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argued that if wages are increased at the expense of the high income classes, the wage increases will not be saved but will be spent for immediate pleasures. The same objection is raised to a heavy taxation of high income classes. It is argued that if taxes rest heavily upon the man who has an income of $10,000 or over, the taxes are paid out of what would otherwise be saved and put into the capital fund. Once the government has collected such taxes, the amount is declared to be devoted to unproductive governmental expenditure. Looking back upon the growth of wealth during the past two generations, we must admit that the gross inequality of income during that period had a profound effect upon capital accumulation. As J. M. Keynes states, “The new rich of the nineteenth century were not brought up to large expenditures, and preferred the power which investment gave them to the pleasures of immediate consumption. In fact, it was precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital improvements which distinguish that age from all others. The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war, could never have come about in a society where wealth was divided equitably.” 2

Nevertheless we should be altogether blind to the meaning of historical change, were we to accept what has been true during one stage of our history as the criterion of what must be true in later stages. There is ample evidence that the wage-earning and middle-class groups are capable of developing habits of thrift. The growth of insurance funds, savings bank deposits, and building and loan association accounts gives evidence of thrift. The formation of coöperative labor banks by leading unions is evidence pointing in the same direction. The degree of success reached by many companies in promoting stock ownership by their own employees carries a similar lesson. It is also significant that during those post-war years when unemployment has been good and the share of national income going to wages high, the supply of savings has been kept up. It is this statistical observation which leads Friday to conclude that, “The old notion that high wages and the distribution of a large portion of the national income to the laborer militates against capital accumulation has been disproved during the last few years.

The whole discussion centers around the education of the masses to habits of saving, the institutionalizing of thrift. Provided only that such a process is moderate and gradual, there appears to be no menace to capital accumulation in a more democratic distribution of wealth. At any rate, the science of economics must guard itself against either defending the present distribution of income merely because of the history of methods of capital accumulation; or supporting a more equitable distribution at a too rapid pace merely because of sympathy for the laborer. Most certainly, the science of economics lends no support to the claim

2 The Economic Consequences of the Peace, pp. 18-19. 3 David Friday, The New Republic, February 13, 1924, p. 305.

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often made in well-to-do circles that it is unsafe to raise wages because by so doing we will inevitably jeopardize capital accumulation.

A closely related point of bitter controversy is whether labor tends to benefit proportionately from the growth of capital. It is common practice to lecture laborers upon their sacred duty to do all in their power to promote the increase of productive capital. They are taught that there is no hope of material increase in wages by making the wage share of present income larger, at the expense of profits or other shares. They are informed, by an array of statistics of income, that their one hope of increasing wages is to produce more. If national production increases, they are assured that automatically wages will correspondingly increase. The laborer, however, has grounds for not being fully convinced on all parts of this instruction. It is true, material wage increases are possible only if production is increased. But there is no guarantee that this possibility will be realized. Real wages decreased per worker from 1896 to 1914, although per capita production increased 21 per cent. During a period of nearly two decades, capital increased, productive power increased, output increased, and the possibility of higher wages increased. But as a matter of cold fact, the purchasing power of the laborer's income actually declined. From 1914 to 1924 real wages increased more rapidly than production, but not enough to make up for the lack of increase in the previous two decades. The lesson seems to be that there is no assurance that the laborer will automatically receive the full benefit of increases in productive capacity. Unless the bargaining power of labor is strong, or the scarcity of supply of labor is marked, there is no guarantee that by the very nature of things labor will gain a full share of the greater national income due to increased production.

As to the effect of taxation upon capital accumulation, our main principle is that taxation which obstructs the growth of productive capital, by that much diminishes the productive capacity of all the people and lowers the standard of living. Taxes are destructive when they hinder the growth of production. With this principle in the abstract, agreement would seem to be easy. But when we attempt to determine to what concrete degree taxation may encroach upon a given individual income, we find much confusion and disagreement. The rich man goes to one extreme in claiming that high taxation of his income will destroy the fund which he would otherwise save, and will therefore prevent the growth of capital. The laborer goes to another extreme in claiming that high taxation of the rich man will simply reduce his extravagances, and have no effect upon his fund of savings. How to make taxation productive is a most important problem. At this point we may let the matter rest by stating the problem as a problem. The complicated issues which are involved in a solution of the problem belong in the chapters on taxation.

4 See George Soule, American Economic Review Supplement, Volume 13, pp. 132 ff.

What is the "Right" Rate for Banks and the Money Market?— There is a very frequent dispute in banking and business circles as to whether the bank rate of interest is high enough or low enough. Bankers are familiar with the fact that credit and capital are two different things, though closely related in their movements. Credit is purchasing power

. over capital, and business men pay interest on credit because it gives them command over capital. What business wants is the use of capital, but to get that, business must first obtain bank credit or money wherewith to purchase capital. The dispute centers in the question whether the interest on money and credit reflects truly the demand for use of capital. If credit is too costly, the business man cannot afford to engage in production. He insists therefore upon the “right" rate of interest from his banker. All this is from the viewpoint of the borrower. But a like consideration is in the mind of the lender. The lender offers purchasing power over goods to some would-be business man, but insists that the interest received shall be "fair" and "right." Both borrower and lender know that interest rates are supposed to bring supply and demand of capital into balance, but it is not so easy to agree upon the exact point where balance is reached. The confusion is the greater because the bank rate or money market rate is only one determinant of the real capital rate or saving rate. What test is there to show when the bank rate reflects the true rate of saving justified by fundamental conditions of demand and supply?

We may eliminate banking reserves as an adequate test. The ratio of loans and discounts to reserves might be an index of sound banking conditions under conditions of stable gold reserves, but war and post-war gold supply has been distributed on such an abnormal and shifting basis that the reserve ratio furnishes no adequate guide to the right money rates.

Two positive tests may be used: the volume of production and the movement of the price level. Interest rates are right when they tend to sustain productive output near to capacity. The first test is therefore a test of effects upon production of goods for the use of the nation. Interest rates are too high when they deter business men from securing the use of capital for normal productive purposes. Interest rates are too low when they permit speculative expansion without any corresponding expansion of tangible production. When the index of credit expansion rises beyond the index of volume of production, it is a warning that interest rates are too low.

The second test, the price level, is closely related to the test just mentioned. When bank credit expands more rapidly than production, the resulting tendency is inflation, measured by the rise of the price level. We may say, therefore, that the "right” interest rate is that which avoids either marked inflation or deflation. It is the rate which tends to stabilize prices within proper limits and to prevent extreme price fluctuations. A stable price level is itself an indication that the volume of money and credit is properly, adjusted to the needs of pro


duction. The proper interest rate is one which effects that adjustment.5

Coördinating Capital with the General Economic Process. In spite of the broad influence of supply and demand over capital and interest, it is nevertheless true that these forces do not establish any equilibrium or balance between capital and industry in general. There is a fundamental problem of coördination of capital accumulation with the actual needs of the whole economic life. One phase of this problem is the frequent occurrence of over-saving and under-consumption. The supply of new capital fluctuates with the business cycle. During certain stages of prosperity, the construction industries are speeded up to capacity, with a sharp acceleration in the output of industrial equipment, new building and plant extension, and other capital equipment. The oversupply of fixed capital is one of the stresses which bring on the crisis stage of the business cycle. Then during depression the output of new industrial equipment and of new construction generally is at low ebb. This unevenness in rate of growth of capital supply may be greatly moderated by carefully formulated plans for stabilizing construction, but such plans are slow in winning adoption by private business con

With the gradual improvement of institutional practice in this regard, we may look forward to an elimination of the worst features of temporary over-saving and under-consumption followed by temporary under-saving and over-consumption.

The control of the official discount rate by the Federal Reserve banks and the influence over commercial interest rates by the banks themselves are another important means of bringing about better coördination of capital growth and industrial need. The interest rate is an effective regulator of the up and down movements of demand for new capital. A raising of rates at the proper time can control the over-production of fixed capital, and an easing of rates at the proper time can stimulate production. Left to themselves, the crude forces of supply and demand bring no automatic adjustment or balance. They are forces which require judicious guidance and direction. The regulation of the interest rate is a most important means of such guidance.

Over-saving and over-investment are also problems related to the export of capital and to foreign investment. Before the World War, England was investing about half her annual savings abroad. Her surplus of savings available for capital, over and above home demand, was very great. Suppose these surplus savings had been thrown on the home investment markets. The over-supply must, in that case, have had the effect of severely depressing the interest rates. What happened was that the investment bankers, seeing that to allow savings to increase the home supply of capital would disastrously affect the receivers of income from stocks and bonds, managed to sustain the interest rate by distributing English savings all over the world. The United States,

5 See W. T. Foster and W. Catchings, Money, Chapter 8; Gustav Cassel, A Theory of Social Economy, pp. 473-485; and Federal Reserve Bulletin, January, 1923, p. 1; February, 1924, p. 78; March, 1920, p. 242.

since the war, appears to face the necessity of exporting capital if the interest rate is to be sustained. As nations advance far in modern production technology, they develop a very high capacity to save.

This saving capacity becomes so high that it threatens to give a heavy oversupply of capital. But this would be a catastrophe to all people depending for income upon ownership of securities. The yield on their securities would drop disastrously under the effect of over-supply. The export of capital will stall off the day of falling interest income for a time. Eventually, however, such a decline appears inevitable.

We say it appears inevitable, but there is one possible escape from this seeming inevitability, namely, by way of a change in the distribution of wealth and income. The home demand for capital may be sustained indefinitely if the purchasing power of the masses is increased. The laboring classes certainly have not reached the zenith of a standard of living. The needs of new capital to provide better working class homes are obvious, but these needs will not become effective demand for building capital until the incomes of the workers are sufficient to pay for better homes. This is illustrative of a broad class of possible uses of capital, all of which wait upon the improvement of working class incomes. A more democratic sharing of national income is one possible step in that direction; an increase in the total national income to be shared is another step. Coördination of mass purchasing power with the rate of capital accumulation is therefore a leading feature of the problem of over-saving and over-investment.

Not only is over-development of total capital supply a problem, but also over-development of certain industries and under-development of others is an equally important problem. At the same time that the railroads have been suffering from a shortage of capital equipment, the bituminous coal mines have had an enormous excess. The United States Coal Commission in its report on the bituminous coal mines in 1923, declared: “The capacity is sufficient to produce at least 25 per cent more than the highest rate attained in periods of peak demand, and if demand were spread evenly over the year, the overdevelopment would be even more pronounced.” Competent engineers have declared that the clothing factories of the country have a producing capacity of 45 per cent in excess of what is necessary, and the boot and shoe factories nearly 100 per cent. In building of homes for workingmen, the nation suffers a severe shortage, but in mining and metallurgical industries or in automobile manufacture, the nation is enormously oversupplied with capital equipment. Capital shortage in some industries is accompanied by capital excess in others. This maladjustment is partly the result of seasonal and cyclical fluctuations, but for the most part is more cause than result. The development of shortage in one branch of industry and excess in another leads to an unbalancing of production, with consequent crisis and depression. The stabilization of capital equipment in

6 See Federated American Engineering Societies, Waste in Industry, p. 17; and W. R. Ingalls, Wealth and Income of the American People, pp. 127-133.

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