IV. The Relation of this Study to the Current Theories of Capital

CHAPTER IV THE RELATION OF THIS STUDY TO THE CURRENT THEORIES OF CAPITAL As already remarked above, the explanation of interest will not be the sole or central purpose of the present study, as was the case with most of the similar investigations in the past. The explanation of interest will The" productivity" b .. d t I th h It theories of interest e an IncI en a oug necessary resu most helpful for our of an attempt to analyse the forces which purpose determine the use made of the productive resources. Our main task is not to explain a particular form of income, or the price of a particular factor of production, but to display the connection between the supply of the various kinds of productive resources, the demand for real income at different dates, and the technique of production that will be chosen. Most of the analytical tools which we shall have to use were, however, created in the past in .

the search for the explanation of interest. And it is natural that the theories of interest which have con tributed most to the elucidation of the problems which we are going to study should be those which stressed the " productivity of capital" and were in consequence based on an analysis of the material structure of production. What follows is in some respects no more than an attempt towards a systematic development and elabora tion of the fundamental ideas underlying the theory of interest of W. S. Jevons, E. v. Bohm-The founders 01 Bawerk, and Knut Wicksell. If, in the modern productivity f . £ It' t f th' analysis course 0 Its re ormu a lon, par s 0 elf theory are changed beyond recognition, this does not alter the fact that their work contains, though perhaps in a somewhat crude and excessively simplified form, nearly 41 42 Introductory PT. 1 all the basic ideas on which the following exposition builds.

Jevons' work, although he was not given time to formulate it in a way in which it was readily intelligible, contained the essential elements of the more fully developed theory. 1 Bohm-Bawerk in many respects simply developed the ideas propounded by Jevons and made them intelligible to wider circles by elaborating them: but at the same time he gave the impetus to a movement away from what seems to me to be the more fruitful approach on Jevonian lines. 2 His effective, although I think mistaken, critique of the earlier productivity theories of interest had the effect of causing later development to centre increasingly round the" psychological" or "time-prefer ence " element in his theory rather than the productivity element. In the first instance Professor Irving Fisher, without in any way denying the importance of the productivity element, has, in a number of earlier works,3 stressed the 1 Apart from the relevant chapters of the Theory of Political Economy (1st ed. 1871, 4th ed. 1911, particularly chap. vii), his unfinished Prin· ciples of Economics (1905) and the additional chapter to this work, printed as Appendix II to the' fourth edition of the The()ry, should be consulted.

2 Cf. Kapital und Kapitalzins, published in two parts (1886 and 1889) and translated under the titles Capital and Interest (1890) and The Positive Theory of Capital (1891), which is still by far the most elaborate and comprehensive discussion of the problems of capital. The third and fourth German editions contain a good deal of important additionnl mnterial in the form of further elucidations, replies to criticisms, nnd discussions of later theories. This material has not so far been avnilable in Engli!)h, although a new complete translation by Mr. Hugh Gait!)kell is in preparation. This ndditional material is particularly important for its treatment of durable goods, which were unduly neglected in the first edition available in English - a fact which hns given rise to much misunderstanding of B6hm·Bawerk's doctrines among English.speaking economists. Some remarks on this subject will be found in B6hm-Bawerk's Recent Literature on Interest (1903). A number of smaller essays in German dealing with particular problems in this field were collected after B6hm-Bawerk's death by Professor F. X. Weiss under the title Kleinere Abhandlungen uber Kapital und ZinB (1926).

• Particularly The Nature of Capital and Income (1906) and The Rate of Interest (1907), which in spite of the new exposition of the OIl. IV Current Theories of Capital 43 psychological factor so much more than the productivity factor that he was at least understood to attach more im portance to the former. More recently he has, however, given us, in the most systematic work on Th d 1 t f e eve opmen 0 the subject which we possess, a formally the time-preference . bi . . f h th approach unImpugna e eXposItIon 0 t e eory of interest. 1 It is a work with which every student of the subject must be familiar. But because of a different distribution of emphasis, and in particular his concen tration on interest rather than on the methods of produc tion, Professor Fisher's work hardly touches on a good deal of what is treated as important in the present study. The time-preference element has, however, been stressed much more exclusively by another author who has developed this side of the Bohm-Bawerkian analysis, namely Professor F. A. Fetter. His writings on the subject, which, apart from the relevant sections of his two textbooks,2 include numerous articles in various periodicals, will be found very suggestive, and in spite of certain obvious differences, have a close afI!nity to some of the leading ideas of the investigation that follows.

This is particularly true of the idea of the rate of interest as an element pervading the whole price-structure. In addition to this branch there is a second branch which also springs from the Jevons-Bohm-Bawerk stem. This is represented almost exclusively by K. Wicksell 3 same set of problems which the author has given us since, will still be found useful for their more detailed treatment of particular problems. 1 The Theory oj Interest (1930). 2 Principles oj Economics (1907) and Economic Principles (1915). 3 Wicksell first treated these problems in extenso in 1893 in his Wert, Kapital und Rente (now· reprinted as no. 15 of the Series of Reprints of Scarce Tracts in Econom1:cs and Political Science, 1933). He later incorporated the main argument, with some improvements, in his Vorlesungen (vol. 1, 1913, and earlier in Swedish), now available in English under the title Lectures on Political Economy (vol. i, 1934).

Certain important points are also contained in his Finanztheoretische Untersuchungen (1896) and Geldzins und Guterpreise (1898; English edition, Interest and Prices, 1936).

44 Introductory PT. I and his pupils (particularly Professor G. Akerman 1 and Professor E. Lindahl 2), who, with the help of certain ideas derived from L. Walras,3 have systematically developed the productivity approach. It is The development of the productivity ap-in the shape into which this type of theory proach has been fashioned by Wicksell that it provides the most useful basis for the present study. Wicksell has seen nearly all the important problems left open by Bohm-Bawerk; and in. fact, after one has oneself found the solution of a difficulty arising when one abandons Bohm-Bawerk's simplifica,tions, one frequently finds it implied or even explicitly stated in some incon spicuous remark in Wicksell's work. It must, however, be admitted that Wicksell did not give an adequate answer to B6hm-Bawerk's objections to an explanation of interest which was based mainly on the marginal pro ductivity principle,and it will be one of the tasks of the present investigation to show why the factors affecting the supply of new capital ought to be relegated to a secondary place, at least in an analysis which is not primarily concerned with the conditions of long-term stationary equilibrium.

Besides the three authors who were responsible for the main steps in the development of the marginal produc tivity analysis of interest, there. are several others who' should be mentioned as having helped to shape those 1 G. Akerman, Realkapital und Kapitalzins, 2 Parts (1923 and 1924). 2 Most of Professor Lindahl's contributions are now available in English in a volume Studie8 in the Theory of Money and Capital (1939). See, however, also the Bibliography at the end of the present volume. 3 Element8 d'economie politique pure (1847-77, 4th ed. 1900), section 5. Probably Walras deserves more than this mention in passing, although his direct influence in this field was not very considerable, and even Wicksell, who in most other respects had absorbed so much of Walras' teaching, fully comprehended his theory of interest only at a late stage. See his Lecture8, vol. i, p. 226, particularly the footnote - which incidentally is also interesting for the distinction between what is now known as the ex ante and ex post rate of interest (or the anticipated and the actual rate of interest, as Wicksell calls them).

CR. IV Current Theorie8 of Capital 45 doctrines. In the first place there are the ingenious pre decessors of this school, H. von Thiinen and, more especi ally, John Rae. 1 The latter's New Principles on the Subject of Political Economy (1834) 2 contains some P d d h re eeessors an ot er acute analyses of points of detail still not Important contrlbub £ d I ~M to e oun e sewhere, and has had considerable effect through its influence on J. S. MilL With regard to more recent contributions this study owes much to Professor F. W. Taussig's Wages and Capital (1897),3 especially for the more felicitous terminology which he has introduced in certain connections. Among the great mass of other pre-war monographs Professor A. Landry's L'Interet du capital (1904) deserves special mention. And finally, L. von Mises, although his published work deals mainly with the more complex problems that only arise beyond the point at which this study ends, has suggested some of the angles from which the more abstract problem is approached in this book. For reasons already explained in the preface, this general acknowledgement of the main obligations will have to stand in place of more detailed references throughout the text. Particularly in the case of Jevons, Bohm-Bawerk, and Wicksell, the constant references which an adequate acknowledgement of the real indebtedness would require have been omitted. But the same applies to most other authors, and the com paratively few references that are given are intended not 1 Perhaps Ri~rdo should also be mentioned here, even if he could scarcely have been aware of all the implications of his theory which Dr.

Victor Edelberg has so ingeniously worked out (1933). There can be no doubt, however, that Wicksell was to a large extent inspired by Ricardo. 2 Republished in a rearranged form with an Introduction by Professor C. W. Mixter under the title The Sociological Theory of Oapital (1905). • Reprinted as no. 13 of the Series of Reprints of Scarce Tracts in Economics and Political Science (London, 1932). Cf. also Professor Taussig's articles: "Capital, Interest and Diminishing Returns", Quarterly Journal of Economics, vol. xxii/3 (1908), and" Outlines of a Theory of Wages ", American Economic A880ciation Quarterly, Third Series, vol. xi, 1910.

46 Introductory PT. I so much as an acknowledgement of an obligation as an illustration, by similarity or contrast, of the point under discussion. 1 The general line of thought which this investigation follows has of late often been described as the" Austrian" theory of capital. In view of the varied nationality of The two current the founders of this theory, and in view methOds of approach of the fact that the men who are comto the capital problem monly regarded as the leaders of the ":Austrian School" of economics are by no means in agreement on it,2 it is questionable whether this designa tion is appropriate. But, in spite of J evons and the other English and American adherents, it cannot be denied that these views have in recent times intruded into Anglo American discussions as a sort of alien element. And perhaps it will assist the reader if an attempt is made to sketch the main points on which the approach followed here differs from the traditional Anglo-American treat ment of the same problems, and particularly, it seems, from the views of those authors who were mainly influ enced by the teachings of Alfred Marshall. This may be conveniently done by setting out the differences point for point in tabular form. In order to make them quite clear one may also be permitted to state the points that are emphasised by the two lines of thought in a rather trenchant and even exaggerated form. It is of course not claimed that the description of either of these approaches in its extreme form does justice to the real position.

Indeed one of the tasks of the following pages will be to amalgamate the t,vo lines of thought into a coherent whole. All that is claimed is that in the "Anglo1 While references in the text to contemporary discussions of these problems have been kept to a minimum, a fairly full list of contributions in this field during the past ten or twenty years which have come to the knowledge of the author has been added as an appendix to this volume. 2 Neither C. Menger nor F. von Wieser, nor - to mention only one name from the later generation - Professor Schumpeter accepted Bohnl-Bawerk's views.

ClI. IV Current Theories of Capita.l 47 . American " treatment the aspects stressed by the second or " Austrian" approach have in more recent times 1 been unduly neglected. In the following list of propositions the first of each pair is. intended to represent the traditional or " Anglo American" point of view, while the second gives the contrasting" Austrian" view on the same problem: lAo Stress is laid exclusively on the role of fixed capital as if capital consisted only of very durable goods. 2A. The term capital goods is reserved to durable goods which are treated as needing replacement only discon tinuously or periodically.3 lB. Stress is laid on the role of circulating capital which arises out of the duration of the process of production, be cause this brings out particu larly clearly some of the characteristics of all capital. 2 2B. Nonpermanence is re garded as the characteristic attribute of all capital goods, and the emphasis is accord ingly laid on the need for continuous reproduction of all capita1. 4 1 It may perhaps be mentioned here that the classical English economists since Ricardo, and particularly J. S. Mill (the latter prob ably partly under the influence o£..J. Rae), were-in this sense much more" Austrian" JAlan their successors.

2 Cf. Wiekseil, Lectures, vol. i, p. 186: "Strictly speaking only short-period capital (in other words circulating capital) can be regarded as capital proper". 3 A consequence of this concept of capital which we cannot discuss here further is the concept of gross investment as referring to the aggregate production of durable goods, and the belief that this lnagnitude is of special significance. It is, of course, closely connected with the distinction between the short and the long period, which, as was shown before, has little meaning for the economic system as a whole. 4 Cf. J. S. Mill, Principles, I/v/7, ed. Ashley, p. 74: "Capital is kept in existence from age to age not by preservation but by perpetual reproduction; every part of it is used and destroyed, but those who destroy it are employed meanwhile in producing more"; and Wicksell, Lectures, vol. i, p. 203: "The accumulation of capital is itself, even under stationary conditions, a necessary element in the problem of production and exchange".

48 Introductory PT. I 3A. The supply of capital goods is assumed to be given for the comparatively short run. 4A. The relevant time factor which we need to consider in order to be able to understand the effect of changes in the rate of interest on t.he value of a particular capital good is assumed to be its individual durability. 5A. The technique employed iri production is supposed to be unalterably determined by the given state of techno logical knowledge. 6A. The need for more capital is assumed to arise mainly out of a lateral expansion of pro duction, i.e. a mere duplica tion of equipment of the kind already in existence. 7A. The change that will initiate additions to the stock of capital is sought in an in crease in absolute demand, i.e. in the total money expendi ture on consumers' goods. 8A. In order to make a lateral expansion of production ap pear possible, the existence aBe It is assumed that the stock of ca Ilital goods is being constantly used up and reproduced.

4B. It is not the individual durability of a particular good but the time that will elapse before the final services to which it contributes will mature that is regarded as the decisive factor. That is, it is not the attributes of the indi vidual good but its position in the whole time structure of production that is regarded as relevant. 5B. Which of the many known technological methods of pro duction will be employed is assumed to be determined by the supply of capital available at each moment. 6B. Additional capital is assumed to be needed for making changes possible in the technique of production (i.e. in the way in which indi vidual resources are used), and to. lead to longitudinal changes in the structure of production. 7B. Changes in the stock of capital are supposed to be determined by changes in the relative demand for con sumers' and producers' goods respectively. 8B. In order to stress the changes in productive tech nique connected with an inCR. IV Current Theories of Capital 49 of unemployed resources of all kinds is postulated.

9A. The demand for capital goods is assumed to vary in the same direction as the demand for consumers' goods but in an exaggerated degree. And, finally: lOA. The analysis is carried out in monetary terms, and a change in demand is assumed to mean a corresponding change in the size of the total money stream. crease of capital, the existence of full employment is usually postulated. 9B. The demand for capital goods is assumed to vary in the opposite direction from the demand for consumers' goods. lOB. The analysis is carried out in "real" terms, and an increase in demand some where must therefore neces sarily mean a corresponding decrease in demand some where else. The last four propositions relate to problems which are already outside the pure theory of capital which forms the subject of this book: they belong more properly to the main theory of monetary problems to which the present study is merely preparatory. But their inclusion in the list may help the reader to see the practical significance of these different ways of approach.

5 CHAPTER V THE NA'TURE OJ<' THE CAPITAL PROBLEM 1 IN the first stage of economic analysis it is usually assumed that all productive resources are given in an unalterable form. They are regarded as sources of services which will Elementaryequl-continue permanently to be available inde Iibrium analysis pendently of any deliberate action to pro proceeds as II all productive resources vide them. This is nearly enough true of were permanent free 2 human labour (which is not deliberately created from economic considerations) and perhaps also of the so-called " indestructible powers of the soil". And the shorter the period of time which we regard as relevant, the wider will be the circle of resources which, for that period, can be regarded as definitively given. This procedure is convenient as a first approach, because it allows us to analyse a number of important relationships without the complications which arise as soon as we take account of the fact that many of the existing resources may be of only limited durability. It is one of the devices which enables us to treat the economic process as" stationary" and to disregard all changes which occur in time. It will be assumed here that this part of economic theory has been fully worked out. 3 There can be no doubt that the picture obtained in this way corresponds very little with reality. If we look at the productive resources of any society at a given moment, we find that only a very small part of them (even apart from the human beings themselves) will con1 An earlier version of this chapter has appeared in German as an article in the Zeitschrift fur N ationalokonomie, 1937.