plays six macroeconomic roles:
Investment is just new capital accumulation in business (both private and state-owned).
Household by convention
do not invest, even if it does exist a capital accumulation in cars, computers,
electric appliances, etc.
that we include in their "cumulative
expenditure is partly devoted to roads, railways, infrastructure,
buildings (as for schools, hospitals,
). All this is clearly capital
accumulation whose utility will last over time. Still, it is quite a common
practice for investment in public sector being considered zero by convention.
inventories stock of finished goods, semi-manufactured goods, and
raw materials in commercial premises, storehouses and producers' plants;
In today's world, investment in immaterial assets is getting more and more important, as with the case of expenditure in Research & Development, human capital, software and other areas.
Financial investments in shares, obligations and other financial instruments are not considered as "investment" in a macroeconomic sense nor in national accountancy. The same is true for real estate exchanges of used buildings (both residential and non-residential).
When considering the issue of the creation and diffusion of innovation through investment, a crucial distinction should be made between complementary investments and competitive investments.
Benefits relate to the effects of investment in terms of increased value added, reduced costs, larger production, higher competitiveness. Hence, profits are expected to be higher, too. The value over time of these benefits (and profits in particular) are compared to the investment costs.
The temporal profile of costs and revenues will be important in the decision whether to undertake the investment or not. In particulare the payback-period, in which the investment is covered by accrued profits, provides important reference for rules-of-thumbs.
In many decision processes and routines, the value over time of benefits will be discounted through a subjective discount rate to keep into account time distance and uncertainty. In others, the decision will be based on more strategic and vital arguments. A new vision of the competitive environment and of the global trends can bring to invest in surprising directions.
The prevailing conventions on time length of loans and bonds (5 - 10 - 15 - 20 - 30 years, with 50 or 100 being more unusual, except in certain countries or markets), coupled with payback periods of different types of investments across sectors and countries select and boost certain specific classes of investment instead of others.
This is because immediate profitability and coverage from stochastic variations of net benefits from an investment can be achieved by taking a loan for a period significantly longer than the payback period of the investment. In this way, the fixed payment per period becomes systematically lower than the net benefits, even during negative shocks. This mechanism, whose fine-tuning involves the level of interest rate, the mean, variance and auto-correlation of net benefits, is very powerful in boosting investment with short-term payback especially when interest rates are high and variance is high, depressing long-term investments.
for investment can be obtained thanks to the following items:
self-financing, in turn due to:
loans from banks and other financial institutions:
3. capital market finance, through the emission of obligations as well as through the issue of shares in the stock market (primary market). The following price fluctuation do not directly have any impact on financing the firm. But it is true that further new emissions of shares often require positively-oriented capital markets.
seed money and expansion capital for new firms provided by venture capitalists
and private equity funds;
5. public funds and incentives for investment from international, national, regional, local institutions.
However, the empirical evidence of microdata shows that investment - at micro level - is infrequent and lumpy. There are periods in which firms decide not to invest and periods of large investment episodes. For better understand the issues at stake see this paper.
Investment expenditure is a bet on future. If the bet is lost, the product does not find a remunerative market and much of the investment expenditure turns out to be a sunk cost that cannot be recovered. In the extreme case, investment is irreversible. Coupled with true uncertainty, irreversibility becomes a fairly important determinant of investment levels across industries, as this paper points out.
In the IS-LM
model, interest rates are considered the unique determinant
of investment. In fact, interest rates play three distinct functions:
they influence the discounted value of net benefits over time;
In all three function, a higher interest should trigger a lower investment, since the present value of benefits will be lower, finance costs higher and economic perspectives worse.
Still, there exists
investments that are not based on interest rates considerations. For instance,
firms have usually a very restricted number of investment projects, carrying
them out when profitability is well above zero. A small change
in interest rate would have simply no impact
on each investment decision, thus on aggregate level as well.
By contrast, the effect of large interest rate changes may be highly asymmetric: a strong increase of interest rate can indeed provoke a fall in investment dynamics whereas a similar decrease may fail to induce investment, if real perspective benefits are lacking.
Saturation of productive capacity represent a key references for firms' decisions to invest. Expectations about future sales will affect investment if the current capacity is not enough to match the forecasted increase in demaned quantities and the firm is committed to fulfill all orders. Given a ratio of fixed capital to sales, the investment required would be (in a very simplified method of estimation) this ratio times the new additional expected sales.
Furthermore, new technology innovation and the need of imitating competitors' adoption of innovation can also force firms to invest, in a process of diffusion that can be boosted by a conducive tax environment, both in terms of tax breaks and pro-diffusion-of-innovation tax.
Investment in real estate new developments and rejuvenation of existing areas are better understood in operations like urban regeneration.
Cumulated investments over time give rise to capital, opening the
path to improvements in production conditions.
can fall if a labour substitution investment prevails with real output
growing less than physical productivity. By contrast, other kinds of investment
and economic situations give rise to an increasing employment.
The quality and composition of employment also depend on the investment
directions. For instance, green jobs significantly depend on wide investment
in green sectors and technologies.
As a GDP component from the current domestic expenditure side, investment has an immediate impact on GDP. An increase of consumption rises GDP by the same amount, other things equal. Moreover, since income (GDP) is an important determinant of consumption, the increase of income will be followed by a rise in consumption: a positive feedback loop has been triggered (between consumption and income) by investment.
Because of this mechanism, imports will grow as well. More directly, investment is often directed to foreign machineries and goods, with an immediate increase of imports.
Countries differ a lot in respect to investment levels and dynamics. Some countries have heavily invested, sacrificing current consumption and triggering an export-led growth, often based on manufacturing. Others keep investment at much lower levels with an unsecure growth path.
large-scale investment effort in clean technologies and processes is seen
as a conditions for coping with climate change. The our book on "Innovative
Economic Policies for Climate Change Mitigation" puts forth the
proposal of a closed long-term fund to influence investment decisions
of private and public bodies.
On the contrary, the
influence of interest rates on investment can be important at turning
points. At peaks, consistent increase of the interest rate would drastically
worsen the costs of existing loans for past investment. Disappointment
from demand grow may combine with this effect to reduce investment dynamics.
Investment often peaks earlier than GDP, triggering a negative income-consumption multiplier, thus prompting a new recessionary direction.
At trough, low interest
rates may be one of the very few good news for firms. Thus, combined with
positive expectations, investment may start growing from the very low
level at which they were.
Positive expectations toward the economy may also bring leading firms to invest earlier than the trough. In so doing they may even invert the business cycle.
On the other hand, investment in machinery may instead follow the lower trough, since the first recovery may simple use the existing, not-fully exploited capital.
Changes in government, with opposition going to the power, can exert an important effect on raising or abating the expectation of business in terms of the overall economic environment and for specific actions.
Needless to say, business cycles have many sources and paths, thus wide discrepancies with the previously presented scenario can arise.
data from 136 countries: a long term time series
Recognizing Investment Opportunities at the Onset of Recoveries - a neural net to model investments in novel fields of economic activity, when firms recognize the emergence of a new technological pattern