Capital Formation - Explained (2024)

Capital formation is the growth in the stock of actual capital in the economy over a particular financial period. In other terms, it means the creation of things that enhance more production. This term is mostly used in the study of macroeconomics. It shares similar meaning with the term capital accumulation. Financial capital, capital goods and human capital all combined lead to Capital formation. The build-up of human capital, financial capital and capital goods all refer to the accumulation of capital. This concept was used by one Economist by the name Adam Smith in his book The Wealth of Nations where he tried to explain why some nations were financially stable than other countries.

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How Does Capital Formation Work?

Capital formation can be explained using the following two perspectives:

• Liberal economists: They believe that capital formation is the heart of economic prosperity. Savings and investment are the most important elements in the development of nations. When the capital formation is at its peak, it will assist societies to advance economically. These economists do not encourage the concentration of capital.
• Anti-capitalist economists: They believe that wealth accumulation leads to economic imbalance and suffering to the people and have a strong belief in the investment of capital to benefit all the people. These people advocate for the concentration of capital.

Many authors and economists have collected information that is included between these two radicals with different views. These distinctions make it somehow strange. Adam Smith was one of the economists that referred to this concept in his attempt to explain why some countries were richer than the others. This was captured in his book The Wealth of Nations. According to him, the accumulation of capital led to this economic disparity. Nations would grow richer in the long run if they saved and invested. The availability of human capital, financial capital and capital goods would lead into this since they will be able to produce more. Karl Marx departed from this concept where he argued that capital accumulation led to the exploitation of workers and economic imbalance. Marx believes that it is primitive to accumulate capital because it does not link direct producers with the means of production. He believes that the accumulation of capital is accompanied by:

• The bankruptcy of the peasants: Because they don't own the farms.
• The concentration of wealth: Only a few people have wealth.