Capital, Interest and Profits

The classical meaning of capital is “wealth that is used in production, including wealth that is in the course of exchange.” That seems clear enough at first, but of all the classical definitions, it is the most controversial. Why is that?

Different studies define terms differently, to serve various goals. Our study seeks to understand the cause of persistent poverty, by analyzing the distribution of goods and services in society. With that goal in mind, let’s review some of the things that — in terms of political economy — capital is not. Capital is not land, because capital is produced by labor; land is not produced. Capital is the material product of labor, not the labor itself — so, capital per se does not take risks, and has no skills. And — this last one creates great confusion — capital is not money, or stock certificates, or bonds. Those things represent ownership of assets, which could be capital, or could be land, or some form of monopoly.

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In this course, we’re looking at capital not as a social class, but as a factor of production. In Henry George’s day, the return to this factor was commonly called "Interest." Although many people use this term differently today, in this course we retain the term for the sake of consistency and simplicity. Henry George himself suggested clarifying the term by calling the return to capital "economic interest" — as distinguished from "financial interest," the commonly-used sense.”

Another thing that capital is not — in its use here as an economic term — is a class of people in society. It has often been held that the concerns of Labor and Capital are at odds in our “Capitalistic” economy. But that can only be true if we are thinking of Labor and Capital as the opposing forces in the dynamic of Class Struggle. In that scheme of things, “Big-C Capital” is the “ownership class” — which owns not just capital goods, but land as well — and controls the doling-out of privileges.

Is capital, in its role as as a factor of production, capable of yielding an exploitative income? Let’s suppose we’ve inherited some capital — the rolling stock of a trucking company, say, worth $500,000 — but no land to put it on. What can we do to get an income from it?

We could sell it, deposit the proceeds in a bank, and get a safe, but small, income. If we think we can get a greater income from running the trucks ourselves, we’ll keep them. To do that, we’ve got to haul stuff in them — we’ve got to use them in actual production. We must rent, or buy, some land to put them on. We must maintain the fleet, or they will soon be worth nothing. We must pay wages to ourselves or to someone else to drive them and service them. If we don’t know how to run a trucking company, we could trade the trucks for some form of capital that we do know how to use. But capital in any form must also be maintained — and operated — and located somewhere. How can the ownership of capital per se yield us an exorbitant income? Owning capital sounds more like a headache than a goldmine!

That may be true — but don’t we see “capitalists” getting rich in our “capitalistic” economy? Don’t we watch wages go down while profits go up?

Profits, in Political Economy

Just what are profits? What is the relationship between profits, wages, interest and rent? First, we must recognize that while profit is an important consideration for individual investors and entrepreneurs, it has nothing to do with our main concern here: the laws that determine how society’s output is distributed. In our everyday sense of things, “profit” is an accounting term that simply means a business’s income, minus its expenses, during a certain period. That income most likely comes from a combination of all three factors: labor, capital and land.

piggyHowever, just as we distinguish between the everyday usage and common meanings of economic terms, many economists — and econ textbooks — introduce a concept called “economic profit.” Whereas normal, or accounting, profit is the difference between a firm’s income and the cost of the factors used in producing it, economic profit is the difference between a firm’s income and the cost of the factors it could have chosen — which is called its opportunity cost. Because it involves comparing choices among alternatives, economic profit is seen as a payment for entrepreneurship — economic decision-making and risk-taking. Some go as far as to define Entrepreneurship as a separate factor of production, which earns a factor payment called Profit. Here is an examination of this scheme of definitions in a mainstream “econ” text. (PDF, 2 pages)

Here’s why this distinction is important: It disguises an error that allows many economists severely underestimate the economic role of land. As reported in US national income statistics, aggregate rent is less than 2% of national income. If rent is no more than that, then land is a relatively trivial factor. However, the national income statistics use a very narrow definition of “rent,” counting only explicit payments for land. It ignores the rent capitalized in purchase prices for land, or land held for collateral, or in the share value of corporations. Added up, those things account for way more than 2% of the nation’s income. So where is the rent?

When “economic profit” is seen as the return to “entrepreneurship,” it allows the unearned income from land rent to count as part of the “legitimate” income earned by risk-taking entrepreneurs. Such income is, generally, immune to criticism (and to most taxation), because entrepreneurial innovation is seen as the backbone of the market economy. But, although it is kept well-hidden in conventional textbooks, this conception of rents and profits doesn’t add up. Rent is either a payment to the passive factor of land or to the active factor of entrepreneurial labor — it can’t be both.

Land is the passive factor in production: natural opportunities which command an unearned payment, independent of anything their owners do. We define Labor as all human exertion, both physical and mental, in production. So, if people want to think of economic profit as a payment for entrepreneurship, that’s fine — as long as they recognize that entrepreneurship is something that people do. Land, as such, decides nothing and takes no risks. Economic Profit, then, cannot contain Interest, or Rent, or any payment to monopoly or privilege. (And, in our task of analyzing the distribution of wealth in society, we can do just fine without this concept. All it tells us is that “economic profit” — the return to entrepreneurial labor — is a subset of wages, the return to all labor.)


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Membership in the Henry George Institute

...has only two requirements: pay your annual dues of $20 (us), and indicate your agreement with our Statement of Purpose. As a member, you get a subscription to the Georgist Journal, and a vote in our annual election for members of the Board of Directors.

STATEMENT OF PURPOSE

In accordance with the philosophy of Henry George, the Henry George Institute holds that all persons have a right to the use of the earth and that all have a right to the fruits of their labor. To implement these rights it is proposed that the rent of land be taken by the community as public revenue, and that all taxes on labor and the fruits of labor be abolished. The Institute believes with George that “liberty means justice and justice is the natural law,” and that the social and economic ills besetting the world today are the result of non-conformance to natural law. The Institute pledges itself to bring this philosophy to the attention of the public by all suitable means.

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Our first course, Understanding Economics, is FREE and self-paced. There are no due-dates or deadlines — yet our staff is always available to answer your questions via email.

It's a good idea to check out the first few readings and video supplements to get ready for your first lesson. Make sure to bookmark our "Site Map" page, which has links to the suggested readings for each lesson (and much more).

When you're ready, click below to enroll. You'll pick a username and a password, and be asked for some more basic information (which we will NOT share with anyone else). We'll need your snail-mail address to send you your certificate when you complete the course!

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Membership in the Henry George Institute

...has only two requirements: pay your annual dues of $20 (us), and indicate your agreement with our Statement of Purpose. As a member, you get a subscription to the Georgist Journal, and a vote in our annual election for members of the Board of Directors.

STATEMENT OF PURPOSE

In accordance with the philosophy of Henry George, the Henry George Institute holds that all persons have a right to the use of the earth and that all have a right to the fruits of their labor. To implement these rights it is proposed that the rent of land be taken by the community as public revenue, and that all taxes on labor and the fruits of labor be abolished. The Institute believes with George that “liberty means justice and justice is the natural law,” and that the social and economic ills besetting the world today are the result of non-conformance to natural law. The Institute pledges itself to bring this philosophy to the attention of the public by all suitable means.

Close this popup

Getting Started with Understanding Economics

Our first course, Understanding Economics, is FREE and self-paced. There are no due-dates or deadlines — yet our staff is always available to answer your questions via email.

It's a good idea to check out the first few readings and video supplements to get ready for your first lesson. Make sure to bookmark our "Site Map" page, which has links to the suggested readings for each lesson (and much more).

When you're ready, click below to enroll. You'll pick a username and a password, and be asked for some more basic information (which we will NOT share with anyone else). We'll need your snail-mail address to send you your certificate when you complete the course!

Enroll today for a rewarding, enriching experience!

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