Importance of Capital Formation

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Capital formation refers to the money that is moved from economically nonproducing activities and made available to businesses. For example, capital formation occurs when individuals set aside some of their earnings for savings and investment. Reinvested business profits and funding of business projects through government or other organizations can also add to capital formation.

Capital Formation and Economic Growth

For a society’s economy to grow long term, it is essential to increase the capacity for producing goods and services. Capital accumulation provides the money businesses need to expand their activities and thus contribute to overall economic growth. For example, capital accumulation makes funds available that a business can use to construct new manufacturing facilities. A ready supply of capital also makes it possible for businesses to invest in new technology and equipment to increase worker productivity. The Federal Reserve Bank of Kansas City cites the historical example of the shift from handwritten to typed documents. The introduction of typewriters increased the productivity of office workers and hence overall economic output.

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