2.8 The Revenue of Capital
The three-factor model of production - land, labor, and capital - places into the category of capital anything that is neither land nor labor, which can be a broad array of things: equipment, materials, and money. It's often simplified to money alone, and this is reactively accurate as money can be used to purchase the other two - so whether an investor furnishes a ton of leather or the equivalent sum of money with which the agent will purchase the same material seems to make little difference, assuming the commodity required for production is available for purchase.
In some instances, the producer furnishes the capital for his own use: he pays out of his own purse for the materials and equipment he needs to engage in productive activity. In other instances, his need or preference is to use the capital of others to produce, and those who contribute capital to his operations expect to share in the profit that their capital has enabled the producer to create.
The question then becomes: what portion of the revenue of production is justly owed to those who provide capital resources? Or, what ratio of the value produced is accurately attributable to the capital contributed?
On Usury
Where productive use of capital is unknown, the loan of a thing is repaid by its return in equal measure, and to suggest that the borrower owes to the lender more than was given is considered unjustified, to the degree of being unethical (usury). In the present age we recognize that capital can be used productively, that those who contribute to production have justly earned some share of the profits.
The notion of loaning at interest has also been criticized as a method by which the rich of exploiting the poor by charging interest - though this does not consider the use that the lender makes of the capital he is able to access by borrowing. Where the borrower makes productive use of borrowed money, the interest is but a trifle. Where he wastes what he borrows, it is a burden. It seems improper to hold the lender to blame for the consequences of a borrower's poor judgment and poor behavior.
Moreover, a prejudice against individuals who have wealth, chiefly by those who do not, exists in general, but seldom considers the means by which a person has become rich: they have produced beyond their own needs, and been thrifty in the use of their resources. It's only by sloth or gluttony that a man remains in poverty, and it is with some irony that we observe the qualities that lead to wealth are virtues, but the result of practicing those virtues is considered vice.
The distaste for money-lending is also an irrational prejudice, particularly against the Jewish. As Christianity condemns the loaning of money, but not the borrowing of it, this has led to a situation for hundreds of years in which Christians in need of loans were beholden to Jewish lenders and, upon failing to make productive use of borrowed sums, refuse to accept the blame for their own misdeeds and direct their hatred to those who loaned them the money to waste.
In the present age, we better recognize the value of capital - not as a thing unto itself, but as a tool that is used to generate revenue. To sell threat to a weaver is not a vice. Neither is it a vice to supply him with thread on the condition of repayment on the sale of his cloth. Nor should it be seen any differently to loan him the money to purchase thread under the same terms of payment.
If we look to the practical outcome, it is clearly to the greater benefit of society for those who have the ability to produce goods to be able to obtain, in advance, the means to be productive, than to sit idle for lack of the materials they need to do so. Hoarded wealth detracts from production, wealth squandered on self-indulgence encourages unhealthy production, but wealth invested in production for the common good (and the profit of the investor) is its most beneficial form of employment.
Against this, the argument against usury, or against the borrowing or lending of capital, seems ignorant and indefensible.
Interest Due to Risk
In Say's time, the notion of usury had been modified - lending money was entirely acceptable, and the argument had instead become over the rate of interest.
The terms of a loan are negotiated between lender and creditor - a private matter into which intrusion is unwarranted. In effect, the rate of interest is agreed upon by the borrower when he seeks to gain money of a creditor, and his complaint of interest comes only when he must fulfill his part of the bargain and wishes then to deviate from the terms he has entered into.
And again, a borrower who makes productive use of the capital has little difficulty in repaying his debt: he projected his revenue at the time the loan was taken and was judicious in his estimation of the amount he would be able to repay. This is the sole factor a lender applies in deciding the terms that he should accept - seeking to pay as little as possible for capital to increase his own revenue, but knowing the limit of his capacity to pay.
Those who lend money also think to their own profit, but recognize that no profit is to be made of a borrower who fails to make payment. In negotiating the rate of interest, he considers not only the value of using his capital, and not only the profit he might make by lending it to another party, but also the degree of confidence he has that a given lender will repay.
This the interest rate demanded of a given borrower is analogous to the premium charged for insurance, considering the security of the lender in the repayment of his funds. Among the factors he considers are the borrower's intended use of the funds - whether it will be productive, the likelihood of being less productive (or entirely lost), the timeliness of repayment, the personal character of the borrower in his demonstrated willingness to repay, and the assistance he may get from authority in collecting from a reluctant debtor.
Say considers the lending practices in classical Athens, where interest rates to merchant seamen fluctuated according to he length and perilousness of their journeys. There was great disparity in the amount of interest demanded of ships that sailed to safe and proximate ports of call than to more distant ports in barbarous locations, as a result of the uncertainty that the voyage would be completed.
Loans are sometimes contracted not for productive investment, but for "mere barren consumption." Lenders are especially wary of this nature of loan, as there is no directly observable means of repayment - the borrower is expected to make repayment, but the means are unclear, presumed to be his typical occupation.
The term of a loan also bears on its interest rate - the sooner the repayment, the less the uncertainty, and the lower the rate demanded. This is subjective, as a ship may sink tomorrow as readily as it may sink six months from now, but it's generally accepted that the greater the length of time, the more opportunity there exits for misfortune. Say makes the connection to credit money: a treasury note that can be redeemed on demand is honored closer to its face value than a note that will be repaid several months hence - in part due to the inconvenience of not having the commodity owed, but also in part due to the risk it will not be available in future.
Moving on to the personal character of the debtor, there can be little doubt that this has tremendous influence on the premium of interest, as it is witnessed that the vices and virtues of men are not strictly fixed but seldom changed: he who has honored his agreements in past is considered likely to do so in future; he who has neglected them in the past is considered likely to do so in future. A special case is the man who has not entered into any debt in the past, and whose character is unknown: hence the reason that those who have borrowed and repaid are more trusted than those who have never borrowed at all - though the virgin debtor is still preferred over one who has willfully neglected his obligations.
The final factor Say describes,. But by no means the final one a creditor may opt to consider, is the assistance he may receive of government in collecting his debts. This contributes to certainty of repayment, and reduces the cost of collection. A government that does not provide such assistance to creditors, and who further prevents creditors from collecting by their own means, removes incentive for borrowers to repay. While it is detrimental to the individual who is unable to repay his debt for government to intervene, it is of greater benefit to all borrowers for lenders to have the certainty of this assistance, and thus lower their rates of interest.
As an aside, Say is opposed to the practice of imprisonment of debtors: to thus confine a person, at the expense of the state, is to prevent him from undertaking any action to settle his debts. The similar practice of enslaving a debtor to his creditor to work off his debts, common in Say's time and witnessed in the cultures of Rome and India, is likewise undesirable, as a man compelled to labor is seldom employed to his greatest benefit.
Returning to the notion of usury, the laws that fix a maximum rate of interest may well be intended to enable more borrowing at a lower rate, but in practice result in less lending: the creditor cannot sufficiently charge for the risk of a loan. This tends to lead to stagnation, as the safest industries are seldom the most profitable or progressive.
Interest Due to Use of Capital
When risk of repayment is addressed, there remains some portion of interest that is assessed due to the use of capital. Returning to the example, the spinner who enters into a joint-venture with a weaver expects a fair share of the profits earned by the sale of the cloth, regardless of the cost of producing thread. Lenders of capital are similarly motivated to share in the profits of the particular use of their capital.
Those who provide capital, like those who provide labor, seek to put it to use where it will earn the greatest return, which makes the measure imprecise. A borrower whose intentions have less potential for profit must match the rate of those who have greater potential in order to be granted a loan. To the individual, this means sacrificing a greater portion of his revenue to his creditor than he might prefer. To a nation, this means that the majority of credit is given only to the most profitable industries, to the detriment of other pursuits. It sometimes means the encouragement of "rare and dangerous" undertakings in favor of more certain and steady ones with less promise for production.
On the other hand, where the supply of capital exceeds the demand for it, lenders must lower rates to put their capital to productive use at all. As such, there is a cycle of expansion and retrenchment in the industry of every nation, and one cannot contrive a rate of interest that is best suited for all situations and all times. Instead, capital and employment in search of one another should be left to negotiate their terms.
Another important distinction to be made is that not all capital is available for production in a nation. Some capital is already engaged, and some remains in circulation. It is only the disposable capital that is available. Consider the owner of any operation: some of his capital is for his near-term consumption, other capital is reinvested in his operations. He does not seek another use for his capital unless he has engaged as much as can be made productive in his operations - and where other opportunities afford him a higher return, it becomes clear that the activity of others is more productive than his own - his self-interest and the benefit of the market are better served if he ceases production and encourages others to produce.
The Unimportance of Money
Money is the medium in which loans are customarily granted, and as such it receives far too much attention in discussions of capital. No-one borrows money simply to have money - they borrow money to have the means to purchase things.
As such, the abundance or scarcity of money has little impact on the rate of interest - though rather esteemed individuals have fallen into the trap of thinking that it does, and advocating the supply of money to a market to stimulate economic progress. This mixes up the cause and effect.
What determines demand of credit is the desire of men in a market to be productive beyond their present means. Where most men are uninspired to be productive, they do not need the means, and demand of credit is low. When many are inspired to undertake new ventures, their need for capital is great, and the demand for credit is higher.
It is not only the inspiration of men to be productive, but the non-monetary resources requisite to production that stimulates a need for credit. Even if a merchant desires to purchase a ship to pioneer a new trade route, if there are no ships available for him to purchase, there is no purpose in seeking credit.
As such, money is relegated to its rightful role as a token of exchange: there is no need of money when there is nothing to be had for it or nothing to be done with it.
The Profits of Capital
The revenue that can be gained by loaning capital to others for use in productivity is a fraction of the profits created by of capital when it is employed in productive activity, from which all value is derived.
Isolating any of the factors of production and assigning to it a specific value is difficult: a given value of goods are created when a field is ploughed - but what fractions of this value are specifically attributable to the plow (capital), the field (land), and the effort of the ploughman (labor) are not easily affixed: if any one of the three is absent, nothing is created at all.
One method seeks to compare "houses" involved in the same trade, but this is unsatisfactory because the other factors may vary as well: two houses of equal capital may generate different levels of revenue as a result of the skill of labor or the productiveness of land; and two houses in the same trade with identical revenue may have different ratios of the factors of production. We can also observe that some industries have less need of capital than others, but neither does this provide much enlightenment.
Within a given operation, it is easier to calculate the value of capital by the proposal of a specific application: the master agent of a weaving house can calculate the value of an additional loom by projecting the revenue of the cloth, less the cost of the tread, less the wages of the laborer, to estimate the value of that capital investment.
Turning to Adam Smith's maxim, human labor is the first price of all things, and as such the value of capital may be considered the additional profit that can be made over the cost of labor: the difference in the value produced by a given number of men will differ from one industry to another - and what one use of labor will produce in excess of alternative uses is caused by something else. Say, however, feels this is overly simplistic and does not account for all factors.
From all of this, he arrives at a murky conclusion: "that the profit of capital, like that of land and other natural sources, is the equivalent given for a productive service, which though distinct from that of human industry, is nevertheless its efficient ally in the production of wealth."
(EN: Which is ultimately to arrive where he began. Land, labor, and capital are used together and ascribing the proportion of revenue to each is a difficult proposition.)
The Social Benefit of the Employment of Capital
Those who are possessed of the factors of production seek to make the most productive use for it: the land-holder to identify the most profitable crop, the laborer to identify the occupation that offers the best wages, and the capitalist to find the investment that offers the best return.
It has been suggested, of the capitalist more often than the other two, that what he finds to be most beneficial to himself is not necessarily the most beneficial to the community at large. This is, even at first glance, contrary to the nature of community, which is merely an aggregate of the results that individuals achieve. Where every man is most productive, the community is most productive.
It is generally considered that the best use of capital is in the production of raw materials, as raw materials feed every other form of industry: food for the laborers, wool for the spinners, wood for the carpenters, and iron for the blacksmith all result in the production of more industry of other kinds. But this is a matter of balance: the creation of a material sets in motion a series of activities that result in finished goods. The other activities are also valid uses of capital (producing iron ore is pointless unless there is another industry to make use of it) and it is taken for granted that some use will be made of the output (there is a limit to the demand for woolen cloth that is not increased because of the presence of more wool).
A similar fallacy is the belief that capital is of greatest benefit to a nation where it is used for expanding the facilities for production of goods: investment in developing land for farming and equipping factories for production creates potential income - but this also takes for granted that the product they are capable of producing will be produced. Thus we see the wastefulness of public funds to give encouragement to unprofitable industry, encouraging the domestic manufacture of goods that could be more cheaply imported for the sake of having productive capacity in an arbitrary location.
It is also generally considered that the best use of capital is for domestic consumption: that any employment of capital that sends goods abroad delivers no value to the citizens of a given nation. Aside of the fact that nations and communities are arbitrary, this overlooks that any good sent abroad brings back equal value in goods that cannot be produced efficiently, or at all, in the domestic market.
As such, Say considers it fortunate that "the natural course of things impels capital into those channels which are the most beneficial to the community." Self-interest may lead a man to seek the greatest profit for himself, but the greatest potential profit is determined by the greatest un-served need of the market: to pursue this profit, the capitalist is indirectly inclined to serve the interests of others.