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The Functions of the Capitalist

( Originally Published Early 1900's )

THERE remains to be considered the effect of investing money in the increase of capital. In the popular mind, one who invests his money is supposed not to expend it. Hence it might be supposed that the effect of the investment of money would be that described in Chapter VII., through the money being withdrawn from circulation. But we now know this opinion to be erroneous. Investing money consists in transfer-ring its ownership to some other person, and receiving in return a right of property in capital of some kind. This will be already clear to the student who has carefully studied the chapter on capital in the second book. The person investing is simply a purchaser of bonds, stocks, or material capital; and if he buys bonds or stocks, he becomes the owner of certain rights in some form of material capital.

Although there may be many transfers of the money thus invested before it finally reaches the hands of laborers, yet it will as a rule ultimately reach them. Suppose, for example, that a person A loans a sum of money x to a friend. Then the friend has x dollars more and A has x dollars less than before, so that the sum total of their power to employ labor remains unchanged. Let the friend purchase bonds from a banker with the money. Then the power of employing w dollars' worth of labor passes to the banker. The money serves the banker no useful purpose until he passes it to some one else, perhaps a customer. Every one into whose hands it falls must be paying or losing interest on it while he keeps it, and he can-not gain the interest until he purchases an ownership in some form of actual capital.

As a general rule it will not pass through many hands until it is employed in hiring laborers to build a house or factory, or to do some other kind of work necessary to the increase of capital. Hence, so far as the employment of labor is concerned, expenditure by investment gives the same kind of employment as any other kind of expenditure, and thus forms no exception to the rule laid down. But if we consider the ulterior effects of this mode of expenditure as compared with that of purchasing commodities for one's own consumption, we shall find that, although the immediate effect is the same, the ultimate effect upon the prosperity of society is very different. The effects may in fact be divided into primary and secondary. The primary effect is that already pointed out in showing that the expenditure does not increase or diminish the sum total of the demand for labor, but only determines into which one of a great number of possible directions the labor shall be directed. The secondary effect is to increase and cheapen the production of sustenance, and thus to diminish its cost to the community and to laborers in general. This secondary effect is produced in so indirect a manner that we must view the process through which it arises from different points of view.

We begin with an example of a special case which will illustrate the theory. Let us suppose that a person, by living in the most economical manner possible, could save $3000 per annum out of his income. He then has his choice of two modes of proceeding :

Firstly, not desiring to live so frugally, he spends his whole income in sustenance for himself. That is instead of living frugally, he demands fine furniture and carpets for his house, books for his library, pictures, jewelry, extra fine clothing, horses and carriages for himself, to the total amount of $3000 per annum.

Secondly, he may abstain from the enjoyment of these luxuries and expend the income thus saved in building houses for rent.

In changing from the former mode of expenditure to the latter he will, as already shown, be diverting a certain amount of the producing power of the country from the work of producing furniture, books, clothing, horses and carriages for him to the work of building houses for him. So far the account is balanced, and the change is neither better nor worse for society at large. It is the same if, after each house is built, he occupies it with his own family, or uses it in any way for his own exclusive benefit. The only change is that society is supplying him with houses for his own use instead of supplying him with the luxuries already described.

But suppose that after each house is built he regards it as an investment of capital and offers it for rent. Then the conditions are altered. Society at large, or the particular class of society which can afford to live in the kind of a house he has built, will have a larger supply of houses at its disposal. The tenants will each be in the enjoyment of a house which they could not afford to build. Leaving out of account the rent they pay, the state of things is the same as if the saver had voluntarily abstained from luxuries in order that these tenants might have houses.

Since, however, the tenants pay rent at the highest market rate, the question may arise whether this rent is not in every way an equivalent for the benefit rendered by the house, so that after all society at large is no better off on account of the second mode of expenditure. The reply should be in the negative. Society is better off because of the additional supply of houses and the consequent lowering of rents. Although the market value of the services rendered and received balance each other, yet the total utilities do not balance. Each tenant enjoys . a complete house without having had to save anything to build it. Could they have had no house until they had built them themselves, they would have been obliged to go for several years almost without shelter.

Suppose that the man, being of a penurious disposition, expends all the rent he receives from his house in building still more houses. It is clear that so long as that process continues the advantage to the tenants continually increases. They all have to pay rent, but that rent is expended in building new houses for more tenants; and so long as the owner himself abstains from any enjoyment of the income, so long do tenants get the entire benefit both of the houses and of the rents.

Let us inquire more closely into the exact nature of the benefit which this investor in houses has conferred. It is plain that, whatever the number of houses he has built by his saving, that additional number have the tenants of the country to live in. The supply being thus enlarged, it is to be expected that the rents will be lower in about the saine proportion, so that the entire body of tenants get more houses for the same sum total of rent. That is, the competition of land-lords lowers rents just as an increased supply of a commodity lowers its price.

But there is one essential difference between this competition and that in the manufacture and sale of commodities. In the latter case there is a certain net cost of production below which no amount of competition can permanently de-press the price. But what the tenant pays rent for is only the use of the house, not its ownership, and the owner makes this use available to him through abstinence, which does not cost money at all. Now, there is no necessary limit to the possible practice of abstinence, and so no necessary limit to a possible fall of house-rents through the competition of capitalists.

To consider the subject in a more general way, let us suppose that nobody saved any money for investment, but that every person in the community expended his entire income in providing for the immediate wants of himself and his family. Then there could be no increase in the, capital of the country. For example, no railway can be built unless certain per-sons feed the laborers who are engaged in building it; and in order to do this it is absolutely necessary that some one should have saved up money or sustenance which he does not want himself. This would not cause any positive loss in a community which did not increase in population, and which was content to remain stationary in its consumption of commodities. That is to say, if all the railways, farms, factories, fences, and other forms of capital, and the whole supply of raw material employed in production, are kept up to their present standard, while population remains the same, the wants of the stationary population will continue to be supplied as well as ever, but no better.

If, however, the owner of a railway should allow the rails to rust out without having saved the funds to replace them, and if the same thing should happen to the other fixed capital of the country, there would be a positive diminution of capital with-out, apparently, any one ceasing to live on his income. But this would amount to the same thing as expending not only one's current income, but also the capital he had before accumulated. In order to keep up his capital the owner must save enough from his income to make good its wear and tear. If he does this and nothing more, he will still be expending his entire income.

Suppose that under these circumstances population increases. Without any new railways, factories, fences, and farms there can be no increase in the production of commodities; or, at least, the increase will not be proportional to that of the labor which would now be available. The result would be a general scarcity and higher prices. Men would be compelled to seek out new farms ; but since, by hypothesis, no one has any money to loan them, they must supply their own wants as best they can while cultivating the farms. Since no new railways are built, the farther they go from the railways the farther they will have to haul their produce to market. Since no more clothing can be made, every one would have to go with a continually diminishing amount of clothes. The result would be scarcity, distress, and perhaps famine, continually increasing from year to year.

Of course the same result would happen yet more rapidly if the owners of capital not only failed to add to their savings, but suffered the capital which they already possessed to go to decay. After the rails are rusted out no more freight can be drawn over the road; after the machinery is worn out no more goods can be made until it is replaced.

Now, the fact is that a large majority of persons in every community do act in precisely this way. They do not save any part of their income to be invested in capital. In fact, our typical idea of a laborer is that of one who has never saved anything from his earnings, while by a capitalist we mean a man who has saved money from his income and employed it in hiring laborers to improve the capital of the country. A large majority of laborers, even if they were placed in possession of capital, would probably employ it in satisfying their current wants. Hence if there were no capitalists there would be a continual increase of misery, want, and starvation which would go on unceasingly with the increase of population.

The same thing may be seen in another light from the communistic point of view (Part II., Chapter IX.). Referring to the conception of a national reservoir of wealth, it is evident that the less sustenance any one draws from this reservoir the more will be left for others. Now, a non-capitalist is a person who withdraws from the reservoir in the form of sustenance everything to which his services entitle him; that is, his whole income. The capitalist is one who does not withdraw. all this sustenance. He leaves in the reservoir that portion of his share to which his investment would entitle him, and, in-stead of taking the sustenance, becomes the owner of capital designed to increase the production of sustenance. Let us call A that part of his income which the capitalist expends for sustenance, and B that part which he invests in capital, say railway stock and machinery.

If he consumed this railway and machinery to supply his own wants, then, so far as the interests of society are concerned, he might as well have taken the portion B in sustenance at once. But he cannot consume any considerable part of his railways, machinery, or other form of capital in the supply of his own needs. The palace-car in which a railway president sometimes travels is indeed a product of the capital of the railway consumed as sustenance. But it is a very small fraction of the earnings of the road. The great function of the road is to produce sustenance and bring it to the reservoir for use by the public.

But the reader must guard against a misunderstanding. We have apparently shown that the capitalist not only leaves his share of sustenance for others to consume, but also the whole product of his capital. But this would be a misinterpretation. It is true that if we suppose the sustenance which he declines to take to have been previously brought into the reservoir, this would be true so far as that particular fund of sustenance is concerned. But he cannot get his capital without employing labor to produce it. So he says to the laborer, "Instead of producing sustenance for me to consume, produce capital for me to use in further production." Hence, in the very act of refusing his sustenance, he withdraws a corresponding amount of labor from the production of sustenance and devotes it to the production of railways, mills, or other forms of capital. Less sustenance and more capital is produced. But do not forget that this diminution of sustenance does not come out of the share of others, but is only the capitalist's own share which he has refused to order.

As already shown, he cannot get any use of his capital except by making sustenance with it. Moreover, if his investment is a profitable one, the amount of sustenance thus made must be greater than that which he refused to consume. Since capital is really a labor-saving contrivance, we must expect that this will always be the case except when bad investments are made.

The question may now be asked, Since all this extra sustenance which he receives as profit belongs to him, in what way is society benefited? The reply is this: By hypothesis, it is sustenance which, although he owns, he does not himself want to consume. If he had wanted to consume it, he would have consumed it in the first place and never purchased his capital at all. Since, then, he necessarily offers this increased supply of sustenance in the public markets for sale, the result is a fall in the price of sustenance generally, arising from a more plentiful supply at the command of the community. Thus we reach the very same result that we did by the former reasoning in the case of houses, the enjoyment of houses being equivalent to the consumption of sustenance.

Let us observe, in illustration of all this, the actual process as we see it going on. A barrel of flour can now be transported from Chicago to New York for about fifty cents. Thus at an insignificant cost the whole population of New York can draw their food from the Western prairies. This would have been impossible unless railways had been built. The railways would never have been built if the Vanderbilts and other wealthy men had not saved up their income and employed it in building railways.

A clear understanding of this intricate subject is so important to one desiring a complete command of it that we shall go over it in yet another way. From what has been said in the preceding chapters it will be seen that the monetary flow to a person whom we call an agent is divisible into two portions, the one irncome, over the expenditure of which he has complete command, and the other business expenses, over which although formally he may have equal command, yet, practically, which he is obliged to expend in the ways deter-mined by the condition of his business. With this latter portion we have at present nothing to do, being concerned only with his expenditure of income.

In relation to his income we may regard him either as producer or consumer. As a producer his income is the money value of his contributions to the wants of others. These contributions may be in the form either of capital or of sustenance, but they are determined immediately by the demands of others for his products, coupled, of course, with his own talents. In other words, if he made shoes rather than clothes, it was not because he thought shoes a better thing to make than clothes, but because he found, or thought he would find, people wanting shoes rather than clothes. In whatever branch of business activity he engaged, we may assume that he chose it on account of the wishes of others rather than of him-self. Hence he is not to be considered responsible for the direction of his producing activities.

But when we consider him as a consumer of commodities or expender of income the case is reversed. He holds in his hands the power of directing an amount of industry represented by his income. He thus becomes a power determining what he shall demand from society; and the question which arises is whether society has any more interest in his demanding one thing than another (cf. Chapter VI.).

From what has been said it will be seen that there are two ways of making this demand. The agent may either purchase something already made, or he may hire laborers to make it. But it has already been shown that these two methods lead substantially to the same result. It is true that in the first case he does not immediately direct any industry at all, since all he does is to purchase from some seller, X, a commodity, C, already made. But in the very act of paying for C he places in X's hands both the power and the disposition to reproduce C in the future by re-employing labor if necessary. Hence, whether he purchases C or employs a laborer to make C, he directs a certain amount of labor to that production in the very act of expending his income.

The only question which we have left is whether the commodity C which the agent demands is sustenance for himself or' capital. The capital may be sustenance for sale to some one else. If he demands sustenance for himself, then his account with society is balanced; he simply consumes the equivalent of his income, that is, of his contributions to the sustenance or capital of others. But if he demands any form of fixed capital, then, until that capital produces something for some one else to enjoy, society at large is in exactly the same condition as if he had demanded sustenance for himself. The changed condition of things arises when that capital begins to produce sustenance which is offered for sale. If we suppose the agent's demand for capital to have included everything necessary to make the capital effective, which of course we must do, then it would have comprised not only fixed capital, but raw material to be manufactured, and sustenance for the laborers employed in the manufacture. To make the matter clear, we may divide his investment into three parts :

F, that part expended in fixed capital ; C, that part expended in raw material for manufacture ; W, that part expended in the payment of wages.

Each of these items represents a fund of labor which he could have required to be devoted to sustenance for him-self.

The portion W represents that portion of the fund of sustenance which he owns and commands, but the right to which he delivers over to the laborers in exchange for other work. Thus the laborers enjoy a certain amount W of sustenance which would otherwise have been consumed by the agent.

The machinery now goes to work ; the raw material is manufactured into some finished product, sustenance or capital, and the result is that an increased product is for sale to society, thus resulting in competition and a reduction of prices.

Let us now consider whether the laborer, that is, the non-capitalist, really has, through the saving of the capitalist, an opportunity to consume a greater value than he produces. Taking the case just as it stands, our answer must be in the negative. Suppose the capitalist to have allowed the tenant to live in his house for a whole year free of rent, except such amount as might be necessary to keep the house in its original condition. Then when the tenant restored the house to the owner at the end of the year, it would be in the same condition as when he took it. He would therefore have consumed nothing more than he reproduced by keeping up the repairs. Hence whatever portion of the rent he pays as interest on the capital invested is over and above his actual consumption of the house. It might therefore seem that he gets no equivalent for that portion of the rent which he pays for interest on capital.

This is the same stumbling-block that we have already de-scribed in the chapter on the rate of interest. It is very evident that the capitalist has given him during the whole year the use and shelter of a house which would never have existed but , for the capitalist's savings. Now, it is this use which measures the benefit conferred, and not the consumption of the house. Perhaps in thirty years the tenant could have saved money enough to build the house himself, but he must have the house now ; and the benefit rendered consists in the capitalist letting him have now what, by his own exertions, he would not have had for thirty years. But it still follows that he must, at the end of his tenancy, return the house in as good order as when he got it, besides paying interest on the capital invested in it.

Returning, then, to our original question, we find it to be really true that the capitalist does not allow the laborer to consume more than he produces. But we must remember that he produces more than he would have produced without capital. Capital, skill, and organization are the great labor-saving agents. The more they improve the more productive labor becomes. Now, the laws of supply and demand permit the laborer to command his full share of this improvement although it was effected by the mental powers of a much higher class of men.

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