The Issue
I've been struggling with understanding the concept of capital and capital goods for a little time now. However, reading Robert Murphy's article on Capital theory helped clarify the concept a lot.I strongly urge you to read the article. Robert has given an excellent example illustrating the difference between sustainable consumption and a consumption based on capital goods, which in the short term may increase the level of consumption, but is bound to create trouble in the long term.
What is Capital?
My understanding of capital now is as follows.
Any thing requires labour and raw materials to produce. At an individual level, an individual can either expend his labour or a tradable material (usually money), to either make a product or get it from someone. When an individual works and gets money for his labour he can either save it or spend it. The money that he saves, essentially serves as a store of his past labour. Now in the future he does not have to again work for obtaining something, he can use the money saved in the past. Or, he can use this accumulated money to buy goods which "augment labour" in producing goods. These are essentially the capital goods, which are bought with accumulated capital.
Now there can be various means of storing his "past labour". He can do so in the form of cash, gold, any other tradable commodity, ownership in a company (stocks), livestock (farmers do this). Each form has its own particular pecularities. But each is representative of some concrete product/labour that was created in the past. Thus, the individual has literally, created his capital. I believe, the same phenomenon acting on a bigger level is what creates capital for the economy as well.
How is it destroyed?
Now, fast forward 5 years down the time lane.
Our particular hard working individual has been working hard for the last 5 years. Spending little money other than his basic needs and some luxuries, and has accumulated a lot of capital in form of cash, stocks and outright ownership of some capital products on say, his farm. Now in this day and time he can stop working and living off his accumulated capital. If he increases his spending and starts spending more money than his capital is generating each month, he'll quickly start eating into the value of his capital goods. He'll live much better than he ever did in the past 5 years, but it is obvious that he'll not succeed in sustaining his uber-spending lifestyle for a long time, and will be quickly back to the same spot he was when he had started building his capital.
Conclusion
Not all consumption is the same. If an individual or an economy starts consuming more than its capital resources and labour are producing, then it is eating into the accumulated wealth, which was accumulated over time and with lot of labour. This sounds so simple. After all don't we all know to "live within our means" ? Yet, this was missed by all the leading economists and intellectuals of US of A?
End Notes
I still don't understand very clearly how injection of liquidity in an economy where people have eaten into their capital assets would work. The Austrians are dead against this on grounds that it distorts the signals that entrepreneurs and companies get from the cost of capital, and thus leads to misallocation of resources. But even non-State players sell capital to the entrepreneurs and corporates. And foreign investors also inject capital into an economy. So what is so bad about the State playing the role of someone with capital coming into the market?
I can only think of one flaw in this - The State does not have the best of track records as a capital allocator.
So what? Here the optimal return on capital is not the issue. The country would surely be happy on a sub-optimal return on its printed money, as long as it gets money into the pockets of millions of jobless people.
Is it a case of 'many a slip between the cup and the lip'?
