Suppose that the wealthy people of any country, not relishing an idle
life, and having a strong taste for gainful labour, were generally
indisposed to accept of a smaller income in order to be relieved from
the labour and anxiety of business. Every producer in flourishing
circumstances would be eager to borrow, and few willing to lend. Under
these circumstances the rate of interest would differ very little from
the rate of profit. The trouble of managing a business is not
proportionally increased by an increase of the magnitude of the
business; and a very small surplus profit above the rate of interest,
would therefore be a sufficient inducement to capitalists to borrow.
We may even conceive a people whose habits were such, that in order to
induce them to lend, it might be necessary to offer them a rate of
interest fully equal to the ordinary rate of profit. In that case, of
course, the productive classes would scarcely ever borrow. But
government, and the unproductive classes, who do not borrow in order to
make a profit by the loan, but from the pressure of a real or supposed
necessity, might still be ready to borrow at this high rate.
Although the inclination to borrow has no _fixed_ or _necessary_ limit
except the power of giving security, yet it always, in point of fact,
stops short of this; from the uncertainty of the prospects of any
individual producer, which generally indisposes him to involve himself
to the full extent of his means of payment. There is never any permanent
want of market for things in general; but there may be so for the
commodity which any one individual is producing; and even if there is a
demand for the commodity, people may not buy it of him but of some other.
There are, consequently, never more than a portion of the producers, the
state of whose business encourages them to add to their capital by
borrowing; and even these are disposed to borrow only as much as they
see an _immediate_ prospect of profitably employing. There is, therefore,
a practical limit to the demands of borrowers at any given instant; and
when these demands are all satisfied, any additional capital offered on
loan can find an investment only by a reduction of the rate of interest.
The amount of borrowers being given, (and by the amount of borrowers is
here meant the aggregate sum which people are willing to borrow at some
given rate,) the rate of interest will depend upon the quantity of
capital owned by people who are unwilling or unable to engage in trade.
The circumstances which determine this, are, on the one hand, the degree
in which a taste for business, or an aversion to it, happens to be
prevalent among the classes possessed of property; and on the other
hand, the amount of the annual accumulation from the earnings of labour.
Those who accumulate from their wages, fees, or salaries, have, of
course, (speaking generally) no means of investing their savings except
by lending them to others: their occupations prevent them from personally
superintending any employment.
Upon these circumstances, then, the rate of interest depends, the amount
of borrowers being given. And the counter-proposition equally holds,
that, the above circumstances being given, the rate of interest depends
upon the amount of borrowers.
Suppose, for example, that when the rate of interest has adjusted itself
to the existing state of the circumstances which affect the disposition
to borrow and to lend, a war breaks out, which induces government, for
a series of years, to borrow annually a large sum of money. During the
whole of this period, the rate of interest will remain considerably
above what it was before, and what it will be afterwards.
Before the commencement of the supposed war, all persons who were
disposed to lend at the then rate of interest, had found borrowers, and
their capital was invested. This may be assumed; for if any capital had
been seeking for a borrower at the existing rate of interest, and unable
to find one, its owner would have offered it at a rate slightly below
the existing rate. He would, for instance, have bought into the funds,
at a slight advance of price; and thus set at liberty the capital of
some fundholder, who, the funds yielding a lower interest, would have
been obliged to accept a lower interest from individuals.
Since, then, all who were willing to lend their capital at the market
rate, have already lent it, Government will not be able to borrow unless
by offering higher interest. Though, with the existing habits of the
possessors of disposable capital, an increased number cannot be found
who are willing to lend at the existing rate, there are doubtless some
who will be induced to lend by the temptation of a higher rate. The same
temptation will also induce some persons to invest, in the purchase of
the new stock, what they would otherwise have expended unproductively in
increasing their establishments, or productively, in improving their
estates. The rate of interest will rise just sufficiently to call forth
an increase of lenders to the amount required.
This we apprehend to be the cause why the rate of interest in this
country was so high as it is well known to have been during the last
war. It is, therefore, by no means to be inferred, as some have done,
that the general rate of profits was unusually high during the same
period, because interest was so. Supposing the rate of profits to have
been precisely the same during the war, as before or after it, the rate
of interest would nevertheless have risen, from the causes and in the
manner above described.
The practical use of the preceding investigation is, to moderate the
confidence with which inferences are frequently drawn with respect to
the rate of profit from evidence regarding the rate of interest; and to
shew that although the rate of profit is one of the elements which
combine to determine the rate of interest, the latter is also acted upon
by causes peculiar to itself, and may either rise or fall, both
temporarily and permanently, while the general rate of profits remains
unchanged.
* * * * *
The introduction of banks, which perform the function of lenders and
loan-brokers, with or without that of issuers of paper-money, produces
some further anomalies in the rate of interest, which have not, so far
as we are aware, been hitherto brought within the pale of exact science.
If bankers were merely a class of middlemen between the lender and the
borrower; if they merely received deposits of capital from those who had
it lying unemployed in their hands, and lent this, together with their
own capital, to the productive classes, receiving interest for it, and
paying interest in their turn to those who had placed capital in their
hands; the effect of the operations of banking on the rate of interest
would be to lower it in some slight degree. The banker receives and
collects together sums of money much too small, when taken individually,
to render it worth while for the owners to look out for an investment,
but which in the aggregate form a considerable amount. This amount may
be considered a clear addition to the productive capital of the country;
at least, to the capital in activity at any moment. And as this addition
to the capital accrues wholly to that part of it which is not employed
by the owners, but lent to other producers, the natural effect is a
diminution of the rate of interest.
The banker, to the extent of his own private capital, (the expenses of
his business being first paid,) is a lender at interest. But, being
subject to risk and trouble fully equal to that which belongs to most
other employments, he cannot be satisfied with the mere interest even
of his whole capital: he must have the ordinary profits of stock, or he
will not engage in the business: the state of banking must be such as to
hold out to him the prospect of adding, to the interest of what remains
of his own capital after paying the expenses of his business, interest
upon capital deposited with him, in sufficient amount to make up, after
paying the expenses, the ordinary profit which could be derived from his
own capital in any productive employment. This will be accomplished in
one of two ways.
1. If the circumstances of society are such as to furnish a ready
investment of disposable capital; (as for instance in London, where the
public funds and other securities, of undoubted stability, and affording
great advantages for receiving the interest without trouble and
realizing the principal without difficulty when required, tempt all
persons who have sums of importance lying idle, to invest them on their
own account without the intervention of any middleman;) the deposits
with bankers consist chiefly of small sums likely to be wanted in a very
short period for current expenses, and the interest on which would
seldom be worth the trouble of calculating it. Bankers, therefore, do
not allow any interest on their deposits. After paying the expenses of
their business, all the rest of the interest they receive is clear gain.
But as the circumstances of banking, as of all other modes of employing
capital, will on the average be such as to afford to a person entering
into the business a prospect of realizing the ordinary, and no more than
the ordinary, profits upon his own capital; the gains of each banker by
the investment of his deposits, will not on the average exceed what is
necessary to make up his gains on his own capital to the ordinary rate.
It is, of course, competition, which brings about this limitation.
Whether competition operates by lowering the rate of interest, or by
dividing the business among a larger number, it is difficult to decide.
Probably it operates in both ways; but it is by no means impossible that
it may operate in the latter way alone: just as an increase in the
number of physicians does not lower the fees, though it diminishes an
average competitor's chance of obtaining them.
It is not impossible that the disposition of the lenders might be such,
that they would cease to lend rather than acquiesce in any reduction of
the rate of interest. If so, the arrival of a new lender, in the person
of a banker of deposit, would not lower the rate of interest in any
considerable degree. A slight fall would take place, and with that
exception things would be as before, except that the capital in the
hands of the banker would have put itself into the place of an equal
portion of capital belonging to other lenders, who would themselves have
engaged in business (e.g., by subscribing to some joint-stock company,
or entering into commandite). Bankers' profits would then be limited to
the ordinary rate chiefly by the division of the business among many
banks, so that each on the average would receive no more interest on his
deposits than would suffice to make up the interest on his own capital
to the ordinary rate of profit after paying all expenses.
2. But if the circumstances of society render it difficult and
inconvenient for persons who wish to live upon the interest of their
money, to seek an investment for themselves, the bankers become agents
for this specific purpose: large as well as small sums are deposited
with them, and they allow interest to their customers. Such is the
practice of the Scotch banks, and of most of the country banks in
England. Their customers, not living at any of the great seats of money
transactions, prefer entrusting their capital to somebody on the spot,
whom they know, and in whom they confide. He invests their money on the
best terms he can, and pays to them such interest as he can afford to
give; retaining a compensation for his own risk and trouble. This
compensation is fixed by the competition of the market. The rate of
interest is no further lowered by this operation, than inasmuch as it
brings together the lender and the borrower in a safe and expeditious
manner. The lender incurs less risk, and a larger proportion, therefore,
of the holders of capital are willing to be lenders.
When a banker, in addition to his other functions, is also an issuer of
paper money, he gains an advantage similar to that which the London
bankers derive from their deposits. To the extent to which he can put
forth his notes, he has so much the more to lend, without himself having
to pay any interest for it.
If the paper is convertible, it cannot get into circulation permanently
without displacing specie, which goes abroad and brings back an
equivalent value. To the extent of this value, there is an increase of
the capital of the country; and the increase accrues solely to that part
of the capital which is employed in loans.
If the paper is inconvertible, and instead of displacing specie
depreciates the currency, the banker by issuing it levies a tax on every
person who has money in his hands or due to him. He thus appropriates to
himself a portion of the capital of other people, and a portion of their
revenue. The capital might have been intended to be lent, or it might
have been intended to be employed by the owner: such part of it as was
intended to be employed by the owner now changes its destination, and is
lent. The revenue was either intended to be accumulated, in which case
it had already become capital, or it was intended to be spent: in this
last case, revenue is converted into capital: and thus, strange as it
may appear, the depreciation of the currency, when effected in this way,
operates to a certain extent as a forced accumulation. This, indeed, is
no palliation of its iniquity. Though A might have spent his property
unproductively, B ought not to be permitted to rob him of it because B
will expend it on productive labour.
In any supposable case, however, the issue of paper money by bankers
increases the proportion of the whole capital of the country which is
destined to be lent. The rate of interest must therefore fall, until
some of the lenders give over lending, or until the increase of
borrowers absorbs the whole.
But a fall of the rate of interest, sufficient to enable the money
market to absorb the whole of the paper-loans, may not be sufficient to
reduce the profits of a lender who lends what costs him nothing, to the
ordinary rate of profit upon his capital. Here, therefore, competition
will operate chiefly by dividing the business. The notes of each bank
will be confined within so narrow a district, or will divide the supply
of a district with so many other banks, that on the average each will
receive no larger amount of interest on his notes than will make up the
interest on his own capital to the ordinary rate of profit.
Even in this way, however, the competition has the effect, to a certain
limited extent, of lowering the rate of interest; for the power of
bankers to receive interest on more than their capital attracts a
greater amount of capital into the banking business than would otherwise
flow into it; and this greater capital being all lent, interest will
fall in consequence.
NOTE:
[7] It would be easy to go over in the same manner any other case. For
instance, we may suppose, that, instead of dispensing with the _whole_
of the fixed capital, material, &c, and taking on labourers in equal
number to those by whom these were produced, _half_ only of the fixed
capital and material is dispensed with; so that, instead of 60 labourers
and a fixed capital worth 6O quarters of corn, we have 80 labourers and
a fixed capital worth 30. The numerical statement of this case is more
intricate than that in the text, but the result is not different.
ESSAY V.
ON THE DEFINITION OF POLITICAL ECONOMY; AND ON THE METHOD OF
INVESTIGATION PROPER TO IT.
It might be imagined, on a superficial view of the nature and objects of
definition, that the definition of a science would occupy the same place
in the chronological which it commonly does in the didactic order. As a
treatise on any science usually commences with an attempt to express, in
a brief formula, what the science is, and wherein it differs from other
sciences, so, it might be supposed, did the framing of such a formula
naturally precede the successful cultivation of the science.
This, however, is far from having been the case. The definition of a
science has almost invariably not preceded, but followed, the creation
of the science itself. Like the wall of a city, it has usually been
erected, not to be a receptacle for such edifices as might afterwards
spring up, but to circumscribe an aggregation already in existence.
Mankind did not measure out the ground for intellectual cultivation
before they began to plant it; they did not divide the field of human
investigation into regular compartments first, and then begin to collect
truths for the purpose of being therein deposited; they proceeded in a
less systematic manner. As discoveries were gathered in, either one by
one, or in groups resulting from the continued prosecution of some
uniform course of inquiry, the truths which were successively brought
into store cohered and became agglomerated according to their individual
affinities. Without any intentional classification, the facts classed
themselves. They became associated in the mind, according to their
general and obvious resemblances; and the aggregates thus formed, having
to be frequently spoken of as aggregates, came to be denoted by a common
name. Any body of truths which had thus acquired a collective
denomination, was called a _science_. It was long before this fortuitous
classification was felt not to be sufficiently precise. It was in a more
advanced stage of the progress of knowledge that mankind became sensible
of the advantage of ascertaining whether the facts which they had thus
grouped together were distinguished from all other facts by any common
properties, and what these were. The first attempts to answer this
question were commonly very unskilful, and the consequent definitions
extremely imperfect.
And, in truth, there is scarcely any investigation in the whole body of
a science requiring so high a degree of analysis and abstraction, as the
inquiry, what the science itself is; in other words, what are the
properties common to all the truths composing it, and distinguishing
them from all other truths. Many persons, accordingly, who are
profoundly conversant with the details of a science, would be very much
at a loss to supply such a definition of the science itself as should
not be liable to well-grounded logical objections. From this remark, we
cannot except the authors of elementary scientific treatises. The
definitions which those works furnish of the sciences, for the most part
either do not fit them--some being too wide, some too narrow--or do not
go deep enough into them, but define a science by its accidents, not its
essentials; by some one of its properties which may, indeed, serve the
purpose of a distinguishing mark, but which is of too little importance
to have ever of itself led mankind to give the science a name and rank
as a separate object of study.
The definition of a science must, indeed, be placed among that class of
truths which Dugald Stewart had in view, when he observed that the first
principles of all sciences belong to the philosophy of the human mind.
The observation is just; and the first principles of all sciences,
including the definitions of them, have consequently participated
hitherto in the vagueness and uncertainty which has pervaded that most
difficult and unsettled of all branches of knowledge. If we open any
book, even of mathematics or natural philosophy, it is impossible not to
be struck with the mistiness of what we find represented as preliminary
and fundamental notions, and the very insufficient manner in which the
propositions which are palmed upon us as first principles seem to be
made out, contrasted with the lucidity of the explanations and the
conclusiveness of the proofs as soon as the writer enters upon the
details of his subject. Whence comes this anomaly? Why is the admitted
certainty of the results of those sciences in no way prejudiced by the
want of solidity in their premises? How happens it that a firm
superstructure has been erected upon an unstable foundation? The
solution of the paradox _is_, that what are called first principles,
are, in truth, _last_ principles. Instead of being the fixed point from
whence the chain of proof which supports all the rest of the science
hangs suspended, they are themselves the remotest link of the chain.
Though presented as if all other truths were to be deduced from them,
they are the truths which are last arrived at; the result of the last
stage of generalization, or of the last and subtlest process of
analysis, to which the particular truths of the science can be
subjected; those particular truths having previously been ascertained
by the evidence proper to their own nature.
Like other sciences, Political Economy has remained destitute of a
definition framed on strictly logical principles, or even of, what is
more easily to be had, a definition exactly co-extensive with the thing
defined. This has not, perhaps, caused the real bounds of the science to
be, in this country at least, practically mistaken or overpassed; but
it has occasioned--perhaps we should rather say it is connected with
--indefinite, and often erroneous, conceptions of the mode in which the
science should be studied.
We proceed to verify these assertions by an examination of the most
generally received definitions of the science.
1. First, as to the vulgar notion of the nature and object of Political
Economy, we shall not be wide of the mark if we state it to be something
to this effect:--That Political Economy is a science which teaches, or
professes to teach, in what manner a nation may be made rich. This
notion of what constitutes the science, is in some degree countenanced
by the title and arrangement which Adam Smith gave to his invaluable
work. A systematic treatise on Political Economy, he chose to call an
_Inquiry into the Nature and Causes of the Wealth of Nations_; and the
topics are introduced in an order suitable to that view of the purpose
of his book.
With respect to the definition in question, if definition it can be
called which is not found in any set form of words, but left to be
arrived at by a process of abstraction from a hundred current modes of
speaking on the subject; it seems liable to the conclusive objection,
that it confounds the essentially distinct, though closely connected,
ideas of _science_ and _art_. These two ideas differ from one another as
the understanding differs from the will, or as the indicative mood in
grammar differs from the imperative. The one deals in facts, the other
in precepts. Science is a collection of _truths_; art, a body of
_rules_, or directions for conduct. The language of science is, This is,
or, This is not; This does, or does not, happen. The language of art is,
Do this; Avoid that. Science takes cognizance of a _phenomenon_, and
endeavours to discover its _law_; art proposes to itself an _end_, and
looks out for _means_ to effect it.
If, therefore, Political Economy be a science, it cannot be a collection
of practical rules; though, unless it be altogether a useless science,
practical rules must be capable of being founded upon it. The science of
mechanics, a branch of natural philosophy, lays down the laws of motion,
and the properties of what are called the mechanical powers. The art of
practical mechanics teaches how we may avail ourselves of those laws and
properties, to increase our command over external nature. An art would
not be an art, unless it were founded upon a scientific knowledge of the
properties of the subject-matter: without this, it would not be
philosophy, but empiricism; [Greek: empeiria,] not [Greek: technae,] in
Plato's sense. Rules, therefore, for making a nation increase in wealth,
are not a science, but they are the results of science. Political
Economy does not of itself instruct how to make a nation rich; but
whoever would be qualified to judge of the means of making a nation
rich, must first be a political economist.