PROCESS OF CAPITAL FORMATION:

The process of capital formation involves following three steps.

1. Increase in the volume of real saving

2. Mobilization of savings
3. Investments of savings in creating real assets.

These three steps are being discussed in some detail.

1. Increase in the volume of real savings: Increase in the volume of real savings
depends upon the following factors.

i. Ability or capacity or power to save and will to save:

The level of savings in a country mainly depends upon the ability or
power or capacity to save. This ability itself depends upon the size of the average
level of income, the size of the family and the standard of living of the people.
The higher the level of average income, the greater will be the rate of savings. If
the average size of the family is small or the people are accustomed to such a
standard of living which is not much consumption-oriented, the power or ability
to save will be higher, otherwise vice versa.
Savings also depend upon the will to save of the people. They may do so
to meet emergencies, for family requirement or for maintaining social status. But
their willingness will depend upon some certain facilities and incentives made
available by the government. People will save if the government is stable and
there is peace and security. Willingness to save of the people will be very poor if
there is lawlessness and disorder and no security of life and property and business
in the country. Further, if the banking and financial institutions are well-
established, paying attractive rates of interests or profits on different term
deposits, providing best services to their clients, people will be willing to save
more. Furthermore, the taxation policy of the government may also affect the
saving attitude of the people. Highly progressive income and property taxes may
discourage the incentive to save. Low rates of taxation, offering different
attractive concessions for savings may encourage will of savings.

ii. Incentives of increasing rates of Profits:

Incentive of increasing rates of profits to the national income may
also help in increasing the level of savings. This can be done through
expanding the economy. For this purpose, a number of incentives should be
provided to enterprises including protects them from foreign competition. The
increased profits will be used in production investment.
iii. Governments role as a saver:
Government can also save by adopting a number of fiscal and monetary
measures. These measures may be in the form of reduction in governments
non-developmental expenditure, expension of export sector and raising money
by public loans etc. If people are not saving voluntarily, inflation can help in
 reducing unnecessary consumption. Besides, government can also increase
savings by running public enterprises.

2. Mobilization of Savings: The next step of capital formation is the mobilization of

savings which can be mobilized through banks, financial institutions, investment
trusts, insurance companies and capital markets. As the savers and the investors
are different people so to bring together the both there must be existed well-
developed and well-organized capital and money markets in the country.

3. Investment of savings in creating real assets:

The third step of capital formation is the investment of savings in creating
real assets. For this purpose, the profit making classes can be induced to play an
important role in agriculture and industrial sectors of the country. Besides, a
regular supply of capable, honest and dependable entrepreneurs must be
maintained. This can be done through providing necessary technical know-how to
produce new products. Further, the facilities of well-developed infrastructure,
means of transport, communication, power, and water, educated and trained
personnel along with financial assistance must be made available.
Domestic sources for capital formation are also required to be
supplemented by external sources.