Chapter 19 of 26 · Capitalism: A Treatise on Economics by George Reisman

Chapter 16. The Net-Consumption/Net-Investment Theory of Profit and Interest

CHAPTER 16

THE NET-CONSUMPTION/NET-INVESTMENT

THEORY OF PROFIT AND INTEREST

PART A

THE POSITIVE THEORY

1. The Nature and Problem of Aggregate Profit In Chapter 13, I showed how production and supply are the source of demand in the sense of purchasing power—that is, real demand. In Chapter 15, I showed how saving and productive expenditure are the source of the great bulk of spending in the economic system. This conclusion followed from the fact that they not only make possible the demand for capital goods, which in a modern economic system almost certainly surpasses the demand for consumers’ goods, but also the payment of wages by business, out of which comes the great bulk of consumer spending. 1 In this chapter, I will make good on the promise I made in Chapter 15 to show how business—taken in the aggregate—is the source not only of the monetary demand for its own products, but of a profitable monetary demand for its products. As I promised, I will show how business “itself generates a monetary demand that is fully sufficient for the profitable sale of its products . . . in the mere fact of purchasing capital goods and paying wages and in declaring dividends and paying interest” and how “in addition, the very increase in production itself operates to add further to both the real and the nominal rate of profit.” I will show, indeed, how there are “virtual springs to the restoration of profitability” waiting to be unleashed whenever inflation and credit expansion bring on a financial contraction and deflation and thereby temporarily impair business prof—

2 itability or wipe it out altogether.

In this chapter, I will explain the determinants both of the aggregate amount of profit in the economic system and I will of present the average a theory rate of of profit profit in which the economic will show system. that in a society characterized by consistent laissez-faire capitalism, and thus free of financial contraction brought on by a preceding inflation or credit expansion, the average rate of profit is always determined at a point that is both high enough to make investment worthwhile and, at the same time, as low as the security of property and all rational provision for the future make possible. Thus, I will show—in contrast to the claims of the Keynesians and the Marxists—that the rate of profit is neither “too low” nor “too high” and that neither pretext constitutes grounds for a policy of government intervention or socialism. 3

The theory of profit I will present in this chapter is the basis on which I was led to the development both of much of the material that I have already presented, in previous chapters, and of much of the material that is yet to come, in subsequent chapters. It is the basis of my having arrived at virtually the whole of the analysis I presented in Chapter 11 and in Chapters 13–15, from the definition of productive expenditure and consumption expenditure through the critique of the conceptual framework of the exploitation theory, the exposition of the philosophy of

productionism, Say’s Law, the causes and cure of mass unemployment, the productivity theory of wages, and the development of my system of aggregate economic accounting. The only major doctrine presented in those chapters concerning which I cannot fully claim my theory of profit to be the basis of my exposition, is the doctrine that the demand for A is the demand for A. This is because it was my reading of John Stuart Mill’s statement of this doctrine, in the form “demand for commodities is not demand for labour,” that precipitated my development of my theory of profit. My theory of profit, as I will show, rests substantially on recognition of the truth grasped by Mill in his famous proposition. Of course, in turn, my theory of profit greatly reinforces and amplifies the truth of that proposition.

In this and subsequent chapters, my theory of profit will provide both the basis of analysis of questions I have not yet considered in this book and a wider perspective and more comprehensive theoretical framework for the analysis of questions that I have already considered. It will thereby make possible both the acquisition of important new knowledge, and valuable reinforcement, amplification, and integration of knowledge that the reader has hopefully already acquired to an important degree.

Before turning to the presentation of my theory of profit, however, it is necessary to attend to a number of important preliminary matters, starting with my treatment of interest.

The Treatment of Interest

The theory of profit I will expound will explain not only the average rate of profit in the economic system but also the rate of interest. The explanation of the rate of interest will follow from the explanation of the rate of profit.

In explaining the rate of profit, my purpose will be to explain what makes possible an excess of business sales revenues over business costs that are exclusive of interest. In other words, I will continue my practice of taking profits as gross of interest cost, that is, prededuction of interest cost. The average rate of profit that I will explain will be the amount of profit thus understood, divided by the amount of capital invested in the economic system both by equity investors—i.e., stockholders, partners, and sole proprietors— on the one side, and by bondholders and other creditors, on the other. In other words, it will be the rate of return found by dividing the sum of profit income earned by business firms plus interest paid by business firms, by the sum of all capital invested in business firms. The result will approximate what many would call the average rate of return on capital invested. 4

As I have already shown, the rate of profit taken prededuction of interest determines the rate of interest that business borrowers are able and willing to pay. In order for them to borrow, they must expect to earn a rate of profit in this sense that is greater than the rate of interest they are asked to pay. At the same time, of course, insofar as business firms are sources of loanable funds, the rate of interest they ask as lenders depends on the rate of profit they expect to be able to make by investing the funds in question in their own operations. In these ways, the rate of profit determines the rate of interest. 5

In addition to being the determinant of the rate of interest, it is the rate of profit inclusive of interest that must be analyzed in order to deal with all the leading questions of economic theory that pertain to the rate of profit and interest taken together, such as the effect on the rate of profit and interest of capital accumulation and of falling prices caused by increased production. It is also this rate of profit that must be analyzed in order to deal with the doctrines of Marxism and Keynesianism, which are directed at the determination and the significance precisely of this rate of profit.

As a result of these considerations, interest payments will enter into the present analysis only in the same way as do dividend payments and the draw of funds by partners and sole proprietors, that is, neither as a productive expenditure nor as a business cost, but only as a source of demand for consumers’ goods by businessmen and capitalists.

The existence of financial institutions, such as banks and insurance companies, may appear to introduce an important complication into the treatment of interest payments, namely, the fact that a substantial portion of interest payments has acquired the status of business sales revenues, from which various costs are deducted and on which profit is earned. Among the costs deducted, of course, are typically further interest payments. For the sake of ease of analysis, I shall simply ignore the existence of this phenomenon and assume that all interest paid by business firms is paid to individuals, to whom it constitutes equivalent net income.

Nevertheless, this complication could easily be dealt with. In calculating the economy-wide amount of profit inclusive of interest, and the average rate of such profit, interest payments to financial institutions could be excluded. They could be treated as part of productive expenditure, as part of the business sales revenues constituted by productive expenditure, and as part of the costs deducted from the sales revenues of the firms that make the payments. This procedure would serve to reduce the sum of profit and interest income in the economic system by the magnitude of the interest payments made by business firms to financial institutions, and then

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 721 to increase it by the magnitude of the profits earned by such institutions on those interest payments and by the amount of interest income those institutions paid to individuals. The net effect would be to reduce the sum of profit and interest income in the economic system by the magnitude of the costs incurred by the various financial institutions, apart from their payment of interest to individuals. The procedure would thus turn out to be tantamount to the assumption both that all interest and dividend payments were made to individuals, which, of course, is the assumption on which I am proceeding, and that their amount is net of the costs incurred by financial institutions, apart from the latters’ payment of interest to individuals. It should be observed that the procedure would serve to convert part of what would otherwise be interest incomes that had to be added to profits, into literal profit incomes—namely, the profit incomes earned by financial institutions on interest revenues. However, to avoid even this much complication, I will, as I have said, simply ignore the existence of financial intermediation.

The Rate of Profit Not Based on Demand and Supply of Capital, but on the Difference Between the Demand for Products and the Demand for Factors of Production

My treatment of interest is consistent with a simplified view of productive expenditure as consisting exclusively of the demand for capital goods and producers’ labor (that is, of course, labor employed by business). This makes it possible to speak interchangeably of productive expenditure and the demand for factors of production by business. The two expressions become equivalent.

If, in contrast, the payment of interest were retained as part of productive expenditure, then using the two expressions interchangeably would imply that the payment of interest was a demand for a factor of production in the same way that the demand for capital goods and producers’ labor are demands for factors of production. The further implication would be that capital was a factor of production standing alongside of and in addition to capital goods and producers’ labor, inasmuch as capital is what is obtained by the payment of interest.

Such a view represents a confusion of ideas. Capital in the sense of a sum of money used to make productive expenditures and thus buy factors of production, or in the sense of the monetary value of the factors of production purchased, is not itself a factor of production. It is simply the means of buying the factors of production, or it is their recorded acquisition value on the books of the firms that buy them. The actual factors of production are capital goods and producers’ labor, not capital goods, producers’ labor, and capital.

These considerations are extremely germane to the question of what determines the average rate of profit in the economic system. As we shall see, in no sense is the rate of profit determined by the supply of and demand for “capital.” Rather, it has everything to do with the difference between two demands: the demand for factors of production by business—that is, the demand for capital goods and producers’ labor—which shows up as costs of production to be deducted from sales revenues, and the greater demand for the products of business, which constitutes business sales revenues. Profit, in essence, is the difference between these two demands. Explanation of the rate of profit and interest must be geared toward explaining the difference between these two demands, not a demand for and supply of “capital,” in which capital is mistakenly conceived as a factor of production. 6

Determinants of the Average Rate of Profit in the Economic System Different from Determinants of the Rate of Profit of the Individual Company or Industry

Although by now it should go without saying, I cannot stress too strongly that what I intend to show in this chapter is the determinants of the average rate of profit in the economic system of a country, indeed, of the world. As I have already indicated, the determinants of this rate of profit are very different from those which determine the rate of profit of an individual company or industry. At the level of the individual company or industry, competitive factors play a major, often by far the largest, role. 7

For example, an individual company that introduces a new and improved product is in a position to increase its profits substantially. It does so, however, by gaining sales revenues at the expense of other companies with which it directly or indirectly competes, and which now experience either an outright reduction in sales revenues or else a failure to gain sales revenues that they otherwise would have gained. As illustration, this was the case with the automobile, which competed not only against the horse and buggy and the railroads but also against industries outside the field of transportation. In the absence of the appearance of the automobile, many of these industries would have gained additional sales revenues as the result of the release of funds from the purchase of such things as food and clothing, made possible by greater efficiency in the production of such goods. Instead, the automobile industry garnered much of these funds. The same is true in all instances in which increases in profits are based on competitive factors. The accompaniment of all such increases in profits is, of course, corresponding decreases in profits elsewhere.

These observations are consistent with what I have said previously about the fact that technological progress

does not raise the average rate of profit. It raises the rate of profit of those firms that introduce the technological advances or are relatively early in their adoption, and equivalently reduces the rate of profit of other firms, in the rest of the economic system. As I have shown, the only way in which technological progress can raise the average rate of profit in the economic system is insofar as it takes place in the production of the monetary commodity or commodities, namely, in the production of gold and silver under a precious-metals monetary standard, and thereby achieves a more rapid rate of increase in the quantity of money and volume of spending. 8

Whole industries, as well as individual companies, are in a position to make higher profits or lower profits, or profits versus outright losses, on the basis of competitive factors. This occurs every time the consumers shift their demand from the products of an industry that has lost their favor to the products of an industry that has gained their favor.

The determinants of the average rate of profit in the economic system, in contrast, exclude all competitive factors. In the economy as a whole, competitive factors are always mutually offsetting. They cannot explain why or to what extent the sum of profits of the individual firms that have profits exceeds the sum of the losses of the individual firms that have losses, that is, why and to what extent there is an aggregate profit in the economic system and thus a positive average rate of profit, nor the specific height of the average rate of profit. To answer these questions, it is necessary to turn to an examination of factors that are very different than the competitive elements that are so vital to the determination of the rate of profit of individual companies and industries.

That the explanation of an aggregate profit and thus a positive average rate of profit depends on different factors than the competitive elements that loom so large in the case of individual firms and industries means that it should not be surprising if a very different significance is often to be attached to the existence of a given average rate of profit in the economic system than to the existence of an equal rate of profit on the part of an individual company or industry. It is one thing if outstanding productive innovators earn, say, a 50 percent annual rate of profit. Such a situation is consistent with the average rate of profit in the economic system being perhaps just 5 percent, and with other businessmen, who are backward and incompetent, suffering reduced profits, including outright losses, that are as large as the exceptional profits of the great innovators. Here the high profits of the innovators are due almost entirely to the improvements in production they introduce or are early to adopt. It is a very different situation if the average rate of profit in the economic system is 50 percent, with the result that even the most backward and incompetent businessmen can earn a substantial rate of profit. In the latter situation, as we shall see, what is present is rapid inflation of the money supply and/or a state of affairs in which the great majority of businessmen and capitalists have come to value a much higher degree of present enjoyment relative to provision for the future. This situation signifies economic decline and impoverishment, while, as we well know, the former situation, in contrast, signifies economic progress and prosperity.

Critique of the Doctrine That the Interest Rate on

Government Bonds Expresses the Pure Rate of

Return to Which Risk Premiums Are Added

My focus on the determinants of the average rate of profit on capital invested is incompatible with the notion that the rate of interest on government bonds expresses the pure rate of return on capital, and that higher rates of return represent an addition of various premiums to this alleged pure rate, which compensate for risk or uncertainty.

I showed in Chapter 6 that it is possible, indeed, likely, that the rate of profit in the narrower sense, that is, the rate of profit on equity investments, is above the average rate of profit, while the rate of interest is below the average rate of profit. 9 It follows that the rate of interest on government bonds, being generally the lowest in any country, will be correspondingly further below the average rate of profit, and not in any sense represent a “pure” rate of profit.

Furthermore, insofar as a “risk” premium merely serves to offset losses on other investments of the same kind, it does not enter into the average rate of return that is actually earned. For, presumably, the losses for the provision of which the risk premium exists do in fact occur, in which case the average rate of return being earned is below the nominal rate containing the risk premium. A risk premium which is merely an offset to losses cannot constitute an element in any average rate of return which is actually earned or paid.

It is different with regard to uncertainty, however. Because of uncertainty, there may be permanent differences in rates of return actually earned. But these rates do not ascend upward from the lowest rate, which allegedly represents the “pure” rate, each containing a premium in addition to the “pure” rate of return. Uncertainty in investment is inescapable, and relative uncertainty cannot add anything to the average rate profit. All that can occur is that those investments of a relatively high degree of uncertainty will afford a rate of profit in excess of the average rate of profit, while those investments of a relatively low degree of uncertainty will afford a rate of profit below the average rate of profit.

The Path of Explanation: Net Consumption and

Net Investment

In its explanation of profits, this chapter follows a path that was indicated in Chapters 13 and 14. There, under the assumption of the complete vertical integration of business and thus that business firms produce all of their own materials and equipment and buy nothing but labor services, I showed that consumption expenditure would constitute the only source of business sales revenues and that wages would constitute the only costs incurred by business. It followed that aggregate profits would equal consumption minus wages, which excess I termed net consumption. 10 In this chapter, I show that net consumption is always the most fundamental determinant of aggregate profit and the average rate of profit, irrespective of the extent of vertical integration of business firms. I then trace the phenomenon of net consumption back to time preference and show that net consumption is actually the vehicle by means of which time preference determines the rate of profit. 11

Alongside net consumption, I also develop the very important role played in the determination of the rate of profit by the phenomenon of net investment, which I showed in Chapter 15 to be the result of differences between productive expenditure and costs. 12 In addition, I explain the influence of changes in the quantity of money and aggregate spending on the rate of profit, which influence I show to be integrally connected with the rate of net investment. Finally, on the basis of the knowledge gained concerning the determinants of the rate of profit, I demonstrate the existence of the virtual springs to profitability that I have referred to, which operate automatically to reestablish a significant positive rate of profit in the economic system following the end of a monetary contraction and the fall in wage rates and prices necessitated by the contraction.

The relationship between profits, on the one side, and net consumption plus net investment, on the other, is directly derivable from propositions already established in Chapter 15. In Chapter 15, I showed that profits, as sales revenues minus costs (s − d), are equal to s c + s b − d, namely, to receipts from the sale of consumers’ goods plus receipts from the sale of capital goods, minus costs. I also showed not only that net investment is B − d, that is, productive expenditure minus those same costs, but also that productive expenditure itself equals s b + w b . 13 It follows from these relationships that profits and net investment are very similar. This is because the equations for both incorporate not only the identical subtrahend d, namely, costs, but also include the identical component s b in the minuend. It follows directly that the difference between profits and net investment is the difference between sales revenues and productive expenditure, which reduces to the difference between s c and w b , that is, to the difference between receipts from the sale of consumers’ goods and the payment of wages by business, which difference is net consumption. In terms of simple algebra, p − I = s c + s b − d − (s b + w b − d ) = s c − w b .

It follows, of course, that if profits minus net investment equals net consumption, profits are equal to the sum of net consumption plus net investment.

The rest of this chapter can be understood essentially simply as an elaboration of the concepts of net consumption and net investment and their explanatory role in the determination of aggregate profit and the average rate of profit in the economic system.

The Problem of Aggregate Profit: Productive Expenditure and the Generation of Equivalent Sales

Revenues and Costs

All business activity is carried on for the purpose of earning a profit. Yet the existence of the very phenomenon of profit in the economic system as a whole, that is, an aggregate profit—an excess of the sum of all profits over the sum of all losses—can appear difficult to explain. This is because productive expenditure, insofar as it constitutes revenue or income payments, bears an equivalent relationship to business sales revenues and to business costs. This is to say, productive expenditure can be understood as generating both an amount of sales revenues equal to itself and an amount of costs equal to itself, which would appear to imply that as far as productive expenditure by itself is concerned, the existence of an aggregate profit would be impossible, at least in the longrun, as a permanent phenomenon.

In elaboration of these points, the reader should consider the following facts. On the one hand, one major portion of productive expenditure—the demand for capital goods—is simultaneously business sales revenues. This part of productive expenditure and this part of business sales revenues are equal by identity, just as a side of one triangle is equal to that of another by identity when the two triangles share that same side. The two are identical because capital goods are sold by business enterprises as well as bought by business enterprises. For example, the demand made for steel sheet by an automobile company, or for flour by a baking company, is simultaneously a part of productive expenditure and a part of sales revenues. From the standpoint of the automobile company or baking company, it is a productive expenditure; from the standpoint of the steel company or flour company, it is sales revenue. From the standpoint

724 CAPITALISM of the economic system as a whole, it is simultaneously both. 14

At the same time, the remaining portion of productive expenditure, insofar as it constitutes revenue or income payments, is made up of wage payments, which, at least as a reasonable first approximation, can be assumed to be expended by their recipients in buying consumers’ goods from business firms in the same accounting period. 15

Thus, directly or indirectly, productive expenditure is to be understood as generating sales revenues equal to itself, and to do so essentially in the same accounting period.

In addition, however, productive expenditure generates business costs equal to itself. We know from Chapter 15 that many of these costs can appear in future accounting periods, indeed, decades in the future, insofar as the productive expenditures are made on account of plant and equipment with many years of useful life. 16 Nevertheless, what must be the result in an economic system with a fixed quantity of money? In such an economic system, it would be reasonable to assume a fixed volume of productive expenditure and a fixed volume of business sales revenues. It would also seem reasonable to assume that at some point, aggregate business costs would rise to equality with the fixed amount of productive expenditure. Indeed, even if, for example, plant and equipment is depreciated over a fifty-year period, after fifty years of the same amount of spending for plant and equipment, annual depreciation charges on fifty years’ worth of such plant and equipment rise to equality with the current annual spending for plant and equipment. Thus, the proposition would appear to be supported that costs deducted from business sales revenues must rise to equality with productive expenditure in conditions in which the same amount of productive expenditure is repeated over and over again, indefinitely.

But this last, of course, would mean that costs rise to equality with business sales revenues insofar as business sales revenues are generated only by productive expenditure. With costs equal to productive expenditure, and sales revenues equal to productive expenditure, both must be equal to each other. Things equal to the same thing are equal to each other. Thus, it would appear that in the conditions of a fixed quantity of money, and in which productive expenditure were the only source of business sales revenues, an aggregate profit simply could not exist as a permanent phenomenon. It would further appear that the average rate of profit in such conditions would have to be zero, at least insofar as productive expenditure were the only determinant of business sales revenues. This is because a zero amount of aggregate profit would mean a zero numerator in any calculation of the average rate of profit.

Several times in the last two paragraphs, I used the word “appear,” instead of making flat-out statements. This is because things would actually not be quite as bad for the rate of profit as I have just indicated. As I will show, even with a fixed amount of productive expenditure taking place year after year, indefinitely, it would always be possible to have some positive amount of profit. There could be profit equal to some positive amount of net investment, that is to say, to some continuing excess of productive expenditure over aggregate costs. 17

Even under such conditions, however, a major negative implication would still be present. This would be that the average rate of profit in the economic system would be continually falling, in the direction of zero. This implication would exist, because insofar as profits correspond to net investment, the net investment constitutes an addition to the amount of capital invested. Thus even if every year there were the same amount of net investment and profit, that constant amount of profit would have to be spread ever thinner, over a continually growing volume of capital invested. Thus, the average rate of profit would be continually falling. For example, if the total capital invested in the economic system were initially 2,000 and there were 100 of profit corresponding to 100 of net investment, the average rate of profit would initially be 5 percent—that is, 100 ⁄ 2,000 . In the next year, however, it would be less than 5 percent—namely, 100 ⁄ 2,100 —then still less, namely, 100 ⁄ 2,200 , and so on. This is because, as I say, the net investment of each year is added to the amount of accumulated capital.

There could be no possibility of the rate of profit holding up by virtue of net investment growing along with the growth in capital invested. This is because in the conditions of a constant amount of productive expenditure, which is the implication of a fixed quantity of money, the only way that net investment could grow would be by virtue of aggregate costs falling. To maintain a given rate of profit, aggregate costs would have to fall by ever increasing amounts—eventually, they would have to fall below zero and go on falling from there, to produce the ever growing amounts of net investment and profit that would be required to keep the rate of profit constant. But this, of course, is simply impossible.

For example, if the initial 100 of profit is the result of productive expenditure being 1,000 and costs being 900, then in the face of productive expenditure continuing to be 1,000, the only way the initial 5 percent rate of profit could be maintained would be if costs now fell to 895. This would provide 5 more of profit to accompany the 100 of additional capital resulting from 100 of net investment. Now, however, net investment becomes 105 and

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capital grows from 2,100 to 2,205. To maintain a 5 percent rate of profit at this point, net investment of 110.25 would be required, which means that costs would have to fall to 889.75. In order for the rate of profit to be maintained at 5 percent, aggregate costs would have to fall at a rate equal to 5 percent compounded on a base of 100. This implies that at some point aggregate costs must fall to zero and then go into minus territory. These results, of course, are absolutely impossible. At some point, aggregate costs must stabilize, if not rise. This implies a fixed or falling amount of profit, while the amount of capital invested continues to grow.

Thus, we are left with the fact that in the conditions of a fixed quantity of money, insofar as productive expenditure alone is the source of business sales revenues, the average rate of profit in the economic system, if not actually at zero, must nevertheless be continually falling toward zero.

This brings me to the first major problem that I believe the theory of aggregate profit and the average rate of profit must solve, namely, to explain how, in the conditions of a fixed quantity of money, the existence of a positive average rate of profit is possible on a longrun, permanent basis, and is so, moreover, without the rate of profit having continually to fall.

2. Net Consumption and the Generation of an Excess of Sales Revenues Over Productive Expenditure

The answer to the question of how a positive average rate of profit can both exist and remain constant in the conditions of a fixed quantity of money and consequent fixed volume of productive expenditure is supplied by the concept of net consumption.

Net consumption, which we already know is the excess of the demand for consumers’ goods from business over the demand for labor by business, is also the source of an equivalent excess of the total demand for the products of business over the total demand for factors of production by business.

The total demand for the products of business is the sum of the respective demands for consumers’ goods and capital goods. Both of these demands are the source of business sales revenues. They are the only direct sources, inasmuch as every expenditure to buy the products of business must be made either for the purpose of making subsequent sales, in which case it is a demand for capital goods, or not for the purpose of making subsequent sales, in which case it is a demand for consumers’ goods. 18 The total demand for factors of production by business is the sum of the demand for labor by business—viz., the demand for producers’ labor—plus the demand for capital goods.

Net consumption is the source of an equivalent excess of the total demand for the products of business over the total demand for factors of production by business because the addition of the demand for capital goods to the demand for consumers’ goods in the minuend, and to the demand for labor by business in the subtrahend, leaves the amount of the inequality unchanged. Equals added to unequals do not affect the amount of the inequality. Thus, if net consumption is the difference between the demand for consumers’ goods from business and the demand for labor by business, it is equally the difference between the total demand for the products of business and the total demand for factors of production by business. Furthermore, inasmuch as the total demand for the products of business is identical with total business sales revenues, while the total demand for factors of production by business is identical with productive expenditure for labor and capital goods, net consumption is the source of an excess of the sales revenues of business over productive expenditure for labor and capital goods.

These conclusions can be expressed in terms both of the notation for demand employed in Chapters 13 and 14, and in terms of the notation for revenues and incomes employed in Chapter 15. In terms of the former, net consumption is D C − D L . In terms of the latter, it is s c − w b . If the demand for capital goods is expressed as D K , then the total demand for the products of business equals D C + D K while the total demand for factors of production by business equals D L + D K . Since D K is present in both expressions, and thus disappears when one is subtracted from the other, the difference between the two expressions remains D C − D L . Thus, net consumption can be expressed as equal to the difference between D C + D K and D L + D K .

In exactly the same way, if receipts from the sale of capital goods are stated as s b , then, as we already know from Chapter 15, total business sales revenues equal s c + s b while productive expenditure equals w b + s b . Since s b is present in both expressions and disappears when one is subtracted from the other, the difference between sales revenues and productive expenditure reduces to s c − w b . Thus, net consumption can also be expressed as equal to the difference between s c + s b and w b + s b .

I turn now to the substantive, as opposed to the purely mathematical, nature of net consumption. Considered substantively, and essentially, net consumption is the consumption expenditure of businessmen and capitalists, including under the latter head, the creditors of business firms as well as the owners of equity capital. (The ranks of the capitalists, of course, also include wage earners insofar as they possess capital. To the extent that the possession of capital enables the consumption of wage

726 CAPITALISM earners to exceed their wages, the excess of their consumption is to be considered the consumption of capitalists and as contributing to net consumption.)

The essential sources of net consumption are the payment of dividends by corporations, the draw of funds by partners and proprietors from their firms, and the payment of interest by business firms. Of course, to the extent that such receipts are themselves saved and productively expended, they count as part of productive expenditure and the demand for factors of production by business. But some significant portion of these receipts is consumed. And to this extent, there is a demand for the products of business over and above the demand for factors of production by business, that is, a source of business sales revenues which has no counterpart in productive expenditure or costs and which thus makes possible an excess of sales revenues over productive expenditure and costs.

In the case of consumption expenditure out of dividends and draw payments, there is absolutely no counterpart whatever in productive expenditure or costs. Such payments do not represent a purchase, or even an exchange, of any kind. They are merely a transfer of funds from business firms to their owners. In the case of interest payments, there is a productive expenditure in the act of paying the interest, and this productive expenditure either immediately or later on shows up as a cost. However, these are productive expenditures and costs that, as I have explained, we deliberately ignore, in order to explain profits gross of interest cost. Consumption out of interest payments from business is a source of an excess of the demand for the products of business over the demand for actual, physical factors of production by business, that is, a source of an excess of sales revenues over the productive expenditure for capital goods and producers’ labor. In this way, it is a source of an excess of sales revenues over costs on account of these physical factors of production, which, of course, is the profit we want to explain.

The role of net consumption in generating an excess of demand for the products of business over the demand for factors of production by business and thus an excess of business sales revenues over productive expenditure is illustrated in Table 16–1. The table, titled “The Components of the Demand for Factors of Production and Products,” is divided into three columns. The leftmost column carries the heading “Demand for Factors of Production by Business (Productive Expenditure),” while the rightmost carries the heading “Demand for the Products of Business (Sales Revenues).” The second column of the table shows that item one under the former head is identically equal to item one under the latter head. Item one in both columns is, of course, the demand for capital goods. The second column of the table further shows that item two under the former head is equalled by item two under the latter head, that is, that the demand for labor and labor’s (viz., wage earners’) demand for consumers’ goods are equal. This equality simply reflects the fact that the wage earners spend at least roughly the equivalent of their wages in buying consumers’ goods from business. Finally, the second column of the table makes clear that item three of the third column, namely, “Businessmen’s and Capitalists’ Demand for Consumers’ Goods,” is the source of the excess of the demand for the products of business over the demand for factors of production by business, that is, of sales revenues over productive expenditure. For this item appears only as a source of demand for the products of business, without any counterpart in the demand for factors of production by business in column 1. Thus, it is a source of sales revenues without counterpart in productive expenditure or cost.

Table 16–2 provides a quantitative illustration of the role of net consumption in making the demand for the products of business exceed the demand for factors of production by business. Repeating the same headings as appeared in columns one and three of Table 16–1, it shows in its own first and third columns that item one under both heads, namely, the demand for capital goods

Table 16–1

The Components of the Demand for Factors of Production and Products

Demand for Factors of Production by Business

(Productive Expenditure)

Demand for the Products of Business

(Sales Revenues)

1. Demand for Capital Goods —IDENTITY— 1. Demand for Capital Goods

2. Demand for Labor —EQUALITY— 2. Labor’s Demand for Consumers’ Goods

SOURCE OF 3. Businessmen’s and Capitalists’ Demand

EXCESS: 3. for Consumers’ Goods

Table 16–2

The Components of Demand Numerically Illustrated

Demand for Factors of Production by

Business (Productive Expenditure)

Demand for the Products of Business

(Sales Revenues)

1. Demand for Capital Goods: 500 —IDENTITY— 1. Demand for Capital Goods: 1,500

2. Labor’s Demand for

2. Demand for Labor: 300 —EQUALITY—

2. Consumers’ Goods: 1,300

SOURCE OF 3. Businessmen’s and Capitalists’ De—

EXCESS: 3. lmand for Consumers’ Goods: 1,200

Total Demand for Factors of

Production by Business: 800 and the demand for capital goods, are identically equal at 500 monetary units. It shows that item two under both heads, namely, the demand for labor and labor’s demand for consumers’ goods, respectively, are equal at 300 monetary units. Finally, it shows item three, which appears in column three only, namely, “Businessmen’s and Capitalists’ Demand for Consumers’ Goods,” as 200 monetary units. When the two sides of the table are added, it is obvious that this last item is the basis of the fact that the total demand for the products of business— sales revenues—amounts to 1,000 monetary units, while the demand for factors of production by business—productive expenditure—amounts to only 800 monetary units.

In making possible an excess of the demand for the products of business over the demand for factors of production by business, net consumption is the basis of the aggregate profit of business in conditions in which costs are equal to the demand for factors of production by business. This is because if the demand for products exceeds the demand for factors of production, then the demand for products exceeds costs that are equal to the demand for factors of production, and does so to exactly the same extent. If one thing exceeds another, than it equally exceeds a third thing that is equal to that other. Thus, demand for products exceeds costs even if costs are fully equal to the demand for factors of production, because the demand for products exceeds the demand for factors of production. In exactly the same way, in the terminology of sales revenues and productive expenditure, sales revenues exceed costs even if costs are fully equal to productive expenditure, because—thanks to net consumption—sales revenues exceed productive expenditure.

Net consumption is the source of aggregate profit because it is the source of the demand for the products

Total Demand for the

Products of Business: 1,000 of business being greater than the demand for factors of production by business, and thus of an excess of the demand for the products of business over costs that are equal to the demand for factors of production by business. In the terminology of sales revenues and productive expenditure, net consumption is the source of aggregate profit because it is the source of the excess of sales revenues over productive expenditure and thus of an excess of sales revenues over costs equal to productive expenditure. To the extent that the demand for the products of business exceeds the demand for factors of production by business, to identically the same extent does the demand for the products of business and the concomitant sales revenues of business exceed costs generated by and equal to the demand for factors of production by business. Equivalently, to the extent that sales revenues exceed productive expenditure, to identically the same extent do they exceed costs generated by and equal to productive expenditure. Thus, in being responsible for the excess of demand for the products of business over the demand for factors of production by business, or, equivalently, the excess of business sales revenues over productive expenditure, the consumption expenditure of businessmen and capitalists—net consumption—is the basis for the existence of a corresponding aggregate profit in the economic system. It is the basis of an exactly equal aggregate profit whenever the costs of business equal the demand for factors of production or, equivalently, productive expenditure.

Net consumption is what explains how it is possible for business in the aggregate regularly and consistently to sell for more than it buys, even under the conditions of an invariable money. It does so because insofar as businessmen and capitalists are themselves consumers, business firms are constantly injecting more funds into the market in toto to buy the products of business than

they expend for factors of production to produce those products. Receipts from the sale of the products of business in every year are generated by the entire expenditure of businessmen and capitalists, which includes their consumption expenditure as well as their productive expenditure; cost of production, on the other hand, tends to equal only their productive expenditure. Thus, the productive process is regularly accompanied by the existence of a demand for the products of business that is greater than the demand for the factors of production by business to produce those products. This is the cause of an excess of demand for the products of business over business costs and thus of business sales revenues over business costs.

To relate this discussion to the proposition that the demand for A is the demand for A, which I developed in the preceding chapter, we now see that the demand for products is not only not the same thing as a demand for factors of production, but regularly and consistently exceeds the demand for factors of production, and, in so doing, generates an amount of profit equal to that excess. The cause of the excess and thus the cause of the profit is the consumption of businessmen and capitalists. The amount of their consumption determines the amount of the excess of the demand for the products of business over the demand for factors of production by business and thus the amount of profit in conditions in which the demand for factors of production by business and the costs of business are equal.

Indeed, the net-consumption theory can be described as being contained in two propositions: (1) The entire demand for factors of production by business is directly (in the case of capital goods) or indirectly (in the case of labor) a source of demand for the products of business. (2) The demand for the products of business, however, is not—to the extent that it is a demand for consumers’ goods—a demand for factors of production by business, but exceeds that demand by the consumption expenditure of businessmen and capitalists.

The role of net consumption in generating not merely an excess of demand for the products of business over the demand for factors of production by business, and thus of sales revenues over productive expenditure, but of an actual aggregate profit in the economic system, that is, an excess of sales revenues over costs, is depicted in Figure 16–1. This figure is an elaborated version of Figure 15–5, which showed the role of the demand for consumers’ goods in determining national income under the conditions of an invariable money. 19

Exactly as in Figure 15–5, Figure 16–1 shows a demand for capital goods of 500 and a demand for consumers’ goods of 500 in every year from Year 2 on. Thus it implicitly shows total business sales revenues as 1,000.

As in Figure 15–5, in response to these equal demands of 500, half the existing 1K of capital goods and 1L of labor are used to produce the next year’s supply of capital goods, while the other half is used to produce the next year’s supply of consumers’ goods. Once again, the entire 1K and 1L are assumed to be used up in this way, and once again, the resulting product is shown as 1K of capital goods plus 1C of consumers’ goods. Because the 1K of capital goods used up in production is replaced out of production, each succeeding year has the same supply of capital goods as the preceding year. And in each succeeding year, of course, the 1K of capital goods is joined by a fresh 1L of labor. As in Figure 15–5, the 500 of expenditure for capital goods each year enters into the cost of the resulting output that constitutes the next year’s supply of capital goods and consumers’ goods.

The only difference between Figure 16–1 and Figure 15–5 is that the former introduces the sources of the 500 of demand for consumers’ goods. It explains these sources in part as 300 of wage payments by business, which makes possible 300 of consumption on the part of wage earners. To this, it adds 200 of consumption on the part of businessmen and capitalists. Figure 16–1 also points out that the 300 of wage payments by business will result in 300 of cost on account of labor in the next year. The 300 of wage payments is transmitted to the cost of the following year’s supply of capital goods and consumers’ goods by way of the center “production boxes,” so to speak.

This is the same transmission mechanism as existed in Figure 15–5, where 500 of cost on account of capital goods alone was transmitted, though it was not named as such at the time. The only difference is that now, instead of the production box from Year 2 on having merely 1K of capital goods at a cost of 500, and showing no cost for the 1L of labor, the 1L of labor carries a cost of 300 as well. The effect of the inclusion of the demand for labor by business is that the costs transmitted to the supplies of capital goods and consumers’ goods available at the start of the following year are correspondingly larger. They are now respectively 50 percent of an 800-total outlay for factors of production instead of 50 percent merely of the 500 outlay for capital goods alone. Thus, the cost values of the capital goods and consumers’ goods available at the start of Year 3 and thereafter are 400 respectively, instead of 250 respectively, as was the case in Figure 15–5.

Figure 16–1 shows that while sales revenues in every year are 1,000, costs, which equal the productive expenditure of the year before, are only 800. Thus, an aggregate profit of 200 exists. In Figure 16–1, this is true explicitly for every year from Year 3 on. In Year 3, sales revenues are 1,000, and costs, equal to the productive expenditure

Figure 16–1

Net Consumption and the Determination of Aggregate Profit

Year 1 mmmmm i1 K OF CAPITAL GOODS

PLUS 1L OF LABOR

PRODUCE:

50% 50%

Year 2 i1K OF CAPITAL GOODS i1C OF CONSUMERS’ GOODS

In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods.

Goods. This 500 of demand for capital goods is This 500 of demand for consumers’ goods is simultaneously 500 of sales simultaneously 500 of sales revenues to the sellers of the capital revenues to the sellers of the consumers’ goods. It results from the payment goods. It will also result in 500 of cost on account of capital of 300 of wages by business, which the wage earners consume, plus 200 of goods to the buyers, next year, when they sell the products the consumption expenditure by businessmen and capitalists. The 300 of wages capital goods are used to produce. also result in 300 of cost on account of labor next year, when the products the wage earners help to produce are sold.

I1 K OF CAPITAL GOODS, at a cost of 500,

PLUS 1L OF LABOR, at a cost of 300,

PRODUCE:

50% 50% mmm m

Year 3 i 1K OF CAPITAL GOODS, at a cost value of i1C OF CONSUMERS’ GOODS, at a cost value of 400 on

400 on account of the capital goods and labor account of the capital goods and labor used to produce used to produce them, i.e., 50% of (500+300) them, i.e., 50% of (500+300)

In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods.

I1 K OF CAPITAL GOODS, at a cost of 500,

PLUS 1L OF LABOR, at a cost of 300,

PRODUCE:

50% 50%

mmmm

Year N in1K OF CAPITAL GOODS, at a cost value of i1C OF CONSUMERS’ GOODS, at a cost value of 400 on

400 on account of the capital goods and labor account of the capital goods and labor used to produce used to produce them, i.e., 50% of (500+300) them, i.e., 50% of (500+300)

In Response to 500 of Demand for Capital In Response to 500 of Demand for Consumers’ Goods.

of Year 2, are only 800. Identically the same situation of businessmen and capitalists themselves. This expen-applies to every year thereafter. What generates an ag-diture, as Figure 16–1 further illustrates, is a source of gregate profit in Figure 16–1 is the fact that in every year, sales revenues, but has no counterpart in productive sales revenues are constant at 1,000, while productive expenditure or, therefore, in costs, which are generated expenditure is constant at 800, which last means that the by past productive expenditure, in this case, the produc-costs of the following year are also 800, at which time tive expenditure of the year before. 20 sales revenues will again be 1,000. An aggregate profit Table 16–3, which is based on the data of Figure 16–1, exists in Figure 16–1 because of the excess of sales presents a further quantitative depiction of the role play-revenues over productive expenditure. This fact implies ed by net consumption in determining aggregate profit. an equal excess of sales revenues over costs, once costs It shows that in each year, Figure 16–1’s productive come to equal productive expenditure, which, in the case expenditure of 800 is the cause of equivalent costs that of Figure 16–1, of course, is the very next year. To say it show up as a deduction from sales revenues in the fol-as simply as possible, the excess of sales revenues over lowing year. This is shown by the arrows sloping down productive expenditure is what explains the excess of and to the right, connecting each year’s 800 of productive sales revenues over costs equal to productive expendi-expenditure to the next year’s 800 of costs. The table also ture. shows each year’s 800 of productive expenditure as the

And, of course, what in turn explains the excess of source of equivalent sales revenues in the same year as sales revenues over productive expenditure in Figure that in which the productive expenditure takes place. 16–1 is net consumption—the consumption expenditure This is shown by the two straight lines, a short one going

Table 16–3

Productive Expenditure, Costs, and Sales Revenues

—the Elements Generating Profit in Figure 16–1

Productive Sales Net

Year Costs Profit

Expenditure Revenues Consumption

1 NA NA

NA NA NA

2 800 NA 1,000 NA 200

3 800 800 1,000 200 200

4 800 800 1,000 200 200

5 800 800 1,000 200 200

N 800 800 1,000 200 200

The table above shows that the productive expenditure of each year shows up as equivalent costs in the next year.

It also shows that a repetition of the same amount of productive expenditure in the next year generates sales revenues equal to those costs. Finally, it shows that the excess of sales revenues over costs is determined by net consumption, which is essentially the consumption expenditure of businessmen and capitalists. (As in Figure 16–1, on which the table is based, quantitative data are not available for Year 1, with the result that neither costs nor profits can be calculated for Year 2.)

down and a longer one going across to the right, that culminate in an arrow pointing upward to the 1,000 of sales revenues of each year. The source of the sales revenues being 1,000 while productive expenditure is 800 is clearly the 200 of consumption expenditure on the part of businessmen and capitalists in each year, which is represented by the item “Net Consumption.” When the 200 of sales revenues generated by this 200 of consumption expenditure are added to the 800 of sales revenues generated by the 800 of productive expenditure, total sales revenues become 1,000. The generation of 1,000 of sales revenues is depicted by the confluence of the two vertical arrows, one representing the 800 of productive expenditure in the year, and the other representing the 200 of consumption on the part of businessmen and capitalists—the item “net consumption.” (Two additional straight lines, again, a short one going down and a longer one going across, but this time to the left, connect net consumption to the second arrow pointing up to sales revenues.) Thus, what enables sales revenues to be 1,000 while productive expenditure and costs are 800 is the consumption expenditure of the businessmen and capitalists in the amount of 200. This consumption expenditure is what makes sales revenues exceed productive expenditure by 200 and thus costs by 200, with the result that 200 of profit is generated.

In order to show the determination not only of the aggregate amount of profit but also of the average rate of profit in the economic system, it is necessary to add yet some further elaboration to the diagrammatic analysis we have been pursuing since Chapter 14. This is done in Figure 16–2, which is an elaboration of Figure 16–1.

In Figure 16–2, each year is described in terms of a series of rows depicting the “Opening Assets of Business,” “Transactions,” and “Production,” respectively. We are already familiar with all of these elements from Figure 16–1, even though they were not explicitly labeled as such at the time. In Figure 16–1, each year began with what in essence was a partial description of the opening assets of business in that year, namely, the quantity 1K of capital goods and the quantity 1C of consumer’s goods. Indeed, in Figure 16–1, starting in Year 3, these quantities were shown as possessing cost values of 400 monetary units each. These cost values were derived on the basis of the transactions and production that took place in the preceding year. Figure 16–1 showed that starting with Year 2, 500 monetary units were expended in buying the 1K of capital goods every year, and 300 monetary units were expended in buying the 1L of labor that was available every year for production. The fact that 800 monetary units in all were thus paid for the factors of production in each year and that then those factors of production were used 50 percent in producing capital goods and 50 percent in producing consumers’ goods, was what underlay the respective cost values of 400 for the capital goods and consumers’ goods appearing at the beginning of Year 3 and all subsequent years.

In Figure 16–2, identically the same kind of “production box” appears in each year as appeared in Figure 16–1. The only difference is that in Figure 16–2 it is labeled as production, in a distinct row. Transactions are described graphically in Figure 16–2, whereas in Figure 16–1, they were described verbally. The only substantive difference between Figures 16–2 and 16–1 is that in Figure 16–2 the opening assets of business that are described in the first row under each year, are not only 1K of capital goods and 1C of consumers’ goods, as before, but also a sum of money—namely, 1,000 units of cash. In addition, the capital goods and consumers’ goods are shown bearing their specific monetary cost values, namely, 400 monetary units each, starting with Year 1, rather than Year 3. The cost values shown in the opening assets of Year 1 are derived by treating Year 1 as representing exactly the same set of conditions as prevailed in all the years of Figure 16–1 from Year 3 on. In Figure 16–2, Year 1 should be understood as representing a year following an indefinite number of previous years just like it and like those that follow it, and as being labeled Year 1 only from the perspective of being the first year singled out for analysis.

The cash, and the various transactions that it finances, are shown in distinct, gray-colored boxes. The transactions, of course, appear in the second, transactions row under each year. They represent expenditure of the money originally held as an opening asset of business, in the first row, namely, the asset “1,000 units of Cash to Be Paid Out.” This sum, and the demand for the goods and services of business that it finances every year, are both assumed to be invariably fixed at 1,000 units of money.

For the sake of simplicity, it is assumed in Figure 16–2 that all transactions take place on the first day of each year, whereafter the various parties retire to engage in the process of producing the output that will become available and will be sold on the first day of the following year. 21 Thus, it is assumed that on the first day of each year, business buys its entire supply of capital goods for the year and pays all the wages and sources of net consumption that it pays for the entire year, and that the recipients of these sums turn around and expend them on that same day in buying a year’s supply of consumers’ goods from business. This assumption permits dealing with all transactions in the economic system at one fell swoop and then turning to the process of production that ensues with the capital goods and labor that have been purchased. The process of production, of course, is de—

Figure 16–2

The Elements Determining the Average Rate of Profit

Year 1

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500

Production:

PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50%

Year 2

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500 Production: PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50%

Year 3

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500 Production: PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50% ...........................................................................................................................................................................................

Year N

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

picted in the production row under each year, as I have already said. As in Figure 16–1, the process of production of each year culminates in the supply of capital goods and consumers’ goods contained in the opening assets of business at the start of the following year. Just as before, it is assumed that all capital goods and labor used in production in any year are fully used up in producing the output that will be sold at the start of the following year. The assumption also continues to be made, of course, that the factors of production in each year are used in accordance with the relative demands for capital goods and consumers’ goods that are expected to exist in the following year, and that these expectations are correct.

In Figure 16–2, in Year 1 and in every succeeding year, 500 units of cash are expended by business firms in buying capital goods, just as was the case in Figure 16–1 from Year 2 on. The origin of the demand for capital goods in the opening cash holding of business is indicated by the small arrow which connects the lower left-hand portion of the gray box “1,000 Units of Cash to Be Paid Out” to the upper righthand portion of the gray box “Demand for Capital Goods: 500.”

The firms that expend the 500 for capital goods receive into their possession 1K of capital goods out of the opening assets of business. That 1K of capital goods will then serve these firms in the process of production depicted in the production row. The conveyance of the 1K of capital goods from the opening assets of business to their subsequent use in production is depicted by a series of three straight lines running from the box representing 1K of capital goods as an opening asset of business, around the box “Demand for Capital Goods: 500” in the transactions row, and culminating in an arrow pointing to the production box in the production row. Thus, as in Figure 16–1, the 1K of capital goods enters into the process of production with a cost value of 500, which is the sum of money that was paid for these capital goods in the transactions row.

At the same time that business firms are buying 1K of capital goods for use in further production, business firms are, of course, also selling that 1K of capital goods. Here, however, Figure 16–2 goes beyond Figure 16–1 in that it shows not only that business in the aggregate is simultaneously both a buyer and a seller of capital goods to the same extent, but also the corollary fact that from the perspective of business as a whole, insofar as the asset “cash” is drawn down in the purchase of capital goods, it is simultaneously replenished in the sale of capital goods. Thus, to this extent, the cash holding of business in the aggregate remains unchanged, and cash will be available to finance the fresh transactions of the following year. This is depicted by a combination of two arrows. First, there is the one running down and to the left from the gray box labeled “1,000 Units of Cash to Be Paid Out” and over to the gray box labeled “Demand for Capital Goods: 500” in the transactions row. And then there is the one that runs vertically upward from this latter box to the white box representing the 1K of capital goods in the opening-assets-of-business row. This second arrow, shows the return to business of the cash paid out by business in the purchase of capital goods.

The opening cash holding of business is also assumed to finance total wage payments of 300 units of money and net consumption in the amount of 200 units of money, which, in combination, in turn make possible the demand for consumers’ goods of 500 units of money. Two small arrows running from the bottom of the box “1,000 Units of Cash to Be Paid Out” to the top of the gray box “Wages: 300 + Net Cons.: 200” indicate the origin of wage payments and the sources of net consumption in the opening cash holding of business. The depiction of wage payments by business together with net consumption as the source of demand for consumers’ goods from business is achieved by means of an ellipse drawn around wages plus net consumption, to which is attached a straight line sloping downward and to the right and that culminates in a vertical arrow pointing up to the gray box representing the demand for consumers’ goods. The up and down arrows running between the gray demandfor-consumers-goods box and the white consumers-goods box signify that money is turned over to business in exchange for the consumers’ goods and that these goods are conveyed into the possession of their buyers.

Thus, in Figure 16–2, as in Figure 16–1, in financing both the demand for capital goods and the demand for consumers’ goods, business itself is shown as the source, direct or indirect, of the entire demand for its products, that is, of all of its own sales revenues. At the same time, however, it is also shown that because the cash that business draws down in making wage and payments and in providing the sources of net consumption is returned to it in the form of receipts from the sale of consumers’ goods, business will have the same 1,000 units of cash available as an opening asset in the next year as it had in the present year. This is because the 500 of cash expended in wage payments and in providing the sources of net consumption which is returned in 500 of receipts from the sale of consumers’ goods, is joined to the 500 of cash expended in the purchase of capital goods and simultaneously returned in the sale of capital goods.

Thus, what Figure 16–2 shows is business making 1,000 of total outlays, on the basis of which it obtains 1,000 of total sales revenues, and, in the receipt of the sales revenues, the return of all the cash that it has laid out.

As in Figure 16–1, the 1L of labor that business buys for its 300 payment of wages, shows up in the production box at its cost value of 300. This is depicted by the ellipse drawn specifically around “Wages: 300” and connected to the production box by a straight line sloping downward and to the left and culminating in a horizontal arrow pointing right, to the production box. Thus, as in Figure 16–1, the production box shows both 1K of capital goods at 500 plus 1L of labor at 300.

Figure 16–2 provides all the elements necessary for the explanation not only of the generation of 1,000 of aggregate sales revenues and 800 of cost on account of capital goods and labor, and thus 200 of aggregate profit, as did Figure 16–1. It also provides the further information necessary for a precise calculation of the average rate of profit in the economic system in every year. It does so in providing knowledge of the total value of the opening assets of business each year, which is shown to be 1,800 monetary units. This amount, which is the sum of the 400 cost value of the 1K of capital goods on hand, plus the 400 cost value of the 1C of consumers’ goods on hand, plus 1,000 of cash, represents the total capital invested in the economic system. It is, in effect, the sum of cash together with the cost value of inventory and net plant and equipment. 22 Thus, it follows that the average rate of profit in the economic system described in Figure 16–2 is precisely 200 ⁄ 1,800 , or 11.1 percent. This is the amount of profit earned in the economic system, divided by the amount of capital invested in the economic system, which latter, as I say, is what the sum of the asset values I have just named represents. 23

Inasmuch as the amount of profit in an economic system with an invariable money, such as that described in Figure 16–2, tends to equal the amount of net consumption, it follows that the rate of profit in such an economic system tends to equal the rate of net consumption. The rate of net consumption is the rate borne by the amount of net consumption to the total capital invested in the economic system. Whatever this rate may be, precisely that is what the average rate of profit in such an economic system must tend to be. In Figure 16–2, for example, the rate of profit of 200 ⁄ 1,800 is precisely equal to the rate of net consumption, which is also 200 ⁄ 1,800 . This is an essential finding of this section, to which reference will be made in subsequent pages.

Net Consumption: Its Other Sources, Wider Meaning, and Relationship to the Saving of Wage Earners

An excess of consumption over wage payments is capable of being caused by factors other than consumption out of dividends, draw, and interest payments, though these are its regular and most important sources and tend to be the only sources in an economic system with an invariable money. Consumption made possible by business firms’ repayment of debt or retirement of outstanding shares of stock is also capable of contributing to consumption spending being greater than wage payments, and thus of causing sales revenues to be greater than productive expenditure and costs. Consumption out of newly created money is likewise capable of so contributing. So too is consumption by wage earners that is made possible by extensions of credit from business firms and which permits their consumption to be greater than their wages. In addition, it should be realized that to whatever extent the total consumption expenditure of wage earners turns out to be less than wages, the excess of consumption over wages is correspondingly reduced.

The term net consumption embraces all sources of consumption in excess of wage payments, and thus of sales revenues in excess of productive expenditure. It also takes into account any possible diminution of this excess that might be caused by the consumption of wage earners being less than wages. Net consumption is simply the total spending to buy consumers’ goods in the economic system, minus wage payments by business firms. It is, as I say, the demand for consumers’ goods minus the demand for labor by business.

It must be pointed out that net consumption equals not only the demand for consumers’ goods minus the wages paid by business firms, but all of consumption, insofar as it constitutes sales revenue or wage income, minus all of wages. This is because the total of such consumption differs from the demand for consumers’ goods only by the addition of wage payments made by consumers— viz., by the w c of Chapter 15. 24 By the same token, the total of wages differs from the wages paid by business firms by those very same wages paid by consumers. Thus,

Net Consumption = s c − w b = s c + w c − (w b + w c) = C − w.

Again, equals added to unequals do not affect the amount of the inequality.

The fact that net consumption can be stated as consumption minus wages provides further confirmation for the fact that aggregate profit tends to equal it. This is because the proposition that profit tends to equal consumption minus wages is a corollary of the previously established proposition that national income tends to equal consumption. National income, of course, is essentially profit plus wages. It should not be surprising therefore, that profit, which necessarily equals national income minus wages, also tends to equal consumption minus wages, i.e., net consumption. That is, if p + w tends to equal C, then p tends to equal C – w. As I have said, the main sources of net consumption (and in an economy

with an invariable money, virtually the only sources worth speaking about in the long run) are dividends, draw, and interest payments. In an economy with an invariable money, net consumption and the consumption of businessmen and capitalists are virtually one and the same. In an economy with an expanding quantity of money, net consumption tends to be somewhat larger than this, reflecting as well consumption spending out of new and additional money. As I have indicated, such net consumption might also include consumption spending by wage earners in excess of wage payments, which is financed by continuing net extensions of credit accompanying the increase in the quantity of money. 25

It is almost certainly the case, however, that the influence of a growing quantity of money and therefore rising wage incomes is to lead wage earners to increase their accumulated savings, in order to maintain a certain balance with their rising incomes. In connection with this fact, it must be stressed that it would be an error to assume that consumption out of wages tends to be less than wages to the extent that wage earners save. Most of the savings of wage earners goes to finance loans for various forms of consumption, above all, home mortgage loans, which are the leading asset of savings banks and life insurance companies, which, of course, in turn are the leading vehicles for wage earners’ saving. Such savings of wage earners are themselves consumed and do not in any way diminish consumption expenditure. They merely transfer it from those who earn the wages to those who borrow the savings made out of wages. The same point, of course, applies to savings of wage earners that are used to finance such things as installment loans for the purchase of personal automobiles and all the various home appliances, and to vacation loans. 26

Of course, to an important extent, the savings of wage earners are used to finance productive expenditures by business firms, and a significant number of wage earners use their savings to launch their own businesses. But when the extensions of credit to wage earners that come from business firms—such as mortgage and installment loans financed by business firms’ time deposits at commercial banks—are offset against such savings by wage earners, it is probable that the whole or practically the whole of wages has an equivalent in consumption on the part of wage earners, irrespective of the fact that the wage earners are engaged in saving.

It should be clearly understood that net consumption explains profits not only in the production and sale of consumers’ goods, but equally in the production and sale of capital goods. It is not accidental that in Figure 16–2, the production of capital goods is fully as profitable as the production of consumers’ goods. (With the cost value of both the capital goods and the consumers’ goods at 400 each, and sales revenue in both cases at 500, the profit in both cases is 100.) The existence of net consumption operates to make the demand for goods at every stage of the productive process exceed the demand for the factors of production required to produce those goods. This is because consumption on the part of businessmen and capitalists engaged in the production of capital goods makes the demand for factors of production at every stage of capital goods production less than the demand for the resulting capital goods at that stage.

The uniformity-of-profit principle cooperates in producing this effect. If the rate of profit is higher in any branch of production than in the rest of the economic system, then a tendency exists to withdraw capital from the less profitable branches and invest it in the more profitable branches. This results in a reduction in productive expenditure in the less profitable branches and an increase in productive expenditure in the more profitable branches.

For these reasons, productive expenditure tends to be less than sales revenues throughout the economic system, and by no means merely in the production of consumers’ goods alone.

Confirming the Critique of the Exploitation Theory

It should be obvious by now that in the conditions of an invariable money, the higher is net consumption, the higher is the amount and rate of profit and that the lower is net consumption, the lower is the amount and rate of profit.

To illustrate this fact, let us assume that businessmen and capitalists, instead of expending 800 monetary units for factors of production and only 200 monetary units in their own consumption, as they do in Figures 16–1 and 16–2, reduce their expenditure for capital goods from 500 to 400 monetary units, and their expenditure for labor from 300 to 200 monetary units, thereby bringing their total expenditure for factors of production down to 600 monetary units while equivalently increasing their consumption expenditure from 200 to 400 monetary units. The demand for factors of production, therefore, is now only 600 monetary units, but the total demand for the products of business remains unchanged at 1,000 monetary units. This last is because the reduction in demand for capital goods is offset by a rise in the demand for consumers’ goods on the part of businessmen and capitalists, and the reduction in the wage earners’ demand for consumers’ goods, resulting from the reduction in the demand for labor, is likewise offset. Thus, the difference between productive expenditure and sales revenue now rises to 400 monetary units, and, hence, aggregate profit now tends to rise to 400 monetary units. This

736 CAPITALISM is because aggregate business costs will fall from 800, of course, also be zero. Precisely this was the case the previous level of productive expenditure, to 600, the elaborated in Chapter 11, in the critique of the theoretical new, lower level of productive expenditure. This is shown framework of the exploitation theory. 29 On the other in Table 16–4. 27 hand, if net consumption were permanently to fall to as

Assuming an invariable money, and thus the demand low a rate as is consistent with the existence of time for the products of business and therefore sales revenues preference—with the result that businessmen and capito be unchanged at 1,000 monetary units, productive talists consumed only the most modest portion of their expenditure and the demand for factors of production by sales revenues and used almost the full amount of them business could, conceivably, vary anywhere from zero to for productive expenditure—the demand for factors of an amount not far short of the full demand for products, production would rise almost to the point of sales reve-namely, 1,000 monetary units. 28 The height of the de-nues. The result would be that the costs deducted from mand for factors of production depends on the height of sales revenues would rise almost to equal the sales reve-net consumption. It will be the higher, the lower is net nues. This, together with the great accumulation of cap-consumption, and the lower, the higher is net consump-ital that would ensue, would mean that the amount and tion. If net consumption—the consumption of business-rate of profit would fall to a minimum.

men and capitalists, who are the recipients of sales Thus, it should now be apparent that in conditions of revenues—were to rise to equal the full amount of sales an invariable money, the rate of profit depends on the rate revenues, the demand for factors of production would of net consumption. It should be equally apparent that fall to zero, and the rate of profit would rise to infinity. insofar as this is the case, the rate of profit and economic This is because in the absence of productive expenditure, progress and prosperity are inversely related, just as the costs to be deducted from sales revenues would fall under an invariable money nominal national income and to zero. Thus the amount of profit would rise to equal the economic progress and prosperity are inversely related. full amount of sales revenues. At the same time, as a This is because to the extent that the rate of profit depends further result of the absence of productive expenditure, on the rate of net consumption, a higher rate of profit the total of capital invested in the economic system signifies a lower relative demand for and production of would fall to zero. With productive expenditure zero, the capital goods. It also signifies a lower demand for labor wages paid in the production of products for sale would, relative to the demand for consumers’ goods.

Table 16–4

A Rise in Profits Caused by a Rise in Net Consumption and Fall in Productive Expenditure

Productive Sales

Year Costs Profit Net Consumption

Expenditure Revenues

1 600 600 1,000 400 400

2 600 600 1,000 400 400

3 600 600 1,000 400 400

4 600 600 1,000 400 400

The 600 of productive expenditure in the above table results from a fall in the demand for capital goods from 500 to 400 and in the demand for labor from 300 to 200, which are the consequence of a rise in net consumption from 200 to 400. Sales revenues continue to equal 1,000: while receipts from the sale of capital goods are 400 instead of 500 and receipts from the sale of consumers’ goods to wage earners are 200 instead of 300, receipts from the sale of consumers’ goods to businessmen and capitalists are now that much larger: 400 instead of 200. The effect is that the excess of sales revenues over productive expenditure is correspondingly increased. And since the productive expenditure of each year determines the costs deducted from sales revenues in the next year, profits are increased equivalently. In other words, the rise in net consumption results in unchanged sales revenues accompanied by equivalently lower costs of production deducted from those sales revenues.

3. The Net-Consumption Theory Further

Considered

The net-consumption theory requires further elaboration. There are, first of all, a number of questions or objections not yet considered, which are almost certain to be raised against it. And then there is the necessity of tracing net consumption back to more fundamental forces.

Why Businessmen and Capitalists Cannot

Arbitrarily Increase the Rate of Net Consumption and the Rate of Profit

A question that can be raised in connection with the net-consumption theory is that if the consumption of the businessmen and capitalists is, at least in part, the cause of the profit they earn, why do they not deliberately increase their consumption and thereby increase the rate of profit?

To answer this question, we need only distinguish between the effect of an increase in the consumption of an individual businessman or capitalist on the profit which he will earn and on the profit which all businessmen and capitalists taken together will earn. An increase in consumption on the part of an individual businessman or capitalist operates to increase the amount of profit in the economic system as a whole, but, at the same time, to reduce the capital of the individual businessman or capitalist in question to a much greater degree, and thereby to reduce the amount of profit which he will earn.

For example, let us assume that, just as in Figure 16–2, the sum of all capitals in the economic system as a whole is 1,800 monetary units and that the aggregate amount of profit is 200 monetary units, equal to 200 monetary units of net consumption. Let us also assume that in this economic system some particular individual businessman or capitalist possesses a capital of 18 monetary units. (This is obviously an enormously large businessman or capitalist, possessing as he does an amount of capital equal to a full 1 percent of the entire capital of the economic system.) If we further assume that this businessman or capitalist possesses the average degree of skill and efficiency in investing his capital, he will earn 2 monetary units in profit on his capital, for that is the product of the average rate of profit of 200 ⁄ 1,800 , or 1 ⁄ 9 , times his individual capital of 18.

Now let us assume that he increases his consumption by 1 monetary unit. In the economic system as a whole, the amount of net consumption and the amount of profit will rise to 201 monetary units, but the capital of this individual businessman or capitalist will have fallen to 17 monetary units, with the result that he earns a smaller amount of profit than before. This is because the now very slightly higher average rate of profit that our individual businessman or capitalist earns of 201 ⁄ 1,799 , when applied to his reduced capital of 17 monetary units, yields an amount of profit of only 1.9 monetary units, as compared with the 2 monetary units of profit that he originally earned. The situation of this individual businessman or capitalist is that he now earns a profit of 17 times 201 ⁄ 1,799 instead of 18 times 200 ⁄ 1,800 . He earns less profit because his capital falls in the ratio of 17 to 18, while aggregate profit rises only in the much smaller ratio of 201 to 200. Thus, his individual share of aggregate profit falls by more than aggregate profit increases. And if, as is more likely the case, our individual businessman or capitalist possessed a capital of one-tenth of 1 percent of the capital of the economic system rather than 1 percent, that is, 1.8 of capital rather than 18 of capital, the reduction in his profits resulting from increasing his consumption by one monetary unit would be even more pronounced. In that case, instead of earning 1.8 times 200 ⁄ 1,800 , he would earn .8 times 201 ⁄ 1,799 . His own individual capital would be cut more than in half, while he succeeded in raising the average rate of profit only very slightly.

The principle here is that while an individual businessman or capitalist can to some extent succeed in raising the general, average rate of profit by increasing his own consumption, he reduces his own individual capital to a greater degree. The effect of his action, therefore, would be to benefit other businessmen and capitalists while harming himself. Thus, businessmen and capitalists are not in a position to attempt deliberately to raise the rate of profit by increasing their own consumption.

The Net-Consumption Rate and the Gravitation of

Relative Wealth and Income

The fact that businessmen and capitalists cannot arbitrarily raise their own individual rates of profit by virtue of increasing their consumption, has major implications for the question of what determines the growth and decline of the fortunes of individual businessmen and capitalists relative to one another.

In an economic system with an invariable money, the general or average rate of profit is determined by the economy-wide—necessarily average—rate of net consumption. Individual businessmen and capitalists, however, consume at widely varying individual rates—some well above the rate of net consumption and some substantially below it. If all businessmen and capitalists had the same productive ability, they would all earn the same rate of profit, as determined by the rate of net consumption. Those individual businessmen and capitalists whose consumption relative to their capitals was below average, would save and accumulate capital, while those individual businessmen and capitalists whose consumption rel—

738 CAPITALISM ative to their capitals was above average would decumulate capital.

For example, in the conditions of Figure 16–2, businessmen and capitalists of average productive ability would earn the average rate of profit of 11.1 percent, which is equal to the net-consumption rate. The businessmen or capitalists of average productive ability whose own individual rates of consumption relative to accumulated capital happened to be 11.1 percent would neither accumulate nor decumulate capital. Those individual businessmen or capitalists of average productive ability whose individual rates of consumption relative to accumulated capital were less than 11.1 percent would accumulate capital. Those whose individual rates were above 11.1 percent would decumulate capital. For example, businessmen and capitalists with a 7 percent rate of consumption relative to accumulated capital would accumulate additional capital at the rate of approximately 4 percent a year. By the same token, those with a 15 percent rate of consumption relative to accumulated capital would decumulate capital at the rate of approximately 4 percent a year.

It follows from this discussion that the rate of net consumption prevailing in the economy as a whole tends to be governed by the rates of consumption relative to accumulated capital of those individual businessmen and capitalists whose rates are the lowest. In the nature of the case, with each passing year, these individuals tend to come into possession of a larger and larger proportion of the total capital of the economic system, while those with above-average rates of consumption progressively deprive themselves of capital. Thus the lower rates of consumption come to prevail on an ever growing proportion of the total capital of the economic system and more and more to govern the overall ratio of net consumption to capital.

This fact, incidentally, implies that even if there were somehow a conspiracy of a large number of businessmen and capitalists to raise the rate of profit by virtue of increasing their consumption, the conspiracy could not succeed for very long. This is because even if these businessmen and capitalists possessed the far greater part of the capital of the economic system and were in a position temporarily to increase their own profits by increasing their consumption, any businessman or capitalist who stood outside the conspiracy would earn that same higher rate of profit and, at the same time, thanks to his lower rate of consumption relative to accumulated capital, would be able rapidly to increase his capital relative to that of the members of the conspiracy. The effect of any such conspiracy would simply be to destroy its members and to replace them with businessmen and capitalists who consumed less relatively to their accumulated capitals. Always, as far as it is governed by the rate of net consumption, the rate of profit tends to be governed by the lowest rates of consumption relative to accumulated capital.

As we already know, and shall see further, net consumption is not the only determinant of the rate of profit. The fact that it is not makes the rate of profit higher than the rate of net consumption. But even so—assuming they are of average productive ability and therefore earn the average rate of profit—those businessmen and capitalists with rates of consumption that are below the net-consumption rate tend to expand relatively to those businessmen and capitalists whose rates of consumption are above the net-consumption rate. For example, it may be that the net-consumption rate in the economic system is 3 percent, say, while the average rate of profit is 6 percent, the difference being the result of the operation of factors other than net consumption (notably, net investment). In such conditions, businessmen and capitalists of average productive ability will earn the average rate of profit of 6 percent. Those with rates of consumption relative to accumulated capital of less than 3 percent will save and invest and thus increase their capital at a more rapid rate than those with rates of consumption relative to capital of greater than 3 percent. A businessman or capitalist with a rate of consumption relative to capital of 2 percent, say, will be able to save and invest two-thirds of his 6 percent rate of profit. He will increase his capital at a 4 percent annual rate. By the same token, a businessman or capitalist with a rate of consumption relative to accumulated capital of 4 percent, say, will be able to save and invest only one-third of his 6 percent rate of profit. He will be able to accumulate additional capital at only a 2 percent annual rate. Thus, just as under the conditions of an invariable money, those businessmen and capitalists with the lowest rates of consumption relative to accumulated capital must tend increasingly to prevail, for they will steadily be increasing the size of their capitals relative to the capitals of businessmen and capitalists with higher rates of consumption relative to accumulated capital.

Of course, individual businessmen and capitalists differ widely in their productive abilities. Those with above-average productive ability earn higher rates of profit than those with below-average productive ability, which latter may actually incur losses. These differences in the individual rates of profit that are earned are no less important in determining the growth or decline of the fortunes of individual businessmen and capitalists. The full principle determining the growth or decline of the fortunes of individual businessmen and capitalists relative to one another must be stated as follows: The relative wealth and income of individual businessmen and capitalists

tends to grow to the degree that their productive ability is above average and their rate of consumption relative to accumulated capital is below average, and to decline to the degree that their productive ability is below average and their consumption relative to accumulated capital is above average.

In an economic system with an invariable money, the wealth and income of the businessmen and capitalists of below-average productive ability and/or above-average rates of consumption would tend to decline absolutely in terms of money. In an economic system with an increasing quantity of money and volume of spending, the monetary value of the wealth and income of such businessmen and capitalists need not decline in absolute terms, but it will still decline to the same extent in relative terms. Thus, for example, instead of the fortunes of the heirs of such great businessmen and capitalists as John Jacob Astor and Cornelius Vanderbilt shrinking from tens of millions to tens of thousands, while the fortunes of new great businessmen and capitalists correspondingly rise, the decline of the former is less and the rise of the latter correspondingly greater in terms of money. If the increase in the quantity of money and volume of spending is great enough, it will be common to have cases in which there is no absolute decline in family fortunes in monetary terms. But then the rise in the fortunes of the newcomers in terms of money is correspondingly greater still. 30

Irrespective of the nature of the monetary system, whether it is invariable or expanding, the present discussion confirms the previous discussion of economic inequality in Chapter 9 of this book, concerning the earning of fortunes in a capitalist economy. 31 Fortunes are earned on the basis of above-average productive ability coupled with below-average rates of consumption relative to accumulated capital. They are made by earning high rates of profit and saving and reinvesting the far greater part of the profits. Relative wealth and income in a capitalist economy always gravitates to those who are most productive and most provident. The further effect is the most rapid possible increase in the absolute amount of real physical wealth, which, of course, is to the benefit of all.

Accumulated Capital as a Determinant of

Net Consumption

A second question or objection that may be raised in connection with the net-consumption theory is that it places the consumption of the businessmen and capitalists ahead of their receipt of profit and thereby reverses cause and effect. To be sure, this is the very opposite of the way in which one usually approaches the relationship between consumption and income. One usually places income before consumption. However, in the case of the consumption of the businessmen and capitalists, the procedure of the net-consumption theory is perfectly proper. This is because businessmen and capitalists possess not only their incomes but also, first and foremost, their capitals. The consumption of businessmen and capitalists is not governed by their incomes, but by their exchangeable wealth, that is, by the sum of their incomes and capitals together. At any given time, their incomes constitute only a small fraction of this total, and their capitals the overwhelmingly greater part. This is true typically even of a whole year’s income. It is even more true insofar as the income earned by businessmen and capitalists is itself conceived as a sum of exchangeable wealth, which it is in the form in which it is actually obtained, such as a quarterly dividend check, or the profits of a particular month or even week or day. It is probable that a decline in the incomes of businessmen and capitalists affects their consumption only to the extent that it represents a decline in this total of their exchangeable wealth.

The consumption of businessmen and capitalists in the real world is never in fact greatly affected by the height of their current incomes. Business enterprises continue to pay interest on loans and, often, dividends on stock, even when these payments are not covered by current earnings. Furthermore, it should be recalled that in addition to dividend and interest payments on the part of business enterprises, funds for consumption can be obtained by businessmen and capitalists by means of the redemption of bond and stock issues by business firms. Imagine the case of a stockholder whose enterprise is currently paying no dividends. If elsewhere in the economic system, a bond or stock issue is redeemed, the stockholder in question can sell a portion of his holdings to these other bond or stockholders whose holdings have been redeemed, and then consume the proceeds. For the bond or stockholders whose holdings have been redeemed will almost certainly wish to reinvest most of the funds they receive, and in so doing they disperse the funds they have received to securities owners throughout the economic system and thereby provide funds for consumption even in cases in which no interest or dividend income has been received. And even apart from any current redemption of securities by business firms, there are always funds in the market available to buy the security holdings of any given individual.

In connection with this discussion, it is worth noting that in the worst years of the Great Depression—1932 and 1933—when total profit income in the United States was approximately $11 billion and $10 billion respectively, net consumption was approximately $17 billion and $15 billion respectively, the difference between prof—

its and net consumption being accounted for by negative net investment in the respective amounts of approximately $6 billion and $5 billion. 32

It is perfectly reasonable that the consumption of businessmen and capitalists should be governed primarily by their capitals rather than by their incomes. Imagine the case of an individual who possesses a capital of $10,000,000, and who customarily earns $500,000 in income on this capital, which, for the sake of simplicity, we assume is all available to him on the first day of the year, having been paid to him at the very end of the year before. 33 Let us assume that he is in the habit of consuming his entire income, and that suddenly this income ceases. Previously, on the first day of each year, he possessed $10,500,000, of which he consumed $500,000 over the course of the year, and employed $10,000,000 to make provision for the future, in the form of investments. Now, on the first day of this year, he possesses only $10,000,000. Will his consumption be appreciably different? Almost certainly not.

If he possesses $10,000,000 instead of $10,500,000, his consumption will be only slightly affected. He will still be a multimillionaire and will still live like one. The fact that he has no income will not have anything remotely like the significance it has for an individual with little or no capital. His loss of $500,000 of income will be taken out both on his current consumption and on his provision for the future, and probably, on average, in the same proportions as he previously consumed and made provision for the future. What is of significance for such an individual is not the decline in his income, but the much more modest decline in the total of his income as obtained plus his capital. The measure of this decline is not 100 percent, as it is in the case of his income, but something less than 5 percent. Rather than expecting his consumption to fall to zero because his income has fallen to zero, it is much more reasonable to expect that both his consumption and his provision for the future will fall in proportion to the fall in his overall exchangeable wealth, that is, in the ratio of $10,000,000 ⁄ $10,500,000 , which of course is 20 ⁄ 21 . Thus, in an average case, he would now most likely consume on the order of $475,000 over the course of the year, and employ on the order of $9,525,000 to make provision for the future. For these sums stand in the same respective proportions to $10,000,000 as do $500,000 and $10,000,000 to $10,500,000.

Thus, even if the income of businessmen and capitalists were to completely disappear for some reason, if they still possessed their capitals, their consumption would continue almost unchanged and very soon restore the rate of profit to its former height insofar as it depends on the rate of net consumption. This is because, given the existence of net consumption and its accompanying excess of sales revenues over productive expenditure, the only way that profit could not exist would be if there were an equivalent excess of cost over productive expenditure, which is to say, if there were an equivalent negative net investment. But continuing negative net investment is an impossibility, if for no other reason than the exhaustion of assets. 34 In the absence of negative net investment, the existence of net consumption guarantees a corresponding positive average rate of profit.

There is a second aspect to the criticism that consumption should not be placed before income. This aspect concerns the genesis of what the businessmen and capitalists consume. I have said that businessmen and capitalists possess not only their incomes, but, first and foremost, their capitals. How, it will be asked, did their capitals originate, if not out of saving out of income? Here we are also involved in the question of how profit is the original form of income in the economic system.

To answer these questions, it must be realized that neither the portion of their exchangeable wealth which they devote to provision for the future nor the portion which they consume, need be acquired by businessmen and capitalists in the form of income—though, of course, in a developed market economy, they almost always will be. Incomes are generated in the process of exchange, and prior to every exchange there must be that which is to be exchanged. It is not income which is the necessary prerequisite to consumption, but a fund of money. This money can be acquired in the form of income, or it can be acquired by the printing or mining of new money, or by the emergence of a monetary employment for commodities already in one’s possession which were acquired either by one’s own labor or in barter exchange. The last two of these—that is, the mining of new money and the emergence of a monetary employment for commodities acquired either by one’s own labor or in barter exchange—were the original source of consumption expenditure and of net consumption. The first incomes were generated by the spending of money, and the money which was spent could not have been acquired as income but only as a commodity produced by one’s own labor or obtained in barter exchange. 35 Such is the original source of consumption expenditure and net consumption in the “early and rude state of society” described by Adam Smith, in which there is only a demand for consumers’ goods and no demand for means of producing products which are to be sold. 36

Thus, true enough, the capitals of businessmen and capitalists are accumulated by saving out of profits. But profits themselves are always caused at least in part by net consumption, whether that net consumption is based mainly on previously accumulated capital, as in the

3333323456 TELTOOhxahnntepe eSt lhecramla ednil miiocatsrhutciiin lugoaaansintntsid:ioi Noo otnhnfnes e mot wo Csfoft in oalnnletnee usgstyhsa uc ocotomiwffvn. pc e Cstoth unianaomerstnlt upn iM anmtonivtoedphenn tiNsgi natoeemgrnert d , eI ab ePnnnapvtrds emiee npnsducrtd mooisspftn oe ilt teadnn iskat nt .ohet” taf ep hI E a nilepnacd “copdeeeneieav afodriarmld,iry tnu hsi acgahens loir dnh(erG a trUw uovl.edefiSn ntse.hga c sDew oat apene dtpo, ee iIai rnolnreltftticim nsorteoolfey cyitnsh tieth:eea oTta eryft’hx ,nCs”eh ei osFnatem uccreeoosm etanmi bPoeseournr ceavm oesvef,psa, Oa, tic 1islfhoas9fanbei5cpt li0sese.. ) t t1o Ah,o 1fpe hsB,p d iwp.umi tf2se.f 5 ia eCsn7trhe ,te– ahssn7lseelc1 Ec bse..ec e b S2eogee. nliteanwo tanmeelirseni oincgn, sp oat,rh fTbo itohfshiv ecet esNh y ,aa aecnpathditraoe n.p rnEe,.a tx t1 ihlan 2Iecvn, lt secoleysowct mtm.he 2eree .a inssnat t.mdh Pee gr roeedsnuuelrctats lA w rcaoctueo loudfn f ptosrl ooloff itwth, e itfh U hene mi htoeardde S optnoalwtye esar, qf1uu9la2 irs9t te-h1re’9s i6 ni5nd cSuotcametmies taeivncata tilol Ta nabebltel i etnos v( hWeismtams aheti ntnhtg aetn obdne tg,h Diun.sn C nin.e:gc U eos.fSs aa. qrGiuloyav rtteherern ,em olirem ani mtn Paortniinothtni’ nosgf i naOcnofyfm inceee ga, vanta.idivl.ae),b n pleept t. i o1n h4vi,e m1st5 ma0t ,et h1ne5t. 2b S.e eTgeih nbene aliomnwgo o,u tfnh ati sms ocofhn natpeht., ,c otohrn iessv upemtn., pj suteiscot. na 7 ws.inergel ec adlacyu’lsa itnedco bmy aed advianigla ubpl teh teo t ohtiamls a fto trh per boepgriientnoirnsg’ ionfc ao dmaey,. c Soerep obrealotew p,r tohfiists s beecftioorne, t naxea, rre tnhtea el nindc oofm thee o sfu pbesresoctniso,n a n“Nd neet Ct ionntesruemstp, atinodn t ahnedn T suimbter aPcrteifnegr ethnec ree.”spective magnitudes of negative net investment which, for their part, were found by subtracting capital consumption allowances from gross private domestic investment. In the process all imputations and inventory valuation adjustments were excluded. The subtraction of net investment from profits in order to arrive at net consumption is indicated by the fact that profits equal the sum of net consumption plus net investment, as we already know. See above, this chap., this pt., sec. 1, the subsection “The Path of

conditions of any modern economic system, or on the original sources I have just described. The essential point is that irrespective of the contribution of prior, saved profits to current and future net consumption, it is current and future net consumption that operate to determine current and future profits. Furthermore, the regress is not infinite, in that net consumption does have ultimate priority over profit in the way I have just shown.

An Explanation of High Saving Rates

Out of High Incomes

We have considered the case of the effect of a loss of income on the consumption of businessmen and capitalists, and have seen that their consumption would not be diminished to anywhere near the extent to which their income falls, because it is based mainly on their possession of capital. Their consumption would tend to fall only to the relatively modest extent that the reduction in their income constituted a fall in the much larger total of their exchangeable wealth consisting of the sum of their capital plus their income as it is obtained. The same analysis applied to the case of the effect of a rise in income on the consumption of businessmen and capitalists shows that an increase in income will likewise tend to have only a modest effect. The increase in income will also tend to be consumed and saved in proportion as they employ this total of capital-plus-its-income in consumption and for making provision for the future.

For example, if the income of our hypothetical businessman or capitalist with $10,000,000 of capital rose from $500,000 to $1,000,000, his consumption would most likely rise only to something on the order of $525,000, while his provision for the future rose to something on the order of $10,475,000, for these sums stand in approximately the same respective proportions to $11,000,000 as do $500,000 and $10,000,000 to $10,500,000. Thus he would consume only about $25,000 of his additional income, and save all the rest of it. The percentage of his income that he saved would go from zero to almost 48 percent. In the same way, if the income he earned on his ten million of capital were $1,500,000, his consumption would rise to something on the order of $550,000 while his provision for the future rose to something on the order of $10,950,000. At this point, the percentage of his income that he saved would be over 60 percent.

This analysis helps to explain both why individuals with higher incomes tend to save larger fractions of their incomes than do those with lower incomes and, at the same time, why there is no tendency toward an ever rising proportion of saving out of income in the economic system as a whole, as the average level of real income rises. It is not the case that individuals having higher incomes save a larger portion of them than individuals having lower incomes, on the basis of any economic law pertaining to the absolute size of income. Rather it is the case that individuals with higher incomes are to a large extent businessmen or capitalists who earn a rate of profit that is higher than the rate of net consumption.

To the extent that this is the case, the income that is over and above what corresponds to the net-consumption rate counts merely as additional exchangeable wealth that is divided between consumption and provision for the future in essentially the same proportions as a lesser sum of exchangeable wealth consisting of capital plus its income. But this means that in the average case the only portion of the additional income that is consumed is a portion itself corresponding to the net-consumption rate, while all the rest goes to saving and provision for the future.

If these individuals were to earn the same amount of profit, however high that might be in absolute terms, and, at the same time, possessed a sufficiently larger amount of accumulated capital, they would consume the full amount of their high incomes. Let their accumulated capitals grow sufficiently relative to their incomes—in other words, let the rate of profit they earn fall to the net-consumption rate—and they will consume all of their income, however high it might be. For example, a businessman or capitalist with an income of $1,000,000 a year may well save half or more of it when his total accumulated capital is $10,000,000, but he would most likely consume all of a $1,000,000 income—and more— if his accumulated capital were $50,000,000, and most certainly if it were $100,000,000. In such a case, his saving out of income would be zero or less than zero. Indeed, on our present assumptions, he would consume all of a $1,000,000 income if his accumulated capital were just $20,000,000.

The fact that high rates of saving are to be found in connection with high rates of profit can also be explained on the basis of the fact that a high rate of saving out of a high rate of profit is the basis of building a fortune. Repeated compounding of the high rate of profit on a rapidly growing capital sum, whose rapid growth is made possible by a high rate of saving, results in the accumulation of a fortune. A high rate of profit provides both the incentive and the means for a high rate of saving, culminating in the possession of a fortune. 37

As previously noted, apart from the connections between high rates of profit and high rates of saving out of income, Milton Friedman has shown the vital role played by expectations concerning permanent or longrun average income in leading individuals to save heavily in periods when their income temporarily exceeds their expectations of this kind. Thus, individuals such as bestselling novelists, prominent athletes, and movie stars,

whose incomes in an individual year or limited period of years are among the highest in the economic system, often save heavily. The reason they do so is not because their incomes are high absolutely or relative to those of the average member of the economic system, but because their incomes are high relative to their own expected longrun average incomes and thus need to be saved heavily to make possible a more even level of consumption over time. 38

Friedman’s insight helps to explain high saving out of profits in a context in which the high rate of profit cannot be expected to continue. In this case, the profits must be heavily saved if the individual is to benefit from them in the years when his profit income will be lower, owing to the prospective fall in the rate of profit he will earn.

Friedman’s insight can also be applied to understanding the disposition of previously accumulated capital between provision for the future and present consumption. Such capital will typically be regarded by its owner as having to serve his wants over a more or less extended period of the future. If the owner of a capital of $10,000,000, wishes to provide for his wants over a period of twenty years, say, and to do so evenly, then the most he will wish to consume in the present year is $500,000. If he earns no income this year, then his capital falls by that amount. In succeeding years, if he continues to earn no income, he may go on consuming $500,000 a year until his capital runs out, or if his “time horizon,” so to speak, remains constant at twenty years, he will progressively diminish his consumption as his capital declines, keeping it at a constant one-twentieth of the declining amount. 39

The present discussion makes it clear that the high rates of saving that take place out of the high incomes existing at any given time are not the result of the absolute height of those incomes. They are the result of the height of those incomes relative to accumulated capital or to the expected longrun average income of the individuals. Where high incomes are not earned as a high rate of profit on capital and are not perceived as higher than one’s longrun average income, they are not accompanied by high rates of saving. That is to say, where they are earned in the form of a low rate of profit on a large sum of capital or where they are earned in the form of high wages which are expected to continue to be earned over the rest of one’s life, the high incomes are not accompanied by high rates of saving. The businessman or capitalist with a large amount of capital relative to his income need not save, because he can look to his existing capital to provide for his future wants even if he consumes an amount equal to the whole or even somewhat more than the whole of his modest rate of profit. A wage earner who can expect to earn a high wage income throughout his life can look to his future wages as the means of providing for his future consumption. It is not necessary for him to make provision for the future beyond providing for old age and other possible periods of incapacity, and for the purchase of goods that are too expensive to be purchased out of current income.

When these facts are understood, it becomes possible to explain such things as why the average American of today does not save a larger proportion of his income than did his grandparents, even though in real terms as well as in monetary terms his income is far greater than theirs was. As has just been shown, the explanation is that higher real income as such, that is, by itself, does not cause a higher rate of saving. Indeed, owing to changes in political conditions that affect the general security of property, such as the tax system and the monetary system, and to changes in cultural values that are philosophical corollaries of the political changes, today’s generation of Americans saves less relative to its income than was the case in the past, even though, for the time being at least, real incomes continue to be far higher than in the past. Confiscatory taxation, fiat money and inflation, and the decline of the sense of individual responsibility have all worked to reduce the degree of provision for the future relative to current consumption and thus to reduce saving out of income, despite the fact that real incomes continue at a level far higher than prevailed in the past and, at least until relatively recently, had even continued to rise. The slower rate of increase in real income that is the result of these causes is also a major cause of the reduced rate of saving out of income. This is implicit in the preceding discussion. 40

Indeed, to maintain that individuals with higher incomes by that very fact tend to save relatively more than individuals with lower incomes, is to reverse cause and effect. This is because it is not high income as such which is the cause of high saving, but high saving which is the cause of high income, both absolutely and relatively. This point can be clearly seen in the light of the analysis we have been carrying on under the assumption of an invariable money. In this analysis, high saving and the high relative demand for capital goods that it makes possible is the cause of high and rising real income in that it is a leading cause of capital accumulation, rising production, and falling prices, which progressively increase the buying power of given money incomes. At the same time, those businessmen and capitalists who save relatively more grow in relative wealth and increase their profits at the expense of those businessmen and capitalists who save relatively less. These businessmen and capitalists have the highest and most rapidly rising real incomes, and while the monetary income of the average member of the economic system remains the same, theirs goes on rising.

The same point is dramatically confirmed by the rapid economic progress and consequent rise in real incomes of such East Asian countries as Japan, Taiwan, and South Korea. All of these countries, not so very long ago, were among the world’s most impoverished nations. Their progress has its foundation largely in a very high degree of saving and provision for the future, which came into being in the midst of poverty. Their saving and provision for the future is clearly the cause, not the effect, of their high and rising real incomes.

Net Consumption and Time Preference

Net consumption is not an ultimate cause of profit. It itself reflects the operation of time preference. As explained in Chapter 2, time preference refers to the fact that, other things being equal, people value the satisfaction of their wants in the present more highly than in the future, and in the nearer future more highly than in the more remote future. 41 Time preference determines the proportions in which people devote their income and wealth to present consumption versus provision for the future. The higher the prevailing degree of time preference, the higher is the proportion in which people devote their wealth and income to present consumption in comparison with provision for the future. The lower is the prevailing degree of time preference, the lower is the proportion in which they devote their wealth and income to present consumption in comparison with provision for the future. In this way, time preference operates to establish the rate of net consumption.

This is so, because to the degree that time preference is high, and people are therefore not prepared to make provision for the future relative to present consumption, the demand for factors of production to produce products which are to be sold will be low, the amount of capital invested will be low, and net consumption will be correspondingly high. Thus the ratio which net consumption and, therefore, profit bear to the demand for factors of production, to costs (which reflect that demand), and to the sum of the capital values of business enterprises will be high. By the same token, to the degree that time preference is low, exactly the reverse will be true and the rate of net consumption and the rate of profit will be correspondingly low. Thus, one can say that the ultimate cause and determinant of the rate of profit, insofar as it depends on net consumption, is time preference.

It may be asked, what is the temporal extent of the periods called the present and the future, between which individuals divide their wealth and income? The answer is that as far as the net-consumption theory is concerned, the absolute extent of these periods is of no importance. One may consider as the present, today, the coming week, the coming month, the coming year, or any period of time extending into the future, however long or short. The reason is that every rate of profit or interest varies directly with the period of time taken as the base. For example, a 10 percent rate of profit on an annual basis is identical with a 20 percent rate of profit on a biennial basis, a 5 percent rate of profit on a semiannual basis, a 2.5 percent rate of profit on a quarterly basis, and a five-sixths of 1 percent rate of profit on a monthly basis. And in precisely the same way that the ratio which the amount of profit or interest bears to a principal varies directly with the period of time under consideration, the ratio which net consumption bears to the sum of the capital values of business enterprises varies directly with the period of time under consideration. The ratio which the net consumption of two years bears to the sum of the capital values of business enterprises is twice as great as the ratio afforded by the net consumption of one year; this in turn is twice as great as the ratio afforded by the net consumption of six months, which, in turn, is twice as great as the ratio afforded by the net consumption of three months, and so on. Thus, if net consumption relative to the sum of the capital values of business enterprises proceeds at the rate of .0274 percent per day, .83 percent per month, 2.5 percent per quarter, 5 percent every six months, 10 percent per year, or 20 percent every two years, it is all the same. A rate of profit of 10 percent on an annual basis will be the result. The rate of net consumption and the rate of profit and interest are of the identical mathematical nature.

This explains, incidentally, why nothing essential depended on our simplifying assumption, earlier in this section, that the entire annual income on a capital sum was available on the first day of the year. It is immaterial whether one has a $500,000 annual income available at the beginning of a year and consumes one’s exchangeable wealth at the annual rate of one twenty-first, or has available, say, only a quarterly income of $125,000 at the beginning of a quarter and consumes one’s exchangeable wealth at the quarterly rate of one eighty-fourth.

It must be stressed that the connection between the rate of profit and time preference is not direct, but indirect. It exists insofar as time preference determines the proportions in which individuals devote their wealth and income to provision for the future relative to present consumption, as manifested in the proportion in which net consumption stands to the demand for factors of production to produce products which are to be sold and to the sum of the capital values of business enterprises. It does not operate on the rate of profit in any other, more direct way. 42

Perhaps the simplest way to understand the operation

of time preference on the rate of profit is in terms of the concept of the “time horizon” referred to previously. 43 If time preference leads businessmen and capitalists to have an average time horizon of twentyone years, over which they wish to make even provision for their wants, then the rate of net consumption will be one twenty-first of capital-plus-its-annual-income. Since the amount of net consumption tends to generate an equivalent amount of profit, this will operate to make the annual income on capital also equal to one twenty-first of the sum of capital-plus-its-annual-income. Thus the rate of profit relative to capital alone will tend to be 5 percent. 44

In exactly the same way, if the average time horizon of businessmen and capitalists were eleven years, and thus they wished to consume an amount equal to one-eleventh of the sum of their capital and its annual income, the rate of net consumption and the rate of profit—as far as it depends on the rate of net consumption—would be 10 percent. If their average time horizon were 51 years, the rate of net consumption and the rate of profit—again, as far as it depends on the rate of net consumption— would be 2 percent. 45

The fact, explained in Chapter 2, that time preference in turn is itself profoundly influenced by the degree of rationality and freedom that prevails in a society implies that as far as the rate of profit depends on the rate of net consumption, it will be the lower, the more rational and the freer a society is. 46 Special emphasis must be placed on the implication that the rate of profit will be the lower the greater is the respect for property rights and thus the security of property. This is the case because to the degree that property rights are respected and property is secure, the more are people motivated to make provision for the future relative to present consumption, and thus the lower will be the rate of net consumption and the rate of profit insofar as the rate of profit depends on the rate of net consumption. In addition, the greater is the security of property, the more will people be motivated, with any given degree of time preference, to make provision for the future in the form of the accumulation of capital rather than the accumulation of hoards of precious metals and gems. This change in the form of provision for the future, given the same degree of time preference, also serves to lower the rate of net consumption and the rate of profit. This is because it represents a greater demand for factors of production by business and the accumulation of greater sums of capital value, as opposed to the accumulation of wealth in the form of consumer assets.

It is important to realize that, however ironically, it follows from these considerations, that all the demagogues and outright bandits in the world who rail against the height of profits and who call for or actually undertake the looting and plundering of property thereby labor to raise the rate of net consumption as high as they can and thus correspondingly to raise the rate of profit. For in striving, as they do, to undermine the security of property in their various capacities of ordinary robbers, members of guerrilla bands, or officials of virtually all contemporary governments, they act to discourage saving and productive expenditure and thereby to increase the relative significance of net consumption. The message they send to businessmen and capitalists is: “Don’t save, don’t invest—because if you do, we will see to it that you do not benefit from doing so, for we will steal or destroy your property or tax it away. If you want to benefit from your wealth, you had better consume it before you lose it to us.”

4. Net Investment as a Determinant of Aggregate Profit and the Average Rate of Profit

The equality between profits and net consumption rests on an equality between productive expenditure and the costs deducted from sales revenues in business income statements. In such circumstances, an excess of sales revenues over costs is possible only to the extent that there is an excess of sales revenues over productive expenditure. As we have seen, since both sales revenues and productive expenditure embrace the demand for capital goods, an excess of sales revenues over productive expenditure rests on an excess of receipts from the sale of consumers’ goods over the demand for labor by business, that is, on net consumption. As we know, net consumption in turn is the result of the consumption expenditure of businessmen and capitalists, financed out of dividend, draw, and interest payments.

However, productive expenditure and costs need not be equal. For reasons I will explain, productive expenditure is usually greater than costs, and sometimes it is less. In these circumstances, net investment, positive or negative, exists. And at such times, the amount of profit in the economic system turns out to equal the sum of net consumption plus net investment.

Figures 16–1 and 16–2 and Tables 16–3 and 16–4 exemplify the fundamental distinction that exists between productive expenditure and costs. In these figures and tables, the productive expenditure of any given year shows up as costs deducted from sales revenues in the following year. By the same token, the costs of any given year are shown as representing the productive expenditure of the year before. Such a fundamental distinction of timing, whether of years, months, or weeks, usually exists between productive expenditure and the costs it generates in business income statements. In essence, today’s productive expenditures for the most part show up as costs in the future, while today’s costs for the most

Table 16–5

The Emergence of Net Investment

Productive Sales Net

Year Costs Profit

Expenditure Revenues Consumption

1 800 800 1,000 200 200

2 900 800 1,000 200 100

3 900 900 1,000 100 100

4 900 900 1,000 100 100

. . . … … … … …

N 900 900 1,000 100 100

The table above shows that in Year 2, proft remains at 200 despite the fall in net consumption to 100 and resulting rise in productive expenditure to 900.The reason is that the rise in costs lags the rise in productive expenditure. Only from Year 3 on, will costs also be 900. In Year 2, the 100 excess of productive expenditure over cost implies the existence of 100 of net investment.

part reflect productive expenditures made in the past. equivalent break in the equality between profits and net

The distinction between productive expenditure and consumption. Specifically, one will observe in Year 2 of costs was explained in detail in Chapter 15. There it was Table 16–5 that productive expenditure exceeds costs by shown that all of productive expenditure which is for 100, and, at the same time, that profits exceed net con-plant and equipment or inventory and work in progress, sumption by 100. For in that year, while productive is added to asset accounts, while the corresponding items expenditure is 900, costs are only 800, and while net of cost, namely, depreciation and cost of goods sold, consumption is only 100, profits in the economic system which reflect previous productive expenditures, are sub-are 200.

tracted from those asset accounts. On this basis, the Table 16–5 is very similar to Table 16–3. Its only difference between productive expenditure and costs in essential difference is that in Year 2 it introduces a rise the economic system was shown to constitute net investin productive expenditure from 800 to 900 monetary ment, that is, the net change in the value of those asset units, which is made possible by an equivalent fall in net accounts. 47 consumption from 200 to 100 monetary units. 48 In all

The continuous equality between productive expen-subsequent years, 900 and 100 monetary units remain the diture and the costs deducted from sales revenues that is respective magnitudes of productive expenditure and net found in Figures 16–1 and 16–2 and in Tables 16–3 and consumption. Total sales revenues, of course, continue 16–4 is the result of nothing more than the assumption at 1,000 monetary units throughout, inasmuch as 100 that productive expenditure is the same year after year, monetary units of additional demand for the products of reinforced by the further assumption that all productive business generated by productive expenditure take the expenditure shows up as costs precisely one year later. place of the 100 monetary units of reduced demand for Under these assumptions, productive expenditure and the products of business coming from the consumption costs show up as the same in amount year after year, to of businessmen and capitalists, viz., from net consump-the end of time. tion. 49 What Table 16–5 shows is that even though pro—

Nevertheless, if one looks at Table 16–5, one can ductive expenditure in Year 2 rises from 800 to 900, costs observe an important break in the equality between pro-continue to be 800, reflecting the fact that productive ductive expenditure and costs, and, at the same time, an expenditure in Year 1 was 800. Only from Year 3 on do

costs rise to the higher level of productive expenditure.

Because of this lag in the rise in costs to reflect the rise in productive expenditure, profits in Year 2 continue to equal 200, despite the fall in net consumption to 100. This is the case inasmuch as sales revenues remain at 1,000 while costs remain at 800. All that has happened so far in Table 16–5 is that net consumption—the demand for consumers’ goods by businessmen and capitalists—is down and productive expenditure and the demand for capital goods and/or the demand for producers’ labor and producers’ labor’s demand for consumers’ goods are up by just as much. Thus, there is no change in aggregate sales revenues and, as yet, no change in aggregate costs. As a result, profits are as yet unchanged, despite the fall in net consumption.

The unmistakable and obvious implication of this inequality between profits and net consumption is that something else, besides net consumption, determines the amount of profit in the economic system. That something else, of course, turns out to be nothing other than net investment. This is because the excess of profits over net consumption is the excess of productive expenditure over costs. Profits remain the same rather than fall to an amount equal to the smaller amount of net consumption, because, while sales revenues remain the same, costs have not yet risen to equal the larger amount of productive expenditure that the smaller amount of net consumption makes possible. If costs did equal the larger productive expenditure, profits would equal sales revenues minus the larger productive expenditure, that is, they would equal the smaller net consumption. So long as costs fall short of the larger productive expenditure, profits exceed the smaller net consumption. This shortfall of costs relative to productive expenditure, or, equivalently, this excess of productive expenditure over costs, is, as we know, net investment. For productive expenditure comprises debits or pluses to the assets of business, while costs comprise credits or minuses to those assets. Thus, to the extent that productive expenditure exceeds costs, the pluses to the assets of business exceed the minuses from those assets, with the result that there is an equivalent net change in the book value of those assets—viz., there is equivalent net investment.

In connection with this last point, it is necessary to keep in mind specifically that productive expenditure incorporates business spending on account of plant and equipment and inventory and work in progress, which represents debits or pluses to these respective asset accounts, while costs include depreciation and cost of goods sold, which represent credits or minuses to these respective asset accounts. The difference is net investment in plant and equipment plus net investment in inventory and work in progress. Insofar as productive expenditure and costs do not comprise such pluses or minuses to assets, they represent identically equal expensed expenditures, that is, items that are not debited to any asset account, but written off—expensed—as made. Such items—for example, many advertising and research and development outlays—are simultaneously productive expenditures and costs. The subtraction of such costs from such productive expenditures nets to zero and thus leaves undisturbed the fact that total productive expenditure minus total costs equals net investment. 50

The relationship between profits and net investment is actually very simple. Net investment is productive expenditure minus costs. Profit is sales revenues minus those same costs. The great bulk of sales revenues, moreover, is generated by and is equal to productive expenditure. Productive expenditure, recall, embraces the demand for capital goods, which at the same time literally is a major component of sales revenues. Furthermore, productive expenditure embraces all the wage payments by business firms, which is the source of the far greater part of receipts from the sale of consumers’ goods by business. Thus, to the extent that productive expenditure exceeds costs and produces corresponding net investment, the sales revenues generated by and equal to productive expenditure exceed those same costs and thus result in profits equal to the net investment. Once again, the existence of net investment means that productive expenditure exceeds costs. At the same time, it means that the portion of business sales revenues generated by and equal to productive expenditure exceeds those same costs, and thus that profit exists at least to the same extent as net investment exists. Indeed, the only thing that prevents a perfect identity between profits and net investment is the extent to which sales revenues exceed productive expenditure, that is, the extent to which net consumption exists.

Table 16–6 illustrates the effect of net investment on profits by incorporating the data from Year 2 of Table 16–5 into a framework similar to that of Table 16–2, which set forth the role of net consumption in making possible an excess of the demand for the products of business over the demand for factors of production by business, that is, of sales revenues over productive expenditure. The table shows that aggregate profit in the economic system equals the sum of net investment plus net consumption. It does so by showing once again the demand for factors of production by business (productive expenditure) on the left and the demand for the products of business (sales revenues) on the right. It shows total sales revenues generated equal to the sum of productive expenditure plus net consumption: specifically, sales revenues of 900 generated by productive expenditure and sales revenues of 100 generated by net consumption.

Table 16–6

Net Investment as a Source of Aggregate Profit

Demand for Factors of Production by

Business (Productive Expenditure)

Demand for Capital Goods: 600

Demand for Labor: 300

Total Demand for Factors of Production by

Business (Productive Expenditure): 900 less:

Costs: 800

Net Investment: 100

The 900 of sales revenues generated by productive expenditure are 600 of receipts from the sale of capital goods plus 300 of receipts from the sale of consumers’ goods to wage earners. The 600 of receipts from the sale of capital goods, of course, are identically equal to the component of productive expenditure representing the demand for capital goods. The 300 of receipts from the sale of consumers’ goods to wage earners are quantitatively equal to the component of productive expenditure representing the demand for labor. The 100 of sales receipts generated by the sale of consumers’ goods to businessmen and capitalists are the receipts representing net consumption. Total sales revenues in Table 16–6, of course, equal 1,000, with 600 representing demand for capital goods and 400 the total demand for consumers’ goods coming both from businessmen and capitalists and from wage earners, together.

Now the deduction of 800 of costs from 900 of pro—

Demand for Products of Business

(Sales Revenues)

≡ Receipts from the Sale of Capital Goods: 1,600

Receipts from the Sale of Consumers’ 1, =

Goods to Wage Earners: 300

Total Sales Revenues Generated by

Productive Expenditure: 1,900 less:

= Costs: 1,800

Profits Corresponding to Net investment: 1,100

Receipts from the Sale of Consumers’

Goods to Businessmen and Capitalists 1,

(Net Consumption): 1,1001

Total Sales Revenues: 1,000 less:

Costs: 1,800

Total Profits: A200

Profits Corresponding to Net Consumption: 0100 ductive expenditure on the left-hand side of Table 16–6 results in net investment of 100. When those same costs are deducted on the righthand side of Table 16–6 from the 900 of sales revenues generated by the 900 of productive expenditure, the result is 100 of profits corresponding to the 100 of net investment. Total profits, of course, are 200, rather than 100, because total sales revenues are 1,000, not 900. Sales revenues are generated by the sum of productive expenditure plus net consumption, not by productive expenditure alone. When the 800 of costs are deducted from this larger total of sales revenues, the total amount of profit surpasses net investment by the amount by which total sales revenues surpass the portion of sales revenues generated by productive expenditure alone, that is, by the amount of sales revenues generated by net consumption.

Perhaps the simplest way to think of the equality between profits and the sum of net consumption plus net

investment is in terms of the following relationships: (1) profits = sales – costs.

(2) profits = sales – productive expenditure + productive expenditure – costs.

(3) sales – productive expenditure = net consumption.

(4) productive expenditure – costs = net investment.

Thus, substituting equations (3) and (4) into equation (2) we obtain:

(5) profits = net consumption + net investment.

In other words, profits are sales minus costs. They are also sales minus productive expenditure plus productive expenditure minus costs. Inasmuch as both sales revenues and productive expenditure contain the demand for capital goods, sales revenues minus productive expenditure reduces to the demand for consumers’ goods minus the demand for labor, that is, to net consumption. Inasmuch as productive expenditure represents pluses to assets, while costs represent minuses to assets, productive expenditure minus costs is net investment. Thus, profits equal net consumption plus net investment.

Table 16–7 further illustrates the relationship between net investment and aggregate profit by showing a variety of possible cost values and the corresponding effects on net investment and profits together. The table assumes that productive expenditure is constant at 800 and that net consumption is constant at 200, with the result that sales revenues in the economic system are constant at 1,000. For purposes of illustration, three different values for aggregate costs are assumed: 800, 700, and 900, labeled (1), (2), and (3) respectively. Under these assumptions, when costs are 800, that is, equal to productive expenditure and to the sales revenues generated by productive expenditure, both net investment and the profits corresponding to net investment are zero. Thus, total profits equal 200, which is the amount by which sales revenues exceed productive expenditure and the costs equivalent to productive expenditure. That is, in this case, profits equal net consumption alone. All of these results are indicated by the label (1). When costs are 700 in the face of the 800 of productive expenditure and the 800 of sales revenues generated by productive expenditure, net investment is 100 and the profits corresponding to net investment are 100. Thus, in this case, total profits equal 300—the sum of the 200 of net consumption plus the 100 of net investment. In other words, they are now equal to the sum of the amount by which sales revenues exceed productive expenditure plus the amount by which productive expenditure exceeds costs. These results are indicated by the label (2). When costs are 900, net investment is minus 100 and profits altogether are 100, equal to the sum of the 200 of net consumption plus the minus 100 of net investment. In this case, profit is equal to the sum of the excess of sales revenues over productive expenditure less the excess of costs over productive expenditure. These results are indicated by the label (3).

As we have seen, the variation of profits with net investment is produced by the fact that net investment exists to the degree that productive expenditure is greater than costs. But since productive expenditure is directly or indirectly the source of equivalent sales revenues, any excess of productive expenditure over costs is accompanied by a precisely equivalent excess of sales revenues over those same costs, which excess represents precisely equivalent profits. That is, to whatever extent productive expenditure exceeds costs and generates net investment, the sales revenues generated by productive expenditure, and equal to productive expenditure, exceed those same costs and generate profit. Thus, to the extent that net investment is positive, and the portion of sales revenues generated by productive expenditure exceeds costs, the excess of total sales revenues over costs is equivalently enlarged and profits exceed net consumption by the amount of net investment. By the same token, to the extent that net investment is negative, and the portion of sales revenues generated by productive expenditure falls short of costs, the total of sales revenues exceeds costs by less than the amount of net consumption; that is, profits are reduced by the amount of negative net investment.

It may be helpful to think of matters this way: while net investment—the excess of productive expenditure over costs—represents an equivalent excess of the part of sales revenues generated by productive expenditure, and equal to productive expenditure, over those same costs, net consumption represents a further excess of sales revenues over costs—the excess of sales revenues over productive expenditure itself. By the same token, while net consumption would generate profits even if costs equalled productive expenditure, the existence of net investment means that costs are equivalently less than productive expenditure and equivalently less than the portion of sales revenues generated by and equal to productive expenditure, and thus that profits exceed net consumption by the amount of net investment.

Under the assumptions we have been making of an invariable money and that all the capital goods and labor of any given year are used up in producing the products just of the next year, net investment is necessarily of short duration. Under such conditions, it can exist only on the strength of a rise in productive expenditure founded on a fall in net consumption, and then it can last only for a

Table 16–7

The Relationship Between Profits and Net Investment

Demand for Factors of Production by Demand for Products of Business

Business (Productive Expenditure) (Sales Revenues)

1, Demand for Capital Goods: 500 ≡ Receipts from the Sale of Capital Goods: 500 Receipts from the Sale of Consumers’ 1, Demand for Labor: 300 = Goods to Wage Earners: 1,300 Total Demand for Factors of Production by Total Sales Revenues Generated by 1, Business (Productive Expenditure): 800 Productive Expenditure: 800 less: less:

1, Costs (1): 800 Costs (1): 800 Costs (2): 700 Costs (2): 1,700 Costs (3): 900 Costs (3): 1,900 Profits Corresponding to Net

Net Investment (1): 10 0 Investment (1): 0000 Profits Corresponding to Net 1, Net Investment (2): 100 Investment (2): 1 100 Profits Corresponding to Net 1 Net Investment (3): -100 Investment (3): -100 Receipts from the Sale of Consumers’

Goods to Businessmen and Capitalists

(Net Consumption): 1,200 Total Sales Revenues: 1,000 Total Profits (1): A200 Total Profits (2): 1,300 Total Profits (3): 1 100 Profits Corresponding to Net Consumption

(in all three cases): 0 200

single year, before costs rise to equal the higher level of productive expenditure. This is the situation in Year 2 of Table 16–5. As we shall soon see, however, in the absence of these assumptions, in particular the assumption of an invariable money, net investment can exist not only as a longstanding, indeed, permanent source of aggregate profit, but also with no tendency toward diminution in its quantitative importance relative to that of net consumption.

Now it follows that since the aggregate amount of profit in the economic system is equal to the sum of net consumption plus net investment, that the average rate of profit in the economic system equals not only the previously described net-consumption rate, but the sum of the net-consumption rate plus the net-investment rate. This is merely to say, that in equalling the amount of net consumption plus the amount of net investment, all divided by the amount of capital invested, the average rate of profit equals the amount of net consumption separately divided by the amount of capital invested (the net-consumption rate) plus the amount of net investment separately divided by the amount of capital invested (the net-investment rate). This is on the elementary algebraic a + b a b principle that = + . In other words, the average c c c rate of profit in the economic system can be expressed as equal to and determined by the rate of net consumption plus the rate of net investment. This formula is of great importance, and I will refer to it repeatedly in subsequent discussion.

Net Investment Versus Negative Net Consumption

Because of net investment, it would be possible for an aggregate profit to exist in the economic system even in the complete absence of net consumption—indeed, even in the face of negative net consumption.

Net consumption falls below the consumption of businessmen and capitalists to the degree that wage payments fail to be accompanied by equivalent consumption expenditures. At the crudest level of analysis, one might imagine a portion of wage payments simply being hoarded by the wage earners. To this extent, receipts from the sale of consumers’ goods to wage earners would be less than wage payments, and the excess of total receipts from the sale of consumers’ goods over wage payments would be correspondingly diminished. The excess of total sales revenues over total productive expenditure would, of course, also be equivalently reduced, inasmuch as it reflects merely the addition of the demand for capital goods both to the demand for consumers’ goods and to the demand for labor. The addition of equals to both sides of a diminished inequality does not alter the diminution of the inequality.

More realistically than being hoarded, a portion of wage payments might be used to finance additional productive expenditures. One can imagine, for example, employee stock-purchase plans, under which a portion of wages is turned back to business firms and used by the firms for the purchase of additional capital goods (or even for the payment of wages to additional workers). The same results would follow to the extent that the savings of wage earners that were deposited in banks were used in making loans to business firms, which then expended the proceeds of the loans in these ways. If—for lack of a better description—such secondary productive expenditures should exceed the financing of wage earners’ consumption by means of loans extended by business firms, then, to that extent, consumption on the part of wage earners as a group would be less than the payment of wages.

The implication of a fall in net consumption here can also be seen in the fact that each dollar of wage income paid by business that is used to make productive expenditures represents two dollars of productive expenditure for every one dollar of sales revenues. This is because there is first a dollar of productive expenditure in the payment of the wages, and then, to the extent that the wages themselves are used to finance productive expenditure, a second dollar of productive expenditure in the expenditure of the wages. There is only one dollar of sales revenue, however, which occurs when the wages are expended in the purchase of capital goods, or when the wage earners whose wages are paid by means of secondary productive expenditure, purchase consumers’ goods.

In these cases, total sales revenues in the economic system would still be the same, but productive expenditure would be larger and net consumption, therefore, as the difference between sales revenues and productive expenditure, would be equivalently reduced. Looked at in more detail, to the extent that the wage earners’ savings were used to buy capital goods, receipts from the sale of capital goods would replace receipts from the sale of consumers goods to wage earners. This fall in receipts from the sale of consumers’ goods, in the face of the same wage payments, would represent diminished net consumption. To the extent that the wage earners’ savings were used to employ additional producers’ labor, whose wages, it may be assumed, were themselves fully consumed, the result would be that while receipts from the sale of consumers’ goods stayed the same, the total wages paid by business would rise. Either way, net consumption would be reduced.

It could also be the case, of course, that the savings of wage earners that were turned back to business would make possible merely the continuation of the same amount

of productive expenditure in the next period instead of a larger amount of productive expenditure in the current period. In this case, the situation would resemble the case of hoarding on the part of the wage earners, in that sales revenues in the current period would be reduced by the amount of such saving, and thus the difference between sales revenues and productive expenditure—i.e., net consumption—would again be equivalently reduced. Unlike the case of hoarding, however, business would receive back the cash it had expended, though in the form of loans or receipts from the sale of securities rather than in the form of sales revenues.

If businessmen and capitalists themselves consumed little or nothing, say, 5 or 10 monetary units instead of 100 or 200 monetary units, and at the same time there were a significant excess of secondary productive expenditure over the granting of new and additional consumer loans by business to wage earners—that is, if the net amount of secondary productive expenditure were significant—the excess of wage payments over the consumption of wage earners would mean the existence of negative net consumption. But even in such an unlikely case, a significant aggregate profit and average rate of profit could still exist in the economic system on the strength of net investment alone. This is illustrated in Tables 16–8 and 16–9.

Table 16–8 assumes that the consumption of businessmen and capitalists is zero and thus that productive expenditure is the only source of sales revenues. It further assumes that a portion of wage payments is simply hoarded. It shows that despite this, an aggregate profit can exist on the basis of net investment. Specifically, the table assumes that the demand for capital goods is 500, and that while the demand for labor is 300, the wage

Table 16–8

Net Investment as the Basis for Aggregate Profit With Sales Revenues Less Than Productive Expenditure

Because of Hoarding or Saving to Finance Loans and Securities Purchases

Demand for Factors of Production by

Business (Productive Expenditure)

Demand for Capital Goods: 500 Demand for Labor: 300 Total Demand for Factors of Production by

Business (Productive Expenditure): 800 less:

Costs: 600

Net Investment: 200

Demand for Products of Business

(Sales Revenues)

≡ Receipts from the Sale of Capital Goods: 1500 Receipts from the Sale of Consumers’ 1, Goods to Wage Earners: 1200 Total Sales Revenues Generated by 1, Productive Expenditure: 0700 Total Sales Revenues Generated by Net

0000 Consumption:

Total Sales Revenues: 0700 less:

= Costs: 0600 Total Profits: n100 Profits Corresponding to Net Investment: 0200 Profits Corresponding to Net Consumption: -100 (The -100 is the result of the assumption of zero of consumption expenditure by businessmen and capitalists plus 200 of demand for consumers’ goods by wage earners minus their 300 of wages.)

earners consume only 200, because they have chosen to hoard 100 of their wages. Thus, sales revenues in the economic system turn out to be only 700 (500 + 200), while productive expenditure is 800 (500 + 300). The underlying basis of this shortfall of sales revenues in comparison with productive expenditure, namely, that wage earners consume only 200, while their wages are 300, represents negative net consumption in the amount of 100—viz., 200 of consumption minus 300 of wages. Nevertheless, even with sales revenues less than productive expenditure, an aggregate profit exists in Table 16–8 by virtue of the costs deducted from sales revenues being further below productive expenditure than are sales revenues. With aggregate costs of 600, as the table assumes, there is an aggregate profit of 100 on the 700 of sales revenues. At the same time, the subtraction of these aggregate costs from 800 of productive expenditure results in net investment of 200. Thus 200 of net investment offsets 100 of negative net consumption and results in an aggregate profit of 100.

The excess of productive expenditure over sales revenues described in Table 16–8 could continue virtually indefinitely if, instead of the current saving of the wage earners being hoarded, which is a case so unlikely that it actually deserves hardly any consideration, they were used in financing loans to business or in purchasing securities from business. In this way, business could repeat its current level of productive expenditure in the next period.

Table 16–9 arrives at an essentially similar result to that of Table 16–8 under the assumption that a portion of wages is used to finance secondary productive expendi—

Table 16–9

Net Investment as the Basis for Aggregate Profit With Sales Revenues Less Than

Productive Expenditure Because of Secondary Productive Expenditure

Demand for Factors of Production by

Business (Productive Expediture)

Demand for Capital Goods: 500 ≡ aaaaaaaaaaaaaaaaaaaaaaaaaaaa+ + 100 Demand for Labor: 300 Total Demand for Factors of Production by

Business (Productive Expenditure): 900 less:

Costs: 600 =

Net Investment: 300

Demand for Products of Business

(Sales Revenues)

0 Receipts from the Sale of Capital Goods: 0,500

+ 0,100

Receipts from the Sale of Consumers’ 1, Goods to Wage Earners: 1,200

Total Sales Revenues Generated by

1,800 Productive Expenditure:

Total Sales Revenues Generated by Net

00,00 Consumption:

Total Sales Revenues: 0,800 less:

Costs: 0,600

Total Profits: 0,200

Profits Corresponding to Net Investment: 0,300

Profits Corresponding to Net Consumption 0-100 (Again, the -100 is the result of the assumed zero of consumption expenditure by

businessmen and capitalists plus 200 of demand for consumers’ goods by wage earners minus their 300 of wages.)

ture in the same accounting period. It shows the wage earners’ saving of 100 of their incomes resulting in a secondary productive expenditure of 100, which is added to the original, primary productive expenditure of 800, thereby bringing total productive expenditure to 900. For the sake of simplicity, the secondary productive expenditure is assumed to be entirely in the form of an additional demand for capital goods. Thus, Table 16–9 shows a demand for capital goods of 500 + 100 and identical receipts from the sale of capital goods of 500 + 100. By the same token, while it shows 300 of demand for labor, it shows only 200 of receipts from the sale of consumers’ goods to wage earners. Thus, while productive expenditure is 900 (500 + 100 + 300), sales revenues are only 800 (500 + 100 + 200). The reason for the disparity, it must be recalled, is that the use of wages to buy capital goods adds to productive expenditure, but does not add to sales revenues; the expenditure for the capital goods merely takes the place of expenditure for consumers’ goods. Because wages themselves are part of productive expenditure, the use of wages to make further productive expenditures has the ability in an extreme case such as the present, to raise productive expenditure above sales revenues.

Thus, in this case, there is again a shortfall of sales revenues relative to productive expenditure in the amount of 100, which represents negative net consumption in the amount of 100 (viz., only 200 of consumption accompanying 300 of wages). But once again, an aggregate profit exists on the strength of net investment—viz., on the strength of costs being below productive expenditure to an extent sufficient to enable them to be below the sales revenues that are below productive expenditure. In Table 16–9, net investment in the amount of 300 is accompanied by profit in the amount of 200. The net investment reflects the fact that while productive expenditure is 900, costs are only 600. Profit is 200, because even though sales revenues are 100 less than productive expenditure, costs are 300 less, which means that costs are 200 less than sales revenues. Thus, in this case, 300 of net investment offsets 100 of negative net consumption and results in an aggregate profit of 200. 51

It must be stressed that the possibility of negative net consumption is extremely remote to begin with, since most savings of wage earners are used to finance consumption expenditures, such as the purchase of homes or personal automobiles, and to the extent that they are not, are largely or entirely offset by loans to wage earners from business for such purposes. Thus, as a practical matter, as I have already said, it is reasonable to assume that virtually 100 percent of wages has a counterpart in consumption expenditure. Moreover, to the extent that savings are used to finance loans for consumption expenditures, the payment of interest on such loans represents a source of return on savings over and above ordinary net consumption—a source that may be termed secondary net consumption.

This is the case because the use of wages to pay interest on consumer loans not only constitutes consumption expenditure from the perspective of those who pay the interest, and, at the same time, interest income from the perspective of those who receive the interest, but also does not diminish the demand for the products of business. This last is because the recipients of the interest are able to spend the proceeds in buying goods or services from business. Thus the demand for the products of business remains the same, while the total of consumption expenditure and the total of interest income in the economic system are increased.

For example, total wage payments in the economic system could be 300 monetary units, of which the wage earners consume 270 monetary units in buying consumers’ goods from business and pay 30 monetary units in interest on consumers’ loans. The recipients of the 30 in consumers’ interest—who could well be wage earners themselves, insofar as they had saved, and their savings had been lent to consumers—could then expend that 30 in buying consumers’ goods of their own from business. As a result, everything would be the same except that 30 more in consumers’ interest had been paid. The situation would be analogous to the case of the wage earners using part of their wages to employ consumers’ labor—or paying taxes to the government, which uses the proceeds to employ consumers’ labor.

In those cases, the effect is to increase the overall demand for labor while leaving all other spending magnitudes the same. 52 Here, the interest on consumer loans is not at the expense of the profits and interest earned on the capital invested in ordinary business firms, but stands as a further source of net consumption and thus of aggregate profit and interest in the economic system. In fact, insofar as it is equivalent to net income, the payment of such interest constitutes a direct addition to the amount of net consumption in the economic system. This is because it is both consumption and, not being wages, an addition to the amount of consumption in excess of wage payments. 53 (Of course, the rate of interest on consumer loans, like the rate of interest on loans to business firms, is governed by the rate of profit on capital invested in business. This is because investing in business or lending to business is typically an alternative for whoever lends to consumers. At the same time, if additional funds are required for loans to consumers, the sources will most likely be parties presently engaged in these activities.)

However, what is decisive is that even if negative net consumption were to exist, however unlikely that might

be, its existence would necessarily be strictly temporary and would be followed by the resumption of a significantly positive rate of net consumption. As the analysis of the next subsection will show, this is because net investment can be indefinitely prolonged. As net investment occurs, the amount of capital invested in the economic system increases. So too, of course, does the volume of accumulated savings, which is comprised both of capital, which is by far its main constituent in any modern economic system, and savings invested in the financing of loans to consumers. In the context of an economic system with an invariable money, in which the sales revenues of business have a fixed limit and all other spending magnitudes are also constrained by the fixity of the quantity of money, the increase in accumulated capital and savings is not only an absolute increase, but also an increase relative to consumption expenditure and incomes. In other words, it constitutes an increase in the degree both of capital intensiveness in the economic system and in provision for the future relative to provision for the present. As a result, its effect is to provide the basis for greater and greater consumption expenditure relative to income, which puts an end to all possibility of negative net consumption. 54

The Prolongation of Net Investment Under an

Invariable Money

When the assumption is dropped that the capital goods and labor of any given year are used up entirely in producing the output available at the start of the next year, then it becomes possible to observe a number of ways in which net investment can be prolonged, and, indeed, prolonged virtually indefinitely. Understanding this fact makes it possible to understand how an aggregate profit and thus a positive average rate of profit can exist even in conditions in which net consumption might be zero or negative and, at the same time, why any such situation with respect to net consumption is strictly temporary.

First of all, insofar as a fall in net consumption brings about a rise in productive expenditure specifically for plant and equipment, which serves in producing the output of a number of future years, the higher level of productive expenditure will result in net investment over a corresponding period of years. This can be illustrated in terms of an individual company.

Thus imagine that a company spends $1 million per year on machinery which lasts 20 years. Even if such machinery goes into service at the very beginning of the year in which it is bought, the cost incurred on account of its use in that one year will not remotely equal its purchase price. Most likely, only one-twentieth of the purchase price of the machinery will show up as a cost in any one year of its 20-year life. This is the result implied by the most commonly used method of calculating depreciation—the method known as straight-line depreciation—which is to depreciate an asset evenly over its entire life. Even where methods of accelerated depreciation are employed, only a fraction of a machine’s purchase price is deducted from sales revenues in any given year, a fraction which is always the smaller, the longer is the expected useful life of the machine.

If the method of straight-line depreciation is followed, then the annual cost on account of the use of the machinery will be only $50,000. Only over a 20-year period will the purchase price of the machinery show up as an equivalent cost, because that is the period over which the machinery serves in production. It follows that if every year this company spends $1 million for such machinery, then only after 20 years will its total annual depreciation cost come to match its million-dollar annual outlay for such machinery. It further follows that until that happens, the firm’s annual expenditure of a million dollars for such machinery results in net investment, which means in this case that net investment will be present for twenty years on the strength of this given, higher level of productive expenditure.

To clearly grasp this fact, it may help to realize that in Year 2 of the present example, the firm will have 2 batches of such machinery, each incurring an annual depreciation of $50,000. In Year 10, it will have 10 batches of such machinery, creating a total current depreciation charge of $500,000. Only in Year 20, and thereafter, will it have 20 batches of such machinery, creating a total current depreciation charge of $1 million. Thus, only from Year 20 on, will its annual depreciation cost on account of such machinery equal its million-dollar annual outlay to purchase such machinery. Until that time, the firm’s productive expenditure for machinery exceeds its depreciation on existing machinery and it experiences corresponding net investment in plant and equipment. 55

Obviously, the same relationships as just described apply to the expenditure for assets of any life. For example, if every year a business expends funds for buildings that will be depreciated over a 50-year period, then it would take 50 years for total annual depreciation cost on account of such buildings to come to equal the firm’s annual outlay for such buildings. Thus, for 50 years, a given additional expenditure for such assets would result in net investment. The relationships obviously apply to the economic system as a whole. If, in the economic system as a whole, there is, say, $500 billion of annual expenditure for machinery and buildings with an average life of 25 years, then such expenditure must be repeated for 25 years before aggregate depreciation cost in the

economic system equals the annual outlay for machinery and buildings. Until that time, there is net investment.

Net investment, and the aggregate profit that accompanies it, can exist not only by virtue of a fall in net consumption and rise in productive expenditure, but even with no fall in net consumption and no rise in productive expenditure. It can exist by virtue of a change in the disposition of a given aggregate amount of productive expenditure. For example, to the extent that productive expenditure shifts from expensed expenditures to expenditure on account of inventories, the productive expenditures involved are debited to assets instead of being instantaneously deducted from sales revenues as costs. The expenditures are added to the inventory/workin-progress account and thereby result in an equivalent diminution of the costs deducted from sales revenues. Thus, there is net investment and corresponding profit.

To the extent that productive expenditure that is already on account of inventories or work in progress is shifted to the account of inventories or work in progress of a kind that requires a longer period of time before coming to market, there is a correspondingly greater deferral of the time before the productive expenditures involved show up as costs deducted from sales revenues. To take an obvious example, if the whiskey distilleries shift from the production of eight-year-old scotch to the production of twelve-year-old scotch, twelve years must go by instead of eight before the outlays for raw whiskey become deductions from sales revenues.

The same kind of phenomenon is potentially present in every case in which products or methods of production entail different periods of time in going from the purchase of labor and materials to a product sold to buyers. In every such case, a shift to products or methods of production requiring more such time represents a correspondingly greater period during which current productive expenditures on account of inventory and work in progress exceed the costs currently being deducted from sales revenues as costs of goods sold.

To use the whiskey example, the shifting of a given amount of productive expenditure from the making of eight-year-old scotch to the making of twelve-year-old scotch, and maintaining this shift throughout the years, means that there will be four years during which the productive expenditures being made for the purpose of producing whiskey remain the same, and the sales revenues they directly or indirectly generate elsewhere in the economic system remain the same, but in which the costs deducted from sales revenues fall, because the assets in question remain in inventory or work in progress. In all such cases, there is less aggregate cost in the economic system and correspondingly more monetary value in the form of inventory/work in progress. In other words, there is correspondingly more net investment and profit.

In this particular case, in which the whiskey industry is assumed to productively expend just the same amount each year, the reduction in aggregate costs would occur specifically in the whiskey industry, which would withhold some of its product from the market for four years. But it could also be the case, and would be far more likely to be the case, that the shift to the production of twelve-year-old scotch would be made possible by a shifting of productive expenditures from outside the whiskey industry to the whiskey industry, rather than by a shifting within the whiskey industry itself. Thus, for the first four years in which the greater concentration on the production of twelve-year-old scotch takes place, the outlays could be financed by funds coming from outside the whiskey industry. This would leave the whiskey industry free to go on producing eight-year-old scotch during that time. Only thereafter would less expenditure be made within the whiskey industry on behalf of producing eight-year-old scotch. Only at the start of Year 5, would the whiskey industry shift a portion of its own funds previously devoted to the acquisition of raw whiskey that would be laid up for eight years, to the acquisition of raw whiskey that would be laid up for twelve years. Its ability to supply whiskey eight years later would not be diminished because, thanks to the previous infusion of funds from the outside, it would already be in possession of a comparable quantity of four-year old whiskey rather than raw whiskey. In this way, eight years later, just as the eight-year-old scotch came to be in reduced supply, its place would be taken by a correspondingly greater supply of twelve-year-old scotch. In this, more likely case, the reduction in aggregate costs in the economic system takes place outside the whiskey industry—in all those industries from which productive expenditures of a kind fairly quickly showing up as costs are withdrawn in order to finance the production of twelve-year-old scotch.

A much greater effect on behalf of net investment, of course, results from the shifting of productive expenditures from expensed expenditures and for inventory and work in progress to expenditures for plant and equipment, and from plant and equipment of a shorter life to plant and equipment of a longer life. Still more powerful effects are achieved in cases in which productive expenditures are shifted to expenditures for plant and equipment which not only last a longer time, but require a greater period of time in their construction. Productive expenditures shifted to things like bridges, tunnels, and canals result in net investment going on for a period of years equal to the sum of the construction time plus the period of useful life over which such assets are depreciated. Only when a given amount of such productive expenditure is repeated for this long a time, does annual

depreciation cost come to equal such annual productive expenditure. Finally, the most enduring source of net investment of all would be productive expenditure for assets of a kind that normally do not depreciate, notably, urban land. 56

In every case in which productive expenditure in the economic system is shifted from a point closer to showing up as a cost deducted from sales revenues to a point further removed from showing up as a cost deducted from sales revenues, the effect, for some period of time, is to bring about a reduction in the aggregate costs deducted from sales revenues. This reduction when taken relative to productive expenditure constitutes net investment. This same reduction when taken relative to sales revenues, which themselves, of course, are generated for the most part by productive expenditure, constitutes an equivalent increase in aggregate profits. Always, the net investment and profit brought about by such shifting of productive expenditure last until a period of time has gone by that is sufficient for the temporally more remote annual productive expenditure to show up in equivalent annual cost.

Net Investment as the Result of the Marginal Productivity of Capital Exceeding the Rate of Profit

The cause of a shift in the disposition of a given amount of aggregate productive expenditure to points more remote from showing up as costs deducted from sales revenue, and the creation of net investment thereby, can be found in an excess of the marginal productivity of capital over the prevailing rate of profit. The marginal productivity of capital in this context must be understood in a special sense—namely, as the savings of cost or additions to sales revenue that additional capital would achieve for individual business firms, relative to the additional capital in question. 57 If, for example, the employment of an additional $1,000,000 of capital would have the effect of reducing the annual costs incurred by a business firm in producing its present output by $100,000, then the marginal productivity of capital for this firm would be 10 percent. The same marginal productivity of capital would be present if the employment of an additional $1,000,000 of capital would make it possible for the firm to produce improved products at the same total annual cost as it now produces its present products, which improved products would bring in an additional $100,000 in annual sales revenues to the firm. The marginal productivity of capital in general represents the array of the marginal productivities of capital of all the individual firms, arranged in descending order. It is the array of all firms’ prospective cost reductions or revenue increases that they expect to be achievable in connection with their present volumes of output, relative to the additional sums of capital that they perceive would be required to achieve them.

Insofar as the marginal productivity of capital is above the going rate of profit in the economic system, an incentive is created to withdraw capital from existing employments to employments of the kind requiring new and additional capital, that is, to more capital-intensive employments. This is because, comparatively speaking, such a change in the employment of capital appears as the more profitable use of the capital in the circumstances. More capital intensiveness is what offers the prospect of lower unit costs through greater efficiency and/or higher selling prices because of improved quality of products.

For example, in the grocery-store industry, those grocery stores with better warehouse facilities, better buildings and fixtures, and a wider variety of merchandise offer a prospect of reduced costs and greater sales revenues compared to grocery stores lacking these improvements. If the size of these cost savings and/or revenue increases relative to the additional capital required to achieve them is greater than the rate of return currently being earned in the grocery business and in the economy generally, then an incentive is created to move capital from its present, relatively less-capital intensive employments in the grocery business into such more-capital-intensive employments, because this is where the capital in question will be employed more profitably. To the extent that the same situation obtains in other industries, the same incentive will exist with respect to the movement of capital in and between them. Thus, if automobile or steel companies with more modern factories and machinery can achieve cost savings or revenue increases relative to the necessary additional capital that are greater than the rate of profit prevailing in those industries and in the economy generally, the incentive will also exist to move capital from its present, relatively less-capital intensive employments in those industries into such more-capital-intensive employments in those industries, because this is where the capital in question will be employed more profitably. (Mergers among existing firms can obviously be highly instrumental in achieving such greater capital intensiveness.)

Now in the face of a given aggregate amount of productive expenditure, the withdrawal of capital from existing employments, where the going rate of return is being earned, to more capital-intensive employments, which offer the prospect of a higher rate of return, entails the shifting of productive expenditure from points temporally less remote from the earning of sales revenues to points temporally more remote from the earning of sales revenues. This is inherent in the nature of movement toward greater capital intensiveness. This in turn oper—

ates to create net investment in the economic system and correspondingly to raise the amount and rate of profit in the economic system. It does so by virtue of the fact that the withdrawal of capital from existing, temporally less remote investments reduces the costs deducted from productive expenditure and sales revenues before the investment of capital in the temporally more remote investments raises such costs. In the interval, there is an addition to net investment and to aggregate profit in the economic system. To take a very simple and dramatic example, the elimination of a portion of the daily expenditures of several pushcart peddlers for groceries at wholesale and its replacement with an equivalent daily expenditure for the construction of grocery stores, means an equivalent virtually immediate reduction in costs deducted from sales revenues and the passage of many years before the appearance of equivalent costs in the form of depreciation on grocery stores.

As I have indicated, the transfer of capital from less remote to more remote employments occurs between industries as well as within industries. For example, it is obvious in such cases as the transfer of capital from investment in grocery stores, say, to investment in electric utilities, say. But the phenomenon is no less present in the provision of new and additional capital for grocery stores by means of the transfer of capital from the electric utility industry, insofar as the capital being transferred is capital invested in such things as inventories and meeting expensed expenditures, while what it is being transferred to is capital invested in fixtures and buildings.

An inference to be drawn from the preceding analysis is that the existence of a marginal productivity of capital in excess of the rate of profit leads to the formation of new and additional capital. This is implied in the fact that the shifting of capital and productive expenditure to more remote employments calls net investment into being. The net investment is an addition to capital.

Despite its role in the causation of net investment and thus profit, it cannot be stressed too strongly that the marginal productivity of capital never directly determines the average rate of profit in the economic system. The rate of profit is always directly determined by the rate of net consumption and the rate of net investment.

The marginal productivity of capital is a concept that properly pertains only to cost savings or revenue increases of individual firms that are achievable by means of the employment of additional capital. Moreover, such cost savings or revenue increases by themselves need not result in corresponding actual profits even for the individual firms that experience them, let alone for the firms with which these firms compete. To say that costs are reduced or revenues increased by $100,000 by virtue of the employment of an additional $1,000,000 of capital is not a sufficient basis for assuming even that the firm employing the additional capital earns a 10 percent rate of profit on its capital. It could well be that all that is involved is that its losses are now $100,000 less than before and its rate of loss is correspondingly reduced.

Furthermore, under an invariable money, to whatever extent lower costs or improved products on the part of this firm result in its having greater sales revenues, other firms in its industry or elsewhere in the economic system will have correspondingly lower sales revenues and thus lower profits. Clearly, there is no basis for making any direct inferences concerning the average rate of profit in the economic system on the basis of the marginal productivity of capital. 58

The impact of the marginal productivity of capital on the rate of profit in the economic system is always indirect, through its effect on the rate of net investment. When the marginal productivity of capital is above the rate of profit, net investment occurs and the rate of profit rises. On the other hand, when the marginal productivity of capital is below the rate of profit, capital is withdrawn from temporally more remote employments to make possible investment in temporally less remote employments, which, in affording the going rate of return, by comparison now appear to offer more profitable uses for the capital in question. In the process, net investment is reduced—indeed, it might even become negative—and the amount and rate of profit are reduced. 59

A leading implication of this discussion is that a tendency exists for the rate of profit and the marginal productivity of capital to equalize, in that when the marginal productivity of capital is above the rate of profit, additional net investment is induced and the rate of profit rises, and when the marginal productivity of capital is below the rate of profit, net investment is curtailed and the rate of profit is reduced. 60

Another important implication of this discussion is that the marginal productivity of capital—in the sense in which I employ the term—is not a matter merely of physical or technical factors. It depends no less on factors that are ultimately a matter of value judgments and psychology. For example, if the demand of the public shifts from a good such as eight-year-old scotch to a good such as twelve-year-old scotch, the marginal productivity of capital is correspondingly increased, inasmuch as by this action the public is now willing to allow a greater premium in the price of a product requiring a greater degree of capital intensiveness in its production. The principle, of course, applies to any shift in demand from goods produced under a lower degree of capital intensiveness to goods whose production requires a higher degree of capital intensiveness.

Net Investment as a Self-Limiting Phenomenon

The fact that net investment takes place in response to the marginal productivity of capital being above the rate of profit, combined with the further fact that net investment itself adds to the rate of profit in the form of the previously described net-investment rate, implies that net investment is an inherently self-limiting phenomenon. This is because the greater is net investment, the higher, other things being equal, is the rate of profit and thus the fewer are the cases in which the marginal productivity of capital exceeds the rate of profit, and thus the more improbable is any further increase in the net-investment rate.

This inherent self-limitation of the net-investment rate operates as an important safeguard against any possibility of even the short-run interests of wage earners being unduly denied for the sake of capital accumulation. 61 This is because any undue increase in net investment would operate to raise the rate of profit relative to the marginal productivity of capital and thereby operate to discourage or even reverse the movement toward greater capital intensiveness. Thus, the extent to which the demand for labor might be reduced in order to make possible an increase in the demand for capital goods is always inherently limited.

Capital Intensification and the Tendency Toward the Disappearance of Net Investment Under an

Invariable Money

As should already be clear from preceding discussion in this chapter, a tendency exists for net investment to disappear under an invariable money. However more remote that portions of productive expenditure may become from having to be deducted from sales revenues as costs, still, if any depreciation whatever exists in connection with such productive expenditures, their continuation year after year will eventually be accompanied by annual depreciation costs that are just as great as those productive expenditures. At that point, the net investment and profits connected with the shift to such productive expenditures come to an end. 62 And if the more remote productive expenditures are not continued until this time, then the associated net investment and aggregate profit come to an end all the sooner, because the shifting of productive expenditures back to points temporarily less remote from being deducted as costs from sales revenues results in the rise in costs to a point of equality with productive expenditure all the sooner.

Under an invariable money and its concomitant limitation on the amount of productive expenditure, the only thing which can make possible the continuation of net investment is the continual shifting of productive expenditures to points temporally more remote from being deducted as costs from sales revenues. Given the existence of such continual shifting, it is possible to imagine the existence of a given amount of net investment going on virtually indefinitely. Indeed, its continuation would be positively encouraged by the falling rate of profit that is implicit in the situation, and which would operate to keep the rate of profit below a falling marginal productivity of capital as the amount of accumulated capital increased. 63 A fall in the rate of profit in this case is implied insofar as the rate of profit depends on the rate of net investment. It follows from the fact that the same amount of net investment would have to be divided by an amount of capital that continually grew by virtue of the net investment. Thus the net investment rate would fall and the rate of profit would fall insofar as it was governed by the net investment rate.

However, because of the existence of net consumption and thus a positive rate of net consumption, the fall in the rate of profit proceeds more slowly than the fall in the rate of net investment. It falls toward the rate of net consumption and can fall no lower without negative net investment taking place, which is clearly not in question here. Thus the encouragement given to net investment by a falling rate of profit progressively diminishes and ultimately must cease altogether.

The existence of any given positive rate of profit in the economic system, based on the rate of net consumption or on a combination of the rate of net consumption and some positive rate of net investment, makes the continual shifting of productive expenditures to more remote points in relation to their deduction as costs from sales revenues progressively more difficult. This is because the existence of any given positive rate of profit requires that to the degree that returns on investment must be postponed, they must be greater at least to the extent of providing a return equal to the going rate of profit compounded for the longer period of time in question. Thus, for example, if the going rate of profit is 5 percent per year, then a productive expenditure made one year in advance of the corresponding sale, needs to bring about at least $5 of profit; more precisely, it needs to bring about at least $5 of additional profit or reduced losses, achieved by means either of reducing costs or adding to sales revenues in the amount of $5. A productive expenditure made two years in advance of the corresponding sale, needs to bring in at least $10.25 in one of these ways, and so on, with the required amount of return increasing at a 5 percent compound rate. Obviously, the higher is the rate of profit, the greater is the obstacle presented by compounding. 64

In the absence of a continual shifting of productive expenditures to points temporally more remote from their deduction as costs from sales revenues—which

ultimately becomes impossible by virtue of the requirement of achieving cost reductions or revenue increases equal at least to those imposed by the rate of net consumption compounded for the length of time in question—costs begin to rise toward productive expenditure. The result is a steady diminution in the amount of net investment and in the amount of corresponding profits in the economic system. The ultimate result is that in the conditions of an invariable money, aggregate profit tends toward equality with net consumption alone.

In effect, the existence of the combination of capital accumulation based on net investment, and a positive rate of profit based at least on the rate of net consumption, sooner or later serves to bring to an end the ability of the marginal productivity of capital to surpass the rate of profit and thereby to continue to call net investment into being. The ultimate result, once again, is that the rate of profit comes to be based on net consumption alone.

The tendency toward the disappearance of net investment under the conditions of an invariable money is greatly reinforced by the fact that an indirect consequence of net investment is an increase in the amount of net consumption in the economic system and thus a corresponding decrease in the amount of productive expenditure. Thus net investment tends to disappear by virtue both of a rise in costs toward the level of productive expenditure and, at the same time, a fall in the magnitude of productive expenditure itself.

Net investment results in a rise in net consumption and thus fall in productive expenditure because its existence constitutes an increase in the amount of accumulated capital and thus of accumulated savings in general. In an economic system with an invariable money, and in which, therefore, aggregate money income does not increase, the increase in the amount of accumulated capital and savings represents a rise in the ratio of accumulated capital and savings to income. As capital and savings accumulate relative to income, the need and desire of people to increase their accumulated capital and savings still further relative to their income diminishes, while their desire to consume their income correspondingly increases.

Thus, individuals with no accumulated capital or savings whatever, have an urgent need to save and accumulate capital. Those who have accumulated capital and savings equal to a year’s income, say, have a less urgent need to do so. Those who have accumulated capital and savings equal to two, three, or five years’ income have a still less urgent need to do so, and so on. At some sufficiently high ratio of accumulated capital and savings to income, the average member of the economic system feels no need to raise the ratio of his accumulated capital and savings any further. Thus, as the ratio of accumulated capital and savings to income rises, net consumption rises and productive expenditure falls. Any possible diminution of net consumption stemming from saving out of wages diminishes, disappears altogether, and is followed by a positive contribution to net consumption on the part of wage earners, a contribution which joins with the growing consumption of businessmen and capitalists, as their accumulated capital and savings increase. The accumulation of savings in the form of loans for the purchase of consumer assets, such as homes and the land sites they occupy, also contributes to rising net consumption and thus to falling productive expenditure. 65

Because of the above reasons, under the conditions of an invariable money, net investment tends to disappear, thereby leaving net consumption as the sole determinant of the amount and rate of profit.

The Process of Capital Intensification

A related approach for understanding the process whereby net investment ultimately must disappear under an invariable money, is to observe just how the economic system becomes more capital intensive as the result of a process of saving. At the same time, this will provide further understanding of the fact that any possible negative net consumption that might temporarily exist as the result of saving on the part of wage earners, must also disappear.

This approach requires tracing out the process of capital intensification step by step. This is done in Table 16–10. In this table, the economic system is assumed to begin with an annual aggregate expenditure for consumers’ goods of 500 units of money. The total value of the capital employed in this economic system at all stages of production combined is assumed initially to be 1,000 units of money. This sum is the value of all the land, buildings, fixtures, plant, and equipment of business firms, less accumulated depreciation reserves, plus the value of all the inventories and work in progress that business firms possess. It also includes the quantity of money held by business firms. 66 Please note that what is referred to here is the value of the capital stock of the economic system, not the annual expenditure for capital goods.

The ratio of accumulated capital to consumption, or, more precisely, to the sum of consumption plus net investment, is typically called the capital-output ratio. More correctly, of course, it should be called the capital-net-output ratio, inasmuch as consumption plus net investment represents the net product of the economic system, not the actual total output. 67 Because of the equality between net product and national income, the ratio can also be expressed as the ratio of capital to national income. 68 Its closeness to the ratio of capital to

760 CAPITALISM

Table 16–10

The Process of Capital Intensification or How More Capital Is Invested When the Demand for Consumers’ Goods Falls

Year K C I

1 1,000 500 0

2 1,000 500 0

3 1,050 450 50

4 1,100 450 50

5 1,150 450 50

6 1,200 450 50

7 1,250 450 50

8 1,300 450 50

9 1,350 450 50

10 1,400 450 50

11 1,450 450 50

12 1,500 450 50

13 1,500 500 0

… … … …

KEY:

K is the value of the accumulated capital stock at year end.

C is the total expenditure for consumers’ goods in the current year.

I is net investment in the current year.

K/(C+I) is the ratio of total accumulated capital to current net national product.

consumption makes it obvious that the socalled capital-output ratio can be taken as a measure of the degree of capital intensiveness in the economic system, alongside the ratios we have mainly used up to now, namely, the ratio of capital to consumption, wages, and sales revenues respectively. 69

What is necessary at this point is to trace out how saving brings about a rise in the capital-net-output ratio from its initial level to a higher level. For the sake of simplicity, the example describes how the ratio is raised from an initial level of 1,000 ⁄ 500 to 1,500 ⁄ 500 , or from 2:1

K/(C+I) K 1 /C 1 K 2 /I 1 1,000/500 1,000/500

1,000/500 900/450 100/50 1,050/500 945/450 105/50 1,100/500 990/450 110/50 1,150/500 1,035/450 115/50 1,200/500 1,080/450 120/50 1,250/500 1,125/450 125/50 1,300/500 1,170/450 130/50 1,350/500 1,215/450 135/50 1,400/500 1,260/450 140/50 1,450/500 1,305/450 145/50 1,500/500 1,500/500

1,500/500 1,500/500

… … …

C 1 is the demand for consumers’ goods in the following year.

I 1 is the volume of net investment in the following year.

K 1 is the portion of existing accumulated capital employed in the production of consumers’ goods to be sold in the following year.

K 2 is the portion of existing accumulated capital employed in the production of the portion of next year’s NNP that is represented by net investment.

to 3:1. It should go without saying, that the principles contained in this example are applicable to the process of capital intensification in general, that is, to a rise in the capital-net-output ratio from any given starting level to any other given level, and for any absolute values of consumption expenditure (or consumption expenditure plus net investment) and the capital stock.

The table assumes that the process of capital intensification is brought about by a reduction in consumption expenditure from 500 to 450 for a period of 10 years. It assumes that in each of these 10 years 50 of savings out

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 761 of net income are invested and added to the preexisting value of the accumulated capital stock, which means that 50 of net investment occurs in each year. It further assumes that once the value of the capital stock has been increased by a cumulative total of 500, so that the ratio of accumulated capital (savings) to income stands at 3:1, people are content with their degree of provision for the future and thus restore their consumption expenditure to 500.

The first column of the table is simply a series of years. The second column, K, presents the amount of accumulated capital year by year; the third, C, the amount of consumer spending year by year; and the fourth, I, the amount of net investment year by year. For the sake of simplicity, I follow my usual practice of assuming that all financial transactions take place on the first day of the year. In the present case, this permits dealing with the net investment of each year both as adding to the accumulated capital of that year and as contributing to the net output available at the start of the following year. Thus, for example, the accumulated capital of 1,050 shown for Year 3 both incorporates the 50 of net investment made in Year 3 and serves in the production of the net output that becomes available at the start of Year 4.

For each year, the fifth column of the table, K/(C+I), presents the ratio of accumulated capital to the socalled net national product (NNP), which, of course, is equal to the sum of consumption plus net investment and to national income. Initially, NNP is equal to 500 of consumption expenditure alone, and will be once again, at the conclusion of the process. But in the interval, as the process of capital intensification takes place, NNP is equal to the sum of 450 of consumption plus 50 of net investment. Because the net product of the economic system comes to be divided into these two portions, 450 of consumption and 50 of net investment, the total accumulated capital stock of the economic system comes to be divided into two corresponding portions: the one portion serving in producing the part of the net product purchased by the consumers, the other portion serving in producing the part of the net product that constitutes net investment.

The division of the capital stock in this way is shown in the last two columns of the table, headed K 1 /C 1 and K 2 /I 1 . It should be observed that C 1 is the demand for consumers’ goods of the following year, and, accordingly, K 1 is the portion of existing accumulated capital employed in the production of consumers’ goods to be sold in the following year. By the same token, I 1 is the volume of net investment of the following year, and K 2 is the portion of existing accumulated capital employed in the production of the portion of next year’s NNP that is represented by net investment. (This aspect of the table is similar to Figures 16–1 and 16–2, in which the disposition of the factors of production within each year is assumed to conform to the pattern of the relative demands for consumers’ goods and capital goods in the following year. The difference is that now the disposition of the net output in the following year between consumption and net investment is taken in place of the relative demands for consumers’ goods and capital goods, which categories of goods, of course, are the components of gross output. 70 )

In Table 16–10, Year 1 represents an initial equilibrium. It shows how the economic system has been operating up to this point. The value of the capital stock is 1,000, the demand for consumers’ goods is 500, and the capital-net-output ratio is 2:1. 71 In Year 2, consumption spending continues to be 500 and saving and net investment continue to be zero. But in this year, the allocation of capital undergoes an important change, in anticipation of the drop in consumption of 50 and emergence of 50 of net investment that is to occur in Year 3, and which will be maintained for a total of 10 years, viz., through Year 12. Accordingly, in Year 2, 100 of capital is transferred from the production of consumers’ goods for Year 3 to the production of the part of the net output of Year 3 that will be represented by net investment. Hence, in Year 2, K 1 /C 1 is 900 ⁄ 450 and K 2 /I 1 is 100 ⁄ 50 . To describe matters in terms of concretes, what will happen in Year 3 is that there will be 50 less of spending for such goods as residential housing and personal automobiles, and 50 more of spending for such goods as factory buildings, trucks, and freighters. Accordingly, in Year 2, 100 of capital is shifted from the production of such goods as residential housing and personal automobiles to the production of such goods as factory buildings, trucks, and freighters.

In Year 3, 50 of saving and net investment occur and result in a rise in the accumulated capital of the economic system from 1,000 to 1,050. This additional 50 of capital is divided between the production of consumers’ goods for Year 4 and the production of the portion of the net output of Year 4 which is represented by net investment; that is, it is divided in the ratio of Year 4’s demand for consumers’ goods to Year 4’s net investment, i.e., in the ratio of 450:50, or 9:1. Thus, 45 of the additional capital is devoted to the production of consumers’ goods of Year 4, and 5 of the additional capital is devoted to the production of the part of the net output of Year 4 that is represented by net investment. Observe that from this point on the employment of capital in the production of consumers’ goods begins rising. Both the production of consumers’ goods and the production of the goods represented by net investment become progressively more capital intensive.

762 CAPITALISM

The process of increasing capital intensiveness in the production both of consumers’ goods and the portion of net output represented by net investment continues from Year 3 to Year 11. By Year 11, total capital has risen from 1,000 to 1,450, of which 1,305 are employed in the production of consumers’ goods for Year 12, and 145 in the production of the part of the net output of Year 12 that will constitute net investment. In Year 12, however, the final 50 of additional capital is accumulated, and, at the same time, the allocation of capital is shifted back from the industries producing for net investment and the increase in capital intensiveness to the industries producing consumers’ goods. This is because having achieved the desired higher ratio of accumulated savings to current income by Year 12, people once again consume the whole of their nominal incomes starting in Year 13.

Of course, both the beginning and the end of the process need not be as abrupt as I have described it. There could be a gradual increase in saving and net investment accompanied by a gradual shift in the allocation of capital to the production of goods representing net investment. And the later, reverse movement could be equally gradual. Nor is it necessary that the changes in the consumption/saving pattern be anticipated with the precision I have presented. Any lack of anticipation of the initial shift will result in comparatively higher profits for the capital goods industries and comparatively lower profits for the consumers’ goods industries, because to this extent there will be a greater demand relative to supply in the case of capital goods and a smaller demand relative to supply in the case of consumers’ goods. By the same token, lack of anticipation of the later, reverse shift will result in comparatively higher profits for the consumers’ goods industries and comparatively lower profits for the capital goods industries, because now the opposite imbalance would ensue.

Under all conditions, however, at the end of the process, the net effect is that people end up with greater provision for the future (both absolutely and relatively), production is more capital intensive, the supply of goods is more abundant and can go on increasing more rapidly (thanks to the increased ability to implement technological advances that more capital intensiveness makes possible), and people restore their consumption expenditure in a condition in which they are better able to afford to do so. It thus works out to be the same as for an individual, who first saves and, as a result, later on puts himself in the position of being able to afford to step up his consumption.

And in just this way, any saving on the part of wage earners which did have the effect of bringing about negative net consumption would prove temporary. It would go on only until wage earners had accumulated savings sufficient to enable them to consume the whole of their wages, at which point, everyone in the economic system would be better off than he had been before. (To be sure, the wage earners would not only consume the whole of their wages but the whole of any profits or interest currently earned on the capital they had accumulated.)

It should be realized, although it is not stated explicitly, that the accumulation of capital and savings in the present analysis leads to a reduction in productive expenditure along with the restoration of consumption expenditure, just as in the previous analysis. This fact is present implicitly in the restoration of consumption expenditure and disappearance of net investment.

5. The Addition to the Rate of Profit Caused by Increases in the Quantity of Money

As we have seen, under an invariable money, as net investment occurs and total capital increases, the economic system becomes more and more capital intensive—i.e., capital rises relative to sales revenues, wages, and consumption. This has a profound bearing on the average rate of profit, over and above its tendency to cause a rise in net consumption and the disappearance of net investment—a bearing that applies to the rate of profit both in nominal and in real terms, and whose precise nature is the subject of this section and the next.

This further bearing on the rate of profit exists because, as we have also seen, a major effect of greater capital intensiveness is that the receptiveness of the economic system to technological progress is increased, which, in turn, can make possible continuous capital accumulation and economic progress. 72 The relevant aspects of the process of capital accumulation and economic progress are the increasing supply of commodities in general and of the monetary commodity or commodities in particular. The effects of the latter on the rate of profit in nominal terms is the subject of this section. The effects of the former on the rate of profit in real terms is the subject of the next section. The rate of profit in nominal terms, or, simply, the nominal rate of profit, is, of course, the rate of profit as ordinarily understood, that is, the amount of money earned as profit, divided by the amount of money invested as capital. The rate of profit in real terms, or simply, the real rate of profit, is the rate of profit adjusted for changes in the purchasing power of money. It is the measure of the gain in actual wealth, if any, that is the result of the earning of any given rate of profit. 73

A growing supply of commodity money is the virtually inevitable accompaniment of a growing overall ability to produce, inasmuch as there is no lack of any

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 763 chemical element in nature, not even gold or silver. 74 Thus there is nothing to stand in the way of this result once net investment has succeeded in raising the degree of capital intensiveness to the point that the receptivity of the economic system to technological progress is such that continuous capital accumulation and economic progress can in fact take place.

Up to now, of course, my discussion of profits has proceeded on the assumption that increases in production take place with no connection to the quantity of money. It should be clear that this assumption needs to be modified in dealing with an economic system whose money is itself a physical commodity, such as gold or silver. The truth is, as I have pointed out repeatedly, that under a gold or silver standard, largescale increases in production are bound to be accompanied by increases in the quantity of money and volume of spending. I will now proceed to show that the effect of this is the addition of a corresponding positive component to the nominal rate of profit. (In the next section, I will show how increases in the ability to produce the mass of ordinary, nonmonetary commodities add a corresponding positive component to the real rate of profit.)

Furthermore, as I have shown, in the case of any individual country using the same money as other countries, as is the case under an international gold or silver standard, the very fact of a more rapid rate of increase in physical production in that country compared with other countries will also increase the quantity of money in that country. This is because the economy of that country will come to constitute a larger proportion of the world’s economic system. As a result, it will come to hold a larger proportion of the world’s supply of commodity money and thus to experience rising spending and sales revenues within its own borders. 75 The effect of an increase in the quantity of money and volume of spending occurring in this way too is to add a positive component to the nominal rate of profit.

Thus, in reality, net investment and the growing capital intensiveness it causes are inherently incompatible with the assumption of a fixed quantity of money and volume of spending, if the money is a commodity money. They necessarily break the constraints of that assumption. The assumption of an invariable money is vital for purposes of economic theory, which can effectively develop its primary propositions in no other context. But the limits of the assumption must be recognized and the effects on the rate of profit of increases in the quantity money dealt with. Only then, can the determinants of the—nominal—rate of profit be considered as fully explained.

The rate of increase in the quantity of money and, accordingly, the volume of spending in the economic system, tends to cause an approximately equivalent increase in the rate of profit. For example, if the quantity of money and the volume of spending in the economic system increase by 2 percent a year, that tends to add approximately 2 percent to the rate of profit. If the quantity of money and volume of spending in the economic system increase at the rate of 5 percent a year, that tends to add approximately 5 percent to the rate of profit. In other words, if the rate of profit would otherwise have been, say, 4 percent, it will now be 6 percent or 9 percent, depending on the rate of increase in the quantity of money and volume of spending in the economic system.

This relationship follows from the very nature of the rate of profit. The rate of profit is the amount of profit earned, on an annualized basis, divided by the capital invested. For example, if a businessman spends $100 for a quantity of merchandise which he sells one year later for $110, his amount of profit is $10 and his rate of profit is 10 percent. If he spends $100 for merchandise that he sells one month later for $101, his annualized rate of profit is 12 percent. If he spends $100 for merchandise that he sells two years later for $120, his annualized rate of profit is, again, 10 percent.

Now if the quantity of money and thus the volume of spending in the economic system are increasing over time, the sales revenues of the average businessman will tend to increase accordingly. If, for example, the quantity of money and volume of spending are increasing at a 2 percent annual rate, our merchant who otherwise would have sold his goods a year later for $110, will now tend to sell them for 2 percent more, that is, for 1.02 x $110, which is $112.20. His rate of profit will thus be 12.2 percent instead of 10 percent. Similarly, the merchant who otherwise would have sold his goods one month later for $101, will now tend to sell them for slightly more. In a period of one month, a 2 percent annual increase in the money supply and volume of spending will tend to raise his sales revenues by 1 ⁄ 12 of 2 percent, i.e., by 1 ⁄ 6 of 1 percent. Thus instead of selling for $101, he will tend to sell for 1.00167 times $101, that is, for $101.17. When annualized, his monthly profit of $1.17 yields a rate of profit of 14.04 percent, which is approximately 2 percent more than his initial profit rate of 12 percent. Similarly, our merchant who initially sold his goods for $120 two years later, will now, at a 2 percent annual increase in the money supply and volume of spending, tend to sell them for 1.02 x 1.02 x $120, or for $124.85. A profit of $24.85, when annualized, turns out to represent a rate of profit of 12.43 percent on the $100 of capital invested. Again, the rate of profit is increased by approximately the same number of percentage points as the rate of increase in the quantity of money and volume of spending in the economic system.

Figure 16–2

The Elements Determining the Average Rate of Profit

Year 1

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500

Production:

PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50%

Year 2

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500 Production: PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50%

Year 3

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500 Production: PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50% ...........................................................................................................................................................................................

Year N

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Figure 16–3

Profits in an Economy with an Increasing Quantity of Money

Year 1

Opening

Assets 1K OF CAPITAL GOODS 1,000 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 300+Net Cons.: 200

Capital Goods: 500 Consumers’Goods: 500

1 K OF CAPITAL GOODS AT 500

Production:

PLUS 1L OF LABOR

AT 300 PRODUCE

50% 50%

Year 2

Opening

Assets 1K OF CAPITAL GOODS 1,100 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 400 Cash to Be Paid Out at a Cost Value of 400

Transactions: Demand for Demand for

Wages: 330+Net Cons.: 220

Capital Goods: 550 Consumers’Goods: 550

1 K OF CAPITAL GOODS AT 550 Production: PLUS 1L OF LABOR

AT 330 PRODUCE

50% 50%

Year 3

Opening

Assets 1K OF CAPITAL GOODS 1,210 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 440 Cash to Be Paid Out at a Cost Value of 440

Transactions: Demand for Demand for

Wages: 363+Net Cons.: 242

Capital Goods: 605 Consumers’Goods: 605

1 K OF CAPITAL GOODS AT 605 Production: PLUS 1L OF LABOR

AT 363 PRODUCE

50% 50%

Year4

Opening

Assets 1K OF CAPITAL GOODS 1,331 Units of 1C OF CONSUMERS’ GOODS of Business: at a Cost Value of 484 Cash to Be Paid Out at a Cost Value of 484

Transactions: Demand for Demand for

Wages: 399+Net Cons.: 266

Capital Goods: 665.5 Consumers’Goods: 665.5

These results are borne out by Figure 16–3 and Table 16–11. Figure 16–3, titled “Profits in an Economy with an Increasing Quantity of Money,” represents the previous Figure 16–2 but with the incorporation of the assumption that the quantity of money and volume of spending in the economic system increase at a 10 percent annual rate. (Such a large percentage increase is assumed strictly for purposes of ease of illustration. The rate of increase under a gold or silver standard would, of course, be far less.) The figure depicts a 10 percent annual increase both in net consumption and in productive expenditure, and, further, in the specific components of productive expenditure, namely, the demand for capital goods and wage payments. On the basis of the assumption that the costs deducted from sales revenues in each year represent the productive expenditure of the year before, it is possible once again to compute the annual amount and rate of profit in the economic system.

In Year 2, the amount of profit turns out to be 300 instead of the 200 which existed in Year 2 of Figure 16–2, under the conditions of an invariable money. (For the sake of convenience of readers who wish to make a direct comparison between Figures 16–2 and 16–3, the former is reproduced directly facing the latter.) This is because sales revenues, constituted by 550 of demand for capital goods and 550 of demand for consumers’ goods, are 1,100, while costs, representing the 800 of productive expenditure of Year 1, are still just 800. In Year 3, with sales revenues at 1,210 and costs at 880 (the latter reflecting the 10 percent rise in demand for capital goods and labor in Year 2), profits rise to 330. And thereafter, the amount of profit continues to increase by 10 percent per year—that is, at the same rate as the increase in the quantity of money and volume of spending. 76

The rate of profit in Figure 16–3, of course, can be computed simply by dividing the amount of profit in each year by the amount of capital that has been invested up to that year. The rate of profit computed for each year of Figure 16–3 can then be compared with the 11.11 percent rate of profit previously computed for each year of Figure 16–2. The difference will then show the effect of the 10 percent annual increase in the quantity of money and volume of spending. It should be expected, of course, that the calculations will show an addition to the rate of profit of approximately 10 percent, viz., that the rate of profit will now be approximately 21 percent instead of 11 percent.

The necessary calculations are carried out in Table

Table 16–11

The Effect of an Increasing Quantity of Money and Rising Volume of Spending on the Nominal Rate of Profit

Year M ∆M in % NC B d 1 1,000 10 200 800 800 2 1,100 10 220 880 800 3 1,210 10 242 968 880 4 1,331 10 266 1,065 968 5 1,464 10 293 1,171 1,065 KEY:

M = Money Supply.

∆M = The Increase in the Money Supply. NC = Net Consumption.

B = Productive Expenditure.

d = Costs Deducted from Sales Revenues. I = Net Investment (B-d).

I s p K r in % ∆r in % 0 1,000 200 1,800 11.11 80 1,100 300 1,900 15.79 * 4.68 88 1,210 330 2,090 15.79 4.68 97 1,331 363 2,299 15.79 4.68 106 1,464 399 2,529 15.79 4.68

* Figures allow for rounding s = Sales Revenues.

p = Profits.

K = Capital.

r = Rate of Profit.

∆r = Increase in the Rate of Profit.

16–11, which is appropriately titled “The Effect of an Increasing Quantity of Money and Rising Volume of Spending on the Nominal Rate of Profit.” Table 16–11 extends the data of Figure 16–3 to a fifth year. For each year, it shows the quantity of money, M, in existence at the start of the year; the percentage rate of increase in the quantity of money, ∆M, which, of course, is 10 percent; the amount of net consumption, NC; the amount of productive expenditure, B; the magnitude of costs deducted from sales revenues, d, which equals the productive expenditure of the previous year; the amount of net investment, I, which, of course, is equal to the difference between the productive expenditure and the costs of any given year; the magnitude of sales revenues, s, which is equal to the sum of net consumption plus productive expenditure; the amount of profit, p, resulting from the subtraction of costs from sales revenues; the amount of capital, K; the rate of profit, r, which results from dividing the amount of profit by the amount of capital; and, finally, ∆r, the difference between this rate of profit and the rate of profit prevailing in the conditions of Figure 16–2. 77

It turns out that the table shows a rise in the rate of profit from 11.11 percent in Year 1, which represents the conditions of Figure 16–2, to 15.79 percent in Year 2 and thereafter. This, of course, represents a surprisingly low addition to the rate of profit of only 4.68 percent, not the approximately 10 percent that previous discussion had led us to expect.

The reconciliation of this result with the reasonable expectation of a 10 percent addition to the rate of profit is to be found in the enormously large role played by the quantity of money in the calculation of capital invested. In each year of Figures 16–2 and 16–3, the quantity of money in the possession of business firms represents over half of their total capitals. This unduly large role of the quantity of money as a component of capital results from the simplifying assumption that all spending in a year takes place on the opening day of the year and is financed out of the preexisting cash holding of business.

The effect of such a large role being assigned to the quantity of money in the calculation of capital is to add a corresponding dead weight, as it were, in the calculation of the rate of profit.

This becomes apparent if the rates of profit in Figures 16–2 and 16–3 are recalculated on the basis of a provisional exclusion of the quantity of money from capital invested. If this is done, the amount of capital in Figure 16–2 turns out to be 800 in every year, as is shown in Table 16–12. Given a 200 amount of profit in each year, the table shows that the recalculated rate of profit for Figure 16–2 in every year is 25 percent rather than 11.11 percent. Similarly, Table 16–13 shows an amount of capital of 800 in Year 1 of Figure 16–3 and a rate of profit in that year of 25 percent. It shows the amount of capital in Years 2 through 5 of Figure 16–3 as 800, 880, 968, and 1,065 respectively. (As with Table 16–11, both tables continue to extend the analysis of Figures 16–2 and 16–3 to a fifth year.)

When these lesser amounts of capital, reflecting the exclusion of money, are divided into the respective amounts of profit of 300, 330, 363, and 399 for Years 2 through 5 of Table 16–13, the corresponding rate of profit turns out to be 37.5 percent in each and every year. This, of course, implies an addition to the rate of profit of 12.5 percent—which is shown in the column labeled ∆r%—and suggests that the actual relationship between the rate of increase in the quantity of money and volume of spending on the one side and the addition to the rate of profit on the other, is that the rate of profit is elevated by a number of percentage points equal to the rate of increase in the quantity of money and volume of spending plus the product of that rate times the initial rate of profit. (The addition to the rate of profit of a further 2.5 percent, over and above the 10 percent corresponding to the increase in the quantity of money and volume of spending, equals the product of the 10 percent annual increase in the quantity of money and volume of spending times the initial rate of profit of 25 percent.)

Table 16–12

Recalculation of Rate of Profit in Figure

Year K-M p r% 1 800 200 25 2 800 200 25 3 800 200 25 4 800 200 25 5 800 200 25

16–2 with Money Excluded from Capital

NC/(K-M)

NC I I/(K-M) in % in %

200 25 0 0 200 25 0 0 200 25 0 0 200 25 0 0 200 25 0 0

Table 16–13

Recalculation of Rate of Profit in Figure 16–3 with Money Excluded from Capital

Year K-M p r% ∆r%

1 800 200 25

2 800 300 37.5 12.5

3 880 330 37.5 12.5

4 968 363 37.5 12.5

5 1,065 399 37.5 12.5

The Impact of Increases in the Quantity of Money on the Net-Investment and Net-Consumption Rates

Further examination of the data of Figure 16–3 and Table 16–11, as recalculated in Table 16–13, shows that the increase in the rate of profit corresponds to the creation of a net-investment rate of 10 percent, which is equal to the rate of increase in the quantity of money and volume of spending, plus an increase in the net-consumption rate of 2.5 percent, i.e., from 25 percent to 27.5 percent. (Both rates, of course, are calculated on the basis of the exclusion of money from capital.)

Observe. In the conditions of Figure 16–2, there is no net investment and the net-investment rate is therefore zero. In the conditions of Figure 16–3, however, net investment equal to 10 percent of capital excluding cash commences. Thereafter, the absolute amount of net investment increases at a rate of 10 percent a year, which is the same rate as capital exclusive of cash increases. Thus net investment is 80 in Year 2, when capital exclusive of cash is 800; 88 in Year 3, when capital exclusive of cash is 880; 97 in Year 4, when capital exclusive of cash is 968; and, finally, 106 in Year 5, when such capital is 1065. In other words, the net-investment rate is 10 percent in each year. In addition, a 10 percent annual increase in the amount of net consumption raises the net-consumption rate by 10 percent of the initial net-consumption rate. The net-consumption rate is elevated in this way because the amount of net consumption in Year 2 increases by 10 percent—i.e., from 200 to 220— before there is any increase in the amount of capital exclusive of cash. And then, in Year 3 and thereafter, as the capital exclusive of cash increases by 10 percent per year, so too does the amount of net consumption.

On the basis of this discussion, it should be clear that the addition to the rate of profit caused by increases in the quantity of money and volume of spending does not represent the creation of a new, distinct component in the rate of profit that is separate from the net-consumption

NC/ Addition Addition NC (K-M) to NC I I/(K-M) to I rate in % in % rate in % in % 200 25 0 0

220 27.5 2.5 80 10 10 242 27.5 2.5 88 10 10 266 27.5 2.5 97 10 10 293 27.5 2.5 106 10 10 and net-investment rates, but represents an addition to those very rates. In other words, the effect of increases in the quantity of money and volume of spending is to raise the rate of profit essentially by virtue of raising the net-investment and net-consumption rates. For the increase in the quantity of money and volume of spending operates to increase both productive expenditure and net consumption in proportion to itself. The growth in productive expenditure from year to year correspondingly elevates productive expenditure above costs, which reflect the productive expenditure of the year before. Thus, the increase in the quantity of money and volume of spending adds to or, indeed, creates net investment. In addition, it increases the amount and rate of net consumption. Specifically, the rate of increase in money and spending adds to the net-investment rate a number of percentage points equal to itself, and to the rate of net consumption a number of percentage points equal to the product of itself times the initial rate of net consumption. 78

Increases in the Quantity of Money and the

Perpetuation of Net Investment

As we have seen, the main impact of the increase in the quantity of money on the rate of profit is by way of the net-investment rate rather than the net-consumption rate. While the increase in the quantity of money and volume of spending merely adds to the net-consumption rate, it tends to be responsible for the whole of the net-investment rate. Indeed, it is what keeps net investment in being. For as I have shown, in an economic system with an invariable money, net investment tends to disappear. 79 It is only the increase in the quantity of money and volume of spending that makes it possible for net investment to be a regular, permanent phenomenon.

A growing quantity of money perpetuates the existence of net investment because it results in growing outlays for the factors of production, and these outlays

are always ahead of the corresponding costs they generate. Imagine, for example, that because of a growing quantity of money, spending for plant and equipment by business rises at the rate of 2 percent per year, or at any given rate. Eventually, annual depreciation charges will also rise by 2 percent per year, or by whatever the rate at which productive expenditure for plant and equipment rises. But the depreciation charges will never catch up with the current spending for plant and equipment because they always reflect earlier such spending, which, in the nature of the case, was less. Thus, net investment occurs simply as a product of the increase in the quantity of money and the volume of spending.

To elaborate on this example, if the average life of plant and equipment is 20 years and the average rate of increase in the quantity of money and volume of spending in the economic system, including spending for plant and equipment, is 2 percent, then in 20 years, plant-and-equipment spending will equal whatever it is currently times 1.02 20 . But total annual depreciation charges in 20 years will equal the summation of one-twentieth of each of twenty years’ plant-and-equipment spending beginning with this year’s plant-and-equipment spending and continuing on up to the plant-and-equipment spending of twenty years hence. The plant-and-equipment spending of nineteen of those twenty years is smaller than the plant-and-equipment spending of Year 20, in a compound proportion of 2 percent per year. Thus the depreciation quotas in Year 20, reflecting the division of each of these progressively smaller annual plant-and-equipment expenditures of the previous years by twenty, are correspondingly smaller. It is a question of comparing

1 1.02 twenty depreciation terms ranging from through ,

20 20 1.02 2 1.02 20 all the way up to , with 1.02 20 . Obviously

20 20 the last term substantially exceeds the sum of the twenty depreciation terms. If it were broken into twenty equal parts, its excess would show up as the summation of

1.02 20 − 1 + 1.02 20 − 1.02 + 1.02 20 − 1.02 2 + . . .

20 20 20 20 20 20

1.02 20 1.02 20

− .

20 20

The difference is net investment in Year 20.

Obviously, the formula and its implications for net investment can easily be generalized to apply to any rate of increase in spending for plant and equipment of any average life, simply by substituting r for 2 percent, and n for 20 years.

It should not be difficult to see that essentially the same kind of relationship as exists between productive expenditure for plant and equipment, and depreciation cost, exists between productive expenditure on account of inventory and work in progress, and cost of goods sold. A growing quantity of money and thus rising volume of spending on account of inventory and work in progress operates to make such productive expenditures regularly exceed cost of goods sold, which reflects earlier such expenditures, which, in the nature of the case, were smaller.

The fact that the net-investment rate tends toward equality with the rate of increase in the quantity of money and volume of spending does not depend on the assumption that the labor and capital goods of any given year are entirely used up in producing the products just of the next year. Nor does it depend on the corollary of that assumption, which is that the costs of any given year are equal simply to the productive expenditure of the year before. The tendency toward equality between the net-investment rate and the rate of increase in the quantity of money and volume of spending does not depend on the number of future years that the means of production of any given year may serve or how long it may take for the value of those means of production to show up fully in the form of costs of production. These conclusions are confirmed by Table 16–14, “The Net-Investment Rate Equals the Rate of Increase in the Money Supply.”

Table 16–14 assumes the existence of plant with a 10-year life. It shows that if a constant amount of productive expenditure for such plant takes place—for the sake of illustration, 500 monetary units per year—annual depreciation cost rises to equality with such productive expenditure in 10 years. At that point net investment declines to zero and the net-investment rate becomes zero. This is after gross plant has grown to 5000 monetary units, cumulative depreciation to 2750 monetary units, and net plant to 2250 monetary units. The table then assumes that starting in Year 11, productive expenditure for plant rises at a 10 percent annual rate (based on a 10 percent annual increase in the quantity of money and volume of spending in general). The year-by-year implications of this are presented for annual depreciation, net investment in plant, and for the respective values of gross plant, cumulative depreciation, and net plant. Finally, the rate of net investment in plant is calculated by dividing each year’s net investment in plant by the value of net plant in the year before. The table shows that under the assumed conditions, the net-investment rate reaches 10 percent—exactly the same as the rate of increase in the quantity of money and volume of spending—in Year 19, and remains at 10 percent in all of the remaining years covered, namely, through and including Year 25.

Plant of any life could be substituted for the plant of

770 CAPITALISM

Table 16–14

The Net Investment Rate Equals the Rate of Increase in the Money Supply

Productive Annual Net

Year Expenditure Depreciation Investment in Gross Plant for Plant Cost Plant

1 500 50 450 500 2 500 100 400 1000 3 500 150 350 1500 4 500 200 300 2000 5 500 250 250 2500 6 500 300 200 3000 7 500 350 150 3500 8 500 400 100 4000 9 500 450 50 4500 10 500 500 0 5000 11 550 505 45 5050 12 605 516 90 5155 13 666 532 133 5321 14 732 555 177 5553 15 805 586 219 5858 16 886 624 261 6244 17 974 672 303 6718 18 1072 729 343 7290 19 1179 797 382 7969 20 1297 877 420 8766 21 1427 964 462 9642 22 1569 1061 509 10606 23 1726 1167 559 11667 24 1899 1283 615 12834 25 2089 1412 677 14117 Note: Because of rounding in the three columns, Net Investment in Plant sometimes deviates slightly from the difference between Productive Expenditure for Plant and Annual Depreciation Cost.

Net

Investment in Cumulative Plant as % of

Net Plant

Depreciation Previous

Year’s Net

Plant

50 450

150 850 88.89 300 1200 41.18 500 1500 25.00 750 1750 16.67 1050 1950 11.43 1400 2100 7.69 1800 2200 4.76 2250 2250 2.27 2750 2250 0.00 2755 2295 2.00 2771 2385 3.90 2803 2518 5.60 2858 2695 7.02 2944 2914 8.14 3068 3176 8.97 3240 3478 9.53 3469 3821 9.86 3766 4203 10.00 4142 4623 10.00 4556 5086 10.00 5012 5594 10.00 5513 6154 10.00 6065 6769 10.00 6671 7446 10.00

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 771

10 year life assumed in the table. In addition, any rate of increase in the quantity of money and annual expenditure for plant could be substituted. In all cases, it would be found that the rate of net investment ultimately came to stabilize at a rate equal to the rate of increase in the quantity of money and volume of spending. Furthermore, exactly the same kind of demonstration could be made in connection with net investment in inventory and work in progress.

The Increase in the Quantity of Commodity Money as an Addition to Aggregate Profit

Finally, the provisional exclusion of money from capital can now be abandoned, and money in the hands of business enterprises restored to the category of capital. With money restored to capital, the addition to the rate of profit will be found to correspond much more closely to the rate of increase in the quantity of money if we adopt the procedure of counting the increase in the quantity of money itself as constituting an equivalent addition to the amount of profit in the economic system. (I will provide the justification for following this procedure in the case of commodity money immediately following the demonstration of the consequences of following it.)

What I mean by counting the increase in the quantity of money itself as part of profits can be illustrated in terms of Figure 16–3 and Table 16–11. There the quantity of money increases by 100 units in Year 2, a further 110 units in Year 3, and so on, at a compound rate of 10 percent per year. What I am maintaining is that the addition to the rate of profit resulting from this increase in the quantity of money will be found to very closely approximate the 10 percent rate of increase in the quantity of money itself if the 100 of increase in the quantity of money in Year 2 is added to the 300 of profit existing in Year 2 on the basis of net consumption and net investment, and the 110 of increase in the quantity of money in Year 3 is added to the 330 of profit existing in Year 3 on the basis of net consumption and net investment, and so on.

If year by year, the increase in the quantity of money itself is added to the amount of profit otherwise existing in the economic system, this addition will be found to provide a rate of profit on the money supply of the year before precisely equal to the rate of increase in the money supply. For example, counting the 100 of additional money in Year 2 as an addition to the amount of profit in Year 2, provides a 10 percent rate of profit on the 1,000 of money counted as capital in Year 1. The 110 of additional money in Year 3 provides a 10 percent rate of profit on the 1,100 of money counted as capital in Year 2, and so on.

Thus the money supply of each year can be counted as part of capital, and no matter how large a part—no matter how exaggerated its size relative to the rest of capital—the rate of profit will increase in accordance with the rate of increase in the quantity of money. This is because the money component of capital no longer operates as a dead weight, since its growth generates a further, additional component in the amount of profit in the economic system. For example, capital can be 1,800 in Year 1, instead of 800, and a 10 percent rate of increase in the quantity of money now brings about not only 80 of net investment in the next year and 20 of additional net consumption, but the 100 of increase in the quantity of money itself enters into the magnitude of profit and provides a 10 percent rate of profit on the 1,000 of the capital of Year 1 that was constituted by money. And similarly in every following year. Thus, the monetary component of capital now has its corresponding profit component when the money supply grows, just as the nonmonetary part of capital has its net investment component in the rate of profit when the money supply grows.

This procedure and its implications for the calculation of the rate of profit, and for the increase in the rate of profit when the money supply grows, are elaborated in Table 16–15. This table is almost identical to Table 16–11. The only difference is that the year-by-year amount of increase in the quantity of money is shown instead of the rate of increase, and, more importantly, the amount and rate of profit—and thus the rise in the rate of profit— are calculated on the basis of the inclusion of the increase in the quantity of money in the amount of profit, alongside of the sum of net consumption plus net investment. The table shows that when recalculated in this way, the rate of profit rises from 11.11 percent to 21.05 percent, where it stabilizes, so long as the quantity of money and volume of spending go on increasing at a 10 percent annual rate. On this basis, the table shows that the recalculated addition to the rate of profit turns out to be 9.94 percent rather than the 4.68 percent of Table 16–11.

In addition, the last three columns of the table show, by means of a second line appearing for each year, that if the monetary component of capital were taken as the money supply of the year before, the addition to the rate of profit would conform exactly to the formula previously elaborated. Namely, to the formula that an increasing quantity of money tends to add a component to the rate of profit equal to the rate of increase in the money supply plus the product of that rate of increase times the rate of profit that would prevail in the absence of an increase in the money supply. For it shows that when calculated in this way, the rate of profit would rise from 11.11 percent to 22.22 percent. This rise in the rate of profit is precisely equal to the sum of the 10 percent rate of increase in the money supply plus 10 percent of the

772 CAPITALISM

Table 16–15

The Effect of an Increasing Quantity of Money and

Rising Volume of Spending on the Nominal Rate of

Profit When the Increase in the Quantity of Money Is Added to the Amount of Profit

YEAR M ∆M NC B d

1 1,000 200 800 800

2 1,100 100 220 880 800

3 1,210 110 242 968 880

4 1,331 121 266 1,065 968

5 1,464 133 293 1,171 1,065

KEY:

M = Money Supply.

∆M = The Increase in the Money Supply.

NC = Net Consumption.

B = Productive Expenditure.

d = Costs Deducted from Sales Revenues.

I = Net Investment (B-d).

11.11 percent rate of profit prevailing in the absence of an increase in the money supply. It is precisely equal to the sum of the 10 percent rate of net investment that is generated plus the increase in the rate of net consumption that is brought about by the 10 percent rate of increase in the quantity of money. 80

Now the procedure of counting the increase in the supply of money as a direct addition to the amount of profit in the economic system can be fully and readily justified in the case of a commodity money. Under a commodity money system, the quantity of gold and silver mined is the equivalent of sales revenues from the perspective of the gold and silver mining concerns. For example, the revenues of a gold mine under a gold standard are the gold it mines. Under a gold standard, a gold mine mines money, and the money it mines is for it the full equivalent of sales revenues.

Of course, gold and silver mines incur substantial costs, and these costs must be subtracted from the bullion revenues of these mines in determining their profits. Indeed, the profits of the money-mining concerns tend to be no greater in relation to capital invested than profits p=

I s NC+I+ K r% ∆r %

∆M

0 1,000 200 1,800 11.11

1,900 21.05 * 9.94 80 1,100 400 1,800 22.22 * 11.11

2,090 21.05 9.94 88 1,210 440

1,980 22.22 11.11

2,299 21.05 9.94 97 1,331 484

2,178 22.22 11.11

2,529 21.05 9.94 106 1,464 532

2,396 22.22 11.11

* Ignores effects of rounding

s = Sales Revenues.

p = Profits.

K = Capital.

r = The Rate of Profit.

∆r = The Increase in the Rate of Profit.

in any other branch of production, and thus do not remotely equal the quantity of money they mine. Nevertheless, under a commodity money, profits in the economic system as a whole do in fact tend to be elevated by the full amount of the money that is mined.

This is because to the extent that the money-mining concerns make productive expenditures and incur corresponding costs, the magnitude of productive expenditures and costs in the rest of the economic system is correspondingly reduced, and thus the magnitude of profits in the rest of the economic system is correspondingly increased. In other words, the devotion of resources to gold and silver mining, to earn the bullion revenues of these industries, equivalently reduces productive expenditure and costs in the rest of the economic system, whose sales revenues are what they are and whose profits are therefore correspondingly increased by the reduction in its productive expenditures and costs. In this way, an increase in the quantity of commodity money, in constituting revenues of the gold and silver mining concerns, constitutes in part the equivalent of the profits of these concerns and, for the rest, the equivalent of a reduction

in the costs and rise in the profits of concerns elsewhere in the economic system, whose productive expenditures and costs are less to the extent that productive expenditures and costs exist in gold and silver mining.

To put matters in still a somewhat different way, the bullion revenues of the money-mining concerns represent not only the equivalent of sales revenues to them, but the equivalent of a precisely equal addition to the aggregate sales revenues of the economic system, in the face of the same magnitudes of productive expenditure and cost in the economic system. The mining of commodity money, thus turns out to be very similar in nature to the existence of a further increment of net consumption, for it is a source if not of an excess of literal sales revenues over productive expenditure, then at least of an excess of sales revenues plus the virtual equivalent of sales revenues—i.e., mined bullion revenues—over productive expenditure.

For these reasons, in the case of commodity money, the procedure of treating the addition to the quantity of money as a direct addition to the amount of profit is fully justified.

In the case of a fiat paper money, of course, it is inappropriate to add the increase in the quantity of money itself to the amount of aggregate profit in the economic system. This is because the increase in the quantity of fiat paper money is not at all analogous to the sales revenues of a business. It is the fruit of a virtual counterfeiting operation, not of any kind of productive venture. Nevertheless, it should be realized that even in this case, the deviation between the increase in the rate of profit caused by the increase in the quantity of money and the rate of increase in the quantity of money itself is far less in reality than is indicated in Table 16–11. This is because the quantity of money in the real world is much smaller in relation to capital and the volume of spending than it is in Figures 16–2 and 16–3, and thus in Table 16–11, which is based on them. As a result, the significance of the “dead weight” constituted by counting the quantity of money in capital is correspondingly reduced. The resulting rates of profit and of changes in the rate of profit, therefore, much more closely approximate those of Tables 16–12 and 16–13, in which money is altogether excluded from capital, than those of Table 16–11, in which it looms so large. For example, if the quantity of money entering into capital had been a tenth of sales revenues instead of equal to sales revenues in Figures 16–2 and 16–3 and in Table 16–11, the resulting rate of profit in each year would have approximated the rates calculated in Tables 16–12 and 16–13.

The statement, earlier in this section, of the effect of increases in the quantity of money on the rate of net consumption in terms of a strict proportionality was almost certainly inaccurate. An increase in the quantity of money would not in fact directly and immediately increase net consumption in proportion to itself, as was assumed, for the sake of simplicity, in Figure 16–3 and the various tables developed on the basis of it. The immediate effect of the increase in the quantity of money on net consumption might well be limited to the extent to which the additional money was perceived as an addition to accumulated wealth. Nevertheless, there is some effect, and one which becomes the greater and more significant, the more rapid is the increase in the quantity of money and volume of spending. The discussion of the consequences of inflation in Chapter 19 provides a variety of grounds for this claim. 81

The fact that the increase in the quantity of money and volume of spending does operate to raise the rate of net consumption, and does so to the degree that the increase in the quantity of money is the more rapid, constitutes a powerful argument for a monetary system in which the increase in the quantity of money is strictly limited. Such a monetary system adds 1, 2, or 3 percentage points through the increase in the quantity of money to the rate of profit which would otherwise be established by the rate of net consumption alone. It thus serves to provide a sufficient incentive to invest money rather than hold it, even in the face of extremely low rates of net consumption—rates of net consumption on the order of 2 or even 1 percent. At the same time, with such modest rates of increase in the quantity of money, it does not serve significantly to raise the rate of net consumption. It thus achieves the possibly important benefits of a higher nominal rate of profit without any significant negative effects.

Such a monetary system, of course, is the 100-percent-reserve gold standard (or parallel 100-percent-reserve gold and silver standards), which compels strict limitation of the increase in the quantity of money to the modest rate of increase in the supply of precious metals. 82

Summary Statement of the Determinants of the

Rate of Profit

To summarize the determinants of the rate of profit: The rate of profit is determined by and equal to the sum of the rate of net consumption plus the rate of net investment. It can also be expressed as tending to equal, as an approximation, the sum of the rate of net consumption plus the rate of increase in the quantity of money and volume of spending. For the rate of increase in the quantity of money and volume of spending tends to generate an equivalent rate of net investment and, in the long run,

to be the only source of net investment.

The increase in the quantity of money and volume of spending also, of course, tends to raise the rate of net consumption. While it may not do so by the product of itself times the rate of net consumption prevailing in the absence of an increase in the quantity of money, it does so at least to some extent, and one which becomes the more significant, the more rapid is the rate of increase in the quantity of money and volume of spending.

The inclusion of money in capital does not materially affect the accuracy of the proposition that the rate of profit is elevated by a percentage approximately equal to the rate of increase in the quantity of money. In the real world, the quantity of money held by business is small relative to capital and sales revenues, and thus the “dead weight” aspect of counting money in capital is minimal. Moreover, under a 100-percent-reserve gold standard, the increase in the quantity of money would itself properly enter into the calculation of total profit and thus completely offset the otherwise dead weight aspect of counting money in capital.

The amount and rate of profit is ultimately determined on the basis of time preference operating through the rate of net consumption, the marginal productivity of capital operating through the rate of net investment, and the rate of increase in the quantity of money operating through both the rate of net investment and the rate of net consumption, though primarily through the former.

6. Increases in the Real Rate of Profit Dependent on Increases in the Production and Supply of Goods

The rate of profit to which increases in the money supply and volume of spending contribute is, of course, the nominal rate of profit, i.e., the rate of profit expressed simply in terms of money. This rate of profit, as everyone should now know, is by no means necessarily equal to the actual rate of gain—the real rate of profit—that businessmen experience, that is, to the rate of increase in their ability to purchase actual physical wealth. This is because it is entirely possible, and very frequently happens, that the same increase in the quantity of money and volume of spending that raises the nominal rate of profit, equivalently raises prices, with the result that absolutely no rise in the real rate of profit occurs. For example, a 2 or a 10 percent increase in money and spending may well succeed in raising prices by 2 or 10 percent at the same time that it adds 2 or 10 percent to the nominal rate of profit. If that happens, then even if someone adds the whole addition to his nominal profit to his capital and thus becomes worth 2 or 10 percent more in terms of money than he was before, he still has not gained anything whatever in terms of buying power. His larger nominal capital is capable of buying no more than was his original nominal capital.

Usually, these are the facts which must be stressed, so that people will realize that a nominal rate of profit of any given percentage by no means implies a corresponding increase in the ability of businessmen to buy goods. In the present context, however, what must be stressed is the fact that under a commodity money, the addition to the nominal rate of profit caused by the increase in the quantity of money not only can be, but typically is, accompanied by an equal or even greater increase in the real rate of profit. This becomes apparent when one realizes that the relationship between the nominal and the real rate of profit depends on the relationship between the rate at which the quantity of money and the volume of spending increase, on the one side, and the rate at which production and the supply of goods increase, on the other. If, for example, when the quantity of money and volume of spending increase at the rate of 2 percent per year, the production and supply of goods also increase at the rate of 2 percent per year, then prices on average will be stable. As our price level formula shows, 1.02 times the spending will buy 1.02 times the production and supply at an unchanged level of prices. Thus, in this case, the 2 percent addition to the nominal rate of profit caused by the increase in money and spending will also represent a 2 percent addition to the real rate of profit, because, at the same time, production and supply have increased at a 2 percent annual rate and have thus kept prices stable.

It is implied in this example that just as increases in the quantity of money and volume of spending add to the nominal rate of profit, so increases in the physical production and supply of ordinary, nonmonetary commodities add to the real rate of profit. The increase in the nominal rate of profit achieved by any given rate of increase in the quantity of money and volume of spending represents an increase in the real rate of profit only if it is accompanied by an equivalent rate of increase in production and supply. For only that will keep prices stable and thus allow the extra nominal profits to represent corresponding additional buying power.

It is no less implied that increases in production and supply can increase the real rate of profit without corresponding increases in the quantity of money and volume of spending, and thus without corresponding increases in the nominal rate of profit. If, for example, the nominal rate of profit were 5 percent with no increase in the quantity of money and volume of spending, and production and supply increased at an annual rate of 2 percent, then prices would fall approximately 2 percent per year. A businessman who began a year with $100 and finished it with $105 would have an increase in real wealth not of

5 percent, but of approximately 7 percent, because his $105 would go about 7 percent further than his initial $100 at prices only 98 percent of what they were at the start of the year.

What we have here is a kind of “Say’s Law of Profits”—namely, that the rate of increase in production and supply adds to the real rate of profit, while the rate of increase in the quantity of money and volume of spending adds only to the nominal rate of profit. More money and spending raise the nominal rate of profit, but are accompanied by a rise in the real rate of profit only insofar as there is an increase in the production and supply of goods. On the other hand, an increase in the production and supply of goods raises the real rate of profit, whether accompanied by an increase in the quantity of money and volume of spending or not. 83

It must always be kept in mind that the addition to the nominal rate of profit caused by more money and spending, and the addition to the real rate of profit caused by more production and supply, are separate and distinct elements, even though they are related under a system of commodity money. They certainly need not proceed at the same pace. There can be prolonged periods in which the increase in the production and supply of ordinary goods exceeds the increase in the supply of money and volume of spending. In such periods, the weighted average of prices falls, and the real rate of profit correspondingly exceeds the nominal rate of profit. If, on the other hand, the rate of increase in the supply of money and volume of spending exceed the rate of increase in the production and supply of goods, the weighted average of prices rises and the nominal rate of profit correspondingly exceeds the real rate of profit. The nominal rate of profit is always related to the real rate of profit in the following way: Namely, the nominal rate of profit plus the fall in prices or minus the rise in prices equals the real rate of profit.

A major principle which stands out is that increases in production and supply always raise the real rate of profit and, under a system of commodity money, by virtue of encompassing increases in production in mining in general and in precious metal mining in particular, also operate, at least to some significant extent, to raise the nominal rate of profit as well. The principle is that under a system of commodity money, increases in production and supply raise both the real and the nominal rate of profit. And it follows that the more rapidly production and supply can be made to increase under a system of commodity money, not only will the nominal and real rates of profit both be higher, but so too will be the proportion of nominal and real profits which is the result of increases in production and supply. In a rapidly progressing economic system that is based on a commodity money, the greater part of profits, both nominal and real, may well be the result of nothing more than the rate of increase in production and supply. 84

There is reason for thinking that under a 100-percent-reserve gold or silver standard, the real rate of profit would typically be above the nominal rate of profit, i.e., that the increase in the production and supply of goods would exceed the increase in money and spending, with the result that prices would normally fall. Such a situation could be expected to be typical because of the difficulties of increasing the production of the precious metals in comparison with the possibilities of increasing production in the rest of the economic system, including the possibility of adding to the list of what constitutes useable natural resources and of extending the range of products that can be produced from many of the useable natural resources already known.

A further major implication of the present discussion is that the inverse relationship that has been shown to exist between economic progress, on the one side, and both nominal national income and the amount and rate of nominal profit, on the other, does not apply to the conditions of a gold or silver money. In these conditions increases in the quantity of money appear as a by-product of the same process which increases the supply of ordinary goods, and are normally within the limit of those increases. As a result, under a gold or silver money, the growing supply of goods which represents economic progress is accompanied by a rising volume of spending, based on a growing supply of gold or silver money which itself is part of the growing supply of physical goods. It is thus accompanied both by an addition to the amount and rate of nominal profit and by rising money incomes of all types.

The inverse relationship between the rate of profit and economic progress pertains to the conditions both of an invariable money and of increases in the quantity of money at rates more rapid than the increase in the supply of a gold or silver money. It does not pertain to the conditions of a gold or silver money under normal circumstances.

Net Investment Without Increasing

Capital Intensiveness

Under the conditions of a gold or silver money, the nominal net investment that results from increases in the quantity of money normally represents equivalent or even morethan-equivalent real net investment. For it represents an addition to the nominal capital of business firms which is accompanied either by no rise in the prices of capital assets on average or, indeed, by a fall in those prices, resulting from the increase in the production of capital goods outstripping the increase in the monetary

demand for them. Such net investment is certainly real net investment, not merely nominal net investment.

Insofar as this additional real net investment represents an increase in the quantity of physical capital goods employed per worker, it can be viewed as constituting an increase in physical capital intensiveness. It is important to realize, however, that it does not constitute an increase in capital intensiveness in the dimension of relative monetary values—that is, in the sense of a rise in the ratio of capital expressed in money to consumption expenditure, or to sales revenues or wage payments. The relative-value dimension of the concept of capital intensiveness is the one which reflects the degree of provision for the future that is made relative to current consumption—that is, the degree to which people save and accumulate capital relative to consuming. It is the dimension to which special attention must be paid in connection with many of the leading problems of economic theory, such as whether or not capital accumulation causes or presupposes a fall in the rate of profit. The relative-value dimension, of course, is the dimension in which I have been primarily measuring capital intensiveness all along.

To be sure, the real net investment that takes place under a gold or silver money in conjunction with nominal net investment, presupposes the existence of a sufficiently high degree of capital intensiveness in the relative-value sense to inaugurate and maintain a process of rising production, including, above all, the production of growing quantities of capital goods. Indeed, my discussion of the effects on the rate of profit of an increase in the quantity of money began with the recognition that the growing capital intensiveness brought about by net investment in the context of an invariable money results in rising production, including the production of the monetary commodities gold and silver. 85 It was this which required my temporarily setting aside the assumption of an invariable money. Nevertheless, the nominal and real net investment which themselves result from the inauguration and maintenance of a sufficiently high degree of capital intensiveness in the relative-value sense do not themselves constitute the achievement of any greater degree of capital intensiveness in this sense.

In its nominal aspect, the resulting derivative net investment, if it can be called that, actually serves merely to maintain the existing, sufficiently high degree of capital intensiveness in the relative-value sense. This is because the same increase in the money supply that is responsible for this net investment, also operates to raise total wage payments, consumption expenditure, and total business sales revenues. Thus the growing nominal capital that such net investment achieves does not mean a rise in nominal capital relative to wages, consumption expenditure, or sales revenues. Only in the context of an invariable money does an increase in nominal capital automatically mean an increase in capital intensiveness in the relative-value sense. It certainly does not mean it in the context of an increasing quantity of money, in which the magnitudes that it must be taken relative to also increase, and do so as the result of the very same cause, namely, the increase in the quantity of money.

Along the same lines, notice that this derivative net investment goes on without any increase in the average life of the assets purchased by business. As I have shown, in an economy with a constant quantity of money and volume of spending, net investment can continue only by virtue of such things as devoting a larger and larger proportion of the outlays for factors of production to plant-and-equipment purchases as opposed to expensed expenditures and purchases of labor and materials to produce inventories, and to purchases of plant and equipment of longer life rather than shorter life. 86 However, this is not true of the net investment which is the result of a growing quantity of money and volume of spending. Such net investment is the result of growing outlays for assets of all descriptions, without any necessary change in favor of such things as spending for plant and equipment or longer-lived plant and equipment.

This net investment continues in its nominal aspect by virtue of the fact that rising productive expenditure, based on a growing quantity of money, tends always to be ahead of costs deducted from sales revenues, which costs reflect the necessarily smaller productive expenditures of previous years. 87 At the same time, in its real aspect, what is present is a growing supply of capital goods from year to year that stands in the same overall quantitative and temporal relationship to the consumers’ goods it will ultimately help to produce as did the smaller supply of capital goods of the year before. 88 Thus, there is no greater capital intensiveness in terms either of the ratio of the money value of capital to consumption expenditure, sales revenues, or money wages, or of the ratio of the physical supply of capital goods to the supply of consumers’ goods that will ultimately result from the supply of capital goods. The only sense in which there is more capital intensiveness is that of the ratio of the supply of capital goods to the supply of labor, and that is essentially the same as the resulting rise in the ratio of consumers’ goods to the supply of labor, i.e., the same as the rise in the productivity of labor.

Capital-Saving Inventions

The fact that capital accumulation can occur without increases in capital intensiveness in the relative-value sense—namely, as the result of technological progress taking place in conjunction with a sufficiently high existing degree of capital intensiveness in the relative—

value sense—should not, of course, be taken as in any way diminishing the importance of capital accumulation. Nevertheless, because the role of technological progress in capital accumulation is generally unperceived, the conviction prevails that capital accumulation is synonymous with greater capital intensiveness in the relative-value sense. Thus, when it is observed that the enormous increase in production that has taken place over the last century or more has not been accompanied by a significant increase in the degree of capital intensiveness in the relative-value sense, the conclusion is drawn that capital accumulation is of relatively little significance and that practically all of the credit for the increase in production should go to technological progress and increases in the productivity of the factors of production, as opposed to capital accumulation. 89 The alleged lack of need for capital accumulation to achieve economic progress is then attributed to “capital-saving inventions,” which allegedly make it possible to produce more and more without additional capital or with only relatively little additional capital.

Now a capital-saving invention can mean either of two things: An invention that makes it possible to produce a given product at a reduced expenditure for factors of production, or an invention that makes it possible to produce a given product by employing a smaller physical quantity of capital goods. In the context of a progressing economy under an invariable money, virtually every invention would be a capital-saving invention in the first sense, for in such an economy there would be an ever greater quantity of products produced without any necessary increase in the sum of capitals invested. Little need be said about capital-saving inventions of this sort. They would simply reflect the falling prices of capital goods and the reduced quantities of labor required in the production of products of any given type. Such inventions, of course, would not in any way imply the use of a smaller quantity of capital goods. Indeed, while ever falling expenditures of money capital were made for given quantities of capital goods, the same aggregate expenditures of money capital would be made for continually increasing quantities of capital goods. However, capital-saving inventions in the second sense, that is, in the sense of a saving of physical capital goods, do require some discussion, inasmuch as it is they which are cited in order to belittle the role played by the accumulation of capital in economic progress.

First of all, it must be realized that such inventions are the exception rather than the rule. If we compare the Middle Ages or any intervening period with the present, it at once becomes apparent that the economic progress of the Western World is overwhelmingly due to the accumulation of a larger supply of capital goods per capita, and not to an economization of the same supply. It is not the case that the supply of capital goods per capita is today the same or not significantly larger than it was in the Middle Ages, only today instead of being embodied in ox carts, simple forges, deer skins, and primitive looms, it is embodied in machinery and materials of greater physical economy. The progressive rise in the standard of living has at each step of the way been made possible by an expansion in the supply of capital goods. Decade by decade, the physical supply of capital goods produced has risen. Had it not, the subsequent increases in the supply of consumers’ goods could not have taken place. The increases merely in iron and steel production, in coal production, in trees felled, in wheat produced, and the indispensable role played by the larger supplies of these commodities in subsequent production should be sufficient to dispel any illusions on this score. To produce a larger quantity of iron and steel consumers’ goods, a larger quantity of iron and steel capital goods is required. To produce more bread, more wheat is required. To build more and larger houses, more lumber or bricks is required.

In certain cases, of course, it is possible to discover methods of physically economizing on the use of materials. A change in women’s fashions may eliminate several square feet of cloth from a dress; an improvement in the design of an automobile engine (assuming the engine itself does not require a larger quantity of capital goods in its own production) may make possible an economization of gasoline and petroleum. Household furniture may be less-cumbersomely designed. Economic progress, however, consists relatively little in making it possible to derive greater advantage from the same quantity of materials. For the far greater part, it consists in increasing the supply of materials. This is because there is a limit to how much cloth can be removed from a dress, to how much mileage can be obtained from a gallon of gasoline, and to how much wood can be removed from furniture. With economic progress, the cloth in the wardrobe of the average woman increases; motorists consume larger quantities of gasoline, requiring larger quantities of petroleum; the individual acquires larger quantities of furniture containing more wood in total. To make this possible, the production of the necessary capital goods must be increased. This principle applies even in the case of computers, where today a relatively small desktop computer has power comparable to that of a room-sized mainframe computer of a generation ago. This is because in place of a few hundred or a few thousand room-sized computers, there are now tens of millions of the desktop computers.

Frequently, what appears to be a saving of capital goods is not. One should not confuse the reduction in the physical quantity required merely of one capital good with an overall reduction in the quantity of capital goods

required to produce a product. And above all, one should not confuse a reduction in the physical size of a capital good with a reduction in the quantity of capital goods it represents. It may be that the capital good now contains a more valuable material embodying a larger quantity of labor in its own production. For example, if the reduction in the size, let us say, of a machine is accomplished by reducing the iron content of the machine, but also involves the use or added use in some way of platinum wire, the machine may very well represent a larger quantity of capital goods than previously, for it may now be the product of a larger quantity of labor. Or again, even if the machine represents the same physical quantities of all materials save one, which has decreased in quantity, e.g., iron ore, but that one has now undergone a higher degree of processing than previously, no real reduction in the quantity of capital goods may be involved; for that smaller quantity of ore, in undergoing a higher degree of processing, may have had as much labor expended upon it as the larger quantity of ore which did not undergo as high a degree of processing. Furthermore, insofar as the product requires the use of more advanced capital goods in its production, that too is a case of needing a larger supply of capital goods. Thus, the tens of millions of today’s personal computers require a larger supply of capital goods in their production than the comparative handful of mainframe computers of the past, not only in the sense of requiring a larger overall physical volume of materials, but also in the sense of requiring the existence of more advanced computer processors, memory chips, and so forth. Improvements in the quality of capital goods is a major aspect of capital accumulation and is to be regarded as an increase in the supply of capital goods.

Finally, even in those cases in which a genuine saving of capital goods does take place, the effect most likely is to increase the supply of capital goods. This is because insofar as capital goods are employed in the production of capital goods, the fall in the amount of capital goods needed per unit of output implies an increase in the production of capital goods. This can easily be demonstrated by using any of our illustrations of the relative production of capital goods and consumers’ goods, such as Figure 16–2, and by assuming an all-round flood of inventions that save capital goods. If the same total output could be produced with, let us say, half the quantity of capital goods, then the employment of the same quantity of capital goods must result in a larger total production; indeed, on the assumption of constant returns to capital goods (at the now higher level), a doubled total production. If the relative production of capital goods is unchanged, this means the production of twice the supply of capital goods as would otherwise have been produced.

Thus, if in the absence of the capital-saving inventions, quantity K of capital goods together with the fixed quantity L of labor would have produced 1K of capital goods and 1C of consumers’ goods, they now produce 2K of capital goods and 2C of consumers’ goods. What is present is merely nothing other than an enormous increase in the efficiency of the economic system in using existing capital goods. No more potent source of capital accumulation could be found. It follows that such capital-saving inventions as have occurred have simply further contributed to the process of capital accumulation and its overwhelming role in increasing production and the standard of living.

The studies which belittle the role of capital accumulation in increasing production commit the further error of taking the rate of return on capital as the measure of the physical contribution of capital goods to production—as the measure of the marginal net physical productivity of capital goods rather than of the marginal productivity of capital as I have used the term. 90 Such an approach ignores the fact that the supply of capital goods is responsible for well over 99 percent of the productivity of labor—for all of the additions to the productivity of labor that have taken place since caveman days, because none of these additions would have been possible without the increase in the supply of capital goods. 91

To some extent, those who deprecate the importance of additional capital in increasing production may be led to do so because of their mistaken views concerning what constitutes an increase in output. As I have shown, using national income as the measure of output, which is the almost universal practice, leads to the fallacy of viewing a fall in the demand for capital goods and rise in the demand for consumers’ goods, which has the effect of increasing national income, as the cause of an increase in output, when in fact its effect is to diminish the increase in output or, if carried far enough, cause a progressive decline in output. 92 In addition, as I have also shown, using national income as the measure of output implies that output increases to the extent that taxes are increased and the resulting increase in revenue is expended in enlarging the government’s payroll, something which in reality also operates to decrease production. 93 The result of these confusions is that the very process of decline in capital formation and the increase in real physical wealth is misidentified as an increase in the efficiency of the economic system on the grounds that the amount of capital required to generate a unit of national income has been reduced.

7. The Inherent Springs to Profitability

This chapter has shown how the productive process generates its own profitability through net consumption

and net investment. It has shown how net investment in the context of an economy with an invariable money, in raising the degree of capital intensiveness, lays the foundation for capital accumulation and rising production and thereby an increasing quantity of commodity money. It has shown how this last, in raising the level of spending from year to year, both perpetuates net investment and adds a corresponding positive component to the rate of profit.

What must be realized now is that these sources of profit are virtual springs to profitability, which operate to restore profitability whenever it might temporarily be lacking for any reason (notably, because of a financial contraction and ensuing depression). Insofar as net consumption exists—and it must exist, whenever savings have been accumulated in a sufficient ratio to income and consumption—the only thing which can prevent the existence of an aggregate profit is negative net investment, which certainly cannot be more than a temporary phenomenon. An increasing quantity of money and rising volume of spending, the by-product of capital accumulation and increasing production, also cannot fail to reestablish profitability.

The potential for net investment, which always exists, constitutes an even more powerful spring to profitability, one whose power increases as the prevailing rate of profit decreases. Whenever aggregate profitability is lacking, not only is net investment sufficient to restore it, but, in addition, as I will show, net investment is more and more encouraged by the fact that the lower is the rate of return on capital, the higher is the degree of capital intensiveness that pays, and thus the more powerful is the stimulus to the existence of net investment, as the means of achieving a higher degree of capital intensiveness. Thus, the economic system is so constituted that if the rate of profit should ever become unduly low, or disappear, that very fact encourages a move toward further capital intensiveness and thereby the calling into being of net investment, which restores the rate of profit. Once I have demonstrated these propositions concerning net investment, it will be possible not only better to understand what causes and perpetuates depressions and unemployment, but also to appreciate just how alien such phenomena are to the actual nature of a capitalist economy.

In order to understand the principle of potential additional net investment serving as a spring to profitability, the context of discussion must be carefully defined. The context is the general rate of profit in the economic system as a whole. More than that, it is the general rate of profit in the economic system as a whole as determined apart from changes in the quantity of money and the overall volume of spending. In other words, it is the rate of profit insofar as it is determined by the rate of net consumption and by the rate of net investment apart from changes on the side of money.

The naming of the first proviso, that it is the general rate of profit in the economy as a whole that is under consideration, should make it possible to avoid committing the fallacy of composition and making an invalid generalization from the consequences of a low rate of profit in an individual industry to the consequences of a low rate of profit in the economic system as a whole. In the case of an individual industry, a low rate of profit means a low rate of profit relative to rates of profit in other industries. The effect of this, of course, is to discourage investment in that industry, indeed, to encourage the withdrawal of capital previously invested. But the context under discussion here is not that of a low rate of profit in a particular industry relative to the rate of profit in other industries. It is that of a low rate of profit prevailing throughout the economic system. If this is kept in mind, then it will not be difficult to see how in these conditions, a low rate of profit actually works to encourage more capital investment rather than less.

To understand this principle, let us consider a number of concrete cases from which we can abstract the essential foundations of the principle. Let us consider, first, the case of a railroad company which is contemplating whether it should construct its line straight through a mountain by digging a tunnel, or detour around the mountain. Digging the tunnel, we assume, constitutes the more-capital-intensive method in that it requires a greater initial capital investment than the alternative. But once in existence, the tunnel would make possible, virtually forever, an annual saving in operating costs, because it would reduce the time required for trains to reach their destination. In reaching its decision, what the railway company considers is how much money the tunnel would potentially save it every year on the basis of savings of train-crew time, fuel consumption, and wear and tear of rolling stock, versus how much more it must invest to construct the tunnel in comparison with the less-capital-intensive detour around the mountain.

The railroad company will decide in favor of the tunnel if the annual savings the tunnel achieves are, when divided by the extra capital its construction requires, greater than the going rate of profit on capital. It will decide against the tunnel if the savings the tunnel achieves are, when divided by the extra capital its construction requires, less than the going rate of profit on capital. For example, imagine that the existence of the tunnel would make possible an annual saving in operating costs of $1 million per year in comparison with the alternative route, and that at the same time, the construction of the tunnel requires $10 million more of capital investment than the alternative route. In this case, the railroad company will

decide in favor of the tunnel if the going rate of return on capital is less than 10 percent. It will decide against the tunnel if the going rate of return on capital is more than 10 percent. This is because its investment in the tunnel will yield a rate of return of 10 percent ($1 million per year divided by $10 million). Whether or not this investment should be undertaken depends on a comparison of its profitability with the profitability of other investments. If the profitability of other investments is greater than 10 percent, then the capital that might be devoted to this investment should instead be devoted to them. If, on the other hand, the profitability of other investments is less than 10 percent, then this investment represents the better alternative, and it should be undertaken.

The essential point here is that the lower is the general rate of return on capital, the better does this particular investment appear by comparison. With a general rate of return of greater than 10 percent, this particular investment is submarginal—that is, it is insufficiently profitable to be undertaken. With a general rate of return of 10 percent, it becomes borderline. With a general rate of return of less than 10 percent, it becomes relatively attractive, and more and more so, the further below 10 percent the general rate of return falls. And as the general rate of return falls below 10 percent, still other investments become attractive by comparison. Capital-intensive improvements representing annual savings in cost equal to only 9 percent, 8 percent, 7 percent, and so on, successively become relatively attractive as the general rate of return falls below these levels. And not only in railroading, of course, but in every area of the economic system. In effect, the general rate of return operates as a standard, a test, which each particular capital-intensive improvement must pass in terms of the size of the annual cost reductions it achieves relative to the additional capital it requires. As the general rate of return falls, the standard—the passing grade, as it were—is reduced, with the result that a growing number of capital-intensive investments become relatively profitable, and the degree of capital intensiveness that pays is increased throughout the economic system. Furthermore, what applies to cost reductions applies equally to quality improvements. The additional revenues derived from these, relative to the additional capital that needs to be invested to achieve them, becomes less and less, as the general rate of return falls.

It pays to examine the same principle at work in another example. Thus, imagine a product that can be produced in a given quantity by any of three different methods of production, representing three different degrees of capital intensiveness. (The differences in capital intensiveness can be taken as reflecting different combinations of production by hand or by machine. The most— capital-intensive method uses the most machinery. The least-capital-intensive method uses the least.) We call these three methods, simply, A, B, and C. As shown in Table 16–16, method A is the least capital intensive, but also the most costly. It requires an investment of $10,000 of capital and results in $9,000 of annual costs to produce a given quantity of the product. Method B requires $20,000 of capital to produce the same quantity of the product but enables production to take place at an annual cost of only $8,000. Finally, method C requires $30,000 of capital to produce the same quantity of the product but enables production to take place at the still lower annual cost of only $7,000.

In the conditions of this example, as the revenue derived from the sale of a given quantity of the product declines, and thus, in the face of given costs, reduces profitability, the effect is to favor methods of production of greater capital intensiveness. The stimulus given to methods of greater capital intensiveness is shown in Table 16–16 by the effects on profits and the rate of profit of three different magnitudes of sales revenues. The largest magnitude of sales revenues, $11,000, which appears in the upper portion of the table, in the row labeled “Annual Sales Revenues (1),” is accompanied by profits of $2,000, $3,000, and $4,000 for methods A, B, and C respectively, and thus by corresponding rates of profit of 20 percent, 15 percent, and 13 1 ⁄ 3 percent respectively. These results appear lower in the table, in the respective rows “Annual Profits (1)” and “Annual Rate of Profit (1).” With sales revenues at $11,000, method A, the least-capital-intensive method, is the relatively most profitable.

When sales revenues for the same quantity of product fall to $10,000, the profits of methods A, B, and C, with their respective costs of $9,000, $8,000, and $7,000, fall to $1,000, $2,000, and $3,000, respectively. This results in the three methods of production now earning the same rate of profit on capital, given their respective capital requirements. These results are shown in the rows labeled “Annual Profits (2)” and “Annual Rate of Profit (2).”

When, finally, sales revenues fall to $9,000, as shown in the row labeled “Annual Sales Revenues (3),” the profits of method A are totally eliminated. Method B continues to show a profit of $1,000, which yields a rate of profit of 5 percent on the $20,000 of capital which must be invested in that method. But method C continues to show a profit of $2,000, which represents a rate of profit of 6 2 ⁄ 3 percent on the $30,000 of capital which must be invested in it. By comparison method C, the most capital intensive of the three methods, is now favored. These results appear in the rows labeled “Annual Profits (3)” and “Annual Rate of Profit (3).”

Table16–16

Capital Intensive Methods and the Rate of Profit

Method of Production: A B C

Capital Required: $10,000 $20,000 $30,000

Annual Production Costs: aa9,000 aa8,000 aa7,000

Annual Sales Revenues (1): 11,000 11,000 11,000

Annual Sales Revenues (2): 10,000 10,000 10,000

Annual Sales Revenues (3): a9,000 a9,000 19,000

Annual Profits (1): 2,000 3,000 4,000

Annual Profits (2): 1,000 2,000 3,000

Annual Profits (3): 0 1,000 2,000

Annual Rate of Profit (1): 20% 15% 13.33%

Annual Rate of Profit (2): 10% 10% 10.00%

Annual Rate of Profit (3): 0 5% 6.67%

This outcome should in no way be thought paradoxi-any given year.

cal. What brings it about is the fact that the more-capi- The rate of profit on capital invested is one of the tal-intensive methods are the lower-cost methods. As determinants of the prices of goods. And its role is the sales revenues for a given quantity of the product fall, the more pronounced, the more time consuming and capital only way to remain profitable is by achieving lower costs intensive the production of a product is, and also the of production. The way to achieve that is by investing higher is the rate of profit. If the rate of profit is 10 percent more capital. 94 per year, then for every $100 invested in a quantity of

As I have indicated, a lower rate of profit favors more raw scotch, the price of eight-year-old scotch must procapital intensiveness not only in cases in which more vide $214, for that is the sum required to yield a 10 capital intensiveness achieves lower-cost methods of percent annual rate of profit on $100 compounded for production, but also in cases in which more capital eight years. By the same token, for every $100 invested intensiveness achieves a better quality of products. An in a quantity of raw scotch, the price of thirty-year-old example which clearly brings out this principle is the scotch must provide the vastly larger sum of $1,745, case of thirty-year-old scotch versus eight-year-old because that is the sum required to yield a 10 percent scotch. Thirty-year-old scotch is a much higher-quality annual rate of profit on $100 compounded for thirty scotch than eight-year-old scotch. Its production also re-years.

quires the use of substantially more capital per unit of Observe. In this case, with the rate of profit at 10 output and is thus correspondingly more capital inten-percent, the thirty-year-old scotch must sell for more than sive. If thirty-year-old scotch is to be produced on a eight times the price of the eight-year-old scotch, so regular basis, then for every unit of scotch reaching the greatly does the 10 percent rate of profit influence its market in any particular year, there must be twentynine relative price. But now let us see what happens if the rate other units, age one through twentynine, in the hands of of profit were 5 percent instead of 10 percent. To yield a its producers. If eight-year-old scotch is to reach the rate of profit of 5 percent compounded for eight years, market on a regular basis, there need be only seven other the eight-year-old scotch would have to sell for $148. To units—the units age one through seven—in the hands of yield a 5 percent rate of profit compounded for thirty its producers, for every unit that comes to the market in years, the thirty-year-old scotch would have to sell for

$432. In this case, with the rate of profit at 5 percent, the thirty-year-old scotch need sell for only 2.9 times the price of the eight-year-old scotch, instead of more than 8 times the price of the eight-year-old scotch, which was the case when the rate of profit was 10 percent. The lower is the rate of profit, the smaller is the premium which must exist in the price of the older scotch. If the rate of profit were zero, the price of thirty or even one-hundred-yearold scotch would need to be no higher than the price of the eight-year-old scotch.

Now what is significant from the point of view of the present discussion, about the prices of the two scotches moving closer together as the rate of profit falls, is that this development is bound to favor the demand for the older, better-quality scotch. As the premium on this scotch falls, people will be able to give greater and greater consideration to its superior quality. As a result, the share of the market served by this more-capital-intensive product increases, and thus the need is created for the overall degree of capital intensiveness in this industry to go up.

This case illustrates the general principle that as the rate of profit falls, the premium in the prices of all higher-quality products whose production is relatively more time consuming diminishes, and thus the share of the market served by such products increases, with the result that a need is created for a higher overall degree of capital intensiveness in the economic system. Some further examples of the application of this principle are the comparative use of woods from trees of different growing times, the relative share of the market supplied with aged beef, and, in general, the share of the market supplied with products requiring the use of relatively more valuable raw materials further back in the production process or requiring the use of relatively more expensive plant and equipment in their production, particularly at earlier stages in their production.

The principle here sheds further light on the effects of a fall in the rate of profit on the use of more-capital-intensive methods of production in general. For example, with a rate of profit of 10 percent per year, a machine which costs $1,000 and lasts 10 years, must, if it is to be worthwhile, bring in each year the sum of $150 in the sales revenue of the product it helps to produce. This sum reflects an annual depreciation charge of $100 plus a 10 percent rate of return on the average capital outstanding in the machine over its life, which latter is one half of the initial capital invested, viz., $500. Thus, over its ten-year life, the machine must bring in a revenue over its cost of $500—i.e., 10 times ($150-$100). But if the rate of profit were 5 percent instead of 10 percent, then the machine would need to bring in each year only $125, and thus, over its ten-year life, only $250 in revenue over its cost. With the reduction in the premium in the revenue from the sale of the product that is required to make a machine pay, the value of the machinery employed in production necessarily tends to increase. And, of course, identically the same principle applies to the value of the buildings employed in production. Thus, the wider principle that capital intensiveness is favored as the rate of profit falls receives further confirmation.

In a very similar way, it can be shown that as the rate of profit falls, the growth of the more-capital-intensive industries in the economic system is favored relatively to the growth of the less-capital-intensive industries, with the result that once again a need is created for a higher overall degree of capital intensiveness in the economic system. This is shown in Table 16–17. There, Industry A, with a ratio of sales to capital of 10:1, is the least capital intensive. Industry B, with a ratio of sales to capital of 1:1, is more capital intensive. Industry C, with

Table 16–17

Capital Intensive Industries and the Rate of Profit

Industry: A

Sales/Capital: 10 Profit/Sales: 01% Profit/Capital: 10%

Sales/Capital: 10 Profit/Sales: 1/2% Profit/Capital: 5%

B C

1 1/3 10% 30% 10% 10%

1 1/3 5% 15% 5% 15%

a ratio of sales to capital of only 1:3, is the most capital intensive. (We can think of Industry A as representing supermarkets, which have an extremely rapid turnover of the portion of their capitals that is invested in inventories, and thus a very high overall ratio of sales to capital. Industry B can be taken as representing the automobile industry. And Industry C, finally, can be taken as representing the electric utility industry, almost all of whose capital is invested in power plants and wires underground, both with an extremely long life.)

The fact that these industries have such unequal rates of capital turnover (the sales to capital ratios) requires, of course, that they have correspondingly unequal profit margins—that is, profits as a percentage of sales—if they are all to earn the same rate of profit on capital invested. 95 Thus, in order for Industry A to earn a 10 percent rate of profit on capital invested, it requires a profit margin of only 1 percent. If it earns a profit of a mere 1 percent of sales, but its sales are 10 times its capital, it earns a 10 percent rate of profit on its capital. Industry B needs to earn a profit margin of 10 percent, if, with its 1:1 ratio of sales to capital, it is to earn a 10 percent rate of profit on its capital invested. And, of course, Industry C needs to earn profits on sales of fully 30 percent, if, with its 1:3 ratio of sales to capital, it is to earn a 10 percent rate of profit on its capital invested. All this is shown in the top half of Table 16–17.

The bottom half of Table 16–17 shows the profit margins that are required in the three industries if the rate of profit on capital invested is 5 percent instead of 10 percent. These lower profit margins are 1 ⁄ 2 percent, 5 percent, and 15 percent, respectively.

Now inasmuch as these lower profit margins are brought about by a fall in the selling prices of the products of the three industries, Table 16–17 implies that a decline in the rate of profit causes a relatively greater reduction in the prices of the products of more-capital-intensive industries than of less-capital-intensive industries. As the rate of profit falls from 10 percent to 5 percent, the price of the product of industry C falls by 15 percent, that of B by 5 percent, that of A by only 1 ⁄ 2 percent, for these are the extent of the price declines needed to achieve the respective reductions in profit margins. Because of this pattern of price reductions, the demand for the products of more-capital-intensive industries is favored, and therefore the need for capital intensiveness in the economic system is once more increased.

Thus, to summarize, a lower rate of profit on capital invested encourages greater capital intensiveness in the economic system by reducing the cost savings that more-capital-intensive investments must achieve relative to the additional capital required. This was shown in the example of the railroad tunnel. It is also accompanied by a more rapid wiping out of the profit margins of higher-cost, less-capital-intensive methods of production than of the profit margins of lower-cost, more-capital-intensive methods of production, with the result that the more-capital-intensive methods are rendered the comparatively more profitable. This was shown in the example of the three methods of producing the same quantity of the same product. In addition, a lower rate of profit reduces the premiums in price or in revenue that more-capital-intensive products, more capital-intensive-methods of production, and more-capital-intensive industries must bear relative to less-capital-intensive products, methods of production, and industries. This was shown in the example of scotch of different ages, the example of the additional revenue required to make the use of machinery or buildings pay, and, finally, the example of the industries of different degrees of capital intensiveness. In all these ways, a lower rate of profit favors a higher degree of capital intensiveness.

If this principle is understood, then it should now be possible to understand the claim made earlier that if for any reason the rate of profit is wiped out or made unduly low, the basis exists for an automatic restoration of profitability through net investment. All one has to realize is that when confronted with an unduly low rate of profit, businessmen are motivated to divert outlays for factors of production from some of their present lines to lines representing a higher degree of capital intensiveness, because, by comparison, these will appear as more profitable lines. Thus, if most businesses are earning little or no profit with the employment of their present amounts of capital, then what they need is more capital, in order to reduce their annual costs of production and/or to increase their sales revenues by virtue of having improved products to sell. In this situation what will happen is a withdrawal of capital from some of its present lines of employment and diversion to more-capital-intensive lines, as representing a more profitable use of existing capital. For example, unprofitable retail businesses will withdraw some of their capital from the retailing trade and make it available in the loan market, where it will be borrowed and used for the construction of things like additional railway tunnels. At the same time, some of the retailers will merge with one another, in order to carry on business more capital intensively and more economically. Such retailers will themselves probably seek additional capital.

What is present here is a shifting of productive expenditures from points less remote from showing up as costs of production to points more remote from showing up as costs of production, with the result that for a more-or-less-extended period of time a reduction takes place in the costs business subtracts both from its outlays for

factors of production and from its sales revenues. 96 This reduction in costs deducted is the reflection of a larger proportion of the output of the economic system being retained within business firms, instead of being turned over to customers in the sale of inventories or lost through depreciation or expensed expenditures. On the one side, it represents the accumulation of assets, which is a hallmark of net investment and the growth in capital intensiveness. On the other side, it represents an increase in profitability. Thus, the effect of the impetus toward additional capital intensiveness is a restoration of business profitability on the strength of the additional net investment entailed.

Of course, as my discussion of the sources of profit has shown, the restoration of profitability achieved by additional net investment is not confined to the existence of that net investment itself. The net investment spring presently under discussion tends to activate the other springs to profitability as well. This is because the higher degree of capital intensiveness that is brought about operates to increase production and thus, in the long run, and indirectly, the rate of increase in the supply of a commodity money. 97 The net investment spring also activates the net consumption spring in that the elimination of negative net investment immediately allows net consumption to generate profits equal to itself. 98 Moreover, in the conditions of recovery from a depression, the accompaniment of the net investment spring is a reduction in the demand for money for holding, which, in the short run, further adds to net investment and the nominal rate of profit, by raising productive expenditure and sales revenues relative to costs.

Wage Rate Rigidities and Blockage of the Springs

Given the existence of the various springs to profitability that have now been explained, the question arises of why the economic system does not in fact always spring back to profitability in the midst of a depression. One part of the answer, of course, is that the process of financial contraction and deflation must first come to an end, so that the financial losses inherent in that process can be avoided. Another essential part of the answer, which is necessary to limit the extent of the financial contraction and deflation, is that there must be a sufficient fall in wage rates. Before the critical net-investment spring can be activated, wage rates must fall to the level required for full employment in the face of the existing demand for money and quantity of money—a demand for money that is greater than it was before the depression, and a quantity of money that is very possibly smaller than it was before the onset of the depression. The demand for money in a depression is greater both because it has been deprived of the stimulus to spending created by inflation and credit expansion, and because of the existence of the process of financial contraction itself, especially when accompanied by bank failures under a fractional reserve banking system, which serve to reduce the quantity of money.

As I explained in Chapter 13, the failure of wage rates to fall to the fullemployment point causes a postponement of investment expenditures, and thus a wiping out of net investment and profitability, indeed, causes negative net investment and losses. 99 The operation of the springs to profitability comes into play only when wage rates reach the new, lower level that has become necessary for full employment, thereby eliminating the threat that present investments will be rendered unprofitable by substantial wage-rate reductions in the year or two ahead. At that point, the operation of the springs guarantees the restoration of net investment and profitability.

Capital Intensiveness and the Monetary

Component in the Rate of Profit

Preceding analysis has shown that there is always need for greater capital intensiveness, that if ever the rate of profit disappears or becomes unduly low, the movement toward greater capital intensiveness acts to raise the rate of profit back up, and that the reestablished rate of profit then limits the move toward any further increase in the degree of capital intensiveness. A question now arises concerning specifically the monetary component that is added to the rate of profit by virtue of the more rapid increase in the supply of commodity money that a higher degree of capital intensiveness brings about. Namely, does the monetary component in the rate of profit operate to reverse the increase in the degree of capital intensiveness that brought it about in the first place, as would a rise in the rate of net consumption or a rise in the rate of net investment brought about by carrying on the process of capital intensification too rapidly?

There is some important evidence for believing that the rise in the rate of profit caused by the monetary component does not have this effect, that it does not react back, as it were, and undermine the higher capital intensiveness on which it rests. This is because there is reason for believing that the relationship between capital intensiveness and the rate of profit pertains exclusively to that portion of the rate of profit that does not reflect the increase in the quantity of money.

The case of the thirty-year-old scotch versus the eight-year-old scotch can be used to perform an intellectual experiment that will demonstrate this point. We have seen how a fall in the rate of profit from 10 percent to 5 percent encouraged capital intensiveness by causing the price of the older scotch to fall to a greater extent than that of the younger scotch and thus to encourage the

purchase of the older, more-capital-intensive scotch at the expense of the purchase of the younger, less-capital-intensive scotch. Now what we will do is see if this encouragement to greater capital intensiveness is reversed by virtue of a more rapid rate of increase in the quantity of money that restores the rate of profit to 10 percent.

We saw that the fall in the rate of profit from 10 percent to 5 percent caused the price of the thirty-yearold scotch to fall from $1,745 to $432, while it caused the price of the eight-year-old scotch to fall from $214 to $148. This implied a fall in the ratio of the price of the older to the younger scotch from over 8:1 ( $1,745 ⁄ $214 ) to less than 3:1 ( $432 ⁄ $148 ). The test of whether or not an addition to the rate of profit by virtue of an increase in the quantity of money undermines the higher capital intensiveness on which the increase in the quantity of money rests will be whether or not the change in the relative prices of the two scotches is reversed by the more rapid rate of increase in the quantity of money.

For the sake of simplicity, we can assume that a more rapid rate of increase in the quantity of money takes place that is sufficient fully to restore the rate of profit, namely, to raise it all the way back up to 10 percent from the 5 percent to which it fell on the basis of a reduction in the rate of net consumption. If in raising the rate of profit back up to 10 percent, the increase in the quantity of money raises the ratio of the price of the thirty-year-old scotch to the price of the eight-year-old scotch back to 8:1, then we will have to conclude that the rise in the rate of profit caused by the more rapid increase in the quantity of money that is attributable to greater capital intensiveness does, indeed, work against the capital intensiveness on which it rests. If, on the other hand, we find that the rise in the rate of profit attributable to the more rapid growth in the quantity of money is not accompanied by any rise in the ratio of the price of the thirty-year-old scotch to the price of the eight-year-old scotch, then we must conclude that this kind of rise in the rate of profit does not work against capital intensiveness.

Well, what do we find? We find that if the quantity of money and volume of spending in the economic system now begin to increase at an annual rate of 5 percent (which is what will operate to raise the rate of profit from 5 percent to approximately 10 percent), the price of thirty-year-old scotch tends to be elevated by a factor of 1.05 30 , which is an increase of 4.32 times. 100 Thus, instead of being $432, it will tend to be $432 x 4.32, or $1,867. By the same token, the price of eight-year-old scotch will tend, in eight years, to be elevated from $148 to $148 x 1.05 8 , or to $218. On this basis, it may appear that the old 8:1 ratio is restored.

But this conclusion would be premature. Because what we must realize is that the more rapid rate of increase in the quantity of money and rise in the volume of spending does not stop its influence on the price of the eight-year-old scotch after eight years. It goes on influencing the price of the eight-year-old scotch year after year. In fact, it influences the price of eight-year-old scotch that will be available in thirty years fully as much as it influences the price of the thirty-year-old scotch that will be available in thirty years. The price of eight-yearold scotch to be available thirty years from now will also tend to be increased by a factor of 1.05 30 —that is, by exactly the same factor as the price of the thirty-year-old scotch. Eight-year-old scotch, thirty years from now, will tend to sell for $148 x 4.32, or $639. The thirty year old scotch, at $1,867, is not eight times as expensive, but less than 3 times as expensive ( $1,867 ⁄ $639 ), just as it was with a rate of return of only 5 percent.

What is decisive in bringing about this result is the fact that the more rapid rate of increase in the quantity of money and volume of spending go on acting on the price of the younger scotch year after year. If, on the other hand, the rise in the rate of profit had been the result of a rise in the rate of net consumption, the price of eight-year-old scotch would have been increased, but the price of eight-year-old scotch thirty years from now would not have tended to be any higher than the price of eight-yearold scotch eight years from now. A rise in the rate of profit attributable to a rise in the rate of net consumption would have raised the prices of the eight-year-old and thirty-year-old scotches unequally, for it would have operated on the price of the one for just eight years and on the price of the other for thirty years. 101 But a rise in the rate of profit attributable to a more rapid rate of increase in the quantity of money is accompanied by equivalent percentage increases in both prices, because the more rapid increase in the quantity of money goes on affecting both prices year after year.

Thus, this case shows that the rise in the rate of profit that results from greater capital intensiveness bringing about a more rapid rate of increase in the supply of commodity money does not react back and undermine the higher degree of capital intensiveness. The case must be understood as demonstrating this fact as a general proposition, because every instance of greater or lesser degrees of capital intensiveness represents merely the outlay of sums of money for longer or shorter times in advance of the sale of the product to whose production the sums of money contribute. In other words, every instance of different degrees of capital intensiveness can be conceived of as the scotch case or combinations of the scotch case.

This conclusion can be readily confirmed in such cases as that of the railway tunnel. In cases of this kind,

786 CAPITALISM the increase in the quantity of money and volume of spending would operate to increase the annual savings in operating costs to the same extent as they operated to increase the nominal rate of profit, for they would operate to make the wages and prices that constituted the operating costs higher each year by the same percentage as they added to the rate of profit. Thus, in such cases, the higher rate of profit brought about by the increase in the quantity of money would not serve to discourage greater capital intensiveness if the greater capital intensiveness were profitable otherwise.

Nevertheless, I have not yet been able satisfactorily to verify this finding in terms of examples of different methods of production capable of producing the same quantity of a given product, and of industries with different capital turnover ratios. In these cases, looking simply at the examples themselves, it appears that a rise in the rate of profit caused by the addition of a monetary component does operate to discourage capital intensiveness. This is because what is present is a rise in sales revenues relative to costs and thus a favoring of less-capital-intensive methods. In view of the fact that, independently of this, the increase in the quantity of money can be shown to have a substantial effect on the rate of net consumption, and thereby without question to undermine capital intensiveness, it is clearly best if the rate of increase in the quantity of money is moderate, as it would be under a 100-percent-reserve gold standard. 102

Capital Intensiveness Under Rapid Obsolescence

Inasmuch as I have just dealt with the question of the possible reactive effect of the increase in the quantity of money caused by a higher degree of capital intensiveness, on the degree of capital intensiveness, this is the logical place to deal with the possible reactive effect of the economic progress caused by a higher degree of capital intensiveness, on the degree of capital intensiveness. Namely, does it react back and reduce the degree of capital intensiveness?

This question arises because in the context of a rapidly progressing economy, the rate of obsolescence of machines and factories increases, necessitating more rapid depreciation. 103 It should not be thought, however, that this implies any tendency toward a diminution in the degree of capital intensiveness in the economic system. For reasons both already explained and yet to be explained, the rate of economic progress is not only positively related to the degree of capital intensiveness, but, if anything, the strength of this relationship is increased by the more rapid obsolescence that is caused by economic progress.

This is because the effect of such obsolescence is to require that a larger proportion of productive expenditure take the form of a demand for machinery and factory construction rather than a demand for labor. This is illustrated by the fact that if the average machine in the economic system can be in service for, say, twenty years, then, on average, for every twenty workers using a machine, only one machine needs to be produced in any given year. But if because of more rapid obsolescence, the average machine can be in service for only ten years, then for every twenty workers using a machine, an average of two machines must be produced in any given year. The effect of such a change is to increase the demand for capital goods at the expense of the demand for labor and thus at the expense of the demand for consumers’ goods, which comes mainly from wage earners. Thus, the result is a rise in the degree of capital intensiveness as measured by the ratio of capital to the demand for consumers’ goods or to wage payments.

This discussion, incidentally, implies the need for a modification in the measurement of capital intensiveness. Up to now, I have described capital intensiveness equivalently in terms of the ratio of capital to consumption expenditure, to wage payments, and to sales revenues. In actuality, the ratio of capital to consumption expenditure or to wage payments is a better measure of capital intensiveness than the ratio of capital to sales revenues. True enough, a rise in the ratio of capital to sales revenues does constitute an increase in the degree of capital intensiveness. But the present discussion calls attention to the fact that the degree of capital intensiveness can increase even though the ratio of capital to sales revenues remains the same or even declines somewhat. Capital intensiveness increases when a larger proportion of sales revenues is for capital goods and a smaller proportion is for consumers’ goods. This change is reflected in the ratio of capital to receipts from the sale of consumers’ goods, but it is not reflected in the ratio of capital to sales revenues as such. Thus, in the above example of the annual purchase of two machines with a ten-year life taking the place of the annual purchase of one machine with a twenty-year life, the ratio of net plant to sales revenues declines slightly, but the ratio of net plant to receipts from the sale of consumers’ goods rises, and thus capital intensiveness increases.

This conclusion is illustrated by taking the initial amount of annual expenditure for plant and equipment as 100 monetary units. Under this assumption, with annual depreciation at the rate of 5 percent, net plant comes to equal 2,000 monetary units of gross plant minus 1,050 monetary units of accumulated depreciation, that is, 950. (Accumulated depreciation amounts to 1,050 monetary units after 20 years because that is the sum of 20 terms starting with 5 and incrementing by 5 each year until, in Year 20, an annual total of 100 of depreciation

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 787 is reached.) If total sales revenues are 1,000 and receipts from the sale of consumers’ goods are 500, then the ratio of capital in the form of net plant to sales revenues is .95 ( 950 ⁄ 1,000 ) and the ratio of capital in the form of net plant to receipts from the sale of consumers’ goods is 1.9 ( 950 ⁄ 500 ). Now, in the face of economic progress and more rapid obsolescence, annual expenditure for plant and equipment rises to 200. This, together with the reduction in the depreciable life of the plant and equipment to 10 years, results in net plant coming to equal 900. (This is because gross plant comes to equal 2,000, as before, but accumulated depreciation comes to equal 1,100 instead of 1,050. The figure of 1,100 is the sum of 10 terms starting with 20 of annual depreciation and incrementing by 20 until 200 of annual depreciation is reached in Year 10.) In this case, the ratio of net plant to sales revenues falls to .9 from .95 ( 900 ⁄ 1,000 ). But because the rise of 100 in annual demand for plant and equipment is at the expense of a fall of 100 in the annual demand for consumers’ goods, capital intensiveness as measured by the ratio of capital to consumption, rises from 1.9 ( 950 ⁄ 500 ) to 2.25 ( 900 ⁄ 400 ).

Such an increase in the degree of capital intensiveness occurs in every case in which a higher degree of capital intensiveness results in more rapid obsolescence of plant and equipment and thus in a rise in the demand for capital goods at the expense of the demand for labor.

Accordingly, it is clear that the effect of a higher degree of capital intensiveness and the more-rapid economic progress and consequent more-rapid obsolescence of plant and equipment that it causes is not to react back and reduce the degree of capital intensiveness.

PART B

THE NET-CONSUMPTION/NET-INVESTMENT THEORY AND

ALTERNATIVE THEORIES

In this part, I present a critical analysis of the major alternative theories of the rate of profit and interest, namely, the productivity theory and the time-preference theory. I also trace essential roots of the net-consumption theory to the writings of Ricardo, and examine a previous very brief and unsatisfactory exposition of the combined net-consumption/net-investment theory put forward earlier in this century by Michael Kalecki and then taken up Joan Robinson.

Apart from the Marxian exploitation theory, which I refuted in Chapter 11, the productivity and time preference theories, or, indeed, as is most often the case, the two taken together in combination, are the most popular theories of the rate of profit and interest. A leading purpose of this part is to show that to whatever extent the productivity of capital and time preference actually do determine the rate of return on capital, they do so exclusively by way of their respective influence on the rate of net investment and the rate of net consumption, and that apart from these connections they have absolutely no influence on the rate of return.

1. Exposition and Critique of the Productivity

Theory in Its Traditional Form

The productivity theory can be understood in terms of a famous example developed by Roscher and then repeated by Böhm-Bawerk in preparation for his critique of the doctrine. Böhm-Bawerk quotes Roscher as follows:

“Let us imagine a nation of fisher[men], without private ownership or capital, dwelling naked in caves, and living on fish caught by hand in pools left by the ebbing tide. All the workers here may be considered equal, and each man is presumed to catch and eat 3 fish per day. But now one prudent man limits his consumption to 2 fish per day for

100 days, lays up in this way a stock of 100 fish, and makes use of this stock to enable him to apply his whole labor power for 50 days to the making of a boat and net. With the aid of this capital he catches 30 fish a day from that time on.” 104

If we assume, as does Böhm-Bawerk, that the boat and net last for 100 days, then we have the following situation. Each day’s use of the boat and net enables the fisherman using it to catch 27 more fish than he otherwise would have, or 2,700 additional fish in all. In the terminology of the contemporary supporters of the productivity theory, this is the marginal gross product of the capital constituted by the boat and net—it is what the boat and net add to the catch of the fisherman. The marginal net product of this capital is found by subtracting the cost of constructing the boat and net, which is the value of the 50 days of labor required to construct them. The value of this labor, according to the supporters of the productivity theory, is 3 fish per day, or 150 fish in total, for that is the product that must be forgone in order to construct the boat and net. (Obviously, the supporters of the productivity doctrine also support the opportunity-cost doctrine.) The marginal net product of the boat and net thus appears as 2,550 fish—the 2,700-fish-marginal-gross product of the boat and net minus the opportunity cost of 150 fish forgone in order to construct the boat and net.

The implied rate of return on capital here is the 2,550 fish of marginal net product divided by the amount of fish representing the average value of the capital invested, which is 75 fish. 105 The resulting rate of return is 3,400 percent. And since this rate of return is earned

788 CAPITALISM over a period of just 150 days and thus could be earned more than twice in a year, the implied annual rate of return is over 2 times that, i.e., more than 6,800 percent.

It should be realized, of course, that the productivity theory by no means necessarily implies the existence of high rates of return. The above rates of return result merely from the particular assumptions that happen to have been used in the example. The supporters of the productivity theory are willing to concede the possible existence of very high rates of return in such primitive conditions, but argue that the law of diminishing returns quickly sets in, which operates to reduce marginal gross and net products relative to successive equal increments of capital invested. Indeed, based on the law of diminishing returns, the productivity theory implies a tendency toward a constantly falling rate of return on capital invested, as additional capital is accumulated. The major factor offsetting this tendency, in its view, is technological progress, which allegedly operates to keep up the rate of profit by creating new investment opportunities.

All of these views can be found in the textbook of Samuelson and Nordhaus, whose exposition is typical and, at the same time, even uses the very example of the fish and boat and net:

. . . investing in capital goods involves indirect or roundabout production. Instead of catching fish with our hands, we find it ultimately more worthwhile first to build nets and boats—and then to use the nets and boats to catch many more fish than we could by hand.

Put differently, we frequently forgo present consumption to increase future consumption. Fewer fish caught today frees up labor for making nets to catch many more fish tomorrow. Society thus invests, or abstains from present consumption, and by waiting obtains a yield or return on that investment. In the most general sense, this yield— more future consumption in return for forgone present consumption—is the return on capital. 106

These passages clearly express the productivity theory’s conception of the rate of profit as representing the physical net productivity of capital. A few paragraphs later, they are followed by the passages I quoted back in Chapter 13, which express equally clearly the productivity theory’s view of the influence of the law of diminishing returns and technological progress on the rate of profit. 107

When I quoted the passages in Chapter 13, I dealt with the productivity theory’s errors with respect to technological progress. I showed technological progress to be a source of the supply of capital goods, not of “the demand for capital,” and to be fundamentally neutral with respect to the average rate of profit. That is, I showed that technological progress neither raises the average rate of profit (except to the extent of contributing to the more rapid increase in the quantity of a commodity money) nor lowers it by virtue of being the cause of alleged deflation, i.e., of falling prices. Later, I showed that in the absence of technological progress, the effect of the operation of the law of diminishing returns would be to reduce the rate of capital accumulation and economic progress, both of which would peter out in the sustained absence of technological progress. 108 This, rather than any reduction in the rate of profit, is the actual effect of the operation of the law of diminishing returns insofar as it is not offset by technological progress. In the next chapter, I will completely lay to rest the doctrine that capital accumulation causes a tendency toward a falling rate of profit. 109

There are further difficulties with the productivity theory in its traditional form. Among them is the fact that it rests on the acceptance of the doctrine of opportunity cost, as is apparent from the example of the boat and net. Needless to say, I have also already exposed the errors of this doctrine. 110 Furthermore, even if the opportunity-cost doctrine were free of error, the productivity theory must break down in every case in which the larger quantity of the consumers’ good produced is physically different than the consumers’ goods forgone in order to produce it. For example, how would one calculate the rate of return if what had to be forgone in order to construct the boat and net were, say, 150 loaves of bread instead of 150 fish? How does one calculate the difference between 2,700 fish and 150 loaves of bread?

This last difficulty implies that the very concept of a marginal net physical productivity of capital goods is simply illegitimate when applied in the context of individual firms and industries, whose output in a division-of-labor society is always physically very different than their inputs. The only legitimate concept of marginal productivity in this context is the one I have employed, which refers to the reductions in money costs and/or increases in sales revenues to be achieved by the employment of additional capital—additional capital, it must be stressed, not in the sense of additional physical capital goods, but in the sense of a monetary value both of the capital goods purchased and of the producers’ labor employed.

In the context of a division-of-labor society, the concept of a marginal net physical productivity of capital goods is legitimate only at the level of the economic system as a whole. The economy as a whole productively consumes capital goods which in turn makes possible the production of an output that replaces the capital goods consumed and more. From the perspective of the economic system as a whole, it is legitimate to view the capital goods consumed and the product produced as homogenous—at the very abstract level of units of wealth consumed and produced. Thus, at this level of abstrac—

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 789 tion, one may properly think in terms of a net physical productivity of capital goods.

It is at this level of abstraction that we will apply and analyze the example offered by Roscher and Böhm-Bawerk concerning the fishermen. When we do so, it will become obvious that the productivity theory in the form in which it is presently expounded—namely, as an attempt to explain the rate of profit on the basis of a net physical surplus in production—simply does not explain what it is absolutely essential for a valid theory of the rate of profit to explain. This, of course, is the answer to the question of just how an economy-wide surplus of money sales revenues over money costs of production comes into existence and is maintained. The existence of such a surplus is indispensable to the existence of a positive average rate of return on capital in the economic system as a whole. Without it, there cannot be a rate of profit or rate of return.

The fact that an individual fisherman or, indeed, everyone in the economic system—which is what all the fisherman taken together in the example are supposed to represent—adopts more productive methods of production and thus turns out a larger physical output does not in fact imply any addition whatever to the total of sales revenues in the economic system or any diminution in aggregate costs of production in the economic system. It thus implies nothing whatever about the average rate of profit in terms of money.

To understand this fact, let us take the case of the fishermen as the basis of an example in terms of money. Let us imagine that there is a society of 1 million fishermen organized into 1 million fishing enterprises, which initially produce 3 million fish a day, which they sell for $3 million, or at a price of $1 per fish. In other words, we take 3 million fish to represent the total physical product of the economic system and $3 million to represent the aggregate monetary demand for that product.

Having made these assumptions, still another problem arises for the productivity theory. Namely, it turns out that in such primitive conditions, in which there are as yet no capital goods and in which, therefore, the manual workers who gather the fish can be presumed simply to produce and sell their own products and not to act as capitalists, the full sales proceeds of the fishermen are profits! This, of course, follows from the fact that, not acting as capitalists, they do not make productive expenditures and therefore have no money costs to deduct from their sales revenues. 111 It also turns out that the rate of return on capital in these conditions is infinite! This last point follows because the fishermen’s profit would be earned on a capital invested of zero. This is because, in the absence of productive expenditure, there can be no capital in terms of money, as well as no costs in terms of money. 112 These facts represent a serious difficulty for the productivity theory, because the theory claims to be an explanation of the genesis of profit and the rate of return, and here they are in existence prior to any capital or productivity of capital, with profit at a height in relation both to sales revenues and to capital that it will never afterwards achieve.

But we can put this difficulty aside and simply imagine that each of these fishermen is paid a wage of, say, $2.50 per day by some kind of external fishing enterprise. This assumption enables us to zero in on the central difficulty of the productivity theory in the context of an economic system that uses money and has an existing economic degree of capitalism—of buying for the sake of subsequently selling. For now we are in a position to see clearly just why the productivity theory in its present form, is simply unable to explain the determination of the general rate of profit.

What we have is the following situation. Because of the use of a boat and net, one individual fisherman produces 30 fish per day instead of 3 fish per day. All the rest of the fisherman continue as before. Thus, the output of the economic system as a whole rises from 3 million fish to 3 million and 27 fish per day. Given the same supply of money in the economic system and the same demand for money for holding, total spending to buy products (in this case represented exclusively by fish) remains $3 million. Thus, total sales revenues in the economic system remain $3 million. As a result, the price of fish declines from $1 per fish to $1 times the fraction formed by dividing 3 million by 3 million and 27.

In these circumstances, our individual fisherman with the tenfold increase in his output takes in almost ten times the sales revenue. The monetary profit of his enterprise is thus very greatly increased. But by the same token, the monetary profits of all the other fishing enterprises in the economic system taken together are equivalently decreased. Collectively, they take in as much less in sales revenue as he takes in more. And thus their profits are as much reduced as his are increased. In the economy as a whole, total sales revenues remain at $3 million and total costs of production remain at $2.5 million (1 million fishing enterprises, each with a wage cost of $2.50). Thus, total profits in the economic system remain at $500,000.

Nothing is changed as far as the average rate of profit is concerned if all the fishing enterprises adopt the use of boats and nets and collectively turn out 30 million fish per day instead of 3 million fish per day. So long as the quantity of money and the demand for money for holding remain the same, aggregate sales revenues remain the same. So long as the average fisherman is paid a wage of $2.50 per day, aggregate costs remain the same. And thus

aggregate profits remain the same—once again, at $500,000. Whatever the money value of the capital invested in the economic system, the average rate of return on capital remains at the figure formed by dividing that amount of capital into the $500,000 of aggregate profit. All that is different is that, because of their tenfold increase in supply in the face of the same aggregate demand, fish now sell for an average price of 10 cents instead of $1. To the extent that nominal profits exist—on some other basis than that of the productivity theory, of course—real profits may be said to be increased by a factor of 10 by virtue of the 90 percent fall in prices. Real wages too are increased by this multiple. But the nominal amount and rate of profit would be unchanged, and nominal wages would be unchanged.

There are only two ways that the adoption of the more productive methods of production symbolized by the boats and nets would be capable of affecting the general monetary rate of return on capital. One would be the extent to which the more productive methods could be applied to the mining of the precious metals under a system of gold and silver commodity money. This would result in a more rapidly growing quantity of money and volume of spending in the economic system, and thus in more rapidly rising aggregate sales revenues, which last would raise the rate of return in the ways explained earlier in this chapter. 113 The other connection to the rate of return would be the extent to which the adoption of the more productive methods entailed net investment apart from increases in the quantity of money.

In the original example of the fisherman, it was assumed that 100 fish were saved up and that labor was then temporarily withdrawn from catching fish and devoted to constructing a boat and net instead, while the worker lived off of his accumulated stock of fish. That element of the example can be translated into monetary terms that have a bearing on the rate of return. Thus, let us imagine that for a time, the million fishing enterprises reduce their production of fish from 3 million per day to 2 million per day. For 150 days, they devote one-third of their labor to the construction of boats and nets (this would be equivalent to devoting their full labor for 50 days, as assumed in the original example). In these 150 days, aggregate sales revenues continue at $3 million per day, as before. But aggregate costs fall from $2.5 million, to only two-thirds of that amount, i.e., to $1.67 million. The fall in aggregate costs takes place because the value of the labor going into the construction of the boats and nets is not charged against sales revenues, but is debited—added—to the value of the boats and nets under construction. In other words, there is a rise in aggregate profit and the average rate of profit, insofar as net investment takes place in connection with the adoption of the more productive methods of production. Apart from the increase in the quantity of money, this is the only way that the adoption of more productive methods of production can be associated with the emergence of an average rate of return on capital in the economic system as a whole. In such cases, it is clear, what raises the rate of return is not the use of the more productive methods, but only such net investment as might take place in making possible their adoption.

Of course, in the context of an invariable money, the adoption of more productive methods of production made possible by a greater supply of capital goods would normally not entail any net investment in monetary terms, nor, therefore, any contribution to aggregate profit. The larger supply of capital goods would usually be the result of the greater production of capital goods that was part of the larger overall production made possible by a preceding increase in the supply of capital goods. As we have seen, this process of capital accumulation continuing indefinitely without need for further increases in the degree of capital intensiveness in the relative-value sense— which would be the necessary result of net investment in the context of an invariable money—is made possible by virtue of technological progress. 114 Thus, under a system of invariable money, while more productive methods of production can be associated with a contribution to the rate of profit, by way of the accumulation of capital necessary to adopt them, as a rule even this association will not be present.

To be sure, in reality, the adoption of the more productive methods of production that an increasing supply of capital goods makes possible is normally accompanied by net investment in monetary terms and a corresponding contribution to aggregate profit. This is in the context of an economic system with an increasing quantity of money. But here too, it is not the adoption of the more productive methods of production, nor even the accumulation of capital required to undertake them, that is responsible for any contribution to the rate of profit, but, this time, the increase in the quantity of money and volume of spending that accompany the capital accumulation and adoption of more productive methods of production.

The truth is that apart from the increase in the quantity of money that it may contribute to, the marginal productivity of capital simply has no bearing on the rate of profit except insofar as it is a cause of net investment in a context in which it results in capital intensification in the relative-value sense. Indeed, the general marginal net productivity of physical capital goods, when conceived in terms of abstract units of wealth, such as has been the practice of this book, is almost certainly far higher than

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 791 the average rate of profit. Thus, for example, ever since the analysis of capital accumulation in Chapter 14, I have consistently assumed that the productive consumption of each unit K of capital goods results in the production of an output equivalent to 2K of capital goods. This implies a general, economy-wide constant marginal net physical productivity of capital goods of 100 percent. Yet the rate of profit in my examples was never even remotely this high. As we saw earlier in this chapter, when 500 monetary units were expended to buy 1K of capital goods, and the resulting output of 1K plus 1C (which was equivalent to 2K of capital goods in terms of the physical wealth it represented) was sold for 1,000 monetary units, the rate of profit was only 11.11 percent, not 100 percent. This was because, first, 300 in wage costs had to be subtracted from the 1,000 of sales revenues, along with 500 of cost on account of capital goods. And then the 200 which remained for profit had to be divided by a capital of 1,800.

We are in a position to see also that profits differ from the general marginal net physical productivity of capital goods by virtue of the difference between increases in production and increases in sales revenues. In the conditions of an invariable money, there are no increases in aggregate sales revenues, no matter how much the general marginal net physical productivity of capital goods may increase. Indeed, we have already seen this just a few paragraphs ago in the demonstration that a tenfold increase in fish production accompanying an extremely high marginal net physical productivity in terms of fish, would not imply any addition to the amount or rate of profit in the conditions of an invariable money. The tenfold supply of fish, we saw, was accompanied by an unchanged aggregate demand and thus unchanged aggregate sales revenues. In the circumstances, all that occurred was a 90 percent reduction in the price of fish, and absolutely no increase in aggregate profits in terms of money.

We can see the same phenomenon in terms of the case of 1K of capital goods and 1L of labor, by assuming that instead of producing an output of 1K and 1C, they produce twice the output, namely, an output of 2K and 2C. Under an invariable money, the sales revenues brought in by this doubled output would still be just 1,000 monetary units. And thus with the same expenditure of 800 monetary units for the factors of production, the amount of profit would remain 200 monetary units, and the rate of profit, 11.11 percent. This would be so even though the general marginal net physical productivity of capital goods had risen from 100 percent to 300 percent, based on the use of 1K of capital goods to produce an output equivalent to 4K of capital goods instead of equivalent merely to 2K of capital goods. The effect of the higher general marginal net physical productivity of capital goods would simply be an increase in output resulting in a fall in prices. The additional 200 percent of general marginal net physical productivity would have no ability to add to profits. It would add to production and reduce prices, but add nothing whatever to monetary profits.

When the concept of the marginal net physical productivity of capital goods is viewed in the light of my analysis of capital accumulation, it becomes clear that while it is not a cause of the rate of profit, it is a cause of the rate of physical capital accumulation and economic progress, or at least of the determination of the height of the relative demand for capital goods that is necessary to achieve physical capital accumulation and economic progress. Taken in the context of the economic system as a whole, as it should be, the concept of the marginal net physical productivity of capital goods is simply what I have all along been referring to as the productivity of capital goods, but taken net of the capital goods used up in production. Seen in this light, its true significance relates to the ability of the economic system to produce and to accumulate capital goods, not to the rate of profit. It determines how much can be produced from any given quantity of capital goods—such as 1K—in terms not only of consumers’ goods but also of further capital goods, and thus what proportion of output must be in the form of capital goods in order to make possible the replacement of the capital goods used up in production.

In summary, when applied in its only proper context, which is at the level of the economic system as a whole, the productivity theory rests on two central errors: First, it equivocates between capital and capital goods, thereby failing to see that wages are paid out of capital. This leads it to understate the cost of production by a failure to consider that portion of the capital used up which is constituted by wage payments, and thus to confuse a percentage of the cost of capital goods with a percentage of total cost and of capital as well. This was present in its implication that the rate of profit should be 100 percent in conditions in which 1K of capital goods produces an output equivalent to 2K of capital goods, when in fact the rate of profit was only 11.11 percent. (Of course, the fact that the rate of profit was even as high as this cannot be explained by the productivity theory, but only by the existence of net consumption or, in a different context, by the existence of net investment along with net consumption.)

Second, the productivity theory ignores the relationship of net productivity to product prices. This enables it to proceed as though a gross physical product in excess of the quantity represented by the capital goods in question constitutes a larger value magnitude to the same extent. This was present in its implication that the rate of

profit should be 300 percent in conditions in which 1K of capital goods produces an output equivalent to 4K of capital goods. Here it overlooked the fact that nothing is automatically present to increase the magnitude of sales revenues as the magnitude of net productivity increases, and that if no such thing is present, the effect is simply a fall in prices, not an addition to profits. Of course, to the extent that such a factor is present, namely, a more rapid increase in the quantity of money and volume of spending, then it is this factor—the increase in money and spending—that must be regarded as the source of the additional profit, not the increase in physical net productivity. Indeed, this criticism is applicable to the productivity theory in every context, inasmuch as the productivity theory attributes the existence of profit as such to an increase in production achieved by the employment of capital goods.

2. Exposition and Critique of the Time-Preference Theory in Its Traditional Form

The time-preference theory in its traditional form seeks to explain the rate of return on capital in the following way. Other things being equal, it argues, people attach greater importance to the satisfaction of their wants in the present than in the future, and in the nearer future rather than in the more remote future. On this basis, the time-preference theory claims, they attach a higher valuation to goods available in the present rather than in the future, and in the nearer future rather than in the more remote future, because goods derive their value from the importance of the wants they serve, and are more highly valued to the degree that the wants they serve are more important. Thus, in the words of Böhm-Bawerk, people value “present goods” more highly than “future goods” of the same kind and quantity. 115 For example, they value an apple or an automobile today more highly than an apple or an automobile not to be available to them until a year from now.

This preference for present goods over future goods supposedly enters into the valuation of the factors of production. The totality of the factors of production required to produce a product is regarded as a future good. For example, the totality of the factors of production required to produce an automobile that will be completed one year from now is regarded for purposes of valuation as a future automobile to be available in one year.

According to the time-preference theory, the fact that factors of production are future goods, which are less highly valued than present goods, is what explains the rate of return on capital. For example, the factors of production required for producing 10 apples to be available a year from today are valued as the equivalent of 10 future apples. But 10 future apples are of less value than 10 present apples. They may be of a value equivalent only to 9 present apples. Thus, the factors of production required for producing 10 future apples begin with a value equal to that of only 9 present apples. But now time passes. At the end of a year, the factors of production required for producing 10 future apples have succeeded in producing those apples. They have “matured” or “ripened” into 10 present apples. Thus, the totality of the factors of production required for producing 10 apples, which began with a value of only 9 present apples, has been transformed into 10 present apples, with a value of 10 present apples. In other words, profit exists because factors of production are future goods, which are purchased at a “discounted value” in comparison to present goods of the same kind and number, and then mature or ripen into present goods, which shake off that discount and sell at the full value appropriate to present goods. (This example, of course, is supposed to apply to all goods, inorganic as well as organic. Thus the factors of production required to produce an automobile or house are also held to begin as future goods and then to mature or ripen into the automobile or house.)

The nature of the process is clearly stated by Rothbard, who essentially does nothing more than adapt the illustration Böhm-Bawerk used against the exploitation theory and which I described in the course of my own critique of the exploitation theory. 116 Thus, Rothbard writes:

Suppose, for example, that a capitalist-entrepreneur hires labor services, and suppose that it can be determined that this amount of labor service will result in a net revenue of

20 gold ounces to the product owner. We shall see below that the service will tend to be paid the net value of its product; but it will earn its product discounted by the time interval until sale. For if the labor service will reap 20 ounces five years from now, it is obvious that the owner of the labor cannot expect to receive from the capitalist the full 20 ounces now, in advance. He will receive his net earnings discounted by the going agio, the rate of interest.

And the interest income will be earned by the capitalist who has assumed the task of advancing the present money. The capitalist then waits for five years until the product matures before recouping his money.

The pure capitalist, therefore, in performing a capital— advancing function in the productive system, plays a sort of intermediary role. He sells money (a present good) to factor owners in exchange for the services of their factors

(prospective future goods). He holds these goods and continues to hire work on them until they have been transformed into consumers’ goods (present goods), which are then sold to the public for money (a present good). The premium that he earns from the sale of present goods, compared to what he paid for future goods, is the rate of interest earned on the exchange. 117

It should be obvious from this quotation that the

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 793 time-preference theory in its traditional form shares with Böhm-Bawerk’s critique of the exploitation theory the enormous error of regarding the wage earners as the real producers of the products, rather than, as is in fact the case, the businessmen and capitalists. The businessmen and capitalists do not buy future goods from wage earners and suppliers. They are the producers of the future goods and have the first and only claim to them; their obligation to the wage earners is to pay the latter for helping them in the production of their—the businessmen’s and capitalists’—products. 118 But even if this error is put aside, further very serious difficulties remain for the time-preference theory in its traditional form.

First of all, the basic formula of the time-preference theory does not demonstrate what it is supposed to demonstrate. By that, I mean that the establishment of a relationship between the value of the factors of production expressed in terms of present goods, and the quantity of present goods that in the future will result from those factors of production, does not in fact convey any information whatever about the height of the rate of return. For example, the fact that 9 present apples are as valuable— in different circumstances—as the factors of production required for producing 10, 20, or 5 future apples, which, when the future comes to pass, will become 10, 20, or 5 present apples, actually says nothing whatever about the rate of return that is earned in producing those future apples. Starting with 9 present apples and ending with 10, 20, or 5 present apples a year later simply does not tell us the rate of return that is actually earned in production.

As evidence of this fact, let us assume that the price of an apple today is $1 and that, in three different, alternative cases, the price of the factors of production required for producing 10, 20, or 5 apples to be available in a year is $9. According to the time-preference theory, the rate of return implied in these three cases is 11 percent, 122 percent, and –44 percent, respectively. This is because next year, there will be 10, 20, or 5 present apples that result from factors of production bearing a value of 9 present apples of today. Thus, according to the time-preference theory, there is a gain (or loss) equal to 1, 11, and (4) units of present apples respectively, which, when divided by the initial 9 present apples, results in the three percentages of gain or loss just named.

It should be obvious that such inferences as to the rate of return rest on the unstated assumption that the price of an apple in the future will be the same as it is in the present. Only then would 10, 20, or 5 apples represent 10, 20, or 5 dollars of sales revenues and thus 1, 11, or 4 dollars of profit or loss and the corresponding rates of profit or loss implied. But in fact, there is absolutely no reason for assuming that the price of apples will stay the same over time. It will certainly not do so in the conditions of an invariable money accompanied by changes on the side of production and supply. In such conditions, where the assumption that the price of present goods is constant must be abandoned, there is no way of inferring what the sales revenue, profit, and rate of return will be merely on the basis of the relationship between the value of factors of production expressed in terms of present goods and the quantities of present goods that will result from the factors of production in the future.

This point can be confirmed by means of our well-tried analysis featuring the output resulting from the use of 1K of capital goods in conjunction with 1L of labor. Recalling Figure 16–2, we have seen that in every year the monetary value of the factors of production required to produce the 1C of consumers’ goods of the following year is 400. We have also seen that the monetary value of the 1C of consumers’ goods sold both in the current year and in the following year is always 500. Thus, it follows that the value of the 400 worth of factors of production required to produce next year’s consumers’ goods, when expressed in terms of consumers’ goods, is always .8C. That is to say, if 500 is the monetary value of 1C of consumers’ goods, 400 is the monetary value of .8C of consumers’ goods. Consumers’ goods, of course, are present goods. Thus, it is now established that in the analysis of Figure 16–2, .8C is the value of the factors of production of any given year, expressed in terms of present goods, that are required to produce the consumers’ goods—the present goods—of the following year.

So long as everything remains stable, and thus the monetary value of 1C of consumers’ goods remains stable, the formula of the time-preference theory appears to be consistent with the monetary rate of profit, at least when it is stated as the gain in value relative to cost of production. Thus, in monetary terms, factors of production worth 400 monetary units produce consumers’ goods worth 500 monetary units, and, at the same time, when expressed in terms of present goods, factors of production worth .8C produce 1C of consumers’ goods. As a result, whether expressed in money or in present goods, the ratio of the value of the product to the value of the factors of production used up to produce it is 5:4.

If, however, in the conditions of Figure 16–2, while everything else remained the same, the production of the economic system were to double between some particular year and the next (to choose a convenient multiple to work with), the formula of the time-preference theory would imply a very different rate of profit than the actual one. It would imply a rate of profit of 150 percent. This is because in this case, factors of production equivalent in exchange value to .8C of consumers’ goods would produce a quantity of consumers’ goods equal to 2C. According to the formula of the time-preference theory,

the gross rate of gain in value in terms of present goods in such a case would then equal 2C/.8C, which is 2.5. When the initial capital is subtracted, this leaves a rate of net gain—a rate of profit—of 1.5, that is, 150 percent. Nevertheless, the monetary rate of profit expressed as a percentage of cost would not be 150 percent. It would still be just 25 percent. This is because in the conditions of an invariable money, the monetary value of the 2C of consumers’ goods would be no greater than the monetary value of the 1C of consumers’ goods was before. In monetary terms, it would still be a matter of 400 monetary units worth of factors of production producing a product worth 500 monetary units. The number of physical present units produced is simply irrelevant to the monetary rate of profit. The effect of their increase is merely to reduce prices, not to add to the rate of profit.

This example has provided a decisive test of the formula of the time-preference theory and has shown that the formula does not hold up. In fact, the example shows that the time-preference theory commits exactly the same kind of error as the productivity theory. Namely, both theories confuse ratios in terms of physical goods, with ratios of monetary value. The time-preference theory confuses the ratio of the present goods produced to the present-goods value of the factors of production used up to produce them, with the ratio of the monetary value of the present goods produced to the monetary value of the factors of production used up to produce them. The productivity theory confuses the ratio of the physical output produced to the physical capital goods used up to produce it, with the ratio of the monetary value of the output to the monetary value of the capital goods used up to produce it. Both theories confuse the physical product with a monetary value and take for granted that increases in the physical product mean equivalent increases in sales revenues, which is simply not the case, as analysis in terms of an invariable money conclusively shows. In contrast to the productivity theory, the time-preference theory’s formula at least makes an allowance for the value of the labor expended in production, and thus the rate of profit it implies deviates from the actual rate somewhat less than does the marginal net physical productivity of capital goods.

It is perhaps not necessary to point out that in exactly the same way, under the conditions of Figure 16–2 and its invariable money, if the production of the economic system were to halve between some particular year and the next, the rate of profit would again remain the same. This, of course, is once again in full contradiction of the time-preference theory’s formula, which implies that the rate of profit in this case must be in the ratio of .5C, which is the quantity of present goods one ends up with, to .8C, which is the present-goods value of the factors of production used up to produce them. The fact is that instead of being –37.5 percent, as the time-preference theory’s formula implies, the rate of profit would continue to be 25 percent when stated as a percentage of costs. This is because the .5C would sell for the same 500 monetary units as 1C sold for, and thus the ratio of sales revenues to costs would still be 500:400.

Thus, in sum, the rate of return in monetary terms has nothing whatever to do with the relationship between the value of factors of production expressed in terms of present goods and the supply of present goods that will later on result from those factors of production. The difference between these two magnitudes of goods is simply irrelevant. What is relevant is the monetary value of the factors of production and the monetary value of the future goods later on, when they become present goods, that is to say, the sales revenues. The relevant relationship is that between two monetary values—the money sales revenues and the money costs—not that between two values expressed in terms of present goods. No valid inference whatever can be drawn from the quantity of present goods one ends up with to the sales revenues one ends up with. It is for this reason, that no valid inference can be drawn either as to the amount or rate of profit on the basis of differences in quantities of present goods represented by factors of production and their products.

The Contradiction Between Böhm-Bawerk’s

“First Cause” and the Doctrine of the

Purchasing-Power Premiums

The error in the formula of the time-preference theory places the theory’s supporters in essentially the same embarrassing situation as the supporters of the productivity theory and its offshoot the doctrine of secular stagnation. 119 Just as the supporters of the productivity theory, who regard technological progress as the cause of a higher demand for capital and thus, allegedly, of a higher rate of profit, are ultimately placed in the contradictory position of regarding technological progress as the cause both of an increase and a decrease in the rate of profit, 120 so the supporters of the time-preference theory are led into the contradiction of regarding increases in production as the cause both of an increase and a decrease in the rate of profit!

On the one hand, the supporters of the time-preference theory correctly perceive an increase in production as reducing the value of future goods relative to present goods, because future goods will thus be more abundant relative to present goods. Indeed, Böhm-Bawerk describes this phenomenon as “the first cause” of the higher valuation of present goods over future goods. 121 The mistaken formula of the time-preference theory then

leads them to believe that the rate of profit is correspondingly increased. (The example of a doubling of production can serve once again. Thus, if the same factors of production with a present-goods value of .8C can produce 2C instead of just 1C, .8C of present goods is held to become the equivalent of 2C of future goods instead of only 1C of future goods. The implied ratio of future goods to present goods thus rises from 125 percent to 250 percent, and the rate of profit, allegedly, from 25 percent to 150 percent.)

Yet, on the other hand, when the supporters of the time-preference theory come to consider the effects of the fall in prices that an increased availability of goods in the future will bring about, they argue that the rate of profit and interest is correspondingly reduced—that it comes to incorporate a “negative price premium” that reduces it by a number of percentage points that is more or less equal to the percentage fall in prices. 122 In this way, the same cause—rising production—is held both to raise and lower the rate of profit.

The truth is, of course, that increases in production neither raise nor lower the rate of profit. The fall in the value of future goods relative to present goods that an increase in production brings about does not raise the rate of profit, because, other things being equal, a larger future output will be sold for the same sales revenues as the alternative smaller future output, and will thus necessarily be accompanied by a corresponding fall in the selling prices of those future goods. The fall in the selling prices of the future goods does not lower the rate of profit because, by the same token, it is the accompaniment of a correspondingly larger quantity of goods to sell. Thus, when there are 2C instead of 1C as the product of factors of production worth .8C, the additional 1C does not add anything to the rate of profit because the 2C sell for the same sum of money as did the 1C. By the same token, the halving of prices when there are 2C of product instead of 1C does not take anything away from the rate of profit, precisely because there are twice as many units to sell at the halved price, and thus sales revenues remain the same. The rate of profit itself, it must never be forgotten, is determined by the relationship between the amount of money for which goods can be sold in the future and the amount of money expended to produce them—irrespective of the physical quantity of the goods produced, irrespective of whether that quantity is larger or smaller than the quantity produced and sold in the present, and irrespective of whether the unit price of that quantity is less or greater than the price of goods in the present. 123

The Discounting Approach

The time-preference theory implies that one can take the prospective value of consumers’ goods as a fixed starting point, and that the value of factors of production is then straightaway derived from the value of consumers’ goods by a process of compound discount. The causal chain, in its eyes, runs from the value of consumers’ goods, together with rate of discount, to the value of factors of production. This belief is stated by Irving Fisher—one of the leading advocates of the time-preference theory—in the clearest possible terms:

The theory of prices, so far as it can be separated into parts, includes: (1) explanation of the prices of final services on which the prices of anterior interactions depend;

(2) explanation of the prices of intermediate interactions, as dependent, through the rate of interest, on [the prices of]

the final services; (3) explanation of the prices of capital instruments as dependent, through the rate of interest, upon the prices of their final services. The first study, which seeks merely to determine the laws regulating the price of final services, is independent of the rate of interest. 124

The notion that the prices of consumers’ goods are independent of the rate of profit and can, therefore, serve as a fixed base for discounting is completely mistaken. Long ago, Ricardo demonstrated that changes in the rate of profit profoundly affect the prices of consumers’ goods. 125 The following example shows precisely how they can do so.

Thus, assume that a quantity of wheat ready for harvesting and a quantity of eight-year-old scotch both regularly sell for $100. If the rate of profit is 10 percent per annum, then, on the assumption that six months must elapse between the planting of the seed and the harvesting of the wheat, the value of the wheat when newly planted will be approximately $95. At the same time, the newly fermenting alcohol corresponding to the prospective quantity of eight-year-old scotch worth $100, will be worth approximately $47. (These figures are implied by the fact at a 10 percent annual rate of return, $95 is the approximate sum that grows to $100 in six months, while $47 is the approximate sum that grows to $100 in eight years.)

Now let us imagine that the rate of profit falls to 5 percent per year. According to the discounting approach, the consequence will simply be that the value of the freshly planted wheat will rise to approximately $97.50 from $95, while the value of the newly fermenting alcohol will rise to approximately $68 from $47, for at a 5 percent annual rate of return, these are the sums that grow to $100 in six months and in eight years respectively.

Nevertheless, insofar as the wheat and the scotch can both be produced by the same labor, such a result is simply impossible. This is because it would imply a much greater rise in the wages of the workers producing the scotch than in the wages of the workers producing the wheat. To see this as clearly as possible, let us substitute for the value of the newly planted wheat and newly fermenting alcohol the value of the labor required

796 CAPITALISM to produce them. If the wheat is produced by 95 units of labor at an initial wage of $1 per unit, while the scotch is produced by 47 units of labor, also at an initial wage of $1 per unit (the wage rates are equal because the labor is assumed to be of the same kind), then a fall in the rate of profit which had no effect but to raise the prices of the factors of production, would imply that the wages of the workers producing the wheat rose in the very modest ratio of $97.50 to $95, while the wages of the workers producing the scotch rose in the much higher ratio of $68 to $47. Yet such a development would be impossible. Any significant rise in the wages of the one occupation relative to the wages of the other occupation would cause a movement of labor out of the relatively lower-paying occupation and into the relatively higher-paying occupation.

The actual effect in this case would be a significant and approximately equal rise in the wage rates of both groups of workers. Thus the rise in wage rates of the workers producing the scotch would be substantially less than in the ratio of $68 to $47, while the rise in the wage rates of the workers producing the wheat would be substantially greater than in the ratio of $97.50 to $95. Both of these developments would be the result of a movement of workers from wheat production to scotch production.

Now the clear implication of this movement of workers from wheat to scotch is an increase in the supply of scotch and decrease in the supply of wheat, which means that in the face of the same respective demands for scotch and wheat as prevailed before, the price of scotch falls and the price of wheat rises. Thus, the effect of the fall in the rate of profit, accompanied by a corresponding rise in the demand for labor and in wage rates, is a change in the relative prices of different consumers’ goods. Consumers’ goods requiring a relatively long period of time to produce, such as scotch, tend to fall in price; while consumers’ goods requiring a relatively short period of time to produce, such as wheat, tend to rise in price, as the result of a combination of a fall in the rate of profit and rise in the demand for labor and thus in wage rates.

Because changes in the rate of profit are thus accompanied by changes in the prices of consumers’ goods, one is not justified in holding that the value of factors of production is determined by a process of discounting independently determined prices of consumers’ goods. It is simply impermissible to imagine that there is the value of consumers’ goods and a rate of discount, and that these two then determine the value of the factors of production. This is because the rate of profit or, better, the forces determining the rate of profit also determine the value of consumers’ goods, and do so insofar as these latter require time in their production. It is not the case that the causal chain runs from value of consumers’ goods, together with rate of discount, to value of factors of production. Rather, the value of consumers’ goods and the value of the factors of production used to produce them are both determined by the forces that determine the rate of profit. That is, they are both determined by the respective supplies of and demands for products and for factors of production, including the specific supplies of and demands for consumers’ goods and producers’ labor.

The discounting approach is, in fact, a denial of the law of supply and demand! I say this, because it seeks to exempt the formation of the prices of factors of production from the operation of that law. In its eyes, only the prices of consumers’ goods are determined by supply and demand; the prices of the factors of production are held to be determined directly by the application of a discount to the prices of consumers’ goods. The truth is that the prices of factors of production are determined by supply and demand no less than the prices of consumers’ goods, and that the rate of discount (viz., profit) then emerges as the result of differences between the demand/supply situation in the market for products and the demand/supply situation in the market for factors of production.

As an approximation, one may say that the difference between the demand for products, inclusive of capital goods, and the demand for factors of production, inclusive of capital goods, is represented by net consumption; while the difference between the supply of products and the supply of factors of production is represented by net investment—insofar as it takes place apart from the increase in the quantity of money and volume of spending. (Net investment of this type exists to the extent that the supply of products sold is less than the supply that corresponds to the factors of production previously purchased. The difference is retained within business firms as an addition to their assets and thus constitutes net investment.) As for the increase in the quantity of money and volume of spending, its effect is to make the demand for products further exceed the demand for the factors of production made in the past to produce them.

The rate of discount—of profit—is the effect of these differences in demand and supply, which, of course, at the same time are also the cause of the differences between the prices of products and the sum of the prices of the factors of production required to produce them. To the extent that the demand for products is greater than the demand for the factors of production used to produce them, or the supply of products is less than the supply of factors of production used to produce them, the prices of products exceed the sum of the prices of the factors of production and there is profit. Indeed, only to this extent is there profit.

The Disappearance of the Higher Value of Present

Goods at the Margin: Böhm-Bawerk’s Abandonment of the Time-Preference Theory

Yet another major problem arises for the time-preference theory in its traditional form. This is the fact that whoever has savings of any kind thereby demonstrates that he values the last unit of wealth that he devotes to the future above an additional unit of wealth that he might devote to enjoyment in the present. In other words, to this extent, at the margin, he has a preference for future goods over present goods. Other things being equal, for the reasons explained in Chapter 2, he undoubtedly values a unit of wealth occupying the same marginal position more highly in the present than in the future, whether it is the fifth, the fiftieth, or the five-hundredth unit. 126 Nevertheless, the fact that he regularly values some future units above additional present units—e.g., the fourth or four-hundredth future unit above the fifth or five-hundredth present unit—makes it incorrect to say that in the market present goods must always be more valuable than future goods. Because of the significance of valuation at the margin, there is no more reason for expecting such a relationship than to expect that water must be valued more highly in the market than diamonds. This is because there are almost always some units of future goods that at the margin are more valuable than present goods.

This was recognized by Böhm-Bawerk, and as a result of it, he virtually abandoned the time-preference theory. In a footnote to his exposition of the theory of interest, he declares:

There are persons who are excessively well provided for in the present, or at least would be, if they wished to use up completely all the means available to them in the present, including the principal of their fortunes. In their case this relation of wants to means of satisfaction engenders a tendency in the opposite direction, that is to say, toward a higher valuation of future goods. . . . This explains one point in connection with persons who command in the present greater means than, in deference to sound economy, they may permit themselves to consume in the present. I refer to the fact that they would regularly arrive at approximate equivalence in their valuation of present and future goods if the first two main causes [of a higher valuation of present over future goods] alone were operative. In their case the decision in favor of present goods can be brought about only through the operation of the third main cause the discussion of which follows immediately at this point in the text. 127

This passage is tantamount to a total abandonment of the time-preference theory by Böhm-Bawerk. This is because the “equivalence” in value between present and future goods at the margin applies to virtually everyone, since almost everyone has some amount of savings. Böhm-Bawerk confirms his abandonment of the time-preference theory by shifting the weight of his argument from his first two main causes of a higher valuation of present goods in comparison with future goods, to his third main cause of such higher valuation. As explained earlier in this section, the meaning attached by Böhm-Bawerk to the “first main cause” is the prospective more abundant provision of goods in the future compared with the present. What he means by the “second main cause” is an alleged systematic undervaluation of the importance of future wants and the means of satisfying them. 128 Böhm-Bawerk’s reference to “the third main cause” as the decisive factor in the higher valuation of present over future goods refers to something that has nothing to do with time preference—namely, to an alleged “technological superiority” of present over future goods, resting on the alleged fact that the possession of present goods permits the adoption of more-time-consuming, more-productive processes of production. At this juncture, Böhm-Bawerk passes from the time-preference theory to a version of the productivity theory, which we need not consider further, since we have already fully refuted that doctrine.

Time preference, of course, does profoundly influence the rate of profit and interest, despite the fact that at the margin, future goods are preferred to present goods almost as often as present goods are preferred to future goods. The connection, as we have seen, is by virtue of its determining the rate of net consumption.

3. The Classical Basis of the Net-Consumption Theory

The role of net consumption as a determinant of profits is implicit in classical economics not only in John Stuart Mill’s proposition that “demand for commodities is not demand for labour,” which we have already considered at length, 129 but also in Ricardo’s proposition that “profits rise as wages fall and fall as wages rise.” While Ricardo’s proposition is open to various interpretations, at least some of the time it can be interpreted as tantamount to the net-consumption theory operating under certain highly restrictive assumptions. For example, Ricardo declares: “If a manufacturer always sold his goods for the same money, for £1,000, for example, his profits would depend on the price of the labour necessary to manufacture those goods. His profits would be less when wages amounted to £800 than when he paid only £600. In proportion then as wages rose would profits fall.” 130

If Ricardo’s proposition is interpreted to mean that under conditions of a fixed aggregate monetary demand for consumers’ goods, the amount of profit depends on the amount of wages paid, which latter is to be taken as equivalent to aggregate costs of production, then his

798 CAPITALISM proposition is both true and fully consistent with the net-consumption theory. 131 In fact, it should be obvious that on this interpretation, the proposition implicitly presupposes the existence of net consumption, in order for the demand for consumers’ goods to exceed the demand for labor in the first place.

Indeed, interpreted in this way, Ricardo’s theory provides a perfectly accurate description of the determinants of aggregate profit and the average rate of profit in the example of the fishermen with the boats and nets presented in the critique of the productivity theory earlier in this chapter. 132 If, as that example assumes, a million fishermen are each paid a wage of $2.50 per day and produce a quantity of fish which always sells for a total of $3 million, then aggregate profit is $500,000, and is so irrespective of the physical quantity of fish produced and sold. What determines aggregate profit in such circumstances is wages, not the physical output of fish produced. 133

The implicit connection between Ricardo’s proposition and the role of net consumption is further reinforced when these words of John Stuart Mill are recalled, words with which Ricardo would surely have agreed: “I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains from consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the labouring classes, or adds any thing to the amount of their employment.” 134 If profits move in the opposite direction of wages, and wages in turn move in the opposite direction of the consumption of businessmen and capitalists, who are the parties who pay the wages, then profits rise as net consumption rises and fall as net consumption falls. 135

Ricardo’s theory of profit is, of course, highly deficient both in limiting itself to the case of an invariable money and in ignoring the demand for capital goods. A satisfactory theory of profit must be able to explain the determinants of profit under conditions in which aggregate monetary demand changes. Furthermore, when the demand for capital goods is taken into account, it is clear that even under an invariable money, profits and wages can rise or fall in conjunction with opposite changes in the demand for capital goods as well as opposite changes in each other, and thus that either could change and not be accompanied by a change in the other. For example, the demand for capital goods could rise at the expense of a fall in net consumption and profits, with no increase in the demand for labor; or the demand for labor could rise at the expense of the demand for capital goods, with no change in the amount of profit.

These deficiencies are at least partially responsible for

Ricardo’s apostasies on the subjects of machinery and war, which he arrives at on the basis of the mistaken assumption that the interests of wage earners always lie with a higher demand for labor, even when it is at the expense of the demand for capital goods or rests on a foundation of taxation. 136 This is because the restricted confines of his theory deprive him of the ability properly to analyze these cases.

Still a further deficiency of Ricardo’s theory is that it never states what it is that allows the demand for consumers’ goods to exceed the demand for labor, and thus for profits to exist in the first place. The concept of net consumption is present in Ricardo’s theory only by implication, not by explicit statement.

Even more serious are Ricardo’s equivocations concerning the word “wages.” The limited validity of his theory depends on wages being understood as total wage payments, viz., as the aggregate demand for labor, and the aggregate demand for labor in turn being understood as the aggregate demand for factors of production as such, and this in the context of a fixed aggregate demand for goods as such. Under those conditions, a rise in wages is tantamount to a fall in net consumption. Unfortunately, Ricardo uses the term wages as representing the aggregate demand for labor only some of the time. At other times, he uses it to mean the wage rates of individual workers. Thus he often argues that increases in wage rates reduce the rate of profit, when in fact their effect is to raise prices. 137 When combined with his error of believing that increases in the price of necessities cause an increase in wage rates, this confusion leads to the corollary error that reductions in the price of necessities raise the rate of profit by virtue of reducing wage rates, a notion that plays an essential role in the Marxian exploitation theory. 138 A thorough critique of Ricardo’s confusion concerning a rise in wage rates as the cause of a reduction in the rate of profit appears in the appendix to this section.

Ricardo’s confusion between wage rates and the total amount of wages in the economic system has also given rise to the doctrine of the socalled Ricardo effect. This is the mistaken belief that a rise in wage rates encourages the use of machinery. 139 A rise in the amount of wages, assuming it is based on a fall in net consumption, means a fall in the amount and rate of profit, hence, an encouragement to the use of machinery. 140 A mere rise in wage rates, however, has no such effect. A rise in wage rates discourages the use of machinery fully as often as it encourages it. Thus, while a rise in the wage rates of workers in employments where the use of machinery might be substituted, can encourage the use of additional machinery, a rise in the wage rates of workers producing machines, or anything necessary to the production of

machines, discourages the use of machinery.

Furthermore, in raising the cost of production and prices of products and thus in reducing the quantities of goods demanded, increases in wage rates indirectly serve to reduce the quantities demanded of all the factors of production required to produce such goods, including the quantities of machines demanded in producing such goods. Thus, increases in wage rates not only cause unemployment and less production, but also, as part of the same process, on net balance actually reduce the overall use of machinery, along with that of all other factors of production.

Finally, even in those isolated instances in which forced increases in wage rates do lead to the greater use of machinery, the effect is in no sense a gain, but merely a diminution of the loss that is imposed. It is a fallacy to assume that in all conditions the use of machinery represents a gain. Whether or not it does so depends on a comparison of the cost of producing a product with and without the use of the machinery in question. If the cost of producing the product is less without the machinery, then there is no gain in producing it with the machinery. There is still no gain, but at most only a diminution of loss, if now a labor union artificially increases the cost of producing the product without the use of machinery, so that by comparison it becomes cheaper to produce the product by means of the use of the machinery. All that is present here is a lesser increase in cost, thanks to the use of the machinery, rather than a greater increase in cost. There is still, however, an increase in cost and corresponding loss.

Appendix to Section 3: Critique of Ricardo’s

Doctrine of the Falling Rate of Profit

As we have seen, Ricardo believed that the rate of profit has a tendency continually to fall. His version of this doctrine is closely connected with his errors concerning the “iron law of wages.” First, he mistakenly believes, in direct contradiction of the facts, that “With the progress of society . . . one of the principal commodities [food] . . . has a tendency to become dearer from the greater difficulty of producing it.” 141 Then he proceeds to the fallacy that somehow in response to this, wage rates must rise to prevent the wage earner from being deprived of subsistence. On the basis of this alleged rise in wage rates, he concludes that there is a tendency toward a continually falling rate of profit. 142

The truth is that with the progress of society, food and everything else becomes less expensive in terms of the labor required to produce it, not more expensive. Even if, as is the case in non-division-oflabor societies, progress is so slow that population growth and the law of diminishing returns offset it, there is still no tendency for the real cost of food or other necessities steadily to rise. Under such conditions, each fall in real cost is merely followed by a rise that pushes the average standard of living back to the level of “minimum subsistence,” and at the utmost, only temporarily below it. There is never any continuing rise in the real cost of food and other necessities with the progress of society. A continuing rise in the real cost of food or other necessities could occur only as part of a process of social and economic retrogression, not progress. It would end with the collapse of society, followed by the extinction of the human race.

Ricardo is also mistaken in believing that a rise in wages must ensue in response to a higher cost of necessities. He is further mistaken in believing that if a rise in wages did ensue in such circumstances, it would reduce the rate of profit.

In part Ricardo’s confusions are the result of his failure to make proper application of his own principle of analyzing economic phenomena in the framework of an invariable money. Had he rigorously adhered to his assumption of an invariable money, and conceived of it in terms of a fixed aggregate expenditure to buy the output of the economy, he might have avoided the confusions to which he fell prey.

First of all, he might have recognized that a growing supply of labor does not result in a combination of falling wages and rising prices—that it is not true that the “labourers” would be “doubly affected.” Even if it were the case that because of the operation of the law of diminishing returns, morethan-proportionately-larger quantities of labor had to be applied to the production of additional quantities of agricultural commodities and minerals when population increased, the effect would still be lower prices of such commodities, not higher prices, though the fall in their prices would be less than the fall in wages. The situation would be an increase in the supply both of labor and of goods, with the increase in the supply of goods being less than the increase in the supply of labor. Thus prices would fall, but by less than wage rates.

Had Ricardo realized that the prices of agricultural commodities and minerals would fall, despite the increase in the quantity of labor required to produce them, he might well have avoided leaping to the totally unwarranted conclusion that wages would rise. He might have recognized the simple fact that in such circumstances the buying power of the wage earners would decline, and that if it declined below the point of “subsistence,” the only remedy would be the extreme one implied in his own theory of wages, namely, a reduction in population followed by a consequent rise in the productivity of labor employed on land. This last would result in the prices of agricultural commodities and minerals rising less than

wage rates when the supply of labor declined as the result of a higher death rate. 143

Indeed, in the conditions of an invariable money, the pressure for a fall in wage rates would be truly overwhelming in the face of an increase in the supply of labor. This is because while the aggregate demand for the products of business would be fixed, the operation of the law of diminishing returns and growing difficulty of producing food and minerals would cause the demand for labor actually to fall. This would be the result of the ensuing growth in land “rents” displacing part of the demand for labor. 144

Furthermore, Ricardo should have known that any arbitrary rise in wage rates that might have been secured by the wage earners would have had to result in corresponding unemployment. And precisely this is the reason why, in a free economy, it would not occur, or, if somehow it did occur, would be quickly reversed.

This is because, contrary to Ricardo’s utterly mistaken implicit assumption that the demand for labor will rise in the face of higher wage rates, there is simply no source of funds for the payment of higher wage rates to the same number of workers. And thus higher wage rates must result in the employment of fewer workers and the production and sale of fewer goods. The fact that the higher wage rates would result in the production and sale of fewer goods would mean that prices would have to rise. Their not rising in the face of decreased production and a fixed aggregate expenditure to buy goods would imply the depletion of inventories, which would be the only means of maintaining the quantity of goods made available for sale. Such depletion could certainly not go on indefinitely. And when it ended, prices would have to rise.

Ricardo considers the objection that a rise in wage rates would mean a rise in product prices rather than a fall in the rate of profit, but he rejects this conclusion, largely on following grounds:

To say that commodities are raised in price is the same thing as to say that money is lowered in relative value; for it is by commodities that the relative value of gold is estimated.

If, then, all commodities rose in price, gold could not come from abroad to purchase those dear commodities, but it would go from home to be employed with advantage in purchasing the comparatively cheaper foreign commodities. It appears, then, that the rise of wages will not raise the prices of commodities, whether the metal from which money is made be produced at home or in a foreign country.

All commodities cannot rise at the same time without an addition to the quantity of money. This addition could not be obtained at home, as we have already shown; nor could it be imported from abroad. To purchase any additional quantity of gold from abroad, commodities at home must be cheap, not dear. The importation of gold, and a rise in the price of all home-made commodities with which gold is purchased or paid for, are effects absolutely incompatible. 145

Ricardo is right in arguing that under an international gold standard, the importation of additional gold from abroad is incompatible with a rise in the prices of domestically produced commodities, that, in fact, gold would be exported. However, he is incorrect in arguing that prices in general can rise only if the quantity of money is increased. They can rise even if the quantity of money and volume of spending are decreased—if production decreases by still more. Precisely this is what happens in the present case, in which wage rates rise.

This is because in this context the decrease in the quantity of money and volume of spending is itself the cause of an equivalent further decrease in production and supply. In the face of any given level of wages rates and prices, less money and spending mean equivalently smaller quantities of goods and labor demanded, which last means an equivalently smaller quantity of labor employed and thus an equivalently smaller supply of goods produced. For example, in the face of any given level of wage rates and prices, 10 percent less money and spending in a country mean a 10 percent reduction in the quantity of goods and labor demanded and thus a 10 percent reduction in employment and production. A second 10 percent reduction in money and spending means a second such reduction in employment and production, and so on. Yet, over and above the reductions in the quantity of labor employed and output produced as the result of less money and spending, there still remains the reduction in employment and production as the result of the rise in wage rates itself.

That is, once the quantity of money and volume of spending stabilize at any point, however much they may have been reduced, the fact that wage rates are higher in the face of the demand for labor that then exists means an inversely proportionate reduction in the quantity of labor demanded and thus in employment and output. Thus, with a reduction in output in inverse proportion to the rise in wage rates, prices must rise in direct proportion to the rise in wage rates, no matter what has happened to the quantity of money and volume of spending. The outcome is dictated by the law of supply and demand. 146

The gold outflow Ricardo described goes on only until the point is reached at which the supply of products produced has fallen sufficiently to equal the smaller quantity of products demanded at the higher prices needed to cover the higher wage rates. The outcome can be viewed as the limitation to price increases imposed by foreign competition ultimately being overcome by virtue of the country’s production being restricted to those goods in which it has sufficient comparative advantage to obtain the necessary higher prices. If there are no such goods, the arbitrary imposition of the higher wage rates would ultimately serve simply to destroy the country in

question as a seat of production.

Ricardo advances another argument attempting to show that product prices cannot rise because of a rise in wage rates. This is the claim that to the same degree that a rise in wage rates might tend to raise the value of commodities, it also tends to raise the value of gold, with the result that product prices—the exchange ratios of commodities against gold—remain unchanged. 147

Here Ricardo violates his normal assumption that the monetary unit possesses invariable value, and thus that all changes in the value of commodities proceed from the side of commodities, not from the side of money. He implicitly assumes that the rise in wage rates reduces the supply of gold to the same extent that it reduces the supply of other commodities, and, therefore, prevents any rise in their prices. This assumption is false, however. While a rise in wage rates does imply a reduction in the production of gold, it by no means implies a reduction in the supply of gold. This is because at any given time, the current production of gold, or any commodity money, constitutes only a small fraction of its total supply, which is the accumulation of many years of its production. A reduction in its current production would almost certainly imply merely a slowing down in the increase of its supply. Thus, the effect of the rise in wage rates would still be a rise in prices—at least in comparison with what they otherwise would have been. This would be the case insofar as the production of ordinary commodities was reduced in the face of the same or still increasing quantity of money and volume of spending. 148

Furthermore, as I have shown, profits as such are not a source of funds for the payment of additional wages; profits are an accounting abstraction. As we have seen, the only possible actual source of funds for the payment of a larger amount of total wages in response to a rise in wage rates would be a diversion of funds from the purchase of capital goods or from the personal consumption expenditure of the businessmen and capitalists. The diversion of funds from the purchase of capital goods to the payment of wages—even if it occurred—would not serve to reduce the amount or rate of profit. It would merely serve to reduce the supply of capital goods and the productivity of labor and thus to raise unit costs and prices all the more.

There is simply no reason to expect a diversion of funds from the personal consumption expenditure of businessmen and capitalists to the payment of wages. A higher degree of saving and productive expenditure— that is, a higher economic degree of capitalism—would be required. But there is no basis for such a development taking place merely because of an approach of real wages to subsistence.

Even if, in dire circumstances, employers could be prevailed upon to increase the wages of their employees out of a sense of charity, the increase in the money paid to them would not be wages, but a charitable contribution. Any employer who appears to pay wages that are higher than those which, in accordance with the conditions of the market, he must pay, does not pay wages, but grants charity. It makes no difference whether the recipient is his son-in-law who is worth only $25,000 per year, but to whom he pays $50,000 in order to please his daughter, or any other employee or employees.

In the virtually impossible case of everyone’s nominal wage coming to contain a significant component of charity, the fact would remain that the component would not be a portion of their wages, but a portion of the employer’s own income or wealth which he saw fit to give away.

If it were merely their income that employers disposed of in this way, then, of course, profit would not be reduced. It would still be earned, but consumed in a different manner. Ironically, if it were not their income, but part of their capital that they chose to give away in charity, then, precisely as the result of a fall in productive expenditure relative to fixed sales revenues, the aggregate amount of profit in the economic system would actually rise, and so too, correspondingly, would the average rate of profit. This is because such a development would imply lower aggregate costs in the face of given aggregate sales revenues. What would be present here would be a rise in the rate of net consumption. 149

Thus, the essential effect of an arbitrary rise in wage rates, if it did occur, and were prevented from being reversed because of a lack of freedom of competition, would be unemployment and less production. The effect of this, in turn, would ultimately have to be a rise in prices sufficient to cover the higher wage rates, not, as Ricardo argues, a decline in the rate of profit. These observations, of course, remove all remaining basis both for Ricardo’s belief in the tendency of the rate of profit to fall with an increase in population and for his related belief that the tendency toward a falling rate of profit is interrupted by improvements in the production of wage earners’ necessities, which allegedly reduce wage rates and thus allegedly raise the rate of profit. As I have shown, the average rate of profit in the economic system is not determined by wage rates, and wage rates, of course, are not determined by the price of wage earners’ necessities. Ricardo’s argument for a falling rate of profit is simply incorrect in every essential respect.

4. Other Proponents of the Net-Consumption/Net-Investment Theory

I arrived at the essentials of the net-consumption/net—

investment theory in 1959, on the basis of the writings of the British classical economists and of Ludwig von Mises, and of a longstanding dispute with Murray Rothbard about whether or not the rate of profit had to fall as the accompaniment of capital accumulation. 150 At the time, and for a number of years thereafter, I believed the theory to be entirely my own, original discovery. In the course of writing my doctoral dissertation, however, in which I presented the substance of the theory and attempted to develop its leading implications, I learned that in the mid-1950s Joan Robinson had propounded, as I put it then, “a theory of profit which in form is almost indistinguishable from my own, though in substance it is much closer to Schumpeter’s theory.” 151

Further investigation revealed that Mrs. Robinson, in turn, had been preceded by some twenty years by the Polish Marxist Michael Kalecki, from whose writings she had learned the doctrine. Kalecki’s exposition originally appeared in journal articles in 1935 and was later presented in his book Theory of Economic Dynamics, first published in 1952. 152

Apart from the fact that both of these authors are clearly in possession of the formula that aggregate profit equals the sum of net consumption plus net investment (though they do not use the expression “net consumption”), there is surprisingly little further similarity between the doctrine presented by them and the doctrine presented by me. This becomes clear even in the manner of arriving at the doctrine. I quote the substance of Kalecki’s derivation of the doctrine in full:

We may consider first the determinants of profits in a closed economy in which both government expenditure and taxation are negligible. Gross national product will thus be equal to the sum of gross investment (in fixed capital and inventories) and consumption. The value of gross national product will be divided between workers and capitalists, virtually nothing being paid in taxes. The income of workers consists of wages and salaries. The income of capitalists or gross profits includes depreciation and undistributed profits, dividends and withdrawals from unincorporated business, rent and interest. We thus have the following balance sheet of the gross national product, in which we distinguish between capitalists’ consumption and workers’ consumption:

Gross Profits Gross Investment

Wages and Salaries Capitalists’ Consumption

Workers’ Consumption

Gross national product Gross national product

If we make the additional assumption that workers do not save, then workers’ consumption is equal to their income.

It follows directly then:

Gross profits = Gross investment + capitalists’ consumption.

What is the significance of this equation? Does it mean that profits in a given period determine capitalists’ consumption and investment, or the reverse of this? The answer to this question depends on which of these items is directly subject to the decisions of capitalists. Now, it is clear that capitalists may decide to consume and to invest more in a given period than in the preceding one, but they cannot decide to earn more. It is, therefore, their investment and consumption decisions which determine profits, and not vice versa. 153

Not only is Kalecki’s theory very different than my own in terms of its derivation, but little or no similarity can be found in the major conclusions he draws from the theory. For example, Kalecki declares that “Another longrun influence considered, rentiers’ savings [i.e., the savings of businessmen and capitalists] was found to be an obstacle rather than a stimulus to development.” 154 Kalecki also seems to embrace the view that a high rate of profit is necessary for investment and that technological progress is necessary as a stimulus to investment. He writes:

Inventions which occur in the course of a given period make certain new investment projects more attractive. The influence of this factor is analogous to that of an increase in aggregate profits which in the course of a given period makes investment projects generally more attractive than they were at the beginning of this period. Each new invention like each increase in profits gives rise to certain additional investment decisions. A steady stream of inventions in its effect upon investment is comparable to a steady rate of increase in profits. 155

In Mrs. Robinson’s theory, the role of net consumption, which she calls “rentier expenditure” is entirely secondary. Thus, she declares:

So far we have abstracted from consumption out of profits and the existence of rentier income. This exclusion was made purely for the sake of exposition. Having established the main lines of the analysis without rentiers, [viz., without net consumption], we must now introduce them into the model. The political and social importance of consumption out of incomes derived from property is very far reaching, but so far as the analysis of accumulation is concerned we shall find that it complicates the argument without requiring any substantial change. 156

In all, Mrs. Robinson devotes about twenty pages of her 435-page book to the discussion of net consumption, including all of its ramifications. 157 In large measure the concept comes up only in connection with a discussion of the wage bill paid in the “investment sector” as making possible a surplus of sales receipts in the consumers’ goods industries over wages paid by the consumers’ goods industries alone. 158 Of these twenty pages, only a few paragraphs constitute either a discussion of the concept itself or an attempt to prove that it is a determinant

of profits. No connection whatever is seen to exist between net consumption and either Mill’s proposition that demand for commodities is not demand for labor (which Mrs. Robinson frequently contradicts), or Ricardo’s doctrine that “profits fall as wages rise.” (Mill does not even appear in the index, and Ricardo is mentioned only in connection with the erroneous doctrine of the socalled Ricardo effect, to which Mrs. Robinson subscribes. 159 ) Kalecki too seems totally unaware of any connection between the concept of net consumption and the writings of the classical economists.

In Mrs. Robinson’s eyes, the primary determinant of profits is what she calls “net investment.” It is not the case, however, that this means we both have the same theory but each emphasize the determinant of profits which the other treats as subordinate. For what Mrs. Robinson and I mean by net investment are two entirely different things. I mean by the term the difference between the monetary value of the assets purchased by business enterprises and the monetary value of the assets used up by business enterprises—i.e., the difference between productive expenditures and aggregate business costs. She means by the term the physical growth in the amount of goods between two points in time. 160 Thus her theory is in reality a quasi-productivity theory, along the lines of Schumpeter’s theory. 161

The fact that Mrs. Robinson, Kalecki, and I share the same essential formula for the determination of aggregate profit is nonetheless true, however surprising it may be, in view of all the enormous substantive differences that exist between us not only with respect to the development and application of the net-consumption/net-investment theory, but with respect to virtually every other aspect of economic theory. They are advocates of socialism, while I, of course, am an advocate of laissez-faire capitalism. Because of this, I could never conceive of cooperating with them in any manner, and thus I never attempted to contact Mrs. Robinson, who continued to be prominent in the economics profession for many years after I became aware of her theory of profit.

Notes

1. As I showed, saving is further necessary in order to make possible the purchase of all expensive consumers’ goods. On these points, see above, pp. 694–696.

2. See above, pp. 696–697.

3. Concerning the Keynesian claim that the rate of profit is “too low,” see below, pp. 867–878.

4. Actually, it will be somewhat larger. This is because the numerator will include profits that represent remuneration necessary to compete with the wages and salaries that the businessmen involved could earn by working elsewhere, as employees. As I have pointed out this is of particular significance in the case of small businessmen and introduces an element of permanent inequality in the rate of return on capital in favor of small business. On this point, see above, p. 186.

5. Cf. above, pp. 186–187. See also above, pp. 520–522. 6. Unfortunately, more often than not, the latter procedure is the practice today. See, for example, the discussion of the theory of capital in Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw Hill Book Company, 1989), pp. 720–725.

7. See above, p. 573.

8. See above, p. 176. See also above, p. 558.

9. See above, pp. 186–187.

10. See above, pp. 569–570 and 651–652.

11. For a discussion of the nature and necessity of time preference, see above, pp. 55–56.

12. See above, pp. 702–705.

13. See above, pp. 700–702.

14. There is an exception to the principle that the demand for capital goods is simultaneously business sales revenues. This is the case of the purchase of second-hand capital goods from sellers who are not dealers in the goods. For example, a restaurant’s purchase of a used delivery truck from a bakery would not constitute sales revenue to the bakery. The bakery’s sales revenue is derived only from the sale of the goods it is in business to produce, namely, baked goods, not its old equipment, whose sale is merely incidental to its regular operations. The same would be true of the purchase of a land site from the bakery or almost any other business: namely, the proceeds would not constitute sales revenue to the seller. Similarly, some portion of what is a demand for second-hand capital goods from the perspective of the buyers might constitute receipts to consumers, which receipts are certainly not business sales revenues—for example, the purchase by a business of a used automobile or land site from a consumer. However, little error results from ignoring all such cases. And, for the sake of ease of analysis, that will be our practice. The reason that little error is entailed in this simplifying procedure is that insofar as the purchase of such capital goods results in costs that the buyers must deduct from their sales revenues, the sellers of the capital goods are generally placed in a position in which the costs they must deduct from their sales revenues are reduced. For example, when the bakery sells its old delivery truck, it need no longer depreciate the truck. In addition, to the extent that businesses acquire capital goods by buying used goods from consumers, there are likely to be approximately offsetting sales of used goods by businesses to consumers, with the result that the effect on costs to be deducted from sales revenues should be insignificant. Insofar as such items are not mutually offsetting, it will be found that any effect that might exist with respect to aggregate profits is accompanied by an offsetting effect in the form of capital gains or capital losses.

15. This assumption is actually compatible with the existence of extensive saving on the part of individual wage earners, insofar as their savings are used to finance consumption expenditures of other wage earners or have a counterpart in consump—

tion expenditures by wage earners that are financed by funds obtained from business firms in the form of extensions of credit. For elaboration of this point, see below, p. 735. Nevertheless, even though it is probably descriptively correct, the net-consumption theory does not depend on this assumption. Concerning this fact, see below, pp. 750–754.

16. See above, pp. 702–705.

17. See below, pp. 754–756.

18. For discussion and defense of these definitions, see above, p. 445.

19. See above, p. 710.

20. Strictly speaking, I should say, no counterpart in the kind of productive expenditure and costs that we are interested in, inasmuch as a portion of net consumption, as we know, is made out of interest payments from business. However, as I have explained, we exclude cost on account of interest and the productive expenditure that generates it, because we are interested in profits prededuction of such interest.

21. This assumption has been present at least implicitly since Figure 14–4.

22. The cost value of plant and equipment is present in the cost value of the 1K of capital goods on hand, together with that of all other capital goods, such as the materials purchased by business. Because all plant and equipment is assumed to be used up in a single year, the distinction between gross plant and equipment and net plant and equipment disappears.

23. For the meaning of capital, see above, p. 449.

24. See above, pp. 700–702.

25. It is possible, of course, in certain circumstances that new and additional money could be introduced into the economic system to finance dividend, draw, or interest payments.

26. The point also applies to education loans. On the subject of why education does not constitute “human capital” and why the expenditure even for vocational education should not be treated as productive expenditure, see above, pp. 455–456. 27. Table 16–4, like Figure 16–2, shows complete data for Years 1 and 2.

28. Later discussion will show why, in the long run, the amount and rate of net consumption must always be significantly positive, and thus that productive expenditure could not lastingly equal, let alone exceed, sales revenues. See below, pp. 750–762 passim. See also below, pp. 856–859.

29. Cf. above, pp. 475–480.

30. The increase in the quantity of money has a similar influence on the monetary value of the capital invested in particular industries and countries. Thus, in the absence of an increase in the quantity of money and volume of spending in the economic system, since, say, 1900, the monetary value of the capital invested in the automobile industry would be greater, though not nearly as much greater as it in fact is, while the monetary value of the capital invested in railroads would be substantially smaller, instead of greater. In the same way, the monetary value of the capital invested in agriculture would be much smaller now than it was in 1900 instead of being greater, while that of the capital invested in industry and commerce would be larger but not nearly as much larger as it now is. The sum of the monetary values of the capitals invested in the United States would be greater, though not nearly as much greater as it in fact is, while that of Western Europe would be substantially smaller instead of much greater. Over the last thirty years or so, the sum of the monetary values of the capitals invested in the United States would have declined substantially instead of increased, while that of Japan and South Korea rose substantially, though much less substantially than they actually have risen.

31. See above, pp. 327–328.

32. The calculations of net consumption are based on data appearing in U.S. Department of Commerce, Office of Business Economics, The National Income and Product Accounts of the United States, 1929–1965 Statistical Tables (Washington, D. C.: U.S. Government Printing Office, n.d.), pp. 14, 150, 152. The amounts of net consumption were calculated by adding up the totals for proprietors’ income, corporate profits before tax, rental income of persons, and net interest, and then subtracting the respective magnitudes of negative net investment which, for their part, were found by subtracting capital consumption allowances from gross private domestic investment. In the process all imputations and inventory valuation adjustments were excluded. The subtraction of net investment from profits in order to arrive at net consumption is indicated by the fact that profits equal the sum of net consumption plus net investment, as we already know. See above, p. 723. Indeed, there we saw directly that net consumption is the difference between profits and net investment.

33. Later discussion will show that nothing depends on the individual having an entire year’s income available to him at the beginning of the year. Exactly the same results would follow if he had only a quarter’s income available to him at the beginning of a quarter, or a month’s income available to him at the beginning of a month, or even just a single day’s income available to him at the beginning of a day. See below, p. 743. 34. The elimination of negative net investment must take place far short of the point of the exhaustion of assets. As we shall see later in this chapter, the lower is the general rate of profit, the more powerful is the inducement to net investment and thus necessarily the elimination of any negative net investment. See below, pp. 779–784.

35. On the origin of money cf. Carl Menger, Principles of Economics (Glencoe, Ill.: The Free Press, 1950), pp. 257–271. See also, above, pp. 506–508.

36. On Smith and the status of consumption and profit in the “early and rude state of society,” see above, pp. 475–480. 37. Of course, in order for a high rate of profit actually to be heavily saved and in fact result in the accumulation of a fortune, the individuals in question must attach a greater value to the larger sum of wealth in the future than to the consumption which must be forgone in order to accumulate it. If this is not the case, then even the highest rates of profit do not result in the accumulation of capital.

38. Friedman’s doctrine is known as “the permanent income hypothesis.” See Milton Friedman, A Theory of the Consumption Function (Princeton, N. J.: Princeton University Press, 1957.)

39. Our previous examples concerning the consumption of businessmen and capitalists were constructed on the implicit assumption of a twentyone year time horizon applied to the consumption of previously accumulated capital and current profit/interest income taken together.

40. Concerning the positive connection between the rate of

profit in real and in monetary terms and the rate of economic progress, see below, p. 775.

41. See above, pp. 55–56.

42. Cf. the discussion of the time preference theory in its traditional form, below, pp. 792–794.

43. See above, pp. 741–743.

44. The 5 percent figure follows from the fact that where i is

1 the annual income on capital and equals × (K + i), then

21i = K +i and thus 20i = K. This last means that i = .

45. It is not necessary, of course, that the concept of time horizon be applied in an all-or-nothing way, in which even provision is made for all the years lying within it and none at all for the years lying beyond it. It might be, for example, that one wants to make even provision for each of the next 10 years and then 50 percent provision for each of the 20 years beyond that. That would be equivalent to having a time horizon in which one wished to make even provision for the next 20 years. 46. See above, p. 58. See also above, pp. 19–21.

47. See above, pp. 702–705. See especially, Table 15–2, on p. 705.

48. Unlike Table 16–3, Table 16–5 shows complete data for Years 1 and 2, as did Figure 16–2 and Table 16–4.

49. It should be realized that from the point of view of the magnitude of sales revenues, it is indifferent whether the 100 of additional demand generated by productive expenditure represents 100 of additional demand for capital goods or 100 of additional demand for labor by business resulting in 100 of additional demand for consumers’ goods by the wage earners of business, or any combination of such additional demands for the products of business totaling 100.

50. See above, pp. 702–705, especially Table 15–2, on p. 705, and the discussion accompanying it. It should be understood that we are temporarily ignoring taxation and thus the presence of taxes in costs.

51. Net investment and profits are 100 larger in Table 16–9 than in Table 16–8—i.e., 300 and 200 respectively versus 200 and 100 respectively—because the 100 of wage-earner saving is spent for capital goods rather than being hoarded or turned back to business in the form of loans or securities purchases to finance productive expenditure in the following period. In being spent in this way, it adds 100 both to productive expenditure and to sales revenues. In enlarging both productive expenditure and sales revenues by 100 in the face of the same aggregate costs of 600, it adds 100 to both net investment and profits. 52. See above, pp. 648–650.

53. The same principles, to be sure, apply to the use of income other than wages either to pay consumer interest or to purchase consumers’ labor.

54. For elaboration of this point, see below, pp. 758–759. 55. It should be realized that the firm’s annual depreciation charge never comes to exceed a million dollars, or whatever the assumed constant amount of annual expenditure for the assets in question may be. This is because once an asset reaches the end of its depreciable life, it no longer contributes to current depreciation. In the case of assets with a 20-year depreciable life, in every year from Year 21 on the depreciation on new assets acquired in the current year merely takes the place of the depreciation of assets now 21 years old and therefore already fully depreciated and no longer subject to additional depreciation. 56. Net investment in connection with the acquisition of land usually does not have a counterpart in aggregate profit, inasmuch as the funds expended in the purchase of land generally do not constitute a sales revenue, but merely receipts from the sale of existing capital or consumer assets. Such net investment does, however, have a counterpart in a capital gain, to the extent that a business seller’s proceeds from the sale of land exceed his own previous acquisition cost of the land.

57. This usage of the concept of marginal productivity must be distinguished from the common one, in which the concept primarily denotes a net physical product attributable to the employment of additional capital goods. For a detailed explanation and discussion of the common usage, see below, pp. 787–788.

58. See below, pp. 787–792, for a detailed critique of the socalled productivity theory of profit/interest.

59. Net investment will not become negative if what places the rate of profit above the marginal productivity of capital is itself the existence of significant net investment and thus the existence of a significant net investment component in the rate of profit. In such a case, the effect will merely be a reduction in the amount of net investment and the size of the net investment component in the rate of profit.

60. The equalization of the rate of profit and the marginal productivity of capital in the sense in which I have been using the concept should not be taken to imply any claim on my part that the rate of profit tends to equalize with the marginal productivity of capital in the usual sense of a marginal net physical product attributable to capital goods. To the contrary, as I will show in my critique of the productivity theory, my analysis of capital accumulation implies that the general marginal net productivity of capital in this sense is permanently and substantially higher than the rate of profit. See below, pp. 787–792. The mistaken belief that the rate of profit and the marginal net physical productivity of capital goods tend to equalize leads to the error of taking the rate of profit as the measure of the physical contribution of capital goods to production, which in turn leads to the error of grossly understating the importance of capital goods to production and its increase. On this subject, see below, pp. 776–778. The mistaken belief that the rate of profit and the marginal net physical productivity of capital goods tend to equalize leads to the error of taking the rate of profit as the measure of the physical contribution of capital goods to production, which in turn leads to the error of grossly understating the importance of capital goods to production and its increase. On this subject, see below, pp. 776–778. 61. Concerning the nonsacrificial character of capital accumulation under capitalism, see above, pp. 639–641.

62. See above, pp. 723–725.

63. Concerning the various ways in which a lower rate of profit operates to encourage greater capital intensivity, see below, pp. 778–784.

64. The present discussion confirms the view of von Mises that time preference—here operating through the rate of net consumption—is what accounts for the fact that more productive but more time-consuming processes of production are not automatically adopted. See Ludwig von Mises, Human Action,

3d ed. rev. (Chicago: Henry Regnery Co., 1966), pp. 482–483, 526.

65. The contribution of wage earners to net consumption exists insofar as they themselves have accumulated sufficient savings, whether in the form of capital or consumer loans, to place them in a position to consume in excess of their wages.

66. In conformity with the actual circumstances of business life, this last can be assumed to constitute a relatively small portion. 67. On the nature of NNP, see above, pp. 675–676 and 700– 702. Capital-output ratios as typically computed include in capital the value of owner-occupied housing and the land on which it stands. Capital computed in this way can be taken as an approximation of total accumulated invested savings in the economic system; a virtually exact equivalence would be achieved if the value of homeowners’ equity were subtracted and the value of interest-bearing consumer loans other than home mortgages were added. (The value of home mortgages is already implicitly included.)

68. We have already encountered this expression of the capital-output ratio. See above, pp. 302 and 364, in particular in the refutation of the argument that free immigration must reduce the ratio of capital to labor.

69. Concerning the relationship between net national product and national income and the fact that both are necessarily close in amount to consumption, see above, pp. 700–702 and 712. 70. In addition, it should be recalled that net investment is not an actual expenditure, nor, therefore, a demand, as the term is used in this book. On this point, see above, p. 717, n. 60. 71. Though static in terms of monetary magnitudes, such a state of affairs is, of course, perfectly compatible with a rising physical volume of production both of consumers’ goods and of capital goods, though a 2:1 capital-net-output ratio would probably be far too low to bring about economic progress in actual practice.

72. See above, pp. 631–632.

73. See above, pp. 228–230, and below, pp. 774–775. For discussion of the analogous distinctions between monetary demand and real demand, and between money wages and real wages, see above, pp. 559–561 and 618–622.

74. See above, pp. 63–66.

75. See above, pp. 531–532.

76. It should be noted that in Year 4 of Figure 16–3, wage payments and net consumption are rounded and thus do not quite add to the demand for consumers’ goods.

77. Because of limited space, all data in the table is rounded to the nearest integer, except for the rate of profit and the change in the rate of profit, which are carried to two decimal places. 78. For an important qualification concerning this last proposition, see below, p. 773.

79. See above, pp. 758–759.

80. Again, see below, for an important qualification concerning the effect of the rate of increase in the quantity of money on the rate of net consumption.

81. See below, pp. 930–937 passim.

82. See below, pp. 951–963, for the full case for a 100-percent-reserve precious metals system.

83. Concerning this aspect of Say’s Law, see above, pp. 559– 561.

84. These observations confirm previous discussion in connection with the critique of the demands of labor unions for the paying over of profits as wages. See above, pp. 654–655. 85. See above, pp. 762–763.

86. See above, pp. 754–756.

87. See above, pp. 768–771.

88. For a discussion of the temporal relationship of productive expenditure to sales revenues, see again pp. 768–771, above. See also, below, pp. 820–824.

89. See, for instance, Moses Abramovitz, Resource and Output Trends in the United States Since 1870 (New York: National Bureau of Economic Research Occasional Paper, no. 52, 1956), pp. 6, 8; and Robert M. Solow, “Technical Change and the Aggregate Production Function,” The Review of Economics and Statistics, 39, August 1957. See also, above, the quotation from Samuelson and Nordhaus on pp. 630–631, where it is claimed that the rise in the productivity of labor is due mainly to technological progress as opposed to capital accumulation. 90. See, for example, the writings of Abramovitz and Solow cited above.

91. Curiously, in a backhanded way, Abramovitz ends up conceding the actual importance of capital accumulation. After first claiming that “the input of resources per head of the population appears to have increased relatively little, while the productivity of resources increased a great deal” in bringing about “the quadrupling—more or less—of net national product per capita,” he ends by acknowledging that “capital per head of the population approximately tripled.” This apparent blatant contradiction of first maintaining that an increase in capital per head has not significantly contributed to the increase in output per capita, and then declaring that a fourfold increase in output per capita has been accompanied by a threefold increase in capital per capita, is left altogether unexplained. See Abramovitz, pp. 8, 10.

92. See above, pp. 712–714.

93. See above, pp. 648–650.

94. The principle that a fall in revenue relative to capital creates a need for more capital accords with my previous finding concerning the significance of high capital requirements. That finding was that far from representing any kind of infringement of the freedom of competition, high capital requirements are evidence of the existence of high competitive standards. A large capital, I showed, is necessary in order to achieve the low costs needed to be profitable in the face of the low prices charged by others. See above, p. 376.

95. On this subject, see above, Chapter 6, n. 1.

96. For an account of the various specific ways in which this can occur, see above, pp. 754–756.

97. Within the borders of any individual country, of course, an increase in the quantity of commodity money is achieved as soon and insofar as the country’s increased production increases its share of world production and thus of the money supply of the world economy.

98. The significance of negative net investment in counteracting the influence of net consumption in the generation of profits is indicated by the data for the years 1932 and 1933, cited above, on pp. 739–740.

99. See above, pp. 589–590. See also the preceding note. 100. Actually, a 5 percent annual increase in the money supply raises the rate of profit to slightly more than 10 percent, in that

THE NET-CONSUMPTION/NET-INVESTMENT THEORY OF PROFIT 807

1.05 times 1.05 is slightly more than 1.10. This kind of result is implicit insofar as there is any induced rise in the rate of net consumption.

101. The same, of course, would be true of a rise in the rate of profit attributable to a rise in the rate of net investment that occurred independently of the increase in the quantity of money. 102. Concerning the undermining of capital formation by means of the overconsumption that inflation causes, see below, pp. 930–937 passim.

103. See above, pp. 576–578.

104. Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland, Ill.: Libertarian Press, 1959), 1:74. According to Böhm-Bawerk, the original quotation is from Wilhelm Roscher, Grundlagen der Nationalökonomie, 10th ed., sec. 189.

105. (The figure of 75 is arrived at by taking the average of 150 fish and zero fish and of corresponding intermediate amounts; 150 fish is the capital outstanding on the last day of the construction of the boat and net and on the first day of their use, while zero is the capital outstanding at the beginning of the first day of the accumulation of capital for their construction and at the end of the last day of their use.

106. Samuelson and Nordhaus, Economics, p. 721. Italics supplied.

107. See above, p. 558.

108. See above, pp. 556–558. See also above, pp. 629–632. 109. See below, pp. 813–820.

110. See above, pp. 459–462.

111. For elaboration on these connections, see above, pp. 475– 480.

112. See above, ibid.

113. See above, pp. 762–774.

114. Capital intensiveness in the relative-value sense, it should be recalled, refers to the value of accumulated capital relative to wages, consumption, and sales revenues.

115. Böhm-Bawerk, Capital and Interest, 2:259, 265. See also von Mises, Human Action, p. 483, and above, pp. 55–56. 116. See above, pp. 484–485.

117. Murray N. Rothbard, Man, Economy, and State, 2 vols. (Princeton, N. J.: D. Van Nostrand Company, Inc., 1962), 1:322. 118. See above, pp. 480–483.

119. The productivity theory implies the doctrine of secular stagnation insofar as it leads to the conclusion that the cause of a low rate of profit is a lack of technological progress.

120. See above, p. 256.

121. Cf. Böhm-Bawerk, Capital and Interest, 2:265–266. 122. See, for example, Irving Fisher, The Theory of Interest (1930; reprint ed., New York: Kelley & Millman, 1954), pp. 36–38. See also—regrettably—von Mises, Human Action, pp. 541–545.

123. On the errors of the belief that falling prices caused by increased production reduce the rate of profit, see above, pp. 569–573 and below, pp. 814–817. For further discussion of the specific errors in the doctrine of the purchasing-power price premiums, see below, pp. 825–826.

124. Irving Fisher, The Theory of Interest, p. 327. Italics supplied. A more recent statement of the same doctrine can be found in Rothbard, Man, Economy, and State, 1:390.

125. See David Ricardo, Principles of Political Economy and

Taxation, 3d ed. (London, 1821), chap. 1, secs. 4–7; reprinted as vol. 1 of The Works and Correspondence of David Ricardo, ed. Piero Sraffa (Cambridge: Cambridge University Press, 1962), pp. 30–51. Subsequent page references to the Sraffa edition appear in brackets.

126. See above, pp. 55–56.

127. Böhm-Bawerk, Capital and Interest, 2:442, n. 23.

128. See ibid., pp. 268–273.

129. See above, pp. 683–685, 720–721, and 725–734.

130. Ricardo, Principles of Political Economy and Taxation, chap. 6 [p. 111].

131. It is relevant to note that Ricardo’s chapter “On Profits,” in which the above passage appears, contains an opening footnote reminding the reader that “I consider money to be invariable in value.” This, of course, means the assumption of a fixed aggregate value of the consumers’ goods.

132. Cf. above, pp. 787–790.

133. This interpretation of Ricardo’s theory, I believe, is fully consistent with his discussion of value in sec. 7 of his chapter on that subject, and helps greatly to clarify that discussion. See above, pp. 495–496.

134. See above, pp. 683–684. Italics added.

135. Essentially the same point was made earlier, in my critique of the exploitation theory. See above, pp. 478–480.

136. See above, pp. 647–650.

137. See above, pp. 494–495.

138. See above, ibid. See also above, pp. 607–642.

139. Cf. von Mises, Human Action, pp. 773–776.

140. For the explanation of how a lower rate of profit encourages greater capital intensiveness, see above, pp. 779–784. 141. Ricardo, Principles of Political Economy and Taxation, chap. 5 [p. 93].

142. See above, pp. 494–495.

143. It must be kept in mind that the conditions being described are those of an essentially stagnant society, such as existed prior to the Industrial Revolution, certainly not those of laissez-faire capitalism.

144. Concerning the reduction in the demand for labor as the result of the rise in land rents, see above, p. 668.

145. Ricardo, Principles of Political Economy and Taxation, chap. 5 [p. 105].

146. The only thing that would prevent prices from rising in proportion to wage rates would be the extent to which a reduced volume of production might be accompanied by a higher productivity of labor. However, such a result is extremely unlikely in view of the greater efficiencies in a division-of-labor society that are the result precisely of the employment of a larger number of workers rather than a smaller number of workers.

147. Cf. Ricardo, Principles of Political Economy and Taxation, chap. 1, sec. 3 [p. 28].

148. The reduction in the production of gold would, however, imply a modest reduction in the rate of profit, inasmuch as it would mean a reduction in the rate of increase in spending of all kinds and thus in the rate of net investment. Such a reduction would be of a nonrepeatable nature inasmuch as wage rates could not continue to be arbitrarily driven up in the face of the mounting unemployment that would result. On this last point, see below, pp. 909–911.

149. For elaboration of the principles and mechanisms involved, see above, pp. 725–734.

150. As stated in the Preface, I maintained that it did not; he maintained that it did.

151. See Joan Robinson, The Accumulation of Capital (Homewood, Ill.: Richard D. Irwin, 1956.) See also George Reisman, The Theory of Aggregate Profit and the Average Rate of Profit, Ph.D. diss., New York University Graduate School of Business Administration (1963; reprinted by University Microfilms, Inc., Ann Arbor, Mich.), p. 247.

152. See Michael Kalecki, “Essai d’une Théorie du Mouvement Cyclique des Affaires,” Revue d’Economie Politique, Mars-Avril 1935; “A Macrodynamic Theory of Business Cycles,” Econometrica, July 1935; Theory of Economic Dynamics, An Essay on Cyclical and LongRun Changes in

CapitalistE conomy (1952; reprint ed., New York: Augustus M. Kelley, 1969.)

153. Kalecki, Theory of Economic Dynamics, pp. 45–47. Emphasis in original.

154. Ibid., p. 161. Insert and italics added.

155. Ibid., p. 158.

156. Robinson, Accumulation, p. 247. Insert and italics added. 157. This and the following paragraph are taken with little change from my doctoral dissertation, The Theory of Aggregate Profit and the Average Rate of Profit, pp. 247–248.

158. Robinson, Accumulation, pp. 43–44, 75, 255.

159. For a critique of this doctrine, see above, pp. 798–799. 160. Robinson, Accumulation, pp. 74, 76, 255.

161. Cf. Joseph Schumpeter, The Theory of Economic Development (Cambridge, Mass.: Harvard University Press, 1951).

Capitalism: A Treatise on Economics

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