The Georgist View of Capital and Interest

by Lindy Davies

Henry George’s theory of capital and interest in Book III, Chapter 3 of Progress and Poverty has long troubled many of his followers. What are we to make of George’s theory of interest today?

Arthur Madsen went as far as omitting the discussion of the cause of interest from his 1953 abridgment (which is still in print) [1]. The Madsen abridgment minimized the distinction between labor and capital as economic factors. This served to emphasize George’s statement that “in truth, the primary division of wealth in distribution is dual, not tripartite.”

Despite the way this sounds out of context, however, George never held that labor and capital are equivalent. He was making the point that wealth distribution is “dual” only in the sense that the returns to labor and capital rise and fall together relative to rent. Nevertheless, this discomfort with George’s views on capital and interest, exemplified by Madsen’s deletion, seems to have contributed to a sense among Georgists that the difference between labor and capital is a fundamentally unimportant “fine point”. Mason Gaffney has shown that this misconception can lead to serious policy errors [2]. Workers suffer if capital is down-taxed at the expense of labor — and Georgists seem irrelevant if they are blind to this fact. Gaffney says that “the tax code is now loaded with biases that favor the use of capital and penalize the use of labor, thus trumping market forces that would to the opposite” — and that the standard Georgist campaign to down-tax buildings does nothing to address this.

George’s Theory

George takes exception to the long-established idea that interest is a reward for abstinence, for “abstinence in itself produces nothing…. If I have a sum of money which I lock up for a year, I have exercised as much abstinence as though I had loaned it.” He did not think that having the capital now, as opposed to getting it later, is sufficient as a cause of interest. In the famous example of the plane and the plank (adapted from Bastiat), George sets up a situation in which time-preference is the only advantage to be gained from a particular piece of capital. A woodcutter, who can produce ten planks per week, faces the decision of whether to borrow a plane, which takes one week to make, and will be worn out at the end of the year. The user of the plane must either abstain from work for one week at the beginning of the year to make a new plane, or for one week at the end of the year to replace a worn-out borrowed one. George reasons that if all capital were like the plane in his example, there would be no reason for interest to be paid. The only advantage would be if the plane were the result of the maker’s superior skill, which is outside of the given conditions.

In reality, though, it’s hard to imagine how that could possibly be. Where did William find the blade for his plane? Was he born knowing how to make one? The very fact that William finds a plane worth owning indicates that it embodies more skill and learning than he can bring to bear without it. It would be a very primitive economy indeed in which every item of capital could be made equally well by each worker. Even a tool as simple as a stone arrowhead requires practice and skill, and very soon, skilled arrow-makers would be advantageously trading their products for the things they desire.

George observes that some forms of capital increase in value of their own accord — with the input of labor, usually, but not due to it — because of the re-productive forces of nature (or because of the analogous differences in natural endowment that lead to greater demand for some products in other places). We can plant seeds in a field, and if we cultivate that field properly, nature will yield a crop. Of course, in order to care for the growing crop, we need shovels and hoes — things that do not grow by themselves, and actually wear out with use. No one would supply those tools if they could not get paid a comparable rate to what they could get if their capital were held in the form of seeds, which are capable of increase.

Capital in different forms yields different benefits. But, because 1) capital is fungible — its value can be turned into capital in any other form; and 2) capital wouldn’t yield the higher rates if some capital weren’t put to use in lower-rate supportive functions like shovels and hoes, competition will tend to ensure that capital gets paid the same marginal rate regardless of what form it’s in. But, capital cannot be used unless there is land to put it on. The general rate of interest will equal the return to capital in its most productive form at the margin of production — the best available rent-free land. Greater capital yields on better lands will go toward rent for access to those better sites.

Brown’s Gentle Correction

Georgist economist Harry Gunnison Brown tackled this issue in a 1948 article in the Henry George News. [3] He agreed that George’s theory of interest was suspect, and he believed that

A correct theory of the causation of interest sharpens the distinction between land and capital and the distinction between land rent and the interest yielded by capital. It therefore makes for a more effective and convincing presentation of the land-value-tax argument. It clarifies the contrast between the philosophy of socialism and that of a sane and self-consistent capitalism.

Brown began by observing that people are better off when they produce wealth by means of a “roundabout process”. Instead of seeking individual self-sufficiency, we make the things we’re best-suited to make — and we endeavor to produce more than we consume. “We must wait for the capital to yield its net return and, indeed, we must wait even for it to yield back its cost,” Brown writes. Saving is essential to our enjoying the benefits of this interdependent, roundabout process.

According to Brown, Henry George’s tale of the plane and the plank ignores the fact that if James is going to spend a week making a plane, he must have something to live on during that week. He can’t eat planks, or wear them, but he can exchange them for the things he needs. But not so with his plane. He has to forego what he could get in exchange for it. If he’s not willing or able to save, then he must pay interest to obtain the present advantage of using a plane.

Brown sees no special importance in the capacity of some capital to increase in value because of the reproductive forces of nature. Like purely mechanical capital (such as planes), time must be spent in creating the finished product. Saving is the essential element. If the producer consumes the product once it is finished, there is none of it left to be used as capital. The most advantageous form in which to cast one’s capital depends on many factors. It could be to take advantage of natural forces. It could be the profit to be gained from selling your product in a place where it cannot be produced locally. It could represent the stored-up knowledge of many years of technological refinement.4 Or, it could just be that even though hand shovels have none of those advantages, people still need hand shovels, and are willing to pay for them.

Coming to Terms

As so often happens in the wacky world of political economy, this discussion has often been complicated by confusion over definitions. The main issue here is that “interest” tends to signify, both in general conversation and modern economics, the payment for borrowing money. Borrowed money can be spent on capital, but it can also buy land, labor or lottery tickets. Money is not the same thing as wealth, so it creates confusion to use the term “interest” to mean the return to capital. Fred Foldvary, in his interesting Georgist/Austrian text The Science of Economics, [5] insists on substituting the term “capital yield” for what Henry George calls “economic interest”, and he makes a good case for its being descriptive and unambiguous.

A straight swap might be an OK idea, but Foldvary’s logic goes a bit further; he implies that the return to capital (wealth that is used in production) really has nothing to do with interest (the return to borrowed money). His reasoning is that interest is simply a payment for time preference — whereas capital yield must include an allowance for capital’s inevitable depreciation. Foldvary says that interest could be rent, or wages, or “capital yield”, depending on which factor(s) one bought with the borrowed money. This opens the question of whether the provision of money is itself a separate economic factor. Henry George would seem to deny that, but among his followers the “money question” is a perennial hot topic. Fred Foldvary, an advocate of free banking, would seem to class seigniorage (to the extent that it isn’t monopolized) as a legitimate return to entrepreneurship. Henry George, on the other hand, along with modern-day reformers like Stephen Zarlenga, sees money (once society reaches a sufficient stage of complexity) as a public good, a natural monopoly whose profit must accrue to the whole community.

Actually Henry George had already dealt with most of these questions. The issue of the payment for capital’s depreciation is a red herring. Whatever the basic cause of interest, it is clear that capital must receive a payment over and above depreciation (a point which George makes); if it didn’t, savers would just put money in banks and never invest in physical capital. Furthermore, George was well aware that lots of borrowed money isn’t used to purchase capital goods; his brief chapter “Of Spurious Capital and Profits Often Mistaken for Interest” [6] has great relevance today.

Although borrowed money isn’t always spent on capital, borrowed capital is almost always gotten in the form of money. There are many different rates of interest for various ways of borrowing money, just as there are many wage rates for different jobs. But we know that wages are ultimately determined by the return to labor at the margin. The same is true of interest (by which we mean “economic interest”, as George puts it, or “capital yield”). So, while it is certainly true that money is not the same thing as capital, money is exchangeable for capital, and the rate of interest at which one borrows money (the marginal rate, minus any premium for convenience, privilege or risk) is the rate at which one borrows capital.

This implies that the marginal return to capital, like the marginal return to labor, will be quite low if there are no viable places where workers can use capital, without paying rent.

Modern readers are apt to think this sounds old-fashioned, pastoral. “Where is this free land today?” they ask. This question should not rattle us! The margin of production is not gone, in this day and age. It is there; its effect on wealth distribution is as profound as ever it was. Where is it? Why, exactly where land speculation and deadweight losses from taxation have lodged it: at zero. And competition drives the wages of unskilled workers, or the interest of risk-averse savers, down to the lowest point that they will accept.

Not That Simple?

One prominent modern writer on these issues, Michael Hudson, insists that the three-factor scheme of wealth distribution is archaic because the FIRE sector (Finance, Insurace and Real Estate), which is set up primarily to manage (and hide from democratic scrutiny) modern society’s vast rental income, operates by complex rules of its own that are not elucidated by 19th-century pie charts. His research shows that the flow of rental income goes mostly to mortgage lenders, along with huge amounts of interest. Individual home-buyers are willing to endure this because they expect to enjoy a “capital gain”, eventually selling their land at its appreciated value (and in the meantime, many home-owners imprudently take advantage of land-price bubbles by borrowing against their home equity). It’s not just controlling the rent that makes the financial industry so powerful, Hudson says, it’s the rent plus the interest on loans used for buying land. Therefore, Hudson claims, it’s folly to try to describe modern-day wealth distribution using the old three-factor model, because it ignores the FIRE sector’s pivotal role. Unless they acknowledge this, Georgists will gain no political traction, for the experts will dismiss them as being stuck in a bygone paradigm.

Hudson applied his thesis in a feature article in the May, 2006 issue of Harper’s magazine. This was seen by many as a breakthrough for Georgist analysis (the Schalkenbach Foundation offers that issue in their catalogue). However, the article, titled “The New Road to Serfdom: An Illustrated Guide to the Coming Real Estate Collapse”, is problematic as a Georgist rallying cry because it offers no solutions. It explains the mechanism of land-bubble borrowing, shows how it could lead to deep recession and debt-bondage for many millions, and concludes, essentially, that we’re screwed. By offering no path out of the impending crisis, Hudson implies that none exists, that society is proceeding to slide off the dialectical cliff that ineluctably awaits it. This seems paradoxical. The main thing that Georgists yearn to do is to demonstrate the relevance of the Georgist remedy to modern problems. Hudson insists that to succeed in doing so we must factor in the role of the financial system. Yet when he had a chance to do just that in a prestigious national forum, he said not a word about public collection of land rent. Perhaps Hudson tried to, and the editors of Harper’s excised it. If so, that would expose a major story behind the housing-bubble tale, one worth shouting from rooftops. If that is indeed what happened, we await Michael Hudson’s account of it.

The Cart, and the Horse

Today’s economy is complex indeed. Market behavior is fabulously nuanced; conflicting incentives fly about, banging into people, firms and each other like a bazillion cosmic rays. This has been the case for a long time. Henry George saw no hope of understanding economic relationships well enough to efficiently subject them to central planning; he said that would be like “asking the carpenter who can build a chicken-house to build a chicken also.” Nevertheless, “building a chicken” — or a least a minimally functional robo-chicken — is just what much of modern-day economics attempts to do. Acceptance of mind-bending complexity is the starting point of most economic analysis. It seems to me that there is a clear theoretical reason for this. It stems from the postulate that there are no — and can never be any — natural laws of the distribution of wealth. If there is no basis in either equity or efficiency for determining what is private or public property, it means, to paraphrase the Bush administration, that “no option is off the table.” Every economic opportunity involves a trade-off, all economic rights are conditional, and there is never, ever, a free lunch. This state of affairs provides a veritable smorgasbord of opportunities for creative obfuscation.

Henry George was passionately committed to shutting down the obfuscators. To him, it was vital to understand that political economy, of all sciences the one that deals most vitally with the day-to-day realities of life, can be grasped by ordinary thinking people, without special training. I offered this image in my afterword to The Science of Political Economy: [7]

Natural opportunities are functionally different from wealth, and can be clearly identified as such…. Let’s imagine factor payments as three colors that get mixed together in the gross receipts of a firm: land is green, labor is red and capital is blue. Mixed together, they become brownish-gray. It’s awfully hard to get any of the original colors out. But before they get mixed, Georgist policy calls for the land portion to be taken — while it is still green — and then the entrepreneur’s profit can be appropriately purple.

The basic Georgist policy proposal focuses on a key piece of data that is not mired in the brownish-gray area where Michael Hudson toils: the rental value of land, at its highest and best use, independent of improvements. This is a value that the real estate industry regularly calculates; indeed, appraisers compete to do so with the highest accuracy. We propose to collect that value for public revenue, and to dispense with other taxes. What aspect of economic relationships would not be more transparent and comprehensible, if society were to collect the rent of land, before private individuals and corporations got hold of it and cooked it by a million different recipes? We need not depend on cabalistic runes in the national income accounts to show that eliminating taxes on wages and commerce, and doing away with land speculation, would do society a world of good.

“How we get there from here” is, of course, less easy. The classic Georgist proposal fails to address one of the big problems to which Hudson’s work alerts us. If the community were to collect enough land rent to reduce, or even eliminate, land prices, home-owners would feel the pain, because they would have borrowed large sums of money to buy an asset whose value we were in the process of seizing. This is a consequence of the ubiquitous, but highly unwise practice of loaning money with which to buy an unproductive, speculative asset such as land.

Mason Gaffney suggests that we address this problem by moving to eliminate loans for buying land. [8] He advocates the “English banking school” position, in which the bulk of loans are self-liquidating “commercial paper”, used for such things as business inventory and plant expansion. One way to move in this direction would be to start adding mortgages to the property tax base. The tax would be passed on to homebuyers in the form of higher interest rates, making mortgages less attractive compared with other loans — thus moving the banking system to a more stable, less speculative footing. These financial moves would be part of a coordinated, real-world campaign to bring about the Georgist remedy at the national level. As land prices started falling (due to public collection of rent), there would be less demand for mortgage loans — and, what people lost in land-value gains would be returned to them in income and sales taxes they didn’t have to pay.

Grasping the intricacies of modern FIRE sector can help us hold our own in high-level conversations. But we need no such exotic expertise to show that the financial system would function much differently — and much better — in a Georgist economy. Far from hindering us in making that point, the three-factor scheme of production and distribution is still the clearest, most illustrative tool in our kit.

Henry George’s theory of interest may need a bit of work — but that should not tempt us to accept lots of other ” modern corrections” to Georgist political economy. This is the view to which Harry Gunnison Brown came after offering his gentle corrections to Henry George’s theory of the causation of interest. Brown was happy to conclude that once we substitute a correct theory for George’s flawed one,

…we find we have not at all weakened the case for the public appropriation of the annual rental value of land, to the promotion of which Henry George devoted so much of eloquence and logic during so many years of his life. On the contrary, we thus make our case clearer, more sharply defined and more persuasive than before.


1. Progress and Poverty, Madsen Abridged Edition, RSF, 1998
2. “The Danger of Favoring Capital over Labor”, Georgist Journal #100, Spring ’04
3. “Henry George and the Causation of Interest”, School of Cooperative Individualism
4. Mike Curtis, personal correspondence
5. Fred Foldvary, The Science of Economics
6. Progress and Poverty, (original edition), Book III, Chapter 4
7. The Science of Political Economy, Abridged Edition, RSF, 2004
8. “Money, Credit and Crisis”, Georgist Journal #105, Autumn, ’06

4 thoughts on “The Georgist View of Capital and Interest

  1. If one carefully reads the unabridged version of Progress and Poverty, one observes a peculiar thing. HG disclaims all possible reasons for there being a return to the owners of capital merely because they own it. Then bang, almost as if he was shying away from his own conclusion, possibly out of fear of the possible political implications, he drops in the stuff about “the reproductive powers of nature”. To me this looks like a last minute throw-in! Philosophically there is an argument for the reproductive powers of nature being classed as land.

    • Thanks, Sue — that’s a very interesting comment. My sense of it is that capital is due a return for whatever non-monopolistic reason that it gets a return in the market, and the “reproductive modes” bit is one such reason. Even if it’s a calf naturally growing into a cow, that still requires an input of labor from the farmer, and thus counts as capital, which is *always* a product of labor. So I don’t think it would make sense to class that as land.

  2. Thanks Lindy, There are some parts of P&P that were for me clear as day from the very first reading, other parts that slowly fall into place with time and yet others that, no matter how many times read – never quite seem to make sense. It was in reading those three chapters for the umpteenth time and still losing the will to live in the mire of Bastiat (and George’s) planks and planes, in the far-fetched claim that all interest arises from ‘reproductive forces’ and in his rationale that the ‘natural equilibrium’ between the returns to capital and labour. Even switching from Kindle to the new annotated copy didn’t help!
    Hence a quick Google search that landed me here.
    And though I didn’t find answers, at least I find myself in highly esteemed company in not finding this aspect of George as straightforward and convincing as what I consider to be his more essential principles.
    As much as I dislike abridged versions of anything, maybe Madsen had a point?!

    • Interesting, Gareth. I prefer to simplify this as much as I can. Seems to me that Georg was very close to being right about the fructification theory: in that that is one case in which capital can increase. It can also increase in other ways, such as in its being worth more in some other place.

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