Economics Dictionary of ArgumentsHome
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| Return on Investment: Return on Investment (ROI) measures the profitability of an investment by comparing its gain or loss to the initial cost. It is calculated as ROI = (Net Profit / Investment Cost) × 100%. Used in finance and business, it evaluates efficiency but ignores factors like time and risk. See also Returns to scale, Capital._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Robert Solow on Return on Investment - Dictionary of Arguments
Harcourt I 7 Capital/Measurements/return on investment/Fisher/SolowVsFisher/Solow/Harcourt: Solow [1963a(1), 1966(2), 1967(3), 1970(4)]: Solow's purpose was, in part, to get away from the obstacles of the measurement of capital and its related problems by developing instead the concept of the rate of return on investment. His own contributions were to graft technical progress on to Fisher's analysis and to apply the resulting concepts empirically, in order to obtain estimates of the orders of magnitude of the rates of return on investment in post-war U.S.A. and West Germany. >Irving Fisher. Joan RobinsonVsSolow: It is argued that neither in theory nor in empirical work has Solow been able completely to escape from the need to define and measure aggregate capital and to work within the confines of a one-commodity model. >Aggregate Capital. Harcourt I 94 Return on investment/Solow/Harcourt: What, then, is the rate of return on investment? Consider a planned economy which has a stock of heterogeneous capital goods, produces a certain volume of one consumption good and is at full employment with its inputs efficiently allocated. (Efficient means only that it is impossible to have more of anything without less of something else.) Compare this situation with possible neighbourhood efficient arrangements in which there is a little less consumption and therefore more capital goods (in physical, not necessarily in value terms). Now change over to an alternative arrangement by saving, i.e. reducing consumption. This allows a one-period gain (the next) in consumption over what it would have been. Make sure that the biggest gain is chosen for a given reduction in consumption now. Finally suppose that in the period after the next the economy reaches the position that it intended to be at by that period anyway. That is, the economy over the three periods has had decided for it - we are all technocrats now - a consumption stream C0 -h, C1+j, C2, .. . instead of one of C0, C1, C2, . . . Then a natural definition of the one-period rate of return on investment (R1) is R1 = j-h/ h = j/h -1 . . .perfectly natural usage. For „technocrats“ see >Capital theory/Solow. Harcourt I 95 Saving/prices/implicit assumptions/Harcourt: We should note the vital importance in all these definitions of an implicit assumption either that saving may be transformed into investment without affecting relative prices or that we are analysing a one-commodity model. Without these assumptions, saving, in the sense of consumption forgone, will not necessarily add the additional consumption because, depending on how prices change, it will be associated with different amounts and types of investment. Hence Solow concentrates on small changes - the notional changes of the neoclassical procedure – and the prices corresponding to a switch-point rate of profits: see Solow [1967(5), 1970(6)]. Measurements: Solow claims that calculating the rate of return requires no measure of the stock of capital, not even necessarily a mention of it, although in some of his theoretical examples and in his empirical work he is unfaithful to himself. He also claims that neoclassical theory, in so far as it centres around the rate of return, can escape from the malleability assumption and 'can accommodate fixity of form and proportions both' (p. 27). Malleability: As an aside but very much related to the malleability assumption, he comments that J. B. Clark's jelly assumption (see Stigler [1941](7), chapter xi, and Samuelson [1962](8)) makes the analysis easier (…). Substitution: Moreover it contains the important kernel of truth that substitution possibilities are easier over longer periods of time even though at any moment of time capital goods may be highly specific and substitution possibilities ex post (if not ex ante) limited: see Hicks [1932](9), pp. 19-21. Harcourt I 96 SalterVsSolow: This seems to be literally true only if we are considering the working out in actual time of the possibilities which exist at the beginning of a Marshallian long period, while not allowing anything to change, other han what was expected to change at the start of the period. The application of results from this analysis to real-world happenings is, therefore, suspect, as Salter [1960(10), 1965(11)], for example, has so clearly shown. >Return on investment/Neo-Keynesianism. Harcourt I 96 SolowVsNeo-Keynesianism: Rates of return on investment are calculated by Solow for two 'poles apart' models of planned economies. The first is an all-purpose onecommodity model with a smooth, well-behaved, constant-returns-toscale production function; the second is Worswick's stockade dictator version of Joan Robinson's model of accumulation (see Worswick [1959](12)). One-period and perpetuity rates of return are obtained and these are shown, in the neoclassical case, to equal the net marginal product of capital. Harcourt: The two extreme cases are chosen in order to show '. . . that the rate of return . . . does not depend for its existence and meaning on the possibility of defining "marginal productivities" or having smoothly variable proportions between the factors of production' (Solow [1963a],(13) p. 30). Harcourt I 97 Saving/investments: These results are offered as the answer (or, rather, an answer) to the important question: What is the pay-off to society from an extra bit of saving transformed into capital formation? Harcourt I 110 Return on investment/Solow/Harcourt: Solow uses a Ricardo-Sraffa system with circulating capital; (…) he shows that the rate of interest is an accurate measure of the social rate of return on investment, provided only that the economy is at full employment and uses competitive pricing, and that we are comparing one stationary state with another which has the same labour force but uses, at the given rate of profits, a different equi-viable technique, namely one that requires more circulating capital, commodity by commodity. Both stationary states are in long-run competitive equilibrium; their net products consist entirely of consumption goods. In order for one economy to move (technocratically) from its technology to the other's, consumption must be cut in one period (or for a number of periods in more complicated cases). Solow shows that the extra consumption per period obtained in perpetuity as a result of this move, when expressed in terms of the common set of prices at the given rates of interest (and wages) and as a proportion of the consumption forgone, similarly measured, equals the rate of interest. Harcourt I 111 This ratio, (…) is Solow's measure of the rate of return in perpetuity, R∞ = p/h. 1. Solow, R. M [1963] 'Heterogeneous Capital and Smooth Production Functions: An Experimental Study', Econometrica, xxxi, pp. 623-45. 2. Solow, R. M., Tobin, J., von Weizsacker, C. C. and Yaari, M. [1966] 'Neoclassical Growth with Fixed Factor Proportions', Review of Economic Studies, xxxm, pp. 79-115. 3. Solow, R. M. [1967] 'The Interest Rate and Transition between Techniques', Socialism, Capitalism and Economic Growth, Essays presented to Maurice Dobb, ed. by C. H. Feinstein (Cambridge: Cambridge University Press), pp. 30-9. 4. Solow, R. M [1970] 'On the Rate of Return: Reply to Pasinetti. Economic Journal, LXXX, pp.423-8. 5. Solow, R. M. [1967] 'The Interest Rate and Transition between Techniques', Socialism, Capitalism and Economic Growth, Essays presented to Maurice Dobb, ed. by C. H. Feinstein (Cambridge: Cambridge University Press), pp. 30-9. 6. Solow, R. M [1970] 'On the Rate of Return: Reply to Pasinetti. Economic Journal, LXXX, pp.423-8. 7. Stigler, George J. [1941] Production and Distribution Theories: The Formative Period (New York: Macmillan). 8. Samuelson, P. A. [1962] 'Parable and Realism in Capital Theory: The Surrogate Production Function', Review of Economic Studies, xxix, pp. 193-206. 9. Hicks, J. R. [1932] The Theory of Wages (London: Macmillan). 10. Salter, W. E. G. [1960] Productivity and Technical Change (Cambridge: Cambridge University Press). 11. Salter, W. E. G. [1965] 'Productivity Growth and Accumulation as Historical Processes', Problems in Economic Development, ed. by E. A. G. Robinson (London: Macmillan), pp. 266-91. 12. Worswick, G. D. N. [1959] 'Mrs. Robinson on Simple Accumulation. A Comment with Algebra', Oxford Economic Papers, xi, pp. 125-41. 13. Solow, Robert M. [1963a] (Professor Dr. F. De Vries Lectures, 1963) Capital Theory and the Rate of Return (Amsterdam: North-Holland)._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Solow I Robert M. Solow A Contribution to the Theory of Economic Growth Cambridge 1956 Harcourt I Geoffrey C. Harcourt Some Cambridge controversies in the theory of capital Cambridge 1972 |
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> Counter arguments against Solow
> Counter arguments in relation to Return on Investment
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