Further Essays in Economics
Leon Maclaren

I

COST OF PRODUCTION AND CHARGES ON PRODUCTION

WEALTH and services are produced by labour acting with the other forces at work in the natural universe. Given the natural universe, nothing further is required to produce wealth and services except the labour of man; and all the wealth and services in the world, taken together, have simply been produced from the universe by human labour.

But in any single undertaking, the total output does not come wholly from the labour of those working in it. Inevitably the undertaking in the course of production will consume wealth and services supplied by other undertakings. Thus the cotton which is woven into cloth in the Lancashire mills is grown, harvested, shipped, and merchanted before the Lancashire mill touches it. Moreover, cotton is not the only product of other undertakings which goes to make the finished cloth. Coal in the furnaces, machinery in the factory, the factory itself and its lighting and heating are all used in manufacturing the cloth. Clearly, therefore, before those engaged in any undertaking begin to add to the general stock of wealth or services, they must have produced sufficient to replace all the wealth and services supplied by other undertakings and consumed in the process of production.

Obviously, no undertaking could long continue unless it produced sufficient to pay for all the wealth and services it consumes, and part of its total output must be set aside for this purpose. This part forms the cost of production. What is left after sufficient of the total output has been set aside to meet this cost is the true or net product of the undertaking.

Thus were a cotton mill to produce cloth for the benefit of all those who have a claim upon its product - landlord, tenant, labourer, moneylender, tax-collector, insurance company and the rest - then part of its total output would have to go to pay for the wealth and services used in production, that is, to meet the cost of production, and only the remainder of the cloth left over would be available for distribution among the various claimants. The amount so distributed would be the true product of the mill. Put shortly, in any undertaking,

WEALTH PRODUCED = TOTAL PRODUCTION - COST OF PRODUCTION

In modern times, however, men rarely produce wealth or services except for sale, so that with the money claim received in exchange, they may obtain other wealth and services. Generally speaking the return to those who have claims on an undertaking depends not on how much the undertaking produces but on how much money it obtains on a sale of what it produces, and how much this money will itself exchange for in terms of wealth and services. In the great majority of cases, therefore, the whole of the output of the undertaking will be sold. Part of the proceeds will then go to meet the cost of production, and the rest to satisfy the claims of those interested in the concern. It will not, of course, be the money which the claimants receive which will constitute their return on the share they have in the undertaking. At that point the exchange will be incomplete. The return to each will be the wealth and services and other valuable things which he receives from the sale of the true product.

The cost of production therefore comes to be that part of the total output of any undertaking which has to be sold in order to pay for the wealth and services supplied by other undertakings and consumed in the process of production. It sometimes happens that one undertaking carries on many activities ancillary to its main purpose - activities which are normally performed by other concerns who supply such an undertaking with wealth and services. Thus a cotton miller may have his own banking or legal department. In such a case, these departments are not a cost of production, since the labourers engaged in them, in so far as they assist in the process of production, are as truly engaged in producing the cotton cloth as are the spinners and weavers.

In fact, cost of production arises because and only because of the division of industry into separate undertakings. If the whole of industry is taken together, there is no cost of production: for what is a cost to one undertaking is the product of another. Thus the men engaged in planting, growing, and harvesting cotton, the crews of the ships carrying it to Lancashire, and the bank clerks who clear the cheques passing through the miller's account, are all engaged in producing the cotton cloth. The division of these processes between different undertakings is merely to suit the conveniences of manufacture and trade. All are costs to the miller; but the cloth he produces is itself a cost to the shirt manufacturer, and so on until we reach the man who wears the shirt.

Wages and interest and taxation and insurance premiums and the cost of acquiring land are not part of the cost of production. They are commonly called so, but this arises from a complete misapprehension and is due to adopting the point of view of the accountant, who (quite properly) views things through the eye of his master, the entrepreneur who employs him. Concerned merely with calculating the profit left after all other claims have been met, the accountant naturally regards everything paid out as a cost. But from an economic point of view such a definition has no validity. Obviously the wages of the labourer and the rent of the tenant, out of which he must pay the landlord, the moneylender, the tax-collector, and all the other claimants, can only come out of the proceeds of the net wealth and services produced by the undertaking, which add to the sum total of production. It is to create this increase in the total stock of wealth and services in the world that men work, and it is upon this increase that men live and governments function. Wages and rent are the object of production, and, taking all industry as one, the final result of production. To say otherwise is to say that all the output of industry which had to be sold to pay not only for all the services rendered by other undertakings, but to pay all taxation, interest, insurance premiums and the like, and to pay the labourers engaged in industry and the owners of the land on which industry operates is a cost. That is, the whole output except the small margin of profit (which is infinitesimal amongst the whole of the world's production) would be a cost of production: which is as much as to say that almost nothing was produced at all.

But not all wealth and services for which an undertaking has to pay, and for which it has therefore to set aside part of its total output, contribute towards the production of this output. They may have become necessary merely to keep the undertaking free from the fetters which prevent it producing. In this case they are not a cost of production but a charge upon the net product of the undertaking.

Of these charges, some of the most important are those resulting from government intervention and control. These charges are placed upon industry for a variety of different reasons; sometimes frankly to restrict the industry, as in the case of marketing boards, tariff machinery and the like; and sometimes under pretence of stimulating the industry, as is the case with supervisory and advisory committees, tribunals, and licensing and approving bodies. But whatever the excuse, these controls result in the establishment of unproductive machinery.

Government intervention is inevitably accompanied by the requirement of elaborate returns, the establishment of large inspectorates, and the imposition of licences and consents as a pre-condition to production. The law under which this machinery is established and maintained is of necessity complicated and difficult. In the result, the undertakings subjected to the controls are obliged to consume wealth and services or to produce wealth and services themselves to meet its requirements. Legal departments have to be established or legal advice sought on matters which have nothing to do with production at all but are simply concerned with problems arising from the controlling laws. Accountants have to be called in, and clerks engaged, as, for example, to deal with the intricacies of income tax, excise, etc. In some instances these special departments reach staggering proportions.

All this has to be paid for; which can only be done by selling part of the undertaking's net product for the purpose. Again, these controls often result in time being lost in production, quite apart from the time spent by those specially employed to deal with them. Failure to obtain a licence or the consent of a government department, or a failure to satisfy it with returns, may result in holding up production. This lost time too has to be paid for, which again can only be done from the sale of part of the net product of the undertaking. All such payments by an undertaking are not costs of production, because they are not made for any contribution to production, but are charges on the net product which have to be met out of it and so reduce it.

Other charges on the net product of every undertaking are rates and taxes except in so far as the rates are payment for services such as water supply, street-lighting, refuse collection and the like, which contribute to the production of the undertaking. Apart from these, rates and taxes are clearly draughts upon the increase in the stock of wealth and services arising from the industry of the taxed undertaking. They are drawn from the net product of industry, or from the proceeds of its sale.

A third and by no means small charge levied on the increase of wealth or services brought about by the work of any undertaking is that exacted by monopolies. The object of monopoly is to enable the monopolist to charge more for some article of wealth or for some service than he could obtain without his monopoly power. Thus the monopolist charges for what he supplies but charges extra in addition because his monopoly enables him to do so. Monopolies are discussed in detail later. It is sufficient here to observe that this extra charge, which owes its origin not to the wealth or services supplied but to the power obtained from the monopoly itself, must reduce the return of those who have to pay without receiving anything in return. In short, the monopolist will be taking from the undertaking part of the increase in the general stock of wealth and services which is due to the work of the undertaking and not to anything the monopolist has contributed.

Yet another charge arises from insurance. All undertakings are faced with certain natural risks arising from the danger of fire, earthquake, lightning, storm damage and the like. But to these inevitable risks, which, taking all industry together, are very slight indeed, are added many other hazards springing from the economic conditions men have created and from legislative attempts to relieve them.

For the labourers, there are the risk of unemployment, and the risks attendant upon poverty, such as ill-health finding them without proper medical attention and without sufficient support even for the basic essentials of life. For the employers, there is the risk of having to pay penalties and compensations to servants or third parties as a result of accidents happening through no fault of theirs. To meet these hazards those engaged in productive undertakings have sometimes voluntarily, sometimes compulsorily, to enter into schemes of insurance.

The basis of insurance is simple. The whole risk is spread over all undertakings. Each contributes to a fund which is paid out to those who are unfortunate. So all undertakings pay part of the proceeds of the sale of their net product in insurance premiums. In addition to insurance against the natural hazards of fire, earthquake, flood, storm and lightning for which premiums are generally speaking light, there are unemployment insurance, health insurance, insurance for workmen's compensation, employer's liability, Factory Act requirements, superannuation, and the like. These are the artificial hazards arising from the economic system in respect of which undertakings incur premiums of insurance. Further, on the principle that the damages must come out of the deepest pocket, employers are made vicariously liable for the negligent acts of their servants, whether or no they have themselves been negligent. None of these things contributes to production, and the necessity of paying for them is yet another charge upon production.

Apart from all these charges, which are imposed either by law or by the necessity of the case, undertakings may, and frequently do, impose charges on themselves.

Thus a small shopkeeper who has worked hard in his shop for a modest return, will frequently charge the business on his death with a pension for his widow. Clearly the payment of this pension is a deduction from the product of his successors who carry on the business and who must accordingly be prepared to work for less than would otherwise be theirs.

At the other end of the scale, in monopoly concerns particularly, posts are often found for friends of those in control: departments are swollen in order to build up the prestige and salary of the departmental manager. All this redundant labour, all the wealth which is consumed by it, must be paid for. In competitive industry such inefficiency might end in disaster, but many an old-established industry built up by the vigour and enterprise of men who stole a march on the world, now languishes under a weight of debt to relations and friends who have no knowledge of or interest in the industry but nonetheless hold decorative directorships and other posts.

Such voluntary charges are dangerous; but monopolies can bear them because they are able to pass them on in the monopoly charges they exact from those who buy their products.

When discussing costs of production we observed that if the whole of industry is taken together there is no cost of production; one man's cost being another man's product. Viewing industry as one, cost of production is eliminated and the result of industry is a single product to be distributed among all the various undertakings which have contributed to its production. The case is otherwise with charges on production. which accumulate and grow if the whole of industry is taken together. Taxation, insurance premiums, monopoly charges, and charges springing from government control which an undertaking pays directly are not the whole of the charges it has to bear. All undertakings endeavour as far as they are able to pass these charges on in price to their customers. The prices which the undertakings have to pay for wealth and services consumed in production, if swollen in this way, are so far as the increase is concerned, not costs, but charges upon production. It makes no difference whether the claim is paid directly or concealed in price. In either event, it is a charge on production. It would therefore be very difficult for any particular undertaking to assess the total charges on its production, for inevitably much of them would be concealed in the prices paid for wealth and services they consume.

As one moves through the chain of industry further from those undertakings which extract wealth directly from nature. so the amount of the charge concealed in price increases until in the final stages of production undertakings pay far greater charges concealed in the prices of what they buy than they pay to direct claimants.

Charges on production are checks on production. At any time there will be undertakings in every industry which are only just paying their way. An increase in the charges they have to bear will force them out of production, while a decrease will make their industry more profitable and so open it to fresh entrants. The piling up of these charges which has been steadily progressing over the last fifty years or more always works against the small man and entrenches the monopolist; for as more and more small undertakings are driven out of production, the control of industry becomes concentrated in fewer hands.

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