Capital and interest

Wicksell’s contributions to the theories of distribution and public finance would have been fully sufficient to secure him a place in the history of economic thought. His pio­neering works in the fields of capital theory and monetary theory have made him even more prominent, and they are connected with each other through the phenomenon of interest rates.

Wicksell’s admiration for Bohm-Bawerk had its origins in two fundamental conun­drums of the neoclassical theory of distribution. The first conundrum is the determina­tion of the size of the capital stock, the second is in the observation that the consumption of capital services, unlike the use of labour, reproduces the capital and generates a permanent income at one and the same time. If factor prices are to be explained by the scarcity of the respective factors, the latter’s quantities must be determined independ­ently of factor prices. The originary factors of production, land and labour, may to some extent be quantifiable in physical units of area and time, such as working hours and acres.

In addition to the difference in measurability, there is a fundamental difference between labour and capital in terms of factor property (stocks) and income (flows). Wicksell (1901 [1934]: 146) pointed out that:

[i]f anybody makes a spade, a plane, or any other capital good, he obtains, by its use, compensa­tion for his work - and he has no obvious claim to anything more. What is enigmatic is that the possession of capital, apparently at least, does procure something more, namely a permanent income in the form of interest, either without sacrifice of capital or while capital is being con­stantly replaced... We must not simply take it for granted that capital can claim the whole of the surplus.

Why did Wicksell refer to Bohm-Bawerk for the solution of these conundrums? The reason is Bohm’s emphasis on the importance of time in processes of production and the intertemporal nature of consumption plans. In Wicksell’s view (1901 [1934]: 172), “the time element... is the real kernel of the capital concept”. Different processes of production require different inputs of capital over different numbers of periods, yet they must yield a uniform rate of interest (per period) in competitive equilibrium.

In Wicksell’s view, the equilibrium rate of interest is basically determined by Bohm’s “Third Ground”, the superior productivity of more roundabout (that is, time-consuming) methods of production - in other words, it is determined by the marginal productivity of capital. At first, Wicksell (1893) had praised Bohm for having given the notion of marginal productivity a precise and generally quantifiable meaning by his concept of the “average period of production”. In the Lectures (1901 [1934]: 184), he still retained Bohm’s notion of the “marginal productivity of waiting” as “a concise general principle, reflecting the essence of productive capital”. Yet he also pointed out that Bohm’s method of determining the rate of interest by way of the average period of production, on the one hand, and time preference, on the other, is applicable only under extremely specific assumptions, if at all. Wicksell argued that the average period of production is not inde­pendent of the rate of interest if the more general method of compounding is used to calculate the average time distance between input and output. In a similar vein, Wicksell (1901 [1934]: 149) had criticized the circular reasoning of the “Walrasian School”, where the rate of interest is determined by the value of capital, which is deduced from its costs of production, these being determined, in turn, by the size of the capital stock and the rate of interest. In the end (as we shall see below), Wicksell himself escaped from such conundrums and tautologies only by taking the aggregate value of capital as given.

Wicksell’s theory of “capitalistic production”, as expounded in his Lectures (1901 [1934]: 144-206) from the second edition (1911) onwards, amounts to determining the rate of interest by the marginal products of dated services of land and labour. Capital is defined as “saved-up labour and saved-up land” (1901 [1934]: 154), a conglomerate of land and labour services of earlier periods. In general equilibrium, the marginal products of these dated services, valued at their prices in the goods markets, correspond to the rent rate and wage rate, multiplied with compound interest. Accordingly, “[i]nterest is the difference between the marginal productivity of saved-up labour and land and of current labour and land” (ibid.).

Since capital is reckoned “as a sum of exchange value - whether in money or as an average of products,... each particular capital-good is measured by a unit extraneous to itself” (1901 [1934]: 149). In Wicksell’s view, this “is a theoretical anomaly which disturbs the correspondence which would otherwise exist between all the factors of production” (ibid.). Failing to close his own model in any other admissible way, Wicksell eventu­ally took recourse to the assumption of a given value sum of “social capital” in order to determine the rate of interest - a procedure that he admitted to be valid only under rather restrictive conditions of static analysis (1911 in Wicksell 1958: 183-4, 1928: 208). Moreover, he demonstrated (in terms of comparative static analysis) that, after a rise in the capital stock of an economy, competition for labour and land makes the marginal productivity of social capital fall below the (representative) rate of interest (1901 [1934]: 148-9). This “curious divergence” from the standard result of the marginal-productivity theory of income distribution was later called the “Wicksell effect” (Uhr 1951: 850-52). It came to play an important role in the Cambridge controversies on the neoclassical theory of capital.