Investment and Economic Growth

Readers Question: Discuss the Importance of Investment in Increasing Economic Growth.

Investment means an increase in capital spending, e.g. buying new machines, building bigger factories (in economics it does not mean saving money in a bank)

Investment is a component of Aggregate Demand (AD). Therefore, if there is an increase in investment it will help to boost AD and therefore economic growth.

If there is spare capacity then a rise in AD will increase economic growth. However, if the economy is close to full capacity, then rising AD will only cause inflation and not an increase in real GDP

Also, it is important to bear in mind that there are other factors that affect AD apart from investment. Therefore, if there was a fall in consumer spending or exports then a rise in investment may not actually increase AD. Investment is not the biggest component of AD, that is Consumer spending.

If investment is effective then it should also increase the productive capacity of the economy. For example, investing in skills and education can increase labour productivity. Investment in new technology and capital can increase the productive capacity of the economy. This helps to shift AS to the right. An increase in AS can increase long term economic growth; it can increase growth without inflation. If investment leads to a significant increase in productivity then it can lead to an increase in the long run trend rate of economic growth.

investment

It depends on the type of investment. For example, government investment in improving industry could be totally inefficient and fail to increase productivity in the economy. However, private sector investment, or investment from oversees may be much more effective in actually increasing productivity.

In the long term, investment is important for improving productivity and increasing the competitiveness of an economy. Without investment, an economy could enjoy high levels of consumption, but this creates an unbalanced economy. There will tend to be a current account deficit, and little investment in future growth prospects.

Economic Growth and Investment

economic growth investment

The period 2009 to 2012 was a period  of low growth, Business investment was more volatile than GDP growth.

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