Read ESSAY IV. of Essays on some unsettled Questions of Political Economy, free online book, by John Stuart Mill, on


The profits of stock are the surplus which remains to the capitalist after replacing his capital:  and the ratio which that surplus bears to the capital itself, is the rate of profit.

This being the definition of profits, it might seem natural to adopt, as a sufficient theory in regard to the rate of profit, that it depends upon the productive power of capital.  Some countries are favoured beyond others, either by nature or art, in the means of production.  If the powers of the soil, or of machinery, enable capital to produce what is necessary for replacing itself, and twenty per cent more, profits will be twenty per cent; and so on.

This, accordingly, is a popular mode of speaking on the subject of profits; but it has only the semblance, not the reality, of an explanation.  The “productive power of capital,” though a common, and, for some purposes, a convenient expression, is a delusive one.  Capital, strictly speaking, has no productive power.  The only productive power is that of labour; assisted, no doubt, by tools, and acting upon materials.  That portion of capital which consists of tools and materials, may be said, perhaps, without any great impropriety, to have a productive power, because they contribute, along with labour, to the accomplishment of production.  But that portion of capital which consists of wages, has no productive power of its own.  Wages have no productive power; they are the price of a productive power.  Wages do not contribute, along with labour, to the production of commodities, no more than the price of tools contributes along with the tools themselves.  If labour could be had without purchase, wages might be dispensed with.  That portion of capital which is expended in the wages of labour, is only the means by which the capitalist procures to himself, in the way of purchase, the use of that labour in which the power of production really resides.

The proper view of capital is, that anything whatever, which a person possesses, constitutes his capital, provided he is able, and intends, to employ it, not in consumption for the purpose of enjoyment, but in possessing himself of the means of production, with the intention of employing those means productively.  Now the means of production are labour, implements, and materials.  The only productive power which anywhere exists, is the productive power of labour, implements, and materials.

We need not, on this account, altogether proscribe the expression, “productive power of capital;” but we should carefully note, that it can only mean the quantity of real productive power which the capitalist, by means of his capital, can command.  This may change, though the productive power of labour remains the same.  Wages, for example, may rise; and then, although all the circumstances of production remain exactly as they were before, the same capital will yield a less return, because it will set in motion a less quantity of productive labour.

We may, therefore, consider the capital of a producer as measured by the means which he has of possessing himself of the different essentials of production:  namely, labour, and the various articles which labour requires as materials, or of which it avails itself as aids.

The ratio between the price which he has to pay for these means of production, and the produce which they enable him to raise, is the rate of his profit.  If he must give for labour and tools four-fifths of what they will produce, the remaining fifth will constitute his profit, and will give him a rate of one in four, or twenty-five per cent, on his outlay.

It is necessary here to remark, what cannot indeed by any possibility be misunderstood, but might possibly be overlooked in cases where attention to it is indispensable, viz., that we are speaking now of the rate of profit, not the gross profit.  If the capital of the country is very great, a profit of only five per cent upon it may be much more ample, may support a much larger number of capitalists and their families in much greater affluence, than a profit of twenty-five per cent on the comparatively small capital of a poor country.  The gross profit of a country is the actual amount of necessaries, conveniences, and luxuries, which are divided among its capitalists:  but whether this be large or small, the rate of profit may be just the same.  The rate of profit is the proportion which the profit bears to the capital; which the surplus produce after replacing the outlay, bears to the outlay.  In short, if we compare the price paid for labour and tools with what that labour and those tools will produce, from this ratio we may calculate the rate of profit.

As the gross profit may be very different though the rate of profit be the same; so also may the absolute price paid for labour and tools be very different, and yet the proportion between the price paid and the produce obtained may be just the same.  For greater clearness, let us omit, for the present, the consideration of tools, materials, &c, and conceive production as the result solely of labour.  In a certain country, let us suppose, the wages of each labourer are one quarter of wheat per year, and 100 men can produce, in one year, 120 quarters.  Here the price paid for labour is to the produce of that labour as 100 to 120, and profits are 20 per cent.  Suppose now that, in another country, wages are just double what they are in the country before supposed; namely, two quarters of wheat per year, for each labourer.  But suppose, likewise, that the productive power of labour is double what it is in the first country; that by the greater fertility of the soil, 100 men can produce 240 quarters, instead of 120 as before.  Here it is obvious, that the real price paid for labour is twice as great in the one country as in the other; but the produce being also twice as great, the ratio between the price of labour and the produce of labour is still exactly the same:  an outlay of 200 quarters gives a return of 240 quarters, and profits, as before, are 20 per cent.

Profits, then (meaning not gross profits, but the rate of profit), depend (not upon the price of labour, tools, and materials-but) upon the ratio between the price of labour, tools, and materials, and the produce of them:  upon the proportionate share of the produce of industry which it is necessary to offer, in order to purchase that industry and the means of setting it in motion.

We have hitherto spoken of tools, buildings, and materials, as essentials of production, co-ordinate with labour, and equally indispensable with it.  This is true; but it is also true that tools, buildings, and materials, are themselves the produce of labour; and that the only cause (cases of monopoly excepted) of their having any value, is the labour which is required for their production.

If tools, buildings, and materials were the spontaneous gifts of nature, requiring no labour either in order to produce or to appropriate them; and if they were thus bestowed upon mankind in indefinite quantity, and without the possibility of being monopolized; they would still be as useful, as indispensable as they now are; but since they could, like air and the light of the sun, be obtained without cost or sacrifice, they would form no part of the expenses of production, and no portion of the produce would be required to be set aside in order to replace the outlay made for these purposes.  The whole produce, therefore, after replacing the wages of labour, would be clear profit to the capitalist.

Labour alone is the primary means of production; “the original purchase-money which has been paid for everything.”  Tools and materials, like other things, have originally cost nothing but labour; and have a value in the market only because wages have been paid for them.  The labour employed in making the tools and materials being added to the labour afterwards employed in working up the materials by aid of the tools, the sum total gives the whole of the labour employed in the production of the completed commodity.  In the ultimate analysis, therefore, labour appears to be the only essential of production.  To replace capital, is to replace nothing but the wages of the labour employed.  Consequently, the whole of the surplus, after replacing wages, is profits.  From this it seems to follow, that the ratio between the wages of labour and the produce of that labour gives the rate of profit.  And thus we arrive at Mr. Ricardo’s principle, that profits depend upon wages; rising as wages fall, and falling as wages rise.

To protect this proposition (the most perfect form in which the law of profits seems to have been yet exhibited) against misapprehension, one or two explanatory remarks are required.

If by wages, be meant what constitutes the real affluence of the labourer, the quantity of produce which he receives in exchange for his labour; the proposition that profits vary inversely as wages, will be obviously false.  The rate of profit (as has been already observed and exemplified) does not depend upon the price of labour, but upon the proportion between the price of labour and the produce of it.  If the produce of labour is large, the price of labour may also be large without any diminution of the rate of profit:  and, in fact, the rate of profit is highest in those countries (as, for instance, North America) where the labourer is most largely remunerated.  For the wages of labour, though so large, bear a less proportion to the abundant produce of labour, there than elsewhere.

But this does not affect the truth of Mr. Ricardo’s principle as he himself understood it; because an increase of the labourer’s real comforts was not considered by him as a rise of wages.  In his language wages were only said to rise, when they rose not in mere quantity but in value.  To the labourer himself (he would have said) the quantity of his remuneration is the important circumstance:  but its value is the only thing of importance to the person who purchases his labour.

The rate of profits depends not upon absolute or real wages, but upon the value of wages.

If, however, by value, Mr. Ricardo had meant exchangeable value, his proposition would still have been remote from the truth.  Profits depend no more upon the exchangeable value of the labourer’s remuneration, than upon its quantity.  The truth is, that by the exchangeable value is meant the quantity of commodities which the labourer can purchase with his wages; so that when we say the exchangeable value of wages, we say their quantity, under another name.

Mr. Ricardo, however, did not use the word value in the sense of exchangeable value.

Occasionally, in his writings, he could not avoid using the word as other people use it, to denote value in exchange.  But he more frequently employed it in a sense peculiar to himself, to denote cost of production; in other words, the quantity of labour required to produce the article; that being his criterion of cost of production.  Thus, if a hat could be made with ten days’ labour in France and with five days’ labour in England, he said that the value of a hat was double in France of what it was in England.  If a quarter of corn could be produced a century ago with half as much labour as is necessary at present, Mr. Ricardo said that the value of a quarter of corn had doubled.

Mr. Ricardo, therefore, would not have said that wages had risen, because a labourer could obtain two pecks of flour instead of one, for a day’s labour; but if last year he received, for a day’s labour, something which required eight hours’ labour to produce it, and this year something which requires nine hours, then Mr. Ricardo would say that wages had risen.  A rise of wages, with Mr. Ricardo, meant an increase in the cost of production of wages; an increase in the number of hours’ labour which go to produce the wages of a day’s labour; an increase in the proportion of the fruits of labour which the labourer receives for his own share; an increase in the ratio between the wages of his labour and the produce of it.  This is the theory:  the reasoning, of which it is the result, has been given in the preceding paragraphs.

Some of Mr. Ricardo’s followers, or more properly, of those who have adopted in most particulars the views of political economy which his genius was the first to open up, have given explanations of Mr. Ricardo’s doctrine to nearly the same effect as the above, but in rather different terms.  They have said that profits depend not on absolute, but on proportional wages:  which they expounded to mean the proportion which the labourers en masse receive of the total produce of the country.

It seems, however, to be rather an unusual and inconvenient use of language to speak of anything as depending upon the wages of labour, and then to explain that by wages of labour you do not mean the wages of an individual labourer, but of all the labourers in the country collectively.  Mankind will never agree to call anything a rise of wages, except a rise of the wages of individual labourers, and it is therefore preferable to employ language tending to fix attention upon the wages of the individual.  The wages, however, on which profits are said to depend, are undoubtedly proportional wages, namely, the proportional wages of one labourer:  that is, the ratio between the wages of one labourer, and (not the whole produce of the country, but) the amount of what one labourer can produce; the amount of that portion of the collective produce of the industry of the country, which may be considered as corresponding to the labour of one single labourer.  Proportional wages, thus understood, may be concisely termed the cost of production of wages; or, more concisely still, the cost of wages, meaning their cost in the “original purchase money,” labour.

We have now arrived at a distinct conception of Mr. Ricardo’s theory of profits in its most perfect state.  And this theory we conceive to be the basis of the true theory of profits.  All that remains to do is to clear it from certain difficulties which still surround it, and which, though in a greater degree apparent than real, are not to be put aside as wholly imaginary.

Though it is true that tools, materials, and buildings (it is to be wished that there were some compact designation for all these essentials of production taken together,) are themselves the produce of labour, and are only on that account to be ranked among the expenses of production; yet the whole of their value is not resolvable into the wages of the labourers by whom they were produced.  The wages of those labourers were paid by a capitalist, and that capitalist must have the same profit upon his advances as any other capitalist; when, therefore, he sells the tools or materials, he must receive from the purchaser not only the reimbursement of the wages he has paid, but also as much more as will afford him the ordinary rate of profit.  And when the producer, after buying the tools and employing them in his own occupation, comes to estimate his gains, he must set aside a portion of the produce to replace not only the wages paid both by himself and by the tool-maker, but also the profits of the tool-maker, advanced by himself out of his own capital.

It is not correct, therefore, to state that all which the capitalist retains after replacing wages forms his profit.  It is true the whole return to capital is either wages or profits; but profits do not compose merely the surplus after replacing the outlay; they also enter into the outlay itself.  Capital is expended partly in paying or reimbursing wages, and partly in paying the profits of other capitalists, whose concurrence was necessary in order to bring together the means of production.

If any contrivance, therefore, were devised by which that part of the outlay which consists of previous profits could be either wholly or partially dispensed with, it is evident that more would remain as the profit of the immediate producer; while, as the quantity of labour necessary to produce a given quantity of the commodity would be unaltered, as well as the quantity of produce paid for that labour, it seems that the ratio between the price of labour and its produce would be the same as before; that the cost of production of wages would be the same, proportional wages the same, and yet profits different.

To illustrate this by a simple instance, let it be supposed that one-third of the produce is sufficient to replace the wages of the labourers who have been immediately instrumental in the production; that another third is necessary to replace the materials used and the fixed capital worn out in the process; while the remaining third is clear gain, being a profit of 50 per cent.  Suppose, for example, that 60 agricultural labourers, receiving 60 quarters of corn for their wages, consume fixed capital and seed amounting to the value of 60 quarters more, and that the result of their operations is a produce of 180 quarters.  When we analyse the price of the seed and tools into its elements, we find that they must have been the produce of the labour of 40 men:  for the wages of those 40, together with profit at the rate previously supposed (50 per cent) make up 60 quarters.  The produce, therefore, consisting of 180 quarters is the result of the labour altogether of 100 men:  namely, the 60 first mentioned, and the 40 by whose labour the fixed capital and the seed were produced.

Let us now suppose, by way of an extreme case, that some contrivance is discovered, whereby the purposes to which the second third of the produce had been devoted, may be dispensed with altogether:  that some means are invented by which the same amount of produce may be procured without the assistance of any fixed capital, or the consumption of any seed or material sufficiently valuable to be worth calculating.  Let us, however, suppose that this cannot be done without taking on a number of additional labourers, equal to those required for producing the seed and fixed capital; so that the saving shall be only in the profits of the previous capitalists.  Let us, in conformity with this supposition, assume that in dispensing with the fixed capital and seed, value 60 quarters, it is necessary to take on 40 additional labourers, receiving a quarter of corn each, as before.

The rate of profit has evidently risen.  It has increased from 50 per cent to 60 per cent.  A return of 180 quarters could not before be obtained but by an outlay of 120 quarters; it can now be obtained by an outlay of no more than 100.

Here, therefore, is an undeniable rise of profits.  Have wages, in the sense above attached to them, fallen or not?  It would seem not.

The produce (180 quarters) is still the result of the same quantity of labour as before, namely, the labour of 100 men.  A quarter of corn, therefore, is still, as before, the produce of 10/18 of a man’s labour for a year.  Each labourer receives, as before, one quarter of corn; each, therefore, receives the produce of 10\18 of a year’s labour of one man, that is, the same cost of production; each receives 10/18 of the produce of his own labour, that is, the same proportional wages; and the labourers collectively still receive the same proportion, namely 10/18, of the whole produce.

The conclusion, then, cannot be resisted, that Mr. Ricardo’s theory is defective:  that the rate of profits does not exclusively depend upon the value of wages, in his sense, namely, the quantity of labour of which the wages of a labourer are the produce; that it does not exclusively depend upon proportional wages, that is, upon the proportion which the labourers collectively receive of the whole produce, or the ratio which the wages of an individual labourer bear to the produce of his individual labour.

Those political economists, therefore, who have always dissented from Mr. Ricardo’s doctrine, or who, having at first admitted, ended by discarding it, were so far in the right; but they committed a serious error in this, that, with the usual one-sidedness of disputants, they knew no medium between admitting absolutely and dismissing entirely; and saw no other course than utterly to reject what it would have been sufficient to modify.

It is remarkable how very slight a modification will suffice to render Mr. Ricardo’s doctrine completely true.  It is even doubtful whether he himself, if called upon to adapt his expressions to this peculiar case, would not have so explained his doctrine as to render it entirely unobjectionable.

It is perfectly true, that, in the example already made use of, a rise of profits takes place, while wages, considered in respect to the quantity of labour of which they are the produce, have not varied at all.  But though wages are still the produce of the same quantity of labour as before, the cost of production of wages has nevertheless fallen; for into cost of production there enters another element besides labour.

We have already remarked (and the very example out of which the difficulty arose presupposes it) that the cost of production of an article consists generally of two parts,-the wages of the labour employed, and the profits of those who, in any antecedent stage of the production, have advanced any portion of those wages.  An article, therefore, may be the produce of the same quantity of labour as before, and yet, if any portion of the profits which the last producer has to make good to previous producers can be economized, the cost of production of the article is diminished.

Now, in our example, a diminution of this sort is supposed to have taken place in the cost of production of corn.  The production of that article has become less costly, in the ratio of six to five.  A quantity of corn, the means of producing which could not previously have been secured but at an expense of 120 quarters, can now be produced by means which 100 quarters are sufficient to purchase.

But the labourer is supposed to receive the same quantity of corn as before.  He receives one quarter.  The cost of production of wages has, therefore, fallen one-sixth.  A quarter of corn, which is the remuneration of a single labourer, is indeed the produce of the same quantity of labour as before; but its cost of production is nevertheless diminished.  It is now the produce of 10/18 of a man’s labour, and nothing else; whereas formerly it required for its production the conjunction of that quantity of labour with an expenditure, in the form of reimbursement of profit, amounting to one-fifth more.

If the cost of production of wages had remained the same as before, profits could not have risen.  Each labourer received one quarter of corn; but one quarter of corn at that time was the result of the same cost of production, as 1 1/5 quarter now.  In order, therefore, that each labourer should receive the same cost of production, each must now receive one quarter of corn, plus one-fifth.  The labour of 100 men could not be purchased at this price for less than 120 quarters; and the produce, 180 quarters, would yield only 50 per cent, as first supposed .

It is, therefore, strictly true, that the rate of profits varies inversely as the cost of production of wages.  Profits cannot rise, unless the cost of production of wages falls exactly as much; nor fall, unless it rises.

The proof of this position has been stated in figures, and in a particular case:  we shall now state it in general terms, and for all cases.

We have supposed, for simplicity, that wages are paid in the finished commodity.  The agricultural labourers, in our example, were paid in corn, and if we had called them weavers, we should have supposed them to be paid in cloth.  This supposition is allowable, for it is obviously of no consequence, in a question of value, or cost of production, what precise article we assume as the medium of exchange.  The supposition has, besides, the recommendation of being conformable to the most ordinary state of the facts; for it is by the sale of his own finished article that each capitalist obtains the means of hiring labourers to renew the production; which is virtually the same thing as if, instead of selling the article for money and giving the money to his labourers, he gave the article itself to the labourers, and they sold it for their daily bread.

Assuming, therefore, that the labourer is paid in the very article he produces, it is evident that, when any saving of expense takes place in the production of that article, if the labourer still receives the same cost of production as before, he must receive an increased quantity, in the very same ratio in which the productive power of capital has been increased.  But, if so, the outlay of the capitalist will bear exactly the same proportion to the return as it did before; and profits will not rise.

The variations, therefore, in the rate of profits, and those in the cost of production of wages, go hand in hand, and are inseparable.  Mr. Ricardo’s principle, that profits cannot rise unless wages fall, is strictly true, if by low wages be meant not merely wages which are the produce of a smaller quantity of labour, but wages which are produced at less cost, reckoning labour and previous profits together.  But the interpretation which some economists have put upon Mr. Ricardo’s doctrine, when they explain it to mean that profits depend upon the proportion which the labourers collectively receive of the aggregate produce, will not hold at all; for that, in our first example, remained the same, and yet profits rose.

The only expression of the law of profits, which seems to be correct, is, that they depend upon the cost of production of wages.  This must be received as the ultimate principle.

From this may be deduced all the corollaries which Mr. Ricardo and others have drawn from his theory of profits as expounded by himself.  The cost of production of the wages of one labourer for a year, is the result of two concurrent elements or factors,-viz., 1st, the quantity of commodities which the state of the labour market affords to him; 2ndly, the cost of production of each of those commodities.  It follows, that the rate of profits can never rise but in conjunction with one or other of two changes,-1st, a diminished remuneration of the labourer; or, 2ndly, an improvement in production, or an extension of commerce, by which any of the articles habitually consumed by the labourer may be obtained at smaller cost. (If the improvement be in any article which is not consumed by the labourer, it merely lowers the price of that article, and thereby benefits capitalists and all other people so far as they are consumers of that particular article, and may be said to increase gross profit, but not the rate of profit.)

So, on the other hand, the rate of profit cannot fall, unless concurrently with one of two events:  1st, an improvement in the labourer’s condition; or, 2ndly, an increased difficulty of producing or importing some article which the labourer habitually consumes.  The progress of population and cultivation has a tendency to lower profits through the latter of these two channels, owing to the well known law of the application of capital to land, that a double capital does not caeteris paribus yield a double produce.  There is, therefore, a tendency in the rate of profits to fall with the progress of society.  But there is also an antagonist tendency of profits to rise, by the successive introduction of improvements in agriculture, and in the production of those manufactured articles which the labourers consume.  Supposing, therefore, that the actual comforts of the labourer remain the same, profits will fall or rise, according as population, or improvements in the production of food and other necessaries, advance fastest.

The rate of profits, therefore, tends to fall from the following causes:-1.  An increase of capital beyond population, producing increased competition for labour; 2.  An increase of population, occasioning a demand for an increased quantity of food, which must be produced at a greater cost.  The rate of profits tends to rise from the following causes:-1.  An increase of population beyond capital, producing increased competition for employment; 2.  Improvements producing increased cheapness of necessaries, and other articles habitually consumed by the labourer.

The circumstances which regulate the rate of interest have usually been treated, even by professed writers on political economy, in a vague, loose, and unscientific manner.  It has, however, been felt that there is some connexion between the rate of interest and the rate of profit; that (to use the words of Adam Smith) much will be given for money, when much can be made of it.  It has been felt, also, that the fluctuations in the market-rate of interest from day to day, are determined, like other matters of bargain and sale, by demand and supply.  It has, therefore, been considered as an established principle, that the rate of interest varies from day to day according to the quantity of capital offered or called for on loan; but conforms on the average of years to a standard determined by the rate of profits, and bearing some proportion to that rate-but a proportion which few attempts have been made to define.

In consequence of these views, it has been customary to judge of the general rate of profits at any time or place, by the rate of interest at that time and place:  it being supposed that the rate of interest, though liable to temporary fluctuations, can never vary for any long period of time unless profits vary; a notion which appears to us to be erroneous.

It was observed by Adam Smith, that profits may be considered as divided into two parts, of which one may properly be considered as the remuneration for the use of the capital itself, the other as the reward of the labour of superintending its employment; and that the former of these will correspond with the rate of interest.  The producer who borrows capital to employ it in his business, will consent to pay, for the use of it, all that remains of the profits he can make by it, after reserving what he considers reasonable remuneration for the trouble and risk which he incurs by borrowing and employing it.

This remark is just; but it seems necessary to give greater precision to the ideas which it involves.

The difference between the profit which can be made by the use of capital, and the interest which will be paid for it, is rightly characterized as wages of superintendance.  But to infer from this that it is regulated by entirely the same principles as other wages, would be to push the analogy too far.  It is wages, but wages paid by a commission upon the capital employed.  If the general rate of profit is 10 per cent, and the rate of interest 5 per cent, the wages of superintendance will be 5 per cent; and though one borrower employ a capital of 100,000_l_., another no more than 100_l_., the labour of both will be rewarded with the same per centage, though, in the one ease, this symbol will represent an income of 5_l_., in the other case, of 5000_l_.  Yet it cannot be pretended that the labour of the two borrowers differs in this proportion.  The rule, therefore, that equal quantities of labour of equal hardness and skill are equally remunerated, does not hold of this kind of labour.  The wages of any other labour are here an inapplicable criterion.

The wages of superintendance are distinguished from ordinary wages by another peculiarity, that they are not paid in advance out of capital, like the wages of all other labourers, but merge in the profit, and are not realized until the production is completed.  This takes them entirely out of the ordinary law of wages.  The wages of labourers who are paid in advance, are regulated by the number of competitors compared with the amount of capital; the labourers can consume no more than what has been previously accumulated.  But there is no such limit to the remuneration of a kind of labour which is not paid for out of wealth previously accumulated, but out of that produce which it is itself employed in calling into existence.

When these circumstances are duly weighed, it will be perceived, that although profit may be correctly analyzed into interest and wages of superintendance, we ought not to lay it down as the law of interest, that it is profits minus the wages of superintendance.  Of the two expressions, it would be decidedly the more correct, that the wages of superintendance are regulated by the rate of interest, or are equal to profits minus interest.  In strict, propriety, neither expression would be allowable.  Interest, and the wages of superintendance, can scarcely be said to depend upon one another.  They are to one another in the same relation as wages and profits are.  They are like two buckets in a well:  when one rises, the other descends, but neither of the two motions is the cause of the other; both are simultaneous effects of the same cause, the turning of the windlass.

There are among the capitalists of every country a considerable number who are habitually, and almost necessarily, lenders; to whom scarcely any difference between what they could receive for their money and what could be made by it, would be an equivalent for incurring the risk and labour of carrying on business.  In this predicament is the property of widows and orphans; of many public bodies; of charitable institutions; most property which is vested in trustees; and the property of a great number of persons unused to business, and who have a distaste for it, or whose other occupations prevent their engaging in it.  How large a proportion of the property lent to the nation comes under this description, has been pointed out in Mr. Tooke’s Considerations on the State of the Currency.

There is another large class, consisting of bankers, bill-brokers, and others, who are money-lenders by profession; who enter into that profession with the intention of making such gains as it will yield them, and who would not be induced to change their business by any but a very strong pecuniary inducement.

There is, therefore, a large class of persons who are habitually lenders.  On the other hand, all persons in business may be considered as habitually borrowers.  Except in times of stagnation, they are all desirous of extending their business beyond their own capital, and are never desirous of lending any portion of their capital except for very short periods, during which they cannot advantageously invest it in their own trade.

There is, in short, a productive class, and there is, besides, a class technically styled the monied class, who live upon the interest of their capital, without engaging personally in the work of production.

The class of borrowers may be considered as unlimited.  There is no quantity of capital that could be offered to be lent, which the productive classes would not be willing to borrow, at any rate of interest which would afford them the slightest excess of profit above a bare equivalent for the additional risk, incurred by that transaction, of the evils attendant on insolvency.  The only assignable limit to the inclination to borrow, is the power of giving security:  the producers would find it difficult to borrow more than an amount equal to their own capital.  If more than half the capital of the country were in the hands of persons who preferred lending it to engaging personally in business, and if the surplus were greater than could be invested in loans to Government, or in mortgages upon the property of unproductive consumers; the competition of lenders would force down the rate of interest very low.  A certain portion of the monied class would be obliged either to sacrifice their predilections by engaging in business, or to lend on inferior security; and they would accordingly accept, where they could obtain good security, an abatement of interest equivalent to the difference of risk.

This is an extreme case.  Let us put an extreme case of a contrary kind.  Suppose that the wealthy people of any country, not relishing an idle life, and having a strong taste for gainful labour, were generally indisposed to accept of a smaller income in order to be relieved from the labour and anxiety of business.  Every producer in flourishing circumstances would be eager to borrow, and few willing to lend.  Under these circumstances the rate of interest would differ very little from the rate of profit.  The trouble of managing a business is not proportionally increased by an increase of the magnitude of the business; and a very small surplus profit above the rate of interest, would therefore be a sufficient inducement to capitalists to borrow.

We may even conceive a people whose habits were such, that in order to induce them to lend, it might be necessary to offer them a rate of interest fully equal to the ordinary rate of profit.  In that case, of course, the productive classes would scarcely ever borrow.  But government, and the unproductive classes, who do not borrow in order to make a profit by the loan, but from the pressure of a real or supposed necessity, might still be ready to borrow at this high rate.

Although the inclination to borrow has no fixed or necessary limit except the power of giving security, yet it always, in point of fact, stops short of this; from the uncertainty of the prospects of any individual producer, which generally indisposes him to involve himself to the full extent of his means of payment.  There is never any permanent want of market for things in general; but there may be so for the commodity which any one individual is producing; and even if there is a demand for the commodity, people may not buy it of him but of some other.  There are, consequently, never more than a portion of the producers, the state of whose business encourages them to add to their capital by borrowing; and even these are disposed to borrow only as much as they see an immediate prospect of profitably employing.  There is, therefore, a practical limit to the demands of borrowers at any given instant; and when these demands are all satisfied, any additional capital offered on loan can find an investment only by a reduction of the rate of interest.

The amount of borrowers being given, (and by the amount of borrowers is here meant the aggregate sum which people are willing to borrow at some given rate,) the rate of interest will depend upon the quantity of capital owned by people who are unwilling or unable to engage in trade.  The circumstances which determine this, are, on the one hand, the degree in which a taste for business, or an aversion to it, happens to be prevalent among the classes possessed of property; and on the other hand, the amount of the annual accumulation from the earnings of labour.  Those who accumulate from their wages, fees, or salaries, have, of course, (speaking generally) no means of investing their savings except by lending them to others:  their occupations prevent them from personally superintending any employment.

Upon these circumstances, then, the rate of interest depends, the amount of borrowers being given.  And the counter-proposition equally holds, that, the above circumstances being given, the rate of interest depends upon the amount of borrowers.

Suppose, for example, that when the rate of interest has adjusted itself to the existing state of the circumstances which affect the disposition to borrow and to lend, a war breaks out, which induces government, for a series of years, to borrow annually a large sum of money.  During the whole of this period, the rate of interest will remain considerably above what it was before, and what it will be afterwards.

Before the commencement of the supposed war, all persons who were disposed to lend at the then rate of interest, had found borrowers, and their capital was invested.  This may be assumed; for if any capital had been seeking for a borrower at the existing rate of interest, and unable to find one, its owner would have offered it at a rate slightly below the existing rate.  He would, for instance, have bought into the funds, at a slight advance of price; and thus set at liberty the capital of some fundholder, who, the funds yielding a lower interest, would have been obliged to accept a lower interest from individuals.

Since, then, all who were willing to lend their capital at the market rate, have already lent it, Government will not be able to borrow unless by offering higher interest.  Though, with the existing habits of the possessors of disposable capital, an increased number cannot be found who are willing to lend at the existing rate, there are doubtless some who will be induced to lend by the temptation of a higher rate.  The same temptation will also induce some persons to invest, in the purchase of the new stock, what they would otherwise have expended unproductively in increasing their establishments, or productively, in improving their estates.  The rate of interest will rise just sufficiently to call forth an increase of lenders to the amount required.

This we apprehend to be the cause why the rate of interest in this country was so high as it is well known to have been during the last war.  It is, therefore, by no means to be inferred, as some have done, that the general rate of profits was unusually high during the same period, because interest was so.  Supposing the rate of profits to have been precisely the same during the war, as before or after it, the rate of interest would nevertheless have risen, from the causes and in the manner above described.

The practical use of the preceding investigation is, to moderate the confidence with which inferences are frequently drawn with respect to the rate of profit from evidence regarding the rate of interest; and to shew that although the rate of profit is one of the elements which combine to determine the rate of interest, the latter is also acted upon by causes peculiar to itself, and may either rise or fall, both temporarily and permanently, while the general rate of profits remains unchanged.

The introduction of banks, which perform the function of lenders and loan-brokers, with or without that of issuers of paper-money, produces some further anomalies in the rate of interest, which have not, so far as we are aware, been hitherto brought within the pale of exact science.

If bankers were merely a class of middlemen between the lender and the borrower; if they merely received deposits of capital from those who had it lying unemployed in their hands, and lent this, together with their own capital, to the productive classes, receiving interest for it, and paying interest in their turn to those who had placed capital in their hands; the effect of the operations of banking on the rate of interest would be to lower it in some slight degree.  The banker receives and collects together sums of money much too small, when taken individually, to render it worth while for the owners to look out for an investment, but which in the aggregate form a considerable amount.  This amount may be considered a clear addition to the productive capital of the country; at least, to the capital in activity at any moment.  And as this addition to the capital accrues wholly to that part of it which is not employed by the owners, but lent to other producers, the natural effect is a diminution of the rate of interest.

The banker, to the extent of his own private capital, (the expenses of his business being first paid,) is a lender at interest.  But, being subject to risk and trouble fully equal to that which belongs to most other employments, he cannot be satisfied with the mere interest even of his whole capital:  he must have the ordinary profits of stock, or he will not engage in the business:  the state of banking must be such as to hold out to him the prospect of adding, to the interest of what remains of his own capital after paying the expenses of his business, interest upon capital deposited with him, in sufficient amount to make up, after paying the expenses, the ordinary profit which could be derived from his own capital in any productive employment.  This will be accomplished in one of two ways.

1.  If the circumstances of society are such as to furnish a ready investment of disposable capital; (as for instance in London, where the public funds and other securities, of undoubted stability, and affording great advantages for receiving the interest without trouble and realizing the principal without difficulty when required, tempt all persons who have sums of importance lying idle, to invest them on their own account without the intervention of any middleman;) the deposits with bankers consist chiefly of small sums likely to be wanted in a very short period for current expenses, and the interest on which would seldom be worth the trouble of calculating it.  Bankers, therefore, do not allow any interest on their deposits.  After paying the expenses of their business, all the rest of the interest they receive is clear gain.  But as the circumstances of banking, as of all other modes of employing capital, will on the average be such as to afford to a person entering into the business a prospect of realizing the ordinary, and no more than the ordinary, profits upon his own capital; the gains of each banker by the investment of his deposits, will not on the average exceed what is necessary to make up his gains on his own capital to the ordinary rate.  It is, of course, competition, which brings about this limitation.  Whether competition operates by lowering the rate of interest, or by dividing the business among a larger number, it is difficult to decide.  Probably it operates in both ways; but it is by no means impossible that it may operate in the latter way alone:  just as an increase in the number of physicians does not lower the fees, though it diminishes an average competitor’s chance of obtaining them.

It is not impossible that the disposition of the lenders might be such, that they would cease to lend rather than acquiesce in any reduction of the rate of interest.  If so, the arrival of a new lender, in the person of a banker of deposit, would not lower the rate of interest in any considerable degree.  A slight fall would take place, and with that exception things would be as before, except that the capital in the hands of the banker would have put itself into the place of an equal portion of capital belonging to other lenders, who would themselves have engaged in business (e.g., by subscribing to some joint-stock company, or entering into commandite).  Bankers’ profits would then be limited to the ordinary rate chiefly by the division of the business among many banks, so that each on the average would receive no more interest on his deposits than would suffice to make up the interest on his own capital to the ordinary rate of profit after paying all expenses.

2.  But if the circumstances of society render it difficult and inconvenient for persons who wish to live upon the interest of their money, to seek an investment for themselves, the bankers become agents for this specific purpose:  large as well as small sums are deposited with them, and they allow interest to their customers.  Such is the practice of the Scotch banks, and of most of the country banks in England.  Their customers, not living at any of the great seats of money transactions, prefer entrusting their capital to somebody on the spot, whom they know, and in whom they confide.  He invests their money on the best terms he can, and pays to them such interest as he can afford to give; retaining a compensation for his own risk and trouble.  This compensation is fixed by the competition of the market.  The rate of interest is no further lowered by this operation, than inasmuch as it brings together the lender and the borrower in a safe and expeditious manner.  The lender incurs less risk, and a larger proportion, therefore, of the holders of capital are willing to be lenders.

When a banker, in addition to his other functions, is also an issuer of paper money, he gains an advantage similar to that which the London bankers derive from their deposits.  To the extent to which he can put forth his notes, he has so much the more to lend, without himself having to pay any interest for it.

If the paper is convertible, it cannot get into circulation permanently without displacing specie, which goes abroad and brings back an equivalent value.  To the extent of this value, there is an increase of the capital of the country; and the increase accrues solely to that part of the capital which is employed in loans.

If the paper is inconvertible, and instead of displacing specie depreciates the currency, the banker by issuing it levies a tax on every person who has money in his hands or due to him.  He thus appropriates to himself a portion of the capital of other people, and a portion of their revenue.  The capital might have been intended to be lent, or it might have been intended to be employed by the owner:  such part of it as was intended to be employed by the owner now changes its destination, and is lent.  The revenue was either intended to be accumulated, in which case it had already become capital, or it was intended to be spent:  in this last case, revenue is converted into capital:  and thus, strange as it may appear, the depreciation of the currency, when effected in this way, operates to a certain extent as a forced accumulation.  This, indeed, is no palliation of its iniquity.  Though A might have spent his property unproductively, B ought not to be permitted to rob him of it because B will expend it on productive labour.

In any supposable case, however, the issue of paper money by bankers increases the proportion of the whole capital of the country which is destined to be lent.  The rate of interest must therefore fall, until some of the lenders give over lending, or until the increase of borrowers absorbs the whole.

But a fall of the rate of interest, sufficient to enable the money market to absorb the whole of the paper-loans, may not be sufficient to reduce the profits of a lender who lends what costs him nothing, to the ordinary rate of profit upon his capital.  Here, therefore, competition will operate chiefly by dividing the business.  The notes of each bank will be confined within so narrow a district, or will divide the supply of a district with so many other banks, that on the average each will receive no larger amount of interest on his notes than will make up the interest on his own capital to the ordinary rate of profit.

Even in this way, however, the competition has the effect, to a certain limited extent, of lowering the rate of interest; for the power of bankers to receive interest on more than their capital attracts a greater amount of capital into the banking business than would otherwise flow into it; and this greater capital being all lent, interest will fall in consequence.