Friday, March 16, 2012

What is a Capital Good?

In economics, it is common to differentiate between goods based on the expected useful life of the good. Short-lived goods, like food and most services, are labelled consumption goods, whereas long-lived goods, like houses, tools, farm equipment, etc., are labelled capital goods. In an interesting post, Scott Sumner applies this insight to a discussion of housing. Sumner makes the point that 'spending' does not equal 'consumption' because some spending is actually investment - the purchase of capital goods. And he points out that houses, owing to their long useful life, are actually capital goods.

I don't think this is a good definition for the bifurcation of goods into capital and consumer goods. First, where's the cut-off in terms of years' of life? The national economic accounts use three years to differentiate between the two. That means my suits are capital goods. Actually, NEA would include all clothing in consumer goods, but my  point is to illustrate the useful life isn't a sufficient criterion to differentiate between types of goods. Furthermore, some items might be consumer goods from one perspective, and capital goods from another. When Ryobi makes a drill, they are building a consumer good. After I buy it and use it to build a bench or cabinet, is it not a capital good for my purposes?

Similarly, Centex and Lenner and KB Homes build houses and sell them to people. From their perspective, houses are consumer goods. From the home buyers' perspective, a house may be a capital good. Or maybe it's a consumer good with a really long life. As I suggest above, the expected useful life is not a sufficient criterion for the capitalness of a good. Incidentally, in real estate economics, the value of the house as consumption is called 'service flow.'

Sumner calls houses 'super capital goods' because they tend to have very long lives. Indeed, well maintained houses can live for hundreds of years - witness the (occupied) castles in the UK and Europe. But I don't think that is sufficient to call something a capital good. If we look at most things considered to be capital goods, we note also that a capital good is a good that is used in the creation of other goods. This is easiest to see in manufacturing, where, for example, big fermenting vats in a brewery are obviously capital goods. So are the conveyor belts, the bottling equipment, and the building that houses all this stuff. Hm... I'm going to go for a brewery tour later.

Capital goods occupy a higher order in the value chain, where consumer goods occupy the lowest order - are closest to the final user. In fact, we'd do better to rename 'capital' to 'producer's' goods to help differentiate a bit (this is the Rothbard way). There would still be a little confusion, since a computer used for enjoyment would be a consumer's good but a computer used for designing new software would be a producer's good. It could even be the same computer! What matters is the purpose. House used as a lawyer's or doctor's office? Capital good. House used as my sleeping quarters and so forth? Consumer good.

1 comment:

  1. Although not a perfect rule, but it sounds like if you can depreciate it, it's a capital good. You, the owner/occupier wouldn't depreciate your house, but a lawyer using his house as an office would (or could).