We have seen that the principal categories of income—wages, interest, rent, and profits—are to be regarded as the prices of the factors of production to which each corresponds, that these prices are determined by the economic process as a whole, and that they cannot be arbitrarily changed without causing a more or less radical dislocation of all economic relationships. Although it has already been made clear that this in no way precludes a successful change in price relationships in favor of wages by acting on the original factors), there are many to whom our findings will be a cause of extreme irritation. They reject the idea that interest and rent, for example, should be placed on the same footing with wages, and argue instead that these highly unjust forms of nonfunctional income should be summarily abolished. Are they not right? And if such abolition is not possible within the framework of our economic system, is this not reason enough to make an end once for all of this system and its execrable “laws” about which economists make such a great to-do?
To add some light to all this heat, it will be useful to distinguish once again between the personal and the functional distribution of income. In truth, we must sharply distinguish between the one fact that rent and interest are paid at all, and the other that they are paid to individuals in such unequal amounts. If the distribution of property were more equal than it is today and if, in consequence, the masses were to receive a larger share of the income accruing from the ownership of land and capital, the attitude of the average person towards rent and interest would probably be much less hostile. We have here, then, two different questions to answer. Let us for the moment confine our attention to the first: whether interest and rent are justified at all, regardless of to whom and in what amounts they are paid. In answering this question we can under no circumstances ignore the fact that rent and interest are not meaningless sources of enrichment but institutions which have a specific significance and function. Although we have already discussed the functions of interest in the preceding paragraph, the point seems to be important enough to justify a fuller and more general explanation. Such an explanation should, above all, secure recognition of the fact that behind rent and interest is concealed a complex of relationships, knowledge of which is just as important in a socialist as in a “capitalist” state.
We know that interest and rent are nothing else than the prices which are paid for the services of the corresponding factors of production. These factors of production are available, however, only in limited quantities, while the demand for them may be measured on a scale which extends to infinity. The formation of prices, which leads in this instance to the phenomena of rent and interest, is thus only a special case (although a very important one) of the general principle of equilibrium which, as we saw previously (pp. 26ff., 33ff.), rules our economic system.
All economic systems, of whatever kind, are confronted with the task of effecting a rational allocation of land and capital as among the various possible uses open to them. This task can be accomplished in different ways. Our economic system is distinguished from others in that it seeks to solve this eternal human task by placing prices on land and capital; in this way, he who wishes to employ one or the other factor is compelled to give way to the person who believes he can put the factor in question to a better use. This is certainly not an ideal solution but it is all the same a solution. It was not thought up by anybody in particular, but came into being in a thoroughly natural way over a span of time which extends back thousands of years. In this long probationary period, it has demonstrated its practicality. A socialist state would have to find some substitute for it. As a matter of fact, such a state, if it wanted to have a rational economy, would have to invent rent and interest even if this were only with the purpose of providing itself with calculating devices to guide it in its use of these scarce factors of production. Otherwise, it would run the danger of having them appear on its books as free goods, thereby opening the doors wide to waste. If the economic calculations of the socialist state were to fail to take account of the scarcity of land and capital by means of some sort of index, these calculations would be hopelessly wrong. But it is to be feared that having destroyed the free market economy, such a state will have deprived itself of the mechanism which alone can solve the mathematical problem involved in calculating an index of this kind.6
In order to appreciate fully the difficulty which would face a socialist state in solving this problem, we must visualize the decisions which the government would have to make every hour of every day. These decisions are far more complicated than those described above in our example of the shoe and automobile industries. To bring us somewhat closer to the realities of the situation, assume that a large number of other industries are simultaneously pressing their claims for capital (e.g., the phonograph industry), that farmers are complaining about shortages of reaping-machines, and that besides all this there is talk of adopting a new-type locomotive. The method which the socialist planned economy usually falls back on in such case is to have the government itself decide, quite arbitrarily, where the capital can be most usefully employed. (It may happen, for instance, that a majority of the decision-making commissars detest phonograph music, in which case they will go over the heads of the only really competent judges, viz., the consumers, and decide that the capital requirements of the phonograph industry will not be met). The other alternative is for the government to leave it up to the population to decide where its capital can be most usefully employed. In such case, as we have seen, the population makes use of a scale which, in our economic system, results in a more or less efficient distribution of capital. Nevertheless, there are grounds for believing that such decisions by the people would be impossible in a socialist state.7 This all goes to prove that interest is not a stupid and provocative device for the impoverishment of some and the enrichment of others, not an organ like the appendix which can be removed with impunity, but a vital organ which in every economic system has an essential function to fulfill.8
The same is true of rent, whose existence is predicated on the necessity of making demand for land conform to the degree of need in each case, and of equating this need with the limited supplies available. Rent fulfills in our economic system a function which must be fulfilled in every economic system, viz., the introduction of reasonable order into the allocation of the limited supply of land. A very vivid appreciation of this function of rent may be had by observing the countryside from the vantage point of an airplane. The division of the land into residential and farm areas, forests and meadows, railroads and highways, the silhouettes of the cities with the skyscrapers in the center and the villas in the outskirts—all this is, fundamentally, the work of rent which through a series of gradations in its amount causes one piece of land to be used for this purpose and another for that purpose. Just as interest—to express this idea in more drastic form—ensures that subways will not be built in every country town, so rent acts to prevent the planting of potatoes in Regent Street or on Fifth Avenue. Rent is a warning, as it were, that land of a given quality or in a given location is scarce, and that therefore it should be entrusted only to those who are able and willing to make the best and most profitable use of it. The general regulatory principle which rules the whole of our economic system comes here, as elsewhere, into full play. That land is reckoned among the production costs of every economic good (since a price in the form of rent must be paid for its use) is an expression of the truth that the use of a piece of land for one purpose precludes its use for another purpose. In consequence, we see that rent differs in no wise from other cost elements.
This, of course, does not prevent rent from exhibiting certain peculiarities which, though the theoreticians of another day gave them undue importance, cannot be ignored. Although it would be an error to speak of an absolutely fixed or even of a monopolized supply of land, it is nonetheless true that land of a given fertility or location is more or less fixed in amount. Hence, where there is increasing demand for land there is a tendency for its price to rise, with no possibility of reestablishing equilibrium between supply and demand through increased production. Consequently, rising standards of living and an increasing population undoubtedly have a tendency to force up rents. On the other hand, we should be careful of over-estimating the strength of this tendency. It would be wrong, for instance, to believe that rent, like a ripening fruit, will wax bigger while the landowner contentedly sleeps. It is too easily forgotten that the rent of a specific piece of land can, in spite of increasing population and economic development, just as easily fall as rise, since there may occur shifts in demand for the several classes of land. With respect to land, one can lose as easily as one can gain, just as in every other form of capital investment. As one share of stock differs from another share, so does one piece of land differ from another due to its location or its quality. It often happens that even within a rapidly expanding urban area considerable losses may be sustained as the result of rent declines in what were once fashionable quarters, whereas they may be sharp increases in rents in areas that had been hitherto neglected. The same principle holds true for agricultural rents which, in spite of population growth, are equally subject to fluctuation. Naturally, we must guard against exaggeration in considering any of these possible alternatives. Still, it often happens that thanks to the sudden development of a city, to improvements in communications systems, or to construction of railroads and canals, those who happen through coincidence to be the owners of the land in question, may be legitimately regarded as the beneficiaries of an “unearned increase in value.” In cases of this kind, special taxation may be justified. But here we are anticipating our discussion of the personal distribution of income.