Friday, September 20, 2013

Chapter 1 - Profit Management

In the Introduction of Bureaucracy, Mises presents two ways to conduct the politico-economic affairs - profit and bureaucratic managements. For him, the choice between bureaucratic and profit managements is inseparable from the choice between socialism and capitalism. In the first chapter of the book, we will explore Mises' understanding of profit management under four sections - basic operation of the free market, economic calculation, the nature of profit management, and the nature of managing personnel under the profit system. 

1. Basic operation of the free market. Mises provides the meaning and goal of the free market. He understands free market as a "system of social cooperation and division of labor that is based on private ownership of the means of production" (p. 20). Profit is the goal in this system. 

One important feature of market economy is the sovereignty of consumers. They are the real bosses. They don't care about the track record of the company or of the entrepreneur. Their only concern is the present quality and lowest price of the product they are buying. And that is why business efficiency is measured by profit and loss, which is dependent on the decision of the consumers. Mises describes this mechanism as "economic democracy in which every penny gives a right to vote" (p. 21).

2. Economic calculation. In order to appreciate the importance of economic calculation, one must first grasp the significance of market prices and the origin and nature of profit. Market prices exist together with private ownership and profit motivation. However, bureaucratic management opposed these two basic foundation of the free market. Socialists think that maintaining them is detrimental to national interest. For Mises, this kind of mindset is prevalent among totalitarian governments: "It has been frequently objected that this orientation of economic activity according to the profit motive . . . . leaves out of consideration the interests of the nation as a whole and takes account only of the selfish interests of individuals, different from and often even contrary to the national interests. This idea lies at the bottom of all totalitarian planning. Government control of business, it is claimed by the advocates of authoritarian management, looks after the nation's well-being, while free enterprise, driven by the sole aim of making profits, jeopardizes national interests" (p. 23). 

This is one major difference between socialism and capitalism and at the same time between bureacratic management and profit management. No economic calculation exists under socialism and bureacratic management due to the absence of market prices, which serves as the common denominator among various factors in the economy. Without the market prices, there is no way to account the diverse skills of the large number of manpower, physical properties of material factors of production and the consideration of different places where these material factors are available. So without the market prices, the planners are blind. 

Concerning profit, it originates in an economic situation that is constantly changing. Without this change, the idea of profit is alien and also in such a world, there is no need for an entrepreneur. This is so simply because an entrepreneur is always seeking for an opportunity to make a profit. As soon as the entrepreneur realizes that the anticipated price of a certain commodity will be higher than the production cost, he takes advantage of it. If the entrepreneur is correct in his assessment, he gains a profit; but if he is wrong he suffers losses. This is the real world of the free market. 

However, profit for a certain commodity does not stay for so long. It starts to disappear when "the prices of the factors of production . . . go up and, . . . those of the products begin to drop" (p. 28). So profit occurs due to "change in market conditions and in methods of production" (ibid.). 

Moreover, in the ideal world where the economic situation is permanent, both entrepreneurship and profit have no place. And without entrepreneurship and profit motivation, market prices do not exist. This makes economic calculation impossible. Therefore, to remove private ownership, entrepreneurship, and profit motivation and to replace them with bureacratic aims in the name of national interest is heading towards economic disaster for central planners are groping in the dark without economic calculation due to the absence of market prices. 

3. The nature of profit management. Under profit management, records such as the profit-and-loss account and the balance sheet are so important to determine the present status and future of an enterprise. Mises called them the "conscience of business" and the "compass of an entrepreneur" (p. 32). By studying them, the business owner can see the total picture of the business without digging into the details. These records are also beneficial to the general manager for he could easily detect which department of the enterprise is contributing to the growth of the company. And after knowing the situation, he could recommend expansion for the growing department and reform or shutting down a poor-performing department in order to arrest the continuous loss. 

4. The nature of managing personnel under the profit system. The records also help in assessing the performance of personnel. In the case of a department manager, his only concern is to see his department contributing profit to the company. If not, as mentioned above, the department will either closed down or the manager himself will be replaced with a more efficient one. So as the department manager does his best, it is not only for the benefit of the company, but also for the sake of his career or for possible financial incentives. 

Compare this under bureaucratic management where there is no record to show about profit and loss. In such an environment where there is no basis for performance, it is easy to retain incompetent workers due to personal considerations or sentimental reasons. Such practices are unsustainable under profit management for the consumers care for nothing but the quality and low price of products and services.