Why Have Private Investments Dropped?

April 19, 2024

What’s in Today’s Article?

Background:

Private investment in India, shown by how much businesses are spending on things like buildings and equipment compared to the total value of the economy, has been slow to grow.
Since 2011-12, this kind of investment has been going down.
The government expected big Indian companies to increase their spending, hoping this would boost the economy.
To encourage this, in 2019, the government reduced corporate taxes from 30% to 22%, hoping that it would prompt companies to invest more.

What is GFCF and Why Does It Matter?

GFCF stands for Gross Fixed Capital Formation.
It refers to the growth in the size of fixed capital in an economy.
- Fixed capital refers to things such as buildings and machinery, for instance, which require investment to be created.
So private GFCF can serve as a rough indicator of how much the private sector in an economy is willing to invest.
Overall GFCF also includes capital formation as a result of investment by the government.
Importance of GFCF:
- Fixed capital helps to boost economic growth and improve living standards by helping workers produce a greater amount of goods and services each year.
- In other words, fixed capital is what largely determines the overall output of an economy and hence what consumers can actually purchase in the market.
- Developed economies such as the U.S. possess more fixed capital per capita than developing economies such as India.

Current Trend in Private Investment in India:

In India, private investment started to grow more after economic changes in the late 1980s and early 1990s made businesses more confident.
Before these changes, private investment stayed around 10% of the total economy.
On the other hand, government spending on projects (public investment) went up steadily from less than 3% in 1950-51 to more than private investment by the early 1980s.
But after the economic changes, private investment became more important for building things like factories and infrastructure.
Private investment kept growing until the global financial crisis in 2007-08.
It went from about 10% of the economy in the 1980s to 27% in 2007-08.
However, after 2011-12, private investment started to decrease, reaching a low of 19.6% of the economy in 2020-21.

Reasons for Fall in Private Investments:

Some Indian economists believe that low consumer spending is the main reason private businesses aren't investing much lately, especially since the pandemic started.
They think that when people spend more, businesses feel confident about future sales and invest more in things like factories and equipment.
- So, they suggest that the government should give people more money to spend, which could boost business investments.
However, looking back at India's history, more consumer spending hasn't always led to more business investments.
In fact, when consumer spending dropped from 90% of the economy in 1950-51 to 54.7% in 2010-11, it was followed by a peak in business investments.
Since 2011-12, consumer spending has gone up while business investments have gone down.
On the other hand, some economists think that deeper issues, like government policies and uncertainty, might be the real reasons behind the drop in business investments.
They point out that when economic reforms began in 1991, business investments went up.
But in the last two decades, when reforms slowed down, investments dropped.
Uncertainty about government policies can also make businesses hesitant to invest in long-term projects.

Conclusion:

Low private investment can slow down economic growth because businesses aren't spending enough on things like factories and machinery, which are important for increasing production.
Some people worry that when the government spends more, it can discourage private businesses from investing because there's less room for them to grow.
On the other hand, some believe that when private businesses aren't investing enough, government spending can help make up for it.
However, it's generally thought that private businesses are better at deciding where to invest money than the government.
Also, taxes used to fund government spending can slow down the economy by taking money away from businesses and consumers.

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