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Capital intensity

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.

Capital intensity and growth

Since the use of tools and machinery makes labor more effective, rising capital intensity (or "capital deepening") pushes up the productivity of labor, so a society that is more capital intensive tends to have a higher standard of living over the long run than one with low capital intensity.

To some economists, promoting capital accumulation is therefore a primary long-term aim of government economic policy. However, the Solow growth model and research in growth accounting suggest that most of economic growth is due to other factors besides capital intensity: these include improvements in technology and economic institutions, rate of population growth, investment in human capital (education and training), infrastructural investment, and the like.

The lessons of the Solow growth model were missed by the Soviet Union. Starting in the 1930s, the Stalin government attempted to force capital accumulation through state direction of the economy. Most economists now believe that while the Soviet system allowed for rapid economic development into the 1950s, as long as large surpluses of land, labor, and raw materials could be tapped by the urban and industrial leading sector, this strategy led to an unbalanced economy with stagnant or slowly-growing standards of living. With the emphasis on raising capital intensity, diminishing returns were hit; the Soviet Union's weak ability to use new technologies meant that this problem was not solved in the same way as in the rich Western countries.

Most free market economists argue that capital accumulation was best aided largely by leaving it alone to be determined by market forces. Monetary stability which increased certainty, low taxation and greater freedom for the entrepreneur would promote capital accumulation.

The Austrian School maintain that the capital intensity of any industry is due to the roundaboutness of the particular industry and consumer demand.

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 amount of labor hired. 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 value 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.

See also

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