MEANING AND IMPORTANCE OF CAPITAL FORMATION

Capital may be defined as that part of wealth, which is used or intended to be used for further production of wealth. The term capital is generally used for capital goods,e.g., plant, machinery, tools, factories,etc. Capital formation refers to the net addition made to the existing stock of capital in a given period of time. It means making of more capital goods such as machines, tools, factories ,canals, electricity, means of communications, and transportations. When resources are used to replace the worn out assets including wear and tear of machinery is known as maintaining capital intact. But capital formation, on the contrary, means increasing the stock of real capital and it obviously helps in raising the level of production of goods services in the country.

HUMAN CAPITAL FORMATION

Capital formation may take the form of material goods such as machinery, buildings, factories etc., or of non material goods like knowledge, skill, intelligence and health of people. Capital formation in the form of non material goods is also called the human capital formation. It implies the development of abilities and skills which are crucial for economic development. It means investment by society in education, investment by employers for imparting training and skill to the workers and also investment by individuals of time and money in their own development.

 The secret of economic progress of the western countries lies in having a high rate of capital formation. The poor countries remain poor because increase in their national income is neutralised by the corresponding over increase of their population. During the period 1870-1913, the national income of England rose by 15% with capital formation taking place at rate of 10 to 15% of the national income. The phenomenal growth of Japanese economy can be ascribed to high rate of capital formation which was nearly 36% of her national income. The poor countries are poor because they are capital-poorcountries. Not only the stock of capital is small but the current rate capital formation is also very low which varies between 6 to 8% of the national income, whereas in advanced countries it ranges between 15 to 25% of the national income.

IMPORTANCE OF CAPITAL FORMATION

 It quickens the pace of economic development by enabling the producers to introduce round about methods of production which increase considerably the productiveness of enterprises, bring about economies of large scale production and widen the market. Large amount of capital is needed to make technological improvements which add to the efficiency and productivity of the economy. As the level of investment rises, further accumulation of capital becomes easier as a result higher rate of increase in national income achieved through the interaction of principles of multiplier and accelerator.

 One of the important factors responsible for low productivity in underdeveloped countries is the utterly inadequate investment in the development of human resources. Investment in material capital may indirectly achieve some development of the human resources, but the direct and more decisive means to do so is through investment in human being. The capital accumulation, though an important factor, is not only factor which determines the pace of economic development. Rate of economic development depends on a number of factors such as natural resources, size and composition of population, economic and social institutions, political conditions, efficiency of the administration, and so on.

CAPITAL OUTPUT RATIO

Capital-output ratio or capital coefficient has assumed great importance in examining the quantitative relationship between capital formation and income growth. This ratio has been used increasingly as a tool of policy formulation and planning in developed and less developed countries. The concept of capital output ratio expresses the relationship between the value of capital investment and the value of output. It refers to the amount of capital required in order to produce a unit of output. When the capital-output ratio in the economy is said to be 5:1, it implies that a capital investment of Rs 5 crores is essential to secure an output (income) worth Rs 1crore. Capital output ratio may be defined as the relationship of investment in a given economy or industry for a given time period to the output of that economy or industry for a similar time period.

It differs from country to country. It is not an automatic process. It is determined by the demand for and supply of capital. The demand for capital is governed by the incentives to invest and the supply of capital depends upon the power will to save. It is the lack of demand for capital and shortage of supply of capital which is responsible for low capital formation in underdeveloped countries. Lack of small size market. Demand side : Other factors which limit the demand for capital are: 1. Lack of Entrepreneurial Ability. (2) Supply Side 2.Lack of Skilled Labour. No formation of capital without savings. 3.Avilability of Cheap labour. (a) Savings by house holds, (b) Savings by 4.Lack of basic facilities. Business houses and (c) Savings by govt. 5.Primitive Agriculture. Saving is affected by 6.High rate of Taxes. (a) Demonstration effect, (b) Hoardings, 7.High Interest rates. (c) lack of Financial institutions, and 8.Unstable Political Conditions. (d) Incongenial Environment.

FACTORS DETERMINING CAPITAL FORMATION

CAPITAL- OUTPUT RATIO

Type equation here.It may thus be defined as given relationship between the investments that are to be made and the annual income resulting from these investments. It expresses the relationship between the value of capital investment and the value of output. It also refers to the amount of capital required in order to produce a unit of output. When the capital output ratio in the economy is said to be 5:1, it implies that a capital investment of Rs 5 crores is essential to secure an output (income) worth Rs 1 crore. Types of Capital- Output ratio. 1.The average capital-output ratio, and 2.The marginal or incremental output ratio. The average capital output ratio indicates (ACOR) the relationship between the existing stock of capital and the resultant flow of current output. It is defined as the ratio of existing capital stock to the aggregate level of current national output. Thus, ACOR = K/Y. It takes into account hitherto and the resultant national income. ACOR is a static concept. The Marginal or Incremental capital-output ratio (ICOR) expresses the relationship between the amount of increase in output(income) Y, resulting from a given increase in stock of capital, K. It is the additional amount of capital or investment needed to produce an additional unit of output per unit of output. Thus, ICOR = K/ Y, where K(=I) is the addition to the capital stock, or investment(I) and Y is addition to the national output. The marginal output ratio refers to all that has been added in a recent period to the capital or income. ICOR is a dynamic concept. The term capital output ratio is applicable as used in economics relates to the incremental or marginal capital output ratio.

 The concept of capital output ratio is applicable not only to an economy but also to its different sectors. There are different capital output ratios for different sectors of the economy depending on the techniques( capital - intensive or labourintensive) Used by them. In a sector using capital intensive techniques, the capital output ratio would be high and in other sector using labour intensive techniques, the capital output ratio would be low. Transport, communications, public utilities and capital good industries have very high sectoral capital output ratios. While capital output ratios in the agricultural sector, manufactured consumers goods industries and service sectors are very low. Capital Output Ratio in Underdeveloped countries Various estimates have been made of capital output ratios in under developed economies. According to H.K. Manmohan Singh, in developed economies the range of capital output ratio is believed to lie between 2.9:1 and 4:1, and in under developed countries this ratio may be supposed to lie between 1.5: 1 and 2:1.

DIFFICULTIES IN THE CALCUCATION OF CAPITAL OUTPUT RATIO

The measurement of value co-efficient which presents problems. An estimate of additional capital stock built up and the additional output generated there from is necessary. According to Paul Streeten, the following are major the problems in the measurement amd therefore, in the application of capital- output ratio. Difficulty to measure total capital. It is not rational to add them up and express their quantity in a single figure. Investment in non - monetized sector. Capacity utilization. Imperfections of the markets. Considers only fixed investment. Additional work shifts.

TECHNOLOGY AND ECONOMIC DEVELOPMENT

Technology is the is the technological knowledge used in production or embodied in capital or machinery. In the broader sense, it can be regarded as a factor input or resource. It is closely related technological knowledge and it includes not only engineering aspect of production but also the economic and organisational aspects and also management and marketing activities. Technological progress and economic development. In the under developed countries the high cost of production and low productivity of labour and capital is due to technological backwardness. The most modern technology being used side by side with the most primitive in the same industry in country like India. Modern technology has entered the underdeveloped countries mostly along with foreign capital and enterprises in primary industries producing for exports such as mining,etc. Direct investment by foreign firms may, some extent, serve the purpose of transferring know-how to underdeveloped countries. Transfer of technology can take place in a number of ways. By the flow of books, journals and other published information; By the movement of people between countries. By foreign investment. By important of machinery and equipment; By technical cooperation programmes, multilateral and bilateral, official and private;

TRANSFER OF TECHNOLOGY TO UNDERDEVELOPED COUNTRIES

Technology transfer implies the transfer of technological knowledge from one country to another either through deliberate government policy or by private channels of communications. The agencies involved in the transfer of technology are government, commercial enterprise such as multinational corporations, private agencies, etc. Transfer of technology to underdeveloped countries poses number of problems and difficulties. Primitive Environment. The utilization of modern technology requires a particular type of social environment which should facilitate the utilization of modern technology. Dearth of basic facilities. New techniques are expensive and require modern equipment and a number of other facilities. The twin requirements for the absorption of new technology are the availability of capital and training facilities for an adequate number of personnel. Diverse Conditions. The conditions for acceptance of knowhow vary from country to country because of the differences in their social structure, political conditions, economic environment, level of education and skill etc., which will call for different methods of transfer.

 Limitations on demand and supply side. In the initial stages of development, the underdeveloped countries will have to depend upon the services of foreign experts. Very few countries have an excess supply of those skills which are urgent The limitations on the demand side are The young and well trained personnel will resent it. The foreign experts will have to be provided with facilities. The foreign experts have to be paid much higher salaries. Lack of Expertise. For assimilation of modern technology, mass education on right lines is very essential. But in underdeveloped countries, there is a of efficient teachers to impart training. The problems of Payments for Technology. Technology generation and industrial innovations are commercial ventures and as such technology import requires payments for the same.

 State has become a power organization to promote and maximise economic welfare of the community. Say's law of market was falsified by the onslaught of the Great Depression of 1929 which shook the world from its economic slumber and passivity. In developed countries, the role of the state is to eliminate business fluctuations. An under developed country can not attain a high rate of investment and growth of output if it is left to the functioning of the market forces. In the underdeveloped countries, the state has to intervene directly to initiate the process of economic development. Contribution of state in economic development. Creation of Economic and Social overheads. Agricultural development. Industrial development. Reduction of inequalities. Optimum allocation of resources and creation of full employment. Development oriented economic policies. Changes in institutional framework.

STATE AND ECONOMIC DEVELOPMENT

on a number of factors. Availability of Natural Resources. A country with abundant natural resources has a low capital output ratio, for it can substitute natural resources for capital. Growth of population. Degree and nature of Technological advance. The nature of technological advance refers to capital-intensive and labour-intensive innovations. If the technological advances are capital intensive in character, the capital output ratio tends to rise. On the other hand, if technological inventions are labour intensive in nature, the capital output will tend to fall. Rate of Investment. The higher the rate of investment, the higher is the capital output ratio. This is because new investment and new technology go together. Composition of Investment. If the government plans a heavy expenditure on public works and public utilities like railways, power, etc., the capital output ratio would be high. But the capital output ratio would be low if the pattern of investment is inclined more towards the development of agriculture and cottage industries which are labour intensive. Relation of factor prices. A reduction in the rate of interest, other factor prices remaining constant, is likely to increase investment demand for capital and thus raise capital output ratio. Similarly, a rise in the wage level, other things remaining the same, may rise capital output ratio if there is a possibility of capital being substituted for labour. Employment policy. Industrialisation. It tends to raise capital output ratio. Impact of export and Import.

FACTORS DETERMINING CAPITALOUTPUT RATIO The size of capital output ratio depends not only on the amount of capital invested but also

 Quality of Managerial and Organizational Skill. A country in which the quantity and quality of managerial skill is high, the capital output ratio would be low. On the other hand, if the quantity and quality of entrepreneurship are low, the capital output ratio would be high. Relation of Factor Prices. A change in factor prices affects the capital output ratio to the extent capital can be substituted for labour. Employment policy. If the policy of the state to provide immediate relief to the unemployment will lead to capital investments on roads, land reclamation,etc. But if the governments policy is towards absorbing the unemployed in large industries especially in manufacturing industries, the capital output ratio would be smaller. Industrialization. Industrialization would raise the capital output ratio. Spread of Education. With the spread of education and literacy , the capital output ratio falls. Impact of Export and Import.