The following points highlight the main reasons for low rate of capital formation in an economy.
(i) Low Level of National Income and Per Capita Income
The root cause of capital deficiency in under-developed countries is low level of real national and per capita income which limits to the motives of savings and investments.
Due to lack of desired investments, capital formation has no increase. Hence, due to low production, there is low national and per capita income and, in turn, this forces to low capital formation.
(ii) Lack in Demand of Capital
Another cause of low rate of capital formation in under-developed countries in lack of demand of capital. In the words of Prof. Nurkse, “Low productivity in under-developed countries, people have low real income and, thus, purchasing power is low and so due to low demand, investment has effect which again reduces national income and productivity and rate of capital formation remains low”.
(iii) Lack in Supply of Capital
Like demand of capital, lack of supply of capital is responsible for low capital formation. However, due to lack of necessary supply of capital in under-developed countries, the process of capital formation is not boosted up. As a result, capital formation remains at low level. Therefore, in the opinion of Prof. Nurkse, Due to low rate of real income per capita in under-developed countries, there is low saving capability; hence, there is less capital. Due to lack of capital, there cannot be established basic business and industries so the production falls down.
(iv) Small Size of Market
Due to small size of domestic market, investment is not encouraged in poor countries. It does not expand the work of economic development and modern machines cannot be used as extra quantity produced has no market access.
(v) Lack of Economic and Social Overheads
Basic overheads like roads, buildings, communication, education, water, health etc. are generally lacked in under-developed countries which react as improper atmosphere for the capital formation and slow process of capital formation.
(vi) Lack of Skilled Entrepreneurs
Able and efficient entrepreneurs are not available in under-developed countries. It is the only reason for low rate of capital formation. Due to absence of risk-taking entrepreneurs, establishment of industries and expansion is quite limited and industrial diversification is not carried out and no balanced development of economy is possible.
(vii) Immobility of Savings
Immobility of saving also causes low rate of capital formation. Due to lack of banking and other credit institutions, poor countries have limited financial activities. Whatever, these financial institutions exist, they are of small size and unable to collect the savings from distant places, thus, resulting in no enthusiasm to savings in a society. This creates the problem of hoarding and saving is used for non-productive purposes.
(viii) Backwardness of Technology
Under-developed countries also face the problem of technical knowledge. Production is carried on old and less productive techniques. As a result, these countries have low productivity and per capita production and income’s low quantity, lowers the standard of the rate of capital formation.
(ix) Demonstration Effect
Demonstration effect also stands in the path of capital formation. Prof. Nurkse has cited the reason of low rate of capital formation, “due to demonstration patterns of people come into contact with best goods or superior patterns of consumption in which old demands are fulfilled by new goods and new plans, then, they after some time fell unrest and discontent. In this way, their knowledge grows their imagination is stimulated, new desires are awakened. By this their propensity to consume becomes high”.
Besides, there is tendency among people of these countries to follow the higher consumption standard of developed countries. In fact, all these actions occur due to demonstration effect which increases the tendency of consumption based on new ways and goods which limit the desire and capability to save in the society.
(x) Lack of Effective Fiscal Policy
Lack of effective fiscal policy or financial policy in under-developed countries also retard capital formation to some extent. Burden of taxation is too much which is out of people’s capacity to bear as their income is quite low. Besides, inflationary circumstances accrue and prices soar extremely high.
This leads to increase in cost price of capitalized goods and not consumption goods by which exported goods in internal market do not hold in external market in competition to best and cheap goods. This creates the problem of unfavorable balance of trade and payment. Thus, these countries have very low rate of economic development and capital formation.
(xi) Lack of Investment Incentives
Still another cause of the low rate of capital formation is the lack of investment incentives in most of the under-developed countries. This leads to low rate of productivity which, in turn restricts capital formation.
(xii) Deficit Financing
In modern times, deficit financing is considered a major resource of capital formation. But, if it crosses its limits, then it tends to low rate of capital formation. Whenever, deficit financing is made in the country, it leads to rise in prices and as a result, all commodities become costly. Under this situation, it becomes hard to save as the entire amount is spent. This results in the saving and low rate of capital formation.
One of the adverse trends observable in the corporate private sector of India is the growing incidence of sickness. It is causing considerable concern to planners and policymakers. It is also putting a severe strain on the economic system, particularly on the banks.
There are various criteria of sickness. According to the criteria accepted by the Reserve Bank of India “a sick unit is one which has reported cash loss for the year of its operation and in the judgment of the financing bank is likely to incur cash loss for the current year as also in the following year.”
A major symptom of sickness is a steady fall in debt-equity ratio and an imbalance in the financial position of the unit. Simply put, a sick unit is one which is unable to support itself through the operation of internal resources (that is, earnings plough-back). As a general rule, the sick units continue to operate below the break-even point (at which total revenue = total cost) and are, thus, forced to depend on external sources for funds of their long-term survival.
Industrial sickness creates various socio-economic problems. When an industrial unit falls sick those who depend on it have to face an uncertain future. They fear loss of jobs. Even if they do not lose jobs they do not get their wages and compensation in time and are, thus, forced to live in extreme hardship.
Of course, sickness is not a special problem of India. It is, undoubtedly, a global phenomenon. Even in industrially advanced countries there are numerous cases of bankruptcy or liquidation. These sick units are nursed back to health through mergers, amalgamations, takeovers, purchase of assets, or outright nationalization. When the-problem becomes really alarming or unmanageable, the unit is permitted to die its natural death.
Industrial sickness has become a major problem of the India’s corporate private sector. Of late, it has assumed serious proportions. A close look reveals that there are, at least, five major causes of industrial sickness, viz., promotional, managerial, technical, financial and political.
An industrial unit may become sick at its nascent stage or after working for quite some time. For instance, two major traditional industries of India, viz., cotton textiles and sugar, have fallen sick largely due to short-sighted financial and depreciation policies. Heavy capital cost escalation arising out of price inflation accentuates the problem. The historical method of cost depreciation is highly inadequate when assets are to be replaced at current cost during inflation.
Moreover, since the depreciation funds are often used to meet working capital needs, it does not become readily available for replacement of worn-out plant and equipment. The end result is that the industrial unit is constrained to operate with old and obsolete equipment, its profitability is eroded and, sooner or later, the unit is driven out of the market by the forces of competition.