The key factor in measuring the economic effects of investment
The key factor in measuring the economic effects of investment is how to measure the flow direction and the amount of funds.
However, the current system of accounting alone is not satisfactory for measuring the flow direction and the amount of funds. In particular, public works do not even have the concept of periodical loss and profit. This is not merely a matter of measurement.
The key factor in measuring investment effects in terms of periodical loss and profit is the depreciation expense. But, depreciation does not actually mean a reduction in asset value. Depreciation is absolutely an accounting system concept. The depreciated portion is reported as an expense, but it does not mean that cash is actually disbursed. On the other hand, repayment of the debt principal is not reported. In other words, depreciation does not agree with the flow of funds.
Accounting reality, physical reality and cash reality are not the same. They are dissociated from each other. If you do not properly understand this, you may be deceived by economic phenomena or businesses. In the end, what you are doing is only balancing the account.
Accounting is a sort of mathematics.
Increasing the corporate tax rate would increase the debt level because the debt principal is reimbursed from after-tax profit and depreciation. If the tax rate were to go up, resources for reimbursing the debt principal would be strained.
A higher rate of equity capital is not always advantageous to a business because profit is eventually distributed according to the concept of profit allocation.
Basically, the funds accumulated within a business are not acknowledged.
The problem is where the funds flow. Are the funds going to the public sector, to family budgets, or to investment? The function of funds depends on the destination of the flow and the amount of the funds.
There two types of fund flows. One is the flow of circulating funds and the other is the flow of fixed funds. Circulating funds are operating funds and their flow is short-term. In contrast, fixed funds are investment funds and their flow is long-term.
Both the circulating flow of funds and the fixed flow of funds are found in the finances of families, corporations and nations. Each of them forms the flow of funds.
Capitalism exists because the flow of fixed funds was established. The establishment of the flow of fixed funds has led to the establishment of the principle of periodical profit and loss.
Business downturns are thought to be caused by circulating funds in some cases, or by fixed funds in other cases. Business downturns are often transient. But, if a downturn continues for a long time, it may destroy the basic structure of the economy.
One of the possible factors of a prolonged business downturn is an event caused by fixed funds. It is the movement resulting from trying to collect fixed funds in association with a business downturn.
Gross capital is the money supply, and expenses form the volume of the money flow. That is to say, gross capital represents the amount of fixed funds, and expenses represent the amount of circulating funds. In view of society overall, the total gross capital is the total of the funds supplied in the market, and the total expenses represent the money supply circulating in the market.
Fixed funds are generated through investment.
Then, what is investment? Investment is providing or inputting resources to acquire future economic value or utility that is higher than the current value.
Investment is provided to facilities, capital, housing, human resources, research and development, real estate and inventories.
Financial institutions raise funds mainly from deposits and loans. When a financial institution acquires deposits, this means an increase in debt.
The primary means that financial institutions use to supply funds to outsiders are to increase loans or to repay deposits.
When a financial institution repays a loan, it means a decrease in assets. Thus, while an increase in deposits means an increase in fixed funds, a decrease in loans means a decrease in fixed funds.
In financial institutions, deposits guide the money supply to center stage while debt supports the money supply behind the scenes.
For this reason, when a debt principal is reimbursed, the money supply is compressed. When money is deposited, the supply volume expands.
When a company borrows 100 million yen from a bank and uses it for facility investment, the borrowed 100 million yen is transferred to the current account of the party from whom the company has purchased the facility. The party who has sold the facility pays the expenses required for manufacturing the facility. Funds circulate through a process like this. But, a large volume of funds is processed inside the financial system. Funds flowing out of the financial system as cash are a relatively small amount compared with the total circulating funds.
If long-term funds were collected all together because of a decline in profits affected by market conditions, even companies with sound earning power would go bankrupt. What is a cause of the decline in profits? Is the cause transient or permanent? Is the problem brought about by an external factor or an internal structure? Unless this is clarified, effective measures cannot be taken.
However, current management executives in financial institutions and policymakers see competitive power as earning power. When profits decline, they try to collect fixed funds, i.e., long-term funds. That is why the supply of fixed funds is disrupted in the market.
In the end, Japanese financial institutions assess investments only with the asset value and the security value. They find value in the remaining value and collectable value. However, the remaining value is nothing but an illusion.
Also, we should not forget that both the security value and the remaining value are the breakup value.
In private corporations, the fund supply through regular business activities is brought about by profits. Therefore, whether corporate performance has a favorable effect or an unfavorable effect on business conditions depends on the earning power.
The fund flow is decided by where the profit is returned. If it is returned to expenses, distribution will be promoted. If it is returned to assets, investments will increase. If it is returned to debt, funds will flow toward collection. If funds flow to the capital side, the dividend will increase.
But, the flow of funds toward investments makes use of debt and capital.
The biggest cause of a business downturn is earning power. The most important issue in connection with earning power is the issue of cost-benefit.
Worsening profits are caused by competitiveness and expenses. When personnel expenses are compared simply, a wage gap of approximately 10 to 2 makes competition unrealistic. The working environment is an internal affair. By necessity, production centers and work sites are moved to low-wage areas. The wage gap is directly connected with the working conditions and employment environment. It is highly predictable that an extreme gap creates a poor working environment for the people.
This means that production centers with poor working environments are more competitive.
Consequently, as the “Bad money drives out good” saying goes, production centers with good employment environments are eliminated and those with poor working environment remain. This is a phenomenon called “exporting poverty.”
Deregulation merely for the purpose of competitiveness leads to acceptance of worsened working conditions.
The purpose of the free economy system is to connect labor and produced goods with money as a medium and to achieve appropriate distribution.
The idea that cheapness is entirely good is easy and shortsighted. If such an idea were taken to extremes, the foundation of the economic system might be destroyed. We should caution against making heroes of lawless discount merchandisers or recommending confusing price wars.
Nothing offers a more reliable measurement of return on investment than that of public investment. Originally, the concept of profit was missing in public investment. Since ROI is measured without the concept of profit, only the designed effects can be expected.
The designed effects are not economic effects in the public sense but private economic effects such as political effects, interest and vested rights. The activity for such effects deviates from the original significance or objective.
Public works projects build the foundation of the national economy. Therefore, they do not function effectively if there is no national vision at the foundation of public works. Continuous flow of funds into the private sector means nothing but transfer of public wealth to private wealth.
The purpose of a free economy is to distribute resources depending on labor.
The important roles of public works are the circulation of funds and distribution of resources.
Therefore, the important factors in public works are the direction and amount of the flow of funds.
The important factors in investment are the direction and the amount of the flow of funds. Funds blindly invested do not always flow into the market.
After an investment is made, the direction of the investment flow may change from the flow at the start of the investment.
For example, in the case of facility investment, the funds flow to the contractor for the facility manufacture and/or installation. After facility operation starts, the funds flow in the direction of reimbursement.
In the case of public works investment, too, investment in the initial stage of a project feeds the funds to the market. After the investment is made, the funds flow to the collection side.
Therefore, in order to measure the economic effects of public works, it is important to assess the direction of the flow of funds.
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