Capital is never quiet - it is always risk-oriented. Capital grows faster when per capita annual savings as cash, land, domestic assets, and investments are 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. Private capital, therefore, plays a significant role in a country's development.
However, if there is high inflation, it indicates larger amount of public debt, which results in increasing amount of tax burden on the people and for the private capital through excessive financial regulations amid global financialisation. In that scenario, financial reporting and tax optimisation strategies play a creative role in achieving desired return on private capital. Screen corporations are there to ensure moderate constant return for sustainability by diversifying wealth into most basic sectors and also 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 feel the pulse of current affairs. Balancing the process of capital accumulation is one of the logical options for 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 business decisions to keep themselves busy or to tear competitors apart (to indeed dig their own graves) in a desperate attempt only to aggravate the falling rate of return.
Whatever may be the rules and institutions that structure the split of share between the owners and capital-stakeholders, 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.
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 labour to produce various types of goods and services that society wants to consume. Dealing with 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 labour; that is, it measures how easy it is to substitute capital for labour, or labour for capital, to produce required goods and services, because technology also needs human skills and competence to function.
To conclude, ever-increasing accumulated capital leads to a falling rate of profit unless the business owners take timely initiatives 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 and advisers, can eventually sustain business profit by avoiding serious capital erosion.
Tofazzul Hussain, FCA is Lead Consultant & Chairman Hussains Business Consultants Ltd.
