What does the Incremental Capital Output Ratio (ICOR) stand for?

They often use the incremental capital-output ratio (ICOR) when people want to understand the link between invested money in an economy and GDP growth. The added unit of capital or investment needed to make an extra unit of output is shown by ICOR.

How to Read the Incremental Capital Output Ratio (ICOR)

ICOR is a way to measure the minimum amount of investment capital a country or other organization needs to make the next unit of production.

Generally, a higher ICOR value is not good because the entity is not producing as efficiently as possible. The measure they use is mainly to determine a country’s production efficiency.

Some people who don’t like ICOR have said that it can’t be used in all situations because countries can only become so efficient with the technology they can access. For instance, a growing country should be able to raise its GDP more than a developed country can with the same amount of resources.

This is why a developed country already has the best technology and facilities, while a developing country still has room to improve. For a developed country to improve, it would have to spend more on research and development (R&D). On the other hand, a growing country can use technology already out there to improve things.

Take the case of Country X, which has an incremental capital output ratio (ICOR) of 10. This means that $10 must be invested in cash to make $1 more in production. Further, if country X’s ICOR was 12 last year, it means that the country is now better at using its wealth.

What the Incremental Capital Output Ratio (ICOR) Can’t Do

There are a lot of things that can go wrong when trying to figure out ICOR for advanced countries. Critics say it can’t adapt to the new economy based on invisible assets. Like design, branding, research, development (R&D), and software that are hard to track or measure.

When looking at investment levels and GDP, it’s harder to determine how to value intangible assets like computers, buildings, and machines.

The need to invest in fixed assets has significantly decreased thanks to on-demand choices like software-as-a-service (SaaS).

You can take this further with the rise of “as-a-service” methods for almost everything. All of this means that companies are making more things with things that are now expensed instead of funded and, therefore, seen as investments.

This is an example of the ICOR.

Based on the idea of planning and carried out through the Five-Year Plans, the Indian economy ran from 1947 to 2017. India’s last five-year plan was the 12th five-year plan of the Government of India.

The Planning Commission of India determined the spending rate needed to reach different levels of growth in the 12th Five-Year Plan. For an 8% growth rate, the market price investment rate would need to be 30.5%. For a 9.5% growth rate, the market price investment rate would need to be 35.8%.

India’s investment rates fell from 36.8% of the country’s GDP in 2007–2008 to 30.8% in 2012–2013. Growth slowed from 9.6% to 6.2% in the same time frame.

India’s growth fell more sharply and dramatically during this time than investment rates. So, the drop in the Indian economy’s growth rate must have been caused by something other than savings rates. And investments. If not, the economy will become less and less efficient. India’s GDP growth rate in 2019 was 4.23%. And its rate of investment as a share of GDP was 30.21%.

The Bank of International Trade, “GDP growth (annual%): India.” Used on August 12, 2021.

Conclusion

• One way to show the connection between how much money is invested in the economy. And the rise in GDP is the incremental capital-output ratio (ICOR).
• ICOR is a way to measure the minimum amount of investment capital in a country. Or another organization needs to make the next unit of production.
• A lower ICOR is better because it means a country’s production is more efficient.
• Some people against ICOR argue that it cannot be used extensively as it aids developing countries in enhancing their facilities and technology.
  More than that, it helps developed countries already at the top of their game.