If you are living with your parents in own house than have ever wondered how the house was built or how your parents were able to purchase a car and other luxurious things, well the answer to this question lies in the concept of capital formation. While having your own house, car and other luxurious things are little things but when you look at from wide angle that is from country’s point of view than capital formation refers to increase in the stock of real capital in the country. Capital formation does not happen overnight rather it happens in stages and that is the reason why you should look at three stages through which capital formation happens –
Capital Formation Stages
Increase in Saving
Capital formation starts when people began to think about saving money because for saving money you need to reduce your current consumption and in this age where people spend first and think later this habit of saving is very difficult to find. In simple words, the foundation of capital formation is laid on the habits of people to save money because just like a child does not run without first learning how to walk in the same way a country cannot have capital formation without citizens of the country having a saving habit.
Mobilization of Saving
If people save money but do not put into banks or financial institutions than that saving is of no use to the nation and this task of mobilization of saving is in the hands of the government because unless government makes proper infrastructure so as to enable people from far-flung areas can deposit their savings into financial institutions like banks and banks in turn can lend that money to entrepreneurs as well as government for the purpose of investment. In simple words, if you do not send your child in the school and expect him or her to clear all exams than it is not fair in the same way saving without the mobilization of saving is of no use and hence government should try to maximize the mobilization of savings.
Conversion of Saving into Investment
Last stage of capital formation is when the saving that is mobilized by banks and financial institutions get converted into investment as companies or government who have taken loan from banks began to put that capital in purchasing machines, purchase of building, materials, furniture and so on which results in increase in the real capital of the country. In simple words, the whole cycle which started with an increase in saving comes to an end when private companies, as well as the government, make investments from money borrowed through banks and financial institutions.
As one can see from that capital formation is a simple yet important process because if a country wants to achieve the status of a superpower than it should have a capital formation for many years because without capital formation no country can become an economically developed nation.