The Positive Theory of Capital

Eugen v. Böhm-Bawerk, from the Warren J. Samuels Portrait Collection
Böhm-Bawerk, Eugen v.
(1851-1914)
CEE
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Editor/Trans.
William A. Smart, trans.
First Pub. Date
1888
Publisher/Edition
London: Macmillan and Co.
Pub. Date
1891
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Book II, Chapter V

Formation of Capital in a Community

II.V.1

Let us take the case of a community embracing ten millions of able-bodied persons. Leaving out of account the current uses of land, so as not to cumber the statement unnecessarily, the annual endowment of such a nation—its original productive powers—thus amounts to ten million years of labour. Its accumulated stock of capital, we shall suppose, represents the fruit of thirty million labour-years (and a corresponding amount of uses of land) invested during previous economic years in intermediate products. Now look at the constitution of this stock of capital more closely.

II.V.2

Every capital is, by its nature, composed of a mass of intermediate products, and the common goal of all these products is to ripen into consumption goods or means of enjoyment. They reach this goal through the continuation of that production process in the course of which they themselves have come into existence. They are all, as it were, on the way towards the goal of human consumption. But the length of the road which they have had to travel is different. This is partly because the various branches of production adopt roundabout ways of various length: mining, for instance, or railway building, takes a much more roundabout and lengthy method than wood-cutting. But it is partly, also, because those goods which constitute the community's capital at the moment are at various points on their respective roads. Many an intermediate product has just entered on a very lengthy roundabout road, as, for instance, a boring machine, whose life-work it will be to drive a gallery in a mine. Some are midway. Others, again, like clothing stuffs ready for making into coats and mantles, are near the end of the journey their particular production process has to take. Now the inventory of capital lays a kind of cross-section through the production processes, thus unlike in length and unlike in stage of progress, and intersects them, of course, at the most different points, just as a national census lays a section through the paths of life, and encounters and registers the individual members of the nation at the most different stages of life.

II.V.3

Considered with reference to the varying distances at which intermediate products lie from the goal of consumption, the total mass of capital divides itself into a number of annual classes or stages of maturity, which may be very appropriately pictured by a diagram of concentric annual circles. Figures 1 and 2.  Click to enlarge in new window.The outmost circle (Fig. 1) embraces those goods which will be transformed into goods ready for consumption within the coming year; the second circle represents those goods which will ripen into consumption goods in the year after; the third circle, those which will be ready the year after that, and so on. In a community where production is not yet strongly capitalistic, the inner circles will rapidly contract (Fig. 2), because, in such a community, very lengthy roundabout ways of production, such as turn out their finished goods only after many years, will be rare. In rich and well-developed communities, again, there will be a considerable number of comprehensive circles, and of these the inner ones will have a content that, although relatively smaller, is not inconsiderable.

II.V.4

This representation of the stages of maturity by concentric circles is peculiarly appropriate on this account that it also gives a very happy expression to the quantitative relations of these stages. Exactly as the outmost of the concentric circles possesses the greatest area, while the inner circles possess a gradually decreasing one, does the first of these classes—that nearest to the completion of the process—always, by its very nature, embrace the largest quota of the total mass of capital, while a decreasingly smaller quota falls to the more remote classes. There are two reasons for this. The first is that the various branches of production generally adopt processes of different lengths—lengths varying with the technical circumstances of each branch. Many complete the entire work of production, from the preliminary processes to the turning out of the finished product, within a year; many require two, three, and five years; only a few have a production period extending over ten, twenty, and thirty years. The result is that in the highest classes—those farthest removed in time from the finished product—only a few branches of production are found; intermediate products, for instance, in the tenth circle can only be provided by those branches of production which have at least a ten years' production period. But the lower circles are filled, not only by those last-named branches of production (for the intermediate products of these very long processes must pass circle by circle towards maturity), but also by those branches of production which have shorter periods. Thus the quantity of intermediate products grows larger and larger up to the first class, and to this first class every branch of production, without exception, sends its representative.

II.V.5

But there is still another circumstance that works in the same direction. The ripening of intermediate products into consumption goods demands a steady addition of current productive powers. At each stage of the production process new labour is added to the intermediate products which have been passed on to it from the previous stage, and they pass on to the following stage in a more advanced state. In one stage the intermediate product wool is changed, by the addition of labour, into the intermediate product yarn; that again in a following stage, by the addition of labour, into the intermediate product cloth, and so on. This has the natural result that, within each branch of production, the amount of invested capital increases with each advancing stage of the production, or, what is the same thing, at every change into a lower circle. Consequently not only are the lower circles, as has been shown, supplied from more branches of production, but they are supplied with relatively larger amounts of capital, and this gives the lower classes a twofold numerical superiority over the higher ones.*32

II.V.6

On these lines we may now put our illustration into figures. To facilitate our survey we shall assume that the total capital of the community is comprised in ten yearly circles. If thirty million labour-years are embodied in this total capital (for simplicity's sake I again leave out invested uses of land) we may assume the following division of the circles. The

1st circle contains the intermediate products of 6 million labour-years.
2d " " " 5 " "
3d " " " 4 " "
4th " " " 3.5 " "
5th " " " 3 " "
6th " " " 2.5 " "
7th " " " 2 " "
8th " " " 1.7 " "
9th " " " l.3 " "
10th " " 1 " "

II.V.7

In the normal course of things the outmost circle becomes divided off from capital each year, and is changed into consumption goods, but the succeeding circles press forward, each circle, by the addition of new labour, advanced one stage, both as regards nearness to maturity and amount of capital invested. The first class, therefore, is changed into consumption goods, the second class into the first, the third into the second, and so on. Now the following important questions suggest themselves. What use must the community make of the original productive powers which come anew into its possession during the current year—that is to say, the new ten million labour-years if, for simplicity's sake, we still leave out uses of land—in order to conserve the capital that is in existence? And how must it act to increase that capital?

II.V.8

These questions are easily answered. To keep the capital at the present level the community must not spend more than four million labour-years in present-time production.*33

II.V.9

With the remaining six million labour-years the stock of capital, reduced by the separating off of the first year's circle, must be brought up in quantity and quality to its former level. This demands that the nine other yearly circles be brought each one step nearer maturity by the addition of the requisite labour, and that the tenth class, which is now non-existent, be new created. The amount of labour necessary for this may be exactly determined. The former second class, in which as yet only five million labour-years have been embodied, needs, in order to make it entirely equal in value to the former first class, an addition of

1 million labour-years.
The 3d class needs an addition of 1 "
" 4th " 0.5 " "
" 5th " 0.5 " "
" 6th " 0.5 " "
" 7th " 0.5 " "
" 8th " 0.3 " "
" 9th " 0.4 " "
" 10th " 0.3 " "
And the creation of a new 10th
class requires the labour of 1
" "
In all 6 " "

II.V.10

It should be noted that it is not a matter of indifference at what point, in which particular circles, the six million labour-years are spent. If, for instance, they were to be spent in making intermediate products, but not according to the above distribution—say they were all spent in making intermediate products of the first circle, which would come to maturity in a year's time—the disadvantage would be twofold: first, the production processes which had only got the length of intermediate products of the higher classes would be brought to a standstill; and second, as we know, the shorter methods would be less productive. With six million labour-years invested in a one year's process, the present would hand over to the future the same number of productive powers indeed, but—what in the last resort is the important thing—these powers would, in virtue of their one year's process, be capable of producing only a smaller amount of products than the present has received for consumption from the past. The next year's production, therefore, would necessarily be reduced, and the stock of capital would not be maintained at its former level.

II.V.11

Again, if the present stock of capital is to be increased, it is evidently necessary that the community give up a portion of the consumption which it might have enjoyed—while still maintaining the stock at its former height;—that it withdraw a portion of the productive powers at its disposal from the service of the present; that it save and employ them for additional future production. Productive powers may be saved in various ways. (1) Other dispositions remaining unchanged, a smaller portion of the current productive powers—say three instead of four million labour-years—may be employed in immediate "present-time production." Or (2) the arrangements for saving may have been already made, and the total capital organised in such a way that the circle which is now passing over into the stage of full maturity contains a less quantity of capital, say five instead of six million labour-years. Inasmuch, then, as only five instead of six million labour-years are now required for the replacement of capital, there remains—if, as before, four out of the ten million labour-years which are the current productive endowment are spent in "present-time production"—one million over, available for the formation of new capital. Or (3) it is conceivable that, at the last moment, the disposition of the capital should be so altered that less passes into the stage of full maturity than was originally contemplated. It is a familiar fact that there are many goods which admit of being employed in a variety of ways. This often makes it possible to put back goods which have already attained full maturity, or which stand quite near to maturity, by several stages. Grain, for instance, instead of being ground for food purposes, may be stored for seed, or used in distilling; coal may heat the blast furnace instead of the domestic oven; iron may build machinery instead of park railings; and so on. If, by thus disposing goods differently, the amount of capital which arrives at maturity becomes reduced from six to five million labour-years, there will, after four million labour-years have been expended in "present-time production," be one million labour-years free for the making of new capital.

II.V.12

All three methods, then,—of which, in practical life, the second is most common, and the first is least so,—agree in one essential point, that during the current year the produce of nine million labour-years only is consumed, while ten million labour-years come forward; that accordingly, in other words, one million labour-years of the current productive endowment are saved.*34

II.V.13

Hitherto we have spoken of the formation of capital by a community as if in such a community there was one single economy, guided by one individual will. Of course this is not the case. It remains, therefore, for us to show how, in a community where industry is divided up and managed by many heads, the productive forces that conduce to the formation of capital are actually disposed, and to inquire whether, as we have maintained, these dispositions presuppose "saving." And since it is claimed, and not without reason, that universal truths should be proved to hold not only in the present and historical organisation, but in every social organisation, I propose in this inquiry to look both at the actual economic form, which is pre-eminently individualistic, and at that form which is at least conceivable, the socialistic. We may begin with the latter as being the easier from the standpoint of our present problem.

II.V.14

In a socialist state from which private capital and private undertaking were banished, and where the entire national production was organised by the state, the formation of capital, and the previous saving of productive powers necessary thereto, would be controlled officially. The method would simply be to put a considerable proportion of the national workers to very lengthy processes, whereby the making of capital, in the form of intermediate products, would be very great, and the amount of matured products in the future would be much increased. Many workers, relatively speaking, would be put to mining, railway-building, regulation of rivers, machine-making, and the like, and few to wine-growing, silk-spinning, lace-making, beer-brewing, cloth-making, and the like. The people would thus be compelled to save by pressure from above, inasmuch as, of the national production thus conducted by the state, in each year relatively few goods would be put at their disposal for immediate consumption—less, that is to say, than might be annually produced and consumed if the existing stock were merely to be maintained. The productive powers left free would be invested in lengthy capitalist processes of production.

II.V.15

Somewhat more complicated, but still easy to grasp in principle, is the procedure in the individualistic organisation of society as we find it in the present day. Here, in the first instance, it is the undertakers who decide how the productive powers, as they come forward annually, shall be employed, and they thus decide the direction which the national production takes. But they do not decide it at their pleasure; they follow impulses given by the prices of products. Where lively demand promises a profitable price they extend their production, and curtail it in those kinds of goods where failing demand can no longer take off the supply, and the prices fall below a paying level. Extension and contraction of supply continue till such time as production has adapted itself to the desire for the particular commodities. In the last resort, therefore, it is not the undertakers who decide the direction of national production, but the consumers, the "public." All depends on the effective desire they exert by means of their income. The income of a people is, in the long-run, identical with the return of its production. The circle that represents a year's income coincides, roughly,*35 with the circle that represents a year's return of its productive powers. If every individual in the community were to consume exactly his year's income in the form of consumption goods, there would arise a demand for consumption goods which, through the agency of prices, would induce the undertakers so to regulate production that, in each year, the return of a whole year's circle of productive powers would take the form of consumption goods. If ten million labour-years (and the corresponding uses of land) form the annual endowment of a people, and this people wishes to consume, and does consume, the whole of its income in the form of consumption goods, it is a necessity that the produce of the whole ten million labour-years (together with the corresponding uses of land) be changed each year into the form of consumption goods. In this case there is no productive power left to dispose of in increasing capital, and capital only remains as it was.

II.V.16

If, on the other hand, each individual consumes, on the average, only three-quarters of his income, and saves the rest, obviously the wish to buy, and the demand for, consumption goods will fall. Only three-fourths of the former consumption goods will find demand and sale. If the undertakers, however, were for some time to continue the old dispositions of production, and bring to market consumption goods to the amount of ten million labour-years, the over-supply would very soon press down the price, business would become unremunerative, and the pressure of loss would compel the undertakers to adapt their production to the changed circumstances of demand. They will now provide that, in one year, only the produce of seven and a half million labour-years is transformed into consumption goods (whether it be by the maturing of the first class, or by adding to "present-time production"*36), and the two and a half millions which remain of the current year's endowment may and will be spent in the increasing of capital. I say "will be spent," for an economically advanced people does not hoard, but puts out what it saves—in the purchase of valuable paper, in deposits in a bank or savings-bank, in loan securities, etc. In these ways the amount saved becomes part of productive credit; it increases the purchasing power of producers for productive purposes; it is thus the cause of an extra demand for means of production or intermediate products; and this, in the last resort, induces those who have the regulation of undertakings to invest the productive powers at their disposal in these intermediate products.

II.V.17

We see, therefore, as a fact, an intimate connection between saving and formation of capital. If no individual saves, the people, as a whole, cannot accumulate capital, because the great consumption of consumption goods forces the producers, by the impulse of prices, so to employ the productive powers that, every year, the produce of a whole year's endowment is demanded and used up in the shape of consumption goods, and no productive powers are left free for the increasing of capital. But if individuals save, the altered demand, again through the impulse of prices, compels the undertakers to dispose of the productive powers differently; fewer powers are put, each year, at the service of the present, and thereby is increased the amount of those productive powers whose produce will be found in suspense as intermediate products; in other words, the economical capital will be increased with a view to an increased consumption in the future.

II.V.18

Now there is still a third possibility. Individuals may consume, on the average, more than their income; instead of saving they may waste their parent sum of wealth. According to our theory, this must lead to a diminution of the community's capital, and, as a fact, it does so. The steps of the process are as follows. By the prevailing extravagance more than a year's income of the community, and, therefore, more than the produce of one year's circle of productive powers, is demanded in the shape of consumption goods. Production, compelled by the impulse of prices, yields to the demand. For instance, the former disposition was that the first circle, with its six million labour-years, should mature during the current year, and that, of the ten million labour-years that form the current endowment, four millions should be spent in "present-time production," and the other six in replacing the capital consumed. Now we shall suppose that, through the extravagant manners of the citizens, the year's demand for consumption goods rises till it requires the produce of twelve million labour-years. The undertakers will act in something like the following manner. Of the current labour endowment they will invest, perhaps, not four but five million labour-years in present production, and, in correspondence with this, the amount devoted to the replacement of capital will shrink from six to five millions. This will cover one million of the extra amount required. At the same time, by differently disposing of such goods as allow of more than one employment, they will perhaps divert the produce of another million of labour-years from a more remote class into the first class, and thus add it to the consumption of the current year. This will cover the second million of the extra demand. The community now receives and consumes what it desires, the produce of twelve million labour-years in the form of consumption goods;*37 but it does so at the expense of the stock of capital, which is insufficiently replaced, and so diminished by two million labour-years.*38

II.V.19

Possibly I have wasted too many words in proving a truth so obvious that no thinking man unskilled in science would ever doubt it. Every child knows that a piece of capital, say a hammer, must be produced if it is to come into existence. And to every simple man it is obvious that no stock of capital can be made, or can increase, if men regularly consume their whole available income; if, in other words, they do not save. It was reserved for the sharp and subtle wits of learned theorists to suggest the first doubt about it. This, however, it would have been difficult to do if, instead of dogmatising on the formation of capital, they had attempted to give a complete and faithful representation of the process by which capital is formed. Here lies the entire, but almost the only, difficulty of these and many other economical doctrines; and this suggests, I might add, the reason why so many abstract deductions are discredited and fail of result. It is not the deductive method that deserves the distrust, but the persons who misapply it. Vulgar errors in thought, indeed, are quite exceptional among capable thinkers; and here the fault lies mostly in this, that the economists in question could not put a sufficiently clear and life-like picture before their minds of the circumstances and processes which they introduced into their deductive arguments as assumptions, or, at least, did not keep it persistently enough before them through all stages of the deduction. Hence, losing touch with life, they began to make deductions, not from truth of facts, but from words of formulas, and so fell without knowing it into the emptiest dialectic. It is because so many economists, as it seems to me, have made this mistake, that I risk being tedious rather than being suspected of sophistry.


Notes for this chapter


32.
Durable productive goods, which give off their use gradually in the course of several years, belong naturally (in various parts of their content as useful goods, or in various annual circles of their activity) to several circles simultaneously.
33.
Under this name (Gegenwartsproduktion) I mean to group, for the sake of shortness, all those acts of production which agree in this, that the original productive powers which are put forth in these acts reach their goal, and turn out consumption goods, within the same economic period. This applies to two kinds of productive acts; partly and principally to those of the final stages, the labour required to transform the first circle of capital into consumption goods (e.g. agricultural labour, the labour of the miller, baker, shoemaker, tailor, etc.), partly to industries where the production process is short, and can be carried through from beginning to end within a single economic period.
34.
If, during the current year, there should be introduced such improvements in the technique of production that the capital, which had taken six million labour-years to produce, could be fully replaced by an expenditure of five million labour-years, there would be a change in the figures of our illustration, but the principle would remain the same. It would now be possible to preserve the capital already in existence, even if five million labour-years were spent in present production, and if the produce of eleven million labour-years in all were spent in immediate consumption (see above, note to p. 109). But in any case the formation of new capital would require the renunciation of some portion of that immediate consumption which would be possible if it were only wished to preserve capital at the same level; in other words, would require that a portion of the "income," which might be consumed without diminishing the stock of capital, be not consumed but saved. Moreover, if technical improvements did not continue to be made, then, after some years—that is to say, when the capital produced according to the old methods of production was quite used up,—the old figures would come true again; capital would be kept at the same level if in any period the produce immediately consumed just corresponded to the productive powers which came forward anew in the same period.
35.
I have neither time nor desire to go into subtle distinctions here, although there is material enough for them. Interesting investigations into the relation between national product and national income—although I cannot altogether agree with them—may be found in R. Meyer's book, pp. 5, 84. See also the investigations of Loris (which appeared while the present volume was passing through the press), entitled Ueber gewisse Werthgesammtheiten und deren Beziehungen zum Geldwerth (Tubinger Zeitschrift, forty-fourth year, part ii. p. 221), where also the yearly "consumption sum," "production sum," and "primary income sum" are treated as "quantitatively, approximately equal" amounts.
36.
The change of disposition will, as we have seen, be made essentially easier by the adaptability of many forms of capital to various uses.
37.
Viz. six million from the original provision of the first circle, one million diverted and added to that by changed disposition, and five millions from the current labour endowment.
38.
The stock originally embraced the return of thirty million labour-years; it now gives seven millions to the consumption of the correct year, and it receives only five millions to replace them, whereby it falls from thirty to twenty-eight million labour-years.

End of Notes


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