Capital (economics)

• 1. Introduction

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  Capital, in economics, is a deceptively plain idea with a long and contested history. A typical example is the machinery used in a factory. The economist's working definition calls it "those durable produced goods that are in turn used as productive inputs for further production" of goods and services. That sentence sounds settled. It is not. The precise definition of capital, how to measure it, and its exact role in production have been subjects of long-standing debate throughout the history of economic thought. Why would something as ordinary as a machine on a factory floor provoke a dispute that stretched across the Atlantic between two universities named Cambridge? Why did one economist insist that stocks and bonds are not really capital at all? And how did a concept once anchored to tools and buildings expand to include trust between people, the world's living organisms, and even knowledge about food? The answers begin with a single distinguishing feature: durability.

• 2. What Makes Capital Capital

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  Durability is the line that separates capital goods from intermediate goods like raw materials, components, or energy consumed during production. Capital provides a flow of productive services over multiple cycles. It facilitates production processes repeatedly rather than being immediately consumed, physically incorporated, or transformed into the final output within a single cycle. The dump truck illustrates the point. A chocolate bar is a consumer good, but the machines that produce the candy are capital goods. An automobile is a consumer good when purchased as a private car. Dump trucks used in manufacturing or construction are capital goods, because companies use them to build roads, dams, buildings, and bridges. Adam Smith added a second clarification that still governs the field. Capital is a stock, so its value can be estimated at a point in time. Investment, by contrast, is production added to the capital stock over time, described as taking place "per year," and is therefore a flow. That distinction between a stock measured in an instant and a flow measured across a year sets up a deeper puzzle about whether the stock can even be added together at all.

• 3. The Trouble With Adding It Up

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  The capital stock is the collection of produced assets held by an individual, company, or nation at a point in time. It comprises both tangible physical capital and intangible non-physical capital. Because these assets vary so widely in form and function, the stock is inherently heterogeneous. That heterogeneity became the heart of a formal academic fight. The Cambridge capital controversy pitted economists at MIT in Cambridge, Massachusetts against economists at the University of Cambridge in the UK over the measurement of capital. The Cambridge, UK side, including Joan Robinson and Piero Sraffa, argued that there is no basis for aggregating the heterogeneous objects that constitute capital goods. The complaint was not abstract hairsplitting. Capital goods are a constituent element of fixed capital, and they play a key role in the economic analysis of growth, production, and the distribution of income. If you cannot meaningfully sum the machines, the buildings, and the software into a single number, the foundations of those analyses come into question.

• 4. A Factor Among Factors

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  Classical and neoclassical economics place capital alongside land and labour as one of the factors of production. This classification originated during the classical economics period and has remained the dominant method for classification. Two tests qualify capital for that status. The good is not used up immediately in production, unlike raw materials or intermediate goods, with the significant exception of depreciation allowance, which like intermediate goods is treated as a business expense. And the good can be produced or increased, in contrast to land and non-renewable resources. Capital appears in standard production functions as an input variable, sitting beside a quantity of labor to yield a rate of output of commodities. There is a twist hidden in that role. While capital is a crucial input to the general production process, the creation of new capital goods such as machinery, buildings, or software is itself the output of specific production activities. Those new goods then enter the capital stock to replace depreciated capital and enable future production. Typically the producers of capital goods are not the same firms that use them. Specialized firms make them. That observation about who builds the machines opens onto why capital shapes which businesses can exist at all.

• 5. The Cost Of Entry

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  Complex products and systems, sometimes abbreviated CoPS, play an important role in today's economy. Capital goods are generally one-of-a-kind, capital-intensive products made of many components, and their production is often organized in projects with several parties cooperating in networks. Examples include hand tools, machine tools, data centers, oil rigs, semiconductor fabrication plants, and wind turbines. Their expense does more than enable production. In an industry where production equipment and materials are costly, they form a high barrier to entry for new companies. A new business that cannot afford the machines it needs may be unable to compete, and turning to another firm for supply can be expensive too. So in industries where the means of production make up a large share of start-up costs, the number of competing companies is often relatively small. The acquisition of machinery and expensive equipment is usually called a capital expense. When a business is struggling it puts off such purchases, since spending on equipment makes no sense if the company will not survive to use it. Capital spending can therefore signal that a manufacturer expects growth or steady demand, a potentially positive economic sign. Because firms use these items to make functional goods for customers, they are sometimes called producers' goods, production goods, or means of production. A capital good moves through a lifecycle of tendering, engineering and procurement, manufacturing, commissioning, maintenance, and sometimes decommissioning.

• 6. Beyond The Physical

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  Since at least the 1960s economists have increasingly focused on broader forms of capital. Investment in skills and education can be viewed as building human capital or knowledge capital, and investment in intellectual property as building intellectual capital. Capital goods themselves can be immaterial when they take the form of intellectual property, requiring substantial investment and subject to amortization, depreciation, and divestment, just like material ones. The modern map of capital has grown crowded. Financial capital represents obligations, is liquidated as money for trade, and trades in financial markets, with a market value based not on money historically invested but on the market's perception of expected revenues and risk. Social capital captures inter-relationships between human beings that carry money-like value, partly showing up in private enterprise as goodwill or brand value. Instructional capital is the transferable aspect of teaching and knowledge that is not inherent in individuals or social relationships. Public capital tries to describe physical infrastructure that supports production in poorly accounted ways, encompassing highways, railways, airports, water treatment facilities, telecommunications, electric grids, public hospitals and schools, police, fire protection, and courts. It remains a problematic term, since many such assets can be either publicly or privately owned. Natural or ecological capital is the world's stock of natural resources, including geology, soils, air, water, and all living organisms, some of which provide free ecosystem services such as the clean water and fertile soil that make human life possible. The expansion has reached the dinner table. Building on Marx and on the sociologist and philosopher Pierre Bourdieu, scholars have recently argued for the significance of culinary capital, the idea that producing, consuming, and distributing knowledge about food can confer power and status.

• 7. Dissenting Definitions

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  Henry George refused to count financial instruments as capital at all. Stocks, bonds, mortgages, promissory notes, and other certificates for transferring wealth, he argued, are not really capital, because their economic value "merely represents the power of one class to appropriate the earnings of another" and "their increase or decrease does not affect the sum of wealth in the community." Werner Sombart and Max Weber located the very origin of capital in double-entry bookkeeping, treating it as a foundational innovation in capitalism. Sombart wrote in "Medieval and Modern Commercial Enterprise" that the concept of capital is derived from this way of looking at things, and that "capital, as a category, did not exist before double-entry bookkeeping." He defined capital as the amount of wealth used in making profits and entered into the accounts. Karl Marx, often confused with David Ricardo on this point, split capital in two. Variable capital is the capitalist's investment in labor-power, which Marx saw as the only source of surplus-value, called variable because the value it produces differs from what it consumes. Constant capital is investment in non-human factors such as plant and machinery, which Marx held contributes only its own replacement value to the commodities it helps produce. In the broader Marxian critique, capital is viewed as a social relation, with a further category of fictitious capital covering intangible representations of physical capital such as stocks, bonds, and securities, described as tradable paper claims to wealth.

• 8. Roundaboutness And Power

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  Eugen Boehm von Bawerk of the Austrian School measured capital intensity by the roundaboutness of production processes. He defined capital as goods of higher order, used to produce consumer goods and deriving their value from them as future goods. The classical view of investment, or capital accumulation, frames it as the production of increased capital, requiring that some goods be made that are not immediately consumed but used instead to produce other goods. Investment is closely related to saving without being identical to it. As Keynes pointed out, saving means not spending all of one's income on current goods or services, while investment means spending on a specific type of good, namely capital goods. Human development theory pushes the concept further, describing human capital through distinct social, imitative, and creative elements, and this thinking forms the basis of triple bottom line accounting. It is carried forward in ecological economics, welfare economics, and theories of green economics, all of which use an abstract notion of capital that effectively removes the requirement that capital be produced like durable goods. The most pointed challenge comes from political economists Jonathan Nitzan and Shimshon Bichler. They have suggested that capital is not a productive entity at all, but solely financial, and that capital values measure the relative power of owners over the broad social processes that bear on profits.