"What Explains India's Falling Corporate Investment Rate"
Gross Capital Formation (GCF)
the share of GDP invested in building new productive assets like factories and machinery
Animal spirits
Keynes's term for business confidence or pessimism that shapes investment decisions
Gross capital formation (GCF), also called investment, means the part of a country's output that is used to create new productive assets such as factories, machines, and buildings rather than being consumed right away. The 2020 GS3 UPSC Mains question on capital formation tests exactly this idea: investment adds to an economy's stock of productive capacity. This stock of capacity then drives future growth. Private corporate investment is the investment made by companies. Its share in India's GDP is a key indicator watched by economists and policymakers.
India's corporate investment rate rose sharply in 2004, jumping from about 6.5% to 10.3% of GDP. This happened during a decade of strong economic growth. It then fell during the 2008 Global Financial Crisis (GFC). It recovered somewhat, but began a long decline after demonetisation in 2016. Unlike the GFC, which was an external shock beyond India's control, demonetisation was a policy choice made within the country. Even the COVID-19 shock in 2020-21 came after the decline had already begun. So it cannot fully explain the trend.
Economists have offered many explanations for this slowdown: weak demand, global uncertainty, high real interest rates, and companies carrying too much debt. A newer explanation looks at the basic economics of what makes a firm decide to invest. It also looks at how this differs sharply for small and large firms.
A firm decides whether to build a factory by weighing three factors. First is expected profitability: how much profit the investment is likely to earn. Most industries have economies of scale. Bigger factories usually earn higher profit rates. This is true up to the point where the firm cannot sell any more than its share of the market allows.
Second is the firm's confidence in that expected profit. 'Animal spirits' is a term coined by John Maynard Keynes for the confidence or pessimism that shapes investment decisions. A shock like demonetisation can make firms less confident about future profits. It can also make them less confident about future government policy. This pushes the whole profitability outlook inward. It hits small firms hardest. Many micro, small and medium enterprises (MSMEs) were forced out of business. …
Explain the meaning of investment in an economy in terms of capital formation. Discuss the factors to be considered while designing a concession agreement between a public entity and a private entity.
Faster economic growth requires increased share of the manufacturing sector in GDP, particularly of MSMEs. Comment on the present policies of the Government in this regard.
With reference to India's corporate tax policy, consider the following statements:
1.The corporate tax rate for domestic companies was reduced from 30% to 22% in 2018.
2.This tax cut was followed by a sustained revival in corporate investment as a share of GDP.
Which of the statements given above is/are correct?
Consider the following statements regarding the determinants of corporate investment:
1.Expected profitability of an investment typically rises with firm size due to economies of scale, up to a market-share limit.
2.'Animal spirits', a term coined by John Maynard Keynes, refers to business confidence that shapes investment decisions.
3.The cost of credit facing a firm is independent of the firm's own capital base.
Which of the statements given above is/are correct?
Match the following economic concepts with the economist most associated with them:
Concept
A.Animal spirits
B.Principle of increasing risk
Economist
1.John Maynard Keynes
2.Michal Kalecki
Select the correct match:
The 'principle of increasing risk' in investment theory, proposed by Michal Kalecki, best explains which of the following?
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