CAPITAL FORMATION AND CAPITAL CONSUMPTION
Capital Formation or Accumulation
Capital formation or capital accumulation refers to increasing a country’s stock of real capital. That is, it refers to increasing the net investment in form of fixed assets.
For a country to be able to accumulate more capital, there must be increase in savings and a reduction in consumption of consumer goods. The rate of economic development of any country is directly related to the rate of capital formation. In most advanced countries like Britain, Japan and the United States of America, stocks of capital are high as a result of high rate of capital formation whereas in many developing countries of the world, there is a low rate of capital accumulation as a result of low per capita income and low savings, which results in what is termed vicious circle of poverty (fig. 4.2) above.
Causes of low capital formation in West African countries
The causes of low capital formation in West African countries include:
- Existence of a vicious circle of poverty: As seen in Fig. 4.2, the existence of low income results in low savings and in turn results in a shortage of capital for investment, which results in low investment. Low investment leads to low output, and eventually to low income. The low income results again to low savings and the vicious circle continues.
- Wasteful expenditure: Many governments in West African countries are involved in wasteful expenditure as they embark on prestigious but non-productive ventures thereby resulting in low capital formation.
- Inequitable distribution of income: In many West African countries, only few individuals are rich while the majority are poor. Even the few rich ones spend their money on prestigious projects which are non-productive and these generally give rise to low capital formation.
- Higher propensity to consume: In many West African countries, the propensity to consume by the people is higher than the propensity to save. There is a high taste for imported goods, e.g. cars, television, rice, clothing materials, etc. This high propensity to consume results in low savings and investment.
- Low savings: Many working class people in West Africa do not have the habit of saving and are usually poor. This may be due to their low earnings, which may not be enough for them to spend not to talk of saving. This usually affects negatively capital formation. The problems of low capital formation can be solved when the above problems are looked into by the various governments of West African countries.
Capital consumption refers to the using up of existing capital stock and not replacing worn-out capital goods used in production. When fixed assets like building, motor vehicles, plants and machinery are being used continuously, they undergo wear and tear, hence such assets depreciate in value. It is this wear and tear of these capital goods which reduces their value that is referred to in economics as consumption or depreciation. During the period of capital consumption, enough savings are not made to maintain and replace depreciating capital goods or assets.
If a country finds it difficult to maintain its stock of capital, either by making provision for depreciation or her inability to replace worn-out capital or asset, such a country is said to be living on capital or consuming capital and this affects the standard of living of the people negatively.