Category: Development Economics

Thinking about capital

You’re reading this post, right here and right now, using capital. You’re using some sort of electronic machine – maybe a computer, maybe a phone, maybe a tablet – in order to read these words. I used a laptop to write them.

Would it have been possible for me to write these words without any machine whatsoever? No computer, no paper, no pen, no nothing. In theory, yes. I could have used my foot to etch some words in the sand. But not only would that have been tedious and impractical, it would also have required you to be there in order to read it. But with my laptop, and its internet connection, I could put this post up on the internet, and anybody could read it, including you. So I could produce something of value (and you could consume it) much more easily because of the presence of capital.

And in general, that holds true for almost everything. Most goods and services are far easier to produce, and turn out to be of far better quality, when produced with the aid of machines. This is true of something as simple as haircuts (scissors), or classes (computers and projectors), and something as complicated as a rocket launch. Machines (that is, capital) help us grow faster.

So a growth in the amount of capital we possess (what economists refer to as capital stock) is almost a prerequisite for economic growth. Now, if this is true, we can make a series of predictions. I have outlined them below.

One, countries that have a low level of capital stock will be poor, and countries that have a high level of capital stock will be rich. Also, countries that are in the process of adding to their capital stock will be growing more rapidly than others.

Are these claims true? Nothing is ever completely true in economics. It is, after all, a social science, and you’ll always have a bit of error. But most economists would agree with the claims made above.

And without getting into the data and the charts, it is possible to see that the claim makes sense. Which country, do you think, has more roads, airports, seaports and power plants – India or the United States of America (USA)? Which country is richer?

Has China added, in the last three decades, an enormous number of airports, seaports and power plants (besides much else)? Has China grown rapidly?

Long story short, if we want India to grow rapidly, we have to add to India’s capital stock. We have to, in the years to come, build more roads, more dams, more solar farms – more everything, really. This will raise, to use a bit of jargon, our productivity. That is to say, it will raise our ability to produce more goods and services in the future – and that is what we mean by growth.

And this is the first intuition behind a model that we will be fleshing out now. The model is called the Solow model, and the intuition is painfully obvious in hindsight: adding to the capital stock helps a nation grow.

Thinking About Long Term Growth

We now know what GDP is, and why it is important to measure growth using GDP. We know what statistical adjustments are made over time so that growth is made truly comparable. We also know the difference between long term and short term growth.

Armed with the answers to all of these questions, we now ask the million dollar question:

What makes a nation grow over time?

That is, if we are to transform India into a developed nation by increasing her growth rate in a sustained, sustainable fashion, then what, specifically, needs to happen? Well, lots of things, is the easy answer. And a true answer, too.

Here’s a better question. What are the things without which this growth story absolutely can not happen?  What are the indispensable factors?

Answering this question takes us into the realm of growth, or development economics. Nomenclature aside, it is the area that lies at the heart of all economic policy-making. What we are looking for is the framework, the core, around which everything else can be built, added and embellished. Just as a truly great dish looks good and tastes better with more accompaniments, but can’t really work without the core ingredients – similarly, our growth story needs some core ingredients, around which we’ll add more stuff later.

And our core ingredients are labor, and capital. Turns out, India’s growth story cannot happen, without first possessing (and growing) capital and labor.

What is capital, and what is labor?

Capital is machinery. You’re almost certainly reading this post on an electronic device, and that device is your capital. The ladle with which a dosa-wala flips a dosa is capital. The pushcart that a chaiwala uses as his makeshift shop is capital. An assembly line in a Tesla factory is capital.

And the effort that I put in to type out this article is labor. The hands that use the ladle to flip the dosa is labor, as is the chaiwala himself and the worker on the factory floor of that Tesla factory. That is all labor.

And any production, anywhere in the world, of any good at all, can only be done with some combination of labor and capital. In order to produce something – anything – you need capital and labor.

The more you produce, the more you grow. The faster you produce, the faster you grow. And so in order to grow more, and grow fast, you need more capital, and you need more labor. So any story about the long term growth prospects of a nation need to start from capital, and labor.

Economists call these the factors of production, and without them, our story can’t start. But with them, we encounter another question: how do you get capital and labor to grow?