Investment and Economic Growth in the UK

INVESTMENT AND ECONOMIC GROWTH
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Investment and Economic Growth
Introduction
Gillespie (2019:16) define investment as the "production of items that are not for immediate consumption." Investment refers to the addition of capital outlay, either in terms of money invested or property purchased in a country's capital stock. Spending on investment goods enhances production levels, which can heighten consumption rates in the future. On the other hand, Sloman and Garratt (2016:15) define economic growth as "more output is produced by the business, more people are employed, consumers have more income to spend, and the government earns more revenue from taxation." Economic growth increases an economy's capacity to produce goods and services over a specific period without inflation. This report will discuss how an increase in investment by firms based in other countries is the most critical factor in increasing economic growth in the United Kingdom (UK). It will also argue for and against increased investment being the main driver of growth in the country.
Theory
Investment and economic growth are connected. Adding capital stock to an economy usually increases the production of goods and services: investment, therefore, contributes to economic growth. Investment can take various forms, from traditional investment in new plants and machinery to investment in technological progress through education and training. Investing in new plants and machinery increases the quantity and quality of goods and services produced. It also improves the ability of a nation to capitalize on its resources and discover new raw materials. Moreover, investing in technological advances enhances the efficiency with which a nation produces goods and services. Education and training also improve labour productivity as a critical factor of production. However, investment in future economic growth must consider the impact of the particular investment on the economy. Specific investments in the economy, such as in infrastructure and technology, have a direct, positive, and measurable positive impact on the economy. In contrast, other investments, such as social infrastructures like housing and health, indirectly positively impact the economy.
The former directly drives economic growth in a knowledge economy, while the latter indirectly drives economic growth by improving labour market flexibility. Therefore, it is essential to target investment depending on the economy's pressing challenges. For instance, developing economies with particular resource advantages tend to prioritize physical infrastructure and technology to facilitate the harvesting and extraction of natural resources. On the other hand, developed economies like the United States that rely more on the secondary and tertiary sectors tend to prioritize construction, manufacturing, and social infrastructure like housing and education to spur industrial production (Goodwin et al., 2020:520-525). Kakwani (1997:20) defines real economic growth as a nation's growth of real income evaluated in monetary units. The actual economic growth rate is expressed in the gross domestic product (GDP). It denotes the change in the value of all goods and services generated in an economy within a particular period after adjusting for price fluctuations. Investing in economic growth (production of goods and services) results in an increase in output and income, which then causes an increase in aggregated demand in terms of real GDP.
Figure 1 below shows how the aggregate demand curve shifts to the right, increasing investment and consumption from AD1 to AD2. Denison (1985:3) defines potential economic growth as the value of the output that a nation's economy would have generated if factors of production were employed at rates consistent with stable inflation and growth. Potential growth is influenced by gains in the long run aggregated supply (LRAS). Investment as a component of aggregate demand influences the potential economic growth in that an increase in productivity shifts the long-run aggregate supply curve to the right in Figure 2. However, certain factors like stronger competition in product markets, tougher competition laws or regulations, and globalization increase the efficiency of an economy employing capital and labour to achieve economic growth.
Figure 1
2047875-955040001543049-10191760011430006667500Price level
17240251333500
AD1 AD2
116205027050900
Real GDP
Adapted from Sloman and Garratt (2016:277)
Figure 2
22383751809750017049751619252047875-955040001543049-10191760011430006667500Price level LRAS1 LRAS2
1714500173990
183832515875 AD1 AD2
116205128448000
Y1 Y2 Real GDP
Adapted from Sloman and Garratt (2016:285)
Country Comparison
* Investment is the primary driver of growth in the UK
There is a need to increase investment by firms based in other countries, given its role as the main driver of growth in the country. Europe accounts for most of the UK's foreign firms based in other countries, with London accounting for almost 60% of Fortune 500 companies (Santander, 2018). Investment by firms based in other countries significantly contributes to the economy of the UK through employment, new capital expenditures, and increased output. Foreign multinationals account for a large proportion of the nation's turnover. For instance, foreign companies in the UK in 2018 represented only 2.1% of all UK businesses but accounted for 40% of UK turnover and 30.3% of UK employment (Office for National Statistics, 2021). This disproportionate contribution by foreign firms to UK turnover and employment figures stems from the fact that they are more productive than local UK companies. Besides, foreign multinationals tend to be larger than local businesses and therefore account for a more significant proportion of local business turnover.
Over half of business turnover (53%) generated in London in 2018 was accounted for by foreign firms, followed by the South East (40%), Wales (33%), Northern Ireland (26%), Yorkshire and the Humber (26%), and the North West (27%) (Department for International Trade, 2021b). Still, the role foreign firms play in the UK's economic growth, employment, and productivity vary across the country depending on the subnational distribution. Some regions such as London and South East, which are the largest destination for foreign firms owing to their favourable economic characteristics (like infrastructure, operational costs, education, and market size), benefits from the impacts of foreign investment more than other regions like Northern Ireland and Wales (Department for International Trade, 2021b). Despite these subnational variations in foreign firms' economic impacts, foreign multinational companies account for more than 55,000 new jobs annually and billions of pounds in earnings (Department for International Trade, 2021a).
* Investment is not the primary driver of growth in the UK.
On the other hand, despite the significance of investment by foreign firms in driving economic growth in the UK, there is a need to diversify away from increased foreign investment. Foreign investment is only one factor, and it is unlikely to increase potential growth permanently. The positive effects of foreign investment on economic growth are restricted by other drivers of economic growth that may be more important than the same. For instance, political instability/uncertainty shortens investors' and policymakers' projections resulting in suboptimal short-term macroeconomic gains. Political instability also disrupts the transfer of investment benefits, including technology, knowledge, innovation, and financial capital. The decision by the UK to leave the European Union (EU) resulted in significant political uncertainty and adversely impacted human and physical capital accumulation and the productivity of domestic firms. During Brexit negotiations, the UK suffered a 38.6% decline in the number of foreign multinational companies expanding their UK activities in 2016-17 (Barklie, 2022).
This decline was primarily the result of reluctance by European companies to invest in the UK at a time when Brexit terms were unknown. Still, market pundits predict that investment by firms based in other countries in the UK will fall further by 37% post-Brexit as UK firms lose the opportunity to exploit EU's scale economies without excessive tariffs (UCL, 2020). A large part of the UK's forei...