§2. Income and Capital

Income, which, as I have stated before, is the most important factor in all economic theory and in interest theory in particular, resolves itself in final analysis into a flow of psychic enjoyments or satisfactions during a period of time. While this concept is the ideal, we can, for purposes of objectivity, approximate this ideal and at the same time impute to the income concept varying degrees of measurability by using in place of psychic income any of the following: real income, cost of living as a measure of real income, or money income.

One objection to the psychic concept of income as a basis for a theory of interest is that it is too narrow and restricted. It is held that the analysis of interest based on this concept "finds the cause of the changes in rates solely in the changed ratio between the stocks of present and of future consumption goods," while the "interest rate market is a funds market, not a machine or raw material or present consumables market."76

"Nor is it entirely clear," continues this criticism, "why, in Fisher's view, the consumption perspective should read the law in point of interest rates to all equipment loan contracts, rather than, as Böhm-Bawerk sometimes appears to assert, the other way about. Why should not both sorts of demands be regarded as of equal title in causal effectiveness in the interest adjustment on final loans?"77

I reply that I do not exclude "equipment loan contracts" from due consideration, but I do maintain that such intermediate loans are made for the purpose of securing Edition: current; Page: [454] larger incomes in the future, and larger incomes mean larger consumption. Production loans then are made only in contemplation of future consumption. Hence, though loans for the acquisition of intermediate goods do greatly preponderate in the loan markets, these loans have power to affect the interest rate only by changing the relative amount of future incomes compared to present incomes.

To the criticism that the consumption concept of income when used as the foundation of interest theory presents but a partial analysis of the supply and demand factors which are operative in determining interest rates, I make this reply: Interest rates are not a resultant of the supply of, and demand for, either capital goods or of capital values—sometimes conceived of as a loanable fund or funds, except as these signify the supply of and demand for income. An investment of capital, so called, is nothing more nor less than the sacrifice of income in anticipation of other, larger, and later income. It is a case of flexing the income stream, reducing it in the present or early future and increasing it in the remoter future. The income stream, so fundamental in the interest problem, includes incomes from all sources. It includes the value of the services of land, machines, buildings, and all other income-producing agents. Upon the value of these services, discounted at the prevailing rate of interest, the valuation of said land, machinery, buildings, and so on depends. What is properly called funds is this valuation of the income stream or portions of it. It should be evident that the approach to the problem of interest through the income stream and the supply of and demand for income gives to the problem the broadest possible basis.

The second indictment of narrowness of my concept Edition: current; Page: [455] of income denies my contention that savings are not income. One writer states this criticism as follows: "As a financial fact, there can be no saving and addition to capital value until there is first a property right to an income calculable in monetary terms (a financial present worth) to be saved. Hence to deny that monetary savings are monetary income is in simple common sense to deny a fait accompli; it is to assume the existence of the effect before its cause."78

In so far as our disagreement here is a matter of words, it may be that my terminology is at fault. I used the term earnings to include capital gain and the term income in the sense of the value of services rendered by capital. There is little objection to changing this terminology, if we are willing to give up saying that capital value is the capitalized value of expected income. We could then maintain that capital gain is income. But if income includes only those elements on the anticipation of which the value of capital depends, then the increase in the value of capital is most emphatically not income.79

In my reply to one critic,80 I pointed out that this criticism seems to overlook, or omit, the mutual relations of Edition: current; Page: [456] discount and interest which constitute the raison d'être for the concepts which I have called capital and income. It is chiefly because savings do not enter into these discount relations on equal terms with other items of income that savings do not form a part of what I have called the income concept. I do not think there are reasons of terminology alone sufficient to justify the inclusion of savings in income. But, if savings are to be so included, some other term must be applied to take the place of what I have called income. The justification of these statements must rest on my books themselves and on later papers devoted to this subject.

But it is held that even aside from the relation of savings and income, a concept of income as services is quite useless. Services are both heterogeneous and incommensurable.81 They cannot be summated to constitute a stock of services. They cannot be thrown together as if all were alike.

An examination of my The Nature Of Capital and Income (for example p. 121), will show that I do not treat all services as alike and capable of being added together. I have emphasized that miscellaneous services cannot be added together until each is multiplied by its price and all are thus reduced to a common denominator.

This criticism of my theory of income seems to overlook the fact that, while enjoyable services (psychic income) and objective services are themselves incommensurable, their values are not. Moreover, when the summation is completely carried out, the values of the physical elements cancel among themselves and leave as the net result only the values of the psychical elements.

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It may be objected that, at one stage in this process, income appears to be more closely related to the expenditure of money than to its receipt and, as such, seems out of keeping with the ordinary idea of income. This seeming contradiction between money income and enjoyable income is readily resolved if we consider debits and credits. When money is spent, the expenditure itself is, it is true, outgo to be debited to the commodities bought with it. But these commodities afterward render a return in satisfactions. These satisfactions are certainly not expenditures, but receipts. Whether money spending is associated with outgo or income is entirely dependent on whether we fix attention on the loss of the money or the gain of the goods and services for which the money is spent.

These services, which constitute income, are related to capital in several ways. As income services, they flow from, or are produced by human beings and the physical environment. When I first came to the study of income and capital, I developed the concept of capital as a stock of wealth existing at an instant of time, and of income as a flow of wealth during a period of time, which concept I advanced in 1896.82 I found it necessary in 1897 to modify my concept of income, and so stated.83 Since then I have found no reason for further modification either of the concept of capital as a stock of wealth existing at an instant of time, or of the concept of income as a flow of services through a period of time, while the values of these are respectively capital value, and income value, often abbreviated into capital and income.

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"It is not possible," it is objected, "to conceive of a literal stock of services at an instant of time; it is possible to conceive of their present worth as a financial fund at an instant of time. Services (taken in the sense of uses either of wealth or of human beings) may conceivably be delayed or hastened, but they are in their very nature a flow; they cannot be heaped up and constitute a stock of services. They can, at most, as they occur be 'incorporated' in durable forms of wealth. If this is so, then why this elaborate contrast between a flow of services, and a fund of something quite different? It is the vestigial remains of the older conception that Fisher has been obliged to discard."84

While, however, I agree that these concepts of capital (as a fund of wealth) and income (as a flow of services) are not commensurate with the theory of interest, it would be a mistake to conclude from the emphasis placed on capital value, not capital goods, in the The Nature of Capital and Income, which was written as an introduction to the theory of interest, that the concept of capital goods emphasized by me in 1896 has been shelved as useless.

In the first place, the goods concept is itself a step in the formulation of the value concept, and secondly, The Nature of Capital and Income does not attempt to cover all of the four different relations between capital and income but only that one relation, income value to capital value, which is of importance to the theory of interest.

This valuation concept of capital, which in my view is necessary to the solution of the interest problem, does not distinguish between land and "produced means to Edition: current; Page: [459] further production." Some writers,85 who hold this latter concept of capital, have contended that my treatment of land as typical of capital in general has led me to erroneous conclusions.

In particular, my criticism of the naïve productivity theories is said to fall down because of this consideration. But, as I have before written,86 "my strictures on the ordinary productivity theories are not dependent on the putting forward of 'land' as typical of all forms of capital" or the particular definition of capital which I have used, but are, for the most part, merely a résumé of the strictures of Böhm-Bawerk, whose definition of capital excludes land. In other words, these criticisms hold true quite regardless of whether land is included in the capital concept or not.

However, while I recognize certain differences which exist between land and so-called artificial capital, these differences are of degree only, and do not carry the importance in most phases of economic theory which adherents of this concept of capital attribute to them. Professor J. B. Clark has presented87 the similarities and dissimilarities of land and other durable agents so comprehensively and adequately that I shall not attempt to go over again this question at this point. However, one phase of this comparison is of importance. It is claimed by those88 who hold land to be non-reproducible and, therefore, to lack a cost of production, that its value is Edition: current; Page: [460] governed by factors quite different from those determining the value of reproducible agents whose production does involve costs of production.

In brief, the contention is that the discount or capitalization principle of valuation upon which my theory rests is applicable only to land, since land value is not affected by cost of production. "If land, the limited gift of nature," one critic writes, "were truly representative of capital, then Fisher's reasoning would be unassailable."89

But since land, it is implied, is not representative of capital in that it does not involve a cost of production, the valuation process which applies to land does not apply to those "produced means to further production" which do incur costs in their production. To a consideration of the relation of cost of production to capital value, therefore, we now turn.