Interest is paid by a debtor to a creditor. It arises not on a loan of wealth, but upon a transfer of a claim upon wealth in return for a promise to retransfer a claim for a like amount at a future date.
The relationship of debtor and creditor is a human relationship and interest is a tribute paid by the servient party to the dominant. The degree of this servitude is to be gathered from the onerous terms which debtors will habitually acccept. They will transfer their chattels, lodge their securities, mortgage their lands and buildings and charge their prospects of income to secure these loans, and will generally subject themselves to such stringent liabilities that both the courts and Parliament have felt it necessary to interfere with the parties' freedom of contract to protect debtors from their own agreements.
The whole structure of limited liability companies, by which the company is endowed with a fictitious personality separate from those of its members, has been built up primarily to protect borrowers from their creditors and to limit their losses in the event of failure. This complex and paradoxical structure has been brought into being, modified, and expanded, to facilitate the kind of industrial structure which has been under examination. It is calculated to encourage enterprising men to take on the heavy responsibilities involved; to raise large sums of money to supply and equip large numbers of men, undertake leases of land with their onerous covenants, and to incur taxation and rates imposed upon production; and to do all this when the margin between success and failure is the narrow margin of profit.
These are the risks and perils of the tenant in occupation of land who seeks to turn good land to productive use. The device used to protect him is one by which a notional or fictitious person, in the form of a company with limited liability, is substituted for him as tenant. Needless, almost, to say, landlords will not always accept these notional tenants, and will sometimes insist on the personal covenant of the promoters; but so far as the rest of the world is concerned, the company is the tenant. In the event of failure the loss to the promoters is the amount of their subscriptions to the funds of the company.
That people rarely see the grotesque side of this Gilbertian arrangement illustrates only too clearly how use has dulled their awareness of the monstrous situation into which society has drifted. As it is, in order to launch and expand the production of wealth, a handful of individuals are obliged to undertake a weight of liability in conditions of such risk that everyone agrees that the liabilities are more than any orditiary mortal can fairly be asked to shoulder. The way out of this predicament is remarkable: the superhuman burden is transferred from men to the shoulders of a fiction, a notional Atlas.
For this relationship of debtor and creditor to arise there must be one person who wants wealth and who desires it so keenly that he is willing to submit himself to the servitude of debt in order to obtain it, and another person who has claims upon wealth which he is willing to transfer, for a consideration. This is a situation which may arise in particular cases in any society. Where, however, wealth is so unevenly distributed that the majority of people receive no more than the least for which they are willing to work, then it is a situation which is likely to be very common. Under these circumstances, it is not surprising to find that very many people indeed are willing to incur this kind of debt, and that money-lending becomes a general practice. Not merely is industry financed by debt. Labourers dependent entirely on their wages incur heavy debts to acquire and furnish their homes and obtain other articles which they cannot afford to buy. From the pawnbroker and tally shop to the international bank and monetary fund, money-lending has become a substantial and reputable business. Is is no longer polite to talk of usury.
Interest, being a secondary claim on wealth, may be drawn from rent or wages. There will, however, be a fundamental difference between borrowing by a labourer and by a tenant. Plainly, when a labourer subjects himself to a claim for interest he has to work to produce the interest. Things, purchased by him by way of loan, will cost him more than if he had bought them outright. What is more, he will be mortgaging his future earnings and incurring all the risks involved. There is always a limit to what he can earn, just as there is a limit to his energy. Normally, he will incur debt in order to acquire at once something which he could only purchase after years of saving. However, if he could afford to purchase it, there is little doubt as what his best course would be.
On the other hand, an enterprising tenant, by borrowing funds to equip the men he employs, may gain for himself a share in the increased rent resulting from the improved production of labour on his land. For him, the debt will not impoverish him by the interest it carries, but may, in fact, enrich him. Indeed, the only way a man can obtain more than the little he can earn where wages are depressed, is by obtaining a share of rent. Borrowing funds to equip an undertaking is one way of doing this. Again, as the system of financing industry by debt becomes general, it grows increasingly difficult for men to be their own masters, unless they can establish an undertaking of their own by organising it in conformity with the general practice. Thus, from the rent-receiver's standpoint, the servitude of debt is offset by the profit he may make upon it, either by obtaining a share of the rent for himself over and above what he has to pay in interest, or by becoming his own master or both.
It is not surprising to find, therefore, that following the large enclosures of land, which took place in Europe during the 15th and 16th centuries, a substantial change came over the general attitude to moneylenders. Prior to these enclosures, the Christian Churches had successfully condemned money lent at an increase as sinful, and the practice was prohibited by law in most countries. Following the enclosures, however, the prohibition failed in practice. The new method of financing industry became an economic necessity, and on these grounds Francis Bacon defends usury in his famous essay on the subject. In face of the facts, the laws on usury were either relaxed or allowed to fall into disuse, and finally governments themselves incurred national debts.
The advantages the tenant may obtain from borrowing does not remove the
servient relationship in which he stands to his creditors. Failure in his
schemes may mean irretrievable ruin. It was to shelter him from this
disaster that the limitation of liability by means of the fictitious
personality of a corporation was devised and that the bankruptcy laws were
As has been seen, where land is all enclosed, interest on loans raised to equip an undertaking must come out of rent. It follows, therefore, that for the loan to be worth-while from the debtors' viewpoint, the increase in rent, flowing from the equipment of the undertaking by means of the loan, must be more than the sum of the interest charged for the loan and the increase in taxation and rates imposed upon the equipment and its use. Now, the increase in productivity resulting from equiping labour will differ in amount from site to site. To take a simple example, let it be supposed that production on each site is 100, 90, 80 and so on, that wages are at their minimum at 45, that taxation takes 10% of production and that the landlord and rating authority take what is left. Let it further be supposed that labour is equipped with only the rudimentary tools such as the wage-earner can provide. The result will be as follows (Fig. 15): -
Now let it be supposed, that by equipping the labourers fully by way of loan, the productivity of labour on each site may be increased by 50%. Allowing nothing for any increase in wages or in the claims of the landlord or the rating authorities, the result will be as in Fig. 16.
It is clear from this diagram that the profit to the tenant from this equipment of labour on his site will fall rapidly from site to site, until, ultimately, it disappears. The inevitable increase in rates, which would accompany the improvement in the use of the land, would of course further reduce this profit.
One would expect, therefore, and it is everywhere to be observed, that as production moves on to inferior land the amount of funds borrowed to equip an undertaking falls, and the share provided by the promoters increases, until the tenant in occupation provides all the funds himself. One would also expect to find a general decline in the standard of equipment, as the tenants come to rely less on loans and become more dependent on their own resources. A walk round any town, or, for that matter, through any agricultural district, makes this only too evident.
It is a matter of great importance to the promoters of business that the interest charge which they have to bear should be as light as possible. The tendency of interest is fortunately to fall towards the least which the moneylender will accept. One of the reasons for this is that the pressure of the landlord's claim, of rates and taxation, all depress the amount of rent available to meet the moneylender's claim. Increases in money rates will, therefore, sharply reduce the amount of borrowing except only in those periods when trade is expanding and profits are consequently increasing. Obviously, a rise in the interest rate does not encourage the stocking and equipping of industry; it discourages it. It may encourage people to lend money, but it certainly does not encourage people to borrow it; and it is the debtor who provides the stock and equipment.
There are two matters which affect the amount which a debtor has to pay in interest. These are the sum he borrows and that rate of interest per centum.
The rate per centum will vary between one loan and another, according to the risk attendant upon the loan. The commonest device for reducing risk involved is to provide the creditor with a security for his loan. Plainly, the better the security, the less the risk. How this device may be used will be more appropriately discussed in a later essay.
Another matter which affects the risk involved is the likelihood of success, and the danger of failure, of the undertaking for whose benefit the loan is made. This margin between success and failure is determined for practical purposes by the margin of profit. Prospective debtors will naturally extol their expectations of profit, and the expectant creditor, who is well advised, will regard the others' protestations of hope with the dourest suspicion. The creditor will doubtless call for accounts, and seeks as best he can to judge of the margin of profit for himself. Assuming the landlord is held at bay by a lease, or has been bought out, the profit to be gained from equipping an undertaking will be greater on better sites than on poorer ones. The result is that the less fortunately situated tenants will find themselves faced with higher demands for interest charges than those on better sites. If they acceed to these demands their narrower profit will be further reduced; in most cases they will be obliged to prune their borrowings accordingly. This tendency for the rate of interest to be more on sites which yield less rent exaggerates the tendency already observed for the equipment of these inferior sites to be itself inferior.
Thus, the dependence of industry for equipment on borrowed funds paid for
by interest drawn from rent has the following results. The advantage of
equipping labourers on a site varying with the productivity of the site,
taxation being levied on production and the processes of production, and
the rate of interest being greater when attendant upon greater risk, the
equipment of labour on the poorer site tends to be inferior. Total
production is thereby reduced and the advantages derived from holding better
sites are exaggerated. Conversely, the difficulties of operating on the
poorer sites will render their working unprofitable, especially when trade
is in a slack season.
Where all land is free, and taxation is assessed on the rent of land so that wages are determined by what a man can earn working for himself on the best land open to use, the situation is altogether different. Let this situation be represented as in the diagram below (Fig. 17).
In these circumstances, equally skilful labour would produce the same wages on every site (represented in the diagram by 75). Where the enclosure of land and taxation reduce the reward of the labourer to the least the labourer is willing to accept, wealth is subtracted from wages and added to rent. Where land is free and taxation is assessed on the rent, this same wealth is available to the labourer to stock and equip his undertaking. The position of labourers on all sites irrespective of varying productivity will be the same in this respect, and whether they supply the funds or raise them by loan will be a matter for themselves. Common prudence, however, will teach them that it is cheaper and better to provide their own stock and equipment rather than pay away part of their wages in an interest charge. Certainly borrowing funds will not yield profits to them as is the case with the entrepreneur. Interest will be a deduction from wages.
Under these circumstances there is no reason at all why poorer sites should be any less well equipped than the better sites. The wealth available to equip the site will vary with the wages earned upon it, that is, not with the site, but with the competence and skill of the labourer. The dependence of labourers on the entrepreneur for employment will not exist. The special talents and qualities required to make a man successful entrepreneur will be valuable in such a society, but no more valuable than the different gifts and qualities with which other men are endowed. The difficulties which now hinder a man from being his own master would be removed. Men would still work in teams because of the substantial advantages to be gained from co-operation; but it would be a willing partnership where each sought the common good of the group for his own benefit; and would not be forced obedience to a master. In such circumstances the productivity of each group would be as high as this willing co-operation could make it, and the return to the group in wages would bear an immediate and direct relationship to its skill and efficiency.