What is capital formation?
Capital formation is a major contributor to economic development. It results in the increase of material and human capital. This happens when society’s resources are made available for development purposes. A proportion of societal incomes in the form of savings are invested to increase capital.
Basically, capital formation refers to the process of production of capital goods, machinery, transportation facilities etc. – all different forms of real capital that increases efficiency and raises the standard of living.
What is the significance of capital formation?
Capital formation means the same for countries worldwide – to meet the basic needs of its citizens. The government may be democratic or communist – differing management styles – but the end is the same. Its aim is to provide the following:
- Building Infrastructure: Infrastructure like roads, railways, power grids and communications systems are the building blocks and this is what capital is needed for.
- Modern Production Systems: Capital helps to develop modern production methods – providing employment to people and goods for consumption.
- Improvement in Human resources: Capital plays a very important role by proving education, Health services, social welfare, environmental protection etc. It helps to improve living conditions and this leads to better productivity.
- Optimizing resources: Adequate capital leads to proper utilization of resources available within a country and leads to rapid economic growth.
- Technological Progress: Money can be invested in research and development to develop better technologies which lead to improvements in all sectors.
- Agriculture and Industry: Availability of capital means that better processes can be applied to both agriculture and industry. New techniques can be applied to increase production and lower cost.
- Growth of National Income: Good capital formation techniques inevitably lead to long term progress and increase in per capita income. The GDP of a country also rises through better production in multiple sectors of the economy.
- Increase in economic activity: Having adequate capital leads to an increase in the supply of goods and services in any country. Inflation is controlled and economies become stable in the long term. This also helps in bringing investments to the country.
- Local production of goods: Having the requisite capital helps countries produce goods that used to be imported – this leads to fewer imports and solves balance of trade issues.
- Less foreign debt: When a country becomes self sufficient, it reduces the dependence on foreign debt and imports.
The importance of capital formation cannot be underestimated and it is a process that has to be repeated from time to time to meet the needs of a growing economy.