Essays on some unsettled Questions of Political Economy

by John Stuart Mill

There is, in short, a productive class, and there is, besides, a class technically styled the monied class, who live upon the interest of their capital, without engaging personally in the work of production.

The class of borrowers may be considered as unlimited. There is no quantity of capital that could be offered to be lent, which the productive classes would not be willing to borrow, at any rate of interest which would afford them the slightest excess of profit above a bare equivalent for the additional risk, incurred by that transaction, of the evils attendant on insolvency. The only assignable limit to the inclination to borrow, is the power of giving security: the producers would find it difficult to borrow more than an amount equal to their own capital. If more than half the capital of the country were in the hands of persons who preferred lending it to engaging personally in business, and if the surplus were greater than could be invested in loans to Government, or in mortgages upon the property of unproductive consumers; the competition of lenders would force down the rate of interest very low. A certain portion of the monied class would be obliged either to sacrifice their predilections by engaging in business, or to lend on inferior security; and they would accordingly accept, where they could obtain good security, an abatement of interest equivalent to the difference of risk.

This is an extreme case. Let us put an extreme case of a contrary kind. Suppose that the wealthy people of any country, not relishing an idle life, and having a strong taste for gainful labour, were generally indisposed to accept of a smaller income in order to be relieved from the labour and anxiety of business. Every producer in flourishing circumstances would be eager to borrow, and few willing to lend. Under these circumstances the rate of interest would differ very little from the rate of profit. The trouble of managing a business is not proportionally increased by an increase of the magnitude of the business; and a very small surplus profit above the rate of interest, would therefore be a sufficient inducement to capitalists to borrow.

We may even conceive a people whose habits were such, that in order to induce them to lend, it might be necessary to offer them a rate of interest fully equal to the ordinary rate of profit. In that case, of course, the productive classes would scarcely ever borrow. But government, and the unproductive classes, who do not borrow in order to make a profit by the loan, but from the pressure of a real or supposed necessity, might still be ready to borrow at this high rate.

Although the inclination to borrow has no fixed or necessary limit except the power of giving security, yet it always, in point of fact, stops short of this; from the uncertainty of the prospects of any individual producer, which generally indisposes him to involve himself to the full extent of his means of payment. There is never any permanent want of market for things in general; but there may be so for the commodity which any one individual is producing; and even if there is a demand for the commodity, people may not buy it of him but of some other. There are, consequently, never more than a portion of the producers, the state of whose business encourages them to add to their capital by borrowing; and even these are disposed to borrow only as much as they see an immediate prospect of profitably employing. There is, therefore, a practical limit to the demands of borrowers at any given instant; and when these demands are all satisfied, any additional capital offered on loan can find an investment only by a reduction of the rate of interest.

The amount of borrowers being given, (and by the amount of borrowers is here meant the aggregate sum which people are willing to borrow at some given rate,) the rate of interest will depend upon the quantity of capital owned by people who are unwilling or unable to engage in trade. The circumstances which determine this, are, on the one hand, the degree in which a taste for business, or an aversion to it, happens to be prevalent among the classes possessed of property; and on the other hand, the amount of the annual accumulation from the earnings of labour. Those who accumulate from their wages, fees, or salaries, have, of course, (speaking generally) no means of investing their savings except by lending them to others: their occupations prevent them from personally superintending any employment.

Upon these circumstances, then, the rate of interest depends, the amount of borrowers being given. And the counter-proposition equally holds, that, the above circumstances being given, the rate of interest depends upon the amount of borrowers.

Suppose, for example, that when the rate of interest has adjusted itself to the existing state of the circumstances which affect the disposition to borrow and to lend, a war breaks out, which induces government, for a series of years, to borrow annually a large sum of money. During the whole of this period, the rate of interest will remain considerably above what it was before, and what it will be afterwards.

Before the commencement of the supposed war, all persons who were disposed to lend at the then rate of interest, had found borrowers, and their capital was invested. This may be assumed; for if any capital had been seeking for a borrower at the existing rate of interest, and unable to find one, its owner would have offered it at a rate slightly below the existing rate. He would, for instance, have bought into the funds, at a slight advance of price; and thus set at liberty the capital of some fundholder, who, the funds yielding a lower interest, would have been obliged to accept a lower interest from individuals.

Since, then, all who were willing to lend their capital at the market rate, have already lent it, Government will not be able to borrow unless by offering higher interest. Though, with the existing habits of the possessors of disposable capital, an increased number cannot be found who are willing to lend at the existing rate, there are doubtless some who will be induced to lend by the temptation of a higher rate. The same temptation will also induce some persons to invest, in the purchase of the new stock, what they would otherwise have expended unproductively in increasing their establishments, or productively, in improving their estates. The rate of interest will rise just sufficiently to call forth an increase of lenders to the amount required.