Directing money. Not how much capital exists. Where it goes, and whether that’s the same as where it would be the most efficient.
Capital allocation is the process and the object of study of directing available money toward some uses rather than others: a firm choosing between reinvestment, debt paydown, and dividends; a household choosing between saving, spending, and giving; an economy channelling investment toward some sectors over others. Misallocation is a distinct, measurable problem from capital scarcity: research on firms across Southern Europe found capital increasingly flowing toward firms with better access to financing rather than firms with better returns on it, a documented productivity loss from allocation quality alone, independent of how much total capital existed.
The same distinction holds at any scale: a pool of money can exist, be genuinely sufficient, and still be badly allocated if the process directing it optimises for something other than actual need or productive use.
On the other hand, a smaller pool can be optimally utilised and bootstrapped by directing it to capital-growing opportunities. And chiseling the fat or overheads radically.
Source: Gopinath, G., Kalemli-Özcan, Ş., Karabarbounis, L. & Villegas-Sánchez, C., “Capital Allocation and Productivity in South Europe,” Quarterly Journal of Economics, 2017.