London: Macmillan and Co.
Part II, Chapter VII
HINDRANCES TO EQUALITY OF RETURNS DUE TO IMPERFECT DIVISIBILITY OF THE UNITS IN TERMS OF WHICH TRANSACTIONS ARE CONDUCTED
§ 1. ALONGSIDE of imperfect knowledge, as discussed in the preceding chapter, stands the cost of movement. Some part of this cost is, of course, represented by the payments that have to be made to various agents in the capital market, promoters, financing syndicates, investment trusts, solicitors, bankers, and others, who, in varying degrees according to the nature of the investment concerned, help in the work of transporting capital from its places of origin to its places of employment. But there is also a less obvious and more peculiar part of the cost of movement, of which some more detailed study is desirable. A pure mathematical treatment of economic problems always assumes that, when there is opportunity anywhere for the profitable employment of given quantities of the several factors of production, each factor can be received there in units that are indefinitely small and are capable of being separated completely from units of any other factor. In so far as this assumption is not warranted, it is readily seen that the tendency to equality of returns will be imperfectly realised. For, on the one hand, if an enterprise is only financed, in respect of any one factor, by means of units, each of which has the value of £1000, it may well be that, though the transference of £1000 worth of the factor to or from elsewhere could not, when equilibrium is established, bring about an increased aggregate return, the transference of a sum less than £1000 could, if it were permitted, do this. In short, when the units, in terms of which transactions are made, are not indefinitely small, the tendency to equality of returns in all uses degrades into a tendency to limitation of inequality—a limitation the extent of which is diminished with every increase in the size of the units. On the other hand, if an enterprise is only financed, in respect of any two factors, by means of units which combine factor A and factor B in a definite proportion, it may well be that, though the transference of one of these complex combined units to or from elsewhere could not, when equilibrium is established, bring about an increased aggregate return, the transference in isolation of some quantity of either of the two factors might have this effect. Hence, when the units, in terms of which transactions are made, are compounded of fixed proportions of two or more factors, the tendency to equality of returns in all uses again degrades into a tendency to limitation of inequality. It follows that largeness and complexity in the units in terms of which transactions are made act in the same way as costs of movement. In general they obstruct the tendency of self-interest to make the returns obtainable by each several factor of production equal in all uses.
§ 2. At one time it may have been true that the units in which capital transactions were made were noticeably large. Of recent years, however, the size of those units has been greatly reduced in two ways. Of these one is obvious, the other relatively obscure. The obvious way is the diminution in the value of individual deposits which banks will accept—the Savings Bank, for example, allows pennies to be deposited separately—and a similar, though less extensive, diminution in the value of the individual shares issued by companies. The more obscure way depends upon the fact that a unit of capital is a two-dimensional entity. A man can reduce the quantity of capital which he provides, not only by altering the number of pounds that he lends over a defined time, but also by altering the time over which he lends a defined number of pounds. Reduction in the time-extension of the units in which capital is borrowed is of great importance in practice, because, whereas most enterprises require funds for a long period, many lenders are only willing to cut themselves off inexorably from their resources for a short period. There have been evolved in the modern world two devices through which the required reduction in time-extension has been effected. The first of these is the actual acceptance of loans for short terms by entrepreneurs, in dependence partly on the elasticity of the wants of their enterprise, and partly on the chance of opportunities for reborrowing elsewhere. The second is the organisation of the Stock Exchange, by resort to which the funded debts of enterprises can be transferred,—a device which is, from the lender's point of view, the next stage to permission to recall his loan from the enterprise itself. These two devices have fairly distinct spheres. To rely too largely on short loans is felt to be dangerous. "In proportion as enterprises depend upon short-time credits rather than upon paid-up capital or permanent loans are they in danger of failure in times of stress"—through inability to renew the credits. There has, therefore, grown up a rough general understanding that short-time paper is an unsuitable means of raising money for things like new equipment, from which the turn-over is necessarily slow; it should be used only to finance expenditure on materials and labour employed in making commodities that are likely to be sold before the maturity of the paper. This distinction between the two devices is not, however, important for the present purpose. Both of the devices are essentially similar, for both depend on the general probability that the willingness of the aggregate community to lend will be less variable than that of a representative individual. In consequence of this, on the one hand, a company, by discounting bills through banks, borrows part of its capital for a series of short terms from different people, thus enabling any one of them to lend for a few months only. On the other hand, a man, who makes savings for a "treat" or to meet an accident, instead of storing what he expects to want, invests it in long-time securities, in reliance on the organisation of the Stock Exchange to enable him to realise his capital at need. These devices are not perfect. In times of stress the discounting of new bills may prove very difficult and costly, and the realisation of capital by the sale of shares may not be possible except at heavy loss. They have availed, however, to bring about a large and important reduction in the time-extension of the units in terms of which capital transactions are conducted. As regards labour transactions, it is plain enough that the units are fairly small. Hence, in the modern world, apart from certain special problems of land transfer that cannot conveniently be discussed here, the only department in which largeness in the units of transactions obstructs the tendency of self-interest to bring about equality of returns in different occupations would seem to be that of employing power. The average wielder of employing power cannot be regarded as indefinitely small, as compared with the aggregate quantity of employing power that is in action in any use. This fact brings it about that the returns to employing power in different uses are checked from approaching very closely towards equality; and, hence, that the national dividend is rendered smaller than it would be if employing power were more fully divisible.
§ 3. Let us next consider complexity, or compound character, in the units in terms of which transactions are made. Here, as before, it is capital which calls for the greatest amount of discussion. For capital, as ordinarily conceived in business, is not a pure elementary factor of production. In the concrete, of course, it appears in the form either of plant and equipment or of a system of connections called goodwill. But this concrete capital is always made up of a combination, in varying proportions, of two factors, namely, waiting and uncertainty-bearing. Under primitive conditions, if an enterprise was undertaken by more than one person, it was practically necessary for each of the several contributors to furnish waiting and uncertainty-bearing in the proportious in which these factors were required in the aggregate. They would, in effect, pool their capital, taking upon each £ lent an equal measure of uncertainty-bearing. They would be partners, or, if we wish to suppose them in the enjoyment of limited liability, joint shareholders in a company whose capital consisted entirely of ordinary shares. In modern times, however, this is no longer necessary. An enterprise that requires, say, x units of waiting plus y units of uncertainty-bearing, need no longer obtain from each subscriber of one unit of waiting y/x units of uncertainty-bearing also. By the device of guarantees its demand can be separated into two streams, in such wise that waiting alone is drawn from one set of people and uncertainty-bearing alone from another set. Guarantees may assume a great variety of forms. They are given to industrialists by insurance companies, which undertake, for a consideration, that the industrialists' earnings shall be unaffected by fire or accident. They are given by Exchange Banks, such as those which, in India before 1893, bought importers' and exporters' bills at the time of their bargain, and so, for a price, insured them against loss (or gain) from any fluctuations in the exchange which might occur in the interval between the bargain and the realisation of the bills. Where industrialists have to do with staple goods, for which grading permits the establishment of future markets, they are given, for the more general risks of business, by speculators. For a miller or cotton merchant, undertaking an order to supply flour or cotton goods, can buy the speculator's promise to provide him with his raw material in the future for a stipulated sum, irrespective of the price which may then prevail in the market. Like guarantees are given to a banker preparing to discount a bill for an industrial enterprise, when a second banker, or a bill-broker, or some independent person, consents to accept, or endorse, the bill, or, as is usual with "cash credits" in Scotland, to stand surety for the original borrower. They are given to a Central Bank, when a People's Bank, working, either on unlimited liability or with a subscribed capital of guarantee, in effect borrows money on behalf of its local clients. They are given finally to a banker or other lender when a borrower obtains a loan from him by a deposit of "collateral" security. By far the most effective form of security consists in government scrip and the share certificates of industrial enterprises. For the deposit of these, unlike the deposit of chattel security, involves no present loss to the depositor, while their ultimate assumption, unlike the foreclosure of a mortgage, threatens no difficulty to the person in whose favour the deposit has been made. Furthermore, the "continuous market" provided for securities by the Stock Exchanges of the world safeguards the holders of them against the danger of slumps in value so sudden and large as those to which persons holding, as collateral, the title-deeds of parcels of real estate are liable. In recent times, partly in consequence of the supersession of partnerships by joint stock companies, the proportion of national wealth represented by stocks and shares, and, therefore, available as collateral security, has enormously increased. According to Schmoller's estimate of a few years before the war, whereas 100 years ago only a very small proportion of any country's wealth was in this form, to-day in Germany 17 per cent—Riesser says 33 per cent—and in England 40 per cent, of it is covered by paper counterparts. According to Mr. Watkins's investigations, 77 per cent of the capital value owned by residents in the United Kingdom, on which estate duty was levied in 1902-3, was "personalty," and, out of personalty, 70 per cent was paper property. As a natural consequence the area over which the device of guarantees can be employed, and, therefore, the segregation of waiting from uncertainty-bearing brought about, has been greatly extended.
§ 4. This device is not, however, the only method by which modern ingenuity has broken up the complex unit of capital into its component parts. It enables waiting to be separated from uncertainty-bearing. But uncertainty-bearing is itself not a single simple thing. To expose a £ to an even chance of becoming 21s. or 19s. is a different thing from exposing it to an even chance of becoming 39s. 10d. or 2d. There are, in short, a great number of different schemes of uncertainty, which different people are ready to shoulder. Over against these there are a great number of different schemes of uncertainty which the undertaking of various business enterprises involves. It is evident that what is offered can be adjusted to what is wanted more satisfactorily when any given demand of industry can be met by combining together a number of different schemes that individually do not fit with it. This can now be done. When enterprises, for which capital had to be provided by several people, were worked on the partnership plan, all those concerned submitted the resources invested by them to the same scheme of uncertainty. Consequently, unless a sufficient number of people could be found ready to undertake that particular scheme of uncertainty, profitable enterprises were liable to be hung up. In the modern world this difficulty has been, in great part, overcome by the device, which joint stock companies now invariably adopt, of raising capital by means of different grades of security. Instead of an arrangement, under which every pound invested in an enterprise is submitted to the same scheme of uncertainty, we have systems of capitalisation combining debentures, cumulative preference shares, non-cumulative preference shares, ordinary shares and, sometimes, further special sub-varieties. Each of these classes of security represents a different scheme, or sort, of uncertainty-bearing. This specialisation of shares into a number of different classes has the same kind of effect in facilitating the distribution of resources in the way most advantageous to the national dividend as the simpler specialisation into two grades, one involving some uncertainty and the other involving none.
§ 5. There is yet one more form of specialisation. Hitherto we have tacitly assumed that a given type of holding in a company will always remain what it was when it was first taken up. In fact, however, this is not so: for, as a company becomes established, holdings, that at first involved much uncertainty-bearing, often cease to do so. The modern system of industrial finance enables adjustment to be made to this fact, so that shares of companies are, in general, held by one set of people while the companies are new, and by a different set of people when they become established. Thus, when an important "proposition" is floated, the funds are provided in the first instance by a contributing syndicate—or are guaranteed by an underwriting syndicate—consisting of persons who are willing to risk large losses in the hope of large gains, but are not prepared to lock up their capital for long. The syndicate in its early stages may succeed in disposing of many shares to speculators on margins and others, who are similarly willing to provide uncertainty-bearing but not waiting; and these, in turn, after a short "flutter," may sell again to others like unto themselves. At a later stage, when trial has shown what the concern is really like, and so has greatly reduced the element of uncertainty-bearing involved in taking up its shares, the "investing public," those who are anxious to furnish waiting without much alloy, come into the field and purchase the shares. In this way providers of uncertainty-bearing and providers of waiting are both afforded an opportunity of playing the parts for which they are respectively fitted.
§ 6. The broad result of these modern developments has been to break up into simple and convenient parts the compound units in terms of which it was formerly necessary for capital transactions to be conducted. In transactions affecting labour and land—apart from the fact, to be examined in Part III., that the family must sometimes be taken as the unit of migration—there has never been any great complexity in the units. In the field of "enterprise" complexity still rules, in so far as employing power can only find an engagement if it brings with it a certain amount of capital. But the advent of salaried managers, working on behalf of joint stock companies, has done much to break down the complex unit here also. In general, therefore, we may conclude that, in the modern world, complexity in the structure of the units in which transactions are conducted is not an important hindrance to adjustments making for equality of returns in different occupations.
Notes for this chapter
For an excellent account of these agencies cf. Lavington, The English Capital Market, ch. xviii.
It must be remembered, as was indicated in § 5 of the preceding chapter, that this tendency is not without incidental disadvantages.
Burton, Financial Crisis, p. 263.
Cf. Meade, Corporation Finance, p. 231.
The nature of the service of "waiting" has been much misunderstood. Sometimes it has been supposed to consist in the provision of money, sometimes in the provision of time, and, on both suppositions, it has been argued that no contribution whatever is made by it to the dividend. Neither supposition is correct. "Waiting" simply means postponing consumption which a person has power to enjoy immediately, thus allowing resources, which might have been destroyed, to assume the form of productive instruments and to act as "harness, by which natural powers are guided so as to assist mankind in his efforts" (Flux, Principles of Economics, p. 89). The unit of "waiting" is, therefore, the use of a given quantity of resources—for example, labour or machinery—for a given time. Thus, to take Professor Carver's example, if a manufacturer buys one ton of coal a day on each day of the year and buys each day's supply one day ahead, the waiting he supplies during that year is one ton of coal for one year—a year-ton of coal (Distribution of Wealth, p. 253). In more general terms, we may say that the unit of waiting is a year-value-unit, or, in the simpler, if less accurate, language of Dr. Cassel, a year-pound. The graver difficulties involved in the conception of uncertainty-bearing are discussed in Appendix I. A caution may be added against the common view that the amount of capital accumulated in any year is necessarily equal to the amount of "savings" made in it. This is not so even when savings are interpreted to mean net savings, thus eliminating the savings of one man that are lent to increase the consumption of another, and when temporary accumulations of unused claims upon services in the form of bank-money are ignored; for many savings which are meant to become capital in fact fail of their purpose through misdirection into wasteful uses.
The essence of the guarantee given by the acceptor's signature is the same whether the bill is drawn in respect of goods received, or is an accommodation bill endorsed by an accepting-house, which lends its name for a consideration. The variety of accommodation bills known as "pig-on-bacon," where the acceptor is a branch of the drawing house under an alias, is, of course, different, because these bills, in effect, bear only one name; and the same thing is substantially true when the fortunes of the endorsing house and the original borrower are so closely interwoven that the failure of the one would almost certainly involve the failure of the other.
The controversy between the advocates of limited and unlimited liability has sometimes been keen. In the ordinary banks and in the Schulze-Delitzsch People's Banks limited liability is the universal rule. On the other hand, in the People's Banks of Italy and originally, before their absorption by the Imperial Federation, in the Raiffeisen Banks of Germany (except that the law insists on some small shares) the method of unlimited liability was adopted, for the reason that the poor people, for whom the banks were designed, would find difficulty in becoming shareholders to any substantial extent.
Cf. Brace, The Value of Organized Speculation, p. 142.
Cf. Fisher, The Rate of Interest, p. 208.
Quoted by Watkins, The Growth of Large Fortunes, p. 42.
For details of. Meade, Corporation Finance,
Part II, Chapter VIII
End of Notes
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