ApEc 3006 - Spring 2010

Creating a capital stock series

For some countries, you can find a capital stock series created by one of the countys govern-
mental agencies or its central bank. Examples of such countries are the U.S., the U.K., Japan, and
Germany. Typically, however, a capital stock series will not be readily available for a country. In
this case, we can use time series from the World Banks, World Development Indicators (WDI) to
construct a good "proxy" for the capital stock levels.
To create a capital stock series we use a method called the perpetual inventory method. The
perpetual inventory method uses the following formula:

= 1 1 + = (1 ) 1 + (1)

Here, is the time level of capital stock is the time level of gross fixed capital formation
and is the rate of depreciation (assumed constant over time). The equation works as follows.
Say the capital stock level at the beginning of 1970 is equal to $1000, the depreciation rate is
equal to 10%, and the new investment level (that comes online in 1971) is equal to $120 (i.e.,
1970 = 1000 1971 = 120 and = 01). Then, in 1971, the capital stock is equal to

1971 = (1 ) 1980 + 1971

or

1971 = (1 01) 1000 + 120

= 900 + 120 = 1020

If gross fixed capital formation in 1981 is equal to $150, then in 1982 the capital stock is equal to

1972 = (1 ) 1981 + 1972

= (1 01) 1020 + 150 = 1068

Note that in order to calculate the capital stock series, we need three pieces of information:

1. a time series on gross fixed capital formation (preferably in constant local currency units),

2. an assumption on the rate of depreciation, and

3. an estimate of the initial capital stock level.

1
 In the above example, we created a capital stock series for 1970, 1971 and 1972. Note, however,
that we assumed we had a value of for 1970, the initial year of our capital stock series. In
most cases, though, you will not have an initial capital stock level. The question, then, is how do
we come up with the initial capital stock? Hall and Jones (1999) used the following formula to
calculate initial capital stocks
0
0 = (2)
+
where 0 is our notation for the initial capital stock. Here, 0 is the level of gross fixed capital
formation in the initial period, is the rate of growth in gross fixed capital formation, and
again represents depreciation.1 Then, given equations (1) and (2), if you have a value of and a
time series on gross fixed capital formation, then you can construct a capital stock series.
To illustrate how we use the perpetual inventory method, consider the following data for Hong
Kong.

Table 1. Gross fixed capital formation in constant local currency units

Year 1980 1981 1982 1983 1984 1985 1986
GFK (constant LCU) 114,473 125,062 127,420 116,970 120,057 120,117 127,396

Furthermore, between 1980 and 2008, the average rate of growth in Hong Kongs gross fixed capital
formation is equal to
= 00403

Using equation (2), along with 1980 = 114473 = 00403 and = 006 (you can make
other assumptions on the value of ), we get our estimate of the initial capital stock:

1980 114473
1980 = = = 1 141 306
+ 00403 + 006
1
Note the = 0 subscript is simply one way to represent the initial period all subsequent periods are "relative"
to 0. For example, if we represent the initial period by = 0, then the next period is + 1 = 0 + 1 = 1 If the initial
period is defined as = 1980 then the next period is 1980 + 1 = 1981
Another example to consider is the equation

= (1 ) 1 +

This equation is notationally equivalent to

+1 = (1 ) + +1

Look over these two equations and think about why they are notationally equivalent.

2
Given this estimate, we then use equation (1) to get the capital stock series:

1980 = 1 141 306

1981 = (1 ) 1980 + 1981 = 096 1 141 306 + 125 062

= 1 197 890

1982 = (1 ) 1981 + 1982 = 096 1 197 890 + 127 420

= 1 325 310

1983 = (1 ) 1982 + 1983 = 096 1 325 310 + 116 970

= 1 442 280

1984 = (1 ) 1983 + 1984 = 096 1 442 280 + 120 057

= 1 562 337

1985 = (1 ) 1984 + 1985 = 096 1 562 337 + 120 117

Problem 1 Table 2 presents gross fixed capital formation levels for Luxemborg. Assuming the
capital stock depreciates at 10% a year, create a capital stock series for Luxemborg.

Table 2. Gross fixed capital formation for Luxemborg (in million Euro)
Year 2000 2001 2002 2003 2004 2005 2006 2007
GFK (constant LCU) 4572 4975.9 5250.2 5374.1 5489.4 5602.2 5775.2 6651.3
The answer is:
Estimated capital stock series associated with Table 2
Year 2000 2001 2002 2003 2004 2005 2006 2007
(constant LCU) 29317.1 31361.2 33475.3 35501.9 37441.1 39299.2 41144.5 43681.3
Problem 2 In footnote 1 we note the equation

= (1 ) 1 +

is notationally equivalent to
+1 = (1 ) + +1

Explain why/how this is true.

References

[1] Hall, Robert E. and Charles I. Jones, 1999, Why Do Some Countries Produce So Much More
Output Per Worker Than Others?, The Quarterly Journal of Economics, Vol. 114(1), 83-116.