Tuesday, June 7, 2011

An Investment in Illiteracy

Smith says profit is evaluated relative to "the value of the stock employed." By "stock" he didn't mean what we think of today -- or, what I think of today -- as stock. Adam Smith meant an accumulation of stuff that could be used for the purpose of making a profit, something we might today call capital.

That doesn't help. 'Capital' is another ambiguous term. Unbelievable as that is, in a land where capitalism is of such vast importance. Ah, but flexibility is important too. We sometimes need to be able to yank the tablecloth out from under an argument, and switch from reference to capital (equipment) to capital (money) without making so much as a ripple in the wineglass.

Smith wrote:

In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them...

As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work...

I picture the first hunter-gatherer who becomes a farmer, having accumulated enough seed to store up and plant in the Spring... Then, a few years later, lending some of his accumulating stock of seed to a neighbor.

I think that's an example of what Smith meant by 'stock'.

With that first farmer we could get into the invention of credit, and the creation of debt, and 'debt precedes money' and all kinds of things. But we won't.

If Farmer One loans his neighbor a bushel of wheat, and at the end of the season the neighbor returns two bushels, the farmer makes a pretty good profit. But if the neighbor only returns a bushel and a handful, the profit is not so good.

A bushel of profit is not so good if the farmer lent ten to get it; worse if he lent a hundred. Profit is measured, as Smith said, relative to the size of the investment.

When I think of "investment" I think of "an investment", like buying shares of Google or something, buying something that we think of as "stock" today. But that is financial investment.
And this only emphasizes the rise in importance of finance in our economy.
The kind of investment that creates profit is productive investment: expanding a business, for example, or starting one. Or operating one. And when you operate a business -- not that I know this from experience, mind you -- you have to spend money. There are tools and equipment to buy and maintain, employees to pay, and materials to be supplied and processed.

I want to compare the 'profit' to all the spending a business does to make that profit. This accumulated spending is, to my mind, a measure of the "stock employed" in the process of making the profit. And I want to refer to all this spending as "investment", in order to say that the profit is a return on investment. That is what I'll be doing in my next few posts.

I don't know whether my use of the word investment meets standard usage. Thought I'd look into that a bit. So, naturally, I went to Wikipedia. Here's the opening paragraph under the heading Investment:

Investment has different meanings in finance and economics. In Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security of principle, as well as security of return, within an expected period of time. In contrast putting money into something with an expectation of gain without thorough analysis, without security of principal, and without security of return is speculation or gambling.

I had to read it three times.

Where is the sentence that tells what 'investment' means in economics?

Yeah, okay. Apparently, I'm not using the word as an economist would. When you finally get to it, Wikipedia says

In economic theory or in macroeconomics, investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production.

That's all right. I'm gonna use the word anyway. I'm gonna do graphs of profit relative to the spending it took to generate that profit, and I'm gonna refer to this as ROI, return on investment.

1 comment:

Greg said...

"In economic theory or in macroeconomics, investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production."

This sounds an awful lot like savings!

So as Mosler says, "investment precedes savings" or savings is the residue of investment (my wording)