Fixed capital

Estimating the value

There are two primary methods for estimating the stock of fixed capital in any nation: direct measurement of the capital stock and perpetual inventory calculations. Attempts have been made to estimate the value of the stock of fixed capital for the whole economy using direct enterprise surveys of "book value", administrative business records, tax assessments, and data on gross fixed capital formation, price inflation and depreciation schedules. A pioneer in this area was the economist Simon Kuznets.

The "perpetual inventory method" (PIM) used to estimate fixed capital stocks was invented by Raymond W. Goldsmith in 1951 and subsequently used around the world. The basic idea of the PIM method is, that one starts off from a benchmark asset figure, and adds on the net additions to fixed assets year by year (using gross fixed capital formation data), while deducting annual estimates of economic depreciation based upon an explicit service life assumption, all data being adjusted for price inflation using a capital expenditure price index. In this way, one obtains a time series of annual fixed capital stocks. This data series can also be modified further with various other adjustments for prices, economic depreciation, etc. (several variants of the PIM approach are nowadays used by economic historians and statisticians).

Economic depreciation

Depreciation as an economic concept distinguishes between "...the value of the stock of capital assets and the annual value of that asset's services, distinguishing between depreciation and inflation as sources of the change in asset value, and distinguishing between the depreciation in asset values and deterioration in an asset's physical productivity." Depreciation is the cost of the stock of capital assets allocated over their service lives in proportion to estimates of their service lives, net of maintenance and repair costs. Economic depreciation, therefore, is "...the decline in asset price (or shadow price) is due to aging and varies with age" Economic depreciation is also characterized by an " ... age-price relationship in which the largest rate of price decline occurs in the early years of asset life." The depreciation write-off permitted for tax purposes may also diverge from that of economic depreciation or "real" depreciation rates. The key factor is the estimate of "economic service life". Economic depreciation can, however, be estimated with "...sufficient precision to be useful in policy analysis."

Investment risk

A business executive who invests in or accumulates fixed capital is tying up wealth in a fixed asset, hoping to make a future profit. Thus, such investment usually implies a risk. Sometimes depreciation write-offs are also viewed partly as compensation for this risk. Often leasing or renting a fixed asset (such as a vehicle) rather than buying it is preferred by enterprises because the cost of using it is lowered thereby, and the real owner may be able to obtain special tax advantages.

Sources of funding for fixed capital investment

An owner can obtain funding for the purchase of fixed capital assets from the aptly named capital market, where loans are given on a long-term basis. Funding can also come from reserve funds, the selling of shares, and the issuing of debentures, bonds or other promissory notes.

Factors which influence fixed-capital requirements

• The nature of the undertaking- the nature of the business, certainly plays a role in determining fixed capital requirements. A florist, for example, needs less fixed capital than a vehicle-assembly factory.
• The size of the undertaking- a general rule that states: the bigger the business, the higher the need for fixed capital.
• The stage of development of the undertaking- the requirement of capital for a new undertaking is usually greater than that needed for an established business that has reached optimum size.

References

• Reed, S. A. (1989). A Historical Analysis of Depreciation Accounting—The United States Steel Experience. Accounting Historians Journal, 16(2), 119-153. Accessed at https://egrove.olemiss.edu/cgi/viewcontent.cgi?article=1341&context=aah_journal.
• Bureau of Economic Analysis,(September 2003) Fixed assets and consumer durable goods in the United States, 1925-1997 https://web.archive.org/web/20170427154750/https://www.bea.gov/national/pdf/Fixed_Assets_1925_97.pdf
• Canberra Group on Capital Stock Statistics Conference, March 1997 http://www.oecd.org/document/63/0,3343,en_2825_500246_1876351_1_1_1_1,00.html

References

1. Varri P. (1987) Fixed Capital. In: Durlauf S., Blume L. (eds) The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. "fixed capital", ''[[The New Palgrave: A Dictionary of Economics]]'', 1st Edition.[https://link.springer.com/referenceworkentry/10.1057/978-1-349-95121-5_81-1]
2. Young, A., & Musgrave, J. C. (1980). Estimation of capital stock in the United States. The measurement of capital (pp. 23-82). University of Chicago Press.
3. Simon Kuznets, ''Gross capital formation, 1919-1933''. New York: National Bureau of Economic Research, 1934.
4. [[Raymond W. Goldsmith]], ''A Perpetual Inventory of National Wealth''. Studies in Income and Wealth, Vol. 14. New York: NBER, 1951, pp. 5-74.
5. Hulten, C. R., & Wykoff, F. C. (1980). The measurement of economic depreciation. Urban Institute. Accessed at [http://econweb.umd.edu/~hulten/webpagefiles/original%20hulten-wykoff%20economic%20depreciation%20study.pdf]
6. (March 1980). "Estimation of Capital Stock in the United States". University of Chicago Press.
7. [http://www.dictionaryofeconomics.com 1st Edition, 1987, (Update Search Results button) at]