Posted by: Dirk | August 27, 2012

Profit sharing as alternative for interest rate

I have been at a book presentation of David Graeber (5,000 years of Debt) in May at Dussmann Berlin and he reminded me of something I have long forgotten: profit-sharing is an alternative for an interest rate. The incentives the two mechanisms create are quite distinct. With an interest rate, the creditor is supposed to get his money (back) whatever occurs. With a profit-sharing agreement, this looks quite differently. Only when the debtor books positive profits does the debtor get his or her share.

Now in the situation of Greece, maybe a profit share agreement would make more sense then an interest rate. The German government would then perhaps better understand what the problem of Greece is. As a result of cuts in government spending, incomes are falling. Since taxes depend on incomes they are falling as well, in fact eating up all budget improvements from the spending cuts.

Sometimes a little rephrasing does wonders. How about replacing interest rates on some sovereign bonds with profit-sharing agreements? It probably has a positive effect on incentives and would point more directly to the heart of the matter.

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Responses

  1. Profit sharing will not make much appeal to those investors who are risk averse since profit sharing also means profit and loss sharing. Cautious investors will prefer fixed interest rate income. However a combination of the two (profit and loss sharing and fixed rate income) could be a preferable approach.

  2. I don’t see “profit sharing” working for an entire country: how does one measure the “profit” made by Greece or any other country?

    However Islamic finance is certainly onto something in taking a dim view of interest and promoting profit sharing instead (not that I know anything about Islamic finance). I suggest there are two areas where interest is questionable.

    First, simply storing up money units (e.g. dollars) is an activity that serves no useful purpose: money units are just numbers in computers. Those numbers can be created in any number any time. Thus there is no reason to reward people who hoard these units.

    Second, borrowing money at interest and investing that money is inherently risky. What happens when the value of the investments falls below the value of money borrowed? The borrower is heading for bankruptcy. The latter activity is exactly what banks do big time under fractional reserve. It’s precisely what gives rise to the need for the TBTF subsidy and the occasional trillion dollar mega bail-out.

    In contrast, under full reserve, depositors (if they want any sort of reward along the lines of interest) have to carry the risk of it all going belly up. I.e. they have to share profits and losses. That way it’s near impossible for banks to go bust.

  3. You should check out the writings of Chris Cook at Open Capital: http://www.opencapital.net/


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