Capital and Finance

Theory and History

Peter Lewin, Nicolás Cachanosky

• Publisher: Routledge
• Year: 2020
• ISBN:
  9780429631696
• Edition: 1
• Topic: Économie
• Subtopic: Politique monétaire

This book applies finance to the field of capital theory. While financial economics is a well-established field of study, the specific application of finance to capital theory remains unexplored. It is the first book to comprehensively study this financial application, which also includes modern financial tools such as Economic Value Added (EVA®).

A financial application to the problem of the average period of production includes two discussions that unfold naturally from this application. The first one relates to the dual meaning of capital, one as a monetary fund and the other one as physical (capital) goods. The second concerns its implications for business-cycle theories. This second topic (1) provides a solid financial microeconomic foundation for business cycles and, also (2) makes it easy to compare different business-cycle theories across the average period of production dimension. By clarifying the obscure concept of average period of production, the authors make it easier to analyze the similarities with and differences from other business-cycle theories.

By connecting finance with capital theory, they provide a new point of view and analysis of the long-standing problems in capital theory as well as other related topics such as the use of neoclassical production functions and theorizing about business cycles. Finally, they emphasize that the relevance of their application rests on both its policy implications and its contributions to contemporary economic theory.

Part I

Capital, production, and time

Capital (I am not the first to discover) is a very large subject, with many aspects; wherever one starts, it is hard to bring more than a few of them into view. It is just as if one were making pictures of a building; though it is the same building, it looks quite different from different angles. As I now realize, I have been walking round my subject, taking different views of it.

(Hicks, 1973a, p. v)

The difficulties attached to capital theory are related to the fact that capital has three “dimensions,” namely, value, quantity (physical goods and services) and time. These interact in any decision involving the concept of capital. The history of capital theory has focused at different times on each of these three aspects of capital. At all times all three dimensions of capital are part of its nature, what changes is what is the focus of the foreground and what is operating implicitly or less-noticeably in the background.

In Part I we survey certain relevant aspects of capital theory combining the financial and economic approach to the subject that serves to seamlessly integrate all three dimensions of capital. This framework will be used throughout the book.

Chapter 1

Capital, income, and the time-value of money

Capital and income

Ideas matter

Our ideas define how we act and how we interpret and analyze the world. Action is defined by its purpose. The thought of how to go from here to our end (the purpose) is defined by our ideas. The nature of our thoughts greatly influences the acts we take and the outcomes that result. Moreover, the ability to think in a particular way may be crucial to the achievement of particular results. The ability to conceptualize in particular ways depends not only on our intelligence and our level of education. It depends also, crucially, on the institutional environment in which we think and act.

This is probably most clear in the case of thinking in order to calculate, that is, calculating in terms of some metric or set of metrics, calculating what the outcome of particular actions will or might be. Calculating implies the ability to quantify and compare in order to mentally (subjectively) weigh the alternative actions that one is able to take. Since possible outcomes from our course of action lie in the future, they are expected outcomes. Such expectations can vary across individuals. The expected outcomes that each individual foresees will be weighed and compared according to the individual’s subjective preferences. This mental ability to perform these calculations, facilitated also by the legal and social environment in which we exist, is of monumental significance, and this is no more true than in the area of capital and finance, which is the subject of this book.

The ability to calculate capital-values is essential to the making of financial investment decisions, without which no modern economy could exist. Capital-value is the result of expectation and calculation, which is contingent on the ideas we have of what capital is and is not. We will see that the question of what capital is, is more important, and more elusive than is usually assumed in most formal treatments of the subject. In addition, the problem of properly defining capital has significant implications in economic theory.

Assets and liabilities, income, and expenditure

We shall use an understanding of capital that is consistent with the following definition by Ludwig von Mises:

Capital is the sum of the money equivalent of all assets minus the sum of the money equivalent of all liabilities as dedicated at a definite date to the conduct of the operations of a definite business unit. It does not matter in what these assets may consist, whether they are pieces of land, buildings, equipment, tools, goods of any kind, and order, claims, receivables, cash, or whatever.

(Mises, 1949, p. 262, italics added. See also Braun [2017], and Braun, Lewin, and Cachanosky [2016])

This definition uses familiar concepts of accounting and finance such as double-entry bookkeeping and, implicitly, the difference between stocks, and flows. Recorded transactions can be traced to their effects on accumulated values of the resources owned by the business firm (assets) and the sums owed by the firms that are payable in the future (liabilities). These accumulated values are stocks. The difference between the value of the assets and liabilities is the equity, sometimes referred to as capital, and what Mises is referring to in the quote above. The equity is measuring the value that belongs to the owners of the firm. However, and this is where Mises’s approach may need some further explication, capital should be understood as a reference to the use of any means of production rather than to its ownership. The ownership of said means of production does not define the nature of their use. If the owner of a firm owns a tool and decides to sell it and then rent it back, such tool does not cease to be capital because there is a change in ownership. The expectation of the ability to continue using that tool in the earning of revenue will figure into the producer/entrepreneur’s calculation of the profitability of the firm. The tool remains an asset used by the firm regardless of who the owner is or how the opportunity cost is recorded for accounting reasons. It is, rather, more accurate to think of capital as the value of all production goods in the ...

Table of contents

• Cover
• Half Title
• Series Information
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• Preface
• Introduction
• Part I Capital, production, and time
• Part II History of capital theory
• Part III Financial applications
• References
• Index