FinancialCapital

Financial Capital is not itself (directly) an input into production processes. Rather, finance is what firms use to buy production inputs.

To keep it simple, assume that the only thing firms ultimately have to exchange are the finished goods they produce. In order to obtain financial capital firms thus have two options: exchange goods they have already produced for finance; exchange promises to supply goods they will produce in future.

There is thus a chain:

(promised) output goods – (exchange for) – finance – (exchange for) – production inputs

In general, suppose that the amount of produced goods a firm has at any point is not large enough to exchange for sufficient finance to buy the inputs it needs in the next period. This makes sense if, for example, the firm is looking to expand. And usually firms have to expand or die (go bust or get eaten up by other firms). Thus it will have to be exchanging promises.

To make it more general, firms make promises against: future sales of produced goods; future sales of unused inputs; future disposals of parts of their business; gains they will make themselves from trading in finance with other firms etc. And just call all of this the firm's future income.

Then in general:

promised future income – (exchange for) – finance – (exchange for) – production inputs

So what is financial capital? Suppose there are two firms, A and B. Firm A produces good X, firm B produces good Y. Firm A needs y1 units of Y as an input in its next round of production. Firm A promises to give firm B x1 units of its good X at a future date, in return for y1 units of the input good now. Is there any financial capital present in this simple two-party exchange?

Perhaps yes: can you say that the promise that firm B now holds from firm A represents an amount q1 of financial capital belonging to firm B?

It seems easier to understand when financial capital can be traded. Suppose firm A writes on a piece of paper 'we promise to pay to firm B x1 of our goods in a year's time.' Can you say that this paper is worth an amount q1? If it is possible for firm B to trade the paper, then it can go to other agents and exchange it for an amount q1 of gold, or money, or anything else.

However a very common form of financial transaction involves a (possibly) not tradeable contract. A firm goes to a bank and, in exchange for a sum of money (a tradeable financial instrument), signs a loan agreement promising to pay back money out of future income. Here the loan agreement, I think, is financial capital (belonging to the bank), but possibly non-tradeable.

Tradeable forms of financial capital are called Financial Instruments:

Example: firm B gives firm A y1 of its input good Y. In exchange, firm A gives it a contract that reads 'We promise to give x1 units of our good X to anyone who presents this paper to us in one year's time.' This paper is something like a bond.

Example: Firm A gives firm C a contract that reads 'We promise to give x1 units of our good X to anyone who presents this paper to us in one year's time.' In exchange, firm C gives firm A a contract which reads 'We promise to give whoever holds this paper a percentage of our profits from now to eternity.' Firm A gives this contract to firm B in exchange for y1 of its input good Y. This contract is something like a share.

Example: (something like money) firm B gives firm A y1 of its input good Y. Firm A gives firm B a piece of paper that reads 'we promise to pay the bearer on demand the sum of q1, signed the bank of patagonia.' Firm A gives the bank of patagonia a piece of paper that reads 'we promise to pay back the sum of q1, made up of any one of a range of financial instruments of that value, in installments over the next ten years.'

Example: (not a contract) firm B gives firm A y1 of its input good Y. In exchange, firm A gives it a lump of gold, or a container of cigarettes.

DariusSokolov