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Clarity on Incremental Capital Output Ratio (ICOR)

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Prashanth Perumal posted on Wed, Apr 24 2013 9:17 AM

Hi guys, would be glad if someone could help me understand ICOR better. As far as the basic definition goes, it's the ratio between investment and the resulting growth rate in an economy.

Firstly, I am not sure if the investment here (as the numerator) refers to nominal monetary financial investment during a year, or the actual amount of fixed capital that is created in an economy during a year.

Secondly, if it's actually the fixed capital formation that is taken as the investment amount for the calculation of ICOR, then, isn't ICOR simply just fixed capital formation as percentage of GDP? The reason being, fixed capital formation is nothing but one of the components in the calculation of GDP (apart from Consumption expenditure, Government expenditure, etc).

Thanks for your time.

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Bogart replied on Thu, Apr 25 2013 12:40 AM

Where to start....

How about that ICOR or really any other calculation based upon GDP is probably useless as GDP is fudged at best.  First, GDP includes government expenditures which add very little output to an economy and infact reduce output in the economy.  But even if you buy this argument, 40% of these expenditures at the federal level in the USA are loaned from the future?

Secondly the methodology of computing the percentage of GDP that is inflation is also complete flawed. 

Lastly, what is aggregate investment in the somewhat free economies of the Western World today?  Investment is not really investment with price fixed interest rates.  Furthermore critical parts of the investment world enjoy the gains but dump losses on tax payers and currency holders.  Is that really investment? 


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