How our economy really works - Brian Hodgkinson

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purchase of land adds nothing to the productive capacity of the economy, except in so far as it was not fully used by the seller. When derelict land comes into production a productive investment seems to have been made. But no more land has been created. The investment merely corrects the dereliction, so that the real remedy would be to avoid dereliction of useful land in the first place. On the other hand, the purchase of capital stimulates the production of capital goods. More capital is available. Work is generated both in the capital goods industries and in the industry to which the capital is applied. Nevertheless, the capital is not the finance used in the purchase. It is the actual physical goods used for production.

      In the British economy today another damaging consequence follows from treating land as capital. Interest rate charges are used to influence the level of investment. When rates rise entrepreneurs are less prepared to buy new capital. This is equally true whether the finance is provided by themselves or whether it is borrowed. But the impact on the purchase of capital is quite different from the impact upon the purchase of land. This is because capital wears out or becomes obsolete relatively quickly. Entrepreneurs seek to recover the cost of the capital within its lifetime, which may be merely five or ten years. On the other hand, land lasts for ever. Hence money used to buy it is very often borrowed for longer periods, usually with a mortgage attached to the loan. Thus the interest rate has a much bigger impact on land purchases than upon capital purchases. Attempts to control the level of investment in capital by varying interest rates are largely futile. A rise in rates deters land purchases, but does little to reduce investment in capital; conversely when rates are reduced. The recent period of very low rates has not significantly helped capital creation, whilst is has had a serious effect on raising house prices, since they are largely determined by land prices. As more land is bought in response to low interest rates, the price of land rises.

      Yet another mistake occurs when capital is wrongly regarded as earning a reward or income over and above its cost of production. Except in the short-run, the only factors of production that do so are land and labour, which have no cost of production but naturally receive rent and wages as their share of the output they produce. Capital appears to receive a return. If a firm invests in a new piece of equipment its income net of all other costs would normally increase. This rise is attributable to the new capital. But over the lifetime of that equipment the extra return will generally be more or less equal to its cost. Why? The reason is that if it were less the equipment would not be introduced, and if it were more the firm making the equipment – in the capital goods industry – would be able to charge more for it. In other words, new capital will receive its supply price, which is the cost of its being produced.

      Of course, if there are interferences in the market for the final goods or for the capital goods, such as monopoly in either sector, the new capital may receive an extra return, called quasi-rent. This, however, is usually a short-run phenomenon, and not a feature of a normal competitive economy in the long-run.

      That capital does receive a return is almost universally accepted. This error arises on one hand owing to quasi-rents, but more importantly from the more fundamental mistake of confusing capital with the finance used to purchase it. Hence capital is thought to earn interest.

      Why is interest paid at all? It is the return on a money loan. The loan is often used to buy capital, so that when interest is paid by the borrower it may appear to the lender that he is receiving interest on the capital. He only really gets the interest for having lent the money. What it is used for is strictly irrelevant. If someone borrows money for a holiday, to gamble, to get married or to buy a house, interest is payable in just the same way as if he, as an entrepreneur, were buying productive machinery. This is equally true if money is lent to buy land. Interest is the return on the money loan.

      The City of London, the greatest ‘capital’ market in the world, raises virtually no capital at all! It raises vast quantities of money loans or advances, some of which finance the purchase of capital. Who has seen machines being manufactured there? Not many are even purchased there. The City’s only claim to create much capital would be when new building occurs there, in which case the actual construction, but not the land used, is capital – no doubt financed within the City.

      Historically it is easy to find examples of capital formation not even involving finance provided by borrowing money. Much was built in the ancient world by slave labour. The great mansions and chateaux of the eighteenth century were financed by rents. The huge developments in Stalin’s USSR, of factories, steel plants, military hardware and the rest, did not require a Stock Exchange. Capital is made from land, labour and previously created capital. Money only enters into the process as a means of exchange, and in the form of loans, if the producers do not command the financial resources needed. So, too, a modern economy, confusingly called ‘capitalist’, could be reformed to make money loans to finance capital investment largely unnecessary. Today, if all the claims by owners of so-called capital were cancelled, the amount of capital in the economy would remain exactly the same.

      Firms naturally look for the best site that is available and affordable to set up in business, or to expand their business. They invest capital on the site by building a factory, office or shop, and equipping it adequately. One site is better than another, owing to natural factors, the urban or rural environment and the nearby public services. Thus it may appear that their capital ‘earns’ a better return in one place than in another. But does it? The extra return on the better site is yet another case of the economic rent of land. This is exactly analogous to the varying productivity of labour on different sites. Work in one place produces more than work in another. The workers may be identical in effort and skill, but the differential remains intractable because the sites differ. So, too, identical capital may be invested on two sites and will appear to produce different yields. The differential arises from location and not from the nature of the capital. How can identical pieces of equipment create different values of production? They could be swapped over with no change in output at either site, for the site makes the difference. That is the one crucial factor that cannot be swapped over. Every site is unique and creates a unique rent attributable to its location and qualities. This is the clearest proof that land is fundamentally different from capital, and should never be confused with it, if there is to be clarity of economic thought.

      Structure of Industry

      THE PRESENT STRUCTURE of industry in Britain is highly complex. It varies from sole traders, like local craftsmen or financial advisers, to partnerships of skilled or professional workers, like small builders, lawyers or dentists, to big companies that control many sites, like chain retailers or major manufacturers, and finally to multinationals, often foreign owned, that run vast empires of various productive units around the world.

      This complexity has developed gradually. Its causes are rarely discussed. They lie in the history of how land, labour and capital have been combined and owned, but these causes still operate today, despite dramatic changes in technology and much else. Land enclosure released, or rather drove, workers from the land on which many had worked as tenants under copyhold or similar customary rights. This supply of unemployed workers moved into towns, where they became dependent on wage labour for their survival. Employers enjoyed the ability to pay the lowest wages that the unemployed would accept, so that profits rose rapidly, enabling them to expand, often from small family firms to multiple site establishments. Such profits were substantially economic rent, unrecorded as such by the freeholders receiving them. Banks gave advances for investment on the security of land and expected ‘profits’.

      By the nineteenth century many firms became too large for the proprietors to finance and to bear the risks on their own. The ingenious device of limited liability provided the answer. The absentee shareholder was born. Railways, cotton, wool, steel, shipping, tobacco and so on became industries run by companies financed by thousands of such shareholders, many of whom had become rich by landholding. A handful of company directors, themselves shareholders, ran each company, increasingly with independence from the views of the shareholders themselves, especially when these were content to become mere rentiers, receiving dividends paid out of profits, the derivation of which might not even interest them.

      By the twentieth century the connection between ownership and actual productive activity

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