I got an email from a colleague (reprinted with permission):
Please settle a bet between me and [another colleague]. One of us maintains that without borrowing and lending, no interest rate could arise. The other of us takes the view that there is always time preference, and this guarantees an interest rate, even in the absence of borrowing and lending (for example, this option has not yet been discovered). Even in this case, one of us maintains, there will be a gap between what workers are paid for goods that are immediately sold, and what workers of equal productivity are paid for goods that don’t come onto the market for a year.
Before I jump in, I want to note that this writer is committed to objectivity; notice that he didn’t say, “I think X, but so-and-so thinks Y, who’s right?” Because then he would have biased me in favor of either the guy I like more, or the guy who is scarier.
But, I will in turn be crafty, and not simply choose which position I endorse. Rather, I will make a series of what I hope are true statements about the way economists should approach these issues, then I will let my colleagues determine who wins the bet.
(1) Economists often make a distinction between an actual market price in a transaction, versus a “hypothetical price” that we imagine must be the case in order to complete our model. For example, suppose we have a group of potential workers and potential employers, and that we know their preferences for leisure/wages and output/money. Every day we can compute what the market-clearing wage is. Now suppose that on a religious holiday, the market-clearing wage is $82/hour, at which price the total quantity supplied and demanded of labor is 0 hours. (Nobody wants to work on this very holy day, and the wage needs to be $82/hour in order to make no employer want to hire even a single hour of labor.) So it’s fine to academically say, “The wage is $82/hour even though no wages are paid,” but on the other hand, in the real world we would have no way of actually knowing that. We couldn’t actually observe what the wage was, so if someone said, “Nope, I don’t see any wages being paid today, so they don’t exist,” then that would be a perfectly defensible statement too.
(2) It is possible for people to earn what everybody would describe as “interest on their invested financial capital” even in situations without explicit lending at a contractual interest rate. For example, suppose it’s December 1 and people would pay $110 for a mature Christmas tree right now, but would only pay $100 for an airtight claim entitling them to delivery of a mature Christmas tree in a year. Furthermore, everyone expects (correctly) that this structure of market prices will be the same, a year from now. In equilibrium, this means that a capitalist could spend $100 today buying a Christmas-tree-that-needs-another-year-to-grow and then hold it for a year. (I’m neglecting any other expenses, including the opportunity cost of the land on which the tree grows.) After a year passes, he sells the mature tree for $110. In general this type of discounting will be applied to factors of production (including labor), and that’s how capitalists earn interest even when they don’t formally lend out a sum of money at a contractual interest rate. Indeed, this is what Bohm-Bawerk referred to as “originary interest” which he (and subsequent Austrians) thought of as more general than the specific offshoot of contractual loans. If you want to see more on this, read up on Bohm-Bawwerk’s masterful demolition of the socialist exploitation theory of interest.
(3) Ah but let me come back full circle: Austrians tend to argue that without money prices various things are metaphorical at best. For example we can vaguely talk about economic calculation in a barter world, but you really need explicit money prices for true accounting to take place. So that’s why I argue in my dissertation for a monetary (as opposed to a “real”) approach to interest theory, where ultimately the market rate of interest is “set” in the explicit, contractual loan market and then the implicit discounts (which also include risk) are adjusted in other intertemporal markets.