save on water. Each step in this process will raise output but at a diminishing
rate. Eventually increasing output further by changing the way water is deliv-
ered to the same seeds, soil, mechanical equipment and labour force will
become nearly impossible. The importance of diminishing returns is that the
relationship between investment and growth will be stronger in a developing
country. Developing countries have a smaller capital stock (both in physical
and human terms) so we can expect investment to yield a greater return.
Chapter 2 provides supporting evidence for this proposition.
A second explanation for the puzzle is that the studies of investment we
have referred to tend to use aggregate measures of investment (summing all
investment in an economy over a period of time). De Long and Summers
(1991, 1992, 1993) argue that it is not all forms of investment, but specifically
investment in equipment that promotes economic growth. Jones (1994)
confirms this by examining a sample of 65 countries between 1960 and 1985
and finds that the most crucial element is machinery (which includes capital
ranging from tractors to computers). Thus aggregate measures of investment
are likely to underestimate the impact of investment on growth. There is an
intuitive rationale behind this finding. Investment in equipment such as
machinery and computers,which are directly used in production, is more
likely to promote economic growth than investment in water supply or housing
which is more closely linked to the demands of urbanization. De Long and
Summers argue that high rates of equipment investment accounted for nearly
half of Japan’s rapid growth after the 1950s. Their results suggest that the
social returns to equipment investment are around 20–30 per cent per annum.
Policy and investment
Having established the causal relation between investment and economic
growth,the next question is what factors or policies cause investment? A huge
number of studies seek identify the policy factors related to investment and
whether the free market or state intervention is the best means to promote high
and efficient investment. From a bewildering array of results for cross-sections
of countries and specific countries over various time periods, very few gener-
alizations can be drawn or generally accepted findings stated:
- Barro (1991) finds that initial human capital has a positive impact, and
government consumption a negative impact, on future physical investment
for a sample of nearly 100 countries. - Jenkins (1998) finds that investment in Zimbabwe is positively influenced
by foreign direct investment (FDI), profits, the price of industrial output,
and negatively by the debt-to-GDP ratio. - Ndikumaru (2000) finds that indicators of financial development, the trade
ratio, and GDP growth had a positive impact, and the black market premium
on the exchange rate, inflation, external debt and public borrowing from the
68 Sources of Growth in the Modern World Economy since 1950