http://www.anti-state.com/murphy/murphy10.htmlToward A Libertarian Theory Of Interest
by Bob Murphy
A lot of people probably wonder why I, brilliant graduate student in economics at a prestigious university, would associate with Internet bad boy Jeremy Sapienza, who many consider the Samuel Adams of market anarchism. Such cynics fail to realize that, once you get past the vulgarity, Sapienza is one sharp fella.
His recent article, “Toward a Non-Academic Theory of Interest,” showcases Sapienza’s analytical prowess, not to mention his commonsense approach that eschews the jargon and artificial sophistication of more renowned “thinkers.” The present essay will follow-up on Jeremy’s thoughts. (Since I’m an “academic,” I obviously had to use a different title.)
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Sapienza starts out with a reasonable request:
- ne thing I have never understood is the popular hatred of the concept of interest. Not only is it decried as a crime against humanity by the Left, it has been maligned by some on the Right, such as Lysander Spooner and Benjamin Tucker. What is it about interest that rubs so many people the wrong way?
That’s not rhetorical: please tell me.
Without mentioning particular authors, I can safely summarize two main reasons for the historical hatred of interest. The most common suspicion derives from a Marxist exploitation approach. Just as the employer is thought to wring “surplus value” out of his underpaid laborers in order to turn a profit, so too is the greedy capitalist thought to exploit those to whom he lends money. A vulgar materialist view holds that only those who work with their hands are actually “producing” value; in short, the “workers” are entitled to the full product of their labor. If you look at the world this way, then of course it is natural to see capitalists as lazy parasites who contribute nothing of value to the productive process; they don’t actually work, they just lend out their “sterile” money and literally get paid for doing nothing.
A more sophisticated view (perhaps the one shared by the thinkers on the Right, though I cannot say) holds that interest is undesirable because it stifles production. There are certain projects that can be undertaken if the rate of interest should fall below a certain threshold. (This is why the Fed is urged to lower interest rates during recessions.) If only we were to abolish interest altogether, the thinking goes, then all sorts of new businesses would be rendered profitable, increasing output and employment and making everyone (except perhaps the parasitic capitalists) better off.
Of course, the fallacy behind this view is that it considers interest to be an “artificial” cost. Primitive Marxists thought the need to make a profit also hindered social welfare. After all, think of how many children’s shoes could be produced, if only the factory owners weren’t worried about the bottom line!
Such a stance ignores the fact of scarcity. The resources that would be channeled into increased shoe production for children would necessarily be taken out of different industries, so that fewer of those goods could be produced.
And it is the same with interest payments. At any time, there is only a limited supply of savings available for investment. Even if we ignore the fact that this pool of savings might drop without interest payments, there would still remain the problem of how to allocate it among competing industries. There is no way to legislate utopia, not even a ban on interest payments.
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The great Austrian economist Eugen von Böhm-Bawerk made lasting contributions to capital and interest theory. He started his investigations with the simple question: Why should the interest rate remain positive? Unlike the exploitation theorists, Böhm-Bawerk wasn’t motivated for reasons of social justice; he was simply curious.
After all, in a competitive market, profit margins are eventually eroded away. If it only costs $100 to make a product, after a while we expect to see the product selling for (close to) $100. So why is it, Böhm-Bawerk asked, that someone can invest $100 today in a project that will earn (say) $110 next year? Why doesn’t the current price of a machine (say) get bid up by capitalists to the full value of the products it is expected to produce in the future?
Böhm-Bawerk’s answer was that present goods are preferred to future goods. To put it succinctly, $110 today is not the same thing as $110 available next year. So just because something will sell for $110 next year doesn’t mean people would be willing to pay that much now for the right to it, and in fact we expect them (for various reasons that I won’t go into) to offer less for it. If they are only willing to pay $100 now for it, that is equivalent to a 10% rate of interest.
Böhm-Bawerk’s approach spawned both the modern neoclassical treatment of interest, as well as the Austrian School’s “pure time preference theory” of interest. Although different in many respects, both theories acknowledge that interest payments correspond to a “real” cost or sacrifice. The fact that people prefer to consume sooner rather than later means that the time aspect of production cannot be ignored, yet it is precisely this that the opponents of interest fail to understand.
By abolishing interest payments, yes, entrepreneurs would find their cost structure greatly lowered, and they could embark on all sorts of grandiose projects. But because they would no longer be penalized (by the invested capital rolling over at interest) for the duration of their projects, the entrepreneurs would make people wait “too long” for consumer goods.
In short, both the neoclassical and Austrian theories serve to “justify” the payment of interest by demonstrating the harm to consumer welfare that would occur if interest payments were abolished.
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Sapienza, however, takes a refreshingly different approach. (Disclaimer: I am a harsh critic of both the neoclassical and Austrian theories, and so naturally am sympathetic to alternative treatments.) Rather than give a consequentialist defense of interest, he turns the issue into a simple matter of property rights:
If I have $10,000…and you want it, why should I give it to you? I’m definitely not a nice guy…so you can bet I want to get paid for my service. You are renting my money, and I have every right to expect to be thanked for my loan with cash.
It is amazing how controversial this simple statement is in the present morass of interest theory. For example, in Human Action Mises goes to great lengths to explode every commonsensical approach to interest;
he says it is not a price, that it is not paid for the services of capital, etc.
But of course interest is a price. The fact that it is expressed as a percentage is merely a convenient shortcut. If the rate of interest is 10%, that just means it costs $10 for every $100 you want to rent for one year. In other words,
Interest = $10 / $100 / year = 10% / year.
Indeed, it is quite useful to view interest as the price for renting money. It has always surprised me that even the Austrians, known for their appreciation of the non-neutrality of money, have chosen to view interest as a “real phenomenon” and divorced it entirely from the problem of money.
But this is a mistake, in my view. Interest rates are fundamentally bound up with money. If we want to focus on the time aspect, we may say that interest is the exchange rate between present and future dollars, not present and future “goods,” a gross aggregation of disparate commodities that should make Austrian economists shudder.
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If we follow Sapienza’s insight, all of the confusions in capital and interest theory—which has been called the black hole of economics—fall away. There is no mystery behind interest payments. The future is uncertain, and in most cases, present dollars can perform all of the same functions as future dollars, and then some. (I.e. you can simply hold a present dollar, and it becomes a future dollar.) To ask someone for a loan is to ask him to (temporarily) part with his property, and he should be paid accordingly.
January 27, 2002
