Saturday, February 16, 2013

Amount of Capital and Roundabout Ways of Production

Increase in production is not the only thing which causes the quantity of goods simultaneously present in an economy, the capital of the economy, to increase.
Capital can also increase when production methods become more capitalistic, more roundabout. We can illustrate our argument by returning to our comparison of the flow of goods over time with the flow of water in a river bed. If the river bed becomes wider it can contain more water than before. But the same happens also if the length of two successive river beds increases. The two streams will then overlap, as it were; the first will still be flowing when the second emerges. More water will be present simultaneously. In the same way, the goods simultaneously present in an economy must increase if production takes more time. Figure 10 illustrates this. If production takes twice as long as before, the goods previously ready for consumption at the end of Period I will now not be consumed until the end of Period II, and will therefore still be present in the economy during Period II when a new production process has already started.
The classical roundabout method of production is production by machines: a worker no longer works by hand or with a few tools, but with the help of a machine.
When a worker changes over to machine production, a new factor of production appears to have been introduced. This, however, is not the case. In the first place the machine itself consists of labor—in so far as it does not consist of raw material, which we disregard for the moment. In the second place, the machine does not really transform the worker's work. What happens is that his present work is added to the work already incorporated in the machine.
The labor incorporated in the machine differs, however, from the labor added in the current production period in that it is work done long before the current period, and that its result is normally not consumed during the immediately following production period but in a later one. On the average, the machine remains in the production process much longer. It is consumed only over long periods. During these periods the labor incorporated in the machines, together with the labor added in running the machines, goes over into the finished goods. Even if the worker can thus produce more quickly with the help of the machine than he could without it the entire production process lasts much longer. It starts not with the current work of the worker using the machine but with the production of the machine itself, and it ends not with the goods completed currently with the help of the machine but with the last goods which the machine is still able to turn out. Only when the machine ceases to be usable at all has the last of the original labor incorporated in it gone over into finished products. This is why production with more capital, with a strengthened—or, as is sometimes said, a deepened—capital structure, takes more time.

FIG. 10
How does an economy change from a less into a more capitalistic one; how does its capital structure deepen? If all the money the entrepreneurs borrow is spent by their workers on consumer goods there is, on our assumptions about their replacement needs, obviously no possibility for entrepreneurs to buy machines. But suppose the workers, or other factors of production who would in the ordinary course of events spend their income on consumption, decide to save and to put the savings at the disposal of the entrepreneurs: then the entrepreneurs would be able to buy capital goods with the money otherwise spent on consumption.
Once the economy has changed over to roundabout methods of production, no further additional saving is needed for their maintenance. The capital structure is deepened once and for all. For the finished goods into which the capital goods are ultimately converted are sold against money. And with this money the entrepreneurs are again able to repay their debts to the capitalists, who can then lend it to them again without recourse to new savings. Figure 11 shows this flow of money.
Needless to say, different goods require production detours of entirely different lengths. Productions taking detours of quite different lengths are therefore always present in an economy. The production detour of domestic help is very short. For the building of houses and skyscrapers the production detour is very long. But if the capital structure is deepened, every production detour lengthens, although not in the same proportion. The new vacuum cleaner used by domestic help, too, means a longer production detour.

FIG. 11
The deepening of the capital structure, the lengthening of production detours, lead to increased production not by the employment of more workers but by an increase in the productivity of the single worker. Work spent on building and then on using a machine yields technically higher results than work applied immediately to the production of the end product. It is more productive.
But the reason for this increased productivity is not that the services of a machine are essentially different from those of a worker. If the machines really performed different work, if they were a different factor of production, it would be impossible for the price of machines to coincide in the long run, as it does, with their cost price. They would sell at a premium. The reason for the increased productivity is that the results of the work embedded in the machine need be available for consumption only after a longer period, that production—or consumption—is allowed to take more time. This “being allowed to take more time” is really the second factor of production, capital—if labor is considered the first.
The entrepreneur who works with machines can repay the money he borrowed from capitalists for the purpose of production only after the amortization of the machines. Per unit of product he thus needs more credits than before the extension of production detours (cf. Figures 10 and 11). For the right to use credits, and thereby to be allowed to take more time—and not for the individual capital good—he has to pay a certain compensation calculated in percentage of the amount of the credits and according to their duration. It is called interest.

Common Sense Economics

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