The Investment And Distribution Of Resources

§ 1. The first difficulty to be cleared up in our study of normal values, is the nature of the motives which govern the investment of resources for a distant return.

We watch the action of a person who neither buys what he wants nor sells what he makes, but works on his own behalf; and who therefore balances the efforts and sacrifices which he makes on the one hand against the pleasures which he expects to derive from their fruit on the other, without the intervention of any money payments at all.

Let us then take the case of a man who builds a house for himself on land, and of materials, which nature supplies gratis; and who makes his implements as he goes, the labour of making them being counted as part of the labour of building the house. He would have to estimate the efforts required for building on any proposed plan; and to allow almost instinctively an amount increasing in geometrical proportion (a sort of compound interest) for the period that would elapse between each effort and the time when the house would be ready for his use. The utility of the house to him when finished would have to compensate him not only for the efforts, but for the waitings22 .

If the two motives, one deterring, the other impelling, seemed equally balanced, he would be on the margin of doubt. Probably the gain would much more than outweigh the “real” cost with regard to some part of the house. But as he turned over more and more ambitious plans, he would at last find the advantages of any further extension balanced by the efforts and waitings required for making it; and that extension of the building would be on the outer limit, or margin of profitableness of the investment of his capital.

There would probably be several ways of building parts of the house; some parts for instance might almost equally well be built of wood or of rough stones: the investment of capital on each plan for each part of the accommodation would be compared with the advantages offered thereby, and each would be pushed forward till the outer limit or margin of profitableness had been reached. Thus there would be a great many margins of profitableness: one corresponding to each kind of plan on which each kind of accommodation might be provided.

§ 2. This illustration may serve to keep before us the way in which the efforts and sacrifices which are the real cost of production of a thing, underlie the expenses which are its money cost. But, as has just been remarked, the modern business man commonly takes the payments which he has to make, whether for wages or raw material, as he finds them; without staying to inquire how far they are an accurate measure of the efforts and sacrifices to which they correspond. His expenditure is generally made piece-meal; and the longer he expects to wait for the fruit of any outlay, the richer must that fruit be in order to compensate him. The anticipated fruit may not be certain; and in that case he will have to allow for the risk of failure. After making that allowance, the fruit of the outlay must be expected to exceed the outlay itself by an amount which, independently of his own remuneration, increases at compound interest in proportion to the time of waiting23 . Under this head are to be entered the heavy expenses, direct and indirect, which every business must incur in building up its connection.

For brevity we may speak of any element of outlay (allowance being made for the remuneration of the undertaker himself) when increased by compound interest in this way, as accumulated; just as we used the term discounted to represent the present value of a future gratification. Each element of outlay has then to be accumulated for the time which will elapse between its being incurred and its bearing fruit; and the aggregate of these accumulated elements is the total outlay involved in the enterprise. The balance between efforts and the satisfactions resulting from them may be made up to any day that is found convenient. But whatever day is chosen, one simple rule must be followed:—Every element whether an effort or a satisfaction, which dates from a time anterior to that day, must have compound interest for the interval accumulated upon it: and every element, which dates from a time posterior to that day, must have compound interest for the interval discounted from it. If the day be anterior to the beginning of the enterprise, then every element must be discounted. But if, as is usual in such cases, the day be that when the efforts are finished, and the house is ready for use; then the efforts must carry compound interest up to that day, and the satisfactions must all be discounted back to that day.

Waiting is an element of cost as truly as effort is, and it is entered in the cost when accumulated: it is therefore of course not counted separately. Similarly, on the converse side, whatever money or command over satisfaction “comes in” at any time is part of the income of that time: if the time is before the day for which accounts are balanced up, then it must be accumulated up to that day; if after, it must be discounted back. If, instead of being converted to immediate enjoyment, it is used as a stored up source of future income, that later income must not be counted as an additional return to the investment24 .

If the enterprise were, say, to dig out a dock-basin on a contract, the payment for which would be made without fail when the work was finished; and if the plant used in the work might be taken to be worn out in the process, and valueless at the end of it; then the enterprise would be just remunerative if this aggregate of outlays, accumulated up to the period of payment, were just equal to that payment. But, as a rule, the proceeds of the sales come in gradually; and we must suppose a balance-sheet struck, looking both backwards and forwards. Looking backwards we should sum up the net outlays, and add in accumulated compound interest on each element of outlay. Looking forwards we should sum up all net incomings, and from the value of each subtract compound interest for the period during which it would be deferred. The aggregate of the net incomings so discounted would be balanced against the aggregate of the accumulated outlays: and if the two were just equal, the business would be just remunerative. In calculating the outgoings the head of the business must reckon in the value of his own work25 .

§ 3. At the beginning of his undertaking, and at every successive stage, the alert business man strives so to modify his arrangements as to obtain better results with a given expenditure, or equal results with a less expenditure. In other words, he ceaselessly applies the principle of substitution, with the purpose of increasing his profits; and, in so doing, he seldom fails to increase the total efficiency of work, the total power over nature which man derives from organization and knowledge.

Every locality has incidents of its own which affect in various ways the methods of arrangement of every class of business that is carried on in it: and even in the same place and the same trade no two persons pursuing the same aims will adopt exactly the same routes. The tendency to variation is a chief cause of progress; and the abler are the undertakers in any trade the greater will this tendency be. In some trades, as for instance cotton-spinning, the possible variations are confined within narrow limits; no one can hold his own at all who does not use machinery, and very nearly the latest machinery, for every part of the work. But in others, as for instance in some branches of the wood and metal trades, in farming, and in shopkeeping, there can be great variations. For instance, of two manufacturers in the same trade, one will perhaps have a larger wages bill and the other heavier charges on account of machinery: of two retail dealers one will have a larger capital locked up in stock and the other will spend more on advertisements and other means of building up the immaterial capital of a profitable trade connection. And in minor details the variations are numberless.

Each man’s actions are influenced by his special opportunities and resources, as well as by his temperament and his associations: but each, taking account of his own means, will push the investment of capital in his business in each several direction until what appears in his judgment to be the outer limit, or margin, of profitableness is reached; that is, until there seems to him no good reason for thinking that the gains resulting from any further investment in that particular direction would compensate him for his outlay. The margin of profitableness, even in regard to one and the same branch or sub-branch of industry, is not to be regarded as a mere point on any one fixed line of possible investment; but as a boundary line of irregular shape cutting one after another every possible line of investment.