Capital Investment versus Utilization in Business Performance and Economic Growth

ABSTRACT Critical review of investment-economic performance literatures in economics and strategic management indicates that more capital investment does not seem to contribute to higher national economic growth or to higher corporate profitability. Instead, greater utilization of capital and human resources does seem to contribute to economic performance. JEL Classification: C21, C22, C23, D24, E13, E22, E23, E24, L25, O16, O51, O57 Keywords: Investment ratio and rate; Capital intensity; Capacity utilization; Employment; Neoclassical economic theory; National economic growth; Corporate profitability; Cross-national panel analysis; Time-series national analysis; Causal inference; Managerial and governmental decision-making I. INTRODUCTION Attempts to improve business performance and achieve higher growth rates of national product often begin with the factor of investment in capital equipment and associated technology, in part to reduce expensive labor and management inputs. "'Economic growth depends on the accumulation of capital' seems as near a truism as can be found in economic theory," according to Gordon Winston (1974: 1312). This has been the dominant "neoclassical" view of economists and of business and governmental leaders seeking to invigorate business performance and economic growth through capital investment, though recently with qualifications (cf. Council of Economic Advisers, 1983: ch. 4; 2001: 27-29, 43, 182; 2005: ch. 1 and 2; Denison, 1983; Maddison, 2001: 101-3, 125, 131, 136, 139, 142). An alternate view questions the central position accorded capital investment in models of business performance and economic growth, as well as the ability of managers to make optimal decisions (Simon, 1979). Robert Solow's (1957) analysis over 40 years found only a minor effect of investment on US economic growth, while Simon Kuznets (1973: 258) observed that attempts to account for growth rates in aggregate production models have resulted mainly in an unexplained residual, that is, in a "measure of our ignorance." Edward Denison (1980: 220) found that: "Capital is not the source of growth despite the contrary view common in financial circles and on Capitol Hill." Referring to Franke's (1979) cross-national analysis using data from his 1967 book, Denison (1980: 220-1) noted that "whatever relationship does exist results more from the effect of rapid growth on investment than from the effect of investment on growth." This at first seems peculiar, since it is in capital that new technology is embodied and might be expected to contribute to economic performance. But the paradox is explained, according to Denison (1979: personal communication), by the fact that only a relatively small portion of investment embodies new technology from which one might at least learn something and might benefit eventually, as in the case of the computer revolution's adverse effects on the financial industry (Franke, 1987) but eventual benefits for the economy as a whole (Brynjolfsson and Hitt, 1998; Franke and Barrett, 2004). Murray Foss (1981: 58) commented that "the contribution of fixed capital to output growth, while considerable, in a sense has been smaller than commonly thought," while Winston (1974: 1315) warned that "an increase in investment brought about by a policy of low capital prices [as in earlier command economies, or as recently in the United States] may reduce the rate of growth by reducing utilization more than investment is increased." Indeed, the World Bank (1996: 2) found for centrally-planned economies that "despite high investment rates--returns to capital formation began a steady and rapid descent in the mid-1950s." Analyzing data from this issue of the World Development Report, Franke's (1999) cross-national regression analyses for the 1980s and early 1990s showed adverse effects of higher investment on subsequent growth. Theory and evidence which seem convincing exist for both perspectives: According to some authors, "strong investment is essential to rapid growth" (Council of Economic Advisers, 2001: 43), which was supported cross-nationally by Hagen and Hawrylyshyn (1969), Humphries (1976), Husain (1967), Robinson (1971), and Sommers and Suits (1971). …