The Positive Theory of Capital
By Eugen v. Böhm-Bawerk
Geschichte und Kritik der Kapitalzins-Theorieen (1884), which I translated in 1890 under the title of
Capital and Interest, Professor Bohm-Bawerk, after passing in critical review the various opinions, practical and theoretical, held from the earliest times on the subject of interest, ended with the words: “On the foundation thus laid, I shall try to find for the vexed problem a solution which invents nothing and assumes nothing, but simply and truly attempts to deduce the phenomena of the formation of interest from the simplest natural and psychological principles of our science.”
The Positive Theory of Capital, published in Innsbruck in 1888, and here rendered into English, is the fulfilment of that promise…. [From the Translator’s Preface, by William A. Smart.]
William A. Smart, trans.
First Pub. Date
London: Macmillan and Co.
The text of this edition is in the public domain. Picture of Eugen v. Böhm-Bawerk courtesy of The Warren J. Samuels Portrait Collection at Duke University.
- Translators Preface
- Authors Preface
- Book I,Ch.I
- Book I,Ch.II
- Book I,Ch.III
- Book I,Ch.IV
- Book I,Ch.V
- Book I,Ch.VI
- Book II,Ch.I
- Book II,Ch.II
- Book II,Ch.III
- Book II,Ch.IV
- Book II,Ch.V
- Book II,Ch.VI
- Book III,Ch.I
- Book III,Ch.II
- Book III,Ch.III
- Book III,Ch.IV
- Book III,Ch.V
- Book III,Ch.VI
- Book III,Ch.VII
- Book III,Ch.VIII
- Book III,Ch.IX
- Book III,Ch.X
- Book IV,Ch.I
- Book IV,Ch.II
- Book IV,Ch.III
- Book IV,Ch.IV
- Book IV,Ch.V
- Book IV,Ch.VI
- Book IV,Ch.VII
- Book V,Ch.I
- Book V,Ch.II
- Book V,Ch.III
- Book V,Ch.IV
- Book V,Ch.V
- Book VI,Ch.I
- Book VI,Ch.II
- Book VI,Ch.III
- Book VI,Ch.IV
- Book VI,Ch.V
- Book VI,Ch.VI
- Book VI,Ch.VII
- Book VI,Ch.VIII
- Book VI,Ch.IX
- Book VI,Ch.X
- Book VII,Ch.I
- Book VII,Ch.II
- Book VII,Ch.III
- Book VII,Ch.IV
- Book VII,Ch.V
The Market for Capital in Its Full Development—
Book VII, Chapter V
Every man has the power of disposal over a certain amount of goods, small or great, partly delivered him as “parent wealth” by the past, partly obtained by him as “income” in the present, and these two together form his “wealth”
(Vermögen). The natural destination of this wealth is to satisfy his wants. It may be said wealth exists for wants. But many wants compete with each other and put in rival claims. On the one hand, wants of different kinds compete at the same point of time; on the other hand, wants of different times—wants of the present and wants of the future—conipete with each other. How are these various claims to be adjusted?
In a good economical system they will be adjusted in accordance with the principle of “economical conduct,” which prescribes that the goods available should secure the highest possible personal utility. And since even the richest man’s wealth is not sufficient to satisfy all his wants and wishes, this again demands that he make a wise selection among his wants so that he may procure satisfaction, as his available means will allow, to the most important, and leave the unimportant unsatisfied. Applied to the competition of different classes of wants this leads to the principle of harmonious satisfaction; by which is meant that, in all branches of want, satisfaction reaches down to the same level of importance, so that, over the whole field, the unit of goods procures the same marginal utility. For if in one department of want a man were to break off the satisfaction he gets at a high level, in order to seek for satisfaction in another department at a lower level, it would mean that he deliberately renounced a greater utility for a less one, and this would be to run counter to economical principles.
But we employ the very same principle of harmonious satisfaction, and for the same reasons, to regulate the competition between the wants of various times. In the economical furtherance of our life we reach the highest possible point, when we distribute the means of satisfaction, which we have at our disposal, over the various periods of time in such a way that the last unit of goods procures the same marginal utility at all points of time. For, so long as this is not the case, we shall, obviously, be able to increase the amount of our gain by withdrawing units of goods from those times in which they procure a smaller marginal utility, and applying them to the provision of those times in which they are fitted to procure a greater marginal utility.
Rationally speaking, therefore, of the presently existing stock of goods we should only consume so much in the present that the satisfaction of present wants is broken off at the same level as the satisfaction of wants will be broken off in future economic periods—considering the then state of wants and satisfactions: everything over that should be preserved for the service of the future. In terms of this rule “parent wealth” should, economically, almost always be saved. For, if it were consumed in the present along with income, the present would be, relatively, over-provided, and provision would be made for unimportant classes of want; while, in the following years, only the current income, and that in decreased amount, would be available, and the consequence would be a loss of satisfaction affecting even important classes of want. In exceptional cases, on the other hand, it is directly on the lines of rational economic management to lay hands on this parent wealth: at such times, say, as the income of the present is abnormally small, or want is abnormally urgent, while the prospects are that the future will bring a more favourable state of provision.
As regards the employment of the current
income, the standard law of harmonious satisfaction of present and future will lead to a very different method of treatment in different cases. People whose future is secured by safe permanent income, and who, at the same time, do not expect any essential increase of their wants, may, quite reasonably, consume their entire current income in the current period;—such people, for instance, as rich landowners who have not a very large family, or who have no wish to secure each of their children in a similarly comfortable life. People, again, whose future income is uncertain or decreasing, or people whose future wants—either their own or their families’—will rise while their income is likely to remain unchanged, must, economically, retain a portion of their present income against the more poorly provided for wants of the future: they must “save,” and must save enough to put the present and the future on a level as regards provision.
To be exact: something more should be saved, and the provision be made a gradually augmenting one. The reason for this lies indeed in the existence of interest. Interest on capital being a fact, what we have to choose between is not whether £100 worth of wealth gives us more utility according as we consume it to-day, or consume it next year, or consume it in two years. The £100 saved to-day increases in the next year, through interest, to £105; in the next again to £110, and so on; and the choice now is whether it is more useful to us to consume £100 to-day, or £105 next year, or £110 the next again. And we shall increase the total amount of our utility by withdrawing more and more goods from the present so long as, with £105 in next year, or £110 in next again, and so on, we can secure a greater marginal utility than by £100 in the present year. Thus while, if there were no interest, the limit of rational saving would be the point at which the utility obtainable with just £100 now, and with £100 obtainable at various future periods, is exactly the same, that limit, when interest is a fact, is the point where the provision for the various periods is so adjusted that £100 to-day are as useful as £105 next year, £110 in two years, and so on. But if an
increasing expenditure in the future only gives the same amount of utility, it presupposes that, as time goes on, wants of less and less urgency are satisfied—in other words, that the provision for future periods is becoming progressively more ample.
Thus it would be if the principle of “economical conduct” were followed with mathematical exactitude. But one might almost say that there is no point where it would be so difficult for men to act up to the claims of this principle as here. To divide their stock of goods adequately between present and future, they would require to know exactly both the future’s want and the future’s provision—the provision which the future periods when they come will make for themselves. But men have merely vague conjectures as to both amounts. Even as to the momentous question of how many future periods should in general be provided for, the uncertainty of human life makes them grope about completely in the dark—an uncertainty which, it must be said, has no disturbing influence on the economical transactions of that very large class who are anxious to provide, not only for themselves, but, with as much or even more devotion, for their heirs. All the more sensibly, however, is economical conduct disturbed by the familiar psychological fact that almost all men, in greater or less degree, underestimate the future and its wants.
Under the influence of the circumstances just described the economical conduct of human affairs suffers a twofold deviation from the ideal of economical provision. First: men provide for the future, on the average, more insufficiently than they should. They do not distribute their goods between present and future in such a way, that the marginal utility of the unit of goods allotted to the present is equal to the effective marginal utilities of those units allotted to future periods and increased by the intermediate interest. They distribute them in such a way that the marginal utility of the present unit of goods is equal to the marginal utility of the units assigned to the future, as that marginal utility is
perspectively reduced. They save something for the future only in so far as it is clear that, if they did not, they would have to do without future satisfactions whose urgency, even as partially underestimated by them, still appears as great as the urgency of the last present wants which are satisfied, while its real urgency is, to a more or less degree, greater. Since the partial undervaluation of the future varies excessively in different individuals, classes, and nations, the divergence from the ideal of economic provision caused by it is, naturally, very different in degree. Among prudent and savingly disposed peoples its influence will be almost nil; in others it will show itself only in an insufficient percentage of saving; in others, again, in the absence of all saving, or even in light-hearted squandering of parent wealth. Second: economical deliberation on the claims of present and future is not often a finely worked-out piece of economic calculation. For the most part it is only a rough and ready reckoning of tendencies. For exact action, before deciding whether to “spend” or “save” a particular sum of goods, one would always have to be making an accurate picture of want, provision, and marginal utility for the current period, and another picture of want, provision, and marginal utility for all future periods. But this is a piece of work which is somewhat difficult, always troublesome, and one that, in spite of all care, offers no guarantee of any correct result; for, in dealing with the future, one is always compelled to work with very uncertain and conjectural data. In these circumstances not only is it easily explained, but, from the point of view of economical conduct, it is even commendable
*39 that the majority of men, instead of repeating from one case to another, or from one year to another, the troublesome and yet deceptive calculation of the claims of present and future, should, once for all, accept the guidance of an economic tendency which suits their circumstances fairly well, and only make a revision on occasion of great changes in their economical position, such as a marriage, receiving a legacy, and the like.
Very often this rough and ready way of economic deliberation takes this form;—that persons, to whom the exact application of the principal rules of economical conduct is too troublesome, make a secondary rule for their circumstances, and for the time live up to it. One man, for example, makes it an inviolable rule to keep his parent wealth intact: another, to leave his cumbered estate free to his children: a third, to put past so much that he may leave each child a farm: a fourth, to save enough to yield himself £500 a year, and so on. Secondary rules like these will generally coincide, more or less, for those who adopt them, with the demands of the true principle of economic conduct. Sometimes, however, they do not thus coincide, with the result that the people who faithfully follow their secondary rule sin grievously against the primary law. For instance, it is grossly uneconomic conduct in any one to cling doggedly to his resolution of not breaking on his parent wealth, and refuse the costly treatment necessary to restore his health; it is uneconomic not to make some sacrifice for the education of one’s children; and so on. Finally, a great deal of uneconomic conduct arises from the fact that people who have once got into a definite habit of saving, quite reasonable at the time when it was commenced, persist in it, in a wooden sort of way, when their economic position has entirely altered. How often do we see people on the very brink of the grave, who have become rich through great saving, still grudging everything to themselves and others, and continuing to scrape and hoard mechanically for love of it. They begin with saving for love, and they end with love for saving.
Of these two deviations from the ideal economic conduct, the first mentioned is the more important and the more pernicious. The neglect of exact calculations prevents people from following closely the guidance of economic conduct, but it very seldom prevents them from being more or less true to it; while the psychological undervaluation of the future forces men positively—and often far—off the lines of economic conduct. In the undervaluation of the future, we have thus to notice a factor of interest and of the interest rate which, economically, is not at all a pleasing one, but, practically, is a very active one. In an earlier chapter we saw that it co-operates in the origin of the phenomenon of interest, in so far as it assists to give a foundation for an undervaluation of future as against present goods: now we come to recognise it also as an exceedingly active indirect determinant of the rate of interest. The stronger its action in a community, the higher will interest rise in that community. For the partial undervaluation of the future leads to curtailing the claims of the future as against those of the present; to assigning too many instruments of satisfaction to present wants and too few to future. But this leads, on the one hand, to an increase of the present claims on subsistence, and, on the other hand, to a wasteful nibbling at the stock, or, at least, to an inadequate renewal and increase of it through saving: and thus emerges the situation favourable to a high rate of interest, viz. that a (relatively) small subsistence fund is eaten up by (relatively) heavy claims on subsistence, and so suffices only to defray these claims for a relatively short period.
The theory I have put forward has a certain resemblance to the noted, or perhaps I should say notorious, “Wage Fund theory” of the older English school. Like it I maintain the existence of a certain Subsistence Fund, from which the wages of labour in any country are defrayed, and, like it, I attribute to the amount of the subsistence fund an important influence on the reciprocal height of wage and interest. But here the resemblance ends. All the other features, and, among them, the most essential features of both theories, are widely divergent. The Wage Fund of English economists, although considered by them a given and fixed amount, is really a fluctuating indefinite amount; an amount which, consequently, cannot give any secure point of support on which to base any conclusion as to the height of wage. I mean that the “amount of capital destined by capitalists to pay wages” is neither equivalent to the total national capital, nor to the total “circulating capital;” nor yet to any one fixed quota of the national capital. It represents a
variable portion of the community’s wealth, and a portion the extent of which
varies directly, among other things, with the height of wages: it is greater when and because wages have risen, smaller when and because wages have fallen. In explaining, then, the rate of wages by an amount which itself is conditioned by the rate of wages, the Wage Fund theory describes a circle.
*40 My Subsistence Fund, on the other hand, starts with a fixed given amount—the stock of wealth accumulated in a community. Of course that amount of goods which specially serves as subsistence for labourers, and which
I might call the “Wage Fund,” forms a part of the total subsistence fund. But the amount of this portion does not hang in the air, as it does in the English theory: in exactly analysing what parties share in the total subsistence fund, and according to what laws, my “wage fund” becomes—at least relatively—fixed and definite.
But the most important difference is the following. The English theory has it that the rate of wages is simply got by dividing the wage fund by the number of existing workers. This is entirely wrong. In any case the labourers get the wage fund wholly and entirely as wage: but that does not say wage for what time;—for one year, or two years, or three years, or more. The increasing of the subsistence fund has not at all the result, assumed by the English school, that, the number of labourers remaining constant, the rate of wage rises in the same proportion as the amount of the fund increases. The increase of the subsistence fund is, in the first instance and principally, used up in lengthening the production period; and it is only in so far as the lengthening of the production period leads, at the same time, to a decrease of the surplus returns (according to the diminishing scale of surplus returns which accompanies successive extensions of production) that it leads to a curtailment of the capitalist’s share, and to a proportionate rise in the wages of labour; the rise too being in a much weaker ratio than the increase of the subsistence fund. The English Wage Fund theory has thus a core of truth, but it is wrapped up in a quite overpowering mass of error.
And now we may dispense with one last abstraction which has served us as scaffolding in our work of explanation. Hitherto we have represented the total supply and the total demand for present goods as concentrated in one single great market. Instead of this, the commerce in present and future commodities is split up into innumerable part markets. First it is divided into certain great groups, such as the Loan market, the Labour market, the Land market, the market for Concrete Capital. And each of these markets is divided up again and again, partly according to branches, partly according to districts of business. There is one market for mortgages, another for business credit in connection with large undertakings, and still another for business credit in connection with small. There are different loan markets for the peasant and for the citizen, for men of position and for the poor artisan or factory hand, and so on. And, again, within each of these subdivisions there are as many distinct local markets as there are natural or artificial districts devoted to that particular department of economic life. The Labour market, too, is as much split up as the Loan market; first, there are as many groups as there are branches of labour, and then each group is divided up into as many part markets as there are local districts. And so on through all the chief groups above named.
What results from this division and subdivision?—As there is not
one market only for present goods, neither is there only one price for them, but many and diverging market prices, as these arise directly out of the relation of supply and demand ruling in each of the individual part markets. There are in the community at the same moment perhaps a hundred different agios on present goods, and, accordingly, a hundred different rates of interest. But the hundreds or thousands of part markets are not hermetically sealed against one another. They are all in communication, and constantly engaged in arbitrating each other’s prices. If in one part market the agio on present goods is for the time abnormally high, new amounts of capital quickly press into it to get the advantage, and thus reduce the advantage again to zero. If, conversely, in one part market the agio is for the moment abnormally low, the fact is sufficient to prevent any further accession of capital, and even to convey a part of the capital employed in it to other and more favourable part markets, till such time as the unfavourable difference of price again disappears.
It is, therefore, quite right to say that the price which obtains in each part market is, indeed,
first determined by the relation of supply and demand as it exists in the special part market, while this local condition of the market itself, and with it the local price also, is determined indirectly by the immensely more powerful pressure exerted by the
totality of supply and demand over the whole community. The vast mass of the national supply, acting under the influence of those tendencies to equalisation with which we are familiar, forces itself into all part markets in proportional amounts. Part markets, where there is not sufficient capital, it hurries from other quarters to supply: from part markets over-supplied it flows off to other communicating part markets. And if there is neither inflowing nor outflowing, and if, therefore, the local market seems to form its local price purely of its own power, it is then that it is really least independent: it does not require to yield to any foreign market influences at the moment just because it has so completely yielded to them already. It is for the moment at rest only because it is supplied, in exactly the proportion which is required and effected, by the pressure coming from the total relation of supply and demand over the community.
It was then no empty abstraction when we spoke of one united gigantic market for present goods, and of the laws of its united market price. The circumstances of the whole decide on the average amount of supply given to the part markets. Local influences may, for long or for short periods, raise the supply above the average level in one place, and depress it below the level in another, but these are only secondary phenomena, showing themselves, as it were, on the surface of the principal movement, and carried up or down with it—just as the surface of a great wave is furrowed and ridged by smaller wavelets that rise and fall with it.
If the mobility of capital were perfect, the particular divergences from the normal rate of interest could not have any considerable strength, and still less any considerable duration. But as matter of fact there are numerous hindrances, little and great, which check the levelling ebb and flow of capital like weirs on a stream, and these raise or depress local prices. People do not so easily change their employments of capital. If sugar-refining yields one per cent more than cloth-making a powerloom weaver does not become a refiner on a snap of the fingers, and it may be a pretty long time before so many people have put capital in sugar-refining that the rate of profit is pressed down to the normal level. Indeed, in specially favourable circumstances, one special branch of industry may retain
permanently an abnormal rate of agio. The disinclination of a great many affluent people to lend their capital, in small amounts and without security, to necessitous persons, from whom it is difficult to get it back without strong personal effort and supervision—or, it may be, lengthy processes and processes of distraint which are painful to one’s own feelings,—almost universally keeps the supply in this particular loan market permanently and abnormally low, and the agio permanently and abnormally high—even disregarding the deduction which must, of course, be made in this case for premium against risk. And, similarly, the discount market may enjoy a permanently and abnormally low rate of interest, owing to the frequent inflow of large amounts of capital seeking short temporary employments, and, naturally, not finding such either in the mortgage market, or in agricultural loans, or in industrial investments. The great security of the investment, again, and the prospect of future rise in value, keeps the rate of interest in immovables always low; and considerations closely akin to this account for the present lower return of interest on state bonds, preferences, etc., payable in gold as compared with those payable in silver or paper.
It is not my intention to pursue the fate of the rate of interest into all these much-tangled bypaths, where special circumstances and special considerations by the thousand may drive it. The divergences from the normal rate—temporary divergences even more than permanent—are, in truth, in their totality a highly important phenomenon. In them lies the soul and the source of the greater part of “undertakers’ profit”; that profit which falls to the undertakers as fruit of their prosperous arbitrage transactions in present goods. But to work this out in detail is a task by itself; an important and grateful task, but one which in importance comes behind the developing of the great law of the rate of interest. In any case it is a task much too troublesome and much too lengthy to tempt me to a new effort, when I am in sight of home after a long and difficult journey. I have stated the way in which the particular abnormalities are connected with the chief law, and for the moment enough has been done towards understanding the theory of them.
And now to finish. On a former occasion, at the end of the historical part of my work, I laid down the programme for my positive theory in the following words.—”To find for the vexed problem a solution which invents nothing and assumes nothing, but simply and truly attempts to deduce the phenomena of the formation of interest from the simplest natural and psychological principles of our science.” I cannot wish more than the recognition that, in the carrying out of the work, I have been true to my programme. For if, through logically developing the elementary theory of value, I have succeeded in obtaining the explanation of interest, it will give the strongest security that could be wished that we are moving on the right lines with
two theories, that of value and that of capital. It can be nothing but a support for my theory of capital, if that theory can assert its existence as the legitimate and natural outcome of a value theory which has already given so many fair proofs of its correctness, and which is now receiving adherence among all systematic schools and in all countries that have shared in the advance of economical theory. And for the value theory, again, it will be a new proof and, perhaps, the most powerful one, if, by its instrumentality, a problem is solved which all theoretical systems hitherto have attempted in vain.
Grundzüge in Conrad’s
Jahrbücher, vol. xiii. p. 68, and in particular Wieser’s
Ursprung und Hauptgesetze, p. 148.
Grundzüge in Conrad’s
Jahrbücher, vol. xiii. p. 74.
Handbuch, second edition, vol. i. p. 643, particularly note 53.