Reflecting on the Theory of Interest
[Reprinted from Land and Freedom, July-August
For centuries the interest question has been a subject of discussion
among philosophers, economists, and reformers of all shades of
opinion, yet it has never been settled. No general agreement has ever
been reached as to what interest is, what causes it, how it is
determined, and whether or not it is equitable.
The feeling that interest is unethical is perhaps as old as interest
itself. Long before Christ was born, the taking of interest was
denounced as unjustifiable by philosophers like Plato, Cicero and
Aristotle. Later the Roman Catholic Church condemned the practice and
laws were passed forbidding it ; but in spite of all efforts at
suppression, interest persisted. This is no doubt the reason why it
came to be regarded as a natural economic fact by all economists, who
have tried ever since to justify interest as the legitimate reward of
those whose industry and thrift (?) have enabled them to accumulate
Today interest is more firmly established than ever. It has become an
integral part of our economic system and is regarded by rich and poor
alike as a beneficial and necessary institution. Interest, we are
told, is the reward of thrift, and thrift is a virtue; could a virtue
bear evil fruits?
Yet, even today, there are thinkers who, like the ancient
philosophers, look upon interest as but a form of privilege and a
tribute upon labor. It seems to me that such views are not without
justification. In fact I believe such feeling to be the logical
reaction in any one possessed of a sense of justice, whose judgment
has not been warped by the incongruous teachings of our plutocratic
No one can possibly question the right of the man who has produced
and accumulated wealth, to live without working as long as it takes
him to consume the wealth he has accumulated; to be told however, that
he should be able to live with- out working for an indefinite period,
and his children, grandchildren and their descendants after him,
without even taking from his accumulation, but entirely from the
interest thereon, is somewhat disturbing to the minds of those who are
convinced of the righteousness of the command: "By the sweat of
thy brow thou shalt eat bread."
I wish to say that my views on interest, as expressed in this
article, in no wise affect my adaptation of Progress and Poverty
in a forthcoming work, The Philosophy of Freedom (advertised
elsewhere in this issue). In that book, I have adhered scrupulously to
the views of Henry George.
However, some prominent Georgeists have suggested that the above
article be printed as an appendix to the aforesaid book, not only to
present students with a new angle on the moot question of interest,
but also to impress upon them that one may disagree with George on
interest and yet fully accept his fundamental philosophy.
HENRY GEORGE'S THEORY OF INTEREST
Progress and Poverty Henry George attempts to explain and
justify interest in a unique theory, in which he bases interest on the
reproductive forces of nature. He tells us (Progress and Poverty,
Book III, Chapter III) that capital, when used in the reproductive
modes, receives a natural increase over and above that due to labor,
and while capital has to yield a certain portion of this increase to
labor, it retains the other portion, which is interest. George then
goes on to say that any one possessing capital can demand and receive
this increase (interest) even though his capital is used in other
modes. For the same reason, he who has money which could buy seeds or
breeding stock will exact from the borrower the interest he could thus
secure from nature.
This is a logical deduction from the premise that nature gives an
increase to capital apart from the return to labor. If, however, the
premise is false, as I believe it is, then the conclusion is not
It cannot be denied that the reproductive forces of nature give an
increase. A small cabbage seed buried in the ground will become a
cabbage weighing several pounds. A calf turned out in the pasture will
in time grow into a cow, and it is evident that such amazing results
are due mostly to nature and not to the labor of man. But it does not
follow that this work of nature increases the capital of the farmer.
The ultimate purpose of all production is the satisfaction of human
wants, and this is obtained by an increase in quality or usefulness as
well as by an increase in quantity. The power of shoes to satisfy
human wants over that of skin and hides is not less than the power of
the wheat crop to satisfy human wants over that of seeds. In either
case the return to labor and capital is based on the value create
whether it be quality or quantity.
When the farmer takes his wheat or his cattle to market he exchanges
something which is partly his work and partly the work of nature. But
does he get anything in exchange for the work of nature? He does not,
for the effect of cooperation of nature is to give more produce for
the same amount of labor, hence, not to increase his return as a
producer but to lower the exchange value of his product.
And the same is true of the increased productivity due to the use of
capital in non-reproductive modes. If the shoemaker has used machinery
which has enabled him to produce more shoes with a given amount of
labor, the effect of this greater productivity will be to lower the
price of shoes. Barring monopoly, he cannot sell the added
productivity due to the use of capital any more than the farmer can
sell the added productivity due to nature.
Henry George has clearly demonstrated that the power which exists in
tools to increase the productiveness of labor cannot be the cause of
interest, and to this I add that neither can the reproductive power of
nature. In this connection I wish to formulate an economic principle
which I deem of importance, inasmuch as it bears on the foregoing
discussion. It is this:
Those forces, outside of man himself, which increase the
productiveness of labor, when such are used to in- crease production,
never benefit the producer as such but always the consumer as such,
unless these forces are monopolized, in which case the benefit will
accrue, not to capital or to labor but to monopoly in the form of
extraordinary profits or in the form of rent.
If this principle is economically sound, it will serve to prove that
the reproductive forces of nature cannot be the basis of interest, for
interest is unquestionably a production cost and cannot benefit the
consumer as such ; and if the reproductive forces of nature do benefit
the consumer by lowering the value of the product, they cannot give
any increase to the labor or the capital of the producers.
But is it not a fact that capital generally obtains a return over and
above its replacement and compensation for risk?
This is an absolute fact in the case of money, though not always a
fact in the case of real capital; but whenever capital can command
such a return, it is certainly not due to the productive forces of
THE NATURE AND FUNCTION OF CAPITAL
The failure to reach an agreement as to the cause of interest is
simply a consequence of the failure to agree as to what interest is,
and this in turn is due to the confusion that exists concerning the
nature and function of capital and its true relation to labor.
What is capital and what is its purpose? Capital is wealth, i.e.,
labor products made or accumulated for the purpose of aiding labor in
production. As production includes making, transporting and
exchanging, capital has been properly defined as wealth in the course
of exchange, i.e., wealth which has not as yet reached the ultimate
In the field of agriculture it consists of: seeds, breeding stock,
tools, machinery, buildings, produce for sale, etc.
In the field of manufacturing, mining or transportation, it consists
of: buildings, machinery, materials, equipment, finished goods, etc.
In the field of commerce it consists of: buildings, equipment, stocks
of merchandise, etc.
When we see the huge and expensive machinery used in a modern mill or
factory, we are apt to think of it as having nothing in common with
the simple tools of the old fashioned cobbler or journeyman mason or
carpenter. Yet, though the difference is enormous, it is but a
difference in degree, not a difference in kind, and for the purpose of
our discussion we might just as well think of capital as a simple tool
such as a spade or a carpenter's plane.
A tool, which is the most characteristic form of capital, is nothing
more than a contraption conceived, produced, and utilized by labor to
produce wealth more efficiently; it is, so to speak, an artificial
amplification of man's physical power by man himself. It is labor's
own brain child, and what is true of tools is true of all other forms
of wealth used as productive instruments.
And now that labor has produced wealth with the aid of this thing
called capital, we are confronted with the task of determining how
much of the produce shall go to capital in interest -- and how much to
labor in wages. Justice demands that each shall receive what it
produces, but what has capital produced?
Capital itself, whatever its form, has no productive power. What we
might term "live capital," of which domestic animals,
cultivated plants and trees are good examples, has a power of growth
but this should not be confused with productive power, which is
essentially a human power. The power of growth is a natural power
altogether independent of man's effort. It is not an attribute of
capital but a characteristic of all living things under any condition.
As for "inanimate capital" such as tools, machinery, etc.,
it is as dead as a door nail and has no more productive power in
itself than would a man's arm cut off from his body. Not that man's
limbs have in themselves any productive power, for man's arms and
hands are but natural tools which can operate only through man's mind.
We speak of physical labor as one thing and of mental labor as
another, but this distinction is not a fundamental one. There is no
such thing as purely physical labor, i. e., labor dissociated from the
exercise of the mental faculties. Even in what we call physical labor,
it is not the hand that produces, it is the mind which directs the
hand. Likewise it is not the tool that produces, it is the mind which
directs the hand that guides the tool.
No matter how much capital existed and no matter how rich the field
of production, not one iota of wealth could they bring forth without
labor. It is only by labor that capital is produced ; it is only in
the hands of labor that it can be utilized productively ; how then,
can we think of capital earning anything to which labor is not
The fact is that capital itself produces nothing and is not entitled
to any part of the product as a factor of production, and this for the
simple reason that capital is not a factor of production.
Here I beg to take issue with all economists, past and present, who
consider capital a factor of production apart from labor. This, in my
opinion, is the economic fallacy which is responsible for the failure
to arrive at a satisfactory conclusion concerning interest.
Capital is not a factor of production, it is merely a factor
(instrumentality) of labor.
Nature provides all animals with such natural implements as enable
them to secure sustenance and protection, together with the instinct
to use them to the best advantage. Nature has not been quite so
generous with man as regards physical assets, but on the other hand
nature has gifted man with that which no animal possesses, viz., the
power of reason. Vested with this power, man can produce tools and
weapons so superior to anything which nature can provide, that they
have enabled him not only to gain dominion over the animal kingdom but
to harness nature itself to do his work.
Bearing in mind that capital is anything external to man which he has
secured through conscious effort and which he uses to aid in
production, was there ever a time when men produced without capital?
Never, for if there ever was a time when human beings lived by
producing all their needs entirely with their bare hands, such human
beings could hardly be called "men." The most primitive
savage we know of made use of objects external to him, fashioned or
secured by him, were it nothing more than sticks and stones.
The use of capital by man is therefore as natural as the use of his
own powers. Labor alone needs capital, labor alone can produce it, and
labor alone can utilize it. It is an integral part of labor. How can
we think of it as a separate factor? It is just as natural for a
laborer to have capital to work with as it is for a buffalo to have
horns or for a tiger to have claws. We expect a laborer to own his
clothes why not his tools?
THE NATURE OF INTEREST
But, since capital can produce nothing without labor, and labor can
produce hardly anything without capital, it is utterly impossible to
determine their respective contribution to a given result on the basis
of what each could have produced alone. How, then, is interest, which
is supposed to represent the contribution of capital in aid of labor,
To this question there is but one answer and one explanation. What we
call interest does not represent the contribution of capital in aid of
labor; it represents that part of labor's produce which labor agrees
to surrender for the Joan of capital. It is determined by supply and
demand in the loan market.
It is not until borrowed capital is used in production that a
division between labor and capital is necessary. The producer who uses
his own capital has no concern in ascertaining what he would have
produced without it, any more than he is interested to know how much
less he would have produced were he stupid instead of intelligent or
sickly instead of healthy.
Had laborers always owned their tools and whatever other labor
products they needed to work with, how could such a thing as interest
ever have been thought of?
If there were, in general, an advantage to labor in borrowing capital
rather than owning it, this might be some justification for interest,
but the cases where borrowing is more advantageous than the use of
one's own capital are exceptions and not the rule. It cannot be said
that laborers do not own their capital because it is more profitable
to borrow it. The incentive to accumulate capital cannot be greater
for the lender who receives interest than it is for the borrower who
pays it. If laborers do not accumulate capital, it cannot be that they
find accumulation unprofitable, it must be that they find it
That we have today a class known as "labor" who use capital
and another class known as "capital" who supply it, is but
the result of economic injustice which, by depriving the laborers of
the fruits of their toil, makes it impossible for them to accumulate
capital and compels them to borrow their own production.
Capital is, as we have seen, an integral part of what in political
economy is called "labor." Accordingly what man produces
with or without the aid of capital is (excluding rent) a return to
labor and can only come under the head of "wages."
Land and labor (including capital) are economic facts essential to
the production of wealth, but while the use of capital is necessary to
production, the borrowing of capital is not. Borrowing and lending are
not economic processes but purely social phenomena. Therefore,
interest, which is nothing more than the price of a loan and the only
cause of which is the need for borrowing, is not an economic fact and
has no place in distribution.
After allowance is made for the replacement of capital, wealth is
divided, not into three parts but only two, viz., rent and wages.
Having established the fact that interest is not a return to capital
as a factor (since capital is not a factor of production), nor a
return to the use of capital (the return to which is wages), but only
to the loan of capital, it remains to be seen how interest is
We hear of borrowing capital and paying interest at a certain rate or
percentage, but what does it mean? When a man goes into the printing
business, for example, does he borrow printing presses, linotypes,
paper, ink, etc. from those who manufacture these products, and does
he pay them interest? Of course not. Those who produce capital goods
are not lenders of capital ; they produce them for sale just as the
farmer produces and sells potatoes. Those who need capital goods buy
them from those who produce them and whose return is therefore wages
and not interest.
But if capital goods are purchased and not borrowed, what is
borrowed? It is the medium of exchange, money or its equivalent, i.e.,
If actual capital were borrowed, we would have an independent rate of
interest for each form of capital, which would be based on the supply
and demand, for loaning purposes, of each particular commodity. But
since all commodities may be secured through the medium of money, it
stands to reason that the rate of interest will be that at which money
or purchasing power may be borrowed. Therefore, interest being a
return to lending, it is the return to money lending, and the interest
rate is determined by supply and demand in the money loan market.
Money or loan interest is therefore pure interest, i.e., only real
interest, and must not be confused with the returns of producing
capitalists, manufacturers, merchants, and other business men, for
though the return to their capital may be affected to some extent by
what they could have secured in the money loan market, it is on the
whole nothing more than wages of superintendence and compensation for
risk commonly known as "profits." It is only when business
is good that such profits include real interest, for when business is
bad and competition keen, the average business man is lucky if he can
maintain his capital and in addition receive a fair compensation for
his work and risk.
In money lending there is no replacement; risk is covered by
collateral and the return is fixed in advance by contract. But the
business man cannot thus fix the rate of return on his capital, for
the price at which he sells his goods is determined by the market and
consequently his profits are always subject to market and business
conditions. Furthermore, the supply of capital goods in productive use
cannot affect interest since it is not part of the supply of loanable
capital. Neither are new capital goods for sale a factor in
determining interest, for the supply of such can only affect their
market price, not the interest rate, which is essentially a loan rate.
It is hardly necessary to point out that, inasmuch as money loans are
secured by collateral, and there being no depreciation or labor
involved, allowing only for any possible insurance against loss, the
return to money lending, viz., interest, is an unearned increment, a
form of privilege to which too little attention has been paid by
economists and social reformers.
In the light of the foregoing discussion we may give answer to the
questions involved in the interest problem, i.e., what is interest?
what causes interest ? how is interest deter- mined? is interest
Interest is the return to the loan of money or its equivalent in
actual wealth. It is caused by the need for borrowing, due in the main
to poverty. It is determined by supply and demand in the money loan
As for the question : Is interest equitable ? this depends on whether
we are considering interest as a private business transaction or as an
institution. The former is equitable be- cause it is a contract freely
entered into by two parties, both of whom, under the prevailing
circumstances, derive a benefit from the transaction. The latter is
inequitable because it is forced upon the people as a result of a
condition of social and economic injustice which creates debts and
which deprives men of the opportunity to receive and accumulate the
wealth which their labor brings into existence.
It is not likely that the borrowing of money shall ever cease
altogether. Life will always have its ups and downs, and men, whether
in private life or in business, may at times be forced or induced by
circumstances to call on others for financial assistance and be
willing to pay for a service thus rendered them. But given just social
conditions and an equitable distribution of wealth, the equation
between the number of those able and willing to lend and the number of
those forced to borrow will be such that loans will be obtainable at
very low rates. Such loans will be but temporary burdens easily borne.
On the other hand, interest as an institution is but the evil fruit
of an evil economic system. It has its roots in land monopoly and the
resultant exploitation of labor. It will tend to disappear with an
equitable distribution of wealth. Public debts will be unnecessary
when the world goes to work instead of going to war and governments
subsist on their legitimate and natural income, the rent of land.
Mortgages and other private debts will vanish when land is free and
wages high. Capital invested together with labor will bring handsome
returns, but capital or money seeking investment without labor will
find little or no market.
This is not to say that there will be no savings to provide for man's
needs in sickness and old age, nor accumulations for future
consumption or future productive undertakings, but the system which
enables an individual to lend his money at interest and watch his
fortune grow while he lives in luxury without doing a stroke of work,
will be a thing of the past.