My 1991 London paper as cited in Italo Romano 2014.11.24. 16:38:54

First Part

Karoly Foldes


The first part of this paper examines capital as an ownership phenomenon of monetary nature. It is written with the purpose of giving an as explicit as possible qualitative account on some theoretical assumptions within the limited boundaries of the matter in question and of space. Practical ownership relations are assessed with regard to this orientation. The review of literature is concentrated here. A section is devoted to the broad complex of social transformation which is connected with the narrow subject by many links. The second part is an updated English summary of some works published by the author for the last twenty years in Hungarian. It deals with several capital related attributes of a monetary system. Conclusions on Hungarian macro-equilibrium trends are concentrated here and not repeated separately.

The choice of topics is motivated by the question whither go newly emerging democracies. Insofar as capital is a part of the answer to this question its modus operandi falls within that choice. What this paper has been trying to do is to assess this mode of working as a diagnostical orientation for transformational processes. That includes a trouble-shooting approach to actual decisions as well as programs of incumbent and would-be decision-makers. They are expected to perceive inquiries into the situation /needless to say, not this only one/ as a kind of software designed for users like them but not dependent on them. Criticism of policy coming from this part is no political judgment and should be distanced from partisan debates.

The paper represents but a modest fraction of Hungarian views on economic matters. Some salient capital phenomena could not be elucidated in it. Particularly, a lot of works on measuring capital and capital-output ratio, the impact of capital on growth and the influence of interest rates on investments have been published. The problems just mentioned have been scrutinized by a number of international academic panels the first of which, after World War II. was held, to our knowledge,in 1958. /1/ (References: See at the end.)

Capital is perceived as a business-like behaviour with respect to property in the context of imperfect markets. This viewpoint would be incompatible with lines of thought theoretically eliminating capital. They are tolerated as well, but here the matter has to be presented on a lower level of abstraction. Definitions will not be discussed.

1.1. Capital and labour

Insofar as social transformation includes the adoption of some first principles it seems to be appropriate to begin this part with a brief remark on a question pertaining to them.

There exists a kind of functional complementarity between capital and labour within the boundaries of their mutual substitution and competitive relations. Capital embodies human intellect while
labour represents human capital to a growing extent. In creative work these two sides may merge into one blend. As a rule, skilled labour is propertied. Millions of small business units are based on a personal union between capital and labour. Together with wage-earners living at middle class level they maintain social stability. This electorate is changing its cyclical allegiance.

XIX-th century capitalism with its crude type of free market gone for good, transformation of Eastern and Central Europe is not aimed at its restoration. There is no substantial confrontation between capital and labour there. In Poland, it was labour that created conditions for the functioning of capital. In Hungary, labour and capital have been fighting together against some ill-conceived measures of the administration, against inflationary pressures.

Another, well-known to specialists link between capital and labour this author has just come across. Self-management is likely to generate some special wage-differentials which may be attributed either to capital market or labour market imperfections existing owing to this system. These two do not exlude each other./2/ And in both cases it is the management of capital by labour that creates this particular pattern of wage determination.

1.2. Capital and time

A transformation process from the domination of preserving social attitudes to the innovating ones is under way. The theory of innovation in its original form /3/ deals with “new combinations” which is also a key problem of present endeavours at structural change with the entrepreneur as the key problem-solving actor of the whole setup. He or she works in an environment of disequilibrium, his or her space of choice is under the influence of this state of affairs. One of the main functions of an
enterpreneur as a market actor is to transform input informations received from this space into output informations, i.e. decisions. The decisions of market actors are interdependent under cooperative or non-cooperative game conditions.

Regarding phenomena in question a fairly considerable part of entrepreneurial activity is engaged in corporations, which are regarded by law as persons distinct from the individuals who in fact compose them. Thus in the English Law of the Persons a corporation is distinct from the directors, and from the shareholders (if any) who are its creditors by contract,and from the beneficiaries (if any) for whom it holds property in trust.

In cases when capital from outside is engaged in a corporation in the form of loans, and also bonds, shares and other securities, prompt money of the investors was exchanged for future money of the company. Future is uncertain. Terminal deals, at least partially, harmonise expectations in connection with this uncertain future. Central authorities are unable to do so. Stock-like dynamics, investor-corporation relations, non-stationary conditions which a futures economy as against an imagined prompt economy is based on evolve out of the profit drive of the capital and its wealth-preserving function. The proper context of the time-problem is the management of the capital of other people by a fairly considerable part of business activity. This peculiar function of entrepreneurship as opposed to ownership is a conspicuous feature of modern capital.

Dynamic economics, particularly in Hicks, gives utmost care to the time elapsed between resource involvement, factor combination and output under non-stationary state, when needs, technology and
resources change. /4/ This concept of time as against others, like that of Bohm-Bawerk is given a well deserved preference in the economic literature.

1.3. Capital as a wealth preserver

A general feature of the capital is that its yield over the whole life-cycle surpasses its original costs. /5/ In Tobin, capital as a yield-producing reservoir of wealth and value stands in both substitution and complementary relation with monetary tools, non-monetary wealth and foreign capital. The market of non-capital and non-monetary wealth-holders influences the valuation of productive capital. And though there is no clear-cut line of demarcation between capital stocks and money flows, still there is an undeniable difference between them. Return rates or yield rates mediate between the dynamics of money flows and the dynamics of capital stocks.

The above considerations of economics have recently much more relevance to the development of capital economy then the erstwhile mutual critique of neoclassical and Post-Keynesian authors. And these lines of thought, very much confrontational in times of the Cambridge contraversy (exhaustively examined in a recent history of the question) /6/ have in the meantime adapted to each other to a considerable degree. For example, in the analysis of the demand and supply of wealth preservers the relationship of which depends, inter alia, on preferences concerning the structure of wealth; on the constraints of substitution between different wealth-preservers; and on expectations about the dynamics of interests, dividends and prices.

There remains a divergence of opinion among various schools with respect to these complex (to be briefly mentioned under the next, 1.4. subheading) but the impossibility of satisfying at once all the optimum requirements of social choice /7/ now appears to be generally accepted. Lack of dictatorship would have been one of the requirements of optimal choice. State influence as well as organisational and situational oligopolies and monopsonies create elements of dictatorship even in market economies, not to mention command systems. As to which theories are most likely to give the most comprehensive behavioural orientation game theory and Simon’s bounded rationality theory are to be mentioned. The latter comprises logical and metalogical foundations of second best decisions. Portfolio selection belongs here.

1.4. Portfolio selection

In Markowitz, there are three major ways in which portfolio theory differs from the theory of the firm and the theory of the consumer. First, it is concerned with investors rather than manufacturing firms or consumers. Second, it is concerned with economic agents who act under uncertainty. Third,it is a theory which can be used to direct practice, at least by large /usually institutional/ investors with sufficient computer and database resources.

The first of these needs no further comment. As far as the second is concerned the neoclassical theory assumes that the competitive firm knows the price at which it will sell the goods it produces. That is what should not be assumed in the analysis of investor behaviour. The existence of uncertainty is essential for the latter. One of its main features i.e. diversification is aimed at reducing uncertainty. /8/ The reader recognises here a problem-setting which traces from Frank Knight.

The third difference is connected with the approximate method of portfolio selection “Thus we prefer an approximate method which is computationally feasible to a precise one which cannot be computed. I believe that this is the point at which Kenneth Arrow’s work on the economics of uncertainty diverges from mine.” /9/ Basic dimensions of a portfolio are the expected returns and its variance. Portfolio components with variances complementing each other in time contribute to maximisation of risk diversification. The risk of an asset is seen as its contribution to the risk of the aggregate portfolio.

In Sharpe the ‘beta value’ of a share indicates its marginal contribution to the risk of the entire portfolio. A beta coefficient greater than 1 shows an above-average effect on the risk of the aggregate portfolio. In an efficient capital market,the risk premium and the expected return on an asset will wary according to this coefficient. /10/ This rather simple method of computation shows the percentage of profit rate growth on a given investment as a result of 1% growth of the average rate. It boils down to an elasticity computation. Worth of mentioning is that average rate stands here not for the whole of the exchange but for some index of a group of securities, e.g. Dow-Jones index. The method is widely used by price experts of financial markets.

Experts analysis however is not the only possible way of portfolio selection. In non-scientific professional publications some curious comparisons are made in this respect. A recent article has illustrated four methods of assembling a portfolio, that is to say the experts’, the directors’ choice, the high yield, and the random. The first group of decision makers is selected out of analysts, fund managers and stockbrokers of the City. The second group consists of directors,who bought shares in their own companies in accordance with law. The importance of these two methods goes without saying. The third one is a high yield portfolio. In the short term, the benefit is a high income, in the longer term the investors enjoy capital growth as the yield falls. The fourth method works as dartboard players do. The article quotes a theory that a chimpanzee armed with a set of darts can perform just as well at stock-picking as a sophisticated fund manager, with all his computers and balance sheet analysis.

The existing share price reflects all the currently known information about a company. The price can be affected by “new” information which cannot be known. Accordingly,a random selection of stocks is likely to grow as quickly as a professionally chosen portfolio of shares. /11/ But, to the contrary, enterpreneurial imagination based on professional expertise demonstrated for example by the Soros-story may give better performance on the long run. There is no space here to demonstrate a most exciting aspect of portfolio decisions, namely, diversification into foreign currencies and securities.