V\B\7 CL4G, Stem $ark &Mt (^allege of Agriculture &t CJartwll UnitiECBitH 3tl}ara. ». ?. Slibranj Cornell University Library HB 171.C46 Outlines of political economy, 3 1924 013 685 403 Cornell University Library The original of this book is in the Cornell University Library. There are no known copyright restrictions in the United States on the use of the text. http://www.archive.org/details/cu31924013685403 OUTLINES OF POLITICAL ECONOMY OUTLINES OF POLITICAL ECONOMY Sir SYDNEY CHAPMAN, K.C.B., Litt.D. SOMETIME PROFESSOR OF POLITICAL ECONOMY AND DEAN OF THE FACULTY OF COMMERCE IN THE UNIVERSITY OF MANCHESTER NEW IMPRESSION LONGMANS, GREEN AND CO. 39 PATERNOSTER ROW, LONDON, E.C. 4 NEW YORK, TORONTO BOMBAY, CALCUTTA AND MADRAS 1923 HB\7\ C4G "And as he had acquired absolutely nothing about political economy or about logic, and was therefore at the mercy of the first agreeable sophistry that might take his fancy by storm, his unfitness to commence the business of being a citizen almost reached perfection." — " Clayhanger," by Arnold Bennett. Made in Great Britain PEEFACE. This third edition is the result of a thorough revision and partial expansion which have involved a complete resetting of the type. The use of the book for teaching had indicated many ways in which it could be improved ; and further additions were rendered desirable by recent economic events connected with the war. Two final chapters on the development of Political Economy have also been added. On a first perusal, all parts in small print should be omitted ; and, in the first instance, only a hasty reading of Book I would be advisable. The diagrams are in- tended only for those who find their understanding aided by diagrams. In every case, these symbolic demon- strations are merely supplementary to the argument in words, which has been made complete without them. My obligations to the writings of other economists, which are none the less though not always apparent, are too numerous to mention ; but my great indebted- ness to Dr. Marshall will be apparent throughout. I have also profited from many criticisms and suggestions, for which I desire to express my gratitude ; and in par- ticular I have most cordially to thank Mr. H. D. Henderson and Mr. C. K. Hobson for revising the proofs of the present edition, and my wife for constant help. S. J. CHAPMAN. University, Manchester, January, 1917. ANALYTICAL TABLE OF CONTENTS. Sections marked * which are in small print, and the occasional para- graphs in small print, may be omitted altogether on a first read- ing. Sections marked ** contain diagrammatic expositions and should not be read by those to whom diagrams are confusing or of little or no assistance. BOOK I. Scope and Method. CHAPTER I. PAGE Natube and Scope cot Political Economy 1 Definition ......... 1 Positive and normative sciences and arts .... Political economy embraces a positive science, a normative science, and several arts ....... 5 Positive economic science may or may not be evolutionary 6 Classification of economic studies . . ... 7 CHAPTER II. Assumptions and Methods of Economic Science ... 9 Can trie actions of free agents be reduced to law ? . .9 The permanence of character and social assimilation 11 The abstract method 13 Historic and realistic methods ... 17 Much of the data of economics is measurable .... 18 Divisions of political economy and relations between them . 18 vii Viii ANALYTICAL TABLE OF CONTENTS BOOK II. Consumption, oe Demand and its Satisfaction. CHAPTER in. Wants and Demand Scope of the economics of consumption . Wants, utility, satisfaction, and demand •Psychological basis of demand Systems of demand ..... PAGE 20 20 21 23 25 CHAPTER IV. Diminishing Utility and Marginal Use 28 Total and marginal utility ....... 28 The law of diminishing utility and its limitations ... 30 **Diagrammatic representation of diminishing utility . . 33 Are all wants satiable? 35 The utility of complements and substitutes ... 37 The basis of laws of utility 38 Marginal quality 38 CHAPTER V. Demand Prices, Expenditure and Consumers' Surplus . . 40 The law of demand price 40 Elasticity of demand 42 "Diagrammatic representation of demand .... 43 The law of substitution or indifference, or equi-marginal utility 44 Observations on the law of substitution .... 46 Consumer's surplus of satisfaction .49 ♦•Diagrammatic representation of equi-marginal returns and consumer's surplus of satisfaction 50 The measurement in money of consumer's surpluses . . 52 •Total consumers' surplus in a country as a whole ... 53 CHAPTER VI. Value, Goods and Wealth 55 Value .55 Goods and wealth 56 Necessaries, comforts and luxuries 59 ANALYTICAL TABLE OP CONTENTS ix BOOK III. Pboduction oe Supply. CHAPTER VII. Nature op Production and the Agents op Production What is production 1 Manufacture specializes the possible usbg of materials The agents in production and their efficiency Adaptability of the productive system . CHAPTER Vm. Capitaii 73 What is social capital ? . . 73 Are free gifts of nature and personal wealth social oapital ? . 76 Industrial capital and classification of social capital . . 77 Private capital 79 Production with oapital is a round-about process ... 80 PAGE 63 63 67 68 71 CHAPTER IX. Machinery and Division of Labour .... The economies of substituting machinery for labour What becomes of the displaced labour ? . Economies of specialized labour and machinery Effect of specialization and machinery on labour , 83 83 84 86 8S CHAPTER X. The Growth and Specialization of Businesses ... 91 The growth of businesses 92 "The normal magnitude of the business 96 The law of substitution, indifference, or equi-marginal returns 97 Expansion and contraction of businesses . ... 99 Specialization of businesses 100 Internal and external economies and the localization of in- dustries 104 CHAPTER XI. The Laws of Increasing: and Decreasing Returns . . 106 Meaning of increasing, decreasing, and constant returns . 106 The non-evolutionary laws of increasing and decreasing returns 108 ANALYTICAL TABLE OF CONTENTS PAGE 111 The evolutionary law of increasing returns "Diagrammatic representation of the counteraction of diminishing returns ........ Ill CHAPTER XII. Markets and Commercial Functions . What are markets ? . Evolution of markets Future dealings .... "Technicalities of dealings in futures Markets for capital .... Price steadiness and its effects Does speculation steady prices ? Marketing and the risks of anticipating . •Distribution of the risks of anticipating •Differentiation of productive systems •Reactions of commercial organization on industrial organiza- tion CHAPTER Xin. Types of Productive Organization .... Agricultural systems ........ Private businesses and companies ...... Co-operation Classes of monopolies Trusts and kartels •Generation and stability of trusts and kartels . 113 113 114 116 117 119 120 121 124 125 128 130 132 132 135 138 142 144 146 BOOK IV. Exchange, ob the Equilibrium between Demand and Supply. CHAPTER XIV. Competition, Barter and the Price op Non-reproducible Things 149 Competition 150 The theory of barter . 151 ••Diagrammatic treatment of barter ...... 154 The price of fixed stocks 155 ANALYTICAL TABLE OF CONTENTS CHAPTER XV. The Long Period and Supply Pbioes . Normal or long-period effects ... Determination of supply prioes *Befinements of the theory of supply prices Cost of production has many meanings . CHAPTER XVI. PAGE 157 157 160 1G4 166 Normal Price . 168 Equilibrium of demand and supply . . 168 ""Equilibrium of demand and supply diagrammatically treated 170 Joint, composite, and alternate demand and supply . . 172 "Diagrammatic representation of joint demand and joint supply . . ... . 174 CHAPTER XVII. The Short Period and Sub-normal Price 176 The short period 176 Sub-normal prices 178 Some features of sub-normal conditions 179 CHAPTER XVIII. Theory of Monopoly Prices 181 Fundamental ideas ... . . 181 Determination of monopoly price in the absence of price dis- criminations .... .... 181 Price discriminations . . 184 Dumping .... 185 Determination of prices when discriminations are possible . 187 **Monopoly price diagrammatically explained .... 189 Restrictions experienced by monopolists . . . 190 CHAPTER XIX. International Trade . . 192 Differences between the theories of home and foreign ex- change 192 International immobility of labour and capital . . . 193 Permanent international trade starts when there are differ- ences between comparative values 194 xh ANALYTICAL TABLE Off CONTENTS PAGE International values • 197 Balance of trade 200 Effects of foreign loans on imports and exports . . . 202 **Diagrainmatio representation 203 BOOK V. Monet and the Mechanism op Exchange. CHAPTER XX. The Theory of Money 206 Inconveniences of barter and emergence of money . . . 20t Choice of the money commodity 209 Determination of the value of money .... 211 **Symbolio and diagrammatic expression of the theory of the value of money 215 Functions of money summarized . 217 Appreciation and depreciation of money . . . 217 Are rising, falling or steady prices best ? . . 218 "Index numbers of prices .... . 220 CHAPTER XXI. Theory of Banking and Credit Money Banking creates a loan fund . How much may the bank lend ? A plausible fallacy . Theory of credit money . Functions and value of banks . 223 223 225 227 229 232 Interdependence of banks and bank amalgamation . . 233 CHAPTER XXII. Foems ov Money ... .... 235 Classification of money . . 235 Free and gratuitous ooinage and Gresham's law . . 23S Credit money 211 •Governmental limitation of note issues .... 242 Inconvertible money 244 Currencies may be exclusively paper but convertible . . 246 ♦Bimetallism 243 *Why bimetallism has been advocated 251 ANALYTICAL TABLE OF CONTEXTS xiii CHAPTER Xim. PAGE The Poeeigs Exchanges akd Eesebtzs ... . 253 Some definitions ..... . 253 The foreign exchanges . 254 Methods of dealing with foreign drains of gold . . 257 *Reserves _ 259 The foreign exchanges and monetary problems during the war 263 CHAPTER XXi y. Trade asd Cbedtt Cycles aitd Crises 266 Synchronism and periodicity of fluctuations in trade . . 266 The climatic explanation ... . 267 The psychological explanation . . 271 The explanation based on competition . . 274 Are trade fluctuations increasing ? . . . 275 Banking in relation to trade cycles ... . . 276 BOOK VI. Distribution, oe the Shaking of Wealth. chapter xxv. ihteodcctobt akd interest . ... 278 Analysis of distribution . . 278 Gross and net interest . ..... 279 Demand for capital . 281 Why capital is saved 283 Saving and the power to save . . . 285 Insurance and saving . . ... 286 Interaction of demand and supply . 287 Possibility of a zero rate of interest . . ... 289 E3eo" of progress on the rate of interest and value of capital 291 Effect of the appreciation and depreciation of money on the rate of interest .... . 292 The earnings and value of fixed capital . 293 "Diagrammatic treatment ... . 295 XIV ANALYTICAL TABLE OF CONTENTS CHAPTER XXVI. PAGE Rent and Quasi-Rent 297 Meaning of rent ......... 297 Rent of differential fertility ....... 298 Marginal value of land ....... 302 Numerical examples ........ 305 "•Diagrammatic representation 306 Situational rent of agricultural land ..... 307 Rent of building sites 309 Personal rents .......... 311 Rent does not determine price ...... 313 Rent of mines, quarries and fisheries ..... 31S Quasi-rent 315 CHAPTER XXVII. Wages and Promts 318 The value of services supplied by labour alone . . . 318 Wages and profits under group production .... 321 Allowance for differences in efficiency between employers . 324 Definition of profits 326 Supplies of labour 326 Competition between grades — vertical mobility . . . 329 Conclusions as regards the determination of wages . . . 331 "The doctrine of the wages fund and the iron law of wages . 333 CHAPTER XXVUt. Summary op the Theory op Distribution — Producers' Surplus and Labour Problems 336 Summary of the theory of distribution .... 336 Producers' surplus of satisfaction or utility .... 339 "Diagrammatic exposition of producer's surplus of utility . 340 The hours of labour . . ... Collective bargaining ..... Pieoe-rates, time-rates, premium systems, sliding scales profit-sharing Methods of industrial peace .... and 341 344 346 349 ANALYTICAL TABLE OF CONTENTS XV CHAPTER XXIX. TAGE Unemployment 352 Causes of unemployment 352 Remedies . 356 Means of mitigating tlio distress caused by unemployment . 359 BOOK VII. P0BL1O Economics and Public Finance. CHAPTER XXX. The State in Relation to Business ... . 361 Classification of State action which is economic . . 361 The need for supplementing private enterprise . 362 State industries . . 367 State control 369 Bounties or subsidies 370 Protection, fair trade, retaliation, and reciprocity . . . 372 Laws to facilitate business 376 Emergency measures 376 CHAPTER XXXI. 380 380 383 385 388 The State in Relation to Social Conditions Factory acts and public health acts The State in relation to wages and employment . The State in relation to social insurance The State in relation to the provision of opportunities Publio provision of the higher social goods and housing . 389 Public aid , 390 The doctrino of maximum satisfaction . . . 393 CHAPTER XXXII. Public Finance . . 395 Public revenues . . 395 The principle of equity in taxation 397 Progressive taxation . 400 Other principles of taxation . 102 Betterment and the unearned increment .... 405 Public debts including war loans 406 XVI ANALYTICAL TABLE OF CONTENTS CHAPTER XXXIH. PAGE The Incidence of Taxes 411 Nature of the problem of incidence 411 Taxes on income and property ..... . 413 Taxes connected with land ...... 414 Taxes on commodities and services 420 "Diagrammatic treatment of taxes on commodities . . ■ 421 Taxes on monopolies 422 Import and export duties ........ 422 Incidence of a taxation system as a whole .... 425 book vm. Development of Political Economy, chapter xxxiv. From Early Times to Adam Smith Early and mediseval times The transition from medisevalism Mercantilism and its critics The Physiocrats Adam Smith .... 428 423 430 432 434 436 CHAPTER XXXV. Pbom Adam Smith to the Present Time 439 The Classical School and some of its critics .... 439 The historical and socialistic reactions .... 444 After John Stuart Mill 448 Appendix. Select List of Books 453 Index 457 BOOK I. SCOPE AND METHOD. 1 CHAPTEE I. NATURE AND SCOPE OP POLITICAL ECONOMY. Definition. — "PoliticalEconomy " is derived from the three Greek words, 7roX«, a state or organized community, oIkos, a house or home, and vo'/ios, law. It means, therefore, ac- cording to its derivation, the law of household management in its application to communities. "Whether the old term " political economy" in its original significance appropriately designates the modern study of which an outline will be given in this book, will become apparent to the reader as he or she proceeds. To-day political economy, or, as it is sometimes called, economics, treats of all the actions of human beings in relation to wealth, including the attitude of people to wealth, the responses of Nature to their attacks on her resources, and the conditions of their productive efficiency, as well as the making, exchanging, sharing, and using of wealth. " Wealth " may be left undefined for the present. For preliminary pur- poses, it may be presumed that the reader has a sufficiently accurate conception of what wealth is. Political economy, as its definition makes plain, is a social 1 N.B. — Sections containing diagrams are merely supplemen- tary, and may, therefore, be studied or not at the choice of the reader, as may also any other parts in small print. 2 OUTLINES OF POLITICAL ECONOMY study. It may be classified as a branch of sociology, and sociology is the study of the natures and activities of indi- viduals, regarded as members of communities, and of the relations between them. A study, or systematized body of knowledge, is defined by (1) its data and (2) its point of view. The data of sociology may be broadly described as all social facts, and the data of political economy as all those social facts which have reference to wealth. The two departments of sociology which have been most systematized are political economy or economics, and poli- tics. Of these two, economics is the more capable of being systematized and is the more highly systematized — for reasons to be explained (p. 18). The rest of sociology is as yet only imperfectly systematized. Much material has yet to be collected, and much classification has yet to be attempted, before any considerable number of fruitful generalizations can be looked for. Economics, we have noticed, is differentiated from general sociology by the fact that the activities which primarily occupy its attention are those which have reference to wealth. Poli- tics is distinguished similarly by the reference of its data to government ; but as some human action has reference at the same time to wealth and to government — public finance and factory legislation, for instance, being subjects which relate to both — economics and politics overlap to some extent. Positive and normative sciences and arts. — So far the term "science" has been avoided, mainly for two reasons. The one reason is that all systematized bodies of knowledge are not sciences, some being what are ordinarily termed " arts ". The other reason is that " science " is an am- biguous term, sometimes used in a narrow sense, but some- times in a broad sense to cover all the results of thinking; about facts from whatever point of view the thinking proceeds,. NATURE AND SCOPE OF POLITICAL ECONOMY 3 There are at least two possible points of view, namely, the positive and the normative. When we assume the positive point of view, we take the facts of the universe as they are. When we assume the normative point of view we deal not with facts, as facts are ordinarily understood, but with the ideals of facts, or standards — "norm" is derived from the Latin word norma, meaning a rule or standard. Ethics (or the science of what conduct ought to be and why) is a normative science. All the so-called natural sciences are positive sciences. Before considering what a science aims at and how scientific investigation is conducted, it will be desirable to define an art. The creator of an art assumes that the attainment, if pos- sible, of a given end has been decided upon, and tries to lay down a logical scheme of rules for its attainment. Navi- gation is an art ; and much of the writing grouped under the heading " politics " really treats of the art of Govern- ment. The end, of which the attainment is desired, may have reference to some particular need ; or it may be the ideal defined as a result of normative inquiries. Arts are sometimes known as practical sciences when attention is focused on their scientific side. It remains to analyse the character of positive science ; and much that will be said holds equally of normative science. The object of every student of positive science is to understand a class of facts. He must first, then, think of his facts as a class, that is see them as similar in certain respects. Thus the world of space is the scope of physics : spatial facts make up the universe for physicists. But the physicist rejects all except certain aspects of these facts ; he notices only their aspects as matter (however that may be interpreted) and motion. Human beings are part of the data for biologists, but merely as living organisms. As sentient and self-con- scious creatures, they are also facts for the psychologist ; as 1* 4 OUTLINES OF POLITICAL ECONOMY engaged in governing and. being governed, they are facts for the political scientist ; as makers and sharers of wealth, they are facts for the economist. It is apparent at once that a flash of insight which reveals a unifying aspect of apparently diverse things is the pre-requisite of a science. The reactions of human intelligence on facts, as they are directly presented, create the universes of science. After provisionally staking out the intellectual field to be surveyed, the scientist has to observe, classify, and explain his facts. The operations of observing, classifying, and explaining are by no means mechanical. They do not consist in just looking at the facts, sorting them according to their out- standing similarities and then waiting for the laws to leap out like Jack-in-the-box. The scientist does not first observe, then classify on the results of observation, then gather up laws which have, as it were, projected themselves. On the con- trary, every process in observing, classifying, and explaining, reacts on every other, and every one necessitates minute investigation under the guidance of ideas. Explanation al- most invariably compels a revision of classification, and even of the results first reached by an analysis of the facts. Some- times, indeed, the nature of the facts is discovered by deduction from the laws connecting them. Thus it is the most advanced inquiries into the laws uniting physical facts which have given rise to the latest theories as regards the substance of the facts themselves. Again, in classifying we must have in mind what are the essential features of the facts from the point of view of the science, as opposed to their external resem- blances ; and we must also have in mind how their relations are to be explained. Explanation broadly refers to the enun- ciation of laws. A law is a generalization which links one change with another in the system of facts. Sometimes " law " is used more broadly, but it is convenient here to confine its reference to the relation commonly known as that of cause and effect. NATURE AND SCOPE OF POLITICAL ECONOMY 5 Political economy embraces a positive science, a normative science, and several arts.— It will already, no doubt, have begun to dawn upon the reader that political economy is not one unified body of knowledge, but several bodies of knowledge which may be distinguished by outlook, aim, and approach. These several separate but kindred studies will be described next, with some of the more obvious rela- tions between them. Later we must return to our prelimin- ary inquiries and ask whether a science of society is possible at all. Provisionally we shall assume that this question must be answered in the affirmative. First we must remind ourselves that economic facts can be regarded from two points of view, namely, the normative and the positive. As on one side eoonomic facts are a part of human conduct, the normative science of political economy is clearly a branch of ethics. We must separately recognize, then, the positive science of economics and economic ethics. Again, because social facts cover human conduct which may be directed to different social ends, various arts of poli- tical economy are possible. Much of the literature of econ- omics is in the form of the art. A writer assumes, for instance, that " sweating " ought to be suppressed and then de- monstrates how he thinks it might be suppressed. Again there is the art of business envisaged by certain writers. It is premised that the business man desires to do the best for himself with his capital, and then it has to be discovered how in general he should act in the various circumstances in which he is likely to be placed. The study is conceived as systematized business strategy and tactics, and strategy and tactics are arts. The numerous works which have been produced on land tenure, in which peasant proprietorship, mitayage, different leasehold systems, and other arrangements, are contrasted with a practical end in view, must be grouped with the arts, though they have, of course, no relation to the 6 OUTLINES OF POLITICAL ECONOMY fine arts. A treatise on the fine arts might be in form scien- tific, of the normative order, and be properly placed under the " science of aesthetics ". Further, an economic art may be related to economic ethics. After ideals have been formulated by the latter, the procedure needed for their realization may be considered, and its consideration makes up an art. In connexion with all economic strategy and tactics, or arts of political economy, we must emphasize the importance of economic science. Action is entailed if ends are to be reached, and the prudent choice of action implies knowledge of its effects. The most developed branch of positive eco- nomic science deals with these relations of cause and effect. Also, for the study of economic ethics, a knowledge of economic science is equally a pre-requisite. The framing of social ideals is not a mere exercise of the imagination. On the con- trary it proceeds largely by deduction from known facts and generalizations relating to society economically conceived. An ideal that can be recommended must be one that is not inconsistent with human nature. It must be workable. The function of a locomotive is to travel ; and nobody ignorant of the principles of mechanics would try to think out the ideal locomotive. But we must never forget that human nature is adaptable and that its modifications can be intentionally directed. Positive economic science may or may not be evolu- tionary. — The recognition of social change brings to our notice economic writings which depict social change in what might be termed the evolutionary order. Some of these writings aim, moreover, at establishing laws or uniformities of social development. It would be as well, perhaps, to classify these writings as evolutionary economic science. This science is not yet an accomplished fact, but it is in the making. Most of the best works on economic history contain masses of evolutionary social science ; but we must not confound the NATURE AND SCOPE OE POLITICAL ECONOMY 7 economic history which aims at restoring and explaining the past for us, in its temporal order, with the evolutionary science which seeks to represent and explain economic progress, in its logical order, and retrogression also because change does not invariably mean advance. Sometimes — perhaps generally — the evolutionary science of economics, which is a positive science, is known as economic dynamics. The positive economic science which is not evolutionary is then known by contrast as economic statics. There are objections, however, to adopting in this connexion the terms " statics " and " dynamics," because in this connexion they are given meanings different from those which they bear in mathematics. In mathematics, statics refers to problems of rest and dynamics to problems of motion. But non-evolutionary economics refers to problems of motion, though it assumes that no change takes place in the fundamental nature of its data. An evolutionary science takes cognizance of the laws of change in the units with which it deals as well as in their grouping. If we choose to give the name " economic dynamics " to evolutionary economics and the name "economic statics '' to non-evolutionary econ- omics, we must remember that we are using " statics " and " dynamics " with meanings different from their mathemati- cal ones. It goes without saying that whenever facts change in nature — as for instance biological facts — an evolutionary science results from the study of them. As the elemental facts of physics do not change in nature, so far as we are aware, there is no evolutionary science of physics. Classification of economic studies.— To sum up we may say that the following are the studies included under economics : — ((1) non-evolutionary or static ; (2) evolutionary or dynamic. 8 OUTLINES OF POLITICAL ECONOMY Economic history. Economic ethics. Practical economics or economic arts. It goes without saying that an examination of one society, from the positive and non-evolutionary point of view, will not necessarily yield the same results as a similar examination of another society, or of the same society in another period, especially wheti the results are intended to be in a high degree realistic and detailed. But, as we shall learn in the next chapter, the construction of a very general economics of a non-evolutionary kind is feasible, though the finished product might prove disappointing in its proportions ; and such a science, which holds broadly of every advanced Western nation under present conditions, is already an accomplished fact. Nevertheless, we must be on our guard against com- mitting what are known as the errors of universalism and perpetualism, that is to say against assuming that generaliza- tions which apply only locally and temporarily have a wider reference. It follows from these reflections that the features of a given economic art may vary from time to time and place to place. The proximate economic ideal of Holland may differ in detail from that of Italy, and likewise the best method of bringing about a given end in the one country may be at variance with the best method of bringing it about in the other. The present work treats mainly of the elements of that positive economic science which is concerned with non-evolu- tionary uniformities, so far as they are common to advanced Western communities at the present time, but we shall occa- sionally fall into discussions which properly belong to other divisions of political economy — because by a too exclusive adherence to one range of considerations we are apt to lose grasp of, and interest in, social life as a whole. CHAPTEE II. ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE. Can the actions of free agents be reduced to law ? — This work treats in the main of that part of political economy ■which is a positive science relating to advanced Western com- munities. But when we think of political economy as a science akin to the natural sciences, we may begin to doubt whether a positive science of things exercising volitional initiative — of things aspiring, striving, failing, and succeed- ing — is possible. There is nothing self-contradictory in the conception of things as acting according to law when they have no volition. They cannot help themselves ; they do not exercise choice ; they are not in a position to refuse to act according to law. Subserviency to law is not inconsist- ent with the nature of these things. The apple cannot confute science by declining to fall to the earth. But is there not something self-contradictory in the conception of things as acting according to law when they have volition ? Cannot any individual, perhaps out of sheer perversity, determine to act so as to break the uniformity of an alleged social law ? Now in this short treatise we cannot pretend to enter into the controversy between those who believe in Free "Will of various degrees and those who believe in Determinism of its several kinds. It is sufficient for our purpose to recognize that a something, which we shall call " volition," distinguishes human beings, if not from animals, at least from all other forms of life, and to consider whether the action of volitional 9 10 OUTLINES OF POLITICAL ECONOMY creatures can be subject to scientific law. One of the pur- poses of the present discussion is to show that economics does not imply any particular view on the question of Free Will. In dealing with the difficulty just described, we may notice in the first place that all the experiences of a volitional creature do not come within the sphere of his choice. If they did, our lives would be very different from what they are. We do not decide to feel pleased or sorry : we cannot help ourselves. I cannot prevent my appetite from getting satisfied if I go on eating. Nor can I prevent myself from getting tired if I go on working without cessation. Nor can I prevent myself from getting more and more inefficient as I get more and more exhausted. Examples need not be multiplied. Much of this uncontrollable experience has a direct bearing on economic uniformities, and much of it affects economic uni- formities indirectly through its bearing on the preferences to which economic uniformities relate. In the second place, we may observe that just as some of our economic experiences are governed by laws of the human organism beyond our control, so some of our economic ex- periences are governed by laws of external nature beyond our control. We get much of our income out of the responses of nature (which is external to us) to our efforts, and these re- sponses are governed by the laws of external nature. To give one example, the law of decreasing returns, so far as it relates to such responses of external nature, derives its uni- formity from the uniformity of nature. In the third place and finally, we may notice that the economist can rely on certain generalizations, the truth of which seems to be at the mercy of caprice (in view of the volition with which the things generalized about are endowed), because man is rational in some degree and struggles to be so in a higher degree. People will not as a rule deliberately do what they think to be foolish. A man may buy a pair of ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE 11 boots for 21s. 6d. when he could procure thorn elsewhere with no more inconvenience for 18s. 6d., if he is not aware of the existence of the cheaper shop ; but he will not of set purpose under modern conditions go to the dearer shop, providing there is no reason for his preferring to deal at the dearer shop rather than the cheaper one. That is to say, other things being equal, he will not elect to buy dear rather than cheap. He might elect to buy dear to achieve social distinction, dis- courage sweating or support local enterprise. But in these events other things are not equal ; motives extraneous to ex- pense are at work, for which the economist can and does allow. Moreover, it is not entirely inconceivable that some persons might deliberately determine to buy dear to prove that econ- omic laws were not laws in the sense that they were uni- versally true. But persons do not act in this way in any appreciable numbers, if at all : if some few did, their actions would have the effect of a drop in a bucket. Insane persons, again, are sometimes possessed by a passion of misrule ; but economics assumes that the great majority of people at large are sane. Hence we may conclude that the uniformity in reason implies some uniformity in human affairs, i.e. law in human affairs. When we lay down a law of social action where volition has play, we do not allege that every man must behave in a certain way, but that in the aggregate men will actually behave in a certain way. Uniformity in the aggre- gate only is affirmed. It is not an avowal damaging to the conception of economics as a science to concede that certain social laws partake of universality in a less degree than most natural laws. The degree of the universality of a social law is naturally not high when its operation presupposes an abundant measure of knowledge, resource, and enterprise in the persons to whom it has reference. The permanence of character and social assimila- tion. — The reader's attention may now be directed to three 12 OUTLINES OF POLITICAL ECONOMY very important features of the data with which the economist is primarily occupied. These features simplify his task, and permit of his fitting the material into generalizations which would otherwise be inapplicable. One of these features consists in the fact that people's characters do not usually change so fundamentally as to lose their distinctive traits. Character is slowly acquired and as a rule only slowly modified — and our acts express our characters. I shall be pretty much the same in a year or so as I am now, and I shall therefore act then much in the same way as I do to-day. The cases in which Nature makes a leap are rare — so rare that in the consideration of aggregates they need not be allowed for. That sudden con- versions take place the most sceptical must allow ; neverthe- less, what is true in general to-day, say of the manners and customs of colliers in South Wales, will still be approximately true in a year, or two years, or ten. Another feature of our data is that all people are in their natures very much alike, apart from the fact that all have the gift of reason. A third feature is that under certain con- ditions they become alike in disposition. The processes by which people are made alike are known as processes of assimilation. They may operate physiologically or psycho- logically, and in both ways they are constantly at work in advanced as well as in primitive communities. Physiological assimilation is especially important to nations which are re- cruited from many races : through intermarriage of the several races with one another, a common racial strain tends to be generated ; but certain sorts of intermixture are frequently resisted. As regards psychological assimilation, this is never absent from any society, and it has both a subconscious, or unvolitional, and a volitional side. We are far more imita- tive of one another than we are aware, when we share in a common life. We imitate one another deliberately, per- ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE 13 haps in order to enjoy social approbation, which is only won when we conform to some extent to the ideas of others in the little worlds to which we belong ; and we also imitate one another because we cannot help it. This imitation, de- liberate and unintentional, expresses the instinct of gregarious- ness in the world of consciousness. Hence we can speak of the standard of life of a class. The standard of life of a class comprises the common habits of its members with reference to spending and working. Most of them tend to spend and work in pretty much the same way. Any two families of the same size with the same wage, if they work at the same trade in the same locality, will usually live pretty much the same lives. They will dress similarly, spend roughly equal amounts on rent and holidays, visit the same entertainments, despise the same things and reject the same food. It may be true that there are as many personalities as persons ; but it is equally true that, despite the numbers of persons in a class, the class personality, so to speak, — the idea of the tribe — will tend to be one. When the class idea affects dress, we call it " fashion " ; when manners, we call it " form " ; when everyday conduct, " respectability ". Its voice is called " public opinion ". In politics it makes parties. In all classes the class idea works and rubs down personal angularities. Its despotism is bene- ficent in so far as it insures a minimum of decency, culture, and sociability, but maleficent if it suppresses all individuality and retards change for the better. The remarks in this section, taken in conjunction with the propositions laid down at the end of Chapter I, should enable us to decide on formal grounds in what sense it is true to say that each country must work out for itself its own political economy. The abstract method. — Economics is occasionally to-day but less frequently than it was a quarter of a century ago — condemned as abstract. But to say that a study is a science is to say that it is abstract. Even the so-called classification 14 OUTLINES OF POLITICAL ECONOMY sciences are abstract. To classify is to generalize and to generalize is to let slip certain facts. But to discard certain facts, if we discard appropriately, is to discover certain truths. The biologist, qua biologist, is blind to all the engaging ways of dogs, which make them companions, and regards each of them merely as a particular species of dog, and as a certain link in the evolutionary chain exhibiting certain peculiarities, all of which peculiarities are general ideas and not facts. Even myself, the biologist takes as something quite other than that which really makes me myself. History, too, in so far as it is selective or philosophizes, is abstract. It is clear, then, that to object to economics because it is abstract is to complain that its method is scientific. The vital question to settle is whether the abstractions of political economy are appropriate. Solvitur ambulando — achievements will justify — if it explains satisfactorily, its abstractions cannot be alto- gether faulty. It is, however, necessary to investigate its past and present abstractions. Man is a bundle of motives and therefore highly complex. For the purposes of science, the conception of this complex had to be simplified. Consequently, certain leading motives used to be disengaged from the rest and personified to form the unit of the science, which was then known as the " econ- omic man ". He was not a lovable creation and he won not a little well-merited, and much undeserved, unpopularity. His vices are nowhere more thoroughly, though melodramatic- ally, exposed than in Dickens's " Hard Times ". But when he was criticized from the scientific point of view, it was sometimes overlooked that the motives isolated happened to be the dominant ones in business relations, with which much of political economy deals. It was frequently overlooked, too, that in many departments of the science this abstract method, despite its defects, led to remarkably correct forecasts. And it was commonly imagined, without sufficient reason, that a ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE 15 sermon -was being preached to the end that people should stifle all motives other than the ones separated for examination. At the same time, nevertheless, criticism was effective in warn- ing economists to be cautious about their practical deductions. The popularizers of political economy, who certainly needed checking, had proved by their appalling practical deductions how dangerous the early abstract method could be in inexpert hands, and how liable people were to think that the real world was the abstract universe of the economists, who on their part did not by any means keep entirely clear of the same unfortunate mistakes. Ultimately, there were strong reactions in procedure : the historical school distrusted and denounced the abstract method ; other writers maintained that social studies should follow more closely the lines of biological studies, which had at the time been stimulated enormously by the doctrine of evolution ; and some demanded a science of men as they ought to be in their business relations. The trend of the period — and not only in social science — was to bring together again things which had been driven apart for a time by scien- tific requirements. But the thinking of things together is barren without the thinking of them apart. It was, therefore, inevitable that a section of political economy should again secede from an environment less amenable than itself to exact formula- tion. It was not necessary, however, that Political Economy should simply revert to the old a priori lines, and it did not. It discovered a new way and along this new way it is advanc- ing — but not to the desertion of other ways — with a caution unpractised before the last quarter of the nineteenth century. The new method consists, not in abstracting a motive, but in abstracting normal or average men and women in normal re- lationships, and abstracting from the activities of such typical people those which have reference to making a living. The 16 OUTLINES OF POLITICAL ECONOMY normal man is the product of the family in which he was brought up, and he may have a family of his own, by which he is again affected. He is taken as possessed of a character whioh has been moulded by family influences, family respon- sibilities, and all the features of his social life. The economist who admits competition, even if he provisionally supposes it to rule unchecked, need not disregard the family and the potency of crystallized public opinion, and make his science unnaturally individualistic. He may admit, and ought to ad- mit, competition only in the degree in which it works within the complex of social impulses — compare, for instance, what has been said above about standards of life. A society is not atomistic but an organism hierarchically constituted of smaller group organisms of which families are the chief. We shall see later how important is the function of the family in the preparation and disposal of the labour of the rising generation and in other ways. The new analytical procedure is metho- dologically superior to the old. From the old, only rough approximations could be derived in most departments of economics ; but it achieved notable results, and for some purposes it is still and will always be resorted to. It may be repeated, in order that no mistake may arise, that modern analytical economics neither assumes nor advises selfishness. But without relegating sentiment to Saturn, we may hold that the affections do not directly enter into most business transactions. " Oh 'tis love, 'tis love, that makes the world go round," asseverated the duchess in " Alice in Wonderland ". " Somebody whispered," said Alice, "that it's done by everybody minding his own business." However, among the impulses which are the motive power of business activities, the affections may play a large part indirectly. A man may work his best to make as much as possible in the interests of his family or friends, or even for philanthropic purposes. And it must not be imagined ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE 17 that, in the absence of altruistic motives, a man who works his hardest for success must be sordid. The passion of great business leaders is commonly quite other than that of the miser. Because the counters which measure commercial gains consist of money, we are apt to go astray in our analysis. Those who play cards for cowries are not mastered by a passion for cowries. Until we understand the motives now at work in the economic field, we are not likely to make the best practical use of economic knowledge. Historic and realistic methods. — -The bare deductive method, which argues from general principles to particular cases, is so dangerous in certain branches of economics that it is incumbent upon the economist to return constantly to reality to test his theory. He will find it profitable, also, to watch patiently the heaving sea of facts as a whole and the interplay of its details. When facts are kept continuously under observation, it is not unlikely that the receptive mind will take the impress of their uniformities. As directly im- pressed, a uniformity must be vague, it is true, but by ab- straction, inference, and special inquiry guided by hypotheses, it can be made definite. As first impressed, it must be a puzzle, because induction, that is generalization from a num- ber of particular cases, may establish that a law is, but not why it is. To find out why it is, we must again fall back on abstraction, selective scrutiny, and deduction. History, too, the imaged sweep of events in the past, by presenting us with data somewhat different from those of the present and differently collocated, and by taking sequences out of time so that they may be perceived at once without our waiting for time to make them, is of incalculable value even to the economist who merely wants to explain social facts as they are in his day. And it goes without saying that, severed from historical studies, the evolutionary science of political economy would be an impossibility. 2 18 OUTLINES OF POLITICAL ECONOMY Much of the data of economics is measurable. — We may now try to account for the relatively high state of de- velopment of positive non-evolutionary economic science in comparison with other social sciences. The chief explana- tion is that the former is concerned largely with facts that can be and are measured. Thus, we can and do express in money the intensity of our wants for different purchasable things, and the degrees of inducement necessary to make us engage in different kinds of work. Most communities possess some kind of money, and money measures the influences which interact in the making and sharing of income. Money, as a measure of value, despite imperfections which will be noted in due course, does in general for economics what standards of space and weight do for physics. As soon as the facts of a body of knowledge become capable of some kind of measurement, that body of knowledge advances to a higher rank among systematized studies, because its facts may be represented as quantitatively interrelated. However, many economic data which are measurable do not lend them- selves readily to exact, or even approximate, measurement It is not generally feasible, therefore, to calculate the quantity of the effect which will follow the causes actually operating at any moment. It will be as well to repeat here that the measurable facts with which the economist deals when he argues deductively are those found among typical persons. Divisions of political economy and relations between them. — There is no agreement among authorities as to the best way of dividing up political economy regarded as a posi- tive non-evolutionary science, but I prefer the division into the economics of (1) consumption, or demand, (2) production or supply, (3) exchange, or the equilibrium of demand and supply, and (4) distribution, or the sharing of wealth. The sources of wealth, and the actions of the members of a com- munity working together to produce it, together with the ASSUMPTIONS AND METHODS OF ECONOMIC SCIENCE 19 effects of their actions, constitute the data of the economics of production. The study of the initial impulses under which production begins is a part of the economics of consumption, while the effects of consuming things, in different degrees and proportions, is another part. The economics of exchange deals ■with the exchanging of things, and explains rates of exchange — why, for instance, some things, in the pile of wealth pro- duced, have more value in exchange than other things. "Distribution," when used to indicate a department of eco- nomics, is applied in a special technical sense, not to mean transportation or the delivering of goods to consumers, but to refer simply to the sharing of the product. It denotes that section of political economy which explains why wages, profits, rent, and so forth, are of the amounts that they are. This brief account of the chief divisions of political economy will convey a rough idea of their contents ; but in order to bring our imagery into closer relation with facts, we must suppose that all the economic processes described above go on at once and continuously. Wealth is distributed, for instance, as it is produced ; the product, which is sometimes called the "national dividend," is always a flow and never a fund. Moreover, as the reader works his way into this treatise he will realize that it is impossible to tear each sec- tion of political economy quite apart from other sections. 2* BOOK II. CONSUMPTION, OE DEMAND AND ITS SATISFACTION. CHAPTBE III. WANTS AND DEMAND. Scope of the economics of consumption. — The econ- omics of consumption comprehends, as we have already learnt, human wants and their direct satisfaction. It includes inquiries into the following subjects : — I. Wants in their relation to the means of satisfying them and to each other. II. The expenditure of income. III. The reactions of the satisfying of wants on produc- tion. In satisfying our wants we are said to consume wealth, when wealth is needed for their satisfaction. I say " when wealth is needed for their satisfaction " because wealth, as or- dinarily conceived, is not always needed for the satisfaction of a want. We sometimes want to do things — to sing, or go for a walk, or sleep — and just doing a thing is not ordinarily regarded as consuming wealth, though the possession of some wealth may frequently be required to do it. A precise mean- ing will have to be assigned to the vague term " wealth," but its definition must be deferred until we have studied wants, 20 WANTS AND DEMAND 21 because wealth is the correlative of certain wants and without wants there would be no wealth. The reactions of consuming on efficiency belong equally to the economics of consumption and the economics of produc- tion. In this treatise we shall only notice these reactions cursorily. The study of wants and demand is assigned to the economics of consumption for the simple reason that they initiate consuming. Wants, utility, satisfaction, and demand. — "Want," which sometimes passes current as synonymous with "desire," is an ambiguous term which may refer (1) to a craving or longing, or (2) to a decision to make sacrifices, if need be, to possess some particular thing, or perform some particular action. There is no contradiction in saying that a man with a passion for alcohol, who is a total abstainer, wants an alco- holic beverage when he wants a glass of water. "What is meant is that he has a longing for beer though he is trying to get not beer but water. It is with want in the second sense- that the economist qua economist is directly concerned, and the relations between wants of this kind we may call " pre- ferences ". The definitions of " utility " and " satisfaction " could not be so easily settled if we entered into the numerous contro- versial issues that have been raised, but it is probably best for the economist to avoid these issues, if possible, as they are really psychological and not, therefore, his concern. And it happens that their avoidance is not difficult as the directly presented facts, about which there is no dispute, are sufficient for his requirements. We may say that things have utility, or yield utility, in the degrees in which they are wanted or preferred, and that satisfactions result from their use in the degrees in which they have utility or are preferred. It is the pre- ferences expressed in wants about which there is no dispute. When we speak of the utility of a thing we need not intend 22 OUTLINES OF POLITICAL ECONOMY more than the degree of preferability to us of that thing ; and similarly, when we speak of the satisfaction got from using that thing we need not mean more than the degree in which our enjoyment of it was preferred by us. We need not intend more than this as economists, and we shall not throughout this work. Consequently, " utility " and " satisfaction " are to be taken merely as conventional representations of degrees of preference ; and preferences are to mean for us the relations between wants understood not as desires but as actual or hypothetical choices (understood, that is to say, in the second sense given to " wants " above). An illustration will aid the reader's comprehension of what exactly our reading of utility and satisfaction comes to. Bentham suggested that in courts of justice witnesses should be invited to state degrees of belief by reference to an objective standard, say to a yard measure. If this suggestion were carried out, and a witness indicated his belief that he met a certain person on a certain day by two feet and his belief that he met him some other day by six inches, he would not mean necessarily that corresponding to these beliefs there were with- in him two subjective states of two feet and six inches in length respectively, or even two such states the one of which was four times greater than the other. He would simply mean, were he a plain man concerned to give evidence and not to provoke a discussion on psychology, that his degrees of belief were related to one another in the ratio of four to one, and to certainty as twenty-four and six are respectively related to thirty-six. The twenty-four inches and six inches would be to him just conventional objective representations of degrees of belief, and nothing more. So, if I should say that a man gets ten units of satisfaction or utility from his newspaper at breakfast, and two units of satisfaction or utility from his coffee, I should simply mean that he prefers the newspaper to the coffee in the ratio of ten WANTS AND DEMAND 23 to two. The ten and the two units of satisfaction or utility, so understood, would be just conventional objective represen- tations of degrees of preference or choice and nothing more. It remains to give to " demand " a clear-out meaning, and here again we find some disagreements in wording if not in substance. Demand is frequently said to be the expression of a want on the part of a person who is in a position to offer something to get what he wants. This view of demand is not wholly satisfactory, as everybody who is not quite desti- tute is in a position to offer something even for the Koh-i-noor diamond. If we try to evade this objection by saying that demanding consists in making a reasonable offer for what we want, we are no better off, since we are then logically com- pelled to define what constitutes in each case a reasonable offer. Sometimes demand is simply regarded as the tangible expression of preferences in terms of exchange, and so it will be regarded in these pages. Demands, we may say, are the quantitative expressions of preferences. The psychological basis of demand. — Some economic writers have assumed that any apparent conflict between the two sorts of wanting described above is illusory. Let us provisionally call want in the second sense, in its reference to economic conditions, " de- mand," and want in the first sense " longing "- Let us also call the psychological state connected with longing, through which action is produced, " impulse ". It is supposed by these writers that demands measure longings or impulses : that, when we seem to act against our impulses, the explanation is that deliberating has brought out other and stronger impulses which, by virtue of their greater strength, triumph over the earlier impulses. Now I should contend that these writers are treating as settled a psychological question (i.e. a question belonging to the science of the mind) which is still controversial, or might at least become so, and a question upon which psychologists alone are capable of expressing an opinion. The economist's intru- sion into psychology is both venturesome and unnecessary. If choice does not always fall on the course to which the strongest 2-1 OUTLINES OF POLITICAL ECONOMY impulse points, the economist is wrong when he represents demand as measuring impulses. And if choice does always fall on the course to which the strongest impulse points, to say that demand measures impulses has no more significance for economic purposes than to say that demand measures preferences. Of course, if it can be maintained psychologically that preference alone indicates the strongest impulse, preference and not impulse is the bedrock of fact upon which our economics must be founded. Choices and the relations between them, or preferences, are the only ulti- mate facts about which we as economists can feel quite sure. And they are sufficient. To go behind them is not our business as economists but the business of psychologists. It may be added that those writers who state that demand, as above interpreted, measures motives or inducements to action, are making either the assertion which has just been criticized, or the assertion which will be examined next, if they do not mean merely that demand measures preferences. There are certain economists who maintain that utility or satis- faction is a measurable thing apart from the fact of choice, and derive their explanation of demand from the consequences in the form of utility or satisfaction to which consumption leads. They may accept the view that impulse is the direct cause of action, but, if so, they believe that the impulse measures the expectation of utility. Choice, they assume, must fall on the action which is followed by the greatest utility or satisfaction, so far as anticipation is not mistaken. They therefore suppose that demand measures utility or satisfaction. Seeming instances to the contrary, they imagine to be explained by the new expectations of utility and disutility aroused after reflection. Against taking this doctrine that demand measures satisfaction as one of the principles of economics, I should bring objections identical with those already advanced against taking the doctrine that demand measures cravings or impulses as a fundamental econ- omic thesis. It is at least likely that we do not choose things in the order of the degrees in which we expect to derive satisfaction from them, if satisfaction is measurable apart from the facts of choice. And if satisfaction is not measurable apart from the facts of choice, and we only know that one of two things has the greater WANTS AND DEMAND 25 utility because it is chosen in a cool hour by a wise man who is not mistaken in his forecasts, then to say that demand measures utility or satisfaction is merely to commit ourselves unnecessarily to an inference from the undoubted fact that demand measures choice or preference. Systems of demand. — Some of the most elemental experi- ences of life have to be pointed out to most of us before we become alive to their existence. The first thing to observe about demand is one of these elemental experiences. It is that all people demand things in groups. Quite strictly speaking, it is questionable whether there is such thing as a detached demand for any article. A student's demands, for instance, for books, ink, pens, paper, a quiet study, leisure, and his numerous other requirements as a student, are all constituents of one massive group demand. Individual things are almost always, if not invariably, demanded as parts of a systematic whole. This systematic whole, or arrangement of grouped demands, is moulded by a variety of influences. In the first place, it is shaped by individual tastes, and, in the second place, by some standard of life or standard of comfort (seep. 13), that is by the conventional ideas prevalent at the time as to the amount and kind of expenditure expected of the members of each particular social class or grade. A person's system of demand is only gradually built up ; and it is only gradually modified. In its initial form it is handed down to him by his parents, and this inheritance is supplemented, subtracted from, and remodelled, as an out- come of his education and experience and the social influences brought to bear upon him. So far as a person is consciously active in the construction of his standard of living, he has to devise that particular compromise, between his individual tastes and the expectations of his friends and his class, which yields him most satisfaction (" satisfaction " as defined on 26 OUTLINES OF POLITICAL ECONOMY pp. 21-3). This compromise is not reached at once, but is approached step by step ; and even if we thought only of pleasing ourselves, it would not be possible to spend an in- come straight away to the best purpose, seeing that our first guesses at the relative amounts of utility obtainable in differ- ent ways are almost bound to be falsified. Systems of demand crystallize into habits ; hence it be- comes difficult for us to alter them fundamentally. It is advantageous that habit should be allowed to settle the small recurrent problems of life for us, because habit economizes time and effort. The housekeeper would never have a moment for anything else if she had to think out her weekly expenditure ab initio every week. But we all run the risk of getting so thickly encrusted with habits that we are rendered incapable of developing. The supreme importance of foster- ing adaptability, of keeping our habits open, so to speak, as well as our minds, while our habits are left at the same time with enough strength to relieve us of the worry of thinking out anew each small outlay, on the recurrence of our needs, is abundantly manifest. Owing to the fact that our systems of demand are only slowly built up, it will frequently be found that a sudden rise of our incomes is accompanied either by a degree of saving which is afterwards curtailed, or for a time by ill-judged extravagance. And, inasmuch as the deprivation of something included in our systems of demand means, not only the loss of the satisfaction derived from consuming it, but also the added discomfort of breaking a habit, it will frequently be found that a reduction of income is accompanied by a run- ing into debt or by the exertion of special efforts to restore the old income. We may gauge the force of habit from the effect upon price of a permanent shrinkage in the supply of something of which the consumption has become habitual. Suppose the wheat supply were permanently cut down. Im- WANTS AND DEMAND 27 mediately there -would follow an immense elevation of price, because most people would not know how to dispense with any of the wheaten bread to which they had grown ac- customed. Ultimately the very high price would subside somewhat, because rye-bread and other forms of food would gradually be substituted for wheaten bread in systems of demand and standards of living. Though the demands of any and every individual must, strictly speaking, be conceived as a whole, some of the con- stituent demands of a group demand are so little dependent upon other demands that they may be conceived as practically independent. Between the others — the closely dependent demands — a number of different relations hold. The chief of these are complementary and substitutional relations. The demands for two or more things may be complementary, and, when so united as complementaries, things are said to be in joint demand. We have an example in the demand for knives, which is a joint demand for knife-blades and knife- handles. Two or more things may be demanded jointly in a fixed ratio or fixed ratios, or in a variable ratio or variable ratios. Again, one or more of the constituents of the joint demand may also be demanded independently, or in a different joint relation. Golf-clubs and golf-balls are jointly demanded in a variable ratio. When golf-balls rise in price, golfers demand fewer, because they take greater care of them, search longer for lost balls, and are less fastidious ; but the demand for golf-clubs is not much affected. The ratio is more rigidly fixed in the case of table-knives and forks. Milk is de- manded in more than one joint relation — for instance with tea and with arrowroot — and also separately as a beverage. Two or more things may be substitutes and may, therefore, be demanded to the partial or almost complete exclusion of each other for the time being. Examples are found in beef and mutton, and tea and coffee. CHAPTEE IV. DIMINISHING UTILITY AND MARGINAL USE. Total and marginal utility. — The central topic of this chapter is to be the law of diminishing utility, but it is necessary to begin with the conception of marginal utility and the distinction between this and total utility, as they have to be used in the enunciation of the law in question. The total utility of a given quantity of any commodity means the whole of the utility or satisfaction obtained by the person consuming it, whereas the marginal utility means the addi- tion made to the total utility by the addition of the last incre- ment consumed. Or, put in terms of preferences, total utility means the degree in which a given quantity of an article is preferred to something else which is taken as a standard for the measurement of wants, while marginal utility means the degree in which the preference was raised by the addition of the last increment. It is easier to speak in terms of utility (or satisfaction) than in terms of preferences, though it is preferences that are intended ; and we shall take the easier course. But it must be remembered that when, in any illustration, we refer to a definite amount of utility, as for instance twelve units of utility, we are having recourse to what is probably a fiction — for it is doubtful whether a unit of utility is a real thing like an inch or an ounce — to enable us to express on paper without circumlocution the undoubted fact that preferences are quantitatively related (see pp. 21-3). The distinction between total utility, in the sense that should 28 DIMINISHING UTILITY AND MARGINAL USE 29 now be fully understood, and marginal utility is by no means difficult to grasp, but it is so fundamental to a great deal of economics that it will be prudent to run the risk of saying too much about it, rather than too little, and illustrate it by means of a concrete example. Let the table beneath relate to the utility of sugar to some particular person : — Pounds of Sugar Consumed per Month. Total Utility Derived from Consumption. Marginal Utility. 1 100 100 2 180 80 o 230 50 4 270 40 5 290 20 Each figure in the third column is obtained by deducting from the figure in the second column, in the same line, the previous figure in the second column. Thus the 20 is ob- tained by deducting 270 from 290. And this is the interpre- tation of the table : if 2 lb. of sugar are consumed monthly the total utility to the supposed consumer is 180 while the marginal utility is 80, but if 3 lb. are consumed the total utility is 230 and the marginal utility is 50, and so on. In this table the increments of the article have been taken too large for the best possible representation of marginal utility, as this is always understood to relate to a very small incre- ment relatively, but the table serves for illustration. The increments were made large to keep down the size of the table, while bringing quantities up to a not unreasonable consumption of sugar and yet showing initial utilities. Now there are two additional points of importance to note. The first is that the marginal utility of a commodity is not the same as the utility yielded (or satisfaction enjoyed) during the consumption of the last increment. Thus, if 5 lb. of sugar 30 OUTLINES OF POLITICAL ECONOMY are consumed by our supposititious person, it must not be assumed that he gets 20 units of utility while consuming the fifth pound. The addition of the fifth pound might have affected his enjoyment of other pounds, so that his fifth pound yielded more or less than 20 units of utility. The 20 units of utility make up the marginal utility, which means the addition made to the total utility got from his monthly consumption of sugar ; and this, for the reason given, is not necessarily the same as the utility yielded during the con- sumption of the fifth pound. Indeed, to be quite precise, we ought to say that the marginal utility of, say, the fifth pound of sugar means the addition made to the total utility obtained by the person in question when his monthly consumption of sugar is raised from 4 lb. to 5 lb. and his means remain otherwise as before. The second additional point to notice is that it is not always possible, even in theory, to assign definite amounts of utility to the initial increments of a com- modity, because these initial utilities may be vast and in- definite, as for instance in the case of water. The law of diminishing utility and its limitations. — Of all the laws of demand far the most important is the law of diminishing utility or of satiable wants. It declares broadly that the more we have of a thing the less we want additional increments of it, or the more we want not to have additional increments of it. "We become gradually indifferent to chocolate, for example, as we consume it less abstemiously, and then inimical to it. Put in terms of utility, the law pro- claims generally that, as the amount of a thing consumed within a given time increases, the utility derived from it in- creases at a diminishing rate (so long as utility increases at all), or, in other words, its marginal utility decreases. This decrease goes on as a rule, if consumption continues, until marginal utility drops to zero ; and if, after zero utility is reached, our supplies of a thing are still unexhausted and we DIMINISHING UTILITY AND MARGINAL USE 31 are forced to consume them, we begin to experience dissatis- faction in place of satisfaction. That this dissatisfaction or disutility (-which is the negative of satisfaction or utility, as pain is the negative of pleasure) will increase at an increasing rate as our supplies increase, needs no proof. The law of diminishing utility, though it holds equally of immediate effects, should ordinarily be taken to relate to effects in the long run, that is to say, to effects after time has been given to the consumer to adapt himself and modify, if need be, his consumption of other things ; for it is with the latter reference that it is of most significance socially. Bear- ing this in mind, we may proceed to review certain limita- tions and apparent limitations of the law of diminishing utility. The first limitation to notice is trifling : it is that in the long run the marginal utility of certain commodities may be- gin by rising though it falls ultimately. We must have a moderate amount of some commodities before we can ap- preciate them. Indeed, if we took the increments of a com- modity small enough, marginal utility would generally mount at first. An ounce of coal, for instance, is no good to any- body ; coal would not yield any value to speak of till very many ounces were available. Another limitation, sometimes called an exception, is due to the fact that some commodities really change in character, or in their appeal to certain consumers, as the quantity of them possessed by those consumers increases. Hence their marginal utilities may steadily rise : for instance, to a col- lector of eggs, the value of great auk's eggs, of which there are very few, might ascend with his success in getting great auk's eggs because they would add at a growing rate to the uniqueness of his collection ; to have two great auk's eggs is to be envied, but to have six is to be a prince among egg collectors. Of the same order are the cases in which the 32 OUTLINES OF POLITICAL ECONOMY utilities of certain things to certain consumers are sensibly governed, not only by the quantities they possess, but also by the quantities possessed by other people, and even by the classes of people who are possessed of the things in question. The value of a telephone to any one user is enhanced when more people get linked on to the service with which it is connected. The value of rare things to a collector appreciates when some of the supply not held by him is destroyed. The value of a thing of fashion may expand as some classes acquire it and contract as other classes acquire it. In order to bring these instances under the law of diminishing utility, we have to limit the law by assuming that the quantity, or distribution, of the supply of the commodity which is not in the hands of the person whose demand we are studying remains constant. We must also remind ourselves (pp. 25, 27) that the value of a thing is almost sure to depend in some degree, though it may be in a very slight degree, upon the abundance of other things which its owner possesses. If a man's income suddenly doubled, the level of the utility yielded him by cer- tain quantities of certain things would be raised, the reason being that his greater wealth in other things brought out the value of these particular things. The utility of furniture is a case in point ; the value of a fourth bedstead to any- body who lived in a cottage might be paltry, but it would become high if he inherited a fortune and a mansion. And the utility of certain other things would be lowered by the increase of income : the value of a bicycle to a man who bicycles because he cannot afford a motor-car may drop to zero when he gets a motor-car. Further, the marginal utility of a person's income as a whole might actually rise as his income rose. His whole scheme of consumption could then be reconstructed ; and in more affluent circumstances he might become a different in- dividual. He might have been debarred by the meagreness DIMINISHING UTILITY AND MARGINAL USE 33 of his income from embarking upon a career which attracted him. If fortune brought him just sufficient wealth to en- able him to follow his bent, his life might be so altered that the marginal utility of his income in his good fortune could easily exceed what the marginal utility of his income had been previously. These numerous qualifications make it plain that the law of diminishing utility as broadly stated at the beginning of this section is lacking in definiteness of pronouncement. For this reason it will be a convenience to recognize not one law but two, namely the law of the diminishing utility of things and the law of the diminishing utility of income, as they might be called. The first holds with few, if any, real ex- ceptions, of the later increments of consumption at least, in the case of all people, so long as their incomes remain about the same. For, the wants which are still felt to press but have to be left unsatisfied are naturally less intense than those picked out to be satisfied, seeing that everybody tries to do the best with his income. But, irrespective of income, this law has a far more limited application, for reasons stated above. The second law holds of almost all incomes when they are in- crementally increased. But when an income is largely in- creased, the law may not apply to the change, as an entirely new plan of expenditure may be adopted, and the new scheme of existence rendered possible may have a high yield in utility. Diagrammatic representation of diminishing utility. — Con- sider fig. 1, ignoring at first the dotted lines. Let 06, be, cd, .stand for successive increments of a commodity, say ounces of tea con- sumed by some person per week. We may represent the satisfaction drawn from 1 oz. by the rectangle on ab, and the satisfaction got from 2 oz. by the rectangles on ab and 6c, and so forth. The rectangles on be, cd, . . . ., therefore, represent the additions made to the satis- faction derived from his consumption by raising the consumption of 3 34 OUTLINES OF POLITICAL ECONOMY tea from 1 oz. to 2 oz., from 2 oz. to 3 oz., and so forth respectively. The law of diminishing utility asserts that the rectangles will get less and less in height successively as we pass from left to right. As we increase our consumption of tea, the total utility enjoyed by us increases, at any rate up to a point, but it increases at a diminish- ing rate. The diminishing rate in our imaginary case is shown by the decrease in size of the rectangles in fig. 1. We must not say that the satisfaction got from the second ounce of tea is the rectangle on be, and the satisfaction got from the third ounce the rectangle on cd, and so forth. When consumption is raised from 1 oz. to 2 oz., all that the facts warrant us in saying is that the total satisfaction derived by the person in question from tea is abedefgh ~i j * r u Fig. 1. Fig. 2. increased by the rectangle on be. The rectangle on be stands for the difference made to his total satisfaction by the second ounce of tea. Similar statements, of course, may be made of all the other rect- angles in the figure. If 3 oz. (ad) of tea are consumed weekly, the total utility is the sum of the rectangles on ab, be, and cd, while the marginal utility is the rectangle on cd. If 4 oz. (ae) of tea are consumed, total utility is the sum of the rectangles on ab, be, cd, and de, while marginal utility is the rectangle on de. When consumption reaches aj in our imaginary case, the utility of the last increment, hj, is zero. When consumption is alt, we find marginal dissatisfaction (or negative satisfaction) instead of marginal satisfaction. The marginal dissatisfaction is the rectangle below jk. And the rectangle below hi is greater than that below DIMINISHING UTILITY AND MARGINAL USE 35 jk. Dissatisfaction is indicated by rectangles below the vertical line al. If al of the commodity is consumed, the net utility derived is equal to the rectangles above al, less the rectangles (marked with dotted lines) below al. Only we must notice that people do not consume things till their marginal utilities become negative, except by mistake. The reader's attention may now be drawn to a method of re- presenting the variation of the utility derived from a commodity with the quantity of it consumed which is more convenient than that followed in constructing fig. 1. If as the basis of fig. 1 we took tenths of ounces instead of ounces, each of the divisions along al would be divided into ten parts and the rectangles standing on these sub-sections would be very narrow. Consequently the difference between the aggregate area of the rectangles and the area enclosed between the line ah, the left boundary of the first rectangle, and a line through h joining the top left-hand corners of the rect- angles, would be very small. And this difference could be made as small as we pleased by taking the units along aj as small as we pleased. Hence fig. 1 may be reduced to fig. 2. We may call UU' in fig. 2a" utility curve " When Oa of the commodity to which the curve relates is consumed, the total utility obtained from it is OacXJ and the marginal utility is a rectangle whose height is ac. If the supply were reckoned in very small increments this rectangle would be very thin. For short, we may simply say that the marginal utility is ac. If 06 is consumed, total utility is 06U and marginal utility is zero. If Od is consumed, total utility is 06U - bed and the marginal disutility is de. The lines meeting at right angles at O are called axes of co- ordinates. The various vertical distances between a curve and OX are called its ordinates, and the horizontal distances between it and OT its abscissae. It is not always possible, theoretically even, to start the curve UU' at a point on OY, because the utility of initial increments of a commodity might be indefinite. Are all wants satiable ? — From the fact that the marginal utility of a commodity may subside to zero, and even sink to a negative quantity, it does not follow that human wants in their 3* 36 OUTLINES OF POLITICAL ECONOMY entirety are within measurable distance of being satiated or are indeed satiable. Man may be conceived as a bundle of wants that are of two different sorts. On the one hand, he wants things that cannot be directly bought, such as health, culture, a model society. These wants, we may affirm, can never be completely appeased. On the other hand, he wants things that can be directly bought, these wants being largely derived from the wants for things that cannot be directly bought. A man may demand dumb-bells because he aspires to be muscular. He may never, perhaps, become as mus- cular as he would like to be, but he will soon have as many dumb-bells as he has any use for if he goes on buying more and more of them. Wants of the second class may all be regarded as theoretic- ally satiable, from a common-sense point of view. Anybody with an income of £10,000,000 oould buy all the purchasable things that he had time to oovet. But, for practical pur- poses, the aggregate wants of the second class, in the case of almost all people, may be regarded as insatiable, because very few people are enormously wealthy. Of almost all people it is true that they could spend without difficulty very much larger incomes, and would enjoy having very much larger incomes to spend. One reason why wants in general are practically insatiable is that new particular wants appear as the old are met. It has been asserted that the satisfaction of old wants actually creates new wants, and there is some ground for the asser- tion. When a student's demand for an elementary book on political economy is satisfied, in the sense that he has pro- cured it and read it, a want for more advanced books on political economy is generated which could not have been generated before. But the fact that new demands become clamorous, after the old demands have been met, does not always mean that new wants have been created by the DIMINISHING UTILITY AND MARGINAL USE 37 satisfaction of the old. Sometimes the wishes underlying the new demands were there all the time, but were qui- escent because we were actively engaged in getting our more urgent oravings assuaged. Wants — except the wants for necessaries — do not ordinarily disturb us much, when there is little chance of their becoming effective demands, because we do not pay much attention to them. They are mere idle wishes which leave us untroubled, like day-dreams. The utility of complements and substitutes. — Suppos- ing that no goods are so indispensable that the utilities of their initial increments are indeterminate, then, if we could add up the satisfactions attributed separately to the consumption of each of a group of goods inoluded in a scheme of con- sumption, we should not produce a sum which is the same as the amount of utility actually enjoyed. We should pro- duce such a sum were all the things independent in value ; but they are not, as we have already perceived. Many articles are bound together by complementary and substi- tutionary relationships. Let us inquire what happens when we add together the value attributed to tea, and the value attributed to coffee, since tea and coffee are partial substitutes. The utility of tea is calculated on the supposition that a person has such a sub- stitute as coffee ; it is less than it would be if he had no coffee. Again, utility is attributed to coffee on the assumption that there is tea to fall back upon. If, therefore, we add together the satisfactions derived from tea and coffee sep- arately, we get too small a total, for we leave out what would be lost by the entire withdrawal of the group of stimulating beverages made up of tea and coffee. Correspondingly, adding the utilities attributed to comple- ments involves adding some utilities twice over. An extreme example is afforded by boots. If I have a boot for the right foot only, its value is insignificant ; but the value of a pair of 38 OUTLINES OF POLITICAL ECONOMY boots is high, so with a right-foot boot only in my possession I should set a high value on a corresponding left-foot boot. Now, H I calculated the utility of a right-foot boot in the same way by estimating what I should lose if it disappeared and I were left with only the left-foot boot, and then added this utility to the utility likewise attributed to the left-foot boot, I should get a total utility greater than that actually yielded by a pair of boots. Less extreme, but similar in kind, are the illustrations which might be drawn from complements the members of which have more independent value, like bread and butter, tea and cream. The basis of laws of utility. — The law of diminishing utility or satiable wants, with its dual reference to individual things and income, the limitations of the law, and the other generalizations laid down above as regards utility, may all be established by the direct introspective inquiry of a number of different persons, supplemented by observation of people's actions. The law of diminishing utility, so far as it holds, may in laddition be confirmed by pointing out that utility varies directly as the urgency of demand, and that the most urgent demands will usually be attended to first. Marginal quality. — " Marginal" is unfortunately an am- biguous term which has a meaning other than, though related to, that set forth above. "With this other meaning, " marginal " must be recognized as having an established place in the nomenclature of economic science. It has reference to the quality of things (including persons and services). When a thing is of such a quality that it is only just worth while using it, in view of all the circumstances, it is sometimes said to be marginal or to have marginal quality. Suppose, for instance, I go into an orchard to pick up a dozen fallen apples for a pudding. The marginal use of apples to me in the circumstances would be the difference made to the utility of the pudding by putting twelve apples into it DIMINISHING UTILITY AND MARGINAL USE 39 instead of eleven, if the apples were all equal in size and quality. If, however, they are not, the apple which is the least satisfactory of the twelve chosen is the marginal apple, meaning the apple of marginal quality. Take another illustration. If an employer engages 100 men for a particular purpose, the difference between the value to him of 99 men and the value to him of 100 men, who are identical in respect of efficiency, is the marginal value to him of labour of the kind in question, or the value to him of labour at the margin. This we have already learnt. Now the marginal man, meaning the man of marginal quality, in this case is the man who is only just efficient enough to be employed for the purpose in question when 100 are going to be employed. Evidently the 100 are not likely to be endowed with exactly the same efficiency. Similarly we may say that the land which it is only just worth while to use, in view of its position or fertility, is the marginal land. Similarly we may say, to put it roughly, that in any given industry the business or firm which is only just efficient enough to continue producing, in the long run, is the marginal business or marginal firm in that industry (see pp. 161-3). This conception of the marginal thing, and the distinction between it and the conception of the marginal use of a class of things, must be firmly grasped before the student advances a step further. CHAPTEE V. DEMAND PRICES, EXPENDITURE, AND CONSUMERS' SURPLUS. The law of demand price. — Demand is expressed in offers of things of value for things of value. Under modern con- ditions offers are ordinarily made in terms of money. Let us then speak of demand in future as an offer of money. Now observe that demand, say for coal, means neither a price, nor a quantity of coal, but the prices which will be paid for differ- ent quantities of coal. Demand, then, states the relations be- tween the quantities that might be purchased and prices. Because of the law of diminishing utility, people will almost always offer less and less per unit for additional supplies of a commodity for consumption in a given period of time ; that is to say, assuming that the article is butter, price would need to be lower if 3 lb. were to be bought than if 2 lb. were to be bought by any person in the month. To be rigidly exact, we should call a person's demand price for a given quantity of a thing, as above described, " marginal demand price," to distinguish it from what the person would give, if need be, were the alternative his being deprived of the thing altogether. This latter payment would obviously be governed by the aggregate, and not the marginal, utility of the given quantity of the thing in question. By combining the demands of all individuals buying in one market, we get market demand pi-ices. "What is meant by 40 DEMAND PRICES, EXPENDITURE, ETC. 41 combining individual demands can be made evident by the following example : — Price. Amount that A would buy. Amount that B would buy. Compound demand, i.e. combined amounts that A and B would buy. 5a. 4s. 3s. 2s. 1 3 8 12 1 4 7 1 4 12 19 What is done here with two consumers could theoretically be done with twenty thousand. But it could only be done theo- retically. It is of value to realize how market demand prices are compounded of individual demand prices, yet our know- ledge of this will not enable us to draw up the market de- mand schedule at any time for any particular oommodity. In general form, parts of a market demand schedule may be indicated nevertheless, after we have watched' side by side variations in price and in amount sold. However, we must remember that the conditions of any society, including the relations between demands, are subject to ceaseless mutations ; and that, therefore, in sketching demand from nature we are delineating a thing that is changing as we draw it. Because in almost all cases previous buyers will not pur- chase more, and new buyers will not appear, unless the price of a thing falls, in almost all cases market demand price will fall as the quantity of the thing offered increases. This infer- ence is evidently valid if market demand may be regarded as compounded of individual demands ; and we know, moreover, from direct observation, that the market demand price for large quantities is less than that for small quantities. It must be pointed out, however, that the simple kind of composition of market demand assumed above provisionally, for the pur- 42 OUTLINES OF POLITICAL ECONOMY poses of exposition, is not actually to be found in numerous oases, while in some cases it is not even an approximation to the facts. This follows from what we have already learnt of the frequent dependence of an individual's demand for a thing upon the total quantity of the thing sold to other people. Consequently, taking the last line in the above table for illus- tration, the correct interpretation is that when the price is 2s., and 19 units are bought altogether, A will acquire 12 of them and B the remaining 7. The point is that B, say, who is prepared to pay 2s. each for 7 units when A has 12, would not necessarily be prepared to do so if A had 6 or 20. In either of these events, B's offer might be higher or lower than 2s. In other words, while market demand is in a sense derived from individual demands, the latter are also in a sense derived from the former. But, when this is conceded, and any person's demand for a given quantity of an article is ex- pressed on the understanding that the total quantity sold at the price is what it is, the general statement made above that individual demand prices almost always fall with in- creased purchases remains true. Elasticity of demand. — One of the most important attri- butes of demand is what is called its elasticity. The term "elasticity '' is applied in a special technical sense to demand. We say that demand is highly elastic if demand price falls very little as consumption is increased ; and that it is highly inelastic if demand price falls rapidly as consumption is increased. Dr. Marshall has suggested that we should call the elasticity of demand " unity," so long as the amount demanded at a price multiplied by the price (that is the aggregate sum paid for what is sold) remains constant. If it were more or less elastic than this, we should say its elasticity was greater or less than unity as the case might bo. Naturally a demand has different elasticities with refer- ence to different quantities. Beneath is an example of a DEMAND PRICES, EXPENDITURE, ETC. 43 demand which has elasticity equal to unity at first, then elasticity greater than unity, and finally elasticity less than unity : — Aggregate Paid Amount Demanded. Price Offered. ( u ; *!? e Pr °4 uct of Figures in Columns 1 and 2), 1 20s. 2 10s. 20s. I Elasticity 3 6s. 8d. 20s. f unity. 5 4s. Id. 20s. 5d. I Elasticity 6 7 3s. 4d. Ssiei 21s.' " f greater than unity. 8 2s. lOd. 22s. 8d. I Elasticity less 9 2s. 18s. f than unity. 10 Is. 6d. It will be realized as we proceed how important the con- ception of elasticity is. Diagrammatic representation of demand. — We may represent the individual or market demand for some commodity or service, as in fig. i3, by a curve, which is usually lettered DD' and is called a demand curve. It sets forth the relations between price and quantity bought, or the amounts that will be bought at different prices in a given time. Price is measured upwards along OY and amounts bought are measured from left to right along OX. It is evident that the curve of market demand prices must descend, since all the curves of individual demand prices, of which it is compounded, descend. An example of composition of two demand curves will be found in fig. 15 on p. 216. Of any two demand curves drawn to the same scale the steeper at any part is the less elastic. But we must be careful not to be deceived by appearances as to the elasticity of curves. A curve that looks steep might be highly elastic. The angle at which a curve descends at any point can be made anything we please by arranging the scales marked along OX and OY. Consider the curve in fig. 3. It is steeper at the left than at the right, but 44 OUTLINES OF POLITICAL ECONOMY it will be seen, on measuring up the rectangles enclosed between the curve and OX and O Y, that it is more elastic at the left than at the right. At the extreme left these rectangles are increasing, but at the extreme right they are decreasing. The area of each rectangle represents price multiplied by quantity. The following sample calculation is made in order that there may be no misunder- standing : — The first rectangle ,, second ,, ,, penultimate,, » last „ Y = 100 x 12s. = 200 x 7s. = 900 x Is. 3d. = 1000 x Is. = 1200s. = 1400s. = 1125s. = 1000s. 100 200 300 400 500 600 700 800 900 1000 Fig. 3. The law of substitution or indifference, or equi- marginal utility. — This law is one of the most fruitful in consequences of all economic laws. We shall remark later that it applies also to production and has an intimate bearing on distribution. As regards expenditure at any one time (p. 49),. the law of substitution, indifference, or equi-marginal utility, affirms that we all tend so to regulate our purchases that the marginal satisfactions per unit of outlay yielded by different things be- DEMAND PRICES, EXPENDITURE, ETC. 45 come equal. It is reasonable to act in this way and most people are disposed to aot reasonably. We all want to get as much satisfaction as possible out of our incomes. We get the mosi satisfaction out of them when we so spend our money that pennyworths of everything are yielding at the margin the same satisfaction. The proof of this proposition is simple. Suppose money spent per week on butter and sugar pro- duces for me per week the utilities shown in the table beneath : — Pence. Aggregate Utility of Butter. Marginal Utility of Butter. Aggregate Utility of Sugar. Marginal Utility of Sugar. 1 10 10 9 9 2 18 8 16 7 3 24 6 20 4 4 29 5 23 3 5 32 3 25 2 6 34 2 26 1 Let us read one line to be sure that we know what the table means. The third line says that threepennyworth ot butter yields an aggregate satisfaction of 24 and a marginal satisfaction of 6, and threepennyworth of sugar yields an aggregate utility of 20 and a marginal utility of 4. Now consider the spending of a sum of 9d. a week on butter and sugar alone, and for the time being ignore other expendi- ture. Imagine that I spend 6d. of this on butter and the remaining 3d. on sugar. Then the marginal utility of butter to me is 2 and the marginal utility of sugar is 4. If I reduce my expenditure on butter by Id., I lose 2 units of utility, but when I spend on sugar the penny so saved I gain 3 units of utility. So there is a net gain of 1 unit of utility. On glancing at the table, we can verify that this is the position of maximum advantage for the expenditure of 9d. 4G OUTLINES OF POLITICAL ECONOMY on butter and sugar. When 5d. buys butter and 4d. buys sugar, aggregate satisfaction is 32 + 23, that is 55 ; when 6d. buys butter and 3d. buys sugar, aggregate satisfaction is 34 + 20 = 54 ; when 4d. buys butter and 5d. buys sugar, aggregate satisfaction is 29 + 25 = 54 ; and all other possible ways of distributing 9d. on the purchase of butter and sugar also yield less than 55 units of satisfaction. What is true in this case, where 9d. has to be spent on butter and sugar, must be true also when larger sums of money and many com- modities are involved. Hence it is proved that income should be so spent that the marginal return of satisfaction to a unit of expenditure becomes the same for all the commodities. Prom this it follows that a thoughtful and careful person will aim at buying such quantities of different things that their prices measure their marginal utilities to him. That is to say, when a person pays 3d. a pound for sugar and Is. a pound for butter, acting sensibly he will buy such quantities that the marginal utility of butter to him per pound becomes approximately four times the marginal utility of sugar to him per pound. The law of equi-marginal utility, substitution, or indiffer- ence, is so-called because it alleges that every person will try to get equi-marginal returns from his expenditure ; that he will seek to attain his end by substituting the more profit- able for the less profitable expenditure whenever he sees an opportunity ; and that, when he has brought about equi- marginal returns, a diminutive accession to his income will be spent indifferently upon one thing or another. Observations on the law of substitution. — The law of equi-marginal returns, which is more commonly known as the law of substitution, is analogous to — even akin to — the law of natural selection by survival of the fittest in zoology. Things which are the fittest to satisfy us, in relation to their cost, survive in effective demand and are bought ; and at the DEMAND PRICES, EXPENDITURE, ETC. 47 margin of purchase the things selected are equally lit to satisfy us in relation to their cost. The law of substitution being so fundamental, it is pecu- liarly essential that no error should be made in interpreting it. It is, therefore, worth while pointing out that the demand prices of different people do not measure the utilities of things as between different people. They cannot, because there is no bridge to connect the utility enjoyed by one person with the utility enjoyed by another, according to the view of utility taken in this book. The so-called utilities obtained by me from different things are regarded here simply as con- ventional indices used to express my preferences, or, as one might say, the relative degrees of expected conduciveness of different things to the satisfaction of my wants and pur- poses in life ; and evidently no such preferential relation can possibly hold as between the use of a thing by me and the use of a thing by somebody else. Moreover, even if it were feasible to compare the utilities enjoyed by one person with those enjoyed by another person, it would still be untrue that the demand prices of different people measured the util- ities of things to different people. They could not, because people would still differ with respect to the range and intensity of their wants, and all people would not have the same amount of money at their disposal. The last point may be expanded since it broaches questions of practical importance. The richer we are the more are we usually willing to pay for what we want, because the lower is the marginal utility of money likely to be to us. Hence the sacrifice made by the rich man is less than the sacrifice made by the poor man when both pay the same price for something, and these sacrifices measure the marginal utility to each of what is bought. The marginal utility of money (which is sometimes spoken of shortly as the utility of money) means the utility that would be lost through the loss of a 48 OUTLINES OF POLITICAL ECONOMY very small amount of one's money income ; and this gener- ally falls as income increases because of the law of diminish- ing utility. It is noteworthy that it is simply the operation of the law of substitution which enables us to speak of the marginal utility of money. The marginal utility of money we have defined in effect as the access of utility got through the lasl penny of income, so to speak. But if the law of substitution, or equi-marginal returns, did not hold in consumption this access of utility might be anything. What it was would de- pend upon what the penny purchased. Spent on one thing, it would have a higher utility than when spent on another thing ; so the marginal utility of money would be meaning- less. But, with the law of substitution at work, the penny brings the same access of utility however it is spent ; for, in this event, inoome is laid out in such proportions on differ- ent things that they yield per penny equi-marginal returns in utility. So, in this event, the marginal utility of money is something definite. We are not of course compelled to distribute our incomes according to the law of substitution or equi-marginal expendi- ture, as a stone thrown into the air is compelled, in a sense, to fall back to the earth ; but as a matter of fact we do, in a certain rough fashion, because we are reasonable. So it is correct to call our tendency to do so a law. But we must be careful to bear in mind that, for a variety of reasons, people only tend to act according to the law of equi-marginal expenditure " in a cer- tain rough fashion " . To measure preference, which fluctuates, is a delicate and perplexing task, and we may easily go astray. Again, we must recognize minima sensibles or the utilities of degrees of expenditure about which the consumer will not trouble. A bachelor with £1000 a year will consume tobacco till its marginal utility to him is zero, because the pennies which he would save weekly by getting its marginal utility DEMAND PEIOES, EXPENDITURE, ETC. 49 up to the general level of the marginal utility yielded him by more expensive things would not be worth the worry of de- liberating. The utility of a few pence is to him below the minimum sensible. Much of the balancing of utilities which brings about equi-marginal returns, one must be particular to observe, moreover, is merely implicit : it only becomes explicit when relatively large outlays are involved. We do not ordinarily take any trouble about this balancing, but jump to conclusions without thinking about it. The law of substitution, indifference, or equi-marginal re- turns, also helps to explain our actions when we decide how much to spend at one time and how much at another time. Very broadly speaking, we try so to arrange our saviag and spending, cateris paribus, that we reap equi-marginal returns continuously. But into the question of thrift numerous dis- turbing factors enter ; so we must defer our consideration of this matter until we reaoh Chapter XXV. Consumer's surplus of satisfaction. — The conception of consumer's surplus, or consumer's rent, has of late been made to play so prominent a role in advanced economic theory that something must be said of it even in an elementary treatise, though neither its value nor the difficulties involved can be fully appreciated by those who are only beginning the study of political economy. The conception has sometimes been designated indifferently that of " consumer's rent " or " con- sumer's surplus ". But it is probably best to avoid the use of the term " rent" in this connexion, at any rate at present, because its use in this connexion necessitates defining " rent " in a way which might not be found convenient. When I pay away money for anything, the marginal or final unit of expenditure is responsible only for my marginal satisfaction. The rest of the expenditure yields more than marginal satisfaction per unit of expenditure. The excess of satisfaction procured, over and above the product of the 4 50 OUTLINES OF POLITICAL ECONOMY marginal satisfaction and the amount of the thing purchased, may be called " consumer's surplus of satisfaction ". It re- presents what I should have lost, other things being equal, had the thing not existed. I should have lost it because I should have spent on a number of other things the money now devoted to it, and should have gained from the money marginal satisfactions only, namely the increases of satisfac- tion got from slightly increasing my supplies of a number of other things. As regards the indeterminate utilities of indis- pensable supplies of things, and the relations between con- sumers' surpluses on substitutes and complements, the reader is referred to pages 53 and 37-8. Diagrammatic representation of equimarginal returns and consumer's surplus of satisfaction. — In fig. 4 measure units of money along OX and units of utility or satisfaction along OY. Let P, C, and M be curves (similar to the curve in fig. 2 on page 34) indicating the marginal utilities derived weekly from consuming such quantities of porridge, coffee and milk re- spectively as can be obtained by spending upon them the sums of money measured along OX. Then, according to the law of equi- marginal returns in consumption, if a sum of money Oa is spent weekly on porridge, Od will be spent on coffee and Oe on milk, because with these expenditures the marginal utilities derived from coffee and milk respectively are made equal to the marginal utility derived from porridge, that is to say ag = dh = ej. In this case the total utility derived from porridge would be represented by the area Oagk, that from coffee by Odhl and that from milk by Oejn. If the income were less, smaller sums would be spent on each article, but expenditure would still be so distributed that marginal returns were equal. Next, we may illustrate with the aid of this figure consumer's surplus of satisfaction. Suppose that I consume in a year a quantity Od of some commodity, say strawberries in this case. Let satisfac- tion be measured along OY, as before, and let the curve C now show the variation of satisfaction with the amount spent per year on strawberries. It descends because of the law of diminishins; DEMAND PRICES, EXPENDITURE, ETC. 51 utility. The total satisfaction got by me from the strawberries is obviously Odhl. The marginal satisfaction derived from a small increment of strawberries, multiplied by the amount spent upon them, is Odhf. The area/W is my consumer's surplus of satisfaction. The area fhl is called the consumer's surplus of satisfaction de- rived from strawberries because it is the net satisfaction which re- sults from my having strawberries. That is to say it expresses the difference made to my income of satisfaction per year by the dis- covery of strawberries, or the loss of satisfaction which I should sustain if strawberries could no longer be cultivated. This has to be proved ; and it can be proved in the following way. The utility of strawberries to me is indicated by the enclosed area in fig. 4, lettered Odhl. Hence if the cultivation of strawberries be- came impossible I should lose an amount of utility equal to the area Odhl. But against this loss a gain has to be set. At any rate I should save per annum what I used to spend on strawberries per annum. Suppose I used to spend 10s. per annum on strawberries ; then I save 10s. per annum. Now the utility obtained by the ex- penditure of the last shilling on strawberries is represented ap- proximately by (ftx-j:, that is by —^ . And my income is so dis- tributed according to the law of substitution or equi-marginal returns (see pages 44-6) that the marginal returns of a shilling upon what- 4* 52 OUTLINES OF POLITICAL ECONOMY ever it is spent is the same. Hence when I come to spend the 10s. that I used to spend on strawberries on other things I cannot get a greater utility for any shilling than -~i approximately. And I should so lay out the 10s., spending a little of it on each of a number of other things, that for no one shilling should I get a satisfaction appreciably less than -y-yi. I should buy a few more cherries, drink some pints more of lemonade, consume a few more apples and so forth until the 10s. was accounted for. Henoe my gain in satisfaction would be approximately the marginal satisfaction of spending multiplied by the amount I save, that is an amount — rrr x 10, which is equal to Odhf. But I have lost satisfaction Odhl from the loss of the straw- berries, as we have seen. Therefore the loss in utility from the loss of strawberries is Odhl - Odhf, that is fhl, which has been denned as consumer's surplus. Again, the consumer's surplus of satisfaction derived from the thing to which the curve P relates is fgh, while that derived from the thing to which the curve M relates is fjn. The measurement in money of consumers' surpluses. — Consumer's surplus is sometimes measured in money, and, as it is easy to misinterpret consumer's surplus when so measured, it will not be superfluous to say a few words about this expression of it. I pay, say, 6d. a pound for straw- berries and buy 20 lb. a year. Suppose I would pay 18s. for the 20 lb. rather than go without strawberries entirely, that is to say, suppose the aggregate of my demand prices per pound for strawberries up to the twentieth pound (as shown by my demand schedule) amounts to 18s. Then my consumer's surplus derived from strawberries is 18s. less the 10s. I spend on them, that is 8s. I lose a con- sumer's surplus of 8s. when strawberries cease to be grown. That is to say, the disappearance of strawberries would have the same effect upon me as a reduction of my income by 8s. a year. It has been assumed in this argument that the DEMAND PRICES, EXPENDITURE, ETC. 53 readjustment of my expenditure would not appreciably affect the utility of money, and this assumption is permissible since the total sum spent on strawberries is small in relation to my total expenditure. Such a money measure of oonsumer's surplus would be inexact if we were dealing with something upon which a large proportion of my income was laid out. But otherwise, consumer's surplus in money is the difference between what we do give and what we would give for a thing rather than be deprived of it altogether. This is manifest when the thing is a single article like a picture. The objection has been brought against the doctrine of consumer's surplus that the initial demand price for an article may be the whole of the consumer's income". Eather than die of thirst, a person would offer all that he possessed for a glass of water. We may at once agree that in a case of this kind the consumer's surplus enjoyed on the whole consumption cannot be measured, though absolute increases and absolute decreases of consumer's surplus up to a certain limit oan be measured. The majority of cases, however, are not of this kind, because an artiole is seldom an indispensable means of preserving life or making it worth living. Deprived of cake, we can still feast on muffins and bread and butter, and deprived even of wheat we can still devise satisfactory meals by substituting for it rye, oats, and potatoes. Total consumers' surplus in a country as a whole. — The money expression in the aggregate of the surpluses derived by a whole community from consuming something raises new difficul- ties. It must, therefore, be introduced with the greatest caution. These difficulties emerge out of the circumstance that the so- called utility enjoyed by one person cannot be added to that enjoyed by another person, or, if it can, that the marginal utility of money would not be the same to all the people who consumed the commodity, say strawberries. Putting the consumers' sur- pluses yielded in a country by strawberries at £10,000 a year, the 54 OUTLINES OF POLITICAL ECONOMY loss of strawberries would only have the same effect as the reduc- tion of the national income by £10,000 a year if (.he reduction were so distributed that the incomes of people who did not con- sume strawberries were not curtailed, while the income of each person who did was diminished by the amount of the consumer s surplus which he derived from strawberries. However, if we take two commodities used by about the same classes in roughly the same relative degrees and the consumers' surplus on one is £6000 a year and on the other £12,000 a year, the probability is that the community would lose twice as much through the withdrawal of the one with the greater consumers' surplus as through the with- drawal of the other. Certain important practical applications of this doctrine will become apparent in a later part of this book. If we use the demand for a thing over a certain period as one factor in the expression of the consumers' surplus in money derived from that thing, we must be sure that units of the thing do not last longer than the stated period. The demand schedule for grand pianos in England in 1910 (if it were discoverable) taken in con- junction with their price would not show the consumers' surplus yielded by them in England in 1910, for many people in England with grand pianos in 1910 would have bought them before 1910. In a case of this kind, it would be necessary to make allowance for the supplies of the article already in use, and the prices paid for them. Actually it is never possible to measure the whole of the con- sumers' surplus yielded by a thing over any period, but it is possible to measure approximately the effects of price variations upon it. CHAPTEE VI. VALUE, GOODS, AND WKALTH. Value. — There has been some confusion over the term " value ". It is ambiguous ; and may refer to value in use or value in exchange. The value in use of a thing is the utility derived from using the thing ; and, as we have found it scientifically necessary to discriminate between marginal utility and total utility, so we must distinguish marginal value in use from total value in use. Value in exchange means what a thing can be exchanged for. If what it can be exchanged for is stated in money, value in ex- change is called "price " . Now, we have learnt that different things are bought in such proportions by different persons that the ratios which the marginal utilities of things bear to one another are the same for all the persons who buy them, and that things exchange for one another in the same ratios. Consequently, values in exchange are objective expressions of marginal values in use, which are subjective. Hence, things that are scarce in relation to the demand for them have a high value in exchange though their total value in use may not be great ; while things which are plentiful in rela- tion to demand have an insignificant value in exchange though their total value in use may be enormous. Some things, indeed, which are so plentiful that their marginal utility is zero, have absolutely no value in exchange. They may have immense aggregate value in use, but ordinarily we should take this for granted and hardly notice it, if we noticed it at all : 55 56 OUTLINES OF POLITICAL ECONOMY it is only when the well runs dry that we become fully alive to the value of water. In positive economics, " value in use " has, of course, no ethical significances ; it stands solely for the utility that things actually have for us, not for the estimation in which we ought to hold them. Some writers have distinguished between elemental, form, place and time utility or value in use. Coal has elemental utility even when undisturbed in a coal-seam. It is given form utility when hewn and broken into pieces of convenient size. It has a maximum of place utility in the coal-souttle by the fireside and its highest time utility in the winter. Goods and wealth. — We are now prepared to define " wealth ". It has a broad and a narrow reference in positive economics. Broadly it means anything which satisfies human wants, directly or indirectly, that is anything whioh has value in use, and, thus broadly conceived, it is sometimes known as goods. Goods may be classified as follows : — transferable (1) Material -j non . transferable (2) Goods I External j V transferabla (3) I [Personal j non . trall8 fe ra ble (4) v. Internal Personal - non-transferable (5) A " transferable " thing is not always a " transportable " thing : it is merely a thing potentially capable of being bought and sold. We thus reach five classes of goods. A few examples will help the reader better than definitions to realize each class. Examples of external-material-transferable goods are bread, butter, and furniture. Examples of external-material-non-transferable goods are sunlight, climate, and the dykes of Holland. An example of external-personal-transferable goods is the goodwill of a business which oan be sold. This is personal because it consists in the habits of persons (the customers VALUE, GOODS, AND WEALTH 57 of the business) ; but, though personal, it is external to the person to whom it is wealth ; and it is transferable because it can be bought and sold. An example of external-personal-non-transferable goods is furnished by so much of a business connexion as cannot be sold because it is attached to a particular person. Some of a tailor's customers, for instance, would transfer their custom to another firm when he retired, instead of dealing with his successor in the same shop ; they being customers through a personal connexion only. Another example is a nation's good repute. Internal-personal-non-transferable goods consist in our powers, faculties, habits, and tastes, which are of value to us — the dexterity, for instance, of violinist or carpenter. Now " wealth " may be used as synonymous with " goods". This is its widest significance. Next in width is the conception of wealth as all goods except internal goods. It is argued for the exclusion of internal goods that it is well not to confound the customary distinction between man, on the one side, and the wealth to which his activities have reference, on the other side. More narrowly " wealth " may be understood in a variety of ways. It has been confined to the things satisfying human wants which are limited in quantity ; again, it has been confined to such only of these things as are produced by labour ; and yet again, it has been said that transferability is an essential attribute of wealth. Nothing but convenience turns upon the dispute about what has to be included in wealth. No particular definition will be selected here, but the context will always make plain what exactly i3 meant when the term " wealth " is employed. It is a truism, but a point to fix in our minds nevertheless, that external goods are goods only in relation to internal goods, and that many internal goods can be realized only through ex- ternal goods. The value of a picture is acquired by seeing it 58 OUTLINES OF POLITICAL ECONOMY with appreciation, and the taste for pictures affords us no enjoy- ment till pictures are seen. Man not only produces wealth in the ordinarily recognized ways, but also makes it in the sense in which Kant meant his doctrine that " man makes nature ". The greater the appreciative power of a people the greater is their potential opulence : Shakespeare's plays are not wealth to barbarians. Education enhances appreciative power and therefore makes wealth. In the light of this paragraph we shall at once admit the incontrovertibility of the statement that, while the demands for things create activities, activities themselves create demands for things. We shall also com- prehend more fully that the value of a thing must vary with time, place, and circumstances. The notion that the attitude of man to things makes wealth recalls Buskin's dogma that " all wealth is Life " and his dis- tinction between wealth and illth. Euskin had in mind what men ought to want and not what they actually do want in any given stage of social development. In short, his discussion of wealth belongs to economic ethics rather than to positive economics. But it is imperative to remind ourselves that people change their notions as regards the goods which are most worth having, and that progress, in one of its highest senses, is measured by the rate at which their notions ap- proximate to true ethical conceptions. Sometimes wealth ethically conceived is called " real wealth," but this term is equiyocal and is used more commonly in economics to indicate the contrast between wealth in money on the one hand and in terms of the goods that it can purchase on the other. Beal income is used in a similar sense. Nor does this exhaust the distinctions to be recognized. It is necessary to distinguish further between the wealth in which all share, which is social wealth, and private wealth, which needs no explanation. Social wealth may be such that none can be precluded from enjoying it — that is external non- VALUE, OOODS, AND WEALTH 59 transferable) goods, whether material or immaterial — like a healthy climate and commendable social customs ; or it may be public property (transferable goods) like pictures in public galleries. There is also the contrast to draw between goods of the first order, which yield satisfaction directly, like bread, and goods of the second or higher orders or intermediate goods, of which olas3 machinery is one of the largest sections. To illustrate the distinctions between goods of the second and higher orders, it is sufficient to say that a machine-tool for making machinery is of a higher order than the machinery which it makes, and that the machines which make the fry- ing-pan are of a higher order than the frying-pan, which aids in the performance of the last productive process whereby some forms of food are rendered ultimate consumers' goods. '' Higher," of course, simply means more indirectly con- nected with the creation of satisfaction. Goods and wealth can be at the same time of the first and a higher order, for in- stance the motor-car which takes the doctor on his rounds and at the same time affords him direct gratification. Personal wealth is no exception ; thus aesthetic appreciation is only a direct good to those whose business is unconnected with the fine arts, but it is both a direct and an indirect good to the professional art critic. It is obvious that the utility of intermediate goods is the utility of the goods of the first order which they aid in furnishing referred back to the means by which these direct goods are attained — it is the utility of clean boots which makes the utility of boot-brushes. For this reason intermediate goods are subject to the law of diminishing utility, for they reflect utilities subject to this law ; but, as we shall learn later, they may be subject to diminishing utility for another reason also, connected with their yield as productive agents. The terms consumers' goods and producers' goods explain themselves. Necessaries, comforts, and luxuries. — Wealth is com- 60 OUTLINES OF POLITICAL ECONOMY monly classified into necessaries, comforts, and luxuries, but these sub-classes of wealth have been defined in a variety of ways. Sometimes the distinctions between them are drawn from an ethical point of view, and in this case a condemnatory implication is usually read into "luxury,'' while necessaries are regarded as things essential to proper living. Sometimes, again, the distinctions are made to turn solely upon the re- actions of different things upon efficiency broadly regarded. When this is done, we may divide necessaries into two classes, and entitle and define the four olasses then obtained, as follows : — Necessaries of life are the things physiologically necessary to maintain existence and secure the continuance of the race. The definition, however, is vague, inasmuch as nothing is said of the average length of life to be assured and the extent of procreation. Necessaries of efficiency are the things, over and above the necessaries of life, the consumption of which adds to the effici- ency of human beings to an extent greater in value than the cost of the things consumed. According to this definition, the price of an article is one of the inoidents which settle whether it is a necessary of efficiency to any particular person or not. Comforts are those things which add appreciably to a person's efficiency, but in a degree that has less value than their cost. Here, again, we observe that the price of a thing helps to determine whether it is a comfort or not. Luxuries are things which when consumed do not appreci- ably add to, and may even detraot from, a person's efficiency. The reader's attention need hardly be drawn specifically to the fact that this classification is not one which can be applied to wealth objectively. The classification has a subjective re- ference and a reference also to occupation. A thing which is a comfort to one person, may be a necessary of efficiency to another, and a luxury to a third ; and a thing which is a com- VALUE, GOODS, AND WEALTH 61 fort to me at one time, or when I am engaged in one kind of work, may be a luxury to me at another time, or when I am engaged in another kind of work. Thinking in a hurry, we might conclude that wise people who realized the future, and knew exactly how their con- sumption would affect their efficiency, would aim merely at providing themselves with necessaries of existence and of efficiency. But we should be illogical if we deduced such a gloomy conclusion. The real income that we enjoy is the satisfaction that we get out of the things purchased with our money incomes, and the satisfaction derived from a luxury might far transcend that derived from a thing necessary for efficiency. It is a truism, but one not infrequently over- looked, that production is a means and not an end. Even the perfectly wise and perfectly good man might choose the luxury and forego the necessary of efficiency without slipping from his pedestal. He might choose to gratify literary tastes which would earn him nothing, instead of studying book-keep- ing though the latter might help him in his business. There is no greater mistake than to test every course of action by its effects on production, when we take up the moralist's position. It certainly cannot be said that in the world, as it is now, our highest welfare, or our welfare as we conceive it, is invariably promoted most when we do what magnifies our money income most. But this mistake is not to be charged against political economy. As a positive science it recommends no course of action. It merely explains people'3 actions in a certain field and points out the effects which succeed different courses of action. It follows from certain of the considerations advanced above that, though it would pay a slave-owner best, from the mone- tary point of view, to give his slaves necessaries and nothing more, the wage which it is most advantageous for the employer of free men to pay is not to be taken as anamount sufficient only 62 OUTLINES OF POLITICAL ECONOMY to provide necessaries of existence and of efficiency. It is not likely that the wage-earner would spend the whole of such a wage on necessaries of existence and necessaries of efficiency. In fact, he would certainly not do so. At least a few comforts and luxuries would figure in his consumption. Hence, some economists recognize conventional necessaries. By " con- ventional necessaries " they mean any things which a person will insist on buying before he has completed his supply of necessaries. Tobacco is to many a conventional necessary : most men, however poor, will buy some tobacco. Conven- tional necessaries are recognized because they must be taken into account when we try to discover what wage will keep the operative at a level of efficiency which, in view of the wage, is most economical from the standpoint of cost of production. But, of course, neither conditions of efficiency, nor what employers would like, settle wages, though they may enter into their determination. BOOK III. PEODUCTION OE SUPPLY. CHAPTER VII. NATURE OF PRODUCTION AND THE AGENTS OF PRODUCTION. What is production? — Producing is making utilities. Widely understood it covers : — 1. Obtaining from land or sea, rivers or lakes, things which grow — for instance, farming and rubber-planting, fishing and sealing. 2. Obtaining from the earth, air, or water, things which do not grow in the ordinary sense — for instance, coal-mining, diamond-seeking, and salt-mining, getting power from the wind, and nitrates from the atmosphere. 3. The manufacturing or making-up of things. 4. Transporting things. 5. Arranging for the distribution of things as opposed to their transportation — i.e. the performance of the commercial functions of disposing of goods among those who want them. 6. The direct furnishing of services to consumers — domestic service, singing, and acting, for example. Certain comments are needed upon this tabulation. We have not distinguished between things and the natural powers by which their acquisition is facilitated. The reader may bear this distinction in mind, nevertheless ; remembering, 63 64 OUTLINES OF POLITICAL ECONOMY however, that it is not always easy to draw. Is coking-coal a thing or a natural power ? Is there any essential difference, from an economic point of view, between manufacturing power but of the Falls of Niagara and manufacturing petrol ? It is of value for some purposes to separate the industries which simply gather natural produots from those which cultivate what they gather. An orchid-seeker pays no regard to future supplies. A deep-sea fisherman does, and is careful not to over-exhaust a particular fishery, especially at breeding time. But the deep-sea fisherman does nothing active to cultivate a fresh supply. The farmer, on the other hand, does ; he breeds live-stock, and ploughs and harrows his land, and sows seed. By the extractive industries we mean those which take away from a stock which can only be reproduced, if at all, after a very lengthy period. The mining industries are the chief extractive industries. Pishing need not be re- garded as extractive, since the food supply for as many fishes as we are likely to want is practically inexhaustible. Farming is not classed as extractive because the elements taken out of the land by a crop can be restored. Land which is carefully worked, and allowed occasionally to lie fallow, is continually brought back by the forces of Nature to its original state after being exhausted by each harvest. Industries which obtain power from water and air are peculiar in that they tap a recurrent supply, the amount of which in the future is not affected by its use in the present. The use of the potential power stored in a high-level lake is, of course, an exception. Quite narrowly interpreted, to the exclusion of the direct furnishing of services to consumers and of commercial work, " producing " is applied to the operations needed to get a thing, other than mere gathering. So farming would be producing, but deep-sea fishing would not. NATURE OF PRODUCTION 65 The economics of production comprises the scientific observation and analysis of the manner in which wealth is created, and the drawing of generalizations relating to it. Now the creation of wealth, liberally conceived, involves the performance of commercial functions as well as others. Commercial functicms are the functions of buying and sell- ing, and bringing goods to the notice of customers, and anticipating consumers' demands and conditions of supply ; whereas industrial functions, broadly regarded, are the functions of growing, extracting or manufacturing anything. Commercial work is inseparably connected with industrial work : industr}- is broken up into parts and the parts are united by commercial links. A firm manufacturing machinery spends energy in seeking out and buying materials and in discovering where machinery is wanted and arranging for its sale. The end of production is to give to the ultimate consumers things that they want when they want them ; and mere manufacturing, farming and mining, do not alone bring this end about. When we glance at production as a whole we at once detect that it consists (1) in industry, by which we have agreed to mean the growing, extracting, and making of things, and (2) in commerce, that is to say, in arranging that the things made, and the things used in making them, shall be appropriate to the needs of the community, and shall be so distributed that each person, as consumer or producer, shall be able to purchase with the mean3 at his disposal what he wants most rather than what he feels indifferent about. The word "parson" in this statement must be held to cover associations. The actual carrying of things over sea and land, that is transportation, we include under industry or the making of things. So to include them will not seem inappropriate, since production even in a factory consists to an appreciable extent in the transporting of things. Ultimately, indeed, pro- 5 66 OUTLINES OF POLITICAL ECONOMY ducing means merely assembling different things in certain relations. To determine where to carry things, so far as the carriage takes place outside works, fisheries, farms or mines, is one of the functions of commerce ; and we may observe here that the decision where to carry things may be formed before they were produced as well as after. There has been much profitless hair-splitting over the ques- tion what is, and what is not, productive labour. What is productive labour, depends upon what we mean by production. If by production we understand simply the creation of tangible things or things that contribute to the making of tangible things, direct services performed for consumers, in so far as they do not contribute to the efficiency of such people in production, thus narrowly conceived, must be designated " un- productive ". But, broadly, all is productive labour which yields, or is intended to yield, something of value : it em- braces all services which we are prepared to pay for. If, again, we make the distinction between productive and unproductive labour turn on results, labour which has been misapplied so ihat it is wasted is unproductive. If a company started to ■cut a canal, and was then compelled to desist because the project was not feasible, the labour already expended would have been unproductive. But the intention was not to use labour unproductively. Among the broad features of production, we may notice that some things may be obtained together, or alternatively, from a given source. Things may be produced jointly in a fixed or a variable ratio ; and a thing produced jointly may have another source of supply, where it may be produced independently or in a different joint relation. Wool and mutton are produced jointly, but we may breed for mutton or for wool. Wheat and straw are produced jointly, but there are other kinds of straw besides wheat straw. Gas and coke are produced jointly, but in some places there NATURE OF PRODUCTION 67 is natural gas stored in the earth which can be tapped. Alternative 'products are found wherever a set of factors can produce more than one thing though only one thing at a time. This has been illustrated above. A loom may turn out fine cloth or rough cloth. The principle of substitution settles to which purpose the loom is put. Manufacture specializes the possible uses of materials. — Each stage of production limits the possible uses to which anything that is being worked up can be put. Eaw cotton may be made into fine cotton wool for surgical and dental uses, sewing cotton and a multitude of different things. When it is spun, its possible use as cotton wool is eliminated, and the tenuity, toughness, and twist of the yam produced limit the number of fabrics and sewing cottons into which it can be introduced. When it is woven, its use as sewing cotton is eliminated, and also its use for fabrics of other qualities. As a fabric it can still become many different articles ; but finally, as a cotton shirt say, it is specialized to one purpose or a very few purposes. Suppose we represent some material (for instance wheat or iron-ore, or cotton) by the letter " X " and the possible con- sumers' or producers' goods which X can become by the small letters of the alphabet. Suppose, moreover, we repre- sent a manufacturing process by " M," and the performance of a manufacturing process on X by multiplying X by M, so that XM means material after undergoing one manufacturing process and XM 2 (=• XM x M) means the material after undergoing two manufacturing processes, and so on. Then we may repre- sent the specialization of the possible uses of a thing, as it passes through stage after stage of manufacturing, as follows : — The possible uses of X are a, b, c, d, e, f, g, h. „ „ „ XM „ a, 6, c, d, e, f. „ ,, ,, XM 3 „ a, b, c, d. „ „ „ XM 3 „ a, 6, t . „ XM 1 „ a, 6. 5 * 68 OUTLINES OF POLITICAL ECONOMY One significant conclusion which follows from this analysis is that an immense change can be brought about in the pro- portions of different finished things in a given community merely by alterations in the later stages of production. The re-arrangement of production which is rendered essential by changes in demand, or in conditions of supply, need not, as a rule, be carried far back in the chain of productive processes ; and, as re- arrangement reaches back, so usually it becomes more trifling. This conclusion has an important bearing on the responsiveness to demand of a community on its productive side. It has been said that when production becomes complicated, differentiated, and roundabout, so that the making even of a simple pocket-handkerchief involves the raising of coal, smelting of ore, construction of machinery of many sorts and so on, society is rendered less adaptable to modifications in demand, because altering the supply of any- thing means altering so much in the productive system. That this view needs qualification, the above analysis renders patent. Moreover, many productive instruments can be de- voted to more than one purpose : we may call to mind the variety of work that can be done by any loom, or sewing machine, or lathe. The agents in production and their efficiency. — The absolutely indispensable agents of production are labour and land. For convenience "land" is to be understood compre- hensively to denote the whole of animate and inanimate nature, exclusive only of human beings, which is of any use economically. It is, however, usual to say now that the agents of production are land, labour, capital, and enterprise, though to exercise enterprise is to labour and capital is not really an original, irreducible, element in production. When, among the agents in production, labour is distinguished from enterprise, "labour" means executive power, and "enter- prise " means initiating, directing, and designing power. NATURE OF PRODUCTION 69 Under primitive conditions, the executive agent must direct himself ; and, when he does, he is both labour and enterprise. A few workmen still direct themselves, even in the most advanced industrial communities ; but, in the mass, modern industry is initiated and directed by other persons who (1), on the one hand, decide what undertakings to start and on what scale, and start them and govern their policy — thereby ex- ercising what is known as the function of undertakers, entre- preneurs, or " enterprisers " as the Americans put it — and (2), on the other hand, plan the methods of producing the things decided upon, organize and direct the production, and estab- lish and maintain relations with the markets for buying and selling — thereby exercising the function of managers. The second function splits up into two, namely industrial managing and commercial managing, which may be in different hands ; and tbe first function may be conceived also as having an in- dustrial and a commercial side. The duties of undertaking and the duties of managing are opposed here, but they shade off into one another. Commonly, entrepreneurs are the ulti- mate managers; but, as recent specialization has brought to the front a class of business men who are almost solely under- takers or entrepreneurs, it will be as well to use " undertaker " or " entrepreneur " with a connotation exclusive of the detailed managing of a business, as contrasted with the laying down of its policy. In the problem of the supply of labour of different kinds, including directing labour, we shall be involved when we come to explain rates of wages (pp. 324-5, 326-31), so nothing need be said specifically about it in the present chapter ; but upon the nature and determinants of the efficiency of labour a few comments may be made. Productivity is measured by the value of what is produced. Other thing3 being equal, therefore, the more a community succeeds in discovering and developing the most valuable 70 OUTLINES OF POLITICAL ECONOMY powers latent in its population, the more efficient will it be. An educational system, which is such (a) that the potential ability of each child is disclosed and (b) that capacity and character are elicited and appropriately trained up, is highly productive ; and the productivity of a community is depend- ent, further, upon the extent to which people find their way to the work best suited to them. The most useful combina- tion of qualities for the workman varies with circumstances. Sometimes physical strength and endurance are most im- portant ; sometimes quickness and skill ; or resourcefulness and intelligence, and, it may be, trustworthiness ; while under rapidly changing conditions, adaptability is of paramount im- portance in certain callings. How the demand for some of these qualities is being affected by progress we shall observe later (pp. 89-90, 344). The efficiency of labour is also governed by climate, the home life, the duration of work, wages and their spending, and the labourer's outlook. A cool bracing climate is invigorating. Work which is interesting is educative ; work which is monotonous, or very heavy, or very tiring, devitalizes the labourer in physique, character, and intelligence. Gloomy surroundings, polluted air, and insanitary conditions about the place of work or the home, breed listlessness if not actual disease. Much social betterment work is, evidently, produc- tive, even in the narrow sense, as well as in the broad sense of adding to the amenities of life. Wages and their spending have obviously a direct bearing upon efficiency, as we have already noticed on pages 60-2. The outlook of people also has an influence on their effectiveness, subtle but potent : for example the ambitious operative, devoid of prospects, is apt to work without spirit. Hereafter we shall have to lay stress on the requirement that production should be appropriate to the needs of society. Production is only kept thus suitable when it is responsive to XATUBE OF PRODUCTION 71 changes in demand- A condition of its ready response to such alterations is that the factors in production should move speedily to the trades and places where they are most wanted for the purposes dictated by demand. From this it follows that the mobility of labour, with reference both to locality and :ride, is of value. These kinds of mobility may be called horizontal and contrasted with vertical mobility, signifying movement of individuals between grades of labour, which we shall consider more rally on pages 329-31. As the relative sizes and local dispersion of different classes and sections of labour may be modified most easily through the training and geographical disposal of the rising generation, the mobility actually required of adults is less than would at first appear. Geograpiiical factors naturally contribute also to a country's riches, it is better, other things being equal, to have fertile than unfertile land ; while stores of coal and ore, and water- power and fisheries, and a climate which ideally fosters crops without debilitating human beings, are endowments second- ary only in worth to a sturdy and gifted racial stock. The accessibility of a country's natural resources is, again, of con- sequence, as are also such other geographical circumstances as conduce to transportation faculties, immunity from catas- trophes having a natural orijrin (like earthquakes and floods), and security trom foreign aggressions Adaptability of the productiYe system. — The productive system has become so excessively complicated that some authorities have feared for its strength and adaptability. The development that has taken place, like the development of machinery, has, of course, been beneficial in lowering the cost of the output ; but the more intricate a machine the more liable is it to break down and the less easy is it to repair, and the same might be true of a highly organized productive system, while its delicacy might prevent it from standing the strain of a 72 OUTLINES OF POLITICAL ECONOMY considerable and rapid accommodation to new conditions. With its highly specialized firms and specialized labour, its commercial ramifications, its organized markets, specialized traders, credit arrangements, and financial machinery, pro- duction, broadly regarded, would seem to have become a system that can suffer disastrous dislocation in many places. It is natural, then, that doubts should have been expressed about its capacity to respond without mishap to a strange situation. But the great European War has now established beyond dispute that its toughness and elasticity are consider- able — which is not surprising seeing that the most adaptable organisms are the most complex organisms, and not the least complex, — and it has demonstrated also that in a crisis the State can do a great deal to facilitate transition, repair damages, and prevent collapse. The explanation of the satis- factory way in which the business world withstood the shock caused by the outbreak of war is manifold, but a few points may be specifically noted. Though the processes required to prepare things for consumers may be many, the character of what is finally turned out may be rapidly altered, as we have already seen (p. 68). Specialized labour can soon as- sume a new but related kind of specialization, and much unspecialized labour can acquire without undue delay some degree of specialization ; while much specialized machinery even can be turned to certain uses for which it is not entirely suitable. Moreover, the specialization in the commercial world and the elaborate technique of business serve in part to bring production into correspondence with new demands when changes take place. Finally, production can sustain a large drain of men to the forces, because all who are left in industry can do more work for a time and many persons who would not otherwise be wage-earning can supplement their efforts. This paragraph will be understood more fully after succeeding chapters have been read. CHAPTEE VIH. CAPITAL. All will agree that capital is an agent in production, though it is not an original element, but all will not agree as to what capital is. The term " capital " is current in distractingly discordant, though related, senses. It has not been found feasible to harmonize them in an all-embracing conception which sacrifices none of the popular ideas associated with the term. Provisionally, in considering what is capital, we may ignore so-called personal capital, in order that our discussion may not be harassed at the start with more perplexities than we are absolutely compelled to admit. Ultimately its claims to inclusion will have to be weighed. Capital may be regarded from the social and from the in- dividual point of view. "We shall commence our researches from the social point of view. What is social capital ? — (a) Let us first examine the view that social capital consists in instrumental goods. Capital, none will dispute, is correlative to income. It is wealth which yields an income, or aids in the production of an income, or is intended to do so. This highly indefinite statement is suffi- ciently exact to begin with. Nobody denies that factories and machinery, cargo-vessels, fishing-smacks and grain- elevators, manure and the drainage of farms, and vertical holes in the ground leading to coal-measures, are a part of social capital. These things constitute, at least by virtue of 73 7i OUTLINES OF POLITICAL ECONOMY their main purpose, wealth used in order to produce more wealth, or to earn an income of wealth. To the extent to which they are so used, they are the goods of the second and higher orders (see p. 59), which have been called instru- mental goods. But when we come to scrutinize these goods minutely, we become aware that some of them have direct as well as indirect value — that some of them serve occasionally as goods of the first order — as for instance the ship which carries cargo but at the same time passengers, some of whom are simply at sea on a pleasure cruise. Such a ship is both instrumental and a thing yielding value directly. And when it comes into dock, is the dock wealth of the first order or wealth of one of the higher orders ? When the tourists land it is wealth of the first order, but when the other pas- sengers land, and the cargo is got out, lo ! it becomes an instrumental thing. Hence we are driven to recognize that instrumental goods and goods with direct value do not make up mutually exclusive classes. (6) To be strictly logical, then, we must admit, it would seem, that the use, or intended use, of wealth settles whether it is capital or not, if we insist on clinging to the idea that capital must be instrumental. Hence the distinction between capital and other wealth becomes in part a psychological one. If I eat my breakfast with my attention concentrated on what I have to do afterwards, and say to myself as I eat it, "I must make a good breakfast because I have heavy work to do this morning and I don't know at what time I shall get lunch," my breakfast is indubitably capital, since it is eaten with a view to my productive efficiency ; or, at any rate, it is parti- ally capital, and in this event the awkward quest jn of how much is capital has to be settled. This conception of capital as wealth used for the production of more wealth is sound enough in theory, but it breaks down in practice where it leaves no dividing line between capital and other wealth. CAPITAL 75 (c) By a natural transition we are next brought to the view that all wealth is capital because all wealth affects income. Some writers escape the conclusion that the ground of distinc- tion between wealth and capital may be a psychological one— namely the intention which underlies the action of consum- ing wealth — by approaching the question of what constitutes capital along another road. They put the problem in this way : Taking the members of a community just as they are, with their attachment to luxuries, their providence and im- prudence, what part of their wealth is a direct or contributory cause of the magnitude of their future income ? Any part of their wealth, in the absence of which future income would be less, these writers call " capital ". The answer which they find to their interrogation is that no part of existing wealth fails to exercise a favourable influence upon future income directly or indirectly, except in so far as the community made mistakes in the past and acquired things which they would rather be without, an exception which for general purposes we may set aside as over-subtle. Hence all wealth must be social capital. The reason advanced for this verdict is as follows. If a community were deprived of some part of its consumers' wealth, it would straightway insist on producing it, or some- thing similar to it. To do this would involve some diversion of labour from the manufacture of things which are a direct aid to production, and the diminution of these aids to produc- tion would cause a diminution of future income. A reference to primitive conditions will make fully compre- hensible this identification of capital with all external wealth. We ask " What was capital to Eobinson Crusoe ? " meaning by his capital that part of his wealth which helped to make his income high. The answer is, generally speaking, all that Eobinson Crusoe possessed. If he had not saved a store of food one year he would have had to collect food somehow the next year, instead of fashioning the plough to which he then 76 OUTLINES OF POLITICAL ECONOMY devoted some of his energy. If at another time his furniture lacked a chair and table, he would have made them instead of constructing the canoe which on its completion raised his income. It is evident that Eobinson Crusoe's future income at any time was a function, as the mathematician would put it, of all that he owned. (d) Other writers reach the same conclusion that all wealth is capital by yet another path. They argue that all wealth is capital because it produces utilities. If capital is everything that produces income, and real income is utility or satisfac- tion, and all wealth yields utility mediately or immediately, they maintain that all wealth must be capital. The distinction between capital and income, as it strikes them, is the dis- tinction between the present value of wealth regarded as a stock (whioh is capital) and the amount of utility which ac- crues to the community periodically, that is from year to year according to customary reckoning (which is income). My piano yields me an annual income of utility out of the music that I get from it. The value of the piano as capital is the sum of the discounted values of the incomes yielded by it for as long as it lasts. So a loom yields an annual income, prim- arily of textile goods but ultimately of their utility, out of the aid that it is in production. The value of the loom as capital is the sum of these annual receipts, discounted, for as long as they last. This notion of capital is clear-cut and leaves nothing in doubt from the point of view of classification ; but it is questionable whether it is the most serviceable conception. Are free gifts of Nature and personal wealth, social capital ? — In connexion with these four broad conceptions of capital it now remains to ask two questions : — Are agents which are free gifts of Nature capital ? On every principle of defining capital discussed above, some natural agents would be admitted into the class of capital, CAPITAL 77 unless we determined in addition to exclude all things not produced by human endeavour. Sometimes such things are excluded, as in the time-worn phrase, " land (meaning natural agents), capital and labour are the factors in production''. If we decide, oh the contrary, that capital should embrace natural resources, we had better make a point of designating them " natural capital ". Can any wealth which is personal, that is which resides in individuals {see pp. 56-7), be social capital ? Natural endow- ments of capacity should hardly be reckoned as capital if ex- ternal natural agents are not so reckoned. We had better resolve to reject both, on grounds of convenience. But consider the following ease. As I spend wealth in making a type- writing machine so I may spend wealth in training myself to be a typist. If the type-writing machine is capital, is not my acquired type-writing dexterity capital ? The affirmative response is logical ; but as our attitude to the dead metal in which type- writing power is embodied (that is a type-writing machine) must be different from our attitude to the conscious, volitional organism in which type- writing dexterity is embodied (that is the typist), it complies with the requirements of social science to mark a boundary line between machines and skilled operatives in some, at least, of our classifications. So, if we choose to call the typist's dexterity and similar wealth '■'capital," let us agree to entitle it "personal capital ". Industrial capital and classification of social capital. — The reader will probably complain that political economy is for ever creating perplexities which the plain man never feels ; and political economy certainly does share with philo- sophy and all sciences the merit of casting doubt on things ordinarily passed unquestioned, and of compelling the student to form judgments for himself. He must decide for himself what view to take of capital. The next paragraph may, however, remove some of the confusion. 78 OUTLINES OF POLITICAL ECONOMY For practical ends it is desirable to introduce the term "industrial capital" and agree to a conventional definition. It would be best to confine it to a part of the class of non- personal goods which have been produced by labour. Of these it should include all producers' goods proper (among which materials and unfinished consumers' goods are to be reckoned) and all things which are being used wholly or in the main in business and only incidentally as con- sumer's goods, like cargo vessels which carry a few pas- sengers for pleasure. On the other hand, it should exclude all consumer's goods, pure and simple, in the hands of consumers, and possibly those in the hands of producers ; and all things which figure in the main as consumers' goods but incidentally as producers' goods, like private motor-cars which their owners sometimes make use of for business pur- poses. Where there was appreciable division of function, as in the case of railway trains which convey numerous holiday-makers, in addition to people travelling to make a living, a rough estimate of the division would have to be framed for any enumeration of the industrial capital in a country. The things under dispute could not bring about a high percentage of error in the total. " Industrial " is, naturally, to be understood broadly to cover agriculture, transportation and trade, as well as industry in the usual sense of the term. Social capital, more broadly regarded, has been divided into : — (1) Auxiliary capital (that is industrial capital as defined above), which covers everything productively auxiliary to consumers' capital. (2) Consumers' capital, on which consumers live while pro- ducing. Machines and factories are auxiliary capital, while houses, clothes, and food are consumers' capital. It has also been divided into : — CAPITAL 79 (1) Fixed capital, which serves a purpose continuously like machines. (2) Circulating capital, which serves its end but once, like leather, which, when made into boots, is no longer material for making into leather goods. And yet again social capital has been divided into : — (1) Specialized capital, which is suited only for a single use or a very limited range of uses. Examples are afforded by combing machines and blast furnaces. (2) Unspecialized capital, like factories which are suited for more than one industry, and railway trucks which can carry goods of many sorts. Specialization is naturally a matter of degree. Private capital. — Private capital is capital regarded from the individual point of view. Upon its nature we need not dwell at any length. An individual's wealth consists in his possession of goods, or share in their possession, and in his claims to goods represented, for instance, by money. The goods of which he owns the whole or the part comprise : — (1) Personal goods. (2) Non-personal goods used, or intended to be used, in- strumen tally, which must be capital to him as well as to society. (3) Non-personal goods used, or intended to be used, as consumers' goods, (a) by himself, or (6) by others on payment of a consideration to him. Non-personal consumers' goods for sale, or hire, or actually hired out, are indisputably capital from the individual point of view, because their owner gets no direct satisfaction out of them but utilizes them, or intends to utilize them, to furnish him with an income. Non-personal consumer's goods which are being consumed by their owner are or are not regarded as private capital according to the view taken of capital generally, which may be a wide or a narrow one. So also 80 OUTLINES OF POLITICAL ECONOMY are personal goods, but we must add now to our previous treatment that external personal goods, like the goodwill of a business, which have an exchange value cannot logically be torn away from the class of private capital. Coming to a person's money, this is potentially what it will buy, and, looked at in this way, we cannot declare whether it is capital or not to its owner until we have decided what constitutes social capital, and perhaps not until we know the purpose for which the money is intended. If it serves as a working balance for its owner's business it is certainly capital. An individual's " business capital" has a perfectly definite meaning. It denotes (a) his money devoted to business, (b) hi3 good3 which are used instrumentally, and (c) his con- sumers' goods which he lets out to others for a profit or in- tends to sell. We dissever from his business capital the consumer's goods used by himself and his money which is not allocated to business. Whether we call these possessions, barred out from business capital, " capital " of another kind or not, is hardly a matter of vital significance. All that a man has is, of course, potentially business capital to him, be- cause he can dispose of all that he has (except a minimum needed for subsistence till an income accrues to him) and devote the proceeds to business. An individual's circulating capital is all his business capital which does not consist in premises and plant. Production with capital is a roundabout process. — On contrasting production with capital and production without capital, we discover that the former involves getting things in a roundabout fashion. The first hunter chased his game, or lurked in ambush, and killed it when within reach with any handy substance of sufficient hardness. In the next stage of civilization the hunter, we may imagine, spends some time fashioning a rough stone implement before setting out in search of game. In short, he sets to work in a roundabout CAPITAL Bl way. When he does this he is having recourse to instru- mental capital. Or, if we like to take capital in a broad sense, we may say that he has recourse to capital as soon as he begins to consume the store of food set by to main- tain him while he makes his stone implement. In a more advanced stage of civilization man's method of procedure becomes even more roundabout. He begins his hunt, so to speak, by mining for ore, which he afterwards smelts and shapes into weapons of the chase. The peculiarity of a community working with much capital is not that it has laid by large stores of consumable com- modities for future use. It will produce most of its consum- able commodities as it goes along. Its peculiarity is that a large percentage of its people are engaged in making instru- ments, and the things of which instruments are made, and in repairing and setting up instruments. By " instruments " I mean instrumental capital— fishing- boats, machinery, and factories and industrial plant of all kinds. In such a com- munity those engaged directly in turning out consumers' commodities are lavishly supplied with mechanical aids. Contrasting such a capitalistic community with a community of the same size without much capital, we discover that most of the population of the latter produce consumers' goods, but turn out a smaller quantity than the former, though far fewer of the population of the former community are directly em- ployed in making consumers' goods. It goes without saying, nevertheless, that we must not con- ceive of all economic advance as rendering production more roundabout. Many important inventions are important be- cause they show us short cuts in production and consequently abridge the productive process. These inventions are im- provements on previous mechanical ideas. Each step in the assumption of new tasks by machinery, however, renders production more indirect or roundabout ; and, generally 6 82 OUTLINES OF POLITICAL ECONOMY speaking, the elongating effect of inventions on productive processes has more than offset its curtailing effect. A process is not more economical because it is more round- about. But it happens that the more economical ways of doing things are frequently the more roundabout. And we naturally apply first the least roundabout of the ways of doing a thing with which we are acquainted, other things being equal. The peculiar economies associated with the use of machinery will be brought out in Chapter IX. The present chapter may be concluded with the obvious remark that it is not merely the quantity of capital that is of importance to a community, but also its application and the form which the fixed part of it assumes. CHAPTEE IX. MACHINERY AND DIVISION OP LABOUR. The economies of substituting machinery for la- hour. — Why does it pay to use any engines, machinery or implements at all? It pays for the following reasons : — (a) For most sorts of work, implements facilitate the ap- plication of labour, or may even be indispensable. (&) The stupendous forces of nature can be pressed into the service of man when engines exist to transmit them and machines for them to drive. A vast amount of highly valu- able work is now done for the performance of which the strength of the most powerful animals would be totally inadequate ; and for the application of animal, other than human, forces to production, mechanical appliances are equally indispensable. (c) Machinery can work faster than human limbs can move. (d) Machinery works more accurately than the human be- ing, because a machine exactly repeats its movements, where- as even the most dexterous operative cannot depend upon exactly repeating his movements. In the power-loom the shuttle is hit with the same force at every stroke ; so the tension on the weft is kept always the same and the fabric comes out even. No hand-loom weaver could throw the shuttle with the same velocity every time, or, after the in- vention of the fly-shuttle, give always the same jerk to the picking-peg which makes the hammers hit the shuttle. But just as soma machine production is superior to hand-work, 83 6 * 64 OUTLINES OF POLITICAL ECONOMY so some hand-work is superior — almost infinitely so — to machine- work. The most pleasing pictures cannot be pro- duced by machinery. However, to the objection that the use of machinery banishes artistic quality from our products, and therefore undermines taste, and brings about ugliness in our surroundings, it may be replied that the bad effects are not caused by the proper use of machinery but by its abuse. Little artistic feeling can be expressed in making plain druggets, sackcloth, and kettles. And machinery can repeat artistic designs cheaply, and thus bring them within the reach of the masses. Where the line should be drawn be- tween this mechanical reproduction and the production of original artistic work of his own by the artisan, eaoh com- munity must decide for itself and express through demand. This matter raises issues which will be discussed in the con- cluding section of the present chapter. What becomes of the displaced labour ? — When the production of anything is made easier by the introduction ot labour-saving machinery, what becomes of the labour no longer required to turn out the article in question in its old quantities ? Thus, suppose a community used to buy 100,000 pairs of stockings a year and 1000 workpeople were engaged in making them. When a machine was introduced which enabled the 100,000 pairs of stockings to be turned out by 500 hands, what would become of the remaining 500 work- people ? Ultimately, if not immediately, the whole of the 500 would be found active in production, for the following reasons : — (1) After the appearance of the labour-saving machinery, stockings would be cheaper and more than 100,000 pairs a year would be bought. Conceivably, as much labour as before, or even more than before, might be engaged in making them ; and in any event less than 500 persons would be dismissed. MACHINERY AND DIVISION OF LABOUR 85 (2) Extra labour might be needed for machine-making for the stocking industry. However, we must allow that it might not, as the new machinery might be so simple that less labour would be called upon to construct new machinery for the larger output of stockings than was called upon to construct the old machinery for the old output. (3) Any displaced labour which was not absorbed by ma- chine-making would be used to provide other goods (hats and ribbons and rides in hansom cabs) which people would be able to afford when they got their stockings cheaper. (4) Even if we argue on the absurd hypothesis that all people were surfeited with their real incomes before the intro- duction of the labour-saving machinery, and would not there- fore demand any additional goods, it will be found that any displaced labour would still be re-absorbed. It would tben be used to provide more leisure. So the case is identical with that just considered. People would buy more leisure if they would not buy more commodities. Their earnings would buy more, and as they wanted no more commodities they would work shorter hours, thus creating a gap in the labour supply for the displaced workpeople to fill. Actually, people would probably buy a few more commodities and a little more leisure. (5) The imaginary case could be put, in response to the last argument, that people might continue working the old time, but save their additional incomes instead of spending them. But the savings when invested would employ labour, as they would also when hoarded, since it is tangible valu- ables which have been produced that are hoarded. When new machinery appears some operatives may lose employment for a time, and others advanced in years may lose it altogether. Moreover, displaced operatives when en- gaged again, but at work new to them, probably earn less than before. Great hardship may consequently be caused 86 OUTLINES OF POLITICAL ECONOMY to individuals, but this matter is not under discussion now ; and with regard to the allied question of the character of the labour required by machinery, as compared with the char- acter of the labour displaced, and the effect of machinery on the well-being of the community, some remarks will be found on pages 88-90. Meanwhile it is important to note that the substitution of machinery for labour can often be effected without throwing any people out of work, even temporarily. New inventions are slowly adopted as a rule, while at first, owing to their imperfections, the saving in labour effected by them is usually small ; so that a re-direction merely of the labour of the rising generation may accomplish all that is required, especially in a growing society. An unrecruited industry shrinks at an increasing pace, and in a decade its shrinkage must be considerable. The amount of labour dis- placement, if any, caused by new machinery depends upon the rate at which the new machinery is introduced. The duration of the unemployment caused, if any, depends (among other things) upon the powers of enterprise and capital to respond to a new situation, and people's capacity to adjust themselves to new trades. As regards this adjust- ment, it is also to be borne in mind that the absorption of any displaced labour can be indirect, and need not be direct. Industries that require more labour will tend to get the most suitable to be had ; any gaps thereby created in other occupations will again tend to be filled in turn by the labour most suitable to fill them that can be attracted ; and so on, with the result that the labour first displaced will tend to be drawn into vacancies which it is most capable of filling satisfactorily. Eoonomies of specialized labour and machinery. — Specialization is sometimes called " division of labour," for traditional reasons. But " specialization " is perhaps the more appropriate term now that machinery figures so largely MACHINERY AND DIVISION OF LABOUR 87 in a modern economy. If the term " division of labour " is employed, it must be understood that "labour " stands for processes and that division of labour covers division of machinery, so to speak. Consider first the productive advantages of specialized labour. The man who undertakes many offices never acquires expert- ness at any one. Even if he forms habits, the habits never become thoroughly ingrained. Usually he has to keep on thinking how to execute each task, and therefore he works slowly and laboriously and wastes energy. Accomplished cyclists, when they contrast their early struggles to ride with their performances after the habit of riding became fixed, will fully realize this economy in specialism. Again, the man who has many duties assigned to him wastes time in passing from one job to another. Enough has been said to show that the productivity of labour should rise as labour is specialized ; but, before leaving the advantages of specializing labour, we should notice that the specialization of labour may lead to inventions which inaugurate further economy. Specialized labour, in contract- ing a habit, tends to abbreviate a productive process and re- duce it to a co-ordination of a few simple movements. So it mechanizes processes and renders it possible for machinery to assume them. Moreover, specialized workers who can concentrate their attention are more likely to hit upon mechanical ideas than workers whose attention is diffused. Now, coming to the economies of specialized machinery, we observe at once that " division of machinery " facilitates division of labour ; and that, in addition to this indirect ad- vantage, it means a direct aid to production. A sewing- machine adapted for hemming cambric handkerchiefs and sheets cannot be particularly appropriate for either class of work, while time is wasted when the sewing-machine is turned from the one class of work to the other and re-adjusted 88 OUTLINES OF POLITICAL ECONOMY accordingly. Clearly, specialized machinery must be more productive than unspecialized machinery. The former is more closely adapted to its ends and, when there is enough for it to do, can be worked more uninterruptedly. Effect of specialization and machinery on labour. — The productiveness of a method of production is not the sole test of its value — to get many commodities is not the only end of life. It might, in the best sense, pay a community to reject the most productive method of making something be- cause it degraded human nature or made work uninteresting. Adam Smith said that in his day a workman in a pin-factory made the eighteenth part of a pin, and another writer sur- mised that the man was made worth the eighteenth part of a pin in being confined to such a limited task. Was the critic right ? It is certainly important that we should inquire — especially in view of the minuteness of specialization in modern industry — whether human nature is degraded by specialization. But this is not a question upon which an economist is necessarily qualified to offer an opinion. The issues involved are largely psychological and social. So my aim here must chiefly be to indicate the considerations to be weighed ; and in passing judgments I shall be speaking tenta- tively. The division of labour which makes work mechanical robs it of interest. But it has been remarked that a man may think at his work, if not about his work, provided that it is not exhausting — and the lively intelligence of many of the old hand-loom weavers was commonly recognized. Apart from any compensation of this kind, however, work which is merely mechanical must be narrowing. But we must not jump to the conclusion that specialization which restricts the sphere of a person's attention is therefore narrowing. It does not necessarily render work more mechanical. Intensity of interest may take the place of extensity of interest, and the MACHINERY AND DIVISION OF LABOUR 89 former may arouse intellectual powers which were unrespon- sive to the latter. When a man toils at some special detail of a manufacturing process, he may find in it an amazing in- tricacy which has a fascination ; and only he who sees this intricacy can discover how to improve the process. It must, however, be confessed that the rank and file have lost some- thing in so far as specialization has taken from the artisan the need of being an artist. Whether this is to be deplored or not, from the point of view of society as a whole, raises questions outside the peculiar domain of economics. Is it good that a Van Dyck should have his paints, canvases, and brushes pre- pared for him ? When painters gave up the artisan part of their work, specialism oreated a number of new non-artistic offices. But the world is the richer in great pictures. Fortunately the mere fact that a particular task is me- chanical, in the sense that it demands the constant repetition of some few simple movements, renders it likely that a me- ohanical contrivance will be invented for its performance. But inventions do not as a rule, in their first shape, at once eliminate all mechanical work. Indeed, they sometimes create a need for the tedious repetition of certain human actions to supplement appliances, as, for instance, feeding and receiv- ing deliveries from semi-automatic machines. Generally speaking, I should say that invention in its first stages, while calling for some labour of greater intelligence than that which had previously been employed, frequently entails a certain amount of work for which a very low grade of labour is efficient enough. Through improvements, however, it is likely that much of this work will be assigned eventually to machinery. The adoption of machinery invariably causes some substi- tution of intelligence for dexterity. The person who was in effect a machine by reason of his dexterity gives place to one who can understand and direct a mechanical process. In a mechanical age the demand for labour tends increasingly to 90 OUTLINES OF POLITICAL ECONOMY take the form of a demand for capacity to control machinery, that is for specialized mechanical skill of a kind which implies both general intelligence and powers of adaptation. Machinery alters fast and the operative's understanding must keep up with its evolution. Machinery calls for more trained intelli- gence, less dexterity on the whole, and, in transitory phases of development, for much labour which need not possess either intelligence or dexterity. The most significant thing is the usurpation by intelligence of the position originally held by dexterity (which means the man-machine). Finally, we must remind ourselves, lest this argument leave one-sided impressions, that, in striking a balance between the advantages and disadvantages of machinery, both objective gains, in in- creased tangible income, and subjective gains or losses, in terms of the satisfaction derived from work, must be taken into account. The objective gains are immense. Some people are still only half-reconciled to production with power-driven machinery because the conditions of life which prevail where its conquests are most complete — the conditions of life in huge dreary towns in the midst of smoke which destroys vegetation and intercepts the sun's light — are peculiarly repugnant to them. But these depressing conditions are removable. Smoke-consuming devices are becoming less costly. We are awakening to the possibility of making industrial towns beautiful. And the interweaving of transportation facilities, combined with the standardisation of machinery, is constantly magnifying the relative economies of producing many things away from the very large towns. To-day when machinery breaks down standardized parts may be sent to take the places of the parts which have given way. CHAPTEE X. THE GROWTH AND SPECIALIZATION OF BUSINESSES. The nature of production is outlined in the three previous chapters, but some detail has yet to be picked out in the sketch there presented. Looked at more closely, production is discovered to be divided up into industries and each in- dustry into businesses. There are the industries of dairy- farming, herring-fishing, boiler-making, boot-making, and so on. And constituting these industries are multitudes of businesses or firms, variously organized and inter-related. Despite conventional usage, the terms " a business " and "a firm" will be employed here as perfect synonyms, and applied with reference to any industry, whether farming, manufacturing, or what not, unless another meaning is im- plied by the context. Attention must now be drawn to certain features of these small producing systems or businesses. They have many interesting features, all of which call for notice in due course. There are the commercial, or buying and selling, relations be- tween them which we pass over at first : to these relations we shall apply our analysis in Chapter XII. Again, there are the great types of industrial organization labelled " Joint- Stock Companies," "Co-operation," " Kartels," "Trusts," and so forth, the study of which must be relegated to a future chapter. To the existence of this diversity of indus- trial form we may be sedulously blind until that future chapter is reached. Indeed, we may go to the length of assuming 91 92 OUTLINES OF POLITICAL ECONOMY that it does not exist, and premise that every business in every field of industry is a private business under the control of a single employer, its owner. The growth of businesses. — For the moment it will be advantageous to concentrate upon one thought only, namely that law and not chance governs in the main the size of each fully-grown business in each industry. There is no tendency in most industries for one business to swell out to enormous proportions and so feed on its successes that it crowds out other businesses and devours the whole market. Up to a point, a firm tends to grow because the larger it becomes the more economically can it produce, other things being equal. Beyond that point, further growth entails less econ- omical production. Let us try to watch in imagination the experiences of a growing business. For simplicity suppose it produces one article only. Take a village shoemaker with a small con- nexion who does all his work himself, and does not provide himself with more than an insignificant quantity of specialized machinery. He does not buy a sewing-machine, let us sup- pose, because he could only work it for, say, ten hours a week, and it would not be profitable to buy one for such limited use. But, when our shoemaker's connexion grows, he en- gages an assistant, and, by specializing their labour, the two together turn out more than twice as much as either could when working alone. It might now pay the shoemaker to acquire a sewing-machine, because it could be kept running for a longer time each week than before. Finally, after engaging more and more assistants, it pays him to have other kinds of machinery also, say even a machine to sew on buttons, because there is enough work to keep even it run- ning for a long time each working day ; and it pays him also to specialize his machinery to a great extent — to have, say, one sewing machine for making the uppers of ladies' and GROWTH AND SPECIALIZATION OF BUSINESSES 93 children's boots, and one for making the uppers of men's boots. No proof is needed that more machinery per head of labour will be introduced as the business enlarges. The men who sew the uppers of boots together use sewing-machines for the purpose as much in the later stage of development of the business as in the earlier stage. But for the three men, say, who used to sew on buttons, one man and a machine are finally substituted. Hence there is more machinery per unit of labour in the business when it is larger. We may imagine that there exist potentially illimitable possibilities of special- izing machinery — fresh mechanical ideas can be worked out and applied as sufficient work is provided. It is the economies associated with the introduction of machinery, and the specialization of labour and machinery (see pp. 83, 86-8;, which bring about group production, that is production by large groups of factors in such a manner that each group works as a unit or systematic whole. Is there any end to the growth of a business ? Certainly there would seem to be ordinarily, even if we consider the question solely from the productive side. The magnitude of a continually expanding business would finally transcend the powers of control of the employer or board of directors, in the great majority of cases at least. It would become unwieldy, and unresponsive to the needs of its circle of customers. Then cost of production would rise, because of the inadequacy of the direction under which the business func- tioned. So we may generalize and affirm that the potential size of a business is governed by : — 1. The capacity of the employer. 2. The character of the market — whether it needs careful attention or not and necessitates constant modification in the work turned out by the factory. 3. The complexity of the work done in the factory. 94 OUTLINES OF POLITICAL ECONOMY When his factory has reached the maximum size the em- ployer's enterprise need not be checked. He may put in a manager and start another factory and control the policy of both. In doing this he is still further specializing himself ; and he may, of course, discover that he has over-reached his powers. All along he has been specializing. He has been successively (a) self-directed, undertaking, unspecialized work- man ; (b) undertaking manager and specialized workman ; (c) undertaking manager ; and (d) undertaker. We are generalizing here about the potential size of the individual business, as we may say, meaning the size to which it can attain, provided the employer is not starved for want of capital, or want of orders when he can produce cheaply enough to deserve them. We have been asking in effect, to use a physiological analogy, what governs the size to which an organism can attain provided it gets a sufficiency of the right sort of food, only the organism about which we have been inquiring is a firm which is an economic organ- ism. Questions of marketing and of control over capital enter into the determination of the size of a business, but for the time being it must suffice merely to mention these questions and refer the reader to pages 99-100, 130. Admittedly, the large business has greater advantages in facilities for obtain- ing capital and credit, in various selling economies, in a greater power of advertisement (where this is of value), and also in a greater capacity to take risks. Eeturning to the purely productive problem, we have a iked why a business grows and why it does not grow indefin- itely, and our answer was in effect this. When a business grows the executive agents become more highly specialized and so more valuable, and more machinery per man can be used. The employer, too, becomes more highly specialized up to a point, and so more valuable. But, beyond this point, the employer can specialize no more, and, if the business still GROWTH AND SPECIALIZATION OF BUSINESSES 95 grows, the field to which he has to give attention is extended and his attention must be diffused. Broadly regarded, personal specialization has a two-fold implication. It implies on the one hand a limitation of the variety of a person's work, and on the other hand a limita- tion merely of the quantity of things with which a person deals. In order to escape the inconvenience of an ambigu- ous terminology, we had better not call the second process specialization. It is best to call it, say, concentration. The opposite of concentration is diffusion. As a business grows, the employer's attention as a manager is diffused, but, so long as he is specializing at the same time, he gets liberated from other duties and can manage more factors in production. After a time, however, he cannot relieve himself of any more functions, and as the business goes on growing his attention is more and more distracted. The effectiveness of his management per unit of the factors organized, therefore, be- gins to diminish. It is true that the larger the business be- comes the richer it becomes in latent economies by way of the use of machinery and specialization of its factors. But these latent economies do not automatically become actual. The employer designs them, and he cannot design any more if he has too many things to think about already. Consequently, many of the latent economies may remain latent. And all the time as the business expands the employer's oversight is being diffused and his control per unit controlled is being weakened. The time is likely to come, therefore, when a further expan- sion of the business results in a balance of loss. Delegation of responsibility or greater complexity in the organization of control and management may put off the evil day — which raises the special problems discussed on pages 136-8 — and there certainly are circumstances in which great industrial combinations flourish ; but for the generality of cases our conclusion holds at some stage of growth. 9G OUTLINES OF POLITICAL ECONOMY So, to sum up as regards the simple illustrative case which we took of a business which produces one kind of article only, we may say (1) that after a certain point has been reached in the enlargement of a business, other things being equal, its marginal expenses tend to rise, and (2) that the posi- tion of equilibrium, respecting its size, is reached when its marginal expenses equal price. The influences which retard the operation of the tendency towards this position of equi- librium are discussed on pages 99-100. Marginal expenses mean the additions made to total expenses by incrementally enlarging the business. It might be objected that the em- ployer would insist on getting a price a little above the marginal oost of production in his works, because he would want something for himself for the extra trouble to which he was put by undertaking the production of the last in- crement that he turned out. Strictly this objection may hold good, but the extra income that the employer would want for himself would be negligible because the extra trouble involved in the production of the last increment would be negligible. We are not evading a difficulty when we affirm that the trouble of working an industrial capital of £10,010 is not recognizably greater than the trouble of working in the same way an industrial capital of £10,000. We may note in passing that what is called the marginal return of a business may be obtained from the marginal ex- pense by dividing the unit of money, with reference to which returns are being measured, by the marginal expense. Thus, if we are measuring returns with reference to sums of £1 and the marginal expense of a pair of slippers in a business is 2s. 6d., the marginal return in that business (per £1) is 8 pairs of slippers. The normal magnitude of the business.— In fig. 5 measure along OX units of produce of a business, and along OY units of money. Assume constancy in the money costs of factors in pro- GROWTH AND SPECIALIZATION OF BUSINESSES 97 duction and in the price of the product. The curve P shows by the vertical distances between it and OX at different places what employer's marginal expenses (apart from any remuneration for the employer's work) would be, in the case of a particular busi- ness, for the various possible sizes of the business which are indi- cated by the units of output measured along OX. Thus, if the output is 0<7, employer's marginal expenses will be bg and total employer's expenses will be represented by Ogbma. The curve P first descends, for reasons explained above, and then ascends. The size of the business in units of output will be Og if bg equals price. The curve Q relates to a more capable employer. If the Fig. 5. first business is of the size Og, his will be of the size Oh because eh must equal — that is, of course, tend to equal — bg. Note that Ogr must be such that Imb is substantially greater than ajl, as otherwise the employer would make little or nothing for himself, seeing that his gross receipts are Ogbj, that is output, Og, multiplied by price, bg. The law of substitution, indifference, or equi-marginal returns. — This will be a suitable place to point out that, just as an employer tries to make his business of such a size that his marginal costs as a whole equal price, so he tries to use factors in production of different sorts in such quantities that the marginal return of each of them equals its cost. Employers' marginal costs of production, as a whole and in relation to each factor in produotion, may not be explicitly 7 98 OUTLINES OF POLITICAL ECONOMY recognized by a wide circle in the business world, but that, with or without names, they play leading parts may be in- ferred from the fact that agents in production are not grouped chaotically and that businesses seldom reach unwieldy dimensions. When we try to envisage the tasks of industrial and com- mercial directors, it soon becomes apparent that both can be brought under the law of substitution, indifference, or equi- marginal returns in certain respects. The producer who is farmer or manufacturer has to maximize the returns ob- tained from a given expenditure on material or land, labour, instruments, and accessories ; and, just as I, in spending my income, get the best results when my marginal returns per unit of expenditure on different things are equal, so he must get the best results when his marginal returns per unit of expenditure on each agent of production are equal. The proof given on pages 44-6 applies here, but let us take a specific example nevertheless. A manufacturer, say, is making steel. If he adds £2 a week to his wages bill to increase his staff of labourers, suppose his weekly product will be raised by one ton of steel. If he adds £2 a week to his interest account to increase his capital, suppose his weekly product will be raised by two tons of steel. Then he will borrow more capi- tal and possibly reduce his labour. And so he will proceed until a unit of additional expenditure will have the same effect on his output whether it purchases labour or capital. It should be superfluous to add that the employer's office of grouping and marshalling the agents in production seldom becomes a sinecure, when a business is not left to decay. Industrial, including agricultural, development is constantly necessitating re-arrangement of the factors in production : every invention or alteration in the costs of different factors renders re-adjustment economical. As to the trader, he also will act like the industrial organizer, for the trader prospers QROWTS AND SPECIALIZATION OF BUSINESSES 99 in the degree in which he so distributes the supplies of an article between different places that the prices paid to him in different places, less his expenses, become equal. This reference to the work of industrial organizers and traders is by no means exhaustive, and the reader must ba on his guard against imagining that their work is simpler than it is. The trader has also to keep himself constantly informed of what is and can be produced and of changes in costs, while studying, in addition, the needs of different markets and anti- cipating to some extent. And the industrial organizer has to go even further beyond a mere mechanical application of the law of equi-marginal returns. He has to choose machinery and change it as need arises ; decide on the classes of labour that he needs ; select his workpeople, after studying the ruling rates of wages ; assign their tasks to them ; settle how particular processes have to be performed ; and arrange, as far as he can, for such systems of paying wages, and such hours of labour and conditions of work generally, that the best results are attained. All this and something more, over and above the determination (so far as it rests with him) of what to produce and when and how much of each thing, is required of the efficient employer. Eecently much has been written under the title " Scientific Management " about the value of scientific methods in the practical solution of pro- blems of industrial organization. The economic questions raised by the various duties of traders and industrial organ- izers will be examined in some detail in due course. Expansion and contraction of businesses. — It seldom happens that individual businesses spring up to their full sizes in a few months. They may take years, even generations, to attain full maturity. The rate at which a firm grows depends upon its ability to win its way in the market or earn the confidence which is the source of its borrowing powers. Businesses attain their maximum size much more rapidly 7* 100 OUTLINES OF POLITICAL ECONOMY in some industries than in others (see p. 130). And just as businesses may grow up slowly so they may die down slowly. As it has been appropriately said, an industry is like a forest and the businesses in it are like the trees. Every industry contains some young and growing firms, some which have reached maturity, and others which are dwindling as they lose their hold on the market. The generation which made a firm passes away, and its successors in control may be less fit than their predecessors to hold their own against the competition of pushing rivals. The rising generation is always knocking at the door. But the decaying business is not obliterated suddenly ; for years it may maintain a position, because the effects of the old management may survive in its organization, or because its past prestige may have left a tradition which advertises it, or because of the persistence of the habits which some people have formed of buying from it. In connexion with the growth of businesses the observation may be recorded that businesses are not equally elastic in all industries. It would be as well to draw a distinction between the "walled industries," namely those carried on in factories, and the "un-walled industries,'' like building. Businesses in the former class are like shell-fish which, in order to as- sume ampler proportions, beyond a certain limit, must dis- card their shells and grow others. The " walled " business may have at one time too much space and excessive provision for motive power, to allow for possible expansion ; while at a later stage in its history it may be cramped and inadequately supplied with power, though not so awkwardly situated that it would pay it to embark on extensions. Hence, in businesses in the walled industries, marginal costs are seldom in the neighbourhood of price, though it is still true and relevant to say that in the exaggerated long run they tend to be. Specialization of businesses. — In previous paragraphs GROWTH AND SPECIALIZATION OF BUSINESSES 101 we have traced the way in which a business finds increasing possibilities of using machinery and specializing its factors as it grows. Now we have to observe that, as an industry grows, its constituent businesses may specialize in respect of the work they undertake, and that in doing so they may find yet further possibilities of using machinery and specializing their factors. Suppose the whole of the industry is in one place. Then, as the market for the industry enlarges, increased output must be got through the emergence, at any rate after a time, of new businesses. But will not the new and old firms be as much alike as Tweedledum and Tweedledee, the new firms intro- ducing no fresh economies ? The answer is in the nega- tive, at least as regards the bulk of the industrial world. Businesses will probably begin to specialize, and specialized businesses eventually reap the advantages of more specialized management, more specialized labour, more specialized machinery, and more machinery per head. It3 economies will probably induce the adoption of as much specialization of businesses as there is scope for, provided that certain con- siderations connected with marketing do not prevent it. The scope for specialization is furnished by the size of the in- dustry, just as scope for specialization among the factors of a business is furnished, other things being equal, by the size of the business. But in some industries, like agriculture, natural conditions may limit the possibilities of specialization ; and, in other cases, its economies may be counteracted, as for in- stance when the cost of material is raised by an increased demand, or when the larger industry has to draw upon inferior agents. That the more specialized business means more specialized management is self-evident. To demonstrate that it means also more specialized labour, take for example a firm with 1000 hands which used to make motor cars and bicycles. 102 OUTLINES OF POLITICAL ECONOMY Say 500 hands worked mainly at motor oars and 500 hands at bicycles ; and that after a time the business confines itself to manufacturing motor oars. Then the employer could manage at least 1000 men under the new conditions since he managed 1000 under the old conditions. In fact under the new conditions he might manage more because his task might present less variety; but let him have, nevertheless, only 1000 men. Now it is evident that there can be more division of labour among people constructing motor cars when they work in groups of 1000 than when they work in groups of 500, and clearly their machinery can be more specialized. And in the former case, since scope is afforded for fresh machinery when scope is afforded for more division of labour, more instrumental capital per head of the opera- tives employed will be drafted into motor-car manufacturing. Nor have we yet completed our enumeration of the econ- omies that may result from the expansion of an industry : for it may cause specialization, not only within the industry, but also in subsidiary industries, such as machine-making, for which the industry in question is the market ; and it may bring about a fall in the C03t of carriage. The specializing of businesses has been going on apace. Compare the engineering works of Boulton & Watt, when James Watt the inventor was a partner — a business typical of its time — with engineering works of to-day. Boulton & Watt manufactured almost everything that is made of the baser metals ; to-day an engineering firm may produce nothing but boilers, or textile machinery, or locomotives, or machine tools. Go back three-quarters of a century and you find the cotton factory which spun many kinds of yarn, and made it up into numerous sorts of fabrics, the typical factory in the cotton industry. To-day you will find, to take one example, a mill devoted to nothing but spinning, and spinning only a certain narrow range of yarns. There is prodigious scope for special- GROWTH AND SPECIALIZATION OF BUSINESSES 103 ization among industrial firms: but in agriculture' the scope is restricted for obvious reasons. In the argument above it is supposed that the whole of an industry is in one place. Now suppose it is scattered, parts being in one country and parts in other countries. Still, the business specialization would remain which was dependent upon the aggregate size of the industry. So the size of the industry abroad, as ivell as at home, may determine business specialisation. But when the industry was scattered, there would be much less business specialization than when it was concentrated in one place, because of the cost of carriage be- tween places far apart and the inconvenience of arranging for sales to and purchases from distant markets. The time-worn, but still undisputed, economic dictum that division of labour is limited by the extent of the market merely affirms indirectly that specialization (division of labour broadly interpreted) is limited by the extent of an industry ; but it is less equivocal, though less direct, than the latter statement, inasmuch as the market must be understood to embrace the foreign market as well as the home market. Two kinds of specialization may be contrasted, namely, that by product and that by process. By specialization by product, a limitation of the classes of things turned out by a business is meant ; and, by specialization by process, a limitation of the number of processes, in a chain of manu- facturing processes, which a business undertakes. If in the worsted industry a business which turned out twenty kinds of cloth gives up producing five of them and supplies only fifteen kinds, we may say that it has specialized by product. Again, in the worsted industry we may distinguish between the processes of (a) wool-combing, (b) spinning, and (c) weaving. If we find a worsted industry each . business of which, as a rule, spins the yarns that it wants for weaving and combs all the wool that it wants for spinning, we may 104 OUTLINES OF POLITICAL ECONOMY say there is no specialization by process. But when we find a worsted industry, some businesses of which comb only, while other businesses spin only and yet others weave only, we may say there is process specialization. The conditions of special- ization by process will be explained on pages 129-30. Internal and external economies and the localization of industries. — There is a generally recognized distinction between the internal and the external economies of a business. The external economies are those in which all businesses in an industry can share, such as the degree of business specialism objectively possible, the conveniences offered by subsidiary industries and facilities for marketing and carriage. The in- ternal economies of a business are those economies which are peculiar to it. The external economies of an industry in any one place become greater, as has already been insisted more than once, (a) with the growth of the industry in that place, and (b), under certain conditions, with growth of the industry in other places with which the place in question is in trading contact. That is to say, the external economies of a business are partly local and partly international : and it is of no small interest to observe that recent progress has tended to reduce the proportion of external economies which are narrowly local. Specialization by process becomes possible among factories scattered over a wide area when transporta- tion facilities become cheap and adequate; and there are other conditions of late development which are extending the area within which certain external economies can be enjoyed. The question of the localisation of industries is a gigantic one, but we can only afford time for a hasty glance at it. (a) The localization of industries is determined partly by physical conditions. Coal-mining can only be carried on where there are coal mines. Iron-smelting is done cheapest in the vicinity of ore and coking coal. And the climate of some places is an aid to certain industries. GROWTH AND SPECIALIZATION OF BUSINESSES 105 (b) It is determined partly by means of transportation. Importing and exporting industries gain from being near ports. And all industries which serve a wide area gain from being on a line of railway. (c) The localization of industries has also been determined in part by the whole complex of economic conditions, includ- ing commercial conditions, supplies of labour, and international exchange. CHAPTBE XI. THE LAWS OF INCREASING AND DECREASING RETURNS. We are now sufficiently prepared to understand the celebrated laws of increasing and decreasing returns. Though the next chapter has an important bearing upon them, we shall antici- pate and treat of them at once while the contents of the two previous chapters are fresh in the reader's mind. Meaning of increasing, decreasing, and constant re- turns. — Increasing, decreasing, and constant returns refer to the additions made to returns, or output, by adding to the quantity of a factor in production, or a group of factors. There is said to be increasing, decreasing, or constant returns, according as these marginal returns rise, fall, or remain unchanged. It is important to notice, however, that when an industry as a whole is said to be subject to increasing, decreasing, or constant returns, as the case may be, the returns usually intended are not the total additions made to the output by the industry's expansion, but the returns having a bearing on the settlement of price, which are the returns at the -margin of particular businesses or in a new marginal business, as we have yet to learn. The reason for this special reference is that it is convenient to bring the conception of increas- ing, decreasing, and constant returns into relation with price determination ; and the returns governing price need not be the same as the full extra returns resulting from the ex- 103 LAWS OF INCREASING AND DECREASING RETURNS 107 pansion of an industry. Thus, in agriculture a rise of the output per unit of expenditure, as more is spent, is perfectly consistent with a fall in the return per unit of expenditure at the margin of cultivation (the amount of which return governs price, as we shall perceive later). This is so because the extension of agriculture might so cheapen agricultural implements and seeds as to lower the average cost per unit of output ; though at the margin these cheapening influences might be more than counteracted, through the inferiority of the new land brought under cultivation in consequence of the expansion of the industry. A simple numerical illustration will make this somewhat difficult point clearer. Suppose in a wheat-growing area a new farm is started on which £1000 a year is expended, while the same sums as before are ex- pended annually on the other farms. Let the return on this new marginal farm be 500 quarters of wheat. Then the return per £10 spent is 5 quarters, and the marginal return on the farm cannot be more than this. But the total in- creased return from the whole wheat area may be more than 500 quarters. For, in addition to the return from the new farm, there may be larger returns from the old farms, since improvements in external economies (p. 104) — such as cheaper agricultural machinery for instance — might result from the supposed extension of farming. Let there be such extra re- turns from all the old farms taken together to the amount of 300 quarters. Then the aggregate additional returns from the whole wheat area would be 800 quarters, namely 500 on the new farm and 300 extra from the old farms. And as the additional expenditure on the wheat-growing is only £1000 per annum, this means a marginal return for the area as a whole of 8 quarters per £10 of extra outlay. The meaning of increasing, decreasing, and constant re- turns, broadly indicated here, will be more apparent after the chapters on supply prices and rent have been studied ; but 108 OUTLINES OF POLITICAL ECONOMY they will probably be clear enough now to convey the general idea that is needed for an understanding of the laws associated with these terms. As regards the application of these terms to whole industries, it will be realized after the foregoing discussion that we may say if we like, and find it the easiest definition to give, that an industry is subject to increasing returns if the price of its product falls with the industry's expansion, to decreasing returns if the price rises, and to constant returns if the price does not alter. Finally, it remains to note that when the reference is to an industry as a whole, or a business as a whole, it is not assumed that an employer is necessarily able to obtain under the new conditions as large a supply of each agent in pro- duction as he would like to have at the old price. Take as an extreme case farming in a country in which all the land is already used, and suppose that the land grows only wheat, that the demand for wheat rises, and that none can be got from abroad. Farmers would like to get more land, but they would be unable to do so. They would, however, raise more wheat from the existing land by applying more capital and labour to it ; and it would be said that there was decreasing returns, because, on every farm that was worked more in- tensively, the return in wheat per unit of cost at the margin would be less under the new conditions than under the old, as we shall learn. The non-evolutionary laws of increasing and decreas- ing returns. — The term law in connexion with increasing, decreasing, or constant returns, as the case may be, has been employed in more senses than one. It is not at all uncommon to use the term without intending anything more than the mere conception of increasing, decreasing, or constant returns ; for instance, to say that an industry is subject to the law of increasing returns without meaning more than that it is sub- ject to increasing returns or that increasing returns rule in it. LAWS OF INCREASING AND DECREASING RETURNS 109 But, as contrasted with this use, it is at least as common So find the term " law " united with " increasing returns " or " decreasing returns " to denote the conditions under which industries are subject to increasing and decreasing returns respectively ; so that the law of decreasing returns, for ex- ample, would state that under such and such circumstances decreasing returns would rule in industries. Even when taken in this latter sense, however, there is an absence of agreement about the enunciation of these laws. This absence of agreement seems to turn in the main upon whether the intention is to indicate the conditions of universal tendencies, or to indicate what is generally found to happen in different classes of industries ; and, in addition, as regards the law of increasing returns, upon whether the intention is to indicate what happens as a rule now or what happens as we pass from one period to another. Consequently we shall cover most views of these laws if we recognize five, namely the abstract and realistic laws of increasing and decreasing returns that are not evolutionary, and the evolutionary law of increasing returns. These five laws it now remains to enunciate. Abstractly the law of increasing returns may generally be phrased as follows : — The expansion of an industry, provided that there is no dearth of suitable agents in production, tends to be accompanied, other things being equal, by increasing returns. The kernel of the proof of this law has been furnished already in the two chapters immediately preceding this one. As the industry gets bigger more specialization and more machinery per head tend to be introduced into it and its sub- sidiary industries, and the means of transportation connected with the industry tend to get more economical. Also the commercial work interlaced with the industry tends to get more economical, as we shall see. Consequently, increasing returns tend to follow. And in the defined circumstances, L10 OUTLINES OF POLITICAL ECONOMY there cannot be any positive counteracting tendencies, because we have supposed that there is no shortage of suitable agents in production. If there were such a shortage, and it was not very serious, there might still be increasing returns, but there might not. As it is practically certain that some of these tendencies to a lower real cost of production would have scope and be effective, we should be perfectly safe in affirming that the expansion of an industry, under the stated conditions, would be invariably accompanied by increasing returns. Abstractly the law of decreasing returns may generally be expressed thus : — The expansion of an industry, provided that additional sup- plies of some agent in production which is essential cannot be obtained, is invariably accompanied, at once or eventually , by decreasing returns, other things being equal. The proof of this is simple. Let all the factors in produc- tion but one essential factor increase and note the result. Suppose the quantity of instrumental capital is fixed and labour and material increase. Labour can become more specialized as its quantity is augmented, but the gain secured through this specialization must ultimately be counteracted because each operative will be progressively deprived of me- chanical aids. The case of the more intensive working of a fixed quantity of land is evidently similar. Of course, de- creasing returns might also appear when additional supplies of all the agents in production could be obtained, provided that the available extra supplies of some essential agent be- came increasingly inferior in quality or limited in quantity. When the law of increasing returns and the law of decreas- ing returns are understood more realistically, the former is taken to assert that the expansion of a manufacturing in- dustry leads generally to increasing returns, and the latter to assert that the expansion of an industry engaged in obtain- ing natural products leads generally to decreasing returns. LAWS OF INCREASING AND DECREASING RETURNS 111 So expressed, these laws may be regarded as founded on an inductive examination of actual productive activities made in the light of the abstract truths which have already been enunciated. The tendency for decreasing returns to rule over our efforts to raise natural products is due to the fact that a prominent part in their creation is played by nature, and that the best and most favourably situated land and mines and fisheries are limited in quantity (see Chap. XXVI.). The evolutionary law of increasing returns. — The evolutionary law of increasing returns results from induction applied historically ; and it may be supported deductively with the aid of theories of progress. It states that in- creasing returns are obtained from manufacture over long periods of time apart from enlargements of the market, and that the tendencies to decreasing returns in the yield of natural products are likely to be substantially counteracted. The cause is invention and increased knowledge. Diagrammatic representation of the counteraction of dim- inishing returns. — In fig. 6 measure " doses of labour and capital " along OX. A " dose of labour and capital " means a sum of money Y spent on different productive agents to the best purpose. Suppose that the money value of each class of agents in production remains constant, so that a dose of labour and capital means a fixed quantity 112 OUTLINES OF POLITICAL ECONOMY of generalized producing power as one might say. Measure returns in wheat along OY. For some country, express by the various vertical distances of curves above OX (in short by their ordinates) what, at different times, marginal returns would have been if the various numbers of doses of labour and capital indicated along OX had been applied to agriculture. Thus, if Oa doses of labour and capital had been applied at the time to which PP' relates, the marginal return would have been ad. " Marginal return " is to be understood here as the return per unit of cost on the marginal farm or as the marginal return on any typical farm. Let PP' be the curve of return at the end of the 17th century. QQ' >> j. )> >. jj 18th „ RR' » ). >> () >> 19th „ We suppose that the curve of a later century lies above that for an earlier century, owing to improvements in agriculture. Let the doses of labour and capital applied in the first period be Oa, in the second 06, and in the third Oc. Then, as the marginal returns (ad in the first period, ae in the second, and cf in the third) rise over the centuries (as shown by the dotted line), there have been increasing returns from an evolutionary point of view. Neverthe- less, wheat production has been subject to decreasing returns in each period. The descent of each of the curves PP', QQ', and RR' indicates the rate of decreasing returns in each period. CHAPTEE XII. MARKETS AND COMMERCIAL FUNCTIONS. What are markets ? — In a complete subsistence economy where each family produces for itself absolutely everything that it needs — to discover which, if it ever existed, we must go back to the Stone-age and the cave man — no exchanging takes place. But, actually, wherever there is a community, however primitive, there is some bartering. "With the introduction of more and more division of labour, the volume of this bartering grows. Economic progress means inter alia specialization, and not merely specialization by product but also speciali- zation by process (see pp. 103-4) ; and it is of importance to notice not only that each step in specialization by product magnifies the place of marketing in the social economy, but also that each step in specialization by process creates the need for the marketing of commodities which were not pre- viously bought and sold. If farmers ground up all their wheat there would be no market for wheat. But when specialization by process appears and one man is farmer only and just grows wheat, while another man is miller and flour-dealer, the former will want to sell some wheat and the latter to buy it. Hence wheat will become an article of com- merce and a wheat market will be established. And what precisely is a market ? Economically interpreted, the term " market " refers, not to a place, but to a commodity , or commodities, and buyers and sellers of the same who are in direct competition with one another. Hence, we may as 113 8 114 OUTLINES OF POLITICAL ECONOMY appropriately speak of world-markets as of local markets. There is a world-market for tea, since most nations are com- peting with one another in the purchase of tea. Further, dealers are not brought into direct competition with one another unless they are dealing within the same range of quantities. The village grocer is not directly in competition as a buyer with any wholesale buyer of tea ; he directly competes with other retailers in buying from wholesale tea dealers. So we may distinguish also between wholesale markets and retail markets. Evolution of markets. — There are various stages in the evolution of markets, the significance of each of which is well worthy of consideration. The chief of these are : — (a) The localization of markets. (b) Dealing by sample. (c) Dealing by grade. (d) Differentiation of markets. (a) The localization of markets saves much of the time which used to be spent by buyers and sellers in moving about to meet one another. For the localized market there is usually a market-place, where goods are displayed, if the market is of a simple kind. "When buyers and sellers are crowded together in one place, competition between them is naturally rendered much more effectual than it can possibly be when they are scattered and have to travel about to bargain with one another. So, in the localized market, one price at one time for one com- modity is likely to rule. A large district may maintain several localized markets of the same kind. In each there is competi- tion, and between them there is also competition. In a sense, therefore, they make up one market. A producer will send his goods to market B, which is further away, rather than to A, which is nearer, if he learns that prices have been ruling so much higher in the more distant market that it is worth his while. The area normally served by a localized market is MABKETS AND COMMEBCIAL FUNCTIONS 115 dependent, of course, upon the provision of transportation facilities. (b) The system of selling by sample contributes substantially to public convenience. It saves the carriage of bulky goods to the market. Also, it enables more persons to deal on the market ; for the market in which samples only are inspected is not cumbered with loads of goods. Further, it enables dealers to get into closer and more continuous contact with one another. Hence the market in which samples are sub- stituted for the actual goods for sale draws on a wider area of supply, and competition within it becomes more thorough- going in its action. All goods cannot in the nature of things be sold by sample. But many natural products can be so sold. Handfuls of wheat taken indiscriminately from the year's harvest of lands of the same quality, in the same district, sown with the same seed, are likely to be the same. Again, things produced in the same mechanical way from the same materials — say pigs of iron from the same tapping of a blast furnace — are likely to be strikingly similar to one another. And yet again, some things may be satisfactorily sorted into classes specifically with a view to selling by sample. (c) The adoption of selling by grade is a step in the develop- ment of certain markets which may have the most far-reaching consequences. Organized dealing in " futures " may be the goal eventually reached. For selling by grade, the various qualities of the gradable commodity are arranged in separate classes, to each of which is given a distinguishing mark or name. Sellers usually try to sort their goods into the same grades, and an attempt is made to keep these grades the same continuously over a lengthy period. When grading has been effected, a buyer can purchase without seeing samples, by simply referring to the name or mark of the grade which he wants. The introduction of dealing by grade yet further 8* 116 OUTLINES OF POLITICAL ECONOMY enlarges and perfects a market, for the same reason that the introduction of buying by sample enlarges and perfects a market. (d) The original market is the mixed market. As the area which a market can serve extends, with improvement in the means of carriage and communication, it first grows in size, and then, under pressure of the claims of commerce, begins to differentiate, that is, to split into sections' — into the fruit and vegetable market, the cattle market, the textile market, the hardware market, the colonial produce market, and so on. Additional differentiation accompanies the emergence of selling by sample and grade, for reasons which will become palpable as we proceed. Future dealings. — On the markets for some things which are highly gradable — for instance on the exchanges for wheat, coffee, copper, coal, tea, oils, rubber, and numerous other com- modities which are in the raw state or near the raw state — future dealing has been so elaborately systematized that the buying and selling of future supplies has been rendered almost as simple as the buying and selling of present supplies. The things which are directly bought and sold on the exchanges where future dealing has been thus promoted are documentary guarantees to deliver certain quantities of the commodity in question at certain times. By means of these tangible tokens, the future supply is brought representatively on to the market. Just as a trader can purchase bills payable at sight, or bills payable after six months or so, and in this way can buy gold for delivery now or in the future, so he can purchase a con- tract for immediate, or future, delivery of cotton, or wheat, or certain other commodities. There is this difference, however, that the purchaser of a produce future cannot be sure of the exact quality of the commodity which will be delivered against it. Consequently the chances are that he will ultimately sell his future back instead of taking delivery of the article. MARKETS AND COMMERCIAL FUNCTIONS 117 The term " futures " is sometimes reserved for contracts for future delivery which circulate on a highly developed produce exchange. Hereafter the term will be used in this restricted way. Other contracts relating to the future will be indicated descriptively, or by such terms as " future transactions," " future business," " future dealings ". " Futures " is some- times used as a generic term to denote " options " also. An option is a right to conclude a bargain on a future date at a fixed price. It may be single, a "put" or a "call " (i.e., a power to sell or to buy), or double, containing both powers. The advantages of transactions in futures are said to be two : (a) that they steady prices ; and (b) that they enable the persons who use, or deal in, the articles in which there are futures to avoid certain risks. Whether such advantages are derived from the use of futures or not, we shall consider later in this chapter. Technicalities of dealings in futures.— In order to limit the variety of the contracts entered into on a highly organized future market, every "future,'' which has reference really to a range of qualities of a commodity, is made to relate directly to one of the qualities, or grades, only. But certain other grades are declared to be deliverable against any future, on payment of allowances to or by the purchaser, according to the inferiority or superiority, as the case might be, of the grade delivered to the grade which is the basis of the future contract. Allowances are settled on some agreed prin- ciple. Again, with the same object in view, that is with the object of curtailing the variety of future contracts, they are made to refer at the same market to a limited number of agreed periods. On a produce exchange, for instance, in January you might find January futures, February futures, March futures, and so on ; and all futures for a stated month would contain exactly the same pro- visions as regards the time and notification of delivery. It will be at once evident that on a highly organized future market elaborate regulations must be observed. The object of most of these regula- tions is to simplify business by substituting uniformity of method for variety. 118 OUTLINES OF POLITICAL ECONOMY There are two classes of buyers of futures. There are those who buy with a view to their future needs for particular grades of the commodity. When a buyer of this class has purchased a future there is no guarantee that the particular grade required by him will be delivered against it. It is best for him, therefore, if he has bought a June future, to receive some time in June the value of the future, that is the value of what would be delivered against it, instead of the commodity that would be delivered against it, which might or might not be what he wanted. The money could be used to purchase the exact grade of the commodity that he wanted. The alternative would be to take delivery of the commodity, which would probably be of the wrong grade for his requirements, and then sell it with a view to purchasing what he wanted. It should be added, however, that on some markets a future contract has come into use which guarantees delivery of a specified grade recognized in the classification of the market ; but even this does not fully meet the requirements of the buyer who wants a precise quality that is part only of a quoted grade. There are other buyers who are not seeking the produce to which futures refer but are trying to make a profit out of buying at a low price and selling at a high price. If they took delivery they would have to sell what they received. It is, therefore, a convenience to everybody concerned that they should directly receive, in place of the commodity, what it would fetch. On highly developed markets — future markets and the Stock Exchange — a system of periodic settlements has appeared and with it dealing in differences. The latter can be explained best by means of an example. If Jones buys from Smith an amount of May futures in some commodity, he has only to pay Smith periodically any sums by which the value of the futures may have fallen between settlement days. Similarly, Jones receives from Smith any sums by which the futures rise. If the futures were bought on 1 January for £1000 and settlement days fell on 11, 25 January, 8 February, and so on fortnightly, and the futures were worth, ac- cording to market quotations, £1100, £1200, and £1150 on these dates in order, then Smith would have to pay Jones £100 on 11 January, and £100 on 25 January, and Jones would have to pay Smith £50 on 8 February. If the futures were cancelled on 8 MABKETS AND COMMERCIAL FUNCTIONS 119 February, Jones would have received £150 on balance, which is just the difference between the value of the futures when he bought (£1000) and their value when he withdrew (£1150). As dealing on differences enables people to enter into large transactions if they have enough capital to cover possible adverse differences, it has increased the volume of dealing, including speculative dealing. The system of periodic settlements performs the important service of periodically testing the solvency of the market and removing those who are not in a position to meet their liabilities. Markets for capital. — To complete our condensed account of markets, something must be said of markets for capital. We may distinguish between the market for capital already invested and the market for new capital. The bulk of the former is embraced by stock exchanges. A typical stock exchange is perhaps the most highly organized of the markets of the world. It is so highly organized because the things bought and sold on stock exchanges, that is shares, are per- fectly graded, so to speak. No produce can be quite perfectly graded. But shares may be regarded as perfectly graded, be- cause the several units of a stock of a given kind are in effect identical : any one ordinary share of a given company is just as good as any other ordinary share of the same company. The market for capital for fresh enterprises is curiously unorganized. The stock exchange is not the market for such capital ; it is, on the contrary, the market in which invested capital is bought and sold. Through operations on the stock exchange the ownership of invested capital changes hands, but the quantity of invested capital is not thereby altered though its value may be affected. Capital is directed to new investments through private in- formation, advertisement, the circulation of prospectuses, financiers, and investing companies. The degree in which banks sink their money in industrial undertakings is limited, as we shall observe later, because they may require their 120 OUTLINES OF POLITICAL ECONOMY money back again at short notice and it is not easy at short notice to sell an interest in a newly projected railway, say, without risk of loss. In some countries banks do more in the way of directly financing industry than in others. In all countries they largely finance commerce — and so industry in- directly — by discounting bills and in other ways. In most countries, investing companies are not responsible for much of the fresh investment in industry which goes on from year to year. They have absorbed far more of this work in the United States than elsewhere. Price steadiness and its effects. — Before trying to answer the question, Does speculation steady prices ? we must dis- pose of two preliminary questions, namely, (1) What is meant by price steadiness ? and (2) In what does the value of price steadiness consist, if it has any value ? If the price of one commodity changes less frequently than the price of another, we may say that the price of the former is steadier than that of the latter, other things being equal. Again, if the price of one commodity varies by smaller percent- ages than the price of another, we may say that the price of the former is steadier than that of the latter, other things being equal. What shall we say, however, if the price of one thing varies less frequently but more violently than the price of another thing ? In view of these and other differences in character between price variations, some sort of measure- ment of steadiness, which attaches an appropriate weight to each of them, must be used. A simple or complex average of variations from the mean price is usually employed. Are steady prices (it being assumed that the purchasing power of money remains constant) preferable to unsteady prices ? In facing this question, we can avoid the perplexities arising from the vague implication of the word " unsteady," by contrasting absolutely unvarying prices with prices that vary in any way whatever but yield the same average. Such a con- MARKETS AND COMMERCIAL FUNCTIONS 121 trast is sufficient for our present purpose. We are dealing not with price variations over periods of years, which may involve substantial alterations of supply, but with market fluctuations from day to day, week to week, and month to month. After a few minutes' thought it will become abundantly ap- parent to the shrewd observer that unvarying prices (when the purchasing power of money remains constant) must be best for the community. Take, as a tangible case to generalize from, the price of some consumer's commodity. Unvarying price results, under the condition denned above parenthetic- ally, when the supplies of this commodity are distributed in time proportionately to demand. And such a distribution produces a maximizing of the satisfaction which can be yielded by the commodity, other things being equal, because it pro- duces equi-marginal returns in time. The reader who is still in doubt may refer back to pages 44-6. Fitful price move- ments enforce irregularity in consumption, which is wasteful of satisfaction. And, so far as they relate to the things needed for production, they are passed on to the prices of consumers' goods, and have the further disadvantage of interrupting the course of production. Does speculation steady prices ? — It is arguable deduc- tively, but only on certain assumptions, that speculation steadies prices, whatever plausible measure of steadiness be taken. The proof runs as follows. A developed market is constituted of experts, of men who devote themselves to study- ing the foreshadowings of supply and the signs of change in demand. When an expert thinks price is going to rise he buys at once for future use ; and, as a result of his action, price does not rise so much in the future as it would have done otherwise, provided that the expert was right in his anticipation. When the expert thinks price is going to fall he limits his purchases as much as possible — that is to say, he holds up as much present demand for the future as he can — 122 OUTLINES OF POLITICAL ECONOMY and, as a result of his action, price does not fall so much in the futuie as it would have done otherwise, provided that the expert was right in his forecast. Now, the expert bases his decisions upon a study of the facts of demand and supply, after a long acquaintance with the facts. Consequently, he will more frequently be right than wrong, if he is a man of judg- ment. If he is not a man of judgment, and is more frequently wrong than right, he will dissipate his resources in time, ard voluntarily leave the market ultimately, or be driven from it by his losses. Hence, through a survival of the fittest, the majority of the experts on the market are likely to be men of judgment who study the market and are more frequently right than wrong. Hence their dealings tend to reduce the range of price variations and to reduce the average variation from the mean price. This deductive proof that speculation (which is aided, be it remembered, by futures on produce exchanges) tends to steady prices rests on two assumptions. The one assumption is that the dealers are experts with knowledge of market conditions. The other is that they do not tamper with the market. By " tampering with the market " is meant dealing with the deliberate intention of altering the level of prices for one's personal profit. The man who makes a great demonstration of selling so as to depress prices, in order that he may buy cheap ultimately, is tampering with the market. The man who " corners " a commodity, that is gets a dominant control over supply, so that by withholding his supply he can force up price, is tampering with the market. Tampering with the market unsteadies prices ; the speculator who tampers with the market aims at altering prices to benefit himself. Now it is known that the market is tampered with from time to time. And it is conceivable that this tampering may tend to unsteady prices more than other business in futures tends MARKETS AND COMMERCIAL FUNCTIONS 123 to steady them. I should conjecture, however, that under present conditions the steadying influences preponderate. Nevertheless, there appears to be no doubt that tampering with the market is commoner than it used to be. The cause is said to be the large scale organization of financiering which the past few years have witnessed, particularly in the United States. When a speculator, whether he is tampering with the market or not, acts in such a way that prices tend to be depressed, he is called, in the expressive slang of the market, a " bear " — a bear tears down with its claws. When his action tends to have the opposite effect he is called a " bull " — it is a matter of common knowledge that a bull tosses with its horns. Sometimes " Longs " and " Shorts " are used for "bulls" and "bears" respectively, because buyers have the produce " coming along " and sellers would be " short of it " after delivering. The deductive argument which proves that speculation steadies prices depends, not only on the supposition that the market is not tampered with, but also on the supposition that all the dealers are experts. But all the dealers on organized markets are not experts. The general public speculate in pro- duce futures as well as in stocks ; and, as the majority of these outside speculators cannot pretend to any expert know- ledge, they are not likely to be more frequently right than wrong in their shots at prevision. They are sheer gamblers ; and the gambler is just as likely to lose as to win. Moreover, as the outside public are peculiarly sensitive to rumours and are liable to react to extremes and yield to panic, the weight of the influence of the public on the market is now heavily on one side and now heavily on the other side. It is just as likely to make unduly low prices lower as higher ; and, if it makes them higher, it is just as likely to make them too high as to bring them to the right level. Speculation by the public is, consequently, a force which should extend the range of price 124 OUTLINES OF POLITICAL ECONOMY variations and increase their number. However, it is probable that this disturbing factor on a developed market is of small im- portance in comparison with the influence of dealing by experts. Marketing and the risks of anticipating. — Certain of the general ideas implicit in the foregoing may be brought out more fully while some further points of importance are indicated. Commercial functions, broadly conceived, are of two sorts. They consist in : — (1) The arranging of purchases and sales. (2) The undertaking of the risks incidental to producing in anticipation of demand. (1) We have already remarked that the first function would be non-existent in a thorough-going subsistence economy. Its purpose is to find the most appropriate buyers for sellers and sellers for buyers. We may think of a market as bounded by producers of an article on the one hand and consumers of it on the other. The producers are, say, Smith, Jones, and Brown, and the consumers are Johnson, Thompson, and Eobinson. The product, suppose, is pig iron. Johnson buys from Brown at, may be, 30s. a ton, while Smith is ready to sell at 29s. a ton though Johnson does not know it. The commercial man finds out this useful fact for Johnson, or for himself if he is a dealer and not merely an agent working on commission, and makes a profit out of the knowledge. But the bulk of the gain cannot be reaped by the commercial men, because, as we shall see on pages 150-1, by competing with one another, they are forced to transfer much of it to the community as a whole. So the commercial man insures that the buyer shall buy at the lowest price possible. He also insures that the seller shall sell at the highest price obtainable, since he equally prevents a commodity from selling at 28s. when it could realize 29s. Further, the commercial man creates value by insuring that each buyer shall get the articles produced by the firm which is turning out just that quality MARKETS AND COMMERCIAL FUNCTIONS 125 of the article which meets most exactly the buyer's require- ments. (2) The performance of the second function referred to above, namely anticipating, is unavoidable under any condi- tions. Even cave-men must frame estimates of their needs before they produce, and in framing their estimates they may make mistakes. Robinson Crusoe when alone could not en- gage in exchanging, but he could not flee the responsibility of anticipating. Eecent economic development, however, has meant the shifting of this responsibility from consumers to a large extent, and production now is almost always ahead of the consumers' expressed requirements. In a modern community we expect to find our wants foreseen. This is the age of the "ready-made" article. We may order our suits to measure, but we choose the cloth from stocks already ac- cumulated and paraded for our inspection. Now guessing, however scientifically, at the future wants of a community is hazardous because change in fashion is not exclusively prescribed by shopkeepers, and incomes have their ups and downs, and the relative quantities demanded of different things depend upon their relative costs which alter from time to time. Upon the distribution of the risks incidental to anticipating demand under various conditions, a ponderous treatise might be penned. Now it must suffice to point out that with progress they have apparently tended increasingly to rest upon specialized commercial men. Distribution of the risks of anticipating. — -Let us take a particular case, by way of illustration, and consider the possible distribution of the risks involved in preparing a country's supply of cotton prints for the summer — remembering that we are tracing possibilities and not attempting to describe the custom of the trade in any particular place. We may begin with the wholesale provider in the home trade who does not produce. Such a house has to prepare its stock of prints for 126 OUTLINES OF POLITICAL ECONOMY the spring. It may get some guidance as to what will be wanted from the retailers, but most of the retailers will probably stock their shops by choosing from the stocks of the wholesale houses. Now, the manufacturers (that is weaving firms, which, we shall suppose for simplicity, do their own printing) may anticipate themselves to some extent, and the wholesale house may choose from their supplies and order what they want if it has not been produced. In this case, manufacturer and wholesaler share in the venture of prophesying about demand. Or the manufacturer may produce only on the order of the wholesale dealer. In this case, the hazard of antici- pating retailers' demand rests exclusively with the wholesale dealer. Generally speaking, it may be said that the latter system tends to be the rule in so far as wholesale dealers stand between manu- facturers and retailers. Nevertheless, in the latter case, the manufacturing business (that is, in our example, the weaving firm which prints) has not been freed from all risks, apart even from those connected with the cost of making up material. There are yet other risks left, namely those created by fluctuations in the price of material, that is, as re- gards our example, in the price of yarn, assuming that the manu- facturer does not spin his own yarn. Now, the weaver would naturally try to shift these back on to the spinner or forward on to the dealer. When the weaver is asked to quote for deliveries of particular cotton fabrics at intervals as they are needed, before quoting, he may try to get, and succeed in getting, quotations from spinners for the yarns that he needs, to be delivered as he needs them, and base his quotations upon these quotations of the spinners. Or the weaver might induce the wholesale dealer to give him the order on the understanding that prices should vary with certain market quotations of yarn ; and then buy yarn as he required it. The history of the risk may be followed up even beyond the spinner, if any of it is passed back to him. The spinner is speculat- ing if he quotes prices for future deliveries of yarn without knowing what his raw cotton is going to cost him. He might avoid speculat- ing by buying at once all the cotton that he needed to execute the order ; but, if the price of cotton were generally expected to fall, he would be ill-advised to do so. And if he did so, the community would lose, because the price of cotton when it was high would be raised MARKETS AND COMMERCIAL FUNCTIONS 127 still higher, and the range of variation in the price of raw cotton would be stretched out. Or, as there are futures in cotton in many cotton markets, the spinner might buy futures in cotton in quanti- ties and for periods to suit his orders for yarn. But to do this would not be to protect himself completely, because the price of futures, as has been explained on pages 117-8, varies with the price of some one grade of cotton which might not be the grade that he wanted. If the grade that he wanted rose in relation to this basis grade, against its special rise in price the spinner would not be insured. So, broadly speaking, we may say that futures provide him with a hedge against a general rise in the price of cotton, but not against a special rise in the price of the exact kind of cotton that he needs. However, the spinner could escape the whole of the risks which we have been analysing, if he could con- tract with some cotton broker to have delivered to him at stated periods stated quantities of the exact kind of cotton that he desired at a price fixed when the contract was made. In this way, the spinner would shift those of his risks connected with fluctuations in the price of material back on to the broker, as the weaver shifted his corresponding risks on to the spinner. The broker in turn could hedge against the bulk of the risks involved in his contract by buy- ing futures on the cotton market, or entering into some of the numerous future transactions which are there embarked upon. He might even make arrangements with other brokers by which he distributed all or some of the risk associated with the " points on or off," that is the risk that the particular grade of cotton that the spinner wanted might rise more than basis grade rose. We need not proceed further, and traGe the element of risk back to the grower of cotton. Of course, when production does not reach back to any market or markets in which futures are used, the shifting of some of the hazard involved in anticipating on to dealers in futures is not feasible ; but there are still dealers in the material to be reckoned with and the producers of it. Our particular case might have been rendered more complex 1 by the inclusion of arrangements for export. In the distribution of the risks involved in anticipating, ten- dencies to uniformity seem to be operative. But, naturally, in dif- ferent industries, under different conditions, different arrangements 128 OUTLINES OF POLITICAL ECONOMY must be expected to be established. We may, perhaps, venture cm two generalizations. The first, already suggested, is that these risks are increasingly settling on specialized commercial men. The second, which is more doubtful, is as follows. On the one hand, the risks of losing through making mistakes in anticipating the needs of consumers tend to be rolled, or shifted in bulk, on to whole- sale and retail dealers, since they are more likely to forecast de- mand correctly than manufacturers. On the other hand, the risks which are run when the future prices of raw material are guessed at (as they are likely to be when finished goods are ordered for delivery far ahead) are probably tending, on the whole, to be shifted back to the initial stage in the productive process, and, if possible, to dealers in the raw material, who are in a more favourable posi- tion than those who work up the raw material, or those who deal in the finished product, for forming correct judgments about future demand and supply in relation to it. But, to this second generaliza- tion, the exceptions are so numerous that it must be regarded as tentative and as having only a limited field of application. Differentiation of productive systems. — It will be an aid to our understanding of commercial functions in their relation to industrial ones to make some analysis of a complex productive process and suggest some ways of explaining how and why it sepa- rates into different businesses, and, when it does so, how its parts are held together ; though we shall be dealing with a group of facts animated by so many conflicting dispositions that it will be almost impossible to find our way to any definite conclusions having a moderate degree of universality. Let A and B be two industrial processes involved in transform- ing some material into finished goods — A and B being respectively, for instance, steel-making and boiler-making, or cotton-spinning and cotton-weaving, or timber-sawing and cabinet-making. Let small letters stand for the commercial work of buying and selling, and let brackets mark the boundaries of businesses. Then the following are examples of the types of business organization that are possible : — (a, A, B, 6) Ja), (A, B), (b) (a), (A, a'), (&' B), (b) (a), (A), (a\ b'), (B), (b) MARKETS AND COMMERCIAL FUNCTIONS 129 These are only examples. The reader will see that other com- binations are possible. To save space, these have not been added to the list. Illustrations drawn from the cotton industry will make plain what is meant. A and B stand respectively for cotton-spinning and cotton manufacturing (that is weaving). The letter " a '' means the commercial function of buying raw cotton, "b" means selling cotton fabric, "a"' means selling yarn, " V " means buying yarn. The formula (a, A, B, b) means that a single business takes responsibility for the purchase of its raw material (through a buyer, perhaps, who is a member or employee of the firm), assuming the risk of fluctua- tion in price ; both spins and wonves ; and sells direct, as it can, to retailers after it has produced. The formula (a), (A, B), (6), means that a wholesale house (6), which may engage in the home trade or foreign trade, places orders with the spinning and manufacturing firm (A, B) and that the latter arranges for its supplies of cotton, to meet its orders, through an independent cotton-broking firm (a) which takes the risk of fluctuation in the price of the cotton needed. In the next formula (a), (A, a'), (b 1 , B), (b) spinning and manu- facturing are represented as having separated into independent businesses. The spinning firm sells its yarn through its seller and the manufacturing firm buys its yam through its own buyer. Ac- cording to the next formula (a), (A), (a', 6'), (B), (6), an indepen- dent yarn agent (a', 6') has appeared through whom (A) disposes of its yarn and (B) buys its yarn. There would, of course, be many yarn agents and many spinners and so forth ; and the yarn agents might be simply agents (that is intermediaries taking no risks) or they might be dealers in yarns taking risks. It seldom happens that one type of organization alone triumphs in an industry. Usually several types will be found side by side. The conditions under which specialization by processes appears in an industry have already been noted, but without being analysed in detail. Apart from the economies of specialization, outstanding conditions, all of which need not be present, would seem to be (1) that the industry should be concentrated in a small locality, so that marketing at a common marketing centre wastes little time and cost of transport is not high ; (2) that it should be as easy for a manufacturer undertaking one of the later processes in the com- 9 130 OUTLINES OF POLITICAL ECONOMY plete chain of production to get satisfactory material by purchasing it as by producing it ; and (3) that the half -finished article turned out by one of the early processes should be used for many pur- poses. But the phenomena of industrial and commercial differ- entiation have been little explored. Integration sometimes takes place where one would expect further differentiation ; and one must remember that the possibility of collecting large groups of capital for its enterprises profoundly affects the form which an industry assumes. Whenever commercial functions tend to separate from the pro- ductive system, and be assumed by independent businesses, they do so largely because of the advantages of business specialism. One leading case from which this particular specializing tendency is ab- sent is that in which producers are turning out special products which they dispose of in private markets. By a " private market " is meant a group of customers who buy from a particular firm because they have formed the habit, or think that its goods yield the best value for the price. Articles which sell by the name or mark of their makers are selling in private markets. Most of the habitual buyers of these articles have become prejudiced in their favour and will not be satisfied with substitutes, though the sub- stitutes may be quite as good. Evidently a producer of such articles will not sell through brokers who are selling also for rival producers. On the contrary, he will try, through the agency of his own travel- lers, to seize and to hold as much of the market as he can. Busi- nesses which have to win their private markets naturally grow slower than others ordinarily, though they may attain ultimately a greater size. The sales of articles which can be easily classified on inspection are not much affected by the reputations of their makers. A firm producing such articles may, therefore, sell more satisfactorily and more economically through independent agents or dealers than through its own salesmen. It goes without saying that it is much more difficult to create a private market in producers' goods than in consumers' goods, because producers as a rule are more expert, more critical, and more alert to seize an advantage, than the ultimate consumers. Reactions of commercial organization on industrial organiza- MARKETS AND COMMERCIAL FUNCTIONS 131 tion. — A complete soientific analysis of commercial organization should trace its reactions upon industrial organization, but in this treatise only the most condensed summary of these reactions can be offered. Industrial specialization by process, we have already learnt, is dependent upon the possibility of creating satisfactory markets in between industrial processes. The existence of such markets is essential to the preservation of continuity of production, after an industrial process has differentiated into independent busi- nesses. Hence much industrial specialization of businesses, with bs vast economies, is dependent upon commercial organization. The separation of industrial functions from commercial functions also brings about larger industrial businesses (with their greater internal division of labour) by enabling the employer to concen- trate his attention on his industrial functions. Moreover, it brings about a closer correspondence between capacity and task in busi- ness. A producer of blankets for export, say, who had to buy his material and sell his blankets unaided by commercial experts, and carry all the risks of these commercial operations, might fail as a blanket-manufacturer, though he might be ideally efficient in per- forming the industrial part of his mixed offices. Another blanket- manufacturer whose factory was badly organized and managed might keep his firm going profitably by virtue solely of his talent as a man of commerce. When commercial functions split away from the industrial, the fittest to survive industrially tend to survive as heads of producing businesses, and the fittest to survive com- mercially tend to secure all the commercial work ; and the com- munity in consequence is made much the better off. The reactions of commercial organization on the form of industrial organization will be cursorily noticed in the next chapter. CHAPTEE XIII. TYPES OP PRODUCTIVE ORGANIZATION. In a single chapter on so intricate a subject, to deal ade- quately with which wide experience would be requisite, a few leading reflections must suffice. Agricultural systems. — In the organization of agriculture the simplest arrangement is for the cultivator to own the land which he cultivates. This plan has its recommendations : " give a man secure tenure of a rock and he will turn it into a garden, give him a nine years' lease of a garden and he will turn it into a desert". But the scheme has its drawbacks also : and both recommendations and drawbacks are relative to time, place, and circumstances. While peasant proprietor- ship insures as a rule that assiduous attention shall be paid to the land, it cannot insure that the land shall be treated in an enlightened fashion and with adequate capital. And, when it is not supplemented with some form of co-operation, a deplorable lack of economy in marketing, and in the dis- tribution of the produce, results. Moreover, under peasant proprietorship, there is a danger of excessive division of hold- ings ; while the abler peasants find it impossible to acquire all the land that they could manage, because of its cost to buy outright ; and many who are best qualified to cultivate the land may have no chance of getting any at all. Some of these disadvantages of peasant proprietorship may be mini- mized by associating with it a leasehold system. Further, in its effect on character and social life also, there may be 132 TYPES OF PBODUCTIVE ORGANIZATION 133 flaws in small-scale occupying ownership. Peasants with little estates of their own, with all their fine characteristics, are apt to be self-sufficient and parsimonious. The land may be made a fetish and everything may be sacrificed to it — affection, happiness, culture, and leisure. That the magic of property turns sand into gold, does not settle the question from the point of view of humanity. Metayage is a system intermediate between peasant pro- prietorship and the leasehold system. Under it farms are united in estates over which rights are exercised by persons whom we shall call landowners, though the land may not be theirs in the sense that they can do just as they like with it. Broadly understood, metayage exists in a variety of forms in many parts of the world, and in some of these forms it shades off into the leasehold system. Where it is found traditionally sanctioned by custom and unaffected by other systems of tenure, the landowner furnishes a portion, if not the whole, of the capital, and the character and extent of the cultivation is generally made a matter of arrangement between him and the cultivator. Though the liberty of the cultivator is restricted, and there may be a fear lest methods of farming should become stereotyped, the enterprise of the cultivator may actually be stimulated, and given opportunities, by a good landowner, whose intelligence will probably be more highly trained than that of the average peasant. As the landowner is a partner, he appropriates some of the produce as his re- muneration, his share being some agreed proportion of the whole. It has been objected to metayage that, as the land- owner takes a certain proportion of the produce, the culti- vator has less inducement to do his best, and, therefore, works the land less intensively. The second ploughing of a field, say, would add 10 bushels of wheat to the produce. If the cultivator received the whole of the ten bushels it might be just worth his while to plough the field a second time. But 134 OUTLINES OF POLITICAL ECONOMY if he received only a proportion of the result, say a half, the other half going to the landowner, it would not. This objection might be weighty were details as regards the work- ing of the holding not settled by arrangement between the landowner and the farmer ; but that it is not a serious ob- jection practically is evident from the fact that in America, which is not a backward country, it is common for the hiring- charge for land to be a proportion of the harvest. Other things being equal, it is obviously an advantage to have the burden of the payment made to the landlords by the culti- vators automatically reduced in bad years, as it is not when farms are leased at a fixed annual charge. Theoretically, under metayage, the size of the farm is readily adapted to the capacity of the cultivator, though actually tenacity of custom has curtailed adaptability in this respect. The leaseholder is left with a freer hand than the metayer, but he is seldom permitted to alter the character of his farm, for instance by breaking up pasture, without the consent of his landlord, and is naturally required to keep the state of the property up to a certain level. Whether the greater liberty which the leaseholder enjoys is a gain or a loss from the public point of view, or his own, depends upon the initiative, resourcefulness and knowledge, of the cultivators. Freedom to make endless mistakes and muddle into embarrassments is a doubtful boon. For the attainment of the most fruitful results from the leasehold system, it is essential that the lease should cover a period lengthy enough to make it worth the farmer's while to spend himself and his resources liberally upon the land. Further, arrangements for compensation for unexhausted improvements, that are equitable both to tenants and landowners, are almost equally essential to prevent the waste of time, land, and capital, which otherwise is unavoidable when a lease is drawing to a close and the farmer is chary about investing fresh capital in the land and is anxious to TYPES OF PRODUCTIVE ORGANIZATION 135 squeeze out of it every atom of value. But, even at its best, the leasehold plan is obviously unsuited to the remote dis- tricts of new countries, where farms have to be made out of rough land, unless the lease is an exceedingly long one. A large reward must be offered to persuade the cultivator to endure the toils and discomforts, and face the dangers and solitude of the pioneer. As regards the size of a farm, nothing need be added to the principles already laid down with reference to businesses generally. The size of a farm depends broadly, and should depend, on the nature of the farming (whether, for instance, it is arable, dairy, or fruit farming, or market gardening), and upon the ability of the cultivator ; though the fact that a farm must be equipped with a house and out-buildings limits the degree in which the division of an estate into separate ten- ancies can be modified, while custom and tradition — markedly in old countries — limit it as well. Private businesses and companies. — Among types of business management the firmest lines of demarcation sepa- rate private businesses, including partnerships, from the companies which are controlled by elected boards of directors. But all companies are cot essentially of the latter class. A business may be dominated by one man, or two or three men, though it has been clothed in the dress of a company in order to dissociate the owner's private property outside the business from liability in respect of business debts, provide for distri- bution of profits among persons who are not active in the business but have an interest in it, or get fresh capital easily, or for other reasons. The peculiar merits of the organization of production in private businesses are (1) that the man at the head of each business is continuously incited by his self-interest to secure efficiency and economy ; and (2) that any man who can find the capital can start any businoss that he likes and, conse- 136 OUTLINES OF POLITICAL ECONOMY quently, that new men keep pushing into the arena where the fittest (in a business sense) survive. These are substan- tial recommendations, only it happens that the second is strictly qualified in industries for a start in which the posses- sion of much capital is requisite, as few who would like to initiate a business are wealthy enough, and, of those who are, only a small proportion care to put so many eggs into one basket. Moreover, fitness to survive, in the business sense intended above, may unfortunately comprise a number of anti-social qualities. In the public company, deliberate selection largely takes the place of the kind of selection just described; and the choice of leaders must frequently be made on more or less slender evidence so that at the best it is a leap in the twilight. But is not the selection which takes place in a regime of private businesses equally a leap in the twilight ? We must grant that it is, but those who leap choose themselves ; and many choose themselves so that selection goes on continu- ously. A man thinks he has it in him to be an entrepreneur and he takes his chance. He may be right, and he might never have been singled out for the position by his fellows ; or he may be wrong, in which case his personal losses force him to dismiss himself. But the fact that he has the imagina- tion and independence of mind to be ambitious, faith in his powers of succeeding, the perseverance to force his way, and the courage to face the inevitable risks when he is prepared to take the final step, is the best augury possible that he is endowed with the right qualities for filling satisfactorily the position to which he aspires. Nevertheless, there is much to be said in favour of the public company. It can rapidly get control of a capital which is beyond the reach of most men in business on their own account ; and control over capital is a matter of predominant importance in certain trades. It may be conjectured, therefore, that public companies in these TYPES OF PRODUCTIVE ORGANIZATION 137 trades might be more enterprising and more efficient than private firms. Again, for risky businesses, it may be easiest to get capital from many people in small sums. Moreover, the public company can enlist at a moderate cost the aid of the best information and business judgment by electing upon its board of directors the men whose advice it would like to have. Mistakes will be made ; but for two directors who may be useless one may be of immense value. It may be true that the most successful employers in a particular trade cannot ordinarily be brought into a company which competes or intends to compete with them, but different sorts of business are strikingly similar in their broad underlying characteristics. It is notable that the policy of the public company, by reason of its constitution, may be different in type from that of the private business or private company. The salaried manager must frequently compromise more than the private employer because of the over-ruling judgment of his directors ; and the directors, too, must compromise when they differ among themselves. Policy has to be justified in the public company. There are advantages in this ; rashness gets nipped in the bud. But there are disadvantages also : there is divided responsibility; and a man who has acquired a. wonderful instinct of sound and original judgment may, nevertheless, prove incapable of analysing the reasons which led him to his conclusions, or of persuading others to share them. Under modern conditions, private businesses and public companies seem to have their respective spheres. When a moderate capital is adequate and constant attention to chang- ing detail is vital, when customers have to be won and are easily lost and changing fashions have to be met, the private business is likely to be the most efficient, for one reason, if for no other, that prompt decisions are necessary and manage- ment cannot be reduced to rule. But when great economies 138 OUTLINES OF POLITICAL ECONOMY can be reaped by large scale organization, or when manage- ment can be systematized, and urgency does not commonly prevent resolutions from being taken at leisure, the company organization is likely to achieve its best results, both absol- utely and relatively to those achieved by private businesses. One plausible generalization would seem to be that, other things being equal, an industry which is flanked by developed markets is more suitable for company organization than one which is not, because in the former commercial risks (see pp. 124-8) may be avoided. Such are the mutations in every productive field, that at one time in an industry the company may gain ground, and at another time the private business. Finally, two points require noting. The first is that it is one thing for a company to take over a thriving concern, which may make its profits out of an unvacillating private market, and another thing for a company to create a business. The second is that the company and the private business may be equally efficient in a given set of circumstances. The one triumphs in one way and the other in another way. Co-operation. — Broadly speaking, co-operation partakes of the company type of organization, but it has peculiar features of its own. Of co-operation there are many kinds. The title " distributive co-operation " is reserved for the cc-opera- tion which begins with an association of consumers. It relates primarily to the retailing of goods, but it has been extended backwards to production. After payment of all expenses (including interest on capital, which is remunerated at a fixed rate, and the cost of any social activities), the common principle is to divide the remainder, that is profits, among members in proportion to their purchases from the stores, a trifling charge being made for membership. Where distributive co-operation is highly developed, wholesale co- operative societies have been established which bear to the retail stores the same relations as the latter bear to their TYPES OF PRODUCTIVE ORGANIZATION 139 members. The retail stores are members of the wholesale, and draw from its profits shares which are proportional to their purchases from it. Wholesale societies purchase in the open market and also produce for themselves in their own factories some of the articles which they sell. Their produc- tion is not, however, to be called " productive co-operation," as that term is conventionally attached to a type of co-opera- tion which has yet to be sketched. But the principle of pro- ductive co-operation, with modifications, is applicable to these productive shops of the wholesale societies. It is applicable also to the work of distributing goods ; and actually a portion of the profits made by some stores are divided among their employees. Needless to say, profit-sharing may be, and has been, introduced into businesses other than co-operative (see p. 349). In the competitive struggle a co-operative store holds a strong position, because its membership furnishes it with a means of gauging the extent of its market over and above those at the disposal of a private shop, and also because the bulk of its market is a private one, as we have expressed it (see p. 130). Moreover, its members are anxious to do what they can to further the interests of the store, either for the sake of magnifying the profits in which they share or for general social reasons. Many co-operators will buy from their stores articles which are not exactly of the kind that they want rather than go elsewhere ; and, in some places, where co-operation is very powerful and the members of a store take great pride in it (and perhaps regard it as embody- ing an important social movement), the store actually sets the fashion. So a co-operative store largely escapes those losses which are incurred by private shops when customers' needs have been incorrectly anticipated. An obvious criticism of distributive co-operation is that, in the degree in which it relies upon the circumstances 140 OUTLINES OF POLITICAL ECONOMY favourable to its prosperity enumerated above, it tends to encourage inappropriateness in production, to suppress in- itiative in demand, and to prevent the displacement of the inefficient manager. The co-operator might contend, however, with some reason (1) that much of the variation in demand is purely capricious, and does no good to anybody, and causes waste, and (2) that inappropriate provision to meet the wants of consumers is prevented in so far as the members of a store are a closely knit social group the individuals in which meet together, for business purposes, recreation and social pleasures and duties, and are thus enabled to bring their in- fluence to bear upon the management of the store. Who, it has been pertinently asked, are most likely to understand what their customers really want, private shop-keepers who see their customers only over the counter, or the managers of co-operative stores who associate with their customers at social and educational gatherings ? Distributive co-operation has been recommended as an agency for thrift ; any higher prices charged in a co-operative store than in private shops being defended on the ground that the payment of some extra pence on weekly purchases is not felt, while the lump sum received on their withdrawal in the form of dividends is felt. Plainly, however, there is a danger to guard against here. The whole of the extra paid in higher prices may not be returned : some part may be lost in careless management. The principles of distributive co-op- eration have been partially applied in such businesses as the Army and Navy Stores and the Civil Service Stores in England. " Productive co-operation " refers strictly to the production undertaken by associated groups of workmen, who may act through an elected committee. It has met with only limited s'iccess. Securing capital has been a difficulty ; also securing capable managers. And not infrequently the inevitable limita- TYPES OF PRODUCTIVE ORGANIZATION 141 tion of the manager's authority has been a serious handicap. However, there are some flourishing co-operative businesses of the productive class. In trades where little capital is needed, and where efficiency depends largely on the application and care of the individual workman (so that in private businesses much supervision is essential), co-operative groups of well- selected men, imbued with the right spirit of mutual help for the accomplishment of a common purpose, may be expected to reap prosperity, and have indeed done so. "Labour co-partnership" means a fusion of some degree of productive co-operation with the ordinary business types. The employees are represented on the board of management and receive a share of the profits. We may express its character by saying that it implies both control-sharing and profit-sharing: a scheme which provides for profit-sharing only is not, properly speaking, labour co-partnership. Labour co-partnership has met with a larger measure of success than complete productive co-operation. Where it has been found advantageous — for instance where a business gains from hav- ing an individuality, to retain which it is important that the workmen employed should not be constantly changing and should do their best for the firm — it is said to produce both contentment and an interest in the business which has a high economic value. In very large businesses it is difficult to apply — and these are the concerns where profit-sharing has the least value, particularly when the labour-cost is low, — but in such businesses, it might be applicable, with modifica- tions, departmentally. People may unite for the attainment of limited ends by co- operation. Small producers are placed at a disadvantage in competing with large producers in certain respects in par- ticular, and in these respects they may combine so as to enjoy co-operatively the economies of large-scale operations. Thus, small farmers may own specialized agricultural machinery 142 OUTLINES OF POLITICAL ECONOMY jointly, and may buy seeds and manure jointly, and jointly arrange with railway companies for the carriage of their pro- duce. The co-operative dairy also seems to have removed a disability under which the small dairy-farmer was labouring. Co-operative credit consists in using the credit and resources of a group to meet the needs for capital of members of the group. The pooled credit of a group is naturally much greater than the aggregate of the individual credits in the group, because all become sureties for each ; and this holds to some extent even of tbe cases in which the liability of members is limited. Other advantages of co-operative credit are that providence is encouraged, and that the members of the co- operative groups informally see to it that loans are properly used, or are at once called in, and that bad debts are not contracted. Co-operative credit is provided through agencies known as agricultural banks, people's banks, or popular banks. They are also called Eaiffeisen banks (after their founder) in certain agricultural districts in Germany and else- where, or Schulze-Delitzsch banks (after their founder) in certain urban districts in Germany ; but many of the last have become large joint-stock organizations which retain little of their original character. Co-operation has bean extended even to house-owning. Co-partnership tenants' societies are associations through which the occupiers of houses on a given estate own the houses in common. Shares may be paid for in instalments, and if any one desires to leave the estate he can sell his share. The superiority of this arrangement over the owner- ship of just his own house by an occupier is twofold : that the risk of loss on a group of houses is less proportionally than the risk of loss on a single house, and that the estate may be laid out to suit the tastes of the occapiers. Classes of monopolies. — Monopolies may be classified into (1) natural, (2) social, (3) legal, and (4) voluntary. TYPES OB' PRODUCTIVE ORGANIZATION 143 Natural monopolies take their origin from the fact that the sources of some valuable natural products are strictly limited. Social monopolies arise out of the peculiar position of certain businesses in the social economy. Sometimes there is no room for more than one business, or a very few businesses, to provide a given service. It might not be possible for two railway lines connecting two small places close together to pay ; and, even if it were, two lines would be less economical than one line. Competing gas companies, again, cannot be permitted to lay their pipes in the same streets. Frequently the provision of public utilities which must be monopolized in a given district, like the furnishing of gas, is undertaken by public authorities ; and, if not, it is usually controlled (pp. 369-70). Among the so-called " social monopolies," we some- times find the commingling of monopoly and competition, and what is scarcely monopoly but rather a limitation of rivalry in such a degree that competition either is not, or is not likely to be, fully effective. There is competition between rival railways, but competition is not, as a rule, untrammelled in the provision of transportation as it is in the provision of boots. Legal monopolies are those oreated by law. Patents and copyrights are the most obvious examples. The justification of these, when they are conferred on inventors and authors, is indicated on page 372. Some social monopolies also enjoy legal support : a railway company, for instance, must usually get authority from the State to build a line, because it may have to acquire some of its land by compulsory pur- chase, and it might be objected to as a nuisance or danger by certain people. Voluntary monopolies may arise (a) from the absorption by one business of other businesses, or the economic destruction of rivals, or (b) from the purchase of competing businesses, or from more or less voluntary agreements. The first method 141 OUTLINES OF POLITICAL ECONOMY is practically impossible if there are many businesses. Among industrial combinations we may broadly contrast (1) those which leave an appreciable part of the individuality of the combining units untouched, and (2) those which destroy it. Commonly, the former are termed " kartels " and the latter " trusts ". Trusts and kartels. — The formation of a trust — by which we understand here the complete merging of several businesses in one big business, whicb, however, may have its constituent works widely scattered — i3 a colossal task, beside which the establishment of a loose combination to maintain prices is insignificant. For the creation of a trust, therefore, any cut-throat competition caused by bad trade is seldom suffi- cient. Commonly it is traceable to the expectation of (a) big economies from large-scale organization, or (b) big profits from the addition of a large volume of capital to that already invested in the industry, or (c) a substantial monopoly revenue from the strict regulation of output or discrimina- tive prices. Further, the conditions are not unfavourable for the formation of a trust if the industry is of such a kind that its efficiency is not appreciably impaired by centralized man- agement. Even when the gains aimed at are chiefly derived from the regulation of prices, the trust may be preferred to the kartel because all control in the former is unified. Immediate gains may be reaped from centralized manage- ment on both the industrial and commercial sides of a business. On the industrial side economies are speedily effected by shut- ting down antiquated or badly situated works, or by enlarging others and adding thereby to internal specialization, or by specializing the several works. The same improvements might be brought about eventually under competition, but only in a far-away future. On the commercial side, the trust, as the kartel which has a central sales association, corrects the overlapping of arrangements for selling. In TYPES OF PRODUCTIVE ORGANIZATION 145 short, it suppresses all commercial functions which have as their object the expansion of the sales of a particular firm rather than the enlargement of the market as a whole. The trust may concentrate on a policy of evoking demand, which it k of doubtful value for any one firm to attempt under competi- tion, because rivals would share in the profits if the attempt succeeded ; and the kartel may make this its policy also, but it may be restrained by the difficulty of persuading its con- stituents to put money into the venture. Nevertheless, gain on the commercial side is not the invariable rule : a combi- nation is apt to flag when marketing is complicated and re- quires unremitting attention to detail — because of incessant alterations in fashion — and continuous and minute acquaint- ance with the by-ways of the market. As the trust has a more laboured birth, so it has a more stable existence than the kartel. Very strong forces are needed to overthrow it, when it is firmly established and not unsuccessful. But it does not follow that, once set up, it is bound to be permanent. It is so recent as a commonplace eco- nomic phenomenon that there is no inductive ground for esti- mating how permanent it is likely to be ; but deductively we may speculate as follows. Leadership in the trust may tend to lose its first enthusiasm and alertness. The removal of com- petition may make way for indolence, or at least a self-satisfied conservativism. Moreover, in the absence of the struggle for existence among organizers in the industrial field which the trust has conquered, the survival of the fittest will hardly operate with thoroughness. The level of capacity of the trust's leaders and managers may, therefore, tend to decline in time : at first its leaders would have been drawn from those who had demonstrated their fitness by rising to the top under competition. Apart from this handicap in the matter of organization, it is possible that the character of the fixed capital managed by 10 146 OUTLINES OF POLITICAL ECONOMY a trust might not keep pace with invention. Under competi- tion in a growing industry, new businesses, fitted with the latest appliances, compel the renewal of the old-fashioned plant against which they compete and thrust fresh ideas upon inert employers. A monopoly might find that it paid best to persevere with its old machines, even if it possessed the insight to realize the economy of new inventions. In this event, a growing divergence between actual and possible costs of production would be witnessed, and, after a time, such a divergence should be sufficient to draw the attention of business enterprise to the industry. Competition might then appear on a small scale. Energetic and resourceful capitalists would be anxious to engage in the industry. In these cir- cumstances the trust, if devitalized and no longer exercising its original fascination over shareholders, would tend to disintegrate ; but in its disintegration the industry would not be destroyed to give place to a new one. The control of the old would pass into many hands at the market price of its shares, and the industry would then undergo reconstruction. Generation and stability of trusts and kartels. — The simplest form of combination is an agreement among producers to regulate prices. If the object is merely to introduce discriminative prices, there is no reason why the combination should not stop at price regulation. If, however, the object is to get larger profits than those reaped under competition, reactions are to be expected which necessitate the assumption of some control by the combination of the supplies to be placed on the market. Production would be apt to outstrip the sales possible at the agreed prices. Hence stocks would tend to accumulate ; and the growing stocks would alarm the manufacturers and undermine their determination to keep prices up. Moreover, if there were doubt about the stability of the agreement as to prices, individual producers would be unwilling to cut down their output appreciably : they would be fearful lest others should not follow suit, and should snatch an ad- vantage were the compact repudiated. Hence, the regulation of TYPES OV PRODUCTIVE ORGANIZATION 147 prices frequently involves, or brings about, the control of sales or output. Control of the latter takes the form of assigning particular markets to particular firms, which is only possible in very excep- tional cases, or apportioning a certain output to eaqh of the several combined firms. Hence one disadvantage of the kartel is that, though it may purport to leave production free, it frequently im- poses rules which seriously restrict the growth of the firms with the greatest vitality. In order to remove this objection, the transfer of the whole or a part of a firm's authorized output, or as- signed market, may be sanctioned. But these transfers, even when freely permitted, do not take place to the extent to which business would naturally pass from one firm to another under free competition. Transfers must be bought, but business which one firm captures from another under competition it gets for nothing. Consequently the kartel has the disadvantage of favouring decaying firms more than growing firms. But one merit which the kartel has over the trutt is that it allows of individual initiative in the management of production ; though, as we have seen, initiative is at the same time discouraged, because its fruits are limited by the protection of the weak firms against the strong. A kartel is easily formed, because no vast financial operations are required to bring it into being ; and it is as easily dissolved, because its dissolution does not necessitate any industrial rearrangements. At most, when it dissolves, selling functions have to pass from a central office to the separate businesses ; and the capital embarked in a central sales association is not relatively considerable. There is some ground for the generalization that kartels, particularly those which have not discriminative prices in view, are more likely to appear in times of depression than in times of prosperity. When trade is bad, competition among sellers is keen and prices are driven down ; and producers may try to escape from this "cut-throat" competition by agreeing to offer their goods unitedly or not to sell below a certain price. What, it may be asked, do they gain from this action 1 The answer is (as the theory of monopoly price to be expounded makes plain), the power to select a price, which, with the sales possible at that price, may be more remunerative to them than the price and out- put which would be reached under the play of competition. When 10* 148 OUTLINES OF POLITICAL ECONOMY trade recovers, the inducement to combine on the part of the stronger firms is weakened, or removed. Its place may even be taken by a strong incentive to shake themselves free from the fetters on their enterprise. A widening market is the opportunity for the pushing and alert. In brink times the most strenuous firms will probably chafe at, and possibly break through, the regu- lations of the kartel which directly limit the output, or the market- ing sphere, of each of its constituent businesses. As regards the generation of trusts, there are two chief sets of circumstances in which the condition marked (b) on page 144: — that is the prospects of large profits from large fresh investments — may appear. The one set is found — to state it in an extreme form — when establishing the industry on a much larger scale would so appreciably lower the cost of production that the commodity would come in touch with a new ran'^o of demands which are highly elastic. The other is found when the industry is passing through something of a revolution, in the matter of productive methods, which wil] prove very costly. As regards the second case, under competi- tion the revolution might take very many years to complete itself, and its expense would retard its consummation. A company with enormous resources could carry the revolution through rapidly ; and by doing so it might make prodigious profits. As regards the first case, there is no assurance that competition will bring about a refounding of the industry on a new scale in a reasonable time, if it will at all. It is presupposed that the industry is at a position of equilibrium, but that actually another position of equilibrium exists for a much larger output. It is presupposed, further, that the distant position of monopoly equilibrium is the more advant- ageous for the monopolist, though it may yield a smaller rate per cent on capital. Evidently, a deliberately planned campaign on a magnificent scale may be needed if this second position is to be seized. BOOK IV. EXCHANGE OE THE EQUILIBEIUM BETWEEN DEMAND AND SUPPLY. CHAPTEE XIV. COMPETITION, BARTER, AND THE PRICE OF NON- REPRODUCIBLE THINGS. The economics of exchange is commonly taken to consist essentially in the theories of rates ind quantities of exchange in the home and foreign trade. The theory of rates of ex- change is known as the theory of barter when no money is used. When money is used, it is known as the theory of price, in its relation to the home trade, and the theory of international values, in its relation to foreign trade. We shall see as we proceed that there is a close analogy between all these theories, and particularly between the theory of barter and the theory of international values. The complete theory of rates of exchange is sometimes called " the theory of value ". But it is best not to give it this title, because by some writers the theory of value is con- ceived as covering also the branch of economics known as distribution, that is the economics of the sharing of wealth. We shall observe in due course that there is not only an in- timate connexion, but also an underlying identity, between the theory of exchange and the theory of distribution. In this chapter we shall inquire into the essentials of the li3 150 OUTLINES OF POLITICAL ECONOMY theory of barter ; but competition must be defined first. Com- petition has frequently been referred to already, but so far the reader's general notion of what is meant by it has been relied upon. This seems as suitable a place as any to fix our ideas about it, as competition dominates most of the exchanging done in the world. Competition. — There is economic competition (a) when would-be buyers bid against one another and (b) when would- be sellers bid against one another. The act of bidding is to be conceived broadly, and all factors in production, as well as other things, are to be regarded as objects of purchase and sale for the purpose of this definition. Thus competition may be one-sided or two-sided. As one-sided, it is competition be- tween buyers or competition between sellers ; and, as two- sided, it implies both. When competition is defined in this way, we realize im- mediately that it does not imply selfishness any more than demand does. The purchaser of a picture may want it to give to somebody else. One person may compete against another for a position because he covets it, not for the sake of money, of which he may have as much as he wants, nor for the sake of power, for which he may not care, but in order that he may play the part which rightly or wrongly he esteems himself fitted to play. As things are, admittedly, such a man maybe a rarity; but in most of us mixed motives prevail. People choose their work with some feeling of its value in the world, and perhaps with a half-heroic intention of making it more valuable, but at the same time they look forward to advancing their material interests — which include the interests of families and possibly of friends. With the value of com- petition and the degree in which it needs control we shall deal in Book VII. Under competition one price only tends to be charged for the same commodity at the same time and place. This COMPETITION' AXD BARTER 151 can easily be proved. If three grocers, Erown, Jones, and Robinson, are trying to sell in a district a certain kind of tea, Brown at 2s. a pound, Jones a: 2s. 6d- a pound, and Robinson at 2s. Sd. a pound, anl J Bro^vn could supply all the tea needed, all consumers who knew of the fact would buy of Brown, and if the fact were fully known Jones and Robinson would sell no tea. In order to sell any tea, Jones and R; :n- son vrc-.il I have to drop their price to 2s. Because of the competition of Brown, neither could extort more than 2s. a potmd from anybody, even were his desire so intense that r;:her that, abandon tea he would buy a certain arnount at is. a pound. If Brown could not supply all the tea needed, nor Bi-own and Jones together, and Robinson vrsuld no:, or could no:, sell for less than 2s. 3d. a pound, tea would seL finally at 2s. 3d. a pound. The public would first flock to Brown's shop, and by compe:ing with one another would force the price up to 2s. 6d. When the price rose to 2s. Cd. they would shop in- differently at Brown's and Jones's, but, as the supply of tea would still be insufficient, they would compete with one an- other and force the price up until it rose to 2s. 8d. and Robinson's supply came into the market. Hence, under competition one price must rule in a market for one commodity, whatever the height of the initial demands of the consumers and whatever the differences between the prices at which sellers are willing to sell if need be. iXobody would insist on selling at the lower price when he was offered the higher price — that is ordinarily. "What is true of tea in the above example is true of everything else when com- petition rules ; and it remains true when there is no money to exxress prices in and they are consequently quoted in terms of otner things. The theory of barter. — Very few words are needed to ex- plain this theory, and it can be explained most convincingly with the aid of an example. Take the case of two savages 152 OUTLINES OF POLITICAL ECONOMY one of -whom possesses a store of apples and the other a store of nuts. Call the one with apples A and the one with nuts N. If the fact is that the fraction which may be written the initial utility of nuts to A the marginal utility of his apples to A is greater than the fraction the marginal utility of his nuts to N the initial utility of apples to N exchange will begin. Thus if A would give one apple for ten nuts rather than have no nuts (which means that the initial utility of a nut to A is J^ of the marginal utility of his apples), and N would give forty nuts for an apple rather than have no apple (which means that the marginal utility of his nuts to N is Jj. of the initial utility of apples to him), both would gain from effecting an exchange. Exchange will continue until the ratio between the marginal utility of apples and the marginal utility of nuts is the same for A and IS . Up to this point, exchanges can be arranged which are beneficial to both, but after this point is reached further exchange would inflict loss on one or both of them. These conclusions follow from the law of substitution, in- difference, or equi-marginal returns, in its application to two persons who can effect substitution through barter only. It is of interest to observe that the final rate of exchange is indeterminate, if we suppose that equilibrium is reached by means of a number of separate exchanges which may be effected at different rates. If A got the best of the bargain in each exchange as a rule, the final rate of exchange would be more favourable to A than it would be if N got the best of the bargain as a rule. In the former case, the final rate of exchange would be a higher price of apples in nuts than in the latter case. It is also of interest to note that, just as the final rate of exchange is indeterminate when the distribution of the advantage resulting from each exchange in a number COMPETITION AND BARTER 153 of exchanges varies, so are the quantities of apples and nuts which would have changed hands when the exchange was complete. Fewer apples and more nuts would have changed hands if A got the best of the bargains on the whole than if N did. Suppose now that there are many savages with apples and many with nuts, and that each savage goes about from one person to another trying to get the most favourable rate of exchange— in short, suppose there is competition. In this event it would not be so easy for anybody to get much the best of the bargain in his transactions, and the range of final rates of exchange would consequently be reduced. The more complete competition became, the more would this be the case. If competition became absolutely perfect — as it could not actually — the higgling of the market would bring about a single rate of exchange at which all would trade, and it would be found that there was only one rate which would produce equilibrium. It would be such that the ratio between the marginal utility of apples and the marginal utility of nuts would be identical to all, after each had exchanged as much as he liked at that ratio. The theory of barter looks more tangled when we suppose that the parties to the barter can by working acquire more of ■the things which they are offering for exchange. When we suppose this, we have to allow for a balancing between the marginal dissatisfaction involved in working and the marginal satisfaction got out of its proceeds after barter has taken place. And yet more complexities appear when we admit that each person can work at producing different things, either apples or nuts, or some of each, or other things. Into these com- plications we need not enter, because, of the principles to be applied in allowing for them, sufficient will be learnt from the treatment which follows of price determination when goods are produced by free agents. As most of us give up the 154 OUTLINES OF POLITICAL ECONOMY practice of barter before we leave school, it might be thought that analysing it here is wilfully to bewilder the student. But this is not so. Apart from explaining equilibria in barter, the theory lies at the foundation of some of the most difficult problems of distribution and international exchange. Diagrammatic treatment of barter.— In fig. 7 measure quantities of nuts along OX and quantities of apples along OY. Suppose that the bartering has to be effected at one rate of ex Y Fig. 7. change only and that A and B begin by tabulating their offers at' different rates of exchange. Let the heights above 05 of points on the curve OA indicate the quantities of apples that A would give for the different quantities of nuts measured along OS ; and, similarly, let the distances between OY and the curve OB indicate the quantities of nuts that B would give for different quantities of apples . The final position of equilibrium is given by the intersec- tion of the curves. Oh of nuts will be paid for 0 i and D 2 are the demand prices for Q. Let S be the supply curve for the com- binations of P and Q. Then Oa units of P and Oa units of Q will be produced and the price of P will be ab and the price of Q will be be. Of course, Oa does not necessarily mean the same amount when it refers to P as when it refers to Q, since in fig. 11 the ratio, between a unit of P and a unit of Q is the ratio in which P and Q ire jointly produced. CHAPTEE XVH. THE SHORT PERIOD AND SUB-NORMAL PRICE. We considered in detail at the beginning of Chapter XV what is denoted by the expression " long period ". It is a technical expression with a definite meaning. " Short period " is another technical expression which is tending to get a definite meaning. In studying the operation of causes in economics, we have to distinguish between (1) instantaneous effects, (2) effects in the short period, and (3) effects in the long period. The short period. — Broadly speaking, short-period results mean the results that are met with — or would be in the ab- sence of fresh independent change — when we disregard con- sequences which are not appreciable until after a long interval. This statement will do for general purposes, but it is too vague to handle scientifically. To make the conception of the short period precise, we must deal separately with de- mand and supply. Applying it first to the circumstances of supply, short-period results may be described as the results that can be attained with existing factors in production as they were at the time of the change which necessitated their re-arrangement. We may think of the factors in production as classes of pro- ducing power each of which is capable of being crystallized into various forms. Men may become skilled colliers, or skilled bricklayers ; a piece of land may become pasture, or an orchard ; a ton of pig-iron may become a boiler, or type- writers. Some crystallized factors may be de-crystallized and 176 THE SHORT PERIOD AND SUB-NORMAL PRICE 177 then re-crystallized into new forms at different degrees of loss and with different degrees of rapidity. Other crystallized factors cannot be given new forms at all. A highly skilled jeweller cannot easily turn to another occupation, but a linen- weaver can easily become a skilled cotton-weaver. An auto- matic shell-machine can shape only shells for guns, but the aid of the same sewing-machine may be enlisted to make either blouses or pillow-cases. Side by side with the crystal- lized factors, there is the new producing power — the rising generation, the season's cotton and the ore just being dug out — about the final form of which we may exercise boundless choice. Short-period supply prices mean marginal supply prices after such modifications as do not take a long time have been made in the relative supplies of things, with the existing factors, crystallized or not, just as they are. Sup- pose there is a sudden increase in the demand for crepe. The short-period supply-prices would be the marginal costs when supply was increased by different amounts with the existing factors in production available just as they were ; or, as we may put it with approximate correctness, before there was a sufficient interval of time for more specialized machinery to be made, more factories to be built, and more labour to become skilled in the cripe industry. This conception of the short period in relation to supply is now generally accepted by economists, but there is less agree- ment about the application of the idea to demand. Probably short-period effects on demand are best understood to mean such partial readjustments of systems of demand as would take place, when readjustments were necessary, before the ingrained habits of people changed and before experience had fully taught how systems of consumption should be remodelled. The reminder may not be superfluous that a system of cod sumption may express the wants of a business for productive purposes as well as a person's needs for consumer's goods 12 . 178 OUTLINES OF POLITICAL ECONOMY It will be realized that short-period positions of equilibrium may not be perfectly attainable in fact, though they are more closely attainable than long-period positions of equilibrium. Sab-normal prices. — The prices reached at short-period positions of equilibrium are known technically as sub-normal prices. These we proceed to investigate on the side of supply. Increased outputs in the short period are obtainable only at enhanced costs of production. This will be evident when it is remembered that the additional outputs can be procured only by working uneconomical hours, or at uneconomical speeds, or with unskilled labour, or with antiquated machinery, and, possibly, in over-crowded workshops, or in workshops suddenly brought into requisition which are not well adapted to the work done in them, and possibly with material not up to the average of that ordinarily used in respect of suitability. Hence the effect of increased demand must be a rise of price in the short period. In order to understand the theory of sub-normal equilibrium when demand drops, it is necessary to distinguish between prime costs and supplementary costs. The prime costs of, say, a particular chair are the specific costs incurred on behalf of that particular chair and of no other chair, apart from the general costs of maintaining the factory in which it was made. More precisely, we may say that the prime costs of a business are the costs which cease when the business stops for a short time. Interest charges on the plant, much depreciation, rent of premises, and salaries continue ; but cost of material, coals and lighting, and weekly wages cease for the time being. These costs which cease are the prime costs. The costs which continue are the supplementary costs. Armed with this distinction we now ask, What is the effect on price of a collapse of demand in the short period, when demand is not expected to react back after a brief interval to a position above its original level ? The answer is, a fall in THE SHORT PERIOD AND SUB-NORMAL PRICE 179 price. The reason is as follows. Producers can only prevent a fall in price by curtailing the supplies offered for sale, and perhaps to a large extent. Curtailing the supplies offered for sale involves piling up stocks, when it is possible, or reducing output. But piling up stocks may be futile and must be costly, because they have to be disposed of at some time and, at any rate, capital is locked up in them so long as they remain. Consequently, it will usually pay to suffer some loss through a fall in price rather than be burdened with heavy stocks. And, as regards reducing output, this is a wasteful proceeding since the full supplementary costs continue whatever the output. So, it is usually the wisest policy to suffer some loss, through a fall in price, with a view to keeping down this waste. Besides, if a producer does not reduce price when demand collapses, other producers may secure his customers by doing so. Hence price almost always drops in the short period when demand temporarily shrinks. As a rule, also, when the shrinkage of demand is expected to be permanent, it must equally be the case that price will drop at first ; for, to contract output sufficiently to prevent a drop in price, means discarding fixed capital which is not yet worn out. Some features of sub-normal conditions. — It is worthy of remark that the effect on supply and price of a tem- porarily attenuated demand may be of several kinds, and that the effect actually experienced in any case is determined by the character of the industry. At the extremes it may take the form (a) of a large contraction of goods offered and a small fall in price, or (6) of a small contraction of goods offered and a large drop in price. A tendency to the latter effect is certainly created in any of the following circumstances, of which the first two relate to supply while the last relates to demand : — (i.) When the proportion of fixed or supplementary charges in the industry is high. 12* 180 OUTLINES OF POLITICAL ECONOMY (ii.) When the commodity is a perishable, so that the em- ployer oannot stock any of his produce. (iii.) When failure to satisfy present demand does not aug- ment future demand. Employers would be loath to satisfy a demand at a loss in the present if the same demand, or the bulk of it, could be satisfied at a profit in the future. Finally, attention may be drawn to the way in which an in- dustry gradually settles down to a new position of equilibrium after a permanent alteration in demand. Say demand in- creases. Then price leaps up suddenly, this being the immedi- ate effect. Next, price tends to subside, at first rapidly, but afterwards much more gradually, until at last the price of the new position of equilibrium is reached, which may be above, below, or the same as, the old price. The accommodations incidental to making the best use of existing factors take place much more rapidly than the accommodations which entail new specializations and the re-specializing of such old factors as can be re-speoialized. Both accommodations, of course, go on pari passu. But in the first few months long-period effects are inconsiderable, while after very many months short-period effects are inconsiderable. Gradually, extra sup- plies of good labour attracted to the industry are trained into first-class efficiency ; gradually their arrangement is im- proved ; and gradually more machinery and engines are built to meet adequately the new needs of the industry. The course of events consequent upon a reduced demand is analogous. A sudden drop in the price will tend to be fol- lowed by a rise, at first comparatively speedy and then more tardy, for reasons which the paragraph above will at once suggest. CHAPTEE XVIII. THEORY OF MONOPOLY PRICES. Fundamental ideas. — There is complete or partial mono- poly in the supply of a thing when there is absence, or unusual hindrance, of competition in the supply of that thing. The monopoly may be in the hands of an individual, but if the supply is large it is more likely to be in the hands of a group of people or a public authority. Hereafter, nevertheless, for convenience, I shall speak as if the monopolist were always a single person. The theory of price under conditions of monopoly will be expounded first on the assumption that monopoly is unrestricted, while throughout we shall be dealing with the long period unless a statement appears to the con- trary. Afterwards allowance will be made for the limitations of a monopolist's power. Determination of price in the absence of price dis- criminations. — We have seen that under competition things tend to sell at a price which only just covers marginal cost of production. This is so because if the price were higher, it would pay new producers to appear and old producers to turn out more ; and the increased supply would bring the price down again. Now, under conditions of monopoly, the forces whioh tend to bring price to the level of marginal cost of production do not operate. There is nothing to prevent the monopolist from getting more than normal remuneration if circumstances are favourable. Supply is under his control and he can raise price by restricting supply. He will do so, 181 182 OUTLINES OF POLITICAL ECONOMY if it pays him to do so ; and it will pay him to do so if his action results in his getting more than normal remuneration for himself. Let us call this excess gain for himself " mon- opoly gain or revenue ". Now, obviously the monopolist employer or company will aim at maximizing this " monopoly gain or revenue " which we define aa the excess over what normal remuneration (after deducting all expenses of production) would be under competi- tion. It is apparent, then, that the monopolist who is guided solely by self-interest will aim at furnishing a supply which is such that a slight increase or decrease of it would diminish his gain over and above what he would get under competition for the work that he does. Outputs which satisfy this condi- tion are said to mark positions of monopoly equilibrium. In any industry there may be more than one possible position of monopoly equilibrium, and the self-seeking man armed with a monopoly of metallic rigidity would naturally select the one which yielded the greatest monopoly gain, if he knew of its possibility. To illustrate, let us suppose that the facts, as regards cost and demand for the product of a monopoly business, are as represented in the table on the opposite page for all quantities of output for which aggregate receipts are not less than aggregate costs. What the em- ployer would earn under competition for the work that he does is reckoned in the costs of production stated. For the sake of argument we assume that variations of less than 100 tons in the output are impossible and that all the output must be sold. There are then two positions of mono- poly equilibrium, namely when the outputs are 1100 and 1300. Small departures from either of these outputs dim- inish monopoly revenue. As an output of 1100 yields the greatest gain, this is the output which the monopolist will ohoose if he knows, or strongly suspects, that the conditions represented in the table as appertaining to such an output THEORY OF MONOPOLY PRICES 183 exist potentially, so to speak, and could be made actual. With such an output price would be £10 18s. Aggregate Re- Output. Cost of Production per unit. Aggregate Cost. Demand Price. Aggregate Receipts. ceipts less Ag- gregate Costs. (Monopoly Revenue. ) Tons. £ s. £ £ s. £ £ 800 11 1 8,840 11 1 8,840 900 10 16 9,720 11 9,900 180 1000 1013 10,650 10 19 10,950 300 1100 10 8 11,440 10 18 11,990 550 1200 10 7 12,420 1011 12,660 240 1300 10 5 13,325 10 10 13,650 325 1400 10 4 14,280 10 6 14,420 140 1500 i 10 3 15,225 10 3 15,225 It might be, of course, that the creation of the monopoly lowered costs of production, and in thi3 case there would be another source of gain. But the theory expounded above clearly holds of this case also, if by costs of production are meant these costs under the monopoly. Only in this case we have to allow that some of the monopoly gain is derived from economies in production and is not extorted from con- sumers. One way of defining a position of monopoly equilibrium is to say that it is a position which is such (o) that the addition made to aggregate receipts by an incremental addition to the monopoly's out- put equals the addition made to aggregate costs (including normal remuneration of employing) and (6) that departures from it in either direction mean that the loss involved exceeds the gain involved. This should be immediately evident. If enlarging an output in- creases incomings more than outgoings, it must pay to enlarge the output. If the statement made in clause (6) does not hold of any given case, the position is not one of stable but of unstable mon- opoly equilibrium, since it would pay to enlarge or contract the output, as the case might be. 184 OUTLINES OF POLITICAL ECONOMY Price discriminations. — So far, we have argued on the assumption that only one price can be charged at any one time. Next we have to consider the less simple case in which more than one price can be charged. When more than one price is charged at the same time, (a) personal, (b) income, (c) trade, or (d) local discriminations or preferences must be created. "Discrimination" and "preference" are used here indifferently to mean the same thing. A personal discrimination is any discrimination which is not of class (b), (c), or (d). When its sole ground is econo- mic, it means charging one man more than another merely because he will pay the higher price if he must ; and it may pay to exact the higher price ffom him and others similarly placed. Personal discriminations are so violently resented, and have been so heatedly denounced, that no monopolist would openly attempt to impose them. Income discriminations are difficult to apply and are very uncommon. Usually in economic relations the income of the purchaser is not known. Discriminations roughly proportional to income may, however, be resorted to indirectly when differ- ent qualities of a thing are supplied, provided that the higher qualities are naturally, and almost exclusively, acquired by the wealthier classes. The extra prices charged for the higher qualities may be much higher than the excess of their cost over the cost of the lower qualities. Income discriminations are sometimes admitted with advantage into the principles of payment for semi-public services. Doctors' fees, for in- stance, are frequently charged on different scales for patients of different classes the demarcations between which are certain levels of income. Trade discriminations mean selling goods at different prices according to the trades to which they are sold. The term is not a very appropriate one, but it is as suitable as any other that could be found. It is seldom feasible to enforce trade THEORY OF MONOPOLY PRICES 185 discriminations, because usually it is easy to hide the ultimate destination of goods. Scales of railway freight charges may be regarded as exemplifying trade discriminations. What the railways sell is transportation, and, when it is needed for the delivery of goods, they sell it cheaper, for example, to coal- owners than to the manufacturers of pianos. Local discriminations exist when a thing is sold cheaper in one place than in another. Local discriminations in the same country in the charges for transportable things are limited by costs of carriage. If excessive internal local discriminations were introduced, businesses would naturally be founded to carry things from places where they were sold cheap to places where they were sold dear. As railway transportation is not itself transportable, local preferences in railway rates have been common. Local discriminations of an appreciable amount in the world's trade in transportable things are quite possible. A monopolist may sell abroad at any price which differs from the home price by cost of carriage between the foreign mar- ket and the home market, if the monopolist produces in a free trade country. And if he produces in a protectionist country, his foreign - price may fall below his home price by cost of carriage plus the amount of the tariff on the importa- tion of such goods as he produces. Were the foreign price to drop below this level, the goods would be sent back to earn a profit out of the high home price. Dumping. — When a complete or partial monopolist sells his goods at a lower price abroad than he does at home, he is said, in the slang of the market, to be " dumping,'' provided that the price charged abroad is less than the cost of pro- duction in the sense that, as the only price, it would not be sufficient to insure the continuance of the industry on its existing scale. Dumping is of three kinds : — 1. Dumping to win foreign markets. 186 OUTLINES OF POLITICAL ECONOMY 2. The dumping of surpluses. 3. The dumping of things deliberately produced to be dumped without regard to destroying foreign competi- tion. Dumping to capture foreign markets is a hazardous specula- tion. The intention of the monopolist who practises it is to sell very cheap until competitors have been driven out of the foreign market, and then to raise the price to recoup him- self for the losses incurred during the dumping and to make a profit. Naturally, when the price is raised the competitors may be attracted back again. If they are not, the country dumped into may lose heavily ; and, even if they are, there may be a serious balance of loss through the temporary wast- age of producing power and the new element of risk thus introduced into industry. It is evident that such dumping, if it comes to more than mere advertising, must be unecono- mical from the international point of view and may be highly damaging to the country whose markets are attacked. The dumping of surpluses is common, but genuine sur- pluses cannot be very large ordinarily. A " surplus " in this connexion denotes output over and above what the mono- polist would have produced (a) if he had correctly estimated demand and cost of production, or (b) if it had been easy to adapt his output to demand. Demand cannot be accurately anticipated, and the derangements caused by altering the out- put of a very large business may be expensive. Hence sur- pluses arise from time to time. It may be better for the monopolist that they should be sold abroad, even for some- thing less than their full cost of production, instead of being placed on the home market, as their absorption by the home market would depress the home price. But it would be difficult to prove that it would be better for any country to which they were sent, in view of the disturbing effects of such irregular supplies on industry, and in view of the fact that THEORY OF MONOPOLY PRICES 187 they need not be sold at muoh less than the price ruling for the time being in the country in question. Producing to dump continuously is another matter. It im- plies that it may pay the monopolist to make permanently such local price discriminations as the existence of distinct nations renders feasible, even if the lowest price is beneath cost of production, as defined in the first paragraph of this section (p. 185). Its possibility is discussed beneath. Observe that monopoly — in the form of speoifio agreements among pro- ducers at least — is requisite if any discriminative charges are to be adhered to. Competition would at once destroy them. Determination of prices when discriminations are pos- sible. — That preferential or discriminative charges will be made by monopolists when they can be made, follows at once from the fact that the monopolist can magnify his gain by making them. If the monopolist can deal separately with two or more groups of purchasers, he will try to sell to each group at such a price that his profits are maximized. It is ex- ceedingly unlikely that his gains will be maximized by sell- ing to each at the same price. And it is, in addition, so exceedingly unlikely as to be practically impossible that his output would be the same when he charged one price as when he charged more than one. In the latter case, his sales might exceed or fall short of his sales in the former case. The substitution of discriminative charges for a single mono- poly price, especially if it brought about larger sales, might prove beneficial on the whole to the community as well as to the monopolist. When discriminative charges are made, can it ever pay the monopolist to keep one of them continuously beneath cost of production ? — that is to say, to take a particular case, can it ever pay to dump abroad year after year beneath cost of pro- duction if foreign competition is not thereby destroyed ? It could never pay if by cost of production is meant the addi- 188 OUTLINES OF POLITICAL ECONOMY tion made to aggregate cost by the production of the things sold at the low price, when this addition is expressed per unit of the quantity dumped ; because this is to say that the cost of the venture is greater than its yield. But it might pay if by cost of production is meant the aggregate cost of the whole output expressed per unit of output. For enlarging the output would reduce this average cost of the whole if increasing returns ruled in the industry, and the seeming loss incurred over sales at the low price might be more than recouped by the saving on the cost of the things sold at a high price. For the same reason, in the case of a combination of firms, the low price might be beneath cost in the marginal firm and yet pay the combination. This is a significant corollary from the theory of monopoly prices ; and there is another corollary closely related to it which is of practical moment. It is that some enterprises which would never be remunerative if one price only were admissible could be rendered remunerative by preferential charges. We have an example in railway charges in certain places ; many a line would never pay if all goods had to be carried at the same rate, except for such additions as repre- sented reasonable compensations for extra difficulties in deal- ing with the goods. But it is essential that the enterprise should be subject to increasing returns ; or that its cost should be a fixed sum however much or little use was made of it, whioh means, broadly, increasing returns since, in this event, the later returns are got without any addition to the cost. The necessity of increasing returns is proved in the paragraph above ; for it is demonstrated there that it only pays to make any charge beneath cost of production (meaning aggregate costs expressed per unit of output or service) when increasing returns rule, and, if no single charge would be remunerative, it is obvious that one at least of the two or more preferential charges that make the enterprise THEORY OF MONOPOLY PRICES 189 pay must be below this cost of production and one at least above it One of the purposes of the State regulation of rail- way rates is to secure such a system of preferential charges as will magnify the use made of railways while adequately remunerating and encouraging railway enterprise. Monopoly price diagrammatically explained. — In figs. 12 and 13 let DD' and DJD'i be the demand curves respectively for two groups of purchasers P and Q of a monopolized article, wheth er they reside in the same country or not. For simplicity suppose that production is subject to constant returns, so that the cost of production (including normal employer's remuneration) expressed per unit of output is a constant. Let the cost of production be Oa, which equals Op. The monopolist will try to sell to each group of purchasers at such a price that his gains from that group of purchasers are a maximum. That is to say, he will try to sell to group P a quantity Og which is such that the rectangle at is the largest that can be introduced between aD, ah, and 6D ; and to sell to Q a quantity Ora which is such that the rectangle pk is the largest that can be introduced between pT> v ph, and hT>- L . It is ex- ceedingly unlikely that 0/ should equal Oj. The monopolist secures the greatest gains when he sells to P at a price 0/ and to Q at a price Oj. Under competition the price would be Oa. Evidently Og + Om may be greater or less than 6ales at a single monopoly price, and D/e + Djjk may be greater or less than the 190 OUTLINES OF POLITICAL ECONOMY consumers' surplus left when a single monopoly price is charged, according to the slopes of DD' and DjDV Figures can be constructed to show what may be expected when production is subject to increasing or decreasing returns, and the conditions under which some of the output may be sold at a price beneath cost of production, as defined in the section above. Restrictions experienced by monopolists. — It must be allowed, in qualification of what has been said above, that a monopolist has seldom a free hand to settle price. He must pay some regard to public opinion. Unpopularity might eventually cause a loss far greater than the profits which would be resigned on the monopolist's deciding not to embark on an unpopular course of action. More or less satisfactory substitutes for the monopolized article may be discovered if people are goaded into seeking them. Again, when competi- tion is not impossible, rival producers may be tempted into the field if the monopolist makes his gain per unit of output excessive. Finally, there is a greater ohance of interference by public authorities when monopolists totally disregard the public interest. Henoe, unpopular discriminations will usually be avoided by monopolists, and they will choose a large output (meaning a low price) if no very substantial addition would be made to monopoly profit by restriction of output. A monopolist's power is further curbed when consumers are allied. A compact union of consumers may force the monopolist to sacrifice a great part of his monopoly revenue. By combining, consumers establish what may be called a consumers' monopoly. When any service or commodity is consumed by one person or one firm only, there is monopoly of consumption, since competition is then absent on the side of demand. It is barely necessary to point out that a public author- ity which worked a monopoly would not be likely to aim at monopoly revenue, as above defined, even within the limita- THEORY OF MONOPOLY PRICES 191 tions just mentioned. If the industry, or service, which it monopolized were used by all classes, it would pay some regard to consumers' surplus (pp. 49-54). From demand and supply schedules (were they obtainable), it would be easy to work out theoretically what the price, or prices, should be on any understanding that so much monopoly revenue was to count as equal in advantage to so much consumers' surplus. CHAPTEE XIX. INTERNATIONAL TRADE. Differences between the theories of home and foreign exchange. — lb is emphatically not cost of transport which differentiates foreign trade from home trade. There is always cost of transport in the home trade, and the cost of transport in the home trade between Aberdeen and London is consider- ably greater than that in the foreign trade between Dover and Calais. The real reason why there is a theory of international values distinct from the theory of home values is that labour and capital flow much less readily between country and country than between different parts of the same country. It is because of the ready transference of labour and capital, in the long run, from industry to industry in any one country that things tend to exchange for one another in the home trade in proportion to their real costs of production. For in- stance, if the supply of any article produced at home is short, the article will realize a price above its cost of production. But then wages and profits in the industry in question will rise, and labour and capital will consequently be attracted, until profits and wages come down to the normal level again, and the thing sells for its cost of production when wages and profits (including interest on capital) are Dormal. It is be- cause flows of labour and capital are retarded internationally that things do not exchange in the foreign trade in proportion to their real costs of production. We must say "real costs" since, in the absence of tariff charges, things do exchange 192 INTERNATIONAL TRADE 193 internationally in proportion to their money costs ; but these money costs cover quite different real costs, owing to the different levels of earnings in different countries. To sum up, as regards the relations between the theory of home exchange and the theory of foreign exchange, we may say that the two have a common basis, but the former has to take account in addition of these flows of labour and capital. It is in con- sequence of these, as we have seen and will realize more fully later, that the first rates of exchange between commodities reached in the home trade are corrected until all the rates are roughly proportional to real costs. The theory of inter- national exchange, then, holds apart from cost of transport to markets ; and there are certain conveniences in disregarding this cost of transport in expounding the theory. But if it is thought a violent procedure to suppose that carriage to con- sumers costs nothing, we can simplify the problem equally well, without altering its character, by reckoning all costs of transport in cost of production. International immobility of labour and capital. — Workmen are unwilling to emigrate to foreign lands because they do not like to be severed from their fellow country-men, and few people can adapt themselves to the manners and customs of a foreign people, which are strange to them. The Englishman wants to remain an Englishman for reasons that are hard to express, and also because he finds it plea- santer to live under the social conditions which governed his upbringing and to which he has grown accustomed. Some races are much more adaptable than others, but, generally speaking, people cling to their national homes like limpets to rocks, whatever their race. Again, there are the difficulties of learning new languages, which act as further checks on the migrations of labour between places where different languages are spoken. It is true that many of these objections do not apply to emigrating to the colonies of one's own country ; and 13 194 OUTLINES OF POLITICAL ECONOMY that when a community has originated from another, as the United States has from England, so that there is some iden- tity of racial characteristics and a sharing in a common past, the two communities are not felt as foreign to one another in any very high degree ; but, nevertheless, among the great majority, there is a disinclination to leave home, though the number of Englishmen who go abroad out of a sheer spirit of adventure is absolutely large. Internationally, capital is not so immobile as labour, but it is comparatively immobile nevertheless. Many capitalists are unwilling to place their money where they cannot watch its use, and under laws and customs with which they are unfamiliar. But they do not feel the same about investing in foreign public funds. Consequently " international se- curities," which consist largely in public stock, and are so called because they have a world-wide reputation, play some part, though a small one, in the distribution of capital through- out the world's industries. They serve in a slight degree as international reservoirs of capital. Suppose that in Prance the yield of first-class industrial stock rises from 4 to 5 per cent while the yield of public stock keeps constant at 3-J- per cent. Then, it may be, little capital will be drawn into French industries from England, where we assume industrial interest to be less. But some money will come out of the French funds to enter the French industries ; the yield of the French funds will, therefore, be raised ; and English money will consequently flow into the French funds, and liberate more French money for investment in French industries. Indirectly, then, as well as directly to some extent, the in- dustries of a country are helped by international flows of capital ; and international flows of capital have been greatly encouraged between certain nations by improved credit, the spread of information, and increased travel. Permanent international trade starts when there are INTERNATIONAL TRADE 195 differences between comparative Yalues. — Broadly speak- ing, the existence of commerce between countries, the ratios of exchange between countries (that is international values), and the quantity of international business, are determined by the conditions which govern the comparative values of differ- ent things in each of the trading countries. Nations will not begin trading with one another to any ex- tent unless comparative values differ. This doctrine will not at once carry conviction, nor even compel understanding ; it will not be superfluous, therefore, to show its application to a single simplified case. We shall imagine that there are two nations only, namely England and Belgium ; that there are two commodities only, apart from gold which is used as money, namely wheat and blankets ; that capital and labour are internationally immobile ; that there is no cost of carriage ; that all production is subject to constant returns ; and that both countries have the same kind of money. Before inter- course is opened let this be the state of affairs : — England produces wheat at £1 a bushel. „ ,, blankets at £2 a bale. Belgium produces wheat at £5 a bushel. „ ,, blankets at £10 a bale. Now, if our doctrine be true, no enduring trade should result when intercourse is opened between England and Belgium, because the ratio of £1 to £2 is identical with that of £5 to £10. Trade will begin, but will soon come to an end. Con- sider in detail what happens. England clearly will export goods and import nothing but money (gold bullion). The level of prices will, therefore, rise in England and fall in Belgium (see Chapter XX). Finally blankets and wheat will cost respectively £3 and £6, say, in both Belgium and England. Then trade must cease, because neither Belgium nor England would gain thereafter from exporting either wheat or blankets. It is, therefore, demonstrated that if the ratios between the 13* 196 OUTLINES OF POLITICAL ECONOMY costs of production in any two lands are identical (that is if their comparative values are identical), enduring commerce between them of any magnitude is impossible, in the sense that nothing is to be gained from it. It is also demonstrated that a country does not necessarily export an article to another country if it can make the article with substantially less labour or less capital, other things being equal, in each case, than the other country. And we may go even further and infer that a country may be beaten in its home markets by goods from abroad which it can manufacture for itself at a lower real cost, incredible as it may appear. Eng- land might possess exceptional advantages for the manufac- ture of steel, with which Belgian facilities in the same respect could not compare, and yet English steel might be undersold in England by Belgian steel. This could happen because England might enjoy even greater relative advantages for the manufacture of cottons. These she would export to Belgium, and Belgium, having to pay in something, might find it most convenient to pay in steel. Next suppose that the initial state of affairs is different. Take it that these are the facts : — England produces wheat at £1 per unit. „ „ blankets at £1 ,, „ Belgium produces wheat at £5 ,, ,, ,, ,, blankets at £10 ,, ,, Then for a time, as before, Belgium imports both wheat and blankets. But the time comes, as a result of the pas- sage of money between Belgium and England, when wheat stands at £2, say, in both countries, blankets costing £2 in England and £4 in Belgium. Then the indifference point is reached as regards the export of wheat, though England's ex- port of blankets must increase ; and, presently, as the trans- ference of money continues, wheat will be costing more than £2 in England, but less than £2 in Belgium. Thereafter, INTERNATIONAL TRADE 19? in consequence, it pays Belgium to export wheat. Here at last are the conditions of enduring trade. Thus we dis- cover that enduring trade is set on foot by international differences between the ratios which the costs of production of commodities bear to one another. If any commodity traded in cannot be produced at all in one of the countries, we may say that its cost of production in that country is infinity. International Yalues. — We have learnt from these ex- amples when lasting commerce may be expected and when it may not, but we have not yet learnt what its amount will be, and what the rates of international exchange will be. The settlement of these matters is more difficult to understand, but it can be explained in a general way without the aid ot mathematical symbols. Let us confine our argument to the simple case in which there are two nations only, England and Belgium, and only two commodities, wheat and blankets, but let us remove the assumption that all production must be subject to constant returns. Then, looking at what tends to happen as trade goes on, we perceive that at the position of equilibrium com- parative values must be identical in the two countries. This follows from the proof already given that if comparative values differ, it will pay traders in either England or Belgium, or both, and cannot damage traders in either, to extend opera- tions, or contract them, until comparative values are the same in both countries. When the two countries begin to trade the relation between comparative costs in the two countries begins to alter, if the production of both commodities in both countries is not subject to constant costs ; for a country in- creases its output of what it exports and decreases its output of what it imports. An alteration in the relation between comparative costs, brought about by foreign trade, may of it- 6Glf be sufficient to cause eventual identity of comparative 198 OUTLINES OF POLITICAL ECONOMY values. If it is not, or if the production of both commodities in both places is subject to constant costs, the production of one commodity in one of the countries, say of wheat in Eng- land, will cease, after trade has reached a certain annual magnitude, and the value of wheat in England will then steadily fall as trade expands and England imports more and more of it. It, still, comparative values are not brought to identity, the production of blankets in Belgium will stop, Belgium's imports of blankets being such in amount that home manufacturers cannot profitably put any on the market. When this happens and commerce still expands, a position of equilibrium, in which the comparative values of wheat and blankets in England and Belgium are identical, must finally be reached. Complicate the imagery by admitting all the countries of the world instead of two only, by supposing that traders in each try to get on the lowest terms what their customers want, and by recognizing the multitudes of commodities with which our needs are satisfied and the conditions of their supply, and there is presented the intricate problem of international values as it actually is ; but the principles brought out in our simple hypothetical exposition above still apply. In this connexion, it is worth while noting how very seldom it happens that the production of anything is confined to one country alone. If England exports a commodity to Prance which is not pro- duced in France, it will usually happen that some third country, with which both England and France trade, will pro- duce it also. The cases of national monopoly are rare ; al- most always the exporter has to compete in the market of a foreign country with the home products of that country or with the products from a third country. Again, the introduc- tion of cost of carriage and import and export duties (com- monly called tariffs) makes ihe problem more involved but does not alter its character. To be quite exact, we must say INTERNATIONAL TRADE 199 that the values referred to are values after cost of carriage to consumers and tariffs, if there are any, have been allowed for. As regards the special case of foreign commerce known as " dumping," this has already been examined (pp. 185-8), and the reader is in a position to decide for himself the extent to which the principles of international trade here expounded apply to it. It is an interesting corollary from this demonstration that a people's foreign trade may decline in consequence of their economic advance, though it is not likely to do so. Thus, imagine a fictitious labour-capital unit which measures pro- ductive efficiency, and suppose the real costs of production in our two countries are as indicated below when there is no trade : — Belgium produces 1 blanket with 10 labour-capital units. „ ,, 2 bushels of wheat ,, „ ,, England produces 3 blankets „ ,, „ „ ,, 3 bushels of wheat „ ,, ., Then Belgium will export wheat to England and England will pay in blankets. Now suppose that industrial advance, mainly affecting agriculture, takes place in England, with the result that eight bushels of wheat can be grown with the ex- penditure of ten labour-capital units and four blankets can be manufactured at the same real cost. What will be the effect ? Clearly, Belgium's trade with England must entirely cease, as soon as industrial organization has accommodated itself to the new conditions. Yet England who has lost her commerce has really progressed. To sum up, as regards the place of comparative values in the theory of international trade, we see that comparative values initiate foreign commerce, govern its course, and de- termine its range ; for foreign trade (1) begin3 only when there are differences between comparative values, internation- ally, and (2) is brought to a position of equilibrium when 200 OUTLINES OF POLITICAL ECONOMY these differences are removed as a result of trade. The famous doctrine of comparative costs, or the doctrine of comparative values, as it may be called, to make it unambiguously cover im- portations by a country of things that it cannot produce, or must cease to produce, is sometimes interpreted widely as affirming both propositions (1) and (2) above but sometimes narrowly as affirming only the former. The balance of trade. — With the demonstration of the doctrine of comparative values, however, we have not com- pleted the theory of international exchange. For, obviously, the final arrangements must, in addition, be such that in- ternational obligations balance. This is sometimes expressed by saying that imports and exports must balance, but so expressed it is literally untrue. What is really meant is that, when every sort of service performed for payment is taken into account, imports and exports must approximately balance in any lengthy period such as a year, in so far as they do not represent gifts, loans, and interest on loans. Time is, of course, needed for the balance, so as to reduce the error caused by the inclusion of a purchase and the exclusion of payment for it. No proof is needed of the necessity of the balance referred to. It is self-evident that in the long run imports must pay and just pay for exports when all goods and services, apart from gifts, loans, and interest on loans, are included, if people do not fail to meet their current obliga- tions. For to say this is the same as saying that in the long run a person's expenditure must equal the value of the goods that he gets, apart from gifts, loans, and interest on loans, if he does not fail to pay his bills. But, naturally, the value of what a person buys or hires any one year need not equal the payments tha,t he makes in that year, because of the existence of credit. Under a strict system of cash on delivery there would, however, be exact correspondence at all times between receipts in goods and payments for them. Credit, we may INTERNATIONAL TRADE 201 appropriately regard in this simile as a loan made by shop- keepers to their customers. The loan is repaid when customers pay their bills. The omission of gifts, loans, and interest on loans is clearly essential, if imports and exports are to balance. Gifts, of course, are not paid for, and they come into a country for the relatives and friends of persons who are abroad. Most of the gifts may take the form of money, but the money is spent on goods, and the country which has sent the money must ultimately meet the obligations represented by the money and export goods of like value. Debts must be ex- cluded because they may not be repaid for many years, if they are repaid at all ; and interest must be excluded because it is a sort of hiring charge for what has been loaned and has to be paid till the loan is repaid. But, even when allowance is made for gifts, loans, and interest on loans, we must not, of course, expect correspond- ence in the long run between those imports and exports which officials can watch and record in statistics. To expect this would be as unreasonable as to expect correspondence be- tween a person's expenditure and the tangible things that are seen going into his house. In foreign intercourse there are officially unrecorded goods and services. The officially unrecorded goods and services provided for Frenchmen, say, by foreign countries are as follows : — (1) Unrecorded valuables which enter France by post. (2) The goods and services which are not directly imported but are provided for Frenchmen abroad. The balance of trade means the balance of economic obligations conferred by different nations, through their members, upon one another. The Frenchman on a visit to London is still a constituent part of the French nation. Again, there is the provisioning of French ships abroad. (3) Services done for France which are not recorded in 202 OUTLINES OF POLITICAL ECONOMY the statistics of things imported by France — for example, the sea-carriage done by English ships for French account, and any agency and financial work done in a foreign country for French account. We may notice, with reference to the large balance of imports in English trade, that England has enormous invest- ments abroad and that she earns a fortune annually for agency and financial work and shipping services. It has been argued that, apart from gifts, imports and ex- ports must balance because claims should be put into the balance sheet. Thus, if Francs makes a loan to Japan, France exports credit documents (money, broadly regarded, which was borrowed to be spent and becomes goods when it is spent) and receives in return bonds of equal value stating the amount of the debt. The bonds, it is said, should be included in French imports. And, when interest is paid on the loan, credit documents enter France (to become ultimately, as the loan became, merchandise or services) and discharges or receipts of equal value go out. These discharges or receipts, it is said, should be included in French exports. Whether this view is taken or not is a matter of indifference. The term " invisible imports and exports " is used to cover (1) all goods and services provided internationally which are not recorded in official trade returns, and sometimes in addi- tion (2) all credit documents, bonds, and claims which pass between countries. Invisible imports and exports are not designated "invisible" because they cannot be seen, but be- cause they are not recorded in official trade returns. Many of them can be seen and felt, even eaten or worn, as we have discerned. Effects of foreign loans on imports and exports. — A few words may be said here of the effects of foreign loans, to prove that we are right in regarding a loan made to a foreign Government, or a foreign business, as a loan of goods. The INTERNATIONAL TBADE 203 loan is first made in money, broadly regarded, but the money is borrowed to be spent. Suppose, as a simple illustrative case, that people in England invest £1,000,000 in Australian industries, thereby lending, as we may say, £1,000,000 to Australia. Then the level of prices will be raised in Australia, not to be restored to the normal level till the extra purchasing- power is lost by Australia, as it must be eventually to pay for the balance of imports brought about by the high level of prices. The additional imports may come from anywhere. But if they oome from any other country than England, that other country will be so placed with its extra means that it, too, attracts additional imports. Finally, the normal level of the world's prices is restored by an extra exportation of £1,000,000 of goods from England. Until this happens, England's exports are encouraged, while her imports are dis- couraged, by her low level of prices after loaning £1,000,000. In effect, then, England has lent Australia, directly or in- directly, £1,000,000 worth of goods. When the loan is re- paid, if it is ever repaid, it is repaid in goods, — not, of course, in the same goods, but in other goods of the same value. A similar portrayal of interest payments would reveal that they, too, are in effect payments in goods made directly or indirectly through the medium of money. The argument will become more convincing to the reader after he has studied the chapters on money which follow. The economic advantages of foreign trade are patent ; and so are the general social advantages which result as a rule from foreign intercourse. "What, if any, countervailing econ- omic or social disadvantages there may be, which call for State restraints on trade, we shall consider in Chapter XXX. Diagrammatic representation. — Those who seek more exact ideas should consider fig. 14, ignoring at first the dotted lines. Quantities of blankets are measured atons? OX and Quantities 204 OUTLINES OF POLITICAL EOONOMY of wheat along OY. Let the curve B represent England's offer of blankets to Belgium for wheat. Let the curve A represent Belgium's offer of wheat to England for blankets. The position of equilibrium is given by tho intersection of the curves. At the position of equilibrium England will export Oh of blankets to Belgium, and Belgium will export to England to pay for the blankets Og of wheat. The ratio of exchange between blankets and wheat in both England and Belgium will be given by the equation, Value of Og of wheat = value of Oh of blankets. X "^C / \. / Jk / / / \>A V / / /' / J? s a / / / / t / // it /^''' >^ " Fi g 14. YVa have, or course, ignored cost of transport, and all other countries, and all other commodities. In order to make plain what exactly each curve means, we must now examine the information which the point m on the curve B conveys. If at the position of equilibrium England is still producing some wheat as well as blankets, the point m means that when Eng- land has produced Oh of blankets, over and above what she needs for herself, and has produced what wheat she requires after import- ing Og of wheat, then marginal cost of production of wheat in England _ Oh marginal cost of production of blankets in England Og But if at the position of equilibrium England has ceased to pro- INTERNATIONAL TRADE 205 duce any wheat, the point m means that when England has pro- duced 07v of blankets, over and above what she needs for herself, and has imported 0 b > c > d. It is not possible to apply the principle of progression with such exactness as to realize equal proportional sacrifice, be- cause (1) utility varies with income differently for differ- 26 402 OUTLINES OF POLITICAL ECONOMY ent persons, and even for the same person at different times ; (2) the variations of utility with income oannot be accurately measured ; and (3) the degree of incidence on different per- sons of many fruitful taxes cannot be minutely traced. But this does not really matter as the basis of taxation is a mixed one and it certainly cannot be laid down that taxation yielding precise equality of proportional sacrifice is necessarily best. Of course, the important thing is that a taxing system as a whole should be properly progressive, and not that every tax in the system should be progressive. The words "degressive" and "regressive" have been ap- plied to taxation, and when they are used, "progressive" is given a special meaning. Progressive taxation then denotes taxation involving proportional sacrifice ; while degressive taxation means that large incomes are taxed at a higher rate than smaller incomes, but not in a degree which involves as great a proportional sacrifice for the former as for the latter ; and regressive taxation means taxing the smaller incomes at a higher rate than the larger incomes. Other principles of taxation. — Besides the principle of equity, other principles of taxation may be laid down. On these some comments are made below. The principle of economy, as it might be called, is a two- sided principle which declares that, other things being equal, taxes should be chosen (1) the cost of collection of which is small in proportion to the proceeds, and (2) the loss occasioned by which to the country is small in proportion to the proceeds. Taxes which are not very productive, and are such that a large army of inspectors must be kept actively at work to see that they are not evaded, offend against the first clause of this principle. Prom the second clause and the theory of the incidence of taxes on commodities, we may deduce that it is bad finance to impose a tax on the products of an industry which is strongly subject to increasing returns (pp. 420-1). PUBLIC FINANCE 403 Under this heading, we may also notice that taxes on luxuries may achieve miracles in the way of economy when oostliness enhances the degree in which they are prized. Diamonds would go out of fashion if their price dropped to twopence apiece, but an enormous tax on wearing them might conceiv- ably bring them into fashion again. Analogously the taxation of things the consumption of which beyond a certain point is detrimental is peculiarly economical — for example the taxa- tion of alcoholic beverages — because it discourages what is undesirable and at the same time raises revenue. But here a sort of principle of State responsibility for public morals is equally involved. The principle of convenience advises that, other things being equal, taxes should be so selected and arranged that the taxpayers are put to the minimum of inconvenience. Indirect taxes put the ultimate payers to no inconvenience, because the ultimate payers do not make a separate payment of the tax but pay it as a part of the price of the things taxed. It is an inconvenience to be constantly interviewed by an official, or to have to make complicated returns repeatedly ; and it is the more insufferable the smaller the sums at stake. Since trouble is a cost, the principle of convenience, as so far ex- pounded, may be regarded broadly as included in the principle of economy. But there are inconveniences of another order to avoid, if " inconvenience " be widely understood. In every country, according to the dispositions and prejudices of its inhabitants, certain acts on the part of tax-collectors would be resented as an infringement of the taxpayers' rights and privileges. For instance, people are apt to be offended by the prying of officials, even when they, the taxpayers, are perfectly honest. With feelings which are deeply and widely rooted, it would be unwise of Governments to collide. Noth- ing damages a Government more than an unpopular tax, when its unpopularity is imbedded in political instincts. 2G* 404 OUTLINES OF POLITICAL ECONOMY whether the latter be reasonable or not. But this is a matter of politics rather than of economics. To these principles is sometimes added what has been called the "principle of clearness," which affirms that people who have to make independent payment of taxes must be able to discover, and without difficulty, what they have to pay, when they have to pay, and why they have to pay. The time of payment must not be left for the collector to settle each year despotically. Moreover, no person must be assessed arbitrarily. Each person must be charged on principles, and be informed of the principles applied in determining what the amount due from him is. Also, the calculations involved in settling his obligations should be of a simple kind, so that he can verify them for himself. In addition, under the principle of clearness, it is some- times laid down that every person should know, or be easily able to ascertain, exactly how much he is paying directly and indirectly in taxes. This requirement, however, would seem to be impracticable, and it is by no means evident that it is desirable as things are. Always to know what you pay is always to feel what you pay. A perpetual chafing at fancied exactions of Government, and short-sighted penuriousness in matters of State expenditure, might result from giving prominence to the full burden of taxation in its incidence on individuals. The best of men are very human when they are paying taxes. On the other hand, a knowledge on the part of each taxpayer of exactly how much he was contributing, directly and indirectly, would be a check on any disposition of Government to tax disproportionately a section of the com- munity, and would insure effective criticism of Government extravagance. And certainly it is advisable that, as a rule, exceptional expenditure, for instance on war, should be ac- companied by an addition to the burden of taxation which is unmistakably felt. The realized burden of taxation should at PUBLIC FINANCE 405 least serve as a barometer of expenditure ; but thee ~> points, again, are largely political. Id the foregoing exposition we have not exhausted by any means the outstanding maxims of taxation. The rest must be ignored, however, except for a hasty glance at a few points. Vacillation in taxing is to be deprecated. As it has been put paradoxically, an old tax is a good tax and a new tax is a bad tax. Time is needed for the community to adapt itself to a new tax, and in the process of accommodation much loss and inequity in incidence may be involved. Of other maxims, not the least important are those which have reference to the financial relations between local governments and the au- thority standing over them. Furthermore, we ought to notice the need of variety in a taxing system and a selection of taxes which, so to speak, supplement one another. Every tax tends to bear inequitably on some people, but when a taxing system is well designed it ought not as a whole to bear inequitably, to any sensible extent, on anybody. And finally there is the matter of elasticity. A taxing system as a whole should be elastic in the sense that its yield can be increased, within moderate limits, by raising in appropriate degrees the rates of all or some of its constituent taxes, without altering substantially the incidence of the system or the proportionate real burden imposed on the country. Betterment and the unearned increment. — What is technically known as betterment comes upon the scenes when any public authority, in carrying out a work of public utility, incidentally confers value in a peculiar degree upon certain pieces of property. Thus, when a public bridge is thrown across a river, demand for the land about the two ends of the bridge is intensified. The claim has been advanced, and admitted in law in many countries, that a special public charge should be imposed upon the value thus incidentally created, which, since it is produced by the public authority, 406 OUTLINES OF POLITICAL ECONOMY has been adjudged as belonging in a sense to the community. Of an analogous order are taxes on war profits, which are obviously equitable and may properly be made very heavy. Unearned increment, like betterment, relates to an accession to the worth of property which has been brought about with- out labour or sacrifice on the part of the owner of the property ; but, while betterment implies that the cause of the value is traceable to specific undertakings of governmental authori- ties, unearned increment, as commonly viewed, does not. Un- earned increment, thus regarded, is the accession to the value of things whioh is the product of social growth or social progress. The augmentation of the value of the ground covered by a town, which is a never failing concomitant of the enlargement of a town, is unearned increment. When it is possible to locate it and measure it, many people hold that it is a singularly suitable object of taxation, since the com- munity made it — involuntarily it is true — and its taxation cannot operate, therefore, as a discouragement of production or saving. However, when the taxation of unearned incre- ment is first adopted, account should be taken of the prices at which property has recently changed hands as these may embraoe some discounted anticipation of increased values. Nobody should be charged, in addition to his fair share of the burden of general taxation, a heavy unearned increment tax on an unearned increment which he has paid for. Public debts including war loans. — The individual should so manage his expenditure that he is not lavish one year at the cost of having to pinch another year ; and the State likewise should so control its finances that the burden of taxation does not vary substantially and irregularly. For this and other reasons the State may have to borrow to meet unusual expenditure ; and it is justified in borrowing provided that it makes arrangements for the repayment of the loan before the unusual burden is likely to recur. PUBLIC FINANCE 407 Loans may be funded or unfunded. A funded loan is em- bodied in stock, which oan be sold, and it always relates to a lengthy period ; whereas an unfunded loan is not represented by stock and consists in borrowing for short periods, or sub- ject to the condition that the money must be returned after due notice has been given by the lender. Unfunded debts, if of large amount, are usually condemned on the ground that they are apt to be more expensive than funded loans (because they are less liquid and the lenders may be put to the trouble of re-investing after a short time). But they are not always more expensive ; and they have a special attrac- tion to some people as the full sum lent can be got back in a reasonable time, whereas if consols, say, are bought they may have to be sold eventually at a loss. Floating debts are made up of temporary loans or loans which may be called in rapidly at the will of the lender. They are there- fore unfunded, but all unfunded debts are not floating debts. A municipality that started and kept on borrowing for terms of, say, three years would not have a floating debt proper till after three years. After that time, however, to keep up its debt, the municipality would have to secure renewals of the loans made to it or find other borrowers to take the place of those who wanted their money back. Floating debts of large amount are somewhat precarious because they might suddenly tend to run down. In this event, the borrower might be greatly embarrassed and put to heavy and unforeseen expense. When interest is low and capital is plentiful, the funding system is safest. But in times of great pressure on capital, the State may have to take risks and borrow as it best can ; and it would certainly seem inadvisable to create long-term loans when the rate of interest is high as they prevent the reduction of the annual burden of the debt when the rate of interest falls. During the war, enormous liabilities were contracted by the Government on short terms of repayment ; 408 OUTLINES OF POLITICAL ECONOMY and for years municipalities in England have largely relied on unfunded debts. In this connexion, emphasis may be laid on the distinction between continuous, or day to day borrow- ing, as it has been called, and borrowing all that is wanted for a specified purpose or period at once. If very large sums are required, the first plan is the cheapest and most fruitful, and has the additional merit of absorbing money as it is saved and not upsetting the money market. Municipalities have largely had recourse to it, and the Government has relied on it to no small extent in its recent war loans. In connexion with borrowing, it should not be overlooked that there are definite limits to its extent. When a country is borrowing of itself, the first limit is furnished on the one hand by the amount that will be saved at home, under the inducement of the reward offered and of patriotism in times of national emergency ; and on the other hand by the share of this that will be taken for business purposes. This limit was soon reached after war broke out. But it can be trans- cended, though there remains another limit which cannot. The ultimate limit is determined by the amount of saving that is physically possible, and the amount that must be absorbed by industry to enable it to function efficiently when this is cut down to the lowest figure possible. It goes without saying that the ultimate limit can only be reached as a result of far-reaching State control. All this follows, of course, from the fact that money only stands for goods and services, and that, in war say, the proportion of its income that a country can borrow is the proportion of its productive power that it can apply to the war, after retaining sufficient to satisfy the wants that it will not forego (according to the first limit), or the wants that it actually cannot forego (according to the second or ultimate limit). It is superfluous to add that there is a limit also to the amount that a country can get from another country (by sale of securities or direct borrowing) in PUBLIC FINANCE 409 the amount that people will save there and the proportion of their savings that they will be willing to contribute in view of the inducement offered. When the ultimate limit has not been reached, as it never can be praotically, and the Government needs more than the people will contribute, it may try to force their hands for a time by creating more money, broadly regarded, either directly or through the bank. The extra money may be spent at once by the Government, or lent to the people (through the banks) on the security of their property and borrowed back by the Government to spend. The second course means that against the inflated currency, which will have to be dealt with some time, the Government has pro- perty pledged ; whereas, if the first course is pursued, it bolds nothing against it. But any suoh attempt to force the hands of the people is costly, as it effects its purpose by raising prices not only against the public but also against the Government ; and it becomes increasingly costly and ulti- mately ruinous, particularly as the voluntary saving of those who were saving before may be checked in the degree in which the cost of living is forced up, so that a part of the Government's gain is reduced to a temporary one only, while its Joss in higher costs remains. Finally, with reference to war loans, we may observe that the proportion of the pro- ductive power of the community that they absorb is less than the proportion that their money value bears to money income because the prices of things needed for the war rise most, under pressure of the exceptionally heavy demand for these things. It goes without saying that the ultimate limit described above with reference to war loans holds also of taxation ; but the practicable limit of taxation is ' reached long before that of the loan, both because of the attitude of the public, and because some people would still be left with inoome that 410 OUTLINES OF POLITICAL ECONOMY oould be borrowed, after a system of taxation generally re- garded as fair had pressed others to the limits of subsistence beyond which it was not desirable to go. One advantage of the tax is that it forces people who would not save to limit their consumption. Taxation and borrowing, of course, come to the same thing, except that the latter carries the burden of interest till it is paid off. Only it should be remarked that the Government can keep down the price to itself of things that it wants by taxing them, when it is feasible to do so. Taxes on things, by raising prices to private consumers, limit their consumption and leave amounts for the Govern- ment that could only have been obtained otherwise through an elevation of prices which it also would have had to pay — that is, so far as goods are bought by the Government in the open market and are not in any sense commandeered. CHAPTER XXXIII. THE INCIDENCE OF TAXES. Nature of the problem of incidence. — We must begin our study of the incidence of taxes, as the subject to which we shall now give attention is commonly called, by drawing a distinction between the impact and the incidence of a tax. The impact is upon the person from whom the tax is collected, but the incidence is upon those who pay eventually. The process by which ultimate incidence is brought about is known as the process of the shifting, or rolling, or repercussion of taxes. If the incidence of a tax is upon the same person as its impact, the tax is sometimes said to be direct. If incidence and impact are upon different persons, it is said to be indirect. But " direct " and " indirect " are sometimes applied to taxes to mark another contrast. By a direct tax is not infrequently meant a tax on persons apart from the nature of their callings, while by an indirect tax is meant a tax on trades, or on com- modities or services, or things or events incidental to their provision. This is probably the commoner use of the terms, and it is the use to which they will be put here. Some people speak of the shifting of taxes as if, in each case, nothing more happened than that a particular payment, or some part of it, was passed on from person to person until some individual was reached who could not pass it on to anybody else. Thus a tax of a penny a pound, say, is placed on soap in some country and the question is asked, Who 411 412 OUTLINES OF POLITICAL ECONOMY pay the pennies on the pounds of soap consumed in that country ? This is far too simple a way of stating the problem of incidence. Take the example given and suppose that soap is not imported. The Government will raise a penny from each pound of soap oonsumed in the country, but the loss inflicted upon the taxpayers may be greater or less than the sum received by the Government. If the incidence of this tax is on the ultimate purchasers of soap, they pay what the Government gets, but they may be involved in contingent gains or losses which must be deducted from or added to this payment. If, in consequence of the diminished consumption of soap brought about by the tax, the price of soap, apart from the tax, falls, the taxpayers make a contingent gain ; but if the effect of diminished consumption is the opposite, they suffer a contingent loss. Again, among the losses inflicted by the soap tax, we must certainly reckon the damage done to those who, as it is said, " escape " the tax, or some part of it, by giving up consuming the taxed article wholly or partially. To give up oonsuming what we like, and substi- tute for it what we desire less, is not a matter of indiffer- ence ; and whenever the demand for a thing taxed is not absolutely inelastic, there is a sacrifice of this kind. From the foregoing we may infer that it is not exaotly cor- rect to speak of the incidence of a tax. What we should say is "the incidence of the effects of a tax". However, the shorter phrase is in common use and serves to save words. The best way to deal with the problem of the incidence of taxes, so called, is to ask, first, What is the loss entailed ? and, secondly, How is the loss distributed? A few preliminary remarks on the conditions under which taxes may be shifted will not be out of place. If a tax is placed on all men over six feet in height, obviously no ways of escaping the tax are open to them except to emigrate or cease to exist. They cannot give up being six feet high. Therefore, THE INCIDENCE OF TAXES 413 providing they elect not to emigrate, they must pay the tax. Similarly, if people are taxed in proportion to their wealth, and the tax amounts to only a small fraction of their posses- sions, those who earn an income are not likely to be induced by the tax to earn less. Consequently they cannot shift the tax. But if carpenters are taxed, while bricklayers, plumbers, and gardeners are not, the trade of carpentering will at once be made relatively less attractive than bricklaying, plumbing, and gardening. Perhaps only a few carpenters will forsake their calling in consequence, but certainly the proportion of the next generation brought up as carpenters will be reduced. Hence, ultimately, the supply of carpenters will shrink rela- tively, and the price paid for their work will be bound to rise. So the effects of the tax will be shifted from the carpenters on to the public who employ carpenters. We shall trace in detail in succeeding paragraphs the in- cidence of certain taxes which have been selected to illustrate the theory of incidence. We shall only be concerned, how- ever, with what tends to happen in the long run ; though ultimate effects may be long delayed and obscured by inter- mediate effects, and be commonly overlooked in consequence, as the rise of the tide may be when we watch the waves. Further, we shall assume provisionally that the repercussion of taxes cannot be in any degree negatived, though it may be delayed, by social friction. We suppose that people will break their habits to escape a tax, and that, when a trade is taxed, people in the trade will not be depressed into a lethargy which will rivet the burden upon them and their children. Of the latter point some notice will be taken later. Taxes on income and property. — When people are taxed in proportion to income, the bulk of the incidence is upon the persons taxed. But in the case of these taxes, as of mast others, if the rate is high so that the saving of capital is appreciably retarded, the community as a whole is also 414 OUTLINES OF POLITICAL ECONOMY affected to a slight extent in that the cost of living rises or is prevented from falling. A tax on personal expenditure has occasionally been recommended on the ground that it would impose little or no check upon saving. The incidence of taxes on property, when the holding, in shares or otherwise, of capital devoted to production is not relatively discouraged, is identical, broadly speaking, with the inoidence of income taxes, that is to say, it is upon the owners of the property taxed. The incidence of taxes on the transference of property at death is similar to that of property taxes, but the former taxes may have the peculiarity of falling, so to speak, between two stools. They do not fall on the people who make no pro- vision, by insurance or otherwise, for the payment of the taxes on the property which they leave, and the beneficiaries are only deprived of what they never possessed. Taxes connected with land. — The problem of the inci- dence of taxes on land, or land and any capital fixed in it, bewilderingly complicated though it appears when unsystem- atically presented, readily lends itself to a piecemeal solution. We shall, therefore, aim at tracing the principles involved by examining a few leading cases in the abstract. (a) Taxes on pure economic rent fall upon the persons who receive the rent. This proposition holds of all true rents, whatever their nature, including personal rents. It is as- sumed, of course, that the taxes are made to apply to all rents of a given class. The conclusion follows from the fact that the taxes, being on rent, do not affect oost directly or in- directly. Were a tax imposed on the rent of land only when the land was used for growing turnips, say, then a part of the incidence would be upon the consumers of turnips, because some land would be withdrawn from turnip-growing and de- voted to other purposes. (b) The incidence of a tax on land proportional to the THE INCIDENCE OF TAXES 415 quantity of its tangible produce may receive attention next. Such a tax makes an addition to the cost of obtaining the produce which is the same for every unit of the produce. Consequently, if the demand for the produce is absolutely in- elastic, price will rise by the amount of the tax, and consumers will lose what the Government gets. And rent will be as be- fore. Eent is the difference between the aggregate costs of the produce and the total receipts for it. The costs are in- creased by the tax multiplied by the amount of the produce ; and the receipts are increased by the same amount. Hence the difference between thein is what it was before. But, as the demand for the produce cannot be absolutely inelastic, its price will rise to some extent. Less will then be consumed, and when less is consumed the marginal cost will fall (see pp. 305-7). Hence price will rise by less than the amount of the tax and rent will fall. Consequently, in the loss occasioned by the tax landlords will share. This demonstration holds whether the produce of the land is the fruit of the earth, or milk (on dairy farms), or cattle and sheep, or office-room (on building sites), or house-room, or what not. (c) In setting out to trace the effects of a tax on the annual value of what is produced from the land (including accom- modation in buildings), we may take the case of house pro- perty to illustrate, as this gives us the problem of rates in an easy form. Each house is taxed according to the annual value of site and house. Consider houses exactly alike, and suppose the one at the situational margin pays a rent of .£40. This is a charge for the house alone ; the marginal site may be assumed provisionally to have no value. Another house pays £60 a year. This is £40 for the house and £20 for the site. Let each be taxed (or rated for local purposes) 25 per cent. Suppose, first, that the demand for houses is quite in- elastic. Then for the house at the margin £50 must be paid, 416 OUTLINES OF POLITICAL ECONOMY namely £40 rent and £10 rates. For the house £40 must be paid as before (as we shall understand better after studying on pages 420-1 the incidence of taxes on commodities, which include buildings), because this is its cost of production and management expressed as an annual payment. Then, for the other house, the occupier would pay at most £50, plus its situational value of £20, that is £70 in all, including rates. He would not pay more because the situational value would remain as it was, and we suppose that he occupies the house because he was the highest bidder for it. Consequently, the rent of this house would have to drop from £60 to £56, be- cause £56 plus 25 per cent (for rates) equals £70, the most that would be paid for it and any charges upon it. The site value will, therefore, fall from £20 to £16, since £40 must still be paid for the house. That is to say, in this case and like cases, if the demand for houses is quite inelastic, the tax paid will fall on the house and the site in proportion to the amount of each in the total rent ultimately paid. But actually, as the demand for houses is not quite inelastic, the situational mar- gin would rise, and situational rent would fall still more. If, instead of a residential house, business premises are on the site, the tax which does not fall on the ground rent falls on those who ultimately consume the utilities furnished in the business premises. This conclusion follows from the fact that otherwise the profits of businesses using much land would be reduced and people would be less eager to enter them. This demonstration holds only of cases in which the quantity of accommodation that can be provided on a given site is fixed, and no doubt there are many such cases. There are also many cases in which the quantity of accommodation that can be provided on a given site is not fixed. Blocks of flats are erected in the centres of some big cities which would never be erected in the suburbs, and these blocks may be of various heights. In these cases, rates would cause less use to be made of central sites (lower buildings would be THE INCIDENCE OF TAXES 417 placed upon them), as will be proved in the next paragraph, and the boundaries of the town would be thrust outwards. Now, ordinarily, the area for building in the immediate outskirts of » town is ex- tensive, and the inconvenience of living a great distance from the centre is not appreciably less than the inconvenience of living a somewhat greater distance from the centre. Consequently the chances are that the value of a given amount of accommodation in the centre would not be appreciably affected by the extension of the town's suburbs. We may conclude, therefore, that it is so highly probable as to be certain for practical purposes that the annual value of central sites, and the aggregate site value of the town, would both fall, in the long run, in a greater degree than they would if a fixed quantity of accommodation were always provided when a site was used. That rates would cause less use to be made of central sites is easily demonstrable. Take a block of flats with eight stories. Suppose that on the eighth story a rent of £90 a year will be paid for accom- modation which could be obtained in a house of two stories on the outskirts of the distant suburbs for £30 a year. Then, for the situa- tional conveniences of the flat, £60 is being paid, and the provision of the flat on the eighth story may be taken to cost in all, with pro- fits, a sum of which a rent of £90 a year is an equivalent. Sup- pose that there are no rates at first, and that rates of 50 per cent on rent are then imposed ; and assume provisionally that the demand for house-room is quite inelastic. After the imposition of the rates, the man in the marginal suburban house pays rates of £15 a year on his £30 house, that is, £45 in all. Then the man in the top flat would pay £45, plus the value of his situation, which was £60, and, on the suppositions made, remains pretty much the same. So he would pay £105 in all, supposing, for the sake of argument, that the value of his situation is still £60. And as rates are 50 per cent of rent, this means that he would pay a rent of £70 and rates amounting to £35. Rather than pay more he would get himself a £30 house built on the country side of our marginal £30 house in the suburbs. But a rent of £90 only just covers the cost of provid- ing his flat. Consequently, after the rates were imposed, no more fiats with eight stories would be built. Finally, observe that this result, whatever the rates, could not possibly be prevented by a 27 418 OUTLINES OF POLITICAL ECONOMY rise in the value of central accommodation, because such a rise could only be brought about by a spreading out of the town foi which ex hypothesi a curtailment of the height of central buildings is essential. It will be realized at once that the theory of the incidence oi taxes on the annual value on the spot of the produce of farms is similar in form to ths theory of the incidence of taxes on building sites, used for business purposes, when the amount of accommodation obtainable from a site is not to be taken as rigidly fixed. (d) Tht theory of the incidence of a tax on all land per acre, ■which one would think should be easy, is in parts difficult The theory is easy enough, if the tax is imposed on all land, whether used or not, and cannot be evaded by giving up the ownership of land. In this event, it must fall entirely on landlords, because the use made of any piece of land, and marginal cost, would not be affected. But when the tax in imposed only on land which is devoted to some service or other, the theory may become involved. Let us begin our examination of the incidence of the latter tax by taking first a very simple case where the theory is simple. Consider building plots, on each of which the same, and an invariable, amount of accommodation is provided. If the demand for these plots is quite inelastic, rent after the im- position of the tax would be as before. The reason is that the owners of marginal sites can escape the tax by withholding land from use. The whole incidence of the tax would be on the occupiers of the residences, or on the consumers of the commodities or services proceeding from the premises, as the case might be, if demand were quite inelastic, but if it were not, rent would suffer some reduction. Complexities are introduced into the problem when we suppose that a variable quantity of accommodation can be furnished on a site. On this supposition, we have circum- stances similar to those of laud in agricultural use. What THE INCIDENCE OF TAXES 419 follows may be read as relating either to farming land or to building land in the long run — only the long run would be much longer in the latter case. A tax proportional to acreage on land in use would throw out of use all land of which the economic rent per acre, under the conditions created by the tax, was less than the amount of the tax. And, as other land would be worked more intensively, the marginal cost of its produce (whether it were corn, or cattle, or buildings, or any- thing else) would rise, and consequently the price of its pro- duce would rise. Hence consumers could not possibly escape being hit ; and, in fact, they would almost certainly have to pay substantially more than the proceeds of the tax. The proof of the latter proposition is too elaborate for insertion here ; as is also the proof of a correlative proposition which holds of this case, namely, that the aggregate paid in rent would, with the same degree of likelihood, be increased despite the loss of rent on the land thrown out of use. With reference to land taxation, there are three other points which ought to be mentioned. The first is that the incidence of land taxes on persons is naturally affected by leases, because leaseholders are tied to their land for specified periods. The leaseholder is to be viewed as landowner in this matter, except with respect to taxes on the rent received by landlords, and apart from any provisions which modify the leaseholder's liabilities according to changes in circumstances. The second point is that a tax upon unoccupied land which could be used, brings a portion of it at least into the market and so tends to lower the value of sites. When such a tax is resolved upon, it is not desirable that it should be so heavy as to discourage all withholding of land from present use in view of future needs. And the third point to notice is the principle of amortization. When a recurrent impost is placed on the possession of a thing, allowance is made for the charge when 27* 420 OUTLINES OF POLITICAL ECONOMY the thing is purchased. Hence, a land tax which reduces rent lowers the capital value of land. Similarly, a tax on the transfer of non-reproducible property lowers its exchange value by the amount of the tax. In this connexion, it is note- worthy, though apparent, that the value of land is sensitive to expectations of change in the rate and nature of taxes affecting its net earnings. Taxes on commodities and ser-Yices. — This section will have no reference to import and export duties, which will be specifically treated later, nor to conditions under which supply is monopolized. Taxes on commodities may be treated as additions to their costs of production. If the demand for a taxed commodity, in the supply of which competition rules, is wholly inelastic, its price must rise by the amount of the tax, and the incidence of the tax must be entirely on the con- sumers. But demand is never wholly inelastic. Conse- quently, after a tax has been imposed on a commodity, less of the commodity will be bought, and the cessation of con- sumption will itself cause loss in the manner described above. Moreover, when a smaller quantity is produced than before, the marginal oost of production may rise or fall. If it rises, price will rise by more than the amount of the tax, and the loss of consumers will be increased accordingly. If it falls, the loss of consumers will be correspondingly reduced. From these conclusions, two maxims may be deduced. The one is not to tax things the demand for which is elastic, other things being equal, when the prime object of the tax is rev- enue ; because, when demand is elastic, a small tax will cause a large contraction of consumption. The other is not to tax things the production of which is subject to marked increas- ing returns, other things being equal, because to do so is to throw away the advantages of increasing returns. The theory of the incidence of taxes on services is identical with that of the incidence of taxes on commodities. A com- THE INCIDENCE OF TAXES 421 modity is merely a service indirectly rendered. And taxes on transfers of reproducible things, or on contracts relating to their provision (like stamp duties on bills of exchange), when they are indispensable, are evidently additions to the cost of producing or delivering things and are, therefore, to be classed with taxes on commodities. Diagrammatic treatment of taxes on commodities. — The conditions of demand and supply of a commodity subject to decreas- ing returns, and of another subject to increasing returns, are re- presented in figs. 20 and 21 respectively. A tax of dh per unit is Yl h s' f ,' *S -" a y ■-'''\y^ h ^*D O J a X Fig. 20. imposed on each commodity. Consequently the supply curve in each case is raised from S to S'. The output in each case is reduced from Oo to 06. The loss of consumers' surplus is efcd, that is to say, consumers suffer a loss equivalent to a loss to them of efcd in money. The gain of the Government in money is eghd. In fig. 20, relating to diminishing returns, eghd is greater than efcd, but it would cease to be if the inclination of S were so slight that fghj were no greater than cdj. In fig. 21, relating to increasing returns, eghd is less than efcd, and is bound to be. The reader can construct a figure for himself to show that, in the case of constant returns, the excess of loss of consumers' rent over the gain of the Govern- ment would be approximately half of the tax per unit multiplied by the reduction of output. 422 OUTLINES OF POLITICAL ECONOMY Taxes on monopolies.— A tax of a lump sum on a mon- opoly rests entirely on the monopolist, provided that his output is so arranged that his net takings are maximized, as it would tend to be in the absence of any of the limitations on his liberty of action discussed on page 190. If, in this event, he is taxed £1000 a year whatever his output, on re- ducing his output he would meet only with additional loss. A percentage tax on monopoly revenue would have a similar incidence, if we suppose that the trouble saved when output is reduced is practically negligible. A tax on the output would probably induce the monopolist to restrict his output and, thus, some of the incidence would be on the consumers. But the rate of such a tax could be made so to rise with price as to stop restriction of output. Of course, were the tax in any of these cases so large as to swallow up the monopoly revenue and something more, the output would ultimately come to an end. Import and export duties. — We must confine ourselves here to the broadest issues only. In what follows, we shall deal mainly with import duties. From the principles brought out in their examination, the effects of export duties can be readily deduced. The reader may find it helpful to conceive of import and export duties as additions made to the cost of transport between countries exacted by the parties imposing the duties. Let us take first protective import duties, and bear in mind that we are only concerned here with what is called their incidence, and not with arguments for protection and free trade. These arguments we have briefly reviewed in Chapter XXX. We are now leaving out of account certain advantages, apart from the cost of things, which are claimed for protection on the one hand, and on the other hand certain advantages of a similar order that are claimed for free trade. The broadest way of treating this question is to consider first the world effects of protective import duties, and then their distribution. THE INCIDENCE OF TAXES 423 Now, we may assume that, in the absence of the duties, countries would, as a rule, engage most in the industries they could prosecute to the greatest advantage. By the duties, some of their activities would be shifted into less profitable channels : hence, there would be loss, apart from the pay- ment of the duties. However, this doctrine does not hold universally ; conceivably some of the new channels might be more profitable than the old ones, and, in so far as they were, there would be gain instead of loss. But a balance of loss may be taken as the usual thing. This being the world effect ordinarily, we have to investigate next the incidence of the loss on people in the country im- posing the protective import duties and on people abroad. Let the country which imposes the import duties be France. And let us provisionally disregard all cases in which France, or any one of the countries exporting to it, exclusively con- sumes or produces an article of international trade. Such cases of what might be loosely termed national monopoly present certain peculiarities, but they have little or no ap- plication to the generality of trade. In the remaining case, we have France exporting what other countries produce also, and importing what other countries are also consuming. Now, the imposition of import duties on certain goods by France, if they are not prohibitive, means that in the new state of trade, when a position of equilibrium is again reached, the prices of these goods in relation to the prices of other things must exceed their cost of production abroad, expressed in the same way, by the amount of the import duties, as otherwise these goods could not continue to be imported. This new position of trade can be brought about by a re-ad- justment of the magnitudes of different industries (a) abroad, or (b) in France. If the extent of the industries affected abroad, directly or indirectly, is large in relation to the extent of the corresponding industries in France, the result will 424 OUTLINES OF POLITICAL ECONOMY be attained mainly by method (b) ; but, in the opposite case, mainly by method (a). It is evident, therefore, that the prob- able loss that has been investigated, when reckoned per head, must usually be large in the taxing country in comparison with what it is abroad (because foreigners will not be in- volved in any substantial industrial re-adjustments) when the sum of all the industries affected abroad is very large in proportion to the size of the corresponding industries in France. In must be remembered, however, that a loss to the world is not bound to result from all protective import duties ; and, further, it must be noticed that, even when it does, there may be a gain to the taxing country, the balance of loss to the world being due to losses abroad. Thus a country ex- porting in the main agricultural produce which was subject to decreasing returns, if it taxed imported manufactures, might gain more through the cheapening of its agricultural produce to the home consumer (in consequence of the diminished export, following on the restricted imports) than it lost through dearer manufactures. Exceptions there certainly are to the general statements made above, but nevertheless the broad conclusion cannot be resisted that in most cases protective import duties will not in the long run do much harm per head to people abroad ; whereas, in the countries imposing them, people will com- monly have to pay the duties (which their Government gains of course), or a great proportion of them, and suffer some- thing in addition through being cut off from what are to them economical sources of supply. It is superfluous to add that, if any import duty is prohibitive, the treasury of the taxing country gains nothing, though there is likely to be a loss, as previously demonstrated, and this loss is likely to fall most heavily on the taxing country. The striking analogy between the theory of protective im- TEE INCIDENCE OF TAXES 425 port duties when circumstances are unfavourable and the theory of taxes on the output of industries subject to decreas- ing returns will be apparent ; and it will be perceived that an import duty, accompanied by a corresponding tax on any home production of the dutiable thing, is simply a tax on consumption and does not present the peculiarities of the protective import duty, unless it is designed to protect the production of a substitute. Let us now try to trace the effects that may be expected when the consumption or production of a commodity affected by a duty is confined to one country. Above we assumed provisionally that no suoh national monopoly, if we may properly call it monopoly, was involved in the trade. Suppose that some country has such a monopoly of consump- tion of some article. Say, for instance, that China alone consumes opium. Then, if China put an import duty on opium, and her demand for opium was very elastic, and opium was produced according to diminishing returns, China would profit largely on balance. Suppose, next, that some country has such a monopoly of production of some article. Suppose, for instance, that Borneo alone can produce nutmegs with facility. Then, were Borneo to place an export duty on nut- megs, and were the demand for them inelastic, Borneo would certainly gain heavily at the expense of foreign countries. Incidence of a taxation system as a whole. — To con- clude this chapter a few words must be said of the reactions that may succeed the incidence of all the taxes in a taxing system. These might be called the seco ndary reactions. They are slower in their operation and tend to be more extensively counteracted by social friction than the primary reactions, but they may alter both the burden of taxation and its dis- tribution. 426 OUTLINES OF POLITICAL ECONOMY Secondary reactions are brought about by the effect of taxes upon saving and upon the power and willingness of people to raise themselves or their children in the social scale. For in- stance, were the taxes of a country to press with exceptional severity upon the class of people with incomes of less than £100, the flow of people from this class to the next higher class would almost certainly be retarded (though a position in the latter class would be made relatively more attractive), because the means at their disposal to enable them to raise themselves or their children would be reduced. Power to mount up in the social scale seems at present to be a much more important regulator of the degree of vertical movement, among the masses of the population, than the relative at- tractiveness of incomes in different grades. If the relative numbers of the people in the lowest classes were ultimately increased by the tax, the burden of the tax upon the commun- ity would be made heavier, because the national income would shrink when more people than before were doing work of small value. And of the burden, thus increased, the share of the poorer people would be magnified, for they would suffer a reduction in wages, owing to the relative increase of their numbers, in addition to having to pay the heavy taxes. The earnings of the classes above them would rise relatively to theirs, because the numbers in these higher classes, taken as a whole, would relatively diminish. It must be remem- bered, however, that vertical mobility suffers many retar- dations. Finally, it is necessary to take into account the depressing effect which the reduction of small incomes has on those who earn them. The ambitions of parents for their children might be so damped by heavy taxes that the chil- dren's opportunities would be curtailed out of all proportion to the limitation of the parents' ability to provide them. In order to illustrate the secondary reactions on taxes as a whole, a case has been selected in which the means possessed THE INCIDENCE OF TAXES 427 by people play a large part in determining their choice of occupations for themselves and their children. In other cases, means have no influence, but a substantial alteration of the relative attractiveness of different positions in the social system might have an appreciable influence. As regards the second- ary reactions which affect saving, the dependence of saving on the means to save will be obvious without comment. BOOK VIII. DEVELOPMENT OF POLITICAL ECONOMY. CHAPTER XXXIV. FROM EARLY TIMES TO ADAM SMITH. The purpose of this chapter and the next is not to give a digest of the views of economists in different ages, but to trace very generally the progress of Political Economy. An introductory sketch is all that can be offered : properly to understand the development of Political Economy, it is neoes- sary to read economic literature side by side with economic history. Early and mediaeval times. — Politioal Economy has had a long, if frequently uneventful, history. Xenophon broke sufficient ground in his Economics to call for notice, but his point of view was largely domestic. Nor did Aristotle over- look economio considerations in his encyclopaedic survey of the social sciences, though he brought little thought to bear on economic analysis. Both then, and afterwards under the Roman Empire, however, economic speculations were rare and rudimentary. And the Middle Ages were even more barren, except for the occasional attention given, mainly by ecclesiastics, to such special questions as poverty and interest on capital, that was more practical in its fruits than theo- retical. It was not until the Renaissance that the modern world really began to awaken to the problems of economics. 428 FBOM EARLY TIMES TO ADAM SMITH 429 For the long neglect of economic questions as a whole and the sudden blaze of interest in them, sufficient reason can be found. In the ancient world, production was carried on piecemeal by inferior classes in the community, and practical thought was concentrated mainly on the political aspects of human affairs. Economic organization was not so much a part of the system of civilized life as the ground in which it was rooted. Throughout the Middle Ages, again, the gov- erning classes were preoccupied with war and the political structure of cities and States. Eoonomic organization re- mained on the whole parochial while nations were being made politically. It is not surprising that the first notable stirrings of economic thought were not aroused till trade and industry began to be controlled for national objects, and social disorders were generated by social changes. When the Feudal System flourished, the weaving of the economic cash nexus was only in its initial stages ; and as, in addi- tion, agriculture was pursued year in year out on the Manor in a customary way, and largely on a subsistence rather than an exchange basis, by classes whose relations to one another never altered, economic theories of rent and agricultural organization were unlikely or out of the question. At most, treatises on estate management and husbandry were to be looked for. And, as in agriculture, so in industry, custom largely ruled, its observance being enforced by gilds, while the unit of manufacture seldom extended far beyond the household. Broadly speaking, there was no economic litera- ture because economic activities were taken for granted and not yet incorporated in the recognized problems of the na- tional life ; and also because there was very little literature of any kind. With the dawning of capitalism, however, the extension of commerce and the increasing dependence on money, at- tention was naturally drawn to currency matters and the rate 430 OUTLINES OF POLITICAL ECONOMY of interest. Nicholas Oresme's work on Money did not appear until 1373. But long before that, and even in ancient times, controversy had arisen over the payment of interest. Eventu- ally, the conflict between political and business requirements, on the one side, and morals or religion, on the other, was resolved, under the pressure of necessity, by the distinction drawn between interest that was and was not usurious. Various arguments were used. Thus the lender ran risks and it was agreed that he was entitled to insurance payments ; and, as against the view that, money being sterile, no in- terest could legitimately be claimed merely for a loan of money, it was allowed that the money might be used to pur- chase what was not barren, for instance flocks and herds, and that in this event the lender might claim a share in the results of their fecundity. Again, as money used in indus- try and trade clearly yielded profit, the right to interest was conceded under the fiction that the lende>' was a partner in the undertakings to which the money was devoted. Ex- ceptions such as these to the law of the Church against usury being admitted, it was only natural that, with the growth of capitalism and the increasing use of loans in trade and politics, the prohibition of interest should have ended in being confined to extortionate payments wrung out of people's necessities. A doctrine that originated in care for the weak and needy could not survive in its early rigidity after the chief borrowers became the rich and powerful. Tha transition from mediasYalisrn. — Many old problems were magnified, while new ones were created, by the dissolu- tion of the mediaeval order, commercial expansion, the dis- covery of the New World, and the distribution of its treasure. From these mixed causes mixed effects followed, which may be separated into two classes, namely the social and the more narrowly economic. The old fabric of society was being de- stroyed and reconstructed ; and this in itself, apart even from FROM EARLY TIMES TO ADAM SMITH 431 the misery which it caused to large numbers in the com- munity, naturally excited speculations about the social system at a time when the bold Greek spirit of inquiry had been recovered through the revival of learning, and Plato's " Ee- public " and Plutarch's "Lycurgus" were again being read. Sir Thomas More wrote his " Utopia " in 1516 ; and, after a long interval, other noted ideal commonwealths were put forth, among the authors of which Francis Bacon holds a high place. These exercises in the theoretic architecture of society were no less political than economic, or more so, and half-poetic and literary, though not intended to be entirely fanciful. The conception of the deliberate creation of social systems was not likely to be dismissed as utterly fantastic, after the State had asserted control over the Church and was already designing or actually trying machinery for the relief or removal of poverty and unemployment. And, as the no- tion of the ideal community was born anew in the economic and political convulsions of the sixteenth and seventeenth centuries, so it was revived once more in the disturbed period at the end of the eighteenth century and the beginning of the nineteenth. But little was achieved, in the way of social studies, beyond the half-serious " Utopia " in the post-medias- val transition age. The one specific economic question of a social kind that was made definite and discussed with judgment was the question of pauperism : Vives wrote his " Treatise in Pauperism " (1526) at the Court of Henry VIII. The enormous expansion of both internal and external trade before the end of the sixteenth century forced into notice certain of the more fundamental factors in commerce. Monetary machinery was one of these ; for the more a community engages in trade, the greater is its dependence on money. In England the currency had depreciated through debasement, clipping, and rubbing, and this was the more serious in view of the fact that the outflow of silver from 432 OUTLINES OF POLITICAL ECONOMY America had also reduced its purchasing power. It was in connexion with the recoinage in the reign of Elizabeth that Sir Thomas Gresham emphasized the generalization which has become a constituent part of economic doctrine under the name of " Gresham's law". An anonymous author, now thought to be John Hales, discussed monetary and other subjects in 1549 in a work entitled " A Discourse of the Commonweal" which was not published till 1581 ; and on the subject of money, Bodin published twice, in 1567 and 1578. Mercantilism and its critics. — -It was not merely currency matters pure and simple, however, which excited most attention in this age, but the whole broad question of external trading relations, including those with the Planta- tions, as the Colonies were then called, which raised the widest issues. Increasingly numerous pamphleteers main- tained that foreign trade could be encouraged and controlled in the interests of national wealth and power, and recom- mended the regulation of industry, and in some cases the overseas carrying trade (by Navigation Acts), with the same end in view. The idea was to foster all that was supposed to contribute to national wealth or strength. This teaching, which is known as Mercantilist, was by no means mistaken throughout, though it was marred by a tendency relatively to over-value the precious metals, foreign trade, the produc- tion of materials, a dense population, and State action. With the contemporary discussion over its tenets and consequences, trade economics made its real beginning. The Mercantilist policy was a gradual growth, and its adoption had already been extensive before the sixteenth century. Of statesmen, Colbert, perhaps, went furthest along the lines of its policy. The first comprehensive economic writer in France, Montcritien de Watteville (or Vastevilte), whose "Treatise on Political Economy" appeared FROM EARLY TIMES TO ADAM SMITH 433 in 1615, had pronounced mercantilist leanings. Of English writers, the most eminent were Thomas Mun, author of an essay on trade with the East Indies (1621), and a posthumous work, "England's Treasure by Foreign Trade" (1664); Sir Josiah Child, remembered for his discourses on trade of 1668 and 1690 ; Sir William Temple, and Charles Davenant. All were moderate mercantilists ; and, generally speaking, moderate mercantilists were at least as much concerned to disprove some of the extreme tenets of Mercantilism as to support it in substance. Mun, the most outstand- ing, believed that it was desirable to aim at a favourable balance of trade, but not necessarily with each country, since an unfavourable balance with one country might result in a more favourable balance with another ; hence he advised the export of money to bring in more money ultimately. Another distinguished Englishman, Sir Dudley North, attacked the system of prohibition (" Discourses upon Trade," 1691). Objections were also advanced by two other English writers of high repute, whose economics were less exclusively con- cerned with trading questions, namely, Sir William Petty, author of "Political Arithmetic" (written in 1671 but not published until 1691) and other works, and Locke the philo- sopher. David Hume, whose penetrating discussions of eco- nomic questions in two volumes of essays (published respec- tively in 1752 and 1753) did much to prepare a broad way for Adam Smith, was equally an opponent of Mercantilism. Despite the trenchant criticism of Mercantilism, however, an " Inquiry into the Principles of Political Economy," with a Mercantilist bias, was issued by Sir James Stewart in 1767; but it counted for little, in view of the tendencies of the time, and sank into obscurity after the phenomenal success of Adam Smith's powerful and more attractive book. In Germany, mer- cantilist teaching flourished for generations. In connexion with the work of the Councd (or Kammer) in many German 28 434 OUTLINES OF POLITICAL ECONOMY States, chairs of what were called Canieralistic sciences had been established in Universities. Out of these studies Politi- cal Economy developed, and for many years it was distinctly mercantilist. But eventually critics made themselves heard in Germany, and also in Prance, as well as in England. The Physiocrats. — The next school of eoonomics to in- fluence the world of thought and action was known as the Pbysiocratic. It took its origin as much in the economic transformation wrought in the eighteenth century, and even before, as in intellectual advance. The striking feature in the new conditions was the strength of private initiative which had for long worked beneath the surface in prescribed channels, and now broke through the crust of political and social regulation and convention in an unrestrainable bold- ness of enterprise. We see its ascendency in both industry and trade ; and, in relation to Mercantilism, in the defiance of the great trading companies by the " Interlopers," or per- sons undertaking, on their own account, foreign ventures which trespassed on the legal or customary monopolies of the Chartered Companies. This pushing individualism had been rendered possible by the growth of private wealth and the development of credit and banking. The Physiocrats maintained that the social system worked of itself to the greatest advantage ; that State and corporate intervention always substituted a less for a greater advantage. It was because they believed in the operation of a sort of natural law in the economic system that they were called Physiocrats, though they called themselves " Economists ". The conception of natural law in social affairs, which is clearly akin to the ancient idea of the Jus Naturae, was common to many writers of the time and reappears in Adam Smith. At least, as applied by the Physiocrats, it brought out the notion of the working of law, in some sense, in economic matters as in external nature. Like most schools, the Physiocrats be- FROM EARLY TIMES TO ADAM SMITH 435 came doctrinaire, and they presented their real discoveries entangled with absurdities. Most interest was excited by the doctrine, strongly emphasized by some of them, that manufactures are " sterile " in that they do not yield a pro- duit net like the land. On the theory of the produit net (which foreshadows the correct conception of rent), they founded their proposal of the single tax. Most of them held that agriculture alone was truly productive, in that it added to the quantity of things, whereas manufacture merely altered the form of things and commeroe their distribution. The confusion in this view between mass and value is apparent ; and of the same confusion, Mercantilist teaching was by no means guiltless. The first elements of the system were published by Quesnay in the " Encyclopedic," and they were developed mainly be- tween 1763 and 1775. The leading Physiocrats were Ques- nay — author of that most abstract statement known as the " Tableau Economique " — and Gournay, while Dupont de Nemours and Mercier-Lariviere were well-known exponents. Gournay softened the rigours of the school by rejecting the crude doctrine of the unproductiveness of industry and com- merce. He concentrated on the importance of a system of natural liberty, and originated the celebrated phrase laissez faire, laissez passer. Gantillon, a French merchant of Irish extraction, had put forward, in 1755, the fundamental ideas embodied in the principles of the Physiocrats ; but it was Quesnay and Gournay who created a school of thought. Of this school, Turgot was also an adherent, but his " Eeflexions on the Production and Distribution of Wealth " (1766) is as notable for its presentation of economics as a systematic whole as for its support of the opinions held by the group to which he belonged. The prominence attained by Physio- cratic teaching was due in part to the financial necessities of the State in France which preceded the Eevolution. Taxa- 28* 436 OUTLINES OF POLITICAL ECONOMY tion had become a matter of the first order of importance, and the Physiocrats were largely drawn into the problem of taxation by their peculiar views. Adam Smith. — The position of Adam Smith's " Wealth of Nations " is unique, and few works have come nearer attain- ing immortality. A volume at least would be needed to pick up all the threads of its author's relations to his forerunners and successors. A remarkable feature of his work is that it stands at a parting of the ways and reaches so far both backwards and forwards. With reference to the past, the " Wealth of Nations " is both assimilative and critical ; and with reference to the future, wonderfully constructive seeing that it was written before the industrial revolution, as we generally understand it, was sufficiently advanced to be pro- perly appreciated. There is no indication that Adam Smith foresaw modern conditions ; yet the " Wealth of Nations " naturally ranks among modern books and is correctly re- garded as the foundation of modern Economics. Though Adam Smith did not guess what the nineteenth century would be like, he hoed and harrowed the ground as if he did, and he presented the human side of economics as it was still found to be long after his death. He was helped to his conception of economics as a systematic whole by the work of the Physiocrats and particularly of Turgot. But his conception went beyond that of any of his contemporaries and predecessors, possibly because it went even beyond the domain proper of Economics. Adam Smith envisaged a comprehensive social philosophy, which he regarded as di- vided into three departments embracing respectively (a) conduct in general, (b) economics, and (c) law and politics. His " Theory of the Moral Sentiments" is in effect the first part of this system ; the " Wealth of Nations " is the second ; and, when death cut short his labours, he had for long been engaged on the third. On his instructions, this unfinished FROM EARLY TIMES TO ADAM SMITH 437 work was destroyed, but happily the lecture notes of a student who had attended this part of Adam Smith's course at Glasgow have been discovered and published. The " Wealth of Nations " is divided into five books. The first treats of " the causes of improvement in the productive powers of labour, and of the order according to which its pro- duce is naturally distributed among the different ranks of the people ". The second treats of " the nature, accumulation, and employment of stock," and the third of the " natural pro- gress of opulence" as contrasted with the results of attempts to direct and regulate it. The fourth part consists almost entirely of an assault on Mercantilism and discussion of the details of economic policy associated with it ; and in this book there is a brief examination of Physiocratic teaching. The fifth book is concerned with public finance. To the Physio- crats, Adam Smith is kindly disposed, because the end of economio freedom was theirs as well as his, and he had been in touch with some of the most distinguished of them when in France. He is emphatic, however, in exposing the cardinal error which gave rise to the over-emphasis of the importance of agriculture ; though the same blemish actually reappears faintly in his own discussion of the effects of using capital in different ways. In assailing Mercantilism, on the other hand, Adam Smith is harshly polemical, for one reason, we may suppose, because reform had yet to be achieved; still, the coolness of his underlying judgment is apparent in the concessions that he makes. Of restraints on trade, he was, moreover, impatient because of his belief in the exist- ence of a sort of natural law, which, in the absenoe of interference, worked to the attainment of the best possible results for the community. This doctrine, which governed the teaching of the Physiocrats also, he probably took over from the philosopher Frances Hutcheson; but with Adam Smith it was as much a reasoned eoonomio conclusion as a 438 OUTLINES OF POLITICAL ECONOMY superstition, and such faults as he fell into should be at- tributed in no small measure to the imperfections of his technical apparatus in the then primitive state of economic science. No doubt his distrust of politicians, whom he deemed "crafty and insidious," predisposed him to accept Hutcheson's doctrine ; but Adam Smith was nothing if not shrewd, and he was under no illusions about the incentives of the ordinary business man. For the details of his purely economic analysis, the reader must be referred to the " Wealth of Nations ". The germ at least of modern theories will be found where there is error, and error is seldom made prominent or left undiluted with truth, for Adam Smith was not only gifted with insight but was essentially a man of sane and cautious judgment. With the " Wealth of Nations ' ' this account of the development of Political Economy comes to a natural halting place. CHAPTEE XXXV. FEOM ADAM SMITH TO THE PRESENT TIME. The classical school and soma of its critics. — Within but a few decades of the publication of the " Wealth of Na- tions," the industrial system was feeling the convulsions of what was almost a re-birth. Not Adam Smith's period, but the next was the age of steam and steel, and it was not until steam and steel began to dominate it, that production fell into the mould of the factory system proper and the large scale organization associated with it. The first great econo- mist to write comprehensively in the new age, with the under- standing that came of growing up with it, was John Stuart Mill, whose merit it was to produce an adequate Political Economy in the general form in which we are familiar with that study to-day. But, before this, other eminent writers liad made contributions to the subject, notably Eicardo, Malthus, and Senior. In chronological order, the work of T. B. Malthus comes first, but it is not of prime significance in the development of economics as a whole. Malthus is celebrated for his discus- sion of the population question, and not for any stamp which his thought impressed on economics in general, though he also wrote a Political Economy. In 1798, he published his essay on the " Principles of Population " in its first form, to give a precise reason for his scepticism about the value of Godwin's and Condorcetfs dreams of social perfectibility. Malthus 433 440 OUTLINES OF POLITICAL ECONOMY put forward the pessimistic view that, given the imagined ideal, growth in numbers would soon level the general state of prosperity down again by swallowing up the material benefits accruing from it. He laid it down baldly that the human race tended to increase in a geometrical progression and food only in an arithmetical progression ; so that popula- tion would, inevitably, outrun the means of subsistence, but for the positive checks of war, pestilence, and famine. Later, he went into the whole question again, and supplemented his more or less a priori speculations with inductive and historical inquiries. The first edition of the new book ap- peared in 1803. In this work, he materially modified his original conclusions, and added to the " positive checks " the preventive one of moral restraint. Malthus was not the first to draw attention to the problem of population ; and it certainly cannot be affirmed that he stated it for all time. Indeed, many of the foroes governing population are still exceedingly obscure ; and, unquestionably, Malthus' pro- nouncements, in their application to social policy, would have been different if he had foreseen the advance that was to take place in roan's control over nature. After Adam Smith, the next great step in economics was taken by Bicardo, though previously Lord Lauderdale and Bentham made some contributions, including criticisms of Adam Smith, and others had written on the Continent to whom some reference will be made later. Bicardo was certainly one of the most original and path-breaking of the world's economists. Though a man of affairs, his interest was in fundamental theory, and his work is not, therefore, characteristic of any particular age, except that it embodies the early nineteenth century assumption of the existence and inevitableness of an all-pervading competition like an atmo- sphere. The main strength of Eicardo lay in his remarkable power of abstraction and generalization ; but, unfortunately, FROM ADAM SMITH TO THE PRESENT TIME 441 he was not equipped by nature or education with an equal power of scientific exposition. Generalizing so widely as he did, he was bound to move in an environment of changing assumptions, but he generally left his reader to guess what they were at each stage of his argument. Doubtless, he never analysed and marshalled them for himself, any more than the painter explains to himself why he selects in the particular way that he does in interpreting nature. Eicardo presents us always with the bare anatomical skeleton — with nothing that is not absolutely essential, to his mind, though he never explains why the things omitted are irrelevancies. He had none of Adam Smith's historical sense or extensive grasp of social facts ; his work is masterly in its clear-cut (though not clearly expounded) conceptions and rigid reason- ing, but it is as hard as concrete. Moreover, Eicardo's "Principles of Political Economy and Taxation" (1817) does not contain a complete science ; it is rather a collection of essays on unsettled economic questions — which were generally left settled for the time being and clamped in an inflexible theory by the time Eicardo had finished with them. He is famed especially for his doctrines, or improvements in doctrine, with reference to rent, money and international trade, whioh have survived in their substance nearly a century of further research ; while much of his remaining teaching, if not at all points satisfactory in itself, had the merit at least of concentrating inquiry where a great part of the truth was eventually found. The danger of all work like Eicardo's is, of course, that it gives rise to the doctrinaire. The chief fault of the school which he created probably lay in their too ready imposition of their theories where dogmatism was out of place, and their unfortunate attempts to read the future, without the aid of history, and in the sole light of abstractions from the present. One of the ablest of Eicardo's critics was Biohard Jones, who attacked him, in a work printed in 1831, 442 OUTLINES OF POLITICAL ECONOMY mainly on the question of distribution and on inductive grounds. The next writer after Eieardo of outstanding capacity is N. W. Senior. His " Political Economy " appeared in the " Encyclopaedia Metropolitan" in 1836, and was republished in 1850. He also wrote numerous lectures and essays. The distinctive feature of the Political Economy is its incisive deduction. Admittedly, it is too abstract, but it marked a stage in the evolution of theory. It is easier to qualify sweeping generalizations than to draw the generalizations that are of fundamental importance, and bring them into due relation and harmony with one another. As regards detail, Senior is best known, perhaps, for his abstinence theory of interest. Senior was a master of theory, but he by no means allowed his theory to shut him out from ob- servation. As a member of the famous Commission on the Poor Laws, he appears to have faced the facts in a proper spirit, and his writings on trade unions and factory legis- lation (" Historical and Philosophical Essays," 1865), if mistaken, were certainly not a priori in substance, though possibly a weft of fact woven on to a warp of doctrine. In this sketch of economics after Adam Smith, we have passed over James Mill and numerous other writers with about the same or greater claims to notice, as our purpose is to concentrate on landmarks. James Mill, who frequently discussed economic questions with Eieardo, and was a disciple of Bentham's, himself wrote a small Political Economy, but he is chiefly remembered as the father of the celebrated John Stuart Mill. Of the latter's work, it is impossible to write at moderate length, and there is no space to write adequately. Some broad references must, therefore, suffice — which is not altogether a matter for regret seeing that Mill may still be read with profit even by those who have no interest in the development of economics. He was FROM ADAM SMITH TO THE PRESENT TIME 443 no historian, but he was almost everything else ; and in this respect — in the breadth of his studies — he comes nearer to Adam Smith than any other of the economists of the past. Like Adam Smith, he was a social philosopher and like Adam Smith he had applied his mind to political science. With his all-round knowledge of social facts, and his grasp of logic and method, he was peculiarly well-equipped for the task to which he set himself of fitting together the fragments that made up the Political Economy of his day, filling in the gaps, and welding the whole together in a coherent system. His " Political Economy " (1848) was an achievement, but, naturally, it fell short of perfection. The parts on wages, for instance, were obviously open to criticism even in the light of the analysis of his day ; though he had a better answer to Thornton's attack on the wages fund doctrine than he seemed to think, and to Longe's also for the matter of that. Again, Mill's system lacks oohesion in places, some parts being only loosely attached to the rest, because of his failure to detect throughout the underlying identity of principle. Thus, he lays it down that distribution is inde- pendent of production and price determination, and is modi- fiable according to human institutions while the latter are not. In fact Mill had not reached the organic conception of a social system, despite his respect for the teaching of Comte. But his admission of elasticity in distribution was a sign of grace, and marked an advance on the absolutism of some of his predecessors. Prom Adam Smith to the time of Mill, Political Economy had progressed abroad as well as at home. In Germany Bau, Nebenius, Hermann, and Thilnen were notable among those who carried on the Smithian tradition, and the last in particular gained repute through his argument drawn from the abstract conception of the isolated state. Of the critics of Adam Smith, Midler was the most original. In Prance 444 OUTLINES OF POLITICAL ECONOMY J. B. Say was an attractive expositor of the fundamental ideas of the " Wealth of Nations " who did more than repeat. On the other hand, Sismondi and Bunoyer struck out lines of their own. The most brilliant protagonist of the competitive system in the latter part of this period was unquestionably Fr&deric Bastiat. His was the type of mind which is at its best, in the application of theories to affairs, when stimulated by controversy. Fortunately, the stimulus was not lacking, and he produced two works glowing with an animation that is inimitable outside France, his " Economic Sophisms " and " Economic Harmonies ". The mention of Bastiat must bring on to the stage two other economists, namely List and Carey, as the three stand, to some extent, in a triangular relationship to one another. Fried/rich List, who died in 1846, four years before Bastiat, struck the national note in economics and called his book the " National System of Political Economy " (1841). Its tone is not unlike that of Mercantilism, but it is not identical. As regards Free Trade, List thought it a good starting policy and a good finishing policy, but, for the period in between, he recom- mended a system of regulation specifically designed to further national ends. H. C. Carey, an American of Irish extrac- tion, may have been influenced to some extent by List, but his conclusions are not throughout of the same fibre. His final views appear in his " Principles of Social Science" (1859). He has much to say of general scientific interest, particularly in the way of criticism of the Eicardian doctrine of rent from the standpoint of a new country, but what brings him into juxtaposition with the two writers already mentioned is his plea that protection is needed for some countries to prevent the exhaustion of their natural resources. This fundamental idea has since been developed in America. The historical and socialistic reactions. — By the middle of the nineteenth century, the stream of reaction against the FROM ADAM SMITH TO THE PRESENT TIME 445 Classical School had become a flood, which did not indeed sweep it away, though happily denuding it of its dogmatism and self-complacency. The reaction was made up of the Historical School and the Socialists. The former is usually understood to embrace three overlapping groups, namely the Eealists (with and without an ethical bent), the Historical School proper, and the Nationalist or Political writers. The Eealists, pure and simple, maintained either that the deductive method was worthless and should be replaced by direct detailed investigation of things as they were, or that it should be sup- plemented by realistic inquiries. The Historical School, narrowly conceived, like the Eealistic, may be roughly divided into parties. On the one hand, the more arrogant saw no use in theory and proposed the substitution of Economic His- tory for Economic Theory. They contended that historical investigation could solve all the economic problems that can be solved. On the other hand, the most modest proposed to apply, through history, a corrective and auxiliary to the analytical method. Needless to say, just as extravagant claims were made by some of the Eealistic and Historical Schools, so they were not unknown on the part of the theorists. The main points in the controversy between the opposing parties have been discussed in Chapter II, but here it remains to add that the reaction, which was led by Eoscher, Hildebrand, and Knies, attracted a numerous com- pany, of whom Brentano, Schmoller, and Wagner are the most prominent. Indeed, it swept through and dominated German Universities, though not invariably in an extreme form, and time mollified some of its earlier asperities. In association with the historical and realistic movement, the National or Political idea of Economics, which we have already noticed in List, was also developed, mainly in later years. In France, the militant Historical School never secured a firm footing, though historical and realistic work of value 446 OUTLINES OF POLITICAL ECONOMY has been done there, and Comte's teaching had much in common with it. In England, Thorold Rogers and Cliffe Leslie voiced some of the new ideas. Many of the new German school were semi-socialistic in the sense that they admitted some of the charges of the socialists against society, and believed in using the engine of the State to a considerable extent. Hence, a group of them were known as the Socialists of the Chair — or Academic Socialists — but the complexion of their socialism was not, as a rule, highly coloured. And socialism is far from being all of one kind. That of St. Simon, if it may be called socialism, is of the Utopian order, and aristocratic in spirit in the way in which Carlyle's teaching, which was influenced by it, was aristocratic. Fourier also dealt with ideals as he conceived them, but as the communism that he recommended was to be made up of small groups of not more than 2000 people, called phalanstires, his schemes were shattered by the spread of the large-scale system of organization. Robert Owen's ideas at one time had muoh in common with Fourier's. These ideal creations appeared just after the French Bevolu- tion, when the notion of State-making seemed less fantastic than it does to-day. Economic socialism, as it may be termed, attained notoriety through the teaching of Karl Marx and Engels coupled with the activities of Lassalle. Karl Marx and Engels gave to working-class grievances, and the vague popular social better- ment notions for which the worst aspects of the industrial revolution were responsible, both arguments and definition, which were derived in part from certain English socialistic writers and from Rodbertus. In his work on " Capital," Karl Marx demonstrated from a misreading of Eicardo that capital resulted from the spoliation of the wage-earning classes. But whether he misread Eicardo or not, is to-day of little moment. The essential point is that the doctrine FROM ADAM SMITH TO THE PRESENT TIME 447 that labour is the sole source of value, and has, therefore, a right to the whole produce of industry, on which his de- monstration rests, is not held by any economist to-day. He also maintained, again using an economic generalization which is undoubtedly untrue, namely the so-called iron or brazen law of wages (pp. 334-5), that the wage-earner could not benefit from progress ; and it became a cardinal tenet of economic socialism that the poor must get poorer in non- socialistic surroundings. Thus, Karl Marx found justification for some drastic change in social organization. Moreover, he contended that reconstruction was inevitable, because the competitive system was self-destructive. The commercial crisis was, in his view, the incurable disease, inherent in competitive organization, which was bound to get worse and worse and eventually compass its dissolution. This he tried to establish by an historical survey, and he confidently fore- told that so overwhelming a crisis would be reached at last that recovery would be impossible, and a new world would have to arise from the ruin. What exactly it would be like he never satisfactorily explained, but it was to mean the socialization of the means of production. And, in his opinion, when the collapse came, industry would be in a form suited to the assumption of a dictatorship by the proletariat, for he regarded it as a law of competition that great businesses should destroy smaller ones and increasingly absorb the market. Time has disproved the sensational parts of the teaching of Karl Marx and of Engels, who was closely associated with him ; but, without any distinctive socialistic economics, it needs no ingenuity to make out a case for social amelioration. Socialistic economics were after all but the counterpart of the equally baseless optimism of the laisser faire school at its worst. Since the time of Karl Marx, State socialism has received most support. This won its position through the 448 OUTLINES OF POLITICAL ECONOMY advance of democratic government, and it pins its faith to a wide extension of State management in the economic field. Of late, however, there has been some reaction from it, in favour of schemes that are associated with what is called syndicalism in its more revolutionary form and guild socialism in its moderate form, which imply a system of autonomous trades on a democratic basis. After John Stuart Mill.— The work of John Elliott Gairnes, whose " Some Leading Principles of Political Economy Newly Expounded " appeared in 1874, is closely connected with the Classical School, the doctrines of which he aimed at developing and improving. His most distinctive contribution was his conception of non-competing groups in the population, and his consequent extension of the principles of international trade to the distribution of wealth. Of the writers in the generation after Mill, William, Stanley Jevons showed the most versatility and originality ; and it would by no means be easy to say whether his greatest work in economics was done in the development of theory or the application of inductive and particularly statistical methods of inquiry to economics. He realized to the full the technical potentialities of Utilitarianism, and in his " Theory of Political Economy " (1871), with the aid of the calculus, he applied it to the foundations of economics. In the use of mathematics he had predecessors : among these mention may be made of Cournot, who put forth his mathematical researches as early as 1838, Gossen, whose speculations followed in 1853, and Fleeming Jenkin, who, just before the appearance of Jevons' "Theory of Political Economy,' 7 had published some sug- gestive papers and diagrammatic illustrations. But Jevons' work was more deep-seated and far-reaching. It may be that the Utilitarianism on which he relied has been so honeycombed with criticism since, that it has crumbled away ; but this, as it happens, is a point of small importance FROM ADAM SMITH TO THE PRESENT TIME 449 since the psychology of economic inducements that has taken its place, serves equally well for the application of the calculus. The permanent value of his work lay not in his interpretation of what he measured, but in his method of measuring with the calculus, and in the underlying idea of continuous relationships between economic forces. Jevons' method led to some notable additions to the theory of ex- change. It is a remarkable thing that Walras, a French writer, about the same time, and quite independently, made the same discoveries. As striking in themselves, though not so fruitful in results, were Jevons' inductive inquiries. Their feature is the perfec- tion of their scientific method ; Jevons assimilated research in positive economics to research in the natural sciences. Trained as a scientist, the bent of his mind to investigation is comprehensible, and his profound grasp of scientific method was brought out in his "Principles of Science". Of these inductive inquiries of Jevons', the best known are his measure- ment of the rise in prices due to the gold discoveries, and his brilliant papers in support of the generalization known as the sun-spot theory of trade cycles. For his work already men- tioned, Jevons occupies an important place in the evolution of economics ; but this was not all that he did or did well. His " State in Eelation to Labour " and " Methods of Social Eeform " showed a capacity to handle the less measurable aspects of certain economic problems ; his books on the "Coal Question" and "Money" (which he was specially qualified to write after his experience for a few years in the Mint at Melbourne) are faithfully realistic and admirably leavened with theory ; and his Political Economy, pub- lished many years after his death, would have added to his services to economics in no trifling degree if it had appeared earlier. The Austrian School, whose leading members were 29 450 OUTLINES OF POLITICAL ECONOMY C. Menger, Wieser, and Bohm-Bawerk, investigated the roots of value on lines not unlike Jevons' but without the mathe- matics. They penetrated further into the psychological deter- minants of value than previous thinkers and thus opened up a new field of research. Bohm-Bawerk' s work is confined to Capital and Interest, and he has at least revealed depths in this subject that were unsuspected before he wrote. The inquiries of the Austrian School have done something to encourage cer- tain interesting lines of development in American economics. Of other writers of this age, mention may be made of Fawcett, Bagehot, whose " Lombard Street " is a classic, Sidgwich, and the evergreen Francis A. Walker, who exercised a great in- fluence on the development of economic studies in the United States, and exhibited in all his writings sturdy common sense and remarkable clarity of thought and lucidity of expression. The awkward task of appraising the work of prominent living writers will not be essayed here, but a few words must be said of the part played in the progress of economics by Marshall and Bdgeworth whose pens are still active. This exception must be made to round off our account of the evolution of Political Economy, because their contributions have in no small measure shaped the science as it is ex- pounded in tbis book. Both, as mathematicians, had an equipment that was of great value for the development of theory as they found it. Alfred Marshall has never neglected the realistic side of economics, but the part of his work upon which emphasis will be laid now is the theoretical. Marshall, for the first time, revealed the unity of the economic system, and pre- sented it as a coherent whole of inter-related parts, func- tioning in mutual dependence upon one another. In his account, a theory, as one may say, takes the place of discon- nected theories. To some extent, but in a less degree, the same kind of unification has been worked out by /. B. Clark FROM ADAM SMITH TO THE PBEBENT TIME 451 in the United States. It is true that Marshall's great book, " The Principles of Economics," first published in 1890, is unfinished, Vol. I only having appeared so far ; but this volume is complete in itself, and though, for instance, it does not cover money, the principles contained in it can be so obviously applied to money, that the theory of money in certain books issued since may be not incorrectly attributed to Marshall. International trade is another large section that is not included, but the theory of this sort of exchange was profoundly affected by the teaching of the Principles ; and, as a matter of fact, in an unpublished memorandum that has been read by numerous economists, Marshall has sketched the doctrines that are now commonly expounded. Coming to detail, without repeating what has gone before 01 attempting to be exhaustive, we may notice, among Marshall's additions to economics, the clear distinction between the long and the short period ; the doctrine of consumer's surplus ; the doctrine of quasi-rent ; and the expansion and refinement of the rent concept. F. Y. Edgeworth has confined himself to the minute in vestigation of particular problems with the instrument of mathematics. His researches have appeared for the most part in the " Economic Journal " and other scientific journals in the United Kingdom and abroad : only one book stands to his name, a brief and early work entitled " Mathematical Psychics " (1881). He writes almost entirely for the econ- omic expert, and is, therefore, little known to the general public, but the results of his investigations are steadily work- ing their way into the recognized body of economics. His earliest discovery was the contract curve, which has a close bearing on questions of distribution and foreign trade. After this, his most important inquiries were probably those relating to international trade, the incidence of taxation, profits, and monopoly and differential charges. 29* 452 OUTLINES OF POLITICAL ECONOMY Political Economy has by no means reached a position of settlement. The Historical School is still making good its undertakings, while it goes without saying that in a changing world the task of realism never ends ; the field of sociology is being broken into ; and theory is being unceasingly revised and improved. When time has been given to grasp the full significance of what has occurred in consequence of the war, some striking developments may be witnessed. APPENDIX. SELECT LIST OP BOOKS. Aitek mastering these outlines, those who desire to make a more complete study of Political Economy should read : — Marshall, Principles of Economics and Industry and Trade. Nicholson, Principles of Political Economy, three vols. Taussig, Principles of Economics, two vols. Of recent, or comparatively recent outlines in English, or treatises on a smaller scale than the two referred to above, mention may be made of those by Bullock, Ely, Fetter, Flux, Gide (trans- lated from French), Hadley, Nicholson, Seager, Seligman, and Walker. The student who aims at getting an all-round knowledge of Political Economy would benefit from examining a few of these works, each of which naturally differs from the present volume in some respects— either in point of view, manner of treatment, or matters of detail. The most important general treatises in foreign languages are : — in German, those by Conrad, Cohn (Vol. II on Finance, translated), Philippovich, Roscher (Vol. I, translated), Schmoller (translated into French), and Wagner (translated into French) ; in French, those by Cauwes, Colson, Gide, Landry, Leroy-Beaulieu, and Pareto ; in Dutch, Pierson's two volumes (translated) ; and, in Italian, Graziani's work. The literature of Political Economy is so voluminous that it is impossible to do more now than indicate some few of the most modern books in English which might be perused by those who are specially interested in particular sections of the subject ; and it is not likely that I have been so fortunate as to have omitted no work which ought to be mentioned. In putting forward the list that 453 454 OUTLINES OF POLITICAL ECONOMY follows I may offer a word of caution. It must be remembered that many parts of Political Economy, particularly parts which touch conflicting interests, or opinions as regards State action, are con- troversial. Consequently many economic works, which are not in- tended for beginners and deliberately made impartial, must be read in an especially questioning frame of mind. In the appended col- lection, books have been placed in the class which seems to have the first claim upon them though they may rightfully belong to more than one class. Scope, Method, Fundamental Ideas and Consumption : J. N. Keynes, Scope and Method of Political Economy ; Patten, Con- sumption of Wealth ; and Smart, Introduction to the Theory oj Value. Capital and Interest : Bohm-Bawerk, Theories of Interest and Positive Theory of Capital (both translated with introductions by Smart); Cassel, Nature and Necessity of Interest ; Gonner, Interest and Saving; Irving Fisher, Nature of Capital and The Rate oj Interest. Mahkets : Emery, Stock and Produce Exchanges ; Jones, Eco- nomic Crises ; Mitchell, Business Cycles ; Robertson, Study oj Industrial Fluctuation ; Withers, Stocks and Shares. (For books on the Money Market see under the heading " Money and Bank- mg".) Industries : It must suffice here merely to mention that numer- ous studies of particular industries and businesses have been made. Trusts and Combinations : Ely, Monopolies and Trusts ; Jenks, The Trust Problem; Levy, Monopoly and Competition (trans.); Macgregor, Industrial Combination; Macrosty, The Trust Move- ment in British Industry ; Eipley, Trusts, Pools, and Corporations. Co-operation: Fay, Co-operation at Home and Abroad; In- dustrial Co-operation, edited by Catherine Webb ; Wolffs People's Banks. International Trade : Bastable, International Trade ; Fisk, International Commercial Policies ; Goschen, Foreign Exchanges. Money and Banking : Bagehot, Lombard St. ; Clare, Money Market Primer ; Conant, Principles of Money and Banking ; Dar- win, Bimetallism; Irving Fisher, The Purchasing Power of Money ; J. M. Keynes, Indian Currency and Finance ; Layton, Introduction APPENDIX 455 to the Study of Prices ; Withers, The Meaning of Money and The War and Lombard St. Jevons, Laughlin, Nicholson, and Walker have also produced works on Money. Small books on banking have been written by Attfield, Dunbar, and Sykes. Wages and Labour. Questions : Beveridge, Unemployment ; Bowley, Wages in the United Kingdom in the XIX Century (statis- tical) ; Brasaey and Chapman, Wages and Employment and Social Betterment; Gilman, Profit-sharing; Knoop, Industrial Arbitra- tion ; Layton, Capital and Labour ; Pigou, Methods of Industrial Peace and Unemployment ; Schloss, Methods of Industrial Re- muneration ; Taussig, Wages and Capital ; Webb, Industrial Demo- cracy ; Ashley, Adjustment of Wages. Mathematical Economics : All who are sufficiently equipped with a knowledge of mathematics should read at least the Appendix to Marshall's Principles of Economics. Other mathematical exposi- tions in English are : Cunynghame, Geometry of Political Economy ; Edgeworth, Mathematical Psychics ; the Appendix to Flux's Eco- nomic Principles ; Jevons, Theory of Political Economy ; Wicksteed, Alphabet of Economic Science. General : Cannan, Wealth ; Carver, Distribution of Wealth ; Clark, Distribution of Wealth and Essentials of Economic Theory ; Hobson, The Industrial System and Evolution of Modern Capitalism ; Pantaleoni, Pure Economics (trans.) ; Pigou, Wealth and Welfare ; Sidgwick, Political Economy ; Smart, Distribution of Income ; D. A. Wells, Recent Economic Changes; Wicksteed, Commonsense of Political Economy ; Wieser, Natural Value (trans.). Public Finance and Taxation : Bastable, Public Finance; Pigou, Protective and Preferential Import Duties ; Seligman, Shift- ing and Incidence of Taxation, and The Income Tax. Introductory Manuals on Public Finance have been prepared by Armitage-Smith, Daniels, and Plehn. Public Economics: The field of Public Economics, including Socialism and Economic and Social Legislation, is too extensive for any satisfactory recommendations as to reading to be made in this brief bibliography. Portions of many of the works mentioned above cover some of the ground. Statistics : Bowley, Elements of Statistics and Elementary Manual of Statistics ; Giffen's Essays ; Jevons' Essays ; Mayo- 456 OUTLINES OF POLITICAL ECONOMY Smith, Science of Statistics ; Udny Yule, Introduction to the Theory of Statistics (highly mathematical). History op Political Economy : Bonar, Philosophy and Politic cal Economy and Malthus and his Work; Canaan, Production and Distribution in English Political Economy ; Cossa, Guide to the Study of Political Economy ; Gide and Rist, History of Economic Doctrines ; Haney, History of Economic Thought ; Higgs, The Physiocrats ; Ingram, History of Political Economy (Ed. by W. A Scott) ; Price, Political Economy in England. Portions at least of the works of some of the following writers in English should be read by those who are making themselves ac- quainted with the history of Political Economy : Adam Smith, Ricardo, Malthus, Senior, J. S. Mill, Cairnes, Cliffe Leslie, and Jevons. Economic History : Introductory Sketches of English Economic History have been written by Cheyney, Cunningham and McArthur, Meredith, Price, and Townsend Warner. The most comprehensive works are Cunningham's and Ashley's. The latter is not yet com- pleted. Treatises on special topics and periods cannot be men- tioned here. Journals : The official journal of the Royal Economic Society is the Economic Journal. Notices of the contents of current issues of the chief journals abroad will be found at the end of each num- ber. The American Econo nvic Review is the organ of the American Economic Association. Of American economic journals there are many. The Journal of tlie Royal Statistical Society and the Quarterly Publications of the American Statistical Association should be added to the list of journals in English. Dictionaries : Palgrave's Dictionary of Political Economy will be found of value as a work of reference. The most exhaustive dictionary is the Handworterbuch der Staatswissenschaften, edited by Conrad, Elster, Lexis, and Loening (8 vols.). Schonberg's Handbuch der Politischen Oekonomie contains many interesting monographs . Official Publications : The statistical and other publications of Public Offices contain much useful information. Some of the re- ports of Commissions and Select Committees are of particular value. INDEX. Absteact method, 13-17. Accident, insurance against, 386. Adaptability of productive system, 71-2. Agents in production, 68. supply prices of, 327-31. Agricultural systems, 132-5. Aid, public, 390-3. Alternative demand (see substi- tutes). — supply, 66-7, 172-5. Amortization, principle of, 419. Anticipating, risks of, 124-8. Appreciation of money, 217-8. Arbitration, 350-1, 384. Arts of economics, 5, 6. Assimilation, social, 11-13. Austrian School, 449-50. Bank Act, English, 243-4. — amalgamation, 233-4. Banking in relation to trade cycles, 276-7. — loans, 223-8. — reserve, 226. — theory, 223-34. Banks, function of, 232-3. — interdependence of, 233-4. Bargaining, collective, 344-6. Barter, 151-5, 206-9. Bastiat, 444. Bearing, 123. Bentham, 440, 442. Betterment, 405-6. Bimetallism, 248-52. Bounties, 370-2. Brassage, 239. Bulling, 123. Businesses, elasticity of, 100. Businesses, growth of, 92-100. — marginal, 39. — private, 135-8. — specialization of, 100-4. Caibkes, 448. Calls, 117. Cameralists, 433-4, Cantillon, 435. Capital, 73-82. — auxiliary, 78. — circulating, 79. — consumers', 78. — demand for, 281-3. — effect of progress on demand for, 291-2 — fixed, 79, 293-6. — industrial, 78. — international immobility of, 193-4. — markets for, 119-20. — natural, 77. — personal, 77. — production with, a round-about process, 80-2. — saving of, 283-5. — social, 73-6. — specialized, 79. — supply and demand, interaction of, 287-9. Carey, 444. Casual labour, 355-6. Cheques, 231-2, 241-2. Child, 433. Circulating capital, 79. Circulation of money, 213. Clark, 450-1. Coinage, debased, 239, 244. — free, 238-40. 467 458 OUTLINES OF POLITICAL ECONOMY Coinage, gratuitous, 239. Coining credit, 229. Collective bargaining, 344-6. Colonial preference, 374. Comforts, 59-62. Commerce, distinguished from in- dustry, 65. Commercial organization, reactions of on industrial organization, 130-1. Companies, 135-8. Comparative values, doctrine of, 194-7, 199-200. Competition, 150-1, 362-7, 383, S93-4. Competition between labour grades, 329-31. Complements, 27, 37-8. Composite demand and supply, 172-3. Conciliation, 350. Constant returns, 106-8. Consumers' capital, 78. — surplus, 49-54. Contract curve, 155. Control of economic enterprise by State, 369-70. Co-operation, 138-42. Co-operative credit, 142. Co-partnership, 141-2. — tenants, 142. Copyright, 372. Cost, 166-7. — marginal, 166. — prime, 178. — supplementary, 178 (see also supply prices). Credit, co-operative, 142. — • during the war, 263-5. — money, 229-32, 241-2. — trade in, 226-7. Currency, 235-52. — and arts, distribution of gold between, 212-4. — debased, 239, 244. — paper, 244-8. Cycles, trade (see fluctuations). Debts, public, 406-10. Decreasing returns, 106-12. abstract law of, 110. Decreasing returns, realistic law of, 110. Deductive method, 13-17. Degressive taxation, 402. Demand, 23-7, 40-4, 157-60, 177. _ — alternative (see also substi- tutes), 173-4. — and supply in relation to agents of production (see interest, rent, wages). — equilibrium of, 168-72, 179-80. — composite, 173. — elasticity of, 42-3. — joint, 27, 172-5. — marginal, 40. — market, 40, 41. — psychological basis of, 23-5. — systems of, 25-7. Depreciation of money, 217-8. Differences, dealing in, 118. Differential advantages, 297-317. Differentiation of markets, 116. — of productive systems, 128-30. Diminishing returns (see decreas- ing returns). — utility, 28-35. Discriminations, price, 184-5. Distribution, analysis and sum- mary of, 278-9, 336-9. Divisions of political economy, 18-19. Dumping, 185-7, 374-5. Dynamics, economic, 7. Economic man, 14. — studies, classification of, 7-8. Edgeworth, 451. Efficiency, necessaries of, 60. — of labour, 70-1. Elasticity of businesses, 100. — of demand, 42-3. for money, 218. — ■ of taxes, 405. Engels, 446-7. Entrepreneurs, function of, 69. Equilibrium, normal and sub-nor- mal, 168-72, 179-80. Equi-marginal returns in busi- nesses, 97-9. ■ in consumption, 44-9. in exchange, 152. INDEX 459 Equi-marginal returns in produc- tion, 97-9. Ethics, economic, 5-6. Evolutionary economics, 6-7. — law of increasing returns, 111- 12. Exchanges, foreign, 253-65. — labour, 356-9, 384. — produce, 116-9. — stock, 119. Exports, bounties on, 371. — duties on, 422, 424, 425. — effects of foreign loans on, 202-3. — invisible, 202. External economies, 104. Factobs in production (see agents in production). Factory Acts, 380-3. Pair trade, 375. Firm, marginal, 39, 162-3. — normal, 160-6. — representative, 164. Fluctuations in trade, explanations of, 267-77. — — banking in relation to, 276-7. periodicity of, 266-7. synchronism of, 266-7. Foreign exchanges, 253-65. during the war, 263-4. — trade (see international trade). Fourier, 446. Free Will, 9-10. Futures, 116-9, 126-8. Geogbaphicai/ factors, influence of, on production, 71. Gold, distribution of, between arts and currency, 212-4. — exchange system, 250. — methods of stopping foreign drains of, 257-9. Goods, nature and classification of, 56-9. Gournay, 435. Government (see State). Grade, selling by, 116. Gresham's law, 240-1, 432. Group production, 93, 336. Growth of businesses, 92-100. Habits, 26. Health Acts, 380-3. Historical methods, 17. Historical School, 15-17, 444-6. History, economic, 6-7. Hours of labour, 341-4. Housing, 890. Hume, 433. Impact of tax, 411-3. Imports, duties on, 372-6, 422-5. — effects of foreign loans on, 202-3. — English balance of, 202. — invisible, 202. — pay for exports, 200-2. Incidence of taxes, 411-27. Inconvertible money, 244-6. Increasing returns, 106-12. abstract law of, 109-10. evolutionary law of, 111-2. realistic law of, 110. Index numbers, 220-2. Indifference curve, 155. — law of (see equi-marginal re- turns). Inductive method, 17. Industrial peace, methodsof, 349-51. — organization, reactions of com- mercial organization on, 130-1. Industries, localization of, 104-5. — walled and unwalled, 100. Industry, distinguished from com- merce, 65. Instrumental goods, 73-4. Insurance against accident, sick- ness and unemployment, 359- 60, 386. — state in relation to, 385-8. — and saving, 286-7. Interest, 278-96. — effect of, on saving, 284-5. — - — -of progress on rate of, 291-2. — ■ gross and net, 279-81. — possibility of zero rate, 289-91. Internal economies, 104. International immobility of labour and capital, 193-4. — trade, 192-205. — — most-favoured-nation clause, 375. — values, 197-200. 460 OUTLINES OF POLITICAL ECONOMY Jevons, 448-9. Joint demand, 27, 172-5. — supply, 66-7, 173-5. — utility of complements and of substitutes, 37-8. Jones, 441-2. Kaktels, 144-8. Laboub, casual, 355-6. — displacement of, by machinery, 83-6. — effect of specialization and ma- chinery on, 88-90. ■ — efficiency of, 70-1. — Exchanges, 356-9, 384. — grades of, 326-9. — hours of, 341-4. — international immobility of, 193-4. — marginal, 39. — mobility, geographical, 329. horizontal, 329. vertical, 329-31. — productive, 66. — specialized, productive advan- tages of, 87-8. — supplies of, 326-8. Laissez faire, 393-4. Land, marginal, 39. value of, 302-5. — taxes on, 414-20 (see also agri- cultural systems, decreasing returns, and rent). Leaseholders, 134-5. Legal tender, 236-7. Life, standard of, 13. Limping standard, 250. List, 444. Loans, bank, 225-8. — foreign, 202-5. — public, 406-10. Localization of industries, 104-5. — of markets, 114. Long-period effects, 157-60. Luxuries, 59-62. Machinery, displacement of labour by, 83-6. — economy of, 83-4, 88-90. Malthus, 439-40. Marginal cost, 96-8, 166. — demand, 40. — firm, 39, 162-3. — land (see land and rent). — returns of business, 96. — thing and marginal use of thing, 38-9. — utility, 28-35, 55-6. of money, 47-9. — value of agents in production (see interest, rent, wages). — workman (see labour). Marketing function, 124-5. Markets, 113-31. — evolution of, 114-6. — for capital, 119-20. — private, 130. Marshall, 450-1. Marx, 446-7. Measurable data, 18. Mediation, 350. Mercantilism, 432-4. Metayage, 133-4. Methods, abstract, historical, in- ductive and realistic, 13-17. Mill, 442-3. Minimum sensibles, 48-9. Mintage, 239. Monetary problems during the war, 263-5. Money, appreciation of, 217-8. — artificial, 238. — classification of, 235-41. — commodity, choice of, 209-11. — credit, 229-32, 241-8. — depreciation of, 217-8. — determination of the purchasing power of, 211-7. — elasticity of demand for, 21S. — functions of, summarized, 217. — inconvertible, 244-8. — marginal utility of, 47-8. — natural, 238. — standard, 237-8. — token, 241. Monopoly, classes of, 142-4. — limitations of, 190-1. — prices, theory of, 181-91. — social, 143. — taxes on, 422 (see also kartels and trusts). INDEX 461 More, 431. Mun, 433. Necessaries, 59-62. — conventional, 62. — of efficiency, 60. — of life, 60. Normal effects, 157-60. — firms, 160-4. — man, the, 15. — price, 168-75. Normative science of economics, 2-6. North, 433. Note issue, natural limits of, 229-31. government limitation of, 242-4. Opportunities, State in relation to provision of, 388-9. Options, 117. Oresrne, 430. Owen, 446. Patents, 372. Peasant proprietorship, 132-3. Pensions, old age, 387. Periodic settlements, 118. Perpetualism, fallacy of, 8. Petty, 433. Physiocrats, 434-6. Politics, relation of economics to, 2-3. Positive science of economics, 2-6. Preference, colonial, 374. Price discriminations, 184-5. — marginal demand, 40. — market demand, 40-1. — monopoly, 181-91. — of fixed stocks, 155-6. — normal (long period), 168-75. — sub-normal (short period), 178-9. — steadiness and its effects, 120-1. Prices, index numbers of, 220-2. Prime cost, 178. Private enterprise, advantages and defects of, 135-8, 362-7. Producers' surplus, 339-41. Production, agents in, 68. Production, definition and classi- fication of, 63-7. — group, 93. — influence of geographical factors on, 71. — law of substitution in, 97-9. — responsiveness of, 68, 71-2. — with capital a round-about pro- cess, 80-2 (see also cost). Productive labour, 66. — organization, types of, 132-48. — system, adaptability of, 71-2. — systems, differentiation of, 128-30. Profits, 321-6. — definition of, 326 (see also in- terest). Profit-sharing, 349. Progressive taxation, 400-2. Protective import duties, 372, 422-5. Psychological basis of demand, 23-5 Public aid, 390-3. — debts, 406-10. — Health Acts, 380-3. — revenues, 395-7. Purchasing power of money, 211-5. Puts, 117. Quasi-rent, 315-7. Quesnay, 435. Rates, 414-8. Eeciprocity, 375. Regressive taxation, 402. Rent, meaning of, 97-8. — of building sites, 309-11. — of differential fertility, 298- 302. — personal, 311-3. — quasi, 315-7. — relation to price, 313-5. — situational, 307-11. Repercussion of taxes, 411-3. Reserves, 226, 257-62. Responsiveness of production, 68, 71-2. Retaliation, 375. Revenues, public, 395-7. 462 OUTLINES OF POLITICAL ECONOMY Eicardo, 440-1. Eodbertus, 446. Boiling of taxes, 411-3. St. Simon, 446. Sample, selling by, 115. Satiability of wants, 35-9. Satisfaction (see utility). — doctrine of maximum, 393-4. Saving, dependent on power to save, 285-6. will, 283-4. — effect of insurance on, 286-7. rise in rate of interest on, 284-5. — taxes on, 413-4. Seasonal unemployment, 353-4. Seigniorage, 239. Selfishness, 16, 17, 150. Senior, 442. Settlements, periodic, 118. Shifting of taxes, 411-3. Short period, 176-8. equilibrium, 179-80. prices, 178-9. Sickness, insurance against, 386. Sliding scales, 347-9. Smith, Adam, 88, 436-8. Social assimilation, 11-3. Socialism, 446-8. Specialization, 94-6. — by process and product, 103-4. — effect on labour, 88-90. — of agents, economies of, 86-8. ■ — of businesses, 100-4. Specialized capital, 79. Specie points, 254-6. Speculation, effect on prices, 121-4. Standard, limping, 250. — money, 237-8. — of life, 13, 25. Standardization, 90. State control, 369-70. during the war, 263-5, 376-9. — economic action, classification of, 361-2. — in relation to housing, 389-90. social insurance, 385 8. • — ■ — the provision of oppor tunities, 388-9. — industries, 367-9. State, laws of, to facilitate busi- ness, 376. limitation of note issues, 242-4. provision of higher social goods, 389-90. — of work, 385. Statics, economic, 7. Stewart, 433. Stock Exchange, 119. Stocks, fixed, price of, 155-6. Sub-normal prices, 178-9. Subsidies, 370-2. Substitutes, 27, 174. joint utility of, 37-8. Substitution, law of (see equi-mar- ginal returns). Sun-spot theory, 268-9. Supplementary costs, 178. Supply, alternative, 67, 168. — composite, 168. — joint, 66-7, 172-5. — prices, normal, 160-6. of factors in production, 339 (see also interest,profits,wages). — and demand (see demand and supply). Surplus, consumers', 49-54. — producers', 339-41. Sweating, wages boards to prevent, 351. Symmetallism, 250. Syndicalism, 448. Taxation, degressive, 402. — faculty theory, 399-400. Taxation, principle of clearness in, 404. of convenience in, 403-4. of economy in, 402-3. of equity in, 397-400. — progressive, 400-2. — regressive, 402. Taxes, oonnected with land, 414-20. — definition of, 397. — direct, 411. — elasticity of, 405. — impact of, 411. — incidence of, 411-27. — indirect, 411. — on commodities, 420-1. — on income, 413-4. INDEX 463 Taxes, on monopolies, 422, — on property, 413-4. — on savings, 414. — on transfers, 414, 421. — on services, 420-1. — repercussion, rolling or shifting of, 411-3. Token money, 241. Trade, balance of, 200-2, 256. — fluctuations (see fluctuations). — international, 192-205. — unions, 344-6. Transfers, taxes on, 414, 421. Trimetallism, 250. Truck Acts, 383. Trusts, 144-8. Turgot, 435, 436. Undertakers, functions of, 69. Unearned increment, 405-6. Unemployment, causes of, 353-6. — means of mitigating the distress caused by, 359-60. — remedies for, 356-9. Unions, trade, 344-6. Universalism, fallacy of, 8. Utility, 21-5. — basis of laws of, 38. — consumers' surplus of, 49-52. ■ — diminishing, 28-35. — elemental, 56. — form, 56. — joint, of substitutes, 37-8. — marginal, 28-30. ■ of money, 48-9. — place, 56. Utility, producers' surplus of, 339- 41. — time, 56. — total, 28-30 (see also equimar- ginal returns). Utopia, 431. Value in use, 55-6. Values, comparative, doctrine of, ■ 194-7, 199. — international, 197-200. Wages boards, anti-svreating, 3 joints, 350-1. — determination of, 318-26, 33 — fund doctrine, 333-5. — group piece rates, 347. — iron or brazen law of, 334-5. — piece-rates, 347. — premium systems, 346-7. — sliding scales, 347-9. — subsistence theory, 332. — time rates, 346. Walker, 450. Walras, 449. Wants, 21-3. — satiability of, 35-7. War, credit during the, 263-5. — foreign exchanges, during the, 263-4. — loans, 406-10. — monetary problems during the, 263-5. — state control during the, 263-5, 376-9. Wealth, 56-9. FEINTED IN QBEAT BRITAIN BY THE UNIVERSITY PRESS, ABERDEEN