Capital and Interest: A Critical History of Economical Theory

The foundation of Hermann’s theory is his conception of the independent use of goods. Quite in contrast to Say, who tries to gloss over the nature of his
services productifs with a few analogies and metaphors, Hermann takes all possible care in explaining his fundamental conception.

He introduces it first in the theory of Goods, where he speaks of the different kinds of usefulness that goods have. “Usefulness may be transitory or it may be durable. It is partly the nature of the goods, partly the nature of the use that determines this point. Transitory, often momentary usefulness belongs to freshly cooked food, and to many kinds of drink. The doing of a service has only a momentary use value, yet its result may be permanent, as is the case in tuition, in a physician’s advice, etc. Land, dwellings, tools, books, money, have a durable use value. Their use, for the time that they last (called in German their
Nutzung),
*17 can be conceived of as a good in itself, and may obtain for itself an exchange value which we call interest.”

But not only are durable goods, but transitory and consumable goods also, capable of affording a durable use. Since this proposition is of cardinal importance in Hermann’s theory, I give his exposition of it in his own words:—

“Technical processes are able, throughout all the change and combination of the usefulness of goods, to preserve the sum of their exchange values undiminished, so that goods, although successively taking on new shapes, still continue unchanged in value. Iron ore, coal, labour, obtain, in the form of pig iron, a combined usefulness to which they all three contribute chemical and mechanical elements. If, then, the pig iron possesses the exchange value of the three exchange goods employed, the earlier sum of goods persists, bound up qualitatively in the new usefulness, added together quantitatively in the exchange value.

“To goods that are of transitory material, technical processes, through this change of form, add economical durability and permanence. This persistence of usefulness and of exchange value which is given to goods otherwise transitory by technical change of form, is of the greatest economical importance. The amount of durable useful goods becomes thereby very much greater. Even goods of perishable material and of only temporary use, by constantly changing their shapes while retaining their exchange value, become re-created so that their use becomes lasting. Thus, as it is in the case of durable goods, so it is in the case of goods changing their form qualitatively, while retaining their exchange value; this use may be conceived of as a good in itself, as a use (
Nutzung) which may itself obtain exchange value.” I shall return to this notable passage later on.

Hermann then makes use of this analysis to introduce his conception of capital, which is based altogether on that of its use.

“Lasting or durable goods, and perishable goods which retain their value while changing their shape, may thus be brought under one and the same conception; they are the durable basis of a use which has exchange value. Such goods we call capital.”
*18

The bridge between these preliminary conceptions and Hermann’s interest theory proper is formed by the proposition that, in economic life, the uses of capital do regularly receive the exchange value, of which, as independent quantities, they are capable. Hermann does not treat this proposition with the emphasis adequate to its importance. Although everything further depends on it, he neither puts it formally, nor gives it any detailed explanation. Explanation, indeed, there is in plenty, but it is rather to be read between the lines than in them. It amounts to this, that the “uses” possess exchange value because they are economical goods—a piece of information which is concise indeed, but may be accepted as satisfactory without further commentary.
*19

His explanation of interest then proceeds as follows.

In almost all productions uses of capital, possessing exchange value, form an indispensable portion of the expenses of production. These expenses are made up of three parts:—

1. Of the outlay of the undertaker—that is, the expenditure of wealth previously existing; as, for instance, principal, secondary, and auxiliary materials, his own labour and that of others, wear and tear of workshops, tools, etc.

2. Of the undertaker’s active intelligence and care in the initiation and carrying on of the undertaking, etc.

3. Of the uses of fixed and floating capital necessary for the production all the time of their employment up till the sale of the product.
*20

Now since, economically, the price of the product must cover the total costs of production, that price must be high enough to cover “not only the outlays, but also the sacrifice that the undertaker makes in the uses of capital, as also in his intelligence and care;” or, as it is usually expressed, over and above the compensation for outlays, the price must yield a profit (profit of capital and profit of undertaking). And more exactly explaining his idea, Hermann adds;—this profit “is by no means merely an advantage that comes by accident in the struggle that determines price.” Rather we should say that profit is as much a compensation for goods possessing exchange value that are really sacrificed in the product as the outlays are. The only difference is that the undertaker makes these outlays in order to procure and hold together certain productive elements already existing, while the uses of the capital employed and his own superintendence of the business are new elements in the work, provided by himself during the production. He makes use of the outlays in order to obtain the highest possible remuneration for these new elements that he adds. “This remuneration is profit” (p. 314).

To make this explanation of profit complete, one thing is still wanting; it should be made clear how it is that, in production, there must be sacrifice of the uses of capital, besides that of the outlays of capital. This Hermann supplies in another place, where at the same time he points out, with great circumstantiality, that all products may ultimately be traced to exertions of labour and uses of capital. In doing so he makes some interesting statements about the character of the “use of goods,” as he conceives of it, and it may be well to give this passage also in full.

He is making an analysis of the sacrifices that are required for the procuring of salt fish. He enumerates labour of catching, use and wear and tear of tools and boats, labour of procuring salt; and again the use of all kinds of tools, casks, and so on. Then he breaks up the boat into wood, iron, cordage, labour, and use of tools; the wood again, into use of the forest and labour; the iron, into use of the mine, and so on. “But this succession of labours and uses does not exhaust the sum total of the sacrifices made in procuring salt fish. There must besides be taken into calculation the period of time during which each element of exchange value is embodied in the product. For from that moment when a labour or a use is employed in the making of a product, the disposal of it in any other way is made impossible. Instead of being made use of in itself, it is simply made to co-operate in the making and delivery of the product to the consumers. To get a proper idea of this, it is to be remembered that labours and uses, so soon as they are employed in the making of a product, enter into floating capital quantitatively, as a constituent element, with the exchange value that they possessed at the time of their employment. With this value they become floating capital. But it is just this amount of value that a man abstains from using in any other way till the product is paid for by the buyer. As with the getting, working up, storing, and conveying, the floating capital grows through ever new labours and uses expended on it, it is itself wealth, the use of which is handed over to the consumers with every new accession of value up to the delivering over of the product to the buyer. And what must be paid for by the buyer is not simply the renunciation of that use which the undertaker might have made of the wealth for his own gratification. No; it is actually a new and peculiar use which is handed over to him along with the wealth itself; the putting together and keeping together, the storing and keeping ready for use, of all the technical elements of the production, from the acquiring of its first basis in natural goods, on through all technical changes and commercial processes, till the product is handed over in the place, at the time and in the quantity desired. This holding together of the technical elements of the product is the service, the objective use of floating capital.”
*21

If we compare the form which Hermann has given to the Use theory with the doctrine of Say, we find them alike in their rough outlines. Both recognise the existence of independent work done by capital. In the fact that capital is made use of in production, both see a sacrifice independent of and separate from the expenditure of the substance of capital. And both explain interest as the necessary compensation for this independent sacrifice. Still, Hermann’s doctrine shows a substantial advance on Say’s. Say had, in fact, given the mere outlines of a theory, inside which the most important features were left blank. His
services productifs are nothing but an ambiguous name, and the very important consideration of how the sacrifice of these services constitutes an independent sacrifice in production—independent, that is, of the substance of capital sacrificed—is very much left to the reader’s fancy. In trying, with true German thoroughness, to work out and make clear these two cardinal points, Hermann has definitely filled in the outlines he took from Say, and in doing so has given to the whole the rank of a solid theory.

A negative merit in Hermann, not to be under estimated, is that he severely abstains from the secondary explanations (explaining interest by productivity) that are so offensive in Say. The expression “productivity” is perhaps as often in his mouth, but he uses it in a sense that, if not happy, is at least not misleading.
*22

Hermann of course has not managed to keep his formulation of the Use theory free from all inconsistencies. In particular it remains doubtful, in his case also, what is the nature of the connection between the exchange value of the uses of capital and the price of the products of capital. Is the price of products high because the exchange value of uses is high? Or, on the contrary, is the exchange value of the uses high because the price of products is high? This point, over which Say falls into the wildest contradictions,
*23 Hermann has not made entirely clear. In the passage given above, and in many others, he obviously inclines to the former view, and so represents the price of products as affected by the value of the uses of capital.
*24 But at the same time there are many expressions which assume just the opposite. Thus (p. 296) he remarks that the determining of the price of products “is itself the first to react on the price of the labours and uses.” And similarly on another occasion (p. 559) he ascribes a determining influence on the price of the incomplete products, not to the constituent costs which have gone to create the incomplete product, but to the finished products which are their final result. It was reserved for Menger to make this difficult question entirely clear.

Thus far we have looked only at Hermann’s doctrine of the origin of interest. But we cannot pass over the quite peculiar views that he propounds on the causes of the different rates of interest.

Hermann starts from the proposition already referred to, that “the total quantity of products,” resolved into its simple constituents, is “a sum of labours and uses of capital.” If we allow this, it becomes clear, in the next place, that all acts of exchange must consist in the exchange of labours and uses of capital possessed by one for labours and uses possessed by another, these labours and uses being either direct or embodied in products. Whatever, then, a man receives for his own labour in other people’s labours and uses is the exchange value of labour, or wage; and “whatever a man receives in the labours and uses of other men, when he offers his own uses for sale, forms the exchange value of these uses, or the profit of capital.” The wages of labour and the profit of capital must therefore, between them, exhaust the total quantity of all products coming to market.
*25

On what, then, depends the rate of profit; or, which is the same thing, the rate of the exchange value of the uses of capital? First, naturally, on the amount of other people’s labours and uses obtainable for these. But this itself depends again, for the most part, on the proportion in which the two participants in the total product, labour and uses of capital, are supplied and demanded as against each other. And of course every increase in the supply of labour tends to diminish wages and to raise profit; and every increase in the supply of uses, to raise wages and lower profit. But, again, the supply of either of these two factors may be increased by two circumstances; either by increase of the available amount or by increase of its productiveness. These circumstances act in the following way.

“If the
amount of capital increases, more uses are offered for sale, more equivalent values are sought for them. Now these equivalent values can only be labours or uses. So far as, in exchange for the increased uses, other uses of capital are demanded, a greater amount of equivalent values is actually disposable. Since then supply and demand are equally increased, the exchange value of the uses cannot alter. But if, as is here assumed, the quantity of labour, on the whole, is not increased, the owners of capital find, for the increased amount of uses which they seek to exchange against labour, only the amount of labour they got before—that is, they get an unsatisfactory equivalent value. The exchange value of uses will therefore sink in comparison with labour; with the same exertions, the labourer will buy more uses. In the exchange of use against use the capitalists now receive the same equivalent value as formerly, but in the exchange of uses against labour they receive less. The amount of profit, therefore, in proportion to the total capital—that is, the rate of profit—must fall. The total quantity of goods produced is indeed increased, but the increase has been divided among capitalists and labourers.

“If the
productiveness of capital increases, or if in the same time it furnishes more means of satisfying needs, the owners of capital offer for sale more useful goods than before, and ask therefore for more equivalent values. They obtain these so far as each one seeks other uses in exchange for his own increased use. Here the supply has risen with the demand. The exchange value must therefore remain unaltered—that is, the uses of equal capitals for equal times exchange with each other—although the character of these uses as regards usefulness is higher than before. But under the assumption that labour is not increased, all the uses with which the capitalist wishes to buy labour do not obtain their former equivalent value; this must raise the competitive demand for labour, and must lower the exchange value of uses as against labour. The labourers now receive more uses for the same amount of labour as before, and find themselves therefore better off; the owners of capital do not themselves enjoy the whole fruit of the increased productiveness of capital, but are compelled to share it with the workers. But the lowering of the exchange value of the uses does not cause the owners of capital any loss, since the reduced value can obtain more means of enjoyment than the higher value formerly obtained.”

On analogous grounds, which we need not further pursue, Hermann shows that the rate of profit rises if the amount or the productiveness of labour decreases.

The most striking feature in this theory certainly is, that Hermann finds a reason for the decline of interest in the increase of the productive power of capital. In this he goes in direct opposition, on the one hand, to Ricardo and his school, who found the principal cause of the declining rate of interest in the decrease of the productiveness of capitals when driven to worse lands; but, on the other hand, to the Productivity theorists also, who, from the nature of their theory, were bound to accept a direct proportion between the degree of productivity and the rate of interest.
*26

Whether the substance of Hermann’s Use theory be tenable or not, I leave in the meantime an open question. But that Hermann’s application of it to explain the height of the interest rate is not correct is, I think, demonstrable even at the present stage of our inquiries.

It appears to me that, in this part of his doctrine, Hermann has made too little distinction between two things that should have been kept very clearly distinct,—the ratio between total profit and total wage, and the ratio between amount of profit and amount of capital, or the rate of interest. What Hermann has put forward admirably explains and proves a lowering or raising of total profit in proportion to wages of labour; but that explains and proves nothing as regards the height of profit, or the rate of interest.

The source of the oversight lies in this: the abstraction—in other respects quite justifiable—in virtue of which he sees nothing in products but the labours and uses out of which they come, Hermann has extended to the sphere of exchange value, where it should never have been applied. Accustomed to look on uses and labours as representatives of all goods, Hermann thought he might look at these representatives even where the matter at issue concerned the high or low exchange value of any one amount. He calculates thus: uses and labours are the representatives of all goods. Consequently if the use buys as many uses as before, but at the same time buys less labours, its exchange value is evidently smaller. Now this is not true. The exchange value of goods (in the sense of “power in exchange,” which is the sense that Hermann always gives to the word) is measured, not only in the quantities of one or two definite kinds of goods that can be got in exchange for it, but
in the average of all goods; among which, in this case, are to be counted all products, each product having equal rights with the goods called “labour” and with the goods called “use of capital.” Thus exchange value is understood in practical life and in economics, and thus also it is understood by Hermann himself. On p. 432 he expressly declares: “Among such differences of the goods in which price is paid, the establishment of an average price, such as we desired for the fixing of exchange value, is not to be thought of, but the conception of exchange value is not impossible on that account. It is arrived at by considering all the average prices which, in the same market, are paid for one good in all goods; it is a series of comparisons of the same good against many other goods. We shall call the exchange value of a good, as thus determined, the ‘real value’ of the good, to distinguish it from the average amount of the money prices, or the money value.”

Now it is not difficult to show that the power in exchange of the use of capital as against products moves in quite a different direction from its power in exchange against other uses and labours. For instance, if the productiveness of all uses and labours rises to exactly double, the power in exchange between uses and labours, as regards each other, is not disturbed; on the other hand, the power in exchange of both as against the products which result from them is very seriously disturbed: it is, that is to say, doubled.

As regards the rate of interest, the question obviously is, What is the proportion between the exchange power of the uses of capital and the exchange power of a quite definite class of product, viz. that real capital which furnishes the “use”? If the power in exchange of the
use of a machine be twenty times less than the exchange power of the
product machine, the use of the machine “buys” £10, while the machine itself obtains £200 as its equivalent value, and the proportion corresponds to a 5 per cent rate of interest. If the exchange value of the use of a machine again is only ten times less than that of the product machine, the one buys £20 while the other buys £200, and the proportion corresponds to a 10 per cent rate of interest.

Now there is no obvious ground for assuming that the exchange value of real capital is determined in a different way from the exchange value of other products, and, as we have seen, the exchange value of products as against the exchange value of uses, generally speaking, can be altered in another proportion than the exchange value between uses and labour
as regards each other is altered. It follows then that the ratio between the power in exchange of the uses of capital and the power in exchange of real capital (in other words, the rate of interest) may take a different course from the proportion of exchange value between uses and labour. Hermann’s rule therefore is not sufficiently proved.
*27

In conclusion, let me say just a word on the position that Hermann assumes towards the “productivity of capital.” I have already said that he often uses the expression, but never with the meaning given to it by the Productivity theory. He is so far from saying that interest is produced directly from capital, that he maintains high productive power to be a cause of the lowering of interest. He expressly guards himself also (p. 542) against being supposed to say that profit is a compensation for “dead use.” He asserts that capital, to give its due results, demands “plan, care, superintendence, intellectual activity generally.” For the rest, he has not himself attached any particularly clear conception to the expression “productivity.” He defines it in the words: “The totality of the ways in which capital is employed, and the relation of the product to the expenditure, constitute what is called the productivity of capital.”
*28 Does he mean by this the relation of the
value of the product to the
value of the expenditure? If so, then high productivity would only accompany high interest, whereas high productivity certainly occasions low interest. Or does he mean the relation of the
quantity of the product to the
quantity of the expenditure? But in economic life quantity, speaking generally, is of no importance. Or does he mean the relation of the
quantity of the product to the
value of the expenditure? But quantity on one side and value on the other are incommensurable. The fact of the matter, it appears to me, is that Hermann’s definition will not stand strict interpretation. On the whole, it is just possible that he may have had in his mind a kind of physical productivity.

In Germany many writers of note have accepted Hermann’s Use theory, and given it their strong support.

One very clear-headed follower of his is Bernhardi.
*29 Without developing the theory any further,—for he contents himself with quoting Hermann’s doctrine incidentally, and expressing agreement with it,
*30—he shows his originality and profound thinking by a number of fine criticisms, directed principally against the English school.
*31 He has, too, a word of censure for the school that stands at the opposite extreme, the blind Productivity theorists, with their “strange contradiction” of ascribing to the dead tool an independent living activity (p. 307).

Mangoldt again takes the same ground as Hermann, and diverges from him only in unimportant particulars. Thus he gives even less importance to the “productivity of capital” in the formation of interest.
*32 He would go so far as abolish that expression as incorrect, although he does not scruple to use it himself “for the sake of brevity.”
*33 Thus, too, where Hermann puts the height of interest in inverse ratio to the productivity of capital, Mangoldt puts it in direct ratio; indeed, he accepts Thünen’s formula, and puts it in direct ratio to the “last applied dose of capital.”

Similarly Mithoff, in his account of the economical distribution of wealth, lately published in Schönberg’s
Handbuch,*34 follows Hermann in all essential respects.

Schäffle takes a peculiar position on the Use theory. One of the most prominent promoters of that critical movement which came into existence with the rise of scientific Socialism, Schäffle was one of the first to pass through the fermentation of opinion which might have been expected when two such different conceptions encountered each other. This fermentation has left very characteristic traces on his utterances on the subject of interest. I shall show later on that in Schäffle’s writings may be found no less than three distinctly different methods of explaining interest. One of these belongs to the older, two to the later “critical” conception. The first of them falls within the group of the Use theories.

In his first great work, the
Gesellschaftliche System der menschlichen Wirtschaft,*35 Schäffle states his entire theory of interest according to the terminology of the Use theory. Profit of capital is with him a profit from the “use (
Nutzung) of capital”: loan interest is a price paid for that use, and its rate depends on the supply and demand of the uses of loan capital: the uses are an independent element in cost, and so on. But there are unmistakable signs that he is not far from giving up the theory he professedly holds. He repeatedly gives the word “use” a signification very far from that attached to it by Hermann. He explains the use of capital as a “working” (
Wirken) of an economical subject by means of wealth; as a “using” (
Benutzung) of wealth for fruitful production; as a “devoting,” an “employment” of wealth, as a “service” of the undertaker—expressions which would lead us to see in the Use, not so much a material element in production issuing from capital, as a personal element proceeding from the undertaker.
*36 This impression is, moreover, confirmed by the fact that Schäffle repeatedly speaks of profit as premium for an economical vocation. Further, he argues positively against the view that profit is a
product of the use of capital contributed to the process of production (ii. p. 389). He charges Hermann with having coloured his theory too much by the idea of an independent productivity in capital (ii p. 459). But, on the other hand, he often uses the word “use” in such a way that it can only be interpreted in the objective, and therefore in Hermann’s sense; as,
e.g. when he speaks of the supply and demand of the uses of loan capital. On one occasion he explicitly admits that in the use, besides the personal element, there may be contained a material element, which he calls the
Gebrauch of capital (ii. p. 458). And notwithstanding his condemnation of Hermann, he himself does not scruple now and then to ascribe “fruitfulness” to the use of capital. Thus he neither entirely accepts the ground of the Use theory nor entirely rejects it.

Even in his later systematic work, the
Bau und Leben des sozialen Körpers,*37 Schäffle’s views have not developed into a completely clear and consistent theory. While he has got beyond the old Use theory in one respect, in another he has come nearer to it. In the
Bau und Leben he always looks upon interest as a “return to the use (
Nutzung) of capital,” which use at all times maintains an economical value. In this he gives up the subjective meaning of use, and now treats it unambiguously as a purely objective element contributed by goods. He speaks of the uses as “functions of goods,” as “equivalents of useful materials in living labour,” as “living energies of impersonal social substance.” Even in the socialist state this objective use would retain its independent value, and thereby preserve its capacity to yield interest. The phenomenon of interest can only disappear if, in the socialist state, the community, as sole owner of capital, should contribute the valuable use of capital gratuitously; in which case the return from it would go to the advantage of the entire social body (iii. p. 491). On the other hand, Schäffle rather diverges from the old Use theory in not acknowledging the use of capital as an ultimate and original element in production, and in tracing all costs of production to labour alone (iii. pp. 273, 274). But in doing so he chances on another line of explanation, which I shall have to discuss at length in another connection.

While these followers of Hermann have not developed his theory so much as broadened it, Knies may fairly claim to have improved it in some essential respects. He has made no change in its fundamental ideas, but he has given these fundamental ideas a much clearer and more unambiguous expression than Hermann himself gave them. That Hermann’s theory was very much in want of such improvement was shown by the many misunderstandings of it. I have already remarked that Schäffle considered Hermann a Productivity theorist. Still more remarkable is it that Knies himself thought he saw in Hermann, not a forerunner, but an opponent.
*38

Knies was not always a Use theorist. In his
Erörterungen über den Kredit,*39 published in 1859, he looked on credit transactions as barter transactions, or, according to circumstances, buying transactions, in which what one party gives is given in the present, and what the other gives as equivalent is given in the future (p. 568). One of the ulterior results of this conception was that interest must not be looked on as an equivalent of a use transferred in the loan, but—almost as Galiani had put it long before
*40—as a part-equivalent of the parent loan itself. But since then Knies has expressly withdrawn this conception, considering that there is no call for such an innovation, and that, on the contrary, there is much to deter one from accepting it.
*41 Later still, in a fully argued-out analysis, he has expressed himself quite directly to the effect, that any consideration of the different values which present and future goods of the same class may possess on account of the greater urgency of immediate need is, though “not quite unfruitful,” still distinctly insufficient to explain the principal point in the phenomenon of interest.
*42

In place of this, in his comprehensive work
Geld und Kredit, Knies has laid down an unusually clear and thoroughly reasoned Use theory.
*43

Although the purpose of this work only called for investigation into Contract interest, Knies yet treats the subject from such a general standpoint that his views on Natural interest may easily be supplied from what he says on the other.

In fundamental ideas he agrees with Hermann. Like him he conceives of the use (
Nutzung) of a good as “that use (
Gebrauch) which lasts through a period of time, and is limitable by moments of time”; a use to be kept quite distinct from the good itself which is the “bearer of the use”; and a use capable of economical independence. To the question which most concerns the Use theory, whether an independent use and its transfer are conceivable and practicable in the case of
perishable goods, he devotes a searching inquiry, which ends with a distinct answer in the affirmative.
*44 Another cardinal question of the Use theory is, whether and why the independent use of capital must possess an exchange value, and obtain a compensation in the form of interest. This question, as we have seen, Hermann does not leave without answer, but he has laid so little stress on the answer, and put it in such an insignificant form, that it has not unfrequently been quite overlooked.
*45 In contrast to this, Knies has carefully reasoned it out, and concludes that “the emergence and the economical justification of a price for use, in the shape of interest, is founded on the same relation as that on which the price of material goods is founded.” The use is an instrument for the satisfaction of human need just as much as the material good is; it is an object that is “economically valuable and that is economically valued.”
*46 When I add that Knies has avoided not only any relapse into the Productivity theory, but even the very appearance of such a relapse, and that he has appended to his theory some very notable criticisms, particularly of the socialistic interest theory, I have said enough to point out how deeply Hermann’s theory is indebted to a thinker equally distinguished for his acuteness and for the conscientiousness of his research.

We now come to that writer who has put the Use theory into the most perfect form in which it could well be put—Karl Menger, in his
Grundsätze der Volkswirthschaftslehre.*47

The superiority of Menger to all his predecessors consists in this, that he builds his interest theory on a much more complete theory of value,—a theory which gives an elaborate and satisfactory answer to the very difficult question of the relation between the value of products and that of their means of production. Does the value of a product depend on the value of its means of production, or does the value of the means of production depend on that of their product? As regards this question economists up till Menger’s time had been very much groping in the dark. It is true that a number of writers had occasionally used expressions to the effect that the value of the means of production was conditioned by the value of their anticipated product; as, for instance, Say, Riedel, Hermann, Roscher.
*48 But these expressions were never put forward in the form of a general law, and still less in the form of an adequate logical argument. Moreover, as must have been noticed, expressions are to be found in these writers which indicate quite the opposite view; and with this opposite view the great body of economic literature fully agrees in recognising as a fundamental law that the cost of goods determines their value.

But so long as economists did not see clearly on this preliminary question, their treatment of the interest problem could scarcely be more than uncertain groping. How could any one possibly explain in clear outline a difference in value between two amounts—expenditure of capital and product of capital—if he did not even know on which side of the relation to seek for the cause, and on which side for the effect?

To Menger, then, belongs the great merit of having distinctly answered this preliminary question. In doing so he has definitely and for all time indicated the point at which, and the direction in which, the interest problem is to be solved.

His answer is this. The value of the means of production (“goods of higher rank,” in his terminology) is determined always and without exception by the value of their products (“goods of lower rank”). He arrives at this conclusion by the following argument.
*49

Value is the importance “which concrete goods, or quantities of goods, receive for us through the fact that we are conscious of being dependent, for the satisfaction of our wants, on having these goods at our disposal.” The amount of value that goods possess always depends on the importance of those wants, which depend for their satisfaction on our disposal over the goods in question. Since goods of “higher rank” (means of production) are only of service to us through the medium of those goods of “lower rank” (products) which result from them, it is clear that the means of production can only have an importance as regards the satisfaction of our wants so far as their
products possess such an importance. If the only use of means of production were to consist in the making of valueless goods, these means of production could evidently in no way obtain value for us.

Further, since that circle of wants the satisfaction of which is conditioned by a product is obviously identical with that circle of wants the satisfaction of which is conditioned by the sum of the means of production of the product, the degree of importance which a product possesses for the satisfaction of our wants, and that which the sum of its means of production possesses, must be essentially identical. On those grounds the anticipated value of the product is the standard not only for the existence, but also for the
amount of the value of its means of production. Finally, since the (subjective) value of goods is also the basis for their price, the price, or, as some people call it, the “economical value” of goods, is regulated by the same principle.

This being the foundation, the interest problem assumes the following shape.

A capital is nothing else than a sum of “complementary goods” of higher rank. Now if this sum derives its value from the value of its anticipated product, how is it that it never quite reaches that value, but is always less by a definite proportion? Or, if it is true that the anticipated value of the product is the source and the measure of the value of its means of production, how is it that real capital is not valued as highly as its product?

To this Menger gives the following acute answer.
*50

The transformation of means of production into products (or, shortly, Production) always demands a certain period of time, sometimes long, sometimes short. For the purposes of production it is necessary that a person should not only have the productive goods at his disposal for a single moment inside that period of time, but should retain them at his disposal and bind them together in the process of production over the whole period of time. One of the conditions of production, therefore, is this: the disposal over quantities of real capital during definite periods of time. It is in this Disposal that Menger places the essential nature of the use of capital.

The use of capital, or the disposal over capital, thus described, in so far as it is in demand and is not to be had in sufficient quantity, may now obtain a value, or, in other words, may become an economical good. When this happens,—as is usually the case,—then, over and above the other means of production employed in the making of a concrete product (over and above,
e.g. the raw materials, auxiliary materials, labour, and so on), there enters into the sum of value contained in the anticipated product, the disposal over those goods that are required for the production, or the use of capital. And since, on that account, in this sum of value there must remain something for the economical good we have called “use of capital,” the other means of production cannot account for the full amount of the value of the anticipated product. This is the origin of the difference in value between the concrete capital thrown into production and the product; and this at the same time is the origin of interest.
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In this doctrine of Menger the Use theory has at last attained to its full theoretical clearness and maturity. In it there is no falling back on old errors; there is nothing that could even recall the old Productivity theories and their dangers; and with that the interest problem has definitely passed from a production problem, which it is not, to a value problem, which it is. The value problem is, at the same time, so clearly and so sharply put, its outlines so happily filled in by the exposition he gives of the value relation between product and means of production, that Menger has not only distanced his predecessors in the Use theory, but has laid a permanent foundation on which all earnest work at the problem of interest must, for the future, be built.

The work of the critic as regards Menger, therefore, is different from that as regards any of his predecessors. In considering the previous doctrines I have purposely laid on one side the question whether the fundamental principle of the Use theory was warranted or not. I have only examined them in the way of asking whether they presented this principle with more or less completeness, with more or less internal consistency and clearness. In fact, up till now I have, to some extent, tested the concrete Use theories by the ideal Use theory, but I have not tested the ideal Use theory itself. In the case of Menger, however, it is only this latter test that needs to be applied. As regards his theory only one critical question remains to be put, but that the most decisive one: Can the Use theory give us a satisfactory explanation of the interest problem?

I shall try to answer this question in such a way that it will not merely be a special criticism of Menger’s formulation of the theory, but will warrant us in forming an opinion on the whole theoretical movement that reaches its highest development with Menger.

In doing so I am conscious of having undertaken one of the most difficult tasks in criticism. Difficult through the general nature of the matter, which has for so many decades baffled the endeavours of the most prominent minds; difficult, in particular, because I shall be compelled to oppose opinions put forward, after most careful consideration, by the best minds of our nation, and supported with most marvellous ingenuity; difficult, finally, in this, that I shall be compelled to oppose ideas that were once vehemently contested in long past times, then won most brilliant victory over their opponents, and since then have been taught and believed in as dogmas. For what follows, then, I must particularly ask the reader to grant me an unbiassed hearing, patience, and attention.