RDP 8704: The Role and Consequences of Investment in Recent Australian Economic Growth 6. Summary and Conclusion

This paper has surveyed the historical evidence on investment. In looking at the role of investment in economic growth we have examined the dual roles of investment as a source of both supply and demand for output.

As a component of demand, investment is notable mainly for its volatility. In other respects, there is little to distinguish investment spending from other components of demand. As a percentage of GDP, total investment has declined since the mid 1960s, relative to both its post-war average and the performance of other OECD countries. Nevertheless, investment has remained at a fairly high level, at around 25 per cent of GDP. At the same time, there have been substantial divergences in investment performance among industries.

However, while the demand aspects of investment are interesting, it was the contribution of investment to the stock of productive capital that absorbed most of our attention. In the final analysis, if an economy has to sustain output growth and real incomes without inflation, it is essential to maintain an adequate stock of productive capital.

The analysis of capital accumulation raises a host of issues, mostly related to measurement. These include: the role of human capital and capital utilisation; aggregation of heterogeneous physical capital; the measurement of labour input; and the role and measurement of technological progress. Our treatment was necessarily rough.

With these shortcomings given, we sought to estimate an aggregate production function for Australia. While the evidence supports the existence of such a production function, it does not strongly support the existence of perfectly competitive factor markets, at least in the short run.

• Based on our estimates, and other supporting evidence, the main conclusions of our paper are:
• despite a sharp fall in the capital/labour ratio since the start of the 1980s, the Australian economy does not appear to be greatly under-capitalised;
• the expansion of employment and reduction in the capital/labour ratio since 1982/83 has been encouraged by the relative factor costs of labour and capital;
• the maintenance of labour productivity through the upswing from mid 1983 appears to reflect high levels of excess capacity of both labour and capital in 1982/83;
• in general, growth appears to have been retarded in periods when factor prices have been well out of line with marginal products;
• in 1986, labour still appears to be cheap relative to its marginal product, while capital remains relatively expensive. (However, the relative costs of debt and equity appear to have altered considerably since the mid 1970s, with equity now considerably cheaper and debt more expensive);
• with signs of capacity constraints being reached in 1986, there will be a need to induce capital widening in coming years if both capital and labour are to grow in tandem without the need for further large falls in real wages; and
• with the improvement in Australia's international competitiveness following exchange rate depreciation in 1985 and the impending introduction of dividend imputation, at least some of the pre-conditions for a return to solid capital growth in the latter part of the 1980s appear to be in place.

Research Department
2 April 1987