Productive capacity is the central resource around which individual lifestyles and standard living consistently revolve. The depth of financial intermediation and the quality of institutional arrangements determine, among other things, the type of possibilities to improve productive capacity, and the expected rewards.
The “Robinson’s” Analysis
A more accurate analysis can be conducted by comprehending the example of the Robinson Crusoe economy, which consists of only one family — the Robinsons. Assume the Robinsons are forced to spend long hours on their farm with bare hands at first. Unless there is a glimmer of good fortune or positive possibilities, the Robinsons are forever condemned to survive under a low standard of living. Assume that the Robinsons improve their hand-eye coordination over time because of their repeated exercises. Assume the Robinsons are devout followers of BöhmBawerk’s (1889) concept that carefully chosen roundabout means of production are more productive, and that they use their free time to produce innovative ideas, such as forging an agricultural implement. Observe that, in the spirit of Böhm-Bawerk, the economy’s productivity will grow once the farm implement is ready and in use. These accomplishments will result in higher living standards. This emphasizes that achieving a quintessential consumer lifestyle is directly proportional to the commitment of current resources in order to construct and improve a system where productive capacity increases.
Investment opportunities can be frequently utilized for exploitative purposes. For example, regardless of the predicted return, any investment proposal that needs outlays outside the Robinsons’ current resource range must be dismissed. Consider a huge number of other household economies, each with a different set of current resource and investment opportunity profiles. The Robinsons may then design a system that permits them to commit both current and future resources to current investing. Financial intermediation is one such technology, as it allows the Robinsons to pledge a fixed amount or a fraction of expected output to creditor household economies in exchange for investment funding. Financial intermediation can boost growth across household economies by allowing economies like the Robinsons to pledge expected outputs in order to acquire present investment. This allows for higher returns on investment to be achieved. However, it causes subtle losses to vaster enterprises. The usefulness and depth of financial intermediation, among other things, is determined by how safe the interests of creditor household economies are in the Robinsons’ endeavor. In order to fund Robinson’s ex-ante, the creditors must be assured of their ex-post returns.
Protection of Creditors
We might envisage a variety of incentive institutional setups that protect creditors to honor their obligations ex-post. These institutional arrangements serve a larger purpose than simply ensuring creditors of a return on their investment. They are also critical in ensuring a stable and predictable investment climate for the Robinsons.
Investment in productive capacity is intrinsically connected to wealth creation, according to the intricate example highlighted above of the Robinsons. Furthermore, both the rate of investment and the returns on investment are heavily influenced by the depth of financial flows and the quality of the institutional environment. Investment has a lengthy history in economic philosophy, stretching back to the discipline’s inception. A considerable portion of economists’ scholarly effort on the topic is devoted to figuring out why some economic agents invest more than others.
The topic continues to pique the interest of modern economists and policymakers alike. This is especially true in light of the modern economy’s growing scale, integration, and complexities, as well as the related separation of the capitalist from the entrepreneur and ownership from management. You can click Lifestyle Blog to get more information.