Capital (economics)
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In economics, capital or capital goods or real capital refers to items of extensive value, it can also be applied to the amount of wealth a person controls or is capable of controlling.
Capital goods may be acquired with money or financial capital. In finance and accounting, capital generally refers to financial wealth, especially that used to start or maintain a business, sometimes referred to as Cash flow.
Capital in narrow and broad uses
In classical economics, capital is one of three (or four, in some formulations) factors of production. The others are land, labor and (in some versions) organization, entrepreneurship, or management.So basically capital is money that can be invested in business. 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 was produced, in contrast to "land," which refers to naturally occurring resources such as geographical locations and minerals.
- 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.)
These distinctions of convenience carried over to neoclassical economics with little change in formal analysis for an extended period. There was the further clarification that capital is a stock. As such, its value can be estimated at a point in time, say December 31. By contrast, investment, as production to be added to the capital stock, is described as taking place over time ("per year"), thus a flow.
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. 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 labor 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.
Further classifications of capital that have been used in various theoretical or applied uses include:
- 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 which provides farms with water.
- Infrastructural capital is non-natural support systems (e.g. clothing, shelter, roads, personal computers) that minimize need for new social trust, instruction, and natural resources. (Almost all of this is manufactured, leading to the older term manufactured capital, but some arises from interactions with natural capital, and so it makes more sense to describe it in terms of its appreciation/depreciation process, rather than its origin: much of natural capital grows back, infrastructural capital must be built and installed.)
In part as a result, 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.
Capital is ace to have in your back pocket!
Capital in classical economics and beyond
Within classical economics, Adam Smith (Wealth of Nations, Book II, Chapter 1) distinguished fixed capital from circulating capital, including raw materials and intermediate products. For an enterprise, both were kinds of capital.
Karl Marx adds a distinction that is often confused with 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. In order to invest, goods must be produced which are not to be immediately consumed, but instead used to produce other goods as a means of production. 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.
The Austrian 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.
Quotes about Capital
- "Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed." Mahatma Gandhi
