One reason why it is so vital to differentiate between profit and interest is that profits contain both rent and interest, and rent varies inversely with interest. If land and capital are considered together, we lose sight of this vital fact! That is because the return to capital, like the return to labor, depends on the margin of production. Here is how Henry George states Ricardo’s Law of Rent: "The rent of land is determined by the excess of its produce over that which the same application can secure from the least productive land in use."
"The Same Application?" What Does That Mean?
You might have have noticed that the conditions of production at the "margin of cultivation" (simple farming and mining) are very different from those on the most valuable land (what goes on in, say, the Financial District). How can there be any such thing as "same application" of labor and capital"?
It will help to recall that the "same application of capital" is not the same thing as "the application of the same capital". That’s because capital is fungible -- it can easily be converted into whatever form is called for under particular conditions.
At the frontier, virtually no production is possible without the use of such simple capital as an axe, a shovel or a plow. Having those tools would make an individual’s labor dozens of times more effective! Doesn’t that mean that the return to capital is actually much higher at the margin?
At the frontier, land is free, so the worker would use as much land as she could profitably use. But if she has any sense, she won't work that land with her bare hands. She will devote some of her labor to securing the capital she needs to make her labor more productive. Using those tools will make her labor, say, maybe, 1,000% more productive than it would have been without them.
Since capital is so important, won't the owner of capital demand an exorbitant payment for its use?
Nope. Capital isn't a monopoly. If our settler can't get it from one greedy capitalist, she can make it herself, or borrow it from someone else. The capital owner has to decide which would benefit him more: to use the tool himself, or to loan it out. If the capitalist decides to loan his capital out, he has decided that the wages he'd earn by working in some other way will be higher than what he could earn by using his capital himself. He will be willing to loan out the tool for the difference between the two.
Why can't he charge more? Well, he could if he had a monopoly -- if no other capital was available to do the job. But that would be an extraordinary situation. Capital is produced by labor -- and in the real world, suppliers of capital goods compete to get labor to pay for their use.
Perhaps the capital owner could take his capital to the city, and in that highly-productive environment, it would enhance labor's productivity much more than it could at the frontier. Ah, yes, but he would have to pay for land on which to use it -- and land in the city is pricey. That is why the laws of distribution tell us that the return to capital at the margin will be the general rate of return to capital everywhere else. Capital may be cast into different forms or put to different uses, in different amounts -- but the rate of return to capital will equal the optimal return that it could get where the land is free.
As long as there is any viable opportunity at the margin of production, that is where the return to capital is determined.
And when there is NO viable self-employment opportunity at the margin, do the laws still remain in effect? Indeed they do -- but in that case there is one difference. Even if the marginal alternative drops to zero, wages and interest cannot fall that low. Labor has to stay alive, and capital must be maintained in usable condition. So if there is no viable margin of production, then wages and interest fall to the lowest level that labor and capital will accept, to get them to come to work.