If capital is to be accumulated, it is evident that society in general must abstain in this sense, the real problem being how to prevent consumption from rising until it absorbs all output, or even more than all output, especially in poor societies. Interest and profit are then regarded as rewards for what is a perfectly real activity — that of not consuming as much as income allows — even if it is a negative one.
It is argued that if the rate of interest and profit were zero, there would be no incentives to abstain from consuming as much as income allows, or from consuming one’s own capital, in which case society would decline. The rate of saving or accumulation is then regarded as a function of the rate of return on capital, and since the accumulation of capital increases the capacity to create income in the future, what the rest of society receives from capitalist recipients of interest and profits is the hope of higher incomes in the future.
It is interesting to observe how many of the ideas of later authors are in fact implicit in Senior’s work.
The next economist who dealt extensively with this problem was Böhm-Bawerk, who had the advantage of writing after the Marxist critique and was an acute critic of Marx. Böhm-Bawerk regarded physical capital as a population of goods, according to which a good was born when it was produced and died when it was consumed.
The growth of the capital structure increased society’s productivity, but this meant that the “average period of production” — that is, the average interval of time between the birth and death of goods — had to increase and production had to become more “roundabout.”
Here again, interest and profit had to be paid to people to persuade them not to diminish, but rather to increase, their capital by postponing consumption, and consequently by making goods exist for a longer time and allowing the establishment of longer-lasting and more productive production processes.
The weakness of Böhm-Bawerk’s theory was the absence of a dynamic element; his theory is in fact a comparative statics of stationary states and therefore casts little light on the dynamic realities of the world. Even so, in a field as difficult as this one, even a little light has some value.
Marshall worked from Senior, using the expression “waiting” instead of “abstinence” as a more neutral term, but essentially it was the same thing. Irving Fisher clarified Böhm-Bawerk’s work in what remains the definitive neoclassical work in this field.
In his great book on the theory of interest, he considers interest essentially as a property of exchanges through time, arising from a dual set of properties of the system. On the money supply side, from the demand for bonds, it arises because there is time preference — that is, impatience — which limits people’s willingness to save and to give present money or goods in exchange for bonds. On the demand for money side, from the supply of bonds, it arises because there is time productivity — that is, more products in the future as a result of restraining natural impatience.
The real problem here, as Böhm-Bawerk also saw very clearly, is not that of any supposed productivity of physical capital, but that of the evaluation of expected future benefits. Interest — and the same may be said of profit — exists if 1,000 dollars of benefits, at constant prices, of any kind in the future are worth less than 1,000 dollars now.
The rate of interest or profit is then that rate of growth at which present value must grow in order to become future value. Thus, if 1,000 dollars now are worth 1,050 dollars one year from now, the interest rate is 5 percent per year. If the value is 950 dollars now, the interest rate is approximately 10 percent per year, so that it is the market value of future expectations that determines the interest rate.
In any case, the question remains: “Why is this value not so high that the interest rate is zero?” Marx and the Marxists mocked the “abstinence” of rich capitalists. Quite rightly, Marx pointed to the phenomenon he called “primitive accumulation” — that is, the concentration of productive resources in the hands of particular individuals through conquest, plunder, extortion, marriage and other non-market mechanisms — and argued that once capital was concentrated in the hands of a few rich people, abstinence was very easy for them, while abstinence by the poor was prohibitively costly and often meant sacrificing the true essential needs of life.
A person at the subsistence level cannot save — abstain from consuming — at all, for any kind of reward. We might argue, of course, that some kind of primitive accumulation is necessary to reduce the cost of abstinence and therefore make capital accumulation and the resulting development possible.
Socialist countries have now come to recognize that something like a rate of return on capital, at least in the form of a rate of time preference, is necessary even in socialist accounting. Otherwise, too many resources are devoted to investment, so that there is too much sacrifice by the present generation for the benefit of future generations, which is extremely difficult to justify by any principle of social justice.
If the interest rate, or at least the rate of time preference, is too low, there may also be too much investment in production processes with a long maturation period, and not enough in short-term investments. This can easily lead to a disastrous waste of investment in projects that cannot be completed because of an excessive commitment of investment resources in the past.
