The Mechanism of Production of Capital
( Originally Published Early 1900's )
THE use and importance of capital arise from the fact that men cannot, by the direct application of their labor to the materials furnished by nature, produce those articles which they desire. For example, they cannot with their own hands make cotton into a shirt. They must have a loom to effect the transformation. The farmer cannot raise wheat without the aid of spades, ploughs, or machinery to till the ground; and after his wheat is raised he needs a mill to grind it into flour. In these cases the loom, the spade, the plough, and the mill are not de-sired for their own sake, but only because they are useful in producing objects of desire. If we continue this analysis we shall see that the wealth of the country may be divided into two portions
1. Wealth which is desired and possessed by its owner for its own sake, because it contributes directly to the gratification of the owner. Examples of such wealth are the houses in which we live, the furniture, books, and pictures which adorn our walls, the clothes we wear, the food we eat, and the coal which is to keep us warm. This kind of wealth we shall call sustenance.
2. Wealth which is desired, not for its own sake, but in order that by it we may obtain such wealth as we do desire for its own sake. Wealth desired, not for its own sake, but for the sake of the. sustenance which it will enable us to produce is called capital.
The distinction between capital and sustenance, though logically a sharp one, cannot be sharply drawn in practice. We cannot always decide without question whether any given kind of wealth is or is not capital. We shall also have to recognize the principle that wealth may possess the quality of capital in different degrees, and maybe capital or not according to its relations to its owner.
There is another definition of capital which at first sight may seem to have no relation to the one just given, but which, when we examine it more closely, we shall see to be equivalent as a consequence of human nature. It is as follows : Capital is that wealth from the enjoyment of which the owners are abstaining in order to gain a future profit.
To show how these two definitions amount to the same thing, let us take first the case of the savage who possesses no power of abstaining from present enjoyment for the sake of future good. He will not try to make any sort of machinery, because before he can get any good from the machinery lie will have to wait a long time, and he is not willing to spend his labor for any benefit to accrue only in the distant future. He would rather chase a buffalo and thus get a skin which he can put on to-morrow than undertake any labor which will not yield him good clothes until next year. If he has corn, he will pound it between two stones, because then he can enjoy the product of his labor the same day when he sits down to his evening meal. But he will not sow it to raise a crop for the next year.
Coming next to civilized men, we find that large numbers of them, even among the well-to-do classes, rarely attempt to ac-quire wealth except for its own sake. They expend all their income on house-rent, furniture, coal, food, clothing, and other things desired for their own sake. Hence they never save. But if a person wants to save up money and gain inter-est on it, he must get something which he does not want for its own sake, but for the sake of something else to be obtained in the future. We may therefore say that wealth from which the owner is abstaining for a future profit is identical with the wealth which is desired, not for its own sake, but in order by its means to obtain more wealth.
Use of the Term Sustenance. We have spoken of wealth which is desired by the owner for its own sake, and is called sustenance. The most important wealth of this kind is the food and clothing which every man must have in order to live, and the house which shelters him from the weather. In the case of the laborer who saves nothing, this is the only kind of wealth which he works for or seeks to possess.
It might at first sight appear proper to confine this term to the food, clothing, and shelter absolutely necessary to sustain the life, health, and physical vigor of the laborer. But it is well known that we cannot draw any sharp line between the necessaries and luxuries of life; nor can we draw any such line between those who are laborers and those who are not. We must therefore include in the term sustenance not only what sustains life, but everything which a person requires or can command for the purpose of unproductive consumption by himself and his family. It includes pictures, furniture and books, and indeed everything which does not produce other wealth in the act of being consumed.
Classification and Examples of Capital. Differences of opinion sometimes arise as to whether special kinds of wealth should or should not be considered capital. To reconcile these differences, we must admit that capital is in part a relative term, depending not merely upon the wealth itself, but on its relation to its owner. If it is something which the owner is not keeping for its own sake, but from the enjoyment of which he is abstaining, then it is capital so far as he is concerned, though it may not be capital when considered in relation to the person who is enjoying it. A difficult question of this sort arises in connection with dwelling-houses. When a person lives in his own house, the house is not capital. He is not abstaining from the enjoyment which the house might afford, and he is keeping the house for its own sake ; hence it is not capital. But if he rents the house to some one else, then he is abstaining from the enjoyment of it; and he is not using it for its own sake, but for the annual rent which he is receiving, or, more exactly, for the sake of the things which he may buy with the rent. Hence the house is capital in its relation to him. But it is not capital in relation to the community at large, for it is clear that houses are built for their own sake, and not to help future production. No more cloth is made and no more wheat brought to market after a house is built than before.
This leads us to say that the quality of capital considered as a relative term may be algebraically negative as well as positive. Relative to the tenant who lives in the house, the house is negative capital, because he is enjoying more wealth than he owns. The idea of capital as a mathematical quantity may be reached by the following course of thought:
Let us compare the wealth owned with the sustenance enjoyed by any person. If we subtract from the total wealth which he owns all that wealth which he employs as sustenance, or is making use of for his own enjoyment, the remain-der will, by definition, be capital, because it is that portion of his wealth from the enjoyment of which he is abstaining.
But it may happen that the individual is enjoying more sustenance than he owns. In this case the definition will re-quire us to subtract a greater quantity from a less, the result of which will be algebraically negative. This is the case with the improvident man. He has perhaps spent every cent he ever earned on objects of desire, and thus has not a dollar saved in the world; yet he may be living in a house which cost ten thou-sand dollars. Then he not only never saved anything, but he is enjoying what somebody else, namely, the owner of the house, has saved. Thus he is an algebraically negative capitalist.
The question may arise whether by limiting capital to things not wanted for their own sake we do not find that after all scarcely anything will be left except capital. For example, the barrel of flour in my pantry, it may be said, is not wanted for its own sake, but for the sake of the bread which will be made from it. One may go even farther, and inquire whether the coal in my cellar is not wanted for the sake of the heat it is to furnish, and is not therefore capital. The reply to this is that we must give a special interpretation to the first definition of. capital. We regard wealth as wanted for its own sake whenever it has reached the hands of the owner who is keeping it for his own exclusive use and is not abstaining from it for the sake of the profit to be gained thereby. Hence when the barrel of flour reaches the family who are to use it it ceases to be capital, though it is capital in the store of the grocer, be-cause he keeps it to get something else with. And, in general, all the wealth of the country which is going through the pro-cesses of manufacture, sale, and transportation may be considered capital.
Fixed and Circulating Capital. Economists divide capital into fixed and circulating. Fixed capital comprises machinery and public and private works which are . employed as agencies in production. Ploughs, fences, and working animals on a farm ; factories and the machinery which they contain ; railways with all their rolling-stock ; ships and storehouses, are examples of fixed capital.
Circulating capital consists of the money which is circulated from hand to hand in the channels of trade, the material under-going the process of manufacture, transportation and sale, and the stores of food and clothing which have not reached their consumers. Following through the process of production as we have already done, we may say that the wheat in the granary, the sheep on the prairie, their wool after it is shorn, the cotton in the factory, the cloth in the hands of the dealer, and the clothes in the clothing-store are all circulating capital.
One difference between the two capitals is that the one is a direct aid to production, while the other is not. They therefore possess the quality of capital in different degrees. A loom is a direct aid to production ; without it we could not make cloth. The plough with its team of horses is a direct aid ; with-out it the farmer would have to use a spade, which would be far less advantageous. The warehouse is such an aid because, although it does not help the production, it preserves the goods from being spoiled by the rain or carried off by thieves. Ships and locomotives are direct aids in transportation. On the other hand, the wool and the cloth are not mere aids to production, but rather the material on which the work of production is performed. They are requisites of production, but not aids to it.
We may also consider circulating capital as that a definite quantity of which is consumed in the production of a definite quantity of any commodity. Thus, to make a coat a definite quantity of cloth is required. To make one yard of cloth of a certain kind a definite amount of wool is required. This we can trace the quantity of the substance through from the be-ginning to the end of a series of productive acts. On the other hand, the needle with which the tailor sews the cloth may be lost before one coat is finished, or it may make a hundred coats without being worn out. We cannot therefore say just how many needles are consumed in making a given number of coats.
A very important part of circulating capital is the store of food, clothing, and other necessaries of life which is laid up in the country for the consumption of the population generally. In fact, from the point of view of some economists, food is to be regarded as the primitive form of all capital. For, before the primitive farmer or mechanic could have made a plough, he must have collected the food to eat while lie was making the utensil. During the process of manufacture the food disappeared and the plough appeared. We shall hereafter see that this idea materially assists us in understanding the subject by connecting labor with capital. From this point of view a pair of boots is simply a product of the following requisites
I. A certain quantity of leather, pegs, tacks, thread, wax, and other materials which went into the boot.
II. A certain amount of wear and tear of tools, rent of work-shop, etc.
III. The food which the shoemaker ate, the clothes which he wore out, and the house-rent which he paid while he was making the boots.
Since the pair of boots is the product of the consumption of this leather, furniture, workshop, house, food, and clothing, we may establish a certain equivalent between them which will assist us in further researches. The labor of the shoemaker was merely the agency which combined the three elements just enumerated into a pair of boots.
The Function of Capital. The great purpose of capital, as indicated in its definition, is of fundamental importance and should be well understood. We may state it in the terms, Capital is employed as a labor-sawing agent.
To show how this is, let us take the case of the primitive farmer who tills the ground with a spade. As his condition improves, or as the country arouud him improves, he is enabled to substitute a plough and a pair of horses for the spade. To find whether this change is advantageous we have to compare the debit and credit side of the account. The plough and horses cost money, or, which amounts to the same thing, they required that the farmer should spend a certain amount of labor in procuring them and taking care of them. This is the debit side of the ac-count. The increased land which they enabled him to cultivate, or the diminished labor with which they enabled him to cultivate his field, forms the credit side of the account. Unless the gain compensates for the labor spent in procuring the team, the latter has not paid for itself. In common language, it has been a bad investment.
Again, in making cloth : a barbarian can make a robe out of coarse material with great labor. By spending his labor in making a loom he will be enabled thereafter to make a better robe with far less labor. If he, or the community to which he belongs, is able to construct a factory and use steam or water power, a still greater saving of labor is effected. But in all cases the labor saved must more than compensate for the labor of producing the capital. Unless the person who produces the capital expects to save labor, he would have had no object in producing it.
If we look around us we will see that nature may be considered as offering to those who will save, a perpetual interest upon their savings, if they employ them judiciously. An example is seen in the case of great public works. By the expenditure of a certain sum of money in digging the Suez Canal there is a perpetual saving not only for ourselves, but for future generations, in the number of ships, the quantity of sails and coal, and the labor of sailors necessary to transport goods from Europe to the East. By digging the Panama Canal there will be a similar perpetual saving of the voyage around Cape Horn. In each case the annual interest or profits on the canal will be the excess of the saving above the cost of working the canal and keeping it in its original good condition. By tunnelling mountains a perpetual saving is made for the future in the cost of transporting goods across them. Every railway which is built diminishes the cost of transporting goods overland. Thus until men have dug every useful canal, built every necessary railway, and tunnelled every mountain which obstructs the transportation of goods from place to place, nature will offer to those who choose to save their earnings a perpetual interest upon their savings, provided they will employ them in such works.
Capital the Result of Abstinence. It is clear that, in order to effect the gain thus described, the labor of producing the capital must have been withdrawn from the production of objects of immediate enjoyment. The primitive farmer who spent all his time in spading the ground in order to obtain a bare support for his family would never save money to buy a plough and team. He must do without a certain amount of the products of his labor as a condition precedent of being able to make the improvement. He may indeed buy his capital on credit, but, apart from the difficulty that his credit may not be good, it is then necessary that some one else shall have abstained from the enjoyment of the fruits of his labor, in order to produce the plough and horses. This last illustrates the case with the vast majority of men. They are in the enjoyment of a large amount of the previous labor of other men, for which they pay a profit. Thus the profit of capital, commonly called interest, is what is paid to the capitalist, not for his labor, but for his abstinence from the enjoyment of the products of his labor, and his willingness to allow others to use his capital.
It may be asked how circulating capital can be considered either as saving labor or as resulting from abstinence, and whether if it does not save labor it does not fail to perform the essential function of capital. It is true that it does not directly operate as a labor-saving agent, but only as an absolute necessity to the progress of the work. But it is a requisite of production which is not intended for the owner's own use, and in order to procure this requisite he must expend money which he otherwise could have spent in his own enjoyment. Since he practises abstinence, and since that practice is itself something which can command money in tire public market, it follows that he must be compensated for it, and thus a profit must be paid on this investment just as it is paid on the investment of machinery in production.
Divided Ownership of Capital. The forms of capital which we have just considered include only material agencies actually employed in production. But in the Ianguage of business the word is used in what is apparently a much wider sense. Whenever men come to bankers to purchase bonds, or other credit property yielding interest, they are said to bring "capital" in order to invest it. In this case the idea is that the entity called capital is something which the owner puts into or invests in the bonds or other things which he purchases. But if we look closely into the matter we shall see that in this case the word is used to designate the money which one has saved up to pay for the bonds or stocks which he purchases.
But these bonds and stocks are also called capital. They may be government bonds, railway bonds, mortgages on real estate, or any immaterial rights by which one gains interest. We thus have two distinct meanings of the word in addition to that which we have already assigned it. This threefold use leads to a confusion which must be cleared up. In the original and proper sense of the word capital consists of nothing but wealth, namely, that wealth which is devoted to further production, or employed in such a way as to yield a profit to its owner. But we have shown that wealth may also be considered in relation to its owner, and when thus considered we have called it property. We have also shown how a given piece of wealth may have various owners who have separate kinds of rights in it, and who may transfer these rights of ownership to other persons.
Now the only difference between material capital actually employed in production and the bonds, stocks, notes, and other securities which people invest in is that the one is wealth, while the other is right of property in wealth. For the most part, the wealth to which this right pertains is material capital of some kind. Some illustrations will make this clear.
Let us first notice the relation of railway bonds to the railway itself. Such a bond is not a part of the railway, but it is a right to a certain definite income from the earnings of the rail-way. In the same way railway stock is a right of property in the railway itself and its net earnings after its debts due the bond-holders are paid. In these cases the wealth or real capital is the railway itself, while the stocks and bonds are merely the evidences of certain rights in the earnings of the railway.
Shares of stock in a company which loans money at inter-est consist in a right to receive a share of the income from the profits made upon forms of material capital, whether rail-ways, ships, or factories, which the company loaned their money to build. It is therefore property in capital, but not the capital itself.
Since the money which one has saved up to invest is properly considered a part of his wealth, we may call it capital, because he is going to buy capital with it, although it is not a direct aid to production. No confusion need arise from this extension of meaning. We now see that the word capital is used in three senses, closely associated, yet not equivalent :
I. In the economic sense, as wealth employed for further production. This may be called absolute capital.
II. To express the rights of ownership in absolute capital, which rights are secured by certain written and printed instruments called bonds, certificates, etc.
III. To indicate the money which one has saved up and which he brings into market to purchase stocks, bonds, or other property in capital.