Capital Investment Choices ...... different to buying groceries!

Is there fundamentally any difference between capital investments and any other kinds of expenditure choices?  In a word—Yes.  Unfortunately—and incorrectly—most economic theory doesn’t differentiate between the two.

When you are making a choice between some alternate consumption goods—apples or oranges for instance—the value in your mind’s eye comes from past experience (Think for a minute how different the decision is regarding some fruit that you’ve never eaten before).  “Value” comes from repeat purchases and trial-and-error, and past experience is usually a reliable guide to the future.  Value materializes quickly.  The actions of others influence this value only peripherally.  And if the value doesn’t materialize the way you expect it too, you can frequently get your money back—there is very little loss in value when your expectations are misplaced.

Capital investment choice on the other hand is open-ended.  You can’t make repeat purchases.  Learning by trial-and-error is possible only at an abstract or conceptual level.  Capital investment choices are choices between alternate paths into the future, and these paths themselves involve follow-on choice constrained by the initial path chosen.  Few elements of the choice can be reversed if this future turns out to be different to your expectations.  Value materializes only slowly over time, and is directly affected by others pursuing their own often-contradictory plans. You can exercise only limited control over large elements of the environment.  And when you make the choice it takes time for the value to be understood.

What style of choices are we talking about here?  Obviously, capital investment decisions in business—mining, transport, utilities, or any capital intensive industry.  But capital investment choices are even more important at an individual level—for family and career choices.  If you choose the wrong career path and the envisaged value doesn’t materialize the way you expect it too, you definitely can’t get your money or your time back.

Caution!  Many models of choice used in business schools are derived from economic theory assuming consumer goods.  Unlike capital goods, consumer markets seldom involve sunk costs—and this makes a big difference.  Naïvely following these models can lock in future choice in ways you would never otherwise agree to.