The theory of earned and unearned incomes; a study of the economic laws of distribution with some of their applications to social policy

Preface

The study here offered is intended to appeal to several classes of readers. My hope is that it will be read by, among others, socialists of the Marxian school, single taxers, and economists. For those orthodox or Marxian socialists who are willing to reexamine the theoretical foundations of their doctrines, interest will attach to the classification of incomes and to the attempt to distinguish between incomes which are earned and incomes which are unearned. The Marxian view that all income from property is ''surplus value" and represents exploitation, is not accepted, but it is made clear that some income from property — as, indeed, from labor also — is unearned. To single taxers the discussion, in Chapter VI, of land rent and its taxation will perhaps be of chief interest, but the rest of the book leads up to and supplements the chapter on land rent in a way to make the whole study significant for this class of readers. I venture to hope, also, that professional economists, as such, will find enough of critical and constructive material in the text and footnotes, to make the study of interest to them. Finally, the book is intended to make an appeal to serious readers of no particular school or of any school of thought and of any business or profession, v/ho are concerned with the evils in our present economic system and who look forward to worth-while changes during or after the war. World-wide democracy will be but half achieved if it be achieved in the political realm only, with no accompanying economic changes.

v

VI Preface

I am under obligation to the Quarterly Journal of Economics for permission to republish, substantially without change, the major part of an article on 'The Marginal Productivity versus the Impatience Theory of Interest," first published in August, 1913. To the American Economic Review I am indebted for permission to use, also in Chapter IV, most of an article on 'The Discount versus the Cost-of-Production Theory of Capital Valuation," originally published in June, 1914. To the Journal of Political Economy I am indebted for permission to republish, in Chapter VI, along with later additions, an article on "The Ethics of Land- Value Taxation," which appeared in May, 1917. The Macmillan Company have kindly consented to the use in Chapter I of this book, of about eight pages taken from the first two Chapters of my Principles of Commerce, published by them. Professor H. J. Davenport of Cornell University has given the manuscript a conscientious and critical overhauling and although I have not been able to accept all of his suggestions, the book has been improved because of his criticisms. To my wife I owe thanks for a careful and critical reading of the entire manuscript and for reading the proof.

May, 1918.

SUGGESTIONS TO READERS

To the general reader whose time or patience may not permit his following the more difficult parts of the argument set forth in the succeeding pages but who nevertheless seeks an understanding of the principal practical conclusions reached, it is suggested that Chapters I, II and IV (but not the Introduction) be entirely omitted, along with the critical footnote discussions in the other chapters. But Chapter IV cannot fairly be omitted by the reader who, familiar with the controversial literature on the theory of the interest rate, has tentatively adopted a conclusion in disagreement with that presented herein. Nor, indeed, should the critically-minded reader fail to glance at the footnotes, since these are inserted in many cases for the express purpose of meeting anticipated criticisms.

VII

SUMMARY OF CHAPTER TOPICS

INTRODUCTION— THE POINT OF VIEW.

THE POINT OF VIEW 3-4

Chapter I. The Determination Of Value 5-45

§ I Value, or the Analogue of Value, to the Isolated Man.

§ 2 Conditions Determining the Extent of an Isolated Man's Production-

§ 3 Utility, Relative Production of Different Goods, and Value, in a Modern Community.

§ 4 Demand and Supply in Relation to Price.

§ 5 Explanations and Qualifications.

§ 6 Speculation in Relation to Price.

§ 7 The Determination of the General Level of Prices.

§ 8 The Relation of Commercial Banking to the General Level of Prices.

Chapter II. Ultimate Determinants Of Value 46-75

§ I Supply of One Good Means Demand for Other Goods.

§ 2 Influences Back of Demand.

§ 3 Influences Back of Supply.

§ 4 Labor Costs in Production.

§ 5 Land and Capital Costs in Production.

§ 6 The Value of Land.

§ 7 Joint Demand and Joint Supply.

CHAPTER HI.

THE CAUSES OF INTEREST 76-111

§ I The Factors of Production. § 2 The Accumulation of Capital.

IX

X Contents by Sections

§ 3 The Productivity of Capital.

§ 4 Capital Accumulation versus Marginal Capital Productiveness.

§ 5 Saving or Abstinence in Relation to Interest.

CHAPTER IV. § I The Choices of a Crusoe

§ 2 The Demand for Present Goods.

§ 3 The Supply of Present Goods Offered for Future Goods.

§4 Demand for and Supply of Present Goods Further Considered.

§ 5 A Concrete Illustration.

§ 6 Interest in a Money Economy.

§ 7 Changing Bank Reserves in Relation to Interest.

§ 8 Rising and Falling Prices in Relation to Interest.

§ 9 Some Further Complications in the Actual Industrial World.

§ lo Interest Earned and Unearned.

CHAPTER \^.

§ 1 The Proximate Determination of Wages.

§ 2 Influence of Physical and Influence of Value Productivity en

Wages. § 3 Comparative Wages in Different Labor Groups. § 4 A Side Light on the Interest Problem. § 5 General Wages and Population. § 6 Immigration and Wages. § 7 Summary.

Chapter VI. The Rent Of Land And Its Taxation 199-254

§ I Land Rent as a Marginal Product of Land.

§ 2 Land Rent versus Capital Interest.

§ 3 Land Rent as an Unearned Income.

§ 4 Improvements by Special Assessments and the Right of Landowners to a Rental Return.

§ 5 Other Services of City Landowners.

§ 6 The Increment of Land Values in Relation to the Settlement of the American West.

Contents by Sections xi

§ 7 Ownership of Land by omall-Family Groups versus Increasing Population in Other Groups.

§ 8 The Bearing of the Contention that there mgy be Other Unearned Increments not Especially Associated with Land.

§ 9 The Taxation of Future Increments of Value.

§ lo Land-Value Taxation in Relation to the Theory of Vested Rights,

§ II A Few Additional Considerations.

THE THEORY OF

EARNED AND UNEARNED

INCOMES

Briefly, then, the universal basis of co-operation is the proportioning of benefits received to services rendered.

Herbert Spencer

He who by any exertion of mind or body adds to the aggregate of enjoyable wealth, increases the sum of human knowledge or gives to human life higher elevation or greater fullness — he is in the large meaning of the words, a "producer," a "workingman," a "laborer," and is honestly earning honest wages. But he who without doing aught to make mankind richer, v/iser, better, happier, lives on the toil of others — he, no matter by what name of honor he may be called, or how lustily the priests of Mammon may swing their censers before him, is in the last analysis but a beggarman or a thief.

Henry George

THE THEORY OF EARNED AND UNEARNED INCOMES

INTRODUCTION

THE POINT OF VIEW

The science of economics may be pursued, as may any science, purely for its own sake. Its pursuit may be an intellectual amusement of the cultured, and the contemplation of its conclusions may be enjoyed by its votaries as one would enjoy a great epic. But the study of economics may also furnish guidance in matters of social policy and may thus serve two ends of which the second is probably by far the more important.

In attempting, through the succeeding pages, to outline a theory of earned and unearned incomes, we shall not be able to lose sight of this second end. We shall, indeed, be continually inquiring how economic forces work, e. g., what influences fix value and price, what are the conditions which cause interest to be paid, how interest rates are determined, what conditions fix wages, what influences make land rent rise or fall. But back of our search for these scientific laws there will lie a purpose and a point of view. The purpose will be to find out those things in the theory of income distribution the knowledge of which may help us to the fairest possible economic organization of society. The point of view will be some notion as to what tests determine whether an income is earned or not and some sort of ideal regarding the desirability of permitting individuals to enjoy incomes which are not earned. With certain qualifications which will become clear as our investigation proceeds, we shall regard incomes as earned when equivalent service is given by their recipients to those from whom the incomes are ultimately drawn; and we shall regard incomes as unearned when their recipients enjoy them without making a corresponding return.

Whether such a distinction has any significance for any individual reader, will depend much on his ethical viewpoint, his general social philosophy. To one who regards absolute equality of incomes as the economic ideal, however great the differences in efficiency, an investigation into the question whether various incomes are earned or not, will seem irrelevant. Likewise, to one who regards the existence of privileged classes drawing large incomes, as a desirable condition of economic and social life, there will be little significance in a conclusion that many of these large incomes are wholly or partly unearned. But there are persons who believe, more or less on utilitarian grounds, that economic society is not well organized unless incomes have some reasonable relation to service rendered by the recipients to those from whom the incomes are in the last analysis, received, and that no class of citizens (unless by way of charitable relief) should be privileged to receive incomes not based on such service. To persons who hold this view, an analysis of incomes which leads eventually to their classification as earned and unearned may seem in very truth to constitute the first step of an inquiry into the nature and possibility of economic democracy.

CHAPTER I § 1 Value, or the Analogue of Value, to the Isolated

Man

By value, in the sense of value in exchange, we ordinarily mean the number of units of some other good or goods, taken as a standard or measure of values that any given article or immaterial benefit will bring in trade. Thus, the value of a man's horse may be 150 bushels of wheat or 30 tons of coal or 75 days of common labor or two dozen operatic performances. The thought is that the horse would sell for — would bring in exchange — such an amount of other goods. Since money is the medium by which exchanges are commonly effected and, therefore, a generally recognized measure of value, we ordinarily express exchange relations in terms of money. We would be much more likely to state the value of the horse as $160 than to state it as (for example) 30 tons of coal. Everyone sells goods for money or buys goods with money or both. Everyone is tolerably familiar with the value of the money unit in terms of various other goods. Everyone knows, that is, about how much of various other goods a dollar will buy. Consequently the statement that a horse is worth $160 includes the other statements and can be readily translated into them. Valuation of

1 Jevons, The Theory of Political Economy^ fourth edition, London (Macmillan), 1911, pp- 78-83.

goods in terms of money is really valuation of them in terms of goods-in-general.

Exchange value is a social phenomenon. It involves the exchanging of one kind of goods for another kind (or kinds) of goods and a comparison of the utility or desirability of the one kind with that of the other. Such a comparison will presumably be made, in fact, by both parties to an exchange. But though exchange value is thus a phenomenon involving human relations as well as involving goods and so is a social phenomenon, nevertheless nearly all of the factors that enter into its determination exist in a state of isolation such as that of a Robinson Crusoe. And so we may, perhaps, with advantage, begin our study of value by a consideration of the comparisons that might enter the mind of a Crusoe who, alone on his island, is engaged in eking out a precarious living. To Crusoe, as to a man in the most advanced modern community, must be presented frequently the necessity of making a choice among different commodities, all of which together he can not secure in anything like the number or quantity desired, and all of which, possibly, he cannot use, since some may be substitutes for others. He must, therefore, compare the utility of one kind of goods with the utility of something else. It may be that he has occasion to decide whether a month's labor which he can spare from other purposes shall be used to build an additional room to his hut or dugout, or whether it shall be used to make him a canoe; whether today's efforts shall be devoted to killing and dressing a goat or whether the day shall be spent in catching fish.

There is, of course, for Crusoe, no value in the sense of power in exchange, since there is no one with whom exchanges can be made. But there is value, if we may use the term in an analogous case, in the sense of comparison of one thing with some other thing or things, i. e. there is comparative utility. If Crusoe would rather spend a month's labor which he has available, in building an additional room than in constructing a canoe, it is probably because the utility of the room is greater to him than the utility of the canoe, or, at any rate, that he believes it to be greater. If he could make the canoe in two weeks and a new goat-skin suit in another two weeks but would rather devote all four weeks to building the additional room, then the room has greater utility to him than the canoe and suit together; or, if the canoe and suit are reckoned equal, the room has more than twice the utility of either. Were Crusoe in a small community with several other inhabitants, he would perhaps be willing to make two canoes for two of his fellow islanders, in return for their building the additional room for him. Then we could say that the value of the room was two canoes or that a canoe was worth the half completed room. Crusoe, alone on his island, can make no trade; but he can appraise the room in terms of canoes and clothes to the extent of deciding whether he will produce the one or the other two. Similar comparisons would be made in the case of goods satisfying somewhat the same need. For a quart of berries, Crusoe might be willing to work two hours and for a boiled lobster two hours. Then the lobster would be worth, to Crusoe, two quarts of berries. Each article can be compared with each other, directly or through the common means of purchasing them all from nature, viz. labor.^

We have now to take into consideration another fact, so far not mentioned. This is that successive units of any article or service have a progressively lower degree of utility. Crusoe's one suit of goat skin, if he can afford no more, will have great utility to him, will be, in fact, indispensable. A second suit will be, perhaps, important but not as much so. A third will be comparatively unimportant. Similarly, a one-room shelter will be indispensable; a second room may be almost indispensable; a third will be a great convenience, a fourth somewhat convenient, and so on. It is certain that Crusoe will get himself enough food to support life, if he possibly can. It is pretty certain that he will build and keep in some repair one room. It is pretty certain that he will keep himself supplied with one suit of clothes. How much beyond these essentials he will go will depend upon his intensity of desire for comforts and luxuries and also upon his strength, energy and willingness to work.

Having seen that the utility of any good diminishes for Crusoe according as he has a large amount of that good, let us reexamine our conclusion regarding the utility to him of a room as compared with that of a canoe. The comparative utilities of these two items of wealth will depend on how much room Crusoe already has as well as upon his

2 Or labor and waiting. See Chapters III and IV.

need for room in general or for a canoe. If he has no room at all, a one-room hut will probably seem much more important to him than a canoe, and, rather than go without it, he might be willing to do much more work than he would do for a small boat. But the utility of a second room would be less and that of a third still less. Suppose Crusoe would as soon have a canoe as to have the third room. Then he would be willing to devote as much labor to getting the one as to securing the other. If the time necessary to build an additional room is four weeks and that necessary to make a canoe is two weeks, he would choose the canoe after he had a sufficient number of rooms so that an additional room would have less than twice the (marginal) utility of a canoe. If, that is, the labor of building a room remains always twice that of making a canoe, regardless of the number of rooms added, then this labor cost determines the number of rooms which Crusoe will build in preference to a canoe and, therefore, the marginal utility of a room (the utility of the last, final or marginal room). The value of a room in terms of canoes will depend upon the utility of an additional room, but this utility will depend upon the number of rooms Crusoe already has and this, again, will depend upon the labor required to build a room.

But suppose that the nearby available material for house building is scarce, that additional rooms necessitate longer trips for materials, and, perhaps, greater search to find materials that are satisfactory, — in other words, that the labor of constructing additional rooms becomes progressively greater as more rooms are built. Then the labor of construction no more determines the utility and value of a room than its utility and value determine the amount of labor which Crusoe will undergo to build it. For if the utility of additional rooms to Crusoe is little, he will construct but one or two rooms and the labor of construction will be slight; whereas, if the utility of additional rooms is great, he will build them, in preference to a canoe, until the labor of construction (per added room) is considerable. Nevertheless it will still be true that when the utility of an additional room becomes less in relation to the labor of construction than is the utility of a canoe in relation to the labor of its construction, Crusoe will cease adding rooms and will turn to the building of a canoe. And the value of a room will still be measured by its utility in relation to the utility of a canoe, or by the labor of its construction in relation to the labor of constructing a canoe. Either method of measurement is correct since either is equivalent^ to the other.

§ 2

Conditions Determining The Extent of An Isolated Man's Production

Having considered the principles determining the relative amounts of different goods that an isolated man will produce, and the values or the comparative utilities of these goods,* we may now profitably give brief attention to the considera-

" At the margin.

* See, however, the further considerations in Chapter IV, § i.

tions determining the total amount of such a man's production. Of course Crusoe will produce necessary food. It is scarcely less certain that he will make himself some clothing and get at least a crude kind of shelter. His different wants will receive satisfaction in the order of and to the extent commensurate with their importance and the ease with which they can be satisfied. The wants remaining unsatisfied will be of progressively less importance in relation to the effort or other sacrifice necessary to satisfy them. On the other hand, additional hours of labor per day soon come to involve discomfort and sacrifice to an increasing degree. If Crusoe works thirteen hours, he will almost certainly find the thirteenth hour of labor harder than the tenth, eleventh or twelfth. He will choose to work eight, ten, twelve or thirteen hours as the case may be, according to the relation between the utility to him of the goods which the last hour's work produces and the disutility (discomfort or labor sacrifice) of the last hour's work. If the importance to him of the goods which his tenth hour produces is more than enough to compensate him for the work done, then he will work ten hours. Or, perhaps, at nine hours and three-quarters the last minute's work just balances in sacrifice the gains to be secured. Then it will be a matter of indifference to him whether he works nine hours and forty-four minutes or nine hours and forty-five minutes, but he will not work nine hours and forty-six minutes.^

5 See Jevons, The Theory of Political Economy, fourth edition, P- 173-

§ 3

Utility, Relative Production of Different Goods, and Value, in a Modern Community

We have seen how an isolated man compares the utility of different objects and what considerations determine the amounts of them that he will produce. Let us now consider how values are determined in a community of persons, where there is division of labor and where, therefore, exchange of goods is a characteristic feature of economic life. In general, and with a qualification which will be made shortly,^ an isolated group of producers, or an entire community isolated from other communities, or society as a whole, produces to a larger degree those things of which its members desire large amounts, provided the sacrifice or cost of production is no greater, and produces to a less extent goods not so much desired. Suppose, for instance, that we are considering a community whose members desire large amounts of bread and, therefore, wheat, but only a small quantity of apples. Then large amounts of wheat will be produced and not many apples. But since the producers of wheat and of apples do not consume most of their own production, their relative tastes and preferences as between these two kinds of goods can not, to any large extent, act upon them directly. It is the tastes and preferences of buyers which affect price by influencing demand. Thus the large general demand for wheat means that there are many persons willing to pay a good

^ See second and third paragraphs after this.

price for it rather than not to have it or rather than to have less of it, that the amounts these persons are willing to purchase can only be produced by the labor of many wheat raisers, and that the prices which the consuming purchasers are willing to pay are such as will make many persons willing to engage in (and devote their land to) wheat production. On the other hand, to say that apples are not greatly desired is to say that, unless the price is very low, there are few persons who want any or that those who want them want but small amounts, or both. It follows that large amounts can not be sold at a remunerative price and that the price consumers will pay is only high enough to keep a comparatively few producers (and few acres) in apple production, and is not high enough to tempt larger numbers into it. Of course if the apple growers do not receive almost as much for their work as the wheat raisers they may not consent, even in small numbers, to continue their occupation very long. But it is entirely possible that there will be a few who will like the work well enough to remain in it even if their return is very slightly less than it might be in the other line of production. There will be some, also, who, while earning, perhaps, less than most wheat raisers, remain apple growers because they are not well adapted for wheat raising and would make even smaller returns in it. Similarly some land will be devoted to apple growing, even with a low price of apples and with consequent small returns to the owner of the land so used, because the land will produce even smaller returns if used for the production of wheat. Furthermore, if there has been produced in the community in question a certain more or less necessary quantity of wheat, additional amounts of wheat will have so little utility that apples or other goods will be preferred. The conditions of demand and value will, therefore, encourage a larger production of wheat than of apples but not a production entirely devoted to wheat.

Thus, in a considerable community, demand and the conditions of production determine the relative amounts of different goods which are produced. Variety of consumption results both from the fact that increasing amounts of any good reduce its marginal utility so that additional amounts are less desired than other things, and also from the fact that additional amounts of any kind of goods may cost more by requiring producers and land which, except for the offering of a high price, would be devoted to another line of production."^ And as with an isolated individual, a community labors, through the activities of its members, to produce goods up to the point where the sacrifice of production is just balanced by the satisfaction or utility or the anticipated satisfaction of consumption.

But in an organized community of the modern industrial type, carrying on economic activities with a considerable degree of specialization or

^ The United States government has recognized this principle, during the present war, by guaranteeing to farmers a minimum price of wheat. An alternative might be government direction of occupations and investment by way of compulsion. A man might be compelled to work in some line of activity for a less return than he could get if allowed to work in some other line.

division of labor, the utility of any goods consumed, to the consiimer, is not necessarily or even probably just equal to the disutility of producing them, to the producer. For in such a community each person engaged in productive activity produces goods or services which others enjoy. ^ The labor sacrifice of the producers of hats may or may not — probably will not — be the exact equivalent of the enjoyment or anticipated enjoyment of the wearers of the hats. Thus, the hats in question may be of the variety affected by the well-to-do for formal evening wear, and may be, therefore, far removed from the list of necessities. The utility of or the satisfaction yielded by these hats may be comparatively slight, but they are purchased because, to their purchasers, the utility of money is also comparatively slight. Yet the disutility of the last hour's work in making them, to the producers of the hats, may be considerable, far more than would be compensated by the enjoyment of such a luxury. These producers may be, for the most part, comparatively poor, so that the payment for the last hour of their labor represents necessities rather than luxuries. The necessities so purchased by them, although worth no more in the market than the hats which they have produced, have to these hat makers a utility corresponding to the labor sacrifice which they have to undergo in earning the necessities. Their necessities have, that is, a utility to them equal to the disutility of producing the hats. But the hats have not, to them, any such utility.

8 Cf. J. B. Clark, Distribution of Wealth, New York (Macrnillan), 1899, p. 390.

On the other hand, the wearers of the hats may be engaged in producing (or capital which their earlier efforts and saving have enabled them to accumulate may be instrumental in producing) the very articles of necessity which the hat producers consume. The utility of these articles, or services, to those who consume them may therefore be much greater than the disutility (of labor or waiting^ or both) required for their production by the classes engaged in producing them.^° In modern industrial society, then, there is a rough correspondence between the utility of the goods which a man buys with the proceeds of his last hour of work, and the disutility of the work. But we cannot; in such a society with its division of labor, its strata of wealthy and poorer classes, and its differences of individual energy and taste, assert any very marked correspondence between the utility of goods to a consumer and the disutility of labor or labor and waiting undergone by a producer.

§ 4

Demand and Supply in Relation to Price

The division of labor characteristic of modern society means that different persons produce different things for a market, that we specialize in

^ See Chapter III, §5, for a brief discussion of whether waiting involves a disutility in the sense of pain-cost.

10 We are here assuming that all the classes under discussion and enjoying incomes, contribute something to production. Nevertheless, there are classes, as we shall later see, which reap where they have not sown.

production and then trade to get what as individuals or family groups we want. The problem of value in such a society is the problem of explaining what factors determine the ratios of exchange between different kinds of goods. The explanation of the problem begins with a study of demand and supply. The price of any article is determined, by the competitive forces of business, at that point which equalizes demand and supply. As has been frequently pointed out, demand must be distinguished from mere desire and supply must be distinguished from stock. There may be many persons who desire automobiles, but whose desires are of no significance economically because not backed by any financial ability to purchase. Demand implies ability to buy as well as desire to buy. Furthermore, since the amount which would be purchased by buyers depends partly on price, demand should be stated in relation to some price. We should therefore say, in defining demand: the demand for any kind of goods, e. g. cotton cloth, at any given price (per yard) is the amount (number of yards) of those goods which purchasers would take at that price.