Role of Capital Accumulation
Why do developing economies and many development economists emphasise so much the role of capital accumulation in the development process?
Capital is a factor of production that can be accumulated through investment. It can be split into at least two groups, physical capital and human capital. Physical capital includes the value of all existing machines, equipment, buildings and infrastructures. Human capital involves the value of productive investments embodied in the labour force. High capital per worker is likely to reflect high living standards and I will discuss strengths and weaknesses of this argument, and its role for developing economies using the neo-classical growth model.
Neoclassical Growth Model
The neo-classical growth model attempts to explain long-run economic growth by looking at capital accumulation, labour or population growth, and increases in productivity. We assume savings are based on a constant fraction of total income (Y).
Yt – Ct = St = sYt
Where Y is income in year t, C is consumption, S is the gross aggregate savings, s is the ratio of saving to GDP or the gross savings rate.
There are two relationships between output and capital. Firstly, the level of capital stock determines the amount of output produced; also the amount of output determines the level of saving and in turn, the capital accumulation over time. We assume capital is subject to decreasing returns so when the capital per worker is already high, the impact on output of the last unit of capital accumulated will always be less than the one before. Another assumption, for simplicity, is that there is no technological developments or labour force growth.
In the short run the model predicts the rate of growth of the economy is determined by capital accumulation, which is in turn determined by the savings rate (s) and the rate of deprecation.
Kt+1 = s f (kt ) − (n +δ)kt
In the long-run rate of growth is exogenously determined and given any constant savings rate, the
Capital is a factor of production that can be accumulated through investment. It can be split into at least two groups, physical capital and human capital. Physical capital includes the value of all existing machines, equipment, buildings and infrastructures. Human capital involves the value of productive investments embodied in the labour force. High capital per worker is likely to reflect high living standards and I will discuss strengths and weaknesses of this argument, and its role for developing economies using the neo-classical growth model.
Neoclassical Growth Model
The neo-classical growth model attempts to explain long-run economic growth by looking at capital accumulation, labour or population growth, and increases in productivity. We assume savings are based on a constant fraction of total income (Y).
Yt – Ct = St = sYt
Where Y is income in year t, C is consumption, S is the gross aggregate savings, s is the ratio of saving to GDP or the gross savings rate.
There are two relationships between output and capital. Firstly, the level of capital stock determines the amount of output produced; also the amount of output determines the level of saving and in turn, the capital accumulation over time. We assume capital is subject to decreasing returns so when the capital per worker is already high, the impact on output of the last unit of capital accumulated will always be less than the one before. Another assumption, for simplicity, is that there is no technological developments or labour force growth.
In the short run the model predicts the rate of growth of the economy is determined by capital accumulation, which is in turn determined by the savings rate (s) and the rate of deprecation.
Kt+1 = s f (kt ) − (n +δ)kt
In the long-run rate of growth is exogenously determined and given any constant savings rate, the