The Incremental Capital Output Ratio (ICOR), which is the ratio of marginal capital output, is a tool that is often used to explain the relationship between the level of investment made in the economy and the resulting increase in gross domestic product (GDP). ICOR indicates the additional units of capital or investment required to produce the additional units of output.
ICOR is a metric that assesses the amount of investment capital a country or other entity needs to produce its next unit of production. Overall, a higher ICOR value is actually not desirable because it indicates that the entity’s production is inefficient. This measure is used primarily to determine the level of production efficiency of a country.
Some ICOR critics have suggested that its use be limited because it exists to the extent that it is efficient at country boundaries based on available technology. For example, a developing country could theoretically increase its Gross Domestic Product by a larger margin with a given amount of resources than a developing country.
This is because developed countries already have the highest level of technology and infrastructure while developing countries have room to improve. Further improvements in developed countries must come from research and development, which is relatively expensive, while developing countries can apply existing technology.
ICOR calculation formula
ICOR = Annual Investment / Annual Increase in GDP
For example, suppose Country A’s marginal capital output ratio (ICOR) is 10. This implies that $10 worth of capital investment is required to generate $1 of additional production. furthermore, if the ICOR of country A was 12 years ago, this means that country A has become more efficient in the use of its capital.
What are the disadvantages of ICOR?
In developed countries, accurately estimating ICOR depends on many problems. The critics’ chief complaint was its inability to adjust to the new economy; an economy increasingly driven by intangible assets, which are difficult to measure or record.
For example, in the 21st century, businesses are increasingly being influenced by design, branding, Research and Development, and software, all of which are more challenging to account for in terms of investment and GDP than tangible assets, such as machines, buildings and computers.
On-demand options such as software-as-a-service (SaaS) have greatly reduced the need for investment in fixed assets. This can be extended further with the advent of the “as-a-service” model for almost anything. It all adds up to businesses that increase their level of production with goods that are now expensed, and not capitalized, and as such, considered an investment.
In the conventional business world we know the word investment,
Investment is; Investment is an addition to the capital stock. The physical definition of capital is all capital goods used in the production process such as machinery, buildings, vehicles, and equipment and others. In the company’s accounting balance, capital is fixed assets (fixed assets) of an entity. In general, capital is called Gross Capital Stocks, namely the accumulation of gross capital formation from year to year which is used to produce new products.
The definition of ICOR is actually based on the concept of the ratio of capital to output called the Capital Output Ratio (COR).
In economics, there are generally two concepts of the capital-output ratio, namely;
Capital-output ratio or Capital Output Ratio (COR)
The ratio that shows the relationship between the existing capital stock and the resulting output, which is often known as the Average Output Ratio (ACOR).
The COR value is obtained by comparing the accumulated capital used with the amount of output produced in a certain period.
Marginal Capital-Output Ratio or Incremental Capital Output Ratio (ICOR)
The ratio that shows the amount of additional capacity (new investment needed to increase or add one unit of output. The difference between the capital ratio and the marginal ratio is the capital ratio is static. While the marginal ratio is dynamic because it shows an increase or increase.
Talking about ratio problems, of course, cannot be separated from calculations involving formulas or formulas. So I will explain a little but in detail what ICOR is. ICOR is an indicator used to explain the relationship between the level of investment in the economy so as to increase the value of gross domestic product (GDP). ICOR here means an additional unit, or external capital in the investment needed to later produce additional units or output.
ICOR acts as a metric that assesses the amount of investment margin so that a country or other entity is required to produce the next unit of production.
Based on the calculation data generated as a whole, if the ICOR value is higher, then it indicates that the entity’s production is inefficient. Because the data results determine the level of production efficiency of a country.
I personally also suggest that the use of ICOR should not be applied to a country, because a country can also be maximized if it is based on qualified technology. For example, theoretically has abundant resources, such as mining products (precious metals, uranium, iron ore and so on). If it is maximized by processing using technology, the capacity can be better for the development of the State’s Economy.
ICOR Benefits and Uses
As we discussed from the brief description above, the ICOR Indicator has the following benefits and uses:
It is used by economists, analysts, the Central Bureau of Statistics and policy makers as parameters and indicators to assess whether or not the use of capital is efficient in generating productivity in an investment activity.
ICOR is able to explain the ratio between the addition of capital to the output produced in an economy.
The higher the ICOR value is an indicator that a country’s economy is less efficient and the lower the ICOR value is a sign that a country’s economy is very efficient.
ICOR is used to describe Every increase in one unit of output value (output) will require an additional capital of “K” units.
ICOR is used by economists and policy makers to see and analyze the productivity of the capital used which affects the amount of economic growth that can be achieved.
Assessment using the Ratio Incremental Capital Output Ratio (ICOR) indicator of the economy
Currently, the US economy is still heavily dependent on and influenced by the performance of the commodity industry, which dominates the needs of exports to various countries, where prices are always fluctuating due to fluctuations in the volume of demand for Commodities from other countries, which in turn affects economic growth and fluctuations in ICOR. Dependence on sources of state income that rely on a commodity-based economic system often causes the ICOR value to be very high, especially in the situation of the world economy affected by COVID-19 where export performance is very low, product competitiveness decreases and the global economic slowdown makes the contribution and added value of commodity exports tend to decline. . Therefore, it must be considered to improve economic performance and increase the competitiveness of commodity-based exports by thinking about the downstream and upstream industries by building a manufacturing industry supporting commodities so that the value, quality and price can increase in the international market. Apart from that , it also improves the performance of the bureaucracy , rules and regulations . distribution and infrastructure also need special attention, including efforts to improve human resources, skills, education and experience are also a top priority in order to create efficiency and added value to pursue a low ICOR value as evidence that a country’s economy is very efficient.
