Capital and interest theories - Chapter 3

American Journal of Economics and Sociology, The,  Dec, 2002  

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Introduction

HARRY GUNNISON BROWN IN HIS YEARS as an instructor at Yale (1910--1916) is said to have solidified his interest in Henry George's proposal to tax land rent. As was argued in the previous chapter, the defense of the distinctiveness of land space from capital was a key to the Georgist proposal. Brown would object to theoretical treatments of interest rate determination in which this distinction played no role. Although Brown never tried to justify Henry George's interest rate theory, he came to oppose the pure time preference theory as espoused by Frank Fetter and he never reconciled his own views with those of Irving Fisher.

The Fisher-Seager Exchange

IN THE YEARS OF BROWN'S EDUCATION, questions on capital and interest were among the most, if not the most, difficult subjects of economic theory. Bohm-Bawerk and Fisher both attested to their intricacy. Moreover, numerous debates and exchanges in journals attracted wide interest, especially in this country. The longest and perhaps best known of these exchanges was between Bohm-Bawerk and John Bates Clark concerning (among other points) the concept of capital. Bohm-Bawerk's theories had greatly influenced the thinking of American economists; however, his theory of interest was received unevenly. Some economists, such as Fetter, Patten and Taussig, were inclined to accept it in part and to emphasize Bohm-Bawerk's "time preference" explanation of interest rates. Others, such as Seligman and Seager, tended to reject the theory for explanations of interest rates that emphasized the "productivity" of capital along the lines of Clark. Irving Fisher's 1907 book, The Rate of Interest, took an intermediate position. In an article in Scientia (1) and later in his Elementary Principles of Economics, Fisher reiterated his theory in simplified form and introduced the term "impatience" to distinguish his view from Bohm-Bawerk's "agio" theory and to replace the term "time preference" that Fisher had employed earlier. Fisher saw the term "impatience" as expressing the "real basis of interest" (2) as well as constituting "a fundamental attribute of human nature." (3)

In 1912, Henry Seager (4) initiated an exchange that ultimately involved Fetter and Brown as well as Fisher. (5) Seager attacked Fisher's "principles" treatment of capital and interest. Fisher later would counter that this was unfair, as his more complete statements were ignored. As mentioned in the previous chapter, Seager took issue with a definition of capital that incorporated land, unlike Bohm-Bawerk's formulation. Moreover, Seager felt that Fisher, in rejecting Bohm-Bawerk's third explanation for interest or the "technical superiority of present over future goods," had denied a role to the productivity of capital in determining interest rate levels. Seager implied that Fisher's theory was methodologically incapable of serving as a theory of production and distribution. Fisher, in his first approximation, had taken income as a given but then had relaxed the assumption in his second approximation in The Rate of Interest. Fisher also countered that he already had given special emphasis to the role of produ ctivity in his theory (if not explicitly in his textbook) and felt that his contribution in this regard was the most original and difficult of the undertaking. (6)

Seager went on to criticize Fisher's refutation of productivity-related theories. Bohm-Bawerk, among others, had found a petitio principii fallacy in using the productivity of capital as an explanation for interest wherein implicitly an existing interest rate was presupposed in the valuation of capital via the discounting of future income from it. To Fisher's reiteration of this charge, Seager gave a somewhat oblique defense. He first charged Fisher with using land to represent capital, thereby obscuring the role of the expenses" of production in the determination of value in exchange. Fisher had used a hypothetical example of an orchard whose physical productivity doubled while the value of its products remained unchanged; the return or interest would remain the same while the value of the orchard would double. (7) Seager agreed in this case that the rate of interest would remain the same, but for a different reason. He viewed the orchard as consisting of reproducible machines or tools and argued that these tools would be multiplied under competitive conditions so as eventually to eliminate in large part a rise in the value of the tools. Yet, the greater returns to the tools would have insufficient impact on the capital market to significantly alter interest rates. Seager clearly felt that Fisher had obscured the issue by adopting the not-so-easily reproducible orchard for his example. Also, inadvertently or not, the orchard example tended to identify productivity theorists with older discredited theories that attempted to find in the productivity of nature a cause for interest.

Fisher recognized that his first example was insufficient and altered the proposition to that of a universal doubling of capital's productivity. He argued,