Capital intensity
Encyclopedia
Capital intensity is the term in economics
for the amount of fixed or real capital
present in relation to other factors of production
, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital/labor ratio, such as from the points along a capital/labor isoquant
.
") pushes up the productivity of labor. Capital intensive societies tend to have a higher standard of living over the long run.
Calculations made by Solow claimed that economic growth was mainly driven by technological progress (productivity growth) rather than inputs of capital and labor. However recent economic research has invalidated that theory, since Solow did not properly consider changes in both investment and labor inputs.
Dale Jorgenson, of Harvard University, President of the American Economic Association in 2000, concludes that: ‘Griliches and I showed that changes in the quality of capital and labor inputs and the quality of investment goods explained most of the Solow residual
. We estimated that capital and labor inputs accounted for 85 percent of growth during the period 1945–1965, while only 15 percent could be attributed to productivity growth… This has precipitated the sudden obsolescence of earlier productivity research employing the conventions of Kuznets and Solow.’
John Ross has analysed the long term correlation between the level of investment in the economy, rising from 5-7% of GDP at the time of the Industrial Revolution in England, to 25% of GDP in the post-war German ‘economic miracle’, to over 35% of GDP in the world’s most rapidly growing contemporary economies of India and China.
Taking the G7 and other largest economies, Jorgenson and Vu conclude: ‘the growth of world output between input growth and productivity… input growth greatly predominated… Productivity growth accounted for only one-fifth of the total during 1989-1995, while input growth accounted for almost four-fifths. Similarly, input growth accounted for more than 70 percent of growth after 1995, while productivity accounted for less than 30 percent.’
Regarding differences in output per capita Jorgenson and Vu conclude: ‘differences in per capita output levels are primarily explained by differences in per capital input, rather than variations in productivity.’
Some economists claimed that the Soviet Union missed the lessons of the Solow growth model, because starting in the 1930s, the Stalin government attempted to force capital accumulation
through state direction of the economy. However, Solow's calculations have been proven invalid, so this is a poor explanation. Modern research shows the main factor for economic growth is the growth of labor and capital inputs, not increases in productivity. Therefore other factors besides capital accumulation
must have been big contributors to the Soviet economic crisis.
Free market
economists tend to believe that capital accumulation should be not be managed by government, but instead be determined by market forces. Monetary stability (which increases confidence), low taxation, and greater freedom for the entrepreneur
would then promote capital accumulation.
The Austrian School
maintains that the capital intensity of any industry is due to the roundaboutness
of the particular industry and consumer demand.
Some businesses commonly thought to be capital-intensive are railways, airlines, oil production and refining, telecommunications, mining, chemical plants, electric power plants, etc.
of future profits? Or do we simply "deflate" the total current money value of capital equipment by the average price of capital goods?
Once this issue has been solved, the capital controversy rears its ugly head.
This controversy points out that measure of capital intensity is not independent of the distribution of income, so that changes in the ratio of profits to wages lead to changes in measured capital intensity.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
for the amount of fixed or real capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
present in relation to other factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital/labor ratio, such as from the points along a capital/labor isoquant
Isoquant
In economics, an isoquant is a contour line drawn through the set of points at which the same quantity of output is produced while changing the quantities of two or more inputs...
.
Capital intensity and growth
The use of tools and machinery makes labor more effective, so rising capital intensity (or "capital deepeningCapital deepening
Capital deepening is a term used in economics to describe an economy where capital per worker is increasing. This is also referred to as increase in the capital intensity. Capital deepening is often measured by the capital stock per labour hour. Overall, the economy will expand, and productivity...
") pushes up the productivity of labor. Capital intensive societies tend to have a higher standard of living over the long run.
Calculations made by Solow claimed that economic growth was mainly driven by technological progress (productivity growth) rather than inputs of capital and labor. However recent economic research has invalidated that theory, since Solow did not properly consider changes in both investment and labor inputs.
Dale Jorgenson, of Harvard University, President of the American Economic Association in 2000, concludes that: ‘Griliches and I showed that changes in the quality of capital and labor inputs and the quality of investment goods explained most of the Solow residual
Solow residual
The Solow residual is a number describing empirical productivity growth in an economy from year to year and decade to decade. Robert Solow defined rising productivity as rising output with constant capital and labor input...
. We estimated that capital and labor inputs accounted for 85 percent of growth during the period 1945–1965, while only 15 percent could be attributed to productivity growth… This has precipitated the sudden obsolescence of earlier productivity research employing the conventions of Kuznets and Solow.’
John Ross has analysed the long term correlation between the level of investment in the economy, rising from 5-7% of GDP at the time of the Industrial Revolution in England, to 25% of GDP in the post-war German ‘economic miracle’, to over 35% of GDP in the world’s most rapidly growing contemporary economies of India and China.
Taking the G7 and other largest economies, Jorgenson and Vu conclude: ‘the growth of world output between input growth and productivity… input growth greatly predominated… Productivity growth accounted for only one-fifth of the total during 1989-1995, while input growth accounted for almost four-fifths. Similarly, input growth accounted for more than 70 percent of growth after 1995, while productivity accounted for less than 30 percent.’
Regarding differences in output per capita Jorgenson and Vu conclude: ‘differences in per capita output levels are primarily explained by differences in per capital input, rather than variations in productivity.’
Some economists claimed that the Soviet Union missed the lessons of the Solow growth model, because starting in the 1930s, the Stalin government attempted to force capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
through state direction of the economy. However, Solow's calculations have been proven invalid, so this is a poor explanation. Modern research shows the main factor for economic growth is the growth of labor and capital inputs, not increases in productivity. Therefore other factors besides capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
must have been big contributors to the Soviet economic crisis.
Free market
Free market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
economists tend to believe that capital accumulation should be not be managed by government, but instead be determined by market forces. Monetary stability (which increases confidence), low taxation, and greater freedom for the entrepreneur
Entrepreneur
An entrepreneur is an owner or manager of a business enterprise who makes money through risk and initiative.The term was originally a loanword from French and was first defined by the Irish-French economist Richard Cantillon. Entrepreneur in English is a term applied to a person who is willing to...
would then promote capital accumulation.
The Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
maintains that the capital intensity of any industry is due to the roundaboutness
Roundaboutness
Roundaboutness, or roundabout methods of production, is the process whereby capital goods are produced first and then, with the help of the capital goods, the desired consumer goods are produced....
of the particular industry and consumer demand.
Capital-intensive industry
Capital-intensive industries use a large portion of capital to buy expensive machines, compared to their labor costs. The term came about in the mid- to late-nineteenth-century as factories such as steel or iron sprung up around the newly industrialized world. With the added expense of machinery, there was greater financial risk. This makes new capital-intensive factories with high tech machinery a small share of the marketplace, even though they raise productivity and output.Some businesses commonly thought to be capital-intensive are railways, airlines, oil production and refining, telecommunications, mining, chemical plants, electric power plants, etc.
Measurement
The degree of capital intensity is easy to measure in nominal terms. It is simply the ratio of the total money value of capital equipment to the total potential output. However, this measure need not be related to real economic activity because it can rise due to inflation. Then the question arises, how do we measure the "real" amount of capital goods? Do we use book value (historical price)? or replacement cost? or the price justified by the present discounted valuePresent value
Present value, also known as present discounted value, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk...
of future profits? Or do we simply "deflate" the total current money value of capital equipment by the average price of capital goods?
Once this issue has been solved, the capital controversy rears its ugly head.
This controversy points out that measure of capital intensity is not independent of the distribution of income, so that changes in the ratio of profits to wages lead to changes in measured capital intensity.