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 lie foregoes this return and must he 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 tal 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.
Explanation of the phenomena of interest must be sought in the laws which make it possible for capital to produce a net return. A large number of theories have been advanced to explain the existence of net return to capital. (See POLITICAL Ecoxomv.) We may notice here th•ee 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 productivity theory, which lays emphasis upon the fact that capital represents an instrument which greatly increases the efficiency of labor, and therefore normally entitles its owner to a reward; and Cl) the exploitation, theory, 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 Iiiihm-Bawerk, who ex plains interest as a result of the universal under valuation of future goods as compared with pres ent goods. The productivity theory finds its for 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 take 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 high. the inducement to save is correspondingly great ; and consequently the supply of capital increases. With increase in supply 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.' BIBLIOGRAPHY. Bffism-Bawerk. Capital and inBibliography. Bffism-Bawerk. Capital and in- terest, translated by Smart (London, 1890) ; id., Positive Theory of Capital, translated by Smart (London, 1891) ; Marx, Capita?, trans lated (London, ISS7) : Clark. The Dist•ibution of 'Wealth (New York. 1599) ; Marshall, Principles of Economics (3d ed., London. 15951. Consult also the authorities referred to under CoNntacT; Ust-ay.