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Åke E. Andersson and David Emanuel Andersson

Expectations of the future as influenced by a recent time series of returns tend to have the greatest influence on the value of capital. Most models of capital valuation employ the assumption that investors in capital make decisions that include a trade-off between risk (also known as “probabilistic uncertainty”) and expected returns. The so-called “CAPM” and “APT” models that we discuss in this chapter posit that investors optimize their portfolios of capital by minimizing risk subject to some required expected return. These procedures are applicable in situations of probabilistic uncertainty where the securities and other assets have a well-documented and uneventful history and other transparent characteristics. However, measures of statistical risk are no more than guesswork in the structurally uncertain situations that are associated with new start-ups and firms that specialize in disruptive product innovations. Uncertainty in this Knightian sense implies a set of possible future outcomes that is open-ended; there is no way to know how many possible outcomes should be listed as feasible. There is thus no structure that allows investors to make use of subjective probabilities in any meaningful sense. Optimism bias is common in situations of structural uncertainty, according to numerous empirical studies. This bias is particularly common when the stakes are high, such as when investment decisions involve start-ups or mergers and acquisitions. In this chapter we also discuss different theories of entrepreneurship before arriving at our conclusion, which is that Frank Knight’s entrepreneurship theory—with ownership, uncertainty and judgment as catchwords—is especially useful as a theoretical foundation for understanding dynamic markets. It is possible to extend Knightian theory in various directions, for example by integrating processes of adaptation and learning along the lines of Brian Arthur’s work. The aggregation of capital into a macro entity is another problem that we address in this chapter. We conclude that the only logical way of measuring macroeconomic capital is using the expectation-derived valuations of firms that stock markets and real estate markets continuously provide to market participants.

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Åke E. Andersson and David Emanuel Andersson

General equilibrium theory has been a dominant mode of thinking among economists since the mid-nineteenth century. In this chapter we claim that the solutions to the equations of deterministic as well as stochastic general equilibrium models are highly dependent on the structure of the infrastructural arena. In short, with the wrong institutions, insufficient networks for communications and transport or insufficient public knowledge and information, competitive equilibria cannot be found. Inclusion of the infrastructure—material networks, public knowledge and institutions—is a prerequisite for realistic theories, irrespective of whether these theories concern the growth of capital, competitive market equilibria or interactions between information flows and market processes. A fatal flaw in the dominant theory is the absence of institutions, especially the absence of property rights structures. Such institutions are necessary for the determination of initial wealth and income distributions as well as for the creation of mechanisms that ensure the stability and uniqueness of price-setting processes. To solve these problems we propose a general theory of the impacts of the material and non-material infrastructures on short-term market equilibria and information flows and on the accumulation of private capital stocks. This theory also allows for the possibility of occasional bifurcations into new economic structures.

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Åke E. Andersson and David Emanuel Andersson

In this chapter we provide a broad overview of the four logistical revolutions that initially only shaped European economic history, but later have come to affect all of the world’s regions. The First Logistical Revolution was a consequence of a slow but persistent extension of transport and communication networks, which eventually resulted in a sudden phase transition and a network that encompassed most of Western Europe. This led to a dramatic spatial restructuring of the European economy and the establishment of hundreds of market towns. While changes to the transport network was the underlying cause of the First Logistical Revolution, later restructurings also depended on other factors that improved network connectivity, especially technological knowledge gains and institutional reforms. The development of reliable credit systems was a major cause of the rapid increase in long-distance trade and commerce in the seventeenth century. Influential decision makers in Amsterdam seized the opportunity to innovate a series of path-breaking financial institutions and organizations in the early seventeenth century. The establishment of the first stock exchange was followed by the first bank with public guarantees. But Amsterdam did not remain unique for long. By the end of the seventeenth century, the Bank of England offered the same services but on a larger scale. The Bank of England had the right to organize transactions involving both money and bills of exchange; it later became the prototype for central banks in all parts of the world. The City of London thereby established its position as a leading financial center, which it has remained ever since. The Third Logistical Revolution is more often called the Industrial Revolution; technological progress was however only a proximate cause of this phase transition. The underlying cause was the abandonment of centrally planned mercantilism, first in Britain and later elsewhere, and the rise of the sort of liberal institutions that are closely associated with Scottish Enlightenment figures such as David Hume and Adam Smith. These institutions included free international trade, unrestricted entry to product markets and the reliable enforcement of private property rights with the help of an independent legal system such as English common law. We are now experiencing a Fourth Logistical Revolution, which is sometimes referred to as the Information Revolution. This ongoing restructuring is primarily a consequence of technological advances in information and telecommunications, which in turn reflect much earlier creative breakthroughs in science, as exemplified by the theoretical contributions of Alan Turing and John von Neumann in the 1930s and 1940s. The main contemporary symptoms are especially rapid global growth rates of international trade in services, science output and patents. In advanced regions of the world, there has been a transformation of the occupational structure away from manual work in the direction of creative knowledge services.

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Åke E. Andersson and David Emanuel Andersson

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Åke E. Andersson and David Emanuel Andersson

Social capital has been used in many different ways, and one aim of this chapter is to introduce a definition that is useful for the general theory that we propose in this book. Consequently, we limit ourselves to three major categories of capital: physical, human and social. Thus real estate capital is a combination of physical and social capital, while wages and salaries are payments for the human and social capital combinations that make each individual worker unique. We argue that it is helpful to use three levels of aggregation when analyzing social capital: micro, meso and macro. At the micro level, we find more or less stable interpersonal networks that tie people to one another in ways that increase “labor productivity,” while the meso level represents the various associations and subcultures that make up what is commonly referred to as civil society. The macro level of social capital is less obviously based on networks: it consists of the shared institutions and values that make a society more or less conducive to economic activities, ranging from everyday market transactions to disruptive product innovations. We thus view “institutional capital” and “cultural capital” as subsets of social capital. Logistical revolutions tend to have a social capital dimension. At present, the most visible manifestation of this is the cohort-driven change in social values from materialist, modernist values toward post-materialist, postmodern ones. Ronald Inglehart was the first to identify this restructuring, referring to it as “the silent revolution” in the 1970s.

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Åke E. Andersson and David Emanuel Andersson

Real estate capital is interesting not because it is a combination of land and physical capital (the usual interpretation), but because it represents a bundle of physical and social capital attributes. In places with high land values despite an elastic supply of land, it is social capital—that is, superior access to other people and adequate institutional support for economic interactions—that explains almost the entire capital value of local real estate. The capital value of real estate is around 50 percent of household wealth in Europe and the United States. In the Eurozone, the value of households’ direct real estate ownership amounted to more than €15 trillion in 2015. The price and thus capital value of a house varies between different locations because of actual and expected differences in accessibility, amenities and local services. An apartment on Fifth Avenue near Central Park may be therefore 50 times more valuable than a seemingly similar apartment in downtown Poughkeepsie, New York. Because of the extreme durability and fixity of real estate, there are substantial entrepreneurial opportunities in real estate markets. New uses, improved technical solutions and changes to the interior and exterior architecture of buildings are thus typical of the most dynamic cities. Some of the greatest increases in the cost of real estate are however not caused by an expansive regional economy, but instead by land use regulations that render the supply of developable land inelastic. North American examples of dramatic planning-induced increases in real estate values include Honolulu, San Francisco and Vancouver. Similar planning initiatives have made some of the world’s financial cities even less affordable than they would have been with less restrictive land use regulations, with Hong Kong and London being two notable examples of the combined land price effects of agglomeration economies and urban growth boundaries.

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Åke E. Andersson and David Emanuel Andersson

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Åke E. Andersson and David Emanuel Andersson

In the late Middle Ages, there was an unprecedented growth in the number of towns in Europe. Economic historians have focused on the critical role of the improved transport and trading network that preceded the growth of trade and the increased division of labor between the new towns as well as between each town and its rural hinterland. Much of Europe had been made up of autarchic fiefdoms until the eleventh century. There had been exceptions such as Venice, which acted as a node for what little trade there was between the eastern and western parts of the Mediterranean. The Crusades opened up new transport and trading opportunities and indirectly paved the way for the establishment of important trading houses in northern Italian cities, which pioneered various profitable banking practices. Examples include the Gran Tavola (the largest bank in Siena) and the extensive commercial and banking network of the Medici family in Florence. Henri Pirenne and later Fernand Braudel showed that the most important factor behind the increase in trading volumes, accumulated wealth and urban manufacturing was the slow but steady expansion of the European transport system, which eventually comprised a network that integrated all parts of Western Europe from the Mediterranean to the Baltic Sea.

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Åke E. Andersson and David Emanuel Andersson

Trade across space is central to economic theory. Trade presumes the existence of a transport system. Already in the eighteenth and nineteenth centuries, economists such as Adam Smith and David Ricardo elaborated upon the gains from trade between two nations. It was the Law of Comparative Advantage in production that explained the gains from trade, according to Ricardo. Eli Heckscher and Bertil Ohlin reformulated Ricardian trade theory by treating spatially trapped resources in different locations as the root cause of the existence of comparative advantages. Their treatment of space-bridging frictions remained implicit, however. Stella Dafermos and Anna Nagurney addressed this neglect by transforming older theories of international trade into a very general class of network-based interregional models of trade and transportation. These were the so-called “variational inequality models.” The German economist Johann Heinrich von Thünen developed an early spatial alternative to mainstream trade theory. In 1826, he formulated a complete general equilibrium theory of transport, location, land use and trade in a continuous one-dimensional model. In the second half of the twentieth century, Martin Beckmann and Tönu Puu showed that von Thünen’s model is applicable to two-dimensional continuous space. Spatial economic theory, which in principle includes all theories of international and interregional trade, has evolved over time. Early implicit models evolved into models with discrete systems of regions and then into models with continuous one- or two-dimensional space. However, all of these theories and models assume the prior existence of a transport system. In this chapter we show that economic actors create networks of nodes (towns) and links (trading routes) because they expect various advantages to arise due to new opportunities for trade. Such network creation is a type of entrepreneurship that exhibits consequences that are unusually collective. Hence agglomerations of people and productive activities reflect accessibility differences and these differences are associated with unequal internal and external scale economies. We also show that there is a self-organizing process of network creation that makes cities more efficient over time.

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Åke E. Andersson and David Emanuel Andersson

Classical economists such as Adam Smith, David Ricardo, John Stuart Mill and Karl Marx introduced the concepts of time and capital to economics. They developed the labor theory of value, thereby assuming that the historical process of accumulated labor would determine the value of capital goods. By the end of the nineteenth century, a number of economists had started to question this approach to capital theory. Carl Menger proposed a completely different theory, focusing instead on the role of expectations. He used this new theory as an argument against the labor theory of value; the subjective preferences of consumers rather than labor inputs were for Menger the ultimate source of economic value, including the value of capital. According to Menger, historical circumstances have made goods available in the present, and these circumstances mostly reflect producers’ expectations of future profits. Subsequently, Eugen von Böhm-Bawerk and Knut Wicksell formulated dynamic models that showed that the expected future flow of returns would determine the value of capital. They linked this to an optimality condition that required the expected growth rate of the capital value to equal the interest rate on loanable funds. In this chapter, we show that markets for works of art offer an especially lucid illustration of the importance of expectations and the irrelevance of labor inputs. Frank Knight was the first economist to analyze the structural uncertainty of long-term expectations, while Irving Fisher showed that the credit market is essential for investors in real capital. Fisher suggested the possibility of using a two-stage decision process. In the first stage, the investor would aim to maximize the expected value of a project. The second stage would make the investor aim at an optimal solution by becoming a borrower in the credit market. Wicksell and later John Maynard Keynes modeled the dual problem of an equilibrium interest rate and another interest rate that arises within the banking system as a cause of inflation or unemployment. Only much later was this to become the main concern of central banks.