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

by John Bates Clark

We will let another figure represent the entire product of the same amount of labor and the same amount of capital that were represented in the former case. We will assume that there is at the outset a complete force of laborers, and that no men are added to it or taken from it; but we will gradually introduce units of capital instead of units of labor as in the former case. The amount of capital is now represented by the line A´E´ and the product of the first unit of it by the line A´C´. The product of the successive units declines along the curve C´D´. The final unit of capital then brings into existence the amount of wealth represented by E´D´. As every other unit now produces the same amount, the capital as a whole creates the quantity represented by A´B´D´E´ and every unit of it makes its own separate contribution to that amount. In this we have simply applied to capital and its earnings the principle we formerly applied to labor and its earnings.

General Form of the Law of Final Productivity.—This principle is the law of final productivity, one of those universal principles which govern economic life in all its stages of evolution. Either one of the two agents of industry, used in increasing quantities in connection with a fixed amount of the other agent, is subject to a law of diminishing returns. The final unit of the increasing agent produces less than did the earlier units in the series. This does not mean that at any one time one unit produces less than another, for at any one time all are equally productive. It means that the tenth unit produces less than the ninth did when there were only nine in use, and that the ninth unit formerly produced less than the eighth did in that still earlier stage of the process in which there were only eight in use, etc. If the productive wealth of the United States were only five hundred dollars per capita instead of more than twice that amount, interest would be higher than it is, because the productive power of every dollar's worth of capital would be more than the productive power of each dollar's worth is now; and, on the other hand, if we continue to pile up fortunes, great and small, till there are in the country two thousand dollars for every man, woman, and child of the population, interest will fall, because the productive power of a dollar's worth will become less than it now is.

How Competition fixes Interest.—We can now see how it is that the capitalist can make the entrepreneur pay over to him the amount left in his hands after paying wages. Every unit of capital that any one offers for hire has a productive power. It can call into existence a certain amount of goods. The offer of it to any entrepreneur is virtually an offer of a fresh supply of the kinds of goods which he is making for sale. Loaning ten thousand dollars to a woolen manufacturer is really selling him the amount of cloth that ten thousand dollars put into his equipment will bring into existence. Loaning a hundred thousand dollars to the manufacturer of steel, so as to enable him in some way to perfect his equipment, is virtually selling him the number of additional tons of steel, ingots, or rails that he can make by virtue of this accession to his plant.

The Significance of Free Competition.—Now, the tender of capital may be made to any entrepreneur in a particular industry, and the existence of free competition between these entrepreneurs implies that a lender of capital can get from one or another of them the whole value of the product that this capital is able to create. A unit of capital in the steel business can produce n tons of steel in a year, and if one employer will not pay the price of n tons for the loan of it, another will. This, indeed, implies an absolutely free competition; but that is the condition of the problem we have first to solve. When we know what ideally active competition will do, we can measure the effects of the obstructions that, in practice, competition actually encounters.

Competition for Capital among Different Industries.—The capitalist can invoke the aid of competition outside of the limits of one particular business. He may offer his loan to steel makers, to woolen manufacturers, cotton spinners, silk weavers, shoemakers, etc. Within each one of these industries perfect competition between the different employers will give him the value of the product which, in that business, his capital is able to create. If, however, what in this way he offers to men in one occupation is worth more than what he offers to men in another line,—if capital is worth more to steel makers than it is to cotton spinners,—he will find a market for his capital in the former industry; and this process of seeking out the employment in which capital is the more productive and there bestowing the loans of capital, will go on until every such local excess of productive power is removed and capital can produce as much wealth in one business as it can in another. Everywhere capital will then be both producing and receiving the same amount, and general interest will everywhere be determined by the final productivity principle acting all through the business world.

When Interest as Directly Determined equals Interest as Residually Measured.—The area BCD of the first figure measures what the entrepreneur has left after paying wages. This amount and no more he can pay as interest, and he will pay it if he has to. The area A´B´D´E´ of the second figure represents what he must pay as interest; and we can now see that, if competition is perfectly free, this amount equals the amount BCD of the first figure. If, after paying wages, there is any more left in the entrepreneur's hands than competition compels him to pay out as interest, he is realizing a net profit; he is selling his goods for more than they cost him, and this, as we saw at the outset, is a condition that under perfect competition cannot continue. The natural price of goods is the cost price. If the market price of anything is in excess of cost, entrepreneurs receive a profit, and in order to do more business and make a larger aggregate of such profit they bring new labor and capital into their industry. The increased output lowers prices, and the excess of gain is thus taken from the entrepreneur. If BCD is smaller than A´B´D´E´, the entrepreneur incurs a loss and will curtail his business and let some labor and capital go where they can produce more.

Taking this remainder of income from the entrepreneur by means of an addition to the output of goods and a reduction of the price of them does not annihilate the income, but bestows it on other recipients; for the reduction in price which destroys an employer's profit can come only in a way that benefits consumers. It means that enlarged production of which we have just spoken, which scatters more goods throughout the community and insures an addition to the real incomes of both laborers and permanent investors.

Effect of Perfect Mobility of Labor and Capital.—Perfect mobility of labor and capital insures that the residuum in the entrepreneur's hands after wages are paid shall all be made over to the capitalist. We encounter here again the static law that, with competition working without let or hindrance, the entrepreneur as such can keep nothing for himself; though if he is also a worker he will get wages, and if he is also a capitalist he will get interest. His business will pay wages on all kinds of labor, including that of management, and interest on all capital, including his own. A net gain above all this it will not afford, and whatever the entrepreneur has left after paying wages he will have to use in paying interest, and vice versa. Laborers and owners of capital have, as it were, to take each others' leavings. Such is the situation in an ideally static condition, though we shall see how it is changed in actual and progressive society.

The area BCD of the first figure is, under static conditions, exactly equal to the area A´B´D´E´ of the second figure, because ACDE represents the whole product, BCD in the first figure represents all that is left of it after wages, measured by ABDE, are paid; and we know by evidence both theoretical and practical that the capitalist, whose share is directly expressed by A´B´D´E´ of the second figure, can claim and get the whole of this amount.

Wages as a Residuum.—It is clear that the same reasoning applies to wages. In the second figure they are represented as a residuum. The area B´C´D´ represents what the entrepreneur has left after paying interest, and nobody can get this amount but the wage earner. The reason, however, why the wage earner can get it is that free competition will give him the amount ABDE of the first figure, and this, under perfectly static conditions, must equal B´C´D´ of the second. Under perfect competition the entrepreneur cannot have any of the amount B´C´D´ left in his hands after meeting the claims that the wage earner makes on him. On the other hand, he must have enough left to pay interest, since otherwise he would be incurring a loss, and that could not fail to force him and others who are in the same situation to contract their operations or go out of business. If the output of goods is reduced, either by the retirement of some employers or the curtailment of product by all, the price of what continues to be sold will be raised to the point at which wages and interest can be paid.