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    Capital Formation

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    Sajal Jain

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    © All Rights Reserved
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    Capital Formation

    Uploaded by

    Sajal Jain
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    © © All Rights Reserved

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    6 views17 pages

    Capital Formation

    Uploaded by

    Sajal Jain

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 17

    INDORE INSTITUTE OF LAW

    (AFFILIATED TO D.A.V.V. & BAR COUNCIL OF


    INDIA, NEW DELHI )

    By
    Dr Chitra Joshi
    Asst. Professor,IIL
    Capital Formation
    Capital Formation

     Capital formation means increasing the stock of real capital in


    a country.

     In other words, capital formation involves making of more


    capital goods such as machines, tools, factories, transport
    equipment, materials, electricity, etc., which are all used for
    future production of goods.

     For making additions to the stock of Capital, saving and


    investment are essential.
     The greater the extent to which the people are willing to
    abstain from present consumption, the greater the extent that
    society will devote resources to new capital formation. If
    society consumes all that it produces and saves nothing, future
    productive capacity of the economy will fall as the present
    capital equipment wears out.
     Factors Affecting Capital Formation

    1. Volume of Saving
    2. Ability to Save
    3. Profit of Public Sector Enterprises
    4. Market Conditions
    5. Facilities of Investment
    6. Modifying Income Tax Policies
    7. Commodity Taxation
    Process of Capital Formation
    (a) Creation of Savings:
    An increase in the volume of real savings so that resources, that
    would have been devoted to the production of consumption
    goods, should be released for purposes of capital formation.
    (b) Mobilization of Savings:
    A finance and credit mechanism, so that the available resources
    are obtained by private investors or government for capital
    formation.
    (c) Investment of Savings
    The savings of the people must be properly invested for the
    purpose of producing capital goods by a good number of honest
    and venturesome entrepreneurs in different productive systems,
    such as agriculture, industry, trade, public works, transport,
    communication and improved technical know-how.
    Causes of Low Rate of Capital Formation in an Economy

     Low Level of National Income and Per Capita Income


    The root cause of capital deficiency in under-developed
    countries is low level of real national and per capita income
    which limits to the motives of savings and investments.

     Lack in Demand of Capital


    Low productivity in under-developed countries, people have
    low real income and, thus, purchasing power is low and so due
    to low demand, investment has effect which again reduces
    national income and productivity and rate of capital formation
    remains low
     Lack in Supply of Capital:
    Like demand of capital, lack of supply of capital is
    responsible for low capital formation. However, due to lack of
    necessary supply of capital in under-developed countries, the
    process of capital formation is not boosted up. As a result,
    capital formation remains at low level.

     Small Size of Market:


    Due to small size of domestic market, investment is not
    encouraged in poor countries. It does not expand the work of
    economic development and modern machines cannot be used
    as extra quantity produced has no market access.
     Lack of Economic and Social Overheads:
    Basic overheads like roads, buildings, communication,
    education, water, health etc. are generally lacked in under-
    developed countries which react as improper atmosphere for
    the capital formation and slow process of capital formation.

     Lack of Skilled Entrepreneurs:


    Able and efficient entrepreneurs are not available in under-
    developed countries. It is the only reason for low rate of
    capital formation. Due to absence of risk-taking entrepreneurs,
    establishment of industries and expansion is quite limited and
    industrial diversification is not carried out and no balanced
    development of economy is possible.
     Immobility of Savings:
    Immobility of saving also causes low rate of capital
    formation. Due to lack of banking and other credit institutions,
    poor countries have limited financial activities.
     Backwardness of Technology:
    Under-developed countries also face the problem of technical
    knowledge. Production is carried on old and less productive
    techniques
     Lack of Effective Fiscal Policy:
    Lack of effective fiscal policy or financial policy in under-
    developed countries also retard capital formation to some
    extent. Burden of taxation is too much which is out of people’s
    capacity to bear as their income is quite low.
     Lack of Investment Incentives:
    Still another cause of the low rate of capital formation is the
    lack of investment incentives in most of the under-developed
    countries. This leads to low rate of productivity which, in turn
    restricts capital formation.
     Deficit Financing:
    Deficit financing is considered a major resource of capital
    formation. But, if it crosses its limits, then it tends to low rate
    of capital formation. Whenever, deficit financing is made in
    the country, it leads to rise in prices and as a result, all
    commodities become costly. Under this situation, it becomes
    hard to save as the entire amount is spent. This results in the
    saving and low rate of capital formation.
     Unequal Distribution of Income and Wealth:
    Since there is extreme unequal distribution of income and
    wealth in most of the under-developed and backward countries
    which keep the rate of capital formation relatively low.

     Demographic Reasons:
    In under-developed countries, the growth rate of population is
    very high which keeps the rate of capital formation at a low
    level.
     Suggestions to Increase the Rate of Capital Formation
     Taxes
    The taxation policy should be revised and adequate tax reliefs
    should be allowed to salaried persons and industrialists.
     Encourage Savings
    Steps should be taken to intensify and motivate small savings,
    for which rate of interest on savings should be attractive.
    Saving schemes like (P.F.) provident fund, compulsory
    insurance, compulsory deposits, etc., should be encouraged
    and extended.
     Facilitate Investment and Production:
    Many more avenues of investment and production should be
    increased by establishing and implementing schemes in
    agriculture, industry, transport, banking, insurance, trade, etc.
     Maintenance of Law and Order:
    The law and order condition in every part of the country
    should be improved and security of life and property must be
    ensured.
     Equal Distribution of Wealth:
    There should be a proper distribution of wealth.
     Improving and Developing Basic Utilities:
    General facilities like means of transportation,
    communication, power plants, ports, technical training
    facilities, etc., should be improved and developed in an
    adequate way.
     Cheap Capital
    The investors avail credits from various agencies for their
    growth, but the rates of interest at which credit is available to
    them is high, thus increasing the cost of capital results in low
    profit margins for investors.
     Identification of Investments
    The productive investments should be encouraged but
    unproductive investments should not be entertained.
     Foreign Capital
    Capital formation in a country can also take place with the
    help of foreign capital, i.e., foreign savings.

     Foreign capital can take the form of:


    (a) Direct private investment by foreigners,
    (b) Loans or grants by foreign governments,
    (c) Loans by international agencies like the World Bank.
    There are very few countries which have successfully
    marched on the road to economic development without
    making use of foreign capital in one form or the other. India is
    receiving a good amount of foreign capital from abroad for
    investment and capital formation under the Five-Year Plans.

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