2 INVESTMENT CRITERIA Introduction Meaning Of Investment Criteria Types of investment criteria
3 INTRODUCTIONIt is difficult to establish a satisfactory criteria for the best allocation of investment because alternative investment criteria will affect total output differently; a certain investment criterion may maximize total output over a given period of time, but another criterion may be more relevant for maximizing output over a different time period.Moreover, the allocation of investment will affect not only total output but also the supply and distribution of the labour force, social and cultural conditions, growth and quality of the population, tastes and technological progress.In short, it can be said that different criteria would be applicable in different situations. The economists have thus put forth a wide range of investment criteria.
4 MEANING OF INVESTMENT CRITERIA “Investment criteria refers to the problem of determining the best utilization of investment resources to minimise capital intensity to maximise social marginal productivity of capital and employment absorption”, states Prof. Meier.Thus investment criterion is a guide to the appropriate utilization of limited investment resources.
5 TYPES OF INVESTMENT CRITERIA Social Marginal Productivity criterion.Criterion of Investment for Acceleration Growth or Reinvestment criterion.Capital Turnover criterion.Time Factor Criterion.Investment criterion to control specific problems.Employment absorption criterion.
6 1. Social Marginal Productivity Criterion Social marginal productivity is a criterion of investment allocation. This is based upon the view-point of Neo-Classical Economists. It states that efficient allocation of investment can be attained by equating the marginal productivity of investment in its alternative uses.This criterion was propounded by A.E. Kahn and Hollis B. Chenery. Social Marginal Productivity is defined as the total net contributions of the marginal unit of investment to national product.
7 LIMITATIONSIt Ignores the Multiplier Effect: It ignores the multiplier effect of investment, also it does not consider the possible changes in the nature and quality of productivity resources.Vague Concept: It is difficult to correctly ascertain social costs and profits market prices. Accordingly, it is difficult to make a precise estimate of the social productivity of investment.Static: Various parameters of the criterion are concerned only with a given time period. In fact, the determinants of economic growth such as population, technology, etc. do not remain constant. These keep on changing over time.It Ignores the Difference in the Nature of Factor of Production: The criterion does not account for the difference in the nature and quality of the factors of production.
8 2. Reinvestment Criterion Prof. Galenson and Leibenstein propounded ‘Reinvestment criterion in This is also called the ‘Criterion for Accelerated Growth’ and ‘Rate of Surplus criterion’.According to this criterion, the principal objective of investment is to raise capital per unit of labour. Economic development of a country should aim at raising the present level of investment. This is possible only when greater part of increased income is reinvested.Annual reinvestment is a significant variable in the context of higher and higher rate of growth over time. For reinvestment it is essential that profits constitute a high proportion of national income, and wages constitute a low proportion.
9 LIMITATIONSWrong Assumptions: It is wrong to assume that high rate of reinvestment depends upon high rate profit.It Violates Social Welfare: It accords significance to the capital intensive technique of production, which might aggravate the problem of unemployment and make the distribution more skewed with concentration of wealth. All this is not good from the social point of view.Capital Deepening is not Always Desirable: It is not essential that density of capital would always generate higher rates of profits and the consequently higher rates of saving. If capital is not judiciously used, profits may fall.Capital Intensive Industries may not Yeild Larger Reinvestment: The assumption of the theory that capital intensive industries would always yield larger reinvestment is also not very convincing.
10 3. Capital Turnover Criterion This criterion was propounded by Profs. J.J. Polak and N.S. Buchanan. This is also known as Rate Turnover criterion and Equal Marginal Productivity criterion. According to this criterion, investment should be so made that high turnover is realized even from low investment of capital, and more and more people are employed.There is scarcity of capital in underdeveloped countries. So that labour intensive technique should be adopted. Accordingly, maximum output is to be realized from a unit of capital invested.
11 LIMITATIONSIt Ignores Time Element: Generally, high-turnover projects have low capital-output ratio in the short period, but not in long period when profits are generally higher.Not Applicable to Dynamic Conditions: The Capital Turnover criterion is applicable only in static conditions, not in dynamic conditions. Only in static conditions can the marginal productivity of investment be in its different uses.Less Total Production: Adoption of labour intensive technology may in fact reduce the level of aggregate production. Also it is essential that with more employment opportunities, aggregate production should always increase.No Possibility of Perfect Substitutions: The assumption of the Turn-over criterion that there is perfect substitutability between labour and capital is also not tenable. In fact, capital and labour may be substituted for each other only upto limited extent.
12 4. Time Factor CriterionProf. A.K. Sen propounded the Time Factor criterion of investment allocation. According to this criterion, Time Factor is an important determinant in a choice of technique. Before making an investment in an enterprise, it should be ascertained how long would it take for the realization of output.Prof. Sen is of the view that while estimating the cost of investment one should not only look at the expenditure incurred but also the time involved between investment and output. If the choice is to be made between any two programmes of investment, the one that yields higher output within the stipulated time should be preferred to the other.
13 LIMITATIONS Difficulty in determining time factor: There is no scientific basis of determining the time factor. It is not certain either, whether the determination of time factor could be left to the discretion of the investors.It ignores other factors:The output of an investment project does not merely depend upon the expenditure incurred on the project. It also depends upon several other factors such as availability of external economies and the growth or decay of other enterprises in the system. Any investment project cannot be evaluated independent of the others.Difficulties in estimating investment and output:Because of changes in the determinants of time-elements viz. technology, wage rate, propensity to consume and the like, it is difficult to make prior estimates of investment and related output.
14 5. Investment criterion to control specific problems This criterion is propounded by Prof. J.J. Polak. It is in fact another form of reinvestment criterion. Its objective is to undertake stable economic development by controlling specific problems arising during the process of economic development.External imbalance: there are two main causes of unfavorable balance of payment of countries. First, in the initial stage of development, the capital goods and raw materials need to be imported in large quantities while exports are comparatively very little in quantity. Second due to increase in monetary income there is increase in the demand for foreign consumption goods causing a foreign exchange crises.Inflationary pressure or internal pressure: in the initial stage of economic development of underdeveloped countries, huge amount is invested in such large projects which have a long gestation period. Consequently the monetary income of the people increases. But the production of consumption goods does not increase in the same proportion.
15 CriticismImport propensity: According to Prof. A.E. Kahn, increase is not necessary due to increase in monetary income as a result of development investment.Slow growth: Change in the composition of investment to control the unfavorable balance of payment and inflationary pressure may slow the rate of growth.Effects of individual investment: The effects of individual investments on balance of payments cannot be separated from other effects.Neglect mobility of resources: The balance of payments is not always affected by the amount of investment but also by the mobility of resource and financial management. This criterion neglects their effect.
16 6. Employment absorption criterion The employment absorption criterion has been propound by Prof. Ragnar Nurkse. This criterion attempts to increase employment opportunities. Prof. Nurkse is of the opinion that in order to eliminate this unemployment, the investment policy should be so formulated as to increase employment opportunities to the great possible extent. Capital saving and labour consuming, labour intensive projects should be allocated prior to achieve these objectives. This will result not only in increasing employment opportunities but also enable the use of disguised unemployment to increase production.
17 CriticismThe labour productivity remains low due to the use of capital saving and labour intensive technique.The labour intensive projects result in low rate of economic development.This criterion lays down more emphasis on increasing employment rather than production. As such it is contrary to the objective of economic development.It is doubtful whether this criterion may result in long run increase in employment.It does not seem possible to increase production if investment is incurred on the basis of this criterion.
18 ConclusionAccording to Dr. Bright Singh, “investment criterion as propounded by different economists are fallacious. The problem of investment criterion is so complex that it is difficult to choose a particular criterion. As there is no co-ordination between the various objectives of growth, so there can be no co-ordination between the various criteria of investment.”However, despite their various shortcomings, investment criteria have found their increasing application during the recent past in the context of planned development programmes of different countries.