RDP 8704: The Role and Consequences of Investment in Recent Australian Economic Growth 1. Introduction

Of all the basic building blocks in macroeconomics, investment is probably the one with which economic analysis has dealt least effectively. There is no shortage of appealing models. Students of the topic are offered a wide range of approaches, from the grass roots simplistic to the inordinately detailed and complex. Yet, when the data are confronted, the gap between theory and practice is usually found to be substantial.

While the empirics of investment remain elusive, the consequences of investment remain at the very heart of economic growth. In the short run, fluctuations in investment are a dominant source of fluctuations in economic growth. In the longer run, investment determines the capital stock and this, probably more than any other factor, determines the trends of growth in economic activity and employment.

This paper considers the role and consequences of investment in Australia's post-war economic growth. In the paper, we have sought to emphasise both the short-run demand and the longer-run supply aspects of investment and capital formation. In tackling this subject we entertained no false illusions about our ability to resolve the unresolvable; inevitably we have found as many puzzles as we have answers. Yet, through all this, a number of relationships appear to hold firm, offering at least some support for accepted wisdom and some binding threads for the maze of data available on investment and capital.

In the remainder of the paper, Section 2 reviews the facts, looking at trends in investment and capital accumulation in aggregate and by sector. Section 3 examines the relationship between capital and trends in economic activity and employment. Section 4 turns to the role of investment in generating cyclical fluctuations in economic activity. Section 5 looks at the determinants of investment and Section 6 provides a brief overview and conclusion.