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What Are the Factors behind Capital Formation?

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  • Written By: Mark Wollacott
  • Edited By: Lauren Fritsky
  • Last Modified Date: 06 November 2016
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Government assets and their value at the time of assessment are the main factors behind capital formation. Assets are broken down into fixed assets such as properties, portable ones such as art and antiques and fluid assets such as cash, stocks and gold. The problem with cash as an asset is that governments often spend their budgets. The total value of capital depends on many factors, but is assessed as a part of government accounting.

Capital formation is a subsection of macroeconomics. The term is typically applied to government and intergovernmental economics; however, it has also been applied to corporate economics. Asset assessments are carried out during each accounting period set by the government.

The assessment is carried out so that a government knows exactly what it has and what the value of its holdings is at that point in time. The results inform government policy, spending, sales and how it manages its investments. Governments that buy or sell assets wisely are able to add to their capital totals. Capital formation is the process by which governments increase the value of their holdings.

Fixed asset values are the most important factors in capital formation. Governments across the world own vast tracts of land from national monuments and departmental offices to parks and nationalized hospitals and schools. In times of economic growth, property values rise and, therefore, without much work, so too does the value of government held land.

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Governments begin capital formation by buying land in times of economic stagnation, when property values fall. In such times, they are also liable to seize land. It is then their choice to hold onto the land or to sell it. The same principle works for gold. If the price of gold falls, then governments can buy more and wait until the price rises again to make a profit.

Vacant land and offices do not raise cash for the government; instead, they suck money out of governmental budgets because of upkeep. In this sense, a government might develop capital formation, but at the same time, it could hemorrhage cash from its budgets. A balance must be struck, therefore, between capital formation and profitability. Land might raise money through rents or might be better off sold for a one-time cash payment.

Cash is a fluid asset that is rarely counted in capital formation. This is because most government cash is earmarked for spending during the fiscal year. Therefore, governments tend not to hold on to much cash as an asset. Government cash depends on tax yields or tax revenue. The amount raised depends upon the tax level-economic performance balance that has been struck.

One of the biggest sources of capital formation, after property, is defense. All military equipment counts towards the fixed assets of the government that bought them. Their post-purchase value depends on what they would fetch if sold, but is often calculated based on their purchase price. Many Western governments find that the defense department or ministry has the most assets when capital is calculated.

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