Capital (economics)

Is Capital Income? (1921) by George Howard Earle, Jr.

Capital is a type of good that can be consumed now, but if consumption is deferred, an increased supply of consumable goods is likely to be available later. Adam Smith defines capital as "That part of a man's stock which he expects to afford him revenue is called his capital." Capital is derived from the Latin word "caput" meaning head, as in "head of cattle".^[1] The term "stock" is derived from the Old English word for stump or tree trunk, i.e. something that grows over time.^[2] It has been used to refer to all the moveable property of a farm since at least 1510.^[3] In Middle Ages France contracted leases and loans bearing interest specified payment in heads of cattle.^[4]

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.

How a capital good is maintained or returned to its pre-production state varies with the type of capital involved. In most cases capital is replaced after a depreciation period as newer forms of capital make continued use of current capital non profitable. It is also possible that advances make an obsolete form of capital practical again.

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).

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.

In classical economic schools of thought, particularly in Marxist political economy,^[5] 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

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.^[6][7] 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, e.g. trees.
• 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 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.^[8]

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".^[9]

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:^[10]

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 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.^[11]

See also

• Cambridge capital controversy
• Capital accumulation
• Capital deepening
• Capital good
• Capitalism
• Capitalist mode of production
• Constant capital
• Das Kapital
• Factors of production
• Means of production
• Organic composition of capital
• Organizational capital
• Physical capital
• The Accumulation of Capital
• Variable capital
• Venture capital
• Wealth (economics)

References

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