ADVERTISEMENTS:
In this essay we will discuss about Capital Formation in India. After reading this essay you will learn about: 1. Meaning of Capital Formation 2. Significance of Capital Formation in Economic Development 3. Scenario in an Underdeveloped Country like India 4. Process 5. Causes of Low Rate 6. Measures.
Contents:
- Essay on the Meaning of Capital Formation
- Essay on the Significance of Capital Formation in Economic Development
- Essay on the Scenario of Capital Formation in an Underdeveloped Country like India
- Essay on the Process of Capital Formation in India
- Essay on the Causes of Low Rate of Capital Formation in India
- Essay on the Measures to Increase the Rate of Capital Formation in India
1. Essay on the Meaning of Capital Formation or Capital Accumulation:
The term capital formation or capital accumulation simply indicates all the reproduced wealth which helps to accumulate wealth both directly and indirectly. The word capital indicates that part of current produce which is used for further production instead of being consumed immediately.
ADVERTISEMENTS:
Similarly, capital formation indicates that part of current product, which is directed to the making of those goods facilitating productions, i.e., machines, tools and instruments, means of transportation and communication, irrigation project, canal etc. Therefore, capital formation broadly involves a sacrifice of immediate consumption in order to obtain a larger flow of consumable goods in future.
However, the term capital formation is used both in broader as well as narrow sense. In narrow sense, capital formation indicates physical capital stock viz., machines, tools etc., but in a broader sense it includes non-physical capital or human resources which include visible and invisible capital, human efficiency, craft, public health etc.
Prof. Colin Clark observed that capital goods are “reproducible wealth used for purposes of production. But capital formation refers to the net addition made to the existing stock of capital in a given period of time.” Thus capital formation may take the form of material goods as well as non-material goods such as knowledge, skill, health etc.
According to Prof. Ragnar Nurkse, “The meaning of capital formation is that society does not apply the whole of its productive activity to the needs and desires of immediate consumption but directs a part of it to the making of capital goods, tools and instrument, machines and transport facilities, plant and equipment— all the various forms of real capital that can so greatly increase the efficiency of productive effort.”
ADVERTISEMENTS:
Again Dr. Singla has aptly stated, “Capital formation consists of both tangible goods like plants, tools and machinery and intangible goods such as high standards of education, health, scientific tradition and research.”
Again Prof. Simon Kuznets rightly stated, “Domestic capital formation would include not only additions to constructions, equipment and inventories within the country, but also other expenditure except those necessary to sustain output at existing lands. It would include outlays on education, recreation and material luxuries that contribute to the greater health and productivity of individuals and all expenditures by society that serve to raise the morale of employed population.”
2. Essay on the Significance of Capital Formation in Economic Development:
Capital formation is considered as an important factor in the economic development of a country. Under developed countries are suffering from vicious circle of poverty and that vicious circle can be broken through adequate capital formation. Capital formation can accelerate the pace of development through fuller utilisation of available resources.
Prof. Lewis has rightly observed, “The Central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 or 5 per cent of its national income or less, converts itself into an economy where voluntary savings is running at about 12 to 15 per cent of national income or more. This is the central problem because the central fact of economic development is rapid capital accumulation including knowledge and skills with capital.”
It is known to all that the country employing higher amount of capital per worker can attain a higher per capita income. Therefore, increase in total production of a country brought about by an increase in capital necessarily increases economic welfare at higher rate than that brought about by an increase in the number of total workers in that country.
Following are some of the important acknowledgeable significance of capital formation in the process of economic development of a country:
(i) Infrastructures:
Formation of sound infrastructure at a priority level through its development of transportation, communication, power, banking etc. is an important significance of capital formation. This leads to development of basic capital goods in an underdeveloped country.
(ii) Use of Complex Methods of Production:
Use of round-about or complex methods of production through the adoption of modern techniques and specialisation leading to rapid growth in production in large scale is an important significance of capital formation.
(iii) Suitable Use of Human Capital Formation:
Capital formation is playing an important role in the qualitative improvement of human resources. A huge amount of capital is required to make necessary arrangement for education, training, health, family welfare, social and economic security etc. on which the human capital formation in a country depends.
(iv) Utilisation of Natural Resources:
ADVERTISEMENTS:
In order to utilise the natural resources of an underdeveloped country to the maximum extent, adequate volume of capital formation is very much important. Thus adequate capital formation makes way for proper and thoughtful exploitation of natural resources of a country.
(v) Attaining Higher Rate of Economic Growth:
In order to attain higher rate of economic growth, the country should have a higher rate of capital formation. Thus higher rate of capital formation, to the extent of 15 to 20 per cent helps a country to attain higher rate of economic growth.
(vi) Technological Upgradation:
Technological progress can create adequate ground for economic progress and necessarily can enhance the pace of economic progress. Again higher rate of capital formation is very important for the technological upgradation of a country and, therefore, capital formation is having important significance in this respect.
(vii) Development of Agricultural and Industrial Sector:
Capital formation is playing an important role in respect of the development of both agricultural and industrial sector of a country. Adequate quantity of capital is required for the modernisation of agriculture and industry so as to adopt latest mechanised techniques, inputs in agriculture as well as for setting up different industries.
(viii) Rise of National Income:
ADVERTISEMENTS:
National income and per capita income of a country can be raised by improving the conditions as well as methods of production and in these respects capital formation is playing an important role. Therefore, in order to attain higher rate of growth in national income, the rate of capital formation must be higher.
(ix) Expansion of Economic Activities:
Increase in the rate of capital formation can expand the level of economic activities in a country through its profitable uses and increased productivity. Capital formation can increase the per capita income, leading to increase in effective demand, and it also increases investment. All these lead to expansion of economic activities.
(x) Reliance on Internal Resources:
Higher rate of capital formation can widen the scope of internal resource mobilisation and thereby can lessen the burden of foreign capital. Thus capital formation helps a country to attain self-sufficiency and can gradually lessen its dependence on foreign capital.
(xi) Higher Level Economic Welfare:
Capital formation helps a country to attain a higher level of economic welfare through abrupt increase in its productivity, income and standard of living of its people, leading to the solution of its crucial problems.
ADVERTISEMENTS:
Although capital formation is playing an important role in economic development but its importance has often been over-emphasised. In addition to the rate of capital formation, other factors on which the rate of economic development depends include natural resources, economic and social institutions, size and composition of population, peoples’, behaviour, knowledge, political conditions, law and order etc.
3. Essay on the Scenario of Capital Formation in an Underdeveloped Country like India:
Capital deficiency is a characteristic feature of underdeveloped countries. Underdeveloped countries require an increased supply of capital for two purposes: to increase national income by transferring population from agricultural to non-agricultural occupations (industrialisation) and to increase its agricultural yields. Thus capital formation is regarded as a key factor in economic development of a country.
In simple terms, capital formation means directing a part of income and wealth for the making of capital goods.
In the words of Prof. Ragnar Nurkse, “The meaning of capital formation is that society does not apply the whole of its productive activity to the needs and desires of immediate consumption but directs a part of it to the making of capital goods, tools and instruments, machines, transport facilities, plant and equipment all the various forms of real capital that can so greatly increase the efficiency effort.”
ADVERTISEMENTS:
Although the definition given by Ragnar Nurkse puts importance only on the physical aspect of capital and made no reference to human capital formation but in recent years the “investment in men” popularly known as human capital formation has also been included within the scope of capital formation.
As Professor W.A. Lewis puts it “the proximate causes of economic growth are the effort to economize, the accumulation of knowledge and its application, and the accumulation of capital. These causes, though conceptually different, usually develop and grow together in any society. Again Simon Kuznets also wrote in this connection, Domestic capital formation would include not only additions to constructions, equipment and inventories within the country, but also other expenditure except those necessary to sustain output at existing lands. It would include outlays on education, recreation and material luxuries that contribute to the greater health and productivity of individuals and all expenditures by society that serve to raise the morale of employed population.”
Although it is true that all the above mentioned three requirements must be met if economic growth is to take place, it seems unquestionable that capital accumulation is the most important limiting factor in the underdeveloped countries of the present day.
The whole process of economic development turns around the possibility of achieving a much higher rate of capital formation than exists at present in most of the under developed countries. There are communities in which per capita income is increasing very slowly, invest only 5 to 6 per cent of their national income, while progressive economies invest 12 per cent per annum or more.
Probably the most important task involved in economic development is to convert an economy from a 5 per cent to 12 per cent saver—with all concomitant changes in attitudes and institutions. This is not an impossible task to achieve in the underdeveloped nation.
‘No nation is so poor’, W.A. Lewis aptly points out, that it could not save 12 per cent of its national income if it wanted to; poverty has never prevented nations from launching upon wars, or from wasting their substance in other ways.
ADVERTISEMENTS:
Prof. Lewis wrote, “The central problem in the theory of economic development is to understand the process by which a community which was previously saving and investing 4 to 5 per cent of its national income or less, converts itself to an economy where voluntary savings is running at about 12 to 15 per cent of national income or more. This is the central problem because the central fact of economic development is rapid accumulation, including knowledge and skill with capital.”
On the problems of capital formation of the underdeveloped countries, Prof. Nurkse wrote, ‘There is small capacity to save, resulting from low level of real income. The low real income is reflection of low productivity, which in its turn is due largely to the lack of capital.
The lack of capital is a result of small capacity of save, or again, “The low level of productivity is the result of small amount of capital used in production.” Economic development, according to productive capacity approach, will mean the discovery of new resources, and better and improved utilisation of existing resources of country.
In other words, this approach means:
(1) A rise in the rate of saving and capital formations to national income and
(2) An increase in the capital-output ratio.
ADVERTISEMENTS:
It has been agreed unanimously that the best known measurable indicator of economic growth in terms of productive assets is the rate of capital formation. It is highly desirable that the capital formed by country, by cutting or reducing the share of consumption, should be productive.
Broadly, economic development can be termed as a process which ensures a new and better utilisation of resources and an increase in the economy’s productive capacity for raising the standard of living of the people.
Economists have agreed that economic development, to a great extent, means capital formation. The urge for economic development arises on account of the fact that as much as 67 per cent of the world population is existing in underdeveloped regions under most pitiable conditions of living with as little as 15 per cent of the world’s total wealth at their disposal.
To get rid of such problems, an underdeveloped country like India should manage to fulfill certain basic, requirements or the ‘minimum critical efforts’, as the United Nations experts call it.
The indispensable role of capital formation has been accepted by Modern Development Economists. The absence of capital is the biggest handicap with the underdeveloped countries like India and thus occupies the central and strategic position in the process of their economic development.
Meier and Baldwin are of the view that the accumulation of real capital in underdeveloped countries involves three independent activities:
(i) An increase in the volume of real savings, so that resources that would have been used for consumption purposes can be released for other purposes;
(ii) A finance and credit mechanism, so that the resources may be claimed by investor;
(iii) The act of investment itself so that resources are used for the production of capital goods.
In an underdeveloped country like India, the role of savings seems to be of foremost importance in relation to its economic development. It is, therefore, necessary that positive efforts should be made to push up the country’s rate of saving in order to bring about development.
The question of the magnitude of savings appears automatically with its importance. Though, requirements are liable to vary from country to country and from time to time, it has been estimated that with a rise of 1 per cent in population, a community should save 4 per cent of national income annually to keep its per capita income from falling.
It is generally found in underdeveloped countries like India that, despite their very small capacity to save, whatever little they save, goes into most uneconomic forms such as the purchase of precious metals and jewellery, luxury building, holding of foreign exchange assets.
Thus the main problem of these countries like India is to bring together idle man and idle equipment to produce goods and services to satisfy felt needs, to channel resources to this end and to subordinate other objectives to the early attainment of a decent minimum standard of living for the masses.
4. Essay on the Process of Capital Formation in India:
Considering the importance of capital formation in the economic growth of underdeveloped countries it is quite essential to look into process of capital formation and to determine the desirable rate of capital formation.
About the desirable rate of capital formation, most of the theories of capital accumulation suggest to step up the rate of capital formation in a short period of time. Prof. Rosenstein Rodan, in his theory of Big Push, also emphasised on a minimum rate of capital accumulation and investment as a necessary condition of economic growth and objected the path of gradualism in this context.
The whole process of physical capital formation in a country is to pass through three important stages:
(i) Generation of Real Domestic Savings:
The first stage of physical capital formation is to generate the volume of real domestic savings through the curtailment of consumption and to divert these resources towards investment purposes. Therefore, it is quite necessary that people should save from the present consumption. But this generation of savings depends upon the power to save, willingness to save and facility to save.
(ii) Mobilisation of Savings:
The second stage of physical capital formation is making provision for the mobilisation of domestic savings so that the mobilised savings can be converted into investible funds. Thus proper steps must be taken for the establishment of adequate number of banking and other financial institutions for mobilising the savings of the community.
Banking facilities offer considerable incentive to boost up the rate of mobilisation and also for channelisation of savings.
(iii) Productive Investment of Savings:
The final stage of the process of capital formation is to invest this mobilised savings in a most productive and efficient manner. This needs investment of this savings into capital goods. It requires the emergence of a class of efficient, skilled, dynamic and daring entrepreneur which can properly utilise the community’s savings into various channels of productive investment.
Alternatively it also requires state’s participation in the entrepreneurial function. Thus in order to increase the rate of capital accumulation in a given period of time, national income (Y) should exceed level of consumption (C).
The excess of national income over the consumption constitutes savings of the country, i.e., Y = C + S and this saving should be again equal to investment, i.e., S = I. Thus investment refers to investible surplus and the capital formation means the addition to the existing capital stock.
Any part of investible surplus should be used for the production of capital goods only for the sake of capital formation and it is one of the pre-conditions of capital formation with the increased volume of savings unless it is used for the production of capital goods.
Moreover, there can be an increase in capital formation if investible resources can be transferred from the production of consumer goods to the production of capital goods.
In the mean time different countries followed different policies to boost up the rate of savings of the community. Russia and other centrally planned economies imposed curbs on consumption for achieving a high rate of saving. Alternatively British economy has been able to raise the rate of saving by maintaining low wage rate and ploughing back business profit for economic expansion.
Both of these policies are extreme in nature. It is quite difficult to follow such a policy in India under the present democratic set up. Thus under such a situation, domestic savings alone may not be sufficient to provide necessary capital for the expansion of the economy.
Thus, if necessary, a part of the investment activities may be financed through the import of foreign capital. Here external assistance is only a short term measure.
In this context, Indian economy has prepared its own path of capital accumulation needed for economic development where much stress has been laid on real domestic savings and a partial stress on the inflow of foreign capital.
During the period of the Second and the Third Plans, inflow of foreign capital at higher rate was permitted for initiating the conditions of take-off but from Fourth Plan onwards, efforts have been made for progressive reduction in the volume of foreign aid to obtain self reliance.
But again during the Eighth Plan, i.e., during the early part of 1990s, India has laid much stress on the import of foreign capital for meeting the problem of depleting foreign exchange reserves and also for conducting its economic re-structuring and reforms smoothly.
5. Essay on the Causes of Low Rate of Capital Formation in India:
In India, the rate of capital formation is low as compared to that of advanced countries of the world. The capital formation primarily depends on the levels of savings and investment attained in the country which are also low in India.
Though the country has attained some improvement in respect of rates of savings and investment, but it remains still lower in comparison to that of other developed countries of the world. It is quite imperative to know the causes responsible behind this low rate of savings and investment in India.
Some of these important causes are given below:
(i) Low rate of growth of national income and per capita income.
(ii) High rate of growth of population leading to heavy population pressure in the country.
(iii) Vicious circle of poverty.
(iv) Higher marginal propensity to consume of the people in India leading to lower propensity to save.
(v) Poor banking facilities in the rural areas of the country.
(vi) Demonstration effect and conspicuous consumption reduces the urge and ability of the people to save.
(vii) Lack of financial institutions to mobilise savings.
(viii) Peoples’ indifferent attitude towards raising the rate of capital formation.
(ix) Continuous inflationary pressures are eroding the saving capacity of the people of the country.
(x) Small size of the market.
(xi) Lack of enterprise.
(xii) Higher rate of taxation in the country is creating disincentive to raise the level of savings and investment.
(xiii) Lack of infrastructural facilities in the country is creating disincentive to raise the level of investment.
(xiv) Backwardness of agriculture resulting in low agricultural productivity is limiting the flow of investment in this sector.
(xv) Application of outdated and primitive techniques of production due to low level of technological knowhow available in the country leads to low productivity in the productive sector.
(xvi) Huge deficit financing adopted continuously by the Government has led to inflationary rise in prices, creating disincentive to investment activities.
6. Essay on the Measures to Increase the Rate of Capital Formation in India:
In order to increase the rate of capital formation in India by raising its level of savings and investment, the following measures may be followed:
(i) Raise the level of national income and per capita income;
(ii) Raise the volume of voluntary savings;
(iii) Mobilising the huge untapped savings;
(iv) Deriving growing surpluses from public sector enterprises of the country;
(v) Controlling hoarding and unproductive investment;
(vi) Controlling inflation so as to raise the saving capacity of the people;
(vii) Introducing suitable monetary policy;
(viii) Rationalising the tax structure so as to promote savings and investment;
(ix) Formulating suitable industrial policy to promote investment in the industrial sector;
(x) Attaining price stability and regulating deficit financing; and
(xi) Making systematic efforts to increase export and curtailing non-essential imports.
