§4. Interest and Functional Distribution

In the theory of distribution interest must be assigned a quite different and much more important rôle than economists thus far have given to it. In classical economics the nature of interest and its place in distribution were not clearly understood. Distribution has been erroneously defined as the division of the income of society into "interest, rent, wages, and profits." Rent and interest are merely two ways of measuring the same income; rent, as the yield per acre or other physical unit, and interest as the same yield expressed as a per cent of capital value. The value of the capital is derived from the income which it yields by capitalizing it at the prevailing rate of interest. To reverse this process by multiplying the capital value by the rate of interest gives the original income, as long as the capital value remains stationary. It is not really a complex product of two factors, but, on the contrary, is the single original factor, namely, income, from which we started. As explained in previous chapters, it is this income which affords the basis for the determination of the rate of interest, and through the rate of interest, of capital value.

The final enjoyable income of society is the ultimate and basic fact from which all values are derived and Edition: current; Page: [332] toward which all economic action is bent. All of this income is derived from capital wealth, if land and man are included in that term, or if not, from capital and man, or capital, land, and man, according to the terminology adopted. This income may all be capitalized, and hence all income (excluding capital gain) may be viewed as interest upon the capital value thus found.

Viewed as above outlined interest is not a part, but the whole, of income (except for capital gain). It includes what is called rent and profits and even wages, for the income of the workman may be capitalized quite as truly as the income of land or machinery. Thus, instead of having interest, rent, wages, and profits as mutually exclusive portions of social income, interest may be regarded as including all four. If we prefer to exclude profits, the reason is because of the element of risk and not because profits are not discountable just as truly as rent and wages. The error of the classical economists and of their modern followers in regarding interest, rent, wages and profits as separate but coördinate incomes is partly due to the failure to perceive that, whereas all income is produced from capital wealth, capital value can emerge only from man's psychic evaluation and capitalization of that income in advance of its occurrence.

Another oversight closely associated with the last stated fallacy is that in which rent and wages are conceived as determined independently of the rate of interest, whereas we have just seen that the rate of interest enters as a vital element into the determination of both. The great defect in the theories propounded by the classical economists lay in their inability to conceive of a general equilibrium and the mutual dependence of sacrifice and enjoyment.

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In discussing the theory of distribution, we shall, therefore, abandon the classical point of view entirely. The classical concepts of distribution are quite inappropriate to explain the every day facts of life and the economic structure. The phrase distribution of wealth, as understood by the ordinary man, implies the problem of the relative wealth of individuals, the problem of the rich and the poor. But the separation of the aggregate income into four abstract magnitudes, even if correctly done, has little to do with the question of how much income the different individuals in society receive.

Only on condition that society was composed of four independent and mutually exclusive groups, laborers, landlords, enterprisers, and capitalists, would the fourfold division of the classical economists be even partially adequate to explain the actual distribution of income. In fact, the four classes all overlap. The enterpriser is almost invariably a genuine capitalist and usually also performs labor; the capitalist is frequently a landlord and laborer, and even the typical laborer is today often a small capitalist and sometimes a landlord. It is true that a century ago in England the lines of social classification corresponded roughly to the abstract divisions proposed at that time by the classical economists. But this fact is of little significance except as explaining historically the origin of the classical theory of distribution.4