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Place of infrastructure spending during an economic recession

 

The growth of any economy is determined by many factors. Amongst the critical factors are infrastructure and industry. Infrastructure investment has historically been a key driver for economic growth.


The Government plays a key role in sparking demand. When economies invest in infrastructure, businesses are enabled to produce and deliver more commodities.


 The Kenyan economy is slowly showing signs of recovery from the pandemic. The economy is projected to grow by an average 5.4 percent during period 2022-24. However, the ongoing global inflationary situation and drought are resulting in growing poverty.


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 According to International Finance Corporation Regional Director for Kenya Jumoke Jagun-Dokunmu “Kenya’s private sector is poised to drive faster job creation and to seize new opportunities from global and regional integration.” Here it is evident that investment would create growth opportunity. With better infrastructure, the allure for investors to invest is greater as there is a greater convenience to set up and trade.


Intermediate inputs

In the production process, infrastructure facilities are considered to be intermediate inputs. Their availability in satisfactory quantity and quality eases input cost and increases the profitability thus allowing higher level of output for industries. In order to carry out infrastructure projects, finances are required. Economies grapple to finance projects. The same is evident for investments in the infrastructure of the manufacturing sector.


Saving and investing are two related strategies to enable financial security. However, the question remains, are savings and investments a key determinant of growth?


 In 1939, economist Roy Harrod, best known for writing “The Life of John Maynard Keynes” was researching economic growth and business cycles. Similarly, American economist Evsey Domar in 1946 published findings on the economic growth rate in terms of savings and capital-output ratio. This led to the Endogenous model “Harrod-Domar model” which is the synthesis of the two consecutive studies.


Harrod and Domar worked separately to develop their highly similar models of economic growth and business cycles. The two economists expanded the short-run Keynesian framework to analyse the growth process in the economies. The investment in physical capital according to these economists has a dual role.


The dual role of investment here means that investment spending generates income on one hand, and also increases the productive capacity of the economy on the other hand. An increase in income as a result of increasing investments is called the demand side effect, whilst the increase in the productive capacity of the economy due to investment is called the supply side effect.


Equilibrium growth

 Both economists were interested in finding an equilibrium growth path that would guarantee greater employment in some sense. Although the two models of Harrod and Domar are similar in many respects, they have some crucial differences as well.


This model was first given by Harrod in 1939. His first concern was to find out if there exists an equilibrium growth rate of output, which, if the economy grows, it will continue to grow at the same rate moving over time. His second concern was to investigate whether such an equilibrium growth path is stable, in the sense that, if ever the economy grew at some different rate then would it automatically move towards an equilibrium growth rate in due time.


 The theory of course came with several assumptions. These include; both savings and investment are net, that is, over and above the depreciation. The economy saves a constant proportion of its income, which implies that the marginal propensity to save is equal to the average propensity to save.


 Income is determined by investment through the multiplier process. If plans of investment are realised the firms do not change the rate of desired investment, whereas if plans are under-realised that is, the actual investment is less than the planned investment, or over-realised, that is actual investment is more than planned, then firms increase or decrease, respectively, the rate of desired investment.


The economy is assumed to begin with full employment of capital. There are no lags between demand and supply. Especially between investment and the creation of productive capacity. Aggregate output in the economy can be written as a function of aggregate physical capital and aggregate labour, measured in suitable units respectively.


It is further assumed that there are constant returns to scale in the aggregate production function, which means that if both the factors are changed by some equal proportion, then output also changes by the same proportion. The relative prices of capital and labour are assumed to remain constant as the economy grows. This assumption has a very crucial implication for the Harrod model.


A constant relative factor price implies a constant capital-labour ratio. These assumptions give a glimpse into the complexities of economies and determining the multiple effects of a set of actions. Domar identifies a link between demand and supply of investment. Both sets of findings complemented each other.


 Harrod wanted to find the rate of growth of investment or output which would sustain itself over time. In order to find out, Harrod does the marriage of multiplier and accelerator effect theories. The accelerator theory of investment tells us that the net investment planned or desired in any period in an economy is a fixed multiple of the expected change in output during that period.


Planned investment

To keep the ratio fixed, planned investment and output must grow at the same rate if the economy has to always remain in short-run equilibrium at all points in time while growing.


The accelerator theory of investment finds its principles coming from the works of economists Thomas Nixon Carver, Albert Aftalion, John Maurice Clark among others. Roy Harrod studied these and stated that the accelerator lay at the heart of the Keynesian business cycle theory.


 As per the accelerator theory of investment, investment acts in response to changing demand conditions. If demand increases, firms are faced with two choices, these are to raise prices in the hope of shaking off that excess demand or to meet the demand by raising supply.


In certain situations, it is witnessed that the former option is exercised. However, in a more Keynesian vision of the world, quantity variations take preference. In order to meet greater production firms would ideally increase the output capacity by investing in plants and equipment.    BY DAILY NATION   

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