Capital (economics)

Capital has a number of related meanings in economics, finance and accounting.

In finance and accounting, capital generally refers to financial wealth, especially that used to start or maintain a business. It is assumed that other styles of capital, e.g. physical capital, can be acquired with money, so there is little need for any further analysis.

Table of contents

1 Capital in classical economic theory
2 Broadening the definition of capital
3 See also

Capital in classical economic theory

In classical economics, capital is one of three factors of production, the others being land and labour. Goods with the following features are capital:

It can be used in the production of other goods (this is what makes it a factor of production).
It is man-made, in contrast to land, which means naturally occurring resources such as geographical locations and minerals.
It is not used up immediately in the process of production.

Investment in classical economic theory is the act of producing capital. In order to invest, goods must be produced which are not to be immediately consumed, but instead used to produce other goods as a means of production. Investment is closely related to saving.

The Austrian economist Eugen von B�hm-Bawerk maintained that capital intensity within a certain industry as determined by consumer demand rather than the supply of saving, through the roundaboutness of production processes.

Broadening the definition of capital

Some economic theorists see capital as physical items such as tools, buildings and vehicles that are used in the production process. Other economists have focussed on broader forms of capital. For example, investment in skills and education can be viewed as building up human capital (or in more detailed analyses, building up individual capital using instructional capital, recognizing that both the individual and the instruction may benefit from the interaction).

Some theories use the terms intellectual capital or knowledge capital which lead to certain questions and controversies discussed in those articles. In general, intellectual capital is that which produces new "intellectual property", and that in turn is "whatever one can get paid royalties for". These are terms that rightly belong in law but mean little in economics.

In modern economic theories, the less controversial analyses break down each of the major factors of production as its own 'style' of capital, allowing for the capital appreciation and depreciation of each asset. Such analyses recognize four styles of capital, or in more detail, six:

Financial capital which represents obligations, and is liquidated as money for trade, and owned by legal entities.
Natural capital which is inherent in ecologies and protected by communities to support life, e.g. a river which provides farms with water.
Infrastructural capital is non-natural support systems (e.g. clothing, shelter, roads, PCs) that minimize need for new social trust, instruction, and natural resources. (almost all of this is manufactured, leading to the older term manufactured capital, but some arises from interactions with natural capital, and so it makes more sense to describe it in terms of its appreciation/depreciation process, rather than its origin: natural capital grows back, infrastructural capital must be built and installed).
Human capital, which in macro-economics or even modern theories such as Natural Capitalism, is narrowly treated as just another way to generate money (via salary). Human development theory recognizes it as being composed of clear and distinctive social, imitative and creative elements:
- Social capital is trust available to all members of a community (e.g. family, guild, customer base), which is typically applied to distribute resources in case of difficult times. Governments tend to rely heavily on social capital, and in some ways trade on it directly by collecting taxes and spending the funds on things which further advance society. Historically in the Western world it was represented and later protected as what came to be known as trademark.
- Instructional capital which is adequately-tested knowledge that persons and communities and software executes to predict/create or avoid futures that they consider desirable, or not. A close parallel term is 'ideas applied in practice', or 'praxis'. Historically in the Western world it was commonly recognized and protected via the patent system that provides limited exclusive rights to gain from an invention.
- Individual capital which is inherent in persons, protected by societies, and trades labor for trust or money . Close parallel concepts are 'talent', 'ingenuity', 'leadership', 'trained bodies', or 'innate skills' that cannot reliably be reproduced by using any combination of any of the others above. Accordingly, it must be seen as a style of capital in its own right. Historically in the Western world it was recognized and rewarded via copyright, even in cases of political or religious leaders (who often fund their retirement by sales of memoirs).

Some analyses differentiate the latter three. They also avoid the term "human" in part to avoid implying that humans are owned, and so that non-human instructional capital (e.g. software), non-human individual capital (e.g. orang-utans painting, or a race-winning horse, or prize stud bull), and the activities of government can be analyzed more exactly for performance, e.g. in a health observatory.

Although it is still possible to calculate the macro economic idea of "human capital" as payments (like salary), it is rarely or not used when discussing the process of planning investment: for this it is broken down into the more specific styles, which are distinct when one considers the means of identifying them, investing in, and exploiting them. The term "human capital" may thus do more harm than good.

Another prompting for the more exact and deeper six-style analysis is that infrastructural capital has declined in financial value relative to intellectual rights, and natural resources have become more scarce. Meanwhile, both human development and biodiversity have become a main priority of government in every developed nation.

In part as a result, separate literatures have developed to describe both natural capital and social capital. Such terms reflect a wide consensus that nature and society both function in such a similar manner as traditional industrial infrastructural capital, that it is entirely appropriate to refer to them as styles of capital in themselves. In particular, they can be used in the production of other goods, are not used up immediately in the process of production, and can be enhanced (if not created) by human effort.

There is also a literature of intellectual capital and intellectual property law. However, this increasingly distinguishes means of capital investment, and collection of potential rewards for patent (imitative or instructional capital), copyright (creative or individual capital), and trademark (social trust or social capital) instruments. Literature that makes these distinctions tends to parallel the six-style analysis, which explains why three distinct bodies of law would have evolved in the first place.

Some analysts, e.g. Baruch Lev, claim there are seven styles of capital. It is not clear how his analysis relates to that of human development theory, as it arises from management accounting practices. It is not very widely used, not at all outside the US, and is under some suspicion as it emerged during the dotcom boom and did not specifically claim that those companies were grossly overvalued or corrupt, as later events proved them to be. This has led to speculation that political capital, or political influence or corruption, is his actual seventh factor. This is probably oversimplified, but calls for comprehensive accounting reform have reached the highest levels in the US, particularly in the wake of major accounting scandals, so it is hard to wholly dismiss this concern.