Essays on some unsettled Questions of Political Economy

We have already remarked (and the very example out of which the difficulty arose presupposes it) that the cost of production of an article consists generally of two parts, – the wages of the labour employed, and the profits of those who, in any antecedent stage of the production, have advanced any portion of those wages. An article, therefore, may be the produce of the same quantity of labour as before, and yet, if any portion of the profits which the last producer has to make good to previous producers can be economized, the cost of production of the article is diminished.

Now, in our example, a diminution of this sort is supposed to have taken place in the cost of production of corn. The production of that article has become less costly, in the ratio of six to five. A quantity of corn, the means of producing which could not previously have been secured but at an expense of 120 quarters, can now be produced by means which 100 quarters are sufficient to purchase.

But the labourer is supposed to receive the same quantity of corn as before. He receives one quarter. The cost of production of wages has, therefore, fallen one-sixth. A quarter of corn, which is the remuneration of a single labourer, is indeed the produce of the same quantity of labour as before; but its cost of production is nevertheless diminished. It is now the produce of 10/18 of a man's labour, and nothing else; whereas formerly it required for its production the conjunction of that quantity of labour with an expenditure, in the form of reimbursement of profit, amounting to one-fifth more.

If the cost of production of wages had remained the same as before, profits could not have risen. Each labourer received one quarter of corn; but one quarter of corn at that time was the result of the same cost of production, as 1 1/5 quarter now. In order, therefore, that each labourer should receive the same cost of production, each must now receive one quarter of corn, plus one-fifth. The labour of 100 men could not be purchased at this price for less than 120 quarters; and the produce, 180 quarters, would yield only 50 per cent, as first supposed 7.

It is, therefore, strictly true, that the rate of profits varies inversely as the cost of production of wages. Profits cannot rise, unless the cost of production of wages falls exactly as much; nor fall, unless it rises.

The proof of this position has been stated in figures, and in a particular case: we shall now state it in general terms, and for all cases.

We have supposed, for simplicity, that wages are paid in the finished commodity. The agricultural labourers, in our example, were paid in corn, and if we had called them weavers, we should have supposed them to be paid in cloth. This supposition is allowable, for it is obviously of no consequence, in a question of value, or cost of production, what precise article we assume as the medium of exchange. The supposition has, besides, the recommendation of being conformable to the most ordinary state of the facts; for it is by the sale of his own finished article that each capitalist obtains the means of hiring labourers to renew the production; which is virtually the same thing as if, instead of selling the article for money and giving the money to his labourers, he gave the article itself to the labourers, and they sold it for their daily bread.

Assuming, therefore, that the labourer is paid in the very article he produces, it is evident that, when any saving of expense takes place in the production of that article, if the labourer still receives the same cost of production as before, he must receive an increased quantity, in the very same ratio in which the productive power of capital has been increased. But, if so, the outlay of the capitalist will bear exactly the same proportion to the return as it did before; and profits will not rise.

The variations, therefore, in the rate of profits, and those in the cost of production of wages, go hand in hand, and are inseparable. Mr. Ricardo's principle, that profits cannot rise unless wages fall, is strictly true, if by low wages be meant not merely wages which are the produce of a smaller quantity of labour, but wages which are produced at less cost, reckoning labour and previous profits together. But the interpretation which some economists have put upon Mr. Ricardo's doctrine, when they explain it to mean that profits depend upon the proportion which the labourers collectively receive of the aggregate produce, will not hold at all; for that, in our first example, remained the same, and yet profits rose.

The only expression of the law of profits, which seems to be correct, is, that they depend upon the cost of production of wages. This must be received as the ultimate principle.

From this may be deduced all the corollaries which Mr. Ricardo and others have drawn from his theory of profits as expounded by himself. The cost of production of the wages of one labourer for a year, is the result of two concurrent elements or factors, – viz., 1st, the quantity of commodities which the state of the labour market affords to him; 2ndly, the cost of production of each of those commodities. It follows, that the rate of profits can never rise but in conjunction with one or other of two changes, – 1st, a diminished remuneration of the labourer; or, 2ndly, an improvement in production, or an extension of commerce, by which any of the articles habitually consumed by the labourer may be obtained at smaller cost. (If the improvement be in any article which is not consumed by the labourer, it merely lowers the price of that article, and thereby benefits capitalists and all other people so far as they are consumers of that particular article, and may be said to increase gross profit, but not the rate of profit.)

So, on the other hand, the rate of profit cannot fall, unless concurrently with one of two events: 1st, an improvement in the labourer's condition; or, 2ndly, an increased difficulty of producing or importing some article which the labourer habitually consumes. The progress of population and cultivation has a tendency to lower profits through the latter of these two channels, owing to the well known law of the application of capital to land, that a double capital does not caeteris paribus yield a double produce. There is, therefore, a tendency in the rate of profits to fall with the progress of society. But there is also an antagonist tendency of profits to rise, by the successive introduction of improvements in agriculture, and in the production of those manufactured articles which the labourers consume. Supposing, therefore, that the actual comforts of the labourer remain the same, profits will fall or rise, according as population, or improvements in the production of food and other necessaries, advance fastest.

The rate of profits, therefore, tends to fall from the following causes: – 1. An increase of capital beyond population, producing increased competition for labour; 2. An increase of population, occasioning a demand for an increased quantity of food, which must be produced at a greater cost. The rate of profits tends to rise from the following causes: – 1. An increase of population beyond capital, producing increased competition for employment; 2. Improvements producing increased cheapness of necessaries, and other articles habitually consumed by the labourer.

The circumstances which regulate the rate of interest have usually been treated, even by professed writers on political economy, in a vague, loose, and unscientific manner. It has, however, been felt that there is some connexion between the rate of interest and the rate of profit; that (to use the words of Adam Smith) much will be given for money, when much can be made of it. It has been felt, also, that the fluctuations in the market-rate of interest from day to day, are determined, like other matters of bargain and sale, by demand and supply. It has, therefore, been considered as an established principle, that the rate of interest varies from day to day according to the quantity of capital offered or called for on loan; but conforms on the average of years to a standard determined by the rate of profits, and bearing some proportion to that rate – but a proportion which few attempts have been made to define.

In consequence of these views, it has been customary to judge of the general rate of profits at any time or place, by the rate of interest at that time and place: it being supposed that the rate of interest, though liable to temporary fluctuations, can never vary for any long period of time unless profits vary; a notion which appears to us to be erroneous.

It was observed by Adam Smith, that profits may be considered as divided into two parts, of which one may properly be considered as the remuneration for the use of the capital itself, the other as the reward of the labour of superintending its employment; and that the former of these will correspond with the rate of interest. The producer who borrows capital to employ it in his business, will consent to pay, for the use of it, all that remains of the profits he can make by it, after reserving what he considers reasonable remuneration for the trouble and risk which he incurs by borrowing and employing it.

This remark is just; but it seems necessary to give greater precision to the ideas which it involves.

The difference between the profit which can be made by the use of capital, and the interest which will be paid for it, is rightly characterized as wages of superintendance. But to infer from this that it is regulated by entirely the same principles as other wages, would be to push the analogy too far. It is wages, but wages paid by a commission upon the capital employed. If the general rate of profit is 10 per cent, and the rate of interest 5 per cent, the wages of superintendance will be 5 per cent; and though one borrower employ a capital of 100,000l., another no more than 100l., the labour of both will be rewarded with the same per centage, though, in the one ease, this symbol will represent an income of 5l., in the other case, of 5000l. Yet it cannot be pretended that the labour of the two borrowers differs in this proportion. The rule, therefore, that equal quantities of labour of equal hardness and skill are equally remunerated, does not hold of this kind of labour. The wages of any other labour are here an inapplicable criterion.

The wages of superintendance are distinguished from ordinary wages by another peculiarity, that they are not paid in advance out of capital, like the wages of all other labourers, but merge in the profit, and are not realized until the production is completed. This takes them entirely out of the ordinary law of wages. The wages of labourers who are paid in advance, are regulated by the number of competitors compared with the amount of capital; the labourers can consume no more than what has been previously accumulated. But there is no such limit to the remuneration of a kind of labour which is not paid for out of wealth previously accumulated, but out of that produce which it is itself employed in calling into existence.

When these circumstances are duly weighed, it will be perceived, that although profit may be correctly analyzed into interest and wages of superintendance, we ought not to lay it down as the law of interest, that it is profits minus the wages of superintendance. Of the two expressions, it would be decidedly the more correct, that the wages of superintendance are regulated by the rate of interest, or are equal to profits minus interest. In strict, propriety, neither expression would be allowable. Interest, and the wages of superintendance, can scarcely be said to depend upon one another. They are to one another in the same relation as wages and profits are. They are like two buckets in a well: when one rises, the other descends, but neither of the two motions is the cause of the other; both are simultaneous effects of the same cause, the turning of the windlass.

There are among the capitalists of every country a considerable number who are habitually, and almost necessarily, lenders; to whom scarcely any difference between what they could receive for their money and what could be made by it, would be an equivalent for incurring the risk and labour of carrying on business. In this predicament is the property of widows and orphans; of many public bodies; of charitable institutions; most property which is vested in trustees; and the property of a great number of persons unused to business, and who have a distaste for it, or whose other occupations prevent their engaging in it. How large a proportion of the property lent to the nation comes under this description, has been pointed out in Mr. Tooke's Considerations on the State of the Currency.

There is another large class, consisting of bankers, bill-brokers, and others, who are money-lenders by profession; who enter into that profession with the intention of making such gains as it will yield them, and who would not be induced to change their business by any but a very strong pecuniary inducement.

There is, therefore, a large class of persons who are habitually lenders. On the other hand, all persons in business may be considered as habitually borrowers. Except in times of stagnation, they are all desirous of extending their business beyond their own capital, and are never desirous of lending any portion of their capital except for very short periods, during which they cannot advantageously invest it in their own trade.

There is, in short, a productive class, and there is, besides, a class technically styled the monied class, who live upon the interest of their capital, without engaging personally in the work of production.

The class of borrowers may be considered as unlimited. There is no quantity of capital that could be offered to be lent, which the productive classes would not be willing to borrow, at any rate of interest which would afford them the slightest excess of profit above a bare equivalent for the additional risk, incurred by that transaction, of the evils attendant on insolvency. The only assignable limit to the inclination to borrow, is the power of giving security: the producers would find it difficult to borrow more than an amount equal to their own capital. If more than half the capital of the country were in the hands of persons who preferred lending it to engaging personally in business, and if the surplus were greater than could be invested in loans to Government, or in mortgages upon the property of unproductive consumers; the competition of lenders would force down the rate of interest very low. A certain portion of the monied class would be obliged either to sacrifice their predilections by engaging in business, or to lend on inferior security; and they would accordingly accept, where they could obtain good security, an abatement of interest equivalent to the difference of risk.

This is an extreme case. Let us put an extreme case of a contrary kind. Suppose that the wealthy people of any country, not relishing an idle life, and having a strong taste for gainful labour, were generally indisposed to accept of a smaller income in order to be relieved from the labour and anxiety of business. Every producer in flourishing circumstances would be eager to borrow, and few willing to lend. Under these circumstances the rate of interest would differ very little from the rate of profit. The trouble of managing a business is not proportionally increased by an increase of the magnitude of the business; and a very small surplus profit above the rate of interest, would therefore be a sufficient inducement to capitalists to borrow.

We may even conceive a people whose habits were such, that in order to induce them to lend, it might be necessary to offer them a rate of interest fully equal to the ordinary rate of profit. In that case, of course, the productive classes would scarcely ever borrow. But government, and the unproductive classes, who do not borrow in order to make a profit by the loan, but from the pressure of a real or supposed necessity, might still be ready to borrow at this high rate.

Although the inclination to borrow has no fixed or necessary limit except the power of giving security, yet it always, in point of fact, stops short of this; from the uncertainty of the prospects of any individual producer, which generally indisposes him to involve himself to the full extent of his means of payment. There is never any permanent want of market for things in general; but there may be so for the commodity which any one individual is producing; and even if there is a demand for the commodity, people may not buy it of him but of some other. There are, consequently, never more than a portion of the producers, the state of whose business encourages them to add to their capital by borrowing; and even these are disposed to borrow only as much as they see an immediate prospect of profitably employing. There is, therefore, a practical limit to the demands of borrowers at any given instant; and when these demands are all satisfied, any additional capital offered on loan can find an investment only by a reduction of the rate of interest.

The amount of borrowers being given, (and by the amount of borrowers is here meant the aggregate sum which people are willing to borrow at some given rate,) the rate of interest will depend upon the quantity of capital owned by people who are unwilling or unable to engage in trade. The circumstances which determine this, are, on the one hand, the degree in which a taste for business, or an aversion to it, happens to be prevalent among the classes possessed of property; and on the other hand, the amount of the annual accumulation from the earnings of labour. Those who accumulate from their wages, fees, or salaries, have, of course, (speaking generally) no means of investing their savings except by lending them to others: their occupations prevent them from personally superintending any employment.

Upon these circumstances, then, the rate of interest depends, the amount of borrowers being given. And the counter-proposition equally holds, that, the above circumstances being given, the rate of interest depends upon the amount of borrowers.

Suppose, for example, that when the rate of interest has adjusted itself to the existing state of the circumstances which affect the disposition to borrow and to lend, a war breaks out, which induces government, for a series of years, to borrow annually a large sum of money. During the whole of this period, the rate of interest will remain considerably above what it was before, and what it will be afterwards.

Before the commencement of the supposed war, all persons who were disposed to lend at the then rate of interest, had found borrowers, and their capital was invested. This may be assumed; for if any capital had been seeking for a borrower at the existing rate of interest, and unable to find one, its owner would have offered it at a rate slightly below the existing rate. He would, for instance, have bought into the funds, at a slight advance of price; and thus set at liberty the capital of some fundholder, who, the funds yielding a lower interest, would have been obliged to accept a lower interest from individuals.

Since, then, all who were willing to lend their capital at the market rate, have already lent it, Government will not be able to borrow unless by offering higher interest. Though, with the existing habits of the possessors of disposable capital, an increased number cannot be found who are willing to lend at the existing rate, there are doubtless some who will be induced to lend by the temptation of a higher rate. The same temptation will also induce some persons to invest, in the purchase of the new stock, what they would otherwise have expended unproductively in increasing their establishments, or productively, in improving their estates. The rate of interest will rise just sufficiently to call forth an increase of lenders to the amount required.

This we apprehend to be the cause why the rate of interest in this country was so high as it is well known to have been during the last war. It is, therefore, by no means to be inferred, as some have done, that the general rate of profits was unusually high during the same period, because interest was so. Supposing the rate of profits to have been precisely the same during the war, as before or after it, the rate of interest would nevertheless have risen, from the causes and in the manner above described.

The practical use of the preceding investigation is, to moderate the confidence with which inferences are frequently drawn with respect to the rate of profit from evidence regarding the rate of interest; and to shew that although the rate of profit is one of the elements which combine to determine the rate of interest, the latter is also acted upon by causes peculiar to itself, and may either rise or fall, both temporarily and permanently, while the general rate of profits remains unchanged.

The introduction of banks, which perform the function of lenders and loan-brokers, with or without that of issuers of paper-money, produces some further anomalies in the rate of interest, which have not, so far as we are aware, been hitherto brought within the pale of exact science.

If bankers were merely a class of middlemen between the lender and the borrower; if they merely received deposits of capital from those who had it lying unemployed in their hands, and lent this, together with their own capital, to the productive classes, receiving interest for it, and paying interest in their turn to those who had placed capital in their hands; the effect of the operations of banking on the rate of interest would be to lower it in some slight degree. The banker receives and collects together sums of money much too small, when taken individually, to render it worth while for the owners to look out for an investment, but which in the aggregate form a considerable amount. This amount may be considered a clear addition to the productive capital of the country; at least, to the capital in activity at any moment. And as this addition to the capital accrues wholly to that part of it which is not employed by the owners, but lent to other producers, the natural effect is a diminution of the rate of interest.

The banker, to the extent of his own private capital, (the expenses of his business being first paid,) is a lender at interest. But, being subject to risk and trouble fully equal to that which belongs to most other employments, he cannot be satisfied with the mere interest even of his whole capital: he must have the ordinary profits of stock, or he will not engage in the business: the state of banking must be such as to hold out to him the prospect of adding, to the interest of what remains of his own capital after paying the expenses of his business, interest upon capital deposited with him, in sufficient amount to make up, after paying the expenses, the ordinary profit which could be derived from his own capital in any productive employment. This will be accomplished in one of two ways.

1. If the circumstances of society are such as to furnish a ready investment of disposable capital; (as for instance in London, where the public funds and other securities, of undoubted stability, and affording great advantages for receiving the interest without trouble and realizing the principal without difficulty when required, tempt all persons who have sums of importance lying idle, to invest them on their own account without the intervention of any middleman;) the deposits with bankers consist chiefly of small sums likely to be wanted in a very short period for current expenses, and the interest on which would seldom be worth the trouble of calculating it. Bankers, therefore, do not allow any interest on their deposits. After paying the expenses of their business, all the rest of the interest they receive is clear gain. But as the circumstances of banking, as of all other modes of employing capital, will on the average be such as to afford to a person entering into the business a prospect of realizing the ordinary, and no more than the ordinary, profits upon his own capital; the gains of each banker by the investment of his deposits, will not on the average exceed what is necessary to make up his gains on his own capital to the ordinary rate. It is, of course, competition, which brings about this limitation. Whether competition operates by lowering the rate of interest, or by dividing the business among a larger number, it is difficult to decide. Probably it operates in both ways; but it is by no means impossible that it may operate in the latter way alone: just as an increase in the number of physicians does not lower the fees, though it diminishes an average competitor's chance of obtaining them.