Economies grow due to increases in the production of goods and services. Economic growth can result from consumer spending, international trade, and business investment.
Periods of growth have occurred throughout history in part due to new discoveries, as in the case of shale oil in the 2000s, making the U.S. one of the top oil producers in the world. The advent of the internet brought new technologies, e-commerce, and revolutionized how business was done.
However, the innovations and technological advances couldn't have occurred without capital investment, which consists of purchases and investments by companies and investors to create a brighter economic future.
Explaining Economic Growth
Economic growth in the U.S. is primarily driven by consumer spending and capital spending from businesses. As consumers buy more homes, for example, home construction and contractors see increases in revenue. As companies invest in their business to expand their products and services, they hire more employees and increase salaries or wages. All of the activity leads to economic growth as measured by gross domestic product or GDP—the total output of goods and services for a nation in a given period.
How Capital Investment Relates to Economic Growth
Capital investment results when businesses purchase capital goods. Capital goods include assets such as factories, machines, computers, vehicles, tools, and other production equipment. Capital investments are long-term in nature that allow companies to generate revenue for many years by adding or improving production facilities and boosting operational efficiency.
Additional or improved capital goods increases labor productivity making companies more productive and efficient. Newer equipment or factories could lead to more products being produced at a faster rate. Also, a new production facility might use less electricity due to new equipment and an energy-efficient building. As a result, the company's profits increase due to more products being produced at a lower cost and with faster turnaround times.
A business does not see an immediate increase in revenue when it develops capital goods. To make it economically viable to increase or improve the capital structure, a company must have adequate cash or funding through issuing debt (bonds) or equity—stock to raise funds.
Increased capital investment allows for more research and development in the capital structure. This expanding capital structure raises the productive efficiency of labor. As labor becomes more efficient, the increased efficiency nationwide leads to economic growth for the entire country or higher gross domestic product.
Capital goods are not the same as financial capital or human capital. Financial capital includes the funds necessary to sustain and grow a business, by either debt or equity, and human capital represents human labor or workers. It requires financial capital to invest in capital goods while it takes human capital to design, build, and operate capital goods.
- Capital investment is when businesses purchase capital goods such as factories, machines, computers, vehicles, and production equipment.
- U.S. economic growth is primarily driven by consumer spending and business investment spending.
- Capital investment can be a differentiating factor in whether the U.S. posts a healthy growth rate or an anemic growth rate.
Example of Capital Investment and Economic Growth
The table below shows the percentage of yearly GDP growth from 2016-2018 according to the BEA or the Bureau of Economic Analysis. The table shows the annual GDP growth rate for each year as well as what contributed to the growth.
- Annual GDP growth was 1.6% for 2016 and 2.9% for 2018.
- The personal spending or expenditures (green) was 1.85% in 2016 and 1.80% in 2018. So, consumer spending between 2016 and 2018 was approximately the same.
- However, capital spending or private business investment (red) was -.24% in 2016 and 1.02% in 2018.
In other words, business investment through purchases of capital goods drove GDP higher in 2018—comprising of 1% of the 2.9% GDP for the year. The table breaks it down further where we can see that structures and equipment purchases were higher in 2018 versus 2016.
Please note: The table above is a truncated version, meaning there were other smaller contributors to growth that are not included.
As the table illustrates, U.S. economic growth is predominately driven by consumer spending and business investment spending. Since consumer expenditures were nearly the same in 2016 and 2018, the extra GDP growth in 2018 was mostly due to higher capital investment. The purchases in capital goods included industrial equipment, transportation, software, and structures such as building or factories.
As a result, capital investment can make a significant impact on economic growth and be a differentiating factor in whether an economy experiences a healthy growth or anemic growth.