Fixed investment
Encyclopedia
Fixed investment in economics
refers to investment in fixed capital
, i.e., tangible capital goods (real means of production
or residential buildings), or to the replacement of depreciated
capital goods which have been scrapped.
Thus, fixed investment is investment in physical assets such as machinery, land, buildings, installations, vehicles, or technology. Normally, a company balance sheet will state both the amount of expenditure on fixed assets during the quarter or year, and the total value of the stock of fixed assets owned.
Fixed investment contrasts with investments in labour, ongoing operating expenses, materials or financial assets. Financial assets may also be held for a fixed term (for example, bonds
) but they are not usually called "fixed investment" because they do not involve the purchase of physical fixed assets. The more usual term for such financial investments is "fixed-term investments". Bank deposits committed for a fixed term such as one or two years in a savings account are similarly called "fixed-term deposits".
Statistical measures of fixed investment, such as provided by the Bureau of Economic Analysis
in the United States, Eurostat
in Europe, and other national and international statistical offices (e.g., the International Monetary Fund
), are often considered by economists to be important indicators of longer-term economic growth (the growth of output and employment) and potential productivity
.
The more fixed capital is used per worker, the more productive the worker can be, other things being equal. For example, a worker who tills the soil only with a spade is normally less productive than a worker who uses a tractor-driven plough to do the same work, because with a tractor one can plough more land in less time, and thus produce more in less time, even if a tractor costs more than a spade. Obviously one would not normally use a tractor to plough a small garden, but in large-scale farming the income earned using a tractor by far outweighs the expense of using a tractor. It is not economical to use a spade for large-scale ploughing, unless the labour is extremely cheap, and the supply of labour is plentiful.
The level of fixed investment by businesses also indicates something about the level of confidence that business owners or managers have about the ability to earn more income from sales in the next few years. The reasoning is that they would be unlikely to tie up additional capital in fixed assets for several years or more, unless they thought it would be a commercially viable proposition in the longer term. If there is too much uncertainty about whether their fixed investment will pay off, they are unlikely to engage in it.
In recent decades, the growth rate of fixed investment in the US, Europe and Japan was relatively low, but in China for example it is relatively high. Often the relativities are expressed as a ratio between gross fixed capital formation
and GDP, or fixed investment per worker employed or per capita
.
of capital.
Normally, for the purpose of accounting, fixed investment refers to "physical assets held for one year or more". The investment capital is therefore "fixed", in the precise sense that the capital is tied up in physical assets for a longer time, and thus cannot be used for other purposes. This contrasts with, for example, investment capital in the form of liquid bank deposits earning interest, or investment in raw materials completely used up in (say) five weeks to produce products which, upon sale, earn income the following month.
The term "fixed investment" may be somewhat ambiguous, because it could refer to the value of a stock of fixed assets being held at a balance date, or to the value of a flow of expenditures on fixed assets across an accounting interval, such as a year. The distinction is not always clearly stated in statistical tabulations - they might refer either to the stock of capital tied up in fixed assets at a balance date, or to how much was spent on fixed equipment during a quarter or year.
In official statistics, attempts are often made to estimate the value of fixed capital
assets in a nation, the value of their depreciation
(or Consumption of fixed capital
) and the value of Gross fixed capital formation
by sector and type of asset. Fixed assets depreciate in value over time, due to wear and tear and market obsolescence. At the end of their useful lifetime (perhaps 7–10 years), they possess only a scrap-value (or at the very least must undergo maintenance work or repairs).
The concept of "gross fixed capital formation" (GFCF) used in official statistics however does not refer to total fixed investment in a country.
For statistical purposes, investment in fixed capital must be distinguished from investment in intermediate goods
. Unlike fixed assets, intermediate goods (for example, commodities like oil, electricity, timber, steel and grain) are completely used up in production (usually within a year). But this distinction is not always easy to draw, for example:
In official statistics, various accounting conventions are adopted to deal with these problems in a standardized way. A further complication is that scrapped fixed assets, being second-hand goods, may be resold and re-used again (for example, second-hand vehicles).
equals the marginal cost of capital. Then the flow of net investment per unit of time is determined by balancing losses from having a less-than-optimal level of capital with the adjustment costs of installing new capital; these adjustment costs in per-unit terms may be an increasing function of the speed of installation.
Another theory of fixed investment determination is based on Tobin's q
, the ratio of the market value to the acquisition cost of an additional unit of physical capital; investment is hypothesized to be an increasing function of this ratio.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
refers to investment in fixed capital
Fixed capital
Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...
, i.e., tangible capital goods (real means of production
Means of production
Means of production refers to physical, non-human inputs used in production—the factories, machines, and tools used to produce wealth — along with both infrastructural capital and natural capital. This includes the classical factors of production minus financial capital and minus human capital...
or residential buildings), or to the replacement of depreciated
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
capital goods which have been scrapped.
Thus, fixed investment is investment in physical assets such as machinery, land, buildings, installations, vehicles, or technology. Normally, a company balance sheet will state both the amount of expenditure on fixed assets during the quarter or year, and the total value of the stock of fixed assets owned.
Fixed investment contrasts with investments in labour, ongoing operating expenses, materials or financial assets. Financial assets may also be held for a fixed term (for example, bonds
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
) but they are not usually called "fixed investment" because they do not involve the purchase of physical fixed assets. The more usual term for such financial investments is "fixed-term investments". Bank deposits committed for a fixed term such as one or two years in a savings account are similarly called "fixed-term deposits".
Statistical measures of fixed investment, such as provided by the Bureau of Economic Analysis
Bureau of Economic Analysis
The Bureau of Economic Analysis is an agency in the United States Department of Commerce that provides important economic statistics including the gross domestic product of the United States. Its stated mission is to "promote a better understanding of the U.S...
in the United States, Eurostat
Eurostat
Eurostat is a Directorate-General of the European Commission located in Luxembourg. Its main responsibilities are to provide the European Union with statistical information at European level and to promote the integration of statistical methods across the Member States of the European Union,...
in Europe, and other national and international statistical offices (e.g., the International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
), are often considered by economists to be important indicators of longer-term economic growth (the growth of output and employment) and potential productivity
Productivity
Productivity is a measure of the efficiency of production. Productivity is a ratio of what is produced to what is required to produce it. Usually this ratio is in the form of an average, expressing the total output divided by the total input...
.
The more fixed capital is used per worker, the more productive the worker can be, other things being equal. For example, a worker who tills the soil only with a spade is normally less productive than a worker who uses a tractor-driven plough to do the same work, because with a tractor one can plough more land in less time, and thus produce more in less time, even if a tractor costs more than a spade. Obviously one would not normally use a tractor to plough a small garden, but in large-scale farming the income earned using a tractor by far outweighs the expense of using a tractor. It is not economical to use a spade for large-scale ploughing, unless the labour is extremely cheap, and the supply of labour is plentiful.
The level of fixed investment by businesses also indicates something about the level of confidence that business owners or managers have about the ability to earn more income from sales in the next few years. The reasoning is that they would be unlikely to tie up additional capital in fixed assets for several years or more, unless they thought it would be a commercially viable proposition in the longer term. If there is too much uncertainty about whether their fixed investment will pay off, they are unlikely to engage in it.
In recent decades, the growth rate of fixed investment in the US, Europe and Japan was relatively low, but in China for example it is relatively high. Often the relativities are expressed as a ratio between gross fixed capital formation
Gross fixed capital formation
Gross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...
and GDP, or fixed investment per worker employed or per capita
Per capita
Per capita is a Latin prepositional phrase: per and capita . The phrase thus means "by heads" or "for each head", i.e. per individual or per person...
.
Why fixed?
The use of the term "fixed" does necessarily not mean the asset "stays in one place", i.e., it does not mean that it is physically immobile, but it refers rather to the circulation (rotation) of flowsStock and flow
Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock variable is measured at one specific time, and represents a quantity existing at that point in time , which may have...
of capital.
Normally, for the purpose of accounting, fixed investment refers to "physical assets held for one year or more". The investment capital is therefore "fixed", in the precise sense that the capital is tied up in physical assets for a longer time, and thus cannot be used for other purposes. This contrasts with, for example, investment capital in the form of liquid bank deposits earning interest, or investment in raw materials completely used up in (say) five weeks to produce products which, upon sale, earn income the following month.
The term "fixed investment" may be somewhat ambiguous, because it could refer to the value of a stock of fixed assets being held at a balance date, or to the value of a flow of expenditures on fixed assets across an accounting interval, such as a year. The distinction is not always clearly stated in statistical tabulations - they might refer either to the stock of capital tied up in fixed assets at a balance date, or to how much was spent on fixed equipment during a quarter or year.
Measurement
The amount of fixed investment may be stated "gross" (before taking into account depreciation) or "net" (after depreciation). By subtracting disposals of fixed assets from additions to fixed assets in an accounting period, we obtain a measure of the net (fixed) capital formation.In official statistics, attempts are often made to estimate the value of fixed capital
Fixed capital
Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...
assets in a nation, the value of their depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
(or Consumption of fixed capital
Consumption of fixed capital
Consumption of fixed capital is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets...
) and the value of Gross fixed capital formation
Gross fixed capital formation
Gross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...
by sector and type of asset. Fixed assets depreciate in value over time, due to wear and tear and market obsolescence. At the end of their useful lifetime (perhaps 7–10 years), they possess only a scrap-value (or at the very least must undergo maintenance work or repairs).
The concept of "gross fixed capital formation" (GFCF) used in official statistics however does not refer to total fixed investment in a country.
- Firstly GFCF measures only the value of additions to the fixed capital stock less the value of disposals of scrapped fixed assets. So normally total fixed investment in a year is in fact a larger value than GFCF. "Total fixed investment" (gross) is not usually a published statistical measure, since economists are interested primarily in the contribution of fixed investment to value addedValue addedIn economics, the difference between the sale price and the production cost of a product is the value added per unit. Summing value added per unit over all units sold is total value added. Total value added is equivalent to Revenue less Outside Purchases...
, i.e., they are interested in the net additions made to the total fixed capital stock (additions less withdrawals). If, hypothetically, the amount of fixed investment and the amount of scrapped fixed assets are equal in value, then the total fixed investment figure would tell us only that the scrapped fixed assets have been replaced. If we want to know by how much the fixed capital stock has increased, we need to know the relationship between fixed assets purchased and disposals of fixed assets.
- Secondly, GFCF does not include land purchases, only investments in land improvementLand improvementLand improvement or land amelioration refers to investments making land more usable by humans. In terms of accounting, land improvements refer to any variety of projects that increase the value of the property...
, mainly because land purchased by one person or company from another does not normally increase the total amount of land there is (except in cases of land reclamationLand reclamationLand reclamation, usually known as reclamation, is the process to create new land from sea or riverbeds. The land reclaimed is known as reclamation ground or landfill.- Habitation :...
such as polders). All that happens is that the same land changes owners. If land is sold, it may yield a capital gainCapital gainA capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor...
for the seller, but such profits from land sales are not usually made explicit in official statistics, in part because a standard valuation of what the land was previously worth is often difficult to operationalize, in particular if the land was improved or developed by the seller. The value of land can increase or decline due to all kinds of factors, and land valuations may differ from place to place. At best one could estimate the total value of land sales in an accounting interval.
For statistical purposes, investment in fixed capital must be distinguished from investment in intermediate goods
Intermediate consumption
Intermediate consumption is an economic concept used in national accounts, such as the United Nations System of National Accounts , the US National Income and Product Accounts and the European System of Accounts .Conceptually, the aggregate "intermediate consumption" is equal to the amount of the...
. Unlike fixed assets, intermediate goods (for example, commodities like oil, electricity, timber, steel and grain) are completely used up in production (usually within a year). But this distinction is not always easy to draw, for example:
- if raw materials are held for more than one year before they are used,
- if expenditure occurs to install, service, insure or repair fixed assets (which can be part of the purchase contract)
- if physical "fixed" assets are sold off again in less than one year.
In official statistics, various accounting conventions are adopted to deal with these problems in a standardized way. A further complication is that scrapped fixed assets, being second-hand goods, may be resold and re-used again (for example, second-hand vehicles).
Theories of fixed investment determination
One theory of the determination of fixed investment focuses on the discrepancy between the current quantity of the fixed capital stock and the optimal or target capital stock. The target capital stock — the level at which a firm's profits would be highest if actual fixed capital holdings equaled that level — is determined as the level at which the marginal product of capitalMarginal product of capital
Marginal product of capital is the additional output resulting from the use of an additional unit of capital . It equals 1 divided by the Incremental capital-output ratio...
equals the marginal cost of capital. Then the flow of net investment per unit of time is determined by balancing losses from having a less-than-optimal level of capital with the adjustment costs of installing new capital; these adjustment costs in per-unit terms may be an increasing function of the speed of installation.
Another theory of fixed investment determination is based on Tobin's q
Tobin's q
Tobin's q was developed by James Tobin as the ratio between the market value and replacement value of the same physical asset:One, the numerator, is the market valuation: the going price in the market for exchanging existing assets. The other, the denominator, is the replacement or reproduction...
, the ratio of the market value to the acquisition cost of an additional unit of physical capital; investment is hypothesized to be an increasing function of this ratio.
Trends
- Fixed investments nowadays can be enormously large (for example, a nuclear power plant might be built for three billion dollars). This creates more risk and means that many financial guarantees and insurance arrangements become necessary.
See also
- CapexCAPEXCAPEX, also known as the Kerala State Cashew Workers Apex Industrial Co-operative Society, is an organization managed by the government of Kerala to promote the cashew industry and especially the export market for cashews.-Organization:...
- Capital accumulationCapital accumulationThe accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...
- Capital formationCapital formationCapital formation is a concept used in macroeconomics, national accounts and financial economics. Occasionally it is also used in corporate accounts. It can be defined in three ways:...
- Consumption of fixed capitalConsumption of fixed capitalConsumption of fixed capital is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets...
- DepreciationDepreciationDepreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
- Economics terminology that differs from common usageEconomics terminology that differs from common usageIn any technical subject, words commonly used in everyday life acquire very specific technical meanings, and confusion can arise when someone is uncertain of the intended meaning of a word...
- Fixed capitalFixed capitalFixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...
- Gross fixed capital formationGross fixed capital formationGross fixed capital formation is a macroeconomic concept used in official national accounts such as the UNSNA, NIPAs and the European System of Accounts . The concept dates back to the NBER studies of Simon Kuznets of capital formation in the 1930s, and standard measures for it were adopted in the...
- Inventory investmentInventory investmentInventory investment is a component of gross domestic product . What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather than in the year they were produced. Conversely, some of the goods sold in a...
- Opex
- Opportunity costOpportunity costOpportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...
- Sunk costSunk costIn economics and business decision-making, sunk costs are retrospective costs that have already been incurred and cannot be recovered. Sunk costs are sometimes contrasted with prospective costs, which are future costs that may be incurred or changed if an action is taken...
External links
- System of National Accounts 2008 http://unstats.un.org/unsd/nationalaccount/SNA2008.pdf