What Is Capital?Tags Capital and Interest Theory
[Editor's note: In this selection, Bastiat explains the role of capital in building wealth, and why it is moral and proper that owners of capital ought to collect interest on the capital they lend out. Excerpt from chapter 5, "Capital and Interest," in The Bastiat Collection (Auburn, AL: Mises Institute, 2011), pp. 147–58. ]
3. What Is Capital?
There are some persons who imagine that capital is money, and this is precisely the reason why they deny its productiveness; for, as John Ruskin and others say, dollars are not endowed with the power of reproducing themselves. But it is not true that capital and money are the same thing.
Before the discovery of the precious metals, there were capitalists in the world; and I venture to say that at that time, as now, everybody was a capitalist, to a certain extent.
What is capital, then? It is composed of three things:
First, of the materials upon which men operate, when these materials have already a value communicated by human effort, which has bestowed upon them the property of exchangeability — wool, flax leather, silk, wood, etc.
Second, instruments that are used for working — tools, machines, ships, carriages, etc.
Third, provisions that are consumed during labor — victuals, fabrics, houses, etc.
Without these things the labor of man would be unproductive and almost void; yet these very things have required much work, especially at first. This is the reason that so much value has been attached to the possession of them, and also that it is perfectly lawful to exchange and to sell them, to make a profit off them if used, to gain remuneration from them if lent. Now for my anecdotes.
4. The Sack of Corn
William, in other respects as poor as Job, and obliged to earn his bread by day-labor, became, nevertheless, by some inheritance, the owner of a fine piece of uncultivated land. He was exceedingly anxious to cultivate it. “Alas!” said he, “to make ditches, to raise fences, to break the soil, to clear away the brambles and stones, to plow it, to sow it, might bring me a living in a year or two; but certainly not today, or tomorrow. It is impossible to set about farming it, without previously saving some provisions for my subsistence until the harvest; and I know by experience that preparatory labor is indispensable in order to render present labor productive.”
The good William was not content with making these reflections. He resolved to work by the day, and to save something from his wages to buy a spade and a sack of corn, without which things he must give up his agricultural projects. He acted so well, was so active and steady, that he soon saw himself in possession of the wished-for sack of corn. “I shall have enough to live upon till my field is covered with a rich harvest.” Just as he was starting, David came to borrow his accumulation of food of him. “If you will lend me this sack of corn,” said David, “you will do me a great service; for I have some very lucrative work in view, which I cannot possibly undertake for want of provisions to live upon till it is finished.” “I was in the same situation,” answered William; “and if I have now secured bread for several months, it is at the expense of my arms and my stomach. Upon what principle of justice can it be devoted to the carrying out of your enterprise instead of mine?”
You may well believe that the bargain was a long one. However, it was finished at length, and on these conditions:
First — David promised to give back, at the end of the year, a sack of corn of the same quality, and of the same weight, without missing a single grain. “This first clause is perfectly just,” said he, “for without it William would give, and not lend.”
Second — He further engaged to deliver one-half bushel of corn for every five bushels originally borrowed, when the loan was returned. “This clause is no less just than the other,” thought he; “for unless William would do me a service without compensation, he would inflict upon himself a privation — he would renounce his cherished enterprise — he would enable me to accomplish mine — he would cause me to enjoy for a year the fruits of his savings, and all this gratuitously. Since he delays the cultivation of his land, since he enables me to prosecute a lucrative employment, it is quite natural that I should let him partake, in a certain proportion, of the profits that I shall gain by the sacrifice he makes of his own profits.”
On his side, William, who was something of a scholar, made this calculation: “Since by virtue of the first clause, the sack of corn will return to me at the end of a year,” he said to himself, “I shall be able to lend it again; it will return to me at the end of the second year; I may lend it again, and so on, to all eternity. However, I cannot deny that it will have been eaten long ago.”
It is singular that I should be perpetually the owner of a sack of corn, although the one I have lent has been consumed forever. But this is explained thus: It will be consumed in the service of David. It will enable David to produce a greater value; and consequently, David will be able to restore me a sack of corn, or the value of it, without having suffered the slightest injury; but on the contrary, having gained from the use of it. And as regards myself, this value ought to be my property, as long as I do not consume it myself. If I had used it to clear my land, I should have received it again in the form of a fine harvest. Instead of that, I lend it, and shall recover it in the form of repayment.
“From the second clause, I gain another piece of information. At the end of the year I shall be in possession of one bushel of corn for every ten that I may lend. If, then, I were to continue to work by the day, and to save part of my wages, as I have been doing, in the course of time I should be able to lend two sacks of corn; then three; then four; and when I should have gained a sufficient number to enable me to live on these additions of a half a bushel over and above and on account of every ten bushels lent, I shall be at liberty to take a little repose in my old age. But how is this? In this case, shall I not be living at the expense of others? No, certainly, for it has been proved that in lending I perform a service; I make more profitable the labor of my borrowers, and only deduct a trifling part of the excess of production, due to my lendings and savings. It is a marvelous thing that a man may thus realize a leisure that injures no one, and for which he cannot be reproached without injustice.”
5. The House
Again, Thomas had a house. In building it, he had extorted nothing from any one whatever. He obtained it by his own personal labor, or, which is the same thing, by the labor of others justly rewarded. His first care was to make a bargain with a handyman, in virtue of which, on condition of the payment of a hundred dollars a year, the latter engaged to keep the house in constant good repair. Thomas was already congratulating himself on the happy days he hoped to spend in this pleasant home, which our laws declared to be his own exclusive property. But Richard wished to use it also as his residence.
“How can you think of such a thing?” said Thomas to Richard. “It is I who have built it; it has cost me ten years of painful labor, and now you would come in and take it for your enjoyment?” They agreed to refer the matter to judges. They chose no profound economists — there were none such in the country. But they found some just and sensible men; it all comes to the same thing; political economy, justice, good sense, are all the same thing. And here is the decision made by the judges: If Richard wishes to occupy Thomas’s house for a year, he is bound to submit to three conditions. The first is to quit at the end of the year, and to restore the house in good repair, saving the inevitable decay resulting from mere duration. The second, to refund to Thomas the one hundred dollars Thomas pays annually to the handyman to repair the injuries of time; for these injuries taking place while the house is in the service of Richard, it is perfectly just that he should bear the expense. The third, that he should render to Thomas a service equivalent to that which he receives. And as to what shall constitute this equivalence of services, this must be left for Thomas and Richard to mutually agree upon.
6. The Plane
One further illustration to the same ethic. A very long time ago there lived in a poor village, a carpenter, who was a philosopher, as all my heroes are in their way. James worked from morning till night with his two strong arms, but his brain was not idle for all that. He was fond of reviewing his actions, their causes, and their effects. He sometimes said to himself, “With my hatchet, my saw, and my hammer, I can make only coarse furniture, and can only get the pay for such. If I only had a plane, I should please my customers more, and they would pay me more. But this is all right; I can only expect services proportioned to those which I render myself. Yes! I am resolved, I will make myself a plane.”
However, just as he was setting to work, James reflected further: “I work for my customers 300 days in the year. If I give ten to making my plane, supposing it lasts me a year, only 290 days will remain for me to make my furniture. Now, in order that I be not the loser in this matter, I must earn henceforth, with the help of the plane, as much in 290 days as I now do in 300. I must even earn more; for unless I do so, it would not be worth my while to venture upon any innovations,” James began to calculate. He satisfied himself that he should sell his finished furniture at a price which would amply compensate him for the ten days devoted to the plane; and when no doubt remained in his mind on this point, he set to work. I beg the reader to note, that the power that exists in the tool to increase the productiveness of labor, is the basis for the successful solution of the experiment that James the carpenter proposed to make.
At the end of ten days, James had in his possession an admirable plane, which he valued all the more for having made it himself. He danced for joy — for like the girl with her basket of eggs, he reckoned in anticipation all the profits he expected to derive from the ingenious instrument; but, more fortunate than she, he was not reduced to the necessity of saying good-by, when the eggs were smashed, to the expected calf, cow, pig, as well as the eggs, together. He was building his fine castles in the air, when he was interrupted by his acquaintance William, a carpenter in the neighboring village. William having admired the plane, was struck with the advantages that might be gained from it. He said to James:
W. You must do me a service.
J. What service?
W. Lend me the plane for a year.
As might be expected, James at this proposal did not fail to cry out, “How can you think of such a thing, William? But if I do you this service, what will you do for me in return?”
W. Nothing. Don’t you know that John Ruskin says a loan ought to be gratuitous? Don’t you know that Proudhon and other notable writers and friends of the laboring classes assert that capital is naturally unproductive? Don’t you know that all the new school of liberal advanced writers say we ought to have perfect fraternity among men? If you only do me a service for the sake of receiving one from me in return, what merit would you have?
J. William, my friend, fraternity does not mean that all the sacrifices are to be on one side; if so, I do not see why they should not be on yours. Whether a loan should be gratuitous I don’t know but I do know that if I were to lend you my plane for a year it would be giving it you. To tell you the truth, that was not what I made it for.
W. Well, we will say nothing about the modern maxims discovered by the friends of the working classes. I ask you to do me a service; what service do you ask me in return?
J. First, then, in a year the plane will be used up, it will be good for nothing. It is only just that you should let me have another exactly like it; or that you should give me money enough to get it repaired; or that you should supply me the ten days which I must devote to replacing it.
W. This is perfectly just. I submit to these conditions. I engage to return it, or to let you have one like it, or the value of the same. I think you must be satisfied with this, and can require nothing further.
J. I think otherwise. I made the plane for myself, and not for you. I expected to gain some advantage from it, by my work being better finished and better paid; by improving my condition. What reason is there that I should make the plane, and you should gain the profit? I might as well ask you to give me your saw and hatchet! What a confusion! Is it not natural that each should keep what he has made with his own hands, as well as his hands themselves? To use without recompense the hands of another, I call slavery; to use without recompense the plane of another, can this be called fraternity?
W. But, then, I have agreed to return it to you at the end of a year, as well polished and as sharp as it is now.
J. We have nothing to do with next year; we are speaking of this year. I have made the plane for the sake of improving my work and condition: if you merely return it to me in a year, it is you who will gain the profit of it during the whole of that time. I am not bound to do you such a service without receiving anything from you in return; therefore, if you wish for my plane, independently of the entire restoration already bargained for, you must do me a service which we will now discuss; you must grant me remuneration.
And this was what the two finally agreed upon: William granted a remuneration calculated in such a way that, at the end of the year, James received his plane quite new, and in addition a new plank, as a compensation for the advantages of which he had deprived himself in lending the plane to his friend.
It was impossible for anyone acquainted with the transaction to discover the slightest trace in it of oppression or injustice.
The singular part of it is, that, at the end of the year, the plane came into James’s possession, and he lent it again; recovered it, and lent it a third and fourth time. It has passed into the hands of his son, who still lends it. Poor plane! How many times has it changed, sometimes its blade, sometimes its handle. It is no longer the same plane, but it has always the same value, at least for James’s posterity. Workmen; let us examine further these little stories.
I maintain, first of all, that the sack of corn and the plane are here the type, the model, a faithful representation, the symbol of all capital; as the half bushel of corn and the plank are the type, the model, the representation, the symbol of all interest. This granted, the following are, it seems to me, a series of consequences, the justice of which it is impossible to dispute.
First. If the yielding of a plank by the borrower to the lender is a natural, equitable, lawful remuneration, the just price of a real service, we may conclude that, as a general rule, it is in the nature of capital when loaned or used to produce interest. When this capital, as in the foregoing examples, takes the form of an instrument of labor, it is clear enough that it ought to bring an advantage to its possessor, to him who has devoted to it his time, his brains, and his strength. Otherwise, why should he have made it? No necessity of life can be immediately satisfied with instruments of labor; no one eats planes or drinks saws, unless, of course, he is a magician. If a man determines to spend his time in the production of such things, he must have been led to it by the consideration of the increased power these instruments give to him; of the time which they save him; of the perfection and rapidity they give to his labor; in a word, of the advantages they procure for him. Now these advantages, which have been obtained by labor, by the sacrifice of time that might have been used for other purposes, are we bound, as soon as they are ready to be enjoyed, to confer them gratuitously upon another? Would it be an advance in social order if the law so stated, and citizens should pay officials for enforcing such a law by force? I venture to say that there is not one amongst you who would support it. It would be to legalize, to organize, to systematize injustice itself, for it would be proclaiming that there are men born to render, and others born to receive, gratuitous services. Grant, then, that interest is just, natural, and expedient.
Second. A second consequence, not less remarkable than the former, and, if possible, still more conclusive, to which I call your attention, is this: Interest is not injurious to the borrower. I mean to say, the obligation in which the borrower finds himself, to pay a remuneration for use of capital, cannot do any harm to his condition. Observe, in fact, that James and William are perfectly free, as regards the transaction to which the plane gave occasion. The transaction cannot be accomplished without the consent of one as well as of the other. The worst that can happen is that James may ask too much; and in this case, William, refusing the loan, remains as he was before. By the fact of his agreeing to borrow, he proves that he considers it an advantage to himself; he proves that after every calculation, whatever may be the remuneration or interest required of him, he still finds it more profitable to borrow than not to borrow. He only determines to do so because he has compared the inconveniences with the advantages. He has calculated that the day on which he returns the plane, accompanied by the remuneration agreed upon, he will have effected more work, with the same labor, thanks to this tool. A profit will remain to him, otherwise he would not have borrowed. The two services of which we are speaking are exchanged according to the law that governs all exchanges, the law of supply and demand. The demands of James have a natural and impassable limit. This is the point at which the remuneration demanded by him would absorb all the advantage that William might find in making use of a plane. In this case, the borrowing would not take place. William would be bound either to make a plane for himself, or do without one, which would leave him in his original condition. He borrows because he gains by borrowing. I know very well what will be told me. You will say, William may be deceived, or, perhaps, he may be governed by necessity, and be obliged to submit to a harsh law.
It may be so. As to errors in calculation, they belong to the infirmity of our nature, and to argue from this against the transaction in question, is objecting to the possibility of loss in all imaginable transactions, in every human act. Error is an accidental fact, which is incessantly remedied by experience. In short, everybody must guard against it. As far as those hard necessities are concerned that force persons to borrow under onerous conditions, it is clear that these necessities existed previously to the borrowing. If William is in a situation in which he cannot possibly do without a plane, and must borrow one at any price, does this situation result from James having taken the trouble to make the tool? Does it not exist independently of this circumstance? However harsh, however severe James may be, he will never render the supposed condition of William worse than it is. Morally, it is true, the lender will be to blame if he demands more than is just; but in an economical point of view, the loan itself can never be considered responsible for previous necessities, which it has not created, and which it relieves to a certain extent. But this proves something to which I shall return. It is evidently for the interest of William, representing here the borrowers, that there shall be many Jameses and planes, or, in other words, lenders and capitals. It is very evident that if William can say to James, “Your demands are exorbitant; there is no lack of planes in the world;” he will be in a better situation than if James’s plane was the only one he could borrow. Assuredly, there is no maxim more true than this — service for service. But let us not forget that no service has a fixed and absolute value compared with others. The contracting parties are free. Each pushes his advantage to the farthest possible point, and the most favorable circumstance for these advantages is the absence of rivalship. Hence it follows that if there is a class of men more interested than any other in the creation, multiplication, and abundance of capital goods, it is mainly that of the borrowers. Now, since capital goods can only be formed and increased by the stimulus and the prospect of remuneration, let this class understand the injury they are inflicting on themselves when they deny the lawfulness of interest, when they proclaim that credit should be gratuitous, when they declaim against the pretended tyranny of capital, when they discourage saving, thus forcing capital to become scarce, and consequently interest to rise.
Third. The anecdote I have just related enables you to explain this apparently objectionable phenomenon, which is termed the duration or perpetuity of interest. Since, in lending his plane, James has been able, very lawfully, to make it a condition that it should he returned to him at the end of a year in the same state in which it was when he lent it, is it not evident that he may, at the expiration of the term, lend it again on the same conditions? If he resolves upon the latter plan, the plane will return to him at the end of every year, and that without end. James will then be in a condition to lend without end; that is, he may derive from it a perpetual interest. It will be said that the plane will be worn out. That is true; but it will be worn out by the hand and for the profit of the borrower. The latter has taken this gradual wear into account and taken upon himself, as he ought, the consequences. He has reckoned that he shall derive from this tool an advantage that will allow him to restore it to its original condition after having realized a profit from it. As long as James does not use this capital himself, or for his own advantage — as long as he renounces the advantages that allow it to be restored to its original condition — he will have an incontestable right to have it restored, and that independently of interest.
Observe besides that if, as I believe I have shown, James, far from doing any harm to William, has done him a service in lending him his plane for a year; for the same reason, he will do no harm to a second, a third, a fourth borrower, in the subsequent periods. Hence you may understand that the interest from capital is as natural, as lawful, as useful, in the thousandth year, as in the first. We may go still further. It may happen that James lends more than a single plane. It is possible, that by means of working, of saving, of privations, of discipline, of activity, he may come to be able to lend a multitude of planes and saws; that is to say, to do a multitude of services.
I insist upon this point — that if the first loan has been a social good, it will be the same with all the others; for they are all similar, and based upon the same principle. It may happen, then, that the amount of all the remunerations received by our honest operative, in exchange for services rendered by him, may suffice to maintain him. In this case, there will be a man in the world who has a right to live without working. I do not say that he would be doing right to give himself up to idleness — but I say that he has a right to do so; and if he does so, it will be at nobody’s expense, but quite the contrary. If society at all understands the nature of things, it will acknowledge that this man subsists on services that he receives certainly (as we all do), but that he receives lawfully in exchange for other services, that he himself has rendered, that he continues to render, and that are real services, inasmuch as they are freely and voluntarily accepted.