Investment spending is a vital component of aggregate expenditure in an economy. It refers to the expenditure incurred on capital goods and equipment that enhance productive capacity and promote economic growth. Investment spending includes business investments on factories, machinery, technology etc. as well as investments in housing, infrastructure and inventories. The level of investment spending has a significant influence on key macroeconomic indicators like GDP growth, employment generation and balance of payments.
Investment and GDP growth
Investment spending directly contributes to GDP growth as it constitutes one of the components of GDP expenditure. An increase in investment spending implies greater production of capital goods and hence growth in aggregate output and income in the economy. Apart from its direct impact, rise in investments also stimulate consumption and exports, thus multiplying GDP growth through accelerator effects. For instance, investment in industrial capacity will support more job creation. The resulting rise in employment and income levels will boost consumer spending. Likewise, investments that enhance export competitiveness will stimulate demand from overseas markets.
Investment multiplier effects
Investments tend to have powerful multiplier effects in the economy. This is because an initial rise in investment leads to a bigger final increase in national income through subsequent increases in consumption. As investment spending goes towards purchase of capital equipment, it raises productivity and profitability of industries. This stimulates even higher investments. Growth of income and output further induces more consumer spending. Thus investment multipliers magnify growth impulses in the economy.
Investment and balance of payments
At the macro level, investment spending also influences a country’s balance of payments position. Rise in investments to expand industrial capacity and infrastructure leads to greater demand for imported capital goods. This worsens the capital account balance. However, over time such investments help boost export competitiveness and foreign exchange earnings. The resulting improvement in current account balance more than offsets the initial impact of higher imports of capital goods.
In summary, investment spending plays a vital role in fuelling medium and long term economic growth. It directly raises productive capacity while also generating multiplier effects on consumption and exports. Therefore, level of investments serves as an important indicator of business confidence and future growth prospects.