Chapter 4: Free IncomeIndustry of the modern sort -- mechanical, specialised, standardised, drawn on a large scale -- is highly productive. When this industrial system of the new order is not hindered by outside control it will yield a very large net return of output over cost, -- counting cost in terms of man power and necessary consumption; so large, indeed, that the cost of what is necessarily consumed in productive work, in the way of materials, mechanical appliances, and subsistence of the workmen, is inconsiderable by comparison. The same thing may be described by saying that the necessary consumption of subsistence and industrial plant amounts to but an inconsiderable deduction from the gross output of industry at any time. So inordinately productive is this familiar new order of industry that in ordinary times it is forever in danger of running into excesses and turning out an output in excess of what the market -- that is to say the business situation -- will tolerate. There is constant danger of "overproduction," So that there is commonly a large volume of man power unemployed and an appreciable proportion of the industrial plant lying idle or half idle. It is quite unusual, perhaps altogether out of the question, to let all or nearly all the available plant and man power run at full capacity even for a limited time. It is, of course, impossible to say how large the net aggregate product over cost would be -- counting the product in percentages of the necessary cost -- in case this industrial system were allowed to work at full capacity and with free use of all the available technological knowledge. There is no safe ground for an estimate, for such a thing has never been tried, and no near approach to such a state of things is to be looked for under the existing circumstances of ownership and control. Even under the most favorable conditions of brisk times the business situation will not permit it. There will at least always be an indefinitely large allowance to be reckoned for work and substance expended on salesmanship, advertising, and competitive management designed to increase sales. This line of expenditures is a necessary part of businesslike management, although it contributes nothing to the output of goods, and in that sense it is to be counted as a necessary deduction from the net productive capacity of the industrial system as it runs. It would also be extremely difficult to make allowance for this deduction, since much of it is not recognised as such by the men in charge and does not appear on their books under any special descriptive heading. In one way and another, and for divers and various reasons, the net production of goods serviceable for human use falls considerably short of the gross output, and the gross output is always short of the productive capacity of the available plant and man power. Still, taken as it goes, with whatever handicap of these various kinds is to be allowed for, it remains patently true that the net product greatly exceeds the cost. So much so that whatever is required for the replacement of the material equipment consumed in production, plus "reasonable returns" on this equipment, commonly amounts to no more than a fraction of the total output. The resulting margin of excess product over cost plus reasonable returns on the material equipment is due to the high productive efficiency of the current state of the industrial arts and is the source of that free income which gives rise to intangible assets. The distinction between tangible assets and intangible is not a hard and fast one, of course, but the difference is sufficiently broad and sufficiently well understood for use in the present connection, so long as no pains is taken to confuse these terms with needless technical verbiage. To avoid debate and digression, it may be remarked that "reasonable returns" is also here used in the ordinary sense of the expression, without further definition, as being sufficiently understood and precise enough for the argument. The play of motives and transactions by which a rough common measure of reasonable returns has been arrived at is taken for granted. A detailed examination of all that matter would involve an extended digression, and nothing would be gained for the argument. According to the traditional view, which was handed on from the period before the coming of corporation finance, and which still stands over as an article of common belief in the certified economic theories, "capital" represents the material equipment, valued at its cost, together with funds in hand required as a "working capital" to provide materials and a labor force. On this view, corporation securities are taken to cover ownership of the plant and the needed working capital; and there has been a slow-dying prejudice against admitting that anything less tangible than these items should properly be included in the corporate capitalisation and made a basis on which to issue corporate securities. Hence that stubborn popular prejudice against "watered stock" which corporation finance had to contend with all through the latter half of the nineteenth century. "Watered stock" is now virtually a forgotten issue. Corporation finance has disposed of the quarrel by discontinuing the relevant facts. There is still a recognised distinction between tangible assets and intangible; but it has come to be recognised in corporation practice that the only reasonable basis of capitalisation for any assets, tangible or intangible, is the earning-capacity which they represent. And the amount of capital is a question of capitalisation of the available assets. So that, if the material equipment, e.g., is duly capitalised on its earning-capacity, any question as to its being "watered" is no longer worth pursuing; since stock can be said to be "watered" only by comparison with the cost of the assets which it covers, not in relation to its earning-capacity. The latter point is taken care of by the stock quotations of the market. On the other hand, intangible assets neither have now nor ever have had any other basis than capitalisation of earning capacity, and any question of "water" in their case is consequently quite idle. Intangible assets will not hold water. Corporation finance is one of the outgrowths of the New Order. And one of the effects wrought by corporation finance is a blurring of the distinction between tangible assets and intangible; inasmuch as both are now habitually determined by a capitalisation of earning-capacity, rather than by their ascertained cost, and it is difficult, if not impossible, to draw a hard and fast line between that part of a concern's earning-capacity which is properly to be assigned to its plant and that which is due to its control of the market. Still, an intelligible distinction is maintained in common usage, between tangible assets and intangible, even if the distinction is somewhat uncertain in detail; and such a distinction is convenient, so long as too sharp a contrast between the two is not insisted on. The earning-capacity of the tangible assets is presumed to represent the productive capacity of the plant, considered as a mechanical apparatus engaged in an industrial process for the production of goods or services; it is presumed to rest on the market value of the mechanical output of the plant. The plant is a productive factor because and in so far as it turns to practical account the state of the industrial arts now in use, -- the community's joint stock of technological knowledge. So soon, or so far, as the plant and its management falls short of meeting the ordinary requirements of this current state of the industrial arts, and fails to make use of such technological knowledge as is commonly employed, the whole works ceases by that much to be a productive factor. The productive efficiency, and the productive value, of any given item of industrial equipment is measured by its effective use of the technological knowledge current in the community for the time being. So also, the productive value of any given body of natural resources land, raw materials, motive power -- is strictly dependent on the degree in which it fits into the industrial system as it runs. This dependence of productive value on conformity to and use of the state of the industrial arts is constantly shown in the case of land and similar natural resources, by the fluctuation of rental values. Land and other resources will be more valuable the more suitable they are for present and prospective use. The like is true for the mechanical equipment, perhaps in a more pronounced degree. Industrial plant, e.g., is always liable to depreciation by obsolescence in case the state of the industrial arts changes in such a way that the method of work embodied in the particular article of equipment is displaced by new and more suitable methods, more suitable under the altered circumstances. In such a case, which is of very frequent occurrence under the new order of industry, any given plant, machine, or similar contrivance may lose all its value as a means of production. And so also, on the other hand, a given plant, as, for instance, a given railway system or dock, may acquire additional productive value through changes in the industrial system which make it more suitable for present use. Evidently the chief, or at least the indispensable, element of productive efficiency in any item of industrial equipment or resources is the use which it makes of the available technological knowledge; and evidently, too, its earning-capacity as a productive factor depends strictly on the same fact, -- the usufruct of the state of the industrial arts. And all the while the state of the industrial arts, which the industrial equipment so turns to account for the benefit of its owner, continues to be a joint stock of industrial knowledge and proficiency accumulated, held, exercised, increased and transmitted by the community at large; and all the while the owner of the equipment is some person who has contributed no more than his per-capita quota to this state of the industrial arts out of which his earnings arise. Indeed the chances are that the owner has contributed less than his per-capita quota, if anything, to that common fund of knowledge on the product of which he draws by virtue of his ownership, because he is likely to be fully occupied with other things, -- such things as lucrative business transactions, e.g., or the decent consumption of superfluities. And at this point the difference between tangible assets and intangible comes in sight, or at least the ground of the habitual distinction between the two. Tangible assets, it appears, are such assets as represent the earning-capacity of any mechanically productive property; whereas intangible assets represent assured income which can not be assigned to any specific material factor as its productive source. Intangible assets are the capitalised value of income not otherwise accounted for. Such income arises out of business relations rather than out of industry; it is derived from advantages of salesmanship, rather than from productive work; it represents no contribution to the output of goods and services, but only an effectual claim to a share in the "annual dividend," -- on grounds which appear to be legally honest, but which can not be stated in terms of mechanical cause and effect, or of productive efficiency, or indeed in any terms that involve notions of physical dimensions or of mechanical action. When the theoreticians explain and justify these returns that go to adroit salesmanship, or "managerial ability," as it is also called, it invariably turns but that the grounds assigned for it are of the nature of figures of speech -- metaphor or analogy. Not that these standard theoretical explanations are to be set aside as faulty, inadequate or incomplete; their great volume and sincerity forbids that. It is rather that they are to be accepted as a faithful account of an insubstantial fact in insubstantial terms. And they are probably as good an account of the equitable distribution of free income as the principles of the modern point of view will tolerate. But while intangible assets represent income which accrues out of certain immaterial relations between their owners and the industrial system, and while this income is accordingly not a return for mechanically productive work done, it still remains true, of course, that such income is drawn from the annual product of industry, and that its productive source is therefore the same as that of the returns on tangible assets. The material source of both is the same; and it is only that the basis on which the income is claimed is not the same for both. It is not a difference in respect of the ways and means by which they are created, but only in respect of the ways and means by which these two classes of income are intercepted and secured by the beneficiaries to whom they accrue. The returns on tangible assets are assumed to be a return for the productive use of the plant; returns on intangible assets are a return for the exercise of certain immaterial relations involved in the ownership and control of industry and trade. Best known by name among intangible assets is the ancient rubric of "good-will," technically so called; which has stood over from before the coming of the new order in business enterprise. This has long been considered the original type-form of intangible assets as a class. By ancient usage the term denotes a customary preferential advantage in trade; it is not designed to describe a body of benevolent sentiments. Good-will has long been known, discussed and allowed for as a legitimate, ordinary and valuable immaterial possession of men engaged in mercantile enterprise of all kinds. It has been held to be a product of exemplary courtesy and fair dealing with customers, due to turning out goods or services of an invariably sound quality and honest measure, and indeed due to the conspicuous practice of the ordinary Christian virtues, but chiefly to common honesty. Similarly valuable, and of a similarly immaterial nature, is the possession of a trade-secret, a trade-mark, a patent-right, a franchise, any statutory monopoly, or a monopoly secured by effectually cornering the supply or the market for any given line of goods or services. From any one of these a profitable advantage may be derived, and they have therefore a market value. They afford their possessor a preferential gain, as against his competitors or as against the general body of customers which the state of the industrial arts and the organisation of business throws in his way. After the analogy of good-will, it has been usual to trace any such special run of free income to the profitable use of a special advantage in the market, which is then appraised as a valuable means of gain and comes to figure as an asset of its possessor. But all this goes to explain how these benefits go to these beneficiaries; it does not account for the fact that there is produced a net output of product available for free distribution to these persons. These supernumerary and preferential gains, "excess profits," or whatever words may best describe this class of free income, may be well deserved by these beneficiaries, or they may not. The income in question is, in any case, not created by the good deserts of the beneficiaries, however meritorious their conduct may be. Honesty may conceivably be the best policy in mercantile pursuits, and it may also greatly serve the convenience of any community in which an honest merchant is found; yet honest dealing, strictly speaking, is an agency of conservation rather than of creation. A trade-secret may also be profitable to the concern which has the use of it, and the special process which it covers may be especially productive; but the same article of technological knowledge would doubtless contribute more to the total productivity of industry if it were shared freely by the industrial community at large. Such technological knowledge is an agency of production, but it is the monopoly of it that is profitable to its possessor as a special source of gain. The like applies to patent-rights, of course. Whereas monopolies of the usual kind, which control any given line of industry by charter, conspiracy, or combination of ownership, derive their special gains from their ability to restrain trade, limit the output of goods or services, and so "maintain prices." Intangible assets of this familiar kind are very common among the business concerns of the new order, particularly among the larger and more prosperous of them, and they afford a rough measure of the ability of these concerns profitably to restrict production. The very large aggregate value of such assets indicates how imperative it is for the conduct of industrial business under the new order to restrict output within reasonable limits, and at the same time how profitable it is to be able to prevent the excessively high productive capacity of modern industry from outrunning the needs of profitable business. For the prosperity of business it is necessary to keep the output within reasonable limits; that is to say, within such limits as will serve to maintain reasonably profitable prices; that is to say, such prices as will yield the largest obtainable net return to the concerns engaged in the business. In this connection, and under the existing conditions of investment and credit, "reasonable returns" means the same thing as "the largest practicable net returns." It all foots up to an application of the familiar principle of "charging what the traffic will bear"; for in the matter of profitable business there is no reasonable limit short of the maximum. In business, the best price is always good enough; but, so also, nothing short of the best price is good enough. Buy cheap and sell dear. Intangibles of this kind, which represent a "conscientious withdrawal of efficiency," an effectual control of the rate or volume of output, are altogether the most common of immaterial assets, and they make up altogether the largest class of intangibles and the most considerable body of immaterial wealth owned. Land values are of much the same nature as these corporate assets which represent capitalised restriction of output, in that the land values, too, rest mostly on the owner's ability to withhold his property from productive use, and so to drive a profitable bargain. Rent is also a case of charging what the traffic will bear; and rental values should properly be classed with these intangible assets of the larger corporations, which are due to their effectual control of the rate and volume of production. And apart from the rental values of land, which are also in the nature of monopoly values, it is doubtful if the total material wealth in any of the civilised countries will nearly equal the total amount of this immaterial wealth that is owned by the country's business men and the investors for whom they do business. Which evidently comes to much the same as saying that something more than one-half of the net product of the country's industry goes to those persons in whom the existing state of law and custom vests a plenary power to hinder production. It is doubtful if the total of this immaterial wealth exceeds the total material wealth in the advanced industrial countries; although it is at least highly probable that such is the case, particularly in the richer and more enlightened of these countries; as, e. g., in America or the United Kingdom, where the principles of self-help and free bargain have consistently had the benefit of a liberal -- that is a broad -- construction and an unbending application. The evidence in the case is not to be had in such unambiguous shape as to carry conviction, for the distinction between tangible assets and intangible is not consistently maintained or made a matter of record. So, e.g., it is not unusual to find that corporation bonds -- railroad or industrial -- which secure their owner a free income and are carried as an overhead charge by the corporation, are at the same time a lien on the corporation's real property; which in turn is likely to be of less value than the corporation's total liabilities. Evidently the case is sufficiently confusing, considered as a problem in the economic theory of capital, but it offers no particular difficulty when considered as a proposition in corporation finance. There is another curious question that will also have to be left as a moot question, in the absence of more specific information than that which is yet available; more a question of idle curiosity, perhaps, than of substantial consequence. How nearly is it likely that the total gains which accrue to these prosperous business concerns and their investors from their conscientious withdrawal of efficiency will equal the total loss suffered by the community as a whole from the incidental reduction of the output? Net production is kept down in order to get a profitable price for the output; but it is not certain whether the net production has to be lowered by as much or more than the resulting increased gain which this businesslike strategy brings to the businesslike strategists. The strategic curtailment of net production below productive capacity is net loss to the community as a whole, including both the business men and their customers; the gains which go to these business concerns in this way are net loss to the community as a whole, exclusive of the business concerns and their investors. The resulting question is, therefore, not whether the rest of the community loses as much as the business men gain, -- that goes without saying, since the gains of the business men in the case are paid over to them by the rest of the community in the enhanced (or maintained) price of the products, but rather it is a question whether the rest of the community, the common man, loses twice as much as the business concerns and their investors gain. The whole case has some analogy with the phenomena of blackmail, ransom, and any similar enterprise that aims to get something for nothing; although it is carefully to be noted that its analogy with these illegitimate forms of gainful enterprise must, of course, not be taken to cast any shadow of suspicion on the legitimacy of all the businesslike sabotage that underlies this immaterial corporate capital and its earning-capacity. In the case of blackmail, ransom, and such like illegal traffic in extortion, it is known that the net loss suffered by the loser and the gainer together exceeds the net gain which accrues to the beneficiary, by as much as the cost of enforcement plus the incidental inconvenience to both parties to the transaction. At the same time, the beneficiary's subsequent employment and consumption of his "ill-gotten gains," as they are sometimes called, whether he consumes them in riotous living or in the further pursuit of the same profitable line of traffic, -- all this, it is believed, does not in any degree benefit the rest of the community. As seen in the perspective of the common good, such enterprise in extortion is believed to be quite wastefully disserviceable. Now, this analogy may be taken for what it is worth; "Analogies do not run on all-fours." But when seen in the same perspective, the question of loss and gain involved in the case of these intangible assets and their earning-capacity falls into something like this shape: Does the total net loss suffered by the community at large, exclusive of the owners of these intangibles, exceed two-hundred percent of the returns which go to these owners? or, Do these intangibles cost the community more than twice what they are worth to the owners? -- the loss to the community being represented by the sum of the overhead burden carried on account of these intangibles plus the necessary curtailment of production involved in maintaining profitable prices. The overhead burden is paid out of the net annual production, after the net annual production has been reduced by so much as may be necessary to "maintain prices at a reasonably profitable figure." A few years ago any ordinarily observant person would doubtless have answered this question in the negative, probably without hesitation. So also, any ordinarily intelligent votary of the established order, as, e.g., a corporation lawyer, a commercial trade journal, or a trade-union official, would doubtless, at that period, have talked down such a question out of hand, as being fantastically preposterous. That would have been before the war experience began to throw light into the dark places of business enterprise as conducted under the new order of industry. Today (October, 1918) -- it is to be admitted with such emotion as may come to hand -- this question is one which can be entertained quite seriously, in the light of experience. In the recent past, as matters have stood up to the outbreak of the war, the ordinary rate of production in the essential industries under businesslike management has habitually and by deliberate contrivance fallen greatly short of productive capacity. This is an article of information which the experience of the war has shifted from the rubric of "Interesting if True" to that of "Common Notoriety." The question as to how much this "incapacity by advisement" has commonly amounted to may be attempted somewhat after this fashion. Today, under compulsion of patriotic devotion, fear, shame and bitter need, and under the unprecedentedly shrewd surveillance of public officers bent on maximum production, the great essential industries controlled by the vested interests may, one with another, be considered to approach -- perhaps even conceivably to exceed -- a fifty-percent efficiency; as counted on the basis of what should ordinarily be accomplished by use of an equally costly equipment having the disposal of an equally large and efficient labor force and equally good natural resources, in case the organisation were designed and managed with an eye single to turning out a serviceable product, instead of, as usual, being managed with an eye single to private gain in terms of price. To the spokesmen of "business as usual" this rating of current production under the pressure of war needs may seem extravagantly low; whereas, to the experts in industrial engineering, who are in the habit of arguing in terms of material cost and mechanical output, it will seem extravagantly high. Publicly, and concessively, this latter class will speak of a 25 percent efficiency; in private and confidentially they appear disposed to say that the rating should be nearer to 10 percent than 25. To avoid any appearance of an ungenerous bias, then, present actual production in these essential industries may be placed at something approaching 50 percent of what should be their normal productive capacity in the absence of a businesslike control looking to "reasonable profits." It is necessary at this point to call to mind that the state of the industrial arts under the new order is highly productive, -- beyond example. This state of the case, that production in the essential industries presumably does not exceed 50 percent of the normal productive capacity, even when driven under the jealous eye of public officers vested with power to act, is presumably due in great part to the fact that these officers, too, are capable business men; that their past training and present bent is such as has been given them by long, exacting and successful experience in the businesslike management of industry; that their horizon and perspective in all that concerns industry are limited by the frame of mind that is native to the countinghouse. They, too, have learned how to think of industry and its administration in terms of profit on investment, and, indeed, in no other terms; that being as near as their daily work has allowed them to take stock of the ways and means of industry. So that they are still guided, in some considerable part, by considerations of what is decent, equitable and prudent in the sight of conservative business men; and this bias necessarily goes with them in their dealings with those ubiquitous, intricate and systematic dislocations of the industrial system which have been found profitable in the management of industry on a footing of competitive sabotage. They still find it reasonable to avoid any derangement of those vested interests that live on this margin of intangible assets that represents capitalised withdrawal of efficiency. In so characterising the situation there is, of course, no inclination to impute blame to these businesslike officials who are patriotically giving their best abilities and endeavors to this work of enforcing an increased production in the essential industries and diverting needed labor and materials from the channels of waste; nor is it intended to cast aspersions on the good faith or the honorable motives of those grave captains of industry whom the officials find it so difficult to divert from the business man's straight and narrow path of charging what the traffic will bear. "They are all honorable men," But like other men they are creatures of habit; and their habit of mind is the outcome of experience in that class of large, responsible and remunerative business affairs that lie somewhat remote from the domain of technology, from that field where the mechanistic logic of the industrial arts has something to say. It is only that the situation as here spoken of rests on settled usage, and that the usage is such as the businesslike frame of mind is suited to; at the same time that this businesslike usage, of fixed charges, vested interests and reasonable profits, does not fully comport with the free swing of the industrial arts as they run under the new order of technology. Nor is there much chance of getting away from this situation of "incapacity by advisement," even under pressure of patriotic devotion, fear, shame and need, inasmuch as the effectual public opinion has learned the same bias and will scarcely entrust the conduct of its serious interests to any other than business men and business methods. To return to the argument. It may be conceded that production in the essential industries, under pressure of the war needs, rises to something like a 50 percent efficiency. At the same time it is presumably well within the mark to say that this current output in these essential industries will amount to something like twice their ordinary output in time of peace and business as usual, One-half of 50 percent is 25 percent; and so one comes in sight of the provisional conclusion that under ordinary conditions of businesslike management the habitual net production is fairly to be rated at something like one-fourth of the industrial community's productive capacity; presumably under that figure rather than over. In the absence of all reflection this crude estimate may seem recklessly hasty, perhaps it may even be thought scandalously unflattering to our substantial citizens who have the keeping of the community's material welfare; but a degree of observation and reflection will quickly ease any feeling of annoyance on that score. So, e.g., if the account as presented above does not appear to foot up to as much as the conclusion would seem to require, further account may be taken of that side-line of business enterprise that spends work and materials in an effort to increase the work to be done, and to increase the cost per unit of the increased work; all for the benefit of the earnings of the concern for whose profit it is arranged. It may be called to mind that there still are half-a-dozen railway passenger stations in such a town as Chicago, especially designed to work at cross purposes and hinder the traffic of competing railway corporations; that on the basis of this ingeniously contrived retardation of traffic there has been erected a highly prosperous monopoly in the transfer of baggage and passengers, employing a large equipment and labor force and costing the traveling public some millions of useless outlay yearly; with nothing better to show for it than delay, confusion, wear and tear, casualties and wrangles, twenty-four hours a day; and that this arrangement is, quite profitably, duplicated throughout the country as often and on as large a scale as there are towns in which to install it. So again, there is an exemplary weekly periodical of the most widely reputable and most profitable class, with a circulation of more than two million, which habitually carries some 60 to 80 large pages of competitive advertising matter, at a time when the most exacting economy of work and materials is a matter of urgent and acknowledged public need; with nothing better to show for it than an increased cost of all the goods advertised, most of which are superfluities. This, too, is only a typical case, duplicated by the thousand, as nearly as the businesslike management of the other magazines and newspapers can achieve the same result. These are familiar instances of business as usual under the new order of industry. They are neither extreme nor extraordinary. Indeed the whole business community is run through with enterprise of this kind so thoroughly that this may fairly be said to be the warp of the fabric. In effect, of course, it is an enterprise in subreption; but in point of moral sentiment and conscious motive it is nothing of the kind. All these intricate arrangements for doing those things that we ought not to have done and leaving undone those things that we ought to have done are by no means maliciously intended. They are only the ways and means of diverting a sufficient share of the annual product to the benefit of the legitimate beneficiaries, the kept classes. But this apparatus and procedure for capturing and dividing this share of the community's annual dividend is costly -- one is tempted to say unduly costly. It foots up to, perhaps, something like one-half of the work done, and it is occupied with taking over something like one-half of the output produced by the remaining one-half of the year's work. And yet, as a business proposition it seems sound enough, inasmuch as the income which it brings to the beneficiaries will presumably foot up to something like one-half of the country's annual production. There is nothing gained by finding fault with any of this businesslike enterprise that is bent on getting something for nothing, at any cost. After all, it is safe and sane business, sound and legitimate, and carried on blamelessly within the rules of the game, One may also dutifully believe that there is really no harm done, or at least that it might have been worse. It is reassuring to note that at least hitherto the burden of this overhead charge of 50 percent plus has not broken the back of the industrial community. It also serves to bring under a strong light the fact that the state of the industrial arts as it runs under the new order is highly productive, inordinately productive. And, finally, there should be some gain of serenity in realising how singularly consistent has been the run of economic law through the ages, and recalling, once more the reflection which John Stuart Mill arrived at some half-a-century ago, that, "Hitherto it is questionable if all the mechanical inventions yet made have lightened the day's toil of any human being."