Growth of Capital Depends Upon Savings, Foreign Loans & Investment

Tue, 10/09/2012 - 06:50 -- Umar Farooq

What do you understand by capital?  On what does the growth of capital in a country depend. According to Alfred Marshall "Capital consists of those kinds of wealth, other than free gifts nature, which yield income" in the words of Samuelson "Capital goods represent, product goods that can be used as factor inputs for further production".

Forms of Capital

Capital has two general forms

  1. Physical or Real Capital i.e. machinery, equipment, buildings etc
  2. Financial Capital e.g. bonds, stock certificates, deposits etc

The growth of capital depends upon many institutional factors as savings, foreign loans, foreign investment as well as political and financial conditions of the country.  Savings play basic role in Capital accumulation. Whatever is left after consumption is saved. These savings are kept with banks, which mobilize them into investment. Actually savings is a diversion of a part of society's currently available resources to the purpose of increasing stock of capital so as to make possible an expansion of income and consumable output in future. So we can say that the growth of capital depends on the increase in the volume of savings, mobilization of savings and investment of savings.

There are three types of domestic savings

  1. Individual savings
  2. Corporate or business savings
  3. Public or Government savings

If there is a gap between savings and planned investment then this might be either filled by deficit financing (printing currency notes or borrowing from people) or by foreign loans and direct private investment by foreign firms. Political stability and Social peace is an important factor for the growth of capital. The country, which has political instability and social unrest, has to face the flight of capital.

Financial institutions, capital and money market are other key factors to determine the growth of capital. The organized capital market and efficient financial institution leads to higher rate of capital formation. Otherwise, savings of the country remain idle.

The stable financial markets along with a sound legal structure provide the security to the capital. The owners of the capital feel protected. But this all is possible if the rate of return on capital is high, taxes are low and there are ample opportunities for investment. If the rate of return is high and society is involved in innovations and inventions then the marginal efficiency of capital will be very high which shows the confidence of capitalist class and their psychological optimism towards the capital growth in the long run. If the businessman becomes pessimistic due to government policies, political instability and low rate of return then in such economies growth of capital will be retarded.