Notes on Teaching the Laws of Wages and Interest
by Lindy Davies
Today we're to talk about teaching the Laws of Wages and Interest. These are part of the the Laws of Distribution. Let's be sure we're clear on what that means. What is it that is being distributed, and who are the recipients? It's important to keep this in mind, because the mainstream/conventional wisdom keeps doing its best to confound it.
Now, after we're done today, take the "Deconstructing" handout home, and think about where it fits in the course. At first, I thought it was about definitions of the factors of production, but I was wrong. The part of our analysis that Neo-Classical Economics is hell-bent on fouling up is the Laws of Distribution. They cannot allow people to find out that such a thing exists. (Why not?)
Anyway, you say you're OK on the Law of Rent — which is what?
Rent depends on the margin of production. What was that, again?
The free land, of course — the least productive land in use. But isn't that irrelevant in the modern world? Where is free land today?
(The answer to this is an illustration of the vast extent of land speculation in today's economy, with the reminder that economically, land is measured not in area but in value. If there were not this wasteful non- and under-use of land, there would be plenty of free land, in places like Jackson, Maine — see "Life at the Margin")
But in any case, the margin of production doesn't disappear just because it goes down to Zero. On the contrary — and this is very important to realize — down to zero is exactly where the margin of production currently is. So what are the implications of this?
We will be able to understand that once we grasp the laws of wages and interest.
Now, what is interest, exactly? "Economic interest" is a kind-of old school term. Some say it is too confusing to have to separate it from the more commonly-understood sense of "financial interest" — and they advocate using a whole separate term: capital yield. That makes some sense. But whether we call it "economic interest" or "capital yield", we have to keep in mind that we're talking about the return to capital as we've defined it: wealth that is used in production.
Often, "Capital" is spoken of as a class of people — the "capitalists". Perhaps it goes without saying (or perhaps not) we are NOT defining capital as a class of people. Capital is a class of things, and interest (capital yield) goes to the owners of those things.
Who makes the decisions about how to use capital and how much to charge for it, etc.? Not capital, because capital cannot make decisions. Only labor can make decisions. "Entrepreneurial decisions" are made by labor.
How, then, can the class of "capitalists" "exploit" the class of "laborers"? Well, they can — and they do. Make no mistake about it. But that statement depends on a different definition of "capital" than we are using here! That definition must, by necessity, include the holders of privilege — owners of advantages that allow them to collect wealth they did not produce.
OK, so now we're clear on what capital and interest are, in political economy. The next question we need to tackle is: why is there interest? Why is it OK that if labor needs certain tools and equipment to produce wealth, it has to pay owners of the tools and equipment for access to them?
Capital gives labor the advantage of having now what it would be able to make later (as in the example of the plane and the plank). But — if that were the only kind of advantage that came from capital, interest wouldn't be justified. Why not? Because the only advantage that comes from capital in that case is its use. Any charge above the cost of maintenance would be a robbery of labor.
What other kinds of advantage can capital provide?
Fructification, and trade. In both cases, capital has the power to increase in value independently of anything labor does to it.
But, we wouldn't be able to use the fructification/trade kind of capital, if we didn't also employ the kind of capital — like shovels, saws, trucks, cash registers, etc. — whose only value is in their use. But! Fructification/trade capital is capable of increasing in value, all by itself — whereas mere-use capital is not! So, to make sure that the mere-use kind of capital is supplied, it will have to get the same return as the fructification/trade capital.
OK, so this shows why/how capital is due some return. And we can clearly see how/why the rent slice of the pie goes to landowners. (Can't we?)
How is the remaining wealth divided between workers and capital owners?
This isn't hard to see if we can remember the bargaining positions of the factors.
Labor needs to eat, sleep and be warm — it needs to work, today. If labor can get access to usable land, labor can work. So the very least that labor will accept is equivalent to what it can get, working for itself, on the best freely-available land. This, folks, is the Law of Wages.
But it can't do much on that land without capital, can it? Labor can see how much more it could accomplish with the use of capital, and it is willing to pay to get it. How much will it have to pay?
Now, this is the kind of thing that modern-day economics is very good at — marginal-cost pricing and such. But Henry George anticipated such thinking in Progress and Poverty. He reasoned that the return to the owner of capital would depend on its best available alternative (its opportunity cost, in other words*). We've already seen this sort of thinking, in equating the return of fructification/trade capital with that of use-only capital. So: what are your alternatives as a capital owner?
You could use your capital at the center of innovation and productivity — and pay a high price for access to the very valuable land there. Or, you could use your capital where the land is free. It's pretty easy to see: subtract the premium you'd have to pay for use of land in better locations, and what's left is the price of capital's capacity to assist labor — in whatever mode the capital is most advantageously deployed. (Capital is interchangeable, and can be represented by money.)
Why isn't there conflict between labor and capital? Simply because labor without capital is quite weak. And capital must be used by labor to yield any income at all. It is only by using capital that labor can hope to get ahead, and capital is only worth having if labor uses it in production. Therefore, capital owners are willing to compete for access to workers. The market will move toward an equilibrium at which the full supply of capital is used, and all the demand for capital is satisfied.
But, workers cannot use capital unless there is land to do it on. The best available land is at the margin of production.
Oh, but the margin of production is at zero, isn't it? So what, then, are the returns to land, labor and capital?
Labor's return depends on the margin of production, which is at zero. But, labor cannot receive NO wages; it must at least survive. Therefore, basic, unskilled labor cannot command any higher wage than bare subsistence, unless it has help from government. (The market for unskilled labor is perfectly competitive.)
And capital? It must be maintained. And there must be a minimum incentive to bring it to market. Beyond that, the return to capital depends on the margin of production, which is now at zero. You can find today's marginal return to capital in the risk-free, adjusted-for-inflation, basic rate of interest. This can sometimes — as in Japan after its huge real-estate bust — be actually negative. Historically it is between one and two percent.
Rent takes the rest. Any mitigation of this basic fact is to be found in various types of "premium" labor. This can take the form of union labor, or domestic labor protected by minimum-wage laws, or highly-educated, skilled labor whose supply is limited, or in the extraordinary cases of NBA players, movie stars or corporate CEOS — whose supply is fixed at a very, very low level. Aside from these bizarre top-shelf examples, the "premium" workers are always in competition with the basic working stiffs whose wages tend inexorably downward.
If all this seems too abstract, consider the example of a capital-owner who has no land. Does he have unearned advantages? I think not. We can look at independent truckers who own their own rigs (most likely, they own a small bit of equity in their rigs) or tree-cutters in Maine who have a huge yard-full of expensive capital equipment, but are just scraping to get by. Owning capital, per se, is not the key to great profits.