Capital Accumulation

Introduction

In basic concepts of economics, capital is a factor of production and it means all the man-made resources which are used in producing goods and services. Buildings, machinery, equipment, vehicles, and other fixed assets are examples of physical capital. Capital stock means the amount of capital goods held by a country at any point in time. Any increase in the capital stock of a country is called capital accumulation and will be discussed in this article in detail.

Definition

The process of obtaining additional capital stock that is used in the production of goods or services is called capital accumulation. It refers to an increase in overall assets from investments or profits and is one of the main building blocks in maintaining a capitalist economy. In simple words, capital accumulation will occur when the additional purchase of capital goods will be more than the depreciation of capital. In that case, the amount of capital goods will increase in a country and hence its productive capacity. This will lead to a higher national output in the long run. 

The Purpose of Capital Accumulation

The goal of capital accumulation is to enhance the value of an initial investment as a return on investment, irrespective of the source, whether that is through rent, appreciation, interest, or capital gains. Capital accumulation can require investment in tangible fixed capital, like machines and factories; portfolio investment, such as the purchase of cryptocurrencies, shares, or bonds; and investment in assets, like housing. Capital includes man-made resources which are used to produce other goods or services, such as factories or machines. The accumulation of capital will need to increase the amount of capital required to overcome the depreciation, a fall in the value of capital goods over time. For instance, when some capital wears out, capital investment is used to overcome this. It involves additional purchases of capital.

The primary focus of capital accumulation is to grow the existing wealth through investment of earned profits and savings. This kind of investment is focused in a variety of ways throughout the economy. One important point to note is that capital accumulation usually does not need to come through the expenditure of money. This can be done by simple means like better organisation of capital assets. For example, a firm can stimulate its output by better organising its factory. This move makes it more efficient without buying additional machines or hiring more employees. In this way, the output increases, leading to an increase in the rate of profit.

How does Capital Formation Occur?

The following points explain how capital accumulation occurs:

• It can occur by reinvesting profits from businesses in other businesses.
• Capital accumulation can also occur through foreign direct investment rate, which is important for developing economies with low capital bases.
• It can occur by encouraging technological innovation, which automatically leads to the productivity growth of capital.
• By increasing human capital, capital also accumulates, such as skilled and better educated workforce, which can lead to an increase in the production possibility frontier. This is called human capital accumulation.
• Discovering new sources of raw materials paved the path to capital accumulation, such as oil reserves.
• Capital accumulation can also occur by increasing the level of savings. According to the Harod-Domar model of the economic growth process, the higher the proportion of income saved, the more investments and higher rates of economic growth.
• Keynesians said that higher savings are not always investments but can be retained or saved without reinvestment.

Factors Involved in Capital Accumulation

There are two main factors that are involved in capital accumulation:

Tangible Assets

A factor that helps grow capital is through the purchase of tangible assets that manage the productive process. Tangible assets are physical assets, like machinery. Improving the skills of workers can also push output through the working of production function; this is called human capital. Investing in financial assets, like bonds, shares, stocks, etc., are also major sources of capital accumulation, but only if their value increases.

Appreciation

Appreciation is another factor in capital accumulation. Appreciation is typically the investment in those physical assets whose values increase over time.

Ways to Measure Capital Accumulation

The following are some ways to measure capital accumulation:

Change in Value of Assets

A way to measure the capital accumulation is to measure the change in the value of assets. For example, corporations use the reinvestment of profits into other businesses to enhance their wealth. They determine the type of business in which they decide on reinvestment into tangible assets or human capital and then determine whether this move adds value to their reinvestment or not.

Depreciation

An analysis of the financial statements of a company can explain the overall capital health and the company’s capital structure. The income statement provides an overall report on profits that contribute to capital accumulation. The cash flow statement can be divided into three segments: cash flows from investing activities, operating activities, and financing activities. Normally, cash flows from operating activities are positive, but cash flows from financing and investing activities are negative. But the total negative cash flows are not the sign of a poorly run business but also depict an investment in the long-term health of a company. This is so because it is crucial that capital accumulation surpass depreciation.

Capital Accumulation and Inequality

Many economists argue that capital accumulation can lead to inequality in a society. This is a primary component of Marxist theoretical model. The concept of inequality arises because a major part of capital accumulation comes from profits from businesses or investments. These profits are continuously reinvested in other businesses that create a self-realising cycle; as a result, the wealthy continue to accumulate more wealth and capital and therefore, control the major aspects of society and the economy. But others argue that a general rise in the wealth of a nation can lead to a redistribution of overall wealth.

Wealth Multiplier Effect

The wealth multiplier effect has a major role in explaining the concept of capital accumulation. For example, a person invests his money to purchase a house worth $5 million. He rents out his property for 8% of its value per year. From this rental income, he reinvests his money in buying more properties. He will quickly be able to see the increase in wealth if there is also a house price growth of 4%.

With the rental yield of 8% and property growth of 4%, within two years, this investor will gain approximately $1.3 million increase in wealth from an initial wealth of $5 million.

Marxist Views of Capital Accumulation

This view concentrates on how profit from business is reinvested in more capital. This helps capitalist class to enhance their dominance and overall wealth in a capitalist society. Marx also believed that capitalism was vulnerable to crisis as profits from investments depended on the state of the economy.

Thomas Piketty

Thomas Piketty, the modern-day economist, also argues that the process of capital accumulation can lead to increased inequality in society. He notes that capital does not have to be invested in business but should be invested in other assets, like housing, bonds, shares, etc. As a general rule, Thomas Piketty argues that wealth grows faster than economic output. He said that the rate of return to wealth is more than the rate of economic growth due to capital accumulation; assets provide a greater rate of return that can be reinvested as compared to the rate of economic growth.

Ricardo’s Model

In the concept of capital accumulation, Ricardo’s model of economic growth has great importance. According to Ricardo, capital accumulation came from profits and the ability and willingness of owners to invest or reinvest the earned profit in more capital.

Robert Merton Solow’s Model

Some growth models that are based on Solow’s model argue that an increase in capital stock can lead to diminishing returns. They also argue that economic growth is determined by technical change and population growth.

Endogenous Growth Model

These models state that capital accumulation can increase the rate of economic growth in the long run. Therefore, to empower capital accumulation, it is important to increase the savings ratios.

Capital Accumulation Plans

Sometimes, capital accumulation is encouraged as a means for developing countries to increase their growth rates for long-term periods. In order to increase capital accumulation, there is a need to increase savings ratios, stay away from corruption, maintain a good banking system and system of loans, and have good infrastructure to make investment more rewarding.

Conclusion

In conclusion, capital accumulation is the additional purchases of capital that are used to produce other goods or services. Successful investors prefer to invest in tangible assets, in order to increase their productive capacity and wealth. Many economists explained the concept of capital accumulation, but the work of Marx is of great worth. Some economists argued that capital accumulation causes inequality in society but some supported this concept by saying that an increase in the wealth of a nation can lead to a redistribution of overall wealth.