Chapter II

, of the effect of changes in the rate of interest on the supply of capital. As was there indicated, there are good reasons for supposing that a fall in the rate of interest would induce some people to save more, and conversely. But the balance of probability is in favor of the conclusion that the _net_ effect of changes in the rate of interest, though perhaps slight, is usually of the more ordinary kind. The decisive argument in this connection is the fact, upon which we have just touched, that savings are supplied largely by people who are relatively rich, and who become richer when the rate of interest rises. For at this point it is necessary to be careful. It is easy to slide from the above conclusion into an argument of the following kind. A higher rate of interest leads to more saving; it is thus necessary to _evoke_ more saving; it is thus required as an _incentive_ to induce people to incur the _sacrifice_ of waiting; this sacrifice represents the "real cost" for which interest is paid.

This terminology of incentive, inducement and sacrifice is of very dubious validity. A rich man, who is made richer by a rise in the rate of interest, will probably save more, but it will be rather because he has become richer than because he is tempted by the higher rate: and the less we talk about his sacrifice the better. Nor is it clear that the attraction of a high rate of interest is an operative factor on the mind of a man to whom saving means a real sacrifice of immediate comfort or enjoyment. Certainly it is only one among many factors, and seldom an important one. A really poor man will think not so much of the annual income which will accrue from his savings, as of the capital sum upon which he or his family can fall back if a rainy day should come. And for this purpose he might save as much as he saves now, even if there were no interest to be obtained thereby. He might even be prepared to lend what he had saved, at least to banks (a deposit with a bank is in effect a loan), for the mere advantage of safe custody. The people who save rather for the sake of the capital sum that can be realized than for that of the annual interest are very numerous, and probably include many men in receipt of quite considerable earned incomes. Moreover, those who consider mainly the future annual income which their savings will yield them, are usually more concerned with its absolute amount than with the ratio it bears to the amount they must save in order to acquire it. For this reason, as has been often recognized, they may save less when the rate of interest rises, since a smaller quantity of savings will insure to them the future annual income they desire to obtain. There is no need to be dogmatic upon any of these points. The psychology of saving is both complex and obscure. Our conclusion must be the negative one that we have insufficient evidence to warrant the assertion that the

## particular rate of interest which happens to prevail is a measure of

the sacrifice involved in saving, even in the case of what we might regard as the "marginal saving." And, if we cannot assert this, we must be careful not to assume it as the basis of other arguments, or as part of a general analysis of price or exchange value.

It is of some interest to observe that the difficulties which our world socialist commonwealth would encounter if it attempted to dispense with the rate of interest, would not necessarily include that of obtaining a supply of capital. It might, indeed, not find it easy to determine the proportions in which it should allocate its productive resources between immediate and distant ends. Our present system cannot be said to have evolved satisfactory principles for the solution of this question; and the socialist commonwealth would have to work out its own solution. But when it directed that labor and materials should be devoted to purposes of long-period utility, there would be an automatic collective saving, of which no one would be conscious as an individual sacrifice. Even at the present time, our capital is not supplied entirely by the savings of individuals, but to an extent, which though quite incalculable is yet certainly considerable, by involuntary saving of an essentially similar type to the above.

§9. _Involuntary Saving_. When a municipality embarks on a municipal tramways scheme or any other industrial enterprise, and pays off by means of a sinking-fund the capital which it borrows in the first instance, the proceeding amounts, as the defenders of municipal trading have rightly claimed, to a compulsory and unconscious saving on the part of the citizens. Their consumption has been postponed willy-nilly as the result of the increased rates or the high charges which they have had to pay; and, when the subscribers to the original loan have been paid off, the capital of the community is enhanced to the extent of that loan. Central governments might similarly increase the supply of capital by devoting annual revenue to capital purposes; though their actual record, as it happens, is mainly of a different kind. But what is chiefly a possibility in the case of Governments has actually been carried out on an enormous scale by other institutions. The development of the joint-stock company system has introduced a new factor into the problem of the supply of capital, which is of immense though but dimly perceived importance. The directors of a company are technically no more than the servants of the shareholders. It is the profit of the shareholders that it is the directors' duty to promote with a single mind, and the whole capital of the concern, including its reserves both open and concealed, is the shareholders' exclusive property. But realities have a way of differing from forms, and just as in political affairs it is common to regard the State as a very different thing to the people who compose it, as a sublime entity with a separate existence of its own, so directors are apt to distinguish between the company and the shareholders. It is the company to which they owe allegiance. To pay away in dividends to shareholders money which they could employ in extending the business or strengthening the position of the company appears to some directors a necessity hardly less unpleasant than an increased wages bill, or an Excess Profits Duty. Concessions must indeed be made to the shareholders' rapacity: but when something has been done in this direction, dust can easily be thrown in their not very observant eyes. Reserves, which within limits are a necessity of sound finance, can be accumulated beyond those limits, and, when the further limits of an extreme but just arguable conservatism have been passed, there remain the innumerable devices, known to every resourceful Board, of hidden reserves, the secret of which is unmenaced by the meager information of a balance-sheet. In all this the shareholder, as the directors occasionally assure themselves, has no real grievance, for he will gain in the long run, from the appreciation in the capital value of his shares, all and perhaps more than all that he foregoes in the meantime in the way of dividends.

In the long run the shareholder is not injured; but in the meantime he is in effect compelled, without any consciousness of the proceeding, to save and to reinvest in the company a portion of the dividends, which he might otherwise have spent. The reserves which are accumulated are not allowed to lie idle: they are employed either in what are really capital extensions of the business, or in the purchase of outside securities, and in either case they represent an increase in the total supply of capital. The principal which these proceedings represent is capable of indefinite extension.

But however possible it might be to secure a supply of capital without the inducement of a rate of interest, that rate is indispensable for dealing with the demand. It is no good saying, "Three per cent seems a fair rate of interest; let us try and limit it to that." Given the amount of savings which are supplied, the rate of interest must be allowed to reach whatever figure is necessary to confine the demand to that amount. Given the quantity of resources which you have available for future needs, the meshes of the sieve must be made as narrow as is necessary to confine the projects that pass through within those limits. And so, indeed, it becomes necessary for any particular business to pay for its capital interest at the market rate, not so much to secure the saving of it as to secure its allocation from the common pool.

§10. _Interest and Distribution_. It is unavoidable that this interest should accrue to whoever it is that supplies the capital. If the capital were supplied, as it might conceivably be, collectively by the community, the interest would accrue to the community, and all would be well. But as things are, the capital is supplied mainly by the savings of individuals, and largely by individuals confined to a relatively narrow class. The profits of Capital have thus a vital influence on the very serious matter of the distribution of wealth between social classes. Now, as experience shows, there is no element in profits which is capable of such radical change in so short a space of time, as is the rate of interest. Even before the war it had become hard for people in Great Britain to realize that 3 per cent Consols had stood at 114 as late as 1896. "How blest," wrote two cynical satirists of society in the same period:

"How blest the prudent man, the maiden pure, Whose income is both ample and secure, Arising from Consolidated Three Per cent Annuities, paid quarterly."[1]

It is impossible to read those lines now without a sense of irony, different from that which they were intended to convey.

Not only is the rate of interest now double what it was a generation ago; we have no good reason to suppose that the present high level will quickly be reduced. The havoc of the war, of which the widespread poverty of Europe and the huge debts of Governments are but two different aspects, makes it almost inevitable that the rate should rule high in the present decade. This cannot but exercise a profound influence, of a most disquieting character on the general level of profits, and to a lesser extent (for here we must allow for the effects of high taxation) on the distribution of real wealth between social classes. Here we are on the threshold of tremendous issues. We almost feel the earth quake beneath our feet. We hear the muffled roar of far-reaching social controversy:

"And 'mid this tumult Kubla heard from far Ancestral voices prophesying war."

[Footnote 1: _Narcissus_, by Samuel Butler and Henry Festing Jones.]

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