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_-_Explanations_and_Theories_001.jpg) The mere plethora of opinions attempting to explain the
existence of interest and justify its payment—accompanied by the credible
critiques of all of these views by noted and respected economists
—should be a sign to everyone that something is not quite right. In the
history of economic thought, one can find the following theories justifying
interest (among others):
(1) The “Colorless” Theories (as Boehm-Bawerk
calls them): These were advanced by Adam Smith, Ricardo and other early
economists. This theory has many flaws, including confusing interest with
gross profit on capital. Ricardo further traced all value of capital back to
labor—but somehow he failed to note that it was never labor that was receiving
the payment for said value.
(2) The Abstinence Theories: These kinds of
theories have popped up every now and then. Economists discovered that “abstinence”
may not be a good word to use and would
often change it to other terms, such as “waiting” (a la Marshall). Interest
is, in essence, the wage one receives for “waiting” or “abstaining” from
immediate consumption. This theory failed because it seems to think that
savings are solely a function of interest, which has been found not to be true.
(3) Productivity Theories: The proponents of this
theory see productivity as being inherent in capital and therefore interest is
simply the payment for that productivity. The theory, as put forward by Say,
assumes that capital produces surplus value but, again, there is no proof to
support that claim. The most that one can claim is that some value has been
created, which is a payment to capital, but one cannot prove that excess or
surplus value has been created, which is the essence of their claim that
interest is justified. Of course, these theories also complete ignore the
monetary factors when analyzing interest.
(4) Use Theories: “Boehm rejected the validity of
the assumption that there was beside each capital good a ‘use’ thereof
which was an independent economic good possessing independent value. He
further emphasized that ‘in the first place, there simply is no such thing
as an independent use of capital,’ and, consequently, it can not have
independent value, nor by its participation give rise to the ‘phenomenon
of excess value.’ To assume such a use is to create an unwarrantable
fiction that contravenes all fact.”
(5) Remuneration Theories: This group of
economists sees interest as the remuneration of “labor performed” by the
capitalist. Although supported by English, French and German economists, perhaps
this view needs no comment.
(6) The Eclectic (combination of earlier theories,
such as Productivity and Abstinence) Theories: Afzal-ur-Rahman writes:
This line of thought seems to reveal a symptom of
dissatisfaction with the doctrine of interest as presented
and discussed by the economists of the past and the present. And, as
no single theory on the subject is in itself considered
satisfactory, people have tried to find a combination of elements from
several theories in order to find a satisfactory solution of the problem.
(7) Modern Fructification Theory: Henry George was
the developer of this theory but it never carried enough weight to have many,
if any, followers.
(8) Modified Abstinence Theory: Yet another unique
theory, proposed by Schellwien; it never had much impact.
(9) The Austrian Theory (The Agio
or Time-Preference Theory): This is the view that Boehm-Bawerk himself
endorses. According to this theory, interest arises “from a difference in
value between present and future goods.” Cassel has critiqued this theory in
detail. It boils down to being a fancy “waiting” theory.
(10) Monetary Theories (the Loanable Funds
Theory, the Liquidity Preference Theory, the Stocks and Flows Theory, the Assets-Preference
Approach): More recently, economists have tried to introduce and emphasize the
influence of monetary factors into the issue of interest. In reality, though,
the emphasis here begins to be switched from why interest is paid to what
determines the prevailing rate of interest. “According to Robertson, interest
in liquidity preference theory is reduced to nothing more than a risk-premium
against fluctuations about which we are not certain. It leaves
interest suspended, so to speak in a void, there being interest
because there is interest.” Similar
critiques have been made of the other views in this family of theories.
(11) Exploitation theory: Incidentally,
socialist economists have always considered interest as nothing but
exploitation. It should be recalled that the “founding fathers” of capitalist
theory, Adam Smith and Ricardo, believed that the source of all value is nothing
but labor. If that is true, then all payments should be made to labor and
interest is nothing but exploitation.
In a couple of places, Afzal-ur-Rahman has provided
excellent conclusions concerning these different theories of interest. He
stated:
A critical
study of the historical development of the phenomenon of interest
has shown that interest is paid to an independent factor of production,
which may be called either waiting or postponement or abstinence
or use etc. But all these theories have failed to answer or to prove as
to why interest is paid or should be paid to this factor. Some point to
the necessity of waiting; others to the necessity of abstinence of
postponement; but none of these explanations answer the question. Neither
mere necessity of waiting or postponement or abstinence nor mere use
or productivity of capital is enough to prove that interest is a necessary
payment for the employment of capital in production. Besides, these
theories have failed to answer how a variable factor can
possibly determine a fixed factor like the rate of interest? How could
such a theory be valid or tenable?
Later he writes:
The monetary
theories, like marginal productivity theories, have made no attempt to
answer the question: why should interest be paid? Or why interest is
paid? They have simply ignored this question and have sought refuge in
the theory of value. They say, like all other things, the price of
capital is determined by the demand for and supply of money. But it seems
that they have forgotten the basic difference between the two problems;
the theory of value is a problem of exchange, while theory of interest is
a problem of distribution. Both loanable funds and liquidity preference
theories are basically supply and demand theories of interest and explain it
with reference to supply of and demand for loanable funds and money
respectively. But they do not give any justification for the phenomenon
of interest. Even if capital has a right to proper compensation as a
reward for its contribution to the creation of wealth, “it can only draw
its share from the increase of national wealth only to the extent of its
contribution to it. It cannot be allowed to run away with its pound of
flesh, determined in advance, and unrelated to the actualities
of production.” According
to Boehm Bawerk, the study of all these theories” reveals the development of
three essentially divergent basic conceptions of the interest problem.” One
group, the representatives of the productivity theory, treats the
interest problem as a problem of production. The socialist-exponents
of the exploitation theories treat the interest problem as purely a problem of distribution;
while the third group, the supporters of the monetary theories, seeks in
the theory of interest, the problem of value. There is no doubt that all these
theorists, having been confused by the very magnanimity and pervasiveness of
the phenomenon of interest, have avoided the main issue as to why interest
should be paid? They have, indeed, spent all their energies in solving
the problem either of waiting or abstinence or productivity or “labour
value” or “the determination of value” and have not said anything about
the origin or the justification of the institution of interest.
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