4.11 John Rae and the 'Austrian' theory of capital and interest

The most remarkable contribution to the theory of capital and interest in the post-Ricardian period was by the drifter and eccentric, John Rae (1796–1872). Rae set forth his theory as part of a tract designed to argue for a protective tariff: Some New Principles on the Subject of Political Economy (Boston, 1834). Rae had the most extensive and fully developed analysis, until Böhm-Bawerk and the Austrians, of the crucial role of time in the theory of capital and interest. In the theory of capital, Rae saw that a key to production is increasing investment in capital goods, themselves the product of labour and nature, and that capital goods can be ranked on the basis of their rate of return, and the time necessarily involved from their formation until their depletion. Specifically, lengthening the process of production, or the time involved in the process of investing in capital, will enable the use of capital goods of greater physical productivity. But while waiting a longer time will enable one to tap more physically productive processes of production, this benefit must always be weighed against the unwelcome necessity of waiting longer into the future until the return from capital is obtained. And here, John Rae presented the fullest development to date of the time-preference theory of interest. To balance against the greater productivity of waiting longer into the future, the capitalist must charge an interest rate based on the greater desirability of present as against future goods. In short, investors must sacrifice present for future goods, and so they must be compensated for this investment by a return reflecting their degree of time-preference. Investors will be sacrificing a smaller present good for a larger future good, the degree of difference – their interest return – being dependent on people's cultural and psychological willingness to take a long-run view of the future. Those with lower time-preference rates, i.e. those who take a longer view of the future, are particularly looking to raise the standard of living of their children; on the other hand, for Rae, those with higher time-preference possess weak intellectual and moral principles and suffer from a ‘defect of the imagination’.

Rae also anticipated Schumpeterian theory in placing great emphasis on the importance of inventions, and stressed that inventions opened up new opportunities for highly profitable capital investment, and that resulting high profits stimulated such investment.

Schumpeter paid high tribute to Rae's achievement, calling his work a ‘theory of capital, conceived in unprecedented depth and breadth’, although, oddly enough, he doesn't mention Rae's stress on inventions. Schumpeter does add, however, that given ‘ten additional years of quiet work, graced by an adequate income’, Rae's New Principles ‘could have grown into another -and more profound – Wealth of Nations’. And Böhm-Bawerk, who had not known of Rae's achievement in the first edition of his History and Critique of Interest Theories, for once was very generous in his glowing account in later editions, calling Rae's work ‘exceedingly original and remarkable’.

John Rae's accomplishment was all the more striking because it did not come from a writer steeped in the economic discussions of the Great Britain of his day. On the contrary, it came from a man who must be described overall as a brilliant drifter, crank and loser. John Rae was a’ Scotsman, born in Aberdeen, the son of a prosperous self-made merchant and shipbuilder. Interested in invention and the natural sciences, Rae, as a young maths student at the University of Aberdeen, presented some inventions in mechanics to his professor, who pronounced them ingenious but impractical. Dropping the matter so as not to irritate his practical-minded father, Rae decided, upon graduation, to go to the University of Edinburgh to study medicine. But, typical of Rae, while studying for his M.D. dissertation, he became convinced that prevailing physiological theories were false, and so he dropped out of medical school, determined to write a grandiose ‘philosophical history’ of mankind. Embarking on this ambitious but truly impractical life work, Rae plunged into the study of biology, philology, ethnology, aeronautics, geology, education, and the social sciences, undoubtedly with radical ideas in them all. Very little of this ever got written or published, his published work consisting of a few scattered articles on such matters as emigration, education, Canadian religion, Hawaiian customs and legislation, and Polynesian languages. His extant unpublished papers are on geological topics.

This sort of life plan was scarcely calculated to yield John Rae a secure income, and the bankruptcy of his father, as well as a possible social stigma from his marrying the daughter of a shepherd, drove him to emigrate to the backwoods of Canada, at the age of 25.

It was during this course of self-study that John Rae read the Wealth of Nations, and developed an antipathy to that Scotsman's general commitment to free trade and laissez-faire. In particular Rae acquired a lifelong interest in protectionism and government subsidies to industry. At least some of that reaction reflected a typically Scottish Calvinist hostility to luxury and consumer indulgence. A strong advocate of thrift and abstinence, Rae lamented any luxurious consumption among the lower classes, which weakens their ‘effective desire for accumulation’. Sensual appetites lead the poor to marry and increase their number of children unduly, also weakening their propensity to save and to raise their standard of living. Rae's first interest in the protective tariff came in Scotland in 1819, attacking the desire of the numerous followers of Adam Smith to greatly lower the taxes and tariffs on whisky, and to allow the manufacture of whisky in small stills. Rae reacted angrily, worrying as he did about the ‘general morals of the people’ resulting from an abundance of cheap whisky.

Arriving in Canada, Rae soon became a schoolmaster at a private school and a physician in the small village of Williamstown, Ontario. Williamstown was a centre of the Scottish Presbyterian settlement in Canada, and Rae, a devout adherent of the Presbyterian Church of Scotland, embroiled himself in the claims of that Church to government support as against the exclusivist claims of the Church of England. Apart from Anglican elitism unsuited to North American conditions, Rae opined, the Presbyterian Church of Scotland insisted on austere morality as against the laxity of the Anglicans. He criticized the United States for not having an established religion, thereby lessening the incomes and tenure of the clergy and weakening the bonds of ‘genuine religion’.

After a decade in Williamstown, John Rae felt it was time to move on. In 1831, he resigned his post as schoolmaster and as one of the three coroners of the Eastern District of Ontario, and moved to Montreal. He had decided to begin work on his life project, or at least a subset of it to be devoted to the ‘Present State of Canada’, which would present his ideas on Canadian geology and economic development, and to make a strong plea for continued Canadian membership in the British Empire. While in Montreal, he petitioned the government of Upper Canada for a travel and research grant to finance this projected work, but the Upper Canada Assembly felt there were more important things to be done and turned down Rae's grant proposal, despite the favourable recommendation of the lieutenant-governor.

Rae was still determined to work on his life project, and he repaired to the lumbering village of Godmanchester, not far from Montreal, where he apparently worked in menial tasks in lumbering while publishing pro-British Empire articles in the Montreal Gazette. There he wrote what was supposed to be another subset of his master plan, his great work on the New Principles of Political Economy.

The spirit of revolution against the British Empire was abroad in Canada, and Rae's letters to the Gazette were vitriolic in denunciation. The criticisms of Britain, he fulminated, were ‘gross misrepresentations, infamous falsehoods and horrid blasphemies’. Recalling the horrors of the French Revolution, Rae thundered that ‘the banners of imperial justice must be displayed, else in a short time the reign of terror be attempted in Canada, and red ruin ride triumphantly’.

In view of Rae's strong connections in Montreal, it is difficult to see why he languished in Godmanchester. His sister, Ann Cuthbert, a poet and headmistress of a boarding school, was married to a wealthy dry-goods merchant, James Fleming. Fleming's brother, John, was a prominent writer as well as a leading official of the Bank of Canada and Bank of Montreal, and the family moved in the circle of leading Scottish Presbyterian merchants and ultra-loyalists of the British Empire, surrounded by a Canadian populace of what they took to be French-Canadian insurgents and radicals.

Rae conceived his New Principles to be another subset of his life work, this time devoted to the growth of nations and to the necessity for a protective tariff and other forms of government promotion of industry. He finished the book in 1833 and originally meant to publish it in England, but for some reason changed his plans and travelled to Boston to seek aid in publishing the book there. In Boston, Rae met and was taken under the wing of the powerful Alexander Hill Everett (1790–1847), a leading Boston Brahmin, a protégé of ex-President John Quincy Adams, and recently Adams's minister to Spain. An accomplished linguist and classicist as well as an attorney, Everett had left government service to become the editor of the prominent and influential North American Review. A decade earlier, Everett had written New Ideas on Population (1823), in which he sensibly attacked Malthus for not realizing that population growth can bring abundance, not poverty, by extending the division of labour, expanding markets and cities, and increasing the production of food and manufactures.

Everett, like the rest of New England, had lately shifted from free trade to the advocacy of a protective tariff, particularly for the region's nascent textile manufacturers. The protectionists were looking around wildly for textbooks and academics who would support their cause, since the works of Adam Smith and J.B. Say were dominant in American universities. Meeting and being impressed with John Rae and hearing of his new protectionist work, Everett was enthusiastic about him and arranged, sight unseen, to publish the book in Boston.

Apparently, Everett had bought a pig in a poke. Reviewing it in the North American Review, Everett damned Rae's New Principles with faint praise. He had been looking for a hard-hitting protectionist tract; instead, he found the book filled with technical jargon he could barely comprehend. And much of it had little or no bearing on the tariff issue. The bulk of the book dealt with the theory of capital and interest, and the importance of the expansion of capital to the growth of a nation. As Everett shrewdly pointed out, these views were not really at variance with those of Adam Smith. And none of it bore directly on the protectionist issue.

To Rae himself the connections were clear, if too remote for those interested in public policy. He believed that economic development depended jointly on new inventions and their application in capital investment, and most of his proposed government policies were subsidies and bounties to new inventions and industries, to be financed by heavy tariffs on the imports of ‘luxuries’. In that way, Rae's Calvinist soul would be satisfied, for the government would be imposing moral principles by promoting thrift, invention and industry, while discouraging sinful luxuries, especially, in a prefigurement of Thorstein Veblen, where ‘consumption is... conspicuous’ and therefore particularly wasteful. Rae's denunciation of luxurious consumption, which Rae boldly called ‘a loss to the society, in proportion to their amount’, did not sit very well with Everett, but his main criticism was that the country needed a ‘well-written and well-reasoned essay on this [protectionist] question’, a work of ‘sufficient compass and authority to serve as a textbook’. Clearly, John Rae's work did not fill the bill.

The book was a commercial failure, and was quickly forgotten. The understandably chagrined and embittered Rae wrote in a letter, years later, that ‘unfortunately, I was induced to publish in Boston, under the assurance from A.H. Everett that it would be appreciated there. He was, however, I believe scared of it. Could not make up his mind, nor could anyone there, if I was right or wrong, and so passed it by with praise of its style, etc. This damned it’. In addition, the free traders and the worshippers at the shrine of Adam Smith — who came in for considerable direct criticism in the book — attacked Rae's work. But possibly more fatal than any of these factors was the timing of the book. For after the tariff of 1833, lowering tariffs considerably, tariff agitation in the United States began to subside, and the tariff was repeatedly lowered throughout the 1840s. Free trade had apparently triumphed, at least until the Civil War.

In Canada, furthermore, there were scarcely any economists or academics fit to appraise Rae's work, and in Britain there was a general scorn for ‘colonials’, and failure to take North Americans seriously. In England, however, Nassau Senior, whose work on capital and interest was not far from Rae's, read the New Principles by the mid-1840s and admired it greatly, and traces of Rae can be found in Senior's later writings. Senior passed the book on to John Stuart Mill, who commended it warmly in his overwhelmingly popular 1848 treatise, the Principles of Political Economy. Rae heard of Mill's praise five years later, through a Canadian friend, and wrote warmly if mournfully to Mill that ‘it is the only thing connected with that publication which has afforded me any gratification’.

Here a mystery arises for the history of economic thought. Despite Mill's warm commendation of Rae's book in what was the dominant treatise on economics for a generation, no economist anywhere picked up on the reference, and knowledge of Rae virtually disappeared. The only exception was the great Italian classical economist Francesco Ferrara (1810–1900), who translated Rae's New Principles into Italian in the mid-1850s. Apart from that, nothing. W. Stanley Jevons, devoted to the history of economic thought, apparently never heard of the book, and even the great Böhm-Bawerk had never read John Rae when in the 1880s he wrote the first edition of his History and Critique of Interest Theories. Rae remained unknown to economists until his memory was revived, and his work reprinted, by Professor Charles Whitney Mixter at the turn of the twentieth century. Perhaps a clue to the puzzle is in Böhm-Bawerk's later editions, where he points out that Mill's encomiums to Rae, while warm, were general and even banal, and scarcely conveyed the brilliance and originality of his work on capital and interest. As Böhm-Bawerk explains it:

But it is a strange fact that in all his numerous quotations [from Rae] John Stuart Mill never included any of the material which constitutes the essence of Rae's original ideas. He quotes, instead, merely ornamental incidentals, and even among those only the sort of thing that could be used to illustrate the traditional doctrines that Mill himself was presenting. And since Rae's book seems to have been read in the original by only extremely few persons, just the most interesting part of its contents remained unknown to his contemporaries. There was little likelihood that they, and even less that subsequent generations would be apprised by Mill's quotations of the importance of the book, or impelled to conduct any research into his quickly forgotten work.²⁷

Disappointed in the reception of his book, unemployed and destitute, Rae won an appointment as headmaster of a government district grammar school in what was then the brawling frontier town of Hamilton, Ontario. There he lived in genteel poverty on a low salary and was continually in debt, but he was apparently beloved by his students and was known in Hamilton as a graceful and elegant ice skater as well as president of the Hamilton Literary Society. There he played a prominent role in the first contingent of Hamilton militia which, in 1837 and 1838, helped put down an armed rebellion by Canadian nationalists anxious to cut the ties with the empire. Rae engaged in aeronautical experiments with balloons, and wrote increasingly on geological topics. He also continued to work on the economic geography of Canada, and finally in 1840, completed his magnum opus, a lengthy book on the ‘Outlines of the natural History and Statutes of Canada’.

Unfortunately, however, the decade of the 1840s saw fate land a series of hammer blows against John Rae. First, the manuscript of his book on Canada was irretrievably lost en route to possible publishers in New York. Second, after teaching in Hamilton for 14 years, Rae was summarily fired in 1848. The problem was that Rae became inevitably embroiled in educational political struggles, particularly over getting Presbyterians appointed to teaching and administrative posts in the Anglican-dominated Ontario school system. Furthermore, in 1843, in the Disruption, the Church of Scotland (and hence its affiliated Presbyterian Church in Canada) split in irretrievable schism, with hard-core Calvinists opposed to secular state domination of the Church splitting off from the established Church of Scotland and forming the Free Church. As we might expect from his character, Rae, along with his friends, joined the Free Church, which lost him the political support of the established Presbyterian officials dominant in his school district. Rae's stay in Hamilton was doomed.

Rae then left Canada and did some school teaching in Boston and New York, where, a year after his dismissal, he received another staggering blow -news of the death of his wife, Eliza. Discouraged, restless, penniless and uprooted at the age of 53, John Rae began a new life of wandering and drift. Attracted by the gold rush, he sailed to California, where he did a little school teaching and carpentry; in ill-health in California, Rae was soon off to the Hawaiian Islands, where he was to spend the rest of his days. There, on the island of Maui, Rae prospered economically for the first time, teaching English to Hawaiian natives, farming, and functioning as medical agent for the board of health. Rae began to blossom politically because of his new friendship with a fellow Scottish expatriate, Robert Crichton Wyllie, a surgeon from Glasgow University, wealthy businessman, and now minister of foreign relations of the Hawaiian Kingdom. With Wyllie's patronage, Rae became coroner, notary public, medical attendant and district judge in Maui.

His favourable circumstances now led Rae to resume his various scientific interests: he wrote articles and papers on geology, particularly on volcanoes, ocean tides, and Hawaiian geology; on the Polynesian language; and tried to revive interest in marketing his long-neglected navigational inventions.

But John Rae was incapable of holding onto money, and so perpetually reverted to destitution. With his patron Wyllie dead, and in ill-health, Rae accepted the offer of an old friend and former student to pay for his trip from Hawaii to live with him permanently at his home in Staten Island. But Rae died on Staten Island the following year.

Restless and eccentric, John Rae in a sense wrote a suitable and poignant epitaph for himself in New Principles, in his sensitive appreciation of the lone role of the inventor or innovator in society:

Pursuing objects not to be perceived by others, or if perceived, whose importance is beyond the reach of their conceptions, the motives of their conduct are necessarily misapprehended. They are esteemed either idlers, culpably negligent in turning account the talents they have got, dullards deficient in the common parts necessary to discharge the common offices of life, or madmen unfit to be trusted with their performance; shut out from the esteem or fellowship of those whose regard they might prize, they are brought into contact with those with whom they can have nothing in common, knaves who laugh at them as their prey, fools who pity them as their fellows. Their characters misunderstood, debarred from all sympathy, uncheered by any approbations, the ‘eternal war’, they have to wage with fortune, is doubly trying, because they are aware, that, if they succumb, they will be borne off the field, not only unknown, but misconceived.²⁸