Tag Archives: Investment

What would US$10,000 invested in 2015 have yielded by 2020?

Just finished reading the book ‘The New World Economy – A Beginner’s Guide’ (2020) by Randy Charles Epping – a recent addition to the King’s College library. It is particularly good for those students who are new to the subject and it explains current issues in a very understandable language. It looks at:

Bitcoin – Economic Crisis to Global Crisis – Ranking Countries – Brexit – Globalisation – Inflation vs Deflation – Hot Money – AI – BRICS – Inequality – Tax Evasion – Climate Change – China – Trade Wars and many more economic issues.

One table I found interesting was the return of US$10,000 over the last five years – see table below. Bitcoin has been incredible but stay clear of Argentinian stocks.

Source: The New World Economy – A Beginner’s Guide (2020) by Randy Charles Epping

Revision note – Investment and MEC

Investment is spending on capital goods by firms and government, which will allow increased production of consumer goods and services in future time periods. Be careful not to confuse the economists’ definition of investment with another interpretation – that investment involves putting funds into financial assets such as stocks and shares. Marginal Efficiency of Capital Theory – As investment increases, the return on the last unit of capital employed will be less and less as a result the Law if Diminishing Returns (i.e. The MEC falls). 

The theory states that it is profitable to invest so long as the MEC (the % return) is greater than the rate of interest (the cost of funds needed to finance the investment). The OPTIMUM level of Investment is where:

% MEC = the rate of interest

At this point, the last unit of investment is covering its costs, and all previous units are profitable.

Gross and Net Investment

An important distinction to make is between gross and net capital investment spending

Net investment is positive when gross investment is higher than depreciation or capital consumption. Then there will be an increase in the nation’s stock of capital.

  • Fixed Investment – is spending on new capital machinery and plant, construction, housing, vehicles, etc.
  • Working Capital – is spending on stocks/inventories of finished goods and raw materials. The accumulation of stocks by firms, whether voluntary or involuntary, is counted as investment.

Gross Domestic Fixed Capital Formation (GDFCF) – is expenditure on fixed assets (buildings, vehicles and plant) either for replacing or adding to the stock of fixed assets.

Gross Domestic Investment Spending + Stockbuilding = Total Gross Investment

Other factors that affect investment demand

1. Expectations – the key to understanding investment decisions
The central message of economic theory and the evidence from business surveys is that capital investment is determined by the relationship between the expected returns from investment and the expected cost of financing the investment.

2. Returns to an investment project

The expected returns from capital investment are determined by the demand for and the price of the output of goods or services generated by an investment and also by the costs of production. A rise in demand for the output that capital is purchased to supply will increase the potential revenue streams that a business can expect from a new project. Similarly, a change in the costs of purchasing the capital inputs the costs of training workers to use new capital and in maintaining the capital stock will also affect the expected rate of return.

3. The importance of business expectations and uncertainty

Expectations of demand, prices and costs over the lifetime of the investment are key determinants of expected returns. There is always uncertainty about the expected rate of return particularly when demand is volatile and sensitive to changes in interest rates, the exchange rate and incomes.

The rate of return from an investment is also influenced by the rate at which an investment project is assumed to depreciate over time.

The cost and availability of internal and external finance is important, as higher costs of finance (e.g. higher interest rates) require greater returns from the investment to ensure that it is profitable.

At this point, the last unit of investment is covering its costs, and all previous units are profitable.

  • If profit levels rise, firms will have more money to spend on investment and will have a greater incentive to do so.
  • Advances in technology may encourage firms to replace less productive capital equipment.
  • The government may also encourage investment by cutting corporation tax on firms’ profits and by giving investment subsidies.

The Marshmallow Effect needed to address global economy

marshmallowYou might have heard of the marshmallow experiment that was carried out with young children. A child was offered a choice between one marshmallow immediately or two small marshmallows if they waited for a short period, approximately 15 minutes, during which the the person running the experiment left the room and then returned. Researchers found that children who were able to wait longer for the preferred rewards tended to have better life outcomes, as measured by SAT scores.

Can this experiment be applied to societies today in that by deferring instant consumption (in order to save and invest) people will enjoy greater incomes as they age?

High saving rates = High investment rates

Jeff Sachs, of the Project Syndicate, recommends 4 actions that are needed to rectify this problem:

1. Global economic progress depends on high global saving and investment. In economic development, as in life, there’s no free lunch: Without high rates of investment in know-how, skills, machinery, and sustainable infrastructure, productivity tends to decline (mainly through depreciation), dragging down living standards.

2. Saving and investment flows should be viewed as global, not national. China has a high savings rate which exceeds local investment needs therefore they can support the low income countries which have limited capital and a very young population. These countries can borrow from China to fund education, infrastructure development etc so to secure greater prosperity.

3. Full employment depends on high investment rates that match high saving rates. Although there maybe significant savings in banks this doesn’t necessarily translate into greater investment. In the past banks funded infrastructure project and company start-ups however today money managers tend to focus on short-term speculative activities which resemble a trip to the casino.

4. High private investments by business depend on high public investments in infrastructure and human capital. Although there maybe significant savings in banks this doesn’t necessarily translate into greater investment. In the past banks funded infrastructure project and company start-ups however today money managers tend to focus on short-term speculative activities which resemble a trip to the casino.

Although there maybe significant savings in banks this doesn’t necessarily translate into greater investment. In the past banks funded infrastructure project and company start-ups however today money managers tend to focus on short-term speculative activities which resemble a trip to the casino.

Investments such as low-carbon energy, smart power grids for cities, and information-based health systems depend on government and private sector partnerships. A lot of private investment needs tone backed by the government to get in the buy in from the private sector. Examples of this are the rail networks, aviation, semiconductors, satellites, GPS, hydraulic fracturing, nuclear power and the Internet would not exist but for such partnerships.

Our global problem today is that the world’s financial intermediaries are not properly steering long-term saving into long-term investments. Global investments are falling short of global saving at full employment which results in inadequate demand as short-term investments tend to be volatile to finance consumption and property.

Advice to China fails the Marshmallow Test

Some economists have stated that China needs to boost consumption (C) and let the renminbi appreciate to reduce exports. However this encourages overconsumption and underinvestment in a country that has high savings and industrial capacity which the global economy can make use of.

Central banks and hedge funds cannot produce long-term economic growth and financial stability. Only long-term investments, both public and private, can lift the world economy out of its current instability and slow growth. Jeff Sachs

China’s unproductive investment justified.

For Developing Economies to grow certain variables have been identified as fundamental to the cause. These fall into two broad areas:

Human Capital – health, education and fertility.
Legal Infrastructure – rule of law (property rights), government interference, democracy and monetary control. These influence fixed capital investment which determines technology.

China InvestmentWhere a Developing Economy has these characteristics, but low income per capita, their potential for increasing GDP/capita is great. However economies with poor governance and low education will remain stuck in this low-income trap. This has been the position a number of African nations have found themselves in for so long.

In the initial years of growth developing economies open themselves up and embrace developed nation technologies and infrastructure. However, to further develop they need to become more innovative and drive the change themselves rather then relying on other countries. It is at this point that many economies struggle and get stuck in what is often known as the middle-income trap.

Many countries are still at such an extremely low level of development and there are years of catch-up growth ahead. China has a high rate of investment as a percentage of GDP but is this just catch-up growth? Many have said that it is too focused on unproductive investment and China’s policymakers are building cities, roads etc to keep the economy growing (Chart 7). However according to the HSBC report China’s level of development today is so much lower than that of the Asian tigers before their rapid expansion (Chart 8). They believe that the strong rate of investment is entirely justified – providing China with much-needed basic infrastructure.

Aussie mineral and energy projects. The next Golden State?

The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) recently published its April report on – “Minerals and energy: major development projects – April 2011 Listing”. It is quite staggering the amount of investment being put into this sector of the Australian economy. At the end of April 2011, there were 94 projects at an advanced stage of development, with a record capital expenditure of $173.5 billion. Below is the breakdown by state and notice the dominance of Western Australia.

In 2010–11, exploration expenditure in Australia’s minerals and energy sector is estimated to be $5.9 billion, broadly similar to expenditure in 2009–10. Investment in mineral exploration remains strong, with Australia expected to record its third highest annual mineral exploration expenditure in 2010–11. Click on the image below to see the ‘Advanced Minerals and Energy Projects’ currently in operation – no wonder they can’t find any workers in the cities.

The Economist last week had an article entitled “Australia the next Golden State” in which they suggested that the country with its booming economy could become the new California.

It already has a successful economy, which unlike California’s has avoided recession since 1991, and a political system that generally serves it well. It is benefiting from a resources bonanza that brings it quantities of money for doing no more than scraping up minerals and shipping them to Asia. It is the most pleasant rich country to live in, reports a survey this week by the OECD. And, since Asia’s appetite for iron ore, coal, natural gas and mutton shows no signs of abating, the bonanza seems set to continue for a while, even if it is downgraded to some lesser form of boom.

And they conclude by saying:

Though the country’s best-known building is an opera house, for example, the arts have yet to receive as much official patronage as they deserve. However, the most useful policy to pursue would be education, especially tertiary education. Australia’s universities, like its wine, are decent and dependable, but seldom excellent. Yet educated workers are essential for an economy competitive in services as well as minerals. First, however, Aussies need a bit more self-belief. After that perhaps will come the zest and confidence of an Antipodean California.