Physical Capital

The term capital is used to refer to a factor of production within economics, one of three primary building blocks (along with land and labor), that in combination can be used to produce goods and services. Although suggesting homogeneity, capital as a term has no fixed conceptual definition, and different schools of economic thought through classical and neoclassical economics have defined it differently. Physical capital is a subset of capital, with other subsets including financial or money and the recently developed human, social, and knowledge capital. However, this subdivision does not result in making physical capital a homogeneous substance, and both its definition and measurement remain problematic.

Since the birth of capitalism and mechanized production, physical capital has been considered a stock of capital goods. Economic production functions, which model production processes using factor inputs, assume this definition. National accounting statistics, however, subtly alter the definition to one of produced assets, which do not necessarily have to be factors of production. A nation's physical capital or capital stock consists of fixed capital assets. The Organisation for Economic Co-operation and Development (OECD) suggests that most countries use a derivation of the United Nations System of National Accounts (SNA) to determine which sorts of goods to include in the fixed capital stock. According to the OECD, the goods included are durable (if lasting longer than one year), tangible (not patents and copyrights), fixed (mobile equipment excluded, but inventories and work in progress included), and reproducible (natural forests and land and mineral deposits are excluded). This provides a relatively clear definition, but means, for example, that items such as housing stock and artistic originals may be included, in contradiction to the economic definition.

Both definitions of physical capital suffer from a problem of measurement. Joan Robinson first raised the problem of how heterogeneous physical capital stock was to be measured in 1954. She argued that a physical measure is impossible if we are dealing with different goods, and a price or monetary measure invokes circular reasoning. This is because the theoretical price of a capital good is a measure of its total future profitability in current money. Yet profits are determined by the quantity of capital used in production; therefore, the quantity of capital cannot be determined by the amount of profit generated without circular reasoning. This is highly problematic for aggregate measures of physical capital, as well as for economic theories that depend upon them as inputs. National statistics ignore the problem by using average historical purchasing prices to calculate quantity of capital. Price is treated as an exogenous variable, independent of future profitability and therefore [Page 675]quantity of capital. Textbook economic theories also ignore the problem when invoking aggregate production functions. More radical approaches, utilizing institutional and evolutionary methods, reject the reduction of production to quantifiable factor inputs and therefore challenge not only the definition and measurement of physical capital, but also how the concept is deployed.