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Capital, Interest, and Rent: Essays in the Theory of Distribution; Fetter, Frank A.
14 paragraphs found.
Introduction, by Murray N. Rothbard

We may apply Fetter's insight to the current textbook explanations of interest rate determination in the market for productive loans. The supply curve of loanable funds is conventionally explained by time preference, while the demand curve for loans by business firms is explained by reference to the "marginal productivity of capital"—in short, by the "natural" rate of interest embodied in the long-term normal rate of profit. But the firm that borrows money in order to hire workers or to buy capital goods is really buying future goods in exchange for a present good, money. In short, the business borrower, like the saver-creditor who lends him money, is buying a future good whenever he makes an investment. If we assume, for example, that there are no business loans but only stock investment, this point is easier to understand. When a man saves and invests in a productive process, he pays workers and other factors now in exchange for services that will yield a product, and therefore an income, at some future time. In short, the capitalist-entrepreneur hires or invests in factors now and pays out money (a present good)in exchange for productive services that are future goods. It is for his service in paying factors now, in advance of the fruits of production, that the capitalist normally earns an interest return, a return for time preference. In sum, every factor of production (whether labor, land, or capital goods) earns, not its marginal value productivity, according to the current conventional explanation, but its marginal productivity discounted by the interest rate or time preference; and the capitalist earns the discount.

Part 2, Essay 1

In criticizing others, Böhm-Bawerk has said: *35 "I grant that capital actually possesses the physical productivity ascribed to it.... But there is not one single feature in the whole circumstance to indicate that this greater amount of goods must be worth more than the capital consumed in its production; and it is this phenomenon of surplus value we have to explain." Now, coming to this explanation in his own positive argument, *36 he asks regarding the earlier productive instrument which he has shown to be technically superior: "But is it superior also in the height of its marginal utility and value? Certainly it is. For, if in every conceivable department of wants for the supply of which we may or shall employ it, it puts more means of satisfaction at our disposal, it must have a greater importance for our well-being." This argument curiously has involved in it the whole question; for, if the importance of the future use were, at the present moment, always greater than the present use, everything would be kept for the future. The reason why this is not done is that the future uses are discounted at the prevailing rate of interest. What we must demand at this point from the author, according to his own canons of criticism, is some proof that the greater technical product of the future has a greater value at this moment than the value of the capital consumed in it. This he quite fails to give. Instead, he says, after confessing that sometimes the opposite is the case: "For one and the same person at one and the same point of time the greater amount has always the greater value." *37 But the crucial question why the greater amount may have a less value at the present moment, when the two products are at two points of time, is not touched. The problem of interest is one that involves a ratio between the value of the capital and the value of the interest. The fact that the value of a given number of productive agents may be the same in any one of a dozen possible uses, though in some of them very long "roundabout processes" would give enormous sums of products and in others smaller amounts are at once secured, shows that the amount of technical product may diverge indefinitely from the value. Böhm-Bawerk has not bridged the gulf between the technical productivity and the surplus of value over the capital investment any better than those whom he has criticized.

Part 2, Essay 6

But there is required no undue stretching of Hume's words to find in them room for a broader thought of a psychological explanation of interest, though the dim outlines of this are only imperfectly sketched. Hume says: "High interest arises from three circumstances [and italicizes three]: A great demand for borrowing, little riches to supply that demand, and great profits arising from commerce.... Low interest, on the other hand, proceeds from the three opposite circumstances: a small demand for borrowing, great riches to supply that demand, and small profits arising from commerce." It is true that this merely states the problem rather than gives a full explanation, recognizing which, Hume says: "We shall endeavor to prove these points; and shall begin with the causes and the effects of a great demand or small demand for borrowing."


But this seems to me to miss in Turgot's discussion its most significant and unique feature. Turgot is seeking to explain, as he says, the valuation of lands in accordance with the proportion which the revenue bears to the value for which they are exchanged, and he does this first without once referring to the current rate of interest on loans or to the current rate of profits in other business (or without taking a rate found in financial markets to use as a capitalization rate in explaining the price of lands). Turgot pretty clearly conceived of an investment rate in land (that is, a discount, or capitalization rate) as discoverable and usable by the simple adjustment of supply and demand of buyers and sellers of land. It is true that Turgot, as he proceeds, shows that the various employments of capital are mutually related in their rates of return by the possibility of shifting investments. But this is valid and does not conflict with his thought of the capitalization of land as occurring primarily through the working of forces independent of the market for monetary loans. Such a view of the possibility of the land capitalization process being prior to the contractual interest rate is not found again until after the beginning of the twentieth century. It is still quite rare. Turgot's view of capitalization, it should be observed, though clear, is limited to explaining the valuation of land. He does not go on to develop a general capitalization theory that would explain in an analogous way the valuation of other "capitals" such as houses, machinery, etc., as built upon and derived from the revenue (or series of future uses) contained in them. Such a conception seems never to have entered his mind. His discussion abounds, however, with references to the influence of waiting, and of time.


Whatever be the relative prices of particular classes of goods, these prices would all be interpenetrated more or less consistently by the time-discount rate peculiar to each market or group. Any such system of prices having become fairly stable at any time and in any country, may be disturbed and altered by changes originating (1) in the medium-of-exchange mechanism, affecting more or less alike all prices, i.e., the general level of prices as expressed in index numbers; or (2) in conditions of time-valuations, acting upon time-prices and capitalization; or (3) in special conditions of demand and supply determining relative prices. The last of these is not negligible, but is of least importance to our present theme and must be passed over here. The first is for our purpose the most important and it will be considered on the assumption that a change occurs from the side of money without any change originating in the psychological factor of time-preference. Finally and more briefly, will be observed the case of individual time-preference changes (so widespread that they affect the prevailing market rates of time-discounts, etc.) without any change originating in the money supply or other exchange mechanism. We say "originating in" not "occurring in" to avoid any suggestion that such changes may not and do not occur as a result of the repercussions of the particular price adjustments in the new situations taken as wholes. Neither of these two problems (1 and 2 above) is simple, and it may be questioned whether the true nature and full bearing of either had been clearly recognized until within the last thirty years.


Without committing ourselves to an inflexible theory, it seems now a good working hypothesis, in view of the known facts, to connect the long-time curves mainly with changes in the fundamental monetary conditions. Chiefly these relate to gold (and silver) production, together with the accompanying conditions as to the use of gold as the "standard" money and unit of prices in the world (if one likes, "the supply of and demand for" gold for use as the standard price unit in the monetary system). Since 1914 irredeemable paper money, crowding gold entirely out of circulation and becoming the sole fluctuating "standard," has a part even more important than gold in the explanation of the price levels of particular countries, and has a very significant part in the explanation of the value of gold throughout the world. Similarly we may find the larger part of the cause of those briefer fluctuations that diverge from the long-time trends, in the changes occurring in that part of the exchange-mechanism consisting of credit agencies (in relation, of course, to the accompanying psychological conditions of hope, fear, confidence, expectations, whether based on calculation or resting merely in emotion, in the business community).

Part 3, Essay 1

The original form of the rent concept makes it an income arising from land, one of the three factors of production. The essential thing distinguishing it from other incomes is the kind of agents for whose use it is paid. This is the first concept defined by Professor Marshall: "The income derived from the ownership of land and other free gifts of nature is called rent." *1 The definition is given in connection with a statement of the kinds of incomes derived from wealth, the other kind mentioned being interest on capital (profits are analyzed into interest of capital and earnings of management). This view of rent is found so repeatedly expressed in the text-books that it may be called the conventional view. The chapter on the agents of production begins:—

"The agents of production are commonly classed as Land, Labour and Capital. By Land is meant the material and forces which Nature gives freely for man's aid, in land and water, in air and light and heat." The next chapter begins, "The requisites of production are commonly spoken of as land, labour and capital: those material things which owe their usefulness to human labour being classed under capital, and those which owe nothing to it being classed as land." A few lines further the explanation is added, "The term 'land' has been extended by economists so as to include the permanent sources of these utilities, whether they are found in land as the term is commonly used, or in seas and rivers, in sunshine and rain, in winds and waterfalls." *2

The usual three shares are not distinctly enumerated when Book VI., on "Value or Distribution and Exchange," is reached; yet the thought appears and determines the order of treatment and the chapter headings. It is said that there has been "left on one side, as far as might be, all considerations turning on the special qualities and incidents of the agents of production"; but there is promised a "more detailed analysis in the following three groups of chapters on demand and supply in relation to labour, to capital and business power, and to land, respectively." *3 The treatment of distribution, accordingly, falls into these three main conventional divisions: "earnings of labour" (chapters 3-5); "interest of capital" (chapters 6-8); and "rent of land" (chapters 9, 10),—where each of the three shares is linked with a corresponding factor.


(a) The argument assumes that the land is in an old settled country, and that therefore its quantity is fixed. Later, however, it is shown that inventions that will turn the soil deeper, discoveries and new means of transportation that will bring into competition great areas of new land, and improvements that make available the resources before unused are constantly changing the limits of the supply of natural resources, in the economic sense of the word "supply." The view that land is a fixed stock for all time is contradicted when it said:—

The supply of fertile land cannot be adapted quickly to the demand for it, and therefore the income derived from it may diverge permanently much from normal profits on the cost of preparing it for cultivation. *17

Despite this it is assumed that the economic supply of land is necessarily and always fixed; and it is then contrasted with the stock or supply of other things, which is supposed to be increasing and capable of indefinite increase. Whether a static or dynamic view be taken, it is logically necessary to take it alike of both factors: either land must be recognized as an increasing and increasable factor, as well as capital, in which case the question becomes the somewhat speculative one as to their probable future rate of increase compared with the urgency of the demand, or both must be treated as fixed for the moment. In either case, when they are looked at from the same standpoint, the appearance of an essential difference in the two kinds of wealth disappears.


Again, objection must be made to the view of the increase of capital. Capital, as the term is here employed, can be increased; but it does not increase because it is employed in one industry rather than in another. It is sure to be employed in some industry or it is not capital. Why should its use in a particular industry increase the total supply? The additional ploughs can be produced to meet the demand only by the use of the available appliances, which are limited in amount, and which, if used for the ploughs, cannot be used for other things. There will be less productive power to put into other industries unless the general stock of wealth is increased. It is hard to see how the use of the existing stock of capital in one industry rather than another can be assumed to be the cause of this. *18


(b) It is argued in the passages under consideration that land and other wealth are different from the point of view of society. This can only mean when both are viewed from that standpoint; but in the argument stated the land only is thus viewed, the capital is still considered only from the individual standpoint. In the case of land the total supply is clearly borne in mind, and the use of land in one industry is seen to take it away from another. But in the case of capital there appears to be a shift to the individual view and the supply used by one undertaker; and, because he can increase or decrease the capital employed in his industry "according to the effective demand" (which means in that one industry), it is concluded that the total supply of capital is thus altered. The objections that have been given in the preceding paragraphs apply here also. The line of reasoning here criticized is interwoven with the idea of the static and dynamic supplies of the various factors; but here and there it can be plainly distinguished.


It has before been assumed that it is possible to estimate the expenses of production while omitting rent; that is, "on the margin of cultivation."

That is, they are estimated for a part of the produce which either is raised on land that pays no rent because it is poor or badly situated; or, is raised on land that does pay rent, but by applications of capital and labour which only just pay their way, and therefore can contribute nothing towards the rent. It is these expenses which the demand must just cover: for if it does not, the supply will fall off, and the price will be raised till it does cover them. Those parts of the produce which yield a surplus will generally be produced even if that price is not maintained; their surplus therefore does not govern the price: while there is no surplus yielded by that portion of the produce the expenses of production of which do take direct part in governing the price. No surplus then enters into that (money) cost of production which gives the level at which the price of the whole supply is fixed. *46

The changes just noted involve a change of thought also from the production of the commodity in question to that of the production of the appliances. The things these appliances take part in producing are still spoken of, but the interest is indirect. In the case of the production of the commodity, the undertaker pays what he is forced to in each case for the agents of production "without troubling himself" about their origin. The period within which the supply affects price is that within which appliances can be diverted from one use to another. Here, however, the price of commodities is supposed to remain unchanged until new appliances can be brought into existence, tempted by the higher income: the period considered important is that within which the supply of "improvements" or of "means of production" can be increased. Their (real) cost is thought of as reflected on in the price of the goods; but let it be noted in passing that this can never raise, it can only lower the price, through increased supply. Only occasionally is it impossible to divert some of the existing appliances almost immediately to other uses with greater or less ease, so that the period sufficient to increase the supply of the commodity rarely is the same as that needed for creating new appliances. When the relation of money costs to the price of commodities was talked of, it was with reference to their influence in increasing or decreasing the supply of the various commodities: when the relation of owner's income to prices is talked of, it is with reference to the effect they will have in increasing or decreasing the supply of available appliances. The undertaker reaps his unexpected profit when the price of his product suddenly rises, and he has either a large stock of it or has contracts out for the materials, so that he can get a large margin between costs and price by producing quickly and more cheaply than his new competitors. The owner reaps an unexpected income when his appliances are suddenly in greater demand. The case to test what the effect is of a relatively fixed supply of appliances on the undertaker's costs is that where he has no standing contract for materials when the increased demand for the product arises; and here can be seen most clearly that money costs do enter into price. The value of the appliance for the time limited would rise, its owner would get an increased income, and the undertaker must meet increased costs if he is to continue to produce the article.


Here mention may be made of a troublesome fallacy in the very definition of land as "the free gifts of nature." If it is defined in this way, man cannot increase land by his efforts; for it is then not land, not being a free gift. Everything to which man has given the slightest effort becomes capital. But, if land be taken in the usual practical sense, as the earth and the materials it affords, whether difficult to get at or not, it is evident that most kinds of land can be secured with varying degrees of difficulty. All economists drop into this conception sooner or later. *68 In this sense, land has a supply price, just as any other good has. The supply is increased when the price is sufficient to meet the money costs in the same practical sense in which this is said of other things. This is plainly admitted when it is said that

the supply of fertile land cannot be adapted quickly to the demand for it, and therefore the income derived from it may diverge permanently much from normal profits on the cost of preparing it for cultivation. *69