Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Other determinants of investment

Four other factors can affect the level of investment in an economy. Because investment is one of the key drivers of economic growth (see Chapter 8), countries that want to grow their economies need to think carefully about the following points:

Tax rates: High tax rates reduce the incentive to invest. If firms know that, say, 50 per cent of any profit they make from a new machine is going to be paid as tax, they’re going to be less likely to buy it.

Secure property rights: Firms want to know that if they buy capital

goods, they’ll retain the use of those goods now and in the future. That is, they want secure property rights and assurances that their property isn’t going to be expropriated either by the state or anyone else. In developed economies this is now relatively rare – but that’s probably why their economies are developed! The safer firms feel, the more likely they are to invest in a country.


Efficiency of the legal system: Often in business, firms enter into contracts with other firms and consumers. A contract is a legal agreement whereby parties agree to certain binding obligations. They’re very important in market economies to ensure that people and firms do what they say they’re going to do. When one party fails to meet its obligations, the other party attempts to seek redress through the legal system. Unfortunately, in some countries enforcing a contract is extremely difficult and arduous, which makes doing business difficult. This situation makes firms reluctant to invest.


Availability of workers: A firm needs workers in order to use the capital it’s purchased – no point having machines if no one’s around to work them. (Although if some technology enthusiasts are to be believed, robots will eventually make human workers redundant.) All other things being equal, firms prefer to invest in countries with a large potential workforce and where wages are relatively low. Formally, if the existing capital stock is small and lots of people are willing to work, the marginal productivity of capital is high, making investment attractive.