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In the broadest sense, capital investment is any spending on future productive capacity. It might be spending to develop land (perhaps planting trees that years later will be harvested for lumber), it might be spending to educate workers, it might be spending to build infrastructure, or it might be spending on research to develop new technologies. The key thing to understand about capital investment is that any money spent on investment is not spent on present production. The choice to spend money on capital investment is a choice to produce less now in order to produce more later. Thus, capital investment is indispensable for long-term economic growth.
How does the choice to invest get made? A key consideration is the availability of loanable funds. The market for loanable funds is the subject of another chapter, but for now, just understand that firms don’t often have large sums of cash sitting at the ready for capital investment. They must go to banks to get funding, in the form of loans, for their capital expenditures. The banks, in turn, only have money to lend if there are households saving money by placing it on deposit with banks. Thus, the amount of savings by households directly affects the amount of money available for capital expenditures by firms. In this way, the savings rate in a country is the single most important determinant of the expenditures made by firms on capital.
Politics also influence the choice to invest. Again, infrastructure spending tends to be government-driven. A politician may find it in their interest to approve, say, a major highway construction bill—but then again, they may instead find it in their interest to reject the highway bill in favor of a tax cut. The highway would please voters eventually, but the tax cut will please voters immediately. As for private firms, how much they spend on investment will also be a function partly of the political environment. To take an extreme example: in a country that goes through frequent, violent political upheavals, firms are less likely to spend a lot of money on capital. It makes no sense to build a factory that is liable to be destroyed or commandeered for use by a rebel military in a year or two.
The relevance of politics to the choice to invest brings us to our next topic: institutions.
