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9. The Formation of Capital
With the nature-given elements limited by his environment, and his labor restricted both by its available supply and its disutility, there is only one way by which man can increase his production of consumers’ goods per unit of time—by increasing the quantity of capital goods. Beginning with unaided labor and nature, he must, to increase his productivity, mix his labor energy with the elements of nature to form capital goods. These goods are not immediately serviceable in satisfying his wants, but must be transformed by further labor into lower-order capital goods, and finally into the desired consumers’ goods.
In order to illuminate clearly the nature of capital formation and the position of capital in production, let us start with the hypothetical example of Robinson Crusoe stranded on a desert island. Robinson, on landing, we assume, finds himself without the aid of capital goods of any kind. All that is available is his own labor and the elements given him by nature. It is obvious that without capital he will be able to satisfy only a few wants, of which he will choose the most urgent. Let us say that the only goods available without the aid of capital are berries and leisure. Say that he finds that he can pick 20 edible berries an hour, and, on this basis, works 10 hours in berry-picking and enjoys 14 hours a day of leisure. It is evident that, without the aid of capital, the only goods open to him for consumption are goods with the shortest period of production. Leisure is the one good that is produced almost instantaneously, while berries have a very short production period. Twenty berries have a production period of one hour. Goods with longer periods of production are not available to him unless he acquires capital goods.
There are two ways in which longer processes of production through the use of capital may increase productivity: (1) they may provide a greater production of the same good per unit of time; or (2) they may allow the actor to consume goods that are not available at all with shorter processes of production.
As an example of the first type of increase in productivity, Robinson may decide that if he had the use of a long stick, he could shake many berries off the trees instead of picking them by hand. In that way he might be able to step up his production to 50 berries an hour. How might he go about acquiring the stick? Obviously, he must expend labor in getting the materials, transporting them, shaping them into a stick, etc. Let us say that 10 hours would be necessary for this task. This means that to obtain the stick, Crusoe must forgo 10 hours’ production of consumers’ goods. He must either sacrifice 10 hours of leisure or 10 hours of berries at 20 per hour (200 berries), or some combination of the two. He must sacrifice, for 10 hours, the enjoyment of consumers’ goods, and expend his labor on producing a capital good—the stick—which will be of no immediate use to him. He will be able to begin using the capital good as an indirect aid to future production only after the 10 hours are up. In the meantime, he must forgo the satisfaction of his wants. He must restrict his consumption for 10 hours and transfer his labor for that period from producing immediately satisfying consumers’ goods into the production of capital goods, which will prove their usefulness only in the future. The restriction of consumption is called saving, and the transfer of labor and land to the formation of capital goods is called investment.
We see now what is involved in the process of capital formation. The actor must decide whether or not to restrict his consumption and invest in the production of capital goods, by weighing the following factors: Does the utility yielded by the increased productivity of the longer process of production outweigh the sacrifice that I must make of present goods to acquire consumers’ goods in the future? We have already seen above the universal fact of time preference—that a man will always prefer obtaining a given satisfaction earlier than later. Here, the actor must balance his desire to acquire more satisfactions per unit of time as against the fact that, to do so, he must give up satisfactions in the present to increase his production in the future. His time preference for present over future accounts for his disutility of waiting, which must be balanced against the utility that will be eventually provided by the capital good and the longer process of production. How he chooses depends on his scale of values. It is possible, for example, that if he thought the stick would provide him with only 30 berries an hour and would take 20 hours to make, he would not make the saving-investment decision. On the other hand, if the stick took five hours to make and could provide him with 100 berries an hour, he might make the decision readily.
If he decides to invest 10 hours in adding to his capital goods, there are many ways in which he might restrict his consumption. As mentioned above, he can restrict any combination of berries or leisure. Setting aside leisure for purposes of simplification, he may decide to take a whole day off at once and produce no berries at all, completing the stick in one day. Or, he may decide to pick berries for eight hours instead of 10, and devote the other two hours a day to making the stick, in which case the completion of the stick will take five days. Which method he will choose depends on the nature of his value scale. In any case, he must restrict his consumption by 10 hours’ worth of labor—200 berries. The rate of his restriction will depend on how urgently he wants the increased production, as compared with the urgency with which he desires to maintain his present supply of berries.
Analytically, there is little difference between working on consumers’ goods, accumulating a stock of them, and then working full time on the capital good, and working on the capital good and consumer goods simultaneously. Other things being equal, however, it is possible that one of the methods will prove more productive; thus, it may be that the actor can complete the task in less time if he works on it continuously. In that case, he will tend to choose the former method. On the other hand, the berries might tend to spoil if accumulated, and this would lead him to choose the latter route. A balance of the various factors on his value scale will result in his decision.
Let us assume that Robinson has made his decision, and, after five days, begins to use the stick. On the sixth day and thereafter, then, 500 berries a day will begin to pour forth, and he will harvest the fruits of his investment in capital goods.
Crusoe can use his increased productivity to increase his hours of leisure as well as to increase his output of berries. Thus, he might decide to cut his daily labor from 10 hours to eight. His output of berries will then be increased, because of the stick, from 200 to 400 berries per day, while Crusoe is able to increase his hours of leisure from 14 to 16 per day. Obviously, Crusoe can choose to take his increased productivity in various combinations of increased output of the good itself and of increased leisure.32
Even more important than its use in increasing output per unit of time is the function of capital in enabling man to acquire goods which he could not at all obtain otherwise. A very short period of production enables Crusoe to produce leisure and at least some berries, but without the aid of capital he cannot attain any of his other wants at all. To acquire meat he must have a bow and arrows, to acquire fish he must have a pole or net, to acquire shelter he must have logs of wood, or canvas, and an axe to cut the wood. To satisfy any such wants, he must restrict his consumption and invest his labor in the production of capital goods. In other words, he must embark on lengthier processes of production than had been involved in culling berries; he must take time out to produce the capital goods themselves before he can use them to enjoy consumers’ goods. In each case, the decisions that he makes in embarking on capital formation will be a result of weighing on his value scale the utility of the expected increased productivity as against the disutility of his time preference for present as compared to future satisfactions.
It is obvious that the factor which holds every man back from investing more and more of his land and labor in capital goods is his time preference for present goods. If man, other things being equal, did not prefer satisfaction in the present to satisfaction in the future, he would never consume; he would invest all his time and labor in increasing the production of future goods. But “never consuming” is an absurdity, since consuming is the end of all production. Therefore, at any given point in time, all men will have invested in all the shorter periods of production to satisfy the most urgently felt wants that their knowledge of recipes allows; any further formation of capital will go into longer processes of production. Other things being equal (i.e., the relative urgency of wants to be satisfied, and the actor's knowledge of recipes), any further investment will be in a longer process of production than is now under way.
Here it is important to realize that “a period of production” does not involve only the amount of time spent on making the actual capital good, but refers to the amount of waiting-time from the start of producing the capital good until the consumers’ good is produced. In the case of the stick and the berries, the two times are identical, but this was so only because the stick was a first-order capital good, i.e., it was but one stage removed from the output of consumers’ goods. Let us take, for example, a more complex case—the building by Crusoe of an axe in order to chop wood to produce a house for himself. Crusoe must decide whether or not the house he will gain will be worth the consumers’ goods forgone in the meantime. Let us say it will take Crusoe 50 hours to produce the axe, and then a further 200 hours, with the help of the axe, to chop and transport wood in order to build a house. The longer process of production which Crusoe must decide upon is now a three-stage one, totaling 250 hours. First, labor and nature produce the axe, a second-order capital good; second, labor, plus the axe, plus nature-given elements, produces logs-of-wood, a first-order capital good; finally, labor and the logs of wood combine to yield the desired consumers’ good—a house. The length of the process of production is the entire length of time from the point at which an actor must begin his labor to the point at which the consumers’ good is yielded.
Again, it must be observed that, in considering the length of a process of production, the actor is not interested in past history as such. The length of a process of production for an actor is the waiting-time from the point at which his action begins. Thus, if Crusoe were lucky enough to find an axe in good condition left by some previous inhabitant, he would reckon his period of production at 200 hours instead of 250. The axe would be given to him by his environment.
This example illustrates a fundamental truth about capital goods: Capital is a way station along the road to the enjoyment of consumers’ goods. He who possesses capital is that much further advanced in time on the road to the desired consumers’ good. Crusoe without the axe is 250 hours away from his desired house; Crusoe with the axe is only 200 hours away. If the logs of wood had been piled up ready-made on his arrival, he would be that much closer to his objective; and if the house were there to begin with, he would achieve his desire immediately. He would be further advanced toward his goal without the necessity of further restriction of consumption. Thus, the role of capital is to advance men in time toward their objective in producing consumers’ goods. This is true for both the case where new consumers’ goods are being produced and the case where more old goods are being produced. Thus, in the previous case, without the stick, Crusoe was 25 hours away from an output of 500 berries; with the stick, he is only 10 hours away. In those cases where capital enables the acquisition of new goods—of goods which could not be obtained otherwise—it is an absolutely indispensable, as well as convenient, way station toward the desired consumers’ good.
It is evident that, for any formation of capital, there must be saving—a restriction of the enjoyment of consumers’ goods in the present—and the investment of the equivalent resources in the production of capital goods. This enjoyment of consumers’ goods—the satisfaction of wants—is called consumption. The saving might come about as a result of an increase in the available supply of consumers’ goods, which the actor decides to save in part rather than consume fully. At any rate, consumption must always be less than the amount that could be secured. Thus, if the harvest on the desert island improves, and Crusoe finds that he can pick 240 berries in 10 hours without the aid of a stick, he may now save 40 berries a day for five days, enabling him to invest his labor in a stick, without cutting back his berry consumption from the original 200 berries. Saving involves the restriction of consumption compared to the amount that could be consumed; it does not always involve an actual reduction in the amount consumed over the previous level of consumption.
All capital goods are perishable. Those few products that are not perishable but permanent become, to all intents and purposes, part of the land. Otherwise, all capital goods are perishable, used up during the processes of production. We can therefore say that capital goods, during production, are transformed into their products. With some capital goods, this is physically quite evident. Thus, it is obvious, for example, that when 100 pounds of bread-at-wholesale are combined with other factors to produce 100 pounds of bread at retail, the former factor is immediately and completely transformed into the latter factor. The using up of capital goods is dramatically clear. The whole of the capital good is used up in each production-event. The other capital goods, however, are also used up, but not as suddenly. A truck transporting bread may have a life of 15 years, amounting to, say, 3,000 of such conversions of bread from the wholesale to the retail stage. In this case, we may say that 1/3,000 of the truck is used up each time the production process occurs. Similarly, a mill converting wheat into flour may have a useful life of 20 years, in which case we could say that l/20 of the mill was used up in each year's production of flour. Each particular capital good has a different useful life and therefore a different rate of being used up, or, as it is called, of depreciation. Capital goods vary in the duration of their serviceableness.
Let us now return to Crusoe and the stick. Let us assume that the stick will have a useful life of 10 days, and is so estimated by Crusoe, after which it wears out, and Crusoe's output reverts to its previous level of 20 berries per hour. He is back where he started.
Crusoe is therefore faced with a choice, after his stick comes into use. His “standard of living” (now, say, at 500 berries a day plus 14 hours of leisure) has improved, and he will not like the prospect of a reduction to 200 when the stick gives out. If he wishes to maintain his standard of living intact, therefore, he must, during the 10 days, work on building another stick, which can be used to replace the old one when it wears out. This act of building another stick involves a further act of saving. In order to invest in a replacement for the stick, he must again save—restrict his consumption as compared to the production that might be available. Thus, he will again have to save 10 hours’ worth of labor in berries (or leisure) and devote them to investing in a good that is only indirectly serviceable for future production. Suppose that he does this by shifting one hour a day from his berry production to the labor of producing another stick. By doing so, he restricts his berry consumption, for 10 days, to 450 a day. He has restricted consumption from his maximum, although he is still much better off than in his original, unaided state.
Thus, the capital structure is renewed at the end of the 10 days, by saving and investing in a replacement. After that, Crusoe is again faced with the choice of taking his maximum production of 500 berries per day and finding himself back to a 200-per-day level at the end of 10 more days, or of making a third act of saving in order to provide for replacement of the second stick when it wears out.33
If Crusoe decides not to replace the first or the second stick, and accepts a later drop in output to avoid undergoing present saving, he is consuming capital. In other words, he is electing to consume instead of to save and maintain his capital structure and future rate of output. Consuming his capital enables Crusoe to increase his consumption now from 450 to 500 berries per day, but at some point in the future (here in 10 days), he will be forced to cut his consumption back to 200 berries. It is clear that what has led Crusoe to consume capital is his time preference, which in this case has led him to prefer more present consumption to greater losses in future consumption.
Thus, any actor, at any point in time, has the choice of: (a) adding to his capital structure, (b) maintaining his capital intact, or (c) consuming his capital. Choices (a) and (b) involve acts of saving. The course adopted will depend on the actor's weighing his disutility of waiting, as determined by his time preference, against the utility to be provided in the future by the increase in his intake of consumers’ goods.
At this point in the discussion of the wearing out and replacement of capital goods we may observe that a capital good rarely retains its full “powers” to aid in production and then suddenly lose all its serviceability. In the words of Professor Benham, “capital goods do not usually remain in perfect technical condition and then suddenly collapse, like the wonderful ‘one-hoss shay.’”34 Crusoe's berry output, instead of remaining 500 for 10 days and then falling back to 200 on the 11th day, is likely to decline at some rate before the stick becomes completely useless.
Another method of maintaining capital may now prove available. Thus, Crusoe may find that, by spending a little time repairing the stick, breaking off weaker parts, etc., he may be able to prolong its life and maintain his output of berries longer. In short, he may be able to add to his capital structure via repairs.
Here again he will balance the added increase in future output of consumers’ goods against the present loss in consumers’ goods which he must endure by expending his labor on repairs. Making repairs therefore requires an independent act of saving and a choice to save. It is entirely possible, for example, that Crusoe will decide to replace the stick, and spend his labor on that purpose, but will not consider it worthwhile to repair it. Which course he decides to take depends on his valuation of the various alternative outputs and his rate of time preference.
An actor's decision on what objects to invest in will depend on the expected utility of the forthcoming consumers’ good, its durability, and the length of his waiting-time. Thus, he may first invest in a stick and then decide it would not be worthwhile to invest in a second stick; instead, it would be better to begin building the axe in order to obtain a house. Or he may first make a bow and arrows with which to hunt game, and after that begin working on a house. Since the marginal utility of the stock of a good declines as the stock increases, the more he has of the stock of one consumers’ good, the more likely he will be to expend his new savings on a different consumers’ good, since the second good will now have a higher marginal utility of product to his invested labor and waiting, and the marginal utility of the first will be lower.
If two consumers’ goods have the same expected marginal utility in daily serviceability and have the same period of waiting time, but one is more durable than the other, then the actor will choose to invest in production of the former. On the other hand, if the total serviceableness of two expected consumers’ goods is the same, and their length of period of production is the same, the less durable good will be invested in, since its total satisfactions arrive earlier than the other. Also, in choosing between investing in one or the other of two consumers’ goods, the actor will, other things being equal, choose that good with the shorter period of production, as has been discussed above.
Any actor will continue to save and invest his resources in various expected future consumers’ goods as long as the utility, considered in the present, of the marginal product of each unit saved and invested is greater than the utility of present consumers’ goods which he could obtain by not performing that saving. The latter utility—of present consumers’ goods for-gone—is the “disutility of waiting.” Once the latter becomes greater than the utility of obtaining more goods in the future through saving, the actor will cease to save.
Allowing for the relative urgency of wants, man, as has been demonstrated above, tends to invest first in those consumers’ goods with the shortest processes of production. Therefore, any given saving will be invested either in maintaining the present capital structure or in adding to it capital in more and more remote stages of production, i.e., in longer processes of production. Thus, any new saving (beyond maintaining the structure) will tend to lengthen production processes and invest in higher and higher orders of capital goods.
In a modern economy, the capital structure contains goods of almost infinite remoteness from the eventual consumers’ goods. We saw above some of the stages involved in the production of a comparatively very simple good like a ham sandwich. The laborer in an iron mine is far removed indeed from the ham sandwich in Jones’ armchair.
It is evident that the problems of measurement that arose in previous sections would be likely to pose a grave difficulty in saving and investing. How do actors know when their capital structure is being added to or consumed, when the types of capital goods and consumers’ goods are numerous? Obviously, Crusoe knows when he has more or fewer berries, but how can a modern complex economy, with innumerable capital goods and consumers’ goods, make such decisions? The answer to this problem, which also rests on the commensurability of different goods, will be discussed in later chapters.
In observing the increased output made possible by the use of capital goods, one may very easily come to attribute some sort of independent productive power to capital and to say that three types of productive forces enter into the production of consumers’ goods: labor, nature, and capital. It would be easy to draw this conclusion, but completely fallacious. Capital goods have no independent productive power of their own; in the last analysis they are completely reducible to labor and land, which produced them, and time. Capital goods are “stored-up” labor, land, and time; they are intermediate way stations on the road to the eventual attainment of the consumers’ goods into which they are transformed. At every step of the way, they must be worked on by labor, in conjunction with nature, in order to continue the process of production. Capital is not an independent productive factor like the other two. An excellent illustration of this truth has been provided by Böhm-Bawerk:
The following analogy will make it perfectly clear. A man throws a stone at another man and kills him. Has the stone killed the man? If the question is put without laying any special emphasis it may be answered without hesitation in the affirmative. But how if the murderer, on his trial, were to defend himself by saying that it was not he but the stone that had killed the man? Taking the words in this sense, should we still say that the stone had killed the man, and acquit the murderer? Now it is with an emphasis like this that economists inquire as to the independent productivity of capital. ... We are not asking about dependent intermediate causes, but about ultimate independent elements. The question is not whether capital plays a part in the bringing about of a productive result—such as the stone does in the killing of the man—but whether, granted the productive result, some part of it is due to capital so entirely and peculiarly that it simply cannot be put to the credit of the two other recognized elementary factors, nature and labor.
Böhm-Bawerk replies in the negative, pointing out that capital goods are purely way stations in the process of production, worked on at every possible stage by the forces of labor and land:
If, today, by allying my labor with natural powers, I make bricks out of clay, and tomorrow, by allying my labor with natural gifts, I obtain lime, and the day after that make mortar and so construct a wall, can it be said of any part of the wall that I and the natural powers have not made it? Again, before a lengthy piece of work, such as the building of a house, is quite finished, it naturally must be at one time a fourth finished, then a half finished, then three-quarters finished. What now would be said if one were to describe these inevitable stages of the work as independent requisites of house-building, and maintain that, for the building of a house, we require, besides building materials and labor, a quarter-finished house, a half-finished house, a three-quarters finished house? In form perhaps it is less striking, but in effect it is not a whit more correct, to elevate those intermediate steps in the progress of the work, which outwardly take the shape of capital, into an independent agent of production by the side of nature and labor.35
And this holds true regardless of how many stages are involved or how remote the capital good is from the ultimate consumers’ good.
Since investment in capital goods involves looking toward the future, one of the risks that an actor must always cope with is the uncertainty of future conditions. Producing consumers’ goods directly involves a very short period of production, so that the uncertainty incurred is not nearly as great as the uncertainty of longer processes of production, an uncertainty that becomes more and more important as the period of production lengthens.36
Suppose that Crusoe, while deciding on his investment in the stick, believes that there is a good possibility of his finding a grove where berries are in abundance, giving him an output of 50 or more berries per hour without the aid of a stick, and also where the berries would be so close as to render the stick useless. In that case, the more likely he thinks are the chances of finding the grove, the less likely he is to make the decision to invest in the stick, which would then be of no help to him. The greater the doubt about the usefulness the stick will have after it is ready, the less likelihood of investing in it, and the more likelihood of either investing in another good or of consuming instead of saving. We can consider that there is a sort of “uncertainty discount” on the expected future utility of the investment that may be so large as to induce the actor not to make the investment. The uncertainty factor in this case works with the time-preference factor to the disadvantage of the investment, against which the actor balances the expected utility of future output.
On the other hand, uncertainty may work as an added spur to making the investment. Thus, suppose that Crusoe believes that a blight may strike the berries very shortly and that if this happens, his unaided berry-output would dangerously decline. If the blight struck, Crusoe would be in great need of the stick to even maintain his output at the present low level. Thus, the possibility that the stick may be of even greater use to him than he anticipates will add to the expected utility of his investment, and the greater the chance of this possibility in Crusoe's view, the more likely he will be to invest in the stick. Thus, the uncertainty factor may work in either direction, depending on the specific situation involved.
We may explain the entire act of deciding whether or not to perform an act of capital formation as the balancing of relative utilities, “discounted” by the actor's rate of time preference and also by the uncertainty factor. Thus, first let us assume, for purposes of simplification, that Crusoe, in making the stick, forgoes 10 hours’ worth of present goods, i.e., 200 berries, and has acquired 1,500 berries three days later as a result of the investment decision. If the 1,500 berries had been immediately available, there would be no doubt that he would have given up 200 berries to acquire 1,500. Thus, 1,500 berries in the present might have a rank of four on his value scale, while 200 berries have a rank of 11:
Now, how will Crusoe decide between 200 berries in the present and 1,500 berries three days from now? Since all choices have to be made on one value scale, Crusoe must grade the utility of 1,500 berries three days from now as against the utility of 200 berries now. If the former is greater (higher on his value scale) he will make the decision to save and invest in the stick. If the latter is greater, and his 200 berries forgone have a greater value than the expectation of 1,500 berries three days from now, then his time preference has conquered the increased utility of stock, and he will not make the saving-investment decision. Thus, the actor's value scale may be:
or it may be:
In case (b) he will make the decision to invest; in case (a) he will not. We can say that the value of 1,500 berries three days from now is the present value of the future good. The expected future good is discounted by the actor according to his rate of time preference. The present value of his expected future good is compared to the present value of the present good on the actor's value scale, and the decision to save and invest is made accordingly. It is clear that the higher the rate of discount, the lower the present value of the future good will be, and the greater the likelihood of abstaining from the investment. On the other hand, the lower the rate of discount, the higher the present value of future goods will be on the actor's value scale, and the greater the likelihood of its being greater than the value of present goods forgone, and hence of his making the investment.
Thus, the investment decision will be determined by which is greater: the present value of the future good or the present value of present goods forgone. The present value of the future good, in turn, is determined by the value that the future good would have if immediately present (say, the “expected future value of the future good”); and by the rate of time preference. The greater the former, the greater will be the present value of the future good; the greater the latter (the rate of discount of future compared to present goods), the lower the present value.
At any point in time, an actor has a range of investment decisions open to him of varying potential utilities for the products that will be provided.37 He also has a certain rate of time preference by which he will discount these expected future utilities to their present value. How much he will save and invest in any period will be determined by comparing these present values with the value of the consumers’ goods forgone in making the investment decision. As he makes one investment decision after another, he will choose to allocate his resources first to investments of highest present value, then to those of next highest, etc. As he continues investing (at any given time), the present value of the future utilities will decline. On the other hand, since he is giving up a larger and larger supply of consumers’ goods in the present, the utility of the consumers’ goods that he forgoes (leisure and others) will increase—on the basis of the law of marginal utility. He will cease saving and investing at the point at which the value of goods forgone exceeds the present value of the future utilities to be derived. This will determine an actor's rate of saving and investing at any time.
It is evident that the problem again arises: How can actors decide and compare time-preference rates for innumerable possible goods and in a complex, modern economy? And here too, the answer for a complex economy lies in establishing commensurability among all the various commodities, present and future, as will be discussed in later chapters.
Now, the uncertainty factors enter into the actor's decision in one way or the other. The delicate procedure of weighing all the various factors in the situation is a complex process that takes place in the mind of every actor according to his understanding of the situation. It is a decision depending purely on the individual judgment, the subjective estimates, of each actor. The “best” decision cannot be exactly, or quantitatively, decided upon in advance by objective methods. This process of forecasting the future conditions that will occur during the course of his action is one that must be engaged in by every actor. This necessity of guessing the course of the relevant conditions and their possible change during the forthcoming action is called the act of entrepreneurship. Thus, to some extent at least, every man is an entrepreneur. Every actor makes his estimate of the uncertainty situation with regard to his forthcoming action.
The concepts of success or failure in entrepreneurship are thus deducible from the existence of action. The relatively successful entrepreneur is the one who has guessed correctly the changes in conditions to take place during the action, and has invested accordingly. He is the Crusoe who has decided not to build the stick because his judgment tells him that he will soon find a new grove of berries, which he then finds. On the other hand, the relatively unsuccessful entrepreneur is the one who has been badly mistaken in his forecast of the relevant changes in conditions taking place during the course of his action. He is the Crusoe who has failed to provide himself with a stick against the blight. The successful actor, the successful entrepreneur, makes correct estimates; the unsuccessful entrepreneur is the one who makes erroneous estimates.
Suppose now that an investment has already been made, and capital goods have already been built with a goal in view, when changing conditions reveal that an error has been made. The actor is then faced with the problem of determining what to do with the capital good. The answer depends on the convertibility of the capital good. If the good becomes worthless in the use for which it is intended, the actor, though having made an error in investing in it in the first place, now has it on his hands and has to make the best of it. If there is another use to which the actor can conveniently transfer the capital good, he will do so. Thus, if Crusoe finds that a new grove has rendered his stick useless for berry-picking, he may use it as a walking stick. He would not have invested in it originally if he had known it would be useless for berry-picking, but now that he has it, he turns it to its most urgent available use. On the other hand, he may feel that it is hardly worthwhile to spend time replacing the stick, now that it is usable only for walking purposes. Or, after working 50 hours and building an axe, he may find a house left by some previous inhabitant. The axe, however, may be convertible to use in something just a bit lower in value—say, building a bow and arrows for hunting or building a boat for fishing. The axe may be so valuable in these uses that Crusoe will still work to replace and maintain it in operation.
It is clear that the accumulated stock of capital goods (or, for that matter, durable consumers’ goods) imposes a conservative force on present-day action. The actor in the present is influenced by his (or someone else's) actions in the past, even if the latter were to some extent in error. Thus, Crusoe might find an axe already available, built by a previous inhabitant. It might not be the sort of axe that Crusoe would consider the best available. However, he may decide, if it is a serviceable axe, to use it as a capital good and to wait until it wears out before replacing it with one of his choosing. On the other hand, he may feel that it is so blunt as to be of little use, and begin immediately to work on an axe of his own.
The conservatism of the past exercises a similar influence on the question of location, another aspect of the same problem. Thus, Crusoe may already have built his house, cleared a field, etc., in one portion of the island. Then, one day, in walking around the island, he might find a section at the other end with far greater advantages in fishing, fruits, etc. If he had not invested in any capital goods or durable consumers’ goods, he would immediately shift his location to this more abundant area. However, he has already invested in certain capital goods: some, such as the axe, are easily convertible to the new location; others, such as the cleared field and the house, cannot be converted in their location. Therefore, he has to decide on his value scale between the advantages and disadvantages of moving: the more abundant fish and fruits versus the necessity of working to build a new house, make a new clearing, etc. He might decide, for example, to stay in the house and clearing until they have worn down to a certain point, without working on a replacement, and then shift to the new location.
If an actor decides to abandon nonconvertible capital, such as the stick or the cleared field, in favor of producing other capital and consumers’ goods, he is not, as some may think, wasting his resources by allowing the emergence of “unused capacity” of his resources. When Crusoe abandons his clearing or stick or house (which may be considered in this connection as equivalent to capital), he is abandoning nonconvertible capital for the sake of using his labor in combination with natural elements or capital goods that he believes will yield him a greater utility. Similarly, if he refuses to go deep into a jungle for berries, he is not “wasting” his nonconvertible supply of land-and-berries, for he judges doing so of far less utility than other uses that he could make of his labor and time. The existence of a capital good not in use reveals an error made by this or by some previous actor in the past, but indicates that the actor expects to acquire a greater utility from other uses of his labor than he could obtain by continuing the capital good in its originally intended use or by converting it to some other use.38
This discussion provides the clue to an analysis of how actors will employ the original nature-given factors of production. In many cases, actors have their choice among the varying elements provided by nature. Thus, suppose that Crusoe, in his explorations of the island, finds that among the possible locations where he can settle, some are abundant in their output of berries (setting aside their production of other consumers’ goods), some less so, and some useless and barren. Clearly, other considerations being equal, he will settle on the most fertile—the “best” land—and employ this factor as far as is determined by the utility of its product, the possibility of investing in useful capital goods on the land, the value he places on leisure, etc. The poorer areas of land will remain unused. As stated above, this development is to be expected; there is no reason to be surprised at such evidence of “unused resources.” On the other hand, if the better areas are used up, then Crusoe will go on to utilize some of the next best areas, until the utility of the supply produced fails to exceed the utility of his leisure forgone. (“Next best” includes all the relevant factors, such as productivity, convenient access to the best land, etc.)
Areas of potential use, but which the actor chooses not to bring into use because it would not “pay” in terms of utilities forgone, are called submarginal areas. They are not objects of action at the moment, but the actor has them in mind for possible future use.
On the other hand, Crusoe's island may be so small or so barren that all his available useful land or water areas must be pressed into use. Thus, Crusoe might have to explore the whole island for his daily output of 200 berries. In that case, if his resources are such that he must always employ all the possibly useful nature-given factors, it is obvious that the actor is pretty close to the bare survival level.
In those cases where nature-given factors are worked on, “improved,” and maintained by human labor, these are, in effect, thereby changed into capital goods. Thus, land that has been cleared, tilled, plowed, etc., by human labor has become a capital good. This land is a produced good, and not an originally given good. Decisions concerning whether and how much to improve the soil, or whether to maintain it or extract the maximum present consumers’ goods at the expense of future losses (“erosion”), are on exactly the same footing as all capital-formation decisions. They depend on a comparison of the expected utility of future production as against the utility of present consumers’ goods forgone.
It is clear that capital formation and the concomitant lengthening of the period of production prolong the period of provision of the actor. Capital formation lengthens the period in the future for which he is providing for the satisfaction of wants. Action involves the anticipation of wants that will be felt in the future, an estimate of their relative urgency, and the setting about to satisfy them. The more capital men invest, the longer their period of provision will tend to be. Goods being directly and presently consumed are present goods. A future good is the present expectation of enjoying a consumers’ good at some point in the future. A future good may be a claim on future consumers’ goods, or it may be a capital good, which will be transformed into a consumers’ good in the future. Since a capital good is a way station (and nature-given factors are original stations) on the route to consumers’ goods, capital goods and nature-given factors are both future goods.
Similarly, the period of provision can be prolonged by lengthening the duration of serviceableness of the consumers’ goods being produced. A house has a longer durability than a crop of berries, for example, and Crusoe's investment in a house considerably lengthens his period of provision. A durable consumers’ good is consumed only partially from day to day, so that each day's consumption is that of a present good, while the stock of the remainder is a future good. Thus, if a house is built and will last 3,000 days, one day's use will consume 1/3,000 of it, while the remainder will be consumed in the future. One three-thousandth of the house is a present good, while the remaining part is a future good.39
It may be added that another method of lengthening the period of production is the simple accumulation of stocks of consumers’ goods to be consumed in the future instead of the present. For example, Crusoe might save a stock of 100 berries to be consumed a few days or a week later. This is often called plain saving, as distinguished from capitalist saving, in which saving enters into the process of capital formation.40 We shall see, however, that there is no essential difference between the two types of saving and that plain saving is also capitalist saving in that it too results in capital formation. We must keep in mind the vital fact that the concept of a “good” refers to a thing the units of which the actor believes afford equal serviceability. It does not refer to the physical or chemical characteristics of the good. We remember our critique of the popular fallacious objection to the universal fact of time preference—that, in any given winter, ice the next summer is preferred to ice now.41 This was not a case of preferring the consumption of the same good in the future to its consumption in the present. If Crusoe has a stock of ice in the winter and decides to “save” some until next summer, this means that “ice-in-the-summer” is a different good, with a different intensity of satisfaction, from “ice-in-the-winter,” despite their physical similarities. The case of berries or of any other good is similar. If Crusoe decides to postpone consuming a portion of his stock of berries, this must mean that this portion will have a greater intensity of satisfaction if consumed later than now—enough greater, in fact, to overcome his time preference for the present. The reasons for such difference may be numerous, involving anticipated tastes and conditions of supply on that future date. At any rate, “berries-eaten-a-week-from-now” become a more highly valued good than “berries-eaten-now,” and the number of berries that will be shifted from today's to next week's consumption will be determined by the behavior of the diminishing marginal utility of next week's berries (as the supply increases), the increasing marginal utility of today's berries (as the supply decreases), and the rate of time preference. Suppose that as a resultant of these factors, Crusoe decides to shift 100 berries for this purpose. In that case, these 100 berries are removed from the category of consumers’ goods and shifted to that of capital goods. These are the sort of capital goods, however, which, like wine, need only maturing time to be transferred into consumers’ goods, without the expenditure of labor (except the possible extra labor of storing and unstoring the berries).
It is clear, therefore, that the accumulation of a stock of consumers’ goods is also saving that goes into capital formation.42 The saved goods immediately become capital goods, which later mature into more highly valued consumers’ goods. There is no essential difference between the two types of saving.
- 32. In this sense, the stick might be called a “labor-saving device,” although the terminology is misleading. It is “labor-saving” only to the extent that the actor chooses to take the increased productivity in the form of leisure.
- 33. It is necessary to emphasize that independent acts of saving are necessary for replacement of goods, since many writers (e.g., J.B. Clark, Frank H. Knight) tend to assume that, once produced, capital, in some mystical way, reproduces itself without further need for acts of saving.
- 34. Cf. Frederic Benham, Economics (New York: Pitman Publishing, 1941), p. 162.
- 35. Böhm-Bawerk, Positive Theory of Capital, pp. 95–96. Also see Mises, Human Action, pp. 480–90, and pp. 476–514.
- 36. This uncertainty is a subjective feeling (“hunch” or estimate) and cannot be measured in any way. The efforts of many popular writers to apply mathematical “probability theory” to the uncertainty of future historical events are completely vain. Cf. Mises, Human Action, pp. 105–18.
- 37. That such a range of investment decisions enabling him to achieve greater future output must always be open to him is a fundamental truth derived from the assumption of human action. If they were not open to him, it would mean that man could not (or rather, believed that he could not) act to improve his lot, and therefore there would be no possibility of action. Since we cannot even conceive of human existence without action, it follows that “investment opportunities” are always available.
- 38. On the “unused capacity” bogey, see Benham, Economics, pp. 147–49.
- 39. Cf. Böhm-Bawerk, Positive Theory of Capital, pp. 238–44.
- 40. Plain saving is not to be confused with an earlier example, when Crusoe saved stocks of consumers’ goods to be consumed while devoting his labor to the production of capital.
- 41. See note 15 above.
- 42. The period of production will be equal to the time difference between the act of saving and the act of future consumption, as in all other cases of investment.