Investment is central to the functioning of any economy. It is the process of committing time, resources and money to produce useful things in the future. Investment underpins production by business, government and individuals (Haskel & Westlake, 2018).
Investment is very important because it builds up the “capital stock”: the assets – tools, and equipment that workers use to produce the goods and services that make up economic output. An asset is an economic resource or property that is expected to provide a benefit over a period. For example, if a bank acquires a new office, it expects to get a benefit that lasts for some time. Capital is the use of assets to generate income and or an increase in the value of the assets over time.
|Investment is what happens when a producer either acquires a fixed asset or spends resources (money, effort, raw materials) to improve it (Haskel & Westlake, 2018).
Capital is the use of assets to generate wealth (Haskel & Westlake, 2018).
Assets are things that have a value and can be sold in financial markets for monetary value (Haskel & Westlake, 2018).
The rate of return on capital plays an important role in economic growth as it incentivises the development and use of new assets in production (Baker, DeLong & Krugman, 2015). Capital investment generates profits for owners of capital through consumer spending, international trade and business investment which drives economic growth.
Investors are willing to develop, buy or hold assets if the rate of return compares well with interest rates on similar capital investment elsewhere in the economy. Return on capital is determined by the time to make a satisfactory return on the investment, the marginal utility of wealth as it declines over time, and tolerance of risk-reward (Baker, DeLong & Krugman, 2015).
Competitive financial markets play a central role in ensuring that capital is allocated to firms with the greatest potential to commercialise new processes and technologies thereby incentivising and fast-tracking technological innovation (Kerr &Nanda, 2014). Businesses and investors go to financial markets to raise money to grow their business and to make more money, respectively (CFI,2019). However, it is worth noting that financial markets only distribute income generated by activity and do not add to that income.
|Marginal utility the added satisfaction that a consumer gains from consuming additional units of goods or services (Investopedia, 2019).
Financial markets are a type of marketplace that provides enables the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives (Investopedia, 2019).
There are many financial markets and they vary in size. For example, formal markets include:
- Cash: banks and other financial intermediaries that offer debt loans.
- Bond or money market: offers opportunities for companies and the government to secure money to finance a project or investment
- Stock market: trades shares of ownership of public companies.
- Commodities market: where traders and investors buy and sell natural resources or commodities such as corn, oil, meat, and gold.
- Derivatives market: involves derivatives or contracts whose value is based on the market value of the asset being traded such as futures contracts or options.
- Forex Market: where currencies are traded and considered the most liquid market in the world as it trades cash assets.
However, there are flaws in these formal markets. For example, it is much harder to fund research and development and start-ups because of the high-risk nature, early stage of development and lack of cash flow. Thus innovation and early-stage business investment might happen through friends and family, angel investment, venture capital, equity crowdfunding and credit card debt.
In addition, firms controlled by private equity and venture capital firms, may not aim to produce new things but to maximise the value of their own shareholders through share buy-backs and short term trading, rather than long-term investments (Mazzucato, 2018).
Financial deregulation and a growing financial sector and products, some markets are able to generate their own revenue and profit without contributing to gross domestic product. New and complicated financial instruments, such as securities and derivatives, allow owners and traders of these products to get rich by capturing value from other sectors, rather than by creating value (Mazzucato, 2018). For example, the futures market allows investors to trade on the potential future value of a bond rather than holding and using that asset to produce additional value.
Finally, capital owners can extract more profits is to identify markets where there is limited competition such as in monopoly markets. Or by holding assets that do not require them to be productive or contribute to production outputs which are called rent-seeking. Both harm economic growth by reducing competition, innovation, and investment in new and better assets. They also waste valuable resources and talents and redistributes capital to the wealthy and powerful (Wong, 2016).
|Monopolistic market: only one company may offer products and services to the public and as a result can restrict output, raise prices, and enjoy super-normal profits in the long run (Investopedia, 2019).
Rent seeking occurs when an entity seeks to increase one’s share of existing wealth without creating new wealth or value Wong, 2016).