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 labor productivity, overall production, and reduced cost of production, which in turn leads to an increase in contribution margin. In its truest essence, human capital deepening helps increase output and productivity.

By increasing the amount of capital per worker, boosts productivity and economic growth. It improves technology adoption, enhances worker efficiency, and drives innovation. By expanding investments in machinery, equipment, and infrastructure, any business or organization can achieve sustainable development and higher living standards, making capital deepening crucial for economic advancement.

• Capital deepening is the method in which the capital per unit of labor is increased by investing in technological advancements. So, it increases labor productivity and overall production and reduces production costs, leading to an increase in contribution margin.
• Capital deepening differs from technological innovation. Therefore, the two should be distinct and used interchangeably.
• Improved labor utilization, higher contribution margin, and lower taxes are the advantages of capital deepening. It increases the labor employed marginal productivity and the total output created by similar delivery.

Capital deepening implies investing more money in increasing the plant, machinery, tools, and equipment, thereby increasing the production unit's capital-to-labor ratio. It aims to increase the marginal productivity of the labor employed and increase the total output produced by the same labor.

Capital is the fixed assets such as plants and machinery or equipment used by the labor to produce 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, 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. It again adds to the output produced.

Capital deepening economics differs from technological innovation, and the two should not be confused or used interchangeably.

Let us understand the formula that acts as a basis for our understanding of capital deepening economicsthrough the explanation below.

Capital Deepening = (Total Capital Stock) / (Total Labor Force)

Where,

• Total Capital Stock refers to the aggregate value of physical capital (machinery, equipment, infrastructure, etc.) in an economy.
• Total Labor Force represents the total number of workers actively engaged in the production process.

Now that we understand the basics of human capital deepening, its formula, and related factors, let us apply the theoretical knowledge into practical application through the examples below.

Example #1

Ashton and Austin, a small car manufacturer with ten workers in their plant could produce five cars a day in an 8-hour shift per day. They expected the demand for cars to grow shorter, and therefore after making a few calculations, they found out that the monthly production would fall short of the monthly demand they expected.

To capture a greater proportion of the expected increased demand, they purchased another assembly line for their factory. This assembly line was in addition to the one already existing, but it doubled its production to 10 cars a day with the same number of workers employed for the same number of hours per day.

It is an example of capital deepening because the assembly line technology was not new for their 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 complete innovation for the factory, it would have switched to a more productive technology and would not have fallen 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, this would have been an example of capital widening instead of deepening capital.

Example #2

In July 2023, world economies were struggling with steady declines in productivity. Several factors like record high inflation, tightness in labor markets, and dull output growth had culminated to form one of the poorest output figures in multiple decades.

As mentioned above, there are several factors that have contributed to the record low performance globally. For starters, a significantly high churn in the labor market and an increase in remote work instead of working at physical offices. Moreover, extremely high inflation rates have forced companies to focus more on value rather than volume.

However, efforts to acknowledge and solve supply shortages had increased construction activity which saved an extreme manufacturing downturn; especially in the electronics, automotive, and transit sectors. Otherwise, a constantly undersupplied environment could have simulated a capital deepening activity across different economies.

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 = AK^αL^1-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 increased K, L, or will not lead to a technological change. A capital increase 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 equipment already being used in the manufacturing process are all examples of capital deepening. However, the adoption of improved technology is represented by A, increasing 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. The labor can produce greater output, and the older method becomes obsolete.

Let us understand the advantages of capital deepening economics through the points below.

• 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 product, then the total output per unit of labor or per unit of time increases.
• Higher Contribution Margin: The same labor is employed, so the wages are not impacted. More machinery, tools, and equipment are employed so greater output. Therefore, the variable cost falls per unit, and the contribution margin or the difference between the selling price and variable cost decreases.
• Lower Taxes: Increase in investment in fixed assets increases the depreciation charges shown on the income statement. It can lead to a reduction in taxable profits, and therefore the firm has to pay lower taxes if the increase in gross profit is lower than the impact of an increase in depreciation.

While human capital deepening offers benefits, it also presents certain disadvantages. Let us discuss them through the points below.

• One of the major drawbacks is the potential for diminishing returns. As an economy invests more in capital, the marginal increase in productivity might decrease over time, leading to a less significant impact on economic growth.
• An excessive focus on capital deepening could neglect investments in other vital areas like education, healthcare, and innovation, hindering holistic development. This approach might also exacerbate income inequality, as those who control capital can benefit disproportionately.
• During economic downturns, overreliance on capital investments can lead to idle resources and reduced flexibility, as the economy might struggle to quickly adjust its capital stock to changing conditions.
• Balancing capital deepening with other aspects of development and considering potential diminishing returns is crucial to ensuring a well-rounded and sustainable growth strategy.

Capital deepening and capital widening are two distinct concepts that relate to an economy’s growth and development. Let us understand their differences through the comparison below.

Capital Deepening

• Capital deepening involves increasing the amount of capital per worker in an economy.
• This can be achieved by investing in more advanced machinery, technology, and infrastructure, which enhances the productivity of each worker.
• As a result, workers become more efficient and can produce more output in the same amount of time.
• Capital deepening is a crucial driver of long-term economic growth as it leads to higher productivity and improved living standards.

Capital Widening

• Capital widening, also known as capital broadening, focuses on expanding the number of workers in an economy without necessarily increasing the amount of capital available per worker.
• This expansion of the labor force can lead to increased overall production due to the larger workforce.
• However, it might not result in the same level of productivity gains that capital deepening can provide.

This has been a guide to what is Capital Deepening. Here we explain its formula, examples, advantages, disadvantages, and compare it with capital widening. You may learn more about financing from the following articles –

• Economic Growth vs Economic Development
• Cost of Labor
• Labor Intensive
• Direct Labor Costs