Capital (economics)

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Not to be confused with economic capital or financial capital.
Finance

In economics, 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. Additionally, some accounting systems recognize the concept of a Triple bottom line which takes into account natural capital and social capital, thus including ecosystems and social relations in the definition of capital.

Control and protection of capital obtained through jobs is the primary means of accumulating wealth in the modern economy. If a broader definition of wealth is used (say including health or well-being) then a broader definition of capital is appropriate.

In all systems of accounting and in all definitions of asset types, the capital goods are not significantly consumed, though they may depreciate in the production process. How a capital good or asset is maintained or regrown or returned to its pre-production state varies based on the type of capital involved.

Manufactured or physical capital is distinct from land (or natural capital) in that capital must itself be produced by human labor before it can be a factor of production. 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.)

In a fundamental sense, capital consists of any produced thing that can enhance a person's power to perform economically useful work—a stone or an arrow is capital for a caveman who can use it as a hunting instrument, and roads are capital for inhabitants of a city. 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. The division between capital and durable good is set in an accounting regime and depends on the types or styles of capital that are recognized as capital assets and the types of goods and services that are recognized as economic. For instance natural capital produces one yield of agricultural output and social capital substitutes significantly for financial in developing economies, and triple bottom line accounting recognizes this. See human capital and instructional capital for other ways in which non-manufactured items are viewed as capital used in production. See intangibles on how the division is drawn.

In classical economic schools of thought, particularly in Marxist political economy,[1] capital is money used to buy something only in order to sell it again to realize a financial profit. For Marx capital only exists within the process of economic exchange—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

In classical and neoclassical economics, capital is one of the factors of production. The others are 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).

Goods with the following features are capital:

  • It can be used in the production of other goods (this is what makes it a factor of production).
  • It 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.)
  • It was produced, in contrast to "land", which refers to naturally occurring resources such as geographical locations and minerals. This last condition is removed and replaced with looser conditions such as the capital asset being fungible, clearly defined in right by a deed or patent, or transferrable between persons, or some such. The requirement that it be produced by a production process similar to a durable good is relatively arbitrary, extremely hotly debated and in any case changes as production processes differ. For instance, it is possible to produce genetic material in a lab or in an organism - thus organisms themselves can be understood as being produced.

These distinctions of convenience have carried over to contemporary economic theory.[2][3] 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.

In Marxian economics, there are distinctions 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 "tradeable 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 protected by communities to support life, e.g., a river that provides farms with water.
  • 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. A far less common term, spiritual capital, refers to the power, influence and dispositions created by a person or an organization’s spiritual belief, knowledge and practice, which is also an aspect of human capital that may not be easily captured as a component social, instructional or individual element.

Public and private sector accounting differ in goals, time scales and accordingly in accounting. The ownership and control of some forms of capital may accordingly justify differentiating it in an economic theory. A blanket term that attempts to characterize all that clearly physical capital that is considered infrastructure and which supports production in unclear or poorly accounted ways is public capital. 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.

Endowment

Endowment is the natural state of something, before it is processed. The production turns an endowment into capital. Just as capital can be split into natural capital etcetera, so endowment can also be split into a country's natural endowment or a population's endowment.[4]

Interpretations

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:[5]

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. It is constant, in that the amount of value committed in the original investment, and the amount retrieved in the form of commodities produced, remains constant.

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 von Böhm-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.[6]

See also

References

  1. ↑ "Definition of Capital on Marxists.org". Encyclopedia of Marxism. Marxism.org. Retrieved 8 February 2013. 
  2. ↑ Paul A. Samuelson and William D. Nordhaus (2004). Economics, 18th ed.,
  3. ↑ Glossary of Terms, "Capital (capital goods, capital equipment)."
       • Deardorff's Glossary of International Economics, Capital.
  4. ↑ http://www.econlib.org/cgi-bin/searchbooks.pl?searchtype=BookSearchPara&id=bbPTC&query=endowment
  5. ↑ 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")
  6. ↑ Capital as Power: A Study of Order and Creorder, Routledge, 2009, p, 228.

Further reading

  • Boldizzoni, F. (2008). "chapters 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

  • Quotations related to Capital at Wikiquote
Types of capital
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Marxist historical
See also: Five Capitals
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