"ECONOMICS" and POLITICAL ECONOMY

Here are the basic factors of the production of wealth and their functions. Click here  for an exercise on how useful clear definitions can be.

Political Economy is the study of how people get a living. What, then, is Economics? Although the two terms are sometimes used interchangeably, there is a subtle distinction to be made between them. "Political Economy" is the older term, and it was used by the classical economists. Most standard textbooks today define "Economics" as "The science of how people make choices for the allocation of scarce resources to satisfy their unlimited desires." That is a statement of the basic dilemma called "the problem of scarcity."

Henry George, like all the classical political economists, recognized that the means for satisfying our desires is human effort, so he stated the problem of scarcity in terms of labor. The basic axiom of political economy, George wrote, is that

People seek to satisfy their desires with the least exertion.

The classical political economists recognized the problem of scarcity, but they were preoccupied with the economic life of the entire community — with the "wealth of nations." They sought to identify the principles that underlie the production and distribution of wealth. As it is most often taught today, economics pays little attention to the distribution of wealth. Why the change? That is a question we will ponder as we go through this course. Because wealth distribution is a central concern for us, we will continue to call our study Political Economy — which we define as:

The science which deals with the natural laws governing the production and distribution of valuable goods and services.

Video Supplement for this lesson

The Three Factors of Production

One of the central characteristics of this course is its focus on land as a distinctive factor of production, which must be considered separately from the other two factors, capital and labor. This is a point that modern-day economics de-emphasizes, or even denies outright. Why is that? Could it be that land was an important economic factor, way back when — but today's social complexity and advanced technology have freed us from dependence on nature?

Not one bit. Land is needed for all production, for all human life and activity of any kind. When most people think of "land," their mental picture is of farm land: crops, orchards, pastures. But in fact, the most valuable natural resource in modern society is urban land. In cities, activities take less land area per head, but more land value, because the price of city land (per unit of area) is hundreds, sometimes thousands of times higher than the price of rural land.

The factors of production are:

LAND.
The entire material universe exclusive of people and their products.

Everything physical (other than human beings) which is not the result of human effort is within the economic definition of land. This concept thus includes not merely the dry surface of the earth, but all natural materials, forces and opportunities. The trees in a virgin forest are land; in a cultivated forest they are wealth.

Radio and TV communications use the radio spectrum, a limited natural resource. Drivers of SUVs and other fuel-burning machinery use the earth's atmosphere as a dump for their greenhouse-gas wastes. To understand the meaning of land as a factor of production, we must conceive and define land broadly, as the entire set of natural opportunities.

LABOR.
All human exertion in the production of wealth and services.

Mental toil is labor as well as muscular effort. All who participate in production by their mental and physical effort are laborers in the economic sense. Thus entrepreneurs as well as blue-collar workers are included.

CAPITAL.
Wealth used in the process of production, which includes wealth in the course of exchange.

Capital is a subset of wealth (see definition below). Any item of wealth could be used as capital; it could be sold or used in production. This is implied in our definition of production, when we note that production is not completed until wealth reaches the final consumer. If an item of wealth is to be used as capital, its owner foregoes consuming it for that time.

It's worth noting that capital is a secondary factor of production. Only the two primary lactors, labor and land, are absolutely necessary. We know that wealth can be created without the use of capital, because capital is wealth. Wealth had to be created before people could choose to use some of it as capital.

In political economy, we define capital as a factor of production. We should note that this is quite different from the way "capital" is defined in conventional economics courses. There, capital is generally considered to be any asset that will yield its owner a return. Such an asset could be "capital goods" (wealth used in production), or it could be land, or money, or the investments in education or skill that are commonly termed "human capital."

Distinguishing the three factors of production is crucial to our analysis. Our most important objective in political economy is to understand the distribution of wealth in society. In order to do that, we need consistent, mututally exclusive definitions of the factors of production. Labor is only human exertion; capital is only physical products of human labor; land is only things not created by human labor. They are not convertible into each other. (For example: something can be built on land, but if the building is destroyed, the value of the bare land remains.)

WEALTH.
All material things produced by labor for the satisfaction of human desires and having exchange value.

This means that wealth must have all of these characteristics:

1. Wealth is material. Human qualities such as skill and mental acumen are not material, hence cannot be classified as wealth.
2. Wealth is produced by labor. Land possesses all the essentials of wealth but one — it is not a product of labor, therefore it is not wealth.
3. Wealth is capable of satisfying human desire. Money is not wealth; it is a medium of exchange whereby wealth can be acquired. Nor are shares of stock, bonds or other securities classifiable as wealth. They are but the evidences of ownership. None of these satisfy desire directly; if they are destroyed, the sum total of wealth is not decreased.
4. Wealth has exchange value. (More on this in a moment.)

Production includes not only the making of things but also bringing them to the consumer. An automobile, for instance, from the extraction of the ore, through the complex procedures of manufacturing and marketing, to the sale to the retail purchaser, is the embodiment of an extensive cooperative effort in production. The factors (makers) in the production of wealth are land, labor and capital.

The goal of production is the satisfaction of human desire. Services are direct satisfactions of human desire, not put into material form.

VALUE.
The quantity of labor, goods or money that people are generally willing to give in exchange for something.

In political economy we deal with exchange, or market value. A thing's exchange value does not depend on how much an individual may (or may not) value the thing; indeed it doesn't depend on any intrinsic quality of the thing. Value also has nothing to do with the amount of labor that went into something. Some natural resources have great value, yet were not produced by labor at all. Other things were created with great amounts of labor, yet have little or no market value — such as a derelict building, a junked car or an old computer.

Personal value or "utility" is, of course, an important consideration; it is the tension between personal value and market value that makes "the market" happen. However, when we refer to "value" in this course, we mean exchange value. This is because of the paramount importance of wealth distribution to our study. If a thing has no market value, it could have great value or importance to some people — yet not affect the overall distribution of valuable things in society.

The meaning of "economic value" is an important and contentious theme in political economy. Here's an essay on Why Theories of Value are Important.

DISTRIBUTION.
The division of production (aggregate wealth and services) among the factors which produce it.

The economic term "distribution" does not refer to the transporting and merchandising of wealth. These processes are part of production. Distribution refers to the division, or apportionment, of the product among the factors of production. The avenues of distribution are rent, wages and interest. The returns to each factor are determined by common forces, but each can be clearly separated from the other two.

RENT.
That part of aggregate production which is the return for the use of land.

We commonly speak of paying "rent" for building accommodations, or for hiring an office machine or an automobile. Because of the essential difference between land and capital, such payments are not economic rent. Because of our focus in this course on the distribution of wealth, we restrict the term rent to the return to land*.

WAGES.
That part of aggregate production which is the return to labor.

Ordinarily wages are thought of as the compensation paid to an employee. Economically speaking, however, wages include the earnings of all whose labor has in some way produced wealth, including the manager of a business enterprise.

INTEREST.
That part of aggregate production which is the return for the use of capital.

In common parlance, a borrower pays "interest" to a creditor. This is also how "interest" is defined in many economics texts: as the payment for time preference — being able to use or consume things now, rather than later.

This element of time preference was also part of the classical economists' concept of interest, which Henry George used. However, George and the classicists were careful to distinguish between true capital (which today is commonly called "capital goods") and returns to other assets such as money, land or financial instruments. Henry George called upon his readers to understand the difference between capital, the factor of production, and "spurious capital and profits commonly mistaken for interest." For the purpose of consistency and simplicity, we have retained George's use of the term "interest" in this course to mean "economic interest" — the return to capital as a factor of production. We should remember that borrowed money may or may not be spent on capital goods; in fact, a great deal of borrowed money goes toward the purchase of land. Similarly, a "capital investment," such as a share of a corporation's stock, includes a mixture of capital, land, and the products of ongoing labor.

George defines his terms carefully in advance, and sticks consistently with his definitions. It is all too common for economists to muddy the waters by not defining their terms, then by using them in shifting ways.

The three factors of production work together to produce a "pie" which includes all goods and services. When we seek to identify the Laws of Distribution, we are looking for the principles that determine what proportional shares go to the three factors under certain conditions.

It is not Land itself that gets rent, of course, but those who own land. It is not Capital itself that gets interest, but the owners of capital. If someone owns both, and manages them himself, then that person gets an income, called "profit," which contains all three elements: rent, interest, and wages-of-management. We don’t consider profits here,* because our job in this course is to analyze functional distribution — to show how wealth is distributed among the three factors that account for it. This is a study of patterns and relationships that affect the entire community. Individual or "personal" distribution — which is what microeconomics explores — is not concerned with the whole community, and uses terms differently, for different goals.

*We'll return to the subject of profits in the next lesson.