A:

An economy grows in only a few specific ways. People might find new or better resources, as with the discovery of oil wells in the 1850s. More people (or more productive people) might enter the workforce. Technology might be improved, as with the advent of the internet. The most important, consistent and controllable way to grow an economy is through improved capital goods structure and growing capital stock, which is where capital investment comes in.

Explaining Capital Investment

Capital investment is the spending of saved money on capital goods. Capital goods include assets such as factories, machines, computers, vehicles, tools and other productive equipment.

Capital goods are not the same as financial capital or human capital. Financial capital includes the funds necessary to sustain and grow a business (debt and equity), and human capital represents actual human labor. It takes financial capital to invest in capital goods, and it takes human capital to design, build and operate capital goods.

Capital Investment, Capital Goods and Economic Growth

Improved capital goods increase labor productivity. A simple example of this can be seen when a lumberjack upgrades from a standard axe to a chainsaw. Superior capital equipment directly makes individuals, businesses and countries more productive and efficient. Increased efficiency leads to economic growth.

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 a pool of saved funds to draw upon. This pool of funds needs to last until the new capital goods lead to additional revenue.

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, more goods are produced (higher gross domestic product) and the economy grows. 

(For related reading, see: What are some of the ways that economic growth can be achieved?)

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