The Effects of Fiscal Policy on Private Business Investment
The fiscal policies adopted by a government have a direct effect on the private business investment. This is because they influence the environment or the market over which the businesses operate. As such, it is prudent to ascertain the importance of long-term fiscal sustainability for economic growth and how a failure in presenting a credible strategy for balancing a government’s budget in the long run would affect private business investment.
The Fostering of Long-Run Economic Growth by Business Investment
Economic growth refers to an increase of the capacity of a given economy to produce services and goods when checked from one time period to another. In essence, an economic growth takes place when a country’s production capacity projects a positive growth with the production levels mostly being measured by an economy’s gross domestic product (GDP). In increasing production, an economy will need resources which are the factors which are used in production such as labor and raw materials. An economy will also need capital which refers to the funds which are needed in order to implement production activities (Greenwood and Holt 117). As such, for an economy to grow, there should be a rise in labor participation, discovery of new resources, increased trade, the implementation of new technologies and increase in labor specialization.
Business investment contributes to economic growth in two major ways: increased capital investment and improved capital goods leading to increase in labor productivity. Increased capital investment encompasses more research and development in a business’s capital structure hence the expanding capital structure increases the labor’s productivity efficiency. As the labor becomes more efficient, more goods/services are produced leading to a higher GDP and the economy grows. Improved capital goods on the other hand also leads to an increase in labor productivity (Greenwood and Holt 118). In a scenario whereby a business invests in superior technology, its productivity increases hence this improvement has a direct positive influence on economic growth.
How interest rates influence the incentive to invest
Interest rates have a direct influence on business’s incentive to invest. Studies have shown that lower interest rates encourages more investment spending since businesses are encouraged to take more financing loans to boast their productivity. This approach eventually leads to a growth in the economy. Governments are known set interest rates through monitory policies by adjusting interest rates to influence demand for goods/services (Greenwood and Holt 117). Lowering interest rates is used as a tool to increase investment spending and to steer economies out of recession. In this case, in periods of economic downturn, the interest rates are lowered to encourage additional investment spending but in periods whereby the economy is in good condition interest rates are increased accordingly to keep inflation at bay.
In a scenario whereby the government runs large budget deficits year after year, it borrows to finance the deficits hence leading to higher equilibrium market interest rate. This approach leads to interest rates being higher than they would be if the government didn’t run large budget deficits. This scenario leads to the market interest rates being high and hence unfavorable for investment spending. As such, businesses do not have the incentive to borrow funds to increase their productivity since the borrowing of funds encompass high interest rates (Greenwood and Holt 119). As such, an economy’s production levels either remain to be stagnant or they show a negative growth. This has the effect of slowing an economy’s growth in the long run.
Fiscal policies implemented by governments have a direct impact on the private business investment. This is shown by the fact that policies which offer the private business investment some incentive to invest leads to growth in the businesses and hence growth in the concerned economy (Greenwood and Holt 118). As such, it is concluded that long-term fiscal sustainability is crucial for economic growth. This is because it affects the investment environment by affecting the equilibrium market interest rates which affect the rate of investment spending hence affecting an economy’s overall growth.
Daphne T. Greenwood., and Richard Holt. Local Economic Development in the 21st Century: Quality of Life and Sustainability. Routledge, 2015.