Investment (Economics)

Investment, in economics, is spending on new capital goods that will be used to produce goods and services in the future. It covers business purchases of machinery, equipment, vehicles, software and buildings; the construction of new homes; and changes in firms' inventories. In national accounts it is the "I" in the expenditure measure of GDP and is recorded mainly as gross fixed capital formation.

The economic meaning differs from everyday usage. Buying a share or a bond is a financial investment for the buyer, but for the economy it only transfers ownership of an existing asset; it becomes investment in the economic sense only when a company uses the money to build or buy new capital. Investment is financed by saving, domestic or foreign, and is the most volatile part of aggregate demand.

A baker who buys flour to make today's bread is spending on supplies. A baker who buys a second oven is investing: the oven will turn out bread for years. Economic investment is that second kind of spending, on things that are not used up straight away but help produce more later.

Across a country, investment means new factories, delivery vans, office software, warehouses, homes and power lines. It matters twice over. Building those things gives work to builders and machine makers now, and once finished they let the economy produce more in future, which is how living standards rise over time.

National statisticians split investment into several parts:

• Business fixed investment. Spending on equipment, structures such as factories and offices, and intellectual property products such as software and research and development, which the international System of National Accounts has counted as investment since its 2008 revision.
• Residential investment. Construction of new homes and major improvements to existing ones, which is sensitive to mortgage rates.
• Inventory investment. The change in stocks of materials and unsold goods; it swings sharply around turning points in the business cycle.
• Public investment. Government spending on roads, schools, hospitals and other infrastructure, usually recorded separately from private investment.

Investment can also be gross or net. Gross investment is all new capital spending; net investment subtracts depreciation, the wearing out of existing capital:

If an economy spends 300 billion on new capital in a year while 220 billion of existing capital wears out, net investment is $300 - 220 = 80$ billion, and the capital stock grows by that amount. Investment financed from abroad, such as a foreign company building a plant, is foreign direct investment.

Firms invest when they expect the return on new capital to exceed its cost. The main influences are:

• The cost of funds. Higher interest rates raise the bar for projects, which is the main channel through which monetary policy works on investment. Firms often judge projects using net present value or an internal rate of return.
• Expected demand. The accelerator principle holds that firms invest more when sales are growing fast, because they need more capacity.
• Confidence and uncertainty. Keynes attributed sudden swings to "animal spirits", and modern research finds that policy and trade uncertainty delays projects.
• Market valuation. James Tobin's q theory compares the market value of firms with the replacement cost of their capital; when q is above 1, investing is attractive.
• Taxes and regulation. Depreciation allowances, investment tax credits and planning rules change the after-tax return on projects.

Investment raises the capital stock, and capital per worker is one of the main sources of productivity growth, along with skills and total factor productivity. Rates vary widely: China has invested over 40 percent of GDP for much of the past two decades, while the United States and United Kingdom typically invest roughly 17 to 22 percent. In the short run, investment is also a leading source of downturns: in a typical US recession private investment falls by a far larger percentage than consumption, then rebounds faster in the recovery. Economists debate how much high investment is worthwhile, since capital can be wasted in property bubbles or prestige projects, and whether weak investment in some rich economies since 2008 reflects low demand, high uncertainty, short-termism in financial markets or a shift towards intangible assets that are harder to measure. Governments also argue over how much public investment should be financed by borrowing.

• U.S. Bureau of Economic Analysis: Gross Domestic Product
• United Nations Statistics Division: System of National Accounts 2008