‘How to’ resource
Investment is an important driver of local productivity and output. This briefing will help local policymakers understand how to think about investment in their local area and develop appropriate policies.
This briefing is part of a series that provides guidance to help policymakers think about local economic performance. It overviews key economic concepts and provides guidance on data and analysis.
What is investment?
Investment is spending to increase or improve capital stocks – i.e. the durable inputs used in the production of goods and services. Investment can be into:
- Physical assets such as machinery, buildings, and broadband cables – generally referred to as ‘tangible capital stocks’.
- Non-physical assets such as software, intellectual property, and branding – generally referred to as ‘intangible capital stocks’.
‘Durability’ distinguishes these inputs from intermediate inputs that are used up in production (such as steel, timber, cotton or sugar).
Capital stocks can be private or public.
- Private capital stocks are owned by individuals or businesses. Examples include machinery and warehouses. Private capital is excludable (i.e. it can only be used by, or with the permission of, its owners) and rival (i.e. it cannot be used by more than one person or business at the same time without reducing availability to others).
- Public capital stocks are provided and maintained by government for societal benefit. Examples include roads, hospitals, and schools. Pure public capital is non-excludable (i.e. everyone can use it) and non-rival (i.e. it can be used by multiple individuals or businesses at once without reducing availability). In reality, much public capital is partially excludable (for example, a bridge can charge a toll) or partially rival (for example, roads can be used by many individuals and businesses but congestion means not everyone can use at same time).
Investment into private capital stocks can be financed from retained income or profits, borrowing from banks or other financial institutions, issuing equity or through grants or loans from the public sector. Investment into public capital stocks is primarily financed through tax revenues or by issuing debt (such as gilts).
Investment into public capital stocks can ‘crowd in’ investment into private capital stocks by reducing risk and creating enabling conditions (for example, investment in ports or roads can reduce transport costs or open new markets for businesses, incentivising business investment). Investment into public capital stocks can also ‘crowd out’ investment into private capital stocks (for example, subsidised housing projects, which offer rents below market rates, can affect private market rents, reducing developer returns, and discouraging them from investing in new housing units). At the national level, increased investment into public capital stocks can lead to interest rates increasing, affecting the cost of finance for the private sector.
Why is investment important for local economic performance?
Investment can directly increase local output. For example, building a house or road creates economic activity. Other types of investment (for example, purchasing new machinery or software) also creates economic activity but not necessarily locally.
More important, long term, is that investment is an important driver of productivity. Productivity measures how efficiently inputs (resources or factors of production) are converted into outputs (goods and services). If businesses want to improve productivity, they might invest in new machinery to speed up production, or new software to tackle more complex and higher value tasks. The amount of machinery or technology available to each worker and the efficiency of machinery or technology can increase output per worker or reduce costs, increasing productivity.
Increasing productivity through investment in capital stocks might have a substitution effect on other inputs. For example, new machinery might replace (substitute) jobs in the short-term, increasing unemployment. Think of business investment in computers in the 1980s and 1990s, reducing the need for staff in a typing pool. In other cases, investment in capital stocks may have a complementary effect on other inputs. Businesses that invested in computers needed IT teams to resolve issues.
Public capital investment can also have powerful and lasting effects on productivity. For example, investment in roads, rail, ports, energy grids, and broadband reduces costs and time for businesses, and boosts efficiency, access to markets, and connectivity.
The quality of investment matters. Poorly targeted or inefficient investment can lead to low returns and wasted funds. If a project is driven by speculation rather than real value creation, it can divert investment (and other resources such as labour) away from more productive uses.
Investment may affect some demographic groups, businesses or areas, but not others. Assessing who benefits and who does not can help mitigate negative effects of investment.
Understanding local investment
The briefing provides a guide to understanding key elements of local performance including:
- How does investment compare to other areas?
- How much investment is there in different asset types?
- How does investment vary across sectors?
- How much foreign investment is there in the area?
- What plans do businesses have for future investment?
- What plans does government have for future investment?
For each question, important considerations, including what might affect performance, are set out, alongside suggested datasets and measures, example analysis, and policy implications. Public investment and access to finance are discussed in more detail in annexes.
