(Later thinking about capital)
The theory of capital was not a matter of primary concern to economists in the late 20th century, though some revival of interest occurred in the late 1950s. Nevertheless, certain problems remain of perennial interest. They may be grouped as follows.

Heterogeneous goods.
First are the problems involved in measuring aggregates of goods. Real capital includes everything from screwdrivers to continuous strip-rolling mills. A single measure of total real capital can be achieved only if each item can be expressed in a common denominator such as a given monetary unit (e.g., dollars, sterling, francs, pesos, etc.). The problem becomes particularly complicated in periods of rapid technical change when there is change not only in the relative values of products but in the nature of the list itself. Only approximate solutions can be found to this problem, and no completely satisfactory measure is ever possible. (see also Index: commodity, national income accounting)
A related problem that has aroused considerable interest among accountants is how to value capital assets that have no fixed price. In the conventional balance sheet the value of some items is based on their cost at an earlier period than that of others. When the general level of prices is changing this means that different items are valued in monetary units of different purchasing power. The problem is particularly acute in the valuation of inventory. Under the more conventional “FIFO” ( First In, First Out) system, inventory is valued at the cost (purchase price) of the latest purchases. This leads to an inflation of inventory values, and therefore of accounting profits, in time of rising prices (and a corresponding deflation under falling prices), which may be an exaggeration of the long-run position of the firm. This may be partially avoided by a competing system of valuation known as LIFO ( Last In, First Out), in which inventory is valued at the purchase price of the earliest purchases. This avoids the fluctuations caused by short-run price-level changes, but it fails to record changes in real long-run values. There seems to be no completely satisfactory solution to this problem, and it is wise to recognize the fact that any single figure of capital value that purports to represent a complex, many-dimensional reality will need careful interpretation.

The accumulation process.
A second problem concerns the factors that determine the rate of accumulation of capital; that is, the rate of investment. It has been seen that investment in real terms is the difference between production and consumption. The classical economist laid great stress on frugality as the principal source of capital accumulation. If production is constant it is true that the only way to increase accumulation is by the reduction of consumption. Keynes shifted the emphasis from the reduction of consumption to the increase of production, and regarded the decision to produce investment goods as the principal factor in determining the rate of growth of capital. In modern theories of economic development great stress is laid on the problem of the structure of production–the relative proportions of different kinds of activity. The advocates of “balanced growth” emphasize the need for a developing country to invest in a wide range of related and cooperative enterprises, public as well as private. There is no point in building factories and machines, they say, if the educational system does not provide a labour force capable of using them. There is also, however, a case to be made for “unbalanced growth,” in the sense that growth in one part of the economy frequently stimulates growth in other parts. A big investment in mining or in hydroelectric power, for example, creates strains on the whole society, which result in growth responses in the complementary sectors. The relation of inflation to economic growth and investment is an important though difficult problem. There seems to be little doubt that deflation, mainly because it shifts the distribution of income away from the profit maker toward the rentier and bondholder, has a deleterious effect on investment and the growth of capital. In 1932, for instance, real investment had practically ceased in the United States. It is less clear at what point inflation becomes harmful to investment. In countries where there has been long continuing inflation there seems to be some evidence that the structure of investment is distorted. Too much goes into apartment houses and factories and not enough into schools and communications.

Capital and time.
A third problem that exists in capital theory is that of the period of production and the time structure of the economic process. This cannot be solved by the simple formulas of the Austrian school. Nevertheless, the problem is a real one and there is still a need for more useful theoretical formulations of it. Decisions taken today have results extending far into the future. Similarly, the data of today’s decisions are the result of decisions that were taken long in the past. The existing capital structure is the embodiment of past decisions and the raw material of present decisions. The incompatibility of decisions is frequently not discovered at the time they are made because of the lapse of time between the decision and its consequences. It is tempting to regard the cyclical structure of human history, whether the business cycle or the war cycle, as a process by which the consequences of bad decisions accumulate until some kind of crisis point is reached. The crisis (a war or a depression) redistributes power in the society and so leads to a new period of accumulating, but hidden, stress. In this process, distortion in the capital structure is of great importance.

Capital and income.
A fourth problem to be considered is the relationship that exists between the stocks and the flows of a society, or in a narrower sense the relation between capital and income. Income, like capital, is a concept that is capable of many definitions; a useful approach to the concept of income is to regard it as the gross addition to capital in a given period. For any economic unit, whether a firm or an individual, income may be measured by that hypothetical amount of consumption that would leave capital intact. In real terms this is practically identical with the concept of production. The total flow of income is closely related to both the quantity and the structure of capital; the total real income of a society depends on the size and the skills of its population, and on the nature and the extent of the equipment with which they have to work. The most important single measure of economic well-being is real income per person; this is closely related to the productivity of labour, and this in turn is closely related to capital per person, especially if the results of investment in human resources, skills, and education are included in the capital stock.

To cite this page:
“Economic Theory: Distribution: the shares of the factors of production: CAPITAL AND INTEREST: Later thinking.” Britannica Online.
[Accessed 23 February 1998].