Capital
Capital is any resource that can be used to increase productivity and create value.
Capital is indispensable to prosperity. Nutritious food, clean water, sturdy homes, safe transportation, reliable energy, modern medicines, and countless other improvements in human life require capital.
Money is one important form of capital, but capital takes many forms besides cash.
A useful way to think about capital is as a person’s starter pack for productivity: the resources available to make something, solve a problem, or create something other people value.
A Lemonade Stand
Imagine that you want to start a lemonade stand. The money you use to buy lemons, cups, water, sweetener, a table, and a sign is capital. Those resources allow you to produce something other people may value enough to purchase.
But financial resources are only one form of capital.
Physical Capital
Tools, machinery, buildings, equipment, computers, vehicles, and other physical resources can increase productivity.
A carpenter with good tools can build more efficiently than a carpenter working only with his hands. A farmer with a tractor can cultivate far more land than a farmer with only a shovel.
Financial Capital
Money that can be invested in productive activity is financial capital. If a friend loans you $50 to buy supplies for your lemonade stand, that money becomes capital when you put it to productive use.
Human Capital
Knowledge, skills, experience, creativity, and abilities that make a person more productive are forms of human capital.
If you are good at math, understand marketing, know how to repair machines, write computer code, cook well, speak several languages, or communicate persuasively, you possess valuable human capital.
Education can increase human capital because learning can make a person more capable of producing things others value.
Social Capital
Relationships and trust can also function as capital.
Suppose a friend loans you money because he trusts you to repay it. Or someone agrees to help build your lemonade stand because you have helped him in the past. Relationships built upon trust make cooperation easier and can open opportunities that otherwise would not exist.
This is often called social capital.
Reputational Capital
A good reputation can also be a valuable resource.
If people know that your lemonade is consistently good and that you are honest in your dealings, they may be more willing to buy from you again, recommend you to others, or try a new product you offer.
A reputation for honesty, competence, and reliability can take years to build and can be destroyed quickly. In that sense, reputation is valuable capital worth protecting.
Everyone Has Capital
One important lesson follows from this broader understanding: A person can possess important capital even if he has very little money.
A young person might have almost no financial capital but possess energy, intelligence, creativity, useful skills, strong relationships, a willingness to work, and a reputation for being trustworthy.
Those resources can be developed and used to create value.
Capital is therefore not merely something possessed by wealthy people or large businesses. Every person possesses some resources that can be cultivated and put to productive use.
Capital Must Be Allocated
Capital does nothing by itself. Someone must decide how it will be used.
A person with $1,000 might hold it in reserve, invest it in a business, purchase tools, pay for additional education, or put it to productive use in countless other ways. Different choices can produce very different results.
People also face different incentives depending upon whose capital they are allocating.
When individuals invest their own capital, they ordinarily bear the rewards of good decisions and the losses caused by bad ones. That gives them strong incentives to think carefully about where and how their resources are used.
When people allocate capital belonging to others, their incentives are different because they do not personally bear the full cost of bad decisions or receive the full reward for good ones.
This problem is explored more fully under the Key Idea Incentives Matter.
Why Capital Matters
Capital allows human beings to become more productive.
Tools multiply the power of labor. Knowledge improves judgment. Money makes investment possible. Relationships make cooperation easier. Reputation creates trust. Skills allow people to perform difficult work well.
The more wisely people accumulate, develop, protect, and invest their capital, the more capable they become of creating value for themselves and for others.
That is why the accumulation and wise use of capital are essential to human prosperity.
