Although the concept of capital appears in almost all important economic debates, textbooks, and daily political issues, it seems that the understanding of capital is completely arbitrary. Money, machines, tools, property, wealth, and financial derivatives – the choice is up to the reader! But is it really that simple?
The analysis of complex economic phenomena such as capital is a serious undertaking for several reasons. It is necessary to identify the economic phenomenon, understand its key determinants, and find an acceptable explanation for its functioning. A special problem may be the boundary between economic and non-economic facts, which often overlap in public debate. How we can set a clear line between economic and non-economic research is a question that the economist Joseph Schumpeter raised more than a century ago.
According to Schumpeter, the answer is quite simple – economic research ends when the causal relationship between two phenomena can be characterized as non-economic. Schumpeter writes: “Then we have achieved what we, as economists capable in a given case, must achieve, and we must give way to other disciplines. If, on the other hand, the causal factor itself is economic in nature, we must continue with the explanation until we reach the economic essence.”
It would not be wrong to say that there is an unlimited number of economic phenomena that penetrate almost every part of social life. Among the fundamental economic phenomena, a special place belongs to the phenomenon of capital, and consequently, to the theory that studies it.
The integrative nature of the concept of capital, as well as the importance of understanding it for the development of economic science, has attracted public attention since the establishment of this discipline. The phenomena of value, production, productivity, imputations, technology, credit, interest, and profit, as well as many others, share common logical foundations with the theory of capital and are very difficult to separate conceptually.
The ambiguity of the concept of capital, if we use the terminology of Friedrich Hayek, makes this topic more than relevant for constant reinterpretation. If we want to gain a minimal insight into the complexity of the phenomenon of capital, it is necessary to refer to the work of certain theorists who have achieved recognized results in this field.
A group of authors belonging, in today’s discourse, to the dominant Neoclassical paradigm, treats all production factors involved in the production process independently. Production occurs through the transformation of production factors, and all used factors, including capital, have the same importance. More precisely, capital and labor are transformed into output in the production process, while the time dimension is not emphasized.
Capital is defined as the sum of physical (equipment, buildings, machines) and financial (cash, securities) factors used in the production process.
This explanation is important from the perspective of the function of capital, but it does not give us enough information about the deeper, philosophical dimension of this concept. To understand the level of complexity of capital, it is necessary to look at the work of theorists who tried to penetrate the essence of the question: how is capital created?
The foundations of capital theory were presented by Carl Menger, the pioneer of the Austrian School of economics. According to Menger, all goods can be grouped according to their distance from consumer goods – first-order goods. A good that is further from final consumption belongs to a higher category of goods and becomes less specialized, opening the possibility for its use in different purposes.
The value of higher-order goods (production goods) is imputed based on the value of lower-order goods in whose production the former participated. More precisely, the value of higher-order goods depends on the expected value of lower-order goods (Menger’s law). In this system, capital represents all inputs that can be used in the production of first-order goods, either directly or indirectly.
Another thinker associated with the theoretical progress of capital theory, whose key works were created in the late 19th century, is Eugen von Böhm-Bawerk. According to Böhm-Bawerk, to understand the phenomenon of capital, it is necessary to introduce the concept of original production factors. Original production factors cannot be reduced to lower-type units and consist of land and labor.
On the other hand, capital belongs to the produced production factor, meaning that capital goods are obtained through the combination of original production factors and time. Capital goods can therefore be divided based on the time required for their production, and the entire production process is observed from the perspective of a roundabout process (a process that requires a certain duration). In Böhm-Bawerk’s analysis, capital is defined as the sum of all intermediate products that appear in all stages of the roundabout production process. All means for producing consumer goods are consequently categorized as capital.
Ludwig von Mises, the founder of the praxeology school of thought, views capital as an independent factor that does not exist outside specific capital goods. Primary capital arises from initially available production factors – labor and natural resources. Capital goods are inseparably connected with the phenomenon of saving, through which they are created. Saving exists, except in special cases, when more is produced than consumed. Therefore, capital goods are transitional states that exist between the initiation of the production process and the realization of consumer goods. Consequently, capital is contained (incorporated) in capital (production) goods and is tied to their use.
The phenomenon of capital mobility gains special significance in Ludwig von Mises’ analysis. Capital mobility is essentially the ability to adapt to alternative productive uses, not literal physical mobility. If a capital good is specific in its structure, mobility necessarily decreases, and the entrepreneur faces higher business risk if an inadequate production structure (composition of capital goods) is chosen.
In the first half of the 20th century, a fundamental contribution to capital theory was made by Nobel laureate Friedrich August von Hayek. In the theoretical studies Prices and Production (1936) and The Pure Theory of Capital (1941), Hayek presents his vision of the phenomenon of capital. Dissatisfied with the neoclassical treatment of capital as a timeless factor, Hayek pays special attention to the structure of production and the element of the time process. The production process is defined as all processes necessary for goods to reach the market (to reach consumers).
Hayek defines capital as production factors that can only be used to maintain income at a specific level.
Production factors can be divided into original production factors (land and labor) and capital. In the production of consumer goods, capital goods are used directly or indirectly, which Hayek categorizes as producer goods. Producer goods that are not original production means but are located between original means and final consumer goods, Hayek calls intermediate goods. Relying on Friedrich von Wieser’s analysis, Hayek defines capital as production factors that can only be used to maintain income at a specific level.
The first half of the 20th century was characterized by intellectual breakthroughs in economic analysis achieved by Joseph Schumpeter. According to Schumpeter, a capitalist economy is a form of economic organization in which goods necessary for production are withdrawn from their previous uses and fixed places in the economic system, based on the action of newly created purchasing power. Non-capitalist (centrally planned) production implies the opposite economic pattern, in which economic allocation occurs through a system of direct commands or agreements between interested parties.
Economic subjects (entrepreneurs) withdraw productive forces for alternative uses guided by new production combinations, which essentially represents the essence of the phenomenon of capital: “Capital is nothing more than a lever by which the entrepreneur subjugates to his control the concrete goods he needs, nothing more than a means of redirecting production factors to new uses, or dictating a new direction of production.”
Based on this definition, we can establish that Schumpeter does not connect the phenomenon of capital to any single category of goods. All goods used by the entrepreneur in production are on the same level. Labor services, machines, materials, production space, and other equipment are necessary for the production process, and the entrepreneur categorizes them in the same way. It can be observed that there are objective differences between production factors used by the entrepreneur, for example, there are physical and functional differences between the services of workers in a dairy and a machine for closing glass bottles, but these differences, according to Schumpeter, are secondary when explaining the core of capital.
Based on all the definitions above, it is possible to form a new (complex) integrated definition of capital, which unites the philosophical interpretation and the need for practically clear properties of capital. The phenomenon of capital is an essential part of the development process, an indicator of economic movements that, based on entrepreneurial initiative, change beyond established economic patterns. Capital manifests as a material representation of new development cycles, as a means of free tendency towards unexplored production combinations. Capital arises in the mind of the economic subject, who is dissatisfied with the current state and seeks change, and materializes through undirected market actions.
Based on the demand for alternative uses of production means, the economic system forms a lever for its own change, which no individual effort could ensure. Precisely because economic subjects aim to improve their situation, capital appears as a necessary lever in the process of materializing their ambitions. It connects economic possibilities with alternative goals and emerges as a link that has meaning only within the framework of a market economy.
From this analysis, one important implication can be drawn: the market economy is the only context in which the concept of capital gains significance. When there is a market economy, there is capital. Property has no market value if it cannot be monetized and exchanged within a certain period. A machine has no market value if its product cannot be sold. Money itself has no market value without the possibility of exchange for goods that we use and consume.
The concept of capital is linked to the need to direct purchasing power into different forms – into real estate, machines and equipment, financial derivatives, and anything in the market that has a value that can be exchanged. Capital is nothing more than a form of market power, a power that directs human activities towards effective and efficient economic goals.
Author: Nebojša Novković, economist
