LIBRARY 
 
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 PROFIT AND WAGES
 
 PROFIT AND WAGES 
 
 A STUDY IN THE DISTRIBUTION 
 OF INCOME 
 
 BY 
 
 G. A. KLEENE 
 
 PROFESSOR OF ECONOMICS, TRINITY COLLEGE, HARTFORD, CONN. 
 
 THE MACMILLAN COMPANY 
 1916
 
 COPYRIGHT, 1916, 
 BY THE MACMII^AN COMPANY. 
 
 Published November, 1916.
 
 PREFACE 
 
 Though its abstract and intricate character has 
 made it an esoteric discipline, the theory of distribution 
 demands the consideration of every serious student 
 of affairs. No fundamental conception of our most 
 important economic problems is attainable except in 
 relation to the factors governing the distribution of 
 income. Unless resigned to superficial views, we cannot, 
 therefore, maintain a passive attitude toward the 
 unsettled state of economic doctrine. In the face of 
 continued failure, neither discouragement nor scepticism 
 should halt the struggle for a definite and accepted 
 theory of distribution. May the publication of this 
 book contribute something to the will to master the 
 difficulties of the problem. 
 
 The author is under obligation for permission to 
 use parts of an article published in the Quarterly Journal 
 of Economics for February, 1912. He is also under 
 great obligation to his wife for criticism and assistance 
 in revision and proof-reading, and to his friend, Mr. 
 Edward Porritt for helpful counsel.
 
 TABLE OF CONTENTS 
 
 CHAPTER I. INTRODUCTION. 
 
 Definitions of distribution and income, i. Concept of 
 psychic income not of service to present inquiry, i. Differ- 
 ences in method of investigation according as the subject 
 is the distribution of wealth or the distribution of income, 
 2. The method of economic theory, 3. Hypothetical 
 assumptions to be made and limitations of our inquiry, 5. 
 Reasons why our inquiry must be largely critical, 7. 
 
 GENERAL OUTLINE OF SUBJECT The parties who share 
 in the total product of society, 8. Different concepts of 
 capital, 9. Capital regarded as subsistence advanced to 
 labor the most fruitful concept for the theory of distri- 
 bution, 1 1 . Distinction between differential and marginal 
 income, 13. First stage in our analysis of distributive 
 process the separation of differential gain from marginal 
 income, 15. The second stage the division of marginal 
 income between capitalist and laborer, 16. Three different 
 methods by which it has been attempted to explain this 
 division, 18. 
 
 CHAPTER II. BOHM-BAWERK'S THEORY OF INTEREST. 
 
 Reasons for beginning a critical study of the problem 
 with Bohm-Bawerk's theory, 20. Bohm-Bawerk's funda- 
 mental concept, 21. Three reasons for preference for 
 present over future goods given by Bohm-Bawerk, 22. 
 The technical superiority of present good no direct ground 
 for preference for present goods but possibly an indirect 
 one, 25. Bohm-Bawerk failed to give a unitary explanation 
 of interest, 28. 
 
 CHAPTER III. THE TIME-PREFERENCE THEORY. 
 
 Attempt to base interest theory on first two grounds of 
 preference mentioned by Bohm-Bawerk, 29. Do these 
 play an actual part in saving and investment? 30. Defini- 
 
 I
 
 TABLE OF CONTENTS 
 
 tion of time-preference, 33. Transition from earlier idea 
 of abstinence to that of time-preference, 35. No post- 
 ponement of consumption of capital in actual investment, 36. 
 Is there an exchange of present for future goods? 39. A 
 less objectionable form of time-preference theory, 43. 
 The consumption loan, 45. The purchase of durable 
 goods not explained by time-preference theory, 46. The 
 reductio ad absurdum of the time-preference theory, 47. 
 Sceptical reaction against theories based on subjective 
 valuations, 49. Excessive rationalism of time-preference 
 theory, 51. Time-preference not a direct determinant 
 of the rate of interest, 53. 
 
 CHAPTER IV. THE ABSTINENCE THEORY. 
 
 The abstinence theory treats only of supply of capital 
 and does not give a complete explanation of the income 
 of capital, 55. Accumulation of capital without subjective 
 cost, 56. Idea of marginal savings, 57. Ambiguities of 
 a formulation of the theory in terms of demand and supply, 
 59. The two fundamental propositions of the theory, 61. 
 Criticism of idea that changes in supply of capital regu- 
 lative of rate of return are brought about by marginal 
 savers, 62. Prime factors determining supply of capital 
 are objective, not subjective, 68. Supply of capital, on 
 the whole, tends to rise with increase in rate of return, 70. 
 Does not decrease as rate of return declines, 71. Factors 
 which prevent extinction of capitalist income, 73. Only 
 extreme changes in rate of interest affect determination 
 to save, 75. Theory of- rate of capitalist income must 
 emphasize objective factors, 77. Does abstinence theory 
 explain existence of interest? 79. 
 
 CHAPTER V. THE PRODUCTIVITY THEORY OF INTEREST. 
 
 The specific productivity theory, 82. Difficulties of 
 imputing a specific product to capital, 82. Vicious circle 
 in deriving value of capital goods, 85. Productivity theory 
 does not show how interest on sums spent for wages is 
 derived, 87. Difficulties growing out of concept of capital 
 
 II
 
 TABLE OF CONTENTS 
 
 and restricted view of productive process, 87. A form of 
 productivity theory suggested by Bohm-Bawerk and 
 Landry, 92. The assumption of a normal lack of capital 
 made by this theory, 94. The theory at bottom almost 
 the same as the specific productivity theory and encounters 
 similar difficulties in determining value of capital invested, 
 95. Importance of the theory, 97. 
 
 CHAPTER VI. THE ESSENTIALS OF A THEORY OF PROFIT AND 
 
 INTEREST. 
 
 Relation of four quantities (gross income, net income, 
 rate, and capital) expressed in two equations, 99. None 
 of theories so far examined has explained, or is justified 
 in assuming as accounted for, more than one quantity, 100. 
 Necessity of accounting for value of 'capital independently 
 of amount of product or rate of profit, 101. Capital consists 
 of wages, and profit of capital is a residual income, 102. 
 Name to be given to our theory, 105. What prevents fall 
 of prices from extinguishing share going to capital? 108. 
 What keeps labor from getting entire marginal product 
 of industry? 109. How is surplus value growing out of a 
 series of processes controlled by different entrepreneurs 
 distributed at a uniform rate to every part of investment 
 made by each entrepreneur? no. Theory here proposed 
 assumes as given factors transmitted from pre-capitalistic 
 times, 112. 
 
 CHAPTER VII. THE THEORY OF WAGES. THE SUPPLY OF 
 LABOR. 
 
 Relation of theory of wages to theory of income of 
 capitalist. 114. Wage theories which might form basis of a 
 residual claimant theory of profit and interest, 115. Mal- 
 thusian basis of subsistence theory, 116. Relation between 
 standards of living and wages, 117. Arbitrary character 
 of assumption of a natural wage, 118. Marx's criticism 
 of subsistence theory, 119. Immigration a disturbing 
 factor, 119. Need of a theory of demand for labor felt 
 by classical economists, 120. Rise of standard of living 
 of wage-earners and its bearing on subsistence theory of 
 
 III
 
 TABLE OF CONTENTS 
 
 wages, 121. Conditions under which subsistence theory 
 has some validity, 122. How supply price of labor is 
 determined, 124. Why geographical differences in wages 
 correspond to differences in productivity, 126. 
 
 CHAPTER VIII. THE THEORY OF WAGES. THE DEMAND FOR 
 LABOR. 
 The wages fund doctrine suggests a collective exchange, 
 
 128. Necessity of laborer and employer coming to terms, 
 
 129. Does possibility of substituting machines for labor 
 show that there is no definite wages fund? 130. Under 
 static conditions and when production period of maximum 
 efficiency has been reached, there is a definite wages fund, 
 133. Bohm-Bawerk's wages fund theory, 135. Is wages 
 fund capable of quick expansion? 137. When viewed as a 
 money fund, 138. When regarded as real income, 139. 
 The bargain theory of wages, 141. Wages fund theory 
 only possible explanation of general level of wages, 142. 
 
 CRITICISM OF PRODUCTIVITY THEORY OF WAGES 
 Erroneous assumption in regard to expansibility of demand 
 for labor, 144. Productivity explains comparative wages 
 only, 146. Can wages be paid out of current product? 149. 
 Productivity determines wages only by its influence on 
 the accumulation of capital, 151. Wages not determined 
 by discounted product of labor because there is no rate 
 of discount established independently of level of wages, 153. 
 Criticism of productivity theory on ground that specific 
 product of labor is not ascertainable, 155. 
 
 CONCLUSION General level of wages is determined by 
 size of wages fund and the supply price of different quan- 
 tities of labor, 157. 
 
 CHAPTER IX. CONCLUSION. 
 
 The two stages in our analysis of the problem of dis- 
 tribution, 159. Criticism of the concept of capital as 
 including land, 160. Criticism of the "law of three rents," 
 1 60. Summary of conclusions reached, 163. The return 
 to the classical school of economists, 164. Unfortunate 
 tendencies of modern economic theorizing: (i) Excessive 
 rationalism, 166. (2) Confusion of problem of distri- 
 bution with that of value, 167. 
 
 IV
 
 PROFIT AND WAGES 
 
 CHAPTER I 
 
 INTRODUCTION 
 
 In the meaning usual to economic literature, 
 distribution is division into parts and the appor- 
 tionment of the parts to those who share in 
 the division. Now it is the distribution of in- 
 come rather than of wealth with which we are 
 here concerned. Income is wealth just pro- 
 duced or come into existence. It should be 
 thought of as a stream and measured by its 
 volume per unit of time. Taking the collective 
 view essential to the science of economics 
 the problem becomes that of the division of 
 the total income or produce of human industry. 
 We are to explain how the flow of goods from 
 mine and farm and factory spreads and divides 
 into streams of private income, into the 
 rent, profit, and interest, for instance, which 
 fall to the well-to-do, or the wages with which 
 the poor must be content. 
 
 As the ultimate significance of these streams 
 of goods is in the uses made of them, one might 
 regard income as consisting of the feelings of 
 the consumer of goods rather than of the goods 
 themselves. But such a conception of income 
 would not serve the purposes of the present 
 inquiry. "Psychic income" is too remote from
 
 2 PROFIT AND WAGES 
 
 the problems with which a study of distribution 
 must begin. The amount of utility derived 
 from equal quantities of any commodity varies 
 widely as between different consumers and 
 even between different times and conditions 
 for the same consumer. The final determina- 
 tion of psychic incomes, therefore, lies in the 
 process of consumption. It comes at a later 
 stage than that of distribution.* 
 
 Income is measurable only as a rate, as 
 amount per unit of time. The total of wealth, 
 on the other hand, cannot be measured otherwise 
 than by taking the quantity existing at a point 
 of time. As such it would include the income 
 of the moment but also the wealth which has 
 arisen or come in at previous times and which 
 still remains unconsumed and undestroyed. 
 When referring to income, the term distribution 
 evidently denotes a process. When applied 
 to wealth, however, it means the result or out- 
 come of a process of distribution, or of a series 
 of such processes. The method of investigation 
 must differ according as the object of inquiry 
 is the process or the result. To picture the 
 result, the distribution of wealth at any point 
 of time, the only satisfactory method would be 
 the statistical. If complete date, were available, 
 the statistician could tell us how many rich 
 men there are and what is their wealth, and how 
 
 *A very satisfactory discussion of income thought of as a stream 
 of goods can be found in Lexis, Allgememe Volkswirtschafts- 
 lehre, p. 137 ff.
 
 INTRODUCTION 3 
 
 many poor there are and what is the depth of 
 their poverty. The explanation of how this 
 distribution came about would constitute an 
 historical problem. It is not, however, the 
 object of the present essay to describe and 
 explain the distribution of an existing stock of 
 wealth. Our problem is the complicated process 
 of parcelling out the newly produced wealth or 
 income of society. In the analysis of such a 
 process statistics and history can give little 
 aid. At least in the initial, and most difficult 
 stages, of the inquiry, the method of "theory" 
 alone is of service. 
 
 This is the method of mental experiment 
 with different lines of approach to the problem, 
 the exploitation of different facts and ideas as 
 tentative premises. The forces of our indus- 
 trial system are so involved that no conception 
 of its operation could be reached by any attempt 
 to describe its details. In fact the more photo- 
 graphic and concrete the picture presented to 
 the mind, the more confusing and difficult 
 the problem becomes. The only feasible pro- 
 cedure, therefore, is to seek for essential facts 
 and to reason from these, while deliberately 
 excluding from view a mass of complicating 
 phenomena. Intellectually portable and man- 
 ageable results are won by selection only. Com- 
 plications must be eliminated, or, in other 
 words, hypothetical assumptions must be made. 
 Economic theory differs from other sciences 
 only in the degree of its hypothetical character.
 
 4 PROFIT AND WAGES 
 
 But for use in practical affairs, or to satisfy a 
 mental craving for a more concrete picture of 
 the world, our first simplified, hypothetical, 
 general theory may be subjected to a series of 
 qualifications by bringing in one by one the 
 complicating conditions which had been ex- 
 cluded at the beginning. Thus a series of prop- 
 ositions may be reached which, descending 
 into ever greater detail, lead us by successive 
 approximations* to a closer view of things as 
 they are. How closely we desire to approxi- 
 mate the confusing reality of our industrial 
 life, or at the other extreme, how far we are 
 willing to carry the process of abstraction to 
 gain a general view, depends largely on our 
 mental constitution. It is not altogether flippant 
 to call it a matter of taste. In the end, however, 
 the use we intend to make of our theories may 
 decide to what degree of abstraction from or 
 approximation to the complexities of the actual 
 world we may safely proceed. 
 
 "The idea of "successive approximations," a metaphor derived 
 from physics and mathematics, has perhaps received its vogue 
 especially from Pareto (Cours d'economie politique, p. 16 ff.). 
 Graziani (Instituzioni di economia politico,, p. 45) attributes 
 the use of the term especially to Pareto and Barone but says 
 that the method itself goes back to the classical writers such 
 as Smith, Ricardo, and the two Mills. It has probably been 
 used more or less deliberately by many writers. The opening 
 paragraph of the third volume of Das Kapital, for instance, 
 shows Marx making conscious use of this method. The mention 
 of Marx suggests the dangers and difficulties of beginning 
 with assumptions too remote from reality. A recent instance 
 of a start too remote from reality, in the present writer's opinion, 
 is that made by Schumpeter (Theorie der wirtschaftlichen 
 Entwicklung) .
 
 INTRODUCTION 5 
 
 It follows from what has just been said that 
 the general theory of the distribution of income 
 aimed at in the following pages must submit to 
 certain limitations. To state some of these, 
 
 (1) it must confine itself to what may be called 
 the primary process of distribution, the dividing 
 up of the product of industry among the parties 
 immediately connected with the productive 
 process. In other words, our problem is that 
 of wages, interest, profit, and rent. How 
 secondary incomes are derived from these pri- 
 mary shares through gift, theft, begging or 
 taxation, need not concern us. Profits or other 
 incomes from business operations which are 
 not productive or whose relation to production 
 is remote and uncertain, must also be omitted 
 from consideration. Various "pecuniary" em- 
 ployments of capital, as Veblen would call 
 them, speculative manipulations, for instance, 
 
 - for all their spectacular interest and dis- 
 turbing significance, must be excluded. To get 
 a clear view of the fundamental factors, our 
 study must stick closely to the process of 
 production and to those classes which draw 
 their living immediately from that process. 
 
 (2) Our study must assume the prevalence of 
 competition. At a time of widespread appre- 
 hension of the growing power of large aggre- 
 gations of capital, this assumption may appear 
 to lead to conclusions somewhat too remotely 
 connected with contemporary conditions. How- 
 ever the extent of the monopoly exercised by those
 
 6 PROFIT AND WAGES 
 
 to whom popular opinion attributes this power, 
 is somewhat in doubt and certainly their 
 power is not absolute. The mixture of com- 
 petition and monopoly in the industrial life of 
 today cannot be understood unless we have a 
 clear conception of the workings of a competitive 
 system. For the purposes of our theory it will 
 be well, therefore, to set aside monopoly as a 
 disturbing factor acting upon a fundamentally 
 competitive order. In other words we reach a 
 "first approximation" by assuming a competitive 
 system. (3) Another limitation to which our 
 theorizing must submit is in the historical 
 range of its application. It is confined to 
 present conditions, to the "system of industrial 
 liberty," to "capitalism." Starting from facts 
 and conditions of the present, it may not assume 
 universal validity for its conclusions. On the 
 other hand it is under no necessity of accounting 
 for the origin and evolution of economic insti- 
 tutions which our industrial system has inherited 
 from the past. It may take their existence for 
 granted, asking only how they affect the quantity 
 of income going to the different "shares in 
 distribution." 
 
 The foregoing limitations are observed 
 throughout this book. Other assumptions will 
 be made from time to time to save the argu- 
 ment from unnecessary complication. Although 
 these are not always explicitly mentioned, we 
 trust they will be reasonably obvious to the 
 reader and will be such as experience has shown
 
 INTRODUCTION 7 
 
 to be necessary to the operations of economic 
 theory. The results reached by the method 
 pursued are necessarily propositions of an 
 abstract character. To the type of mind that 
 hungers for graphic and abundant detail they 
 may appear very unsatisfactory. But our 
 present aim is an analysis of the industrial 
 world, not photography, and so no other course 
 lies open. 
 
 To find the starting points for an analysis 
 of the distributive process it will be prudent to 
 examine the results of the mental experimen- 
 tation of leading thinkers in this field. The 
 stock of facts and ideas with which theory 
 operates is selected from a complex reality 
 largely in the form of general impressions of 
 what may prove significant. A review of the 
 impressions of able theorists as to what elements 
 enter into the determination of the shares in 
 distribution, and of the failures and successes 
 of the different theories set forth, is the only 
 sure precaution against making a false start. 
 Our work then must be largely critical. That 
 to save time the discussion is restricted to 
 theories which still have some standing in 
 scientific controversy will, we trust, commend 
 itself to the approval of those competent in 
 economic studies. But before entering into 
 the necessarily technical, and perhaps confusing, 
 detail of a critical study, it may be well for the 
 sake of perspective to offer the reader a general
 
 8 PROFIT AND WAGES 
 
 sketch of the field we are to enter. This is the 
 purpose of the remaining pages of this chapter. 
 
 The classical economists represented the 
 national product as divided among landowners, 
 capitalists, and laborers three rather distinct 
 classes in the social life of the England of their 
 day. A fortunate tradition for the theory of 
 1 distribution was thus established by an historical 
 accident of time and place. Had the owners of 
 capital and those of land been merged as com- 
 pletely as they were in some countries and as 
 they are in the England of the present time, 
 economic theorists might have failed to isolate 
 the share in distribution that falls to the land- 
 owner as such. A part, at least, of what goes 
 under the popular term of rent of land, has 
 important characteristics which distinguish it 
 from the income of capital. As will soon appear, 
 it is a differential gain of a rather permanent 
 character. Not to recognize this would seriously 
 distort our picture of the distributive process. 
 In the writer's opinion, it was fortunate also 
 that economists did not at once make and 
 emphasize the distinction between capitalist 
 and entrepreneur, which later came into fashion. 
 The capitalist is lender and investor only of 
 capital, the entrepreneur user of it. To an 
 increasing degree the entrepreneur is coming 
 to be not an individual, but a group of men, 
 a corporation. It will be convenient, however, 
 throughout most of our discussion to think of
 
 INTRODUCTION 9 
 
 him as an individual business manager. So 
 conceived, he is the one controlling and directing 
 the process of the production of wealth. The 
 products are his until he sells them. If they are 
 unsaleable, the loss is his. He may be capitalist 
 and landowner besides being entrepreneur. In- 
 deed, he usually owns some capital. Out of 
 the process of buying, borrowing, and hiring 
 for his business, and the sale of the products, 
 he gets his profit. To the landowner he pays 
 rent, to the capitalist interest, to the laborer 
 wages. The problem for the theory of distribu- 
 tion is, what determines the amount of each 
 of these shares in distribution rent, interest, 
 wages, and the entrepreneur's profit. 
 
 Confusion enters into this controversial 
 matter at the very outset, through the failure 
 to agree upon some distinct concept of capital. 
 What is this thing whose ownership gives the 
 power to get an income without labor, or in 
 other words, to levy on the labor of others? 
 Popular terminology is indefinite and shifting. 
 One meaning suggested by it, that of capital 
 as a sum of money is obviously inadequate for 
 our inquiry. Even if it were permissible either 
 to overlook bank credit or to regard it as a 
 kind of money, this popular concept would be 
 too superficial. It is what is bought with the 
 money by the managers of productive enter- 
 prises that makes it effective in securing an 
 income and, which, therefore, constitutes the 
 true capital. It will be advantageous at least
 
 io PROFIT AND WAGES 
 
 in our first approximate formulation of the 
 theory of distribution, to forget the existence of 
 money and to think of commodities and services 
 as exchanged by barter, though with a celerity 
 and ease not possible to that crude method of 
 exchange. 
 
 Passing from popular usage to that of the 
 more scientific literature of economics, we meet 
 a discouraging diversity of opinion. In general, 
 however, there are two tendencies. One is 
 to regard capital as a sum of value, the other 
 as consisting of concrete goods of some kind. 
 To consider capital as value (or as a sum of 
 prices) instead of using value or price merely 
 to measure a quantum of capital, gives a con- 
 cept useful only to one theory of interest, the 
 time-preference theory, and not acceptable, 
 therefore, unless that theory can be accepted.* 
 Of course the concept is also useful to the book- 
 keeping or accounting of private and individual 
 economics (Privatwirtschaft). Our aim, how- 
 ever, is not to describe the individual's method 
 of measuring his gains, but to explain the 
 source and amount of income that goes to the 
 owners of capital as a class. 
 
 *Professor Clark employs a concept of this kind in connection 
 with a productivity theory. Obviously, however, it is the 
 concrete "capital goods," which he distinguishes from the 
 fund of capital or capital proper, which really aid production 
 and constitute the basis of the capitalist's income, not the 
 abstract fund or collective value of these goods. See remarks 
 by Carver in Quarterly Journal of Economics, May, 1907. 
 See also the trenchant criticism by Bohm-Bawerk ibid., 
 November, 1906, and February, 1907, and by Veblen ibid., 
 February, 1908.
 
 INTRODUCTION 1 1 
 
 Of definitions of capital as concrete goods 
 there is a considerable variety but two may be 
 taken as dividing between them a large part 
 of the usage of economic literature one, that 
 of capital as consisting of "intermediate goods" 
 or goods produced to be used in further pro- 
 duction; the other, as subsistence maintaining 
 labor in the long process of production, and 
 advanced to the laborers out of past product 
 by the capitalist class. Which of these is to 
 be preferred can be decided only when we 
 inquire what each leads to when used as a basis 
 for a theory of interest. Some reasons will be 
 given at this point for choosing the view of 
 capital as subsistence advanced to the laborers. 
 The chief purpose of these remarks, however, 
 is not to dispose definitively of the question of 
 the proper definition of capital, but to give the 
 reader the background of a general picture 
 of the production and distribution of wealth. 
 
 If capitalists as a class enjoy a peculiar income, 
 that income must in some way be traced to 
 the peculiar contribution made to the pro- 
 ductive process by capitalists as a class. To 
 this contribution it would seem appropriate 
 to give the name capital if that trouble-breeding 
 term is to be used at all. * Now what capitalists 
 
 *Something might be said in favor of dropping the term alto- 
 gether from economic theory because of the confusion it has 
 always caused. The dreary debate about its proper meaning 
 has had the advantage of establishing in our terminology a 
 number of convenient names for proposed claimants for the 
 title of capital, e. g., intermediate goods, producers' goods,
 
 12 PROFIT AND WAGES 
 
 as a class contribute is the subsistence of the 
 laborer or wages (that is real wages). This 
 appears when we consider the entire process of 
 the production of any consumable commodity, 
 viewing it as beginning with the first labor 
 employed to make any instrument or material 
 used in the course of the long process. Pro- 
 duction is then seen to be simply the use of 
 labor power on the physical world. The process 
 of making any commodity may be, and usually 
 is, divided into different stages, controlled by 
 different entrepreneurs. The latter contribute 
 the labor of scheming and directing, but the 
 capitalists, or the entrepreneurs in so far as 
 they are capitalists, contribute nothing but the 
 wages paid to the laborers.* This is the one 
 investment of capitalists as a class with reference 
 to productive enterprise. The "capital goods" 
 such as machines, raw material, etc., which 
 appear in the productive process, are bought 
 by one capitalist or entrepreneur from another. 
 The purchase and sale of these products or 
 intermediate goods, however, is a purely intra- 
 class affair. Such purchases and sales are a 
 
 consumers' goods, durable goods. The use of these terms in 
 place of the ambiguous word capital would clarify many 
 economic discussions. 
 
 "Our reason for not mentioning the rent of land among the 
 payments made by the capitalist will soon appear (page 15 ff.). 
 Taxes may also be disregarded. We may think of them as 
 paid out of income and, in any case, as having no necessary 
 direct relation to the process of producing and distributing 
 wealth.
 
 INTRODUCTION 13 
 
 means of dividing up between different capital- 
 ists the capital investment necessary in the 
 long process of producing any consumable 
 commodity. The buyer of a machine for 
 instance, pays the seller the wages the latter 
 had paid in having the machine made. As the 
 price of the machine, however, also includes 
 interest and profit to the seller, the purchase 
 and sale of such "intermediate goods" also 
 appears as means of dividing up the profits 
 and gains of capital of the entire productive 
 process. But these transactions within the 
 class of capital owners constitute no part of 
 the necessary contribution of the capitalist 
 class to the process of production. The necessary 
 contribution of this class, the investment from 
 which it derives its income, the mysterious 
 thing called capital, consists of the subsistence 
 or "real wages" given the laborer. For the 
 theory of distribution at least, this seems the 
 most fruitful conception of capital. 
 
 And now we return to the question asked a 
 few pages back as to what determines the amount 
 of each share in distribution of rent, interest, 
 profit, and wages. In the attempt to give a 
 preliminary sketch of the questions at issue, 
 we may start with an idea which has come 
 very near to having gained universal acceptance 
 among economists, and make it the background 
 for a formulation of the principal contending 
 theories. This idea is that of a distinction 
 between differential and marginal income. The
 
 i 4 PROFIT AND WAGES 
 
 productive result of the investments made by 
 capitalists and entrepreneurs varies widely. 
 Any return in excess of the lowest or marginal 
 rate of productivity is a differential gain, and 
 may take the form either of rent of land, or 
 of differential profit. The most permanent 
 differences in productivity are inherent in the 
 quality and location of the land which is used. 
 Less stable differences may be traced to the 
 differing abilities and luck of the entrepreneurs. 
 As the capital of the world increases, entre- 
 preneurs proceed to less and less productive 
 investments assuming that they first took 
 advantage of the best opportunities. The 
 course of investment is from more to less 
 productive lands and locations, stopping at 
 successive "extensive margins," and also from 
 more to less productive investments on the 
 same land, according to the "law of diminishing 
 returns," making successive stops at "intensive 
 margins."* On the assumption of perfect 
 mobility of capital, a given total of capital 
 will be so distributed in its investment as to 
 establish a uniformly productive margin along 
 
 *The law of diminishing returns from land will hold, that is 
 there will be an increase of total product but a dirriinished 
 product per unit of investment, if the additional "capital" 
 invested takes the form of, or results in, an increased appli- 
 cation of either labor or capital goods to the land. As will 
 appear later, it is possible that an increased supply of capital 
 may bring about nothing but an increase in the rate of wages. 
 In that case, of course, there is no increase of total or decrease 
 of marginal product. The relative shares received by capital 
 and labor will be changed, but there will be no change in the 
 differential gains.
 
 INTRODUCTION 15 
 
 both the extensive and intensive frontier. Addi- 
 tions to the supply of capital can then be invested 
 at the margin only, and get only the marginal 
 rate of return unless they can displace capital 
 at other points. The competition of this new 
 capital with the older supplies which it is 
 capable of displacing, tends to make the marginal 
 rate the rate of return for all capital, by giving 
 the landowner the power to demand all in 
 excess of this (except the " ability rent" of the 
 superior entrepreneur) as a rent.* At the 
 outset, of course, the entrepreneur receives the 
 entire product, but the destination of all the 
 differential gain, the surplus over the marginal 
 rate of return, is apparent. 
 
 We may thus view the problem of distribution 
 as being, at the first stage, a question between 
 
 *The rate of "productivity" of capital at the margin would 
 vary accordingly to the ability of the entrepreneurs managing 
 it. A marginal rate, therefore, if it is to be something definite, 
 implies a marginal managerial ability. The amount of capital 
 (and consequent size of business) controlled by different 
 entrepreneurs tends to vary according to their ability and 
 energy, the least competent of the entrepreneurs able to 
 maintain themselves against competition, the marginal entre- 
 preneurs, controlling the smallest business units. This on 
 the assumption, very far indeed from being fully justified by 
 the reality, that the control of capital is distributed according 
 to ability and not by accident and favor. Because of the 
 advantages of large scale production, those able to manage 
 large amounts of capital will get a higher rate of return than 
 the marginal entrepreneur, a differential profit, even for their 
 marginal investments. The marginal rate pays only interest 
 and "wages of management" to capitalist and entrepreneur, 
 but the abler entrepreneurs get more than this rate. Even 
 under static conditions, therefore, there is a differential profit 
 graded roughly according to the ability of the entrepreneur. 
 Under dynamic conditions, there are also the temporary gains 
 that come to the alert, progressive, and lucky ones.
 
 1 6 PROFIT AND WAGES 
 
 entrepreneur and landowner. Whatever the 
 productive forces applied to the land, they 
 represent capital investment to the entrepre- 
 neur. When they yield a surplus above the 
 marginal rate, this becomes either the rent 
 of the landowner or the differential profit of 
 the entrepreneur. But this division between 
 differential and marginal income is not the 
 whole of the distribution to be made. The 
 entrepreneur has also to deal with the laborer 
 and the question then becomes that of dividing 
 marginal income, the product remaining after 
 the subtraction of the differential gains. Here 
 we reach the questions most in controversy. 
 The fact of differential gains is pretty well 
 acknowledged, however much economists may 
 disagree in regard to its different aspects. 
 But on the problem of the division of the 
 "marginal product" between capitalist and 
 entrepreneur, on the one hand, and the laborer, 
 on the other, there are the most persistent and 
 irreconcilable differences of opinion. A dis- 
 cussion of the theory of distribution inevitably 
 must deal chiefly with the controversies over 
 the character of the apportionment of the 
 marginal product between capital and labor. 
 
 A diagram may be used to show the relation 
 between differential and marginal incomes. Let 
 the figure CAED represent the total product 
 of industry. Distance from line AE measures 
 productivity and distance along AE the quantity 
 of capital invested. DE indicates productivity
 
 INTRODUCTION 
 
 at the margin, and CBD the total of differen- 
 tial gains (rent and differential profit). The 
 controversial problem for the theory of distribu- 
 tion is that of accounting for the division of 
 ABDE between labor and capital.* 
 
 Holding throughout the point of view gained 
 by setting aside rent and some profits as differ- 
 ential and concentrating our attention on the 
 division of the marginal product and the rates 
 
 *The diagram is constructed with reference to illustrating the 
 quantitative aspects of the division of the total product rather 
 than the source of each share. It would be misleading if it 
 suggested that labor and capital get their return from the 
 same monthly or annual product. If capital gets its return 
 from current product, then wages must be thought as paid out 
 of earlier product. The rectangle A BDE should really be 
 interpreted as that part of the gross income of the entrepreneur 
 left after deducting rent and differential profit, and the portion 
 marked "return to labor" as the equivalent of the wages 
 which have been paid. 
 
 For the sake of a simplified statement no mention is made 
 above of non-differential profits, or what are sometimes regarded 
 as "wages of management." Some writers would merge 
 them with the return to capital as part of the "profit of capital" 
 ( Kapitalgewinn) ; others would merge them with wages as 
 payment for labor. Reasons for giving our preference to the 
 former alternative will appear later.
 
 1 8 PROFIT AND WAGES 
 
 of interest and wages thus established, we may 
 mention briefly some of the principal attempts 
 to explain the division of product between 
 capital and labor. 
 
 One method of explaining the existing division 
 of ABDE is to find a factor determining one of 
 the two shares independently of the other and 
 of the amount to be divided. This leaves the 
 recipient of the other a "residual claimant." 
 Ricardo, for instance, describes the share going 
 to labor as determined by the cost of the laborer's 
 subsistence according to some more or less 
 fixed standard of living. The remainder of 
 the marginal product would then constitute 
 "profit of capital." Or, on the other hand, 
 wages may be made to appear a residual income 
 by representing the return to capital as deter- 
 mined by some subjective factor such as cost 
 of abstinence or waiting, or by the degree of 
 preference for present over future possession. 
 A favorite variant of the theory appears when 
 wages are spoken of as the discounted marginal 
 product, the rate of discount being set by 
 the "rate of time-preference." 
 
 ' Another method of explaining the division 
 of the marginal product is to seek for an inde- 
 pendent explanation for each of the two shares. 
 Thus the theory of specific productivity declares 
 that capital and labor receive each its specific 
 product. 
 
 Another method rests on a denial of the 
 possibility of an independent explanation for
 
 INTRODUCTION 19 
 
 either share and declares the existing division 
 to be simply the outcome of a struggle between 
 capital and labor. This is the view suggested 
 by the frequent reference of German writers 
 to Machtverhaltnisse, to relative power, as deter- 
 mining distribution, and by the somewhat more 
 definite "bargain theory" of wages set forth by 
 Davidson.* 
 
 In seeking to account for the division of 
 product between capital and labor, we appear 
 to be restricted in our choice to one of the three 
 methods just indicated. We must find (i) 
 an independent explanation for either wages or 
 the gains of capital, in which case we may 
 account for the other share as residual. If that 
 cannot be done we must either find (2) an inde- 
 pendent explanation for wages and also such an 
 explanation for interest, or (3) we must regard 
 the division of product between capital and 
 labor as the outcome of a tug of war. 
 
 * The Bargain Theory of Wages.
 
 CHAPTER II 
 BOHM-BAWERK'S THEORY OF INTEREST 
 
 It is a not uncommon practice to treat of 
 one of the shares in distribution, of wages, for 
 instance, or interest, or rent, without showing 
 its relation to the remaining shares. A satis- 
 factory theory of any one, however, implies 
 some particular view in regard to the others. 
 Every consistent thinker on these subjects 
 holds a definite theory of distribution as a 
 whole. He cannot rest satisfied with discon- 
 nected theories of wages, interest, profit, and 
 rent. But, however desirable it might appear 
 to consider theories of the entire process of 
 distribution, rather than theories of particular 
 incomes, a critical study such as has been 
 proposed above, must accomodate itself to 
 the disjointed character of economic discussion. 
 A beginning must be made with some one of 
 the so-called shares, and for various reasons 
 the theory of interest will best serve as an 
 introduction to the problem before us. 
 
 Now a strategic point at which to begin 
 is given by the agio theory of Bohm-Bawerk. 
 It is a highly developed and individual doctrine, 
 based on a searching criticism of other theories. 
 Stated with great clearness and amply elabor- 
 ated, it is free from the obscurities of much 
 of the older speculation on this subject. It
 
 BOHM-BAWERK S THEORY OF INTEREST 21 
 
 will be desirable, therefore, in the case of this 
 eminent writer to depart from the rule, adopted 
 in most of the following pages, of considering 
 general types and schools of thought rather 
 than the formulations of particular theorists. 
 
 The fundamental concept of Bohm-Bawerk's 
 theory is a preference for present goods over an 
 equal quantity of future goods of the same kind. 
 Because of this preference, he holds, interest 
 is paid as a premium for present goods given 
 in exchange for future goods; or expressed 
 differently, interest is a discount to which 
 future goods are subject when exchanged for 
 present. Now undoubtedly a preference of 
 this kind exists, and may manifest itself when 
 there is occasion for comparing present and 
 future sums of money, or commodities readily 
 exchanged for money. This preference, however, 
 is obviously due, in large part, if not wholly, 
 to the possibility of obtaining interest from the 
 investment of money. It is a result of the 
 existence of the institution of interest rather 
 than a possible factor in bringing about its 
 existence. The problem raised by Bohm- 
 Bawerk's theory therefore becomes the highly 
 hypothetical one of whether, if there were no 
 interest payment to be expected if, for 
 instance, interest were prohibited and the pro- 
 hibition enforced, there would still be a 
 preference for present goods, (or money as a 
 means of purchasing goods) over future goods 
 (or money). And Bohm-Bawerk adds to the
 
 22 PROFIT AND WAGES 
 
 hypothetical character of the problem by elimi- 
 nating the effect of any uncertainty in regard 
 to future goods, such uncertainty not being 
 necessary to a preference for present goods 
 though adding to the discount of future goods.* 
 If a preference for present over future possession, 
 existing independently of the possibility of 
 obtaining interest and not arising from any 
 uncertainty or risk attaching to the future 
 goods, could be proved, this preference being 
 felt by a considerable number of persons and 
 to a degree sufficient to be of significance and 
 to lend probability to a theory based upon it, 
 then Bohm-Bawerk's theory would not, indeed, 
 be fully established, but would have a clear 
 title to further consideration. For a complete 
 demonstration of the truth of the theory, it 
 would be necessary to show that such a prefer- 
 ence for present goods could and does alone 
 account both for the existence of interest and 
 its amount.** 
 
 As proof of the existence and operation of 
 the preference for present goods to which he 
 attributes the appearance of interest on capital, 
 Bohm-Bawerk gives three "causes" of such 
 
 ""I repeat that the element of uncertainty, which is the cause 
 of a lesser value being put upon particular classes of future 
 goods, has no causal connection with the phenomenon of 
 interest. The lesser valuation which is its effect is a special 
 one, and extends to one class of future goods only, and there 
 it bears' the character of a deduction as premium for risk." 
 Positive Theory of Capital, p. 247. 
 
 **Except in so far as the amount is affected by the element of risk.
 
 BOHM-BAWERK'S THEORY OF INTEREST 23 
 
 preference: (i) differences in relative pro- 
 vision for present and future wants, typical 
 cases being that of immediate distress and that 
 of prospects of increased wealth in the future, 
 
 (2) the underestimate of future advantages 
 and future goods due to want of imagination, 
 defect in will, and the uncertainty of life, and 
 
 (3) the "technical superiority" of present goods. 
 The third of these causes of preference, being 
 
 based on a technical fact in the field of pro- 
 duction, is evidently of a different nature from 
 the other two. It is also the one which has 
 been most called into question, and, therefore, 
 may properly be the first to be subjected to 
 a critical examination. The "technical superi- 
 ority of present goods," according to Bohm- 
 Bawerk, rests on the greater productivity of a 
 long process of production compared with any 
 shorter process using the same quantum of 
 productive powers. In this statement the 
 process of production of any commodity must 
 be understood as including not only every step 
 in making and marketing the commodity in 
 question, but all preliminary steps, such as 
 extracting and refining the raw material, making 
 and transporting necessary instruments of pro- 
 duction, et cetera. The longer process, therefore, 
 is the one with the relatively larger amount of 
 the results of previous labor employed in the 
 later stages. In the older and more familiar 
 phrase, it is the one with the larger "investment
 
 2 4 PROFIT AND WAGES 
 
 of capital."* The proposition that an extension 
 of the process of production over a longer 
 period results in an increase of product per 
 unit of investment, is at bottom only the 
 familiar assertion of the productive advantage 
 of increasing capital equipment. Bohm- 
 Bawerk's novel formulation of this, however, 
 led to some controversy. In his Strittige Fragen 
 and in the third edition of the Positive Theorie 
 des Kapitales, he has no difficulty in disposing 
 of most of the objections made to the proposi- 
 tion in question. However, it appears that a 
 continued lengthening of the production period, 
 beyond a certain point, results, not in an increas- 
 ing, but in a decreasing rate of return.** With 
 
 "The amount of capital invested does not, however, vary 
 exactly with the length of the productive process. See third 
 edition of the Positive Theorie des Kapitales (Exkurs V). 
 
 **To measure the length of the production period of any com- 
 modity, we must take, according to Bohm-Bawerk (Positive 
 Theory, page 88), not the "absolute" duration, the time elapsing 
 between the first step in the process and the last, but its average. 
 The latter is calculated by first multiplying each productive 
 unit invested (of labor and of "uses of land") by the number 
 of years from the time of investment to the completion of the 
 consumable commodity, then adding together these arith- 
 metical products and dividing by the number of units invested. 
 Bohm-Bawerk, in his explanation, leaves out "for the sake of 
 simplification," the co-operating "uses of land." In this we 
 may follow him with a clear conscience if we reflect that, on 
 the margin of land, there is no special outlay for rent and 
 hence no investment, other than what is paid for labor, entering 
 into the calculations of the entrepreneur. Now let us assume 
 the total of labor employed in making a given commodity to 
 remain unchanged, the length of the production period being 
 increased by increasing the proportion of this labor invested 
 in the earlier stages of the productive process. The result 
 would be an increasing proportion of equipment to labor at
 
 BOHM-BAWERK S THEORY OF INTEREST 25 
 
 this qualification we may accept Bohm-Bawerk's 
 proposition in regard to the relative productivity 
 of different production periods. 
 
 Now can it be shown that the greater produc- 
 tivity of the longer processes is a reason for 
 preferring present to future goods or earlier 
 to later ones? The only way to do this would 
 be to show that, of productive processes to be 
 begun at different times, those with an earlier 
 start are the longer and consequently more 
 productive ones, or, in other words, that post- 
 poning a process of production means shortening 
 it and thereby diminishing its productivity. 
 But a shortening of postponed enterprises at 
 a sacrifice of productive efficiency would be 
 without motive, unless it be permissible to 
 assume that whether the start be early or late, 
 the date when the product is completed is the 
 same. It is as if we had to decide that whether 
 we begin in 1914 or 1915 or 1916, the product 
 was to be finished on, but neither before nor 
 
 the later stages. The entire product would pass through the 
 hands of the laborers at the latest stages and their output, 
 therefore, would measure the productivity of the whole process. 
 After the increase of the production period has brought about 
 the maximum amount of equipment each of these laborers 
 could use effectively, and the maximum he could produce, 
 further extensions of the process would result, at best, in no 
 increase and, perhaps, in a decrease of the product per laborer. 
 At the same time the number of these laborers is diminished 
 as more of them are shifted to the earlier stages. The outcome 
 would be a decline in the total product, and as the total of 
 labor invested was assumed to remain unchanged, a corre- 
 sponding decline in the amount of product per unit of labor 
 invested. A further extension of the production period would 
 be to no one's interest.
 
 26 PROFIT AND WAGES 
 
 after, a definite date in 1917. Obviously such 
 an assumption respecting the time when pro- 
 ductive processes must yield their fruit, is 
 without warrant save as applied to exceptional 
 cases. Contracts for completing buildings or 
 furnishing supplies within a certain time (not 
 usually on a definite date) are common enough, 
 but being made under conditions which allow 
 practically no choice as to the time of beginning 
 work, are not relevant to our problem. The 
 only occasions for comparing productive pro- 
 cesses begun at different times, but aiming at 
 completion on the same date, would be those 
 created by expected events or opportunities 
 of a temporary and unusual character, by what 
 German writers would call a Konjunktur. Such 
 would be the occurrence of an international 
 exposition, the opening of a canal or of a new 
 railway, the outbreak of a war, etc. But most 
 economists would agree that there is a difference 
 between a Konjunktur gewinn, the gains of a 
 special and temporary opportunity, and interest 
 on capital, and that the latter income must be 
 derived from some more constant and regular 
 source. As regards the great majority of 
 productive operations there is no occasion for 
 comparing the results of processes begun at 
 different times and no necessity for shortening 
 postponed processes because of any need for 
 completing them on a given date. It is, there- 
 fore, impossible to prove a purely technical or 
 productive advantage in present over future
 
 BOHM-BAWERK S THEORY OF INTEREST 27 
 
 possession of the means of starting a productive 
 enterprise. The only conceivable conditions 
 under which such a "technical superiority of 
 present goods" could arise are too exceptional 
 and restricted to form the basis of a theory of 
 interest. 
 
 The greater productivity of the longer process, 
 of the larger investment of capital, under 
 certain conditions and within certain limits, is 
 a fact and one of some significance to the theory 
 of interest. Bohm-Bawerk presents it as the 
 most important of those which must enter 
 into the explanation of the income of the 
 capitalist. In the writer's opinion he does not 
 overestimate the relative importance of the 
 technical factor. It is, in truth, the only one 
 of those given by him that constitutes an 
 essential element of a general theory of interest. 
 But he has not given the right name to the fact 
 which he is using. It is not a superiority of 
 present goods, i. e., a technical advantage 
 of present over future possession, but the 
 productive advantage of having a certain capital 
 over that of having less capital or none at all. 
 It may, perhaps, form the basis for a kind of 
 productivity theory, but it cannot be fitted 
 into a pure agio theory. In short, it does not 
 constitute a direct and immediate cause of 
 preference for present over future goods. 
 
 In a more remote way, however, it may be 
 the cause of such preference. If we grant 
 that the greater productivity of the longer
 
 28 PROFIT AND WAGES 
 
 process is one of the factors causing the existence 
 of interest, and that the possibility of deriving 
 interest from money, or goods convertible into 
 money, is a good reason for wishing to have 
 said goods or money now rather than later, 
 we must conclude that the superior productivity 
 of long processes is indeed a ground of prefer- 
 ence for present goods. But such preference is 
 a result, and not as Bohm-Bawerk would have 
 it, a cause of the existence of interest on capital. 
 In regard to the "technical factor" we may 
 conclude, therefore, that its contribution to 
 the creation or maintenance of interest on 
 capital cannot be of the same nature as that 
 of Bohm-Bawerk's other "causes of preference 
 for present goods." Bohm-Bawerk's bias in 
 favor of unitary theory, or, as Landry calls it, 
 his "fear of eclecticism," has apparently led 
 him to make a desperate attempt to demonstrate 
 the technical factor to be a direct cause of 
 preference for present goods, parallel in its 
 action with the other two factors. Such an 
 attempt must necessarily fail and the three 
 "causes" cannot be brought together under 
 one head. If all three are to be retained for 
 the explanation of interest, a theory resting 
 on time-preference alone, a pure agio theory, 
 is an impossibility.
 
 CHAPTER III 
 
 THE TIME-PREFERENCE THEORY 
 
 The conclusion reached in the preceding 
 chapter that Bohm-Bawerk's technical factor 
 will not fit into a pure agio theory, is that held 
 by apparently the great majority of economists. 
 With some qualifications, perhaps, this factor 
 may form the basis, of a kind of productivity 
 theory. It cannot be made to appear as a 
 direct cause of a preference for having goods 
 at one point of time, rather than at another. 
 But now arises the question as to whether a 
 satisfactory theory may be reached by elimi- 
 nating the technical factor from consideration 
 and operating with the other two causes of 
 preference, those which a careless but con- 
 venient usage permits us to call the subjective 
 factors. This has been the method of several 
 recent writers* and may be regarded as a very 
 consistent development of the tendency to 
 reduce economics to a theory of valuation. It 
 merits a careful examination. But instead of 
 assuming the active existence of the subjective 
 factors and inquiring merely into their sufficiency 
 to give a complete theory, it is necessary to 
 approach the problem in a more fundamentally 
 sceptical attitude and to ask whether these 
 
 *Especially Professors Fetter and Irving Fisher.
 
 30 PROFIT AND WAGES 
 
 factors actually play any part whatever in 
 bringing about the existence of interest or in 
 regulating its amount and percentual rate. 
 
 Let us then take a glance at the two non- 
 technical or subjective causes of preference 
 mentioned by Bohm-Bawerk. In regard to the 
 second of these, the underestimate of future 
 advantages, it may be admitted that lack of 
 imagination, weakness of will in the face of the 
 temptations of present enjoyment, the uncer- 
 tainty of human life and, perhaps, other cir- 
 cumstances, may bring about a tendency to 
 over-rate present compared with future goods. 
 This, of course, is acknowledging the existence 
 of uneconomic tendencies. It is admitting the 
 irrational, the uneconomic man as a disturbing 
 force into the beautifully ordered, rational 
 world of economic theory. Yet if actual man- 
 kind is so irrationally disposed, why not recog- 
 nize the fact in economic study? Doubts 
 regarding the importance of the factor, arise, 
 however, when we ask whether persons whose 
 preference for present goods rests on such 
 weakly human grounds are likely to be in a 
 position to offer sufficient security for the 
 fulfillment of contracts, to be enabled to enter 
 into an exchange of future for present goods. 
 The important question in this connection, in 
 fact the only relevant question, is not whether 
 such preference for present goods might or does
 
 THE TIME-PREFERENCE THEORY 31 
 
 exist, but whether it plays a part in the business 
 facts that give rise to interest on loans and 
 investments. 
 
 And the same remark applies to Bohm-Bawerk's 
 first cause of preference for present possession. 
 We may grant that an anticipated relatively 
 more abundant provision for future wants is 
 an experience entering into the lives of a con- 
 siderable number of persons. That is, they 
 have such anticipations, whether or not these 
 lead to any conscious preference for present 
 goods or to actual offers of a premium for 
 present possession. That it is the experience 
 of the majority may perhaps be doubted and 
 it is not impossible that conditions may be 
 reversed and the present be the relatively better 
 provided for. In that case it would be rational 
 to feel a preference for future over present goods. 
 This possibility is hardly referred to by Bohm- 
 Bawerk, whose thinking is directed toward 
 finding the explanation of interest in what he 
 considers the almost universal human attitude 
 of a preference for goods in the present.* Of 
 course those who prefer future goods to present 
 goods, might be represented along with those 
 having only a slight preference for present goods, 
 as parties to an exchange with those feeling a 
 relatively strong preference for goods in the 
 present. But, on the whole, the agio theory 
 
 *However, he holds that for most capitalists this preference 
 rests on the "technical superiority" of present goods and that 
 the first two grounds of preference, the subjective ones, are 
 of no effect. See 3d ed. of Positive Theorie, p. 521.
 
 32 PROFIT AND WAGES 
 
 requires that preference for present goods be a 
 more urgent and wide spread factor than the 
 preference for future goods. If such should 
 not be the case, that is if those preferring present 
 goods could always find persons with a prefer- 
 ence for future goods, an exchange might be 
 arranged, advantageous to both parties, in 
 which no interest or discount need appear. Now 
 does Bohm-Bawerk's first "cause," the factor 
 of a difference between provision for present 
 and for future wants, take a shape such as to 
 create a very general preference for goods in 
 the present? It appears, at least, doubtful. 
 Those whose income is gained by their own 
 labor, may in youth have before them the 
 prospect of earning power increasing with age 
 and experience; but such increase of income 
 may be accompanied by the increased expenses 
 of a growing family, and will be followed by a 
 decline of earning power with advancing years. 
 Those, on the other hand, whose income is 
 derived from investments, may have reason 
 for expecting a constant growth of income from 
 their increasing accumulation of savings. Their 
 relative underestimate of future goods would 
 however be due to the existence of income on 
 capital. To represent it as a cause of interest 
 would obviously be reasoning in a circle. 
 
 Bohm-Bawerk's first two grounds of prefer- 
 ence for present goods, the subjective factors, 
 appear, therefore, to offer no very secure founda- 
 tion to a theory of interest. In fact, Bohm-
 
 THE TIME-PREFERENCE THEORY 33 
 
 Bawerk himself virtually surrenders them except 
 in his theory of the "consumption loan." The 
 exponents of the pure agio theory, however, 
 have put forward no other grounds of such 
 preference. They rest their case entirely on 
 something for which no adequate explanation 
 has been given. 
 
 But for the sake of argument let us grant 
 that there may be good reasons for wishing to 
 have goods at one time rather than at another, 
 and that, on most occasions the preference 
 would be for goods in the present. For any 
 preference, one way or the other, between goods 
 to be got at different points of time, we may 
 use the convenient term time- preference.* When 
 such preferences are presented as growing out 
 of fairly definite, quantitative comparisons, we 
 evidently have an extension or development of 
 the Austrian theory of value; the "economic 
 man" being represented as comparing the rela- 
 tive utilities not only of different goods in the 
 present and immediate future, but of the 
 prospective goods of years to come. Interest 
 becomes a problem in "subjective value." For 
 let us note, that when Bohm-Bawerk's technical 
 factor is eliminated from consideration, the 
 comparison between goods, or between the 
 
 "This term is used by Professor Irving Fisher but in a more 
 restricted sense, as a preference for present over future goods. 
 ( The Rate of Interest, p. 88 and elsewhere.) In Professor 
 Fetter's Economics the term time-value is used in the sense 
 in which time-preference is employed here.
 
 34 PROFIT AND WAGES 
 
 "incomes" from goods coming at different 
 points of time, is made by the consumer and 
 between consumable goods only. 
 
 This may arouse doubts in regard to the 
 applicability of the theory to those facts in 
 which the consensus of opinion among econo- 
 mists looks for the chief source of interest. 
 What part do the factors it emphasizes play 
 in real business? When capital goods or profit- 
 able opportunities are valued, it is on the 
 basis of expected pecuniary returns, of that 
 interest whose nature and amount the theory 
 in question seeks to explain, of the objective 
 facts of the industrial world rather than of the 
 subjective states of the consumer. How to 
 bridge the gulf between the subjective, the 
 consumer's estimates of goods, and the objective 
 facts of industry, constitutes a serious problem 
 for those who would base interest on time- 
 preference alone. 
 
 What are the actual mental states of the 
 men who put their capital into business and 
 get an income in the shape of interest? The 
 professorial imagination has displayed great 
 ingenuity in showing how comparisons between 
 present and future utilities might be made and 
 time- values noted. But such mental exercises 
 are of no importance unless time-preference is 
 a psychic state that actually enters into the 
 transactions out of which interest grows; unless 
 it plays a part in borrowing, lending, and 
 investing. The only relevant question, there-
 
 THE TIME-PREFERENCE THEORY 35 
 
 fore, is not that as to possible reasons for having 
 a time-preference, or as to the possibility of 
 the occurrence of this state of mind, but as to 
 whether such a preference or valuation is an 
 essential part of the psychology of business. 
 What really goes on in the investor's mind? 
 In the borrower's and in the lender's mind? 
 
 That economists have been so ready to accept 
 time-preference as a factor affecting invest- 
 ment is possibly due to an uncritical identifica- 
 tion of it with the older concept of abstinence; 
 the transition from the older to the more recent 
 conception being facilitated by the use of 
 such terms as postponement, prospectiveness, 
 and waiting. In the idea of an exchange of 
 present against future goods in which time- 
 preference may play a part, we have, however, 
 something essentially different from the thought 
 of the older abstinence theorists, and a view 
 of things less likely to recommend itself to an 
 unsophisticated understanding of what takes 
 place in this world. By the older writers 
 abstinence was taken to mean abstaining from 
 consumption in order to accumulate and invest 
 capital, and the continuance of the abstention 
 in order to maintain the capital accumulated. 
 It was regarded as involving some deprivation 
 or "cost" and, therefore, requiring some com- 
 pensation. Interest was the necessary "reward 
 of abstinence." This view, however, did not 
 of necessity imply that in the exercise of absti- 
 nence there was a postponement of consumption,
 
 36 PROFIT AND WAGES 
 
 i. e., that the capital sum saved and maintained 
 by abstinence, was ever to be consumed. Such 
 an idea, however, is suggested by Bohm-Bawerk's 
 exchange of present for future goods. It implies 
 in the capitalist's mind a comparison of two 
 quantities of consumable goods; of a present 
 quantity on the one hand, with an equal future 
 quantity of goods, in addition to the interest, 
 on the other. 
 
 This manner of presenting the calculations 
 of investors is an obvious departure from the 
 facts, a misrepresentation of the psychology of 
 investment. Very few investors ever con- 
 template consuming what they call their capital. 
 Investment to them does not mean postponing 
 the consumption of the equivalent of what they 
 have saved. In fact, whatever hardship or 
 cost may have been involved in saving a given 
 capital, it would probably appear a more 
 heartrending thing to be obliged to consume the 
 capital that has been saved. The capital sum, 
 therefore, does not enter into both terms of 
 the comparison between present and future 
 goods. What the investor does is to compare 
 the present or early consumption of, let us say, 
 one thousand dollars worth of goods once and 
 for all, with the later consumption of a per- 
 manent, annual income of fifty dollars worth 
 of goods, obtainable without labor. There is 
 a comparison, indeed, of consumable goods, 
 or if you will, of "psychic income" or utilities 
 of goods ; but it is of goods or income appearing
 
 THE TIME- PREFERENCE THEORY 37 
 
 under very different conditions. The one thou- 
 sand dollars if spent for purposes of consumption 
 are gone. Another accumulation of one thousand 
 dollars can be obtained perhaps only by per- 
 forming labor. The fifty dollars received as 
 interest, may be spent, but an equivalent sum 
 will come again, year after year, and without 
 exacting labor from the investor. A relatively 
 large temporary satisfaction of wants may be 
 given up when one thousand dollars is saved; 
 a permanent, unlaborious recurrence of a much 
 smaller sum is gained. The permanent char- 
 acter of interest income and the fact that it 
 comes without labor on the part of the recipient, 
 are to the capitalist the significant character- 
 istics of the "future goods" he purchases by 
 means of his "present goods." These real or 
 apparent characteristics a theory of interest 
 must account for. Their existence granted, 
 we can see why men will make sacrifices to 
 obtain interest. 
 
 In the case of the active entrepreneur, as 
 distinguished from the capitalist-lender, the 
 calculations of an investment are slightly differ- 
 ent, but equally unfavorable to the time- 
 preference concept. The entrepreneur also hopes 
 to get a permanent income as a percentual 
 rate of his thousand dollars; but he looks for 
 a higher rate than the capitalist, for what 
 following the usage of the classical economists, 
 we may call "profits of capital." When receiving 
 the higher rate he does not expect entirely to
 
 38 PROFIT AND WAGES 
 
 avoid risk and labor. The most important 
 aspect of investment to him is the fact that it 
 represents business opportunity. Neither cap- 
 italist, nor entrepreneur, however, let a future 
 capital sum enter into comparison with present 
 goods. They are not conscious of making any 
 such exchange of present against future goods 
 as is suggested by the language of Bohrri- 
 Bawerk and his followers. 
 
 It is evident that the purposes and calcula- 
 tions that lead up to and prevail in the process 
 of investment are not those suggested by the 
 theory under consideration. Time-preference 
 is certainly not consciously present and it is 
 hard to see how the institution of interest can 
 rest upon a mental state which capitalists would 
 fail to recognize as having any connection with 
 their business. Indirect evidence, moreover, 
 that estimates of time value are not an important 
 factor may be found by considering the rates 
 of interest on loans for different lengths of 
 time. If a comparison of the utility or value 
 of the capital sums loaned and returned, or 
 of the goods these sums represent, played any 
 part, then the longer the time intervening 
 before the payment of the loan, the higher the 
 agio or total of interest necessary as premium 
 on present goods or discount of the distant 
 future goods. If the preference for present 
 possession grew in direct ratio with the length 
 of the loan period, a uniform annual rate of 
 interest would be demanded for all loans of
 
 THE TIME-PREFERENCE THEORY 39 
 
 equal risk. A thirty year loan of one thousand 
 dollars, for instance, would receive six times as 
 many annual payments of fifty dollars as a 
 five year loan. But perhaps it may be argued 
 that if time preference governs the loan market, 
 a prospect of payment at a very distant date 
 would call for a higher rate of discount than a 
 short period loan, that if a five year loan is 
 satisfied with 5 x $50, a thirty year loan would 
 demand 3ox$6o; preference for present goods 
 and sums growing at a greater rate than the 
 time interval before the final payment. The 
 facts of the loan market, however, do not fit 
 either of the above suppositions as to the rate 
 of growth of preference for present possession 
 with increasing remoteness of future payments, 
 and do not, therefore, fit the necessities of the 
 time-preference theory. Instead of a rate of 
 interest on long time loans equal to or greater 
 than that on short loans, we usually have a 
 lower rate ; evidence that an undisturbed annual 
 income is desired and not the return of the 
 whole equivalent of the "present goods" invested. 
 Something needs to be said about the idea 
 of an exchange of present against future goods 
 which has played more or less of a part in the 
 agio theory. The term "exchange" suggests 
 two parties. "It takes two to make a trade." 
 The investor or capitalist gives present goods in 
 return for future goods. But who is it that 
 gives the future goods? In the so-called "con- 
 sumption loan" the borrower appears clearly
 
 40 PROFIT AND WAGES 
 
 to be the one who offers things in the future. 
 But the consumption loan is one of the minor 
 incidents of the modern economic system and 
 may be passed over for the present. If it is 
 not possible to make the idea of a trade in 
 time-values fit the facts of the "production 
 loan" and the use of capital in business, the 
 major characteristics of the capitalistic world, 
 it is evident that the factors suggested by it 
 can play at most a very subordinate part. 
 
 Turning, therefore, to the production loan, 
 we ask, who are the parties to an exchange in 
 which present goods are given for future goods? 
 Is there such an exchange between the capitalist 
 as lender and the entrepreneur as borrower? 
 The capitalist gives up present goods to the 
 entrepreneur. The latter, however, far from 
 consuming them, turns them into his business 
 and looks for a future return. Obviously both 
 entrepreneur and capitalist look for a future 
 return. They share in the profits of capital. 
 The capitalist because free from risk and the 
 labor of directing the productive and com- 
 mercial process contents himself with a part 
 of these profits known as interest. Interest is 
 "commuted profits."* What is really given 
 in exchange, therefore, is not consumable quan- 
 tities of wealth of different date like the 
 dinners of polite society - - but different means 
 and conditions of securing income. The entre- 
 preneur receives the means of controlling the 
 
 *Hadley, Economics, p. 270.
 
 THE TIME-PREFERENCE THEORY 41 
 
 productive or business process, the opportunity 
 of making a gain by luck and the exercise of 
 his business talents. The capitalist, on the 
 other hand, receives an income without labor 
 and often substantially without risk. But 
 both devote present wealth to future income. 
 If anywhere there is an exchange of present 
 against future goods, it is not between entre- 
 preneur and capitalist. We must look else- 
 where for an answer to the question as to who 
 gives the future goods. 
 
 If there is an actual exchange of earlier for 
 later goods, connected in any way with the 
 capitalistic production of wealth, apparently 
 it must be between entrepreneur and laborer, 
 the laborer being the seller of future goods. 
 Now the wage contract may indeed be regarded 
 as an exchange, but not as a conscious exchange 
 of time- values. The laborer knows nothing 
 of giving future goods. He has no goods to 
 give, either now or in prospect. As Loria 
 remarks, he is not so fortunate as to compete 
 with the Roman Church in its traffic in future 
 blessings.* He has only his labor-power. That 
 may be used to produce goods which are to be 
 finished and sold in the future, and so, by figure 
 of speech, these products, and the labor-power 
 itself, may be called "future goods." But this 
 labor-power is a future good that can seldom 
 "ripen" into a present good unless the employer 
 consents to take it into his hire. So all that will 
 
 *// capitalismo e la scienza. Chap. I.
 
 42 PROFIT AND WAGES 
 
 be clear to the employe's mind is that with the 
 employer's consent, he may work and receive 
 wages. The goods he makes, he cannot think of 
 giving in return for anything, because they 
 are not his to give. All the characteristic features 
 of an exchange are lacking. Yet if interest is 
 to be accounted for as the agio in an exchange 
 of time- values, the employe must be represented 
 as giving commodities which he may never 
 see in their completed form, whose amount and 
 value he does not know, and giving them 
 subject to a discount. That discount, if there 
 is a conscious trade in time- values, should 
 satisfy the time-preference of both employer 
 and laborer. But it requires no argument to 
 show that the laborer knows nothing about such 
 a discount. If he has not read the latest theorist 
 he does not suspect that he has a rate of time- 
 preference at all. Was any such rate ever men- 
 tioned in the contest between trade-union and 
 employer? 
 
 Possibly the obvious absurdities of the idea 
 of an exchange when applied to the wage- 
 contract, the one business relation in which 
 present goods appear to be given for future goods 
 on a large scale are not necessary implica- 
 tions of the time-preference theory. Perhaps 
 the use of the term "exchange" is simply an 
 instance of unhappy terminology and may be 
 avoided.* It might be argued that although 
 
 *It may be suspected that if it were not for the apparent apolo- 
 getic value of the idea of an exchange between present and 
 future goods, the idea would have received little notice.
 
 THE TIME-PREFERENCE THEORY 43 
 
 the laborer is no conscious buyer or seller of 
 time- values, the time-preference rate of cap- 
 italist and employer determines the rate of 
 profit and interest. In that case, in trying to 
 demonstrate a general preference for present 
 over future enjoyment, the time-preference 
 theorist may eliminate the laboring classes from 
 consideration as irrelevant to the subject.* 
 
 To state the possibly consistent time-prefer- 
 ence theory which may be reached by dis- 
 carding the idea of a conscious bargain in time- 
 values between employer and employe, the 
 laborer might be represented as merely selling 
 his labor for what he can get, while employers 
 are led by competition to pay the discounted 
 value of the product of that labor, the rate of 
 discount being determined by the capitalist's 
 rate of time-preference. This, of course, is 
 possible only on the assumption that capitalists 
 prefer present to future goods and at a definite 
 rate of preference (at least, so far as the marginal 
 supply of capital is concerned). That the com- 
 petition of employers will give the laborer the 
 full product of his labor discounted at not 
 more than the "necessary" rate of discount, 
 is of course one of the cheerful assumptions of 
 
 *The time-preference of laborers is of significance, in this con- 
 nection, only in so far as laborers are capitalists and not always 
 even then. A large part of the savings of the working class 
 are such savings "for a rainy day" as would be made even if 
 there were no interest receivable upon their accumulations. 
 We may infer, therefore, that but a very small part of the 
 capital funds of the world are affected in any way by the 
 preference of laborers for present over future goods.
 
 44 PROFIT AND WAGES 
 
 the productivity theory of wages. This assump- 
 tion, as will be shown in a later chapter, is 
 questionable. Let us note only, that if one is 
 willing to accept the productivity theory of 
 wages in the form just stated, and also the 
 idea of a definite rate of time-preference held 
 by capitalists, we can get a very consistent 
 theory of the rate and amount of interest and 
 profit of capital. Capitalists and entrepreneurs 
 as a class pay simply wages, nothing more.* 
 These wages according to the theory just 
 suggested are the discounted value of the total 
 product, the discount being determined by the 
 time-preference rate of the capitalist class. 
 
 This theory would not give us a complete 
 theory of why there is interest at all. A complete 
 explanation of the existence of the institution 
 of interest and profit of capital would have 
 to take definite cognizance among other things 
 of the existence and conditions of a special 
 class so situated that its rate of time-preference, 
 if indeed it has one, can play no part in deter- 
 mining the share that it may get of the product 
 of its labor. But the formulation of a complete 
 theory of the existence of interest is a difficult 
 and probably impossible task. In our view the 
 method of theory should attack primarily the 
 problem of the rate and amount of each share 
 in distribution. As a theory of the rate and 
 amount of the income of capital, the time- 
 
 *Setting aside rent and taxes and, of course, all payments not 
 connected with the productive process.
 
 THE TIME-PREFERENCE THEORY 45 
 
 preference theory, as we have seen, may be 
 stated in fairly consistent form. It rests on 
 certain dubious assumptions in regard to the 
 wage-contract, which will be reserved for later 
 examination. The objection against the theory 
 to be stated at this point, however, is the one 
 suggested by our analysis of the psychology of 
 investment. There is no comparison between 
 present and future capital sums and no dis- 
 coverable definite subjective rate of time-prefer- 
 ence in the minds of capitalists and entrepreneurs. 
 Whatever be the mental states of these gentle- 
 men, they are not those suggested by this 
 theory. Whether some other, happier formu- 
 lation of the subjective condition of the capitalist 
 class can be substituted for the time-preference 
 notion, and give us a satisfactory theory of 
 the rate and amount of capitalist gain, may be 
 left to later consideration. At this point we 
 are concerned only to show the failure of the 
 time-preference theory. 
 
 Other than the contract between entrepreneur 
 and laborer, the only transactions that suggest 
 the idea of an "exchange" of present for future 
 goods are the loan for consumption and the 
 purchase of durable goods. To imagine the 
 parties to a consumption loan as adepts in the 
 utilitarian calculus, with definite time-prefer- 
 ences, may be less difficult than most of the 
 trials of faith imposed upon us by the time 
 preference theorists. However, it seems some- 
 what doubtful whether actual cases of such
 
 46 PROFIT AND WAGES 
 
 mental attitudes are discoverable. In any case 
 it does not appear probable that subjective 
 factors alone could account for the rate of 
 interest on this class of loans. The lender, for 
 instance, is less likely to think of his present 
 and future "psychic incomes," than of the risk 
 and of the rate of pecuniary return on the various 
 investments, productive and unproductive, open 
 to him. Is it not simpler to regard the interest 
 payment on a loan for consumption as a deriva- 
 tive phenomenon and look for a fundamental 
 theory of interest in the circumstances determin- 
 ing the income on productive loans and invest- 
 ments? After all, a secondary phenomenon such 
 as the consumption loan affords too narrow a 
 basis to support a comprehensive theory of 
 capitalistic income. 
 
 When we come to consider durable goods, 
 we are asked by the time-preference theorists 
 to regard the purchaser as buying the future 
 utilities or services given by these goods and, 
 therefore, estimating the value of the goods 
 he buys by discounting these psychic futurities. 
 The most durable of all purchasable things is 
 land. According to this theory, the price paid 
 for a piece of land, or, in other words, the 
 present goods given in exchange for the future 
 goods to be derived as income from the land, 
 must equal these future goods discounted accord- 
 ing to the prevailing rate of time-preference. 
 The price, in short, is the present value of a
 
 THE TIME-PREFERENCE THEORY 47 
 
 seemingly endless series of annual incomes.* 
 Calculation of the price would have to proceed 
 by adding the discounted values of the successive 
 prospective annual returns until returns so 
 remote were reached that their present value 
 is infinitesimal. Obviously this is not and 
 never was the method followed by any actual 
 buyer of land. 
 
 With some goods of a less durable nature 
 than land, as, for instance, in the case of a 
 dwelling house, the calculation supposed by 
 the time-preference theory, may seem less 
 absurd. But how is it with goods of a still less 
 durable character, a piece of cheap furniture, 
 for instance, or a suit of clothes, or a box of 
 cigars? Their utilities are spread out over 
 future time. Do we discount these utilities 
 when we think of buying the articles? All, 
 even the most evanescent goods, are to be 
 consumed at a future moment, though that 
 future be but a fraction of a second removed 
 from the present. Must we be prepared to 
 view the discounting of "psychic income" as 
 entering into the determination of all commodity 
 values? Here obviously we are beginning to 
 approach the absurd. 
 
 Now possibly the application of its funda- 
 mental principle to the value of consumption 
 goods is not necessary to the time-preference 
 theory. It has been referred to here to show 
 how far the bias in favor of psychological 
 
 *Bohm-Bawerk does not hesitate to call it an "infinite" series.
 
 48 PROFIT AND WAGES 
 
 theory has led the exponents of time-preference 
 away from reality. If economics must get 
 back to subjective factors, why not consider 
 income as consisting of utilities rather than of 
 the goods giving these utilities? And if utilities 
 are income, why should not the income be 
 capitalized? In other words, why not arrive 
 at the value of a cigar by discounting the 
 prospective pleasures of a smoke? "Logic 
 is logic" even when it leads to absurdity. But 
 obviously the unblenching stibjective valuation- 
 ists have led economic theory far from the 
 observable facts of industrial life. 
 
 The departure from reality has come, of 
 course, by stages. As Private Mulvaney would 
 say, "one thing led to another." First, we were 
 given the "economic man" -not a real man 
 but supposed to be enough like a man of business, 
 during business hours, to illustrate what might 
 happen in the industrial world. Then this 
 "economic man" developed into a Benthamite 
 psychologist, but ever growing more subtle 
 in his thinking, weighing and comparing utilities 
 - after a time even of infinitesimal increments. 
 Differential calculus was called upon to demon- 
 strate the precision of his thought. When 
 after a time the feeling of strangeness had 
 worn off and our economist Frankensteins 
 began to feel at ease with their monstrous 
 creation, they saw that the clever creature 
 could not be confined to estimating utilities 
 that are all within one area or zone of time,
 
 THE TIME-PREFERENCE THEORY 49 
 
 as if he had no sense of time at all. No, he must 
 look ahead and project his arrangement of 
 utilities far into the future. So carefully does 
 he distribute his consumption of commodities 
 over the days, months, and years, that the 
 least want satisfied at any moment of time 
 has the same importance as the marginal want 
 satisfied at any other moment. If by some 
 investment of wealth, he disturbs his beautiful 
 equilibre de la consommation, he knows exactly 
 what rate of interest he must demand to com- 
 pensate for the cost of this disturbance.* Such 
 are the achievements of this hero of economic 
 mythology. He has delighted our fancy, but 
 the time has come to ask whether anybody 
 ever saw anything like him in sober reality. 
 And it is reality which economists profess to 
 describe, though of necessity employing the 
 method of abstraction. By "successive approxi- 
 mations," we have been led to hope, the abstrac- 
 tions of economic theory could gradually close 
 in upon reality, almost attaining it. But 
 obviously there are economic speculations that 
 act more like successive dispersions from the 
 facts of life. 
 
 Of course, we may expect that soon or late 
 there will appear a sceptical reaction against 
 the development of the principle of subjective 
 valuation, and a disposition to appeal to the 
 coarse judgments of the popular consciousness. 
 Thus Lexis writes in opposition to the agio 
 
 "Landry, L'interet du capital, Chap. II.
 
 5 o PROFIT AND WAGES 
 
 theory though apparently thinking only of 
 Bohm-Bawerk's exposition and not of the fine- 
 spun developments of recent writers that 
 "the question of the significance of a time- 
 difference the distantia temporis between 
 the beginning and end of a loan-transaction 
 * * * was considered by the Canonists. The 
 profit on a bill of exchange was justified by the 
 difference in monetary standards and the dis- 
 tance between the place where the bill was 
 drawn and the place of payment. But for the 
 time difference all compensation was uncon- 
 ditionally excluded evidence that the idea 
 of a difference in value between a present and 
 a future sum was as remote from the economic 
 consciousness of that time as it is from the 
 minds of the money lenders and house owners 
 of today. But motives and considerations 
 which do not demonstrably and consciously 
 determine the actions of individuals and thereby 
 cause collective phenomena (Massenwirkungeri) 
 cannot be regarded as factors of any importance 
 in political economy (wesentliche Faktoren fur 
 die Volkswirtschaft) . " * 
 
 Possibly Lexis carries his scepticism too far. 
 The refusal to consider anything but factors 
 which are demonstrable and conscious to the 
 popular mind, might exclude actually operating 
 forces from examination. The popular mind 
 is not acute in analysis nor conscious of its own 
 processes. If, for instance, the question whether 
 
 *Article Zins in Worterbuch der Volkswirtschaft, Bd. II.
 
 THE TIME-PREFERENCE THEORY 51 
 
 estimates of marginal utility entered into the 
 ordinary shopper's mind, were submitted to 
 any group of plain people, the answer probably 
 would be an hilarious negative. Yet while 
 the average man would find it difficult to 
 discover by introspection any of the subtle 
 workings of the utilitarian calculus, relative 
 marginal utility may after all have some influ- 
 ence on the distribution of his expenditures. 
 Not that he carefully compares utilities. But 
 if the marginal utilities of different lines of 
 expenditure get out of alignment a distressing 
 insufficiency at some point will lead to sober 
 reflections and an effort to make a better pro- 
 portioned provision for the different groups of 
 wants. Moreover, imitation leads to a dis- 
 tribution of expenditures according to class 
 standards, the outgrowth of the experience of 
 the class and its gradual but not clearly conscious 
 adjustment of expenditure to money income. 
 The marginal utilities that affect the relative 
 demand for different commodities on the market 
 are to a large degree objective facts and social 
 standards to which the individual conforms 
 unconsciously. 
 
 Thus marginal utility although not recog- 
 nized by the popular mind, is a factor to which 
 economic theorists are justified in giving some 
 recognition. But when we come to deal with 
 time- values and preferences, we are entering a 
 sphere where even the roughest, least conscious
 
 52 PROFIT AND WAGES 
 
 \ 
 
 adjustment of expenditure to relative needs 
 seems to be beyond the reach of probability. 
 Manipulation of the "time-shapes" of income 
 is practically impossible. To be sure, some 
 successful spreading of expenditure, of the 
 "psychic income" of the consumer, over the 
 week, the month, even over the year is accom- 
 plished. It has been the study of many a 
 pedagogical household. But who would claim 
 that this has any perceptible effect on the 
 business of deriving interest from capital invest- 
 ments? For longer periods of time, the unfore- 
 seeable changes in subjective and objective 
 conditions of life, make both the experience 
 of the individual and of social classes of no 
 avail in effecting any rational equalization 
 over time, of the stream of "psychic income." 
 We have a right to demand that in theorizing, 
 more definite and demonstrable factors be taken 
 than the "time-shape" of income, "time- values," 
 and "rate of time-preference." To reach general 
 conclusions economists are obliged to assume the 
 action of intelligent self interest, to picture life 
 as more rational than it is in reality. The time- 
 preference theory, however, carries rationalism 
 to excess. By attributing superhuman powers 
 to the economic man it becomes completely 
 detached from the actual world. A highly 
 hypothetical proposition, subjected to succes- 
 sive qualifications, may constitute the nucleus 
 of a series of valuable "approximations" to 
 reality. If, however, the first, obvious quali-
 
 THE TIME-PREFERENCE THEORY 53 
 
 fication is a complete denial of the initial 
 hypothesis, there should be an end of experiment 
 with such fictitious stuff. The time-preference 
 theory is a remarkably consistent piece of 
 theorizing and therein doubtless lies its great 
 attraction. But it is spun out of nothing. 
 
 It is not denied that expectations, or let us 
 say rather hopes and fears, of an increase or 
 decrease in the proportion of income to wants 
 may have some influence on saving, lending, 
 and borrowing; may be among the psychic 
 conditions out of which these acts sometimes 
 arise. The business of life insurance depends 
 on an appeal to such motives.* The amount 
 of savings which seek interest-yielding invest- 
 ments may be affected by their intensity. 
 Influencing the supply of loan funds they may 
 have some influence on the rate of interest. But 
 to grant that these expectations, hopes, and 
 fears have an influence on the rate of interest is 
 far from admitting that they are a direct 
 determinant, sufficiently definite and powerful, 
 to be given a place in a carefully formulated 
 general theory of the rate of interest. And 
 in any case they are subordinate in importance 
 to most of the purposes and calculations that 
 rule in the direct investment of capital in the 
 
 *It should be noted, however, that in buying life insurance, 
 the one really clear and important case of an occasion for 
 comparing amounts of consumable wealth of different periods 
 with reference to a difference in the state of provision for the 
 wants of these periods, the preference is for future goods, and, 
 therefore, the reverse of the time-preference called for by the 
 theory under consideration.
 
 54 PROFIT AND WAGES 
 
 productive process. Of these calculations, we 
 have seen, the concept of time preference gives 
 a false notion. We may conclude, therefore, 
 that the effort to reconstruct Bohm-Bawerk's 
 theory by etiminating the technical factor and 
 basing the argument exclusively on subjective 
 estimates of time- value, cannot contribute much 
 to the elucidation of the problem of interest. 
 The idea of a sacrifice of present goods in return 
 for future goods may have some value in the 
 apologetics of the capitalistic system. That, 
 however, is of no concern to disinterested 
 economic theory. The important fact is that 
 time-preference has too little relation to the 
 actual forces at work in the industrial world, 
 to serve as an explanation of the amount and 
 rate of capitalist income.
 
 CHAPTER IV 
 
 THE ABSTINENCE THEORY 
 
 The controversial success of the Austrian 
 theory of value has created a bias in favor of 
 explanations of economic phenomena in terms 
 of subjective valuation. It has fostered the 
 ideal of a unitary theory based on some psycho- 
 logical factor. In the time-preference theory 
 of interest we have the extreme expression of 
 this tendency. It is, however, the only modern 
 psychological theory of distribution which pro- 
 fesses to offer all the elements of a theory. If 
 we reject it, we must turn to objective, non- 
 psychological factors for at least part of the 
 explanation of the problem. The only other 
 theory which may be called subjective or 
 psychological is the abstinence theory. Recent 
 adherents of the latter, however, do not claim 
 completeness for it. It is advanced as a treat- 
 ment of the factor of supply of capital only, as 
 part of a dual theory of interest in which demand 
 for capital is described as starting from technical 
 and business facts. All that we need to con- 
 sider, therefore, in reference to this theory is 
 whether it states a factor affecting supply of 
 capital sufficiently important to warrant its 
 inclusion in a general theory and whether it 
 correctly represents the mechanism by which 
 this factor comes into play.
 
 56 PROFIT AND WAGES 
 
 In favor of the abstinence theory it may be 
 said that it gives a possibly less definite, but 
 also less questionable, description of the mental 
 states of the investor than the time-preference 
 theory. In some modern versions the concept 
 of abstinence is practically converted into that 
 of time-preference. It is possible, however, to 
 formulate the abstinence theory in such a way 
 as to avoid the erroneous conception of an 
 exchange of present against future goods in 
 the form of an exchange of a present capital 
 sum C, against a lump sum C+i (i representing 
 interest). The exchange may be taken to be 
 that of C against a series i, i, i, i, - - - 
 of regularly recurrent sums. Abstinence is 
 represented as the subjective cost of a per- 
 manent, regularly recurrent (usually annual) 
 income, obtained without labor. 
 
 Now does this theory give us an entirely 
 acceptable account of the psychology of saving 
 and investment, of supply of capital? The 
 answer will depend in part upon whether saving 
 and investment really involve a subjective cost. 
 If the term abstinence were taken to mean 
 merely any abstention from consumption in 
 favor of investment, it is obvious that it would 
 frequently involve no perceptible subjective 
 cost. But even when used in this broad, color- 
 less sense, the term would be too narrow to 
 apply to the mental states involved in all cases 
 of investment. In many instances sums are 
 invested that would not have been spent for
 
 THE ABSTINENCE THEORY 57 
 
 consumption goods even if there had been no 
 possibility of investing them. In such cases 
 there is, of course, no abstention or abstinence 
 from consumption. The abstinence theory does 
 not, therefore, at least in its cruder form, 
 convey an entirely truthful impression of the 
 psychology of the capitalist. Its implication 
 of a subjective cost is true of only a limited 
 part of the field of investment. Saving and 
 investment without perceptible subjective cost 
 or hardship occurs not only when there is an 
 unspent residuum of an income so large that 
 it would be distressing to the recipient to find 
 ways of spending it. The maintenance of a 
 capital sum once saved and its increase by 
 accumulation at compound interest probably 
 means little subjective cost to the confirmed 
 saver, even if he be the recipient of only a moder- 
 ate income. Besides the saving of individuals 
 there is growing up an increasingly important 
 saving of an impersonal character. By depre- 
 ciation accounts, the managers of corpora- 
 tions provide for the maintenance of capital . 
 and by the accumulation of surplus for an 
 increase of capital, without the slightest con- 
 sciousness of abstinence on the part of the 
 majority of stockholders. And there is the 
 "manufacture of credit" by banks. Whether 
 this, however, constitutes an increase of capital 
 in a real sense is a disputed point. 
 
 It must be recognized, however, that modern 
 expositions of the theory do not attribute all
 
 58 PROFIT AND WAGES 
 
 saving and investment to abstinence. They 
 aim primarily at an analysis of the factors 
 determining the rate of interest. As they view 
 the matter, it is the subjective cost or abstinence 
 of the marginal savings that is just paid for by 
 the rate of interest, the rate established by the 
 equalization of demand and supply. Savings 
 other than the marginal may be subject to little 
 or no cost, but receive the benefit of the rate 
 that must be paid in order to overcome the 
 marginal saver's reluctance to undergo the 
 necessary abstinence. The greater the amount 
 of capital available throughout the field of 
 industry, the less is gained by its use at the 
 margin and the lower in consequence the rate 
 of interest. If the rate rises as a result of 
 greater demand, increased savings will be induced ; 
 if the rate falls, the marginal savings will fall 
 off because of diminished inducements. It is 
 implied, therefore, by the theory, that saving 
 rises and falls with the rate of interest though 
 not necessarily in the same degree. Thus it 
 regulates the supply of capital and thereby its 
 marginal gains, in such a way as to establish 
 a rate of interest that pays for the abstinence 
 of the marginal savings. And it is further 
 implied that the changes in the supply of saving 
 necessary to bring about this equilibrium 
 between rate and abstinence, are in the saving 
 which can be called marginal and involves the 
 cost of abstinence.
 
 THE ABSTINENCE THEORY 59 
 
 The interacting factors supposed to deter- 
 mine the rate of interest are stated in terms of 
 demand and supply. This gives occasion for 
 some criticism of a more or less formal character. 
 What is the meaning of "supply" of capital? 
 Is it the supply of loan-capital only or of the 
 total of capital whether borrowed or owned 
 by those who employ it? Since the demand is 
 represented as being regulated by the marginal 
 "productivity" of capital, and this depends on 
 the total of capital used, it is necessary to take 
 the word supply as signifying the total. Now 
 what rate have we to consider in this discussion 
 that of profit or that of interest? As the total of 
 capital is under consideration, it is evidently 
 the rate of profit. Yet the theory professes to 
 be a theory of interest.* 
 
 If the rate of profit and that of interest always 
 varied together and in the same direction, it 
 would not be misleading to represent the rate 
 of interest by that of profit in a discussion of 
 the interaction of demand and supply. There 
 are theoretical grounds for expecting these 
 two rates to move together. There appear to 
 be, however, historical instances of their failure 
 to do so and even of their going in opposite 
 directions. Now as saving and the supply of 
 
 *Sometimes the return on marginal investments of capital 
 is represented as being interest only, the entrepreneur in 
 search of profit having borrowed capital until all excess of 
 profit over interest has disappeared on the last portion borrowed. 
 Here the habit of thinking of infinitesimal increments has 
 led to the improbable conclusion that entrepreneurs will do 
 and continue to do things which result in no gain to themselves.
 
 60 PROFIT AND WAGES 
 
 capital are represented by the theory under 
 discussion as being in response to, or induced 
 by, a rate of return, there arises the difficulty 
 that some savers are affected by the rate of 
 interest alone, others by the rate of profit as 
 well as by the rate of interest. Those who are 
 capitalists only, unwilling to run risks, without 
 ability or inclination to manage a business, 
 will not in their saving be affected by the rate 
 of profit at all, unless that rate in its movement 
 drags the rate of interest with it. The entre- 
 preneur, however, in his saving will be affected 
 by both rates, though conceivably in conflicting 
 ways. If the rate of profit declines, he has 
 apparently less inducement to save capital than 
 before. If at the same time, however, the rate 
 of interest should remain unchanged, or should 
 rise, he might have a stronger motive than 
 before for owning the capital he uses instead of 
 borrowing. Or the capitalist and investor within 
 him, rather than the entrepreneur and specu- 
 lator, might develop and feel himself drawn to 
 increased saving by the prospect of a safe 
 interest return. If, however, we may assume 
 that the two rates move in the same direction 
 and in such degree as to leave always the same 
 margin between them, all classes of savers may 
 be regarded as affected in much the same way, 
 and one difficulty of the theory under con- 
 sideration will be overcome. 
 
 We have seen that the statement of the 
 theory of interest in terms of demand and
 
 THE ABSTINENCE THEORY 61 
 
 supply leads to some ambiguities in regard to 
 the meaning of the word supply. In like manner 
 it forces us to employ the term "demand" in 
 a somewhat metaphorical sense in the case of 
 the entrepreneur who saves and uses his own 
 capital. Can such capital be described as 
 supplied in response to a demand except by 
 twisting the meaning of the language? Who 
 makes the demand? 
 
 Of course these objections to the modern 
 form of the abstinence theory are largely formal, 
 striking at defects and ambiguities of state- 
 ment and the awkwardly hypothetical character 
 of its propositions, but not calling into question 
 the possibly large measure of truth it may con- 
 tain. The pedagogic rather than the scientific 
 value of the theory is impugned. Yet in spite 
 of the risk of a strained form of statement 
 distorting the perspective and throwing minor 
 factors into misleading prominence, it would 
 probably be maintained by many writers that 
 the demand and supply formulation of the 
 theory of interest is the most practicable and 
 compact form of expression possible. The 
 pertinent question is, Does it give an approxi- 
 mately true description of the factors at work? 
 More cannot be expected from any theory and 
 unreasonable demands must not be made of 
 the theorist. 
 
 There are, however, objections of a more 
 material character which may be made to the
 
 62 PROFIT AND WAGES 
 
 abstinence theory. It involves two funda- 
 mental propositions which analysis will call 
 into question. These are: 
 
 First, the total amount of capital rises 
 or falls with a rise or fall of the rate of 
 profit (or interest). In this manner the 
 rate of return to capital is regulated and 
 kept from extreme fluctuations. A corol- 
 lary indicates that the rate cannot fall to 
 zero and the theory thus appears to account 
 for the necessity and continuance of interest 
 on capital as well as for its rate and amount. 
 Second, the changes in the amount of 
 capital which are regulative of the rate of 
 return are brought about through the 
 operations of the marginal savers. 
 Granting for the moment the substantial 
 truth of the first proposition, although we shall 
 see later that it is not always valid, let us 
 examine the second. The validity of this 
 proposition is vital to the abstinence theory. 
 If changes in the "supply" of capital regulative 
 of the rate of return on capital are not deter- 
 mined primarily by the course of marginal 
 saving, of saving determined by mental states 
 affected by the expected rate of return, then 
 the decisive factors must lie on the side of 
 "demand," or in any case, be of an objective 
 rather than of a subjective character. 
 
 Now, to begin with, are marginal savings 
 relatively of sufficient amount to have a decisive 
 influence on the rate of profit and interest?
 
 THE ABSTINENCE THEORY 63 
 
 Does the tail wag the dog? There is to be sure, 
 no way of deciding definitely what proportion 
 of the world's capital owes its existence and 
 maintenance to the marginal saver. The statis- 
 tician may seek for data in regard to the sums 
 which are saved and invested, but there is no 
 numerical record of the mental states attending 
 such saving. We can be guided only by our 
 general impressions. To the present writer 
 it appears that whatever may have been true 
 in some communities and in the earlier stages 
 of capitalism, abstinential, marginal savings are 
 today relatively unimportant. They appear 
 very small indeed when we set over against them 
 (i) the large accumulations of capital made 
 without thought by recipients of large incomes, 
 the unspent residua of income of careless, happy 
 spenders; such accumulation proceeding at a 
 more or a less rapid rate according as the 
 larger incomes rise or fall; (2) the impersonal 
 creation of capital made by managers of cor- 
 porations accumulating surplus out of earnings 
 without consulting the willingness of the stock- 
 holder to abstain from consumption; (3) the 
 stores of capital amassed in the past, which, 
 whatever may have been their cost of abstinence 
 in the saving, are now maintained inviolate 
 from all thought of ever being consumed, and 
 incapable, therefore, of decrease except through 
 misfortune; (4) the "rainy day" savings which 
 would be made even if there were no such 
 thing as interest or profit on capital, and (5)
 
 64 PROFIT AND WAGES 
 
 as factors diminishing the supply of capital, 
 the waste and destruction of capital in unpro- 
 ductive, unfortunate, or fraudulent enterprises; 
 the wreckage of promoter and speculator, and 
 the wasteful and destructive armaments of 
 military nations. 
 
 Moreover whatever be our estimate of the 
 quantity of abstinential saving and of saving 
 affected at all by the contemplation of a rate 
 of interest, we must make a considerable 
 deduction for that portion which proceeds in 
 a manner directly contrary to the assumptions 
 of the abstinence theory. To some who experi- 
 ence the pangs of abstinence a fall of the interest 
 rate is the occasion for saving more not less, 
 a rise the occasion for saving less. "As Sargant 
 has pointed out," says Marshall, "if a man has 
 decided to go on working and saving till he has 
 provided a certain income for his old age, or 
 for his family after death, he will find that he 
 has to save more if the rate of interest is low 
 than if it is high."* How large is the deduction 
 we must make for saving which proceeds 
 contrary to the expectations of the theory, 
 there is no way of estimating. It is sufficient 
 to make it doubtful what the effect is on absti- 
 nential, calculated savings taken as a whole, 
 of any change in the rate of interest and profit. 
 Three hypotheses may be suggested. First, 
 that abstinential savings as a whole rise and 
 fall with the interest rate, moving in the same 
 
 ^Principles of Economics, 6th edition, p. 235.
 
 THE ABSTINENCE THEORY 65 
 
 direction. Second, that they move in the 
 opposite direction. Third, that the opposing 
 tendencies are equal, so that changes in the 
 interest rate make no change in the total of 
 abstinent ial saving. Only the first of these 
 is in accord with the necessities of the abstinence 
 theory. But are we justified in rejecting the 
 other two as obviously impossible? And in 
 any case can the net resultant of the opposed 
 tendencies be of sufficient amount to be con- 
 sidered an important factor in determining the 
 rate of return on capital?* 
 
 *The consideration of conscious, deliberate, and calculating 
 saving alone leaving out of view the unconscious and imper- 
 sonal forces accumulating, maintaining, or wasting capital 
 seems likely to leave one in doubt as to the exact effect of 
 a given change in the interest rate. Thus Marshall after 
 giving an illustration of the idea we have quoted from him, 
 proceeds: "It is then possible that a continued fall in the rate 
 of interest may be accompanied by a continued increase in 
 the yearly additions to the world's capital. But none the less 
 is it true that a fall in the distant benefits to be got by a given 
 amount of working and waiting for the future does tend on 
 the whole to diminish the provision which people make for 
 the future * * * that a fall in the rate of interest tends 
 to check the accumulation of wealth." Here we have the 
 traditional view of the effect of a fall in the interest rate 
 expressed in terms of tendency and "as a whole," while the 
 opposite effect is allowed as "possible." The most thorough 
 discussion of the mental states of savers is probably that by 
 Professor Conner. Conner concludes "alterations in the rate 
 operate in different directions. But no positive and universal 
 determination is possible, for the forces are irregular and 
 exist in no fixed relations. It is, however, clear that it is 
 incorrect to say that at a given time there is only one rate of 
 interest able to bring about a particular amount of accumu- 
 lation. On the contrary, different rates may bring into being 
 the same amount of accumulated wealth and capital." Interest 
 and Saving, p. 75 ff.
 
 66 PROFIT AND WAGES 
 
 For the sake of argument let us grant the 
 first of the three hypotheses. Then the adherent 
 of the abstinence theory is confronted with the 
 logical necessity of showing that other factors 
 determining supply of capital act in the same 
 direction as the marginal savings, in their total 
 effect. And, furthermore, if the abstinence 
 theory is to be more than a description of a 
 very minor factor, if it is to be more than a 
 fraction of a complete explanation, it becomes 
 necessary to prove that the action of the various 
 forces determining the amount of capital other 
 than the marginal savings, must be determined 
 by the latter. In other words, these other 
 forces apparently so much greater in their 
 effect than the operations of the marginal 
 saver, must be shown to be led or started by 
 the marginal saver in the direction in which 
 he is going. 
 
 That obviously is an absurdity. What, 
 for instance, is the possible relation of the 
 marginal saver's worries, to the large quantities 
 of capital supplied by those who cannot be said 
 to save, for that connotes some thought and 
 purpose, but who accumulate large sums by 
 failing to spend all they receive? Assume a 
 more or less stable standard of living among 
 those whose income is large enough to make 
 some accumulation of capital habitual and 
 continuous, and we can see that changes in the 
 rate of accumulation easily follow corresponding 
 changes in the volume of income. There is
 
 THE ABSTINENCE THEORY 67 
 
 no searching of heart and of pocket-book to 
 see whether some anticipated though uncertain 
 percentage offers sufficient reward for the pangs 
 of abstinence. It may be that there is some 
 addition to or substraction from the world's total 
 of capital brought about by the contemplation 
 of the movements of the interest rate, but, 
 in any case, the abstinence theory gives an ill 
 proportioned picture of what actually takes 
 place by its emphasis on savings induced by 
 expectations of given amounts of reward. It 
 carries the dubious implication that more or 
 less of calculating abstention from consumption 
 makes a great difference and that the prime 
 factor in bringing things to an equilibrium is 
 a mental occupation with a future fact, that is, 
 with an anticipated rate of gain. Is it not a 
 truer view to regard as the moving factor one 
 that belongs to the past rather than to the 
 future, the fact of increased or decreased income? 
 The mainspring of the great movements of 
 the supply of capital cannot be found in the 
 marginal saver's mind. This is the opinion 
 forced upon us when we consider the accumu- 
 lations made without thought and effort out 
 of large incomes. In like manner we fail to 
 find any discoverable connection between painful 
 abstinence calculations and the reservations 
 for surplus made out of the earnings of large 
 corporations or even of smaller business units. 
 And what have considerations of abstinence to 
 do with maintaining in the face of any fall of
 
 68 PROFIT AND WAGES 
 
 the interest rate yet experienced, the capital 
 sums once saved? What pang of abstinence 
 could ordinarily be balanced against the grief 
 of parting with capital? And finally when we 
 come to the various forces wasting and destroy- 
 ing capital, as they manifest themselves espe- 
 cially in times of crisis and of war, we may 
 confess our inability to give a full explanation 
 of their appearance, and yet have no hesitation 
 in declaring that the marginal saver's states 
 of mind count for nothing in these affairs. 
 
 If the calculations of the marginal saver are 
 not the mainspring of the great forces deter- 
 mining the amount of capital in the world, the 
 abstinence theory fails as an explanation of 
 the quantity and rate of capitalist income. Our 
 argument has led to the conclusion that no 
 simple, easily formulated psychological factor 
 can account for increase or decrease of capital. 
 The prime factors must be objective. How 
 large is the product of industry and how much 
 of it is left after wage earners and other recipients 
 of small pay have drawn their share? In other 
 words what is the income in the shape of rent, 
 interest, and profits out of which capital is 
 accumulated? Out of which it may almost be 
 said to accumulate itself. And what are the 
 factors determining the waste and destruction 
 of capital, the only factors capable of causing a 
 positive decrease in the total of capital and not 
 merely a slackening in the rate of its increase? 
 Such are the overwhelmingly important forces
 
 THE ABSTINENCE THEORY 69 
 
 making the supply of capital what it is. They 
 act in entire independence of the marginal 
 saver's supposed balancing of the cost of absti- 
 nence against the attractions of an anticipated 
 reward. They are objective rather than sub- 
 jective factors and will not fit the logical neces- 
 sities of the abstinence theory. And it may be 
 added, they are equally recalcitrant to the needs 
 of the time-preference theory. It matters 
 nothing to the argument whether we speak of 
 the cost of abstinence or the cost of waiting, 
 the reluctance to abstain from consuming or 
 the reluctance to postpone consumption. The 
 fact is that no unobjectionable formulation of 
 the process we are trying to explain is possible 
 in terms of anything psychological. 
 
 It appears to the writer that sufficient grounds 
 have been given for rejecting the abstinence 
 theory and its possible variants. Some con- 
 sideration, however, may be given to the 
 question whether marginal savings move with 
 the greater forces determining supply of capital 
 and in the same direction. Or, to state the 
 question with a different emphasis, do the great 
 forces other than the marginal saver's operations, 
 act in the same direction in response to changes 
 in the rate of interest and profit as the marginal 
 savings, assuming the latter to act as described 
 by the abstinence theory? In that case, although 
 neither of these two sets of factors determines 
 the other, the fact of their being more or less 
 synchronous and parallel, would make it possible
 
 70 PROFIT AND WAGES 
 
 to maintain that the abstinence theory describes 
 a part of the forces determining supply of capital, 
 though a very small part, and that as long as 
 we care only for the direction of change and 
 not for the amount, the abstinence theory 
 could predict correctly what will happen under 
 given conditions. However, not even that 
 slight concession may be made to the value of 
 the theory. It isn't true that the decisive 
 factors always and necessarily increase or de- 
 crease the total of capital according as the rate 
 of interest and profit rises or falls. These 
 factors may at times act in that manner, and 
 thus prevent large fluctuations in the rate 
 of return on capital, but, as will appear, such 
 is not their invariable action. In fact it is not 
 possible to formulate any "law" or simple 
 general proposition in regard to the influence 
 of the rate of interest or profit, on increase or 
 decrease of capital. 
 
 Leaving out of view the marginal saver and 
 giving attention only to the great and decisive 
 factors determining supply of capital, let us 
 ask first what happens when the rate of interest 
 and profit goes up. Usually we may expect 
 an increase of capital. This will be at an 
 accellerated rate if the rise in the rate of interest 
 and profit indicates a rise of the total of interest 
 and profit; if, for instance, there has been a 
 great advance in productive efficiency, or in- 
 creased opportunities for the exploitation of 
 new lands or cheap labor. In that event there
 
 THE ABSTINENCE THEORY 71 
 
 will be a rapid accumulation of capital in the 
 shape of unspent residua of income and large 
 reservations for capital use out of gross profits 
 by business managers. At such times it may 
 almost be said with truth that the opportunity 
 for large gains creates the capital to exploit 
 the opportunity. A less rapid growth of capital 
 may occur when the higher rate of interest and 
 profit indicates the higher productive margin 
 at which destructive influences, as for instance 
 a great war, have left the diminished total of 
 the world's capital. In spite of the high rates 
 the total income in the shape of interest and 
 profits is less than before and the rate of growth 
 of the total capital, will, therefore, probably 
 be less. Whether slowly or rapidly, however, 
 the total of capital may be expected to grow 
 when the rate of return goes up. And yet this 
 is not the inevitable outcome because there 
 may come into play the forces wasting and 
 destroying capital, forces so unpredictable and 
 erratic as to have the appearance of extraneous 
 and accidental factors from the view point of 
 economic theory. 
 
 If the movement of capital in response to 
 a rising rate of interest and profit is, on the 
 whole, in accord with that assumed, though not 
 correctly explained, by traditional economic 
 thought, the same cannot be said of the results 
 of a fall of the rate of capitalist gain. If, what 
 is the most probable case, the fall in the rate of 
 return is due to the lowering of the productive
 
 72 PROFIT AND WAGES 
 
 margin brought about by the increase of capital, 
 the total of income in the shape of interest and 
 profit has been increased. New supplies of 
 capital seeking investment receive only a low 
 rate but the recipients of interest, profit, and rent, 
 as a class, are wealthier than before. The 
 accumulation of new capital out of these incomes 
 might therefore be expected to continue in 
 greater rather than in lesser volume. 
 
 The case of a lowered rate signifying a general 
 decline in productive efficiency and, therefore, 
 a decrease of the total of incomes in the shape 
 of interest and profit, is so purely hypothetical 
 and remote from our experience, that it seems 
 hazardous to speculate concerning it. Capital 
 might simply show a decreased rate of growth. 
 There would probably still be some saving for 
 a rainy day. And even if the total of capital 
 did not increase there need be no decrease. 
 The large capital accumulations of the past 
 might be jealously guarded against the desires 
 of spendthrift and consumer. The same con- 
 siderations probably apply to the case of a 
 general diminution of interest and profit brought 
 about by labor gaining a larger proportion of 
 the total product of industry. In fact all 
 conceivable conditions seem to include some 
 saving, that is, some addition to the stock of 
 capital, and a holding on to what has once 
 been saved.
 
 THE ABSTINENCE THEORY 73 
 
 Whatever conditions we assume, it seems 
 difficult to prove any probable, positive decrease 
 in the total of the world's capital. In what 
 appears for an advanced industrialism the 
 most likely cause of a decline in the rate of 
 capitalist return, that is the lowering of the 
 margin of investment brought about by the 
 increase of capital itself, the result is an accel- 
 erated increase in capital. But if such is the case, 
 what keeps the rising tide of capital from 
 forcing the marginal rate of profit downwards 
 until it vanishes from sight? What makes the 
 continuance of the capitalistic system itself 
 possible? 
 
 Economists apparently have not given much 
 consideration to the distressing thought of a 
 rate of profit reduced to zero. The classical 
 writers, however, frequently raised the question 
 as to what agencies resisted the strong "tendency 
 of profits to a minimum." First among these, 
 says Mill, is "one which is so simple and so 
 conspicuous, that some political economists, 
 especially M. de Sismondi and Dr. Chalmers, 
 have attended to it almost to the exclusion of 
 all others. This is the waste of capital in 
 periods of over-trading and rash speculation, 
 and in the commercial revulsions by which such 
 times are always followed."* To "over-trading 
 and rash speculation" we may add the destruc- 
 tion and waste of capital by militarism. The 
 second of the "counter-agencies" according to 
 
 'Principles of Political Economy, Book IV, Chap. IV.
 
 74 PROFIT AND WAGES 
 
 Mill is "improvements in production." So far 
 it appears that capitalism is saved by waste and 
 progress. A third factor, mentioned by Mill, 
 "the perpetual overflow of capital into colonies 
 or foreign countries," indicates that the day 
 of reckoning may be postponed by the extension 
 of capitalism into new territory. 
 
 Thus either by the destruction of the super- 
 fluity of capital, or by the enlargement of 
 opportunities for investment through invention 
 or geographical expansion, the rate of interest 
 and profit is kept alive. We shall not undertake 
 a thorough examination of the extent to which 
 the fall in the rate of capitalist return itself 
 calls out these counteracting forces. That a 
 low rate of interest stimulates speculation and 
 unsafe enterprises is fairly obvious. The in- 
 fluence of the over-accumulation of capital on 
 governmental expenditures and imperialistic pol- 
 icies is no secret. Of the restlessness of a world 
 forced to seek an ever expanding field for 
 investment we have abundant evidence. The 
 worry of our age has been its redundant capital. 
 
 Our discussion has shown the impossibility 
 of formulating any simple general law in regard 
 to the response of capital supply to a changing 
 rate of return. There is no definite supply price 
 in the shape of a rate of interest for any given 
 amount of capital. On the whole a rise in the 
 rate of return tends to be followed quickly by 
 an increased supply. On the other hand, a 
 fall in the rate of return may find no immediate
 
 THE ABSTINENCE THEORY 75 
 
 check. When finally checked it is by such 
 forces as an expansion of the capitalistic area, 
 progress and invention in productive methods, 
 and large waste and destruction of capital. 
 
 The views in regard to the supply of capital 
 which we have set forth, lack the attractive 
 simplicity of the abstinence theory. But that 
 simplicity, like the excessive rationalism of the 
 time-preference theory, is not found in the 
 actual phenomena. The theory supposes a 
 more refined and persistently followed utilitarian 
 calculus than seems probable, or possible to 
 real human beings. The writer does not deny, 
 of course, that there may be serious reflection 
 on the question of spending less and saving more. 
 To a rationalistic view the utility of saving 
 might appear to be increased every time the 
 interest rate moves upward a little. But is 
 the problem of the relative attractions of saving 
 and spending raised in anybody's mind every 
 time the interest rate changes? Are not such 
 considerations rather occasional? They help 
 to establish habits of spending or saving a 
 certain amount. Then if the income out of 
 which saving is made rises, an increased "saving" 
 takes place without thought of what rate of 
 interest may be obtained by it. 
 
 To be sure it is conceivable that very great 
 and sudden changes in the rate of return might 
 shake people out of their established habits 
 into deliberately saving more or less. If the
 
 76 PROFIT AND WAGES 
 
 rate, for instance, were suddenly to jump to 
 twenty per centum, saving would have attrac- 
 tions it never had before. A sudden drop to- 
 one-tenth of one per cent, would have most 
 disturbing and unpredictable effects on those 
 who had hitherto been in the habit of saving. 
 But do changes of such amount as experience 
 teaches us to expect, lead to new calculations 
 of how much we may save or spend every 
 time they occur? When the rate rises from, say 
 four per cent, to four and a fraction, or even 
 to five; or falls from four to three and a fraction, 
 or even to three per cent, how many are there 
 who form new resolutions? An expected return 
 on investment of some kind may give an induce- 
 ment to saving, a support to the habit of saving, 
 - for some persons, a general reason for saving 
 at all. But that does not mean that different 
 definite rates of prospective return directly 
 determine the amount of saving and maintenance 
 of capital. The implication of the abstinence 
 theory that expected rates of return have 
 this definite determinative effect is an unproved 
 assumption. But even if the painful calculations 
 of some marginal savers pursue the course 
 described by the exponents of the abstinence 
 theory, are they of sufficient consequence to 
 make any real difference? Are not their con- 
 tributions to the current supply of capital so 
 insignificant compared with those from other 
 sources, that a general theory of the income of 
 capital is warranted in disregarding them?
 
 THE ABSTINENCE THEORY 77 
 
 The great factors determining the supply of 
 capital, we may call, for lack of a better term, 
 objective, in contrast with the subjective deter- 
 minants set forth by the abstinence and time- 
 preference theories. Set over against these 
 objective forces, the calculated, abstinential 
 savings appear, to the extent of their tenuous 
 being, a mere epiphenomenon of our modern 
 industrial system. 
 
 If the view just presented gives a substan- 
 tially true picture of what takes place in the 
 existing world of capital accumulation and 
 investment, it follows that the theory of the 
 rate of interest should aim first to account for 
 what we have called the objective factors. 
 It should inquire into what determines the 
 opportunities of a gainful use of different 
 amounts of capital, i. e., it should give us first 
 of all a theory of the origin and rate of profit. 
 In doing this it will be well to avoid metaphor 
 and not to speak of a "demand" for capital. 
 A large amount of capital never changes hands 
 and there is no question as to who is to use it 
 and upon what terms. It is neither demanded 
 nor supplied. It is merely owned and used. 
 When the rate of profit has been accounted 
 for, theory may proceed to the problem of the 
 rate of interest, the problem of how profit is 
 divided between capitalist and entrepreneur. 
 
 The more fundamental problem of the rate 
 of profit which makes possible a rate of interest, 
 cannot be stated satisfactorily in terms of
 
 7 8 PROFIT AND WAGES 
 
 demand and supply. Theory may recognize 
 that the amount (not the supply) of capital is 
 a determinant of the rate of profit, and also 
 that saving affects that amount and thereby 
 the rate of return. But saving should not be 
 put forward as a factor acting independently 
 or as being quantitatively determined by factors 
 independent of and distinct from the objective, 
 technical or business factors, which make the 
 rate of profit. In other words, saving should 
 not be represented as determined by subjective 
 factors. While such factors may affect some 
 saving, the decisive, regulative changes in the 
 supply of capital cannot be attributed to them. 
 The actions and purposes which determine 
 conscious saying, the calculations of abstinence, 
 such as they are, cannot be co-ordinate in 
 importance for the theory of profit, with the 
 facts which determine the gains of capital. 
 There is no bargain made in saving. The 
 saver as such has nothing to say in the matter 
 of making capital yield a profit. It is the users 
 of capital, their skill and opportunities, that 
 really signify. The usual demand and supply 
 formulation of the abstinence theory, by giving 
 to saving and abstinence on the one side, an 
 appearance of as great importance as that of 
 the objective factors on the other, gives a 
 misleading perspective to all the factors at 
 work. The habit of thinking in terms of demand 
 and supply has its drawbacks. We need to 
 break away from the see-saw of demand and
 
 THE ABSTINENCE THEORY 79 
 
 supply to reach a just appreciation of the 
 relative importance and direction of the forces 
 which make the existing amount and rate of 
 capitalist income. 
 
 The objection to the abstinence theory coming 
 especially from socialistic quarters, that the 
 large capital accumulations of the rich are 
 subject to no cost of abstinence, was apparently 
 met by limiting the significance of abstinence 
 to the marginal saver. But this answer, we 
 have seen, is not conclusive. It was not proved 
 by the adherents of the theory that abstinential 
 savings are of sufficient amount to be in any 
 way regulative of the rate of interest. The 
 capital which comes without abstinence, with 
 its larger volume and more rapid changes, 
 leaves the tendencies and effects of abstinential 
 savings a purely secondary movement, of imper- 
 ceptible influence on the actual rate of capital- 
 istic income. We need not look to the abstinence 
 theory for any clear light on the problem of 
 the amount and rate of interest and profit. 
 It fails as fully as the time-preference theory 
 to show primarily subjective factors as the 
 direct determinants of the rate of income. 
 
 Our criticism of the abstinence theory has 
 aimed to show that it fails to account for the 
 amount and rate of return on capital. There is 
 the further question as to why there is interest 
 at all. Why is it possible to obtain an income 
 without labor? Whether an answer to this 
 question entirely satisfactory to all students
 
 8o PROFIT AND WAGES 
 
 can ever be given seems somewhat doubtful. 
 In any case, among the data necessary to an 
 explanation of the existence of the institution 
 of interest there are legal and historical factors 
 with which the economic theory is not fitted to 
 cope. Now it may be granted to the abstinence 
 theory that it has brought to light, in the cost 
 character of the abstinence necessary to some 
 saving, one of the conditions essential to the 
 existence of interest. If saving involved no 
 sacrifice, the volume of capital would rise to 
 the point of making interest impossible. Capital 
 would be free to all. But if it should cost 
 nothing to save, it is evident that income must 
 consist of "free goods." The character of the 
 abstinence involved in saving is, therefore, not 
 only one of the conditions of the appearance 
 of the institution of interest but of practically 
 all economic life. It is a proposition of such 
 general character that it seems pedantic to cite 
 it at all instead of taking it for granted. How- 
 ever, we need not object if an explanation of 
 the existence of capitalist income should take 
 some cognizance of the fact that capital depends 
 on saving, and that because our income consists 
 of "economic goods" and not of "free goods," 
 saving involves abstinence. But if we seek 
 an explanation of the existing amount of capi- 
 talist income, the consideration of abstinence 
 and in general of subjective factors, is of slight 
 advantage. We may grant too that the con- 
 cept of abstinence may play some part in
 
 THE ABSTINENCE THEORY 81 
 
 capitalistic apologetics. With that however 
 we are not here concerned. The obviously 
 important facts for the purposes of the theory 
 we are seeking, are not subjective but objective 
 in their nature; and to these our attention 
 must now be directed.
 
 CHAPTER V 
 
 THE PRODUCTIVITY THEORY OF INTEREST 
 
 When we turn to the study of the objective 
 factors of the process of capitalistic production 
 and distribution, we are confronted by various 
 attempts to deduce interest from the "produc- 
 tivity of capital." These productivity theories 
 differ in clearness and expository detail, in the 
 extent and manner of combination with other 
 theories, and in the definition of capital taken 
 as a starting point. The most popular form 
 operates with a conception of capital as a 
 group of concrete goods used as instruments of 
 production. With such instruments, if of the 
 right kind, labor obviously can produce more 
 than without. This excess of product is imputed 
 in more or less metaphorical language to the 
 concrete capital goods, and the assumption is 
 made that it corresponds in some way with the 
 amount of income that the capitalist normally 
 receives from the use of his capital. 
 
 Two problems are presented by this form of 
 the theory. First, how can the part due to 
 capital in the joint product of capital and labor 
 be marked off from that due to labor? And 
 secondly, how can we ascertain what part of 
 the product imputed to capital is to be regarded 
 as replacement of the capital used up, and what 
 as net remainder may be stated as a percentual
 
 THE PRODUCTIVITY THEORY OF INTEREST 83 
 
 return upon that capital? Or in other words, 
 as it is the value of the capital itself which must 
 be deducted from the part of the product 
 imputed to capital, how is that value determined? 
 To determine the product to be imputed to 
 capital it would apparently be necessary to 
 know what labor can produce without capital. 
 If all excess of product above this, no more and 
 no less, is to go to the capitalist, wages would 
 have to be just equal to what the labor employed 
 could have produced without the aid of capital.* 
 It does not appear to be easy to determine 
 precisely what that amount would be. Nor 
 does this determination of wages appear probable 
 when applied to certain grades of labor. It is 
 pretty clear, for instance, that many kinds of 
 skill and ability would be of very little use 
 outside of capitalistic industries. If it were 
 true that labor gets only what it could produce 
 without capital, then skilled labor, on the whole, 
 would receive the lowest wages paid in any 
 industry. It would be inexpedient to take up 
 the consideration of the theory of wages at this 
 point, but it should be noted that the inter- 
 pretation of the productivity theory just given 
 suggests a view of wages that cannot be brought 
 into accord with any of the theories of wages 
 prevailing at present. Moreover, its implication 
 that none of the productive advantages of 
 
 *To avoid complications of statement, differential profit and 
 rent are omitted from consideration at this point and through- 
 out our discussion of capitalist income. The problem is that 
 of the division of marginal product.
 
 84 PROFIT AND WAGES 
 
 capitalism go to the wage-earner would not be 
 very attractive to most exponents of the pro- 
 ductivity theory. 
 
 The form of the theory now most in favor, 
 however, does not clearly impute to capital the 
 total of product in excess of what labor unaided 
 by capital could produce, but only an amount 
 depending on a rate determined by the pro- 
 ductivity of the last and least productive unit 
 of capital taken on. This "marginal" rate 
 forced upon the entire amount of capital leaves 
 that part of the product of the earlier incre- 
 ments which is in excess of this rate, as something 
 that does not go to the capitalist but to some 
 other "claimant" in the distributive process 
 to the landowner, or to the entrepreneur, or 
 to the laborer. This method of calculating 
 imputed returns is also applied to labor. Alter- 
 nately injecting now a "dose" of capital, now 
 of labor, we are asked to observe the productive 
 effect of each to get its "specific productivity" 
 and rate of payment. It is to be noted that 
 the dose must be a homeopathic one. A large 
 increment of either factor would necessarily 
 call for a simultaneous increase in the other. 
 In that case the additional product obtained 
 would be a joint product of capital and labor, 
 not a "specific" product of either, and there 
 would be no way of ascertaining what pro- 
 portion of it should be imputed to each. This
 
 THE PRODUCTIVITY THEORY OF INTEREST 85 
 
 gives an air of extreme unreality to the theory 
 in question. Is the calculus of small doses a 
 possibility in the conduct of actual business? 
 
 Granting, however, for the sake of argument, 
 that in some way, the return to be attributed 
 to capital can be calculated, the popular specific 
 productivity theory is next confronted with 
 the difficulty of the second problem mentioned 
 above, the problem of determining the value 
 of the capital. Critics of the theory have shown 
 conclusively that it fails at this point. How 
 can you compare the product with the capital 
 to which it is imputed in such manner as to 
 ascertain a percentual rate of return? The 
 goods produced and the "capital" that "pro- 
 duced" them are of unlike physical character 
 and, therefore, incommensurable. How can 
 you express yards of textiles as a percentage 
 of the looms from which they have issued? 
 Physical measurements give no basis of com- 
 parison. Evidently we must resort to market 
 values. If we ask how the capital good gets 
 its market value, we are told by modern econo- 
 mists that it is derived from its product. But 
 why is not the value of the capital good equal 
 to its entire product? Why is there in the 
 value of the product a surplus called interest? 
 Because, for some reason, the entrepreneur 
 will not pay for the capital good more than the 
 discounted value of its products. It appears, 
 therefore, that the discount and interest rate, 
 which the productivity theory represents as
 
 86 PROFIT AND WAGES 
 
 arising from a comparison of values, is assumed 
 in getting the value of one of the terms of the 
 comparison, an obvious case of circular rea- 
 soning. This objection to the popular form of 
 productivity theory is a logical inference from 
 a theory of value that regards demand based 
 on estimates of utility on the part of buyers, 
 as the chief, or one of the chief, determinants 
 of value. It is hard to see how those who hold 
 the Austrian theory of value can accept a pro- 
 ductivity theory of interest while denning capital 
 as concrete goods used as instruments of pro- 
 duction. 
 
 If instead of looking forward to the product 
 for the source of the value of the capital good, 
 it be permissible to look backward to its expenses 
 of production, a productivity theory based on 
 the concept of capital as consisting of concrete 
 goods, would still be exposed to the criticism 
 that it is reasoning in a circle. A view of the 
 entire process of production shows the invest- 
 ment of capitalists and entrepreneurs, as a class, 
 to consist of advances to labor. If we might 
 assume these advances, that is wages, deter- 
 mined in some way independently of the product 
 of capitalistic industry (by the "cost" of labor, 
 for instance) we should get a value for capital 
 with which the net product might be legitimately 
 compared in calculating the percentual rate 
 of return. But the theory we are considering 
 confines the term capital to concrete goods used 
 in the later stages of production. The price
 
 THE PRODUCTIVITY THEORY OF INTEREST 87 
 
 of these goods includes not only payment for the 
 labor employed in making them, including the 
 labor of all the preparatory stages, but also 
 accumulated interest and profit. Obviously 
 it is not possible to get the value of the capital 
 good without assuming a rate of income upon 
 capital. Whatever method this theory takes 
 of accounting for the value of capital goods, 
 involves it in a vicious circle. 
 
 We might therefore regard the theory we have 
 just considered as disposed of, and pass on to 
 other variants of the productivity theory. It 
 is desirable, however, to point out some diffi- 
 culties arising from the restricted concept of 
 capital employed by this theory. Obviously 
 the entrepreneur expects to gain at least the 
 rate of interest from all of his business outlays, 
 not merely from what he spends for "capital 
 goods," but also from his expenditures for labor. 
 The exponents of the specific productivity theory 
 say nothing about the interest earned by the 
 employer's pay roll. Yet the fact of this 
 interest cannot be denied. Or, is it an illusory 
 phenomenon? Could it be argued that all 
 interest grows out of capital goods alone but 
 that it is spread as a uniform rate over the entire 
 investment of capitalist and entrepreneur? If 
 this were the case, the actual rate known to 
 business men would be smaller than the rate 
 of productivity of the capital goods, and the 
 productivity theory, while indicating the source 
 of interest, would stand in need of further
 
 88 PROFIT AND WAGES 
 
 development to explain how the actual rate of 
 interest is established. The problem confronting 
 the productivity theorists would be the inverse 
 of that met by Karl Marx. To obtain the rate 
 of profit Marx had to show how the surplus 
 value due only to " variable capital," i. e., to 
 what is paid for labor, is assigned to and ex- 
 pressed as a percentage of, the total investment, 
 of both "constant" and variable capital. The 
 productivity theorist would have to meet the 
 problem of spreading a surplus from the use 
 of the "constant" capital, the concrete capital 
 goods, over the entire capital, variable and 
 constant. Unlike Marx they have made no 
 effort to solve their problem. 
 
 Or may interest on the wages fund be regarded 
 as a derivative income? Could it be argued, 
 in a manner analogous to the reasoning of the 
 fructification theory, that, because the capitalist 
 can obtain interest from capital goods, he will 
 refuse to buy labor except at a discount which 
 will yield him the same rate of interest? But 
 capital goods have no productive value unless 
 served by labor and the entrepreneur could not 
 refuse to buy labor and turn entirely to capital 
 goods. If, under such conditions, labor submits 
 to a discount, that fact needs to be explained. 
 The productivity theory suggests no explanation. 
 
 Such are some of the difficulties of the form 
 of the productivity theory which we have been 
 considering. They arise out of the restricted 
 conception of capital. The usage of the business
 
 THE PRODUCTIVITY THEORY OF INTEREST 89 
 
 world is to regard all outlays whether for labor 
 or for "capital goods," as an investment of 
 capital and to expect or hope for a return in 
 profit or interest on every part of the invest- 
 ment. In taking capital in the sense of concrete 
 instruments of production, the theory fails to 
 take account of important interest-yielding 
 investments. Moreover, this restricted con- 
 cept of capital, limits the view to one segment 
 of the long process of capitalistic production. 
 It has nothing to say about the labor that made 
 the "capital good," the machine, for instance, 
 nor the conditions under which that labor was 
 employed. It does not go back to the beginning 
 of the productive process, but fixes attention 
 on one of the later stages in asking what is 
 added to total product by the use of a given 
 capital good. It proceeds, in the language 
 of Bohm-Bawerk, as if the capital had dropped 
 from heaven. A theory operating with such 
 a restricted concept of capital must be expected 
 to come to grief. 
 
 But now we may inquire whether taking 
 into consideration every class of investment 
 directly connected with productive industry, 
 and viewing the process of production as a 
 whole and not by detached portions, a pro- 
 ductivity theory may be constructed that can 
 escape the pitfalls in the way of the ordinary 
 productivity theory and meet the demands 
 that must be made upon a complete theory.
 
 90 PROFIT AND WAGES 
 
 If we view the productive process as a whole, 
 it appears that we have nothing before us but 
 human labor acting upon the physical world. 
 There is no capital as a distinct productive 
 factor. The investment of the capitalist and 
 entrepreneur, the "use of capital" regarded 
 from the point of view of production, is nothing 
 but a special way of applying labor the 
 "round-about," indirect, capitalistic way. And 
 while nothing but labor is used, nothing is 
 paid out by the entrepreneur in his business, 
 nothing is "invested," that is not looked upon 
 as capital. If, however, we regard the entire 
 process, entrepreneurs as a class appear to 
 pay out nothing but wages. It is only between 
 members of the class of entrepreneurs, between 
 those in control of the different segments of 
 the process of production of any commodity, 
 that payments are made for anything that is 
 not labor. The purchase and sale of "inter- 
 mediate goods" necessary in making the con- 
 sumable goods which are the ultimate outcome 
 of an extended process, is a purely intra-class 
 affair. As such these transactions are only a 
 method of dividing up the investment and the 
 gains of capital in an extended process. In a 
 comprehensive view of the process of production, 
 there are, therefore, no separate outlays for 
 labor and for capital. How then can one 
 distinguish a "specific product" of capital?
 
 THE PRODUCTIVITY THEORY OF INTEREST 91 
 
 How trace any such connection between product 
 and the return of capital as would justify us in 
 formulating a productivity theory? 
 
 In the attempt to make out a productive 
 return in some way imputable to capital, one 
 might be disposed to point to the fact that the 
 capitalistic, indirect method of applying labor 
 gives a larger productive result than the non- 
 capitalistic, direct use of labor. This is not 
 saying merely that labor with tools can produce 
 more than labor without tools. It means that 
 a given quantity of labor will yield a larger 
 result if some of it is used to make tools than 
 if all of it were used without such helps. That 
 the productive advantage of the capitalistic 
 process, the surplus of product it can yield 
 above that given by an equal amount of labor 
 used in non-capitalistic ways, is an important 
 source (if not the only one) of the income of 
 capitalist and entrepreneur, is a statement 
 not likely to meet with contradiction. Whether 
 the amount of this surplus can be definitely 
 ascertained or not, whether all of it goes to 
 capitalist and entrepreneur, or whether the 
 laborer may receive a portion of it, whether 
 capitalist and entrepreneur are restricted to it 
 or can derive gains from other sources, it seems 
 pretty certain that such a large part of the 
 income of capital is drawn from this surplus of 
 product, that if there were no such surplus, 
 capitalism as we know it, could not exist.
 
 92 PROFIT AND WAGES 
 
 The recognition of the superior productive 
 power of the capitalistic process as a condition 
 necessary to the existence of profit and interest, 
 does not, however, give us a complete theory 
 of profit and interest. There remains to be 
 explained the process by which a percentual 
 rate is brought about and of course the explana- 
 tion may not assume this rate. The time- 
 preference theory would account for the rate 
 by an appeal to subjective factors. The pro- 
 ductivity theory, however, or any theory based 
 on objective factors, must show the value of 
 the investment, the "capital" as determined 
 in some way independently of the discounted 
 value of the product. Can any conceivable 
 productivity theory meet these demands? 
 
 At this point we need to consider a version 
 of the theory which perhaps may come to be 
 the authoritative one for many who hold the 
 faith. It is suggested by some passages in 
 Bohm-Bawerk's writings and may be picked out 
 in fairly definite form from the eclectic theory 
 of Landry. Its basis is not the productivity 
 of particular concrete capital goods, but rather 
 the productive advantage of an extension of 
 the "production period," or if you will, the 
 productive advantage of a longer process of 
 production as compared with any shorter one. 
 Successive investments taking such a form as 
 to result in extensions of the production period, 
 bring about an increase of return, at least 
 within certain limits, over and above what
 
 THE PRODUCTIVITY THEORY OF INTEREST 93 
 
 could be produced in a shorter process. If we 
 may suppose different methods of producing 
 the same commodity, some more capitalistic 
 than others, or to put it in other words, if we 
 suppose productive processes of different length 
 in the same industry, the investment necessary 
 to pass from the less to the more capitalistic 
 method, from the shorter to the longer process, 
 may have imputed to itself the increase of 
 product realized.* There remains to be 
 accounted for the persistence of the older and 
 less capitalistic methods, the relatively under- 
 equipped establishments existing side by side 
 with the superior. There is to be explained 
 the failure of some of the better equipped even, 
 to reach the maximum of efficient equipment 
 which the technical knowledge of the time 
 seems to make possible. Why does not the 
 most effective form and degree of equipment 
 known become general throughout each industry? 
 The answer given is, "Because of the insuf- 
 ficiency of capital available," capital appearing 
 to mean chiefly the means of supporting labor, 
 in the long drawn out, capitalistic processes 
 of production. Because of this lack of capital, 
 
 *The word "method" is used for the sake of brevity. There 
 need not, however, be a distinct difference in general method. 
 The difference thought of is rather in the degree of equipment 
 with some of the results of the earlier stages of a long process, 
 i. e., it is a difference in the length of the "production period" 
 as measured by B6hm-Bawerk (Positive Theory, Book II, 
 Chapter II). When, however, this difference reaches a certain 
 degree, it becomes difficult to think of it as only quantitative 
 and not as a qualitative one, i. e., it becomes a difference 
 in method.
 
 94 PROFIT AND WAGES 
 
 there remain abundant opportunities for gainful 
 extensions of the productive process and the 
 gains must fall to the owners of capital. 
 
 This assumption of a normal insufficiency of 
 capital is somewhat open to question. It is 
 in conflict with the obvious redundancy of 
 capital which appears from time to time. If, 
 indeed, Bohm-Bawerk were right in thinking 
 the rate of product capable of indefinite increase 
 through lengthening of the "production period," 
 there never could be capital enough to exploit 
 fully the endless succession of productive oppor- 
 tunities. Bohm-Bawerk's idea, however, we 
 have seen is erroneous.* There are limits, 
 perhaps quickly reached, to the productive 
 possibilities of employing additional capital 
 in extending the production period. In conse- 
 quence it is quite conceivable that in a time 
 of rapid increase of capital, there may be, not 
 only no lack of capital, but an excess. The 
 persistence of relatively ill-equipped establish- 
 ments and of unexploited opportunities in the 
 face of such abundance of capital, can be ex- 
 plained in large part by reference to factors 
 which economists are wont to group under the 
 title of "friction." Capital is not a perfect 
 fluid inevitably finding its own level and filling 
 every depression. And not all productive 
 opportunities are controlled by men of sufficient 
 ability and credit to command all the capital 
 which might be advantageously employed. A 
 
 *See footnote, page 24.
 
 THE PRODUCTIVITY THEORY OF INTEREST 95 
 
 plethora of capital may, therefore, obtain, at 
 least, in a temporarily static or unprogressive 
 society. In a dynamic stage of industry, 
 progressive inventions will, for a time, create 
 opportunities in excess of what the capital 
 available can exploit; although, as we have 
 seen in the preceding chapter, the opportunity 
 for large capitalistic gains may rapidly create 
 the necessary supply of capital. A dynamic 
 state appears, therefore, to be a necessary 
 assumption of the productivity theory which 
 we are at present considering.* It is not a 
 theory applicable to static conditions. 
 
 The formulation of the productivity theory 
 we are considering, has some points of super- 
 iority over that which operates with the notion 
 
 *This suggests the theory recently advanced by Schumpeter, 
 some comment on which may be introduced at this point. 
 Accepting Clark's argument that in a static state there is no 
 "waiting," and that the agio theory is, therefore, inapplicable; 
 accepting also Bohm-Bawerk's refutation of the specific 
 productivity theory of interest and of the abstinence theory, 
 Schumpeter concludes that interest on capital in a static 
 society is inexplicable and hence impossible, and that the 
 explanation of the appearance of interest must be sought in 
 dynamic factors. To the present writer a fundamental defect 
 in Schumpeter's views is found in his theory of wages. No 
 static society such as Schumpeter supposes ever existed or 
 could exist, but if it is permissible to the imagination to con- 
 struct such a state, why not make one in which the unchanging 
 supply of capital (acting as a "wages fund") is not sufficient 
 to raise wages to the full product of labor? In that case there 
 would be interest on capital. However, the concept of an 
 entirely static state is full of pitfalls and had best be avoided 
 by the theorist. It is frequently necessary to think of a par- 
 ticular group of conditions in static terms, and such has long 
 been the practice of economists. But Schumpeter is wrong 
 in thinking that his construction of a complete and entirely 
 static state is a logical continuation of the classical tradition.
 
 96 PROFIT AND WAGES 
 
 of capital as consisting of instruments of pro- 
 duction. In its use of concepts made familiar 
 by Bohm-Bawerk it presents a view of the 
 productive process as a whole instead of viewing 
 it by segments. But on closer examination it 
 appears to be only a different formulation of 
 the theory of marginal productivity. An exten- 
 sion of the productive process means that a 
 larger proportion of the total labor employed 
 is used in the preparatory process of making 
 and perfecting instruments of production. Labor 
 in the later stages will therefore become equipped 
 with more instruments, and the full productive 
 advantage, the greater quantity of consumable 
 goods, resulting from this rearrangement of 
 the proportions of labor employed at the 
 different stages in the production of commodi- 
 ties, will not appear until the additional instru- 
 ments have been used. Now it shows a better 
 understanding of what is fundamental to attri- 
 bute the increase of product to the investment 
 making possible an extension of the production 
 period, rather than to the capital goods which 
 are the results of this investment. But it 
 doesn't after all give us an essentially different 
 theory. Like the more familiar formulations 
 of the productivity theory this version also 
 represents the rate of interest as determined 
 by the gains of the additional or marginal 
 increments of investment. And like them it 
 fails to give a satisfactory answer to the question 
 as to what determines the value or price of
 
 THE PRODUCTIVITY THEORY OF INTEREST 97 
 
 what is invested. Assuming the value of labor, 
 like that of other production goods, to be the 
 discounted value of its product, it assumes 
 what it should explain. Viewing the productive 
 process as a whole it suggests that the only 
 investment made by capitalists as a class is 
 what is advanced to labor in the form of wages.* 
 Now if wages, the price of labor, could be 
 shown to be determined independently of the 
 discounted product of labor, the way would be 
 open to demonstrating an income as a percentual 
 rate of interest upon an independently deter- 
 mined capital value. This way, however, is 
 closed to the productivity theorists by the 
 theory of wages held by them. 
 
 It does not appear that any form of produc- 
 tivity theory has as yet been able to account 
 in a satisfactory way for the rate of interest. 
 Yet there must be some truth, or something 
 exercising the attraction of truth, at the bottom 
 
 *Bohm-Bawerk includes "uses of land" (Bodennutzungen). 
 There is no "price of the uses of land," that is no rent, at the 
 margin, and following our plan of viewing the problem as that 
 of the division of the marginal product only, we might dis- 
 regard the difficulties which would arise for the productivity 
 theory from the attempt to include rent in the investment. 
 If rent is paid at the end of the productive process, as a share 
 of the product, it creates no difficulties for the productivity 
 theory. If paid in advance, it supposedly equals the discounted 
 value of the product assigned to it. In that case there enters 
 the illegitimate assumption of a discount rate already estab- 
 lished. It may be remarked in this connection that the con- 
 cept of a price of uses of land, employed by Bohm-Bawerk 
 and Schumpeter, is an unfortunate substitution for the older 
 concept of land rent. It conveys the misleading suggestion 
 that different quantities of uses of a given piece of land may 
 be bought at a given point of time.
 
 98 PROFIT AND WAGES 
 
 of such persistently recurring ideas as those 
 formulated, in one way or another, in the 
 various productivity theories. Capitalism is 
 more productive than labor not aided by 
 capital. To the writer it appears that the 
 form of productivity theory we have just 
 examined, the theory suggested by Bohm- 
 Bawerk and Landry, has some elements neces- 
 sary to a complete explanation of profit and 
 interest, and that with one important modifi- 
 cation or addition, it can be converted into, or 
 led over into, the most satisfactory solution 
 of the problem at present attainable by the 
 method of abstraction and general theory. 
 The necessary modification is to be reached by 
 the way of a theory of wages. Before pro- 
 ceeding to the formulation of a theory of profit 
 and interest, it will be well, however, to call 
 to mind just what is the nature of the problem 
 before us.
 
 CHAPTER VI 
 
 THE ESSENTIALS OF A THEORY OF PROFIT AND 
 INTEREST 
 
 To make income appear as interest,* it must 
 be expressed as a proportion or percentual 
 rate. Profit of capital too is to be stated as a 
 rate. If it were not calculable in this form, 
 the entrepreneur would not know what to bid 
 in his bargain with the capitalist, and the 
 capitalist would be ignorant of the business 
 value of what he had to offer. The existence 
 of a rate, however, presupposes two values, 
 (i) the income that is calculated as a rate 
 and (2) the capital sum of which the income 
 is to be stated as a percentage. Let the rate 
 be represented by R, the net income by I, 
 the capital by C. Then 
 
 I = CR 
 
 This equation gives us three quantities of 
 importance in the theory of interest. A fourth 
 significant quantity, the gross income, rep- 
 resented by I', is given in the equation 
 I'-I+C 
 
 Having four quantities in two equations, it 
 will suffice to know two of the four in order 
 to calculate the others. The theory of interest 
 need not, therefore, explain the quantitative 
 determination of more than two of these quan- 
 tities. These, however, must be capable of 
 calculation independently of the other two.
 
 ioo PROFIT AND WAGES 
 
 To derive them by assuming one or both of 
 the remaining quantities, and then to turn 
 about and use them in accounting for the 
 latter, would obviously be reasoning in a circle. 
 
 None of the theories so far examined has 
 explained, or appears to be justified in assuming 
 as accounted for, more than one quantity. 
 That quantity is I', the gross income, if taken 
 in the sense of the product in the shape of 
 consumable goods of a completed process of 
 production. Its amount is explained by refer- 
 ence to the technical conditions of production 
 and its value by the demand of the market. 
 If, however, I' is to include the product of 
 different stages of the process of production, 
 -intermediate or producers' goods, as well 
 as consumers' goods, it cannot be accounted 
 for without bringing in one of the remaining 
 three quantities. 
 
 The productivity theory aims to explain R 
 by showing the relation between C and either 
 I or I'. It must, therefore, account for the 
 value of C, and at that point, as critics have 
 shown, the theory breaks down. 
 
 The time-preference and abstinence theories 
 seek the origin of R in subjective conditions. 
 If successful in this, they would not need C 
 or I to account for R but could, on the contrary, 
 derive C and I from the R which they have 
 explained, and the I' which they might legiti- 
 mately assume as known. If, however, the 
 criticism of these theories presented in Chapters
 
 THE ESSENTIALS OF A THEORY 101 
 
 III and IV are at all valid, the attempt to 
 derive R from, subjective factors has proved a 
 failure. The time-preference view is false to 
 the psychology of investment and the abstinence 
 theory, while suggesting subjective factors which 
 may have some influence on investment, fails 
 to prove that such factors give a definite quan- 
 titative result, or in other words, that they 
 make R just what it is. 
 
 If we take any process of production from 
 beginning to end, I', its product in the shape 
 of consumers' goods, may be assumed as known 
 and accounted for. One other quantity must 
 be found. This can not be R. The productivity 
 theory makes no effort to show an independent 
 origin of R; the time-preference and abstinence 
 theories have failed in that attempt. It must 
 therefore be I or C. No way has yet been 
 suggested of accounting for I without using 
 either C or R. The theory of interest must 
 therefore seek to show the quantitative deter- 
 mination of C. No other course appears to 
 be left open. 
 
 With C determined as well as I', the minimum 
 of data needed to account for the rate of profit 
 and interest is given. But C must be deter- 
 mined independently of I and R. Furthermore, 
 as there appears to be no way of deriving C 
 from I' except by a not permissible introduction 
 of either R or I, we may say that it is a necessity 
 of theory to account for C without resort to 
 I'. Capital (C) as quantitatively determined
 
 102 PROFIT AND WAGES 
 
 must be accounted for independently of the 
 other three quantities with which the theory 
 of interest and profit has to reckon. 
 
 What is this capital (C)? If we view the 
 production of any kind of consumable goods 
 as a whole and disregard its segmentation into 
 particular industries, we see that what entre- 
 preneurs and capitalists as a class invest, is 
 just wages, nothing more. If wages as C can 
 be shown to be determined independently of 
 the gross income (I') of industry, then I, the 
 net return to capital, can be obtained by sub- 
 traction from gross income, and R is easily 
 
 reckoned by the formula . The theory of in- 
 
 \^s 
 
 terest as we have seen is driven to account for 
 C independently of the product of industry I' 
 and the rate of interest or profit (R). If capital 
 is restricted to so-called "capital goods" this 
 is impossible. The value of a machine, for 
 instance, as has been shown, cannot be obtained 
 without assuming a rate of profit and interest. 
 Nor will the money invested serve the purposes 
 of theory. It is not money, but what can be 
 bought with it that is the source of income. 
 The only way to get an independently deter- 
 mined investment upon which the return ob- 
 tained can be calculated as a rate, is to view 
 the process of production as a whole. Then it 
 will appear that the investment made by entre-
 
 THE ESSENTIALS OF A THEORY 103 
 
 preneurs and capitalists is all in the form of 
 wages. C, therefore, consists of the total of 
 wages. 
 
 If the above conclusion in regard to the 
 direction in which we must seek for a solution 
 of the problem of the amount and rate of 
 income on capital is correct, it will be necessary 
 to find an explanation of wages apart from the 
 size of the product of the productive process 
 (I') or the prevailing rate of capitalist return (R). 
 That, however, brings us into conflict with the 
 productivity theory of wages, which in one 
 form or other, commands the adherence of 
 most economists. 
 
 Now the theory of a specific product of labor, 
 separable from the specific product of capital, 
 and determining wages, we have already dis- 
 posed of by implication in our criticism of the 
 specific productivity theory of interest. It 
 is in obvious conflict with the fact that the 
 employer regards the sums paid out in wages 
 as capital on which he must earn interest, at 
 least. He could not afford to pay more than 
 the discounted value of the product to the 
 laborer. The widely accepted theory of wages 
 as determined by the discounted marginal 
 product, however, stands in a much stronger 
 position. A detailed criticism of it will be 
 given in Chapter VIII. This form of the 
 productivity theory has the advantage of not 
 being out of harmony with the conception of 
 the productive process gained when it is viewed
 
 104 PROFIT AND WAGES 
 
 as a whole. When this view is taken it appears 
 very clearly that we are driven to a choice 
 between two theories of residual income.* One 
 theory would hold the rate of profit to be 
 determined by subjective factors, by calcula- 
 tions of the cost of abstinence or waiting. In 
 that case the wage earner, receiving the product 
 of labor discounted, is the residual claimant. 
 The other would find an independent explana- 
 tion of wages, in which case profit of capital 
 can be accounted for as residual income. The 
 former alternative is not open to us if our 
 criticism of the time-preference and abstinence 
 theories is valid. There remains, therefore, 
 only the residual claimant theory of profit. 
 
 The details of a theory of wages on which 
 this view of profits can be based will be developed 
 in the two following chapters. The remainder 
 of this chapter will be given to an exposition 
 of the theory of profits we have reached on the 
 assumption that the theory of wages necessary 
 to it can be demonstrated. Anticipating a 
 little, however, we may state that the explana- 
 tion of wages to be given is based, in part, on 
 the idea of a supply price of labor determined 
 chiefly by conditions outside of capitalistic 
 industries and localities. The gains of capital 
 are largely a result of the productive superiority 
 
 "Unless with the "bargain theory" of wages, we practically 
 give up the attempt to account for the existing division of 
 the marginal product between capital and labor, and declare 
 it to be simply the somewhat indeterminate outcome o a 
 struggle.
 
 THE ESSENTIALS OF A THEORY 105 
 
 of the capitalistic method. By using expensive, 
 "roundabout" processes and methods of utilizing 
 natural forces, not accessible to the laborer 
 because of his ignorance and poverty; by 
 organizing, disciplining, and driving laborers 
 to greater effort than they will or can put forth 
 when working by and for themselves, capit- 
 alistic industry produces a surplus, a value in 
 excess of what is paid out in wages. The wages 
 paid constitute the capital invested, if we 
 regard industry as a whole. The surplus 
 product is profit of capital plus land rent. 
 Setting aside rent and differential profit as the 
 excess income of investments receiving more 
 than the marginal return, this surplus, as profit 
 of capital, can be stated as a percentual rate 
 of the sum paid out of wages. How this rate 
 is divided between capitalist and entrepreneur, 
 establishing a rate of interest, as distinct from 
 this rate of profit, we need not consider at 
 present. It is not a problem that presents 
 insuperable difficulties.* The crucial problem 
 is the rate of profit. 
 
 This theory of profit makes the productive 
 advantage of the capitalistic process appear 
 as an important source of profit and interest, 
 yet cannot properly be called a productivity 
 theory. The surplus of product left after wages 
 are paid, which constitutes profit, while largely 
 
 *A very satisfactory account of how the rate of interest is 
 established can be found in Hadley's Economics, p. 269 ff.
 
 io6 PROFIT AND WAGES 
 
 due to the technological advantage of using 
 capital, can in part be traced to other sources. 
 Some of it is due to the knowledge and energy 
 of those organizing industry. Some also to 
 all those forces, whether operating within or 
 without the sphere of capitalism, which make a 
 cheap supply of labor by keeping down the 
 standard of living and narrowing the economic 
 opportunities of non-capitalistic labor.* Nor 
 does it follow that the entire technological 
 advantage will go to capitalist and entrepreneur, 
 and that the laborer may never have a share 
 in it. Some of the surplus may be used to lure 
 labor into the capitalistic system. Some may 
 go to labor when a strong union, seizing a 
 temporary advantage, drives a hard bargain. 
 Some goes to skilled labor which has been 
 reared within capitalistic districts and which 
 outside of capitalistic industries could look for 
 no return whatever. 
 
 The title of productivity theory would not 
 fit the views here set forth. Nor would the 
 term exploitation theory be any more appro- 
 priate, although it is suggested that interest 
 grows out of a portion of the product of labor 
 withheld from the laborer. The term exploita- 
 tion carries an ethical connotation which it 
 would have been well to keep out of economic 
 
 *Loria and Oppenheimer have especially emphasized conditions 
 of land ownership as a source of capitalistic gain. See a good 
 summary of Loria's writings by Rabbeno in Political Science 
 Quarterly, Vol. VII. Of Oppenheimer's writings, see especially 
 his Theorie der reinen und politischen Okonomie.
 
 THE ESSENTIALS OF A THEORY 107 
 
 theory. Whether there is the moral wrong of 
 exploitation at the source of capitalistic income 
 is a question outside of the scope of economic 
 investigation. It is not probable that the 
 purely economic theory of distribution can 
 contribute more than a small part of the data 
 necessary to a judgment upon the present 
 social system as a whole, and of the ethical 
 status of the income of capital in particular. 
 We are taking a small and inadequate view of 
 the problem raised by socialism, if hopes or 
 fears of settling that problem give any bias 
 to our thought in the study of the theory of 
 interest and profit. 
 
 It is desirable, therefore, if a name must be 
 given to the theory here set forth, to find a 
 term without ethical flavor. Such a safe, 
 colorless term, one properly applicable, is that 
 of residual-claimant theory. It is the name 
 which has been given to the theory of profit on 
 capital of Ricardo and Marx, with which our 
 theory is in substantial agreement.* 
 
 At this point it will be desirable to consider 
 briefly three questions suggestive of objections 
 to the theory here advanced, (i) What is 
 there to prevent excess product due to capital 
 
 *See Hollander (The Residual Claimant Theory of Distribution 
 in Quarterly Journal of Economics, February, 1903) who applies 
 the name to the theory of Ricardo. In the third of an interest- 
 ing series of articles on "Wertrechnung und Preisrechnung im 
 Marxschen System," in the Archiv fur Sozialwissenschaft 1907, 
 Bortkiewicz suggests the name Abzugstheorie for the theory 
 of Ricardo and Marx.
 
 io8 PROFIT AND WAGES 
 
 from bringing about a fall of values which would 
 extinguish profit and interest? (2) What keeps 
 labor from demanding and obtaining all that it 
 produces? (3) How is the surplus value grow- 
 ing out of a series of processes, under the control 
 of different entrepreneurs, distributed as a 
 fairly uniform rate to every part of the invest- 
 ment made by each entrepreneur, and not 
 alone to the sums paid out as wages? 
 
 To take up the first question: why does not 
 the surplus value including profit and interest 
 disappear in a fall of prices? How can the 
 profit be kept from the "consumer?" There 
 is here suggested the objection sometimes made 
 to the productivity theory of interest, that it 
 does not show how the capitalist can keep his 
 "product of capital" from lowering prices till 
 interest disappears. This apparent difficulty 
 is by some writers made the occasion for bringing 
 in the cost of abstinence as a necessary check 
 upon redundancy of capital and capitalistic 
 production. The objectors, however, fall into 
 the common error of thinking of but one industry 
 at a time. Excess of product in one industry 
 might indeed bring about a "ruinous" fall in 
 value. A general fall of values, however, is 
 impossible. 
 
 Moreover the objection that profit and interest 
 will be surrendered to the "consumer" unless 
 production is in some way limited, rests on an 
 erroneous conception of the status of the con- 
 sumer. When we look at things, not from the
 
 THE ESSENTIALS OF A THEORY 109 
 
 point of view of a single industry, but of the 
 industrial system as a whole, it is obvious that 
 the "consumers," the purchasing public, are 
 not a class distinct from the "producers," nor 
 an independent factor governing prices. The 
 purchasers or consumers are the capitalists 
 and laborers of the productive process. As 
 long as the laborers do not receive the whole 
 sum of money and credit possessed by capitalist 
 and entrepreneur, as long as the latter retain 
 something for themselves, this something, added 
 to the purchasing power in the hands of the 
 laboring class, will keep the total of prices of 
 commodities above the total paid out as wages. 
 The sum of prices cannot extinguish profit of 
 capital by falling to the sum of the outlays for 
 wages. As long as the capitalist and employer 
 are not obliged to surrender everything to the 
 employe, profit and interest will continue. 
 
 But may profit of capital throughout industry 
 as a whole be made to disappear by a rise of 
 wages? This is the second objection our theory 
 must meet. Why does not labor obtain the 
 entire product? As long as the value of the 
 product is in excess of the wages paid, would 
 it not be profitable to employ additional labor? 
 Would not this be kept up until in every industry 
 wages equalled the marginal product, leaving 
 only a differential profit on the more productive 
 investment but no profit or interest at the 
 margin. The adherents of the abstinence or 
 time-preference theories would assert that the
 
 no PROFIT AND WAGES 
 
 needs of the marginal saver, the cost of his 
 abstinence or waiting, or the degree of his 
 reluctance to give up present for future goods, 
 would check the upward course of wages. 
 Do these subjective factors act as a check on 
 any forces tending to narrow the rate of profit? 
 And if they do not, what is there to save capit- 
 alist income from extinction? In Chapter IV 
 it has been shown how doubtful and uncertain 
 is the influence of subjective factors in checking 
 the fall of profit. It was also shown, however, 
 that, when additional supplies of capital meet 
 a vanishing rate of return, either forces destruc- 
 tive of redundant capital are brought into 
 action, or new opportunities are somehow found 
 for profitable exploitation. Does an increasing 
 supply of capital have a tendency to raise 
 wages? Whether it does or not, there are 
 forces sufficient to check an increase of capital 
 leading up to an extinction of profit, forces 
 so erratic in their operation, however, that 
 it is impossible to predict their course by any 
 simple formula. But the factors determining 
 the scale of wages form the subject matter 
 of the two chapters following this. A full 
 discussion of whether they could threaten profit 
 with extinction would be out of place at this 
 point. 
 
 The third difficulty which must be met by 
 the theory here advanced is that, suggested by 
 the question as to how the surplus product 
 growing out of a series of processes under the
 
 THE ESSENTIALS OF A THEORY in 
 
 control of different entrepreneurs, is distributed 
 as a fairly uniform rate and assigned to each 
 entrepreneur's investment and, moreover, to 
 every part of it and not alone to the sum paid 
 out as wages. Apparently a rate can be cal- 
 culated only by the summation of the incomes 
 of all the capitalists and entrepreneurs and the 
 estimation of this sum as a percentage of the 
 total paid out as wages. But how is one to 
 proceed from this rate to a rate assigned to 
 every part of the investment, to machinery and 
 buildings, as well as to the sums paid as wages? 
 As a matter of fact, the rate of total profit is 
 purely theoretical. The gain to capital which 
 arises as a surplus of total product over the 
 total of wages is a quantity not estimated by 
 any one as a percentual rate. It is a quantity, 
 however, for which entrepreneurs engage in a 
 struggle and out of this struggle arises an average 
 rate of profit which coincides with the theoretical 
 rate of total profit. 
 
 If the entire process of making any given 
 commodity, including the production of all 
 material and instruments entering into the 
 product, or used up in the process, were con- 
 trolled by one entrepreneur, whether an indi- 
 vidual, a partnership, or a corporation, it 
 would be possible to state total returns above 
 wages as a percentual rate upon wages regarded 
 as the investment. Actually the process is 
 divided up among different entrepreneurs, and 
 among these the return in excess of wages, is
 
 ii2 PROFIT AND WAGES 
 
 divided roughly according to the extent of 
 their investment. If the entrepreneurs of the 
 earlier stages of the process of production seek 
 unusual gains at the expense of those in the 
 later stages, the latter can threaten to make 
 themselves independent of the former by under- 
 taking to produce for themselves the materials 
 and instruments they may need. Or they 
 can encourage competitors of a more reasonable 
 frame of mind. In like manner the entrepreneurs 
 of the earlier stages can defend themselves 
 against those of the later. Thus, through 
 bargaining and competition, a rate of profit 
 becomes established for any given industry. 
 By movements of capital from one industry 
 to another, the rate is equalized throughout 
 the industrial system.* This equalized or 
 average rate of profit is, of course, only a 
 theoretical approximation to actual conditions, 
 a static goal never fully attained in this dynamic 
 world. The sums invested are given a share 
 in the returns according to the time at which 
 they enter the investment. In other words, 
 the rate assigned makes allowance for the time 
 element, and is calculated and compounded 
 according to a custom established before modern 
 capitalism itself. 
 
 The solution of the problem of profit of capital 
 and interest given above, assumes the existence 
 of interest and capitalistic calculation. What 
 
 *Compare Ricardo, Principles, Chapter IV, and Marx, Kapital, 
 Vol. Ill, especially Chapter X.
 
 THE ESSENTIALS OF A THEORY 113 
 
 the historical origin of interest may have been, 
 how such an income was possible before the 
 modern machinery of production, and why it 
 was estimated and compounded at a time rate, 
 are questions we need not seek to answer. 
 The theory aimed at in all of the foregoing 
 discussion, applies to the modern era alone and 
 may, therefore, assume as given such factors 
 as have been transmitted from pre-capitalistic 
 times. As long as the method of "theory" 
 takes its premises from conditions now open 
 to observation and not from the historical past, 
 it must, of necessity, submit to such limitations. 
 It reveals the forces at work in the present and 
 the conditions of their continuance. It can 
 make no pretense of throwing light on the 
 whole course of the evolution of economic 
 institutions whose birth has preceded our his- 
 torical era.
 
 CHAPTER VII 
 
 THE THEORY OF WAGES. THE SUPPLY OF LABOR 
 
 Our discussion of the income of capital has 
 led of necessity to the question as to what 
 determines wages. The marginal product of 
 industry is divided between profit and wages. 
 A theory of either of these shares carries, by 
 implication at least, a definite opinion in regard 
 to the determinants of the other. The view of 
 profit and interest as residual, set forth in the 
 preceding chapter, rests distinctly on the assump- 
 tion that wages are determined independently 
 of the rate of profit and of the value of the 
 product. Obviously the next step in our argu- 
 ment must be to establish a theory of wages in 
 harmony with this assumption. Such a theory, 
 however, is not likely to meet a very ready 
 acceptance unless the, at present widely held, 
 productivity theory of wages can be dislodged. 
 A criticism of this theory will be offered in the 
 next chapter. In passing, however, it should 
 be pointed out that because of the close relation 
 between profit and wages, our criticism of certain 
 theories of interest, if valid, has by implication 
 given a refutation of the productivity theory 
 of wages associated with these theories. If, 
 for instance, there is no specific product imput- 
 able to capital, separable from the specific 
 product of labor, then there is no specific product
 
 THE SUPPLY OF LABOR 115 
 
 of labor. Thus the weakness of the specific 
 productivity theory of interest is also the weak- 
 ness of the specific productivity theory of wages. 
 Moreover, the impossibility of regarding em- 
 ployers as willing to pay out sums of money 
 for wages upon which they do not earn interest 
 at least; in other words, to pay the full undis- 
 counted product of labor to the laborer, 
 makes the specific productivity theory appear 
 too obviously inadequate to deserve much 
 attention. 
 
 A theory much in fashion to-day, is that of 
 wages determined by the discounted marginal 
 product, the rate of discount being fixed by the 
 "rate of time-preference" or the "cost of wait- 
 ing." But, if we have succeeded in our attempt 
 to show that time-preference or calculation of 
 the cost of waiting, or postponement, or absti- 
 nence, or any subjective valuations by whatever 
 name, can create no definite rate of discount, 
 then obviously wages cannot be explained as 
 determined by discounting the product. 
 
 In the view of profit of capital as a residual 
 claimant set forth by Ricardo and others, the 
 underlying theory is that of wages determined 
 by the cost of subsistence of the laborer. If 
 this theory of wages were acceptable, our 
 argument would have brought us to the Ri- 
 cardian view of distribution in most of its 
 essential positions. Another basis for a theory 
 of profit as residual, might possibly be found 
 in the bargain theory of wages, the theory
 
 n6 PROFIT AND WAGES 
 
 that wages are the outcome of a contest, of 
 Machtverhaltnisse. A discussion of these two 
 theories must be undertaken, but also of those 
 in obvious conflict with the theory of profit 
 and interest for which we are contending. 
 Following the course of historical evolution let 
 us begin with an examination of the subsistence 
 theory. 
 
 The argument for this theory was based on 
 Malthusian views in regard to the growth of 
 population. If wages rose above the "natural 
 wage," earlier marriages and a higher birth 
 rate increased the supply of laborers and 
 reduced wages to the old level. If wages fell 
 below the natural wage, postponement of mar- 
 riage and a lowered birth rate, diminishing the 
 supply of labor, raised wages again.* 
 
 But how much was the ' 'natural wage?" 
 It was supposed to give the laborer a living 
 according to the customary standard of his 
 class. How this "standard of living" originated, 
 the classical enconomists did not inquire. It 
 was an historical problem which they were 
 under no necessity of solving. All that was 
 essential to their argument was that the standard 
 should be stable. This implied that in times of 
 falling wages, the standard would not be sac- 
 rificed to the desire for marriage; but that in 
 times of rising wages, marriage would be the 
 
 *A minor factor was the death rate varying inversely with 
 changes in wages. It makes no difference to the argument 
 to omit its action from consideration.
 
 THE SUPPLY OF LABOR 117 
 
 first claimant on the increased income. It 
 supposed a great fixity in the manner of living 
 of the working classes in everything except the 
 age of getting married and the consequent 
 eventual size of the family. 
 
 Now if the term "natural wage" was to have 
 a definite meaning, it was that of a wage suf- 
 ficient to maintain at the customary standard 
 a family of a given average size.* As actual 
 wages departed from the natural wage, the 
 standard of comfort was maintained by a varia- 
 tion in the average size of the working class 
 family. Thus except in short periods of transi- 
 tion and adjustment, actual wages would always 
 cover the standard of living. This correspond- 
 ence between wages and the standard of living 
 could not, however, be regarded as evidence 
 that the standard effectively determined actual 
 wages. Unless one considered results in the 
 long run, the truer view would be that wages 
 on the one hand, determined primarily by 
 "demand," and the standard of living on the 
 other, had no effect on each other, but together 
 determined the average size of workingmen's 
 families. To express the same thought in 
 a different manner, the standard of living 
 maintained itself in the face of fluctuating 
 wages by varying the average size of families. 
 If, however, one looked at the tendencies of 
 a long run, it would appear that these changes 
 
 *To be very precise, a given average size and composition, as 
 expenses would vary somewhat according to age and sex.
 
 n8 PROFIT AND WAGES 
 
 in the average size of the family would eventually 
 affect the supply of labor and thus influence 
 the level of wages. 
 
 It should be noted, however, that the factor 
 set forth by the classical writers as regulating 
 the supply of labor was obviously extremely 
 slow in its action. It might take fifteen to 
 twenty years for a sufficient number of children 
 to be born and trained to industrial pursuits, 
 to increase effectively the supply of labor; or 
 before the death rate overtaking a diminished 
 birth rate could effectively decrease the supply. 
 Because of this slowness, the regulation of the 
 supply through the growth or decline of the 
 laboring population would bring wages back 
 to the "natural wage," only if disturbances 
 of the actual or "market" wage through fluctua- 
 tions on the side of "demand" did not occur 
 except at long intervals. 
 
 But is there a natural wage? Ricardo defined 
 it as the amount necessary to enable laborers 
 "to subsist and perpetuate their race, without 
 either increase or diminution." Now the en- 
 tirely stationary wage-earning population sup- 
 posed by Ricardo, in all probability, never 
 existed. And if population has always either 
 increased or decreased, "natural" wages were 
 never paid. The concept of natural wages, 
 therefore, could at best serve as a means of 
 exposition only, indicating an ideal point of 
 equilibrium towards which the forces making 
 the rate of wages were supposed to be working.
 
 THE SUPPLY OF LABOR 119 
 
 The slow operation of the factors set forth 
 by the Malthusian argument for the subsistence 
 theory, forms the basis of Marx's criticism of 
 this argument. Holding that there is a decennial 
 cycle of prosperity and crisis, he reasons that 
 long before a rise or fall of wages could have 
 any effect on population the whole scene would 
 be shifted by various phases of the business 
 cycle.* As an objection to the notion that a 
 given natural wage could be brought about 
 primarily by the movements of population, 
 Marx's argument has great force. It does not, 
 however, dispose of the fact that the size of 
 the working population has an effect on wages. 
 Indeed, the further development of Marx's 
 own ideas on wages implies such an effect. 
 Nor does Marx prove that wage fluctuations 
 are of such disconcerting frequency that the 
 movement of population cannot at all be affected 
 by a rise or fall of wages. 
 
 An objection to the Malthusian argument 
 for the theory analogous to that presented by 
 Marx, is suggested by the part which immigra- 
 tion plays today in almost all the great industrial 
 districts of the world. Against the vast tide 
 of immigrants, the slow changes caused by 
 fluctuations in the native birth rate seem of 
 very slight significance. It should be remarked, 
 
 *Das Kapital, Chapter 23, Section 3.
 
 120 PROFIT AND WAGES 
 
 however, that at the time the subsistence 
 theory gained its position in orthodox political- 
 economy, this difficulty did not exist 
 
 In view of the slowness of the factors described 
 in the classical exposition of the subsistence 
 theory, there was obviously the need of a 
 theory of wages in which the supply of labor 
 should be regarded as practically fixed for the 
 time being a theory of actual, or " market 
 wages," as distinct from the "natural wages" 
 towards which things tended vaguely in the 
 long run. In such a theory the emphasis would 
 necessarily be on "demand" for labor. That 
 the subsistence theory was not a complete 
 explanation of the rate of wages was clearly 
 recognized by its classical exponents. They 
 supplemented it with the wages-fund theory 
 in which the emphasis was placed on the factor 
 of demand, and which aimed to explain market 
 wages. Thus two theories were held simul- 
 taneously. In one, the wages fund theory, 
 the supply of labor was regarded as fixed for 
 the time being. The other, the subsistence 
 theory, we have seen could account for existing 
 wages, only on the assumption that changes in 
 demand occurred at long intervals only, or 
 in other words, that the factor of demand was 
 fixed for long periods of time. 
 
 Now it might appear from the trend of our 
 discussion up to this point, that our chief con- 
 cern must be a theory of "market wages" and 
 of the factor of demand. Though recognizing
 
 THE SUPPLY OF LABOR 121 
 
 that anything affecting the birth rate would 
 ultimately influence the supply of labor, and 
 therefore, affect wages, it might appear that 
 we are forced to consider such influences so 
 slow in their operation and so disturbed by 
 various factors of more rapid movement, that 
 all attempts to embody them in a general 
 formulation of a wage theory should be given 
 up. Why not rest satisfied with a theory based 
 on the assumption of population as fixed for 
 the time being? It will appear, however, in 
 the further progress of our analysis, that we 
 need not give up trying to make some definite 
 statement in regard to the factor of the supply 
 of labor. Indeed, there is something like a 
 definite supply price of labor, as important in 
 its influence on wages as anything on the side 
 of demand. 
 
 But let us return to the subsistence theory. 
 The greatest obstacle to its continued and 
 unquestioned acceptance appeared when it was 
 seen that the standard of living of a large part 
 of the industrial population was rising. If 
 wages had gone downward instead of upward, 
 the standard might have exhibited greater 
 fixity. As it was, the idea began to gain ground 
 that the standard of living was too unstable 
 to be regarded as a regulator of wages. The 
 concept of a natural wage vanished into thin 
 air. Even the more modern idea of supply 
 prices for different quantities of labor, the idea 
 of wages acting as inducement for an increased
 
 122 PROFIT AND WAGES 
 
 or decreased supply of labor as they rose or 
 fell, became untenable. If, for instance, a 
 rise of wages carried the standard of comfort 
 upward, its ultimate effect might be, by lowering 
 the birth rate, to decrease rather than to 
 increase the working population. It did not 
 appear, however, that the standard is so in- 
 stantly and extremely variable that there is 
 no standard at all. For the time being there 
 is a standard, though possibly a short-lived one. 
 In the interval before the change to a different 
 level, the standard has some effect on the birth 
 rate and, therefore, ultimately on the supply of 
 labor and its price. But if it affects wages it 
 is also affected by them. The definite, non- 
 reciprocal action on wages assigned to it by the 
 classical school is not perceptible. 
 
 But though the subsistence theory of wages, 
 based on the Malthusian argument, became 
 involved in all these difficulties, it does not 
 follow that it was never, at any place, a valid 
 explanation of the facts. Within certain geo- 
 graphical and historical limits, some of its 
 reasoning may be applicable. On the back- 
 ground of modern capitalism, to be sure, with 
 its large fluctuations of employment, its pressing 
 host of immigrants, and the instability of all 
 standards of comfort and discomfort, the Ricard- 
 ian doctrine of a natural wage looks like some 
 pale, ancestral shade. But it was from a different 
 world that Malthus gathered the evidence for 
 the "principle of population" which was made
 
 THE SUPPLY OF LABOR 123 
 
 the basis of the theory of natural wages. For 
 most of the people of the eighteenth century 
 there was still the regular routine of agricultural 
 pursuits calling for almost the same number of 
 workers year after year. There was little 
 immigrant labor and the manner of living, 
 consecrated by custom, was almost incapable 
 of variation. In the backward, rural districts 
 of the old world from which today we derive 
 our supply of unskilled laborers, we 'may still 
 see conditions differing but little from those 
 pictured by Malthus. To be sure the portentous 
 fact of emigration has broken into the quiet 
 current of their life. The established standard 
 of living, however, still possesses stability. 
 A temporary fall of income results in emigration 
 and postponement of marriages, a rise, in 
 earlier marriages and a higher birth rate. 
 New commodities enter but slowly into cus- 
 tomary use. The luxuries and novelties of the 
 well-to-do are both geographically and socially 
 too remote to lure to a more expensive scale 
 of living. Of course, the subsistence theory 
 may not be applied without qualification to 
 an explanation of the income of the laboring 
 population of these non-capitalistic regions. 
 As already indicated, the theory cannot, in any 
 case, offer a complete explanation of the level 
 of wages. If, however, we had only these old 
 world conditions to consider, the classical
 
 i2 4 PROFIT AND WAGES 
 
 doctrine of wages adjusted to cost of subsistence 
 might be allowed as a rough approximation 
 of the actual forces at work. 
 
 It may be asked, what is the need of any 
 reference to old world conditions? Our con- 
 cern is with the dividing up of the product of 
 capitalistic industry and, therefore, with the 
 wage level of modern industrial centres only. 
 The reply to be given is that it is a mistake 
 to fix the attention exclusively upon the indus- 
 trial areas or to think of economic life as all 
 within an isolated, national unit. The con- 
 ditions of the distant sources of our labor 
 supply cannot be without influence upon indus- 
 trial wages. We may be sure that an important 
 factor determining wages in all growing indus- 
 trial centres is found in the terms upon which 
 additional laborers can be secured. But securing 
 additional laborers means attracting increased 
 immigration. The average income of the old 
 world population from which our unskilled 
 laborers are almost entirely drawn may be 
 said, therefore, to constitute part of the supply 
 price of labor for our industries. That much, 
 at least, must be paid and in order to induce 
 men to immigrate something more. We may 
 leave open the question as to whether this 
 income determined by pre-capitalistic conditions, 
 is best explained by emphasizing the customary 
 standard of living, or the narrow productive 
 opportunities of these workers. For us the 
 significant fact is that this income plus an
 
 THE SUPPLY OF LABOR 125 
 
 amount sufficient to act as inducement to 
 emigrate to the regions of modern industry, 
 is the price which must be paid to secure the 
 lower grades of labor for our industries. 
 
 For the higher grades there enter other factors, 
 less easily summarized in general formulae. 
 Often it will be necessary to regard the supply 
 of certain kinds of skilled labor as practically 
 fixed. So far as it is possible to make out a 
 "supply price" for an additional amount of 
 one of the higher grades, it equals the wages 
 of unskilled labor, determined, as we have 
 seen, in large part by non-capitalistic condi- 
 tions, with enough in addition to induce 
 part of the working population to undergo the 
 necessary training, or to bear the expense of 
 educating their children, towards a more spec- 
 ialized or more intelligent type. 
 
 The price of unskilled labor, therefore, is 
 fundamental to the determination of the wages 
 of all grades of employment. From the point 
 of view of capitalistic industry it is cost rather 
 than utility that makes the supply price of 
 labor. In other words, the average income set 
 by conditions outside of capitalistic industry 
 enters as an independent factor into the deter- 
 mination of wages paid in capitalistic industries. 
 
 If the views set forth above are correct, we 
 may speak of a fairly definite supply price for 
 labor. It varies both with the grade of labor and 
 with locality. At the distant sources of our
 
 126 PROFIT AND WAGES 
 
 immigrant labor, in the backward, rural dis- 
 tricts of the old world, a fairly stable standard 
 of living makes a rise or fall of wages result 
 respectively in an increase or decrease in the 
 rate of growth of the population. Such adjust- 
 ments of the supply of labor, however, are 
 slow and imperfect. For the areas of capital- 
 istic enterprise, the important factor deter- 
 mining supply of labor is immigration. More 
 or less of immigrant labor can be attracted as 
 wages are raised or lowered. 
 
 An important part of the supply price con- 
 sists of the amount necessary to act as induce- 
 ment to undergo the expense and hardship of 
 immigration. The supply price of labor will, 
 therefore, tend to vary directly with the distance 
 from the sources of immigrant labor and with 
 the perfection of means of communication. 
 It is often assumed that wide geographical 
 differences in the remuneration of labor are 
 due to corresponding differences in produc- 
 tivity.* The views just set forth suggest a 
 different explanation of the undoubted fact 
 that where wages are high, the productivity 
 of labor is likely to be high. Where, for geo- 
 graphical reasons, the supply price of labor 
 is high, only the most productive uses of labor 
 are profitable to the employer. Where, on the 
 other hand, the supply price is low, the appli- 
 cation of successive "doses" of labor may be 
 
 *For instance, in discussions of the influence of protective tariffs.
 
 THE SUPPLY OF LABOR 127 
 
 carried further down the scale of diminishing 
 returns, to a lower margin of productivity. 
 
 These propositions in regard to the supply 
 price of labor do not, of course, give a complete 
 explanation of the wage level. An examination 
 of the forces making what is called "demand 
 for labor" must be the next step in our analysis.
 
 CHAPTER VIII 
 
 THE THEORY OF WAGES. THE DEMAND FOR LABOR 
 
 The subsistence theory emphasized factors 
 affecting the supply of labor, but implied the 
 action of both demand and supply as deter- 
 minants of the price of labor. It was avowedly 
 only a theory of what wages tended to be in 
 the long run. The wages fund theory of the 
 classical economists gave an explanation of 
 what constituted the total demand for labor, 
 but fitted this into a theory of temporary 
 "market wages" only. There was no reference 
 to what made demand in the long run, but 
 obviously this was determined by the accumu- 
 lation of capital. The relation between total 
 demand for labor and the total working popu- 
 lation determined wages for each season of 
 employment, but in the long run these "market 
 wages" or actual scales of payment tended 
 towards the "natural wage." 
 
 The wages fund doctrine is an example of 
 the bold collective conceptions of the classical 
 school. Brushing aside the factors entering 
 into all the diverse, particular wage contracts, 
 it gave a view of the wage level as a whole, as 
 though capitalists united as a class dealt with 
 labor as a class. It rested on the thought that 
 so viewed, capitalists and laborers are forced 
 to make an exchange with each other; that
 
 THE DEMAND FOR LABOR 129 
 
 each party brings just one commodity to this 
 trade, the capitalists their capital, the laborers 
 their labor power, and that each party is 
 obliged to give its entire commodity in exchange 
 for that of the other. 
 
 In a rough way these views are true as 
 true, perhaps, as any general theory in this 
 field ever can be. That the laborers have to 
 sell their commodity on pain of starvation is 
 obvious. To be sure, some of them might 
 emigrate, and the supply of labor might be 
 varied a little by a greater or less number 
 acting as their own employers in agriculture, 
 or as handicraftsmen, or petty shopkeepers. 
 This, however, does not substantially qualify 
 the fact that the larger part of the quantum of 
 labor-power existing at the time being has no 
 "reservation price," that it has to be sold no 
 matter how low the scale 'of payment.* That 
 despite this cruel necessity not all labor power 
 is sold and that some deteriorates and becomes 
 unsaleable, are qualifications which may fairly 
 be omitted from a general statement of 
 tendencies. 
 
 *It must be remembered that at this point we are considering 
 a theory of the forces of the moment only, those making 
 "market wages." In the long run, of course, the classical 
 economists held that cost of subsistence was a reservation 
 price for labor. It may be remarked that they gave no thought 
 to the fact that with a fixed number of laborers employed, 
 there may still be an increase or decrease in average perfor- 
 mance, and that efficiency may, therefore, be said to have its 
 reservation price. However, we may assume a standard of 
 efficiency for the time being, not susceptible of rapid change, 
 and, therefore, not giving occasion for much qualification of 
 the statements made above.
 
 i 3 o PROFIT AND WAGES 
 
 A similar necessity of coming to terms rests 
 on the class of capitalists. They must seek 
 to invest all of their capital as long as there 
 is a prospect of gain. They will not succeed 
 at once in investing all, just as some labor- 
 power fails to find an immediate market. But 
 in order to indicate general tendencies, we are 
 justified in assuming that all of the labor-power 
 and all of the capital are disposed of. The efforts 
 of capitalist and laborer to sell or invest all 
 they have to sell or invest, whether entirely 
 successful or not, make the rates of remuneration 
 what they are. The wages fund theory, like 
 other economic theories, only indicates the 
 point of equilibrium toward which economic 
 forces are working. It deals with the statics 
 of the problem of wages. Friction and "dy- 
 namic" changes in the factors assumed may 
 bring it about that the point is never actually 
 reached. We have in consequence to rest 
 satisfied with a formulation of tendencies only. 
 
 But if capitalists succeed in investing all 
 of their capital, does that mean that it all 
 goes to pay wages? Must all investment be 
 regarded as fundamentally an exchange between 
 capitalist and laborer? May not the capitalist 
 employer use part of his funds to buy "capital 
 goods" -machines, for instance, instead of 
 hiring labor? Such objections, of course, occur 
 readily to those who either differentiate wages 
 funds entirely from capital or regard them as 
 only part of capital. If it is permissible to look
 
 THE DEMAND FOR LABOR 131 
 
 at the problem of wages from the point of 
 view of an individual business or segment of 
 the long productive process, the wages fund 
 doctrine, of course, appears absurd. But the 
 wages fund theory is not one of particular 
 wages, or wages in particular industries, but 
 an attempt to explain the general wage level. 
 It might appear, therefore, that the investment 
 of the class of capitalists as a whole only should 
 be taken into consideration. In that case what 
 one capitalist gives to another, the price paid 
 for a machine, for instance, should be eliminated 
 from consideration. Only that is invested and 
 a source of gain for the capitalist class as a 
 whole, and, therefore, to be regarded as capital, 
 which goes to other classes. Disregarding 
 advance payments of rent, only that which goes 
 to the laborers, i. e., the wages fund is capital. 
 According as it distributed over a large or a 
 small number of laborers, it makes a low or 
 high average of payment. Its division between 
 different groups and grades of labor may 
 change. Buying machines for an industry, for 
 instance, may mean diminishing the number 
 of workers employed and total wages paid in 
 that particular industry w r hile increasing the 
 employment and wages of men engaged in 
 making machines. 
 
 Such is the view of the effect of buying 
 additional machinery suggested by the concept 
 of capital for which we have contended. But 
 the matter is not quite so simple. It is begging
 
 132 PROFIT AND WAGES 
 
 the question to rule out from consideration 
 business outlays other than those for wages, 
 by appealing to a definition of capital which 
 expressly excludes such outlays. The fact 
 that the wages fund alone is a source of gain 
 to capitalists as a class, makes it legitimate 
 in a general theory of distribution, to restrict 
 the term capital to this fund. But the relevant 
 question at this point is whether all of what men 
 accumulate for investment and regard as "cap- 
 ital,' ' ultimately reaches the laborer ; or whether 
 part of it may be paid to other parties, to the 
 special group of capitalists who sell machines, 
 for instance, and be consumed by them. The 
 total funds accumulated for use in business 
 must be invested. But must they all go to pay 
 wages; or if not, is there a definite and fixed 
 part of these investment funds destined exclu- 
 sively for the payment of wages? 
 
 When entrepreneurs substitute the purchase 
 of machines for the hiring of labor, they appear 
 to diminish the wages fund. But there must 
 occur an increased employment of men in 
 making machines. Does this mean that the 
 point of application of the wages fund is shifted 
 without change in the size of the fund itself? 
 The prices paid for the machines cover the 
 wages advanced to those who had made them. 
 If these prices included nothing else, that is 
 if employers simply spent their capital for 
 wages and, on the return of an equivalent from 
 the sale of the products, reinvested this and
 
 THE DEMAND FOR LABOR 133 
 
 again spent it all for wages, if, in short, there 
 were no interest and profit for the capitalist; 
 then, indeed, all of the investment funds would 
 have to go to the laborers, and the only question 
 would be as to how the total is divided between 
 different groups of workers. But the price of 
 a machine includes profit and interest. Now 
 if, in the language of Bohm-Bawerk, the average 
 production period be lengthened, that is if 
 more of the products of earlier labor be used 
 in the later stages of the production of con- 
 sumable goods, then there would be an increased 
 outlay not only for labor at the earlier stages 
 but also for profits and interest to the capitalists 
 in charge of these stages. Part of what might 
 have gone to the laborers at the later stages, 
 is by this change of the production period 
 converted into profits for a particular group of 
 capitalists. Of course, coming to the latter 
 as an increase of profit it would probably be 
 invested at once and most of it used in paying 
 wages. If, however, this increment of profit 
 were consumed by its recipients, the total 
 wages fund would be, to that extent, diminished. 
 This might appear to qualify seriously the 
 validity of the assumption necessary to the 
 wages fund doctrine that there is a definite 
 fund destined for nothing but the payment of 
 wages. If, however, we consider the conditions 
 under which such a contraction of the fund, 
 as has just been suggested, could occur, it will 
 appear that it is still allowable to make the
 
 134 PROFIT AND WAGES 
 
 assumption of a fairly definite wages fund. 
 The outcome of such an extension of the pro- 
 duction period, of the increased material equip- 
 ment of the later stages, should be an increase 
 of product and profit. What is paid as profits 
 to the capitalists selling machines is an advance 
 payment of their part in the increased profits 
 of the longer productive process. The incre- 
 ment of product of the longer process would, 
 at first, fall into the hands of the employers, 
 but a large part would be added to capital and 
 pass into the hands of the laborer as wages. 
 Thus only in the transition to a longer produc- 
 tion period would there be a considerable 
 deduction from the funds destined to be paid 
 out as wages. 
 
 Moreover the substitition of machines, for 
 men on a large scale would probably indicate 
 the appearance of inventions of a revolutionary 
 character. Such, of course, appear from time 
 to time but should be regarded as dynamic in 
 character. They may change some of the 
 factors of the problem, such as the size of the 
 investment fund and the proportion of it used 
 in paying wages, and bring about a new resultant 
 average wage. The theory we are considering, 
 however, treats only of the static aspects of 
 the problem of wages. To be sure, Bohm- 
 Bawerk argues that apart from inventions, 
 that is taking a static point of view, the average 
 production period could be advantageously 
 lengthened, if it were not for the lack of "cap-
 
 THE DEMAND FOR LABOR 135 
 
 ital." His argument, however, rests on the 
 assertion of the possibility of an indefinite 
 increase of the rate of productivity with every 
 extension of the production period, that is with 
 every increase of material equipment to labor 
 employed. This assertion has been shown in 
 an earlier chapter to be an error.* In times 
 of abundant capital it is likely, therefore, that 
 the productively most advantageous proportion 
 of equipment has been reached by all entre- 
 preneurs except those doomed to fail. In other 
 words, for every commodity there is a pro- 
 duction period not likely to be greatly changed 
 except by the dynamic factor of invention. 
 When this has been reached, the wages fund 
 may be regarded as a fairly definite proportion 
 of the total funds for investment. 
 
 It may be remarked in this connection that 
 Bohm-Bawerk has set forth a theory of general 
 wages which is virtually a wages fund theory, 
 though he would not have it so regarded. It 
 adds an element not developed in the classical 
 doctrine by showing that a given fund may be 
 used to hire labor for longer or shorter periods. 
 Unless the length of the period is established, 
 the average wage remains indeterminate. An 
 increase of capital (of what Bohm-Bawerk 
 calls the "subsistence fund"), instead of giving 
 a corresponding increase of wages to a fixed 
 number of laborers, might be employed in part 
 to lengthen the production period. The problem 
 
 *See note page 24.
 
 1 36 PROFIT AND WAGES 
 
 of the determination of wages, therefore, becomes 
 that of showing how the efforts of the class of 
 entrepreneurs to secure a maximum gain for 
 themselves, establishes an equilibrium between 
 three factors, the given subsistence fund, 
 the total number of laborers, and the length 
 of the production period. In developing this 
 idea, Bohm-Bawerk assumes that there is an 
 unlimited possibility of increasing per capita 
 product by lengthening the production period. 
 As has been shown, however, there is a maximum 
 of product attainable. If the supply of capital 
 is such that the point of maximum productivity 
 has been reached, the production period is fixed 
 and the conditions assumed by the older wages 
 fund doctrine prevail that is, the wages 
 fund and the number of laborers alone determine 
 the level of wages. Under such static conditions 
 an increased investment of capital cannot advan- 
 tageously make a longer production period. 
 It can only enlarge the total productive enter- 
 prise by starting additional business units or 
 enlarging existing ones. Even this is impossible 
 unless the increase of capital is accompanied 
 by an increased supply of labor. If the labor 
 supply increases less rapidly than capital, a 
 rise of the wage level must ensue. 
 
 It is a necessary assumption of the wages 
 fund theory that there is a fairly definite fund 
 all of which will be used in the payment of 
 wages. To state it more cautiously, there will 
 be an attempt to use all of it and that means
 
 THE DEMAND FOR LABOR 137 
 
 paying it out in wages. And the attempt to 
 use all of the fund is an important determinant 
 of average wages. It would be fatal to the 
 theory if it could be shown that the fund was 
 capable of rapid contraction whenever the 
 wage level was not altogether pleasing to 
 capitalists. Of course, the possibility of erratic 
 outside forces suddenly destroying capital or 
 blocking its investment is not relevant. And 
 from any point of view it must be assumed that 
 the wages paid are less than the value of the 
 product turned out. There must be some 
 profit. But we should have to reject the theory 
 if it could be shown that dissatisfaction with 
 the general rate of profit resulted immediately 
 in a contraction of the wages fund, or in other 
 words, that capitalists would hold back from 
 employment any considerable part of their 
 wages fund while there was still any profit to 
 be gained. 
 
 Our discussion up to this point has been in 
 defense of the wages fund theory and in support 
 of its assumption of a fund not capable of 
 rapid contraction. We have not, however, as 
 yet examined some of the arguments which, 
 when brought against it in the sixties and 
 seventies of the last century, led to its sudden 
 and all too complete abandonment. The critics 
 of that time aimed to demonstrate a ready 
 expansibility of the total of funds destined 
 for the employment of labor. Little was said 
 about a contract ibility of the fund, though
 
 138 PROFIT AND WAGES 
 
 of course, that quality might be assumed as 
 implied in its expansibility. The turn the 
 discussion took was, no doubt, the result of 
 the use which had been made of the theory by 
 opponents of trade unionism. Could an organ- 
 ized group of laborers get higher wages without 
 a corresponding reduction of the remuneration 
 of other workingmen, or was the total which 
 might be paid to the laboring classes rigidly 
 limited? That was the question upon which 
 all arguments tended to converge. 
 
 Unfortunately the attacks upon the wages 
 fund theory were based on a misconception, 
 though a pardonable one, in view of the care- 
 lessness with which the theory was usually 
 formulated.* The fund was thought of as 
 money, not as real income; the wages paid 
 as money wages, not as real wages. Viewed 
 thus it was readily seen that credit currency 
 added an elastic element to the fund. Of 
 course credit is somewhat limited by the quantity 
 of cash underlying it. Beyond a certain point 
 further expansion is impossible unless all con- 
 siderations of safety are thrown to the wind. 
 It would take us too far afield to consider all 
 the conditions of credit expansion and con- 
 traction. Only in so far as the wage level is 
 concerned with such fluctuation is the matter 
 at all relevant to our discussion. Other factors, 
 such as speculation and political rumor, epi- 
 demics of optimism or depression, perhaps 
 
 "Taussig, Wages and Capital, Chapter XII.
 
 THE DEMAND FOR LABOR 139 
 
 most of the forces determining the degree of 
 credit expansion, must be regarded as dis- 
 turbing outsiders by the theory of wages. 
 The thought of these forces suggests how 
 inadequately the confused and shifting reality 
 is described by general theory and should teach 
 caution in the application of abstract doctrine 
 to concrete problems. But if general theory 
 is at all permissible, then the theorist is war- 
 ranted in disregarding such disturbing factors 
 and proceeding as if they did not exist. One 
 of the traditional and necessary methods of 
 economic theory is to disregard the existence 
 of a fluctuating supply of money and credit, 
 and to fasten the attention on real income only. 
 Now what of the wages fund when thought 
 of as real income, as a stock of subsistence or 
 consumers' goods such as laborers could con- 
 sume? This evidently at any particular time 
 is very little subject to possible increase. If 
 the wages fund theory be thought of as applying 
 only to the market wages of the moment, or 
 of a short season, it is obviously right in its 
 assumption of a predetermined, possible total 
 of wages. If, for instance, an aggressive 
 trade-unionism could force an increase of money 
 wages, there would, for a time, be no corre- 
 sponding or considerable rise of real wages. 
 If the increased funds needed to pay higher 
 wages were made possible by an expansion of 
 credit, the money and credit left to the class 
 of employers generally for their personal use
 
 140 PROFIT AND WAGES 
 
 would not be diminished.* In any case, the 
 capitalist and employing classes would not 
 diminish their consumption of necessaries but, 
 if any economy became necessary, would exercise 
 it by a decreased purchase of luxuries. With an 
 increasing money demand for necessaries from 
 the laboring class and no falling off of demand 
 from other classes, prices of necessaries would 
 rise and real wages to that extent would fail 
 to increase. It appears, therefore, that if only 
 the immediate results of a general rise of money 
 wages, such as we have supposed, were to be 
 considered, there would be no sufficient reason 
 for calling the wages fund doctrine into question. 
 If, however, a longer period of time be taken 
 into view, it will appear that the greater profits 
 gained by producers of necessaries would lead 
 to a shifting of capital from the production 
 of luxuries to that of necessaries and then the 
 higher level of money wages, if still maintained, 
 would mean a higher average of real wages. 
 The higher scale of payment for labor would 
 correspond to a larger wages fund but the 
 increase of the fund would appear as the effect, 
 and not as the cause, of the higher level of 
 wages. Capital funds used to raise wages would 
 have been created by credit expansion. That 
 part of the real income of the capitalist class 
 consisting of luxuries would have been dimin- 
 ished. But all this can be thought of as happen- 
 
 *Such aggressive and successful unionism, however, might 
 cause a shrinkage of credit.
 
 THE DEMAND FOR LABOR 141 
 
 ing only on the assumption that capitalists 
 as a whole do not increase the quantity of 
 money income spent for consumers' goods, 
 or in other words, that they are content to 
 consume fewer goods while saving as large a 
 money fund for investment as before. Unless 
 there is as much saved as before, capital and 
 the wages fund will be diminished, and the 
 general rise of wages will have been but a 
 temporary one. 
 
 With a very thrifty capitalist class, deter- 
 mined never to lessen its annual saving, a 
 general rise of wages at the expense of profit 
 and of the current consumption of the rich, is 
 conceivable. In a theoretical discussion it 
 may be given some weight. But it should be 
 noted that if this constitutes an objection to 
 the wages fund theory, it is one of which most 
 of the critics of that theory are debarred from 
 making use. Holding, as they do, some form 
 of the abstinence theory, they should argue 
 that no permanent increase of the wages fund 
 at the expense of profit and interest is possible. 
 
 The theory which most gains support from 
 the possibility of an increase of the total of 
 real wages through aggressive labor organization 
 is that which may be called the "bargain 
 theory" the theory that the respective shares 
 of capitalist and laborer depend on the outcome 
 of a struggle between them. That this theory 
 emphasizes an important factor in the making 
 of actual wage scales, no one conversant with
 
 1 42 PROFIT AND WAGES 
 
 the facts would deny. Whatever general theory 
 of wages we come to accept, we must give some 
 recognition to this factor, at least as supple- 
 menting the main propositions of our theory. 
 The present writer would hold, however, that 
 the statement that wages are determined by 
 a struggle or bargain, the outcome of which 
 is largely decided by the relative aggressiveness 
 and obstinacy of the contending parties, 
 while true, does not carry analysis as far as 
 it should be carried. Our theory should aim 
 to note the effect of the resources and strategic 
 positions of both parties on the issue of the 
 struggle. Without such further development 
 of the analysis, the positive contribution of the 
 theory would be little more than a truism, 
 while its negative implication that there is 
 nothing more to be said, would be an evasion 
 of all the difficulties of the problem. 
 
 As our discussion has shown, the account 
 given by the wages fund theory of how the 
 general scale of wages is made, fails to allow 
 for many disturbing factors. It is a very 
 abstract doctrine and would need to be supple- 
 mented and qualified extensively before it 
 could be regarded as anything but a very rough 
 approximation to reality. Why give it any 
 thought at all if it falls so far short of giving a 
 definite and accurate picture of industrial facts? 
 The answer to this objection is that the wages 
 fund theory gives what no other theory has 
 given or can give an explanation of the
 
 THE DEMAND FOR LABOR 143 
 
 general wage level as distinguished from com- 
 parative or particular wages. It is analogous 
 to the so-called "quantity theory" of money 
 or theory of the general price level, and as 
 necessary to the explanation of actual wages 
 as the quantity theory is to that of actual 
 prices. The theory of particular or comparative 
 wages, like the theory of relative prices of 
 commodities, or, as it is ordinarily called, the 
 theory of "value," presupposes a general level. 
 Both of these theories of relative magnitude 
 must assume a given fund or flow, the one a 
 wages fund, the other a given quantum of 
 money and credit. The problem in both cases 
 is how the fund is divided up between particular 
 values or prices. For the purposes of a general 
 theory of distribution, however, we need to 
 explain the absolute height of wages, not the 
 comparative scale of payment of different classes 
 of labor. In order to explain how the marginal 
 product is divided between capital and labor, 
 it is necessary to show not why one set of 
 laborers get more than another but what 
 determines either the average or the total of 
 wages. Only on that basis can the share going 
 to capital be accounted for. 
 
 No theory other than that of the wages fund 
 can properly be called a theory of general wages 
 or of the general wage level. The subsistence 
 theory, though contributing to the explanation 
 of both general and relative wages, is con- 
 fessedly incomplete and can serve, at best,
 
 144 PROFIT AND WAGES 
 
 only as part of a complete explanation. The 
 productivity theory, practically the only wage 
 theory to have gained general acceptance, 
 though professing to explain general wages, 
 has unconsciously applied a method of reasoning 
 permissible only to an explanation of particular 
 wages. This aspect of current speculation on 
 wages, and the productivity theory in general, 
 must now be subjected to a critical examination. 
 
 Although some assumptions in regard to 
 the supply of labor must be pre-supposed, the 
 productivity theory in its usual formulation 
 is devoted entirely to an analysis of the forces 
 on the side of demand. This one-sided emphasis 
 has doubtless been favored by the Austrian 
 theory of value with its analysis of demand 
 as varying with the utility and price of the 
 commodity demanded. Applied with great 
 success to the elucidation of the value of con- 
 sumers' goods, this theory of value was at 
 once extended to producers' goods including 
 labor. No questions were raised as to whether 
 demand for labor might not differ radically 
 from demand for consumers' goods. Labor 
 was described as subject to a law of diminishing 
 productivity homologous with the diminishing 
 utility of the unit of an increasing quantity of 
 a consumer's good, and its market value as 
 determined by the utility, that is the pro- 
 ductivity, of the marginal unit, to the buyer. 
 
 Now this description of demand for labor 
 as of altogether the same nature as that for
 
 THE DEMAND FOR LABOR 145 
 
 consumable commodities, leads to an erroneous 
 conception of the demand as almost indefinitely 
 extensible. Demand for a consumption good 
 means the offer of a part only of the purchasing 
 power in the hands of the consumer, the total 
 being distributed among a large number of 
 consumable commodities. Demand for any 
 of these goods can be almost indefinitely in- 
 creased by abstaining from or diminishing the 
 purchase of other goods. If good A rises in 
 utility as compared with B, C and D, the 
 demand for it increases while that for B, C and 
 D falls off. Demand for labor, viewing it 
 collectively and not from the point of view of 
 one industry or of a single industrial establish- 
 ment, is limited by the total of funds destined 
 for the payment of wages. These funds, how- 
 ever, instead of being assigned to the purchase 
 of a vast variety of things, as are consumers' 
 funds, are intended for the purchase of labor 
 alone. There is no choice between different 
 goods with the possibility of increasing demand 
 for any of them by withdrawing funds from the 
 purchase of the others. Entrepreneurs may 
 choose between the production of a great diver- 
 sity of goods but whatever their choice, it 
 involves the purchase of labor, the universal 
 requisite of the productive process. In the 
 use of the wages fund they have no choice 
 between different things but only between 
 different uses of the same thing.
 
 146 PROFIT AND WAGES 
 
 In short, there is a fund all of which must be 
 invested and the size of which is an important 
 determinant of the level of prices paid for labor. 
 It is distributed as wages among different grades 
 of work in such manner as to tend towards an 
 equality in the marginal rate of profit. Such a 
 distribution of the fund makes the wages of 
 different kinds of labor vary according to their 
 marginal productivity. But it would be an 
 error to leap to the conclusion that, because 
 comparative wages are graded according to 
 productivity, wages are equal to the marginal 
 product of labor (or the marginal product 
 discounted) and that productivity directly deter- 
 mines the absolute as well as the relative scale 
 of payment.* Productivity may be appealed 
 to for the purpose of explaining comparative 
 rates of remuneration only. As a theory of 
 relative wages, the productivity theory may be 
 accepted as, at least, a fairly satisfactory partial 
 explanation of existing wage scales. Its pretense 
 to a valid explanation of general wages, however, 
 must be rejected. The absolute scale of pay- 
 ment, the general level, can be explained only 
 by a reference to the total of purchasing power 
 directed to the employment of labor. 
 
 This brings us back to the wages fund theory. 
 We may regret that it seems vague and exces- 
 sively abstract, that only by admitting exten- 
 
 *This is the error of a considerable part of the attempted statis- 
 tical verification of the productivity theory by Professor 
 Moore (Laws of Wages, especially in Chapters IV and VI).
 
 THE DEMAND FOR LABOR 147 
 
 sive qualifications and exceptions, it can be 
 made to appear as an approximately accurate 
 picture of reality. The aim of economic thought, 
 however, should be to specify and formulate as 
 accurately as possible the various qualifying 
 propositions which are to be made, but to treat 
 these as developments or modifications of the 
 wages fund doctrine, not as grounds for rejecting 
 it in toto. The attitude of a large number of 
 economists towards the quantity theory of 
 money might well indicate the treatment which 
 should have been, but was not, accorded to 
 the wages fund doctrine. Various efforts at 
 precise statement of all the factors determining 
 the general price level have given us something 
 much more complicated and perplexing than 
 the bold and crude quantity theory of an 
 earlier time. But for all these developments 
 of the theory, there is, on the whole, little 
 disposition to deny that the existing quantum 
 of money is one of the most important factors 
 in making the scale of prices, and that the 
 quantity theory needs to be perfected, not 
 rejected. 
 
 The objections raised above to the productiv- 
 ity theory may be made somewhat clearer by 
 diagrams. These, it may be remarked, will 
 aid us in our constructive as well as in our 
 critical task. In Figure I a fixed supply of 
 labor (ab) is assumed, a condition conceivable 
 as true for short periods; ir. Figure II a varia- 
 ble supply with an increasing supply price
 
 148 
 
 PROFIT AND WAGES 
 
 represented by an ascending supply curve. Since 
 the productivity theory regards wages as deter- 
 mined by marginal productivity and the location 
 of the margin depends on the number of laborers 
 employed, some assumptions must be made 
 in regard to supply. The two most probable 
 cases are given and they are not such as could 
 in reason be objected to by adherents of the 
 productivity theory. To simplify the problem 
 it is assumed that there is only one grade of 
 labor. As usual, distance along the abscissa 
 or base line represents supply or numbers of 
 laborers. The distance of points on the curve 
 ec from the base line represents productivity. 
 
 5 a 
 
 
 Figure I 
 
 Figure II 
 
 Now the productivity theorist would assume 
 that the productivity curve ec may be regarded 
 as a demand curve, representing what employers 
 could pay without loss for different quantities 
 of labor. Under the given conditions of supply 
 they would hold that the price per unit of labor
 
 THE DEMAND FOR LABOR 149 
 
 would come to equal be.* But at this point 
 there has crept in the common error that what 
 is possible for one or for a few, is possible for 
 all. An individual employer could pay labor 
 what it produces at the margin (discounted). 
 If his capital was insufficient for this outlay, 
 he could borrow. But the totality of employers 
 could not do this unless the total funds available 
 for the payment of wages equalled marginal 
 product per unit of labor multiplied by the 
 whole number of units employed. In other 
 words the collective wages fund would need 
 to be equal to what is represented by the 
 rectangle abed in each diagram. If it were 
 less than this, if, for instance, it equalled 
 the shaded portion of each diagram, the rate 
 of payment per unit of labor would be indicated 
 by the width of this shaded strip (bb r in Figure 
 I, fg in Figure II). It could not be more than 
 that but would tend to equal all of it. 
 
 There is an assumption underlying the pro- 
 ductivity theory that wages are paid out of 
 current product; in other words, that the 
 labor of a given week or month is paid out of 
 the product of that week or month. If that 
 assumption were valid, labor's productivity 
 would create the fund out of which it is paid 
 
 *If we assume that employers would not in any case pay more 
 than the discounted value of the product as wages, the curve 
 ec could be taken to represent discounted value of product. 
 If it represents full value of product, then the wages per unit 
 of labor would be something less than cb, and in the case 
 illustrated by Figure II something less than ab of labor would 
 be employed.
 
 1 50 PROFIT AND WAGES 
 
 and it would be quite possible to pay labor the 
 full equivalent of its product. But if we look, 
 not at the money funds involved, but at real 
 income, it is obvious that the larger part of 
 the current product consists of unfinished goods, 
 or what Bohm-Bawerk would call "future 
 goods;" and that the consumable wealth of 
 which the real wages of labor consist is, for the 
 most part, the product of labor performed 
 weeks or months ago. The notion that wages 
 could be paid out of current product grew in 
 part out of the onslaught made on a misunder- 
 stood wages fund doctrine. The misconception, 
 already referred to in this chapter, of the wages 
 fund as consisting of money or a sum of value 
 expressed in terms of money, suggested that by 
 means of credit the cash proceeds from the sale 
 of current product could be anticipated and 
 used to pay current wages. With less anxiety 
 to have done with the wages fund theory, and a 
 clearer general view of the production and dis- 
 tribution of real as distinguished from money 
 income, of the relation of past to present and 
 future in the continuous flow of products, 
 economic theory might have kept a better 
 perspective and a stronger grasp on the funda- 
 mental factors. 
 
 Confusion also grew out of the unfortunate 
 tendency to look at things too exclusively from 
 the point of view of an individual employer or 
 business. It brought into the mental fore- 
 ground the individual employer's estimate of
 
 THE DEMAND FOR LABOR 151 
 
 what wages he could pay as dependent on the 
 anticipated value of the product, but failed to 
 place in strong relief the important fact that 
 collectively capitalists and employers could 
 not or would not advance in wages more than 
 what they had saved out of past product and 
 destined for investment. 
 
 Now let us return to the consideration of 
 our diagrams in order to examine certain 
 objections which might occur to the -reader. 
 The difference between the wage and the 
 marginal product constitutes the profit of capital, 
 equal in Figure I to cb' and in Figure II to the 
 extension of fg necessary to reach the curve 
 ec.* The rate of profit as indicated in Figure 
 
 I would be 7/7 . Owing to the mobility of cap- 
 ital, always cheerfully taken for granted in 
 economic theory, there would be a tendency 
 towards the same marginal rate throughout 
 the entire industrial field, and wages every- 
 where would tend to equal the marginal product 
 discounted by the prevailing rate of profit. 
 
 As a statement of what wages equal, of the 
 amount of wages, this is in agreement with the 
 productivity theory. Not, however, as a formu- 
 lation of the process by which wages are deter- 
 mined. Our argument shows wages to be 
 determined, not by the productivity of labor 
 
 *Assuming that the curve ec represents the full, not a discounted, 
 value of the product an assumption we make from this 
 point on.
 
 i 5 2 PROFIT AND WAGES 
 
 and an independently established rate of dis- 
 count, as the productivity theorist would hold, 
 but by the wages fund and the number of 
 laborers, under the conditions given in Figure I ; 
 and by the wages fund and the supply prices 
 of labor, under the conditions of Figure II. 
 Profit is shown to be a residual left after wages 
 are paid, and the rate of profit the result, and 
 not a cause, of the scale of wages. 
 
 Adherents of the abstinence and time-prefer- 
 ence theories, however,' would hold that the 
 prevailing rate of profit (at least under static 
 conditions) is a necessary rate determined by 
 cost of abstinence or waiting, or by the rate 
 of time-preference or something of that sort. 
 If the rate of profit were more than this, they 
 might argue, there would be an increase of 
 capital, that is, of the wages fund, and a con- 
 sequent rise of wages until the diminished 
 rate of profit was no longer sufficient to cause 
 any further increase of capital. Then wages 
 would be equal to marginal product discounted 
 according to an independently determined rate 
 of discount (a rate determined by subjective 
 factors) . Product and the rate of discount would 
 appear to be the two determinants of wages 
 and we should apparently have reached the 
 productivity theory of wages now most in favor. 
 It should be noted, however, that the degree 
 of marginal productivity of labor is not, in this 
 way, proved to be the direct and immediate 
 determinant of wages which the prevailing
 
 THE DEMAND FOR LABOR 153 
 
 theory seems to consider it, but acts through 
 the amount of accumulation of capital which 
 it makes possible. If, for instance, there were 
 a general increase of productive power which 
 could be represented diagrammatically by a 
 productivity curve drawn at a greater distance 
 from the horizontal base line wages would 
 not rise until the higher profits had resulted in 
 an increase of capital with which to pay wages. 
 The strongest objection, however, to regarding 
 wages as determined by the discounted marginal 
 product, is the consideration that the rate of 
 discount cannot enter into the determination 
 of wages as an independent factor but is itself 
 determined by the prevailing price of labor. 
 It is not true that capital must grow until there 
 results a necessary rate of profit which makes 
 further increase of capital impossible. There 
 is probably no rate so small as to stop altogether 
 the further growth of capital. The largest 
 accumulations are made out of the differential 
 gains of earlier, or intramarginal investments, 
 and are not much affected by the decreasing 
 rate of gain left to additional supplies of capital. 
 Some saving would occur if there were no interest 
 or profit at all, and capital once accumulated 
 is not willingly consumed. In any case, as 
 shown in the chapter on the abstinence theory, 
 the great forces determining the supply of 
 capital and thereby the marginal rate of return, 
 have very little connection with the dubious
 
 i 54 PROFIT AND WAGES 
 
 and uncertain subjective factors emphasized 
 by the abstinence and time-preference theories. 
 
 No general and simple explanation of what 
 makes the total of capital or of the wages fund 
 is possible. The theory of distribution, therefore, 
 must rest satisfied to assume the given amount 
 of capital as one of its data. As to wages, we 
 may say that the wages fund and the factors 
 regulating the supply of labor are the chief 
 determinants. Productivity plays no part except 
 for its permissive influence on the accumulation 
 of capital. Marginal productivity has but 
 a small share in this indirect influence on wages 
 because most capital is accumulated out of 
 earlier or intramarginal investments. As to 
 the rate of discount, that cannot be thought of 
 as determined independently of wages. What- 
 ever tenuous connection may exist between it 
 and the subjective conditions of saver and 
 investor, its most important direct determinant 
 is the wage level. It is an effect, not a cause 
 of the scale of remuneration for labor. 
 
 As an explanation of general wages the 
 productivity theory should be unreservedly 
 rejected. It has the fundamental defect, as 
 we have seen, of treating demand for labor as 
 homologous with demand for particular con- 
 sumers' goods. As a theory of the comparative 
 scale of payment of different employments 
 and grades of labor, however, it is entitled to 
 consideration. Possibly the failure of the classi- 
 cal school to set forth clearly the part which
 
 THE DEMAND FOR LABOR 155 
 
 relative productivity plays in grading particular 
 wages, may be one reason why the factor of 
 productivity in the end was assigned a part 
 of greater importance than is properly due to 
 it in the theory of both general and particular 
 wages. That the wages fund theory, being an 
 explanation of average wages or the general 
 wage level only, left unexplained the difference 
 in payment between various occupations, was 
 obvious enough to the classical writers. Unfor- 
 tunately, however, their treatment of particular 
 wages, a problem of inferior theoretical interest, 
 was somewhat perfunctory, and was likely 
 to be no more than a repetition of some obser- 
 vations made by Adam Smith.* Meanwhile 
 superficial and optimistic impressions of the 
 effect of increasing productivity on the earnings 
 of labor, together with the shifting of the view 
 point of economic reasoning by the so-called 
 Austrian school, have given the productivity 
 theory a position of unmerited security. 
 
 Of course it has not altogether escaped the 
 fate of all economic theories of being called 
 into question and denounced as fallacious. 
 The usual point of attack, however, has not 
 been that chosen in the preceding pages, but 
 one suggested by the apparent practical dif- 
 ficulties of ascertaining marginal productivity.* 
 
 "Canaan, Production and Distribution, 1776-1848, p. 364. 
 
 **See especially Arturo Labriola, Distribuzione del dividendo e 
 produttivita marginali, * Corne"lissen, Theorie du salaire, and 
 two articles by Richard Schuller in the Archiv fur Sozial- 
 wissenshaft, July and November, 1911. Schuller 's discussion
 
 156 PROFIT AND WAGES 
 
 Can and does an employer estimate the 
 marginal productivity of labor, either of that 
 which he employs or of labor in general? It 
 must be confessed that the problem looks 
 somewhat puzzling. What, for instance, is 
 the size of the marginal unit? Is it one man or 
 a group of men? The increment of product 
 due to the last of one hundred men taken on, 
 would be less that the average product per 
 man of the group of hundred men. How can 
 one know what value to impute to each of 
 several grades of labor associated in varying 
 proportions in the production of different com- 
 modities and in different industries? The 
 doctors disagree in regard to the laws of "impu- 
 tation." But even if we may accept one of the 
 formulations offered, does it not require the 
 eye of faith to detect the operation of any such 
 law in the actual world? Does not the fact that 
 the employer usually estimates, not the product 
 of the individual laborer or of a group of laborers, 
 but what he calls his "labor cost," make the 
 utilitarian calculus applied to the purchase of 
 labor appear somewhat unreal? 
 
 However, labor cost is a function of pro- 
 ductivity, and thus indirectly the productivity 
 of labor enters into the employer's estimates 
 of the advantage of hiring labor. In fact all 
 
 is especially suggestive because of its concrete and pains- 
 taking character. The best known criticism in the English 
 language is probably that by Hobson. See "The Industrial 
 System," p. 112 ff. See also an article by W. M. Adriance in 
 the Quarterly Journal of Economics, November, 1904.
 
 THE DEMAND FOR LABOR 157 
 
 of the difficulties raised by the critics only 
 indicate that in the real world, in place of the 
 precise calculations attributed to the employer 
 by the productivity theory, we find only guess 
 work, and rough approximations of what is 
 profitable. It is not proved that as a formu- 
 lation of tendencies, of points of equilibrium 
 towards which economic forces work, the cal- 
 culus of the productivity theory may not be 
 accepted. The real weakness of that theory 
 lies, as we have seen, in the assumption that 
 employers are able and somehow willing to pay 
 either the full value of the marginal product, or 
 this value discounted according to some inde- 
 pendently established rate of discount. As an 
 account of what makes the comparative scales 
 of remuneration for labor the theory may pass 
 muster. It does not give an acceptable explana- 
 tion of the absolute earnings of labor, that is 
 of the general level or average of wages. 
 
 This concludes our critical examination of 
 wage theories. Its primary purpose was con- 
 structive, and to the attentive reader the positive 
 results are already apparent. Stated briefly 
 the theory to which our discussion has led us, 
 is the wages fund doctrine modified by the 
 conception of a flexible supply of labor with 
 a gradually rising scale of supply prices. The 
 assumption of a temporarily fixed number of 
 laborers made by the classical exponents of 
 the wages fund theory, is no longer tenable,
 
 158 PROFIT AND WAGES 
 
 because of the part played by immigration in 
 the labor markets of all the great industrial 
 areas. The conditions determining wages today 
 are those indicated by Figure II (Page 148). 
 If the lower curve be taken to indicate the 
 supply prices of labor, rising as the quantity 
 of labor is to be increased, and determined 
 chiefly by conditions outside of the capitalistic 
 regions of the world and by the expenses and 
 hardships of emigration then an increasing 
 wages fund will be divided, not among a station- 
 ary number of workers, but among a supply of 
 laborers increased by immigration. 
 
 For the lowest grades of unskilled labor, 
 the prices necessary to attract an increasing 
 number probably rise very slowly. The supply 
 curve might properly be drawn so as to run 
 almost parallel with the horizontal base line 
 for a large part of its course. In that case, 
 the supply price would be the chief determinant 
 of wages and an increasing wages fund would 
 result in an increased number of employes in 
 capitalistic industry rather than in a rise of 
 wages. At some point, however, the curve 
 would begin to turn upwards. Our simplest 
 formula must be that the size of the wages 
 fund, or the supply of capital as we conceive 
 it, together with the supply prices of different 
 quantities of labor, determine the general level 
 of wages.
 
 CHAPTER IX 
 
 CONCLUSION 
 
 To gather up the results of our inquiry, the 
 outline of the problem of distribution given in 
 Chapter I may be recalled. The first stage in 
 the analysis was that of the division of product 
 between landowner and entrepreneur. It was 
 pointed out that where there is product in 
 excess of the marginal rate of productivity, this 
 surplus must fall to the landowner, unless, 
 as the result of superior luck and ability, it 
 takes the form of a differential profit. The 
 second stage of the problem was the determina- 
 tion of the rate of profit, profit including both 
 the income of the entrepreneur (exclusive of 
 any differential gain he may obtain) and that 
 of the capitalist. This rate of profit, however, 
 depends on the division of the marginal product 
 between entrepreneur and laborer, and the 
 problem, therefore, becomes that of finding 
 both a theory of profit and of wages. The 
 character and the terms of the division between 
 capital and labor constitute the most contro- 
 versial matter in the whole theory of distribu- 
 tion. That, however, it is a question of dividing 
 a marginal product, the margin being thought 
 of as both an intensive and an extensive land
 
 160 PROFIT AND WAGES 
 
 margin, has come very near being generally 
 accepted.* 
 
 There are, however, certain ideas which have 
 obtained some currency, but which cannot be 
 fitted into this formulation of the problem, and 
 to these we must now advert for a moment. 
 First, we may take note of a disposition to 
 bring land under the concept of capital, making 
 rent appear as a part of the share known as 
 interest. The objection to be made to this 
 conception is that the total supply of land 
 cannot be increased by saving, or indeed, by 
 any practicable means. As the amount of 
 capital is obviously a determinant of the rate 
 of interest, and in all of its forms other than 
 that of land, can be increased by saving, land, 
 though denned as capital, is left standing 
 outside of the formulation of the important 
 factors determining the income of capital. 
 Additional reasons for declining to subsume 
 land under capital can be found in all the 
 considerations advanced in favor of viewing 
 capital as subsistence advanced to labor. 
 
 We may note next the theory which, pro- 
 ceeding apparently on the assumption that land 
 is variable in quantity, regards its rate of 
 return as determined by the specific product 
 
 *We need not consider at length the views of those who deny 
 the existence of no-rent land. Provided rent as a return above 
 that on an intensive margin is recognized, that is provided the 
 concept of a margin is accepted, there is no substantial depart- 
 ure from the formulation of the problem of distribution upon 
 which our discussion is based.
 
 CONCLUSION 161 
 
 of its marginal increment. It is not opposed 
 to the conception of land rent as a differential 
 gain, but refuses to consider this differential 
 character as anything distinctive. Wages and 
 interest, it is argued, may also be viewed as 
 of the nature of "rents." Add successive 
 "doses" of any of the three factors of production, 
 - land, labor, and capital to a fixed quantum 
 of the other two. Its rate of return will then 
 be established by the addition to total product 
 made by the last dose, while the differential 
 or excess of the earlier or intra-marginal doses, 
 falls as a "rent" to the other two factors, those 
 thought of as fixed for the time being, and as 
 being dosed by the factor in question. Each 
 share in distribution can thus be made to appear 
 both as a marginal return and as a rent. 
 
 This "law of the three rents" is, of course, 
 a complicated form of specific productivity 
 theory, and the difficulty already confronting 
 this theory, of demonstrating a specific product 
 for labor and one for capital, is greatly aug- 
 mented when it becomes necessary to impute 
 something to a third factor.* All the objections 
 which may be made to the specific productivity 
 theory may be made against this variant of 
 the theory. Furthermore, as land is often fixed 
 
 *To add a fourth factor, the services of the entrepreneur, and 
 to think of this as applied in doses and rewarded according 
 to its marginal productivity, does not increase the difficulties 
 of an already overtaxed theory of imputation, but is open to 
 other objections. See Edgeworth, "The Theory of Distri- 
 bution," Quarterly Journal of Economics, February, 1904.
 
 1 62 PROFIT AND WAGES 
 
 in quantity and almost never capable of con- 
 siderable increase, except in the form of no- 
 rent land, the variability of this "factor of 
 production" assumed by the "law of the three 
 rents," is in conflict with facts which the 
 economists may not disregard. Of course, a 
 particular establishment or industry may secure 
 additional amounts of rent-bearing land. It 
 can do this if it can extract a larger return from 
 the increments of land in question that was 
 obtained in the enterprises from which the 
 land was withdrawn. In other words, advan- 
 tageous rearrangements of productive forces 
 are possible. Such changes, however, have 
 nothing to do with the shifting of the entire 
 productive margin which the specific produc- 
 tivity theory pictures as resulting from increased 
 or decreased supply of a factor of production. 
 Unless the total supply of rent bearing land is 
 capable of considerable increase, the dosing 
 principle of determining a specific rate of 
 return is not applicable to land. The total 
 supply being practically fixed, the return to 
 the landowner must necessarily take the form 
 of a differential gain, of a product in excess of 
 that resulting from the marginal investment 
 of the variable factors of production. It is 
 only by falling into the all too common vice 
 of regarding the problem of industry from the 
 point of view of one particular business unit, 
 that one can reach the mystic doctrine of the 
 Trinity of Rents.
 
 CONCLUSION 163 
 
 To return to our fundamental assumption 
 that it is a marginal product which is to be 
 divided between capital and labor, we found 
 that the various attempts at a solution of 
 this controversial problem, may be grouped 
 under three heads. In other words, three 
 methods have been tried in the attempt to 
 account for the terms of the division of product 
 between capital and labor. First, an inde- 
 pendent explanation of one share, either wages 
 or profit, the other being treated as a residual. 
 Second, an independent explanation of each, 
 but the two covering the entire marginal 
 product the productivity theory. Third, the 
 assertion that the division of the product be- 
 tween labor and capital is the outcome of a 
 struggle the bargain theory. 
 
 Commenting on these in reversed order, we 
 may say that the bargain theory virtually 
 gives up the problem. There is a struggle 
 between employer and laborer, and the com- 
 parative aggressiveness and obstinacy of the 
 contestants may largely determine the out- 
 come. The problem for the economist, however, 
 is to define the strategic points on which the 
 contestants base their demands. What alterna- 
 tive has each party in mind when refusing 
 the terms of the other? To call the process of 
 distribution a bargain or a struggle may be 
 unobjectionable terminology, but does not ex- 
 plain its results.
 
 1 64 PROFIT AND WAGES 
 
 The second of the three methods of explaining 
 distribution, the productivity theory, is open to 
 various objections which need not be repeated 
 at this point. There is left to us, therefore, 
 only the method of proving either the laborer, 
 or the employer to be the residual claimant. This 
 is impossible in the case of the laborer because 
 the return to capitalist and employer cannot 
 be explained independently of the wage earner's 
 share. The time-preference and abstinence 
 theories cannot account for the rate of return 
 for capital except by imposing a fiction on our 
 minds. There remains, therefore, as the only 
 apparent solution, the demonstration of the 
 scale of wages as independent of the size of the 
 product and of the share going to capital. 
 The explanation of wages propounded in the 
 chapter preceding this, the wages fund theory 
 supplemented by a theory of the supply price 
 of labor, satisfies these requirements and makes 
 it possible to represent profit of capital as a 
 residual income. 
 
 The conclusions reached carry us back to 
 doctrines of the classical school. They include 
 the classical concept of profit of capital, in 
 place of the later notion of profit and interest 
 as independent shares; a residual claimant 
 theory of this profit not differing greatly from 
 Ricardo's; and the wages fund theory. 
 
 It would, of course, be absurd to insist that 
 the last word on all questions of distribution
 
 CONCLUSION 165 
 
 is to be found in the pages of the classical 
 school. Much remains to be corrected or 
 elaborated. But the strategic points of attack 
 on fundamental problems were more clearly 
 perceived by Ricardo and his generation than 
 by the majority of their successors. Not 
 given to academic refinements and subtleties, 
 nor led by radical attacks on property to bend 
 scientific inquiry in the direction of an apolo- 
 getic of capitalism, their thought moved directly 
 and with single aim upon the significant and 
 fundamental features of the industrial system 
 before them. So far as later developments 
 shift the point of view which must be taken 
 by the theory of distribution, the most sig- 
 nificant is the large international movement 
 of capital and labor. The part played by immi- 
 grant workers in the advanced industrial areas 
 of today makes it necessary to look beyond 
 the narrow national boundaries of the labor 
 market as conceived by the earlier economists. 
 In our theory of the stipply price of labor, 
 recognition has been given to these changed 
 conditions. Other products of economic evolu- 
 tion it has not been necessary to examine. 
 The growth of corporations and the increasing 
 complexity of what Veblen would group as 
 "pecuniary employments" have opened fields 
 for investigation scarcely thought of by the 
 classical economists. The analysis of these 
 developments, however, is not an essential 
 part of the "first approximation," the general
 
 1 66 PROFIT AND WAGES 
 
 and fundamental theory aimed at in the pre- 
 ceding pages. For the same reason we may 
 decline to discuss the problem of monopoly 
 gains. In the search for a satisfactory funda- 
 mental theory without which the details of 
 an inquiry into the capitalistic processes of 
 these latter days are without meaning, the 
 classical thinkers are still our best guides. The 
 very fact that they are free from the perplexities 
 of later developments in theory and practice, 
 makes them a valuable propaedeutic to the 
 study of the problems of our time. But this 
 praise is only for their scientific work, their 
 unbiased analysis of things as they are. Their 
 political ideals and attitude towards social 
 reform have less significance to our generation 
 and, in any case, are irrelevant to the present 
 inquiry. 
 
 The considerations which have led us to 
 reject a large part of the fruits of more recent 
 theory, are stated at length in the critical 
 passages of the preceding chapters. It will 
 not be necessary to recapitulate them at this 
 point. Let us rather take note of certain 
 general tendencies which manifest themselves 
 in almost all of the errors into which modern 
 theory has fallen. 
 
 First, there is the excessive rationalism of 
 the utilitarian calculus, whose pedigree may 
 be traced to Bentham, but whose greatest 
 vogue has come through the influence of the 
 so-called Austrian school. It culminates in the
 
 CONCLUSION 167 
 
 time-preference theory and in some of its 
 phases is not free from the suspicion of an 
 apologetical Tendenz. As we have seen, it 
 attributes to savers and investors, feats of 
 calculation of subjective costs and gains which 
 are utterly impossible to mortal man. A 
 psychological turn of very questionable advan- 
 tage was thus given to the theory of distribution. 
 It seems indeed doubtful whether psychology 
 will ever make a positive contribution to the 
 explanation of how the real income of society 
 is distributed. In any case, the application 
 of a crude, hedonistic psychology to the problem 
 was a misfortune. 
 
 Another unfortunate tendency in modern 
 economics is the consideration of the problem 
 of distribution as essentially included in the 
 general theory of value. There are, of course, 
 analogies between the purchase and sale of 
 consumers' goods (the proper theme of the 
 theory of value in economic literature) and the 
 purchase and sale of the services of the "factors 
 of production." But the problem in the two 
 cases is not identical. To the theory of value, 
 commodities appear as competing for the con- 
 sumer's favor. Even monopoly products com- 
 pete because the competition referred to is 
 not that between different sellers of the same 
 commodity, but that between different com- 
 modities. The problem of value, in other 
 words, is that of the relative prices of goods, - 
 of the proportionate amounts of money and
 
 1 68 PROFIT AND WAGES 
 
 credit in the hands of the consumers assigned 
 to the purchase of each commodity. 
 
 Now can this way of looking at the matter 
 explain the remuneration of the factors of 
 production? In trying to develop the analogy 
 the entrepreneur must evidently be assigned 
 the role played by the consumer in the theory 
 of value. Can he choose, as the productivity 
 theories represent him, between different 
 "factors of production;" as the consumer 
 chooses between different consumable goods? 
 If, for the sake of argument, we accept the 
 idea of capital as consisting of "intermediate 
 goods," we have three factors of production 
 which the entrepreneur may purchase.* He 
 needs all three, though the proportions in which 
 he takes them might vary. So far the analogy 
 holds between demand for factors of production 
 and that for consumers' goods, though there 
 are only three of these so-called factors, while 
 consumable goods are numbered by the thou- 
 sand. When, however, we look at the side of 
 supply, important differences appear. If any 
 factor is insufficiently rewarded it cannot change 
 into some better remunerated factor. If, on 
 
 "The problem becomes very perplexing when the entrepreneur's 
 function is represented as a fourth factor of production. It 
 is something not purchased by the entrepreneur but by the 
 consumers of the products of industry, and, therefore, does 
 not compete with the other three factors for the favor of the 
 same set of possible purchasers.
 
 CONCLUSION 169 
 
 the contrary, commodity A cannot command 
 a satisfactory price, its producers can turn to 
 the production of commodities B, C, or D. 
 The insufficiently remunerated factor of pro- 
 duction may not even have its supply dimin- 
 ished. We have seen that in the case of capital 
 there is likely to be no decrease in the total 
 supply, but only a slackening in the rate of 
 increase. In the case of labor the process of 
 decreasing supply, that is of lowering population, 
 is extremely slow. In the case of land there 
 is no possibility of diminishing supply. 
 
 Let us return now to the question of demand 
 for the factors of production. The analogy 
 between the remuneration of the factors of 
 production, and the payment of prices for 
 consumers' goods, vanishes utterly when we 
 reject the conception of capital as consisting 
 of intermediate goods. There are reasons for 
 regarding capital as simply the means of pay- 
 ment for hired labor. Use of capital means 
 employment of labor. There is no choosing 
 between labor and capital for the employer. 
 He buys labor by means of capital. The choice 
 apparently existing between the purchase of 
 labor and of "capital goods" is really a choice 
 between different kinds of labor. Instead of 
 having three factors to choose from, the entre- 
 preneur, therefore, appears to have only two. 
 
 But, if we grant the existence of no-rent 
 land and no-rent margins, we have the possibility
 
 1 70 PROFIT AND WAGES 
 
 of dispensing with the payment of a price for 
 the use of land. Then there remains but one 
 thing to buy for the entrepreneur, and that is 
 labor. The entrepreneur (and the capitalist 
 acting through the entrepreneur) must buy 
 labor and it can be bought of the laborer only. 
 The laborer, in his turn, must sell his labor, 
 and it can be sold to the entrepreneur only. 
 Instead of competing factors getting a price 
 from a common purchaser, the process of 
 distribution becomes a bargaining between two 
 social classes. Both of them must ultimately 
 come to terms, although the compelling forces 
 on the two sides may be of very unequal urgency. 
 Such a bargain may be covered by a very general 
 and abstract theory of value and exchange, 
 but all the really significant and interesting 
 features disappear under such treatment. The 
 attempt to approximate the theory of distri- 
 bution to the more specialized theory of the 
 values of commodities can only lead to con- 
 fusion, and should be abandoned. 
 
 Like the excessively rationalistic, psycho- 
 logical character of modern economics, the 
 tendency to confuse the problem of distribution 
 and that of value, is also largely to be attributed 
 to the influence of the Austrian theory of value. 
 The enthusiasm with which the latter was 
 received caused the ready acceptance of the 
 analogous reasoning of the productivity theory.
 
 CONCLUSION 171 
 
 Indeed, the modern theorist felt most at ease 
 when speculating on the subject of value. 
 Every question in economics had perforce to 
 be haled into this field. For the theory of 
 distribution, however, the outcome was a dis- 
 torted perspective and a failure to grasp the 
 significant elements of the problem.
 
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