§ 4. The interest of which we have been speaking, and which is the reward of waiting, is true or Net Net and Gross Interest; but what commonly passes by the interest. name of Interest, includes other elements besides this, and may be called Gross Interest.

includes some

a

These additional elements are the more important, the lower and more rudimentary the state of commercial Gross interest security and of the organization of credit. Thus, Insurance for instance, in mediæval times, when a prince gainst risk, wanted to forestall some of his future revenues, he borrowed perhaps a thousand ounces of silver, and undertook to pay back fifteen hundred at the end of a year. There was how

ever no perfect security that he would fulfil the promise; and perhaps the lender would have been willing to exchange that promise for an absolute certainty of receiving thirteen hundred at the end of the year. In that case, while the nominal rate at which the loan was made, was fifty per cent., the real rate was thirty.

agement.

The necessity for making this allowance for insurance against risk is so obvious, that it is not often and also Earnoverlooked. But it is less obvious that every ings of Manloan causes some trouble to the lender; that when, from the nature of the case, the loan involves considerable risk, a great deal of trouble has often to be taken to keep these risks as small as possible; and that then a great part of what appears to the borrower as interest, is, from the point of view of the lender, Earnings of Management of a troublesome business.

invested in the various trades is such that, if capitalized at 33 years' purchase (that is on the basis of interest at three per cent.), it would amount to some seven thousand million pounds. For the capital already invested in improving land and erecting buildings, and in making railways and machinery, has its value determined by the net income (or Quasi-rent) which it will produce: and if its prospective income-yielding power should diminish, its value would fall accordingly and would be the capitalized value of that smaller income after allowing for depreciation.

At the present time the net interest on capital in England is a little over three per cent. per annum; for no more than that can be obtained by investing in such first-rate Stock Exchange securities as yield to the owner a secure income without appreciable trouble or expense on his part. And when we find capable business men borrowing on perfectly secure mortgages, at (say) four per cent., we may regard that gross interest of four per cent. as consisting of net interest, or interest proper, to the extent of a little over three per cent., and of Earnings of Management by the lenders to the extent of rather less than one per cent.

Again, a pawnbroker's business involves next to no risk; but his loans are generally made at the rate of 25 per cent. per annum, or more; the greater part of which is really Earnings of Management of a troublesome business. Or to take a more extreme case, there are men in London and Paris and probably elsewhere, who make a living by lending money to costermongers: the money is often lent at the beginning of the day for the purchase of fruit, &c., and returned at the end of the day, when the sales are over, at a profit of ten per cent.; there is little risk in the trade, and the money is seldom lost. Now a farthing invested at ten per cent. a day would amount to a billion pounds at the end of a year. But no one can become rich by lending to costermongers; because no one can lend much in this way. The so-called interest on the loans really consists almost entirely of earnings of a kind of work for which few capitalists have a taste.

Further analy

§ 5. It is then necessary to analyse a little more carefully the extra risks which are introduced into sis of Gross in- business when much of the capital used in it has been borrowed. Let us suppose that two men are carrying on similar businesses, the one working with his own, the other chiefly with borrowed capital.

terest.

There is one set of risks which is common to both; which may be described as the TRADE RISKS of the particular

Trade Risks.

business in which they are engaged. They arise from fluctuations in the markets for their raw materials and finished goods, from unforeseen changes of fashion, from new inventions, from the incursion of new and powerful rivals into their respective neighbourhoods, and so on. But there is another set of risks, the burden of which has to be borne by the man working with borrowed capital, and not by the other; and we may call them PERSONAL RISKS. For he who lends capital to be used by Personal another for trade purposes, has to charge a high Risks. interest as insurance against the chances of some flaw or deficiency in the borrower's personal character or ability.

The price then that the borrower has to pay for the loan of capital, and which he regards as interest, is Gross interest from the point of view of the lender more does not tend properly to be regarded as profits: for it includes to equality. insurance against risks which are often very heavy, and Earnings of Management for the task, which is often very arduous, of keeping those risks as small as possible. Variations in the nature of these risks and of the task of management will of course occasion corresponding variations in the Gross interest, so called, that is paid for the use of money. The tendency of competition is therefore not towards equalizing this Gross interest: on the contrary, the more thoroughly lenders and borrowers understand their business, the more certainly will some classes of borrowers obtain loans at a lower rate than others.

We must defer to a later stage our study of the marvellously efficient organization of the modern Money Market by which capital is transferred from one place where it is superabundant to another where it is wanted; or from one trade that is in the process of contraction to another which is being expanded and at present we must be contented to take it for granted that a very small difference between the rates of Net interest to be got on the loan of capital in two different

modes of investment in the same Western country will cause capital to flow, though perhaps by indirect channels, from the one to the other1.

1 Up to this point Principles VI. vI. differs from the present Chapter chiefly in matters of detail and of secondary importance. But there follows some account of the misconceptions of the true nature of interest current in the Middle Ages, and of those which have led Marx and other socialists to regard interest as a thing unjust in itself. There is at the end of the Chapter a Note on the way in which rapid changes in the purchasing power of money make the real rate of interest very different from the nominal rate, and alternately enrich lenders at the expense of borrowers and vice versa.

CHAPTER VII.

DEMAND AND SUPPLY IN RELATION TO CAPITAL, BUSINESS POWER AND INDUSTRIAL ORGANIZATION.

§ 1. In the concluding Chapters of Book IV. we made some study of the various forms of business This Chapter management, and the faculties required for them; the latter part

in relation to

and we saw how the supply of business power in of Book IV. command of capital may be regarded as consisting of three elements, the supply of capital, the supply of the business power to manage it, and the supply of the organization by which the two are brought together and made effective for production'. We have now to carry this study further; and to inquire more closely into the nature of the services which the business undertaker renders to society, and the rewards of this work. We shall find that the causes which govern the earnings of business men are less arbitrary, and present closer analogies to those which govern other kinds of earnings than is commonly supposed.

Survival.

We must however make a distinction at starting. The Struggle for Survival tends to make those Action of the methods of organization prevail, which are best Struggle for fitted to thrive in their environment; but not necessarily those best fitted to benefit their environment, unless it happens that they are duly rewarded for all the benefits which they confer, whether direct or indirect. And in fact this is not so. For as a general rule the Law of Substitution—which is nothing more than a special and limited application of the Law of Survival of the Fittest-tends to 1 See Book IV. Ch. VIII.