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Thursday, September 6, 2012

The Factors of Production

Our admonition to regard the economic process as a whole made up of many parts is the more justified in view of the close relationship between the act of production and the act of exchange (circulation) . In this connection, the Silesian poet Logau, in the candid aphorism which we have selected as motto for this chapter, happened 300 years ago upon an economic truth which it was left to modern theory to elucidate: production is, at bottom, nothing else than a perpetual exchange transaction with Nature by which we seek to exchange on the most advantageous terms our efforts against the produced commodities. It is a transaction in which the concept of marginal utility finds just as pertinent application as in exchange in the narrower and more usual sense.7 Conversely, it may be said that exchange is nothing else than production, i.e., the procuring of goods through the making of corresponding sacrifices. Production and exchange are similar in that both require certain expenditures to obtain a good: indeed, the whole meaning of the social division of labor resides in this, that it permits each of us to choose the most economical way of procuring needed goods. That is the whole secret of the division of labor, especially of the international division of labor, which many find it so hard to understand.
Of what then do the expenditures made in production consist? If we push our inquiry still farther back, we find that all these expenditures may be traced finally to three categories of production elements (factors of production) which in turn are not further divisible: labor, land, and capital.
Of these three factors of production, labor requires the least explanation. There is no need to define it for it is clear to everyone that labor is the really active and directing element in production. So preeminently important is this factor that it is easy to understand the constantly repeated efforts to make it the sole factor of production and of costs. At all events, we must keep ever in mind that the concept “labor” is to be taken in a sense sufficiently large to encompass all human activity, intellectual as well as physical, directive as well as directed. Thus, the activity of an entrepreneur must be there included. It follows further that the labor factor of production will fall into numerous sub-classes, each of these possessing its own market, its own wage scale, its own special features. Moreover, these individual labor markets will not necessarily stand in close relationship to one another.8
Similarly, little difficulty is experienced in comprehending the significance of land (or Nature in general) as a factor of production. Its role in production is characterized by the fact that it serves simultaneously as a location (cf. Chapter III, Note 1) and as a reservoir of the raw materials and the energy which lie dormant in the land. The latent energy and the raw materials of the earth, to the exploitation of which primary organic production (agriculture, forestry, fishing) and primary inorganic production (mining) are devoted, comprise the final and most basic sources of mankind’s supply of goods. In common with the labor factor of production, land exhibits the special characteristic of not forming a homogeneous mass but of falling (according to its location or to its varying content of raw materials) into innumerable sub-classes. The location of the land is of especial importance because, in contrast to the other factors of production, land is immovable: Mohammed must, in truth, always go to the mountain.
Labor and land are things easily grasped, their importance is self-evident and their role in production is clear. Everyone knows that they are indispensable, that they represent ultimate elements of production which are not reducible to any further common denominator. But what about the factor of production we call capital? Here begin the difficulties.
Let us start with a fairly simple situation in which capital will figure—the production of grain. When we say that for this purpose we require capital in addition to land and labor, what do we mean? Concretely, we visualize the following requirements: tools, draft animals, seed, fertilizer, farm buildings, machines, and lastly, a supply of foodstuffs (subsistence fund) to be consumed during the time which elapses between sowing and harvesting. This is a roundabout way of expressing the fact that man cultivates the land not only with the bare strength of his arms but with all sorts of auxiliary means as well. But what is the justification for regarding these auxiliary means as a third independent factor of production? Cannot all such items be subsumed under labor and land? For example, a plough contains wood and iron and its manufacture requires the expenditure of a certain amount of labor. The truth is, however, that the plough contains still a third component whose presence, though not immediately visible, can be ascertained by a process of deduction. Let us assume that the farmer makes the plough himself and that in consequence he will have to employ a part of his time in the production of a plough instead of in the production of food. For the farmer, this entails a diminishment of his current supply of consumption goods. As long as he is engaged in making the plough, either he will eat less or he will live from a supply of foodstuffs which he has previously stored up. Should he choose the latter alternative, he will still have had, during some former period, to reduce his consumption in an amount corresponding to his present stock of such foodstuffs. This restriction of consumption pays for itself in the future, however, for a plough, compared with primitive forms of cultivation, will result in an enormous increase in yield. Thus we see that the production of a plough requires not only the combined services of land and labor but a further essential condition—the restriction, in one form or another, of consumption. It is only after this current sacrifice is compensated in the future by the larger yield obtained thanks to the plough that the balance, so to speak, is struck. Until then, the farmer is obliged to wait for the rewards due to his work and to his restriction of consumption. We arrive at the same result if we come somewhat closer to reality and assume that the farmer does not make the plough himself but orders it made by the smith. The smith is then paid in money which the farmer could otherwise have used to buy consumption goods.
By this renunciation of complete enjoyment at the present moment in favor of the future, i.e., by “waiting,” capital acquires the character of an independent factor of production, a factor which cannot be subsumed under either land or labor. Since present supplies can be diminished in favor of the future only within fixed limits, the capital factor of production is always scarce. This is a point of the greatest importance and one which has to be borne constantly in mind. Were it not for this fact, it would be difficult to understand why all the scythes in the world have not long since been replaced by mechanical reapers, all the sewing needles by sewing machines, all bicycles by automobiles, and all streetcars by subways. Hence it is that we are obliged to pay a price for this scarce “something” just as we do for butter or for string, and this price is nothing other than interest.
“Waiting,” the essential ingredient of the capital factor of production, may take different forms. The form it takes in the case of the (purchased) plough is clear. The money which has been “put” into the plough has been withheld from current consumption uses and the farmer must wait until the extra yield obtained with the plough offsets the amount of his investment. The same principle is involved in building a house where the landlord must wait until the sum of his rents equals the costs of constructing the house. In either case we have to do with that kind of “waiting” which is associated with the investment of capital (fixed capital). The purpose of this capital investment is to provide means of production which are to be used over several production periods. But the farmer must take into account still another kind of waiting. Between the plowing and the seeding of the soil and the sale of the harvest stretches a period of several months: in autumn, there are expenditures for labor, seed, and fertilizer which are recovered only after the sale of crops in the summer of the following year. In the meantime, the farmer and his family must live; he must, therefore, have either a supply of consumption goods in reserve or a sum of money for the purchase of such consumption goods. Here again, a period of waiting is involved, but waiting of a different character than that which we observed in the first instance. The farmer must await repayment (for the duration of the period of production) not only for the labor, raw materials, and auxiliary equipment used in the process of production but also for the consumption goods required during this process (subsistence fund). Waiting of this type involves the use of what is termed working capital (circulating capital). The relation of fixed capital to working capital is the same as that of a meat-grinding machine to the meat which is put through it.
Naturally, it is not required that the producer himself do the “waiting.” By obtaining a loan he can, in effect, shift the burden of waiting onto the shoulders of some other person, the latter receiving his indemnification in the form of interest. Depending upon the kind of “waiting” involved, the credit thus obtained is either an investment credit or an operating credit. The possibility of obtaining such a credit obviously changes nothing with respect to the fact that for the capital thus supplied someone must undergo a period of “waiting,” of adjournment of his consumption irrespective of whether this occurs in some sector of the national economy or—as in the case of an international transfer of capital—of the world economy.
We can now see from the very fulness of explanation which it requires that capital is set off from the other two factors of production by a number of peculiarities. It is these peculiarities which make the analysis of capital one of the most difficult problems of economics.9 Part of the difficulty derives from the circumstance that capital, differently from land and labor, is subject to quantitative changes effected by human decisions and economic considerations. The quantity is increased in a process known as the formation of capital and is diminished by the consumption of capital.10 Here it should be observed that a certain fixed amount of capital is available to the economy at any given moment; this amount can be increased within a given period of time, but only within certain limits. There is a way, of course, of stretching these limits and of forcibly increasing the quantity of capital, viz., through credit expansion. But an increase of capital which is effected by such a radical method is ordinarily purchased at the cost of a subsequent crisis.11
Finally, we must touch briefly on that aspect of capital which renders it so repugnant to the adversaries of our capitalist system, the socialists, and one to which we too cannot remain indifferent. This is the circumstance that capital is not only an elementary factor of production but, in its current context, also a source of private income for which apparently no services are rendered in return. Both notions must be kept rigorously distinct, however. Saying that capital is an indispensable factor of production does not imply that we are taking a position on the question of who should own this factor of production. The first point is uncontested whereas perennial controversy rages around the question of the ownership of capital. Naturally, even a socialist state cannot do without capital as a factor of production since in a socialist state, as in any other, it will be necessary to economize so that worn-out machines can be replaced and new ones built. The Russian Five Year Plan is nothing if not such a socialist method of creating capital on a colossal scale. It is not the use of capital which distinguishes the socialist from the capitalist economy, but only the fact that this capital, under socialism, belongs to the state. But we must not imagine that we have refuted socialism simply because we can show that capital is necessary even in a socialist state. No serious socialist questions the necessity of capital; what he demands is that it belong to the “community.” Whether this demand is reasonable or not is a question we have reserved for discussion in another place.

Economics of the Free Society

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