§5. Interest and Personal Distribution

The main problem of distribution, as I see it, is concerned with the determination and explanation of the amounts and values of capitals and incomes possessed Edition: current; Page: [334] by different individuals in society. It is astonishing how little economists have contributed to resolving the problems of distribution so conceived. A statistical beginning was made by Professor Pareto in his presentation of interesting "curves of distribution of income."5 For the United States, Professor W. I. King6 and the National Bureau of Economic Research7, and for England, Sir Josiah Stamp8 have made and analyzed important statistical compilations on the amount and distribution of income and capital wealth by income groups and social classes. On the theory of distribution, especially the rôle of interest in distribution, John Rae seems to have contributed more than any other writer9. He showed in a vivid way that persons who had naturally what we have called in this book a low rate of impatience or preference for present over future income tended to accumulate savings, whereas those who had the opposite trait tended to spend their incomes and even their capitals.

In previous chapters it is shown that the rates of preference among different individuals are equalized by borrowing and lending or, what amounts to the same thing, Edition: current; Page: [335] by buying and selling. An individual whose rate of preference for present enjoyment is unduly high will contrive to modify his income stream by increasing it in the present at the expense of the future. The effects upon incomes may be traced to capital by applying the principles explained in The Nature of Capital and Income, Chapter XIV.

If a modification of the income stream is such as to make the rate of realized income relative to capital value exceed the standard rate of income returns, capital will be depleted to the extent of the excess, and the individual, group, or class, under consideration will grow poorer. This condition may be brought about either by borrowing immediate income and paying future income, or by selling instruments whose returns extend far into the future and buying those which yield more immediate returns. Individuals of the type of Rip Van Winkle, if in possession of land and other durable instruments, will either sell or mortgage them in order to secure the means for obtaining enjoyable services more rapidly. The effect will be upon society as a whole that those individuals who have an abnormally low estimate of the future and its needs will gradually part with the more durable instruments, and that these will tend to gravitate into the hands of those who have the opposite trait.

By this transfer an inequality in the distribution of capital is gradually effected, and this inequality once achieved tends to perpetuate itself. The poorer a man grows the more keen is his appreciation of present goods likely to become. When once the spendthrift is on the downward road, he is likely to continue in the same direction. When he has succeeded in losing all his capital except his own person, the process usually comes to an Edition: current; Page: [336] end, because civilized societies in self-protection frown upon chattel slavery and involuntary servitude. Many examples, however, of forced labor and even slavery still survive. The negro farmers of the Southern States, the Mexican peons, the peasants of Russia until recently, the forced labor and slavery in many tropical colonies, such as Java,10 the Congo, and other African countries, are examples in point.

Reversely, when an individual has saved a considerable capital, his rate of preference for the present diminishes still further, and accumulation becomes still easier. Hence, in many countries the rich and poor come to be widely and permanently separated, the former to constitute an hereditary aristocracy of wealth and the latter, a helpless proletariat.

This progressive sifting, by which the spenders grow poorer and the savers richer, would go on even if, as assumed in our first and second approximations, there were no risk element. But it goes on far faster when as in actual life there is risk. While savings unaided by luck will ultimately enrich the saver, the process is slow as compared with the rapid enrichment which comes from the good fortune of those few who assume risks and then happen to guess right. Likewise, while millions of people lose their small properties by thriftlessness, the more rapid impoverishment comes from guessing wrong. This will often turn a rich man into a poor man within a few years and sometimes within a few days.

It should also be noted, especially when the element of uncertainty is taken into account, that borrowing may be the means of gaining great wealth quite as well as of Edition: current; Page: [337] losing it. The business borrower who borrows in order to invest always hopes to gain and often succeeds beyond his expectations.

The rates of return over cost in various investment opportunities play an important rôle in both. Henry Ford and others grew rich not so much because of thrift as because they took advantage of unusual investment opportunities, in which the rates of return over cost proved to be many times the market rate of interest.

Besides thrift and luck, with their opposites, there is another factor closely associated with the process of accumulation or dissipation. This is habit. It has been noted that a person's rate of preference for present over future income, given a certain income stream, will be high or low according to the past habits of the individual. If he has been accustomed to simple and inexpensive ways, he finds it fairly easy to save and ultimately to accumulate a little property. The habits of thrift being transmitted to the next generation, by imitation or by heredity or both, result in still further accumulation. The foundations of some of the world's greatest fortunes have been based upon thrift.

Reversely, if a man has been brought up in the lap of luxury, he will have a keener desire for present enjoyment than if he had been accustomed to the simple living of the poor. The children of the rich, who have been accustomed to luxurious living and who have inherited only a fraction of their parents' means, may spend beyond their means and thus start the process of the dissipation of their family fortune. In the next generation this retrograde movement is likely to gather headway and to continue until, with the gradual subdivision of the fortune and the reluctance of the successive generations Edition: current; Page: [338] to curtail their expenses, the third or fourth generation may come to actual poverty.

The accumulation and dissipation of wealth do sometimes occur in cycles. Thrift, ability, industry and good fortune enable a few individuals to rise to wealth from the ranks of the poor. A few thousand dollars accumulated under favorable circumstances may grow to several millions in the next generation or two. Then the unfavorable effects of luxury begin, and the cycle of poverty and wealth begins anew. The old adage, "From shirt sleeves to shirt sleeves in four generations," has some basis in fact. This cyclical movement is more likely to occur in countries like the United States, where, owing to the rapidly changing conditions, there is more chance either to rise or fall in the economic scale. Wherever, as in the older countries of Europe, conditions have become fixed and less subject to changes of any kind, incomes and wealth are likely to remain relatively unchanged in the same families, generation after generation. This tendency is strengthened in England, where the customs of inheritance have helped to keep large fortunes intact in the hands of the eldest son.

We are not concerned here with creating a complete theory of personal distribution and its changes. This would include the effects of many factors other than thrift. But here we are interested simply in the rôle of interest and thrift in distribution.