Investment is one of the four components of a country’s gross domestic product. It is the use of money in order to accumulate capital, which will be used by other entities. For this reason, it is called productive investment, because it is an expense made with the aim of producing new goods. Investment can be made by households or by firms, always by private entities, since public investment is considered when analysing government spending. In the case of households, usually, their main investment is in the form of buying a new house, whereas in the case of firms investment is very diverse: capital equipment, machinery, vehicles, or inventories. Gross private spending can be divided into three categories: residential investment, which basically consists of buildings and houses; non-residential investment, such as machinery or tools; and change in inventories of firms.
Investment has an outcome called multiplier effect. This effect consists on the fact that any amount of money spent today in investment result in more than that amount in the future. Consequently, an increase of investment results in a higher increase of future rent, leading to higher economic growth and living standards. Countries with an elevated degree of investment have a better development projection in the long run. John Maynard Keynes made this concept popular in his “The General Theory of Employment, Interest and Money”, 1936, even though the idea came from one of his students, Richard Kahn, who developed it in his paper “The Relation of Home Investment to Unemployment”, 1931.
When analysing business cycles, we must note that investment is highly procyclical: during expansion, investment usually increases, firms have more funds and reinvest them or they have easier access to borrowing. By contrast, during recessions, investment is one of GDP’s components that more quickly decline, which makes more difficult the recovery.