Two types of risk affect the volume of investment which have not
commonly been distinguished, but which it is important to
distinguish. The first is the entrepreneur's or borrower's risk and
arises out of doubts in his own mind as to the probability of his
actually earning the prospective yield for which he hopes. If a man
is venturing his own money, this is the only risk which is
relevant.
But where a system of borrowing and lending exists, by which I
mean the ranting of loans with a margin of real or personal
security, a second type of risk is relevant which we may call the
lender's risk. This may be due either to moral hazard, i.e.
voluntary default or other means of escape, possibly lawful, from
the fulfilment of the obligation, or to the possible insufficiency
of the margin of security, i.e. involuntary default due to the
disappointment of expectation. A third source of risk might be
added, namely, a possible adverse change in the value of the
monetary standard which renders a money-loan to this extent less
secure than a real asset; though all or most of this should be
already reflected, and therefore absorbed, in the price of durable
real assets.
Now the first type of risk is, in a sense, a real social cost,
though susceptible to diminution by averaging as well as by an
increased accuracy of foresight. The second, however, is a pure
addition to the cost of investment which would not exist if the
borrower and lender were the same person. Moreover, it involves in
part a duplication of a proportion of the entrepreneur's risk,
which is added twice to the pure rate of interest to give
the minimum prospective yield which will induce the investment. For
if a venture is a risky one, the borrower will require a wider
margin between his expectation of yield and the rate of interest at
which he will think it worth his while to borrow; whilst the very
same reason will lead the lender to require a wider margin between
what he charges and the pure rate of interest in order to induce
him to lend (except where the borrower is so strong and wealthy
that he is in a position to offer an exceptional margin of
security). The hope of a very favourable outcome, which may balance
the risk in the mind of the borrower, is not available to solace
the lender.
This duplication of allowance for a portion of the risk has not
hitherto been emphasised, so far as I am aware; but it may be
important in certain circumstances. During a boom the popular
estimation of the magnitude of both these risks, both borrower's
risk and lender's risk, is apt to become unusually and imprudently
low.
The schedule of the marginal efficiency of capital is of
fundamental importance because it is mainly through this factor
(much more than through the rate of interest) that the expectation
of the future influences the present. The mistake of regarding the
marginal efficiency of capital primarily in terms of the
current yield of capital equipment, which would be correct
only in the static state where there is no changing future to
influence the present, has had the result of breaking the
theoretical link between to-day and to-morrow. Even the rate of
interest is, virtually, a current phenomenon; and if we
reduce the marginal efficiency of capital to the same status, we
cut ourselves off from taking any direct account of the influence
of the future in our analysis of the existing equilibrium.
The fact that the assumptions of the static state often underlie
present-day economic theory, imports into it a large element of
unreality. But the introduction of the concepts of user cost and of
the marginal efficiency of capital, as defined above, will have the
effect, I think, of bringing it back to reality, whilst reducing to
a minimum the necessary degree of adaptation.
It is by reason of the existence of durable equipment that the
economic future is linked to the present. It is, therefore,
consonant with, and agreeable to, our broad principles of thought,
that the expectation of the future should affect the present
through the demand price for durable equipment.