Capital, Interest & Profits

Video Supplement for this lesson
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?

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.

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.

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.

However, 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.)