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Chapter 6—Production: The Rate of Interest and Its Determination (continued)

5. Time Preference, Capitalists, and Individual Money Stock

     When we state that the time-preference schedules of all indi­viduals in the society determine the interest rate and the propor­tion of savings to consumption, we mean all individuals, and not some sort of separate class called “capitalists.” There is a tempta­tion, since the production structure is analyzed in terms of dif­ferent classes—landowners, laborers, and capitalists—to conclude that there are three definite stratified groups of people in society corresponding to these classifications. Actually, in economic anal­ysis of the market we are concerned with functions rather than whole persons per se. In reality, there is no special class of capital­ists set off from laborers and landowners. This is not simply due to the trite fact that even capitalists must also be consumers. It is also due to the more important fact that all consumers can be capitalists if they wish. They will be capitalists if their time-pref­erence schedules so dictate. Time-market diagrams such as shown above apply to every man, and not simply to some select group known as capitalists. The interchange of the various aggregate supply and demand diagrams throughout the entire time market sets the equilibrium rate of interest on the market. At this rate of interest, some individuals will be suppliers of present goods, some will be demanders, the curves representing the supply and demand schedules of others will be coinciding with their line of origin and they will not be in the time market at all. Those whose time-preference schedules at this rate permit them to be sup­pliers will be the savers—i.e., they will be the capitalists.

     The role of the capitalists will be clarified if we ask the ques­tion: Where did they get the money that they save and invest? First, they may have obtained it in what we might call “current” production; i.e., they could have received the money in their cur­rent capacities as laborers, landowners, and capitalists. After they receive the money, they must then decide how to allocate it among various lines of goods, and between consumption and investment. Secondly, the source of funds could have been money earned in past rounds of production and previously “hoarded,” now being “dishoarded.” We are, however, leaving out hoarding and dishoarding at this stage in the analysis. The only other source, the third source, is new money, and this too will be dis­cussed later.

     For the moment, therefore, we shall consider that the money from which savings derive could only have come from recent earnings from production. Some earnings were obtained as cap­italists, and some as owners of original factors.

     The reader might here have detected an apparent paradox: How can a laborer or a landowner be a demander of present goods, and then turn around and be a supplier of present goods for investment? This seems to be particularly puzzling since we have stated above that one cannot be a demander and a supplier of present goods at the same time, that one’s time-preference schedule may put one in one camp or the other, but not in both. The solution to this puzzle is that the two acts are not performed at the same time, even though both are performed to the same extent in their turn in the endless round of the evenly rotating economy.

     Let us reproduce the typical individual time-preference sched­ule (Figure 48). At a market interest rate of 0A, the individual would supply savings of AB; at a market interest rate of 0C, he would demand money of amount CE. Here, however, we are analyzing more carefully the horizontal axis. The point 0 is the point of origin. It is the point at which the person deliberates on his course of action, i.e., the position he is in when he is consult­ing, so to speak, his time-preference scales. Specifically, this is his position with respect to the size of his money stock at the time of origin. At point O, he has a certain money stock, and he is considering how much of his stock he is willing to give up in ex­change for future goods or how much new stock he would like to acquire while giving up future goods. Suppose that he is a saver. As the curve moves to the right, he is giving up more and more of his present money stock in exchange for future goods; therefore, his minimum interest return becomes greater. The further the curve goes to the right, then, the lower will his final money stock be. On the other hand, consider the same individual when he is a demander of present goods. As the curve proceeds to the left, he increases his stock of present goods and gives up future goods. Considering both sides of the point of origin, then, we see that the further right the curve goes, the less stock he has; the further left, the greater his stock.

     Given his time-preference schedule, therefore, he is bound to be in a greater supply position the more money he has, and in more of a demand position the less money he has. Before the laborer or landowner sells his services, he has a certain money stock—a cash balance that he apparently does not reduce below a certain minimum. After he sells his services, he acquires his money income from production, thereby adding to his money stock. He then allocates this income between consumption and savings-investment, and we are assuming no hoarding or dishoard­ing. At this point, then, when he is allocating, he is in a far dif­ferent position and at a different point in time. For now he has had a considerable addition to his money stock.

     Let us consider (Figure 49) the individual’s time-market graph with two different points of origin, i.e., two different sizes of money stock, one before he earns his income (I), and one immedi­ately after (II).

     Here we see how a laborer or a landowner can be a demander at one time, in one position of his money stock, and a supplier at another time. With very little money stock, as represented in the first diagram, he is a demander. Then, he acquires money in the productive arena, greatly increases his money stock, and therefore the point of origin of his decision to allocate his money income shifts to the left, so that he might well become a supplier out of his income. Of course, in many cases, he is still a demander or is not on the time market at all. To coin a phrase to distinguish these two positions, we may call his original condition a “pre-in­come position” (before he has sold his services for money), and the latter a “post-income position”—his situation when he is allo­cating his money income. Both points of origin are relevant to his real actions.

     We have seen above that a landowner’s pre-income demand  for money is likely to be practically inelastic, or vertical, while a laborer’s will probably be more elastic. Some individuals in a post-income position will be suppliers at the market rate of in­terest; some will be demanders; some will be neutral. The four diagrams in Figure 50 depict various pre-income and post-income time-preference situations, establishing individual time-market curves, with the same market rate of interest applied to each one.

     The line AB, across the page, is our assumed market rate of interest, equilibrated as a result of the individual time-preference scales. At this rate of interest, the landowner and the laborer (I and II) are shown with demands for present money (pre-in­come), and diagrams III and IV depict a demander at this rate and a neutral at this rate, one who is moved neither to supply nor to demand money in the time market. Both the latter are in post-­income situations.

     We conclude that any man can be a capitalist if only he wants to be. He can derive his funds solely from the fruits of previous capitalist investment or from past “hoarded” cash balances or solely from his income as a laborer or a landowner. He can, of course, derive his funds from several of these sources. The only thing that stops a man from being a capitalist is his own high time-preference scale, in other words, his stronger desire to con­sume goods in the present. Marxists and others who postulate a rigid stratification—a virtual caste structure in society—are in grave error. The same person can be at once a laborer, a land­owner, and a capitalist, in the same period of time.[26]

     It might be argued that only the “rich” can afford to be capitalists, i.e., those who have a greater amount of money stock. This argument has superficial plausibility, since from our diagrams above we saw that, for any given individual and a given time­-preference schedule, a greater money stock will lead to a greater supply of savings, and a lesser money stock to a lesser supply of savings. Ceteris paribus, the same applies to changes in money income, which constitute additions to stock. We cannot, however, assume that a man with (post-income) assets of 10,000 ounces of gold will necessarily save more than a man with 100 ounces of gold. We cannot compare time preferences interpersonally, any more than we can formulate interpersonal laws for any other type of utilities. What we can assert as an economic law for one person we cannot assert in comparing two or more persons. Each person has his own time-preference schedule, apart from the spe­cific size of his monetary stock. Each person’s time-preference schedule, as with any other element in his value scale, is entirely of his own making. All of us have heard of the proverbially thrifty French peasant, compared with the rich playboy who is always running into debt. The common-sense observation that it is generally the rich who save more may be an interesting his­torical judgment, but it furnishes us with no scientific economic law whatever, and the purpose of economic science is to furnish us with such laws. As long as a person has any money at all, and he must have some money if he participates in the market society to any extent, he can be a capitalist.

6. The Post-Income Demanders

     Up to this point we have analyzed the time-market demand for present goods by landowners and laborers, as well as the derived demand by capitalists. This aggregate demand we may call the producers’ demand for present goods on the time market. This is the demand by those who are selling their services or the services of their owned property in the advancing of produc­tion. This demand is all pre-income demand as we have defined it; i.e., it takes place prior to the acquisition of money income from the productive system. It is all in the form of selling factor services (future goods) in exchange for present money. But there is another component of net demand for present goods on the time market. This is the post-income component; it is a demand that takes place even after productive income is acquired. Clearly, this demand cannot be a productive demand, since owners of future goods used in production exercise that demand prior to their sale. It is, on the contrary, a consumers’ demand.

     This subdivision of the time market operates as follows: Jones sells 100 ounces of future money (say, one year from now) to Smith in exchange for 95 ounces of present money. This future money is not in the form of an expectation created by a factor of production; instead, it is an I.O.U. by Jones promising to pay 100 ounces of money at a point one year in the future. He exchanges this claim on future money for present money—95 ounces. The discount on future money as compared with present money is precisely equivalent to that in the other parts of the time market that we have studied heretofore, except that the present case is more obvious. The rate of interest finally set on the market is determined by the aggregate net supply and net demand schedules throughout the entire time market, and these, as we have seen, are determined by the time preferences of all the individuals on the market. Thus, in the case of Figure 50 above, in diagram III we have a case of a net (post-income) demander at the market rate of interest The form that his demand takes is the sale of an I.O.U. of future money—usually termed the “bor­rowing” of present money. On the other hand, the person whose time-market curve is shown in diagram IV has such a time-pref­erence configuration that he is neither a net supplier nor a net demander at the going rate of interest—he is not on the time market at all—in his post-income position.

     The net borrowers, then, are people who have relatively higher time-preference rates than others at the going rate of interest, in fact so high that they will borrow certain amounts at this rate. It must be emphasized here that we are dealing only with consumption borrowing—borrowing to add to the present use of Jones’ money stock for consumption. Jones’ sale of future money differs from the sales of the landowners and laborers in another respect; their transactions are completed, while Jones has not yet completed his. His I.O.U. establishes a claim to future money on the part of the buyer (or “lender”) Smith, and Smith, to complete his transaction and earn his interest pay­ment, must present his note at the later date and claim the money due.

     In sum, the time market’s components are as follows:

        These demands are aggregated without regard to whether they are post- or pre-income; they both occur within a relatively brief time period, and they recur continually in the ERE.

     Although the consumption and the productive demands are aggregated to set the mar­ket rate of interest, a point of great importance for the pro­ductive system is revealed if we separate these demands ana­lytically. The diagram in Figure 51 depicts the establishment of the rate of interest on the time market.

     The vertical axis is the rate of interest; the horizontal axis is gold ounces. The SS curve is the supply-of-savings schedule, de­termined by individual time preferences. The CC curve is the schedule of consumers’ loan demands for present goods, consist­ing of the aggregate net demand (post-income) at the various hypothetical rates of interest. The DD curve is the total demand for present goods by suppliers of future goods, and it consists of the CC curve plus a curve that is not shown—the demand for present goods by the owners of original productive factors, i.e., land and labor. Both the CC and the DD curves are determined by individual time preferences. The equilibrium rate of interest will be set by the market at the point of intersection of the SS and DD curves—point E.

     The point of intersection at E determines two important re­sultants: the rate of interest, which is established at 0A, and the total supply of savings AE. A vital matter for the productive sys­tem, however, is the position of the CC curve: the larger CC is at any given rate of interest, the larger the amount of total savings that will be competed for and drawn away from production into consumers’ loans. In our diagram, the total savings going into investment in production is BE.

     The relative strength of productive and consumption demand for present goods in the society depends on the configurations of the time-preference schedules of the various individuals on the market. We have seen that the productive demand for present goods tends to be inelastic with respect to interest rates; on the other hand, the consumers’ loan curve will probably display greater elasticity. It follows that, on the demand side, changes in time preferences will display themselves mostly in the con­sumption demand schedule. On the supply side, of course, a rise in time preferences will lead to a shift of the SS curve to the left, with less being saved and invested at each rate of interest. The effects of time-preference changes on the rate of interest and the structure of production will be discussed further below.

     It is clear that the gross savings that maintain the production structure are the “productive” savings, i.e., those that go into productive investment, and that these exclude the “consumption” savings that go into consumer lending. From the point of view of the production system, we may regard borrowing by a con­sumer as dissaving, for this is the amount by which a person’s consumption expenditures exceed his income, as contrasted to savings, the amount by which a person’s income exceeds his con­sumption. In that case, the savings loaned are canceled out, so to speak, by the dissavings of the consumption borrowers.

     The consumers’ and producers’ subdivisions of the time mar­ket are a good illustration of how the rate of interest is equalized over the market. The connection between the returns on invest­ment and money loans to consumers is not an obvious one. But it is clear from our discussion that both are parts of one time market. It should also be clear that there can be no long-run deviation of the rate of interest on the consumption loan market from the rate of interest return on productive investment. Both are aspects of one time market. If the rate of interest on consum­ers’ loans, for example, were higher than the rate of interest return from investment, savings would shift from buying future goods in the form of factors to the more remunerative purchase of I.O.U.’s. This shift would cause the price of future factors to fall, i.e., the interest rate in investment to rise; and the rate of interest on consumers’ loans to fall, as a result of the compe­tition of more savings in the consumer loan arena. The everyday arbitrage of the market, then, will tend to equalize the rate of interest in both parts of the market. Thus, the rate of interest will tend to be equalized for all areas of the economy, as it were in three dimensions—“horizontally” in every process of production, “vertically” at every stage of production, and “in depth,” in the consumer loan market as well as in the production structure.

7. The Myth of the Importance of the Producers’ Loan Market

     We have completed our analysis of the determination of the pure rate of interest as it would be in the evenly rotating economy—a rate that the market tends to approach in the real world. We have shown how it is determined by time preferences on the time market and have seen the various components of that time market. This statement will undoubtedly be extremely puzzling to many readers. Where is the producers’ loan market? This market is always the one that is stressed by writers, often to the exclusion of anything else. In fact, “rate of interest” gen­erally refers to money loans, including loans to consumers and producers, but particularly stressing the latter, which is usually quantitatively greater and more significant for production. The rate of interest of money loans to the would-be producer is sup­posed to be the significant rate of interest. In fact, the fashion­able neoclassical doctrine holds that the producers’ loan market determines the rate of interest and that this determination takes place as in Figure 52, where SS is the supply of savings entering the loan market, and DD is the demand for these loans by producers or entrepreneurs. Their intersection allegedly determines the rate of interest.

     It will be noticed that this sort of approach completely over­looks the gross savings of the producers and, even more, the demand for present goods by owners of the original factors. In­stead of being fundamentally suppliers of present goods, capitalists are portrayed as demanders of present goods. What de­termines the SS and DD sched­ules, according to this neoclassi­cal doctrine? The SS curve is admittedly determined by time preferences; the DD curve, on the other hand, is supposed to be determined by the “mar­ginal efficiency of capital,” i.e., by the expected rate of return on the investment.

     This approach misses the point very badly because it looks at the economy with the superficial eye of an average businessman. The businessman borrows on a producers’ loan market from individual savers, and he judges how much to borrow on the basis of his expected rate of “profit,” or rate of return. The writers assume that he has available a shelf of investment projects, some of which would pay him, say 8 percent, some 7 percent, some 3 percent, etc., and that at each hypothetical interest rate he will borrow in order to invest in those projects where his return will be as high or higher. In other words, if the interest rate is 8 percent, he will borrow to invest in those projects that will yield him over 8 percent; if the rate is 4 percent, he will invest in many more projects—those that will yield him over 4 percent, etc. In that way, the demand curve for savings, for each individual, and still more for the aggregate on the mar­ket, will slope rightward as demand curves usually do, as the rate of interest falls. The intersection sets the market rate of interest.

     Superficially, this approach might seem plausible. It usually happens that a businessman foresees such varying rates of return on different investments, that he borrows on the market from different individual savers, and that he is popularly considered the “capitalist” or entrepreneur, while the lenders are simply savers. This lends plausibility to terming the DD curve in Figure 52, the demand by capitalists or entrepreneurs for money (present goods). And it seems to avoid mysterious complexities and to focus neatly and simply on the rate of interest for producers’ loans—the loans from savers to businessmen—in which they and most writers on economics are interested. It is this rate of interest that is generally discussed at great length by economists.

     Although popular, this approach is wrong through and through, as will be revealed in the course of this analysis. In the first place, let us consider the construction of this DD curve a little more closely. What is the basis for the alleged shelf of available projects, each with different rates of return? Why does a particular invest­ment yield any net monetary return at all? The usual answer is that each dose of new investment has a “marginal value produc­tivity,” such as 10 percent, 9 percent, 4 percent, etc., that naturally the most pro­ductive investments will be made first and that therefore, as sav­ings increase, further investments will be less and less value-­productive. This provides the basis for the alleged “businessman’s demand curve,” which slopes to the right as savings increase and the interest rate falls. The cardinal error here is an old one in economics—the attribution of value-productivity to monetary in­vestment. There is no question that investment increases the physical productivity of the productive process, as well as the productivity per man hour. Indeed, that is precisely why invest­ment and the consequent lengthening of the periods of produc­tion take place at all. But what has this to do with value-produc­tivity or with the monetary return on investment, especially in the long run of the ERE?

     Suppose, for example, that a certain quantity of physical factors (and we shall set aside the question of how this quantity can be measured) produces 10 units of a certain product per period at a selling price of two gold ounces per unit. Now let us postulate that investment is made in higher-order capital goods to such an extent that productivity multiplies fivefold and that the same original factors can now produce 50 units per period. The selling price of the larger supply of product will be less; let us assume that it will be cut in half to one ounce per unit. The gross revenue per period is increased from 20 to 50 ounces. Does this mean that value-productivity has increased two and a half times, just as physical productivity increased fivefold? Certainly not! For, as we have seen, producers benefit, not from the gross revenue received, but from the price spread between their selling price and their aggregate factor prices. The increase in physical produc­tivity will certainly increase revenue in the short run, but this refers to the profit-and-loss situations of the real world of un­certainty. The long-run tendency will be nothing of the sort. The long-run tendency, eventuating in the ERE, is toward an equali­zation of price spreads. How can there be any permanent benefit when the cumulative factor prices paid by this producer increase from, say, 18 ounces to 47 ounces? This is precisely what will happen on the market, as competitors vie to invest in these profitable situations. The price spread, i.e., the interest rate, will again be 5 percent.

     Thus the productivity of production processes has no basic relation to the rate of return on business investment. This rate of return depends on the price spreads between stages, and these price spreads will tend to be equal. The size of the price spread, i.e., the size of the interest rate, is determined, as we have seen at length, by the time-preference schedules of all the individuals in the economy.

     In sum, the neoclassical doctrine maintains that the interest rate, by which is largely meant the producers’ loan market, is co­-determined by time preference (which determines the supply of individual savings) and by marginal (value) productivity of in­vestment (which determines the demand for savings by businessmen), which in turn is determined by the rates of return that can be achieved in investments. But we have seen that these very rates of return are, in fact, the rate of interest and that their size is determined by time preferences. The neoclassicists are partly right in only one respect—that the rate of interest in the producers’ loan market is dependent on the rates of return on investment. They hardly realize the extent of this dependence, however. It is clear that these rates of return, which will be equalized into one uniform rate, constitute the significant rate of interest in the production structure.[27][28]

     Discarding the neoclassical analysis, we may ask: What, then, is the role of the productive loan market and of the rate of in­terest set therein? This role is one of complete and utter depend­ence on the rate of interest as determined above, and manifesting itself, as we have seen, in the rate of investment return, on the one hand, and in the consumers’ loan market, on the other. These latter two markets are the independent and important subdivisions of the general time market, with the former being the important market for the production system.

     In this picture, the producers’ loan market has a purely sub­sidiary and dependent role. In fact, from the point of view of fundamental analysis, there need not be any producers’ loan mar­ket at all. To examine this conclusion, let us consider a state of business affairs without a producers’ loan market. What is needed to bring this about? Individuals save, consuming less than their income. They then directly invest these savings in the production structure, the incentive for investment being the rate of interest return—the price spread—on the investment. This rate is deter­mined, along with the rate on the consumers’ loan market, by the various components of the time market that we have portrayed above. There is, in that case, no producers’ loan market. There are no loans from a saving group to another group of investors. And it is clear that the rate of interest in the production structure still exists; it is determined by factors that have nothing to do with the usual discussion by economists of the producers’ loan market.

8. The Joint-Stock Company

     It is clear that, far from being the centrally important ele­ment, the producers’ loan market is of minor importance, and it is easy to postulate a going productive system with no such mar­ket at all. But, some may reply, this may be all very well for a primitive economy where every firm is owned by just one capital­ist-investor, who invests his own savings. What happens in our modern complex economy, where savings and investment are sep­arated, are processes engaged in by different groups of people—the former by scattered individuals, the latter by relatively few directors of firms? Let us, therefore, now consider a second possi­ble situation. Up to this point we have not treated in detail the question whether each factor or business was owned by one person or jointly by many persons. Now let us consider an economy in which factors are jointly owned by many people, as largely hap­pens in the modern world, and we shall see what difference this makes in our analyses.

     Before studying the effect of such jointly owned companies on the producers’ loan market, we must digress to analyze the nature of these companies themselves. In a jointly owned firm, instead of each individual capitalist’s making his own investments and making all his own investment and production decisions, various individuals pool their money capital in one organization, or business firm, and jointly make decisions on the investment of their joint savings. The firm then purchases the land, labor, and capital-goods factors, and later sells the product to consumers or to lower-order capitalists. Thus, the firm is the joint owner of the factor services and particularly of the product as it is produced and becomes ready for sale. The firm is the product-owner until the product is sold for money. The individuals who contributed their saved capital to the firm are the joint owners, successively, of: (a) the initial money capital—the pooled savings, (b) the serv­ices of the factors, (c) the product of the factors, and (d) the money obtained from the sale of the product. In the evenly rotat­ing economy, their ownership of assets follows this same step-by­-step pattern, period after period, without change. In a jointly owned firm, in actual practice, the variety of productive assets owned by the firm is large. Any one firm is usually engaged in various production processes, each one involving a different pe­riod of time, and is likely to be engaged in different stages of each process at any one particular time. A firm is likely to be producing so that its output is continuous and so that it makes sales of new units of the product every day.

     It is obvious, then, that if the firm keeps continually in busi­ness, its operations at any one time will be a mixture of invest­ment and sale of product. Its assets at any one time will be a mix­ture of cash about to be invested, factors just bought, hardly begun products, and money just received from the sale of prod­ucts. The result is that, to the superficial, it looks as if the firm is an automatically continuing thing and as if the production is somehow timeless and instantaneous, ensuing immediately after the factor input.

     Actually, of course, this idea is completely unfounded. There is no automatic continuity of investment and production. Pro­duction is continued because the owners are continually mak­ing decisions to proceed; if they did not think it profitable to do so, they could and do at any point alter, curtail, or totally cease operations and investments. And production takes time from initial investment to final product.

     In the light of our discussion, we may classify the types of as­sets owned by any firm (whether jointly or individually owned) as follows:

On this entire package of assets, a monetary evaluation is placed by the market. How this is done will be examined in detail later.

     At this point, let us revert to the simple case of a one-shot in-vestment, an investment in factors on one date, and the sale of the resulting product a year later. This is the assumption involved in our original analysis of the production structure; and it will be seen below that the same analysis can be applied to the more complex case of a melange of assets at different stages of produc­tion and even to cases where one firm engages in several different production processes and produces different goods. Let us con­sider a group of individuals pooling their saved money capital to the extent of 100 ounces, purchasing factors with the 100 gold ounces, obtaining a product, and selling the product for 105 ounces a year later. The rate of interest in this society is 5 percent per annum, and the rate of interest return on this investment conforms with this condition. The question now arises: On what principle do the individual owners mutually apportion their shares of the assets? It will almost always be the case that every individual is vitally interested in knowing his share of the joint assets, and consequently firms are established in such a way that the principle of apportionment is known to all the owners.

     At first one might be inclined to say that this is simply a case of bargaining, as in the case of the product jointly owned by all the owners of the factors. But the former situation does not apply here. For in the case discussed above, there was no principle whereby any man’s share of ownership could be distinguished from that of anyone else. A whole group of people worked, con­tributed their land, etc., to the production process, and there was no way except simple bargaining by which the income from the sale of the product could be apportioned among them. Here, each individual is contributing a certain amount of money capital to begin with. Therefore, the proportions are naturally established from the outset. Let us say that the 100 ounces of capital are contributed by five men as follows:

A . . . . . . . 40 oz.
B . . . . . . . 20 oz.
C . . . . . . . 20 oz.
D . . . . . . . 15 oz.
E . . . . . . .   5 oz.

In other words, A contributes 40 percent of the capital, B 20 percent, C 20 percent, D 15 percent, E 5 percent. Each individual owner of the firm then owns the same percentage of all the assets that he contributed in the beginning. This holds true at each step of the way, and finally for the money obtained from the sale of the product. The 105 ounces earned from the sale will be either reinvested in or “dis­invested” from the process. At any rate, the ownership of these 105 ounces will be distributed in the same percentages as the capital invested.

     This natural structure of a firm is essentially the structure of a joint-stock company. In the joint-stock company, each investor-­owner receives a share—a certification of ownership in proportion to the amount he has invested in the total capital of the company. Thus, if A, B, . . . E above form a company, they may issue 100 shares, each share representing a value, or an asset, of one ounce. A will receive 40 shares; B, 20 shares; C, 20 shares, etc. After the sale of the product, each share will be worth 5 percent more than its original, or par, value.

     Suppose that after the sale, or indeed at any time before the sale, another person, F, wishes to invest in this company. Suppose that he wishes to invest 30 ounces of gold. In that case, the in­vestment of money savings in the company increases from 100 (if before the sale) or 105 (if after the sale) by 30 ounces. Thirty new shares will be issued and turned over to F, and the capital value of the firm increases by 30 ounces. In the vast majority of cases where reinvestment of monetary revenue is going on continuously, at any point in time the capital value of a firm’s assets will be the appraised value of all the productive assets, including cash, land, capital goods, and finished products. The capital value of the firm is increased at any given time by new in­vestment and is maintained by the reinvestments of the owners after the finished product is sold.

     The shares of capital are generally known as stock; the total par value of capital stock is the amount originally paid in on the formation of the company. From that point on, the total capital value of assets changes as income is earned, or, in the world of uncertainty, as losses are suffered, and as capital is reinvested or withdrawn from the company. The total value of capital stock changes accordingly, and the value of each share will differ from the original value accordingly.

     How will the group of owners decide on the affairs of the company? Those decisions that must be made jointly will be made by some sort of voting arrangement. The natural voting arrange­ment, which one would expect to be used, is to have one vote per share of voting stock, with a majority of the votes deciding. This is precisely the arrangement used in the joint-stock company and its modern form, the corporation.

     Of course, some joint-stock company arrangements differ from this, according to the desires of the owners. Partnerships can be worked out between two or more people on various principles. Usually, however, if one partner receives more than his propor­tionate share of invested capital, it is because he is contributing more of his labor or his land to the enterprise and gets paid ac­cordingly. As we shall see, the rate paid to the labor of the “work­ing partner” will be approximately equal to what he could earn in labor elsewhere, and the same is true for payment to the land or any other originally owned factor contributed by a partner. Since partnerships are almost always limited to a few, the relation­ships are more or less informal and need not have the formal pat­terns of the joint-stock company. However, partnerships will tend to work quite similarly. They provide more room for idiosyn­cratic arrangements. Thus, one partner may receive more than his share of capital because he is loved and revered by the others; this is really in the nature of a gift to him from the rest of the partners. Joint-stock companies hew more closely to a formal principle.

     The great advantage of the joint-stock company is that it pro­vides a more ready channel for new investments of saved capital. We have seen how easy it is for new capital to be attracted through the issuance of new shares. It is also easier for any owner to withdraw his capital from the firm. This greater ease of with­drawal vastly increases the temptation to invest in the company. Later on we shall explore the pricing of stock shares in the real world of uncertainty. In this real world, there is room for great differences of opinion concerning the appraised value of a firm’s assets, and therefore concerning the monetary appraised value of each share of the firm’s stock. In the evenly rotating economy, however, all appraisals of monetary value will agree—the prin­ciples of such appraisal will be examined below—and therefore the appraised value of the shares of stock will be agreed upon by all and will remain constant.

     While the share market of joint-stock companies provides a ready channel for accumulating savings, the share market is strictly dependent on the price spreads. The savings or dissavings of capitalists are determined by time preferences, and the latter establish the price spread in the economy. The value of capital invested in the enterprise, i.e., its productive assets, will be the sum of future earnings from the capital discounted by the rate of interest. If the price spreads are 5 percent, the rate of in­terest return yielded on the share market (the ratio of earnings per share to the market price of the share) will tend to equal the rate of interest as determined elsewhere on the time market—in this case, 5 percent.

     We still have a situation in which capitalists supply their own saved capital, which is used to purchase factors in expectation of a net monetary return. The only complications that develop from joint-stock companies or corporations are that many capitalists contribute and own the firm’s assets jointly and that the price of a certain quantum of ownership will be regulated by the market so that the rate of interest yield will be the same for each individ­ual share of stock as it is for the enterprise as a whole. If the whole firm buys factors for a total price of 100 and sells the product a year later for 105, for a 5-percent return, then, say, 1/5 of the shares of ownership of this firm will sell for an aggregate price of 20 and earn an annual net return of one ounce. Thus, the rates of interest for the partial shares of capital will all tend to be equal to the rate of interest earned on the entire capital.[29]

     Majority rule in the joint-stock companies, with respect to total shares owned, does not mean that the minority rights of owners are overridden. In the first place, the entire pooling of resources and the basis on which it is worked out are voluntary for all parties concerned. Secondly, all the stockholders, or owners, have one single interest in common—an increase in their monetary re­turn and assets, although they may, of course, differ concerning the means to achieve this goal. Thirdly, the members of the mi­nority may sell their stock and withdraw from the company if they so desire.

     Actually, the partners may arrange their voting rights and ownership rights in any way they please, and there have been many variations of such arrangements. One such form of group ownership, in which each owner has one vote regardless of the number of shares he owns, has absurdly but effectively arrogated to itself the name of “co-operative.” It is obvious that partner­ships, joint-stock companies, and corporations are all eminently co-operative institutions.[30]

     Many people believe that economic analysis, while applicable to individually owned firms, does not hold true for the modern economy of joint-stock companies. Nothing could be further from the truth. The introduction of corporations has not fundamen­tally changed our analysis of the interest rate or the savings-in­vestment process. What of the separation of “management” from ownership in a corporation? It is certainly true that, in a joint­-stock firm, the owners hire managerial labor to supervise their workers, whereas individual owners generally perform their own managerial labor. A manager is just as much a hired laborer as any other worker. The president of a company, just like the ditch digger, is hired by the owners; and, like the ditch digger, he ex­pends labor in the production process. The price of managerial labor is determined in the same way as that of other labor, as will be seen below. On the market, the income to an independ­ent owner will also include the going wage for that type of managerial labor, which joint-stock owners, of course, will not receive. Thus, we see that, far from rendering economic analysis obsolete, the modern world of the corporation aids analysis by separating and simplifying functions in production—spe­cifically, the managerial function.

     In addition to the capital-supplying function, the corporate capitalists also assume the entrepreneurial function: the cru­cial directing element in guiding the processes of production to­ward meeting the desires of the consumers. In the real world of uncertainty, it takes sound judgment to decide how the mar­ket is operating, so that present investment will lead to future profits, and not future losses. We shall deal further with the nature of profit and loss, but suffice it to say here that the ac­tive entrepreneurial element in the real world is due to the presence of uncertainty. We have been discussing the determi­nation of the pure rate of interest, the rate of interest as it al­ways tends to be and as it will be in the certain world of the ERE. In the ERE, where all techniques, market demands and supplies, etc., for the future are known, the investment func­tion becomes purely passive and waiting. There might still be a supervisory or managerial labor function, but this can be analyzed under prices of labor factors. But there will no longer be an entrepreneurial function because future events are known.

     Some have maintained, finally, that joint-stock companies make for a separation of savings and investment. Stockholders save, and the managers do the investing. This is completely fallacious. The managers are hired agents of the stockholders and subject to the latters’ dictation. Any individual stockholder not satisfied with the decisions of the majority of owners can dispose of his ownership share. As a result, it is effectively the stockholders who save and the stockholders who invest the funds.[31]

     Some people maintain that since most stockholders are not “interested” in the affairs of their company, they do not effectively control the firm, but permit control to pass into the hands of the hired managers. Yet surely a stockholder’s interest is a matter of his own preference and is under his own control. Pre­ferring his lack of interest, he permits the managers to continue their present course; the fundamental control, however, is still his, and he has absolute control over his agents.[32] A typical view asserts:

The maximizing of dividend income for stockholders as a group is not an objective that is necessarily unique or paramount. Instead, management officials will seek to improve the long-run earnings and competitive position of the firm and their own prestige as managers.[33]

But to “improve the long­-run earnings” is identical with maximizing stockholders’ income, and what else can develop the “prestige” of managers? Other theorists lapse into the sheer mysticism of considering the “corporation”—a conceptual name which we give to an institution owned by real individuals—as “really” existing and acting by itself.[34]

[26]This Marxian error stemmed from a very similar error introduced into economics by Adam Smith. Cf. Ronald L. Meek, “Adam Smith and the Classical Concept of Profit,” Scottish Journal of Political Economy, June, 1954, pp. 138–53.

[27]For brilliant dissections of various forms of the “productivity” theory of interest (the neoclassical view that investment earns an interest return because capital goods are value-productive), see the following articles by Frank A. Fetter: “The Roundabout Process of the Interest Theory,” Quarterly Journal of Economics, 1902, pp. 163–80, where Böhm-Bawerk’s highly unfortunate lapse into a productivity theory of interest is refuted; “Interest Theories Old and New,” pp. 68–92, which presents an extensive development of time-preference theory, coupled with a critique of Irving Fisher’s concessions to the productivity doctrine; also see “Capi­talization Versus Productivity, Rejoinder,” American Economic Review, 1914, pp. 856–59, and “Davenport’s Competitive Economics,” Journal of Political Economy, 1914, pp. 555–62. Fetter’s only mistake in interest theory was to deny Fisher’s assertion that time preference (or, as Fisher called it, “impatience”) is a universal and necessary fact of human action. For a demonstration of this important truth, see Mises, Human Action, pp. 480ff.

[28]On Keynes’ failure to perceive this point, see p. 371 of this chapter, note 5 above.

[29]The shares of stock, or the units of property rights,

have the charac­teristic of fungibility; one unit is exactly the same as another. . . . We have a mathematical division of the one set of rights. This fungible quality makes possible organized commodity and security markets or exchanges. . . . With these fungible units of . . . property rights we have a possible acceleration of changes of ownership and in membership of the groups. . . . If a course of market dealings arises, the unit of property has a swift cash conversion value. Its owner may readily re­sume the cash power to command the uses of wealth. (Hastings Lyon, Corporations and their Financing [Boston: D.C. Heath, 1938], p. 11)

Thus, shares of property as well as total property have become readily marketable.

[30]The literature on the so-called “co-operative movement” is of remark­ably poor quality. The best source is Co-operatives in the Petroleum Industry, K.E. Ettinger, ed. (New York: Petroleum Industry Research Foundation, 1947), especially pt. I, Ludwig von Mises, “Observations on the Co-operative Movement.”

[31]See Mises, Human Action, pp. 301–05, 703–05.

[32]The proxy fights of recent years simply give dramatic evidence of this control.

[33]Edgar M. Hoover, “Some Institutional Factors in Business Decisions,” American Economic Review, Papers and Proceedings, May, 1954, p. 203.

[34]For example, see Gerhard Colm, “The Corporation and the Corporation Income Tax in the American Economy,” American Economic Review, Papers and Proceedings, May, 1954, p. 488.

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