Monday, July 2, 2012

Investment

I used to work at places with long names that were not easy to summarize when introducing myself. Say, for instance, I was meeting someone at a party or talking to a stranger at a bus stop. Unless they were working in the same line of business, it would be a bit of a mouthful for me to say,"I'm senior economist at the Vale Columbia Center on Sustainable International Investment under Columbia Law School and the Earth Institute at Columbia University" (up to last September) or "senior economist, principal administrator and head of global relations in the Investment Division of the OECD" (from 2002 to 2010). Even if they knew what Columbia University or the OECD was, probably the only word that would register would be "investment". So I might often just say,"I work on investment policies". The response would usually be something like "my cousin also works in an investment bank" or "so  you can tell me what to do with my pension, then?". And I would have to explain that I wasn't working on exactly that kind of investment.

So what sort of investing am I referring to in the slogan "Invest for Development"?



When economists talk about "investment", they are most of the time thinking about fixed investment, that is, investment in fixed assets like machinery and equipment, and the buildings to put them in. These assets can then be used, with the addition of labor and raw materials or components, to produce finished goods that you and I can buy in the shops.

"Investment" can also be used for inventories (US) or stocks (UK), which are also things you build up in preparation for producing finished goods. But chances are the next time you hear an economist speaking about "investment picking up"  he or she will be talking mainly about the other kind of investment: fixed capital investment. (Investment in inventories/stocks is also an important indicator of which way the economy is going, but terms like "stockbuilding" are used so that people don't confuse it with the other kind of investment.)

The complete phrase used in the national income accounts that add up to a country's annual gross domestic product (GDP) is "gross fixed capital formation", summarized as "capital investment".

Economists also nowadays talk about "investment in human capital". Several decades ago, it was discovered that investment in fixed assets like machine tools only accounted for half of economic growth in developed countries like the US. Researchers put two and two together and concluded that the other half must be improvements in the productivity of labor (the amount produced per worker) resulting from such things as increased education and training, summarized as "human capital". Though some economists dissented, the general view is nevertheless that investment in human capital, including mainly healthcare and education, is a vital factor in a country's economic development.

In a later blog post I will go into what I mean by "development". At this point it's enough to say that it covers many more things than income growth. For these things to become available, there needs to be an initial investment. Investing means forgoing current consumption so that you can build for the future. This is a sacrifice you can only make if you already possess something to consume. If you have nothing, you may have to borrow or accept a gift. If you have almost nothing and you don't want to borrow or accept handouts, you might just depress your own consumption to build your capital. This applies to households, also to whole countries.

Which is best, borrowing, accepting aid, working extra hard, or some other method? There is no "right way". Each country has to choose its own road. In practice, a really poor country has to adopt a mixture of all these just to survive. The key thing is that someone in charge has to realize that no economy can be sustained without saving and investment. If the country does not have enough income or a high enough saving rate for savings to pay for investment, then it will have to obtain the extra funding from abroad, making it dependent on others.

In future blogs I will be looking at the various ways a society can fund its development so that all its citizens can lead fulfilling and happy lives. There is no single path to this objective, but there are many wrong roads.

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