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8. Inconvertible Capital

5. The Entrepreneur's View of Malinvestment

The foregoing discussion makes quite clear the conduct of the individual entrepreneur and of the individual capitalist in the face of losses that come about through the commitment of inconvertible capital in enterprises in which a person having complete knowledge of all the relevant circumstances would no longer invest it today. Nevertheless, the way in which businessmen and the press generally discuss these matters differs markedly in many respects from our description. Yet it is only the businessman's view of the situation that is different; his conduct, however, is in complete conformity with our description of it.

Let us suppose that it becomes obvious that the earning capacity of an enterprise will be permanently diminished in the future or that a diminution of revenue that had hitherto been regarded as temporary proves to be lasting. This fact is appraised in different ways—particularly in the case of corporations and other similar associations for raising capital—according to whether it is necessary to make clear in the books the loss of fixed capital that has taken place, or whether this can be avoided because the fixed investments do not at present appear in the books with higher appraisements than correspond to their now diminished values. It is hardly necessary to point out that this has nothing to do with the question whether the enterprise should be abandoned altogether in view of the new state of affairs. It is obvious that what gives this secondary decision such great importance is merely consideration for what the stockholders may think of the achievements of the responsible management, for the credit of the firm, and for the price of its stock.

One often hears the view expressed that when a concern writes off a great part of its investment this very fact offers it the possibility of entering into competition with other firms that operate under more favorable conditions. Here too the situation is no different from the case just mentioned. The book value of a concern's fixed investment has no bearing whatever on the question of its ability to withstand competition. What is alone decisive is whether, after covering all current operating costs and after paying interest on the circulating capital, there is still so much left over from the gross revenue that something more can be reaped than an adequate return on the value which, after discontinuation of the enterprise, the fixed capital would have in view of the possibility of using it for other production (occasionally this will be only the scrap value of the machines and bricks). In that case the continuation of the enterprise is more profitable than its discontinuation. If the fixed capital has a higher book value than corresponds to its present and probable future earning capacity, then the book value must be lowered to that extent.

What the businessman wants to say in using his mode of expression is nothing else than that an enterprise whose investment has already been written off either wholly or to a great extent out of previous earnings appears, when considered in regard to the entire duration of its life, as still profitable even in the later periods of its existence if only it is still able to pay interest on the circulating capital.

The case is similar where, as is generally said, competition with enterprises operating for the rest under more favorable conditions is possible because a source of special advantage not within their reach is available—like the value of a popular brand name. If the remaining conditions of production were perfectly equal, then this advantage would constitute the source of a differential rent. As the situation stands, the resources needed to make up an existing disadvantage are obtained from it.