Investment
From WikiTextbook
Investment, briefly defined, is a temporary donation of money to a cause in expectation of making a profit.
An example of investment is spending by companies on capital goods. It also includes spending on working capital such as stocks of finished goods and work in progress.
Investment is often modelled as a function of income and interest rates, given by the relation I = (Y, i). An increase in income will encourage higher investment, whereas a higher interest rate may discourage investment as it becomes more expensive to borrow money. Even if a firm chooses to use its own funds in an investment, the interest rate represents an opportunity cost of investing those funds rather than loaning them out for interest.
Gross and Net Investment
An important distinction to make is between gross and net capital investment spending:
Net investment refers to an activity of spending which increases the availability of fixed capital goods or means of production. It is the total spending on new fixed investment minus replacement investment, which simply replaces depreciated capital goods.
Gross (Private Domestic) Investment is the measure of investment used to compute GDP. This is an important component of GDP because it provides an indicator of the future productive capacity of the economy. It includes replacement purchases plus net additions to capital assets plus investments in inventories. It usually amounts to between 15 and 18 percent of GDP. Net investment is gross investment minus depreciation.
Why do Firms Invest?
These are the five main reasons why firms may choose to invest;
- To take advantage of higher expected profits from expanding output and meeting a rise in consumer demand.
- To generate a rise in productive capital.
- To improve efficiency through technological progress.
- To exploit economies of scale and thereby bring down long-run average total cost.
- As a barrier to entry - extra capacity can force out potential compamies in the market, protect the monopoly power of existing firms and thereby increase abnormal profits in the longrun.
Marginal Efficiency of Capital (MEC)
Theory
The keynesian theory of investment is based on interest rates and how they effect the level of planned investment in the economy. A fall in interest rate should decrease the cost of planned investment and hence more companies will invest. However, when the interest rate increases the cost of planned invesment will increase causing less planned investment. Shown in the graph below.
http://www.revisionguru.co.uk/graphics/diagrams/economics/unit3/invest51.gif
Shifts in the marginal efficiency of capital
At each rate of intrest, planned investment can change. For example, if there was a rise in expected rates of return on investment then there will be more planned investment. This would cause an outward shift from MEC1 to MEC2.
Also, the MEC curve could shift inward causing less planned investment. This could happen if there was a fall in business confidence causing less planned investment at each rate of interest. Curve MEC1 will shift inward to MEC3.
http://www.revisionguru.co.uk/graphics/diagrams/economics/unit3/invest52.gif
The Accelerator Theory
The accelerator is based on an assumption of a stable or fixed capital to output ratio. It all depends on the demand for something. for example; if demand is higher than the current capacity of a company, they may think about expanding and building new plants/factories and/or buying more machionery to help cope with the heavier demand. Therefore, depends on the rate of national income. A slow down in demand would perhaps put a halt on capital investment.
The accelerator effect in economics refers to a positive effect on private fixed investment of the growth of the market economy (measured e.g. by gross domestic product). Rising GDP (an economic boom or prosperity) implies that businesses in general see rising profits, increased sales and cash flow, and greater use of existing capacity. This usually implies that profit expectations and business confidence rise, encouraging businesses to build more factories and other buildings and to install more machinery. (This expenditure is called fixed investment.) This may lead to further growth of the economy through the stimulation of consumer incomes and purchases.
The accelerator effect also goes the other way: falling GDP (a recession) hurts business profits, sales, cash flow, use of capacity, and expectations. This in turn discourages fixed investment, making a recession worse (especially when the multiplier effect is remembered).
http://www.revisionguru.co.uk/graphics/diagrams/economics/unit6/invest2.gif
Investment in the UK today
Recent Trends In the Growth of Consumption and Investment Spending
The is a positive relationship between the investment spending and consumption, although this was slow in the early 1990, due to a recession. As consumer demand accelerated so did investment due to capacity shortages and low interest rates, however although much of investment spending is consumption induced (the accelerator theory) there are other factors which need to be taken into account. In the later half of 2005 there was a increase in consumption after a period of weak consumption. Investment increased by 1.6% mainly due to an increase in government rather than businesses investment which was weaker than expected.
Research and Development Spending
This is an important factor in the development of the economy which helps international competitiveness, it includes developing new products and production processes, the Uk ecnomy has invested less than other similar countries. 1997 the UK expenditure on R&D was £14.7 billion which represents 1.80 per cent of GDP, below the EU average of 1.83. It is pharmaceuticals, which have the highest R&D costs.
In 2003 this was £20.8 billion or 2.6%of GDP, it was up on the 2002 was £19.8b,this has been decreasing since 1986/87 where net government spending on R&D was, at 2003 prices, £8.5 billion and is now £7.9 billion. However less was spent on defence, In 2003, 32 % and in 1995 37%.
Capital Base
This is an initial investment plus subsequent investments made by an investor into their portfolio and is important because it provides a benchmark when measuring returns. Without it, investors and companies would be unaware of how they are doing relative to their investments.
British companies have a smaller capital base than other international competitors, this has problems in the economy, with an impact on the long-run trend for growth. Gross tangible fixed assets per employee - a measure of capital invested over time - is estimated to be £96,000, £53,000 below the international average. Capital investment per employee by British companies in 1997 was £9,000, £4,700 less than the average for Europe, North America and Japan.
In 2000 Gordon Brown decided that he had to increase capital investment which would hopefully save £10 million a year in certain industries. He also wanted millions of pounds to provide a global network of British information and services abroad. This would encourage residents of the UK to use more IT skills and build up a greater source of knowledge - looking to the future of the infomation age.
Foreign Direct Investment and the UK Economy
Foreign direct investment is an investment abroad, usually where the company being invested in is controlled by the foreign corporation. An important decision was made in 1979, by abolishing foreign exchange controls making it easier to invest in the UK, mainly from Asia and The USA, this has helped production, employment and income in the manufacturing and service sector.
In 2005 there was an increase in industrial confidence, meaning the country attracted the highest amount of foreign investment, receiving US$219 billion of FDI inflows, this 24..4% of all global FDI inflows (49%of EU regions, the highest level of FDI ever recorded in a European country).
In 2004 the cumulative ‘‘stock’’ of foreign investment in the UK was more than US$770 billion, the second highest level of FDI stock globally.
The UK is the largest single destination globally for US investment and in 2005 attracted 28 per cent of all US investment into the European Union. Indeed, the UK has attracted more US FDI than the combined totals of Germany, France, Spain, Italy and Ireland
Inward Investment and the Regional Economic Problem
Inward investment is the injection of money from an external source into a region, so it is able to purchase order capital goods so a branch can locate or develop its presence in the region
Regional economic policy is important, many grants go to private sector to boost northern economies. In many of these areas the number of claimants on sickness and incapacity benefit is high. In the run-up to the 1997 general election William Hague, then Secretary of State for Wales, announced what he called “the biggest vote of confidence the Welsh economy has ever had”. LG, the South Korean electronics firm, had announced that it was setting up a factory in Newport in what was the largest single inward investment Europe had ever seen.
Between 1992 and 2002, 53 per cent of the value of RSA (Regional Selective Assistance) grant awarded went to foreign owned companies. In addition, inward investment is disproportionately concentrated in the greater south-east (especially for non-manufacturing projects).
UK investment in a international context
Total investment spending in the period 1996-01 for the UK has grown more strongly that in other periods (the 1991-95 period includes the years in which the British economy was last in (recession). This should help to improve our economic performance in the long run, as investment helps improve aggregate supply. However the United States has invested a lot more that the UK concentrated in new economy sectors such as telecoms, media and technology (TMT).
Statistics
Investment figures from the ONS
Excel spreadsheet with investment data from the Bank of England
Further Reading
6.7.2000 Economist: Foreign Direct Investment (requires subscription)
5.7.2000 BBC: UK leads foreign investment
