How Does Investment Affect Productivity and Economic Growth?

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A country’s economy is more than the sum of each individual’s economic status; it’s a collection of values — and transactions — beyond an individual’s actual cash in hand. When looking into a national economy and how it can be affected, there’s a crossover between investment, productivity and growth in terms of what can make an economy successful. In order to look into these factors, it’s worthwhile to take the time to define each of them in an economic sense.

What Is an Investment?

An investment is any money put into something with the expectation of future benefits. It’s money or other resources committed to something that will (hopefully) provide profit in the future. Stocks, bonds and shares represent a type of investment that expects a gain through an interest rate. The money invested now is expected to be returned in the future with a higher value.

Investments can also mean money dedicated to capital spending, which builds the capacity of an entity to produce whatever goods and services it markets. With regard to a national economy, investments are any resources that are put back into the economy to stimulate growth and productivity.

What Is Economic Growth?

Economic growth occurs when an economy sees an increase in the amount of goods and services exchanged over a certain time period, often measured using GDP. Growth in national accounting terms is often adjusted for inflation values over time to provide a more realistic measure of how the economy has grown.

This can be measured using four factors:

  1. Labor productivity
  2. Labor intensity (hours worked)
  3. Participation rate (percentage of the labor population that is working) 
  4. Demographics comparing the working-age labor population against the entire population 

Growth can come from both an increase in available production (a capital investment that yields more resources than before) or an increase in productivity.

What Is Productivity?

Productivity, in the economic sense, is the value of output produced by one unit of input over a certain period of time. It’s a measure of the value created against the resources spent to create. It’s also often measured over a period of time to compare changes in productivity per unit of input.

Increased productivity can come from improvements in efficiency, which can involve technical improvements from capital investments, training and education for the laboring workforce and general improvements in technology as society develops. For example, newer machines may be more energy efficient, providing additional cost savings.

Investment and the Economy

In a basic equation, investment leads to productivity improvements, which in turn lead to increased growth. This then leads to improved profits and additional investment, and in an ideal economy, the cycle continues. Thus, investment is somewhat the key critical point.

On an individual scale, investment can mean either spending money on one’s personal business or investing it into stocks, bonds and other financial resources meant to provide future value through interest. On the national economic scale, investments back into capital are the ones that tie into economic measures and economic growth.

What Is Capital Investment?

Capital investment can affect a national economy in multiple ways. First, the capital investment should increase the capacity and/or efficiency of production, which will lead to economic growth, which shows up in two critical ways. First is the ability for businesses to reinvest their profits to continue this growth, and second, the labor population and consumers who obtain employment due to this growth will have more money on hand, which will increase their spending. This provides additional revenue and capital for businesses, and businesses can then continue the cycle of investment to increase production.

Capital investment doesn’t provide an immediate return. The company will take the portion of revenue it has allocated for capital and/or sell stock shares to produce cash on hand. This allows the company to explore research and development — a human type of capital that has no immediate profit but promises increased revenue down the line — to help direct the investments to the most promising area.

Research and development isn’t entirely about generating completely new ideas; it’s also about tracking developing technologies and advising management on how innovative new technology could help improve efficiency and productivity. This step may seem costly and with no direct return, but R&D is what helps a company ensure that its investment capital will in fact produce those future benefits.

Considerations Surrounding Investments

Another factor to remember is that investment is necessary to keep a company moving forward whether or not it is making improvements. All businesses undergo wear and tear, aging and equipment malfunctions in their factories and facilities alike. A minimum capital investment is required to keep the business going as is over a period of time.

If companies aren’t even making this minimal investment, their production will eventually fail, and the economy will falter and decline because of it. The national economy depends on all of the businesses that make up its assets to foster growth because that push is what keeps the economy growing.

Spending and Saving

Consumer spending and saving can also have an effect on economic growth. When consumers have more money, they spend more, which feeds growth back into the economy. However, consumers can’t spend all of their money, or they’ll have none in the future and may go into debt during an emergency, so consumers save as well. Saving can affect the economy in two entirely different ways depending on the national economic status.

Consumer saving can in fact lead to economic growth through a different pathway: banks. As consumers invest their money into savings, banks have more resources available to lend to businesses looking to invest in capital. The banks, however, will only want to lend this money in a promising economy where things are stable and growth is already happening. In a recession or an unstable economy, banks are far less likely to offer affordable loans on the market.

Consumer saving can also take valuable cash out of the economy if savings are stashed under a mattress rather than in the bank. This can then lead to a slowdown in growth. With a tightened flow of cash and lower velocity of transactions, business revenues will drop. Investment in capital will be reduced in order to keep the existing pieces of the company afloat. This can then lead to a recession if it goes on long enough since money continues to sit in banks rather than circulate through the economy.

Investment and Long-Term Economic Growth

When looking at the national economy, it’s also important to consider how consumers’ spending habits might change based on their income. For example, at lower incomes, consumers will have little to no savings — perhaps negative savings if they’ve borrowed money or run up a credit card — and will only spend on the things they need. At higher incomes, of course, consumers spend more, but they also start saving more, and the level of savings increases as incomes rise.

Thus, it seems better for the economy when consumers on average are earning more than the bare minimum required to live, as this feeds money back into companies when their goods and services are purchased. It also feeds additional money into banks which can then loan that money for capital investment. National economic growth is significantly influenced by consumer spending.

Income for Companies

For companies, income can be represented as the profits or revenues they receive for the products they sell. However, the concept is somewhat the same except that businesses don’t necessarily have savings accounts into which they deposit money for the long term. Instead, the balance between spending on investments and not spending is chosen by a set of factors: the company’s income, the market landscape and the state of the economy.

When a company has a successful year and can pay off all of its bills and its dividends to shareholders, obviously it will have more money to invest. During a weaker year, the company may choose to limit capital spending on expansions, instead focusing on maintenance and repair.

Effect of Investment on Economic Growth

The importance of savings and investment for economic growth cannot be overstated. The relationship between investment, economic growth and productivity and their subsequent effects on the economy seem obvious, but they are all dependent on the market conditions and the expected economic performance. Growth begets growth: Investment leads to increased productivity and thus to economic growth, which returns money back to the beginning of the cycle. However, upsets to this balance will disrupt the cycle and slow down the growth.

Slowed growth does not necessarily mean movement into the negative. For example, slowing economic growth will also slow the rate of inflation, allowing money to carry more value than expected. It also slows down the use of natural resources and utilities and allows space for alternative technologies that may not have been feasible before due to the market growth rate and demand but look attractive now.

Disruptions to the National Economy

So, what can disrupt a growing national economy? Today’s landscape is global, and while countries still track their own internal economic status, other nations can certainly create economic waves that spread outside their own borders. Many factors unrelated to capital investment and productivity increases can potentially disrupt a country’s economic growth.

  • Crisis in another nation that has a significant stake in imports, exports or raw material supply for the initial nation can disrupt economic growth. This can include natural disaster, governmental upset, war and a number of other occurrences.

  • Changing governmental regulations within a country can initiate roadblocks for others. For example, material safety data sheets used to be a standard format accepted worldwide for chemical transport. However, when Europe decided to change to a new standard, chemical industries in the United States had to spend significant amounts of money to have their material safety data sheets

    rewritten.

    Changes in trade relations, including modifying tariffs and taxes, can significantly affect the pricing of raw materials, which can key directly into a company’s bottom line.

    A market crash, such as the stock market crash of 2008, can have drastic and lasting impacts on the national economy. The key point is that these are emergency crashes which occur unexpectedly rather than predicted slowdowns of economic growth.

    * Increased uneven wealth distribution (further separation of the ultra rich and the middle and lower classes) can lead to changes in spending habits as the economy grows overall, but an increasing number of consumers has relatively less to spend.

In order to invest wisely, companies need to be aware of the overall state of the national economy as well as the trends over the last few years and projections experts make as to future market direction. In an ideal state, markets could continue to grow as investments pay off, leaving wages and the standard of living to rise.

References

About the Author

Danielle Smyth is a writer and content marketer from upstate New York. She has been writing on business-related topics for nearly 10 years. She owns her own content marketing agency, Wordsmyth Creative Content Marketing (www.wordsmythcontent.com) and she works with a number of small businesses to develop B2B content for their websites, social media accounts, and marketing materials. In addition to this content, she has written business-related articles for sites like Sweet Frivolity, Alliance Worldwide Investigative Group, Bloom Co and Spent.