Principles of Economics
BOOK II, CHAPTER IV
§ 1. In a primitive community each family is nearly self-sufficing, and provides most of its own food and clothing and even household furniture. Only a very small part of the income, or comings in, of the family is in the form of money; when one thinks of their income at all, one reckons in the benefits which they get from their cooking utensils, just as much as those which they get from their plough: one draws no distinction between their capital and the rest of their accumulated stock, to which the cooking utensils and the plough alike belong*42.
But with the growth of a money economy there has been a strong tendency to confine the notion of income to those incomings which are in the form of money; including "payments in kind" (such as the free use of a house, free coals, gas, water), which are given as part of an employee's remuneration, and in lieu of money payments.
In harmony with this meaning of Income, the language of the market-place commonly regards a man's capital as that part of his wealth which he devotes to acquiring an income in the form of money; or, more generally, to acquisition (Erwerbung) by means of trade. It may be convenient sometimes to speak of this as his trade capital; which may be defined to consist of those external goods which a person uses in his trade, either holding them to be sold for money or applying them to produce things that are to be sold for money. Among its conspicuous elements are such things as the factory and the business plant of a manufacturer; that is, his machinery, his raw material, any food, clothing, and house-room that he may hold for the use of his employees, and the goodwill of his business.
To the things in his possession must be added those to which he has a right and from which he is drawing income: including loans which he has made on mortgage or in other ways, and all the command over capital which he may hold under the complex forms of the modern "money market." On the other hand debts owed by him must be deducted from his capital.
This definition of capital from the individual or business point of view is firmly established in ordinary usage; and it will be assumed throughout the present treatise whenever we are discussing problems relating to business in general, and in particular to the supply of any particular group of commodities for sale in open market. Income and capital will be discussed from the point of view of private business in the first half of the chapter; and afterwards the social point of view will be considered.
§ 2. If a person is engaged in business, he is sure to have to incur certain outgoings for raw material, the hire of labour, etc. And, in that case, his true or net income is found by deducting from his gross income "the outgoings that belong to its production*43."
Anything which a person does for which he is paid directly or indirectly in money, swells his nominal income; while no services that he performs for himself are commonly reckoned as adding to his nominal income. But, though it is best generally to neglect them when they are trivial, account should for consistency be taken of them, when they are of a kind which people commonly pay for having done for them. Thus a woman who makes her own clothes or a man who digs in his own garden or repairs his own house, is earning income; just as would the dressmaker, gardener or carpenter who might be hired to do the work.
In this connection we may introduce a term of which we shall have to make frequent use hereafter. The need for it arises from the fact that every occupation involves other disadvantages besides the fatigue of the work required in it, and every occupation offers other advantages besides the receipt of money wages. The true reward which an occupation offers to labour has to be calculated by deducting the money value of all its disadvantages from that of all its advantages; and we may describe this true reward as the net advantages of the occupation.
The payment made by a borrower for the use of a loan for, say, a year is expressed as the ratio which that payment bears to the loan, and is called interest. And this term is also used more broadly to represent the money equivalent of the whole income which is derived from capital. It is commonly expressed as a certain percentage on the "capital" sum of the loan. Whenever this is done the capital must not be regarded as a stock of things in general. It must be regarded as a stock of one particular thing, money, which is taken to represent them. Thus £100 may be lent at four per cent., that is for an interest of £4 yearly. And, if a man employs in business a capital stock of goods of various kinds which are estimated as worth £10,000 in all; then £400 a year may be said to represent interest at the rate of four per cent. on that capital, on the supposition that the aggregate money value of the things which constitute it has remained unchanged. He would not, however, be willing to continue the business unless he expected his total net gains from it to exceed interest on his capital at the current rate. These gains are called profits.
The command over goods to a given money value, which can be applied to any purpose, is often described as "free" or "floating" capital*44.
When a man is engaged in business, his profits for the year are the excess of his receipts from his business during the year over his outlay for his business. The difference between the value of his stock of plant, material, etc. at the end and at the beginning of the year is taken as part of his receipts or as part of his outlay, according as there has been an increase or decrease of value. What remains of his profits after deducting interest on his capital at the current rate (allowing, where necessary, for insurance) is generally called his earnings of undertaking or management. The ratio in which his profits for the year stand to his capital is spoken of as his rate of profits. But this phrase, like the corresponding phrase with regard to interest, assumes that the money value of the things which constitute his capital has been estimated: and such an estimate is often found to involve great difficulties.
When any particular thing, as a house, a piano, or a sewing machine is lent out, the payment for it is often called Rent. And economists may follow this practice without inconvenience when they are regarding the income from the point of view of the individual trader. But, as will be argued presently, the balance of advantage seems to lie in favour of reserving the term Rent for the income derived from the free gifts of nature, whenever the discussion of business affairs passes from the point of view of the individual to that of society at large. And for that reason, the term Quasi-rent will be used in the present volume for the income derived from machines and other appliances for production made by man. That is to say, any particular machine may yield an income which is of the nature of a rent, and which is sometimes called a Rent; though on the whole, there seems to be some advantage in calling it a Quasi-rent. But we cannot properly speak of the interest yielded by a machine. If we use the term "interest" at all, it must be in relation not to the machine itself, but to its money value. For instance if the work done by a machine which cost £100 is worth £4 a year net, that machine is yielding a quasi-rent of £4 which is equivalent to interest at four per cent. on its original cost: but if the machine is worth only £80 now, it is yielding five per cent. on its present value. This however raises some difficult questions of principle, which will be discussed in Book V.
§ 3. Next to consider some details relating to capital. It has been classed as Consumption capital, and Auxiliary or Instrumental capital: and though no clear distinction can be drawn between the two classes, it may sometimes be convenient to use the terms, with the understanding that they are vague. Where definiteness is necessary, the terms should be avoided; and explicit enumerations should be given. The general notion of the distinction which the terms are designed to suggest, can be gathered from the following approximate definitions.
Consumption capital consists of goods in a form to satisfy wants directly; that is, goods which afford a direct sustenance to the workers, such as food, clothes, house-room, etc.
Auxiliary, or instrumental, capital is so called because it consists of all the goods that aid labour in production. Under this head come tools, machines, factories, railways, docks, ships, etc.; and raw materials of all kinds.
But of course a man's clothes assist him in his work and are instrumental in keeping him warm; and he derives a direct benefit from the shelter of his factory as he does from the shelter of his house*45.
We may follow Mill in distinguishing circulating capital "which fulfils the whole of its office in the production in which it is engaged, by a single use," from fixed capital "which exists in a durable shape and the return to which is spread over a period of corresponding duration*46."
§ 4. The customary point of view of the business man is that which is most convenient for the economist to adopt when discussing the production of goods for a market, and the causes which govern their exchange value. But there is a broader point of view which the business man, no less than the economist, must adopt when he studies the causes which govern the material wellbeing of the community as a whole. Ordinary conversation may pass from one point of view to another without any formal note of the change: for if a misunderstanding arises it soon becomes manifest; and confusion is cut short by a question or by a volunteered explanation. But the economist may take no risks of that sort: he must make prominent any change in his point of view or in his uses of terms. His path might have seemed smoother for the time, if he had passed silently from one use to another: but in the long run better progress is made by a clear indication of the meaning attached to each term in every doubtful case*47.
Let us then during the remainder of this chapter deliberately adopt the social, in contrast with the individual point of view: let us look at the production of the community as a whole, and at its total net income available for all purposes. That is, let us revert nearly to the point of view of a primitive people, who are chiefly concerned with the production of desirable things, and with their direct uses; and who are little concerned with exchange and marketing.
From this point of view income is regarded as including all the benefits which mankind derive at any time from their efforts, in the present and in the past, to turn nature's resources to their best account. The pleasure derived from the beauties of the rainbow, or the sweet taste of the fresh morning air, are left out of the reckoning, not because they are unimportant, nor because the estimate would in any way be vitiated by including them; but solely because reckoning them in would serve no good purpose, while it would add greatly to the length of our sentences and the prolixity of our discussions. For a similar reason it is not worth while to take separate account of the simple services which nearly every one renders to himself, such as putting on his clothes; though there are a few persons who choose to pay others to do such things for them. Their exclusion involves no principle; and time spent by some controversial writers on discussing it has been wasted. It simply follows the maxim De minimis non curat lex. A driver who, not noticing a pool in his way, splashes a passer by is not held to have done him legal injury; though there is no distinction in principle between his act and that of another, who by a similar lack of attention, did serious harm to someone else.
A man's present labour yields him income directly, when devoted to his own use; and he looks to be paid for it in some for or another if he devotes it as a matter of business to the service of others. Similarly any useful thing which he has made or acquired in the past, or which has been handed down to him, under the existing institutions of property, by others who have so made or acquired it, is generally a source of material benefit to him directly or indirectly. If he applies it in business, this income generally appears in the form of money. But a broader use of this term is occasionally needed, which embraces the whole income of benefits of every sort which a person derives from the ownership of property however applied: it includes for instance the benefits which he gets from the use of his own piano, equally with those which a piano dealer would win by letting out a piano on hire. The language of common life while averse to so broad a use of the term Income as this even when discussing social problems, yet habitually includes a certain number of forms of income, other than money income.
The Income Tax Commissioners count a dwelling-house inhabited by its owner as a source of taxable income, though it yields its income of comfort directly. They do this, not on any abstract principle; but partly because of the practical importance of house-room, partly because the ownership of a house is commonly treated in a business fashion, and partly because the real income accruing from it can easily be separated off and estimated. They do not claim to establish any absolute distinction in kind between the things which their rule includes, and those which it excludes.
Jevons, regarding the problem from a purely mathematical point of view, was justified in classing all commodities in the hands of consumers as capital. But some writers, while developing this suggestion with great ingenuity, have treated it as a great principle; and that appears to be an error in judgment. A true sense of proportion requires us not to burden our work with the incessant enumeration of details of secondary importance, of which no account is taken in customary discourse, and which cannot even be described without offending against popular conventions.
§ 5. This brings us to consider the use of the term capital from the point of view of inquiries into the material wellbeing of society as a whole. Adam Smith said that a person's capital is that part of his stock from which he expects to derive an income. And almost every use of the term capital, which is known to history, has corresponded more or less closely to a parallel use of the term Income: in almost every use, capital has been that part of a man's stock from which he expects to derive an income.
By far the most important use of the term Capital in general, i.e. from the social point of view, is in the inquiry how the three agents of production, land (that is, natural agents), labour and capital, contribute to producing the national income (or the national dividend, as it will be called later on); and how that income is distributed among the three agents. And this is an additional reason for making the terms Capital and Income correlative from the social, as we did from the individual point of view.
Accordingly it is proposed in this treatise to count as part of capital from the social point of view all things other than land, which yield income that is generally reckoned as such in common discourse; together with similar things in public ownership, such as government factories: the term Land being taken to include all free gifts of nature, such as mines, fisheries, etc., which yield income.
Thus it will include all things held for trade purposes, whether machinery, raw material or finished goods; theatres and hotels; home farms and houses: but not furniture or clothes owned by those who use them. For the former are and the latter are not commonly regarded as yielding income by the world at large, as is shown by the practice of the income tax commissioners.
This usage of the term is in harmony with the common practice of economists of treating social problems in broad outline to start with, and reserving minor details for later consideration: it is in harmony also with their common practice of taking Labour to include those activities, and those only, which are regarded as the source of income in this broader use of the term. Labour together with capital and land thus defined are the sources of all that income of which account is commonly taken in reckoning up the National Income*48.
§ 6. Social income may be estimated by adding together the incomes of the individuals in the society in question, whether it be a nation or any other group of persons. We must however not count the same thing twice. If we have counted a carpet at its full value, we have already counted the values of the yarn and the labour that were used in making it; and these must not be counted again. And further, if the carpet was made of wool that was in stock at the beginning of the year, the value of that wool must be deducted from the value of the carpet before the net income of the year is reached; while similar deduction must be made for the wear and tear of machinery and other plant used in making it. This is required by the general rule, with which we started, that true or net income is found by deducting from gross income the outgoings that belong to its production.
But if the carpet is cleaned by domestic servants or at steam scouring works, the value of the labour spent in cleaning it must be counted in separately; for otherwise the results of this labour would be altogether omitted from the inventory of those newly-produced commodities and conveniences which constitute the real income of the country. The work of domestic servants is always classed as "labour" in the technical sense; and since it can be assessed en bloc at the value of their remuneration in money and in kind without being enumerated in detail, its inclusion raises no great statistical difficulty. There is however some inconsistency in omitting the heavy domestic work which is done by women and other members of the household, where no servants are kept.
Again, suppose a landowner with an annual income of £10,000 hires a private secretary at a salary of £500, who hires a servant at wages of £50. It may seem that if the incomes of all these three persons are counted in as part of the net income of the country, some of it will be counted twice over, and some three times. But this is not the case. The landlord transfers to his secretary, in return for his assistance, part of the purchasing power derived from the produce of land; and the secretary again transfers part of this to his servant in return for his assistance. The farm produce the value of which goes as rent to the landlord, the assistance which the landlord derives from the work of the secretary, and that which the secretary derives from the work of the servant are independent parts of the real net income of the country; and therefore the £10,000 and the £500 and the £50 which are their money measures, must all be counted in when we are estimating the income of the country. But if the landlord makes an allowance of £500 a year to his son, that must not be counted as an independent income; because no services are rendered for it. And it would not be assessed to the Income tax.
As the net payments on account of interest etc. due to an individual—net, i.e. after deducting those due from him to others—are part of his income, so the money and other things received net by a nation from other countries are part of its income.
§ 7. The money income, or inflow, of wealth gives a measure of a nation's prosperity, which, untrustworthy as it is, is yet in some respects better than that afforded by the money value of its stock of wealth.
For income consists chiefly of commodities in a form to give pleasure directly; while the greater part of national wealth consists of the means of production, which are of service to the nation only in so far as they contribute to producing commodities ready for consumption. And further, though this is a minor point, consumable commodities, being more portable, have more nearly uniform prices all the world over than the things used in producing them: the prices of an acre of good land in Manitoba and Kent differ more than those of a bushel of wheat in the two places.
But if we look chiefly at the income of a country we must allow for the depreciation of the sources from which it is derived. More must be deducted from the income derived from a house if it is made of wood, than if it is made of stone; a stone house counts for more towards the real richness of a country than a wooden house which gives equally good accommodation. Again, a mine may yield for a time a large income, but be exhausted in a few years: in that case, it must be counted as equivalent to a field, or a fishery, which yields a much smaller annual income, but will yield that income permanently.
§ 8. In purely abstract, and especially in mathematical, reasoning the terms Capital and Wealth are used as synonymous almost perforce, except that "land" proper may for some purposes be omitted from Capital. But there is a clear tradition that we should speak of Capital when considering things as agents of production; and that we should speak of Wealth when considering them as results of production, as subjects of consumption and as yielding pleasures of possession. Thus the chief demand for capital arises from its productiveness, from the services which it renders, for instance, in enabling wool to be spun and woven more easily than by the unaided hand, or in causing water to flow freely wherever it is wanted instead of being carried laboriously in pails; (though there are other uses of capital, as for instance when it is lent to a spendthrift, which cannot easily be brought under this head). On the other hand the supply of capital is controlled by the fact that, in order to accumulate it, men must act prospectively: they must "wait" and "save," they must sacrifice the present to the future.
At the beginning of this Book it was argued that the economist must forego the aid of a complete set of technical terms. He must make the terms in common use serve his purpose in the expression of precise thought, by the aid of qualifying adjectives or other indications in the context. If he arbitrarily assigns a rigid exact use to a word which has several more or less vague uses in the market place, he confuses business men, and he is in some danger of committing himself to untenable positions. The selection of a normal use for such terms as Income and Capital must therefore be tested by actually working with it*49.
Notes for this chapter
This and similar facts have led some people to suppose not only that some parts of the modern analysis of distribution and exchange are inapplicable to a primitive community; which is true: but also that there are no important parts of it that are applicable; which is not true. This is a striking instance of the dangers that arise from allowing ourselves to become the servants of words, avoiding the hard work that is required for discovering unity of substance underlying variety of form.
See a report of a Committee of the British Association, 1878, on the Income Tax.
Professor Clark has made the suggestion to distinguish between Pure Capital and Capital Goods: the former is to correspond to a waterfall which remains stationary; while Capital Goods are the particular things which enter and leave the business, as particular drops pass through the waterfall. He would of course connect interest with pure capital, not with capital goods.
See above II. III. 1.
Adam Smith's distinction between fixed and circulating capital turned on the question whether the goods "yield a profit without changing masters" or not. Ricardo made it turn on whether they are "of slow consumption or require to be frequently reproduced"; but he truly remarks that this is "a division not essential, and in which the line of demarcation cannot be accurately drawn." Mill's modification is generally accepted by modern economists.
Compare above II. I. 3.
Just as for practical purposes it is better not to encumber ourselves with specifying the "income" of benefit which a man derives from the labour of brushing his hat in the morning, so it is better to ignore the element of capital vested in his brush. But no such consideration arises in a merely abstract discussion: and therefore the logical simplicity of Jevons' dictum that commodities in the hands of consumers are capital has some advantages and no disadvantages for mathematical versions of economic doctrines.
A short forecast of some of this work may be given here. It will be seen how Capital needs to be considered in regard both to the embodied aggregate of the benefits derivable from its use, and to the embodied aggregate of the costs of the efforts and of the saving needed for its production: and it will be shown how these two aggregates tend to balance. Thus in V. IV., which may be taken as in some sense a continuation of the present chapter, they will be seen balancing directly in the forecasts of an individual Robinson Crusoe; and—for the greater part at least—in terms of money in the forecasts of a modern business man. In either case both sides of the account must be referred to the same date of time; those that come after that date being "discounted" back to it; and those that come before being "accumulated" up to it.
A similar balancing in regard to the benefits and the costs of capital at large will be found to be a chief corner stone of social economy: although it is true that in consequence of the unequal distribution of wealth, accounts cannot be made up from the social point of view with that clearness of outline that is attainable in the case of an individual whether a Robinson Crusoe, or a modern business man.
In every part of our discussion of the causes that govern the accumulation and the application of productive resources, it will appear that there is no universal rule that the use of roundabout methods of production is more efficient than direct methods; that there are some conditions under which the investment of effort in obtaining machinery and in making costly provision against future wants is economical in the long run, and others in which it is not: and that capital is accumulated in proportion to the prospectiveness of man on the one hand, and on the other to the absorption of capital by those roundabout methods, which are sufficiently productive to remunerate their adoption. See especially IV. VII. 8; V. IV.; VI. I. 8; and VI. VI. 1.
The broader forces, that govern the production of capital in general and its contribution to the national income, are discussed in IV. VII. IX.-XI.: the imperfect adjustments of the money measures of benefits and costs to their real volume are discussed chiefly in III. III.-V; IV. VII.; and VI. III.-VIII.; the resulting share in the total product of labour and capital, aided by natural resources, which goes to capital, is discussed chiefly in VI. I. II. VI.-VIII. XI. XII.
Some of the chief incidents in the history of the definitions of Capital are given in Appendix E.
End of Notes
Return to top