Economic Efficiency of Capital Investments

an indicator that provides a picture of the planned connections and quantitative relations between the expenditures of socialist society for expansion and simple reproduction of fixed capital stock and the results obtained. The direct result of capital investment is that production capacities and nonproduction facilities are put into operation; the eventual result is a growth in output and material services and, ultimately, a growth in national income.

The theories and techniques devised by Soviet economists for determining the economic efficiency of capital investments provide a basis for selecting the optimal alternatives of capital investments when drawing up long-term and current (annual or quarterly) plans and plans for specific projects; they play a direct role in the management of enterprises (associations), branches of the economy, and integrated programs with particular goals for economic development.

Between 1951 and 1976 the USSR invested 1.46 trillion rubles, and 1.351 trillion rubles’ worth of fixed capital stock became operational. In that same period the total fixed assets (production and nonproduction) increased eightfold, and net output (national income) increased sevenfold. Capital investment in production fixed assets accounts for two-thirds of all investment.

The effect (result) of capital investments in production for the national economy, branches of the economy, and subbranches that keep the appropriate records is manifested in the growth of the gross product, final product, and net product (national income), expressed in terms of value and in physical terms. Efficiency is measured, however, by the ratio of the result (output) to the expenditures (investments) needed to produce the result.

In branches, subbranches, and enterprises (associations) that do not calculate net output (national income), profit is used as an index of the effect, and efficiency is taken as the ratio of profit to the value of capital or as the ratio of the growth in profit to the growth in the value of capital (or of capital investment). This index does not give a quantitative description of the overall economic efficiency of capital investments, because it does not include a considerable part of the net product, such as wages or the social consumption funds; it does make possible an evaluation of the dynamics of capital investment.

The effect of capital investments in the nonproduction sphere is expressed in the growth of services that meet nonproduction sociocultural needs, such as housing, consumer services, education, and health care. Efficiency is measured as the ratio of physical results—for example, residential housing space, the number of places in schools, or the number of hospital beds—to expenditures (investments).

Determining the absolute (general) efficiency of capital investments—the ratio of effect to expenditures—is of great importance in planning the reproduction of the social product and subjecting it to analysis, especially in view of the need to increase the efficiency of social production under conditions of full employment of the work force and an increasing use of natural resources (seeECONOMIC EFFICIENCY OF SOCIALIST PRODUCTION). In branches of the economy and in enterprises, indexes of the capital-output ratio and capital productivity are used; these are compared with indexes of the prime cost of production. A rise in the capital-output ratio or a decline in capital productivity may be offset by a decline in current expenditures and be recouped within a prescribed period. This is the esential feature of the problem of payoff on capital investment (seePAYOFF ON CAPITAL INVESTMENT).

The economic efficiency of capital investments in both the production and nonproduction spheres depends to a considerable extent on several factors: the lowering of actual expenditures for construction, improvements in construction quality, the reduction of construction time, the degree to which production capacities are developed, and the attainment of projected economic indexes.

A distinction is made between the planned and actual efficiency of capital investments. Planned efficiency is set by the plan, which has taken into account potentials for using internal production resources, for increasing the productivity of labor, for lowering the material-output and capital-output ratios, for achieving technological progress, and for increasing the scale of production. A value is assigned to planned efficiency on the basis of the ratio of the planned effect to expenditures. Actual efficiency is determined by comparing report data on expenditures with data on the effect; these data are compared for trie national economy, branches of the economy, and enterprises.

The comparative economic efficiency of capital investments is used to make the best choice among possible capital investment alternatives in overall planning and the planning of specific projects, with a view to turning out products that will meet a given demand. Capital investments and current expenditures are compared, variant by variant, and the investments most attractive in terms of payoff time and discounted expenditures are selected. In order to calculate comparative efficiency, it is important to determine correctly the standard, or normative, coefficient of efficiency, which is inversely proportional to the standard payoff time.

A planned standard of comparative efficiency is used to arrive at an annual figure for capital investments and to add them in with current expenditures. The planned standard represents the minimum permissible level of economy on current costs or minimum permissible level of profits, in relation to a given investment, at which that investment becomes acceptable. The Standard Methods for the Determination of the Economic Efficiency of Capital Investment permit branches of the economy to adjust the standard coefficient of comparative efficiency for the national economy that appears in their instructions for determining economic efficiency; such adjustments take into account the particular features of the various branches of the economy or regions of the country, such as differences in wages, in the technological makeup of assets, in indirect economic effects, and in climate.

The Standard Methods call for a method of discounting based on compound interest to relate expenditures made at various times to a particular period. The planned standard for discounting reflects the average accumulation of capital for the national economy in relation to production assets and is therefore in accordance with the rate of growth of social production. Capital investment at the end of the first year, together with its increment, becomes C(1 + B), which, when reinvested, becomes C(1 + B)(1 + B), or C(1 + B)², by the end of the second year; by the end of the nth year the figure becomes C(1 + B)ⁿ.

Investments in the nth year may be converted into those of the first year by dividing the later figure by (1 + B)ⁿ or multiplying it by 1/(1 + B)ⁿ. In this method of discounting the optimal investments is that in which the total discounted capital investments and current expenditures are, other things being equal, the lowest; a common measure can then be applied to investments made at different times, and the investments can be compared and added.