- July 20, 2019
- Posted by: Tofazzul Hussain
- Category: Business and Investment
Capital is never quiet- it is always risk oriented. Capital grows faster when per capita annual saving as cash, land, domestic assets, and in investments is equal to or less than per capita annual income.From the country’s perspective, net public wealth of a country is a very important indicator of its richness, and public wealth is usually significantly lower than total private wealth. Therefore, private capital plays a significant role is country’s development.
However, if there is a high inflation, it indicates larger amount of public debt, which results in increasing amount of tax burden for the people and for the private capital through excessive financial regulations amid the financialised the global economy. In that scenario, financial reporting and tax optimization strategies work to be creative for the sake of achievement of desired return on the private capital. Creation of screen corporations set up abounds to ensure moderate constant return for sustainability by diversifying wealth into most basic sectors and in real estate and financial assets.
Allocation of capital is an intelligent work- delicate enough to warrant methodical application of past business knowledge and to exert the feeling of the pulse of current affairs. Balancing the process of capital accumulation is one of the logical optionsfor structural growth. In free economic system return on capital can be steadily added with capital but when the size gets too big to easily move, the owners of the capital start taking unnecessary businessdecisions to keep themselves busy or to tear competitors apart (to indeed dig own grave) in a desperate attempt only to aggravate the falling rate of return.
Whatever the rules and institutions that structure the owners’ capital-stakeholders’ share split may be, it is natural to expect that the marginal productivity of capital decreases as the stock of capital increases unless there is a limited supply of real assets for a large population. The interesting question is therefore not whether the marginal productivity of capital decreases when the stock of capital increases but rather how fast it decreases. In particular, the central question is how much the return on capital decreases when the capital/income ratio increases.Two cases are possible. If the return on capital falls more than proportionately when the capital/income ratio increases, then the share of capital income in national income decreases when capital/income ratio decreases.The return on capital is particularly high after any natural or manmade calamities, when capital is scarce, in keeping with the principle of decreasing marginal productivity.
It is nevertheless important to emphasize that cases mentioned above are theoretically possible. Everything depends on the vagaries of technology, or more precisely, everything depends on the range of technologies available to combine capital and labor to produce the various types of goods and services that society wants to consume. In thinking about these questions, economists often use the concept of a “production function”, which is a mathematical formula reflecting the technological possibilities that exist in a given society. One characteristic of a production function is that it defines an elasticity of substitution between capital and labor; that is, it measures how easy it is to substitute capital for labor, or labor for capital, to produce required goods and services, because technology also needs human skills and competence to function.
As I come to the end of this dynamics of return on capital, it is worth pointing out the conclusion that ever increasing accumulated capital ultimately leads inexorably to a falling rate of profit unless the business owners take up timely initiative to profitably employ the surplus capital in a diversified portfolio of assets. The owners and management of the business enterprises and companies, who are knowledge centric, persistent, observant, and innately passionate about the business, and most importantly who are team players and surrounded by prudent business associates, advisors and cronies, can eventually sustain business profit by avoiding serious capital erosion.
About the writerof this Article:
TofazzulHussain FCA, Lead Consultant & Chairman
HUSSAINS Business Consultants Ltd, a business & tax advisory firm for local and foreign investors