Economics: The Basics: Capital

Having taken a look at land and labor it is now time to reflect upon capital, the Classical economists’ third factor of production.  Like land, capital is a term that encompasses a number of different things, not all of which are strictly capital from the Classical point of view.  One comes across the term in all sorts of contexts – natural capital, social capital, intellectual capital, political capital, financial capital and so on.  So, it is fair to ask: What, in fact, is this thing called capital?

From an economic perspective it is important to understand that capital is a form of wealth.  So, in order to understand capital we need first to understand wealth.  Wealth can be thought of as embodying prosperity or well-being.  In many cases it is associated with riches or an abundance of possessions but it need not be limited to material things.  For example in terms of well-being it is thought of as including physical and mental health.  Many of us also include money and financial instruments as representing wealth but, as we shall see this is not strictly correct from an economic viewpoint.

From a Classical point of view wealth is the result of human exertion.  Essentially it is the result of the application of labor to land.  What do we mean by this?  As we noted in a previous post land includes not only the surface of the Earth but all the natural resources that are available to us.  To take a simplistic example  such as an apple tree:  it is a simplistic example but it is land from the economist’s point of view,  being one of the three factors of production.  Its natural propensity is to produce apples.  To the extent that one picks the apples one has applied labor to land and the picked apples become wealth.  Obviously not so many apple trees will be found growing unattended these days,  and there is an important ownership issue here,  but to avoid getting sidetracked we will leave that for a later post.  The point is that the act of picking the apples creates wealth.  To the extent that timber is harvested and turned into lumber that becomes wealth.  The transformation of the lumber into tables and chairs further adds to the stock of wealth.

An important factor here is that the application of labor to land must be to create something for which there is demand.  To the extent that one gathered apples for which there was no demand there would be no creation of wealth.  To the extent that one harvested damaged or decaying timber there would be limited or no demand for the lumber.  It is an easy point to miss but wealth necessarily requires that the articles in question have value.  Unless the application of labor to land results in something that is fit for use or consumption,  it will have no value and therefore cannot be characterized as wealth.

So, having gathered the apples there are some choices – they can be consumed immediately, stored for later consumption, bartered or sold or, lastly, saved and planted with a view to creating an apple orchard.

In the first instance of more or less immediate consumption the apples are classified as wealth only for so long as they are not consumed.  To the extent that the apples are stored for later consumption one can think of them as representing a store of labor.  Clearly, in the case of apples, there is a real risk of deterioration and wealth can and does decay with the passage of time.  This is no less true of more substantial forms of wealth such as a residence.  There is not a homeowner who does not appreciate the need to keep up with repairs to prevent the ravages of the passage of time and use.

Now in the case of the apples that are bartered or sold and those that are set aside for use as seed they are of a different character in the sense that they do not satisfy the immediate need of the owner for apples.  Rather, they have been retained with a different use in mind.  The intent is that they be used to acquire or generate additional wealth.  This is what in strict terms we call capital, that part of wealth used to generate additional wealth.

In view of this we can now revisit some of the ‘so-called’ forms of capital mentioned  before.  Using the strict definition of capital we can see that natural capital, in fact, is land and not capital at all.  Social, intellectual and political capital are also not capital but labor albeit of a rather specialized category.  Financial capital, perhaps the least understood, is also not capital.  Money, credit, and financial instruments are strictly speaking claims on wealth and not wealth, let alone that special form of wealth defined as capital.  Money or credit are not the direct result of the application of labor to land even though they are exchangeable for wealth.  We want the money, not for its own sake, but rather for what we can buy with it.

As we have noted previously, unlike the hard sciences, economics suffers from a degree of laxity in the interpretation of the most basic terms that are used in its exposition.  Hardly surprising therefore that misunderstandings arise.


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