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Dictionary of the History of Ideas

Studies of Selected Pivotal Ideas
170 occurrences of ideology
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170 occurrences of ideology
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The Market Economic Order with Growth: Capital
and Interest; Rent, Wages, and Profit.
Discussion of
section II-B needs as introduction a brief description
of the economic order under which modern progress
has occurred, which should begin with a historical note.
The “existing order” is a mixture of organization forms,
mainly based on free exchange, especially two which
arose out of feudalism in roughly historical sequence.
The enterprise system was preceded by a handicraft
stage, with marketing of products but little dealing in
the means of production. To be pictured are families—
perhaps with one or more apprentices—each special-
izing in a final product, using simple tools owned by
the users. The product is sold in a market for money,
with which are bought for consumption various prod-
ucts of other family units. Each of these maintains its
own productive capacity, of person and property, and
may increase this more or less, as in the Crusoe econ-
omy. This system survives to a substantial extent, in
farming, repair work, and professional services. (Our
familiar social-ethical problems due to inequality,
wealth, and poverty, could arise in such a system—and
did, in history.)

The past few centuries have seen handicraft pro-
gressively replaced by a much more complex system,
rooted in a higher order of specialization. In an enter-
prise-economy, production of any final good is carried
on by an organization of persons and equipment, with
much internal specialization of roles. This enterprise
is legally owned by a person or small group, the
“entrepreneur,” who buys from outside owners most
of the labor power and property services it uses. The
entrepreneur may also own any part of the property
it uses—often subject to creditor claims, a complication
to be considered in due course. The simplest arrange-
ment is for the entrepreneur to hire property services,
paying rent; the correct meaning of that term applies
to all property alike, the traditional limitation to
“land” being a misuse of words. (The term “rent” might
well apply to the hiring of persons, where the payment
happens to be called “wages”—or, it would make for
clear thinking if a common word, such as “hire” were
used for both.)


The working of the system is explained by describing
the general equilibrium which “economic forces” tend
to establish, relative to given conditions—as to persons
and their wants, resources, and technology—or, in
Marshall's words, “would bring about if the conditions
of life were stationary long enough for them to work
out their full effect” (op. cit., p. 347). Some limitations
of this tendency will call for notice. At equilibrium,
simultaneously all consumer expenditures would buy
at the margin equal increments of satisfaction and all
productive resources would yield (marginally) equal
increments of value product, all prices being equal to
costs (ignoring monopoly). The economic forces are
human preferences, expressed in partly rational
choices. This conclusion should be qualified by the fact
that the system pictured embodies “feedback” princi-
ples, and as in a mechanical situation, these typically
produce oscillations, where responses are not instanta-
neous—and they do so in economic affairs, creating
serious problems.

Enterprise organization is inevitable, if men strive
to get ahead, which they often do (not universally, as
Adam Smith strangely assumed). It can hardly be
imagined without use of money, as a unit of value and
intermediary in exchange. (But, to repeat, money-
lending is not inevitable, since a loan is always equiva-
lent to another transaction, a lease or sale.) The main
economic decisions are made formally by entrepre-
neurs, interacting with their opposite numbers in mar-
kets, and acting directly or through agents whom they
hire. But they are finally responsible to consumers and
owners of productive agents—act in a real sense as
agents of both, and “at equilibrium” have no power
at all. (Describing the system as “consumer sover-
eignty” states a half truth.)

Both business and politics are dominated by the
agency relation. Personal freedom is mostly freedom
to choose agents—usually among competing seekers
of the role. The entrepreneur is the central figure of
the modern economy. Each buys productive services,
makes products, and sells both in markets, in competi-
tion with all others, hoping to make some profit. This
profit is an element in the entrepreneur's own income
(along with the earnings of his own services or prop-
erty); but it is as likely to be negative, i.e., a loss, as
a gain, which the word “profit” misleadingly suggests.
The profit-system should be called profit-seeking, or
“profit-and-loss.” As noted above, the classical polit-
ical-economists misconceived profit, failed to distin-
guish the entrepreneur function, and only incidentally
recognized loan interest. Even J. S. Mill merely divided
“gross profit” into three parts (op. cit., p. 407), and
then endorsed (on p. 416) the Ricardian theory. (This
system was taken over by the Marxists and used logi-
cally in propaganda for a social revolution—in place
of its strange use as a basis for a doctrine of laissez-
faire; in the case of “rent” it served, also logically, in
propaganda for land-value confiscation—by some po-
litical unit itself without the individual owner's essen-
tially valid claim—which Marshall recognized.)

Profit, correctly defined (including loss), is clearly the
result of an imperfect working of the competitive
market system, due in turn to the uncertainty of the
future and the limited foresight of entrepreneurs. (If
any one of them knew the future, he would not suffer
loss, and if his competitors knew, he could not make
a gain.) Uncertainty can often (in practice not always)
be reduced by insurance or dealing with cases in
groups, but never eliminated. To understand enterprise
and profit, it is useful first to imagine a situation in
which labor alone is productive and where just two
persons wish to cooperate. The matters on which they
must agree—what to produce, by what procedure, and
the division of the joint result—might conceivably be
settled by negotiation. But this would be difficult, and
it seems more reasonable to expect formation of a
partnership, in which one party will make the decisions
and grant to the other a stated amount of the product,
himself taking any excess over the agreed share, and
making up the loss if there is a deficit. The “active”
partner is then an entrepreneur, paying wages and
receiving profit, or incurring loss. (The entrepreneur
might consider what he could have made by working
alone as wages and view profit as only the difference
between this and what he realizes.) No new principle
is introduced if either or both parties also furnish the
services of nonhuman productive agents which they
may own; payment for the use of any such item will
be a rent.

The next step in the explanatory hypothesis has been
suggested, and is a pivotal idea. Instead of a lease for
any nonhuman agent, the parties may agree on a sale,
the previous owner taking a “note” for the price, and
receiving interest instead of rent. Under theoretically
ideal conditions—perfect knowledge and economic
rationality—the sale price and interest rate would
make the payment (per time unit) the same as in the
other case. Under conditions resembling those of real
life, the actual figures would be fixed by the best op-
portunity open for investment, the principal being the
cost of creating a new income source with the same
yield as that whose use is being transferred. Shifting
attention from the two-person situation to a competi-
tive economy, intelligent selection of opportunities in
the market will fix a uniform rate—after allowance for
costs, uncertainties, attitudes towards risk-taking, and
especially for complications due to the use of money.

If a temporary arrangement is desired, an agreement
for later resale will still make the two arrangements
fully interchangeable. The result will differ if risk


attitudes differ—or as will be explained, if the actual
risk differs for the two parties. The latter is the case
in real social life, and this is the main general reason
why the lease procedure is used in some cases and the
sale in others.

In a social economy, income-yielding assets are
bought and sold, at prices which strongly tend to equal
their expected yield capitalized at the going interest
rate, which in turn strongly tends to equal the rate
to be expected on the best new investment opportu-
nities open. But these prices are affected by numberless
uncertainties, and any rise or fall in the value of an
asset impinges on the formal owner. Hence if the
prospective user of a given asset is on any ground more
optimistic as to its future market value than is the
current owner, who turns it over to him for use, they
will agree on a price making a sale with a loan prefer-
able to both parties over any lease on which they can
agree, and conversely for the opposite situation.

However, the motive for lending money, rather than
leasing some income source, is vastly strengthened in
the major type of cases where it is done in modern
life, that is, not in connection with the transfer for
use of existing assets, but with investment by one party
to create a new source of income to be used by another.
This again could be arranged, by the first party making
the investment himself and leasing the result to the
other; but the two must then agree on the kind of
capital good to fit the needs of the prospective user,
and for obvious reasons they usually agree on a loan
of money. In fact, of course, lending money to entre-
preneurs for “real” investment has become a major
vocation—that which now best defines the “capitalist.”
Thus the act of investing is divided: owners of abstract
wealth held in the form of money (itself to them an
investment) invests the money financially by lending
to entrepreneurs who invest materially by buying pro-
ductive services and creating income sources. (Other
complications arise, but need not be considered here.)
Each mode of investing may involve a “profit” (or loss),
i.e., may yield more or less than might have been had
through perfect foresight.

Some lending and borrowing is done for other pur-
poses, notably consumption in anticipation of receiving
income, or to avoid a sale of assets. This consumption
loan is unimportant in the market, and finally comes
under the same principles—apart from a motive of
charity. Any economic loan must have security and is
always an alternative to the sale or lease of the asset
in question. In a progressive society, a person's con-
sumption of capital merely subtracts something from
its growth in the whole economy. (Net social disinvest-
ment hardly occurs, or does so only under disor-
ganization by a crisis.)

It has been held that as investment grows the yield-
rate must tend to fall—due to diminishing returns. As
noted above, this ignores the fact that much investment
increases the yield of capital-goods by creating new
knowledge, a field of investment that shows no tend-
ency to exhaustion but rather the contrary—and also
goes into more people, and useful human qualities
other than technical knowledge. And much goes into
exploration for natural resources. These familiar fields
perhaps tend to become at some time fully known, but
not in combination with new knowledge, and exhaus-
tive knowledge cannot be foreseen. As to the yield-rate,
the reasonable expectation is more of what has hap-
pened through modern history, some “seesaw” in the
rate of yield as opening of new investments runs ahead
of or falls behind exhaustion of old. Moreover, “the”
rate in any market at any time is a complex of “pure
interest” and numerous other factors (risk, transaction
cost, etc., and especially the monetary situation and
business prospects), so that the true rate is not definitely

A pivotal idea in the published discussion of interest
theory has been the “dogma” that interest is paid
because human nature systematically prefers present
goods to future goods of like kind and amount. This
is a fallacy because it overlooks two patent facts: first,
that while one does not want to postpone today's
consumption until tomorrow, neither does one want
to consume tomorrow's provisions today; and further,
that perpetual postponement of all consumption is
impossible. Given provisions for two days, there seems
to be no economic principle or general fact of psy-
chology to determine the precise distribution between
the two. Abstract rationality would surely call for
something near uniformity over time, but some persons
will diverge in one direction and some in the other.
Of this, Alfred Marshall gave the homely illustration
of boys eating a plum pudding: some will pick out the
plums and eat them first, some will save them to the
last, and others eat them as they come to them. An
intelligent person of means (not on the point of suicide)
will certainly consume some of his income (or wealth,
by disinvestment) day by day, and keep some provision
for the future; but as to how much of the latter he
will invest for a future increase, again no general prin-
ciple can say.

It surely seems reasonable to prefer enjoyment while
one is alive rather than after death; but, as remarked
before, people do deliberately leave accumulated
wealth at death—and significant net social accumula-
tion depends on the wide prevalence of such conduct.
Economic science can say only that decision between
consuming and investing some part of one's means is
a matter of taste, not arguable—like consumption


choices—(ignoring contracted obligations) and that
rational conduct dictates making any investment that
is made at the going rate; i.e., at the margin of growth
of capital wealth in the society at the time, or in some
newly discovered better opportunity—where the re-
turn above the going rate would be profit.