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How Capital Investment Influences Economic Growth

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Economic growth, as measured by gross domestic product (GDP), is spurred by an increasing production of goods and services. Consumer spending, international trade, and businesses that invest in capital impact the flow of supply and demand.

If consumers buy more homes, revenue increases in the construction market and for contractors. As companies expand their products and services through capital investment, they may hire more employees and increase salaries or wages.

Key Takeaways

  • Capital investment includes real estate, manufacturing plants, machinery, computers, vehicles, and production equipment.
  • Economic growth can be measured by gross domestic product (GDP), the total monetary or market value of all the finished goods and services.
  • In the U.S., economic growth is primarily driven by consumer spending and capital investment.

What Is Capital Investment?

Capital investment occurs when businesses purchase capital goods like buildings, machinery, equipment, vehicles, and tools. These tangible assets are used to produce goods or services. Capital investment is a means for a company to further its business objectives.

For a business to increase or improve its capital structure, it must have adequate funding. Typically, a business would seek this funding by issuing debt–or bonds–or equity–by issuing stocks. Capital investments are long-term investments; they allow companies to generate revenue for many years by adding or improving production facilities and boosting operational efficiency.

Capital investment allows for research and development, a first step to taking new products and services to the market. Additional or improved capital goods increase labor productivity by making companies more efficient. Newer equipment or factories lead to more products being produced at a faster rate. This increased efficiency leads to economic growth for the country and a higher nationwide GDP.

In 2023, according to a study conducted by the Federal Reserve Bank of Richmond, approximately 40% of firms surveyed reported that high-interest rates caused them to decrease capital spending, an increase over the 30% of firms with similar responses in 2022.

Gross Domestic Product (GDP)

Gross domestic product is the total monetary or market value of all the finished goods and services produced within a country in a given period. The U.S. government releases an annualized GDP estimate for each quarter and year. GDP is a comprehensive scorecard of an economy’s economic health and growth.

Without capital investment, innovation is not possible. Discoveries of new natural resources or the invention of new technology, such as the Internet in the 1980s, may prompt periods of high economic growth. In the early 2000s, shale oil reserves were discovered in the U.S. and deemed the country the world’s largest crude oil producer.

21%

Capital investment in technology produced the Internet, responsible for 21% of GDP growth between 2006-2011.

Investment vs. Growth

The images below show the percentage of yearly domestic business investment compared to GDP growth from 2021 to 2023, according to the Bureau of Economic Analysis (BEA). In the graph below, business investment in the United States decreased 5.8% from 2021 to 2022 and 4.0% from 2022 to 2023.

During the same period, GDP fell 8.1% from 2021 to 2022, and 1.7% from 2022 to 2023.

How Does Financial and Human Capital Compare to Capital Goods?

Capital goods are not the same as financial capital or human capital. Financial capital is the necessary funds to sustain and grow a business, which a company secures by issuing either debt–in the form of bonds–or equity–in the form of shares. Human capital refers to human labor or workers. Before a company can invest in capital goods, it must have the resources and infrastructure to secure financial capital. Human capital is used to design, build, and operate capital goods.

How Does Consumer Spending Affect GDP?

After businesses have produced goods and services, consumer spending, also known as personal consumption expenditures (PCE), is the measure of the spending on goods and services by people of the United States. According to the Bureau of Economic Analysis (BEA), PCE accounts for about two-thirds of domestic spending and is a significant driver of GDP.

Which Industries Have Large Capital Expenditures?

Industries such as automobile manufacturing, energy, transportation, and semiconductors have large capital expenditures.

The Bottom Line

Businesses make capital investments in real estate, facilities, computers, and equipment. An increase in capital spending helps improve economic growth, as measured by GDP. Economic growth in the United States is driven by consumer spending and capital investment.

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