest on his capital.
Still again, such a tenant may borrow part of the needed funds to
construct the capital, providing the remainder from his own savings.
If he does so, then the interest from his own capital used in the
business is unpredictable and subject to fluctuation while the
lender's interest and the landowner's rent are, both of them,
relatively constant and predictable.
By means of these various agreements, freely entered into in the
operation of the system of free private enterprise, some accept
relatively fluctuating and uncertain rent or interest or wages while
others arrange for rent or interest or wages that are relatively
constant and certain. But the fact that some accept more risk than
others does not change or in any essential respect weaken the argument
for distinguishing among the various incomes on the basis of whether
they are due, respectively, to the recipients' labor, to their
ownership of capital that has been brought into existence through work
and saving, or to their ownership of part of the earth. If the use of
the term "profits" diverts attention from such a functional
analysis-and often, I think, it does-it may seriously interfere with
the development of a general under- standing of what is most
fundamentally awry in the division of the product of industry among
the various contracting parties concerned with it.
- Even though a corporation is
run, in the main, by a hired president or manager, the
stockholders-at any rate some of the larger stockholders-may
participate in management, as through attendance at stockholders'
meetings. It may be contended, therefore, that some small part of
their dividends should be reckoned, in strict theory, as "wages"
- Because it involves something
of a digression from the main theme, I am not including in the
text above any analysis of the excess gains of monopoly. Such
excess gains may accrue to labor, if one or more persons are
protected by labor union or governmental or other restriction
against the competition of other workers in the particular
occupation. They may accrue to the owners of capital, if the
capital of rivals is in a similar manner excluded from the
particular industry, e.g., by the threat or actuality of unfair
competition on the part of the would-be monopolist. And they may
accrue to the owners of land, if other land is forcibly kept out
of the particular line of production, as by the quota restrictions
in the Agricultural Adjustment Act or by the threat of unfair
competition, or if, through complete monopoly by one company or
monopolistic collusion among several companies, the number of coal
or copper mines or oil wells in use is restricted so as to hold
down output and thus hold up price. The excess gains of monopoly
may be, therefore, excess wages or excess interest or excess rent
or any two or all three of these. If this fact is kept clearly in
mind, there is perhaps no objection to referring to the excess
gains of monopoly as monopoly "profits." But then we
should logically, it would seem, use the expression "monopoly
profits" for the excess wages paid to workers in a trade
where, by limiting the number of their competitors, e.g., through
limitation of apprentices, the workers in control of the trade are
able to command higher wages for their labor than would otherwise
be possible to them; or else we should distinguish between (say)
corporate "monopoly profits" and labor "monopoly
profits." And in thus referring to the "monopoly profits"
of labor, we are including in "profits" incomes that are
almost invariably thought of, spoken of and written of as "wages"!
But it is certainly important to distinguish between incomes
earned in fair competition and the excess (and Unearned) gains of
monopoly, whether these excess gains accrue to capitalists, to
landowners or to workers.
- The continously larger than
average returns to the superior manager are, of course, to be
regarded as wages and mirror such a manager's superior