Question

Compare and contrast E. Bohm-Bawerk’s and J.B. Clark’s theories of interest.

Answer 1

Theory of Interest # 1. Productivity Theory of Interest:

This theory of Interest was expounded by J. B. Clark and F. H. Knight. Further Marshall, J. B. Say, Von-Thunen supported this theory.

According to this theory interest arises on account of the productivity of capital.

The amount that labour produces with the help of capital goods is generally larger than the amount it can produce when working by itself. Machinery and tools invariably add to the income of those that use them. That is why they are demanded by individual employers.

Further some classical economists hold that Interest is the reward paid to capital because it is productive. In fact, Interest is paid out of the productivity of capital. When more amount of capital is employed along with labour and other resources, the over-all productivity improves.

By employing capital the borrower (entrepreneur) obtains higher production, he ought to pay a part of this additional production to the owner of capital in the form of Interest. The theory implies that capital is demanded because it is productive. And, because is productive its price, i.e., Interest must be paid.

Its Criticisms:

The important criticisms of this theory are as follows:

i. This theory is one sided:

Economists have called this theory as one-sided. It is half-truth, because it is related only to the demand aspect of capital and it completely ignores the supply side. If, however, the supply of capital is abundant, then, however great the capital productivity may be, the question of Interest will not arise, or at-least, Interest will be only normal.

ii. Considers only the higher productivity of capital:

Next, this theory suggests that when productivity of capital is higher, Interest is payable. On the contrary if capital is in short supply, greater will be the relative scarcity and higher will be the rate of Interest.

iii. Productivity of Capital Varies:

Again, productivity of capital varies in different industries and in different trades. This means that Interest rates should differ from industry to industry. However, the fact is that the pure Interest rate will be the same throughout the market and the borrower may borrow capital for any use.

iv. Difficult to measure the exact productivity:

It is difficult to measure the exact productivity of capital, as capital cannot produce anything without the help of labour and other factors.

v. How much interest for consumption loans?

This theory fails to explain the Interest paid for consumption loans. Because in practice we find that interest-bearing loans are also made for consumption purposes.

Theory of Interest # 2. The Austrian or Agio Theory of Interest or Bohm-Bawerk’s “The Time- Preference Theory”:

John Rae expounded this theory in the year 1834. Further, Bohm Bawerk developed this theory in an elaborate way. Bohm-Bawerk, an Austrian economist, is the main exponent of this theory which seeks to explain Interest on the basis of time-preference.

According to this theory, Interest is the price of time of reward for agio, i.e., time preference. It has been argued that man generally prefers present income to a future income and consumption. There is an ‘agio’ or premium on present consumption as compared to a future one.

People prefer enjoyment of present goods to future goods because future satisfaction, when viewed from the present, undergoes a discount. Interest is this discount, which must be paid in order to induce people to lend money and thereby to postpone present satisfaction to a future date. Thus, Interest is the reward made for inducing people to change their time-preference from the present to the future.

According to Bohm-Bawerk, the positive time-preference of people may be attributed to the following reasons:

a. As compared to the future or remote wants, present wants are more intensely felt by the people.

b. Future wants are often under-estimated by people on account of various factors like lack of will power to resist temptation, deficiency of imagination, uncertainty about future as to whether they will be able to enjoy etc.

c. Present goods seem to have a technical superiority over future goods in a capitalist method of production because the present goods can be invested and re-invested immediately. Because of the higher productivity of capital, thus, more goods can be accrued in the immediate future while the future goods can be invested and re-invested in the remote future only.

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