LIBRARY UNIVERSITY OF CALIFORNIA RIVERSIDE PRINCIPLES OF ECONOMICS THE MACMILLAN COMPANY NEW YORK BOSTON CHICAGO BAN FRANCISCO MACMILLAN & CO., LIMITED LONDON BOMBAY CALCUTTA MELBOURNE THE MACMILLAN CO. OF CANADA, LTD. TORONTO PRINCIPLES OF ECONOMICS F/W. BY TAUSSIG HENRY LEE PROFESSOR OF ECONOMICS IN HARVARD UNIVERSITY VOLUME I SECOND EDITION REVISED ff orfc THE MACMILLAN COMPANY 1917 All righU reserved .i COPYRIGHT, 1911, 1915, Bv THE MACMILLAN COMPANY. Set up and electrotyped. Published September, 1911. Reprinted November, December, 1911; August, October, 1912; February, September, November 19131 Second edition revised January, 1915. Reprinted October, December, 1915; August, 1916; January, August, 1917. NottoooB J. 8. Cushlnp Co. Berwick & Smith Co. Norwood, Mass., U.S.A. PATRI DILECTO FILIVS GRATVS PREFACE I HAVE tried in this book to state the principles of economics in such form that they shall be comprehensible to an educated and intelligent person who has not before made any systematic study of the subject. Though designed in this sense for begin- ners, the book does not gloss over difficulties or avoid severe reasoning. No one can understand economic phenomena or pre- pare himself to deal with economic problems who is unwilling to follow trains of reasoning which call for sustained attention. I have done my best to be clear, and to state with care the grounds on which my conclusions rest, as well as the conclusions them- selves, but have made no vain pretense of simplifying all things. The order of the topics has been determined more by conven- ience for exposition than by any strict regard for system. In general, a subject has been entered on only when the main conclu- sions relating to it could be followed to the end. Yet so close is the connection between the different parts of economics that it has been necessary sometimes to go part way in the consideration of matters on which the final word had to be reserved for a later stage. Taxation has offered, as regards its place in the arrangement, per- haps the greatest difficulties. It is so closely connected with eco- nomics that some consideration of it seemed essential ; whereas public finance in the stricter sense, whose problems are political quite as much as economic, has been omitted. Yet a suitable place for taxation was not easy to find. I concluded finally to put the chapters on this subject at the very close, even though they may have the effect of an anticlimax, coming as they do after those on socialism. The book deals chiefly with the industrial conditions of modern countries, and most of all with those of the United States. Eco- nomic history and economic development are not considered in any set chapters, being touched only as they happen to illustrate one or another of the problems of contemporary society. Some topics to which economists give much attention in discussion among themselves receive scant attention or none at all. I have vii viii PREFACE omitted entirely the usual chapters or sections on definition, methodology, and history of dogma ; and have said little on such a topic as the subjective theory of value, which in my judgment is of less service for explaining the phenomena of the real world than is supposed by its votaries. These matters and others of the same sort are best left to the professional literature of the subject. I hope this book is not undeserving the attention of specialists; but it is meant to be read by others than specialists. Though not written on the usual model of textbooks, and not planned primarily to meet the needs of teachers and students, the book will prove of service, I hope, in institutions which offer substantial courses in economics. The fact that it is addressed to mature persons, not to the immature, should be an argument in favor of such use rather than against it. Being neither an encyclopedic treatise nor a textbook of the familiar sort, it offers no voluminous footnotes and no detailed directions for collateral reading. When facts and figures not of common knowledge have been cited, my sources of information have been stated. At the close of each of the eight Books into which the whole is divided, I have given suggestions for further reading and study, mention- ing the really important books and papers. I have expressed in the text, as occasion arose, my obligations to the contemporary thinkers from whom I have derived most stimulus. For great aid in revising the manuscript and proof, on matters both of form and substance, I am indebted to my colleagues Drs. B. F. Foerster and E. E. Day of Harvard University. F. W. TAUSSIG. HARVARD UNIVERSITY, March, 1911. NOTE TO THE SECOND EDITION IN the present edition changes have been made with the design of bringing to date the discussion of some important problems. The chapter on banking in the United States has been entirely re-written ; as it now stands, it includes a description of the Fed- eral Reserve Bank system and a consideration of the principles underlying the new legislation. The chapter on trusts and com- binations has been largely re-written, with reference to the laws enacted in 1914. Considerable revision has been made in the chapter on workmen's insurance, calling attention to the note- worthy steps taken of late years in England and the United States. The chapters on taxation and especially on income taxes, and on some other topics, have been similarly brought to date. So far as concerns questions of principle and general reasoning, the text, barring emendations on minor points, has been left as when first published. F. W. TAUSSIG. December, 1914. CONTENTS BOOK I THE OBGANIZATION OF PRODUCTION CHAPTER 1 VOL.I PAGES WEALTH AND LABOR 3-14 Section 1. The subject matter of economics, 3 Sec. 2. Wealth ; free goods; economic goods. Wealth and welfare, 6 Sec. 3. Goods may become economic through mere scarcity ; but commonly do so because of the exertion of labor, 7 Sec. 4. Activity may be irksome or pleasurable. Labor usually is continuous, monotonous, irksome, 8 Sec. 6. Some sorts of labor always pleasurable, 10 Sec. 6. The irksomeness of most labor to be lessened by better gen- eral opinion, and by greater leisure through shorter hours, 12. CHAPTER 2 PRODUCTIVE AND UNPRODUCTIVE LABOR 15-29 Section 1. Labor given to material objects deemed alone produc- tive by earlier English economists. Objections to this view, 15 Sec. 2. Labor creates utilities only ; all labor that issues in utility is productive. Is there nonmaterial wealth ? 17 Sec. 3. Is there any unproductive labor ? Labor given to things harmful, 20 Sec. 4. Labor of judges and lawyers ; of soldiers, 23 Sec. 5. Pred- atory labor. "Business." The law and unproductive labor, 26. CHAPTER 3 THE DIVISION OF LABOR AND THE DEVELOPMENT OF MODERN IN- DUSTRY ._ 30-48 Section 1. Two forms of the division of labor : the simpler and the more complex, 30 Sec. 2. Advantages from the simpler form ; dexterity, continuity, adaptation to aptitudes, 31 Sec. 3. Advan- tage from the more complex form : the development of machinery. The industrial revolution of the eighteenth century. The use of nature's power, 83 Sec. 4. Division of labor means unconscious cooperation. Exchange, 37 Sec. 5. Exchange formerly covered a limited economic area. Cheap transportation (railways) makes the area wide, 38 Sec. 6. Wider markets bring more minute divi- jri xii CONTENTS VOL. 1 PAGES sion of labor. Illustration from butcher's trade, 41 Sec. 7. The geographical division of labor, illustrated by the United States and Great Britain, 43 Sec. 8. Two sorts of gain from geographical division of labor, 45. CHAPTER 4 LARGE-SCALE PRODUCTION 49-66 Section 1. Growth of large-scale production illustrated by certain industries : cotton goods, iron, agricultural implements, 49 Sec. 2. Advantages of large-scale production : use of machinery, saving in general expenses, buying and selling, utilization of by- products, experimenting, 52 Sec. 3. Limitations, chiefly from difficulties of superintendence. The case of agriculture. Other industries. Scarcity of able managers as a cause of limitation, 55 Sec. 4. Combination, horizontal and vertical. The Steel Corpo- ration as an example. Other examples. The tendency to vertical combination less strong than that to horizontal, 69 Sec. 6. Com- petition often wasteful ; though the waste is less than it seems. Combination rules only over part of industry, 65. CHAPTER 5 CAPITAL 67-85 Section 1. Production is spread over time. This fact disguised by the division of labor. Increasing use of plant and machinery in modern times, 67 Sec. 2. Producer's wealth and consumer's wealth; capital, 69 Sec. 3. Capital rests on a surplus, 71 Sec. 4. In what sense capital rests on saving. Hoarding contrasted with saving for investment, 72 Sec. 6. Investment means advances to laborers. Inequality of possessions in relation to advances. Middlemen for investment and advances, 74 Sec. 6. The mainte- nance of capital, as well as its creation, involves saving, 77 Sec. 7. Some corollaries. Saving usually irksome, and undertaken for a reward ; interest, 79 Sec. 8. Capital and the owner's inten- tion, 80 Sec. 9. Saving and investment do not necessarily lead tc the making of capital. Spendthrift loans. Government debts, 81 Sec. 10. Some distinctions : capital to the individual and capital to the community. "Capital" and "capital goods," 83. CHAPTER 6 THE CORPORATE ORGANIZATION OF INDUSTRY .... 86-96 Section 1. Partnerships and corporations. Limited liability. Corporations from the legal point of view and from the economic, 86 Sec. 2. Advantages from corporate organization. Large- CONTENTS xiii VOL. I PASM scale operations facilitated ; new and venturesome investments promoted; stimulus to savings and investment, 89 Sec. 3. Ease of transfer serves to divide risks and so promote investments, and to bring control into capable hands. But it leads to great evils : overreaching, stock exchange gambling, control by the unscrupu- lous, 91 Sec. 4. Increasing importance of financial middlemen. Power of trusted bankers and managers, 95 Sec. 5. High security of much corporate property makes the leisure class more perma- nent, 96. CHAPTER 7 SOME CAUSES AFFECTING PRODUCTIVENESS . ... . 97-110 Section 1. The effect of high wages (abundant food) on the pro- ductivity of labor. High wages in the main a result, not a cause, of efficiency, 97 Sec. 2. Effects of skill and intelligence on pro- ductivity. General education. Technical education, in its effect for the individual and for the community, 101 Sec. 3. Leader- ship. The business man ; the man of science. Freedom and mobility as promoting leadership. The motives to leadership, 105 Sec. 4. The immaterial equipment of a community ; how affected by training and by inheritance, 108. REFERENCES ON BOOK I ' . " . . . . . . . 110 CHAPTER 8 INTRODUCTORY : EXCHANGE, VALUE, PRICE 118-119 Section 1. Exchange the consequence of the division of labor, 113 Sec. 2. Money as the medium of exchange, 114 Sec. 3. Value and utility. The notion of value in exchange, 116 Sec. 4. A general rise in values ; a general rise in prices. Stability in general prices provisionally assumed, 117. CHAPTER 9 VALUE AND UTILITY . . . .. ; / . . . . 120-137 Section 1. Utility a necessary condition of value ; but value not proportional to utility, 120 Sec. 2. Increase of supply brings low- ering of value ; because of differences of means, and, fundamentally, because of the law of diminishing utility. Effects of varying the commodities supplied. Possible exceptions to the general principle, 124 Sec. 3. Total utility and marginal utility, 124 Sec. 4. Value depends on marginal utility. Qualifications and explanations. The marginal utility of money, 126 Sec. 5. Consumer's surplus. xiv CONTENTS TOL. PAH Sundry limitations on its significance and on the possibility of meas- uring it, 128 Sec. 6. How state and measure the income of a community ? 133 Sec. 7. The law of diminishing utility points to the conclusion that inequality lessens maximum happiness, 135. CHAPTER 10 MABKET VALUE. DEMAND AND SUPPLY 138-158 Section 1. The conditions of demand and the demand curve. Demand possibly discontinuous, usually continuous, 138 Sec. 2. How value is determined by marginal utility, for a fixed supply. The equation of demand and supply, 143 Sec. 3. A varying sup- ply: the equilibrium of demand and supply, 144 Sec. 4. How far the supposition of a fixed supply, how far that of a varying supply, conforms to the facts. The circumstances that act on daily and on seasonal prices, 146 Sec. 5. Qualifications as to the market value of capital goods, 151 Sec. 6. Retail prices seem to follow wholesale prices, but in the end govern wholesale prices. The advantage of fixed retail prices, 153 Sec. 7. Current market prices are what people commonly mean when they speak of " fair" prices, 155 Sec. 8. Sporadic cases where value is affected by utility to sellers, 156. CHAPTER 11 SPECULATION 159-169 Section 1. The fundamental effect of speculation is to mitigate fluctuations, 159 Sec. 2. Dealing in futures lessens fluctuations, 161 Sec. 3. Exchanges ; standardizing, 163 Sec. 4. The evils of speculation : gambling ; unproductive labor, 165 Sec. 5. The evils of stock exchange speculation, 167. CHAPTER 12 VALUE UNDER CONSTANT COST ....... 170-179 Section 1. The simplest case first assumed : a supply absolutely flexible, free competition, constant cost. Value then determined by cost, 170 Sec. 2. Illustration by diagram, 172 Sec. 3. The proposition points to a tendency or approximation only ; to what happens in a "static," not in a "dynamic," state, 174 Sec. 4. Some explanations and qualifications. Flexibility in supply never perfect, often much impeded. Changes in demand from fashion. How far free competition holds. Good will. A small surplus above cost price may mean large profits, 176. CONTENTS xv CHAPTER 13 TOL .i rjkam VALTTE AND VABYING COSTS. DIMINISHING RETURNS . . . 180-188 Section 1. The equilibrium of value where marginal utility and marginal cost balance. The simile of the scissors, 180 Sec. 2. Permanent variations in cost affect long-run value differently from temporary variations, 183 Sec. 3. Diminishing returns, 185 Sec. 4. Permanent variations, or diminishing returns, appear most in the extractive industries, 186. CHAPTER 14 VALUE AND INCREASING RETURNS 189-198 Section 1. The equilibrium of supply and demand under increas- ing returns. How the case differs from that of diminishing returns. Long-run results considered, 189 Sec. 2. What industries show increasing returns. Causes of the tendency. External economies. Localization of industry ; labor supply, 191 Sec. 3. Internal economies, if continuing indefinitely, lead to monopoly, 193 Sec. 4. Possibility of several points of equilibrium. Increasing returns commonly come slowly, but sometimes fast, 195. CHAPTER 15 MONOPOLY VALUE 199-217 Section 1. Monopoly affects price through limitation of supply. This proposition qualified as to transactions between middlemen, especially as to producer's capital, 199 Sec. 2. How price is fixed if a monopolist has a fortuitous supply ; how, if he produces his supply at constant cost. Monopoly profit. Destruction of part of the supply possible, but not probable. Diamond mining as illus- trating monopoly price, 201 Sec. 3. Monopoly price under in- creasing returns. Copyrighted books as illustrations. Monopoly price under diminishing returns, 205 Sec. 4. Possibility of vary- ing prices under monopoly, usually disguised. Copyrighted books ; telephone rates. Converse case of uniform prices under monopoly, 208 Sec. 5. "Dumping" explained by monopoly, 211 Sec. 6. Unqualified monopoly rare ; various limitations and qualifications, 212 Sec. 7. "Corners" (of a season's supply) do not per se affect price to consumers, but affect dealers and speculators. Some among the consumers may be affected by corners. Successful corners rare, 214. CHAPTER 16 JOINT COST AND JOINT DEMAND . 218-224 Section 1. Joint cost : effect of increase or decrease in demand. Influence of separable items of expense. "By-products." Com- xvi CONTENTS VOI.. I PAOIS plex case where both monopoly and joint cost exist. Influence of large plant, 218 Sec. 2. Joint demand. The constituent most limited in supply feels most the effect of an increase of demand. Labor in building trades as an illustration. Joint demand usually causes peculiarities less enduring than those arising from joint cost, 221. REFERENCES ON BOOK II 224 BOOK III MONET AND THE MECHANISM OF EXCHANGE CHAPTER 17 THE PRBCIOCS METALS. COINAGE . ... 227-235 Section 1. The precious metals the main constituents of the circulating medium, 227 Sec. 2. Qualities that have caused them to be selected for monetary use : luster, freedom from deterioration, limited supply. Their value and monetary use now rest largely on convention, 228 Sec. 3. Coinage a public function. Free coinage; bullion and coin interchangeable. The mint price of gold, 230 Sec. 4. Plentifulness of money is per se a matter of indifference, 233. CHAPTER 18 QUANTITY OF MONEY AND PRICES 236-251 SECTION 1. The value of money is inverse to its quantity, 236 Sec. 2. Qualifications of this principle. Flow, or rapidity of circu- lation, of money and of goods, 238 Sec. 3. Diversion of specie from monetary use through consumption in the arts. Effects of rise and fall in prices ; changes in industrial demand. Tendency to sharper separation of monetary and industrial use, 242 Sec. 4. Diversion of specie from the monetary supply of Western countries by its flow to the East, 245 Sec. 5. An increase in the supply of money does not ordinarily affect people's ways of using it, but may do so when barter is in process of being superseded by money exchange, as was the case in the sixteenth century, 247 Sec. 6. The conclusions of this chapter, though simple and provisional, hold good in essentials for more complicated conditions, 250. CHAPTER 19 THB COST OF SPECIB IN RELATION TO ITS VALUE . . . 252-264 Section 1. The determination of the value of the precious metals by their marginal cost is impeded by (1) their durability ; (2) their irregular and aleatory production ; (3) the unexpected occurrence of new sources of supply, 262 Sec. 2. Illustrations from history. The American specie of the sixteenth century, and the price revo- CONTENTS xvii VOL. I PAGES lution of 1550-1650, 255 Sec. 3. The Australian and Californian gold discoveries of 1850, and their comparatively slight effect on prices, 258 Sec. 4. The increase of gold supply since 1890, and its effect on prices, 260 Sec. 5. For considerable periods, the value of gold determines what shall be the marginal source of supply ; it is not the marginal source of supply which determines its value, 262. CHAPTER 20 BIMETALLISM . V 265-273 Section 1. Both metals long used side by side. The fully devel- oped double standard illustrated, 265 Sec. 2. Mint ratio and market ratio ; overvalued and undervalued metal. Tendency of the overvalued metal to displace the undervalued, illustrated by the experience of the United States, 266 Sec. 3. "Gresham's Law," 269 Sec. 4. Subsidiary coin and its proper regulation, 271. CHAPTER 21 BIMETALLISM (continued). THE DISPLACEMENT OF SILVER . 274-289 Section 1. The double standard in France, and elsewhere, until recent times. Its tendency to keep the relative value of gold and silver stable. This effect produced by French bimetallism, 1825- 1873, 274 Sec. 2. New situation after 1870. Free coinage of silver ceased in 1873. Thereafter, gold the standard in France and the Latin Union, 277 Sec. 3. German thalers, 280 Sec. 4. The United States ; acts of 1873, 1878, 1890, and 1893. Silver dollars and silver certificates, 281 Sec. 5. Cessation of free coinage in British India in 1893. Decline in the price of silver, 284 Sec. 6. Would universal bimetallism conduce to a stable ratio between gold and silver ? 286 Sec. 7. Would universal bimetallism conduce to stable prices ? 288. CHAPTER 22 CHANGES IN PRICES .' . . 290-309 Section 1. Changes in prices measured by index numbers. The simple arithmetical mean, 290 Sec. 2. Weighted index numbers. Medians. Illustration from prices in the United States, 1890-1906, 291 Sec. 3. Effects of changes in prices on creditors and debtors, 297 Sec. 4. Peculiar problem where the movement of prices is different from that of money incomes, 298 Sec. 5. A multiple standard impracticable, 302 Sec. 6. Rising prices seem to cause prosperity, falling prices adversity. This due to the slower advance of money wages, and the consequent gains or losses of employers of labor, 303 Sec. 7. Changes in prices are accompanied by changes in the rate of interest. The parallel movement due, not xviii CONTENTS to any conscious adjustment, but in part to the effects on business profits, in part to the general causes of oscillations in prices, 307. CHAPTER 23 GOVERNMENT PAPER MONET 310-330 Section 1. Inconvertible paper, or fiat money, dependent on an established habit of using paper money. Its value depends on its quantity, provided it circulates freely. Possible failure to circulate freely ; possible collapse from extreme overissue, 310 Sec. 2. Paper drives out specie. Depreciation from overissue. The specie premium does not measure real depreciation with accuracy. Pros- pect of redemption affects specie premium, 314 Sec. 3. Illustration from United States experience in 1862-1879, 318 Sec. 4. Over- issue rarely avoided. On what terms resumption of specie pay- ments should be undertaken after a period of depreciation, 320 Sec. 5. "Inconvertible specie." The rupee in British India; sil- ver florins in Austria, 323 Sec. 6. International paper ? The grounds for using gold, 326 Sec. 7. Convertible government paper. United States certificates of deposit. United States notes, or greenbacks. Other cases of convertible paper, 326. CHAPTER 24 BANKING AND THE MEDIUM OF EXCHANGE ..... 831-347 Section 1. Two functions of banks : in relation to investment and to the circulating medium. The investment operations, 331 Sec. 2. Bank notes, payable on demand. The safer they are, the less likely to be presented for payment. They tend to displace specie. Effect of prohibition of small denominations, 333 Sec. 3. Deposits may arise through cash placed in a banker's custody ; but may be created. The mode of creating and maintaining deposits, in connection with loans. The check is the deposit in act of use, 336 Sec. 4. The offsetting of checks, chiefly through clearing houses. Great development of clearing houses, 341 Sec. 5. Deposits as a circulating medium, 343 Sec. 6. Effects of deposit banking on the circulation of money ; on that of bank notes, 345. CHAPTER 25 BANKING OPERATIONS 348-369 Section 1. Cash in banks' vaults tends to be reduced to the mini- mum. The other resources should be of a liquid sort. Discount of commercial paper, loans on collateral securities, "outside paper." Growing tendency to combine these operations with investment operations, 348 Sec. 2. Relation of the rate of discount (interest) XIX rot. r MAM to the quantity of cash held by banks. Greater fluctuations on demand loans ; their connection with speculation, 352 Sec. 3. Qualities of a successful banker ; importance of good will for the profits of banking, 356 Sec. 4. Banks do not create capital, but affect the direction in which investment shall be made, and exercise a selective influence among business men. Their social utility stands and falls with the utility of the system of private property, 357. CHAPTER 26 CENTRALIZED BANKING SYSTEMS . . . . ... 360-374 Section 1. Need of regulating issue of bank notes. Centralization of issue in Europe, 360 Sec. 2. The Bank of France the simplest case. Its semiprivate organization ; monopoly of note issue ; great stock of specie ; advantages and disadvantages, 361 Sec. 3. The Bank of England under the act of 1844. Issue and Banking depart- ments. Relation to other banks of deposit ; large cash holdings. Procedure in times of crisis, 365 Sec. 4. The Reichsbank of Germany. Conditions of note issue. Relation to other banks, 370. CHAPTER 27 THE BANKING SYSTEM OF THE UNITED STATES .... 375-385 Section 1. The old national bank system. Note issue secured by bonds, 375 Sec. 2. Regulation of deposits; requirements as to reserves under the old system. The Federal Reserve Banks ; new requirements. Are there still grounds for compelling all banks to hold stated reserves ? 377 Sec. 3. The Federal Reserve Board ; its large powers, especially as regards the issue of Federal reserve notes, 383 Sec. 4. Absence of branch banking ; great numbers of scattered independent institutions. Advantages and disadvantages of such decentralization, 384. CHAPTER 28 SOME PROBLEMS OF LEGISLATION ON BANKING .... 386-399 Section 1. Grounds for special protection of notes. Legal position of note holders and depositors. Some degree of protection is settled in the United States ; further protection, as by deposit insurance or guarantee, is not out of the question, 386 Sec. 2. An elastic cur- rency. Grounds on which elasticity is desirable ; adaptability to fluctuating needs, and permeation of credit facilities. Failure to secure these gains under the national banking system, 390 Sec. 3. Advantages or disadvantages of central banks. Security of notes not necessarily greater. Pecuniary profit to government negligible. Support to public in time of crisis of high importance. Lack of flexibility a drawback, though one of lessening importance in the United States, 393 Sec. 4. The possibility of political entangle- ment a grave consideration in the United States, 396. xx CONTENTS CHAPTER 29 VOL.! PAGES CRISES AND INDUSTRIAL DEPRESSION 400-411 Section 1. Two phases of crises: industrial depression and finan- cial collapse. Periodicity of crises exaggerated, but regularity of recurrence unmistakable. General features, 400 Sec. 2. Indus- trial depression due to maladjustment in the division of labor, and especially in the making of new capital. Railways ; iron and steel production, 403 Sec. 3. The psychological factor; the contagion of business optimism and depression. The part played by mer- chants and retail dealers, 404 Sec. 4. During the period of de- pression, the machinery of production and exchange is out of gear. The cause and sequence of revival, 406 Sec. 5. Maladjustment in investment ; making of new capital beyond the limits set by avail- able savings. Influence of corporate securities, 408. CHAPTER 30 FINANCIAL PANICS . 412-426 Section 1. Panics as to business men. Interlacing debts and credits, and possibility of general collapse. Demand for accommo- dation in times of crisis, 412 Sec. 2. Position of the banks : de- mands for loans and for cash. Need of a bold policy. Aid which a central bank can give, 413 Sec. 3. Peculiar dangers in the United States, from the wide diffusion of deposit banking. Clearing house action when an individual bank is threatened. Difficulties when all the banks are threatened, 416 Sec. 4. Former devices for dealing with panics, through combined action and clearing house certifi- cates, inadequate in the United States. Severity of the panics of 1873, 1893, 1907. The Federal Reserve system designed as a rem- edy, 418 Sec. 6. Industrial evils of crises hard to remedy. In the main, inevitable concomitants of private industry, 423. CHAPTER 31 THE THEORY OF PRICES ONCE MORE 427-445 Section 1. Credit ordinarily does not supplant money, but post- pones its use. For short periods, extension of credit per se may influence prices, 427 Sec. 2. Credit in the form of negotiable paper, especially bank notes, may be a complete substitute for money. Credit through offsetting of transactions completely sup- plants money. The clearing house does this on a great scale, 428 Sec. 3. Prices depend on purchasing power in terms of money, not only specie, but paper money, credit, bank notes, deposits. Peculiar problem as to bank money, especially deposits : inter- dependence of the volume of purchasing power and the volume of CONTENTS xxi YOU I FA6U transactions, 430 Sec. 4. How the volume of deposits depends on the quantity of specie ; from (a) direct necessity, (6) binding cus- tom, (c) legal requirement, 432 Sec. 6. (d) Interaction of de- posits, notes, specie, 435 Sec. 6. (e) The temper of the business community, 437 Sec. 7. Influence of foreign trade. Prices in credit-using and deposit-using countries affected by prices in other countries, 439 Sec. 8. Illustration of the preceding principles, from analysis of the way in which an increase of gold supply affects prices, 441 Sec. 9. Schemes for regulation of prices through index numbers and increase or decrease of paper money. Money based on specie not ideal, but the best available, 442 Sec. 10. In what sense the term " money " is best used, 444. REFERENCES ON BOOK III 445-446 BOOK IV INTERNATIONAL TRADE CHAPTER 32 THE FOREIGN EXCHANGES -* . . 449-467 Section 1. The "foreign exchanges," based on the varying coin- age systems of different countries. How bills of exchange settle payments without the movement of specie, 449 Sec. 2. The par of exchange, and premium and discount of exchange ; illustrated by sterling exchange in New York, 451 Sec. 3. Bankers as middlemen in foreign exchange. Fluctuations in rates, due to the higgling of the market, 453 Sec. 4. Dealings between a series of countries, illustrated by transactions between the United States, England, and Brazil, 456 Sec. 6. In what manner prices are influenced : in the long run, by the flow of specie ; for shorter periods, by the rates of discount. Various complicating factors, 458 Sec. 6. Foreign exchange between gold-standard and silver- standard countries. The case of British India until 1893, 462 Sec. 7. Foreign exchange when there is depreciated paper. Rela- tion between imports and exports, general prices, and specie pre- mium, 464 Sec. 8. " Domestic exchange " in the United States ; in times past an important matter, now reduced within very slight range of fluctuation, 466. CHAPTER 33 THE BALANCE OF INTERNATIONAL PAYMENTS . . . . 468-478 Section 1. Other items than merchandise exports and imports. Lending and borrowing and their effects on exports and imports. International dealings in securities, 468 Sec. 2. Expenses of trav- elers and nonresidents. Remittances from the United States by xxii CONTENTS TOL. . PAGES immigrants. Freight charges, 472 Sec. 3. Position of a country that mines specie, 473 Sec. 4. Illustration from the international trade of the United States, 1790-1908, 476 Sec. 5. The notion of a favorable and unfavorable balance of trade. Usual attitude of the business community. In the main, an excess of imports or of exports is no indication of loss or gain ; least of all, in the trade between one country and any other country, 476. CHAPTER 34 THE THEORY OF INTERNATIONAL TRADE. WHY GOODS ARE EXPORTED AND IMPORTED ......... 480-493 Section 1. Some familiar facts : money incomes and prices differ in different countries ; but prices of goods entering into interna- tional trade tend to be the same. Money wages not necessarily low in exporting countries, 480 Sec. 2. A country exports those things in which its labor is relatively efficient, in which it has a comparative advantage. Illustrations from countries of high wages and of low wages, 482 Sec. 3. Specially low wages of a particular class of laborers operate as a comparative advantage. General low wages do not affect international trade or enable universal under- selling, 485 Sec. 4. A country may import things for which its labor is productive, if its labor is even more productive for other things. But international trade rests largely on absolute differences in cost, 488 Sec. 5. The gain from differences in comparative cost is dependent on immobility of labor between countries, 490 Sec. 6. A country may import part of the supply of a given com- modity, produce a part at home. Difference between extractive and manufacturing industries in this regard, 491 CHAPTER 35 THE THEORY OF INTERNATIONAL TRADE (continued) . WHEREIN THE GAIN CONSISTS 494-507 Section 1. Difference between exchange within a country and international exchange. Varying rates of wages in different coun- tries show varying gain from the exchanges between them, 494 Sec. 2. An illustrative case, England and Italy. Demand and utility determine relative wages and prices. Slow and obscured operation of this cause, through the influence of the specie supply on prices, 495 Sec. 3. Effects of changes in international demand ; of new articles of export ; of payments other than for merchandise, 498 Sec. 4. Difficulty of following these causes in detail, illus- trated by the case of the United States since 1873, 499 Sec. 5. Money incomes, not prices, important in determining the gain from international trade, 501 Sec. 6. Two causes act on the gain : the CONTENTS xxiii VOL. I FAWM play of international demand and the efficiency of labor in produc- ing exported goods. The last cause settles the general rate of money wages, 603 Sec. 7. High money wages and other incomes do not necessarily bring high domestic prices. Illustration from the United States, 604. CHAPTER 36 PROTECTION AND FREE TRADE. THE CASE FOR FREE TRADE . 508-523 Section 1. The main argument for free trade is simple. Persist- ence of mercantilist notions, 608 Sec. 2. Some popular arguments for protection : creating a home market ; the truck-farm case ; creating employment, 610 Sec. 3. The effect of protection on wages. General wages lowered, though some particular wages pos- sibly kept up, 513 Sec. 4. The principle of equalizing cost of production, 616 Sec. 5. Effects of duties on prices and on con- sumers. A national loss only if domestic products are substituted for those imported. Monopoly may bring special gain to domestic capitalists, but brings no national loss. Labor monopoly may bring special gains to particular laborers, 618. CHAPTER 37 PROTECTION AND FREE TRADE. SOME ARGUMENTS FOR PROTECTION 524-546 Section 1. Protective duties, by their effects on general money incomes, may bring more advantageous terms of international ex- change, 524 Sec. 2. Protection to young industries. Applicable hi the main to manufactures only. Difficulty of gauging its success in specific cases, 526 Sec. 3. Political considerations, illustrated by the case of shipping subsidies, 530 Sec. 4. Social considers tions may tell against manufactures, but not necessarily so. The contemporary controversy in Germany ; Agrarstaat vs. Industrie- staat. The argument as to the failure of food supplies, 533 Sec. 5. Peculiar dependence of England on international trade and on ex- ports. Possibility of strengthening her position as exporter by agreements with colonies and by threats of retaliation, 636 Sec. 6. Growth of protection during the last generation, 538 Sec. 7. Economic effects of protection in the United States ; impossible to measure with accuracy, but certainly exaggerated in popular dis- cussion, 640 Sec. 8. Conditions under which manufactures would maintain themselves without protection. Effect of machinery in connection with comparative costs, 542 Sec. 9. Concluding remarks on the working of protection in the United States, 545. REFERENCES ON BOOK IV 646-547 xxiv CONTENTS VOLUME II BOOK V THE DISTRIBUTION OF WEALTH CHAPTER 38 VOL. n PAGES INTEREST ON CAPITAL USED IN PRODUCTION. THE CONDITIONS OF DEUAND ........... 8-15 Section 1. What is meant by distribution, 3 Sec. 2. The essential problem as to interest. Money is not the cause of inter- est, nor does its quantity affect the rate of interest, 4 Sec. 3. Why there is a demand for present means ; the effectiveness of the time-using processes of production. Is capital productive ? 5 Sec. 4. How the marginal effectiveness or productivity of capital determines the rate of return. A consumer's surplus arises from the more effective applications. Analogy to the problems of value and utility, 8 Sec. 5. Is there a general tendency to diminish- ing returns from successive doses of capital ? 11. CHAPTER 39 INTEREST (continued). THE EQUILIBRIUM OF DEMAND AND SUPPLY 16-28 Section 1. Accumulation of present means needs an inducement, 16 Sec. 2. The gradations in the disposition to save. Cases where the inducement needs to be slight, 16 Sec. 3. Cases where a return is sought. Possibility that a lowered return will sometimes induce larger savings. More often, lowered return checks saving. The conception of marginal savers, 19 Sec. 4. Diagrams express- ing the equilibrium of supply and demand. Savers' surplus, 22 Sec. 5. The steadiness of the rate of interest in modern times and its significance, 26 Sec. 6. The race between accumulation and improvement, 27. CHAPTER 40 INTEREST, FURTHER CONSIDERED . . . . . . 29-43 Section 1. Loans for consumption introduce no new principle as to demand, but are much affected by the absence of full competition, 29 Sec. 2. Public borrowing for wars an important form of such loans in modern times, 32 Sec. 3. Durable consumer's goods, as a form of investment, again introduce no new principle, 32 Sec. 4. No grounds for distinguishing between producer's capital and consumer's capital, so far as interest is concerned. Exchange of present for future the most general statement of the cause of inter- est, 35 Sec. 5. The mechanism of banking and credit makes interest all-pervasive, 37 Sec. 6. Variations in the rate of in- CONTENTS xxv VOL. II PA4HB terest in different countries and for different investments, 38 Sec. 7. The justification and social significance of interest, 41. CHAPTER 41 OVERPKODUCTION AND' OVERINVESTMENT . * : . . . 44-54 Section 1. Overproduction in the sense of excess beyond the possibility of use, is impossible. The extensibility of wants, 44 Sec. 2. Overproduction, in the sense of production beyond the stage of profit, is possible if investment proceeds unendingly. The process of advances to laborers and the readjustment of production under the supposed conditions. Check to the extreme result, from the cessation of accumulation. The reasoning of Rodbertus criti- cized, 45 Sec. 3. A real tendency to overproduction, through overinvestment in the familiar industries, 60 Sec. 4. Industries with large plant, best managed under continuity of operation, are tempted to overproduction or else to combination, 52 Sec. 5. The phenomena of crises and industrial depression are in reality different from those of overproduction, 53. CHAPTER 42 RENT, AGRICULTURE, LAND TENURE ...... 55-75 Section 1. The theory of surplus produce or "rent." Rent does not enter into the price-determining expenses of production. Rent is not the specific product of land, 55 Sec. 2. The existence of rent is dependent upon diminishing returns from land. Advantages of situation as affecting rent, 58 Sec. 3. Qualifications of the principle of diminishing returns : a possible stage of increasing re- turns ; specific plots alone to be considered ; a given stage of agri- cultural skill assumed, 61 Sec. 4. The stage when the tendency to diminishing returns is sharp, 64 Sec. 5. Are there original and indestructible powers of the soil ? Predatory cultivation ; inten- sive and extensive agriculture. Inherent differences tend to be lessened, but do not disappear, 65 Sec. 6. Land tenure. Culti- vation by owners, each with moderate holdings, of greatest social advantage, 70 Sec. 7. Should the community appropriate or retain for itself agricultural rent ? 72. CHAPTER 43 03BAN SITB RBNT 78-91 Section 1. How rent arises on sites for retail trading, wholesale trading, manufactures, dwellings, 76 Sec. 2. The principle of diminishing returns on urban sites ; its operation less steep than for agricultural land, 80 Sec. 3. Site rent depends upon shrewd- xxvi CONTENTS VOL. It PAGM ness in utilization. The activity of real estate speculators, 83 Sec. 4. When capital is sunk irrevocably in the soil, there is diffi- culty in separating rent from return on capital. How far ground rent is identical with economic rent, 84 Sec. 6. How far the activity of real estate dealers and speculators is productive, 87 Sec. 6. Urban rent is sometimes deliberately created ; is it then economic rent ? 89. CHAPTER 44 RENT (concluded) 92-106 Section 1. The rent of mines, how influenced by risk. Dimin- ishing returns on mines, 92 Sec. 2. Are mining royalties rent ? 96 Sec. 3. The selling price of a site is a capitalization of its rent, 97 Sec. 4. The problem of appropriating rent for the pub- lic is presented most sharply by urban sites. The possibility of leases on long term by the state ; the historical development of unqualified private ownership and of vested rights, 98 Sec. 6. The future increase of rent a proper object of taxation. Modes of levying such taxes, 102. CHAPTER 45 MONOPOLY GAINS 107-114 Section 1. Absolute monopolies ; industrial monopolies. Patents and copyrights as instances of absolute monopolies ; the grounds for creating them by law, 107 Sec. 2. " Public service " monopo- lies. Increasing returns and increasing profits, 110 Sec. 3. Com- binations and " Trusts " ; the uncertainty as to the extent of their monopoly power, 112 Sec. 4. The capitalization of monopoly gains and the problems as to vested rights, 113. CHAPTER 46 THE NATUEB AND DEFINITION OF CAPITAL 115-123 Section 1. Is the distinction between interest and rent tenable, in view of the wide extent of differential gains of a monopoly sort ? Grounds for maintaining that all returns from property of any kind are homogeneous, 115 Sec. 2. A different conception of "rent" and " interest," the two being regarded as different ways of stating the same sort of income. "Artificial" and "natural" capital. How measure the amount of capital ? 117 Sec. 3. The important questions are on the effectiveness of competition, the existence of a normal rate of interest, the justification of interest, 120. CONTENTS xxvii CHAPTER 47 TOL.II PAGES DIFFERENCES OP WAGES. SOCIAL STRATIFICATION . . . 124-146 Section 1. Differences of wages which serve to equalize attractive- ness of different occupations ; domestic servants, university teachers, public employees, 124 Sec. 2. Irregularity of employment and risk in their effect on relative wages. Expense of training, 126 Sec. 3. Obstacles to free movement bring about real differences. Full monopoly rare, 127 Sec. 4. Expense of education as an obstacle to mobility, 129 Sec. 5. Inequalities of inborn gifts and social stratification. Uncertainty of our knowledge concerning the influence of inborn gifts, 130 Sec. 6. Noncompeting groups, roughly analyzed as five. The broad division between soft-handed and hard-handed occupations, 134 Sec. 7. Tendency to greater mobility in modern times. The position of common laborers, 138 Sec. 8. What differences in wages would persist if all choice were free, 141 Sec. 9. Why the wages of women are low, and wherein the labor of women is socially advantageous, 142. CHAPTER 48 WAGBS AND VALUE 147-157 Section 1. " Expenses of production " and " cost of production " again considered. If there were perfect freedom of choice among laborers, value would be governed by cost, 147 Sec. 2. There being noncompeting groups, demand (marginal utility) governs relative wages. How this principle applies to a grade or group ; marginal indispensability, 148 Sec. 3. Qualifications : earnings may be so divergent as to cause seepage from one group into another ; the standard of living may affect numbers within a group, 162 Sec. 4. The lines of social stratification are stable; hence changes from the existing adjustments of value are not usually affected by them, 153 Sec. 5. The theory of international trade brought into harmony with the theory of value under noncompeting groups, 154 Sec. 6. Analogies between international trade and domestic trade, 156. CHAPTER 49 BUSINESS PROFITS . . . . ... . . . 158-171 Section 1. Business profits rest on the assumption of risks, 158 Sec. 2. Position of the business man as receiver of a residual in- come. Irregularity and wide range of this income, its relation to prices. Though irregular, it is not due to chance, 159 Sec. 3. The part played by inborn ability ; that played by opportunity, environ- ment, training, 161 Sec. 4. The qualities requisite for success : imagination, judgment, courage. Mechanical talent not so iiupor- xxviii CONTENTS vox., n PAGES tant as might be expected. Relations of the business man to inventors. Diversity of qualities among the successful, 163 Sec. 6. A process of natural selection among business men. Natu- ral capacity tells more than in most occupations, 166 Sec. 6. Motives of business activity and money-making. Social ambition the main impulse ; other motives are also at work, 167 Sec. 7. What changes would occur if business ability were very plentiful and capacity for muscular labor very scarce, 170. CHAPTER 50 BUSINESS PROFITS (continued) 172-191 Section 1. Analogy between business profits and rent. A similar analogy in other occupations. How far the element of risk vitiates the analogy, 172 Sec. 2. The difference in business abilities ex- plains differences in cost of production. The conception of the "representative firm" as settling normal expenses of production, 175 Sec. 3. One of the manifestations of business ability is in the selection of good natural resources. In the end, an important difference between economic rent and differential business profits, 177 Sec. 4. The connection between the return on capital and business profits. Relations between owners and managers of capi- tal at different times. Modern tendency toward a separation of functions and rewards, 179 Sec. 5. For considerable periods, command of capital brings in a given enterprise the probability of larger profits ; but not in the long run without business ability, 181 Sec. 6. For industry as a whole and capital as a whole, there is a connection for considerable periods between interest and business profits. How they may diverge in the end, 183 Sec. 7. A view of business profits which distinguishes them sharply from wages, as arising solely in a dynamic state, 184 Sec. 8. Another view, which lays emphasis on risk, and distinguishes between the wages of salaried managers and the "profits" of independent business men. The salaried manager often rewarded de facto in proportion to "profits," 185 Sec. 9. Legitimate and illegitimate business profits. Their restriction within the legitimate limits dependent on the removal of monopoly gains and the maintenance of a high plane of competition, 187. CHAPTER 51 GENERAL WAGES 192-B08 Section 1. The fundamental question as to general wages is raised by the case of hired laborers, 192 Sec. 2. The notion that lavish expenditure creates demand for labor and makes wages high. Con- sequences of investment as compared with "expenditure," 192 Sec. 3. The fallacy of "making work." Why hired laborers uni- CONTENTS xxix VOL. II PAGK8 versally desire that employment should be created and dislike labor-saving appliances, 194 Sec. 4. The theory of the specific product of labor as determining wages, 197 Sec. 6. Wages depend on the discounted marginal product of labor. Explanation of "margin" and of "discount." Advances to laborers, 198 Sec. 6. Some qualifications. (1) The current rate of interest is assumed to be settled by time preference ; otherwise there is reason- ing in a circle. (2) A broad competitive margin is assumed, otherwise there is no settlement either of interest or of wages, 200 Sec. 7. The mechanism of advances to laborers, the flow of real income into their hands, the reservoir of existing supplies, the replacement of what is advanced, 203 Sec. 8. With the increas- ing complexity of production, interest tends to be a larger part, wages a smaller part, of the total income of society, 205 Sec. 9. The theory of general wages, though it seems remote from the prob- lems of real life, is of high importance for the great social ques- tions, 207. CHAPTER 52 POPULATION . . . ...-. . . . . . 209-225 Section 1. The Malthusian theory, how far strengthened by bio- logical science, 209 Sec. 2. The maximum birth rate, the minimum death rate, the consequent possibilities of multiplication. In what sense there is a tendency to rapid multiplication ; the positive and preventive checks, 210 Sec. 3. The actual birth rates and death rates of some countries in modern times. A high birth rate ordinarily entails a high death rate. Explanation of exceptions. The situation in the United States, 214 Sec. 4. Does a high birth rate cause low wages, or vice versa f Interaction of causes. A limitation of numbers not a cause, but a condition, of general pros- perity and high wages, 220 Sec. 5. The standard of living affects wages, not directly, but through its influence on numbers. Fallacies on this subject, 221 Sec. 6. Mode in which the modern decline in the birth rate has taken place, 223. CHAPTER 53 POPULATION (continued) - 226-237 Section 1. Differences between social strata in birth rates, and their relation to varying standards of living, 226 Sec. 2. The main cause of the general tendency to lower birth rate is social ambition. Its connection with private property and individualism. Illustration from native-born and immigrants in the United States, 230 Sec. 3. Is the preventive check being carried too far ? Eugen- ics and race suicide, 234. xxx CONTENTS CHAPTER 64 TOL . M PASES INEQUALITY AND rrs CAUSES 238-256 Section 1. The fact of inequality : distribution has a roughly pyramidal form. Figures indicating the distribution of income for Prussia, for Great Britain, for London, 238 Sec. 2. The dis- tribution of property, as indicated by probates in Great Britain, by tax statistics in Prussia, 242 Sec. 3. How far it appears that inequality is becoming greater. Dearth of information regarding distribution in the United States, 245 Sec. 4. The causes of inequality : differences in inborn gifts ; the maintenance of ac- quired advantages, through opportunity and, above all, through inheritance, 246 Sec. 5. Inheritance to be justified as essential for the maintenance of capital under a system of private property. Possible limitations of inheritance, through taxation and in other ways, 248 Sec. 6. The grounds on which private property rests. The utilitarian reasoning : differences in inborn gifts, accumu- lation, inheritance. The leisure class ; its economic and moral position, 251 Sec. 7. Whatever the eventual changes, private property, inequality, and the leisure class, will long endure, 255. REFERENCES ON BOOK V 257 BOOK VI PROBLEMS OF LABOR CHAPTER 55 TRADE-UNIONS 261-284 Section 1. Introductory. Character of the questions in this book : they involve the weighing of conflicting considerations, and are affected by social sympathy, 261 Sec. 2. Bargaining power of laborers strengthened by unions. Weakness of the single laborer. Immobility of labor ; lack of reserve funds ; perishability, 262 Sec. 3. Monopolistic tendencies of trade-unions of skilled workers ; not often of permanent importance. The open union, such as alone can develop among the less skilled, a potent instrument for good, 266 Sec. 4. Closed shop or open shop ? A strong case prima facie for the closed shop with the open union, 269 Sec. 6. The danger of a check to progress and efficiency under the closed shop. Limitation of output ; piece work ; the standard rate ; labor-saving appliances ; discipline, 271 Sec. 6. A division between open shop and closed shop not unacceptable. Grounds of employers' opposition often untenable, 276 Sec. 7. The scab and the use of violence. The tie-up, 279 Sec. 8. The unionist movement likely to extend, and entitled to sympathy, 282. CONTENTS xxxi CHAPTER 56 vox., n PAOEA LABOR LEGISLATION 285-302 Section 1. Labor legislation, like labor organization, aims to standardize conditions of employment. Legislation on the hours of labor for women and children the typical case. Other sorts of restriction. Situation in the United States, 285 Sec. 2. Why legislation must supplement and support the laborers' own efforts. A great moving force behind it is the growth of altruism, 289 Sec. 3. Limitation of hours for men comparatively rare. Are there grounds on principle for confining such legislation to women and children ? Constitutional questions in the United States, 291 Sec. 4. The demand for an eight-hour day deserves support. Intro- duced suddenly and universally, the eight-hour day would mean a decline in product and in wages ; introduced gradually, and pari passu with improvements in production, it brings unmixed gain, 293 Sec. 5. Minimum wages introduce no new principle, but present the problem how to deal with the unemployable, 297. CHAPTER 67 SOME AGENCIES FOR INDUSTRIAL PEACE 303-322 Section 1. Profit sharing affects profits as the residual element. Some modes of applying it. Immediate and deferred participation, 303 Sec. 2. Profit sharing will not be widely applied unless it pays, by increasing efficiency. Uncertain connection between profits and workmen's efficiency. Importance of the employer's personality, 306 Sec. 3. Other methods of linking employee to employer: " gainsharing " and "welfare" arrangements, 309 Sec. 4. The sliding scale, applicable where product is homogeneous. Not in harmony with the general principle of employer's assumption of industrial risks, yet often helpful toward avoiding friction and dispute, 311 Sec. 5. Arbitration, private and public. Not appli- cable where such matters as recognition of union or the closed shop are in dispute ; but applicable to questions of wages and the like. Private boards imply trade agreements and organized unions. Public boards are usually boards of conciliation, but none the less helpful, 313 Sec. 6. Compulsory arbitration, carried to its logical outcome, means settlement of all distribution by public authority, and may be the entering wedge to socialism. Possibility that it will remain indefinitely in a halfway stage and not proceed to this outcome, 316 Sec. 7. Compulsory arbitration in the limited range of "public service" industries presents no such deep- reaching questions, and ought to be applied, 320. xxxii CONTENTS CHAPTER 68 V0 i,.n PAGES WORKMEN'S INSURANCE. POOR LAWS 323-345 Section 1. Irregularity of earnings and its causes, 323 Sec. 2. Provision against accident is feasible through insurance. The German system, the English, the French. The charges, though levied on the employer, are likely to come ultimately out of wages, 323 Sec. 3. Insurance against sickness no less feasible. The Friendly Societies, the German system of compulsory insurance. The possibility of malingering and the need of supervision, 328 Sec. 4. Old-age pensions in European countries and in Australia. Are they deterrents to thrift ? The pecuniary difficulties not in- superable, 331 Sec. 5. The situation in the United States as to ac- cidents long chaotic ; the need of reform. Rapid spread of compen- sation for accident. The political difficulties in the way of this reform and others, 334 Sec. 6. Unemployment, though it tends to correct itself, is a continuing phenomenon. Difficulties of applying any method of insurance. Possibility of supplementing trade-union out-of-work benefits. The British National Insurance act of 1911. Relief works, 337 Sec. 7. Poor laws : the conflict between sym- pathy and caution. Relief may be liberal where no danger of demoralization exists. For the able-bodied, it needs to be admin- istered with the utmost caution, 342. CHAPTER 69 COOPERATION 346-369 Section 1. Cooperation attempts to dispense with the business man. Its various forms, 346 Sec. 2. Cooperation in retail trad- ing, when done by the well-to-do, of no social significance. When done by workingmen, as in Great Britain, it has larger effects. Methods of the workingmen's stores and causes of their success. The movement elsewhere, 347 Sec. 3. Credit cooperation in Ger- many ; its methods and results. Other sorts of societies, and development in other countries, 352 Sec. 4. Cooperation in pro- duction would most affect the social structure, but has had the least development. Causes of failure ; the rarity of the business qualities, and the limitations of workingmen. The future of co- operation, 355. REFERENCES ON BOOK VI 859-360 RAILWAY PROBLEMS . . . ... . . . 363-381 Section 1 . Railways an instrument for furthering the geographical division of labor. Corollary from this that they are not to the CONTENTS xxxiii public interest unless they pay, 363 Sec. 2. Economic character- istics of railways ; first, the great plant. Consequent tendency to decreasing cost. Hence also frequency of rapid transition from financial failure to financial success, 366 Sec. 3. Second, the ele- ment of joint cost, both as to fixed charges and operating expenses. Charging what the traffic will bear ; classification of freight, 369 Sec. 4. Justification of charging what the traffic will bear lies in full utilization of the railway equipment, 372 Sec. 6. The pecul- iar severity of railway competition explained by joint cost. How far lower competitive rates on long hauls are justified, 373 Sec. 6. Other consequences of joint cost : flexibility of rates, and difficulty of deciding what is a reasonable rate, 375 Sec. 7. Chaotic rates in the United States, and concession to favored shippers, partly corrupt, partly the result of competition, 376 Sec. 8. " Rebates" and the grounds for prohibiting them. Rate agreements and pools as aids in preventing discriminations. Inconsistency of our legisla- tion on rebates and rate agreements, 379. CHAPTER 61 RAILWAY PROBLEMS (continued) . . . . . . 382-396 Section 1. Effects of railways on distribution. An unearned increment analogous to rising rent of land, 382 Sec. 2. Tendency toward concentration of ownership ; how promoted by American methods of corporate organization. Overcapitalization and its con- sequences, 384 Sec. 3. Stock speculation, stimulated by over- capitalization, has facilitated acquisition of control by the "great operators," 388 Sec. 4. "Inside management" and its evils, 390 Sec. 5. What benefits have come from private ownership in the United States, and how far railway fortunes have been earned, 391 Sec. 6. Increasing tendency to monopoly, and need of public control over rates, 394. CHAPTER 62 PUBLIC OWNERSHIP AND PUBLIC CONTROL ... . S97-418 Section 1. What are "public service" industries? The legal conception less important than the economic ; the essential earmark is monopoly, 397 Sec. 2. The spur of profit necessary for im- provements in the arts ; hence a preliminary stage of private ownership is inevitable, 401 Sec. 3. The question of vested rights when public ownership displaces private. "Franchises" should always be for limited terms. Purchase at market value, 403 Sec. 4. Are there criteria marking some industries as suitable for public management ? The tests suggested by Jevons ; distrust of public officials underlies them all, 405 Sec. 5. To secure trust- xxxiv CONTENTS VOL. a PAQBB worthy and efficient public officials is partly a problem of political machinery. Some difficulties of public management, as regards the employment of labor and the maintenance of progress, 407 Sec. 6. The fundamental requisite in a democracy is a generally high level of character and intelligence. In what way corruption is connected with monopoly industries, 409 Sec. 7. The future of democracy depends on its success in dealing with these indus- tries. Experiments in ownership to be welcomed, especially in municipalities. The prejudices of the business class on this matter, 411 Sec. 8. Public regulation the only alternative to public ownership. The two types of regulating boards. Publicity as a means of supervision. Overcapitalization. The essential object is to limit prices and profits. The elevation of the standards of private management. Supervised quasi-public management only a halfway stage ? 413. CHAPTER 63 COMBINATIONS AND TRUSTS 419-442 Section 1. Combinations in restraint of trade and the common law rule making them void. Surprising effectiveness of this rule, 419 Sec. 2. Modern forms of combination in the United States : the "trust," the holding company, the unified corporation. The Kartel in Germany. The fact of monopoly, not the form of com- bination, the important thing, 420 Sec. 3. The permanency of combination as affected (1) by the economies of large-scale manage- ment; (2) the devices of " unfair" competition, railway favors, discriminations in prices, factor's agreements, advertising devices. The effective defense against "unfair" competition is not from legislation so much as from large-scale competition, 424 Sec. 4. Will large-scale competition persist ? The pressure from constant accumulation of fresh capital. Potential competition, and the possible emergence of f oresighted management tinctured by a sense of public responsibility, 430 Sec. 5. The possible public advan- tages of combination lie in the mitigation of industrial fluctuations. The supposed ruinous effect of competition to be judged from this point of view, 433 Sec. 6. The legislative problems. Federal reg- ulation called for on publicity, capitalization, eventually perhaps on profits and prices, 437 Sec. 7. The earmarks of monopoly : size, profits, discriminating prices, 439 Sec. 8. Legislation in the United States. The act of 1890 and its enforcement. The acts of 1914 ; the Federal Trade Commission, 441. CHAPTER 64 SOCIALISM . . . . 443-459 Section 1. Proposals for large-scale socialism have superseded those for isolated communism. The essence of socialism is economic CONTENTS xxxv VOL. n PASM transformation ; changes in religion, the family, political institu- tions, are not essential to its program. Nor is violent change essential, 443 Sec. 2. Land and capital to be in public hands ; not necessarily public property in every instance. The peculiar problem as to agricultural land. Wages to be the only form of income. Exchange and money in the socialist state, 446 Sec. 3. Three conceivable principles of distribution : need, sacrifice, effi- ciency, 449 Sec. 4. How far public ownership, as adopted in present society, is socialistic ; how far labor legislation and the like are so, 454 Sec. 6. Some current objections to socialism are of little weight ; for example, that the huge organization is imprac- ticable, that goods could not be valued, that capital could not be accumulated. Would freedom disappear ? 456. CHAPTER 65 SOCIALISM (continued) 460-478 Section 1. The family and the problem of population under socialism. The Malthusian difficulty a real one, 460 Sec. 2. Vigor and efficiency among the rank and file. The absence of the power of discharge. The irksomeness of labor, 462 Sec. 3. Leadership and the ways of securing it. The love of distinction ; can it be satisfied by the laurel wreath ? Mixture of higher and lower aspects in the love of distinction. The possible growth of altruism, 464 Sec. 4. The selection of leaders in a socialist state. Genius and originality likely to be deadened, 466 Sec. 5. Mate- rial progress through the improvement of capital likely to be checked. Is a change in distribution alone now needed ; can ad- vance in production be neglected ? 468 Sec. 6. The problem is essentially one of motive and character. Human nature and ideals of emulation and distinction are subject to change. Though social- ism and current movements of reform rest on the same force, the difference in degree is vast, 470 Sec. 7. Is socialism to be the ultimate outcome of social evolution ? The materialistic interpre- tation of history and its prophecies. The certainty that change will be gradual and the impossibility of foreseeing how far it will finally go, 473. REFEREKCES ON BOOK VII . 478-479 BOOK VIII TAXATION CHAPTER 66 SOME PRINCIPLES UNDERLYING TAXATION 488-496 Section 1. The essential nature of taxation : no quid pro quo. Taxes a sign of wider consciousness of common interest, 483 xxxvi CONTENTS VOL. U PASM Sec. 2. Proportional or progressive taxation ? This question of justice inextricably^ connected with the general question of social justice and the righteousness of inequalities in wealth. " Ability" and "equality of sacrifice" are inconclusive principles, 485 Sec. 3. Should funded incomes be taxed at higher rates than un- funded ? 490 Sec. 4. Can taxes be made higher according to the source or nature of the income ? 492 Sec. 6. Progressive taxation of interest, on the principle of taxing saver's rent, 494. CHAPTER 67 IHCOMB AND INHERITANCE TAXES 497-514 Section 1. Income taxes present the problem of progression sharply ; yet should be considered in connection with other taxes, 497 Sec. 2. Income taxes limited as a rule to the well-to-do classes. The exemption of small incomes rests partly on social grounds, partly on administrative expediency, 498 Sec. 3. The British income tax and the device of stoppage at the source. Dec- larations of a taxpayer's entire income rarely required. The system not consistent with progression, 500 Sec. 4. The Prussian income tax as a type of progressive taxation on entire income. Declara- tion necessary. Conditions necessary for the effective administra- tion of such a tax, 505 Sec. 5. Inheritance taxes are comparatively easy of enforcement, and lend themselves readily to progression. Carried too far, they check accumulation and the increase of capi- tal, 507 Sec. 6. Some further considerations on inheritance and income taxes, 510 Sec. 7. The income tax question in the United States. The constitutional amendment of 1913 and the income tax of that year, 612. CHAPTER 68 TAXES ON LAND AND BUILDINGS 616-52 1 ) Section 1. Taxes on land (e.g. an urban site) rest definitively on the owner, and operate to lessen economic rent by so much, 515 Sec. 2. Taxes on buildings tend to be shifted to the occupier. Qualifications and limitations of this proposition, 518 Sec. 3. Effects of taxes on real property, land and buildings combined, 521 Sec. 4. In the long run, it makes no difference in the inci- dence of such taxes whether they are first imposed on owner or tenant ; but for short periods, it does. Similarly, it is in the main of no concern whether the assessment be on rental or on capital value; though in some respects the two ^methods bring different results, 522 Sec. 5. Concealed taxation of workingmen through taxes on their dwellings, 525 Sec. 6. Taxes on real property should be primarily local taxes, 626. CONTENTS xxxvii CHAPTER 69 TOL. n PAGE* THE GENERAL PROPERTY TAX 528-649 Section 1. The general property tax works sufficiently well under simple industrial conditions, 528 Sec. 2. In complex modern com- munities it is impracticable. Many incomes arise which do not rest on property ; many forms of property are not readily reached ; the development of debts and credits, of corporate organization, causes difficulties, 629 Sec. 3. The rate of taxation important. Its influence in the case of securities. Complete breakdown of the system as to these, 532 Sec. 4. The taxation of corporations and of corporate securities. "Double taxation" of stocks and bonds. A method analogous to stoppage at the source should be applied. Difficulties of apportionment between conflicting jurisdictions, 536 Sec. 5. Mortgages and mortgage notes present similar problems, 540 Sec. 6. Public securities present especial difficulties for a property-tax system. Is it expedient to exempt them from taxa- tion ? 543 Sec. 7. Possible ways of reforming American methods of taxing securities : complete exemption, moderate tax on capital value, tax on the income, 644 Sec. 8. A question of principle: how far can the taxation of income-yielding property be carried without checking accumulation ? 647. CHAPTER 70 TAXES ON COMMODITIES 660-560 Section 1. Direct and indirect taxes. Various ways in which "indirect" taxes are levied on commodities, 550 Sec. 2. In the simplest case, of a competitive commodity produced under constant returns, a tax tends to be shifted to consumers. Explanation and qualification of this principle, 551 Sec. 3. Complexities where the commodity is produced under increasing or diminishing returns; where there is monopoly. Cautions to be observed in the applica- tion of theoretic reasoning on these topics, 553 Sec. 4. Taxes on imports present no peculiarities, except as they bring a rival un- taxed supply and thus raise the questions concerning protection, 667 Sec. 5. Taxes on commodities are little noticed by con- sumers. They are commonly on articles of large consumption, and regressive in their effects. A large and varied list of article* is most easily reached by customs duties, 557. REFERENCES ON BOOK VIII ..,.,,... 561 BOOK I THE ORGANIZATION OF PRODUCTION CHAPTER 1 OF WEALTH AND LABOR 1. To define with accuracy the scope and contents of eco- nomics is not of importance in the earlier stages of its study. The precise demarcation of its subject matter, and its relation to other branches of knowledge, can be understood only when something is known of its main conclusions. It suffices at the outset to indicate by an example what is the nature of the prob- lems dealt with. A good example is found in the economic position of one of the most familiar articles of use, water. In a thinly settled community, where springs and streams are abundant, water is free to all. No question can arise as to its ownership or as to the mode in which the community should deal with it. Every one is fortunate in having an unlimited supply. No one can gain advantage by taking possession of part of it, or devoting labor to procuring it. Water under such conditions is said to be a "free" good, not an "economic" good. It is not an economic good, in the sense that no economic problems arise regarding it. Every one has all he wants, and thereby is prospered ; what more is there to say? A stage may come very early when some labor will be given to making the water conveniently available, and when it will be no longer strictly a free good; and when yet no economic questions of any complexity arise. The individual may dig a well, or pipe the water from a spring or stream to his dwelling. The very first economic problem, that which may even be considered the fundamental problem, then emerges : How much effort is it worth while to give to the supply of this convenience ? 3 4 THE ORGANIZATION OF PRODUCTION But the problem remains a very simple one, so long as the in- dividual exerts himself to satisfy his own wants only. There is no dealing with others, no sale, no question of price. If men were to work solely for the satisfaction of their own wants, the difficult economic questions would not arise at all. A more complex stage is reached when water is brought in by some individuals and sold to others. In Oriental towns the water carrier, with his runlet or skin, is still a familiar figure. In our own cities private individuals sometimes sell carboys of spring water or distilled water. Here questions of sale and price arise. What settles the terms on which water is sold? What settles the earnings of those who supply it? Are they in a position of advantage or not? Here are matters less simple. Still another stage (not necessarily a later stage) is reached when common action is taken to procure the water. Here the problem may remain comparatively simple, or it may become one of the troublesome problems of modern communities. The traveler in Italy sees the village fountain, supplied by its aqueduct ; even in larger towns, through some parts of Europe, the public fountain has remained until very recently the chief source of supply. The water is no longer strictly a "free" good, since effort and expense were required to bring it where wanted. But the effort was made long ago, does not need to be renewed (there are no expenses of upkeep), and there is so much water that it can be used ad libitum. In the modern city, however, the case has become different. There are great reservoirs, elaborate pumping stations, mains, and pipes. Water is supplied abundantly and conveniently to every house- hold. There is not only a vast initial outlay for the plant, but a continuing cost of upkeep. The questions arise, Who shall make the outlay and manage the supply ? Shall there be public or private ownership? And, whether under public or private ownership, what are to be the conditions of sale? Conceiv- ably the water, if under public management, may still be sup- plied gratuitously to all, as it is at the village fountain; or OF WEALTH AND LABOR 5 payment may be required of the users. The questions of profit arise, of sound public policy, of possible monopoly gains, of con- flict between financial and hygienic considerations. The really complex problems of economics arise full-fledged. 2. To designate these different sorts of conditions, some quasi-technical terms are often used: "free goods," "economic goods," "public goods," "wealth." What are free goods and what are economic goods has just been indicated. Fresh air, climate, sunshine, are the obvious cases of free goods ; so is water under the simplest conditions, or standing timber in a thinly settled and well-wooded country. Scarcity is the earmark of an economic good, scarcity, that is, relatively to the demand. Water becomes an economic good when effort is needed to obtain it in the quantity desired, at the place of use. It is conceivable that in the future fresh air may become, for considerable parts of mankind, an economic good. It is so already when many persons are gathered in a large room or hall. Fans, conduits, engines, are installed; it becomes a question how the needful efforts shall be best directed, who shall bear the expense. With the concentration of popu- lation in great cities, and the multiplication of agencies that pollute the air in them, it is possible that elaborate means will have to be taken for keeping it healthful. Then the same complex problems will present themselves as in the case of water; all resting on the relative scarcity of the thing in question. "Public goods" are economic goods supplied gratuitously to individuals, yet involving effort and consequent expense to some one. Though free to the users, they are not free goods. Such is water at the public fountain ; such are public education, parks, museums, free concerts, bridges, and highways. What goods shall be public, and by whom the expense of providing them shall be met, whether by levy on all persons, or on some only, these are the problems as to public functions and as to taxation for defraying their expense; among the most diffi- cult and far-reaching that the economist has to deal with. 6 THE ORGANIZATION OF PRODUCTION It was common in the older books on our subject to define political economy (a phrase replaced in modern times by the simpler "economics") as the "science of wealth." In this usage, "wealth" meant all the economic goods, including the public goods. Either term wealth or economic goods serves to describe the subject matter with which economics has to deal ; those things which men want, which are not free, and which present the problems of effort, of satisfaction through effort, of the organization of industry. Evidently a community is the better off, the more free goods it has and the less the range of things that come within the category of "wealth." Where unlimited pure water and fresh air are at every one's disposal, the conditions of life are eased by so much. A mild and equable climate relieves the people of some favored spots from much labor that must be given else- where to protection from heat or cold. It may be said, with an appearance of paradox, that the more things in the nature of wealth a community has, the less prosperous it is. The paradox is easily solved. The wealth of a community is not the sum total of things on which its welfare depends, these include its free goods as well as its economic goods. The more things are free, the easier are the conditions of living. The more things are economic, the wider is the range of commodities concerning which the economic problems arise, and the wider is the scope of the science of "wealth." The abundance of free goods, though prima facie advanta- geous to a community, does not always coexist with the highest degree of prosperity. In tropical and semitropical countries the conditions of living are on the whole easier than in temperate countries. Some sorts of food are free or nearly free, and protection does not need to be provided against the cold of winter. But the climate saps energy, and checks the develop- ment of physical vigor and of intellectual capacity. Hence the peoples of temperate regions, from the very obstacles they have to overcome, gain resources within themselves which lead eventually to greater prosperity. So it is with individuals. OF WEALTH AND LABOR 7 He who has always had abundant means at his command often lacks endurance and spirit, and in the end is surpassed in hap- piness as well as in riches by him who had to face harder con- ditions at the start. 3. In the preceding paragraph wealth has been spoken of as the result of effort. But there are cases where a commodity is wealth, is an economic good, even though it be obtained without effort. A free gift of nature may be wealth, if it is limited in quantity. On some parts of the seashore the waves dislodge from near- lying rocks quantities of kelp, which is useful as a fertilizer. Like multitudes of other articles, its use is indirect; it does not satisfy wants directly, but is an aid in the operations for satis- fying them. Obviously, it may none the less be wealth. If kelp were steadily borne to the shore in such quantities that every one could get all he wished, it would be a free good in the strict economic sense. But if it is deposited in limited quantities on favored spots, and if many farmers are desirous of using it, it will command a price as it lies on the beach, before even the hand of man has touched it. And the same supply which at one time was so abundant as to command no price, may be brought by the growth of population within the circle of things bought and sold, and so become one of the goods with which economic science deals. Meteoric stones, usually disintegrated by heat before touching the earth's surface, in some instances reach the ground. Being scarce, and in our days esteemed for scientific research or even for the satisfac- tion of mere curiosity, they command a price, and, though the free gift of nature, are not free goods in the economic sense. The same narrowing of the circle of free goods, and the same widening of that of economic goods or wealth, appear if there be not a natural, but an artificial, scarcity of goods. A supply of water or timber, unlimited in quantity for the needs of a given community, may come by force or by long-settled law under the control of some individual or individuals. By limit- ing the amount which others shall have, the owners may make 8 THE ORGANIZATION OF PRODUCTION such things a source of income for themselves and cause them to enter the list of economic goods. Monopoly per se raises some of the questions with which economic science has to deal. This simplest sort of scarcity may seem to be exceptional ; and as to the things which we usually think of as goods or commodities, it is so. The instances just adduced are excep- tional. In the vast majority of cases commodities become economic after some labor has been applied to fashioning them. Though scarcity (that is, relative scarcity) still underlies the notion of wealth or economic goods, it is scarcity in the sense that the materials supplied by nature need to be adapted to man's use by his labor. Labor, or effort of some sort, is usu- ally the cause or condition of economic phenomena. There is one large class of things, however, for which this statement does not hold : limited natural agents, of which land is the most conspicuous. These are not commonly called goods or wares; but they are economic goods in the strict sense, being limited in quantity and of high service in satisfying wants. Agricultural land, power and deep-water sites, forests, mineral lands, all are often economic goods by virtue of mere natural limitation of quantity. They present, as will appear in due course, some of the most intricate social and economic problems. 4. What is labor, may seem a simple matter. Most people would say that they are more than sufficiently familiar with it. Yet some questions arise concerning it that go to the heart of economics, and the last word on them cannot be said until the very close of the exposition of the whole subject. Some activities are agreeable, some are irksome. Some are undertaken for the pleasure of doing, some for a reward. Not infrequently the two satisfactions are gained simultaneously from the selfsame activity; it is both a source of pleasure in itself, and it brings a reward. So far as the nature of the muscular or nervous effort is con- cerned, no distinction can be drawn between the agreeable and the irksome activities, or between those which are undertaken for pleasure and those which are undertaken for pay. Such OF WEALTH AND LABOR 9 severe physical labor, combined with hardship and exposure, as mountain climbing, is done for pleasure by tourists and for pay by guides. The pursuit of athletic sports is the most fa- miliar of recreations and is also a familiar profession. A multi- tude of occupations ordinarily pursued for gain woodworking, gardening, painting, acting are also pursued by many persons for the satisfaction which the doing affords. None the less it is true that the greatest part of the activity which men carry on in getting a living does not give pleasure. The chief reason seems to be that activity, in order to be effec- tive toward getting a living, must be steady, unvaried, and long-continued; and it must be, in an important sense, not free. The characteristic of most activities that are sources of pleasure in themselves is the element of freshness or novelty, and the absence of compulsion. The guide who climbs moun- tains year after year, and knows the tracks by heart, soon finds the task a weary one ; and this the more, because, in order to earn his living, he must follow his tracks regularly, regardless of his health or spirits at the moment. It is the zest of novelty and the sense of freedom and choice that cause pleasure in the summer's arduous vacation. Inactivity and idleness soon become irksome; but, with few exceptions, steady application to the same task also soon becomes irksome. In savage and barbarian communities, the men usually confine themselves to the chase and to war. The monotonous work of cultivating fields and of preparing food is left to the women. Though hunting and fishing often entail the most strenuous exertion and the severest hardship, they do not com- monly endure long, and they are almost surely varied by changes and respites. The variety and the sudden changes give play for emulation and for satisfying the love of distinction, that for slaughter also, instincts which have a powerful effect in many fields of economic activity. An alternation of periods of complete idleness and of feverish activity is characteristic of those early stages of society in which men give themselves to the unchecked satisfaction of their instinctive propensities. 10 THE ORGANIZATION OF PRODUCTION The sort of labor that occupies the mass of mankind in civ- ilized societies, and that which brings the largest product, is mainly of the continuous, monotonous, and irksome kind. This is more especially the case where the division of labor has been much elaborated. The wide extension of the division of labor, as we shall presently see, has been a main cause in modern times of the greater abundance of material goods, and of the extraordinary advance in material prosperity. But it has probably also been a cause of greater weariness and unattractiveness for most labor. Even in the simpler and older form of the division of labor, where one man was carpenter, another smith, another cobbler, there was of necessity a steady repetition of operations and no little monotony of work. But in the remarkable splitting up of occupations which has resulted from the elaboration of machinery in modern times, it is rare that a workman does all the work of his trade, or even knows how to do it. He is no longer a cobbler making a whole shoe, but a factory hand attending hour after hour and week after week to the same minute piece of machine work. Moreover, in a dense population and with strictly enforced ownership of property and of land, he is under compulsion to do continuous work of some such sort, in order to keep body and soul to- gether. He lacks variety, and he lacks freedom. He may find pleasure in exerting himself strenuously at sports ; but the labor of getting his living yields in itself little satisfaction. 5. Some sorts of labor, though pursued systematically and continuously, seem never to become wearisome. This is the case with much intellectual labor, especially that of persons who are engaged in the pursuit of knowledge and in the satisfac- tion of man's insatiable curiosity about the things that surround him. Persons of artistic temperament painters, musicians, poets have often so strong an instinctive bent toward one kind of activity that nothing can hold them from it and nothing ever pall the pleasure of the exertion. And any occupation which satisfies the instinct of emulation has unceasing charm. He who can achieve things which few can achieve, and which OF WEALTH AND LABOR 11 many would like to achieve, rarely tires of his work. The actor, even though his occupation involves the monotonous and long- continued repetition of the most trifling details, never fails to get a thrill of pleasure from the breathless silence or stirring applause of his audience. Were he compelled to go through his part as often and as rigorously under the cold supervision of an indifferent supervisor, and under that only, how flat and stale it would become ! For a similar reason, work of leader- ship and command almost always is continuously pleasurable. It satisfies the love of distinction and the desire for domination ; and it has a real or apparent element of freedom. Hence the work of the employer commonly affords more satisfaction than that of the employee, and often is continued, from mere love of the doing as well as from habit, long after the reward or profit from the exertion has ceased to be valued. These exceptions should not blind us to the fact that by far the greater part of the world's work is not in itself felt to be pleasurable. Some reformers have hoped to reach a social system under which all work should be in itself a source of satis- faction. It is probable that such persons are made optimistic by the nature of their own doings. They are writers, schemers, reformers; they are usually of strongly altruistic character, and the performance of any duty or set task brings to them the approval of an exacting conscience ; and they believe that all mankind can be brought to labor in their own spirit. The world would be a much happier place if their state of mind could be made universal. But the great mass of men are of a hum- drum sort, not born with any marked bent or any loftiness of character. Moreover, most of the world's work for the satis- faction of our primary wants must be of a humdrum sort, and often of a rough and coarse sort. There must be ditching and delving, sowing and reaping, hammering and sawing, and all the severe physical exertion which, however lightened by tools and machinery, yet can never be other than labor in the ordinary sense of the term. Reference has just been made to a greater monotony of 12 THE ORGANIZATION OF PRODUCTION labor in modern times, under the influence of growing use ol machinery and growing specialization of labor. But the extent of the change in this regard may be easily exaggerated. Ruskin has dwelt on the charm of the medieval craftsman's task, who felt the joy of work that had beauty and character. Yet this joy was probably shared by few in medieval times, or in any other. Then, as now, most work involved the repetition of the same operations, and was felt to be tedious and exacting. It is not easy for us to picture the conditions of life in earlier societies, organized in a very different way from our own ; but it is more than probable that the mass of mankind found their tasks then on the whole no pleasanter or lighter than now. 6. We may hope that, as the material conditions of man- kind improve, especially in the countries of advanced civiliza- tion, gains will be achieved as regards the irksomeness of ordi- nary labor. Some alleviation will come from a mere change in the state of opinion in the community. The sense of dis- tinction affects the satisfaction from exertion. A task admired is an attractive task, and one despised is unattractive. The common attitude of the more favored classes has long been to contemn manual labor and those who perform it. Such was the natural attitude in communities based on slavery, or on its successor, feudalism ; and such remains too often the attitude of that leisure class which in modern times adopts many of the traditions of feudalism. The growing democratization of society may be expected to change this, and to raise the dignity and self-respect of labor of all kinds, manual or mental. Greater ease of movement between different classes and greater equali- zation of their conditions will add to the esteem in which all kinds of manual labor are held, and may remove some at least of the causes that now contribute to make it unwelcome. The chief mode, nevertheless, in which labor is likely to be made less irksome is not by a change in its character or its intrinsic attractiveness, but by a diminution in its severity. It will probably be lightened by the increasing perfection of tools and the increasing use of machinery ; though on the other OF WEALTH AND LABOR 13 hand, it may be that from this cause its monotony will become no less, perhaps greater. More important is the prospect that the hours of labor are likely to be shortened, and the hours for recreation and variety correspondingly lengthened. The weari- ness of labor is by no means in proportion to the number of hours spent on it. For a healthy and well-nourished person, the first hours of work are not a source of fatigue. Some writers have indeed maintained that during these earlier hours bar- ring perhaps a brief initial period of stiffness there is a sense of pleasure rather than of pain. This may be the case in intellec- tual activity, and in some handicraft occupations; and the experience is a familiar one in holiday jaunts. But little direct consciousness of pleasure comes at any stage from the stated work of the great majority of men. The difference between the earlier parts of their day and the later is not so much that the former are pleasant and the latter unpleasant, as that fatigue does not begin until some hours have passed, and then becomes increasingly severe with each of the later hours. When indeed the hours of labor are unduly prolonged, fatigue becomes so great and so deep-seated that the period of rest and sleep does not suffice to remove it. The next day begins again with fatigue, and worse succeeds worse. Such was the effect of the factory system in its early stages in England ; such is still the situation in backward countries like Russia. Under these wretched conditions, the work of the day has covered eleven, twelve, even fourteen, hours. In the United States, in our own day, some of the steel-making industries, whose operations go on night and day, have had two shifts, in each of which the men worked twelve hours. To cut off one, two, three hours, from such a day's labor is to cut off a much larger proportion of the weariness of labor. The movement for shorter hours has been one of the most beneficent aspects of the betterment of material conditions in civilized countries during the last two or three generations. The day's labor was first cut down to eleven and ten, partly from the pressure of workmen's organizations and partly from 14 THE ORGANIZATION OF PRODUCTION legislation restricting the hours of women and children em- ployed in factories. It is still in process of being reduced. The ideal of the trade unions is now to lower it to eight hours; a limit which has already been reached in the more prosperous and highly paid trades, and is likely to be at- tained by a larger and larger proportion of manual workers. We shall have occasion to consider at a later stage the signifi- cance of this shortening of the period of work, the nature and causes of the gains so secured, and the fallacies which have attached themselves to the short-hour movement. 1 But in itself that movement should have the sympathy of every friend of humanity. Notwithstanding all the alleviations of the irksomeness of labor, through moderate tasks, free time for recreation, a rational respect for labor of all kinds, the larger part of the world's work will always be felt to be irksome. A fortunate minority may work at tasks which are in themselves pleasur- able and are not performed chiefly for the return which they bring. But most work is now undertaken for reward, would not be done without reward, and is strenuous and well directed in proportion to the reward. It is doubtless true that the mass of mankind, though they find their labor irksome or repellent, are yet happier than they would be under complete idleness, or with only that fitful kind of exertion which attracts the savage. But labor is commonly felt to be a hardship, and the pay which it secures is the dominant motive for undertaking it. The fundamental problems that arise in economics are concerned with the relation between unwelcome exertion and the remu- neration which induces that exertion. See Book VI, Chapter 56. CHAPTER 2 OF LABOR IN PRODUCTION 1. The relation of labor to production may seem simple. Yet it has been the occasion of great difference of opinion among acute thinkers, and it presents some nice questions. We commonly speak of a tailor as making clothes, a carpenter as making a table, a cobbler as making boots. The briefest reflection shows that this is a careless use of language. The labor of the tailor but gives the finishing touch to the work previously done by a long series of persons, the shepherd who tended the flocks, the wool shearer, those who transported the wool by land and sea, the carder and spinner and weaver, not to mention those who made the tools and machinery of these workers. Similarly the carpenter is the last of a succession of persons who worked toward a common end, those who felled the trees, fashioned the timber, transferred it from the woods, and so on. Many laborers, arranged in long series, combine in making even the simplest commodities. But it is clearly all these laborers, taken together, who pro- duce the commodities ; and can it not be said these alone are the producers of wealth? Wealth has been described as con- sisting of those goods which are not free. The term refers primarily to things that are tangible and material. Many laborers produce no wealth in this sense. Such are domestic servants, policemen, actors, singers, teachers. Does not their work stand in a different relation to production from that of laborers who make material things and carry on production in the common meaning of the word ? This was the opinion of many of the earlier writers on eco- nomics, especially the English writers from Adam Smith to John Stuart Mill. Their view was that only such laborers as turned 15 16 THE ORGANIZATION OF PRODUCTION out material things were productive; all others were unpro* ductive. A liberal interpretation was indeed given to their definition of the productive laborers. Not only those who directly handled materials and fashioned them were included, the day laborer, the carpenter, and the smith ; but those also by whom the operations were guided and promoted, the em- ployer who directed the manual laborers, the foreman and the engineer, the teacher who trained the engineer. Even the teacher of the humblest workman may conceivably be re- garded as contributing to the operations of material production, in so far as the diffusion of even the rudiments of education raises intelligence and adds to efficiency. But with the widest latitude in interpretation, a great range of persons, doing all sorts of work and by it earning a living, remained outside the class of the so-called productive laborers. Domestic servants, lawyers and judges and policemen, all the army and navy, not to mention persons who provided mere amusement, were classed as unproductive. As Adam Smith remarked, "in the same class [of unproductive laborers] must be ranked, some both of the gravest and most important and some of the most frivolous professions : churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera singers, opera dancers." This distinction between productive and unproductive laborers was early attacked and long debated. It was pointed out that it seemed to affix some sort of stigma an accusation of uselessness, of being in need of support from others on whole classes of persons whose work was admitted to be hon- orable and often seemed to be indispensable. But this was after all not material; whether or no an "unproductive" occu- pation was to be regarded as honorable, the essential question was and is whether there are differences between this kind of work and the other which are important for the welfare of the com- munity. It was much more to the point that the distinction led to difficulties and inconsistencies. The musician was regarded as an unproductive laborer; was the artisan who OF LABOR IN PRODUCTION 17 made his instrument his violin nevertheless productive ? The labor of the violin-maker issued in material wealth, or, as Adam Smith said, in "a vendible commodity." Yet its only object was to make an instrument to be used by the musi- cian; and was not the consistent view that of regarding the two sets of persons as combining for a common result, just as the sheep shearer, the weaver, and the tailor combine in making clothing ? And if thus working together for the same end, was one to be set apart as productive, the other as unproductive? All members of the navy and army were classed as unproduc- tive; yet those who built the ships, made the guns and the powder, were supposed to be productive. If one set were unproductive, why not the other ? 2. The solution of these difficulties is indicated by a con- ception which the British economists, though they followed it in other directions, were curiously slow to use with reference to their discussion of productive labor. It points to satisfactions, or utilities, as the aim and end of production. We shall see, as we progress, how hi various directions economic science gains, and is often brought to unity and consistency, by the analysis of production as ending in utilities. If it is a careless use of language to speak of a carpenter as "mak- ing" a table, it may also be said to be a careless use of language, or, at best, a short-cut expression for a complicated act, to speak of any artisan or set of artisans as "making" anything. The amount of matter in the world is not subject to man's control. He cannot add to it one atom or subtract one atom. All that he can do is to change forms and combination. And just this he does in production. He fashions and refashions material things. He puts them into forms in which they serve his wants. Such is obviously the nature of the carpenter's work, the tailor's, the cook's. It is not less true of those whom we de- scribe as "producing materials." The plants from which man secures the greatest part of his food and most of the materials he uses, get their constituent parts from the soil and the air. What man does is to arrange conditions favorable for their 18 THE ORGANIZATION OF PRODUCTION growth. The minerals which he uses are a fixed store in the earth's crust. When we say that coal is produced, we mean that it is brought to the surface and made available for our use. The modes in which man brings about utilities or satisfac- tions are many. Not only are plants grown, and coal, iron, copper brought up from the mines; not only are these raw materials shaped and adapted for their different uses, they are also transported to the places, often very distant, where they reach the hands of those whose wants they finally satisfy. They are bought by traders from one set of persons, and sold again to another; and among the traders there is a division of labor, some buying at wholesale and selling again to the re- tailers, who dispose of the commodities to their customers. The phrase "place utility" has been used to describe the con- tributions of those engaged in transportation and trade ; and it serves to bring into relief the fact that such persons, though they do not shape or fashion commodities, yet contribute to their utilization. Now, since the essence of production is that it leads to satis- factions or utilities, it follows that any labor or effort that yields utilities is productive. The musician whose performance brings us pleasure does precisely the same sort of thing as the florist whose blossoms last a few hours. The domestic servant contributes to our ease just as does the artisan who supplies the furniture for our dwellings. No doubt there are gradations in the importance of the wants supplied by different workers. The essentials of life are most important; the conveniences and luxuries come after them ; and these gradations, as we shall see, have economic consequences. But they are not significant for our present purpose; they give no ground for distinguishing between those producers who embody utilities in material objects, and those who do not. If we were called on to dispense with the services of some of the producers, we might put aside, as easily spared, first, the buffoons and the opera dancers who figure as unproductive hi Adam Smith's list. But we might OF LABOR IN PRODUCTION 19 also put aside at once the scene painters at the opera, the printers of trashy books, the makers of cloying sweets and noxious drinks. And if, on the other hand, we were called on to say what producers we should retain to the last, we should select not only those who supply the material things essential for existence, food, clothing, shelter, but also the physician who preserves our health and the teacher who maintains the education on which rests civilization. The distinction between things essential and things dispensable is by no means the same as that between material and immaterial sources of utilities. We conclude, then, that all those whose labors satisfy wants all those who bring about satisfactions or utilities are to be reckoned as taking part in production, and are to be called productive laborers. Certain it is, whatever phraseology we care to apply, that no conclusions of importance for economics flow from the distinction between those who shape material wealth and those who bring about utilities of other kinds. And the test of the value of a distinction or classification is always that significant propositions can be laid down as to the things put into a given class which do not hold for those outside the class. This conclusion also enables us to dispose of an allied question : Is there nonmaterial wealth ? Those who denied the old prop- osition, who maintained that labor which did not embody a utility in material objects was nevertheless productive often maintained that there was such a thing as "nonmate- rial " wealth. The phrase certainly is not in accord with com- mon usage. We think ordinarily of wealth as something that can be kept and accumulated, and intend by it tangible things ; and hi this sense it is a contradiction in terms to speak of im- material wealth. But if we use the more technical and there- fore more precise phrase, "economic goods," we include all those things and services which satisfy human wants and are not to be had free. Services of those whom Adam Smith and his followers called unproductive laborers come under this head. 20 THE ORGANIZATION OF PRODUCTION They are desired and prized, often highly prized ; and they are yielded by human effort. The rewards earned by these efforts are an important topic in economic science, and the utilities provided are an important part of the sum of utilities which constitute, in the last analysis, the community's income. If we mean by wealth anything about which economic problems arise, we must make the term coextensive with the term " eco- nomic goods " ; and then we may speak of nonmaterial wealth. 3. From this interpretation of the terms, it would seem to follow that all labor belongs to the productive class. If not only the butcher and the baker are in this class, but the barber and the fiddler, do any remain who are to be regarded as unproductive ? Obviously, there are some persons who are outside the pale of productive activity. The paupers, thieves, swindlers, ne'er-do-wells, are parasites. Thieves and swindlers often exert themselves severely, though not often continuously. But their activity is purely predatory. They contribute nothing; they simply try to get things away from others. Whether or no we should apply the term "labor" to their exertions, it is certainly not to be called productive labor. A different question arises as to some labor carried on without violation of the law and without conscious delinquency, yet certainly of doubtful aspect. A quack medicine, containing ingredients which the maker knows to be noxious, or at best harmless, may be puffed by mendacious advertising into wide- spread use. Can it be said that the labor devoted to preparing it and persistently circulating lies about it is productive of satisfactions, and therefore to be reckoned as productive labor ? To take another case, of still a different sort, what shall we say of the labor given in well-nigh all communities to the pro- duction and sale of intoxicating liquors ? Among physiologists the settled conclusion is that, though the use of these stimulants in the lighter forms may lead to no serious harm, that of dis- tilled spirits is overwhelmingly bad. It is certain that an immense amount of misery and vice comes from the widespread OF LABOR IN PRODUCTION 21 use of strong liquors ; that the diminution in their consump- tion during the last generation or two has brought better- ment for mankind; and that the world would be a much happier place if drunkenness could be stamped out. What has the economist to say of labor given to the production of things harmful ? These cases call for discrimination. They may be cases of fraud and deceit. They may be cases of wants misdirected, but none the less wants really felt and really satisfied. Fraud and deceit mean that a person does not secure that which he expected and was led to expect. In an ordinary sale, the seller is not presumed by the law to give a guarantee as to the quality of the thing sold: caveat emptor. But where a guarantee is given, or a precise description equivalent to a guarantee, the buyer has a remedy in the courts. The distinction made by the law is substantially that which the economist would make. The quack medicine may be a draft of flavored water or disguised alcohol. But so long as the purchaser wants this sort of thing, and buys] be- cause he has a notion it will do him good, the purveyor adds to the sum of satisfactions. The case is different where the purchaser wants one thing, and is deceived into taking some- thing else ; since then his felt wants are not satisfied. Inter- mediate is the case where the purchaser does not know precisely what he wants, and is wheedled into taking something which the other man wants to sell. Here it is often difficult to draw the line. Is the buyer foolish, or is he swindled ? Does the seller lie outright, or is he merely expansive in praise of his wares ? What the law can do is to aid in making the situation clear; and this is particularly needful where the consequences of mis- understanding are serious. Hence the pure-food and pure-drug legislation, and the legislation requiring that the composition of nostrums be precisely stated on their labels. Where the want is really felt and really satisfied, the labor that brings satisfaction must be adjudged by the economist produc- tive ; and this, even though the ultimate consequences be harmful 22 THE ORGANIZATION OF PRODUCTION The keeper of a dramshop is a productive laborer, even though he purveys something which often causes misery. To enter on inquiries about the final effect on human welfare would raise many questions of a different sort from those within the strict range of economics; inquiries which, if consistently followed in all cases, would range into almost every field of knowledge. There are physiologists who believe that meat, though men like it, is unnecessary for nourishment and is frequently a cause of disease. Others maintain that such stimulants as tea and coffee are of ill effect ; that health and happiness are promoted by abstinence from them. To judge between these various advocates and reformers is no part of the essential task of the economist. So long as a person who buys a thing or pays for a service really desires it, the labor which yields him the satisfaction is productive. The economist is concerned to in- quire what labor is productive in this sense and what is not, and what are the various aspects and consequences of men's activities in trying to satisfy their wants. A case which may call for nice distinction between labor that is productive, even though morally questionable, and labor that is predatory, is that of the professional gambler. For example, those who maintain the luxurious establishment at Monte Carlo may be regarded, on the one hand, as simply purveying to that love of games of chance which is so universal as almost to be classed as instinct. So far as they do so so far as the act of gaming is pleasurable to their customers they supply a satis- faction, even though it may be desirable for permanent welfare that this craving be kept in check. On the other hand, so far as both parties croupier and gamester are merely trying to get each other's money, and care not for the play per se, the activities of both are predatory. Just what motive underlies the gamester's wagers may be a matter for nice psychological analysis. No doubt the two distinguishable motives love of play and cupidity for the other man's money are often combined. There are certainly instances enough where the pleasure of the play counts for nothing, and where cupidity OF LABOR IN PRODUCTION 23 alone is at work ; and then the keeper of the gambling estab- lishment is simply predatory. Returning now to such articles as were considered a moment ago drugs and alcoholic spirits, whose effects may be noxious we may note the obvious distinction between saying that a given kind of labor is productive and saying that it ought to be exercised. Though a want may be satisfied by the labor, it does not follow that happiness, or the best kind of happiness, is promoted thereby. The law may prohibit gambling, or the manufacture and sale of liquor, because it is thought best that men should not have the gratifications at all. Whether or no a prohibition of this kind should be enacted raises questions, to repeat, of very wide range, to whose solution the economist can doubtless contribute, but on which he says by no means the final word. The labor which yields a service may be, in the eye of the economist, strictly productive; but it may be a kind of productive labor which had better not be exercised. 4. The meaning which we affix to the word " productive" is further illustrated by one of those professions which Adam Smith regarded as indeed grave and important, but none the less unproductive, the law. With the lawyer may be grouped the judge, the policeman, the jailer, all those concerned with the administration of the law. In a sense, their services are not necessary. They do not conduce directly to the production of material goods or to the rendering of services or utilities to consumers. They are inevitable adjuncts to the processes of production, rather than immediately contributing factors. If all men were honest, truthful, fair-minded, and willing to abide at once by the decision of an impartial arbitrator, the work of the legal profession and of all its hangers-on could be dispensed with, or at least reduced to insignificant dimensions. If virtue were universal, policemen and jailers would disappear, and lawyers would have little or nothing to do. Yet the experience of all peoples shows that men being what they are the work of the legal profession becomes indispensable in any com- plex society. As property is accumulated and diversified, as 24 THE ORGANIZATION OF PRODUCTION exchanges between men multiply, as the precise relations between different persons come to be carefully defined by law, the business of interpreting the complex system is put into the hands of a separate profession. The settlement of differences is intrusted to judges; the orderly conduct of affairs is aided by the advice of lawyers; the observance of the law is enforced by the police. No doubt an ill-devised legal system entails more labor of this sort than would suffice under a better system; and the un- prejudiced observer must question whether the law of our modern communities works as efficiently as it might. But a clumsy instrument, though it involves more labor than one well adjusted, is none the less useful. Similar considerations apply to the army and navy. The immediate object of the soldier's work is destruction. He must be supported by the rest of the community; he does not con- tribute directly to its well-being. Yet military protection has been, through almost all history, an indispensable condition for the sustained conduct of peaceful industry. Like the police- man, the soldier is needed because of the bad passions of man. And even where defense is not necessary, and armaments are maintained from national vanity or senseless rivalry, the soldier nevertheless must be reckoned productive in the sense that he does what people wish to have done and what they pay him for. The army and navy may be only dangerous playthings. But men are not less foolish when they pay for tawdry ornament or vulgar amusement. It is not for the economist to sit in judgment on then- tastes. There is indeed a situation in which a military force is, from the economist's point of view, clearly unproductive. This is where it is used solely and simply for aggression. A pirate is obviously not a productive laborer. Unfortunately many of the heroes of history have been no better than pirates. The armies of the first Napoleon swarmed over Europe, levying tribute wherever they penetrated. No doubt deep-lying his- torical forces served to bring on the wars of the Napoleonic period. Some conflict was inevitable between the old feudal OF LABOR IN PRODUCTION 25 order of society and that new order which arose with the French Revolution. But the domineering spirit of Napoleon turned the conflict in its later stages to mere aggression on the one side, ex- hausting defense against aggression on the other. That defense was necessary; yet all the effort applied both to offense and defense was in the last analysis a fruitless application of labor. Lest this mode of considering the military be judged shallow by some of our fellow economists, it is likely to be so regarded by many Germans, in whose contemporary civilization prepara- tion for war plays so large a part, let it be added that the bare economic side of the matter is not the only one to be considered. Complex political and social questions present themselves, quite beyond the scope of a book on economics. No range of top- ics brings out more clearly the need of considering problems that are partly economic from other points of view as well. Even as a problem in economics alone, the industrial progress of mankind has often proceeded in strange ways. Civilization has gone forward on the powder cart, as in our Civil War. Ag- gression itself sometimes leads to happier ends. The English first took possession of India in a spirit of sheer rapacity. Yet their rule, resting as it still does on force, has much promoted the material welfare of the native races. And hi the conflicts between civilized peoples also, whatever their origin, a better order and a higher prosperity have often emerged from wars that were seemingly causeless. Reflections of this sort will occur to every thoughtful reader, and lead him to qualify and interpret what has here been said of the relating of armaments and wars to the principle which underlies the conception of productive labor. 5. There remain to be considered questions as to the re- lations of certain kinds of activity to the productiveness of labor. Are any of the business doings which go on in modern society to be judged unproductive? When unscrupulous persons solicit funds from the gullible, ostensibly for "investment" or "speculation," and in due time run off with the money, their labor, systematic and strenuous 26 THE ORGANIZATION OF PRODUCTION though it may be, is obviously predatory. Not only they, but the clerks and assistants whom they employ (whether these be accomplices or innocent), are unproductive. Now it is main- tained that, outside the range of operations so clearly predatory as to be made criminal by law, there are not a few others, within the pale of the law, whose economic effect is substantially the same. This is alleged, to take a familiar example, of speculative transactions in general. In our highly organized modern com- munities, an immense amount of buying and selling is done for a turn in the market. A man buys wheat or cotton which he does not want and which never gets into his possession; he promptly sells his nominal title at an advance in price, pocketing what is called a profit. Is any contribution made to the sum of utilities by such transactions ? It may be assumed that the pleasure of the game, which may be an element in gambling with cards or dice, here plays but a negligible part; the motive is simply to get gain somehow. The most conspicuous opera- tions of the sort are on the stock exchange, where sales and purchases take place on an enormous scale with no traceable effect in adding to production or to social income. The business involves an elaborate apparatus, brokers, clerks, officers, a periodical press of its own. As the clerks of a bare swindler are unproductive, so must be those of the broker, if he is himself in the parasitic class. But this sort of allegation has been pushed further. A large part of what is ordinarily called " business " has been placed under the same ban. Not only those who are usually called speculators, but those who "operate" in real estate buy and sell land for a margin of profit and the bankers who "handle" stocks and bonds are described as mere parasites. Nay, all business men, of every kind, have been condemned by socialist writers as essentially unproductive, that is, so far as they are not directly doing work of management and superintendence. By them" business" has been adjudged, simply a way of secur- ing a gain through the ignorance or weakness of others, and therefore to be condemned as useless to society. OF LABOR IN PRODUCTION 27 The questions here raised cannot be answered until after a consideration of some very complex matters. But the mode in which they should be dealt with and the nature of the answers to be sought can be indicated now, even though with some antici- pation of later conclusions. Thus, as regards one of the set of operations supposed to be unproductive, speculative dealings, it must be admitted that the charge is in part founded. Though some speculative dealings in commodities and securities serve a useful purpose, others are in large part mere wagers, akin in their economic effect to vulgar gambling. 1 Judged by the test which we have set up, whether the labor adds to the sum of utilities, all those who engage in mere wagering speculation are unproductive laborers : not only the principals, but the brokers who execute their orders, the clerks who record them, the mechanics who put together and operate the " ticker " in the broker's quarters. All belong in the class whose work serves no useful end. The same test is to be applied to the activity of business men ; but here the balance of gain is much clearer. Though the greater part of speculative dealings is probably of no utility, the greater part of business men's doings has great utility. The indictment of the socialists, which charges that they are pre- dominantly unproductive, far overshoots the mark. The func- tion of the manager or leader of industry is of high service in production. He adds conspicuously to the abundance of com- modities and the satisfaction of wants. But it is none the less true that in any large center of industry there will be found plenty of persons engaged in "business" whose doings are es- sentially parasitic. They pick up a living, perhaps a very comfortable one, by shreds and patches of dealings, by shrewd- ness in buying and selling, by waiting for land or securities to rise in value. Often they are sober, solid citizens, personally estimable ; so indeed are, as a rule, the stockbrokers who pro- vide the facilities for the gambling speculators. These respect- able persons would resent with indignation the suggestion that 'Compare Book II, Chapter 11. 28 THE ORGANIZATION OF PRODUCTION they belong in the predatory and parasitic class. But one of the most remarkable phenomena presented to the student of economics is the ignorance of all sorts of persons as to their place and function in the industrial world. The broker or merchant, no less than the mechanic or clerk, sees the little corner in which he is at work, and knows nothing of its relations to the com- munity as a whole. The respectability of an employment, and even the spirit in which it is pursued, give no certain clew to its effect on the general welfare. It is the aim of the legal system under which we live the system of private property to inhibit predatory doings. Hence not only physical violence, but fraud and deceit, are for- bidden and punished. This aim of the law is in the main at- tained. He who earns his living in a lawful manner commonly contributes to the sum total of satisfactions. He does what another person is willing to pay him for ; or, in the more tech- nical language of economics, he brings forth utilities, and so is a productive laborer. The view, sanctioned more or less explicitly by some socialist writers, according to which the work of manual laborers alone is productive, and all the income-earning and money-making of the well-to-do classes are unproductive, carries the indictment against the existing system too far. But the fact that criticism against the working of private property is exaggerated should not blind us to the fact that there exist opportunities for securing an income or even amassing a for- tune, not beyond the pale of the law, yet of a kind which the economist must regard as predatory, and so unproductive. Some opportunities of this kind are due to imperfections in the law as it stands. With changes in economic conditions, pro- ceedings that once seemed helpful to the promotion of the gen- eral welfare, and perhaps at one stage were helpful, cease to be so, or remain so only in part. Thus joint stock companies, or corporations, have proved a device of great efficacy in further- ing improvements in the arts and in securing more abundant and varied production. On the other hand, the statutes under which corporations may be organized, especially in our American OF LABOR IN PRODUCTION 29 states, have often made possible precisely that evil of which the socialist critics complain : mere thimblerigging and plunder- ing. The reform of the laws of incorporation in such a manner as to keep the good and reject the evil is now one of the pressing problems in the United States. To discriminate clearly between the operations that are in the end helpful toward satisfying wants, and those that are not, is sometimes impossible even after the nicest weighing of the results by the best judges. The law, for instance, withholds its sanction from mere wagering contracts. Yet transactions which are wagers cannot be distinguished in outward form from others which are useful to society. There is a vague con- sciousness in the public mind that some persons are engaged in "legitimate" business, while others doing the same sort of thing, "illegitimately" occupied, are "plungers." But to draw a pre- cise line between those that may be approved and those that may not, is no less difficult for the business man, however in- telligent and wide-minded, than for the judge or the economist. So it is with the law of fraud and deceit. As long as men are free to choose for themselves and act according to their own judgments, those who are shrewd and watchful will make better bargains than those who are dull and unobservant. When does one man overreach another, when does he simply leave him to judge for himself as to his own interests ? The probabilities are that for the sake of securing the large general benefits that flow from private property and competitive dealings we shall always have to permit some doings that are on the line between the productive and the predatory. If the law brings it about that labor is applied in the main to the satisfaction of wants ; if it restrains most of the unproductive doings; if the system as a whole works well, and these predatory operations are only its loose ends, it will be better to accept them as inevitable and to set off against them the general benefits. Absolute per- fection in human arrangements is not to be looked for. CHAPTER 3 THE DIVISION OP LABOR AND THE DEVELOPMENT OF MODERN INDUSTRY I 1. The division of labor is one of the great central facts in modem society. Some of the most difficult questions of eco- nomic theory, the most common popular fallacies, the most serious problems of legislation, have their roots in the division of labor. The division of labor may be analyzed under two heads. On the one hand there is the simpler form, under which a workman carries through the whole of one of the stages in production. The tailor, the cobbler, the carpenter, ply their several trades. On the other hand there is the more complex form, under which there is a splitting up of several operations all belonging to one stage of production. In more primitive stages of in- dustry the shoemaker might be a tanner, and the whole process of converting the rawhide into a shoe thus be in one hand. Nowadays, the shoe itself is not put together by the cobbler; it is the work of a large number of different workmen in a factory, of whom some do nothing but cut the leather, others stitch it, others put on the soles, still others the heels, and so on, with an elaborated parceling of different operations. Obviously, a hard-and-fast line cannot be drawn between these two aspects of the division of labor. No craftsman carries through from beginning to end any one operation in produc- tion. The tailor buys his materials of the .cloth maker; the cloth maker buys his wool of the farmer or grazier. The cloth maker and the grazier in turn buy tools of the mechanic, who buys materials from the ironworker and woodworker. On the other hand, the tailor does not necessarily carry his own work through even the whole of the stage with which he is 30 THE DIVISION OF LABOR 31 concerned. It may be divided between the cutter and the stitcher ; and similarly the cloth maker's may be parceled out between the weaver, the fuller, the dyer. The difference be- tween the simpler and the more complex division of labor is essentially one of degree. Nevertheless, this difference of degree is important. The two sorts of arrangement bring about somewhat different advantages and give rise to different social conditions. 2. Let us consider first the simpler division of labor. This dates far back into antiquity. The familiar crafts are of very old standing. The extent to which their names have been adopted as surnames shows how, among modern peoples, occupations were separated in that comparatively simple state of society, in the Middle Ages, when patronymics were in pro- cess of formation. The Carpenters, Masons, Smiths, Weavers, Drapers, Tailors, Dyers, Saddlers, Shoemakers, Millers, Bakers, Coopers, and such other common surnames indicate what sort of division of labor was maintained for hundreds of years with comparatively little change. The chief advantage in production from this form of the division of labor is the gain in dexterity which comes from the constant practise of the same occupation. So familiar are we with the effect of practise that we assume as a matter of course the skill which comes from it. Reading, writing, the donning of our clothes and the lacing of our boots, are effected with ease, almost without effort, from the ingrained effects of custom and iteration. Piano playing and typewriting are marvelous to the inhabituated, easy to the point of indifference for the practised hand. The acquired dexterity of the craftsman and mechanic make their productive capacity infinitely greater than they would be if each had to carry on a dozen occupations and were half proficient in any one. Other gains also have been enumerated as accruing from the simpler division of labor. There is a saving in time when the same task is followed without interruption. The carpenter, even though no more dexterous than the farmer, can yet accom- 32 THE ORGANIZATION OF PRODUCTION plish more in the hour or the day than the farmer who tries to do jobs of tinkering in his spare moments. Something also is due to the adaptation of tasks to the abilities of the workers. There are differences between the inborn abilities of individuals, even as regards tasks for which training and practise are the most important causes of dexterity. Among mechanics a cer- tain proportion only have the sure eye and the deft hand which are required for the most exacting tasks. It is obviously advantageous that they should confine themselves chiefly to these, leaving the less exacting to persons of ordinary capacity. Even for comparatively simple occupations there are dif- ferences in the qualifications of individual workmen. The work of a motorman on an electric car seems of the most mo- notonous sort, easily accomplished by any adult. Yet it re- quires a certain steadiness and alertness of attention not pos- sessed by all laborers. How far differences of this sort are the result solely of inborn qualities, how far brought about or accentuated by education and environment, need not here be considered. So long as they exist, there is a gain if each indi- vidual is called on to do only that for which he has the greatest aptitude. The last-mentioned factor in the division of labor the adaptation of tasks to varying aptitudes is of most importance as between those who work with their heads and those who work with their hands. Though there is mental training as well as manual training, and though instruction and practise tell in the lawyer's trade as well as in the mechanic's, inborn abilities are important in greater degree for the former. This is more particularly the case in all work which calls for initiative, superintendence, direction. There is a difference of far-reaching effect between those who have the qualities for leadership, whether in the arts or in intellectual life, and those who must belong to the rank and file. There is often a very great gain when those who are born leaders can devote themselves solely to the work which they alone can do, or which they can do best, leaving to others, with no such capacities, the routine mechanical or clerical work. THE DIVISION OF LABOR 33 The great mass of men, however, have no special aptitudes. For them, continued practice, begun or aided by systematic training, is the chief cause, even though not the only cause, oi skill in any particular sort of work. In the main, the division of labor is a cause rather than a result of specialized capacity. Most dexterous men are so because they have long practised a given art ; they do not practise it because they are born with dexterity. 3. Let us turn now to what we have styled the more com- plex form of the division of labor. This is the salient charac- teristic of the development of industry during the last century and a half; a development which has gone on with accelerat- ing pace in very recent times. The change in industry and the nature of the new order of things can be described most concisely by saying that the tool has been replaced by the machine. Though the gain in efficiency from the division of labor arises chiefly from the dexterity acquired by repetition, none of the trades familiar under the simpler division of labor was reduced to the continuous repetition of identical movements. The car- penter, the mason, the smith, the tailor, each was master of his trade as a whole, and, while gaining proficiency from unceasing practise, yet turned from one part of the occupation to another. The instruments which these artisans used were tools, of varied kinds, adapted to the different parts of their occupations. A "tool," as that word is still commonly used, means a hand tool, put in motion by human force and requir- ing adaptation, judgment, flexibility. The gradual elaboration of the division of labor slowly en- larged the number of occupations, diminished the range of each one, and tended to reduce each more and more to an identical routine. Thus the making of cloth was divided between the spinner, the weaver, the fuller, the dyer. The division between the spinner and the weaver, itself one of the oldest, became eventually of much moment, for it gave occa- sion for one of the epoch-making applications of machinery 34 THE ORGANIZATION OF PRODUCTION and power. When the steady repetition of the same move- ment becomes an important part of an industrial art, it is possible to apply other force than that of man's muscles. No machine, even in the highly elaborated forms of modern times, can rival in dexterity and flexibility the human hand. But whenever the same thing is to be done over and over, the blind forces of nature, working through a machine, can do it as well as the human hand, and indeed better than most human hands. The division of labor in its simpler form gradually was de- veloped to the point where the application of power was pos- sible. The gain from the application of power proved so great that there was a reaction on the division of labor : an induce- ment to split up the steps in production still further, to reduce more and more of them to the repetition of identical movements, and so to make possible in still greater degree the use of natural forces. The great change toward the use of machines and power set in during the second half of the eighteenth century. The textile trades felt its influence first. In 1764, Hargreaves in- vented the spinning jenny; in 1769, Arkwright brought out his rival spinning machine ; in 1779 Crompton invented an appa- ratus which combined the devices of Hargreaves and Arkwright. and brought the spinning machine to a still further stage of perfection. All three were directed to the mechanical repeti- tion of the twisting of the fiber; and water power was soon applied to setting them in motion. Not long afterwards, weav- ing was also subjected to the same principles. The power loom was gradually elaborated, and in the beginning of the nineteenth century began to supplant steadily the hand loom. By the close of that century, the old-fashioned weaver's trade had become, in advanced countries like England and the United States, a thing of the past. The textile material to which these inventions were first applied was cotton; for this has an even and homogeneous fiber which makes it most readily available for machinery operated continuously at uniform speed. Wool, linen, and silk, being of less even fiber, were subjected to THE DIVISION OF LABOR 35 the machine process later than cotton, through a long series of subsidiary inventions. It has not been until our own day that silk, the most delicate and irregular of these fibers, has come to be manipulated on a large scale by power machinery. Water power was used for the textile manufactures in their earlier stages; but it was soon supplemented and largely re- placed by the steam engine. The steam engine was brought by Watt to the stage of effective working in 1781. It was first used on a large scale for the pumping of water out of mines, an obvious case for the application of power, since it calls for the unchanging performance of the simplest of movements. It was soon applied further, not only to the textile industries and to a wide range of other manufactures, but to transportation. Steam was used in navigation' by Fulton on the Hudson River in 1807. An even more important application of steam to transportation came when the locomotive was perfected by Stephenson in 1830. This created the modern railroad, and, as we shall presently see, marked the beginning of a still further development of the division of labor. The series of great inventions of which these were the most important, brought about what is known as the Industrial Revolution, a change in the arts, and a consequent change in economic and social conditions, greater than has appeared during a like short time in any stage of human history. Its fundamental economic characteristic has been the elaboration of the division of labor, through the splitting up of the stages of production into separate operations, each one of which is repeated continuously and so may be carried on by the machine. The carpenter's sawing, planing, joining, molding, each of these is now done separately by machinery, usually in estab- lishments that tend steadily to become larger and larger and to subdivide still more the various operations of the trade. The cobbler of former days put together a shoe by himself ; in a modern factory the shoe goes through some eighty different processes. So it is with ironworking, with all the elaborated processes of the textile industries, with printing and book- 36 THE ORGANIZATION OF PRODUCTION making, not least with the very making of machines and tools. The machines now used are vastly more complex and more efficient than was dreamed of in the early stages of the appli- cation of power, and have extended the principle of the auto- matic repetition of identical movements to tasks long thought too intricate to be amenable to such methods. The work of the hand is not indeed superseded ; the skillful workman and the adaptable tool retain a large place in industry; but the range of their work tends to become more and more restricted. Within each branch of industry, as one stage after another is subjected to the machine process, the other stages have a nar- rower and simpler range, in which inventive spirit constantly finds new opportunities for the application of power. Thus the character and the working of the division of labor have been profoundly and all but universally modified. The essential gain from this modern development of the division of labor has come from the virtually unlimited store of natural power. Once the identity of movement has been secured, there is no work so heavy, no operation so delicate, but that the machine can repeat it day in, day out. Human labor applied first to putting together the machine, then to guiding the natural forces that move it, accomplishes vastly more than the same amount of labor applied to the making and using of the simpler tools of former days. Coal and fall- ing water are the great sources of power; and though nature does not supply them without limit, the application of ma- chinery has not yet been fettered for human needs by any limi- tation, nor is it likely to be fettered in the future, as far as we can look forward into it. The labor required for any one operation in production has been immensely lessened by the industrial changes of the last century, and appears likely to be lessened no less rapidly and largely in the century before us. The period in which we live has been aptly called the age of machinery. Its characteristic phenomena are mainly the results of the use of machinery; and they will engage our THE DIVISION OF LABOR 37 attention in many parts of our subject. They are seen in the growth of capital, and the increasing power and importance of the business man who has control of capital; in the spread of production on a large scale, and the tendency to monopoly in many branches of industry ; in a new position of the workmen, a wider gap between employers and employees, and a conse- quent development both of labor organizations and of employers' associations; in grave social problems from the employment of women and children in factories; not least, in a loss of individuality in the working population, and a strengthening of the lines of demarcation between social classes. Of all these consequences of the complex division of labor more will be said as we proceed. 4. The division of labor obviously means that the persons who carry on the several operations of a given branch of in- dustry combine to bring about the final result. It means, no less clearly, that those engaged in different industries combine to satisfy the varied wants of the community. Each contrib- utes his special product to be used by all; each uses the prod- ucts contributed by the rest. The division of labor may thus be described also as the combination or cooperation of labor. That combination may conceivably be carried out deliber- ately, with conscious control and coordination, with immediate sharing of the joint output, and without exchange. In the ancient civilizations of Greece and of Rome we get glimpses of establishments of the rich and privileged in which the several trades are plied by slaves for the benefit of the whole house- hold. In the earlier Middle Ages, also, we find seigniorial possessions, where the serfs have specialized occupations, and con- tribute in kind to the lord's needs. Even in modern times, we have examples of communistic societies, in which there is a division of labor among the individual members, yet no ex- change; each member contributing his part to the common income and each receiving from that income a share deemed equitable. Such a society does not approach so nearly to self- sufficiency as the ancient household or the medieval estate; 38 THE ORGANIZATION OF PRODUCTION it must buy and sell on a considerable scale with the outside world, whereas those earlier organizations bought very few things (salt and iron, for example). Yet within its own limits the division of labor leads to no exchange between members. Commonly, however, the division of labor has brought with it as a natural corollary the exchange of the several commodi- ties produced by different workers. The cases noted in the preceding paragraph are comparatively rare in economic his- tory ; at all events, they give no clew to the phenomena of the modern industrial world. There the division of labor almost always means exchange, and the relation between the workers is very different from that in a community where there is con- scious and deliberate combination of effort. It is strictly true that the workers in a modern society combine in bringing about a joint output; but the consciousness of cooperation is lost. The individual is not thinking of the joint output. Only if he happens to be versed in the books and theories of economic writers, and bears them in mind in his active hours, is he aware that he is carrying on one small operation toward a joint output and shares in the manifold contribution which others make to that joint output. The things on which he works are not part of a common store, but are private property, bought and sold, cared for and guarded, by each individual for himself. He thinks only of the particular product which he sells, and of the terms on which he can buy other products. He is intent on the results of the exchange thus made, and tries to secure for himself the best terms of exchange. Private property and exchange are well-nigh universally the conse- quences of the division of labor, and the phenomena of ex- change are the dominant phenomena of the modern world. 5. For some centuries preceding the industrial revolution of the eighteenth century, the typical form of exchange was that between the small city or town and the agricultural region immediately surrounding it. This was the period of the simpler form of the division of labor, of the familiar handicraft ; the period of the tool, preceding the modern period of the THE DIVISION OF LABOR 39 machine. The city of early modern times was the center of an industrial community which was in the main self-contained. Within the city the burghers carried on the arts and crafts. To it the surrounding rural population brought food and ma- terials, and in it they made their purchases. The city crafts- men were united in the gilds which were so conspicuous a feature of the economic organization of that period. Each craft was open only to the members of a gild, who trained apprentices and employed journeymen, and transmitted from generation to generation the knowledge of its trade. The organization of the gilds, and the regulation and restriction of their membership, were inevitable and doubtless beneficial at the outset, assuring protection and mutual aid, and the maintenance of skill in the arts. In later times, their regula- tions were made the means of monopoly; they had long out- lived their usefulness even before the great inventions of the industrial revolution put an end to the economic organization of which they were a part. But these are aspects of the gild system not closely related to our present topic. So far as it Dears on the division of labor, it was part of what the Germans call Stadtwirthschaft, the city organization of industry. A map of England and of the greater part of western Europe from say 1350 to 1800 is dotted with a large number of cities of modest size, each the center of a more or less isolated economic area. There was, indeed, some exchange of special commodities between different countries and between the different economic areas within a country; but the main exchanges were be- tween the city and the surrounding agricultural district, and the characteristic stage of the mechanical arts was that of the division of labor between the familiar crafts organized in the medieval gilds. The steps through which this organization of industry has been replaced by that characteristic of modern times were at first slow and gradual. But in the eighteenth century, the industrial revolution brought a sudden burst of great changes. Without pausing to consider the events of the sixteenth and 40 THE ORGANIZATION OF PRODUCTION seventeenth centuries, which prepared the way for these changes, we may contrast the final result with the conditions of the early simpler division of labor, and so understand better the conditions of our own day. The economic area has been immensely widened. It has come to include the whole of a country, in some respects the whole of the world. There is division of labor not only be- tween the different crafts within a city, but quite as much between different cities and countries. On the other hand, the crafts themselves have been split up into more minute sub- divisions, and different parts of each are followed in widely separated localities. These tendencies have been immensely promoted by the modern improvements in transportation, improvements which have themselves been the results of the introduction of machinery. The use of power, especially through the steam engine, was the dominant factor in the industrial revolution; and in no direction has it had larger effect than from its application to traction and to navigation. An epoch-making invention was that of the locomotive. Roads had been much improved in England during the latter part of the eighteenth century, when Telford and Macadam devised their methods of constructing roadways. During the same period canals had also been dug, and used to no small extent both in France and in England; and the people of the United States, always driven by their special industrial con- ditions to search eagerly for improvements in communication, pushed the use of roadways and canals in the first quarter of the nineteenth century. But in 1830 came the locomotive. In this case, as in that of the steam engine, and indeed of almost all great advances in the arts, the final attainment of the successful device was due to a long series of experiments by many contrivers. Stevenson in 1830 perfected rather than invented the locomotive. So the modern railway was created ; and thereby began a second industrial revolution, or at least a second phase of the industrial revolution. Side by side with the railway have acted the great improvements in water THE DIVISION OF LABOR 41 transportation. The application of steam to navigation, through the paddle wheel, was a comparatively simple matter, and was accomplished early in the nineteenth century. But the paddle-wheel steamer was too clumsy, too liable to damage in storm, for communication across great bodies of water; and it was not until Ericsson's invention of the screw, in the middle of the nineteenth century, that ocean navigation under- went a great change. This change in any case was not so far- reaching as that wrought by the railway; for water transpor- tation by sailing vessels had always been comparatively cheap ; whereas land transportation had been slow and dear, and its dearness had imposed great obstacles to the division of labor within large land areas. 6. As Adam Smith remarked in 1776, in the earlier stages of the modern era, the division of labor is limited by the extent of the market. The village cobbler will turn out no more shoes than it is possible to dispose of within the economic area he can reach. To divide the work of shoemaking between the cutter, the stitcher, the heeler, the laster, is not feasible unless as many shoes can be marketed as the .combined labor of all will produce. A modern shoe factory, with its elaborate machinery and highly developed division of labor, turns out thousands of pairs of shoes daily. These shoes can find their purchasers only in a large population reached from the central source of supply. Many other illustrations could be given of the way in which the divison of labor has been pushed farther and farther with the extension of the market consequent on cheapened transpor- tation. Furniture is made nowadays in large factories, often placed near the sources of timber supply and distant from the persons who are to use the articles. The cabinetmaker of olden days has been replaced by workmen who tend and direct a series of machines, each of which performs unceasingly its part in the operations of sawing, planing, grooving, turning, polishing. Plows are no longer made by the village black- smith, but put together hi the great factory and then distrib- 42 THE ORGANIZATION OF PRODUCTION uted broadcast over the earth. Unless it were possible so to distribute them, plows could not be made in quantities at the factory, and there could be no elaborated division of labor in making them. One of the most striking results of the widen- ing of the market is seen in the transformation of the butcher's trade. Until within the last thirty years, the butcher carried on his work as he had done it for thousands of years before. His cattle came from near-by farmers, and the meat was sup- plied to near-by customers. Through the larger part of the United States, he has now been supplanted by the great pack- ing establishment, where cattle are slaughtered by the thou- sand. In these establishments dozens of different stages in dissecting the carcass are allotted to as many different sets of workmen. The application of power has not here been carried as far as in some other industries ; yet at every stage where it is possible, the machine is set to work; and where it is not, the workman is assigned to the unceasing repetition of a single operation. 1 Every part of the animal is used, and every part is manipulated on a large scale under a further minute division 1 "It would be difficult to find another industry where division of labor has been so ingeniously and microscopically worked out. The animal has been sur- veyed and laid off like a map ; and the men have been classified in over thirty specialties and twenty rates of pay, from 16 cents to 50 cents an hour. The 50-cent man is restricted to using the knife on the most delicate parts of the hide (floorman) or to using the ax in splitting the backbone (splitter) ; and, wherever a less skilled man can be slipped in at 18 cents, 18J^ cents, 20 cents, 21 cents, 22 J^ cents, 24 cents, 25 cents, and so on, a place is made for him, and an occupa- tion mapped out. In working on the hide alone there are nine positions, at eight different rates of pay. A 20-cent man pulls off the tail, a 22J^-cent man pounds off another part where good leather is not found, and the knife of the 40-cent man cuts a different texture and has a different ' feel ' from that of the 50-cent man. Skill has become specialized to fit the anatomy. . . . "The division of labor grew with the industry, following the introduction of the refrigerator car and the marketing of dressed beef, in the decade of the sev- enties. Before the market was widened by these revolutionizing inventions, the killing gangs were small, since only the local demands were supplied. But when the number of cattle to be killed each day increased to a thousand or more, an increasing gang or crew of men was put together ; and the best men were kept at the most exacting work." Professor J. R. Commons, in the Quarterly Journal of Economics, Vol. XIX, pp. 3, 6. It will be noticed that here there seems to be scope for that advantage from the division of labor which is secured from the adaptation of the tasks to the varying abilities of the several workers. Cp. p. 32, above. THE DIVISION OF LABOR 43 of labor. The output in all its varied forms the meat of all qualities, the fat, the hide, the bones, the horns, the very hair all is then marketed to millions of people, distant hundreds of miles, sometimes thousands of miles, from the packing estab- lishment. All such elaborate organization and division rests on the possibility of transporting the products a great distance, and so supplying an enormous population from one central point. 7. The great improvements in transportation during the nineteenth century have given immensely wider scope to a phase of the division of labor which we have not yet considered. This is the geographical division of labor. In medieval and early modern times, those articles only could be transported for any considerable distance which had great value in small bulk. Such were drugs, spices, fine cloths, rare silks and cottons, choice weapons and armor. These were used chiefly by the small circle of the rich ; trade in them did not affect the mass of the population. Where water trans- portation could be used, there was indeed some possibility of trade and exchange in the bulkier commodities. For this reason, England, with her insular position and much-indented seacoast, was able at a comparatively early stage to export such commodities as wool, copper, and tin, and to develop in some degree the geographical division of labor. With the im- provement and enlargement of vessels', the greater security of the seas, and the use of the mariner's compass, trade by water gradually grew to greater and greater dimensions. A still further extension came in the latter part of the eighteenth century, when parts of the interior of the civilized countries were tapped by canals. But the most far-reaching develop- ment of the geographical division of labor came with the rail- way; for the railway can reach all parts of the land. The industry of almost every part of the world has been transformed by this mighty solvent. The United States at the present time presents what is prob- ably the most extreme case of geographical division of labor 44 THE ORGANIZATION OF PRODUCTION highly developed under the influence of cheap transportation. The southern part of New England is a manufacturing hive. The food and raw materials there used come from all parts of the world. The wheat and other breadstuffs come from the Mississippi and Missouri valleys; the meat and animal prod- ucts from the same regions, and some from regions farther west ; the cotton from the Southern states ; the wool from the trans- Missouri region, Australia, Argentina, China, Siberia. All sorts of manufactured articles are sent out from New England in exchange, cotton and woolen fabrics, boots and shoes, metal wares, tools and machinery. The anthracite district of eastern Pennsylvania, again, is 4 given wholly to the mining of hard coal ; all its manifold supplies come from without. Pitts- burgh is the center of a district in western Pennsylvania given wholly to the mining of bituminous coal and to manufactures which use that fuel, such as iron and steel and glass. Here too, the food, clothing, articles of comfort and luxury, are obtained from all parts of the United States and of the world. No part of the country is self-sufficing ; each is constantly send- ing its products to distant regions, and in return receiving the product of distant regions. An example no less striking of the geographical division of labor is to be found in the present condition of Great Britain. That country now imports the greater part of its food, four fifths of its breadstuffs, and more than half of its meat and other food supplies. Its wheat comes chiefly from the United States, Canada, Russia, Argentina; its meat very largely from the United States and Australasia. All the cotton and almost all the wool which serve to clothe its people are brought from other countries. These various commodities, as well as the others which come from tropical regions, are obtained in exchange for a great range of manufactures exported. The people of Great Britain, by devoting their labor chiefly to manufactures and exchanging them for the imported foodstuffs and raw materials, get vastly larger returns than they could by producing everything at home. New England and old THE DIVISION OF LABOR 45 England are in substantially the same industrial position. It is probable that neither could support its present population on its own soil; it is certain that neither could satisfy in this way the imperative needs for food, clothing, shelter, warmth, except on very much harder terms and with very much scantier results. Each is dependent on trade with other regions; the main difference being that in the one case virtually the whole of the trade crosses the political border, and in the other a large part of it is within the same nation. In consequence of this highly developed division of labor, the position of cities is essentially different from what it was in medieval times. They are no longer dependent for food and materials on the agricultural regions surrounding them, nor do these regions depend on the adjacent cities for their supplies of manufactured commodities. As regards the country sur- rounding them, the cities are centers for the distribution of goods rather than for production. Many cities have special articles of manufacture, and in this sense are producing centers ; but their specialties are disposed of over all the world through the distributing centers. The very large cities, with a wide range of miscellaneous manufactures, and with a great dis- tributing trade, overlap in their economic areas. 8. The gains from the geographical division of labor are of two sorts, analogous to the two sorts of gain from the divi- sion of labor between individuals. In part they arise from the adaptation of different regions to the production of specific articles, and in part from the proficiency which is the result of exclusive application to one task. The division of labor between tropical and temperate coun- tries obviously brings the gain arising from specific adaptation. Tropical fruits, spices, coffee, sugar, are exchanged for the wheat and corn of temperate climes. The southern part of the United States, again, has a climate peculiarly adapted for growing cotton; while in the great central plains there is a corn belt and a wheat belt, great stretches of country with climate and soil peculiarly adapted to one or the other of the 46 THE ORGANIZATION OF PRODUCTION staple cereals. The abundant deposits of excellent coal in the western part of Pennsylvania cause that district to devote itself to coal mining and to the industries for which cheap fuel is essential. Extraordinary deposits of iron ore have been found on the shores of Lake Superior, and thousands of work- men there mine the ore, procuring from other parts of the coun- try all the varied articles which they consume. Italy has a climate adapted to the culture of the grape and of citrous fruits, and she exports them to the countries of more rigorous climate. Italy has no coal ; she imports it, chiefly from the great beds of Great Britain. The enumeration might be indefinitely extended. It is obvious that there is a gain when the wheat and corn are produced in the regions favoring them, the iron and coal where they are most abundant, the cotton where the soil is best. This geographical division of labor is not indeed all-embracing ; there are obstacles to its sweeping application from such causes as the force of custom and cost of transpor- tation. Yet there is a strong and steady tendency toward the pursuit of a branch of production in that place for which the natural advantages are greatest. Different in origin and basis, though the same in effect, is that division of labor between different regions which rests on the mere fact of specialization and acquired skill. Exchange be- tween individuals, though based in part on differences in native aptitudes, rests in the main on acquired dexterity. So it is in considerable degree between different regions. When once an industry is conducted on a large scale, with elaborate ma- chinery and with a great output, it will tend to be concen- trated. But there may be no strong reason for its concentra- tion at one place rather than another. There is no cause in the natural conditions why Bridgeport and New Haven in Con- necticut should be specialized centers for the manufacture of metal wares, Brockton in Massachusetts for shoes, Cohoes in New York for knit goods, Nottingham and Bradford in Eng- land for laces and woolen stuffs, Lyons for silks, Chemnitz in Saxony for hosiery. THE DIVISION OF LABOR 47 For certain sorts of industries there is simply a gain when a number of establishments carrying on operations of the same sort are clustered together. Subsidiary industries spring up, supplying them with materials or accessories. When workmen skilled in particular operations are required, their selection and adaptation is easier. The mere attractiveness of a city (for most persons) makes it easier to secure and retain a steady force of laborers. Sometimes the first cause of the location of an industry in a particular place has been the energy, ingenuity, resource, of some individual. His capacity as leader builds up an establishment ; others then follow his lead. Sometimes the natural adaptation of a spot causes an industry to spring up there, and later to persist from the mere effect of acquired advantage. Thus some of the manufacturing cities of New England, such as Lowell and Lawrence, grew up on sites having water power, before steam power was as fully developed as in later times, and when the transportation of coal was more costly. It is doubtful whether the water power would now cause these centers of population to be built up; but being there, they tend to remain. All through the broad, flat country of the Mississippi Valley there have sprung up cities and towns, of which one is the seat of the manufacture of vehicles, a second of furniture, a third of engines and machines, with no obvious causes why one place rather than another should possess the particular industry. In whatever place the industry is, the advantages of concentration are secured. A wide market from cheap transportation makes possible the conduct of the industry on a large scale and so the use of much capital, of elaborate machinery, of specialization, and minute division of labor. A considerable part of the division of labor between nations, and a large volume of trade between them, seem to rest on this second cause. Especially as regards manufactured articles, some countries have advantages in production which rest not on natural resources, but on acquired efficiency. England's manufacture of certain kinds of woolen goods, the silk manu- facture in France, perhaps the linen manufacture of the north 48 THE ORGANIZATION OF PRODUCTION of Ireland, present cases of this kind. This is the real basis of the argument for protection to young industries. So far as the division of labor between countries and their trade are the results of natural differences, they are best left to work out their results without restriction. But so far as they rest on acquired skill, there is at least a possibility that they may be superseded to advantage by similar division of labor and similar trade within the country. 1 1 See what is said on this subject in Book IV, Chapter 37, 2. CHAPTER 4 LARGE-SCALE PRODUCTION 1. The tendency to large-scale production has shown itself in all civilized countries since the industrial revolution. It has profoundly modified social as well as economic conditions, and bids fair to modify them still further in the future. The characteristic feature of the tendency is that the size of the individual establishment becomes larger, and that the total number of establishments becomes smaller. In a period of very rapid growth, it may happen not only that each unit becomes larger, but that the total number increases. More commonly, however, the total number decreases, or remains stationary; while yet the individual establishment becomes greater in size, and the productiveness of the industry as a whole is much enlarged. The following figures from the Census publications of the United States, indicating the growth of some great manufacturing industries during the period from 1850 to 1905, will serve as illustration. AGRICULTURAL IMPLEMENTS YEAB No. ESTAB- LISHMENTS WAGE- EARNERS CAPITAL (IN MILLIONS) PRODUCT (IN MILLIONS) 1850 1,333 7,220 $ 3.6 $6.8 1860 2,116 17,093 13.9 20.8 1870 2,076 25,249 34.8 52.1 1880 1,943 39,580 62.1 68.6 1890 910 38,827 145.3 81.3 1900 715 46,582 157.7 101.2 1905 648 47,394 196.7 112.0 49 50 THE ORGANIZATION OF PRODUCTION IKON AND STEEL YEAR No. ESTAB- LISHMENTS WAOE- EARNERS CAPITAL (IN MILLIONS) PEODDCT (IN MILLIONS) 1850 468 24,874 $ 21.9 $20.4 1860 542 35,189 44.6 52.8 1870 808 75,037 121.8 207.2 1880 792 133,023 209.9 296.6 1890 719 171,181 414.0 478.7 1900 669 222,607 590.5 804.0 1905 605 242,740 948.7 905.9 COTTON GOODS YEAR No. ESTAB- LISHMENTS WAGE- EARNERS CAPITAL (IN MILLIONS) PRODUCT (IN MILLIONS) 1850 1,094 92,286 $74.5 $ 61.9 1860 1,091 122,028 98.6 115.7 1870 956 135,369 140.7 177.5 1880 1,005 187,587 219.5 210.9 1890 905 218,876 354.0 267.9 1900 1,055 302,861 467.2 339.2 1905 1,154 315,814 613.1 450.5 The figures in all three cases tell the same story. The total capital, the total product, the total number of persons em- ployed, increase at a very rapid rate. Not so the total number of establishments. In the case of cotton goods, it remains curiously constant; for iron and steel, increases slightly; for agricultural implements, decreases sharply. There has been throughout the half century a great and combined advance in the average capital, the average product, the average number of employees. 1 1 The figures are taken chiefly from Special Reports of the Census of 1905 (Part IV, Table 1, for Agricultural Implements ; Part IV, p. 4, for Iron ; Special Report on Combined Textiles, Table 1). For iron, the figures for 1850 and 1860, added from the Census Reports for those years, are of uncertain value. The number of establishments making cotton goods in 1880 is swelled by the inclu- sion under that head of some outlying establishments. Though subject to correc- tion for these reasons and for others, the statistics are sufficiently trustworthy. In the interpretation of the figures, however, it must be borne in mind that they do not tell the whole story. In at least two of the industries iron and LARGE-SCALE PRODUCTION 51 These three cases have been selected as illustrations, because they represent different stages in the march of large-scale production. In the cotton manufacture the change during the half century was least. By 1850 that industry was already established on the factory basis, and since then no essentially new forms of organization have developed. The iron manu- facture (that is, the making of crude iron and steel) shows relatively a greater change. Most marked of all is the trans- formation in the third case. In 1850 agricultural implements were still made in the main on a small scale, and by handicraft methods. Since then large-scale production has transformed the industry in even greater degree than the figures indicate ; for the stated number of establishments is swelled, and the averages per establishment are kept down, by the survival of a large number of petty shops. A similar general tendency shows itself in all the advanced countries: large-scale production gains ground. Yet it must not be supposed that the growth is such as to have crowded out the smaller enterprises, or even to indicate that in the course of time they must disappear entirely. Figures enabling comparisons to be made for successive periods and for all the industries of a given country, are not easily found. The following are available, for Germany, and are significant. They show what percentage of the total persons employed in steel, and agricultural implements the average per establishment is kept low, and the growth of large-scale operations obscured, by the fact that a considerable number of small establishments survive, side by side with a few very large ones. These few very large ones are really representative of conditions in the industry ; but the census figures do not convey this fact. Further, in all three industries, and especially the iron manufacture and that of agricultural implements, com- bination and large-scale operation have been going on in forms of which the cen- sus figures do not take account. The census regards an establishment in any one place as independent and separate, even though it be owned and managed by per- sons or corporations having establishments of the same sort in other places. As a matter of fact, during the last decade or two, establishments in different places have come largely under the control of the same corporations or individuals; hence the drift toward concentration is more marked than the figures indicate. And, finally, prices of the several articles declined during the half century covered ; hence the increase in the average output per establishment was even greater in terms of quantity (in tons of iron or yards of cloth) than in terms of value. 52 THE ORGANIZATION OF PRODUCTION Germany were engaged, at certain dates, in manufacturing establishments of different size. 1882 1895 1907 Per cent of persons doing work alone 25.2% 16.4% 10.1% Per cent of persons in establishments employ- ing 2 @ 5 persons 29.9 23.5 19.4 Per cent of persons in establishments employ- ing 6 @ 10 persons 6.0 7.2 66 Per cent of persons in establishments employ- ing 11 @ 50 persons 12.6 16.6 18.4 Per cent of persons in establishments employ- ing 51 @ 200 persons 11.9 17.0 20.1 Per cent of persons in establishments employ- ing 201 @ 1000 persons 10.9 13.9 17.3 Per cent of persons in establishments employ- ing over 1000 persons 3.5 5.4 8.1 It will be seen that the one-person establishment, and those employing five persons or less, have lost ground greatly. Those in the next tier (6 to 10 employees) hold their own ; all the others gain, and the very greatest rate of gain is in the class of very large establishments. 1 2. The causes of the growth of large-scale production are to be found mainly in the revolutionary changes in the arts during the last century and a half. Underlying them all is the increasing division of labor and the increasing use of machinery. A necessary condition has been the widening of the market under the influence of the opened transportation. A tool or machine of any kind is advantageous only if it is used for a number of operations. The greater the number of operations, the more is it worth while to have an elaborate tool, and to give much labor to its making. Machinery moved by 1 1 take these figures from Professor Bucher's paper in the Zeitschrift ftir die gesammte Staalswissenschaft, 1910, Heft 3, p. 430. Professor Biicher points out that for Germany, as for the United States, census figures do not tell the whole story of the growth of large-scale operations, since several establishments forming part of one larger enterprise are frequently reckoned by the censua as separata and independent. LARGE-SCALE PRODUCTION 53 power is a highly elaborate tool. The larger the scale on which an enterprise is conducted, the better is the opportunity for using machinery to advantage. The gain from its use arises from several sources. Power itself becomes cheaper per unit as it is applied on a large scale. Both for first installment and for running expenses, a large steam engine costs less, for each horse power, than a small one ; which means economy if the establishment is large enough to utilize all the power supplied. Again, subsidiary operations can be carried on to advantage by machinery. The use of steam shovels in handling coal, ores, earth, and of similar instruments for loading and unloading vessels, depends on the work being massed in large quantities at one spot. An ocean steamship of 10,000 tons carries freight more cheaply than one of 5000, and one of 20,000 tons more cheaply still. Wherever the traffic is heavy, as between Europe and the United States, the huge steamship is economical. Where the traffic is less heavy and less regular, as in the trade with South America and outlying regions, the ship of moderate size holds its own. The greatest of the American corporations making agricultural implements, one that illustrates conspicu- ously the tendency to large-scale production, the Inter- national Harvester Company, has a machine whose sole work is to shape poles for wagons and harvesters. The machine cost $2500; it saves a cent per pole; it is worth while only because poles by the hundred thousand are made each year. Other causes, more or less closely connected with the growing use of machinery, have strengthened the tendency to large- scale production. Just as all the several expenses for the plant and power become less per unit as the output enlarges, so the general expenses for administration and counting-room work tend to become less. Clerks are kept more continuously oc- cupied, and more elaborate division of labor among them is feasible. Superintendent and foreman can take charge of the full number of men which each can direct to advantage. One watchman, one engineer, one timekeeper, can usually serve a large establishment as effectively as a small one. All the mis- 54 THE ORGANIZATION OF PRODUCTION cellaneous expenses of general management are less in proportion to a large output. The mercantile management of a large enterprise the buy- ing of materials and the selling of the product also offers opportunity for economy and efficiency. Supplies can usually be bought to greater advantage. This is commonly spoken of as if due simply to greater bargaining power on the part of the large buyer, and to greater pressure of competition among those who wish to sell to him. But in the main it is due to the fact that mercantile operations themselves, and especially whole- sale operations, are carried on more economically when on a large scale. Expenses for clerk work, rentals of office premises, and the like, which constitute the main outlays of the wholesale dealer, are no greater for large transactions than for small. Hence brokers and wholesale dealers can sell at lower prices to those who buy habitually in large amounts. Again, the disposal of the output is often at less expense for a large establishment than for a small one, and often at still less expense for a very large establishment than for a moderately large one. Advertising and notoriety much affect the marketing of sundry commodities. When once appeal is made not to a limited local market but to a large and extensive constituency, the disposal of the great quantities of goods turned out by a modern factory becomes by no means the least difficult of its manager's tasks. All the apparatus for drumming up custom traveling salesmen, trade catalogues, and the like is the more effective, and the less costly per unit of product, in proportion as it operates on a large scale. Advertising is most effective when spread over the land with every sort of device ; when it is sys- tematized and put in charge of a separate manager. All such elaboration of marketing is both a result and a further cause of a great volume of business. The utilization of "by-products" 1 is another of the advantages of large-scale production. At the great packing houses which 1 Better, "joint products" ; see Book II, Chapter 16, 1. LARGE-SCALE PRODUCTION 55 do so much of the butcher's work of the United States, every particle of the slaughtered animal is used, and many things which would go to waste in the small shop become a source of profit. A very large woolen factory finds it advantageous to utilize the fatty matter which is attached to the wool as it comes from the sheep's back. This grease, which must in any case be scoured out of the wool, goes to waste in a smaller es- tablishment ; whereas the large mill, by putting in a plant for the special purpose of treating the grease, finds it a source of gain. Great ironworks find it possible to utilize the gas expelled from coal in the coking process ; either selling the gas, purified, in a near-by city, or using it at once for fuel in their own fur- naces. A large sawmill can put in a plant for burning its own sawdust, dispensing with other fuel for power. Other advantages of large-scale production arise from the possibilities of experimenting with new devices and new meth- ods. Some ventures will fail, some succeed. In a very great enterprise, the successes may be expected in the long run to outweigh the failures; the enterprise insures itself, so to speak, against the inevitable risks of experimenting. Where opera- tions are conducted on a small scale, the failure of one experi- ment may ruin the entire undertaking. Again, the best tech- nical skill, the best-trained engineers and chemists, are more easily and more economically employed by the great establish- ment. As with expensive but efficient machinery, their use is advantageous only for a very large output, and is most eco- nomical for the largest output. 3. The limitations on large-scale production arise mainly from the infirmities of human nature. The extension of the scale of operations means an ever increasing reliance upon hired labor and an ever-lessening reliance on spontaneous self-interest. If all men worked with as much energy and spirit for an em- ployer as they do for themselves, the spread of large-scale production would be almost without bounds. A striking illus- tration of the influence of this limiting factor is shown in the differing tendencies of agriculture and of manufactures. 56 THE ORGANIZATION OF PRODUCTION The operations of agriculture are necessarily spread over a considerable area; and they are not easily subjected to a fixed routine. Both circumstances make supervision difficult. Man- ufactures, on the other hand, bring the concentration of hundreds or thousands of workmen under a single roof or in a small area. Moreover, in manufactures, machinery means the repetition of identical operations. Hence a routine can be fixed, and work- men assigned to fixed tasks, and their faithfulness controlled, with comparative ease. But in agriculture much must be left to the zeal and intelligence of the individual worker. The consequence is that agriculture has nowhere shown the same tendency to enlargement of the scale of production which is so unmistakable in manufactures. It is true that some countries are usually spoken of as countries of large farming; England is the type of such a country. It is true, also, that in some parts of the United States (in the North Central region, for example) there has been in recent years a slight tendency to increase in the size of farms. But a farm which is called large is an industrial unit of comparatively small size. One which employs twenty men the year round is considered large; yet a factory employing this number is a small affair. The tasks of twenty men engaged in farming would be spread over several hundred acres, and must present troublesome questions in as- signing and supervising the work. Farms of this size are com- paratively rare. By far the greater part of agricultural work is done on farms where a single man, having under him perhaps one other or a few others, conducts the operations on his own account. In the early stages of the development of some parts of the United States, so-called "bonanza" farming has appeared for a time. Where great level tracts of fertile land have been suddenly opened to cultivation, as in the interior valleys of California or in the Red River Valley of the Dakotas, wheat culture has sometimes been carried on for a while over thousands of acres, with dozens of men and vehicles and with expensive machinery. But this has proved only a temporary phase. As the fertility of virgin soil begins to be exhausted, and a more varied LARGE-SCALE PRODUCTION 57 and careful use of it is called for, 1 these great tracts are split up into smaller units. The head of a large factory can devise means for supervising his men and for securing the execution of his orders. But the owner of a farm can use hired labor to advan- tage only when his own example and his own oversight supply the needed stimulus. Some industries, though spread over a large area and presenting difficulties for the supervision of hired labor, are so much more effective when on a large scale that these disadvantages are not decisive. The railway is an example. Many of its employees are necessarily scattered over great tracts of country. The supervision of the innumerable agents calls for an intricate and expensive apparatus of rules and regulations, bookkeeping and auditing. But the work is done so much more cheaply on a large scale that this difficulty and the expense entailed by it are more than offset. Sometimes, on the other hand, industries which offer possi- bilities of economy from large operations are for other reasons limited to small ones. Though retail dealings can be conducted to advantage on a large scale, with economies in purchases and in administration, with better utilization of premises, with more continuous activity by the force of salesmen, the smaller shops still hold their own. The opportunities for large-scale retailing are availed of in the cities by the so-called department stores ; establishments whose growth has been immensely promoted of late years by the improvements in urban transportation. But even in a large city, and especially in its outlying quarters, small or moderate retail shops continue. The reason is that often the purchaser must have his source of supply near at hand. The ubiquitous corner drug store of our American cities persists against large competitors. A glance at such a volume as the Statistical Abstract of the United States, with its summary of the number of establish- ments and volume of transactions hi various kinds of business, shows instructively which among them, for reasons of this sort, i Compare Book V, Chapter 42, 5. 58 THE ORGANIZATION OF PRODUCTION lesist the tendency to concentration. The strictly manufacture ing establishments show the characteristic features of the mod- ern movement. Though the volume of transactions becomes immensely greater, the number of establishments becomes less. So it is with the manufacture of agricultural implements, of boots and shoes, of carpets, chemicals, firearms, glass, cotton, woolen and silk fabrics, sewing machines. Those industries which, like the retail shop, purvey more directly to the consumer, or for other reasons must be near the persons with whom they have dealings, increase their numbers pari passu with the increase in population and with the volume of their own transactions. Such are blacksmithing, carpentering, plumbing, bread baking, printing, painting, and paper hanging. Here there is no marked tendency toward an enlargement of the size of the individual establishment, still less any victory of great-scale production. The limitations of men's faculties explain why large-scale operations do not make their way, even in manufactures, with unfailing certainty. What has been said in the preceding para- graphs may seem to imply that the transition to greater size takes place quasi-automatically. This is by no means the case. It depends on the energy, ambition, insight, of individual men. Every new machine, every change to larger scale, involves risks, calls for planning and judgment, is dependent on some individ- ual's initiative. If an indefinite number of individuals were capable of this sort of work, the march of progress would be faster and large-scale operations would make their way more surely and speedily. As it is, these changes wait on the impulse given by the comparatively few individuals who have the capacity for industrial leadership. Occasionally some such individual reorganizes his business upon a larger scale and with more highly developed plant and machinery. Then others follow his lead, and a whole industry is rapidly transformed. This has happened during the last two decades in the iron manufac- ture, especially in the United States and in Germany. Carnegie in the former, Krupp in the latter, led the way in a remarkable development. Usually, however, the advance takes place by LARGE-SCALE PRODUCTION 59 gradual and tentative steps, like those in the growth of the size of ocean steamships. The industrial revolution, so far as regards its pace, has been in reality not a revolution but a slow and gradual change, dependent on the energy and ingenuity of in- dividuals, and limited by the scarcity of men possessing such qualities. 4. A new phase of large-scale production has come to be of great and almost ominous importance during the present gen- eration. Perhaps it should be called large-scale management rather than large-scale production; since it involves not so much an increase in the size of the individual establishments as the combination under single management of several estab- lishments. It takes two forms, which may be described as horizontal and vertical. Horizontal combination is the union under single management of a number of enterprises of the same sort. They are usually few, and each is usually on a large scale. As the size of the representative establishment in any industry enlarges, and the number of individual establishments shrinks, the stage is finally reached where but a few survive a dozen, perhaps. These then combine; not in the sense that one huge establishment supersedes the dozen, but that the dozen, while retaining their technical independence, are owned and managed as one. Though large-scale operation may have reached its limit so far as the mechanical apparatus of production goes, some gain may still be secured from united large-scale administration. A typical example is the American Sugar Refining Company. A modern refinery is a huge concern, costing a couple of millions of dollars, and putting out 10,000, even 15,000, barrels of sugar a day. Yet there are limits to its size. Beyond a certain point, enlargement no longer adds economy in operation. When an output be- yond this capacity is called for, a second refinery of the same kind is erected, and so on until the total supply is provided. All these refineries, however, may be managed from one com mon center, with at least possibilities of economy. Their sup- plies may be bought in common, and distributed among them 60 THE ORGANIZATION OF PRODUCTION in such a manner as to insure continuity in operation and the minimum outlay for transportation. This last factor, economy in transportation, is of great consequence where the chief material (raw sugar, in this instance) comes from great distances, and, being rapidly worked up, must be continually and sys- tematically replaced. Machinery may be made identical, or "standardized," in the different works, and its repair and re- placement thus facilitated. These and other possible economies may be offset, to be sure, in whole or in part, by the inherent diffi- culties of large-scale management, notably the increasing difficulty of supervision. Experience, and especially the test of competition, can alone settle with certainty whether the advantages offset the disadvantages. Horizontal combination is typical of the so-called "trust." The motive for such union under single management is two- fold. Partly it is to secure economy in management; but largely it is to put an end to competition and bring about a more or less effective monopoly. So far as economy is secured, the movement, which has attained such extraordinary dimen- sions in the last ten years, may be to the public advantage. But if monopoly develops, it has grave possibilities of public disadvantage. How far monopoly in fact is likely to result, and how far cheapening of production is in fact brought about, is still uncertain; time and experience alone can show. But it is clear that in some respects at least, and for some indus- tries, such combination brings an extension of large-scale pro- duction and concentrated management. Different in its essential features is vertical combination, or, as it is sometimes called, the integration of industry. The usual outcome of the division of labor has been that the several steps in production which succeed each other in time have been conducted in independent establishments. But in some important trades there has appeared of late a tendency to unite such successive stages under single management. Thus the iron industry, in the traditional organization, was split up into a number of separate branches. One producer that is, a LARGE-SCALE PRODUCTION 61 capitalist hiring and directing a group of workmen carried on ore mining, and disposed of his ore to other producers en- gaged in smelting it into pig iron. Still another producer similarly cut the wood and converted it into charcoal, this in earlier days when wood supplied the fuel for iron making; or, after coke supplanted charcoal, mined the coal and made it into coke. The pig-iron maker, who had bought the ore and the fuel, sold his product to the puddler or steel maker, who in turn sold his bar iron or steel to the machinist, the builder, the wire maker. Vertical combination, or the inte- gration of industry, appears when all these successive steps are united under single management, when all the phases of iron and steel making are combined in one great enterprise. The United States Steel Corporation carries out this sort of combination in a typical manner, and on an enormous scale. Itself a union of previous combinations which had adopted the same method on a scale already great, this corporation owns vast mines of iron ore, of coal, and of limestone. The mines are situated chiefly on the shores of Lake Superior, the coal mines chiefly in Pennsylvania. Most of the ore is carried to the coal, and smelted in the great iron-making district of which Pittsburgh is the center ; but in part the coal is carried north and west, meeting the ore halfway, to be smelted at various places on the Great Lakes. To transport these ma- terials, the corporation has its own railways in the Lake Su- perior region, and in the region from Pittsburgh to Lake Erie; and it owns a great fleet of steamers and barges on the Lakes. The pig iron, made in its own furnaces, is converted into steel of various shapes in its own steel mills. The further operations of converting the steel into rails, structural and bridge shapes, plates and sheets, tubing, and wire, are carried on in still other establishments. In no other industry, and nowhere else in the world, has the experiment of vertical combination been con- ducted on so great a scale. The iron and steel manufacture offers an unusually tempting field for vertical combination, chiefly, it would seem, because 62 THE ORGANIZATION OF PRODUCTION of the concentration of the supplies of raw material, coal and iron ore. Those who, at any stage of rising demand, possess the mines of coal and iron, have the whip hand in the situation ; hence the manufacturers of the more finished forms of iron and steel have sought to gain control of the mines, by purchase or amalgamation. This tendency has shown itself in some degree in Great Britain, and has proceeded in Germany almost as far as in the United States. The combination of a series of superimposed establishments has now become the normal form of organization in the iron manufacture. Some tendencies of the same sort are found in other indus- tries. The International Paper Company owns great tracts of spruce forest, cuts the timber and logs, floats them to its own pulp mills, and there manufactures the paper which is used in such enormous quantity by our newspapers. The Harvester Company, already referred to, owns forests and cuts timber; it owns its iron and coal mines, and makes its iron and steel. The Sugar Refining Company owns its forests and makes its barrels. Other industries have shown a similar development in another direction, in the marketing of goods. The usual arrangement is for a separation between manufacturing and marketing. The shoe manufacturer commonly sells his output to the wholesale dealer or "selling agent," who in turn often sells to an intermediate dealer, the jobber, and sometimes directly to the retailer. But some shoe manufacturers have undertaken not only the making but the marketing of their wares. They have established their own retail shops, scattered in many cities over the country, and through them deal directly with the consumer. Again, the American Tobacco Company, by establishing its own retail shops in great numbers, has like- wise combined the distribution of goods with their production. Vertical combination and horizontal combination may go hand in hand. The American Tobacco Company has attempted to combine all the establishments manufacturing tobacco for smoking and chewing ; and the extension of its operations into the retail disposal of its products has been the outgrowth of LARGE-SCALE PRODUCTION 63 the endeavor to form and strengthen this all-embracing hori- zontal combination. The Steel Corporation owns many iron furnaces, many steel mills, many tube works, many sheet-steel and tin-plate works, and thus exemplifies also the union of the two kinds of combination. The Steel Corporation has carried horizontal combination in some branches to the point of nearly complete monopoly; thus it owns virtually all the sheet-steel and tin-plate mills and tube works in the United States. But it produces little more than half the pig iron, and has by no means a monopoly of the steel rails or structural steel. In Germany, the Stahlwerksverband (Steel Works Association) has formed a compact pool in the iron and steel manufacture, though one that does not go the full length of completely unified ownership. In Great Britain, on the other hand, while many large works have extended their operations downward to the control of mines and upward to the making of finished products, there is very little of horizontal combination; the several great enterprises go their own way independently. In the case of the boot and shoe manufacturers, just spoken of, who own their own tanneries or sell at retail their own shoes, the com- bination is vertical only; there is no attempt at horizontal combination. The movement toward vertical combination is less strong than that toward horizontal combination. The iron trade, which presents so striking a case of the former, is exceptional. The desire to secure control of a limited, or at least concen- trated, raw material, which has promoted the integration of the iron trade, has not affected others, in which the sources of raw material are more scattered. In the manufacture of cotton, wool, silk, or flax, there is no indication of any move- ment for control of the supply of raw material or for vertical combination in any other way. On the contrary, the tendency seems to be rather toward a minuter division. The textile industries in Great Britain and on the "Continent have always been split up into separate industries to a greater degree than in the United States. In Europe, spinning, weaving, bleaching, 64 THE ORGANIZATION OF PRODUCTION dyeing, printing, are usually carried on as distinct industries. The tradition in the United States has been for the combina- tion of several of these steps especially spinning and weav- ing in one organization ; yet even in this country the move- ment of late years seems to be in the other direction. In the shoe manufacture, while there has been the marketing arrangement just noted, and in some cases a combination of leather tanning with manufacturing, the trend does not seem to be toward greater combination. Some establishments do nothing but make soles, others do nothing but make box toes, and so on. The movement toward combination, whether horizontal or vertical, is in part a result of the intensified competition which comes with the greater investment of fixed capital and the greater size of the separate enterprises. But very largely it results from the discovery of the possibilities of organization. What are the limits to the size of the enterprise which can be managed as a unit? The single factory, perhaps large, was supposed until comparatively recent times to represent that limit. But as the scale of industry has been enlarged, the operations have been systematized and subjected to more perfect control. The task of management itself has been sub- divided. Separate persons are intrusted with the purchase of supplies, the sale of product, the maintenance of plant, the hiring and superintendence of labor, accounting and auditing. The genius of men with great inborn capacity for business has led to even greater perfection of organization. The tele- graph, the telephone, improved postal service, have promoted large-scale management as they have large-scale production. These striking changes have been the results of skill, judgment, and administrative capacity in the guiding individuals, and also the cause of an increasing demand for the persons possessing such qualities. None the less, the larger the scale of operations, the more do its disadvantages appear. There is need for an expensive system of control, for supervision, accounting, auditing, the LARGE-SCALE PRODUCTION 65 effective prompting of energy and economy. The test of com- petition settles in the long run whether the great combination is the more efficient agent in production. If it can produce more cheaply, it can sell more cheaply, and displace its rivals. 1 5. Notwithstanding the wastes of competition, and the possible economies of large-scale production, competing estab- lishments hold their own over the greater part of the field of industry. There is no present prospect that competition will be generally supplanted by combination and monopoly. That competition operates wastefully seems in some cases obvious. The milk of a city, for example, is usually supplied by a number of dealers, each with his own set of customers scattered irregularly over a large area. If all who lived in a given quarter were supplied by one dealer, a clear economy in delivery would be secured. If the whole supply for an entire urban district were under single large-scale management, there would be a possibility of cheapening the product still further, and (what in this case is specially important) of improving its quality. Retail dealers, especially in such things as groceries and foodstuffs, overlap in similar wasteful fashion. Commonly, too, the areas supplied by competing manufacturers overlap. Advertising, again, seems to be in large part designed to induce a customer to turn simply from one dealer to another. If there were no competition, if one great establishment sup- planted ten rivals, the same wants would make themselves felt, the same purchases would be made, the expense of adver- tising eliminated, the goods sold cheaper. Though some tendency is seen toward getting rid of the causes of waste, the tendency is not very marked. With the growth of great cities, large firms and companies have come in great degree to control urban milk supply, yet with little indication that complete and systematic combination is emerging. The great manufacturing "trusts" endeavor to avoid cross freights, by making shipments from that one among their establishments 1 To this statement of the automatic action of competition there are some qualifications, considered in Book VII, Chapter 63, 3. 66 THE ORGANIZATION OF PRODUCTION which is nearest the point of delivery. But, as a rule, rnanu* facturers continue to compete and to ship in a seemingly hap- hazard way. The same is true of retail trade, where all sorts of establishments, great and small, vie for the customer and duplicate facilities in the traditional and apparently wasteful fashion. The waste is probably less than it seems. Competition keeps every one keyed to a high pitch, nerves the shrewd and alert, weeds out the inefficient. Advertising is part of the mechan- ism of competition as well as of combination. Not least, com' petition leaves the purchaser some freedom; he is not sub- jected to the alternative of turning to one single purveyor or else doing without. Even the most benevolent and considerate monopolist becomes often exasperating; how much more so the ordinary trader when no longer spurred by competition ! A choice as to what you would have, and when and how you would have it, satisfies a deep-rooted human instinct. In the advocacy of socialistic organization, the advantages of unified supply are much dwelt on. But the consumer in the socialist state would have to accept whatever the all-controlling public managers put before him. The satisfaction which comes from freedom of choice explains in large part the persistence of competition. The movement toward combination has been so conspicu- ous of late years that the extent of the field which it covers has been exaggerated. Agriculture shows it least ; transportation, especially by land, shows it most. In mining, there is the striking case of the iron trade ; and there is also, in the United States, the striking case of anthracite coal, where the strictly limited area of supply and the close connection with transpor- tation have brought about effective combination. Nevertheless, most mining is still carried on by independent producers. In manufactures, most industries have not reached the stage of combination. Over the greater part of the industrial field, though production tends to be on a larger scale, with great use of machinery and minuter division of labor, competition still prevails. CHAPTER 5 CAPITAL 1. The increasing complexity of the division of labor and the growing use of machinery have added to the number of separate stages in production and to the length of time over which the whole process is spread. Hence the greater need of a supply of tools and materials, the importance of capital, the problems which relate to owners of capital and to the income from capital. Production is spread over time in any society advanced beyond the most primitive savagery; and this not merely for the several subdivided steps in production, but for production as a whole. That agriculture takes time, from the sowing of the seed to the reaping of the crop, is obvious. But the sowing is not the beginning, nor is the reaping the end. The seed must have been itself sown and husbanded, and the tools for cultivation must have been prepared in advance. After the harvest, the grain which is reaped may indeed be available for satisfying human needs almost at once; it is so in a small, self-contained community, such as we still see in a village of Hindustan. But in the countries of advanced civilization grain is carried by rail or water to a mill, probably distant; there ground into flour; then carried another distance to dealers ; and finally, after a considerable interval, put into the hands of the consumer. Each of these steps not only takes time in itself, but implies the existence of apparatus which has been made in the past and has taken time to make, the railway or steamship, the flour mill, the warehouses and shops of the middlemen. Almost all the operations of production require first the procuring of materials from nature's resources, then their fashioning with the aid of tools and machinery. Let the 67 68 THE ORGANIZATION OF PRODUCTION reader but consider the mode in which the familiar articles of daily use have come into his hands, the clothing and the footgear, the furniture and household utensils, the books and ornaments, the house in which he dwells, and he will see how long has been the series of operations, how intricate the division of labor for each one, and how extended the period from the beginning of production to the final attainment of the consumable or enjoyable article. This fundamental fact, resting oh the complex division of labor, is yet disguised by that very division. The tanner who puts his leather on the market, the farmer who sells his flax, the ironmaster who sells his steel or iron, each thinks of him- self as marketing a completed product. By the sale he gets money, and so the command of the enjoyable things he wishes to buy or of the things needed for continuing production. He never stops to reflect what must further be done to the thing which he sells ; how it must pass through the hands of a long chain of producers and dealers before it reaches in consumable form those whose wants are finally satisfied. In modern times, the most significant aspect of this element of time in production is found in the increasing use of machinery and plant of all sorts. Machinery, though it may be simply a more intricate kind of tool, adds so much to the preparatory work that it has greatly accentuated the problems that arise from the spreading of production over time. A factory requires a year or years to build ; the machinery in it requires still more time to make. Many years are needed for constructing a railway ; a generation for such a work as the Suez Canal or the Panama Canal. The factory, and the machinery in it, exist for the pur- pose of eventually turning out things to be used and enjoyed. The railway and canal facilitate the geographical division of labor, and serve to promote, through a series of steps which only begin when these means of transportation have been completed, the eventual abundance of things to be used and enjoyed. One simple fact illustrates how marked the tendency toward greater use of plant has been in the period since the industrial revolu- CAPITAL 69 tion began. The world's annual production of iron has multi- plied tenfold the last half century, and sixtyfold in the last cen- tury. 1 Iron is used solely (the exceptions are insignificant) as an instrument of production; it is the foundation of the material apparatus of civilization; it means plant, tools, machinery. The enormous quantities of it which have been turned out in modern times, and especially during the last generation, signify an extraordinary increase in the construction of elaborate and expensive apparatus, and a corresponding extension of time in the operations of production. 2. If we were to take a cross section of the community's pos- sessions at any given time, we should find them to be of the most diverse sort. There would be, in the first place, such things as iron ore and steel bars, timber and wool and cotton, factories and railways and ships, stocks of all sorts in warehouses, com- modities ready for sale in the retailers' shops. And in the second place, there would be houses, furniture, clothing and food, in the hands of those using them for the satisfaction of wants. To the first set of things we apply the term capital, or producer's capital; the second set we call consumer's capital, or wealth that is not capital. The first set we may speak of as unfinished goods, the second set as finished and enjoyable goods. For some purposes of economic analysis they are similar, for other purposes dis- similar. The difference between them is at bottom only a dif- ference of degree; yet is so great as to justify a distinction. 2 For the present, we shall find it convenient to apply the term " capital " specifically to the first set, to producer's capital. The second set will be referred to as enjoyable or consumable or finished commodities; and only when speaking of them in 1 The world's annual output of pig-iron was : In 1800 825,000 tons In 1850 4,750,000 tons In 1870 11,900,000 tons In 1905 53,700,000 tons 1 The difference in degree is one as to the time when satisfaction or utility accrues. That time is commonly nearer in the case of consumer's wealth or con- sumer's capital, and mora distant in the case of producer's capital. See what is said below on these, subjects, Book V, Chapter 40. 70 THE ORGANIZATION OF PRODUCTION those aspects and relations which offer analogies to the first, shall we refer to them as consumer's capital. Capital, then, that is, producer's capital, is not in en- joyable form ; it is not now a source of satisfaction. It exists for the purpose of increasing consumer's wealth. Its relation to enjoyable goods is twofold. On the one hand, it may be said gradually to " ripen" into such goods. On the other hand, it is a means of increasing their supply. It is easy to see that raw materials, as they are commonly called, ripen into finished commodities. Wool is converted by successive steps into clothing, stone and timber into a house, grain into bread. But a process the same in essentials takes place as to tools and machinery. Suppose a printing machine to last for one year only, being worn out and worthless at the close of the year. The books printed with its aid are the product not only of the labor applied to making the paper and other materials, of that applied by the compositors and other workmen in the printing office, but also of that applied in the construction of the printing machine itself. If we suppose that one hundred books are printed in the course of the year, the machine may be said to have ripened into so m&ny enjoyable goods, and each of these may be said to have embodied in it one hundredth of the labor which was given to constructing the machine. The ma- chine as such has disappeared, just as the paper and ink as such have disappeared ; in place of all three we have the printed books. If the machine lasts for ten or twenty years, the labor of constructing it contributes to making a much greater quantity of books, and a smaller fraction of the labor of construc- tion is embodied in each book. So of all machinery and all plant. It wears out sooner or later, and may be said sooner or later to ripen into goods that satisfy our wants. The most important single cause of the abundance of con- sumable goods, and so of the improvement in the material welfare of mankind, is found in those forms of capital which are com- monly spoken of as fixed, in tools, machinery, plant. Cer- tainly this has been the most important cause of the remark- CAPITAL 71 able advance in material welfare which the civilized countries have made during the last century. Erect a great cotton or woolen mill, a shoe factory, a large sugar refinery or flour mill, take much time and apply much labor for getting ready an elaborate apparatus, and eventually you will secure your product in greater abundance and with less labor embodied in each unit. The making of machinery itself has illustrated this tendency as strikingly as any other branch of production. The manufacture of iron and steel, conducted on a great scale, with elaborate and expensive plant, serves to turn out in cheap- ness and abundance the metal indispensable for the apparatus of production at large. Locomotives, textile machinery, ag- ricultural implements, not to mention the simpler tools of the mechanic, are themselves made with machinery. In order that all this application of plant may work smoothly and effectively, the supply of materials must also have been on a large scale ; and this again involves prolonged preparation. A great iron furnace, kept in blast night and day, year in and year out, takes into its maw huge quantities of iron ore, coal, and limestone, which, no less than the furnace itself, must be made ready in advance. So the textile mill requires its wool or cot- ton or silk, the shoe factory its leather, the refinery its raw sugar. Through all the complicated operations the trend is the same ; elaborate preparation, production spread over time, much capi- tal, eventual plenty, and cheapness of the consumable goods. 3. In order that there shall be capital and time-using pro- duction, there must have been at some previous period a surplus. The more of capital is to be employed, the more must there be a surplus to draw on. In the very earliest stages of the formation of capital, that surplus showed itself directly in the fact of spare time. The first rude implements of stone and bronze must have been fashioned during hours when labor did not need to be given for the satisfaction of imperative wants, when there was a chance of doing something else. What motives may have influenced man during this stage, and by what chance the first tools were 72 THE ORGANIZATION OF PRODUCTION hit on, we cannot guess. Very possibly a mere instinct of con- trivance was the moving cause. A reasoned understanding of the gain from having tools and supplies must have set in at an early stage. The choice under the simplest conditions is between the present and the future, between idleness or amusement for the moment and provision for future needs. The greater the surplus, the greater the time and labor which can be given for future needs. When the arts are at so low a stage that little is produced beyond the bare necessaries of ex- istence, provision for the future can be made only on a scanty scale. On the other hand, the very scantiness of capital is an obstacle to the efficiency of labor and so to the existence of any considerable surplus. During long ages mankind was thus in a position of double difficulty. Without capital the productiveness of labor was meager, and yet with meager productiveness of labor there was little possibility of creating more capital. It is not to be understood that the slenderness of the surplus stock was the only obstacle to the creation of capital. Igno- rance of natural laws and of the possibilities of tool making, carelessness for the future, were no less important. But with- out the surplus the very foundation for building up any effec- tive apparatus of production was lacking. Here, as often, the first step was the hardest. Once man had become possessed of some capital, the productiveness of his labor became greater, and thereby the creation of still more capital became easier. 4. In the preceding section we have spoken of capital as being made or created. But capital is also said to be saved and accumulated. Both expressions are accurate. If we think of one person or set of persons as being alone concerned with the steps by which capital comes into existence, we can see that this person both provides for the future by saving, and uses his surplus in shaping tools or getting together materials. But in a society having an elaborated division of labor, these two things are rarely done by one person ; that is, they are rarely done together by one person for any given item of capital. When all incomes and expenditures take the form of money, savings CAPITAL 73 are made, not by putting aside things in kind for one's own use, but by putting aside money for future needs. On the other hand, tools and other apparatus of production are made for the market by persons who are not consciously providing for the future. They are bought by other persons who wish to " invest," that is, to get capital. The process by which these separate steps are made to bring about their joint result in the modern organization of industry deserves careful consideration. Saving may take the form of simple hoarding. The miser who puts away a store of coin, saves and provides for his own or others' needs. But no addition to the apparatus of production results from such saving. Where property is insecure, from the rapacity of a despot or from the feebleness of a government unable to protect against foreign invaders, hoarding is sometimes done on a large scale. In British India, during many centuries pre- ceding the British occupation, both these causes of insecurity existed. Hence those who had means put them largely into the form of specie and jewels, articles having much value in little bulk and capable of being hid or carried away. The European aggressors of the seventeenth or eighteenth century found great stores of such wealth in Hindustan, not because that country had rich mines, but because the people had attained a consider- able civilization and prosperity, and had hoarded long. Not- withstanding the peace and security which British rule has long maintained, the habit of putting accumulated means into this form has continued in India to our own time. In France, for a long period preceding the French Revolution, the peasantry those among them, comparatively few, who had anything at all in the way of a surplus put away coins, one at a time, hid- den in the chimney or garret, until they had accumulated enough to buy a scrap of land. Fear of spoliation and ignorance of other ways of doing anything with the money caused their saving to take the form of hoarding. No addition to capital was thereby promoted. Nor was there any addition to capital even when the accumulated coins were brought out for the purchase of land. The noble of whom the purchase was made probably frittered 74 THE ORGANIZATION OF PRODUCTION away the proceeds, and the only immediate result of the peas- ant's accumulation was the transfer of land from one hand to another. Such practises continued in France after the Revolu- tion and until the latter part of the nineteenth century, when the war between France and Germany, which shook so many of the established traditions of France, served largely to bring to an end the habit of putting aside hoards of specie. The great bulk of saving, however, takes in modern times the form of investment. Contrast the process of hoarding with what happens when money is put away in a savings bank, an opera- tion which we may select as typical of the methods of investment in a modern community. The person who leaves his cash with the savings bank commonly thinks only that it is safe, and that he is paid something as interest on it. But the cash is not kept in the coffers of the institution. A small fraction only is re- tained, to meet possible calls of depositors who wish to make withdrawals. Almost all of it is lent out to persons who use it for making a profit. Now profit arises, in the ordinary course of things, from the operations of production ; and the person who borrows money uses it for the purchase of things needed in pro- duction. He may be a manufacturer, who erects a building, buys machinery and supplies, hires workmen. He may be a merchant, who buys commodities from the manufacturer, and carries them one stage further in the successive stages which bring them at last to the consumer. Every person who directs production such as the manufacturer or merchant uses a large part of his means in buying materials or tools or stores from producers of a previous stage, so recouping them for the outlays they have already made. The money means which are put at the disposal of the business class as a whole are a most im- portant part of the mechanism for adding to the concrete appa- ratus of production. 5. The fundamental fact in this elaborate mechanism of saving and investment is that advances are made to laborers. One set of persons put aside money means; through various channels, other persons are given command of these money CAPITAL 75 means, and use them to set laborers to work. Here, again, the division of labor between those who carry on the successive stages of production conceals the essential nature of their opera- tions. A manufacturer spends only a part of his means upon hiring laborers directly ; the rest he uses in buying plant and ma- terials and in the ^ JV >^r expenses of production. But those materials were themselves fashioned by laborers to whom another set of advances had to be made by a previous capitalist. The wholesale or retail merchant hires comparatively few laborers, only a set of clerks and a porter or two. But he recoups by his purchases of goods the advances of a long series of preceding employers, himself giving only the finishing touches in the whole process. Looking at the operations of capitalists and employers as a whole, and reflecting on the outcome of the divi- sion of labor among them and their workmen, we find that all capital is made by labor, and all the operations of the capitalist class are resolvable into a succession of advances to laborers. These advances, just spoken of as money turned over to la- borers, consist ultimately in a provision of commodities for their use. The money is but the medium whereby laborers get com- mand of the commodities which they buy. These commodities things to eat, to wear, to give shelter are in the last analysis what the employing class hands over to those whom it employs. Some of the advances were made in the past, and are repre- sented now by plant and materials, still in use, of which the full equivalent has not yet been reproduced in finished form. Some are made from day to day, in the course of current operations. The whole of existing capital may thus be described as a great accumulated surplus which has been used and is being used for maintaining labor, while provision is made for the future. The process of setting laborers to work in the initial stages of pro- duction is going on all the time ; similarly that of bringing arti- cles to the final stage of consumable form. The wide separation, in modern societies, of the two acts needful for the creation of capital saving and the application of labor is mainly the result of inequality. Persons of the 76 THE ORGANIZATION OF PRODUCTION well-to-do class have a considerable surplus over current needs, and save with comparative ease. They own most of the appa- ratus of production. But most persons in our modern societies are not of the well-to-do class, and have little in the way of a surplus. They have small accumulations, and they are mainly hired by others in carrying on the operations of time-consuming production, and in making and maintaining capital. No doubt, some savings are made by the working classes; and through the agency of savings banks and similar institutions, these savings have increased rapidly. But, while absolutely con- siderable, they are no large proportion of the total of accu- mulated means. The greater part of the capital owned and maintained in modern communities arises from the savings of the comparatively small numbers of the more fortunate classes. A chain of middlemen commonly connects the individual who saves with the laborer to whom advances are made. The em- ployer himself, though he almost always uses some means of his own, commonly is a borrower. He borrows, however, not from the savers directly, but from their various agents and repre- sentatives. The savings bank, for example, collects surplus sums from individual savers, yet often deals with the em- ployer of labor only through brokers and other middlemen. It buys stocks and bonds from brokers and banking firms. The banking firms have issued them after long negotiations with the persons undertaking the operations to which the whole series of transactions is in the end directed. Bankers are the typical intermediaries; their essential function is to direct the stream of surplus money income into one direction or another, and to put into the control of one or another group of employers the means for setting laborers to work. Life insurance companies, which collect and equalize funds put aside by many individuals in order to provide for future needs, are among the great modern agencies of saving. Like the savings banks, they commonly make their investments not by direct loans to employers, but through bankers and other intermediaries who take the first risks of production and guaran- CAPITAL 77 tee the investors a secure return. During the last half cen- tury there has been an immense increase in the amount of savings and investments by persons who themselves are neither desirous nor competent to direct actively the operations of production. Hence there has been a great development of the class of middlemen who intervene between them and the active managers; there have been great possibilities of profit for those middlemen, great possibilities of abuse in positions of trust, but also great effectiveness in collecting and investing the savings that underlie the enormous growth in the total capital of modern communities. 6. Not only the creation of capital involves labor and saving; its maintenance does so also. All forms of material wealth wear out in course of time. Some sorts of capital are indeed very durable, such as irrigation dams and ditches, or granite docks. Some last a considerable time, as buildings and machinery. Others are used up very quickly, as the coal which is consumed under the boiler. All need to be replaced as time goes on ; some slowly, in proportion as they last long; some quickly, in proportion as they are rapidly used up. In order that the existing apparatus of pro- duction may be maintained, a certain amount of labor must steadily be given to its renewal and replacement. This labor must be supported, and its support means repeated demand upon surplus and savings. The manner in which this takes place may be illustrated by the depreciation account which appears on the books of every manufacturing enterprise. The manufacturer knows that his machinery wears out, and that, if his capital is to remain un- impaired, he must set aside something annually to replace it. Not only does his machinery wear out, but, in a period of rapid improvement and invention like our own, it fast becomes antiquated, and he must be prepared for the possibility of hav- ing to discard it even before it has ceased to be workable. If we assume that its life is ten years, he must set aside annually something like one tenth of its value ; to put it more exactly, 78 he must put aside such sums as, invested and compounded, will make up the value at the close of the decade. If he is to secure a permanent profit, he must reckon these amounts as part of his expenses. Yet, in the first instance, the amounts are free sums, or so much surplus, not expected to be used for current expenses. 1 They are presumably used for purchasing new apparatus to replace that worn out; but they are not necessarily so used. Commonly, capital is maintained intact; not in the sense that the same machinery or materials are maintained indefi- nitely, but in the sense that, as they wear out, other ma- chinery and materials are regularly produced to take their place. The surpluses which are put aside to balance deprecia- tion are again invested in the same enterprise and the same instruments, or in some other. The habit of saving is strongly intrenched among the well-to-do. Spendthrifts are rare, and such extravagances as occur are more than balanced by the fresh accumulations of new savers and investors. Consequently the making of new capital of machinery, materials, and all sorts of apparatus goes on constantly. Those persons who in the established division of labor are engaged in the machine- making trades, have the well-founded expectation that their apparatus will be bought to replace that which has worn out. Thus the manufacturer finds new machines already prepared, or at least finds all the materials ready to be put together by other machinery made ad hoc. Under the division of labor, provision is constantly made for anticipated needs, and among those needs that of replacing of capital steadily makes itself felt. The repair of capital, as well as its complete replacement 1 In practise, the actual setting aside of money, and its investment over a term of years, as a separate fund toward depreciation, is probably rare. Usu- ally, a sum is each year debited on the books against earnings, for deprecia- tion. On the other hand, one or another item of plant is renewed or repaired each year the whole does not become useless at one fell swoop and the sums spent for replacement are charged against the depreciation account. In any given year, more or less may be actually so spent than is regularly set aside for depreciation. If less is spent, and the depreciation fund accumulates, it is often used, in a profitable enterprise, for putting in additional machinery or improvements, it is invested in the plant rather than for the plant. CAPITAL 79 when worn out, calls for the recurrent exercise of saving. Some kinds of apparatus must be touched up a little from day to day in order to be in good working order. Such is the case with the roadbed of a railway, which needs almost hourly attention, and would become quite unusable if neglected for a few weeks. The locomotive of a railway, again, is subjected to constant heavy strain, and needs to be sent to the machine shop at frequent intervals; until finally, after perhaps a gen- eration of alternate using and patching, it goes to the scrap heap, and has to be replaced with a new one. The continued maintenance of capital by operations of this sort means the steady application of labor hired (in the last resort) by persons who mean to keep their capital intact. 7. Even at this early stage, some corollaries from the propositions as to capital and saving may be stated. Saving on a large scale is commonly undertaken not merely to provide for future wants, but in the expectation of a separate reward in the form of interest on capital. The theory of interest, which has many complications, will be considered in its due place; it suffices here to say that, under a regime of private property, the receipt of some such return on savings is a con- dition of the creation and maintenance of the whole stock of capital. Some economists have indeed implied that it is only the first making of capital that calls for the deliberate use of a surplus, and that capital, once made, reproduces itself auto- matically without any effort on the owner's part, and without any need of stimulus or resource in the way of interest. 1 This view arises from assuming that what is habitually done is done without choice or effort. The habitual replacement of capital takes place not by any automatic process, but because the owners recurrently choose to save and to invest surplus sums as they are acquired. Were there no motive for doing so were there no such thing as interest on capital habits would change; and not only the creation of new capital, but the maintenance of that already existing, would be endangered. l E.g. J. B. Clark, The Distribution of Wealth, Ch. IX. 80 THE ORGANIZATION OF PRODUCTION Such, at all events, would be the result in communities, of the kind familiar to us, in which there is accumulation and owner- ship of capital by private individuals. What would be the method of accumulating capital under the very different con- ditions of a socialist community, where all capital was owned by the state, opens another set of questions, which must be reserved for later consideration. 1 8. In the older books on economics it was often laid clown that the distinction between capital and noncapital was merely a matter of the owner's intention. According as he chose between investing and spending, between providing for the future and enjoying in the present, there was capital or there was enjoyable wealth. The impression was left that some magic change was wrought in the nature of commodities by the mere volition of their owner. Obviously this could not be literally true. Most articles are by their nature such that they can be used only in one way, either for present enjoy- ment or as producer's capital. Iron and steel, for example, to which reference was made in an earlier paragraph, are almost of necessity capital. They are used for making tools, machines, buildings, and can rarely be used for any other purpose. All factories and all materials are in the same case. Almost uni- versally any concrete form of wealth is by its nature fit to be used once for all either as capital or as a source of immediate enjoyment. Could the owner, nevertheless, exercise his choice by selling his capital (say a factory), and using the proceeds at will for investment or for enjoyment? A little reflection shows that such a disposal cannot change the nature of the factory. Sale means simply transfer to another hand; the factory remains, and its purchaser can use it only as an instrument of produc- tion. The individual can change by sale the nature of his own possessions, but he cannot thereby change the nature of the apparatus of production. Nevertheless, the owner's intention is in the long run im- 1 See Book VII, Chapter 63, 5. CAPITAL 81 portant, nay decisive, in determining whether wealth shall or shall not take the form of producer's capital. As the various kinds of wealth wear out and need to be renewed or replaced, a choice is recurrently presented to the owners as to the way in which they shall use their surplus possessions, whether they shall continue investment and maintain capital, or cease in- vestment and cause labor to be directed to making consumable goods. For any given period they may have committed them- selves irrevocably to investment, and cannot change the form which their property has taken. But as time passes, and the process of using and renewing the various kinds of wealth goes on, they have again the option which they had in the initial stages. They may save and invest, or they may spend and enjoy. However considerable the length of time over which the capital of a community, when once constructed, endures in the shape which has been given it, and however slow the process by which the disposition of the capitalists takes effect, it is still true that in the long run the owners' intention determines whether there shall or shall not be capital. 9. Saving and investment have been spoken of so far as leading to the making of capital. But they do not necessarily do so ; and some consideration of the cases where they do not is essential to an understanding of the relations of the individual saver to the general welfare. All that the individual investor is concerned with is the safety of his principal and the return on it in the way of interest. If a spendthrift wishes to borrow, and gives a sufficient guaran- tee of repayment, by mortgage or other pledge, a loan is made to him as freely as to a business man who proposes to put up a factory. But the loan to the spendthrift has nothing to do with the making of capital. It leads to the same results as if the original owner of the surplus sums had devoted them to present use. It causes labor to be directed to producing truffles and champagne, not factories and machinery. Spendthrift loans, incurred by individuals, are common in backward countries, but with industrial progress tend to become 82 THE ORGANIZATION OF PRODUCTION relatively unimportant. The Hindu peasant still borrows from the village usurer, as his kind have done for centuries; he will pledge his crops, his land, his very self, to give a feast on the marriage of his daughter. During the transition from the Middle Ages to the modern period, kings and feudal digni- taries borrowed heavily (often from the Jews), in part for crusades and dynastic wars, in part to satisfy the developing taste for lavish expenditure of money income. But in modern times operations of this sort have become of little importance as compared with the total of borrowing and of spending. Pawnbroking has become a petty business. Most borrowing by private persons takes place in the course of investment. Yet another kind of spendthrift borrowing remains of great economic importance by governments for war purposes. Where highways or railwaj^s or irrigation works are constructed from loans, we have the ordinary phenomena of saving, in- vesting, capital making. But where the sums advanced by investors are used for war expenditures, we have saving and investing, but no resulting capital. We have vast waste by contending armies, and great loans that are so far as their strictly economic consequences are concerned essentially of the spendthrift sort. Every modern state has a great debt, and these debts repre- sent in the main war loans. The national debt of France now amounts to some 3000 millions of dollars ; that of England to millions. Both are the legacies (almost exclusively) of wars. The United States borrowed 2500 millions during the Civil War, and our war debt still outstanding (1909) amounts to 1000 millions of dollars. The consols and rentes and government bonds by which these debts are evidenced represent to the in- dividual investor the acme of solidity and security. Yet they are the most intangible of the forms of wealth. They stand simply for claims on the community at large, an obligation by the public to pay stated sums to the creditors. In no sense do they stand for capital to the community. This great phenomenon has a bearing on the social signifi- CAPITAL 83 cance of interest as a return on capital. Interest means a leisure class. Rightly or wrongly, some persons are supported in idleness by the rest of the community. Against the burden may be set the fact that the community possesses useful in- struments which could not have been got except through some one's saving. This is, in essentials, the justification of interest. But in the case of national debts the community has obtained no useful instruments. The justification of the claim to interest by the public creditors themselves is of course in no way affected by this consideration. Their rights must be held as inviolable as those of other lenders. But the social justification of interest would be much less strong if all saving and all investment were for the conduct of war, and if nothing of permanent economic effect remained but endless generations of pensioners. 10. Some further distinctions as to capital call for brief consideration. An individual thinks that to be capital which yields him an income ; but there is an obvious distinction between that which 'is capital for the community and that which is, in the usual sense, "capital" to the individual. Stocks, bonds, and securities yield an income to the owner, and are regarded by him as part of his capital. In themselves these are simply evidences of ownership or of indebtedness. A stock certificate states that the holder has certain fractions of ownership in a given concrete thing or set of things. A bond is a mere promise to pay. Bonds are commonly issued as the result of operations of saving and investing which have to do with the making of capital. But, as the case of government securities shows, they may be the result of operations which are quite wasteful. Though capital to the individual, they may or may not signify the creation or the existence of real capital. Consumer's wealth is not commonly regarded by an individual as part of his capital. A factory ; a stock of materials or goods used in business operations; money on hand or in bank, not in the nature of spare cash for current expenses, but a fund or reserve for business purposes, such things he thinks of as 84 THE ORGANIZATION OF PRODUCTION capital. Household furniture, clothing, horses and carriages, he does not so reckon, since these yield him no income. Pos- sibly a dwelling, though occupied by the owner and yielding no direct income, would still be regarded by him as part of his capital ; for he might reflect that, if he did not own it, he would have to hire one at a rental, and hence might conclude that his own is equivalent to income-yielding property. Dwellings not occupied by the owner, but let to tenants, would unques- tionably be regarded as capital. Everyday usage is hazy, and "capital," like other common words, is used in different senses. For the purposes of economic study, we shall disregard the individual's point of view, and shall consider the subject of capital, as we shall other subjects, from the point of view which is important for the community. Whether, so considered, there is an important difference be- tween producer's and consumer's wealth, will be discussed at a later stage. 1 It suffices here to say that in speaking of capital, we shall have in mind real things, and not rights to things ; and we shall have in mind producer's capital, those things which are part of the community's apparatus of production. Some writers have distinguished between "capital" and "capital goods." By the latter term they mean the concrete apparatus of production, just that to which, in the preceding paragraph, the single word " capital " was affixed. But by the word "capital" alone these writers mean the value of the con- crete apparatus; and they sometimes speak as if there were a sort of distillation or essence of capital, distinct from the tangible capital goods in which it is embodied. It is often convenient to measure and record capital in terms of value and price, as so much money. In that way alone can the various constituent elements be reduced to a common denominator. An individual usually states his capital as being so much in money value. His capital obviously consists, not of the stated sum of money, but of factories, machines, buildings, merchandise, stocks and bonds, if you please, the various 1 See below, Book V, Chapter 40, 3. CAPITAL 85 things which make up an individual's "capital." He simply measures it in terms of the price for which the whole would sell. Similarly, we can reckon the community's capital in terms of the price for which the whole would sell. If the total prices, at current rates, of the various factories, instruments, materials, goods in stock, are added together, the sum will give an idea of how much capital the community possesses. It would give a very imperfect idea. Statistics of this sort, occasionally col- lected by public officials for census purposes, are in many ways misleading. Yet if we wish to measure total capital or total wealth at all, we can proceed only in this unsatisfactory way. Though some forms of capital can be measured in other terms, machinery, for example, in terms of horse-power, or textile mills in terms of spindles and looms, the only measurable element common to all forms is that they have value and price, and the only way of reaching a quantitative statement as to the whole is in terms of value and price. But it is not to be supposed that there is any such thing as capital distinct from the capital goods. The only actual and existent thing is the concrete apparatus of production. Its value or price is merely a relation to other things, a mode of measuring it. Hence in the following pages, we shall com- monly denote by "capital" the concrete things, or "capital goods." Sometimes, it is true, convenience in conforming to everyday terminology will require a departure from this usage. We shall have occasion to speak, for example, of the capital of a bank, which is always reckoned in terms of money; and in other discussions the word may refer to the values and prices of things rather than to the things themselves. What sense is meant, will ordinarily be clear from the context. 1 1 For some references on Capital, see below, at the close of Book V CHAPTER 6 THE CORPORATE ORGANIZATION OF INDUSTRY 1. The growth of large-scale operations has caused a great development of combined action by producers and investors; that is, by those who guide production and those who own the apparatus of production. Association by the manual laborers themselves, for the conduct of production, is a different thing. It might conceivably be an important and even dominant form of industrial organization; but in fact it is not. 1 The form which is more important than any other in the modern world is the association in the business corporation of capitalist owners and managers. The simplest form of association by such persons is the part- nership of two or more persons. The distinguishing mark of the partnership in the eye of the law was originally the joint and several liability of the partners for all debts ; and this still re- mains in most cases. Each of the partners is liable individually and without limit for all debts of the firm. A creditor, if his claim is not met according to stipulation, may levy on any one of them, and may secure the full amount of his debt from that one. The mode in which the partners then settle the distribu- tion of the obligation among themselves is a matter with which the creditor need not concern himself. The distinguishing mark of the corporation is limited liability. The several associated persons contribute to the undertaking, in the form of a subscription to shares or capital stock, a given sum. Their liability for debts is then limited in proportion to the original subscription. Usually it is limited to the pre- cise amount subscribed. When they have once paid in that sum in full, the par value of their shares, they can be 1 See what is said in Book VI, Chapter 58, of cooperation by workingmen. 86 THE CORPORATE ORGANIZATION OF INDUSTRY 87 s called on to pay no more. Occasionally there is a different liability. For example, in our national bank corporations, the liability is double; the shareholder may be called on to pay not only his original subscription, but (in case of need for meeting debts) as much more. Some limitation there always is. The shareholder in a corporation is never liable, as is a partner, to the full extent of his means. The legal distinction between a partnership and a corpora- tion does not run parallel with that which is significant for the purposes of economic study. For the economist, the impor- tant distinction is between an association of a very few persons, well known to each other and actively engaged in the under- taking, and an association of a considerable number of persons, strangers to each other and generally investors not closely con- cerned with the management. Size, though not necessarily sig- nificant, yet distinguishes roughly the two kinds of economic organization. It is true that some corporations are small, some partnerships large. But usually the conduct of operations on a considerable scale, and with a considerable number of partic- ipants, is in the corporate form; while partnerships usually confine themselves to more moderate undertakings. During the last half century, legislation in English-speaking countries has greatly modified the sharp distinction which the law drew in earlier times between the partnership and the cor- poration. The strict rules of the older common law made the partnership a cumbrous form of organization. It had to be wound up on the death of any partner, and it was in other ways hampered in continuity of operation. Accordingly statutes have permitted partnerships to have some of the characteristics of corporations, continuing existence, inactive members, some limitation of liability. On the other hand, corporations have been allowed to enter on all sorts of industrial fields which formerly were shut to them. Originally, industrial corporations were authorized only where some special public interest was supposed to be involved ; as in the case of the great companies for foreign trade in the seventeenth and eighteenth century, of 88 THE ORGANIZATION OF PRODUCTION banking corporations, and, in later days, canals, turnpikes, railways, and the like. But the convenience of this form of associated action, compared with the cumbrousness of the part- nership, caused a gradual extension of its field, until at present any and every sort of industrial enterprise may be conducted in corporate form. The consequence is that many business corporations are of small size, owned and managed by a few individuals whose relations to each other are substantially those of partners. The choice between a corporation of this sort and a partnership of the older type is often determined by the peculiarities of the law in the place of action, by its tax methods, by its legal procedure. The fundamental distinction of limitation of liability has ceased to be of vital importance. It is true that a partnership with un- limited liability may be expected to enjoy better credit, since those who lend to it have more to fall back on. But credit in modern times depends very much on the personality and busi- ness repute of the borrowers ; or, if there be question as to their business standing, it depends on the direct pledge of property. The other conveniences of corporate organization outweigh any disadvantage on the score of credit. Hence "Smith & Jones, Incorporated," or "Smith & Jones, Limited," or the "Smith & Jones Company," supersede plain "Smith & Jones"; but this change in the legal form of organization is of little economic consequence. Very different, to repeat, is the economic significance of what we may call the true corporation. Here there are many share- holders, directors selected from among them, and managers chosen by the directors, in other words, a clear separation between owners and managers. This is the sort of organization chiefly found when production takes place on a very large scale. In our own time, and in the United States, many people associate with the term "corporation" something still different ; not only divided ownership and large-scale operations, but special public importance. They think of corporations as having a monopoly power, and therefore peculiarly subject to public THE CORPORATE ORGANIZATION OF INDUSTRY 89 regulation. "Public service corporations" are spoken of as if they were the corporations. Whether there is a clear line of distinction between the so-called "public" corporations and the others, and whether large-scale operations in themselves bring monopoly and public responsibility, will be considered in another place. 1 For the present we are concerned simply with those aspects of corporate development which have to do with the growth of large-scale production in modern times, and with the modern mechanism of saving and investment. Not only corporations of the "public service" kind, but others which are commonly regarded as having no special duties or relations of a public sort, present these aspects. Hence, in the following sections, we shall speak of "corporations" in the sense indicated above, those which operate on a large scale, which have many shareholders, and in which investors and managers are clearly separated. 2. The advantages of the corporation for the development of industry have been great. In the first place, large-scale operations have been facilitated. Many modern enterprises require so great a capital that no individual could supply it. In some of the older books on economics, it was said that such enterprises could be undertaken only by the state ; and hence mere size was regarded as a crite- rion for public management of industry. This reason for re- sorting to public management can now have no force. Though no individual or small group of individuals be able to furnish the funds needed, the corporate combination of numerous individ- uals can supply the means for any undertaking, however large. Limitation of liability has been a chief factor in promoting large-scale operations under corporate organization. Every enterprise involves risk, especially in its first stages. Where the enterprise is large, the amount risked and the consequent liability are correspondingly large. If each individual who took shares were liable for debts, as a partner is, without a limit, investment would be checked. Occasionally it has hap- See Book VII, Chapter 6. 90 THE ORGANIZATION OF PRODUCTION pened that a great business, conducted in essentials under cor* porate form, but without the legal safeguard of limited liability, has met reverses and failed. Each shareholder has in such a case been subject to levy for all his property. Thus when the Glasgow Bank failed in 1878, hundreds of small shareholders in Scotland were ruined because each was liable for the debts without limit. Probably few of them were clearly aware of this possibility when they became owners of their shares. The general practise of strict incorporation and consequent limita- tion of liability had put them off their guard. If experience like theirs were frequent, it would not be possible to gather the capital for large enterprises by contributions from many scat- tered individuals. Again, new enterprises, both large and small, and especially those which are large, have been promoted by the limitation of liability. The progress of invention in modern times, the diversification of industry, the increase of productive power, all this has taken place by successive ventures, each of which meant at the outset uncertainty and risk. It is comparatively easy to induce a person to take a few shares, or even a good number of shares, in a novel undertaking presenting possibilities of profit ; but if participation involves also the possible loss of his entire fortune, he will be slow to join. Such a great risk will be taken only if the possibilities of profit be very great indeed ; that is, if the prices of the commodity or service in question promise to be high enough to yield an exceptional profit. Limi- tation of liability and consequent readiness to invest in venture- some operations mean not only that more such operations will be carried on, but that the community will get the output on better terms. Perhaps most important of all the ways in which corporate organization has promoted the development of industry has been the ease of investment, and the consequent stimulus to saving and the making of capital. In the eighteenth century almost the only possibility of investing in securities was through the purchase of public obligations ; and these, though they meant THE CORPORATE ORGANIZATION OF INDUSTRY 91 investment by the individual, usually brought no increase in the community's capital. Merchants and persons in active bus- iness could indeed manage the investment of their surplus means in factories, warehouses, ships, and the like. But the investor pure and simple could not turn to these. If he did not buy government securities, he had little choice but to buy and im- prove real property. Real property is not divisible into con- venient shares, and involves a good deal of management and not a little risk. The modern security market, on the other hand, offers an almost limitless field for the investment of savings, great and small. Railways, factories, steamships, mines, all are conducted under corporate form, and corporate obligations representing them can be bought at a moment's notice by any one. Savings have been made liquid, so to speak, and can flow with ease and in any desired volume wherever there is a prospect of their advantageous use. The ease of investment in corporate enterprises has stimulated savings, and, by a reciprocal influence, the unceasing accumulation of savings has made possible an immense increase of real capital under corporate management. 3. The consequences of ease of transfer for corporate shares deserve special attention. It is by no means essential to cor- porate organization ; for conceivably those who have embarked as shareholders in a company might bind themselves to stick to it for good or ill. But transferability is so ancient and so nearly universal that it is commonly thought of as a natural and neces- sary part of corporate organization. Transferability, like limitation of liability, is advantageous for the community in that it makes possible a greater division of risks. A person who has invested by taking shares in a given corporation is not thereby committed to the bitter end. If he does not think well of its prospects, or comes across some oppor- tunity which he finds more promising, he can sell his shares to another person who has a better opinion than his own of the original venture. As will be explained more fully in the later discussion of speculation and exchanges, ease of sale in any set 92 THE ORGANIZATION OF PRODUCTION of business dealings facilitates venturesome operations, and permits them to be carried on at a smaller margin of profit. 1 It is so with sales of securities and speculative operations on the stock exchanges. The essential advantage of such transactions for the public is that they operate as a sort of insurance against risk, and so stimulate investment, especially in new enterprises. Transferability of shares probably has another advantage. It tends to bring ownership and control into the hands of the shrewd and competent. Those who judge best of the prospects of an enterprise, and who exercise influence intelligently toward its skillful management, buy out those who are less capable. Good judgment is perhaps the most important quality for suc- cess in business operations, and tells immensely both for an in- dividual's money-making and for the efficient utilization of the community's labor and capital. 2 Whether the reward which such judgment secures, often so large and so quickly won, is in proportion to the services rendered, may be an open question. But judgment does tell immensely, and transferability of cor- porate shares aids in making it tell. Transferability, however, has had some consequences that are not so clearly beneficial. The sense of association for com- mon ends has virtually disappeared among the shareholders of the modern corporation. Though it persists more or less in the closely owned family corporation (the quasi-partnership), it is gone where the holders are many and widely separated. Each looks out for himself; deserts the venture in case of expected loss as a rat deserts a sinking ship, or, if he expects a gain, quickly gathers in from his associates a larger number of shares for his own profit. To sell out when the affairs of a corporation are going badly, to buy in when they are going well, is the height of business acumen. This is quite inconsistent with the original notion of a joint venture for common profit or common loss; but it is not for a moment thought of as violating any principle of morals or of fair play. No doubt it brings the advantages 1 See Book II, Chapter 11. 8 Compare Book V, Chapter 49, 4. THE CORPORATE ORGANIZATION OF INDUSTRY 93 just mentioned: the constant buying and selling minimize risk for the individual, and make for control by the shrewd and able. But it is among the phases of individualism that bring a shock to a nice moral sense. The extraordinary growth of corporate enterprises, and the transferability of their shares, have brought into existence the modern stock exchanges, with all their conspicuous and some- times overshadowing influences. The homogeneity of shares and other securities makes them available for purchase and sale by all sorts of persons, and thus peculiarly adapted for speculative dealings. 1 By far the greater part of the transactions on the ex- changes have nothing to do directly with the process of actual investment ; usually that has been completed before the securities are listed. It is only in the way of anticipation, through the in- direct influence of the prospect of easy transfer, that stock exchange dealings promote the increase of factories, railways, con- crete capital. Though the gain in this way is real, it is accompanied by a vast deal of unproductive effort in the way of stock gam- bling; nor is it easy to say whether the social gain on the whole outweighs the social loss. Most persons who discuss these matters have but hazy notions as to what constitutes the social loss or gain. They assume the corporate organization of industry as a settled fact, without discriminating wherein it is really to the general advantage. They assume transferability of shares to be a settled fact, without stopping to think whether the gain from quickened investment outweighs the material and moral loss from gambling. Still less do they consider whether the ad- vantage from more efficient management at the hands of the shrewd outweighs the social disadvantage arising from greater inequalities in wealth. Transferability often brings still other unwelcome conse- quences. Control passes not only to the shrewd, but to the unscrupulous also. The directors and other "insiders" who are best informed about the prospects of a corporation play the game with loaded dice when they buy from the ordinary share- 1 Compare again what is said below in Book II, Chapter 11. 94 THE ORGANIZATION OF PRODUCTION holders or sell to them. This sort of action is not indeed sanc- tioned, as buying and selling among ordinary shareholders is, either by law or by general opinion. In the eye of the law, a director is in a fiduciary position. He is not allowed to profit from dealings with those whose interests he has in charge, and is under obligation to disgorge any gains from such unfaithful doings. In the corporation of moderate size, whose shares are closely held, violation of fiduciary duty is frowned on by public opinion also. But in the great corporations the rigging of the market and speculative profit from inside information are not condemned with seriousness in business circles ; and this largely for the reason that so many play the same game, or try to play it. The whole fry of buyers and sellers of stock are try- ing to overreach each other. Those who fail lack only the shrewdness or good fortune, not the will, to get the booty. In stock exchange gambling, as in dicing and card playing and speculation in grain or cotton, it is the presence of a great mass of greedy and gullible persons that creates the opportu- nities for the comparatively few who are strong and shrewd as well as unscrupulous. It is but just to add that corporate management has often shown a high regard for the duties of directors and officers, es- pecially in the case of those companies of moderate size in which, as has just been said, public opinion is still strong in condemning bad faith. And almost invariably, even in cor- porations of the most miscellaneous ownership, the rights of the shareholder who is duly registered on the books are scru- pulously respected. He gets the benefit of every accruing profit, of every windfall, however ignorant or incompetent he be in the details of management. This sort of regard for the shareholder indeed is a sine qud non of corporate investment. It is like the good faith of brokers in adhering scrupulously to bargains sig- nified only by a nod of the head or a stroke of the pen on a sale-sheet. Without the certain maintenance of the mech- anism for carrying on the agreed operations, the whole fabric of corporate investment would collapse. It is in the process THE CORPORATE ORGANIZATION OF INDUSTRY 95 of buying and selling, of becoming a shareholder, that there is play for manipulation. And here again it is sometimes diffi- cult to draw a clear line between the exercise of good judgment and the abuse of official position. 4. Another consequence of the growth of corporations has been the increasing power of financial middlemen. The in- vestor has ceased not only to manage capital, but to use care and judgment of his own as to the use of his savings in creating it. The investment banks are the most important real directors of the course of investment. Such are the historic private bank- ing houses of England and the United States the Barings, the Rothschilds, the Morgans and the newly-developed large banking institutions of all modern countries, most conspicuous perhaps in Germany. From them "the public" buys its secu- rities, chiefly the stocks and bonds of corporations. This pur- chase, much affected by the advice and repute of the financing bank, constitutes for the individual the act of investment. What corporations shall be organized, what industries carried on, what railways, mines, factories equipped, is decided by the financial middlemen, in consultation with the more immediately active managers of industry. Hence the great power of those bankers who secure the con- fidence and support of numbers of investors. It is common to speak of the "control" of a given enterprise a railway, a factory or combination of factories, a mine or complex of mines as being in the hands of an individual or a few individuals ; and the public is staggered by calculations of the hundreds and thousands of millions' worth of capital which are dominated by a Morgan or a Rothschild. Control of this sort does not signify necessarily or usually a concentrated ownership of those mil- lioas. It does signify concentrated power, based on the con- fidence which a multitude of investors have in the judgment and leadership of commanding personalities. The concentration of control in few hands shows itself most strikingly in the United States. Though we have been singularly reluctant to concentrate political control, we have been un- 96 THE ORGANIZATION OF PRODUCTION hesitating in the acceptance of concentrated industrial control It is odd that in England, where unification of responsibility has been carried to the maximum in public affairs (at least, in the central government), directors still direct in industry, and the powers of presiding managers are still strictly limited. In the United States, where the tradition of checks and balances continues to shape political organization, directors in industrial corporations are often no more than figureheads, while presidents are benevolent despots. This development of one-man rule has no doubt promoted boldness, efficiency, progress; but it has also concentrated power in a degree to justify uneasiness. 5. Still another consequence of the development and refine- ment of corporate organization is an advance not only in the ease of making investments, but in the stability of the mere investor's position. The ingenuity of the financial middlemen in vying for the custom and support of the great army of savers, has provided more and more secure ways of investment. All sorts of securities are offered ; not only those with risks and with a possibility of large returns, but those with low return and absolute safety. Government securities still possess a special prestige as to safety and hence yield but the lowest rate of interest. Corporate securities are also offered which are hardly less safe, and enable the purchaser to dismiss all worry as to the maintenance of principal and income. The position of the property owner, if he is content with a low rate of return, is highly secure. It used to be said, and is still occasionally repeated, that the maintenance of a fortune calls for as much ability as the making of it ; that riches have wings ; that it is but three generations from shirt sleeves to shirt sleeves. This is far from being the case in modern times. Chiefly as a result of corporate organization, a sort of abstract or distilled property has grown up, exempt from the vicissitudes of industry. The rich and the well-to-do, if they are content with low rates of return, can make their position almost impregnable, and, through inheritance, can maintain it indefinitely. A leisure class, based not on feudal privilege, but on savings, investment, and productive enterprise, has become a stable part of modern society. CHAPTER 7 SOME CAUSES AFFECTING PRODUCTIVENESS 1. The preceding chapters have dealt with such causes affecting the productiveness of industry as the division of labor, the advance of large-scale production, the use and the growth of capital. Some other factors bearing on the efficiency of labor in production will be considered in the present chapter. Among these other factors is the quality of the laborers. The increase of production depends not only on the marshalling and organization of the laborers and on their equipment with capital, but also on the strength and skill of the individual work- men. These two factors strength and skill may be taken up separately. There is what may be called the steam engine theory of the efficiency of labor. It maintains, or perhaps implies rather than maintains, that the vigor of the laborer is in proportion to what he consumes. The more is turned over to him, the stronger will he be, and the more will he produce ; just as the power got from a steam engine depends on the fuel burned in the fire box. Feed your laborer better, and he will be able to do so much more. The proposition is an optimistic and comforting one. It would indicate that higher wages will always pay the employer. There is a measure of truth in this view. It holds good par- ticularly of the simplest unskilled labor, such as calls for con- tinuous and heavy muscular exertion. Sometimes men are so underfed that their physical strength suffers.- Emplo3 r ers of large gangs of laborers find that it pays to feed them abundantly. Military operations which involve heavy labor, and especially those involving long marches, are more likely to succeed if the rank and file get good rations. Millions of people in backward H 97 98 THE ORGANIZATION OF PRODUCTION and semi-civilized countries, such as China and India, are under- fed. It is probable that their efficiency could be increased by more food and better housing. No small proportion of laborers in civilized countries are in the same situation. Mr. Rowntree, in his investigations on the city of York in England, made an estimate of the money wages which would secure, at current prices in England, the food, shelter, clothing needed for physical efficiency. The sum was about 20 shillings a week for a family of five ; and the earnings of one sixth of the wage-earning class in York fall short of that sum. 1 The case is probably no less dis- heartening for many laborers in all parts of Europe ; and, not- withstanding the higher general range of wages in the United States, there may be some workmen perhaps but few rela- tively, yet in absolute numbers not insignificant whose state is equally miserable in this country also. It may seem that where laborers are underfed, an increase of wages up to the point of nourishment adequate for full physical efficiency will not be difficult to bring about, since the added product will make the added wages worth while. But the case is not so simple as it appears. Though the laborers in general may gain in effectiveness from more ample subsist- ence, and though the community may become thereby a healthier and happier social body, the individual who makes the advances to the laborers will not necessarily gain. If, indeed, the laborers were slaves, there would be some chance of direct profit from feeding them better. They would remain the property of the master, and he would reap where he had sown. Even as regards slaves, to be sure, it is not always profitable to go to the expense of full feeding. It may be cheaper to work them hard on poor fare, to wear them out in a few years, and to buy new ones for the same wretched round, a practise said to have been de- liberately followed on some Southern plantations in the slavery days. However this may be, it is obvious that the case of free men is essentially different.. The gain in effectiveness from better fare inures to the laborer himself. Any employer who 1 B. S. Rowntree, Poverty: a Study of Town Life, Chapter IV. SOME CAUSES AFFECTING PRODUCTIVENESS 99 would make the needed advances could have no assurance of recouping himself. The effects of full subsistence on effective- ness do not appear either with quickness or with certainty. The process is not quick, because time is needed to bring weakened and demoralized laborers into good condition. It is not certain, because some among them are so enfeebled by sustained hard- ship, or congenitally so weak in constitution, that they will never become able-bodied. Even though a body of underfed laborers, if in hand systematically, could be brought to a pitch of full vigor, the risks and uncertainties, as well as the prob- ability that the regenerated men would betake themselves to employment elsewhere, make it hopeless for a profit-seeking employer to carry out any operation of the kind. It is only under exceptional circumstances, where large gangs of selected men are at work in out-of-the-way places and are therefore under a quasi-compulsion to stick to their job say in build- ing the Panama Canal or at construction camps in remote regions, that it is to the immediate interest of the employer to supply the means for ample support. The class of underfed laborers, comparatively small though it be in modern communities, presents a distressing problem. They are ill paid because they are inefficient; they are ineffi- cient, for one reason, because they are ill paid. Yet they are easily demoralized; too often they remain still inefficient if better paid from charitable funds. Neither physically nor morally do they respond readily to possibilities of improvement. Often the adults are hopeless ; the children alone can be taken in hand with prospects of success. Hence even when there is a prima fade case for increasing the productiveness of labor by adding to the reward of labor, the precise method of ac- complishing the result is hard to devise. Only public or quasi-public action can grapple with the problem; and this must include suppression or elimination of the unfit, as well as uplifting of the potentially capable. All this reasoning and speculation, however, is concerned only with the minimum necessary for health and strength: 100 THE ORGANIZATION OF PRODUCTION the minimum for health and strength, be it noted, not foi keeping body and soul together. Men can live and do work for less than is necessary to enable them to do full work. The minimum for efficiency is above the starvation level. But when they once get what is necessary for complete physical vigor, anything in addition is mere surplus; surplus, that is, in that it no further increases efficiency. If obtained, it must be as the consequence of skill and productiveness ; it becomes a result of high efficiency, and ceases to be a cause of efficiency. Nor is the minimum for full vigor a very high one. An abundant vegetable diet, rude shelter, and simple clothing are all that a man needs to do the hardest work which the human frame can stand. The frugal Italian or the rice-fed Chinaman, if only he gets enough of his simple fare, can do as much as the meat- eating Irish- American. In some of the higher walks of life, the minimum for effi- ciency is doubtless to be measured more liberally. Something more is called for than that which is indispensable for muscular efficiency. The work of a lawyer, physician, teacher, business- man, calls for alertness of mind and bodily health more than for physical vigor. The requisite response of intelligence will often be lacking if the surroundings dull the mind or enfeeble the spirit. Hence as regards intellectual work we may count among the necessaries for efficiency, varied food, ample lodging, restful relaxation. It is hard to say just how far such sources of enjoyment, procured by a larger income, are really necessary for the best exertion of the mental faculties. Those who are accustomed to comfortable living and to pleasant distractions easily convince themselves that these are necessary to keep them fresh for their work. It is a sort of excuse, too, or justifica- tion, of the existing inequalities in income to believe that they are inevitable, in the sense that the work which earns the higher income could not be accomplished without the freer life which that higher income secures. Yet plain living and high thinking are not incompatible. The luxuries and comforts to which most persons of the well-to-do classes are habituated could SOME CAUSES AFFECTING PRODUCTIVENESS 101 be in large measure foregone without loss of vigor or freshness. Some comfort, some leisure, some distraction, are doubtless necessary for the best intellectual work. But a modest income and a scale of expenditure much below that of most members of the well-to-do class would suffice. 2. Different from strength are skill and intelligence. These tell strongly on the efficiency of the individual workman and on the productivity of industry at large. Many of the improvements in the arts depend for their application on a good degree of intelligence. The Hottentot cannot use tools even of a comparatively simple kind because his brain power is not sufficiently developed. Negroes are employed in great numbers in the gold mines and diamond mines of South Africa, but for simple pick and shovel work only. For handling and guiding machines skilled and intelli- gent white mechanics must be employed. Many of the opera- tions of agriculture require nothing beyond delving and ditch- ing. But the fruitful agriculture of advanced peoples calls for care, discrimination, intelligence, and could not be practised by Indian ryots or Russian peasants. Many routine opera- tions of modern industry can be carried on by any persons capable of giving steady attention. But that very faculty, like the ability and willingness to do prolonged continuous labor, is not a matter of course. It is not possessed by savages ; it is a slowly acquired quality of civilized man. No doubt there is a growing range of machine work in which very slender intellectual or moral qualities are needed. In many factory operations of modern times, the human worker is hardly more than another steady and dependable automaton. Along with labor of this sort, however, there must always go some propor- tion of labor more flexible, more observing, more highly trained. This is the quality of mechanics' work, as distinguished from that of "laborers' " in the narrower sense. Here accuracy, watchfulness, skill, intelligence, are called for; and here these qualities are indispensable for efficiency. The effect of education on the productiveness of labor is not 102 THE ORGANIZATION OF PRODUCTION simple. In some respects, a wide diffusion of education ifc conducive to greater efficiency of the population at large; in other respects, the extension of education raises economic questions not so easy to answer. The simplest kind of pick and shovel work seems to be done as effectively by the illiterate workman as by the educated. This is also the case, as has just been remarked, with much modern factory labor. And even in many handicrafts, edu- cation is not indispensable for a high degree of skill. The work of the craftsmen of the Middle Ages in Europe, and that of the same class of workers in modern Japan and indeed in some parts of contemporary Europe, show that illiteracy is no obstacle to the deftest use of tools. Nevertheless, it remains true that a wide diffusion of educa- tion is a most effective means toward productiveness. It is effective particularly toward propagating new kinds of effi- ciency. When an art has once been learned by slow steps, for thus, historically, mankind has acquired most of the arts, its mere transmission from generation to generation, its main- tenance and even perfection, take place by the simplest imita- tion, unaided by book learning. But the rapid spread and utilization of improvements are immensely promoted by the ease of intellectual communication. Mere ability to read and write opens at once a whole new world. He who possesses it can learn from the experience of all mankind, no longer from that of his parents and masters only. The extension of such a great improvement as the system of interchangeable parts has depended largely on widespread elementary education. A complex tool or machine a plow, a reaper, a bicycle is made nowadays on standardized patterns, each part being a precise duplicate of every other part made from the same pattern. When there is a break, the needed part can be re- placed at once. The system makes possible the wide use of intricate apparatus in localities distant from repair shops. But its adoption is possible, in turn, only if those who are to use the apparatus have some general intelligence and if they SOME CAUSES AFFECTING PRODUCTIVENESS 103 can read instructions. In the United States the unexampled use of labor-saving agricultural implements, all made with interchangeable parts, has rested not only on the intelligence of the people, but on the universal diffusion of elementary education. The great industrial advance of Germany during the last generation is due in large measure to the same factors. Technical education obviously has a direct economic effect. The training of civil engineers, mechanical engineers, electrical engineers, conserves from generation to generation the elabo- rate acquired arts. It promotes, too, the advance of the arts. In the past, great inventions and improvements have probably come as often from the workshop as from the laboratory. Under the conditions of the modern world, and especially with the more methodical application of natural science to the arts, the laboratory is likely to play a larger and larger part, both directly, through the inventions that come full-fledged from the laboratory, and indirectly, through the work of those who have had its training. All training for the arts and professions tends to become more systematic in the modern world. The engineer gets his fundamental training, not in the workshop or in the field, but in the technological school ; the physician or the lawyer gets his, not from the active practitioner, but from the professional school. The same movement is seen in the extension of in- dustrial training to the familiar mechanic arts. Apprenticeship to a craftsman was for centuries the mode in which these arts were maintained and transmitted. But the conditions of modern industry have made apprenticeship ineffective and virtually obsolete. The "master" of former times has well- nigh disappeared; he is replaced by the large employer, out of touch with his individual workmen, whether young or old. Those preliminary stages of industrial training which were hi former times provided by apprenticeship should now be un- dertaken by systematic trade schools, and should be a part of the general system of public education. The time is not distant when the normal entrance to a trade will be through 104 THE ORGANIZATION OF PRODUCTION such schools, precisely as the normal entrance to the so-called liberal professions is through their professional schools. We must distinguish sharply between the effect of such education on individuals and on the community. As between individuals, the wide diffusion of educational opportunities has simply an equalizing effect. For the community, it tends to raise general efficiency; but it is not likely to raise general efficiency in the same degree as it raises the earnings of some individuals. It tends to break down any privileged position which may exist among those who now possess technical or professional skill. It may tend to lower their earnings. On the other hand it tends to raise the earnings of those who are enabled more easily to acquire such skill. The trade unions are usually opposed to the establishment of trade schools, from a fear that it will lower the rate of wages in the more highly-paid trades. This fear, though much exaggerated,is not entirely without foundation. People who descant on the advantages of educa- tion, and especially of industrial education, often contrast the high wages of a skilled workman or trained engineer with the low wages of an unskilled laborer, and assume the difference to measure the relative productiveness of the two. They forget that if all men could easily procure the training for the better paid occupation, numbers in that occupation would be greater, and pay in it would be less. Wide and free diffusion of all sorts of vocational training would almost cer- tainly increase the productive power of the community as a whole ; but it would also tend to lessen the differences in earn- ings which now exist, and to lower the earnings of some indi- viduals and some classes now favored. 1 General education in all its grades, from that of the ele- mentary school to that of the university, though not directed to a clearly defined industrial end, doubtless has its considerable economic effects. Largely it is an end in itself, or at least a means to other ends than industrial efficiency. The mere attainment of knowledge and understanding is a satisfaction 1 On this subject more is said below, in Book V, Chapter 47. SOME CAUSES AFFECTING PRODUCTIVENESS 105 in itself, to some persons a great joy. Among man's traits none is more remarkable than his insatiable curiosity concerning all things in the heavens and the earth. The satisfaction of that curiosity is one of the constant ends of human endeavor. And knowledge opens the way, it need not be said, to the higher and nobler enjoyment of life. But general education has its more immediate economic effects also. Though reading and writ- ing do not make the ditch digger stronger, and geometry and literature do not add directly to the skill of the mechanic, all education makes for intelligence, discrimination, the utilization of opportunities, the spread of improvements. It makes also for sobriety, honesty, and steady endeavor. The more it is directed to uplifting the character and training the faculties, and the less it follows dull routine, the more does it achieve these ends. Where it fails to achieve them, the remedy, even in the interest of bare industrial efficiency, is still not to curtail it, but to improve it. 3. Not least effective among the forces that bear on pro- ductiveness is leadership. It is exercised by business managers, by engineers and technical experts, and by men of science. Economic efficiency is profoundly affected by the success of a community in securing good leaders. When intricate tools and machinery are put together by skilled mechanics, and when all this apparatus is guided to its productive outcome by still other skilled mechanics, one is tempted to say that here are the real producers. But a little consideration leads to the inclusion with them of the designers, the inventors and engineers. It requires still further reflection to include also the directors and employers. These last, the business class, seem to some persons, notably to the socialists, to be mere exploiters. The real work seems to be done by the others ; the business men sit by and merely levy toll. There is no greater misapprehension. The effectiveness of industry depends on the business man's leadership almost as much as that of an army depends on generalship. Under a complicated divi- sion of labor, the various factors of production must be brought 106 THE ORGANIZATION OF PRODUCTION together and properly combined. The different kinds of labor and capital must be applied to the best natural resources. The long gap between producer and consumer must be bridged. The skilled mechanic and even the engineer would commonly be helpless without the guidance of the business leader. Especially is this the case where industry is rapidly shifting. Courage, energy, judgment, and command of capital are indispensable for economic progress. Much more will be said, as we proceed, on the significance of industrial leadership. Another kind of leadership is that of the man of science. The progress of material civilization depends on the understanding of nature's laws. The astronomer, the physicist, the chemist, the biologist lay the foundation for the development of the arts. Their efforts are usually stimulated in greater degree than with most men by motives of the higher sort, by the single-minded search for truth, or by love of fame rather than hope of material reward. The influence of scientific investigation on the arts, though often indirect and unexpected, is none the less far- reaching. Faraday had no concern for the industrial possibilities when he discovered the induced current; yet how profoundly economic progress has been affected by the dynamo ! 1 Leaders are rare. Most men are commonplace. Among the means for promoting progress none are more important than the discovery and stimulation of those who have high abilities. Freedom of opportunity and diffusion of education are the means for discovering those possessing unusual gifts. Among the classes of men who now lack education and are depressed by illiterate surroundings, there may be many persons of talent and an occasional genius. To the general advantage of a wide diffu- sion of education is to be added the fact that it helps to arouse and develop all the gifted. It is probable, to be sure, that high inborn capacity is most common among those to whom education 1 My colleague, Professor C. L. Jackson, has called my attention to Perkin's discovery of purple dye, which led to the aniline dye industry, and to th investigations of Graebe and Liebermann on alizarin, which led to the manu- facture of that coloring stuff from coal tar; further instances of industrial changes consequent on the discoveries of pure science. SOME CAUSES AFFECTING PRODUCTIVENESS 107 and opportunity are already open. We touch here on the debatable problem of the origin and significance of social classes. There is evidence tending to show that the well-to-do are in their more favored position because they possess, on the whole, higher intellectual ability. But the proposition, even if established, is subject to much qualification ; and certainly it must be admitted that there is among the less prosperous some fund of capacity which fails to be utilized. Though gifted persons are probably less common, in proportion to numbers, among the so-called lower classes, there may be many of them. The full development in these of all their qualities for better efficiency, above all for leadership, is one of the most important objects of widely diffused education. Freedom and democracy operate to develop to the full the scanty number of leaders. The abolition of class privileges in modern times thus has been not only of political and social con- sequence, but has had direct economic effects also. The in- dustrial preeminence of England during the eighteenth and nine- teenth centuries was due largely to her free institutions. The lowborn person's opportunities to rise, even though restricted, were better than on the Continent, and England profited accord- ingly. In the United States such opportunities have been more free than ever before in any part of the world, and to this factor, above all others, is due the wonderful material prosperity of the country. Those possessed of the qualities for leadership must not only be given a free field ; they must also be stimulated to the full exercise of their gifts. Inequality of some sort appears to be indispensable as a stimulus. Obviously we have here a question different from those con- sidered in the preceding pages. There is- an essential difference between providing a gifted person with the wherewithal to en- able him to do his best and offering him a reward which will stimulate him to do his best. A reward in some way propor- tioned to the rarity and effectiveness of unusual faculties seems necessary to induce their exertion to the highest pitch. Such, 108 THE ORGANIZATION OF PRODUCTION at all events, has been the experience of mankind with the gift of industrial leadership. No stimulus to economic activity has yet been found comparable in efficacy to that of the prospect of large earnings. Inequality of incomes and posses- sions, so far as based on differences in industrial efficiency, is a most potent instrument toward general efficiency in pro- duction. This, to be sure, is the individualist view. It assumes that most men are influenced in their bargaining and income-earning by preponderantly selfish motives. The extreme collectivist view is that men can be readily induced to the full application of their faculties by other than selfish motives. Neither view can be maintained without qualification. Some sorts of leadership are undertaken with little consideration of reward. Those having the very highest intellectual gifts in letters, in the fine arts, in pure science, exercise them in pursuance of a well- nigh irresistible impulse. On the other hand, industrial leader- ship and industrial efficiency seem to depend on industrial reward. Whether there are possibilities of stimulating them without inequality, or at all events without great inequality, is a question reaching into the most difficult problems of eco- nomics, and its full consideration must be postponed to a later stage. 1 Suffice it to say that material reward, in the shape of high income and the chance of a fortune, has hitherto proved wonderfully potent and apparently indispensable in eliciting and spurring economic leadership. 4. In sum, the effectiveness of industry depends not only on material equipment, but also on what we may call immaterial equipment ; not only on accumulated surplus in the way of capital, but on accumulated moral and intellectual qualities. Maintenance and transmittal are not less important for this immaterial capital than for the community's material capital. Education transmits from generation to generation the acquired attainments of the race, from the rudiments of reading and writing to the most elaborate technical training. Not only > See Book VII, Chapter 65. SOME CAUSES AFFECTING PRODUCTIVENESS 109 these intellectual attainments, but moral qualities likewise, must be handed down to the successive generations. Habits of industry, truthfulness, honesty, sobriety, of consideration for others, of care for the common good, all these are of slow growth, and rest on repeated example and precept. In some degree there is transmission also by inheritance. The biologists still differ on the question whether acquired traits are inherited. The more general opinion seems to be that they are not, and that only inborn qualities are passed on from parent to descendant. If this be the rule universal in nature, man also must conform to it ; and then some at least of the qualities that mark the civilized man can be maintained only by set training. Others perhaps have been incorporated in his nature by a process of selection, through the weeding out, in the long course of history, of those having a less civilizable dis- position. Human nature changes and improves, and the quality of men is now finer than it was thousands of years ago, perhaps than it was centuries ago. Repeatedly there are projects for hastening the process through design, by breeding men, as animals are bred, from strains deliberately selected. Without entering here on the far-reaching questions which such proposals raise, it may be said that, for a future as far as we can look into it, the slow and haphazard process of unconscious selection will alone affect the transmission and possible improvement of inborn qualities. As regards the general average of ability and charac- ter, heredity leaves man, from one generation to another, on the whole in statu quo. But persistent and repeated training not only keeps man- kind in statu quo: it offers more immediate possibilities of advance. No less than inherited quality, it contributes to make the difference between the civilized man and the savage. Man's great moral, intellectual, educational capital must be conserved, like his material capital, by unremitting effort ; and like that it can be increased by effort. In both ways, the effort is largely altruistic. It results from the cares and sacrifices of parents, and from the conscious endeavor of the community to improve 110 THE ORGANISATION OF PRODUCTION the quality of all its members through the diffusion of education. But it results also in no small degree from the self-regarding motives, from the desire of each individual to better his own condition and that of his family. Certain it is that man now starts from a vantage ground which makes possible still further advance. Some of his qualities for civilization he has inherited ; some of those same qualities he acquires and transmits by con- stant effort. The outcome of all is the great immaterial capital of the community ; a possession not less important for the gen- eral welfare, and perhaps not less extensible, than his capital of tools and materials. REFERENCES ON BOOK I On productive and unproductive labor, see the often-cited passages in Adam Smith, Wealth of Nations, Book II, Chapter III ; and those in J. S. Mill, Principles of Political Economy, Book I, Chapter III. W. Roscher, Political Economy, Book I, Chapter III, gives an excellent his- torical and critical account. Among modern discussions, none is more de- serving of attention than the paper by Professor T. Veblen, on "indus- trial" and "pecuniary" employments, in Proceedings of the American Economic Association, 1901, No. 1. A recent discussion, with not a little of clouded thought, is in the Verhandlungen des Vereins fur Sozialpolitik, 1909 ; especially a paper by Professor E. Philippovich and the discussion thereon. On the division of labor, Charles Babbage, On the Economy of Ma- chinery and Manufactures (1837), is still to be consulted. On modern developments, the Thirteenth Annual Report of the Commissioner of Labor (U. S.) on Hand and Machine Labor (1899) contains a multi- tude of illustrations. A keen analysis of the division of labor in its historical forms is in K. Biicher, Die Entstehung der Volkswirthschaft (7th ed., 1910) ; translated into English from the 3d German edition under the title Industrial Evolution (1901). On the industrial revolu- tion of the eighteenth century, see the well-ordered narrative in Man- toux, La revolution indvstrielle au xviii* siecle (1906), and the less systematic but more philosophical account in A. Toynbee, Lectures on the Industrial Revolution (10th ed., 1894). On capital, see the references given below, at the close of Book V. Much as has been written of late on corporate doings and corporate organization, I know of no helpful references on the topics considered in Chapter 6. BOOK II VALUE AND EXCHANGE CHAPTER 8 INTRODUCTORY : EXCHANGE, VALUE, PRICE 1. The division of labor brings in its train the exchange of goods between those who undertake the separated acts of pro- duction. Exchange in turn brings the phenomena of value, money, and prices. With these phenomena we shall be con- cerned in the present Book and in the Book following. As has already been noted, the division of labor does not bring exchange as a necessary consequence. 1 There may be the self- sufficing patriarchal family, with division of labor but without exchange; or its counterpart, the communistic society, self- sufficing at least in some degree. Even in the modern family, there is division of labor, after a sort, between man and wife. But commonly we consider the family as a unit, and think of the housewife, when she works for husband and family, as work- ing for that of which she is but a part. Similarly, the patriarchal family and the communistic society are considered by their mem- bers as economic units. Exchange arises from a separation of interests. As between individuals, it has grown with the growth of private property. Throughout by far the greater part of modern industry, division of labor prevails, and with it private property and labor for one's self and family. Hence exchange and its concomitants, value and price. Production for one's self holds its own longest in agriculture. Yet even in this industry, division of labor and exchange are rapidly extending in the highly developed countries of our time. In the United States the self-sufficing farmer of earlier days has well-nigh disappeared; and even the stolid peasant of Europe is being transformed by the modern methods of easy communica- tion and easy exchange. Though the farmer still produces part of 1 See Book I, Chapter 3, 4. I 113 114 VALUE AND EXCHANGE his own food, especially vegetables and fruit, there is a steady tendency toward widening the range of agricultural products which are bought and sold. Grain is sold by the individual farmer, flour is bought ; cattle are sold, meat is bought ; milk and cream are sold, butter is bought. In other occupations than agriculture the division of labor has worked out its consequences to the last stage. No labor is given to the direct satisfaction of each worker's wants by himself; all is turned to the indirect process of specialization and exchange. Hence sale, price, value, and the whole mechanism of exchange, become the characteris- tic economic phenomena. 2. Almost as early as the division of labor, a medium for exchanging the various products came into use. Barter the direct exchange of products may be carried on under a very simple division of labor; yet even then it is inconvenient, and as soon as the first stages of savagery have been passed, some use of a medium of exchange appears. Any commodity in general use will serve passably as a medium of exchange. He who has an article to sell, and cannot find at once the precise kind and quantity of the things he wishes to buy, will accept a staple commodity, with which sooner or later he will be able to procure the things he wants. Hence in various stages of civilization, the most diverse commodities have been used to obviate the inconveniences of barter. In Homeric times the value of things was often stated in terms of oxen ; for such occasional exchanges as are made among primitive pastoral peoples are naturally effected in terms of their staple commodity, cattle. 1 For a considerable time in the early history of the colony of Virginia, tobacco was almost the sole article of export, and the chief commodity habitually produced for a market ; it became the recognized medium of exchange in the colony. Furs, 1 Mr. Wicksteed remarks (The Common Sense of Political Economy, p. 137) that "there is more evidence in the Homeric poems of the valuation of female slaves, of tripods, or of gold or brass armor, in terms of so many cattle, than there is of any direct transfer of cattle in payment of those goods." It is prob- ably true, also, of the other commodities mentioned in the text that they were used more freely for measuring relative values than for effecting exchanges. INTRODUCTORY: EXCHANGE, VALUE, PRICE 115 salt, tea, cocoa, have served the purpose with other people. But by far the most widespread among the things so used have been the precious metals, gold and silver. We need not pause at this stage to consider what qualities fit them peculiarly for serving as a medium of exchange, their luster and consequent attractiveness for ornament, their freedom from rust and deterioration, their homogeneity, their divisibility. Nor need we consider how the device of coining has increased their fitness for carrying on purchases and sales; nor in what ways paper representatives or substitutes for them have come to be so widely used in our own time. These are topics that belong to the subject of money, to which much attention must be given later. It suffices here to note how completely division of labor and exchange work out their results through the use of money. Every producer gets his return in amounts of money. The exceptions in any of the countries of advanced civilization are so few and are so rapidly disappearing that they serve only to make clear how virtually universal is the rule. Exchange takes place by first selling goods or services for money, and by then buying with the money such other goods and services as are wanted. The fundamental fact of exchange is thus ob- scured by the very mechanism that so perfectly facilitates it. Just as the cooperation and combination which are essential features of the division of labor are carried on without a con- sciousness of any combined action, so the process of exchange goes on without the consciousness that it is the aim and end of all buying and selling. 3. The value of a commodity means in economics its power of commanding other commodities in exchange. It means the rate at which the commodity exchanges for others. If a bushel of wheat can be exchanged for a large quantity of other things, for many pounds of iron, many yards of cloth, many ounces of salt, its value is high ; the possessor of it can procure many of these things. If a bushel of wheat can be exchanged for but few pounds of iron, few yards of cloth, few ounces of 116 VALUE AND EXCHANGE salt, its value is low; the possessor of it can procure few of these things. It is immaterial that the exchange does not take place directly, but by the process of first disposing of the wheat for the medium of exchange, money, and then pro- curing with the money the iron, cloth, salt, or other desired commodities. The result of the double operation is the same as if the exchange had taken place by direct barter. Only it is reached by a more convenient method. The value of a commodity, thus conceived, is its value in exchange. This is very different from its usefulness, or utility, or importance. In everyday discourse, we use the word " value " sometimes to indicate exchange value, sometimes to indicate utility or importance. We speak of the value of iron as greater than that of gold, and the value of wheat as greater than that of diamonds. We mean thereby that iron and wheat are more important, satisfy more urgent wants than gold and diamonds. Yet we also speak of gold and diamonds as more valuable commodities than iron and wheat; then we use the terms " value " and " valuable " in the sense of value in exchange, and mean that exchange and sale take place on such terms that with comparatively little gold and diamonds the owner can secure much iron and wheat. For the purposes of economics this latter sense, exchange value, is the most impor- tant. A third sense, however, may be noted in passing. People sometimes speak of the "value" of a thing as greater or less than that which appears in an actual transaction of exchange. They speak of a house as being "worth" more than they paid for it, or of a commodity or a stock exchange security as selling for less than its "intrinsic value." They mean that the cur- rent price is different from the price that is likely to be paid in the long run, or different from the price which they think proper and just. In the sense which we have adopted, value means simply the actual rate in exchange, and there can be no value other than that registered by sales and exchanges. That the word is also used with this third signification, of proper INTRODUCTORY: EXCHANGE, VALUE, PRICE 117 or intrinsic worth, only shows how vague and uncertain is everyday phraseology. Economists have often pointed out how much troubled they are, both in exposition and in their own thinking, by having to employ familiar terms, like capital and value, which in everyday use have various and shifting meanings. For the purposes of economics, one mean- ing or definition must be selected, and held to with care. In the following pages "value" will be used strictly in the sense which economists have adopted for it, a relation in exchange. By the price of a commodity is signified the amount of money which it will command; in other words, its value in terms of the accepted medium of exchange. The notion of price is familiar, whereas that of value is one to which the beginner in economics must become accustomed. In modern times price means, in almost all advanced countries, the amount which is got, in exchange, of the particular money medium which these countries have adopted, gold. Paper and metallic substitutes for gold are often used, equal in exchange value to the gold, and performing the functions of a medium of exchange precisely as it does. The peculiarities of paper, silver, and copper as money will receive attention in due time. For the present we shall assume that gold is the medium of exchange, and that price is measured in coins of gold, say dollars. Coins, it needs hardly to be added, are simply pieces of gold manufactured with care and containing each a given weight of metal of uniform quality. 4. From the definition of value, it follows that there can be no general rise in values, and no general fail in values. Value is a term expressing the relation of exchange between commodities. If at a given time a commodity procures in exchange less of others than at an earlier time, it has fallen in value; but pro tanto those other commodities have risen in value. All cannot rise and fall together. A change in the value of any one of them, or any set of them, means a converse change in the value of the rest. On the other hand, a change in general prices is not only possible, but is one of the familiar 118 VALUE AND EXCHANGE and recurring phenomena of economics. Wheat, iron, diamonds, things in general, may all exchange for more dollars now than they did ten years ago; and ten years hence they may ex- change for less dollars than they command now. Evidently a general rise or fall in prices signifies a change in the value of money, that is, of gold. When all prices rise, and things exchange each for a greater number of dollars, the dollar can buy less than it did. Its power of commanding other things is less, and its value has fallen. When every single thing exchanges for a smaller number of dollars ; that is, when prices have fallen, the dollar buys more, and its value has risen. The value of money is inverse to the level of prices. When prices are high, the value of money is low. When prices are low, the value of money is high. The mere fact of a rise or fall in the price of a single com- modity, therefore, does not indicate whether or no its value has changed. It may be that this single commodity alone has fallen in price, others remaining as before. In that case the fall in price registers also a fall in value. Or it may be that other commodities likewise have fallen in price to the same extent. In that case there has been a rise in the value of money, and a fall in the value of all commodities as compared with gold; but no change has occurred in the values of com- modities inter se. The value of gold, that is, the general level of prices, changes but slowly. Though prices of individual commodities change quickly, all do not change quickly in the same direction. A rise in the price of any one is likely to be accompanied by a declining price of another, or by stationary prices of the others. So gradual are changes in the general range of prices, so uncer- tain the comparison and offsetting of the complex individual changes, a rise here, a fall there, no change at all in a third, that it is often difficult to ascertain for a short period whether a general change has really taken place. If, indeed, an upward or downward movement continues for years, it usually becomes unmistakable. We can ascertain then whether the value of INTRODUCTORY: EXCHANGE, VALUE, PRICE 119 money has risen or fallen, and can measure with some accuracy the extent of the change. But unless the lapse of time exceed two or three years, it is often not easy to determine what has been the general trend ; so stable are prices for short periods. But though general prices and the value of money change thus slowly, the prices of individual articles change quickly and considerably. The price of wool or cotton or iron may rise by ten per cent in the course of a month; and changes are common in the prices of individual articles of wheat, cotton, copper, coal by ten, twenty, thirty, per cent in the course of a single year. Where the price of one thing changes, other prices remaining the same, the new price evidently registers a change in value. The ordinary fluctuations in the prices of things hence signify corresponding changes in their values. For the purposes of an orderly and systematic exposition of economic principles, we shall assume for the present stability in general prices ; hence that a change in the price of an article signifies a change in its value. If an individual article rises in price under these conditions, it commands more of other things in exchange, and rises in value; and conversely if it falls in price. We shall thus use the familiar examples of price and money in our illustrations and figures, and shall put aside, for consideration at a later stage, the problems of fluctuations in the general level of prices. CHAPTER 9 VALUE AND UTILITY 1. An object can have no value unless it has utility. No one will give anything for an article unless it yield him satis- faction. Doubtless people are sometimes foolish, and buy things, as children do, to please a moment's fancy; but at least they think at the moment that there is a wish to be gratified. Doubtless, too, people often buy things which, though yielding pleasure for the moment, or postponing pain, are in the end harmful. But here, as has already been explained, we must accept the consumer as the final judge. The fact that he is willing to give up something in order to procure an article proves once for all that for him it has utility, it fills a want. On the other hand, no less evidently, the value of an object is not in proportion to its utility. Free goods, such as fresh air, pure water, the beauty of nature, may have high utility, though wholly without value. Only slight value may attach to other things having high utility. In our advanced civilized communities the simplest and most wholesome articles of food have low value ; they are cheap. Yet they satisfy the most elemental and pressing of wants, and have great utility. So it is of other necessaries of life, as clothing, shelter, or warmth ; great utility often goes with low value. On the other hand, some things whose exchange value is high have utilities which we do not ordinarily reckon great. Jewels, tasteless ornaments, a stupid book printed four hundred years ago, such things sometimes command a high price, though the satisfactions they yield are not of a high order or apparently highly prized. 2. The supply of a commodity, as we all know, closely affects its value. When an article becomes abundant, its price falls ; when it is scarce, its price rises. The causes of these 120 VALUE AND UTILITY 121 fluctuations are two, very different in nature and social sig- nificance. One obvious cause, and that which many persons are likely to think of first, is the difference in means between rich and poor. Those who are able to pay highest, secure the first in- stallments of any commodity that comes to market. If there be comparatively few installments, each will command a high price. As more and more are offered, the price must be lowered in order to bring them within the means of the less rich. Finally, if the supply be greatly increased, the price must be lowered very much in order to make possible purchases by the poor. But the same result would appear if there were no differ- erences between rich and poor, if all persons had the same incomes. Then, also, an increasing supply would bring a de- creasing price. The causes which under these altered condi- tions would yet lead to the same inverse variation are of the second sort; and they are the fundamental causes. Consider any familiar article of daily use, the knives, forks, spoons, on your table, the clothing you wear, the house you live in. One set of knives and forks is essential to cleanly eating. A second set is highly convenient, a third somewhat less so ; there is a decline in utility, until at last the stage is reached where an additional set is a mere encumbrance. So with clothing. One suit is necessary. A second and a third add to comfort. More and more can be used, yet with a steady tendency to lessening satisfaction with the successive installments. One room in a house, or a one-room house, is indispensable for existence. The added comfort and decency from a second room are very great ; and further additions to houseroom continue to yield satisfactions. But though the rate of diminution in utility may be for some time comparatively slow, the tendency still is present, and before long the stage is reached, when more houseroom serves to satisfy only the love of dis- play, not to yield substantial comfort. All things, it may be observed, which minister to the love of display, have the pos- sibility of maintaining this sort of utility in a curious degree. 122 VALUE AND EXCHANGE The mere fact that a thing is rare that it is of a sort not possessed by others, and so distinguishes its owner gives utility to things otherwise useless; a notable example is an old postage stamp. 1 Additions to the supply of many classes of articles may for a long time give additional satisfaction, if the individual things be varied and adapted to gratify the love of distinction; as with the garments and houses of the rich. But the tendency to diminishing utility none the less persists. The more of these things you have, the less you prize any one. The addition of a new coat to an abundant supply, of a new room to a house already large, brings less satisfaction than the preceding coats or rooms brought. To this general tendency we give the name of the principle, or law, of diminishing utility. Successive doses of the same commodity or service yield diminishing utilities. If the doses be continued indefinitely, the point of satiety will be reached. Then further doses yield no satisfaction whatever ; the utility of each additional dose becomes nil. This principle, as has just been intimated, and as will presently be explained further, ap- plies in strictness only to doses of the same commodity (or service). Vary the thing supplied, even though different only in small degree, then the result will not be quite the same. The diminution in utility may be prevented or checked ; and the point of satiety may be indefinitely postponed. From the fact that there is a limit to the possibilities of satisfaction from increasing the supply of any one article, it is not to be inferred that limits in utility exist for all articles taken together. But none the less it remains true that all enjoyments tend to pall if repeated. If any one of us were called on to retrench, to dispense with some enjoyments now possessed, he would find himself cutting off first those things least prized, and then in succession various others in the inverse order of their utility ; a process which would make it clear not only that some things 1 No doubt the instinct of acquisition (the "collecting" instinct) plays its part as regards such articles, in combination with the instinct for distinction through display. VALUE AND UTILITY 123 have more utility than others, but that some doses of the same thing have more utility than other doses of that thing. It is this fact of different and diminishing utility that explains the growing variety in the articles produced and the growing complexity of production and consumption. As the productive power of mankind increases, and especially as the commodities in common use become more abundant, labor is constantly turned in new directions. It is given not so much to making more of the same things as to making different things. Abundance without variety means that the approach to satiety is rapid. Bread, in most civilized countries, is cheap, being produced with comparatively little labor. With increase in the effectiveness of industry, more and more bread could be pro- duced with the same labor. But some of this labor turns to other kinds of food as bread becomes cheaper, to meat, eggs, butter, vegetables, fruit, sugar. A varied diet, such as is pos- sible in modern times, marks a great advance not only over the monotony of savages' food, but over the very restricted diet with which civilized peoples had to content themselves until the last century or two. The essentials of clothing, also, are plentiful and cheap, and a comparatively small part of the labor of a modern country is given to the covering needed simply for health and decency. A vast deal of labor is given to making more convenient and attractive clothing. With the growing productiveness of labor, any one of the familiar articles of every- day use tends to be put on the market in such quantities that people care less and less for additional increments, and the prices of these articles are ever tending to fall. Variety in pro- duction must take place if consumption is to respond. There are articles to which the principle of diminishing utility does not apply as unfailingly as the preceding statement sug- gests. Though stimulants on the whole show unquestionably the tendency to lessening response, the conscious effect from the first few doses does not always show it. The second or third glass of liquor may be as much enjoyed as the first. Or, to speak of higher things, the second or third reading of noble 124 VALUE AND EXCHANGE verse, or hearing of beautiful music, often gives greater pleasure than the first. Again, there are many cases where a preliminary stage of doubtful satisfaction is succeeded, with habituation, by unquestionably greater satisfaction ; as with tobacco and oysters. Many a novel article needs to be insinuated into people's liking. As this is brought about (perhaps by skillful advertising), the article reaches a stage where a larger supply of it is sold, not at a lower price per unit, but at a higher. In such cases, however, the tastes of the purchasers may be said to have changed in the interval. At any given stage of taste and popularity, the principle of diminishing utility will apply. It is not worth while to enter on refinements as to whether, in the cases just mentioned, there are real or only apparent exceptions to the principle. The qualifications that may be needed are of no great importance. The tendency shows itself so widely and with so few exceptions that there is no significant inaccuracy in speaking of it as universal. 3. From the law of diminishing utility we are led to the conceptions of total utility and of marginal utility. Utility can be measured, for the purposes of economic study, in one way only : by the amount which a person will give to pro- cure an article or a service. Enjoyment or satisfaction is sub- jective. The objective test of it is willingness to pay. What a person will pay for an article rather than go without it, is the only test by which we can ascertain with any approach to pre- cision how much satisfaction it brings him. Hence price, actual or potential, is the economic measure of utility. Not infre- quently in discussion of this set of subjects, it is said or implied that the utility of an article is the price it commands or might command. This language is inaccurate. Price simply indicates utility. Consider now how price may measure the utility, to an in- dividual, of several units of a given commodity, say five oranges. Suppose them to be offered in succession, each being appraised by itself without thought of there being more to come. The first we may believe to be so fragrant and refreshing that the VALUE AND UTILITY 125 individual would pay 50 cents rather than go without it. The second, yielding less satisfaction, would command only 25 cents ; the third would command still less, say 15 cents ; the fourth, 10 ; and the fifth only 5. The total utility of the five would be in- dicated by the sum of the amounts which the several units would have commanded separately, namely : For the first orange 50 cents For the second orange 25 cents For the third orange 15 cents For the fourth orange 10 cents For the fifth orange 5 cents For the total supply 105 cents Suppose now, on the other hand, that the five oranges exist as a stock, possessed together by the individual. All are alike. Take away any one, and the loss of utility or satisfaction will be the same as if any other had been taken away. Each has the same degree of importance for his welfare. As installments or successive doses, they have differing utility. But possessed as a stock, they have each the same economic importance. Any one would be parted with on the same terms as another. And those terms the price would be settled by the utility (satisfaction) yielded by the last of them if they were enjoyed in succession. The price at which the fifth would be bought (or sold) is the price at which any one of a stock of five would be bought (or sold). That price measures the marginal utility, or final utility, of the supply. Economic importance; marginal utility ; final utility ; the satisfaction got from any one unit of a stock, all these expressions come to the same thing. It may seem paradoxical to say that all the constituents of a stock have the same economic importance, and that none the less some have greater utility than others. But there is no real paradox. It must be remembered that utility means satisfac- tions or enjoyments. To possess a stock is not to enjoy it (except so far as, by association of ideas, mere ownership gives pleasure ; as in case of a miser's hoard). The stock is necessarily enjoyed, not as a whole, but by installments ; and as it comes to be so 126 VALUE AND EXCHANGE enjoyed, the successive installments yield lessening satisfaction. Economic importance is something different ; it is the satisfac- tion dependent, not on the whole stock, but on any one of the constituents of the stock. Considered in this way, all the con- stituents are alike ; even though, considered as sources of enjoy- ment when actually used, they are of varying utility. 4. Let us return now to the relation between the supply of an article and its price. Increase in supply means lower price. It also means lessening utility from the added units. The price of a commodity depends, as the case is commonly stated, on the least of the utilities yielded by the supply, or on final utility. Price, or value, depends on the utility of the last increment. Properly qualified, and properly understood, the principle is sound; and not only so, but of primary impor- tance. First as to the qualifications. The proposition is true, in strictness, only if we suppose many competing buyers and sellers. And in fact most things are brought to market by com- peting sellers, and are purchased by competing buyers. Assume now that a given supply, say 1000 oranges, is offered by the sel- lers. Among the buyers are some whose means are large, others who value oranges highly. Both sets would be willing to pay a high price for a few oranges rather than go without. But there are more oranges than these purchasers are eager for. To induce the rest to buy, or to induce the eager purchasers to buy more, the price must be lowered. As the sellers are many and competing, the price of the whole supply will be uniform. Any one seller, trying to obtain a higher price from the eager buyers, would be undersold by others. There would be one price at which the whole lot would go, and that would be the price which tempted the last buyer ; or, to be more accurate, the last purchase by any of the buyers. This last purchase, and the price which must be offered to induce it, would settle the terms for all the transactions. Next, as to the just understanding of the proposition. Ob- serve that the last buyer and the last purchase have been spoken VALUE AND UTILITY 127 of, not the last or marginal utility. In the usual statements of this fundamental principle of value, it is said simply that selling price, or exchange value, depends on marginal utility. The as- sumption is here tacitly made that all the buyers are in the same position and that all have the same means. From this it would follow that a less sum of money paid out denoted a less utility, and that he who bought the last unit of the whole supply was not only the last purchaser, but the purchaser to whom that unit gave the least satisfaction. The fact is, however, that pur- chasers have very different means, and, as just pointed out, this circumstance is of vast importance in explaining the fall in price which actually takes place when supply is increased. The de- pendence of selling price on the last purchaser (or the last purchase) is not affected by the inequality of incomes. But the significance of the final purchase for the utility or satisfaction- yielding power of the last installment of the supply is much affected. The simple and familiar fact that a rich man, when paying out a given sum of money, often gets less satisfaction than a poor man when he pays out the same sum, is expressed in more techni- cal terms by saying that the marginal utility of money is less to the rich than to the poor. A dollar signifies little to the man of means. If he parts with it, his loss in welfare is vastly less than that of the poor man who parts with the same amount. A high price therefore does not necessarily indicate great utility to those paying it. It may signify only that the mar- ginal utility of money is small. The phrase "marginal utility of money" must, however, be used with caution. Money has utility in a different way from other things. It is valued not because it serves in itself to satisfy wants, but as a medium of exchange, having purchasing power over other things. Gold jewelry is subject to the law of diminishing utility precisely as other things are. But gold coin money is subject to it only in the sense that an individual buys first the things he prizes most, and then other things in the order of their less utility. Strictly speaking, the statement that 128 VALUE AND EXCHANGE money has varying utility and that there is a marginal utility ot money is only a way of saying that the things bought with money have varying utility, and that some among them are at the mar- gin of utility. 1 5. The conceptions of total utility and marginal utility lead to that of consumer's surplus. Consumer's surplus is the phrase applied by Professor Mar- shall (who has done more than any other writer to make clear this whole subject) to the difference between the sum which measures total utility and that which measures total exchange value. The total exchange value of a set of goods is obviously the price per unit (determined by marginal utility) multiplied by the number of units. But the total utility of the units as they come to be enjoyed is a different quantity. Thus, our orange-eater would have been willing to pay for the first orange 50 cents, but had to pay only 5 cents. He had a "surplus" of 45 cents' worth of satisfaction. Using the same figures as before for the supposed supply of five oranges, we get the following comparison between the prices that would have been paid and the prices that were paid in fact ; the difference indicating consumer's surplus. POTENTIAL PRICE, MEASURING TO- ACTUAL PRICE CONSUMER'S SURPLUS TAL UTILITY For the first orange .... 50 5 45 For the second orange . 25 5 20 For the third orange . . . 15 5 10 For the fourth orange . . 10 5 5 For the fifth orange .... 5 5 For the whole supply . . 105 25 80 The case is stated here in the simplest terms, and on the assump- tion that the price of this small supply of oranges would be determined as the price of the usual large supply of commodi- ties as they come to market in the actual world, by marginal utility, or at a price which carries off the last increment. With- 1 See what is said further on this topic, and on the peculiarities of the value of money, in Book III, Chapter 18. VALUE AND UTILITY 129 out stopping now to inquire how far this assumption in fact holds good where a very few commodities are put on sale, 1 let us con- sider the nature of consumer's surplus, as here typified. How substantial is this surplus ? and how far is this mode of measuring it satisfactory ? To ask these questions is only to ask, in different words, how substantial total utility is, and how far we can measure total utility. One limitation of the first importance has already been in- dicated when considering marginal utility and its connection with demand. If all persons had the same income, then will- ingness to pay a given amount for an article might be fairly assumed to mean that the article had the same utility for each of them. But some have greater incomes than others; the marginal utility of money is less to the rich; and the pay- ment by them of a larger sum does not signify a higher utility. A rich man will pay for hothouse fruits or vegetables a sum quite out of the question for a person of modest means. The latter may secure, at a season of greater plenty, precisely the same things for a price much lower. The rich man probably gets no greater enjoyment from his expensive purchase ; or, if so (counting as part of his pleasure the gratification of the love of distinction), by no means in proportion to the higher price he pays. If some of the familiar comforts of civilized life become scarce, fresh milk or good bread, they would command a high price, even if all persons had the same incomes. But the price would go still higher if there were a circle of per- sons able and ready to bid heavily for them without making serious gaps in their incomes. The special increase of price resulting from this latter circumstance is indicative, not of specially high utility, but of large means for purchasing utilities. Still another qualification is suggested by the fact of in- equality. Many articles which command a high price satisfy the passion for display. Such are the precious stones, rare paintings, and statues. No doubt many things of this sort the great works of art are intrinsically beautiful, and yield 1 See the next chapter in this book, Chapter 10, 9. X 130 VALUE AND EXCHANGE enduring and unalloyed pleasures; and it is their intrinsic beauty, tested by time, that is at the basis of their high value. Being not only beautiful, but also rare, they satisfy in addition the deep-rooted instinct of emulation and desire for distinction. They have what has been called a prestige value. They com- mand a higher price simply because they are already high in price. Suppose now that such things become common and therefore cheap; that diamonds, for example, become very plentiful, and that their price falls to some such level as that of glass beads. The intrinsic qualities of diamonds would remain ; their luster and brilliancy, their hardness. The satis- faction which the previous limited supply had given might be thought, therefore, to remain undiminished. Yet in fact it would be vastly diminished ; for diamonds would no longer be evidences of wealth and social station. Consumer's surplus, as measured by the previous high price, would evaporate. Consumer's surplus is thus unsubstantial for a considerable range of articles now much esteemed and paid for at high prices. Not only the favorite objects of rich collectors, such as rare paintings and books, belong in this class, but many others which are not commonly thought of as belonging there. Handsome houses, fashionable clothes, even choice food, get no small part of their power of yielding utilities from their satisfying the sense of distinction. As to all these, total utility and consumer's surplus are highly elusive. Another qualification concerns articles at the other end of the scale, things of simple necessity. Measured in terms of the prices that would be given for the early doses, con- sumer's surplus is very high for bread, clothing, houseroom, for the minimum of food, raiment, and shelter. Rather than dispense with these, anything would be given ; life itself de- pends on them. Total utility and consumer's rent may be calculated to be infinite. Certain it is that, were they to become very scarce, their price would go to a very high range ; and this, irrespective of whether there were or were not in- equalities of incomes among the purchasers. But a question VALUE AND UTILITY 131 may be raised as to the nature of the utilities derived from these necessaries. The satisfaction they give is of a negative sort. The chronicler of Lewis and Clark's expedition across the American continent narrates that at one stage the explorers subsisted on dried salmon in the form of a tasteless powder, so unappetizing that only the absplutely necessary amount was eaten. Some such situation is in the mind of an ingenious and stimulating thinker, Professor Patten, who has distinguished between a "pain economy" and a "pleasure economy." The first phrase describes that economic stage in which the efforts of man suffice only to yield the indispensable minimum ; to prevent hunger, thirst, freezing; to ward off pain, not to yield satisfaction. The second describes that better stage when the first elemental wants have been attended to, and positive enjoyment begins ; when food is appetizing as well as sufficient, when clothing and houseroom are attractive. Now, in reckoning total utility and consumer's surplus, we do well to begin only when this second stage has been reached. Let those utilities which are of the indispensable sort be set aside. Only where the stage has been reached of possible comfort, of some choice in the direction of expenditure, can there be anything in the nature of a real surplus of satisfaction for the consumer. But this is true not only of absolute necessaries, but in a good degree of conventional necessaries. Equipages and horses are conventional necessaries for many members of the Conti- nental aristocracy. They would be immensely missed if the individual had to give them up. Yet the real enjoyment from them is doubtful. So it is with the starched linen and close- fitting clothes of the well-to-do, which are insignia of the wearer's exemption from manual labor. The satisfaction from them is chiefly negative ; their loss would be more keenly felt than their presence is enjoyed. Positive satisfaction is indi- cated in very uncertain degree by the price which under the stress of convention the individual would pay rather than do without such things. 132 VALUE AND EXCHANGE Not the least of the difficulties in the way of measuring utilities by potential prices is the practical one that we have no means of knowing what are the prices that would be paid for the several installments of a commodity. In our illustrative case it has been assumed that the first orange would be so greatly enjoyed as to command a price of 50 cents. But in hardly any actual case do we know what price would have been fetched by the first installment, or by a series of earlier installments. All we know is that they would command much more than that settled by marginal utility for the actual supply. We have some information (though not very much even here) regarding the variations of prices in the neighborhood of the range familiar to us. We observe how oranges, cigars, bread, meat, sugar, go up and down as the quantities become some- what greater or less than those usually put on the market. But we have no precise knowledge of what would happen if the quantity of any one of these varied very greatly from the usual amount. Statistics of prices, however perfected, throw no light on the highest range that would be paid if supply became very small. These accumulated difficulties make it impossible to meas- ure in any precise way total utility or consumer's surplus. The figures which have been given for illustration are useful in making the conceptions clear, but are misleading in that they imply accuracy of measurement. We cannot set down the complete price schedule ; and even if we could, the differences in incomes, the illusiveness of prestige, the doubtful satisfac- tion of a pain economy, combine to render a calculation of real enjoyment impracticable. We cannot measure with any ap- proach to accuracy the satisfactions got from wealth. None the less, total utility and consumer's surplus are not fanciful. That they are real, is shown by their accord with familiar phrases. We often say that we get a thing for less than it is worth to us, meaning that what we give for it offers less satisfaction than the thing we buy. This is merely stated with more care and precision when we say that a consumer's VALUE AND UTILITY 133 surplus is secured. Though that surplus may not be clear either at the lower end of the scale of consumption, where bare neces- saries alone are bought, or at the upper end, where mere vanity is satisfied, it is unmistakable with what may be called the true enjoyments of life. A varied diet, abundant houseroom, clothing and fittings that permanently please the taste, the gratification which all men get from the mimic arts, distraction coming after monotonous work, the pleasures of the intellect, these are things not less enjoyed when abundant and cheap. They often have a utility much greater than is indicated by the price paid for them. Though their utility be not susceptible of measurement, total utility is certainly large, and consumer's surplus is correspondingly large. 6. The discussion of utility, total utility, and consumer's surplus leads to another question, How state and measure the income of a community ? An individual usually thinks of his income, and measures it, in terms of money. Similarly, the income of a community is usually stated in terms of money. So long as the prices of commodities and services remain the same, this mode of esti- mating income is for most purposes sufficient. The condition stated of stable prices is obviously important. If all money incomes double, and all prices also double, the community is no better off than before. It simply conducts its exchanges with a different scale for the medium of exchange. Hence we proceed naturally to the next step. Money in- come is significant simply as a way of measuring the quantity of the things which the money buys. We may think, therefore, of real income in contrast to money income, of the necessities, conveniences, and luxuries of life. We must reckon, also, as part of real income, the services of those who used to be called "unproductive," actors, musicians, servants, and so on. The more we can get of such "real" income, of all kinds, the more prosperous we are as individuals and as a community. But we may go a step beyond. We have seen l that the i See Book I, Chapter 2, 2. 134 VALUE AND EXCHANGE act of production consists in the creation of utilities. Now, just as all production in the last analysis consists in the creation of utilities, so all income consists in the utilities or satisfactions created. Economic goods are not ends in themselves, but means to the end of satisfying wants. In a preceding chapter, we have distinguished between capital and wealth which is not capital, or (in other phraseology) between consumer's wealth and producer's capital. But consumer's wealth, which we may treat in one sense as "real" income, is an instrument no less than producer's capital. It, too, is a means, not an end. Our food, clothing, furniture, may be said to yield psychic income. They shed utilities, so to speak, as long as they last. In the final analysis, the income of an individual or of a community consists of the sum of utilities steadily accruing from its store of economic goods. It consists, that is, of the total utility of all its goods. Nevertheless, for almost all purposes of economic study, it is best to content ourselves with a statement, and an attempt at measurement, in terms not of utility but of money income or of real income. The reason for this rejection of a principle which is in itself sound lies in the conclusion just reached re- garding total utility and consumer's surplus : they cannot be measured. The other ways of stating and measuring income lead to results of some certainty. We can measure money income. Though our statistics for the total money income of (say) the people of the United States are far from complete, the task of ascertaining that income is not hopeless. Indeed, it has been accomplished for some countries with sufficient accuracy. 1 We can also measure the general range of prices. We know, there- fore, whether a given sum of money incomes at one time means more than a given sum at another time. If we know that money incomes have increased, and that the range of prices is unchanged, we are sure that real income, in terms of con- sumable commodities, has increased. 1 See, for a recent example, R. E. May's estimate of the money income of the German people in the Jahrbuch fiir Gesetzgebung, 1909, Heft 4. VALUE AND UTILITY 135 Further, we can do something toward measuring "real" income directly. We can ascertain what has been the con- sumption, per head of population, at different times, of such articles as flour, sugar, tea, coffee, cotton, wool, and the like. The results give indications of value regarding the increase of income in terms of commodities. We know that the average consumption of such things has much increased in recent times, and that material welfare has so far advanced. But how far total utility or "psychic income" has increased, we have no accurate notion. We may feel sure that it has increased in some degree ; but whether in the same degree as consumer's wealth, or in less, or even in greater, degree, 1 we do not know. We cannot measure how great total utility was before the increased supply of economic goods, or how great after. The supply of the things which minister to en- joyment can be measured, but not enjoyment itself. Virtually all problems of legislation and applied economics can be settled, and habitually are settled, according to the results in terms of the former sort of income. Hence we do best, for almost all economic reasoning, not to go beyond the tangible and measurable facts of consumer's wealth. Even though consumer's goods be but a sort of capital, and even though total utility be, in the last analysis, the true income, the only kind of income about which we can reach results of quantitative accuracy is that "real" income which consists of enjoyable things. 7. The principle of diminishing utility, if applied unflinch- ingly, leads to the conclusion that inequality of incomes brings a less sum of human happiness than equality of incomes, and that the greater the inequality, the less the approach to maximum happiness. If additional increments of any com- modity yield less enjoyment than preceding increments, the same is true of increments of income in general. A man who 1 If we accept the distinction between a pain economy and a pleasure economy, and begin to reckon total utility and consumer's surplus only when a surplus over necessaries appears, we may conclude that for a considerable stage after the first emergence of a surplus, total utility increases in greater degree than consumer's wealth. 136 VALUE AND EXCHANGE already has five oranges gains less from a sixth than he who has but one orange gains from a second. A man who has an income of $10,000 gains less from an additional $100 than does the man who has an income of $1000. This is stated in another way in the proposition that gambling between persons of equal income always brings an economic loss. If two men, each having $1000, bet $100, the gain to the winner from the increase of his possessions to $1100 is less than the loss to the loser from the drop of his possessions to $900. All this follows directly from the hedonistic calculus, from the principle of diminishing utility. We have just seen that the hedonistic calculus is not to be applied unflinchingly. It needs to be qualified, for example, in its application to the necessaries of life, to pain economy and pleasure economy. Additions of income (that is, of goods purchasable) which come after the first needs of bare existence have been met, may mean not only an increase of happiness, but a more than proportionate increase. Hence if one half of a people have a considerable surplus over necessaries, and the rest the bare necessaries only, the sum of enjoyments may be greater than if all had the same income, if the surplus were spread thin over the entire mass. And it hardly needs to be said that the hedonistic calculus, even where it does lead clearly to the conclusion that enjoy- ment is subject to diminishing return, does not tell the whole story of human happiness. One of the unfailing sources of satisfaction, deep-rooted in human nature, is the response to the instincts of emulation and distinction. But distinction implies inequality. Though there may be distinction and inequality in other ways, in rank or fame, difference in economic possessions has been an immense stimulus and an immense resource to almost all men. The spice and flavor of life would be gone with flat equality. None the less, it remains true that there is an opposition be- tween inequality and maximum happiness. The opposition becomes obvious when there is very great inequality. High dis- VALUE AND UTILITY 137 parity of incomes means a net loss in happiness ; the rich gain less than the poor lose. Though some emulation and distinction be essential to a full and happy life, and though some inequality of income be a natural consequence of distinction, such great inequalities as are familiar in modern society, and indeed in all societies advanced much beyond barbarism, cannot possibly bring the most effective distribution of the material sources of enjoyment. Emulation in ostentation palls ; it is the least last- ing of all the satisfactions derived from distinction. The con- sciousness, more or less obscure, of the inconsistency between maximum happiness and great inequality underlies the whole modern social movement ; for essentially this movement has for its goal a more equal distribution of income. From this flow the characteristic tendencies of our time, curbing of monopo- lies, extension of government industry, labor legislation, progres- sive taxation ; last, but not least, socialism. Inequality may be, and probably is, an indispensable spur to the full application of men's best faculties, and an inevitable outcome of free and vigor- ous industry. But prima fade it does not lead to the best distribution of well-being. It is always on the defensive ; and the greater and more lasting it is, the more difficult is its defense. CHAPTER 10 MARKET VALUE. DEMAND AND SUPPLY 1. In the preceding chapter the first principle of value has already been stated. The value of an article depends on its mar- ginal utility. It is the price at which the last installment can be disposed of, the price that settles, in turn, under the ordinary conditions of competition in the market, the price at which the whole supply will be sold. It remains to illustrate this prin- ciple further, and to explain in what manner it operates in the complexities of actual life. Let us first illustrate the main principle graphically. On Figure 1, prices are measured along the perpendicular axis Y; quantities, i.e. the several installments offered in the market, are measured on the horizontal axis OX. Let it be supposed that the first dose, say of sugar, is represented by the horizontal line OA, and that this dose would command the price OP. Its value would then be indicated by the area OP A' A, the quantity multiplied by the price. Suppose now a second dose to be offered, indicated by the line OB. Under the influence of the principle of diminishing utility, its price would sink to OP', and the whole supply would now be sold at this price (or rather, as will presently be explained, at no higher price than this). The total value of the increased supply would now be indicated by the area OP'B'B. Add now another dose, the supply being OC ; the price sinks again, and the value of the whole supply is OP"C'C. And so on, with the supply OD, the price will be OP'", and the whole value OP'"D'D, and with the supply OE, the price will be OP"" and the whole value OP""E'E. Strictly speaking, under the conditions here assumed, we should not know that the price for the quantity OB, for example, 138 MARKET VALUE. DEMAND AND 'SUPPLY 139 was fixed at the amount indicated by the lines OP' or BB'. We should only know that it was not higher than OP' and not lower than OP" (CC"). In order to induce the supply OB to be taken off, the price must be at least as low as OP' ; otherwise, the buyer would not take it. But if the buyer offered less than A' .n' C' n ' p' p' p" p'" p"" c U > ) A B C D L Fio. 1. OP', the seller would still rather dispose of his supply than have it left on his hands ; and until another potential buyer came on the scene, there is no telling what price the seller might not accept. But if another buyer comes, to whom the dose has the utility measured by OP", and who is willing to pay the price so measured, the seller can compel the second buyer, stationed at B, to pay at least as much as the third competitor, stationed at C, would offer. Price, therefore, would be somewhere between OP' and OP", or somewhere between BB' and CC'. So in each of the successive stages. The price must be at least low enough to tempt the last buyer, who must be called in to dispose of the whole supply offered. It may go a bit lower than this, until the point is reached at which a new buyer would enter and prevent the more desirous buyer the more "capable" buyer, as he has sometimes been called from beating the seller down. If there be a considerable difference between the utilities of the 140 VALUE AND EXCHANGE installments to successive buyers, there is a considerable range within which price is indeterminate. We have already noted, however, that in the ordinary course FIG. 2. of business dealings there are no such abrupt stages in demand as the preceding diagram assumes. There are not a paltry half- dozen purchasers, and a few pieces on sale, for any given article. There are many buyers, to whom great supplies are offered. Among the many buyers, there are always some just ready to step forward; some to whom the utility of the additional dose is only a shade less than was the utility of the previous dose, and who are therefore called into the active purchasing market by the lower price. This situation is described, in the technical language which economists have found convenient, by saying that demand is continuous. Where there are gaps be- tween the utilities to different purchasers, and consequently between the prices they are willing to pay, demand is discon- tinuous. The successive steps from A' to B', C", D', E' in Figure 1 indicated such discontinuity of demand. The nearer together these points are, the smaller is each step, and the less is MARKET VALUE. DEMAND AND SUPPLY 141 the range within which price is indeterminate. For the immense majority of dealings in modern communities, the points are so near together, the gradation of utility and demand is so close, that they may be represented as joined into a line or curve. That curve, on a diagram such as is commonly used in graphic illustrations of these principles, always has a smooth downward inclination from left to right, like the unbroken line DD' in Figure 2. It indicates that successive doses of any article have gradually diminishing utility, and must be offered at prices that insensibly become lower and lower as greater quantities are disposed of. It is called the demand curve. The shape which that curve assumes indicates the nature of the demand for the commodity. If it descends slowly, as does the dotted line ee' in Figure 2, it indicates that, as greater quan- tities are offered on the market, new purchasers appear readily and the decline in price is slow. The demand for the commodity is then said to be elastic. On the other hand, a curve descending quickly, like the broken line ii', in Figure 2, indicates that util- ity or purchasing power diminishes rapidly, that new purchasers do not readily appear, and that the decline in price with increas- ing supply is abrupt. In such a case the demand for the com- modity is said to be inelastic : consumption does not respond promptly to a lowering of prise. The cause of inelasticity must be, in some degree, rapid diminution of the utility of added installments ; but this cause may be accentuated by inequality in means. If some purchasers are very rich, others well-to-do, many others poor, commodities may meet a highly inelastic demand in the market, but not necessarily suffer a correspond- ing diminution in their power of yielding enjoyments to man- kind. The demand for necessaries is inelastic. A certain quantity of bread will be bought, whatever the price. No doubt a high price will in some degree check consumption, and a low price will lead to more liberal or careless use. But when the indispens- able supply has once been got, the decline in utility from greater quantities is rapid. For articles of this sort, a comparatively 142 VALUE AND EXCHANGE small shortage in supply will cause a large increase in price, while a comparatively small redundancy will cause a rapid decline. The sharp inclination of the demand curve ii' is the graphic representation of the inelastic demand for necessaries and oi the abrupt fluctuations in price under slight changes in supply, Any article which, though not necessary, is yet clung to with per- sistence by consumers, has a similarly inelastic demand. Meat, for example, though not a necessary, has an inelastic demand among the well-to-do. On the other hand, the substantial comforts of life things not indispensable, yet prized by all the world often have an elastic demand. Such are those articles of food which, though not necessaries, please by their flavor and variety. For almost all except the well-to-do meat is such an article. In the upper part of the supply it has an inelastic demand, in the lower part a very elastic demand. Sugar, fruits, vegetables, tea, coffee, and cocoa have probably an elastic demand through- out the range of supply ; so have books, furniture, houseroom, clean and decent clothing. In general, elasticity of demand is increased by an equal dis- tribution of wealth, while an unequal distribution leads to in- elasticity in demand. This effect of inequality illustrates once again the caution which needs to be observed in applying the principle of diminishing utility to the phenomena of value as they appear in modern communities. If all people had the same in- comes, diminishing utility would be the one cause acting on the elasticity of demand, and the inclination of the demand curve would be significant of the rate of .diminution in the enjoyments yielded by successive increments. In fact, the demand curve is much affected by the circumstance that persons of means can af- ford to bid high for the first increments, while the great number of those with small means cannot bid until a low price is reached. The lower bids of the latter signified by a sharply descending demand curve mean a diminution not so much in enjoyments as in money means. This qualification must be borne in mind when, in the succeeding pages, value is spoken of as depending on mar- MARKET VALUE. DEMAND AND SUPPLY 143 ginal utility ; that phrase being used, for brevity, to indicate the complex conditions on which depends the price fetched by the last increment of a supply. 2. We proceed to consider now the mode in which the value or price of an article is determined at any particular time, the problem of market value. Suppose the supply of a commodity to be fixed ; suppose it to be offered on the market by competing sellers ; suppose it all to be offered without reserve. Then the value of that commodity will be determined by its marginal utility. If all is not sold at that price by the competing sellers, some part of the stock will not be disposed of. This situation is graphically represented in Fig- ure 3. Given a supply OS, the resulting price will be at the point where the perpendicular line SS' will cut the demand curve DD'. That line (SS f OP) measures the marginal utility of the supply OS, and so measures the price at which that supply will be sold. The total exchange value of the supply is indicated by the area OPS'S the supply multiplied by the price. Total utility is indicated by the irregular area DOSS' ; consumer's surplus by the (more or less triangular) area DPS'. Those purchasers who, rather than go without the article, would have been willing under stress to pay a higher price than SS' as high as OD secure some surplus of satisfaction. The same proposition, on the mode in which the value of an article at any given time is determined, was stated by the older writers in a somewhat different way. They said that market value was settled by the equation of supply and demand. The everyday way of putting it is to say simply that the value of a thing is determined by supply and demand. This is loose, since it implies that supply and demand are causes that act in- dependently, and are not themselves influenced by price. But demand, in the sort of case here supposed, is certainly affected by price. The lower the price of an article, the more of it will be demanded; the higher the price, the less will be de- manded. To say that price depends on demand, therefore, seems to be reasoning in a circle ; since, if price is affected by demand, 144 VALUE AND EXCHANGE demand is no less affected by price. Hence the more careful phrase just quoted ; the equation of supply and demand. Given a fixed supply, there is one price at which the quantity demanded will be just equal to this quantity supplied. To assume that there is one such price, and not more than one, is to assume con- tinuity of demand, as explained in the preceding section, an as- sumption that holds good of the vast majority of articles bought and sold in the markets. This one price evidently represents the marginal utility of the supply. Though the phrase "marginal utility " was not used by the older writers, their version of an equation of demand and supply states substantially the same proposition as the more modern one which reasons on the basis of diminishing utility and marginal utility. 3. In both of these statements of the principle of market value, the older one of an equation and the newer one of the marginal utility of supply, the underlying assumption is that a fixed quantity is put on the market. But is this assump- tion tenable? Does it conform to the usual state of facts? We have just said that demand, in the sense of quantity de- MARKET VALUE. DEMAND AND SUPPLY 145 manded, is not independent of price. Is not the same true of supply? In the ordinary case, it is hardly accurate to say that the quantity offered in the market is fixed, and is inde- pendent of price. As price goes higher, more sellers will be tempted to offer their wares, and supply will become larger. As prices go lower, supply will become smaller. Must not the theory of market value be adjusted to variable supply as well as to variable demand? It is true that in some instances the supposition of a fixed supply is clearly in accord with the facts. When a large crop of strawberries comes on the market, it must be disposed of once for all. There is no keeping back any part of the supply of a perishable commodity. The total quantity on hand must be disposed of for what it will fetch, for the marginal price. Not very long ago, the list of commodities of this kind was a large one; it included fresh fish, all vegetables and fruits, even meat. But modern improvements for the preservation of most such things, through cold storage and canning, have greatly shortened the list. Most commodities are not put on sale with headlong suddenness. They are offered in install- ments. They come into the market in a flow or stream, not as an abruptly offered stock. The rate at which they come in, and the amount which will be offered at any given time, depend on the price. A higher price quickens the flow and leads to larger supply ; a lower price checks the flow. It is not difficult to adjust the theory of market value to the case of variable supply. On Figure 4, let SS f represent the conditions of a supply that varies with price, becoming greater as price rises and smaller as price falls. Here, as on the pre- vious figures, quantities are measured horizontally along the. axis OX or parallel to it, and prices perpendicularly along the axis OK or parallel to it. At the price SA, we may suppose the quantity OA to be forthcoming on the market. As the price rises, the quantity increases. At the price PP', the quantity offered is OP' ; at the price S'A', the quantity offered is OA'. Evidently the line SPS', which is the supply curve, has 146 VALUE AND EXCHANGE an upward inclination, the reverse of the inclination of the demand curve DD'. A rise in price, which causes the quan- tity demanded to become less, causes the quantity offered to become greater. The supply and demand curves, moving in opposite direc- tions, must meet; and in our figure they meet at P. The price PP' is the equilibrium price, the market price fixed by the play of varying supply and demand. At that point the quantity offered is equal to the quantity demanded: the equation is Y FIG. 4. satisfied. If a higher price is asked, the quantity demanded will be less and the quantity offered will be greater. Sellers will put on the market more than buyers will take ; price will fall; some sellers will then withdraw and some buyers will come in, until equilibrium is reached. And so in the reverse case : at any lower price, some sellers will withdraw, some buyers will be tempted in, and readjustment will again bring the price to the point of equilibrium PP'. 4. It has just been said that of these two modes of state- ment the one proceeding on the supposition of a fixed supply, MARKET VALUE. DEMAND AND SUPPLY 147 the other on that of a variable supply the second is more in accord with the facts. Yet the first also is so in accord. Both must be had in mind for an understanding of the course of prices in a market. On any given day, in a well-organized market, the actual settlement of market price undoubtedly takes place through an adjustment of supply as well as through a response from demand. On the cotton exchange or the produce exchange, or in any place where brokers and dealers meet, a process of higgling and bargaining goes on. More or less of the article is offered and demanded, with fluctuations in prices which are usually within narrow limits on any one day and which result in an equilibrium price for that day. But this daily equilib- rium price is itself affected by an underlying and more im- portant equilibrium price. While the amount which is offered in the market from day to day the supply varies consider- ably, and varies in response to changes in price, the total amount which can be supplied over a larger period usually is fixed. Take, as a typical case, the price of cotton, which fluctuates on the exchanges from day to day in response to the ever changing play of offer and demand. The total amount of cotton available for the season is not a variable quantity. It is so much and no more, depending on the crop of that season. The price at which the whole will be disposed of depends on its marginal utility or on the equation of supply and demand (whichever mode of statement be preferred) and is the out- come of a total supply which is fixed. The fluctuations in price from day to day oscillate about this seasonal equilibrium price. Still using the cotton market and cotton prices for examples, we may note that, while the supply for the season is fixed, no one knows in advance with certainty just how great that supply is ; still less at what price the supply, even if accurately known, would be disposed of. Hence a period of uncertainty, of rumors and guesses, of selling and buying by brokers and dealers and manufacturers, by any one who chooses to operate 148 VALUE AND EXCHANGE on the cotton market, in short, all the phenomena of specu- lation. Cotton in the United States (the crop in this country dominates the world market) is picked in the autumn, and the amount harvested is known by December 1. But through- out the summer months there are reports of the condition of the growing plants, which foreshadow, though with uncertainty, the amount of the coming crop. During the picking season more and more certainty is reached. Finally, under modern methods of gathering such information, the amount comes to be accurately known. Then arises the question to what degree the price will be affected by the amount. It is certain that a small crop will command a higher price, a large crop a smaller price. But the conditions of demand or consumption are fluctuating from year to year, no less than the supply from the crops. Just what will be the seasonal equilibrium price for a crop of a given size, no one can say in advance. It is reached by a succession of tentative market prices. From day to day, and from month to month, the market price is settled by the adjustment of variable amounts offered in the market by dealers. For the season, it is settled by the adjustment of a fixed supply to the marginal price at which the whole will be disposed of. It is not to be supposed that even on a single day is there one price rigidly settled by the equilibrium of demand and supply. Even in the most highly organized markets there may be simultaneous sales at different prices ; and, where there are newly discovered conditions affecting the seasonal range, such as a crop report, there may be considerable fluctuations in the course of a day. These oscillations give the opportunity to the astute bargainer. Some buyers, not cool-headed enough to bide their time, will pay more than the equilibrium price. On the other hand, some sellers, unduly anxious lest their supplies be left on their hands, will sell at less. The shrewd and unexcitable person, carefully watching the course of deal- ings, may buy at one price from the over-eager sellers and sell on the same day at a profit to over-eager buyers. It is MARKET VALUE. DEMAND AND SUPPLY 149 sometimes said that all the capital a speculator needs is a pencil and a block of paper, and all the knowledge he needs is a knowl- edge of human nature. This is by no means the whole story, yet it is true that a certain faculty of judging human nature, and an impassive demeanor, are important in the equipment of the professional dealer, and play no small part in those specu- lative operations which are discussed in the next chapter. The more the actual dealings in a market are confined to persons who are shrewd and well-informed, the more probable is it that there will be an exact equilibrium price. And in any market where dealings are habitually conducted on a con- siderable scale, there will be an equilibrium price which, though not rigid, is maintained between comparatively narrow limits; and that price will represent the judgment then currently held of the probable seasonal price. Here, as in all economic analysis, we have to do not with hard and fast phenomena, but with the wavering doings of human beings. For the sake of bringing out clearly the underlying general probability a probability which often is so great as to be virtually a certainty we state our reasoning and conclusions in semi-mathematical form, as in the diagrams and figures that have preceded. But it must be remembered that the conclusions hold good not with mathe- matical certainty, but simply as statements of tendencies to which the actual market conditions more or less conform. What is true of cotton, holds of other agricultural commodi- ties, whose supply also is settled by the crops of each season : of wheat, corn, and other grains, of hay, flax and hemp, hops, sugar, tea, coffee. There is always a seasonal price, around which fluctuate the market prices for shorter periods. Vir- tually this holds of other commodities also. It is true that agricultural commodities show more unmistakably than most others the temporary fixation of supply. The supply of manu- factured commodities changes more smoothly and continuously. The amounts offered in the market can often be increased and diminished without waiting for nature's processes of growth. But even here there are important limitations. For any givec 150 VALUE AND EXCHANGE period of moderate length a half year or a year there is something like a fixed supply. Iron, for example, is continu- ously produced, and the amount of production responds in some degree to the fluctuations in price. But the quantity available for any given period depends on the mines of iron ore and of coal which are open, and still more on the furnaces and works which are ready to smelt and shape the iron. The supply can be increased or decreased only with considerable difficulty. It will not readily decrease, because the existing iron mines and works will be kept going, unless the prospects for profit are very bad indeed ; continuous operation is a condition of almost any profit at all. Nor can it be rapidly increased. New mines and works can indeed be added, but this takes time. Again, though the output from the existing con- cerns does not come on the market at any fixed or regular rate, it is almost sure to be offered for sale within the current season of operations. Thus a seasonal equilibrium of supply and demand establishes itself. Around this seasonal price the current market prices fluctuate, as varying amounts are offered and demanded from day to day and from week to week. Sometimes dealers, looking far ahead, carry stocks over a considerable period. In this way, the supply on hand, even the seasonal supply, may be sensibly affected, and the seasonal market price may be affected correspondingly. If, for ex- ample, the wheat crop in any year is very large, and the price unusually low, some dealers may withdraw considerable amounts from sale, store them, and plan to sell them at a profit in the next year, when a smaller supply and higher prices may be expected. But this is a risky operation. It involves the locking up of large money means. The next season may again bring a large crop. There is the possibility that the wheat held in storage may spoil and become valueless. As a matter of fact, very little wheat (in comparison with the total supply) is carried over from year to year, and the yearly price is deter- mined almost solely by the crop for the time being. It is perhaps otherwise with durable commodities. If iron and MARKET VALUE. DEMAND AND SUPPLY 151 copper are unusually cheap, stocks of them may be bought and put aside, with a minimum expense for storage, and with no risk of deterioration, in expectation of higher prices after a year or two. Yet even for these durable articles, such opera- tions seem to be uncommon. Most persons in active busi- ness, and especially dealers and middlemen, do not try to look far ahead. They study the conditions of the present and the immediate future, and govern themselves accordingly. The withdrawal of stocks from the seasonal market seems to be no considerable factor in the play of demand and supply. 5. Strictly speaking, the principle of marginal utility applies to consumer's wealth only. Capital yields no utilities directly. Materials, implements, machinery are but means for procuring utilities at a later date. Their utility is a derived one, depending on the utility of the consumable goods they aid in making. Though the principle of marginal utility works out its results for capital goods also, it does so through an intricate process and with some complications. For example, when the cotton crop is small, the price of cotton rises ; marginal utility is greater, we say, for the smaller supply. But the cotton is sold by the planters and farmers first to the dealers and speculators ; they sell to the manufacturers ; these again, through another set of dealers, sell the cotton cloth to those who wear it. It is the satisfactions got by these ulti- mate consumers that in the end determine the value of cotton for a given supply. But the manufacturers are the immediate buyers; and it is they who are commonly spoken of, in the language of the market, as the "consumers" of cotton. They are often in a position in which they must buy cotton. They have a plant which must be run if it is to earn anything at all, and a force of workmen which, to remain efficient, must be kept together. Each manufacturer wishes to keep his plant working at full capacity, and his workmen fully employed ; yet with a small crop, there is less cotton to be worked up. On the other hand, the extent to which consumers will pay at a higher rate for the diminished amount of cotton cloth is an uncertain 152 VALUE AND EXCHANGE factor. The manufacturers try to get from the merchants and dealers to whom they sell, a higher price for cloth corre- sponding to the higher price of cotton. Both these sets of business men will say that it is the high price of cotton which causes the high price of cloth. Yet the reverse is at bottom the case; only because the cloth can be sold at a high price does the raw material command a high price. How close the correspondence in price will be, how much the investments and commitments of the manufacturers will affect the situation, how the calculations and transactions of cotton dealers and speculators, and cloth merchants and buyers, will act on prices at any one date and through the season, these are matters on which the action of the fundamental economic forces is slow and uncertain. There are analogous complications when there is a very abundant cotton crop. Then manufacturers are not prepared to work up an unusual supply of the raw material; merchants and retailers are not certain how far and at what prices they can find a market for additional quantities of cloth. Though cotton cloth is a commodity having an elastic demand, raw cotton, despite the fact that demand for it is derived from that for cloth, may show from season to season fluctuations such as one would expect in a commodity for which the demand is inelastic. Other kinds of capital goods are to be used for durable tools and plant. Such are iron, copper, timber, brick, stone. In the end, the demand for these also rests on the utility of the enjoy- able commodities made with them ; they also have a derived utility. But proximately the demand for them is from persons who wish to use them in connection with new investments. When the prospect of profit is good, the prices of these things rise ; when the prospects are bad, their prices fall. Hence their prices are closely connected with those alternations of activity and depression, of good times and bad times, which are among the most puzzling of economic phenomena. It is true that their market price is settled by the amount which the last purchaser the least eager of the buyers is willing to pay. And in MARKET VALUE. DEMAND AND SUPPLY 153 the end, no doubt, what that purchaser is willing to pay de- pends on what he can get in turn for the consumable goods made with the aid of the capital goods. But the chain of connection is a very long and irregular one, and the market price is uni- versally affected by current expectations as to investment activity. It would be absurd to apply to these articles any strict principle of marginal utility. That principle, like others in economics, works out its results only in the long run, and with all sorts of qualifications and complications. 6. Retail prices might be expected to illustrate most clearly the play of marginal utility ; for here enjoyable goods are sold to their consumers, and the utilities from them are nearest realization. Yet in fact retail prices seem less subject to the working of supply and demand than wholesale prices. Retail prices are governed proximately by custom. People pay the traditional or going price. Even the amounts which they purchase appear to be governed by custom ; they buy the quantities which they are in the habit of consuming. And the retail prices which establish themselves as customary seem to be governed by wholesale prices. The retail dealers charge more when there is a considerable and apparently definitive rise in wholesale prices; and competition among themselves causes them to charge less when there is a considerable and lasting fall. No doubt, the accommodation of retail to whole- sale prices is slow. When wholesale prices rise, shopkeepers hesitate to ask more, partly because each one fears that his rival may entice a customer away by keeping to the old price for a while. Conversely when wholesale prices fall, no shopkeeper willingly gives his customer the benefit of the change : he waits until some competitor precipitates it. But the two sets of prices in the end move together. Though retail prices are governed proximately by custom, they seem in the end to follow whole- sale prices. But all this is in appearance only. The consumption of every commodity is affected by its price. A rise in price checks pur- chasers, a fall hi price stimulates them. Though it would appear 154 VALUE AND EXCHANGE that people continue to buy simply what they are used to buy- ing, this is true only of buyers who are above the margin, those who have been enjoying a consumer's surplus. There are always some just on the margin, to whom, at the ruling price, the purchase is just worth while and who cease buying when the price goes up. And conversely, when price falls, there are always some additional purchases. How great the changes in consump- tion are with rising or falling price, depends on the elasticity of demand. But some degree of sensitiveness there always is. So certain is this, that the wholesale dealers reckon on it in ad- vance, and at once accommodate the current prices in the whole- sale market. It is they who usually are best informed regard- ing the general situation. They know when a crop is short, or a new source of supply has been opened, or an invention is cheapening production and increasing the amount offered in the market. It is they, too, who can best observe when the habits of consumers are undergoing change and so are affecting the purchases of a commodity. In case of an increase in demand, any one retailer may indeed notice that his customers are buying more than before ; but this may seem to him an isolated phenom- enon. He simply orders more from his wholesale agent, and expects to sell more at the old price. But when orders from many retail dealers thus come in to many wholesalers, the market responds and price goes up. The retail dealer then charges more to his customers because he has paid the wholesaler more for his goods; the real influence at work being that the cus- tomers, taken as a whole, want the goods more. Here, as in all the phenomena of value and price, the stocks held by dealers, whether retail or wholesale, have an effect in preventing abrupt changes, and sometimes obscure and delay the restoration of the equilibrium of supply and demand. In the end, however, that equilibrium, resting on the demand of the marginal purchaser and so on the principle of marginal utility, settles both whole- sale and retail prices. In the earlier stages of industrial life, and even in many coun- tries which have attained a comparatively advanced stage, retail MARKET VALUE. DEMAND AND SUPPLY 155 prices are fixed by a direct process of higgling between sellers and buyers. In the very earliest and most primitive stages, indeed, when exchanges are few and sporadic, higgling plays a very im- portant part. There is then nothing in the nature of a market price or customary price ; and the astuteness of the bargainers, the needs and whims of the moment, even the possibility of physical force, affect the terms of exchange. As the division of labor is extended farther, and continuous exchange and sale develop, something like a market price establishes itself. That market price is likely soon to become a customary price, repre- senting roughly an equilibrium of current demand and supply ; but, though customary, it is likely also to be subject to bargaining, and to vary more or less from the customary rate. In the highly developed countries of modern times, bargaining in retail dealings has been almost entirely discarded. The dealer sets a price at which he will sell, and at that price the pur- chaser may take the article or leave it. The tacit understand- ing is that the price so fixed shall be the current or market price, and that it shall be the same for all customers at the shop. The practise of fixed prices saves a vast amount of time and friction. The purchaser need not be on the watch to discover what other dealers are asking, and what is the going price ; while, if he is not a marginal purchaser, but is enjoying some consumer's surplus, he need not be on his guard lest the dealer take advantage of his potential demand. The ease of everyday purchases and the efficiency of labor in retail operations are immensely promoted. Retailing on a large scale, conducive as it is to economy of labor, would be impossible without the practise of fixed prices. In many parts of the continent of Europe it has not been fully adopted. There the retail dealer still asks, not the price which he will take once for all, but a price which he hopes to get from the individual purchaser, and which he is prepared to lower if the purchaser bargains shrewdly. The result is friction, waste of time, and inefficiency. 7. The current market rate is what people usually have in mind when they speak of a "fair" price. This is what the 156 VALUE AND EXCHANGE retail dealer is expected to charge as his fixed sum. If he asks a higher price than is usually asked at the time by other dealers for the same thing, still more, if he asks a higher price from one purchaser than from another, he is said to be charging unreasonably, or overreaching, or even cheat- ing; and he is likely to lose his custom. There is often a similar attitude in regard to wholesale prices. Many large dealings in the wholesale market are concluded, in the great civilized communities, on the principle of fixed prices. A manufacturer or merchant in search of a given article orders what he wants from an agent or correspondent of established reputation, with the understanding that a fair price that is, the ruling market price will be charged. Here, as in retail dealings, confidence in honesty, and acceptance of prices as they stand, conduce to the easy dispatch of business. Underlying all, however, is bargaining somewhere, a more or less overt adjustment of price to supply and demand. What is a fair price in the fundamental sense what is the really just price at which goods shall be sold are questions much more difficult than is supposed by most persons who use the phrases. In- deed, few who talk of fair and unfair prices are conscious of the problems involved. But they are problems not of exchange, but of distribution, and therefore taken up at a later stage of the inquiry. 8. The discussion throughout the preceding pages has pro- ceeded on the assumption that utility to the buyer is the only aspect of utility that needs consideration. The seller is supposed to put his wares on the market once for all, and to dispose of them, sooner or later, on such terms as their utility to buyers makes possible. But may not utility to sellers also affect price, by affecting supply ? May not part of the supply be withdrawn by the sellers, for their own use ? Would not the extent of this withdrawal depend on the price, and so introduce a further com- plication in the theory of market value ? It is entirely conceivable that utility to sellers should thus affect price. In the case of the five oranges, supposed above, it MARKET VALUE. DEMAND AND SUPPLY 157 is conceivable that the holder of them might consider the pos- sibility of enjoying one himself, and would be led to do so more and more as the price descended. At fifty cents he would readily part with one of his oranges, but at five cents he might conclude to eat one, and so withdraw part of the supply. And if we suppose, not one seller with a few oranges, but many sellers with many oranges, and suppose that among these sellers there is a considerable possibility of withdrawals for consumption, we have a new problem, more complicated than that of sales based on utility to buyers only. A great deal of intellectual ability has been given by economic writers to the analysis of this problem, and to the careful statement of the terms of ex- change that would result under various hypothetical conditions. But almost all this subtle analysis is in the air. Under a de- veloped division of labor, utility to sellers does not affect value. Men produce with no reference to their own consumption. They produce for the market. The supplies in their hands of the things made by them are so great that the importance to them of any unit is nil. They throw their product on the market without reserve. No doubt, if that product were very great indeed, such as to make the marginal utility to pur- chasers almost nil, the sellers might stop to consider whether they could not use some fraction of it themselves. Farmers may consume more apples when a very heavy crop causes apples (on the tree?) to be nearly valueless. But any supply created by effort and with a view to sale is rarely so far increased that price sinks near zero; and where by mischance price is very greatly lowered, the effect of utilization by the makers (sellers) is so slight as to be negligible. Virtually the whole supply is, in the ordinary case, offered once for all on the market. The case would be different if supplies got into people's hands without reference from the start to sale and disposal. If they were rained down from heaven, in small amounts, price would be affected by utility to sellers quite as much as by utility to buyers. In early times, before division of labor and exchange had de- veloped far, sporadic exchanges took place, we may imagine, 158 VALUE AND EXCHANGE under these apparently simple, though really complex, conditions. But they must have taken place either with very vague con- sciousness of utility, or under the influence of customs which greatly affected the actual terms of exchange. Ingenious hedonistic calculations probably throw little light on what hap- pens in the stray exchanges of barbarians. There are, however, in the modern world occasional cases where exchange is affected by utility to sellers. When a fine old picture or a family heirloom is put on the market, its price may depend much on the attachment which the owner feels for it. Articles of this sort, of sporadic and limited supply, are in any case largely indeterminate in value ; since buyers are few, and demand is discontinuous. Their price may be made still more indeterminate by the fact that the seller (or sellers) may set store by the few specimens. The same is true, though in very much less degree, of dwellings adapted to individual tastes. The or- dinary house, planned like many others of its class, comes on the market on nearly the same terms as other goods of ho- mogeneous supply. But an odd house, built to suit the owner's idiosjoicrasies of taste, stands more or less by itself. Its selling price may depend not only on the going price for houses of this range of desirability as estimated in the general market (that is, as estimated by buyers), but also on the attachment which the owner has for this -particular one. CHAPTER 11 SPECULATION 1. The phenomena of speculation connect themselves with the settlement of market prices. Something more may now be said on the good and ill of speculative dealings. The term "speculation" is used in various senses. Often it implies the buying and selling of things by a person whose main business in life is different, "dabbling" in the market by "out- siders." But as often it implies buying and selling by persons who expect to make their living or their fortune by dealing in one commodity or in certain sets of commodities, persons who are "professional speculators." These are sometimes distinguished again from "legitimate" dealers, the wheat merchant, the cotton factor, who buy and sell a commodity year in and year out, and are permanent middlemen for those who have it to sell and those who wish to buy it. Between these various sorts of persons there are insensible gradations. All their operations have their effect in determining market price ; and all are more or less in the nature of speculative dealings. The fundamental effect of speculation is to promote the establishment of the equilibrium of supply and demand. It tends to make daily market prices conform to the seasonal market price, and to make the seasonal market price such that the whole seasonal supply is disposed of. Those who are skillful and painstaking in estimating the seasonal supply, and are shrewd and experienced in foreseeing the effect of a given supply on price, are the persons who are likely to make money in speculation. They buy when others offer at a price lower than the facts of the market warrant; they sell when others bid a price higher than the facts warrant. The more the deal- 159 160 VALUE AND EXCHANGE ings of the market are confined to buying and selling between such shrewd and experienced dealers, the more likely is it that the seasonal price will be quickly and smoothly reached, and the less will be the fluctuations in price. With the inevitable un- certainties as to the amounts of the forthcoming supplies and the conditions of consumption and demand, there will always be differences of judgment between even the most expert dealers. There will be fluctuations in price, some ups and downs, some unexpected gains and losses, " speculative' 7 profits or losses. But the general effect of speculation is to lessen fluctuations, and promote the smooth course of exchange and consumption. This lessening of fluctuations is advantageous alike to the ultimate consumers, and to those manufacturers who in busi- ness parlance are often spoken of as the "consumers" of a raw material. For the ultimate consumers, say of wheat, the early and exact adjustment of price brings more even utilization of the available supply. If the crop be short, some lessening of consumption is inevitable; and it is better that the deficit be spread through the season. The sooner and the more exactly the higher price is reached, the more likely is this result. Con- versely, a large crop is better sold at a low price throughout the season than at prices ranging from high to low as the season progresses. The good effect of speculation in this direction has been illustrated from the experiences of older days, when wide fluc- tuations in the price of food were common. Under modern conditions, with great areas of supply brought into competition by railways and steamships, abrupt changes in the supply of most foodstuffs and raw materials are rare. A poor crop in one country or section is likely to be offset by a good crop elsewhere. The seasonal supplies do indeed change, and prices go up and down under their influence; but the variations are seldom great. But under such conditions as existed under the limited geographical division of labor before the eighteenth century, great fluctuations were common. Then the area from which any district or city got its food and materials was strictly SPECULATION 161- limited. A crop deficiency meant a short supply, and necessi- tated the adjustment of consumption to that short supply. The dealers or speculators or "forestallers" who secured the supply and at once demanded high prices for it, brought about the inevitable adjustment, and caused a more even utilization of the stock in hand. All this was reasoned out by some of the older writers on economics, and led them to a warm defense of speculators and to a condemnation of laws aimed against speculation. Very likely their defense of specu- lation was carried too far. The process of buying from the farmers did not necessarily take place under active competition by the dealers or speculators, nor did that of selling to the consumers ; and the gains of the speculators were enhanced by the ignorance or heedlessness of both farmers and consumers, and might easily be thought larger than could seem reasonable. We know very little of the details of what took place in these early days, and are prone to project into them ideas or con- clusions based on our own experiences. But none the less it is probable that even in those times the influence of speculation was in the main to lessen fluctuations and promote the expedient rate of consumption. It is certain that this is its tendency under the modern conditions of wide markets, full information, active competition. The development of cold storage in recent times has led to precisely this sort of evened distribution of supply under the influence of dealings that are essentially speculative. Fruit, meat, fish, eggs, no longer come on the market in spasmodic and irregular amounts. Supplies that are heavy at one time are bought by dealers, put in storage, and held for sale at a later period of scantier supply. Prices are more equable, and on the whole the profits of dealers are probably less. There is less risk to them, and the community gets its supplies at a smaller charge for their services as middlemen. 2. The process of lessening fluctuations and distributing risks is much promoted by the practise of dealing in "futures," a practise with which the term " speculation " is especially 162 VALUE AND EXCHANGE associated. Goods are bought and sold not only for imme- diate delivery, but for future delivery as well. The person say the dealer who undertakes to deliver in the future a certain quantity of wheat at a certain price may not have in his possession the goods he sells ; indeed, in the common course of such dealings in the modern markets, he usually does not have them. He gauges the probabilities of the future, and undertakes delivery on the terms which those probabilities suggest. Virtually, he guarantees a certain price for the future, and takes his chances as to whether the guarantee will bring him gain or loss. The buyer is then relieved of the risk. The advantage of this security is easily seen. The miller, for example, may wish to close a contract for the sale of flour in the future. By securing the needed wheat at a guaranteed price, he is freed from all the risk of ups and downs, and can give his undivided attention to his proper business of manufac- turing flour. 1 Hence it has happened, since the establishment of exchanges and the development of their varied operations, that millers carry on their business with a much smaller margin of profit than formerly. The difference in price, weight for weight, between wheat and flour, is much less than it was thirty or forty years ago, and the public gains in so far. When, for example, the flour-milling industry was first established at Minneapolis, -where the falls of the Mississippi supplied power for grind- ing the wheat of a region singularly adapted to its growth, the possibility of profit for the miller was great. But he then underwent also the chances of loss from fluctuation in the price of wheat. As the exchanges developed, and with them 1 Even if he is not contracting for the future sale of flour at a given price, but is simply manufacturing continuously for the market, he can escape by this same mechanism from the risk of fluctuations in the price of wheat. When he buys a given quantity of wheat to be ground into flour, he can sell for future delivery the same quantity of wheat. Thereafter, as wheat goes up or down, he loses as much by the one of these transactions as he gains by the other. The fluctua- tions no longer trouble him. This is the common practise among "conserva- tive" millers. Cotton manufacturers also are getting more and more into the practise of thus "hedging" in their purchases of raw cotton. SPECULATION 163 the practise of dealing for future delivery, he was able to free himself from these chances. The consequent regularity and solidity of the industry contributed to its systematic develop- ment on a great scale, and so to the cheapening of flour. Inven- tions and improvements, no doubt, contributed greatly ; but the elimination of market risks had an important share in reducing the difference between the price of wheat and the price of flour. Both in merchandizing and in manufacturing, the growth of large-scale transactions, though it has increased the gains of those individuals who have the ability to carry on large operations, has lessened the margin between buying price and selling price, and so has operated to lower prices for the consuming public. The dealer or speculator who has sold for future delivery does not usually run all the risks of the transaction himself. He is likely before long to buy from another dealer, for future delivery, some part of what he has contracted to deliver, perhaps the whole ; that other dealer, in turn, shifts part of the business to a third; and so on. The process of gauging the course of the market fluctuations is hardly ever carried through the whole of a season by one person for any one transaction. The dealers constantly buy and sell among themselves, and divide risks and profits and losses. It is extremely rare, consequently, that any one dealer or any one person buys at the lowest price of a season and sells at the highest price, making the utmost possible gain; or that any one buys at the highest and sells at the lowest price, incurring the maximum loss. Every dealer has losses as well as gains. On the whole, if he is shrewd and experienced, he gains more than he loses. He may lose money in one season, but he will make money in another, and in the long run he will earn something in the nature of a professional income. If he is gifted with unusual ability for such operations, he may make gains almost invariably, reap great profits from large transactions, and close his career with a fortune. 3. When commodities are produced on a large scale for distant markets and for scattered purchasers, and middlemen 164 VALUE AND EXCHANGE become necessary links in the division of labor, it is inevitable that the middlemen should arrange to be near each other for the convenient disposal of their business. A street corner may serve as a meeting place. Traders in one commodity will settle near each other in a given street; hence in every great city there are dry goods streets, hardware streets, boot and shoe and leather streets, and so on. When, in a populous and thriving country, commodities are produced in large quantities and are necessarily dealt in by many persons, an exchange is set up, a room or building where the traders meet at fixed hours. Rules are agreed on, governing and interpreting their transactions in such detail that enormous sales are effected by a nod of the head, and are recorded on scraps of paper with a few figures and initials. The actual dealings on exchanges are often done by brokers only, who are middlemen for the middle- men. They act simply as agents, earn their living by a com- mission (usually an extraordinarily small one) on sales and purchases, and buy or sell for any one who chooses to transact business through them. The smooth dispatch of business on exchanges is further assisted by the "standardizing" of the articles dealt in; that is, by grading and classifying them according to quality. This process puts an end to all disputes regarding the quality of the things contracted for. Thus grain is examined, as it reaches the Chicago market, by publicly appointed inspectors, and is graded as being No. 1, No. 2, No. 3. Thereafter, when a pur- chaser has his wheat delivered to him, neither he nor his vendor need inquire further whether it is of the stipulated quality. Delivery of elevator receipts, certifying the grade, satisfies all contracts. Any article that is homogeneous in quality, or is easily classified into distinct grades, can thus be dealt in with the minimum of friction. Grain is the typical commodity of this sort. Cotton is similar to it, through its evenness of quality. Wool, which varies remarkably, is much less susceptible of rapid speculative purchase and sale. Attempts have been made to standardize iron, and in England a system of semi- SPECULATION 165 official grading exists under which large transactions in it are carried on; but in the United States and on the Continent this mode of dealing in iron has never come into considerable use. 4. Against the advantages which professional speculative dealings bring are to be set serious evils. These evils are made possible and are enhanced by the very facilities which enable speculation to work out its good effects. When once a commodity has been standardized, a new possibility opens ; anybody and everybody can deal in it. Ordinarily, he who buys an article must know something about it. He must be able to judge whether what is offered to him is good or bad in quality, worth more or less. But on an ex- change where commodities are officially graded, no such ques- tions arise. Only price, present and future, need be con- sidered. Any one can buy if he thinks the present price low, or sell if he thinks it high. Such buying and selling are done, on an enormous scale, by large numbers of persons who do not possess or wish to possess the articles they buy or sell, and whose only concern is to make a profit by taking advantage of fluctuations in prices. They virtually bet on the future price of the commodities, and gamble about it as men gamble on cards or on horse races. In form, their dealings are like any others on the exchange. The brokers receive from these "outsiders" orders to buy and sell, and by the rules of the exchange are held responsible for delivery at the stipulated time. The brokers, in turn, hold their customers to this same responsibility. But, though thus in form like any other dealings, on the better-known exchanges, the cotton and grain ex- changes, for example, the immense majority of the trans- actions have in view no bona fide business. The machinery which has been devised for the easy and rapid transaction of business is utilized for gambling on a large scale. Here we have an example of unproductive labor. Of course, dealers, middlemen, brokers, are useful, and their labor is pro- ductive, so far as they serve to facilitate exchanges under an 166 VALUE AND EXCHANGE elaborate division of labor. Just how much labor can be use- fully given to this sort of work, it would be difficult to say. If the only persons engaged in the transactions were merchants and dealers who systematically and continuously gave their time and effort to it, their number would adjust itself automatically to the work required, much as the number of carpenters or physicians adjusts itself to actual needs. But where there is "illegitimate" speculation on a great scale, the number of brokers and dealers accommodates itself to this new demand for their services. Not only the labor of the speculators, but that of their agents, is unproductive; it adds nothing to the output of society. In no country is there so much of this parasitic activity as in the United States, for here all the con- ditions favorable to it are found, a highly developed division of labor, markets and exchanges on a great scale, and a popu- lation both venturesome and prosperous. "Business" to many an American means simply speculative gambling. Unquestionably, the "outside" speculators, or the "public," are, like all amateur gamblers, losers as a class; and most of them are in the long run losers individually. The shrewd and experienced professional dealers know better than they the probable course of prices, sell to them and buy from them to advantage, and on the whole make money from them. Occa- sionally an able or lucky person makes a hit, and carries off a large share of plunder from a successful operation on the ex- change. This then acts on the imagination of others like a great prize won in a lottery. The chances that the speculative public will lose are almost as great as the chances that the purchasers of lottery tickets as a whole will lose : they amount almost to a certainty. Unmistakable as are the evils of speculative gambling, it is exceedingly difficult to check them by legislation, still more to put an end to them. The common law already makes void transactions which are sales in form merely, and which con- template a settlement only of the difference between present and future price. But on the exchanges all transactions pur- SPECULATION 167 port to be, and in strict legal effect are, for the actual delivery of the commodities. An obvious remedial measure is to pro- hibit buying and selling for future delivery, since it is in con- nection with such contracts that the gambling operations most often take place. But this would put an end, also, to the benefits which the community gets from contracts for futures; and it is a question whether the loss would not outweigh the gain. The common opinion of American and English economists is against the prohibition of future contracts, which, so far as grain is concerned, has been put into effect in Germany. Yet the evils of speculative gambling are so great that something may be risked for the purpose of lessening them. Lotteries and avowed gambling houses have been prohibited, and the law does its utmost to prevent wholesale betting on horse races; and all it can do to stamp out other forms of gambling is wel- come. No doubt, the most effective remedy would be a better moral standard for all industry, and an aroused public opinion against all kinds of gambling. But the worship of wealth, and the well-nigh universal desire to make money on easy terms, even though at the expense of others, together with the close association of this sort of speculation with business dealing rightly deemed legitimate, render it difficult to bring public opinion to bear. 5. What has been said in the preceding sections applies in the main to stock exchange speculation also ; but the problems appear here in accentuated form. Here, too, advantages are to be set against evils. The advantages, it is true, are of a different sort from those secured by grain and cotton exchanges. They arise, not from the lessening of fluctuations or the facilitation of large-scale dealings, but from the promotion of investment. 1 They are real and important. But the evils are no less real, and are intensified by the unusual ease of entering on the trans- actions. Stock exchange securities are ideally homogeneous and standardized. One share of a given corporation's stock is pre- cisely as good as any other share. If it is easy for any one to buy i See Book I, Chapter 6. 168 VALUE AND EXCHANGE grain or cotton, even though he has never looked at the articles, it is still easier for any one to buy stocks and bonds, even though he knows nothing about the corporation that issues them. At the same time, fluctuations in the prices of securities are large and frequent. Opinion regarding their probable course depends (or seems to depend) quite as much on general judgment and general prospects as on expert information. Hence rampant speculation, by outsiders and insiders. Here, as in the case of commodity speculation, the "public" loses in the immense majority of trans- actions. The professional speculators and dealers get the ad- vantage of the miscellaneous public, both because they are better informed regarding the real prospects of the enterprises whose securities are dealt in, and because they are (by a process of quasi-natural selection) persons shrewd in judging human nature and quick to take advantage of the irresolute. Yet notwith- standing the constant losses, there is an unfailing stream of per- sons who take fliers on the stock exchanges. There are probably few Americans of the well-to-do classes who have not at one time or another tried their hands at a stock speculation ; and there are a great many who habitually gamble in stocks. The im- mense majority of these dealings are concentrated at' the New York Stock Exchange, which is at once the greatest institution in the world for facilitating investment and the greatest of gambling hells. The evil from the situation arises not only or chiefly from the losses of the unsuccessful speculators. What these lose, others gain, and usually there is not much to choose between winners and losers. The economic loss arises primarily from the waste of much brains and energy on unproductive doings. The waste is more than that of the labor given directly, the labor of the brokers and their under-strappers, and of the speculators themselves. It is increased by the demoralization of many men in the community who take no great direct share in speculation. Like all gambling, it distracts from the sober, continuous work on which the common welfare rests. Morally, it is no less harmful. In every aspect the evil is one of the greatest in contemporary society. SPECULATION 169 It must be frankly confessed that no really promising remedies have been suggested. Some excrescences have been aimed at in recent proposals for reform in New York proposals which look to improvement through the revision and enforcement of the rules made by the exchanges for themselves. Such things as rigging of the market, "wash sales," manipulation of prices with intent to deceive, are to be thus prevented. But even if all of these tricks were cut out, the main evil would remain. In Germany a more drastic remedy has been tried, the require- ment of publicity in stock dealings, through enrollment of names and transactions on a register open to general inspection. It is expected that men will refrain from stock gambling, as they will from many doings of doubtful aspect, if they must be seen in the act. Such a requirement would be met in the United States by the objection that it intrudes on the sacrosanct secrecy of business, an objection commonly brought against public supervision of every sort, yet in itself of little weight. Much more serious is the objection that in Germany the regu- lation has in fact had little effect : stock speculation has re- mained much the same in character and amount. Possibly this is because of the difficulty of effective enforcement. At all events, though the evil is there, no clear remedy of a direct sort is in sight. Greater regularity of all industry would lessen fluctu- ation in values, and so lessen speculation ; but this would be at the cost of progress. Better public opinion would lessen " out- side " speculation ; but the enlightenment of public opinion pro- ceeds very slowly. CHAPTER 12 VALUE UNDER CONSTANT COST 1. In the preceding chapter, the adjustment of value was considered under the supposition that supply was fixed ; fixed, not indeed for the day or the week, nor rigidly over any length of time, but fixed on the whole for the season or the period of pro- duction. But even for the agricultural commodities whose pro- duction is seasonal, there is variation in supply over a series of seasons. For other commodities there is clearly a considerable and sometimes rapid flexibility in supply. The amount pro- duced and put on the market changes more or less easily. In what way do the variations in supply take place, and in what way do they affect the value of commodities ? We may begin by taking the simplest case, and, for the purpose of bringing into sharp relief a principle, make again an extreme supposition. In the preceding discussion of demand and supply and of market value, an absolutely fixed supply was assumed at the outset. Let now the other extreme be assumed, a supply absolutely flexible. Suppose a commodity produced, under the simplest conditions, by a large number of persons. Suppose that all these persons are competing with each other ; that any one of them can easily engage in producing the commodity, and as easily withdraw from producing it. Suppose all to be carry- ing on operations under the same conditions, no one of them producing more cheaply than another. Such a commodity would be brought to market under conditions of constant cost, and would be sold at a price conforming to that cost. At any moment its value would indeed be determined directly by its quantity, that is, by marginal utility as analyzed in the last three chapters. But if its value, so determined, were greater 170 VALUE UNDER CONSTANT COST 171 than its cost, more persons would be led to engage in its pro- duction, supply would increase, and value would fall. If its value at any time were less than its cost, some persons would .withdraw from its production, supply would decrease, and value would rise. The greater the ease of entering on the industry and of withdrawing from it, the more rapid and certain would be the adjustment of supply to that amount which would just sell at cost price. If perfect flexibility in supply be assumed, the ad- justment of value to cost would be perfect, and the article would always sell for just what it cost to produce it. Before proceeding further, a word of explanation, and in some ways of warning, is needed, as to the sense in which cost of pro- duction is here spoken of. The term is used in very nearly the ordinary commercial sense; it refers to the outlays which an employing capitalist must make in order to get a commodity to market. Chief among those is the outlay for the wages. Charges for material are another item. These charges, it is true, commonly imply that another capitalist has previously paid laborers to make the materials, which then have been sold to the particular employer in question ; hence the latter may be said to have indirectly hired these other laborers also. Not only the wages paid to workmen, directly or indirectly, must be in- cluded, but a reasonable remuneration for the employer's own time and trouble. This remuneration, like that of the workmen employed, is to be reckoned according to current market stand- ards, what a workman or an employer of this kind would ordinarily receive for his labor. Again, interest on the capital used is to be included, reckoned also according to the current market rate. If the employer borrows the capital, he must pay the current rate of interest on it. If he owns his capital, he con- siders that he could get a return on it at that rate by lending it out to some one else ; and he regards interest on his own capital precisely as he regards remuneration for his own labor, some- thing for which a return at the usual rate is to be expected. It will be noticed that rent paid for land is not included in this enu- meration, although a business man would include it in his reckoning 172 VALUE AND EXCHANGE of cost. The reasons for this, omission will be made plain when the subject of rent comes up for consideration. These various outlays, or equivalents of outlay, are sometimes spoken of as "expenses of production." When that term is used and is distinguished from "cost of production," emphasis is laid on the fact that the employing capitalist is concerned solely with what he pays for labor, for materials, for the use of free or fixed capital. When, on the other hand, the term cost of pro- duction is used so as to imply a distinction from expenses of production, reference is made to the sacrifices undergone ; to the labor of the hired workman, and not to his wages ; to the trouble, anxiety, and work of superintendence of the employer, not to his profits or ordinary gains ; to the previous saving by which the capital has been accumulated, not to the interest on that capital. As will be seen at a later stage, some of the most important and difficult problems of economics connect themselves with the distinction between cost of production in the sense of labor and sacrifice, and expenses of production in the sense of outlays. 1 For the present, however, we need not do more than point out the distinction, in order to make clear in what sense we are speaking of cost. We mean by it outlays of a capitalist. If we should think of a workman, or set of workmen, producing independently and without being hired by employers, we should reckon cost of production for them, not in terms of hours or days of work (i.e. sacrifice), but in terms of the wages they would ordinarily get for their work. 2. The mode in which value would be adjusted under the conditions of constant cost and absolutely flexible supply is in- dicated on Figure 5. The cost of the commodity is indicated by SO, the distance from the horizontal axis OX to the line SS'. Whatever the amount of the commodity produced, that cost remains the same for each unit brought to market ; whether the quantity be OA, OB, OC, the cost per unit is the same. Hence SS f , indicating the conditions of supply, runs parallel to OX. Let the line DD' indicate the conditions of demand, as in pre- 1 $ee Book V, Chapter 48. VALUE UNDER CONSTANT COST 173 vious diagrams. It descends as quantity becomes greater, price falling with the increase in supply and the consequent lessening of marginal utility. The supply of the commodity would then settle at the amount OB or SB'. The demand and supply lines would intersect at the point B' ; there would be equilibrium at the quantity OB and the price BB' (= SO) . If the supply should dimmish to OA, the price might rise temporarily to A A', A' being the point at which the supply OA intersects the demand lines. The marginal utility of the diminished supply would be raised to A A' ; the smaller supply (OA) would sell at a higher price. But that higher price would lead, under the conditions of constant cost, to a prompt increase in supply. Producers would be getting more than sufficed to induce them to bring the commodity to market. They would compete with each other, increase supply, and so bring down price. If the supply should be increased, not only to B, but to C, the total being then OC, they would overreach themselves. For the amount OC, the price would be CC', the point of intersection with the demand line being then C'. This sum (CC') is less than cost; some 174 . VALUE AND EXCHANGE producers would promptly withdraw ; supply would again dimm- ish. For the quantity OB, the price is just sufficient to make production worth while to all, and at that amount the supply would settle. If now for any reason demand should increase, quantity would so increase as still to leave price at the same point. Sup- pose a change in fashion, or other cause leading to an increased demand. This is represented by a shifting of the demand line to the right. It is now dd f , whereas before it was DD' ; at each several price, more of the commodity is demanded than was demanded before at that price, and the marginal utility of any given supply is greater than it was before. With the supply OB, the price, under these new conditions of demand, would be not BB', but BB'd, higher than cost. Supply would again in- crease, until the total supply was OX. Then the demand line would be intersected at the point E and price would be XE = BB'. A new equilibrium would be established, not with a change in price, but with a change in quantity supplied. Under the conditions of constant cost and free competition, demand or marginal utility determines not price , but quantity supplied. The proximate condition determining value is in- deed always marginal utility. Where supply is fixed, price is settled once for all by marginal utility. But where cost is con- stant and supply is completely flexible, price cannot depart far from the level fixed by cost. The supply on the market will be such as can be disposed of at the cost price. 3. The assumptions made at the beginning of this chapter constant cost, flexible supply, free competition are never, in a literal sense, in conformity with the facts of industry. There never is a case when these conditions are exactly fulfilled. None the less, there is a wide range of industry in which an approxima- tion toward their fulfillment is found, and in which the principle of value under constant cost explains the broad facts. Cost is never exactly equal for all producers. In this chapter, constant cost has been spoken of ; but it is not material whether we speak of constant or of equal cost, if changes in the general VALUE UNDER CONSTANT COST 175 level take place simultaneously for all the producers. An invention or improvement may lower cost for all ; the hori- zontal supply line on the diagram may be lowered; but the result is merely adjustment to a new level, not the introduction of a new set of conditions. If, however, the lowering of cost takes place not at the same time for all the producers, nor in equal degrees, we have a new principle and a different case, production at varying cost. This is what in fact happens when inventions bring about a reduction in cost. The change takes place by suc- cessive steps. The more shrewd and enterprising of the com- petitors introduce the improvements first ; others follow suit ; gradually all adopt it. And by the time all have adopted one improvement, another may be introduced, and the same steps are again gone through. If there be a succession of changes, and such are likely in the highly progressive modern industries, equality of cost never exists. There are always some producers who are turning out their goods at lower cost than others. None the less, there is, over probably the greater part of the industrial field, a tendency to equality of cost. The differences in cost are not permanent ; the process is simply one of gradual and irregular adjustment to the new level, instead of prompt and even adjustment. Some writers have stated the difference between actual con- ditions and long-run tendencies, by distinguishing between a static and a dynamic state. In a static state competition has worked out its full result, and, unless there are permanent causes of variation, commodities of the class here considered are pro- duced at a uniform cost and always sold at a price correspond- ing precisely to that cost. In a dynamic state, there is flux and change, variation in cost, oscillation of price. Yet the dynamic state tends to subside into the static. Unless there be incessant reappearance of disturbing forces, the dynamic state will cease. The real problem is thus not whether price is in strict con- formity to a cost of production uniform for all competitors, but whether there is rough approximation to this situation and 176 VALUE AND EXCHANGE a tendency toward its full attainment in a static state. And such a tendency, to repeat, exists over a very large part, prob- ably the larger part of the field of industry. A comparison has often been made to the tendency of the ocean to keep its level. Tides, currents, storms, cause disturbances, and it is never true in a literal sense that the level is maintained; none the less, there is a normal level, and the actual height of the water tends to conform to it. Or a comparison might be made to the tendency of the air to maintain a certain pressure. This pressure (measured by the barometer) is said to be 29.9 inches at sea level. In fact, it may be more or less, and rarely does the barometer stand precisely at the normal figure. None the less, it oscillates about that figure, and tends to return to it. At any height above sea level, there will again be oscil- lations, with a different range, and with a tendency to return to the new normal figure. 4. By way of illustration and explanation, some of the disturbing causes may be briefly considered. Most universal, perhaps, is lack of flexibility in supply. There never is complete ease of variation, such as to bring about the steady accommodation of supply to the precise quantity which will sell at the cost price. Even under the simplest con- ditions of handicraft production, there is no such flexibility. As plant and machinery become more important, every con- siderable change in output involves time and expense. Though there is some flexibility in the output from an existing plant, it does not go far. Any considerable increase in supply involves the making of new plant, and any considerable decrease in- volves the abandonment of some of the old. Changes of this sort, involving a readjustment of the preliminary investment, not only take place slowly, but are much affected by vague general sentiment. Business men, not much less than others, go with the crowd. When the belief gets abroad that such and such an industry is "a good thing," they flock into it with no very careful calculation. On the other hand, when affairs go ill, it is with reluctance that existing plants shut down. VALUE UNDER CONSTANT COST 177 When the signs of increasing demand show themselves, new plants are at first constructed slowly and hesitatingly; then, at the later stages of a sustained increase, with uncalculating excess. Hence the oscillations of modern industry, often affecting many trades at once, and bringing in their train in- dustrial crises. The prices of things subject to rapid changes in demand are especially fluctuating, even though they be produced under con- ditions approximating those of constant cost. Almost all textile goods that are used for outer garments are affected by the caprices of fashion. For textiles worn by women, the changes in the demand are extraordinary. The stuff which is for the moment in fashion cannot be turned out as fast as the women want it; while that which was in fashion but a year ago can hardly be sold at any price. Amid such sharp changes in demand, supply cannot be easily accommodated, and the conformity of price to cost works itself out only as a rough sort of average. The conformity of price to cost depends, of course, on the free competition of producers. So far as there is combination or monopoly, it does not work itself out. One of the most uncertain problems of modern industry is the extent of monopo- listic combination, combinations so effective that there is no longer even an approximate determination of price by cost. Large scale production tends to limit the number of individual competitors, and facilitates monopoly conditions. But the change in this direction, striking as it has been in the last half century, has not gone so far as to displace competition over more than a limited range of industries. 1 Over the greater part of the economic field competition is still in force, though often irregularly and spasmodically, and the tendency is still for the prices of things to conform to their cost. An important obstacle to the play of competition sometimes arises from custom and good will, from brands, labels, trade-marks. Where producers and consumers are separated 1 Compare Book I, Chapter 4 ; and Book VII, Chapter 63. 178 VALUE AND EXCHANGE by a long chain of intermediaries, the consumers often look to some external and familiar mark in deciding which among competing products they will select. Hence the immense part played by advertising. It is a familiar saying in business circles that it pays to advertise a good article. Certainly it pays, and sometimes pays enormously, to create and maintain good will. He who has induced many people to get into the way of buying a particular brand, may sell at a price higher than that of his competitors, or sell in greater volume and with more steadiness. No doubt this sort of advantage does not come by accident. It is slowly created by shrewdness, patience, persistence. The profitableness of a trade-mark is due at the outset to. the business ability of some individual, and connects itself with questions, to be considered later, concerning the variations of gains among individual business men. In fact, the whole problem of competition and cost is a fundamental one ; it ramifies into all parts of economics ; and all its aspects can be taken up only step by step as we proceed. Where production is on a large scale, a very slight difference in price, or change in price, may make a great difference in profit. In railway operations, an extra twentieth of a cent in the charge per ton per mile may mean millions of dollars in revenue. In sugar refining, an extra tenth of a cent per pound on refined sugar means the difference between moderate gains and great gains. What is thus true of a difference in price, is, of course, true of a difference in expenses: he who saves a tenth or twentieth of a cent per unit of output is on the way to fortune. Many of the great combinations which are sup- posed to make vast monopoly profits, and which in fact make unusual profits, do so by a very small margin. Price exceeds cost by only a fraction, but profits exceed the normal amount by a large total. Those staple articles which are used regularly from year to year in much the same quantities are sold at comparatively even prices, which are surprisingly close to constant (i.e. uni- form) costs. So it is with flour, with the ordinary kinds of VALUE UNDER CONSTANT COST 179 cotton cloths and of boots and shoes. Here are businesses of cents : a fraction more or less means the difference between profit and loss. An able business manager, quick to introduce all improvements, will be turning out his goods at a cost lower by only a trifle than that of his competitors ; or, having succeeded in making a reputation for a particular sort of shoe or a particular brand of cloth, he may get a price a trifle higher than others get. By either slight differential advantage he will make large profits. Other things are commonly sold with a wider "margin of profit" i.e. a wider difference between expense per unit and selling price because there is more risk, more irregularity, more balancing of possible losses against the expected rates of gain. All these things need to be taken into account when it is said that price is governed by cost of production, a proposition which, to repeat, holds good only as a statement of a tendency, of an approximation to what would happen in a "static" state. CHAPTER 13 VALUE AND VARYING COSTS. DIMINISHING RETURNS 1. Let us suppose now that the several producers who compete with each other in putting a given article on the market have not the same facilities ; that for some of them the expenses of production are greater than for others. We need Y not concern ourselves for the present with the question why there are such differences. Let us assume them to exist, and consider what consequences follow. The situation is illustrated by the diagram. The conditions of demand are again indicated by the descending line DD'. The conditions of supply are indicated by the rising line SS', 180 VALUE AND VARYING COST 181 The varying distance from the horizontal axis OX to the line SS' measures the varying cost of different installments of the supply. Some producers those most favorably equipped can put the commodity on the market at the comparatively low cost OS. Perhaps a certain moderate quantity can be so produced at constant cost. If the conditions of demand were such that only this moderate quantity were wanted at the constant cost price, if the demand curve were to intersect the supply curve somewhere near S, the normal price would be OS. So far the case would be identical with that studied in the preceding chapter. But now the conditions of demand, as indicated by the line DD', are such that a much greater quantity is wanted at the price OS than can be furnished at that price. The supply put on the market increases, but as it increases, additional installments can no longer be produced at the cost OS. With the quantity OA, for example, the cost of the last installment reaches A A'. As more is produced, cost still increases, indicated by the continuing ascent of the supply curve from A' to P'. At P' finally the demand curve is met. At the price BP' (=OP) the quantity OB can be disposed of. Equilibrium is established ; the quantity demanded equals the quantity supplied ; and price settles at the amount BP'. The whole supply will be sold at the price OP ( = BP') ; and the selling value of the whole, i.e. the quantity multiplied by the price, will be indicated by the rectangle OPP'B. It is true that the more fortunate producers could sell the commodity to advantage at a less price. At the price OS or A A' they would still find it worth while to bring it to market. But the total quantity which will meet the demand at an equilibrium price cannot be supplied unless producers less fortunate con- tribute their quota. These will not do so unless they get their higher cost price BP'. At that price the whole supply will be disposed of. The more favorably situated producers will get the price necessary to induce their rivals, who have poorer facilities, to contribute to the supply. We may speak of the producers at B, whose cost of produc- 182 VALUE AND EXCHANGE tion is BP', as the marginal producers. Their cost price is also the measure of the marginal utility of the commodity. Marginal cost and marginal utility thus coincide; and when they coincide, there is equilibrium. If the quantity supplied should increase beyond B, in the direction of F, marginal utility would be less, and marginal cost would be greater. Supply could not long be maintained beyond the point B, for producers would then be receiving less than cost. So long as the conditions of demand and supply remained as indicated by the lines DD' or SS', price would settle at the amount BP'. The relation of demand and supply to value is somewhat different here from what it was in the cases discussed in the preceding chapters. Where the supply of a commodity is fixed (the case which underlies the reasoning of Chapter 10), the value of a commodity is settled by the conditions of demand ; that is, by the marginal utility of that supply. Where, on the other hand, the cost of a freely produced commodity is fixed (the case discussed in Chapter 12), the value of the commodity is settled by the conditions of supply; that is, by cost. Demand in this case determines, in the long run,^only the quantity which shall be put on the market. But in the case now under consideration, the conditions of demand and of supply both have a permanent influence in settling price. As the quantity shifts, not only does marginal utility vary, but marginal cost. A lessening of demand would not only lessen the quantity put on the market, but would also lessen mar- ginal cost. Conversely, an increase of demand would not only cause more to be put on the market, but would also raise normal price, since the additional quantity would be produced at greater cost. Hence demand and supply marginal utility and cost mutually determine normal price. The economist who has best set forth the general theory of value, Professor Marshall, has ingeniously compared the influence of demand and supply to the working of a pair of scissors. If one blade of a pair of scissors is held still, and the other moves, we may say that the second does the cutting. VALUE AND VARYING COST 183 Yet it could not cut unless the other blade were there. So when supply is fixed, we may say that demand settles value; yet it does so only because supply is there and does not move. When cost is constant, we may say that cost settles value. Yet it does so only because there is a demand for the com- modity, and because supply readily adjusts itself to the amount which will be demanded at the cost price. If cost is variable in the manner discussed in the present chapter, both supply and demand both cost and utility exercise a mutual influence on normal price. Both blades of the scissors are in motion. All the various manifestations of value (under the conditions of an advanced division of labor and of exchange flowing from that division) can be analyzed as interactions of supply and demand. Neither can be said to settle value in- dependently of the other. 2. The differences in advantage between producers may be due to permanent or to temporary causes. According as they are temporary or permanent, they are of very different signifi- cance for the theory of value and for the welfare of society. Differences of a temporary sort are the most common. They are so common that they may be said in one sense to be universal. As indicated in the last chapter, it probably never happens in communities familiar to us, that all those engaged in a given industry are carrying on their operations in the same way. Some have better plant, better organization, better location, than others ; can bring their products to market at less expense ; and, selling at the same price, can reap larger gains. But these differences, if their causes are not permanent, tend constantly to disappear. If one man has better plant or machinery than another, and if there be no permanent reason why the second should not also set up the better outfit, he is likely sooner or later to do so. If he does not do so, he is likely to be driven out of the market. Others will adopt the more effective method of production, will increase the quantity they put on the market, and will be able to undersell him 184 VALUE AND EXCHANGE without foregoing a profit. Where the methods of cheapened production are open to all, they are sure sooner or later to be adopted by all. We say, sooner or later ; for the process takes time, especially when changes in the arts are rapid. The civilized world has been for generations in a dynamic state. More or less tem- porary causes of differences are constantly appearing, dis- appearing, and reappearing. At any given time, the usual conditions are not those of uniform cost, but of varying cost. But under these conditions value cannot be said to be deter- mined by marginal cost of production. Value is always deter- mined proximately by the marginal utility of the supply. Given the total supply that comes on the market, whether put on in large sudden doses, or by gradual increments, and the price will be such that the whole is sold. For the marginal pro- ducer this price may or may not be equal at any given time to cost. With the oscillations of demand, and the various causes of nonadjustment to normal conditions which were considered in the preceding chapter, the season's price may be such as to make the marginal producer prosperous, or such as to make him a bankrupt. If he becomes prosperous, his more enterprising and successful rivals, the infra-marginal producers, become even more so, and are tempted to extend their opera- tions. If he is on the way to bankruptcy, they may yet be able to hold their own. In time, he disappears, and his better- equipped or better-situated rivals supplant him. In time, too, it is cost of production at their hands which acts on supply, and thus acts on price. In other words, disregarding temporary and seasonal fluctuations, the principle of constant cost regulates long-run value where there are non-permanent differences be- tween rival producers. In such a case, it is cost of production at the hands of the more capable and better-equipped producers, not cost of production at the hands of the marginal producer, that settles the long-run price as distinguished from the market price. 1 1 Compare what is said in Book V, Chapter 50, 1, 2. VALUE AND VARYING COST 185 The situation is otherwise where there are permanent causes of difference between producers. Then cost at the hands of the marginal producer does settle the long-run price. The point about which oscillations range, and to which price tends to con- form, is cost for the least advantageous producer. Without him, the total supply cannot be enlarged to the point at which there is an equilibrium of normal supply and demand. If there were no limit to the amount which the more advantageous pro- ducers could bring to market, if this fortunate set of producers could increase the output indefinitely at constant cost, the marginal producer would be driven out, and the conditions would be those of constant cost. There being such a limit, he must be called on for the maintenance of supply, and there must be in the long run a price which will make it worth his while to contribute. Value is then determined in the long run by cost to the marginal producer ; but at what point in the varying scale of costs that producer will be, depends on the conditions of demand. 3. Instead of speaking of varying cost, or increasing cost, we may speak of diminishing returns. Increasing cost and diminishing returns are opposite aspects of the same tendency. Looking again at the diagram, we may see that the marginal producer at B has, for the same addition to the supply, greater expenses than the better-situated producers at A and 0. As the quantity put on the market increases along the axis OX, cost for every fresh installment becomes greater. With every proportional increase in outlay, there is a less addition to the supply, a tendency to diminishing return. It matters not whether we say that the tendency to diminish- ing return is felt by the infra-marginal producers themselves, or by those whom we have regarded as the marginal producers. It is felt by both. There is an increase of cost as supply in- creases, and the price must be such as to make the increased cost worth while. Those who are better situated may find, as they try to enlarge their contribution to the supply, that they cannot do so on the same relatively easy terms as for the 186 VALUE AND EXCHANGE earlier installments : they encounter diminishing returns. Oi this same difficulty may be met by others who add to the supply. Given the tendency, the result remains that normal price settles at the point of cost of production for the last increment. It would be more accurate, therefore, to speak of the marginal product or marginal increment, than of the mar- ginal producer, as fixing the long-run price. Though we use the term " cost " in this series of chapters in the sense of outlays by a capitalist, and measure increasing cost by the increase in outlays as additional supplies are brought to market, the cause of this rising cost is commonly an increase of cost in the other sense, cost in terms of labor, exertion, sacri- fice, or disability. 1 When additional supplies of a commodity bring permanently greater expense to the producing capitalist, this result is usually due to the fact that more labor is required or a greater volume of capital is called for, i.e. more saving by those who furnish the capital. The distinction between expenses of pro- duction and cost in the sense of labor and sacrifice, though it will be found of great significance for some problems, is not impor- tant here. Where expense increases permanently for successive additions to supply, where returns diminish in proportion to outlay, we have also diminishing returns in the sense that the same labor yields a lessening output. That part of the theory of value which we are considering in this chapter has its foundation mainly in some unalterable conditions in the world about us : in the fact that nature enables labor to be applied less advantageously under some conditions than under others, and that the continued application of labor on even the most advantageous sites meets sooner or later a tendency to diminish- ing return. 4. In what circumstances, and over how great a range of industries, do we find varying cost, or diminishing returns ? In general, differences in cost are permanent in the extractive industries, in agriculture, forestry, mining. In agriculture, good land yields more to labor than land less i See Chapter 12, 1. VALUE AND VARYING COST 187 good. The prairies of Illinois are more fertile than the stony fields of New England, and the black earth of Russia than the sandy soil of Brandenburg. All] the climatic factors such as sunshine, precipitation, the length of the seasons have their influence, as well as the physical and chemical constitution of the soil. Of these and their effects we shall have occasion to say more at a later stage ; it suffices here to emphasize the obvious fact that there are differences. 1 Not only are there such differences, but there is further an unmistakable tendency to diminishing returns on any plot of land. The amount of produce which can be obtained from the best land is limited ; and the amount which can be ob- tained from that land under the best conditions is limited. By applying more labor and capital, it is usually possible to add to the produce from a given piece of land ; but it is not possible to get more produce in proportion to the addition of labor and capi- tal. Hence there are permanent differences, not only between different soils, but between the successive applications of labor and capital on the same soil. So agricultural production pre- sents typically the application of the principle of value which we are now considering. In forests, likewise, there are obvious differences of the same sort. Some are better than others. Advantage in location and accessibility plays no less a part than advantage in the size and character of the timber; yet either kind of advantage counts. Mines present differences of an analogous kind ; they are affected both by accessibility to the market and intrinsic productiveness. Both forests and mines have industrial pecul- iarities, especially in their development during very modern times ; but of both, the general conditions of varying cost and diminishing returns hold good. In manufacturing industries, which shape and transform the materials brought out by the extractive industries, the principle of diminishing returns is applicable in less degree. But, though the differences in cost between competing producers are commonly 1 See Book V, Chapter 42. 188 VALUE AND EXCHANGE of the transitional or "dynamic" sort, they sometimes have permanent causes. One manufacturer may have more water power than others, or an unequaled site on a harbor front. In the earlier days of the development of power and machinery, a first-rate water power was of great advantage. Later, steam largely superseded water power; partly because of the great advances in the efficiency and economy of steam engines, partly because they could be set up at any desired place, and so per- mitted better access to markets or to materials. In recent years the generation and transmission of electric power has again made falling water more important, and may prove the cause of enduring differences in the effectiveness of manufacturing es- tablishments. In the main, however, the poorer establishments do not maintain themselves indefinitely side by side with the better. They are steadily displaced by the better, and these by the still better. The causes of difference are not as permanent, nor do they affect so many branches of production, as in the extractive industries. CHAPTER 14 VALUE AND INCREASING RETURNS 1. In the preceding chapter the theory of value was applied to the conditions of increasing cost or diminishing returns. We turn now to the reverse conditions, those of diminishing cost or increasing returns. Suppose that, as additional supplies of a commodity are pro- duced, the cost of each unit becomes not greater, but less. Such a tendency is represented in the Figure 7 where line SS', indicating the conditions of supply, has a downward slope. The line DD', representing the conditions of demand, necessarily has a downward slope, indicating the diminishing utility of suc- cessive increments. Equilibrium will be reached at the point 190 VALUE AND EXCHANGE where the two curves meet, at P r . At that point the quantity brought to market sells at the price BP', which equals its cost of production. The total quantity put on the market will nor- mally be OB, and its total selling price will be OPP'B. It is to be observed that this figure represents a situation differ- ent in essential respects from that represented in Figure 6 in the preceding chapter. In that case some among the competing producers were supposed to contribute to the supply at less cost than others. They reaped a producer's surplus. In the present case, however, all producers are on the same plane ; all have the advantage of lessening cost and increasing returns. No por- tion of the supply continues to be produced at a cost different from the marginal cost. With the supply OB, for example, the cost per unit of the commodity is BP' for each and every pro- ducer. If for any reason the supply should be reduced, cost for each unit would be greater. Suppose, for example, that demand should decline, the demand curve shifting to the left, to dd', so as to intersect the supply curve at A'. The quantity normally supplied would then be OA, selling at the price A A'. All pro- ducers would find their cost per unit higher than when the quan- tity supplied was OB ; for A A' is greater than BP'. But at neither price would there be differences between producers. Total cost and total selling value in either case would be repre- sented by parallelograms; at the price A A ' by the area OAA'C, and at the price BP' by the area OPP'B. There is no such phenomenon as surplus gain to any producer. This case differs, again, from that considered in the latter part of Chapter 12. There the effect of a general lowering of the supply schedule was considered, on the supposition that the reduction was due to some extraneous cause not directly connected with increase in supply. Here the reduction is sup- posed to be directly due to such an increase : the mere fact of greater supply brings a decline in cost per unit of supply. Cost, uniform for all producers, becomes less for each as more is pro- duced. All these three cases, on the other hand, are alike, in that long- VALUE AND INCREASING RETURNS 191 run results are considered. Uniformity of costs, and the auto- matic decline in cost for all producers with increasing supply, never are found in industry. Where the conditions are favorable for a general decline in cost, some producers, as we have seen, take advantage of them more promptly than others; and so long as this "dynamic" situation continues, we have a lowering of cost for some producers, but not for all. This situation, how- ever, will not endure : those who do not avail themselves of the improvements are underbid and driven from the market, and the "static" state of uniform cost is approached. The case would be different if those who had the better facilities were not subject to competition from others on even terms, and could not themselves increase their output indefinitely at lower cost. With such a limitation to their advantages, we should have precisely the case of varying costs, as discussed in the preceding chapter. Here cost is supposed to be uniform, but not constant, it becomes less per unit as the number of units increases. The long-run result is an interaction of demand and supply ; both blades of the scissors are cutting. 2. What now are the industries in which there is a tendency to increasing return, and what are the causes of this tendency ? The first question is comparatively easy to answer. The tendency appears in manufacturing, in transportation, in mining, in all the industries in which we have seen the tendency to large- scale production. In agriculture, though it sometimes appears as a passing phase, it is not ordinarily found at all ; and the same is true of systematic forestry. The greater the extent to which plant and machinery can be used, the more concentrated the industry and the smaller the area on which a given volume of production can be turned out, the more probable is the tendency to lessening cost and increasing return. The second question calls for some discrimination. Increas- ing returns may be due to external economies or to internal economies, again phrases suggested by Professor Marshall, and pointing to forces different in character and effect. Further, increasing returns may be due to changes in the arts, or may 192 VALUE AND EXCHANGE take place even without them. It is not always easy to separate those causes of increasing return which act under static con- ditions from those which act under conditions of progress in the arts. Yet it will make the subject clearer if at the outset we take up the two cases independently. First, consider external economies. These are such as arise outside of the establishment which gains thereby in efficiency and in diminution of cost. An example at once simple and typical is the diminution in cost of machinery and adjuncts, as these are made in larger quantities. The more cotton mills there are, and the more machinery they use, the larger the scale on which the machinery itself can be made. As the machinery becomes cheaper the expenses of the cotton manufacturer become less. Again, the construction of large steel ships in the United States is now carried on for a much smaller tonnage than in Great Britain. Consequently various adjuncts needed for ships, compasses, capstans, winches, donkey-engines, sundry vessel fittings are called for in much larger quantity in Great Britain, are systematically and uni- formly made on a larger scale, and are cheaper for the ship- builder. These external economies would indeed be at the disposal of the American shipbuilder if he could buy such things in Great Britain without restriction. But the United States imposes on them a heavy customs duty. Within the country, they are made in less quantity than in Great Britain ; indeed, often they have to be made separately for each ship. Whether procured from abroad or at home, they are therefore dearer. In consequence, the shipbuilder finds this item of expense greater than it would be if ships were built in large numbers in the United States. Still another example is in the boot and shoe manufacture. When this is carried on exten- sively, and especially when a number of establishments are in the same locality, subsidiary industries arise which supply cheaply the special tools, materials, and fittings, the shoe- strings, eyes, metal fittings, the paper boxes for packing, not to mention the machinery. The gain in external economies of VALUE AND INCREASING RETURNS 193 this sort is one of the reasons for the concentration of an in- dustry in a given place; of shoe manufacturing in Brockton and Lynn, of silk manufacturing in Paterson, of cotton manu- facturing in Lowell and Fall River, of metal wares in Bridgeport. In every such place the factories, merely because of their num- ber, command resources and economies which an isolated establishment finds hard to secure. An important gain of this sort comes from the presence of a large experienced labor force. In almost every establishment the workmen are more or less shifting. The changes are more frequent in industries exposed to seasonal fluctuations, as the boot and shoe manufacture is, or to irregularities in demand, as in the case of establishments making machinery. They are less frequent where steady wants are supplied by staples, as in the soap manufacture, and where long-established businesses are conducted by firms of settled prestige. In many ways they are unfortunate, yet seem to be an inevitable outcome not only of the variations in demand for labor and its supply, but of the monotony of factory labor. Certain it is that workmen come and go, and new men must be found to replace those who leave. They are more likely to be found in manufacturing centers, and in centers where there are indus- tries of the same sort or of similar sorts. No doubt there are drawbacks for the employer in such centers. His laborers are more likely to be organized in unions, and to press for higher wages ; and the expense of urban sites needs to be considered. 1 But the fact that manufacturing towns grow shows that they offer net advantages. In an isolated establishment, the loss of a few skilled and trained workmen may cripple the whole. But in an industry which has grown to considerable dimen- sions, and which is concentrated in certain towns or districts, there is a general diffusion of skill in its various branches. The smooth and continuous conduct of operations is promoted by this external economy. 3. Internal economies are those which arise within the 1 Compare what is said in Book V, Chapter 43. 194 VALUE AND EXCHANGE establishment itself, and are independent of the general growth of the industry. All the gains from the extension of large- scale production (as distinguished from increasing volume of production) are of this sort, the gains from larger plant and more effective power, from greater specialization of machinery, better handling of materials, more elaborate division of labor among the workmen, and more refined adaptation of each man's task to his capacity. One of the most interesting ques- tions in regard to these advantages and their limits is the extent of the gain which comes from horizontal combination, from the union under single management of a number of single establishments each of which has developed within itself the more immediate internal economies. It is not certain how far, in the long run, horizontal combination leads to still further internal economies. Nor is it clear how far vertical combina- tion, or the integration of industry, leads to internal economies. It seems to do so beyond doubt in some of the great industries of modern times, especially in the iron manufacture. But in other directions it has not made such unmistakable progress. In most industries, the enlargement of the industrial unit beyond a certain point, whether in combination horizontally with similar units or vertically with related units, does not seem to lead with certainty to internal economies. If internal economies were attained indefinitely as the scale of operations increased, the stage would be eventually reached of complete concentration and complete monopoly. If each establishment, or each combination of establishments, found as it grew in size that its efficiency and its economies increased, the successively enlarging enterprises would undersell those rivals who failed to enlarge, and finally nothing would be left but one giant in sole possession of the field. This is the theo- retically complete "trust," able to undersell all rivals by virtue of its economies in production. Such a trust has a monopoly, but evidently a tempered monopoly. Prices cannot be raised beyond the point at which producers who operate on a smaller scale can compete. If the rate at which internal economies VALUE AND INCREASING RETURNS 195 accrue is slow, if the cheapening of production from each enlargement of the scale of operations is slight, this check on the power of the monopoly is substantial. 4. In the first section of this chapter, the supposition was tacitly made that there is only one point of equilibrium un- der conditions of increasing returns, and the Figure on p. 190 was constructed on this supposition. But a very little con- sideration shows that there may be two points of equilibrium. The demand and supply curves have the same inclination, and may intersect at more points than one. The above Figure (Fig. 8) illustrates this possibility. SS' intersects DD' at A', again at B', again at C". (Let the reader disregard for the moment the dotted line ss'.) A' is a point of stable equilibrium ; so is C'. B' is not a point of stable equilibrium. It is true that the demand and supply curves intersect at this point. Immediately beyond B', however, the demand curve is above the supply curve ; demand price is higher than supply price. An in- crease of output beyond B would be profitable to producers, 196 VALUE AND EXCHANGE since the commodity can be sold, in the quantities between B and C, at prices higher than cost of production. But C" is again a point of true equilibrium ; since the supply price be- yond C' is higher than the demand price, and an increase of supply beyond C would be unprofitable. Both A' and C' are thus, to repeat, points of stable equilibrium. Price might set- tle at either, and remain at either It is indeed conceivable that a body of venturesome producers would extend supply be- yond A, confident that cost per unit would decline unfailingly with increase of total output, and that eventually (after B was passed) demand price would again be above supply price. But the outcome of expansion of this sort must appear uncertain. If equilibrium were established at A', it would presumably re- main; yet if it were established at C', it would also remain. Theoretically there may be an indefinite number of such points of stable equilibrium. But though there is this possibility of several points of equilib- rium, actual conditions probably present very rare instances of the sort. A steep slope like that of the line SS' is less rep- resentative of what usually happens than a gentle slope like that of the dotted line ss f . Such a dotted line is likely to meet DD' but once (at C", the third point of intersection for SS'). It is not widely different from the horizontal line which represents the conditions of constant cost. External economies are most likely to affect cost in the man- ner last described. As a rule, they operate slowly, almost im- perceptibly, bringing a steady tendency toward lessening of expenses with increase of output, yet a tendency so gradual that for any given season or series of seasons the conditions may seem to differ little from those of constant cost. Internal economies, on the other hand, sometimes are rapid in their introduction and operation. This happens especially when great changes take place in the arts, and when a new commodity is brought into use. Changes in the arts and inventions, though they do not neces- sarily affect either the total output or that of the individual VALUE AND INCREASING RETURNS 197 establishment, yet commonly affect both. The cheapening of goods which results from improvements usually stimulates demand in considerable degree, causes the total output to be larger, and so brings into operation external economies as well as additional internal economies. Improvements have com- monly been in the direction of larger plant and more expensive machinery, greater division of labor, production on a larger scale. Not infrequently the arts have advanced so fast as to cause an abrupt diminution of cost, leave the equilibrium of supply and demand unsettled for years, and afford at least the possibility of more than one point of equilibrium. Besse- mer's invention immensely reduced the cost of steel making; it also involved expensive plant and machinery; it gave great opportunities for large-scale production and highly elaborated organization; it thus led to very rapidly declining cost. The application of machinery to watch making has led to similar results; and in this case the commodity was one subject to a very elastic demand, hence with a possibility of multiple points of equilibrium. New commodities, introduced suddenly or rapidly, often bring a strong tendency to decreasing cost with increasing supply. When first offered, they are strange to the buying public, must break the crust of habit, must wait for a read- justment of other devices and wants. Being thus marketable in small quantities only, they are produced on a small scale. As they become familiar and in wide use, the quantity that can be sold greatly increases, production on a large scale be- comes possible, both internal and external economics are intro- duced effectively, and cost of production declines rapidly. The demand schedule for such articles often shows a high degree of elasticity, especially in the lower ranges, as the articles come into common use. The history of the bicycle illustrates this development : its slow introduction in the early stages, its rapidly increasing favor when once accepted and generally used, its rapid decline in cost and price when produced in larger quantities and on a larger scale. 198 VALUE AND EXCHANGE Not infrequently it happens, however, that a new com- modity is patented or in some other way falls under single control. This situation brings a new complication, arising from monopoly : the subject of the next chapter. CHAPTER 15 MONOPOLY VALUE 1. A monopolized commodity will be sold, by a person doing business for gain, on such terms as will yield the largest net revenue. We may assume, at the outset at least, that persons possessed of a monopoly act with shrewdness, and ad- just their supply with intelligence and success so as to secure this maximum gain. We say, adjust the supply; for this is the mode in which the monopolist can affect price and profit. The conditions of demand are beyond his control. When once the supply is settled and put on the market, the price at which it will sell depends on the play of demand. In this regard, monopoly value presents no peculiarities. Its special problems arise in so far as the monopolist can make the supply larger and smaller at will. With a given supply, put on the market en bloc, 1 the price will be the same whether it is in the hands of a single person or of several competing persons. There is some one price which measures its marginal utility, some one price at which the whole can be sold, and no more than the whole, and that price will rule. This proposition, like so many in economics, needs to be taken broadly, as a statement of a tendency, not of literal detail; with precisely the same allowance for irregularity and imperfect adaptation that must be made for any general state- ment on values and prices. Most men in active business would at first blush deny it. They would say that a com- bination or monopoly can secure a higher price than compet- ing persons can, even for the same supply. They know that a higher price can be obtained, in the first instance at least, from the middlemen, the wholesale or retail dealers, to whom 1 Sec 4 in this chapter for the significance of this qualification. 199 200 VALUE AND EXCHANGE the monopolist usually makes his direct sales. When producers are competing, these dealers are very apt to play off one against another, and to induce the shaving of an offered price by threatening to turn to a competitor. No doubt, if all of the dealers do this successfully, competition among them will tend to lower prices in the end for the retail purchasers. At that final stage, it will appear whether the prices are such as to bring about the equation of supply and demand. But com- petition among dealers, and especially among retail dealers, operates with friction ; and the lower prices which competition among manufacturers causes these to concede to dealers may redound for a considerable time to the dealers' profit, not to that of consumers. Conversely, a monopoly may squeeze the dealers, so to speak; charge them higher prices, which yet they do not find it feasible for some time, at least to pass on to consumers. And even when such a rise in prices reaches consumers, the effect on their purchases is not immediate or automatic. If indeed the rise is great, and the demand for the commodity is elastic, a reduction in purchases will be prompt. The monopolist will find almost at once that he can- not sell the same supply at higher prices. But if the rise in price is not great, people will very possibly continue to buy for some time what they have been in the habit of buying. They may be uneasy and irritated by the higher charge, yet for the moment may not adapt themselves to the new situation by curtailing their purchases. The monopolist may then hold the raised price for a while, even if it reaches consumers. Mean- while, in a growing community, new consumers may be added, or the old consumers may get larger incomes. An increase in demand may overtake the higher price, and make it permanent ; and then it will seem as if the mere fact of monopoly had caused prices to rise. The position of middlemen as buffers, easing and delaying the pressure of the forces at work, appears even more strongly in the case of producer's goods. As has already been said, 1 1 See above, Chapter 10, 5. MONOPOLY VALUE 201 the play of demand and utility is much modified in the prices of such things, iron, copper, timber, wool. The connection between the price ultimately paid for finished goods by con- sumers and the ruling price among dealers for materials is often a slow and uncertain one. Still slower is that between the materials for tools, like iron and copper, and the consumable articles which in the end the tools serve to make. Here there is a possible influence of monopoly on price which would not appear if the monopolist sold an enjoyable commodity directly to the consumers. It is to be noted, further, that the first step taken by a monop- olist is usually to settle his price, not his supply. The holder of a patent, for example, will offer the patented article at a given price; he will not usually determine in advance the amount which he will put on the market. If he finds that, at the given price, he can sell more than he expected, he will add to the supply. If he finds that he cannot sell so much, he will let the stock which he has on hand go off gradually, and in the future will add to it slowly and cautiously. In other words, he experiments with the supply which he can dispose of at the price fixed ; and perhaps, as time goes on, lowers or raises his price, according to the response from purchasers. Probably he is only half conscious that his control over price rests on his control over supply; yet the shrewd business man is very rarely in doubt that this is the fundamental condition for keeping a price above the competitive level. 2. The power of a monopolist over price being exercised, then, fundamentally through his control over supply, let us examine further in what way the control is exercised. The simplest case is that of a supply which has cost nothing, something in the nature of treasure-trove. Such a fixed supply, if put on the market in toto, will fetch a given price. But the owner may reason that a less supply will fetch a higher price. If the demand be inelastic, half of the supply may fetch more than double the price, and so yield a larger gross sum. It will then be in the interest of the monopolist to destroy half the 202 VALUE AND EXCHANGE supply, and put on the market only the remaining half. If the demand is elastic, it will more probably be to his advantage to put the whole on the market. The price per unit, to be sure, will be lower than if only half were sold, but not so much lower as to make the gross yield less. It is usually to the interest of a monopolist to restrict sensibly the supply of a commodity sub- ject to inelastic demand, and to be liberal with the supply of one subject to elastic demand. Suppose next that the supply is net fortuitous, but is pro- duced by the monopolist under the ordinary conditions, with capital invested, laborers hired, sundry expenses of production incurred. Then the monopolist will aim to obtain not the larg- est gross amount, but the largest net profit. And that net profit he will try to make larger than the usual profits of capitalists. It may be assumed that in any case the monopolist would be able to secure on his capital, by investment in other directions, interest at the usual rate ; and that for his own labor of direction and superintendence he would be able to secure the reward usually accruing to labor of the same skill and assiduity. Those normal gains we reckon among the expenses of production, or at least not as due to monopoly. It is the excess above them that constitutes monopoly profit. It is probable that few monopolists consciously separate their gains in this way. They rarely distinguish between monopoly profits proper and ordinary returns for their capital and labor. They simply rejoice that they pay dividends at ten or twenty per cent, or are able to be munificent in salaries to themselves and their associates. If closely questioned, however, they would soon distinguish the share in these gains which is due to monopoly alone. It is that share, monopoly profits in the strict sense, which now interests us. If the monopolist produces his commodity under the con- ditions of constant cost, his calculation of net profit will be simple. Figure 9 will illustrate it. The cost of producing the com- modity is there represented by the distance from to C, and is the same whether a large or small amount of the commodity MONOPOLY VALUE 203 be produced; it is OC = AC' = EC" . The price at which any given quantity will sell depends on the conformation of the demand curve DD'. If a quantity OA is put on the market, it can all be sold at the price A A ' . The total cost of this quantity is OCC'A. Monopoly profit will then be indicated by the area X Fio. 9. CPA'C'. But if the quantity OB is put on the market, the price must be lowered to BB', that being the price at which the whole quantity OB can be disposed of. Monopoly profit is now the area CP'B'C". If the first area, CPA'C', is the larger of the two, it will be to the interest of the monopolist to restrict his output to the quantity OA. But if the area CP'B'C" is the larger, it will be to his interest to enlarge his output to the amount OB. As has already been said, the elasticity of demand has an important influence on the calculations of the monopolist. If demand is elastic, if a lowering of price will greatly stimu- late consumption and purchases, the line DD' will have a gentler slope, and the quantity which can be disposed of at the 204 VALUE AND EXCHANGE price OP' will be greater than OB. The parallelograms indicat- ing gross receipts and monopoly profit will be longer, and larger in area. Under such conditions it is probable that monopoly profit will be larger for a comparatively low price than for a high one. In the preceding section it was said that a monopolist might find it to his advantage to destroy part of a supply, in order to sell the remainder for a larger gross amount. But such de- struction can take place very rarely. Fortuitous supplies, coming into a monopolist's hands without cost, hardly ever occur. When a monopolist's supply is produced, and costs something, it is obviously easier and cheaper to refrain from pro- ducing a part of it than to destroy a part after it has been pro- duced. Only from miscalculation or causes beyond control (such as superabundance of crops) may a monopolist find de- struction to his advantage. It seems to be well established that in the eighteenth century the Dutch East India Company at times burnt part of its crop of cloves in order to be able to sell the remainder at prices so much higher as to increase its gross receipts. Similar destruction would hardly be ventured in a modern community ; fear of retribution from an outraged public opinion would prevent it. 1 The mode in which a monopolist commonly proceeds in the adjustment of supply is illustrated by the conditions of diamond production in recent years. Virtually all new diamonds come from the mines at Kimberley in South Africa. These are under the single ownership of the De Beers Company, formed by an amalgamation, under the guidance of Cecil Rhodes, of a number of competing mines. Some of the mines are not worked, and the total supply is intentionally limited to the amount which can be sold to best advantage. The demand for diamonds, after a certain point, is highly inelastic. They are bought chiefly for purposes of display. Scarcity and high price are the basis of 1 When a publisher prints a limited edition of a book, and then distributes the type, he may be said to wipe out part of the supply in order to sell at a higher price the restricted portion which he prints. MONOPOLY VALUE 205 their utility; if very abundant, they would be little prized. Hence it is clearly to the advantage of the De Beers Company to curtail production and limit the supply. 1 Were the commodity one like copper, with a very elastic demand, it might pay such a monopolist to work the source of supply to its utmost capacity. 3. Suppose now that the monopolized commodity is pro- duced, not under the conditions of constant cost, but under those of diminishing cost (increasing returns). The calculations of the monopolist then become complex. He must consider on the one hand the extent to which price will fall as a larger supply is put on the market, and on the other hand, how much cost will fall as more is produced. The situation is again easily illustrated by a diagram. 1 The De Beers Company controls 95 per cent of the world's diamond produc- tion. See G. F. Williams, The Diamond Mines of South Africa, Vol. I, p. 291 ; Vol. II, p. 161. I have referred to the diamond monopoly as K it presented a case of constant cost. This is not probable in the case of mines, least of all where the occurrence of the product is as irregular as in diamond mines. But the motives that lead to a curtailment of supply are essentially the same, 206 VALUE AND EXCHANGE On Figure 10 DD' has a slight inclination, representing a very elastic demand. SS', the supply curve, has a steep inclination, at least in its upper range, representing a very rapid decline in cost per unit as supply is enlarged. If the monopolist produces and puts on the market the quantity OA, he will find the cost per unit to be AC, and the total cost to be COAC. That supply will be sold at the price AA' ; the gross receipts will be OP A' A, and the monopoly profit will be CPA'C. If, on the other hand, the quantity produced is the larger amount OB, the cost per unit will be only BC', and the cost of the total supply will be C'OBC'. That supply can be sold at the price BB'. The gross receipts will be ORB'B, and the monopoly profits will be C'RB'C'. Evidently the monopoly profit will be much greater with the lower price than with the higher price ; this because the conditions assumed are those of very elastic demand and of rapidly decreasing cost. The less elastic the demand, and the less rapid the decrease in cost, the more probable is it that the monopolist will find it to his advantage to limit the supply and keep up the price. The reader will easily see that a number of maximum monop- oly profits and ruling monopoly prices are possible. To express in one single statement all the elements of the case would require mathematical formulation. Such a formulation, however, has an appearance of accuracy which is often misleading ; and this is true even of a comparatively simple diagram like that given above. Some of the elements in the situation must be more or less a matter of guess work for the monopolist ; especially the degree of elasticity in demand, and the rate of decreasing cost with enlarged production. Even in the case of a perfectly un- restrained monopoly, and such are very rare, monopoly price is usually fixed by a sort of rule of thumb. Though probably at a point considerably above the competitive price, it is not settled by any refined calculation of the precise point of maxi- mum profit. Sharply decreasing cost, or increasing return, is most likely to appear where articles are newly introduced. At first these MONOPOLY VALUE 207 are bought and used in small amounts. Later, as they become familiar and widely used, they are produced in larger quantities, and the principle of increasing returns applies. Not infrequently new articles are monopolized, being protected by patent or copy- right laws. They then give a most apt illustration of the work- ing of the principles here under consideration. Thus, the Wels- bach mantles attached to gaslights were long protected by patent in all advanced countries. 1 They enabled a much better light to be had for a less expenditure on gas, and they contami- nated the air less. The demand for them was highly elastic. They were produced much more cheaply in large quantities. Hence, though monopolized, they were sold at a price which, per unit of product, was not greatly above cost price ; none the less, on the enormous quantity which could be sold, they yielded mo- nopoly profits very great in the aggregate. A situation essentially similar appears in the case of copy- righted books. Books conform to the principle of decreasing cost. The expense of typesetting and of making the stereotype plates is the same whether one thousand copies be printed or fifty thousand. The other expenses of bookmaking paper, presswork, binding, and the like are tolerably uniform per unit, yet some of them show slightly diminishing cost as more books are printed from the same plates. On the whole, the cost per unit is much less for a large edition than for a small one. A common device of publishers is to issue a limited edition, often with numbered copies, and dispose of it at a high rate to collectors and other persons who prize the possession of a rare thing. They calculate that the profit will be greater from a small edition at a high price, than from a large edition at a low price. The same result appears with scientific books, which often appeal to but a small circle of readers and for which the demand is inelastic. The few copies printed are sold at a comparatively high price to those who desire them. Were they salable in large quantities, their cost and probably their price would be lower. On the other hand, new books which many people may be tempted to 1 This patent expired in the United States in 1906. 208 VALUE AND EXCHANGE read popular novels, for example are sold at the outset for a lower price, for they present the conditions both of decreasing cost and of elastic demand. It is obvious that under conditions of increasing cost (dimin- ishing returns) the situation of a monopolist will again be differ- ent. The probability of a sharp limitation of supply is evi- dently greater if the increase of supply entails greater cost for the additional output. If the demand be highly inelastic, the monopolist will certainly be disposed to restrict his output very much ; for the price he can get will rise much with lessened supply, while his expenses will fall. And even with an elastic demand, he will have to reckon, not indeed with rapidly falling price as output increases, but with some increase in cost. Mo- nopoly, however, with diminishing returns is probably rare. It may appear in the case of some uncommon mineral products, obtained from a single source of supply or a few combined sources (the South African diamond mines may present an example). On the whole monopoly conditions, complete or partial, are much more likely to be found with commodities produced under constant or under increasing returns. 4. Monopoly presents another possibility, different install- ments of the supply may be sold at varying prices. Under com- petition, one price prevails throughout the market ; no one seller is allowed by the others to get a higher price. In the preceding paragraphs it has been tacitly assumed that the same holds good under monopoly. But it does not necessarily hold. Look, for example, at Figure 9 (p. 203) representing monopoly under the conditions of constant cost. The monopolist cannot but look with longing eyes at the possible profits represented by the area CPA'C'. It is true that the one uniform price yield- ing him the largest gain may be the price OP' ( = BB'}, at which his monopoly profits are CP'B'C". But may he not get in addition the extra profit potentially to be had on the quantity OA, which would sell, if put on the market by itself, at the price AA't May he not charge a high price to the richer or more eager buyers, while selling at a lower rate to those not able or willing to pay the high price ? MONOPOLY VALUE 209 To sell directly and openly at varying prices to different pur- chasers is, to be sure, not always feasible or politic. There is the possibility of resale by the favored purchaser. Moreover, the instinct of equality or "fair treatment" is to be reckoned with. Its violation arouses a feeling of resentment, which may affect purchasers or lead to hostile legislation. Hence the monopolist, if he discriminates, is likely to disguise his discrimination. But in some degree he will not infrequently secure from the upper strata of buyers that higher price which would otherwise inure to them as consumer's surplus. Thus the monopolist may put the commodity on the market in installments. He may sell at a high price first to those whose demand is keenest ; and then, after a pause, put on the market a further supply at a lower price. Substantially this is often done by publishers with copyrighted books, especially such as are reasonably sure to have a considerable vogue. A first edition is offered at a comparatively high price. After a season or two, a much cheaper "popular" edition is put out, tempting a whole army of buyers for whom the first edition was too ex- pensive. There is, indeed, some pretense of a difference between the two. The popular edition is printed on cheaper paper, has a less elaborate binding, or may be in paper cover. But the difference in cost between the two forms is usually small, and by no means accounts for the difference in selling price. That dif- ference results in the main from the publisher's effort to tap in succession the several strata of buyers. Something of the same sort happens not infrequently in the case of patented articles. These may be sold at a high price for the first installments put on the market, and at prices much reduced as the great mass of buyers are sought. There is, to be sure, another factor, already referred to. Being patented, the articles must be of a new sort; since the law gives the monopoly, or patent, only on the ground of this novelty. The market is necessarily uncertain. The patentee is likely to pro- ceed cautiously. The moderate quantity put on the market at the outset does not allow the advantages of large-scale pro- 210 VALUE AND EXCHANGE duction ; hence, though price is high, cost also is high. If it were certain from the start that the article would find a wide sale, large plant and elaborate division of labor might be ap- plied from the beginning, great quantities might be produced, a small part sold at once at high prices, the rest stored away until it was time to satisfy the demand at lower prices. But this involves risk. Commonly, the earlier installments are pro- duced and sold tentatively, and the advantages of low cost are not reaped until the possibility of large sales at low prices is proved by successive experiments. A direct instance of discrimination in price seems to be supplied by the telephone. This is a monopoly in most com- munities, and indeed, whether under private or public manage- ment, ought to be a monopoly. The commodity, or service, is not of a transferable kind; hence one obstacle to discrimi- nation possible resale is out of the way. Telephone rates are commonly adjusted on the basis of what the user can pay; they are higher in cities and in thickly settled districts than in rural districts. Some parts of the variations in charges are doubtless due to differences in cost, but in the main they seem to be the outcome of monopoly conditions. A converse case occurs when a monopoly charges a level rate to all persons, under conditions which would lead com- peting producers to charge rates varying according to cost. Probably the uniform five-cent fare on American street railways could not be maintained but for monopoly conditions. Custom, convenience in collection, and a disposition to conciliate the public, account here for the one rate of fare which the monopoly charges. The most striking case of this sort, however, is where a public authority carries on an industry as a monopoly. The uniform rate of postage on letters is to be explained largely in this way. The two-cent rate is highly profitable on short distance letters, and especially on letters in the large cities. If competing producers carried on the business, some of them would enter this profitable part of the field and carry letters there for much less than two cents. Private individuals or MONOPOLY VALUE 211 corporations who might undertake letter service in outlying districts of thin population, especially the rural districts, would have to charge considerably more; or else the govern- ment would have to do the work at a heavy financial loss. The existing monopoly enables the government to cover the loss in one region from the profit in another. The postal service is administered at a very moderate uniform rate, either with profit, as in European countries, or at a comparatively small loss, as in the United States. The social and educational advantages of thus conducting the service, as a monopoly with uniform rates, are too obvious to need emphasis. 5. The possibility of charging different prices to different purchasers explains the phenomenon of "dumping," that is, the disposal of commodities in a foreign country at one price, and to domestic purchasers at another and higher price. In the absence of monopoly, that is, if producers were competing freely, all purchasers would get commodities at the same price. The producers might, indeed, gain collectively by selling part of the supply at a low rate, and the rest at a higher. Where market conditions are disadvantageous, and where the total supply cannot be sold on remunerative terms, there is a strong inducement to resort to such tactics. But no one producer will sacrifice himself for the benefit of the rest; he will not slaughter the whole or a part of his stock in order that others may gain. If, however, all were to carry out an agreement to sacrifice each a specified share of his supply, reserving the remainder for higher prices, the object might conceivably be accomplished. Here, to be sure, there is this obstacle : a pos- sibility that the favored purchaser may resell to those from whom it is proposed to exact the higher price. But if the favored purchaser is a foreigner, and if a heavy duty on imports prevents him from sending back the "dumped" commodity to the domestic market, the obstacle is removed. The domestic price can then be kept higher, and the gain from this source may outweigh the loss on the dumped sales to foreigners; especially if the commodity be one for which the demand is 212 VALUE AND EXCHANGE inelastic and of which an increased supply on the domestic market would greatly depress the price. If the operation be carried on by a compact monopoly, it is possible that the foreign sales themselves will be at remunerative rates, and that the higher domestic price will yield monopoly profits still fur- ther enhanced. The more complete the monopoly, the more likely will be inequalities in the nature of "dumping." Even in cases of halfway monopoly or temporary monopoly, something of the sort may happen, though the discriminations will be less striking and less continued. Any producer or vendor of a "specialty" a particular brand, an unusual commodity is apt to be for a time in a position of semi-monopoly. So far as he con- trols the given article, he may find it advantageous to get rid of part of his supply in a foreign country, or in any out-of-the- way region, in order not to "spoil" his domestic market. Where control of the market rests only on good will, or on established plant and reputation, the extent to which dumping can be carried is obviously less than in the case of a firm and enduring monopoly. Where, on the other hand, many pro- ducers are steadily competing in the sale of a staple commodity, dumping will not arise at all. 6. Complete and unqualified monopoly is rare. Hence too much stress should not be laid on the theory of monopoly price in explaining the phenomena of actual life. A monopoly exercised by a government for fiscal reasons gives perhaps the best chance of exacting the full monopoly profit. When the Khedive of Egypt, in the days before the English occupation, maintained a monopoly of the salt trade, he prob- ably squeezed out of it remorselessly all that could be exacted from his unfortunate subjects. But generally fiscal monopolies do not exercise their power to the utmost. They are not un- common in civilized countries, being simply a method of securing public revenue by monopoly management instead of by taxes. Such are the tobacco and salt monopolies in Austria and Italy, the tobacco monopoly in France, the spirit monopo- MONOPOLY VALUE 213 lies in Switzerland and Russia. These are rarely exploited up to their maximum yield. A given net revenue, varying accord- ing to the financial needs of the several states, is sought, and the adjustment of supply and of prices is pressed no further. Patented and copyrighted articles, again, seem to fulfill the conditions of perfect monopoly; the law forbids competition once for all. But the holder of such a monopoly must reckon with the competition of more or less available substitutes, and thus is compelled to abate his prices and enlarge his supplies more than he would otherwise do. Copyrighted books, for example, must meet the competition of other copyrighted books of a similar kind, not to mention those on which the copyright has expired. A first-rate textbook yields a good monopoly profit, sometimes a very high one. Yet if the price be put too high, others, little worse, can be used in its place. The gain from a copyrighted or patented article often arises not so much from selling it at a higher price than others of a similar sort, as from selling much more of it at about the same price. This gain is obviously the greater if the conditions of production are those of decreasing cost. In other cases, also, of real or apparent or halfway monopoly, there are commonly checks. Many so-called monopolies lack a legal basis and even a solid industrial basis. Such is the case with most of the "trusts" which have been formed by horizontal combination. They must be ever on the watch against competitors, and very few, if any, are in a position to exercise unrestrained monopoly power. Others, again, though more securely founded, must be on their guard against regula- tion or displacement by public authority. Such are the so- called "public service" industries, the railway, the street rail- way, the telegraph, the telephone, the gas companies. Both of these sorts of cases, so important in modern industry, will engage our attention as we proceed. Here it suffices to note that the monopoly is in one way or another qualified. Finally, the dullness or torpor of a monopolist must be reckoned with. The strict reasoning of the theory of monopoly 214 VALUE AND EXCHANGE price assumes him to press his advantage shrewdly and to the utmost. He may do nothing of the kind. The spur of com- petition the one force which more than any other stimulates enterprise and business intelligence is lacking. The secure monopolist is likely to be content with a good comfortable profit, and to let well enough alone. It may happen, indeed, that another and shrewder person will see the possibilities, will buy out the inert possessor, and proceed to manage the affair with more vigor and profit. Such has been not infrequently the course of events in the public service monopolies of modern times, especially in those whose possibilities of profit have been connected with changes in the arts and the rapid growth of great cities. But this is not a matter on which prediction can be ventured. The actual working of monopoly, while it conforms more or less to the theoretical analysis, is often highly uncertain and irregular. 7. It remains to say a word about one form of monopoly which frequently comes into public notice, the "corner." This word usually implies not that the sources of production have come permanently under monopoly control, but that the avail- able supply has been got for the time into a single hand. Re- currently, persons of speculative bent try their hands at this operation, buying up the whole supply of an article, and then selling it, if possible, at a large profit. So far as the ordinary course of market prices is concerned, mere cornering has no effect. If supply remains the same, price to consumers will not be more or less because an article is in single hands. Yet the cornerer may make money. If so, this is because he has foreseen more quickly or more shrewdly than others a shortage in the seasonal supply. By buying the whole of it at moderate prices from producers or dealers less shrewd, he may profit by an advance. But that advance was certain to come sooner or later. The profit is not obtained at the expense of consumers. The question is simply which set of producers or middlemen will accurately gauge the market price of the season and profit accordingly. This is especially MONOPOLY VALUE 215 true of articles that are in consumable form, or very nearly in consumable form. Such is ice, the supply of which, in regions depending on natural (winter-frozen) ice, is absolutely fixed by the contingencies of the weather ; or a vegetable like tomatoes, the crop of which, for canning purposes, has sometimes been bought out by speculators engineering a corner. The price of these things is settled with much precision by the play of demand and supply, i.e. by marginal utility, and it matters not to the consumer whether that supply be in a single hand or not. In the case of producer's goods, such as metals and raw materials, the possible effect on prices from a corner is greater, for the reasons already indicated. Provided the corner is rigorous, provided all the available supplies and avenues of supply are effectively controlled, there is at least a possi- bility that middlemen and producers who are committed to operations in which the raw materials are needed, will be mulcted for a higher price than would rule without the corner. Quite another situation appears when the persons against whose purses the corner is aimed are not the consumers, but other dealers and speculators, and especially the speculators who have been buying or selling for future delivery. Most speculators ars simply betting on future prices. They are doing so, in the majority of cases, with incomplete or ill-inter- preted information. A speculative corner is commonly directed against those who have sold for future delivery, that is, those who have agreed to sell for a given price, at a fixed date in the future, something which they do not own. A shrewd and daring person, or even one not shrewd but only daring, who believes that many persons have oversold for future delivery, may try to buy up the whole supply available at the stipulated date. If he succeeds, he may then dictate the price at which they must buy from him, in order to keep their en- gagements; and the difference between that price and the price he has paid for his purchases makes the profit of the corner. Evidently the persons who are directly affected are 216 VALUE AND EXCHANGE not the consumers, but only other .dealers and speculators. In so far, it is a case of diamond cut diamond. Yet the consuming public is by no means without its con- cern in these speculative corners. Some of its purchases may be of a sort that cannot be postponed, and must be made at the ruling market price. This buying comes from those more eager or necessitous persons, who would ordinarily get the article at the normal market price, and would secure a con- sumer's surplus. During the crucial period of a corner say during the month of May, if wheat for May delivery is the bone of contention wheat will sell at an artificially high price. The cornerer is intent on buying every part of supply that comes to market, to prevent his opponents from getting the means of satisfying their contracts. These opponents, in turn, are under no less pressure to secure the supplies. Until the struggle is over, until either the corner "bursts" because the cornerer finds he cannot possibly buy the entire supply, or else the "short sellers" acknowledge themselves defeated and "settle" with their opponent, so long the market price is high, and those who are under the necessity of buying for bona fide use must pay accordingly. When the struggle is over, price goes back suddenly to the normal level for the season, or even below that level. Most consumers are no worse off than before, and sometimes are better off, in consequence of the rapid disposal of supplies long withheld from the market. Successful corners are rare. Usually those who attempt them underestimate the supply and overstrain their credit. When the bidding of the contending speculators raises prices, all sorts of unexpected nooks and crannies prove to have scraps of supply that are hurried on the market to take advantage of the golden opportunity; while the usual consumption is curtailed, and so far leaves more of the usual supply available. In order to hold the corner, enormous sums must be provided, always by borrowing on a vast scale, with hypothecation of what is already controlled ; and the insistence of a large creditor may precipitate a collapse. Where the commodity is not, like MONOPOLY VALUE 217 agricultural products, the subject of seasonal cultivation, but is continuously produced, the difficulties in the way of a corner are even greater. In 1887-1888 a noted attempt was made by a group of French speculators, headed by one Secretan, to corner copper. At once copper poured in from every part of the world, and all sorts of unknown or half-worked mines added to the product. The corner, after keeping up prices for many months, and causing disturbance and expense to those whose purchases had of necessity to be made during its opera- tion, finally failed disastrously ; its promoter was led to suicide, and a great French bank which had lent him large funds was compelled to suspend payments./ CHAPTER 16 JOINT COST AND JOINT DEMAND 1. Not infrequently commodities are produced at joint cost ; the same operations which turn out one in the group turn out another also. Such are mutton and wool ; beef, hides, and horn ; copper, gold, silver from ores containing these diverse metals ; cotton fiber and cotton seed. Commodities produced at joint cost are of interest to us because of the peculiar problems of price which they present. A perfect example of joint production is that of cotton fiber and cotton seed. To make the fiber marketable, the seed must be separated from it ; all the expenses of cultivation and of gin- ning are necessarily incurred for the two together. But the prices per pound at which fiber and seed sell are very different. For every pound of lint (fiber) there are about two pounds of seed. At the prices of recent years (1903-1908) the fiber has sold at about ten cents a pound ; the seed at about one half cent a pound. It may be assumed, with little divergence from the facts, that cotton is produced under conditions of competition, and that there is a large margin at which the cost is practically constant. Fiber and seed between them therefore sell, taking their average prices over a series of years, for what it costs to produce them. But the apportionment of this total price be- tween the two joint products depends on the relative demand for them, or, in the terms which we have learned to use, on their marginal utility. The marginal utility of the cotton fiber from a given crop is much greater than the marginal utility of the seed produced along with it ; hence cotton sells at a much higher price per pound. It follows that an increase of demand for a commodity which is produced jointly with another, may cause a fall in the price of 218 JOINT COST AND JOINT DEMAND 219 that other. If the demand for cotton increases, its price will rise. This will not directly affect the price of seed, for which the supply and the conditions of demand remain the same. But the higher price of cotton is likely to stimulate production, and more both of fiber and of seed will be brought to market. The conditions of demand remaining unchanged for seed, its price must fall as supply is enlarged. Production will be increased until, in the end, the two between them will again sell for their joint expenses of production. But as the seed now sells at a lower price, the fiber must sell at a somewhat higher price ; and the definitive outcome of the greater demand for fiber will thus be a larger output of both constituents. It will cause a higher price for the one and yet entail a lower price for the other. The opposite effect would follow if demand for one of the articles should become not greater, but less. In most instances of joint cost, the situation is not so simple as this ; for usually each article entails some separate items of ex- pense. It is rare that, as with cotton fiber and cotton seed, all the expenses are incurred, to the very last stage, jointly for the two. The common case is more like that of wool and mutton ; though produced in the main at j oint cost, each brings some special expenses of its own. The wool must be sheared; the sheep must be slaughtered and dressed for mutton. Wool and meat must each sell for at least the special cost connected with them, so a minimum price is set. In what proportion the remaining (joint) cost will be secured from the two will then depend on the play of demand, as in the simpler case of cotton fiber and seed. The phrase "by-products" is often applied to denote some of the commodities produced at joint cost. When one of them habitually sells at a much lower price than the other, it is spoken of as a by-product ; or when a material for which no use has been known, comes to be utilized and to have a market value, it is so described. Both reasons explain why cotton seed is com- monly spoken of as a by-product, not, as in strictness it should be, as a joint product. One of the most striking instances of joint cost is in the utilization of the various parts of slaughtered ani- 220 VALUE AND EXCHANGE mals. The hide, the bristles, the bones, the horns, the hoofs, the blood, the various organs, all are turned to some sort of use, usually with items of special cost pertaining to each. As the meat is the most important and familiar product, the others are commonly called by-products. The advance in the arts of production, especially under the influence of chemical science, has led to the utilization of many materials previously wasted, and so has made the principle of joint cost of wider and wider application. Wool, produced at joint cost with mutton, further illustrates also this aspect of the principle. As wool comes from the sheep's back, it contains much fatty matter, which must be got rid of before the fiber can be used for textile purposes. This matter, formerly waste, has in recent times been extracted, in some degree refined, and has proved useful in treating leather and for other purposes. Simi- larly, cotton seed, itself a joint product, supplies not only the oil pressed out of it (and that oil of various grades, serviceable for various purposes), but also the oil cake remaining after extrac- tion, which is used as food for cattle. The slag which comes to the surface of the molten matter in a pig-iron furnace, and of which vast quantities formerly accumulated near the furnaces (some parts being perhaps turned to account locally as ballast under railway ties), has lately been used as a material in the manufacture of cement. 1 Coal tar, one of the by-products from the making of gas and coke, has been found by chemistry to contain the materials for cheap and effective dyestuffs, and also for important drugs. The crude oil which comes from the coal-bearing strata, and which has formed so wonderful an ad- dition to man's resources during the last half century, is the basis of a number of products, having partly joint cost and partly special cost, kerosene (illuminating oil), naphtha, gasoline, lubricating oil, dyes, paraffin and candles, vaseline. For the utilization of some joint products a large plant is indispensable ; as in the case of wool grease or coal oil prod- 1 In Germany the slag left by the Thomas and other basic processes is the most important source of supply of phosphorus used as fertilizer. JOINT COST AND JOINT DEMAND 221 ucts. In so far, the advance of the arts has promoted the growth of large-scale production, and so has intensified the social problems which arise from it. Large-scale production, in turn, may lead to monopoly, or largely facilitate it. Then another complication appears. Either monopoly alone or joint cost alone entails consequences for value which diverge far from the simpler cases. When the two are combined, a variety of interacting forces must be considered, joint and separate cost, marginal utility and elasticity of demand, mo- nopoly and maximum profit, and the effects upon monopoly of possible competition, of public opinion and public regula- tion, and of inert management. The Standard Oil Company in the United States illustrates all these complications. It has had a more or less effective monopoly, due to various causes, among which large-scale production and the utilization of joint products have played their part; and these various joint products have been marketed at prices influenced by all the factors mentioned in our discussion of monopoly, except probably that of inert management. Whenever a very large fixed capital is used not for a single purpose, but for varied purposes, the influence of the principle of joint cost shows itself. Of this the most striking instance appears in the adjustment of railway rates a case, however, so complex that its consideration is best postponed to a later chapter. 1 Where a large plant is used for producing one homogeneous commodity, say steel rails or plain cotton cloth, the peculiar effects of joint cost cannot, of course, appear. True, if such a plant, or combination of plants, has a monopoly or semi-monopoly, there may be varying prices for different portions of the one homogeneous product; there may be "dumping," as in the case of steel rails. 2 But this is a very different phenomenon from that of value under joint cost. 2. A different case from joint cost is joint demand, where what is wanted is not a single article, but a combination of 1 See Book VII, Chapter 60, especially 3. * See above, Chapter 15, 4, 5. 222 VALUE AND EXCHANGE articles. Thus a demand for dwellings is a demand for the completed accommodation. The purchaser is indifferent to the prices for brick, wood, glass, hardware ; all he looks for is the house which combines these various materials. If we suppose an increase in the demand for houses in a given district, and a rise in their prices, the change will be reflected in a rise in the prices of the several materials. If the materials were used solely for the reconstruction of houses, and if they were put on the market under the same conditions, all equally limited in supply, or all equally extensible in supply, - there would be no reason for expecting a greater rise in price for one than for the others. But the conditions of supply, as of demand, are likely to be different for the several constituents. Some may be easily obtainable in unlimited quantities at short notice ; some may be temporarily or permanently limited. So far as any constituent is solely devoted to the given purpose and is limited in supply, so far is it likely to be peculiarly affected by the changes in demand for the joint product. Those constituents which serve other purposes also, and hence are on the market for miscellaneous sale, will be diverted toward the joint product by the increase in price; enlarging supply here will check in some degree the rise in price. If the supply of any constituent be unlimited and easily ex- tensible at constant cost, its price will not rise at all. Supply will promptly respond to the new demand, and the effect of that demand will appear solely with the other constituents. And if all the constituents except one be easily procured in larger quantities, and if their supplies thus respond quickly to an increased demand, that exceptional constituent will get the full benefit of the increase in price. The different kinds of labor needed in building operations, as well as the different kinds of materials, illustrate the working of joint demand. A demand for houses and business premises means a demand for all kinds of workmen, for unskilled laborers, for bricklayers, masons, and carpenters, for plumbers and elec- tricians, and (in the case of high structures in American cities) , JOINT COST AND JOINT DEMAND 223 for ironworkers. Some of these occupations are so widespread that an increased demand for a particular kind of labor in any one place easily draws an increased supply. This is most obviously true of ordinary manual labor, plain pick and shovel work. More of it can usually be got with little difficulty from other places. With the rougher kinds of carpenter's work the situa- tion is similar. But it is different with the highly skilled trades, and with those to which access is fettered by trade-union re- striction. Here it is more difficult to add to the labor supply. Hence increased activity in building may have the effect of very greatly raising the wages of the workmen in these groups, while bringing comparatively little change for the others. Such a result has in recent years appeared frequently in Ameri- can cities, strikingly so in New York. The rapid growth in urban population, combined with great improvements in build- ing methods, has brought about astonishing activity in adding to and in remodeling dwellings and business premises. Cer- tain kinds of laborers, not easily increased in supply by recruiting from other occupations or from other places, have been in in- sistent demand, such as plumbers, tile workers, electrical work- ers, housesmiths (i.e. structural ironworkers). These have felt more than the others the demand for the joint product, and have secured extraordinarily high wages. Artificial restriction of the supply by trade-union regulation has played no small part in securing for them an exceptionally larger share of the possi- ble gain. Ordinarily, joint demand has not the same sort of permanent effect on value that joint supply has. In the long run, the con- ditions of supply are the more important in affecting value. Though it is true, as appears most strikingly in the cases of increas- ing cost and of monopoly value, that there is a constant inter- action of supply and demand, the dominant forces for most com- modities are those of supply. Where an increased joint demand affects most strongly some one commodity or some one kind of labor, because that happens to be the constituent whose supply is least easily extensible, there is none the less likely to be an 224 VALUE AND EXCHANGE increase in its supply. A readjustment of value takes place of the same sort as would have taken place if the demand had been not joint, but solely and separately for this one thing. If more brick is wanted, more will be produced ; and an increased de- mand for houses, though it may for the moment raise the price of brick, will not do so permanently. But the situation is different with joint cost ; an increase in the demand for cotton fiber may have a permanent effect in lowering the price of cotton seed. The immediate effect of an increase of demand is usually greater in case of joint demand; but the ultimate effect is usually greater in case of joint supply. REFERENCES ON BOOK II Easily the first and most valuable book to be consulted on the theory of value is A. Marshall, Principles of Economics (6th ed., 1910), especially Books III, IV, V. An admirable introductory sketch is in T. N. Carver, Distribution of Wealth, Chapter I ; another excellent compact statement is in I. Fisher, Elementary Principles of Economics, chs. XV-XVIII. On the play of utility, see P. H. Wickstead, The Common Sense of Political Economy (1910) ; Chapter II of Book I and Chapter III of Book II are valuable supplements to Marshall's dis- cussion of consumer's surplus. Compare also M. Pantaleoni, Pure Economics (English translation, 1898), Part II. On speculation, consult H. C. Emery, Speculation in the Stock and Produce Exchanges of the United States (1896). The so-called Austrian theory of value, in which stress is laid on utility as dominating value, is set forth most fully in F. Wieser, Natural Value (English translation, 1893). A more compact statement is in Bohm-Bawerk, Positive Theory of Capital (English translation, 1891), Books III and IV. BOOK III MONEY AND THE MECHANISM OF EXCHANGE CHAPTER 17 THE PRECIOUS METALS. COINAGE 1. We have already considered the part which money plays in the division of labor. 1 It is the medium by which exchanges are effected, and by which the consequences of the division of labor are worked out. It is the medium, too, in which the rela- tive values of commodities are expressed. At any given time, the price of a commodity registers its value. If iron sells for one cent a pound, and copper sells for ten cents a pound, their rela- tive values are as one to ten. If the price of copper rises to twenty cents, iron remaining as before, their relative values become as one to twenty. But if iron sells for two cents, and copper for twenty, their values remain as one to ten ; and what has happened is a change in their value relatively to the cents. A rise in both prices has taken place, which means a fall in the purchasing power of money ; that is, a fall in its value. Thus money, though an accurate measure at any given time, is by no means necessarily an accurate measure for different times. The most difficult monetary problems are those concerning the variations in its own value, that is, concerning the fluctuations in the general range of prices. We have seen also that, while any commodity that is in general demand may serve the purposes of a medium of ex- change, the most important by far have been gold and silver. Throughout most of the period over which the historical record extends, they have been the main constituents of the circulat- ing medium. During the last century, they have been sup- plemented to a high degree by paper substitutes or equivalents, and monetary conditions have been by this process profoundly 1 See Book II, Chapter 8. 227 228 MONEY AND THE MECHANISM OF EXCHANGE affected. But specie 1 is still, and bids fair long to remain, the basis of the medium of exchange for all advanced countries. We can best begin the discussion of monetary questions by treating them as if specie were the sole constituent of the medium of exchange ; introducing thereafter the several quali- fications which arise from the use of paper money and of the complex credit instruments. 2. Historically, the chief reason why gold and silver be- came the money metals was that they satisfied the craving for adornment. Things that minister to the deep-rooted love of display are in unfailing demand ; and any commodity that is in unfailing demand may perform passably the functions of a medium of exchange Hence the wide variety of things that have so served, cattle, grain, salt, furs, tobacco, and what not. It is the luster and sheen of gold and silver that caused them to be highly prized in the early stages of civilization, when other ways of producing these effects were not known. The glitter of the bauble is the origin of the monetary use of the precious metals; precisely as glass beads and scarlet cloth are serviceable for barter by explorers who push into those regions (now few) where savagery is still unaffected by the conventional ways of civilized man. Other qualities contributed greatly to making gold and silver the money metals. They are singularly free from lia- bility to deterioration. Rust does not affect them. They retain their luster with unusual constancy. Most important of all, they have proved to be sufficiently abundant for money use, and yet not so abundant that they have ceased to be prized. Any metal that is fairly scarce might be selected for monetary use. Iron was used in the early days of Rome. Copper was used to a considerable extent in later times ; and it is still in use, though only under conditions that deprive it of much significance. In the course of time, both iron and copper have been discovered and produced in such great quantities 1 1 use "specie" to signify gold and silver used for monetary purposes, whether coined or uncoined. THE PRECIOUS METALS. COINAGE 229 that they have ceased to have any special value from their rarity. Gold and silver remain comparatively scarce. Though common, and very widely distributed (gold perhaps most widely distributed of all), they are rarely found, in large amounts, or under conditions which enable great quantities to be secured at small cost. Highly productive mines have been not infre- quently discovered, and during our own time new sources are being exploited to a striking extent. Some of these changes have had far-reaching effects on prices and on the modes of use for the two metals. Some of them, too, have caused the question to be raised, at one time and another, whether silver, or gold, or both, might not become so abundant and so cheap as no longer to be fit to serve as money. On the whole, how- ever, their scarcity and high cost have continued. Though now produced in quantities that are enormous as compared with those of former centuries, their annual production is still very small as compared with that of iron, lead, copper, tin, and zinc. 1 The continued use of gold and silver for money rests very largely on convention, not on the intrinsic factors of beauty and scarcity. Once established as the money metals, they retain their position to a great degree by force of custom. Anything which passes readily from hand to hand has value from its mere acceptability. The strong influence of conven- tion and habit is illustrated by the wampum of the American Indians. These strings of shells, originally sought because fancied for ornament, were in course of time accepted, without thought of their ornamental qualities, as a medium of exchange 1 The total production, the world over, of the more familiar metals was in 1900: Metric Tons Pig Iron 41,000,000 Lead 860,000 Copper 486,000 Zinc 471,000 Tin 85,000 Aluminum 7,800 Nickel 7,500 Silver 5,650 Gold . . 388 230 MONEY AND THE MECHANISM OF EXCHANGE for the Indian tribes and the early settlers. Among certain African tribes, tiny axes (called bikei) serve as the medium of exchange. It is clear that they are conventionalized survivals from a time when the purpose was served by real axes, which had the prime quality of general acceptability. 1 Paper money illustrates the same tendency. In the first stages of its use, it had to be really exchangeable on demand for specie ; otherwise it would not be taken in payment. But once people were used to it, and accustomed to seeing it received by every one and paid out by every one, it proved able to circulate as money with little reference to its convertibility into specie. 2 Specie has had for many centuries the established position which paper money has secured within very modern times. Just because all the world accepts it as money, it is peculiarly fit to serve as money. Further, the fact that specie serves so universally as money tends to maintain its value, by giving it a utility for social prestige. Many of the non-monetary purposes for which gold and silver are used have become of minor importance. Brass and sundry imitations often do as well. Between the service- ability of plated ware and solid silver there is no substantial difference. The one great utility which the sterling metal retains is like that of the diamond, it satisfies the love of distinction. The fact that gold and silver are used as money keeps up their value; the fact that they are valuable gives them utility for display; and this in turn serves to sustain their value for monetary as well as for non-monetary uses. 3. Coins are stamped and certified pieces of metal. Uni- formity, and consequent ease in reckoning prices, are made possible by coinage. The fact that the metals can be split up into pieces absolutely uniform is one of the qualities which fit them for monetary use ; though, to be sure, it is a quality pos- sessed not only by gold and silver, copper and nickel, but by other metals as well. 1 See Miss Mary Kingsley's Travels in West Africa, p. 320. 2 See below, Chapter 23, 1. THE PRECIOUS METALS. COINAGE 231 Coinage has been almost universally carried on as a public function. In all advanced countries it is now so carried on without exception. Conceivably, private persons might under- take it, the users of money being allowed to judge of the weight and fineness of the pieces as they are allowed to judge of the quality of the spoons and forks which they use. In this way silver is used to the present day as the medium of exchange in China. But the convenience of coins as a medium of exchange would be immensely lessened if every one had to ascertain for himself whether each piece was what it purported to be. Gov- ernments therefore reserve to themselves the monopoly of coinage, and punish as a crime the manufacture by private persons of money pieces. Historically, a strong reason for the public monopoly of coinage was the desire of kings and princes to make a profit by coinage operations, often dishonestly, through intentional debasement of the coin. 1 In modern times, however, the monopoly is maintained because through it alone uniformity in the circulating medium can be secured. Coins are so manufactured that they cannot be clipped or whittled without easy detection of the defect. Hence designs are always put on both sides, and the edges have corrugations (milling) or lettering. If the coins were simply round flat pieces of metal with smooth edges, shavings could be scraped or cut from them without easy detection. Such "sweating" was common in earlier days, before the art of coinage had been perfected. Modern machinery turns out pieces so skillfully manufactured that troubles of this sort have practically ceased. Coins, again, are never made of pure metal Gold and silver, without alloy, are soft, and coins made of them alone would wear out fast under active use. Hence a small percentage of base metal usually copper is added, the mixture giving the needed hardness and toughness. In most countries, gold and silver coins are 900 fine; that is, they contain 900 parts in gold or silver for every 1000 of gross weight. This is the 1 For a modern instance of the same sort, see Slatin's Fire and Sword in the Sudan, pp. 541-643. 232 MONEY AND THE MECHANISM OF EXCHANGE fineness of the coins of the United States. Great Britain still coins her gold pieces with a fineness of 916| ; that is, the pro- portion of alloy is not 1 in 10, but 1 in 12. In the typical case, which alone we consider for the present, there is free coinage. That is, every holder of bullion may bring it to the mint, and, no matter how much he brings, have it converted into coin. The cost of manufacturing the coin is usually borne in modern communities by the public. When so borne, coinage is gratuitous as well as free. But the mint may return to the applicant coins containing a slightly less amount of specie than he presented. The difference retained by the mint then constitutes a charge to meet its expenses, in whole or in part. Such a difference or deduction is called a seigniorage (a name derived from the exclusive coinage rights of the king or feudal seigneur). Where a seigniorage is charged, the exchange value of coin may exceed to that extent the value of bullion. The mints of most countries, however, return to the person who presents gold bullion precisely the same weight of fine gold in the shape of coins. Sometimes, indeed, this return is not immediate ; there is a delay corresponding to the length of time required for the manufacture of the coin. Thus, in the United States, a period of six weeks usually elapses between the delivery of bullion and the return of coin. Such a delay may cause the value of bullion to be slightly less than the value of coin, even though there be free coinage without seign- iorage, since there is a loss of interest during the period of waiting. These causes of divergence between gold bullion and gold coin whether seigniorage or delay in coinage have ceased to be of appreciable importance. Not only can gold bullion be converted into coin at the mint without charge, or for a trifling charge, but gold coin can be readily converted into gold bullion, either by private melting, or by arrangement, common at the mints, for giving bullion in exchange for coin at fixed rates. The situation is very different with silver, copper, and nickel, which are not freely coined, and which present problems of their own. As THE PRECIOUS METALS. COINAGE 233 for gold, it may be said, without substantial variance from the facts, that bullion and coin are interchangeable. The rate at which coin is given for bullion is the "mint price of gold." In England the mint price of standard gold is 3 17s. 10%d. per ounce; each ounce is manufactured into sovereigns at this rate. In France the mint price of fine gold is 3447.74 francs per kilogram, in Germany it is 2790 marks per kilogram; the figures again indicating how many francs or marks are manufactured from the kilogram of gold. Because the amount of gold coin given for bullion never varies (so long as the coinage legislation remains unchanged), people often speak of the value of gold as unvarying. Accustomed to think of all exchanges and all values in terms of price, they think of the value of gold as the price (the mint price) of gold bullion. But obviously the value both of gold bullion and of gold coin is really a very different matter. It depends on the general range of prices of commodities, or, rather it is the general range of prices ; and this is by no means free from variation. In the United States, the phrase "mint price of gold" is not often used, because our coinage legislation proceeds not by specifying what number of dollars shall be manufactured out of a given weight (say an ounce) of gold, but by specifying how much gold the dollar shall contain. The dollar is required to contain 23.22 grains of fine gold. Dollar-pieces are no longer corned ; they proved too small for convenient use ; five-dollar pieces are coined with five times this weight of gold, ten-dollar pieces with ten times the weight. The mint price of gold, if that phrase were used with reference to OUT coinage system, would be $20.67 per ounce. 4. Before closing this introductory chapter, something may be said of the place which money and the mechanism of exchange hold among the factors that bear on the prosperity of a community. Every person sells his wares or services for money, and commands the wares and services of others in proportion as he has more or less money. It is natural to suppose that what brings prosperity to the individual brings prosperity to all. Yet a moment's reflection makes it clear that here, as so often, the inference is not warranted. If all persons sell their wares for more money, no one gains thereby. The individual gains from having more money only if others have not more money, if he can buy from others at as low prices as before. If all prices and all money incomes are high, no one is bettered thereby. Money is the means by which each person procures the comforts and necessaries of life; or, to speak more accu- rately, it is the medium by which each person exchanges the particular things he produces or owns for the various commodi- ties which he wishes to buy. The more money there is, the more of this medium is used in every act of exchange. But prosperity depends on the abundance of the things exchanged, not on that of the counters used in effecting the exchanges. This is so obvious that mere statement suffices for proof. None the less, it happens often that people who are half trained, and see only one aspect of economic phenomena, believe that abundance of gold or silver, or of paper substitutes for them, is the one thing needful to make the world better off. Many educated and intelligent persons, who would scorn to hold this opinion in its crudest form, yet hold some phase of it by impli- cation. Thus, in connection with trade between one country and another, most people assume that such a state of foreign trade as brings money into the country leads to prosperity, while such a state as carries money out leads to adversity. All notions of this sort are the results of half thinking. The flow of specie into a country or out of it, in the course of inter- national trade, is usually a matter of indifference. Where it is a matter of consequence, the mere increase or decrease in the supply of money is only the first step in a series of events that may affect the country's prosperity. 1 Whenever a person speaks of that which "brings money into the country" (or into the city or the village) as being good for it, the probabilities 1 See the discussion of international trade in Book IV, especially Chapter 32, and Chapter 36, 1. THE PRECIOUS METALS. COINAGE 235 are that he has not mastered the elementary principles of economics. One of the simplest of these principles is that money is primarily an instrument for enabling the division of labor to work out its end with smoothness, and that, bar- ring some niceties presently to be considered, its large or small supply is a matter of no consequence. But though the quantity of money, and the consequent use of more or less of the counters in each operation of exchange, be matters of indifference, the universal use of money in exchanges is by no means a matter of indifference. It has not merely the obvious effect of facilitating the division of labor and so pro- moting the output from the operations of production: it has ulterior consequences no less important. Without it neither merchants and traders nor manufacturers could carry on large- scale operations. All the phases of large-scale production, with its far-reaching social consequences, are dependent on a de- veloped and smooth-working money regime ; it is indissolubly connected with capitalism and capitalistic enterprise. It un- derlies all lending and borrowing, all investment, the issue of cor- porate securities, financial operations of every kind. It has psychological effects as well as effects obviously economic. It affords a universal goal for the instinct of accumulation and possession, creating an environment in which every one strives for money, half forgetful of the purposes which the possession of money serves. All things are put in a pecuniary light, all effort is proximately to make money, all efficiency and all prod- uct are measured in terms of money. Though not the funda- mental cause underlying the problems of the unequal division of wealth and income, it is yet a condition of the emergence of these problems in the characteristic modern forms : social classes distinguished by differences in money means, capital owned by comparatively few. From one point of view the least essential part of the organization of production and distri- bution, it is from another point of view the one essential part. Without it, the characteristic modern problems could hardly be imagined. CHAPTER 18 THE QUANTITY or MONEY AND PRICES 1. What determines the value of money? That is, what determines the general range of prices? The value of money obviously is high when the general range of prices is low ; for a given amount of money will then buy much of other things. Its value obviously is low when the general range of prices is high ; for a given amount of money will then buy little of other things. What, now, causes its value to be high or low, prices to be low or high ? The first step toward answering this question is to understand the relation between the quantity of money and its value. The fundamental relation is a very simple one. Double the quantity of money, and, other things being equal, prices will be twice as high as before and the value of money one half. Halve the quantity of money, and, other things being equal, prices will be one half what they were before, and the value of money double. That an increase in quantity tends to lower value, is a proposition holding good of all commodities. The special prop- osition concerning money is that its value tends to vary pre- cisely in proportion to its quantity. This constant relation does not hold good of any other commodity. Double the quantity of wheat, and its value will probably fall to much less than half of what it was before. Double the quantity of sugar, and its value will probably fall by no means to one half. For both wheat and sugar, the outcome will depend on the elasticity of demand. But in the case of money, there is no question as to elasticity of demand, and no such difficulty in prediction. The value of money, under the simplest conditions, is exactly inverse to its quantity. 236 THE QUANTITY OF MONEY AND PRICES 237 This is what is called the quantity theory of money. Con- cerning it a hot controversy has long waged. It has been ve- hemently denied; and often it has been erroneously stated. Rightly stated it conforms to the facts, but it must be rightly stated and understood. In the preceding paragraph it has been put boldly, with the purpose to bring out clearly the fundamental truth. But the reader will note the phrases "other things being equal" and "under the simplest conditions." Great qualification and elaboration will be required before the bold statement can be made to fit the complicated phenomena of actual life, especially in modern times. The last word cannot be said until a long series of topics have been covered. 1 For the present, let us consider the essential ground on which the prop- osition rests, and some of the simplest qualifications. These essential grounds are found in the nature of the demand for money. People often say that the demand for money is without limit. They mean thereby that any individual desires to secure possession or control of as much as he can. But he desires possession or control as a means, not as an end. Money is not eaten or drunk or directly enjoyed. It is a means of get- ting other commodities ; it is sought in order to be spent. We may set aside, as negligible, the case of the miser who gloats over money for its own sake, and also some other possible cases of hoarding. All the money, whether any individual has con- trol of much or little of it, is spent sooner or later. The demand for it what is offered in exchange for it consists of the commodities on sale. But the commodities on sale are simply all the commodities that are to be exchanged. The demand for money, in any given community at any given time, is constant. It h not subject to change because of the greater or less range of prices. Whether goods sell for less or more, all of them will still be sold, and will still be offered for money. Hence, when there is twice as much money, the same number of commodities will be offered for the money, and prices will be twice as high as before. 1 See Chapter 31, at the close of this Book. 238 MONEY AND THE MECHANISM OF EXCHANGE In other words, there is no such thing as elasticity in the de- mand for money. The principle of marginal utility is not appli- cable. When wheat and sugar are offered more abundantly in the market, their value falls according to the decreasing utility of successive increments. The total sum spent on any one com- modity the quantity sold multiplied by the price per unit may become greater or less as the number of units grows larger. But the total amount of goods offered for money, which con- stitutes the demand for money, is not affected by its value. That total remains always the whole number of commodities that are exchanged through this medium. The general process is the exchange of the whole number of commodities for the whole number of money pieces ; the equation fixes the value of money according to the relative abundance of money and of goods. 2. Let us now begin to introduce the explanations and quali- fications of this fundamental principle. In the first place, we should not speak of the whole number of commodities, or even of the whole number exchanged ; but only of the number exchanged through the medium of money. Some goods are consumed by those who produce them, and do not enter the circle of exchange at all. Such are agricultural products consumed by those who grow them. These evidently do not constitute at any time demand for money. But with the growing elaboration of the division of labor, the proportion of goods so used tends to be- come steadily less. In a country like the United States at the present time it is not far from the truth to say that air things that are produced are exchanged. Nor is it far from the truth to say that all things exchanged at all are sold for money and exchanged through money. So far as barter is practised, there is obviously no demand for money. Goods exchanged by barter constitute demand directly for each other. But barter has disappeared even more completely than production for one's own consumption. Much more important is a qualification as to the rate or man- ner in which goods and money meet each other in exchange. The preceding statements seem to imply that all the goods are THE QUANTITY OF MONEY AND PRICES 239 exchanged for all the money in one transaction. Obviously this does not happen. At any given moment, or on any given day, only a fraction of the goods is being sold, and only a fraction of the money is being used in purchases. Here, as elsewhere in economics, we should have in mind a flow rather than a fund. The total stock of commodities is indeed sold sooner or later, and may be conceived as a fund. But only a portion of it actually comes to the monetary market in any one day or week or other unit of time, the rest following in orderly sequence. There is a flow of goods into actual exchange. Similarly, the total quan- tity of money does not constitute a fund, but flows into actual use for purchasing goods in a tolerably regular sequence. The phrase "rapidity of circulation" has been used for money, to indicate this obvious fact. Of the total money actually on hand in a community a portion only is at any given time at work, so to speak. The money idle in our pockets does not directly affect prices; only that which is buying goods at the counter does so. What proportion is at work, depends on the habits of the people. It is affected by their geographical distribution and by the character of their industries. In a thinly settled agricultural section, where access to shops is not easy or frequent, a larger portion of the money is likely to be idle than in a thickly settled manufacturing or commercial section. The temper of the people is a factor. If they are confident of themselves, perhaps unduly confident, and thoughtless of the morrow, they are likely to spend money as fast as it comes into their hands, and let little of it remain idle at any time. These remarks apply to the larger transactions of merchants and dealers as well as to the everyday purchases of consumers. Traders and producers always have on hand more money than they are using in purchases ; the proportion depending partly on the nature of their business operations, partly on their tempera- ment. The fact that these classes, in countries like the United States, use not actual cash, but checks against bank deposits, does not alter the situation; it only supplies another illustra- tion of the difference between the fund of money and its flow. 240 MONEY AND THE MECHANISM OF EXCHANGE The total of their deposits in banks constitutes the fund; the checks by which purchases are effected from day to day con- stitute the flow. Though we are anticipating in speaking of deposits and checks, whose use as substitutes for cash will be considered in due time, 1 it may be noted that the same principles are applicable to this more complex monetary medium as to money in its simplest form. In every form, the medium of ex- change has its flow, or rate of use, its rapidity of circulation. Similarly, goods have their rapidity of circulation. In more familiar language, they have their rate of turnover. This also depends obviously on a great variety of circumstances. It is likely to be rapid in a large city, slower in the country. It is affected, like the flow of money, by the temper of the people. It is likely to be quicker in an energetic and restless country like the United States than in a more slowly moving country like France. It is likely to vary in different parts of the United States. It varies, too, in different branches of trade. The turnover of a grocer's shop is more rapid than that of a hardware dealer's, that of a flour mill than that of a textile factory. Yet the flow of goods as a whole takes place steadily and continuously, and in a given community with a surprisingly regular course. Thus the proportion of money which is actually buying goods is not accidental ; it is determined by the silent force of custom. It may be irregular for an individual, but over thousands and millions of individuals it follows a steady course. The flow of goods to market takes place at a similarly regular rate. Hence we may argue with confidence that if "the total quantity of money be increased, that quantity which is used in making purchases at any given time will be correspondingly increased. Suppose, for example, to use an illustration of Mill's, that suddenly every one in the community has twice as much money. The only thing that can be done with it is to spend it. There is nothing to alter the habits of the people ; nothing to cause a larger proportion to be kept in the pocket or in reserve. 2 1 See below in this Book, Chapter 24, 3. 1 See, however, what is said below, in 5. THE QUANTITY OF MONEY AND PRICES 241 The quantity of goods remains the same, nor is there anything to alter the mode hi which people and dealers bring their goods to market. The flow of money will be doubled, the flow of gooda unchanged, and prices will be twice as high as before. The same effect which would ensue from a doubling in the quantity of money would ensue also from a doubling of its rapid- ity of circulation. If twice as much of the total stock is steadily in use for purchasing goods, the effect is the same as if the quan- tity were doubled without any change in the ways of using it. The propositions which were laid down in the opening para- graph obviously assumed that the quantity of goods, and the flow of goods into exchange, remain constant. So much was implied by the qualification "other things remaining the same." Needless to say, the quantity of goods does not always remain the same. If it be doubled when the quantity of money is doubled, prices will be unchanged. If goods be doubled, money being the same, and the flow of goods to market unaffected, prices will fall one half. If the flow of goods to market their rapidity of circulation be so affected that twice as large a proportion of goods are regularly offered, prices will again fall one half. Rapidity of circulation is greater for money than for goods. To put it in other words, the proportion which, at any one time, the money actually offered for goods bears to the total supply of money is greater than the proportion which the goods offered for money bear to the total supply of goods awaiting exchange. The reason for this difference is obvious. Money can always be used without delay in purchases ; goods can often be sold but slowly. Money need never wait for a buyer ; goods must often wait for one. Many commodities have necessarily a slow turn- over, as hardware and household furniture. Other things, like dwellings to let, warehouses, and factories, are in the market only by fractions or installments, only the utilities which they shed, so to speak, are being offered for sale, and their disposal is sluggish. Money comes into the market quickly. Though there may be hoards, and occasionally an accumulation of unused 242 MONEY AND THE MECHANISM OF EXCHANGE money in the hands of people who are getting larger incomes than they are used to, money in the main is kept at work briskly, at a rate greater or less for any given time and country according to the ways and customs of the people. These various corrections and qualifications of the simple fundamental principle the reader will hereafter be supposed to bear in mind. We shall speak of the value of money as deter- mined by its quantity ; meaning thereby that, if other things re- main the same, an increase of the total stock of money brings a corresponding increase in the flow of money used in making per- chases and adds pro tanto to the money offered in exchange for commodities. 3. Let us proceed now to inquire how far the monetary supply of specie is different from its total supply. The precious metals are used in the arts as well as for mon- etary purposes. But the demand for them in the arts fol- lows no such special law as does the demand for money. Utility or satisfaction-yielding quality determines the demand for gold trinkets and implements in the same irregular way as it deter- mines the demand for wheat or sugar. The quantitative effect of an increase of supply is unpredictable; the elasticity of demand may show any scale of gradation. If the same proportion of the total supply of gold and silver were always used in the arts, this difference between the mon- etary and the industrial demands would be of no consequence for the theory of money. But that proportion is not neces- sarily the same. To a certain degree it is influenced by the very value of the monetary supply. If, for example, prices and money incomes in general should go up, in consequence of greater abundance of gold, gold bullion would not advance; since, as we have seen, gold bullion is always at the same price in terms of coin. For gold jewelry, spec- tacles, and the like, the raw material would be as cheap as before ; they would advance in price only so far as the expense of manu- facturing them from the bullion would be greater. Relatively to money incomes they would be cheaper than before. This THE QUANTITY OF MONEY AND PRICES 243 greater cheapness would almost certainly cause more to be bought than before, and a greater proportion of the bullion would be diverted into the arts. A scarcity of gold, and con- sequent fall in prices and incomes, might be expected to have the converse effect. Gold articles would be relatively dearer, and presumably would be bought in smaller quantity than before. The industrial consumption would divert less gold from the mint. Even without a rise or fall in the value of gold (i.e. in gen- eral prices), changes in habits and tastes affect its industrial consumption. Gold jewelry may become more fashionable, gilding and gold leaf more in vogue, gold spectacles may be thought more convenient or becoming. A greater proportion of the available stock will then be removed from the monetary supply. Of these two sets of causes, the first seems to have less effect than the second. Changes in general prices rarely occur on such a scale as to bring about considerable results of the sort stated. The price of jewelry and other gold articles is affected not only by the price of bullion, but by the expenses of manufac- ture. These expenses fluctuate in correspondence with changes in general prices. If all prices go up, that of bullion will in- deed remain the same ; but wages and other items of outlay in manufacturing jewelry will go up as other goods and services do. An advance of twenty-five per cent in general prices is a very marked one. Yet such an advance would mean, not that gold articles would remain unchanged in price, but only that their prices would lag somewhat behind the general advance. They would go up perhaps twenty per cent, instead of twenty- five. The effect on their consumption would probably be small. The second factor that bears on the industrial use of the metals changes in habits and fashion seems to be of more importance. The great growth of wealth during the last half century has led to a larger use of gold in the arts; precisely as it has led to a larger use of diamonds. Not until recent years was any methodical attempt made to ascertain 244 MONEY AND THE MECHANISM OF EXCHANGE the extent and growth of this use. For the decade from 1880 to 1890 the industrial consumption of gold (including export to the East, of which more will be said presently) was esti- mated to be, in terms of dollars, about $60,000,000 a year. In 1912 the amount was supposed to be triple, about $174,000,000 for that year. Some part of this reported in- crease was no doubt due to insufficient counting in the earlier period ; but none the less, an increase there undoubtedly was. The change was by no means in proportion to that in the total production of gold, which was about $100,000,000 a year in 1880-1890, and no less than $460,000,000 in 1912. In the earlier period, more than half of the gold produced was diverted from the monetary use of Western countries ; in the later year, less than two-fifths was so diverted. The total stock of gold in the world was estimated in 1900 at about $9,000,000,000, of which something more than one half was in use as money, the rest in use for the arts. What is in use for the arts may be regarded as practically lost from the monetary supply. A part of it, no doubt, returns sooner or later to monetary channels ; for plate, jewelry, and the like are sometimes melted and perhaps are then coined. But most of it is definitively lost. Whatever part returns has been little influenced by the value of money. Changes in fashion and habits chiefly determine the remelting, just as they chiefly determine how much shall go into the arts in the first instance. In the main, the use of the precious metals in the arts goes its own way, leaving for the monetary supply the annually accru- ing surplus of production over and above the independent industrial consumption. This separation of industrial from monetary use ' is more complete at present than it was in earlier times. In medieval Europe a link might be cut from a gold chain and used in making a payment ; and the cavaliers melted their plate freely to supply funds for the Stuarts. In British India, where con- ditions continue in many ways medieval, the silver ornaments of the natives and their rupees were interchanged constantly THE QUANTITY OF MONEY AND PRICES 245 and freely until very recent times; notwithstanding the new position of the rupee since 1893, 1 they still remain to a certain degree interchangeable. Even in advanced countries some shift from monetary to industrial use takes place to this day ; but, as has been said, there is an increasing tendency to sharp demarcation and to the settlement of the industrial use by independent causes. The industrial consumption of silver has shown, like that of gold, a marked growth in recent times. In the United States it seems to have more than quadrupled in the period between 1880 and 1906. 2 This change, like the other, is due in large part to increasing wealth and to a fashion for silver plate and trinkets. No doubt it is due also to the lower price of silver. The price of silver has fallen since 1873 about one half. But the case of silver is different in one important respect from that of gold. Silver is no longer a freely coined metal ; it does not become money in the same way as gold. Silver bullion, like tin or copper, has its price in terms of gold, and its use in the arts is affected by price through the same mechanism as tin and copper. The use of gold is affected, as we have seen, through the more obscure and unfamiliar in- fluence of ups and downs in general prices and in general money incomes. 4. Still another diversion of gold and silver from monetary use is important for the countries of Western civilization. This is the drain of specie to the East, which has been going on for centuries, and seems likely to continue for a long time in the future. In the trade between the West and the East, and especially that between Europe and India, as far back as we have any definite knowledge about it, the merchandise sent from the East has exceeded in money value that sent in return from 1 See below, Chapter 21, 5. * In the United States, it seems to have been less than five million ounces a year in the early eighties, and over 20 million ounces a year in 1902-1906. See the Report of the Director of the Mint on the Production of Precious Metals, 1906, p. 27. 246 MONEY AND THE MECHANISM OF EXCHANGE the West. A balance has remained steadily due to Eastern countries, and has caused a steady flow of gold and silver, and especially of silver, to go to them in payment of the balance. The excess thus due has sometimes increased, sometimes de- clined. It has fluctuated with the variations in demand for the several commodities exchanged between the two regions, with the accidents of seasons and crops, with the appearance of new articles of export on either side. On the whole, the balance to be paid by Western countries has tended to become less in the last ten or twenty years, largely because sundry goods of Western manufacture have been called for in greater amount by the Eastern population (petroleum, for example, and cotton cloths). But a balance to pay there has been for centuries, and still is. Hence specie steadily flows to the East. This specie is lost to the Western countries as if it had been absorbed once for all in the arts, almost as if it had been dropped into the sea. It disappears from the monetary and industrial supplies of Europe and America. India chiefly British India has been aptly described as a sink, into which flow gold and silver, and especially silver, never to return. The explanation of this complete diversion and almost disap- pearance lies in the unusual industrial conditions of India ; con- ditions which are found in other parts of the East also, though nowhere else so strikingly. China is in a somewhat similar situation, and Japan formerly was; but India, and especially that part which is now British India, has played much the most important role in this curious monetary experience. The region has long had an enormous population; in 1900 some three hundred millions. This population is mainly agricultural ; it is ignorant and stolid. It uses metallic money almost solely, very little paper money or other substitutes. The rapidity of circulation of its money is low. Moreover, the people are given to the use of both gold and silver for ornament and for hoarding. The bracelets, rings, and jewels serve both to gratify vanity in the present and to store purchasing power for possible want in the future. Hence great amounts of THE QUANTITY OF MONEY AND PRICES 247 specie can find their way into India, and flow into use, without much effect on general prices; indeed, for long periods, without any measurable effect at all on prices. No such steady inflow could well take place into a Western country without influencing prices. As will be seen when the subject of inter- national trade is reached, a continued large absorption of specie by a highly organized industrial community is not possible. A large inflow will raise prices ; this will tempt imports and check exports; then the flow of specie in payment for excess of exports will cease. But in a country like India the response of prices to increasing specie supply is very slow indeed. In the course of generations, it is true, a response will be found. Dur- ing the last half century, and especially the last quarter cen- tury, prices and money incomes in the East have gone up, not to a marked degree, but appreciably ; 1 but during the pre- ceding centuries the upward movement, though probably there, had been so slight and slow as not to be clearly discernible. The rending of old bonds of caste and custom, the growing habituation to security of property, the opening of railroads, have much affected the industrial and monetary situation. But it still remains true, and will probably long continue so, that great quantities of the precious metals steadily flow to the East, to stay there ; affecting prices and the value of money, it is true, but so gradually that the flow is rarely checked, and is resumed with new force whenever a large riew supply is added to the stock of Western nations, or whenever the demand for Eastern commodities causes an upward movement in their export. 5. In one important case an increase in the supply of money may affect its mode of use, and so introduce a new factor. This is where an added supply facilitates a transition from barter to a money regime. This sort of case cannot occur when once exchange by money is fully established, when all goods and services are sold for money. Then an increase 1 See a paper by F. J. Atkinson, on " Prices in India, 1870-1908," in Journal Royal Statistical Society, September, 1909. 248 MONEY AND THE MECHANISM OF EXCHANGE in the quantity of money means simply that two gold or silver pieces, or five, or ten, are used where one had been used before. Adam Smith supposed this to have been the only important consequence of the increase in the European supply of specie which came in the sixteenth and seventeenth centuries from the American mines. 1 Gold and silver plate indeed became thereby more plentiful, "a real conveniency, though surely a very trifling one." For the rest, Adam Smith goes on, "in order to make the same purchases, we must load ourselves with a greater quantity of gold and silver, and carry about a shilling in our pocket when a groat would have done before." But this was not the only change that took place. The greater plenty of specie contributed to its use in transactions pre- viously effected without it, and caused still other transactions (exchanges) to be carried on which before had not been carried on at all. The period (about from 1550 to 1650) was one of great in- dustrial transformation. The economic regime of the Middle Ages was being rapidly displaced. Under that regime, the division of labor and exchange had been much limited, and a large proportion of the exchanges and payments that did take place were effected in kind, that is, by barter, not in money. It is conceivable that the break-up of such a situation, and the substitution of a complete monetary regime, should come about without any change in the supply of money. This would mean that the same supply must suffice for a larger number of trans- actions, and that prices must go down. But in communi- ties so tied by custom as were those of Europe at the time, this process could have taken place, if at all, only with the greatest difficulty. The mere absence of a supply- of specie, adequate for carrying on a larger volume of transactions with- out a great lowering of prices, was an almost insuperable obstacle to the extension of monetary exchanges. The new specie vastly facilitated the transition. It supplied a lubrica- tor, so to speak, for the smooth and rapid working of the more 1 Compare what is said of this great change in the next chapter. THE QUANTITY OF MONEY AND PRICES 249 effective machinery of exchange. It penetrated quickly and easily into all western Europe, and made possible a much wider adoption of money payments; not only without the distress, real or fancied, that lower prices bring, but, through the abundance of the supply, with markedly higher prices. Thereby the division of labor was extended into many new industrial fields, and the ease of exchange was made greater in many fields where such a division already was practised. A real advance in the efficacy of production was secured, and a real gain in welfare. 1 None the less, Adam Smith's view, though historically incom- plete for the particular case, was in principle sound. He wrote at a time when people still had false notions of the advantages from the plentifulness of the precious metals. Being intent on disabusing them of such notions, he was led to overlook the real advantages which a community may secure from the easy procurement of a needed medium of exchange. But when once this medium of exchange has been procured, and when once it is in fully effective use, reasoning like Adam Smith's is not to be gainsaid. If ten times the labor were given to gold mining that is now given, and ten times the gold were thereby got, the world would not be better off ; ten gold pieces would simply be used in every transaction where one is used now. The process of transition, to be sure, the change from lower to higher prices, or vice versa, would bring some important consequences of its own ; but these would not affect the final outcome. Barring the transitional effects, it is immaterial whether prices are low or high, whether many tokens or a few are used to facilitate each act of exchange. 1 Some dim understanding of this fact a groping toward a substantial truth probably contributed to the over-importance attached to a plentiful supply of specie by the writers of the seventeenth century, and commonly by those of the eighteenth century also. But the beliefs of these " mercantile " writers were also much affected by the political power of those princes who, at a time when feudal dues were being replaced by money taxes and payments, and when the money dues were yet hard to enforce, had the command of plenty of specie. And mere confusion of thought further explains their attitude. Here, as on so many subjects, things which seem simple when once they have been cleared up, were long puzzling to men of high intelligence. 250 MONEY AND THE MECHANISM OF EXCHANGE It has been suggested by some writers that there is still another way in which the play of utility may affect the rela- tion between the quantity of specie and its value; it may affect the monetary use directly. When money becomes more abundant, people, it is said, will use it less constantly. They will keep more of it in their pockets, use less in purchases. The merchant, too, will keep in his till a larger balance when money is plentiful than when it is scarce. But this, in my judgment, is not a probable result. There is no good reason to suppose that money will be used in a different way when there is more of it. If, indeed, the increase in quantity takes place under circumstances that destroy its general accep- tability (as in the case of excessive paper money) the use of money and the demand for it will be affected. 1 But a mere increase of specie, or of other sorts of money enjoying general acceptability, will not affect its flow into use or lessen the effec- tiveness of each unit in the shaping of prices. Any individual, it is true, who gets a larger share of the total money on hand may thereby be led to change his ways of using it. A pros- perous person ordinarily keeps a larger reserve of cash, in pro- portion to his income and his purchases, than one of slender means; and the rapidity of circulation of the money that goes through his hands is less. But if all persons in the com- munity have more money than before, so that its distribution among individuals and classes remains the same, the mode of using the circulating medium will not be affected. The same proportion will be applied to purchases in any given period, and prices will go up in proportion to the general increase in quantity. 6. In this chapter, be it remembered, the principles under- lying the value of money have been treated on the assumption that specie alone is used. This case is obviously very different from the complicated one which we find in the actual conditions of civilized countries, where not only specie, but paper money and an intricate credit machinery, are used in effecting payments. 1 See below, Chapter 23, 1. THE QUANTITY OF MONEY AND PRICES 251 But the same principles hold good here, if adjusted. In- stead of saying that the general range of prices depends (other things being equal) on the quantity of specie, we must say that it depends on the total quantity of money means, or of the avail- able total purchasing power in terms of money. In proportion as this total purchasing power becomes greater or less, prices will rise or fall, other things, such as the flow of commodities for sale into the market, being still assumed to be the same. A very troublesome problem is the relation between this total of pur- chasing power on the one hand, and the total quantity on the other hand of gold or other freely coined specie. This problem cannot be solved until the whole range of substitutes for specie and the whole machinery of credit payments have been ex- amined. 1 The conclusions of the present chapter must there- fore be taken as provisional. Yet it may be said at once that they do hold good in the long run of the actual course of affairs. For short periods, even for many years, it is often difficult to trace any connection between the quantity of specie and prices. Even in the long run, it is never possible to trace that precise inverse relation to the value of money which has been deduced in the preceding pages. On the other hand, in the long run, a rela- tion between the volume of specie and prices is in fact to be dis- cerned ; while the precise quantitative relation between prices and the total purchasing power in terms of money remains un- shaken. 1 See below, Chapter 31, where the theory of prices is restated with the qualifications amplified. CHAPTER 19 THE COST OF SPECIE IN RELATION TO ITS VALUE 1. The value of money has been considered in the preceding chapter so far as demand and supply directly affect it. But the supply of specie, like that of any other article, is affected by its value. When value is high, the supply is likely to become greater ; when it is low, supply is likely to become less. Specie comes from surface deposits and from mines, chiefly from mines. What are the conditions of supply ? In general, articles yielded by mines show the phenomena of varying costs and of diminishing returns. Some mines are better than others ; any one mine tends, as more is extracted, to encounter sooner or later increasing costs. On grounds of general reasoning, we are then led to expect that the value of the precious metals will conform in the long run to their cost of production at the poorest mine, or at the poorest part of the best mines. It will conform, we should expect, to the marginal cost of production. In fact, however, no close correspondence, nor even a rough correspondence, can be made out between the cost of the pre- cious metals and their value. This, at least, is the situation with regard to gold. For silver the correspondence is perhaps in very recent times closer, yet through most of human history it has been equally uncertain for silver and for gold. The main causes of this lack of conformity with the theoretical scheme are three, the durability of the precious metals, the aleatory charac- ter of mining, and the irregular discoveries of new sources of supply. Of these three causes, the most important is the first. The durability of the precious metals brings it about that changes in current output affect the total stock very slowly. For most 252 THE COST OF SPECIE 253 commodities the supplies produced five years ago are quite out of the market. This holds good even of durable articles like iron and copper. The iron mined five years ago may indeed be still in existence, but it has been fashioned into implements and is committed to uses which practically withdraw it from the market. So far as gold and silver are used in the arts, they also are, in the main, withdrawn from the market. But gold and silver used as money remain in the monetary market indefinitely. Even if cost of production is greatly reduced, and the annual out- put greatly enlarged, as has been the case in recent years, the monetary stock changes but gradually, and value is affected but slowly. 1 Next, the very conditions of production at the mines have been irregular through almost the whole course of history, and, though perhaps less markedly, remain irregular to this day. The irregularity appears in mining not only for gold and silver, but for all metals. It is difficult to ascertain in advance what will come out of a hole in the ground. For those mineral products which occur in large masses, under conditions enabling syste- matic tests and samples, the element of uncertainty and risk, though ever present, is at least greatly less. Such is the case with coal and iron ore. Copper mining seems to be much more speculative ; gold and silver mining, even more so. With these the elements of uncertainty are great, and the obstacles in the way of an adjustment of value to marginal cost corre- spondingly great. The aleatory character of the production of gold and silver has been accentuated by another circumstance. Mining for them has always had a peculiar fascination, and cool-headed cal- culation has been absent more than in other mining. In gen- 1 The world's monetary stock of gold was estimated in 1907 at roughly $7,200,000,000. (Helfferrich, Das Geld, edition of 1909, p. 203.) The product in that year was $440,000,000 ; deducting the gold used in the arts (130-150 millions), there remained for the year a net addition to the monetary stock of say $300,000,000, or about 4 per cent. As compared with any period except the present decade (1900-1910), this was ail extraordinary addition to the supply, absolutely and proportionally. 254 MONEY AND THE MECHANISM OF EXCHANGE eral, it might be expected that there would be successes enough to offset (with some rough approximation) the failures; prizes against the blanks in the lottery. But, as is so commonly the case with avowed lotteries, the blanks are overlooked, the prizes only are seen. A gold mine, in everyday speech, stands for riches. Statesmen, explorers, investors, have been deceived by the glamor of mining for specie. The profitableness of such mining depends, not on getting the specie, but on getting it with sufficiently little labor and expense. A large output may be got at an expense so high as to wipe out all profit. But people have been constantly tempted to gold and silver mining without rational weighing of yield and cost. The late Professor Soetbeer, a very well-informed and sagacious observer, came to the con- clusion that as a whole the production of the precious metals was carried on at a loss. Most persons who have engaged in it have overestimated the possible prizes. They have disregarded not only the blanks, but, to a large extent, the inevitable expenses. In very modern times, gold and silver mining have come to be carried on more systematically, on a larger scale and with less risk. This change is due to the improvements in mining meth- ods which make it possible to extract the metals from low-grade ores. In former times, the main sources of supply were pockets of very rich ore, and very rich alluvial deposits. The occurrence, however, of such lucky finds is irregular, and their continued productivity, even after they have been hit upon, is even more irregular. But there are other deposits, where the ore has a small content of fine metal, but is very large in amount and is easily tested and measured. By establishing a great plant, and treating vast bodies of ore, quantities and profits can be secured with hardly more irregularity than those in mining iron ore. The same is true of alluvial mining when conducted not on chance deposits in the beds of streams, but on whole hillsides washed by powerful hydraulic machinery. Methods of this more businesslike sort have brought the great increase in the output of gold and silver during the generation just passed. Third, and closely connected with what has just been said, is THE COST OF SPECIE 255 the influence of new sources of supply. This factor has played an important part in the production and prices of all the metals, especially in modern times; as, for example, in regard to iron and copper. It has always had special importance with the precious metals, because of that amalgamation of old and new supplies which results from their durability. When new and rich mines have been discovered, the output from them has not displaced existing stocks, but has simply been added to them. It is so, also, with the output from the unsuccessful mines. Though poor mines may have been unprofitable to those exploit- ing them, the gold and silver yielded by them have contributed permanently to the amount in use. Hence the monetary stock at any given time has been a jumble from rich mines and poor mines; ancient supplies from forgotten sources have mingled with new additions from well-known regions; there has been accidental discovery and scientific exploitation ; the whole finally constitutes one vast homogeneous mass, exerting its influence on value through its total quantity. 2. These general statements can be illustrated by consider- ing the history of some of the great changes in the supply of the precious metals. By far the most remarkable change in recorded history took place between the middle of the sixteenth and the middle of the seventeenth century. Then the production and supply of both gold and silver were revolutionized. For the sake of simplicity, gold has been chiefly spoken of in the preceding pages. But until comparatively recent times silver was a more important monetary metal than gold. Gold and silver were used inter- changeably at the period of this great revolution, and the sup- plies and the values of both may be treated for this period as if they were one. During the Middle Ages and the Renaissance specie had been comparatively scarce. Some supplies had been left over from the days of the Roman Empire ; and there was some production, especially of silver, in Germany, Sweden, Bohemia, Spain. The general range of prices was low. So far as can be made 256 MONEY AND THE MECHANISM OF EXCHANGE out from a comparison of the commodities dealt in then and now, prices in the fifteenth century were only one fourth or one fifth of what they were in the nineteenth. It must be remem- bered, too, that payment in kind was still largely prevalent ; hence the supply of gold and silver which was on hand served to carry on exchanges for only a limited part of the commodities produced and used. The discovery of America led in the sixteenth century to a sudden enormous increase in the supply. The conquest of Mexico in 1519-1521 and that of Peru shortly afterward enabled the rapacious Spaniards to seize large accumu- lated treasures. Even more important was the production from the rich mines of these countries, mines partly known already to the natives, partly discovered by the Spaniards. By far the most important were the mines at Potosi, discovered in 1545. Silver was chiefly produced, and it was in the form of silver that the monetary supply of Europe was chiefly increased. In the first decades of the sixteenth century the total production of silver had been on the average 1,500,000 ounces a year. It rose to near 3,000,000 ounces in the period from 1521 to 1544, and in the period beginning with 1545 (the year of the opening of Potosi) it leaped to 10,000,000 ounces a year. About the last figure it remained for two centuries thereafter. 1 This great mass of new specie was brought to Europe by the Spanish treasure fleets. A share was captured on the way by the English and Dutch buccaneers; but most of it reached Spain, and thence made its way over Europe. Very large amounts never went into circulation in Spain, but were sent by the Spanish monarchs, especially Charles V, Philip II, and Philip IV, to meet the expenses of their armies in Italy, Germany, France, and the Netherlands. Through one channel or the other, the silver and gold reached all Europe. In part, as was noted in the preceding chapter, it simply enabled exchange by money to supersede exchange by barter; it percolated, so to speak, into spaces not previously 1 Figures for the annual production of the precious metals are given regularly in the reports of the United States Director of the Mint. THE COST OF SPECIE 257 occupied. But even with this absorption, the increase in quan- tity was so great as to swell the amount of money relatively to the commodities exchanged, and so to bring about what is known as the price revolution of the sixteenth century. The total supply in Europe has been estimated thus : l GOLD (OUNCES) SILVEB (OUNCES) In 1493. . 17,682,500 225,050,000 In 1544 26,202,250 295,458,500 In 1600 :. 38,322,800 771 600 000 In 1660 48,225,000 1 005 330 500 Stated in terms of dollars, this means that the stock of gold and silver, taken together, rose from about $580,000,000 in 1493 to $1,620,000,000 in 1600 and to $2,500,000,000 in 1660. By the middle of the seventeenth century, prices had risen to double or treble what they were at the opening of the sixteenth century. The change worked itself out chiefly during the hundred years from 1550 to 1650, a century of far-reaching industrial transfor- mation in many directions, and of social and political changes as important, all complicated and affected by the great rise in prices. The great advance in prices the fall in the value of money was due unquestionably to the increase in the quantity of specie. But it would be misleading to speak of it as determined or measured by a corresponding change in cost of production. The miserable laborer more than half slave in Peru and Mexico was forced to his work in the mines by the brutal Spaniard ; great quantities of specie came from the rich mines ; but it would be absurd to speak of any commercial adjustment of value to cost. 1 1 take these figures (converting kilograms into ounces) from Wiebe's Geschichte der Preisrevolution im 1 6. und 17. Jahrhundert, p. 28 1 . They are at best very rough estimates. The figure for 1493 (the starting point) is most uncertain of all. Moreover, the estimates are for the total metallic stock, not for the monetary stock. My own impression is that the increase in monetary supply itself was greater than these figures indicate ; but one can have nothing more than an impression, no certain knowledge, s 258 MONEY AND THE MECHANISM OF EXCHANGE By the middle of the seventeenth century something like a state of equilibrium had been reached. The supplies of specie from the mines, it is true, continued to be as large as they had been since 1545, and even increased somewhat during the eighteenth century. But the total stock on hand had been so swelled that the continuing additions were of much less proportionate effect. A fair degree of stability in value had come from the durability of the accumulated stock. There was, moreover, a steady advance of population and wealth, an improvement in the arts, and so an increase of the quantity of goods presented for sale. Hence during the second half of the seventeenth century and the greater part of the eighteenth, the range of prices was tolerably stable, with rather a downward than an upward trend. During the first half of the nineteenth century, the trend of prices was dis- tinctly, though not rapidly, downward. This downward move- ment was not due to any decreased supplies of specie ; on the contrary, the production of silver increased considerably, and that of gold held its own. But the great expansion which had followed the industrial revolution of the eighteenth century was in full swing, and the quantity of transactions increased more rapidly than the monetary supplies. 3. Another far-reaching change in the production of precious metals set in about 1850. It was gold that now was chiefly affected. Gold deposits of extraordinary richness were discovered almost simultaneously in California and Australia. The pro- duction rose from an annual average of something like 500,000 ounces in 1820-1840 to an annual average of over 6,000,000 ounces in 1851-1860 ; and this rate of production was main- tained, with no marked changes, for nearly half a century. Stated in terms of dollars, the annual gold supply rose from, roughly, $10,000,000 in 1820-1840 to about $125,000,000 in 1850- 1895. During the twenty-five years from 1850 to 1875, as much gold was produced and added to the world's stock as had been produced during the three and a half centuries from 1492 to 1850. If the dividing line be put at 1840 (for there was al- ready a marked increase from 1840 to 1850), it appears that the THE COST OF SPECIE 259 gold product between 1840 and 1875 markedly exceeded that between 1492 and 1840. The change in the monetary stock was of course much greater. Of the amount which had been produced between 1492 and 1850, a large proportion had been lost by absorption in the arts, by abrasion, and (so far as Euro- pean countries were concerned) by exportation to the eastern hemisphere. The total monetary stock of gold in Europe was in 1850 about 38,000,000 ounces, or, in terms of dollars, about $780,000,000. So sharp was the increase in production that, by 1860, the total monetary stock (after allowing for industrial consumption during the decade) was reckoned at 88,000,000 ounces, or about $1,800,000,000. In ten years the monetary supply of gold had doubled. 1 The effect on prices after 1850, however, was not comparable to that of the earlier period. Price did indeed rise after 1850 in Europe and the United States, and remained at a com- paratively high level for about a quarter of a century. But the advance was one of only twenty or thirty per cent. No such revolution in prices took place as that which followed the discovery of America. The explanation of this slight effect from a cause apparently so powerful is to be found in several directions. There was a steady increase in the demand for money. The civilized world was progressing fast, and the volume of commodities produced and exchanged was enlarging. Next, and probably this was more important in the decades immediately after 1850, the new supplies of gold were added to an existing stock com- posed, not of gold only, but of both gold and silver, and of the two metals coined and used with equal freedom. In that stock silver had been the major constituent in 1850. Finally, the new supplies of gold in part served simply to displace silver Of this process of substitution more will be said when the topic of bimetallism is reached. 2 It suffices here to note that in France 1 I take these figures from Soetbeer's Materials on the Silver Question, 1887 (English translation, p. 150). 1 In the next following chapter. 260 MONEY AND THE MECHANISM OF EXCHANGE and other bimetallic countries, much gold simply took the place of silver, the silver being lost to civilized countries by steady exportation to the Orient. So far as such substitution went on, the new supplies of gold served to alter the com- position of the metallic money of Europe, but not to add to its total volume. There was indeed a net addition to the total volume, and an addition more than in proportion to the greater volume of commodities. Hence a rise in prices took place; but only to that moderate extent which has been indicated. 4. We pass over for the present the period of falling prices in the last quarter of the nineteenth century, since that period can be best considered in connection with bimetallism. In the production of gold, another great change has been taking place during the closing years of the nineteenth century and the opening years of the twentieth. The annual output of gold had remained nearly stationary after the Californian and Australian discoveries of 1850. During the decade 1880-1890, there had been some slight tendency to decline, but no marked change. Thereafter production rose rapidly ; it doubled before the close of the nineteenth century; it quadrupled within five years thereafter. In 1880-1890 the annual production had been on the average something like one hundred millions of dollars. In the year 1900 it was over 250,000,000 ; in 1910, 455,000,000. The change was almost miraculous. The total production of gold was greater during the twenty years 1891- 1910, than it was during the forty years 1850-1890 ; and during each of these periods it was much greater than it had been during the centuries that elapsed between 1493 and 1850. 1 This vast addition to the stock of gold was the foundation of the rise in prices which took place in the Western nations, and indeed the world over, during the first decade of the cen- tury (1900-1910). What other causes were at work, and to what extent the simple quantity theory must be modified hi 1 The production of gold may be grouped as follows : Aggregate during the 257 years, 1493-1850 152,000,000 ounces. Aggregate during the 40 years, 1850-1890 232,000,000 ounces. Aggregate during the 20 years, 1891-1910 284,000,000 ounces. THE COST OF SPECIE 261 accounting for the higher prices, need not here be considered. The increase in the gold supply was the dominant cause. It cannot be foreseen how far that increase will go, or how far it will contribute to yet higher prices. One circumstance which operated as a drag on the upward movement of prices in 1850-1875 was not present, namely, the displacement of silver. Gold had won its victory. Silver had been displaced once for all, or at least reduced to a subsidiary place. The additions to the gold supply were in the main net additions to the mone- tary stock of Western countries, and additions of extraordinary amount. No doubt, the great and steady growth in the volume of commodities brought an increasing demand to meet the increasing supplies of gold; but whether the demand grew in proportion must be doubted. The new supplies of gold were derived, as already remarked, chiefly from low-grade ores; that is, from great deposits of ore having a very low content of gold, but capable of being worked systematically on a great scale. It is profitable to mine ore which yields only $10 (half an ounce) to the ton ; that is, ore which contains gold in the proportion 1 : 75,000.* The most notable source of this kind is in South Africa, where the mines of the Transvaal tempted the fortune hunters and led to the subjection of the sturdy Boers. The so-called reef there is of great extent and calculable richness. For a con- siderable time the Transvaal mines alone produced annually nearly as much as the world's annual output in the richest period of the Californian and Australian discoveries. Similar deposits are worked, by the same improved methods, in the United States, and indeed in all parts of the world. American mining engineers and managers have been foremost in this march of improvement. As a result, the efficiency of labor in producing specie has been increased to the same degree as, nay, of late to a greater degree than in producing coal or iron or most manufactured commodities. 1 There are even mines, worked with handsome profit, in which the ore con- tains only $2.50 gold to the ton, or one part in 300,000. 262 MONEY AND THE MECHANISM OF EXCHANGE It is obvious that any uniform increase in the gold supply, even though great, tends to become progressively less in its effect. Each increment enlarges permanently the existing stock ; and the succeeding increments, though equally great, are less in proportion to the stock as enlarged. The increase in supply takes place by arithmetical progression ; it would have to take place by geometrical progression in order to continue to lift prices at the same rate as at the start. The monetary supply of gold doubled between 1850 and 1860. But after 1860, the stock on hand had been so much enlarged that, though the same annual output was maintained, the rate' of enlargement in the total supply was much relaxed. When a stream of water floods a valley, the first inflow raises the level very fast. As the inflow continues, there is a widening of the area over which the water spreads, and the same addition to the supply pro- duces a steadily lessening effect in raising the surface. So it is with an increase in the supply of the money metals. 5. At the beginning of this chapter it was said that w.e should expect gold to be governed in value by the principles that apply under varying costs and diminishing returns. That is, we should expect value to be determined, in the long run, by cost at the poorest source of supply, or at the marginal mine. In fact, however, over periods as long as it is commonly worth our while to consider, the relation is more nearly the op- posite. It is not so true that cost at the marginal mine governs value, as it is that current value determines what sort of mine shall remain in operation and shall become the marginal mine. This inverted relation is due to the operation of two of the factors noted in the first section : the durability and conse- quent large accumulated stock of gold, and the irregularity in the discovery of new supplies. The great stock on hand deter- mines or at least underlies the value of the specie. Those mines that are workable at this value continue to yield their supplies. Those that are not workable at this value cease. (We disregard here the aleatory character of gold mining, THE COST OF SPECIE 263 which causes no little production even at a loss.) The richer mines, which yield a large profit at current values, a fortiori continue to yield supplies; very probably the major part of the annual output comes from them. Value does not accom- modate itself to cost at their hands, because of the slow in- fluence of the annual yield on the total stock. A decline in the value of gold that is, a general rise in prices makes things harder for the poorer mines, and some of them cease operations. But cessation on their part may have but a neg- ligible effect on the total stock. Search for new mines is con- stantly going on. All new ventures add something to the annual yield, even though many of them are unprofitable and therefore only of temporary effect. Some of the ventures are highly successful, and on occasions as in California and Australia in 1850, and in the Transvaal since 1890 contribute huge supplies suddenly. It might be expected that a high value of gold (that is, low prices) would stimulate the search for it, a low value (high prices) dampen the search. Some such tend- encies there doubtless are. But they are overshadowed, in their effects on total stock and on value, by the steadiness of the total stock and the irregularities of discovery and exploita- tion. Historically, therefore, it is very difficult to discover any but the loosest connection between the cost of gold and its value. Over long periods for generations at a time the value of the metal determines which among the mines are able to hold their own. It is not these mines that determine the metal's value. This proposition, at all events, seems now to hold good of gold. Until very recent times it held good of silver also. During the great silver flood which followed the discovery of America, the mines in Germany and other parts of Europe had to ac- commodate themselves to the new range of prices and the new value of silver. Those which were no longer profitable under these new conditions ceased operations; and the silver pro- duction of Europe shrank sensibly during that period. Within the last thirty or forty years, however, silver has been put 264 MONEY AND THE MECHANISM OF EXCHANGE into a very different position. It has become, in the main, an industrial metal, like tin, copper, nickel ; and its value is determined now by causes essentially the same as those acting on these other metals. This great change in the position of silver is the main subject of the following two chapters. CHAPTER 20 BIMETALLISM 1. In the preceding pages no attempt was made to consider the relations between gold and silver. The supply of specie was treated as if gold and silver constituted a homogeneous mass. Throughout most of monetary history, however, prob- lems and difficulties have arisen in the endeavor to treat the two metals as homogeneous. These difficulties became accen- tuated in the nineteenth century, and finally resulted, at the close of that century, in the displacement of silver from the position of a freely coined money metal. This change, one of the most notable in monetary history, was brought about in a surprisingly short space of time. For long centuries silver had been freely coined, and had been the more important monetary metal; it was discarded from this use in the brief course of one generation. Both before and after the great inflow of specie from the Spanish-American mines, the two metals were used interchange- ably. Silver was relatively the more plentiful, and the more commonly used. It was entirely possible to coin each metal independently, and let the two sorts of pieces circulate together, but not on any common basis. Yet it was highly convenient to link them together in some way, so arranging their denomi- nations that they could be used interchangeably. Gradually the double standard system developed : both metals were manufactured into coins of the same or similar names and denominations. The method is illustrated in the system of the United States. The silver dollar contains 371 grains of pure silver, or 412? grains of silver -^ fine. The gold dollar contains (or rather, if coined, would contain) 23.22 grains of pure gold, or 25.8 grains of gold T$ fine. Their weights are to 265 266 MONEY AND THE MECHANISM OF EXCHANGE each other as 16 to 1 (15.988 is the precise figure, commonly spoken of as 16). This is the coinage ratio; the silver dollar contains sixteen times as much pure metal as the gold dollar. Similarly, in France, the five-franc piece of silver contains 347.22 grains of pure silver, and the corresponding piece of gold would contain 22.4 grains of pure gold. The coinage ratio in this case is 15j to 1. Under the pure and simple double standard both metals are freely coined. Any holder of silver bullion can bring it to the mint, and have it manufactured into coin without limit of quantity ; and the holder of gold bullion has the same right. Moreover, all coins, whether silver or gold, are made full legal tender for the payment of debts ; that is, of debts contracted, as most debts are, simply in terms of so many dollars or francs. These two elements free coinage and full legal tender are the essentials of the complete double standard. 2. When the double standard is adopted, the question arises whether the ratio at which the metals are coined by the mint and are thus given purchasing power in the form of money, conforms to their relative value as bullion. If at the mint 16 ounces of silver are coined in the market into as many dollars as 1 ounce of gold; and if, as bullion, 15 or 15^ ounces of silver can be sold at a price equivalent to 1 ounce of gold, no one will bring silver to the mint. The silver will be more valuable as bullion than as coin ; and experience proves that a very small fraction of difference suffices to decide that the metal shall not be presented for coinage. If, on the other hand, silver as bullion can be sold only at the rate of 16i or 17 ounces of silver for 1 ounce of gold, no one will bring gold to the mint. The holder of an ounce of gold can get for it at the mint only as many coined dollars as he can get for 16 ounces of silver. By exchanging his gold in the market for 16i or 17 ounces of silver bullion, he can get more coined dollars; and accord- ingly he will present at the mint silver bullion only. To repeat, a very small variation between the ratio fixed at the mint and that which rules in the open market, will cause one or the other BIMETALLISM 267 of the two metals to be the sole one presented at the mint for coinage. The metal which tends, under such conditions, to be pre- sented at the mint is said to be overvalued. The metal which is not presented, and which indeed may be subjected to the opposite process of being melted into bullion from coin, is said to be undervalued. Strictly speaking, the mint regulations do not put a valuation on either metal; they simply state the conditions of coinage. But the regulations, when they are those of the complete double standard, do lay down, in an effective way, a relative value. Where silver is coined at a ratio of 16 to 1 with gold, and silver is worth in the market 15 to 1 of gold, the coinage system says that 16 ounces of silver are required to buy as much as 1 ounce of gold; the market says that 15 ounces suffice. Silver is given a higher value in the market, a lower value by the mint; by the mint it is undervalued. And where silver is worth 17 ounces in the market, it is overvalued at the mint if coined at this same ratio of 16 to 1. The mint then says that 16 ounces of silver are required to buy as much as 1 ounce of gold, but in the market 17 ounces are needed to buy as much. That metal which is overvalued will tend to become the sole constituent of the metallic circulating medium. It alone will be presented at the mint for coinage. This, to be sure, will tend to withdraw it pro tanto from the bullion market; and this process will tend to raise its value as bullion. Con- versely the undervalued metal, not being presented at the mint for coinage, will tend to be more plentiful in the market as bullion ; and this will tend to lower in turn its value. The offer of free coinage under the double standard thus in some measure exercises a steadying influence on the relative value of gold and silver ; a fact which, as will presently appear, has been of no small importance in monetary history. But if there be a permanent force at work which brings about a continuing differ- ence, even though a slight one, between the market valuation and the mint valuation, then the undervalued metal will grad- \ 268 MONEY AND THE MECHANISM OF EXCHANGE ually go out of circulation, the overvalued metal will come more and more into circulation, and eventually the metallic money will consist of the overvalued alone. If there is a con- siderable and sustained variation between mint and market valuations, this process will work itself out very quickly; the cheaper or overvalued metal will displace the other in a very short time. No country's history presents a simpler illustration of these principles than that of the United States. When our coinage system was established in 1792, the complete double standard was adopted, at the ratio of 15 to 1. That ratio was chosen after careful inquiry; but it proved to differ from the market ratio, which was about 15i to 1. At least this ratio was accepted about ten years later for the coinage system of France. Silver accordingly was overvalued at the United States mint, and gold was undervalued. No gold was presented for coin- age, and the metallic circulating medium consisted wholly of silver. 1 In 1834, in consequence of various causes, 1 Silver dollars of United States mintage were, in fact, little used in this earlier period. The coins were chiefly of foreign mintage, largely Mexican dollars, which passed current at rates specified by law for their receipt in payment of public dues. The foreign coins took the place of the United States coins be- cause they were abraded or light weight. (Note what is said in 3 about Gresham's Law.) The changes in the coinage system of the United States are shown in the following table. The coinage ratio, it must be remembered, rests on the relative weight of pure metal in the coins. UNITED STATES COINAGE GOLD DOLLAR SILVER DOLLAR YEAH Standard Standard RATIO Gold (gross weight of Fineness Pure Gold Silver (gross weight of Fineness Pure Silver coin) coin) grains grains grains grains 1792 27.00 916.66 / /lOOO 24.75 416 892.4 / /1000 37li 15tol 1834 25.8 899.225 / /1000 23.2 416 " 37li 16.002 to 1 1837 25.8 900/ /1000 23.22 412 900/ /lOOO 37li 15.988 to 1 The pure content of the silver dollar has remained the same throughout, BIMETALLISM 269 partly a reaction against undue use of paper money, partly an irrational desire to use gold because of the discovery of what were supposed to be large deposits in North Carolina, the ratio was abruptly changed. It was made 16 to 1. It overvalued gold as much as the old ratio had overvalued silver. Gold alone was now presented at the mint for coinage. Silver gradually drifted out of circulation and out of the country. The change was virtually from a silver standard to a gold standard. After the California gold discoveries in 1850, the change became pro- nounced. Great quantities of gold were coined at the mint, and silver quite disappeared. Arrangements were indeed made (in 1853) for the use of silver, as subsidiary coin, and in later years its coinage into legal tender dollars was resumed; but these later modes of using silver present new questions, of which more will be said shortly. 3. The tendency of the overvalued metal to drive out the undervalued is often termed Gresham's Law. The name is derived from a Sir Thomas Gresham of the sixteenth century, who gets undeserved fame, as if he had been the discoverer of the tendency. The "law" is simply the commonplace fact, long recognized, that where coins of different bullion value circulate side by side, the poorer, if there be enough of them, will displace the better. The cheaper money metal will be used by preference in presentation at the mint and in making payments ; the dearer will be used by preference in the arts or for bullion purposes. An important illustration of this tendency is in the displace- ment of full-weight coins by light-weight or abraded coins of the same metal. Until very recent times the machinery for manufac- turing coins worked slowly and somewhat imperfectly. It was difficult to turn out a great many coins rapidly ; and the coins 371i grains of fine silver. The change in ratio was accomplished in 1834 by lessening the amount of pure metal in the gold dollar. In 1837 further minor changes were made, bearing chiefly on the proportions of alloy in the coins. These proportions had previously been irregular. The fineness was now made fa for both gold and silver, and at the same time a slight addition was made to the pure content of the gold dollar, making a trifling change in the coinage ratio. 270 MONEY AND THE MECHANISM OF EXCHANGE minted not only were subject to ordinary abrasion, but, in con- sequence of uneven mintage, were specially subject to clipping. New and good coins were therefore likely to be picked out for use in the arts or for exportation, while only the poorer pieces remained in circulation. Such seems to have been the common situation of silver coins until far into the nineteenth century. Silver com, because of its more frequent use, is more subject to abrasion than gold. It is, moreover, more likely to pass current and to remain in circulation, even though abraded ; for, since it is used in minor transactions, a trifling deficiency in bullion con- tent, even a considerable deficiency, is likely to be disregarded. People commonly accept the smaller pieces as they are offered in payment, without troubling themselves to inspect them. Hence to give an example in the United States during the period from 1792 to 1834, when silver was the money metal in circulation, foreign silver pieces of various mintage were in actual use. These foreign coins had been authorized for use in public payments, because at the beginning no United States mint or coins existed. When the mint was established and coins were issued from it, the new coins could not displace the foreign pieces, being full-weight and preferably used for the arts or exportation. Hence the coinage, which seemed futile, was discontinued, and only the more or less inaccurate foreign coins remained in circu- lation. Difficulties of a similar sort were long encountered in all European countries, from the Middle Ages through the eighteenth century. The remedies for them are simple : first, the plentiful and accurate manufacture of full-weight coin ; second, the withdrawal of all legal sanction (such as receipt in payment of public dues) from other coin; and third, the redemption at the public charge of pieces which become worn by ordinary wear. It was formerly common to enact that pieces which had suffered in weight beyond a certain tolerance should not only lose their validity as legal tender, but should be redeemed at the mint merely as bullion, not at their face value. The holder, thus called on to suffer the loss in value from abrasion, tried to pass them on to another person. Since the payment of ready money is BIMETALLISM 271 usually welcome to the payee, even coins much abraded remained indefinitely in circulation. It is now the common practise, and the sound one for governments, to redeem at their face value all coins which have not been intentionally clipped or sweated. 1 At the same time, the machinery for providing new and good coins is amply adequate. Hence the particular troubles here described have well-nigh disappeared. 4. The difficulties commonly experienced under the double standard have caused resort to another mode of using both met- als together. Gold is made the only freely coined metal and the only one having complete legal tender quality, and silver, though still coined, is not coined freely, but in limited amounts and solely for use as a minor coin. This method was first systematically followed by England when she adopted the single gold standard in 1816. It has since been adopted, so far as subsidiary silver is concerned, by all the civilized countries, and has become a normal accompaniment of the existing gold standard system. The system of the United States may serve as an example. The high value of gold makes it unavailable in minor payments. The smallest gold piece which can be conveniently used is the quarter eagle ($2.50), corresponding to the British half sover- eign, the German ten-mark piece, the French ten-franc piece. Even the quarter eagle and the corresponding coins of foreign countries are of doubtful serviceability ; they are easily lost or overlooked, and are subject to comparatively rapid abrasion. A piece of the sovereign or half eagle size ($5) is the smallest gold coin that is thoroughly satisfactory. Yet a multitude of transactions must be settled with money of smaller denomina- tions. Silver coins are convenient in sizes from the ten-cent piece to the dollar piece. For the smallest transactions, even silver has not bulk enough; for these, resort must be had to nickel and copper. Under the complete double standard it may well happen that, if silver is undervalued, all the silver coin, large and small, 1 The United States, however, redeems gold coins at their face value only where the depreciation is not more than one-half of one per cent. 272 MONEY AND THE MECHANISM OF EXCHANGE will disappear and that an inconvenient scarcity of small change will ensue. This is precisely what happened in the United States under the system which was adopted in 1834 and 1837. Silver then was undervalued, and gold gradually took its place. When finally the California gold poured in abundantly after 1850 and gold coinage at the mint assumed large dimensions, silver completely disappeared from circulation. Hence in 1853 an act was passed which created the subsidiary system in this country. Silver coins were authorized, half dollars, quarters, and dimes, containing so light a content of fine silver that no one would be tempted to export them or to melt them for the arts. The silver half dollar, for instance, was made to contain (and still contains) 172.8 grains of fine silver, or 345.6 grains for two half dollars. The silver dollar, whose free coinage at that time was still authorized, contained (and still contains) 37li grains. If all silver coins had been freely minted at the rate newly adopted for the half dollars and for the other subsidiary coins (345.6 grains to the dollar), silver would then have been overvalued, and in turn would have displaced gold. But some- thing very different from free coinage was put into operation. No private person was entitled to present silver at the mint for conversion into small coin. The government itself bought the silver bullion in the market, and alone arranged for its coinage. The amount which the government thus bought and coined was limited to the quantity supposed necessary to meet the needs of small-change transactions. Thus the silver coins would not be exported, and yet would not displace gold. To guard against possible abuse, it was further provided that the subsidiary coin should be legal tender only up to a limited sum, now fixed at $10. Obviously, the government makes a profit by an operation of this sort. The overvalued silver coins are paid out by the gov- ernment in its ordinary disbursements, or are exchanged by it for full-value gold. In either case there is a profit. This also is often called a "seigniorage," though it differs in important respects from the seigniorage which may be charged on the freely coined and full-value pieces. BIMETALLISM 273 Such are the essential principles of subsidiary coinage. Sub- stantially the system had long been followed as to the copper and nickel coins adapted for petty transactions. These have been token coins ever since gold and silver came to be used as the standard metals. In fact, the underlying principle an artificial value due to limitation of quantity was followed, or attempted to be followed, in the " billon " coins common in Europe from the Middle Ages until the first part of the nine- teenth century. These were pieces in denominations for small transactions, having some percentage of silver, but chiefly alloy, issued by kings and princes primarily for profit, and given a circulation within their territories. The issues were often ex- cessive ; the opportunity for profit was abused. In this regard, as in so many others, coinage practise during the nineteenth century was greatly improved, and now is well-nigh perfected. No state now coins subsidiary pieces, whether silver or nickel or copper, with a view primarily to profit. The profit accrues because it is incident to the best method of providing a conven- ient medium for small transactions. The regulation of subsidiary coin is carried on with variations of detail in different countries. The quantity coined is some- times fixed at so much per head of population. Thus in Ger- many subsidiary silver is minted at the rate of 15 marks (for- merly 10 marks) per head of population ; in France at the rate of 7 francs (formerly 6 francs) per head. In Great Britain no specific limit is set ; the Bank of England arranges for the coin- age of such amounts as experience from time to time shows to be needed. In the United States, also, no limit is set. To prevent any possible depreciation of the subsidiary coin, it is usually redeemable at its face value by the government treasuries when presented in reasonable quantity. Thus in the United States subsidiary silver coins are redeemable when pre- sented in sums of $20, in Germany when presented hi sums of 200 marks. The same object is accomplished by receiving them without limit of quantity in payment of public dues, as is done in France. T CHAPTER 21 BIMETALLISM, continued. THE DISPLACEMENT OF SILVER 1. We turn now to a consideration of the relation between silver and gold during the nineteenth century and to the train of events which ended in the virtual discarding of silver and the general adoption of the single gold standard. The double standard, as has already been said, prevailed over almost all Europe until very recent times. It was chosen by the United States, in 1792, as the normal system. It was maintained by France when in 1803 she established her present system of decimal coins. In England, it is true, the single gold standard, with silver for subsidiary coins only, was adopted in 1816. England had had, through the eighteenth century, a nominal double standard, with a circulation composed in fact chiefly of gold. In 1816 the gold standard was formally and definitively established. But on the continent of Europe in general the double standard prevailed, with a stock of metallic money made up, as a rule, chiefly of silver. France alone had a circulation in which gold, though by no means the largest constituent, yet was important side by side with silver. That great country emerged from the wars of the Napoleonic period in a prosperous state ; and her greatness, continued prosperity, and her large stock of both metals had an important influence on monetary history for over half a century. It has already been said that the very existence of the double standard tends to bring the relative values of gold and silver toward the ratio chosen. When a supply of the overvalued metal is attracted to the mint, so much less of it is left in the open market. Its value tends to rise, it becomes less overvalued, perhaps ceases to be overvalued at all. When, on the other 274 THE DISPLACEMENT OF SILVER 275 hand, a supply of the undervalued metal is melted or exported, so much more of it comes on the market. The additional sup- ply tends to lower its value, and the market ratio comes nearer to the mint ratio. A country having a double standard may be said to be in the position of one who offers to buy and sell at its coinage ratio (say 15? to 1) any quantity of gold and silver that may be offered. This is not literally the case ; the country does not directly buy gold and silver bullion. But its free coinage of both is tantamount to purchase, so long as a supply of both metals remains in circulation, and the substitution of one for the other can actually take place. When once either metal has completely displaced the other, this consequence no longer appears. Some effect of this sort was produced by France during the second quarter of the nineteenth century ; and a marked effect was produced in the third quarter. 1 Whenever the price of silver fell in terms of gold, silver tended to be sent to France for coinage, and gold tended to flow out of France. Whenever the price of silver rose in terms of gold, gold tended to be sent to France for coinage, and silver tended to flow out. A high price of silver in terms of gold means, of course, a low market ratio, while a low price of silver means a high ratio. 2 During the greater part of the period from 1820 to 1850, the price of silver was somewhat lower than the equivalent of the French ratio of 15| to 1. Silver tended to flow into France ; gold tended to flow 1 The first quarter of the nineteenth century was much disturbed ; moreover, our information as to the flow of specie into and out of France is exact only after 1822. Hence the narrative in the text is confined to the second and third quarters. 2 The relation of the ratio to the usually quoted price of silver may be stated thus : AT THE RATIO OF THE PRICE OF FINE SILVER IN UNITED STATES MONET is THE PRICE OF BAR SILVER (.925 FINE) IN BRITISH MONET is 16 :1 15i: 1 15 :1 $1.2919 per ounce 1.3336 per ounce 1.3780 per ounce 58.93d. per ounce 60.83 per ounce 62.86 per ounce 276 MONEY AND THE MECHANISM OF EXCHANGE out. The French circulation then consisted chiefly of silver; the proportion of gold was not large, and a very great substitu- tion would have led to the complete disappearance of gold. That stage was nearly reached, but not quite. France was growing in population and wealth, and there was the basis for a large net increase in the stock of specie. Much of the added silver made its way into circulation without displacing gold, and the outflow of the latter metal, though it seems to have come very near to exhausting the stock in circulation, did not entirely do so. After 1850 the situation abruptly changed. The unexampled supplies of new gold from California and Australia were poured into the world's markets. The price of silver rose ; the ratio fell. It became advantageous to send gold, not silver, for coinage into France. A very great influx of gold took place, amounting for the decade 1850-1860 to over three thousand million francs ($600,000,000). A corresponding, though by no means an equal, outflow of silver took place. For in this period, as in that pre- ceding, France increased her metallic stock, with the difference that now the addition was all in the form of gold, whereas before it had been chiefly in the form of silver. The silver which was steadily exported from France tended to keep down the price of silver bullion in the market, and so maintained the market ratio not far from 15^ to 1, though now with a tendency to a figure lower than 15^ rather than higher. The bimetallic regime in France during the period immediately following 1850 thus served to steady both the general range of prices and the ratio between gold and silver. A great part of the new gold simply displaced silver in France. The superseded metal, again, made its way very largely to the East. The con- stant movement of specie to the East, which has already been described, happened in this period to be unusually large. There the silver was absorbed without sensibly affecting prices even in those regions. The free opening for coining both metals in France has been justly described as operating like a parachute to arrest the fall in the value of gold. Some fall that is, some THE DISPLACEMENT OF SILVER 277 rise in prices did indeed take place ; but it was less sharp than would have been the case without the French coinage influence. This episode has been cited by the advocates of bimetallism, and justly, as an illustration of the benefits that may come from their system. Some critics have maintained that the result failed of attainment, so far as concerns the relative value of gold and silver, because the market ratio was not perfectly steady. It fluctuated, tending to be a trifle above 15 to 1 before 1850, a trifle below after 1850. But no one would maintain that an unfailing steadiness at the price exactly equivalent to a ratio of 15^ to 1 was either possible or in any significant degree desirable. It suffices if a reasonable approach to steadiness is secured. Some fluctuations, according to the changing currents in inter- national trade and in the foreign exchanges, are inevitable ; so much will become clear when at a later stage the subject of the foreign exchanges is taken up. In essentials, the bimetallists can point to the French experience, certainly during the period after 1850, as counting in favor of their system. 2. Later in the nineteenth century another change set in, not quite so abrupt as that after 1850, but no less unexpected. The production of gold had reached its maximum about 1860, and thereafter barely held its own. The inflowing new supplies were still very great as compared with any period before 1850 ; but they spread over a larger area, and they were met by an in- creasing volume of goods. The industries of the civilized world were rapidly expanding, and the demand for money on the whole kept pace with the supply. On the other hand, a change began in the production of silver. Great discoveries were made in the United States, the beginnings of an increase in the pro- ductiveness of silver mining as striking as that which had taken place in gold mining. The price of silver in the market fell slightly about 1865. Silver no longer flowed out of France, and some silver flowed in. The market price for a few years was equivalent almost exactly to the ratio of 15 to 1. Then in 1873 it fell more sharply, became equivalent to a ratio of 16 to 1, and 278 MONEY AND THE MECHANISM OF EXCHANGE led to a new inversion of the movement ; gold began to flow out of France in large quantities, and silver began to flow in. This inversion proved unwelcome. Gold had come to be regarded, reasonably or unreasonably, as .the preferable metal. The practise of England, the leading industrial country, was the main cause of this preference. The German Empire, when re- organizing its currency system in 1871, adopted the gold standard once for all, influenced chiefly by the English example. The coinage of the United States had been, after 1850, practically on a gold basis. France, not wishing to lose her gold, in 1873 stopped the free coinage of silver. In this measure France no longer acted alone. With other countries she had formed in 1865 the Latin Union ; the other countries being Belgium, Switzerland, Italy, and Greece. 1 The main object of the Union was the adoption of a uniform decimal coinage system, based on the French franc. Complete bimetallism, with free coinage of both metals at 15 1 to 1, was also adopted ; and thereafter all these countries had to act in common in their mint and coinage legislation. France was by all odds the most important power in the Union, industrially as well as politically. With the checkered and interesting history of the Union we have not space to deal. It served a useful end by promoting the spread of the rational franc (decimal) system, but it led to much friction and inconvenience between the adherent countries. So far as the coinage of silver was concerned, the states of the Latin Union found it necessary to act together. The decisive steps were taken in 1873-1874 ; then free coinage ceased, though not all of silver coinage. In 1873 France, acting alone at first, limited the amount of five-franc pieces (that is, of full-tender silver) which would be coined at the mint. Belgium, also acting alone, im- posed a similar limitation in 1873. In 1874, the Latin Union, by a special agreement, prescribed the same policy for its mem- 1 Greece joined the Latin Union in 1868. Spain adopted the franc system, but did not join the Union. Greece and Italy, though members, have counted for less than the other countries, because their currency, during practically all of the time when action regarding silver coinage was under consideration, was on a paper basis. As to the working of paper money, see Chapter 23, below. THE DISPLACEMENT OF SILVER 279 bers, the amount of five-franc pieces to be coined being appor- tioned among them. Limitation was soon followed by com- plete cessation. In 1878 the coinage of five-franc pieces was stopped; and it has never been resumed. Bimetallism came to an end. The cessation of silver coinage left the metallic circulation of these countries in a situation not different on the surface from that of bimetallism, yet in essentials very different. Gold and silver coins continued to circulate side by side, and maintained the relative values assigned to them at the mint. The silver five-franc pieces were not subsidiary coins; they were legal tender without limit in payment of debts. Yet in important respects they were like subsidiary coin. They were no longer freely minted ; and their intrinsic or bullion value was different from that which they had as coin. The price of silver bullion continued to fall after 1873 and after 1878. If free coinage of silver had been retained in France and the Latin Union, silver would have been presented at their mints in larger quantities. But it was no longer accepted. Gold alone was freely coined. The silver coins were as good as the gold for payments within each country, and indeed throughout the Union, since they were of uniform shape and content. They were (and are) legal tender without limit; and they were received without limit in payments to the government for taxes and other dues. Large quantities of gold, on the other hand, were also in circulation. This gold had to be in use, in addition to the silver. If the monetary supply had been confined to the silver alone, its limited quantity would have caused prices to be low ; this again would have caused imports to be small, exports to be large ; money would have flowed hi ; and the only kind of money which now could flow in was gold. 1 The silver five-franc pieces, like the subsidiary coin, were given an artificial value by the limitation of their quantity; and their value conformed to that of freely coined gold. 1 The reasoning here anticipates what will be said later of the working of international trade. But this part of the theory of international trade is so simple that its bearing will be readily seen. Compare Book IV, Chapter 32, 280 MONEY AND THE MECHANISM OF EXCHANGE To this situation in France and the Latin Union, never estab- lished by design, but reached through a succession of unfore- seen steps, the name " limping standard " has been applied. The silver coin, though intrinsically of less value than the gold, hobbles along, maintained at equality by being coupled with its stronger associate. The same situation has developed in other countries also, partly by deliberate action, partly by steps taken with as little intent as in the Latin Union of bring- ing about a limping standard. 3. Germany adopted a limping standard deliberately, though only as a transitional measure. As has just been said, her gold standard was adopted in 1871, when a uniform coinage system was created for the newly established empire. The monetary unit was the mark, whose gold content is nearly that of the English shilling ; that is, the twenty-mark piece is not far from the English sovereign. The metallic circulation, however, had been before that time chiefly of silver, largely in the form of thaler pieces having a silver content equal to that of about three and one half francs. These thaler pieces were in part withdrawn and replaced with new gold pieces. But in part they were left in circulation. Their complete replacement with gold was a task which it was thought best (and wisely so thought) to carry out gradually. No new coinage of thalers, of course, was permitted. Those left in circulation were declared legal tender at the rate of three marks for the thaler. Notwithstanding their insufficient in- trinsic value, they were left on a parity with gold precisely like the silver five-franc pieces of the Latin Union, by the limitation of their quantity, by their full legal tender power, and by their acceptance in payment of all public dues. The original intention had been to leave the thalers in cir- culation only during a comparatively brief period of tran- sition. It was expected that from time to time, as they were received in the public tills, they would be withdrawn, melted into bullion, sold as such, and replaced by gold coins. This process, indeed, went on for a few years. But after 1873 the THE DISPLACEMENT OF SILVER 281 price of silver fell sharply, and sales of the metal were a losing business. Moreover, the advocates of bimetallism bitterly opposed the sales. The German government, by way of partial concession to the bimetallists, and also from a cautious desire to await the future as to the supplies and availability of the two metals, in 1879 stopped the withdrawal of the thalers and the sale of the bullion. For many years thereafter the thalers remained in circulation. In 1900, however, steps were finally taken toward getting rid of them, though in a way some- what different from that originally contemplated. The act of that year provided for their retirement by gradual recoinage into subsidiary money. The permissible amount of subsidiary coin, which had been originally ten marks per head, was then raised to fifteen marks ; the additional quantity of such coin was to be got by using the old thalers. Most of the thalers were soon recoined, and the rest will disappear as the increase of the population of Germany calls for more subsidiary coin. Virtually, the limping standard has ceased to exist in Germany. 4. In the United States a result exactly similar to that in France has been brought about, without intent, through a succession of compromises and half measures. The history of this episode cannot be fully understood until price move- ments and paper money have been dealt with. So far as the silver situation is concerned, it will suffice to state briefly the important events. In 1873 the coinage of silver dollars that is, of the full tender, freely coined silver was dropped in the United States. It was in this year, too, that France suspended free coinage; but the coincidence in date was fortuitous. The United States in 1873 had only paper money in circulation; depreciated paper, or so-called fiat money. If there had been specie hi circulation (and for some important purposes specie was in use, though not in active circulation) ,'that specie would have been gold. After the coinage changes of 1834 and 1837, and the influx of new gold that began in 1850, gold alone had been the real basis of the monetary system. The existence of a nominal 282 MONEY AND THE MECHANISM OF EXCHANGE double standard had been forgotten. In 1873 the coinage legislation of the country was overhauled and consolidated, in the expectation, realized in 1879, that paper money would be given up soon and a specie system reestablished. In this revision of the statutes, the silver dollar was dropped from the list of coins that could be struck. Therewith bimetallism, long obsolete in practice, was formally ended by law. The change naturally attracted little attention. In later years, when a strong agitation for renewed use of silver had sprung up, the dropping of the silver dollar was often called "the crime of 1873." It was supposed to have been stealthily done by per- sons interested in securing the gold standard. In fact, it was done quietly because nobody at the time thought it of any moment. After 1873 a period of depression and of falling prices set in. A strong party in the United States wished to check the fall, and welcomed any legislation which would add to the quantity of money in use. 1 For a generation, there was agitation for a return to complete bimetallism, to the free coinage of both gold and silver. At the old ratio of 16 to 1, and at the market prices of silver after 1873, this would have meant the actual coinage of silver alone. Yet this radical step, though often it seemed impending, was never taken. By way of compromise two great measures were passed, each providing for a large though limited quantity of overvalued silver dollars. In 1878 the so-called Bland-Allison Act was passed, requiring the monthly purchase by the government of not less than $2,000,000 worth of silver bullion, nor more than $4,000,000 worth ; this bullion to be coined into dollars of the old content (412i grains of standard silver, 371i grains of pure silver). The minimum only under the act was in fact bought and coined, $2,000,000 worth of silver. The number of dollars obviously was more than two million a month. If the price 1 Not a political party is here meant ; neither Democrats nor Republicans were consistent in their policy as regards silver coinage. The silver party was made up of adherents from both political parties. THE DISPLACEMENT OF SILVER 283 of silver, in terms of the money which the government used in buying it (this money was gold after 1879) happened to be low, more silver bullion could be bought with the fixed sum of $2,000,000 and a larger number of dollars coined ; if the price was high, less bullion could be bought, and less dollars coined. In fact, during the period from 1878 to 1890, when this act was in force, the outcome was the monthly coinage on the average of about two and one half million silver dollars, or thirty million a year. These dollars were precisely like the French five-franc pieces; overvalued, limited in quantity, full legal tender, and in every respect as valid for payments as gold. In 1890 a second measure was enacted, again a compromise between free silver coinage and rejection of silver. Without entering on the details of this complicated and luckless statute, it may be said, in sum, that during the three years of its life (it was repealed in 1893) silver was purchased by the govern- ment which added eventually not less than 218,000,000 silver dollars to the country's money supply. Under the act of 1878, there had been coined, in round numbers, 352,000,000 such dollars. When these operations finally came to an end, a total of 570,000,000 dollars of overvalued silver had been injected into the circulating medium. It is not so much in the form of coin, as in that of the silver certificate, that the silver has made its way into actual circula- tion. This kind of paper money, as the name indicates, is merely a certificate or warrant stating that so many silver dollars (one, two, five, as the case may be) are held in the government vaults and will be paid to the bearer on demand. Since the paper representatives are for most people more conven- ient than the somewhat bulky dollars, their issue has greatly facilitated the actual circulation of the additional money. Evidently the possibility of adding these hundreds of millions to the monetary supply of the United States, and yet keeping them equal in value to gold, has rested on the fact that this is a huge country; and not only a huge country, but one 284 MONEY AND THE MECHANISM OF EXCHANGE whose industry advances at a prodigious rate. In addition to the silver, there are other forms of overvalued money. The bank notes and government notes in circulation, which will be described in the ensuing chapters, may also be said to be over- valued. An indefinite increase in the quantity of all this overvalued or "fiduciary" money would mean the eventual expulsion of gold. Indeed, at one time, between 1890 and 1893, the rate of increase, under the act of 1890, was so great that gold seemed about to be expelled; and this probability was one cause of the remarkable crisis of 1893, and of the repeal of the act. In recent years, the population, resources, and industrial output of the United States have advanced by leaps and bounds. The quantity of commodities offered in exchange for money has risen enormously. Hence gold has not only remained in the country, side by side with the silver, but the quantity in monetary use has much increased. The conse- quence has been that the overvalued silver has had its stronger companion side by side, and has been held up to an equal value ; it has been as good as gold. 5. One other important event remains to be noted, the last in the chain of those which deposed silver from its former monetary place. In 1893, the same year in which the United States ceased its purchases of silver for coinage into dollars, British India put an end to the free coinage of silver. The flow of specie to the East, already referred to, 1 had always been chiefly in the form of silver. British India, by far the most important country of the East, had coined that silver freely into rupees (whose bullion content is about two fifths that of the United States dollar). The continued fall in the price of silver caused serious embarrassments, of which more will be said elsewhere. 2 After long and patient waiting, the British government in India finally took the drastic step of closing its mints to silver. Thus in one year, 1893, the last two great markets for silver the United States and British 1 Chapter 18, 4. * Chapter 23, 5 ; Chapter 32, 6. THE DISPLACEMENT OF SILVER 285 India were closed. This was just twenty years after the France mint began the great change. The bottom seemed to drop out of silver in 1893. Its pro- duction had been steadily increasing for a quarter of a century. Before 1870 the annual supply from the mines had been about thirty million ounces. After 1870, it rose thus : MILLION OUNCES Average annual product in the 5-year period 1871-1875 63 1876-1880 79 1881-1885 92 1886-1890 109 1891-1895 158 1896-1900 165 1901-1905 168 So great a fresh supply pressing on the market, with most mints closed to free coinage, caused a steady decline in price. In terms of United States money, the ounce of silver fell from $1.29 in 1873 to about $.90 in 1892. The American purchases under the acts of 1878 and 1890 did not serve to prevent that decline, though doubtless they made it less abrupt. With the two closures of 1893 (in the United States and British India), the price fell sharply to $.67. In 1894 it was on the average about $.64. Since 1893 silver has maintained, on the whole, the levels reached in that year both as to production and price. The production has not sensibly diminished or sensibly increased; the price has been in the neighborhood of $.60 an ounce. At that price the market ratio is about 34 to 1. It follows that the silver dollar contains less than half its nominal content; that is, as metal it is worth less than fifty cents in gold. The French five-franc pieces are overvalued to a similar degree. Silver has become in all the leading countries a commodity like any other, fluctuating in price according to market condi- tions. It is bought in large quantities by governments for manufacture into subsidiary coin, and the demand for this purpose has proved to increase steadily. It is used in the arts in growing quantities; and the East still absorbs considerable 286 MONEY AND THE MECHANISM OF EXCHANGE amounts, partly for monetary use, partly for ornament, partly for hoarding. That its production continues undiminished, notwithstanding the great fall in price, indicates that its marginal cost is not greater than the price that has ruled during the last fifteen years (1893-1908). It will now be obvious why, as was stated in the preceding chapter, the value of silver is related to its expenses of pro- duction in a different way from what it was in former centuries? and in a different way from gold. Silver no longer has a free opening in monetary use. The annual supply can no longer be added, as can that of gold, to a vast monetary stock. What part shall be added to the circulating medium in the form of subsidiary coin depends on the purchases which governments choose to make. The annual supply is sold, like that of other metals, at whatever price it will fetch. The price corresponds in a rough way to its marginal cost, and is in a rough way determined by its marginal cost. The existing silver coins of the countries of the limping standard are kept at an artificial value ; but this artificial value has no influence on the value of the newly accruing output from the mines. 6. Two entirely different questions of principle arose during the course of the deposition of silver. One concerned the rela- tive values of gold and silver, and the effects on those relative values of bimetallism and of monometallism. The other con- cerned the general range of prices and the effects on prices of bimetallism and monometallism. The bimetallists contended that their system conduced to a more stable ratio between silver and gold. They also contended that it conduced to a greater stability in prices. On the first question they were probably in the right ; on the second question the verdict of recent history has been on the whole against them. We have seen, in the case of France, that the very existence of complete bimetallism free coinage of both metals tends to keep the value of the two metals in correspondence with the ratio. Suppose now that the industrial area over which free coin- age prevailed had been very much larger than France. Sup- THE DISPLACEMENT OF SILVER 287 pose that not only France and the Latin Union, but England, Germany, the United States, had coined silver and gold freely at the French ratio of 15? to 1. From this vast area the ex- pulsion of gold would have been difficult, nay, well-nigh impos- sible. The countries mentioned include all those in which gold is freely coined on a great scale, or at least all those in which gold was so coined during the period of the great fall in silver. Whither could the gold have been driven ? The ordinary avenue of departure exportation could hardly have been followed, since there were no important countries to which large quan- tities of gold could have been exported. A rapid rise in general prices would perhaps have stimulated a markedly increased in- dustrial consumption ; but this would have been a slow process, coming to its term long before all the gold had been absorbed in the arts. A rapid rise in general prices, again, might conceivably have checked the production of gold ; but this, too, would have been a slow and uncertain process, having its term like the other, at the point where the poorer mines had been brought to a stop. The monetary stock of gold would have remained in monetary use without great change, and would perforce have remained in circulation side by side with silver. This result would have been the more probable because, if the leading coun- tries had adopted bimetallism at a common ratio, the lesser countries would have been likely to join them. International bimetallism, applied unflinchingly by the leading countries, would have brought about the proximate object, the con- current circulation of the two metals as money, and a market value corresponding to the mint ratio. This conclusion is subject to possible qualification. It rests on the assumption that people in general, and the business com- munity in particular, would accede to the regulations contem- plated (and in part prescribed) by governments. Thus, silver would be made a legal tender in payment of debts, and therefore as good as gold for a vitally important monetary use. Con- ceivably, however, general opinion general prejudice, if one is disposed so to call it would boycott the use of silver. As 288 MONEY AND THE MECHANISM OF EXCHANGE . will be seen in connection with the history of paper money, 1 the power of government in forcing the use of a particular kind of money has its limits. To make money legal tender is by no means necessarily to make it pass in general circulation. But in the special case here supposed for silver, it is not probable that a government would have overpassed the limits within which it would affect the use of money. Silver was in most parts of the world, in the period from 1873 to 1893, a familiar and not unwel- come form of money. True, in Great Britain it was not familiar, and much prejudice in that country, and in the United States and Germany also, would have had to be overcome; yet the obstacles against the acceptance of the new situation would hardly have been insuperable. The direct obstacles in the way of international bimetallism were political. There never was a chance for the conclusion of a compact. Great Britain at no time was willing to accede, except as to British India, which would not have brought any new strength to the bimetallic league. Without Great Britain, Germany would not come in ; without at least one of those coun- tries, the United States would not. Whatever the abstract possibilities of united bimetallism, the project never had a working prospect of realization. 7. Very different is the second question that arose, regard- ing the stability, not of the ratio between the metals, but of the general range of prices. And this, obviously, is by far the more important question. It does not matter much to the com- munity (though it may very greatly concern the mine owners) whether silver exchanges for gold at the rate of 15 to 1 or 30 to 1. But it matters very much whether prices go up or go down or remain stable. That they should remain as stable as possible is the desirable situation. How far would international bi- metallism have promoted this result? The answer to this question depends on the extent to which the total supply of specie gold and silver would have been affected. In the year 1890 the answer seemed doubtful. 1 See below in this book, Chapter 23, 1. THE DISPLACEMENT OF SILVER 289 The production of gold then seemed virtually stationary. That of silver, on the other hand, was rapidly mounting, in face even of a steady fall in the price of silver. The opponents of bimetallism maintained that silver, once restored to free coinage, would be produced in immensely greater quantity. Under modern mining methods, vast known deposits of low-grade silver-bearing ore can be treated; the question is not one of discovery or speculation, but simply of calculable profit. Raise the price of silver to $1.33 an ounce (the price in United States gold corresponding to a ratio of 15^ to 1), and floods of silver may be expected to come out. Some cool-headed observers predicted that the addition to the monetary stock would be so huge as to double prices in ten years. The bimetallists on the other hand said that the increase in output would not at all be so great, and that, with a stationary or declining output of gold, and with a great area over which the total stock could spread, the change in prices would be slow, and so far as it did take place rather beneficial than otherwise. Whatever doubt there may have been regarding the probabili- ties of the case and there was much, about 1890 was set at rest by the new conditions governing the supply of gold which set in after that date. The wonderful increase in the annual product of that metal has already been described. The danger of a scant supply of gold so scant as to keep prices moving downward disappeared. If silver had been freely coinable as well as gold, the total supply of the two metals would have in- creased without fail at a portentous rate. Even at the low prices of silver which have prevailed since 1893, the production of that metal has not diminished; it has remained stationary. At doubled prices, it would surely have increased rapidly, and so have added much more to the supply of specie. Bimetallism would have led not to stable prices, but to prices even less stable, and advancing even more rapidly, than under the single gold standard. The extraordinary increase in the production of gold has put an end, probably forever, certainly for an indefinite period, to all proposals for rehabilitating silver. CHAPTER 22 CHANGES IN PRICES 1. Two topics will be taken up in the present chapter: first, how to ascertain and measure whether changes in prices have taken place ; second, what are the consequences for good or ill of such changes. Of the causes of the changes nothing more will be said for the present. The measurement of changes in the value of money would be easy if all prices went up and down together. But this they never do. Some prices go up, while others go down. Occa- sionally in times of very great and rapid movement, all prices change in the same direction. Even then, they do not all change to the same extent ; some rise or fall in less degree than others ; hence, though the fact of a change in a given direction may be clear, the extent of the change becomes difficult to meas- ure. To get a summary expression of the general trend of prices, resort is had to the method of index numbers. An example will best explain how an index number is constructed. Suppose that on January 1, 1900, the price of iron was $15 a ton, of wheat $1 a bushel, of cotton 10 cents a pound, of wool 40 cents a pound. These are called the base prices. Later prices are expressed in relation to them, usually by stating them in terms of a percentage. Suppose that a year later, on January 1, 1901, the prices of these four commodities have come to be $20 for iron, $1.25 for wheat, 10 cents for cotton, 36 cents for wool. Then the actual prices, and the percentage relation between them, would stand thus: 290 CHANGES IN PRICES 291 190 i< )01 BASE PRICE 100 PRICE PERCENTAGE TO BABE $15.00 100 $20.00 133 Wheat 1.00 100 1.25 125 Cotton .... .10 100 .10 100 Wool .40 100 .36 90 Total .... 400 448 Average (arithmeti- cal mean) 100 112 The index number was 400 for 1900, and rose to 448 for 1901. Reduced to the arithmetic mean, the index number for 1900 was 100; that for 1901 became 112. Sometimes index numbers are given in the first form by simple summation ; such, for example, is the mode in which the well-known index number of the Lon- don Economist is made up. More often the numbers are aver- aged. The base average, of course, is always 100 ; the average for any other year is then a percentage of the base average. In the example just given, the index number shows a rise in prices of twelve per cent ; or, rather, as the very word " index " implies, indicates a rise to that extent. If, now, instead of four commodities, fifty or a hundred were treated in this way, we should feel some confidence in the indica- tion obtained as to a general change in prices. If the sum- marized result as to a large number of articles is an advance of ten or twenty per cent in the index number, it is tolerably certain that most commodities have gone up in price. No doubt it is possible that the result has been due to the fact that half the commodities went up a great deal, and that the other half went down, though but moderately. But an examination of actual changes, even a cursory one, almost always shows, where a marked change has occurred in an index number, that the large majority of prices have moved in the one way indicated. The index number serves, therefore, to point to a fact, that on the whole prices have gone up. 2. Other modes of reaching index numbers are proposed, the arithmetical mean being criticized as crude and inadequate. Some of the suggested improvements may be briefly noted, and the usefulness of the simpler method tested by comparison with the results from those more complex. The geometrical mean has been advocated; and sometimes other mathematical means. Of the geometric mean it is said, with undoubted truth, that its use will mitigate a misleading effect on, the index number from extraordinary fluctuations in the price of a single article. With the use of logarithms the geometric mean is easy to ascertain ; and it has quite as good a right to be entitled a "true" average as the arithmetic. Another proposal is for the use of the median. Let the index numbers be made up, not by averaging, but by ascertaining mid- way points. Arrange the several price quotations for any year (reduced to a uniform basis as for the other methods) in nu- merical order, and then ascertain that figure which stands in the middle of the series, that figure on either side of which there are an equal number of quotations. For various sorts of obser- vations the median is thought by statisticians to be at least as significant as any average; and though comparatively un- familiar, it is easy to use. Even more than the geometric mean, it prevents an extremely high or low price of some one article, or of a very few articles, from having an undue influence on the index number. 1 Entirely different is the improvement of the simpler method 1 Thus if a series of price quotations, reduced to a basis of 100, were 86 102 90 106 94 110 97 120 100 the median would be 100. If the last figure were not 120, but 150, the median would still be 100. There being in this series an odd number of figures, the median is the middle one. If there were an even number, the median would lie between the two middle figures, and would be in so far indefinite. But where there are many figures, as is always the case with price quotations, the median is sufficiently precise. For an illustration of divergence between the median and the arithmetic mean, see Chapter 23, p. 318. CHANGES IN PRICES 293 itself the arithmetic mean by taking account of the rela- tive importance of the different articles ; or, as it is technically put, by weighting the articles. A change in the price of wheat, for example, is of much more importance than a change in the price of wool. If wheat were to double in price, the purchasing power of a given income would be seriously affected ; if wool were to double in price, much less. The varying importance of different commodities may be regarded in the construction of an index number by assigning weight to the commodities in the proportion of their consumption. If the community as a whole spends four times as much of its income on wheat as on wool, wheat may be counted as if it were four articles and wool as if it were one. If twice as much is spent on cotton as on wool, cotton may be counted as if it were two articles ; while iron, on similar assumptions, may be counted as three. The prices just used for illustration would then be made up into an index number as follows : 1900 1901 WEIGHT BASE PRICE WEIGHTED BASH PRICE PERCENTAGE OP CHANGE IN PRICE WEIGHTED CHANGE IN PRICE Wheat . . 4 $1.00 400 $1.25 125 500 Cotton. 2 .10 200 .10 100 200 Wool . . 1 .40 100 .36 90 90 Iron. . . Total . 3 10 15.00 300 20.00 133| 400 1000 1190 Average 100 119 This weighted average indicates a rise in prices from 100 to 119, whereas the simple average indicated one from 100 to 112 only. And the weighted average is plainly the more significant ; since the higher prices of widely used articles like wheat and iron are more important than the lower price of the less used wool. Though the weighted index number is clearly preferable, the application of this more refined method presents difficulties. It is not easy to ascertain the consumption or relative weight of the several articles, especially where a very large number (100 or 294 MONEY AND THE MECHANISM OF EXCHANGE more perhaps) are included in the list. Moreover, the consump- tion of the different articles varies. Changes in habits take place ; one article may be much less used in 1910 than in 1900 ; how readjust its weighting and the whole weighted index num- ber? These difficulties, and others that might be instanced, though not insuperable, add to the complications of weighting. In regard to all these suggestions, whether for improvement in the arithmetic mean or for the use of a different mean, it must be borne in mind that no index number corresponds to a real thing. It is not like the mean of certain observations in natural science such, for example, as those for measuring the distance between the earth and the sun of which any one may err, but whose average will point to a single specific fact. An index number points to no single fact. It gives, to repeat, only an indication of the general trend of prices. People often speak and think loosely on this topic, as if an index number told the whole story once for all. There is no one change in prices. There is a medley of many changes, different in direction and degree. All that we can hope to secure by averaging and sum- marizing is some concise statement of the general drift. Now experience in the application of the various methods to the same sets of figures shows that the simple arithmetic mean, when applied to a sufficiently large number of price quotations, gives substantially the same results as more refined methods. If many articles are in the list, some of much importance, some of little, it is unlikely that all the important articles will fluctuate in one direction and all the unimportant in another. If they did so (as in the example just given), weighting would be indispensable. But the fluctuations in fact are likely to be distributed among the several classes in much the same way. An unusual change in the price of a particular article, whether it be consumed in large amounts or in small, will not affect greatly an average made up from many price quotations. And in practise it has been found that the simple unweighted average brings results not very different from those obtained after weighting. Similarly, it has been found that the method of the median does not yield, CHANGES IN PRICES 295 for such fluctuations in prices as take place under a specie standard, 1 results substantially different from those of either the simpler or the weighted arithmetical mean. This similarity of outcome is illustrated by the following chart, showing the course of four index numbers reached in different ways, all based on the same quotations of prices. 2 One repre- sents the simple arithmetic mean of 250 price quotations ; the second, another arithmetic mean of the same prices consoli- 1 Compare what is said below, Chapter 23, p. 318. * The four series are : (1) The Department of Labor's arithmetic means, for prices of 250 articles. (2) Professor W. C. Mitchell's rearrangement of the same price figures : "The Bureau's list of commodities contains anomalies such as the inclusion of a single series [of quotations] for wheat and ten for cotton sheetings ; two for hogs and three for glassware, etc. The result is most unscientific weighting in what purports to be an unweighted index number. To remedy this obvious defect, I have combined the series for nearly identical articles, thereby reducing the number of series to 145." Journal of Political Economy, May, 1910, p. 372 ; cp. the same writer's Gold, Prices, and Wages under the Greenback Standard, p. 19. (3) The median for the same (145) series of quotations, as calculated by Professor Mitchell. (4) A weighted index number for 50 staple articles, selected from among the 250 (145) ; the weighting being on the plan of the Gibson index, but revised by Professor Mitchell. The figures of the four series are : I ARITHMETIC MEAN op 250 QUOTA- TIONS II ARITHMETIC MEAN OF 145 QUOTA- TIONS III MEDIAN OF 145 QUOTATIONS IV WEIGHTED INDEX NUMBERS PROM 50 QUOTATIONS 1890 112.9 114.1 112 114.0 1891 111.7 112.7 111 113.9 1892 106.1 106.1 107 105.1 1893 105.6 105.0 104 105.2 1894 96.1 95.6 96 93.9 1895 93.6 92.8 94 93.9 1896 90.4 88.8 90 86.6 1897 89.7 88.7 91 89.2 1898 93.4 93.5 94 95.0 1899 101.7 102.5 100 103.4 1900 110.5 111.3 109 111.6 1901 108.5 109.6 107 109.2 1902 112.9 113.7 110 116.2 1903 113.6 113.8 111 115.3 1904 113.0 113.9 112 116.3 1905 115.9 115.8 114 \ 117.9 1906 122.5 122.3 119 123.4 296 MONEY AND THE MECHANISM OF EXCHANGE dated into 145 quotations; the third, the median of these same 145 quotations ; the fourth, a weighted index number of 50 among these commodities. The prices are at wholesale, in LJJ UJ 5 2 O O 5 2 X X I- H the United States, for the period 1890-1906; the "base," indi- cated by 100, is in each case the average (arithmetic mean) for the decade 1890-1899. CHANGES IN PRICES 297 3. A rise in prices is of advantage to debtors ; a fall in prices is of advantage to creditors. When prices go up in the interval between the contracting and the paying of a debt, the debtor, on returning to his creditor the amount of money borrowed, returns less in the way of commodities. Conversely, when prices go down in the interval, the debtor, on returning the same money, returns more in the way of commodities. Most changes in prices are slow; from year to year there is little variation. Most debts, on the other hand, are for short periods of time. Hence fluctuations in general prices do not ordinarily cause injustice or serious embarrassment. Even over a period of several years the dealings between debtor and cred- itor are usually carried on with sufficient equity. An index number change of five per cent in a single year is unusual. Commonly our observations must extend over two or three years if we are to make sure that any general rise or fall is really in progress. A change of five per cent or ten per cent, as registered in an index number, would probably be little noticed by most debtors and creditors. Each would be concerned only with the particular articles bought or sold by him ; and these articles might remain unchanged in price, or move in a different direction from the index numbers, or in different degree. It is only abrupt and marked changes in prices that disturb the usual approxi- mate equity of debt payments. Under a specie standard, such changes do not take place ; this much is brought about by the durability of specie and the consequent slowness of changes in the total stock. Violent changes, over short periods of time, take place, if at all, from resort to irredeemable paper money. There is a sound basis for the attitude which most people take, of regarding specie as stable in value and measuring incomes, possessions, debts and credits, once for all in terms of money. The case is different with debts having a long time to run. As to these, even under a specie regime, there is a considerable possibility of injustice and hardship. In the course of twenty years, possibly in the course of ten, marked changes in general prices may occur, and with them marked injustice to debtors or to 298 MONEY AND THE MECHANISM OF EXCHANGE creditors, as the case may be. Though obligations running over such a long period are not often contracted by individuals, they are not uncommon on the part of corporations and of govern- ments. European governments, to be sure, when they borrow, usually do not undertake to repay the principal sum at any given date ; they promise only the regular payment of a stipulated rate of interest. They reserve the option of repaying the principal (either at times expressly stated or at their discretion), but they need not repay unless it suits them. In such case they have a protection against loss from price changes, though their creditors have none. The United States government has often borrowed on long time, and exposed itself to possible loss ; a practise, how- ever, which has been kept in recent years within such moderate limits as not to forebode substantial difficulties. Many of our great corporations, however, and especially the railway corpora- tions, have borrowed quite without regard to possible price changes, and indeed also with disregard of possible changes in the rate of interest. Bonds have been issued payable after the lapse of twenty, forty, even one hundred, years, without provision for redemption in the interval. Who can say what will be the range of prices after the lapse of decades or of a century ? Such long-time obligations find a market because most invest- ors (like other people) think of the value of money as unchanging, and because they are glad to have an income, supposed to be fixed, guaranteed for a long time. Corporations, on the other hand, when they wish to raise great sums of money, adopt the devices which will entice the investor. Yet in such engagements both debtors and creditors take great and unpredictable risks. Under monetary systems as they now are, and are likely long to remain, these risks can be avoided only by restricting all loans to periods of a moderate number of years. 4. A different question as to justice between debtor and creditor arises from the fact that money wages and other money incomes do not necessarily move in the same way as the prices of commodities. In the preceding sections, it has been tacitly assumed that these two movements of prices and of money CHANGES IN PRICES 299 incomes proceed pan passu. But they do not always do so. One may lag behind the other; or the movements may be in opposite directions. Suppose, for example, to take the sort of case which, for- tunately, is most probable, that industry is progressing, the arts are advancing, the prosperity of the community growing. This means that real incomes are becoming larger ; that the com- modities and utilities at the command of the community as a whole, and on the average for each person, are more abundant. The concrete way in which that abundance must show itself, where all transactions and all exchanges are carried on through money, is in cheapness of goods relatively to incomes. Goods may become cheaper, money incomes remaining the same ; or money incomes may become greater, prices remaining the same ; or some intermediate relation may appear. In any case, prices and incomes will not move together. Relatively to prices, money incomes will rise. Thus, during the period of falling prices after 1873, money in- come on the whole did not fall. The evidence to prove this relates chiefly to the familiar crafts and to unskilled or little skilled labor; since comparison of wages at different times is here easiest. Money wages on the whole did not fall after 1873 ; they rather tended to rise. So it was as to those rates of wages which are euphemistically called salaries, the pay of teachers, corporation employees, public officials. The same upward tend- ency, or, at the least, stationary tendency, showed itself in the more irregular money incomes of professional and business men. With rising or stationary wages and incomes, and with falling prices, real incomes, in term of commodities and of utilities, must have gone up substantially. Obviously, this was the nat- ural outcome of industrial progress and cheapened production. That same outcome of progress and cheapness, however, must be expected to appear in a period of rising prices ; only in this case in a different way. If prices advance, money incomes must advance at least as much, if real income is to remain the same. If the same fundamental forces are at work to promote progress 300 MONEY AND THE MECHANISM OF EXCHANGE and relative cheapness, wages and all money incomes must ad- vance even more than prices. If the increasing gold supply of the last ten years proves in fact to bring about continuously ris- ing prices, we must expect that this change will be accompanied by an even greater rise in money incomes. 1 What, under such circumstances, are the relations between debtors and creditors? With prices falling and incomes sta- tionary, debtors, paying their debts with the same amount of money, repay to creditors more in the way of commodities. This may be called repayment according to a labor standard. It is true that the debtor pays back more commodities than he got ; but those commodities represent the same money income and (presumably) the same amount of labor as before. It may be fairly argued that the debtor suffers no injustice, if at the time of repayment he has the same money income as when he contracted the debt. The creditor simply shares in the greater cheapness of commodities due to improved production. Suppose, on the other hand, that there are stationary prices and rising incomes. The debtor, paying back the same money, pays back also the same commodities. It may again be fairly argued that the creditor suffers no injustice. He gets back precisely what he lent, in terms both of money and of goods. He can be said to suffer hardship only in that he fails to share the full advantage of progress. He does not experience, as others do, rising receipts with stationary expenses. The results in the two cases are dif- ferent ; yet in each it may be plausibly argued that the out- come is just, or at least not unjust. It is fortunate that this intricate question of justice does not present itself in such a way as to involve the likelihood of any serious departure from the familiar and accepted principles of equity in debt payments. Just as movements in general prices 1 Long-run effects are here had in mind, and especially those long-run effects which are to be expected from steady gains in the efficiency of industry. The proximate effect of increasing gold supply is, as pointed out in the next section, to cause prices to rise faster than the wages of hired laborers (though not faster than all money incomes) . It is only in the long run that this effect is counter- acted by that of continued improvement in the art*. CHANGES IN PRICES 301 proceed slowly, and therefore do not entail serious injustice as re- gards most debts, so the relative changes of prices, money, and money incomes proceed slowly. Thus the inverse movement of wages and prices between 1873 and 1896, referred to a moment ago, could be noticed only after careful observation of five-year and ten-year periods. Again, if it proves true as there is reason to expect it will in the long run that rising prices during the next generation will be accompanied by money incomes rising still more, this change also will come slowly and gradually, as the ultimate result of the irregular march of improvements in production. If it be asked, none the less, which of these two situations stationary incomes with falling prices, or rising incomes with stationary prices brings the more equitable adjustment of the relations between debtor and creditor, the answer can- not be given with ready assurance. The problem involves a consideration of the whole problem of the right distribution of wealth, and more particularly the question whether equal return for equal labor is the right basis for dealings between man and man. 1 In this case, as in most others, we must be content if the outcome is satisfactory on the whole; if clear injustice is avoided, even though that which is ideally just be not attained. The monetary use of the precious metals brings advantages which outweigh its disadvantages. Specie in the main has brought, and still brings, stability of prices. It is an invaluable safeguard against crude experimenting and arbitrary change. The system of private property and free exchange works better under a specie standard than it seems likely to work under any other medium of exchange yet discovered. Though the standard inures sometimes to the advantage of debtors, sometimes to that of creditors, and though sometimes it brings complex conditions under which very difficult questions of equity arise, none the less, we must be satisfied if it brings on the whole a satisfactory working arrangement. No part of the existing organization of society rests more frankly on a utilitarian basis than the use of specie as the medium of exchange. 1 See Book VII, Chapter 64, 3. 302 MONEY AND THE MECHANISM OF EXCHANGE 5. The proposal for a multiple standard as a means of remedying the effects of falling and rising prices on debtors and creditors is to be judged by this same utilitarian standard. Briefly, the proposal is as follows. Let there be kept accurate records of the prices of a great number of commodities, and let the index numbers show at stated periods how the general level has changed. Let debtors then repay creditors in such way that the same quantity of commodities be returned the creditors. Thus, if the general index number rises from 100 to 110, let the debtor who has borrowed $100 pay back $110 ; for only by, the repayment of this larger sum does the creditor get as much in the way of commodities as he gave. Conversely, if the index number falls from 100 to 90, let the debtor pay back $90 for every $100 that he borrowed. To any such scheme there are various objections. The un- certainty as to the best way of computing index numbers, the varying results reached by different methods of equal validity, the difficulty of recording with certainty the actual changes in prices, the inevitable margin of error, here is one set of objec- tions. Another arises from the possibility, just discussed, that money incomes may change in a different direction from com- modity prices ; though this is commonly evaded, in discussions of the multiple standard, by the tacit assumption that a quid pro quo in terms of commodities is necessarily just. The conclusive objection, however, is that under the multiple standard certainty and calculability would cease to exist in all transactions involv- ing postponed payments. No man would know, when con- tracting a debt, what he would be called on to repay when it became due. He would have to watch each monthly or quarterly report of the index-number bureau, and guess in the meanwhile how his affairs would have to be adjusted. It is true that, as things now are, changes in the prices of the particular things which each person buys and sells cause uncertainty. But every one in business necessarily watches these changes and adapts his doings from day to day to the shifting conditions ; : ndeed, so to watch them, is a main part of business. To add CHANGES IN PRICES 303 to this inevitable cause of uncertainty another from unpredict- able changes in index numbers would make all industrial opera- tions irregular and halting. If the scheme were put into effect, people would rebel against it at the first trial. Or, if it were ar- bitrarily maintained, the speculative element in all transactions would become more marked, risks would be greater, the mar- gin of gain for middlemen would become wider, the action of competition less smooth and less effective. The business classes in the end would recoup themselves from the rest of the com- munity for the trouble and risk imposed. The plan has been rightly called one for a "fancy" monetary standard. Whether from the point of view of difficulty in administration or of the outcome under the best conceivable administration, it must be rejected on any sober consideration. 6. It might seem that, barring the effects on debtors and creditors, rising or falling prices are not of consequence. It is certainly of no consequence whether a community reaches finally a stage of high prices or of low prices. The only differ- ence in the end is whether many counters or few shall be used in exchanges. But the process of reaching the end may bring results of its own. It is maintained by many that the tran- sition to higher prices brings good results, the transition to lower prices bad results. Periods of rising prices are, in fact, commonly periods of pros- perity. In part, to be sure, that prosperity is rather apparent than real. People so habitually reckon their incomes and re- sources in terms of money that they think themselves better off when money incomes go up. They disregard, in some degree at least, the fact that their expenses go up also. But it is not merely a matter of deceptive appearances. The business class feels a stimulus from rising prices ; and so long as the manage- ment of industry is in the hands of the business class, that which stimulates its members to activity commonly acts as a real stimulus to productive industry. In part, no doubt, the effect on business men, as on others, is psychological. They think they are gaining when prices rise, whether in fact they do 304 MONEY AND THE MECHANISM OF EXCHANGE or do not gain as regards the purchasing power of their incomes ; and this appearance of gain spurs them to activity. But they secure also real and substantial advantages. These advantages do not arise chiefly from the fact that busi- ness men are debtors. They are both debtors and creditors. It is true that in relation to the investors, they are debtors. But the men of large affairs the wholesale merchants, the manu- facturers, the bankers are creditors quite as much as debtors, in relation to the rest of the community ; and it is the large- scale men who give the tone and temper to the business class. The chief explanation of the optimism and activity which business men as a class show in times of rising prices arises from the relation which they as a class hold to the laborers as a class. At bottom their main operation is to hire laborers ; and they hire laborers to advantage at such times, because the prices of commodities go up faster than money wages. That wages go up more slowly than prices is one of the best- attested facts in economic history. It holds good of almost all sorts of hired persons, not only manual laborers, but clerks, overseers, teachers, salaried officials. It is due mainly to the force of custom, which is especially strong as to wages ; and it is strengthened often by the lack of bargaining power among laborers. It is connected with many peculiarities in the dealings between employers and employees, and especially with the position of the employer as feeling the brunt of any industrial change. Of the fact there can be no question; when prices rise, the wages of hired workers do not rise as fast. But, as has been already said, and will be more fully explained at a later stage, 1 the operations of capitalists as a class, and of business men as the managers of investment, are resolvable into a succession of advances to laborers. Their total expenses consist in the last analysis in a series of wages payments. To the extent that prices of commodities advance faster than ex- penses for the labor they buy, the payers of wages gain. 1 Of all these matters, more is said in the chapters on Business Profits and Wages, in Book VI, Chapters 49, 50, 51. Cp. also Book I, Chapter 5, 5. CHANGES IN PRICES 305 It is familiar experience that those business men gain most in periods of rising prices whose operations involve in largest degree the payment of wages. The mere trader or merchant usually gains least; the prices of the things he buys go up almost as fast as the prices of the things he sells. The manu- facturer who buys few materials, and whose expenses are chiefly in the direct purchase of labor, profits most of all. Such, for example, is the situation of a highly integrated enterprise like the United States Steel Corporation, which hires laborers directly l to dig iron ore, mine coal, convert the coal into coke, transport these materials, smelt and shape the iron and steel. When the prices of the iron and steel go up, it gains hugely, since its main outlay, for wages payments, is nearly stable. Those iron and steel makers, however, who have to buy iron ore, or coal and coke, gain comparatively little; the prices of their materials go up pari passu with those of their products. The business man who is nearest the ground, so to speak, nearest the laborer, profits most from the relative stability of wages. Conversely, the business class as a whole commonly loses in periods of falling prices. Then, the same forces tending to keep wages stable, a fall in prices brings loss. Probably wages feel the effect of falling prices less slowly than they do those of rising prices. The employer's superior bargaining power enables him more readily to stave off the loss, just as it aids him in reaping the gain. But some loss there is, for the same funda- mental reason, on him falls the first effect of any change. Whatever the business class thus gains in periods of rising prices, may appear to be obtained at the cost of others; and conversely as to their loss from falling prices. What the employers gain (in the first case) , the laborers prima fade lose. And it is true that the activity and prosperity of flush times are a doubtful boon to the laborers. 2 But in one respect they 1 That is, through its subsidiary corporations. Between the subsidiary cor- poration there is nominal purchase of materials. 1 It may happen that money wages do not overtake at all the advance in prices. Such seems to have been the result of the great price revolution of the x 306 MONEY AND THE MECHANISM OF EXCHANGE seem really to gain ; employment is more constant, for the pace of industry is more even as well as more quick. Periods of falling prices are more likely to be periods of slackened enter- prise and irregular employment. The energy and consecutive- ness of operation depend largely on the temper of the business class. They are the leaders, and on their hopes and fears depends the course of modern industry. The gains which are reaped by them, in times of rising prices, may be needlessly high, and out of proportion to their services to society; but in return something is got in the way of unhesitating and sus- tained activity. The effects of falling and rising prices on business profits are modified in that complex case, referred to in the preceding section, where prices and money incomes do not move together. If there be, in consequence of general improvements in the arts, falling prices but stationary money incomes, it would seem that no depressing influence will be felt in business circles. What concerns the business man is not price per unit of product, but total receipts from his output compared with total out- lays for that output. He may pay out as much per unit of labor, and receive less per unit of product, and yet may make profits because there is more of product per unit of labor, this being the result of greater efficiency of labor. On the other hand, if there be rising wages and rising prices, though prices rising in the end less high, the sort of movement which is likely to appear when there is growing efficiency of labor and at the same time rapid increase in the money supply, the busi- ness class will feel an exhilarating influence no less than in the simple case of rising wages and rising prices. Though prices be stationary, yet the total receipts from the output will be greater, since more is turned out per unit of labor ; and though wages rise, they are likely to rise less fast than gross receipts. In the first case, the depressing effect of falling prices is mitigated or overcome by improvements in production. In the second case, sixteenth century. When this had run its course, prices (of food, at least) had risen more than money wages, and commodity wages had definitively fallen. CHANGES IN PRICES 307 the stimulating effect of rising prices is accentuated by improve- ments. The first case seems to have appeared in the period of falling prices and stationary wages from 1873 to 1896 ; the second case during the period of rising wages and rising prices during the period that followed 1896. 7. Another influence of changing prices may be on the rate of interest. 1 If prices rise, the creditor loses ; but it may be that he will secure a higher rate of interest at such times, and that this will offset the loss from payment of the principal in depreciated money. And conversely, if prices fall, the debtor may get his loan at a lower rate of interest, thus securing an offset against the loss to him from lowered prices. It is con- ceivable that this sort of compensation will take place steadily, even automatically, and that thereby all disturbing effects on the relations between debtor and creditor will be obviated. There can be little question that periods of rising prices are, in fact, usually periods of higher interest rates, and that during periods of falling prices interest rates are lower. The explana- tion of this fact has been the occasion of much critical discus- sion, and cannot be said to be entirely clear. It would seem to be tolerably certain that there is no con- scious adjustment of the rate of interest to changes in prices ; and this for the simple reason that such changes can rarely be foretold. Sometimes, to be sure, persons who are versed in economic theory and economic history believe that conditions exist which will lead to a rise in prices. Such was the case after the Californian and Australian gold discoveries of 1850; such has been the case in recent years (1900-1910). But the rise in prices after 1850 was much less than had been expected by very competent persons ; 2 and it may be that the similar expectations held by some good judges in our own day will 1 The topic taken up in this section will be better understood after reading the chapters on Banking and Crises in the present Book, and those on Interest and Business Profits in Book VI. It may perhaps be postponed until these have been read. * Chevalier, a distinguished economist, and by no means a closet economist, im- mensely overestimated the probable effects of these gold discoveries. 308 MONEY AND THE MECHANISM OF EXCHANGE prove mistaken. Certainly the fall in prices which took place after 1873 was unexpected. And whether or no a few persons can foresee price changes, the great mass of lenders and bor- rowers do not even think about them. Except in times of extraordinary fluctuations (such as are due to paper money), they regard money as fixed in value. They reckon their gains and losses as well as their interest payments in terms of money only. They do not trouble themselves with adjustments of the "real" rate of interest to coming changes in prices. It is possible, none the less, that there may be some adjust- ment by an unconscious process. If all who are debtors are seen to be gaining in times of rising prices, and if it becomes current opinion that buying on credit and borrowing are profit- able operations, there may be a press of demand for loans, and so a rise in the rate of interest. The converse phenomenon of slackened demand for loans and low rates of interest may show itself, for reasons of the same sort, in times of falling prices, when those who have borrowed are seen to be often in straits. There are other causes, however, which go far to explain the oscillations in demand for loans and in the rate of interest. Among these, and in my judgment a weighty one, is the fact of higher business profits due to the comparatively slow advance of money wages. Borrowers are mainly " producers "; that is, they are mainly business men engaged in guiding the operations of production. In times when their prospects for gain are good, and such is the case when wages lag behind rising prices, all want more "capital " ; that is, more money means that will give them command of more capital goods and more labor. Though interest depends in the long run on other factors than business profits, it is derived proximately from business profits, and follows these in its ups and downs. The gains which the members of the business class make in times of rising prices, and the losses they incur with falling prices, go far to account for the corresponding oscillations of interest. Still another cause is to be found in the working of the ma- chinery of credit. In the preceding paragraphs, activity in CHANGES IN PRICES 309 business operations has been spoken of as a result of rising prices. But it is also a cause of rising prices. Even though there be no influence of a distinctly monetary sort (such as an in- crease in the specie supply), prices may go up from the general expansion of credit, a phenomenon of which more will be said in its proper place. 1 It suffices here to point out that, as between active times with high rates of interest and dull times with low rates of interest, there is an interaction of cause and effect; or, more accurately perhaps, there are sundry effects all due to one commanding cause. Both rising interest and rising prices are in large degree due to a common cause, the general fever of activity ; and both falling interest and falling prices are promoted by a common cause of the same sort, in- dustrial lethargy. Certain it is that there is no exact or automatic relation between fluctuations in prices and fluctuations in the rate of interest. Some writers have supposed there is ; that when prices fall, interest so falls that the debtor's gain in the interest rate offsets his loss from lower prices. Conversely, when prices rise, interest is supposed to rise just enough to offset the credi- tor's loss. But such adjustment as statistical inquiry reveals seems to be but partial ; the creditor or debtor, so far as they get alleviation from shifting interest rates, get only a partial alleviation. And this partial alleviation is not the result of any conscious adjustment, still less of any automatic correction of inequities in debt payments. The roughly parallel move- ments of prices and rates of interest are not explicable in the main from anything in the way of calculation by debtors and creditors. If this process tends to promote equity in the deal- ings between these classes under the existing monetary regime, it is partly the result of other causes acting on the interest rate, but mainly because, after all, fluctuations in prices are slow and their effect in disturbing the outcome of most credit transactions not considerable. 1 Chapter 29, especially 3. CHAPTER 23 GOVERNMENT PAPER MONEY 1. In this chapter we shall consider paper money issued by governments, and particularly inconvertible or irredeemable paper money. All paper money contains on its face a promise to pay; but in the case of government paper that promise is more often broken than kept. The most perplexing and at the same time most instructive problems relating to paper money arise when it is not what on its face it purports to be, when it is not convertible into specie. Inconvertible paper has been called fiat money, because its use as money and its value depend on the mere command of the political authority. The extent to which the edict of the sovereign or legislature can cause a scrap of paper to serve as money, and to maintain its value as money, may be both over- stated and understated. Historically, all money has had its origin, directly or indirectly, not in any compulsion or even in any deliberate selection, but in the customary acceptance of some commodity of general serviceability. When, however, such a commodity has once come to be habitually used as money, public authority can very much 'affect its value and the mode in which it circulates. Paper pieces, similarly, can be made to serve as money by mere government fiat only when a people has already become habituated to the use of a paper medium of exchange. Modern communities began using money of this sort on a considerable scale in the latter part of the seventeenth century, when public and semi-public banks issued promises to pay, which readily passed into circulation because really convertible into specie. By the eighteenth cen- tury, paper substitutes for metallic money had become so fa- miliar that the way was easy for the issue by public authorities 310 GOVERNMENT PAPER MONEY 311 of inconvertible paper. Partly by taking advantage of the established habit, partly by mere force of law, governments found it possible to make promises to pay that were only nominal circulate as freely as gold and silver. Let it be assumed that those conditions exist without which there can be no circulation of inconvertible paper, some habit- uation to paper promises to pay, and a strong government. Let it be assumed further that the government exerts its strength to bolster up the paper which it issues. This is done commonly by making the paper a legal tender for debts (i.e. for those expressed simply in current money) and by making it receivable at its face value for taxes and other public dues. Suppose that by these means the paper is made to circulate freely, passing from hand to hand as readily as specie. What then determines its value ? Evidently, the reasoning already set forth as to metallic money will hold good of paper money also : its value, too, will be determined by its quantity. If it is issued in the same quantity as the specie previously in circulation, and if it com- pletely displaces that specie (as ordinarily it will), the range of prices will be precisely what it was before, and the value of the paper will be as great as that of the specie had been. If it be issued in twice the quantity of the specie, prices will be doubled, and the value of money will be one half. These statements are subject to the same qualifications that would have to be applied to specie itself. They assume that rapidity of circulation remains the same, and that the quantity of commodities and their mode of coming to market remain the same, qualifications which have been already discussed. They assume, too, that the use of credit substitutes for money, and especially the bank methods of credit, are unchanged, important qualifications which remain to be considered. Yet all these corrections in no sense touch the essential truth ; the value of freely circulating paper money depends on its quantity. Though it be quite inconvertible, though there be no prospect of its redemption in specie, it will retain its value and perform all the functions of money. It will 312 MONEY AND THE MECHANISM OF EXCHANGE obviously have a prima fade advantage over specie, in that it will cost the country less. Gold and silver can be produced only with much labor. Paper money costs but a trifle. A cheap and apparently serviceable medium of change is sub- stituted for a dear one. All this, to repeat, rests on the supposition that the paper money circulates freely. It does not necessarily circulate freely. Conceivably, people will distrust the government, or dislike to use paper, or for whatever reason refuse to accept it readily in current transactions. Then it will either not get into cir- culation at all, or it will have a value determined in a different way. Of this sort of possibility a striking illustration appeared in the state of California during and after our Civil War, from 1862 to 1879. The government of the United States issued paper money in such a quantity as to cause prices to rise and the money to depreciate. In California, as in other states, the paper was legal tender, and was receivable for public dues; nor was there any distrust or hostility towards the federal government. But there was a strong feeling call it preju- dice or reasonable preference in favor of gold and against paper; a feeling due to the fact that California was then in the first stage of her great gold discoveries, and that gold was a plentiful medium for all transactions. Every debtor had the legal right to pay off his debts in depreciated paper. But if he did so, he was a marked man (the creditor was likely to post him publicly in the newspapers), and he was virtually boy- cotted. Throughout this period paper was not used in Cali- fornia. The people of the state conducted their transactions in gold, while all the rest of the United States used the 'incon- vertible paper. 1 The same factor widespread unwillingness to use the paper affects its circulation and value with highly dramatic effect, when a government grossly abuses the possibilities of the case, and issues it in great and constantly increasing quantity. Then 1 See Moses, "Legal Tender Notes in California," Quarterly Journal oj Economics, Vol. VII, p. 1. GOVERNMENT PAPER MONEY 313 the stage may be reached when no one will longer accept the paper, and when the bottom completely drops out of it. Its value then falls not only because its quantity is very great, but because people are no longer willing to accept it in exchange for goods. Its supply is increased ; and at the same time the demand for it (the offer of goods for money) declines, may even cease entirely. Such was the case with the notes which the Scotch schemer and adventurer, Law, persuaded the French govern- ment to issue in 1720. They were put forth in such enormous and unceasing amounts that they completely lost acceptability and depreciated to nothing. 1 Such was the case with the paper money issued by the American Congress during the Revolution. Continental money was printed in amounts so vast that it be- came utterly distrusted, and depreciated much more than in proportion to its quantity (whence the saying, "not worth a Continental ") Such, too, was the case with the assignats of the French Revolution in 1790-1796, when the French government put out notes which at first were redeemable in land, but soon were poured forth without pretense of any redemption, and in such unlimited quantities that they became quite worthless. Still later, in 1864-1865, the same was the fate of the paper money of the Southern Confederacy. But no such extremity of depreciation has been reached in more recent instances. During the nineteenth century many countries resorted to issues of paper money, and depreciation commonly ensued. Yet, with the exception of the hapless South- 1 The breakdown of confidence in the paper seems to have taken place in this case with dramatic suddenness. An effort by the government to put a limit to depreciation caused an unexpected and utter collapse. "During the first stages of depreciation, " strange as it may appear, the deterioration of the notes in value does not appear to have affected their circulation. All that people looked to was nominal value, and while the notes were called livres, nobody inquired what a livre meant. But the instant the denomination was altered ; the instant government declared that a note for ten livres should be worth only five, the baselessness of the paper fabric was detected. The terror was as universal and as blind as the confidence had been. To use Sir James Steuart's words, on the 22d of May, a man with one hundred millions of bank notes might have starved in the street." SENIOR, Three Lectures on the Cost of Obtaining Money, p. 76. The reference is to Sir James Steuart's Principles of Political Economy, Part II, Chapter 59 (Vol. Ill, p. 52, edition of 1770). 314 MONEY AND THE MECHANISM OF EXCHANGE ern Confederacy during our Civil War, no important country in the nineteenth century carried the process so far that con- fidence in the paper was completely lost. Very considerable issues have been made, under conditions which enabled the paper to maintain its circulation and to depend for its value on its quantity. This sort of situation, less extreme but in many ways less simple than the kind already illustrated, will be mainly discussed, in the following sections. 2. Paper money, whether convertible or inconvertible, tends to drive out specie. The expulsion takes place through the opera- tions of international trade. The newly issued paper enlarges the quantity in circulation, and sooner or later raises prices. The rise in prices causes imports to be greater, exports to be less; and specie flows out in payment of the imports. Paper money, of course, does not flow out; it cannot circulate in foreign coun- tries. The mechanism is not usually so simple as this ; sundry complications in its working will appear when the subject of foreign trade is reached for detailed consideration. But in essentials the process is here stated correctly. Specie disap- pears through the channels of international trade, in propor- tion as paper money is issued. If half as much paper is put out as the specie previously in circulation, the medium of exchange will become half paper, half specie. If exactly as much paper is put out, all the specie will disappear, and only paper will re- main. And a fortiori this will be the case if the paper exceeds in quantity the specie previously used. 1 This last stage is that of "overissue" ; that is, of issue beyond the point where prices remain the same as under a specie regime. Any added quantity of paper, beyond this point, is no longer offset by an equivalent expulsion of specie, but creates an abnormal level of prices. All the consequences of such a rise show themselves. Creditors lose, debtors gain. Prices of com- 1 Theoretically, these statements require a correction, because the outflow of specie will raise prices in foreign countries, and so affect the whole inter- national level and therefore the relation of paper to specie in the issuing country. But this correction is of no real importance in the experience of countries that have resorted to paper. GOVERNMENT PAPER MONEY 315 modities rise faster than do ordinary wages, and faster than those incomes which are called "fixed," because strongly affected by custom. Business men make money. The rate of interest rises. An exhilaration is felt in the industrial world, precisely as when prices rise from added supplies of specie. The exhilaration lasts so long, and only so long, as the process is kept up. It is the result not of higher prices, but of rising prices. When once the higher level is reached all around, quiescence comes ; nay, as a rule, lethargy. The effect is like that of a drug ; when the stimulus no longer acts, a reaction sets in. One of the recurring phenomena of periods of rising prices, whether from specie or paper, is the complaint that there is not enough money. However much the quantity of money may have been increased, people aver there is not enough "to do the business," or not enough "to finance prosperity." This simply means that prices have been adjusted to the in- creased supply, that the upward movement has reached its term, and that the pleasant stage of apparently advancing pros- perity has come to an end. Hence there always springs up a plentiful crop of persons who advocate still further additions to the monetary supply. Most people have only vague notions of what money is, what are its functions, how it affects prosperity. Their instinctive attitude is almost always that of welcoming an increase in the money sup- ply. Especially during and after periods of rising prices, the panacea of ever plentiful money has many ardent advocates. Sober sense sooner or later returns to the great mass of the com- munity, and the projects of fiat-money advocates are brushed aside. But one of the greatest objections to paper issues is the unsettlement which they cause in people's ideas on the nature and effects of money. Absurd notions emerge, and the simplest lessons of economics must be retaught. The right ad- justment of the monetary system intrinsically a task of no small difficulty has to be undertaken in face of a tumult of ignorance, passion, and dishonesty. When paper has been issued in such amounts as to cause a 316 MONEY AND THE MECHANISM OF EXCHANGE rise in prices above the level at which they would have stood Under a specie standard, specie ceases to circulate and becomes itself a commodity. Paper becomes the sole medium of ex- change, and gold (or silver, as the case may be) js bought and sold at prices in paper, like other things. In precisely the same way, after the gold standard established itself in the civilized countries, silver, being no longer a full money metal, was bought and sold in terms of gold, Under a regime of overissued paper gold sells at a premium in paper, and paper is depreciated in terms of gold. The paper is a nominal promise to pay in gold, but is not equal in value to the gold which it purports to repre- sent. Hence the price of gold is commonly stated, not in terms of so much per ounce or pound, but in terms of itself, so to speak, how many paper "dollars" are needed to buy one gold dollar. Gold never disappears entirely from such a country, even though it ceases to be the medium of exchange and disappears from ordinary circulation. Some gold is always wanted for use in the arts; and for 1 these uses it is bought and sold, like copper or nickel. Some is commonly wanted also for transactions which are by special stipulations to be carried out in gold. A class of dealers in gold usually appears, who make it a business to buy and sell this metal, as other dealers do with the commoner metals. The premium on gold roughly measures the depreciation of the paper, but measures it no more than roughly. The real deprecia- tion of the paper is the rise in prices. That could be measured, more or less accurately, by the index-number method. But any rise in prices is, as we have seen, irregular. Some com* modities advance more than others, some not at all, some decline. The change in any one may or may not be such as to indicate the general change. So it is with the price of gold, or the specie premium. It is subject to influences of its own, among the most important of which is the demand for remittances abroad, the necessary use of gold in transactions with foreign countries. Sometimes these special influences cause the premium to be in advance of the general rise in price, sometimes to lag behind. Yet the divergencies between the specie premium and the real GOVERNMENT PAPER MONEY 317 depreciation of the paper, though sometimes very pronounced, are not likely to endure long on a considerable scale. The premium usually indicates with fair accuracy the real depreciation of paper money. If the premium on the average is about 100 (i.e. if 200 of paper are needed to buy 100 of gold), we may infer that paper prices are about double what gold prices would be. If the premium is somewhere between 10 and 20, as it was in the United States during the years from 1870 to 1876, which pre- ceded the return to a specie standard, we may be sure that prices in general are somewhat higher, but not greatly higher, than they would be in gold. And when the premium steadily de- clines over a period of years, we may infer that paper prices are coming nearer to what gold prices would have been, that they either are falling, or are failing to rise as gold prices elsewhere are rising. One of the factors which lead to special fluctuations in the gold premium is the prospect of the redemption of the paper in gold. Paper money is rarely issued with the intention or expectation that it will depreciate. The issue commonly takes place under stress, as a supposedly temporary expedient, with little time for deliberation, and with a desire to return as soon as possible to a specie basis. Any event which makes early redemption in specie probable, lowers the premium ; any untoward event raises it. When Napoleon broke loose from Elba in 1814, the premium on gold in England rose ; when the news of Water- loo came, it fell sharply. In the United States, the premium fell at once after the battle of Gettysburg, and rose high during the anxious summer of 1864. Such abrupt turns have led to the statement that confidence in the paper money governs its value, or at least greatly affects its value. It is more legitimate to say that confidence in redemption affects the value of the specie. General prices do not move up and down under the influence of military or political fortunes. It is the price of specie that is affected ; for dealers and speculators discount at once the con- sequences for the financial stability of the government and for the possible resumption of specie payments. 318 MONEY AND THE MECHANISM OF EXCHANGE 3. Of the various phenomena connected with paper money, no better illustration can be found than in the experience of the United States from 1862 to 1879, to which references have al- ready been made. During the Civil War, in 1862-1865, great quantities of inconvertible paper were issued, far in excess of the specie previously in circulation. Prices rose rapidly, and at the close of 1864 were at least double what they had been in 1861. The specie premium rose in the same degree, and at one time (in July, 1864) was at the extraordinary height of 185; that is, a dollar of gold sold for $2.85 in paper. Immediately after the close of the war, in 1865, some parts of the paper money issues were withdrawn; prices fell sharply, and the price of gold dropped to about 150., i.e. the gold premium sank to 50. Throughout all these stirring and anxious years, the paper continued to circulate readily (except in distant Cali- fornia), and with no such loss of confidence as comes from complete discredit of the issues. The quantity, though reduced in 1865, still remained redundant, and depreciation lasted for many years, until finally in 1879 specie payments were resumed. The process by which prices were brought to the gold level and by which the real depreciation of the paper was ended, was rather that of growing demand for money, because of the in- crease of population and wealth, than of lessening the supply of money through retirement of a large part of the paper. It was a process not inaptly called " growing up to the currency." The course of events is illustrated by the chart, which shows the range of prices during the period from 1860 to 1880. The index number which best indicates the course of prices is the median, not the arithmetic mean; because, for some of the years of greatest fluctuation, the arithmetic mean was unduly affected by the extreme prices of a few commodities. Nothing could show better the evils of excessive paper money than the soaring line of 1862-1865, and the sinking line of later years; the inequities between debtor and creditor, the instability of pecuniary relations, the slow and painful process of return to the normal standard. 1 GOVERNMENT PAPER MONEY 319 A E r s i 2 I 8 1 The chart is based on the figures given in Mitchell's Gold, Prices, and Wages under the Greenback Standard, pp. 59, 60. No more careful inquiry into the history of prices has been made than is contained in this admirable monograph. None the less, some of the phenomena of the period are not yet fully understood, especially the great rise in prices in 1864-1865. For comparison, the chart shows the course of prices in Germany as well as in the United States ; the index numbers for Germany being calculated from the prices of precisely the same articles as for the United States. For each country, both the arithmetic means and the medians are shown. The divergence of the two sets of lines indicates unmistakeably the effect of the American paper issues. 320 MONEY AND THE MECHANISM OF EXCHANGE It was during the ten years, more or less, preceding the re- sumption of specie payments, that the paper money advo- cates had their opportunity. Then all sorts of fallacies about the blessings of plentiful money had vogue. The controversy led, as is inevitable in a democratic community, to a long succession of compromises. One of these was the act for the resumption of specie payments itself. Still another result of this unsettled period was the injection of silver into the currency under the acts of 1878 and 1890. 1 4. History shows that overissue, always threatened by paper money, has rarely been avoided. Resort to this easy way of meeting public expenditures has usually been the conse- quence of war. Though Law's notes of 1720 in France were not due directly to military needs, the other well-known cases of notes utterly discredited, the assignats of the French Revolution, the Continental money of our own War of Independence, the Con- federate notes of 1862-1865, all arose from the stress of war. Other issues which reached the stage of depreciation, though not of complete collapse, were due to the same sort of stress. England resorted to paper money (in the form of Bank of England notes, made inconvertible by law) during the Napoleonic wars. Prussia, during the same period, turned to direct state is- sues. Austria long had a much discredited paper money. Not- withstanding endeavors to resume, the wars of 1853, 1859, 1866, kept Austria to a paper money regime, until, in very recent times, she has succeeded in regaining specie equivalence. Russia, until our own time, has hardly known what specie money means. Spain, Portugal, the South American countries, all have fallen into the paper money slough, and most have not yet extricated themselves. The United States, as we have seen, had her trying experience during and after the Civil War. It deserves to be noted, too, that the War of 1812-1815 brought the United States to the verge of government issues. Had that war lasted a little longer, the final step toward a paper regime would prob- ably have been taken. The cases of resort to paper, without en- 1 Cf. Chapter 21, 4. GOVERNMENT PAPER MONEY 321 suing depreciation and unsettlement, can be counted on the fin- gers of one band. The most notable is that of France in the War of 1870-1871. The notes of the Bank of France (which were made virtually government paper, not exchangeable for specie), were issued in large amounts to aid the government in its finan- cial exigencies during and after that great struggle. Yet the situation was handled with such caution and skill that only a slight specie premium appeared, lasting a short time only. The possible gain from a resort to paper was secured in this case without any serious drawback. 1 The probability of overissue, with all its disturbing conse- quences, is the main ground for condemning paper money. To this must be added the corresponding disturbance of the reverse process, the return to specie payments. So un- settling is a paper money regime that no community has will- ingly retained it, and every advanced country which has fallen into it has sooner or later extricated itself. Though paper money may do all the work of a circulating medium, it does so with a constant prospect of backsliding. Whether there is enough of it, or too much, or too little, is always a matter in the discretion of the government for the time being. The value of specie is deeply rooted in the established ways of mankind. For any one country, its value is not within the control of legislation at all. Its international acceptance gives it a basis on which the currency system of a country can rest securely. Hence every capable and ambitious community which has resorted to paper money resolves in the end, even at great sacrifice, to get back to specie. A difficult problem sometimes presents itself as to the way in which the return to a specie basis shall take place ; whether by redeeming the paper at its face value in specie, or at its mar- ket value. The first course has the bracing effect of recogniz- ing a promise to pay as really a promise, and of meeting it to the letter. The second, however, may be more substantially equita- ble where the paper money has been depreciated for a long time. iCf, Chapter 26, 53, Y 322 MONEY AND THE MECHANISM OF EXCHANGE Then the injustice caused between debtors and creditors can no longer be undone. A new generation has come on the scene, and has made its engagements on the basis of paper. To shift these into specie engagements, with a transition to prices presumably lower, is to injure present debtors as much as past creditors were injured. Hence if the paper is depreciated, say one third (the price of gold being 150 in paper), and if it has been de- preciated to this extent for many years, the most equitable plan is to redeem it in gold at two thirds of its nominal value. This is done most simply by creating a new coin having two thirds of the gold content of the former coin. The existing paper standard, and the existing range of prices and incomes, are thereby recog- nized once for all, but are anchored for the future to a firm specie basis. This is substantially what Austria and Russia have done in their resumption operations of recent years. 1 But where the paper money is not of long standing ; where the community has not become habituated to any sustained and fairly constant depreciation; where return to a specie standard has been steadily expected, and has been borne in mind as at least a possibility by all lenders and borrowers, there the sound policy is to resume at par. Redeem the paper at its full nominal value, and maintain the good tradition that a dol- lar is a dollar. Doubtless it is a half-illusory tradition. The gold dollar is not necessarily a stable dollar. But it is a dollar more stable than any which the legislation of a particular coun- try is likely to devise by itself. In this matter, as in so many others, it is well that sound rules of general expediency should crystallize into moral precepts. The doctrine that it is honest to redeem a paper dollar in gold at its face value, no doubt implies more as to the nature of " honesty" than the average man will understand, but is not to be caviled at unless there be very seri- 1 This, too, is what Japan did when she changed from a silver to a gold basis in 1897. It is true that Japan did not have paper money ; her currency was based on silver, which had been depreciating, with reference to gold, as the price of silver fell after 1873. Determined to adopt the ways of advanced countries, Japan turned to the gold standard, and established a new coin, the gold yen, equal in value to the silver yen as it stood at the time. GOVERNMENT PAPER MONEY 323 ous grounds for questioning the substantial balance of equity in favor of specie in general and gold in particular. At all events, the return to specie payments has commonly taken place by resumption at par. This was the case in Eng- land after the Napoleonic wars; it was the case in Italy, in the resumption of 1883 (then half-hearted and unsuccessful, and only in recent years really accomplished). It was the case in the United States in 1879. Austria and Russia, which have just been referred to as changing from paper to gold on the basis of the market value of their paper, had the excuse that "specie" for them might have meant either silver or gold. Their paper had been issued at a time when silver was the familiar and accepted monetary metal in most parts of the world and in their own boundaries. They returned to specie at a time when gold had become the accepted metal, and when silver had much depreciated in terms of gold. The establish- ment of a new gold standard took place, reasonably enough, on the basis, not of depreciated silver, but of new gold coins representing the market value of the paper in the period of resumption. 5. An interesting case, illustrating in another way how the quantity of money acts on its value, is that of what may be called inconvertible specie. The conspicuous instance is the rupee of British India. It is a silver coin, having about the same content of fine silver (165 grains) as forty-four cents of the American silver dollar. Formerly it was freely coined at the mints of British India ; that great region had the single silver standard. When the fall in the price of silver set in after 1873, the rupee began to depreciate in terms of gold. The fall of silver had important effects. It necessarily influenced the foreign trade of India ; it influenced also the finances of the Indian government. That government has large payments to make in England, almost always in gold. It collects its revenue in silver in India. The lower the price of silver in terms of gold, the farther will the Indian revenues fall short of meeting gold payment in England. When silver sold in London at 324 MONEY AND THE MECHANISM OF EXCHANGE about 6 Id. per ounce (i.e. when the ratio of silver to gold was about 15 to 1), the rupee was worth 23d. in English money. At the lowest price which silver touched until 1892 (40 546 INTERNATIONAL TRADE abolished in 1913, and at the same time coal, lumber, hides, and other materials were made free of duty. Nothing has been said, in this review of the tariff problem in our own country, of some of its more obvious bad aspects, the pressure of interested producers to obtain measures favorable to themselves, the contributions of a semi-corrupt character to party chests, the log rolling by which each legis- lator strives to secure in the general scramble duties that will be of benefit, or at least will be thought of benefit, to his own constituents. The tendency, in popular government, for each representative to press the real or supposed interests of his special constituents is the greatest evil of democracy. It has been experienced to the full in our tariff legislation. But it appears in many directions, in things good as well as in things doubtful, in education, harbor improvements, the postal service, public control of railways and other industries. Some- thing of the sort must be faced whenever the state undertakes to direct and regulate matters of economic consequence. We must keep in mind chiefly the general outcome, under such working conditions as the existing state of political machinery makes possible ; and from this point of view the question of pro- tection also must be judged. REFERENCES ON BOOK IV On the foreign exchanges, see G. J. Goschen, The Theory of the For- eign Exchanges (last ed., 1901) ; G. Clare, The A B C of the Foreign Exchanges (1895) ; H. Withers, Money-changing (1913). On inter- national trade, the chapters in J. S. Mill, Principles of Political Economy (last ed., 1871), Book III, Chapter 17 seq., though in some parts unduly elaborated, are still unsurpassed. A good modern statement, almost too compact, is in C. F. Bastable, The Theory of International Trade (4th ed., 1903). A mathematical treatment is in three papers by F. Y. Edgeworth, "The Theory of International Values," in the Economic Journal, Vol. IV (1894). I venture to refer also to my own paper on "Wages and Prices in Relation to International Trade," Quarterly Journal of Economics, Vol. XX, August, 1906. Notwithstanding the mass of literature on free trade and protec- tion, no book covers the controversy satisfactorily. H. Fawcett, Free SOME ARGUMENTS FOR PROTECTION 547 Trade and Protection (1885), states the simpler reasoning in favor of free trade and refutes the cruder protectionist fallacies. H. G. Brown, International Trade and Exchange (1914) gives a good compact exposi- tion of the foreign exchanges and of the principles underlying the tariff controversy. A. C. Pigou, Protective and Preferential Import Duties (1906) , is able and discriminating, but written with reference chiefly to the contemporary controversy (1895-1905) in Great Britain. On this, see also W. J. Ashley, The Tariff Problem (1903). On the German de- bates, see, among others, L. Pohle, Deutschland am Scheidewege (1902), and A. Wagner, Agrar-und Industriestaat (1902), both in favor of pro- tection for agriculture ; and on the other side, L. Brentano, Die Schrecken des Industriestaates (1901), and H. Dietzel, Weltwirthschaft und Volks- wirtschaft (1900). On the tariff history of the United States, E. Stan- wood, American Tariff Controversies in the Nineteenth Century (1903), a narrative account of legislation and discussion by a protectionist ; and F. W. Taussig, The Tariff History of the United States (ed. of 1914) and Some Aspects of the Tariff Question (1915). Printed in the United States of America. HPHE following pages contain advertise- ments of books on kindred subjects An Introduction to Public Finance By CARL C. PLEHN, Ph.D. Third edition, enlarged and partly rewritten, $f.ff "The book as it first appeared was an excellent one; in the present form its usefulness has been greatly enhanced," says the Journal of Political Economy. "At present the best text on public finance for general use.'' Political Science Quarterly. Public Finance By C. F. BASTABLE, M.A., LL.D., Professor of Political Economy in the University of Dublin. Published in London, 1892. Third edition, 1903. Cloth, 8vo, 780 pages, Practical Problems in Banking and Currency Being a number of selected addresses delivered in recent years by prominent bankers, financiers, and economists. Edited by WALTER HENRY HULL With an Introduction by the Hon. C. F. PHILLIPS, of New York. Published in New York, 1907. 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