Capital
Formation:
Meaning and Definition:
Capital
is one of the important factors which governs the quantity and
the composition of output in a country. If there are increasing
resources of capital in a country, it results in technological
discoveries, raises productivity of labor, increases the rate of
economic development and provides higher standard of living for
the masses.
In case, there is deficiency of capital assets such
as machinery equipment tools, dams. roads, railways, bridges,
etc., etc., the country then remains trapped in the vicious
circle of poverty. Capital accumulation/formation, thus, in brief is at
the vary core of economic development.
It may
here be remembered that though capital occupies a central
position, to the process of development yet, we cannot ignore
the other factors like education, effective government, social
Justice, attitude of the people to work, etc., etc. These
factors play a significant role in the economic progress of a
country.
Economic development is thus a multidimensional
phenomenon which is the result of a combination of social,
cultural, political, and economic factors. To quote Ranger
Nurkse:
"Economic development has much to do with human
endowments, social attitudes, political conditions, and
historical accidents. Capital is necessary but not a sufficient
condition of economic progress".
Capital
Formation:
Capital
formation is the process of building up the capital stock of a
country through investing in productive plants and equipments.
Capital formation, in other words, involves the increasing of
capital assets by efficient utilization of the available and
human resources of the country.
Sources of Capital Formation and
Importance:
The stock
of capital goods can be built up and increased through two main
sources:
(1) Domestic
Resources and (2) External Resources.
(1)
Domestic Resources:
Domestic
resources play an important part in promoting development
activities in the country. These sources in brief are:
(i) Voluntary Savings.
There are two main sources of voluntary savings (a)
households (b) business sector. As
regards the volume of personal savings of the households. It
depends upon various factors such as the income per capita,
distribution of wealth, availability of banking facilities,
value
system of the society,
etc.
In the under-developed countries, the saving potential of
the people is low as a greater number of them suffer from
absolute poverty. So far as the rich
section of the, society is concerned, they mostly spend their
wealth on the purchase of real estates. luxury goods, or take it
abroad to safe keeping. There is, therefore very little saving
forthcoming from the high income group.
The
business sector is an important source of voluntary savings in
the less developed countries. They usually hesitate in assuming
the risks associated with investment. The fear of
nationalization and political instability further demands their
incentive to save and invest in the country. The statistics of
many underdeveloped countries indicate that both these sources
hardly manage to save 15% of their GDP. This is not even
sufficient to maintain the present standard of living of
the masses.
(ii) Involuntary
Savings. In the developing countries, the income per capita
of the people
is low. Their propensity to consume mainly due to
demonstration effect is very high. As the flow of savings is
inadequate to meet the capital needs of the country, the
government, therefore adopts measures which restrict consumption
and increase the volume of savings.
The traditional methods used
for increasing the volumes of savings are (a) taxation (b)
compulsory schemes for lending to the government. The two fiscal
measures stated above are very sensitive and delicate:
They should be devised and handled very
carefully.
For instance,
if the people of low and middle income groups are heavily taxed
through various forms of taxation, their power, (whatever
little) to save will be
burdened with taxes. The tax structure is to be devised in such
a manner that it should provide incentive to work, save and
invest for various levels of income groups.
(iii)
Government Borrowing. The volume of domestic savings can
also be increased through government borrowing. The government
issues long and short term bonds of various denominations and
mobilizes saving from the genera! public as well as from the
financial institutions.
In the
developing countries, there are many obstacles which stand in
the way of government's borrowing. For instance, the money and
capital market is unorganized. The rural sector is not provided
with adequate financial institution. People being illiterate
prefer to invest their savings in gold, jewellery, etc. The
government of developing countries should, therefore, evolve a
workable programme of mobilizing the savings of the people both
in the urban and rural sectors.
(iv) Use
of Idle Resources. In the developing countries of the world
there are many resources which remain unutilized and
underutilized. If they are properly tapped and diverted to
productive purposes, the rate of capital formation can increase
rapidly.
For instance, in most of the low income countries,
there is a disguised unemployment in the rural sector. If the
surplus farmers are employed at nominal wages in or near their
villages for the construction of roads, tube-wells, canals,
school buildings, etc., or their
services are acquired on self-help basis for capital creating
projects, they can
be a valuable source of capital formation in the country.
(v)
Deficit Financing. Deficit financing is regarded an
important source of capita! formation. In the developed
countries this method is used for increasing effective demand
and ensuring continued high levels of economic activity. In the
less developed countries, it is used to meet the development and
non development expenditure of the government.
(2) External Resources:
External resources has following
types:
(i) Foreign Economic Assistance.
There is a controversy over the impact of inflow of capital for
the development of a country. It is argued that capital is one
of the variable in the growth process. If the government of a
country is ineffective and people are not receptive to social
changes, the inflow of capital resources and technical
assistance would go waste.
In case,
the developing nations needing foreign capital and technical
assistance have the will to absorb capital and technical
knowledge and the social and political barriers are overcome,
capital then becomes
the touchstone of economic development. The main benefits of the
foreign economic assistance, however, in brief are as under:
(a)
Foreign loans bridge saving gap. In Pakistan, like most of
the developing countries, the domestic saving average 14% of
GDP. The low rate of saving is not sufficient to achieve the
desired rate of growth in the country. Foreign loans supplement
domestic savings and help in bridging the resource gap between
the desired investment and the domestic savings.
(b)
Close
the trade gap. In Pakistan, the export earnings are
persistently
falling short of import
requirements. The foreign, exchange gap caused by excess of
import/export is being filled up with inflow of capital.
(c) Provides greater
employment opportunities.
The financing of various
projects
with the help of foreign assistance provides greater employment
opportunities in a country.
(d) Increase in
productivity of various economic sectors.
The inflow of
capital and technical know-how
increases the productive capital of various sectors of the
economy.
(e) Increase in real
wages.
The foreign resources help in increasing
marginal
productivity of labor in the recipient country. The real wages
of the workers are thus increased with the help of foreign
assistance.
(f) Provision of
higher products.
The foreign capital helps in the
establishment of industries in the country. The inflow of
technical knowledge improves the quantity and quality of
manufactured goods and makes them available at lower prices to
the domestic consumers.
(g) Increase in tax
revenue.
The profits earned on foreign investment are
taxes by the government, The revenue of the state is thus
increased.
(h) External
economies.
The inflow of foreign capital and advanced
technology stimulates domestic enterprises. The firm avails of
the benefits of external economies like that of training of
labor, introduction of new technology, new machinery, etc.,
etc.
(ii) Donor Country and the Economic
Assistance: Here a
question can be asked .as to why the developed nations are kind
in giving aid to the developing countries? According to the rich
nations, the foreign aid is given for a combination of
humanitarian and self-interest reasons:
(a)
Humanitarian ground. If a country is faced with famine,
drought, epidemic, diseases, earthquake etc., it is obligatory
for the developed nations to help that country financially
purely on humanitarian grounds. The rich countries are extending
economic assistance in the form of grants to the poor nations of
the world.
(b)
Self-interest
reasons.
Foreign economic assistance is also provided on
the following self interest reasons by the donor countries.
(a) The foreign aid
may be given to protect the developing country from
the influence of-other camp
countries.
(b) The donor country
may have surplus products. In order to check the
fall in the prices of products in the domestic market and to
maintain level of production, the surplus goods are exported to
the needy countries on loan.
(c) Economic
assistance is also provided by the. donor countries to
remove the economic disparities among
the nations of the world.
(d) Some advanced
nations particularly the socialist countries provide
financial and technical help for the
propagation of political ideology in the capitalist developing
countries.
(e) Foreign aid is
also given for increasing the camp followers of the
donor countries.
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