Chapter 16
SUNDRY OBSERVATIONS ON THE NATURE OF CAPITAL
I
An act of individual saving means¾so
to speak¾a decision not to have
dinner to-day. But it does not necessitate a decision to have
dinner or to buy a pair of boots a week hence or a year hence or
to consume any specified thing at any specified date. Thus it
depresses the business of preparing to-day's dinner without
stimulating the business of making ready for some future act of
consumption. It is not a substitution of future
consumption-demand for present consumption-demand,¾it is a net diminution of such demand.
Moreover, the expectation of future consumption is so largely
based on current experience of present consumption that a
reduction in the latter is likely to depress the former, with the
result that the act of saving will not merely depress the price
of consumption-goods and leave the marginal efficiency of
existing capital unaffected, but may actually tend to depress the
latter also. In this event it may reduce present
investment-demand as well as present consumption-demand.
If saving consisted not merely in abstaining from present
consumption but in placing simultaneously a specific order for
future consumption, the effect might indeed be different. For in
that case the expectation of some future yield from investment
would be improved, and the resources released from preparing for
present consumption could be turned over to preparing for the future
consumption. Not that they necessarily would be, even in this
case, on a scale equal to the amount of resources
released; since the desired interval of delay might require a
method of production so inconveniently 'roundabout' as to have an
efficiency well below the current rate of interest, with the
result that the favourable effect on employment of the forward
order for consumption would eventuate not at once but at some
subsequent date, so that the immediate effect of the
saving would still be adverse to employment. In any case,
however, an individual decision to save does not, in actual fact,
involve the placing of any specific forward order for
consumption, but merely the cancellation of a present order.
Thus, since the expectation of consumption is the only raison
d'être of employment, there should be nothing paradoxical in
the conclusion that a diminished propensity to consume has cet.
par. a depressing effect on employment.
The trouble arises, therefore, because the act of saving
implies, not a substitution for present consumption of some
specific additional consumption which requires for its
preparation just as much immediate economic activity as would
have been required by present consumption equal in value to the
sum saved, but a desire for 'wealth' as such, that is for a
potentiality of consuming an unspecified article at an
unspecified time. The absurd, though almost universal, idea that
an act of individual saving is just as good for effective demand
as an act of individual consumption, has been fostered by the
fallacy, much more specious than the conclusion derived from it,
that an increased desire to hold wealth, being much the same
thing as an increased desire to hold investments, must, by
increasing the demand for investments, provide a stimulus to
their production; so that current investment is promoted by
individual saving to the same extent as present consumption is
diminished.
It is of this fallacy that it is most difficult to disabuse
men's minds. It comes from believing that the owner of wealth
desires a capital-asset as such, whereas what he really
desires is its prospective yield. Now, prospective yield
wholly depends on the expectation of future effective demand in
relation to future conditions of supply. If, therefore, an act of
saving does nothing to improve prospective yield, it does nothing
to stimulate investment. Moreover, in order that an individual
saver may attain his desired goal of the ownership of wealth, it
is not necessary that a new capital-asset should be
produced wherewith to satisfy him. The mere act of saving by one
individual, being two-sided as we have shown above, forces
some other individual to transfer to him some article of wealth
old or new. Every act of saving involves a 'forced' inevitable
transfer of wealth to him who saves, though he in his turn may
suffer from the saving of others. These transfers of wealth do
not require the creation of new wealth¾indeed,
as we have seen, they may be actively inimical to it. The
creation of new wealth wholly depends on the prospective yield of
the new wealth reaching the standard set by the current rate of
interest. The prospective yield of the marginal new investment is
not increased by the fact that someone wishes to increase his
wealth, since the prospective yield of the marginal new
investment depends on the expectation of a demand for a specific
article at a specific date.
Nor do we avoid this conclusion by arguing that what the owner
of wealth desires is not a given prospective yield but the best
available prospective yield, so that an increased desire to own
wealth reduces the prospective yield with which the producers of
new investment have to be content. For this overlooks the fact
that there is always an alternative to the ownership of real
capital-assets, namely the ownership of money and debts; so that
the prospective yield with which the producers of new investment have to be content cannot fall
below the standard set by the current rate of interest. And the
current rate of interest depends, as we have seen, not on the
strength of the desire to hold wealth, but on the strengths of
the desires to hold it in liquid and in illiquid forms
respectively, coupled with the amount of the supply of wealth in
the one form relatively to the supply of it in the other. If the
reader still finds himself perplexed, let him ask himself why,
the quantity of money bcing unchanged, a fresh act of saving
should diminish the sum which it is desired to keep in liquid
form at the existing rate of interest.
Certain deeper perplexities, which may arise when we try to
probe still further into the whys and wherefores, will be
considered in the next chapter.
II
It is much preferable to speak of capital as having a yield
over the course of its life in excess of its original cost, than
as being productive. For the only reason why an asset
offers a prospect of yielding during its life services having an
aggregate value greater than its initial supply price is because
it is scarce; and it is kept scarce because of the
competition of the rate of interest on money. If capital becomes
less scarce, the excess yield will diminish, without its having
become less productive¾at least in
the physical sense.
I sympathise, therefore, with the pre-classical doctrine that
everything is produced by labour, aided by what used to be
called art and is now called technique, by natural resources
which are free or cost a rent according to their scarcity or
abundance, and by the results of past labour, embodied in assets,
which also command a price according to their scarcity or
abundance. It is preferable to regard labour, including, of
course, the personal services of the entrepreneur and his
assistants, as the sole factor of production, operating in a given
environment of technique, natural resources, capital equipment
and effective demand. This partly explains why we have been able
to take the unit of labour as the sole physical unit which we
require in our economic system, apart from units of money and of
time.
It is true that some lengthy or roundabout processes are
physically efficient. But so are some short processes. Lengthy
processes are not physically efficient because they are long.
Some, probably most, lengthy processes would be physically very
inefficient, for there are such things as spoiling or wasting
with time.
With a given labour force there is a definite limit to the
quantity of labour embodied in roundabout processes which can be
used to advantage. Apart from other considerations, there must be
a due proportion between the amount of labour employed in making
machines and the amount which will be employed in using them. The
ultimate quantity of value will not increase indefinitely,
relatively to the quantity of labour employed, as the processes
adopted become more and more roundabout, even if their physical
efficiency is still increasing. Only if the desire to postpone
consumption were strong enough to produce a situation in which
full employment required a volume of investment so great as to
involve a negative marginal efficiency of capital, would a
process become advantageous merely because it was lengthy; in
which event we should employ physically inefficient processes,
provided they were sufficiently lengthy for the gain from
postponement to outweigh their inefficiency. We should in fact
have a situation in which short processes would have to be
kept sufficiently scarce for their physical efficiency to
outweigh the disadvantage of the early delivery of their product.
A correct theory, therefore, must be reversible so as to be able
to cover the eases of the marginal efficiency of capital
corresponding either to a positive or to a negative rate of interest; and it
is, I think, only the scarcity theory outlined above which is
capable of this.
Moreover there are all sorts of reasons why various kinds of
services and facilities are scarce and therefore expensive
refatively to the quantity of labour involved. For example,
smelly processes command a higher reward, because people will not
undertake them otherwise. So do risky processes. But we do not
devise a productivity theory of smelly or risky processes as
such. In short, not all labour is accomplished in equally
agreeable attendant circumstances; and conditions of equilibrium
require that articles produced in less agreeable attendant
circumstances (characterised by smelliness, risk or the lapse of
time) must be kept sufficiently scarce to command a higher price.
But if the lapse of time becomes an agreeable attendant
circumstance, which is a quite possible case and already holds
for many individuals, then, as I have said above, it is the short
processes which must be kept sufficiently scarce.
Given the optimum amount of roundaboutness, we shall, of
course, select the most efficient roundabout processes which we
can find up to the required aggregate. But the optimum amount
itself should be such as to provide at the appropriate dates for
that part of consumers' demand which it is desired to defer. In
optimum conditions, that is to say, production should be so
organised as to produce in the most efficient manner compatible
with delivery at the dates at which consumers' demand is expected
to become effective. It is no use to produce for delivery at a
different date from this, even though the physical output could
be increased by changing the date of delivery;¾except
in so far as the prospect of a larger meal, so to speak, induces
the consumer to anticipate or postpone the hour of dinner. If,
after hearing full particulars of the meals he can get by fixing
dinner at different hours, the consumer is expected to decide in favour
of 8 o'clock, it is the business of the cook to provide the best
dinner he can for service at that hour, irrespective of whether
7.30, 8 o'clock or 8.30 is the hour which would suit him best if
time counted for nothing, one way or the other, and his only task
was to produce the absolutely best dinner. In some phases of
society it may be that we could get physically better dinners by
dining later than we do; but it is equally conceivable in other
phases that we could get better dinners by dining earlier. Our
theory must, as I have said above, be applicable to both
contingencies.
If the rate of interest were zero, there would be an optimum
interval for any given article between the average date of input
and the date of consumption, for which labour cost would be a
minimum;¾a shorter process of
production would be less efficient technically, whilst a longer
process would also be less efficient by reason of storage costs
and deterioration. If, however, the rate of interest exceeds
zero, a new element of cost is introduced which increases with
the length of the process, so that the optimum interval will be
shortened, and the current input to provide for the eventual
delivery of the article will have to be curtailed until the
prospective price has increased sufficiently to cover the
increased cost¾a cost which will be
increased both by the interest charges and also by the diminished
efficiency of the shorter method of production. Whilst if the
rate of interest falls below zero (assuming this to be
technically possible), the opposite is the case. Given the
prospective consumers' demand, current input to-day has to
compete, so to speak, with the alternative of starting input at a
later date; and, consequently, current input will only be worth
while when the greater cheapness, by reason of greater technical
efficiency or prospective price changes, of producing later on
rather than now, is insufficient to offset the smaller return
from negative interest. In the case of the great majority of articles it
would involve great technical inefficiency to start up
their input more than a very modest length of time ahead of their
prospective consumption. Thus even if the rate of interest is
zero, there is a strict limit to the proportion of prospective
consumers' demand which it is profitable to begin providing for
in advance; and, as the rate of interest rises, the proportion of
the prospective consumers' demand for which it pays to produce
to-day shrinks pari passu.
III
We have seen that capital has to be kept scarce enough in the
long-period to have a marginal efficiency which is at least equal
to the rate of interest for a period equal to the life of the
capital, as determined by psychological and institutional
conditions. What would this involve for a society which finds
itself so well equipped with capital that its marginal efficiency
is zero and would be negative with any additional investment; yet
possessing a monetary system, such that money will 'keep' and
involves negligible costs of storage and safe custody, with the
result that in practice interest cannot be negative; and, in
conditions of full employment, disposed to save?
If, in such circumstances, we start from a position of full
employment, entrepreneurs will necessarily make losses if they
continue to offer employment on a scale which will utilise the
whole of the existing stock of capital. Hence the stock of
capital and the level of employment will have to shrink until the
community becomes so impoverished that the aggregate of saving
has become zero, the positive saving of some individuals or
groups being offset by the negative saving of others. Thus for a
society such as we have supposed, the position of equilibrium,
under conditions of laissez-faire, will be one in which
employment is low enough and the standard of life sufficiently miserable to bring
savings to zero. More probably there will be a cyclical movement
round this equilibrium position. For if there is still room for
uncertainty about the future, the marginal efficiency of capital
will occasionally rise above zero leading to a 'boom', and in the
succeeding 'slump' the stock of capital may fall for a time below
the level which will yield a marginal efficiency of zero in the
long run. Assuming correct foresight, the equilibrium stock of
capital which will have a marginal efficiency of precisely zero
will, of course, be a smaller stock than would correspond to full
employment of the available labour; for it will be the equipment
which corresponds to that proportion of unemployment which
ensures zero saving.
The only alternative position of equilibrium would be given by
a situation in which a stock of capital sufficiently great to
have a marginal efficiency of zero also represents an amount of
wealth sufficiently great to satiate to the full the aggregate
desire on the part of the public to make provision for the
future, even with full employment, in circumstances where no
bonus is obtainable in the form of interest. It would, however,
be an unlikely coincidence that the propensity to save in
conditions of full employment should become satisfied just at the
point where the stock of capital reaches the level where its
marginal efficiency is zero. If, therefore, this more favourable
possibility comes to the rescue, it will probably take effect,
not just at the point where the rate of interest is vanishing,
but at some previous point during the gradual decline of the rate
of interest.
We have assumed so far an institutional factor which prevents
the rate of interest from being negative, in the shape of money
which has negligible carrying costs. In fact, however,
institutional and psychological factors are present which set a
limit much above zero to the practicable decline in the rate of
interest. In particular the costs of bringing borrowers and lenders
together and uncertainty as to the future of the rate of
interest, which we have examined above, set a lower limit, which
in present circumstances may perhaps be as high as 2 or 2½ per
cent on long term. If this should prove correct, the awkward
possibilities of an increasing stock of wealth, in conditions
where the rate of interest can fall no further under laissez-faire,
may soon be realised in actual experience Moreover if the minimum
level to which it is practicable to bring the rate of interest is
appreciably above zero, there is less likelihood of the aggregate
desire to accumulate wealth being satiated before the rate of
interest has reached its minimum level.
The post-war experiences of Great Britain and the United
States are, indeed, actual examples of how an accumulation of
wealth, so large that its marginal efficiency has fallen more
rapidly than the rate of interest can fall in the face of the
prevailing institutional and psychological factors, can
interfere, in conditions mainly of laissez-faire, with a
reasonable level of employment and with the standard of life
which the technical conditions of production are capable of
furnishing.
It follows that of two equal communities, having the same
technique but different stocks of capital, the community with the
smaller stocks of capital may be able for the time being to enjoy
a higher standard of life than the community with the larger
stock; though when the poorer community has caught up the rich¾as, presumably, it eventually will¾then both alike will suffer the fate of
Midas. This disturbing conclusion depends, of course, on the
assumption that the propensity to consume and the rate of
investment are not deliberately controlled in the social interest
but are mainly left to the influences of laissez-faire.
If¾for whatever reason¾the rate of interest cannot fall as fast
as the marginal efficiency of capital would fall with a rate of
accumulation corresponding to what the community would choose to save at a rate of interest equal
to the marginal efficiency of capital in conditions of full
employment, then even a diversion of the desire to hold wealth
towards assets, which will in fact yield no economic fruits
whatever, will increase economic well-being. In so far as
millionaires find their satisfaction in building mighty mansions
to contain their bodies when alive and pyramids to shelter them
after death, or, repenting of their sins, erect cathedrals and
endow monasteries or foreign missions, the day when abundance of
capital will interfere with abundance of output may be postponed.
'To dig holes in the ground', paid for out of savings, will
increase, not only employment, but the real national dividend of
useful goods and services. It is not reasonable, however, that a
sensible community should be content to remain dependent on such
fortuitous and often wasteful mitigations when once we understand
the influences upon which effective demand depends.
IV
Let us assume that steps are taken to ensure that the rate of
interest is consistent with the rate of investment which
corresponds to full employment. Let us assume, further, that
State action enters in as a balancing factor to provide that the
growth of capital equipment shall be such as to approach
saturation-point at a rate which does not put a disproportionate
burden on the standard of life of the present generation.
On such assumptions I should guess that a properly run
community equipped with modern technical resources, of which the
population is not increasing rapidJy, ought to be able to bring
down the marginal efficiency of capital in equilibrium
approximately to zero within a single generation; so that we
should attain the conditions of a quasi-stationary community
where change and progress would result only from changes in technique, taste, population and institutions, with
the products of capital selling at a price proportioned to the
labour, etc., embodied in them on just the same principles as
govern the prices of consumption-goods into which capital-charges
enter in an insignificant degree.
If I am right in supposing it to be comparatively easy to make
capital-goods so abundant that the marginal efficiency of capital
is zero, this may be the most sensible way of gradually getting
rid of many of the objectionable features of capitalism. For a
little reflection will show what enormous social changes would
result from a gradual disappearance of a rate of return on
accumulated wealth. A man would still be free to accumulate his
earned income with a view to spending it at a later date. But his
accumulation would not grow. He would simply be in the position
of Pope's father, who, when he retired from business, carried a
chest of guineas with him to his villa at Twickenham and met his
household expenses from it as required.
Though the rentier would disappear, there would still be room,
nevertheless, for enterprise and skill in the estimation of
prospective yields about which opinions could differ. For the
above relates primarily to the pure rate of interest apart from
any allowance for risk and the like, and not to the gross yield
of assets including the return in respect of risk. Thus unless
the pure rate of interest were to be held at a negative figure,
there would still be a positive yield to skilled investment in
individual assets having a doubtful prospective yield. Provided
there was some measurable unwillingness to undertake risk, there
would also be a positive net yield from the aggregate of such
assets over a period of time. But it is not unlikely that, in
such circumstances, the eagerness to obtain a yield from doubtful
investments might be such that they would show in the aggregate a
negative net yield.