5.07. Present and Future Goods: The Pure Rate of Interest

0:007. Present and Future Goods, The Pure Rate of Interest We are deferring until later the major part of the analysis of the pricing of productive services and factors. At this point we can see, however, that the purchasing of labor and land services are directly analogous. The classical discussion of productive income treats labor as earning wages, whereas land earns rents, and the two are supposed to be subject to completely different laws. Actually, however, the earnings of labor and land services are analogous. Both are original and productive factors, and in the case in which land is hired rather than bought, both are rented per unit of time rather than sold outright.

0:51Generally, writers on economics have termed those capitalists entrepreneurs who buy labor and land factors in expectation of a future monetary return from the final product. They are entrepreneurs, however, only in the actual economy of uncertainty. In an evenly rotating economy, where all the market actions are repeated in an endless round, and there is therefore no uncertainty, entrepreneurship disappears. There is no uncertain future to be anticipated, and about which forecasts are made. To call these capitalists simply entrepreneurs, then, is tacitly to imply that in the evenly rotating economy there will be no capitalists, that is, no group that saves money and hires the services of factors, thereby acquiring capital and consumers' goods to be sold to the consumers.

1:54Actually, however, there is no reason why pure capitalists should not continue in the ERE, the evenly rotating economy. Even if final returns and consumer demand are certain, the capitalists are still providing present goods to the owners of labor and land, and thus relieving them of the burden of waiting Let us assume, simply, that the sum the capitalists paid out was 95 ounces, and that the final The capital sale was for 100 ounces. The five ounces accruing to the capitalists is payment for their function of supplying present goods and waiting for a future return.

2:59In short, the capitalists in year one bought future goods for 95 ounces and then sold the transformed product in year two for 100 ounces when it had become a present good. In other words, in year one, the market price of an anticipated certain income of 100 ounces was only 95 ounces. It is clear that this arises out of the universal fact of time preference, and of the resulting premium of a given good at present over the present prospect of its future acquisition. In the monetary economy, since money enters into all transactions, In our discussions, the discount of a future good against a present good can, in all cases, be expressed in terms of one good, money.

3:54This is so because the money commodity is a present good, and because claims to future goods are almost always expressed in terms of future money income. The factors of production in our discussion have all been assumed to be purely specific to a particular line of production. When the capitalists have saved money, money capital, however, they are at liberty to purchase factor services in any line of production. Money, the general medium of exchange, is precisely non-specific. For example, the saver sees that he can invest 95 ounces in the aforementioned production process and earn 100 ounces in a year. Whereas he can invest 95 ounces in some other process and earn 110 ounces in a year, he will invest his money in the process earning the greater return.

4:56Clearly, the line in which he will feel impelled to invest will be the line that earns him the The Greatest Rate of Return on His Investment The concept of rate of return is necessary in order for him to compare different potential investments for different periods of time and involving different sums of money. For any amount of money that he saves, he would like to earn the greatest amount of net return, that is, the greatest rate of net return. The absolute amount of return has to be reduced to units of time, and this is done by determining the rate per unit of time.

5:42Thus, a return of 20 ounces on an investment of 500 ounces after two years is 2% per annum, while a return of 15 ounces on the same investment after one year is a return of 3% per annum. If your data work themselves out and continue without change, the rate of net return on the investment of money capital will, in the ERE, be the same in every line of production. If capitalists can earn 3% per annum in one production process and 5% per annum in another, they will cease investing in the former and invest more in the latter, until the rates The rates of return are uniform. In the E.R.E. there is no entrepreneurial uncertainty, and the rate of net return is the pure exchange ratio between present and future goods.

6:44This rate of return is the rate of interest. The pure rate of interest will be uniform for all periods of time and for all lines of production and will remain constant in the ERE. The term pure rate of interest corresponds to Mises' term, originary rate of interest. Suppose that at some time the rates of interest earned are not uniform as between several lines of production. If capitalists are generally earning 5% interest and a capitalist is obtaining 7% in a particular line, other capitalists will enter this line and bid away the factors of production from him by raising factor prices.

7:34Thus, if a capitalist is paying factors 93 ounces out of 100 income, a competing capitalist can offer 95 ounces and outbid the first for the use of the factors. The first, then, forced to meet the competition of other capitalists, will have to raise his bid eventually to 95, disregarding for simplicity the variation in percentages based on the The same equalization process will occur, of course, between capitalists and firms within the same line of production, the same industry. There is always competitive pressure, then, driving toward a uniform rate of interest in the economy.

8:24This competition, it must be pointed out, does not take place simply between firms in the same industry or producing similar products. Since money is the general medium of exchange and can be invested in all products, this close competition extends throughout the length and breadth of the production structure. A fuller discussion of the determination of the rate of interest will take place in Chapter 6, but one thing should here be evident. The classical writers erred grievously in their discussion of the income-earning process in production. They believed that wages were the reward of labor, rents the reward of land, and interest the reward of capital goods, The Three Supposedly Coordinate and Independent Factors of Production But such a discussion of interest was completely fallacious.

9:23As we have seen and shall see further, capital goods are not independently productive. They are the imputable creatures of land and labor and time. Therefore, capital goods generate no interest income. We have seen, in keeping with this analysis, that no income accrues to the owners of capital goods as such. Here the listener is referred to one of the great works in the history of economic thought, Eugen von Boehm-Bawerk's Capital and Interest, where the correct theory of interest is outlined. In particular, the various false theories of interest are brilliantly dissected. This is not to say that the present author endorses all of Boehm-Bawerk's Theory of Interest as presented in his Positive Theory of Capital.

10:16If the owners of land and labor factors receive all the income, for example 100 ounces, when they own the product jointly, Why do their owners consent to sell their services for a total of 5 ounces less than their full worth? Is this not some form of exploitation by the capitalists? The answer, again, is that the capitalists do not earn income from their possession of capital goods, or because capital goods generate any sort of monetary income. The capitalists earn income in their capacity as purchasers of future goods in exchange for supplying present goods to owners of factors.

11:04It is this time element the result of the various individuals' time preferences and not the alleged independent productivity of capital goods from which the interest rate and interest income arise. The capitalists earn their interest income, therefore, by supplying the services of present goods to owners of factors in advance of the fruits of their production, acquiring their products by this purchase and selling the products at the later date when they become present goods. Thus capitalists supply present goods in exchange for future goods. The capital goods hold the future goods and have work done on them until they become present goods.

11:56They have given up money in the present for a greater sum of money in the future, and the interest rate that they have earned is the agio, or discount on future goods as compared with present goods, that is, the premium commanded by present goods over future goods. We shall see that this exchange rate between present and future goods is not only uniform in the production process but throughout the entire market system. It is the social rate of time preference. It is the price of time on the market as the resultant of all the individual valuations of that good. How the agio or pure interest rate is determined in the particular time exchange markets will be discussed further.

12:49Here we shall simply conclude by observing that there is some agio which will be established uniformly throughout the economy and which will be the pure interest rate on the certain In Expectation of Future Goods as Against Present Goods