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Introduction: The Problem of Interest - Eugen von Böhm-Bawerk, Capital and Interest: A Critical History of Economic Theory 
Capital and Interest: A Critical History of Economic Theory, trans. William A. Smart (London: Macmillan, 1890).
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The Problem of Interest
It is generally possible for any one who owns capital to obtain from it a permanent net income, called Interest.4
This income is distinguished by certain notable characteristics. It owes its existence to no personal activity of the capitalist, and flows in to him even where he has not moved a finger in its making. Consequently it seems in a peculiar sense to spring from capital, or, to use a very old metaphor, to be begotten of it. It may be obtained from any capital, no matter what be the kind of goods of which the capital consists: from goods that are barren as well as from those that are naturally fruitful; from perishable as well as from durable goods; from goods that can be replaced and from goods that cannot be replaced; from money as well as from commodities. And, finally, it flows in to the capitalist without ever exhausting the capital from which it comes, and therefore without any necessary limit to its continuance. It is, if one may use such an expression about mundane things, capable of an everlasting life.
Thus it is that the phenomenon of interest, as a whole, presents the remarkable picture of a lifeless thing producing an everlasting and inexhaustible supply of goods. And this remarkable phenomenon appears in economic life with such perfect regularity that the very conception of capital has not infrequently been based on it.5
Whence, and why does the capitalist, without personally exerting himself, obtain this endless flow of wealth?
These words contain the theoretical problem of interest. When the actual facts of the relation between interest and capital, with all its essential characteristics, are described and fully explained, that problem will be solved. But the explanation must be complete both in compass and in depth. In compass, inasmuch as all forms and varieties of interest must be explained. In depth, inasmuch as the explanation must be carried without a break to the very limits of economical research: in other words, to those final, simple, and acknowledged facts with which economical explanation ends; those facts which economics rests on, but does not profess to prove; facts the explanation of which falls to the related sciences, particularly to psychology and natural science.
From the theoretical problem of interest must be carefully distinguished the social and political problem. The theoretical problem asks why there is interest on capital. The social and political problem asks whether there should be interest on capital—whether it is just, fair, useful, good,—and whether it should be retained, modified, or abolished. While the theoretical problem deals exclusively with the causes of interest, the social and political problem deals principally with its effects. And while the theoretical problem is only concerned about the true, the social and political problem devotes its attention first and foremost to the practical and the expedient.
As distinct as the nature of the two problems is the character of the arguments that are used by each of them, and the strictness with which the arguments are used. In the one case the argument is concerned with truth or falsehood, while in the other it is concerned for the most part with expediency. To the question as to the causes of interest there can be only one answer, and its truth every one must recognise if the laws of thought are correctly applied. But whether interest is just, fair, and useful or not, necessarily remains to a great extent a matter of opinion. The most cogent argumentation on this point, though it may convince many who thought otherwise, will never convert all. Suppose, for instance, that by the soundest of reasoning it was shown to be probable that the abolition of interest would be immediately followed by a decline in the material welfare of the race, that argument will have no weight with the man who measures by a standard of his own, and counts material welfare a thing of no great importance—perhaps for the reason that earthly life is but a short moment in comparison with eternity, and because the material wealth that interest ministers to will rather hinder than help man in attaining his eternal destiny.
Prudence urgently demands that the two problems which are so fundamentally distinct should be kept sharply apart in scientific investigation. It cannot be denied that they stand in close relation with each other. Indeed it appears to me that there is no better way of coming to a correct decision on the question whether interest be a good thing, than by getting a proper knowledge of the causes which give rise to it. But we must remember that this connection only entitles us to bring together the results; it does not justify us in confusing the investigations.
Confusing these investigations will, in fact, endanger the correct solution of either problem, and that on several grounds. In the social and political question there naturally come into play all sorts of wishes, inclinations, and passions. If both problems are attempted at the same time, these will find entrance only too easily into the theoretical part of the inquiry, and there, in virtue of the real importance they have in their proper place, weigh down one of the scales—perhaps that very one which would have remained the lighter if nothing but grounds of reason had been put in the balance. What one wishes to believe, says an old and true proverb, that one easily believes. And if our judgment on the theoretical interest problem is perverted, it will naturally react and prejudice our judgment on the practical and political question.
Considerations like these show that there is constant danger that an unjustifiable use may be made of arguments in themselves justifiable. The man who confuses the two problems, or perhaps mistakes the one for the other, and, looking at the matter in this way, forms one opinion upon both, will be apt to confuse the two groups of arguments also, and allow each of them an influence on his total judgment. He will let his judgment as to the causes of the phenomenon of interest be guided, to some extent, by principles of expediency—which is wholly and entirely bad; and he will let his judgment as to the advantages of interest as an institution be, to some extent, directly guided by purely theoretical considerations—which, at least, may be bad. In the case, e.g. where the two problems are mixed up, it might easily happen that one who sees that the existence of interest is attended by an increased return in the national production, will be disposed to agree with a theory which finds the cause of interest in a productive power of capital. Or it may happen that one comes to the theoretical conclusion that interest has its origin in the exploitation of the labourer, made possible by the relations of competition between labour and capital; and on that account he may, without more ado, condemn the institution of interest, and advocate its abolition. The one is as illogical as the other. Whether the existence of interest be attended by results that are useful or harmful to the economical production of a people, has absolutely nothing to do with the question why interest exists; and our knowledge of the source from which interest springs, in itself gives us no ground whatever for deciding whether interest should be retained or abolished. Whatever be the source from which interest comes—even if that source be a trifle muddy—we have no right to decide for its abolition unless on the ground that the real interests of the people would be advanced thereby.
In economical treatment this separation of the two distinct problems, which prudence suggests, has been neglected by many writers. But although this neglect has been the source of many errors, misunderstandings, and prejudices, we can scarcely complain of it, since it is the practical problem of interest that has brought the theoretical problem and its scientific treatment to the front. Through the merging of the two problems into one, it is true, the theoretical problem has of necessity been worked at under circumstances which were not favourable for the discovery of truth. But without this merging very many able writers would not have worked at it at all. It is all the more important that we profit in the future by such experiences of the past.
The intentionally limited task to which I intend to devote myself in the following pages is that of writing a critical history of the theoretical problem of interest. I shall endeavour to set down in their historical development the scientific efforts made to discover the nature and origin of interest, and to submit to critical examination the various views which have been taken of it. As to opinions whether interest is just, useful, and commendable, I shall only include them in my statement so far as that is indispensable for getting at the theoretical substance that they contain.
Notwithstanding this limitation of subject, there will be no lack of material for a critical history, either as regards the historical or as regards the critical part. A whole literature has been written on the subject of interest, and a literature which, in mere amount, is equalled by few of the departments of political economy, and by none in the variety of opinion it presents. Not one, nor two, nor three, but a round dozen of interest theories testify to the zeal with which economists have devoted themselves to the investigation of this remarkable problem.
Whether these exertions were quite as successful as they were zealous may with some reason be doubted. The fact is that, of the numerous views advanced as to the nature and origin of interest, no single one was able to obtain undivided assent. Each of them, as might be expected, had its circle of adherents, larger or smaller, who gave it the faith of full conviction. But each of them omitted considerations enough to prevent its being accepted as a completely satisfactory theory. Still even those theories which could only unite weak minorities on their side showed themselves tenacious enough to resist extinction. And thus the present position of the theory exhibits a motley collection of the most conflicting opinions, no one of them strong enough to conquer, and no one of them willing to admit defeat; the very number of them indicating to the impartial mind what a mass of error they must contain.
I venture to hope that the following pages may bring these scattered theories a little nearer to a point.
Before I can apply myself to my proper task I must come to an understanding with my readers as to some conceptions and distinctions which we shall have to make frequent use of in the sequel.
Of the many meanings which, in the unfortunate and incongruous terminology of our science, have been given to the word Capital, I shall confine myself, in the course of this critical inquiry, to that in which capital signifies a complex of produced means of acquisition—that is, a complex of goods that originate in a previous process of production, and are destined, not for immediate consumption, but to serve as means of acquiring further goods. Objects of immediate consumption, then, and land (as not produced) stand outside our conception of capital.
I shall only justify my preference for this definition meantime on two grounds of expediency. Firstly, by adopting it a certain harmony will be maintained, so far, at least, as terminology is concerned, with the majority of those writers whose views we shall have to state; and secondly, this limitation of the conception of capital defines also most correctly the limits of the problem with which we mean to deal. It does not fall within our province to go into the theory of land rent. We have only to give the theoretical explanation of that acquisition of wealth which is derived from different complexes of goods, exclusive of land. The more complete development of the conception of capital I reserve for a future occasion.6
Within this general conception of capital, further, there are two well-known shades of difference that require to be noted. There is the National conception of capital, which embraces the national means of economic acquisition, and only these; and there is the Individual conception of capital, which includes everything that is a means to economic acquisition in the hands of an individual—that is to say, those goods by means of which an individual obtains wealth for himself, no matter whether the goods are, from the point of view of the national economy, means of acquisition or means of enjoyment, goods for production or goods for consumption. Thus, e.g. the books of a circulating library will fall under the individual conception of capital, but not under the national conception. The national conception, if we except those few objects of immediate consumption lent at interest to other countries, includes merely the produced means of production belonging to a country. In what follows we shall chiefly be concerned with the national conception of capital, and shall, as a rule, keep this before us when the word capital by itself is used.
The income that flows from capital, sometimes called in German Rent of Capital, we shall simply call Interest.7
Interest makes its appearance in many different forms.
First of all, we must distinguish between Gross interest and Net interest. The expression gross interest covers a great many heterogeneous kinds of revenue, which only outwardly form a whole. It is the same thing as the gross return to the employment of capital; and this gross return usually includes, besides the true interest, such things as part replacement of the substance of capital expended, compensation for all sorts of current costs, outlay on repairs, premiums for risk, and so on. Thus the Hire or Rent which an owner receives for the letting of a house is a Gross interest; and if we wish to ascertain what we may call the true income of capital contained in it, we must deduct a certain proportion for the running costs of upkeep, and for the rebuilding of the house at such time as it falls into decay. Net interest, on the other hand, is just this true income of capital which appears after these heterogeneous elements are deducted from gross interest. It is the explanation of Net interest with which the theory of interest naturally has to do.
Next, a distinction must be drawn between Natural interest and Contract or Loan interest. In the hands of one who employs capital in production, the utility of his capital appears in the fact that the total product obtained by the assistance of the capital possesses, as a rule, a higher value than the total cost of the goods expended in the course of production. The excess of value constitutes the Profit of capital, or, as we shall call it, Natural interest.
The owner of capital, however, frequently prefers to give up the chance of obtaining this natural interest, and to hand over the temporary use of the capital to another man against a fixed compensation. This compensation bears different names in common speech. It is called Hire, and sometimes Rent (in German Miethzins and Pachtzins) when the capital handed over consists of durable or lasting goods. It is generally called Interest when the capital consists of perishable or fungible goods.8 All these kinds of compensation, however, may be appropriately grouped under the name of Contract interest or Loan interest.
While, however, the conception of Loan interest is exceedingly simple, that of Natural interest requires more close definition.
It may with reason appear questionable if the entire profit realised by an undertaker from a process of production should be put to the account of his capital.9 Undoubtedly it should not be so where the undertaker has at the same time occupied the position of a worker in his own undertaking. Here there is no doubt that one part of the "profit" is simply the undertaker's wage for the work he has done. But even where he does not personally take part in the carrying out of the production, he yet contributes a certain amount of personal trouble in the shape of intellectual superintendence—say, in planning the business, or, at the least, in the act of will by which he devotes his means of production to a definite undertaking. The question now is whether, in view of this, we should not distinguish two quotas in the total sum of profit realised by the undertaking; one quota to be considered as result of the capital contributed, a second quota to be considered as result of the undertaker's exertion.
On this point opinions are divided. Most economists draw some such distinction. From the total profit obtained by the productive undertaking they regard one part as profit of capital, another as undertaker's profit. Of course it cannot be determined with mathematical exactitude, in each individual case, how much has been contributed to the making of the total profit by the objective factor, the capital, and how much by the personal factor, the undertaker's activity. Nevertheless we borrow a scale from outside, and divide off the two shares arithmetically. We find what in other circumstances a capital of definite amount generally yields. That is shown most simply by the usual rate of interest obtainable for a perfectly safe loan of capital. Then, of the total profit from the undertaking, that amount which would be enough to pay the usual rate of interest on the capital invested in it, is put down to capital, while the remainder is put to the account of the undertaker's activity as the profit of undertaking. For instance, if an undertaking in which a capital of £100,000 is invested yields an annual profit of £9000, and if the customary rate of interest is 5 per cent, then £5000 will be considered as profit on capital, and the remaining £4000 as undertaker's profit.
On the other hand, there are many, especially among the younger economists, who hold that such a division is inadmissible, and that the so-called undertaker's profit is homogeneous with the profit on capital.10
This discussion forms the subject of an independent problem of no little difficulty—the problem of Undertaker's Profit. The difficulties, however, which surround our special subject, the problem of interest, are so considerable that I do not feel it my duty to add to them by taking up another. I purposely refrain then from entering on any investigation, or giving any decision as to the problem of undertaker's profit. I shall only treat that as interest which everybody recognises to be interest—that is to say, the whole of contract interest,11 and, of the "natural" profit of undertaking only so much as represents the rate of interest usually obtainable for capital employed in undertaking. The question whether the so-called undertaker's profit is a profit on capital or not I purposely leave open. Happily the circumstances are such that I can do so without prejudice to our investigation; for at the worst it is just those phenomena which we all recognise as interest that constitute the great majority, and contain the characteristic substance of the general interest problem. Thus we can investigate with certainty into the nature and origin of the phenomenon of interest without requiring to decide beforehand on the exact boundary-line between the two profits.
I need scarcely say that, in these scanty remarks, I do not suppose myself to have given an exhaustive, or even a perfectly correct statement of the principles of the theory of capital. All that I have attempted to do is to lay down as briefly as possible a useful and certain terminology, on the basis of which we may have a common understanding in the critical and historical part of this work.
[4.]Many German economists use the word Kapitalrente as well as Kapitalzins. Sanders defines Rente as "Einkünfte die man als Nutzung voll Grundstücken, Kapitalien, and Rechten bezieht." So Littré gives Rente as "Revenu annuel." The word occurs in Chaucer as equivalent of income:—
[5.]Thus Hermann in his Staatswirthschaftliche Untersuchungen, p. 211, defines capital as "Vermögen, das seine Nutzung, wie ein immer neues Gut, fortdauernd dem Bedürfniss darbietet, ohne an seinem Tauschwerth abzunehmen."
[6.]A promise now fulfilled by the publication of the Positive Theorie des Kapitales, Innsbruck, 1889.—W. S.
[7.]Kapitalzins. The word "Interest" in English does not require any addition.—W. S.
[8.]"Es heisst Mieth-oder Pachtzins, wenn das überlassene Kapital aus dauerbaren Gütern bestand. Es heisst Zinsen oder Interessen, wenn das Kapital aus verbrauchlichen oder vertretbaren Gütern bestand." I have translated the passage to suit our English usage of the words. The adjective "vertretbar" (for which the legal "fungible" is the only equivalent) indicates that the thing lent is not itself given back, but another of the same kind. Grain and money are the typical fungibles.—W. S.
[9.]I think it advisable to translate Unternehmer and Unternehmung throughout by Undertaker and Undertaking. Rowland Hill, when he adapted Greensleaves to a psalm, said he did not see why the devil should have all the good tunes. Neither, in my opinion, should our science any longer deny itself these useful words, introduced by Adam Smith himself, simply because they are usually confined with us to one special branch of industry.—W. S.
[10.]On the whole question see Pierstorff, Die Lehre vom Unternehmergewinn Berlin, 1875.
[11.]Of course only so far as it is net interest.