The most basic formula in economics
GDP is the sum of spending by consumers and government plus investment and net exports.
GDP = (C+G) + (I+X)
Investment (I) reveals the most about where the economy is heading. Without investment, there would be no money for government and consumers to spend. Investment includes total investment by both the government and private business. Investment helps create the new businesses and jobs that put money in consumers' pockets.
Consumption is typically by far the largest share of the spending in the economy - more than half. Investment is usually much smaller, around 20% of GDP in developed economies and 25% in developing economies, give or take.
Investment is the most important indicator of change
Investment is by far the most important indicator of change, because booms or busts in investment typically drive recessions and recoveries. In the U.S., investment is 6 times more volatile than consumption, and during a typical recession it contracts by more than 10%, while growth in consumer spending merely slows down.
Successful nations versus those facing weak prospects
In successful nations, investment is generally rising as a share of the economy. When investment is rising , economic growth is much more likely to accelerate.
Any emerging country is generally in a strong position to grow rapidly when investment is high - roughly between 25% and 35% of GDP - and rising.
On the other hand, economies face weak prospects when investment is low, roughly 20% of GDP or less - and falling.
Much of what makes the emerging world feel chaotic reflects a shortage of investment in the basics.
In developed economies, investment spending tends to be lower because basic infrastructure is already built. So pay less attention to the level of spending as a share of GDP and more to whether is is rising or falling.
Strong growth in investment is almost always a good sign, but the stronger it gets, the more important it is to track where the spending is going.
Good and bad investment binges.
The best binges unfold when companies funnel money into projects that fuel growth in the future: new technology, new roads and ports, or especially, new factories.
Of the 3 main economic sectors - agriculture, services and manufacturing - manufacturing has been the ticket out of poverty for many countries.
No other sector has the proven ability to play the booster role of job creation and economic growth that manufacturing has in the past.
As a nation develops, investment and manufacturing both account for a shrinking share of the economy, but they continue to play an outsize role in driving growth.
An investment binge can be judged by what it leaves behind.
Following a good binge on manufacturing, technology, or infrastructure, the country finds itself with new cement factories, fiber-optic cables, or rail lines, which will help the economy grow as it recovers.
Bad binges - in commodities or real estate - often leave behind trouble.
- Investment does little to raise productivity when it goes into real estate, which has other risks as well: it is often financed by heavy debts that can drag down the economy.
- When money flows into commodities like oil, it tends to chase rising prices and evaporate without a trace as prices collapse.
So, while investment booms are often a good sign, it matters a great deal where the money is going.
