Hayek , and Sir John Hicks. His theories of interest and capital were catalysts in the development of economics, but today his original work receives little attention. Second, for psychological reasons the marginal utility of a good declines with time. Economists have accepted both as valid reasons for positive time-preference. Production, he noted, is roundabout, meaning that it takes time. It uses capital, which is produced, to transform nonproduced factors of production—such as land and labor—into output.
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First, to state the problem. This, however, immediately suggests the question why a public which, as a rule, is not willing to pay more than it can help for anything, should pay prices such as allow of this profit. Interest seems to be defined as that annual return to capital which may be obtained, as a rule, without personal exertion. Accepting this answer we should expect to find the phenomenon of interest most easily studied in the case of a Limited Liability Company, where the personal exertion of the shareholders is limited to choosing the investment, subscribing the capital, and receiving the dividends.
A careful consideration of the balance sheet of any such company will guard us against a common misunderstanding. Such a balance sheet will generally show two funds—a Depreciation Fund and an Insurance Fund. The former, sometimes called Sinking, Wear and Tear, Repairs, or Replacement of Capital Fund, secures that fixed capital, or its value, is replaced in the proportion in which it is worn out, and thus provides a guarantee that the value of the parent capital is not encroached upon, or inadvertently paid away in dividend.
The latter, sometimes called Equalisation of Dividend Fund, is a provision for averaging the losses that are sure to occur over a series of years, and are really a portion of the current expenses. It is only after these funds are provided for that the dividend is paid over to the shareholders, and this accentuates two important facts: 1 that interest properly so called is something distinct from any portion of parent capital, and 2 that it is not accounted for by insurance against risks.
The question now is, Is such a dividend pure interest? Here we have to reckon with the familiar fact that limited companies, under similar conditions, pay the most various rates of dividend. If a sound industrial company is known to be paying a dividend higher than a certain definite percentage on its capital, the value of the stock, or parent capital, will rise to the point where dividend corresponds to an interest no greater than this definite percentage— e.
There is, in short, in every country, although varying from country to country, a certain annual return which can be obtained by capital with a minimum of risk, without personal exertion of the owner. Its level is usually determined by the market price of the national security.
This we should probably consider the proper economic interest for capital invested in Great Britain. Any return above this level we should consider, either as due to the insecurity of the capital as invested i. Now it is this interest proper, obtainable by the owner of capital without risk and without personal effort, that is the object of our problem.
In which of the many forms that interest takes can we best study its nature? The nation as a whole cannot pay interest on its debts unless the citizens as individuals produce the wealth wherewith this interest is paid, otherwise the nation will be paying away its capital.
To study interest as expressed in the annual payments on the Consolidated National Debt would be to make the common mistake of explaining Natural Interest by Contract Interest, which is very much the same as explaining why people pay interest by showing that they do pay it. The phenomenon, then, must, primarily, be studied as it appears in some or other of the forms of production of wealth.
Let us take the case of a manufacturing company. In normal capitalist production, that is to say, not only is the value of capital consumed in the production process replaced, but a surplus of value appears. It has not always been perceived by economists that this surplus value is the essential phenomenon of what we call interest,—that interest on capital consists of this very surplus value and nothing else,—but whenever it is perceived the question almost suggests itself, What does this surplus value represent?
Is it merely a surplus, or is it of the nature of a wage? In other words, is it something obtained either by chance or force, and corresponding to no service rendered by anybody or anything; or is it something connected with capital or the capitalist that, economically speaking, deserves a return or a wage? When a manufacturer engages his capital in production he, as it were, throws it into solution, and risks it all on the chance of the consuming public paying a certain price for the products into which his capital is transformed.
If they will not pay any price at all the capital never reappears; even the labour, which bound up its fortunes with the materials and machinery of manufacture, loses its wage, or would do so except for the wage contract which pays labour in advance. If the consumers, again, will only pay a price equal to the value of the capital consumed, the various workers, including the employer proper, will get their wage, and the value of the capital itself will be unimpaired, but there will be no interest.
It is only if the consumers are willing to pay a higher price that capital can get its interest. The surplus then, which we call interest, appears primarily in the value or price of products—that is to say, interest is, in the first instance, paid over by the consumer of goods in the price of the products he buys.
Now it seems intelligible, although it is not really so intelligible as is usually assumed, that the public will always pay a price for products sufficient to reimburse the wages paid in producing them. The labourer, theoretically, is paid by what he makes—although this proposition requires more careful statement and limitation than can be given it here—and wages are supposed, prima facie, to represent an equivalent in value contributed to the product by the worker.
But that the consuming world, over and above this wage, will pay a surplus which does not represent any equivalent value given to the product, is only conceivable on the supposition that the public is unconscious that it is paying such a surplus.
This supposition, however, is incredible in a community where most of the consumers are also producers. To lose as consumer what one gains as producer is a game of Beggar my Neighbour which would scarcely commend itself to business men.
The surplus then may be assumed to represent something contributed by capital to the value of products. If, now, we appeal to the common consciousness to say what it is that capital does, or, forbears to do, that it should receive interest, we shall probably get two answers. One will be that the owner of capital contributes a valuable element to production; the other, that he abstains from using his wealth in his own immediate consumption.
On one or other of these grounds, the capitalist is said to deserve a remuneration, and this remuneration is obtained by him in the shape of interest. Now it might possibly be the case that both answers point to elements indispensable in the explanation of interest, but a slight consideration will show that the two answers are very different from one another.
The one is positive—that capital does something; the other negative—that the capitalist abstains from doing something. In the one case interest is a payment for a tool; in the other, a recompense for a sacrifice. In the one case the capitalist is paid because the capital he lends produces, or helps to produce, new wealth; in the other he is paid because he abstains from diminishing wealth already produced.
It will become evident as we go on that, on these two answers, which spring to the lips of any business man asked to account for interest, are based the most important of the theories criticised in the present book. The first answer is the basis of the Productivity theories and of the Use theories; the second is the basis of the Abstinence theory. The argument of the Productivity theory may be put thus. Human labour, employing itself on the materials given free by nature, and making use of no powers beyond the natural forces which manifest themselves alike in the labourer and in his environment, can always produce a certain amount of wealth.
But when wealth is put into the active forms of capital—of which machinery may be taken as instance and type—and capital becomes intermediary between man and his environment of nature, the result is that the production of wealth is indefinitely increased.
The difference between the results of labour unassisted and labour assisted by capital is, therefore, due to capital, and its owner is paid for this service by interest. The more complex formulations of it—where, for instance, emphasis is laid on the displacement of labour by capital, and interest is assumed to be the value formerly obtained as wage, or where prominence is given to the work of natural powers which, though in themselves gratuitous, are made available only in the forms of capitalist production—he has called the Indirect theories.
How slight a claim this explanation has to the dignity of a scientific theory appears in its practical definition of interest as the whole return to capitalist production which is not accounted for by labour. Yet the statement just given is elaborate and logical in comparison with that of many of the economists who profess the Productivity theory. Their usual treatment of the interest problem is to co-ordinate capital with the other factors of production, land and labour, and assume that interest is the payment for the services of capital, as wage is for the services of labour, give ample illustration of the triumphs of capitalist production, and pass on to discuss the rise and fall of its rate.
If, however, we demand an answer to what we have formulated as the true problem of interest, we shall make the discovery that the Productivity theory has not even put that problem before itself. The amount of truth in the theory is that capital is a most powerful factor in the production of wealth, and that capital, accordingly, is highly valued.
The theory, that is to say, explains why the manufacturer has to pay a high price for raw materials, for the factory buildings, and for the machinery—the concrete forms of capital generally.
It does not explain why he is able to sell the manufactured commodity, which is simply these materials and machines transformed by labour into products, at a higher price than the capital expended. It must be admitted that there is something very plausible in this theory, particularly in apparently simple illustrations of it. An unemployed carpenter borrows them. The fifty shillings interest he pays seems almost an inadequate return for the added productiveness given to his labour over the year.
Is not the interest made possible by the qualities of the tools? The facts here are as stated: without production there would be no interest. So without land there would be no turnips, but the existence of land is scarcely the sufficient cause of the turnips. His labour also would be rendered productive; and in the same degree, but he would pay no interest.
The important circumstance forgotten in this theory is that the productiveness of concrete capital is already discounted in its price. The chest of tools would be of no value but for the natural forces embodied in them or made available by them.
To ascribe interest to the productive power of capital is to make a double charge for natural forces—in the price and in the interest. Meanwhile we may note one significant circumstance in all these transactions,—that the emergence of interest is dependent on a certain lapse of time between the borrowing and the paying. It cannot be too often reiterated that the theory which explains interest must explain surplus value—not a surplus of products which may obtain value and may not; not a surplus of value over the amount of value produced by labour unassisted by capital; but a surplus of value in the product of capital over the value of the capital consumed in producing it.
The insufficiency of the present theory to meet these requirements may be shown in another way. If, however, the emergence of surplus value in the case of simple labour needs explanation, much more does it in the case of capitalist production. What is a product or commodity but raw material plus labour? Labour and capital co-operate in making it, and the individual form and share of each is lost in the joint product. But, of the two, labour is the living factor, and if surplus value does emerge in capitalist production as a regularly recurring phenomenon, it is more likely that it comes from the living agent than from the dead tool.
Thus the Productivity theory ends in suggesting that other and hostile theory according to which surplus value comes from labour, and is only snatched away by capital. But the fact is that, in all this, we have an entire misconception of the origin of value. Value cannot come from production. What labour does is to produce a quantity of commodities, and what capital co-operating with labour usually does is to increase that quantity.
These commodities, under certain known conditions, will usually possess value, though their value is little proportioned to their amount; indeed, is often in inverse ratio. But the value does not arise in the production, nor is it proportional to the efforts and sacrifices of that production.
The causal relation runs exactly the opposite way. But if neither capital nor labour can create value, how can it be maintained that capital employed in production not only reproduces its own value, but produces a value greater than itself?
I confess I find some difficulty in stating the economic argument of what our author has called the Use theory of interest, and I am almost inclined to think that he has done too much honour to some economists in ascribing to them this theory, or, indeed, any definite theory at all.
If, however, we look carefully into this illustration, we shall see that William not only had the use of the plane but the plane, itself, as appears from the fact that the plane was worn out during the year.
To put it another way. As things are, he pays nothing on 1st January; he has the use of the plane over the year; by 31st December the plane is consumed; and next day he has to pay over to James a precisely similar plane plus a plank. The essential difference between the two transactions is that, on 1st January the price of the plane is another similar plane; on the 31st December it is a plane plus a plank.
This again suggests a very different source of interest, viz. This is rendered more plausible by the fact that most loans of capital are made in money; we unconsciously assume the gold or notes we receive to be the same gold or notes we lent.
Are we to conclude then that durable goods admit of an independent use possessing independent value, and that perishable goods do not? This theory, in fact, affords a striking instance of how our science has revenged itself for our unscientific treatment of it.
In no other way can I account for the fact that, a hundred years after the appearance of Wealth of Nations, the great American and German economists should be devoting so much of their time to elementary and neglected conceptions. Every good is nothing but the sum of its uses, and the value of a good is the value of all the uses contained in it.
If, on the contrary, it is so constituted that its life-work extends over a period of time, then each individual use diminishes the sum of uses which constitutes the essential nature of the good. But Consumption is only a single exhaustive use, and Use is only a prolonged consumption. This at once enables us to estimate the Use theory of interest.
The true nature of the loan transaction is, not that in it we get the use of capital and return it deteriorated, but that we get the capital itself, consume it, and pay for it by a new sum of value which somehow includes interest. If, however, we admit this, we are landed in the old problem once more—how do goods, when used as capital in production, increase in value to a sum greater than their own original value?
Eugen Böhm von Bawerk
Labor cannot increase its share at the expense of capital. The most significant span of scholarly activity was his years at the University of Innsbruck After serving in this capacity and assuming other governmental duties, he returned to teaching in With a chair at the University of Vienna, he became a colleague of Wieser, successor to the retired Menger. Reviewing this new translation, Mises described this "monumental work" as "the most eminent contribution to modern economic theory.
Capital and Interest: A Critical History of Economical Theory
First, to state the problem. This, however, immediately suggests the question why a public which, as a rule, is not willing to pay more than it can help for anything, should pay prices such as allow of this profit. Interest seems to be defined as that annual return to capital which may be obtained, as a rule, without personal exertion. Accepting this answer we should expect to find the phenomenon of interest most easily studied in the case of a Limited Liability Company, where the personal exertion of the shareholders is limited to choosing the investment, subscribing the capital, and receiving the dividends. A careful consideration of the balance sheet of any such company will guard us against a common misunderstanding.