Principles of Political Economy

Book II, Chapter XV: Of Profits

CHAPTER XV.: of Profits

§ 1. Having treated of the labourer' share of the produce, we next proceed to the share of the capitalist; the profits of capital or stock; the gains of the person who advances the expenses of production—who, from funds in his possession, pays the wages of the labourers, or supports them during the work; who supplies the requisite buildings, materials, and tools or machinery; and to whom, by the usual terms of the contract, the produce belongs, to be disposed of at his pleasure. After indemnifying him for his outlay, there commonly remains a surplus, which is his profit; the net income from his capital: the amount which he can afford to spend in necessaries or pleasures, or from which by further saving he can add to his wealth.

As the wages of the labourer are the remuneration of labour, so the profits of the capitalist are properly, according to Mr. Senior' well-chosen expression, the remuneration of abstinence. They are what he gains by forbearing to consume his capital for his own uses, and allowing it to be consumed by productive labourers for their uses. For this forbearance he requires a recompense. Very often in personal enjoyment he would be a gainer by squandering his capital, the capital amounting to more than the sum of the profits which it will yield during the years he can expect to live. But while he retains it undiminished, he has always the power of consuming it if he wishes or needs; he can bestow it upon others at his death; and in the meantime he derives from it an income, which he can without impoverishment apply to the satisfaction of his own wants or inclinations.

Of the gains, however, which the possession of a capital enables a person to make, a part only is properly an equivalent for the use of the capital itself; namely, as much as a solvent person would be willing to pay for the loan of it. This, which as everybody knows is called interest, is all that a person is enabled to get by merely abstaining from the immediate consumption of his capital, and allowing it to be used for productive purposes by others. The remuneration which is obtained in any country for mere abstinence, is measured by the current rate of interest on the best security: such security as precludes any appreciable chance of losing the principal. What a person expects to gain, who superintends the employment of his own capital, is always more, and generally much more, than this. The rate of profit greatly exceeds the rate of interest. The surplus is partly compensation for risk. By lending his capital, on unexceptionable security, he runs little or no risk. But if he embarks in business on his own account, he always exposes his capital to some, and in many cases to very great, danger of partial or total loss. For this danger he must be compensated, otherwise he will not incur it. He must likewise be remunerated for the devotion of his time and labour. The control of the operations of industry usually belongs to the person who supplies the whole or the greatest part of the funds by which they are carried on, and who, according to the ordinary arrangement, is either alone interested, or is the person most interested (at least directly), in the result. To exercise this control with efficiency, if the concern is large and complicated, requires great assiduity, and often, no ordinary skill. This assiduity and skill must be remunerated.

The gross profits from capital, the gains returned to those who supply the funds for production, must suffice for these three purposes. They must afford a sufficient equivalent for abstinence, indemnity for risk, and remuneration for the labour and skill required for superintendence. These different compensations may be either paid to the same, or to different persons. The capital, or some part of it, may be borrowed: may belong to some one who does not undertake the risks or the trouble of business. In that case, the lender, or owner, is the person who practises the abstinence; and is remunerated for it by the interest paid to him, while the difference between the interest and the gross profits remunerates the exertions and risks of the undertaker.∗. Sometimes, again, the capital, or a part of it, is supplied by what is called a sleeping partner; who shares the risks of the employment, but not the trouble, and who, in consideration of those risks, receives not a mere interest, but a stipulated share of the gross profits. Sometimes the capital is supplied and the risk incurred by one person, and the business carried on exclusively in his name, while the trouble of management is made over to another, who is engaged for that purpose at a fixed salary. Management, however, by hired servants, who have no interest in the result but that of preserving their salaries, is proverbially inefficient, unless they act under the inspecting eye, if not the controlling hand, of the person chiefly interested: and prudence almost always recommends giving to a manager not thus controlled, a remuneration partly dependent on the profits; which virtually reduces the case to that of a sleeping partner. Or finally, the same person may own the capital, and conduct the business; adding, if he will and can, to the management of his own capital, that of as much more as the owners may be willing to trust him with. But under any or all of these arrangements, the same three things require their remuneration, and must obtain it from the gross profit: abstinence, risk, exertion. And the three parts into which profit may be considered as resolving itself, may be described respectively as interest, insurance, and wages of superintendence.

§ 2. The lowest rate of profit which can permanently exist, is that which is barely adequate, at the given place and time, to afford an equivalent for the abstinence, risk, and exertion implied in the employment of capital. From the gross profit, has first to be deducted as much as will form a fund sufficient on the average to cover all losses incident to the employment. Next, it must afford such an equivalent to the owner of the capital for forbearing to consume it, as is then and there a sufficient motive to him to persist in his abstinence. How much will be required to form this equivalent depends on the comparative value placed, in the given society, upon the present and the future: (in the words formerly used) on the strength of the effective desire of accumulation. Further, after covering all losses, and remunerating the owner for forbearing to consume,1. there must be something left to recompense the labour and skill of the person who devotes his time to the business. This recompense too must be sufficient to enable at least the owners of the larger capitals to receive for their trouble, or to pay to some manager for his, what to them or him will be a sufficient inducement for undergoing it. If the surplus is no more than this, none but large masses of capital will be employed productively; and if it did not even amount to this, capital would be withdrawn from production, and unproductively consumed, until, by an indirect consequence of its diminished amount, to be explained hereafter, the rate of profit was raised.

Such, then, is the minimum of profits: but that minimum is exceedingly variable, and at some times and places extremely low; on account of the great variableness of two out of its three elements. That the rate of necessary remuneration for abstinence, or in other words the effective desire of accumulation, differs widely in different states of society and civilization, has been seen in a former chapter. There is a still wider difference in the element which consists in compensation for risk. I am not now speaking of the differences in point of risk between different employments of capital in the same society, but of the very different degrees of security of property in different states of society. Where, as in many of the governments of Asia, property is in perpetual danger of spoliation from a tyrannical government, or from its rapacious and ill-controlled officers; where to possess or to be suspected of possessing wealth, is to be a mark not only for plunder, but perhaps for personal ill-treatment to extort the disclosure and surrender of hidden valuables; or where, as in the European Middle Ages, the weakness of the government, even when not itself inclined to oppress, leaves its subjects exposed without protection or redress to active spoliation, or audacious withholding of just rights, by any power individual; the rate of profit which persons of average dispositions will require, to make them forego the immediate enjoyment of what they happen to possess, for the purpose of exposing it and themselves to these perils, must be something very considerable. And these contingencies affect those who live on the mere interest of their capital, in common with those who personally engage in production. In a generally secure state of society, the risks which may be attendant on the nature of particular employments seldom fall on the person who lends his capital, if he lends on good security; but in a state of society like that of many parts of Asia, no security (except perhaps the actual pledge of gold or jewels) is good: and the mere possession of a hoard, when known or suspected, exposes it and the possessor to risks, for which scarcely any profit he could expect to obtain would be an equivalent; so that there would be still less accumulation than there is, if a state of insecurity did not also multiply the occasions on which the possession of a treasure may be the means of saving life or averting serious calamities. Those who lend under these wretched governments, do it at the utmost peril of never being paid. In most of the native states of India, the lowest terms on which any one will lend money, even to the government, are such, that if the interest is paid only for a few years, and the principal not at all, the lender is tolerably well indemnified. If the accumulation of principal and compound interest is ultimately compromised at a few shil1ings in the pound, he has generally made an advantageous bargain.

§ 3. The remuneration of capital in different employments, much more than1. the remuneration of labour, varies according to the circumstances which render one employment more attractive, or more repulsive, than another. The profits, for example, of retail trade, in proportion to the capital employed, exceed those of wholesale dealers or manufacturers, for this reason among others, that there is less consideration attached to the employment. The greatest, however, of these differences, is that caused by difference of risk. The profits of a gunpowder manufacturer must be considerably greater than the average, to make up for the peculiar risks to which he and his property are constantly exposed. When, however, as in the case of marine adventure, the peculiar risks are capable of being, and commonly are, commuted for a fixed payment, the premium of insurance takes its regular place among the charges of production, and the compensation which the owner of the ship or cargo receives for that payment, does not appear in the estimate of his profits, but is included in the replacement of his capital.

The portion, too, of the gross profit, which forms the remuneration for the labour and skill of the dealer or producer, is very different in different employments. This is the explanation always given of the extraordinary rate of apothecaries' profit; the greatest part, as Adam Smith observes, being frequently no more than the reasonable wages of professional attendance; for which, until a late alteration of the law, the apothecary could not demand any remuneration, except in the prices of his drugs. Some occupations require a considerable amount of scientific or technical education, and can [1848] only be carried on by persons who combine with that education a considerable capital. Such is the business of an engineer, both in the original sense of the term, a machine-maker, and in its popular or derivative sense, an undertaker of public works. These are always the most profitable employments. There are cases, again, in which a considerable amount of labour and skill is required to conduct a business necessity of limited extent. In such cases, a higher than common rate of profit is necessary to yield only the common rate of remuneration. “In a small seaport-town,” says Adam Smith, “a little grocer will make forty or fifty per cent upon a stock of a single hundred pounds, while a considerable wholesale merchant in the same place will scarce make eight or ten per cent upon a stock of ten thousand. The trade of the grocer may be necessary for the conveniency of the inhabitants, and the narrowness of the market may not admit the employment of a larger capital in the business. The man, however, must not only live by his trade, but live by it suitably to the qualifications which it requires. Besides possessing a little capital, he must be able to read, write, and account, and must be a tolerable judge, too, of perhaps fifty or sixty different sorts of goods, their prices, qualities, and the markets where they are to be had cheapest. Thirty or forty pounds a year cannot be considered as too great a recompense for the labour of a person so accomplished. Deduct this from the seemingly great profits of his capital, and little more will remain, perhaps, than the ordinary profits of stock. The greater part of the apparent profit is, in this case, too, real wages.”

All the natural monopolies (meaning thereby those which are created by circumstances, and not by law) which produce or aggravate the disparities in the remuneration of different kinds of labour, operate similarly between different employments of capital. If a business can only be advantageously carried on by a large capital, this in most countries limits so narrowly the class of persons who can enter into the employment, that they are enabled to keep their rate of profit above the general level. A trade may also, from the nature of the case, be confined to so few hands, that profits may admit of being kept up by a combination among the dealers. It is well known that even among so numerous a body as the London booksellers, this sort of combination long continued to exist.1. I have already mentioned the case of the gas and water companies.

4. After due allowance is made for these various causes of inequality, namely, differences in the risk or agreeableness of different employments, and natural or artificial monopolies; the rate of profit on capital in all employments tends to an equality. Such is the proposition usually laid down by political economists, and under proper explanations it is true.

That portion of profit which is properly interest, and which forms the real remuneration for abstinence, is strictly the same, at the same time and place, whatever be the employment. The rate of interest, on equally good security, does not vary according to the destination of the principal, though it does vary from time to time very much according to the circumstances of the market. There is no employment in which, in the present state of industry, competition is so active and incessant as in the lending and borrowing of money. All persons in business are occasionally, and most of them constantly, borrowers: while all persons not in business, who possess monied property, are lenders. Between these two great bodies there is a numerous, keen, and intelligent class of middlemen, composed of bankers, stockbrokers, discount brokers, and others, alive to the slightest breath of probable gain. The smallest circumstance, or the most transient impression on the public mind, which tends to an increase or diminution of the demand for loans either at the time or prospectively, operates immediately on the rate of interest: and circumstances in the general state of trade, really tending to cause this difference of demand, are continually occurring, sometimes to such an extent, that the rate of interest on the best mercantile bills has been known to vary in little more than a year (even without the occurrence of the great derangement called a commercial crisis) from four, or less, to eight or nine per cent. But, at the same time and place, the rate of interest is the same, to all who can give equally good security. The market rate of interest is at all times a known and definite thing.

It is far otherwise with gross profit; which, though (as will presently be seen) it does not vary much from employment to employment, varies very greatly from individual to individual, and can scarcely be in any two cases the same. It depends on the knowledge, talents, economy, and energy of the capitalist himself, or of the agents whom he employs; on the accidents of personal connexion; and even on chance. Hardly any two dealers in the same trade, even if their commodities are equally good and equally cheap, carry on their business at the same expense, or turn over their capital in the same time. That equal capitals give equal profits, as a general maxim of trade, would be as false as that equal age or size gives equal bodily strength, or that equal reading or experience gives equal knowledge. The effect depends as much upon twenty other things, as upon the single cause specified.

But though profits thus vary, the parity on the whole, of different modes of employing capital (in the absence of any natural or artificial monopoly) is, in a certain and a very important sense, maintained. On an average (whatever may be the occasional fluctuations) the various employments of capital are on such a footing as to hold out not equal profits, but equal expectations1. of profit, to persons of average abilities and advantages. By equal, I mean after making compensation for any inferiority in the agreeableness or safety of an employment. If the case were not so; if there were, evidently, and to common experience, more favourable chances of pecuniary success in one business than in others, more persons would engage their capital in the business, or would bring up their sons to it; which in fact always happens when a business, like that of an engineer at present [1848], or like any newly established and prosperous manufacture, is seen to be a growing and thriving one. If, on the contrary, a business is not considered thriving; if the chances of profit in it are thought to be inferior to those in other employments; capital gradually leaves it, or at least new capital is not attracted to it; and by this change in the distribution of capital between the less profitable and the more profitable employments, a sort of balance is restored. The expectations of profit, therefore, in different employments, cannot long continue very different: they tend to a common average, though they are generally oscillating from one side to the other side of the medium.

This equalizing process, commonly described as the transfer of capital from one employment to another, is not necessarily the onerous, slow, and almost impracticable operation which it is very often represented to be. In the first place, it does not always imply the actual removal of capital already embarked in an employment. In a rapidly progressive state of capital, the adjustment often takes place by means of the new accumulations of each year, which direct themselves in preference towards the more thriving trades. Even when a real transfer of capital is necessary, it is by no means implied that any of those who are engaged in the unprofitable employment relinquish business and break up their establishments. The numerous and multifarious channels of credit, through which, in commercial nations, unemployed capital diffuses itself over the field of employment, flowing over in greater abundance to the lower levels, are the means by which the equalization is accomplished. The process consists in a limitation by one class of dealers or producers, and an extension by the other, of that portion of their business which is carried on with borrowed capital. There is scarcely any dealer or producer on a considerable scale, who confines his business to what can be carried on by his own funds. When trade is good, he not only uses to the utmost his own capital, but employs, in addition, much of the credit which that capital obtains for him. When, either from over-supply or from some slackening in the demand for his commodity, he finds that it sells more slowly or obtains a lower price, he contracts his operations, and does not apply to bankers or other money dealers for a renewal of their advances to the same extent as before. A business which is increasing holds out, on the contrary, a prospect of profitable employment for a larger amount of this floating capital than previously, and those engaged in it become applicants to the money dealers for larger advances, which, from their improving circumstances, they have no difficulty in obtaining. A different distribution of floating capital between two employments has as much effect in restoring their profits to an equilibrium, as if the owners of an equal amount of capital were to abandon the one trade and carry their capital into the other. This easy, and as it were spontaneous, method of accommodating production to demand, is quite sufficient to correct any inequalities arising from the fluctuations of trade, or other causes of ordinary occurrence. In the case of an altogether declining trade, in which it is necessary that the production should be, not occasionally varied, but greatly and permanently diminished, or perhaps stopped altogether, the process of extricating the capital is, no doubt, tardy and difficult, and almost always attended with considerable loss; much of the capital fixed in machinery, buildings, permanent works, &c. being either not applicable to any other purpose, or only applicable after expensive alterations; and time being seldom given for effecting the change in the mode in which it would be effected with least loss, namely, by not replacing the fixed capital as it wears out. There is besides, in totally changing the destination of a capital, so great a sacrifice of established connexion, and of acquired skill and experience, that people are always very slow in resolving upon it, and hardly ever do so until long after a change of fortune has become hopeless. These, however, are distinctly exceptional cases, and even in these the equalization is at last effected. It may also happen that the return to equilibrium is considerably protracted, when, before one inequality has been corrected, another cause of inequality arises; which is said to have been continually the case, during a long series of years, with the production of cotton in the Southern States of North America; the commodity having been upheld at what was virtually a monopoly price, because the increase of demand, from successive improvements in the manufacture, went on with a rapidity so much beyond expectation that for many years the supply never completely overtook it. But it is not often that a succession of disturbing causes, all acting in the same direction, are known to follow one another with hardly any interval. Where there is no monopoly, the profits of a trade are likely to range sometimes above and sometimes below the general level, but tending always to return to it; like the oscillations of the pendulum.

In general, then, although profits are very different to different individuals, and to the same individual in different years, there cannot be much diversity at the same time and place in the average profits of different employments, (other than the standing differences necessary to compensate for difference of attractiveness,) except for short periods, or when some great permanent revulsion has overtaken a particular trade. If any popular impression exists that some trades are more profitable than others, independently of monopoly, or of such rare accidents as have been noticed in regard to the cotton trade, the impression is in all probability fallacious, since if it were shared by those who have greatest means of knowledge and motives to accurate examination, there would take place such an influx of capital as would soon lower the profits to the common level. It is true that, to persons with the same amount of original means, there is more chance of making a large fortune in some employments than in others. But it would be found that in those same employments, bankruptcies also are more frequent, and that the chance of greater success is balanced by a greater probability of complete failure. Very often it is more than balanced: for, as was remarked in another case, the chance of great prizes operates with a greater degree of strength than arithmetic will warrant, in attracting competitors; and I doubt not that the average gains, in a trade in which large fortunes may be made, are lower than in those in which gains are slow, though comparatively sure, and in which nothing is to be ultimately hoped for beyond a competency. The timber trade of Canada is [1848] one example of an employment of capital partaking so much of the nature of a lottery, as to make it an accredited opinion that, taking the adventurers in the aggregate, there is more money lost by the trade than gained by it; in other words, that the average rate of profit is less than nothing. In such points as this, much depends on the characters of nations, according as they partake more or less of the adventurous, or, as it is called when the intention is to blame it, the gambling spirit. This spirit is much stronger in the United States than in Great Britain; and in Great Britain than in any country of the Continent. In some Continental countries the tendency is so much the reverse, that safe and quiet employments probably yield a less average profit to the capital engaged in them, than those which offer greater gains at the price of greater hazards.

It must not however be forgotten, that even in the countries of most active competition, custom also has a considerable share in determining the profits of trade. There is sometimes an idea afloat as to what the profit of an employment should be, which though not adhered to by all the dealers, nor perhaps rigidly by any, still exercises a certain influence over their operations. There has been in England a kind of notion, how widely prevailing I know not, that fifty per cent is a proper and suitable rate of profit in retail transactions: understand, not fifty per cent on the whole capital, but an advance of fifty per cent on the wholesale prices; from which have to be defrayed bad debts, shop rent, the pay of clerks, shopmen, and agents of all descriptions, in short all the expenses of the retail business. If this custom were universal, and strictly adhered to, competition indeed would still operate, but the consumer would not derive any benefit from it, at least as to price; the way in which it would diminish the advantages of those engaged in the retail trade, would be by a greater subdivision of the business. In some parts of the Continent the standard is as high as a hundred per cent. The increase of competition however, in England at least, is rapidly tending to break down customs of this description. In the majority of trades (at least in the great emporia of trade), there are now numerous dealers whose motto is, “small gains and frequent” —a great business at low prices, rather than high prices and few transactions; and by turning over their capital more rapidly, and adding to it by borrowed capital when needed, the dealers often obtain individually higher profits; though they necessarily lower the profits of those among their competitors, who do not adopt the same principle.1;. Nevertheless, competition, as remarked∗. in a previous chapter, has, as yet, but a limited dominion over retail prices; and consequently the share of the whole produce of land and labour which is absorbed in the remuneration of mere distributors, continues exorbitant; and there is no function in the economy of society which supports a number of persons so disproportioned to the amount of work to be performed.

§ 5. The preceding remarks have, I hope, sufficiently elucidated what is meant by the common phrase, “the ordinary rate of profit;” and the sense in which, and the limitations under which, this ordinary rate has a real existence. It now remains to consider, what causes determine its amount.

2. To popular apprehension it seems as if the profits of business depended upon prices. A producer or dealer seems to obtain his profits by selling his commodity for more than it cost him. Profit altogether, people are apt to think, is a consequence of purchase and sale. It is only (they suppose) because there are purchasers for a commodity, that the producer of it is able to make any profit. Demand—customers—a market for the commodity, are the cause of the gains of capitalists. It is by the sale of their goods, that they replace their capital, and add to its amount.

This, however, is looking only at the outside surface of the economical machinery of society. In no case, we find, is the mere money which passes from one person to another, the fundamental matter in any economical phenomenon. If we look more narrowly into the operations of the producer, we shall perceive that the money he obtains for his commodity is not the cause of his having a profit, but only the mode in which his profit is paid to him.

The cause of profit is, that labour produces more than is required for its support. The reason why agricultural capital yields a profit, is because human beings can grow more food, than is necessary to feed them while it is being grown, including the time occupied in constructing the tools, and making all other needful preparations: from which it is a consequence, that if a capitalist undertakes to feed the labourers on condition of receiving the produce, he has some of it remaining for himself after replacing his advances. To vary the form of the theorem: the reason why capital yields a profit, is because food, clothing, materials, and tools, last longer than the time which was required to produce them; so that if a capitalist supplies a party of labourers with these things, on condition of receiving all they produce, they will, in addition to reproducing their own necessaries and instruments, have a portion of their time remaining, to work for the capitalist. We thus see that profit arises, not from the incident of exchange, but from the productive power of labour; and the general profit of the country is always what the productive power of labour makes it, whether any exchange takes place or not. If there were no division of employments, there would be no buying or selling, but there would still be profit. If the labourers of the country collectively produce twenty per cent more than their wages, profits will be twenty per cent, whatever prices may or may not be. The accidents of price may for a time make one set of producers get more than the twenty per cent, and another less, the one commodity being rated above its natural value in relation to other commodities, and the other below, until prices have again adjusted themselves; but there will always be just twenty per cent divided among them all.

I proceed, in expansion of the considerations thus briefly indicated, to exhibit more minutely the mode in which the rate of profit is determined.

§ 6. I assume, throughout, the state of things, which, where the labourers and capitalists are separate classes, prevails, with few exceptions, universally; namely, that the capitalist advances the whole expenses, including the entire remuneration of the labourer. That he should do so, is not a matter of inherent necessity; the labourer might wait until the production is complete, for all that part of his wages which exceeds mere necessaries; and even for the whole, if he has funds in hand, sufficient for his temporary support. But in the latter case, the labourer is to that extent really a capitalist, investing capital in the concern, by supplying a portion of the funds necessary for carrying it on; and even in the former case he may be looked upon in the same light, since, contributing his labour at less than the market price, he may be regarded as lending the difference to his employer, and receiving it back with interest (on whatever principle computed) from the proceeds of the enterprise.

The capitalist, then, may be assumed to make all the advances, and receive all the produce. His profit consists of the excess of the produce above the advances; his rate of profit is the ratio which that excess bears to the amount advanced. But what do the advances consist of?

It is, for the present, necessary to suppose, that the capitalist does not pay any rent; has not to purchase the use of any appropriated natural agent. This indeed is scarcely ever the exact truth. The agricultural capitalist, except when he is the owner of the soil he cultivates, always, or almost always, pays rent: and even in manufactures, (not to mention ground-rent,) the materials of the manufacture have generally paid rent, in some stage of their production. The nature of rent, however, we have not yet taken into consideration; and it will hereafter appear, that no practical error, on the question we are now examining, is produced by disregarding it.

If, then, leaving rent out of the question, we inquire in what it is that the advances of the capitalist, for purposes of production, consist, we shall find that they consist of wages of labour.

A large portion of the expenditure of every capitalist consists in the direct payment of wages. What does not consist of this, is composed of materials and implements, including buildings. But materials and implements are produced by labour; and as our supposed capitalist is not meant to represent a single employment, but to be a type of the productive industry of the whole country, we may suppose that he makes his own tools, and raises his own materials. He does this by means of previous advances, which, again, consist wholly of wages. If we suppose him to buy the materials and tools instead of producing them, the case is not altered: he then repays to a previous producer the wages which that previous producer has paid. It is true, he repays it to him with a profit; and if he had produced the things himself, he himself must have had that profit, on this part of his outlay, as well as on every other part. The fact, however, remains, that in the whole process of production, beginning with the materials and tools, and ending with the finished product, all the advances have consisted of nothing but wages; except that certain of the capitalists concerned have, for the sake of general convenience, had their share of profit paid to them before the operation was completed. Whatever, of the ultimate product, is not profit, is repayment of wages.

§ 7. It thus appears that the two elements on which, and which alone, the gains of the capitalists depend, are, first, the magnitude of the produce, in other words, the productive power of labour; and secondly, the proportion of that produce obtained by the labourers themselves; the ratio, which the remuneration of the labourers bears to the amount they produce. These two things form the data for determining the gross amount divided as profit among all the capitalists of the country; but the rate of profit, the percentage on the capital, depends only on the second of the two elements, the labourer' proportional share, and not on the amount to be shared. If the produce of labour were doubled, and the labourers obtained the same proportional share as before, that is, if their remuneration was also doubled, the capitalists, it is true, would gain twice as much; but as they would also have had to advance twice as much, the rate of their profit would be only the same as before.

We thus arrive at the conclusion of Ricardo and others, that the rate of profits depends on wages; rising as wages fall, and falling as wages rise. In adopting, however, this doctrine, I must insist upon making a most necessary alteration in its wording. Instead of saying that profits depend on wages, let us say (what Ricardo really meant) that they depend on the cost of labour.

Wages, and the cost of labour; what labour brings in to the labourer, and what it costs to the capitalist; are ideas quite distinct, and which it is of the utmost importance to keep so. For this purpose it is essential not to designate them, as is almost always done, by the same name. Wages, in public discussions, both oral and printed, being looked upon from the point of view of the payers, much oftener than from that of the receivers, nothing is more common than to say that wages are high or low, meaning only that the cost of labour is high or low. The reverse of this would be oftener the truth: the cost of labour is frequently at its highest where wages are lowest. This may arise from two causes. In the first place, the labour, though cheap, may be inefficient. In no European country are wages so low as they are (or at least were1.) in Ireland: the remuneration of an agricultural labourer in the west of Ireland not being more than half the wages of even the lowest-paid Englishman, the Dorsetshire labourer. But if, from inferior skill and industry, two days' labour of an Irishman accomplished no more work than an English labourer performed in one, the Irishman' labour cost as much as the Englishman' , though it brought in so much less to himself. The capitalist' profit is determined by the former of these two things, not by the latter. That a difference to this extent really existed in the efficiency of the labour, is proved not only by abundant testimony, but by the fact, that notwithstanding the lowness of wages, profits of capital are not understood to have been higher in Ireland than in England.

The other cause which renders wages, and the cost of labour, no real criteria of one another, is the varying costliness of the articles which the labourer consumes. If these are cheap, wages, in the sense which is of importance to the labourer, may be high, and yet the cost of labour may be low; if dear, the labourer may be wretchedly off, though his labour may cost much to the capitalist. This last is the condition of a country over-peopled in relation to its land; in which, food being dear, the poorness of the labourer' real reward does not prevent labour from costing much to the purchaser, and low wages and low profits co-exist. The opposite case is exemplified in the United States of America. The labourer there enjoys a greater abundance of comforts than in any other country of the world, except some of the newest colonies; but owing to the cheap price at which these comforts can be obtained (combined with the great efficiency of the labour), the cost of labour to the capitalist is at least not higher, nor the rate of profit lower, than in Europe.1.

The cost of labour, then, is, in the language of mathematics, a function of three variables: the efficiency of labour; the wages of labour (meaning thereby the real reward of the labourer); and the greater or less cost at which the articles composing that real reward can be produced or procured. It is plain that the cost of labour to the capitalist must be influenced by each of these three circumstances, and by no others. These, therefore, are also the circumstances which determine the rate of profit; and it cannot be in any way affected except through one or other of them. If labour generally became more efficient, without being more highly rewarded; if, without its becoming less efficient, its remuneration fell, no increase taking place in the cost of the articles composing that remuneration; or if those articles became less costly, without the labourer' obtaining more of them; in any one of these three cases, profits would rise. If, on the contrary, labour became less efficient (as it might do from diminished bodily vigour in the people, destruction of fixed capital, or deteriorated education); or if the labourer obtained a higher remuneration, without any increased cheapness in the things composing it; or if, without his obtaining more, that which he did obtain became more costly; profits, in all these cases, would suffer a diminution. And there is no other combination of circumstances, in which the general rate of profit of a country, in all employments indifferently, can either fall or rise.

The evidence of these propositions can only be stated generally, though, it is hoped, conclusively, in this stage of our subject. It will come out in greater fulness and force when, having taken into consideration the theory of Value and Price, we shall be enabled to exhibit the law of profits in the concrete—in the complex entanglement of circumstances in which it actually works. This can only be done in the ensuing Book. One topic still remains to be discussed in the present one, so far as it admits of being treated independently of considerations of Value; the subject of Rent; to which we now proceed.1.

Book II, Chapter XVI: Of Rent

CHAPTER XVI.: of Rent

§ 1. The requisites of production being labour, capital, and natural agents; the only person, besides the labourer and the capitalist, whose consent is necessary to production, and who can claim a share of the produce as the price of that consent, is the person who, by the arrangements of society, possesses exclusive power over some natural agent. The land is the principal of the natural agents which are capable of being appropriated, and the consideration paid for its use is called rent. Landed proprietors are the only class, of any number or importance, who have a claim to a share in the distribution of the produce, through their ownership of something which neither they nor any one else have produced. If there be any other cases of a similar nature, they will be easily understood, when the nature and laws of rent are comprehended.

It is at once evident, that rent is the effect of a monopoly; though the monopoly is a natural one, which may be regulated, which may even be held as a trust for the community generally, but which cannot be prevented from existing. The reason why landowners are able to require rent for their land, is that it is a commodity which many want, and which no one can obtain but from them. If all the land of the country belonged to one person, he could fix the rent at his pleasure. The whole people would be dependent on his will for the necessaries of life, and he might make what conditions he chose. This is the actual state of things in those Oriental kingdoms in which the land is considered the property of the state. Rent is then confounded with taxation, and the despot may exact the utmost which the unfortunate cultivators have to give. Indeed, the exclusive possessor of the land of a country could not well be other than despot of it. The effect would be much the same if the land belonged to so few people, that they could, and did, act together as one man, and fix the rent by agreement among themselves. This case, however, is nowhere known to exist: and the only remaining supposition is that of free competition; the landowners being supposed to be, as in fact they are, too numerous to combine.

§ 2. A thing which is limited in quantity, even though its possessors do not act in concert, is still a monopolized article. But even when monopolized, a thing which is the gift of nature, and requires no labour or outlay as the condition of its existence, will, if there be competition among the holders of it, command a price, only if it exists in less quantity than the demand. If the whole land of a country were required for cultivation, all of it might yield a rent. But in no country of any extent do the wants of the population require that all the land, which is capable of cultivation, should be cultivated. The food and other agricultural produce which the people need, and which they are willing and able to pay for at a price which remunerates the grower, may always be obtained without cultivating all the land; sometimes without cultivating more than a small part of it; the lands most easily cultivated being preferred in a very early stage of society;1. the most fertile, or those in the most convenient situations, in a more advanced state. There is always, therefore, some land which cannot, in existing circumstances, pay any rent; and no land ever pays rent, unless, in point of fertility or situation, it belongs to those superior kinds which exist in less quantity than the demand—which cannot be made to yield all the produce required for the community, unless on terms still less advantageous than the resort to less favoured soils.

There is land, such as the deserts of Arabia, which will yield nothing to any amount of labour; and there is land, like some of our hard sandy heaths, which would produce something, but, in the present state of the soil, not enough to defray the expenses of production. Such lands, unless by some application of chemistry to agriculture still remaining to be invented, cannot be cultivated for profit, unless some one actually creates a soil, by spreading new ingredients over the surface, or mixing them with the existing materials. If ingredients fitted for this purpose exist in the subsoil, or close at hand, the improvement even of the most unpromising spots may answer as a speculation: but if those ingredients are costly, and must be brought from a distance, it will seldom answer to do this for the sake of profit, though the “magic of property” will sometimes effect it. Land which cannot possibly yield a profit, is sometimes cultivated at a loss, the cultivators having their wants partially supplied from other sources; as in the case of paupers, and some monasteries or charitable institutions, among which may be reckoned the Poor Colonies of Belgium. The worse land which can be cultivated as a means of subsistence, is that which will just replace the seed, and the food of the labourers employed on it, together with what Dr. Chalmers calls their secondaries; that is, the labourers required for supplying them with tools, and with the remaining necessaries of life. Whether any given land is capable of doing more than this, is not a question of political economy, but of physical fact. The supposition leaves nothing for profits, nor anything for the labourers except necessaries: the land, therefore, can only be cultivated by the labourers themselves, or else at a pecuniary loss: and à fortiori, cannot in any contingency afford a rent. The worst land which can be cultivated as an investment for capital, is that which, after replacing the seed, not only feeds the agricultural labourers and their secondaries, but affords them the current rate of wages, which may extend to much more than mere necessaries; and leaves for those who have advanced the wages of these two classes of labourers, a surplus equal to the profit they could have expected from any other employment of their capital. Whether any given land can do more than this, is not merely a physical question, but depends partly on the market value of agricultural produce. What the land can do for the labourers and for the capitalist, beyond feeding all whom it directly or indirectly employs, of course depends upon what the remainder of the produce can be sold for. The higher the market value of produce, the lower are the soils to which cultivation can descend, consistently with affording to the capital employed, the ordinary rate of profit.

As, however, differences of fertility slide into one another by insensible gradations; and differences of accessibility, that is, of distance from markets, do the same; and since there is land so barren that it could not pay for its cultivation at any price; it is evident that, whatever the price may be, there must in any extensive region be some land which at that price will just pay the wages of the cultivators, and yield to the capital employed the ordinary profit, and no more. Until, therefore, the price rises higher, or until some improvement raises that particular land to a higher place in the scale of fertility, it cannot pay any rent. It is evident, however, that the community needs the produce of this quality of land; since if the lands more fertile or better situated than it, could have sufficed to supply the wants of society, the price would not have risen so high as to render its cultivation profitable. This land, therefore, will be cultivated; and we may lay it down as a principle that so long as any of the land of a country which is fit for cultivation, and not withheld from it by legal or other factitious obstacles, is not cultivated, the worst land in actual cultivation (in point of fertility and situation together) pays no rent.

§ 3. If, then, of the land in cultivation, the part which yields least return to the labour and capital employed on it gives only the ordinary profit of capital, without leaving anything for rent; a standard is afforded for estimating the amount of rent which will be yielded by all other land. Any land yields just as much more than the ordinary profits of stock, as it yields more than what is returned by the worst land in cultivation. The surplus is what the farmer can afford to pay as rent to the landlord; and since, if he did not so pay it, he would receive more than the ordinary rate of profit, the competition of other capitalists, that competition which equalizes the profits of different capitals, will enable the landlord to appropriate it. The rent, therefore, which any land will yield, is the excess of its produce beyond what would be returned to the same capital if employed on the worst land in cultivation. This is not, and never was pretended to be, the limit of metayer rents, or of cottier rents; but it is the limit of farmers' rents. No land rented to a capitalist farmer will permanently yield more than this; and when it yields less, it is because the landlord foregoes a part of what, if he chose, he could obtain.

This is the theory of rent, first propounded at the end of the last century by Dr. Anderson, and which, neglected at the time, was almost simultaneously rediscovered, twenty years later, by Sir Edward West, Mr. Malthus, and Mr. Ricardo. It is one of the cardinal doctrines of political economy; and until it was understood, no consistent explanation could be given of many of the more complicated industrial phenomena. The evidence of its truth will be manifested with a great increase of clearness, when we come to trace the laws of the phenomena of Value and Price. Until that is done, it is not possible to free the doctrine from every difficulty which may present itself, nor perhaps to convey, to those previously unacquainted with the subject, more than a general apprehension of the reasoning by which the theorem is arrived at. Some, however, of the objections commonly made to it, admit of a complete answer even in the present stage of our inquiries.

It has been denied that there can be any land in cultivation which pays no rent; because landlords (it is contended) would not allow their land to be occupied without payment. Those who lay any stress on this as an objection, must think that land of the quality which can but just pay for its cultivation, lies together in large masses, detached from any land of better quality. If an estate consisted wholly of this land, or of this and still worse, it is likely enough that the owner would not give the use of it for nothing; he would probably (if a rich man) prefer keeping it for other purposes, as for exercise, or ornament, or perhaps as a game preserve. No farmer could afford to offer him anything for it, for purposes of culture; though something would probably be obtained for the use of its natural pasture, or other spontaneous produce. Even such land, however, would not necessarily remain uncultivated. It might be farmed by the proprietor; no unfrequent case even in England. Portions of it might be granted as temporary allotments to labouring families, either from philanthropic motives, or to save the poor-rate; or occupation might be allowed to squatters, free of rent, in the hope that their labour might give it value at some future period. Both these cases are of quite ordinary occurrence. So that even if an estate were wholly composed of the worst land capable of profitable cultivation, it would not necessarily lie uncultivated because it could pay no rent. Inferior land, however, does not usually occupy, without interruption, many square miles of ground; it is dispersed here and there, with patches of better land intermixed, and the same person who rents the better land, obtains along with it inferior soils which alternate with it. He pays a rent, nominally for the whole farm, but calculated on the produce of these parts alone (however small a portion of the whole) which are capable of returning more than the common rate of profit. It is thus scientifically true, that the remaining parts pay no rent.

§ 4. Let us, however, suppose that there were a validity in this objection, which can by no means be conceded to it; that when the demand of the community had forced up food to such a price as would remunerate the expense of producing it from a certain quality of soil, it happened nevertheless that all the soil of that quality was withheld from cultivation, by the obstinacy of the owners in demanding a rent for it, not nominal, nor trifling, but sufficiently onerous to be a material item in the calculations of a farmer. What would then happen? Merely that the increase of produce, which the wants of society required, would for the time be obtained wholly (as it always is partially), not by an extension of cultivation, but by an increased application of labour and capital to land already cultivated.

Now we have already seen that this increased application of capital, other things being unaltered, is always attended with a smaller proportional return. We are not to suppose some new agricultural invention made precisely at this juncture; nor a sudden extension of agricultural skill and knowledge, bringing into more general practice, just then, inventions already in partial use. We are to suppose no change, except a demand for more corn, and a consequent rise of its price. The rise of price enables measures to be taken for increasing the produce, which could not have been taken with profit at the previous price. The farmer uses more expensive manures; or manures land which he formerly left to nature; or procures lime or marl from a distance, as a dressing for the soil; or pulverizes or weeds it more thoroughly; or drains, irrigates, or subsoils portions of it, which at former prices would not have paid the cost of the operation; and so forth. These things, or some of them, are done, when, more food being wanted, cultivation has no means of expanding itself upon new lands. And when the impulse is given to extract an increased amount of produce from the soil, the farmer or improver will only consider whether the outlay he makes for the purpose will be returned to him with the ordinary profit, and not whether any surplus will remain for rent. Even, therefore, if it were the fact, that there is never any land taken into cultivation, for which rent, and that too of an amount worth taking into consideration, was not paid; it would be true, nevertheless, that there is always some agricultural capital which pays no rent, because it returns nothing beyond the ordinary rate of profit: this capital being the portion of capital last applied—that to which the last addition to the produce was due: or (to express the essentials of the case in one phrase), that which is applied in the least favourable circumstances. But the same amount of demand, and the same price, which enable this least productive portion of capital barely to replace itself with the ordinary profit, enable every other portion to yield a surplus proportioned to the advantage it possesses. And this surplus it is, which competition enables the landlord to appropriate. The rent of all land is measured by the excess of the return to the whole capital employed on it, above what is necessary to replace the capital with the ordinary rate of profit, or in other words, above what the same capital would yield if it were all employed in as disadvantageous circumstances as the least productive portion of it; whether that least productive portion of capital is rendered so by being employed on the worst soil, or by being expended in extorting more produce from land which already yielded as much as it could be made to part with on easier terms.

It is not pretended that the facts of any concrete case conform with absolute precision to this or any other scientific principle. We must never forget that the truths of political economy are truths only in the rough: they have the certainty, but not the precision, of exact science.1. It is not, for example, strictly true that a farmer will cultivate no land, and apply no capital, which returns less than the ordinary profit. He will expect the ordinary profit on the bulk of his capital. But when he has cast in his lot with his farm, and bartered his skill and exertions, once for all, against what the farm will yield to him, he will probably be willing to expend capital on it (for an immediate return) in any manner which will afford him a surplus profit, however small, beyond the value of the risk, and the interest which he must pay for the capital if borrowed, or can get for it elsewhere if it is his own. But a new farmer, entering on the land, would make his calculations differently, and would not commence unless he could expect the full rate of ordinary profit on all the capital which he intended embarking in the enterprise. Again, prices may range higher or lower during the currency of a lease, than was expected when the contract was made, and the land, therefore, may be over or under-rented: and even when the lease expires, the landlord may be unwilling to grant a necessary diminution of rent, and the farmer, rather than relinquish his occupation, or seek a farm elsewhere when all are occupied, may consent to go on paying too high a rent. Irregularities like these we must always expect; it is impossible in political economy to obtain general theorems embracing the complications of circumstances which may affect the result in an individual case. When, too,2. the farmer class, having but little capital, cultivate for subsistence rather than for profit, and do not think of quitting their farm while they are able to live by it, their rents approximate to the character of cottier rents, and may be forced up by competition (if the number of competitors exceeds the number of farms) beyond the amount which will leave to the farmer the ordinary rate of profit. The laws which we are enabled to lay down respecting rents, profits, wages, prices, are only true in so far as the persons concerned are free from the influence of any other motives than those arising from the general circumstances of the case, and are guided, as to those, by the ordinary mercantile estimate of profit and loss. Applying this twofold supposition to the case of farmers and landlords, it will be true that the farmer requires the ordinary rate of profit on the whole of his capital; that whatever it returns to him beyond this he is obliged to pay to the landlord, but will not consent to pay more; that there is a portion of capital applied to agriculture in such circumstances of productiveness as to yield only the ordinary profits; and that the difference between the produce of this, and any other capital of similar amount, is the measure of the tribute which that other capital can and will pay, under the name of rent, to the landlord. This constitutes a law of rent, as near the truth as such a law can possibly be: though of course modified or disturbed in individual cases, by pending contracts, individual miscalculations, the influence of habit, and even the particular feelings and dispositions of the persons concerned.

§ 5. A remark is often made, which must not here be omitted, though, I think, more importance has been attached to it than it merits. Under the name of rent, many payments are commonly included which are not a remuneration for the original powers of the land itself, but for capital expended on it. The additional rent which land yields in consequence of this outlay of capital, should, in the opinion of some writers, be regarded as profit, not rent. But before this can be admitted, a distinction must be made. The annual payment by a tenant almost always includes a consideration for the use of the buildings on the farm; not only barns, stables, and other outhouses, but a house to live in, not to speak of fences and the like. The landlord will ask, and the tenant give, for these, whatever is considered sufficient to yield the ordinary profit, or rather (risk and trouble being here out of the question) the ordinary interest, on the value of the buildings: that is, not on what it has cost to erect them, but on what it would now cost to erect others as good: the tenant being bound, in addition, to leave them in as good repair as he found them, for otherwise a much larger payment than simple interest would of course be required from him. These buildings are as distinct a thing from the farm as the stock or the timber on it; and what is paid for them can no more be called rent of land, than a payment for cattle would be, if it were the custom that the landlord should stock the farm for the tenant. The buildings, like the cattle, are not land, but capital, regularly consumed and reproduced; and all payments made in consideration for them are properly interest.

But with regard to capital actually sunk in improvements, and not requiring periodical renewal, but spent once for all in giving the land a permanent increase of productiveness, it appears to me that the return made to such capital loses altogether the character of profits, and is governed by the principles of rent. It is true that a landlord will not expend capital in improving his estate, unless he expects from the improvement an increase of income surpassing the interest of his outlay. Prospectively, this increase of income may be regarded as profit; but when the expense has been incurred, and the improvement made, the rent of the improved land is governed by the same rules as that of the unimproved. Equally fertile land commands an equal rent, whether its fertility is natural or acquired; and I cannot think that the incomes of those who own the Bedford Level or the Lincolnshire Wolds ought to be called profit and not rent because those lands would have been worth next to nothing unless capital had been expended on them. The owners are not capitalists, but landlords; they have parted with their capital; it is consumed, destroyed; and neither is, nor is to be, returned to them, like the capital of a farmer or manufacturer, from what it produces. In lieu of it they now have land of a certain richness, which yields the same rent, and by the operation of the same causes, as if it had possessed from the beginning the degree of fertility which has been artificially given to it.

Some writers, in particular Mr. H. C. Carey, take away, still more completely than I have attempted to do, the distinction between these two sources of rent, by rejecting one of them altogether, and considering all rent as the effect of capital expended. In proof of this, Mr. Carey contends that the whole pecuniary value of all the land in any country, in England for instance, or in the United States, does not amount to anything approaching to the sum which has been laid out, or which it would even now be necessary to lay out, in order to bring the country to its present condition from a state of primaeval forest. This startling statement has been seized on by M. Bastiat1. and others, as a means of making out a stronger case than could otherwise be made in defence of property in land. Mr. Carey' proposition, in its most obvious meaning, is equivalent to saying, that if there were suddenly added to the lands of England an unreclaimed territory of equal natural fertility, it would not be worth the while of the inhabitants of England to reclaim it: because the profits of the operation would not be equal to the ordinary interest on the capital expended. To which assertion if any answer could be supposed to be required, it would suffice to remark, that land not of equal but of greatly inferior quality to that previously cultivated, is continually reclaimed in England, at an expense which the subsequently accruing rent is sufficient to replace completely in a small number of years. The doctrine, moreover, is totally opposed to Mr. Carey' own economical opinions. No one maintains more strenuously than Mr. Carey the undoubted truth, that as society advances in population, wealth, and combination of labour, land constantly rises in value and price. This, however, could not possibly be true, if the present value of land were less than the expense of clearing it and making it fit for cultivation; for it must have been worth this immediately after it was cleared; and according to Mr. Carey it has been rising in value ever since.

When, however, Mr. Carey asserts that the whole land of any country is not now worth the capital which has been expended on it, he does not mean that each particular estate is worth less than what has been laid out in improving it, and that, to the proprietors, the improvement of the land has been, in the final result, a miscalculation. He means, not that the land of Great Britain would not now sell for what has been laid out upon it, but that it would not sell for that amount plus the expense of making all the roads, canals, and railways. This is probably true, but is no more to the purpose, and no more important in political economy, than if the statement had been, that it would not sell for the sums laid out on it plus the national debt, or plus the cost of the French Revolutionary war, or any other expense incurred for a real or imaginary public advantage. The roads, railways, and canals were not constructed to give value to land: on the contrary, their natural effect was to lower its value, by rendering other and rival lands accessible: and the landlords of the southern counties actually petitioned Parliament against the turnpike roads on this very account.

The tendency of improved communications is to lower existing rents, by trenching on the monopoly of the land nearest to the places where large numbers of consumers are assembled. Roads and canals are not intended to raise the value of the land which already supplies the markets, but (among other purposes) to cheapen the supply, by letting in the produce of other and more distant lands; and the more effectually this purpose is attained, the lower rent will be. If we could imagine that the railways and canals of the United States, instead of only cheapening communication, did their business so effectually as to annihilate cost of carriage altogether, and enable the produce of Michigan to reach the market of New York as quickly and as cheaply as the produce of Long Island—the whole value of all the land of the United States (except such as lies convenient for building) would be annihilated; or rather, the best would only sell for the expense of clearing, and the government tax of a dollar and a quarter per acre; since land in Michigan, equal to the best in the United States, may be had in unlimited abundance by that amount of outlay. But it is strange that Mr. Carey should think this fact inconsistent with the Ricardo theory of rent. Admitting all that he asserts, it is still true that as long as there is land which yields no rent, the land which does yield rent, does so in consequence of some advantage which it enjoys, in fertility or vicinity to markets, over the other; and the measure of its advantage is also the measure of its rent. And the cause of its yielding rent is that it possesses a natural monopoly; the quantity of land, as favourably circumstanced as itself, not being sufficient to supply the market. These propositions constitute the theory of rent laid down by Ricardo; and if they are true, I cannot see that it signifies much whether the rent which the land yields at the present time, is greater or less than the interest of the capital which has been laid out to raise its value, together with the interest of the capital which has been laid out to lower its value.

Mr. Carey' objection, however, has somewhat more of ingenuity than the arguments commonly met with against the theory of rent; a theorem which may be called the pons asinorum of political economy, for there are, I am inclined to think, few persons who have refused their assent to it except from not having thoroughly understood it. The loose and inaccurate way in which it is often apprehended by those who affect to refute it, is very remarkable. Many, for instance, have imputed absurdity to Mr. Ricardo' theory, because it is absurd to say that the cultivation of inferior land is the cause of rent on the superior. Mr. Ricardo does not say that it is the cultivation of inferior land, but the necessity of cultivating it, from the insufficiency of the superior land to feed a growing population: between which and the proposition imputed to him there is no less a difference than that between demand and supply. Others again allege as an objection against Ricardo, that if all land were of equal fertility, it might still yield a rent. But Ricardo says precisely the same. He says that if all lands were equally fertile, those which are nearer to their market than others, and are therefore less burthened with cost of carriage, would yield a rent equivalent to the advantage; and that the land yielding no rent would then be, not the least fertile, but the least advantageously situated, which the wants of the community required to be brought into cultivation. It is also distinctly a portion of Ricardo' doctrine, that even apart from differences of situation, the land of a country supposed to be of uniform fertility would, all of it, on a certain supposition, pay rent: namely, if the demand of the community required that it should all be cultivated, and cultivated beyond the point at which a further application of capital begins to be attended with a smaller proportional return. It would be impossible to show that, except by forcible exaction, the whole land of a country can yield a rent on any other supposition.1.

§ 6. After this view of the nature and causes of rent, let us turn back to the subject of profits, and bring up for reconsideration one of the propositions laid down in the last chapter. We there stated, that the advances of the capitalist, or in other words, the expenses of production, consist solely in wages of labour; that whatever portion of the outlay is not wages, is previous profit, and whatever is not previous profit, is wages. Rent, however, being an element which it is impossible to resolve into either profits or wages, we were obliged, for the moment, to assume that the capitalist is not required to pay rent—to give an equivalent for the use of an appropriated natural agent: and I undertook to show in the proper place, that this is an allowable supposition, and that rent does not really form any part of the expenses of production, or of the advances of the capitalist. The grounds on which this assertion was made are now apparent. It is true that all tenant farmers, and many other classes of producers, pay rent. But we have now seen, that whoever cultivates land, paying a rent for it, gets in return for his rent an instrument of superior power to other instruments of the same kind for which no rent is paid. The superiority of the instrument is in exact proportion to the rent paid for it. If a few persons had steam-engines of superior power to all others in existence, but limited by physical laws to a number short of the demand, the rent which a manufacturer would be willing to pay for one of these steam-engines could not be looked upon as an addition to his outlay, because by the use of it he would save in his other expenses the equivalent of what it cost him: without it he could not do the same quantity of work, unless at an additional expense equal to the rent. The same thing is true of land. The real expenses of production are those incurred on the worst land, or by the capital employed in the least favourable circumstances. This land or capital pays, as we have seen, no rent; but the expenses to which it is subject, cause all other land or agricultural capital to be subjected to an equivalent expense in the form of rent. Whoever does pay rent gets back its full value in extra advantages, and the rent which he pays does not place him in a worse position than, but only in the same position as, his fellow-producer who pays no rent, but whose instrument is one of inferior efficiency.

We have now completed the exposition of the laws which regulate the distribution of the produce of land, labour, and capital, as far as it is possible to discuss those laws independently of the instrumentality by which in a civilized society the distribution is effected; the machinery of Exchange and Price. The more complete elucidation and final confirmation of the laws which we have laid down, and the deduction of their most important consequences, must be preceded by an explanation of the nature and working of that machinery—a subject so extensive and complicated as to require a separate Book.1.

Book III: EXCHANGE

Book III, Chapter I: Of value

CHAPTER I: OF VALUE

§ 1. The subject on which we are now about to enter fills so important and conspicuous a position in political economy, that in the apprehension of some thinkers its boundaries confound themselves with those of the science itself. One eminent writer has proposed as a name for Political Economy, “Catallactics,” or the science of exchanges: by others it has been called the Science of Values. If these denominations had appeared to me logically correct, I must have placed the discussion of the elementary laws of value at the commencement of our inquiry, instead of postponing it to the Third Part; and the possibility of so long deferring it is alone a sufficient proof that this view of the nature of Political Economy is too confined. It is true that in the preceding Books we have not escaped the necessity of anticipating some small portion of the theory of Value, especially as to the value of labour and of land. It is nevertheless evident, that of the two great departments of Political Economy, the production of wealth and its distribution, the consideration of Value has to do with the latter alone; and with that, only so far as competition, and not usage or custom, is the distributing agency. The conditions and laws of Production would be the same as they are, if the arrangements of society did not depend on Exchange, or did not admit of it. Even in the present system of industrial life, in which employments are minutely subdivided, and all concerned in production depend for their remuneration on the price of a particular commodity, exchange is not the fundamental law of the distribution of the produce, no more than roads and carriages are the essential laws of motion, but merely a part of the machinery for effecting it. To confound these ideas, seems to me, not only a logical, but a practical blunder. It is a case of the error too common in political economy, of not distinguishing between necessities arising from the nature of things, and those created by social arrangements: an error which appears to me to be at all times producing two opposite mischiefs; on the one hand, causing political economists to class the merely temporary truths of their subject among its permanent and universal laws; and on the other, leading many persons to mistake the permanent laws of Production (such as those on which the necessity is grounded of restraining population) for temporary accidents arising from the existing constitution of society—which those who would frame a new system of social arrangements are at liberty to disregard.

In a state of society, however, in which the industrial system is entirely founded on purchase and sale, each individual, for the most part, living not on things in the production of which he himself bears a part, but on things obtained by a double exchange, a sale followed by a purchase—the question of Value is fundamental. Almost every speculation respecting the economical interests of a society thus constituted implies some theory of Value: the smallest error on that subject infects with corresponding error all our other conclusions; and anything vague or misty in our conception of it creates confusion and uncertainty in everything else. Happily, there is nothing in the laws of value which remains [1848] for the present or any future writer to clear up; the theory of the subject is complete: the only difficulty to be overcome is that of so stating it as to solve by anticipation the chief perplexities which occur in applying it: and to do this, some minuteness of exposition, and considerable demands on the patience of the reader, are unavoidable. He will be amply repaid, however (if a stranger to these inquiries), by the ease and rapidity with which a thorough understanding of this subject will enable him to fathom most of the remaining questions of political economy.

§ 2. We must begin by settling our phraseology. Adam Smith, in a passage often quoted, has touched upon the most obvious ambiguity of the word value; which, in one of its senses, signifies usefulness, in another, power of purchasing; in his own language, value in use and value in exchange. But (as Mr. De Quincey has remarked) in illustrating this double meaning Adam Smith has himself fallen into another ambiguity. Things (he says) which have the greatest value in use have often little or no value in exchange; which is true, since that which can be obtained without labour or sacrifice will command no price, however useful or needful it may be. But he proceeds to add, that things which have the greatest value in exchange, as a diamond for example, may have little or no value in use. This is employing the word use, not in the sense in which political economy is concerned with it, but in that other sense in which use is opposed to pleasure. Political economy has nothing to do with the comparative estimation of different uses in the judgment of a philosopher or of a moralist. The use of a thing, in political economy, means its capacity to satisfy a desire, or serve a purpose. Diamonds have this capacity in a high degree, and unless they had it, would not bear any price. Value in use, or as Mr. De Quincey calls it, teleologic value, is the extreme limit of value in exchange. The exchange value of a thing may fall short, to any amount, of its value in use; but that it can ever exceed the value in use implies a contradiction; it supposes that persons will give, to possess a thing, more than the utmost value which they themselves put upon it as a means of gratifying their inclinations.

The word Value, when used without adjunct, always means, in political economy, value in exchange; or as it has been called by Adam Smith and his successors, exchangeable value, a phrase which no amount of authority that can be quoted for it can make other than bad English. Mr. De Quincey substitutes the term Exchange Value, which is unexceptionable.

Exchange value requires to be distinguished from Price. The words Value and Price were used as synonymous by the early political economists, and are not always discriminated even by Ricardo. But the most accurate modern writers, to avoid the wasteful expenditure of two good scientific terms on a single idea, have employed Price to express the value of a thing in relation to money; the quantity of money for which it will exchange. By the price of a thing, therefore, we shall henceforth understand its value in money; by the value, or exchange value of a thing, its general power of purchasing; the command which its possession gives over purchaseable commodities in general.

§ 3. But here a fresh demand for explanation presents itself. What is meant by command over commodities in general? The same thing exchanges for a great quantity of some commodities, and for a very small quantity of others. A suit of clothes exchanges for a great quantity of bread, and for a very small quantity of precious stones. The value of a thing in exchange for some commodities may be rising, for others falling. A coat may exchange for less bread this year than last, if the harvest has been bad, but for more glass or iron, if a tax has been taken off those commodities, or an improvement made in their manufacture. Has the value of the coat, under these circumstances, fallen or risen? It is impossible to say: all that can be said is, that it has fallen in relation to one thing, and risen in respect to another. But there is another case, in which no one would have any hesitation in saying what sort of change had taken place in the value of the coat: namely, if the cause in which the disturbance of exchange values originated was something directly affecting the coat itself, and not the bread or the glass. Suppose, for example, that an invention had been made in machinery by which broadcloth could be woven at half the former cost. The effect of this would be to lower the value of a coat, and if lowered by this cause, it would be lowered not in relation to bread only or to glass only, but to all purchaseable things, except such as happened to be affected at the very time by a similar depressing cause. We should therefore say that there had been a fall in the exchange value or general purchasing power of a coat. The idea of general exchange value originates in the fact, that there really are causes which tend to alter the value of a thing in exchange for things generally, that is, for all things which are not themselves acted upon by causes of similar tendency.

In considering exchange value scientifically, it is expedient to abstract from it all causes except those which originate in the very commodity under consideration. Those which originate in the commodities with which we compare it, affect its value in relation to those commodities; but those which originate in itself affect its value in relation to all commodities. In order the more completely to confine our attention to these last, it is convenient to assume that all commodities but the one in question remain invariable in their relative values. When we are considering the causes which raise or lower the value of corn, we suppose that woollens, silks, cutlery, sugar, timber, &c., while varying in their power of purchasing corn, remain constant in the proportions in which they exchange for one another. On this assumption, any one of them may be taken as a representative of all the rest; since in whatever manner corn varies in value with respect to any one commodity, it varies in the same manner and degree with respect to every other; and the upward or downward movement of its value estimated in some one thing is all that need be considered. Its money value, therefore, or price, will represent as well as anything else its general exchange value, or purchasing power; and from an obvious convenience will often be employed by us in that representative character; with the proviso that money itself do not vary in its general purchasing power, but that the prices of all things, other than that which we happen to be considering, remain unaltered.

§ 4. The distinction between Value and Price, as we have now defined them, is so obvious, as scarcely to seem in need of any illustration. But in political economy the greatest errors arise from overlooking the most obvious truths. Simple as this distinction is, it has consequences with which a reader unacquainted with the subject would do well to begin early by making himself thoroughly familiar. The following is one of the principal. There is such a thing as a general rise of prices. All commodities may rise in their money price. But there cannot be a general rise of values. It is a contradiction in terms. A can only rise in value by exchanging for a greater quantity of B and C; in which case these must exchange for a smaller quantity of A. All things cannot rise relatively to one another. If one-half of the commodities in the market rise in exchange value, the very terms imply a fall of the other half; and reciprocally, the fall implies a rise. Things which are exchanged for one another can no more all fall, or all rise, than a dozen runners can each outrun all the rest, or a hundred trees all overtop one another. Simple as this truth is, we shall presently see that it is lost sight of in some of the most accredited doctrines both of theorists and of what are called practical men. And as a first specimen we may instance the great importance attached in the imagination of most people to a rise or fall of general prices. Because when the price of any one commodity rises, the circumstance usually indicates a rise of its value, people have an indistinct feeling when all prices rise, as if all things simultaneously had risen in value, and all the possessors had become enriched. That the money prices of all things should rise or fall, provided they all rise or fall equally, is in itself, and apart from existing contracts, of no consequence. It affects nobody’s wages, profits, or rent. Every one gets more money in the one case and less in the other; but of all that is to be bought with money they get neither more nor less than before. It makes no other difference than that of using more or fewer counters to reckon by. The only thing which in this case is really altered in value is money; and the only persons who either gain or lose are the holders of money, or those who have to receive or to pay fixed sums of it. There is a difference to annuitants and to creditors the one way, and to those who are burthened with annuities, or with debts, the contrary way. There is a disturbance, in short, of fixed money contracts; and this is an evil, whether it takes place in the debtor’s favour or in the creditor’s. But as to future transactions there is no difference to any one. Let it therefore be remembered (and occasions will often arise for calling it to mind) that a general rise or a general fall of values is a contradiction; and that a general rise or a general fall of prices is merely tantamount to an alteration in the value of money, and is a matter of complete indifference, save in so far as it affects existing contracts for receiving and paying fixed pecuniary amounts, 1 and (it must be added) as it affects the interests of the producers of money.

§ 5. Before commencing the inquiry into the laws of value and price, I have one further observation to make. I must give warning, once for all, that the cases I contemplate are those in which values and prices are determined by competition alone. In so far only as they are thus determined, can they be reduced to any assignable law. The buyers must be supposed as studious to buy cheap, as the sellers to sell dear. The values and prices, therefore, to which our conclusions apply, are mercantile values and prices; such prices as are quoted in price-currents; prices in the wholesale markets, in which buying as well as selling is a matter of business; in which the buyers take pains to know, and generally do know, the lowest price at which an article of a given quality can be obtained; and in which, therefore, the axiom is true, that there cannot be for the same article, of the same quality, two prices in the same market. Our propositions will be true in a much more qualified sense of retail prices; the prices paid in shops for articles of personal consumption. For such things there often are not merely two, but many prices, in different shops, or even in the same shop; habit and accident having as much to do in the matter as general causes. Purchases for private use, even by people in business, are not always made on business principles: the feelings which come into play in the operation of getting, and in that of spending their income, are often extremely different. Either from indolence, or carelessness, or because people think it fine to pay and ask no questions, three-fourths of those who can afford it give much higher prices than necessary for the things they consume; while the poor often do the same from ignorance and defect of judgment, want of time for searching and making inquiry, and not unfrequently from coercion, open or disguised. For these reasons, retail prices do not follow with all the regularity which might be expected the action of the causes which determine wholesale prices. The influence of those causes is ultimately felt in the retail markets, and is the real source of such variations in retail prices as are of a general and permanent character. But there is no regular or exact correspondence. Shoes of equally good quality are sold in different shops at prices which differ considerably; and the price of leather may fall without causing the richer class of buyers to pay less for shoes. Nevertheless, shoes do sometimes fall in price; and when they do, the cause is always some such general circumstance as the cheapening of leather: and when leather is cheapened, even if no difference shows itself in shops frequented by rich people, the artizan and the labourer generally get their shoes cheaper, and there is a visible diminution in the contract prices at which shoes are delivered for the supply of a workhouse or of a regiment. In all reasoning about prices, the proviso must be understood, “supposing all parties to take care of their own interest.” Inattention to these distinctions has led to improper applications of the abstract principles of political economy, and still oftener to an undue discrediting of those principles, through their being compared with a different sort of facts from those which they contemplate, or which can fairly be expected to accord with them.

Book III, Chapter II: Of demand and supply in their relation to value

CHAPTER II: of demand and supply in their relation to value

§ 1. That a thing may have any value in exchange, two conditions are necessary. It must be of some use; that is (as already explained), it must conduce to some purpose, satisfy some desire. No one will pay a price, or part with anything which serves some of his purposes, to obtain a thing which serves none of them. But, secondly, the thing must not only have some utility, there must also be some difficulty in its attainment. “Any article whatever,” says Mr. De Quincey,∗ “to obtain that artificial sort of value which is meant by exchange value, must begin by offering itself as a means to some desirable purpose; and secondly, even though possessing incontestably this preliminary advantage, it will never ascend to an exchange value in cases where it can be obtained gratuitously and without effort; of which last terms both are necessary as limitations. For often it will happen that some desirable object may be obtained gratuitously; stoop, and you gather it at your feet; but still, because the continued iteration of this stooping exacts a laborious effort, very soon it is found that to gather for yourself virtually is not gratuitous. In the vast forests of the Canadas, at intervals, wild strawberries may be gratuitously gathered by shiploads: yet such is the exhaustion of a stooping posture, and of a labour so monotonous, that everybody is soon glad to resign the service into mercenary hands.”

As was pointed out in the last chapter, the utility of a thing in the estimation of the purchaser is the extreme limit of its exchange value: higher the value cannot ascend; peculiar circumstances are required to raise it so high. This topic is happily illustrated by Mr. De Quincey. “Walk into almost any possible shop, buy the first article you see; what will determine its price? In the ninety-nine cases out of a hundred, simply the element D—difficulty of attainment. The other element U, or intrinsic utility, will be perfectly inoperative. Let the thing (measured by its uses) be, for your purposes, worth ten guineas, so that you would rather give ten guineas than lose it; yet, if the difficulty of producing it be only worth one guinea, one guinea is the price which it will bear. But still not the less, though U is inoperative, can U be supposed absent? By no possibility; for, if it had been absent, assuredly you would not have bought the article even at the lowest price. U acts upon you, though it does not act upon the price. On the other hand, in the hundredth case, we will suppose the circumstances reversed: you are on Lake Superior in a steam-boat, making your way to an unsettled region 800 miles a-head of civilization, and consciously with no chance at all of purchasing any luxury whatsoever, little luxury or big luxury, for the space of ten years to come. One fellow-passenger, whom you will part with before sunset, has a powerful musical snuff-box; knowing by experience the power of such a toy over your own feelings, the magic with which at times it lulls your agitations of mind, you are vehemently desirous to purchase it. In the hour of leaving London you had forgot to do so; here is a final chance. But the owner, aware of your situation not less than yourself, is determined to operate by a strain pushed to the very uttermost upon U, upon the intrinsic worth of the article in your individual estimate for your individual purposes. He will not hear of D as any controlling power or mitigating agency in the case; and finally, although at six guineas a-piece in London or Paris you might have loaded a waggon with such boxes, you pay sixty rather than lose it when the last knell of the clock has sounded, which summons you to buy now or to forfeit for ever. Here, as before, only one element is operative; before it was D, now it is U. But after all, D was not absent, though inoperative. The inertness of D allowed U to put forth its total effect. The practical compression of D being withdrawn, U springs up like water in a pump when released from the pressure of air. Yet still that D was present to your thoughts, though the price was otherwise regulated, is evident; both because U and D must coexist in order to found any case of exchange value whatever, and because undeniably you take into very particular consideration this D, the extreme difficulty of attainment (which here is the greatest possible, viz. an impossibility) before you consent to have the price racked up to U. The special D has vanished; but it is replaced in your thoughts by an unlimited D. Undoubtedly you have submitted to U in extremity as the regulating force of the price; but it was under a sense of D’s latent presence. Yet D is so far from exerting any positive force, that the retirement of D from all agency whatever on the price—this it is which creates as it were a perfect vacuum, and through that vacuum U rushes up to its highest and ultimate gradation.”

This case, in which the value is wholly related by the necessities or desires of the purchaser, is the case of strict and absolute monopoly; in which, the article desired being only obtainable from one person, he can exact any equivalent, short of the point at which no purchaser could be found. But it is not a necessary consequence, even of complete monopoly, that the value should be forced up to this ultimate limit; as will be seen when we have considered the law of value in so far as depending on the other element, difficulty of attainment.

§ 2. The difficulty of attainment which determines value is not always the same kind of difficulty. It sometimes consists in an absolute limitation of the supply. There are things of which it is physically impossible to increase the quantity beyond certain narrow limits. Such are those wines which can be grown only in peculiar circumstances of soil, climate, and exposure. Such also are ancient sculptures; pictures by old masters; rare books or coins, or other articles of antiquarian curiosity. Among such may also be reckoned houses and building-ground, in a town of definite extent (such as Venice, or any fortified town where fortifications are necessary to security); the most desirable sites in any town whatever; houses and parks peculiarly favoured by natural beauty, in places where that advantage is uncommon. Potentially, all land whatever is a commodity of this class; and might be practically so in countries fully occupied and cultivated.

But there is another category (embracing the majority of all things that are bought and sold), in which the obstacle to attainment consists only in the labour and expense requisite to produce the commodity. Without a certain labour and expense it cannot be had: but when any one is willing to incur these, there needs be no limit to the multiplication of the product. If there were labourers enough and machinery enough, cottons, woollens, or linens might be produced by thousands of yards for every single yard now manufactured. There would be a point, no doubt, where further increase would be stopped by the incapacity of the earth to afford more of the material. But there is no need, for any purpose of political economy, to contemplate a time when this ideal limit could become a practical one.

There is a third case, intermediate between the two preceding, and rather more complex, which I shall at present merely indicate, but the importance of which in political economy is extremely great. There are commodities which can be multiplied to an indefinite extent by labour and expenditure, but not by a fixed amount of labour and expenditure. Only a limited quantity can be produced at a given cost: if more is wanted, it must be produced at a greater cost. To this class, as has been often repeated, agricultural produce belongs; and generally all the rude produce of the earth; and this peculiarity is a source of very important consequences; one of which is the necessity of a limit to population; and another, the payment of rent.

§ 3. These being the three classes, in one or other of which all things that are bought and sold must take their place, we shall consider them in their order. And first, of things absolutely limited in quantity, such as ancient sculptures or pictures.

Of such things it is commonly said, that their value depends upon their scarcity: but the expression is not sufficiently definite to serve our purpose. Others say, with somewhat greater precision, that the value depends on the demand and the supply. But even this statement requires much explanation, to make it a clear exponent of the relation between the value of a thing, and the causes of which that value is an effect.

The supply of a commodity is an intelligible expression: it means the quantity offered for sale; the quantity that is to be had, at a given time and place, by those who wish to purchase it. But what is meant by the demand? Not the mere desire for the commodity. A beggar may desire a diamond; but his desire, however great, will have no influence on the price. Writers have therefore given a more limited sense to demand, and have defined it, the wish to possess, combined with the power of purchasing. To distinguish demand in this technical sense, from the demand which is synonymous with desire, they call the former effectual demand.∗ After this explanation, it is usually supposed that there remains no further difficulty, and that the value depends upon the ratio between the effectual demand, as thus defined, and the supply.

These phrases, however, fail to satisfy any one who requires clear ideas, and a perfectly precise expression of them. Some confusion must always attach to a phrase so inappropriate as that of a ratio between two things not of the same denomination. What ratio can there be between a quantity and a desire, or even a desire combined with a power? A ratio between demand and supply is only intelligible if by demand we mean the quantity demanded, and if the ratio intended is that between the quantity demanded and the quantity supplied. But again, the quantity demanded is not a fixed quantity, even at the same time and place; it varies according to the value; if the thing is cheap, there is usually a demand for more of it than when it is dear. The demand, therefore, partly depends on the value. But it was before laid down that the value depends on the demand. From this contradiction how shall we extricate ourselves? How solve the paradox, of two things, each depending upon the other?

Though the solution of these difficulties is obvious enough, the difficulties themselves are not fanciful; and I bring them forward thus prominently, because I am certain that they obscurely haunt every inquirer into the subject who has not openly faced and distinctly realized them. Undoubtedly the true solution must have been frequently given, though I cannot call to mind any one who had given it before myself, except the eminently clear thinker and skilful expositor, J. B. Say. I should have imagined, however, that it must be familiar to all political economists, if the writings of several did not give evidence of some want of clearness on the point, and if the instance of Mr. De Quincey did not prove that the complete non-recognition and implied denial of it are compatible with great intellectual ingenuity, and close intimacy with the subject matter.

§ 4. Meaning, by the word demand, the quantity demanded, and remembering that this is not a fixed quantity, but in general varies according to the value, let us suppose that the demand at some particular time exceeds the supply, that is, there are persons ready to buy, at the market value, a greater quantity than is offered for sale. Competition takes place on the side of the buyers, and the value rises: but how much? In the ratio (some may suppose) of the deficiency: if the demand exceeds the supply by one-third, the value rises one-third. By no means: for when the value has risen one-third, the demand may still exceed the supply; there may, even at that higher value, be a greater quantity wanted than is to be had; and the competition of buyers may still continue. If the article is a necessary of life, which, rather than resign, people are willing to pay for at any price, a deficiency of one-third may raise the price to double, triple, or quadruple.∗ Or, on the contrary, the competition may cease before the value has risen in even the proportion of the deficiency. A rise, short of one-third, may place the article beyond the means, or beyond the inclinations, of purchasers to the full amount. At what point, then, will the rise be arrested? At the point, whatever it be, which equalizes the demand and the supply: at the price which cuts off the extra third from the demand, or brings forward additional sellers sufficient to supply it. When, in either of these ways, or by a combination of both, the demand becomes equal and no more than equal to the supply, the rise of value will stop.

The converse case is equally simple. Instead of a demand beyond the supply, let us suppose a supply exceeding the demand. The competition will now be on the side of the sellers: the extra quantity can only find a market by calling forth an additional demand equal to itself. This is accomplished by means of cheapness; the value falls, and brings the article within the reach of more numerous customers, or induces those who were already consumers to make increased purchases. The fall of value required to re-establish equality is different in different cases. The kinds of things in which it is commonly greatest are at the two extremities of the scale; absolute necessaries, or those peculiar luxuries, the taste for which is confined to a small class. In the case of food, as those who have already enough do not require more on account of its cheapness, but rather expend in other things what they save in food, the increased consumption occasioned by cheapness carries off, as experience shows, only a small part of the extra supply caused by an abundant harvest;∗ and the fall is practically arrested only when the farmers withdraw their corn, and hold it back in hopes of a higher price; or by the operations of speculators who buy corn when it is cheap, and store it up to be brought out when more urgently wanted. Whether the demand and supply are equalized by an increased demand, the result of cheapness, or by withdrawing a part of the supply, equalized they are in either case.

Thus we see that the idea of a ratio, as between demand and supply, is out of place, and has no concern in the matter: the proper mathematical analogy is that of an equation. Demand and supply, the quantity demanded and the quantity supplied, will be made equal. If unequal at any moment, competition equalizes them, and the manner in which this is done is by an adjustment of the value. If the demand increases, the value rises; if the demand diminishes, the value falls: again, if the supply falls off, the value rises; and falls if the supply is increased. The rise or the fall continues until the demand and supply are again equal to one another: and the value which a commodity will bring in any market is no other than the value which, in that market, gives a demand just sufficient to carry off the existing or expected supply.

This, then, is the Law of Value, with respect to all commodities not susceptible of being multiplied at pleasure. Such commodities, no doubt, are exceptions. There is another law for that much larger class of things, which admit of indefinite multiplication. But it is not the less necessary to conceive distinctly and grasp firmly the theory of this exceptional case. In the first place, it will be found to be of great assistance in rendering the more common case intelligible. And in the next place, the principle of the exception stretches wider, and embraces more cases, than might at first be supposed.

§ 5. There are but few commodities which are naturally and necessarily limited in supply. But any commodity whatever may be artificially so. Any commodity may be the subject of a monopoly: like tea, in this country, up to 1834; tobacco in France, opium in British India, at present [1848]. The price of a monopolized commodity is commonly supposed to be arbitrary; depending on the will of the monopolist, and limited only (as in Mr. De Quincey’s case of the musical box in the wilds of America) by the buyer’s extreme estimate of its worth to himself. This is in one sense true, but forms no exception, nevertheless, to the dependence of the value on supply and demand. The monopolist can fix the value as high as he pleases, short of what the consumer either could not or would not pay; but he can only do so by limiting the supply. The Dutch East India Company obtained a monopoly price for the produce of the Spice Islands, but to do so they were obliged, in good seasons, to destroy a portion of the crop. Had they persisted in selling all that they produced, they must have forced a market by reducing the price, so low, perhaps, that they would have received for the larger quantity a less total return than for the smaller: at least they showed that such was their opinion by destroying the surplus. Even on Lake Superior, Mr. De Quincey’s huckster could not have sold his box for sixty guineas, if he had possessed two musical boxes and desired to sell them both. Supposing the cost price of each to be six guineas, he would have taken seventy for the two in preference to sixty for one; that is, although his monopoly was the closest possible, he would have sold the boxes at thirty-five guineas each, notwithstanding that sixty was not beyond the buyer’s estimate of the article for his purposes. Monopoly value, therefore, does not depend on any peculiar principle, but is a mere variety of the ordinary case of demand and supply.

Again, though there are few commodities which are at all times and for ever unsusceptible of increase of supply, any commodity whatever may be temporarily so; and with some commodities this is habitually the case. Agricultural produce, for example, cannot be increased in quantity before the next harvest; the quantity of corn already existing in the world, is all that can be had for sometimes a year to come. During that interval, corn is practically assimilated to things of which the quantity cannot be increased. In the case of most commodities, it requires a certain time to increase their quantity; and if the demand increases, then, until a corresponding supply can be brought forward, that is, until the supply can accommodate itself to the demand, the value will so rise as to accommodate the demand to the supply.

There is another case, the exact converse of this. There are some articles of which the supply may be indefinitely increased, but cannot be rapidly diminished. There are things so durable that the quantity in existence is at all times very great in comparison with the annual produce. Gold, and the more durable metals, are things of this sort; and also houses. The supply of such things might be at once diminished by destroying them; but to do this could only be the interest of the possessor if he had a monopoly of the article, and could repay himself for the destruction of a part by the increased value of the remainder. The value, therefore, of such things may continue for a long time so low, either from excess of supply or falling off in the demand, as to put a complete stop to further production; the diminution of supply by wearing out being so slow a process, that a long time is requisite, even under a total suspension of production, to restore the original value. During that interval the value will be regulated solely by supply and demand, and will rise very gradually as the existing stock wears out, until there is again a remunerating value, and production resumes its course.

Finally, there are commodities of which, though capable of being increased or diminished to a great, and even an unlimited extent, the value never depends upon anything but demand and supply. This is the case, in particular, with the commodity Labour; of the value of which we have treated copiously in the preceding Book: and there are many cases besides, in which we shall find it necessary to call in this principle to solve difficult questions of exchange value. This will be particularly exemplified when we treat of International Values; that is, of the terms of interchange between things produced in different countries, or, to speak more generally, in distant places. But into these questions we cannot enter, until we shall have examined the case of commodities which can be increased in quantity indefinitely and at pleasure; and shall have determined by what law, other than that of Demand and Supply, the permanent or average values of such commodities are regulated. This we shall do in the next chapter.

Book III, Chapter III: Of cost of production, in its relation to value

CHAPTER III: of cost of production, in its relation to value

§ 1. When the production of a commodity is the effect of labour and expenditure, whether the commodity is susceptible of unlimited multiplication or not, there is a minimum value which is the essential condition of its being permanently produced. The value at any particular time is the result of supply and demand; and is always that which is necessary to create a market for the existing supply. But unless that value is sufficient to repay the Cost of Production, and to afford, besides, the ordinary expectation of profit, the commodity will not continue to be produced. Capitalists will not go on permanently producing at a loss. They will not even go on producing at a profit less than they can live on. Persons whose capital is already embarked, and cannot be easily extricated, will persevere for a considerable time without profit, and have been known to persevere even at a loss, in hope of better times. But they will not do so indefinitely, or when there is nothing to indicate that times are likely to improve. No new capital will be invested in an employment, unless there be an expectation not only of some profit, but of a profit as great (regard being had to the degree of eligibility of the employment in other respects) as can be hoped for in any other occupation at that time and place. When such profit is evidently not to be had, if people do not actually withdraw their capital, they at least abstain from replacing it when consumed. The cost of production, together with the ordinary profit, may therefore be called the necessary price, or value, of all things made by labour and capital. Nobody willingly produces in the prospect of loss. Whoever does so, does it under a miscalculation, which he corrects as fast as he is able.

When a commodity is not only made by labour and capital, but can be made by them in indefinite quantity, this Necessary Value, the minimum with which the producers will be content, is also, if competition is free and active, the maximum which they can expect. If the value of a commodity is such that it repays the cost of production not only with the customary, but with a higher rate of profit, capital rushes to share in this extra gain, and by increasing the supply of the article, reduces its value. This is not a mere supposition or surmise, but a fact familiar to those conversant with commercial operations. Whenever a new line of business presents itself, offering a hope of unusual profits, and whenever any established trade or manufacture is believed to be yielding a greater profit than customary, there is sure to be in a short time so large a production or importation of the commodity, as not only destroys the extra profit, but generally goes beyond the mark, and sinks the value as much too low as it had before been raised too high; until the over-supply is corrected by a total or partial suspension of further production. As already intimated,∗ these variations in the quantity produced do not presuppose or require that any person should change his employment. Those whose business is thriving, increase their produce by availing themselves more largely of their credit, while those who are not making the ordinary profit, restrict their operations, and (in manufacturing phrase) work short time. In this mode is surely and speedily effected the equalization, not of profits perhaps, but of the expectations of profit, in different occupations.

As a general rule, then, things tend to exchange for one another at such values as will enable each producer to be repaid the cost of production with the ordinary profit; in other words, such as will give to all producers the same rate of profit on their outlay. But in order that the profit may be equal where the outlay, that is, the cost of production, is equal, things must on the average exchange for one another in the ratio of their cost of production: things of which the cost of production is the same, must be of the same value. For only thus will an equal outlay yield an equal return. If a farmer with a capital equal to 1000 quarters of corn, can produce 1200 quarters, yielding him a profit of 20 per cent; whatever else can be produced in the same time by a capital of 1000 quarters, must be worth, that is, must exchange for, 1200 quarters, otherwise the producer would gain either more or less than 20 per cent.

Adam Smith and Ricardo have called that value of a thing which is proportional to its cost of production, its Natural Value (or its Natural Price). They meant by this, the point about which the value oscillates, and to which it always tends to return; the centre value, towards which, as Adam Smith expresses it, the market value of a thing is constantly gravitating; and any deviation from which is but a temporary irregularity, which, the moment it exists, sets forces in motion tending to correct it. On an average of years sufficient to enable the oscillations on one side of the central line to be compensated by those on the other, the market value agrees with the natural value; but it very seldom coincides exactly with it at any particular time. The sea everywhere tends to a level; but it never is at an exact level; its surface is always ruffled by waves, and often agitated by storms. It is enough that no point, at least in the open sea, is permanently higher than another. Each place is alternately elevated and depressed; but the ocean preserves its level.

§ 2. The latent influence by which the values of things are made to conform in the long run to the cost of production is the variation that would otherwise take place in the supply of the commodity. The supply would be increased if the thing continued to sell above the ratio of its cost of production, and would be diminished if it fell below that ratio. But we must not therefore suppose it to be necessary that the supply should actually be either diminished or increased. Suppose that the cost of production of a thing is cheapened by some mechanical invention, or increased by a tax. The value of the thing would in a little time, if not immediately, fall in the one case, and rise in the other; and it would do so, because if it did not, the supply would in the one case be increased, until the price fell, in the other diminished, until it rose. For this reason, and from the erroneous notion that value depends on the proportion between the demand and the supply, many persons suppose that this proportion must be altered whenever there is any change in the value of the commodity; that the value cannot fall through a diminution of the cost of production, unless the supply is permanently increased; nor rise, unless the supply is permanently diminished. But this is not the fact: there is no need that there should be any actual alteration of supply; and when there is, the alteration, if permanent, is not the cause, but the consequence of the alteration in value. If, indeed, the supply could not be increased, no diminution in the cost of production would lower the value: but there is by no means any necessity that it should. The mere possibility often suffices; the dealers are aware of what would happen, and their mutual competition makes them anticipate the result by lowering the price. Whether there will be a greater permanent supply of the commodity after its production has been cheapened, depends on quite another question, namely, on whether a greater quantity is wanted at the reduced value. Most commonly a greater quantity is wanted, but not necessarily. “A man,” says Mr. De Quincey,∗ “buys an article of instant applicability to his own purposes the more readily and the more largely as it happens to be cheaper. Silk handkerchiefs having fallen to half-price, he will buy, perhaps, in threefold quantity; but he does not buy more steam-engines because the price is lowered. His demand for steam-engines is almost always predetermined by the circumstances of his situation. So far as he considers the cost at all, it is much more the cost of working this engine than the cost upon its purchase. But there are many articles for which the market is absolutely and merely limited by a pre-existing system, to which those articles are attached as subordinate parts or members. How could we force the dials or faces of timepieces by artificial cheapness to sell more plentifully than the inner works or movements of such timepieces? Could the sale of wine-vaults be increased without increasing the sale of wine? Or the tools of shipwrights find an enlarged market whilst shipbuilding was stationary?.... Offer to a town of 3000 inhabitants a stock of hearses, no cheapness will tempt that town into buying more than one. Offer a stock of yachts, the chief cost lies in manning, victualling, repairing; no diminution upon the mere price to a purchaser will tempt into the market any man whose habits and propensities had not already disposed him to such a purchase. So of professional costume for bishops, lawyers, students at Oxford.” Nobody doubts, however, that the price and value of all these things would be eventually lowered by any diminution of their cost of production; and lowered through the apprehension entertained of new competitors, and an increased supply; though the great hazard to which a new competitor would expose himself, in an article not susceptible of any considerable extension of its market, would enable the established dealers to maintain their original prices much longer than they could do in an article offering more encouragement to competition.

Again, reverse the case, and suppose the cost of production increased, as for example by laying a tax on the commodity. The value would rise; and that, probably, immediately. Would the supply be diminished? Only if the increase of value diminished the demand. Whether this effect followed, would soon appear, and if it did, the value would recede somewhat, from excess of supply, until the production was reduced, and would then rise again. There are many articles for which it requires a very considerable rise of price materially to reduce the demand; in particular, articles of necessity, such as the habitual food of the people in England, wheaten bread: of which there is probably almost as much consumed, at the present cost price, as there would be with the present population at a price considerably lower. Yet it is especially in such things that dearness or high price is popularly confounded with scarcity. Food may be dear from scarcity, as after a bad harvest; but the dearness (for example) which is the effect of taxation, or of corn laws, has nothing whatever to do with insufficient supply: such causes do not much diminish the quantity of food in a country; it is other things rather than food that are diminished in quantity by them, since, those who pay more for food not having so much to expend otherwise, the production of other things contracts itself to the limits of a smaller demand.

It is, therefore, strictly correct to say, that the value of things which can be increased in quantity at pleasure, does not depend (except accidentally, and during the time necessary for production to adjust itself,) upon demand and supply; on the contrary, demand and supply depend upon it. There is a demand for a certain quantity of the commodity at its natural or cost value, and to that the supply in the long run endeavours to conform. When at any time it fails of so conforming, it is either from miscalculation, or from a change in some of the elements of the problem: either in the natural value, that is, in the cost of production; or in the demand, from an alteration in public taste or in the number or wealth of the consumers. These causes of disturbance are very liable to occur, and when any one of them does occur, the market value of the article ceases to agree with the natural value. The real law of demand and supply, the equation between them, still holds good: if a value different from the natural value be necessary to make the demand equal to the supply, the market value will deviate from the natural value; but only for a time; for the permanent tendency of supply is to conform itself to the demand which is found by experience to exist for the commodity when selling at its natural value. If the supply is either more or less than this, it is so accidentally, and affords either more or less than the ordinary rate of profit; which, under free and active competition, cannot long continue to be the case.

To recapitulate: demand and supply govern the value of all things which cannot be indefinitely increased; except that even for them, when produced by industry, there is a minimum value, determined by the cost of production. But in all things which admit of indefinite multiplication, demand and supply only determine the perturbations of value, during a period which cannot exceed the length of time necessary for altering the supply. While thus ruling the oscillations of value, they themselves obey a superior force, which makes value gravitate towards Cost of Production, and which would settle it and keep it there, if fresh disturbing influences were not continually arising to make it again deviate. To pursue the same strain of metaphor, demand and supply always rush to an equilibrium, but the condition of stable equilibrium is when things exchange for each other according to their cost of production, or, in the expression we have used, when things are at their Natural Value.

Book III, Chapter IV: Ultimate analysis of cost of production

CHAPTER IV: ultimate analysis of cost of production

§ 1. The component elements of Cost of Production have been set forth in the First Part of this enquiry.∗ The principal of them, and so much the principal as to be nearly the sole, we found to be Labour. What the production of a thing costs to its producer, or its series of producers, is the labour expended in producing it. If we consider as the producer the capitalist who makes the advances, the word Labour may be replaced by the word Wages: what the produce costs to him, is the wages which he has had to pay. At the first glance indeed this seems to be only a part of his outlay, since he has not only paid wages to labourers, but has likewise provided them with tools, materials, and perhaps buildings. These tools, materials, and buildings, however, were produced by labour and capital; and their value, like that of the article to the production of which they are subservient, depends on cost of production, which again is resolvable into labour. The cost of production of broadcloth does not wholly consist in the wages of weavers; which alone are directly paid by the cloth manufacturer. It consists also of the wages of spinners and woolcombers, and, it may be added, of shepherds, all of which the clothier has paid for in the price of yarn. It consists too of the wages of builders and brickmakers, which he has reimbursed in the contract price of erecting his factory. It partly consists of the wages of machine-makers, iron-founders, and miners. And to these must be added the wages of the carriers who transported any of the means and appliances of the production to the place where they were to be used, and the product itself to the place where it is to be sold.

The value of commodities, therefore, depends principally (we shall presently see whether it depends solely) on the quantity of labour required for their production; including in the idea of production, that of conveyance to the market. “In estimating,” says Ricardo,∗ “the exchangeable value of stockings, for example, we shall find that their value, comparatively with other things, depends on the total quantity of labour necessary to manufacture them and bring them to market. First, there is the labour necessary to cultivate the land on which the raw cotton is grown; secondly, the labour of conveying the cotton to the country where the stockings are to be manufactured, which includes a portion of the labour bestowed in building the ship in which it is conveyed, and which is charged in the freight of the goods; thirdly, the labour of the spinner and weaver; fourthly, a portion of the labour of the engineer, smith, and carpenter, who erected the buildings and machinery by the help of which they are made; fifthly, the labour of the retail dealer and of many others, whom it is unnecessary further to particularize. The aggregate sum of these various kinds of labour, determines the quantity of other things for which these stockings will exchange, while the same consideration of the various quantities of labour which have been bestowed on those other things, will equally govern the portion of them which will be given for the stockings.

“To convince ourselves that this is the real foundation of exchangeable value, let us suppose any improvement to be made in the means of abridging labour in any one of the various processes through which the raw cotton must pass before the manufactured stockings come to the market to be exchanged for other things; and observe the effects which will follow. If fewer men were required to cultivate the raw cotton, or if fewer sailors were employed in navigating, or shipwrights in constructing, the ship in which it was conveyed to us; if fewer hands were employed in raising the buildings and machinery, or if these, when raised, were rendered more efficient; the stockings would inevitably fall in value, and command less of other things. They would fall, because a less quantity of labour was necessary to their production, and would therefore exchange for a smaller quantity of those things in which no such abridgement of labour had been made.

“Economy in the use of labour never fails to reduce the relative value of a commodity, whether the saving be in the labour necessary to the manufacture of the commodity itself, or in that necessary to the formation of the capital, by the aid of which it is produced. In either case the price of stockings would fall, whether there were fewer men employed as bleachers, spinners, and weavers, persons immediately necessary to their manufacture: or as sailors, carriers, engineers, and smiths, persons more indirectly concerned. In the one case, the whole saving of labour would fall on the stockings, because that portion of labour was wholly confined to the stockings; in the other, a portion only would fall on the stockings, the remainder being applied to all those other commodities, to the production of which the buildings, machinery, and carriage, were subservient.”

§ 2. It will have been observed that Ricardo expresses himself as if the quantity of labour which it costs to produce a commodity and bring it to market, were the only thing on which its value depended. But since the cost of production to the capitalist is not labour but wages, and since wages may be either greater or less, the quantity of labour being the same; it would seem that the value of the product cannot be determined solely by the quantity of labour, but by the quantity together with the remuneration; and that values must partly depend on wages.

In order to decide this point, it must be considered, that value is a relative term: that the value of a commodity is not a name for an inherent and substantive quality of the thing itself, but means the quantity of other things which can be obtained in exchange for it. The value of one thing must always be understood relatively to some other thing, or to things in general. Now the relation of one thing to another cannot be altered by any cause which affects them both alike. A rise or fall of general wages is a fact which affects all commodities in the same manner, and therefore affords no reason why they should exchange for each other in one rather than in another proportion. To suppose that high wages make high values, is to suppose that there can be such a thing as general high values. But this is a contradiction in terms: the high value of some things is synonymous with the low value of others. The mistake arises from not attending to values, but only to prices. Though there is no such thing as a general rise of values, there is such a thing as a general rise of prices. As soon as we form distinctly the idea of values, we see that high or low wages can have nothing to do with them; but that high wages make high prices, is a popular and widely-spread opinion. The whole amount of error involved in this proposition can only be seen thoroughly when we come to the theory of money; at present we need only say that, if it be true, there can be no such thing as a real rise of wages; for if wages could not rise without a proportional rise of the price of everything, they could not, for any substantial purpose, rise at all. This surely is a sufficient reductio ad absurdum, and shows the amazing folly of the propositions which may and do become, and long remain, accredited doctrines of popular political economy. It must be remembered too that general high prices, even supposing them to exist, can be of no use to a producer or dealer, considered as such; for if they increase his money returns, they increase in the same degree all his expenses. There is no mode in which capitalists can compensate themselves for a high cost of labour, through any action on values or prices. It cannot be prevented from taking its effect on low profits. If the labourers really get more, that is, get the produce of more labour, a smaller percentage must remain for profit. From this Law of Distribution, resting as it does on a law of arithmetic, there is no escape. The mechanism of Exchange and Price may hide it from us, but is quite powerless to alter it.

§ 3. Although, however, general wages, whether high or low, do not affect values, yet if wages are higher in one employment than another, or if they rise and fall permanently in one employment without doing so in others, these inequalities do really operate upon values. The causes which make wages vary from one employment to another, have been considered in a former chapter. When the wages of an employment permanently exceed the average rate, the value of the thing produced will, in the same degree, exceed the standard determined by mere quantity of labour. Things, for example, which are made by skilled labour, exchange for the produce of a much greater quantity of unskilled labour; for no reason but because the labour is more highly paid. If, through the extension of education, the labourers competent to skilled employments were so increased in number as to diminish the difference between their wages and those of common labour, all things produced by labour of the superior kind would fall in value, compared with things produced by common labour, and these might be said therefore to rise in value. We have before remarked that the difficulty of passing from one class of employments to a class greatly superior, has hitherto caused the wages of all those classes of labourers who are separated from one another by any very marked barrier, to depend more than might be supposed upon the increase of the population of each class considered separately; and that the inequalities in the remuneration of labour are much greater than could exist if the competition of the labouring people generally could be brought practically to bear on each particular employment. It follows from this that wages in different employments do not rise or fall simultaneously, but are, for short and sometimes even for long periods, nearly independent of one another. All such disparities evidently alter the relative costs of production of different commodities, and will therefore be completely represented in their natural or average value.

It thus appears that the maxim laid down by some of the best political economists, that wages do not enter into value, is expressed with greater latitude than the truth warrants, or than accords with their own meaning. Wages do enter into value. The relative wages of the labour necessary for producing different commodities, affect their value just as much as the relative quantities of labour. It is true, the absolute wages paid have no effect upon values; but neither has the absolute quantity of labour. If that were to vary simultaneously and equally in all commodities, values would not be affected. If, for instance, the general efficiency of all labour were increased, so that all things without exception could be produced in the same quantity as before with a smaller amount of labour, no trace of this general diminution of cost of production would show itself in the values of commodities. Any change which might take place in them would only represent the unequal degrees in which the improvement affected different things; and would consist in cheapening those in which the saving of labour had been the greatest, while those in which there had been some, but a less saving of labour, would actually rise in value. In strictness, therefore, wages of labour have as much to do with value as quantity of labour: and neither Ricardo nor any one else has denied the fact. In considering, however, the causes of variations in value, quantity of labour is the thing of chief importance; for when that varies, it is generally in one or a few commodities at a time, but the variations of wages (except passing fluctuations) are usually general, and have no considerable effect on value.

§ 4. Thus far of labour, or wages, as an element in cost of production. But in our analysis, in the First Book, of the requisites of production, we found that there is another necessary element in it besides labour. There is also capital; and this being the result of abstinence, the produce, or its value, must be sufficient to remunerate, not only all the labour required, but the abstinence of all the persons by whom the remuneration of the different classes of labourers was advanced. The return for abstinence is Profit. And profit, we have also seen, is not exclusively the surplus remaining to the capitalist after he has been compensated for his outlay, but forms, in most cases, no unimportant part of the outlay itself. The flax-spinner, part of whose expenses consists of the purchase of flax and of machinery, has had to pay, in their price, not only the wages of the labour by which the flax was grown and the machinery made, but the profits of the grower, the flax-dresser, the miner, the iron-founder, and the machine-maker. All these profits, together with those of the spinner himself, were again advanced by the weaver, in the price of his material, linen yarn: and along with them the profit of a fresh set of machine-makers, and of the miners and iron-workers who supplied them with their metallic material. All these advances form part of the cost of production of linen. Profits, therefore, as well as wages, enter into the cost of production which determines the value of the produce.

Value, however, being purely relative, cannot depend upon absolute profit, no more than upon absolute wages, but upon relative profits only. High general profits cannot, any more than high general wages, be a cause of high values, because high general values are an absurdity and a contradiction. In so far as profits enter into the cost of production of all things, they cannot affect the value of any. It is only by entering in a greater degree into the cost of production of some things than of others, that they can have any influence on value.

For example, we have seen that there are causes which necessitate a permanently higher rate of profit in certain employments than in others. There must be a compensation for superior risk, trouble, and disagreeableness. This can only be obtained by selling the commodity at a value above that which is due to the quantity of labour necessary for its production. If gunpowder exchanged for other things in no higher ratio than that of the labour required from first to last for producing it, no one would set up a powder-mill. Butchers are certainly a more prosperous class than bakers, and do not seem to be exposed to greater risks, since it is not remarked that they are oftener bankrupts. They seem, therefore, to obtain higher profits, which can only arise from the more limited competition caused by the unpleasantness, and to a certain degree, the unpopularity, of their trade. But this higher profit implies that they sell their commodity at a higher value than that due to their labour and outlay. All inequalities of profit which are necessary and permanent, are represented in the relative values of the commodities.

§ 5. Profits, however, may enter more largely into the conditions of production of one commodity than of another, even though there be no difference in the rate of profit between the two employments. The one commodity may be called upon to yield profit during a longer period of time than the other. The example by which this case is usually illustrated is that of wine. Suppose a quantity of wine, and a quantity of cloth, made by equal amounts of labour, and that labour paid at the same rate. The cloth does not improve by keeping; the wine does. Suppose that, to attain the desired quality, the wine requires to be kept five years. The producer or dealer will not keep it, unless at the end of five years he can sell it for as much more than the cloth as amounts to five years' profit, accumulated at compound interest. The wine and the cloth were made by the same original outlay. Here then is a case in which the natural values, relatively to one another, of two commodities, do not conform to their cost of production alone, but to their cost of production plus something else. Unless, indeed, for the sake of generality in the expression, we include the profit which the wine-merchant foregoes during the five years, in the cost of production of the wine: looking upon it as a kind of additional outlay, over and above his other advances, for which outlay he must be indemnified at last.

All commodities made by machinery are assimilated, at least approximately, to the wine in the preceding example. In comparison with things made wholly by immediate labour, profits enter more largely into their cost of production. Suppose two commodities, A and B, each requiring a year for its production, by means of a capital which we will on this occasion denote by money, and suppose to be 1000l. A is made wholly by immediate labour, the whole 1000l. being expended directly in wages. B is made by means of labour which costs 500l. and a machine which cost 500l., and the machine is worn out by one year’s use. The two commodities will be exactly of the same value; which, if computed in money, and if profits are 20 per cent per annum, will be 1200l. But of this 1200l., in the case of A, only 200l., or one-sixth, is profit: while in the case of B there is not only the 200l., but as much of 500l. (the price of the machine) as consisted of the profits of the machine-maker; which, if we suppose the machine also to have taken a year for its production, is again one-sixth. So that in the case of A only one-sixth of the entire return is profit, whilst in B the element of profit comprises not only a sixth of the whole, but an additional sixth of a large part.

The greater the proportion of the whole capital which consists of machinery, or buildings, or material, or anything else which must be provided before the immediate labour can commence, the more largely will profits enter into the cost of production. It is equally true, though not so obvious at first sight, that greater durability in the portion of capital which consists of machinery or buildings, has precisely the same effect as a greater amount of it. As we just supposed one extreme case, of a machine entirely worn out by a year’s use, let us now suppose the opposite and still more extreme case of a machine which lasts for ever, and requires no repairs. In this case, which is as well suited for the purpose of illustration as if it were a possible one, it will be unnecessary that the manufacturer should ever be repaid the 500l. which he gave for the machine, since he has always the machine itself, worth 500l.; but he must be paid, as before, a profit on it. The commodity B, therefore, which in the case previously supposed was sold for 1200l. of which sum 1000l. were to replace the capital and 200l. were profit, can now be sold for 700l., being 500l. to replace wages, and 200l. profit on the entire capital. Profit, therefore, enters into the value of B in the ratio of 200l. out of 700l., being two-sevenths of the whole, or 28 4/7 per cent, while in the case of A, as before, it enters only in the ratio of one-sixth, or 16 2/3 per cent. The case is of course purely ideal, since no machinery or other fixed capital lasts for ever; but the more durable it is, the nearer it approaches to this ideal case, and the more largely does profit enter into the return. If, for instance, a machine worth 500l. loses one-fifth of its value by each year’s use, 100l. must be added to the return to make up this loss, and the price of the commodity will be 800l. Profit therefore will enter into it in the ratio of 200l. to 800l., or one-fourth, which is still a much higher proportion than one-sixth, or 200l. in 1200l., as in case A.

From the unequal proportion in which, in different employments, profits enter into the advances of the capitalist, and therefore into the returns required by him, two consequences follow in regard to value. One is, that commodities do not exchange in the ratio simply of the quantities of labour required to produce them; not even if we allow for the unequal rates at which different kinds of labour are permanently remunerated. We have already illustrated this by the example of wine: we shall now further exemplify it by the case of commodities made by machinery. Suppose, as before, an article A made by a thousand pounds' worth of immediate labour. But instead of B, made by 500l. worth of immediate labour and a machine worth 500l., let us suppose C, made by 500l. worth of immediate labour with the aid of a machine which has been produced by another 500l. worth of immediate labour: the machine requiring a year for making, and worn out by a year’s use; profits being as before 20 per cent. A and C are made by equal quantities of labour, paid at the same rate: A costs 1000l. worth of direct labour; C, only 500l. worth, which however is made up to 1000l. by the labour expended in the construction of the machine. If labour, or its remuneration, were the sole ingredient of cost of production, these two things would exchange for one another. But will they do so? Certainly not. The machine having been made in a year by an outlay of 500l., and profits being 20 per cent, the natural price of the machine is 600l.: making an additional 100l. which must be advanced, over and above his other expenses, by the manufacturer of C, and repaid to him with a profit of 20 per cent. While, therefore, the commodity A is sold for 1200l., C cannot be permanently sold for less than 1320l.

A second consequence is, that every rise or fall of general profits will have an effect on values. Not indeed by raising or lowering them generally, (which, as we have so often said, is a contradiction and an impossibility): but by altering the proportion in which the values of things are affected by the unequal lengths of time for which profit is due. When two things, though made by equal labour, are of unequal value because the one is called upon to yield profit for a greater number of years or months than the other; this difference of value will be greater when profits are greater, and less when they are less. The wine which has to yield five years' profit more than the cloth, will surpass it in value much more if profits are 40 per cent, than if they are only 20. The commodities A and C, which, though made by equal quantities of labour, were sold for 1200l. and 1320l., a difference of 10 per cent, would, if profits had been only half as much, have been sold for 1100l. and 1155l., a difference of only 5 per cent.

It follows from this, that even a general rise of wages, when it involves a real increase in the cost of labour, does in some degree influence values. It does not affect them in the manner vulgarly supposed, by raising them universally. But an increase in the cost of labour, lowers profits; and therefore lowers in natural value the things into which profits enter in a greater proportion than the average, and raises those into which they enter in a less proportion than the average. All commodities in the production of which machinery bears a large part, especially if the machinery is very durable, are lowered in their relative value when profits fall; or, what is equivalent, other things are raised in value relatively to them. This truth is sometimes expressed in a phraseology more plausible than sound, by saying that a rise of wages raises the value of things made by labour, in comparison with those made by machinery. But things made by machinery, just as much as any other things, are made by labour, namely, the labour which made the machinery itself: the only difference being that profits enter somewhat more largely into the production of things for which machinery is used, though the principal item of the outlay is still labour. It is better, therefore, to associate the effect with fall of profits than with rise of wages; especially as this last expression is extremely ambiguous, suggesting the idea of an increase of the labourer’s real remuneration, rather than of what is alone to the purpose here, namely, the cost of labour to its employer.

§ 6. Besides the natural and necessary elements in cost of production—labour and profits—there are others which are artificial and casual, as for instance a tax. The tax on malt is as much a part of the cost of production of that article as the wages of the labourers. The expenses which the law imposes, as well as those which the nature of things imposes, must be reimbursed with the ordinary profit from the value of the produce, or the things will not continue to be produced. But the influence of taxation on value is subject to the same conditions as the influence of wages and of profits. It is not general taxation, but differential taxation, that produces the effect. If all productions were taxed so as to take an equal percentage from all profits, relative values would be in no way disturbed. If only a few commodities were taxed, their value would rise: and if only a few were left untaxed, their value would fall. If half were taxed and the remainder untaxed, the first half would rise and the last would fall relatively to each other. This would be necessary in order to equalize the expectation of profit in all employments, without which the taxed employments would ultimately, if not immediately, be abandoned. But general taxation, when equally imposed, and not disturbing the relations of different productions to one another, cannot produce any effect on values.

We have thus far supposed that all the means and appliances which enter into the cost of production of commodities, are things whose own value depends on their cost of production. Some of them, however, may belong to the class of things which cannot be increased ad libitum in quantity, and which therefore, if the demand goes beyond a certain amount, command a scarcity value. The materials of many of the ornamental articles manufactured in Italy are the substances called rosso, giallo, and verde antico, which, whether truly or falsely I know not, are asserted to be solely derived from the destruction of ancient columns and other ornamental structures; the quarries from which the stone was originally cut being exhausted, or their locality forgotten.∗ A material of such a nature, if in much demand, must be at a scarcity value; and this value enters into the cost of production, and consequently into the value, of the finished article. The time seems to be approaching when the more valuable furs will come under the influence of a scarcity value of the material. Hitherto the diminishing number of the animals which produce them, in the wildernesses of Siberia, and on the coasts of the Esquimaux Sea, has operated on the value only through the greater labour which has become necessary for securing any given quantity of the article, since, without doubt, by employing labour enough, it might still be obtained in much greater abundance for some time longer.

But the case in which scarcity value chiefly operates in adding to cost of production, is the case of natural agents. These, when unappropriated, and to be had for the taking, do not enter into cost of production, save to the extent of the labour which may be necessary to fit them for use. Even when appropriated, they do not (as we have already seen) bear a value from the mere fact of the appropriation, but only from scarcity, that is, from limitation of supply. But it is equally certain that they often do bear a scarcity value. Suppose a fall of water, in a place where there are more mills wanted than there is water-power to supply them; the use of the fall of water will have a scarcity value, sufficient either to bring the demand down to the supply, or to pay for the creation of an artificial power, by steam or otherwise, equal in efficiency to the water-power.

A natural agent being a possession in perpetuity, and being only serviceable by the products resulting from its continued employment, the ordinary mode of deriving benefit from its ownership is by an annual equivalent, paid by the person who uses it, from the proceeds of its use. This equivalent always might be, and generally is, termed rent. The question, therefore, respecting the influence which the appropriation of natural agents produces on values, is often stated in this form: Does Rent enter into Cost of Production? and the answer of the best political economists is in the negative. The temptation is strong to the adoption of these sweeping expressions, even by those who are aware of the restrictions with which they must be taken; for there is no denying that they stamp a general principle more firmly on the mind, than if it were hedged round in theory with all its practical limitations. But they also puzzle and mislead, and create an impression unfavourable to political economy, as if it disregarded the evidence of facts. No one can deny that rent sometimes enters into cost of production. If I buy or rent a piece of ground, and build a cloth manufactory on it, the ground-rent forms legitimately a part of my expenses of production, which must be repaid by the product. And since all factories are built on ground, and most of them in places where ground is peculiarly valuable, the rent paid for it must, on the average, be compensated in the values of all things made in factories. In what sense it is true that rent does not enter into the cost of production or affect the value of agricultural produce, will be shown in the succeeding chapter.

Book III, Chapter V: Of rent, in its relation to value

CHAPTER V: of rent, in its relation to value

§ 1. We have investigated the laws which determine the value of two classes of commodities: the small class which, being limited to a definite quantity, have their value entirely determined by demand and supply, save that their cost of production (if they have any) constitutes a minimum below which they cannot permanently fall; and the large class, which can be multiplied ad libitum by labour and capital, and of which the cost of production fixes the maximum as well as the minimum at which they can permanently exchange. But there is still a third kind of commodities to be considered: those which have, not one, but several costs of production: which can always be increased in quantity by labour and capital, but not by the same amount of labour and capital; of which so much may be produced at a given cost, but a further quantity not without a greater cost. These commodities form an intermediate class, partaking of the character of both the others. The principal of them is agricultural produce. We have already made abundant reference to the fundamental truth, that in agriculture, the state of the art being given, doubling the labour does not double the produce; that if an increased quantity of produce is required, the additional supply is obtained at a greater cost than the first. Where a hundred quarters of corn are all that is at present required from the lands of a given village, if the growth of population made it necessary to raise a hundred more, either by breaking up worse land now uncultivated, or by a more elaborate cultivation of the land already under the plough, the additional hundred, or some part of them at least, might cost double or treble as much per quarter as the former supply.

If the first hundred quarters were all raised at the same expense (only the best land being cultivated); and if that expense would be remunerated with the ordinary profit by a price of 20s. the quarter; the natural price of wheat, so long as no more than that quantity was required, would be 20s.; and it could only rise above, or fall below that price, from vicissitudes of seasons, or other casual variations in supply. But if the population of the district advanced, a time would arrive when more than a hundred quarters would be necessary to feed it. We must suppose that there is no access to any foreign supply. By the hypothesis, no more than a hundred quarters can be produced in the district, unless by either bringing worse land into cultivation, or altering the system of culture to a more expensive one. Neither of these things will be done without a rise in price. This rise of price will gradually be brought about by the increasing demand. So long as the price has risen, but not risen enough to repay with the ordinary profit the cost of producing an additional quantity, the increased value of the limited supply partakes of the nature of a scarcity value. Suppose that it will not answer to cultivate the second best land, or land of the second degree of remoteness, for a less return than 25s. the quarter; and that this price is also necessary to remunerate the expensive operations by which an increased produce might be raised from land of the first quality. If so, the price will rise, through the increased demand, until it reaches 25s. That will now be the natural price; being the price without which the quantity, for which society has a demand at that price, will not be produced. At that price, however, society can go on for some time longer; could go on perhaps for ever, if population did not increase. The price, having attained that point, will not again permanently recede (though it may fall temporarily from accidental abundance); nor will it advance further, so long as society can obtain the supply it requires without a second increase of the cost of production.

I have made use of Price in this reasoning, as a convenient symbol of Value, from the greater familiarity of the idea; and I shall continue to do so as far as may appear to be necessary.

In the case supposed, different portions of the supply of corn have different costs of production. Though the 20, or 50, or 150 quarters additional have been produced at a cost proportional to 25s., the original hundred quarters per annum are still produced at a cost only proportional to 20s. This is self-evident, if the original and the additional supply are produced on different qualities of land. It is equally true if they are produced on the same land. Suppose that land of the best quality, which produced 100 quarters at 20s., has been made to produce 150 by an expensive process, which it would not answer to undertake without a price of 25s. The cost which requires 25s. is incurred for the sake of 50 quarters alone: the first hundred might have continued for ever to be produced at the original cost, and with the benefit, on that quantity, of the whole rise of price caused by the increased demand: no one, therefore, will incur the additional expense for the sake of the additional fifty, unless they alone will pay for the whole of it. The fifty, therefore, will be produced at their natural price, proportioned to the cost of their production; while the other hundred will now bring in 5s. a quarter more than their natural price—than the price corresponding to, and sufficing to remunerate, their lower cost of production.

If the production of any, even the smallest, portion of the supply, requires as a necessary condition a certain price, that price will be obtained for all the rest. We are not able to buy one loaf cheaper than another because the corn from which it was made, being grown on a richer soil, has cost less to the grower. The value, therefore, of an article (meaning its natural, which is the same with its average value) is determined by the cost of that portion of the supply which is produced and brought to market at the greatest expense. This is the Law of Value of the third of the three classes into which all commodities are divided.

§ 2. If the portion of produce raised in the most unfavourable circumstances obtains a value proportioned to its cost of production; all the portions raised in more favorable circumstances, selling as they must do at the same value, obtain a value more than proportioned to their cost of production. Their value is not, correctly speaking, a scarcity value, for it is determined by the circumstances of the production of the commodity, and not by the degree of dearness necessary for keeping down the demand to the level of a limited supply. The owners, however, of those portions of the produce enjoy a privilege; they obtain a value which yields them more than the ordinary profit. If this advantage depends upon any special exemption, such as being free from a tax, or upon any personal advantages, physical or mental, or any peculiar process only known to themselves, or upon the possession of a greater capital than other people, or upon various other things which might be enumerated, they retain it to themselves as an extra gain, over and above the general profits of capital, of the nature, in some sort, of a monopoly profit. But when, as in the case which we are more particularly considering, the advantage depends on the possession of a natural agent of peculiar quality, as for instance of more fertile land than that which determines the general value of the commodity; and when this natural agent is not owned by themselves; the person who does own it, is able to exact from them, in the form of rent, the whole extra gain derived from its use. We are thus brought by another road to the Law of Rent, investigated in the concluding chapter of the Second Book. Rent, we again see, is the difference between the unequal returns to different parts of the capital employed on the soil. Whatever surplus any portion of agricultural capital produces, beyond what is produced by the same amount of capital on the worst soil, or under the most expensive mode of cultivation, which the existing demands of society compel a recourse to; that surplus will naturally be paid as rent from that capital, to the owner of the land on which it is employed.

It was long thought by political economists, among the rest even by Adam Smith, that the produce of land is always at a monopoly value, because (they said) in addition to the ordinary rate of profit, it always yields something further for rent. This we now see to be erroneous. A thing cannot be at a monopoly value, when its supply can be increased to an indefinite extent if we are only willing to incur the cost. If no more corn than the existing quantity is grown, it is because the value has not risen high enough to remunerate any one for growing it. Any land (not reserved for other uses, or for pleasure) which at the existing price, and by the existing processes, will yield the ordinary profit, is tolerably certain, unless some artificial hindrance intervenes, to be cultivated, although nothing may be left for rent. As long as there is any land fit for cultivation, which at the existing price cannot be profitably cultivated at all, there must be some land a little better, which will yield the ordinary profit, but allow nothing for rent: and that land, if within the boundary of a farm, will be cultivated by the farmer; if not so, probably by the proprietor, or by some other person on sufferance. Some such land at least, under cultivation, there can scarcely fail to be.

Rent, therefore, forms no part of the cost of production which determines the value of agricultural produce. Circumstances no doubt may be conceived in which it might do so, and very largely too. We can imagine a country so fully peopled, and with all its cultivable soil so completely occupied, that to produce any additional quantity would require more labour than the produce would feed: and if we suppose this to be the condition of the whole world, or of a country debarred from foreign supply, then, if population continued increasing, both the land and its produce would really rise to a monopoly or scarcity price. But this state of things never can have really existed anywhere, unless possibly in some small island cut off from the rest of the world; nor is there any danger whatever that it should exist. It certainly exists in no known region at present. Monopoly, we have seen, can take effect on value, only through limitation of supply. In all countries of any extent there is more cultivable land than is yet cultivated; and while there is any such surplus, it is the same thing, so far as that quality of land is concerned, as if there were an infinite quantity. What is practically limited in supply is only the better qualities; and even for those, so much rent cannot be demanded as would bring in the competition of the lands not yet in cultivation; the rent of a piece of land must be somewhat less than the whole excess of its productiveness over that of the best land which it is not yet profitable to cultivate; that is, it must be about equal to the excess above the worst land which it is profitable to cultivate. The land or the capital most unfavourably circumstanced among those actually employed, pays no rent; and that land or capital determines the cost of production which regulates the value of the whole produce. Thus rent is, as we have already seen, no cause of value, but the price of the privilege which the inequality of the returns to different portions of agricultural produce confers on all except the least favoured portions.

Rent, in short, merely equalizes the profits of different farming capitals, by enabling the landlord to appropriate all extra gains occasioned by superiority of natural advantages. If all landlords were unanimously to forego their rent, they would but transfer it to the farmers, without benefiting the consumer; for the existing price of corn would still be an indispensable condition of the production of part of the existing supply, and if a part obtained that price the whole would obtain it. Rent, therefore, unless artificially increased by restrictive laws, is no burthen on the consumer: it does not raise the price of corn, and is no otherwise a detriment to the public, than inasmuch as if the state had retained it, or imposed an equivalent in the shape of a land-tax, it would then have been a fund applicable to general instead of private advantage.

§ 3. Agricultural productions are not the only commodities which have several different costs of production at once, and which, in consequence of that difference, and in proportion to it, afford a rent. Mines are also an instance. Almost all kinds of raw material extracted from the interior of the earth—metal, coals, precious stones, &c., are obtained from mines differing considerably in fertility, that is, yielding very different quantities of the product to the same quantity of labour and capital. This being the case, it is an obvious question, why are not the most fertile mines so worked as to supply the whole market? No such question can arise as to land; it being self-evident, that the most fertile lands could not possibly be made to supply the whole demand of a fully-peopled country; and even of what they do yield, a part is extorted from them by a labour and outlay as great as that required to grow the same amount on worse land. But it is not so with mines; at least, not universally. There are, perhaps, cases in which it is impossible to extract from a particular vein, in a given time, more than a certain quantity of ore, because there is only a limited surface of the vein exposed, on which more than a certain number of labourers cannot be simultaneously employed. But this is not true of all mines. In collieries, for example, some other cause of limitation must be sought for. In some instances the owners limit the quantity raised, in order not too rapidly to exhaust the mine: in others there are said to be combinations of owners, to keep up a monopoly price by limiting the production. Whatever be the causes, it is a fact that mines of different degrees of richness are in operation, and since the value of the produce must be proportional to the cost of production at the worst mine (fertility and situation taken together), it is more than proportional to that of the best. All mines superior in produce to the worst actually worked, will yield, therefore, a rent equal to the excess. They may yield more; and the worst mine may itself yield a rent. Mines being comparatively few, their qualities do not graduate gently into one another, as the qualities of land do; and the demand may be such as to keep the value of the produce considerably above the cost of production at the worst mine now worked, without being sufficient to bring into operation a still worse. During the interval, the produce is really at a scarcity value.

Fisheries are another example. Fisheries in the open sea are not appropriated, but fisheries in lakes or rivers almost always are so, and likewise oyster-beds or other particular fishing grounds on coasts. We may take salmon fisheries as an example of the whole class. Some rivers are far more productive in salmon than others. None, however, without being exhausted, can supply more than a very limited demand. The demand of a country like England can only be supplied by taking salmon from many different rivers of unequal productiveness, and the value must be sufficient to repay the cost of obtaining the fish from the least productive of these. All others, therefore, will if appropriated afford a rent equal to the value of their superiority. Much higher than this it cannot be, if there are salmon rivers accessible which from distance or inferior productiveness have not yet contributed to supply the market. If there are not, the value, doubtless, may rise to a scarcity rate, and the worst fisheries in use may then yield a considerable rent.

Both in the case of mines and of fisheries, the natural order of events is liable to be interrupted by the opening of a new mine, or a new fishery, of superior quality to some of those already in use. The first effect of such an incident is an increase of the supply; which of course lowers the value to call forth an increased demand. This reduced value may be no longer sufficient to remunerate the worst of the existing mines or fisheries, and these may consequently be abandoned. If the superior mines or fisheries, with the addition of the one newly opened, produce as much of the commodity as is required at the lower value corresponding to their lower cost of production, the fall of value will be permanent, and there will be a corresponding fall in the rents of those mines or fisheries which are not abandoned. In this case, when things have permanently adjusted themselves, the result will be, that the scale of qualities which supply the market will have been cut short at the lower end, while a new insertion will have been made in the scale at some point higher up; and the worst mine or fishery in use—the one which regulates the rents of the superior qualities and the value of the commodity—will be a mine or fishery of better quality than that by which they were previously regulated.

Land is used for other purposes than agriculture, especially for residence; and when so used, yields a rent, determined by principles similar to those already laid down. The ground rent of a building, and the rent of a garden or park attached to it, will not be less than the rent which the same land would afford in agriculture: but may be greater than this to an indefinite amount; the surplus being either in consideration of beauty or of convenience, the convenience often consisting in superior facilities for pecuniary gain. Sites of remarkable beauty are generally limited in supply, and therefore, if in great demand, are at a scarcity value. Sites superior only in convenience are governed as to their value by the ordinary principles of rent. The ground rent of a house in a small village is but little higher than the rent of a similar patch of ground in the open fields: but that of a shop in Cheapside will exceed these, by the whole amount at which people estimate the superior facilities of money-making in the more crowded place. The rents of wharfage, dock and harbour room, water-power, and many other privileges, may be analysed on similar principles.

§ 4. Cases of extra profit analogous to rent, are more frequent in the transactions of industry than is sometimes supposed. Take the case, for example, of a patent, or exclusive privilege for the use of a process by which cost of production is lessened. If the value of the product continues to be regulated by what it costs to those who are obliged to persist in the old process, the patentee will make an extra profit equal to the advantage which his process possesses over theirs. This extra profit is essentially similar to rent, and sometimes even assumes the form of it; the patentee allowing to other producers the use of his privilege, in consideration of an annual payment. So long as he, and those whom he associates in the privilege, do not produce enough to supply the whole market, so long the original cost of production, being the necessary condition of producing a part, will regulate the value of the whole; and the patentee will be enabled to keep up his rent to a full equivalent for the advantage which his process gives him. In the commencement indeed he will probably forego a part of this advantage for the sake of underselling others: the increased supply which he brings forward will lower the value, and make the trade a bad one for those who do not share in the privilege: many of whom therefore will gradually retire, or restrict their operations, or enter into arrangements with the patentee: as his supply increases theirs will diminish, the value meanwhile continuing slightly depressed. But if he stops short in his operations before the market is wholly supplied by the new process, things will again adjust themselves to what was the natural value before the invention was made, and the benefit of the improvement will accrue solely to the patentee.

The extra gains which any producer or dealer obtains through superior talents for business, or superior business arrangements, are very much of a similar kind. If all his competitors had the same advantages, and used them, the benefit would be transferred to their customers, through the diminished value of the article: he only retains it for himself because he is able to bring his commodity to market at a lower cost, while its value is determined by a higher. All advantages, in fact, which one competitor has over another, whether natural or acquired, whether personal or the result of social arrangements, bring the commodity, so far, into the Third Class, and assimilate the possessor of the advantage to a receiver of rent. Wages and profits represent the universal elements in production, while rent may be taken to represent the differential and peculiar: any difference in favour of certain producers, or in favour of production in certain circumstances, being the source of a gain, which, though not called rent unless paid periodically by one person to another, is governed by laws entirely the same with it. The price paid for a differential advantage in producing a commodity, cannot enter into the general cost of production of the commodity.

A commodity may no doubt, in some contingencies, yield a rent even under the most disadvantageous circumstances of its production: but only when it is, for the time, in the condition of those commodities which are absolutely limited in supply, and is therefore selling at a scarcity value; which never is, nor has been, nor can be, a permanent condition of any of the great rent-yielding commodities: unless through their approaching exhaustion, if they are mineral products (coal for example), or through an increase of population, continuing after a further increase of production becomes impossible: a contingency, which the almost inevitable progress of human culture and improvement in the long interval which has first to elapse, forbids us to consider as probable.

Book III, Chapter VI: Summary of the theory of value

CHAPTER VI: summary of the theory of value

§ 1. We have now attained a favourable point for looking back, and taking a simultaneous view of the space which we have traversed since the commencement of the present Book. The following are the principles of the theory of Value, so far as we have yet ascertained them.

I. Value is a relative term. The value of a thing means the quantity of some other thing, or of things in general, which it exchanges for. The values of all things can never, therefore, rise or fall simultaneously. There is no such thing as a general rise or a general fall of values. Every rise of value supposes a fall, and every fall a rise.

II. The temporary or Market Value of a thing, depends on the demand and supply; rising as the demand rises, and falling as the supply rises. The demand, however, varies with the value, being generally greater when the thing is cheap than when it is dear; and the value always adjusts itself in such a manner, that the demand is equal to the supply.

III. Besides their temporary value, things have also a permanent, or as it may be called, a Natural Value, to which the market value, after every variation, always tends to return; and the oscillations compensate for one another, so that, on the average, commodities exchange at about their natural value.

IV. The natural value of some things is a scarcity value; but most things naturally exchange for one another in the ratio of their cost of production, or at what may be termed their Cost Value.

V. The things which are naturally and permanently at a scarcity value are those of which the supply cannot be increased at all, or not sufficiently to satisfy the whole of the demand which would exist for them at their cost value.

VI. A monopoly value means a scarcity value. Monopoly cannot give a value to anything except through a limitation of the supply.

VII. Every commodity of which the supply can be indefinitely increased by labour and capital, exchanges for other things proportionally to the cost necessary for producing and bringing to market the most costly portion of the supply required. The natural value is synonymous with the Cost Value and the cost value of a thing, means the cost value of the most costly portion of it.

VIII. Cost of Production consists of several elements, some of which are constant and universal, others occasional. The universal elements of cost of production are, the wages of the labour, and the profits of the capital. The occasional elements are taxes, and any extra cost occasioned by a scarcity value of some of the requisites.

IX. Rent is not an element in the cost of production of the commodity which yields it; except in the cases (rather conceivable than actually existing) in which it results from, and represents, a scarcity value. But when land capable of yielding rent in agriculture is applied to some other purpose, the rent which it would have yielded is an element in the cost of production of the commodity which it is employed to produce.

X. Omitting the occasional elements; things which admit of indefinite increase, naturally and permanently exchange for each other according to the comparative amount of wages which must be paid for producing them, and the comparative amount of profits which must be obtained by the capitalists who pay those wages.

XI. The comparative amount of wages does not depend on what wages are in themselves. High wages do not make high values, nor low wages low values. The comparative amount of wages depends partly on the comparative quantities of labour required, and partly on the comparative rates of its remuneration.

XII. So, the comparative rate of profits does not depend on what profits are in themselves; nor do high or low profits make high or low values. It depends partly on the comparative lengths of time during which the capital is employed, and partly on the comparative rate of profits in different employments.

XIII. If two things are made by the same quantity of labour, and that labour paid at the same rate, and if the wages of the labourer have to be advanced for the same space of time, and the nature of the employment does not require that there be a permanent difference in their rate of profit; then, whether wages and profits be high or low, and whether the quantity of labour expended be much or little, these two things will, on the average, exchange for one another.

XIV. If one of two things commands, on the average, a greater value than the other, the cause must be that it requires for its production either a greater quantity of labour, or a kind of labour permanently paid at a higher rate; or that the capital, or part of the capital, which suPports that labour, must be advanced for a longer period; or lastly, that the production is attended with some circumstance which requires to be compensated by a permanently higher rate of profit.

XV. Of these elements, the quantity of labour required for the production is the most important: the effect of the others is smaller, though none of them are insignificant.

XVI. The lower profits are, the less important become the minor elements of cost of production, and the less do commodities deviate from a value proportioned to the quantity and quality of the labour required for their production.

XVII. But every fall of profits lowers, in some degree, the cost value of things made with much or durable machinery, and raises that of things made by hand; and every rise of profits does the reverse.

§ 2. Such is the general theory of Exchange Value. It is necessary, however, to remark that this theory contemplates a system of production carried on by capitalists for profit, and not by labourers for subsistence. In proportion as we admit this last supposition—and in most countries we must admit it, at least in respect of agricultural produce, to a very great extent—such of the preceding theorems as relate to the dependence of value on cost of production will require modification. Those theorems are all grounded on the supposition, that the producer’s object and aim is to derive a profit from his capital. This granted, it follows that he must sell his commodity at the price which will afford the ordinary rate of profit, that is to say, it must exchange for other commodities at its cost value. But the peasant proprietor, the metayer, and even the peasant-farmer or allotment-holder—the labourer, under whatever name, producing on his own account—is seeking, not an investment for his little capital, but an advantageous employment for his time and labour. His disbursements, beyond his own maintenance and that of his family, are so small, that nearly the whole proceeds of the sale of the produce are wages of labour. When he and his family have been fed from the produce of the farm (and perhaps clothed with materials grown thereon, and manufactured in the family) he may, in respect of the supplementary remuneration derived from the sale of the surplus produce, be compared to those labourers who, deriving their subsistence from an independent source, can afford to sell their labour at any price which is to their minds worth the exertion. A peasant, who supports himself and his family with one portion of his produce, will often sell the remainder very much below what would be its cost value to the capitalist.

There is, however, even in this case, a minimum, or inferior limit, of value. The produce which he carries to market, must bring in to him the value of all necessaries which he is compelled to purchase; and it must enable him to pay his rent. Rent, under peasant cultivation, is not governed by the principles set forth in the chapters immediately preceding, but is either determined by custom, as in the case of metayers, or, if fixed by competition, depends on the ratio of population to land. Rent, therefore, in this case, is an element of cost of production. The peasant must work until he has cleared his rent and the price of all purchased necessaries. After this, he will go on working only if he can sell the produce for such a price as will overcome his aversion to labour.

The minimum just mentioned is what the peasant must obtain in exchange for the whole of his surplus produce. But inasmuch as this surplus is not a fixed quantity, but may be either greater or less according to the degree of his industry, a minimum value for the whole of it does not give any minimum value for a definite quantity of the commodity. In this state of things, therefore, it can hardly be said, that the value depends at all on cost of production. It depends entirely on demand and supply, that is, on the proportion between the quantity of surplus food which the peasants choose to produce, and the numbers of the non-agricultural, or rather of the non-peasant population. If the buying class were numerous and the growing class lazy, food might be permanently at a scarcity price. I am not aware that this case has anywhere a real existence. If the growing class is energetic and industrious, and the buyers few, food will be extremely cheap. This also is a rare case, though some parts of France perhaps approximate to it. The common cases are, either that, as in Ireland until lately, the peasant class is indolent and the buyers few, or the peasants industrious and the town population numerous and opulent, as in Belgium, the north of Italy, and parts of Germany. The price of the produce will adjust itself to these varieties of circumstances unless modified, as in many cases it is, by the competition of producers who are not peasants, or by the prices of foreign markets.

§ 3. Another anomalous case is that of slave-grown produce: which presents, however, by no means the same degree of complication. The slave-owner is a capitalist, and his inducement to production consists in a profit on his capital. This profit must amount to the ordinary rate. In respect to his expenses, he is in the same position as if his slaves were free labourers working with their present efficiency, and were hired with wages equal to their present cost. If the cost is less in proportion to the work done, than the wages of free labour would be, so much the greater are his profits: but if all other producers in the country possess the same advantage, the values of commodities will not be at all affected by it. The only case in which they can be affected, is when the privilege of cheap labour is confined to particular branches of production, free labourers at proportionally higher wages being employed in the remainder. In this case, as in all cases of permanent inequality between the wages of different employments, prices and values receive the impress of the inequality. Slave-grown will exchange for non-slave-grown commodities in a less ratio than that of the quantity of labour required for their production; the value of the former will be less, of the latter greater, than if slavery did not exist.

The further adaptation of the theory of value to the varieties of existing or possible industrial systems may be left with great advantage to the intelligent reader. It is well said by Montesquieu, “Il ne faut pas toujours tellement épuiser un sujet, qu'on ne laisse rien à faire au lecteur. Il ne s'agit pas de faire lire, mais de faire penser.”∗

Book III, Chapter VII: Of money

CHAPTER VII: of money

§ 1. Having proceeded thus far in ascertaining the general laws of Value, without introducing the idea of Money (except occasionally for illustration,) it is time that we should now superadd that idea, and consider in what manner the principles of the mutual interchange of commodities are affected by the use of what is termed a Medium of Exchange.

In order to understand the manifold functions of a Circulating Medium, there is no better way than to consider what are the principal inconveniences which we should experience if we had not such a medium. The first and most obvious would be the want of a common measure for values of different sorts. If a tailor had only coats, and wanted to buy bread or a horse, it would be very troublesome to ascertain how much bread he ought to obtain for a coat, or how many coats he should give for a horse. The calculation must be recommenced on different data, every time he bartered his coats for a different kind of article; and there could be no current price, or regular quotations of value. Whereas now each thing has a current price in money, and he gets over all difficulties by reckoning his coat at 4l. or 5l., and a four-pound loaf at 6d. or 7d. As it is much easier to compare different lengths by expressing them in a common language of feet and inches, so it is much easier to compare values by means of a common language of pounds, shillings, and pence. In no other way can values be arranged one above another in a scale; in no other can a person conveniently calculate the sum of his possessions; and it is easier to ascertain and remember the relations of many things to one thing, than their innumerable cross relations with one another. This advantage of having a common language in which values may be expressed, is, even by itself, so important, that some such mode of expressing and computing them would probably be used even if a pound or a shilling did not express any real thing, but a mere unit of calculation. It is said that there are African tribes in which this somewhat artificial contrivance actually prevails. They calculate the value of things in a sort of money of account, called macutes. They say one thing is worth ten macutes, another fifteen, another twenty.∗ There is no real thing called a macute: it is a conventional unit, for the more convenient comparison of things with one another.

This advantage, however, forms but an inconsiderable part of the economical benefits derived from the use of money. The inconveniences of barter are so great, that without some more commodious means of effecting exchanges, the division of employments could hardly have been carried to any considerable extent. A tailor, who had nothing but coats, might starve before he could find any person having bread to sell who wanted a coat: besides, he would not want as much bread at a time as would be worth a coat, and the coat could not be divided. Every person, therefore, would at all times hasten to dispose of his commodity in exchange for anything which, though it might not be fitted to his own immediate wants, was in great and general demand, and easily divisible, so that he might be sure of being able to purchase with it whatever was offered for sale. The primary necessaries of life possess these properties in a high degree. Bread is extremely divisible, and an object of universal desire. Still, this is not the sort of thing required: for, of food, unless in expectation of a scarcity, no one wishes to possess more at once, than is wanted for immediate consumption; so that a person is never sure of finding an immediate purchaser for articles of food; and unless soon disposed of, most of them perish. The thing which people would select to keep by them for making purchases, must be one which, besides being divisible and generally desired, does not deteriorate by keeping. This reduces the choice to a small number of articles.

§ 2. By a tacit concurrence, almost all nations, at a very early period, fixed upon certain metals, and especially gold and silver, to serve this purpose. No other substances unite the necessary qualities in so great a degree, with so many subordinate advantages. Next to food and clothing, and in some climates even before clothing, the strongest inclination in a rude state of society is for personal ornament, and for the kind of distinction which is obtained by rarity or costliness in such ornaments. After the immediate necessities of life were satisfied, every one was eager to accumulate as great a store as possible of things at once costly and ornamental; which were chiefly gold, silver, and jewels. These were the things which it most pleased every one to possess, and which there was most certainty of finding others willing to receive in exchange for any kind of produce. They were among the most imperishable of all substances. They were also portable, and containing great value in small bulk, were easily hid; a consideration of much importance in an age of insecurity. Jewels are inferior to gold and silver in the quality of divisibility; and are of very various qualities, not to be accurately discriminated without great trouble. Gold and silver are eminently divisible, and when pure, always of the same quality; and their purity may be ascertained and certified by a public authority.

Accordingly, though furs have been employed as money in some countries, cattle in others, in Chinese Tartary cubes of tea closely pressed together, the shells called cowries on the coast of Western Africa, and in Abyssinia at this day blocks of rock salt; though even of metals, the less costly have sometimes been chosen, as iron in Lacedaemon from an ascetic policy, copper in the early Roman republic from the poverty of the people; gold and silver have been generally preferred by nations which were able to obtain them, either by industry, commerce, or conquest. To the qualities which originally recommended them, another came to be added, the importance of which only unfolded itself by degrees. Of all commodities they are among the least influenced by any of the causes which produce fluctuations of value. No commodity is quite free from such fluctuations. Gold and silver have sustained, since the beginning of history, one great permanent alteration of value, from the discovery of the American mines; and some temporary variations, such as that which, in the last great war,1 was produced by the absorption of the metals in hoards, and in the military chests of the immense armies constantly in the field. In the present age the opening of new sources of supply, so abundant as the Ural mountains, California, and Australia,2 may be the commencement of another period of decline, on the limits of which it would be useless at present to speculate. But on the whole, no commodities are so little exposed to causes of variation. They fluctuate less than almost any other things in their cost of production. And from their durability, the total quantity in existence is at all times so great in proportion to the annual supply, that the effect on value even of a change in the cost of production is not sudden: a very long time being required to diminish materially the quantity in existence, and even to increase it very greatly not being a rapid process. Gold and silver, therefore, are more fit than any other commodity to be the subject of engagements for receiving or paying a given quantity at some distant period. If the engagement were made in corn, a failure of crops might increase the burthen of the payment in one year to fourfold what was intended, or an exuberant harvest sink it in another to one-fourth. If stipulated in cloth, some manufacturing invention might permanently reduce the payment to a tenth of its original value. Such things have occurred even in the case of payments stipulated in gold and silver; but the great fall of their value after the discovery of America, is, as yet,1 the only authenticated instance; and in this case the change was extremely gradual, being spread over a period of many years.

When gold and silver had become virtually a medium of exchange, by becoming the things for which people generally sold, and with which they generally bought, whatever they had to sell or to buy; the contrivance of coining obviously suggested itself. By this process the metal was divided into convenient portions, of any degree of smallness, and bearing a recognised proportion to one another; and the trouble was saved of weighing and assaying at every change of possessors, an inconvenience which on the occasion of small purchases would soon have become insupportable. Governments found it their interest to take the operation into their own hands, and to interdict all coining by private persons; indeed, their guarantee was often the only one which would have been relied on, a reliance however which very often it ill deserved; profligate governments having until a very modern period seldom scrupled, for the sake of robbing their creditors, to confer on all other debtors a licence to rob theirs, by the shallow and impudent artifice of lowering the standard; that least covert of all modes of knavery, which consists in calling a shilling a pound, that a debt of one hundred pounds may be cancelled by the payment of a hundred shillings. It would have been as simple a plan, and would have answered the purpose as well, to have enacted that “a hundred” should always be interpreted to mean five, which would have affected the same reduction in all pecuniary contracts, and would not have been at all more shameless. Such strokes of policy have not wholly ceased to be recommended, but they have ceased to be practised; except occasionally through the medium of paper money, in which case the character of the transaction, from the greater obscurity of the subject, is a little less barefaced.

§ 3. Money, when its use has grown habitual, is the medium through which the incomes of the different members of the community are distributed to them, and the measure by which they estimate their possessions. As it is always by means of money that people provide for their different necessities, there grows up in their minds a powerful association leading them to regard money as wealth in a more peculiar sense than any other article; and even those who pass their lives in the production of the most useful objects, acquire the habit of regarding those objects as chiefly important by their capacity of being exchanged for money. A person who parts with money to obtain commodities, unless he intends to sell them, appears to the imagination to be making a worse bargain than a person who parts with commodities to get money; the one seems to be spending his means, the other adding to them. Illusions which, though now in some measure dispelled, were long powerful enough to overmaster the mind of every politician, both speculative and practical, in Europe.

It must be evident, however, that the mere introduction of a particular mode of exchanging things for one another by first exchanging a thing for money, and then exchanging the money for something else, makes no difference in the essential character of transactions. It is not with money that things are really purchased. Nobody’s income (except that of the gold or silver miner) is derived from the precious metals. The pounds or shillings which a person receives weekly or yearly, are not what constitutes his income; they are a sort of tickets or orders which he can present for payment at any shop he pleases, and which entitle him to receive a certain value of any commodity that he makes choice of. The farmer pays his labourers and his landlord in these tickets, as the most convenient plan for himself and them; but their real income is their share of his corn, cattle, and hay, and it makes no essential difference whether he distributes it to them directly, or sells it for them and gives them the price; but as they would have to sell it for money if he did not, and as he is a seller at any rate, it best suits the purposes of all, that he should sell their share along with his own, and leave the labourers more leisure for work and the landlord for being idle. The capitalists, except those who are producers of the precious metals, derive no part of their income from those metals, since they only get them by buying them with their own produce: while all other persons have their incomes paid to them by the capitalists, or by those who have received payment from the capitalists and as the capitalists have nothing, from the first, except their produce, it is that and nothing else which supplies all incomes furnished by them. There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.

The introduction of money does not interfere with the operation of any of the Laws of Value laid down in the preceding chapters. The reasons which make the temporary or market value of things depend on the demand and supply, and their average and permanent values upon their cost of production, are as applicable to a money system as to a system of barter. Things which by barter would exchange for one another, will, if sold for money, sell for an equal amount of it, and so will exchange for one another still, though the process of exchanging them will consist of two operations instead of only one. The relations of commodities to one another remain unaltered by money: the only new relation introduced is their relation to money itself; how much or how little money they will exchange for; in other words, how the Exchange Value of money itself is determined. And this is not a question of any difficulty, when the illusion is dispelled, which caused money to be looked upon as a peculiar thing, not governed by the same laws as other things. Money is a commodity, and its value is determined like that of other commodities, temporarily by demand and supply, permanently and on the average by cost of production. The illustration of these principles, considered in their application to money, must be given in some detail, on account of the confusion which, in minds not scientifically instructed on the subject, envelopes the whole matter; partly from a lingering remnant of the misleading associations, and partly from the mass of vapoury and baseless speculation with which this, more than any other topic of political economy, has in latter times become surrounded. I shall therefore treat of the Value of Money in a chapter apart.

Book III, Chapter VIII: Of the value of money, as dependent on demand and supply

CHAPTER VIII: of the value of money, as dependent on demand and supply

§ 1. It is unfortunate that in the very outset of the subject we have to clear from our path a formidable ambiguity of language. The Value of Money is to appearance an expression as precise, as free from possibility of misunderstanding, as any in science. The value of a thing is what it will exchange for: the value of money, is what money will exchange for; the purchasing power of money. If prices are low, money will buy much of other things, and is of high value; if prices are high, it will buy little of other things, and is of low value. The value of money is inversely as general prices: falling as they rise, and rising as they fall.

But unhappily the same phrase is also employed, in the current language of commerce, in a very different sense. Money, which is so commonly understood as the synonym of wealth, is more especially the term in use to denote it when it is the subject of borrowing. When one person lends to another, as well as when he pays wages or rent to another, what he transfers is not the mere money, but a right to a certain value of the produce of the country, to be selected at pleasure; the lender having first bought this right, by giving for it a portion of his capital. What he really lends is so much capital; the money is the mere instrument of transfer. But the capital usually passes from the lender to the receiver through the means either of money, or of an order to receive money, and at any rate it is in money that the capital is computed and estimated. Hence, borrowing capital is universally called borrowing money; the loan market is called the money market: those who have their capital disposable for investment on loan are called the monied class: and the equivalent given for the use of capital, or in other words, interest, is not only called the interest of money, but, by a grosser perversion of terms, the value of money. This misapplication of language, assisted by some fallacious appearances which we shall notice and clear up hereafter,∗ has created a general notion among persons in business, that the Value of Money, meaning the rate of interest, has an intimate connexion with the Value of Money in its proper sense, the value or purchasing power of the circulating medium. We shall return to this subject before long: at present it is enough to say, that by Value I shall always mean Exchange Value, and by money the medium of exchange, not the capital which is passed from hand to hand through that medium.

§ 2. The value or purchasing power of money depends, in the first instance, on demand and supply. But demand and supply, in relation to money, present themselves in a somewhat different shape from the demand and supply of other things.

The supply of a commodity means the quantity offered for sale. But it is not usual to speak of offering money for sale. People are not usually said to buy or sell money. This, however, is merely an accident of language. In point of fact, money is bought and sold like other things, whenever other things are bought and sold for money. Whoever sells corn, or tallow, or cotton, buys money. Whoever buys bread, or wine, or clothes, sells money to the dealer in those articles. The money with which people are offering to buy is money offered for sale. The supply of money, then, is the quantity of it which people are wanting to lay out; that is, all the money they have in their possession, except what they are hoarding, or at least keeping by them as a reserve for future contingencies. The supply of money, in short, is all the money in circulation at the time.

The demand for money, again, consists of all the goods offered for sale. Every seller of goods is a buyer of money, and the goods he brings with him constitute his demand. The demand for money differs from the demand for other things in this, that it is limited only by the means of the purchaser. The demand for other things is for so much and no more; but there is always a demand for as much money as can be got. Persons may indeed refuse to sell, and withdraw their goods from the market, if they cannot get for them what they consider a sufficient price. But this is only when they think that the price will rise, and that they shall get more money by waiting. If they thought the low price likely to be permanent, they would take what they could get. It is always a sine quâ non with a dealer to dispose of his goods.

As the whole of the goods in the market compose the demand for money, so the whole of the money constitutes the demand for goods. The money and the goods are seeking each other for the purpose of being exchanged. They are reciprocally supply and demand to one another. It is indifferent whether, in characterizing the phenomena, we speak of the demand and supply of goods, or the supply and the demand of money. They are equivalent expressions.

We shall proceed to illustrate this proposition more fully. And in doing this, the reader will remark a great difference between the class of questions which now occupy us, and those which we previously had under discussion respecting Values. In considering Value, we were only concerned with causes which acted upon particular commodities apart from the rest. Causes which affect all commodities alike do not act upon values. But in considering the relation between goods and money, it is with the causes that operate upon all goods whatever that we are specially concerned. We are comparing goods of all sorts on one side, with money on the other side, as things to be exchanged against each other.

Suppose, everything else being the same, that there is an increase in the quantity of money, say by the arrival of a foreigner in a place, with a treasure of gold and silver. When he commences expending it (for this question it matters not whether productively or unproductively), he adds to the supply of money, and, by the same act, to the demand for goods. Doubtless he adds, in the first instance, to the demand only for certain kinds of goods, namely, those which he selects for purchase; he will immediately raise the price of those, and so far as he is individually concerned, of those only. If he spends his funds in giving entertainments, he will raise the prices of food and wine. If he expends them in establishing a manufactory, he will raise the prices of labour and materials. But at the higher prices, more money will pass into the hands of the sellers of these different articles; and they, whether labourers or dealers, having more money to lay out, will create an increased demand for all the things which they are accustomed to purchase: these accordingly will rise in price, and so on until the rise has reached everything. I say everything, though it is of course possible that the influx of money might take place through the medium of some new class of consumers, or in such a manner as to alter the proportions of different classes of consumers to one another, so that a greater share of the national income than before would thenceforth be expended in some articles, and a smaller in others; exactly as if a change had taken place in the tastes and wants of the community. If this were the case, then until production had accommodated itself to this change in the comparative demand for different things, there would be a real alteration in values, and some things would rise in price more than others, while some perhaps would not rise at all. These effects, however, would evidently proceed, not from the mere increase of money, but from accessory circumstances attending it. We are now only called upon to consider what would be the effect of an increase of money, considered by itself. Supposing the money in the hands of individuals to be increased, the wants and inclinations of the community collectively in respect to consumption remaining exactly the same; the increase of demand would reach all things equally, and there would be an universal rise of prices. We might suppose, with Hume, that some morning, every person in the nation should wake and find a gold coin in his pocket: this example, however, would involve an alteration of the proportions in the demand for different commodities; the luxuries of the poor would, in the first instance, be raised in price in a much greater degree than other things. Let us rather suppose, therefore, that to every pound, or shilling, or penny, in the possession of any one, another pound, shilling, or penny, were suddenly added. There would be an increased money demand, and consequently an increased money value, or price, for things of all sorts. This increased value would do no good to any one; would make no difference, except that of having to reckon pounds, shillings, and pence, in higher numbers. It would be an increase of values only as estimated in money, a thing only wanted to buy other things with; and would not enable any one to buy more of them than before. Prices would have risen in a certain ratio, and the value of money would have fallen in the same ratio.

It is to be remarked that this ratio would be precisely that in which the quantity of money had been increased. If the whole money in circulation was doubled, prices would be doubled. If it was only increased one-fourth, prices would rise one-fourth. There would be one-fourth more money, all of which would be used to purchase goods of some description. When there had been time for the increased supply of money to reach all markets, or (according to the conventional metaphor) to permeate all the channels of circulation, all prices would have risen one-fourth. But the general rise of price is independent of this diffusing and equalizing process. Even if some prices were raised more, and others less, the average rise would be one-fourth. This is a necessary consequence of the fact that a fourth more money would have been given for only the same quantity of goods. General prices, therefore, would in any case be a fourth higher.

The very same effect would be produced on prices if we suppose the goods diminished, instead of the money increased: and the contrary effect if the goods were increased or the money diminished. If there were less money in the hands of the community, and the same amount of goods to be sold, less money altogether would be given for them, and they would be sold at lower prices; lower, too, in the precise ratio in which the money was diminished. So that the value of money, other things being the same, varies inversely as its quantity; every increase of quantity lowering the value, and every diminution raising it, in a ratio exactly equivalent.

This, it must be observed, is a property peculiar to money. We did not find it to be true of commodities generally, that every diminution of supply raised the value exactly in proportion to the deficiency, or that every increase lowered it in the precise ratio of the excess. Some things are usually affected in a greater ratio than that of the excess or deficiency, others usually in a less: because, in ordinary cases of demand, the desire, being for the thing itself, may be stronger or weaker: and the amount of what people are willing to expend on it, being in any case a limited quantity, may be affected in very unequal degrees by difficulty or facility of attainment. But in the case of money, which is desired as the means of universal purchase, the demand consists of everything which people have to sell; and the only limit to what they are willing to give is the limit set by their having nothing more to offer. The whole of the goods being in any case exchanged for the whole of the money which comes into the market to be laid out, they will sell for less or more of it, exactly according as less or more is brought.

§ 3. From what precedes, it might for a moment be supposed that all the goods on sale in a country, at any one time, are exchanged for all the money existing and in circulation at that same time: or, in other words, that there is always in circulation in a country, a quantity of money equal in value to the whole of the goods then and there on sale. But this would be a complete misapprehension. The money laid out is equal in value to the goods it purchases; but the quantity of money laid out is not the same thing with the quantity in circulation. As the money passes from hand to hand, the same piece of money is laid out many times, before all the things on sale at one time are purchased and finally removed from the market: and each pound or dollar must be counted for as many pounds or dollars, as the number of times it changes hands in order to effect this object. The greater part of the goods must also be counted more than once, not only because most things pass through the hands of several sets of manufacturers and dealers before they assume the form in which they are finally consumed, but because in times of speculation (and all times are so, more or less) the same goods are often bought repeatedly, to be resold for a profit, before they are bought for the purpose of consumption at all.

If we assume the quantity of goods on sale, and the number of times those goods are resold, to be fixed quantities, the value of money will depend upon its quantity, together with the average number of times that each piece changes hands in the process. The whole of the goods sold (counting each resale of the same goods as so much added to the goods) have been exchanged for the whole of the money, multiplied by the number of purchases made on the average by each piece. Consequently, the amount of goods and of transactions being the same, the value of money is inversely as its quantity multiplied by what is called the rapidity of circulation. And the quantity of money in circulation is equal to the money value of all the goods sold, divided by the number which expresses the rapidity of circulation.

The phrase, rapidity of circulation, requires some comment. It must not be understood to mean the number of purchases made by each piece of money in a given time. Time is not the thing to be considered. The state of society may be such that each piece of money hardly performs more than one purchase in a year: but if this arises from the small number of transactions—from the small amount of business done, the want of activity in traffic, or because what traffic there is, mostly takes place by barter—it constitutes no reason why prices should be lower, or the value of money higher. The essential point is, not how often the same money changes hands in a given time, but how often it changes hands in order to perform a given amount of traffic. We must compare the number of purchases made by the money in a given time, not with the time itself, but with the goods sold in that same time. If each piece of money changes hands on an average ten times while goods are sold to the value of a million sterling, it is evident that the money required to circulate those goods is 100,000l. And conversely, if the money in circulation is 100,000l., and each piece changes hands by the purchase of goods ten times in a month, the sales of goods for money which take place every month must amount on the average to 1,000,000l.

Rapidity of circulation being a phrase so ill adapted to express the only thing which it is of any importance to express by it, and having a tendency to confuse the subject by suggesting a meaning extremely different from the one intended, it would be a good thing if the phrase could be got rid of, and another substituted, more directly significant of the idea meant to be conveyed. Some such expression as “the efficiency of money,” though not unexceptionable, would do better; as it would point attention to the quantity of work done, without suggesting the idea of estimating it by time. Until an appropriate term can be devised, we must be content, when ambiguity is to be apprehended, to express the idea by the circumlocution which alone conveys it adequately, namely, the average number of purchases made by each piece in order to effect a given pecuniary amount of transactions.

§ 4. The proposition which we have laid down respecting the dependence of general prices upon the quantity of money in circulation, must be understood as applying only to a state of things in which money, that is, gold or silver, is the exclusive instrument of exchange, and actually passes from hand to hand at every purchase, credit in any of its shapes being unknown. When credit comes into play as a means of purchasing, distinct from money in hand, we shall hereafter find that the connexion between prices and the amount of the circulating medium is much less direct and intimate, and that such connexion as does exist no longer admits of so simple a mode of expression. But on a subject so full of complexity as that of currency and prices, it is necessary to lay the foundation of our theory in a thorough understanding of the most simple cases, which we shall always find lying as a groundwork or substratum under those which arise in practice. That an increase of the quantity of money raises prices, and a diminution lowers them, is the most elementary proposition in the theory of currency, and without it we should have no key to any of the others. In any state of things, however, except the simple and primitive one which we have supposed, the proposition is only true other things being the same: and what those other things are, which must be the same, we are not yet ready to pronounce. We can, however, point out, even now, one or two of the cautions with which the principle must be guarded in attempting to make use of it for the practical explanation of phenomena; cautions the more indispensable, as the doctrine, though a scientific truth, has of late years been the foundation of a greater mass of false theory, and erroneous interpretation of facts, than any other proposition relating to interchange. From the time of the resumption of cash payments by the Act of 1819, and especially since the commercial crisis of 1825, the favourite explanation of every rise or fall of prices has been “the currency;” and like most popular theories, the doctrine has been applied with little regard to the conditions necessary for making it correct.

For example, it is habitually assumed that whenever there is a greater amount of money in the country, or in existence, a rise of prices must necessarily follow. But this is by no means an inevitable consequence. In no commodity is it the quantity in existence, but the quantity offered for sale, that determines the value. Whatever may be the quantity of money in the country, only that part of it will affect prices which goes into the market of commodities, and is there actually exchanged against goods. Whatever increases the amount of this portion of the money in the country, tends to raise prices. But money hoarded does not act on prices. Money kept in reserve by individuals to meet contingencies which do not occur, does not act on prices. The money in the coffers of the Bank, or retained as a reserve by private bankers, does not act on prices until drawn out, nor even then unless drawn out to be expended in commodities.

It frequently happens that money, to a considerable amount, is brought into the country, is there actually invested1 as capital, and again flows out, without having ever once acted upon the markets of commodities, but only upon the market of securities, or, as it is commonly though improperly called, the money market. Let us return to the case already put for illustration, that of a foreigner landing in the country with a treasure. We supposed him to employ his treasure in the purchase of goods for his own use, or in setting up a manufactory and employing labourers; and in either case he would, caeteris paribus, raise prices. But instead of doing either of these things, he might very probably prefer to invest his fortune at interest; which we shall suppose him to do in the most obvious way, by becoming a competitor for a portion of the stock, exchequer bills, railway debentures, mercantile bills, mortgages, &c., which are at all times in the hands of the public. By doing this he would raise the prices of those different securities, or in other words would lower the rate of interest; and since this would disturb the relation previously existing between the rate of interest on capital in the country itself, and that in foreign countries, it would probably induce some of those who had floating capital seeking employment, to send it abroad for foreign investment rather than buy securities at home at the advanced price. As much money might thus go out as had previously come in, while the prices of commodities would have shown no trace of its temporary presence. This is a case highly deserving of attention: and it is a fact now beginning to be recognised, that the passage of the precious metals from country to country is determined much more than was formerly supposed by the state of the loan market in different countries, and much less by the state of prices.

Another point must be adverted to, in order to avoid serious error in the interpretation of mercantile phenomena. If there be, at any time, an increase in the number of money transactions, a thing continually liable to happen from differences in the activity of speculation, and even in the time of year (since certain kinds of business are transacted only at particular seasons); an increase of the currency which is only proportional to this increase of transactions, and is of no longer duration, has no tendency to raise prices. At the quarterly periods when the public dividends are paid at the Bank, a sudden increase takes place of the money in the hands of the public; an increase estimated at from a fifth to two-fifths of the whole issues of the Bank of England. Yet this never has any effect on prices; and in a very few weeks, the currency has again shrunk into its usual dimensions, by a mere reduction in the demands of the public (after so copious a supply of ready money) for accommodation from the Bank in the way of discount or loan. In like manner the currency of the agricultural districts fluctuates in amount at different seasons of the year. It is always lowest in August: “it rises generally towards Christmas, and obtains its greatest elevation about Lady-day, when the farmer commonly lays in his stock, and has to pay his rent and summer taxes,” and when he therefore makes his principal applications to country bankers for loans. “Those variations occur with the same regularity as the season, and with just as little disturbance of the markets as the quarterly fluctuations of the notes of the Bank of England. As soon as the extra payments have been completed, the superfluous” currency, which is estimated at half a million, “as certainly and immediately is reabsorbed and disappears.”∗

If extra currency were not forthcoming to make these extra payments, one of three things must happen. Either the payments must be made without money, by a resort to some of those contrivances by which its use is dispensed with; or there must be an increase in the rapidity of circulation, the same sum of money being made to perform more payments; or, if neither of these things took place, money to make the extra payments must be withdrawn from the market for commodities, and prices, consequently, must fall. An increase of the circulating medium, conformable in extent and duration to the temporary stress of business, does not raise prices, but merely prevents this fall.

The sequel of our investigation will point out many other qualifications with which the proposition must be received, that the value of the circulating medium depends on the demand and supply, and is in the inverse ratio of the quantity;1 qualifications which, under a complex system of credit like that existing in England, render the proposition an extremely incorrect expression of the fact.

Book III, Chapter IX: Of the value of money, as dependent on cost of production

CHAPTER IX: of the value of money, as dependent on cost of production

§ 1. But money, no more than commodities in general, has its value definitively determined by demand and supply. The ultimate regulator of its value is Cost of Production.

We are supposing, of course, that things are left to themselves. Governments have not always left things to themselves. They have undertaken to prevent the quantity of money from adjusting itself according to spontaneous laws, and have endeavoured to regulate it at their pleasure; generally with a view of keeping a greater quantity of money in the country, than would otherwise have remained there. It was, until lately, the policy of all governments to interdict the exportation and the melting of money; while, by encouraging the exportation and impeding the importation of other things, they endeavoured to have a stream of money constantly flowing in. By this course they gratified two prejudices; they drew, or thought that they drew, more money into the country, which they believed to be tantamount to more wealth; and they gave, or thought that they gave, to all producers and dealers, high prices, which, though no real advantage, people are always inclined to suppose to be one.

In this attempt to regulate the value of money artificially by means of the supply, governments have never succeeded in the degree, or even in the manner, which they intended. Their prohibitions against exporting or melting the coin have never been effectual. A commodity of such small bulk in proportion to its value is so easily smuggled, and still more easily melted, that it has been impossible by the most stringent measures to prevent these operations. All the risk which it was in the power of governments to attach to them, was outweighed by a very moderate profit.∗ In the more indirect mode of aiming at the same purpose, by throwing difficulties in the way of making the returns for exported goods in any other commodity than money, they have not been quite so unsuccessful. They have not, indeed, succeeded in making money flow continuously into the country; but they have to a certain extent been able to keep it at a higher than its natural level; and have, thus far, removed the value of money from exclusive dependence on the causes which fix the value of things not artificially interfered with.

We are, however, to suppose a state, not of artificial regulation, but of freedom. In that state, and assuming no charge to be made for coinage, the value of money will conform to the value of the bullion of which it is made. A pound weight of gold or silver in coin, and the same weight in an ingot, will precisely exchange for one another. On the supposition of freedom, the metal cannot be worth more in the state of bullion than of coin; for as it can be melted without any loss of time, and with hardly any expense, this would of course be done until the quantity in circulation was so much diminished as to equalize its value with that of the same weight in bullion. It may be thought however that the coin, though it cannot be of less, may be, and being a manufactured article will naturally be, of greater value than the bullion contained in it, on the same principle on which linen cloth is of more value than an equal weight of linen yarn. This would be true, were it not that Government, in this country, and in some others, coins money gratis for any one who furnishes the metal. The labour and expense of coinage, when not charged to the possessor, do not raise the value of the article. If Government opened an office where, on delivery of a given weight of yarn, it returned the same weight of cloth to any one who asked for it, cloth would be worth no more in the market than the yarn it contained. As soon as coin is worth a fraction more than the value of the bullion, it becomes the interest of the holders of bullion to send it to be coined. If Government, however, throws the expense of coinage, as is reasonable, upon the holder, by making a charge to cover the expense (which is done by giving back rather less in coin than has been received in bullion, and is called levying a seignorage), the coin will rise, to the extent of the seignorage, above the value of the bullion. If the Mint kept back one per cent to pay the expense of coinage, it would be against the interest of the holders of bullion to have it coined, until the coin was more valuable than the bullion by at least that fraction. The coin, therefore, would be kept one per cent higher in value, which could only be by keeping it one per cent less in quantity, than if its coinage were gratuitous.

The Government might attempt to obtain a profit by the transaction, and might lay on a seignorage calculated for that purpose; but whatever they took for coinage beyond its expenses, would be so much profit on private coining. Coining, though not so easy an operation as melting, is far from a difficult one, and, when the coin produced is of full weight and standard fineness, is very difficult to detect. If, therefore, a profit could be made by coining good money, it would certainly be done: and the attempt to make seignorage a source of revenue would be defeated. Any attempt to keep the value of the coin at an artificial elevation, not by a seignorage, but by refusing to coin, would be frustrated in the same manner.∗

§ 2. The value of money, then, conforms, permanently, and, in a state of freedom, almost immediately, to the value of the metal of which it is made; with the addition, or not, of the expenses of coinage, according as those expenses are borne by the individual or by the state. This simplifies extremely the question which we have here to consider: since gold and silver bullion are commodities like any others, and their value depends, like that of other things, on their cost of production.

To the majority of civilized countries, gold and silver are foreign products: and the circumstances which govern the values of foreign products, present some questions which we are not yet ready to examine. For the present, therefore, we must suppose the country which is the subject of our inquiries, to be supplied with gold and silver by its own mines, reserving for future consideration how far our conclusions require modification to adapt them to the more usual case.

Of the three classes into which commodities are divided—those absolutely limited in supply, those which may be had in unlimited quantity at a given cost of production, and those which may be had in unlimited quantity, but at an increasing cost of production—the precious metals, being the produce of mines, belong to the third class. Their natural value, therefore, is in the long run proportional to their cost of production in the most unfavourable existing circumstances, that is, at the worst mine which it is necessary to work in order to obtain the required supply. A pound weight of gold will, in the gold-producing countries, ultimately tend to exchange for as much of every other commodity as is produced at a cost equal to its own; meaning by its own cost the cost in labour and expense, at the least productive sources of supply which the then existing demand makes it necessary to work. The average value of gold is made to conform to its natural value in the same manner as the values of other things are made to conform to their natural value. Suppose that it were selling above its natural value; that is, above the value which is an equivalent for the labour and expense of mining, and for the risks attending a branch of industry in which nine out of ten experiments have usually been failures. A part of the mass of floating capital which is on the look out for investment, would take the direction of mining enterprise; the supply would thus be increased, and the value would fall. If, on the contrary, it were selling below its natural value, miners would not be obtaining the ordinary profit; they would slacken their works; if the depreciation was great, some of the inferior mines would perhaps stop working altogether: and a falling off in the annual supply, preventing the annual wear and tear from being completely compensated, would by degrees reduce the quantity, and restore the value.

When examined more closely, the following are the details of the process. If gold is above its natural or cost value—the coin, as we have seen, conforming in its value to the bullion—money will be of high value, and the prices of all things, labour included, will be low. These low prices will lower the expenses of all producers; but as their returns will also be lowered, no advantage will be obtained by any producer, except the producer of gold: whose returns from his mine, not depending on price, will be the same as before, and his expenses being less, he will obtain extra profits, and will be stimulated to increase his production. E converso if the metal is below its natural value: since this is as much as to say that prices are high, and the money expenses of all producers unusually great: for this, however, all other producers will be compensated by increased money returns: the miner alone will extract from his mine no more metal than before, while his expenses will be greater: his profits therefore being diminished or annihilated, he will diminish his production, if not abandon his employment.

In this manner it is that the value of money is made to conform to the cost of production of the metal of which it is made. It may be well, however, to repeat (what has been said before) that the adjustment takes a long time to effect, in the case of a commodity so generally desired and at the same time so durable as the precious metals. Being so largely used not only as money but for plate and ornament, there is at all times a very large quantity of these metals in existence: while they are so slowly worn out, that a comparatively small annual production is sufficient to keep up the supply, and to make any addition to it which may be required by the increase of goods to be circulated, or by the increased demand for gold and silver articles by wealthy consumers. Even if this small annual supply were stopt entirely, it would require many years to reduce the quantity so much as to make any very material difference in prices. The quantity may be increased, much more rapidly than it can be diminished; but the increase must be very great before it can make itself much felt over such a mass of the precious metals as exists in the whole commercial world. And hence the effects of all changes in the conditions of production of the precious metals are at first, and continue to be for many years, questions of quantity only, with little reference to cost of production. 1 More especially is this the case when, as at the present time, many new sources of supply have been simultaneously opened, most of them practicable by labour alone, without any capital in advance beyond a pickaxe and a week’s food; and when the operations are as yet wholly experimental, the comparative permanent productiveness of the different sources being entirely unascertained.

§ 3. Since, however, the value of money really conforms, like that of other things, though more slowly, to its cost of production, some political economists have objected altogether to the statement that the value of money depends on its quantity combined with the rapidity of circulation; which, they think, is assuming a law for money that does not exist for any other commodity, when the truth is that it is governed by the very same laws. To this we may answer, in the first place, that the statement in question assumes no peculiar law. It is simply the law of demand and supply, which is acknowledged to be applicable to all commodities, and which, in the case of money as of most other things, is controlled, but not set aside, by the law of cost of production, since cost of production would have no effect on value if it could have none on supply. But, secondly, there really is, in one respect, a closer connexion between the value of money and its quantity, than between the values of other things and their quantity. The value of other things conforms to the changes in the cost of production, without requiring, as a condition, that there should be any actual alteration of the supply: the potential alteration is sufficient; and if there even be an actual alteration, it is but a temporary one, except in so far as the altered value may make a difference in the demand, and so require an increase or diminution of supply, as a consequence, not a cause, of the alteration in value. Now this is also true of gold and silver, considered as articles of expenditure for ornament and luxury; but it is not true of money. If the permanent cost of production of gold were reduced one-fourth, it might happen that there would not be more of it bought for plate, gilding, or jewellery, than before; and if so, though the value would fall, the quantity extracted from the mines for these purposes would be no greater than previously. Not so with the portion used as money; that portion could not fall in value one-fourth, unless actually increased one-fourth; for, at prices one-fourth higher, one-fourth more money would be required to make the accustomed purchases; and if this were not forthcoming, some of the commodities would be without purchasers, and prices could not be kept up. Alterations, therefore, in the cost of production of the precious metals, do not act upon the value of money except just in proportion as they increase or diminish its quantity; which cannot be said of any other commodity. It would therefore, I conceive, be an error, both scientifically and practically, to discard the proposition which asserts a connexion between the value of money and its quantity.

It is evident, however, that the cost of production, in the long run, regulates the quantity; and that every country (temporary fluctuations excepted) will possess, and have in circulation, just that quantity of money which will perform all the exchanges required of it, consistently with maintaining a value conformable to its cost of production. The prices of things will, on the average, be such that money will exchange for its own cost in all other goods: and, precisely because the quantity cannot be prevented from affecting the value, the quantity itself will (by a sort of self-acting machinery) be kept at the amount consistent with that standard of prices—at the amount necessary for performing, at those prices, all the business required of it.

“The quantity wanted will depend partly on the cost of producing gold, and partly on the rapidity of its circulation. The rapidity of circulation being given, it would depend on the cost of production: and the cost of production being given, the quantity of money would depend on the rapidity of its circulation.”∗ After what has been already said, I hope that neither of these propositions stands in need of any further illustration.

Money, then, like commodities in general, having a value dependent on, and proportional to, its cost of production; the theory of money is, by the admission of this principle, stript of a great part of the mystery which apparently surrounded it. We must not forget, however, that this doctrine only applies to the places in which the precious metals are actually produced; and that we have yet to enquire whether the law of the dependence of value on cost of production applies to the exchange of things produced at distant places. But however this may be, our propositions with respect to value will require no other alteration, where money is an imported commodity, than that of substituting for the cost of its production the cost of obtaining it in the country. Every foreign commodity is bought by giving for it some domestic production; and the labour and capital which a foreign commodity costs to us is the labour and capital expended in producing the quantity of our own goods which we give in exchange for it. What this quantity depends upon,—what determines the proportions of interchange between the productions of one country and those of another,—is indeed a question of somewhat greater complexity than those we have hitherto considered. But this at least is indisputable, that within the country itself the value of imported commodities is determined by the value, and consequently by the cost of production, of the equivalent given for them; and money, where it is an imported commodity, is subject to the same law.1

Book III, Chapter X: Of a double standard, and subsidiary coins

CHAPTER X: of a double standard, and subsidiary coins

§ 1. Though the qualities necessary to fit any commodity for being used as money are rarely united in any considerable perfection, there are two commodities which possess them in an eminent, and nearly an equal degree; the two precious metals, as they are called; gold and silver. Some nations have accordingly attempted to compose their circulating medium of these two metals indiscriminately.

There is an obvious convenience in making use of the more costly metal for larger payments and the cheaper one for smaller: and the only question relates to the mode in which this can best be done. The mode most frequently adopted has been to establish between the two metals a fixed proportion; to decide, for example, that a gold coin called a sovereign should be equivalent to twenty of the silver coins called shillings: both the one and the other being called, in the ordinary money of account of the country, by the same denomination, a pound: and it being left free to every one who has a pound to pay, either to pay it in the one metal or in the other.

At the time when the valuation of the two metals relatively to each other, say twenty shillings to the sovereign, or twenty-one shillings to the guinea, was first made, the proportion probably corresponded, as nearly as it could be made to do, with the ordinary relative values of the two metals grounded on their cost of production: and if those natural or cost values always continued to bear the same ratio to one another, the arrangement would be unobjectionable. This, however, is far from being the fact. Gold and silver, though the least variable in value of all commodities, are not invariable, and do not always vary simultaneously. Silver, for example, was lowered in permanent value more than gold, by the discovery of the American mines; and those smal1 variations of value which take place occasionally do not affect both metals alike. Suppose such a variation to take place: the value of the two metals relatively to one another no longer agreeing with their rated proportion, one or other of them will now be rated below its bullion value, and there will be a profit to be made by melting it.

Suppose, for example, that gold rises in value relatively to silver, so that the quantity of gold in a sovereign is now worth more than the quantity of silver in twenty shillings. Two consequences will ensue. No debtor will any longer find it his interest to pay in gold. He will always pay in silver, because twenty shillings are a legal tender for a debt of one pound, and he can procure silver convertible into twenty shillings for less gold than that contained in a sovereign. The other consequence will be, that unless a sovereign can be sold for more than twenty shillings, all the sovereigns will be melted, since as bullion they will purchase a greater number of shillings than they exchange for as coin. The converse of all this would happen if silver, instead of gold, were the metal which had risen in comparative value. A sovereign would not now be worth so much as twenty shillings, and whoever had a pound to pay would prefer paying it by a sovereign; while the silver coins would be collected for the purpose of being melted, and sold as bullion for gold at their real value, that is, above the legal valuation. The money of the community, therefore, would never really consist of both metals, but of the one only which, at the particular time, best suited the interest of debtors; and the standard of the currency would be constantly liable to change from the one metal to the other, at a loss, on each change, of the expense of coinage on the metal which fell out of use.

It appears, therefore, that the value of money is liable to more frequent fluctuations when both metals are a legal tender at a fixed valuation, than when the exclusive standard of the currency is either gold or silver. Instead of being only affected by variations in the cost of production of one metal it is subject to derangement from those of two. The particular kind of variation to which a currency is rendered more liable by having two legal standards, is a fall of value, or what is commonly called a depreciation; since practically that one of the two metals will always be the standard, of which the real has fallen below the rated value. If the tendency of the metals be to rise in value, all payments will be made in the one which has risen least; and if to fall, then in that which has fallen most.

§ 2. The plan of a double standard is still occasionally brought forward by here and there a writer or orator as a great improvement in currency. It is probable that, with most of its adherents, its chief merit is its tendency to a sort of depreciation, there being at all times abundance of supporters for any mode, either open or covert, of lowering the standard. Some, however, are influenced by an exaggerated estimate of an advantage which to a certain extent is real, that of being able to have recourse, for replenishing the circulation, to the united stock of gold and silver in the commercial world, instead of being confined to one of them, which, from accidental absorption, may not be obtainable with sufficient rapidity. The advantage without the disadvantages of a double standard, seems to be best obtained by those nations with whom one only of the two metals is a legal tender, but the other also is coined, and allowed to pass for whatever value the market assigns to it.1

When this plan is adopted, it is naturally the more costly metal which is left to be bought and sold as an article of commerce. But nations which, like England, adopt the more costly of the two as their standard, resort to a different expedient for retaining them both in circulation, namely, to make silver a legal tender, but only for small payments. In England, no one can be compelled to receive silver in payment for a larger amount than forty shillings. With this regulation there is necessarily combined another, namely, that silver coin should be rated, in comparison with gold, somewhat above its intrinsic value; that there should not be, in twenty shillings, as much silver as is worth a sovereign: for if there were, a very slight turn of the market in its favour would make it worth more than a sovereign, and it would be profitable to melt the silver coin. The over-valuation of the silver coin creates an inducement to buy silver and send it to the Mint to be coined, since it is given back at a higher value than properly belongs to it: this, however, has been guarded against, by limiting the quantity of the silver coinage, which is not left, like that of gold, to the discretion of individuals, but is determined by the government, and restricted to the amount supposed to be required for small payments. The only precaution necessary is, not to put so high a valuation upon the silver, as to hold out a strong temptation to private coining.1

Book III, Chapter XI: Of credit, as a substitute for money

CHAPTER XI: of credit, as a substitute for money

§ 1. The functions of credit have been a subject of as much misunderstanding and as much confusion of ideas, as any single topic in Political Economy. This is not owing to any peculiar difficulty in the theory of the subject, but to the complex nature of some of the mercantile phenomena arising from the forms in which credit clothes itself; by which attention is diverted from the properties of credit in general, to the peculiarities of its particular forms.

As a specimen of the confused notions entertained respecting the nature of credit, we may advert to the exaggerated language so often used respecting its national importance. Credit has a great, but not, as many people seem to suppose, a magical power; it cannot make something out of nothing. How often is an extension of credit talked of as equivalent to a creation of capital, or as if credit actually were capital. It seems strange that there should be any need to point out, that credit being only permission to use the capital of another person, the means of production cannot be increased by it, but only transferred. If the borrower’s means of production and of employing labour are increased by the credit given him, the lender’s are as much diminished. The same sum cannot be used as capital both by the owner and also by the person to whom it is lent: it cannot supply its entire value in wages, tools, and materials, to two sets of labourers at once. It is true that the capital which A has borrowed from B, and makes use of in his business, still forms part of the wealth of B for other purposes: he can enter into arrangements in reliance on it, and can borrow, when needful, an equivalent sum on the security of it; so that to a superficial eye it might seem as if both B and A had the use of it at once. But the smallest consideration will show that when B has parted with his capital to A, the use of it as capital rests with A alone, and that B has no other service from it than in so far as his ultimate claim upon it serves him to obtain the use of another capital from a third person C. All capital (not his own) of which any person has really the use, is, and must be, so much subtracted from the capital of some one else.∗

§ 2. But though credit is but a transfer of capital from hand to hand, it is generally, and naturally, a transfer to hands more competent to employ the capital efficiently in production. If there were no such thing as credit, or if, from general insecurity and want of confidence, it were scantily practised, many persons who possess more or less of capital, but who, from their occupations, or for want of the necessary skill and knowledge, cannot personally superintend its employment, would derive no benefit from it: their funds would either lie idle, or would be, perhaps, wasted and annihilated in unskilful attempts to make them yield a profit. All this capital is now lent at interest, and made available for production. Capital thus circumstanced forms a large portion of the productive resources of any commercial country; and is naturally attracted to those producers or traders who, being in the greatest business, have the means of employing it to most advantage; because such are both the most desirous to obtain it, and able to give the best security. Although, therefore, the productive funds of the country are not increased by credit, they are called into a more complete state of productive activity. As the confidence on which credit is grounded extends itself, means are developed by which even the smallest portions of capital, the sums which each person keeps by him to meet contingencies, are made available for productive uses. The principal instruments for this purpose are banks of deposit. Where these do not exist, a prudent person must keep a sufficient sum unemployed in his own possession, to meet every demand which he has even a slight reason for thinking himself liable to. When the practice, however, has grown up of keeping this reserve not in his own custody but with a banker, many small sums, previously lying idle, become aggregated in the banker’s hands; and the banker, being taught by experience what proportion of the amount is likely to be wanted in a given time, and knowing that if one depositor happens to require more than the average, another will require less, is able to lend the remainder, that is, the far greater part, to producers and dealers: thereby adding the amount, not indeed to the capital in existence, but to that in employment, and making a corresponding addition to the aggregate production of the community.

While credit is thus indispensable for rendering the whole capital of the country productive, it is also a means by which the industrial talent of the country is turned to better account for purposes of production. Many a person who has either no capital of his own, or very little, but who has qualifications for business which are known and appreciated by some possessors of capital, is enabled to obtain either advances in money, or more frequently goods on credit, by which his industrial capacities are made instrumental to the increase of the public wealth; and this benefit will be reaped far more largely, whenever, through better laws and better education, the community shall have made such progress in integrity, that personal character can be accepted as a sufficient guarantee not only against dishonestly appropriating, but against dishonestly risking, what belongs to another.

Such are, in the most general point of view, the uses of credit to the productive resources of the world. But these considerations only apply to the credit given to the industrious classes—to producers and dealers. Credit given by dealers to unproductive consumers is never an addition, but always a detriment, to the sources of public wealth. It makes over in temporary use, not the capital of the unproductive classes to the productive, but that of the productive to the unproductive. If A, a dealer, supplies goods to B, a landowner or annuitant, to be paid for at the end of five years, as much of the capital of A as is equal to the value of these goods remains for five years unproductive. During such a period, if payment had been made at once, the sum might have been several times expended and replaced, and goods to the amount might have been several times produced, consumed, and reproduced: consequently B’s withholding 100l. for five years, even if he pays at last, has cost to the labouring classes of the community during that period an absolute loss of probably several times that amount. A, individually, is compensated, by putting a higher price upon his goods, which is ultimately paid by B: but there is no compensation made to the labouring classes, the chief sufferers by every diversion of capital, whether permanently or temporarily, to unproductive uses. The country has had 100l. less of capital during those five years, B having taken that amount from A’s capital, and spent it unproductively, in anticipation of his own means, and having only after five years set apart a sum from his income and converted it into capital for the purpose of indemnifying A.

§ 3. Thus far of the general functions of Credit in production. It is not a productive power in itself, though, without it, the productive powers already existing could not be brought into complete employment. But a more intricate portion of the theory of Credit is its influence on prices; the chief cause of most of the mercantile phenomena which perplex observers. In a state of commerce in which much credit is habitually given, general prices at any moment depend much more upon the state of credit than upon the quantity of money. For credit, though it is not productive power, is purchasing power; and a person who, having credit, avails himself of it in the purchase of goods, creates just as much demand for the goods, and tends quite as much to raise their price, as if he made an equal amount of purchases with ready money.

The credit which we are now called upon to consider, as a distinct purchasing power, independent of money, is of course not credit in its simplest form, that of money lent by one person to another, and paid directly into his hands; for when the borrower expends this in purchases, he makes the purchases with money, not credit, and exerts no purchasing power over and above that conferred by the money. The forms of credit which create purchasing power are those in which no money passes at the time, and very often none passes at all, the transaction being included with a mass of other transactions in an account, and nothing paid but a balance. This takes place in a variety of ways, which we shall proceed to examine, beginning, as is our custom, with the simplest.

First: Suppose A and B to be two dealers, who have transactions with each other both as buyers and as sellers. A buys from B on credit. B does the like with respect to A. At the end of the year, the sum of A’s debts to B is set against the sum of B’s debts to A, and it is ascertained to which side a balance is due. This balance, which may be less than the amount of many of the transactions singly, and is necessarily less than the sum of the transactions, is all that is paid in money; and perhaps even this is not paid, but carried over in an account current to the next year. A single payment of a hundred pounds may in this manner suffice to liquidate a long series of transactions, some of them to the value of thousands.

But secondly. The debts of A to B may be paid without the intervention of money, even though there be no reciprocal debts of B to A. A may satisfy B by making over to him a debt due to himself from a third person, C. This is conveniently done by means of a written instrument, called a bill of exchange, which is, in fact, a transferable order by a creditor upon his debtor, and when accepted by the debtor, that is, authenticated by his signature, becomes an acknowledgment of debt.

§ 4. Bills of exchange were first introduced to save the expense and risk of transporting the precious metals from place to place. “Let it be supposed,” says Mr. Henry Thornton,∗ “that there are in London ten manufacturers who sell their article to ten shopkeepers in York, by whom it is retailed; and that there are in York ten manufacturers of another commodity, who sell it to ten shopkeepers in London. There would be no occasion for the ten shopkeepers in London to send yearly to York guineas for the payment of the York manufacturers, and for the ten York shopkeepers to send yearly as many guineas to London. It would only be necessary for the York manufacturers to receive from each of the shopkeepers at their own door the money in question, giving in return letters which should acknowledge the receipt of it; and which should also direct the money, lying ready in the hands of their debtors in London, to be paid to the London manufacturers, so as to cancel the debt in London in the same manner as that at York. The expense and the risk of all transmission of money would thus be saved. Letters ordering the transfer of the debt are termed, in the language of the present day, bills of exchange. They are bills by which the debt of one person is exchanged for the debt of another; and the debt, perhaps, which is due in one place, for the debt due in another.”

Bills of exchange having been found convenient as means of paying debts at distant places without the expense of transporting the precious metals, their use was afterwards greatly extended from another motive. It is usual in every trade to give a certain length of credit for goods bought: three months, six months, a year, even two years, according to the convenience or custom of the particular trade. A dealer who has sold goods, for which he is to be paid in six months, but who desires to receive payment sooner, draws a bill on his debtor payable in six months, and gets the bill discounted by a banker or other money-lender, that is, transfers the bill to him, receiving the amount, minus interest for the time it has still to run. It has become one of the chief functions of bills of exchange to serve as a means by which a debt due from one person can thus be made available for obtaining credit from another. The convenience of the expedient has led to the frequent creation of bills of exchange not grounded on any debt previously due to the drawer of the bill by the person on whom it is drawn. These are called accommodation bills; and sometimes, with a tinge of disapprobation, fictitious bills. Their nature is so clearly stated, and with such judicious remarks, by the author whom I have just quoted, that I shall transcribe the entire passage.∗

“A, being in want of 100l., requests B to accept a note or bill drawn at two months, which B, therefore, on the face of it, is bound to pay; it is understood, however, that A will take care either to discharge the bill himself, or to furnish B with the means of paying it. A obtains ready money for the bill on the joint credit of the two parties. A fulfils his promise of paying it when due, and thus concludes the transaction. This service rendered by B to A is, however, not unlikely to be requited, at a more or less distant period, by a similar acceptance of a bill on A, drawn and discounted for B’s convenience.

“Let us now compare such a bill with a real bill. Let us consider in what points they differ, or seem to differ; and in what they agree.

“They agree, inasmuch as each is a discountable article; each has also been created for the purpose of being discounted; and each is, perhaps, discounted in fact. Each, therefore, serves equally to supply means of speculation to the merchant. So far, moreover, as bills and notes constitute what is called the circulating medium, or paper currency of the country, and prevent the use of guineas, the fictitious and the real bill are upon an equality; and if the price of commodities be raised in proportion to the quantity of paper currency, the one contributes to that rise exactly in the same manner as the other.

“Before we come to the points in which they differ, let us advert to one point in which they are commonly supposed to be unlike; but in which they cannot be said always or necessarily to differ.

“Real notes (it is sometimes said) represent actual property. There are actual goods in existence, which are the counterpart to every real note. Notes which are not drawn in consequence of a sale of goods, are a species of false wealth, by which a nation is deceived. These supply only an imaginary capital; the others indicate one that is real.

“In answer to this statement it may be observed, first, that the notes given in consequence of a real sale of goods cannot be considered as on that account certainly representing any actual property. Suppose that A sells 100l. worth of goods to B at six months' credit, and takes a bill at six months for it; and that B, within a month after, sells the same goods, at a like credit, to C, taking a like bill; and again, that C, after another month, sells them to D, taking a like bill, and so on. There may then, at the end of six months, be six bills of 100l. each, existing at the same time; and every one of these may possibly have been discounted. Of all these bills, then, only one represents any actual property.

“In order to justify the supposition that a real bill (as it is called) represents actual property, there ought to be some power in the bill-holder to prevent the property which the bill represents, from being turned to other purposes than that of paying the bill in question. No such power exists; neither the man who holds the real bill, nor the man who discounts it, has any property in the specific goods for which it was given: he as much trusts to the general ability to pay of the giver of the bill, as the holder of any fictitious bill does. The fictitious bill may, in many cases, be a bill given by a person having a large and known capital, a part of which the fictitious bill may be said in that case to represent. The supposition that real bills represent property, and that fictitious bills do not, seems, therefore, to be one by which more than justice is done to one of these species of bills, and something less than justice to the other.

“We come next to some point in which they differ.

“First, the fictitious note, or note of accommodation, is liable to the objection that it professes to be what it is not. This objection, however, lies only against those fictitious bills which are passed as real. In many cases it is sufficiently obvious what they are. Secondly, the fictitious bill is, in general, less likely to be punctually paid than the real one. There is a general presumption, that the dealer in fictitious bills is a man who is a more adventurous speculator than he who carefully abstains from them. It follows, thirdly, that fictitious bills, besides being less safe, are less subject to limitation as to their quantity. The extent of a man’s actual sales forms some limit to the amount of his real notes; and as it is highly desirable in commerce that credit should be dealt out to all persons in some sort of regular and due proportion, the measure of a man’s actual sales, certified by the appearance of his bills drawn in virtue of those sales, is some rule in the case, though a very imperfect one in many respects.

“A fictitious bill, or bill of accommodation, is evidently in substance the same as any common promissory note; and even better in this respect, that there is but one security to the promissory note, whereas in the case of the bill of accommodation, there are two. So much jealousy subsists lest traders should push their means of raising money too far, that paper, the same in its general nature with that which is given, being the only paper which can be given, by men out of business, is deemed somewhat discreditable when coming from a merchant. And because such paper, when in the merchant’s hand, necessarily imitates the paper which passes on the occasion of a sale of goods, the epithet fictitious has been cast upon it; an epithet which has seemed to countenance the confused and mistaken notion, that there is something altogether false and delusive in the nature of a certain part both of the paper and of the apparent wealth of the country.”

A bill of exchange, when merely discounted, and kept in the portfolio of the discounter until it falls due, does not perform the functions or supply the place of money, but is itself bought and sold for money. It is no more currency than the public funds, or any other securities. But when a bill drawn upon one person is paid to another (or even to the same person) in discharge of a debt or a pecuniary claim, it does something for which, if the bill did not exist, money would be required: it performs the functions of currency. This is a use to which bills of exchange are often applied. “They not only,” continues Mr. Thornton,∗ “spare the use of ready money; they also occupy its place in many cases. Let us imagine a farmer in the country to discharge a debt of 10l. to his neighbouring grocer, by giving him a bill for that sum, drawn on his cornfactor in London for grain sold in the metropolis; and the grocer to transmit the bill, he having previously indorsed it, to a neighbouring sugar-baker, in discharge of a like debt; and the sugar-baker to send it, when again indorsed, to a West India merchant in an outport, and the West India merchant to deliver it to his country banker, who also indorses it, and sends it into further circulation. The bill in this case will have effected five payments, exactly as if it were a 10l. note payable to a bearer on demand. A multitude of bills pass between trader and trader in the country, in the manner which has been described; and they evidently form, in the strictest sense, a part of the circulating medium of the kingdom.”

Many bills, both domestic and foreign, are at least presented for payment quite covered with indorsements, each of which represents either a fresh discounting, or a pecuniary transaction in which the bill has performed the functions of money. Within the present generation,1 the circulating medium of Lancashire, for sums above five pounds, was almost entirely composed of such bills.

§ 5. A third form in which credit is employed as a substitute for currency, is that of promissory notes. A bill drawn upon any one and accepted by him, and a note of hand by him promising to pay the same sum, are, as far as he is concerned, exactly equivalent, except that the former commonly bears interest and the latter generally does not; and that the former is commonly payable only after a certain lapse of time, and the latter payable at sight. But it is chiefly in the latter form that it has become, in commercial countries, an express occupation to issue such substitutes for money. Dealers in money (as lenders by profession are improperly called) desire, like other dealers, to stretch their operations beyond what can be carried on by their own means: they wish to lend, not their capital merely, but their credit, and not only such portion of their credit as consists of funds actually deposited with them, but their power of obtaining credit from the public generally, so far as they think they can safely employ it. This is done in a very convenient manner by lending their own promissory notes payable to bearer on demand: the borrower being willing to accept these as so much money, because the credit of the lender makes other people willingly receive them on the same footing, in purchases or other payments. These notes, therefore, perform all the functions of currency, and render an equivalent amount of money which was previously in circulation, unnecessary. As, however, being payable on demand, they may be at any time returned on the issuer, and money demanded for them, he must, on pain of bankruptcy, keep by him as much money as will enable him to meet any claims of that sort which can be expected to occur within the time necessary for providing himself with more: and prudence also requires that he should not attempt to issue notes beyond the amount which experience shows can remain in circulation without being presented for payment.

The convenience of this mode of (as it were) coining credit, having once been discovered, governments have availed themselves of the same expedient, and have issued their own promissory notes in payment of their expenses; a resource the more useful, because it is the only mode in which they are able to borrow money without paying interest, their promises to pay on demand being, in the estimation of the holders, equivalent to money in hand. The practical differences between such government notes and the issues of private bankers, and the further diversities of which this class of substitutes for money are susceptible, will be considered presently.

§ 6. A fourth mode of making credit answer the purposes of money, by which, when carried far enough, money may be very completely superseded, consists in making payments by cheques. The custom of keeping the spare cash reserved for immediate use or against contingent demands, in the hands of a banker, and making all payments, except small ones, by orders on bankers, is in this country spreading to a continually larger portion of the public. If the person making the payment, and the person receiving it, keep their money with the same banker, the payment takes place without any intervention of money, by the mere transfer of its amount in the banker’s books from the credit of the payer to that of the receiver. If all persons in London kept their cash at the same banker’s, and made all their payments by means of cheques, no money would be required or used for any transactions beginning and terminating in London. This ideal limit is almost attained in fact, so far as regards transactions between dealers. It is chiefly in the retail transactions between dealers and consumers, and in the payment of wages, that money or bank notes now pass, and then only when the amounts are small. In London, even shopkeepers of any amount of capital or extent of business have generally an account with a banker; which, besides the safety and convenience of the practice, is to their advantage in another respect, by giving them an understood claim to have their bills discounted in cases when they could not otherwise expect it. As for the merchants and larger dealers, they habitually make all payments in the course of their business by cheques. They do not, however, all deal with the same banker, and when A gives a cheque to B, B usually pays it not into the same but into some other bank. But the convenience of business has given birth to an arrangement which makes all the banking houses of the City of London, for certain purposes, virtually one establishment. A banker does not send the cheques which are paid into his banking house, to the banks on which they are drawn, and demand money for them. There is a building called the Clearing-house, to which every City banker sends, each afternoon, all the cheques on other bankers which he has received during the day, and they are there exchanged for the cheques on him which have come into the hands of other bankers, the balances only being paid in money;1 or even these not in money, but in cheques on the Bank of England. By this contrivance, all the business transactions of the City of London during that day, amounting often to millions of pounds, and a vast amount besides of country transactions, represented by bills which country bankers have drawn upon their London correspondents, are [1848] liquidated by payments not exceeding on the average 200,000l.∗

By means of the various instruments of credit which have now been explained, the immense business of a country like Great Britain is transacted with an amount of the precious metals surprisingly small; many times smaller, in proportion to the pecuniary value of the commodities bought and sold, than is found necessary in France, or any other country in which, the habit and the disposition to give credit not being so generally diffused, these “economizing expedients,” as they have been called, are not practised to the same extent. What becomes of the money thus superseded in its functions, and by what process it is made to disappear from circulation, are questions the discussion of which must be for a short time postponed.

Book III, Chapter XII: Influence of credit on prices

CHAPTER XII: influence of credit on prices

§ 1. Having now formed a general idea of the modes in which credit is made available as a substitute for money, we have to consider in what manner the use of these substitutes affects the value of money, or, what is equivalent, the prices of commodities. It is hardly necessary to say that the permanent value of money—the natural and average prices of commodities—are not in question here. These are determined by the cost of producing or of obtaining the precious metals. An ounce of gold or silver will in the long run exchange for as much of every other commodity, as can be produced or imported at the same cost with itself. And an order, or note of hand, or bill payable at sight, for an ounce of gold, while the credit of the giver is unimpaired, is worth neither more nor less than the gold itself.

It is not, however, with ultimate or average, but with immediate and temporary prices, that we are now concerned. These, as we have seen, may deviate very widely from the standard of cost of production. Among other causes of fluctuation, one we have found to be the quantity of money in circulation. Other things being the same, an increase of the money in circulation raises prices, a diminution lowers them. If more money is thrown into circulation than the quantity which can circulate at a value conformable to its cost of production, the value of money, so long as the excess lasts, will remain below the standard of cost of production, and general prices will be sustained above the natural rate.

But we have now found that there are other things, such as bank notes, bills of exchange, and cheques, which circulate as money, and perform all the functions of it: and the question arises, Do these various substitutes operate on prices in the same manner as money itself? Does an increase in the quantity of transferable paper tend to raise prices, in the same manner and degree as an increase in the quantity of money? There has been no small mount of discussion on this point among writers on currency, without any result so conclusive as to have yet obtained general assent.

I apprehend that bank notes, bills, or cheques, as such, do not act on prices at all. What does act on prices is Credit, in whatever shape given, and whether it gives rise to any transferable instruments capable of passing into circulation or not.

I proceed to explain and substantiate this opinion.

§ 2. Money acts upon prices in no other way than by being tendered in exchange for commodities. The demand which influences the prices of commodities consists of the money offered for them. But the money offered is not the same thing with the money possessed. It is sometimes less, sometimes very much more. In the long run indeed, the money which people lay out will be neither more nor less than the money which they have to lay out: but this is far from being the case at any given time. Sometimes they keep money by them for fear of an emergency, or in expectation of a more advantageous opportunity for expending it. In that case the money is said not to be in circulation: in plainer language, it is not offered, nor about to be offered, for commodities. Money not in circulation has no effect on prices. The converse, however, is a much commoner case; people make purchases with money not in their possession. An article, for instance, which is paid for by a cheque on a banker, is bought with money which not only is not in the payer’s possession, but generally not even in the banker’s, having been lent by him (all but the usual reserve) to other persons. We just now made the imaginary supposition that all persons dealt with a bank, and all with the same bank, payments being universally made by cheques. In this ideal case, there would be no money anywhere except in the hands of the banker: who might then safely part with all of it, by selling it as bullion, or lending it, to be sent out of the country in exchange for goods or foreign securities. But though there would then be no money in possession, or ultimately perhaps even in existence, money would be offered, and commodities bought with it, just as at present. People would continue to reckon their incomes and their capitals in money, and to make their usual purchases with orders for the receipt of a thing which would have literally ceased to exist. There would be in all this nothing to complain of, so long as the money, in disappearing, left an equivalent value in other things, applicable when required to the reimbursement of those to whom the money originally belonged.

In the case however of payment by cheques, the purchases are at any rate made, though not with money in the buyer’s possession, yet with money to which he has a right. But he may make purchases with money which he only expects to have, or even only pretends to expect. He may obtain goods in return for his acceptances payable at a future time; or on his note of hand; or on a simple book credit, that is, on a mere promise to pay. All these purchases have exactly the same effect on price, as if they were made with ready money. The amount of purchasing power which a person can exercise is composed of all the money in his possession or due to him, and of all his credit. For exercising the whole of this power he finds a sufficient motive only under peculiar circumstances; but he always possesses it; and the portion of it which he at any time does exercise, is the measure of the effect which he produces on price.

Suppose that, in the expectation that some commodity will rise in price, he determines, not only to invest in it all his ready money, but to take up on credit, from the producers or importers, as much of it as their opinion of his resources will enable him to obtain. Every one must see that by thus acting he produces a greater effect on price, than if he limited his purchases to the money he has actually in hand. He creates a demand for the article to the full amount of his money and credit taken together, and raises the price proportionally to both. And this effect is produced, though none of the written instruments called substitutes for currency may be called into existence; though the transaction may give rise to no bill of exchange, nor to the issue of a single bank note. The buyer, instead of taking a mere book credit, might have given a bill for the amount; or might have paid for the goods with bank notes borrowed for that purpose from a banker, thus making the purchase not on his own credit with the seller, but on the banker’s credit with the seller, and his own with the banker. Had he done so, he would have produced as great an effect on price as by a simple purchase to the same amount on a book credit, but no greater effect. The credit itself, not the form and mode in which it is given, is the operating cause.

§ 3. The inclination of the mercantile public to increase their demand for commodities by making use of all or much of their credit as a purchasing power, depends on their expectation of profit. When there is a general impression that the price of some commodity is likely to rise, from an extra demand, a short crop, obstruction to importation, or any other cause, there is a disposition among dealers to increase their stocks, in order to profit by the expected rise. This disposition tends in itself to produce the effect which it looks forward to, a rise of price: and if the rise is considerable and progressive, other speculators are attracted, who, so long as the price has not begun to fall, are willing to believe that it will continue rising. These, by further purchases, produce a further advance: and thus a rise of price for which there were originally some rational grounds, is often heightened by merely speculative purchases, until it greatly exceeds what the original grounds will justify. After a time this begins to be perceived; the price ceases to rise, and the holders, thinking it time to realize their gains, are anxious to sell. Then the price begins to decline: the holders rush into the market to avoid a still greater loss, and, few being willing to buy in a falling market, the price falls much more suddenly than it rose. Those who have bought at a higher price than reasonable calculation justified, and who have been overtaken by the revulsion before they had realized, are losers in proportion to the greatness of the fall, and to the quantity of the commodity which they hold, or have bound themselves to pay for.

Now all these effects might take place in a community to which credit was unknown: the prices of some commodities might rise from speculation, to an extravagant height, and then fall rapidly back. But if there were no such thing as credit, this could hardly happen with respect to commodities generally. If all purchases were made with ready money, the payment of increased prices for some articles would draw an unusual proportion of the money of the community into the markets for those articles, and must therefore draw it away from some other class of commodities, and thus lower their prices. The vacuum might, it is true, be partly filled up by increased rapidity of circulation; and in this manner the money of the community is virtually increased in a time of speculative activity, because people keep little of it by them, but hasten to lay it out in some tempting adventure as soon as possible after they receive it. This resource, however, is limited: on the whole, people cannot, while the quantity of money remains the same, lay out much more of it in some things, without laying out less in others. But what they cannot do by ready money, they can do by an extension of credit. When people go into the market and purchase with money which they hope to receive hereafter, they are drawing upon an unlimited, not a limited fund. Speculation, thus supported, may be going on in any number of commodities, without disturbing the regular course of business in others. It might even be going on in all commodities at once. We could imagine that in an epidemic fit of the passion of gambling, all dealers, instead of giving only their accustomed orders to the manufacturers or growers of their commodity, commenced buying up all of it which they could procure, as far as their capital and credit would go. All prices would rise enormously, even if there were no increase of money, and no paper credit, but a mere extension of purchases on book credits. After a time those who had bought would wish to sell, and prices would collapse.

This is the ideal extreme case of what is called a commercial crisis. There is said to be a commercial crisis, when a great number of merchants and traders at once, either have, or apprehend that they shall have, a difficulty in meeting their engagements. The most usual cause of this general embarrassment, is the recoil of prices after they have been raised by a spirit of speculation, intense in degree, and extending to many commodities. Some accident which excites expectations of rising prices, such as the opening of a new foreign market, or simultaneous indications of a short supply of several great articles of commerce, sets speculation at work in several leading departments at once. The prices rise, and the holders realize, or appear to have the power of realizing, great gains. In certain states of the public mind, such examples of rapid increase of fortune call forth numerous imitators, and speculation not only goes much beyond what is justified by the original grounds for expecting rise of price, but extends itself to articles in which there never was any such ground: these, however, rise like the rest as soon as speculation sets in. At periods of this kind a great extension of credit takes place. Not only do all whom the contagion reaches employ their credit much more freely than usual; but they really have more credit, because they seem to be making unusual gains, and because a generally reckless and adventurous feeling prevails, which disposes people to give as well as take credit more largely than at other times, and give it to persons not entitled to it. In this manner, in the celebrated speculative year 1825, and at various other periods during the present century, the prices of many of the principal articles of commerce rose greatly, without any fall in others, so that general prices might, without incorrectness, be said to have risen. When, after such a rise, the reaction comes, and prices begin to fall, though at first perhaps only through the desire of the holders to realize, speculative purchases cease: but were this all, prices would only fall to the level from which they rose, or to that which is justified by the state of the consumption and of the supply. They fall, however, much lower; for as, when prices were rising, and everybody apparently making a fortune, it was easy to obtain almost any amount of credit, so now, when everybody seems to be losing, and many fail entirely, it is with difficulty that firms of known solidity can obtain even the credit to which they are accustomed, and which it is the greatest inconvenience to them to be without; because all dealers have engagements to fulfil, and nobody feeling sure that the portion of his means which he has entrusted to others will be available in time, no one likes to part with ready money, or to postpone his claim to it. To these rational considerations there is superadded, in extreme cases, a panic as unreasoning as the previous overconfidence; money is borrowed for short periods at almost any rate of interest, and sales of goods for immediate payment are made at almost any sacrifice. Thus general prices, during a commercial revulsion, fall as much below the usual level as during the previous period of speculation they have risen above it: the fall, as well as the rise, originating not in anything affecting money, but in the state of credit; an unusually extended employment of credit during the earlier period, followed by a great diminution, never amounting, however, to an entire cessation of it, in the later.

It is not, however, universally true that the contraction of credit, characteristic of a commercial crisis, must have been preceded by an extraordinary and irrational extension of it. There are other causes; and one of the more recent crises, that of 1847, is an instance, having been preceded by no particular extension of credit, and by no speculations; except those in railway shares, which, though in many cases extravagant enough, yet being carried on mostly with that portion of means which the speculators could afford to lose, were not calculated to produce the wide-spread ruin which arises from vicissitudes of price in the commodities in which men habitually deal, and in which the bulk of their capital is invested. The crisis of 1847 belonged to another class of mercantile phenomena. There occasionally happens a concurrence of circumstances tending to withdraw from the loan market a considerable portion of the capital which usually supplies it. These circumstances, in the present case, were great foreign payments, (occasioned by a high price of cotton and an unprecedented importation of food,) together with the continual demands on the circulating capital of the country by railway calls and the loan transactions of railway companies, for the purpose of being converted into fixed capital and made unavailable for future lending. These various demands fell principally, as such demands always do, on the loan market. A great, though not the greatest, part of the imported food was actually paid for by the proceeds of a government loan. The extra payments which purchasers of corn and cotton, and railway shareholders, found themselves obliged to make, were either made with their own spare cash, or with money raised for the occasion. On the first supposition, they were made by withdrawing deposits from bankers, and thus cutting off a part of the streams which fed the loan market; on the second supposition, they were made by actual drafts on the loan market, either by the sale of securities, or by taking up money at interest. This combination of a fresh demand for loans, with a curtailment of the capital disposable for them, raised the rate of interest, and made it impossible to borrow except on the very best security. Some firms, therefore, which by an improvident and unmercantile mode of conducting business had allowed their capital to become either temporarily or permanently unavailable, became unable to command that perpetual renewal of credit which had previously enabled them to struggle on. These firms stopped payment: their failure involved more or less deeply many other firms which had trusted them; and, as usual in such cases, the general distrust, commonly called a panic, began to set in, and might have produced a destruction of credit equal to that of 1825, had not circumstances which may almost be called accidental, given to a very simple measure of the government (the suspension of the Bank Charter Act of 1844) a fortunate power of allaying panic, to which, when considered in itself, it had no sort of claim.∗

§ 4. The general operation of credit upon prices being such as we have described, it is evident that if any particular mode or form of credit is calculated to have a greater operation on prices than others, it can only be by giving greater facility, or greater encouragement, to the multiplication of credit transactions generally. If bank notes, for instance, or bills, have a greater effect on prices than book credits, it is not by any difference in the transactions themselves, which are essentially the same, whether taking place in the one way or in the other: it must be that there are likely to be more of them. If credit is likely to be more extensively used as a purchasing power when bank notes or bills are the instruments used, than when the credit is given by mere entries in an account, to that extent and no more there is ground for ascribing to the former a greater power over the markets than belongs to the latter.

Now it appears that there is some such distinction. As far as respects the particular transactions, it makes no difference in the effect on price whether A buys goods of B on simple credit, or gives a bill for them, or pays for them with bank notes lent to him by a banker C. The difference is in a subsequent stage. If A has bought the goods on a book credit, there is no obvious or convenient mode by which B can make A’s debt to him a means of extending his own credit. Whatever credit he has, will be due to the general opinion entertained of his solvency; he cannot specifically pledge A’s debt to a third person, as a security for money lent or goods bought. But if A has given him a bill for the amount, he can get this discounted, which is the same thing as borrowing money on the joint credit of A and himself: or he may pay away the bill in exchange for goods, which is obtaining goods on the same joint credit. In either case, here is a second credit transaction, grounded on the first, and which would not have taken place if the first had been transacted without the intervention of a bill. Nor need the transactions end here. The bill may be again discounted, or again paid away for goods, several times before it is itself presented for payment. Nor would it be correct to say that these successive holders, if they had not had the bill, might have attained their purpose by purchasing goods on their own credit with the dealers. They may not all of them be persons of credit, or they may already have stretched their credit as far as it will go. And at all events, either money or goods are more readily obtained on the credit of two persons than of one. Nobody will pretend that it is as easy a thing for a merchant to borrow a thousand pounds on his own credit, as to get a bill discounted to the same amount, when the drawee is of known solvency.

If we now suppose that A, instead of giving a bill, obtains a loan of bank notes from a banker C, and with them pays B for his goods, we shall find the difference to be still greater. B is now independent even of a discounter: A’s bill would have been taken in payment only by those who were acquainted with his reputation for solvency, but a banker is a person who has credit with the public generally, and whose notes are taken in payment by every one, at least in his own neighbourhood: insomuch that, by a custom which has grown into law, payment in bank notes is a complete acquittance to the payer, whereas, if he has paid by a bill, he still remains liable to the debt, if the person on whom the bill is drawn fails to pay it when due. B therefore can expend the whole of the bank notes without at all involving his own credit; and whatever power he had before of obtaining goods on book credit, remains to him unimpaired, in addition to the purchasing power he derives from the possession of the notes. The same remark applies to every person in succession, into whose hands the notes may come. It is only A, the first holder, (who used his credit to obtain the notes as a loan from the issuer,) who can possibly find the credit he possesses in other quarters abated by it; and even in his case that result is not probable; for though, in reason, and if all his circumstances were known, every draft already made upon his credit ought to diminish by so much his power of obtaining more, yet in practice the reverse more frequently happens, and his having been trusted by one person is supposed to be evidence that he may safely be trusted by others also.

It appears, therefore, that bank notes are a more powerful instrument for raising prices than bills, and bills than book credits. It does not, indeed, follow that credit will be more used because it can be. When the state of trade holds out no particular temptation to make large purchases on credit, dealers will use only a small portion of the credit power, and it will depend only on convenience whether the portion which they use will be taken in one form or in another. It is not until the circumstances of the markets, and the state of the mercantile mind, render many persons desirous of stretching their credit to an unusual extent, that the distinctive properties of the different forms of credit display themselves. Credit already stretched to the utmost in the form of book debts, would be susceptible of a great additional extension by means of bills, and of a still greater by means of bank notes. The first, because each dealer, in addition to his own credit, would be enabled to create a further purchasing power out of the credit which he had himself given to others: the second, because the banker’s credit with the public at large, coined into notes, as bullion is coined into pieces of money to make it portable and divisible, is so much purchasing power superadded, in the hands of every successive holder, to that which he may derive from his own credit. To state the matter otherwise; one single exertion of the credit-power in the form of book credit is only the foundation of a single purchase: but if a bill is drawn, that same portion of credit may serve for as many purchases as the number of times the bill changes hands: while every bank note issued renders the credit of the banker a purchasing power to that amount in the hands of all the successive holders, without impairing any power they may possess of effecting purchases on their own credit. Credit, in short, has exactly the same purchasing power with money; and as money tells upon prices not simply in proportion to its amount, but to its amount multiplied by the number of times it changes hands, so also does credit; and credit transferable from hand to hand is in that proportion more potent than credit which only performs one purchase.

§ 5. All this purchasing power, however, is operative upon prices only according to the proportion of it which is used; and the effect, therefore, is only felt in a state of circumstances calculated to lead to an unusually extended use of credit. In such a state of circumstances, that is, in speculative times, it cannot, I think, be denied, that prices are likely to rise higher if the speculative purchases are made with bank notes, than when they are made with bills, and when made by bills than when made by book credits. This, however, is of far less practical importance than might at first be imagined; because, in point of fact, speculative purchases are not, in the great majority of cases, made either with bank notes or with bills, but are made almost exclusively on book credits. “Applications to the Bank for extended discount,” says the highest authority on such subjects,∗ (and the same thing must be true of applications to other banks) “occur rarely if ever in the origin or progress of extensive speculations in commodities. These are entered into, for the most part if not entirely, in the first instance, on credit, for the length of term usual in the several trades; thus entailing on the parties no immediate necessity for borrowing so much as may be wanted for the purpose beyond their own available capital. This applies particularly to speculative purchases of commodities on the spot, with a view to resale. But these generally form the smaller proportion of engagements on credit. By far the largest of those entered into on the prospect of a rise of prices, are such as have in view importations from abroad. The same remark, too, is applicable to the export of commodities, when a large proportion is on the credit of the shippers or their consignees. As long as circumstances hold out the prospect of a favourable result, the credit of the parties is generally sustained. If some of them wish to realize, there are others with capital and credit ready to replace them; and if the events fully justify the grounds on which the speculative transactions were entered into (thus admitting of sales for consumption in time to replace the capital embarked) there is no unusual demand for borrowed capital to sustain them. It is only when by the vicissitudes of political events, or of the seasons, or other adventitious circumstances, the forthcoming supplies are found to exceed the computed rate of consumption, and a fall of prices ensues, that an increased demand for capital takes place; the market rate of interest then rises, and increased applications are made to the Bank of England for discount.” So that the multiplication of bank notes and other transferable paper does not, for the most part, accompany and facilitate the speculation; but comes into play chiefly when the tide is turning, and difficulties begin to be felt.

Of the extraordinary height to which speculative transactions can be carried upon mere book credits, without the smallest addition to what is commonly called the currency, very few persons are at all aware. “The power of purchase,” says Mr. Tooke,∗ “by persons having capital and credit, is much beyond anything that those who are unacquainted practically with speculative markets have any idea of.... A person having the reputation of capital enough for his regular business, and enjoying good credit in his trade, if he takes a sanguine view of the prospect of a rise of price of the article in which he deals, and is favoured by circumstances in the outset and progress of his speculation, may effect purchases to an extent perfectly enormous, compared with his capital.” Mr. Tooke confirms this statement by some remarkable instances, exemplifying the immense purchasing power which may be exercised, and rise of price which may be produced, by credit not represented by either bank notes or bills of exchange.

“Amongst the earlier speculators for an advance in the price of tea, in consequence of our dispute with China in 1839, were several retail grocers and tea-dealers. There was a general disposition among the trade to get into stock: that is, to lay in at once a quantity which would meet the probable demand from their customers for several months to come. Some, however, among them, more sanguine and adventurous than the rest, availed themselves of their credit with the importers and wholesale dealers, for purchasing quantities much beyond the estimated demand in their own business. As the purchases were made in the first instance ostensibly, and perhaps really, for the legitimate purposes and within the limits of their regular business, the parties were enabled to buy without the condition of any deposit; whereas speculators, known to be such, are required to pay 2l. per chest, to cover any probable difference of price which might arise before the expiration of the prompt, which, for this article, is three months. Without, therefore, the outlay of a single farthing of actual capital or currency in any shape, they made purchases to a considerable extent; and with the profit realized on the resale of a part of these purchases, they were enabled to pay the deposit on further quantities when required, as was the case when the extent of the purchases attracted attention. In this way, the speculation went on at advancing prices (100 per cent and upwards) till nearly the expiration of the prompt; and if at that time circumstances had been such as to justify the apprehension which at one time prevailed, that all future supplies would be cut off, the prices might have still further advanced, and at any rate not have retrograded. In this case, the speculators might have realized, if not all the profit they had anticipated, a very handsome sum, upon which they might have been enabled to extend their business greatly, or to retire from it altogether, with a reputation for great sagacity in thus making their fortune. But instead of this favourable result, it so happened that two or three cargoes of tea which had been transhipped were admitted, contrary to expectation, to entry on their arrival here, and it was found that further indirect shipments were in progress. Thus the supply was increased beyond the calculation of the speculators: and, at the same time, the consumption had been diminished by the high price. There was, consequently, a violent reaction on the market; the speculators were unable to sell without such a sacrifice as disabled them from fulfilling their engagements, and several of them consequently failed. Among these, one was mentioned, who having a capital not exceeding 1200l. which was locked up in his business, had contrived to buy 4000 chests, value above 80,000l., the loss upon which was about 16,000l.

“The other example which I have to give, is that of the operation on the corn market between 1838 and 1842. There was an instance of a person who, when he entered on his extensive speculations, was, as it appeared by the subsequent examination of his affairs, possessed of a capital not exceeding 5000l., but being successful in the outset, and favoured by circumstances in the progress of his operations, he contrived to make purchases to such an extent, that when he stopped payment his engagements were found to amount to between 500,000l. and 600,000l. Other instances might be cited of parties without any capital at all, who, by dint of mere credit, were enabled, while the aspect of the market favoured their views, to make purchases to a very great extent.

“And be it observed, that these speculations, involving enormous purchases on little or no capital, were carried on in 1839 and 1840, when the money market was in its most contracted state; or when, according to modern phraseology, there was the greatest scarcity of money.”

But though the great instrument of speculative purchases is book credits, it cannot be contested that in speculative periods an increase does take place in the quantity both of bills of exchange and of bank notes. This increase, indeed, so far as bank notes are concerned, hardly ever takes place in the earliest stage of the speculations: advances from bankers (as Mr. Tooke observes) not being applied for in order to purchase, but in order to hold on without selling when the usual term of credit has expired, and the high price which was calculated on has not arrived. But the tea speculators mentioned by Mr. Tooke could not have carried their speculations beyond the three months which are the usual term of credit in their trade, unless they had been able to obtain advances from bankers, which, if the expectation of a rise of price had still continued, they probably could have done.

Since, then, credit in the form of bank notes is a more potent instrument for raising prices than book credits, an unrestrained power of resorting to this instrument may contribute to prolong and heighten the speculative rise of prices, and hence to aggravate the subsequent recoil. But in what degree? and what importance ought we to ascribe to this possibility? It may help us to form some judgment on this point, if we consider the proportion which the utmost increase of bank notes in a period of speculation, bears, I do not say to the whole mass of credit in the country, but to the bills of exchange alone. The average amount of bills in existence at any one time is supposed greatly to exceed [1848] a hundred millions sterling.∗ The bank note circulation of Great Britain and Ireland seldom exceeds forty millions, and the increase in speculative periods at most two or three. And even this, as we have seen, hardly ever comes into play until that advanced period of the speculation at which the tide shows signs of turning, and the dealers generally are rather thinking of the means of fulfilling their existing engagements, than meditating an extension of them: while the quantity of bills in existence is largely increased from the very commencement of the speculations.

§ 6. It is well known that of late years, an artificial limitation of the issue of bank notes has been regarded by many political economists, and by a great portion of the public, as an expedient of supreme efficacy for preventing, and when it cannot prevent, for moderating, the fever of speculation; and this opinion received the recognition and sanction of the legislature by the Currency Act of 1844. At the point, however, which our inquiries have reached, though we have conceded to bank notes a greater power over prices than is possessed by bills or book credits, we have not found reason to think that this superior efficacy has much share in producing the rise of prices which accompanies a period of speculation, nor consequently that any restraint applied to this one instrument can be efficacious to the degree which is often supposed, in moderating either that rise, or the recoil which follows it. We shall be still less inclined to think so, when we consider that there is a fourth form of credit transactions, by cheques on bankers, and transfers in a banker’s books, which is exactly parallel in every respect to bank notes, giving equal facilities to an extension of credit, and capable of acting on prices quite as powerfully. In the words of Mr. Fullarton,∗ “there is not a single object at present attained through the agency of Bank of England notes, which might not be as effectually accomplished by each individual keeping an account with the bank, and transacting all his payments of five pounds and upwards by cheque.” A bank, instead of lending its notes to a merchant or dealer, might open an account with him, and credit the account with the sum it had agreed to advance: on an understanding that he should not draw out that sum in any other mode than by drawing cheques against it in favour of those to whom he had occasion to make payments. These cheques might possibly even pass from hand to hand like bank notes; more commonly, however, the receiver would pay them into the hands of his own banker, and when he wanted the money, would draw a fresh cheque against it: and hence an objector may urge that as the original cheque would very soon be presented for payment, when it must be paid either in notes or in coin, notes or coin to an equal amount must be provided as the ultimate means of liquidation. It is not so, however. The person to whom the cheque is transferred may perhaps deal with the same banker, and the cheque may return to the very bank on which it was drawn: this is very often the case in country districts; if so, no payment will be called for, but a simple transfer in the banker’s books will settle the transaction. If the cheque is paid into a different bank, it will not be presented for payment, but liquidated by set-off against other cheques; and in a state of circumstances favourable to a general extension of banking credits, a banker who has granted more credit, and has therefore more cheques drawn on him, will also have more cheques on other bankers paid to him, and will only have to provide notes or cash for the payment of balances; for which purpose the ordinary reserve of prudent bankers, one-third of their liabilities, will abundantly suffice. Now, if he had granted the extension of credit by means of an issue of his own notes, he must equally have retained, in coin or Bank of England notes, the usual reserve: so that he can, as Mr. Fullarton says, give every facility of credit by what may be termed a cheque circulation, which he could give by a note circulation.

This extension of credit by entries in a banker’s books, has all that superior efficiency in acting on prices, which we ascribed to an extension by means of bank notes. As a bank note of 20l., paid to any one, gives him 20l. of purchasing power based on credit, over and above whatever credit he had of his own, so does a cheque paid to him do the same: for, although he may make no purchase with the cheque itself, he deposits it with his banker, and can draw against it. As this act of drawing a cheque against another which has been exchanged and cancelled, can be repeated as often as a purchase with a bank note, it effects the same increase of purchasing power. The original loan, or credit, given by the banker to his customer, is potentially multiplied as a means of purchase, in the hands of the successive persons to whom portions of the credit are paid away, just as the purchasing power of a bank note is multiplied by the number of persons through whose hands it passes before it is returned to the issuer.

These considerations abate very much from the importance of any effect which can be produced in allaying the vicissitudes of commerce, by so superficial a contrivance as the one so much relied on of late, the restriction of the issue of bank notes by an artificial rule. An examination of all the consequences of that restriction, and an estimate of the reasons for and against it, must be deferred until we have treated of the foreign exchanges, and the international movements of bullion. At present we are only concerned with the general theory of prices, of which the different influence of different kinds of credit is an essential part.

§ 7.1 There has been a great amount of discussion and argument on the question whether several of these forms of credit, and in particular whether bank notes, ought to be considered as money. The question is so purely verbal as to be scarcely worth raising, and one would have some difficulty in comprehending why so much importance is attached to it, if there were not some authorities who, still adhering to the doctrine of the infancy of society and of political economy, that the quantity of money compared with that of commodities, determines general prices, think it important to prove that bank notes and no other forms of credit are money, in order to support the inference that bank notes and no other forms of credit influence prices. It is obvious, however, that prices do not depend on money, but on purchases. Money left with a banker, and not drawn against, or drawn against for other purposes than buying commodities, has no effect on prices, any more than credit which is not used. Credit which is used to purchase commodities affects prices in the same manner as money. Money and credit are thus exactly on a par, in their effect on prices; and whether we choose to class bank notes with the one or the other, is in this respect entirely immaterial.

Since, however, this question of nomenclature has been raised, it seems desirable that it should be answered. The reason given for considering bank notes as money, is, that by law and usage they have the property, in common with metallic money, of finally closing the transactions in which they are employed; while no other mode of paying one debt by transferring another has that privilege. The first remark which here suggests itself is, that on this showing, the notes at least of private banks are not money; for a creditor cannot be forced to accept them in payment of a debt. They certainly close the transaction if he does accept them; but so, on the same supposition, would a bale of cloth, or a pipe of wine; which are not for that reason regarded as money. It seems to be an essential part of the idea of money that it be legal tender. An inconvertible paper which is legal tender is universally admitted to be money; in the French language the phrase papier-monnaie actually means inconvertibility, convertible notes being merely billets à porteur. It is only in the case of Bank of England notes under the law of convertibility, that any difficulty arises; those notes not being a legal tender from the Bank itself, though a legal tender from all other persons. Bank of England notes undoubtedly do close transactions, so far as respects the buyer. When he has once paid in Bank of England notes, he can in no case be required to pay over again. But I confess I cannot see how the transaction can be deemed complete, as regards the seller, when he will only be found to have received the price of his commodity provided the Bank keeps its promise to pay. An instrument which would be deprived of all value by the insolvency of a corporation, cannot be money in any sense in which money is opposed to credit. It either is not money, or it is money and credit too. It may be most suitably described as coined credit. The other forms of credit may be distinguished from it as credit in ingots.

§ 8. Some high authorities have claimed for bank notes, as compared with other modes of credit, a greater distinction in respect to influence on price, than we have seen reason to allow; a difference, not in degree, but in kind. They ground this distinction on the fact that all bills and cheques, as well as all book-debts, are from the first intended to be, and actually are, ultimately liquidated either in coin or in notes. The bank notes in circulation, jointly with the coin, are therefore, according to these authorities, the basis on which all the other expedients of credit rest; and in proportion to the basis will be the superstructure; insomuch that the quantity of bank notes determines that of all the other forms of credit. If bank notes are multiplied, there will, they seem to think, be more bills, more payments by cheque, and I presume, more book credits; and by regulating and limiting the issue of bank notes, they think that all other forms of credit are, by an indirect consequence, brought under a similar limitation. I believe I have stated the opinion of these authorities correctly, though I have nowhere seen the grounds of it set forth with such distinctness as to make me feel quite certain that I understand them. It may be true that, according as there are more or fewer bank notes, there is also in general (though not invariably), more or less of other descriptions of credit; for the same state of affairs which leads to an increase of credit in one shape, leads to an increase of it in other shapes. But I see no reason for believing that the one is the cause of the other.1 If indeed we begin by assuming, as I suspect is tacitly done, that prices are regulated by coin and bank notes, the proposition maintained will certainly follow; for, according as prices are higher or lower, the same purchases will give rise to bills, cheques, and book credits of a larger or a smaller amount. But the premise in this reasoning is the very proposition to be proved. Setting this assumption aside, I know not how the conclusion can be substantiated. The credit given to any one by those with whom he deals, does not depend on the quantity of bank notes or coin in circulation at the time, but on their opinion of his solvency: if any consideration of a more general character enters into their calculation, it is only in a time of pressure on the loan market, when they are not certain of being themselves able to obtain the credit on which they have been accustomed to rely; and even then, what they look to is the general state of the loan market, and not (preconceived theory apart) the amount of bank notes. So far as to the willingness to give credit. And the willingness of a dealer to use his credit depends on his expectations of gain, that is, on his opinion of the probable future price of his commodity; an opinion grounded either on the rise or fall already going on, or on his prospective judgment respecting the supply and the rate of consumption. When a dealer extends his purchases beyond his immediate means of payment, engaging to pay at a specified time, he does so in the expectation either that the transaction will have terminated favourably before that time arrives, or that he shall then be in possession of sufficient funds from the proceeds of his other transactions. The fulfilment of these expectations depends upon prices, but not especially upon the amount of bank notes. He may, doubtless, also ask himself, in case he should be disappointed in these expectations, to what quarter he can look for a temporary advance, to enable him, at the worst, to keep his engagements. But in the first place, this prospective reflection on the somewhat more or less of difficulty which he may have in tiding over his embarrassments, seems too slender an inducement to be much of a restraint in a period supposed to be one of rash adventure, and upon persons so confident of success as to involve themselves beyond their certain means of extrication. And further, I apprehend that their confidence of being helped out in the event of ill-fortune, will mainly depend on their opinion of their own individual credit, with, perhaps, some consideration, not of the quantity of the currency, but of the general state of the loan market. They are aware that, in case of a commercial crisis, they shall have difficulty in obtaining advances. But if they thought it likely that a commercial crisis would occur before they had realized, they would not speculate. If no great contraction of general credit occurs, they will feel no doubt of obtaining any advances which they absolutely require, provided the state of their own affairs at the time affords in the estimation of lenders a sufficient prospect that those advances will be repaid.

Book III, Chapter XIII: Of an inconvertible paper currency

CHAPTER XIII: of an inconvertible paper currency

§ 1. After experience had shown that pieces of paper, of no intrinsic value, by merely bearing upon them the written profession of being equivalent to a certain number of francs, dollars, or pounds, could be made to circulate as such, and to produce all the benefit to the issuers which could have been produced by the coins which they purported to represent; governments began to think that it would be a happy device if they could appropriate to themselves this benefit, free from the condition to which individuals issuing such paper substitutes for money were subject, of giving, when required, for the sign, the thing signified. They determined to try whether they could not emancipate themselves from this unpleasant obligation, and make a piece of paper issued by them pass for a pound, by merely calling it a pound, and consenting to receive it in payment of the taxes. And such is the influence of almost all established governments, that they have generally succeeded in attaining this object: I believe I might say they have always succeeded for a time, and the power has only been lost to them after they had compromised it by the most flagrant abuse.

In the case supposed, the functions of money are performed by a thing which derives its power for performing them solely from convention; but convention is quite sufficient to confer the power; since nothing more is needful to make a person accept anything as money, and even at any arbitrary value, than the persuasion that it will be taken from him on the same terms by others. The only question is, what determines the value of such a currency; since it cannot be, as in the case of gold and silver (or paper exchangeable for them at pleasure), the cost of production.

We have seen, however, that even in the case of a metallic currency, the immediate agency in determining its value is its quantity. If the quantity, instead of depending on the ordinary mercantile motives of profit and loss, could be arbitrarily fixed by authority, the value would depend on the fiat of that authority, not on cost of production. The quantity of a paper currency not convertible into the metals at the option of the holder, can be arbitrarily fixed; especially if the issuer is the sovereign power of the state. The value, therefore, of such a currency is entirely arbitrary.

Suppose that, in a country of which the currency is wholly metallic, a paper currency is suddenly issued, to the amount of half the metallic circulation; not by a banking establishment, or in the form of loans, but by the government, in payment of salaries and purchase of commodities. The currency being suddenly increased by one-half, all prices will rise, and among the rest, the prices of all things made of gold and silver. An ounce of manufactured gold will become more valuable than an ounce of gold coin, by more than that customary difference which compensates for the value of the workmanship; and it will be profitable to melt the coin for the purpose of being manufactured, until as much has been taken from the currency by the subtraction of gold, as had been added to it by the issue of paper. Then prices will relapse to what they were at first, and there will be nothing changed except that a paper currency has been substituted for half of the metallic currency which existed before. Suppose, now, a second emission of paper; the same series of effects will be renewed; and so on, until the whole of the metallic money has disappeared: that is, if paper be issued of as low a denomination as the lowest coin; if not, as much will remain as convenience requires for the smaller payments. The addition made to the quantity of gold and silver disposable for ornamental purposes, will somewhat reduce, for a time, the value of the article; and as long as this is the case, even though paper has been issued to the original amount of the metallic circulation, as much coin will remain in circulation along with it, as will keep the value of the currency down to the reduced value of the metallic material; but the value having fallen below the cost of production, a stoppage or diminution of the supply from the mines will enable the surplus to be carried off by the ordinary agents of destruction, after which, the metals and the currency will recover their natural value. We are here supposing, as we have supposed throughout, that the country has mines of its own, and no commercial intercourse with other countries; for, in a country having foreign trade, the coin which is rendered superfluous by an issue of paper is carried off by a much prompter method.

Up to this point, the effects of a paper currency are substantially the same, whether it is convertible into specie or not. It is when the metals have been completely superseded and driven from circulation, that the difference between convertible and inconvertible paper begins to be operative. When the gold or silver has all gone from circulation, and an equal quantity of paper has taken its place, suppose that a still further issue is superadded. The same series of phenomena recommences: prices rise, among the rest the prices of gold and silver articles, and it becomes an object as before to procure coin in order to convert it into bullion. There is no longer any coin in circulation; but if the paper currency is convertible, coin may still be obtained from the issuers, in exchange for notes. All additional notes, therefore, which are attempted to be forced into circulation after the metals have been completely superseded, will return upon the issuers in exchange for coin; and they will not be able to maintain in circulation such a quantity of convertible paper as to sink its value below the metal which it represents. It is not so, however, with an inconvertible currency. To the increase of that (if permitted by law) there is no check. The issuers may add to it indefinitely, lowering its value and raising prices in proportion; they may, in other words, depreciate the currency without limit.

Such a power, in whomsoever vested, is an intolerable evil. All variations in the value of the circulating medium are mischievous: they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious. The person who buys for himself, or gives to another, an annuity of 100l., does not know whether it will be equivalent to 200l. or to 50l. a few years hence. Great as this evil would be if it depended only on accident, it is still greater when placed at the arbitrary disposal of an individual or a body of individuals; who may have any kind or degree of interest to be served by an artificial fluctuation in fortunes; and who have at any rate a strong interest in issuing as much as possible, each issue being in itself a source of profit. Not to add, that the issuers may have, and in the case of a government paper, always have, a direct interest in lowering the value of the currency, because it is the medium in which their own debts are computed.

§ 2. In order that the value of the currency may be secure from being altered by design, and may be as little as possible liable to fluctuation from accident, the articles least liable of all known commodities to vary in their value, the precious metals, have been made in all civilized countries the standard of value for the circulating medium; and no paper currency ought to exist of which the value cannot be made to conform to theirs. Nor has this fundamental maxim ever been entirely lost sight of, even by the governments which have most abused the power of creating inconvertible paper. If they have not (as they generally have) professed an intention of paying in specie at some indefinite future time, they have at least, by giving to their paper issues the names of their coins, made a virtual, though generally a false, profession of intending to keep them at a value corresponding to that of the coins. This is not impracticable, even with an inconvertible paper. There is not indeed the self-acting check which convertibility brings with it. But there is a clear and unequivocal indication by which to judge whether the currency is depreciated, and to what extent. That indication is, the price of the precious metals. When holders of paper cannot demand coin to be converted into bullion, and when there is none left in circulation, bullion rises and falls in price like other things; and if it is above the Mint price, if an ounce of gold, which would be coined into the equivalent of 3l. 17s. 101/2d., is sold for 4l. or 5l. in paper, the value of the currency has sunk just that much below what the value of a metallic currency would be. If, therefore, the issue of inconvertible paper were subjected to strict rules, one rule being that whenever bullion rose above the Mint price, the issues should he contracted until the market price of bullion and the Mint price were again in accordance, such a currency would not be subject to any of the evils usually deemed inherent in an inconvertible paper.

But also such a system of currency would have no advantages sufficient to recommend it to adoption. An inconvertible currency, regulated by the price of bullion, would conform exactly, in all its variations, to a convertible one; and the only advantage gained, would be that of exemption from the necessity of keeping any reserve of the precious metals; which is not a very important consideration, especially as a government, so long as its good faith is not suspected, needs not keep so large a reserve as private issuers, being not so liable to great and sudden demands, since there never can be any real doubt of its solvency. Against this small advantage is to be set, in the first place, the possibility of fraudulent tampering with the price of bullion for the sake of acting on the currency; in the manner of the fictitious sales of corn, to influence the averages, so much and so justly complained of while the corn laws were in force. But a still stronger consideration is the importance of adhering to a simple principle, intelligible to the most untaught capacity. Everybody can understand convertibility; every one sees that what can be at any moment exchanged for five pounds, is worth five pounds. Regulation by the price of bullion is a more complex idea, and does not recommend itself through the same familiar associations. There would be nothing like the same confidence, by the public generally, in an inconvertible currency so regulated, as in a convertible one: and the most instructed person might reasonably doubt whether such a rule would be as likely to be inflexibly adhered to. The grounds of the rule not being so well understood by the public, opinion would probably not enforce it with as much rigidity, and, in any circumstances of difficulty, would be likely to turn against it; while to the government itself a suspension of convertibility would appear a much stronger and more extreme measure, than a relaxation of what might possibly be considered a somewhat artificial rule. There is therefore a great preponderance of reasons in favour of a convertible, in preference to even the best regulated inconvertible currency. The temptation to over-issue, in certain financial emergencies, is so strong, that nothing is admissible which can tend, in however slight a degree, to weaken the barriers that restrain it.

§ 3. Although no doctrine in political economy rests on more obvious grounds than the mischief of a paper currency not maintained at the same value with a metallic, either by convertibility, or by some principle of limitation equivalent to it; and although, accordingly, this doctrine has, though not till after the discussions of many years, been tolerably effectually drummed into the public mind; yet dissentients are still numerous, and projectors every now and then start up, with plans for curing all the economical evils of society by means of an unlimited issue of inconvertible paper. There is, in truth, a great charm in the idea. To be able to pay off the national debt, defray the expenses of government without taxation, and in fine, to make the fortunes of the whole community, is a brilliant prospect, when once a man is capable of believing that printing a few characters on bits of paper will do it. The philosopher’s stone could not be expected to do more.

As these projects, however often slain, always resuscitate, it is not superfluous to examine one or two of the fallacies by which the schemers impose upon themselves. One of the commonest is, that a paper currency cannot be issued in excess so long as every note issued represents property, or has a foundation of actual property to rest on. These phrases, of representing and resting, seldom convey any distinct or well-defined idea: when they do, their meaning is no more than this—that the issuers of the paper must have property, either of their own, or entrusted to them, to the value of all the notes they issue: though for what purpose does not very clearly appear; for if the property cannot be claimed in exchange for the notes, it is difficult to divine in what manner its mere existence can serve to uphold their value. I presume, however, it is intended as a guarantee that the holders would be finally reimbursed, in case any untoward event should cause the whole concern to be wound up. On this theory there have been many schemes for “coining the whole land of the country into money” and the like.

In so far as this notion has any connexion at all with reason, it seems to originate in confounding two entirely distinct evils, to which a paper currency is liable. One is, the insolvency of the issuers; which, if the paper is grounded on their credit—if it makes any promise of payment in cash, either on demand or at any future time—of course deprives the paper of any value which it derives from the promise. To this evil paper credit is equally liable, however moderately used; and against it a proviso that all issues should be “founded on property,” as for instance that notes should only be issued on the security of some valuable thing expressly pledged for their redemption, would really be efficacious as a precaution. But the theory takes no account of another evil, which is incident to the notes of the most solvent firm, company, or government; that of being depreciated in value from being issued in excessive quantity. The assignats, during the French Revolution, were an example of a currency grounded on these principles. The assignats “represented” an immense amount of highly valuable property, namely the lands of the crown, the church, the monasteries, and the emigrants; amounting possibly to half the territory of France. They were, in fact, orders or assignments on this mass of land. The revolutionary government had the idea of “coining” these lands into money; but, to do them justice, they did not originally contemplate the immense multiplication of issues to which they were eventually driven by the failure of all other financial resources. They imagined that the assignats would come rapidly back to the issuers in exchange for land, and that they should be able to reissue them continually until the lands were all disposed of, without having at any time more than a very moderate quantity in circulation. Their hope was frustrated: the land did not sell so quickly as they expected; buyers were not inclined to invest their money in possessions which were likely to be resumed without compensation if the Revolution succumbed: the bits of paper which represented land, becoming prodigiously multiplied, could no more keep up their value than the land itself would have done if it had all been brought to market at once: and the result was that it at last required an assignat of six hundred francs to pay for a pound of butter.1

The example of the assignats has been said not to be conclusive, because an assignat only represented land in general, but not a definite quantity of land. To have prevented their depreciation, the proper course, it is affirmed, would have been to have made a valuation of all the confiscated property at its metallic value, and to have issued assignats up to, but not beyond, that limit; giving to the holders a right to demand any piece of land, at its registered valuation, in exchange for assignats to the same amount. There can be no question about the superiority of this plan over the one actually adopted. Had this course been followed, the assignats could never have been depreciated to the inordinate degree they were; for—as they would have retained all their purchasing power in relation to land, however much they might have fallen in respect to other things—before they had lost very much of their market value, they would probably have been brought in to be exchanged for land. It must be remembered, however, that their not being depreciated would pre-suppose that no greater number of them continued in circulation than would have circulated if they had been convertible into cash. However convenient, therefore, in a time of revolution, this currency convertible into land on demand might have been, as a contrivance for selling rapidly a great quantity of land with the least possible sacrifice; it is difficult to see what advantage it would have, as the permanent system of a country, over a currency convertible into coin: while it is not at all difficult to see what would be its disadvantages; since land is far more variable in value than gold and silver; and besides, land, to most persons, being rather an encumbrance than a desirable possession, except to be converted into money, people would submit to a much greater depreciation before demanding land, than they will before demanding gold or silver.∗ 1

§ 4. Another of the fallacies from which the advocates of an inconvertible currency derive support, is the notion that an increase of the currency quickens industry. This idea was set afloat by Hume, in his Essay on Money, and has had many devoted adherents since; witness the Birmingham currency school, of whom Mr. Attwood was at one time the most conspicuous representative. Mr. Attwood maintained that a rise of prices, produced by an increase of paper currency, stimulates every producer to his utmost exertions, and brings all the capital and labour of the country into complete employment; and that this has invariably happened in all periods of rising prices, when the rise was on a sufficiently great scale. I presume, however, that the inducement which, according to Mr. Attwood, excited this unusual ardour in all persons engaged in production, must have been the expectation of getting more commodities generally, more real wealth, in exchange for the produce of their labour, and not merely more pieces of paper. This expectation, however, must have been, by the very terms of the supposition, disappointed, since, all prices being supposed to rise equally, no one was really better paid for his goods than before. Those who agree with Mr. Attwood could only succeed in winning people on to these unwonted exertions by a prolongation of what would in fact be a delusion; contriving matters so, that by a progressive rise of money prices, every producer shall always seem to be in the very act of obtaining an increased remuneration which he never, in reality, does obtain. It is unnecessary to advert to any other of the objections to this plan than that of its total impracticability. It calculates on finding the whole world persisting for ever in the belief that more pieces of paper are more riches, and never discovering that, with all their paper, they cannot buy more of anything that they could before. No such mistake was made during any of the periods of high prices, on the experience of which this school lays so much stress. At the periods which Mr. Attwood mistook for times of prosperity, and which were simply (as all periods of high prices, under a convertible currency, must be) times of speculation, the speculators did not think they were growing rich because the high prices would last, but because they would not last, and because whoever contrived to realize while they did last, would find himself, after the recoil, in possession of a greater number of pounds sterling, without their having become of less value. If, at the close of the speculation, an issue of paper had been made, sufficient to keep prices up to the point which they attained when at the highest, no one would have been more disappointed than the speculators; since the gain which they thought to have reaped by realizing in time (at the expense of their competitors, who bought when they sold, and had to sell after the revulsion) would have faded away in their hands, and instead of it they would have got nothing except a few more paper tickets to count by.

Hume’s version of the doctrine differed in a slight degree from Mr. Attwood’s. He thought that all commodities would not rise in price simultaneously, and that some persons therefore would obtain a real gain, by getting more money for what they had to sell, while the things which they wished to buy might not yet have risen. And those who would reap this gain would always be (he seems to think) the first comers. It seems obvious, however, that for every person who thus gains more than usual, there is necessarily some other person who gains less. The loser, if things took place as Hume supposes, would be the seller of the commodities which are slowest to rise; who, by the supposition, parts with his goods at the old prices, to purchasers who have already benefited by the new. This seller has obtained for his commodity only the accustomed quantity of money, while there are already some things of which that money will no longer purchase as much as before. If, therefore, he knows what is going on, he will raise his price, and then the buyer will not have the gain, which is supposed to stimulate his industry. But if, on the contrary, the seller does not know the state of the case, and only discovers it when he finds, in laying his money out, that it does not go so far, he then obtains less than the ordinary remuneration for his labour and capital; and if the other dealer’s industry is encouraged, it should seem that his must, from the opposite cause, be impaired.

§ 5. There is no way in which a general and permanent rise of prices, or in other words, depreciation of money, can benefit anybody, except at the expense of somebody else. The substitution of paper for metallic currency is a national gain: any further increase of paper beyond this is but a form of robbery.

An issue of notes is a manifest gain to the issuers, who, until the notes are returned for payment, obtain the use of them as if they were a real capital: and so long as the notes are no permanent addition to the currency, but merely supersede gold or silver to the same amount, the gain of the issuer is a loss to no one; it is obtained by saving to the community the expense of the more costly material. But if there is no gold or silver to be superseded—if the notes are added to the currency, instead of being substituted for the metallic part of it—all holders of currency lose, by the depreciation of its value, the exact equivalent of what the issuer gains. A tax is virtually levied on them for his benefit. It will be objected by some, that gains are also made by the producers and dealers who, by means of the increased issue, are accommodated with loans. Theirs, however, is not an additional gain, but a portion of that which is reaped by the issuer at the expense of all possessors of money. The profits arising from the contribution levied upon the public, he does not keep to himself, but divides with his customers.

But besides the benefit reaped by the issuers, or by others through them, at the expense of the public generally, there is another unjust gain obtained by a larger class, namely by those who are under fixed pecuniary obligations. All such persons are freed, by a depreciation of the currency, from a portion of the burthen of their debts or other engagements: in other words, part of the property of their creditors is gratuitously transferred to them. On a superficial view it may be imagined that this is an advantage to industry; since the productive classes are great borrowers, and generally owe larger debts to the unproductive (if we include among the latter all persons not actually in business) than the unproductive classes owe to them; especially if the national debt be included. It is only thus that a general rise of prices can be a source of benefit to producers and dealers; by diminishing the pressure of their fixed burthens. And this might be accounted an advantage, if integrity and good faith were of no importance to the world, and to industry and commerce in particular. Not many, however, have been found to say that the currency ought to be depreciated on the simple ground of its being desirable to rob the national creditor and private creditors of a part of what is in their bond. The schemes which have tended that way have almost always had some appearance of special and circumstantial justification, such as the necessity of compensating for a prior injustice committed in the contrary direction.

§ 6. Thus in England, for many years subsequent to 1819, it was pertinaciously contended, that a large portion of the national debt and a multitude of private debts still in existence, were contracted between 1797 and 1819, when the Bank of England was exempted from giving cash for its notes; and that it is grossly unjust to borrowers (that is, in the case of the national debt, to all tax-payers) that they should be paying interest on the same nominal sums in a currency of full value, which were borrowed in a depreciated one.1 The depreciation, according to the views and objects of the particular writer, was represented to have averaged thirty, fifty, or even more than fifty per cent: and the conclusion was, that either we ought to return to this depreciated currency, or to strike off from the national debt, and from mortgages or other private debts of old standing, a percentage corresponding to the estimated amount of the depreciation.

To this doctrine, the following was the answer usually made. Granting that, by returning to cash payments without lowering the standard, an injustice was done to debtors, in holding them liable for the same amount of a currency enhanced in value, which they had borrowed while it was depreciated; it is now too late to make reparation for this injury. The debtors and creditors of to-day are not the debtors and creditors of 1819: the lapse of years has entirely altered the pecuniary relations of the community; and it being impossible now to ascertain the particular persons who were either benefited or injured, to attempt to retrace our steps would not be redressing a wrong, but superadding a second act of wide-spread injustice to the one already committed. This argument is certainly conclusive on the practical question; but it places the honest conclusion on too narrow and too low a ground. It concedes that the measure of 1819, called Peel’s Bill; by which cash payments were resumed at the original standard of 3l. 17s. 10½d., was really the injustice it was said to be. This is an admission wholly opposed to the truth. Parliament had no alternative; it was absolutely bound to adhere to the acknowledged standard; as may be shown on three distinct grounds, two of fact, and one of principle.

The reasons of fact are these. In the first place, it is not true that the debts, private or public, incurred during the Bank restriction, were contracted in a currency of lower value than that in which the interest is now paid. It is indeed true that the suspension of the obligation to pay in specie did put it in the power of the Bank to depreciate the currency. It is true also that the Bank really exercised that power, though to a far less extent than is often pretended; since the difference between the market price of gold and the Mint valuation, during the greater part of the interval, was very trifling, and when it was greatest, during the last five years of the war, did not much exceed thirty per cent. To the extent of that difference, the currency was depreciated, that is, its value was below that of the standard to which it professed to adhere. But the state of Europe at that time was such—there was so unusual an absorption of the precious metals, by hoarding, and in the military chests of the vast armies which then desolated the Continent, that the value of the standard itself was very considerably raised: and the best authorities, among whom it is sufficient to name Mr. Tooke, have, after an elaborate investigation, satisfied themselves that the difference between paper and bullion was not greater than the enhancement in value of gold itself, and that the paper, though depreciated relatively to the then value of gold, did not sink below the ordinary value, at other times, either of gold or of a convertible paper. If this be true (and the evidences of the fact are conclusively stated in Mr. Tooke’s History of Prices) the foundation of the whole case against the fundholder and other creditors on the ground of depreciation is subverted.

But, secondly, even if the currency had really been lowered in value at each period of the Bank restriction, in the same degree in which it was depreciated in relation to its standard, we must remember that a part only of the national debt, or of other permanent engagements, was incurred during the Bank restriction. A large part had been contracted before 1797; a still larger during the early years of the restriction, when the difference between paper and gold was yet small. To the holders of the former part, an injury was done, by paying the interest for twenty-two years in a depreciated currency: those of the second, suffered an injury during the years in which the interest was paid in a currency more depreciated than that in which the loans were contracted. To have resumed cash payments at a lower standard would have been to perpetuate the injury to these two classes of creditors, in order to avoid giving an undue benefit to a third class, who had lent their money during the few years of greatest depreciation. As it is, there was an underpayment to one set of persons, and an overpayment to another. The late Mr. Mushet took the trouble to make an arithmetical comparison between the two amounts. He ascertained, by calculation, that if an account had been made out in 1819, of what the fundholders had gained and lost by the variation of the paper currency from its standard, they would have been found as a body to have been losers; so that if any compensation was due on the ground of depreciation, it would not be from the fundholders collectively, but to them.

Thus it is with the facts of the case. But these reasons of fact are not the strongest. There is a reason of principle, still more powerful. Suppose that, not a part of the debt merely, but the whole, had been contracted in a depreciated currency, depreciated not only in comparison with its standard, but with its own value before and after; and that we were now paying the interest of this debt in a currency fifty or even a hundred per cent more valuable than that in which it was contracted. What difference would this make in the obligation of paying it, if the condition that it should be so paid was part of the original compact? Now this is not only truth, but less than the truth. The compact stipulated better terms for the fundholder than he has received. During the whole continuance of the Bank restriction, there was a parliamentary pledge, by which the legislature was as much bound as any legislature is capable of binding itself, that cash payments should be resumed on the original footing, at farthest in six months after the conclusion of a general peace. This was therefore an actual condition of every loan; and the terms of the loan were more favourable in consideration of it. Without some such stipulation, the Government could not have expected to borrow, unless on the terms on which loans are made to the native princes of India. If it had been understood and avowed that, after borrowing the money, the standard at which it was commuted might be permanently lowered, to any extent which to the “collective wisdom” of a legislature of borrowers might seem fit—who can say what rate of interest would have been a sufficient inducement to persons of common sense to risk their savings in such an adventure? However much the fundholders had gained by the resumption of cash payments, the terms of the contract insured their giving ample value for it. They gave value for more than they received; since cash payments were not resumed in six months, but in as many years, after the peace. So that waving all our arguments except the last, and conceding all the facts asserted on the other side of the question, the fundholders, instead of being unduly benefited, are the injured party; and would have a claim to compensation, if such claims were not very properly barred by the impossibility of adjudication, and by the salutary general maxim of law and policy, “quod interest reipublicae ut sit finis litium.”

Book III, Chapter XIV: Of excess of supply

CHAPTER XIV: of excess of supply

§ 1. After the elementary exposition of the theory of money contained in the last few chapters, we shall return to a question in the general theory of Value, which could not be satisfactorily discussed until the nature and operations of Money were in some measure understood, because the errors against which we have to contend mainly originate in a misunderstanding of those operations.

We have seen that the value of everything gravitates towards a certain medium point (which has been called the Natural Value), namely, that at which it exchanges for every other thing in the ratio of their cost of production. We have seen, too, that the actual or market value coincides, or nearly so, with the natural value only on an average of years; and is continually either rising above, or falling below it, from alterations in the demand, or casual fluctuations in the supply: but that these variations correct themselves, through the tendency of the supply to accommodate itself to the demand which exists for the commodity at its natural value. A general convergence thus results from the balance of opposite divergences. Dearth, or scarcity, on the one hand, and over-supply, or in mercantile language, glut, on the other, are incident to all commodities. In the first case, the commodity affords to the producers or sellers, while the deficiency lasts, an unusually high rate of profit: in the second, the supply being in excess of that for which a demand exists at such a value as will afford the ordinary profit, the sellers must be content with less, and must, in extreme cases, submit to a loss.

Because this phenomenon of over-supply, and consequent inconvenience or loss to the producer or dealer, may exist in the case of any one commodity whatever, many persons, including some distinguished political economists, have thought that it may exist with regard to all commodities; that there may be a general over-production of wealth; a supply of commodities in the aggregate, surpassing the demand; and a consequent depressed condition of all classes of producers. Against this doctrine, of which Mr. Malthus and Dr. Chalmers in this country, and M. de Sismondi on the Continent, were the chief apostles, I have already contended in the First Book;∗ but it was not possible, in that stage of our inquiry, to enter into a complete examination of an error (as I conceive) essentially grounded on a misunderstanding of the phenomena of Value and Price.

The doctrine appears to me to involve so much inconsistency in its very conception, that I feel considerable difficulty in giving any statement of it which shall be at once clear, and satisfactory to its supporters. They agree in maintaining that there may be, and sometimes is, an excess of productions in general beyond the demand for them; that when this happens, purchasers cannot be found at prices which will repay the cost of production with a profit; that there ensues a general depression of prices or values (they are seldom accurate in discriminating between the two), so that producers, the more they produce, find themselves the poorer, instead of richer; and Dr. Chalmers accordingly inculcates on capitalists the practice of a moral restraint in reference to the pursuit of gain; while Sismondi deprecates machinery, and the various inventions which increase productive power. They both maintain that accumulation of capital may proceed too fast, not merely for the moral, but for the material, interests of those who produce and accumulate; and they enjoin the rich to guard against this evil by an ample unproductive consumption.

§ 2. When these writers speak of the supply of commodities as outrunning the demand, it is not clear which of the two elements of demand they have in view—the desire to possess, or the means of purchase; whether their meaning is that there are, in such cases, more consumable products in existence than the public desires to consume, or merely more than it is able to pay for. In this uncertainty, it is necessary to examine both suppositions.

First, let us suppose that the quantity of commodities produced is not greater than the community would be glad to consume: is it, in that case, possible that there should be a deficiency of demand for all commodities for want of the means of payment? Those who think so cannot have considered what it is which constitutes the means of payment for commodities. It is simply commodities. Each person’s means of paying for the productions of other people consists of those which he himself possesses. All sellers are inevitably and ex vi termini buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply: everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. It is probable, indeed, that there would now be a superfluity of certain things. Although the community would willingly double its aggregate consumption, it may already have as much as it desires of some commodities, and it may prefer to do more than double its consumption of others, or to exercise its increased purchasing power on some new thing. If so, the supply will adapt itself accordingly, and the values of things will continue to conform to their cost of production. At any rate, it is a sheer absurdity that all things should fall in value, and that all producers should, in consequence, be insufficiently remunerated. If values remain the same, what becomes of prices is immaterial, since the remuneration of producers does not depend on how much money, but on how much of consumable articles, they obtain for their goods. Besides, money is a commodity; and if all commodities are supposed to be doubled in quantity, we must suppose money to be doubled too, and then prices would no more fall than values would.

§ 3. A general over-supply, or excess of all commodities above the demand, so far as demand consists in means of payment, is thus shown to be an impossibility. But it may perhaps be supposed that it is not the ability to purchase, but the desire to possess, that falls short, and that the general produce of industry may be greater than the community desires to consume—the part, at least, of the community which has an equivalent to give. It is evident enough that produce makes a market for produce, and that there is wealth in the country with which to purchase all the wealth in the country; but those who have the means may not have the wants, and those who have the wants may be without the means. A portion, therefore, of the commodities produced may be unable to find a market from the absence of means in those who have the desire to consume, and the want of desire in those who have the means.

This is much the most plausible form of the doctrine, and does not, like that which we first examined, involve a contradiction. There may easily be a greater quantity of any particular commodity than is desired by those who have the ability to purchase, and it is abstractedly conceivable that this might be the case with all commodities. The error is in not perceiving that though all who have an equivalent to give might be fully provided with every consumable article which they desire, the fact that they go on adding to the production proves that this is not actually the case. Assume the most favourable hypothesis for the purpose, that of a limited community, every member of which possesses as much of necessaries and of all known luxuries as he desires: and since it is not conceivable that persons whose wants were completely satisfied would labour and economize to obtain what they did not desire, suppose that a foreigner arrives and produces an additional quantity of something of which there was already enough. Here, it will be said, is over-production: true, I reply; over-production of that particular article: the community wanted no more of that, but it wanted something. The old inhabitants, indeed, wanted nothing; but did not the foreigner himself want something? When he produced the superfluous article, was he labouring without a motive? He has produced, but the wrong thing instead of the right. He wanted, perhaps, food, and has produced watches, with which everybody was sufficiently supplied. The new comer brought with him into the country a demand for commodities, equal to all that he could produce by his industry, and it was his business to see that the supply he brought should be suitable to that demand. If he could not produce something capable of exciting a new want or desire in the community, for the satisfaction of which some one would grow more food and give it to him in exchange, he had the alternative of growing food for himself; either on fresh land, if there was any unoccupied, or as a tenant, or partner, or servant, of some former occupier, willing to be partially relieved from labour. He has produced a thing not wanted, instead of what was wanted; and he himself, perhaps, is not the kind of producer who is wanted; but there is no over-production; production is not excessive, but merely ill assorted. We saw before, that whoever brings additional commodities to the market, brings an additional power of purchase; we now see that he brings also an additional desire to consume; since if he had not that desire, he would not have troubled himself to produce. Neither of the elements of demand, therefore, can be wanting, when there is an additional supply; though it is perfectly possible that the demand may be for one thing, and the supply may unfortunately consist of another.

Driven to his last retreat, an opponent may perhaps allege that there are persons who produce and accumulate from mere habit; not because they have any object in growing richer, or desire to add in any respect to their consumption, but from vis inertiae. They continue producing because the machine is ready mounted, and save and re-invest their savings because they have nothing on which they care to expend them. I grant that this is possible, and in some few instances probably happens; but these do not in the smallest degree affect our conclusion. For, what do these persons do with their savings? They invest them productively that is, expend them in employing labour. In other words, having a purchasing power belonging to them, more than they know what to do with, they make over the surplus of it for the general benefit of the labouring class. Now, will that class also not know what to do with it? Are we to suppose that they too have their wants perfectly satisfied, and go on labouring from mere habit? Until this is the case; until the working classes have also reached the point of satiety—there will be no want of demand for the produce of capital, however rapidly it may accumulate; since, if there is nothing else for it to do, it can always find employment in producing the necessaries or luxuries of the labouring class. And when they too had no further desire for necessaries or luxuries, they would take the benefit of any further increase of wages by diminishing their work; so that the over-production which then for the first time would be possible in idea, could not even then take place in fact, for want of labourers. Thus, in whatever manner the question is looked at, even though we go to the extreme verge of possibility to invent a supposition favourable to it, the theory of general over-production implies an absurdity.

§ 4. What then is it by which men who have reflected much on economical phenomena, and have even contributed to throw new light upon them by original speculations, have been led to embrace so irrational a doctrine? I conceive them to have been deceived by a mistaken interpretation of certain mercantile facts. They imagined that the possibility of a general over-supply of commodities was proved by experience. They believed that they saw this phenomenon in certain conditions of the markets, the true explanation of which is totally different.

I have already described the state of the markets for commodities which accompanies what is termed a commercial crisis. At such times there is really an excess of all commodities above the money demand: in other words, there is an under-supply of money. From the sudden annihilation of a great mass of credit, every one dislikes to part with ready money, and many are anxious to procure it at any sacrifice. Almost everybody therefore is a seller, and there are scarcely any buyers; so that there may really be, though only while the crisis lasts, an extreme depression of general prices, from what may be indiscriminately called a glut of commodities or a dearth of money. But it is a great error to suppose, with Sismondi, that a commercial crisis is the effect of a general excess of production. It is simply the consequence of an excess of speculative purchases. It is not a gradual advent of low prices, but a sudden recoil from prices extravagantly high: its immediate cause is a contraction of credit, and the remedy is, not a diminution of supply, but the restoration of confidence. It is also evident that this temporary derangement of markets is an evil only because it is temporary. The fall being solely of money prices, if prices did not rise again no dealer would lose, since the smaller price would be worth as much to him as the larger price was before. In no manner does this phenomenon answer to the description which these celebrated economists have given of the evil of over-production. The permanent decline in the circumstances of producers, for want of markets, which those writers contemplate, is a conception to which the nature of a commercial crisis gives no support.

The other phenomenon from which the notion of a general excess of wealth and superfluity of accumulation seems to derive countenance, is one of a more permanent nature, namely, the fall of profits and interest which naturally takes place with the progress of population and production. The cause of this decline of profit is the increased cost of maintaining labour, which results from an increase of population and of the demand for food, outstripping the advance of agricultural improvement. This important feature in the economical progress of nations will receive full consideration and discussion in the succeeding Book.∗ It is obviously a totally different thing from a want of market for commodities, though often confounded with it in the complaints of the producing and trading classes. The true interpretation of the modern or present state of industrial economy is that there is hardly any amount of business which may not be done, if people will be content to do it on small profits; and this, all active and intelligent persons in business perfectly well know: but even those who comply with the necessities of their time, grumble at what they comply with, and wish that there were less capital, or, as they express it, less competition, in order that there might be greater profits. Low profits, however, are a different thing from deficiency of demand; and the production and accumulation which merely reduce profits, cannot be called excess of supply or of production. What the phenomenon really is, and its effects and necessary limits, will be seen when we treat of that express subject.

I know not of any economical facts, except the two I have specified, which can have given occasion to the opinion that a general over-production of commodities ever presented itself in actual experience. I am convinced that there is no fact in commercial affairs which, in order to its explanation, stands in need of that chimerical supposition.

The point is fundamental; any difference of opinion on it involves radically different conceptions of Political Economy, especially in its practical aspect. On the one view, we have only to consider how a sufficient production may be combined with the best possible distribution; but, on the other, there is a third thing to be considered—how a market can be created for produce, or how production can be limited to the capabilities of the market. Besides, a theory so essentially self-contradictory cannot intrude itself without carrying confusion into the very heart of the subject, and making it impossible even to conceive with any distinctness many of the more complicated economical workings of society. This error has been, I conceive, fatal to the systems, as systems, of the three distinguished economists to whom I before referred, Malthus, Chalmers, and Sismondi; all of whom have admirably conceived and explained several of the elementary theorems of political economy, but this fatal misconception has spread itself like a veil between them and the more difficult portions of the subject, not suffering one ray of light to penetrate. Still more is this same confused idea constantly crossing and bewildering the speculations of minds inferior to theirs. It is but justice to two eminent names to call attention to the fact, that the merit of having placed this most important point in its true light belongs principally, on the Continent, to the judicious J. B. Say, and in this country to Mr. [James] Mill; who (besides the conclusive exposition which he gave of the subject in his Elements of Political Economy) had set forth the correct doctrine with great force and clearness in an early pamphlet, called forth by a temporary controversy, and entitled, Commerce Defended; the first of his writings which attained any celebrity, and which he prized more as having been his first introduction to the friendship of David Ricardo, the most valued and most intimate friendship of his life.

Book III, Chapter XV: Of a measure of value

CHAPTER XV: of a measure of value

§ 1. There has been much discussion among political economists respecting a Measure of Value. An importance has been attached to the subject greater than it deserved, and what has been written respecting it has contributed not a little to the reproach of logomachy, which is brought, with much exaggeration, but not altogether without ground, against the speculations of political economists. It is necessary, however, to touch upon the subject, if only to show how little there is to be said on it.

A Measure of Value, in the ordinary sense of the word measure, would mean something by comparison with which we may ascertain what is the value of any other thing. When we consider farther, that value itself is relative, and that two things are necessary to constitute it, independently of the third thing which is to measure it; we may define a Measure of Value to be something, by comparing with which any two other things, we may infer their value in relation to one another.

In this sense, any commodity will serve as a measure of value at a given time and place; since we can always infer the proportion in which things exchange for one another, when we know the proportion in which each exchanges for any third thing. To serve as a convenient measure of value is one of the functions of the commodity selected as a medium of exchange. It is in that commodity that the values of all other things are habitually estimated. We say that one thing is worth 2l., another 3l.; and it is then known, without express statement, that one is worth two-thirds of the other, or that the things exchange for one another in the proportion of 2 to 3. Money is a complete measure of their value.

But the desideratum sought by political economists is not a measure of the value of things at the same time and place, but a measure of the value of the same thing at different times and places: something by comparison with which it may be known whether any given thing is of greater or less value now than a century ago, or in this country than in America or China. And for this also, money, or any other commodity, will serve quite as well as at the same time and place, provided we can obtain the same data; provided we are able to compare with the measure not one commodity only, but the two or more which are necessary to the idea of value. If wheat is now [1852] 40s. the quarter, and a fat sheep the same, and if in the time of Henry the Second wheat was 20s., and a sheep 10s., we know that a quarter of wheat was then worth two sheep, and is now only worth one, and that the value therefore of a sheep, estimated in wheat, is twice as great as it was then; quite independently of the value of money at the two periods, either in relation to those two articles (in respect to both of which we suppose it to have fallen), or to other commodities in respect to which we need not make any supposition.

What seems to be desired, however, by writers on the subject, is some means of ascertaining the value of a commodity by merely comparing it with the measure, without referring it specially to any other given commodity. They would wish to be able, from the mere fact that wheat is now 40s. the quarter, and was formerly 20s., to decide whether wheat has varied in its value, and in what degree, without selecting a second commodity, such as a sheep, to compare it with; because they are desirous of knowing, not how much wheat has varied in value relatively to sheep, but how much it has varied relatively to things in general.

The first obstacle arises from the necessary indefiniteness of the idea of general exchange value—value in relation not to some one commodity, but to commodities at large. Even if we knew exactly how much a quarter of wheat would have purchased, at the earlier period, of every marketable article considered separately, and that it will now purchase more of some things and less of others, we should often find it impossible to say whether it had risen or fallen in relation to things in general. How much more impossible, when we only know how it has varied in relation to the measure. To enable the money price of a thing at two different periods to measure the quantity of things in general which it will exchange for, the same sum of money must correspond at both periods to the same quantity of things in general, that is, money must always have the same exchange value, the same general purchasing power. Now, not only is this not true of money, or of any other commodity, but we cannot even suppose any state of circumstances in which it would be true.

§ 2. A measure of exchange value, therefore, being impossible, writers have formed a notion of something, under the name of a measure of value, which would be more properly termed a measure of cost of production. They have imagined a commodity invariably produced by the same quantity of labour; to which supposition it is necessary to add, that the fixed capital employed in the production must bear always the same proportion to the wages of the immediate labour, and must be always of the same durability: in short, the same capital must be advanced for the same length of time, so that the element of value which consists of profits, as well as that which consists of wages, may be unchangeable. We should then have a commodity always produced under one and the same combination of all the circumstances which affect permanent value. Such a commodity would be by no means constant in its exchange value; for (even without reckoning the temporary fluctuations arising from supply and demand) its exchange value would be altered by every change in the circumstances of production of the things against which it was exchanged. But if there existed such a commodity, we should derive this advantage from it, that whenever any other thing varied permanently in relation to it, we should know that the cause of variation was not in it, but in the other thing. It would thus be suited to serve as a measure, not indeed of the value of other things, but of their cost of production. If a commodity acquired a greater permanent purchasing power in relation to the invariable commodity, its cost of production must have become greater; and in the contrary case, less. This measure of cost is what political economists have generally meant by a measure of value.

But a measure of cost, though perfectly conceivable, can no more exist in fact, than a measure of exchange value. There is no commodity which is invariable in its cost of production. Gold and silver are the least variable, but even these are liable to changes in their cost of production, from the exhaustion of old sources of supply, the discovery of new, and improvements in the mode of working. If we attempt to ascertain the changes in the cost of production of any commodity from the changes in its money price, the conclusion will require to be corrected by the best allowance we can make for the intermediate changes in the cost of the production of money itself.

Adam Smith fancied that there were two commodities peculiarly fitted to serve as a measure of value: corn, and labour. Of corn, he said that although its value fluctuates much from year to year, it does not vary greatly from century to century. This we now know to be an error: corn tends to rise in cost of production with every increase of population, and to fall with every improvement in agriculture, either in the country itself, or in any foreign country from which it draws a portion of its supplies. The supposed constancy of the cost of the production of corn depends on the maintenance of a complete equipoise between these antagonizing forces, an equipoise which, if ever realized, can only be accidental. With respect to labour as a measure of value, the language of Adam Smith is not uniform. He sometimes speaks of it as a good measure only for short periods, saying that the value of labour (or wages) does not vary much from year to year, though it does from generation to generation. On other occasions he speaks as if labour were intrinsically the most proper measure of value, on the ground that one day’s ordinary muscular exertion of one man, may be looked upon as always, to him, the same amount of effort or sacrifice. But this proposition, whether in itself admissible or not, discards the idea of exchange value altogether, substituting a totally different idea, more analogous to value in use. If a day’s labour will purchase in America twice as much of ordinary consumable articles as in England, it seems a vain subtlety to insist on saying that labour is of the same value in both countries, and that it is the value of the other things which is different. Labour, in this case, may be correctly said to be twice as valuable, both in the market and to the labourer himself, in America as in England.

If the object were to obtain an approximate measure by which to estimate value in use, perhaps nothing better could be chosen than one day’s subsistence of an average man, reckoned in the ordinary food consumed by the class of unskilled labourers. If in any country a pound of maize flour will support a labouring man for a day, a thing might be deemed more or less valuable in proportion to the number of pounds of maize flour it exchanged for. If one thing, either by itself or by what it would purchase, could maintain a labouring man for a day, and another could maintain him for a week, there would be some reason in saying that the one was worth, for ordinary human uses, seven times as much as the other. But this would not measure the worth of the thing to its possessor for his own purposes, which might be greater to any amount, though it could not be less, than the worth of the food which the thing would purchase.

The idea of a Measure of Value must not be confounded with the idea of the regulator, or determining principle, of value. When it is said by Ricardo and others, that the value of a thing is regulated by quantity of labour, they do not mean the quantity of labour for which the thing will exchange, but the quantity required for producing it. This, they mean to affirm, determines its value; causes it to be of the value it is, and of no other. But when Adam Smith and Malthus say that labour is a measure of value, they do not mean the labour by which the thing was or can be made, but the quantity of labour which it will exchange for, or purchase; in other words, the value of the thing estimated in labour. And they do not mean that this regulates the general exchange value of the thing, or has any effect in determining what that value shall be, but only ascertains what it is, and whether and how much it varies from time to time and from place to place. To confound these two ideas would be much the same thing as to overlook the distinction between the thermometer and the fire.

Book III, Chapter XVI: Of some peculiar cases of value

CHAPTER XVI: of some peculiar cases of value

§ 1. The general laws of value, in all the more important cases of the interchange of commodities in the same country, have now been investigated. We examined, first, the case of monopoly, in which the value is determined by either a natural or an artificial limitation of quantity, that is, by demand and supply; secondly, the case of free competition, when the article can be produced in indefinite quantity at the same cost; in which case the permanent value is determined by the cost of production, and only the fluctuations by supply and demand; thirdly, a mixed case, that of the articles which can be produced in indefinite quantity, but not at the same cost; in which case the permanent value is determined by the greatest cost which it is necessary to incur in order to obtain the required supply. And lastly, we have found that money itself is a commodity of the third class; that its value, in a state of freedom, is governed by the same laws as the values of other commodities of its class; and that prices, therefore, follow the same laws as values.

From this it appears that demand and supply govern the fluctuations of values and prices in all cases, and the permanent values and prices of all things of which the supply is determined by any agency other than that of free competition: but that, under the régime of competition, things are, on the average, exchanged for each other at such values, and sold at such prices, as afford equal expectation of advantage to all classes of producers; which can only be when things exchange for one another in the ratio of their cost of production.

It is now, however, necessary to take notice of certain cases, to which, from their peculiar nature, this law of exchange value is inapplicable.

It sometimes happens that two different commodities have what may be termed a joint cost of production. They are both products of the same operation, or set of operations, and the outlay is incurred for the sake of both together, not part for one and part for the other. The same outlay would have to be incurred for either of the two, if the other were not wanted or used at all. There are not a few instances of commodities thus associated in their production: for example, coke and coal-gas are both produced from the same material, and by the same operation. In a more partial sense, mutton and wool are an example: beef, hides, and tallow: calves and dairy produce: chickens and eggs. Cost of production can have nothing to do with deciding the value of the associated commodities relatively to each other. It only decides their joint value. The gas and the coke together have to repay the expenses of their production, with the ordinary profit. To do this, a given quantity of gas, together with the coke which is the residuum of its manufacture, must exchange for other things in the ratio of their joint cost of production. But how much of the remuneration of the producer shall be derived from the coke, and how much from the gas, remains to be decided. Cost of production does not determine their prices, but the sum of their prices. A principle is wanting to apportion the expenses of production between the two.

Since cost of production here fails us, we must revert to a law of value anterior to cost of production, and more fundamental, the law of demand and supply. The law is, that the demand for a commodity varies with its value, and that the value adjusts itself so that the demand shall be equal to the supply. This supplies the principle of repartition which we are in quest of.

Suppose that a certain quantity of gas is produced and sold at a certain price, and that the residuum of coke is offered at a price which, together with that of the gas, repays the expenses with the ordinary rate of profit. Suppose, too, that at the price put upon the gas and coke respectively, the whole of the gas finds an easy market, without either surplus or deficiency, but that purchasers cannot be found for all the coke corresponding to it. The coke will be offered at a lower price in order to force a market. But this lower price, together with the price of the gas, will not be remunerating: the manufacture, as a whole, will not pay its expenses with the ordinary profit, and will not, on these terms, continue to be carried on. The gas, therefore, must be sold at a higher price, to make up for the deficiency on the coke. The demand consequently contracting, the production will be somewhat reduced; and prices will become stationary when, by the joint effect of the rise of gas and the fall of coke, so much less of the first is sold, and so much more of the second, that there is now a market for all the coke which results from the existing extent of the gas manufacture.

Or suppose the reverse case; that more coke is wanted at the present prices, than can be supplied by the operations required by the existing demand for gas. Coke, being now in deficiency, will rise in price. The whole operation will yield more than the usual rate of profit, and additional capital will be attracted to the manufacture. The unsatisfied demand for coke will be supplied; but this cannot be done without increasing the supply of gas too; and as the existing demand was fully supplied already, an increased quantity can only find a market by lowering the price. The result will be that the two together will yield the return required by their joint cost of production, but that more of this return than before will be furnished by the coke, and less by the gas. Equilibrium will be attained when the demand for each article fits so well with the demand for the other, that the quantity required of each is exactly as much as is generated in producing the quantity required of the other. If there is any surplus or deficiency on either side; if there is a demand for coke, and not a demand for all the gas produced along with it, or vice versâ; the values and prices of the two things will so readjust themselves that both shall find a market.

When, therefore, two or more commodities have a joint cost of production, their natural values relatively to each other are those which will create a demand for each, in the ratio of the quantities in which they are sent forth by the productive process. This theorem is not in itself of any great importance: but the illustration it affords of the law of demand, and of the mode in which, when cost of production fails to be applicable, the other principle steps in to supply the vacancy, is worthy of particular attention, as we shall find in the next chapter but one that something very similar takes place in cases of much greater moment.

§ 2. Another case of value which merits attention, is that of the different kinds of agricultural produce. This is rather a more complex question that the last, and requires that attention should be paid to a greater number of influencing circumstances.

The case would present nothing peculiar, if different agricultural products were either grown indiscriminately and with equal advantage on the same soils, or wholly on different soils. The difficulty arises from two things: first, that most soils are fitter for one kind of produce than another, without being absolutely unfit for any; and secondly, the rotation of crops.

For simplicity we will confine our supposition to two kinds of agricultural produce; for instance, wheat and oats. If all soils were equally adapted for wheat and for oats, both would be grown indiscriminately on all soils, and their relative cost of production, being the same everywhere, would govern their relative value. If the same labour which grows three quarters of wheat on any given soil, would always grow on that soil five quarters of oats, the three and the five quarters would be of the same value. If, again, wheat and oats could not be grown on the same soil at all, the value of each would be determined by its peculiar cost of production on the least favourable of the soils adapted for it which the existing demand required a recourse to. The fact, however, is that both wheat and oats can be grown on almost any soil which is capable of producing either: but some soils, such as the stiff clays, are better adapted for wheat, while others (the light sandy soils) are more suitable for oats. There might be some soils which would yield, to the same quantity of labour, only four quarters of oats to three of wheat; others perhaps less than three of wheat to five quarters of oats. Among these diversities, what determines the relative value of the two things?

It is evident that each grain will be cultivated in preference, on the soils which are better adapted for it than for the other; and if the demand is supplied from these alone, the values of the two grains will have no reference to one another. But when the demand for both is such as to require that each should be grown not only on the soils peculiarly fitted for it, but on the medium soils which, without being specifically adapted to either, are about equally suited for both, the cost of production on those medium soils will determine the relative value of the two grains; while the rent of the soils specifically adapted to each, will be regulated by their productive power, considered with reference to that one alone to which they are peculiarly applicable. Thus far the question presents no difficulty, to any one to whom the general principles of value are familiar.

It may happen, however, that the demand for one of the two, as for example wheat, may so outstrip the demand for the other, as not only to occupy the soils specially suited for wheat, but to engross entirely those equally suitable to both, and even encroach upon those which are better adapted to oats. To create an inducement for this unequal apportionment of the cultivation, wheat must be relatively dearer, and oats cheaper, than according to the cost of their production on the medium land. Their relative value must be in proportion to the cost on that quality of land, whatever it may be, on which the comparative demand for the two grains requires that both of them should be grown. If, from the state of the demand, the two cultivations meet on land more favourable to one than to the other, that one will be cheaper and the other dearer, in relation to each other and to things in general, than if the proportional demand were as we at first supposed.

Here, then, we obtain a fresh illustration, in a somewhat different manner, of the operation of demand, not as an occasional disturber of value, but as a permanent regulator of it, conjoined with, or supplementary to, cost of production.

The case of rotation of crops does not require separate analysis, being a case of joint cost of production, like that of gas and coke. If it were the practice to grow white and green crops on all lands in alternate years, the one being necessary as much for the sake of the other as for its own sake; the farmer would derive his remuneration for two years' expenses from one white and one green crop, and the prices of the two would so adjust themselves as to create a demand which would carry off an equal breadth of white and of green crops.

There would be little difficulty in finding other anomalous cases of value, which it might be a useful exercise to resolve: but it is neither desirable nor possible, in a work like the present, to enter more into details than is necessary for the elucidation of principles. I now therefore proceed to the only part of the general theory of exchange which has not yet been touched upon, that of International Exchanges, or, to speak more generally, exchanges between distant places.

Book III, Chapter XVII: On international trade

CHAPTER XVII.: on international trade

§ 1. The causes which occasion a commodity to be brought from a distance, instead of being produced, as convenience would seem to dictate, as near as possible to the market where it is to be sold for consumption, are usually conceived in a rather superficial manner. Some things it is physically impossible to produce, except in particular circumstances of heat, soil, water, or atmosphere. But there are many things which, though they could be produced at home without difficulty, and in any quantity, are yet imported from a distance. The explanation which would be popularly given of this would be, that it is cheaper to import than to produce them: and this is the true reason. But this reason itself requires that a reason be given for it. Of two things produced in the same place, if one is cheaper than the other, the reason is that it can be produced with less labour and capital, or, in a word, at less cost. Is this also the reason as between things produced in different places? Are things never imported but from places where they can be produced with less labour (or less of the other element of cost, time) than in the place to which they are brought? Does the law, that permanent value is proportioned to cost of production, hold good between commodities produced in distant places, as it does between those produced in adjacent places?

We shall find that it does not. A thing may sometimes be sold cheapest, by being produced in some other place than that at which it can be produced with the smallest amount of labour and abstinence. England might import corn from Poland and pay for it in cloth, even though England had a decided advantage over Poland in the production of both the one and the other. England might send cottons to Portugal in exchange for wine, although Portugal might be able to produce cottons with a less amount of labour and capital than England could.

This could not happen between adjacent places. If the north bank of the Thames possessed an advantage over the south bank in the production of shoes, no shoes would be produced on the south side; the shoemakers would remove themselves and their capitals to the north bank, or would have established themselves there originally; for being competitors in the same market with those on the north side, they could not compensate themselves for their disadvantage at the expense of the consumer: the mount of it would fall entirely on their profits; and they would not long content themselves with a smaller profit, when, by simply crossing a river, they could increase it. But between distant places, and especially between different countries, profits may continue different; because persons do not usually remove themselves or their capitals to a distant place, without a very strong motive. If capital removed to remote parts of the world as readily, and for as small an inducement, as it moves to another quarter of the same town; if people would transport their manufactories to America or China whenever they could save a small percentage in their expenses by it; profits would be alike (or equivalent) all over the world, and all things would be produced in the places where the same labour and capital would produce them in greatest quantity and of best quality. A tendency may, even now, be observed towards such a state of things; capital is becoming more and more cosmopolitan; there is so much greater similarity of manners and institutions than formerly, and so much less alienation of feeling, among the more civilized countries, that both population and capital now move from one of those countries to another on much less temptation than heretofore. But there are still extraordinary differences, both of wages and of profits, between different parts of the world. It needs but a small motive to transplant capital, or even persons, from Warwickshire to Yorkshire; but a much greater to make them remove to India, the colonies, or Ireland. To France, Germany, or Switzerland, capital moves perhaps almost as readily as to the colonies; the difference of language and government being scarcely so great a hindrance as climate and distance. To countries still barbarous, or, like Russia or Turkey, only beginning to be civilized, capital will not migrate, unless under the inducement of a very great extra profit.

Between all distant places therefore in some degree, but especially between different countries (whether under the same supreme government or not,) there may exist great inequalities in the return to labour and capital, without causing them to move from one place to the other in such quantity as to level those inequalities. The capital belonging to a country will, to a great extent, remain in the country, even if there be no mode of employing it in which it would not be more productive elsewhere. Yet even a country thus circumstanced might, and probably would, carry on trade with other countries. It would export articles of some sort, even to places which could make them with less labour than itself; because those countries, supposing them to have an advantage over it in all productions, would have a greater advantage in some things than in others, and would find it their interest to import the articles in which their advantage was smallest, that they might employ more of their labour and capital on those in which it was greatest.

§ 2. As I have said elsewhere∗ after Ricardo (the thinker who has done most towards clearing up this subject)† “it is not a difference in the absolute cost of production, which determines the interchange, but a difference in the comparative cost. It may be to our advantage to procure iron from Sweden in exchange for cottons, even although the mines of England as well as her manufactories should be more productive than those of Sweden; for if we have an advantage of one-half in cottons, and only an advantage of a quarter in iron, and could sell our cottons to Sweden at the price which Sweden must pay for them if she produced them herself, we should obtain our iron with an advantage of one-half as well as our cottons. We may often, by trading with foreigners, obtain their commodities at a smaller expense of labour and capital than they cost to the foreigners themselves. The bargain is still advantageous to the foreigner, because the commodity which he receives in exchange, though it has cost us less, would have cost him more.”

To illustrate the cases in which interchange of commodities will not, and those in which it will, take place between two countries, Mr. [James] Mill, in his Elements of Political Economy,‡ makes the supposition that Poland has an advantage over England in the production both of cloth and of corn. He first supposed the advantage to be of equal amount in both commodities; the cloth and the corn, each of which required 100 days' labour in Poland, requiring each 150 days' labour in England. “It would follow, that the cloth of 150 days' labour in England, if sent to Poland, would be equal to the cloth of 100 days' labour in Poland; if exchanged for corn, therefore, it would exchange for the corn of only 100 days' labour. But the corn of 100 days' labour in Poland was supposed to be the same quantity with that of 150 days' labour in England. With 150 days' labour in cloth, therefore, England would only get as much corn in Poland, as she could raise with 150 days' labour at home; and she would, in importing it, have the cost of carriage besides. In these circumstances no exchange would take place.” In this case the comparative cost of the two articles in England and in Poland were supposed to be the same, though the absolute costs were different; on which supposition we see that there would be no labour saved to either country by confining its industry to one of the two productions and importing the other.

It is otherwise when the comparative, and not merely the absolute costs of the two articles are different in the two countries. “If,” continues the same author, “while the cloth produced with 100 days' labour in Poland was produced with 150 days' labour in England, the corn which was produced in Poland with 100 days' labour could not be produced in England with less than 200 days' labour; an adequate motive to exchange would immediately arise. With a quantity of cloth which England produced with 150 days' labour, she would be able to purchase as much corn in Poland as was there produced with 100 days' labour; but the quantity which was there produced with 100 days' labour, would be as great as the quantity produced in England with 200 days' labour.” By importing corn, therefore, from Poland, and paying for it with cloth, England would obtain for 150 days' labour what would otherwise cost her 200; being a saving of 50 days' labour on each repetition of the transaction: and not merely a saving to England, but a saving absolutely; for it is not obtained at the expense of Poland, who, with corn that costs her 100 days' labour, has purchased cloth which, if produced at home, would have cost her the same. Poland, therefore, on this supposition, loses nothing; but also she derives no advantage from the trade, the imported cloth costing her as much as if it were made at home. To enable Poland to gain anything by the interchange, something must be abated from the gain of England: the corn produced in Poland by 100 days' labour must be able to purchase from England more cloth than Poland could produce by that amount of labour; more therefore than England could produce by 150 days' labour, England thus obtaining the corn which would have cost her 200 days, at a cost exceeding 150, though short of 200. England therefore no longer gains the whole of the labour which is saved to the two jointly by trading with one another.

§ 3. From this exposition we perceive in what consists the benefit of international exchange, or in other words, foreign commerce. Setting aside its enabling countries to obtain commodities which they could not themselves produce at all; its advantage consists in a more efficient employment of the productive forces of the world. If two countries which trade together attempted, as far as was physically possible, to produce for themselves what they now import from one another, the labour and capital of the two countries would not be so productive, the two together would not obtain from their industry so great a quantity of commodities, as when each employs itself in producing, both for itself and for the other, the things in which its labour is relatively most efficient. The addition thus made to the produce of the two combined, constitutes the advantage of the trade. It is possible that one of the two countries may be altogether inferior to the other in productive capacities, and that its labour and capital could be employed to greatest advantage by being removed bodily to the other. The labour and capital which have been sunk in rendering Holland habitable, would have produced a much greater return if transported to America or Ireland. The produce of the whole world would be greater, or the labour less, than it is, if everything were produced where there is the greatest absolute facility for its production. But nations do not, at least in modern times, emigrate en masse; and while the labour and capital of a country remain in the country, they are most beneficially employed in producing, for foreign markets as well as for its own, the things in which it lies under the least disadvantage, if there be none in which it possesses an advantage.

§ 4. Before proceeding further, let us contrast this view of the benefits of international commerce with other theories which have prevailed, and which to a certain extent still prevail, on the same subject.

According to the doctrine now stated, the only direct advantage of foreign commerce consists in the imports. A country obtains things which it either could not have produced at all, or which it must have produced at a greater expense of capital and labour than the cost of the things which it exports to pay for them. It thus obtains a more ample supply of the commodities it wants, for the same labour and capital; or the same supply, for less labour and capital, leaving the surplus disposable to produce other things. The vulgar theory disregards this benefit, and deems the advantage of commerce to reside in the exports: as if not what a country obtains, but what it parts with, by its foreign trade, was supposed to constitute the gain to it. An extended market for its produce—an abundant consumption for its goods—a vent for its surplus—are the phrases by which it has been customary to designate the uses and recommendations of commerce with foreign countries. This notion is intelligible, when we consider that the authors and leaders of opinion on mercantile questions have always hitherto been the selling class. It is in truth a surviving relic of the Mercantile Theory, according to which, money being the only wealth, selling, or, in other words, exchanging goods for money, was (to countries without mines of their own) the only way of growing rich—and importation of goods, that is to say, parting with money, was so much subtracted from the benefit.

The notion that money alone is wealth, has been long defunct, but it has left many of its progeny behind it; and even its destroyer, Adam Smith, retained some opinions which it is impossible to trace to any other origin. Adam Smith’s theory of the benefit of foreign trade, was that it afforded an outlet for the surplus produce of a country, and enabled a portion of the capital of the country to replace itself with a profit. These expressions suggest ideas inconsistent with a clear conception of the phenomena. The expression, surplus produce, seems to imply that a country is under some kind of necessity of producing the corn or cloth which it exports; so that the portion which it does not itself consume, if not wanted and consumed elsewhere, would either be produced in sheer waste, or, if it were not produced, the corresponding portion of capital would remain idle, and the mass of productions in the country would be diminished by so much. Either of these suppositions would be entirely erroneous. The country produces an exportable article in excess of its own wants from no inherent necessity, but as the cheapest mode of supplying itself with other things. If prevented from exporting this surplus, it would cease to produce it, and would no longer import anything, being unable to give an equivalent; but the labour and capital which had been employed in producing with a view to exportation, would find employment in producing those desirable objects which were previously brought from abroad: or, if some of them could not be produced, in producing substitutes for them. These articles would of course be produced at a greater cost than that of the things with which they had previously been purchased from foreign countries. But the value and price of the articles would rise in proportion; and the capital would just as much be replaced, with the ordinary profit from the returns, as it was when employed in producing for the foreign market. The only losers (after the temporary inconvenience of the change) would be the consumers of the heretofore imported articles; who would be obliged either to do without them, consuming in lieu of them something which they did not like as well, or to pay a higher price for them than before.

There is much misconception in the common notion of what commerce does for a country. When commerce is spoken of as a source of national wealth, the imagination fixes itself upon the large fortunes acquired by merchants, rather than upon the saving of price to consumers. But the gains of merchants, when they enjoy no exclusive privilege, are no greater than the profits obtained by the employment of capital in the country itself. If it be said that the capital now employed in foreign trade could not find employment in supplying the home market, I might reply, that this is the fallacy of general over-production, discussed in a former chapter: but the thing is in this particular case too evident to require an appeal to any general theory. We not only see that the capital of the merchant would find employment, but we see what employment. There would be employment created, equal to that which would be taken away. Exportation ceasing, importation to an equal value would cease also, and all that part of the income of the country which had been expended in imported commodities, would be ready to expend itself on the same things produced at home, or on others instead of them. Commerce is virtually a mode of cheapening production; and in all such cases the consumer is the person ultimately benefited; the dealer, in the end, is sure to get his profit, whether the buyer obtains much or little for his money. This is said without prejudice to the effect (already touched upon, and to be hereafter fully discussed) which the cheapening of commodities may have in raising profits; in the case when the commodity cheapened, being one of those consumed by labourers, enters into the cost of labour, by which the rate of profits is determined.

§ 5. Such, then, is the direct economical advantage of foreign trade. But there are, besides, indirect effects, which must be counted as benefits of a high order. One is, the tendency of every extension of the market to improve the processes of production. A country which produces for a larger market than its own, can introduce a more extended division of labour, can make greater use of machinery, and is more likely to make inventions and improvements in the processes of production. Whatever causes a greater quantity of anything to be produced in the same place, tends to the general increase of the productive powers of the world.∗ There is another consideration, principally applicable to an early stage of industrial advancement. A people may be in a quiescent, indolent, uncultivated state, with all their tastes either fully satisfied or entirely undeveloped, and they may fail to put forth the whole of their productive energies for want of any sufficient object of desire. The opening of a foreign trade, by making them acquainted with new objects, or tempting them by the easier acquisition of things which they had not previously thought attainable, sometimes works a sort of industrial revolution in a country whose resources were previously undeveloped for want of energy and ambition in the people: inducing those who were satisfied with scanty comforts and little work, to work harder for the gratification of their new tastes, and even to save, and accumulate capital, for the still more complete satisfaction of those tastes at a future time.

But the economical advantages of commerce are surpassed in importance by those of its effects which are intellectual and moral. It is hardly possible to overrate the value, in the present low state of human improvement, of placing human beings in contact with persons dissimilar to themselves, and with modes of thought and action unlike those with which they are familiar. Commerce is now what war once was, the principal source of this contact. Commercial adventurers from more advanced countries have generally been the first civilizers of barbarians. And commerce is the purpose of the far greater part of the communication which takes place between civilized nations. Such communication has always been, and is peculiarly in the present age, one of the primary sources of progress. To human beings, who, as hitherto educated, can scarcely cultivate even a good quality without running it into a fault, it is indispensable to be perpetually comparing their own notions and customs with the experience and example of persons in different circumstances from themselves: and there is no nation which does not need to borrow from others, not merely particular arts or practices, but essential points of character in which its own type is inferior. Finally, commerce first taught nations to see with good will the wealth and prosperity of one another. Before, the patriot, unless sufficiently advanced in culture to feel the world his country, wished all countries weak, poor, and ill-governed, but his own: he now sees in their wealth and progress a direct source of wealth and progress to his own country. It is commerce which is rapidly rendering war obsolete, by strengthening and multiplying the personal interests which are in natural opposition to it. And it may be said without exaggeration that the great extent and rapid increase of international trade, in being the principal guarantee of the peace of the world, is the great permanent security for the uninterrupted progress of the ideas, the institutions, and the character of the human race.

Book III, Chapter XVIII: Of international values

CHAPTER XVIII: of international values

§ 1. The values of commodities produced at the same place, or in places sufficiently adjacent for capital to move freely between them—let us say, for simplicity, of commodities produced in the same country—depend (temporary fluctuations apart) upon their cost of production. But the value of a commodity brought from a distant place, especially from a foreign country, does not depend on its cost of production in the place from whence it comes. On what, then, does it depend? The value of a thing in any place depends on the cost of its acquisition in that place; which, in the case of an imported article, means the cost of production of the thing which is exported to pay for it.

Since all trade is in reality barter, money being a mere instrument for exchanging things against one another, we will, for simplicity, begin by supposing the international trade to be in form, what it always is in reality, an actual trucking of one commodity against another. As far as we have hitherto proceeded, we have found all the laws of interchange to be essentially the same, whether money is used or not; money never governing, but always obeying, those general laws.

If, then, England imports wine from Spain, giving for every pipe of wine a bale of cloth, the exchange value of a pipe of wine in England will not depend upon what the production of the wine may have cost in Spain, but upon what the production of the cloth has cost in England. Though the wine may have cost in Spain the equivalent of only ten days' labour, yet, if the cloth costs in England twenty days' labour, the wine, when brought to England, will exchange for the produce of twenty days' English labour, plus the cost of carriage; including the usual profit on the importer’s capital, during the time it is locked up, and withheld from other employment.

The value, then, in any country, of a foreign commodity, depends on the quantity of home produce which must be given to the foreign country in exchange for it. In other words, the values of foreign commodities depend on the terms of international exchange. What, then, do these depend upon? What is it which, in the case supposed, causes a pipe of wine from Spain to be exchanged with England for exactly that quantity of cloth? We have seen that it is not their cost of production. If the cloth and the wine were both made in Spain, they would exchange at their cost of production in Spain; if they were both made in England, they would exchange at their cost of production in England: but all the cloth being made in England, and all the wine in Spain, they are in circumstances to which we have already determined that the law of cost of production is not applicable. We must accordingly, as we have done before in a similar embarrassment, fall back upon an antecedent law, that of supply and demand: and in this we shall again find the solution of our difficulty.

I have discussed this question in a separate Essay, already once referred to; and a quotation of part of the exposition then given will be the best introduction to my present view of the subject. I must give notice that we are now in the region of the most complicated questions which political economy affords; that the subject is one which cannot possibly be made elementary; and that a more continuous effort of attention than has yet been required will be necessary to follow the series of deductions. The thread, however, which we are about to take in hand, is in itself very simple and manageable; the only difficulty is in following it through the windings and entanglements of complex international transactions.

§ 2. “When the trade is established between the two countries, the two commodities will exchange for each other at the same rate of interchange in both countries—bating the cost of carriage, of which, for the present, it will be more convenient to omit the consideration. Supposing, therefore, for the sake of argument, that the carriage of the commodities from one country to the other could be effected without labour and without cost, no sooner would the trade be opened than the value of the two commodities, estimated in each other, would come to a level in both countries.

“Suppose that 10 yards of broadcloth cost in England as much labour as 15 yards of linen, and in Germany as much as 20.” In common with most of my predecessors, I find it advisable, in these intricate investigations, to give distinctness and fixity to the conception by numerical examples. These examples must sometimes, as in the present case, be purely supposititious. I should have preferred real ones; but all that is essential is, that the numbers should be such as admit of being easily followed through the subsequent combinations into which they enter.

This supposition then being made, it would be the interest of England to import linen from Germany, and of Germany to import cloth from England. “When each country produced both commodities for itself, 10 yards of cloth exchanged for 15 yards of linen in England, and for 20 in Germany. They will now exchange for the same number of yards of linen in both. For what number? If for 15 yards, England will be just as she was, and Germany will gain all. If for 20 yards, Germany will be as before, and England will derive the whole of the benefit. If for any number intermediate between 15 and 20, the advantage will be shared between the two countries. If, for example, 10 yards of cloth exchange for 18 of linen, England will gain an advantage of 3 yards on every 15, Germany will save 2 out of every 20. The problem is, what are the causes which determine the proportion in which the cloth of England and the linen of Germany will exchange for each other.

“As exchange value, in this case as in every other, is proverbially fluctuating, it does not matter what we suppose it to be when we begin: we shall soon see whether there be any fixed point about which it oscillates, which it has a tendency always to approach to, and to remain at. Let us suppose, then, that by the effect of what Adam Smith calls the higgling of the market, 10 yards of cloth in both countries exchange for 17 yards of linen.

“The demand for a commodity, that is, the quantity of it which can find a purchaser, varies, as we have before remarked, according to the price. In Germany the price of 10 yards of cloth is now 17 yards of linen, or whatever quantity of money is equivalent in Germany to 17 yards of linen. Now, that being the price, there is some particular number of yards of cloth, which will be in demand, or will find purchasers, at that price. There is some given quantity of cloth, more than which could not be disposed of at that price; less than which, at that price, would not fully satisfy the demand. Let us suppose this quantity to be 1000 times 10 yards.

“Let us now turn our attention to England. There, the price of 17 yards of linen is 10 yards of cloth, or whatever quantity of money is equivalent in England to 10 yards of cloth. There is some particular number of yards of linen which, at that price, will exactly satisfy the demand, and no more. Let us suppose that this number is 1000 times 17 yards.

“As 17 yards of linen are to 10 yards of cloth, so are 1000 times 17 yards to 1000 times 10 yards. At the existing exchange value, the linen which England requires will exactly pay for the quantity of cloth which, on the same terms of interchange, Germany requires. The demand on each side is precisely sufficient to carry off the supply on the other. The conditions required by the principle of demand and supply are fulfilled, and the two commodities will continue to be interchanged, as we supposed them to be, in the ratio of 17 yards of linen for 10 yards of cloth.

“But our suppositions might have been different. Suppose that, at the assumed rate of interchange, England has been disposed to consume no greater quantity of linen than 800 times 17 yards: it is evident that, at the rate supposed, this would not have sufficed to pay for the 1000 times 10 yards of cloth which we have supposed Germany to require at the assumed value. Germany would be able to procure no more than 800 times 10 yards at that price. To procure the remaining 200, which she would have no means of doing but by bidding higher for them, she would offer more than 17 yards of linen in exchange for 10 yards of cloth: let us suppose her to offer 18. At this price, perhaps, England would be inclined to purchase a greater quantity of linen. She would consume, possibly, at that price, 900 times 18 yards. On the other hand, cloth having risen in price, the demand of Germany for it would probably have diminished. If, instead of 1000 times 10 yards, she is now contented with 900 times 10 yards, these will exactly pay for the 900 times 18 yards of linen which England is willing to take at the altered price: the demand on each side will again exactly suffice to take off the corresponding supply; and 10 yards for 18 will be the rate at which, in both countries, cloth will exchange for linen.

“The converse of all this would have happened, if, instead of 800 times 17 yards, we had supposed that England, at the rate of 10 for 17, would have taken 1200 times 17 yards of linen. In this case, it is England whose demand is not fully supplied; it is England who, by bidding for more linen, will alter the rate of interchange to her own disadvantage; and 10 yards of cloth will fall, in both countries, below the value of 17 yards of linen. By this fall of cloth, or, what is the same thing, this rise of linen, the demand of Germany for cloth will increase, and the demand of England for linen will diminish, till the rate of interchange has so adjusted itself that the cloth and the linen will exactly pay for one another; and when once this point is attained, values will remain without further alteration.

“It may be considered, therefore, as established, that when two countries trade together in two commodities, the exchange value of these commodities relatively to each other will adjust itself to the inclinations and circumstances of the consumers on both sides, in such manner that the quantities required by each country, of the articles which it imports from its neighbour, shall be exactly sufficient to pay for one another. As the inclinations and circumstances of consumers cannot be reduced to any rule, so neither can the proportions in which the two commodities will be interchanged. We know that the limits within which the variation is confined, are the ratio between their costs of production in the one country, and the ratio between their costs of production in the other. Ten yards of cloth cannot exchange for more than 20 yards of linen, nor for less than 15. But they may exchange for any intermediate number. The ratios, therefore, in which the advantage of the trade may be divided between the two nations are various. The circumstances on which the proportionate share of each country more remotely depends, admit only of a very general indication.

“It is even possible to conceive an extreme case, in which the whole of the advantage resulting from the interchange would be reaped by one party, the other country gaining nothing at all. There is no absurdity in the hypothesis that, of some given commodity, a certain quantity is all that is wanted at any price; and that, when that quantity is obtained, no fall in the exchange value would induce other consumers to come forward, or those who are already supplied to take more. Let us suppose that this is the case in Germany with cloth. Before her trade with England commenced, when 10 yards of cloth cost her as much labour as 20 yards of linen, she nevertheless consumed as much cloth as she wanted under any circumstances, and, if she could obtain it at the rate of 10 yards of cloth for 15 of linen, she would not consume more. Let this fixed quantity be 1000 times 10 yards. At the rate, however, of 10 for 20, England would want more linen than would be equivalent to this quantity of cloth. She would, consequently, offer a higher value for linen; or, what is the same thing, she would offer her cloth at a cheaper rate. But, as by no lowering of the value could she prevail on Germany to take a greater quantity of cloth, there would be no limit to the rise of linen or fall of cloth, until the demand of England for linen was reduced by the rise of its value, to the quantity which 1000 times 10 yards of cloth would purchase. It might be, that to produce this diminution of the demand a less fall would not suffice than that which would make 10 yards of cloth exchange for 15 of linen. Germany would then gain the whole of the advantage, and England would be exactly as she was before the trade commenced. It would be for the interest, however, of Germany herself to keep her linen a little below the value at which it could be produced in England, in order to keep herself from being supplanted by the home producer. England, therefore, would always benefit in some degree by the existence of the trade, though it might be a very trifling one.”

In this statement, I conceive, is contained the first elementary principle of International Values. I have, as is indispensable in such abstract and hypothetical cases, supposed the circumstances to be much less complex than they really are: in the first place, by suppressing the cost of carriage; next, by supposing that there are only two countries trading together; and lastly, that they trade only in two commodities. To render the exposition of the principle complete it is necessary to restore the various circumstances thus temporarily left out to simplify the argument. Those who are accustomed to any kind of scientific investigation will probably see, without formal proof, that the introduction of these circumstances cannot alter the theory of the subject. Trade among any number of countries, and in any number of commodities, must take place on the same essential principles as trade between two countries and in two commodities. Introducing a greater number of agents precisely similar cannot change the law of their action, no more than putting additional weights into the two scales of a balance alters the law of gravitation. It alters nothing but the numerical results. For more complete satisfaction, however, we will enter into the complex cases with the same particularity with which we have stated the simpler one.

§ 3. First, let us introduce the element of cost of carriage. The chief difference will then be, that the cloth and the linen will no longer exchange for each other at precisely the same rate in both countries. Linen, having to be carried to England, will be dearer there by its cost of carriage; and cloth will be dearer in Germany by the cost of carrying it from England. Linen, estimated in cloth, will be dearer in England than in Germany, by the cost of carriage of both articles: and so will cloth in Germany, estimated in linen. Suppose that the cost of carriage of each is equivalent to one yard of linen; and suppose that, if they could have been carried without cost, the terms of interchange would have been 10 yards of cloth for 17 of linen. It may seem at first that each country will pay its own cost of carriage; that is, the carriage of the article it imports; that in Germany 10 yards of cloth will exchange for 18 of linen, namely, the original 17, and 1 to cover the cost of carriage of the cloth; while in England, 10 yards of cloth will only purchase 16 of linen, 1 yard being deducted for the cost of carriage of the linen. This, however, cannot be affirmed with certainty; it will only be true, if the linen which the English consumers would take at the price of 10 for 16, exactly pays for the cloth which the German consumers would take at 10 for 18. The values, whatever they are, must establish this equilibrium. No absolute rule, therefore, can be laid down for the division of the cost, no more than for the division of the advantage: and it does not follow that in whatever ratio the one is divided, the other will be divided in the same. It is impossible to say, if the cost of carriage could be annihilated, whether the producing or the importing country would be most benefited. This would depend on the play of international demand.

Cost of carriage has one effect more. But for it, every commodity would (if trade be supposed free) be either regularly imported or regularly exported. A country would make nothing for itself which it did not also make for other countries. But in consequence of cost of carriage there are many things, especially bulky articles, which every, or almost every, country produces within itself. After exporting the things in which it can employ itself most advantageously, and importing those in which it is under the greatest disadvantage, there are many lying between, of which the relative cost of production in that and in other countries differs so little, that the cost of carriage would absorb more than the whole saving in cost of production which would be obtained by importing one and exporting another. This is the case with numerous commodities of common consumption; including the coarser qualities of many articles of food and manufacture, of which the finer kinds are the subject of extensive international traffic.

§ 4. Let us now introduce a greater number of commodities than the two we have hitherto supposed. Let cloth and linen, however, be still the articles of which the comparative cost of production in England and in Germany differs the most; so that, if they were confined to two commodities, these would be the two which it would be most their interest to exchange. We will now again omit cost of carriage, which, having been shown not to affect the essentials of the question, does but embarrass unnecessarily the statement of it. Let us suppose, then, that the demand of England for linen is either so much greater than that of Germany for cloth, or so much more extensible by cheapness, that if England had no commodity but cloth which Germany would take, the demand of England would force up the terms of interchange to 10 yards of cloth for only 16 of linen, so that England would gain only the difference between 15 and 16, Germany the difference between 16 and 20. But let us now suppose that England has also another commodity, say iron, which is in demand in Germany, and that the quantity of iron which is of equal value in England with 10 yards of cloth, (let us call this quantity a hundredweight) will, if produced in Germany, cost as much labour as 18 yards of linen, so that if offered by England for 17 it will undersell the German producer. In these circumstances, linen will not be forced up to the rate of 16 yards for 10 of cloth, but will stop, suppose at 17; for although, at that rate of interchange, Germany will not take enough cloth to pay for all the linen required by England, she will take iron for the reminder, and it is the same thing to England whether she gives a hundredweight of iron or 10 yards of cloth, both being made at the same cost. If we now superadd coals or cottons on the side of England, and wine, or corn, or timber, on the side of Germany, it will make no difference in the principle. The exports of each country must exactly pay for the imports; meaning now the aggregate exports and imports, not those of particular commodities taken singly. The produce of fifty days' English labour, whether in cloth, coals, iron, or any other exports, will exchange for the produce of forty, or fifty, or sixty days' German labour, in linen, wine, corn, or timber, according to the international demand. There is some proportion at which the demand of the two countries for each other’s products will exactly correspond: so that the things supplied by England to Germany will be completely paid for, and no more, by those supplied by Germany to England. This accordingly will be the ratio in which the produce of English and the produce of German labour will exchange for one another.

If, therefore, it be asked what country draws to itself the greatest share of the advantage of any trade it carries on, the answer is, the country for whose productions there is in other countries the greatest demand, and a demand the most susceptible of increase from additional cheapness. In so far as the productions of any country possess this property, the country obtains all foreign commodities at less cost. It gets its imports cheaper, the greater the intensity of the demand in foreign countries for its exports. It also gets its imports cheaper, the less the extent and intensity of its own demand for them. The market is cheapest to those whose demand is small. A country which desires few foreign productions, and only a limited quantity of them, while its own commodities are in great request in foreign countries, will obtain its limited imports at extremely small cost, that is, in exchange for the produce of a very small quantity of its labour and capital.

Lastly, having introduced more than the original two commodities into the hypothesis, let us also introduce more than the original two countries. After the demand of England for the linen of Germany has raised the rate of interchange to 10 yards of cloth for 16 of linen, suppose a trade opened between England and some other country which also exports linen. And let us suppose that, if England had no trade but with this third country, the play of international demand would enable her to obtain from it, for 10 yards of cloth or its equivalent, 17 yards of linen. She evidently would not go on buying linen from Germany at the former rate: Germany would be undersold, and must consent to give 17 yards, like the other country. In this case, the circumstances of production and of demand in the third country are supposed to be in themselves more advantageous to England than the circumstances of Germany; but this supposition is not necessary: we might suppose that if the trade with Germany did not exist, England would be obliged to give to the other country the same advantageous terms which she gives to Germany; 10 yards of cloth for 16, or even less than 16, of linen. Even so, the opening of the third country makes a great difference in favour of England. There is now a double market for English export, while the demand of England for linen is only what it was before. This necessarily obtains for England more advantageous terms of interchange. The two countries, requiring much more of her produce than was required by either alone, must, in order to obtain it, force an increased demand for their exports, by offering them at a lower value.

It deserves notice, that this effect in favour of England from the opening of another market for her exports, will equally be produced even though the country from which the demand comes should have nothing to sell which England is willing to take. Suppose that the third country, though requiring cloth or iron from England, produces no linen, nor any other article which is in demand there. She however produces exportable articles, or she would have no means of paying for imports: her exports, though not suitable to the English consumer, can find a market somewhere. As we are only supposing three countries, we must assume her to find this market in Germany, and to pay for what she imports from England by orders on her German customers. Germany, therefore, besides having to pay for her own imports, now owes a debt to England on account of the third country, and the means for both purposes must be derived from her exportable produce. She must therefore tender that produce to England on terms sufficiently favourable to force a demand equivalent to this double debt. Everything will take place precisely as if the third country had bought German produce with her own goods, and offered that produce to England in exchange for hers. There is an increased demand for English goods, for which German goods have to furnish the payment; and this can only be done by forcing an increased demand for them in England, that is, by lowering their value. Thus an increase of demand for a country’s exports in any foreign country enables her to obtain more cheaply even those imports which she procures from other quarters. And conversely, an increase of her own demand for any foreign commodity compels her, caeteris paribus, to pay dearer for all foreign commodities.

The law which we have now illustrated, may be appropriately named, the Equation of International Demand. It may be concisely stated as follows. The produce of a country exchanges for the produce of other countries, at such values as are required in order that the whole of her exports may exactly pay for the whole of her imports. This law of International Values is but an extension of the more general law of Value, which we called the Equation of Supply and Demand.∗ We have seen that the value of a commodity always so adjusts itself as to bring the demand to the exact level of the supply. But all trade, either between nations or individuals, is an interchange of commodities, in which the things that they respectively have to sell constitute also their means of purchase: the supply brought by the one constitutes his demand for what is brought by the other. So that supply and demand are but another expression for reciprocal demand: and to say that value will adjust itself so as to equalize demand with supply, is in fact to say that it will adjust itself so as to equalize the demand on one side with the demand on the other.

§ 5. To trace the consequences of this law of International Values through their wide ramifications, would occupy more space than can be here devoted to such a purpose.1 But there is one of its applications which I will notice, as being in itself not unimportant, as bearing on the question which will occupy us in the next chapter, and especially as conducing to the more full and clear understanding of the law itself.

We have seen that the value at which a country purchases a foreign commodity does not conform to the cost of production in the country from which the commodity comes. Suppose now a change in that cost of production; an improvement, for example, in the process of manufacture. Will the benefit of the improvement be fully participated in by other countries? Will the commodity be sold as much cheaper to foreigners, as it is produced cheaper at home? This question, and the considerations which must be entered into in order to resolve it, are well adapted to try the worth of the theory.

Let us first suppose, that the improvement is of a nature to create a new branch of export: to make foreigners resort to the country for a commodity which they had previously produced at home. On this supposition, the foreign demand for the productions of the country is increased; which necessarily alters the international values to its advantage, and to the disadvantage of foreign countries, who, therefore, though they participate in the benefit of the new product, must purchase that benefit by paying for all the other productions of the country at a dearer rate than before. How much dearer, will depend on the degree necessary for re-establishing, under these new conditions, the Equation of International Demand. These consequences follow in a very obvious manner from the law of international values, and I shall not occupy space in illustrating them, but shall pass to the more frequent case, of an improvement which does not create a new article of export, but lowers the cost of production of something which the country already exported.

It being advantageous, in discussions of this complicated nature, to employ definite numerical amounts, we shall return to our original example. Ten yards of cloth, if produced in Germany, would require the same amount of labour and capital as twenty yards of linen; but by the play of international demand, they can be obtained from England for seventeen. Suppose now, that by a mechanical improvement made in Germany, and not capable of being transferred to England, the same quantity of labour and capital which produced twenty yards of linen, is enabled to produce thirty. Linen falls one-third in value in the German market, as compared with other commodities produced in Germany. Will it also fall one-third as compared with English cloth, thus giving to England, in common with Germany, the full benefit of the improvement? Or (ought we not rather to say), since the cost to England of obtaining linen was not regulated by the cost to Germany of producing it, and since England, accordingly, did not get the entire benefit even of the twenty yards which Germany could have given for ten yards of cloth, but only obtained seventeen—why should she now obtain more, merely because this theoretical limit is removed ten degrees further off?

It is evident tha,t in the outset, the improvement will lower the value of linen in Germany, in relation to all other commodities in the German market, including, among the rest, even the imported commodity, cloth. If 10 yards of cloth previously exchanged for 17 yards of linen, they will now exchange for half as much more, or 25½ yards. But whether they will continue to do so will depend on the effect which this increased cheapness of linen produces on the international demand. The demand for linen in England could scarcely fail to be increased. But it might be increased either in proportion to the cheapness, or in a greater proportion than the cheapness, or in a less proportion.

If the demand was increased in the same proportion with the cheapness, England would take as many times 25½ yards of linen, as the number of times 17 yards which she took previously. She would expend in linen exactly as much of cloth, or of the equivalents of cloth, as much in short of the collective income of her people, as she did before. Germany, on her part, would probably require, at that rate of interchange, the same quantity of cloth as before, because it would in reality cost her exactly as much; 25½ yards of linen being now of the same value in her market, as 17 yards were before. In this case, therefore, 10 yards of cloth for 25½ of linen is the rate of interchange which under these new conditions would restore the equation of international demand; and England would obtain linen one-third cheaper than before, being the same advantage as was obtained by Germany.

It might happen, however, that this great cheapening of linen would increase the demand for it in England in a greater ratio than the increase of cheapness; and that if she before wanted 1000 times 17 yards, she would now require more than 1000 times 25½ yards to satisfy her demand. If so, the equation of international demand cannot establish itself at that rate of interchange; to pay for the linen England must offer cloth on more advantageous terms; say, for example, 10 yards for 21 of linen; so that England will not have the full benefit of the improvement in the production of linen, while Germany, in addition to that benefit, will also pay less for cloth. But again, it is possible that England might not desire to increase her consumption of linen in even so great a proportion as that of the increased cheapness; she might not desire so great a quantity as 1000 times 25½ yards: and in that case Germany must force a demand by offering more than 25½ yards of linen for 10 of cloth; linen will be cheapened in England in a still greater degree than in Germany; while Germany will obtain cloth on more unfavourable terms; and at a higher exchange value than before.

After what has already been said, it is not necessary to particularize the manner in which these results might be modified by introducing into the hypothesis other countries and other commodities. There is a further circumstance by which they may also be modified. In the case supposed the consumers of Germany have had a part of their incomes set at liberty by the increased cheapness of linen, which they may indeed expend in increasing their consumption of that article, but which they may likewise expend in other articles, and among others, in cloth or other imported commodities. This would be an additional element in the international demand, and would modify more or less the terms of interchange.

Of the three possible varieties in the influence of cheapness on demand, which is the more probable—that the demand would be increased more than the cheapness, as much as the cheapness, or less than the cheapness? This depends on the nature of the particular commodity, and on the tastes of purchasers. When the commodity is one in general request, and the fall of its price brings it within reach of a much larger class of incomes than before, the demand is often increased in a greater ratio than the fall of price, and a larger sum of money is on the whole expended in the article. Such was the case with coffee, when its price was lowered by successive reductions of taxation; and such would probably be the case with sugar, wine, and a large class of commodities which, though not necessaries, are largely consumed, and in which many consumers indulge when the articles are cheap and economize when they are dear. But it more frequently happens that when a commodity falls in price, less money is spent in it than before: a greater quantity is consumed, but not so great a value. The consumer who saves money by the cheapness of the article, will be likely to expend part of the saving in increasing his consumption of other things: and unless the low price attract a large class of new purchasers who were either not constomers of the article at all, or only in small quantity and occasionally, a less aggregate sum will be expended on it. Speaking generally, therefore, the third of our three cases is the most probable: and an improvement in an exportable article is likely to be as beneficial (if not more beneficial) to foreign countries, as to the country where the article is produced.

§ 6.1 Thus far had the theory of international values been carried in the first and second editions of this work. But intelligent criticisms (chiefly those of my friend Mr. William Thornton), and subsequent further investigation, have shown that the doctrine stated in the preceding pages, though correct as far as it goes, is not yet the complete theory of the subject matter.

It has been shown that the exports and imports between the two countries (or, if we suppose more than two, between each country and the world) must in the aggregate pay for each other, and must therefore be exchanged for one another at such values as will be compatible with the equation of international demand. That this, however, does not furnish the complete law of the phenomenon, appears from the following consideration: that several different rates of international value may all equally fulfil the conditions of this law.

The supposition was, that England could produce 10 yards of cloth with the same labour as 15 of linen, and Germany with the same labour as 20 of linen; that a trade was opened between the two countries; that England thenceforth confined her production to cloth, and Germany to linen; and, that if 10 yards of cloth should thenceforth exchange for 17 of linen, England and Germany would exactly supply each other’s demand: that, for instance, if England wanted at that price 17,000 yards of linen, Germany would want exactly the 10,000 yards of cloth, which, at that price, England would be required to give for the linen. Under these suppositions it appeared, that 10 cloth for 17 linen would be, in point of fact, the international values.

But it is quite possible that some other rate, such as 10 cloth for 18 linen, might also fulfil the conditions of the equation of international demand. Suppose that, at this last rate, England would want more linen than at the rate of 10 for 17, but not in the ratio of the cheapness; that she would not want the 18,000 which she could now buy with 10,000 yards of cloth, but would be content with 17,500, for which she would pay (at the new rate of 10 for 18) 9722 yards of cloth. Germany, again, having to pay dearer for cloth than when it could be bought at 10 for 17, would probably reduce her consumption to an amount below 10,000 yards, perhaps to the very same number, 9722. Under these conditions the Equation of International Demand would still exist. Thus, the rate of 10 for 17, and that of 10 for 18, would equally satisfy the Equation of Demand: and many other rates of interchange might satisfy it in like manner. It is conceivable that the conditions might be equally satisfied by every numerical rate which could be supposed. There is still therefore a portion of indeterminateness in the rate at which the international values would adjust themselves; showing that the whole of the influencing circumstances cannot yet have been taken into account.

§ 7. It will be found that, to supply this deficiency, we must take into consideration not only, as we have already done, the quantities demanded in each country of the imported commodities; but also the extent of the means of supplying that demand which are set at liberty in each country by the change in the direction of its industry.

To illustrate this point it will be necessary to choose more convenient numbers than those which we have hitherto employed. Let it be supposed that in England 100 yards of cloth, previously to the trade, exchanged for 100 of linen, but that in Germany 100 of cloth exchanged for 200 of linen. When the trade was opened, England would supply cloth to Germany, Germany linen to England, at an exchange value which would depend partly on the element already discussed, viz. the comparative degree in which, in the two countries, increased cheapness operates in increasing the demand; and partly on some other element not yet taken into account. In order to isolate this unknown element, it will be necessary to make some definite and invariable supposition in regard to the known element. Let us therefore assume, that the influence of cheapness on demand conforms to some simple law, common to both countries and to both commodities. As the simplest and most convenient, let us suppose that in both countries any given increase of cheapness produces an exactly proportional increase of consumption or, in other words, that the value expended in the commodity, the cost incurred for the sake of obtaining it, is always the same, whether that cost affords a greater or a smaller quantity of the commodity.

Let us now suppose that England, previously to the trade, required a million of yards of linen, which were worth, at the English cost of production, a million yards of cloth. By turning all the labour and capital with which that linen was produced, to the production of cloth, she would produce for exportation a million yards of cloth. Suppose that this is the exact quantity which Germany is accustomed to consume. England can dispose of all this cloth in Germany at the German price; she must consent indeed to take a little less until she has driven the German producer from the market, but as soon as this is effected, she can sell her million of cloth for two millions of linen; being the quantity that the German clothiers are enabled to make by transferring their whole labour and capital from cloth to linen. Thus England would gain the whole benefit of the trade, and Germany nothing. This would be perfectly consistent with the equation of international demand: since England (according to the hypothesis in the preceding paragraph) now requires two millions of linen (being able to get them at the same cost at which she previously obtained only one), while, the prices in Germany not being altered, Germany requires as before exactly a million of cloth, and can obtain it by employing the labour and capital set at liberty from the production of cloth, in producing the two millions of linen required by England.

Thus far we have supposed that the additional cloth which England could make, by transferring to cloth the whole of the capital previously employed in making linen, was exactly sufficient to supply the whole of Germany’s existing demand. But suppose next that it is more than sufficient. Suppose that while England could make with her liberated capital a million yards of cloth for exportation, the cloth which Germany had heretofore required was 800,000 yards only, equivalent at the German cost of production to 1,600,000 yards of linen. England therefore could not dispose of a whole million of cloth in Germany at the German prices. Yet she wants, whether cheap or dear (by our supposition), as much linen as can be bought for a million of cloth: and since this can only be obtained from Germany, or by the more expensive process of production at home, the holders of the million of cloth will be forced by each other’s competition to offer it to Germany on any terms (short of the English cost of production) which will induce Germany to take the whole. What terms these would be, the supposition we have made enables us exactly to define. The 800,000 yards of cloth which Germany consumed, cost her the equivalent of 1,600,000 linen, and that invariable cost is what she is willing to expend in cloth, whether the quantity it obtains for her be more or less. England therefore, to induce Germany to take a million of cloth, must offer it for 1,600,000 of linen. The international values will thus be 100 cloth for 160 linen, intermediate between the ratio of the costs of production in England, and that of the costs of production in Germany: and the two countries will divide the benefit of the trade, England gaining in the aggregate 600,000 yards of linen, and Germany being richer by 200,000 additional yards of cloth.

Let us now stretch the last supposition still farther, and suppose that the cloth previously consumed by Germany, was not only less than the million yards which England is enabled to furnish by discontinuing her production of linen, but less in the full proportion of England’s advantage in the production, that is, that Germany only required half a million. In this case, by ceasing altogether to produce cloth, Germany can add a million, but a million only, to her production of linen, and this million, being the equivalent of what the half million previously cost her, is all that she can be induced by any degree of cheapness to expend in cloth. England will be forced by her own competition to give a whole million of cloth for this million of linen, just as she was forced in the preceding case to give it for 1,600,000. But England could have produced at the same cost a million yards of linen for herself. England therefore derives, in this case, no advantage from the international trade. Germany gains the whole; obtaining a million of cloth instead of half a million, at what the half million previously cost her. Germany, in short, is, in this third case, exactly in the same situation as England was in the first case; which may easily be verified by reversing the figures.

As the general result of the three cases, it may be laid down as a theorem, that under the supposition we have made of a demand exactly in proportion to the cheapness, the law of international values will be as follows:—

The whole of the cloth which England can make with the capital previously devoted to linen, will exchange for the whole of the linen which Germany can make with the capital previously devoted to cloth.

Or, still more generally,

The whole of the commodities which the two countries can respectively make for exportation, with the labour and capital thrown out of employment by importation, will exchange against one another.

This law, and the three different possibilities arising from it in respect to the division of the advantage, may be conveniently generalized by means of algebraical symbols, as follows:—

Let the quantity of cloth which England can make with the labour and capital withdrawn from the production of linen, be = n.

Let the cloth previously required by Germany (at the German cost of production) be = m.

Then n of cloth will always exchange for exactly 2m of linen.

Consequently if n = m, the whole advantage will be on the side of England.

If n = 2m, the whole advantage will be on the side of Germany.

If n be greater than m, but less than 2m, the two countries will share the advantage; England getting 2m of linen where she before got only n; Germany getting n of cloth where she before got only m.

It is almost superfluous to observe that the figure 2 stands where it does only because it is the figure which expresses the advantage of Germany over England in linen as estimated in cloth, and (what is the same thing) of England over Germany in cloth as estimated in linen. If we had supposed that in Germany, before the trade, 100 of cloth exchanged for 1000 instead of 200 of linen, then n (after the trade commenced) would have exchanged for 10m instead of 2m. If instead of 1000 or 200 we had supposed only 150, n would have exchanged for only 3/2 m. If (in fine) the cost value of cloth (as estimated in linen) in Germany exceeds the cost value similarly estimated in England, in the ratio of p to q, then will n, after the opening of the trade, exchange for

m.∗

§ 8. We have now arrived at what seems a law of International Values of great simplicity and generality. But we have done so by setting out from a purely arbitrary hypothesis respecting the relation between demand and cheapness. We have assumed their relation to be fixed, though it is essentially variable. We have supposed that every increase of cheapness produces an exactly proportional extension of demand; in other words, that the same invariable value is laid out in a commodity whether it be cheap or dear; and the law which we have investigated holds good only on this hypothesis, or some other practically equivalent to it. Let us now, therefore, combine the two variable elements of the question, the variations of each of which we have considered separately. Let us suppose the relation between demand and cheapness to vary, and to become such as would prevent the rule of interchange laid down in the last theorem from satisfying the conditions of the Equation of International Demand. Let it be supposed, for instance, that the demand of England for linen is exactly proportional to the cheapness, but that of Germany for cloth, not proportional. To revert to the second of our three cases, the case in which England by discontinuing the production of linen could produce for exportation a million yards of cloth, and Germany by ceasing to produce cloth could produce an additional 1,600,000 yards of linen. If the one of these quantities exactly exchanged for the other, the demand of England would on our present supposition be exactly satisfied, for she requires all the linen which can be got for a million yards of cloth: but Germany perhaps, though she required 800,000 cloth at a cost equivalent to 1,600,000 linen, yet when she can get a million of cloth at the same cost, may not require the whole million; or may require more than a million. First, let her not require so much; but only as much as she can now buy for 1,500,000 linen. England will still offer a million for these 1,500,000; but even this may not induce Germany to take so much as a million; and if England continues to expend exactly the same aggregate cost on linen whatever be the price, she will have to submit to take for her million of cloth any quantity of linen (not less than a million) which may be requisite to induce Germany to take a million of cloth. Suppose this to be 1,400,000 yards. England has now reaped from the trade a gain not of 600,000 but only of 400,000 yards; while Germany, besides having obtained an extra 200,000 yards of cloth, has obtained it with only seven-eighths of the labour and capital which she previously expended in supplying herself with cloth, and may expend the remainder in increasing her own consumption of linen, or of any other commodity.

Suppose on the contrary that Germany, at the rate of a million cloth for 1,600,000 linen, requires more than a million yards of cloth. England having only a million which she can give without trenching upon the quantity she previously reserved for herself, Germany must bid for the extra cloth at a higher rate than 160 for 100, until she reaches a rate (say 170 for 100) which will either bring down her own demand for cloth to the limit of a million, or else tempt England to part with some of the cloth she previously consumed at home.

Let us next suppose that the proportionality of demand to cheapness, instead of holding good in one country but not in the other, does not hold good in either country, and that the deviation is of the same kind in both; that, for instance, neither of the two increases its demand in a degree equivalent to the increase of cheapness. On this supposition, at the rate of one million cloth for 1,600,000 linen, England will not want so much as 1,600,000 linen, nor Germany so much as a million cloth: and if they fall short of that amount in exactly the same degree: if England only wants linen to the amount of nine-tenths of 1,600,000 (1,440,000), and Germany only nine hundred thousand of cloth, the interchange will continue to take place at the same rate. And so if England wants a tenth more than 1,600,000, and Germany a tenth more than a million. This coincidence (which, it is to be observed, supposes demand to extend cheapness in a corresponding, but not in an equal degree∗) evidently could not exist unless by mere accident: and in any other case, the equation of international demand would require a different adjustment of international values.

The only general law, then, which can be laid down, is this. The values at which a country exchanges its produce with foreign countries depend on two things: first, on the amount and extensibility of their demand for its commodities, compiled with its demand for theirs; and secondly, on the capital which it has to spare from the production of domestic commodities for its own consumption. The more the foreign demand for its commodities exceeds its demand for foreign commodities, and the less capital it can spare to produce for foreign markets, compared with what foreigners spare to produce for its markets, the more favourable to it will be the terms of interchange: that is, the more it will obtain of foreign commodities in return for a given quantity of its own.

But these two influencing circumstances are in reality reducible to one: for the capital which a country has to spare from the production of domestic commodities for its own use is in proportion to its own demand for foreign commodities: whatever proportion of its collective income it expends in purchases from abroad, that same proportion of its capital is left without a home market for its productions. The new element, therefore, which for the sake of scientific correctness we have introduced into the theory of international values, does not seem to make any very material difference in the practical result. It still appears, that the countries which carry on their foreign trade on the most advantageous terms, are those whose commodities are most in demand by foreign countries, and which have themselves the least demand for foreign commodities. From which, among other consequences, it follows, that the richest countries, caeteris paribus,gain the least by a given amount of foreign commerce: since, having a greater demand for commodities generally, they are likely to have a greater demand for foreign commodities, and thus modify the terms of interchange to their own disadvantage. Their aggregate gains by foreign trade, doubtless, are generally greater than those of poorer countries, since they carry on a greater amount of such trade, and gain the benefit of cheapness on a larger consumption: but their gain is less on each individual article consumed.

§ 9. We now pass to another essential part of the theory of the subject. There are two senses in which a country obtains commodities cheaper by foreign trade; in the sense of Value, and in the sense of Cost. It gets them cheaper in the first sense, by their falling in value relatively to other things: the same quantity of them exchanging, in the country, for a smaller quantity than before of the other produce of the country. To revert to our original figures; in England, all consumers of linen obtained, after the trade was opened, 17 or some greater number of yards for the same quantity of all other things for which they before obtained only 15. The degree of cheapness, in this sense of the term, depends on the laws of International Demand, so copiously illustrated in the preceding sections. But in the other sense, that of Cost, a country gets a commodity cheaper when it obtains a greater quantity of the commodity with the same expenditure of labour and capital. In this sense of the term, cheapness in a great measure depends upon a cause of a different nature: a country gets its imports cheaper, in proportion to the general productiveness of its domestic industry; to the general efficiency of its labour. The labour of one country may be, as a whole, much more efficient than that of another; all or most of the commodities capable of being produced in both, may be produced in one at less absolute cost than in the other; which, as we have seen, will not necessarily prevent the two countries from exchanging commodities. The things which the more favoured country will import from others, are of course those in which it is least superior; but by importing them it acquires, even in those commodities, the same advantage which it possesses in the articles it gives in exchange for them. Thus the countries which obtain their own productions at least cost, also get their imports at least cost.

This will be made still more obvious if we suppose two competing countries. England sends cloth to Germany, and gives 10 yards of it for 17 yards of linen, or for something else which in Germany is the equivalent of those 17 yards. Another country, as for example France, does the same. The one giving 10 yards of cloth for a certain quantity of German commodities, so must the other: if, therefore, in England, these 10 yards are produced by only half as much labour as that by which they are produced in France, the linen or other commodities of Germany will cost to England only half the amount of labour which they will cost to France. England would thus obtain her imports at less cost than France, in the ratio of the greater efficiency of her labour in the production of cloth: which might be taken, in the case supposed, as an approximate estimate of the efficiency of her labour generally; since France, as well as England, by selecting cloth as her article of export, would have shown that with her also it was the commodity in which labour was relatively the most efficient. It follows, therefore, that every country gets its imports at less cost, in proportion to the general efficiency of its labour.

This proposition was first clearly seen and expounded by Mr. Senior,∗ but only as applicable to the importation of the precious metals. I think it important to point out that the proposition holds equally true of all other imported commodities; and further, that it is only a portion of the truth. For, in the case supposed, the cost to England of the linen which she pays for with ten yards of cloth, does not depend solely upon the cost to herself of ten yards of cloth, but partly also upon how many yards of linen she obtains in exchange for them. What her imports cost to her is a function of two variables; the quantity of her own commodities which she gives for them, and the cost of those commodities. Of these, the last alone depends on the efficiency of her labour: the first depends on the law of international values; that is, on the intensity and extensibility of the foreign demand for her commodities, compared with her demand for foreign commodities.

In the case just now supposed, of a competition between England and France, the state of international values affected both competitors alike, since they were supposed to trade with the same country, and to export and import the same commodities. The difference, therefore, in what their imports cost them, depended solely on the other cause, the unequal efficiency of their labour. They gave the same quantities; the difference could only be in the cost of production. But if England traded to Germany with cloth, and France with iron, the comparative demand in Germany for those two commodities would bear a share in determining the comparative cost, in labour and capital, with which England and France would obtain German products. If iron were more in demand in Germany than cloth, France would recover, through that channel, part of her disadvantage; if less, her disadvantage would be increased. The efficiency, therefore, of a country’s labour, is not the only thing which determines even the cost at which that country obtains imported commodities—while it has no share whatever in determining either their exchange value, or, as we shall presently see, their price.1

Book III, Chapter XIX: Of money, considered as an imported commodity

CHAPTER XIX: of money, considered as an imported commodity

§ 1. The degree of progress which we have now made in the theory of Foreign Trade, puts it in our power to supply what was previously deficient in our view of the theory of Money; and this, when completed, will in its turn enable us to conclude the subject of Foreign Trade.

Money, or the material of which it is composed, is, in Great Britain, and in most other countries, a foreign commodity. Its value and distribution must therefore be regulated, not by the law of value which obtains in adjacent places, but by that which is applicable to imported commodities—the law of International Values.

In the discussion into which we are now about to enter, I shall use the terms Money and the Precious Metals indiscriminately. This may be done without leading to any error; it having been shown that the value of money, when it consists of the precious metals, or of a paper currency convertible into them on demand, is entirely governed by the value of the metals themselves: from which it never permanently differs, except by the expense of coinage when this is paid by the individual and not by the state.

Money is brought into a country in two different ways. It is imported (chiefly in the form of bullion) like any other merchandize, as being an advantageous article of commerce. It is also imported in its other character of a medium of exchange, to pay some debt due to the country, either for goods exported or on any other account. There are other ways in which it may be introduced casually; these are the two in which it is received in the ordinary course of business, and which determine its value. The existence of these two distinct modes in which money flows into a country, while other commodities are habitually introduced only in the first of these modes, occasions somewhat more of complexity and obscurity than exists in the case of other commodities, and for this reason only is any special and minute exposition necessary.

§ 2. In so far as the precious metals are imported in the ordinary way of commerce, their value must depend on the same causes, and conform to the same laws, as the value of any other foreign production. It is in this mode chiefly that gold and silver diffuse themselves from the mining countries into all other parts of the commercial world. They are the staple commodities of those countries, or at least are among their great articles of regular export; and are shipped on speculation, in the same manner as other exportable commodities. The quantity, therefore, which a country (say England) will give of its own produce, for a certain quantity of bullion, will depend, if we suppose only two countries and two commodities, upon the demand in England for bullion, compared with the demand in the mining country (which we will call Brazil) for what England has to give. They must exchange in such proportions as will leave no unsatisfied demand on either side, to alter values by its competition. The bullion required by England must exactly pay for the cottons or other English commodities required by Brazil. If, however, we substitute for this simplicity the degree of complication which really exists, the equation of international demand must be established not between the bullion wanted in England and the cottons or broadcloth wanted in Brazil, but between the whole of the imports of England and the whole of her exports. The demand in foreign countries for English products must be brought into equilibrium with the demand in England for the products of foreign countries; and all foreign commodities, billion among the rest, must be exchanged against English products in such proportions as will, by the effect they produce on the demand, establish this equilibrium.

There is nothing in the peculiar nature or uses of the precious metals, which should make them an exception to the general principles of demand. So far as they are wanted for purposes of luxury or the arts, the demand increases with the cheapness, in the same irregular way as the demand for any other commodity. So far as they are required for money, the demand increases with the cheapness in a perfectly regular way, the quantity needed being always in inverse proportion to the value. This is the only real difference, in respect to demand, between money and other things; and for the present purpose it is a difference altogether immaterial.

Money, then, if imported solely as a merchandize, will, like other imported commodities, be of lowest value in the countries for whose exports there is the greatest foreign demand, and which have themselves the least demand for foreign commodities. To these two circumstances it is however necessary to add two others, which produce their effect through cost of carriage. The cost of obtaining bullion is compounded of two elements; the goods given to purchase it, and the expense of transport: of which last, the bullion countries will bear a part, (though an uncertain part,) in the adjustment of international values. The expense of transport is partly that of carrying the goods to the bullion countries, and partly that of bringing back the bullion: both these items are influenced by the distance from the mines; and the former is also much affected by the bulkiness of the goods. Countries whose exportable produce consists of the finer manufactures, obtain bullion, as well as all other foreign articles, caeteris paribus, at less expense than countries which export nothing but bulky raw produce.

To be quite accurate, therefore, we must say—The countries whose exportable productions are most in demand abroad, and contain greatest value in smallest bulk, which are nearest to the mines, and which have least demand for foreign productions, are those in which money will be of lowest value, or, in other words, in which prices will habitually range the highest. If we are speaking not of the value of money, but of its cost, (that is, the quantity of the country’s labour which must be expended to obtain it,) we must add to these four conditions of cheapness a fifth condition, namely, “whose productive industry is the most efficient.” This last, however, does not at all affect the value of money, estimated in commodities: it affects the general abundance and facility with which all things, money and commodities together, can be obtained.

Although, therefore, Mr. Senior is right in pointing out the great efficiency of English labour as the chief cause why the precious metals are obtained at less cost by England than by most other countries, I cannot admit that it at all accounts for their being of less value; for their going less far in the purchase of commodities. This, in so far as it is a fact, and not an illusion, must be occasioned by the great demand in foreign countries for the staple commodities of England, and the generally unbulky character of those commodities, compared with the corn, wine, timber, sugar, wool, hides, tallow, hemp, flax, tobacco, raw cotton, &c., which form the exports of other commercial countries. These two causes will account for a somewhat higher range of general prices in England than elsewhere, notwithstanding the counteracting influence of her own great demand for foreign commodities. I am, however, strongly of opinion that the high prices of commodities, and low purchasing power of money in England, are more apparent than real. Food, indeed, is somewhat dearer; and food composes so large a portion of the expenditure when the income is small and the family large, that to such families England is a dear country. Services, also, of most descriptions, are dearer than in the other countries of Europe, from the less costly mode of living of the poorer classes on the Continent. But manufactured commodities (except most of those in which good taste is required) are decidedly cheaper; or would be so if buyers would be content with the same quality of material and of workmanship. What is called the dearness of living in England, is mainly an affair not of necessity but of foolish custom; it being thought imperative by all classes in England above the condition of a day-labourer that the things they consume should either be of the same quality with those used by much richer people, or at least should be as nearly as possible undistinguishable from them in outward appearance.

§ 3. From the preceding considerations, it appears that those are greatly in error who contend1 that the value of money, in countries where it is an imported commodity, must be entirely regulated by its value in the countries which produce it; and cannot be raised or lowered in any permanent manner unless some change has taken place in the cost of production at the mines. On the contrary, any circumstance which disturbs the equation of international demand with respect to a particular country, not only may, but must, affect the value of money in that country—its value at the mines remaining the same. The opening of a new branch of export trade from England; an increase in the foreign demand for English products, either by the natural course of events, or by the abrogation of duties; a check to the demand in England for foreign commodities, by the laying on of import duties in England or of export duties elsewhere; these and all other events of similar tendency, would make the imports of England (bullion and other things taken together) no longer an equivalent for the exports; and the countries which take her exports would be obliged to offer their commodities, and bullion among the rest, on cheaper terms, in order to re-establish the equation of demand: and thus England would obtain money cheaper, and would acquire a generally higher range of prices. Incidents the reverse of these would produce effects the reverse—would reduce prices; or, in other words, raise the value of the precious metals. It must be observed, however, that money would be thus raised in value only with respect to home commodities, in relation to all imported articles it would remain as before, since their values would be affected in the same way and in the same degree with its own. A country which, from any of the causes mentioned, gets money cheaper, obtains all its other imports cheaper likewise.

It is by no means necessary that the increased demand for English commodities: which enables England to supply herself with bullion at a cheaper rate, should be a demand in the mining countries. England might export nothing whatever to those countries, and yet might be the country which obtained bullion from them on the lowest terms, provided there were a sufficient intensity of demand in other foreign countries for English goods, which would be paid for circuitously with gold and silver from the mining countries. The whole of its exports are what a country exchanges against the whole of its imports, and not its exports and imports to and from any one country; and the general foreign demand for its productions will determine what equivalent it must give for imported goods, in order to establish an equilibrium between its sales and purchases generally; without regard to the maintenance of a similar equilibrium between it and any country singly.

Book III, Chapter XX: Of the foreign exchanges

CHAPTER XX: of the foreign exchanges

§ 1. We have thus far considered the precious metals as a commodity, imported like other commodities in the common course of trade, and have examined what are the circumstances which would in that case determine their value. But those metals are also imported in another character, that which belongs to them as a medium of exchange; not as an article of commerce, to be sold for money, but as themselves money, to pay a debt, or effect a transfer of property. It remains to consider whether the liability of gold and silver to be transported from country to country for such purposes, in any way modifies the conclusions we have already arrived at, or places those metals under a different law of value from that to which, in common with all other imported commodities, they would be subject if international trade were an affair of direct barter.

Money is sent from one country to another for various purposes: such as the payment of tributes or subsidies; remittances of revenue to or from dependencies, or of rents or other incomes to their absent owners; emigration of capital, or transmission of it for foreign investment. The most usual purpose, however, is that of payment for goods. To show in what circumstances money actually passes from country to country for this or any of the other purposes mentioned, it is necessary briefly to state the nature of the mechanism by which international trade is carried on, when it takes place not by barter but through the medium of money.

§ 2. In practice, the exports and imports of a country not only are not exchanged directly against each other, but often do not even pass through the same hands. Each is separately bought and paid for with money. We have seen, however, that, even in the same country, money does not actually pass from hand to hand each time that purchases are made with it, and still less does this happen between different countries. The habitual mode of paying and receiving payment for commodities, between country and country, is by bills of exchange.

A merchant in England, A, has exported English commodities, consigning them to his correspondent B in France. Another merchant in France, C, has exported French commodities, suppose of equivalent value, to a merchant D in England. It is evidently unnecessary that B in France should send money to A in England, and that D in England should send an equal sum of money to C in France. The one debt may be applied to the payment of the other, and the double cost and risk of carriage be thus saved. A draws a bill on B for the amount which B owes to him: D, having an equal amount to pay in France, buys this bill from A, and sends it to C, who, at the expiration of the number of days which the bill has to run, presents it to B for payment. Thus the debt due from France to England, and the debt due from England to France, are both paid without sending an ounce of gold or silver from one country to the other.

In this statement, however, it is supposed, that the sum of the debts due from France to England, and the sum of those due from England to France, are equal; that each country has exactly the same number of ounces of gold or silver to pay and to receive. This implies (if we exclude for the present any other international payments than those occurring in the course of commerce), that the exports and imports exactly pay for one another, or, in other words, that the equation of international demand is established. When such is the fact, the international transactions are liquidated without the passage of any money from one country to the other. But if there is a greater sum due from England to France, than is due from France to England, or vice versâ, the debts cannot be simply written off against one another. After the one has been applied, as far as it will go, towards covering the other, the balance must be transmitted in the precious metals. In point of fact, the merchant who has the amount to pay, will even then pay for it by a bill. When a person has a remittance to make to a foreign country, he does not himself search for some one who has money to receive from that country, and ask him for a bill of exchange. In this, as in other branches of business, there is a class of middlemen or brokers, who bring buyers and sellers together, or stand between them, buying bills from those who have money to receive, and selling bills to those who have money to pay. When a customer comes to a broker for a bill on Paris or Amsterdam, the broker sells to him, perhaps the bill he may himself have bought that morning from a merchant, perhaps a bill on his own correspondent in the foreign city: and to enable his correspondent to pay, when due, all the bills he has granted, he remits to him all those which he has bought and has not resold. In this manner these brokers take upon themselves the whole settlement of the pecuniary transactions between distant places, being remunerated by a small commission or percentage on the amount of each bill which they either sell or buy. Now, if the brokers find that they are asked for bills on the one part, to a greater amount than bills are offered to them on the other, they do not on this account refuse to give them: but since, in that case, they have no means of enabling the correspondents on whom their bills are drawn, to pay them when due, except by transmitting part of the amount in gold or silver, they require from those to whom they sell bills an additional price, sufficient to cover the freight and insurance of the gold and silver, with a profit sufficient to compensate them for their trouble and for the temporary occupation of a portion of their capital. This premium (as it is called) the buyers are willing to pay, because they must otherwise go to the expense of remitting the precious metals themselves, and it is done cheaper by those who make doing it a part of their especial business. But though only some of those who have a debt to pay would have actually to remit money, all will be obliged, by each other’s competition, to pay the premium; and the brokers are for the same reason obliged to pay it to those whose bills they buy. The reverse of all this happens if, on the comparison of exports and imports, the country, instead of having a balance to pay, has a balance to receive. The brokers find more bills offered to them than are sufficient to cover those which they are required to grant. Bills on foreign countries consequently fall to a discount; and the competition among the brokers, which is exceedingly active, prevents them from retaining this discount as a profit for themselves, and obliges them to give the benefit of it to those who buy the bills for purposes of remittance.

Let us suppose that all countries had the same currency, as in the progress of political improvement they one day will have: and, as the most familiar to the reader, though not the best, let us suppose this currency to be the English. When England had the same number of pounds sterling to pay to France, which France had to pay to her, one set of merchants in England would want bills, and another set would have bills to dispose of, for the very same number of pounds sterling; and consequently a bill on France for 100l. would sell for exactly 100l., or, in the phraseology of merchants, the exchange would be at par. As France also, on this supposition, would have an equal number of pounds sterling to pay and to receive, bills on England would be at par in France, whenever bills on France were at par in England.

If, however, England had a larger sum to pay to France than to receive from her, there would be persons requiring bills on France for a greater number of pounds sterling than there were bills drawn by persons to whom money was due. A bill on France for 100l. would then sell for more than 100l., and bills would be said to be at a premium. The premium, however, could not exceed the cost and risk of making the remittance in gold, together with a trifling profit; because if it did, the debtor wouLd send the gold itself, in preference to buying the bill.

If, on the contrary, England had more money to receive from France than to pay, there would be bills offered for a greater number of pounds than were wanted for remittance, and the price of bills would fall below par: a bill for 100l. might be bought for somewhat less than 100l., and bills would be said to be at a discount.

When England has more to pay than to receive, France has more to receive than to pay, and vice versâ. When, therefore, in England, bills on France bear a premium, then, in France, bills on England are at a discount: and when bills on France are at a discount in England, bills on England are at a premium in France. If they are at par in either country, they are so, as we have already seen, in both.

Thus do matters stand between countries, or places, which have the same currency. So much of barbarism, however, still remains in the transactions of the most civilized nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbours, a peculiar currency of their own. To our present purpose this makes no other difference, than that instead of speaking of equal sums of money, we have to speak of equivalent sums. By equivalent sums, when both currencies are composed of the same metal, are meant sums which contain exactly the same quantity of the metal, in weight and fineness; but when, as in the case of France and England, the metals are different, what is meant is that the quantity of gold in the one sum, and the quantity of silver in the other, are of the same value in the general market of the world: there being no material difference between one place and another in the relative value of these metals. Suppose 25 francs to be (as within a trifling fraction it is) the equivalent of a pound sterling. The debts and credits of the two countries would be equal, when the one owed as many times 25 francs, as the other owed pounds. When this was the case, a bill on France for 2500 francs would be worth in England 100l., and a bill on England for 100l. would be worth in France 2500 francs. The exchange is then said to be at par: and 25 francs (in reality 25 francs and a trifle more)∗ is called the par of exchange with France. When England owed to France more than the equivalent of what France owed to her, a bill for 2500 francs would be at a premium, that is, would be worth more than 100l. When France owed to England more than the equivalent of what England owed to France, a bill for 2500 francs would be worth less than 100l., or would be at a discount.

When bills on foreign countries are at a premium, it is customary to say that the exchanges are against the country, or unfavourable to it. In order to understand these phrases, we must take notice of what “the exchange,” in the language of merchants, really means. It means the power which the money of the country has of purchasing the money of other countries. Supposing 25 francs to be the exact par of exchange, then when it requires more than 100l. to buy a bill for 2500 francs, 100l. of English money are worth less than their real equivalent of French money: and this is called an exchange unfavourable to England. The only persons in England, however, to whom it is really unfavourable are those who have money to pay in France; for they come into the bill market as buyers, and have to pay a premium: but to those who have money to receive in France, the same state of things is favourable; for they come as sellers, and receive the premium. The premium, however, indicates that a balance is due by England, which might have to be eventually liquidated in the precious metals: and since, according to the old theory, the benefit of a trade consisted in bringing money into the country, this prejudice introduced the practice of calling the exchange favourable when it indicated a balance to receive, and unfavourable when it indicated one to pay: and the phrases in turn tended to maintain the prejudice.

§ 3. It might be supposed at first sight that when the exchange is unfavourable, or, in other words, when bills are at a premium, the premium must always amount to a full equivalent for the cost of transmitting money: since, as there is really a balance to pay, and as the full cost must therefore be incurred by some of those who have remittances to make, their competition will compel all to submit to an equivalent sacrifice. And such would certainly be the case, if it were always necessary that whatever is destined to be paid should be paid immediately. The expectation of great and immediate foreign payments sometimes produces a most startling effect on the exchanges.∗ But a small excess of imports above exports, or any other small amount of debt to be paid to foreign countries, does not usually affect the exchanges to the full extent of the cost and risk of transporting bullion. The length of credit allowed generally permits, on the part of some of the debtors, a postponement of payment, and in the mean time the balance may turn the other way, and restore the equality of debts and credits without any actual transmission of the metals. And this is the more likely to happen, as there is a self-adjusting power in the variations of the exchange itself. Bills are at a premium because a greater money value has been imported than exported. But the premium is itself an extra profit to those who export. Besides the price they obtain for their goods, they draw for the amount and gain the premium. It is, on the other hand, a diminution of profit to those who import. Besides the price of the goods, they have to pay a premium for remittance. So that what is called an unfavourable exchange is an encouragement to export, and a discouragement to import. And if the balance due is of small amount, and is the consequence of some merely casual disturbance in the ordinary course of trade, it is soon liquidated in commodities, and the account adjusted by means of bills, without the transmission of any bullion. Not so, however, when the excess of imports above exports, which has made the exchange unfavourable, arises from a permanent cause. In that case, what disturbed the equilibrium must have been the state of prices, and it can only be restored by acting on prices. It is impossible that prices should be such as to invite to an excess of imports, and yet that the exports should be kept permanently up to the imports by the extra profit on exportation derived from the premium on bills; for if the exports were kept up to the imports, bills would not be at a premium, and the extra profit would not exist. It is through the prices of commodities that the correction must be administered.

Disturbances, therefore, of the equilibrium of imports and exports, and consequent disturbances of the exchange, may be considered as of two classes; the one casual or accidental, which, if not on too large a scale, correct themselves through the premium on bills, without any transmission of the precious metals; the other arising from the general state of prices, which cannot be corrected without the subtraction of actual money from the circulation of one of the counties, or an annihilation of credit equivalent to it; since the mere transmission of bullion (as distinguished from money), not having any effect on prices, is of no avail to abate the cause from which the disturbance proceeded.

It remains to observe, that the exchanges do not depend on the balance of debts and credits with each country separately, but with all counties taken together. England may owe a balance of payments to France; but it does not follow that the exchange with France will be against England, and that bills on France will be at a premium; because a balance may be due to England from Holland or Hamburg, and she may pay her debts to France with bills on those places; which is technically called arbitration of exchange. There is some little additional expense, partly commission and partly loss of interest, in settling debts in this circuitous manner, and to the extent of that small difference the exchange with one country may vary apart from that with others; but in the main, the exchanges with all foreign countries vary together, according as the country has a balance to receive or to pay on the general result of its foreign transactions.

Book III, Chapter XXI: Of the distribution of the precious metals through the commercial world

CHAPTER XXI: of the distribution of the precious metals through the commercial world

§ 1. Having now examined the mechanism by which the commercial transactions between nations are actually conducted, we have next to inquire whether this mode of conducting them makes any difference in the conclusions respecting international values, which we previously arrived at on the hypothesis of barter.

The nearest analogy would lead us to presume the negative. We did not find that the intervention of money and its substitutes made any difference in the law of value as applied to adjacent places. Things which would have been equal in value if the mode of exchange had been by barter, are worth equal sums of money. The introduction of money is a mere addition of one more commodity, of which the value is regulated by the same laws as that of all other commodities. We shall not be surprised, therefore, if we find that international values also are determined by the same causes under a money and bill system, as they would be under a system of barter; and that money has little to do in the matter, except to furnish a convenient mode of comparing values.

All interchange is, in substance and effect, barter: whoever sells commodities for money, and with that money buys other goods, really buys those goods with his own commodities. And so of nations: their trade is a mere exchange of exports for imports; and whether money is employed or not, things are only in their permanent state when the exports and imports exactly pay for each other. When this is the case, equal sums of money are due from each country to the other, the debts are settled by bills, and there is no balance to be paid in the precious metals. The trade is in a state like that which is called in mechanics a condition of stable equilibrium.

But the process by which things are brought back to this state when they happen to deviate from it, is, at least outwardly, not the same in a barter system and in a money system. Under the first, the country which wants more imports than its exports will pay for, must offer its exports at a cheaper rate, as the sole means of creating a demand for them sufficient to re-establish the equilibrium. When money is used, the country seems to do a thing totally different. She takes the additional imports at the same price as before, and as she exports no equivalent, the balance of payments turns against her; the exchange becomes unfavourable, and the difference has to be paid in money. This is in appearance a very distinct operation from the former. Let us see if it differs in its essence, or only in its mechanism.

Let the country which has the balance to pay be England, and the country which receives it, France. By this transmission of the precious metals, the quantity of the currency is diminished in England, and increased in France. This I am at liberty to assume. As we shall see hereafter, it would be a very erroneous assumption if made in regard to all payments of international balances. A balance which has only to be paid once, such as the payment made for an extra importation of corn in a season of dearth, may be paid from hoards, or from the reserves of bankers, without acting on the circulation. But we are now supposing that there is an excess of imports over exports, arising from the fact that the equation of international demand is not yet established: that there is at the ordinary prices a permanent demand in England for more French goods than the English goods required in France at the ordinary prices will pay for. When this is the case, if a change were not made in the prices, there would be a perpetually renewed balance to be paid in money. The imports require to be permanently diminished, or the exports to be increased; which can only be accomplished through prices; and hence, even if the balances are at first paid from hoards, or by the exportation of bullion, they will reach the circulation at last, for until they do, nothing can stop the drain.

When, therefore, the state of prices is such that the equation of international demand cannot establish itself, the country requiring more imports than can be paid for by the exports; it is a sign that the country has more of the precious metals or their substitutes in circulation, than can permanently circulate, and must necessarily part with some of them before the balance can be restored. The currency is accordingly contracted: prices fall, and among the rest, the prices of exportable articles; for which, accordingly, there arises, in foreign countries, a greater demand: while imported commodities have possibly risen in price, from the influx of money into foreign countries, and at all events have not participated in the general fall. But until the increased cheapness of English goods induces foreign countries to take a greater pecuniary value, or until the increased dearness (positive or comparative) of foreign goods makes England take a less pecuniary value, the exports of England will be no nearer to paying for the imports than before, and the stream of the precious metals which had begun to flow out of England, will still flow on. This efflux will continue, until the fall of prices in England brings within reach of the foreign market some commodity which England did not previously send thither; or until the reduced price of the things which she did send, has forced a demand abroad for a sufficient quantity to pay for the imports, aided, perhaps, by a reduction of the English demand for foreign goods, through their enhanced price, either positive or comparative.

Now this is the very process which took place on our original supposition of barter. Not only, therefore, does the trade between nations tend to the same equilibrium between exports and imports, whether money is employed or not, but the means by which this equilibrium is established are essentially the same. The country whose exports are not sufficient to pay for her imports, offers them on cheaper terms, until she succeeds in forcing the necessary demand: in other words, the Equation of International Demand, under a money system as well as under a barter system, is the law of international trade. Every country exports and imports the very same things, and in the very same quantity, under the one system as under the other. In a barter system, the trade gravitates to the point at which the sum of the imports exactly exchanges for the sum of the exports: in a money system, it gravitates to the point at which the sum of the imports and the sum of the exports exchange for the same quantity of money. And since things which are equal to the same thing are equal to one another, the exports and imports which are equal in money price, would, if money were not used, precisely exchange for one another.∗

§ 2. It thus appears that the law of international values, and, consequently, the division of the advantages of trade among the nations which carry it on, are the same, on the supposition of money, as they would be in a state of barter. In international, as in ordinary domestic interchanges, money is to commerce only what oil is to machinery, or railways to locomotion—a contrivance to diminish friction. In order still further to test these conclusions, let us proceed to re-examine, on the supposition of money, a question which we have already investigated on the hypothesis of barter, namely, to what extent the benefit of an improvement in the production of an exportable article is participated in by the countries importing it.

The improvement may either consist in the cheapening of some article which was already a staple production of the country, or in the establishment of some new branch of industry, or of some process rendering an article exportable which had not till then been exported at all. It will be convenient to begin with the case of a new export, as being somewhat the simpler of the two.

The first effect is that the article falls in price, and a demand arises for it abroad. This new exportation disturbs the balance, turns the exchanges, money flows into the country (which we shall suppose to be England), and continues to flow until prices rise. This higher range of prices will somewhat check the demand in foreign countries for the new article of export; and will diminish the demand which existed abroad for the other things which England was in the habit of exporting. The exports will thus be diminished; while at the same time the English public, having more money, will have a greater power of purchasing foreign commodities. If they make use of this increased power of purchase, there will be an increase of imports: and by this, and the check to exportation, the equilibrium of imports and exports will be restored. The result to foreign countries will be, that they have to pay dearer than before for their other imports, and obtain the new commodity cheaper than before, but not so much cheaper as England herself does. I say this, being well aware that the article would be actually at the very same price (cost of carriage excepted) in England and in other countries. The cheapness, however, of the article is not measured solely by the money-price, but by that price compared with the money incomes of the consumers. The price is the same to the English and to the foreign consumers; but the former pay that price from money incomes which have been increased by the new distribution of the precious metals; while the latter have had their money incomes probably diminished by the same cause. The trade, therefore, has not imparted to the foreign consumer the whole, but only a portion, of the benefit which the English consumer has derived from the improvement; while England has also benefited in the prices of foreign commodities. Thus, then, any industrial improvement which leads to the opening of a new branch of export trade, benefits a country not only by the cheapness of the article in which the improvement has taken place, but by a general cheapening of all imported products.

Let us now change the hypothesis, and suppose that the improvement, instead of creating a new export from England, cheapens an existing one. When we examined this case on the supposition of barter, it appeared to us that the foreign consumers might either obtain the same benefit from the improvement as England herself, or a less benefit, or even a greater benefit, according to the degree in which the consumption of the cheapened article is calculated to extend itself as the article diminishes in price. The same conclusions will be found true on the supposition of money.

Let the commodity in which there is an improvement, be cloth. The first effect of the improvement is that its price falls, and there is an increased demand for it in the foreign market. But this demand is of uncertain amount. Suppose the foreign consumers to increase their purchases in the exact ratio of the cheapness, or, in other words, to lay out in cloth the same sum of money as before; the same aggregate payment as before will be due from foreign countries to England; the equilibrium of exports and imports will remain undisturbed, and foreigners will obtain the full advantage of the increased cheapness of cloth. But if the foreign demand for cloth is of such a character as to increase in a greater ratio than the cheapness, a larger sum than formerly will be due to England for cloth, and when paid will raise English prices, the price of cloth included; this rise, however, will affect only the foreign purchaser, English incomes being raised in a corresponding proportion; and the foreign consumer will thus derive a less advantage than England from the improvement. If, on the contrary, the cheapening of cloth does not extend the foreign demand for it in a proportional degree, a less sum of debts than before will be due to England for cloth, while there will be the usual sum of debts due from England to foreign countries; the balance of trade will turn against England, money will be exported, prices (that of cloth included) will fall, and cloth will eventually be cheapened to the foreign purchaser in a still greater ratio than the improvement has cheapened it to England. These are the very conclusions which we deduced on the hypothesis of barter.

The result of the preceding discussion cannot be better summed up than in the words of Ricardo.∗ “Gold and silver having been chosen for the general medium of circulation, they are, by the competition of commerce, distributed in such proportions amongst the different countries of the world as to accommodate themselves to the natural traffic which would take place if no such metals existed, and the trade between countries were purely a trade of barter.” Of this principle, so fertile in consequences, previous to which the theory of foreign trade was an unintelligible chaos, Mr. Ricardo, though he did not pursue it into its ramifications, was the real originator. No writer who preceded him appears to have had a glimpse of it: and few are those who even since his time have had an adequate conception of its scientific value.

§ 3. It is now necessary to inquire, in what manner this law of the distribution of the precious metals by means of the exchanges, affects the exchange value of money itself; and how it tallies with the law by which we found that the value of money is regulated when imported as a mere article of merchandize. For there is here a semblance of contradiction, which has, I think, contributed more than anything else to make some distinguished political economists resist the evidence of the preceding doctrines. Money, they justly think, is no exception to the general laws of value; it is a commodity like any other, and its average or natural value must depend on the cost of producing, or at least of obtaining it. That its distribution through the world, therefore, and its different value in different places, should be liable to be altered, not by causes affecting itself, but by a hundred causes unconnected with it; by everything which affects the trade in other commodities, so as to derange the equilibrium of exports and imports; appears to these thinkers a doctrine altogether inadmissible.

But the supposed anomaly exists only in semblance. The causes which bring money into or carry it out of a country through the exchanges, to restore the equilibrium of trade, and which thereby raise its value in some countries and lower it in others, are the very same causes on which the local value of money would depend if it were never imported except as a merchandize, and never except directly from the mines. When the value of money in a country is permanently lowered by an influx of it through the balance of trade, the cause, if it is not diminished cost of production, must be one of those causes which compel a new adjustment, more favourable to the country, of the equation of international demand: namely, either an increased demand abroad for her commodities, or a diminished demand on her part for those of foreign countries. Now an increased foreign demand for the commodities of a country, or a diminished demand in the country for imported commodities, are the very causes which, on the general principles of trade, enable a country to purchase all imports, and consequently the precious metals, at a lower value. There is therefore no contradiction, but the most perfect accordance in the results of the two different modes in which the precious metals may be obtained. When money flows from country to country in consequence of changes in the international demand for commodities, and by so doing alters its own local value, it merely realizes, by a more rapid process, the effect which would otherwise take place more slowly, by an alteration in the relative breadth of the streams by which the precious metals flow into different regions of the earth from the mining countries. As, therefore we before saw that the use of money as a medium of exchange does not in the least alter the law on which the values of other things, either in the same country or internationally, depend, so neither does it alter the law of the value of the precious metal itself: and there is in the whole doctrine of international values, as now laid down, a unity and harmony which is a strong collateral presumption of truth.

§ 4. Before closing this discussion, it is fitting to point out in what manner and degree the preceding conclusions are affected by the existence of international payments not originating in commerce, and for which no equivalent in either money or commodities is expected or received; such as a tribute, or remittances of rent to absentee landlords, or of interest to foreign creditors, or a government expenditure abroad, such as England incurs in the management of some of her colonial dependencies.

To begin with the case of barter. The supposed annual remittances being made in commodities, and being exports for which there is to be no return, it is no longer requisite that the imports and exports should pay for one another: on the contrary, there must be an annual excess of exports over imports, equal to the value of the remittance. If, before the country became liable to the annual payment, foreign commerce was in its natural state of equilibrium, it will now be necessary for the purpose of effecting the remittance, that foreign countries should be induced to take a greater quantity of exports than before: which can only be done by offering those exports on cheaper terms, or, in other words, by paying dearer for foreign commodities. The international values will so adjust themselves that either by greater exports, or smaller imports, or both, the requisite excess on the side of exports will be brought about; and this excess will become the permanent state. The result is that a country which makes regular payments to foreign countries, besides losing what it pays, loses also something more, by the less advantageous terms on which it is forced to exchange its productions for foreign commodities.

The same results follow on the supposition of money. Commerce being supposed to be in a state of equilibrium when the obligatory remittances begin, the first remittance is necessarily made in money. This lowers prices in the remitting country, and raises them in the receiving. The natural effect is that more commodities are exported than before, and fewer imported, and that, on the score of commerce alone, a balance of money will be constantly due from the receiving to the paying country. When the debt thus annually due to the tributary country becomes equal to the annual tribute or other regular payment due from it, no further transmission of money takes place; the equilibrium of exports and imports will no longer exist, but that of payments will; the exchange will be at par, the two debts will be set off against one another, and the tribute or remittance will be virtually paid in goods. The result to the interest of the two countries will be as already pointed out: the paying country will give a higher price for all that it buys from the receiving country, while the latter, besides receiving the tribute, obtains the exportable produce of the tributary country at a lower price.

Book III, Chapter XXII: Influence of the currency on the exchanges and on foreign trade

CHAPTER XXII: influence of the currency on the exchanges and on foreign trade

§ 1. In our inquiry into the laws of international trade, we commenced with the principles which determine international exchanges and international values on the hypothesis of barter. We next showed that the introduction of money as a medium of exchange makes no difference in the laws of exchanges and of values between country and country, no more than between individual and individual: since the precious metals, under the influence of those same laws, distribute themselves in such proportions among the different countries of the world, as to allow the very same exchanges to go on, and at the same values, as would be the case under a system of barter. We lastly considered how the value of money itself is affected, by those alterations in the state of trade which arises from alterations either in the demand and supply of commodities, or in their cost of production. It remains to consider the alterations in the state of trade which originate not in commodities but in money.

Gold and silver may vary like other things, though they are not so likely to vary as other things, in their cost of production. The demand for them in foreign countries may also vary. It may increase, by augmented employment of the metals for purposes of art and ornament, or because the increase of production and of transactions has created a greater amount of business to be done by the circulating medium. It may diminish, for the opposite reasons; or from the extension of the economizing expedients by which the use of metallic money is partially dispensed with. These changes act upon the trade between other countries and the mining countries, and upon the value of the precious metals, according to the general laws of the value of imported commodities: which have been set forth in the previous chapters with sufficient fulness.

What I propose to examine in the present chapter, is not those circumstances affecting money, which alter the permanent conditions of its value; but the effects produced on international trade by casual or temporary variations in the value of money, which have no connexion with any causes affecting its permanent value. This is a subject of importance, on account of its bearing upon the practical problem which has excited so much discussion for sixty years past, the regulation of the currency.

§ 2. Let us suppose in any country a circulating medium purely metallic, and a sudden casual increase made to it; for example, by bringing into circulation hoards of treasure, which had been concealed in a previous period of foreign invasion or internal disorder. The natural effect would be a rise of prices. This would check exports, and encourage imports; the imports would exceed the exports, the exchanges would become unfavourable, and the newly acquired stock of money would diffuse itself over all countries with which the supposed country carried on trade, and from them, progressively, through all parts of the commercial world. The money which thus overflowed would spread itself to an equal depth over all commercial countries. For it would go on flowing until the exports and imports again balanced one another: and this (as no change is supposed in the permanent circumstances of international demand) could only be, when the money had diffused itself so equally that prices had risen in the same ratio in all countries, so that the alteration of price would be for all practical purposes ineffective, and the exports and imports, though at a higher money valuation, would be exactly the same as they were originally. This diminished value of money throughout the world (at least, if the diminution was considerable) would cause a suspension, or at least a diminution, of the annual supply from the mines: since the metal would no longer command a value equivalent to its highest cost of production. The annual waste would, therefore, not be fully made up, and the usual causes of destruction would gradually reduce the aggregate quantity of the precious metals to its former amount; after which their production would recommence on its former scale. The discovery of the treasure would thus produce only temporary effects; namely, a brief disturbance of international trade until the treasure had disseminated itself through the world, and then a temporary depression in the value of the metal, below that which corresponds to the cost of producing or of obtaining it; which depression would gradually be corrected, by a temporarily diminished production in the producing countries, and importation in the importing countries.

The same effects which would thus arise from the discovery of a treasure, accompany the process by which bank notes, or any of the other substitutes for money, take the place of the precious metals. Suppose that England possessed a currency wholly metallic of twenty millions sterling, and that suddenly twenty millions of bank notes were sent into circulation. If these were issued by bankers, they would be employed in loans, or in the purchase of securities, and would therefore create a sudden fall in the rate of interest, which would probably send a great part of the twenty millions of gold out of the country as capital to seek a higher rate of interest elsewhere, before there had been time for any action on prices. But we will suppose that the notes are not issued by bankers, or money-lenders of any kind, but by manufacturers, in the payment of wages and purchase of materials, or by the government in its ordinary expenses, so that the whole amount would be rapidly carried into the markets for commodities. The following would be the natural order of consequences. All prices would rise greatly. Exportation would almost cease; importation would be prodigiously stimulated. A great balance of payments would become due, the exchanges would turn against England, to the full extent of the cost of exporting money; and the surplus coin would pour itself rapidly forth, over the various countries of the world, in the order of their proximity, geographically and commercially, to England. The efflux would continue until the currencies of all countries had come to a level; by which I do not mean, until money became of the same value everywhere, but until the differences were only those which existed before, and which corresponded to permanent differences in the cost of obtaining it. When the rise of prices had extended itself in an equal degree to all countries, exports and imports would everywhere revert to what they were at first, would balance one another, and the exchanges would return to par. If such a sum of money as twenty millions, when spread over the whole surface of the commercial world, were sufficient to raise the general level in a perceptible degree, the effect would be of no long duration. No alteration having occurred in the general conditions under which the metals were procured, either in the world at large or in any part of it, the reduced value would no longer be remunerating and the supply from the mines would cease partially or wholly, until the twenty millions were absorbed;∗ after which absorption, the currencies of all countries would be, in quantity and in value, nearly at their original level. I say nearly, for in strict accuracy there would be a slight difference. A somewhat smaller annual supply of the precious metals would now be required, there being in the world twenty millions less of metallic money undergoing waste. The equilibrium of payments, consequently, between the mining countries and the rest of the world, would thenceforth require that the mining countries should either export rather more of something else, or import rather less of foreign commodities; which implies a somewhat lower range of prices than previously in the mining countries, and a somewhat higher in all others; a scantier currency in the former, and rather fuller currencies in the latter. This effect, which would be too trifling to require notice except for the illustration of a principle, is the only permanent change which would be produced on international trade, or on the value or quantity of the currency of any country.

Effects of another kind, however, will have been produced. Twenty millions, which formerly existed in the unproductive form of metallic money, have been converted into what is, or is capable of becoming, productive capital. This gain is at first made by England at the expense of other countries, who have taken her superfluity of this costly and unproductive article off her hands, giving for it an equivalent value in other commodities. By degrees the loss is made up to those countries by diminished influx from the mines, and finally the world has gained a virtual addition of twenty millions to its productive resources. Adam Smith’s illustration, though so well known, deserves for its extreme aptness to be once more repeated. He compares the substitution of paper in the room of the precious metals, to the construction of a highway through the air, by which the ground now occupied by roads would become available for agriculture. As in that case a portion of the soil, so in this a part of the accumulated wealth of the country, would be relieved from a function in which it was only employed in rendering other soils and capitals productive, and would itself become applicable to production; the office it previously fulfilled being equally well discharged by a medium which costs nothing.

The value saved to the community by thus dispensing with metallic money, is a clear gain to those who provide the substitute. They have the use of twenty millions of circulating medium which have cost them only the expense of an engraver’s plate. If they employ this accession to their fortunes as productive capital, the produce of the country is increased, and the community benefited, as much as by any other capital of equal amount. Whether it is so employed or not, depends, in some degree, upon the mode of issuing it. If issued by the government, and employed in paying off debt, it would probably become productive capital. The government, however, may prefer employing this extraordinary resource in its ordinary expenses; may squander it uselessly, or make it a mere temporary substitute for taxation to an equivalent amount; in which last case the amount is saved by the taxpayers at large, who either add it to their capital or spend it as income. When paper currency is supplied, as in our own country, by bankers and banking companies, the amount is almost wholly turned into productive capital: for the issuers, being at all times liable to be called upon to refund the value, are under the strongest inducements not to squander it, and the only cases in which it is not forthcoming are cases of fraud or mismanagement. A banker’s profession being that of a money-lender, his issue of notes is a simple extension of his ordinary occupation. He lends the amount to farmers, manufacturers, or dealers, who employ it in their several businesses. So employed, it yields, like any other capital, wages of labour and profits of stock. The profit is shared between the banker, who receives interest, and a succession of borrowers, mostly for short periods, who after paying the interest, gain a profit in addition, or a convenience equivalent to profit. The capital itself in the long run becomes entirely wages, and when replaced by the sale of the produce, becomes wages again; thus affording a perpetual fund, of the value of twenty millions, for the maintenance of productive labour, and increasing the annual produce of the country by all that can be produced through the means of a capital of that value. To this gain must be added a further saving to the country, of the annual supply of the precious metals necessary for repairing the wear and tear, and other waste, of a metallic currency.

The substitution, therefore, of paper for the precious metals, should always be carried as far as is consistent with safety; no greater amount of metallic currency being retained than is necessary to maintain, both in fact and in public belief, the convertibility of the paper. A country with the extensive commercial relations of England is liable to be suddenly called upon for large foreign payments, sometimes in loans, or other investments of capital abroad, sometimes as the price of some unusual importation of goods, the most frequent case being that of large importations of food consequent on a bad harvest. To meet such demands it is necessary that there should be, either in circulation or in the coffers of the banks, coin or bullion to a very considerable amount, and that this, when drawn out by any emergency, should be allowed to return after the emergency is past. But since gold wanted for exportation is almost invariably drawn from the reserves of the banks, and is never likely to be taken directly from the circulation while the banks remain solvent, the only advantage which can be obtained from retaining partially a metallic currency for daily purposes is that the banks may occasionally replenish their reserves from it.

§ 3. When metallic money had been entirely superseded and expelled from circulation, by the substitution of an equal amount of bank notes, any attempt to keep a still further quantity of paper in circulation must, if the notes are convertible, be a complete failure. The new issue would again set in motion the same train of consequences by which the gold coin had already been expelled. The metals would, as before, be required for exportation, and would be for that purpose demanded from the banks, to the full extent of the superfluous notes; which thus could not possibly be retained in circulation. If, indeed, the notes were inconvertible, there would be no such obstacle to the increase of their quantity. An inconvertible paper acts in the same way as a convertible, while there remains any coin for it to supersede: the difference begins to manifest itself when all the coin is driven from circulation (except what may be retained for the convenience of small change), and the issues still go on increasing. When the paper begins to exceed in quantity the metallic currency which it superseded, prices of course rise; things which were worth 5l. in metallic money, become worth 6l. in inconvertible paper, or more, as the case may be. But this rise of price will not, as in the cases before examined, stimulate import, and discourage export. The imports and exports are determined by the metallic prices of things, not by the paper prices: and it is only when the paper is exchangeable at pleasure for the metals that paper prices and metallic prices must correspond.

Let us suppose that England is the country which has the depreciated paper. Suppose that some English production could be bought, while the currency was still metallic, for 5l., and sold in France for 5l. 10s., the difference covering the expense and risk, and affording a profit to the merchant. On account of the depreciation this commodity will now cost in England 6l., and cannot be sold in France for more than 5l. 10s., and yet it will be exported as before. Why? Because the 5l. 10s., which the exporter can get for it in France, is not depreciated paper, but gold or silver: and since in England bullion has risen, in the same proportion with other things—if the merchant brings the gold or silver to England, he can sell his 5l. 10s. for 6l. 12s., and obtain as before 10 per cent for profit and expenses.

It thus appears, that a depreciation of the currency does not affect the foreign trade of the country: this is carried on precisely as if the currency maintained its value. But though the trade is not affected, the exchanges are. When the imports and exports are in equilibrium, the exchange, in a metallic currency, would be at par; a bill on France for the equivalent of five sovereigns, would be worth five sovereigns. But five sovereigns, or the quantity of gold contained in them, having come to be worth in England 6l., it follows that a bill on France for 5l. will be worth 6l. When, therefore, the real exchange is at par, there will be a nominal exchange against the country, of as much per cent as the amount of the depreciation. If the currency is depreciated 10, 15, or 20 per cent, then in whatever way the real exchange, arising from the variations of international debts and credits, may vary, the quoted exchange will always differ 10, 15, or 20 per cent from it. However high this nominal premium may be, it has no tendency to send gold out of the country, for the purpose of drawing a bill against it and profiting by the premium; because the gold so sent must be procured, not from the banks and at par, as in the case of a convertible currency, but in the market at an advance of price equal to the premium. In such cases, instead of saying that the exchange is unfavourable, it would be a more correct representation to say that the par has altered, since there is now required a larger quantity of English currency to be equivalent to the same quantity of foreign. The exchanges, however, continue to be computed according to the metallic par. The quoted exchanges, therefore, when there is a depreciated currency, are compounded of two elements or factors; the real exchange, which follows the variations of international payments, and the nominal exchange, which varies with the depreciation of the currency, but which, while there is any depreciation at all, must always be unfavourable. Since the amount of depreciation is exactly measured by the degree in which the market price of bullion exceeds the Mint valuation, we have a sure criterion to determine what portion of the quoted exchange, being referable to depreciation, may be struck off as nominal; the result so corrected expressing the real exchange.

The same disturbance of the exchanges and of international trade, which is produced by an increased issue of convertible bank notes, is in like manner produced by those extensions of credit, which, as was so fully shown in a preceding chapter, have the same effect on prices as an increase of the currency. Whenever circumstances have given such an impulse to the spirit of speculation as to occasion a great increase of purchases on credit, money prices rise, just as much as they would have risen if each person who so buys on credit had bought with money. All the effects, therefore, must be similar. As a consequence of high prices, exportation is checked and importation stimulated; though in fact the increase of importation seldom waits for the rise of prices which is the consequence of speculation, inasmuch as some of the great articles of import are usually among the things in which speculative overtrading first shows itself. There is, therefore, in such periods, usually a great excess of imports over exports; and when the time comes at which these must be paid for, the exchanges become unfavourable, and gold flows out of the country. In what precise manner this efflux of gold takes effect on prices, depends on circumstances of which we shall presently speak more fully; but that its effect is to make them recoil downwards, is certain and evident. The recoil, once begun, generally becomes a total rout, and the unusual extension of credit is rapidly exchanged for an unusual contraction of it. Accordingly, when credit has been imprudently stretched, and the speculative spirit carried to excess, the turn of the exchanges, and consequent pressure on the banks to obtain gold for exportation, are generally the proximate cause of the catastrophe. But these phenomena, though a conspicuous accompaniment, are no essential part of the collapse of credit called a commercial crisis; which, as we formerly showed,∗ might happen to as great an extent, and is quite as likely to happen, in a country, if any such there were, altogether destitute of foreign trade.

Book III, Chapter XXIII: Of the rate of interest

CHAPTER XXIII: of the rate of interest

§ 1. The present seems the most proper place for discussing the circumstances which determine the rate of interest. The interest of loans, being really a question of exchange value, falls naturally into the present division of our subject: and the two topics of Currency and Loans, though in themselves distinct, are so intimately blended in the phenomena of what is called the money market, that it is impossible to understand the one without the other, and in many minds the two subjects are mixed up in the most inextricable confusion.

In the preceding Book∗ we defined the relation in which interest stands to profit. We found that the gross profit of capital might be distinguished into three parts, which are respectively the remuneration for risk, for trouble, and for the capital itself, and may be termed insurance, wages of superintendence, and interest. After making compensation for risk, that is, after covering the average losses to which capital is exposed either by the general circumstances of society or by the hazards of the particular employment, there remains a surplus, which partly goes to repay the owner of the capital for his abstinence, and partly the employer of it for his time and trouble. How much goes to the one and how much to the other, is shown by the amount of the remuneration which, when the two functions are separated, the owner of capital can obtain from the employer for its use. This is evidently a question of demand and supply. Nor have demand and supply any different meaning or effect in this case from what they have in all others. The rate of interest will be such as to equalize the demand for loans with the supply of them. It will be such, that exactly as much as some people are desirous to borrow at that rate, others shall be willing to lend. If there is more offered than demanded, interest will fall; if more is demanded than offered, it will rise; and in both cases, to the point at which the equation of supply and demand is re-established.

Both the demand and supply of loans fluctuate more incessantly than any other demand or supply whatsoever. The fluctuations in other things depend on a limited number of influencing circumstances; but the desire to borrow, and the willingness to lend, are more or less influenced by every circumstance which affects the state or prospects of industry or commerce, either generally or in any of their branches. The rate of interest, therefore, on good security, which alone we have here to consider (for interest in which considerations of risk bear a part may swell to any amount) is seldom, in the great centres of money transactions, precisely the same for two days together; as is shown by the never-ceasing variations in the quoted prices of the funds and other negotiable securities. Nevertheless, there must be, as in other cases of value, some rate which (in the language of Adam Smith and Ricardo) may be called the natural rate; some rate about which the market rate oscillates, and to which it always tends to return. This rate partly depends on the amount of accumulation going on in the hands of persons who cannot themselves attend to the employment of their savings, and partly on the comparative taste existing in the community for the active pursuits of industry, or for the leisure, ease, and independence of an annuitant.

§ 2. To exclude casual fluctuations, we will suppose commerce to be in a quiescent condition, no employment being unusually prosperous, and none particularly distressed. In these circumstances, the more thriving producers and traders have their capital fully employed, and many are able to transact business to a considerably greater extent than they have capital for. These are naturally borrowers: and the amount which they desire to borrow, and can obtain credit for, constitutes the demand for loans on account of productive employment. To these must be added the loans required by Government, and by landowners, or other unproductive consumers who have good security to give. This constitutes the mass of loans for which there is an habitual demand.

Now it is conceivable that there might exist, in the hands of persons disinclined or disqualified for engaging personally in business, a mass of capital equal to, and even exceeding, this demand. In that case there would be an habitual excess of competition on the part of lenders, and the rate of interest would bear a low proportion to the rate of profit. Interest would be forced down to the point which would either tempt borrowers to take a greater amount of loans than they had a reasonable expectation of being able to employ in their business, or would so discourage a portion of the lenders, as to make them either forbear to accumulate, or endeavour to increase their income by engaging in business on their own account, and incurring the risks, if not the labours, of industrial employment.

On the other hand, the capital owned by persons who prefer lending it at interest, or whose avocations prevent them from personally superintending its employment, may be short of the habitual demand for loans. It may be in great part absorbed by the investments afforded by the public debt and by mortgages, and the remainder may not be sufficient to supply the wants of commerce. If so, the rate of interest will be raised so high as in some way to re-establish the equilibrium. When there is only a small difference between interest and profit, many borrowers may no longer be willing to increase their responsibilities and involve their credit for so small a remuneration: or some who would otherwise have engaged in business, may prefer leisure, and become lenders instead of borrowers, or others, under the inducement of high interest and easy investment for their capital, may retire from business earlier, and with smaller fortunes, than they otherwise would have done. Or, lastly, there is another process by which, in England and other commercial countries, a large portion of the requisite supply of loans is obtained. Instead of its being afforded by persons not in business, the affording it may itself become a business. A portion of the capital employed in trade may be supplied by a class of professional money lenders. These money lenders, however, must have more than a mere interest; they must have the ordinary rate of profit on their capital, risk and all other circumstances being allowed for. But it can never answer to any one who borrows for the purposes of his business, to pay a full profit for capital from which he will only derive a full profit: and money-lending, as an employment, for the regular supply of trade, cannot, therefore, be carried on except by persons who, in addition to their own capital, can lend their credit, or, in other words, the capital of other people: that is, bankers, and persons (such as bill-brokers) who are virtually bankers, since they receive money in deposit. A bank which lends its notes, lends capital which it borrows from the community, and for which it pays no interest. A bank of deposit lends capital which it collects from the community in small parcels; sometimes without paying any interest, as is the case with the London private bankers; and if, like the Scotch, the joint stock, and most of the country banks, it does pay interest, it still pays much less than it receives; for the depositors, who in any other way could mostly obtain for such small balances no interest worth taking any trouble for, are glad to receive even a little. Having this subsidiary resource, bankers are enabled to obtain, by lending at interest, the ordinary rate of profit on their own capital. In any other manner, money-lending could not be carried on as a regular mode of business, except upon terms on which none would consent to borrow but persons either counting on extraordinary profits, or in urgent need: unproductive consumers who have exceeded their means, or merchants in fear of bankruptcy. The disposable capital deposited in banks; that represented by bank notes; the capital of bankers themselves, and that which their credit, in any way in which they use it, enables them to dispose of; these, together with the funds belonging to those who, either from necessity or preference, live upon the interest of their property, constitute the general loan fund of the country: and the amount of this aggregate fund, when set against the habitual demands of producers and dealers, and those of the Government and of unproductive consumers, determines the permanent or average rate of interest; which must always be such as to adjust these two amounts to one another.∗ But while the whole of this mass of lent capital takes effect upon the permanent rate of interest, the fluctuations depend almost entirely upon the portion which is in the hands of bankers; for it is that portion almost exclusively which, being lent for short times only, is continually in the market seeking an investment. The capital of those who live on the interest of their own fortunes, has generally sought and found some fixed investment, such as the public funds, mortgages, or the bonds of public companies, which investment, except under peculiar temptations or necessities, is not changed.

§ 3. Fluctuations in the rate of interest arise from variations either in the demand for loans or in the supply. The supply is liable to variation, though less so than the demand. The willingness to lend is greater than usual at the commencement of a period of speculation, and much less than usual during the revulsion which follows. In speculative times, money-lenders as well as other people are inclined to extend their business by stretching their credit; they lend more than usual (just as other classes of dealers and producers employ more than usual) of capital which does not belong to them. Accordingly, these are the times when the rate of interest is low; though for this too (as we shall hereafter see) there are other causes. During the revulsion, on the contrary, interest always rises inordinately, because, while there is a most pressing need on the part of many persons to borrow, there is a general disinclination to lend. This disinclination, when at its extreme point, is called a panic. It occurs when a succession of unexpected failures has created in the mercantile, and sometimes also in the non-mercantile public, a general distrust in each other’s solvency; disposing every one not only to refuse fresh credit, except on very onerous terms, but to call in, if possible, all credit which he has already given. Deposits are withdrawn from banks; notes are returned on the issuers in exchange for specie; bankers raise their rate of discount, and withhold their customary advances; merchants refuse to renew mercantile bills. At such times the most calamitous consequences were formerly experienced from the attempt of the law to prevent more than a certain limited rate of interest from being given or taken. Persons who could not borrow at five per cent, had to pay, not six or seven, but ten or fifteen per cent, to compensate the lender for risking the penalties of the law: or had to sell securities or goods for ready money at a still greater sacrifice.

In the intervals between commercial crises, there is usually a tendency in the rate of interest to a progressive decline, from the gradual process of accumulation: which process, in the great commercial countries, is sufficiently rapid to account for the almost periodical recurrence of these fits of speculation; since, when a few years have elapsed without a crisis, and no new and tempting channel for investment has been opened in the meantime, there is always found to have occurred in those few years so large an increase of capital seeking investment, as to have lowered considerably the rate of interest, whether indicated by the prices of securities or by the rate of discount on bills; and this diminution of interest tempts the possessor to incur hazards in hopes of a more considerable return.

1 The rate of interest is, at times, affected more or less permanently by circumstances, though not of frequent, yet of occasional occurrence, which tend to alter the proportion between the class of interest-receiving and that of profit-receiving capitalists. Two causes of this description, operating in contrary ways, have manifested themselves of late years, and are now producing considerable effects in England. One is the gold discoveries. The masses of the precious metals which are constantly arriving from the gold countries, are, it may safely be said, wholly added to the funds that supply the loan market. So great an additional capital, not divided between the two classes of capitalists, but aggregated bodily to the capital of the interest-receiving class, disturbs the pre-existing ratio between the two, and tends to depress interest relatively to profit. Another circumstance of still more recent date, but tending to the contrary effect, is the legalization of joint-stock associations with limited liability. The shareholders in these associations, now so rapidly multiplying, are drawn almost exclusively from the lending class; from those who either left their disposable funds in deposit, to be lent out by bankers, or invested them in public or private securities, and received the interest. To the extent of their shares in any of these companies (with the single exception of banking companies) they have become traders on their own capital; they have ceased to be lenders, and have even, in most cases, passed over to the class of borrowers. Their subscriptions have been abstracted from the funds which feed the loan market, and they themselves have become competitors for a share of the remainder of those funds: of all which, the natural effect is a rise of interest. And it would not be surprising if, for a considerable time to come, the ordinary rate of interest in England should bear a higher proportion to the common rate of mercantile profit, than it has borne at any time since the influx of new gold set in.∗

The demand for loans varies much more largely than the supply, and embraces longer cycles of years in its aberrations. A time of war, for example, is a period of unusual drafts on the loan market. The Government, at such times, generally incurs new loans, and as these usually succeed each other rapidly as long as the war lasts, the general rate of interest is kept higher in war than in peace, without reference to the rate of profit, and productive industry is stinted of its usual supplies. During part of the last war with France, the Government could not borrow under six per cent, and of course all other borrowers had to pay at least as much. Nor does the influence of these loans altogether cease when the Government ceases to contract others; for those already contracted continue to afford an investment for a greatly increased amount of the disposable capital of the country, which if the national debt were paid off, would be added to the mass of capital seeking investment, and (independently of temporary disturbance) could not but, to some extent, permanently lower the rate of interest.

The same effect on interest which is produced by Government loans for war expenditure, is produced by the sudden opening of any new and generally attractive mode of permanent investment. The only instance of the kind in recent history on a scale comparable to that of the war loans, is the absorption of capital in the construction of railways. This capital must have been principally drawn from the deposits in banks, or from savings which would have gone into deposit, and which were destined to be ultimately employed in buying securities from persons who would have employed the purchase money in discounts or other loans at interest: in either case, it was a draft on the general loan fund. It is, in fact, evident, that unless savings were made expressly to be employed in railway adventure, the amount thus employed must have been derived either from the actual capital of persons in business, or from capital which would have been lent to persons in business. In the first case, the subtraction, by crippling their means, obliges them to be larger borrowers; in the second, it leaves less for them to borrow; in either case it equally tends to raise the rate of interest.

§ 4.1 I have, thus far, considered loans, and the rate of interest, as a matter which concerns capital in general, in direct opposition to the popular notion, according to which it only concerns money. In loans, as in all other money transactions, I have regarded the money which passes, only as the medium, and commodities as the thing really transferred—the real subject of the transaction. And this is, in the main, correct: because the purpose for which, in the ordinary course of affairs, money is borrowed, is to acquire a purchasing power over commodities. In an industrious and commercial country, the ulterior intention commonly is, to employ the commodities as capital: but even in the case of loans for unproductive consumption, as those of spendthrifts, or of the Government, the amount borrowed is taken from a previous accumulation, which would otherwise have been lent to carry on productive industry; it is, therefore, so much subtracted from what may correctly be called the amount of loanable capital.

There is, however, a not unfrequent case, in which the purpose of the borrower is different from what I have here supposed. He may borrow money, neither to employ it as capital nor to spend it unproductively, but to pay a previous debt. In this case, what he wants is not purchasing power, but legal tender, or something which a creditor will accept as equivalent to it. His need is specifically for money, not for commodities or capital. It is the demand arising from this cause, which produces almost all the great and sudden variations of the rate of interest. Such a demand forms one of the earliest features of a commercial crisis. At such a period, many persons in business who have contracted engagements, have been prevented by a change of circumstances from obtaining in time the means on which they calculated for fulfilling them. These means they must obtain at any sacrifice, or submit to bankruptcy; and what they must have is money. Other capital, however much of it they may possess, cannot answer the purpose unless money can first be obtained for it; while, on the contrary, without any increase of the capital of the country, a mere increase of circulating instruments of credit (be they of as little worth for any other purpose as the box of one pound notes discovered in the vaults of the Bank of England during the panic of 1825) will effectually serve their turn if only they are allowed to make use of it. An increased issue of notes, in the form of loans, is all that is required to satisfy the demand, and put an end to the accompanying panic. But although, in this case, it is not capital, or purchasing power, that the borrower needs, but money as money, it is not only money that is transferred to him. The money carries its purchasing power with it wherever it goes; and money thrown into the loan market really does, through its purchasing power, turn over an increased portion of the capital of the country into the direction of loans. Though money alone was wanted, capital passes; and it may still be said with truth that it is by an addition to loanable capital that the rise of the rate of interest is met and corrected.

Independently of this, however, there is a real relation, which it is indispensable to recognise, between loans and money. Loanable capital is all of it in the form of money. Capital destined directly for production exists in many forms; but capital destined for lending exists normally in that form alone. Owing to this circumstance, we should naturally expect that among the causes which affect more or less the rate of interest, would be found not only causes which act through capital, but some causes which act, directly at least, only through money.

1 The rate of interest bears no necessary relation to the quantity or value of the money in circulation. The permanent amount of the circulating medium, whether great or small, affects only prices; not the rate of interest. A depreciation of the currency, when it has become an accomplished fact, affects the rate of interest in no manner whatever. It diminishes indeed the power of money to buy commodities, but not the power of money to buy money. If a hundred pounds will buy a perpetual annuity of four pounds a year, a depreciation which makes the hundred pounds worth only half as much as before, has precisely the same effect on the four pounds, and cannot therefore alter the relation between the two. The greater or smaller number of counters which must be used to express a given amount of real wealth, makes no difference in the position or interests of lenders or borrowers, and therefore makes no difference in the demand and supply of loans. There is the same amount of real capital lent and borrowed; and if the capital in the hands of lenders is represented by a greater number of pounds sterling, the same greater number of pounds sterling will, in consequence of the rise of prices, be now required for the purposes to which the borrowers intend to apply them.

But though the greater or less quantity of money makes in itself no difference in the rate of interest, a change from a less quantity to a greater, or from a greater to a less, may and does make a difference in it.

Suppose money to be in process of depreciation by means of an inconvertible currency, issued by a government in payment of its expenses. This fact will in no way diminish the demand for real capital on loan; but it will diminish the real capital loanable, because, this existing only in the form of money, the increase of quantity depreciates it. Estimated in capital, the amount offered is less, while the amount required is the same as before. Estimated in currency, the amount offered is only the same as before, while the mount required, owing to the rise of prices, is greater. Either way, the rate of interest must rise. So that in this case increase of currency really affects the rate of interest, but in the contrary way to that which is generally supposed; by raising, not by lowering it.

The reverse will happen as the effect of calling in, or diminishing in quantity, a depreciated currency. The money in the hands of lenders, in common with all other money, will be enhanced in value, that is, there vill be a greater amount of real capital seeking borrowers; while the real capital wanted by borrowers will be only the same as before, and the money amount less: the rate of interest, therefore, will tend to fall.

We thus see that depreciation, merely as such, while in process of taking place, tends to raise the rate of interest: and the expectation of further depreciation adds to this effect; because lenders who expect that their interest will be paid and the principal perhaps redeemed, in a less valuable currency than they lent, of course require a rate of interest sufficient to cover this contingent loss.

But this effect is more than counteracted by a contrary one, when the additional money is thrown into circulation not by purchases but by loans. In England, and in most other commercial countries, the paper currency in common use, being a currency provided by bankers, is all issued in the way of loans, except the part employed in the purchase of gold and silver. The same operation, therefore, which adds to the currency also adds to the loans: the whole increase of currency in the first instance swells the loan market. Considered as an addition to loans it tends to lower interest, more than in its character of depreciation it tends to raise it; for the former effect depends on the ratio which the new money bears to the money lent, while the latter depends on its ratio to all the money in circulation. An increase, therefore, of currency issued by banks, tends, while the process continues, to bring down or to keep down the rate of interest. A similar effect is produced by the increase of money arising from the gold discoveries; almost the whole of which, as already noticed, is, when brought to Europe, added to the deposits in banks, and consequently to the amount of loans; and when drawn out and invested in securities, liberates an equivalent amount of other loanable capital. The newly-arrived gold can only get itself invested, in any given state of business, by lowering the rate of interest; and as long as the influx continues, it cannot fail to keep interest lower than, all other circumstances being supposed the same, would otherwise have been the case.

As the introduction of additional gold and silver, which goes into the loan market, tends to keep down the rate of interest, so any considerable abstraction of them from the country invariably raises it; even when occurring in the course of trade, as in paying for the extra importations caused by a bad harvest, or for the high-priced cotton which, under the influence of the American civil war, was imported from so many parts of the world. The money required for these payments is taken in the first instance from the deposits in the hands of bankers, and to that extent starves the fund that supplies the loan market.

The rate of interest, then, depends essentially and permanently on the comparative amount of real capital offered and demanded in the way of loan; but is subject to temporary disturbances of various sorts from increase and diminution of the circulating medium; which derangements are somewhat intricate, and sometimes in direct opposition to first appearances. All these distinctions are veiled over and confounded, by the unfortunate misapplication of language which designates the rate of interest by a phrase (“the value of money”) which properly expresses the purchasing power of the circulating medium. The public, even mercantile, habitually fancies that ease in the money market, that is, facility of borrowing at low interest, is proportional to the quantity of money in circulation. Not only, therefore, are bank notes supposed to produce effects as currency, which they only produce as loans, but attention is habitually diverted from effects similar in kind and much greater in degree, when produced by an action on loans which does not happen to be accompanied by any action on the currency.

For example, in considering the effect produced by the proceedings of banks in encouraging the excesses of speculation, an immense effect is usually attributed to their issues of notes, but until of late hardly any attention was paid to the management of their deposits; though nothing is more certain than that their imprudent extensions of credit take place more frequently by means of their deposits than of their issues. “There is no doubt,” says Mr. Tooke,∗ “that banks, whether private or joint stock, may, if imprudently conducted, minister to an undue extension of credit for the purpose of speculations, whether in commodities, or in over-trading in exports or imports, or in building or mining operations, and that they have so ministered not unfrequently, and in some cases to an extent ruinous to themselves, and without ultimate benefit to the parties to whose views their resources were made subservient.” But, “supposing all the deposits received by a banker to be in coin, is he not, just as much as the issuing banker, exposed to the importunity of customers, whom it may be impolitic to refuse, for loans or discounts, or to be tempted by a high interest? and may he not be induced to encroach so much upon his deposits as to leave him, under not improbable circumstances, unable to meet the demands of his depositors? In what respect, indeed, would the case of a banker in a perfectly metallic circulation differ from that of a London banker at the present day? He is not a creator of money, he cannot avail himself of his privilege as an issuer in aid of his other business, and yet there have been lamentable instances of London bankers issuing money in excess.”

In the discussions, too, which have been for so many years carried on respecting the operations of the Bank of England, and the effects produced by those operations on the state of credit, though for nearly half a century there never has been a commercial crisis which the Bank has not been strenuously accused either of producing or of aggravating, it has been almost universally assumed that the influence of its acts was felt only through the amount of its notes in circulation, and that if it could be prevented from exercising any discretion as to that one feature in its position, it would no longer have any power liable to abuse. This at least is an error which, after the experience of the year 1847, we may hope has been committed for the last time. During that year the hands of the bank were absolutely tied, in its character of a bank of issue; but through its operations as a bank of deposit it exercised as great an influence, or apparent influence, on the rate of interest and the state of credit, as at any former period; it was exposed to as vehement accusations of abusing that influence; and a crisis occurred, such as few that preceded it had equalled, and none perhaps surpassed, in intensity.

§ 5. Before quitting the general subject of this chapter, I will make the obvious remark, that the rate of interest determines the value and price of all those saleable articles which are desired and bought, not for themselves, but for the income which they are capable of yielding. The public funds, shares in joint-stock companies, and all descriptions of securities, are at a high price in proportion as the rate of interest is low. They are sold at the price which will give the market rate of interest on the purchase money, with allowance for all differences in the risk incurred, or in any circumstance of convenience. Exchequer bills, for example, usually sell at a higher price than consols, proportionally to the interest which they yield; because, though the security is the same, yet the former being annually paid off at par unless renewed by the holder, the purchaser (unless obliged to sell in a moment of general emergency), is in no danger of losing anything by the resale, except the premium he may have paid.

The price of land, mines, and all other fixed sources of income, depends in like manner on the rate of interest. Land usually sells at a higher price, in proportion to the income afforded by it, than the public funds, not only because it is thought, even in this country, to be somewhat more secure, but because ideas of power and dignity are associated with its possession. But these differences are constant, or nearly so; and in the variations of price, land follows, caeteris paribus, the permanent (though of course not the daily) variations of the rate of interest. When interest is low, land will naturally be dear; when interest is high, land will be cheap. The last long war presented a striking exception to this rule, since the price of land as well as the rate of interest was then remarkably high. For this, however, there was a special cause. The continuance of a very high average price of corn for many years had raised the rent of land even more than in proportion to the rise of interest and fall of the selling price of fixed incomes. Had it not been for this accident, chiefly dependent on the seasons, land must have sustained as great a depreciation in value as the public funds: which it probably would do, were a similar war to break out hereafter; to the signal disappointment of those landlords and farmers who, generalizing from the casual circumstances of a remarkable period, so long persuaded themselves that a state of war was peculiarly advantageous, and a state of peace disadvantageous, to what they chose to call the interests of agriculture.

Book III, Chapter XXIV: Of the regulation of a convertible paper currency

CHAPTER XXIV: of the regulation of a convertible paper currency

§ 1. The frequent recurrence during the last half century of the painful series of phenomena called a commercial crisis, has directed much of the attention both of economists and of practical politicians to the contriving of expedients for averting, or, at the least, mitigating its evils. And the habit which grew up during the era of the Bank restriction, of ascribing all alterations of high and low prices to the issues of banks, has caused inquirers in general to fix their hopes of success in moderating those vicissitudes upon schemes for the regulation of bank notes. A scheme of this nature, after having obtained the sanction of high authorities, so far established itself in the public mind, as to be, with general approbation, converted into a law, at the renewal of the Charter of the Bank of England in 1844: and the regulation is still in force, though with a great abatement of its popularity, and with its prestige impaired by three1 temporary suspensions, on the responsibility of the executive, the earliest little more than three years after its enactment. It is proper that the merits of this plan for the regulation of a convertible bank note currency should be here considered. Before touching upon the practical provisions of Sir Robert Peel’s Act of 1844, I shall briefly state the nature, and examine the grounds, of the theory on which it is founded.

It is believed by many, that banks of issue universally, or the Bank of England in particular, have a power of throwing their notes into circulation, and thereby raising prices, arbitrarily; that this power is only limited by the degree of moderation with which they think fit to exercise it; that when they increase their issues beyond the usual amount, the rise of prices, thus produced, generates a spirit of speculation in commodities, which carries prices still higher, and ultimately causes a reaction and recoil, mounting in extreme cases to a commercial crisis; and that every such crisis which has occurred in this country within mercantile memory, has been either originally produced by this cause, or greatly aggravated by it. To this extreme length the currency theory has not been carried by the eminent political economists who have given to a more moderate form of the same theory the sanction of their names. But I have not overstated the extravagance of the popular version; which is a remarkable instance to what lengths a favourite theory will hurry, not the closet students whose competency in such questions is often treated with so much contempt, but men of the world and of business, who pique themselves on the practical knowledge which they have at least had ample opportunities of acquiring. Not only has this fixed idea of the currency as the prime agent in the fluctuations of price made them shut their eyes to the multitude of circumstances which, by influencing the expectation of supply, are the true causes of almost all speculations, and of almost all fluctuations of price; but in order to bring about the chronological agreement required by their theory between the variations of bank issues and those of prices, they have played such fantastic tricks with facts and dates as would be thought incredible, if an eminent practical authority had not taken the trouble of meeting them, on the ground of mere history, with an elaborate exposure. I refer, as all conversant with the subject must be aware, to Mr. Tooke’s History of Prices. The result of Mr. Tooke’s investigations was thus stated by himself, in his examination before the Commons' Committee on the Bank Charter question in 1832; and the evidences of it stand recorded in his book: “In point of fact, and historically, as far as my researches have gone, in every signal instance of a rise or fall of prices, the rise or fall has preceded, and therefore could not be the effect of, an enlargement or contraction of the bank circulation.”

The extravagance of the currency theorists, in attributing almost every rise or fall of prices to an enlargement or contraction of the issues of bank notes, has raised up, by reaction, a theory the extreme opposite of the former, of which, in scientific discussion, the most prominent representatives are Mr. Tooke and Mr. Fullarton. This counter-theory denies to bank notes, so long as their convertibility is maintained, any power whatever of raising prices, and to banks any power of increasing their circulation, except as a consequence of, and in proportion to, an increase of the business to be done. This last statement is supported by the unanimous assurances of all the country bankers who have been examined before successive Parliamentary Committees on the subject. They all bear testimony that (in the words of Mr. Fullarton∗) “the amount of their issues is exclusively regulated by the extent of local dealings and expenditure in their respective districts, fluctuating with the fluctuations of production and price, and that they neither can increase their issues beyond the limits which the range of such dealings and expenditure prescribes, without the certainty of having their notes immediately returned to them, nor diminish them, but at an almost equal certainty of the vacancy being filled up from some other source.” From these premises it is argued by Mr. Tooke and Mr. Fullarton, that bank issues, since they cannot be increased in amount unless there be an increased demand, cannot possibly raise prices; cannot encourage speculation, nor occasion a commercial crisis; and that the attempt to guard against that evil by an artificial management of the issue of notes is of no effect for the intended purpose, and liable to produce other consequences extremely calamitous.

§ 2. As much of this doctrine as rests upon testimony, and not upon inference, appears to me incontrovertible. I give complete credence to the assertion of the country bankers very clearly and correctly condensed into a small compass in the sentence just quoted from Mr. Fullarton. I am convinced that they cannot possibly increase their issue of notes in any other circumstances than those which are there stated. I believe, also, that the theory, grounded by Mr. Fullarton upon this fact, contains a large portion of truth, and is far nearer to being the expression of the whole truth than any form whatever of the currency theory.

There are two states of the markets: one which may be termed the quiescent state, the other the expectant, or speculative, state. The first is that in which there is nothing tending to engender in any considerable portion of the mercantile public a desire to extend their operations. The producers produce and the dealers purchase only their usual stocks, having no expectation of a more than usually rapid vent for them. Each person transacts his ordinary amount of business, and no more; or increases it only in correspondence with the increase of his capital or connexion, or with the gradual growth of the demand for his commodity, occasioned by the public prosperity. Not meditating any unusual extension of their own operations, producers and dealers do not need more than the usual accommodation from bankers and other money lenders; and as it is only by extending their loans that bankers increase their issues, none but a momentary augmentation of issues is in these circumstances possible. If at a certain time of the year a portion of the public have larger payments to make than at other times, or if an individual, under some peculiar exigency, requires an extra advance, they may apply for more bank notes, and obtain them; but the notes will no more remain in circulation than the extra quantity of Bank of England notes which are issued once in every three months in payment of the dividends. The person to whom, after being borrowed, the notes are paid away, has no extra payments to make, and no peculiar exigency, and he keeps them by him unused, or sends them into deposit, or repays with them a previous advance made to him by some banker: in any case he does not buy commodities with them, since by the supposition there is nothing to induce him to lay in a larger stock of commodities than before. 1 Even if we suppose, as we may do, that bankers create an artificial increase of the demand for loans by offering them below the market rate of interest, the notes they issue will not remain in circulation; for when the borrower, having completed the transaction for which he availed himself of them, has paid them away, the creditor or dealer who receives them, having no demand for the immediate use of an extra quantity of notes, sends them into deposit. In this case, therefore, there can be no addition, at the discretion of bankers, to the general circulating medium: any increase of their issues either comes back to them, or remains idle in the hands of the public, and no rise takes place in prices.

But there is another state of the markets, strikingly contrasted with the preceding, and to this state it is not so obvious that the theory of Mr. Tooke and Mr. Fullarton is applicable; namely, when an impression prevails, whether well founded or groundless, that the supply of one or more great articles of commerce is likely to fall short of the ordinary consumption. In such circumstances all persons connected with those commodities desire to extend their operations. The producers or importers desire to produce or import a larger quantity, speculators desire to lay in a stock in order to profit by the expected rise of price, and holders of the commodity desire additional advances to enable them to continue holding. All these classes are disposed to make a more than ordinary use of their credit, and to this desire it is not denied that bankers very often unduly administer. Effects of the same kind may be produced by anything which, exciting more than usual hopes of profit, gives increased briskness to business: for example, a sudden foreign demand for commodities on a large scale, or the expectation of it; such as occurred on the opening of Spanish America to English trade, and has occurred on various occasions in the trade with the United States. Such occurrences produce a tendency to a rise of price in exportable articles, and generate speculations, sometimes of a reasonable, and (as long as a large proportion of men in business prefer excitement to safety) frequently of an irrational or immoderate character. In such cases there is a desire in the mercantile classes, or in some portion of them, to employ their credit, in a more than usual degree, as a power of purchasing. This is a state of business which, when pushed to an extreme length, brings on the revulsion called a commercial crisis; and it is a known fact that such periods of speculation hardly ever pass off without having been attended, during some part of their progress, by a considerable increase of bank notes.

To this, however, it is replied by Mr. Tooke and Mr. Fullarton, that the increase of the circulation always follows instead of preceding the rise of prices, and is not its cause, but its effect. That in the first place, the speculative purchases by which prices are raised, are not effected by bank notes but by cheques, or still more commonly on a simple book credit: and secondly, even if they were made with bank notes borrowed for that express purpose from bankers, the notes, after being used for that purpose, would, if not wanted for current transactions, be returned into deposit by the persons receiving them. In this I fully concur, and I regard it as proved, both scientifically and historically, that during the ascending period of speculation, and as long as it is confined to transactions between dealers, the issues of bank notes are seldom materially increased, nor contribute anything to the speculative rise of prices. It seems to me, however, that this can no longer be affirmed when speculation has proceeded so far as to reach the producers. Speculative orders given by merchants to manufacturers induce them to extend their operations, and to become applicants to bankers for increased advances, which, if made in notes, are not paid away to persons who return them into deposit, but are partially expended in paying wages, and pass into the various channels of retail trade, where they become directly effective in producing a further rise of prices. I cannot but think that this employment of bank notes must have been powerfully operative on prices at the time when notes of one and two pounds' value were permitted by law. Admitting, however, that the prohibition of notes below five pounds has now rendered this part of their operation comparatively insignificant by greatly limiting their applicability to the payment of wages, there is another form of their instrumentality which comes into play in the latter stages of speculation, and which forms the principal argument of the more moderate supporters of the currency theory. Though advances by bankers are seldom demanded for the purpose of buying on speculation, they are largely demanded by unsuccessful speculators for the purpose of holding on; and the competition of these speculators for a share of the loanable capital makes even those who have not speculated more dependent than before on bankers for the advances they require. Between the ascending period of speculation and the revulsion, there is an interval extending to weeks and sometimes months, of struggling against a fall. The tide having shown signs of turning, the speculative holders are unwilling to sell in a falling market, and in the meantime they require funds to enable them to fulfil even their ordinary engagements. It is this stage that is ordinarily marked by a considerable increase in the amount of the bank-note circulation. That such an increase does usually take place is denied by no one. And I think it must be admitted that this increase tends to prolong the duration of the speculations; that it enables the speculative prices to be kept up for some time after they would otherwise have collapsed; and therefore prolongs and increases the drain of the precious metals for exportation, which is the leading feature of this stage in the progress of a commercial crisis: the continuance of which drain at last endangering the power of the banks to fulfil their engagement of paying their notes on demand, they are compelled to contract their credit more suddenly and severely than would have been necessary if they had been prevented from propping up speculation by increased advances, after the time when the recoil had become inevitable.

§ 3. To prevent this retardation of the recoil, and ultimate aggravation of its severity, is the object of the scheme for regulating the currency, of which Lord Overstone, Mr. Norman, and Colonel Torrens, were the first promulgators, and which has, in a slightly modified form, been enacted into law.∗

According to the scheme in its original purity, the issue of promissory notes for circulation was to be confined to one body. In the form adopted by Parliament, all existing issuers were permitted to retain this privilege, but none were to be hereafter admitted to it, even in the place of those who might discontinue their issues: and, for all except the Bank of England, a maximum of issues was prescribed, on a scale intentionally low. To the Bank of England no maximum was fixed for the aggregate amount of its notes, but only for the portion issued on securities, or, in other words, on loan. These were never to exceed a certain limit, fixed in the first instance at fourteen millions.† All issues beyond that amount must be in exchange for bullion; of which the Bank is bound to purchase, at a trifle below the Mint valuation, any quantity which is offered to it, giving its notes in exchange. In regard, therefore, to any issue of notes beyond the limit of fourteen millions, the Bank is purely passive, having no function but the compulsory one of giving its notes for gold at 3l. 17s. 9d., and gold for its notes at 3l. 17s. 10½d., whenever and by whomsoever it is called upon to do so.

The object for which this mechanism is intended is that the bank-note currency may vary in its amount at the exact times, and in the exact degree, in which a purely metallic currency would vary. And the precious metals being the commodity that has hitherto approached nearest to that invariability, in all the circumstances influencing value, which fits a commodity for being adopted as a medium of exchange, it seems to be thought that the excellence of the Act of 1844 is fully made out, if under its operation the issues conform in all their variations of quantity, and therefore, as is inferred, of value, to the variations which would take place in a currency wholly metallic.

1 Now, all reasonable opponents of the Act, in common with its supporters, acknowledge as an essential requisite of any substitute for the precious metals, that it should conform exactly in its permanent value to a metallic standard. And they say, that so long as it is convertible into specie on demand, it does and must so conform. But when the value of a metallic or of any other currency is spoken of, there are two points to be considered; the permanent or average value, and the fluctuations. It is to the permanent value of a metallic currency that the value of a paper currency ought to conform. But there is no obvious reason why it should be required to conform to the fluctuations too. The only object of its conforming at all is steadiness of value; and with respect to fluctuations the sole thing desirable is that they should be the smallest possible. Now the fluctuations in the value of the currency are determined, not by its quantity, whether it consist of gold or of paper, but by the expansions and contractions of credit. To discover, therefore, what currency will conform the most nearly to the permanent value of the precious metals, we must find under what currency the variations in credit are least frequent and least extreme. Now, whether this object is best attained by a metallic currency (and therefore by a paper currency exactly conforming in quantity to it) is precisely the question to be decided. If it should prove that a paper currency which follows all the fluctuations in quantity of a metallic, leads to more violent revulsions of credit than one which is not held to this rigid conformity, it will follow that the currency which agrees most exactly in quantity with a metallic currency is not that which adheres closest to its value; that is to say, its permanent value, with which alone agreement is desirable.

Whether this is really the case or not we will now inquire. And first, let us consider whether the Act effects the practical object chiefly relied on in its defence by the more sober of its advocates, that of arresting speculative extensions of credit at an earlier period, with a less drain of gold, and consequently by a milder and more gradual process. I think it must be admitted that to a certain degree it is successful in this object.

I am aware of what may be urged, and reasonably urged, in opposition to this opinion. It may be said, that when the time arrives at which the banks are pressed for increased advances to enable speculators to fulfil their engagements, a limitation of the issue of notes will not prevent the banks, if otherwise willing, from making these advances; that they have still their deposits as a source from which loans may be made beyond the point which is consistent with prudence as bankers; and that even if they refused to do so, the only effect would be that the deposits themselves would be drawn out to supply the wants of the depositors; which would be just as much an addition to the bank notes and coin in the hands of the public, as if the notes themselves were increased. This is true, and is a sufficient answer to those who think that the advances of banks to prop up failing speculations are objectionable chiefly as an increase of the currency. But the mode in which they are really objectionable, is as an extension of credit. 1 If, instead of increasing their discounts, the banks allow their deposits to be drawn out, there is the same increase of currency (for a short time at least), but there is not an increase of loans, at the time when there ought to be a diminution. If they do increase their discounts, not by means of notes, but at the expense of the deposits alone, their deposits (properly so called) are definite and exhaustible, while notes may be increased to any amount, or, after being returned, may be reissued without limit. It is true that a bank, if willing to add indefinitely to its liabilities, has the power of making its nominal deposits as unlimited a fund as its issues could be; it has only to make its advances in a book credit, which is creating deposits out of its own liabilities, the money for which it has made itself responsible becoming a deposit in its hands, to be drawn against by cheques; and the cheques when drawn may be liquidated (either at the same bank or at the clearing house) without the aid of notes, by a mere transfer of credit from one account to another. I apprehend it is chiefly in this way that undue extensions of credit, in periods of speculation, are commonly made. But the banks are not likely to persist in this course when the tide begins to turn. It is not when their deposits have already begun to flow out, that they are likely to create deposit accounts which represent, instead of funds placed in their hands, fresh liabilities of their own. But experience proves that extension of credit, when in the form of notes, goes on long after the recoil from over-speculation has commenced. When this mode of resisting the revulsion is made impossible, and deposits and book credits are left as the only sources from which undue advances can be made, the rate of interest is not so often, or so long, prevented from rising, after the difficulties consequent on excess of speculation begin to be felt. On the contrary, the necessity which the banks feel of diminishing their advances to maintain their solvency, when they find their deposits flowing out, and cannot supply the vacant place by their own notes, accelerates the rise of the rate of interest. Speculative holders are therefore obliged to submit earlier to that loss by resale, which could not have been prevented from coming on them at last: the recoil of prices and collapse of general credit take place sooner.

To appreciate the effects which this acceleration of the crisis has in mitigating its intensity, let us advert more particularly to the nature and effects of that leading feature in the period just preceding the collapse, the drain of gold. A rise of prices produced by a speculative extension of credit, even when bank notes have not been the instrument, is not the less effectual (if it lasts long enough) in turning the exchanges: and when the exchanges have turned from this cause, they can only be turned back, and the drain of gold stopped, either by a fall of prices or by a rise of the rate of interest. A fall of prices will stop it by removing the cause which produced it, and by rendering goods a more advantageous remittance than gold, even for paying debts already due. A rise of the rate of interest, and consequent fall of the prices of securities, will accomplish the purpose still more rapidly, by inducing foreigners, instead of taking away the gold which is due to them, to leave it for investment within the country, and even send gold into the country to take advantage of the increased rate of interest. Of this last mode of stopping a drain of gold, the year 1847 afforded signal examples. But until one of these two things takes place—until either prices fall, or the rate of interest rises—nothing can possibly arrest, or even moderate, the efflux of gold. Now, neither will prices fall nor interest rise, so long as the unduly expanded credit is upheld by the continued advances of bankers. It is well known that when a drain of gold has set in, even if bank notes have not increased in quantity, it is upon them that the contraction first falls, the gold wanted for exportation being always obtained from the Bank of England in exchange for its notes. But under the system which preceded 1844, the Bank of England, being subjected, in common with other banks, to the importunities for fresh advances which are characteristic of such a time, could, and often did, immediately re-issue the notes which had been returned to it in exchange for bullion. It is a great error, certainly, to suppose that the mischief of this re-issue chiefly consisted in preventing a contraction of the currency. It was, however, quite as mischievous as it has ever been supposed to be. As long as it lasted, the efflux of gold could not cease, since neither would prices fall nor interest rise while these advances continued. Prices, having risen without any increase of bank notes, could well have fallen without a diminution of them; but having risen in consequence of an extension of credit, they could not fall without a contraction of it. As long, therefore, as the Bank of England and the other banks persevered in this course, so long gold continued to flow out, until so little was left that the Bank of England, being in danger of suspension of payments, was compelled at last to contract its discounts so greatly and suddenly as to produce a much more extreme variation in the rate of interest, inflict much greater loss and distress on individuals, and destroy a much greater amount of the ordinary credit of the country, than any real necessity required.

I acknowledge (and the experience of 1847 has proved to those who overlooked it before) that the mischief now described may be wrought, and in large measure, by the Bank of England, through its deposits alone. It may continue or even increase its discounts and advances, when it ought to contract them: with the ultimate effect of making the contraction much more severe and sudden than necessary. I cannot but think, however, that banks which commit this error with their deposits, would commit it still more if they were at liberty to make increased loans with their issues as well as their deposits. I am compelled to think that the being restricted from increasing their issues, is a real impediment to their making those advances which arrest the tide at its turn, and make it rush like a torrent afterwards1: and when the Act is blamed for interposing obstacles at a time when not obstacles but facilities are needed, it must in justice receive credit for interposing them when they are an acknowledged benefit. In this particular, therefore, I think it cannot be denied, that the new system is a real improvement upon the old.

§ 4. But however this may be, it seems to me certain that these advantages, whatever value may be put on them, are purchased by still greater disadvantages.

In the first place, a large extension of credit by bankers, though most hurtful when, credit being already in an inflated state, it can only serve to retard and aggravate the collapse, is most salutary when the collapse has come, and when credit instead of being in excess is in distressing deficiency, and increased advances by bankers, instead of being an addition to the ordinary amount of floating credit, serve to replace a mass of other credit which has been suddenly destroyed. Antecedently to 1844, if the Bank of England occasionally aggravated the severity of a commercial revulsion by rendering the collapse of credit more tardy and hence more violent than necessary, it in return rendered invaluable services during the revulsion itself, by coming forward with advances to support solvent firms, at a time when all other paper and almost all mercantile credit had become comparatively valueless. This service was eminently conspicuous in the crisis of 1825–6, the severest probably ever experienced; during which the Bank increased what is called its circulation by many millions, in advances to those mercantile firms of whose ultimate solvency it felt no doubt; advances which if it had been obliged to withhold, the severity of the crisis would have been still greater than it was. If the Bank, it is justly remarked by Mr. Fullarton,∗ complies with such applications, “it must comply with them by an issue of notes, for notes constitute the only instrumentality through which the Bank is in the practice of lending its credit. But those notes are not intended to circulate, nor do they circulate. There is no more demand for circulation than there was before. On the contrary, the rapid decline of prices which the case in supposition presumes, would necessarily contract the demand for circulation. The notes would either be returned to the Bank of England as fast as they were issued, in the shape of deposits, or would be locked up in the drawers of the private London bankers, or distributed by them to their correspondents in the country, or intercepted by other capitalists, who, during the fervour of the previous excitement, had contracted liabilities which they might be imperfectly prepared on the sudden to encounter. In such emergencies, every man connected with business, who has been trading on other means than his own, is placed on the defensive, and his whole object is to make himself as strong as possible, an object which cannot be more effectually answered than by keeping by him as large a reserve as possible in paper which the law has made a legal tender. The notes themselves never find their way into the produce market; and if they at all contribute to retard” (or, as I should rather say, to moderate) “the fall of prices, it is not by promoting in the slightest degree the effective demand for commodities, not by enabling consumers to buy more largely for consumption, and so giving briskness to commerce, but by a process exactly the reverse, by enabling the holders of commodities to hold on, by obstructing traffic and repressing consumption.”

The opportune relief thus afforded to credit, during the excessive contraction which succeeds to an undue expansion, is consistent with the principle of the new system; for an extraordinary contraction of credit, and fall of prices, inevitably draw gold into the country, and the principle of the system is that the bank-note currency shall be permitted, and even compelled, to enlarge itself, in all cases in which a metallic currency would do the same. But, what the principle of the law would encourage, its provisions in this instance preclude, by not suffering the increased issues to take place until the gold has actually arrived: which is never until the worst part of the crisis has passed, and almost all the losses and failures attendant on it are consummated. The machinery of the system withholds, until for many purposes it comes too late, the very medicine which the theory of the system prescribes as the appropriate remedy.∗

This function of banks in filling up the gap made in mercantile credit by the consequences of undue speculation and its revulsion, is so entirely indispensable, that if the Act of 1844 continues unrepealed, there can be no difficulty in foreseeing that its provisions must be suspended, as they were in 1847, in every period of great commercial difficulty, as soon as the crisis has really and completely set in.† Were this all, there would be no absolute inconsistency in maintaining the restriction as a means of preventing a crisis, and relaxing it for the purpose of relieving one. But there is another objection, of a still more radical and comprehensive character, to the new system.

Professing, in theory, to require that a paper currency shall vary in its amount in exact conformity to the variations of a metallic currency, it provides, in fact, that in every case of an efflux of gold, a corresponding diminution shall take place in the quantity of bank notes; in other words, that every exportation of the precious metals shall be virtually drawn from the circulation; it being assumed that this would be the case if the currency were wholly metallic. This theory, and these practical arrangements, are adapted to the case in which the drain of gold originates in a rise of prices produced by an undue expansion of currency or credit; but they are adapted to no case beside.

When the efflux of gold is the last stage of a series of effects arising from an increase of the currency, or from an expansion of credit tantamount in its effect on prices to an increase of currency, it is in that case a fair assumption that in a purely metallic system the gold exported would be drawn from the currency itself; because such a drain, being in its nature unlimited, will necessarily continue as long as currency and credit are undiminished. But an exportation of the precious metals often arises from no causes affecting currency or credit, but simply from an unusual extension of foreign payments, arising either from the state of the markets for commodities, or from some circumstance not commercial. In this class of causes, four, of powerful operation, are included, of each of which the last fifty years of English history afford repeated instances. The first is that of an extraordinary foreign expenditure by government, either political or military; as in the revolutionary war, and, as long as it lasted, during the Crimean war. The second is the case of a large exportation of capital for foreign investment; such as the loans and mining operations which partly contributed to the crisis of 1825, and the American speculations which were the principal cause of the crisis of 1839. The third is a failure of crops in the countries which supply the raw material of important manufactures; such as the cotton failure in America, which compelled England, in 1847, to incur unusual liabilities for the purchase of that commodity at an advanced price. The fourth is a bad harvest, and a great consequent importation of food; of which the years 1846 and 1847 presented an example surpassing all antecedent experience.

In none of these cases, if the currency were metallic, would the gold or silver exported for the purposes in question be necessarily, or even probably, drawn wholly1 from the circulation. It would be drawn from the hoards, which under a metallic currency always exist to a very large amount; in uncivilized countries, in the hands of all who can afford it; in civilized countries chiefly in the form of bankers' reserves. Mr. Tooke, in his Inquiry into the Currency Principle, bears testimony to this fact; but it is to Mr. Fullarton that the public are indebted for the clearest and most satisfactory elucidation of it. As I am not aware that this part of the theory of currency has been set forth by any other writer with anything like the same degree of completeness, I shall quote somewhat largely from this able production.

“No person who has ever resided in an Asiatic country, where hoarding is carried on to a far larger extent in proportion to the existing stock of wealth, and where the practice has become much more deeply engrafted in the habits of the people, by traditionary apprehensions of insecurity and the difficulty of finding safe and remunerative investments, than in any European community—no person who has had personal experience of this state of society, can be at a loss to recollect innumerable instances of large metallic treasures extracted in times of pecuniary difficulty from the coffers of individuals by the temptation of a high rate of interest, and brought in aid of the public necessities, nor, on the other hand, of the facility with which those treasures have been absorbed again, when the inducements which had drawn them into light were no longer in operation. In countries more advanced in civilization and wealth than the Asiatic principalities, and where no man is in fear of attracting the cupidity of power by an external display of riches, but where the interchange of commodities is still almost universally conducted through the medium of a metric circulation, as is the case with most of the commercial countries on the Continent of Europe, the motives for amassing the precious metals may be less powerful than in the majority of Asiatic principalities; but the ability to accumulate being more widely extended, the absolute quantity amassed will be found probably to bear a considerably larger proportion to the population.∗ In those states which lie exposed to hostile invasion, or whose social condition is unsettled and menacing, the motive indeed must still be very strong; and in a nation carrying on an extensive commerce, both foreign and internal, without any considerable aid from any of the banking substitutes for money, the reserves of gold and silver indispensably required to secure the regularity of payments, must of themselves engross a share of the circulating coin which it would not be easy to estimate.

“In this country, where the banking system has been carried to an extent and perfection unknown in any other part of Europe, and may be said to have entirely superseded the use of coin, except for retail dealings and the purposes of foreign commerce, the incentives to private hoarding exist no longer, and the hoards have all been transferred to the banks, or rather, I should say, to the Bank of England. But in France, where the bank-note circulation is still comparatively limited, the quantity of gold and silver coin in existence I find now currently estimated, on what are described as the latest authorities, at the enormous sum of 120 millions sterling; nor is the estimate at all at variance with the reasonable probabilities of the case. Of this vast treasure there is every reason to presume that a very large proportion, probably by much the greater part, is absorbed in the hoards. If you present for payment a bill for a thousand francs to a French banker, he brings you the silver in a sealed bag from his strong room. And not the banker only, but every merchant and trader, according to his means, is under the necessity of keeping by him a stock of cash sufficient not only for his ordinary disbursements, but to meet any unexpected demands. That the quantity of specie accumulated in these innumerable depôts, not in France only, but all over the Continent, where banking institutions are still either entirely wanting or very imperfectly organized, is not merely immense in itself, but admits of being largely drawn upon, and transferred even in vast masses from one country to another, with very little, if any, effect on prices, or other material derangements, we have had some remarkable proofs:” among others, “the signal success which attended the simultaneous efforts of some of the principal European powers (Russia, Austria, Prussia, Sweden, and Denmark) to replenish their treasuries, and to replace with coin a considerable portion of the depreciated paper which the necessities of the war had forced upon them, and this at the very time when the available stock of the precious metals over the world had been reduced by the exertions of England to recover her metallic currency.... There can be no doubt that these combined operations were on a scale of very extraordinary magnitude, that they were accomplished without any sensible injury to commerce or public prosperity, or any other effect than some temporary derangement of the exchanges, and that the private hoards of treasure accumulated throughout Europe during the war must have been the principal source from which all this gold and silver was collected. And no person, I think, can fairly contemplate the vast superflux of metallic wealth thus proved to be at all times in existence, and, though in a dormant and inert state, always ready to spring into activity on the first indication of a sufficiently intense demand, without feeling themselves compelled to admit the possibility of the mines being even shut up for years together, and the production of the metals altogether suspended, while there might be scarcely a perceptible alteration in the exchangeable value of the metal.”∗

Applying this to the currency doctrine and its advocates, “one might imagine,” says Mr. Fullarton,∗ “that they supposed the gold which is drained off for exportation from a country using a currency exclusively metallic, to be collected by driblets at the fairs and markets, or from the tills of the grocers and mercers. They never even allude to the existence of such a thing as a great hoard of the metals, though upon the action of the hoards depends the whole economy of international payments between specie-circulating communities, while any operation of the money collected in hoards upon prices must, even according to the currency hypothesis, be wholly impossible. We know from experience what enormous payments in gold and silver specie-circulating countries are capable, at times, of making, without the least disturbance of their internal prosperity; and whence is it supposed that these payments come, but from their hoards? let us think how the money market of a country transacting all its exchanges through the medium of the precious metals only, would be likely to be affected by the necessity of making a foreign payment of several millions. Of course the necessity could only be satisfied by a transmission of capital; and would not the competition for the possession of capital for transmission which the occasion would call forth, necessarily raise the market rate of interest? If the payment was to be made by the government, would not the government, in all probability, have to open a new loan on terms more than usually favourable to the lender?” If made by merchants, would it not be drawn either from the deposits in banks, or from the reserves which merchants keep by them in default of banks, or would it not oblige them to obtain the necessary amount of specie by going into the money market as borrowers? “And would not all this inevitably act upon the hoards, and draw forth into activity a portion of the gold and silver which the money-dealers had been accumulating, and some of them with the express view of watching such opportunities for turning their treasures to advantage?...

“To come to the present time [1844], the balance of payments with nearly all Europe has for about four years past been in favour of this country, and gold has been pouring in till the influx amounts to the unheard-of sum of about fourteen millions sterling. Yet, in all this time, has any one heard a complaint of any serious suffering inflicted on the people of the Continent? Have prices there been greatly depressed beyond their range in this country? Have wages fallen, or have merchants been extensively ruined by the universal depreciation of their stock? There has occurred nothing of the kind. The tenor of commercial and monetary affairs has been everywhere even and tranquil; and in France more particularly, an improving revenue and extended commerce bear testimony to the continued progress of internal prosperity. It may be doubted, indeed, if this great efflux of gold has withdrawn, from that portion of the metallic wealth of the nation which really circulates, a single napoleon. And it has been equally obvious, from the undisturbed state of credit, that not only has the supply of specie indispensable for the conduct of business in the retail market been all the while uninterrupted, but that the hoards have continued to furnish every facility requisite for the regularity of mercantile payments. It is of the very essence of the metallic system, that the hoards, in all cases of probable occurrence, should be equal to both objects; that they should, in the first place, supply the bullion demanded for exportation, and in the next place, should keep up the home circulation to its legitimate complement. Every man trading under that system, who, in the corse of his business, may have frequent occasion to remit large sums in specie to foreign countries, must either keep by him a sufficient treasure of his own or must have the means of borrowing enough from his neighbours, not only to make up when wanted the amount of his remittances, but to enable him, moreover, to carry on his ordinary transactions at home without interruption.”

In a country in which credit is carried to so great an extent as in England, one great reserve, in a single establishment, the Bank of England, supplies the place, as far as the precious metals are concerned, of the multitudinous reserves of other countries. The theoretical principle, therefore, of the currency doctrine would require, that all those drains of the metal which, if the currency were purely metallic, would be taken from the hoards, should be allowed to operate freely upon the reserve in the coffers of the Bank of England, without any attempt to stop it either by a diminution of the currency or by a contraction of credit. Nor to this would there be any well-grounded objection, unless the drain were so great as to threaten the exhaustion of the reserve, and a consequent stoppage of payments; a danger against which it is possible to take adequate precautions, because in the cases which we are considering, the drain is for foreign payments of definite amount, and stops of itself as soon as these are effected. And in all systems it is admitted that the habitual reserve of the Bank should exceed the utmost amount to which experience warrants the belief that such a drain may extend; which extreme limit Mr. Fullarton affirms to be seven millions, but Mr. Tooke recommends an average reserve of ten, and in his last publication, of twelve millions. 1 Under these circumstances, the habitual reserve, which would never be employed in discounts, but kept to be paid out exclusively in exchange for cheques or bank notes, would be sufficient for a crisis of this description; which therefore would pass off without having its difficulties increased by a contraction either of credit or of the circulation. But this, the most advantageous dénouement that the case admits of, and not only consistent with but required by the professed principle of the system, the panegyrists of the system claim for it as a great merit that it prevents. They boast, that on the first appearance of a drain for exportation—whatever may be its cause, and whether, under a metallic currency, it would involve a contraction of credit or not—the Bank is at once obliged to curtail its advances. And this, be it remembered, when there has been no speculative rise of prices which it is indispensable to correct, no unusual extension of credit requiring contraction; but the demand for gold is solely occasioned by foreign payments on account of government, or large corn importations consequent on a bad harvest.

2 Even supposing that the reserve is insufficient to meet the foreign payments, and that the means wherewith to make them have to be taken from the loanable capital of the country, the consequence of which is a rise of the rate of interest; in such circumstances some pressure on the money market is unavoidable, but that pressure is much increased in severity by the separation of the Banking from the Issue Department. The case is generally stated as if the Act only operated in one way, namely, by preventing the Bank, when it has parted with (say) three millions of bullion in exchange for three millions of its notes, from again lending those notes, in discounts or other advances. But the Act really does much more than this. It is well known, that the first operation of a drain is always on the Banking Department. The bank deposits constitute the bulk of the unemployed and disposable capital of the country; and capital wanted for foreign payments is almost always obtained mainly by drawing out deposits. Supposing three millions to be the amount wanted, three millions of notes are drawn from the Banking Department (either directly or through the private bankers, who keep the bulk of their reserves with the Bank of England), and the three millions of notes, thus obtained, are presented at the Issue Department, and exchanged against gold for exportation. Thus a drain upon the country at large of only three millions is a drain upon the Bank virtually of six millions. The deposits have lost three millions, and the reserve of the Issue Department has lost an equal amount. As the two departments, so long as the Act remains in operation, cannot even in the utmost extremity help one another, each must take its separate precautions for its own safety. Whatever measures, therefore, on the part of the Bank, would have been required under the old system by a drain of six millions, are now rendered necessary by a drain only of three. The Issue Department protects itself in the manner prescribed by the Act, by not re-issuing the three millions of notes which have been returned to it. But the Banking Department must take measures to replenish its reserve, which has been reduced by three millions. Its liabilities having also decreased three millions, by the loss of that amount of deposits, the reserve, on the ordinary banking principle of a third of the liabilities, will bear a reduction of one million. But the other two millions it must procure by letting that amount of advances run out, and not renewing them. Not only must it raise its rate of interest, but it must effect, by whatever means, a diminution of two millions in the total amount of its discounts: or it must sell securities to an equal amount. This violent action on the money market for the purpose of replenishing the Banking reserve, is wholly occasioned by the Act of 1844. If the restrictions of that Act did not exist, the Bank, instead of contracting its discounts, would simply transfer two millions, either in gold or in notes, from the Issue to the Banking Department; not in order to lend them to the public, but to secure the solvency of the Banking Department in the event of further unexpected demands by the depositors. And unless the drain continued, and reached so great an amount as to seem likely to exceed the whole of the gold in the reserves of both departments, the Bank would be under no necessity, while the pressure lasted, of withholding from commerce its accustomed amount of accommodation, at a rate of interest corresponding to the increased demand.∗

I am aware it will be said that by allowing drains of this character to operate freely upon the Bank reserve until they cease of themselves, a contraction of the currency and of credit would not be prevented, but only postponed; since if a limitation of issues were not resorted to for the purpose of checking the drain in its commencement, the same or a still greater limitation must take place afterwards, in order, by acting on prices, to bring back this large quantity of gold, for the indispensable purpose of replenishing the Bank reserve. But in this argument several things are overlooked. In the first place, the gold might be brought back, not by a fall of prices, but by the much more rapid and convenient medium of a rise of the rate of interest, involving no fall of any prices except the price of securities. Either English securities would be bought on account of foreigners, or foreign securities held in England would be sent abroad for sale, both which operations took place largely during the mercantile difficulties of 1847, and not only checked the efflux of gold, but turned the tide and brought the metal back. It was not, therefore, brought back by a contraction of the currency, though in this case it certainly was so by a contraction of loans. But even this is not always indispensable. For in the second place, it is not necessary that the gold should return with the same suddenness with which it went out. A great portion would probably return in the ordinary way of commerce, in payment for exported commodities. The extra gains made by dealers and producers in foreign countries through the extra payments they receive from this country, are very likely to be partly expended in increased purchases of English commodities, either for consumption or on speculation, though the effect may not manifest itself with sufficient rapidity to enable the transmission of gold to be dispensed with in the first instance. These extra purchases would turn the balance of payments in favour of the country, and gradually restore a portion of the exported gold; and the remainder would probably be brought back, without any considerable rise of the rate of interest in England, by the fall of it in foreign countries, occasioned by the addition of some millions of gold to the loanable capital of those countries. Indeed, in the state of things consequent on the gold discoveries, when the enormous quantity of gold annually produced in Australia, and much of that from California, is distributed to other countries through England, and a month seldom passes without a large arrival, the Bank reserves can replenish themselves without any re-importation of the gold previously carried off by a drain. All that is needful is an intermission, and a very brief intermission is sufficient, of the exportation.

For these reasons it appears to me, that notwithstanding the beneficial operation of the Act of 1844 in the first stages of one kind of commercial crisis (that produced by over-speculation), it on the whole materially aggravates the severity of commercial revulsions. And not only are contractions of credit made more severe by the Act, they are also made greatly more frequent. “Suppose,” says Mr. George Walker, in a clear, impartial, and conclusive series of papers in the Aberdeen Herald, forming one of the best existing discussions of the present question—”suppose that, of eighteen millions of gold, ten are in the Issue Department and eight are in the Banking Department. The result is the same as under a metallic currency with only eight millions in reserve, instead of eighteen.... The effect of the Bank Act is, that the proceedings of the Bank under a drain are not determined by the amount of gold within its vaults, but are, or ought to be, determined by the portion of it belonging to the Banking Department. With the whole of the gold at its disposal, it may find it unnecessary to interfere with credit, or force down prices, if a drain leave a fair reserve behind. With only the banking reserve at its disposal, it must, from the narrow margin it has to operate on, meet all drains by counteractives more or less strong, to the injury of the commercial world; and if it fail to do so, as it may fail, the consequence is destruction. Hence the extraordinary and frequent variations of the rate of interest under the Bank Act. Since 1847, when the eyes of the Bank were opened to its true position, it has felt it necessary, as a precautionary measure, that every variation in the reserve should be accompanied by an alteration in the rate of interest.” To make the Act innocuous, therefore, it would be necessary that the Bank, in addition to the whole of the gold in the Issue Department, should retain as great a reserve in gold or notes in the Banking Department alone, as would suffice under the old system for the security both of the issues and of the deposits.

§ 5. There remain two questions respecting a bank-note currency, which have also been a subject of considerable discussion of late years: whether the privilege of providing it should be confined to a single establishment, such as the Bank of England, or a plurality of issuers should be allowed; and in the latter case, whether any peculiar precautions are requisite or advisable, to protect the holders of notes against losses occasioned by the insolvency of the issuers.

The course of the preceding speculations has led us to attach so much less of peculiar importance to bank notes, as compared with other forms of credit, than accords with the notions generally current, that questions respecting the regulation of so very small a part of the general mass of credit cannot appear to us of such momentous import as they are sometimes considered. Bank notes, however, have so far a real peculiarity, that they are the only form of credit sufficiently convenient for all the purposes of circulation to be able entirely to supersede the use of metallic money for internal purposes. Though the extension of the use of cheques has a tendency more and more to diminish the number of bank notes, as it would that of the sovereigns or other coins which would take their place if they were abolished; there is sure, for a long time to come, to be a considerable supply of them, wherever the necessary degree of commercial confidence exists, and their free use is permitted. The exclusive privilege, therefore, of issuing them, if reserved to the Government or to some one body, is a source of great pecuniary gain. That this gain should be obtained for the nation at large is both practicable and desirable: and if the management of a bank-note currency ought to be so completely mechanical, so entirely a thing of fixed rule, as it is made by the Act of 1844, there seems no reason why this mechanism should be worked for the profit of any private issuer, rather than for the public treasury. If, however, a plan be preferred which leaves the variations in the amount of issues in any degree whatever to the discretion of the issuers, it is not desirable that to the ever-growing attributions of the Government so delicate a function should be superadded; and that the attention of the heads of the state should be diverted from larger objects, by their being besieged with the applications, and made a mark for all the attacks, which are never spared to those deemed to be responsible for any acts, however minute, connected with the regulation of the currency. It would be better that treasury notes, exchangeable for gold on demand, should be issued to a fixed amount, not exceeding the minimum of a bank-note currency; the remainder of the notes which may be required being left to be supplied either by one or by a number of private banking establishments. Or an establishment like the Bank of England might supply the whole country, on condition of lending fifteen or twenty millions of its notes to the government without interest; which would give the same pecuniary advantage to the state as if it issued that number of its own notes.

The reason ordinarily alleged in condemnation of the system of plurality of issuers which existed in England before the Act of 1844, and under certain limitations still subsists, is that the competition of these different issuers induces them to increase the amount of their notes to an injurious extent. But we have seen that the power which bankers have of augmenting their issues, and the degree of mischief which they can produce by it, are quite trifling compared with the current over-estimate. As remarked by Mr. Fullarton,∗ the extraordinary increase of banking competition occasioned by the establishment of the joint-stock banks, a competition often of the most reckless kind, has proved utterly powerless to enlarge the aggregate mass of the bank-note circulation; that aggregate circulation having, on the contrary, actually decreased. In the absence of any special case for an exception to freedom of industry, the general rule ought to prevail. It appears desirable, however, to maintain one great establishment like the Bank of England, distinguished from other banks of issue in this, that it alone is required to pay in gold, the others being at liberty to pay their notes with notes of the central establishment. The object of this is that there may be one body responsible for maintaining a reserve of the precious metals sufficient to meet any drain that can reasonably be expected to take place. By disseminating this responsibility among a number of banks, it is prevented from operating efficaciously upon any: or if it be still enforced against one, the reserves of the metals retained by all the others are capital kept idle in pure waste, which may be dispensed with by allowing them at their option to pay in Bank of England notes.

§ 6. The question remains whether, in case of a plurality of issuers, any peculiar precautions are needed to protect the holders of notes from the consequences of failure of payment. Before 1826, the insolvency of banks of issue was a frequent and very serious evil, often spreading distress through a whole neighbourhood, and at one blow depriving provident industry of the results of long and painful saving. This was one of the chief reasons which induced Parliament, in that year, to prohibit the issue of bank notes of a denomination below five pounds, that the labouring classes at least might be as little as possible exposed to participate in this suffering. As an additional safeguard, it has been suggested to give the holders of notes a priority over other creditors, or to require bankers to deposit stock or other public securities as a pledge for the whole amount of their issues. The insecurity of the former bank-note currency of England was partly the work of the law, which, in order to give a qualified monopoly of banking business to the Bank of England, had actually made the formation of safe banking establishments a punishable offence, by prohibiting the existence of any banks, in town or country, whether of issue or deposit, with a number of partners exceeding six. This truly characteristic specimen of the old system of monopoly and restriction Was done away with in 1826, both as to issues and deposits, everywhere but in a district of sixty-five miles radius round London, and in 1833 in that district also, as far as relates to deposits. 1 It was hoped that the numerous joint-stock banks since established would have furnished a more trustworthy currency, and that under their influence the banking system of England would have been almost as secure to the public as that of Scotland (where banking was always free) has been for two centuries past. But the almost incredible instances of reckless and fraudulent mismanagement which these institutions have of late afforded (though in some of the most notorious cases the delinquent establishments have not been banks of issue), have shown only too clearly that, south of the Tweed at least, the joint-stock principle applied to banking is not the adequate safeguard it was so confidently supposed to be: and it is difficult now to resist the conviction, that if plurality of issuers is allowed to exist, some kind of special security in favour of the holders of notes should be exacted as an imperative condition.1

Book III, Chapter XXV: Of the competition of different countries in the same market

CHAPTER XXV: of the competition of different countries in the same market

§ 1. In the phraseology of the Mercantile System, the language and doctrines of which are still the basis of what may be called the political economy of the selling classes, as distinguished from the buyers or consumers, there is no word of more frequent recurrence or more perilous import than the word underselling. To undersell other countries—not to be undersold by other countries—were spoken of, and are still very often spoken of, almost as if they were the sole purposes for which production and commodities exist. The feelings of rival tradesmen, prevailing among nations, overruled for centuries all sense of the general community of advantage which commercial countries derive from the prosperity of one another: and that commercial spirit which is now one of the strongest obstacles to wars, was during a certain period of European history their principal cause.

Even in the more enlightened view now attainable of the nature and consequences of international commerce, some, though a comparatively small, space must still be made for the fact of commercial rivality. Nations may, like individual dealers, be competitors, with opposite interests, in the markets of some commodities, while in others they are in the more fortunate relation of reciprocal customers. The benefit of commerce does not consist, as it was once thought to do, in the commodities sold; but, since the commodities sold are the means of obtaining those which are bought, a nation would be cut off from the real advantage of commerce, the imports, if it could not induce other nations to take any of its commodities in exchange; and in proportion as the competition of other counties compels it to offer its commodities on cheaper terms, on pain of not selling them at all, the imports which it obtains by its foreign trade are procured at greater cost.

These points have been adequately, though incidentally, frustrated in some of the preceding chapters. But the great space which the topic has filled, and continues to fill, in economical speculations, and in the practical anxieties both of politicians and of dealers and manufacturers, makes it desirable, before quitting the subject of international exchange, to subjoin a few observations on the things which do, and on those which do not, enable countries to undersell one another.

One country can only undersell another in a given market, to the extent of entirely expelling her from it, on two conditions. In the first place, she must have a greater advantage than the second country in the production of the article exported by both; meaning by a greater advantage (as has been already so fully explained) not absolutely, but in comparison with other commodities; and in the second place, such must be her relation with the customer country in respect to the demand for each other’s products, and such the consequent state of international values, as to give away to the customer country more than the whole advantage possessed by the rival country; otherwise the rival will still be able to hold her ground in the market.

Let us revert to the imaginary hypothesis of a trade between England and Germany in cloth and linen: England being capable of producing 10 yards of cloth at the same cost with 15 yards of linen, Germany at the same cost with 20, and the two commodities being exchanged between the two countries (cost of carriage apart) at some intermediate rate, say 10 for 17. Germany could not be permanently undersold in the English market, and expelled from it, unless by a country which offered not merely more than 17, but more than 20 yards of linen for 10 of cloth. Short of that, the competition would only oblige Germany to pay dearer for cloth, but would not disable her from exporting linen. The country, therefore, which could undersell Germany, must, in the first place, be able to produce linen at less cost, compared with cloth, than Germany herself; and in the next place, must have such a demand for cloth, or other English commodities, as would compel her, even when she became sole occupant of the market, to give a greater advantage to England than Germany could give by resigning the whole of hers; to give, for example, 21 yards for 10. For if not—if, for example, the equation of international demand, after Germany was excluded, gave a ratio of 18 for 10, Germany could again enter into the competition; Germany would be now the underselling nation; and there would be a point, perhaps 19 for 10, at which both countries would be able to maintain their ground, and to sell in England enough linen to pay for the cloth, or other English commodities, for which, on these newly-adjusted terms of interchange, they had a demand. In like manner, England, as an exporter of cloth, could only be driven from the German market by some rival whose superior advantages in the production of cloth enabled her, and the intensity of whose demand for German produce compelled her, to offer 10 yards of cloth, not merely for less than 17 yards of linen, but for less than 15. In that case, England could no longer carry on the trade without loss; but in any case short of this, she would merely be obliged to give to Germany more cloth for less linen than she had previously given.

It thus appears that the alarm of being permanently undersold may be taken much too easily; may be taken when the thing really to be anticipated is not the loss of the trade, but the minor inconvenience of carrying it on at a diminished advantage; an inconvenience chiefly falling on the consumers of foreign commodities, and not on the producers or sellers of the exported article. It is no sufficient ground of apprehension to the English producers to find that some other country can sell cloth in foreign markets at some particular time, a trifle cheaper than they can themselves afford to do in the existing state of prices in England. Suppose them to be temporarily undersold, and their exports diminished; the imports will exceed the exports, there will be a new distribution of the precious metals, prices will fall, and as all the money expenses of the English producers will be diminished, they will be able (if the case falls short of that stated in the preceding paragraph) again to compete with their rivals. The loss which England will incur, will not fall upon the exporters, but upon those who consume imported commodities; who, with money incomes reduced in amount, will have to pay the same or even an increased price for all things produced in foreign countries.

§ 2. Such, I conceive, is the true theory, or rationale, of underselling. It will be observed that it takes no account of some things which we hear spoken of, oftener perhaps than any others, in the character of causes exposing a country to be undersold.

According to the preceding doctrine, a country cannot be undersold in any commodity, unless the rival country has a stronger inducement than itself for devoting its labour and capital to the production of the commodity; arising from the fact that by doing so it occasions a greater saving of labour and capital, to be shared between itself and its customers—a greater increase of the aggregate produce of the world. The underselling, therefore, though a loss to the undersold country, is an advantage to the world at large; the substituted commerce being one which economizes more of the labour and capital of mankind, and adds more to their collective wealth, than the commerce superseded by it. The advantage, of course, consists in being able to produce the commodity of better quality, or with less labour (compared with other things); or perhaps not with less labour, but in less time; with a less prolonged detention of the capital employed. This may arise from greater natural advantages (such as soil, climate, richness of mines); superior capability, either natural or acquired, in the labourers; better division of labour, and better tools, or machinery. But there is no place left in this theory for the case of lower wages. This, however, in the theories commonly current, is a favourite cause of underselling. We continually hear of the disadvantage under which the British producer labours, both in foreign markets and even in his own, through the lower wages paid by his foreign rivals. These lower wages, we are told, enable, or are always on the point of enabling them to sell at lower prices, and to dislodge the English manufacturer from all markets in which he is not artificially protected.

Before examining this opinion on grounds of principle, it is worth while to bestow a moment’s consideration upon it as a question of fact. Is it true, that the wages of manufacturing labour are lower in foreign countries than in England, in any sense in which low wages are an advantage to the capitalist? The artisan of Ghent or Lyons may earn less wages in a day, but does he not do less work? Degrees of efficiency considered, does his labour cost less to his employer? Though wages may be lower on the Continent, is not the Cost of Labour, which is the real element in the competition, very nearly the same? That it is so seems the opinion of competent judges, and is confirmed by the very little difference in the rate of profit between England and the Continental countries. But if so, the opinion is absurd that English producers can be undersold by their Continental rivals from this cause. It is only in America that the supposition is primâ facie admissible. In America, wages are much higher than in England, if we mean by wages the daily earnings of a labourer: but the productive power of American labour is so great—its efficiency, combined with the favourable circumstances in which it is exerted, makes it worth so much to the purchaser, that the Cost of Labour is lower in America than in England; as is indicated by the fact that the general rate of profits and of interest is higher.1

§ 3. But is it true that low wages, even in the sense of low Cost of Labour, enable a country to sell cheaper in the foreign market? I mean, of course, low wages which are common to the whole productive industry of the country.

If wages, in any of the departments of industry which supply exports, are kept, artificially, or by some accidental cause, below the general rate of wages in the country, this is a real advantage in the foreign market. It lessens the comparative cost of production of those articles, in relation to others; and has the same effect as if their production required so much less labour. Take, for instance, the case of the United States in respect to certain commodities, prior to the civil war.2 Tobacco and cotton, two great articles of export, were produced by slave labour, while food and manufactures generally were produced by free labourers, neither working on their own account or paid by wages. In spite of the inferior efficiency of slave labour, there can be no reasonable doubt that in a country where the wages of free labour were so high, the work executed by slaves was a better bargain to the capitalist. To whatever extent it was so, this smaller cost of labour, being not general, but limited to those employments, was just as much a cause of cheapness in the products, both in the home and in the foreign market, as if they had been made by a less quantity of labour. If, when the slaves in the Southern States were emancipated, their wages rose to the general level of the earnings of free labour in America, that country might have been obliged to erase some of the slave-grown articles from the catalogue of its exports, and would certainly be unable to sell any of them in the foreign market at the accustomed price. Accordingly, American cotton is now habitually at a much higher price than before the war. Its previous cheapness was partly an artificial cheapness, which may be compared to that produced by a bounty on production or on exportation: or, considering the means by which it was obtained, an apter comparison would be with the cheapness of stolen goods.

An advantage of a similar economical, though of a very different moral character, is that possessed by domestic manufactures; fabrics produced in the leisure hours of families partially occupied in other pursuits, who, not depending for subsistence on the produce of the manufacture, can afford to sell it at any price, however low, for which they think it worth while to take the trouble of producing. In an account of the Canton of Zurich, to which I have had occasion to refer on another subject, it is observed,∗ “The workman of Zurich is to-day a manufacturer, to-morrow again an agriculturist, and changes his occupations with the seasons, in a continual round. Manufacturing industry and tillage advance hand in hand, in inseparable alliance, and in this union of the two occupations the secret may be found, why the simple and unlearned Swiss manufacturer can always go on competing, and increasing in prosperity, in the face of those extensive establishments fitted out with great economic, and (what is still more important) intellectual, resources. Even in those parts of the Canton where manufactures have extended themselves the most widely, only one-seventh of all the families belong to manufactures alone; four-sevenths combine that employment with agriculture. The advantage of this domestic or family manufacture consists chiefly in the fact, that it is compatible with all other avocations, or rather that it may in part be regarded as only a supplementary employment. In winter, in the dwellings of the operatives, the whole family employ themselves in it: but as soon as spring appears, those on whom the early field labours devolve abandon the in-door work; many a shuttle stands still; by degrees, as the field-work increases, one member of the family follows another, till at last, at the harvest, and during the so-called ‘great works,’ all hands seize the implements of husbandry; but in unfavourable weather, and in all otherwise vacant hours, the work in the cottage is resumed, and when the ungenial season again recurs, the people return in the same gradual order to their home occupation, until they have all resumed it.”

In the case of these domestic manufactures, the comparative cost of production, on which the interchange between countries depends, is much lower than in proportion to the quantity of labour employed. The workpeople, looking to the earnings of their loom for a part only, if for any part, of their actual maintenance, can afford to work for a less remuneration than the lowest rate of wages which can permanently exist in the employments by which the labourer has to support the whole expense of the family. Working, as they do, not for an employer but for themselves, they may be said to carry on the manufacture at no cost at all, except the small expense of a loom and of the material; and the limit of possible cheapness is not the necessity of living by their trade but that of earning enough by the work to make that social employment of their leisure hours not disagreeable.

§ 4. These two cases, of slave labour and of domestic manufactures, exemplify the conditions under which low wages enable a country to sell its commodities cheaper in foreign markets, and consequently to undersell its rivals, or to avoid being undersold by them. But no such advantage is conferred by low wages when common to all branches of industry. General low wages never caused any country to undersell its rivals, nor did general high wages ever hinder it from doing so.

To demonstrate this, we must return to an elementary principle which was discussed in a former chapter.∗ General low wages do not cause low prices, nor high wages high prices, within the country itself. General prices are not raised by a rise of wages, any more than they would be raised by an increase of the quantity of labour required in all production. Expenses which affect all commodities equally, have no influence on prices. If the maker of broadcloth or cutlery, and nobody else, had to pay higher wages, the price of his commodity would rise, just as it would if he had to employ more labour; because otherwise he would gain less profit than other producers, and nobody would engage in the employment. But if everybody has to pay higher wages, or everybody to employ more labour, the loss must be submitted to; as it affects everybody alike, no one can hope to get rid of it by a change of employment, each therefore resigns himself to a diminution of profits, and prices remain as they were. In like manner, general low wages, or a general increase in the productiveness of labour, does not make prices low, but profits high. If wages fall, (meaning here by wages the cost of labour,) why, on that account, should the producer lower his price? He will be forced, it may be said, by the competition of other capitalists who will crowd into his employment. But other capitalists are also paying lower wages, and by entering into competition with him they would gain nothing but what they are gaining already. The rate then at which labour is paid, as well as the quantity of it which is employed, affects neither the value nor the price of the commodity produced, except in so far as it is peculiar to that commodity, and not common to commodities generally.

Since low wages are not a cause of low prices in the country itself, so neither do they cause it to offer its commodities in foreign markets at a lower price. It is quite true that if the cost of labour is lower in America than in England, America could sell her cottons to Cuba at a lower price than England, and still gain as high a profit as the English manufacturer. But it is not with the profit of the English manufacturer that the American cotton spinner will make his comparison; it is with the profits of other American capitalists. These enjoy, in common with himself, the benefit of a low cost of labour, and have accordingly a high rate of profit. This high profit the cotton spinner must also have: he will not content himself with the English profit. It is true he may go on for a time at that lower rate, rather than change his employment; and a trade may be carried on, sometimes for a long period, at a much lower profit than that for which it would have been originally engaged in. Countries which have a low cost of labour, and high profits, do not for that reason undersell others, but they do oppose a more obstinate resistance to being undersold, because the producers can often submit to a diminution of profit without being unable to live, and even to thrive, by their business. But this is all which their advantage does for them: and in this resistance they will not long persevere, when a change of times which may give them equal profits with the rest of their countrymen has become manifestly hopeless.

§ 5. There is a class of trading and exporting communities, on which a few words of explanation seem to be required. These are hardly to be looked upon as countries, carrying on an exchange of commodities with other countries, but more properly as outlying agricultural or manufacturing establishments belonging to a larger community. Our West India colonies, for example, cannot be regarded as countries, with a productive capital of their own. If Manchester, instead of being where it is, were on a rock in the North Sea, (its present industry nevertheless continuing,) it would still be but a town of England, not a country trading with England; it would be merely, as now, a place where England finds it convenient to carry on her cotton manufacture. The West Indies, in like manner, are the place where England finds it convenient to carry on the production of sugar, coffee, and a few other tropical commodities. All the capital employed is English capital; almost all the industry is carried on for English uses; there is little production of anything except the staple commodities, and these are sent to England, not to be exchanged for things exported to the colony and consumed by its inhabitants, but to be sold in England for the benefit of the proprietors there. The trade with the West Indies is therefore hardly to be considered as external trade, but more resembles the traffic between town and country, and is amenable to the principles of the home trade. The rate of profit in the colonies will be regulated by English profits; the expectation of profit must be about the same as in England, with the addition of compensation for the disadvantages attending the more distant and hazardous employment; and after allowance is made for those disadvantages, the value and price of West India produce in the English market must be regulated, (or rather must have been regulated formerly,) like that of any English commodity, by the cost of production. For the last twelve or fifteen years1 this principle has been in abeyance: the price was first kept up beyond the ratio of the cost of production by deficient supplies, which could not, owing to the deficiency of labour, be increased; and more recently the admission of foreign competition has introduced another element, and some of2 the West India Islands are undersold, not so much because wages are higher than in Cuba and Brazil, as because they are higher than in England: for were they not so, Jamaica could sell her sugars at Cuban prices, and still obtain, though not a Cuban, an English rate of profit.

It is worth while also to notice another class of small, but in this case mostly independent communities, which have supported and enriched themselves almost without any productions of their own, (except ships and marine equipments,) by a mere carrying trade, and commerce of entrepôt; by buying the produce of one country, to sell it at a profit in another. Such were Venice and the Hanse Towns. The case of these communities is very simple. They made themselves and their capital the instruments, not of production, but of accomplishing exchanges between the productions of other countries. These exchanges are attended with an advantage to those countries —an increase of the aggregate returns to industry—part of which went to indemnify the agents for the necessary expenses of transport, and another part to remunerate the use of their capital and mercantile skill. The countries themselves had not capital disposable for the operation. When the Venetians became the agents of the general commerce of Southern Europe, they had scarcely any competitors: the thing would not have been done at all without them, and there was really no limit to their profits except the limit to what the ignorant feudal nobility could and would give for the unknown luxuries then first presented to their sight. At a later period competition arose, and the profit of this operation, like that of others, became amenable to natural laws. The carrying trade was taken up by Holland, a country with productions of its own and a large accumulated capital. The other nations of Europe also had now capital to spare, and were capable of conducting their foreign trade for themselves: but Holland, having, from a variety of circumstances, a lower rate of profit at home, could afford to carry for other countries at a smaller advance on the original cost of the goods, than would have been required by their own capitalists; and Holland, therefore, engrossed the greatest part of the carrying trade of all those countries which did not keep it to themselves by Navigation Laws, constructed, like those of England, for that express purpose.

Book III, Chapter XXVI: Of distribution, as affected by exchange

CHAPTER XXVI: of distribution, as affected by exchange

§ 1. We have now completed, as far as is compatible with our purposes and limits, the exposition of the machinery through which the produce of a country is apportioned among the different classes of its inhabitants; which is no other than the machinery of Exchange, and has for the exponents of its operation the laws of Value and of Price. We shall now avail ourselves of the light thus acquired, to cast a retrospective glance at the subject of Distribution. The division of the produce among the three classes, Labourers, Capitalists, and Landlords, when considered without any reference to Exchange, appeared to depend on certain general laws. It is fit that we should now consider whether these same laws still operate, when the distribution takes place through the complex mechanism of exchange and money; or whether the properties of the mechanism interfere with and modify the presiding principles.

The primary division of the produce of human exertion and frugality is, as we have seen, into three shares, wages, profits, and rent; and these shares are portioned out to the persons entitled to them, in the form of money, and by a process of exchange; or rather, the capitalist, with whom in the usual arrangements of society the produce remains, pays in money, to the other two sharers, the market value of their labour and land. If we examine, on what the pecuniary value of labour, and the pecuniary value of the use of land, depend, we shall find that it is on the very same causes by which we found that wages and rent would be regulated if there were no money and no exchange of commodities.

It is evident, in the first place, that the law of Wages is not affected by the existence or non-existence of Exchange or Money. Wages depend on the ratio between population and capital; and would do so if all the capital in the world were the property of one association, or if the capitalists among whom it is shared maintained each an establishment for the production of every article consumed in the community, exchange of commodities having no existence. As the ratio between capital and population, in all old countries, depends on the strength of the checks by which the too rapid increase of population is restrained, it may be said, popularly speaking, that wages depend on the checks to population; that when the check is not death, by starvation or disease, wages depend on the prudence of the labouring people; and that wages in any country are habitually at the lowest rate to which in that country the labourer will suffer them to be depressed rather than put a restraint upon multiplication.

What is here meant, however, by wages, is the labourer’s real scale of comfort; the quantity he obtains of the things which nature or habit has made necessary or agreeable to him: wages in the sense in which they are of importance to the receiver. In the sense in which they are of importance to the payer, they do not depend exclusively on such simple principles. Wages in the first sense, the wages on which the labourer’s comfort depends, we will call real wages, or wages in kind. Wages in the second sense, we may be permitted to call, for the present, money wages; assuming, as it is allowable to do, that money remains for the time an invariable standard, no alteration taking place in the conditions under which the circulating medium itself is produced or obtained. If money itself undergoes no variation in cost, the money price of labour is an exact measure of the Cost of Labour, and may be made use of as a convenient symbol to express it.

The money wages of labour are a compound result of two elements: first, real wages, or wages in kind, or, in other words, the quantity which the labourer obtains of the ordinary articles of consumption; and secondly, the money prices of those articles. In all old countries—all countries in which the increase of population is in any degree checked by the difficulty of obtaining subsistence—the habitual money price of labour is that which will just enable the labourers, one with another, to purchase the commodities without which they neither cannot or will not keep up the population at its customary rate of increase.1 Their standard of comfort being given, (and by the standard of comfort in a labouring class, is meant that, rather than forego which, they will abstain from multiplication,) money wages depend on the money price, and therefore on the cost of production, of the various articles which the labourers habitually consume: because if their wages cannot procure them a given quantity of these, their increase will slacken, and their wages rise. Of these articles, food and other agricultural produce are so much the principal, as to leave little influence to anything else.

It is at this point that we are enabled to invoke the aid of the principles which have been laid down in this Third Part. The cost of production of food and agricultural produce has been analyzed in a preceding chapter. It depends on the productiveness of the least fertile land, or of the least productively employed portion of capital, which the necessities of society have as yet put in requisition for agricultural purposes. The cost of production of the food grown in these least advantageous circumstances, determines, as we have seen, the exchange value and money price of the whole. In any given state, therefore, of the labourers' habits, their money wages depend on the productiveness of the least fertile land, or least productive agricultural capital; on the point which cultivation has reached in its downward progress—in its encroachments on the barren lands, and its gradually increased strain upon the powers of the more fertile. Now, the force which urges cultivation in this downward course is the increase of people; while the counter-force which checks the descent, is the improvement of agricultural science and practice, enabling the same soil to yield to the same labour more ample returns. The costliness of the most costly part of the produce of cultivation is an exact expression of the state, at any given moment, of the race which population and agricultural skill are always running against each other.

§ 2. It is well said by Dr. Chalmers, that many of the most important lessons in political economy are to be learnt at the extreme margin of cultivation, the last point which the culture of the soil has reached in its contest with the spontaneous agencies of nature. The degree of productiveness of this extreme margin is an index to the existing state of the distribution of the produce among the three classes, of labourers, capitalists, and landlords.

When the demand of an increasing population for more food cannot be satisfied without extending cultivation to less fertile land, or incurring additional outlay, with a less proportional return, on land already in cultivation, it is a necessary condition of this increase of agricultural produce that the value and price of that produce must first rise. But as soon as the price has risen sufficiently to give to the additional outlay of capital the ordinary profit, the rise will not go on still further for the purpose of enabling the new land, or the new expenditure on old land, to yield rent as well as profit. The land or capital last put in requisition, and occupying what Dr. Chalmers calls the margin of cultivation, will yield, and continue to yield, no rent. But if this yields no rent, the rent afforded by all other land or agricultural capital will be exactly so much as it produces more than this. The price of food will always on the average be such, that the worst land, and the least productive instalment of the capital employed on the better lands, shall just replace the expenses with the ordinary profit. If the least favoured land and capital just do thus much, all other land and capital will yield an extra profit, equal to the proceeds of the extra produce due to their superior productiveness; and this extra profit becomes, by competition, the prize of the landlords. Exchange, and money, therefore, make no difference in the law of rent: it is the same as we originally found it. Rent is the extra return made to agricultural capital when employed with peculiar advantages; the exact equivalent of what those advantages enable the producers to economize in the cost of production: the value and price of the produce being regulated by the cost of production to those producers who have no advantages; by the return to that portion of agricultural capital, the circumstances of which are the least favourable.

§ 3. Wages and Rent being thus regulated by the same principles when paid in money, as they would be if apportioned in kind, it follows that Profits are so likewise. For the surplus, after replacing wages and paying rent, constitutes Profits.

We found in the last chapter of the Second Book, that the advances of the capitalist, when analyzed to their ultimate elements, consist either in the purchase or maintenance of labour, or in the profits of former capitalists; and that therefore profits, in the last resort, depend upon the Cost of Labour, falling as that rises, and rising as it falls. Let us endeavour to trace more minutely the operation of this law.

There are two modes in which the Cost of Labour, which is correctly represented (money being supposed invariable) by the money wages of the labourer, may be increased. The labourer may obtain greater comforts; wages in kind—real wages—may rise. Or the progress of population may force down cultivation to inferior soils, and more costly processes; thus raising the cost of production, the value, and the price, of the chief articles of the labourer’s consumption. On either of these suppositions, the rate of profit will fall.

If the labourer obtains more abundant commodities, only by reason of their greater cheapness; if he obtains a greater quantity, but not on the whole a greater cost; real wages will be increased, but not money wages, and there will be nothing to affect the rate of profit. But if he obtains a greater quantity of commodities of which the cost of production is not lowered, he obtains a greater cost; his money wages are higher. The expense of these increased money wages falls wholly on the capitalist. There are no conceivable means by which he can shake it off. It may be said—it is, not unfrequently, said—that he will get rid of it by raising his price. But this opinion we have already, and more than once, fully refuted.∗

The doctrine, indeed, that a rise of wages causes an equivalent rise of prices, is, as we formerly observed, self-contradictory: for if it did so, it would not be a rise of wages; the labourer would get no more of any commodity than he had before, let his money wages rise ever so much; a rise of real wages would be an impossibility. This being equally contrary to reason and to fact, it is evident that a rise of money wages does not raise prices; that high wages are not a cause of high prices. A rise of general wages falls on profits. There is no possible alternative.

Having disposed of the case in which the increase of money wages, and of the Cost of Labour, arises from the labourer’s obtaining more ample wages in kind, let us now suppose it to arise from the increased cost of production of the things which he consumes; owing to an increase of population, unaccompanied by an equivalent increase of agricultural skill. The augmented supply required by the population would not be obtained, unless the price of food rose sufficiently to remunerate the farmer for the increased cost of production. The farmer, however, in this case sustains a twofold disadvantage. He has to carry on his cultivation under less favourable conditions of productiveness than before. For this, as it is a disadvantage belonging to him only as a farmer, and not shared by other employers, he will, on the general principles of value, be compensated by a rise of the price of his commodity: indeed, until this rise has taken place, he will not bring to market the required increase of produce. But this very rise of price involves him in another necessity, for which he is not compensated. As the real wages of labour are by supposition unaltered, he must pay higher money wages to his labourers. This necessity, being common to him with all other capitalists, forms no ground for a rise of price. The price will rise, until it has placed him in as good a situation in respect of profits, as other employers of labour: it will rise so as to indemnify him for the increased labour which he must now employ in order to produce a given quantity of food: but the increased wages of that labour are a burthen common to all, and for which no one can be indemnified. It will be paid wholly from profits.

Thus we see that increased wages, when common to all descriptions of productive labourers, and when really representing a greater Cost of Labour, are always and necessarily at the expense of profits. And by reversing the cases, we should find in like manner that diminished wages, when representing a really diminished Cost of Labour, are equivalent to a rise of profits. But the opposition of pecuniary interest thus indicated between the class of capitalists and that of labourers, is to a great extent only apparent. Real wages are a very different thing from the Cost of Labour, and are generally highest at the times and places where, from the easy terms on which the land yields all the produce as yet required from it, the value and price of food being low, the cost of labour to the employer, notwithstanding its ample remuneration, is comparatively cheap, and the rate of profit consequently high.1 We thus obtain a full confirmation of our original theorem that Profits depend on the Cost of Labour: or, to express the meaning with still greater accuracy, the rate of profit and the cost of labour vary inversely as one another, and are joint effects of the same agencies or causes.

But does not this proposition require to be slightly modified, by making allowance for that portion (though comparatively small) of the expenses of the capitalist, which does not consist in wages paid by himself or reimbursed to previous capitalists, but in the profits of those previous capitalists? Suppose, for example, an invention in the manufacture of leather, the advantage of which should consist in rendering it unnecessary that the hides should remain for so great a length of time in the tan-pit. Shoemakers, saddlers, and other workers in leather, would save a part of that portion of the cost of their material which consists of the tanner’s profits during the time his capital is locked up; and this saving, it may be said, is a source from which they might derive an increase of profit, though wages and the Cost of Labour remained exactly the same. In the case here supposed, however, the consumer alone would benefit, since the prices of shoes, harness, and all other articles into which leather enters, would fall, until the profits of the producers were reduced to the general level. To obviate this objection, let us suppose that a similar saving of expense takes place in all departments of production at once. In that case, since values and prices would not be affected, profits would probably be raised; but if we look more closely into the case we shall find, that it is because the cost of labour would be lowered. In this as in any other case of increase in the general productiveness of labour, if the labourer obtained only the same real wages, profits would be raised: but the same real wages would imply a smaller Cost of Labour; the cost of production of all things having been, by the supposition, diminished. If, on the other hand, the real wages of labour rose proportionally, and the Cost of Labour to the employer remained the same, the advances of the capitalist would bear the same ratio to his returns as before, and the rate of profit would be unaltered. The reader who may wish for a more minute examination of this point, will find it in the volume of separate Essays to which reference has before been made.∗ The question is too intricate in comparison with its importance, to be further entered into in a work like the present; and I will merely say, that it seems to result from the considerations adduced in the Essay, that there is nothing in the case in question to affect the integrity of the theory which affirms an exact correspondence, in an inverse direction, between the rate of profit and the Cost of Labour.

Book IV: INFLUENCE OF THE PROGRESS OF SOCIETY ON PRODUCTION AND DISTRIBUTION

Book IV, Chapter I: General characteristics of a progressive state of wealth

CHAPTER I: general characteristics of a progressive state of wealth

§1. The three preceding Parts include as detailed a view as our limits permit, of what, by a happy generalization of a mathematical phrase, has been called the Statics of the subject. We have surveyed the field of economical facts, and have examined how they stand related to one another as causes and effects; what circumstances determine the amount of production, of employment for labour, of capital and population; what laws regulate rent, profits, and wages; under what conditions and in what proportions commodities are interchanged between individuals and between countries. We have thus obtained a collective view of the economical phenomena of society, considered as existing simultaneously. We have ascertained, to a certain extent, the principles of their interdependence; and when the state of some of the elements is known, we should now be able to infer, in a general way, the contemporaneous state of most of the others. All this, however, has only put us in possession of the economical laws of a stationary and unchanging society. We have still to consider the economical condition of mankind as liable to change, and indeed (in the more advanced portions of the race, and in all regions to which their influence reaches) as at all times undergoing progressive changes. We have to consider what these changes are, what are their laws, and what their ultimate tendencies; thereby adding a theory of motion to our theory of equilibrium—the Dynamics of political economy to the Statics.

In this inquiry, it is natural to commence by tracing the operation of known and acknowledged agencies. Whatever may be the other changes which the economy of society is destined to undergo, there is one actually in progress, concerning which there can be no dispute. In the leading countries of the world, and in all others as they come within the influence of those leading countries, there is at least one progressive movement which continues with little interruption from year to year and from generation to generation; a progress in wealth; an advancement of what is called material prosperity. All the nations which we are accustomed to call civilized, increase gradually in production and in population: and there is no reason to doubt, that not only these nations will for some time continue so to increase, but that most of the other nations of the world, including some not yet founded, will successively enter upon the same career. It will, therefore, be our first object to examine the nature and consequences of this progressive change; the elements which constitute it, and the effects it produces on the various economical facts of which we have been tracing the laws, and especially on wages, profits, rents, values, and prices.

§2. Of the features which characterize this progressive economical movement of civilized nations, that which first excites attention, through its intimate connexion with the phenomena of Production, is the perpetual, and so far as human foresight can extend, the unlimited, growth of man's power over nature. Our knowledge of the properties and laws of physical objects shows no sign of approaching its ultimate boundaries: it is advancing more rapidly, and in a greater number of directions at once, than in any previous age or generation, and affording such frequent glimpses of unexplored fields beyond, as to justify the belief that our acquaintance with nature is still almost in its infancy. This increasing physical knowledge is now, too, more rapidly than at any former period, converted, by practical ingenuity, into physical power. The most marvellous of modern inventions, one which realizes the imaginary feats of the magician, not metaphorically but literally—the electro-magnetic telegraph—sprang into existence but a few years after the establishment of the scientific theory which it realizes and exemplifies. Lastly, the manual part of these great scientific operations is now never wanting to the intellectual: there is no difficulty in finding or forming, in a sufficient number of the working hands of the community, the skill requisite for executing the most delicate processes of the application of science to practical uses. From this union of conditions, it is impossible not to look forward to a vast multiplication and long succession of contrivances for economizing labour and increasing its produce; and to an ever wider diffusion of the use and benefit of those contrivances.

Another change, which has always hitherto characterized, and will assuredly continue to characterize, the progress of civilized society, is a continual increase of the security of person and property. The people of every country in Europe, the most backward as well as the most advanced, are, in each generation, better protected against the violence and rapacity of one another, both by a more efficient judicature and police for the suppression of private crime, and by the decay and destruction of those mischievous privileges which enabled certain classes of the community to prey with impunity upon the rest. They are also, in every generation, better protected, either by institutions or by manners and opinion, against arbitrary exercise of the power of government. Even in semi-barbarous Russia, acts of spoliation directed against individuals, who have not made themselves politically obnoxious, are not supposed to be now so frequent as much to affect any person's feelings of security. Taxation, in all European countries, grows less arbitrary and oppressive, both in itself and in the manner of levying it. Wars, and the destruction they cause, are now usually1 confined, in almost every country, to those distant and outlying possessions at which it comes into contact with savages. Even the vicissitudes of fortune which arise from inevitable natural calamities, are more and more softened to those on whom they fall, by the continual extension of the salutary practice of insurance.

Of this increased security, one of the most unfailing effects is a great increase both of production and of accumulation. Industry and frugality cannot exist where there is not a preponderant probability that those who labour and spare will be permitted to enjoy. And the nearer this probability approaches to certainty, the more do industry and frugality become pervading qualities in a people. Experience has shown that a large proportion of the results of labour and abstinence may be taken away by fixed taxation, without impairing, and sometimes even with the effect of stimulating, the qualities from which a great production and an abundant capital take their rise. But those qualities are not proof against a high degree of uncertainty. The Government may carry off a part; but there must be assurance that it will not interfere, nor suffer any one to interfere, with the remainder.

One of the changes which most infallibly attend the progress of modern society, is an improvement in the business capacities of the general mass of mankind. I do not mean that the practical sagacity of an individual human being is greater than formerly. I am inclined to believe that economical progress has hitherto had even a contrary effect. A person of good natural endowments, in a rude state of society, can do a great number of things tolerably well, has a greater power of adapting means to ends, is more capable of extricating himself and others from an unforeseen embarrassment, than ninety-nine in a hundred of those who have known only what is called the civilized form of life. How far these points of inferiority of faculties are compensated, and by what means they might be compensated still more completely, to the civilized man as an individual being, is a question belonging to a different inquiry from the present. But to civilized human beings collectively considered, the compensation is ample. What is lost in the separate efficiency of each, is far more than made up by the greater capacity of united action. In proportion as they put off the qualities of the savage, they become amenable to discipline; capable of adhering to plans concerted beforehand, and about which they may not have been consulted; of subordinating their individual caprice to a preconceived determination, and performing severally the parts allotted to them in a combined undertaking. Works of all sorts, impracticable to the savage or the half-civilized, are daily accomplished by civilized nations, not by any greatness of faculties in the actual agents, but through the fact that each is able to rely with certainty on the others for the portion of the work which they respectively undertake. The peculiar characteristic, in short, of civilized beings, is the capacity of co-operation; and this, like other faculties, tends to improve by practice, and becomes capable of assuming a constantly wider sphere of action.

Accordingly there is no more certain incident of the progressive change taking place in society, than the continual growth of the principle and practice of co-operation. Associations of individuals voluntarily combining their small contributions now perform works, both of an industrial and of many other characters, which no one person or small number of persons are rich enough to accomplish, or for the performance of which the few persons capable of accomplishing them were formerly enabled to exact the most inordinate remuneration. As wealth increases and business capacity improves, we may look forward to a great extension of establishments, both for industrial and other purposes, formed by the collective contributions of large numbers; establishments like those called by the technical name of joint-stock companies, or the associations less formally constituted, which are so numerous in England, to raise funds for public or philanthropic objects, 1 or, lastly, those associations of workpeople either for production, or to buy goods for their common consumption, which are now specially known by the name of co-operative societies.

The progress which is to be expected in the physical sciences and arts, combined with the greater security of property, and greater freedom in disposing of it, which are obvious features in the civilization of modern nations, and with the more extensive and more skilful employment of the joint-stock principle, afford space and scope for an indefinite increase of capital and production, and for the increase of population which is its ordinary accompaniment. That the growth of population will overpass the increase of production, there is not much reason to apprehend; and that it should even keep pace with it, is inconsistent with the supposition of any real improvement in the poorest classes of the people. It is, however, quite possible that there might be a great progress in industrial improvement, and in the signs of what is commonly called national prosperity; a great increase of aggregate wealth, and even, in some respects, a better distribution of it; that not only the rich might grow richer, but many of the poor might grow rich, that the intermediate classes might become more numerous and powerful, and the means of enjoyable existence be more and more largely diffused, while yet the great class at the base of the whole might increase in numbers only, and not in comfort nor in cultivation. We must, therefore, in considering the effects of the progress of industry, admit as a supposition, however greatly we deprecate as a fact, an increase of population as long-continued, as indefinite, and possibly even as rapid, as the increase of production and accumulation.

With these preliminary observations on the causes of change at work in a society which is in a state of economical progress, I proceed to a more detailed examination of the changes themselves.

Book IV, Chapter II: Influence of the progress of industry and population on values and prices

CHAPTER II: influence of the progress of industry and population on values and prices

§ 1. The changes which the progress of industry causes or presupposes in the circumstances of production, are necessarily attended with changes in the values of commodities.

The permanent values of all things which are neither under a natural nor under an artificial monopoly, depend, as we have seen, on their cost of production. But the increasing power which mankind are constantly acquiring over nature, increases more and more the efficiency of human exertion, or, in other words, diminishes cost of production. All inventions by which a greater quantity of any commodity can be produced with the same labour, or the same quantity with less labour, or which abridge the process, so that the capital employed needs not be advanced for so long a time, lessen the cost of production of the commodity. As, however, value is relative; if inventions and improvements in production were made in all commodities, and all in the same degree, there would be no alteration in values. Things would continue to exchange for each other at the same rates as before; and mankind would obtain a greater quantity of all things in return for their labour and abstinence, without having that greater abundance measured and declared (as it is when it affects only one thing) by the diminished exchange value of the commodity.

As for prices, in these circumstances they would be affected or not, according as the improvements in production did or did not extend to the precious metals. If the materials of money were an exception to the general diminution of cost of production, the values of all other things would fall in relation to money, that is, there would be a fall of general prices throughout the world. But if money, like other things, and in the same degree as other things, were obtained in greater abundance and cheapness, prices would be no more affected than values would: and there would be no visible sign in the state of the markets, of any of the changes which had taken place; except that there would be (if people continued to labour as much as before) a greater quantity of all sorts of commodities, circulated at the same prices by a greater quantity of money.

Improvements in production are not the only circumstance accompanying the progress of industry which tends to diminish the cost of producing, or at least of obtaining, commodities. Another circumstance is the increase of intercourse between different parts of the world. As commerce extends, and the ignorant attempts to restrain it by tariffs become obsolete, commodities tend more and more to be produced in the places in which their production can be carried on at the least expense of labour and capital to mankind. As civilization spreads, and security of person and property becomes established, in parts of the world which have not hitherto had that advantage, the productive capabilities of those places are called into fuller activity, for the benefit both of their own inhabitants and of foreigners. The ignorance and misgovernment in which many of the regions most favoured by nature are still grovelling, afford work, probably, for many generations before those countries will be raised even to the present level of the most civilized parts of Europe. Much will also depend on the increasing migration of labour and capital to unoccupied parts of the earth, of which the soil, climate, and situation are found, by the ample means of exploration now possessed, to promise not only a large return to industry, but great facilities of producing commodities suited to the markets of old countries. Much as the collective industry of the earth is likely to be increased in efficiency by the extension of science and of the industrial arts, a still more active source of increased cheapness of production will be found, probably, for some time to come, in the gradually unfolding consequences of Free Trade, and in the increasing scale on which Emigration and Colonization will be carried on.

From the causes now enumerated, unless counteracted by others, the progress of things enables a country to obtain at less and less of real cost, not only its own productions but those of foreign countries. Indeed, whatever diminishes the cost of its own productions, when of an exportable character, enables it, as we have already seen, to obtain its imports at less real cost.

§ 2. But is it the fact, that these tendencies are not counteracted? Has the progress of wealth and industry no effect in regard to cost of production, but to diminish it? Are no causes of an opposite character brought into operation by the same progress, sufficient in some cases not only to neutralize, but to overcome the former, and convert the descending movement of cost of production into an ascending movement? We are already aware that there are such causes, and that, in the case of the most important classes of commodities, food and materials, there is a tendency diametrically opposite to that of which we have been speaking. The cost of production of these commodities tends to increase.

This is not a property inherent in the commodities themselves. If population were stationary, and the produce of the earth never needed to be augmented in quantity, there would be no cause for greater cost of production. Mankind would, on the contrary, have the full benefit of all improvements in agriculture, or in the arts subsidiary to it, and there would be no difference, in this respect, between the products of agriculture and those of manufactures.1 The only products of industry which, if population did not increase, would be liable to a real increase of cost of production, are those which, depending on a material which is not renewed, are either wholly or partially exhaustible; such as coal, and most if not all metals; for even iron, the most abundant as well as most useful of metallic products, which forms an ingredient of most minerals and of almost all rocks, is susceptible of exhaustion so far as regards its richest and most tractable ores.

When, however, population increases, as it has never yet failed to do when the increase of industry and of the means of subsistence made room for it, the demand for most of the productions of the earth, and particularly for food, increases in a corresponding proportion. And then comes into effect that fundamental law of production from the soil, on which we have so frequently had occasion to expatiate; the law, that increased labour, in any given state of agricultural skill, is attended with a less than proportional increase of produce. The cost of production of the fruits of the earth increases, caeteris paribus, with every increase of the demand.

No tendency of a like kind exists with respect to manufactured articles. The tendency is in the contrary direction. The larger the scale on which manufacturing operations are carried on, the more cheaply they can in general be performed. Mr. Senior has gone the length of enunciating as an inherent law of manufacturing industry, that in it increased production takes place at a smaller cost, while in agricultural industry increased production takes place at a greater cost. I cannot think, however, that even in manufactures, increased cheapness follows increased production by anything amounting to a law. It is a probable and usual, but not a necessary, consequence.

As manufactures, however, depend for their materials either upon agriculture, or mining, or the spontaneous produce of the earth, manufacturing industry is subject, in respect of one of its essentials, to the same law as agriculture. But the crude material generally forms so small a portion of the total cost, that any tendency which may exist to a progressive increase in that single item, is much over-balanced by the diminution continually taking place in all the other elements; to which diminution it is impossible at present to assign any limit.

The tendency, then, being to a perpetual increase of the productive power of labour in manufactures, while in agriculture and mining there is a conflict between two tendencies, the one towards an increase of productive power, the other towards a diminution of it, the cost of production being lessened by every improvement in the processes, and augmented by every addition to population; it follows that the exchange values of manufactured articles, compared with the products of agriculture and of mines, have, as population and industry advance, a certain and decided tendency to fall. Money being a product of mines, it may also be laid down as a rule, that manufactured articles tend, as society advances, to fall in money price. The industrial history of modern nations, especially during the last hundred years, fully bears out this assertion.

§ 3. Whether agricultural produce increases in absolute as well as comparative cost of production, depends on the conflict of the two antagonist agencies, increase of population, and improvement in agricultural skill. In some, perhaps in most, states of society, (looking at the whole surface of the earth,) both agricultural skill and population are either stationary, or increase very slowly, and the cost of production of food, therefore, is nearly stationary. In a society which is advancing in wealth, population generally increases faster than agricultural skill, and food consequently tends to become more costly; but there are times when a strong impulse sets in towards agricultural improvement. Such an impulse has shown itself in Great Britain during the last twenty or thirty1 years. In England and Scotland agricultural skill has of late increased considerably faster than population, insomuch that food and other agricultural produce, notwithstanding the increase of people, can be grown at less cost than they were thirty years ago:2 and the abolition of the Corn Laws has given an additional stimulus to the spirit of improvement. In some other countries, and particularly in France, the improvement of agriculture gains ground still more decidedly upon population, because though agriculture, except in a few provinces, advances slowly, population advances still more slowly, and even with increasing slowness; its growth being kept down, not by poverty, which is diminishing, but by prudence.

Which of the two conflicting agencies is gaining upon the other at any particular time, might be conjectured with tolerable accuracy from the money price of agricultural produce (supposing bullion not to vary materially in value), provided a sufficient number of years could be taken, to form an average independent of the fluctuations of seasons. This, however, is hardly practicable, since Mr. Tooke has shown that even so long a period as half a century may include a much greater proportion of abundant and a smaller of deficient seasons than is properly due to it. A mere average, therefore, might lead to conclusions only the more misleading, for their deceptive semblance of accuracy. There would be less danger of error in taking the average of only a small number of years, and correcting it by a conjectural allowance for the character of the seasons, than in trusting to a longer average without any such correction. It is hardly necessary to add, that in founding conclusions on quoted prices, allowance must also be made as far as possible for any changes in the general exchange value of the precious metals.∗3

§ 4. Thus far, of the effect of the progress of society on the permanent or average values and prices of commodities. It remains to be considered in what manner the same progress affects their fluctuations. Concerning the answer to this question there can be no doubt. It tends in a very high degree to diminish them.

In poor and backward societies, as in the East, and in Europe during the Middle Ages, extraordinary differences in the price of the same commodity might exist in places not very distant from each other, because the want of roads and canals, the imperfection of marine navigation, and the insecurity of communications generally, prevented things from being transported from the places where they were cheap to those where they were dear. The things most liable to fluctuations in value, those directly influenced by the seasons, and especially food, were seldom carried to any great distances. Each locality depended, as a general rule, on its own produce and that of its immediate neighbourhood. In most years, accordingly, there was, in some part or other of any large country, a real dearth. Almost every season must be unpropitious to some among the many soils and climates to be found in an extensive tract of country; but as the same season is also in general more than ordinarily favourable to others, it is only occasionally that the aggregate produce of the whole country is deficient, and even then in a less degree than that of many separate portions; while a deficiency at all considerable, extending to the whole world, is a thing almost unknown. In modern times, therefore, there is only dearth, where there formerly would have been famine, and sufficiency everywhere when anciently there would have been scarcity in some places and superfluity in others.

The same change has taken place with respect to all other articles of commerce. The safety and cheapness of communications, which enable a deficiency in one place to be supplied from the surplus of another, at a moderate or even a small advance on the ordinary price, render the fluctuations of prices much less extreme than formerly. This effect is much promoted by the existence of large capitals, belonging to what are called speculative merchants, whose business it is to buy goods in order to resell them at a profit.

These dealers naturally buying things when they are cheapest, and storing them up to be brought again into the market when the price has become unusually high; the tendency of their operations is to equalize price, or at least to moderate its inequalities. The prices of things are neither so much depressed at one time, nor so much raised at another, as they would be if speculative dealers did not exist.

Speculators, therefore, have a highly useful office in the economy of society; and (contrary to common opinion) the most useful portion of the class are those who speculate in commodities affected by the vicissitudes of seasons. If there were no corn-dealers, not only would the price of corn be liable to variations much more extreme than at present, but in a deficient season the necessary supplies might not be forthcoming at all. Unless there were speculators in corn, or unless, in default of dealers, the farmers became speculators, the price in a season of abundance would fall without any limit or check, except the wasteful consumption that would invariably follow. That any part of the surplus of one year remains to supply the deficiency of another, is owing either to farmers who withhold corn from the market, or to dealers who buy it when at the cheapest and lay it up in store.

§ 5. Among persons who have not much considered the subject, there is a notion that the gains of speculators are often made by causing an artificial scarcity; that they create a high price by their own purchases, and then profit by it. This may easily be shown to be fallacious. If a corn-dealer makes purchases on speculation, and produces a rise, when there is neither at the time nor afterwards any cause for a rise of price except his own proceedings; he no doubt appears to grow richer as long as his purchases continue, because he is a holder of an article which is quoted at a higher and higher price: but this apparent gain only seems within his reach so long as he does not attempt to realize it. If he has bought, for instance, a million of quarters, and by withholding them from the market, has raised the price ten shillings a quarter; just so much as the price has been raised by withdrawing a million quarters, will it be lowered by bringing them back, and the best that he can hope is that he will lose nothing except interest and his expenses. If by a gradual and cautious sale he is able to realize, on some portion of his stores, a part of the increased price, so also he will undoubtedly have had to pay a part of that price on some portion of his purchases. He runs considerable risk of incurring a still greater loss; for the temporary high price is very likely to have tempted others, who had no share in causing it, and who might otherwise not have found their way to his market at all, to bring their corn there, and intercept a part of the advantage. So that instead of profiting by a scarcity caused by himself, he is by no means unlikely, after buying in an average market, to be forced to sell in a superabundant one.

As an individual speculator cannot gain by a rise of price solely of his own creating, so neither can a number of speculators gain collectively by a rise which their operations have artificially produced. Some among a number of speculators may gain, by superior judgment or good fortune1 in selecting the time for realizing, but they make this gain at the expense, not of the consumer, but of the other speculators who are less judicious. They, in fact, convert to their own benefit the high price produced by the speculations of the others, leaving to these the loss resulting from the recoil. It is not to be denied, therefore, that speculators may enrich themselves by other people's loss. But it is by the losses of other speculators. As much must have been lost by one set of dealers as is gained by another set.

When a speculation in a commodity proves profitable to the speculators as a body, it is because, in the interval between their buying and reselling, the price rises from some cause independent of them, their only connexion with it consisting in having foreseen it. In this case, their purchases make the price begin to rise sooner than it otherwise would do, thus spreading the privation of the consumers over a longer period, but mitigating it at the time of its greatest height: evidently to the general advantage. In this, however, it is assumed that they have not overrated the rise which they looked forward to. For it often happens that speculative purchases are made in the expectation of some increase of demand, or deficiency of supply, which after all does not occur, or not to the extent which the speculator expected. In that case the speculation, instead of moderating fluctuation, has caused a fluctuation of price which otherwise would not have happened, or aggravated one which would. But in that case, the speculation is a losing one, to the speculators collectively, however much some individuals may gain by it. All that part of the rise of price by which it exceeds what there are independent grounds for, cannot give to the speculators as a body any benefit, since the price is as much depressed by their sales as it was raised by their purchases; and while they gain nothing by it, they lose, not only their trouble and expenses, but almost always much more, through the effects incident to the artificial rise of price, in checking consumption, and bringing forward supplies from unforeseen quarters. The operations, therefore, of speculative dealers, are useful to the public whenever profitable to themselves; and though they are sometimes injurious to the public, by heightening the fluctuations which their more usual office is to alleviate, yet whenever this happens the speculators are the greatest losers. The interest, in short, of the speculators as a body, coincides with the interest of the public; and as they can only fail to serve the public interest in proportion as they miss their own, the best way to promote the one is to leave them to pursue the other in perfect freedom.

I do not deny that speculators may aggravate a local scarcity. In collecting corn from the villages to supply the towns, they make the dearth penetrate into nooks and corners which might otherwise have escaped from bearing their share of it. To buy and resell in the same place, tends to alleviate scarcity; to buy in one place and resell in another, may increase it in the former of the two places, but relieves it in the latter, where the price is higher, and which, therefore, by the very supposition, is likely to be suffering more. And these sufferings always fall hardest on the poorest consumers, since the rich, by outbidding, can obtain their accustomed supply undiminished if they choose. To no persons, therefore, are the operations of corn-dealers on the whole so beneficial as to the poor. Accidentally and exceptionally, the poor may suffer from them: it might sometimes be more advantageous to the rural poor to have corn cheap in winter, when they are entirely dependent on it, even if the consequence were a dearth in spring, when they can perhaps obtain partial substitutes. But there are no substitutes, procurable at that season, which serve in any great degree to replace bread-corn as the chief article of food: if there were, its price would fall in the spring, instead of continuing, as it always does, to rise till the approach of harvest.

There is an opposition of immediate interest, at the moment of sale, between the dealer in corn and the consumer, as there always is between the seller and the buyer: and a time of dearth being that in which the speculator makes his largest profits, he is an object of dislike and jealousy at that time, to those who are suffering while he is gaining. It is an error, however, to suppose that the corn-dealer's business affords him any extraordinary profit: he makes his gains not constantly, but at particular times, and they must therefore occasionally be great, but the chances of profit in a business in which there is so much competition, cannot on the whole be greater than in other employments. A year of scarcity, in which great gains are made by corn-dealers, rarely comes to an end without a recoil which places many of them in the list of bankrupts. There have been few more promising seasons for corn-dealers than the year 1847, and seldom was there a greater break-up among the speculators than in the autumn of that year. The chances of failure, in this most precarious trade, are a set-off against great occasional profits. If the corn-dealer were to sell his stores, during a dearth, at a lower price than that which the competition of the consumers assigns to him, he would make a sacrifice, to charity or philanthropy, of the fair profits of his employment, which may be quite as reasonably required from any other person of equal means. His business being a useful one, it is the interest of the public that the ordinary motives should exist for carrying it on, and that neither law nor opinion should prevent an operation beneficial to the public from being attended with as much private advantage as is compatible with full and free competition.

It appears, then, that the fluctuations of values and prices arising from variations of supply, or from alterations in real (as distinguished from speculative) demand, may be expected to become more moderate as society advances. With regard to those which arise from miscalculation, and especially from the alterations of undue expansion and excessive contraction of credit, which occupy so conspicuous a place among commercial phenomena, the same thing cannot be affirmed with equal confidence. Such vicissitudes, beginning with irrational speculation and ending with a commercial crisis, have not hitherto become either less frequent or less violent with the growth of capital and extension of industry. Rather they may be said to have become more so: in consequence, as is often said, of increased competition; but, as I prefer to say, of a low rate of profits and interest, which makes capitalists dissatisfied with the ordinary course of safe mercantile gains.1 The connexion of this low rate of profit with the advance of population and accumulation, is one of the points to be illustrated in the ensuing chapters.

Book IV, Chapter III: Influence of the progress of industry and population, on rents, profits, and wages

CHAPTER III: influence of the progress of industry and population, on rents, profits, and wages

§ 1. Continuing the inquiry into the nature of the economical changes taking place in a society which is in a state of industrial progress we shall next consider what is the effect of that progress on the distribution of the produce among the various classes who share in it. We may confine our attention to the system of distribution which is the most complex, and which virtually includes all others—that in which the produce of manufactures is shared between two classes, labourers and capitalists, and the produce of agriculture among three, labourers, capitalists, and landlords.

The characteristic features of what is commonly meant by industrial progress, resolve themselves mainly into three, increase of capital, increase of population, and improvements in production; understanding the last expression in its widest sense, to include the process of procuring commodities from a distance, as well as that of producing them. The other changes which take place are chiefly consequences of these; as, for example, the tendency to a progressive increase of the cost of production of food; arising from an increased demand, which may be occasioned either by increased population, or by an increase of capital and wages, enabling the poorer classes to increase their consumption. It will be convenient to set out by considering each of the three causes, as operating separately; after which we can suppose them combined in any manner we think fit.

Let us first suppose that population increases, capital and the arts of production remaining stationary. One of the effects of this change of circumstances is sufficiently obvious: wages will fall; the labouring class will be reduced to an inferior condition. The state of the capitalist, on the contrary, will be improved. With the same capital, he can purchase more labour, and obtain more produce. His rate of profit is increased. The dependence of the rate of profits on the cost of labour is here verified; for the labourer obtaining a diminished quantity of commodities, and no alteration being supposed in the circumstances of their production, the diminished quantity represents a diminished cost. The labourer obtains not only a smaller real reward, but the product of a smaller quantity of labour. The first circumstance is the important one to himself, the last to his employer.

Nothing has occurred, thus far, to affect in any way the value of any commodity; and no reason, therefore, has yet shown itself, why rent should be either raised or lowered. But if we look forward another stage in the series of effects, we may see our way to such a consequence. The labourers have increased in numbers: their condition is reduced in the same proportion; the increased numbers divide among them only the produce of the same amount of labour as before. But they may economize in their other comforts, and not in their food: each may consume as much food, and of as costly a quality as previously; or they may submit to a reduction, but not in proportion to the increase of numbers. On this supposition, notwithstanding the diminution of real wages, the increased population will require an increased quantity of food. But since industrial skill and knowledge are supposed to be stationary, more food can only be obtained by resorting to worse land, or to methods of cultivation which are less productive in proportion to the outlay. Capital for this extension of agriculture will not be wanting; for though, by hypothesis, no addition takes place to the capital in existence, a sufficient amount can be spared from the industry which previously supplied the other and less pressing wants which the labourers have been obliged to curtail. The additional supply of food, therefore, will be produced, but produced at a greater cost; and the exchange value of agricultural produce must rise. It may be objected, that profits having risen, the extra cost of producing food can be defrayed from profits, without any increase of price. It could, undoubtedly, but it will not; because, if it did, the agriculturist would be placed in an inferior position to other capitalists. The increase of profits, being the effect of diminished wages, is common to all employers of labour. The increased expenses arising from the necessity of a more costly cultivation, affect the agriculturist alone. For this peculiar burthen he must be peculiarly compensated, whether the general rate of profit be high or low. He will not submit indefinitely to a deduction from his profits to which other capitalists are not subject. He will not extend his cultivation by laying out fresh capital, unless for a return sufficient to yield him as high a profit as could be obtained by the same capital in other investments. The value, therefore, of his commodity will rise, and rise in proportion to the increased cost. The farmer will thus be indemnified for the burthen which is peculiar to himself, and will also enjoy the augmented rate of profit which is common to all capitalists.

It follows, from principles with which we are already familiar, that in these circumstances rent will rise. Any land can afford to pay, and under free competition will pay, a rent equal to the excess of its produce above the return to an equal capital on the worst land, or under the least favourable conditions. Whenever, therefore, agriculture is driven to descend to worse land, or more onerous processes, rent rises. Its rise will be twofold, for, in the first place, rent in kind, or corn rent, will rise; and in the second, since the value of agricultural produce has also risen, rent, estimated in manufactured or foreign commodities (which is represented, caeteris paribus, by money rent) will rise still more.

The steps of the process (if, after what has been formerly said, it is necessary to retrace them) are as follows. Corn rises in price, to repay with the ordinary profit the capital required for producing additional corn on worse land or by more costly processes. So far as regards this additional corn, the increased price is but an equivalent for the additional expense; but the rise, extending to all corn, affords on all, except the last produced, an extra profit. If the farmer was accustomed to produce 100 quarters of wheat at 40s., and 120 quarters are now required, of which the last twenty cannot be produced under 45s., he obtains the extra five shillings on the entire 120 quarters, and not on the last twenty alone. He has thus an extra 25l. beyond the ordinary profits, and this, in a state of free competition, he will not be able to retain. He cannot however be compelled to give it up to the consumer, since a less price than 45s. would be inconsistent with the production of the last twenty quarters. The price, then, will remain at 45s., and the 25l. will be transferred by competition not to the consumer but to the landlord. A rise of rents is therefore inevitably consequent on an increased demand for agricultural produce, when unaccompanied by increased facilities for its production. A truth which, after this final illustration, we may henceforth take for granted.

The new element now introduced—an increased demand for food—besides occasioning an increase of rent, still further disturbs the distribution of the produce between capitalists and labourers. The increase of population will have diminished the reward of labour: and if its cost is diminished as greatly as its real remuneration, profits will be increased by the full amount. If, however, the increase of population leads to an increased production of food, which cannot be supplied but at an enhanced cost of production, the cost of labour will not be so much diminished as the real reward of it, and profits, therefore, will not be so much raised. It is even possible that they might not be raised at all. The labourers may previously have been so well provided for, that the whole of what they now lose may be struck off from their other indulgences, and they may not, either by necessity or choice, undergo any reduction in the quantity or quality of their food. To produce the food for the increased number may be attended with such an increase of expense, that wages, though reduced in quantity, may represent as great a cost, may be the product of as much labour, as before, and the capitalist may not be at all benefited. On this supposition the loss to the labourer is partly absorbed in the additional labour required for producing the last instalment of agricultural produce; and the remainder is gained by the landlord, the only sharer who always benefits by an increase of population.

§ 2. Let us now reverse our hypothesis, and instead of supposing capital stationary and population advancing, let us suppose capital advancing and population stationary; the facilities of production, both natural and acquired, being, as before, unaltered. The real wages of labour, instead of falling, will now rise; and since the cost of production of the things consumed by the labourer is not diminished, this rise of wages implies an equivalent increase of the cost of labour, and diminution of profits. To state the same deduction in other terms; the labourers not being more numerous, and the productive power of their labour being only the same as before, there is no increase of the produce; the increase of wages, therefore, must be at the charge of the capitalist. It is not impossible that the cost of labour might be increased in even a greater ratio than its real remuneration. The improved condition of the labourers may increase the demand for food. The labourers may have been so ill off before, as not to have food enough; and may now consume more: or they may choose to expend their increased means partly or wholly in a more costly quality of food, requiring more labour and more land; wheat, for example, instead of oats, or potatoes. This extension of agriculture implies, as usual, a greater cost of production and a higher price, so that besides the increase of the cost of labour arising from the increase of its reward, there will be a further increase (and an additional fall of profits) from the increased costliness of the commodities of which that reward consists. The same causes will produce a rise of rent. What the capitalists lose, above what the labourers gain, is partly transferred to the landlord, and partly swallowed up in the cost of growing food on worse land or by a less productive process.

§ 3. Having disposed of the two simple cases, an increasing population and stationary capital, and an increasing capital and stationary population, we are prepared to take into consideration the mixed case, in which the two elements of expansion are combined, both population and capital increasing. If either element increases faster than the other, the case is so far assimilated with one or other of the two preceding: we shall suppose them, therefore, to increase with equal rapidity; the test of equality being, that each labourer obtains the same commodities as before, and the same quantity of those commodities. Let us examine what will be the effect, on rent and profits, of this double progress.

Population having increased, without any falling off in the labourer's condition, there is of course a demand for more food. The arts of production being supposed stationary, this food must be produced at an increased cost. To compensate for this greater cost of the additional food, the price of agricultural produce must rise. The rise extending over the whole amount of food produced, though the increased expenses only apply to a part, there is a greatly increased extra profit, which, by competition, is transferred to the landlord. Rent will rise, both in quantity of produce and in cost; while wages, being supposed to be the same in quantity, will be greater in cost. The labourer obtaining the same amount of necessaries, money wages have risen; and as the rise is common to all branches of production, the capitalist cannot indemnify himself by changing his employment, and the loss must be borne by profits.

It appears, then, that the tendency of an increase of capital and population is to add to rent at the expense of profits: though rent does not gain all that profits lose, a part being absorbed in increased expenses of production, that is, in hiring or feeding a greater number of labourers to obtain a given amount of agricultural produce. By profits, must of course be understood the rate of profit; for a lower rate of profit on a larger capital may yield a larger gross profit, considered absolutely, though a smaller in proportion to the entire produce.

This tendency of profits to fall, is from time to time counteracted by improvements in production: whether arising from increase of knowledge, or from an increased use of the knowledge already possessed. This is the third of the three elements, the effects of which on the distribution of the produce we undertook to investigate; and the investigation will be facilitated by supposing, as in the case of the other two elements, that it operates, in the first instance, alone.

§ 4. Let us then suppose capital and population stationary, and a sudden improvement made in the arts of production; by the invention of more efficient machines, or less costly processes, or by obtaining access to cheaper commodities through foreign trade.

The improvement may either be in some of the necessaries or indulgences which enter into the habitual consumption of the labouring class; or it may be applicable only to luxuries consumed exclusively by richer people. Very few, however, of the great industrial improvements are altogether of this last description. Agricultural improvements, except such as specially relate to some of the rarer and more peculiar products, act directly upon the principal objects of the labourer's expenditure. The steam-engine, and every other invention which affords a manageable power, are applicable to all things, and of course to those consumed by the labourer. Even the power-loom and the spinning-jenny, though applied to the most delicate fabrics, are available no less for the coarse cottons and woollens worn by the labouring class. All improvements in locomotion cheapen the transport of necessaries as well as of luxuries. Seldom is a new branch of trade opened, without, either directly or in some indirect way, causing some of the articles which the mass of the people consume to be either produced or imported at smaller cost. It may safely be affirmed, therefore, that improvements in production generally tend to cheapen the commodities on which the wages of the labouring class are expended.

In so far as the commodities affected by an improvement are those which the labourers generally do not consume, the improvement has no effect in altering the distribution of the produce. Those particular commodities, indeed, are cheapened; being produced at less cost, they fall in value and in price, and all who consume them, whether landlords, capitalists, or skilled and privileged labourers, obtain increased means of enjoyment. The rate of profits, however, is not raised. There is a larger gross profit, reckoned in quantity of commodities. But the capital also, if estimated in those commodities, has risen in value. The profit is the same percentage on the capital that it was before. The capitalists are not benefited as capitalists, but as consumers. The landlords and the privileged classes of labourers, if they are consumers of the same commodities, share the same benefit.

The case is different with improvements which diminish the cost of production of the necessaries of life, or of commodities which enter habitually into the consumption of the great mass of labourers. The play of the different forces being here rather complex, it is necessary to analyse it with some minuteness.

As formerly observed,∗ there are two kinds of agricultural improvements. Some consist in a mere saving of labour, and enable a given quantity of food to be produced at less cost, but not on a smaller surface of land than before. Others enable a given extent of land to yield not only the same produce with less labour, but a greater produce; so that, if no greater produce is required, a part of the land already under culture may be dispensed with. As the part rejected will be the least productive portion, the market will thenceforth be regulated by a better description of land than what was previously the worst under cultivation.

To place the effect of the improvement in a clear light, we must suppose it to take place suddenly, so as to leave no time, during its introduction, for any increase of capital or of population. Its first effect will be a fall of the value and price of agricultural produce. This is a necessary consequence of either kind of improvement, but especially of the last.

An improvement of the first kind, not increasing the produce, does not dispense with any portion of the land; the margin of cultivation (as Dr. Chalmers terms it) remains where it was; agriculture does not recede, either in extent of cultivated land, or in elaborateness of method: and the price continues to be regulated by the same land, and by the same capital, as before. But since that land or capital, and all other land or capital which produces food, now yields its produce at smaller cost, the price of food will fall proportionally. If one-tenth of the expense of production has been saved, the price of produce will fall one-tenth.

But suppose the improvement to be of the second kind; enabling the land to produce, not only the same corn with one-tenth less labour, but a tenth more corn with the same labour. Here the effect is still more decided. Cultivation can now be contracted, and the market supplied from a smaller quantity of land. Even if this smaller surface of land were of the same average quality as the larger surface, the price would fall one-tenth, because the same produce would be obtained with a tenth less labour. But since the portion of land abandoned will be the least fertile portion, the price of produce will thenceforth be regulated by a better quality of land than before. In addition, therefore, to the original diminution of one-tenth in the cost of production, there will be a further diminution, corresponding with the recession of the “margin” of agriculture to land of greater fertility. There will thus be a twofold fall of price.

Let us now examine the effect of the improvements, thus suddenly made, on the division of the produce; and in the first place, on rent. By the former of the two kinds of improvement, rent would be diminished. By the second, it would be diminished still more.

Suppose that the demand for food requires the cultivation of three qualities of land, yielding, on an equal surface, and at an equal expense, 100, 80, and 60 bushels of wheat. The price of wheat will, on the average, be just sufficient to enable the third quality to be cultivated with the ordinary profit. The first quality therefore will yield forty and the second twenty bushels of extra profit, constituting the rent of the landlord. And first, let an improvement be made, which, without enabling more corn to be grown, enables the same corn to be grown with one-fourth less labour. The price of wheat will fall one-fourth, and 80 bushels will be sold for the price for which 60 were sold before. But the produce of the land which produces 60 bushels is still required, and the expenses being as much reduced as the price, that land can still be cultivated with the ordinary profit. The first and second qualities will therefore continue to yield a surplus of 40 and 20 bushels, and corn rent will remain the same as before. But corn having fallen in price one-fourth, the same corn rent is equivalent to a fourth less of money and of all other commodities. So far, therefore, as the landlord expends his income in manufactured or foreign products, he is one-fourth worse off than before. His income as landlord is reduced to three-quarters of its amount: it is only as a consumer of corn that he is as well off.

If the improvement is of the other kind, rent will fall in a still greater ratio. Suppose that the amount of produce which the market requires, can be grown not only with a fourth less labour, but on a fourth less land. If all the land already in cultivation continued to be cultivated, it would yield a produce much larger than necessary. Land, equivalent to a fourth of the produce, must now be abandoned; and as the third quality yielded exactly one-fourth, (being 60 out of 240,) that quality will go out of cultivation. The 240 bushels can now be grown on land of the first and second qualities only; being, on the first, 100 bushels plus one-third, or 133 1/3 bushels; on the second, 80 bushels plus one-third, or 106 2/3 bushels; together 240. The second quality of land, instead of the third, is now the lowest, and regulates the price. Instead of 60, it is sufficient if 106 2/3 bushels repay the capital with the ordinary profit. The price of wheat will consequently fall, not in the ratio of 60 to 80, as in the other case, but in the ratio of 60 to 106 2/3. Even this gives an insufficient idea of the degree in which rent will be affected. The whole produce of the second quality of land will now be required to repay the expenses of production. That land, being the worst in cultivation, will pay no rent. And the first quality will only yield the difference between 133 1/3 bushels and 106 2/3, being 26 2/3 bushels instead of 40. The landlords collectively will have lost 33 1/3 out of 60 bushels in corn rent alone, while the value and price of what is left will have been diminished in the ratio of 60 to 106 2/3.

It thus appears, that the interest of the landlord is decidedly hostile to the sudden and general introduction of agricultural improvements. This assertion has been called a paradox, and made a ground for accusing its first promulgator, Ricardo, of great intellectual perverseness, to say nothing worse. I cannot discern in what the paradox consists; and the obliquity of vision seems to me to be on the side of his assailants. The opinion is only made to appear absurd by stating it unfairly. If the assertion were that a landlord is injured by the improvement of his estate, it would certainly be indefensible; but what is asserted is, that he is injured by the improvement of the estates of other people, although his own is included. Nobody doubts that he would gain greatly by the improvement if he could keep it to himself, and unite the two benefits, an increased produce from his land, and a price as high as before. But if the increase of produce took place simultaneously on all lands, the price would not be as high as before; and there is nothing unreasonable in supposing that the landlords would be, not benefited, but injured. It is admitted that whatever permanently reduces the price of produce diminishes rent: and it is quite in accordance with common notions to suppose that if, by the increased productiveness of land, less land were required for cultivation, its value, like that of other articles for which the demand had diminished, would fall.

I am quite willing to admit that rents have not really been lowered by the progress of agricultural improvement; but why? Because improvement has never in reality been sudden, but always slow; at no time much outstripping, and often falling far short of, the growth of capital and population, which tends as much to raise rent, as the other to lower it, and which is enabled, as we shall presently see, to raise it much higher, by means of the additional margin afforded by improvements in agriculture. First, however, we must examine in what manner the sudden cheapening of agricultural produce would affect profits and wages.

In the beginning, money wages would probably remain the same as before, and the labourers would have the full benefit of the cheapness. They would be enabled to increase their consumption either of food or of other articles, and would receive the same cost, and a greater quantity. So far, profits would be unaffected. But the permanent remuneration of the labourers essentially depends on what we have called their habitual standard; the extent of the requirements which, as a class, they insist on satisfying before they choose to have children. If their tastes and requirements receive a durable impress from the sudden improvement in their condition, the benefit to the class will be permanent. But the same cause which enables them to purchase greater comforts and indulgences with the same wages, would enable them to purchase the same amount of comforts and indulgences with lower wages; and a greater population may now exist, without reducing the labourers below the condition to which they are accustomed. Hitherto this and no other has been the use which the labourers have commonly made of any increase of their means of living; they have treated it simply as convertible into food for a greater number of children. It is probable, therefore, that population would be stimulated, and that after the lapse of a generation the real wages of labour would be no higher than before the improvement: the reduction being partly brought about by a fall of money wages, and partly through the price of food, the cost of which, from the demand occasioned by the increase of population, would be increased. To the extent to which money wages fell, profits would rise; the capitalist obtaining a greater quantity of equally efficient labour by the same outlay of capital. We thus see that a diminution of the cost of living, whether arising from agricultural improvements or from the importation of foreign produce, if the habits and requirements of the labourers are not raised, usually lowers money wages and rent, and raises the general rate of profit.

What is true of improvements which cheapen the production of food, is true also of the substitution of a cheaper for a more costly variety of it. The same land yields to the same labour a much greater quantity of human nutriment in the form of maize or potatoes, than in the form of wheat. If the labourers were to give up bread, and feed only on those cheaper products, taking as their compensation, not a greater quantity of other consumable commodities, but earlier marriages and larger families, the cost of labour would be much diminished, and if labour continued equally efficient, profits would rise; while rent would be much lowered, since food for the whole population could be raised on half or a third part of the land now sown with corn. At the same time, it being evident that land too barren to be cultivated for wheat might be made in case of necessity to yield potatoes sufficient to support the little labour necessary for producing them, cultivation might ultimately descend lower, and rent eventually rise higher, on a potato or maize system, than on a corn system; because the land would be capable of feeding a much larger population before reaching the limit of its powers.

If the improvement, which we suppose to take place, is not in the production of food, but of some manufactured article consumed by the labouring class, the effect on wages and profits will at first be the same; but the effect on rent very different. It will not be lowered; it will even, if the ultimate effect of the improvement is an increase of population, be raised: in which last case profits will be lowered. The reasons are too evident to require statement.

§ 5. We have considered, on the one hand, the manner in which the distribution of the produce into rent, profits, and wages, is affected by the ordinary increase of population and capital, and on the other, how it is affected by improvements in production, and more especially in agriculture. We have found that the former cause lowers profits; and raises rent and the cost of labour: while the tendency of agricultural improvements is to diminish rent; and all improvements which cheapen any article of the labourer's consumption, tend to diminish the cost of labour and to raise profits. The tendency of each cause in its separate state being thus ascertained, it is easy to determine the tendency of the actual course of things, in which the two movements are going on simultaneously, capital and population increasing with tolerable steadiness, while improvements in agriculture are made from time to time, and the knowledge and practice of improved methods become diffused gradually through the community.

The habits and requirements of the labouring classes being given (which determine their real wages), rents, profits, and money wages at any given time, are the result of the composition of these rival forces. If during any period agricultural improvement advances faster than population, rent and money wages during that period will tend downward, and profits upward. If population advances more rapidly than agricultural improvement, either the labourers will submit to a reduction in the quantity or quality of their food, or if not, rent and money wages will progressively rise, and profits will fall.

Agricultural skill and knowledge are of slow growth, and still slower diffusion. Inventions and discoveries, too, occur only occasionally, while the increase of population and capital are continuous agencies. It therefore seldom happens that improvement, even during a short time, has so much the start of population and capital as actually to lower rent, or raise the rate of profits. There are many countries in which the growth of population and capital is not rapid, but in these agricultural improvement is less active still. Population almost everywhere treads close on the heels of agricultural improvement, and effaces its effects as fast as they are produced.

The reason why agricultural improvement seldom lowers rent, is that it seldom cheapens food, but only prevents it from growing dearer; and seldom, if ever, throws land out of cultivation, but only enables worse and worse land to be taken in for the supply of an increasing demand. What is sometimes called the natural state of a country which is but half cultivated, namely, that the land is highly productive, and food obtained in great abundance by little labour, is only true of unoccupied countries colonized by a civilized people. In the United States the worst land in cultivation is of a high quality (except sometimes in the immediate vicinity of markets or means of conveyance, where a bad quality is compensated by a good situation);1 and even if no further improvements were made in agriculture or locomotion, cultivation would have many steps yet to descend, before the increase of population and capital would be brought to a stand; but in Europe five hundred years ago, though so thinly peopled in comparison to the present population, it is probable that the worst land under the plough was, from the rude state of agriculture, quite as unproductive as the worst land now cultivated; and that cultivation had approached as near to the ultimate limit of profitable tillage, in those times as in the present. What the agricultural improvements since made have really done is, by increasing the capacity of production of land in general, to enable tillage to extend downwards to a much worse natural quality of land than the worst which at that time would have admitted of cultivation by a capitalist for profit; thus rendering a much greater increase of capital and population possible, and removing always a little and a little further off the barrier which restrains them; population meanwhile always pressing so hard against the barrier, that there is never any visible margin left for it to seize, every inch of ground made vacant for it by improvement being at once filled up by its advancing columns. Agricultural improvement may thus be considered to be not so much a counterforce conflicting with increase of population, as a partial relaxation of the bonds which confine that increase.

The effects produced on the division of the produce by an increase of production, under the joint influence of increase of population and capital and improvements of agriculture, are very different from those deduced from the hypothetical cases previously discussed. In particular, the effect on rent is most materially different. We remarked that—while a great agricultural improvement made suddenly and universally would in the first instance inevitably lower rent—such improvements enable rent, in the progress of society, to rise gradually to a much higher limit than it could otherwise attain, since they enable a much lower quality of land to be ultimately cultivated. But in the case we are now supposing, which nearly corresponds to the usual course of things, this ultimate effect becomes the immediate effect. Suppose cultivation to have reached, or almost reached, the utmost limit permitted by the state of the industrial arts, and rent, therefore, to have attained nearly the highest point to which it can be carried by the progress of population and capital, with the existing amount of skill and knowledge. If a great agricultural improvement were suddenly introduced, it might throw back rent for a considerable space, leaving it to regain its lost ground by the progress of population and capital, and afterwards to go on further. But, taking place, as such improvement always does, very gradually, it causes no retrograde movement of either rent or cultivation; it merely enables the one to go on rising, and the other extending, long after they must otherwise have stopped. It would do this even without the necessity of resorting to a worse quality of land; simply by enabling the lands already in cultivation to yield a greater produce, with no increase of the proportional cost. If, by improvements of agriculture, all the lands in cultivation could be made, even with double labour and capital, to yield a double produce, (supposing that in the meantime population increased so as to require this double quantity) all rents would be doubled.

To illustrate the point, let us revert to the numerical example in a former page. Three qualities of land yield respectively 100, 80, and 60 bushels to the same outlay on the same extent of surface. If No. 1 could be made to yield 200, No. 2, 160, and No. 3, 120 bushels, at only double the expense, and therefore without any increase of the cost of production, and if the population, having doubled, required all this increased quantity, the rent of No. 1 would be 80 bushels instead of 40, and of No. 2, 40 instead of 20, while the price and value per bushel would be the same as before: so that corn rent and money rent would both be doubled. I need not point out the difference between this result, and what we have shown would take place if there were an improvement in production without the accompaniment of an increased demand for food.

Agricultural improvement, then, is always ultimately, and in the manner in which it generally takes place also immediately, beneficial to the landlord. We may add, that when it takes place in that manner, it is beneficial to no one else. When the demand for produce fully keeps pace with the increased capacity of production, food is not cheapened; the labourers are not, even temporarily, benefited; the cost of labour is not diminished, nor profits raised. There is a greater aggregate production, a greater produce divided among the labourers, and a larger gross profit; but the wages being shared among a larger population, and the profits spread over a larger capital, no labourer is better off, nor does any capitalist derive from the same amount of capital a larger income.

The result of this long investigation may be summed up as follows. The economical progress of a society constituted of landlords, capitalists, and labourers, tends to the progressive enrichment of the landlord class;1 while the cost of the labourer's subsistence tends on the whole to increase,2 and profits to fall. Agricultural improvements are a counteracting force to the two last effects; but the first, though a case is conceivable in which it would be temporarily checked, is ultimately in a high degree promoted by those improvements; and the increase of population tends to transfer all the benefits derived from agricultural improvement to the landlords alone. What other consequences, in addition to these, or in modification of them, arise from the industrial progress of a society thus constituted, I shall endeavour to show in the succeeding chapter.

Book IV, Chapter IV: Of the tendency of profits to a minimum

CHAPTER IV: of the tendency of profits to a minimum

§ 1. The tendency of profits to fall as society advances, which has been brought to notice in the preceding chapter, was early recognized by writers on industry and commerce; but the laws which govern profits not being then understood, the phenomenon was ascribed to a wrong cause. Adam Smith considered profits to be determined by what he called the competition of capital; and concluded that when capital increased, this competition must likewise increase, and profits must fall. It is not quite certain what sort of competition Adam Smith had here in view. His words in the chapter on Profits of Stock∗ are, “When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profits; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must produce the same effect in them all.” This passage would lead us to infer that, in Adam Smith's opinion, the manner in which the competition of capital lowers profits is by lowering prices; that being usually the mode in which an increased investment of capital in any particular trade, lowers the profits of that trade. But if this was his meaning, he overlooked the circumstance, that the fall of price, which if confined to one commodity really does lower the profits of the producer, ceases to have that effect as soon as it extends to all commodities; because, when all things have fallen, nothing has really fallen, except nominally; and even computed in money, the expenses of every producer have diminished as much as his returns. Unless indeed labour be the one commodity which has not fallen in money price, when all other things have: if so, what has really taken place is a rise of wages; and it is that, and not the fall of prices, which has lowered the profits of capital. There is another thing which escaped the notice of Adam Smith; that the supposed universal fall of prices, through increased competition of capitals, is a thing which cannot take place. Prices are not determined by the competition of the sellers only, but also by that of the buyers; by demand as well as supply. The demand which affects money prices consists of all the money in the hands of the community, destined to be laid out in commodities; and as long as the proportion of this to the commodities is not diminished, there is no fall of general prices. Now, howsoever capital may increase, and give rise to an increased production of commodities, a full share of the capital will be drawn to the business of producing or importing money, and the quantity of money will be augmented in an equal ratio with the quantity of commodities. For if this were not the case, and if money, therefore, were, as the theory supposes, perpetually acquiring increased purchasing power, those who produced or imported it would obtain constantly increasing profits; and this could not happen without attracting labour and capital to that occupation from other employments. If a general fall of prices, and increased value of money, were really to occur, it could only be as a consequence of increased cost of production, from the gradual exhaustion of the mines.

It is not tenable, therefore, in theory, that the increase of capital produces, or tends to produce, a general decline of money prices. Neither is it true, that any general decline of prices, as capital increased, has manifested itself in fact. The only things observed to fall in price with the progress of society, are those in which there have been improvements in production, greater than have taken place in the production of the precious metals; as for example, all spun and woven fabrics. Other things, again, instead of falling, have risen in price, because their cost of production, compared with that of gold and silver, has increased. Among these are all kinds of food, comparison being made with a much earlier period of history. The doctrine, therefore, that competition of capital lowers profits by lowering prices, is incorrect in fact, as well as unsound in principle.

But it is not certain that Adam Smith really held that doctrine; for his language on the subject is wavering and unsteady, denoting the absence of a definite and well-digested opinion. Occasionally he seems to think that the mode in which the competition of capital lowers profits, is by raising wages. And when speaking of the rate of profit in new colonies, he seems on the very verge of grasping the complete theory of the subject. “As the colony increases, the profits of stock gradually diminish. When the most fertile and best situated lands have been all occupied, less profit can be made by the cultivators of what is inferior both in soil and situation.” Had Adam Smith meditated longer on the subject, and systematized his view of it by harmonizing with each other the various glimpses which he caught of it from different points, he would have perceived that this last is the true cause of the fall of profits usually consequent upon increase of capital.

∗2. Mr. Wakefield, in his Commentary on Adam Smith, and his important writings on Colonization, takes a much clearer view of the subject, and arrives, through a substantially correct series of deductions, at practical conclusions which appear to me just and important; but he is not equally happy in incorporating his valuable speculations with the results of previous thought, and reconciling them with other truths. Some of the theories of Dr. Chalmers, in his chapter “On the Increase and Limits of Capital,” and the two chapters which follow it, coincide in their tendency and spirit with those of Mr. Wakefield; but Dr. Chalmers' ideas, though delivered, as is his custom, with a most attractive semblance of clearness, are really on this subject much more confused than even those of Adam Smith, and more decidedly infected with the often refuted notion that the competition of capital lowers general prices; the subject of Money apparently not having been included among the parts of political economy which this acute and vigorous writer had carefully studied.

Mr. Wakefield's explanation of the fall of profits is briefly this. Production is limited not solely by the quantity of capital and of labour, but also by the extent of the “field of employment.” The field of employment for capital is twofold; the land of the country, and the capacity of foreign markets to take its manufactured commodities. On a limited extent of land, only a limited quantity of capital can find employment at a profit. As the quantity of capital approaches this limit, profit falls; when the limit is attained, profit is annihilated; and can only be restored through an extension of the field of employment, either by the acquisition of fertile land, or by opening new markets in foreign countries, from which food and materials can be purchased with the products of domestic capital. These propositions are, in my opinion, substantially true; and, even to the phraseology in which they are expressed, considered as adapted to popular and practical rather than scientific uses, I have nothing to object. The error which seems to me imputable to Mr. Wakefield is that of supposing his doctrines to be in contradiction to the principles of the best school of preceding political economists, instead of being, as they really are, corollaries from those principles; though corollaries which, perhaps, would not always have been admitted by those political economists themselves.

The most scientific treatment of the subject which I have met with is in an essay on the effects of Machinery, published in the Westminster Review for January 1826, by Mr. William Ellis:∗ which was doubtless unknown to Mr. Wakefield, but which had preceded him, though by a different path, in several of his leading conclusions. This essay excited little notice, partly from being published anonymously in a periodical, and partly because it was much in advance of the state of political economy at the time. In Mr. Ellis's view of the subject, the questions and difficulties raised by Mr. Wakefield's speculations and by those of Dr. Chalmers, find a solution consistent with the principles of political economy laid down in the present treatise.

§ 3. There is at every time and place some particular rate of profit, which is the lowest that will induce the people of that country and time to accumulate savings, and to employ those savings productively. This minimum rate of profit varies according to circumstances. It depends on two elements. One is, the strength of the effective desire of accumulation; the comparative estimate, made by the people of that place and era, of future interests when weighed against present. This element chiefly affects the inclination to save. The other element, which affects not so much the willingness to save as the disposition to employ savings productively, is the degree of security of capital engaged in industrial operations. A state of general insecurity no doubt affects also the disposition to save. A hoard may be a source of additional danger to its reputed possessor. But as it may also be a powerful means of averting dangers, the effects in this respect may perhaps be looked upon as balanced. But in employing any funds which a person may possess as capital on his own account, or in lending it to others to be so employed, there is always some additional risk, over and above that incurred by keeping it idle in his own custody. This extra risk is great in proportion as the general state of society is insecure: it may be equivalent to twenty, thirty, or fifty per cent, or to no more than one or two; something, however, it must always be: and for this, the expectation of profit must be sufficient to compensate.

There would be adequate motives for a certain amount of saving, even if capital yielded no profit. There would be an inducement to lay by in good times a provision for bad; to reserve something for sickness and infirmity, or as a means of leisure and independence in the latter part of life, or a help to children in the outset of it. Savings, however, which have only these ends in view, have not much tendency to increase the amount of capital permanently in existence. These motives only prompt persons to save at one period of life what they purpose to consume at another, or what will be consumed by their children before they can completely provide for themselves. The savings by which an addition is made to the national capital usually emanate from the desire of persons to improve what is termed their condition in life, or to make a provision for children or others, independent of their exertions. Now, to the strength of these inclinations it makes a very material difference how much of the desired object can be effected by a given amount and duration of self-denial; which again depends on the rate of profit. And there is in every country some rate of profit, below which persons in general will not find sufficient motive to save for the mere purpose of growing richer, or of leaving others better off than themselves. Any accumulation, therefore, by which the general capital is increased, requires as its necessary condition a certain rate of profit; a rate which an average person will deem to be an equivalent for abstinence, with the addition of a sufficient insurance against risk. There are always some persons in whom the effective desire of accumulation is above the average, and to whom less than this rate of profit is a sufficient inducement to save; but these merely step into the place of others whose taste for expense and indulgence is beyond the average, and who, instead of saving, perhaps even dissipate what they have received.

I have already observed that this minimum rate of profit, less than which is not consistent with the further increase of capital, is lower in some states of society than in others; and I may add, that the kind of social progress characteristic of our present civilization tends to diminish it. In the first place, one of the acknowledged effects of that progress is an increase of general security. Destruction by wars, and spoliation by private or public violence, are less and less to be apprehended; and the improvements which may be looked for in education and in the administration of justice, or, in their default, increased regard for opinion, afford a growing protection against fraud and reckless mismanagement. The risks attending the investment of savings in productive employment require, therefore, a smaller rate of profit to compensate for them than was required a century ago, and will hereafter require less than at present. In the second place, it is also one of the consequences of civilization that mankind become less the slaves of the moment, and more habituated to carry their desires and purposes forward into a distant future. This increase of providence is a natural result of the increased assurance with which futurity can be looked forward to; and is, besides, favoured by most of the influences which an industrial life exercises over the passions and inclinations of human nature. In proportion as life has fewer vicissitudes, as habits become more fixed, and great prizes are less and less to be hoped for by any other means than long perseverance, mankind become more willing to sacrifice present indulgence for future objects. This increased capacity of forethought and self-control may assuredly find other things to exercise itself upon than increase of riches, and some considerations connected with this topic will shortly be touched upon. The present kind of social progress, however, decidedly tends, though not perhaps to increase the desire of accumulation, yet to weaken the obstacles to it, and to diminish the amount of profit which people absolutely require as an inducement to save and accumulate. For these two reasons, diminution of risk and increase of providence, a profit or interest of three or four per cent is as sufficient a motive to the increase of capital in England at the present day, as thirty or forty per cent in the Burmese Empire, or in England at the time of King John. In Holland during the last century a return of two per cent on government security, was consistent with an undiminished, if not with an increasing, capital. But though the minimum rate of profit is thus liable to vary, and though to specify exactly what it is would at any given time be impossible, such a minimum always exists; and whether it be high or low, when once it is reached, no further increase of capital can for the present take place. The country has then attained what is known to political economists under the name of the stationary state.

§ 4. We now arrive at the fundamental proposition which this chapter is intended to inculcate. When a country has long possessed a large production, and a large net income to make savings from, and when, therefore, the means have long existed of making a great annual addition to capital; (the country not having, like America [1848], a large reserve of fertile land still unused;) it is one of the characteristics of such a country, that the rate of profit is habitually within, as it were, a hand's breadth of the minimum, and the country therefore on the very verge of the stationary state. By this I do not mean that this state is likely, in any of the great countries of Europe, to be soon actually reached, or that capital does not still yield a profit considerably greater than what is barely sufficient to induce the people of those countries to save and accumulate. My meaning is, that it would require but a short time to reduce profits to the minimum, if capital continued to increase at its present rate, and no circumstances having a tendency to raise the rate of profit occurred in the meantime. The expansion of capital would soon reach its ultimate boundary, if the boundary itself did not continually open and leave more space.

In England, the ordinary rate of interest on government securities, in which the risk is next to nothing, may be estimated [1848] at a little more than three per cent: in all other investments, therefore, the interest or profit calculated upon (exclusively of what is properly a remuneration for talent or exertion) must be as much more than this amount, as is equivalent to the degree of risk to which the capital is thought to be exposed. Let us suppose that in England even so small a net profit as one per cent, exclusive of insurance against risk, would constitute a sufficient inducement to save, but that less than this would not be a sufficient inducement. I now say, that the mere continuance of the present annual increase of capital, if no circumstance occurred to counteract its effect, would suffice in a small number of years to reduce the rate of net profit to one per cent.

To fulfil the conditions of the hypothesis, we must suppose an entire cessation of the exportation of capital for foreign investment. No more capital sent abroad for railways or loans; no more emigrants taking capital with them, to the colonies, or to other countries; no fresh advances made, or credits given, by bankers or merchants to their foreign correspondents. We must also assume that there are no fresh loans for unproductive expenditure, by the government, or on mortgage, or otherwise; and none of the waste of capital which now takes place by the failure of undertakings which people are tempted to engage in by the hope of a better income than can be obtained in safe paths at the present habitually low rate of profit. We must suppose the entire savings of the community to be annually invested in really productive employment within the country itself; and no new channels opened by industrial inventions, or by a more extensive substitution of the best known processes for inferior ones.

Few persons would hesitate to say, that there would be great difficulty in finding remunerative employment every year for so much new capital and most would conclude that there would be what used to be termed a general glut; that commodities would be produced, and remain unsold, or be sold only at a loss. But the full examination which we have already given to this question,∗ has shown that this is not the mode in which the inconvenience would be experienced. The difficulty would not consist in any want of a market. If the new capital were duly shared among many varieties of employment, it would raise up a demand for its own produce, and there would be no cause why any part of that produce should remain longer on hand than formerly. What would really be, not merely difficult, but impossible, would be to employ this capital without submitting to a rapid reduction of the rate of profit.

As capital increased, population either would also increase, or it would not. If it did not, wages would rise, and a greater capital would be distributed in wages among the same number of labourers. There being no more labour than before, and no improvements to render the labour more efficient, there would not be any increase of the produce; and as the capital, however largely increased, would only obtain the same gross return, the whole savings of each year would be exactly so much subtracted from the profits of the next and of every following year. It is hardly necessary to say that in such circumstances profits would very soon fall to the point at which further increase of capital would cease. An augmentation of capital, much more rapid than that of population, must soon reach its extreme limit, unless accompanied by increased efficiency of labour (through inventions and discoveries, or improved mental and physical education), or unless some of the idle people, or of the unproductive labourers, became productive.

If population did increase with the increase of capital, and in proportion to it, the fall of profits would still be inevitable. Increased population implies increased demand for agricultural produce. In the absence of industrial improvements, this demand can only be supplied at an increased cost of production, either by cultivating worse land, or by a more elaborate and costly cultivation of the land already under tillage. The cost of the labourer's subsistence is therefore increased; and unless the labourer submits to a deterioration of his condition, profits must fall. In an old country like England, if, in addition to supposing all improvement in domestic agriculture suspended, we suppose that there is no increased production in foreign countries for the English market, the fall of profits would be very rapid. If both these avenues to an increased supply of food were closed, and population continued to increase, as it is said to do, at the rate of a thousand a day, all waste land which admits of cultivation in the existing state of knowledge would soon be cultivated, and the cost of production and price of food would be so increased, that, if the labourers received the increased money wages necessary to compensate for their increased expenses, profits would very soon reach the minimum. The fall of profits would be retarded if money wages did not rise, or rose in a less degree; but the margin which can be gained by a deterioration of the labourers' condition is a very narrow one: in general they cannot bear much reduction; when they can, they have also a higher standard of necessary requirements, and will not. On the whole, therefore, we may assume that in such a country as England, if the present annual amount of savings were to continue, without any of the counteracting circumstances which now keep in check the natural influence of those savings in reducing profit, the rate of profit would speedily attain the minimum, and all further accumulation of capital would for the present cease.

§ 5. What, then, are these counteracting circumstances, which, in the existing state of things, maintain a tolerably equal struggle against the downward tendency of profits, and prevent the great annual savings which take place in this country from depressing the rate of profit much nearer to that lowest point to which it is always tending, and which, left to itself, it would so promptly attain? The resisting agencies are of several kinds.

First among them, we may notice one which is so simple and so conspicuous, that some political economists, especially M. de Sismondi and Dr. Chalmers, have attended to it almost to the exclusion of all others. This is, the waste of capital in periods of over-trading and rash speculation, and in the commercial revulsions by which such times are always followed. It is true that a great part of what is lost at such periods is not destroyed, but merely transferred, like a gambler's losses, to more successful speculators. But even of these mere transfers, a large portion is always to foreigners, by the hasty purchase of unusual quantities of foreign goods at advanced prices. And much also is absolutely wasted. Mines are opened, railways or bridges made, and many other works of uncertain profit commenced, and in these enterprises much capital is sunk which yields either no return, or none adequate to the outlay. Factories are built and machinery erected beyond what the market requires, or can keep in employment. Even if they are kept in employment, the capital is no less sunk; it has been converted from circulating into fixed capital, and has ceased to have any influence on wages or profits. Besides this, there is a great unproductive consumption of capital, during the stagnation which follows a period of general over-trading. Establishments are shut up, or kept working without any profit, hands are discharged, and numbers of persons in all ranks, being deprived of their income, and thrown for support on their savings, find themselves, after the crisis has passed away, in a condition of more or less impoverishment. Such are the effects of a commercial revulsion: and that such revulsions are almost periodical, is a consequence of the very tendency of profits which we are considering. By the time a few years have passed over without a crisis, so much additional capital has been accumulated, that it is no longer possible to invest it at the accustomed profit: all public securities rise to a high price, the rate of interest on the best mercantile security falls very low, and the complaint is general among persons in business that no money is to be made. Does not this demonstrate how speedily profit would be at the minimum, and the stationary condition of capital would be attained, if these accumulations went on without any counteracting principle? But the diminished scale of all safe gains inclines persons to give a ready ear to any projects which hold out, though at the risk of loss, the hope of a higher rate of profit; and speculations ensue, which, with the subsequent revulsions, destroy, or transfer to foreigners, a considerable amount of capital, produce a temporary rise of interest and profit, make room for fresh accumulations, and the same round is recommenced.

This, doubtless, is one considerable cause which arrests profits in their descent to the minimum, by sweeping away from time to time a part of the accumulated mass by which they are forced down. But this is not, as might be inferred from the language of some writers, the principal cause. If it were, the capital of the country would not increase; but in England it does increase greatly and rapidly. This is shown by the increasing productiveness of almost all taxes, by the continual growth of all the signs of national wealth, and by the rapid increase of population, while the condition of the labourers is certainly not declining, but on the whole improving.1 These things prove that each commercial revulsion, however disastrous, is very far from destroying all the capital which has been added to the accumulations of the country since the last revulsion preceding it, and that, invariably, room is either found or made for the profitable employment of a perpetually increasing capital, consistently with not forcing down profits to a lower rate.

§ 6. This brings us to the second of the counter-agencies, namely, improvements in production. These evidently have the effect of extending what Mr. Wakefield terms the field of employment, that is, they enable a greater amount of capital to be accumulated and employed without depressing the rate of profit: provided always that they do not raise, to a proportional extent, the habits and requirements of the labourer. If the labouring class gain the full advantage of the increased cheapness, in other words, if money wages do not fall, profits are not raised, nor their fall retarded. But if the labourers people up to the improvement in their condition, and so relapse to their previous state, profits will rise. All inventions which cheapen any of the things consumed by the labourers, unless their requirements are raised in an equivalent degree, in time lower money wages: and by doing so, enable a greater capital to be accumulated and employed, before profits fall back to what they were previously.

Improvements which only affect things consumed exclusively by the richer classes, do not operate precisely in the same manner. The cheapening of lace or velvet has no effect in diminishing the cost of labour; and no mode can be pointed out in which it can raise the rate of profit, so as to make room for a larger capital before the minimum is attained. It, however, produces an effect which is virtually equivalent; it lowers, or tends to lower, the minimum itself. In the first place, increased cheapness of articles of consumption promotes the inclination to save, by affording to all consumers a surplus which they may lay by, consistently with their accustomed manner of living; and unless they were previously suffering actual hardships, it will require little self-denial to save some part at least of this surplus. In the next place, whatever enables people to live equally well on a smaller income, inclines them to lay by capital for a lower rate of profit. If people can live on an independence of 500l. a year in the same manner as they formerly could on one of 1000l., some persons will be induced to save in hopes of the one, who would have been deterred by the more remote prospect of the other. All improvements, therefore, in the production of almost any commodity, tend in some degree to widen the interval which has to be passed before arriving at the stationary state: but this effect belongs in a much greater degree to the improvements which affect the articles consumed by the labourer, since these conduce to it in two ways; they induce people to accumulate for a lower profit, and they also raise the rate of profit itself.

§ 7. Equivalent in effect to improvements in production, is the acquisition of any new power of obtaining cheap commodities from foreign countries. If necessaries are cheapened, whether they are so by improvements at home or importation from abroad, is exactly the same thing to wages and profits. Unless the labourer obtains, and by an improvement of his habitual standard, keeps, the whole benefit, the cost of labour is lowered, and the rate of profit raised. As long as food can continue to be imported for an increasing population without any diminution of cheapness, so long the declension of profits through the increase of population and capital is arrested, and accumulation may go on without making the rate of profit draw nearer to the minimum. And on this ground it is believed by some, that the repeal of the corn laws has opened to this country a long era of rapid increase of capital with an undiminished rate of profit.

Before inquiring whether this expectation is reasonable, one remark must be made, which is much at variance with commonly received notions. Foreign trade does not necessarily increase the field of employment for capital. It is not the mere opening of a market for a country's productions, that tends to raise the rate of profits. If nothing were obtained in exchange for those productions but the luxuries of the rich, the expenses of no capitalist would be diminished; profits would not be at all raised, nor room made for the accumulation of more capital without submitting to a reduction of profits: and if the attainment of the stationary state were at all retarded, it would only be because the diminished cost at which a certain degree of luxury could be enjoyed, might induce people, in that prospect, to make fresh savings for a lower profit than they formerly were willing to do. When foreign trade makes room for more capital at the same profit, it is by enabling the necessaries of life, or the habitual articles of the labourer's consumption, to be obtained at smaller cost. It may do this in two ways; by the importation either of those commodities themselves, or of the means and appliances for producing them. Cheap iron has, in a certain measure, the same effect on profits and the cost of labour as cheap corn, because cheap iron makes cheap tools for agriculture and cheap machinery for clothing. But a foreign trade which neither directly, nor by any indirect consequence, increases the cheapness of anything consumed by the labourers, does not, any more than an invention or discovery in the like case, tend to raise profits or retard their fall; it merely substitutes the production of goods for foreign markets in the room of the home production of luxuries, leaving the employment for capital neither greater nor less than before. It is true, that there is scarcely any export trade which, in a country that already imports necessaries or materials, comes within these conditions: for every increase of exports enables the country to obtain all its imports on cheaper terms than before.

A country which, as is now the case with England,1 admits food of all kinds, and all necessaries and the materials of necessaries, to be freely imported from all parts of the world, no longer depends on the fertility of her own soil to keep up her rate of profits, but on the soil of the whole world. It remains to consider how far this resource can be counted upon, for making head during a very long period against the tendency of profits to decline as capital increases.

It must, of course, be supposed that with the increase of capital, population also increases; for if it did not, the consequent rise of wages would bring down profits, in spite of any cheapness of food. Suppose then that the population of Great Britain goes on increasing at its present rate, and demands every year a supply of imported food considerably beyond that of the year preceding. This annual increase in the food demanded from the exporting countries can only be obtained either by great improvements in their agriculture, or by the application of a great additional capital to the growth of food. The former is likely to be a very slow process, from the rudeness and ignorance of the agricultural classes in the food-exporting countries of Europe, while the British colonies and the United States are already in possession of most of the improvements yet made, so far as suitable to their circumstances. There remains as a resource, the extension of cultivation. And on this it is to be remarked, that the capital by which any such extension can take place, is mostly still to be created. In Poland, Russia, Hungary, Spain, the increase of capital is extremely slow. In America it is rapid, but not more rapid than the population. The principal fund at present available for supplying this country with a yearly increasing importation of food, is that portion of the annual savings of America which has heretofore been applied to increasing the manufacturing establishments of the United States, and which free trade in corn may possibly divert from that purpose to growing food for our market. This limited source of supply, unless great improvements take place in agriculture, cannot be expected to keep pace with the growing demand of so rapidly increasing a population as that of Great Britain; and if our population and capital continue to increase with their present rapidity, the only mode in which food can continue to be supplied cheaply to the one, is by sending the other abroad to produce it.1

§ 8. This brings us to the last of the counter-forces which check the downward tendency of profits, in a country whose capital increases faster than that of its neighbours, and whose profits are therefore nearer to the minimum. This is, the perpetual overflow of capital into colonies or foreign countries, to seek higher profits than can be obtained at home. I believe this to have been for many years one of the principal causes by which the decline of profits in England has been arrested. It has a twofold operation. In the first place, it does what a fire, or an inundation, or a commercial crisis would have done: it carries off a part of the increase of capital from which the reduction of profits proceeds. Secondly, the capital so carried off is not lost, but is chiefly employed either in founding colonies, which become large exporters of cheap agricultural produce, or in extending and perhaps improving the agriculture of older communities. It is to the emigration of English capital, that we have chiefly to look for keeping up a supply of cheap food and cheap materials of clothing, proportional to the increase of our population; thus enabling an increasing capital to find employment in the country, without reduction of profit, in producing manufactured articles with which to pay for this supply of raw produce. Thus, the exportation of capital is an agent of great efficacy in extending the field of employment for that which remains: and it may be said truly that, up to a certain point, the more capital we send away, the more we shall possess and be able to retain at home.

In countries which are further advanced in industry and population, and have therefore a lower rate of profit, than others, there is always, long before the actual minimum is reached, a practical minimum, viz., when profits have fallen so much below what they are elsewhere, that, were they to fall lower, all further accumulations would go abroad. In the present state of the industry of the world, when there is occasion, in any rich and improving country, to take the minimum of profits at all into consideration for practical purposes, it is only this practical minimum that needs be considered. As long as there are old countries where capital increases very rapidly, and new countries where profit is still high, profits in the old countries will not sink to the rate which would put a stop to accumulation; the fall is stopped at the point which sends capital abroad. It is only, however, by improvements in production, and even in the production of things consumed by labourers, that the capital of a country like England is prevented from speedily reaching that degree of lowness of profit, which would cause all further savings to be sent to find employment in the colonies, or in foreign countries.1

Book IV, Chapter V: Consequences of the tendency of profits to a minimum

CHAPTER V: consequences of the tendency of profits to a minimum

§ 1. The theory of the effect of accumulation on profits, laid down in the preceding chapter, materially alters many of the practical conclusions which might otherwise be supposed to follow from the general principles of Political Economy, and which were, indeed, long admitted as true by the highest authorities on the subject.

It must greatly abate, or rather, altogether destroy, in countries where profits are low, the immense importance which used to be attached by political economists to the effects which an event or a measure of government might have in adding to or subtracting from the capital of the country. We have now seen that the lowness of profits is a proof that the spirit of accumulation is so active, and that the increase of capital has proceeded at so rapid a rate, as to outstrip the two counter-agencies, improvements in production, and increased supply of cheap necessaries from abroad: and that unless a considerable portion of the annual increase of capital were either periodically destroyed, or exported for foreign investment, the country would speedily attain the point at which further accumulation would cease, or at least spontaneously slacken, so as no longer to overpass the march of invention in the arts which produce the necessaries of life. In such a state of things as this, a sudden addition to the capital of the country, unaccompanied by any increase of productive power, would be but of transitory duration; since, by depressing profits and interest, it would either diminish by a corresponding amount the savings which would be made from income in the year or two following, or it would cause an equivalent amount to be sent abroad, or to be wasted in rash speculations. Neither, on the other hand, would a sudden abstraction of capital, unless of inordinate amount, have any real effect in impoverishing the country. After a few months or years, there would exist in the country just as much capital as if none had been taken away. The abstraction, by raising profits and interest, would give a fresh stimulus to the accumulative principle, which would speedily fill up the vacuum. Probably, indeed, the only effect that would ensue, would be that for some time afterwards less capital would be exported, and less thrown away in hazardous speculation.

In the first place, then, this view of things greatly weakens, in a wealthy and industrious country, the force of the economical argument against the expenditure of public money for really valuable, even though industriously unproductive, purposes. If for any great object of justice or philanthropic policy, such as the industrial regeneration of Ireland, or a comprehensive measure of colonization or of public education, it were proposed to raise a large sum by way of loan, politicians need not demur to the abstraction of so much capital, as tending to dry up the permanent sources of the country's wealth, and diminish the fund which supplies the subsistence of the labouring population. The utmost expense which could be requisite for any of these purposes, would not in all probability deprive one labourer of employment, or diminish the next year's production by one ell of cloth or one bushel of grain. In poor countries, the capital of the country requires the legislator's sedulous care; he is bound to be most cautious of encroaching upon it, and should favour to the utmost its accumulation at home, and its introduction from abroad. But in rich, populous, and highly cultivated countries, it is not capital which is the deficient element, but fertile land; and what the legislator should desire and promote, is not a greater aggregate saving, but a greater return to savings, either by improved cultivation, or by access to the produce of more fertile lands in other parts of the globe. In such countries, the government may take any moderate portion of the capital of the country and expend it as revenue, without affecting the national wealth: the whole being either drawn from that portion of the annual savings which would otherwise be sent abroad, or being subtracted from the unproductive expenditure of individuals for the next year or two, since every million spent makes room for another million to be saved before reaching the overflowing point. When the object in view is worth the sacrifice of such an amount of the expenditure that furnishes the daily enjoyments of the people, the only well-grounded economical objection against taking the necessary funds directly from capital, consists of the inconveniences attending the process of raising a revenue by taxation, to pay the interest of a debt.

The same considerations enable us to throw aside as unworthy of regard, one of the common arguments against emigration as a means of relief for the labouring class. Emigration, it is said, can do no good to the labourers, if, in order to defray the cost, as much must be taken away from the capital of the country as from its population. That anything like this proportion could require to be abstracted from capital for the purpose even of the most extensive colonization, few, I should think, would now assert: but even on that untenable supposition, it is an error to suppose that no benefit would be conferred on the labouring class. If one-tenth of the labouring people of England were transferred to the colonies, and along with them one-tenth of the circulating capital of the country, either wages, or profits, or both, would be greatly benefited by the diminished pressure of capital and population upon the fertility of the land. There would be a reduced demand for food: the inferior arable lands would be thrown out of cultivation, and would become pasture; the superior would be cultivated less highly, but with a greater proportional return; food would be lowered in price, and though money wages would not rise, every labourer would be considerably improved in circumstances, an improvement which, if no increased stimulus to population and fall of wages ensued, would be permanent; while if there did, profits would rise, and accumulation start forward so as to repair the loss of capital. The landlords alone would sustain some loss of income; and even they, only if colonization went to the length of actually diminishing capital and population, but not if it merely carried off the annual increase.

§ 2. From the same principles we are now able to arrive at a final conclusion respecting the effects which machinery, and generally the sinking of capital for a productive purpose, produce upon the immediate and ultimate interests of the labouring class. The characteristic property of this class of industrial improvements is the conversion of circulating capital into fixed: and it was shown in the first Book,∗ that in a country where capital accumulates slowly, the introduction of machinery, permanent improvements of land, and the like, might be, for the time, extremely injurious; since the capital so employed might be directly taken from the wages fund, the subsistence of the people and the employment for labour curtailed, and the gross annual produce of the country actually diminished. But in a country of great annual savings and low profits, no such effects need be apprehended. Since even the emigration of capital, or its unproductive expenditure, or its absolute waste, do not in such a country, if confined within any moderate bounds, at all diminish the aggregate amount of the wages fund—still less can the mere conversion of a like sum into fixed capital, which continues to be productive, have that effect. It merely draws off at one orifice what was already flowing out at another; or if not, the greater vacant space left in the reservoir does but cause a greater quantity to flow in. Accordingly, in spite of the mischievous derangements of the money-market which were at one time occasioned by the sinking of great sums in railways, I was never able to agree with those who apprehended mischief, from this source, to the productive resources of the country.1 Not on the absurd ground (which to any one acquainted with the elements of the subject needs no confutation) that railway expenditure is a mere transfer of capital from hand to hand, by which nothing is lost or destroyed. This is true of what is spent in the purchase of the land; a portion too of what is paid to parliamentary agents, counsel, engineers, and surveyors is saved by those who receive it, and becomes capital again: but what is laid out in the bonâ fide construction of the railway itself is lost and gone; when once expended, it is incapable of ever being paid in wages or applied to the maintenance of labourers again; as a matter of account, the result is that so much food and clothing and tools have been consumed, and the country has got a railway instead. But what I would urge is, that sums so applied are mostly a mere appropriation of the annual overflowing which would otherwise have gone abroad, or been thrown away unprofitably, leaving neither a railway nor any other tangible result. The railway gambling of 1844 and 1845 probably saved the country from a depression of profits and interest, and a rise of all public and private securities, which would have engendered still wilder speculations, and when the effects came afterwards to be complicated by the scarcity of food, would have ended in a still more formidable crisis than was experienced in the years immediately following. In the poorer countries of Europe, the rage for railway construction might have had worse consequences than in England, were it not that in those countries such enterprises are in a great measure carried on by foreign capital. The railway operations of the various nations of the world may be looked upon as a sort of competition for the overflowing capital of the countries where profit is low and capital abundant, as England and Holland. The English railway speculations are a struggle to keep our annual increase of capital at home; those of foreign countries are an effort to obtain it.∗

It already appears from these considerations, that the conversion of circulating capital into fixed, whether by railways, or manufactories, or ships, or machinery, or canals, or mines, or works of drainage and irrigation, is not likely, in any rich country, to diminish the gross produce or the amount of employment for labour. How much then is the case strengthened, when we consider that these transformations of capital are of the nature of improvements in production, which, instead of ultimately diminishing circulating capital are the necessary conditions of its increase, since they alone enable a country to possess a constantly augmenting capital without reducing profits to the rate which would cause accumulation to stop. There is hardly any increase of fixed capital which does not enable the country to contain eventually a larger circulating capital, than it otherwise could possess and employ within its own limits; for there is hardly any creation of fixed capital which, when it proves successful, does not cheapen the articles on which wages are habitually expended. All capital sunk in the permanent improvement of land lessens the cost of food and materials; almost all improvements in machinery cheapen the labourer's clothing or lodging, or the tools with which these are made; improvements in locomotion, such as railways, cheapen to the consumer all things which are brought from a distance. All these improvements make the labourers better off with the same money wages, better off if they do not increase their rate of multiplication. But if they do, and wages consequently fall, at least profits rise, and, while accumulation receives an immediate stimulus, room is made for a greater amount of capital before a sufficient motive arises for sending it abroad. Even the improvements which do not cheapen the things consumed by the labourer, and which, therefore, do not raise profits nor retain capital in the country, nevertheless, as we have seen, by lowering the minimum of profit for which people will ultimately consent to save, leave an ampler margin than previously for eventual accumulation, before arriving at the stationary state.

We may conclude, then, that improvements in production, and emigration of capital to the more fertile soils and unworked mines of the uninhabited or thinly peopled parts of the globe, do not, as appears to a superficial view, diminish the gross produce and the demand for labour at home; but, on the contrary, are what we have chiefly to depend on for increasing both, and are even the necessary conditions of any great or prolonged augmentation of either. Nor is it any exaggeration to say, that within certain, and not very narrow, limits, the more capital a country like England expends in these two ways, the more she will have left.

Book IV, Chapter VI: Of the stationary state

CHAPTER VI: of the stationary state

§ 1. The preceding chapters comprise the general theory of the economical progress of society, in the sense in which those terms are commonly understood; the progress of capital, of population, and of the productive arts. But in contemplating any progressive movement, not in its nature unlimited, the mind is not satisfied with merely tracing the laws of the movement; it cannot but ask the further question, to what goal? Towards what ultimate point is society tending by its industrial progress? When the progress ceases, in what condition are we to expect that it will leave mankind?

It must always have been seen, more or less distinctly, by political economists, that the increase of wealth is not boundless: that at the end of what they term the progressive state lies the stationary state, that all progress in wealth is but a postponement of this, and that each step in advance is an approach to it. We have now been led to recognize that this ultimate goal is at all times near enough to be fully in view; that we are always on the verge of it, and that if we have not reached it long ago, it is because the goal itself flies before us. The richest and most prosperous countries would very soon attain the stationary state, if no further improvements were made in the productive arts, and if there were a suspension of the overflow of capital from those countries into the uncultivated or ill-cultivated regions of the earth.

This impossibility of ultimately avoiding the stationary state—this irresistible necessity that the stream of human industry should finally spread itself out into an apparently stagnant sea—must have been, to the political economists of the last two generations, an unpleasing and discouraging prospect; for the tone and tendency of their speculations goes completely to identify all that is economically desirable with the progressive state, and with that alone. With Mr. M'Culloch, for example, prosperity does not mean a large production and a good distribution of wealth, but a rapid increase of it; his test of prosperity is high profits; and as the tendency of that very increase of wealth, which he calls prosperity, is towards low profits, economical progress, according to him, must tend to the extinction of prosperity. Adam Smith always assumes that the condition of the mass of the people, though it may not be positively distressed, must be pinched and stinted in a stationary condition of wealth, and can only be satisfactory in a progressive state. The doctrine that, to however distant a time incessant struggling may put off our doom, the progress of society must “end in shallows and in miseries,” far from being, as many people still believe, a wicked invention of Mr. Malthus, was either expressly or tacitly affirmed by his most distinguished predecessors, and can only be successfully combated on his principles. Before attention had been directed to the principle of population as the active force in determining the remuneration of labour, the increase of mankind was virtually treated as a constant quantity; it was, at all events, assumed that in the natural and normal state of human affairs population must constantly increase, from which it followed that a constant increase of the means of support was essential to the physical comfort of the mass of mankind. The publication of Mr. Malthus' Essay is the era from which better views of this subject must be dated; and notwithstanding the acknowledged errors of his first edition, few writers have done more than himself, in the subsequent editions, to promote these juster and more hopeful anticipations.

Even in a progressive state of capital, in old countries, a conscientious or prudential restraint on population is indispensable, to prevent the increase of numbers from outstripping the increase of capital, and the condition of the classes who are at the bottom of society from being deteriorated. Where there is not, in the people, or in some very large proportion of them, a resolute resistance to this deterioration—a determination to preserve an established standard of comfort—the condition of the poorest class sinks, even in a progressive state, to the lowest point which they will consent to endure. The same determination would be equally effectual to keep up their condition in the stationary state, and would be quite as likely to exist. Indeed, even now, the countries in which the greatest prudence is manifested in the regulating of population are often those in which capital increases least rapidly. Where there is an indefinite prospect of employment for increased numbers, there is apt to appear less necessity for prudential restraint. If it were evident that a new hand could not obtain employment but by displacing, or succeeding to, one already employed, the combined influences of prudence and public opinion might in some measure be relied on for restricting the coming generation within the numbers necessary for replacing the present.

§ 2. I cannot, therefore, regard the stationary state of capital and wealth with the unaffected aversion so generally manifested towards it by political economists of the old school. I am inclined to believe that it would be, on the whole, a very considerable improvement on our present condition. I confess I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on; that the trampling, crushing, elbowing, and treading on each other's heels, which form the existing type of social life, are the most desirable lot of human kind, or anything but the disagreeable symptoms of one of the phases of industrial progress. It may be a necessary stage in the progress of civilization, and those European nations which have hitherto been so fortunate as to be preserved from it, may have it yet to undergo. It is an incident of growth, not a mark of decline, for it is not necessarily destructive of the higher aspirations and the heroic virtues; as America, in her great civil war, has proved to the world, both by her conduct as a people and by numerous splendid individual examples, and as England, it is to be hoped, would also prove, on an equally trying and exciting occasion.1 But it is not a kind of social perfection which philanthropists to come will feel any very eager desire to assist in realizing. Most fitting, indeed, is it, that while riches are power, and to grow as rich as possible the universal object of ambition, the path to its attainment should be open to all, without favour or partiality. But the best state for human nature is that in which, while no one is poor, no one desires to be richer, nor has any reason to fear being thrust back by the efforts of others to push themselves forward.

That the energies of mankind should be kept in employment by the struggle for riches, as they were formerly by the struggle of war, until the better minds succeed in educating the others into better things, is undoubtedly more desirable than that they should rust and stagnate. While minds are coarse they require coarse stimuli, and let them have them. In the meantime, those who do not accept the present very early stage of human improvement as its ultimate type, may be excused for being comparatively indifferent to the kind of economical progress which excites the congratulations of ordinary politicians; the mere increase of production and accumulation. For the safety of national independence it is essential that a country should not fall much behind its neighbours in these things. But in themselves they are of little importance, so long as either the increase of population or anything else prevents the mass of the people from reaping any part of the benefit of them. I know not why it should be matter of congratulation that persons who are already richer than any one needs to be, should have doubled their means of consuming things which give little or no pleasure except as representative of wealth; or that numbers of individuals should pass over, every year, from the middle classes into a richer class, or from the class of the occupied rich to that of the unoccupied. It is only in the backward countries of the world that increased production is still an important object: in those most advanced, what is economically needed is a better distribution, of which one indispensable means is a stricter restraint on population. Levelling institutions, either of a just or of an unjust kind, cannot alone accomplish it; they may lower the heights of society, but they cannot, of themselves, permanently1 raise the depths.

On the other hand, we may suppose this better distribution of property attained, by the joint effect of the prudence and frugality of individuals, and of a system of legislation favouring equality of fortunes, so far as is consistent with the just claim of the individual to the fruits, whether great or small, of his or her own industry. We may suppose, for instance (according to the suggestion thrown out in a former chapter∗), a limitation of the sum which any one person may acquire by gift or inheritance to the amount sufficient to constitute a moderate independence. Under this twofold influence society would exhibit these leading features: a well-paid and affluent body of labourers; no enormous fortunes, except what were earned and accumulated during a single lifetime; but a much larger body of persons than at present, not only exempt from the coarser toils, but with sufficient leisure, both physical and mental, from mechanical details, to cultivate freely the graces of life, and afford examples of them to the classes less favourably circumstanced for their growth. This condition of society, so greatly preferable to the present, is not only perfectly compatible with the stationary state, but, it would seem, more naturally allied with that state than with any other.

There is room in the world, no doubt, and even in old countries, for a great increase of population, supposing the arts of life to go on improving, and capital to increase. But even if innocuous, I confess I see very little reason for desiring it. The density of population necessary to enable mankind to obtain, in the greatest degree, all the advantages both of co-operation and of social intercourse, has, in all the most populous countries, been attained. A population may be too crowded, though all be amply supplied with food and raiment. It is not good for man to be kept perforce at all times in the presence of his species. A world from which solitude is extirpated is a very poor ideal. Solitude, in the sense of being often alone, is essential to any depth of meditation or of character; and solitude in the presence of natural beauty and grandeur, is the cradle of thoughts and aspirations which are not only good for the individual, but which society could ill do without. Nor is there much satisfaction in contemplating the world with nothing left to the spontaneous activity of nature; with every rood of land brought into cultivation, which is capable of growing food for human beings; every flowery waste or natural pasture ploughed up, all quadrupeds or birds which are not domesticated for man's use exterminated as his rivals for food, every hedgerow or superfluous tree rooted out, and scarcely a place left where a wild shrub or flower could grow without being eradicated as a weed in the name of improved agriculture. If the earth must lose that great portion of its pleasantness which it owes to things that the unlimited increase of wealth and population would extirpate from it, for the mere purpose of enabling it to support a larger, but not a better or a happier population, I sincerely hope, for the sake of posterity, that they will be content to be stationary, long before necessity compels them to it.

It is scarcely necessary to remark that a stationary condition of capital and population implies no stationary state of human improvement. There would be as much scope as ever for all kinds of mental culture, and moral and social progress; as much room for improving the Art of Living, and much more likelihood of its being improved, when minds ceased to be engrossed by the art of getting on. Even the industrial arts might be as earnestly and as successfully cultivated, with this sole difference, that instead of serving no purpose but the increase of wealth, industrial improvements would produce their legitimate effect, that of abridging labour. Hitherto [1848] it is questionable if all the mechanical inventions yet made have lightened the day's toil of any human being. They have enabled a greater population to live the same life of drudgery and imprisonment, and an increased number of manufacturers and others to make fortunes. They have increased the comforts of the middle classes. But they have not yet begun to effect those great changes in human destiny, which it is in their nature and in their futurity to accomplish. Only when, in addition to just institutions, the increase of mankind shall be under the deliberate guidance of judicious foresight, can the conquests made from the powers of nature by the intellect and energy of scientific discoverers become the common property of the species, and the means of improving and elevating the universal lot.

Book IV, Chapter VII: On the probable futurity of the labouring classes

CHAPTER VII: on the probable futurity of the labouring classes

§ 1. The observations in the preceding chapter had for their principal object to deprecate a false ideal of human society. Their applicability to the practical purposes of present times consists in moderating the inordinate importance attached to the mere increase of production, and fixing attention upon improved distribution, and a large remuneration of labour, as the two desiderata. Whether the aggregate produce increases absolutely or not, is a thing in which, after a certain amount has been obtained, neither the legislator nor the philanthropist need feel any strong interest: but, that it should increase relatively to the number of those who share in it, is of the utmost possible importance; and this, (whether the wealth of mankind be stationary, or increasing at the most rapid rate ever known in an old country,) must depend on the opinions and habits of the most numerous class, the class of manual labourers.

1 When I speak, either in this place or elsewhere, of “the labouring classes,” or of labourers as a “class,” I use those phrases in compliance with custom, and as descriptive of an existing, but by no means a necessary or permanent, state of social relations. I do not recognize as either just or salutary, a state of society in which there is any “class” which is not labouring; any human beings, exempt from bearing their share of the necessary labours of human life, except those unable to labour, or who have fairly earned rest by previous toil. So long, however, as the great social evil exists of a non-labouring class, labourers also constitute a class, and may be spoken of, though only provisionally, in that character.

Considered in its moral and social aspect, the state of the labouring people has latterly been a subject of much more speculation and discussion than formerly; and the opinion that it is not now what it ought to be, has become very general. The suggestions which have been promulgated, and the controversies which have been excited, on detached points rather than on the foundations of the subject, have put in evidence the existence of two conflicting theories, respecting the social position desirable for manual labourers. The one may be called the theory of dependence and protection, the other that of self-dependence.

According to the former theory, the lot of the poor, in all things which affect them collectively, should be regulated for them, not by them. They should not be required or encouraged to think for themselves, or give to their own reflection or forecast an influential voice in the determination of their destiny. It is supposed to be the duty of the higher classes to think for them, and to take the responsibility of their lot, as the commander and officers of an army take that of the soldiers composing it. This function, it is contended, the higher classes should prepare themselves to perform conscientiously, and their whole demeanour should impress the poor with a reliance on it, in order that, while yielding passive and active obedience to the rules prescribed for them, they may resign themselves in all other respects to a trustful insouciance, and repose under the shadow of their protectors. The relation between rich and poor, according to this theory (a theory also applied to the relation between men and women)1 should be only partly authoritative; it should be amiable, moral, and sentimental: affectionate tutelage on the one side, respectful and grateful deference on the other. The rich should be in loco parentis to the poor, guiding and restraining them like children. Of spontaneous action on their part there should be no need. They should be called on for nothing but to do their day's work, and to be moral and religious. Their morality and religion should be provided for them by their superiors, who should see them properly taught it, and should do all that is necessary to ensure their being, in return for labour and attachment, properly fed, clothed, housed, spiritually edified, and innocently amused.

This is the ideal of the future, in the minds of those whose dissatisfaction with the Present assumes the form of affection and regret towards the Past.1 Like other ideals, it exercises an unconscious influence on the opinions and sentiments of numbers who never consciously guide themselves by any ideal. It has also this in common with other ideals, that it has never been historically realised. It makes its appeal to our imaginative sympathies in the character of a restoration of the good times of our forefathers. But no times can be pointed out in which the higher classes of this or any other country performed a part even distantly resembling the one assigned to them in this theory. It is an idealization, grounded on the conduct and character of here and there an individual. All privileged and powerful classes, as such, have used their power in the interest of their own selfishness, and have indulged their self-importance in despising, and not in lovingly caring for, those who were, in their estimation, degraded, by being under the necessity of working for their benefit. I do not affirm that what has always been must always be, or that human improvement has no tendency to correct the intensely selfish fillings engendered by power; but though the evil may be lessened, it cannot be eradicated, until the power itself is withdrawn. This, at least, seems to me undeniable, that long before the superior classes could be sufficiently improved to govern in the tutelary manner supposed, the inferior classes would be too much improved to be so governed.

I am quite sensible of all that is seductive in the picture of society which this theory presents. Though the facts of it have no prototype in the past, the feelings have. In them lies all that there is of reality in the conception. As the idea is essentially repulsive of a society only held together by the relations and feelings arising out of pecuniary interests, so there is something naturally attractive in a form of society abounding in strong personal attachments and disinterested self-devotion. Of such feelings it must be admitted that the relation of protector and protected has hitherto been the richest source. The strongest attachments of human beings in general, are towards the things or the persons that stand between them and some dreaded evil. Hence, in an age of lawless violence and insecurity, and general hardness and roughness of manners, in which life is beset with dangers and sufferings at every step, to those who have neither a commanding position of their own, nor a claim on the protection of some one who has—a generous giving of protection, and a grateful receiving of it, are the strongest ties which connect human beings; the feelings arising from that relation are their warmest feelings; all the enthusiasm and tenderness of the most sensitive natures gather round it; loyalty on the one part and chivalry on the other are principles exalted into passions. I do not desire to depreciate these qualities.1 The error lies in not perceiving, that these virtues and sentiments, like the clanship and the hospitality of the wandering Arab, belong emphatically to a rude and imperfect state of the social union; and that the feelings between protector and protected, whether between kings and subjects, rich and poor, or men and women,2 can no longer have this beautiful and endearing character where there are no longer any serious dangers from which to protect. What is there in the present state of society to make it natural that human beings, of ordinary strength and courage, should glow with the warmest gratitude and devotion in return for protection? The laws protect them, wherever the laws do not criminally fail in their duty.3 To be under the power of some one, instead of being as formerly the sole condition of safety, is now, speaking generally, the only situation which exposes to grievous wrong. The so-called protectors are now the only persons against whom, in any ordinary circumstances, protection is needed. The brutality and tyranny with which every police report is filled, are those of husbands to wives, of parents to children. That the law does not prevent these atrocities, that it is only now making a first timid attempt to repress and punish them, is no matter of necessity, but the deep disgrace of those by whom the laws are made and administered. No man or woman who either possesses or is able to earn an independent livelihood, requires any other protection than that which the law could and ought to give. This being the case, it argues great ignorance of human nature to continue taking for granted that relations founded on protection must always subsist, and not to see that the assumption of the part of protector, and of the power which belongs to it, without any of the necessities which justify it, must engender feelings opposite to loyalty.

Of the working men, at least in the more advanced countries of Europe, it may be pronounced certain, that the patriarchal or paternal system of government is one to which they will not again be subject. That question was decided, when they were taught to read, and allowed access to newspapers and political tracts; when dissenting preachers were suffered to go among them, and appeal to their faculties and feelings in opposition to the creeds professed and countenanced by their superiors; when they were brought together in numbers, to work socially under the same roof; when railways enabled them to shift from place to place, and change their patrons and employers as easily as their coats; when they were encouraged to seek a share in the government, by means of the electoral franchise.1 The working classes have taken their interests into their own hands, and are perpetually showing that they think the interests of their employers not identical with their own, but opposite to them. Some among the higher classes flatter themselves that these tendencies may be counteracted by moral and religious education: but they have let the time go by for giving an education which can serve their purpose. The principles of the Reformation have reached as low down in society as reading and writing, and the poor will not much longer accept morals and religion of other people's prescribing. I speak more particularly of this country, especially the town population, and the districts of the most scientific agriculture or the highest wages, Scotland and the north of England. Among the more inert and less modernized agricultural population of the southern counties, it might be possible for the gentry to retain, for some time longer, something of the ancient deference and submission of the poor, by bribing them with high wages and constant employment; by insuring them support, and never requiring them to do anything which they do not like. But these are two conditions which never have been combined, and never can be, for long together. A guarantee of subsistence can only be practically kept up, when work is enforced and superfluous multiplication restrained by at least a moral compulsion. It is then, that the would-be revivers of old times which they do not understand, would feel practically in how hopeless a task they were engaged. The whole fabric of patriarchal or seignorial influence, attempted to be raised on the foundation of caressing the poor, would be shattered against the necessity of enforcing a stringent Poor-law.

§ 2. It is on a far other basis that the well-being and well-doing of the labouring people must henceforth rest. The poor have come out of leading-strings, and cannot any longer be governed or treated like children. To their own qualities must now be commended the care of their destiny. Modern nations will have to learn the lesson, that the well-being of a people must exist by means of the justice and self-government, the δικαιοσ[w1]νη and σωχροσ[w1]νη of the individual citizens. The theory of dependence attempts to dispense with the necessity of these qualities in the dependent classes. But now, when even in position they are becoming less and less dependent, and their minds less and less acquiescent in the degree of dependence which remains, the virtues of independence are those which they stand in need of. Whatever advice, exhortation or guidance is held out to the labouring classes, must henceforth be tendered to them as equals, and accepted by them with their eyes open. The prospect of the future depends on the degree in which they can be made rational beings.

There is no reason to believe that prospect other than hopeful. The progress indeed has hitherto been, and still is, slow. But there is a spontaneous education going on in the minds of the multitude, which may be greatly accelerated and improved by artificial aids. The instruction obtained from newspapers and political tracts may not be the most solid kind of instruction, but it is an immense improvement upon none at all. 1 What it does for a people has been admirably exemplified during the cotton crisis, in the case of the Lancashire spinners and weavers, who have acted with the consistent good sense and forbearance so justly applauded, simply because, being readers of newspapers, they understood the causes of the calamity which had befallen them, and knew that it was in no way imputable either to their employers or to the Government. It is not certain that their conduct would have been as rational and exemplary, if the distress had preceded the salutary measure of fiscal emancipation which gave existence to the penny press. The institutions for lectures and discussion, the collective deliberations on questions of common interest, the trade unions, the political agitation, all serve to awaken public spirit, to diffuse variety of ideas among the mass, and to excite thought and reflection in the more intelligent. Although the too early attainment of political franchises by the least educated class might retard, instead of promoting, their improvement, there can be little doubt that it has been greatly stipulated by the attempt to acquire them.1 In the meantime, the working classes are now part of the public; in all discussions on matters of general interest they, or a portion of them, are now partakers; all who use the press as an instrument may, if it so happens, have them for an audience; the avenues of instruction through which the middle classes acquire such ideas as they have, are accessible to, at least, the operatives in the towns. With these resources, it cannot be doubted that they will increase in intelligence, even by their own unaided efforts; while there is reason to hope that great improvements both in the quality and quantity of school education will be effected by the exertions either of government or of individuals, and that the progress of the mass of the people in mental cultivation, and in the virtues which are dependent on it, will take place more rapidly, and with fewer intermittences and aberrations, than if left to itself.

From this increase of intelligence, several effects may be confidently anticipated. First: that they will become even less willing than at present to be led and governed, and directed into the way they should go, by the mere authority and prestige of superiors. If they have not now, still less will they have hereafter, any deferential awe, or religious principle of obedience, holding them in mental subjection to a class above them. The theory of dependence and protection will be more and more intolerable to them, and they will require that their conduct and condition shall be essentially self-governed. It is, at the same time, quite possible that they may demand, in many cases, the intervention of the legislature in their affairs, and the regulation by law of various things which concern them, often under very mistaken ideas of their interest. Still, it is their own will, their own ideas and suggestions, to which they will demand that effect should be given, and not rules laid down for them by other people. It is quite consistent with this, that they should feel respect for superiority of intellect and knowledge, and defer much to the opinions, on any subject, of those whom they think well acquainted with it. Such deference is deeply grounded in human nature; but they will judge for themselves of the persons who are and are not entitled to it.

§ 3. It appears to me impossible but that the increase of intelligence, of education, and of the love of independence among the working classes, must be attended with a corresponding growth of the good sense which manifests itself in provident habits of conduct, and that population, therefore, will bear a gradually diminishing ratio to capital and employment. This most desirable result would be much accelerated by another change, which lies in the direct line of the best tendencies of the time; the opening of industrial occupations freely to both sexes. The same reasons which make it no longer necessary that the poor should depend on the rich, make it equally unnecessary that women should depend on men; and the least which justice requires is that law and custom should not enforce dependence (when the correlative protection has become superfluous) by ordaining that a woman, who does not happen to have a provision by inheritance, shall have scarcely any means open to her of gaining a livelihood, except as a wife and mother. Let women who prefer that occupation, adopt it; but that there should be no option, no other carrière possible for the great majority of women, except in the humbler departments of life, is a flagrant social injustice.1 The ideas and institutions by which the accident of sex is made the groundwork of an inequality of legal rights, and a forced dissimilarity of social functions, must ere long be recognised as the greatest hindrance to moral, social, and even intellectual improvement. On the present occasion I shall only indicate, among the probable consequences of the industrial and social independence of women, a great diminution of the evil of over-population. It is by devoting one-half of the human species to that exclusive function, by making it fill the entire life of one sex, and interweave itself with almost all the objects of the other, that the animal instinct in question is nursed into the disproportionate preponderance which it has hitherto exercised in human life.

§ 4. The political consequences of the increasing power and importance of the operative classes, and of the growing ascendancy of numbers, which, even in England and under the present institutions, is rapidly giving to the will of the majority at least a negative voice in the acts of government, are too wide a subject to be discussed in this place. But, confining ourselves to economical considerations, and notwithstanding the effect which improved intelligence in the working classes, together with just laws, may have in altering the distribution of the produce to their advantage, I cannot think that they will be permanently contented with the condition of labouring for wages as their ultimate state.1 They may be willing to pass through the class of servants in their way to that of employers; but not to remain in it all their lives. To begin as hired labourers, then after a few years to work on their own account, and finally employ others, is the normal condition of labourers in a new country, rapidly increasing in wealth and population, like America or Australia. 1 But in an old and fully peopled country, those who begin life as labourers for hire, as a general rule, continue such to the end, unless they sink into the still lower grade of recipients of public charity. In the present stage of human progress, when ideas of equality are daily spreading more widely among the poorer classes, and can no longer be checked by anything short of the entire suppression of printed discussion and even of freedom of speech, it is not to be expected that the division of the human race into two hereditary classes, employers and employed, can be permanently maintained. The relation is nearly as unsatisfactory to the payer of wages as to the receiver. If the rich regard the poor as, by a kind of natural law, their servants and dependents, the rich in their turn are regarded as a mere prey and pasture for the poor; the subject of demands and expectations wholly indefinite, increasing in extent with every concession made to them. 2 The total absence of regard for justice or fairness in the relations between the two, is as marked on the side of the employed as on that of the employers. We look in vain among the working classes in general for the just pride which will choose to give good work for good wages; for the most part, their sole endeavour is to receive as much, and return as little in the shape of service, as possible. It will sooner or later become insupportable to the employing classes, to live in close and hourly contact with persons whose interests and feelings are in hostility to them. Capitalists are almost as much interested as labourers in placing the operations of industry on such a footing, that those who labour for them may feel the same interest in the work, which is felt by those who labour on their own account.

The opinion expressed in a former part of this treatise respect. ing small landed properties and peasant proprietors, may have made the reader anticipate that a wide diffusion of property in land is the resource on which I rely for exempting at least the agricultural labourers from exclusive dependence on labour for hire. Such, however, is not my opinion. I indeed deem that form of agricultural economy to be most groundlessly cried down, and to be greatly preferable, in its aggregate effects on human happiness, to hired labour in any form in which it exists at present; because the prudential check to population acts more directly, and is shown by experience to be more efficacious; and because, in point of security, of independence, of exercise of any other than the animal faculties, the state of a peasant proprietor is far superior to that of an agricultural labourer in this or any other old country. Where the former system already exists, and works on the whole satisfactorily, I should regret, in the present state of human intelligence, to see it abolished in order to make way for the other, under a pedantic notion of agricultural improvement as a thing necessarily the same in every diversity of circumstances. In a backward state of industrial improvement, as in Ireland, I should urge its introduction, in preference to an exclusive system of hired labour; as a more powerful instrument for raising a population from semi-savage listlessness and recklessness, to persevering industry and prudent calculation.

But a people who have once adopted the large system of production, either in manufactures or in agriculture, are not likely to recede from it; and when population is kept in due proportion to the means of support, it is not desirable that they should. Labour is unquestionably more productive on the system of large industrial enterprises; the produce, if not greater absolutely, is greater in proportion to the labour employed: the same number of persons can be supported equally well with less toil and greater leisure; which will be wholly an advantage, as soon as civilization and improvement have so far advanced, that what is a benefit to the whole shall be a benefit to each individual composing it.1 And in the moral aspect of the question, which is still more important than the economical, something better should be aimed at as the goal of industrial improvement, than to disperse mankind over the earth in single families, each ruled internally, as families now are, by a patriarchal despot, and having scarcely any community of interest, or necessary mental communion, with other human beings. The domination of the head of the family over the other members, in this state of things, is absolute; while the effect on his own mind tends towards concentration of all interests in the family, considered as an expansion of self, and absorption of all passions in that of exclusive possession, of all cares in those of preservation and acquisition. As a step out of the merely animal state into the human, out of reckless abandonment to brute instincts into prudential foresight and self-government, this moral condition may be seen without displeasure. But if public spirit, generous sentiments, or true justice and equality are desired, association, not isolation, of interests, is the school in which these excellences are nurtured. The aim of improvement should be not solely to place human beings in a condition in which they will be able to do without one another, but to enable them to work with or for one another in relations not involving dependence. Hitherto there has been no alternative for those who lived by their labour, but that of labouring either each for himself alone, or for a master. But the civilizing and improving influences of association, and the efficiency and economy of production on a large scale, may be obtained without dividing the producers into two parties with hostile interests and feelings, the many who do the work being mere servants under the command of the one who supplies the funds, and having no interest of their own in the enterprise except to earn their wages with as little labour as possible. The speculations and discussions of the last fifty years, and the events of the last thirty,1 are abundantly conclusive on this point. If the improvement which even triumphant military despotism has only retarded, not stopped, shall continue its course,2 there can be little doubt that the status of hired labourers will gradually tend to confine itself to the description of workpeople whose low moral qualities render them unfit for anything more independent: and that the relation of masters and work-people will be gradually superseded by partnership, in one of two forms: in some cases, association of the labourers with the capitalist; in others, and perhaps finally in all,1 association of labourers among themselves.

2 § 5. The first of these forms of association has long been practised, not indeed as a rule, but as an exception. In several departments of industry there are already cases in which every one who contributes to the work, either by labour or by pecuniary resources, has a partner's interest in it, proportional to the value of his contribution. It is already a common practice to remunerate those in whom peculiar trust is reposed, by means of a percentage on the profits: and cases exist in which the principle is, with excellent success, carried down to the class of mere manual labourers.

In the American ships trading to China, it has long been the custom for every sailor to have an interest in the profits of the voyage; and to this has been ascribed the general good conduct of those seamen, and the extreme rarity of any collision between them and the government or people of the country. An instance in England, not so well known as it deserves to be, is that of the Cornish miners. “In Cornwall the mines are worked strictly on the system of joint adventure; gangs of miners contracting with the agent, who represents the owner of the mine, to execute a certain portion of a vein and fit the ore for market, at the price of so much in the pound of the sum for which the ore is sold. These contracts are put up at certain regular periods, generally every two months, and taken by a voluntary partnership of men accustomed to the mine. This system has its disadvantages, in consequence of the uncertainty and irregularity of the earnings, and consequent necessity of living for long periods on credit; but it has advantages which more than counterbalance these drawbacks. It produces a degree of intelligence, independence, and moral elevation, which raise the condition and character of the Cornish miner far above that of the generality of the labouring class. We are told by Dr. Barham, that ‘they are not only, as a class, intelligent for labourers, but men of considerable knowledge.’ Also, that ‘they have a character of independence, something American, the system by which the contracts are let giving the takers entire freedom to make arrangements among themselves; so that each man feels, as a partner in his little firm, that he meets his employers on nearly equal terms.’... With this basis of intelligence and independence in their character, we are not surprised when we hear that ‘a very great number of miners are now located on possessions of their own, leased for three lives or ninety-nine years, on which they have built houses;’ or that “281, 541l. are deposited in saving banks in Cornwall, of which two-thirds are estimated to belong to miners.'”∗

Mr. Babbage, who also gives an account of this system, observes that the payment to the crews of whaling ships is governed by a similar principle; and that “the profits arising from fishing with nets on the south coast of England are thus divided: one-half the produce belongs to the owner of the boat and net; the other half is divided in equal portions between the persons using it, who are also bound to assist in repairing the net when required.” Mr. Babbage has the great merit of having pointed out the practicability, and the advantage, of extending the principle to manufacturing industry generally.∗1

1 Some attention has been excited by an experiment of this nature, commenced above thirty years ago by a Paris tradesman, a house-painter, M. Leclaire,∗ and described by him in a pamphlet published in the year 1842. M. Leclaire, according to his statement, employs on an average two hundred workmen, whom he pays in the usual manner, by fixed wages or salaries. He assigns to himself, besides interest for his capital, a fixed allowance for his labour and responsibility as manager. At the end of the year, the surplus profits are divided among the body, himself included, in the proportion of their salaries.† The reasons by which M. Leclaire was led to adopt this system are highly instructive. Finding the conduct of his workmen unsatisfactory, he first tried the effect of giving higher wages, and by this he managed to obtain a body of excellent workmen, who would not quit his service for any other. “Having thus succeeded” (I quote from an abstract of the pamphlet in Chambers' Journal,‡) “in producing some sort of stability in the arrangement of his establishment, M. Leclaire expected, he says, to enjoy greater peace of mind. In this, however, he was disappointed. So long as he was able to superintend everything himself, from the general concerns of his business down to its minutest details, he did enjoy a certain satisfaction; but from the moment that, owing to the increase of his business, he found that he could be nothing more than the centre from which orders were issued, and to which reports were brought in, his former anxiety and discomfort returned upon him.” He speaks lightly of the other sources of anxiety to which a tradesman is subject, but describes as an incessant cause of vexation the losses arising from the misconduct of workmen. An employer “will find workmen whose indifference to his interests is such that they do not perform two-thirds of the amount of work which they are capable of; hence the continual fretting of masters, who, seeing their interests neglected, believe themselves entitled to suppose that workmen are constantly conspiring to ruin those from whom they derive their livelihood. If the journeyman were sure of constant employment, his position would in some respects be more enviable than that of the master, because he is assured of a certain amount of day's wages, which he will get whether he works much or little. He runs no risk, and has no other motive to stimulate him to do his best than his own sense of duty. The master, on the other hand, depends greatly on chance for his returns: his position is one of continual irritation and anxiety. This would no longer be the case to the same extent, if the interests of the master and those of the workmen were bound up with each other, connected by some bond of mutual security, such as that which would be obtained by the plan of a yearly division of profits.”

Even in the first year during which M. Leclaire's experiment was in complete operation, the success was remarkable. Not one of his journeymen who worked as many as three hundred days, earned in that year less than 1500 francs, and some considerably more. His highest rate of daily wages being four francs, or 1200 francs for 300 days, the remaining 300 francs, or 12l., must have been the smallest amount which any journeyman, who worked that number of days, obtained as his proportion of the surplus profit. M. Leclaire describes in strong terms the improvement which was already manifest in the habits and demeanour of his workmen, not merely when at work, and in their relations with their employer, but at other times and in other relations, showing increased respect both for others and for themselves. 1 M. Chevalier, in a work published in 1848,∗ stated on M. Leclaire's authority, that the increased zeal of the workpeople continued to be a full compensation to him, even in a pecuniary sense, for the share of profit which he renounced in their favour. 2 And M. Villiaumé, in 1857,† observes:—“Though he has always kept himself free from the frauds which are but too frequent in his profession, he has always been able to hold his ground against competition, and has acquired a handsome competency in spite of the relinquishment of so great a portion of his profits. Assuredly he has been only thus successful because the unusual activity of his workpeople, and the watch which they kept over one another, have compensated him for the sacrifice made in contenting himself with only a share of the gain.ℍ∗

The beneficent example set by M. Leclaire has been followed, with brilliant success, by other employers of labour on a large scale at Paris; and I annex, from the work last referred to (one of the ablest of the many able treatises on political economy produced by the present generation of the political economists of France), some signal examples of the economical and moral benefit arising from this admirable arrangement.†

1 Until the passing of the Limited Liability Act, it was held that an arrangement similar to M. Leclaire's would have been impossible in England, as the workmen could not, in the previous state of the law, have been associated in the profits, without being liable for losses. One of the many benefits of that great legislative improvement has been to render partnerships of this description possible, and we may now expect to see them carried into practice. Messrs Briggs, of the Whitwood and Methley collieries, near Normanton in Yorkshire, have taken the first step. They now work these mines by a company, two-thirds of the capital of which they themselves continue to hold, but undertake, in the allotment of the remaining third, to give the preference to the “officials and operatives employed in the concern;” and, what is of still greater importance, whenever the annual profit exceeds 10 per cent, one-half the excess is divided among the work-people and employés, whether shareholders or not, in proportion to their earnings during the year. It is highly honourable to these important employers of labour to have initiated a system so full of benefit both to the operatives employed and to the general interest of social improvement: and they express no more than a just confidence in the principle when they say, that “the adoption of the mode of appropriation thus recommended would, it is believed, add so great an element of success to the undertaking as to increase rather than diminish the dividend to the shareholders.”1

2 § 6. The form of association, however, which if mankind continue to improve, must be expected in the end to predominate, is not that which can exist between a capitalist as chief, and work-people without a voice in the management, but the association of the labourers themselves on terms of equality, collectively owning the capital with which they carry on their operations, and working under managers elected and removable by themselves. So long as this idea remained in a state of theory, in the writings of Owen or of Louis Blanc, it may have appeared, to the common modes of judgment, incapable of being realised, and not likely to be tried unless by seizing on the existing capital, and confiscating it for the benefit of the labourers; which is even now imagined by many persons, and pretended by more, both in England and on the Continent, to be the meaning and purpose of Socialism. But there is a capacity of exertion and self-denial in the masses of mankind, which is never known but on the rare occasions on which it is appealed to in the name of some great idea or elevated sentiment. Such an appeal was made by the French Revolution of 1848. For the first time it then seemed to the intelligent and generous of the working classes of a great nation, that they had obtained a government who sincerely desired the freedom and dignity of the many, and who did not look upon it as their natural and legitimate state to be instruments of production, worked for the benefit of the possessors of capital. Under this encouragement, the ideas sown by Socialist writers, of an emancipation of labour to be effected by means of association, throve and fructified; and many working people came to the resolution, not only that they would work for one another, instead of working for a master tradesman or manufacturer, but that they would also free themselves, at whatever cost of labour or privation, from the necessity of paying, out of the produce of their industry, a heavy tribute for the use of capital; that they would extinguish this tax, not by robbing the capitalists of what they or their predecessors had acquired by labour and preserved by economy, but by honestly acquiring capital for themselves. If only a few operatives had attempted this arduous task, or if, while many attempted it, a few only had succeeded, their success might have been deemed to furnish no argument for their system as a permanent mode of industrial organization. But, excluding all the instances of failure, there exist, or existed a short time ago,1 upwards of a hundred successful, and many eminently prosperous, associations of operatives in Paris alone, besides a considerable number in the departments. An instructive sketch of their history and principles has been published, under the title of L'Association Ouvrière Industrielle et Agricole, by H. Feugueray: and as it is frequently affirmed in English newspapers that the associations at Paris have failed, by writers who appear to mistake the predictions of their enemies at their first formation for the testimonies of subsequent experience, I think it important to show by quotations from M. Feugueray's volume, strengthened by still later testimonies,2 that these representations are not only wide of the truth, but the extreme contrary of it.

The capital of most of the associations was originally confined to the few tools belonging to the founders, and the small sums which could be collected from their savings, or which were lent to them by other workpeople as poor as themselves. In some cases, however, loans of capital were made to them by the republican government: but the associations which obtained these advances, or at least which obtained them before they had already achieved success, are, it appears, in general by no means the most prosperous. The most striking instances of prosperity are in the case of those who have had nothing to rely on but their own slender means and the small loans of fellow-workmen, and who lived on bread and water while they devoted the whole surplus of their gains to the formation of a capital.

“Often,” says M. Feugueray,∗ “there was no money at all in hand, and no wages could be paid. The goods did not go off, the payments did not come in, bills could not get discounted, the warehouse of materials was empty; they had to submit to privation, to reduce all expenses to the minimum, to live sometimes on bread and water.... It is at the price of these hardships and anxieties that men who began with hardly any resource but their good will and their hands, succeeded in creating customers, in acquiring credit, forming at last a joint capital, and thus founding associations whose futurity now seems to be assured.”

I will quote at length the remarkable history of one of these associations.∗

“The necessity of a large capital for the establishment of a pianoforte manufactory was so fully recognised in the trade, that in 1848 the delegates of several hundred workmen who had combined to form a great association, solicited from the government a subvention of 300,000 francs [12,000l.], being a tenth part of the whole sum voted by the National Assembly. I remember that, as one of the Commission charged with the distribution of the fund, I tried in vain for two hours to convince the two delegates with whom the Commission conferred, that their request was exorbitant. They answered imperturbably, that their trade was a peculiar one; that the association could only have a chance of success on a very large scale and with a considerable capital; that 300,000 francs were the smallest sum which could sufffice them, and that they could not reduce the demand by a single sou. The Commission refused.

“Now, after this refusal, the project of a great association being abandoned, what happened was this. Fourteen workmen, and it is singular that among them was one of the two delegates, resolved to set up by themselves a pianoforte-making association. The project was hazardous on the part of men who had neither money nor credit: but faith does not reason—it acts.

“Our fourteen men therefore went to work, and I borrow from an excellent article by M. Cochut in the National, the accuracy of which I can attest, the following account of their first proceedings.

“Some of them, who had worked on their own account, brought with them in tools and materials the value of about 2000 francs [80l.]. There was needed besides a circulating capital. Each member, not without difficulty, managed to subscribe 10 francs [8s.]. A certain number of workmen not interested in the society gave their adhesion by bringing small contributions. On March 10, 1849, a sum of 229½ francs [9l. 3s. 7½d.] having been realized, the association was declared constituted.

“This sum was not even sufficient for setting up, and for the small expenses required from day to day for the service of a workshop. There being nothing left for wages, nearly two months elapsed without their touching a farthing. How did they subsist during this interval? As workmen live when out of employment, by sharing the portion of a comrade who is in work; by selling or pawning bit by bit the few articles they possess.

“They had executed some orders. They received the payment on the 4th of May. That day was for them like a victory at the opening of a campaign, and they determined to celebrate it. After paying all debts that had fallen due, the dividend of each member amounted to 6 francs 61 centimes. They agreed to allow to each 5 francs [4s.] on account of his wages, and to devote the surplus to a fraternal repast. The fourteen shareholders, most of whom had not tasted wine for a year past, met, along with their wives and children. They expended 32 sous [1s. 4d.] per family. This day is still spoken of in their workshops with an emotion which it is difficult not to share.

“For a month longer it was necessary to content themselves with the receipt of five franca per week. In the course of June a baker, either from love of music or on speculation, offered to buy a piano, paying for it in bread. The bargain was made at the price of 480 francs. It was a piece of good luck to the association. They had now at least what was indispensable. They determined not to reckon the bread in the account of wages. Each ate according to his appetite, or rather to that of his family; for the married shareholders were allowed to take away bread freely for their wives and children.

“Meanwhile the association, being composed of excellent workmen, gradually surmounted the obstacles and privations which had embarrassed its starting. Its account-books offer the best proof of the progress which its pianos had made in the estimation of buyers. From August 1849 the weekly contingent rises to 10, 15, and 20 francs per week; and this last sum does not represent all their profits, each partner having left in the common stock much more than he received from it. Indeed it is not by the sum which the member receives weekly that his situation can be judged, but by the share acquired in the ownership of a property already considerable. The following was the position of the association when it took stock on the 30th December 1850.

“At this period the number of shareholders was thirty-two. Large workshops and warehouses, rented for 2000 francs, were no longer sufficient for the business.

Frs. Cents.

∗ “The last two items consisted of safe securities, nearly all of which have since been realized.”

† “These adherents are workmen of the trade, who subscribed small sums to the association at its commencement: a portion of them were reimbursed in the beginning of 1851. The sum due to creditors has also been much reduced: on the 23rd of April it only amounted to 113 francs 59 centimes.”

Independent of tools, valued at . . . . . 5,922 60

They possessed in goods and especially in

materials, the value of . . . . . . . 22,972 28

They had in cash . . . . . . . . . 1,021 10

” in bills . . . . . . . . . 3,540

There was due to them∗ . . . . . . . 5,861 90

——————

They had thus to their credit . . . . . . 39,317 88

Against this are only to be debited 4737 francs

86 centimes due to creditors, and 1650 francs

to eighty adherents;† in all . . . . . 6,387 86

——————

Remaining . . . . . . . . . 32,930 02

[£1319 4s.]

which formed their indivisible capital and the reserve of the individual members. At this period the association had 76 pianos under construction, and received more orders than they could execute.”

From a later report we learn that this society subsequently divided itself into two separate associations, one of which, in 1854, already possessed a circulating capital of 56,000 francs‡ [2240l.]. In 1863 its total capital was 6520l.

The same admirable qualities by which the associations were carried through their early struggles, maintained them in their increasing prosperity. Their rules of discipline, instead of being more lax, are stricter than those of ordinary workshops; but being rules self-imposed, for the manifest good of the community, and not for the convenience of an employer regarded as having an opposite interest, they are far more scrupulously obeyed, and the voluntary obedience carries with it a sense of personal worth and dignity. With wonderful rapidity the associated workpeople have learnt to correct those of the ideas they set out with which are in opposition to the teaching of reason and experience. Almost all the associations, at first, excluded piece-work, and gave equal wages whether the work done was more or less. Almost all have abandoned this system, and after allowing to every one a fixed minimum, sufficient for subsistence, they apportion all further remuneration according to the work done: most of them even dividing the profits at the end of the year, in the same proportion as the earnings.∗

It is the declared principle of most of these associations that they do not exist for the mere private benefit of the individual members, but for the promotion of the co-operative cause. With every extension, therefore, of their business, they take in additional members, not (when they remain faithful to their original plan) to receive wages from them as hired labourers, but to enter at once into the full benefits of the association, without being required to bring anything in, except their labour: the only condition imposed is that of receiving during a few years a smaller share in the annual division of profits, as some equivalent for the sacrifices of the founders. When members quit the association, which they are always at liberty to do, they carry none of the capital with them: it remains an indivisible property, of which the members for the time being have the use, but not the arbitrary disposal: by the stipulations of most of the contracts, even if the association breaks up, the capital cannot be divided, but must be devoted entire to some work of beneficence or of public utility. A fixed, and generally a considerable, proportion of the annual profits, is not shared among the members, but added to the capital of the association, or devoted to the repayment of advances previously made to it: another portion is set aside to provide for the sick and disabled, and another to form a fund for extending the practice of association, or aiding other associations in their need. The managers are paid, like other members, for the time which is occupied in management, usually at the rate of the highest paid labour: but the rule is adhered to, that the exercise of power shall never be an occasion of profit.

Of the ability of the associations to compete successfully with individual capitalists, even at an early period of their existence, M. Feugueray said, “The associations which have been founded in the last two years” (M. Feugueray wrote in 1851) “had many obstacles to overcome; the majority of them were almost entirely without capital: all were treading in a path previously unexplored; they ran the risks which always threaten innovators and beginners. Nevertheless, in many of the trades in which they have been established, they are already formidable competitors of the old houses, and are even complained of on that account by a part of the bourgeoisie. This is not only true of the cooks, the lemonade sellers, and hair-dressers, trades the nature of which enables the associations to rely on democratic custom, but also in other trades where they have not the same advantages. One has only to consult the makers of chairs, of arm-chairs, of files, and one will learn from them if the most important establishments in their respective trades are not those of the associated workmen.”

1 The vitality of these associations must indeed be great, to have enabled about twenty of them to survive not only the anti-socialist reaction, which for the time discredited all attempts to enable workpeople to be their own employers—not only the tracasseries of the police, and the hostile policy of the government since the usurpation—but in addition to these obstacles, all the difficulties arising from the trying condition of financial and commercial affairs from 1854 to 1858. Of the prosperity attained by some of them even while passing through this difficult period, I have given examples which must be conclusive to all minds as to the brilliant future reserved for the principle of co-operation.∗

1 It is not in France alone that these associations have commenced a career of prosperity. To say nothing at present of Germany, Piedmont, and Switzerland (where the Konsum-Verein of Zürich is one of the most prosperous co-operative associations in Europe), England can produce cases of success rivalling even those which I have cited from France. Under the impulse commenced by Mr. Owen, and more recently propagated by the writings and personal efforts of a band of friends, chiefly clergymen and barristers, to whose noble exertions too much praise can scarcely be given, the good seed was widely sown; the necessary alterations in the English law of partnership were obtained from Parliament, on the benevolent and public-spirited initiative of Mr. Slaney; many industrial associations, and a still greater number of co-operative stores for retail purchases, were founded. Among these are already many instances of remarkable prosperity, the most signal of which are the Leeds Flour Mill, and the Rochdale Society of Equitable Pioneers. Of this last association, the most successful of all, the history has been written in a very interesting manner by Mr. Holyoake;∗ and the notoriety which by this and other means has been given to facts so encouraging, is causing a rapid extension of associations with similar objects in Lancashire, Yorkshire, London, and elsewhere.

The original capital of the Rochdale Society consisted of 28l.; brought together by the unassisted economy of about forty labourers, through the slow process of a subscription of twopence (afterwards raised to threepence) per week. With this sum they established in 1844 a small shop, or store, for the supply of a few common articles for the consumption of their own families. As their carefulness and honesty brought them an increase of customers and of subscribers, they extended their operations to a greater number of articles of consumption, and in a few years were able to make a large investment in shares of a Co-operative Corn Mill. Mr. Holyoake thus relates the stages of their progress up to 1857:—

“The Equitable Pioneers' Society is divided into seven departments : Grocery, Drapery, Butchering, Shoemaking, Clogging, Tailoring, Wholesale.

“A separate account is kept of each business, and a general account is given each quarter, showing the position of the whole.

“The grocery business was commenced, as we have related, in December 1844, with only four articles to sell. It now includes whatever a grocer's shop should include.

“The drapery business was started in 1847, with an humble array of attractions. In 1854 it was erected into a separate department.

“A year earlier, 1846, the Store began to sell butcher's meat, buying eighty or one hundred pounds of a tradesman in the town. After a while the sales were discontinued until 1850, when the Society had a warehouse of its own. Mr. John Moorhouse, who has now two assistants, buys and kills for the Society three oxen, eight sheep, sundry porkers and calves, which are on the average converted into 130l. of cash per week.

“Shoemaking commenced in 1852. Three men and an apprentice make, and a stock is kept on sale.

“Clogging and tailoring commenced also in this year.

“The wholesale department commenced in 1852, and marls an important development of the Pioneers' proceedings. This department has been created for supplying any members requiring large quantities, and with a view to supply the co-operative stores of Lancashire and Yorkshire, whose small capitals do not enable them to buy in the best markets, nor command the services of what is otherwise indispensable to every store—a good buyer, who knows the markets and his business, who knows what, how, and where to buy. The wholesale department guarantees purity, quality, fair prices, standard weight and measure, but all on the never-failing principle, cash payment.”

In consequence of the number of members who now reside at a distance, and the difficulty of serving the great increase of customers, “Branch Stores have been opened. In 1856 the first Branch was opened in the Oldham Road; about a mile from the centre of Rochdale. In 1857 the Castleton Branch, and another in the Whitworth Road, were established, and a fourth Branch in Pinfold.”

The warehouse, of which their original Store was a single apartment, was taken on lease by the Society, very much out of repair, in 1849. “Every part has undergone neat refitting and modest decoration, and now wears the air of a thoroughly respectable place of business. One room is now handsomely fitted up as a news room. Another is neatly fitted up as a library.... Their news room is as well supplied as that of a London club.” It is now “free to members, and supported from the Education Fund,” a fund consisting of 2½ per cent of all the profits divided, which is set apart for educational purposes. “The Library contains 2200 volumes of the best, and among them, many of the most expensive books published. The Library is free. From 1850 to 1855, a school for young persons was conducted at a charge of twopence per month. Since 1855, a room has been granted by the Board for the use of from twenty to thirty persons, from the ages of fourteen to forty, for mutual instruction on Sundays and Tuesdays....

“The corn-mill was of course rented, and stood at Small Bridge, some distance from the town—one mile and a half. The Society have since built in the town an entirely new mill for themselves. The engine and the machinery are of the moat substantial and improved kind. The capital invested in the corn-mill is 8450l., of which 3731l. 15s. 2d. is subscribed by the Equitable Pioneers' Society. The corn-mill employs eleven men.”

At a later period they extended their operations to the staple manufacture itself. From the success of the Pioneers' Society grew not only the co-operative corn-mill, but a co-operative association for cotton and woollen manufacturing. “The capital in this department is 4000l., of which sum 2042l. has been subscribed by the Equitable Pioneers' Society. This Manufacturing Society has ninety-six power-looms at work, and employs twenty-six men, seven women, four boys, and five girls—in all forty-two persons....”

“In 1853 the Store purchased for 745l.; a warehouse (freehold) on the opposite side of the street, where they keep and retail their stores of flour, butcher's meat, potatoes, and kindred articles. Their committee-rooms and offices are fitted up in the same building. They rent other houses adjoining for calico and hosiery and shoe stores. In their wilderness of rooms, the visitor stumbles upon shoemakers and tailors at work under healthy conditions, and in perfect peace of mind as to the result on Saturday night. Their warehouses are everywhere as bountifully stocked as Noah's Ark, and cheerful customers literally crowd Toad Lane at night, swarming like bees to every counter. The industrial districts of England have not such another sight as the Rochdale Co-operative Store on Saturday night.”∗ Since the disgraceful failure of the Rochdale Savings Bank in 1849, the Society's Store has become the virtual Savings Bank of the place.

The following Table, completed to 11360 from the Almanack published by the Society, shows the pecuniary result of its operations from the commencement.

Year. No. of

members. Amount of Capital. Amount of cash sales

in store (annual). Amount of profit

(annual).

∗ [1865] The latest report to which I have access is that for the quarter ending September 20, 1864, of which I take the following abstract from the November number of that valuable periodical the Co-operator, conducted by Mr. Henry Pitman, one of the most active and judicious apostles of the Co-operative cause:—“The number of members is 4580, being an increase of 132 for the three months. The capital or assets of the society is 59,536l. 10s. 1d., or more than last quarter by 3687l. 13s. 7d. The cash received for sale of goods is 45,806l. 0s. 10½d., being an increase of 2283l. 12s. 5½d. as compared with the previous three months. The profit realized is 5713l. 2s. 7½d., which, after depreciating fixed stock account 182l. 2s. 4½d., paying interest on share capital 598l. 17s. 6d., applying 2½ per cent to an educational fund, viz. 122l. 17s. 9d., leaves a dividend to members on their purchases of 2s. 4d. in the pound. Non-members have received 261l. 18s. 4d., at 1s. 8d. in the pound on their purchases, leaving 8d. in the pound profit to the society, which increases the reserve fund 104l. 15s. 4d. This fund now stands at 1352l. 7s. 11½d., the accumulation of profits from the trade of the public with the store since September 1862, over and above the 1s. 8d. in the pound allowed to such purchasers.”

£ s. d. £ s. d. £ s. d.

1844 28 28 0 0 ——— ———

1845 74 181 12 5 710 6 5 32 17 6

1846 86 252 7 1½ 1,146 17 7 80 16 3½

1847 110 286 5 3½ 1,924 13 10 72 2 10

1848 140 397 0 0 2,276 6 5½ 117 16 10½

1849 390 1,193 19 1 6,611 18 0 561 3 9

1850 600 2,299 10 5 13,179 17 0 889 12 5

1851 630 2,785 0 1½ 17,638 4 0 990 19 8½

1852 680 3,471 0 6 16,352 5 0 1,206 15 2½

1853 720 5,848 3 11 22,760 0 0 1,674 18 11½

1854 900 7,172 15 7 33,364 0 0 1,763 11 2½

1855 1400 11,032 12 10½ 44,902 12 0 3,106 8 4½

1856 1600 12,920 13 1½ 63,197 10 0 3,921 13 1½

1857 1850 15,142 1 2 79,788 0 0 5,470 6 8½

1858 1950 18,160 5 4 71,689 0 0 6,284 17 4½

1859 2703 27,060 14 2 104,012 0 0 10,739 18 6½

1860∗ 3450 37,710 9 0 152,063 0 0 15,906 9 11

I need not enter into similar particulars respecting the Corn-Mill Society, and will merely state that in 1860 its capital is set down,on the same authority, at 26,618l. 14s. 6d., and the profit for that single year at 10,164l. 12s. 5d. For the manufacturing establishment I have no certified information later than that of Mr. Holyoake, who states the capital of the concern, in 1857, to be 5500l. But a letter in the Rochdale Observer of May 26, 1860, editorially announced as by a person of good information, says that the capital had at that time reached 50,000l.: and the same letter gives highly satisfactory statements respecting other similar associations; the Rosendale Industrial Company, capital 40,000l.; the Walsden Co-operative Company, capital 8000l.; the Bacup and Wardle Commercial Company, with a capital of 40,000l.; “of which more than one-third is borrowed at 5 per cent, and this circumstance, be reduced to during the last two years of unexampled commercial prosperity, has caused the rate of dividend to shareholders to rise to an almost fabulous height.”

1 It is not necessary to enter into any details respecting the subsequent history of English Co-operation; the less so, as it is now one of the recognised elements in the progressive movement of the age, and, as such, has latterly been the subject of elaborate articles in most of our leading periodicals, one of the most recent and best of which was in the Edinburgh Review for October 1864: and the progress of Co-operation from month to month is regularly chronicled in the Co-operator. I must not, however, omit to mention the last great step in advance in reference to the Co-operative Stores, the formation in the North of England (and another is in course of formation in London) of a Wholesale Society, to dispense with the services of the wholesale merchant as well as of the retail dealer, and extend to the Societies the advantage which each society gives to its own members, by an agency for co-operative purchases, of foreign as well as domestic commodities, direct from the producers.

2 It is hardly possible to take any but a hopeful view of the prospects of mankind, when, in two leading countries of the world, the obscure depths of society contain simple working men whose integrity, good sense, self-command, and honourable confidence in one another, have enabled them to carry these noble experiments to the triumphant issue which the facts recorded in the preceding pages attest.

From the progressive advance of the co-operative movement, a great increase may be looked for even in the aggregate productiveness of industry. The sources of the increase are twofold. In the first place, the class of mere distributors, who are not producers but auxiliaries of production, and whose inordinate numbers, far more than the gains of capitalists, are the cause why so great a portion of the wealth produced does not reach the producers—will be reduced to more modest dimensions. Distributors differ from producers in this, that when producers increase, even though in any given department of industry they may be too numerous, they actually produce more: but the multiplication of distributors does not make more distribution to be done, more wealth to be distributed; it does but divide the same work among a greater number of persons, seldom even cheapening the process. By limiting the distributors to the number really required for making the commodities accessible to the consumers-which is the direct effect of the co-operative system—a vast number of hands will be set free for production, and the capital which feeds and the gains which remunerate them will be applied to feed and remunerate producers. This great economy of the world's resources would be realized even if co-operation stopped at associations for purchase and consumption, without extending to production.

The other mode in which co-operation tends, still more efficaciously, to increase the productiveness of labour, consists in the vast stimulus given to productive energies, by placing the labourers, as a mass, in a relation to their work which would make it their principle and their interest—at present it is neither—to do the utmost, instead of the least possible, in exchange for their remuneration. 1 It is scarcely possible to rate too highly this material benefit, which yet is as nothing compared with the moral revolution in society that would accompany it: the healing of the standing feud between capital and labour; the transformation of human life, from a conflict of classes struggling for opposite interests, to a friendly rivalry in the pursuit of a good common to all; the elevation of the dignity of labour; a new sense of security and independence in the labouring class; and the conversion of each human being's daily occupation into a school of the social sympathies and the practical intelligence.

Such is the noble idea which the promoters of Co-operation should have before them. But to attain, in any degree, these objects, it is indispensable that all, and not some only, of those who do the work should be identified in interest with the prosperity of the undertaking. Associations which, when they have been successful, renounce the essential principle of the system, and become joint-stock companies of a limited number of shareholders, who differ from those of other companies only in being working men; associations which employ hired labourers without any interest in the profits (and I grieve to say that the Manufacturing Society even of Rochdale has thus degenerated) are, no doubt, exercising a lawful right in honestly employing the existing system of society to improve their position as individuals, but it is not from them that anything need be expected towards replacing that system by a better. Neither will such societies, in the long run, succeed in keeping their ground against individual competition. Individual management, by the one person principally interested, has great advantages over every description of collective management. Co-operation has but one thing to oppose to those advantages—the common interest of all the workers in the work. When individual capitalists, as they will certainly do, add this to their other points of advantage; when, even if only to increase their gains, they take up the practice which these co-operative societies have dropped, and connect the pecuniary interest of every person in their employment with the most efficient and most economical management of the concern; they are likely to gain an easy victory over societies which retain the defects, while they cannot possess the full advantages, of the old system.

Under the most favourable supposition, it will be desirable, and perhaps for a considerable length of time, that individual capitalists, associating their work-people in the profits, should coexist with even those co-operative societies which are faithful to the co-operative principle. Unity of authority makes many things possible, which could not or would not be undertaken subject to the chance of divided councils or changes in the management. A private capitalist, exempt from the control of a body, if he is a person of capacity, is considerably more likely than almost any association to run judicious risks, and originate costly improvements. Co-operative societies may be depended on for adopting improvements after they have been tested by success, but individuals are more likely to commence things previously untried. Even in ordinary business, the competition of capable persons who in the event of failure are to have all the loss, and in the case of success the greater part of the gain, will be very useful in keeping the managers of co-operative societies up to the due pitch of activity and vigilance.

When, however, co-operative societies shall have sufficiently multiplied, it is not probable that any but the least valuable work-people will any longer consent to work all their lives for wages merely; both private capitalists and associations will gradually find it necessary to make the entire body of labourers participants in profits. Eventually, and in perhaps a less remote future than may be supposed, we may, through the co-operative principle, see our way to 1 a change in society, which would combine the freedom and independence of the individual, with the moral, intellectual, and economical advantages of aggregate production; and which, without violence or spoliation, or even any sudden disturbance of existing habits and expectations, would realize, at least in the industrial department, the best aspirations of the democratic spirit, by putting an end to the division of society into the industrious and the idle, and effacing all social distinctions but those fairly earned by personal services and exertions. Associations like those which we have described, by the very process of their success, are a course of education in those moral and active qualities by which alone success can be either deserved or attained. As associations multiplied, they would tend more and more to absorb all work-people, except those who have too little understanding, or too little virtue, to be capable of learning to act on any other system than that of narrow selfishness. As this change proceeded, owners of capital would gradually find it to their advantage, instead of maintaining the struggle of the old system with work-people of only the worst description, to lend their capital to the associations; to do this at a diminishing rate of interest, and at last, perhaps, even to exchange their capital for terminable annuities. In this or some such mode, the existing accumulations of capital might honestly, and by a kind of spontaneous process, become in the end the joint property of all who participate in their productive employment: a transformation which, thus effected, (and assuming of course that both sexes participate equally in the rights and in the government of the association)∗ would be the nearest approach to social justice, and the most beneficial ordering of industrial affairs for the universal good, which it is possible at present to foresee.

1 § 7. I agree, then with the Socialist writers in their conception of the form which industrial operations tend to assume in the advance of improvement; and I entirely share their opinion that the time is ripe for commencing this transformation, and that it should by all just and effectual means be aided and encouraged. But while I agree and sympathize with Socialists in this practical portion of their aims, I utterly dissent from the most conspicuous and vehement part of their teaching, their declamations against competition. With moral conceptions in many respects far ahead of the existing arrangements of society, they have in general very confused and erroneous notions of its actual working; and one of their greatest errors, as I conceive, is to charge upon competition all the economical evils which at present exist. They forget that wherever competition is not, monopoly is; and that monopoly, in all its forms, is the taxation of the industrious for the support of indolence, if not of plunder. They forget, too, that with the exception of competition among labourers, all other competition is for the benefit of the labourers, by cheapening the articles they consume; that competition even in the labour market is a source not of low but of high wages, wherever the competition for labour exceeds the competition of labour, as in America, in the colonies, and in the skilled trades; and never could be a cause of low wages, save by the overstocking of the labour market through the too great numbers of the labourers' families; while, if the supply of labourers is excessive, not even Socialism can prevent their remuneration from being low. Besides, if association were universal, there would be no competition between labourer and labourer; and that between association and association would be for the benefit of the consumers, that is, of the associations; of the industrious classes generally.

I do not pretend that there are no inconveniences in competition, or that the moral objections urged against it by Socialist writers, as a source of jealousy and hostility among those engaged in the same occupation, are altogether groundless. But if competition has its evils, it prevents greater evils. As M. Feugueray well says,∗ “The deepest root of the evils and iniquities which fill the industrial world, is not competition, but the subjection of labour to capital, and the enormous share which the possessors of the instruments of industry are able to take from the produce.... If competition has great power for evil, it is no less fertile of good, especially in what regards the development of the individual faculties, and the success of innovations.” It is the common error of Socialists to overlook the natural indolence of mankind; their tendency to be passive, to be the slaves of habit, to persist indefinitely in a course once chosen. Let them once attain any state of existence which they consider tolerable, and the danger to be apprehended is that they will thenceforth stagnate; will not exert themselves to improve, and by letting their faculties rust, will lose even the energy required to preserve them from deterioration. Competition may not be the best conceivable stimulus, but it is at present a necessary one, and no one can foresee the time when it will not be indispensable to progress. Even confining ourselves to the industrial department, in which, more than in any other, the majority may be supposed to be competent judges of improvements; it would be difficult to induce the general assembly of an association to submit to the trouble and inconvenience of altering their habits by adopting some new and promising invention, unless their knowledge of the existence of rival associations made them apprehend that what they would not consent to do, others would, and that they would be left behind in the race.

Instead of looking upon competition as the baneful and anti-social principle which it is held to be by the generality of Socialists, I conceive that, even in the present state of society and industry, every restriction of it is an evil, and every extension of it, even if for the time injuriously affecting some class of labourers, is always an ultimate good. To be protected against competition is to be protected in idleness, in mental dulness; to be saved the necessity of being as active and as intelligent as other people; and if it is also to be protected against being underbid for employment by a less highly paid class of labourers, this is only where old custom, or local and partial monopoly, has placed some particular class of artisans in a privileged position as compared with the rest; and the time has come when the interest of universal improvement is no longer promoted by prolonging the privileges of a few. If the slop-sellers and others 1 of their class have lowered the wages of tailors, and some other artisans, by making them an affair of competition instead of custom, so much the better in the end. What is now required is not to bolster up old customs, whereby limited classes of labouring people obtain partial gains which interest them in keeping up the present organization of society, but to introduce new general practices beneficial to all; and there is reason to rejoice at whatever makes the privileged classes of skilled artisans feel that they have the same interests, and depend for their remuneration on the same general causes, and must resort for the improvement of their condition to the same remedies, as the less fortunately circumstanced and comparatively helpless multitude.1

BOOK V: ON THE INFLUENCE OF GOVERNMENT

Book V, Chapter I: Of the functions of government in general

CHAPTER I: of the functions of government in general

§ 1. One of the most disputed questions both in political science and in practical statesmanship at this particular period relates to the proper limits of the functions and agency of governments. At other times it has been a subject of controversy how governments should be constituted, and according to what principles and rules they should exercise their authority; but it is now almost equally a question to what departments of human affairs that authority should extend. And when the tide sets so strongly towards changes in government and legislation, as a means of improving the condition of mankind, this discussion is more likely to increase than to diminish in interest. On the one hand, impatient reformers, thinking it easier and shorter to get possession of the government than of the intellects and dispositions of the public, are under a constant temptation to stretch the province of government beyond due bounds: while, on the other, mankind have been so much accustomed by their rulers to interference for purposes other than the public good, or under an erroneous conception of what that good requires, and so many rash proposals are made by sincere lovers of improvement, for attempting, by compulsory regulation, the attainment of objects which can only be effectually or only usefully compassed by opinion and discussion, that there has grown up a spirit of resistance in limine to the interference of government, merely as such, and a disposition to restrict its sphere of action within the narrowest bounds. From differences in the historical development of different nations, not necessary to be here dwelt upon, the former excess, that of exaggerating the province of government, prevails most, both in theory and in practice, among the Continental nations, while in England the contrary spirit has hitherto been predominant.

The general principles of the question, in so far as it is a question of principle, I shall make an attempt to determine in a later chapter of this Book: after first considering the effects produced by the conduct of government in the exercise of the functions universally acknowledged to belong to it. For this purpose, there must be a specification of the functions which are either inseparable from the idea of a government, or are exercised habitually and without objection by all governments; as distinguished from those respecting which it has been considered questionable whether governments should exercise them or not. The former may be termed the necessary, the latter the optional, functions of government. 1 By the term optional it is not meant to imply, that it can ever be a matter of indifference, or of arbitrary choice, whether the government should or should not take upon itself the functions in question; but only that the expediency of its exercising them does not amount to necessity, and is a subject on which diversity of opinion does or may exist.

§ 2. In attempting to enumerate the necessary functions of government, we find them to be considerably more multifarious than most people are at first aware of, and not capable of being circumscribed by those very definite lines of demarcation, which, in the inconsiderateness of popular discussion, it is often attempted to draw round them. We sometimes, for example, hear it said that governments ought to confine themselves to affording protection against force and fraud: that, these two things apart, people should be free agents, able to take care of themselves, and that so long as a person practises no violence or deception, to the injury of others in person or property, 2 legislatures and governments are in no way called on to concern themselves about him. But why should people be protected by their government, that is, by their own collective strength, against violence and fraud, and not against other evils, except that the expediency is more obvious? If nothing but what people cannot possibly do for themselves, can be fit to be done for them by government, people might be required to protect themselves by their skill and courage even against force, or to beg or buy protection against it, as they actually do where the government is not capable of protecting them: and against fraud every one has the protection of his own wits. But without further anticipating the discussion of principles, it is sufficient on the present occasion to consider facts.

Under which of these heads, the repression of force or of fraud, are we to place the operation, for example, of the laws of inheritance? Some such laws must exist in all societies. It may be said, perhaps, that in this matter government has merely to give effect to the disposition which an individual makes of his own property by will. This, however, is at least extremely disputable; there is probably no country by whose laws the power of testamentary disposition is perfectly absolute. And suppose the very common case of there being no will: does not the law, that is, the government, decide on principles of general expediency, who shall take the succession? and in case the successor is in any manner incompetent, does it not appoint persons, frequently officers of its own, to collect the property and apply it to his benefit? There are many other cases in which the government undertakes the administration of property, because the public interest, or perhaps only that of the particular persons concerned, is thought to require it. This is often done in case of litigated property; and in cases of judicially declared insolvency. It has never been contended that in doing these things, a government exceeds its province.

Nor is the function of the law in defining property itself so simple a thing as may be supposed. It may be imagined, perhaps, that the law has only to declare and protect the right of every one to what he has himself produced, or acquired by the voluntary consent, fairly obtained, of those who produced it. But is there nothing recognized as property except what has been produced? Is there not the earth itself, its forests and waters, and all other natural riches, above and below the surface? These are the inheritance of the human race, and there must be regulations for the common enjoyment of it. What rights, and under what conditions, a person shall be allowed to exercise over any portion of this common inheritance cannot be left undecided. No function of government is less optional than the regulation of these things, or more completely involved in the idea of civilized society.

Again, the legitimacy is conceded of repressing violence or treachery; but under which of these heads are we to place the obligation imposed on people to perform their contracts? Nonperformance does not necessarily imply fraud; the person who entered into the contract may have sincerely intended to fulfil it: and the term fraud, which can scarcely admit of being extended even to the case of voluntary breach of contract when no deception was practised, is certainly not applicable when the omission to perform is a case of negligence. Is it no part of the duty of governments to enforce contracts? Here the doctrine of non-interference would no doubt be stretched a little, and it would be said that enforcing contracts is not regulating the affairs of individuals at the pleasure of government, but giving effect to their own expressed desire. Let us acquiesce in this enlargement of the restrictive theory, and take it for what it is worth. But governments do not limit their concern with contracts to a simple enforcement. They take upon themselves to determine what contracts are fit to be enforced. It is not enough that one person, not being either cheated or compelled, makes a promise to another. There are promises by which it is not for the public good that persons should have the power of binding themselves. To say nothing of engagements to do something contrary to law, there are engagements which the law refuses to enforce, for reasons connected with the interest of the promiser, or with the general policy of the state. A contract by which a person sells himself to another as a slave would be declared void by the tribunals of this and of most other European countries. There are few nations whose laws enforce a contract for what is looked upon as prostitution, or any matrimonial engagement of which the conditions vary in any respect from those which the law has thought fit to prescribe. But when once it is admitted that there are any engagements which for reasons of expediency the law ought not to enforce, the same question is necessarily opened with respect to all engagements. Whether, for example, the law should enforce a contract to labour, when the wages are too low or the hours of work too severe: whether it should enforce a contract by which a person binds himself to remain, for more than a very limited period, in the service of a given individual: whether a contract of marriage, entered into for life, should continue to be enforced against the deliberate will of the persons, or of either of the persons, who entered into it. Every question which can possibly arise as to the policy of contracts, and of the relations which they establish among human beings, is a question for the legislator; and one which he cannot escape from considering, and in some way or other deciding.

Again, the prevention and suppression of force and fraud afford appropriate employment for soldiers, policemen, and criminal judges; but there are also civil tribunals. The punishment of wrong is one business of an administration of justice, but the decision of disputes is another. Innumerable disputes arise between persons, without mala fides on either side, through misconception of their legal rights, or from not being agreed about the facts, on the proof of which those rights are legally dependent. Is it not for the general interest that the State should appoint persons to clear up these uncertainties and terminate these disputes? It cannot be said to be a case of absolute necessity. People might appoint an arbitrator, and engage to submit to his decision; and they do so where there are no courts of justice, or where the courts are not trusted, or where their delays and expenses, or the irrationality of their rules of evidence, deter people from resorting to them. Still, it is universally thought right that the State should establish civil tribunals; and if their defects often drive people to have recourse to substitutes, even then the power held in reserve of carrying the case before a legally constituted court, gives to the substitutes their principal efficacy.

Not only does the State undertake to decide disputes, it takes precautions beforehand that disputes may not arise. The laws of most countries lay down rules for determining many things, not because it is of much consequence in what way they are determined, but in order that they may be determined somehow, and there may be no question on the subject. The law prescribes forms of words for many kinds of contract, in order that no dispute or misunderstanding may arise about their meaning: it makes provision that if a dispute does arise, evidence shall be procurable for deciding it, by requiring that the document be attested by witnesses and executed with certain formalities. The law preserves authentic evidence of facts to which legal consequences are attached, by keeping a registry of such facts; as of births, deaths, and marriages, of wills and contracts, and of judicial proceedings. In doing these things, it has never been alleged that government oversteps the proper limits of its functions.

Again, however wide a scope we may allow to the doctrine that individuals are the proper guardians of their own interests, and that government owes nothing to them but to save them from being interfered with by other people, the doctrine can never be applicable to any persons but those who are capable of acting in their own behalf. The individual may be an infant, or a lunatic, or fallen into imbecility. The law surely must look after the interests of such persons. It does not necessarily do this through officers of its own. It often devolves the trust upon some relative or connexion. But in doing so is its duty ended? Can it make over the interests of one person to the control of another, and be excused from supervision, or from holding the person thus trusted responsible for the discharge of the trust?

There is a multitude of cases in which governments, with general approbation, assume powers and execute functions for which no reason can be assigned except the simple one, that they conduce to general convenience. We may take as an example, the function (which is a monopoly too) of coining money. This is assumed for no more recondite purpose than that of saving to individuals the trouble, delay, and expense of weighing and assaying. No one, however, even of those most jealous of state interference, has objected to this as an improper exercise of the powers of government. Prescribing a set of standard weights and measures is another instance. Paving, lighting, and cleansing the streets and thoroughfares, is another; whether done by the general government, or, as is more usual, and generally more advisable, by a municipal authority. Making or improving harbours, building lighthouses, making surveys in order to have accurate maps and charts, raising dykes to keep the sea out, and embankments to keep rivers in, are cases in point.

Examples might be indefinitely multiplied without intruding on any disputed ground. But enough has been said to show that the admitted functions of government embrace a much wider field than can easily be included within the ring-fence of any restrictive definition, and that it is hardly possible to find any ground of justification common to them all, except the comprehensive one of general expediency; nor to limit the interference of government by any universal rule, save the simple and vague one, that it should never be admitted but when the case of expediency is strong.

§ 3. Some observations, however, may be usefully bestowed on the nature of the considerations on which the question of government interference is most likely to turn, and on the mode of estimating the comparative magnitude of the expediencies involved. This will form the last of the three parts, into which our discussion of the principles and effects of government interference may conveniently be divided. The following will be our division of the subject.

We shall first consider the economical effects arising from the manner in which governments perform their necessary and acknowledged functions.

We shall then pass to certain governmental interferences of what I have termed the optional kind (i.e. overstepping the boundaries of the universally acknowledged functions) which have heretofore taken place, and in some cases still take place, under the influence of false general theories.

It will lastly remain to inquire whether, independently of any false theory, and consistently with a correct view of the laws which regulate human affairs, there be any cases of the optional class in which governmental interference is really advisable, and what are those cases.

The first of these divisions is of an extremely miscellaneous character: since the necessary functions of government, and those which are so manifestly expedient that they have never or very rarely been objected to, are, as already pointed out, too various to be brought under any very simple classification. Those, however, which are of principal importance, which alone it is necessary here to consider, may be reduced to the following general heads.

First, the means adopted by governments to raise the revenue which is the condition of their existence.

Secondly, the nature of the laws which they prescribe on the two great subjects of Property and Contracts.

Thirdly, the excellences or defects of the system of means by which they enforce generally the execution of their laws, namely, their judicature and police.

We commence with the first head, that is, with the theory of Taxation.

Book V, Chapter II: On the general principles of taxation

CHAPTER II: on the general principles of taxation

§ 1. The qualities desirable, economically speaking, in a system of taxation, have been embodied by Adam Smith in four maxims or principles, which, having been generally concurred by subsequent writers, may be said to have become classical, and this chapter cannot be better commenced than by quoting them.∗

“1. The subjects of every state ought to contribute to the support of the government, as nearly as possible in proportion to their respective abilities: that is, in proportion to the revenue which they respectively enjoy under the protection of the state. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation.

“2. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person. Where it is otherwise, every person subject to the tax is put more or less in the power of the tax-gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of such aggravation, some present or perquisite to himself. The uncertainty of taxation encourages the insolence and favours the corruption of an order of men who are naturally unpopular, even when they are neither insolent nor corrupt. The certainty of what each individual ought to pay is, in taxation, a matter of so great importance, that a very considerable degree of inequality, it appears, I believe, from the experience of all nations, is not near so great an evil, as a very small degree of uncertainty.

“3. Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it. A tax upon the rent of land or of houses, payable at the same term at which such rents are usually paid, is levied at a time when it is most likely to be convenient for the contributor to pay; or when he is most likely to have wherewithal to pay. Taxes upon such consumable goods as are articles of luxury are all finally paid by the consumer, and generally in a manner that is very convenient to him. He pays them by little and little, as he has occasion to buy the goods. As he is at liberty, too, either to buy or not to buy, as he pleases, it must be his own fault if he ever suffers any considerable inconvenience from such taxes.

“4. Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state. A tax may either take out or keep out of the pockets of the people a great deal more than it brings into the public treasury, in the four following ways. First, the levying of it may require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people.” Secondly, it may divert a portion of the labour and capital of the community from a more to a less productive employment. “Thirdly, by the forfeitures and other penalties which those unfortunate individuals incur who attempt unsuccessfully to evade the tax, it may frequently ruin them, and thereby put an end to the benefit which the community might have derived from the employment of their capitals. An injudicious tax offers a great temptation to smuggling. Fourthly, by subjecting the people to the frequent visits and the odious examination of the tax-gatherers, it may expose them to much unnecessary trouble, vexation, and oppression:” to which may be added, that the restrictive regulations to which trades and manufactures are often subjected to prevent evasion of a tax, are not only in themselves troublesome and expensive, but often oppose insuperable obstacles to making improvements in the processes.

The last three of these four maxims require little other explanation or illustration than is contained in the passage itself. How far any given tax conforms to, or conflicts with them, is a matter to be considered in the discussion of particular taxes. But the first of the four points, equality of taxation, requires to be more fully examined, being a thing often imperfectly understood, and on which many false notions have become to a certain degree accredited, through the absence of any definite principles of judgment in the popular mind.

§ 2. For what reason ought equality to be the rule in matters of taxation? For the reason that it ought to be so in all affairs of government. As a government ought to make no distinction of persons or classes in the strength of their claims on it, whatever sacrifices it requires from them should be made to bear as nearly as possible with the same pressure upon all, which, it must be observed, is the mode by which least sacrifice is occasioned on the whole. If any one bears less than his fair share of the burthen, some other person must suffer more than his share, and the alleviation to the one is not, caeteris paribus,so great a good to him, as the increased pressure upon the other is an evil. Equality of taxation, therefore, as a maxim of politics, means equality of sacrifice. It means apportioning the contribution of each person towards the expenses of government so that he shall feel neither more nor less inconvenience from his share of the payment than every other person experiences from his. This standard, like other standards of perfection, cannot be completely realized; but the first object in every practical discussion should be to know what perfection is.

There are persons, however, who are not content with the general principles of justice as a basis to ground a rule of finance upon, but must have something, as they think, more specifically appropriate to the subject. What best pleases them is, to regard the taxes paid by each member of the community as an equivalent for value received, in the shape of service to himself; and they prefer to rest the justice of making each contribute in proportion to his means, upon the ground, that he who has twice as much property to be protected, receives, on an accurate calculation, twice as much protection, and ought, on the principles of bargain and sale, to pay twice as much for it. Since, however, the assumption that government exists solely for the protection of property, is not one to be deliberately adhered to; some consistent adherents of the quid pro quo principle go on to observe, that protection being required for person as well as property, and everybody's person receiving the same amount of protection, a poll-tax of a fixed sum per head is a proper equivalent for this part of the benefits of government, while the remaining part, protection to property, should be paid for in proportion to property. There is in this adjustment a false air of nice adaptation, very acceptable to some minds. But in the first place, it is not admissible that the protection of persons and that of property are the sole purposes of government. The ends of government are as comprehensive as those of the social union. They consist of all the good, and all the immunity from evil, which the existence of government can be made either directly or indirectly to bestow. In the second place, the practice of setting definite values on things essentially indefinite, and making them a ground of practical conclusions, is peculiarly fertile in false views of social questions. It cannot be admitted, that to be protected in the ownership of ten times as much property, is to be ten times as much protected. Neither can it be truly said that the protection of 1000l. a year costs the state ten times as much as that of 100l. a year, rather than twice as much, or exactly as much. The same judges, soldiers, and sailors who protect the one protect the other, and the larger income does not necessarily, though it may sometimes, require even more policemen. Whether the labour and expense of the protection, or the feelings of the protected person, or any other definite thing be made the standard, there is no such proportion as the one supposed, nor any other definable proportion. If we wanted to estimate the degrees of benefit which different persons derive from the protection of government, we should have to consider who would suffer most if that protection were withdrawn: to which question if any answer could be made, it must be, that those would suffer most who were weakest in mind or body, either by nature or by position. Indeed, such persons would almost infallibly be slaves. If there were any justice, therefore, in the theory of justice now under consideration, those who are least capable of helping or defending themselves, being those to whom the protection of government is the most indispensable, ought to pay the greatest share of its price: the reverse of the true idea of distributive justice, which consists not in imitating but in redressing the inequalities and wrongs of nature.

Government must be regarded as so pre-eminently a concern of all, that to determine who are most interested in it is of no real importance. If a person or class of persons receive so small a share of the benefit as makes it necessary to raise the question, there is something else than taxation which is amiss, and the thing to be done is to remedy the defect, instead of recognizing it and making it a ground for demanding less taxes. As, in a case of voluntary subscription for a purpose in which all are interested, all are thought to have done their part fairly when each has contributed according to his means, that is, has made an equal sacrifice for the common object; in like manner should this be the principle of compulsory contributions: and it is superfluous to look for a more ingenious or recondite ground to rest the principle upon.

§ 3. Setting out, then, from the maxim that equal sacrifices ought to be demanded from all, we have next to inquire whether this is in fact done by making each contribute the same percentage on his pecuniary means. Many persons maintain the negative, saying that a tenth part taken from a small income is a heavier burthen than the same fraction deducted from one much larger: and on this is grounded the very popular scheme of what is called a graduated property tax, viz. an income tax in which the percentage rises with the amount of the income.

On the best consideration I am able to give to this question, it appears to me that the portion of truth which the doctrine contains, arises principally from the difference between a tax which can be saved from luxuries, and one which trenches, in ever so small a degree, upon the necessaries of life. To take a thousand a year from the possessor of ten thousand, would not deprive him of anything really conducive either to the support or to the comfort of existence; and if such would be the effect of taking five pounds from one whose income is fifty, the sacrifice required from the last is not only greater than, but entirely incommensurable with, that imposed upon the first. The mode of adjusting these inequalities of pressure, which seems to be the most equitable, is that recommended by Bentham, of leaving a certain minimum of income, sufficient to provide the necessaries of life, untaxed. Suppose 50l. a year to be sufficient to provide the number of persons ordinarily supported from a single income with the requisites of life and health, and with protection against habitual bodily suffering, but not with any indulgence. This then should be made the minimum, and incomes exceeding it should pay taxes not upon their whole amount, but upon the surplus. If the tax be ten per cent., an income of 60l. should be considered as a net income of 10l., and charged with 1l. a year, while an income of 1000l. should be charged as one of 950l. Each would then pay a fixed proportion, not of his whole means, but of his superfluities.∗ An income not exceeding 50l. should not be taxed at all, either directly or by taxes on necessaries; for as by supposition this is the smallest income which labour ought to be able to command, the government ought not to be a party to making it smaller. This arrangement, however, would constitute a reason, in addition to others which might be stated, for maintaining taxes on articles of luxury consumed by the poor. The immunity extended to the income required for necessaries, should depend on its being actually expended for that purpose; and the poor who, not having more than enough for necessaries, divert any part of it to indulgences, should like other people contribute their quota out of those indulgences to the expenses of the state.

The exemption in favour of the smaller incomes should not, I think, be stretched further than to the amount of income needful for life, health, and immunity from bodily pain. If 50l. a year is sufficient (which may be doubted) for these purposes,1 an income of 100l. a year would, as it seems to me, obtain al1 the relief it is entitled to, compared with one of 1000l., by being taxed only on 50l. of its amount. It may be said, indeed, that to take 100l. from 1000l. (even giving back five pounds) is a heavier impost than 1000l. taken from 10,000l. (giving back the same five pounds). But this doctrine seems to me too disputable altogether, and even if true at all, not true to a sufficient extent, to be made the foundation of any rule of taxation. Whether the person with 10,000l. a year cares less for 1000l. than the person with only 1000l. a year cares for 100l., and if so, how much less, does not appear to me capable of being decided with the degree of certainty on which a legislator or a financier ought to act.2

Some indeed contend that the rule of proportional taxation bears harder upon the moderate than upon the large incomes, because the same proportional payment has more tendency in the former case than in the latter, to reduce the payer to a lower grade of social rank. The fact appears to me more than questionable. But even admitting it, I object to its being considered incumbent on government to shape its course by such considerations, or to recognize the notion that social importance is or can be determined by amount of expenditure. Government ought to set an example of rating all things at their true value, and riches, therefore, at the worth, for comfort or pleasure, of the things which they will buy: and ought not to sanction the vulgarity of prizing them for the pitiful vanity of being known to possess them, or the paltry shame of being suspected to be without them, the presiding motives of three-fourths of the expenditure of the middle classes. The sacrifices of real comfort or indulgence which government requires, it is bound to apportion among all persons with as much equality as possible; but their sacrifices of the imaginary dignity dependent on expense, it may spare itself the trouble of estimating.

Both in England and on the Continent a graduated property tax (l'impôt progressif) has been advocated, on the avowed ground that the state should use the instrument of taxation as a means of mitigating the inequalities of wealth. I am as desirous as any one that means should be taken to diminish those inequalities, but not so as to relieve the prodigal at the expense of the prudent.1 To tax the larger incomes at a higher percentage than the smaller is to lay a tax on industry and economy; to impose a penalty on people for having worked harder and saved more than their neighbours. It is not the fortunes which are earned, but those which are unearned, that it is for the public good to place under limitation.2 A just and wise legislation would abstain from holding out motives for dissipating rather than saving the earnings of honest exertion.3 Its impartiality between competitors would consist in endeavouring that they should all start fair, and not in hanging a weight upon the swift to diminish the distance between them and the slow.4 Many, indeed, fail with greater efforts than those with which others succeed, not from difference of merits, but difference of opportunities; but if all were done which it would be in the power of a good government to do, by instruction and by legislation, to diminish this inequality of opportunities, the differences of fortune arising from people's own earnings could not justly give umbrage.5 With respect to the large fortunes acquired by gift or inheritance, the power of bequeathing is1 one of those privileges of property which are fit subjects for regulation on grounds of general expediency; and I have already suggested,∗ as a possible mode2 of restraining the accumulation of large fortunes in the hands of those who have not earned them by exertion, a limitation of the amount which any one person should be permitted to acquire by gift, bequest, or inheritance. Apart from this, and from the proposal of Bentham (also discussed in a former chapter) that collateral inheritance ab intestato should cease, and the property escheat to the state, I conceive that inheritances and legacies, exceeding a certain amount, are highly proper subjects for taxation: and that the revenue from them should be as great as it can be made without giving rise to evasions, by donation inter vivos or concealment of property, such as it would be impossible adequately to check. The principle of graduation (as it is called,) that is, of levying a larger percentage on a larger sum, though its application to general taxation would be in my opinion objectionable,3 seems to me both just and expedient4 as applied to legacy and inheritance duties.5

The objection to a graduated property tax applies in an aggravated degree to the proposition of an exclusive tax on what is called “realized property,” that is, property not forming a part of any capital engaged in business, or rather in business under the superintendence of the owner: as land, the public funds, money lent on mortgage, and shares (I presume) in joint-stock companies. Except the proposal of applying a sponge to the national debt, no such palpable violation of common honesty has found sufficient support in this country, during the present generation, to be regarded as within the domain of discussion. It has not the palliation of a graduated property tax, that of laying the burthen on those best able to bear it; for “realized property” includes the far larger portion of the provision made for those who are unable to work, and consists, in great part, of extremely small fractions. I can hardly conceive a more shameless pretension, than that the major part of the property of the country, that of merchants, manufacturers, farmers, and shopkeepers, should be exempted from its share of taxation; that these classes should only begin to pay their proportion after retiring from business, and if they never retire should be excused from it altogether. But even this does not give an adequate idea of the injustice of the proposition. The burthen thus exclusively thrown on the owners of the smaller portion of the wealth of the community, would not even be a burthen on that class of persons in perpetual succession, but would fall exclusively on those who happened to compose it when the tax was laid on. As land and those particular securities would thenceforth yield a smaller net income, relatively to the general interest of capital and to the profits of trade; the balance would rectify itself by a permanent depreciation of those kinds of property. Future buyers would acquire land and securities at a reduction of price, equivalent to the peculiar tax, which tax they would, therefore, escape from paying; while the original possessors would remain burthened with it even after parting with the property, since they would have sold their land or securities at a loss of value equivalent to the fee-simple of the tax. Its imposition would thus be tantamount to the confiscation for public uses of a percentage of their property, equal to the percentage laid on their income by the tax. That such a proposition should find any favour, is a striking instance of the want of conscience in matters of taxation, resulting from the absence of any fixed principles in the public mind, and of any indication of a sense of justice on the subject in the general conduct of governments. Should the scheme ever enlist a large party in its support, the fact would indicate a laxity of pecuniary integrity in national affairs, scarcely inferior to American repudiation.

§ 4. Whether the profits of trade may not rightfully be taxed at a lower rate than incomes derived from interest or rent, is part of the more comprehensive question, so often mooted on the occasion of the present income tax, whether life incomes should be subjected to the same rate of taxation as perpetual incomes: whether salaries, for example, or annuities, or the gains of professions, should pay the same percentage as the income from inheritable property.

The existing tax treats all kinds of incomes exactly alike, taking its sevenpence (now [1871] fourpence) in the pound, as well from the person whose income dies with him, as from the landholder, stockholder, or mortgagee, who can transmit his fortune undiminished to his descendants. This is a visible injustice: yet it does not arithmetically violate the rule that taxation ought to be in proportion to means. When it is said that a temporary income ought to be taxed less than a permanent one, the reply is irresistible, that it is taxed less; for the income which lasts only ten years pays the tax only ten years, while that which lasts for ever pays for ever. 1 On this point some financial reformers are guilty of a great fallacy. They contend that incomes ought to be assessed to the income tax not in proportion to their annual amount, but to their capitalized value: that, for example, if the value of a perpetual annuity of 100l. is 3000l., and a life annuity of the same amount, being worth only half the number of years' purchase, could only be sold for 1500l., the perpetual income should pay twice as much per cent income tax as the terminable income; if the one pays 10l. a year the other should pay only 5l. But in this argument there is the obvious oversight, that it values the incomes by one standard and the payments by another; it capitalizes the incomes, but forgets to capitalize the payments. An annuity worth 3000l. ought, it is alleged, to be taxed twice as highly as one which is only worth 1500l., and no assertion can be more unquestionable; but it is forgotten that the income worth 3000l. pays to the supposed income tax 10l. a year in perpetuity, which is equivalent, by supposition, to 300l., while the terminable income pays the same 10l. only during the life of its owner, which on the same calculation is a value of 150l., and could actually be bought for that sum. Already, therefore, the income which is only half as valuable, pays only half as much to the tax; and if in addition to this its annual quota were reduced from 10l. to 5l., it would pay, not half, but a fourth part only of the payment demanded from the perpetual income. To make it just that the one income should pay only half as much per annum as the other, it would be necessary that it should pay that half for the same period, that is, in perpetuity.

1 The rule of payment which this school of financial reformers contend for, would be very proper if the tax were only to be levied once, to meet some national emergency. On the principle of requiring from all payers an equal sacrifice, every person who had anything belonging to him, reversioners included, would be called on for a payment proportioned to the present value of his property. I wonder it does not occur to the reformers in question, that precisely because this principle of assessment would be just in the case of a payment made once for all, it cannot possibly be just for a permanent tax. When each pays only once, one person pays no oftener than another; and the proportion which would be just in that case, cannot also be just if one person has to make the payment only once, and the other several times. This, however, is the type of the case which actually occurs. The permanent incomes pay the tax as much oftener than the temporary ones, as a perpetuity exceeds the certain or uncertain length of time which forms the duration of the income for life or years.

2 All attempts to establish a claim in favour of terminable incomes on numerical grounds—to make out, in short, that a proportional tax is not a proportional tax—are manifestly absurd. The claim does not rest on grounds of arithmetic, but of human wants and feelings. 3 It is not because the temporary annuitant has smaller means, but because he has greater necessities, that he ought to be assessed at a lower rate.

In spite of the nominal equality of income, A, an annuitant of 1000l. a year, cannot so well afford to pay 100l. out of it, as B who derives the same annual sum from heritable property; A having usually a demand on his income which B has not, namely, to provide by saving for children or others; to which, in the case of salaries or professional gains, must generally be added a provision for his own later years; while B may expend his whole income without injury to his old age, and still have it all to bestow on others after his death. If A, in order to meet these exigencies, must lay by 300l. of his income, to take 100l. from him as income tax is to take 100l. from 700l., since it must be retrenched from that part only of his means which he can afford to spend on his own consumption. Were he to throw it rateably on what he spends and on what he saves, abating 70l. from his consumption and 30l. from his annual saving, then indeed his immediate sacrifice would be proportionately the same as B's: but then his children or his old age would be worse provided for in consequence of the tax. The capital sum which would be accumulated for them would be one-tenth less, and on the reduced income afforded by this reduced capital, they would be a second time charged with income tax; while B's heirs would only be charged once.

The principle, therefore, of equality of taxation, interpreted in its only just sense, equality of sacrifice, requires that a person who has no means of providing for old age, or for those in whom he is interested, except by saving from income, should have the tax remitted on all that part of his income which is really and bonâ fide applied to that purpose.

1 If, indeed, reliance could be placed on the conscience of the contributors, or sufficient security taken for the correctness of their statements by collateral precautions, the proper mode of assessing an income tax would be to tax only the part of income devoted to expenditure, exempting that which is saved. For when saved and invested (and all savings, speaking generally, are invested) it thenceforth pays income tax on the interest or profit which it brings, notwithstanding that it has already been taxed on the principal. Unless, therefore, savings are exempted from income tax, the contributors are twice taxed on what they save, and only once on what they spend. A person who spends all he receives, pays 7d. in the pound, or say three per cent, to the tax, and no more; but if he saves part of the year's income and buys stock, then in addition to the three per cent which he has paid on the principal, and which diminishes the interest in the same ratio, he pays three per cent annually on the interest itself, which is equivalent to an immediate payment of a second three per cent on the principal. So that while unproductive expenditure pays only three per cent, savings pay six per cent: or more correctly, three per cent on the whole, and another three per cent on the remaining ninety-seven. The difference thus created to the disadvantage of prudence and economy, is not only impolitic but unjust. To tax the sum invested, and afterwards to tax also the proceeds of the investment, is to tax the same portion of the contributor's means twice over. The principal and the interest cannot both together form part of his resources; they are the same portion twice counted: if he has the interest, it is because he abstains from using the principal; if he spends the principal, he does not receive the interest. Yet because he can do either of the two, he is taxed as if he could do both, and could have the benefit of the saving and that of the spending, concurrently with one another.

1 It has been urged as an objection to exempting savings from taxation, that the law ought not to disturb, by artificial interference, the natural competition between the motives for saving and those for spending. But we have seen that the law disturbs this natural competition when it taxes savings, not when it spares them; for as the savings pay at any rate the full tax as soon as they are invested, their exemption from payment in the earlier stage is necessary to prevent them from paying twice, while money spent in unproductive consumption pays only once. It has been further objected, that since the rich have the greatest means of saving, any privilege given to savings is an advantage bestowed on the rich at the expense of the poor. I answer, that it is bestowed on them only in proportion as they abdicate the personal use of their riches; in proportion as they divert their income from the supply of their own wants, to a productive investment, through which, instead of being consumed by themselves, it is distributed in wages among the poor. If this be favouring the rich, I should like to have it pointed out, what mode of assessing taxation can deserve the name of favouring the poor.

2 No income tax is really just from which savings are not exempted; and no income tax ought to be voted without that provision, if the form of the returns, and the nature of the evidence required, could be so arranged as to prevent the exemption from being taken fraudulent advantage of, by saving with one hand and getting into debt with the other, or by spending in the following year what had been passed tax-free as saving in the year preceding. If this difficulty could be surmounted, the difficulties and complexities arising from the comparative claims of temporary and permanent incomes, would disappear; for, since temporary incomes have no just claim to lighter taxation than permanent incomes, except in so far as their possessors are more called upon to save, the exemption of what they do save would fully satisfy the claim. But if no plan can be devised for the exemption of actual savings, sufficiently free from liability to fraud, it is necessary, as the next thing in point of justice, to take into account in assessing the tax, what the different classes of contributors ought to save. And there would probably be no other mode of doing this than the rough expedient of two different rates of assessment. There would be great difficulty in taking into account differences of duration between one terminable income and another; and in the most frequent case, that of incomes dependent on life, differences of age and health would constitute such extreme diversity as it would be impossible to take proper cognizance of. It would probably be necessary to be content with one uniform rate for all incomes of inheritance, and another uniform rate for all those which necessarily terminate with the life of the individual. In fixing the proportion between the two rates, there must inevitably be something arbitrary; perhaps a deduction of one-fourth in favour of life-incomes would be as little objectionable as any which could be made, it being thus assumed that one-fourth of a life-income is, on the average of all ages and states of health, a suitable proportion to be laid by as a provision for successors and for old age.∗

Of the net profits of persons in business, a part, as before observed, may be considered as interest on capital, and of a perpetual character, and the remaining part as remuneration for the skill and labour of superintendence. The surplus beyond interest depends on the life of the individual, and even on his continuance in business, and is entitled to the full amount of exemption allowed to terminable incomes. 1 It has also, I conceive, a just claim to a further amount of exemption in consideration of its precariousness. An income which some not unusual vicissitude may reduce to nothing, or even convert into a loss, is not the same thing to the feelings of the possessor as a permanent income of 1000l. a year, even though on an average of years it may yield 1000l. a year. If life-incomes were assessed at three-fourths of their amount, the profits of business, after deducting interest on capital, should not only be assessed at three-fourths, but should pay, on that assessment, a lower rate. Or perhaps the claims of justice in this respect might be sufficiently met by allowing the deduction of a fourth on the entire income, interest included.

These are the chief cases, of ordinary occurrence, in which any difficulty arises in interpreting the maxim of equality of taxation. The proper sense to be put upon it, as we have seen in the preceding example, is, that people should be taxed, not in proportion to what they have, but to what they can afford to spend. It is no objection to this principle that we cannot apply it consistently to all cases. A person with a life-income and precarious health, or who has many persons depending on his exertions, must, if he wishes to provide for them after his death, be more rigidly economical than one who has a life-income of equal amount, with a strong constitution, and few claims upon him; and if it be conceded that taxation cannot accommodate itself to these distinctions, it is argued that there is no use in attending to any distinctions, where the absolute amount of income is the same. But the difficulty of doing perfect justice is no reason against doing as much as we can. Though it may be a hardship to an annuitant whose life is only worth five years' purchase, to be allowed no greater abatement than is granted to one whose life is worth twenty, it is better for him even so, than if neither of them were allowed any abatement at all.1

§ 5. Before leaving the subject of Equality of Taxation, I must remark that there are cases in which exceptions may be made to it, consistently with that equal justice which is the groundwork of the rule. Suppose that there is a kind of income which constantly tends to increase, without any exertion or sacrifice on the part of the owners: those owners constituting a class in the community, whom the natural course of things progressively enriches, consistently with complete passiveness on their own part. In such a case it would be no violation of the principles on which private property is grounded, if the state should appropriate this increase of wealth, or part of it, as it arises. This would not properly be taking anything from anybody; it would merely be applying an accession of wealth, created by circumstances, to the benefit of society, instead of allowing it to become an unearned appendage to the riches of a particular class.

Now this is actually the case with rent. The ordinary progress of a society which increases in wealth, is at all times tending to augment the incomes of landlords; to give them both a greater amount and a greater proportion of the wealth of the community, independently of any trouble or outlay incurred by themselves. They grow richer, as it were in their sleep, without working, risking, or economizing. What claim have they, on the general principle of social justice, to this accession of riches? In what would they have been wronged if society had, from the beginning, reserved the right of taxing the spontaneous increase of rent, to the highest amount required by financial exigencies? I admit that it would be unjust to come upon each individual estate, and lay hold of the increase which might be found to have taken place in its rental; because there would be no means of distinguishing in individual cases, between an increase owing solely to the general circumstances of society, and one which was the effect of skill and expenditure on the part of the proprietor. The only admissible mode of proceeding would be by a general measure. The first step should be a valuation of all the land in the country. The present value of all land should be exempt from the tax; but after an interval had elapsed, during which society had increased in population and capital, a rough estimate might be made of the spontaneous increase which had accrued to rent since the valuation was made. Of this the average price of produce would be some criterion: if that had risen, it would be certain that rent had increased, and (as already shown) even in a greater ratio than the rise of price. On this and other data, an approximate estimate might be made, how much value had been added to the land of the country by natural causes; and in laying on a general land-tax, which for fear of miscalculation should be considerably within the amount thus indicated, there would be an assurance of not touching any increase of income which might be the result of capital expended or industry exerted by the proprietor.

But though there could be no question as to the justice of taxing the increase of rent, if society had avowedly reserved the right, has not society waived that right by not exercising it? In England, for example, have not all who bought land for the last century or more, given value not only for the existing income, but for the prospects of increase, under an implied assurance of being only taxed in the same proportion with other incomes? This objection, in so far as valid, has a different degree of validity in different countries; depending on the degree of desuetude into which society has allowed a right to fall, which, as no one can doubt, it once fully possessed. In most countries of Europe, the right to take by taxation, as exigency might require, an indefinite portion of the rent of land, has never been allowed to slumber. In several parts of the Continent, the land-tax forms a large proportion of the public revenues, and has always been confessedly liable to be raised or lowered without reference to other taxes. In these countries no one can pretend to have become the owner of land on the faith of never being called upon to pay an increased land-tax. In England the land-tax has not varied since the early part of the last century. The last act of the legislature in relation to its amount, was to diminish it; and though the subsequent increase in the rental of the country has been immense, not only from agriculture, but from the growth of towns and the increase of buildings, the ascendancy of landholders in the legislature has prevented any tax from being imposed, as it so justly might, upon the very large portion of this increase which was unearned, and, as it were, accidental. For the expectations thus raised, it appears to me that an amply sufficient allowance is made, if the whole increase of income which has accrued during this long period from a mere natural law, without exertion or sacrifice, is held sacred from any peculiar taxation. From the present date, or any subsequent time at which the legislature may think fit to assert the principle, I see no objection to declaring that the future increment of rent should be liable to special taxation; in doing which all injustice to the landlords would be obviated, if the present market-price of their land were secured to them; since that includes the present value of all future expectations. With reference to such a tax, perhaps a safer criterion than either a rise of rents or a rise of the price of corn, would be a general rise in the price of land. It would be easy to keep the tax within the amount which would reduce the market value of land below the original valuation: and up to that point, whatever the amount of the tax might be, no injustice would be done to the proprietors.1

§ 6. But whatever may be thought of the legitimacy of making the State a sharer in all future increase of rent from natural causes, the existing land-tax (which in this country unfortunately is very small) ought not to be regarded as a tax, but as a rent-charge in favour of the public; a portion of the rent, reserved from the beginning by the State, which has never belonged to or formed part of the income of the landlords, and should not therefore be counted to them as part of their taxation, so as to exempt them from their fair share of every other tax. As well might the tithe be regarded as a tax on the landlords: as well, in Bengal, where the State, though entitled to the whole rent of the land, gave away one-tenth of it to individuals, retaining the other nine-tenths, might those nine-tenths be considered as an unequal and unjust tax on the grantees of the tenth. That a person owns part of the rent, does not make the rest of it his just right, injuriously withheld from him. The landlords originally held their estates subject to feudal burthens, for which the present land-tax is an exceedingly small equivalent, and for their relief from which they should have been required to pay a much higher price. All who have bought land since the tax existed have bought it subject to the tax. There is not the smallest pretence for looking upon it as a payment exacted from the existing race of landlords.

These observations are applicable to a land-tax, only in so far as it is a peculiar tax, and not when it is merely a mode of levying from the landlords the equivalent of what is taken from other classes. In France, for example, there are [1848] peculiar taxes on other kinds of property and income (the mobilier and the patente); and supposing the land-tax to be not more than equivalent to these, there would be no ground for contending that the State had reserved to itself a rent-charge on the land. But wherever and in so far as income derived from land is prescriptively subject to a deduction for public purposes beyond the rate of taxation levied on other incomes, the surplus is not properly taxation, but a share of the property in the soil, reserved by the state. In this country there are no peculiar taxes on other classes, corresponding to, or intended to countervail, the land-tax. The whole of it, therefore, is not taxation, but a rent-charge, and is as if the state had retained, not a portion of the rent, but a portion of the land. It is no more a burthen on the landlord, than the share of one joint tenant is a burthen on the other. The landlords are entitled to no compensation for it, nor have they any claim to its being allowed for, as part of their taxes. Its continuance on the existing footing is no infringement of the principle of Equal Taxation.∗

We shall hereafter consider, in treating of Indirect Taxation, how far, and with what modifications, the rule of equality is applicable to that department.

§ 7. In addition to the preceding rules, another general rule of taxation is sometimes laid down, namely, that it should fall on income, and not on capital. That taxation should not encroach upon the amount of the national capital, is indeed of the greatest importance; but this encroachment, when it occurs, is not so much a consequence of any particular mode of taxation, as of its excessive amount. Over-taxation, carried to a sufficient extent, is quite capable of ruining the most industrious community, especially when it is in any degree arbitrary, so that the payer is never certain how much or how little he shall be allowed to keep; or when it is so laid on as to render industry and economy a bad calculation. But if these errors be avoided, and the amount of taxation be not greater than it is at present even in the most heavily taxed country of Europe, there is no danger lest it should deprive the country of a portion of its capital.

To provide that taxation shall fall entirely on income, and not at all on capital, is beyond the power of any system of fiscal arrangements. There is no tax which is not partly paid from what would otherwise have been saved; no tax, the amount of which, if remitted, would be wholly employed in increased expenditure, and no part whatever laid by as an addition to capital. All taxes, therefore, are in some sense partly paid out of capital; and in a poor country it is impossible to impose any tax which will not impede the increase of the national wealth. But in a country where capital abounds, and the spirit of accumulation is strong, this effect of taxation is scarcely felt. Capital having reached the stage in which, were it not for a perpetual succession of improvements in production, any further increase would soon be stopped—and having so strong a tendency even to outrun those improvements, that profits are only kept above the minimum by emigration of capital, or by a periodical sweep called a commercial crisis; to take from capital by taxation what emigration would remove, or a commercial crisis destroy, is only to do what either of those causes would have done, namely, to make a clear space for further saving.

I cannot, therefore, attach any importance, in a wealthy country, to the objection made against taxes on legacies and inheritances, that they are taxes on capital. It is perfectly true that they are so. As Ricardo observes, if 100l. are taken from any one in a tax on houses or on wine, he will probably save it, or a part of it, by living in a cheaper house, consuming less wine, or retrenching from some other of his expenses; but if the same sum be taken from him because he has received a legacy of 1000l., he considers the legacy as only 900l., and feels no more inducement than at any other time (probably feels rather less inducement) to economize in his expenditure. The tax, therefore, is wholly paid out of capital: and there are countries in which this would be a serious objection. But in the first place, the argument cannot apply to any country which has a national debt, and devotes any portion of revenue to paying it off; since the produce of the tax, thus applied, still remains capital, and is merely transferred from the tax-payer to the fundholder. But the objection is never applicable in a country which increases rapidly in wealth. The amount which would be derived, even from a very high legacy duty, in each year, is but a small fraction of the annual increase of capital in such a country; and its abstraction would but make room for saving to an equivalent amount: while the effect of not taking it, is to prevent that amount of saving, or cause the savings, when made, to be sent abroad for investment. A country which, like England, accumulates capital not only for itself, but for half the world, may be said to defray the whole of its public expenses from its overflowings; and its wealth is probably at this moment as great as if it had no taxes at all. What its taxes really do is, to subtract from its means, not of production, but of enjoyment; since whatever any one pays in taxes, he could, if it were not taken for that purpose, employ in indulging his ease, or in gratifying some want or taste which at present remains unsatisfied.

Book V, Chapter III: Of direct taxes

CHAPTER III: of direct taxes

§ 1. Taxes are either direct or indirect. A direct tax is one which is demanded from the very persons who, it is intended or desired, should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another: such as the excise or customs. The producer or importer of a commodity is called upon to pay a tax on it, not with the intention to levy a peculiar contribution upon him, but to tax through him the consumers of the commodity, from whom it is supposed that he will recover the amount by means of an advance in price.

Direct taxes are either on income, or on expenditure. Most taxes on expenditure are indirect, but some are direct, being imposed not on the producer or seller of an article, but immediately on the consumer. A house-tax, for example, is a direct tax on expenditure, if levied, as it usually is, on the occupier of the house. If levied on the builder or owner, it would be an indirect tax. A window-tax is a direct tax on expenditure; so are the taxes on horses and carriages, and the rest of what are called the assessed taxes.

The sources of income are rent, profits, and wages. This includes every sort of income, except gift or plunder. Taxes may be laid on any one of the three kinds of income, or an uniform tax on all of them. We will consider these in their order.

§ 2. A tax on rent falls wholly on the landlord. There are no means by which he can shift the burthen upon any one else. It does not affect the value or price of agricultural produce, for this is determined by the cost of production in the most unfavourable circumstances, and in those circumstances, as we have so often demonstrated, no rent is paid. A tax on rent, therefore, has no effect, other than its obvious one. It merely takes so much from the landlord, and transfers it to the state.

This, however, is, in strict exactness, only true of the rent which is the result either of natural causes, or of improvements made by tenants. When the landlord makes improvements which increase the productive power of his land, he is remunerated for them by an extra payment from the tenant; and this payment, which to the landlord is properly a profit on capital, is blended and confounded with rent; which indeed it really is, to the tenant, and in respect of the economical laws which determine its amount. A tax on rent, if extending to this portion of it, would discourage landlords from making improvements: but it does not follow that it would raise the price of agricultural produce. The same improvements might be made with the tenant's capital, or even with the landlord's if lent by him to the tenant; provided he is willing to give the tenant so long a lease as will enable him to indemnify himself before it expires. But whatever hinders improvements from being made in the manner in which people prefer to make them, will often prevent them from being made at all: and on this account a tax on rent would be inexpedient, unless some means could be devised of excluding from its operation that portion of the nominal rent which may be regarded as landlord's profit. This argument, however, is not needed for the condemnation of such a tax. A peculiar tax on the income of any class, not balanced by taxes on other classes, is a violation of justice, and amounts to a partial confiscation. I have already shown grounds for excepting from this censure a tax which, sparing existing rents, should content itself with appropriating a portion of any future increase arising from the mere action of natural causes. But even this could not be justly done, without offering as an alternative the market price of the land. In the case of a tax on rent which is not peculiar, but accompanied by an equivalent tax on other incomes, the objection grounded on its reaching the profit arising from improvements is less applicable: since, profits being taxed as well as rent, the profit which assumes the form of rent is liable to its share in common with other profits; 1 but since profits altogether ought, for reasons formerly stated, to be taxed somewhat lower than rent properly so called, the objection is only diminished, not removed.

§ 3. A tax on profits, like a tax on rent, must, at least in its immediate operation, fall wholly on the payer. All profits being alike affected, no relief can be obtained by a change of employment. If a tax were laid on the profits of any one branch of productive employment, the tax would be virtually an increase of the cost of production, and the value and price of the article would rise accordingly; by which the tax would be thrown upon the consumers of the commodity, and would not affect profits. But a general and equal tax on all profits would not affect general prices, and would fall, at least in the first instance, on capitalists alone.

There is, however, an ulterior effect, which, in a rich and prosperous country, requires to be taken into account. When the capital accumulated is so great and the rate of annual accumulation so rapid, that the country is only kept from attaining the stationary state by the emigration of capital, or by continual improvements in production; any circumstance which virtually lowers the rate of profit cannot be without a decided influence on these phenomena. It may operate in different ways. The curtailment of profit, and the consequent increased difficulty in making a fortune or obtaining a subsistence by the employment of capital, may act as a stimulus to inventions, and to the use of them when made. If improvements in production are much accelerated, and if these improvements cheapen, directly or indirectly, any of the things habitually consumed by the labourer, profits may rise, and rise sufficiently to make up for all that is taken from them by the tax. In that case the tax will have been realized without loss to any one, the produce of the country being increased by an equal, or what would in that case be a far greater, amount. The tax, however, must even in this case be considered as paid from profits, because the receivers of profits are those who would be benefited if it were taken off.

But though the artificial abstraction of a portion of profits would have a real tendency to accelerate improvements in production, no considerable improvements might actually result, or only of such a kind as not to raise general profits at all, or not to raise them so much as the tax had diminished them. If so, the rate of profit would be brought closer to that practical minimum to which it is constantly approaching: and this diminished return to capital would either give a decided check to further accumulation, or would cause a greater proportion than before of the annual increase to be sent abroad, or wasted in unprofitable speculations. At its first imposition the tax falls wholly on profits: but the amount of increase of capital, which the tax prevents, would, if it had been allowed to continue, have tended to reduce profits to the same level; and at every period of ten or twenty years there will be found less difference between profits as they are, and profits as they would in that case have been: until at last there is no difference, and the tax is thrown either upon the labourer or upon the landlord. The real effect of a tax on profits is to make the country possess at any given period, a smaller capital and a smaller aggregate production, and to make the stationary state be attained earlier, and with a smaller sum of national wealth. It is possible that a tax on profits might even diminish the existing capital of the country. If the rate of profit is already at the practical minimum, that is, at the point at which all that portion of the annual increment which would tend to reduce profits is carried off either by exportation or by speculation; then if a tax is imposed which reduces profits still lower, the same causes which previously carried off the increase would probably carry off a portion of the existing capital. A tax on profits is thus, in a state of capital and accumulation like that in England, extremely detrimental to the national wealth. And this effect is not confined to the case of a peculiar, and therefore intrinsically unjust, tax on profits. The mere fact that profits have to bear their share of a heavy general taxation, tends, in the same manner as a peculiar tax, to drive capital abroad, to stimulate imprudent speculations by diminishing safe gains, to discourage further accumulation, and to accelerate the attainment of the stationary state. This is thought to have been the principal cause of the decline of Holland, or rather of her having ceased to make progress.

Even in countries which do not accumulate so fast as to be always within a short interval of the stationary state, it seems impossible that, if capital is accumulating at all, its accumulation should not be in some degree retarded by the abstraction of a portion of its profit; and unless the effect in stimulating improvements be a full counter-balance, it is inevitable that a part of the burthen will be thrown off the capitalist, upon the labourer or the landlord. One or other of these is always the loser by a diminished rate of accumulation. If population continues to increase as before, the labourer suffers: if not, cultivation is checked in its advance, and the landlords lose the accession of rent which would have accrued to them. The only countries in which a tax on profits seems likely to be permanently a burthen on capitalists exclusively, are those in which capital is stationary, because there is no new accumulation. In such countries the tax might not prevent the old capital from being kept up through habit, or from unwillingness to submit to impoverishment, and so the capitalist might continue to bear the whole of the tax. It is seen from these considerations that the effects of a tax on profits are much more complex, more various, and in some points more uncertain, than writers on this subject have commonly supposed.

§ 4. We now turn to Taxes on Wages. The incidence of these is very different, according as the wages taxed are those of ordinary unskilled labour, or are the remuneration of such skilled or privileged employments, whether manual or intellectual, as are taken out of the sphere of competition by a natural or conferred monopoly.

I have already remarked, that in the present low state of popular education, all the higher grades of mental or educated labour are at a monopoly price; exceeding the wages of common workmen in a degree very far beyond that which is due to the expense, trouble, and loss of time required in qualifying for the employment. Any tax levied on these gains, which still leaves them above (or not below) their just proportion, falls on those who pay it; they have no means of relieving themselves at the expense of any other class. The same thing is true of ordinary wages, in cases like that of the United States, or of a new colony, where, capital increasing as rapidly as population can increase, wages are kept up by the increase of capital, and not by the adherence of the labourers to a fixed standard of comforts. In such a case some deterioration of their condition, whether by a tax or otherwise, might possibly take place without checking the increase of population. The tax would in that case fall on the labourers themselves, and would reduce them prematurely to that lower state to which, on the same supposition with regard to their habits, they would in any case have been reduced ultimately, by the inevitable diminution in the rate of increase of capital, through the occupation of all the fertile land.

Some will object that, even in this case, a tax on wages cannot be detrimental to the labourers, since the money raised by it, being expended in the country, comes back to the labourers again through the demand for labour. The fallacy, however, of this doctrine has been so completely exhibited in the First Book,∗ that I need do little more than refer to that exposition. It was there shown that funds expended unproductively have no tendency to raise or keep up wages, unless when expended in the direct purchase of labour. If the government took a tax of a shilling a week from every labourer, and laid it all out in hiring labourers for military service, public works, or the like, it would, no doubt, indemnify the labourers as a class for all that the tax took from them. That would really be “spending the money among the people.” But if it expended the whole in buying goods, or in adding to the salaries of employés who bought goods with it, this would not increase the demand for labour, or tend to raise wages. Without, however, reverting to general principles, we may rely on an obvious reductio ad absurdum. If to take money from the labourers and spend it in commodities is giving it back to the labourers, then, to take money from other classes, and spend it in the same manner, must be giving it to the labourers; consequently, the more a government takes in taxes, the greater will be the demand for labour, and the more opulent the condition of the labourers. A proposition the absurdity of which no one can fail to see.

In the condition of most communities, wages are regulated by the habitual standard of living to which the labourers adhere, and on less than which they will not multiply. Where there exists such a standard, a tax on wages will indeed for a time be borne by the labourers themselves; but unless this temporary depression has the effect of lowering the standard itself, the increase of population will receive a check, which will raise wages, and restore the labourers to their previous condition. On whom, in this case, will the tax fall? According to Adam Smith, on the community generally, in their character of consumers; since the rise of wages, he thought, would raise general prices. We have seen, however, that general prices depend on other causes, and are never raised by any circumstance which affects all kinds of productive employment in the same manner and degree. A rise of wages occasioned by a tax, must, like any other increase of the cost of labour, be defrayed from profits. To attempt to tax day-labourers, in an old country, is merely to impose an extra tax upon all employers of common labour; unless the tax has the much worse effect of permanently lowering the standard of comfortable subsistence in the minds of the poorest class.

We find in the preceding considerations an additional argument for the opinion already expressed, that direct taxation should stop short of the class of incomes which do not exceed what is necessary for healthful existence. These very small incomes are mostly derived from manual labour; and, as we now see, any tax imposed on these, either permanently degrades the habits of the labouring class, or falls on profits, and burthens capitalists with an indirect tax, in addition to their share of the direct taxes; which is doubly objectionable, both as a violation of the fundamental rule of equality, and for the reasons which, as already shown, render a peculiar tax on profits detrimental to the public wealth, and consequently to the means which society possesses of paying any taxes whatever.

§ 5. We now pass, from taxes on the separate kinds of income, to a tax attempted to be assessed fairly upon all kinds; in other words, an Income Tax. The discussion of the conditions necessary for making this tax consistent with justice, has been anticipated in the last chapter. We shall suppose, therefore, that these conditions are complied with. They are, first, that incomes below a certain amount should be altogether untaxed. This minimum should not be higher than the amount which suffices for the necessaries of the existing population. The exemption from the present [1857] income tax, of all incomes under 100l., a year, and the lower percentage formerly levied on those between 100l., and 150l., are only defensible on the ground that almost all the indirect taxes press more heavily on incomes between 50l., and 150l., than on any others whatever.1 The second condition is, that incomes above the limit should be taxed only in proportion to the surplus by which they exceed the limit. 2 Thirdly, that all sums saved from income and invested, should be exempt from the tax: or if this be found impracticable, that life incomes, and incomes from business and professions, should be less heavily taxed than inheritable incomes, in a degree as nearly as possible equivalent to the increased need of economy arising from their terminable character: allowance being also made, in the case of variable incomes, for their precariousness.

An income-tax, fairly assessed on these principles, would be, in point of justice, the least exceptionable of all taxes. The objection to it, in the present low state of public morality,3 is the impossibility of ascertaining the real incomes of the contributors. The supposed hardship of compelling people to disclose the amount of their incomes, ought not, in my opinion, to count for much. One of the social evils of this country is the practice, amounting to a custom, of maintaining, or attempting to maintain, the appearance to the world of a larger income than is possessed; and it would be far better for the interest of those who yield to this weakness, if the extent of their means were universally and exactly known, and the temptation removed to expending more than they can afford, stinting real wants in order to make a false show externally. At the same time, the reason of the case, even on this point, is not so exclusively on one side of the argument as is sometimes supposed. So long as the vulgar of any country are in the debased state of mind which this national habit presupposes—so long as their respect (if such a word can be applied to it) is proportioned to what they suppose to be each person's pecuniary means—it may be doubted whether anything which would remove all uncertainty as to that point, would not considerably increase the presumption and arrogance of the vulgar rich, and their insolence towards those above them in mind and character, but below them in fortune.

Notwithstanding, too, what is called the inquisitorial nature of the tax, no amount of inquisitorial power which would be tolerated by a people the most disposed to submit to it, could enable the revenue officers to assess the tax from actual knowledge of the circumstances of contributors. Rent, salaries, annuities, and all fixed incomes, can be exactly ascertained. But the variable gains of professions, and still more the profits of business, which the person interested cannot always himself exactly ascertain, can still less be estimated with any approach to fairness by a tax-collector. The main reliance must be placed, and always has been placed, on the returns made by the person himself. No production of accounts is of much avail, except against the more flagrant cases of falsehood; and even against these the check is very imperfect, for if fraud is intended, false accounts can generally be framed which it will baffle any means of inquiry possessed by the revenue officers to detect: the easy resource of omitting entries on the credit side being often sufficient without the aid of fictitious debts or disbursements. The tax, therefore, on whatever principles of equality it may be imposed, is in practice unequal in one of the worst ways, falling heaviest on the most conscientious. The unscrupulous succeed in evading a great proportion of what they should pay; even persons of integrity in their ordinary transactions are tempted to palter with their consciences, at least to the extent of deciding in their own favour all points on which the smallest doubt or discussion could arise: while the strictly veracious may be made to pay more than the state intended, by the powers of arbitrary assessment necessarily intrusted to the Commissioners, as the last defence against the tax-payer's power of concealment.

It is to be feared, therefore, that the fairness which belongs to the principle of an income tax, cannot1 be made to attach to it in practice: and that this tax, while apparently the most just of all modes of raising a revenue, is in effect more unjust than many others which are primâ facie more objectionable. This consideration would lead us to concur in the opinion which, until of late, has usually prevailed—that direct taxes on income should be reserved as an extraordinary resource for great national emergencies, in which the necessity of a large additional revenue overrules all objections.

The difficulties of a fair income tax have elicited a proposition for a direct tax of so much per cent, not on income, but on expenditure; the aggregate amount of each person's expenditure being ascertained, as the amount of income now is, from statements furnished by the contributors themselves. The author of this suggestion, Mr. Revans, in a clever pamphlet on the subject,∗ contends that the returns which persons would furnish of their expenditure would be more trustworthy than those which they now make of their income, inasmuch as expenditure is in its own nature more public than income, and false representations of it more easily detected. He cannot, I think, have sufficiently considered, how few of the items in the annual expenditure of most families can be judged of with any approximation to correctness from the external signs. The only security would still be the veracity of individuals, and there is no reason for supposing that their statements would be more trustworthy on the subject of their expenses than that of their revenues; especially as, the expenditure of most persons being composed of many more items than their income, there would be more scope for concealment and suppression in the detail of expenses than even of receipts.

The taxes on expenditure at present in force, either in this or in other countries, fall only on particular kinds of expenditure, and differ no otherwise from taxes on commodities than in being paid directly by the person who consumes or uses the article, instead of being advanced by the producer or seller, and reimbursed in the price. The taxes on horses and carriages, on dogs, on servants, are all of this nature. They evidently fall on the persons from whom they are levied—those who use the commodity taxed. A tax of a similar description, and more important, is a house-tax; which must be considered at somewhat greater length.

§ 6. The rent of a house consists of two parts, the ground-rent, and what Adam Smith calls the building-rent. The first is determined by the ordinary principles of rent. It is the remuneration given for the use of the portion of land occupied by the house and its appurtenances; and varies from a mere equivalent for the rent which the ground would afford in agriculture to the monopoly rents paid for advantageous situations in populous thoroughfares. The rent of the house itself, as distinguished from the ground, is the equivalent given for the labour and capital expended on the building. The fact of its being received in quarterly or half-yearly payments, makes no difference in the principles by which it is regulated. It comprises the ordinary profit on the builder's capital, and an annuity, sufficient at the current rate of interest, after paying for all repairs chargeable on the proprietor, to replace the original capital by the time the house is worn out, or by the expiration of the usual term of a building lease.

A tax of so much per cent on the gross rent, falls on both those portions alike. The more highly a house is rented, the more it pays to the tax, whether the quality of the situation or that of the house itself is the cause. The incidence, however, of these two portions of the tax must be considered separately.

As much of it as is a tax on building-rent, must ultimately fall on the consumer, in other words the occupier. For as the profits of building are already not above the ordinary rate, they would, if the tax fell on the owner and not on the occupier, become lower than the profits of untaxed employments, and houses would not be built. It is probable however that for some time after the tax was first imposed, a great part of it would fall, not on the renter, but on the owner of the house. A large proportion of the consumers either could not afford, or would not choose, to pay their former rent with the tax in addition, but would content themselves with a lower scale of accommodation. Houses therefore would be for a time in excess of the demand. The consequence of such excess, in the case of most other articles, would be an almost immediate diminution of the supply: but so durable a commodity as houses does not rapidly diminish in amount. New buildings indeed, of the class for which the demand had decreased, would cease to be erected, except for special reasons; but in the meantime the temporary superfluity would lower rents, and the consumers would obtain perhaps nearly the same accommodation as formerly for the same aggregate payment, rent and tax together. By degrees, however, as the existing houses wore out, or as increase of population demanded a greater supply, rents would again rise; until it became profitable to recommence building, which would not be until the tax was wholly transferred to the occupier. In the end, therefore, the occupier bears that portion of a tax on rent, which falls on the payment made for the house itself, exclusively of the ground it stands on.

The case is partly different with the portion which is a tax on ground-rent. As taxes on rent, properly so called, fall on the landlord, a tax on ground-rent, one would suppose, must fall on the ground-landlord, at least after the expiration of the building lease. It will not, however, fall wholly on the landlord, unless with the tax on ground-rent there is combined an equivalent tax on agricultural rent. The lowest rent of land let for building is very little above the rent which the same ground would yield in agriculture: since it is reasonable to suppose that land, unless in case of exceptional circumstances, is let or sold for building as soon as it is decidedly worth more for that purpose than for cultivation. If, therefore, a tax were laid on ground-rents without being also laid on agricultural rents, it would, unless of trifling amount, reduce the return from the lowest ground-rents below the ordinary return from land, and would check further building quite as effectually as if it were a tax on building-rents, until either the increased demand of a growing population, or a diminution of supply by the ordinary causes of destruction, had raised the rent by a full equivalent for the tax. But whatever raises the lowest ground-rents, raises all others, since each exceeds the lowest by the market value of its peculiar advantages. 1 If, therefore, the tax on ground-rents were a fixed sum per square foot, the more valuable situations paying no more than those least in request, this fixed payment would ultimately fall on the occupier. Suppose the lowest ground-rent to be 10l. per acre, and the highest 1000l., a tax of 1l. per acre on ground-rents would ultimately raise the former to 11l., and the latter consequently to 1001l., since the difference of value between the two situations would be exactly what it was before: the annual pound, therefore, would be paid by the occupier. But a tax on ground-rent is supposed to be a portion of a house-tax, which is not a fixed payment, but a percentage on the rent. The cheapest site, therefore, being supposed as before to pay 1l., the dearest would pay 100l., of which only the 1l. could be thrown upon the occupier, since the rent would still be only raised to 100l. Consequently, 99l. of the 100l. levied from the expensive site, would fall on the ground-landlord. A house-tax thus requires to be considered in a double aspect, as a tax on all occupiers of houses, and a tax on ground-rents.

In the vast majority of houses, the ground-rent forms but a small proportion of the annual payment made for the house, and nearly all the tax falls on the occupier. It is only in exceptional cases, like that of the favourite situations in large towns, that the predominant element in the rent of the house is the ground-rent; and among the very few kinds of income which are fit subjects for peculiar taxation, these ground-rents hold the principal place, being the most gigantic example extant of enormous accessions of riches acquired rapidly, and in many cases unexpectedly, by a few families, from the mere accident of their possessing certain tracts of land, without their having themselves aided in the acquisition by the smallest exertion, outlay, or risk. So far therefore as a house-tax falls on the ground-landlord, it is liable to no valid objection.

In so far as it falls on the occupier, if justly proportioned to the value of the house, it is one of the fairest and most unobjectionable of all taxes. No part of a person's expenditure is a better criterion of his means, or bears, on the whole, more nearly the same proportion to them. A house-tax is a nearer approach to a fair income tax, than a direct assessment on income can easily be; having the great advantage, that it makes spontaneously all the allowances which it is so difficult to make, and so impracticable to make exactly, in assessing an income tax: for if what a person pays in house-rent is a test of anything, it is a test not of what he possesses, but of what he thinks he can afford to spend. The equality of this tax can only be seriously questioned on two grounds. The first is, that a miser may escape it. This objection applies to all taxes on expenditure: nothing but a direct tax on income can reach a miser. But as misers do not now hoard their treasure, but invest it in productive employments, it not only adds to the national wealth, and consequently to the general means of paying taxes, but the payment claimable from itself is only transferred from the principal sum to the income afterwards derived from it, which pays taxes as soon as it comes to be expended. The second objection is, that a person may require a larger and more expensive house, not from having greater means, but from having a larger family. Of this, however, he is not entitled to complain; since having a large family is at a person's own choice: and, so far as concerns the public interest, is a thing rather to be discouraged than promoted.∗

A large portion of the taxation of this country is raised by a house-tax. The parochial taxation of the towns entirely, and of the rural districts partially, consists of an assessment on house-rent. The window-tax, which was also a house-tax, but of a bad kind, operating as a tax on light, and a cause of deformity in building, was exchanged in 1851 for a house-tax properly so called, but on a much lower scale than that which existed previously to 1834. It is to be lamented that the new tax retains the unjust principle on which the old house-tax was assessed, and which contributed quite as much as the selfishness of the middle classes to produce the outcry against the tax. The public were justly scandalized on learning that residences like Chatsworth or Belvoir were only rated on an imaginary rent of perhaps 200l. a year, under the pretext that owing to the great expense of keeping them up, they could not be let for more. Probably, indeed, they could not be let even for that, and if the argument were a fair one, they ought not to have been taxed at all. But a house-tax is not intended as a tax on incomes derived from houses, but on expenditure incurred for them. The thing which it is wished to ascertain is what a house costs to the person who lives in it, not what it would bring in if let to some one else. When the occupier is not the owner, and does not hold on a repairing lease, the rent he pays is the measure of what the house costs him: but when he is the owner, some other measure must be sought. A valuation should be made of the house, not at what it would sell for, but at what would be the cost of rebuilding it, and this valuation might be periodically corrected by an allowance for what it had lost in value by time, or gained by repairs and improvements. The amount of the amended valuation would form a principal sum, the interest of which, at the current price of the public funds, would form the annual value at which the building should be assessed to the tax.

As incomes below a certain amount ought to be exempt from income tax, so ought houses below a certain value from house-tax, on the universal principle of sparing from all taxation the absolute necessaries of healthful existence. In order that the occupiers of lodgings, as well as of houses, might benefit, as in justice they ought, by this exemption, it might be optional with the owners to have every portion of a house which is occupied by a separate tenant, valued and assessed separately, as is now usually the case with chambers.