Chapter 4 Adam Smith and the Development of the Problem It has never, I think, been the good fortune of any founder of a scientific system to think out to the very end even the more important ideas that constitute his system. The strength and lifetime of no single man are sufficient for that. It is enough if some few of the ideas which have to play the chief part in the system are put on a perfectly safe foundation, and analysed in all their ramifications and complexities. It is a great deal if, over and above that, an equal carefulness falls to the lot of a few other favoured members of the system. But in all cases the most ambitious spirit must be content to build up a great deal that is insecure, and to fit into his system, on cursory examination, ideas which it was not permitted him to work out. We must keep these considerations before us if we would rightly appreciate Adam Smith's attitude towards our problem. Adam Smith has not overlooked the problem of interest; neither has he worked it out. He deals with it as a great thinker may deal with an important subject which he often comes across, but has not time or opportunity to go very deeply into. He has adopted a certain proximate but still vague explanation. The more indefinite this explanation is, the less does it bind him to strict conclusions; and a many-sided mind like Adam Smith's, seeing all the many different ways in which the problem can be put, but lacking the control which the possession of a distinct theory gives, could scarcely fail to fall into all sorts of wavering and contradictory expressions. Thus we have the peculiar phenomenon that, while Adam Smith has not laid down any distinct theory of interest, the germs of almost all the later and conflicting theories are to be found, with more or less distinctness, in his scattered observations. We find the same phenomenon in Adam Smith as regards many other questions. The line of thought which seems to commend itself principally to him as explaining natural interest occurs in very similar language in the sixth and eighth chapters of book i of the Wealth of Nations. It amounts to this, that there must be a profit from capital, because otherwise the capitalist would have no interest in spending his capital in the productive employment of labourers.(1*) General expressions like these have of course no claim to stand for a complete theory.(2*) There is no reasoned attempt in them to show what we are to represent as the actual connecting links between the psychological motive of the capitalist's self-interest and the final fixing of market prices which leave a difference between costs and proceeds that we call interest. But yet, if we take those expressions in connection with a later passage,(3*) where Smith sharply opposes the "future profit" that rewards the resolution of the capitalist to the "present enjoyment" of immediate consumption, we may recognise the first germs of that theory which Senior worked out later on under the name of the Abstinence theory. In the same way as Adam Smith asserts the necessity of interest, and leaves it without going any deeper in the way of proof, so does he avoid making any systematic investigation of the important question of the source of undertaker's profit. He contents himself with making a few passing observations on the subject. Indeed in different places he gives two contradictory accounts of this profit. According to one account, the profit of capital arises from the circumstance, that, to meet the capitalist's claim to profit, buyers have to submit to pay something more for their goods than the value which these goods would get from the labour expended on them. according to this explanation, the source of interest is an increased value given to the product over that value which labour creates; but no explanation of this increase in value is given. According to the second account, interest is a deduction which the capitalist makes in his own favour from the return to labour, so that the workers do not receive the full value created by them, but are obliged to share it with the capitalist. According to this account, profit is a part of the value created by labour and kept back by capital. Both accounts are to be found in a great number of passages; and these passages, oddly enough, sometimes stand quite close to each other, as, e.g. in the sixth chapter of the first book. Adam Smith has been speaking in that chapter of a past time, -- of course a mythical time, -- when the land was not yet appropriated, and when an accumulation of capital had not yet begun, and has made the remark that, at that time, the quantity of labour required for the production of goods would be the sole determinant of their price. He continues: "As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials. In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials and the wages of the workmen, something must be given for the profits of the undertaker of the work, who hazards his stock in this adventure." This sentence, when taken with the opposite remark of the previous paragraph (that, in primitive conditions, labour is the sole determinant of price), very clearly expresses the opinion that the capitalist's claim of interest causes a rise in the price of the product, and is met from this raised price. But Adam Smith immediately goes on to say: "The value which the workman adds to the material, therefore, resolves itself in this case into two parts, of which the one pays the wages, the other the profits of the employer upon the whole stock of materials and wages which he advanced." Here again the price of the product is looked upon as exclusively determined by the quantity of labour expended, and the claim of interest is said to be met by a part of the return which the worker has produced. We meet the same contradiction, put even more strikingly, a page farther on. "In this state of things," says Adam Smith, "the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him." This is an evident paraphrase of the second account. But immediately after that come the words: "Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour." He could scarcely have said more plainly that the effect of a claim of interest is to raise prices without curtailing the wages of labour. Later on he says alternately: "As in a civilised community there are but few commodities of which the exchangeable value arises from labour only, rent and profit contributing largely to that of the far greater part of them, so the annual produce of its labour will always be sufficient to purchase or command a much greater quantity of labour than was employed in raising, preparing, and bringing that produce to market" (first account, chap. vi.) "The produce of almost all other labour is liable to the like deduction of profit. In all arts and manufactures the greater part of the workmen stand in need of a master to advance them the materials of their work, and their wages and maintenance till it be completed. He shares in the produce of their labour, or in the value which it adds to the materials upon which it is bestowed; and in this consists his profit" (second account, chap. viii.) "High or low wages and profit are the causes of high or low price; high or low rent is the effect of it" (first account, chap. xi.) Contradictions like these on the part of such an eminent thinker admit, I think, of only one explanation; -- that Adam Smith had not thoroughly thought out the interest problem; and -- as is usual with those who have only imperfectly mastered a subject -- was not very particular in his choice of expressions, but allowed himself to be swayed very much by the changing impressions which the subject may have made on him from time to time. Adam Smith, then, has no perfected theory of interest.(4*) But the suggestions he threw out were all destined to fall on fruitful soil. His casual remark on the necessity of interest was developed later into the Abstinence theory. In the same way the two accounts he gave of the source of interest were taken up by his followers, logically carried out, and raised into principles of independent theories. With the first account -- that interest is paid out of an additional value which the employment of capital calls into existence -- are connected the later Productivity theories. With the second account -- that interest is paid out of the return to labour -- are connected the Socialist theories of interest. Thus the most important of later theories trace their pedigree back to Adam Smith. The position taken by Adam Smith towards the question may be called that of a complete neutrality. He is neutral in his theoretical exposition, for he takes the germs of distinct theories and puts them beside each other, without giving any one of them a distinct prominence over the others. And he is neutral in his practical judgment, for he maintains the same reserve, or rather the same contradictory hesitancy, both in praise and blame of interest. Sometimes he commends the capitalists as benefactors of the human race, and as authors of enduring blessing;(5*) sometimes he represents them as a class who live on deductions from the produce of other people's labour, and compares them significantly with people "who love to reap where they never sowed."(6*) In Adam Smith's time the relations of theory and practice still permitted such a neutrality, but it was not long allowed to his followers. Changed circumstances compelled them to show their colours on the interest question, and the compulsion was certainly not to the disadvantage of the science. The special requirements of economic theory could not any longer put up with uncertain makeshifts. Adam Smith had spent his life in laying down the foundations of his system. His followers, finding the foundations laid, had now time to take up those questions that had been passed over. The development now reached by the related problems of land-rent and wages gave a strong inducement to pursue the interest problem. There was a very complete theory of land-rent; there was a theory of wages scarcely less complete. Nothing was more natural than that systematic thinkers should now begin to ask in earnest about the third great branch of income the whence and wherefore of the income that comes from the possession of capital. But in the end practical life also began to put this question. Capital had gradually become a power. Machinery had appeared on the scene and won its great triumphs; and machinery everywhere helped to extend business on a great scale, and to give production more and more of a capitalist character. But this very introduction of machinery had begun to reveal an opposition which was forced on economic life with the development of capital, and daily grew in importance,the opposition between capital and labour. In the old handicrafts undertaker and wage-earner, master and apprentice, belonged not so much to different social classes as simply to different generations. What the one was the other might be, and would be. If their interests for a time did diverge, yet in the long run the feeling prevailed that they belonged to one station of life. It is quite different in great capitalist industry. The undertaker who contributes the capital has seldom or never been a workman; the workman who contributes his thews and sinews will seldom or never become an undertaker. They work at one trade like master and apprentice; but not only are they of two different ranks, they are even of different species. They belong to classes whose interests diverge as widely as their persons. Now machinery had shown how sharp could be the collision of interest between capital and labour. Those machines which bore golden fruit to the capitalist undertaker had, on their introduction, deprived thousands of workers of their bread. Even now that the first hardships are over there remains antagonism enough and to spare. It is true that capitalist and labourer share in the productiveness of capitalist undertaking, but they share in this way, that the worker usually receives little -- indeed very little -- while the undertaker receives much. The worker's discontent with his small share is not lessened, as it used to be in the case of the handicraft assistant, by the expectation of himself in time enjoying the lion's share; for, under large production, the worker has no such expectation. On the contrary, his discontent is aggravated by the knowledge that to him, for his scanty wage, falls the harder work; while to the undertaker, for his ample share in the product, falls the lighter exertion-often enough no personal exertion whatever. Looking at all these contrasts of destiny and of interest, if there ever came the thought that, at bottom, it is the workers who bring into existence the products from which the undertaker draws his profit -- and Adam Smith had come wonderfully near to such a thought in many passages of his widely read book -- it was inevitable that some pleader for the fourth estate should begin to put the same question with regard to natural interest as had been put many centuries earlier, by the friends of the debtor, with regard to Loan interest, Is interest on capital just? Is it just that the capitalist-undertaker, even if he never moves a finger, should receive, under the name of profit, a considerable share of what the workers have produced by their exertions? Should not the entire product rather fall to the workers? The question has been before the world since the first quarter of our century, at first put modestly, then with increasing assertiveness; and it is this fact that the interest theory has to thank for its unusual and lasting vitality. So long as the problem interested theorists alone, and was of importance only for purposes of theory, it might have slumbered on undisturbed. But it was now elevated to the rank of a great social problem which the science neither could nor would overlook. Thus the inquiries into the nature of Natural interest were as numerous and solicitous after Adam Smith's day as they had been scanty and inadequate before it. It must be admitted that they were as averse as they were numerous. Up till Adam Smith the scientific opinion of the time had been represented by one single theory. After him opinion was divided into a number of theories conflicting with each other, and remaining so with rare persistence up till our own day. It is usually the case that new theories put themselves in the place of the old, and the old gradually yield the position. But in the present case each new theory of interest only succeeded in placing itself by the side of the old, while the old managed to hold their place with the utmost stubbornness. In these circumstances the course of development since Adam Smith's time presents not so much the picture of a progressive reform as that of a schismatic accumulation of theories. The work we have now before us is clearly marked out by the nature of the subject. It will consist in following the development of all the diverging systems from their origin down to the present time, and in trying to form a critical opinion on the value, or want of value, of each individual system. As the development from Adam Smith onwards simultaneously pursues different lines, I think it best to abandon the chronological order of statement which I have hitherto observed, and to group together our material according to theories. To this end I shall try first of all to make a methodical survey of the whole mass of literature which will occupy our attention. This will be most easily done by putting the characteristic and central question of the problem in the foreground. We shall then see at a glance how the theory differentiates itself on that central question like light on the prism. What we have to explain is the fact that, when capital is productively employed, there regularly remains over in the hinds of the undertaker a surplus proportional to the amount of this capital. This surplus owes its existence to the circumstance that the value of the goods produced by the assistance of capital is regularly greater than the value of the goods consumed in their production. The question accordingly is, Why is there this constant surplus value? To this question Turgot had answered, There must be a surplus, because otherwise the capitalists would employ their capital in the purchase of land. Adam Smith had answered, There must be a surplus, because otherwise the capitalist would have no interest in spending his capital productively. Both answers we have already pronounced insufficient. What then are the answers given by later writers? At the outset they appear to me to follow five different lines. One party is content with the answers given by Turgot and Smith, and stands by them. This line of explanation was still a favourite one at the beginning of our century, but has been gradually abandoned since then. I shall group these answers together under the name of the Colourless theories. A second party says, Capital produces the surplus. This school, amply represented in economic literature, may be conveniently called that of the Productivity theories. I may here note that in their later development we shall find the productivity theories splitting up into many varieties; into Productivity theories in the narrower sense, that assume a direct production of surplus on the part of capital; and into Use theories, which explain the origin of interest in the roundabout way of making the productive use of capital a peculiar element in cost, which, like every other element of cost, demands compensation. A third party answers, Surplus value is the equivalent of a cost which enters as a constituent into the price, viz. abstinence. For in devoting his capital to production the capitalist must give up the present enjoyment of it. This postponement of enjoyment, this "abstinence," is a sacrifice, and as such is a constituent element in the costs of production which demands compensation. I shall call this the Abstinence theory. A fourth party sees in surplus value the wage for work contributed by the capitalist. For this doctrine, which also is amply represented, I shall use the name Labour theory. Finally, a fifth party -- for the most part belonging to the socialist side -- answers, Surplus value does not correspond to any natural surplus whatever, but has its origin simply in the curtailment of the just wage of the workers. I shall call this the Exploitation theory. These are the principal lines of explanation. They are certainly numerous enough, yet they are far from exhibiting all the many forms which the interest theory has taken. We shall see rather that many of the principal lines branch off again into a multitude of essentially different types; that in many cases elements of sever theories are bound up in a new and peculiar combination; and that, finally, within one and the same theoretical type, the different ways in which common fundamental thoughts are formulated, are often so strongly contrasted and so characteristic that there would be some justification in recognising individual shades of difference as separate theories. That our prominent economic writers have exerted themselves in so many different ways for the discovery of the truth is an eloquent witness of its discovery being no less important than it is hard. We begin with a survey of the Colourless theories. NOTES: 1. "In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials and the wages of the workmen, something must be given for the profits of the undertaker of the work, who hazards his stock in the adventure.... He could have no interest to employ them unless he expected from the sale of their work something more than what was sufficient to replace his stock to him; and he could have no interest to employ a great stock rather than a small one unless his profits were to bear some proportion to the extent of his stock" (M'Culloch's edition of 1863, p. 22). The second passage runs: "And who would have no interest to employ him unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit" (p. 30). 2. See also Pierstorff, Lehre vom Unternehmerggwinn, Berlin, 1875, p. 6; and Platter, "Der Kapitalgewinn bei Adam Smith" (Hildebrand's Jahrbücher, vol. xxv. p. 317, etc.) 3. Book ii. chap. i. p. 123, in M'Culloch's edition. 4. When Plater in the essay above mentioned (p. 71) comes to the conclusion that, "if Smith's system be taken strictly, profit on capital appears unjustifiable," it could only be by laying all the weight on the one half of Smith's expressions, and leaving the other out of account as contradictory to his other principles. 5. Book ii. chap. iii. 6. Book i. chap. vi. The sentence was written primarily about landowners, but in the whole chapter interest on capital and rent of land are treated as parallel as against wages of labour.