Gross fixed capital formation

Gross fixed capital formation

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Gross fixed capital formation (GFCF) is a macroeconomic concept used in official national accounts
National accounts
National accounts or national account systems are the implementation of complete and consistent accounting techniques for measuring the economic activity of a nation. These include detailed underlying measures that rely on double-entry accounting...

 such as the UNSNA, NIPA
Nipa
NIPA, Nipa or nipah may refer to:* Nipa palm, Nypa fruticans* Nipa grass, Distichlis palmeri* Nipah virus, a Henipavirus* National Income and Product Accounts * National Institute of Public Administration...

s and the European System of Accounts
European System of Accounts
The European System of Accounts is the system of national accounts and regional accounts used by members of the European Union. It was most recently updated in 1995 ....

 (ESA). The concept dates back to the NBER studies of Simon Kuznets
Simon Kuznets
Simon Smith Kuznets was a Russian American economist at the Wharton School of the University of Pennsylvania who won the 1971 Nobel Memorial Prize in Economic Sciences "for his empirically founded interpretation of economic growth which has led to new and deepened insight into the economic and...

 of capital formation
Capital formation
Capital formation is a concept used in macroeconomics, national accounts and financial economics. Occasionally it is also used in corporate accounts. It can be defined in three ways:...

 in the 1930s, and standard measures for it were adopted in the 1950s. Statistically it measures the value of acquisitions of new or existing fixed assets by the business sector, governments and "pure" households (excluding their unincorporated enterprises) less disposals of fixed assets. GFCF is a component of the expenditure on GDP, and thus shows something about how much of the new value added
Value added
In economics, the difference between the sale price and the production cost of a product is the value added per unit. Summing value added per unit over all units sold is total value added. Total value added is equivalent to Revenue less Outside Purchases...

 in the economy is invested rather than consumed.

GFCF is called "gross" because the measure does not make any adjustments to deduct the consumption of fixed capital
Consumption of fixed capital
Consumption of fixed capital is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets...

 (depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

 of fixed assets) from the investment figures. For the analysis of the development of the productive capital stock, it is important to measure the value of the acquisitions less disposals of fixed assets beyond replacement for obsolescence of existing assets due to normal wear and tear. "Net net fixed investment" excludes the depreciation of existing assets from the figures for new fixed investment, and is called net fixed capital formation.

Obviously GFCF is not a measure of total investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...

, because only the value of net additions to fixed assets is measured, and 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
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

 outlay.

The most important exclusion from GFCF is land sales and purchases. The original reason, leaving aside complex valuation problems involved in estimating the value of land in a standard way, was that if a piece of land is sold, the total amount of land already in existence, is not regarded as being increased thereby; all that happens is that the ownership of the same land changes. Therefore, only the value of land improvement
Land improvement
Land improvement or land amelioration refers to investments making land more usable by humans. In terms of accounting, land improvements refer to any variety of projects that increase the value of the property...

 is included in the GFCF measure as a net addition to wealth. In special cases, such as land reclamation
Land reclamation
Land reclamation, usually known as reclamation, is the process to create new land from sea or riverbeds. The land reclaimed is known as reclamation ground or landfill.- Habitation :...

 from the sea, a river or a lake (e.g. a polder
Polder
A polder is a low-lying tract of land enclosed by embankments known as dikes, that forms an artificial hydrological entity, meaning it has no connection with outside water other than through manually-operated devices...

), new land can indeed be created and sold where it did not exist before, adding to fixed assets. The GFCF measure always applies to the resident enterprises of a national territory, and thus if e.g. oil exploration occurs in the open seas, the associated new fixed investment is allocated to the national territory in which the relevant enterprises are resident.

Data is usually provided by statistical agencies annually, but sometimes quarterly. Fluctuations in this indicator are often considered to show something about future business activity, business confidence and the pattern of economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...

. In times of economic uncertainty or recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

, typically business investment in fixed assets will be reduced, since it ties up additional capital for a longer interval of time. with a risk that it will not pay itself off (and fixed assets may therefore also be scrapped faster). Conversely, in times of robust economic growth, fixed investment will increase across the board, because the observed market expansion makes it likely that such investment will be profitable in the future.

Definition


Detailed standard definitions of gross fixed capital formation (GFCF) are provided by the United Nations System of National Accounts
United Nations System of National Accounts
The United Nations System of National Accounts is an international standard system of national accounts, the first international standard being published in 1953...

 (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) and in the European System of Accounts (ESA) are very similar.

GFCF is a flow
Stock and flow
Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...

 value. It is measured by the total value of a producer's acquisitions, less disposals, of fixed assets during the accounting period plus certain additions to the value of non-produced assets (such as subsoil assets or major improvements in the quantity, quality or productivity of land) realised by the productive activity of institutional units. In this way GFCF is a measure of gross net investment (acquisitions less disposals) in fixed capital assets by enterprises, government and households within the domestic economy, during an accounting period such as a quarter or a year:
  • Fixed assets are acquired through purchases, barter trade, capital transfers in kind, financial lease, improvement of fixed assets and natural growth of those natural assets that yield repeat products. The acquisition value includes acquisition taxes and fees and measures "all-up" costs of fixed investment.
  • Fixed assets are disposed of by sales, barter trade and capital transfers in kind. Disposal of fixed assets excludes consumption of fixed capital and exceptional losses due to natural disasters.


It is worth noting that fixed assets in national accounts have a broader coverage than fixed asset
Fixed asset
Fixed assets, also known as a non-current asset or as property, plant, and equipment , is a term used in accounting for assets and property which cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as liquid assets...

s in business accounts. Fixed assets are produced assets that are used repeatedly or continuously in production processes for more than one year. The stock of produced fixed assets consists of tangible assets (e.g. residential and non-residential building, roads, bridges, airports, railway, machinery, transport equipment, office equipment, vineyards and orchards, breeding livestock, dairy livestock, draught animals, sheep and other animals reared for their wool). The European System of Accounts (ESA95) explicitly includes produced intangible assets (e.g. mineral exploration
Mineral exploration
Mineral exploration is the process of finding ore to mine. Mineral exploration is a much more intensive, organized and professional form of mineral prospecting and, though it frequently uses the services of prospecting, the process of mineral exploration on the whole is much more involved.-Stages...

, computer software, copyright
Copyright
Copyright is a legal concept, enacted by most governments, giving the creator of an original work exclusive rights to it, usually for a limited time...

 protected entertainment, literary and artistics originals) within the definition of fixed assets.

The range of fixed assets included in statistical measurement is defined by the purpose in using them. A vehicle for example is a fixed asset, but vehicles are included in GFCF only if they are actually used in work activities, i.e. if they fall within the scope of "production". A car for personal use only is not normally included. The boundaries are not always easy to define however, since vehicles may be used both for personal purposes and for work purposes; a conventional rule is usually applied in that case.

Non-produced assets (e.g. land except the value of land improvements, subsoil assets, mineral reserves, natural resources such as water, primary forests) are excluded from the official measure of GFCF. Also ordinary repair work, purchases of durable household equipment (e.g. private cars and furniture) and animals reared for their meat are not part of GFCF.

In the 1993 version of the UNSNA (2003 SNA) the acquisition of armaments is not recorded as GFCF but as final consumption expenditure
Final consumption expenditure
In the national accounts expenditure on goods and services that are used for the direct satisfaction of individual needs or collective needs of members of the community is recorded in the use of income account under the transaction final consumption expenditure .The most important part of final...

 and intermediate consumption
Intermediate consumption
Intermediate consumption is an economic concept used in national accounts, such as the United Nations System of National Accounts , the US National Income and Product Accounts and the European System of Accounts .Conceptually, the aggregate "intermediate consumption" is equal to the amount of the...

. The definition of fixed assets was reviewed with the update of the SNA that led to the System of National Accounts 2008 (2008 SNA). Expenditure on weapons that meet the general definition of assets have been reclassified as GFCF.

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. Some countries include the insurance of fixed assets as part of GFCF.

An important change in the GFCF boundary in the 2008 SNA relates to the treatment of expenditure on research and development
Research and development
The phrase research and development , according to the Organization for Economic Co-operation and Development, refers to "creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of...

 (R&D). R&D which is measured by the value of expenditures on creative work undertaken on a systematic basis in order to increase the stock of knowledge, and the use of this stock to devise new applications, it is argued, should be recognized as part of GFCF. This means that R&D expenditure is recorded as the production of an asset instead of intermediate consumption, which has the effect of increasing GDP. It should be noted that this output measure focuses on the direct effect of R&D only; external benefits of R&D are not considered in this output measurement. Also, the 2008 SNA still explicitly excludes human capital as assets.

Data and time series


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 net additions to the stock of fixed capital, since the purchase prices of investment goods is recorded. Usually statistics departments provide quarterly and annual data on GFCF. The GFCF of "pure" households is often considered as an indicator of households' confidence in the future since it consists of their investments in dwellings. However, the GFCF figure for dwellings refers only to the value of the net additions of the housing stock and housing improvements.

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, the market sector versus the non-market sector).


GFCF time series
Time series
In statistics, signal processing, econometrics and mathematical finance, a time series is a sequence of data points, measured typically at successive times spaced at uniform time intervals. Examples of time series are the daily closing value of the Dow Jones index or the annual flow volume of the...

 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
Fixed capital
Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...

 stock. This stock
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

 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
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....

 according to some method, all data being adjusted for price inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

 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
Valuation (finance)
In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability. Valuations can be done on assets or on liabilities...

 for all assets. By implication, it is also almost impossible to obtain a reliable measure of the aggregate rate of profit
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...

 on physical capital invested, i.e. the rate of return. Arguably though, the data do provide an "indicator" of the trend over time; using mathematical models one can estimate that the true rate is most likely to lie within certain quantitative limits.

Economic analysis


Differences in the investment rates between countries very often mirror different levels of economic development and catching-up processes. This may be illustrated for the example of the member states of the European Union. Since the beginning of the millennium the average ratio of GFCF to GDP fluctuates around 20% in the European Union of 27 member states as a whole (EU-27). For some member states which accessed the Union in 2004 and later (mostly countries in central and eastern Europe where the level of GDP is still comparably low), the ratio rose to more than 25% in some years. When the consumption of fixed capital is deducted from the figures the resulting ratio of net fixed capital formation to net domestic product is around 8% for the average of the EU-27; again substantially higher ratios of more than 15% can be observed for some of the new EU member states such as Spain. Higher investment rates in poorer countries will lead to more equivalent living condition across Europe in the long-term through accelerated economic growth and an improved equipment of the labour force with modern infrastructure and technology. The detailed data on which these observations were made can be http://nui.epp.eurostat.ec.europa.eu/nui/show.do?query=BOOKMARK_DS-071045_QID_-4703121F_UID_-3F171EB0&layout=time,L,X,0;geo,L,Y,0;unit,L,Z,0;direct,L,Z,1;indic_na,L,Z,2;sector,L,Z,3;INDICATORS,L,Z,4;&zSelection=DS-071045direct,PAID;DS-071045unit,MIO_EUR;DS-071045indic_na,B1NM;DS-071045INDICATORS,FLAG;DS-071045sector,S1;&rankName1=direct_1_0_-1_2&rankName2=sector_1_0_-1_2&rankName3=unit_1_0_-1_2&rankName4=INDICATORS_1_0_-1_2&rankName5=indic-na_1_0_-1_2&rankName6=time_1_0_0_0&rankName7=geo_1_2_0_1&sortC=ASC_-1_FIRST&rStp=&cStp=&rDCh=&cDCh=&rDM=true&cDM=true&empty=false&wai=false&time_mode=NONE&lang=ENdownloaded from Eurostat's website].

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. Often it is bought from Europe, North America and Japan, where fixed assets are on average scrapped more quickly.

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. But 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 if it occurs on a quantitatively significant scale (for example, vehicles). 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
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....

 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.

Weaponry in the 2008 Revision of the UNSNA


In the 1993 UNSNA standards (and earlier), 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 http://www.oecd.org/dataoecd/60/8/41545834.pdf.

This approach somewhat increases the measure of total GFCF and by implication the total GDP of arms-producing countries, because expenditures and sales of weaponry are very large, especially in the United States and Europe. According to the Swedish research institute SIPRI
SIPRI
Stockholm International Peace Research Institute is an independent international institute dedicated to research into conflict, armaments, arms control and disarmament...

, global military expenditure by governments in 2008 is estimated to have totaled $1,464 billion, or approximately 2.4% of the value of world GDP in 2008, but arms expenditure is only one component of this expenditure. In 2007, the combined arms sales of the SIPRI Top 100 arms-producing companies reached $347 billion. According to SIPRI, forty-four US companies accounted for 61 per cent of the Top 100’s arms sales in 2007, while 32 West European companies accounted for 31 per cent of the sales. Russia, Japan, Israel and India accounted for most of the rest. Including US arms sales in US GDP would raise the measure by up to 1.8%.

The main original reasons for largely excluding military weaponry expenditures from total asset, investment and gross product measures were that military weaponry is used to destroy people and property, which is not value-adding production (although rebuilding destroyed assets can stimulate the economy), and/or that the relevant figures were a military secret. However, since military capital expenditures consume a large amount of tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...

 money, and because it is difficult to hide expenditures on weaponry, it is nowadays argued that it is appropriate that those expenditures should be publicly accounted for.

See also

  • Capital formation
    Capital formation
    Capital formation is a concept used in macroeconomics, national accounts and financial economics. Occasionally it is also used in corporate accounts. It can be defined in three ways:...

  • Consumption of fixed capital
    Consumption of fixed capital
    Consumption of fixed capital is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets...

  • European System of Accounts
    European System of Accounts
    The European System of Accounts is the system of national accounts and regional accounts used by members of the European Union. It was most recently updated in 1995 ....

  • Fixed capital
    Fixed capital
    Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...

  • Fixed investment
    Fixed investment
    Fixed investment in economics refers to investment in fixed capital, i.e., tangible capital goods , or to the replacement of depreciated capital goods which have been scrapped....

  • Intermediate consumption
    Intermediate consumption
    Intermediate consumption is an economic concept used in national accounts, such as the United Nations System of National Accounts , the US National Income and Product Accounts and the European System of Accounts .Conceptually, the aggregate "intermediate consumption" is equal to the amount of the...

  • Investment-specific technological progress
    Investment specific technological progress
    Investment-specific technological progress refers to progress that requires investment in new equipment and structures embodying the latest technology in order to realize its benefits.-Introduction:...