2.5.1-9: The Original Factors or Terms of Wealth Production

Module 2, Section 5.1-9

The Original Factors or Terms of Wealth Production


5.1 The classical economists originally used three major terms in the description of the factors of the production of wealth - Land, Labor, and Capital. The term “Land” was used in a broad sense to connote all natural opportunities or forces. “Labor” meant all human exertion applied to the production of wealth. “Capital” referred to all wealth used to produce more wealth – tangible items like tools and technologies. Capital was not the same as money, which as a symbol system was viewed as a convenient method of exchanging goods and services, more efficient than barter.

5.2 The output of production is distributed in returns to these three factors. Land rent is that part that goes to owners of land as payment for the use of natural opportunities. (Note: classical economists simply used the term “rent” which in this context ONLY refers to the return to the owner of land.) Wages are that part that constitutes the reward for human exertion. Interest is that part that constitutes the return for the use of capital (again, defined as wealth produced from labour on land used to produce more wealth, not money or “finance capital.”)

5.3 These terms mutually exclude each other. The income of any individual may be made up from any one, two, or all three of these sources. But to discover the laws of the distribution of wealth we must keep them separate.

The classical economists had a clear understanding of how and why land values increase as population increases and society develops. David Ricardo was the first to formulate the Law of Rent, building on ideas of those who preceded him. He wrote that, when an economy is growing, “rent is not only absolutely increasing, but that it is also increasing in its ratio to the capital employed on the land.”

Adam Smith and Henry George asserted that gains in land value/rent, generated by the efforts of the community as a whole, should be captured for the benefit of the community as a whole. George, in his book Progress and Poverty, explained how the failure to capture increase in land values for public benefits eventually and inevitably results in significant market distortion, severe maldistribution of wealth, and numerous social problems.

Neo-liberal economists eliminated land as one of the three factors of production, subsuming it into capital. They base their arguments on only two factors, labor and capital. Their variety of economics also discarded important concepts about what happens to land values as market economies progress along with the understanding of the root causes of the wealth divide. (For more information on this topic see The Corruption of Economics by Mason Gaffney and Fred Harrison.)

5.4 The error of so-called “neoclassical economics” has now been clearly revealed and can be traced to an erroneous viewpoint. It is this flaw that is preventing the neoclassical economics model from solving the problem of poverty alongside progress.

5.5 We live in a society where capitalists hire labor. They thus seem to be the initiators or first movers in production. Neoclassical economists look to capital as the prime factor in production. They see land as its instrument, and labor as its agent or tool. This viewpoint is in the form and course of their reasoning, in the character of their illustrations, and even in their choice of terms. Everywhere capital is the starting point, and the capitalist the central figure.

5.6 Although Adam Smith clearly defined the three factors of production as Land, Labour, and Capital, he later adopted the view that Capital employs Labour. Yet Smith retained a fundamental understanding of the Law of Rent. He said: Every improvement in the circumstances of society tends either directly or indirectly to raise the real rent of land, to increase the wealth of the landlord. (Wealth of Nations, Book I, p. 275). This part of Smith's economic thought is rarely mentioned. For more quotes from economists who had some understanding of the Land Problem and the Law of Rent please go to Quotes at the top of the course website and click on the Economists section. For more on the problem of how neoclassical economics obscures the issue of land and natural resource rights read this paper which formed the basis for the aforementioned Corruption of Economics. http://homepage.ntlworld.com/janusg/coe/!index.htm.

5.7 When we consider the origin and natural sequence of things, we see that capital does not come first, it comes last. Capital as “wealth used to produce more wealth” is not the employer of labor -- it is, in reality, produced by labor, both mental and physical labour, beginning with labour on land and natural resources.

5.8 There must be land before labor can be exerted. And labor must be exerted before capital can be produced. Capital is a result of labor, a form of labor, a subdivision of the general term. It is only stored-up labor, used by labor to assist in further production. Labor is the active and initial force. Therefore, labor is the employer of capital, not vice versa -- and it is even possible for labor to produce wealth directly from raw materials without being aided by capital.

5.9 So the natural order is this: Land, Labor and Capitol. Instead of using Capital as our initial point, we should start from Land.