The Law Of Interest
The product of the final unit of labor--an amount which in practice is
measured without any tracing of the previous growth of the working
force--sets the standard of the rate of wages. We have now to see that
the rate of interest has a similar basis; and yet it is worth while to
build up, wholly in imagination, a fund of capital, just as we have
made up the force of laborers, increment by increment. This will have
the
be determined.
Interest as a Residual Amount
The area BCD in our former figure
represents the difference between the total product of an industry and
the wages paid to laborers. If there is no net profit accruing to the
entrepreneur, this area must represent interest. It is what is left
for the capitalist on the supposition that he and the laborer together
get all that there is. If the goods sell for what they cost, this must
be the fact, and the amount represented by BCD has thus to go to
capital, since, by a rule of exclusion, it cannot go to the
entrepreneur nor to the laborer. The mill and its contents earn for
their operator nothing but simple interest on the money they have
cost. Paying the laborers discharges the first claim on the product,
and there then remains only enough of the product to pay the remaining
claim, that of capital.
The question still remains to be answered, how the capitalist, if he
is a different person from the entrepreneur, or operator of the
mill, can make this functionary pay over to him all that he has in his
hands after paying the wages of labor.
The Importance of the Residuum
The above reasoning does not
satisfactorily show what influence the capitalist can use to make the
entrepreneur pay over to him the entire amount of the residuum. It
shows that after paying wages the entrepreneur will have a certain
amount left, but it is not thus far clear how the capitalist can get
it from him. The fact that the laborers get only the amount
represented by ABDE and that the whole amount is ACDE does,
however, at least show that the entrepreneur has the amount BCD
left in his hands, and that he is able to pay this amount to the
capitalist if by any appeal to competition the capitalist is able to
make him do it.
Interest not determined Residually
The fact is that the interest
on capital is fixed exactly as are the wages of labor.
We will let another figure represent the entire product of the same
amount of labor and the same amount of capital that were represented
in the former case. We will assume that there is at the outset a
complete force of laborers, and that no men are added to it or taken
from it; but we will gradually introduce units of capital instead of
units of labor as in the former case. The amount of capital is now
represented by the line A'E' and the product of the first unit of it
by the line A'C'. The product of the successive units declines along
the curve C'D'. The final unit of capital then brings into existence
the amount of wealth represented by E'D'. As every other unit now
produces the same amount, the capital as a whole creates the quantity
represented by A'B'D'E' and every unit of it makes its own separate
contribution to that amount. In this we have simply applied to capital
and its earnings the principle we formerly applied to labor and its
earnings.
General Form of the Law of Final Productivity
This principle is
the law of final productivity, one of those universal principles which
govern economic life in all its stages of evolution. Either one of the
two agents of industry, used in increasing quantities in connection
with a fixed amount of the other agent, is subject to a law of
diminishing returns. The final unit of the increasing agent produces
less than did the earlier units in the series. This does not mean that
at any one time one unit produces less than another, for at any one
time all are equally productive. It means that the tenth unit produces
less than the ninth did when there were only nine in use, and that
the ninth unit formerly produced less than the eighth did in that
still earlier stage of the process in which there were only eight in
use, etc. If the productive wealth of the United States were only
five hundred dollars per capita instead of more than twice that
amount, interest would be higher than it is, because the productive
power of every dollar's worth of capital would be more than the
productive power of each dollar's worth is now; and, on the other
hand, if we continue to pile up fortunes, great and small, till there
are in the country two thousand dollars for every man, woman, and
child of the population, interest will fall, because the productive
power of a dollar's worth will become less than it now is.
How Competition fixes Interest
We can now see how it is that the
capitalist can make the entrepreneur pay over to him the amount left
in his hands after paying wages. Every unit of capital that any one
offers for hire has a productive power. It can call into existence a
certain amount of goods. The offer of it to any entrepreneur is
virtually an offer of a fresh supply of the kinds of goods which he is
making for sale. Loaning ten thousand dollars to a woolen manufacturer
is really selling him the amount of cloth that ten thousand dollars
put into his equipment will bring into existence. Loaning a hundred
thousand dollars to the manufacturer of steel, so as to enable him in
some way to perfect his equipment, is virtually selling him the number
of additional tons of steel, ingots, or rails that he can make by
virtue of this accession to his plant.
The Significance of Free Competition
Now, the tender of capital
may be made to any entrepreneur in a particular industry, and the
existence of free competition between these entrepreneurs implies
that a lender of capital can get from one or another of them the whole
value of the product that this capital is able to create. A unit of
capital in the steel business can produce n tons of steel in a year,
and if one employer will not pay the price of n tons for the loan of
it, another will. This, indeed, implies an absolutely free
competition; but that is the condition of the problem we have first to
solve. When we know what ideally active competition will do, we can
measure the effects of the obstructions that, in practice, competition
actually encounters.
Competition for Capital among Different Industries
The capitalist
can invoke the aid of competition outside of the limits of one
particular business. He may offer his loan to steel makers, to woolen
manufacturers, cotton spinners, silk weavers, shoemakers, etc. Within
each one of these industries perfect competition between the different
employers will give him the value of the product which, in that
business, his capital is able to create. If, however, what in this way
he offers to men in one occupation is worth more than what he offers
to men in another line,--if capital is worth more to steel makers than
it is to cotton spinners,--he will find a market for his capital in
the former industry; and this process of seeking out the employment in
which capital is the more productive and there bestowing the loans of
capital, will go on until every such local excess of productive power
is removed and capital can produce as much wealth in one business as
it can in another. Everywhere capital will then be both producing and
receiving the same amount, and general interest will everywhere be
determined by the final productivity principle acting all through the
business world.
When Interest as Directly Determined equals Interest as Residually
Measured
The area BCD of the first figure measures what the
entrepreneur has left after paying wages. This amount and no more he
can pay as interest, and he will pay it if he has to. The area
A'B'D'E' of the second figure represents what he must pay as
interest; and we can now see that, if competition is perfectly free,
this amount equals the amount BCD of the first figure. If, after
paying wages, there is any more left in the entrepreneur's hands
than competition compels him to pay out as interest, he is realizing a
net profit; he is selling his goods for more than they cost him, and
this, as we saw at the outset, is a condition that under perfect
competition cannot continue. The natural price of goods is the cost
price. If the market price of anything is in excess of cost,
entrepreneurs receive a profit, and in order to do more business and
make a larger aggregate of such profit they bring new labor and
capital into their industry. The increased output lowers prices, and
the excess of gain is thus taken from the entrepreneur. If BCD is
smaller than A'B'D'E', the entrepreneur incurs a loss and will
curtail his business and let some labor and capital go where they can
produce more.
Taking this remainder of income from the entrepreneur by means of an
addition to the output of goods and a reduction of the price of them
does not annihilate the income, but bestows it on other recipients;
for the reduction in price which destroys an employer's profit can
come only in a way that benefits consumers. It means that enlarged
production of which we have just spoken, which scatters more goods
throughout the community and insures an addition to the real incomes
of both laborers and permanent investors.
Effect of Perfect Mobility of Labor and Capital
Perfect mobility
of labor and capital insures that the residuum in the entrepreneur's
hands after wages are paid shall all be made over to the capitalist.
We encounter here again the static law that, with competition working
without let or hindrance, the entrepreneur as such can keep nothing
for himself; though if he is also a worker he will get wages, and if
he is also a capitalist he will get interest. His business will pay
wages on all kinds of labor, including that of management, and
interest on all capital, including his own. A net gain above all this
it will not afford, and whatever the entrepreneur has left after
paying wages he will have to use in paying interest, and vice versa.
Laborers and owners of capital have, as it were, to take each others'
leavings. Such is the situation in an ideally static condition, though
we shall see how it is changed in actual and progressive society.
The area BCD of the first figure is, under static conditions,
exactly equal to the area A'B'D'E' of the second figure, because
ACDE represents the whole product, BCD in the first figure
represents all that is left of it after wages, measured by ABDE, are
paid; and we know by evidence both theoretical and practical that the
capitalist, whose share is directly expressed by A'B'D'E' of the
second figure, can claim and get the whole of this amount.
Wages as a Residuum
It is clear that the same reasoning applies to
wages. In the second figure they are represented as a residuum. The
area B'C'D' represents what the entrepreneur has left after paying
interest, and nobody can get this amount but the wage earner. The
reason, however, why the wage earner can get it is that free
competition will give him the amount ABDE of the first figure, and
this, under perfectly static conditions, must equal B'C'D' of the
second. Under perfect competition the entrepreneur cannot have any
of the amount B'C'D' left in his hands after meeting the claims that
the wage earner makes on him. On the other hand, he must have enough
left to pay interest, since otherwise he would be incurring a loss,
and that could not fail to force him and others who are in the same
situation to contract their operations or go out of business. If the
output of goods is reduced, either by the retirement of some employers
or the curtailment of product by all, the price of what continues to
be sold will be raised to the point at which wages and interest can be
paid.
Wages and Interest both adjusted at Social Margins of
Production
It is to be noted that wages and interest are fixed at
the social margin of production, which means that they equal what
labor and capital respectively can produce by adding themselves to the
forces already at work in the general field of employment. In making
the supposition that, owing to some disturbing fact, a particular
entrepreneur has not enough after paying wages to pay interest, we
assume that the rate of interest is fixed, in this way, in the general
field and not merely in his establishment.
If B'C'D' were larger than ABDE, the entrepreneur would be
selling goods for more than cost and realizing a net profit, which he
cannot do in a static state; but a pure profit is not only possible
but actual in a dynamic state.
In actual business total returns represented by ACDE amount to more
than the sum represented by ABDE (wages) plus A'B'D'E' (interest).
There are conditions that in practical life are continually bringing
this to pass in different lines of business, though not in all of them
at once. The real world is dynamic and therefore the true net profit,
or the share of the entrepreneur in the strict sense of the term, is
a positive quantity. This income is always determined residually. It
is a remainder and nothing else. It is what is left when wages and
interest are paid out of the general product. To the entrepreneur
comes the price of the products that an industry creates. Out of this
he pays wages and interest, and very often he has something remaining.
There is no way of determining this profit except as a remainder. The
return from the sale of the product is a positive amount fixed by the
final utility principle. Wages and interest are positive amounts, and
each of them is fixed by the final productivity principle. The
difference between the first amount and the sum of the two others is
profit, and it is never determined in any other way than by
subtracting outgoes from a gross income. It is the only share in
distribution that is so determined. Entrepreneur's profits and
residual income are synonymous terms. In the static state no such
residual income exists, but from a dynamic society it is never absent.
Every entrepreneur makes some profits or losses, and in society as a
whole the profits greatly predominate.
Summary of Facts concerning a Static Adjustment of Wages
We know
then that in any industry wages and interest absorb the whole product,
because any deviation from that rule in a particular group is
corrected in the way above mentioned. Moreover, general wages and
interest, as determined by the law of final productivity, must equal
those incomes when they are determined residually. The area of the
rectangular portion of one of the foregoing figures must equal the
area of the three-sided part of the other. The question arises why
all entrepreneurs might not get a uniform profit at once. This would
not lure any labor or capital from one group or subgroup to another.
If, after paying wages and interest at market rates, the
entrepreneurs in each industry have anything left, the entire labor
and capital are producing more than they get and there is an
inducement to managers and capitalists to withdraw from their present
employers and become entrepreneurs on their own account. Such an
entrepreneur entering the field, drawing marginal labor and capital
away from the entrepreneurs who are already there and combining them
in a new establishment, can make them produce more than he will have
to pay them and pocket the difference. If such a condition were
realized, there would be a gain in starting new enterprises, since
luring away marginal agents and combining them in new establishments
would always be profitable. When we introduce into the problem dynamic
elements we shall see that centralization, which makes shops larger
instead of smaller, makes industries more productive, and that what
happens when net profits appear is more often the enlarging of one
establishment than the creation of new ones. Entrepreneurs in the
large establishments can afford to resist the effort made by others to
lure away any of the labor or capital which they are employing, and
they will do this for the sake of retaining their profits. They can do
it by bidding against each other, in case any of them are making
additions to their mills or shops, and also by bidding against
any new employers who may appear. Perfect competition requires
that this bidding for labor and capital shall continue up to the
profit-annihilating point. Here, as elsewhere in the purely static
part of the discussion, we have to make assumptions that are
rigorously theoretical and put out of view in a remorseless way
disturbing elements which appear in real life. The static state
requires that all entrepreneurs who survive the sharp tests of
competition should have equally productive establishments, which means
that they should all be able to get the same amount of product from a
given amount of labor and capital. The actual fact is that differences
of productive power still survive. There are some small establishments
which, within the little spheres in which they act, are as productive
as large ones; but there are also some which are struggling hopelessly
against large rivals in the general market and are destined erelong to
give up the contest. In other words, the centralizing and leveling
effects of competition are approximated but never completely realized
in actual life.
A fact that it is well to note is that the test of final productivity
is inaccurately made when unduly large amounts of labor and capital
are made the basis of the measurement. Take away, for instance, a
quarter of the working force, estimate the reduction of the product
which this withdrawal occasions, and attribute this loss entirely to
the labor which has been taken away, and you estimate it too highly.
With so large a section of the labor withdrawn the capital would work
at a disadvantage, and a part of the reduction of the product would be
due to this fact. If we should take away all the labor, the capital
would be completely paralyzed, and the product would become nil. It
would obviously be inaccurate to say that the whole product is
attributable to the labor, on the ground that withdrawing the labor
annihilates it all. With any large part of the labor treated as a
single unit, the loss of product occasioned by a withdrawal of such a
unit is more than can be accurately imputed to it as its specific
product. The smaller the increments or units are made, the less
important is this element of inaccuracy, and it becomes a wholly
negligible quantity when they become very small. A study of the forms
of the productivity curves will show that if we take as the increment
of labor used in making the test only a tenth of the whole force, we
exaggerate the product imputable to it by a very minute fraction, say
by less than a one-hundredth part; and if we take a hundredth of the
labor as a final unit, we exaggerate the product that is solely
attributable to it by an amount so minute that it is of no consequence
in practice or in any theory that tries to be applicable to practice.
A question may be raised as to whether we are correct in saying that
the entrepreneur's profit is residual, in view of the fact that the
entire product of a business is at the mercy of the management, so
that a bad manager may reduce it or a good one may increase it. It may
be further claimed that that part of the management of a business
which consists in making the most far-reaching decisions cannot safely
be intrusted to a salaried superintendent or other paid official and
must get its returns, if at all, in the form of profits. Even in this
case the gains are secured by making the gross return, which is the
minuend in the case, large, leaving the two subtrahends, wages and
interest, unchanged, and thus creating a remainder or residuum. We
shall later see to what extent entrepreneurs do in fact create the
profits that come to them.
The complete static conception of society requires that no
entrepreneur should be left in the field who cannot continue
indefinitely to hold his own against the competition of his rivals,
and this requires essential equality of productive power on the part
of all of them. It is not necessary, however, that all should operate
upon an equal scale of magnitude, for an interesting feature of modern
life is the need of many small productive establishments that cater to
local demands and to wants which, without being local, call for only a
few articles of a kind. Repairs, small orders, and peculiar orders are
executed more cheaply in small establishments, and they survive under
the very rule of essential equality of productive power which static
conditions require. For catering to the general market and producing
staple goods the large establishment has a decisive advantage, and
this insures the centralization which is the marked feature of recent
industrial life.
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