What is Capital Deepening?
Capital Deepening is the process in which the amount of capital per unit of labor is increased by investing in technological advancements thereby increasing the labor productivity, overall production, and reduced cost of production, which in turn leads to an increase in contribution margin.
Capital is the fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. such as plant and machinery or equipment that are used by the labor to produces goods and services. Production can be increased in the short run by increasing the number of labor employed or by increasing the shifts in production. However, if the scale of operations has to be increased, the fixed investment needs to be increased.
If there is only one machine, only a few workers can work on it without leading to overcrowding, but if the number of machines increases, then more workers can work on them and produce more products per unit of time.
Further, mechanization increases the productivity of labor as compared to that when the output is produced manually. This again adds to the output produced.
Capital deepening is different from technological innovation, and the two should not be confused or used interchangeably.
A small car manufacturer who has ten workers in his plant was earlier able to produce five cars a day in an 8-hour shift per day. He expected the demand for cars to grow in the near future, and therefore after making a few calculations, he found out that the monthly production would fall short of the monthly demand he can expect.
To capture a greater proportion of the expected increased demand, he bought another assembly line for his factory. This assembly line was in addition to the one already existing, but it doubled his production to 10 cars a day with the same number of workers employed for the same number of hours per day.
This is an example of capital deepening because the technology of the assembly line was not new for his plant; it was just an increase in the amount of money invested in the fixed assets, which led to an increase in production.
Had the assembly line been a completely new innovation for the factory, it would have been a switch to a more productive technology and would not fall under capital deepening.
One important point here is that the number of workers has not increased, and therefore the capital to labor ratio has increased. Had the number of workers also increased in the same proportion, keeping the capital to labor ratio unchanged, then this would have been an example of capital widening instead of capital deepening.
Capital Deepening and Standard Economic Growth
The Standard Economic growth model is, at times, also referred to as the Solow-Swan Model. To understand the model, we need to, first of all, understand what is meant by the Total factor productivity.
Below is the Cobb-Douglas production function:
Y = AKαL1-α
- Y stands for output
- K is the capital employed
- L is the labor employed
- is the elasticity of capital
- is the elasticity of labor
Any increase in output due to an increase in K, L, or will not lead to a technological change. An increase in capital would lead to capital deepening.
However, the A is the measure of the state of technology. It represents the total factor productivity of labor. As explained earlier, increasing the investment in the plant, machinery, and equipmentPlant, Machinery, And EquipmentProperty plant and equipment (PP&E) refers to the fixed tangible assets used in business operations by the company for an extended period or many years. Such non-current assets are not purchased frequently, neither these are readily convertible into cash. already being used in the manufacturing process are all examples of capital deepening. But the adoption of improved technology is represented by A, and it increases the total factor productivity.
For example, using a manual blender versus an electronic blender in a cooking establishment is an example of an increase in total factor productivity because now the labor can produce greater output, and the older method is becoming obsolete.
- Better Utilization of Labor: When labor produces manually, their marginal product is lower. However, if the same labor is given the equipment which can increase his marginal productMarginal ProductThe marginal product formula can be ascertained by calculating the change in production level and then dividing the same by the difference in the factor of production. In most cases, the denominator is 1, based on every 1 unit of increment in an aspect of production., then the total output per unit of labor or per unit of time increases.
- Higher Contribution Margin: The same number of labor is employed, so the wages are not impacted. More machinery, tools, and equipment are employed, so the output is greater, and therefore per unit, the variable cost falls and contribution margin or the difference between the selling price and variable cost decreases.
- Lower Taxes: Increase in investment in fixed assets increases the depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. charges shown on the income statement. This can lead to a reduction in taxable profits, and therefore the firm has to pay lower taxes if the impact of the increase in gross profit is lower than the impact of an increase in depreciation.
Capital deepening implies investing a greater amount of money in increasing the plant, machinery, tools, and equipment and thereby increasing the capital to labor ratio of the production unit. This is aimed at increasing the marginal productivity of the labor employed and therefore increases the total output produced by the same number of labor.
This has been a guide to what is capital deepening and its definition. Here we discuss an example and economic growth of capital deepening along with advantages. You may learn more about financing from the following articles –