Question

i. What is capital formation?
ii. What are three stages of capital formation?
iii. Explain three reasons for the low rate of capital formation in India.

Answer 1

i. Capital formation : "Capital formation consists of both tangible goods like plants, tools and machinery and intangible goods like high standard of education, health, scientific progress and research".
ii. The process of capital formation consists of the following steps:
(i) Creation of savings: It is the first step in the process of capital formation. It is savings which are transformed into capital. If there is no saving, there cannot be any capital formation, even if all other conditions are favourable for capital formation. Savings are done by households and it depends on their income and willingness to save.
(ii): Mobilization of savings: If savings are kept in the form of idle cash at home, they will not lead to capital formation. In this case, the rate of investment in the country will be low, even though the rate of savings is high. The savings must be mobilized from the savers. In a modern society, financial and other institutions as well as the capital markets perform this function. People may keep their savings in the banks or other financial institutions. They can also buy shares or bonds issued by companies.
(iii) Investment of savings: Even mobilization of savings is not sufficient for a high rate of capital formation. The mobilized savings must be actually used by producers for the purpose of investment. For instance, the money kept by the people in the banks must be lent out by the banks to the producers who can use the money.
The causes of low capital formation in India are as follows:
(i) Lack of ability to save: The chief cause of the low rate of capital formation is the low rate of savings. The low rate of saving, in turn, is explained by a number of factors. Among these, the inability to save is the most important. Because of the problem of poverty, the vast majority of the people of India are not in a position to save more than a negligible part of their incomes.
(ii) Lack of willingness to save: It is true that a significant part of the Indian population does not have the willingness to save. Even today there are parts of the Indian economy where a feudal types of economic system prevails. Under this system even those who have the ability to save (for instance, the landlords) spend most of their incomes on consumption or on conspicuous consumption.
(iii) Insufficient opportunities to save: In some cases people in India also do not have sufficient opportunities to save. Inadequate expansion of the public sector banks and other financial institutions in the rural areas, lack of faith of the people upon the indigenous bankers, lack of knowledge of the people regarding the secured savings opportunities, etc. are some of the reasons for such sufficient savings opportunity in India.
(iv): Inadequate mobilization of savings: India also suffers from the problem of inadequate mobilization of savings. The savings that are made by the people are not always used for capital formation. People often keep their savings in the form of cash and gold at home. These are not productively used. This is partly due to inadequate development of the banking habits of the people and partly to the under developed state of the banking and financial network particularly in the rural areas.