Capital Formation
What is Capital Formation?
Most simply, capital formation is the increase of capital stock. Capital stock is the term used in macroeconomics for an entity’s, usually a nation’s, total amount of goods not directly consumed. Goods not directly consumed include equipment, factories and all other goods that are used to create the flow of goods and services that are directly consumed.
How is Capital Formation calculated?
Capital formation = fixed capital investment + the increase in the value of inventories held + net lending to foreign countries
Capital formation is always calculated for a fixed period such as a year or quarter. Also, note that though “lending to foreign countries” is added, this value can be negative and actually decrease capital formation.
What is the origin of Capital Formation?
The statistical methods for estimating capital formation were created by Simon Kuznets during the 1930s. Despite the long history of capital formation calculations, it remains notoriously difficult to accurately measure due to issues with both accurately valuing capital assets and the general intricacies of any national statistics.
Why is Capital Formation important?
High rates of capital formation are considered indicative of rapid growth in an economy’s productive capacity which will in turn lead to rapid growth in aggregate income.