A Note on Interest

Accumulating capital involves retention of an opportunity to consume in exchange for which surplus labour – labour whose subsistence needs are already funded – can be deployed as finance. Without finance being provided, any return on investment would not be realised, and this therefore confronts us with the following questions: how much of this gain is owed to holders of capital as interest, and what governs this?

In essence, a saver holding capital can provide finance by pledging a relatively liquid asset (typically money) in exchange for a relatively illiquid one (such as a receivable or equity). The shift from liquidity to illiquidity implies a cost measured by the delay (or the risk of economic loss on liquidation) that must be endured by the financier before being able to consume goods and services. This is offset by the gross gains made by the saver’s transaction counterparty, the investor, realised as greater future output.

Investing surplus labour means that consumption (principally workers’ subsistence) has been funded in advance of completion of the works. However, the full wages of labour still need to be paid (the consumption component owing to the provider of finance, which is thus repaid “at par”). Rent must also be discharged in full. The only basis for any excess remaining as a net investment return would be to cover interest charged by the provider of finance in satisfaction of the saver’s “time preference” for immediacy (liquidity).

In certain circumstances, the pure opportunity cost of deferred consumption may be zero, and if this could somehow sustain zero interest rates there would be no return on capital – allowing wages (including for intellectual property) and rent to absorb all the gains. (As intellectual property is diffused, rents take the lion’s share of gains; the biggest beneficiaries of antitrust laws are landlords.)

But savers do not just face a delay on consumption; in parallel, they face an opportunity cost measured as wages foregone by not investing in their own productivity. Zero interest rates would therefore imply an expectation of zero income gains to be made from investing (or else a monopoly on the expertise needed to achieve such gains).

Whereas for non-savers, surplus labour would need to be expended in raising productivity, savers already have the resources (surplus labour) with which to purchase equipment and thereafter enjoy higher wages (at least than would otherwise be the case). Accordingly, if the saver is instead to finance investment undertaken by someone else, in addition to receiving back par he should expect compensation for the loss of wages over the same period. This is a component of time preference and therefore interest.

Provided its fruits are not hoarded as goods – which would dampen aggregate consumption in proportion – but instead exchanged for the opportunity to consume (ie for capital in the form of debt, equity, rental receivables or money), surplus labour can be used to finance investment. Interest plays an essential role in this exchange, without which investment would be curtailed to the detriment of all.

Interest does not impinge upon the funds drawn on to pay wages. This is because wages (for generalised labour ie not “protected” by patented intellectual property) are constantly squeezed down towards the margin of cultivation, the socially-determined minimum return needed – after payment of rent – before labour will be supplied. The return on capital must, therefore, come out of what would otherwise have been drawn as rent. This exerts a stabilising influence on rents: in times of euphoria, higher interest offsets higher output; and vice versa.

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