Gross investment is the sum of expenditures for new capital purchases and the replacement of depreciated capital. The company buys new capital goods, such as factories and equipment, to increase its production capacity. Meanwhile, capital replacement is to maintain existing capacity.
The difference between net and gross investment
Gross investment is different from net investment. The latter only includes adding new capacity. If we write it down in a mathematical formula, the equation is:
Gross investment = Net investment + Depreciation
Gross investment does not show an actual change in the stock of capital goods in the economy because it includes a depreciation component. Thus, the value may be only as large as the depreciation of capital goods and only to maintain current capacity. Gross investment can be zero but never negative.
Conversely, the production capacity of an economy increases as long as the net investment is positive. The figure can be negative when the existing stock of capital depreciates faster than is its replacement.
In calculating gross domestic product (GDP), we only enter gross figures, not net statistics. Thus, as long as gross investment increases, GDP will increase.
The four factors that influence investment spending are:
- Interest rate
- Earnings expectations
- The presence of new technology
- Capacity utilization
Interest rates represent borrowing costs. In increasing production capacity, businesses often borrow, instead of using internal capital. If interest rates rise, the cost of funding becomes more expensive and reduces investment in the economy. The opposite effect applies when interest rates fall.
Earnings expectations depend on the level of demand in the market, reflected by economic growth. When the economy grows, the demand for goods and services is strong. Businesses are optimistic about their future profits, encouraging them to increase production and invest in capital goods.
Too, new technology also affects business competitiveness. Adopting it makes businesses more productive. Conversely, if they don’t buy it, it makes them less competitive.
The last factor is capacity utilization. A capacity utilization rate of nearly 100% is a signal for businesses to invest. Of course, they should consider the demand conditions. If the demand prospect is strong, the purchase of new capital goods is the right decision to anticipate further demand.