capital-intensive

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.

Calculations made by Solow claimed that the majority of economic growth was due to technological progress rather than inputs of capital and labour. Recent economic research has, however, found the calculations made to support this claim to be invalid as they do not take into account changes in both investment and labour inputs.

Dale Jorgenson, of Harvard University, President of the American Economic Association in 2000, concludes that: ‘Griliches and I showed that changes in the quality of capital and labor inputs and the quality of investment goods explained most of the Solow residual. We estimated that capital and labor inputs accounted for 85 percent of growth during the period 1945–1965, while only 15 percent could be attributed to productivity growth… This has precipitated the sudden obsolescence of earlier productivity research employing the conventions of Kuznets and Solow.’^[1]

John Ross has analysed the long term correlation between the level of investment in the economy, rising from 5-7% of GDP at the time of the Industrial Revolution in England, to 25% of GDP in the post-war German ‘economic miracle’, to over 35% of GDP in the world’s most rapidly growing contemporary economies of India and China.^[2]

Taking the G7 economies and the largest non-G7 economies Jorgenson and Vu conclude in considering: ‘the growth of world output between input growth and productivity… input growth greatly predominated… Productivity growth accounted for only one-fifth of the total during 1989-1995, while input growth accounted for almost four-fifths. Similarly, input growth accounted for more than 70 percent of growth after 1995, while productivity accounted for less than 30 percent.’

Regarding differences in output per capita Jorgenson and Vu conclude: ‘differences in per capita output levels are primarily explained by differences in per capital input, rather than variations in productivity.’^[3]

Some economists have claimed that 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. However in light of the fact that Solow's calculations have not stood up to modern examination, and modern research shows the decisive factor in economic growth is the growth of inputs not the growth of productivity, whatever were the reasons for the economic crisis of the USSR they cannot be explained in terms of analogies to conclusions by Solow that can no longer be accepted in light of the factual evidence.

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.

Capital-intensive industry

Used to describe any industry that has to use a majority of its capital to buy expensive machines instead of more labour. This term came about in the mid- to late-nineteenth-century as factories such as steel or iron sprung up around the newly industrialized world. ^[4] With machinery being the primary cost the factories have a higher cost and therefore a higher level of risk involved. ^[5] This makes new capital-intensive factories a small share of the marketplace. The benefit of these factories is that they promise a high level of productivity since high tech machinery which raises the productivity of labor resulting in greater output. ^[6] A business is considered capital intensive based on the ratio of the capital required to the amount of labor that is required. ^[7] Some common business commonly thought to be capital-intensive are railways, airlines, oil production and refining, telecommunications, mining, chemical plants, electric power plants, etc. ^[8]

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

• Labor intensity
• Organic composition of capital

References

1. ^ http://economics.harvard.edu/faculty/jorgenson/files/EconOfProductivity_Elgar_2009.pdf
2. ^ http://ablog.typepad.com/keytrendsinglobalisation/2009/05/investment-savings-and-growth-international-experience-in-relation-to-some-current-economic-issues-f.html
3. ^ Dale W. Jorgenson and Khuong Vu, 'Information Technology and the World Economy', Scandandavian Journal of Economics 2005.
4. ^ Hunt, Lynn, Thomas R. Martin, Barbara H. Rosenwein, R. P. Hsia, and Bonnie G. Smith. The Making of the West: Peoples and Cultures. 3rd ed. Vol. C. Boston: Bedford/St. Martin's, 2009. 730.
5. ^ www.economywatch.com/world-industries/capital-intensive.html
6. ^ www.economywatch.com/world-industries/capital-intensive.html
7. ^ www.investopedia.com/terms/c/capitalintensive.asp
8. ^ www.solutionmatrix.com/capital-intensive.html