VII. Capital and the "Subsistence Fund"

CHAPTER VII CAPITAL AND THE "SUBSISTENCE FUND" WE must return now to the considerations from which we started in Chapter V. The significance of the various forms of the productivity of investment which we dis cussed in the last chapter is, as we have The relallon between seen that the existence of a stock of re-the stock of capital , and current Investsources of limited durability enables us to ment keep income permanently above the level that could be secured by the direct use of current pure input. It does so by providing income during the time that we have to wait for the return of the input that is being currently invested. But it is important, even at this early stage of the exposition, that we should not unduly simplify the relationship. between the stock of nonpermanent resources and the possible range of investment periods. The very expressive term" subsistence fund" which has been used to describe this function of the stock of nonpermanent resources is apt to be misleading in a number of ways. It is of course not a stock of actual means of subsistence, but only a stock of resources which can be turned into means of subsistence, i.e. into consumers' goods. l The 1 N. W. Senior was again the first person until comparatively recent times who saw this connection at all clearly. "Nor is it absolutely necessary", he writes (Political Ecorwmy, 1836, pp. 78-79), "though if Adam Smith's words were taken literally, such a necessity might be inferred, that, before a man dedicates himself to a peculiar brand of production, a stock of goods should be stored up to supply him with Ais subsistence and materials and tools, till his own product has been completed and Bold. That he must be kept supplied with these articles is true; but they need not have been stored up before he first sets to work, they may have been produced while his work is in progress. . . .

That fund must comprise in specie some of the things wanted. The painter must have his canvas, the weaver his loom, and materials, not enough, perhaps, to complete his web, but to commence it. As to 85 86 Introductory PT. 1 process of transforming these resources into consumers' goods requires the co-operation of current input; and the amount of consumers' goods that they will yield and the time when those consumers' goods will accrue, will depend on the way in which the services of the permanent and the nonpermanent resources are combined. The latter, therefore, do not represent a fixed quantity of consumers' goods or a stream of them of fixed time shape. It is all a question of which combination of the different resources is most advantageous. The fact that it is the existence of nonpermanent resources which enables us to invest the servic~s of the permanent resources does not mean that the fruits df the former will always be consumed at the earliest date when they can be made available, and that only the latter will be invested. Whenever a greater output is to be expected from further postponing the return from nonpermanent resources, and in the meantime using the services of the permanent resources, this arrange ment will be the one to be adopted. It cannot be too strongly emphasised that the services from nonpermanent resources, no less than those from permanent resources, are objects of investment.

As has already been remarked, most nonpermanent resources owe their existence to the fact that they make investment possible without a temporary reduction in the income stream. All or nearly all the manUnder perfectly stationary condljions made equipment is nonpermanent, and the stock of nonpermanent resources the greater part, although by no means all, would be Identical of the nonpermanent resources existing with the stock of produced means 01 at any moment consists of man-made production equipment. This brings us back to the relation of my definition of capital as the" stock of non permanent resources" to the traditional one of the " produced means of production". those commodities, however, which the workman subsequently requires, it is enough if the fund on which he relies is a productive fund, keeping pace with his wants, and virtually set apart to answer them."

CH. VII Capital and the" Subsistence Fund" 87 Indeed these two definitions merely emphasise different aspects of the same process, which, as completely station ary conditions were approached, would tend to become identICal. As time goes on the nonpermanent resources have to be replaced by deliberately produced equipment, and ultimately, if technological progress stopped, all non permanent resources which were the gift of nature would be exhausted. And there would of course be no additions to strictly permanent resources in a stationary state. Con sequently, under perfectly stationary conditions·, where everything continually repeated itself in an unchanging wP,y, the genetic definition of capital as the produced means of production would also define the nonpermanent resources and the way in which they would be currently reproduced. But the fact that a definition would be adequate under purely stationary conditions means less in the theory of capital than almost anywhere else in economics (with the exception of the theory of money). The Most capital problems theory of capital is largely concerned with arise only outside the limits of a slationary the significance of those wasting resources slale which, in Wicksell's words, "cannot, strictly speaking, be included in the scheme of a stationary economy ".1 Thus it is only by an extreme and almost numbing effort of abstraction that the theory of capital can be made to satisfy the requirements of stationary analysis. In actual life the existing stook of capital goods is always the result of an accidental historical process, consisting of a suc cession of unforeseen changes, and they will never be reproduced in exactly the same form. They were only produced in this particular form because certain kinds of equipment happened to be available as the result of past history.

The essential characteristic of capital, and the one which affects the use of current input, is that it needs replacement .and in consequence leads to investment. 1 cr. Lectnres, vol. i, p. 151.

88 Introductory PT. 1 This in turn leads to the creation of new capital, but once this new capital exists the historical aspect becomes irrelevant. The important thing is not that the capital Under dynamic con-has been produced, but that it (or some dltions the relevant equivalent) has to be reproduced. Under lact is only that resources are nOD-stationary conditions the two aspects will permanent, and not f d . that they have been 0 course coincide. But under ynamlc conproduced ditions this will not be so. If income is to be maintained permanently at the higher level which the wasting natural resources make possible, these resources will, as they are exhausted, have to be replaced by pro duced means of production. 1 And occasionally it may be found advantageous to replace nonpermanent resources by some change of the surface of the earth, which, like a tunnel, may be expected to remain permanently useful.

The last case is particularly interesting because it points to a significant difference between the two defini tions. On the classical definition the tunnel, and any other piece of man-made equipment that was regarded as permanent, would be counted as capital mer~ly because of its historical origin. Actually, however, once it existed it would have none of those effects on the use of current input which are peculiar to the nonpermanent resources. It would no longer represent a supply of capital which, if conditions changed, could be transformed into a more desirable shape. Nor would it (either from the social or from the private viewpoint) represent a reserve on which 1 It may be pointed out here, although it does not strictly belong to our present subject, that a treatment of the problem of the con servation of exhaustible resources under the aspect of their representing part of the national capital, would at last put the somewhat confused discussion of these problems on a sounder basis. There is, of course, no reason why, e.g., forests should be maintained at the particular size at which they happen to be at any given historical moment - although there may be other considerations that have to be taken into account than merely the direct profitability of the forests in question (effects on climate, soil erosion, aesthetic considerations, etc.). But it should always be kept in mind that any exhaustible resource represents just one item of the national capital which may be more useful in some other form into which it can be converted.

CH. VII Capital and the " Subsistence Fund" 89 one could draw in order to obtain a temporary increase in current income. Although it would be a "produced means of production", it would have none of the char acteristics which create the special problems relating to " capital". 1 It should be observed at this point that the concept of capital arose out of the need for distinguishing the " substance" of an asset (which has to be replaced) from its yield: that is, for dividing gross returns between amortisation and interest. This is of itself sufficient reason for reserving the term for nonpermanent assets. Where there is no "turnover" of stock, but only a per manent stream of services, no problems of capital arise. But there is another, even more fundamental, reason why the definition of capital as the produced means of production should be definitely abandoned. And this is, that it is a remnant of the cost of production Thetradllionaicapilal theories of value of the old views which concept Is a remnant , ~~~~~~ sought the explanation of the economic lion theory 01 value attributes of a thing in the forces embodied in it. 2 But, except as a source of knowledge, the actual history of a particular thing, i.e. the way in which it has acquired its qualities, is entirely irrelevant. It has nothing whatever to do with the decision as to how the thing shall be used henceforth. Bygones are bygones in the theory of capital no less than elsewhere in economics. And the use of concepts which see the significance of a good in past expenditure on it can only be misleading.

All this does not mean that the relation of capital to investment, and the creation of capital by investment, is not of the utmost importance. In fact it is so important that the greater part of what follows will consist of an attempt to clarify this relationship. What it does mean 1 Cf. the passage flOm Wicksell, quoted above, p. 57, footnote. S Cf. C. Menger, Zur Theme des Capitals, passim, and the passage from Professor F. H. Knight's discussion of these problems already quoted (see above, p. 10, footnote).

90 Introductory PT. I is that the important thing is not the relation of existing capital to past investment, but its influence on current investment, its influence on the creation of the capital goods of the future. For all problems connected with the demand for capital, the possibility of producing new equipment is fundamental. And all the time concepts used in the theory of capital, particularly those of the various investment periods, refer to prospective periods, and are always "forward-looking" and never "back ward-looking". But for determining what resources are functioning as capital at any given moment, the essential point is not that particular resources h.ave been produced; it is that they are not permanent, but of limited durability, and therefore must be replaced by some new resources if the income stream is not to decline. If in our definition of which of the present resources are to be considered as capital and which are not, we single out the nonpermanent resources as capital, we The double aspect 01 must not overlook in doing so that in a the capital problem sense the capital problem is double-faced and that its two aspects make it necessary to recognise two categories of goods which are not .necessarily identical.

From the first point. of view we 1l.re concerned with what it is that enables us to wait, and from the second point of view with what it is that enables us to draw advantage from this possibility of waiting. The investment which the waiting makes possible can of course take the form only of things which can be produced. And when we are thinking of the capital to be produced this can of course consist only of such things as can be produced. But what we mean when we say that the existence of particular present resources makes waiting possible is that these resources provide a temporary income stream during the period while we wait for some other income to mature. There is no other concrete meaning which we can attach to the vague but much used concept of the " amount of waiting" available than the amount of services available OR. VII Capital and the " Subsistence Fund" 91 in the near future as compared with those which will only be available in the more distant future. And there can be no doubt that this is the sense in which the term capital is used in everyday speech. A person who in the present year cannot lay hands upon a greater amount of resources than will recurrently become available to him in every successive year is not commonly regarded as commanding any capital in addition to his income, however large that income may be. A big landowner, for instance, may well be short of capital and, unless he is able to " raise capital" on the security of his land, be unable to make any investments to intensify the cultiva tion of his land. 1 And a country may be very rieh in land and lack the capital, which may be supplied by another country whose total wealth may be much smaller.

A person or a country, on the other hand, who in addition to a secured (and non-anticipatable) stream of permanent income commands an amount of resources which can be used up in the near future, is generally held to own capital. It has recently been suggested 2 that instead of the traditional concept of produced means of production or of the concept of nonpermanent resources used bere, the reproducible or augmentable resources Th . In r e sign eance 0 ought to be considered as representing Ihe"augmenlabilily" " . l" B' f h £ 01 resources capIta . ut qmte apart rom t e act that the criterion of augmentability is either exceedingly vague or, if taken literally, would narrow down the range of augmentable resources in such a way as to make the 1 It is true that because of this possibility to borrow on the security of land (or any other permanent resource) the distinction between capital and land tends to become blurred and individuals more and more tend to treat land as a part of their" capital". But the distinc.

tion between capital and land is surely not an invention of the econo mists and I find it diffi(lult to believe that the efforts of a number of moderru economists (particularly Professor Fisher, Professor Fetter, and Edwin Cannan) to expand the concept of capital so as to include all wealth are to be recommended. 2 N. Kaldor, 1937, p. 219.

92 Introductory PT. 1 concept useless for our purpose,! the point that is relevant for our problem is not that certain existing resources can be replaced by others which are in some technological sense similar to them, but that they have to be replaced by something, whether similar or not, if the income stream is not to decline. A deposit of metal ore is no less capital because it cannot be reproduced, and vice versa the water-power of an existing stream would not become capital in the relevant sense because of the poss.ibility of creating a new stream by collecting rain-water which is now allowed to evaporate. What determines the special common characteristics of capital goods is not that they can be reproduced, but how they can be used: namely, that they can be made to The sense In -which yield all their services in the comparatively the constituents of near future. And it is this fact and no the stock of capital can be aald to have a other which in a sense makes them one comcommon quality mon "fund"; that they are capable of producing income for the same period of time, the com paratively near future. Even very different consumers' goods that are available at the same time are· substitutes to a much higher degree than even otherwise identical goods which, however, are available at dates very distant from each other. And so long as we can increase our in come by investing, that is, postponing the date when some resources will yield consumable services, everything which can be used to give an income during the interval, and so 1 Mr. Kaldor's definition of "producible" or "augmentable"

resources appears to be that they have perfect (or at least very close) substitutes which it is economically possible (i.e. profitable) to produce. If perfect substitutability (in the sense of the goods by which the existing resources are replaced having an infinite elasticity of substitution with the latter) were required, nothing except goods which it is profit able to reproduce in exactly identical form would have to be counted as capital. But if only the existence of close substitutes is required, where is one to draw the line? On the other hand, if only resources which it is economically possible to reproduce are to be counted as capital, all obsolete machinery would cease to be capital as soon as better machines became available; while if the technological possiCll. VII Capital and the " Subsistence Fund" 93 will enable us to make use of the opportunities of invest ment, possesses the common attribute of being a condition of making investment possible. In other words, so long as there is a special inducement to postpone the date when some resources will yield their final services, the common attribute of the things capable of rendering services in the interval is a scarce" factor" on which certain additions to our future income depend. But if the opportunities of adding to output by investment should cease, although part of our resources would still have the exclusive attri bute of being capable of rendering services in the near future, yet the existence of any particular unit of such factors would cease to be a condition for the possibility of investment and their common quality of being available in the near future would cease to be scarce relatively to demand.

The recognition that the constituents of the stock of capital possess in this sense a common quality has often led economists to speak of it as if it could be treated as a homogeneous " fund ", an "amount The concept of cap of waiting", or as a given quantity of ltat .. a fund " capital disposal" or of" pure capital" in the abstract. If these terms were used occasionally to express no more than has been explained in the preceding paragraphs, little objection would be raised against them. Unfortunately, however, much more far-reaching assertions have been made about the real existence of such a fund which I cannot but regard as pure mysticism. The best known representatives of this view are of course J. B. Clark and Professor Gustav Cassel, and the views of the former have recently been revived by no less an authority than Professor F. H. Knight. In his opinion, the" basic issue" which at present divides economists "is the old and familiar one between two conceptions of capital. In one bility of producing substitutes were to decide, even land could not be excluded, since it is possible to grow practically any fruit in artificial compounds (" tray farming ").

94 Introductory PT. 1 view it consists of 'things' of limited life which are periodically worn out and reproduced; in the other it is a ' fund' which is maintained intact though the things in which it is invested may go and come to any extent. In the second view, which is of course the one advocated here,! the capital' fund' may be thought of as either a value or a ' capacity' to produce a. perpetual flow of in come." 2 I am afraid, with all due respect to Professor Knight, I cannot take this view seriously because I can not attach any meaning to this mystical " fund " and I shall not treat this view as a serious rival of the one here adopted. What I have to say about the former I have said in another place,3 and here I shall not discuss it again beyond pointing out certain errors ,vhich are due to its influence. 4 1 I.e. by Professor Knight. 2 F. H. Knight, 1935c, p. 57. 3 Hayek, 1936a.

4 See below, Chapters XXIII-XXV.

PART II INVESTMENT IN A SIMPLE ECONOMY CHAPTER VIII THE OUTPUT FUNCTION AND THE INPUT FUNCTION THE task of this part of our investigation will be to study the various possible relationships between the organisation of production and the size of the product with special regard to the productivity of "invest-The plan of this part ment", that is, the use of different sorts of of the Investigation time-consuming methods of production. The different ways in which time may enter between the application of resources and the maturing of the product are, how ever, so varied and are in real life usually combined in so many complicated and complex patterns, that before we can successfully investigate the influence of productivit,Y considerations on the choice of a particular investment structure, it will be necessary to set, out in some detail the different types of relationships that may occur.