2.2. Capital formation
Capital formation is a function of the savings rate, q, and depreciation rate, d, and therefore involves human behavioral aspects as well as physical degradation of capital stock. Changes in the fundamental
driving forces of q and d would impact directly on capital formation dynamics and/or on the marginal product of capital. Persistent trends have been established in the capital–output ratio, K/Y, in developed economies and also in terms of the mean global savings rate. However, economic output is raised through the beneficiation or conversion of natural resources into useful goods and services, part of which is reinvested into the conversion cycle, in the form of capital, to raise more output. Although such reinvestment is recognizedrecognized as a necessary condition for growth, we do not consider capital as an explicit factor of production since it is accumulated from excess output (above what is needed to satisfy consumer demand). Capital formation trends therefore merely describe the degree of reinvestment that has supported the established growth regime. Capital could be a growth constraint under conditions that fundamentally change established trends. These include:
1. Changes in the propensity for saving such that more output is consumed and less is reinvested into the productive cycle.
2. The capital requirements in the production cycle increase under diminishing returns in the harnessing of natural resources. Based on the above, we do not consider capital as an explicit factor of production. We assume that the conditions of balanced growth will be sustained into the future at constant K/Y and that this ratio would support the full growth potential as defined by factors associated with explicit economic inputs such as natural resources and AFP. We include quality improvements in capital, traditionally accounted under TFP , implicitly in our economic growth formulation.