Page:The New International Encyclopædia 1st ed. v. 10.djvu/785

* INTEREST. 697 INTEREST. rate of interest is charged. In France the legal rate is 5 per cent., but more may be demanded by contract. The usual nietliod of calculating interest is to compute it on the principal sum originally due for the period which has elapsed at the time of computation, but by agreement compound interest may be allowed; that is. the arrears of interest for each year are added to the principal sum, and interest for the fcjllowing jear is computed on this accumulation, and so on, thus giving the investor interest upon interest. It is customary to compute interest in this manner upon deposits in savings iiistitutions. In popular usage, interest is the payment made by a borrower for the use of a sum of wealth for a definite |)eriod of time; it is expressed as the ratio which that payment bears to the value of the wealth loaned — the 'principal.' In economic theory the term interest is used in a bro.ader sense, and signifies the return for the use of capi- tal, whether the employment of capital is made directly by its owner or by another person to whom it has been loaned. In the latter instance it appears as a sum paid by the borrower over and above the amount received in loan. It is calculated at a cert«ain percentage of the capital to be paid annually. Economists distinguish from interest that part of the gross product which is necessary to re])lace the original capital, and the extra return to capital which appears in enterprises involving risk of loss, as well as chance gains and the abnormal return due to superior management. The last three forms of income are usually classed under the head of profits (q.v.). Loan or contract interest may be paid for ' wealth for immediate consumption as well as for wealth which is employed as capital. In the earlier stages of industrial development, when little capital was used, loans normally assumed the former character. Jloney was loaned to those persons who were in temporary distress, or to spendthrifts who desired to an- ticipate future revenues. In either case the repayment of the principal was a hardship, and the additional payment of interest, usually cal- culated at a high rate because of uncertainty of repayment or because of the necessities of the borrower, was peculiaily vexatious. For these reasons the taking of interest was generally con- demned by public sentiment, and frequently pe- nalized by legislators. (See U.SVRY.) This was the case in ancient and mediaeval nations ; and much the same attitude survives in backward comnmnities of the present day. With the de- velopment of capitalistic production, the gain to the borrower who invests the wealth borrowed in productive enterprise became so obvious that the opposition to int^-rest declined, and no longer exists among business men. In competitive industry there is a close con- nection between loan interest and the return to capital. It is obvious that the explanation of loan interest lies in the fact that had the owner of the capital employed it himself he could have secured a return from its use. When he turns it over to. some one else he foregoes this return and must be compensated for it. It is immaterial whether the lender would have used his capital in productive enterprise or whether the borrower does so. The fact that it might be so used estab- lishes a claim for compensation. Such an explana- tion does not make it clear why the owner of capi- t;il secures a return for its use, but admitting that in the present economic order he does so, it explains why the borrower pays interest upon a loan. It also serves to indicate certain limits upon the rates of interest under normal circum- stances. Lenders cannot demand more, nor can borrowers expect to pay less than the return normally expected from the employment of capi- tal in productive industry. Kxplanation of the phenomena of interest must be sought in the laws which make it possible for capital to produce a net return. -V large number of theories have been advanced to exjilain the existence of net return to capital. (See Political Economy.) We may notice here three theories which have attained the largest following: (1) The abstinence theory, which re- gards interest as a reward for the abstinence which the capitalist exercises in employing his wealth for productive purposes instead of con- suming it unproductively ; (2) the produvticily theory, which lays emphasis upon the fact that capital represents an instrument which greatly increases the elticiency of labor, and therefore normally entitles its owner to a reward; and (i) the exploitation Xheory, which regards labor as the sole source of wealth, the income known as interest being merely a tribute to the capitalists who hold a monopoly of the opportunities for ■ employment. In recent economics a variety of the abstinence theory has gained a large following under the leadership of Professor Biihm-Bawcrk, who e.- plains interest as a result of the universal under- valuation of future goods a.s compared with pres- ent goods. The productivity theory finds its fore- most champion in Prof. .J. B. Clark. In his view, capital, as a limited agent capable of in- creasing the output of industry, is productive in the same sense in which labor is productive; and the measure of this productivity is the loss to industry which would result if the least impor- tant portion of capital were withdrawn. In explaining the laws which govern interest, Prof. Alfred Marshall and his followers tike a posi- tion midway between the productivity and ab- stinence schools. The rate of interest depends upon the relations between the demand and the supply of capital. The demand for capital varies with the opportunity for its productive employ- ment; the supply varies with the readiness of individuals to postpone consumption to a future date. If productivity is liigh, the inducement to save is correspondingly great ; and consequently the supply of capital increases. With increase in suiqily of capital, its productivity declines, until no reason exists for further creation of capital. The rate of interest, therefore, tends to become fixed at the point where the productivity of capital is just sufficient to compensate those who save for the disadvantages which attend the postponing of consumption, or 'waiting.' Bii5i.Tooi!.pnv. Bc'ihm-Bawerk. Capilal <inii In- terest, translated by Smart (London, 1890); id.. Positive Theory of Capital, translated by Smart (London. 1891); JIarx. Capital, trans- lated (London, 1SS7) : Clark. The Distribution of AVeaJth (New York. 1809) ; ilarshall. Principles of Economics (^d ed.. London, 1895). Consult also the authorities referred to under Contbact; UsiRY.