Posts Tagged ‘capital formation’

A Note on Capital

March 9, 2014

Capital describes an opportunity for someone to consume a measure of goods now or in the future without having to expend labour. Assuming the goods to be consumed do not currently exist, labour will of course be expended to allow the opportunity to be taken. But this labour will be expended by others, to whom the capital under consideration will be distributed in order to elicit the goods.

So capital, in abstract terms, represents labour-time, namely the amount that must be expended to satisfy the opportunity to consume. Labour is the source of the only constraint on capital formation – it exerts the only fundamental cost on production – because, uniquely, human toil creates an additional subsistence need. Wages cannot fall below this margin of subsistence or else the labourer would not be able even to live.

The margin of subsistence must be capable of being met out of output or else the work is essentially non-productive. But workers may demand well in excess of this margin so as to save enough in anticipation of old age, when they will become decreasingly productive and eventually unable to work. Saving is precisely what motivates capital formation in the first place, and allows workers to create capital.

Whereas labour expended must consume part of its fruits, rent imposes no such constraint on capital formation: using the resources on which rent accrues does not imply additional consumption because land already exists, freely and in spite of human activity. It is this fact that actually defines rent, which is a key channel by which capital created is subsequently distributed.

It might appear that when high enough rent will constrain capital formation by leaving insufficient reward for the producer, thus removing the incentive to work. However this is a reversal of causality: rent does not constrain productivity but rather it is productivity that constrains rent. Far from being its nemesis, rent is a sign of productive opportunity: where land accrues no rent, this is because, at best, it scarcely yields enough to cover wages, and most likely is below the margin of cultivation dividing land that is in use from land that is idle.

By the same token, labour working on superior land does not automatically command higher wages, because rent absorbs any surplus over the margin of cultivation. This, Ricardo’s Law of Rent, is the consequence of competition over scarce resources (in this case location). As well as the significance of rent as a channel for distributing capital, this law is among the most important – and least prioritised – observations for economists. Socialising rights to rent, by taxing and remitting rent to all, is the only tool to combat poverty – and to democratise the use of capital.