Gross capital formation in % of gross domestic product in world economy

Gross fixed capital formation (GFCF) is a macroeconomic concept used in official national accounts such as the NIPAs and UNSNA since the 1930s. Statistically it measures the value of additions to fixed assets purchased by business, government and households less disposals of fixed assets sold off or scrapped. Data are usually provided by statistical agencies annually, but sometimes quarterly. Fluctuations in this indicator are often considered to show something about future business activity and the pattern of economic growth. GFCF is a component of the expenditure on GDP.

[edit] Concept and data

The statistical aggregate of GFCF is a measure of the net new investment in fixed capital assets by enterprises, government and households within the domestic economy, during an accounting period such as a quarter or a year.

While it is not possible to measure the value of the total fixed capital stock very accurately, it is possible to obtain a fairly reliable measure of the trend in new fixed investment.

Usually statistics departments provide quarterly and annual data on GFCF, which function as economic indicators of the level of business activity.

Often detailed breakdowns are available on request for GFCF,

• by type of asset (plant, machinery, land improvements, buildings, vehicles, etc.)
• by industry (for example, manufacturing, construction, services)
• economic sector (residential buildings versus non-residential buildings, or government sector versus private sector).

Obviously GFCF is not a measure of total investment, because all kinds of financial assets are excluded, as well as stocks of inventories and other operating costs. If, for example, one examines a company balance sheet, it is easy to see that fixed assets are only one component of the total annual capital outlay.

[edit] Definition

GFCF is a flow value. It is usually defined as the total value of additions to fixed assets by resident producer enterprises, less disposals of fixed assets during the quarter or year, plus additions to the value of non-produced assets (such as discoveries of mineral deposits, or land improvements).

Normally these assets are tangible assets, but in some cases they are intangible intellectual property including artwork and software. The debate continues about the exact definitional boundaries. The main asset types are plant & machinery, equipment, vehicles, land-improvements and buildings.

Some important assets are typically excluded from the official measure of GFCF. These include land (except that the value of land improvements is included), armaments and military installations, the value of repair work, the value of standing timber, farm animals, and durable household equipment.

Detailed standard definitions of GFCF are provided by the United Nations System of National Accounts (UNSNA) and the IMF Balance of Payments system. The definitions used by the US Bureau for Economic Analysis for the National Income & Product Accounts (NIPA's) are very similar.

GFCF is called "gross" because the measure does not make any adjustments for the depreciation of assets. In some ways, this terminology is confusing, because, in substance, the aim is to measure the value of the net additions to the fixed capital stock. In other words, it is the net capital formation that is of interest. Accidental damage and destruction are disregarded in the valuation, but tax levies and acquisition fees are included in GFCF. So it is the "all-up" costs of fixed investment that are being measured.

It is sometimes difficult to draw an exact statistical boundary between GFCF and intermediate consumption, insofar as the expenditure concerns alterations to fixed assets owned. In some cases, this expenditure can refer to new fixed investment, in others only to operating costs relating to the maintenance or repair of fixed assets.

[edit] Time series

GFCF time series data is often used to analyse the trends in investment activity over time, deflating or reflating the series using a price index. But it is also used to obtain alternative measures of the fixed capital stock. This stock could be measured at surveyed "book value", but the problem there is that the book values are often a mixture of valuations such as historic cost, current replacement cost, current sale value and scrap value. That is, there is no uniform valuation.

Using the alternative of the so-called "perpetual inventory method", one begins with a benchmark asset figure and then cumulates GFCF year by year (or quarter by quarter), while deducting depreciation according to some method, all data being adjusted for price inflation using a capital expenditure price index. Sometimes statisticians calculate "average service lives" for assets as a basis for valuation and depreciation estimates.

Econometricians acknowledge that the value of fixed assets is almost impossible to measure accurately, because of the difficulty of obtaining a standard valuation for all assets. By implication, it is also almost impossible to obtain a reliable measure of the aggregate rate of profit on capital invested, i.e. the rate of return. Arguably though, the data do provide an "indicator" of the trend over time.

[edit] Second-hand fixed assets

The fixed assets purchased may nowadays include substantial used assets traded on second-hand markets, the quantitatively most significant items being road vehicles, planes, and industrial machinery. Worldwide, this growing trade is worth hundreds of billions of dollars, and countries in Eastern Europe and Latin America, Russia, China, India and Morocco use large quantities of second-hand machinery.

Fixed assets disposed of may be sold for continued use by another producer, abandoned by the owner, sold as scrap, or recycled in part or as a whole. Occasionally a complete industrial plant is purchased, dismantled and reassembled somewhere else. Because GFCF conceptually includes many transactions in used fixed assets by resident firms, which are valued lower than new assets, this creates problems for the estimation and valuation of the gross capital stock.

If enterprise A sells a used asset to enterprise B, the valuation errors caused by the way that A and B each report this transaction will cancel out only if an overstatement of A’s reported GFCF is exactly matched by the understatement in B’s reported GFCF. But if assets migrate from one industry to another, or are imported and exported, or (in the case of means of transport) switch between different uses, the errors will persist. It may appear as though the total fixed capital stock has grown, even although the “net addition to fixed assets” refers only to the change in ownership of an already existing asset.

Statistical treatment of the trade in second-hand fixed assets varies among different countries. Increasingly an attempt is made in many countries to identify the trade in second-hand assets separately. In principle, if a fixed asset is bought during the year by one organization, and then resold to another organization during the same year, it should not be counted as investment twice over in that year; otherwise the true growth of the fixed capital stock would be overestimated. Hence statistical agencies traditionally often measured only the acquisition of newly produced fixed assets, or else tried to measure the net purchases of used assets. In general, also, the expenditure on Gross Domestic Product of which GFCF is a component should definitionally include only newly produced fixed assets, not second-hand assets. GDP is supposed to measure the net new output, the new value added to the existing stock of wealth. But given a growing domestic and international trade in second-hand equipment, GFCF may understate the true level of gross fixed investment activity and overstate the real additions to the capital stock, insofar as fixed assets produced at a previous time and resold later are also invested in, without this showing up in the accounts.

[edit] Weaponry in the 2008 Revision of the UNSNA

In the 1993 UNSNA standards, offensive weaponry and their means of delivery were excluded from capital formation, regardless of the length of their service life. Conceptually, the UNSNA accounts regarded military assets as providing "defence services" only at the point of their acquisition. Arms expenditure regarded as intermediate consumption could, according to this accounting treatment, only refer to sales or exports in a different accounting period. If weapons were sold during the same year or a quarter, this necessitated "counter-intuitive" entries in the accounts for government (a capital addition is cited as a capital deduction, and vice versa). The 2008 UNSNA revision therefore recommends that all military expenditure that meets general UNSNA criteria for capital formation (investment in goods which are used in production for more than one year) will be treated as capital formation. Weapons systems and military inventories will be separately distinguished within fixed capital formation and inventories [1].

[edit] References

• UNSNA [2]
• NIPA [3]
• OECD [4]
• Canberra Stock Conference [5]
• Fixed assets and durable consumer goods in the United States 1925-1997 [6]
• Oskar Morgenstern, On the Accuracy of Economic Observations, 2nd edition, Princeton University Press, 1965.
• Hill, TP (1979), Profits and Rates of Return. OECD, Paris.

[edit] See also

• Intermediate consumption
• Fixed investment
• Fixed capital
• Capital formation
• Investment-specific technological progress