Friday, 19 June 2009

How much is my country's capital worth?

Capital is the physical equipment and material used in producing new goods. It is made by investment. Much research has found a link between a country's capital and its output, and so there is a link with investment too. Investment is something that can be changed by a country, and so other things being the same, a country can alter its output too.

If output grows quickly when capital increases, then investment is even more important. To find out how strong the link is, we have to have good measures of output and capital. Output is relatively easy to work out since much of it is sold every year so it can be found by surveys, amongst other means. For capital, it is trickier, since it is not completely sold every year.

One method of finding out the capital in a country is to ask everyone and every company what equipment they have, and then work out its value by looking at the market prices for the equipment, if it is still sold. The method will be time-consuming and expensive, if it is possible at all.

An alternative method is to say that investment makes capital, so to estimate a country's capital we can add up its past investment in some way. Many writers assume that investment goes straight into capital, so 10 francs of investment become 10 francs of capital. They also assume that past investment becomes less valuable every year. 10 francs of capital made this year are worth more than 10 francs made a year ago, which is worth more than 10 francs made two years ago.

Old capital may be less valuable because it breaks. The same equipment in two different countries may break at similar rates. It may also become less valuable because it is used to make a product that fewer people want to buy as time goes on. People's preferences may change faster in one country than another if the country has faster improvements in the products it has available. These countries are likely to have high investment rates, too, since high investment is likely to encourage technological change. So high investment is likely to be associated with faster reduction in capital value.

Sometimes, someone might be interested in how fast a country's capital deteriorates physically. At other times, they might be interested in how valuable it is for making new goods. Deterioration rates and whether they are the same across countries depend on how people want use the calculated capital.

There is a research paper discussing these issues here.

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