controversy will be of service to us, if it makes clear the manner and
the spirit in which the marginal conception should be handled. It
should be regarded not as a rigid formula which we can apply to
diverse problems without considering the special features they
present, but rather as a signpost which will enable us to find our
way, a compass by which we may steer between the shoals of triviality
and sophistry to the crux of any problem with which we have to deal.
Let us illustrate its practical uses by an example which is of great
interest and far-reaching practical importance at the present day. As
has been already observed, the war has left behind it in all countries
a great and almost certainly permanent increase in nominal purchasing
power. Since the armistice prices have moved upwards and downwards
with unprecedented violence; and it would be very rash to prophesy the
precise level at which they will ultimately settle (using that word
with considerable relativity). But, for reasons for which the reader
is referred to Volume II in this series, it is safe enough to say that
the general level of post-war will greatly exceed that of pre-war
prices. Now this will apply not only to consumers' goods like milk and
clothes, or to raw materials like pig-iron and cotton, but in very
much the same degree to things like factories and machinery. Things of
this last type are sometimes called "capital goods," because it is in
them that a large part of the capital of a business is embodied. Now
the fact that it will cost much more than it did before the war to
construct fresh capital goods, has a significance which very few
people appreciate. An existing factory cost, let us say, $500,000 to
build and equip with machinery before the war. To construct a similar
factory to-day would cost, let us assume (it is probably a moderate
assumption) $1,000,000. Suppose 10 per cent to be the gross profit
that is necessary to attract capital to the particular industry. Then
it will not pay to construct this new factory unless the trade
prospects point to the probability of a profit of about $100,000 per
annum. But if the old factory is equally well managed, it too should
be able to earn this $100,000, which upon the capital actually sunk
would represent a rate of 20 per cent. The particular figures given
are, of course, purely illustrative; the conclusion to which they
point is that, if new enterprises are to be undertaken, pre-war
enterprises are likely to yield a rate of profit, on their fixed
capital at least, increased in rough proportion to the price-level. Of
course, in years when trade is bad, the factory which dates from
pre-war times will not earn a profit of this kind, it may very likely
make an actual loss. At those times it is very certain that few new
factories will be erected. But it is difficult to reconcile a
condition of trade activity, in which the constructional industries
are busily employed, with a rate of profit to pre-war businesses on
the fixed part of their capital of a lesser order of magnitude than
has been indicated. It makes no difference, it should be observed,
whether we suppose the new enterprises to take the form of starting of
new concerns or extending old ones; in neither case will they be
undertaken, unless there is reason to expect an adequate return on the
capital which they require at post-war constructional prices. High
profits (taking always good years together with bad) on capital sunk
before the war in buildings and machinery are thus a likely
consequence of an increase in the price-level.
This fact is, indeed, the counterpart or complement of another
phenomenon with which we are more familiar. While prices are actually
rising, profits, as we have come to recognize, necessarily rule high,
because every trader or manufacturer is constantly in the position of
selling at a higher price-level, stock which he purchased, or goods
made from materials which he purchased at a lower level. He thus
acquires an abnormal profit on his circulating capital, which is
essentially similar to the profit on fixed capital, which we have just
examined. The difference is that the former profit is crowded into the
years when prices are actually on the increase, and thus is very
noticeable indeed; while the latter profit continues to accrue in
smaller instalments after prices have settled down, as it were, at the
higher level, and is not exhausted until the buildings and machinery
have become obsolete. But the two profits are essentially similar,
and in the long run should be commensurate. In the one case, stock can
be sold for a large profit, because it cannot be replaced except at a
higher price; in the other case, plant and buildings yield a higher
income because _they_ cannot be replaced except at a higher
price. Indeed, if the owners choose, the plant and building can, like
the stock, be sold at their appreciated value, as has been widely done
by the owners of cotton mills in Great Britain since the armistice.
There is nothing in these considerations that should surprise us, or
even shock our moral sense. For what they have indicated is an
increase of money profits in rough proportion to the price-level, so
that the aggregate profits will represent about as much real income as
before.[1] The conclusion therefore amounts to no more than this, that
you cannot alter fundamentally the distribution of wealth between
labor and capital by merely inflating the currency, or otherwise
juggling with the price-level. And this is only what we should expect,
if there are any laws of distribution of sufficient importance and
permanence to justify the many volumes which have been devoted to
them.
[Footnote 1: Assuming that the rate of interest has remained
unaltered. In fact it has greatly increased since pre-war days, and
this points to a still further increase of money profits, and an
increase in the real income which they represent. See Chapter VIII,
§10]
But this somewhat tame conclusion does not make it any less important
to grasp clearly the significance of the appreciation in the value of
capital goods. A failure to realize it lies at the root of our
bewildered muddling of many crucial problems of the day. In the matter
of housing, for instance, we know we cannot build houses at less than
two or three times their prewar cost, and yet we cannot endure to see
the owners of pre-war houses obtaining a commensurate increase of
rent. And so, in Great Britain, we pass Rent Restriction Acts, and
Housing Acts, and then, in a fit of economy we suspend the latter, and
let the former stand, while the housing shortage becomes steadily more
acute. When we hand the railways back from State control to private
hands, our horror at the idea of the companies receiving larger money
profits than they did before the war leads us to lay down principles
for the fixing of fares and freight charges, which take no account of
post-war construction costs; and then, in alarm lest we may have
thereby made it unprofitable for the companies to spend a single penny
of fresh capital upon further development, we seek to provide for
capital expenditure by cumbrous and dubious expedients. Doubtless we
shall muddle through somehow with such policies: and, public opinion
being what it is, they may perhaps have been about the best policies
that were practicable. But the problems would have been easier to
handle, if the public generally were a little less disposed to think
in terms of averages, and a little more in terms of margins, if we all
of us instinctively realized that the cost that really matters is the
cost at which additional production is profitable under the conditions
ruling at the time, or in the immediate future.
§6. _General Relation between Price, Utility and Cost_. Let us
conclude this chapter by summing up the conclusions which have emerged
as to the relations of utility and cost to price.
The price of a commodity is determined by the conditions of both
supply and demand; and neither can logically be said to be the
superior influence, though it may sometimes be convenient to
concentrate our attention on one or other of them. The chief factor on
which the conditions of demand depend is the utility (as measured in
terms of money). The chief factor on which the conditions of supply
depend is the cost of production (again as measured in terms of
money). The prevailing trend towards an equilibrium of demand and
supply can thus be expressed as follows:--
LAW VI. A commodity tends to be produced on a scale at which its
marginal cost of production is equal to its marginal utility, as
measured in terms of money, and both are equal to its price.
CHAPTER V
JOINT DEMAND AND SUPPLY
§1. _Marginal Cost under Joint Supply_. Several references have been
made above to joint products, a relation which it will be convenient
now to describe as that of Joint Supply. Our sense of symmetry should
make us look for a parallel relation on the side of demand; and it is
not far to seek. There is a "joint demand" for carriages and horses,
for golf clubs and golf balls, for pens and ink, for the many groups
of things which we use together in ordinary life. But the most
important instances of Joint Demand are to be found when we pass from
consumers' to producers' goods. There, indeed, Joint Demand is the
universal rule. Iron ore, coal and the services of many grades of
operatives are all jointly demanded for the production of steel; wool,
textile machinery and again the services of many operatives are
jointly demanded for the production of woollen goods (to mention in
each case only a few things out of a very extensive list). Now we have
already noted that, when commodities are jointly supplied, there is an
obvious difficulty in allocating to each of them its proper share of
the joint cost of production. There is a similar difficulty in
estimating the utility of a commodity which is demanded jointly with
others. Thus, the utility of wool is derived from that of the woollen
goods which it helps to make. But the utility of the factories, the
machinery and the operatives employed in the woollen and worsted
industries is derived from precisely the same source. How much, then,
of the utility of woollen goods should be attributed to the wool and
how much to the textile machinery? Can we make any sense of the notion
of utility as applying to one of these things, taken by itself? And,
if not, how can we explain the price of a thing like wool in terms of
utility and cost, since we cannot disentangle its cost from that of
mutton, nor its utility from that of a great variety of other things?
Here the conception of the margin enables us to grapple with a problem
which would otherwise be insoluble. For, while it is impossible to
separate out the total utility and cost of wool, it is not impossible
to disentangle its marginal utility and its marginal cost. The
proportion in which wool and mutton are supplied cannot be radically
transformed; but it can be varied within certain limits, by rearing,
for instance, a different breed of sheep. Variations of this kind have
been an important feature of the economic history of Australasia,
where sheep farming is the leading industry. Before the days of cold
storage, Australia and New Zealand could not export their mutton to
European markets, though they could export their wool. Wool was
accordingly much the most valuable product; the mutton was sold in the
home markets, where, the supply being very plentiful, the price was
very low. In the circumstances, the Australasian farmers naturally
concentrated on breeding a variety of sheep whose wool-yielding were
superior to their mutton-yielding qualities. The development of the
arts of refrigeration led in the eighties to an important change. It
became possible to obtain relatively high prices for frozen mutton in
overseas markets. There was, therefore, a marked tendency, especially
in New Zealand, to substitute, for the merino, the crossbred sheep
which yields a larger quantity of mutton and a smaller quantity of
wool of poorer quality. Now if we calculate the cost of maintaining
the number of merino sheep which will yield a given quantity of wool,
and calculate the cost of maintaining the larger number of crossbred
sheep which will be required to yield the _same_ quantity of wool
(allowing for differences of quality) the extra cost which would be
incurred in the latter case must be attributed entirely to the extra
mutton that would be obtained. This extra cost we can regard as
constituting the marginal cost of mutton. So long as this marginal
cost falls short of the price of mutton, it will be profitable to
extend further the substitution of crossbred for merino sheep. The
process of substitution will in fact be continued until we reach the
point at which the marginal cost is about equal to the price.
Similarly by starting with the numbers of merino and crossbred
sheep which would yield the same quantity of mutton, we can calculate
the marginal cost of wool; and again the tendency will be for this
marginal cost to be equal to the price.[1]
[Footnote 1: It may be found difficult to grasp this point when stated
in general terms. The following arithmetical example may make it
plainer:--
Suppose a merino sheep yields 9 units of mutton and 10 units of wool.
Suppose a crossbred sheep yields 10 units of mutton and 8 units of
wool.
Suppose, further, that a merino sheep and a crossbred sheep each cost
the same sum, say, for convenience, £10, to rear and maintain; and
that there are no special costs assignable to the wool and the mutton
respectively, as, of course, in fact there are.
Then 10 merino sheep, yielding 90 units of mutton + 100 units of wool,
cost £100; while 9 crossbred sheep, yielding 90 units of mutton + 72
units of wool, cost £90.
Hence you could obtain an extra 28 units of wool for an extra cost of
£10, by maintaining 10 merino sheep rather than 9 crossbred sheep. The
marginal cost of wool is thus £ 10/28 per unit.
Similarly 8 merino sheep, yielding 72 units of mutton + 80 units of
wool, cost £80; while 10 crossbred sheep, yielding 100 units of mutton
+ 80 units of wool, cost £100.
Hence you could obtain an extra 28 units of mutton for an extra cost
of £20, by maintaining 10 crossbred sheep in place of 8 merinos. The
marginal cost of mutton is thus £ 20/28 per unit.
So long as the price obtainable for wool exceeds £ 10/28, and that
obtainable for mutton does not exceed £ 20/28 per unit, it will pay to
substitute merino for crossbred; and conversely. If the price of wool
exceeds £ 10/28 and the price of mutton also exceeds £ 20/28, it will
be profitable to expand the supply of both breeds, until as the result
of the increased supply, one of the above conditions ceases to
obtain. Conversely, if the prices of both products are less than the
figures indicated, sheep farming of both kinds will be restricted.
The resultant of the processes of expansion or restriction, and
substitution, will be that, unless one of the breeds is eliminated,
the prices of mutton and wool will equal their respective marginal
costs. These marginal costs may, of course, alter as the process of
substitution extends. For the relative cost of maintaining merinos and
crossbreds will not be the same for every farmer. Here again it is the
costs at the "margin of substitution" that matter.]
§2. _Marginal Utility under Joint Demand_. On the side of demand there
exist as a rule similar possibilities of variation. _Some_ machinery,
_some_ labor, _some_ materials of various kinds, are all indispensable
in the production of any manufactured commodity. But the proportions
in which these factors are combined together can be varied, and are
frequently varied in practice as the result of the ceaseless pursuit
of economy by business men. To produce pig-iron, you need both coal
and iron ore; but, if coal becomes more costly, it is possible to
economize its use. Machinery and labor must be used together, in some
cases in proportions which are absolutely fixed. But there is in
nearly every industry a debated question as to whether the
introduction of some further labor-saving machine would be worth
while, or some improved machine which would represent the substitution
of more capital plus less labor for less capital plus more labor. A
farmer can cultivate his land, to use a common expression, more
intensively or less intensively; in other words, he can apply larger
or smaller quantities of capital and labor (the proportion between
which he can also vary) to the same amount of land. The problem is
essentially the same as that of the substitution of the crossbred for
the merino. We can take the various possible combinations of the
factors of production, and contrast two cases in which different
quantities of one factor are employed, together with equal quantities
of the others. The extra product which will be yielded in the case in
which the larger quantity of the varying factor is employed can then
be regarded as the marginal product (or marginal utility) of the extra
quantity of that factor; and we can say that the employment of this
factor will be pushed forward to the point where this marginal product
will be roughly equal to the price that must be paid for it. We can
thus lay down the most important proposition that the relation between
marginal utility and price holds good generally of the ultimate agents
of production; that the rent of land, the wages of labor, and, we can
even add, the profits of capital tend to equal their (derived)
marginal utilities, or, as it is sometimes expressed, their marginal
net products.
Whenever, therefore, the proportions in which two or more things are
produced or used together can be varied, the relations of joint supply
and joint demand are perfectly consistent with a specific marginal
cost and marginal utility for each commodity.
§3. _A contrast between Cotton and Cotton-seed, and Wool and
Mutton_. But it sometimes happens that such variations cannot be
made. Thus, it has not been found possible (so far as I am aware) to
alter the proportions in which cotton lint and cotton-seed are yielded
by the cotton plant. Roughly speaking, you get about 2 pounds of
cotton-seed for every 1 pound of cotton lint (or raw cotton), and
though this proportion may vary somewhat from plantation to
plantation, it is upon the knees of the gods, and not upon the will of
the planter that the variation depends. We cannot, therefore, speak
with accuracy of the separate marginal costs of raw cotton and
cotton-seed. It is true that some plantations are so far distant from
any seed-crushing mill that it is not worth while to sell the seed as
a commercial product; and it might seem, therefore, as though we might
regard the entire costs of cotton growing on _such_ plantations as
constituting the marginal costs of raw cotton. But planters, so
situated, derive a considerable value from their cotton-seed by using
it as fodder for their live stock or as a manure. You can, of course,
argue that proper allowance is automatically made for this factor, as
a deduction from the costs of raw cotton, when you add up the expenses
of the plantation. In the same way you can deduct the price which a
planter who sells his cotton-seed obtains for it, from the total costs
of the plantation, and call the remainder the costs of the raw
cotton. But this is really to reason in a circle. For in either case
the magnitude of the deduction depends on the marginal utility of the
cotton-seed. And the notion of the cost of anything becomes blurred
and blunted if we so use it that it must be deduced from the utility
of something else, which is not an agent in the production of the
thing in question.
This point is not merely an academic one. It means that we cannot
explain the _relative_ prices of cotton lint and cotton-seed in terms
of cost at all, whether marginal or otherwise. The influence of cost
will be confined to the _sum_ of the prices of the two things. Upon
this sum it will exert precisely the same influence as it exerts upon
price in general, by affecting the total quantities of the two things
that will be supplied. But upon the distribution of this sum between
lint and seed, cost will exert no influence whatever, because it
cannot affect the proportions in which they are supplied. It may
assist some readers if I state the matter in more concrete terms. Cost
of production will be one of the factors which will result in the
production of an annual cotton crop in the United States of, let us
say, 10 million tons of seed cotton. This crop will yield roughly
6-2/3 million tons of cotton-seed, and 3-1/3 million tons (or rather
more than 13 million bales) of lint. The combined price received by
the planter of (let us say) 14.4 cents for 1 pound of lint plus 2
pounds of seed should correspond roughly to the marginal joint costs
of production. But the factor of cost has no influence at all in
determining that this combined price is made up of a price of 12 cents
per pound for lint, and only 1.2 cents per pound (or $24 per ton) for
cotton-seed. To account for this we must rely entirely upon demand. We
can say, shortly, that the respective prices must be such as will
enable the demand to carry off 6-2/3 million tons of seed, and 3-1/3
million tons of raw cotton. Or we can go further and say that the
marginal utility of a pound of raw cotton, when 3-1/3 million tons are
supplied, is ten times as great as that of a pound of seed when 6-2/3
million tons are supplied.
If accordingly the demand for cotton-seed were to expand considerably
owing, say, to the discovery of some new use for the oil, which is its
most valuable constituent; the effect would be first a rise in the
price of cotton-seed, and, subsequently, by stimulating cotton
growing, a more plentiful supply and a lower price for raw cotton. And
so far at least as the increased supply is concerned, this must
necessarily be the effect, "other things being equal"; though, to be
sure, it might be outweighed and obscured by other influences such as
the boll-weevil. But it is _not_ the case that an increased demand for
mutton must necessarily increase the supply or lower the price of
wool; and it is most unlikely to do so in any similar degree. For,
here, the separate marginal costs of the two things exert their
influence. An increased demand for mutton will stimulate sheep
farming, but it will also stimulate the substitution of crossbred for
merino breeds; and the resultant of these two opposite tendencies upon
the supply of wool is logically indeterminate. As a matter of history
we know that the development of cold storage in the eighties (which we
may regard for the present purpose as equivalent to an increased
demand for Australian mutton) caused considerable perturbation in the
woollen and worsted industries of Yorkshire. They were faced with a
dwindling supply and a soaring price of merino wool; and the
adaptability with which they met the situation, and won prestige for
the crossbred tops, and yarns and fabrics, to which they largely
turned is a matter of just pride in the trade to-day. The fact,
however, that this alteration in the supply of wool was a matter not
only of quantity but of quality, while it takes nothing from the
substance of the preceding argument, makes it difficult to draw a
clear moral, bearing on the present issue, from this incursion into
history.
§4. _The Importance of being Unimportant_. The above contrast between
cases in which variation is possible, and those in which it is not
possible, is reproduced with a heightened significance when we turn
back to joint demand. The cases are perhaps less common in which it is
_impossible_ to alter the proportions in which different commodities
are jointly demanded, but there are many cases in which it is not
nearly worth while to do so (and this amounts to very much the same
thing). Cases of this sort are especially likely to occur when we are
dealing with a commodity which accounts for only a tiny fraction of
the costs of the industry which is its chief consumer. Sewing cotton,
for example, is jointly demanded, with many other things, by the
tailoring and other clothing trades; but the money which these trades
spend on sewing cotton is so small a part of their total expenditure,
that no ordinary variation in its price is likely to make it worth
while to study the ways and means of using it in smaller
quantities. When sewing cotton is bought by the domestic consumer,
considerations which are fundamentally the same, though somewhat
different in form, point to a similar conclusion. It is thus very
difficult to assign to sewing cotton a specific marginal utility. This
difficulty is of great importance in connection with the possibilities
of monopolistic exploitation. For it means that the demand blade of
the scissors upon which we rely to cut off excrescences of price is
blunted, and if accordingly the producers constitute a strong enough
combination to control the supply blade, they will possess an unusual
power of advancing their selling prices as they choose. I am far from
suggesting that Messrs. J. & P. Coats are to be condemned as an
extortionate monopoly. On the contrary, during 1919, when the profits
in highly competitive industries like the main branches of the cotton
and woollen trades, soared exuberantly, the record of this concern
seems to me one of distinct moderation. But the present point is that
they possess an exceptional _power_ to fix the price of sewing cotton
as they choose, and that this is attributable in no small degree to
the fact that sewing cotton constitutes an essential but relatively
trifling item in the expenses of the processes in which it is
employed.
Perhaps the point will be made clearer if we turn from the selling
prices of commercial products, in regard to which there is a strong
and not ineffective public sentiment against "profiteering," to the
remuneration of different classes of labor. With an instinctive
disposition towards megalomania, it is often claimed in Great Britain
that the miners, being a very numerous and well-organized body of
workpeople, were in a stronger strategic position than most workpeople
for exacting the remuneration they desire. It is quite true that a
stoppage of work in the coal industry causes us a high degree of
inconvenience, and temporary concessions may thereby be obtained which
might otherwise have been refused. But this is a dubious advantage,
and we grossly exaggerate its real importance. The truth is that the
strategic position of the miners in regard to wages questions is by no
means strong. For their wages constitute a very large percentage of
the cost of coal; and the price of coal in its turn is a most
important element in the costs of many of the industries which are its
principal consumers. Great Britain, moreover, is far from possessing
a monopoly of coal. If, accordingly, the wages of the miners are
temporarily pushed up to a high point, the result will certainly be a
diminished demand for British coal, which will lead before long to
their fighting a losing battle to maintain the concessions they have
won. Contrast their position with that of the steel smelters, whose
wages (high though the wage rates are) constitute a very small
percentage of the costs of steel production, and we must agree I think
that we have in this distinction the main reason why the steel
smelters, though they hardly ever go on strike, have as a rule been
able to do so much better for themselves than the miners.
When a commodity or service is such that an appreciable alteration in
its price has only a slight effect upon the quantity demanded, the
demand is said to be _inelastic_. Conversely, when a small change in
price greatly alters the quantity demanded, we call the demand
_elastic_. In the former case, it is worth nothing, a larger aggregate
sum of money will be spent upon the thing when its price is high than
when it is low, while the opposite is true in the latter case. This
distinction is of considerable importance in connection with many
problems (e.g. of taxation); and the terms, elastic demand and
inelastic demand, are worth remembering. We may thus express the
above conclusions by saying that the demand for sewing-cotton is
highly inelastic, and that the demand for coal miners is more elastic
than that for steel smelters.
§5. _Capital and Labor_. Cases in which it is impracticable to make
any variation in the proportions in which different things are used
together are, however, the exception rather than the rule. Where
variation is possible, we are confronted with an uncertainty as to the
way in which an increased supply of one thing will react on the demand
for another, similar to our uncertainty as to whether an increased
demand for mutton would augment or diminish the supply of wool. It is,
for instance, of the highest importance to give a clear answer, if we
can, to the question whether an increased supply of capital will
increase the demand for labor. The chief effect of an increased
supply of capital is to facilitate the extended use of expensive
machines: to some extent these machines will increase the demand for
labor; to some extent they will be substituted for it. Which of these
two tendencies will outweigh the other we cannot be absolutely
sure. But fortunately we can be far more nearly sure than was possible
in the analogous case of wool and mutton. An increase in the supply of
capital increases the demand for the commodities, from which the
demand for labor is derived, in both the senses discussed in Chapter
II. First it makes them cheaper to buy, and thus increases the
quantity that will be bought. It is this that is parallel to the
effect of an increased demand for mutton in making it more profitable
to breed sheep. But it also serves to increase the purchasing power
with which to buy commodities, because it increases the aggregate real
wealth of the community, and it thus serves to raise the whole demand
curve. This last consideration is so important as to make it
overwhelmingly probable, apart from the evidence of history, that an
increase in the supply of capital (and the same may be said of an
increase in the supply of the other agents of production) will on
balance increase the demand for labor. The evidence of history points
to the same conclusion. The history of the last hundred years displays
an unprecedented accumulation of capital, and an unprecedented
extension of machinery, associated with an unprecedented improvement
in the standard of living throughout the whole community. This is
powerful testimony in favor of the view that an increase in the supply
of capital and the use of machinery will usually enhance on balance
the demand for labor. Moreover, though this is not conclusive, there
is little room for doubt that an obstructive attitude towards the
extension of machinery in a particular country, or a particular
district, is misguided. For its effect must be to make production
more costly there than it is elsewhere, and to lead, slowly perhaps,
but very surely, to the transference of the industry to other regions.
§6. _Conclusions as to Joint Supply and Joint Demand_. Here, however,
we are beginning to digress. Let us sum up in a general form our
conclusions as to the way in which changes in the supply or demand of
a commodity react upon the demand or supply of the other things with
which it is jointly demanded or supplied. Everything turns, as we have
seen, on the possibility of variation in the proportions in which the
things are used or produced together; and this, it is also clear, is a
matter of degree. Our conclusions, therefore, had best take the
following form:--
LAW VII. When two or more things are jointly demanded, in proportions
which cannot easily be varied, the tendency will be for an increase
(or decrease) in the supply of one of them to increase (or
decrease) the demand for the others. These results will be more
certain, and more marked, the more difficult it is to vary the
proportions in which the things are used.
Similarly, when two or more things are jointly supplied, in
proportions which cannot easily be varied, the tendency will be for
an increase (or decrease) in the demand for one of them to increase
(or decrease) the supply of the others. These results again will be
more certain and more marked, the more difficult it is to vary the
proportions in which the things are supplied.
§7. _Composite Supply and Composite Demand_. Joint Demand and Joint
Supply do not complete the list of relations between the demand and
supply of different things. Between tea and coffee, or beef and mutton
there is a relation of a different kind. These things are in large
measure what we call "substitutes" for one another. An increased
supply, and a lower price of mutton, will probably induce us to
consume less beef. This relation it is convenient to describe as
Composite Supply. Beef and mutton make up a composite supply of meat;
tea and coffee a composite supply of a certain type of beverage. For
any group of things, between which the relation of Composite Supply
exists, we can say, with complete generality, that an increased supply
of one of them will tend to diminish the demand for the
others. Parallel to the relation of Composite Supply is that of
Composite Demand. There are frequently several alternative uses in
which a commodity or service can be employed; and these alternative
uses make up a composite demand for the thing in question. Thus
railways, gasworks, private households and a great variety of
industries contribute to a Composite Demand for coal. It is worth
noting that there is frequently an association in practice between
Joint Demand and Composite Supply on the one hand; and between Joint
Supply and Composite Demand on the other. Wool and mutton, for
instance, we have described as an instance of Joint Supply; but, in so
far as the proportions of wool and mutton can be varied, we can regard
these things as constituting a Composite Demand for sheep. And this
conception may help us to retain a clearer and more orderly picture of
the problems we have discussed above. We can regard the fact that wool
and mutton are produced together as their Joint Supply aspect, and the
fact that these proportions can be varied as their Composite Demand
aspect; and the question as to whether an increased demand for mutton
will increase the supply of wool turns upon whether the former aspect
is more important than the latter. Similarly labor and machinery,
employed together for the same purpose, form an instance of Joint
Demand; but in so far as they can be substituted for one another, they
constitute a Composite Supply of alternative agents of production.
These four relations of Joint Demand, Joint Supply, Composite Demand
and Composite Supply are well worth remembering and distinguishing
from one another. They are of immense importance in every branch of
economic affairs. There are hardly any economic problems upon which we
are fitted to express an opinion, unless we have a lively sense of the
far-reaching ramifications of cause and consequence, of the subtle and
often unexpected interconnections between different industries and
different markets. To gape at these complexities in a confused stupor
is as foolish as it is to ignore them. But confusion and stupor are
only too likely to represent our final state of mind, if we attempt to
deal with these complications, one by one as they occur to us, in a
piecemeal and haphazard fashion. We need a clear method, a systematic
plan by which we may search them out, and fit them into place. The
four relations which we have enumerated supply us with such a plan and
method. For they represent something more than a series of pompous
names for familiar notions. They constitute a classification of the
various ways in which the demand and supply of one thing can affect
the demand and supply of others; a classification which is exhaustive
when we add the relation of derived demand, and an analogous relation
on the supply side which we must now notice.
§8. _Ultimate Real Costs_. Just as the utility of "producers' goods"
is derived from that of the "consumers' goods" which they help to
make; so the cost of any commodity is derived from the cost of the
things which help to make it. Moreover, just as we recognize that the
utility of "consumers' goods" lies at the back of all demand, and
constitutes the ultimate end of all production; so we cannot but feel,
however obscurely, that behind the phenomena of money costs, there
must lie certain ultimate costs, of which all money costs are but the
measure. But when we try to explain what the nature of these real
costs may be, we are plunged in difficulty. Wages, it may indeed seem
at first sight, present no trouble. There is the effort and the
fatigue, the unpleasantness of human labor, to represent real
costs. But can we suppose that these things are measured with any
approach to accuracy by the wages which are paid in actual fact? Is it
true, even as a broad general rule, that the services which are most
arduous and most disagreeable command the highest price? And wages are
not the only ingredient of money costs. There are profits: to what
real costs do profits correspond? More difficult still, to what does
rent correspond? These plainly are not questions upon which he who
runs may read. It will be necessary to devote the next four chapters
to their elucidation.
CHAPTER VI
LAND
§1. _The Special Characteristics of Land_. In the great process of
co-operation by which the wants of mankind are supplied, Nature is an
indispensable participant. She renders her assistance in an infinite
variety of ways, of which the properties of the soil which man
cultivates form only one; but the sunshine and rain which enable the
farmer to grow his crops; the coal and iron ore beneath the surface of
the earth, can be regarded for our present purpose as forming part of
the land with which they are associated. We can thus concentrate upon
land as the representative of the free gifts of nature, which are of
economic significance. Land in modern communities is for the most part
privately owned. It can be bought and sold for a price, and acquired
by inheritance. Moreover, it is a common practice, particularly in the
United Kingdom, for an owner who does not wish himself to cultivate or
otherwise use the land, not to sell it to the man who does, but to
lease it to him for a term of years for an annual payment which we
term rent. It is therefore natural and convenient to envisage the
problems, which we shall consider in this chapter, as problems
concerning the price and rent of land. But, once again, the laws and
principles which we shall state and illustrate in terms of the current
systems of ownership and tenure, possess a much deeper significance
than this terminology might suggest.
The fact that land is a free gift of Nature distinguishes it in
various ways from commodities which are produced by man. The
peculiarities which are most important from the economic standpoint
are (1) that the supply of land is, broadly speaking, fixed and
unalterable, and (2) that its quality and value vary, from piece to
piece, with a variation which is immense in its range, but fairly
continuous in its gradation. These are thus two aspects from which
the phenomena of price and rent can be regarded; aspects which it is
usual to call, (1) the scarcity aspect, (2) the differential aspect.
§2. _The Scarcity Aspect_. The fact that the supply of land is fixed
has the following significance. If the demand for land increases, the
price will tend to rise. This is also true, for a short period at
least, of an ordinary commodity. But, in the latter case, there would
ensue an increase in supply which would serve to check the rise in
price, and possibly, if production on a larger scale led to improved
methods of production, bring the price down eventually below its
original level. In the case of land, no such reaction is
possible. There is nothing, therefore, to restrain the price (and the
rent) of land from rising indefinitely, and without limit, if the
demand for it should continue to increase. Conversely, if the demand
for land falls off, there is nothing to check the consequent fall in
price and rent. In the case of ordinary commodities, the supply would
be diminished, because most things are either consumed by being used,
or wear out in the course of time, and a regular annual production is
therefore necessary to sustain their supply at the existing level. But
land remains, whether it is used or not; and its supply is, broadly
speaking, just as incapable of being diminished, as it is of being
increased. Changes in the demand for land in either direction are thus
likely to affect its price in a much greater degree than that in which
the price of an ordinary commodity will be affected by a corresponding
change in its demand.
For most purposes, however, it is of more interest to compare land
with other agents of production, especially with capital and labor,
rather than with ordinary commodities. Now, as we have already noted,
there is some doubt as to the manner in which the supply of capital or
labor is likely to be affected by alterations in demand price. But the
supply of capital and the supply of labor, even if we suppose them to
be as entirely unresponsive to price changes as is the supply of land,
are at any rate not fixed. Not only _may_ they vary for many reasons,
but they are in fact likely to vary in direct proportion to the
population. An increase in population implies an increase in the
supply of labor; and it is likely to be accompanied by an increase in
the supply of capital; in other words, the supply of these agents will
expand, as the demand for them expands. But the supply of land will
remain what it was. This fact is enormously important in connection
with the broad problem of population, which will form the theme of
Volume VI.
But it is important also in other connections. It has been the
dominating factor in many absorbing controversies upon high policy
regarding the ownership of land, or the taxation of land values, upon
which we can touch but lightly here. It has seemed to many writers a
reasonable proposition to lay down, that the ordinary course of the
progress of society, the increase of population and industry, must
mean, as a broad general rule, a constant increase in the demand for
land. And, if that be granted, it seems to follow that the price and
rent of land will tend constantly to increase. John Stuart Mill,
accordingly, in the middle of the last century, asserted that "the
ordinary progress of a society, which increases in wealth, is at all
times tending to augment the incomes of landlords; to give them both a
greater amount and a greater proportion of the wealth of the
community, independently of any trouble or outlay, incurred by
themselves,"[1] and upon the strength of this assertion, he justified
the policy of imposing a special tax upon what we have come to call
the "unearned increment" of land. But how far does actual experience
bear his assertion out? In Great Britain we have seen in the last
half-century an undoubted increase in urban rents; but over long
periods at least, there was a marked fall in both the prices and rents
of agricultural land, despite the fact that the country was
"increasing in wealth" as rapidly as ever before. This was due, of
course, in the main to the increased supplies of wheat and other
foodstuffs coming from the New World: and if, accordingly, we choose
to lump together not only our own urban and agricultural land, but the
land of other countries as well, and to speak vaguely of the demand
for land as a whole, it might seem as though we could argue that
Mill's generalization still holds good. But even this is by no means
certain and in any case such a generalization is of very little
service: what the illustration should rather suggest to us, is the
danger of speaking of land vaguely as a whole, and the importance of
turning our attention to the variations in value between different
kinds and different pieces.
[Footnote 1: _Principles of Political Economy_, by John Stuart Mill.]
§3. _The Differential Aspect_. Most ordinary commodities are not
produced on a single, uniform pattern. As a rule there are many
variations of grade and quality, and consequently of price. But these
variations are usually designed to meet the differences of taste among
the purchasers, and we do not expect to find that any variety of an
ordinary commodity will be produced, which is so poor in quality as to
be entirely valueless. But since it is nature which has produced the
land, without any assistance or guidance from man, there are many
pieces of land which are so unfertile, or are otherwise so unsuitable
for productive purposes, as to be quite valueless from the economic
standpoint. Even in a densely populated country like Great Britain,
there are considerable tracts of land which it is unprofitable to
employ for any economic purpose whatsoever, and which possess no
further value than what the mere pride of ownership may give
them. This fact makes it possible to apply the conception of the
margin to the case of land with particularly illuminating results.
In the first place, however, it should be observed that the value of
any piece of land does not depend solely on the intrinsic fertility of
the soil. The fact that land is an immobile thing makes its
_situation_ a factor of great importance. In the case of urban land,
situation is, of course, the only thing that counts. The value of a
site in Bond Street or the City is entirely unaffected by its capacity
or incapacity for potato-growing purposes. But even for agricultural
land, situation is a most important matter. A farm, which is so remote
that considerable transport charges must be incurred to bring its
produce to market, will be less sought after, and less valuable, than
one which is much better situated though somewhat less fertile. In
what follows, therefore, we must speak of the "quality" of a piece of
land in a broad sense to include advantages of situation, as well as
of fertility. Let us now, imagine the different pieces of land in
Great Britain to be arranged in order of quality, so that we have a
long series, with land of the best quality at one end, and of the
poorest quality at the other. At the latter end, we will have such
land as is found near the top of Snowden or Ben Nevis, which it
clearly does not pay to cultivate at all. Somewhere, then, between
these two extremes, we shall come to a point where the land is just,
but only just, worth cultivating, or where, to revert to a form of
words we previously employed, it is a matter of _doubt_, whether the
land is really worth using for a productive purpose. Such land we can
regard as the "marginal land"; and since the variety of nature is at
once infinite and fairly minutely graduated we shall probably find
that on one side of this margin there is much land which is only
slightly superior, and on the other, much which is only slightly
inferior, to the marginal land itself. What, then, is likely to be the
value and the rent of this marginal land, this land which is just on
the "margin of cultivation"? Some readers may find the answer
startling. The rent of the marginal land will be nil, because it will
not pay to cultivate it, if any appreciable rent is charged. A piece
of land for which it is worth a tenant's while to pay an appreciable
rent, will not be the marginal land, because there will be land just
slightly inferior to it which it will also pay to cultivate if a
somewhat lower rent is charged. And so we can pass to poorer and
poorer qualities of land, with an ever diminishing rent, until at the
margin of cultivation the derived utility of the land is negligible
and the rent vanishes.
This certainly is a somewhat abstract conception; but it is by no
means so remote from reality as may at first sight appear. The reader
may protest that in the course of an extensive and varied acquaintance
with landowners, he has not yet run across this peculiar marginal
type, who lets his land for no rent at all. But there, if his
experience is really extensive, I think he is mistaken. It so happens
that the ordinary agricultural landowner leases out his land, not by
itself, but together with a variety of other things such as farm
buildings, which it costs him a considerable sum of money to
provide. He will not as a rule be willing to go to this expense,
unless he sees his way to obtain for the farm an annual payment, which
represents at least a fair return on this capital outlay, as big a
return as he could have got, for instance, by investing the same
amount of money in some gilt-edged security. This annual payment
will, it is true, be called rent; but the significance of this is that
what we term rent in ordinary life is usually a complex thing, made up
of two essentially distinct elements, viz. the normal return on the
capital goods supplied together with the land, and what we may call
the "net rent," or the "pure rent" attributable to the land
itself. Now will any reader make so bold as to say that there is no
land under cultivation, in respect of which this net rent is either
nil or negligible? The landowners will not agree with him. It is not
a question, it should be observed, as to whether the rent obtained
represents more than a fair return on the purchase price paid for the
land; that is quite another matter. The question is whether the rent
obtained exceeds a fair return on the capital sum spent on the
buildings, etc.; with which every farm must be equipped to let at
all. In fact there are not a few farms where there is no such excess,
and where accordingly there is no "net rent" or "pure rent" which can
be attributed to the land.
The question whether it would be profitable to cultivate any piece of
land, turns upon whether the receipts which would be obtained by
selling the produce would exceed the costs of cultivation: and under
these costs of cultivation we must include, of course, the
remuneration of the farmer's services. Farmers, like other people,
have to live; and they would not take on the troublesome job of
farming, unless there seemed a prospect of making a living out of
it. The remuneration of the farmer takes, of course, the form not of a
salary, but of profits: and these profits vary very much from year to
year, and from place to place, and from man to man. But they are
essentially payment for work done, and an ordinary profit must be
regarded therefore as part of the necessary costs of farming. Thus it
will not be worth while to cultivate a piece of land, and the land
will in fact lie unused, upon which a careful farmer might obtain a
profit in the ordinary sense, of no more than $50 or $100 a year. The
marginal land will be land which yields a decent profit to a decent
farmer, as well as a gross rent to the landowner, sufficient to
compensate him for his capital outlay, but nothing further.
What, then, will be the rent of a fertile and well-situated farm,
about which there is no doubt that it is well worth cultivating? Part
of the gross rent which the landowner receives must again be regarded
as merely a return for the capital expended in equipping the farm for
use; but in this case, there will be a residue left over, which
constitutes the net rent of the land. The net rent will measure the
derived utility of the land to its occupier, and will in general
represent (very roughly, of course, in practice) the differential
advantage of cultivating the land in question rather than land on the
"margin of cultivation." This differential advantage may take either,
or both, of the forms, of a larger produce per acre, or a lower cost
of production and marketing. But, in any case, the extra profit,
which, if no rent were charged, a decent farmer could obtain by
cultivating the farm in question, rather than a marginal farm, will be
roughly equal to the net rent which his landlord can exact from him,
if his landlord so chooses. The landlord may, of course, not choose to
exact a rent as high as this; and as a matter of fact, in a country
like Great Britain landlords often content themselves with less. The
traditions associated with the ownership of agricultural land, and
with the relations between landlord and tenant serve to soften the
edge of economic law, and to subject the rents which are actually
fixed to the control in no small measure of the general sense of what
is fair or customary. In such cases the landlord makes the farmer a
present, for the time being, of part of the economic rent. On the
other hand, as Irish agrarian history well illustrates, the landlord
may sometimes expropriate under the name of rent, permanent
improvements which are due to the labors or the expenditure of the
tenant. This is, of course, particularly likely to happen, whenever it
is the custom to leave to the tenant the obligation of providing the
capital equipment of the farm, which in Great Britain is, for the most
part, the recognized duty of the owner. Again, in the case of urban
land in the South of England, expropriations of this kind are an
essential and well-understood feature of the leasehold system. The
owner grants a lease for a long period of time, usually ninety-nine
years, for a ground rent, which is notoriously below the true economic
rent of the land, subject to the condition that the leaseholder must
erect upon the land and keep in good repair certain buildings, which
on expiry of the lease will become the property of the ground
owner. Here the nominal ground rent is only part of the total rent
which is really paid; the ultimate transference of the buildings
representing often the more important part. There is, in fact, a great
variety of systems of land tenure, some of which are highly complex,
the respective merits of which vary greatly, and which constitute a
most important problem for statesmen and legislators. Considerations
of this kind in no way diminish the importance of the general analysis
of rent, which we are pursuing in the present chapter. Rather they
make it the more important, because we cannot properly weigh the
merits of any system of land tenure, until we have grasped clearly the
principles governing the rent of land in the purest form. But
certainly we must never forget that the rent we are discussing may
differ very greatly from, though it will vitally influence, the money
payments which are called rent in actual life. It is the pure economic
rent, the rent which represents the _full_ annual payment which it
would be worth paying to obtain the use of the land alone, which will
measure, as we have said, the differential advantage of the land in
question over land on the margin of cultivation.
A clear grasp of this relation helps us to perceive that an increase
in the prosperity of the community may sometimes influence rents in an
unexpected way. It all depends on the causes which have given rise to
the increased prosperity. An advance, for instance, in agricultural
science will facilitate a more abundant supply of foodstuffs; but it
will not necessarily increase the aggregate rents of agricultural
land. For if it takes the form, say, of the discovery of some new
artificial manure, it will very likely facilitate production on the
less fertile soils far more than it will on the more fertile soils
where artificial manures are not so necessary. It will thus tend to
diminish the differential advantages of working on the more fertile
farms, and their rents will accordingly fall, possibly by much more in
the aggregate than any increase in the rents of the farms near the
margin of cultivation. The point may, perhaps, be better understood if
we pass from agricultural to urban land, and ask what would be the
effect on site values of a great improvement in the facilities of
internal transport. Push the case to an extreme, and suppose passenger
transport to become so cheap and so quick that there ceases to be any
advantage in living in a town so as to be near your place of work.
Urban landlords would no longer be able to obtain the high rents they
now receive for the sites of houses in or near a town. For most people
would prefer to move out into the country where sites can be obtained
at little more than an agricultural rent. The country covers so large
an area relatively to the towns that the supply of rural sites would
be still very plentiful as compared with the demand. Their rents would
not, therefore, rise by very much, although the rents of the housing
sites in towns would fall heavily. Of course, there are other factors
to be taken into account before we could pronounce upon the effect on
aggregate rents. Central sites for shops might, for instance, fetch a
higher rental than before. The purpose of this discussion is not to
generalize but to show the danger of generalizing about rents in the
aggregate, or land as a whole.
§4. _The Margin of Transference_. The last illustration may serve,
however, to remind us of an obvious fact which we must now take into
account. The same piece of land may be used for a variety of purposes.
It may have been used for growing corn, and later it may be devoted to
the building of houses, or, as at Slough, to a repair depot for motor
vehicles. It need hardly be said that the land will, as a general
rule, be put to the use in which its value is greatest; or to speak
more strictly, in which the biggest rent, or the biggest selling price
can be obtained. But the notion of the differential advantages which a
piece of land possesses over the marginal land becomes decidedly more
complicated when we take account of this variety of uses. Let us turn
our attention, for instance, to the sites used for shop and office
purposes, and consider what we can regard as the marginal site in this
connection. Clearly it will not be the marginal land of which we
spoke above, which it only just paid to cultivate, and which yielded
no rent at all. For this will probably be agricultural land in an
out-of-the-way district, where no one would dream of setting up an
office or a shop. Any site upon which a sane man would contemplate
setting up a shop will certainly possess value for other purposes,
such as house-building. Hence the marginal site for shopkeeping
purposes will not be like our marginal farm, a site which yields no
rent.
As regards many pieces of land, there is no doubt as to the purposes
for which they can most profitably be used. This piece will command a
much higher rent as a shop site than in any other capacity; for that
piece house-building is the obvious employment; for another,
agriculture. But in quite a number of instances there is considerable
uncertainty. It is not clear whether upon this site it will be better
to erect a house or a shop, or if the latter, what kind of a shop. It
is not clear whether it will pay to use that farm land for a building
scheme; and, within the domain of agriculture, which of course
comprises an immense variety of really different industries, it is
often a very moot point indeed whether a certain field should be left
under grass, or brought under the plow. Cases of this sort are not
phantoms of the imagination; they emerge on every side as concrete
problems with which some one or other is dealing every day, and it is
these cases which constitute the marginal land for the purposes of a
particular occupation. The marginal sites for shops are the sites for
which it is only just worth while to pay rents sufficient to entice
them away from houses. And the rent for a site in Bond Street, or
elsewhere, which is so much more suitable for shop purposes that no
alternative use would be worth considering, will exceed the rent paid
for one of these marginal sites by, roughly speaking, the extra
advantage it possesses for shop purposes. Or will fall short of it, it
may be well to add, to the extent of its comparative disadvantage. For
there may be many such marginal sites, some of which will fetch low
rents, and others very high rents indeed; the same site being often of
great potential utility for a large variety of occupations. Between
any two occupations there will thus usually be a _margin of
transference_, which we must conceive not as a point, but as an
irregular line, upon or near to which there will be many pieces of
land, differing greatly in the rents which they fetch. These
variations of rent will correspond to the differences between the
advantages or derived utilities which the sites possess for _both_ the
occupations in question. The position of such margins of transference
will of course alter as industrial conditions change, and, when they
alter, the rents of sites which are not near any margin of
transference will be affected also. Thus an increased demand for the
products of any particular industry will make it profitable for that
industry to offer higher rents, and thus draw land away from other
occupations. This will have the effect of raising, though possibly to
a very slight extent, the rents of sites which still remain in other
uses; for there will be fewer of them available; and their derived
utilities will consequently be increased.
But here, as everywhere, it is upon the margin that our attention
should be focussed, because it is round about the margin (wherever it
is found) that the changes are taking place which really matter for
society. When Mr. Mallaby-Deeley buys an estate in Covent Garden from
the Duke of Bedford, the transaction hardly deserves the degree of
public interest it excites. Nothing has happened which is of material
consequence to anyone except the two gentlemen concerned; the various
sites are still used for the various purposes for which they were used
before; nothing has occurred that really matters. But when houses are
pulled down for the erection of a cinema, or when a field is diverted
from tillage to pasture, something has happened which affects for good
or ill the interests of the whole community. Conversion from tillage
to pasture represents, indeed, a tendency which has been very marked
in Great Britain during the last generation, and has aroused
misgivings in many public-spirited observers. Possibly for a variety
of reasons, these misgivings may be justified; certainly the problem
is well worthy of attention. But when in this way the issue is raised
of tillage versus pasture, it is essential, if we are to discuss it
rationally, that we should envisage it clearly as applying only to a
limited portion of agricultural land, to the portion which lies
somewhere near the margin of transference, as things are now, between
the two forms of agriculture. It might be socially desirable to bring
under the plow a field which the farmer finds it only _slightly_ more
profitable to lease under grass; but this would be highly improbable
in the case of a field where the balance of argument to the farmer in
favor of pasture is overwhelming. The position of the margin of
transference between different uses may, in other words, be somewhat
out of place from the social point of view, and it may be desirable by
appeals and propaganda, even conceivably by the devices of State
subsidy and compulsion, to push it forwards or backwards in greater or
less degree. But it will be necessarily a matter of degree, and
nothing could be more foolish than to speak as though there was, or
could be, some ideal method of cultivation equally applicable to all
lands, without regard to their climatic and other conditions. Needless
to say, none of the agricultural experts who sometimes deplore the
decline of arable farming are guilty of such foolishness. But the
sense of the diversity of nature which is very vivid to them may
sometimes be lacking in people who live in towns, and a firm grasp of
the marginal notion may serve best to keep the latter from forgetting
it.
§5. _The Necessity of Rent_. Behind all such detailed applications
there lies a more general consideration which deserves attention. The
way in which the land of a country is used, the way in which it is
apportioned between the countless alternative employments that are
possible, is a most important matter, more important perhaps than any
questions as to the size of the incomes which particular landowners
receive by virtue of their rights of ownership. How is this
apportionment effected as things are now? The answer is clear: mainly
by the agency of either rent or price. The business which finds it
worth while to offer the highest rent or the highest price for any
piece of land will, as a rule, be able to command its use. And, with
this as the governing principle, an apportionment is secured between
shops, offices, factories, agriculture, between the immense variety of
different employments covered by each of these broad headings; not a
rigid unvarying apportionment, but one which constantly changes as
economic circumstances change, and as the margin of transference
between different occupations moves hither and thither. This
apportionment takes place at present as the result of the independent
decisions and bargains of many private individuals, who are thinking
mainly of their own interests, and not of those of the community. But
this state of affairs might be altered. The land might be nationalized
and allocated to its various uses by the co-ordinated labors of a
great State department, or some other agency of the collective
will. However improbable such a change, it is perfectly conceivable.
But what is not conceivable is that any State department should handle
the job with a success even approaching that of the present system,
unless it continued to use, as its main instrument, the criterion of
either rent or price. That a piece of land would yield a higher rent
in one occupation than in any other is not conclusive evidence that it
is best to devote it to the former purpose, but it is very good
evidence, and it should be allowed to prevail unless it is
demonstrably outweighed, as it possibly might often be, by
considerations of a different kind. That it would not be well for the
community to employ land in the city of London for corn-growing
purposes, however desirable might be a revival of home agriculture, is
so obvious that it may seem to have no bearing on the present issue.
But it is only an extreme indication of the absurd and wasteful use of
our natural resources, which would grow up slowly but surely, if we
dispensed with ideas of rent and price as sordid irrelevancies, and
allocated our land on the basis of a balancing of the loftiest
arguments of a vague and sentimental character. If you are prepared
for the distribution of land to become stereotyped, for each piece to
continue indefinitely in its present use, then indeed you might
dispense with rent, as primitive societies very largely do. That would
mean stagnation and, for an industrial country, decay. But if changes
are ever to be contemplated, a simple quantitative measure is the only
safeguard against utter chaos. Thus rent, like interest, will be found
indispensable as a measure under any efficient system of society, even
if it might not always represent the payment of sums of money to
private individuals. And that is why the principles governing rent
possess, as I indicated at the outset of this chapter, an importance
more fundamental than our present system of ownership and tenure.
§6. _The Question of Real Costs_. But we must not forget the
preliminary question that started us upon our analysis of the agents
of production. The rent which a manufacturer or farmer has to pay for
his land he naturally includes in his cost of production. But does
this money cost to the individual correspond to, and measure, any real
cost to the community as a whole? Here let us note in the first place
that if only we could disregard the variety of uses to which land is
put, if we could suppose that all industry was agriculture, and that
agriculture was a single industry with a single product, we could
argue that rent does not enter into marginal costs at all. For we
could regard the marginal producer as the one working on a marginal
farm, whereas we have seen there is no pure rent. The rent which other
producers have to pay would thus represent merely the destination of
the surplus profits which arise wherever actual costs fall short of
marginal costs. This way of looking at the matter has proved
attractive to some thinkers, not in the least because of a desire to
palliate the effects of landlordism, but because it fits in so well
with our general sense of rent as a "surplus," and a surplus as
something distinct from a necessary price. But it is clearly
illegitimate in an economic theory which professes "to describe the
facts." The marginal land for many purposes fetches, as we have seen,
a considerable rent; and this rent is certainly part of the marginal
costs and of the necessary price of the products of the particular
industry. The answer to our question is, however, not now very
difficult to see. Land, greatly as it differs in many respects from
the other agents of production, resembles them in the very important
respect that, being used for one purpose, it is not available for
other purposes, and that the productive powers of the community in
other directions are thereby diminished. This is the real cost to the
community, which attaches to the products of any industry, in virtue
of the land which it occupies; not any human labors or sacrifices
required to produce the land itself, but the curtailment of the
natural resources available for productive use elsewhere. This is the
real cost of which rent is the money measure, and generally speaking
an accurate measure at the margin of transference between one
occupation and another. A somewhat fanciful use of the term cost, this
may seem perhaps, one not quite in accordance with our instinctive
sense of what real costs should be. But possibly the real costs
represented by wages and profits may turn out to be not so very
different, and we had best leave the matter there, until we have
examined the nature of these other costs.
§7. _Rent and Selling Price_. In this chapter we have spoken mainly of
the rent rather than the price of land: the relation between the two
things is fairly obvious and well understood, but it will be well not
to close the chapter without a brief account of it. The price of any
piece of land is affected by all the considerations on which its rent
depends, but it is also affected by another factor which has no
influence whatever upon rent. This factor is the rate of
interest. The higher the rate of interest, the higher the return which
a man could obtain by buying gilt-edged securities, the lower will be
the price that he will pay for a piece of land which yields a given
rent. We can express the relation more precisely by the formula Price
= (Rent * 100)/(Rate of Interest), though we must be careful, in
applying this formula in practice to allow for the possible deviations
between the nominal and the true rent, and similar complications. The
price, it must be observed, is derived in this way from the rent, not
the rent from the price.[1] Rent is thus logically the simpler, price
the more complex thing. It is well, therefore, to analyze in the
first instance the principles of rent, if we live in a country where
the practice of leasing land for annual rent is less common than it is
in Great Britain, even if, for whatever reason, it is the price of
land with which we are concerned in practice. The problem of price
contains two distinct elements which it is not easy to handle when
mixed up together. For the rate of interest represents in itself an
important branch of economics, which will require a separate chapter
to itself.
[Footnote 1: In this the rent of land differs fundamentally from that
of other things, such as houses. For the price of a house is largely
influenced by the costs of construction of new houses, and should
correspond closely to them in the long run. The same relation between
rent, price and rate of interest will hold good; but the rents will be
affected by changes in the rate of interest, owing to the reactions of
such changes on the supply of houses.]
CHAPTER VII
RISK-BEARING AND ENTERPRISE
§1. _Profits and Earnings of Management_. The profits of a business,
as they are ordinarily reckoned, whether for the purposes of income
tax or of a balance sheet, comprise several elements which are
fundamentally distinct. The relative importance of these various
elements varies greatly from one type of business to another. The
profits of a private business include, for instance, the remuneration
of the work of management, which in the case of a Joint Stock Company
is mostly paid for by salaries or directors' fees. It is to their
profit that farmers, small shopkeepers, and the partners of a private
firm look not merely for a return upon their capital, but for the
reward of their own labors. "Earnings of Management," as they are
usually termed (though in truth they often cover other and humbler
forms of labor) are thus frequently one of the ingredients of profits.
§2. _The Payment for Risk-bearing_. There is another element of great
importance about which our ordinary ideas are apt to be so vague that
it will be well to devote a chapter to its examination. This is the
element of payment for risk, or rather the reward of risk-bearing.
Risk is inherent in all business, as it is inherent in all life. The
vagaries of nature and the vagaries of man are alike responsible. The
farmer may find his harvest ruined by a drought or by a deluge; the
coal or the gold, for the extraction of which you have perhaps set up
an extensive mining plant, may come to an end which is unexpectedly
abrupt. You may put your money into roller-skating rinks and find that
cinemas have become the rage with the fickle public; sometimes "the
market" may decline for causes which remain obscure but with
consequences which are disagreeably plain. But while risk is always
present in some degree, the degree varies enormously from one industry
to another. Now, it is obvious enough that in an exceptionally risky
industry, where there is a considerable possibility that the capital
invested will yield no return at all, the profits of those concerns
which succeed are likely to exceed the rate of interest on gilt-edged
securities. But what is likely to be the magnitude of this excess? Is
risk-taking rewarded if there is any such excess, however small? Or
will it suffice that the gains and losses should average out to a fair
rate of interest over the whole industry? To enable us to think
closely let us suppose for a moment that we can measure accurately
what the chances are.
Suppose, then, that there were a precisely equal chance of success on
the one hand and failure on the other in any enterprise, failure
involving a complete loss of all the capital invested. Suppose,
further, 6 per cent to be at the time a fair return on a perfectly
secure investment. What would be the return which must be expected
from the risky enterprise, in the event of its succeeding, before it
will be undertaken? The reader may be tempted to answer, 12 per cent.
But 12 per cent would not suffice. An equal chance of 12 per cent or
nothing, as compared with a certainty of 6 per cent, does not mean
that the risk in the former case is paid for to the tune of 6 per
cent. It means that it is not paid for at all. In each case what a
mathematician would call the _expectation_ is a return of 6 per
cent. The odds are evenly balanced; in the long run, over a large
number of cases, if the law of averages works as we assume it does,
you would get just as much from the one type of investment as the
other. Now, risky enterprises will not, as a rule, be undertaken on
terms like these; investors and business men will not take risks with
the odds precisely equal; they must have them, or believe that they
have them, in their favor.
§3. _Monte Carlo and Insurance_. To assert this is not to ignore the
strength of the appeal which the gambling instinct makes to many, if
not to most of us. The taste for gambling is, indeed, so deep and
widespread that it would be foolish to leave it out of account in this
connection. It is clear enough that at places like Monte Carlo people
are prepared to have the odds unmistakably against them, apparently
for the sheer pleasure and exhilaration of taking risks. Moreover,
though for most people play at Monte Carlo represents a mere holiday
indulgence, it would be unsafe to assume that what appeals to them
there will not also appeal to them in their business affairs. But what
exactly is the secret of the charm of Monte Carlo? It is the great
attractive force of a small chance of a large gain, as compared with
the deterrent force of a large chance of a small loss. People will
readily pay $5 for one chance in a hundred of making no more, perhaps,
than $400 or $450. And it is very likely that this holds good in the
world of business. If, for example, we were to suppose that the
promoters of a new enterprise were confronted with one chance in fifty
of a profit of 50 per cent per annum on their capital, as against
forty-nine chances of a profit of 5 per cent, this might well prove a
more attractive prospect than a certain return of 6 per cent, although
the strict _expectation_ of profit would be smaller in the former
case. But the risks of business enterprise are not often of this
type. They conform more usually to the opposite type of a large chance
of a relatively small gain, balanced by a small chance of serious loss
or entire failure. Now for almost everyone the possibility of a great
loss will count as a deterrent (just as the possibility of a great
gain may count as an attraction) for much more than its strict
actuarial value.
The truth of this proposition is demonstrated by the existence of
institutions more impressive than Monte Carlo--the Insurance
Companies, which play so large a part in the economic life of modern
times. Every year, and upon an ever-growing scale, both private
individuals and business concerns pay sums of money, which reach in
the aggregate a colossal sum, as premiums to insure themselves against
loss by Fire, Shipwreck, Burglary, Death, Death Duties, against every
risk which Insurance Companies will cover. Now Insurance Companies
are not, as we say, in business for their health. They find their
business profitable, and pay good dividends to their shareholders.
Moreover, they incur a considerable expenditure on offices, on
clerical staff, on agents, and the like. All these payments must be
defrayed out of the premiums they receive; so that it is plain that
the premiums greatly exceed the _expectation_ of the risks insured.
The odds are heavily in favor of the Insurance Company--of that the
stupidest person can have no shadow of doubt. Yet we continue to
insure, as private individuals and as business men, and so far from
being ashamed of our proceedings as a weak and nerveless folly, which
somehow we are unable to resist, we blazon them forth in the strong
accents of conscious pride. We preach insurance to our neighbors as
the core of self-regarding duty, and, if ever we feel a twinge of
uneasiness, it is lest we, too, may have omitted in some particular to
practice what we preach.
The significance of this is unmistakable. Be our psychology what it
may, however deep and irrepressible our taste for derring-do, however
inadequate the scope which the dull routine of modern life affords for
our adventurous impulses, we are most of us anxious to avoid the risk
of great financial loss. We are very glad to find someone to take it
off our shoulders if we can; so glad that we are prepared to pay him
for the service, to pay him a sum which covers not only the actuarial
equivalent of the risk, but something substantial over and above. In
this we are entirely rational. Our conduct is justified by the law of
the diminishing utility of money, which was noted at the end of
Chapter III. It would be plainly foolish, for instance, to substitute
for the certainty of an income of $2500 per annum an even chance of
$5000 or nothing, since the utility to us of $5000 is not twice as
great as that of $2500.
The majority of business risks are not of a kind against which it is
possible to insure. Insurance companies confine themselves to risks
which are mainly a matter of what we call objective rather than
subjective chance, i.e. risks in respect of which knowledge of
detailed facts peculiar to the individual case is of minor
importance. But such knowledge is of paramount importance in the case
of ordinary business risks. If, for example, a new enterprise is to be
undertaken, the special knowledge and experience which its promoters
possess is a vital factor in determining their estimate of the risk
involved. An outsider with no special knowledge would necessarily
require to estimate the risk far more highly if we were to form a
rational opinion on the basis of _his_ knowledge. So great, indeed,
would be the risk to him, that we can lay it down as a sound maxim
that people are extremely rash who invest their money in risky
undertakings about which they know very little. This subjective aspect
of business risk has a significance to which it will be necessary to
revert.
But, though most business risks are not and cannot be a matter for
premiums and policies, the principle, which the practice of insurance
illustrates, applies none the less. In the light of their knowledge
and experience, the promoters of a new undertaking must weigh up the
chances of failure and success, though they will not do so by the
precise methods of an actuary. They will require that any chances of
serious loss should be balanced by such chances of exceptional gain,
as would raise the _expectation_ of profit well above the normal
return on secure investments. The more risky the project seems the
greater, generally speaking, must be the _expectation_ of profit
required to induce people to undertake it.
If we suppose business men to calculate reasonably, it follows that
the average profits in any industry over a long period of years,
reckoning in the losses of the concerns which disappear altogether,
are likely to be higher, the more risky is the industry. Such a result
will not, of course, occur in every case. Even when the calculations
are reasonable, they may be entirely falsified by the event. Moreover,
business men may not calculate reasonably on the information which
they have. But, unless we suppose their judgment to be subject to a
prevailing bias in one direction, i.e. to be unduly optimistic as a
general rule, _we_ should expect, and in any case _they_ must expect,
profits above the ordinary in a risky industry.
This conclusion is sufficiently important. Far too many people, though
they admit it when it is expressly stated and dismiss it even as a
tiresome commonplace, are apt to neglect it when the occasion for
applying it arises. For example, the great importance to any industry
of good management is generally recognized, and the consequent
desirability of paying adequate salaries to the managerial staff. The
importance of securing a supply of capital is very widely recognized,
and the practical necessity of paying a fair rate of interest is thus,
however grudgingly, conceded. But the "residuary profits," as they
are called, which accrue at present to the owners of a business, are
denounced in some quarters in a sweeping fashion, which seems to
ignore altogether the all-pervading element of risk. People speak as
though you might appropriately limit profits in every industry to some
uniform percentage on the capital employed, without making it clear
whether you would even be allowed to make up in good years for the
losses incurred in bad. The effect of introducing any such crude
device into our present industrial system could only be to paralyze
enterprises of an unusually risky kind, which, so far from being
pushed to an excess at present, are more probably curtailed unduly
from the standpoint of what is socially desirable. Like the fixing of
a low maximum price for a commodity it would cause the supply to
wither up and disappear.
§4. _Risk under Large-scale Organization_. While this is true of the
present economic system, the question is worth considering whether it
represents a fundamental necessity, whether, for instance, under our
world socialist commonwealth the factor of risk-bearing need play so
important a part as it does in the actual business world. This
question cannot be answered with a conclusive simplicity; opposing
considerations present themselves, between which it is not easy to
strike a balance. On the one hand, in accordance with the law of
averages gains and losses tend to cancel out over a large series of
transactions, _when reasonable calculations have been made_. Thus
Insurance Companies, while they take heavy risks off the shoulders of
policy-holders, incur relatively trifling risks themselves; they can
predict the aggregate sums which they will be called upon to pay
within a small margin of error. In the same way it might seem that
every enlargement of the scale of business would make for an automatic
insurance and a consequent economy of risk; and thus that if all
businesses were comprised in a single financial unit, gains and losses
would cancel out over so wide a range that the degree of risk
remaining would be almost negligible.
This might indeed happen, if business risks were mainly of that
objective kind in which the insurance companies specialize; for then
we could assume that the chances of success or failure would be
estimated reasonably. But, in fact, most business risks, not being of
this kind, must be estimated by processes of human judgment, which are
very fallible. And here we must take account of the law of averages in
another aspect, with a different bearing on the argument. When an
industry comprises a large number of separate concerns, and the
decisions accordingly are taken by many men, acting independently of
one another, the errors of calculation will tend to some extent to
cancel one another out. The undue optimism of one man will be balanced
by the undue pessimism of another; and, if there is no prevailing bias
in either direction, the errors of judgment will not affect the
results for the industry as a whole. But where the effective decisions
are taken by very few men, the chances are far greater of a
preponderating balance of error in one direction. The risks dependent
on the factor of human judgment tend therefore to increase.
This truth can be illustrated by a phenomenon which is fairly
familiar. It is recognized by intelligent persons that the risks of
speculation in a particular commodity market or stock market increase
more than proportionately to the scale of operations. A man who sets
out as a "bull" upon a small scale can buy without sending up the
price against him in the process, and, if he decides later that his
judgment is mistaken, he can at any time cut his losses and sell out
without much difficulty. But a "bull" on a very large scale cannot
complete his purchases except at a price which has been raised in
consequence of his own action, and he cannot count on being able to
"unload" at or near the market price, should he decide to do so. If,
accordingly, he miscalculates, he cannot save himself from serious
loss as a smaller man might do by a prompt discovery of his error. His
difficulties spring from the fundamental fact that the effects of his
calculations are too great to be offset by those of the different, and
often opposite, calculations of other men.
Upon the issue whether a growth in the size of the business unit is
likely to diminish risk, the law of averages thus cuts both ways. The
risks arising from the element of pure chance are more likely, those
arising from miscalculation are less likely, to cancel out. Upon
these grounds alone, it would be unsafe to conclude that there would
be on balance an economy of risk under any system of national or world
socialism.
§5. _The Entrepreneur_. There remains, however, an aspect of the
problem which is perhaps more important than those discussed above. It
is probable that risks would be estimated and undertaken more wisely
or less wisely under a different system of society or of industrial
organization? Upon this issue, methods of precise analysis are out of
place, but we may have something to learn from the emphatic testimony
of tradition. It has become an axiom of business men that, while
Governments can manage with more or less competence a safe and routine
business like a Postal Service, their success would be unlikely to
prove conspicuous in undertakings where the element of risk is
great. There, it is said, we owe everything in the past to the
enterprise of individual men (for even joint-stock companies have not
been notable as pioneers) adventuring their own fortunes in accordance
with their own unfettered judgment. This contention, however much we
may desire to qualify it, has unquestionably a large measure of truth,
and the explanation is not difficult to discover. For the wise taking
of risks in industrial development of an experimental character,
peculiar conditions and special qualities are required. First, it is
necessary to envisage distinctly the promising though risky
opportunity, and this calls not infrequently for imagination of a none
too common order. Then it must be studied with insight and expert
knowledge and weighed by processes which are as much intuitive as
intellectual. The reasons for or against taking a particular business
risk are seldom such as can adequately be expressed in terms of
arithmetic, or even by clear arguments the soundness of which is
proportioned to their logical cogency. The mysterious faculty of
judgment enters in; and from mental processes which defy analysis
there emerge ultimately conviction and the will to act. But it is
precisely here that Government Departments are apt to fail. It is here
that the individual, who need consult no one but himself, has a pull
over any form of organization, where decisions are reached by the
method of debate and agreement among a heterogeneous committee. Hence
it is that we have come to regard exceptional risk-taking as the
peculiar province of individual enterprise. It is probable that these
deficiencies of corporate organization are tending to diminish, and it
is an interesting question how far it may be found possible to
eliminate them in the future.
Meanwhile the above considerations have an important bearing on the
rewards which can often be obtained from risky enterprises. The number
of individuals who are in a position to envisage a business
opportunity, and to assess with some confidence the chances of success
and failure is very limited. Not only must they possess special
knowledge, ability, imagination, confidence in their own judgment, and
the capacity to act on it; they must also have at their disposal
considerable financial resources. To combine all these advantages
represents a union of circumstances which is distinctly rare. The
fortunate few, who do combine them, are thus generally able to extract
in the form of profits a high price for their services, a price which
covers not only the strict reward of risk-bearing, and the necessary
remuneration of their own service, but a handsome payment for the
special qualities and advantages which have been indicated. Profits,
moreover, may vary between one industry and another, not only in
accordance with the real risk which is entailed, but with the degree
to which the supply of special knowledge, etc., is scarce or abundant.
This consideration goes a long way to explain the large fortunes which
enterprising business men are often able to amass. It also throws some
much-needed light upon the functions which such men discharge. They
perform to a large extent the work of management; they supply capital
on what may be a considerable scale; but it is the taking of business
risk which is perhaps their most characteristic function. It is the
union of these functions which distinguishes them as an essentially
different type from the salaried manager who has invested his savings
in rubber or in oil. In other languages there is a specific name for
the man who combines all these three functions; in French he is called
an "entrepreneur," in German an "Unternehmer." It is much to be
regretted that in English we have no clear corresponding word. The
word "capitalist" is not uncommonly employed to do duty in this
connection, but this is a source of much confusion. For the word is
also used, and more appropriately, to include all investors, whether
or not they are active business men.
§6. _Risk-taking and Control_. But there is an allied confusion of
more importance. We commonly suppose it to be a leading feature of our
present "capitalist system" that the control of industry rests in the
hands of those who supply the capital. Nor, as a general statement, is
this untrue. But it conceals the essential point. Strictly speaking,
it is risk-taking with which control is associated. The mere lending
of money carries with it no title to control. Governments and
municipalities concede no such title to the subscribers to their
loans; nor does a company to its debenture holders. The shareholders'
ultimate control is based upon the fact that they bear the financial
risks of the concern. Nor is this a matter of mere legal form. It is
not uncommon for ordinary shares to carry with them a greater voting
power than the preference shares of a corresponding value. The
principle which such arrangements endeavor to express is clear:
control should rest with him who bears the risk. It is with this
principle rather than with a mulish insistence on the rights of
property, that advocates of "workers' control" and the like have got
to reckon. It is upon this ground that (as they may quite conceivably
do) they must make good their case.
§7. _General Analysis of Profits_. Let us conclude this chapter by
clearing the ground for the next. Earnings of management, payments for
risk-taking and for the special knowledge and advantages associated
with it, are ingredients of the gross profits of a business. The chief
element that remains is that of interest on capital. Frequently,
indeed, it is not the only one. As we saw in the last chapter, a
farmer may not be required by his landlord to pay the full economic
rent for his farm; and he may therefore make profits above the normal
level, above the ordinary return for his own services, his own capital
expenditure, and the risks to which he is necessarily exposed. In such
a case the farmer is really the recipient, as we have already
suggested, of part of the economic rent of the land; and an element of
rent accordingly enters into his gross profits. But profits may
include a surplus element which may arise in a great variety of other
ways. A business may possess some decided advantage which is not open
to competitors; and it may reap high profits accordingly. You can,
for instance, if you choose, regard the high money profits, which, as
was suggested in Chapter IV, are likely to accrue in future to the
owners of pre-war factories, as a surplus profit of this kind. But
while, as this illustration indicates, the phenomenon of surplus
profits becomes of very great importance when we seek to study the
distribution of wealth, it need not detain us here. For the surplus
element arises only in so far as the costs of a business are lower
than the marginal costs; and it is the marginal costs, which, with
good reason, we are now endeavoring to analyze. The marginal costs
must include a normal profit, i.e. a profit which will cover earnings
of management, the reward of risk and enterprise, interest on capital,
but nothing further. It remains, then, only to consider this last
element of interest.
CHAPTER VIII
CAPITAL
§1. _A Reference to Marx_. Interest is the price paid simply for the
use of capital. But what is capital, and in what does its use consist?
What claim has it to be regarded as an independent factor of
production? Our very familiarity with the term, our habit of employing
it with the rich looseness of every-day life is an obstacle to the
clearness of thought, which is again essential. We recognize, most of
us, clearly enough that capital, although we reckon it in terms of
money, consists, like income, of real things; factories, machinery,
materials and the like. It is quite obvious that these things are of
use, are, indeed, indispensable for production; what more natural than
that capital should command a price? It almost seems as though we
might pass, without further ado, to a detailed discussion of the
forces which determine the amount of this price.
But this account does not bring out the essential point as brief
reference to a very famous controversy will show. Some ingenious
writers in the last century, the most notable of whom was Karl Marx,
set out to prove that, in our modern society, workpeople are
"exploited," robbed of the "whole produce of their labor," to the full
extent of the return which accrues to capital. The argument was
exceedingly complex in detail; but it boils down to this: The
factories and machinery which are admittedly essential to production
were themselves produced in exactly the same way as consumable
goods. They were produced by labor, working with the assistance of
nature, and, again, if you choose, of capital in the form of further
factories, machinery, etc. But these further capital goods can in
their turn be regarded as the product of labor, nature and capital;
and so we can proceed until it seems as though the element of capital
must disappear in the last analysis, as though labor and nature were
the sole ultimate agents of production, and the reward of capital
represented no more than the exercise of the exploiter's power. In one
form or another this argument still dominates the minds of a large
proportion of the so-called "rebels" against the existing social
order.
If we are to meet this argument, if, which is perhaps more important,
we are to understand the true nature of capital, we cannot rest
content with saying that it consists of factories and machinery, and
that these are essential to the worker. Just as it was well to get
behind the money terms, in which we often think of capital, to the
real goods; so we have now to get behind the real goods to something
else. What this something else is, the first chapter may have already
done something to reveal.
§2. _Waiting for Production_. Between production and consumption there
is an interval of time. All productive processes take time to
accomplish. The farmer must plow the soil and sow the seed months
before he can reap the harvest which will reward him for his
efforts. Meanwhile, he must live, and in order that he may live he
must consume. If he employs laborers he must pay them wages, that they
too may consume and live. For both purposes he requires purchasing
power, which represents of course command over real things; and if he
has not sufficient purchasing power of his own, he must borrow from
someone else who has. In either case it is not enough that the farmer
and his laborers should work; no less essential is it that someone
should _wait_. The farmer must wait till he has sold his crops, both
for the reward of his own labor and for the repayment of the wages he
advances in the meantime to his laborers. Or, if he cannot afford to
wait, and borrows in anticipation of the harvest, then the lender must
wait, until the farmer, having sold his crop, is able to repay
him. Thus the period of time involved in all production gives rise to
a demand for _waiting_, which someone or other must supply, if the
production is to take place. It is this waiting which is the essential
reality underlying the phenomena of capital and interest. It is really
this which constitutes an independent factor of production, distinct
from labor and nature, and equally necessary.
§3. _Waiting for Consumption_. But let us carry the argument a step
further. After the farmer has sold his crops, there are many stages
through which they must pass, at each of which more waiting is
required, before they reach the ultimate consumer. But then the
waiting is at an end.
This, however, is by no means the case with a great number of
commodities. Let us take the case of a speculative builder. While he
is building a house he, like the farmer, must wait (or find someone to
wait on his behalf), for his own reward, and for the repayment of his
expenditure on wages and materials. But, after the house is built, if
he lets it to a tenant for an annual rent, his waiting is far from
over. Not until many years have passed will the rent payments add up
to a sum which equals or exceeds his outlay. He may, of course, sell
the house, and thus bring his waiting to an end. But then the
purchaser must wait, no matter whether or not he is the occupier. For
no one would consider the use of a house for a day, a month, or a year
as an adequate return for the price it cost to buy. The occupier-owner
pays for the prospect of its use for a long and perhaps indefinite
number of years ahead, and he must wait to enjoy the benefits for
which he pays now in full. Waiting is as inherent in the consumption
of durable things as it is in all production.
Now most industries are consumers of durable things of a very
expensive kind. Here we come back to the factories and machinery which
ordinarily spring to our mind at the mention of the word capital. Not
merely does the construction of these things involve waiting; their
consumption involves waiting on a vastly larger scale. Just as with a
house, many years must elapse before their derived utility can even
approximate to their purchase price. It is mainly to supply the
waiting involved in the consumption of such durable goods, that a
typical joint-stock company issues shares for public subscription. The
waiting required to cover the period of time, which its own productive
process requires, is largely supplied by means of bank overdrafts or
other forms of short-period borrowing. More strictly, fixed capital
represents the waiting involved in the consumption of durable things;
circulating capital the waiting involved in current production.
This distinction loses its sharpness when we consider not the affairs
of a particular business, but the industrial system as a whole. Then
the period of time involved in the consumption of durable instruments
falls into place as part of the time required for the production of
the ultimate consumers' goods. We can even, perhaps, conceive of an
"average period of production" for industry and commerce as a whole;
and this conception is not without its uses. For it serves to bring
out the fact that the period of consumption, and the period of
production in the narrower sense, are only two aspects of the same
fundamental thing, the interval of time which elapses between work and
the utility, which is its ultimate purpose. It serves, moreover, to
make clear that anything which lengthens this interval of time
increases the demand for waiting, or in other words, the demand for
capital; and, conversely, that anything which shortens this interval
diminishes the demand for capital.
§4. _Capital not a Stock of Consumable Goods_. But the distinction
between the two forms of waiting, though not fundamental, is none the
less worth noting. It enables us to keep our theory in conformity
with fact, to look at the phenomenon of capital the right way up; and
it is easy, if we are not careful, to slip into the habit of looking
at it upside down. People sometimes speak as though the commodities
which constitute our capital, instead of being mainly, as our plain
sense tells us that they are, factories, machinery and other durable
instruments, were rather a _store_ or _stock_ of immediately
consumable goods. The argument takes the following form. It is
consumers' goods, things like food and clothes, which the farmer, the
builder and their workpeople consume while they are working. To enable
them to work, therefore, it is vital that such things should not in
the past have been consumed as soon as they were made; part of them
must have been saved, and carried forward for future use.
Furthermore, the longer the time that the work on which people are now
engaged takes to yield its product, the larger must be this store of
consumers' goods. For these products, when they are completed, will
serve (taking society as a whole) to replace the store which in the
meantime is being used up, so that the longer this replacement takes,
the larger must be the initial store. Conversely, the larger the
store of consumers' goods available, the more distant is the future
for which we can afford to work. It is thus the store or stock of
consumers' goods which represents our real capital; for it is the
magnitude of this store which determines how far we can devote our
energies to purposes which are remote in time.
Now this is pure mysticism. Regarded literally, it is in direct
conflict with the facts. The processes of industry are fairly regular
and continuous. At any moment, large quantities of consumers' goods of
almost every kind are on the point of completion; at the same moment
equally large quantities are consumed. The things which we buy were
finished, very likely, only recently; or, if in fact they have lain
idle for some time in stock, there is nothing essential or at all
helpful in that fact. It represents rather a defect--a maladjustment
which should be rectified. Even many kinds of agricultural produce do
not need to be carried forward from one year to another, for they are
produced in many parts of the world, where the seasons come at
different periods of the year. It is conceivable, therefore, that we
might consume all non-durable things the moment they were ready, and
the degree to which we approximate to this ideal is a mark of the
efficiency of our economic system. A large store of consumable goods
is thus _not_ a fundamental necessity of a prosperous society.