XIX. INTEREST: Originary Interest
XIX. INTEREST
2. Originary Interest
Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value
assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the
discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself. There
prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the
evenly rotating economy the rate of originary interest is the same for all commodities.
Originary interest is not "the price paid for the services of capital."[1] The higher
productivity of more time-consuming roundabout methods of production which is referred to by Bohm-Bawerk and by some
later economists in the explanation of interest, does not explain the phenomenon. It is, on the contrary, the
phenomenon of originary interest that explains why less time-consuming methods of production are resorted to in spite
of the fact that more time-consuming methods would render a higher output per unit of input. Moreover, the phenomenon
of originary interest explains why pieces of usable land can be sold and bought at finite prices. If the future
services which a piece of land can render were to be valued in the same way in which its present services are valued,
no finite price would be high enough to impel its owner to sell it. Land could neither be bought nor sold against
definite amounts of money, nor bartered against goods which can render only a finite number of services. Pieces of land
would be bartered only against other pieces of land. A superstructure that can yield during a period of ten years an
annual revenue of one hundred dollars would be priced (apart from the soil on which it is built) at the beginning of
the second year at none hundred dollars, and so on.
Originary interest is not a price determined on the market by the [p. 527] interplay of
the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and
supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and
capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate
future and how much to provision for remoter periods of the future.
People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor
the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual
valuation of present goods as against future goods.
The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of
originary interest as manifested in the discount of future goods.
Originary interest is a category of human action. It is operative in any valuation of external things and can never
disappear. If one day the state of affairs were to return which was actual at the close of the first millennium of the
Christian era when some people believed that the ultimate end of all earthly things was impending, men would stop
providing for future secular wants. The factors of production would in their eyes become useless and worthless. The
discount of future goods as against present goods would not vanish. It would, on the contrary, increase beyond all
measure. On the other hand, the fading away of originary interest would mean that people do not care at all for
want-satisfaction in nearer periods of the future. It would mean that they prefer to an apple available today,
tomorrow, in one year or in ten years, tow apples available in a thousand or ten thousand years.
We cannot even think of a world in which originary interest would not exist as an inexorable element in every kind
of action. Whether there is or is not division of labor and social cooperation and whether there is or is not division
of labor and social cooperation and whether society is organized on the basis of private or of public control of the
means of production, originary interest is always present. In a socialist commonwealth its role would not differ from
that in the market economy.
Bohm-Bawerk has once for all unmasked the fallacies of the naive productivity explanations of interest, i.e., of the
idea that interest is the expression of the physical productivity of factors of production. However, Bohm-Bawerk has
himself based his own theory to some extent on the productivity approach. In referring in his explanation to the
technological superiority of more time-consuming, roundabout processes of production, he avoids the crudity of the
naive productivity [p. 528] fallacies. But in fact he returns, although in a subtler form,
to the productivity approach. Those later economists who, neglecting the time-preference idea, have stressed
exclusively the productivity idea contained in Bohm-Bawerk's theory cannot help concluding that originary interest must
disappear if men were one day to reach a state of affairs in which no further lengthening of the period of production
could bring about a further increase in productivity.[2] This is, however, utterly wrong. Originary
interest cannot disappear as long as there is scarcity and therefore action.
As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and
economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because
neither for the former nor for the latter can full contentment be attained. Then a change in the employment of factors
of production which withdraws such factors from their employment for want-satisfaction in the remoter future must
necessarily impair the state of satisfaction in the nearer future and improve it in the remoter future. If we were to
assume that this is not the case, wi should become embroiled in insoluble contradictions. We may at best think of a
state of affairs in which technological knowledge and skill have reached a point beyond which no further progress is
possible for mortal men. No new processes increasing the output per unit of input can henceforth be invented. But if we
suppose that some factors of production are scarce, we must not assume that all processes which-apart from the time
they absorb--are the most productive ones are fully utilized, and that no process rendering a smaller output per unit
of input is resorted to merely because of the fact that it produces its final result sooner than other, physically more
productive processes. Scarcity of factors of production means that we are in a position to draft plans for the
improvement of our well-being the realization of which is unfeasible because of the insufficient quantity of the means
available. It is precisely the unfeasibility of such desirable improvements that constitutes the element of scarcity.
The reasoning of the modern supporters of the productivity approach is misled by the connotations of Bohm-Bawerk's term
roundabout methods of production and the idea of
[p. 529] technological improvement which it suggests. However, if there is scarcity, there
must always be an unused technological opportunity to improve the state of well-being by a lengthening of the period
of production in some branches of industry, regardless of whether of not the state of technological knowledge has
changed. If the means are scarce, if the praxeological correlation of ends and means still exists, there are by
logical necessity unsatisfied wants with regard both to nearer and to remoter periods of the future. There are
always goods the procurement of which we must forego because the way that leads to their production is too long and
would prevent us from satisfying more urgent needs. The fact that we do not provide more amply for the future is the
outcome of a weighing of satisfaction in nearer periods of the future against satisfaction in remoter periods of the
future. The ratio which is the outcome of this valuation is originary interest.
In such a world of perfect technological knowledge a promoter drafts a plan A according to which a hotel in
picturesque, but not easily accessible, mountain districts and the roads leading to it should be built. In examining
the practicability of this plan he discovers that the means available are not sufficient for its execution. Calculating
the prospects of the profitability of the investment, he comes to the conclusion that the expected proceeds are not
great enough to cover the costs of material and labor to be expended and interest on the capital to be invested. He
renounces the execution of project A and embarks instead upon the realization of another plan, B.
According to plan B the hotel is to be erected in a more easily accessible location which does not offer all
the advantages of the picturesque landscape which plan A had selected, but in which it can be built either
with lower costs of construction or finished in a shorter time. If no interest on the capital invested were to enter
into the calculation, the illusion could arise that the state of the market data--supply of capital goods and the
valuations of the public--allows for the execution of plan A. However, the realization of plan A
would withdraw scarce factors of production from employments in which they could satisfy wants considered more urgent
by the consumers. It would mean a manifest malinvestment, a squandering of the means available.
A lengthening of the period of production can increase the quantity of output per unit of input or produce goods
which cannot be produced at all within a shorter period of production. But it is not true that the imputation of the
value of this additional wealth to the capital goods required for the lengthening of the period of production generates
interest. If one were to assume this, one would relapse
[p. 530] into the crassest errors of the productivity approach, irrefutably exploded by
Bohm-Bawerk. The contribution of the complementary factors of production to the result of the process is the reason
for their being considered as valuable; it explains the prices paid for them and is fully taken into account in the
determination of these prices. No residuum is left that is not accounted for and could explain interest.
It has been asserted that in the imaginary construction of the evenly rotating economy no interest would
appear.[3] However, it can be shown that this assertion is incompatible with the assumptions on
which the construction of the evenly rotating economy is based.
We begin with the distinction between two classes of saving: plain saving and capitalist saving. Plain saving is
merely the piling up of consumers' goods for later consumption. Capitalist saving is the accumulation of goods which
are designed for an improvement of production processes. The aim of plain saving is later consumption; it is merely
postponement of consumption. Sooner or later the goods accumulated will be consumed and nothing will be left. The aim
of capitalist saving is first an improvement in the productivity of effort. It accumulates capital goods which are
employed for further production and are not merely reserves for later consumption. The boom derived from capitalist
saving is the increase of the quantity of goods produced or the production of goods which could not be produced at all
without its aid. In constructing the image of an evenly rotating (static) economy, economists disregard the process of
capital accumulation; the capital goods are given and remain, as, according to the underlying assumptions, no changes
occur in the data. There is neither accumulation of new capital through saving, nor consumption of capital available
through a surplus of consumption over income, i.e., current production minus the funds required for the maintenance of
capital. It is now our task to demonstrate that these assumptions are incompatible with the idea that there is no
interest.
There is no need to dwell, in this reasoning, upon plain saving. The objective of plain saving is to provide for a
future in which the saver could possibly be less amply supplied than in the present. Yet, one of the fundamental
assumptions characterizing the imaginary construction of the evenly rotating economy is that the future does not differ
at all from the present, that the actors are fully aware of this fact
[p. 531] and act accordingly. Hence, in the frame of this construction, no room is left for
the phenomenon of plain saving.
It is different with the fruit of capitalist saving, the accumulated stock of capital goods. There is in the evenly
rotating economy neither saving and accumulation of additional capital goods nor eating up of already existing capital
goods. Both phenomena would amount to a change in the data and would thus disturb the even rotation of such an
imaginary system. Now, the magnitude of saving and capital accumulation in the past--i.e., in the period preceding the
establishment of the evenly rotating economy--was adjusted to the height of the rate of interest. If--with the
establishment of the conditions of the evenly rotating economy--the owners of the capital goods were no longer to
receive any interest, the conditions which were operative in the allocation of the available stocks of goods to the
satisfaction of wants in the various periods of the future would be upset. The altered state of affairs requires a new
allocation. Also in the evenly rotating economy the difference in the valuation of want-satisfaction in various periods
of the future cannot disappear. Also in the frame of this imaginary construction, people will assign a higher value to
an apple available today as against an apple available in ten or a hundred years. If the capitalist no longer receives
interest, the balance between satisfaction in nearer and remoter periods of the future is disarranged. The fact that a
capitalist has maintained his capital at just 100,000 dollars was conditioned by the fact that 100,000 present dollars
were equal to 105,000 dollars available twelve months later. These 5,000 dollars were in his eyes sufficient to
outweigh the advantages to be expected from an instantaneous consumption of a part of this sum. If interest payments
are eliminated, capital consumption ensues.
This is the essential deficiency of the static system as Schumpeter depicts it. It is not sufficient to assume that
the capital equipment of such a system has been accumulated in the past, that it is now available to the extent of this
previous accumulation and is henceforth unalterably maintained at this level. We must also assign in the frame of this
imaginary system a role to the operation of forces which bring about such a maintenance. If one eliminates the
capitalist's role as receiver of interest, one replaces it by the capitalist's role as consumer of capital. There is no
longer any reason why the owner of capital goods should abstain from employing them for consumption. Under the
assumptions implied in the imaginary construction of static conditions (the evenly rotating economy) there is no need
to keep them in reserve for rainy days. But even if, inconsistently enough, we
[p. 532] were to assume that a part of them is devoted to this purpose and therefore
withheld from current consumption, at least that part of capital will be consumed which corresponds to the amount
that capitalist saving exceeds plain saving.[4]
If there were no originary interest, capital goods would not be devoted to immediate consumption and capital would
not be consumed. On the contrary, under such an unthinkable and unimaginable state of affairs there would be no
consumption at all, but only saving, accumulation of capital, and investment. Not the impossible disappearance of
originary interest, but the abolition of payment of interest to the owners of capital, would result in capital
consumption. The capitalists would consume their capital goods and their capital precisely because there is originary
interest and present want-satisfaction is preferred to later satisfaction.
Therefore there cannot be any question of abolishing interest by any institutions, laws, or devices of bank
manipulation. He who wants to "abolish" interest will have to induce people to value an apple available in a hundred
years no less than a present apple. What can be abolished by laws and decrees is merely the right of the capitalists to
receive interest. But such decrees would bring about capital consumption and would very soon throw mankind back into
the original state of natural poverty.
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[1]. This is the popular definition of interest as, for instance, given by Ely, Adams,
Lorenz, and Young, Outlines of Economics (3d ed. New York, 1920), p. 493.
[2]. Cf. Hayek, "The Mythology of Capital," The Quarterly Journal of Economics,
L (1936), 223 ff. However Professor Hayek has since partly changed his point of view. (Cf. his article "Time-Preference
and Productivity, a Reconsideration," Economica, XII [1945], 22-25.) But the idea criticized in the text is
stil widely help by economists.
[3]. Cf. J. Schumpeter, The Theory of Economic Development, trans. by R. Opie
(Cambridge, 1934), pp. 34-46, 54.
[4]. Cf. Robbins, "On a Certain Ambiguity in the Conception of Stationary Equilibrium,"
The Economic Journal, XL (1930), 211 ff.