Capital and Interest: A Critical History of Economical Theory

N. W. Senior must be regarded as the founder of the Abstinence theory. It appeared first in his lectures delivered before the University of Oxford, and later in his
Outlines of the Science of Political Economy.*1

Rightly to estimate Senior’s theory we must for a moment recall the position which the doctrine of interest held in England about the year 1830.

The chief writers of the modern school of political economy, Adam Smith and Ricardo—the former with less, the latter with greater distinctness—had pronounced labour to be the only source of value. Logically carried out, this could leave no room for the phenomenon of interest. All the same, interest existed as a fact, and exerted an undeniable influence on the relative exchange value of goods. Adam Smith and Ricardo took notice of this exception to the “labour principle,” without seriously trying either to reconcile the disturbing exception with the theory, or to explain it by an independent principle. Thus with them interest forms an unexplained and contradictory exception to their rule.

This the succeeding generation of economical writers began to perceive, and they made the attempt to restore harmony between theory and practice. They did so in two different ways. One party sought to accommodate practice to theory. They held fast by the principle that labour alone creates value, and did their best to represent even interest as the result and wage of labour,—in which, naturally, they were not very successful. The most important representatives of this party are James Mill and M’Culloch.
*2

The other party with more propriety tried to accommodate theory to fact. This they did in various ways. Lauderdale pronounced capital, as well as labour, to be productive, but his views found little acceptance among his countrymen. Ever since the time of Locke English economists were much too thoroughly acquainted with the idea that capital itself is the result of labour to be willing to recognise in it an independent productive power. Others again, with Malthus at their head, found a way of escape in explaining profit as a constituent part of the costs of production alongside of labour. Thus, formally at least, was the phenomenon of interest brought into harmony with the ruling theory of value. Costs, they said, regulate value. Interest is one of the costs. Consequently the value of products must be high enough to leave a profit to capital after labour has received its remuneration.

It must be admitted that this explanation left substantially everything to be desired. It was too evident that profit was a surplus over the costs, and not a constituent part of them; a result and not a sacrifice.

Thus neither of the economic positions which were then taken on the theory of interest was quite satisfactory. Each had some adherents, but more opponents; and these opponents found a welcome opening for attack in the sensible weaknesses of the doctrine. The opportunity was amply utilised. The one party was forced to see its assertion translated into the ridiculous statement that the increment of value which a cask of wine gets through lying in a cellar can be traced to labour. The other party was forced, by inexorable logic, to confess that a surplus is not an outlay. And while the two parties were thus at variance over the proper foundation of interest, a third party began to make itself heard, if only modestly at first,—a party which explained interest as having no economical foundation, as being merely an injury to the labourer.
*3

Amid this restless and barren surging of opinions came Senior, proclaiming a new principle of interest, viz. that interest is a reward for the capitalist’s Abstinence.

Isolated statements expressing the same idea had indeed appeared frequently before Senior’s time. We may see it foreshadowed in the often recurring observation of Adam Smith and Ricardo that the capitalist must receive interest, because otherwise he would have no motive for the accumulation and preservation of capital; as also in the nice opposition of “future profit” to “present enjoyment” in another part of Adam Smith’s writings.
*4 More distinct agreement is shown by Nebenius in Germany and Scrope in England.

Nebenius found the explanation of the exchange value of the services of capital, among other things, in this, that capitals are only got through more or less painful privations or exertions, and that men can only be induced to undergo these by getting a corresponding advantage. But he does not discuss the idea any further, and shows himself in the main an adherent of a Use theory which shades into the Productivity theory.
*5

Scrope puts the same idea still more directly.
*6 After having explained that, over and above the replacement of the capital consumed in production, there must remain to the capitalist some surplus, because it would not be worth his while to spend his capital productively if he were to gain nothing by it, he explicitly declares (p. 146): “The profit obtained by the owner of capital from its productive employment is to be viewed in the light of a compensation to him for abstaining for a time from the consumption of that portion of his property in personal gratification.” In what follows it must be confessed that he treats the idea as if it was peculiarly “time” that was the object of the capitalist’s sacrifice; argues in a lively way against M’Culloch and James Mill, who had declared “time” to be only a word, an empty sound, which could do nothing, and was nothing; and does not even hesitate to declare that time is a constituent part of the costs of production: “The cost of producing any article comprehends (1) the labour, capital, and time required to create and bring it to market” (p. 188),—a strange falling off, which scarcely need be seriously discussed.

Now this same idea, which his predecessors merely touched on, Senior has made the centre of a well-constructed theory of interest: and whatever we may think of the correctness of its conclusions, we cannot deny it this credit that, among the confused theories of that time, it was remarkable for its systematic grasp, its consistent logic, and the thorough manner in which it puts its materials to the best advantage. An epitome of the doctrine will confirm this judgment.

Senior distinguishes between two “primary” instruments of production, labour and natural agents. But these cannot attain to complete efficiency if they are not supported by a third element. This third element Senior calls Abstinence, by which he means “the conduct of a person who either abstains from the unproductive use of what he can command, or designedly prefers the production of remote to that of immediate results” (p. 58).

His explanation why he does not take the usual course of pronouncing capital to be the third element in production is rather ingenious. Capital is, he says, not a simple original instrument; it is in most cases itself the result of the co-operation of labour, natural agents, and abstinence. Consequently, if we wish to give a name to the peculiar element—the element separate from the productive powers of labour and nature—which becomes active in capital, and stands in the same relation to profit as labour stands to wage, we cannot name anything but abstinence (p. 59).

Of the manner in which this element takes part in the accumulation of capital, and at the same time, indirectly, in the results of production, Senior repeatedly gives ample illustrations. I give one of the shortest in his own words:—

“In an improved state of society the commonest tool is the result of the labour of previous years, perhaps of previous centuries. A carpenter’s tools are among the simplest that occur to us. But what a sacrifice of present enjoyment must have been undergone by the capitalist who first opened the mine of which the carpenter’s nails and hammer are the product! How much labour directed to distant results must have been employed by those who formed the instruments with which the mine was worked! In fact, when we consider that all tools, except the rude instruments of savage life, are themselves the product of earlier tools, we may conclude that there is not a nail among the many millions annually fabricated in England which is not to a certain degree the product of some labour for the purpose of obtaining a distant result, or, in our nomenclature, of some abstinence undergone before the conquest, or perhaps before the Heptarchy” (p. 68).

Now the “sacrifice,” which lies in the renunciation or postponement of enjoyment, demands indemnification. This indemnification consists in the profit of capital. But admitting this one must ask, In the economical world is the capitalist able to enforce what may be called his moral claim on indemnification? To this important question Senior gives the answer in his theory of price.

The exchange value of goods depends, according to Senior, partly on the usefulness of the goods, partly on the limitation of their supply. In the majority of goods (exception being made of those in which any natural monopoly comes into play) the limit of supply consists only in the difficulty of finding persons who are willing to submit to the costs necessary for making them. In so far as the costs of production determine the amount of supply they are the regulator of exchange value; and indeed chiefly in this way, that the costs of production of the buyer—that is, the sacrifice with which the buyer could himself produce or procure the goods—constitute the “maximum of price,” and the cost of production of the seller the “minimum of price.” But these two limits approximate each other in the case of that majority of goods which come under free competition. In their case therefore the costs of production simply make up a sum that determines the value.

But the costs of production consist of
the sum of the labour and abstinence requisite for the production of goods. In this sentence we come to the theoretical connection between the doctrine of interest and that of price. If the sacrifice Abstinence is a constituent part of the costs of production, and these costs of production regulate value, the value of goods must always be great enough to leave a compensation for the abstinence. In this way the surplus value of products of capital, and with it natural interest on capital, is formally explained.

To this last exposition Senior adds a criticism of the interest theory of several of his predecessors which almost deserves to be called classical. He exposes among other things in a forcible way the blunder which Malthus had committed in putting profit among costs. But not content with criticising, he explains very beautifully how Malthus had fallen into the mistake. Malthus had rightly perceived that, beyond the sacrifice of labour, there is another sacrifice made in production. But since there was no term by which to designate it, he had called the sacrifice by the name of its compensation, in the same way as many people call wage of labour (which is the compensation for the sacrifice of labour) a constituent part of cost, instead of calling the labour itself by that name. Torrens, again, who had already blamed Malthus for his mistake, had himself committed a sin of omission. He had rightly eliminated “profit” from the costs of production, but was himself quite unable to fill the gap.