Essentials of Economic Theory Part 1

Essentials of Economic Theory.

by John Bates Clark.

PREFACE

In a work on the "Distribution of Wealth," which was published in 1899, I expressed an intention of offering later to my readers a volume on "Economic Dynamics, or The Laws of Industrial Progress."

Though eight years have since pa.s.sed, that purpose is still unexecuted, and it has become apparent that any adequate treatment of Economic Dynamics will require more than one volume of the size of the present one. In the meanwhile it is possible to offer a brief and provisional statement of the more general laws of progress.

Industrial society is going through an evolution which is transforming its structure and all its activities. Four general changes are going on within the producing organization, and the resultant of them, under favorable conditions, should be an enrichment in which all cla.s.ses would share. Population is increasing, capital is acc.u.mulating, technical methods are improving, and the organization of productive establishments is perfecting itself; while over against these changes in industry is an evolution in the wants of the individual consumer, whom industry has to serve. The nature, the causes, and the effects of these changes are among the subjects treated in this volume.

The Political Economy of the century following the publication of the "Wealth of Nations" dealt more with static problems than with dynamic ones. It sought to obtain laws which fixed the "natural" prices of goods and those which, in a like way, governed the natural wages of labor and the interest on capital. This term _natural_ as thus used, was equivalent to static. If the laws of value, wages, and interest had at this time been correctly stated, they would have furnished standards to which, in the absence of all change and disturbance, actual values, wages, and interest would ultimately have conformed.

The economic theory of this time succeeded in formulating, correctly or otherwise, principles of economic statics and a fragment or two of a science of economic dynamics, although the distinction between the two divisions of the science was not clearly before the writers' eyes.

The law of population contained in the work of Malthus is the only systematic statement then made of a general law of economic change.

Though histories of wages, prices, etc., furnished some material for a science of Economic Dynamics, none of them attained the dignity of a presentation of law or merited a place in Economic Theory. Students of Political Economy were at that date scarcely awakened to the perception of laws of dynamics, and still less were they conscious of the need of a systematic statement of them. A modest beginning in the way of formulating such laws the present work endeavors to make.

The first fact which becomes apparent when economic progress is studied, is that static laws have a general application and are as efficient in a society which is undergoing rapid transformation as in one that is altogether changeless. Water in a tranquil pool is affected by static forces. Let a quant.i.ty of other water rush in and there are superinduced on these forces others which are highly dynamic. The original forces are as strongly operative as ever, and if the inflow were to stop, would again reduce the surface to a level.

The laws of hydrostatics affect the waters in the rapids of Niagara as truly as they do those in a tranquil pool; but in the rapids a further set of forces is also operative. In the work referred to, issued in 1899, an effort was made to isolate the phenomena of Economic Statics and to attain the laws which govern them. Necessarily this study made a certain impression of unreality, since it put out of sight changes which are actually going on and are the conspicuous fact of modern life. It a.s.sumed the conditions of a world without any such movement and endeavored to formulate laws which, in such a condition, would fix standards of value, wages, interest, etc. It put actual changes out of sight, intentionally and heroically, but with a full recognition of the fact that they are actually taking place and must in due time be introduced and studied. We live in what is _par excellence_ an age of progress, and it is in part for the sake of perceiving the laws of progress that we first disentangle from them the laws of rest and make a separate study of these. The world from which change is excluded is unreal, but the _static laws_ which can be most clearly discerned by mentally creating such a world have reality. Every day's transactions are governed by them as truly as a physical element like water in active movement is affected by forces which, if they acted alone, would bring it to a state of permanent rest. The first purpose, therefore, of the present work is to show the presence and dominance in the real world of the forces described in the earlier work. It brings static laws into view and endeavors to show how they act at any one particular stage of industrial evolution. Even while changes are examined, the fact is perceived that there are steadily at work forces which, if changes should cease, would make society conform to a certain imaginary static model and makes wages and interest also conform to static standards.

Another purpose of the work is to examine seriatim the effects of different changes, to gauge the probability of their continuance, and to determine the resultant of all of them acting together. It is important to know under what conditions changes proceed at a normal rate, and when the standard of wages rises as it naturally should. As the actual rate of wages pursues its rising standard, but lags somewhat behind it, it is necessary to know what determines the interval between the two, and when the interval is normal. What is called "economic friction" is the cause of this interval and is an element that is amenable to law.

There is to be studied, not only the friction which obstructs the action of natural forces, but positive perversions of the forces themselves. Of these the chief is monopoly; and its influence, its growth, the sources of its power, and its prospect of continuance have to be determined. The actual tendencies of the economic system are against it, and so--if we except a few monopolies created for special ends--are both the spirit and the letter of the civil law. In a country in which law held complete sway, all objectionable monopolies would be held in repression. In order to see how much economic forces can be made to do in this direction, the present work discusses railroads and their charges, and some of the practices of great industrial corporations, and tries to determine what type of measures a government should take in dealing with these powerful agents. In connection with monopoly and with the conditions of economic progress a study is made of trade unions, strikes, boycotts, and the arbitration of disputes between employers and employed, and also of the policy of the state in connection with them, and with money and protective duties.

It is my belief that students should become acquainted with the laws of Economic Dynamics, and that they can approach the study of them advantageously only after a study of Economic Statics. The present work is in a form which, as is hoped, will make it available for use in cla.s.s rooms, not as a subst.i.tute for elementary text-books, but as supplementary to them. It omits a large part of what such books contain, presents what they do not contain, and tries to be of service to those who wish for more than a single introductory volume can offer.

An essential part of the theory of wages here stated was presented in a paper read before the American Economic a.s.sociation, in December, 1888, and published in a monograph of the American Economic a.s.sociation in March, 1889; and other parts of this theory were issued at intervals following that date. The theory of value was published in the _New Englander_ for July, 1881. I had not then chanced to see the early statements of the principle of marginal appraisal contained in the works of Von Thunen and Jevons, and did not consciously borrow anything from their writings, but I gladly render to them the credit that is their due. I do not fear that I shall be supposed to have borrowed other parts of the general theory here offered. The theory of capital here stated was first presented in a monograph of the American Economic a.s.sociation for May, 1888, and the discussion of money of which the present work gives a summary, in articles in the _Political Science Quarterly_ for September, 1895, and for June and September, 1896. The discussion of the relation of protective duties to monopoly appeared in the same quarterly for September, 1904.

The author should, perhaps, apologize for the fewness of the citations from other works which this volume contains. The richness of the recent literature of Economic Theory, especially in America, would have made it necessary to use much s.p.a.ce if the resemblances and the contrasts presented by points in this volume, and corresponding points in other volumes, had been noted.

Worthy of special attention, if citations had been given, would have been the writings of Professors Irving Fisher, Simon N. Patten, and Frank A. Fetter of this country, and Professor Friedrich von Wieser of Prague, who have worked in various parts of the same field in which the studies here offered belong, and also those of Minister Eugen von Bohm-Bawerk of Vienna, who has treated some of the same themes in a strongly contrasted way. If merited attention were paid to the works of Hadley, Taussig, Carver, Seligman, Giddings, Seager, Walker, and a host of eminent foreign scholars, a large part of the s.p.a.ce in the book would have to be thus preempted.

I desire most gratefully to acknowledge the a.s.sistance which in the preparation of this book I have received from my colleague, Professor H. L. Moore of Columbia University, from my son, Mr. John Maurice Clark, Fellow in Economics in Columbia University, and from my former colleague, Professor A. S. Johnson of the University of Nebraska.

Besides reading the ma.n.u.script and offering valuable suggestions, Professor Johnson has kindly taken upon himself the reading of the proof.

JOHN BATES CLARK.

ESSENTIALS OF ECONOMIC THEORY

CHAPTER I

WEALTH AND ITS ORIGIN

The creation and the use of wealth are everywhere governed by natural laws, and these, as discovered and stated, const.i.tute the science of Economics. Some of them come into operation only when men live in more or less civilized societies and work in an organized way, while others are operative wherever men work at all. Every man who lives must have something that can be called wealth, and, unless it is given to him, he must do something in order to get it. A solitary hunter, living in a cave, eating the flesh of animals and clothing himself in their skins, would create wealth and use it; but he would not take part in a social kind of industry. What he does could not be described as a bit of "social," "national," or "political" economy. Yet the gaining of his living would be an economic operation and would involve a creating and using of wealth. A statement of the laws governing the processes by which such a man makes the earth yield to him means of support and comfort would const.i.tute a Science of the Economy of Isolated Life, which is a part of the general Science of Economics.

_Primitive Capital._--If an isolated man hunts with good implements, he gets more game than he would have done if he had not used some of his time in making such implements. It pays such a man to interrupt his hunting long enough to make a spear or a bow and arrows. This amounts to saying that it is an advantage to him to become, in a simple way, a capitalist as well as a laborer; for the primitive implements of the chase are forms of _productive_ wealth, or capital.

Moreover, if he possesses foresight, he will keep enough food within reach to tide him over periods when game is not to be had, and such a store is another form of capital.

_The Field of General Economics._--The economy of a man who works only for himself is subject to laws that are based on his own nature and the character of his material environment. Because he is what he is and because nature is what it is there is a certain way in which he must proceed, if he will live at all, and there are certain conditions which must exist, if he is to live well. The inherent productive power of labor and of capital is of vital concern to him, since he is both a laborer and a capitalist; but he is in no way interested in what we commonly call the relations of labor and capital, since that expression always suggests the dealings of one cla.s.s of men, who labor, with another cla.s.s, who own or control productive wealth. The study of such relations takes us at once into the domain of _Social_ Economy; but we can study certain universal laws of wealth without at all entering that domain. When we speak of the power that resides in a bow and arrow, we refer to a truth of _General_ Economics and one which ill.u.s.trates the inherent power of capital, though we may be far from thinking of lenders and borrowers in a modern "money market" or of dealings of any one cla.s.s of men with any other.

_The Field of Social Economics._--The moment that we begin to examine economic relations that different cla.s.ses of men sustain to each other, we enter the realm of _Social_ Economics; and we do this whenever we study modern business dealings. Even our hunter would take part in a social economy if he began to sell some of his game; and from that time on his income would depend, not wholly on his relation to material nature, but partly on his relation to other men. A good market for his game would come to be of the greatest importance to him; and a market for anything implies a social method of securing wealth.

_Fundamental Facts Common to Primitive Life and Social Life._--The relations which men sustain to each other in civilized industry are thrown into the foreground in the science of Social or "Political"

Economy.[1] It is an organized system of industry in which we are engaged, and it is that which we care most to understand. Until recently we have had a far less satisfactory understanding of the social element in industry--that is, of the relations that men who are producing wealth sustain to each other--than we have had of such general facts as a primitive producer needs to know. We have had, for example, much information concerning the materials which the earth contains and the way to make them useful. We have had a practical knowledge of what wealth is and of the mode of creating it, and we have been able to identify it as we have seen it either in the raw or the finished state. We have known what labor is, how it proceeds and what helps it needs to enable it to make clothing, to prepare food, etc. We have not known as much about the way in which the modern market for such products is regulated, and how a modern tailor or baker shares gains with the man who employs him and provides him with materials and tools, and the main purpose of studying Economics is to get an understanding of such social facts; but this cannot be done without first bringing before the mind the more general facts concerning the inherent nature of wealth itself and of the activities that are always necessary--in uncivilized life as well as in civilized--for creating and using it.

[1] Past usage renders the somewhat misleading term _Political Economy_ more available than the more accurately descriptive term _Social Economics_, as the t.i.tle of the science which treats of the creation and use of wealth by an organized society. Either t.i.tle implies the existence of such an organization, but the word _political_ calls attention to the fact that it is under a government. The fact that, in a study of wealth, is most important is that the exchanges of products which spontaneously take place create an industrial society whose activities, going on as they do under a government, const.i.tute the subject of the studies which are properly indicated by the traditional term, Political Economy. Government as such is not the subject of those studies.

_General Facts First in the Natural Order of Study._--The primitive and general facts concerning industry, which, in a broad sense, is the creating of wealth, need to be known before the social facts can profitably be studied; and a statement of the principles of Political Economy should therefore begin by presenting a body of truth which is independent of politics and sociology and so general that it is ill.u.s.trated even in that simplest of all conditions, in which no market exists and every man makes by his own labor all the goods that he uses. The wealth of a Crusoe, that of a solitary Esquimau, and that of a pygmy in equatorial Africa have laws as well as that of a European or American employer or bondholder. The qualities in matter which make a share of it important for promoting the welfare of its possessor can be detected in the simplest commodities that are anywhere used. All kinds of industrial products have a common origin.

Labor and capital act together in making a birch canoe as truly as they do in producing a transatlantic liner; and the productive power of each of these two agents is everywhere governed by certain general laws. Before ascertaining what is true of wealth when capital has become complex and when laborers have become specialists, each producing one particular part of one product and securing many finished goods in exchange for it, it is well to state some facts relating to wealth which are so general that they appear in all stages of civilization.

_The Nature of Wealth._--The old English word _weal_ describes a condition of life. It is the state of being "well off," or of having one's wants amply supplied. Well-being in a broad sense of the term may depend largely on a man's state of health, his temperament, his conscience, or his relation to his friends; but the weal that is so secured is not described as a state of wealth. That depends on the possession of useful and material things, and the rich man has more of them than other men. The term _wealth_, which originally signified the state of being rich, afterwards came to be applied to the things which make a man rich, and it is thus that the term is used in the science of Economics.

_What Things const.i.tute Wealth._--It is clear that useful things, like air, which are at hand in unlimited quant.i.ty, do not make any one rich in this comparative sense, for they benefit all alike; and, in so far as they are concerned, all men are on the same level of welfare.

Moreover, since they are so abundant as to shower benefits everywhere in profusion, the quant.i.ty of them that a man has at his disposal may be lost or thrown away with entire impunity. He would only have to help himself again from the abounding supply which nature thrusts on him in order to be as well off as he was before. A bucketful of water on the sh.o.r.e of Lake Superior is of no importance to the man who has it. If it were spilled on the sand, the man would have only to dip up another bucketful, with an expenditure of effort that would be too small to take account of. If, however, fresh water were scarce, every bucketful would have its importance, and the loss of that quant.i.ty would make a distinct impression on the man's well-being. Whenever each particular part of the supply has this power to make a possessor better off than he would be without it, the substance is a form of wealth. The quality of being _specifically_ important is, therefore, the essential attribute of all the concrete forms of wealth. Sand by the seash.o.r.e does not have any specific importance, since it is so abundant that the gain or loss of a wheelbarrow load would not make a man better off or worse off; but a pile of sand by the side of an unfinished building has this quality. There every barrow load is of consequence, for the available quant.i.ty is so small that diminutions reduce and additions increase the wealth of the possessor. Sand on the sh.o.r.e has the inherent power to help make mortar, and water in Lake Superior has the power to quench thirst, but neither of them has the attribute which would make it a form of wealth, namely, specific importance. Particular parts of the supply may be lost with impunity.

_Varieties of Utility._--We have used the term _importance_, rather than usefulness or utility, to describe the quality which, if it exists in every particular bit of a substance, makes it all a form of wealth. With due care we may use the term _utility_. In a way even a cup of water dipped by a fisherman from the lake is useful, for it renders a service. Though the man might lose it and be no poorer, he cannot say that the thing has no utility of any kind. He can say that it has no importance. What it has we may call _absolute_ utility, or the power to do for a man something which he wishes to have done. When the fisherman is thirsty the water will do him good. It has an absolute service-rendering power; and yet this cupful makes the owner no better off than he would be without it, since the service which it is capable of rendering would be rendered whether the man had it or not. Absolute utility in an article is the power to render any service whatever, regardless of the question whether it would be rendered equally well if the article were absent. If conditions were such that the man would have to go thirsty in case he spilled his cupful of water, then this little supply would have what we may term _effective_ utility, and this means that the presence of the particular bit is a positive element in conducing to the man's welfare. Usable things have absolute utility even when they are superabundant, but they have effective utility only when the quant.i.ty of them is so limited that every particular bit of it is of some importance. Absolute utility and limitation of supply insure to them this quality; and this principle holds true in the economy of the most primitive state as well as in that of a civilized one.

_The Origin of Wealth._--Some of the things that have this kind[2] of utility have been given to man by nature. She has furnished some materials that are useful and has not furnished them in quant.i.ties sufficient to prevent them from being _specifically_ important. On account of the comparatively n.i.g.g.ardly way in which she has doled them out to man, every bit of the supply has a power to benefit him; and if he gains some portions, he goes upward in the scale of well-being, and if he loses some, he goes downward. Wild fruits and fruit trees come in this category; and a savage who should build his hut in a small grove of banana trees, if he could keep other people out of it, would be, by so much, better off than they. The grove and its fruits would const.i.tute their owner's wealth.

[2] The term _final_ utility is used with much the same significance as specific importance. It is the utility of the last and least important part of the supply, and the use of the term requires us to think of the supply as offered to users unit by unit till the whole amount is in their hands.

The first unit, when it stands alone, is more important than any later one will be. The second is of less consequence, and the last is the least important of all. When, however, all have been supplied and are together available for use, one is as important as another. Each one has an effective utility which is measured by the service rendered by the last one.

The term _specific_ indicates that we measure the importance of the supply of an article not in its entirety, but bit by bit, while the term _effective_ is the ant.i.thesis of _absolute_ and means that each bit of the supply not only renders an absolute service, but renders one which would not be gratuitously rendered by some other part of the supply in case this portion were removed or destroyed. We do not here think of the supply as built up from nothing to its present size bit by bit, but look at it as it stands and measure the importance of any particular quant.i.ty. When we speak of final utility, we think of a series of "increments" supplied one after another, and in this case the successive increments become less and less important, since, after some have been supplied, the want of the kind of good that they represent is less keenly felt. The conception of the series of units is merely a means of isolating one unit from a total number and obtaining a mental measurement of its importance which corresponds with the effective importance of any unit in the entire quant.i.ty.

_Land an Original Form of Wealth._--Land is the original gift of nature to humanity, and wherever there are people enough to make the possession of a particular piece of it important, it becomes a form of wealth. It can be valueless only when population is very spa.r.s.e; and then an increase in the number of people dwelling on it gives to it early the attribute of specific importance. The land that is accessible to a growing population cannot long be superabundant.

_Forms of Wealth produced by Labor._--Few useful goods are presented to man by nature in a finished state, and it is therefore necessary for man to exert himself in order to get the goods that he needs in the condition in which he can use them. He must make raw substances more useful than they naturally are, and as he does this the things become partly products of his labor. Of course the supply of them is limited, since labor is so.

_Labor a Wealth Creator._--Labor is a wealth-creating effort, and there is no labor that is successful in attaining its purpose that does not help to bring into a serviceable condition something that can be identified as an economic good or a form of wealth. Some effort, indeed, fails in what it attempts to do and therefore produces nothing. We may build a machine that will not work, or make a product that no one wants; but labor that attains a rational purpose is always economically productive.

_Protective Labor and the Attribute it imparts to Useful Matter._--Labor may be cla.s.sed according to the particular result that it accomplishes. In saying that the banana grove in our ill.u.s.tration is wealth to the savage who resides in it, we had to insert the proviso that he is able to keep other persons out of it. Exclusive possession or owners.h.i.+p is necessary in order that things may continue to be effectively useful to any particular person or persons. If they are superabundant, as we have seen, no part of the supply is important; but it is also true that if they are scarce and a man is not able to keep any of them, they will not serve him. In order that an economic good may be effective, it must be appropriable, and where claimants are numerous and lawless it may take much of the owner's time and effort to keep the article in his possession. The savage must personally protect his goods, and to some extent the civilized man must do so; for however well policed a city may be, it will not do to leave purses or portable goods by the wayside. Protective labor is necessary in all stages of social advancement. In civilized life, indeed, we delegate much of it to a special cla.s.s of persons,--policemen, judges, lawyers, and legislators,--and this is the most fundamental division of labor that civilization entails; but the work has to be done in any stage of social evolution. Crusoe's goods would have been worth nothing to him if he could not have kept them from the savages who, in time, appeared on his island; and they would have been worth little if he had been forced to spend most of his time in guarding them.

Appropriability is, therefore, a further essential attribute of the things which can make particular men richer by reason of their presence. When such things are actually brought into owners.h.i.+p, their utilities become available, as they would not otherwise be. Effort expended in protecting property is wealth-creating, since it causes those service-rendering powers which otherwise would be only potential in goods to become active. In other words, it gives to things which are otherwise in a condition to be effectively useful a further quality which they require in order that they may actually promote an owner's well-being.

_Industrial Labor._--Industrial labor is the ant.i.thesis of protective labor, and it invariably changes the qualities of material objects in such a way as to make them useful; that is to say, it directly creates utilities.[3] These utilities are of different kinds, and the labor may be cla.s.sified according to the kind it creates.

[3] The term _create_ is here used in a somewhat loose sense and does not imply that the man originates matter or even that he always transforms it without calling in, as an aid, the forces of nature. The farmer must depend on vital forces in soil and air in order to raise a crop. What he and other laborers do is to cause the product in some way to come into existence, and he and they may in this sense be said to create the products which would not appear without them.

_Elementary Utility._--An elementary utility is created when a substance is either dug out of the ground, as is done in mining, or when it is secured through the vital forces of the earth, as is done in agriculture. Hunting, fis.h.i.+ng, and stock raising should be cla.s.sed with agriculture, since they use the resources of animate nature to secure for mankind new raw products on which labor will confer further useful qualities. This utility has to be created by men in every stage of industrial development, from that of a tropical savage to that of men in the most advanced civilization.[4]

[4] The distinction between elementary utility and others does not need to be applied with the utmost strictness, for mining creates form utility by breaking up ma.s.ses of ore, and place utility by making them accessible. Agriculture shapes its products and moves them to places of storage. It is convenient in practice to adhere to the more general cla.s.sification suggested in the text.

_Form Utility._--A form utility is created when a raw material is fas.h.i.+oned into a new shape, subdivided, or combined with other materials, as is done in manufacturing and, in a certain way, in commerce. Buying goods in bulk and selling them in small quant.i.ties is the creating of form utilities and makes an addition to total wealth.

Oil in small cans is worth far more for consumption than it would be if each consumer were forced to buy a tankful. Sugar is worth more to a consumer when it is doled out to him in paper sacks than it would be if it were to be had only in hogsheads. Merchants are not mere exchangers, for they make positive additions to the utility of goods.

In primitive life no such cla.s.s exists; and yet form utilities of every kind are created, since men make for themselves the goods that they use and adapt them in shape and in quant.i.ty to their current needs.