Essentials of Economic Theory / As Applied to Modern Problems of Industry and Public Policy

by John Bates Clark

We have already represented, in a highly simplified form, the synthesis by which the goods which make up the income of society are produced. A, B, and C represent different raw materials, and they are changed by a series of transmutations into A´´´, B´´´, and C´´´, which stand for all the consumers' goods that the society uses. They represent food, clothing, furnishings, vehicles, and countless means of comfort and pleasure.

The Making of Active Instruments of Production.—It is necessary always to have and use a stock of tools, machines, buildings, and other active instruments of production; and as these wear out in the using, it is necessary that there should be persons who occupy themselves in keeping the stock replenished. Under a system of division of labor there would be special industries devoted to the making of new appliances of production to take the place of those which are worn out and discarded, and also to make repairs on those which are still in use. For illustration, we may let the symbol H´´´ represent all active capital goods that the society uses, the various raw materials which enter into such active goods being represented by H and the partly made instruments by H´ and H´´. If the stock of appliances is not growing larger, just enough of the articles H´´´ are made to replace the discarded ones. No producer gets new machinery, but every one keeps his stock intact.

The Simplified Representation Correct in Principle.—We have now a very simple representation of what actually goes on under the name of the division of labor, and yet the representation is in essential points accurate. In reality a very detailed and minute division and subdivision of industries takes place and the varieties of goods produced are innumerable. Society, as a whole, is making the most highly composite product that can be conceived; namely, consumers' wealth in its countless forms. Each of the grand divisions of society—the general groups that we have represented by the series of A's or of B's—makes a complete article; but even that is in its own way far more composite than the symbol indicates, for it is apt to contain several kinds of raw material and to be made up of a large number of distinct utilities, each of which has its own set of producers. This complexity of the process of production does not change the principle of distribution, by which the product is virtually analyzed into its component elements and the value of each element is assigned to those who create it. This principle can be clearly represented by assuming that each subgroup has one distinct utility to create and that it takes only four of these to make an A´´´, a B´´´ or a C´´´.

A Synthesis within Each Subgroup.—There is within each subgroup a synthesis going on, and this also may be complex. Labor and capital dig ore from the ground—an unusually simple process; and yet there are several distinct operations to be performed before the ore is ready for smelting. When it comes to fashioning the metal into useful shapes, the operations become very numerous and require many subordinate trades even for the making of one product. How many mechanical operations go to the making of a bicycle, an automobile, or a steam yacht? Too many to be represented in any table, but not enough to change at all the principle according to which those who help to make one of these composite products are paid according to their contributions to it. We may consider that all the work that is done in one kind of mill creates one utility. Though there are many subtrades in making a shoe and many more in making a watch, we may proceed as though there were only one transformation of the raw material required in each case. We may let the division between the contiguous subgroups be made commercially rather than merely mechanically, and regard the establishments that buy material and sell it in a more highly wrought condition as moving it forward by one stage on the road to completion, however many changes they may have made in it in the different departments of their several mills. The difference between shoes, on the one hand, and the leather and findings of which they are made, on the other, thus passes for one utility. A manufacturer of shoes puts his leather and findings through many operations before he has shoes for sale; but it is convenient to call all that the manufacturer imparts to these raw elements before he makes them over in their new form to the merchant, one subproduct.

Further Complexities which may be Disregarded.—One man may be in several of the general groups. It is possible, for example, that he may furnish raw materials which enter into more than one finished article. Iron is so extensively used that it goes into more products than can easily be counted. The man who digs iron ore contributes to the making of bridges, rails, locomotives, buildings, machines, ships, and tools in indefinite number and variety. The price of each of the articles into which any of this material goes contains in itself the price of that part of the raw material which goes into it. There is steel in a ship, and the maker of that part of the output of raw steel which goes into a ship gets his pay from the price of the vessel; and so with the crude metal which goes into a bridge, a building, an engine, etc. What the producer of a material gets from each source tends, under perfectly free competition, to equal in amount what he contributes toward the value of the corresponding article. In terms of our table a miner may furnish ore from which iron is taken for the making of both A´´´ and B´´´; and if so, when the distributive process analyzes these products into their elements, the value of what he has in each case contributed will fall to him. He will be paid according to the help he has afforded in the making of the A´´´ and the B´´´, and this fact does not change in principle the manner in which the income of society is divided. If the man helped to make only one thing, he would get a part of the price of that one thing; but if he helps to make several, he will get a part of the price of each of them. Each group has one grand function to perform, such as the making of an A´´´, and if the man helps in more than one, and is paid accordingly, his total pay is according to the amount he produces in all the different functions he performs, and the principle of distribution works as perfectly as it would if the man were confined to the single subgroup A. For simplicity we assume that he is so.

The Functions of Capitalist, Laborer, and Entrepreneur often performed by One Person.—One person may perform several functions, not only by contributing to the products of several groups, but by contributing in more than one way to the product of one subgroup. He may, for example, both labor and furnish capital, and he may, further, perform a special coördinating function which is not labor, in the technical sense, and scarcely involves any continuous personal activity at all, but is essential for rendering labor and capital productive. What this function is we shall presently see. We shall term it the function of the entrepreneur, using this term in an unusually strict way. We shall keep this function quite distinct from the work of the superintendent or manager of a business.

How Much the Term "Labor" Covers.—We include under the term labor all effort expended in a routine way in carrying on business. The overseers in the shops, the bookkeepers, clerks, secretaries, treasurers, agents, and, in short, all who perform any of the labor of management for which they get or can get salaries are laborers in the comprehensive sense in which we use the word. It comes about that the employer usually labors; for he does the highest and most responsible work in his own mill or shop. It is not, however, in his capacity as entrepreneur, or "undertaker," that he labors; for, as the entrepreneur, properly speaking, he employs and pays for all the work that receives a stipend. He may employ himself, indeed, and set aside a stated sum to pay his own salary; but this means that in his capacity as entrepreneur he needs a good manager and hires himself to act in that capacity. Scrupulous fidelity is the most important quality that a manager can possess, and the employer can always trust himself to possess it so long as it is his own interests that he controls.

Entrepreneur and Capitalist.—In the same way we include in the capital of an establishment whatever invested funds the employer himself supplies, as well as what he hires from others. Here again a man is likely to serve in more than one capacity, for as an entrepreneur he hires capital and as a capitalist he lets it out for hire, so that in the one capacity he hires capital from himself acting in the other capacity. The man "puts money" into his own business and gets interest for the use of it.

The Different Functions of the Same Man distinguished in Business.—This distinction between the different functions that one person may perform is not a mere refinement of theory, but is something that is recognized in business and has great practical importance. In a corporation officials who are also stockholders receive salaries that are usually reckoned on the basis of the amount that they could get in the market if they were to enter the employment of other corporations and do the same kind of work they are now doing. Favoritism may give them considerably more than this amount, but even then this amount is the basis of the calculation which fixes their stipend. If they are paid more than their work is worth to their own corporations, what they get is something besides wages or any other normal and legitimate income. If they accept for their time less than they are worth, they make a donation to the corporation. Neither filching something for nothing out of the returns of the corporation, nor giving it a gratuity, is to be here assumed as existent, since we are not dealing with the phenomena of quasi-plunder or eccentric benevolence. The character of wages of management, as the reward for a high grade of labor, is recognized in business life, and the salary of the manager, whether he is a stockholder or not, is usually expressed in a definite sum of money and is gauged, crudely or accurately, according to his value as a servant of the company.

Dividends often Composite.—In like manner it is important in the bookkeeping of a company to ascertain how much of the return to the stockholders is merely interest on the capital they have themselves invested and how much is true profit, or the net gain which is over and above interest. In business life a distinction is pretty clearly maintained between the three kinds of income that have been described; namely, the reward of labor in all its forms, the reward of capital, going to whoever furnishes it, and the reward of a coördinating function, or the function of hiring both labor and capital and getting whatever their joint product is worth above the cost of the elements which enter into it. This essentially commercial margin of returns from production above all costs of production is profits in the strict sense and would be nonexistent in an absolutely static industry. It comes into existence in consequence of the changes with which social Economic Dynamics deals.