Capital (economics)

In economics, capital consists of an asset that can enhance one's power to perform economically useful work. For example, in a fundamental sense a stone or an arrow is capital for a caveman who can use it as a hunting instrument, while roads are capital for inhabitants of a city.

Adam Smith defines capital as "that part of man's stock which he expects to afford him revenue". The term "stock" is derived from the Old English word for stump or tree trunk. It has been used to refer to all the moveable property of a farm since at least 1510.[1]

Capital goods, real capital, or capital assets are already-produced, durable goods or any non-financial asset that is used in production of goods or services.[2]

Capital is distinct from land (or non-renewable resources) in that capital can be increased by human labor. At any given moment in time, total physical capital may be referred to as the capital stock (which is not to be confused with the capital stock of a business entity).

Capital is an input in the production function. Homes and personal autos are not usually defined as capital but as durable goods because they are not used in a production of saleable goods and services.

In Marxian political economy,[3] capital is money used to buy something only in order to sell it again to realize a profit. For Marx capital only exists within the process of the economic circuit (represented by M-C-M') —it is wealth that grows out of the process of circulation itself, and for Marx it formed the basis of the economic system of capitalism. In more contemporary schools of economics, this form of capital is generally referred to as "financial capital" and is distinguished from "capital goods".

In narrow and broad uses

Classical and neoclassical economics regard capital as one of the factors of production (alongside the other factors: land and labour). All other inputs to production are called intangibles in classical economics. This includes organization, entrepreneurship, knowledge, goodwill, or management (which some characterize as talent, social capital or instructional capital).

This is what makes it a factor of production:

  • The good is not used up immediately in the process of production unlike raw materials or intermediate goods. (The significant exception to this is depreciation allowance, which like intermediate goods, is treated as a business expense.)
  • The good can be produced or increased (in contrast to land and non-renewable resources).

These distinctions of convenience have carried over to contemporary economic theory.[4][5] There was the further clarification that capital is a stock. As such, its value can be estimated at a point in time. By contrast, investment, as production to be added to the capital stock, is described as taking place over time ("per year"), thus a flow.

Marxian economics distinguishes between different forms of capital:

  • constant capital, which refers to capital goods
  • variable capital, which refers to labor-inputs, where the cost is "variable" based on the amount of wages and salaries are paid throughout the duration of an employee's contract/employment,
  • fictitious capital, which refers to intangible representations or abstractions of physical capital, such as stocks, bonds and securities (or "tradable paper claims to wealth")

Earlier illustrations often described capital as physical items, such as tools, buildings, and vehicles that are used in the production process. Since at least the 1960s economists have increasingly focused on broader forms of capital. For example, investment in skills and education can be viewed as building up human capital or knowledge capital, and investments in intellectual property can be viewed as building up intellectual capital. These terms lead to certain questions and controversies discussed in those articles.

Modern types of capital

Detailed classifications of capital that have been used in various theoretical or applied uses generally respect the following division:

  • Financial capital, which represents obligations, and is liquidated as money for trade, and owned by legal entities. It is in the form of capital assets, traded in financial markets. Its market value is not based on the historical accumulation of money invested but on the perception by the market of its expected revenues and of the risk entailed.
  • Natural capital, which is inherent in ecologies and which increases the supply of human wealth
  • Social capital, which in private enterprise is partly captured as goodwill or brand value, but is a more general concept of inter-relationships between human beings having money-like value that motivates actions in a similar fashion to paid compensation.
  • Instructional capital, defined originally in academia as that aspect of teaching and knowledge transfer that is not inherent in individuals or social relationships but transferrable. Various theories use names like knowledge or intellectual capital to describe similar concepts but these are not strictly defined as in the academic definition and have no widely agreed accounting treatment.
  • Human capital, a broad term that generally includes social, instructional and individual human talent in combination. It is used in technical economics to define “balanced growth”, which is the goal of improving human capital as much as economic capital.
  • Public capital is a blanket term that attempts to characterize physical capital that is considered infrastructure and which supports production in unclear or poorly accounted ways. This encompasses the aggregate body of all government-owned assets that are used to promote private industry productivity, including highways, railways, airports, water treatment facilities, telecommunications, electric grids, energy utilities, municipal buildings, public hospitals and schools, police, fire protection, courts and still others. However it is a problematic term insofar as many of these assets can be either publicly or privately owned.

Separate literatures have developed to describe both natural capital and social capital. Such terms reflect a wide consensus that nature and society both function in such a similar manner as traditional industrial infrastructural capital, that it is entirely appropriate to refer to them as different types of capital in themselves. In particular, they can be used in the production of other goods, are not used up immediately in the process of production, and can be enhanced (if not created) by human effort.

There is also a literature of intellectual capital and intellectual property law. However, this increasingly distinguishes means of capital investment, and collection of potential rewards for patent, copyright (creative or individual capital), and trademark (social trust or social capital) instruments.

Interpretations

Economist Henry George argued that financial instruments like stocks, bonds, mortgages, promissory notes, or other certificates for transferring wealth is not really capital, because "Their economic value merely represents the power of one class to appropriate the earnings of another" and "their increase or decrease does not affect the sum of wealth in the community".[6]

Some thinkers, such as Werner Sombart and Max Weber, locate the concept of capital as originating in double-entry bookkeeping, which is thus a foundational innovation in capitalism, Sombart writing in "Medieval and Modern Commercial Enterprise" that:[7]

The very concept of capital is derived from this way of looking at things; one can say that capital, as a category, did not exist before double-entry bookkeeping. Capital can be defined as that amount of wealth which is used in making profits and which enters into the accounts."

Within classical economics, Adam Smith (Wealth of Nations, Book II, Chapter 1) distinguished fixed capital from circulating capital. The former designated physical assets not consumed in the production of a product (e.g. machines and storage facilities), while the latter referred to physical assets consumed in the process of production (e.g. raw materials and intermediate products). For an enterprise, both were types of capital.

Karl Marx adds a distinction that is often confused with David Ricardo's. In Marxian theory, variable capital refers to a capitalist's investment in labor-power, seen as the only source of surplus-value. It is called "variable" since the amount of value it can produce varies from the amount it consumes, i.e., it creates new value. On the other hand, constant capital refers to investment in non-human factors of production, such as plant and machinery, which Marx takes to contribute only its own replacement value to the commodities it is used to produce.

Investment or capital accumulation, in classical economic theory, is the production of increased capital. Investment requires that some goods be produced that are not immediately consumed, but instead used to produce other goods as capital goods. Investment is closely related to saving, though it is not the same. As Keynes pointed out, saving involves not spending all of one's income on current goods or services, while investment refers to spending on a specific type of goods, i.e., capital goods.

Austrian School economist Eugen Boehm von Bawerk maintained that capital intensity was measured by the roundaboutness of production processes. Since capital is defined by him as being goods of higher-order, or goods used to produce consumer goods, and derived their value from them, being future goods.

Human development theory describes human capital as being composed of distinct social, imitative and creative elements:

  • Social capital is the value of network trusting relationships between individuals in an economy.
  • Individual capital, which is inherent in persons, protected by societies, and trades labour for trust or money. Close parallel concepts are "talent", "ingenuity", "leadership", "trained bodies", or "innate skills" that cannot reliably be reproduced by using any combination of any of the others above. In traditional economic analysis individual capital is more usually called labour.
  • Instructional capital in the academic sense is clearly separate from either individual persons or social bonds between them.

This theory is the basis of triple bottom line accounting and is further developed in ecological economics, welfare economics and the various theories of green economics. All of which use a particularly abstract notion of capital in which the requirement of capital being produced like durable goods is effectively removed.

The Cambridge capital controversy was a dispute between economists at Cambridge, Massachusetts based MIT and University of Cambridge in the UK about the measurement of capital. The Cambridge, UK economists, including Joan Robinson and Piero Sraffa claimed that there is no basis for aggregating the heterogeneous objects that constitute 'capital goods.'

Political economists Jonathan Nitzan and Shimshon Bichler have suggested that capital is not a productive entity, but solely financial and that capital values measure the relative power of owners over the broad social processes that bear on profits.[8]

See also

References

  1. ^ "Online Etymology Dictionary". Online Etymology Dictionary. Retrieved 14 December 2014.
  2. ^ Boulding, Kenneth E. "Capital and interest". Encyclopedia Britannica. Retrieved July 22, 2017.
  3. ^ "Definition of Capital on Marxists.org". Encyclopedia of Marxism. Marxism.org. Retrieved 8 February 2013.
  4. ^ Paul A. Samuelson and William D. Nordhaus (2004). Economics, 18th ed.
  5. ^ Glossary of Terms, "Capital (capital goods, capital equipment)."
       • Deardorff's Glossary of International Economics, Capital.
  6. ^ George, Henry. "Progress and Poverty, Chapter 2". www.henrygeorge.org. Bob Drake. Retrieved July 22, 2017.
  7. ^ Lane, Frederic C; Riemersma, Jelle, eds. (1953). Enterprise and Secular Change: Readings in Economic History. R. D. Irwin. p. 38. (quoted in "Accounting and rationality" Archived 2011-07-22 at the Wayback Machine)
  8. ^ Capital as Power: A Study of Order and Creorder, Routledge, 2009, p, 228.

Further reading

  • Boldizzoni, F. (2008). "4–8". Means and ends: The idea of capital in the West, 1500–1970. New York: Palgrave Macmillan.
  • Hennings, K.H. (1987). "Capital as a factor of production". The New Palgrave: A Dictionary of Economics. v. 1. pp. 327–33.

External links

Capital Economics

Capital Economics is an economic research consultancy based in London. In 2012 it won the Wolfson Economics Prize for the best proposal on how a member state could leave the eurozone.

Capital accumulation

Capital accumulation (also termed the accumulation of capital) is the dynamic that motivates the pursuit of profit, involving the investment of money or any financial asset with the goal of increasing the initial monetary value of said asset as a financial return whether in the form of profit, rent, interest, royalties or capital gains. The process of capital accumulation forms the basis of capitalism, and is one of the defining characteristics of a capitalist economic system.

Capital asset

A capital asset is defined to include property of any kind held by an assessee, whether connected with their business or profession or not connected with their business or profession. It includes all kinds of property, movable or immovable, tangible or intangible, fixed or circulating. Thus, land and building, plant and machinery, motorcar, furniture, jewellery, route permits, goodwill, tenancy rights, patents, trademarks, shares, debentures, securities, units, mutual funds, zero-coupon bonds etc. are capital assets.

Capital flight

Capital flight, in economics, occurs when assets or money rapidly flow out of a country, due to an event of economic consequence. Such events could be an increase in taxes on capital or capital holders or the government of the country defaulting on its debt that disturbs investors and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic strength.

This leads to a disappearance of wealth, and is usually accompanied by a sharp drop in the exchange rate of the affected country—depreciation in a variable exchange rate regime, or a forced devaluation in a fixed exchange rate regime.

This fall is particularly damaging when the capital belongs to the people of the affected country, because not only are the citizens now burdened by the loss in the economy and devaluation of their currency, but probably also, their assets have lost much of their nominal value. This leads to dramatic decreases in the purchasing power of the country's assets and makes it increasingly expensive to import goods and acquire any form of foreign facilities, e.g. medical facilities.

Capital good

A capital good (also called complex products and systems or (CoPS)) is a durable good that is used in the production of goods or services. Capital goods are one of the three types of producer goods, the other two being land and labour. The three are also known collectively as "primary factors of production"

This classification originated during the classical economics period and has remained the dominant method for classification.

Many definitions and descriptions of capital goods production have been proposed in the literature. Capital goods are generally considered one-of-a-kind, capital intensive products that consist of many components. They are often used as manufacturing systems or services themselves.

Examples include automated storage and retrieval systems, automatic test equipment, battleships, baggage handling systems, data centers, oil rigs, roller coaster equipment, semiconductor fabrication plants, and wind turbines. Their production is often organized in projects, with several parties cooperating in networks (Hicks et al. 2000; Hicks and McGovern 2009; Hobday 1998).

A capital good lifecycle typically consists of tendering, engineering and procurement, manufacturing, commissioning, maintenance and (sometimes) decommissioning . In terms of economics, capital goods are tangible property. A society acquires capital goods by saving wealth that can be invested in the means of production. People use them to produce other goods or services within a certain period. Machinery, tools, buildings, computers, or other kinds of equipment that are involved in production of other things for sale are capital goods. The owners of the capital good can be individuals, households, corporations or governments. Any material used to produce capital goods is also considered a capital good.

Capital intensity

Capital intensity is the amount of fixed or real capital present in relation to other factors of production, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital to labor ratio, such as from the points along a capital/labor isoquant.

Circulating capital

Circulating capital includes intermediate goods and operating expenses, i.e., short-lived items that are used in production and used up in the process of creating other goods or services. This is roughly equal to intermediate consumption. Finer distinctions include raw materials, intermediate goods, inventories, ancillary operating expenses and (working capital). It is contrasted with fixed capital. The term was used in more specialized ways by classical economists such as Adam Smith, David Ricardo and Karl Marx.

Where the distinction is used, circulating capital is a component of (total) capital, also including fixed capital used in a single cycle of production. In contrast to fixed capital, it is used up in every cycle (raw materials, basic and intermediate materials, combustible, energy…). In accounting, the circulating capital comes under the heading of current assets.

Building on the work of Quesnay and Turgot, Adam Smith (1776) made the first explicit distinction between fixed and circulating capital. In his usage, circulating capital includes wages and labour maintenance, money, and inputs from land, mines, and fisheries associated with production.According to Karl Marx (second volume of Das Kapital, end of chapter 7) the turnover of capital influences "the processes of production and self-expansion", the two new forms of capital, circulating and fixed, "accrue to capital from the process of circulation and affect the form of its turnover". In the following chapter Marx defines fixed capital and circulating capital. In chapter 9 he claims: "We have here not alone quantitative but also qualitative difference."

Conventionally, (physical) capital assets held by a business for more than one year are regarded in annual accounting statements as "fixed", the rest as "circulating". In modern economies such as the United States, roughly half of the intermediate inputs bought or used by businesses are in fact services, and not goods.

Factors of production

In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, finished goods and services. The utilized amounts of the various inputs determine the quantity of output according to the relationship called the production function. There are three basic resources or factors of production: land, labor, and capital. The factors are also frequently labeled "producer goods or services" to distinguish them from the goods or services purchased by consumers, which are frequently labeled "consumer goods".

There are two types of factors: primary and secondary. The previously mentioned primary factors are land, labor, and capital goods.

Materials and energy are considered secondary factors in classical economics because they are obtained from land, labour, and capital. The primary factors facilitate production but neither becomes part of the product (as with raw materials) nor becomes significantly transformed by the production process (as with fuel used to power machinery). Land includes not only the site of production but also natural resources above or below the soil. Recent usage has distinguished human capital (the stock of knowledge in the labor force) from labor. Entrepreneurship is also sometimes considered a factor of production. Sometimes the overall state of technology is described as a factor of production. The number and definition of factors vary, depending on theoretical purpose, empirical emphasis, or school of economics.

Human capital

Human capital is the stock of habits, knowledge, social and personality attributes (including creativity) embodied in the ability to perform labor so as to produce economic value.Human capital is unique and differs from any other capital. It is needed for companies to achieve goals, develop and remain innovative. Companies can invest in human capital for example through education and training enabling improved levels of quality and production. Human capital theory is closely associated with the study of human resources management as found in the practice of business administration and macroeconomics.

The original idea of human capital can be traced back at least to Adam Smith in the 18th century. The modern theory was popularized by Gary Becker, an economist and Nobel Laureate from the University of Chicago, Jacob Mincer, and Theodore Schultz. As a result of his conceptualization and modeling work using Human Capital as a key factor, the Nobel Prize for Economics, 2018, was awarded (jointly) to Paul Romer who founded the modern innovation-driven approach to understanding economic growth.

In the recent literature, the new concept of task-specific human capital was coined in 2004 by Robert Gibbon, an economist at MIT, and Michael Waldman, an economist at Cornell University. The concept emphasizes that in many cases, human capital is accumulated specific to the nature of the task (or, skills required for the task), and the human capital accumulated for the task are valuable to many firms requiring the transferable skills. This concept can be applied to job-assignment, wage dynamics, tournament, promotion dynamics inside firms, etc.

Individual capital

Individual capital, the economic view of talent, comprises inalienable or personal traits of persons, tied to their bodies and available only through their own free will, such as skill, creativity, enterprise, courage, capacity for moral example, non-communicable wisdom, invention or empathy, non-transferable personal trust and leadership.

Instructional capital

Instructional capital is a term used in educational administration after the 1960s, to reflect capital resulting from investment in producing learning materials.

Some have objected to this phrasing, which is an elaboration of referring to training as "human capital", either for the same reason that phrase is objectionable, or on the grounds that it implies that the human in which the knowledge is "invested" is a resource to be exploited.

Instructional capital can be used to guide or limit or restrict action by people (individual capital) or equipment (infrastructural capital) (if the learning materials are computer programs). It cannot generally make either individuals or infrastructure do what they are not trained or designed to do, but it can help prevent them from doing most stupid, destructive and dangerous things.

When people begin to trust instructions, they tend to associate social capital with them, as symbolized by a brand, flag or label. This usually opens up a possibility for those with power to start cheating and/or creating bad instructions that can no longer be trusted, but the good reputation of the brand, flag or label protects them from being caught for longer than would be the case without the symbol that is associated with good reputation.

Intellectual capital

Intellectual capital is the intangible value of a business, covering its people (human capital), the value relating to its relationships (relational capital), and everything that is left when the employees go home (structural capital), of which intellectual property (IP) is but one component. It is the sum of everything everybody in a company knows that gives it a competitive edge. The term is used in academia in an attempt to account for the value of intangible assets not listed explicitly on a company's balance sheets. On a national level intellectual capital refers to national intangible capital, NIC.

A second meaning that is used in academia and was adopted in large corporations is focused on the recycling of knowledge via knowledge management and intellectual capital management (ICM). Creating, shaping and updating the stock of intellectual capital requires the formulation of a strategic vision, which blends together all three dimensions of intellectual capital within the organisational context through exploration, exploitation, measurement, and disclosure. Intellectual capital is used in the context of assessing the wealth of organizations. A metric for the value of intellectual capital is the amount by which the enterprise value of a firm exceeds the value of its tangible (physical and financial) assets. Directly visible on corporate books is capital embodied in its physical assets and financial capital; however all three make up the value of an enterprise. Measuring the real value and the total performance of intellectual capital's components is a critical part of running a company in the knowledge economy and Information Age. Understanding the intellectual capital in an enterprise allows leveraging of its intellectual assets. For a corporation, the result will optimize its stock price.

The IFRS (International Financial Reporting Standards) committee developed the International Accounting System 38 with the purpose of prescribing the accounting treatment for intangible assets. IAS 38.8 defines an intangible asset as an identifiable non-monetary asset without physical substance. An asset is a resource that is controlled by the entity as the result of past events (for example purchase or self-creation) and from which future economic benefits (inflows of cash or other benefits) are expected.

Liquid capital

Liquid Capital, or Fluid capital is a readily convertible asset, such as money or other bearer economic instruments, as opposed to a long term asset like real estate. Liquid capital may be held by individuals, companies, or governments.

Globalization means that developing countries have easier access to liquid capital from around the world, but if a country becomes too dependent on foreign liquid capital any political or economic difficulties can be exacerbated by capital flight.

Means of production

In economics and sociology, the means of production (also called capital goods) are physical and non-financial inputs used in the production of economic value. These include raw materials, facilities, machinery and tools used in the production of goods and services. In the terminology of classical economics, the means of production are the "factors of production" minus financial and human capital.

The social means of production are capital goods and assets that require organized collective labor effort, as opposed to individual effort, to operate on. The ownership and organization of the social means of production is a key factor in categorizing and defining different types of economic systems.

The means of production includes two broad categories of objects: instruments of labor (tools, factories, infrastructure, etc.) and subjects of labor (natural resources and raw materials). People operate on the subjects of labor using the instruments of labor to create a product; or stated another way, labor acting on the means of production creates a good. In an agrarian society the principal means of production is the soil and the shovel. In an industrial society the means of production become social means of production and include factories and mines. In a knowledge economy, computers and networks are means of production. In a broad sense, the "means of production" also includes the "means of distribution" such as stores, the internet and railroads (Infrastructural capital).

Modigliani–Miller theorem

The Modigliani–Miller theorem (of Franco Modigliani, Merton Miller) is an influential element of economic theory; it forms the basis for modern thinking on capital structure. The basic theorem states that in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. Since the value of the firm depends neither on its dividend policy nor its decision to raise capital by issuing stock or selling debt, the Modigliani–Miller theorem is often called the capital structure irrelevance principle.

The key Modigliani-Miller theorem was developed in a world without taxes. However, if we move to a world where there are taxes, when the interest on debt is tax-deductible, and ignoring other frictions, the value of the company increases in proportion to the amount of debt used. And the source of additional value is due to the amount of taxes saved by issuing debt instead of equity.

Modigliani was awarded the 1985 Nobel Prize in Economics for this and other contributions.

Miller was a professor at the University of Chicago when he was awarded the 1990 Nobel Prize in Economics, along with Harry Markowitz and William F. Sharpe, for their "work in the theory of financial economics", with Miller specifically cited for "fundamental contributions to the theory of corporate finance".

Natural capital

Natural capital is the world's stock of natural resources, which includes geology, soils, air, water and all living organisms. Some natural capital assets provide people with free goods and services, often called ecosystem services. Two of these (clean water and fertile soil) underpin our economy and society and make human life possible.It is an extension of the economic notion of capital (resources which enable the production of more resources) to goods and services provided by the natural environment. For example, a well-maintained forest or river may provide an indefinitely sustainable flow of new trees or fish, whereas over-use of those resources may lead to a permanent decline in timber availability or fish stocks. Natural capital also provides people with essential services, like water catchment, erosion control and crop pollination by insects, which in turn ensure the long-term viability of other natural resources. Since the continuous supply of services from the available natural capital assets is dependent upon a healthy, functioning environment, the structure and diversity of habitats and ecosystems are important components of natural capital. Methods, called 'natural capital asset checks', help decision-makers understand how changes in the current and future performance of natural capital assets will impact on human well-being and the economy.

Organizational capital

Organizational capital is the value to an enterprise which is derived from organization philosophy and systems which leverage the organization’s capability in delivering goods or services.

Physical capital

In economics, physical capital or just capital is a factor of production (or input into the process of production), consisting of machinery, buildings, computers,etc.Its is divided into 2 categories-working and fixed capital.The production function takes the general form Y=f(K, L, N), where Y is the amount of output produced, K is the amount of capital stock used, L is the amount of labor used, and N is the amount of natural resources used. In economic theory, physical capital is one of the three primary factors of production; the others are natural resources (including land), and labor—the stock of competences embodied in the labor force. Physical capital is distinct from human capital (a result of investment in the human agent), circulating capital, and financial capital. Physical capital is fixed capital, which is any kind of real physical asset that is not used up in the production of a product. Usually the value of land is not included in physical capital as it is not a reproducible product of human activities.

Symbolic capital

In sociology and anthropology, symbolic capital can be referred to as the resources available to an individual on the basis of honor, prestige or recognition, and serves as value that one holds within a culture. A war hero, for example, may have symbolic capital in the context of running for political office.

Theorists have argued that symbolic capital accumulates primarily from the fulfillment of social obligations that are themselves embedded with potential for prestige. Much as with the accumulation of financial capital, symbolic capital is 'rational' in that it can be freely converted into leveraging advantage within social and political spheres. Yet unlike financial capital, symbolic capital is not boundless, and its value may be limited or magnified by the historical context in which it was accumulated. Symbolic capital must be identified within the cultural and historical frame through which it originated in order to fully explain its influence across cultures.Objects, as abstract representations of their environments, may also possess symbolic capital. This capital may be embedded in the built environment, or urban form of a city, as a symbolic representation of that land's cultural value. For example, landmarks usually have symbolic value and utility. They become landmarks precisely because they have symbolic value. This reciprocal relationship provides the landmark with cultural or environmental meaning, while at the same time lending its environment a layer of prestige.

Types of capital
By form
By term
Marxist analytical
Marxist historical

This page is based on a Wikipedia article written by authors (here).
Text is available under the CC BY-SA 3.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.