Increasing investment in physical capital allows for continued increases in productivity and economic growth. This is an example of changes in productivity resulting from changes in inputs; in this case, the input is physical capital. Similarly, human capital —the knowledge and skills that people obtain through education, experience, and training—is important, and strong educational institutions are vital. A well-educated workforce is generally more productive, providing higher output per worker.
Well-educated workers can make the most efficient use of existing technologies. They are also more likely to develop new technologies. Further, a persistent growth in the level of educational attainment will likely lead to growing productive capacity, the key to future economic growth. While both physical and human capital are important to economic growth, both have their limits and their benefits tend to diminish over time.
Knowledge and ideas that lead to better use of existing resources increasing output per input are driving forces behind continuing long-run economic growth. The innovation resulting from new ideas is key to continued technological progress. Consider the computerized tax-filing example. When a new computer is produced, the inputs required to build it are not much different from a computer built 10 years ago, but today's computer has much larger implications for labor productivity than earlier versions.
The computer has improved over time as the result of new knowledge, ideas, and innovations incorporated into the design of its hardware and software. Of course, all of this happens within the institutional structures of an economy, our next topic. In addition to productivity-boosting factors such as physical and human capital, economies with high rates of economic growth often share characteristics related to economic institutions that support or reward productive activity.
Notice that "institutions" is used differently in this context than you may have seen before. When discussing economic growth, we can think of institutions as the foundational rules of the game noted by Douglass North in the opening quote; they include not only laws and regulations, but also customs and practices. Institutions work through the incentive structure in an economy and are important in explaining why some countries experience faster growth than others.
Both institutions and the incentives they offer affect improvements in long-term growth. Some of these institutions might not seem directly related to economics, but institutions clearly have an impact on the potential output of the economy. For example, patent protections are examples of laws that ensure that firms developing new technologies are able to profit from them. The firm's profit motive provides the incentive to produce new goods and services, as well as the technologies that benefit society and result in economic growth.
Traditionally, people have reasoned that patent protection enables firms to profit from their costly research and development efforts; as a result, they are willing to invest in the first place. We can also consider the custom of honesty, which enhances the confidence of those conducting economic transactions. If honesty cannot be assumed, economic transactions may be more "costly" to complete. In his lecture accepting the Nobel Prize, North said that institutions "form the incentive structure of a society and the political and economic institutions, in consequence, are the underlying determinant of economic performance.
First, strong property rights are important. Citizens who feel confident that their private property is secure are more likely to invest in the future. A strong legal infrastructure, supported by the rule of law , must exist to create such confidence.
The rule of law , as opposed to the rule of man, ensures that legal decisions remain consistent and predictable over time and are not at the mercy of individual political leaders or administrations. In short, strong property rights ensure that private investment and innovation are properly rewarded, which provides the incentive for future productive economic activity.
Second, competitive markets foster efficiency, which promotes growth. Prices signal when goods and services are becoming more or less scarce. Producers and consumers respond. For example, when markets are competitive and flexible, a shortage of bicycles results in higher bicycle prices. The higher price signals producers to supply a greater quantity of the good more bicycles , and the higher price signals consumers to reduce the quantity of bicycle purchases.
Over time, the bicycle shortage is resolved. Our bicycle example applies to the overall economy: If prices are allowed to change quickly to reflect underlying conditions, markets can adjust. When inflation is high and volatile, price signals become less effective and can result in inefficient production and distribution of goods and services. The Federal Reserve's role in price stability—maintaining a low and stable inflation rate over time—minimizes the distortionary effects of inflation in this process.
Free trade extends the benefits of free markets beyond national borders and allows for more competition within industries, which provides additional productivity gains. For example, American carmakers increased their level of efficiency as a result of rising competition from foreign carmakers in the s and s.
Finally, efficient financial institutions facilitate intermediation between savers and borrowers. This means that financial institutions such as banks, credit unions, stock markets, and bond markets transform the deposits of savers into loans for borrowers who wish to invest in among other things new capital , technology, and infrastructure —all key ingredients for growth. For example, a bank might bundle the deposits of many savers to lend to a small business that wants to invest in new technology.
Shin finds that countries with well-developed financial markets allocate resources more effectively than countries with less-well-developed financial markets. As such, well-developed financial markets are an essential ingredient for long-run economic growth. The importance of these institutions became apparent during the financial crisis, when credit markets nearly froze and the economy slid into a deep recession. When credit markets stop functioning, modern economies do not usually grow.
As such, the role of central banks as lenders of last resort is key to maintaining confidence in an economy's financial infrastructure. NOTE: The graph shows the relationship between private fixed investment in equipment and software blue line , important to productivity and economic growth, and commercial and industrial loans at all commercial banks red line.
Both were affected by the financial crisis and the related recession indicated by the gray bar. The role of incentives is vital in this regard. Incentives matter—a lot. The decisions to save, invest, attend college, start a business, hire an additional worker, buy a piece of equipment, or develop a new idea depend on a multitude of factors.
Among the most important factors is the role of well-designed institutions. How a nation designs and operates its economic and political infrastructure is crucial because such infrastructure provides the proper incentives for individuals, firms, and policymakers to undertake activities that generate rising standards of living over time. Institutions, Institutional Change, and Economic Performance. New York: Cambridge University Press, , p. For example, Boldrin and Levine find "no empirical evidence that [patents] serve to increase innovation and productivity" p.
See Boldrin, Michele and Levine, David. Louis Regional Economist , July , 21 3 , pp. If key non-renewable resources, like oil, are exhausted the productive capacity of an economy may be reduced. This happens more quickly as a result of the application of ultra-efficient production methods, and when countries over-specialise in producing goods from non-renewable resources. Sustainable growth means that the current rate of growth is not so fast that future generations are denied the benefit of scarce resources, such as non-renewable resources, and a clean environment.
Real capital, such as machinery and equipment, wears out with use and its productivity falls over time. As the output from real capital falls, the productivity of labour will also fall. The quality and productivity of labour also depends on the acquisition of new skills. Therefore, if an economy does not invest in people and technology its PPF will slowly move inwards.
Allocating scarce funds to capital goods, such as machinery, is referred to as real investment. If an economy chooses to produce more capital goods than consumer goods, at point A in the diagram, then it will grow by more than if it allocated more resources to consumer goods, at point B, below. To achieve long run growth the economy must use more of its capital resources to produce capital rather than consumer goods.
As a result, standards of living are reduced in the short run, as resources are diverted away from private consumption. However, the increased investment in capital goods enables more output of consumer goods to be produced in the long run. This means that standards of living can increase in the future by more than they would have if the economy had not made such as short-term sacrifice. Hence economies face a choice between high levels of consumption in the short run and the long run.
If an economy chooses to produce more capital goods than consumer goods, at point A in the diagram, then it will grow by more than if it allocated more resources to consumer goods, at point B. There is a trade-off between the short and the long run. In the short run, the economy must use resources to produce capital rather than consumer goods. Standards of living are reduced in the short run, as resources are diverted away from private consumption.
However, in the longer run the increased investment in capital goods enables more output of consumer goods to be produced. This means that standards of living can increase by more than they would have if the economy had not made the short-term sacrifice. An economy can grow because of an increase in productivity in one sector of the economy — this is called asymmetric growth.
For example, an improvement in technology applied to industry Y, such as motor vehicles, but not to X, such as food production, would be illustrated by a shift of the PPF from the Y-axis only. If workers, or other resources, are moved from one sector to another, then the position of the PPF will change, with an increase in the maximum output in the industry receiving the resources, and a fall in the maximum output of the industry losing resources.
Competitive markets. Economic growth has two meanings: Firstly, and most commonly, growth is defined as an increase in the output that an economy produces over a period of time, the minimum being two consecutive quarters. The second meaning of economic growth is an increase in what an economy can produce if it is using all its scarce resources.
What creates growth?
Productivity , in the economic sense, is the value of output produced by one unit of input over a certain period of time. Increased productivity can come from improvements in efficiency, which can involve technical improvements from capital investments, training and education for the laboring workforce and general improvements in technology as society develops. For example, newer machines may be more energy efficient, providing additional cost savings.
In a basic equation, investment leads to productivity improvements, which in turn lead to increased growth. This then leads to improved profits and additional investment, and in an ideal economy, the cycle continues. Thus, investment is somewhat the key critical point. On the national economic scale, investments back into capital are the ones that tie into economic measures and economic growth.
Capital investment can affect a national economy in multiple ways. First is the ability for businesses to reinvest their profits to continue this growth, and second, the labor population and consumers who obtain employment due to this growth will have more money on hand, which will increase their spending. This provides additional revenue and capital for businesses, and businesses can then continue the cycle of investment to increase production. This allows the company to explore research and development — a human type of capital that has no immediate profit but promises increased revenue down the line — to help direct the investments to the most promising area.
Another factor to remember is that investment is necessary to keep a company moving forward whether or not it is making improvements. All businesses undergo wear and tear, aging and equipment malfunctions in their factories and facilities alike. A minimum capital investment is required to keep the business going as is over a period of time. The national economy depends on all of the businesses that make up its assets to foster growth because that push is what keeps the economy growing. Consumer spending and saving can also have an effect on economic growth.
When consumers have more money, they spend more, which feeds growth back into the economy. Saving can affect the economy in two entirely different ways depending on the national economic status. Consumer saving can in fact lead to economic growth through a different pathway: banks.
As consumers invest their money into savings, banks have more resources available to lend to businesses looking to invest in capital. The banks, however, will only want to lend this money in a promising economy where things are stable and growth is already happening. In a recession or an unstable economy, banks are far less likely to offer affordable loans on the market. Consumer saving can also take valuable cash out of the economy if savings are stashed under a mattress rather than in the bank.
This can then lead to a slowdown in growth. With a tightened flow of cash and lower velocity of transactions, business revenues will drop. Investment in capital will be reduced in order to keep the existing pieces of the company afloat. This can then lead to a recession if it goes on long enough since money continues to sit in banks rather than circulate through the economy. At higher incomes, of course, consumers spend more, but they also start saving more, and the level of savings increases as incomes rise.
Thus, it seems better for the economy when consumers on average are earning more than the bare minimum required to live, as this feeds money back into companies when their goods and services are purchased. It also feeds additional money into banks which can then loan that money for capital investment. National economic growth is significantly influenced by consumer spending.
For companies, income can be represented as the profits or revenues they receive for the products they sell. When a company has a successful year and can pay off all of its bills and its dividends to shareholders, obviously it will have more money to invest. In the modernization of the national economy, investment plays an important role in the achievement as in the following: provision production with new modern equipments and technologies, industrialization the national economy, additional perfection of competitiveness, increase the role and importance in the world arena, expansion exports and reaching high economic growth in our country.
Therefore, special attention has so far been paid to the development of structural change of the economy and to rational, efficient use of investments. It is concrete evidence that, increasing the volume of foreign and especially foreign direct investment yearly, shows deep structural changes in our economy where active and clearly directed investment policy have been in run and functioning properly.
One of the advantages of running right investment policy in attracting domestic and foreign investments to national economy leads to firstly protecting national economy from global financial and economic crisis and secondly providing stable growth in economy. As a result, the country's gross domestic product in the last 5 years, grew by 8. Last year, investments in the economy grew by It is obvious that active and clearly directed investment policy regulated in our country is responsible for the growth of domestic investment.
In particular, such investments amounted to Last year, commercial banks' investment activity has also expanded. Today, our country's investment policy has another advantageous aspect. A distinctive feature of the investment policy to ensure deep processing of local raw material resources, organizing production on the basis of new high-tech industries is reflected in the investment projects as of priority importance.
Usually investments are classified into several criteria, which include namely domestic and foreign investments. In addition, these investments are usually differentiated from each other according to several factors.
In particular, domestic investments are regulated by resident legal entities operating in the country, whereas foreign investments, which are generally devoted in order to take advantage from other state funds, are at the disposal of foreign investors. General description of foreign investment was defined by Frank Heniusning as follows: foreign investment is an investment from one country into another country's territory as the exported investments.
Financial investments, on the other hand, are paper agreements, which include for example shares, bonds and other forms of securities. In developing economy, a major part of the investments is real investment. In developing economy, in order to develop financial investments it is important to increase real investments.
These two forms of investments are not actually against each other, on the contrary they are completmentary. Foreign investment is an important source of capital for a country. At the moment, only on the account of investments major capital can be renewed, and on this basis, the quality can be improved and production cost can be reduced and this will lead to the growth of competitiveness of products.
In addition, many aspects of foreign investments can be mentioned as in the following:. For this, foreign investments should be directed into main spheres of national economy;. Through foreign investments triggers the revival of the national economy, contemporary manufacturing, and production of highly competitive goods.
This, in turn, will lead to creating new job opportunities, solution to economic and social problems in the country. After all, the President of the Republic of Uzbekistan Islam Karimov stated on January 16, , «the results of socio-economic development of and the most important priorities of economic program for », in a meeting held at the Cabinet of Ministers: «A rapid and balanced economic growth and implementing deeper structural changes into the economy which is directed to the active and targeted investment policy are considered the most important factor».
We got familiarized with the features of the above mentioned foreign investments. Considering the fact that the demand for domestic investment is increasing day by day, we should take into account a number of characteristics of domestic investments. Currently, localization program is being implemented in practice in our country. The localization is a process of manufacturing the same type of local products, which are previously produced goods in a foreign country and then imported into a host one for the consumption of local community and economic entities.
Today, we can see a number of positive aspects through the localization process of the production and service sectors:. On the basis of decree No. According to the program, a total of 1, projects, accounts for It is important to note that, during the years — it is under the localization program that planned through new projects to produce finished products, spare parts, components, and materials, which substitute types of import products.
Due to local production of goods and services for the leading sectors of the economy and development of industrial cooperation, the share of local trade is growing year by year. The above mentioned figures and indicators show that Uzbekistan with a favorable business environment has targets to modernizate production, renew technical and technological approach with economic reforms to creating well-being climate for investment in the country.
In order to maintain and further expands these opportunities on attracting investment annually, a number of tasks should be performed and factors affecting the well-being of investment should be deeply analysed:. On a thorough examination of the factors listed above.
If an economy wants to increase its current level of investment, it must. For an economy to increase investment it must a ; For an economy to increase investment, it must: · increase saving. ; If an economy wants to increase its. Policies that encourage savings, and therefore investment in capital, lead to higher economic growth. Similarly, policies that encourage technological change.