The following points highlight the top two resources that raise the rate of capital formation in an economy. They are: 1. Domestic Savings, and 2. External Sources.

Resource # 1. Domestic Savings:

Domestic savings are the most reliable source of investment which helps to break the vicious circle of poverty and underdevelopment.

In an economy, domestic saving can be increased either by increased production or reduced consumption or by both.

Thus, the volume of investible surplus can be increased through :


(i) raising the productivity of the people;

(ii) curtailing the consumption of the rich.

The following measures can be adopted to increase the domestic savings:

(i) Drive to Save:

Saving drive go a long way to solve the acute problem of augmenting savings. Efforts should be made through propaganda. Common masses can be persuaded to save in their own interest or in the interest of their family.


They should be educated and motivated to develop the habit of saving for their children, for building houses or as a safeguard against old age, sickness or any other emergency. In the same fashion, issuing of saving certificates, bonds are also helpful in mobilising savings. The profits of saving should be advertised so that general people may tend to change their attitude.

(ii) Establishment of Financial Institutions:

In poor and less developed countries, people hoard their unspent current income and invest in jewellery, gold property etc. Therefore, such countries must have well organised financial institutions where country men may easily deposit their unspent money. Moreover, developed capital and money market can give impetus.

The money collection process should be simple so that even the laymen do not find any hardship in depositing and getting loans. Special attention should be made to make various institutions on sound footing like Insurance, Compulsory Provident Fund, and Provident-cum- Pension schemes and opening of new bank as especially in rural areas and cooperative societies.

(iii) Reduction in Income Inequalities:

This method is also regarded as the measure adopted in order to achieve high rates of saving and investment. People in under-developed countries possessed lower marginal propensity to save. High income group spend more money on luxury goods, thus, savings are less.


Therefore, riches should be equally distributed in these countries so that low income groups may have more income and this may lead to increase in the size and quantity of domestic savings.

(iv) Fiscal Measures:

As voluntary savings are not sufficient for capital formation in poor and backward countries, the Govt., can mobilise the resources through fiscal policy. These measures are in the form of budgetary surplus, taxation, reduction in government expenditure, expansion of export sector, loans and deficit financing.

Besides, growth oriented long-term saving policy should be evolved so that the process of development may get momentum.

Taxation is an effective instrument of fiscal measure for reducing consumption and transferring resources for productive investment. By the way of taxation, the government can take away a portion of the surplus resources of the people and can either make it available to the private investors or can itself utilise it for capital projects.

Therefore, taxation helps the capital formation in two ways (i) by transferring private resources to the state for utilisation in the desired channels and (ii) by providing incentives to the private sector to increase production.

Furthermore, public bowing is another method of diverting resources from unproductive to productive channels. But, its scope is also restricted in such countries as there is lack of organised capital and money markets.

To make it more successful, net work of propaganda and social education is most important. Therefore, fiscal policy should be devised in such a manner as to provide sufficient incentive to the private sector and public sector for saving and investment.

(v) Reduction in Consumption:

Prof. R. Nurkse and Prof. W. A. Lewis are of the opinion that saving can be raised through restricting consumption. It is argued that the level of consumption of the common people in under-developed countries is extremely below the subsistence line.

Therefore, the rate of saving can be increased by curtailing the conspicuous consumption of the rich and by diverting an increasing percentage of the increments in national income to capital formation.

(vi) Inflation:


When a country does not possess sufficient funds for capital formation, inflation is the potent measure. In fact, it is regarded hidden or invisible tax. Hence, through inflation, compulsory and voluntary savings can be raised.

According to Prof. Nurkse, “We must accept that in broad sector, inflation can be an effective means of forced saving and in this since, it is effective in under-developed countries.” With inflation, prices rise and they reduce consumption.

As a result, resources are diverted towards -investment from consumption. But this method is considered dangerous as there is dissatisfaction in society and rise in price badly effects the living standard of workers. Prof. Nurkse has observed that in most cases inflation leads to wrong directions to savings. The investment is made for luxury goods industries and essential public utilities are destroyed. In fact, it is the source of social upheaval and dissatisfaction.

(vii) Proper Utilisation of National Resources:

The main drawback within the under-developed countries is the proper utilisation of resources. There are profuse human and natural resources but they are not properly exploited. With the proper development of technical knowledge, education and training facilities, productivity of labour can be en-chanced and model techniques can be put to their best use. This helps to raise the rate of saving and capital formation as labour efficiency increases to a greater extent.

(viii) Utilisation of Hoarded Resources:


In under-developed countries, people invest their extra saved income in hoarding ornaments, precious gold, jewellery and religious pursuits. Moreover, they are not ready to part with gold and jewellery and are reluctant in bonds voluntarily.

It is, therefore, necessary that government should take steps to prohibit by law to possess above stipulated quantity. Private trading in gold should be regulated. The use of pure gold for manufacturing ornaments should be banned. In this manner, hoarded resources like gold can be utilised for making investment in productive channels, which, in turn leads to capital formation.

(ix) Income from Public Enterprises:

Another method which the government can avail to mobilise domestic saving for productive investment is by establishing public enterprises and corporations. Public enterprise and corporations are a substitute for private enterprises in under-developed countries.

They get funds in the form of equity capital and bonded debt from open market. They also receive foreign loans or collaborate with foreign enterprises. In most of the socialistic welfare states public enterprises are in the hands of government. Therefore, the profit earned by these concerns can be well utilised for capital formation.

(x) Rural Savings:


Rural savings are still another measures to solve the problem of mobilisation of domestic resources for capital formation. Therefore, government should take measures to link rural savings with local development projects. This, in turn, leads to rapid development in the backward and poor countries.

(xi) Deficit Financing:

As in under-developed countries, vast population lives below the poverty line, their low level of income puts a limit on tax revenue. Whenever a curb is imposed on consumption through taxation, it badly affects the desire to work and save.

In the same way, it also seems to be most undesirable and politically impracticable due to administrative deficiencies. Thus, deficit financing is justifiable to satisfy the increased demand for money.

(xii) Utilisation of Disguised Unemployment:

It is widely accepted that there exists a saving potential in the disguised unemployment in over populated countries of the world. If this potential is effectively utilised, it can become a major source of capital formation and further more economic development.

Resource # 2. External Sources:

Domestic sources for capital formation are generally scare and they are required to be supplemented by external sources which are discussed below:

(i) Private Foreign Investment:

The less developed and poor countries take the advantages of foreign investment from private foreign investment which is in the shape of private business firms or persons. Foreign investors invest with the feeling of making more profits from modern techniques and efficient management.


In modern times, this system is not much favoured as private foreign investors invest only in capital import industries in which they are interested and do not take care of public welfare.

(ii) Loans, Grants and Aid from Foreign Government:

These methods are used for foreign governments through heavy machines, instruments, other capitalised goods by imports. Furthermore, loans, grants are also given to the needed countries. These funds can be used by the country in any form.

Foreign loans and grants generally have deep burden on the domestic government and major portion of national income goes as interest to the concerned country. Therefore, proper care follow the policy to encourage export and restrict imports.

(iii) Restrictions of Imports:

Still another external measure to raise capital formations is the restriction of imports. It means that restrictions should be imposed on all luxury imports and foreign exchange may be saved. This method can only be successful if the domestic income saved on imported consumer goods are not invested on luxury and semi-luxury goods at home.

(iv) Terms of Trade:

Another vital source for achieving means for capital formation in under-developed countries is the favourable terms of trade. It means if the terms of trade make in favour of such countries, then it is in a position to import large quantities of capital goods.

The main benefit of this form of capital formation is that this does not lead to increasing the burden of international debt and neither one has to face struggle through the domestic loans and grants. Domestic economy is also saved from un-stability.